# C.l.T., PUNJAB. HARYANA, J & K, H.P. & UNION TERRITOR\ OF CHANDIGARH v. PANIPAT WOOLLEN & GENERAL MILLS. CO. LTD. CHANDIGARH January 21, l 976

- **Citation:** [1976] 3 S.C.R. 186
- **Court:** Supreme Court of India
- **Decided:** 1976
- **Case number:** Civil Appeals Nos. 622 & 623 of 1971
- **Bench:** R. S. Sarkar!A, S. Murtaza Fazal Ali
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/c-l-t-punjab-haryana-j-k-h-p-union-territor-of-chandigarh-v-panipat-woollen-6750
- **Pages:** 16

## Headnote

Income Tox Act (II of 1922), s. 10(2) (xv)-Scope of-Payment under
agreen1e11t between assessee and selling agent to the /Wter-Whether pernzissible
deduction~ or a1no1111t to divi.Yion of profits between the two.
Practice-Power of High Court to go outside staten1e11t df case subn1itted'
by Tribunal.
In 1952, the asscssee·company installed a new plant by raising a loan from
the Industrial Finance Corporation, and appointed a sole selling agent of
its.
product. Jn 1953, the assessee changed the selling agent, and entered into an
agreement with another selling agent.
Under the agreement, the agent was to
make advances and finance the assessee.
Under cl. 7(1) of the agreement, the
agent \Vas to get a commission at the rate of 1!% orr the net proceeds of the
sales of ail its goods; and 50% commission on the net profits of the ne\v plant
(the net profits being ascertained after deducting all the manufacturing costs,
interest, insurance, etc.). The selling agent advanced 2 sums of money in the
assessment years 1956·57 and 1957·58 r~spcctively, ancl received, during those
2 years, two sums as their 50% commission on the net profits of the new plant.
The assessee claimed, in its returns for those 2 years, that the amounts paid
as commission to the selling agent were expenses incurred' to earn profit and
could. therefore, be deducted under s. 10(2)(xv) lncome Tax Act, 1922~ but
the Jncome Tax Officer disallowed the claim.
On appeal, the Appellate Assistant Commissioner held in favour of the assessee, but the Tribunal, on further
appeal, held that the agreement between the assessee and the selling agent
amounted to a ioint venture for the distribution of profits between the two, after
the profits were ascertained, and upheld the contention of the Revenue that
the two sums were not legal deductions withins. l0'(2}(xv).
On reference, the
High Court held in favour of the assessee.
Allowing the appeal to this Court,
F
HELD: (l)(a) In order to fall withins. 10'(2)(xv) the deduction claimec!
G
H
must an1ount to an expenditure lNhich was 1aid out or expended wholly and exclusively for the1 purpose of the business, profession or vocation; and' this dependS".
upon the facts of each case; and
[191 G-H]
(b) In ·order to determine the reasonableness of the expenditure, the test of
cornn1ercial expediency would have to be adjudged from the point of vie\v of
the businessm:ln :1nd not of the Income Tax Department. [191-H-192A]
(2) Jt is we11-sett1ed that the Court, in order to construe_ an_ agreement has.
to look to the substance or the essence of it rather than to its form.
A party
cannot escape the consequences of law merely by d'escribihg an agreernent in a
particular form. though, in essence and substnnce. it may be a different tran·
saction.
r194 G~Hl
(a) Clause 3 of the agreement requires not onry consultation by the assessee
with the selling agent, but also the consent, for- the programme of manufacture
of the product. that is. if the agent withholds its consent. it could veto the programmi of mai1ufacture.
Such a Iimit~ti'on praced· on the power of the assesseeis not in consonance with a pure and simple contract of agency.
[192 F-G}
(b) Under cl. 6(1) the selling agent would have to make a full and complete
investment for the working of the new plant to ttie fiJllCst possible capacity
' •
C.I.T. v. PANIPAT WOOLLEN MILLS
187
including wa,ges, power, stores, repairs etc.
This is more in consonance \Vith
A .
.a partnership than an agency.
[193 C-DJ
(c) Clause 6(ii) provides that the plant should be
~ommencement and the termination of the agreement.
the role of a simple selling agent.
[193 D-E]
overhauled before the
This is also beyond
(cl) Sub-clauses (viii) and (ix) of cl. 6 show that any damage to the goods
in transit would have to be debited to the account of the new plant and that such
accounts would have to be maintained separately. The object of these subB
.clauses is that the selling agent should be in a position to ascertain the net profit

## Text

_Characters 0–39,622 of 51,033. This is a partial read: ask again with offset=39622 for what follows._

186
A
C.l.T., PUNJAB. HARYANA, J & K, H.P. & UNION TERRITOR\
OF CHANDIGARH
B
c
D
E
v.
PANIPAT WOOLLEN & GENERAL MILLS. CO. LTD.
