# BRITISH INDIA CORPORATION v. COMMISSIONER OF INCOME-TAX, U.P LUCKNOW

- **Citation:** [1973] 2 S.C.R. 524
- **Court:** Supreme Court of India
- **Decided:** 1972-10-03
- **Bench:** K. S. Hegde, P. Jaganmohan Reddy, I. D. Dua
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/british-india-corporation-v-commissioner-of-income-tax-u-p-lucknow-5871
- **Pages:** 9

## Headnote

Excess Profits Tax Ac: .. 1940, Schedule I, r.12
(!)-Determination
by office,. H'llether expenditure is ireasonab/e and 11ec£•ssary-Tests for.
Rule 12 ( 1) of Schedule I to the Excess Profits Tax Act. D40. is
designed to prevent the dissipation of excess pofits by intlating °'penditure
which bas_ no relation to the requirements of the business. The test is
whether the expenditure is unreasonable and unnecessary haring regard
to the requirements of the business, and, in the case of directors' fees or
other payments for services, to the actual services rendered. A!l ::-elevant
facts, especiaUy commercial expediency or commercial practice, must be
taken into consideration b)· the ExCess Profits Tax Officer in con3idering
whether the expenditure is reasonable and necessary; that is, he c"1lld not
ap.PlY the nile to increases that can be justified on ordinary commercial
principles, because, an increase iit profits n1ay in certain cases b~ Clue to
increase in the activity of the management or increase in the estab!ishmcnt
justifying a corresponding increase in the expenditure.
But when huge
profits are earned,. not due to any activity of managers but due to national
emergencies such as war situati<>.n•, the govem,ment is entitled to a certain
share of the excess profits computed under the Act. Any commission paid
on the excess profits for which the manage!\' pr employees made no sort
of contribution would ex facie be unreasonable and unnecessary and the
Excess Profits Tax Officer would be justified in disallowing the proportion,
which, according to him, was unreasonable and unnecessary having regard
to the requirements of the business. [530A-D; 53 !G-H; 532A]
In the present case, the assessee is a public limited com.Panv having
several branches and subsidiary compaimes. It hds a Board of Directors
which looks after its business. The managers who look after the branche'
of the c'ompany are also members of the Board. The assossee was rem·
underating its directors 'by way of commission based on a certain fixed
percentage of its net audited profits.
The phrase 'net audited profits'
was clarified to mean the amount after depreciation ha.d been allowed
for, but prior to any allocation or appropriation
of profits
including
provision· for taxation.
The Excess Profits Tax Act came into force on
April 5, 1940, and on 27th Inly. 1940, the phrase 'including provision
for tax' in the clarification, was further clarified that it was intended to
cover all forms of taxation including excess profits tax and other like
impositions.
Therefore, no deduction of ex_t;ess
profits tax was to be
mad~ prior to the calculation of managerial commissions. For the char·
gea.ble accounting years 1945 and 1946 the Excess Profits Tax Officer
found that the assessee had made large profits and held that if the commis~ion was to be paid on the \net audited profits the whole exce3S p"e>lits
would be taken into account for the payment of commission; that a portion of the commission attributable to extess profits, in the peculiar circumstances of war conditio:ris. was _not reasonable an'1 necessaJ1Y wjthin·
the meaning of r. 12 (I), and that any pdyment, in excess of the agreed
proportion of the net profits after deduction of excess profits tax, was nM
justified. He. therefore, dis>allowed a percentage of the said excess profits
·which would be payable to the State on actje>unt of exress proftts
ta.x
liability. [526A-H; 527A-C]
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llRfflSH INDIA CORP. V. C.I.T. (Jaganmohan Reddy, J.)
525
On the question \Vhcthcr the
disaJIOYia~ncc for each of the years was
rightly made, the Tribunal and the High Court held against the assessec.
Dismissing thL' <ippcal to this Court,
HELD : The Excess Profits Tax Officer and the Tribunal have given
valid reasons for not a\lov•ing the entire commision claimed on the basis
of the audited accounts without deducting the excess profits tax .. [5310]'•
A !1111edahad
Ma11ufact11ring &. Calico Printing Co.
v.
