1. The Income-tax Appellate Tribunal, Patna Bench, has stated a case under section 66(1) of the Income-tax Act, 1922 (hereinafter referred to as the Act), and referred to this court for giving its opinion on the following question of law:

“Whether, on the facts and circumstances of the case, the Tribunal was correct in applying the provision of section 10(4A) of the Income-tax Act to the case of the assessee and in disallowing Rs. 11,436 out of the remuneration paid to the managing director and deputy managing director in accordance with the provisions of the articles of association of the company?”

2. The facts stated in the statement of the case are these: The assessee is a private limited company, carrying on the business of mica mining. For the assessment year 1959-60, the assessee claimed a deduction of Rs. 66,106, being the remuneration paid to the managing director, Shree A.K Samonta, and the deputy managing director, Shree B. Samonta. The said amount of remuneration was paid to the two directors in accordance with article 42 of the articles of association of the company, which authorised payment of thirty per cent, of the net profits before depreciation. The managing director and the deputy managing director each received a sum of Rs. 33,053, being fifteen per cent, of the net profits of the company, before making any allowance for depreciation. Originally, under article 42 of the articles of association of the company, the entire thirty per cent, of the annual net profits of the company was to be paid by way of remuneration to the managing director only, with a minimum guarantee of Rs. 5,000. By a special resolution of the board of directors, passed on the 29th December, 1950, a deputy managing director was also appointed in accordance with article 40 of the articles of association and the remuneration of thirty per cent, was split up in equal proportion to be paid to the two directors. From the assessment year 1951-52 up to the assessment year 1959-60, the assessee had paid remuneration to the aforesaid two directors calculated at thirty per cent, of the net profits (of course, without taking into consideration the depreciation). The claim for deduction of the remuneration so paid was accepted and allowed by the income-tax authorities up to the assessment year 1956-57, but, on and from the assessment year 1957-58 they considered the amount of remuneration paid to the managing director and the deputy managing director on the basis of the percentage of profits as excessive and unreasonable having regard to the legitimate needs of the company and the benefit derived by or accruing to it therefrom. The amounts, of course, were varied by the Appellate Assistant Commissioner and also by the Tribunal in respect of the years 1957-58 and 1958-59. In respect of the former year, the Tribunal allowed the claim almost in full. In respect of the assessment year 1958-59, as against the claim of Rs. 74,190, the Tribunal allowed the sum of Rs. 48,000 only under section 10(4A) of the Act. In respect of the assessment year 1959-60, with which we are concerned in this case, as against the claim of Rs. 66,106, the Income-tax Officer allowed a sum of Rs. 54,670 on the average of the remuneration paid to the two directors during the last preceding three years, that is to say, he disallowed a sum of Rs. 11,436, under section 10(4A) of the Act. The disallowance was maintained by the Appellate Assistant Commissioner and the Tribunal in appeals filed by the assessee. In respect of the year 1958-59, a reference had been called for and made under section 66(2) of the Act in Miscellaneous Judicial Case No. 1005 of 1961. That case has recently been decided on the 13th October, 1965, by a Bench of this court, consisting of R.K Choudhary and A.B.N Sinha JJ. Having considered the facts and the amounts allowed and disallowed in respect of the assessment year 1958-59, their Lordships came to the conclusion that the power under section 10(4A) of the Act must be exercised with reference to the legitimate needs of the company and the benefit derived by or accrued to the company from the remuneration so paid or claimed, and it was not so exercised in relation to the facts of the year 1958-59. In this view of the matter, although their Lordships refused to answer the first part of the question, as to whether the Appellate Tribunal was legally correct in applying the provisions of section 10(4A) of the Act on the ground that the question had not been raised before the Tribunal, they answered the second part of the question, as framed, in favour of the assessee, that is to say, the answer given by the Bench in that case was that the Appellate Tribunal was not legally justified in disallowing a portion of the remuneration paid to the two directors in accordance with the provisions of the articles of association of the company. But the said answer was given with reference to the particular facts of the case of that year as, in the final portion of the order, it was also observed:

“It will, however, be open to the department to re-examine, if they so choose, the question of reasonableness, excessiveness or otherwise of the allowance claimed by the assessee under the head ‘remuneration paid to directors’ for the assessment year 1958-59 in the light of the observations made above and come to its own conclusions in regard to that matter.”

3. We are, therefore, of the opinion that the earlier case was decided by this Bench with reference to the facts of that case and on the principle of law decided with reference to the provisions of the statute contained in section 10(4A) of the Act. The income-tax authorities were given the liberty to go into the question of the allowance claimed on behalf of the assessee-company on account of the remuneration paid to the two directors over again and come to their own conclusions in the matter.

4. Coming to the facts of the instant case, we find that the disallowance has been maintained by the Tribunal on a consideration of the grounds given by the Income-tax Officer in his assessment order. That order states that the average of the three years 1956-57, 1957-58 and 1958-59 has been taken and that has been taken on the basis of the figures which had been claimed by the assessee-company under the head of remuneration paid to the directors and not on the basis of the assessed figures. In our opinion that is a valid ground for the Income-tax Officer to take. Moreover, a reference has been made to the reasons given in the assessment order relating to the assessment year 1957-58 for disallowing a portion of the remuneration paid to the two directors. Although a copy of that order had been produced before the other Bench at the time of the hearing of the reference case in relation to the year 1958-59, it was not produced before us and we had not the advantage of perusing for ourselves the grounds mentioned therein, but we get those grounds from the statement of the case stated by the assessee-company in its application under section 66(1) of the Act filed before the Tribunal. In paragraph 4 of the statement, the amounts of remuneration paid during each assessment year have been noted and in respect of the three years, the average of which has been taken by the Income-tax Officer, the amounts mentioned in this paragraph are exactly the same as mentioned in the assessment order. In paragraph 6 it has been said that in regard to the assessment years 1957-58 and 1958-59 the Income-tax Officer objected to its allowance in full on the following grounds:

“(a) The qualifications of the directors, meriting them for such an inordinate high remuneration, are not known.

