Saraswati Industrial Syndicate Ltd. v. Commissioner Of Income-Tax.

Jai Singh Sekhon, J.:— This judgment will dispose of Income-tax References Nos. 23 to 27 of 1984, as these involve the same factual and legal controversy and arise out of the same order of the Income-tax Appellate Tribunal.

2. The factual matrix of the case contained in the statement of facts is that the assessee-company is running a sugar mill.

3. It follows the accounting year ending on 31st August. The assessee-company paid to the Yamuna Syndicate Ltd. sole selling agency commission of Rs. 16,97,870 in the assessment year 1975–76 and Rs. 20,30,659 in the assessment year 1976–77. The Income-tax Officer, vide para 1 of the assessment order for 1975–76 after detailed discussion in para 15 of the assessment order for the assessment year 1976–77, noted that Yamuna Syndicate Ltd. was appointed by the assessee-company as its sole selling agent up to July, 1975, and thereafter was only a selling agent for sale of sugar. The Income-tax Officer noted that the said Yamuna Syndicate Ltd. held more than 20% of the equity shares of the assessee-company and, therefore, the said selling agent was a person who had substantial interest in the assessee-company within the meaning of section 2(32) of the Income-tax Act and thus the expenditure in excess of Rs. 72,000 by the assessee-company on payment to the said selling agent was disallowable under section 40(c) of the Income-tax Act. The Income-tax Officer was of the view that “person”] in section 2(31) included a company and selling agent being a company was covered by section 40(c) and that both sections 40(c) and 40A(2) applied to the present case, but, because of legislative injunction embodied in the proviso to section 40A(2)(a), only section 40(c) was applicable according to the Income-tax Officer. The Income-tax Officer, accordingly, gave notices to the assessee on this point for both the years and the assessee filed replies dated November 19, 1976, and. July 27, 1978, for the assessment years 1975–76 and 1976–77 claiming applicability of section 4C A(2) and not section 40(c). The Income-tax Officer, however, rejected the assessee's contentions and added back the commission of Rs. 16,97,870 in the assessment year 1975–76 and Rs. 20,30,639 in the assessment year 1976–77. The Commissioner of Income-tax (Appeals) deleted the addition by relying upon the decision of the Income-tax Appellate Tribunal, Chandigarh Bench, in order dated April 3, 1975, in I.T.A No. 73 in Avon Cycles (P) Ltd., as. well as of the Karnataka High Court in T.T Pvt. Ltd. v. ITO, [1980] 121 ITR 551. The Revenue being aggrieved against the order of the Commissioner went in appeals. Both these appeals were; dismissed by the Appellate Tribunal in view of the ratio of the decision of this High Court in CIT v. Avon Cycles (P) Ltd., [1980] 126 ITR 448 and, of the Karnataka High Court in TT. Pvt. Ltd.'s case, [1980] 121 ITR 551. The Revenue then filed an application before the Tribunal for making a reference to the High Court, mainly on the ground that in Avon Cycles' case, [1980] 126 ITR 448 (P & H), the selling agent was a partnership firm and it was held that the payment by the manufacturing company to the sole selling agency partnership did not amount to direct or indirect remuneration or benefit to directors and relatives of directors as there was no nexus between the ser vices rendered by the partners of the firm and payment of commission by the company to the firm, whereas, in the case in hand, the payment was made by the manufacturing company to the selling agency company which had a substantial interest in the manufacturing company and, therefore, remuneration or benefit or amenity accrued to a person who had a sub stantial interest in the manufacturing company and thus the case in hand was distinguishable from Avon Cycles' case, [1980] 126 ITR 448 (P & H). The appellate authority then referred the following question for the opinion of this court:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that selling agency commission of Rs. 16,97,870 and Rs. 20,30,639 paid by the assessee to Yamuna Syndicate Ltd. was an allowable expenditure for the assessment years 1975–76 and 1976–77?”