CHANDIGARH
January 21, l 976
[R. S. SARKAR!A AND S. MURTAZA FAZAL ALI, JJ.)
Income Tox Act (II of 1922), s. 10(2) (xv)-Scope of-Payment under
agreen1e11t between assessee and selling agent to the /Wter-Whether pernzissible
deduction~ or a1no1111t to divi.Yion of profits between the two.
Practice-Power of High Court to go outside staten1e11t df case subn1itted'
by Tribunal.
In 1952, the asscssee·company installed a new plant by raising a loan from
the Industrial Finance Corporation, and appointed a sole selling agent of
its.
product. Jn 1953, the assessee changed the selling agent, and entered into an
agreement with another selling agent.
Under the agreement, the agent was to
make advances and finance the assessee.
Under cl. 7(1) of the agreement, the
agent \Vas to get a commission at the rate of 1!% orr the net proceeds of the
sales of ail its goods; and 50% commission on the net profits of the ne\v plant
(the net profits being ascertained after deducting all the manufacturing costs,
interest, insurance, etc.). The selling agent advanced 2 sums of money in the
assessment years 1956·57 and 1957·58 r~spcctively, ancl received, during those
2 years, two sums as their 50% commission on the net profits of the new plant.
The assessee claimed, in its returns for those 2 years, that the amounts paid
as commission to the selling agent were expenses incurred' to earn profit and
could. therefore, be deducted under s. 10(2)(xv) lncome Tax Act, 1922~ but
the Jncome Tax Officer disallowed the claim.
On appeal, the Appellate Assistant Commissioner held in favour of the assessee, but the Tribunal, on further
appeal, held that the agreement between the assessee and the selling agent
amounted to a ioint venture for the distribution of profits between the two, after
the profits were ascertained, and upheld the contention of the Revenue that
the two sums were not legal deductions withins. l0'(2}(xv).
On reference, the
High Court held in favour of the assessee.
Allowing the appeal to this Court,
F
HELD: (l)(a) In order to fall withins. 10'(2)(xv) the deduction claimec!
G
H
must an1ount to an expenditure lNhich was 1aid out or expended wholly and exclusively for the1 purpose of the business, profession or vocation; and' this dependS".
upon the facts of each case; and
[191 G-H]
(b) In ·order to determine the reasonableness of the expenditure, the test of
cornn1ercial expediency would have to be adjudged from the point of vie\v of
the businessm:ln :1nd not of the Income Tax Department. [191-H-192A]
(2) Jt is we11-sett1ed that the Court, in order to construe_ an_ agreement has.
to look to the substance or the essence of it rather than to its form.
A party
cannot escape the consequences of law merely by d'escribihg an agreernent in a
particular form. though, in essence and substnnce. it may be a different tran·
saction.
r194 G~Hl
(a) Clause 3 of the agreement requires not onry consultation by the assessee
with the selling agent, but also the consent, for- the programme of manufacture
of the product. that is. if the agent withholds its consent. it could veto the programmi of mai1ufacture.
Such a Iimit~ti'on praced· on the power of the assesseeis not in consonance with a pure and simple contract of agency.
[192 F-G}
(b) Under cl. 6(1) the selling agent would have to make a full and complete
investment for the working of the new plant to ttie fiJllCst possible capacity
' •
C.I.T. v. PANIPAT WOOLLEN MILLS
187
including wa,ges, power, stores, repairs etc.
This is more in consonance \Vith
A .
.a partnership than an agency.
[193 C-DJ
(c) Clause 6(ii) provides that the plant should be
~ommencement and the termination of the agreement.
the role of a simple selling agent.
[193 D-E]
overhauled before the
This is also beyond
(cl) Sub-clauses (viii) and (ix) of cl. 6 show that any damage to the goods
in transit would have to be debited to the account of the new plant and that such
accounts would have to be maintained separately. The object of these subB
.clauses is that the selling agent should be in a position to ascertain the net profits
and control the working of the ne\v plant.
fl93El
(e) An analysis of the terms of cl. 7(i) shows that the selling agent \"'as able
to secure most liberal and profitable· terms.
While it is difficult to lay do\vn
any rule of universal application as to \Vhat percentage of profit would be con-
.sistent with the payment in lieu of services, the conduct of the selling agent, in
the present case, in sharing half of the net profits is not consistent with payments
made to <igents for services rendered. Taking the totality of the provisions of
C
the agreement, the. percentage of profits and the manner in which it is to be determined is n1ore consistent with the position cf the selling agent as a partner than
as an agent.
f194 A-Cl
(f) In cl. 7 there is also provision for the· selling agent sharing the loss incurred by the assessee, by deducting 50% o.f the !oss from its remuneration. and
for a lumμ sum deduction of Rs. 50,000 /- towards depreciation etc., for determining the net profit or loss position. Clause 7(iv) provides for a separate
-commission account to be m'aintained by the selling agent and for payment of
D
commission every 6 months. Having regard to the terms and conditions of the
agreement, the view taken by the Tribunal that the tWo sums were not legally
deductible under s. 10(2) (xv) was correct. By contributing to the investments.
