# THE COMMISSIONER OF EXCESS PR:OFITS TAX, MADRAS v. N. M. RAYALOO IYER & SONS

- **Citation:** [1961] 3 S.C.R. 60
- **Court:** Supreme Court of India
- **Decided:** 1961
- **Bench:** J. L. Kapur, M. Hidayatullah, J.C. Shah
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/the-commissioner-of-excess-pr-ofits-tax-madras-v-n-m-rayaloo-iyer-sons-2056
- **Pages:** 18

## Headnote

Excess Profits Tax-Deductions-Remuneration of managing
agent-Percentage of net profits less outgoings-Excess Profits tax,
if included in outgoings-Construction of agreement-Commission
paid to branch managers-Deduction when reasonable and necessary-Indian Income-tax Act, I9Z2 (II of I92Z), ss. Io(z)(xv),
Ip(z)(x)-Excess Profits Tax Act, I940 (IS of I940), ss. 2(I6), I9,
ZI, Sch. I, cl. (IZ).
The respondents, a firm carrying on business in dyes and
chemicals under the name and style of Colours Trading Company, with their head office at Madurai and thirtee_n branch
offices in different towns, were the chief representatives in South
India of the products of the I. C. I., a manufacturing concern.
M was employed as the General Manager of the respondents and
by virtue of an agreement, he was to be paid remuneration at
the rate of Rs. 3,000 per annum and rzt% of the net profits of
the company calculated by deducting from the gross profits of
the business the salaries, wages and other outgoings. The
branch offices were managed by local managers and assistant
managers who were paid in addition to monthly, salary, annual
and special bonus and dearness allowance. The respondents
received from the I. C. I. commission at varying rates on the
different prodncts sold to them and with effect from April r,
1944, the LC.I. allowed a special emergency commission of 5%
recommending that r% out of the commission allowed may be
passed on by the respondents to their sub-distributors. The respondents claimed to have distributed to their employees commission pursuant to the recommendation of the LC.I. at rates varying between 2% and 7!% and in some cases at a rate as high as
rzo/o. Though under the service agreement, commission was
payable to the employees only if the turnover exceeded
Rs. r,00,000 net in any year, the respondents claimed to have
paid them commission at generous rates even when the turnover fell far short of that amount. In the year of account
ending April 12, 1945, there was a revision of the scales of salaries of the employees, as a result of which the employees received an amount equal to zi times the enhanced basic salary
and also commission sometimes exceeding rz times the basic
salary.
In computing the total income of the respondents for the
years 1943-44 and r944-45 for purposes of income-tax, the
Income-tax Officer disallowed the payment of rzi% of the net
' •
I
•
3 s.c.R. SUPREME COURT REPORTS
61
profits to M, and for the years 1945-49 he disallowed the comz96o
mission paid to the branch managers and other employees on
--. .
the ground that taking into account all the circumstances the The Commissiofter
remuneration paid to the employees was adequate and that any of Excess Profits.
additional commission paid was in excess of what was reasonTax, Madras
able or necessary. The Appellate Tribunal confirmed the order
v.
of the Income-tax Officer except in the case of M to whom payN. M. Rayaloo
ment of 5 % of the net profits without deduction of Excess
Iyer "" Sons
Profits Tax or Business Profits Tax, or rz% after deduction of
Excess Profits Tax or Business Profits Tax, whichever was
higher, was regarded as permissible deduction. The High Court,
on reference, took the view, inter alia, that in determining the
net profits under the agreement with M, the excess profits tax
could not be deducted, that in considering tbe question whether the bonus or commission paid to the employees in the present case might be permitted as a justifiable deduction, in the
light of s. ro(2)(x} of the Income-tax Act and r. 12 of Sch. 1
of the Excess Profits Tax Act, the test of reasonableness of
the expenditure was to be judged from the point of view of a
business man and not by the application of any subjective
standard of a taxing officer, and that on an analysis of the materials furnished, there was nothing per se unreasonable in the
amounts of commission actually paid by the respondents to the
branch managers and assistant managers.