4. The assessee-company also moved reference applications before the appellate authority for these very assessment years, contending that the Income-tax Officer had allowed 10% depreciation on plant and machinery as the chemicals were mixed with sugarcane juice to filter and purify the juice, although the assessee had claimed 15% depreciation on account of the corrosive effect of these chemicals. On appeal by the assessee, the Commissioner of Income-tax (Appeals) allowed 15% depreciation on this account, but the Appellate Tribunal on appeal by the Revenue, restored the order of the Income-tax Officer allowing 10% depreciation only. The Income-tax Officer also disallowed Rs. 44,251 out of the staff welfare expenditure on account of refreshments in office work by treating the same as entertainment expenditure. The Commissioner of Income-tax disallowed Rs. 39,751 out of the same but upheld the disallowance of Rs. 4,500 in the absence of details. Both the Revenue and the assessee came up in appeals before the Appellate Tribunal. The Appellate Tribunal allowed Rs. 7,119 as expenditure spent on providing refreshments in the meetings of the company's board of directors and general body meetings. On both these counts, the following two questions were referred at the instance of the assessee for the opinion of this court:

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that sugar mill machinery was entitled to 10% depreciation and not 15% depreciation in the assessment years 1975–76 and 1976–77?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the expenditure of Rs. 7,119 for supplying refreshments, etc., in the meetings of the company's board of directors and general body meeting was in the nature of entertainment expenditure for the assessment year 1976–77?

5. We have heard learned counsel for the parties, besides perusing the order of the Appellate Tribunal as well as the statement of facts.

6. The controversy whether the selling agency commission of Rs. 16,97,870 and Rs. 20,30,659 paid by the assessee to Yamuna Syndicate Ltd. was allowable expenditure for the assessment years 1975–76 and 1976–77 is fully settled by the decision of the Division Bench of this court in Avon Cycles' case, [1980] 126 ITR 448 (P & H). Simply because in Avon Cycles' case, the sole selling agency is a partnership concern while, in the present case, the sole selling agency being a company it cannot be said that the ratio of the above referred Division Bench judgment is not attracted to the facts of the case in hand, because, in legal terminology, a company stands on a better footing and is in itself a corpus juris, whereas a firm does not enjoy that legal status. Under these circumstances, even if the sole selling agency company had substantial interest in the assessee-company, it cannot be said that the benefit which they got from the assessee-company would fall under section 40(c)(i) of the Act, because such commission paid to the selling agency company by the assessee-company is in lieu of the services rendered by the former in the business activities after incurring some expense and would not amount to payment of remuneration. Under these circumstances, it will make no difference whether the sole selling agency is a firm or a company. Thus, the present case is fully covered by the decision of a Division Bench judgment of this court in Avon. Cycles' case, [1980] 126 ITR 448 (P & H). In that case, the controversy regarding the application of section 40(c) of the Income-tax Act, 1961 (hereinafter referred to as “the Act”), was dealt with as under, as is apparent from the headnote:

“section 40(c) will apply only if the expenditure by a company results directly or indirectly in the provision of remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or such other person, as the case may be. Where a company pays commission to a firm as its sole selling agent and the partners of the firm are directors of the company and their relatives there is no nexus between the services rendered by the partners of the firm and the payment of commission by the company to the firm. The firm which takes the responsibility for sale of the products of the company enters into a business activity. The selling agency firm has to incur expenditure on many items for performing the duties entrusted to it under the agreement between the company and the firm. The activity of the firm is in the nature of business. The directors of the company or their relatives who are partners of the firm if they get shares from the profits of the firm get the same as partners of the firm and this money cannot be said to be remuneration paid by the company to the directors or their relatives directly or indirectly. The word ‘remuneration’, in its ordinary meaning, connotes ‘reward, recompense, pay, wages or salary for services rendered’. The commission paid to the firm in lieu of services rendered by the firm in its business activity cannot be said to be payment of reward, recompense, pay, wages or salary for the services rendered by a director or a relative of his. The payment of commission cannot also fall within the ambit of the word ‘benefit’ used in section 40(c). The speech of the Finance Minister and the note to section 40(c) on its amendment in 1972 show that the provision was amended to discourage the payment of high salaries and remuneration to the persons mentioned in the section. There is no indication that the payment of commission made to a firm by a company in discharge of the contractual obligations for the services rendered by the firm in its business activity is to be covered under section 40(c). The provisions of section 40(c), as amended in 1972, do not cover payments of commission by a company to a sole selling agency firm, the partners of which are directors of the company or relatives of the directors and the payments cannot be disallowed under section 40(c).”