by controlling the manufacturing programme, by sharing to the extent of 5() per
cent in the net profits ascertained in the manner stipulated in the agreen1ent,
and above all, by agreeing to share 50 per cent of the losses which are to be
deducted from the commission of the agent, the selling agent has actually contributed to a joint venture and became completely equated with the assessee, and,
E
therefore, the agreement between the two is really a sort of a partnership and
has been given the cloak and colour of an agency to conceal the real intent and
purpose of the commercial venture; and it must be construed as an agreement
for division of profits in specified proportions. [194 C-D, F; 195 E-G: 201 E-Fl
British Sugar Manufacturers Ltd. v. Harris (Inspector of Taxes), 7 I.T.R.
101, applied.
(3) The decision in Dltaram1'iI's case (43 J.T.R. 7)
is
distinguishable.
(195 G-H]
F
(a) In that case it was not agreed between the assessee and the trust. which
-a.greed to advance a loan to him, that the profits would be. ascertained after deducting the net expenses as in the agreement in the present case.
[196 B-C]
(b) While the contract was to be carried on in accordance with the policy
"Settled between the assessee and the trust, in that case, it did not give any veto
power to the trust to torpedo the contract.
In the present case, the agreement
gave to the selling agents controlling power at every stage in the programme of
G
manufacture and even at the stage of the sale of the products, by requiring the
consent of the selling agent.
fl96 C-DJ
( c) Not only was there no provision in Dliaran1vir's case under which the
trust was to share the loss, but there was an express provision to the contrary.
Therefore, the payment of interest at the rate of 6 per cent on the loan advanced
1o the assessee by the trust and a percentage in the profits, in that case, is quite
consistent with a remuneration in lieu of services lent and would amount to an
expenditure incurred by the assessee, wholly and exclusively for the purpose
H
of the business which was conducted by the assessee.
[196 D-EJ
( 4) In the present case, it is difficult to hold that commercial expediency dictated the assessee to allow itself to be completely overshadowed by its selling
.A
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188
SUPREME COURT REPORTS
[197613. s.c.R ..
agent. so as to pay them not only for the services rendered but allow them to
share profits, control the manufacture of goods and to share the losses. The
test of commercial expediency cannot be r¢.uced to the shape of a ritualistic
formula.
The test merely means that the Court will place itself in the position
of a businessman and find ollt lY·hether the expenses incurred could be said to
have been laid out for the purpose of the business, or whether the transaction
was merely a subterfuge for the purpose of sharing or dividing the profits ascertained in a particular manner. In the ultimate analysis1 the matter \\'Ou!d depend
on the intention of the parties as spelt out from the terms for the agreement or
the surrounding circums~nces, the nature or character of the trade or venturep
the purpose for which the expenses are incurred and the object which is s;:ught
to be achieved for incurring those expenses. lf the expenses incurred amount
to a profit of an enduring nature, they niay be treated as
capital expenditure;
v;he~as, if the expenses merely serve to promote or increase the commercial
activity, they. may amount- to an expenditu_re which is incurred for the purpose
of the business.
[1961;I-197D]
I. K. Woollen Manufacturers v. Commissioner Of lnco1ne TaxJ U.P. [1969]1
.s.C.R. 525, distinguished.
Com1nissioner of Income Tax, Kera/a v. Travancore Sugar and Che1nical:1
-Ltd., 88 I.T.R. 1, 10; Commissioner of Income Tax, Bombay v. Poona Electric
Supply Co. Ltd., 49 I.T.R. 913, 924 and lamshedpur Motor Accessories Stores
v. Commissioner of Income Tax, Bihar & Orissa. 95 I.T.R. 6_64, 672 referred to.
(5) The High Court is not -entitled to go behind the Statement of the case
submitted by the Tribunal.
But, in the present case. in interpreting the agree-·
ment, the High Court relied upan what it called surrounding
circumstances,
namely. that the assessee was a losing concern from its inception, that it was in
such a bad shape that it had to get rid of its fust selling agent_
because,
it
caused considerable embarrassment to the assessee while the second selling: agent
\Vas prepared to give the assessee advantageous terms; that the selling ag~nt had
no other connection than a business connection with the assessee; and that because of the death of one of the promoters of the assessee, who commanded
credit in the money market, the assessee was not able to raise money from the
banks. But, these facts were not found by the Tribunal nor was there any
\\'arrant for any of the assumptions. [198G-199C]
·
Co1nmissioner of Incomf!'-Tax, Poona ·v. Manna 'Ran1ji and Company, 86
I.T.R. 29, 37, followed.
(6) The facts found by the Tribunal and those mentioned in its Staterue_nt
of the case to the High Court, lead to the inescapable conclusion that the agreement is nothing but a joint venture to divide the profits after they are ascertained~ and hence, the payments to the se1Iing agent cannot, in any sense, he
,deemed to be expenses incurred by the as5esse-e for the purpose of its business
or for earning profits.