Held: (1) that th

## Text

_Characters 0–39,890 of 40,755. This is a partial read: ask again with offset=39890 for what follows._

Dece.mbef' 8.
60
SUPREME COURT REPORTS
THE COMMISSIONER OF EXCESS
PR:OFITS TAX, MADRAS
v.
N. M. RAYALOO IYER & SONS.
[1961)
(J. L. KAPUR, M. HIDAYATULLAH and J.C. SHAH, JJ.)
Excess Profits Tax-Deductions-Remuneration of managing
agent-Percentage of net profits less outgoings-Excess Profits tax,
if included in outgoings-Construction of agreement-Commission
paid to branch managers-Deduction when reasonable and necessary-Indian Income-tax Act, I9Z2 (II of I92Z), ss. Io(z)(xv),
Ip(z)(x)-Excess Profits Tax Act, I940 (IS of I940), ss. 2(I6), I9,
ZI, Sch. I, cl. (IZ).
The respondents, a firm carrying on business in dyes and
chemicals under the name and style of Colours Trading Company, with their head office at Madurai and thirtee_n branch
offices in different towns, were the chief representatives in South
India of the products of the I. C. I., a manufacturing concern.
M was employed as the General Manager of the respondents and
by virtue of an agreement, he was to be paid remuneration at
the rate of Rs. 3,000 per annum and rzt% of the net profits of
the company calculated by deducting from the gross profits of
the business the salaries, wages and other outgoings. The
branch offices were managed by local managers and assistant
managers who were paid in addition to monthly, salary, annual
and special bonus and dearness allowance. The respondents
received from the I. C. I. commission at varying rates on the
different prodncts sold to them and with effect from April r,
1944, the LC.I. allowed a special emergency commission of 5%
recommending that r% out of the commission allowed may be
passed on by the respondents to their sub-distributors. The respondents claimed to have distributed to their employees commission pursuant to the recommendation of the LC.I. at rates varying between 2% and 7!% and in some cases at a rate as high as
rzo/o. Though under the service agreement, commission was
payable to the employees only if the turnover exceeded
Rs. r,00,000 net in any year, the respondents claimed to have
paid them commission at generous rates even when the turnover fell far short of that amount. In the year of account
ending April 12, 1945, there was a revision of the scales of salaries of the employees, as a result of which the employees received an amount equal to zi times the enhanced basic salary
and also commission sometimes exceeding rz times the basic
salary.
In computing the total income of the respondents for the
years 1943-44 and r944-45 for purposes of income-tax, the
Income-tax Officer disallowed the payment of rzi% of the net
' •
I
•
3 s.c.R. SUPREME COURT REPORTS
61
profits to M, and for the years 1945-49 he disallowed the comz96o
mission paid to the branch managers and other employees on
--. .
the ground that taking into account all the circumstances the The Commissiofter
remuneration paid to the employees was adequate and that any of Excess Profits.
additional commission paid was in excess of what was reasonTax, Madras
able or necessary. The Appellate Tribunal confirmed the order
v.
of the Income-tax Officer except in the case of M to whom payN. M. Rayaloo
ment of 5 % of the net profits without deduction of Excess
Iyer "" Sons
Profits Tax or Business Profits Tax, or rz% after deduction of
Excess Profits Tax or Business Profits Tax, whichever was
higher, was regarded as permissible deduction. The High Court,
on reference, took the view, inter alia, that in determining the
net profits under the agreement with M, the excess profits tax
could not be deducted, that in considering tbe question whether the bonus or commission paid to the employees in the present case might be permitted as a justifiable deduction, in the
light of s. ro(2)(x} of the Income-tax Act and r. 12 of Sch. 1
of the Excess Profits Tax Act, the test of reasonableness of
the expenditure was to be judged from the point of view of a
business man and not by the application of any subjective
standard of a taxing officer, and that on an analysis of the materials furnished, there was nothing per se unreasonable in the
amounts of commission actually paid by the respondents to the
branch managers and assistant managers.