Commt'. oJ,
E.P.T.,

## Text

524
BRITISH INDIA CORPORATION
v.
COMMISSIONER OF INCOME-TAX, U.P .. LUCKNOW
October 3, 1972
[K. S. HEGDE, P. JAGANMOHAN REDDY AND I. D. DUA, JJ.J
Excess Profits Tax Ac: .. 1940, Schedule I, r.12
(!)-Determination
by office,. H'llether expenditure is ireasonab/e and 11ec£•ssary-Tests for.
Rule 12 ( 1) of Schedule I to the Excess Profits Tax Act. D40. is
designed to prevent the dissipation of excess pofits by intlating °'penditure
which bas_ no relation to the requirements of the business. The test is
whether the expenditure is unreasonable and unnecessary haring regard
to the requirements of the business, and, in the case of directors' fees or
other payments for services, to the actual services rendered. A!l ::-elevant
facts, especiaUy commercial expediency or commercial practice, must be
taken into consideration b)· the ExCess Profits Tax Officer in con3idering
whether the expenditure is reasonable and necessary; that is, he c"1lld not
ap.PlY the nile to increases that can be justified on ordinary commercial
principles, because, an increase iit profits n1ay in certain cases b~ Clue to
increase in the activity of the management or increase in the estab!ishmcnt
justifying a corresponding increase in the expenditure.
But when huge
profits are earned,. not due to any activity of managers but due to national
emergencies such as war situati<>.n•, the govem,ment is entitled to a certain
share of the excess profits computed under the Act. Any commission paid
on the excess profits for which the manage!\' pr employees made no sort
of contribution would ex facie be unreasonable and unnecessary and the
Excess Profits Tax Officer would be justified in disallowing the proportion,
which, according to him, was unreasonable and unnecessary having regard
to the requirements of the business. [530A-D; 53 !G-H; 532A]
In the present case, the assessee is a public limited com.Panv having
several branches and subsidiary compaimes. It hds a Board of Directors
which looks after its business. The managers who look after the branche'
of the c'ompany are also members of the Board. The assossee was rem·
underating its directors 'by way of commission based on a certain fixed
percentage of its net audited profits.
The phrase 'net audited profits'
was clarified to mean the amount after depreciation ha.d been allowed
for, but prior to any allocation or appropriation
of profits
including
provision· for taxation.
The Excess Profits Tax Act came into force on
April 5, 1940, and on 27th Inly. 1940, the phrase 'including provision
for tax' in the clarification, was further clarified that it was intended to
cover all forms of taxation including excess profits tax and other like
impositions.
Therefore, no deduction of ex_t;ess
profits tax was to be
mad~ prior to the calculation of managerial commissions. For the char·
gea.ble accounting years 1945 and 1946 the Excess Profits Tax Officer
found that the assessee had made large profits and held that if the commis~ion was to be paid on the \net audited profits the whole exce3S p"e>lits
would be taken into account for the payment of commission; that a portion of the commission attributable to extess profits, in the peculiar circumstances of war conditio:ris. was _not reasonable an'1 necessaJ1Y wjthin·
the meaning of r. 12 (I), and that any pdyment, in excess of the agreed
proportion of the net profits after deduction of excess profits tax, was nM
justified. He. therefore, dis>allowed a percentage of the said excess profits
·which would be payable to the State on actje>unt of exress proftts
ta.x
liability. [526A-H; 527A-C]
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llRfflSH INDIA CORP. V. C.I.T. (Jaganmohan Reddy, J.)
525
On the question \Vhcthcr the
disaJIOYia~ncc for each of the years was
rightly made, the Tribunal and the High Court held against the assessec.
Dismissing thL' <ippcal to this Court,
HELD : The Excess Profits Tax Officer and the Tribunal have given
valid reasons for not a\lov•ing the entire commision claimed on the basis
of the audited accounts without deducting the excess profits tax .. [5310]'•
A !1111edahad
Ma11ufact11ring &. Calico Printing Co.
v.
Commt'. oJ,
E.P.T., 38 l.T.R. 675 followed.