Pondicherry Railway -Co.~ Ltd. v. Commissioner of /11con1e Tax,
Madras.
AI.R. 193LP.Ci 165, 170, referred to.
·
CIVIL APPELLATE JURISDICTION : Civil Appeals Nos. 622 & 623
of 1971.
Appeals by special leave from -the judgment and order dated the
20-1-1970 of the Punjab and Haryana High Court at Chandigarh in
I.T. Reference No. 2 of 1965.
B. B. Ahuja and S. P. Nayar, for the appellants.
A, N. Goyal, for the respondent
The Judgment of the Court was delivered by
FAZAL Au, J.-These are appeals by the Revenue by special leave
against the order of the High Court of Punjab & Haryana
dated
•
~ ,
/'
•
' •
C.I.T. v. PANIPAT WOOLLEN MILLS (Fazal Ali,!.)
189
January 20, 1970 answering the questions referred to the High Court
A
by the Tribunal in favour of the assesseeslrespondents and against the
Revenue.
The appeal arises. in the following circumstances.
M/s. Panipat Woollen & General Mills Co. Ltd.-hereafter referred to as 'the assessee Company' had two Departments-( 1) for
spinning of yarn from raw and waste wool and (2) for spinning of
B
yarn from imported wool tops. The second Department which carried
on the operations of spinning of yarn from imported wool tops was
started some time in the year 1952. Weaving operations were, however, carried on in both these Departments. One of the Departments
was known as M/s. Panipat Woollen Mills, Kharar while the other
one was known as Mis. Navin Woollen Mills.
It is said that the
assessec Company was running at a constant loss as a result of which
c
in 1952 the assessee Company decided to instal a plant for manufacture of worsted yarn from imported wool tops by raising a loan of
Rs. 7 lakhs from the Industrial Finance Corporation. The plant went
into production in September 1952. The assessee Company appointed
M/s. Murlidhar Chiranjilal as the sole selling agents for the worsted
yarn on payment of 2 % commission. Subsequently on December 15,
1953 the assessec Company entered into an agreement with Mis.
,D
Saligram Premnath under which the latter were appointed as the sole.
selling agents on certain specified conditions, the important of which
being that the agents were to finance the assessee Company to the
extent of Rs. 2,50,000/- and the assessee Company agreed to pay 6%
interest on the advances to be made by the agents and further agreed
to pay 2 % commission on the net proceeds of sales of goods in India.
Before expiry of this agreement, another agreement was entered into
E
by the assessce Company with the agents on October 20, 1955 under
which the agents were to get 6% interest on all the advances made
by them, l:i-% commission on net sales and 50% commission on net
sales of the worsted plant.
What is more was that the agents agreed
to a deduction of 50% of the loss incurred by the assessee Company
from their remuneration.
There were a number of other conditions
with which we shall deal later.
The selling agents M/s. Saligram
F
Premnath advanced a sum of Rs. 6,26,8471- and Rs. 8,71,8731- and
received Rs. 37,157/- and Rs. 73,7871- as 50% commission on the
net profits of the worsted plant in the course of two years, namely,
assessment years 1956-57 ending on March 31, 1956 and 1957-58
ending on March, 31, 1957.
The assessee Company accordingly in
its return for the year 1956-57 claimed the amount of Rs. 37,157/-
and Rs. 73,7871- for the assessment year 1957-58 as a deduction
c;;
under the provisions of s. 10(2) (xv) of the Income-tax Act, 1922.
'·
The case of the assessee was that the two amounts mentioned above
being in the nature of commission paid to the selling agents would be
deemed expenses incurred by the Company in order to earn profits
and would, therefore, fall within the ambit of s. 10(2) (xv) of the
Income-tax Act, 1922-hereafter referred to as 'the Act'.
The Income-tax Officer, however, disallowed the deduction and held that the
, ~
deduction claimed was actually a division of profits after the profits
Jiad come into existence and had been ascertained, and therefore could
not be claimed as a valid deduction under the provisions of the Act.
/
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B
c
190
SuPREME COURT REPORTS
[1976) 3 S.C.R.
The assessee Company went up in appeal to the Appellate Assistant
Commissioner who accepted the plea of the assessee Company and
held that the payment was a permissible deduction as it was incurred
for the purpose of the assessee's trade in order to facilitate the business
of the assessec.
The Revenue then went up in appeal before the
Tribunal which after considering the facts and the law on the subject
upheld the contention of the Revenue and held that the sums in question were not legal deductions as contemplated under s. 10(2)(xv)
of the Act but amounted to application of profits after they were earned.
The Tribunal further held that the agreement dated October 20, 1955
amounted to a joint venture for the distribution of profits between the
assessee Company and the selling agents after the profits were ascertained.