Held: (1) that the question whether in the computation of
the taxbale income, the commission payable to M under the
agreement entered into with him by the respondents should be
allowed before deducting the excess profits tax, depended on the
true interpretation of the agreement; the expression "outgoing''
in the agreement was not restricted to business or commercial
outgoings but included the excess profits tax paid by the assessees, and that, consequently, the net profits of which M was to
be given a percentage by way of commission should be computed
after deducting the excess profits tax paid.
Commissioner of Income-tax, Delhi v. Delhi Flour Mills Co.,
Ltd., [1959] Supp. l S.C.R. 28, relied on.
(2) that under cl. (12) of Sch. I of the Excess Profits Tax
Act, 1940, it was for the Excess Profits Tax Officer, subject to
review by the Tribunal, to decide whether the deduction was
reasonable and necessary, having regard to the requirements of
the business and in case of payments for services, to the actual
services rendered by the persons concerned; it was not open to
the High Court exercising its jurisdiction on questions referred
to it under the Excess Profits Tax Act, to substitute its own
view as to what may be regarded as reasonable and necessary
and to set aside the decision of the taxing authorities on a reappreciation of the evidence. If the High Court considered
that the taxing authorities had committed an error in law by
misconceiving the evidence or by applying erroneous tests or
62
SUPREME COURT REPORTS
[1961]
i960
otherwise by acting perversely, the proper course for it was in
-
answering the questions submitted, to lay down the true princiThe Co1nmissioner ples applicable to the ascertainment_ of the permissible deducof Excess Profits tions and to leave it to the taxing authorities to adjudicate upon
Tax, Madras
the reasonableness and necessity of the expenses in the light of
v.
the requirements of the business.
N. M. Rayaloo
) l
l
(3 1: iat t iere was ample evidence in support of the concluIyer & Sons
Shah ].
sion of the Excess Profits Tax Officer which was confirmed by
the Tribunal, and that the question, whether the disallowance
by the excess profits tax authorities of the commission paid to
branoh managers was justified under r. 12 of Sch. I of the
Excess Profits Tax Act, should have been answered in the
affiti:na tive.
· CrVIL APPELLATE JURISDICTION:
Civil Appeals
, Nos. 494 and 495 of 1958
Appeals from the judgment and order dated April
18, 1955, of the Madras High Court in Case referred
Nos. 53 of 1952 and 44 of 1953.
Hardayal Hardy and D. Gupta, for the appellant.
A. V.
Viswanatha Sastri, R. Ganapathy Iyer,
S. Padmanabhan and G. Gopalakrishnan, for the respondent.
1960. December 8.
The Judgment of the Court
was delivered by
SHAH, J.-These are two appeals filed with certificates of fitness granted by the High Court of Judicature at Madras. Appeal No. 494 of 1958 arises out
of orders passed in certain Excess Profits Tax
Appeals and Appeal No. 495 of 1958 arises out of
orders passed in certain Income-tax References, Excess Profits Tax Appeals and Business Profits Tax
Appeals.
M/s. N. M. Rayaloo Iyer & Sons-hereinafter referred to as the assessees-are a firm carrying on business
principally in dyes and chemicals. They are the chief
representatives in "South India" of the products of
the Imperial Chemical Industries Company (India)
Ltd.-hereinafter referred to as the "LC.I.".
The
business in dyes and chemicals was in the years material to these appeals, conducted in the name and style
of "Colours Trading Company'', with its Head Office
at Madura and in. thirteen branch offices in different
'
• '
f
Ii
3 S.C.R. SUPREME COURT REPORTS
63
towns in "South India". The busines was carried on
z96o
originally in partnership by three brothers, N. M. R.Th c-· .
e
ommissioner
Venkatakrishna Iyer, N. M. R. Subbaraman and N. M. of E~cess p,ofits
R. Krishnamurti. On April 13, 1946, N. M. R. SubbaTax, Mad.as
raman retired from the firm and the share of N. M. R.
v.
Venkatakrishna Iyer was taken over by a private N. M. Rayaloo
limited company N.111. R. Venkatakrishna Iyer &
Iyer & Sons
Sons Ltd., but the business was, notwithstanding the
Shah 1.
changes in the personnel, continued in the original
name and style. One N. M. R.' Mahadevan (son of
N. M. R. Venkatakrishna Iyer)-hereinafter referred
to as Mahadevan-was employed by the assessees as
the General Manager of the Colours Trading Co.