British India Corporalio11 Ltd. v. Commr. of E.P. T •• 33 l.T.R. 826
and Shya111/a/ Pra1111arain v, · C.l.T .. 27 l.T.R. 404 referred to
CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 1987 to
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1988 of )969.
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II
Appeals by certificate from the judgment an<l order dated
October 22, 1965 of the Allahabad High Court in Income-tax
Reference No. 154 of 1957.
S. T. Desai. Alok Kumar Verma and B. P. SinJ?h for the appellant.
B. Sen, J. Ramam1m/1y, B. D. Sharma artd R. N. Sachthey for
the respondent.
The Judgment of the Court was delivered by
JAGANMOHAN REDDY, J. These appeals-are by certificate against
the Judgment of the Allahabad High Court in a reference under
s. 21 of the Excess Profits Tax Act, 1940 (hereinafter called the
'Act') read with s. 66(2) Qf the Indian Income-tax Act, 1922.
The questions referred were in respect of the two chargeable
accounting periods being January l, 1945 to December 31, 1945
and January 1, 1946 to March 31, 1946 and are given below:- ·
I. Whether on the facts and circumstances of this
case the amount of Rs. 5,39,057 /- was rightly disallowed under rule 12 (1) of the Schedule to the Excess
Profits Tax Act ?
2. Whether on the facts and circumstances of this
case the amount of Rs. 1,28,743/- was rightly
disallowed under rule 12 (I) of Schedule I to the Excess
Profits Tax Act ?
Both these questions were answered in the affirmative.
The facts and circumstances of the case on which
these
answers were given are :-The assessee is a public limited company (herinafter called the 'Corporation') havi_ng several _branches
and subsidiary companic» It has a Board of Directors wluch looks
'after its husincS'. The branches of the Company are )naked after
hy managers who ar~ members of the Board of D1rcclnrs. It
526
SUPREME COURT REPORTS
[1973] 2 S.C.R.
appears that for a long time and even before the Act came into
force the corporation has been remunerating its directors includin~ ~e Managing Directo~ and branch managers by way of comIlllss1on based on a certam fixed percentage of its net audited
profits.
This commission was in addition to the directors''-fees
and/ or stipulated monthly salary. In the case of a branch manager the amount of commission to be paid was calculated on the
profits of the branch of which l)e was in charge. In the case of
others the profits made by the Corporation as a whole were taken
into consideration. The commissiun (o be ptid was either fixed
at the time of appointment or by resolution passed subsequently.
In so far as the two chargeable accounting periods are concerned,
thi;: position in regard to the payment of the commission has been
set out in the .statement of the case but this is not relevant for the
purpose of these appeals except to note, as we have earlier mentioned, that the commission was to be calculated with reference
to the net audited profits which phrase was Clarified by a resolution
of the Corporation dated February 24, 1940. That resolution is
as follows :--
"Commission.
In order to regularise previous Resolutions on the
subject of Managerial Commission, the Board· resolved
that commission oil profits would be payable to the
Managing Director and the Branch Managers entitled
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thereto, on net audited profits, only after depreciation
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had bee1.1 allowed for but prior to any allocation or
appropriation of such profits including provision for
taxation."
Though it is not mentioned in the statement of the case we can
take judicial notice of it that the Excess Profits Tax Bill was
introduced in the Central Legislative Assembly on January 27,
F
1940 and after it was passed, received the assent of the GovemorGeneral on April 5, 194\l. On July 27. 1940 the phrase 'including
provision for taxation' was further clarified by
the
following
resolution :-
"The Board, therefore, resolved that the words
'including provision for taxation' were intended to and
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did specifically cover all forms of taxation including the
Excess Profits Tax and other like impositions and,
therefore, no deduction of excess profits tax and other
like impositions from the audited profits should be made
prior to the calculation of Managerial commissions.
The Board also resolved that this ruling. which could
H
only be regarded as fair and reasonable should have
effect retrvsoectivelv to the commission paid in respect
of the year 1939." ·
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BRITISH INDIA CORP, v. C.I.T. (Jaganmohan Reddy, J.)