The assessee Company then approached the Tribunal for
making a reference to the High Court and the Tribunal accordingly
referred the !oilowing two questions to the High Court for its opinion :
"l. Whether on the facts and in the circumstances of the
case, the Tribunal rightly held that the sums of Rs. 37,157/-
\
and Rs. 73,787 /- were chargeable to tax in the hands of the
A
assessce Company in the assessment
years 1956-57 and
1957-58 respectively?
D
2. Whether on the facts and in the
circumstances
of
the case, the Tribunal rightly disallowed the assessee Company's claim for deduction of the payment of Rs. 37,157 /-
and Rs. 73,787/-, under sec. 10(1) and Sec. 10(2)(xv)
of the Income-tax Act, 1922, in the assessment years 195657 and 1957-58 respectively?"
E
The High Court by its i.udgment dated January 20, 1970, answered
both the questions in favour of the assessee Company and held that
the payments in question amounted to a legitimate deduction under
s. 10(2)(xv) of the Act, and the Tribunal was wrong in disallowing
the same.
Thereafter the appellant moved the High Court for grant
o( leave to appeal to the Supreme Court which having been rejected
the appellant filed a petition for special leave.
The special leave
F
having been granted, the appeal is now before us.
G
H
The High Court in reversing the order of the Tribunal mainly
relied on what it described as the surrounding circumstances under
which the alleged payments were made to the selling agents by the
assessee Company as spelt out from the agreement entered into by the
assessee Company with the selling agents. The main point which was
argued before the Tribunal as also before the High Court was that the
cumulative effect of the interpretation of the various clauses of the
agreement dated October 20, 1955 unmistakably revealed that in the
garb of an agency the parties entered into a joint venture for distributing the net profits, after being ascertained ,between themselves and that
is why there was an express provision in the agreement by which the
agents agreed to share the losses to the extent of 50% which were to
be deducted from the remuneration payable to the agents.
The Tribunal held that the agreement amounted to a joint venture resulting
in division of net profits and therefore the amount paid to the agents
could not be claimed by the assessee Company as a deduction under
•
C.l.T. v. PANIPAT WOOLLEN MILLS (Fazal Ali, J.)
191
s. 10(2)(xv) of the Act, as it was not incurred for the purpose of
the business or for earning profits.
The High Court held that the
mere fact that the agents agreed to share the profits and the losses
would not take the case of the assessee beyond the ambit of s.
10(2)(xv) of the Act in order to show that the payments made to
the agents were not expenses incurre.d for the purpose of the business.
The High Court laid special emphasis on the fact that the Revenue
could not examine the question of the commercial expediency of the
businessman to incur expenses or earn profits in a particular manner.
The High Court accordingly found that the agreement per se was a
contract of agency and not a joint venture and accordingly the High
Court accepted the plea of the assessee Company.
In support of the appeal Mr. Ahuja, the learned standing counsel
for the Revenue submitted the following two points before us :
(1) In the first place it was submitted that there being
an express provision in the agreement dated October 20,
1955 by which the agents agreed to share losses which was
a provision peculiar to the present transaction and was not
at all covered by any authority cited before the Tribunal
or the High Court, that itself was proof positive of the fact
that the transaction amounted to a joint venture with a view
to division of profits; and
(2) It was argued that the High Court had exceeded
its jurisdiction in travelling beyond the agreed statement of
the case framed by the Tribunal and had relied on certain
A
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materials which were not at all found by the Tribunal in its
E
order nor were those materials mentioned in the statement
of the case.
Mr. A. N. Goyal counsel for the assessee Company has, however.
submitted that the view taken by the High Court is absolutely correct
and t.he facts of the present case are clearly covered by the decision
of this Court in Dharamvir Dlu'r v. Commissioner of Income-tax,
Bihar & Orissa( 1 ). A number of other cases have also been cited at
the Bar and we shall refer to the same after marshalling the facts
found in the present case.
Before comin~ to the. facts it may be necessary to mention that
there can be no dispute with respect to the two important propositions;
(I) that in order to fall within s. 1 O (2) (xv) of the
Ac~ the dedu.ct10n claimed must amount to an expenditure
which was laid out or expended wholly and exclusively for
t~e purpose of the business, profession or vocation. ·This
will naturally depend upon the facts of each case.
F
G
(2) that in order to determine the question of reasona?lene.ss of the expenditure,. the test of commercial expedienc) wo1;'1d have to be adjudged from the point of view
H
of the busmessman and not of
the
Income-tax Depart-
(!) 42 l.T.R. 7.
192
SUPREME COURT REPORTS
[I 976] 3 S.C.R.
A
ment.
With this preface we now proceed to deal with the
facts of the present case on the basis of which the questions
of law referred to the High Court and answered in favour of
the assessee Company arise.
ll
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To begin with, it is conceded by the learned standing counsel for
the Revenue that the asscssee Company was running at a loss as a
result of which it had to raise a loan of several lakhs of rupees franc
the Industrial Finance Corporation. It was perhaps for this reason
that the assessec Company entered into an agreement with the new
selling agents M/s Saligram Premnath who were prepared to give to
the assessee Company better and more profitable terms.