(b) The allowances made for the previous assessment years in respect of the remuneration paid are not binding on the department.

(c) The remuneration payable to the directors should have been restricted to 5% of the net profits for one director and 10% of the net profits for all the directors in accordance with section 309 of the Indian Companies Act, 1956, although that provision did not apply to private limited companies.”

5. The Income-tax Officer, therefore, inferred that the said directors being in virtual control of the company, their remuneration had been fixed to their best advantage and without regard to the legitimate needs of the company.”

6. Apart from the other grounds mentioned by the Income-tax Officer, we would pointedly refer to ground No. (c). It is no doubt true that section 309 of the Indian Companies Act, 1956, applies to the case of a public limited company and not to a private limited company, but some guidance can legitimately be had from the provision of the proviso to sub-section (3) of section 309 of the Indian Companies Act, 1956. In principle, therefore, if the income-tax authorities think that payment of remuneration to the directors of the private limited company on the ratio of thirty per cent, of the net profits, when the company is making more profits is excessive and unreasonable, regard being had to the legitimate business needs of the company and the benefit derived by or accruing to it from the services rendered by the directors, it cannot be said that the exercise of the discretion given to the Income-tax Officer, under section 10(4A) of the Act, has been arbitrary or capricious. It is a matter of common knowledge and experience that the extra profits earned by a company in a particular year cannot necessarily be correlated to the services rendered by its director or directors. Various other factors contribute or may contribute to the earning of extra profits in a particular year or years. And, in that event, it will be a legitimate exercise of the discretion by an Income-tax Officer, if he says that the amount of remuneration paid to the director or the directors is excessive or unreasonable within the meaning of sub-section (4A) of section 10 of the Act. In the case in hand, the disallowance of the sum of Rs. 11,436 out of the claim of Rs. 66,106 by the Income-tax Officer, the Appellate Assistant Commissioner or the Appellate Tribunal cannot be said to be arbitrary, capricious or based upon no grounds or whimsical grounds. In that view of the matter, we would hold that if the provision of section 10(4A) applies, then a portion of the allowance claimed on behalf of the assessee-company cannot be said to have been unjustifiably or illegally disallowed by the authorities.

7. In this case, the question as to whether the provisions of section 10(4A) would apply or not has got to be answered, as it was specifically raised before the Tribunal and it was submitted on behalf of the assessee that the provisions could not apply and for two reasons:

(i) That sub-clause (a) of sub-section (4A) of section 10 of the Act in terms speaks about “allowance” and does not cover the remuneration paid to a director or directors.

(ii) That neither of the two directors in this case has a substantial interest in the company within the meaning of sub-clause (iii) of clause (6C) of section 2 of the Act.

8. The argument was rejected by the Tribunal, and, in our opinion, rightly. Section 10(4A) of the Act provides:

“10. (4A) Nothing in sub-section (2) shall, in the computation of the profits and gains of a company, be deemed to authorise the making of—

(a) any allowance in respect of any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or a person who has a substantial interest in the company within the meaning of sub-clause (iii) of clause (6C) of section 2, or

(b) any allowance in respect of any assets of the company used by any person referred to in clause (a) either wholly or partly for his own purposes or benefit,

‘if in the opinion of the Income-tax Officer any such allowance is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom.”

9. It would be noticed that the word “allowance” mentioned either in sub-clause (a) or (b) has got reference to the word “allowance” mentioned in sub-section (2) of section 10; which says, “such profits or gains shall be computed after making the following allowance, namely……………”, and, then, it is provided in sub-section (4A) that, in the computation of the profits and gains of the company, the allowance in respect of any remuneration paid to a director or a person who has a substantial interest, in the company is not to be allowed in full under certain conditions. It is manifest, therefore, that the remuneration paid to a director and claimed by way of allowance by the company in the computation of its profits and gains can be sliced by the Income-tax Officer on the grounds mentioned in sub-section (4A) of section 10 of the Act.

10. Sub-clause (iii) of sub-section (6C) of section 2 of the Act states:

“‘income’ includes………….

(iii) the value of any benefit or perquisite, whether convertible into money or not, obtained from a company either by a director or by any other person who has a substantial interest in the company (that is to say, who is concerned in the management of the business of the company, being the beneficial owner of shares, not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits, carrying not less than twenty per cent, of the voting power), and any sum paid by any such company in respect of any obligation which but for such payment would have been payable by the director or other person aforesaid…”

11. The Tribunal has rightly pointed out that the phrase, “has a substantial interest in the company”, as provided for in the said sub-clause governs the word “person” and not the word “director” otherwise the latter word would be superfluous, as the former would include the latter also. Moreover, as a matter of construction, it is obvious that if the benefit is obtained from a company either by a director or by any other person possessing the substantial interest, as mentioned in the said sub-clause, it has to be included in his income. In the result, therefore, we hold that, on the facts and in the circumstances of this case, the Tribunal was correct in applying the provisions of section 10(4A) of the Act to the case of the assessee-company. Both parts of the question referred to this court are answered in favour of the department and against the assessee.

12. We shall make no order as to costs in this case.