In respect of the chargeable accounting period ending December
31, 1945 the Excess :Profits Tax Officer had observed in his order
dated December 15, 1947 a~ follows :-
"For reasons stated m the order dated 30-3-1945
and Rule 12 Schedule I for the chargeable accounting
period Up to 31-12-1943, I hold that, having regard to
the requirements of the business and the actual services
rendered by the persons concerned, the
commission
allowed to the management and directors is both unreasonable and unnecessary.
Any payment in excess
of the agre~ proportion of the net profits after deduction of Excess Profits Tax is not justified."
The Excess Profits Tax Officer accordingly held that Rs. 11,47,143
for the first chargeable accounting period and Rs. 11,06,693 for
ihe second ~hargeable accounting period could not be allowed and
was further of the view that a portion of it was not reasonable and
necessary having regard to the requirements of the business and
the actual services rendered by the persons concerned.
It was
pointed out that the commission of the nature under consideration
was beir1g paid by the Corporation ~ven before the Act came into
force and that such commission was being allowed in its entirely
for purposes of computing profits under s: 10 of the Income-tax
Act, 1922 in the two corresponding assessments made under s. I 0
of the Income-tax Act. Though this was so under the Income-tax
Act the Excess Profits Tax Officer on the facts of the case and
having regard to rule 12 of the Schedule to the Act took the view
that since the commission in the respective chargeable accounting
periods were paid out of the profits which could not be retained
by the Corporation, a portion of the commission attributable to
the Excess Profits Tax Act earned in the peculiar circumstances
of a national calamity was not "reasonable and necessary" within
the meaning of the said rule. It was found that for the first chargeable accounting period the Excess profits payable were approximately Rs. 64,36,000/- but if the commission was to be paid
on the net audited profits of Rs. 1.37 crores, the whole excess
profits which could not be retained by the Corporation for its own
use would be taken into account for the payment of the commission as such be determined the portion to be disallowed was at
8.43 of the said excess profits which will be payable to the State
on account of the Exces Profits Tax liability. On this basis the
amount worked out was Rs. 5,39,057. Applying the same method
for the following. accounting chargeable period ended March 31,
1946 he determined the amount as Rs. 1,28,743/-. These two
amounts were disallowed in ihe assessments for the respective
chargeable accounting periods. In arriving at these amounts .. th~
Excess Profits Tax Officer ignored the terms of appointment and
the resolutions and drew support from the orders passed by the
528
SUPREME COURT REPORTS
(1973] 2 S.C.R.
A
Tribunal in respect of the two prior assessments for the accounting
·periods ended December 31, 1943 and December 31, 1946, against
which orders of the Tribunal a reference had earlier been made
to the Allahabad High Court. This reference wits then pending
before it when the subsequent assessments were being dealt with.
In the appeals against assessments made for the accounting periods
in the instant case, it was admitted on behalf of the Corporation
before the Tribunal that there was no new material other than
what was on record in the Excess Profits Tax assessment files and
the Tribunal files relating to the chargeable accounting periods for
the years 1943 and 1944. These files were produced before the
Tribunal in the appeals for the assessments in
question.
The
Tribunal however dismissed those appeals following its earlier decision relaiing to the chargeable accounting periods for 1943 and
J 944.
Against that order the High Court on a reference under
the Act considered a similar question, viz. whether the amounts
claimed by the Corporation in respect of each of the assessment
year was rightly disailowed under rule 12 ( 1 ) of the First Schedule
to the Act.
In the earlier reference for the assessment in respect of the
as.sessment years I 943 and 1944, a Bench of the Allahabad High
Court in British India Corporation Ltd. v. Commr. of E.P.T. (')
consisting .of Hhargava, J. (as he was) and Mehrotra, J. were
of the view that the findings of the Excess Profits Tax Officer that
the payments were both not necessary and not reasonable amounted
to:holding that'the previous practice and agreements gave no indi-
,'chtion that the commission had to be paid without deducting the
excess profits tax from the net profits and that the payments made
were beyond the terms of the agreement. According to that court
this was not the basis on which the question of reasonableness and
necessity of the payments had to be decided. But what the officer
and the Tribunal .ought to have decided is the question whether or
hot these payments were necessary and justified, having regard to
the ordinary commercial practice and co.11mercial expediency und
taking .into account the services rendered by the persons to whom
the _payments were made. Bhargava, J. who delivered the judgement of the Bench in arriving at the conclusion that the disallowance of the amounts was act justified followed a J'.ull Bench judgement of that Court in Shyamlal Pragnarain v. C.l.T.( 2). In that
Full Bench it was observed that what the Excess Profits Tax Officer
had to bear in mind is that the amount could be disallowed in
whole or in part if it was found that it was not reasonable and it
was not necessary having regard to the requirements of the business and the actual services rendered by
the
managers.