By
letter dated April 17, 1940, the assessees wrote to
Mahadevan agreeing to pay him remuneration at the
rate of Rs. 1,800 per annum and 5% of the net profits
of the concern (Colours Trading Company) calculated
by deducting from the gross profits of the business,
salaries, wages and other outgoings but without
making any deduction for capital. By letter dated
March 30, 1943, the salary of Mahadevan was fixed at
Rs. 3,000 per annum and the commission was enhanced to 12!% of the net profits of the Colours Trading
Company. The branch offices were managed by local
managers and assistant managers who were paid in
addition to monthly salary, annual and special bonus
and dearness allowance. The assessees received from
the I. C. I. commission at rates varying between
7}% and 12% on different products sold to them.
With effect from April 1, 1944, the I. C. I. allowed a
special emergency commission of 5% on all dyes and
dye-stuffs sold to the a.ssessees.
This special emergency commission was increased to 15% on a.II sales on
or after March 1, 1945, but was subsequently reduced
to 10% on sales on and after September 1, 1946.
These appeals relate to the liability of the assessees
to EJxcess .Profits Tax for the chargeable accounting
periods ending April 13, 1943, April 12, 1944, April
12, 1945, and March 31, 1946, and for Business Profits
Tax for the chargeable accounting periods ending
April 12, 1946, March 31, 1947, April 13, 1947, March
31, 1948, and April 12, 1948.
64
SUPREME COURT REPORTS
[1961)
r96o
The assessees claimed that they had paid to their
--
employees in the years of account 1942-43 to 1947-48
The Commissionu
d ·
d f
'
t'
h
of Excess Profit• ~rn er agre~ments execute
rom. t1~e to 11?e a s are
Tax Madras
rn the special emergency comm1ss10n received from
' v.
the I. C. I., in addition to monthly salary, dearness
N. M. Rayaloo allowance and general and special bonus. The I. C. I.
Iyer &· Sons
in allowing the emergency commission by its letter
Shah ].
dated January 24, 1944, recommended that 1 % out
of the 5% commission allowed may be "passed on"
by the assessees to their "sub-distributors".
The
assessees claimed that pursuant to this recommendation, they paid to their employees commission at rates
varying between 1!% to 4%, and when the emergency
commission was increased to 15% and the I. C. I. by
letter dated February 23, 1945, recommended that
6% out of this commission may be passed on to the
sub-distributors, the assessees claimed to have distributed commission at rates varying from 2% to 7!%
and in some cases at a rate as high as 12%. Under
the service agreements, commission was payable to
the employees only if the turnover in dyes exceeded
Rs. 1,00,000 net in any year, but to employees in
several branches the assessees claimed to have paid
commission at generous rates even when the turnover
fell far short of that amount. In the year of account
ending April 12, 1945, there was a revision of the
scales of salaries of the employees, and the assessees
commenced giving to their employees dearness allowance and special bonus which in the aggregate exceeded 50% of the basic annual salary and also annual
bonus equal to the annual salary. The result of this
revision of emoluments was that each employee
received an amount equal to at least 2! times his
enhanced basic salary. In addition to this remuneration, the assessees claimed that they had paid a share
in the commission which in some cases exceeded 12
times the basic salary.
In computing the total income of the assessees for
the years 1943-44 and 1944-45 for purposes of incometax, the Income-tax Officer disallowed the payment of
12!% of the net profits of the Colours Trading Co. to
Mahadevan and in computing the income for the
t
I
(
i ' I
. '
r
3 S.C.R. SUPREME COURT REPORTS
65
assessment years 1945-46, 1946-47, 1947-48 and 1948r96o
49 the Income-tax Officer disallowed the commission T' c -. .