7. Thus, the question at the instance of the Revenue is answered in the affirmative, i.e, in favour of the assessee.

8. The controversy whether the assessee's sugar mill company is entitled to 10% depreciation on machinery and not 15% depreciation on account of the corrosive effect of the chemicals on the metal machinery also stands fully settled by the decision of a Division Bench of this court in CIT v. Saraswati Industrial Syndicate Ltd., [1982] 136 ITR 758. In that case also, the assessee-sugar mill was claiming depreciation at the rate of 15% under section 32(1)(ii) of the Act, in respect of the written down value of certain machinery on the ground that during its use the machinery came into contact with corrosive chemicals as contemplated by item (7), clause B, entry (ii) of Para III of Pt. 1 of App. I to the Income-tax Rules, 1962. In that case, the Income-tax Officer as well as the Appellate Assistant Commissioner had allowed depreciation at the normal rate of 10%, but on appeal the Tribunal allowed depreciation at the rate of 15% on the ground that the expression “corrosive chemicals” covered not only free chemicals but also non-free chemicals mixed in the cane juice as they had a corrosive effect on metals. On a reference made to the High Court “Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the words “corrosive chemicals” employed in entry (ii)B(7) of Para. III of Part I of Appendix I to the Income-tax Rules, 1962, contemplate not only free chemicals but also non-free chemicals of corrosive effect?”, the Division Bench held as under (at p. 760):

“As noticed above, the Tribunal allowed depreciation at the rate of 15 per cent, because it was of the view that the term ‘corrosive chemicals’ would cover not only free chemicals but also non-free chemicals. To elucidate this view, learned counsel for the assessee argued that sugarcane juice, which comes into contact with the machinery, contains lime and sulphuric acid, which are corrosive chemicals and the fact that they were mixed with sugarcane juice would be of no consequence. We are unable to subscribe to this view. Lime and sulphuric acid are mixed with the sugarcane juice to filter and purify the juice but by their-mixture, the juice itself is not converted into a chemical.

According to Webster's Dictionary, the word ‘chemical’, when used as noun, means a substance, as an acid, alkali, salt, synthetic, organic compound, obtained by a chemical process prepared for use in a chemical manufacture or used for producing a chemical effect. It is obvious from the dictionary meaning of the word ‘chemical’ that sugarcane juice cannot be covered by this term simply because some acid has been mixed with it for its filtration. Moreover, the acid and the lime is mixed in the sugarcane juice for the purpose of its filtration and once the chemical reaction has been caused, most of its effect would be lost and whatever remains, settles down along with the sediment at the bottom. Thereafter, the filtered sugarcane juice which comes into contact with the machines before it is converted into crystallised sugar cannot be said to be a corrosive chemical by any stretch of reasoning.”

9. Thus, this question is answered in the affirmative, i.e, in favour of the Revenue.

10. The controversy whether the Tribunal had rightly allowed an expenditure of Rs. 7,119 for supply of refreshments, etc., in the meetings of the company's board of directors and general body meetings, also stands settled by the decision of this court in CIT v. Haryana Financial Corporation Ltd., [1989] 180 ITR 18 (P & H). In that case, it was held that the expenditure incurred by the assessee on refreshments to the customers or its directors, even during the course of business, would be covered as expenditure under section 37(2A) of the Act and would be allowable only to the extent permissible by that provision. Thus, this question is also answered in the affirmative, i.e, in favour of the Revenue.