The
quesion as to the terms of the contract, it said "may have been a
(I) 33 T.T.R. 826.
(2) 27 J.T.R. 404.
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BR!TiSH !NOIA CORP. V. C.l.T. (Jaganmohan Red(iy, J.)
529
matter of importance as between the employer and the employee
but not ier the purposes of the determination of the question of
reasonableness or necessity either under the Income-tax Act or
the Excess Profits Tax Act" which had to be judged in the light
of the requirements of business and to the exigencies of the business keeping in view ordinary commercial practice and conunercial
expediency.
When the Tribunal decided the appeal which is the subject
matter <'f this reference, the decision of the High Court, as we
said earlier, had not been rendered and consequently it did not
have. the benefit of that decision the High Court in the judgment
under "ppeat however obser<-ed :-
"The Full Bench did not discuss whether for disallowing a deduction both unreasonableness and
want of
Decessity are required or either is enough and presumed
presumably from the fact that both reasonableness and
necessity are required for allowing it that
both
are
required.
As the question was not expressly raised before and decided by Bhargava and Mehrotra, JJ. in one
c~se and the Fulll Bench in the other case, the assumpti'.>n on which they proceeded would. not bind us."
In our view, these observations are not justified because in
both those cases the aspects referred to were certainly kept in view
in dete'.1llining the questions·before them. It appears that the
Revenue did not appeal against the decision of Bhargava
and
Mehro:ra. JJ. in the case above referred. The Excess Profits Ta~
Officer had made the assessments basing them on the reasons given
in the earlier orders relating to the chargeable accounting years
1943 and 1944 which were referred to in the statement of the
case.
We also find that the High Court in its earlier judgment
was neot justified in thinking that the Excess Profits Tax Officer had
not applied the requirements of rule 12 of the Schedule to the A.ct.
Rule 12(1) of Schedule I which is relevant is as follows:-
"(I) In c<;>mputing the _profits of any chargeable
accountmg penod no deduction shall be allowed in resG
pect of expenses in excess of the amount which the Excess
Profit< Tax Officer consid~rs reasonable and necessary
havmg regard to the reqmrements of the business and
i~ the case of directors' fees or other payments for ser'.
VIces, to the a,ctual services rendered by . the
person
concerned;
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Provided that no disallowance under this rule shall
be made by the Excess Profits Tax Officer unless he has
obtained the prior authority of the Commissioner of
Excess Profits Tax."
590
SUPREME COURT REPORTS
[1973] 2 s.c.R.
This rule is designed to prevent the dissipation of tne excess profits
by inflating expenditure which has no relation to the requirements
of the business. The test is, whether .the expenditure is unreasonable and unnecessary having regard to the requirements of the
business and in the case of directors' fees or other payments for
services to the actual services rendered. There is of course no
reference in this rule to commercial expediency or commercial
practice in considering whether an expenditure is unreasonable
and unnecessary paving regard to the requirements of the business.
But that is another way of saying that all releva11t factors niust be
taken into consideration by the Excess Profits Tax Officer in considering whether that expenditure is reasonable and necessary.