The main
question to be determined is as to whether or not the agreement dated
October 20, 1955 read as a whole amonnts to a joint venture for the .
purpose of division of profits.
In order to decide this question it
may be necessary to refer to some important portions of the second
agreement which alone is relevant for the purpose of deciding this
point. We might mention, however, that so far as the first agreement
is concerned the terms thereof do not make out a case of joint venture
but appear to be iu cousonance with the agreement being one of an
agency simpliciter.
It is the second agreement that in our opinion
appears to change the eutire complexion of the case.
This agreement
is set out at p. 17 of the Paper Book and consists of ten main clauses.
The agreement was to enurc for a period of two years to commence
from January I, 1956 or the date on which manufacturing actually
starts under the agreement whichever is later.
This is provided in
clause 2 of the agreement. It was further provided that the period
of the agency could be extended further by mutual consent. Clause
3 (ii) runs thus :
"Programme for the manufacture of goods will be made
from time to time by the Company in consultation and with
the consent of the Agents."
F
It may be noticed that this clause requires not only consultation with
the agents for the progn1111n1c of 1nanufacture of goods but a tacit
consent of the agents.
Tn other words, if the agents withheld their
consent, they could veto the programme of manufacture.
Such a
limitation placed on the power of the assessee Company does not
appear to us to be in consonance with a pure and simple contract of
G
agency.
Clause 6 which deals with financial arrangements may be
extracted thus :
H
"(i) The Agents shall invest full amount for the working of the Worsted Plant to the full possible capacity beginning from the purchase of tops to the completion of the
yarn sales including wages, power, stores, and repairs and
mamtenance etc.
Such mvestments and expenses incurred
on tops, manufacturing, bank charges, transport, insurance
and octroi will be debited to the account of the Company.
C.I.T. V. PANIPAT WOOLLEN MILLS (Fazal Ali, !.)
193
· (ii) Before the beginning of the arrangements under this
A
Agreement, the Machinery of the Worsted Plant will be overhauled
and similarly before
this arrangement
ends the
Machinery will be overhauled.
x
x
x
x
x
(viii) In case of any loss or damage to the toi:s or goods
in· transit or in godowns, the same will be debited to the
account of the Worsted Plant.
(ix) The accounts of lhe Worsted Plant will be maintained separately in an office situated near the Worsted
Plant and the Agents will have free access to the account
books.
x
x
x
x
Sub-clause (i) clearly contemplates lhat the agents would have to
make lull and complete investment for the working of the worsted
plant to the fullest possible capacity including wages, power, stores,
repairs and maintenance etc.
This provision appears to be more
in consonance with the terms of a person who is a partner in a venture rather than one who is a mere agent. Further more, sub-clause
(ii) provides that before the agreement starts the machinery of the
worsted plant would be overhauled and would be again overhauled
before the agreement ends.
This provision also has its own importance and appears to be beyond the role of the selling agents
simpliciter.
Sub-clauses (viii) and (ix) extracted above clearly show that
the damage to the tops or goods in transit would have to be debited
to the account of the worsted plant and such accounts would have
to be maintained separately.
The obvious object is that the agents
should be in a position to ascertain the net profits and control the
working of the worsted plant. Clause 7 is the most important clause
of this agreement, which, in our opinion, clearly shows that the agreement in essence and in purport is a sort of a partnership or a joint
venture rather than a contract of agency. Sub-clause (i) of clause 7
runs thus :
"7. Conunission
(i) The Agents shall be allowed a commission at !}%
(one and a quarter per cent) on the net proceeds of sales
of all goods.
Such commission shall be chargeable upon
money actually credited to the Company, and not on outstanding debts, if any. Besides, Agents will get 50% (fifty
per cent) commission on the net profits of the Worsted
Plant.
The net profits will be ascertained after deducting
all the manufacturing expenses, interest, insurance, depreciation and selling commission etc.
For ailowina annual depreciation in the value of the machinery and buildings and
mterest on the value of machinery, bdldings and commencmg from the date on which manufacturing actually starts
under this Agreement, a lump sum of Rs. 50,000/- has been
agreed to be deducted for determining the net profits or loss
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position. In case of net Joss, if any, there will be a deduction of 50% (fifty per cent) of such loss from the Agent's
Account."
Analysing the terms of this sub-clause it would appear that
the agents have been able to secure most liberal and profitable
terms.
To begin with they were to get a commission at the rate of
one and a quarter per cent on the net proceeds of sales of all goods.
There can be no objection to this.
Secondly, the agents will get
50% commission on the net profits of the worsted plant.
The net
profits would have to be ascertained after deducing all the manufacturing costs, interest, insurance etc.
The conduct of the agen.ts in
sharing half of the net profits does not appear to us to be consistent
with the payments made to the agents for services rendered.
It is
difficult to Jay down any rule of universal application as to what percentage of profit would be consistent with the payment in lieu of services but taking the totality of the provisions of the agreement it seems
to us that the percentage of profits and the manner in which it is to be
-determined is more consistent with the position of a partner than that
of an Agent.
Finally the provision for sharing the loss incurred by
the Company and for a lump sum deduction of Rs. 50,000/- is totally
inconsistent with a contract of agency. Further more, sub-clause (iv)
of clause 7 provides as under :
"(iv) The commission account will be maintained separately by the Agents and the commission will be payable
to the Agents by the Company every six months.
In the
same way, the amount of Rs. 25,000/- for six months as
provided in sub-clause (i) above, will be paid to the Company every half-year within ten days.
The profit and loss
account of the Worsted Plant will be made every six months
within ten days and the adjustments will be made accordingly by actual payments, as the case may be, within ten
days."
The above sub-clause clearly provides for a separate commission account to be maintained by the agents and the commission to be paid
every six months.
Consequently the agents agreed to pay a sum of
Rs. 25,000/- for six months every half year within ten days.
We
might further mention here that the provision in the agreement regarding sharing of the loss is absolutely peculiar to this particular
agreement and there is not a single authority, which has, in spite of
such a provision, held that the transaction does not amount to a
joint venture or a division of profits.
The provision regarding the
consent of the agents to the sales and the programme of manufacture
is also pertinent in order to determine whether the transaction amounted to a joint venture in the garb of a contract of agency. It is well
settled that the Court in order to construe an agreement has to look
to the substance or the essence of it rather than to its form. A party
cannot escape the consequences
of law merely by describing an
agreement in a particular form though in essence and in substance it
may be a different transaction.
In .these circumstances, therefore, if
we construe the agreement as a sort of a joint venture or a transaction like a partnership which has been given the form and appearance
d a contract of agency, the law must have its course.
•
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C.l.T. 1'. PANIPAT WOOLLEN MILLS (Fazal Ali, !.)
I 95
Our attention has been drawn by the learned counsel for the Revenue to a decision in British Sugar Manufacturers Ltd. v. Harris
(Inspector of Taxes )( 1), where Greene, M. R. clearly observed that
where a person contributes to some sort of joint adventure which
ultimately results in division of profits, it could not be construed as
a remuneration for services.
In this connection, Greene, M. R. observed as follows :
'·rt is not cash that passes in exchange for these profits,
it is services; and the badge of such a contract is remuneration for services, and therefore the first thing that this remuneration would certainly not be is a share of profits purchased
by
the
employee.
x
x
x
I can conceive of a case where a person contributes to some
sort of joint adventure services, while others contribute perhaps capital,
land, plant, and goods, arranging
between
themselves (it may be something short of a partnership)
that nobody shall get anything until the pool of profits is
ascertained, and then they shall divide it up between them in
specified proportions. That, it seems to me would be a real
agreement for division of profits, because there would be
one profit fund only. There would not be two 'profit' funds
to be ascertained for different purposes."
These observations seem to us to cover the facts of the instant case:
Having regard to the terms and conditions of the agreement detailed
and analysed above, there can be no doubt that the agents by contribnting to the investments and by sharing the profits as also the
losses have actually contributed to a joint venture and ultimate division of the profits with the principals and the agreement must be
construed as an agreement for division of the profits in specified proportions as mentioned therein.
Tt is true that in the aforesaid case
on the facts found the Court held that the transaction did not amount
to a joint venture but it was clearly pointed out in the judgment
that there is a very thin line of distinction between a contract for payment of a share of profits simpliciter and a payment of remuneration
which is deductible in truth from the profits divisible. We, therefore,
find ourselves in complete agreement with the observations made by
Greene, M. R., which aptly apply to the facts of the present case on
the basis of the various clauses of the agreement dated October 20,
1955.
The High Court, however. appears to have relied upon the decision in Dharamvir Dhir's case (supra). The facts. of that
case
appear to be clearly distinguishable from those of the present case.
What had happened in Dharamvir Dhir's case
was
that the
assessee was an employee of the firm earning a particular salary. The.
employee entered into a coal raising contract with a coal company
and ·as he did not have the necessary funds he persuaded a oublic
charitable trust to advance to him sums upto 1 ! lakhs on payment of
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interest at 6 per cent. and share ll/16ths of the profits of the ,businc'5.
The assessee agreed that the coal raising contract would be
carried on in accordance with the policy settled between him and. the
trust and the trust could withdraw its money at any time. It is, therefore, clear that in the first place the agenl, namely, the trust, agreed
to finance the assessee by giving him a lorn of Rs. l t lakhs at 6 per
cent interest.
This was undoubtedly permissible.
The trust was. also
to get ll/16th of the profits of the business. It was, however, not
agreed between the parties that the profits would be ascertained after
deducting the net expenses as mentioned in the agreement before us.