What it means is that the Excess Profits Tax Officer could not
apply the rule to increase that can be· justified on ordinary commercial principles because an increase. in profits may in certain
cases be due to increase in the activity of the management or increase .in the establishment justifying a corresponding increase in
the expenditure. The Full Bench decision in Shyamlal's case came
up consideration by this Court in Ajzmedabad Manufacturmg &
Calico Printing Co. v. Commr. of E.P.T.('). That was also a
case where the question was whether in determining the profits on
which the percentage had to be dete1mined for payment of bonus
to five of its employees and the contribution to be made to the
provident funds of 53 employees, deduction,of depreciation. incometax and super-tax in respect of first category and deduction of
income-tax or excess profits tax in respect of the second category
could. be made before arriving at the profits., The Excess :Orofits
Tax Officer came to the concfusion that the payments were unnecessarily lar~e and unreasonable having regard to the requirements of the business and without taking up each individual case
he held, applying rule 12 that it was not necessary for the assessee
company for the purpose of its business to calculate the bonus or
the contribution on that basis of net profits before the deduction
of excess profits tax. He accordingly disallowed the excess of the
payment calculated without deduction of. that tax. In upholding
the disallowance. this Court held that there was material on which
the Excess Profits Tax Officer could arrive at a finding and on
which the Tribunal could confirm that finding. In that case also
the Excess Profits Tax Officer, in the assessment order relating to
the chargeable accounting year ending December 31, 1943 gave
sufficient reasons for disailowing the an10unts which reasons were
inco~rated by reference in the assessment orders pertaining to
the d1sal!owance of the claim in the chargellble accounting years
in question.
In the earlier order the reasons given were as follows:-
"The rates of commission ·were fixed long prior. to
the commencement of the present war and no deduction
(1) 38 I.T.R. 675.
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BRITISH INDIA CORP, v. C.l.T. (Jagannwhan Reddy, J.)
531
was admitedly made for the Exce8s Profits Tax liability
in ccmputing the net profit of the corporation for the
purpOSe of calculating commission payable to directors
and management.
As a result of war conditions the
profits of the Corporation have gone .up tremendously
from about Rs. 10 lakhs in the pre-war period to about
Rs. 2 crores during the relevant chargeable accounting
period and the commission to managerrient on the basis
of net profhs has risen in the same proportion. Since the
Excess Profits Tax, which is intended to prevent the
owner of a business from making a large fortune out of
what is a national danger, is ItOt deducted out of net
profits in calculating commission, 'an employee stands
to benefit from the national emergency to a greater extent
than an employer'; (Wd{chand & Co. Ltd. v. The Hindustan Construction Co. Ltd.
( 12 I.T.R.
104 ). It
therefore, appears both unnecessary and unreasonable to
pay more than the agreed proportion of the profits after
deduction of Excess Profits Tax. In the circumstances,
I hold that the increased expenditure under commission
although of a nature which under the provisions of s. 10
of the Income-tax Act, is in itself an allowable deduction, is unreasonable and unnecessary having regard to
the requirements of the business and the actual services
rendered by the persons concerned."
After giving these reasons he went on to say :
"Having held that the aforesaid payments of commission are unjustifiable and exceptional the question
arises as to what the reasonable amount, having regard
to the requirements of the business and the actual services rendered by the persons should be. As mentioned
above, any payment in excess of the agreed proportion
of the net profits after deduction of Excess Profits Tax is
unreasonable and unnecessary."
The Excess Profits Tax Officer accordingly computed what was
the reasonable amount of commission which should be allowed.
We can find very little justification in the criticism that no reasons
have been given by the Excess Profits Tax OIEcer or the Tribunal
for not allowing the entire commission claimed on the basis of
the audited accounts without deducting the taxes paid including
the excess prqfits tax. It is obvious that when huge profits are
e:irne~ not due to any activity of the managers but due to war
s1tuat1on, the Government is entitled to a certain share of the
excess profits computed under the Act.
Any commission paid
on the excess profits for which the managers or employees made
no sort of contribution would ex facie be unreasonable and unnecessary and the Excess Profits Tax Officer was perfectly iustified
532
SCPREME COURT REPORTS
(1973) 2 S.C.R.
in disaliowing certain. proportion which according to him was
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unreasonable and unnecessary having regard to the requiremen(s
of the business. In this view, the answers rendered by Jhe High
Court cannot be disturbed and these appeals are accordingly dismissed with costs.
V.P.S.
Appeals dismissed.