It is true that the contract was to be carried on in accordance with
the policy settled between the assessee and the trust but that did not
give any veto power to the trust to tarpedo the contract. In the instant
case the agreement clearly provided !or the consent of the agents not
only at the beginning of the manufacture of the yarn by the plant to
he installed by the assessee Company but at every stage in the programme of manufacture. Even at the stage of the sale of the products
the consent of the agents was necessary.
In other words, the· agents
were given a complete controlling power so far as the manufacture
and sale of the products of the assessee Company were concerned.
No such stipulation is to be found in Dharamvir Dhir' s case (supra).
Finally, not only there was no provision in Dharamvir Dhir's case
under which the trust was to share the losses but there was an express provision to the contrary, namely, that the trust was not liable
for any loss. Thus the mere payment of interest at the rate of 6 per
cent. on the Joan advanced to the asscssec and a percentage in the
profits of the business would be quite consistent with a remuneration
in lieu of services lent and would certainly amount to an expenditure
incurred by the assessee wholly and exclusively for the purpose of the
business which was conducted by the assessee.
The same, however,
cannot be said of the present case. It was on the peculiar facts of
the Dharamvir Dhir's case that this Court observed as follows:
"On the facts proved in the present case the trust agreed
to finance the business of the appellant on the terms set out
in the agreement and there is nothing to show that he could
have m.ade any better arrangements or wonld not have lost
the contract if he had failed to enter into the agreement,
i.e. the agreement to pay the amounts in dispute.
Therefore, in a commercial sense, the payments were an expenditure wholly and exclusively laid ou_l for the purpose of the
business."
G
It may be mentioned that this Court had considered the decisio;,. in
the British Sugar Manufacturers Ltd.'s case (supra) and had approved
of the same.
Great stress was laid by counsel for the assessee Company on the
fact that this Court could not go behind the commercial expediency
which had to be determined from the point of view of a businessman.
H
Even so whatever be the commercial considerations, it is djfficult to
hold that the commercial expediency dictated the assessee Company
to allow itself to he completely overshadowed by its selling agents so
as to pay them not only for the services rendered but also allow them
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C.I.T. v. PANIPAT WOOLLEN MILLS (Fazal Ali,!.)
197
to share profits control the manufacture of the goods and the proA
gramme thereof and also to share the losses. The test of commercial
expediency cannot be reduced in the shape of a ritualistic formula,
nor can it be put in a water-tight compartment so as to be contined
in a strait jacket.
The test merely means that the Court will place
itself in the position of a businessman and find out whether the expenses incurred could be said to have been laid out for the purpose
of the business or the transaction was merely a subterfuge for
the
B
purpose of sharing or dividing the profits ascertained in a particular
manner.
It seems to us that in ultimate analysis the matter would
depend on the intention of the parties as spelt out from the terms of
the agreement or the surrounding circumstances, the nature or character of the trade or venture, the purpose for which the expenses are
incurred and the object which is sought to be achieved for incurring
those expenses.
If the expenses incurred amount to a profit of art
C
enduring nature they may be treated as capital expenditure, where~s if
the expenses merely serve to promote or increase the commercial
activity they may amount to an expenditure which is incurred for
the purpose of the business.
Reliance was also placed by counsel for the assessee Companv
on the decision in J. K. Woollen Manufacturers v. Commissioner of
D
Income Tax, U.P.(' ), where this Court observed as follows:
"The question as to whether an amount claimed as expenditure was laid out or expended wholly or exclusively
for the purpose of business, profession or vocation as required und,.r Section 10(2) (xv) of the Income Tax Act
has to be decided on the facts and in the light of the circumstances of each particular case.
x
x
x
x
In our opinion, neither the High Court nor the Appellate
Tribunal has applied the proper legal test in this case. As
pointed out by this Court in C.l.T. Bombay v. Walchand
and Co. Private Ltd., 1967-65 ITR 381= (AIR 1967 SC
1435) in applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of the business, reasonableness
of the expenditure has to be adjudged from the point of
view of the businessman and not of the Income Tax Department. It is, of course, open to the Appellate Tribunal to
come to a conclusion either that the alleged payment is not
real or that it is not incurred by the assessee in the character of trader or it is not laid out wholly and exclusively for
the purpose of the business of the assessee and to disallow
it. But it is not the function of the Tribunal to determine
the remuneration which in their view should be paid to an
employee of the assessee."
Tt w?uld appear that in the aforesaid case the only question was regardmg the qu.antum of remuneration to be given to the General
Manager and this Court observed that the businessman must be given
complete freedom t°, fix the terms of his employees after taking an
(I) [1969] I. S. C.R. 525.
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overall view of the situation.
This was not at all a case where an
agreement like the present one was entered into between the assessee
Company and its agents.
On the other hand in Commissioner of
Income-tax, Kera/a v.