•
·
11e
01nmissioner
paid to the branch managers and other employees. of Excess Profits
In appeal the Appellate Assistant Commissioner set
Tax. Madras
aside the order which disallowed the amount of comv.-
mission paid to Mahadevan and following the order N. M. Rayaloo
of the Income-tax Appellate Tribunal in certain
Iyer & Sons
Excess Profits Tax appeals, allowed 5% of the net
Shah J.
profits without deduction of Excess Profits Tax or
Business Profits Tax, or 12i% after deduction of Excess
Profits Tax or Business Profits Tax whichever was
higher. That order was confirmed in appeal by the
Income-tax Appellate Tribunal. The Tribunal also
confirmed the order disallowing the emergency commission paid to the branch managers and other employees, and in the computation of taxable income for
purposes of Income-tax, Excess Profits Tax and Business Profits Tax, added back all those payments. At
the instance of the assessees, the Tribunal referred
two sets of questions to the High Court under s. 66( 1)
of the Income-tax Act read withs. 21 of the Excess
Profits Tax Act.
Questions 1 to 3 in Referred Case No. 44 of 1953
were:
(1) Whether in allowing a deduction under s. 10(2)
(xv) of the Income-tax Act, the Income-tax Officer is
precluded from going into the question whether the
amount was paid wholly and exclusively for the purpose of the assessee's business?
(2) Whether there was any material before the
Tribunal to hold that the commission payment to
N. M. R. Mahadevan at 12i% before deduction of Excess Profits Tax or Business Profits Tax was not
wholly and exclusively laid out for the purpose of the
assessee's business?
(3) Whether the commission payment to the
branch managers, assistant managers and other employees is an expenditure laid out wholly and exclusively
for the purpose of the business?
Questions referred in Referred Case No. 53 of
1952 were:
9
66
SUPREME COURT REPORTS
[1961]
I960
(1) Whether the Appellate Tribunal erred in law
-
in holding that in accordance with the terms of letters
TofheECcomnnp·ssi~;," dated 17th April, 1940, and 30th March, 1943, and the
,;- ess
roJ. s
•
b
Tax, Mad,as
conduct of the parties the Excess Profits Tax pa ya le
..•.
by the assessee should be deducted from the profits
N. M. Rayaloo before the commission of 12!% payable to M. N. R.
Iyu & Sons
Mahadevan is calculated?
Shah ].
(2) Whether there is any material on evidence
sufficient in law for the Appellate Tribunal to hold
that the commission of 12! % on profits paid to Mahadevan was unreasonable within the meaning of Rule
12 of Schedule l of the Excess Profits Tax Act?
(3) Whether on the facts and circumstances of
the case the disallowance by the Excess Profits Tax
authorities of the commission paid to branch managers
is justified under Rule 12 of Schedule 1 of the Excess
Profits Tax Act?
The material provisions relating to allowances
under the Excess Profits Tax Act and the Business
Profits Tax Act (which Act superseded the Excess
Profits Tax Act as from March 30, 1946) were on the
questions arising in this case substantially the same
and hereafter reference to the Excess Profits Tax Act
will in respect of the period after March 30, 1946, be
deemed to be a reference to the Business Profits Tax
Act.
In the opinion of the High Court, in computing the
taxable income, the deductions claimed by the assessees fell to be ·considered not under s. l0(2)(xv) of
Income-tax Act but properly under s. 10(2)(x) of the
Income-tax Act, the latter being a specific provision
in the Act relating to deduction of commission or
bonus paid to an employee. The High Court observed
that in assessing liability to Excess Profits Tax the
bonus or commission paid to the employees of the tax
payer may be permitted as a deduction in the light of
s. 10(2)(x) of the Income-tax Act and r. 12 of Sch. I "to
the Excess Profits Tax Act. The case of Mahadevan,
according to the High Court, did not present much
difficulty, the only question which fell to be determined in this case being whether in allowing deduction of
commission at the rate of 121% on the net profits, the
3 S.C.R. SUPREME COURT REPORTS
67
Excess Profits Tax paid by the assessees was to be
'960
taken into account. Following a judgment of the Pun- Th c -. . •
0
, .
,f J .
D lh,
e
ommtssion.r
jab High Court in ommissioner OJ
ncome-tax,
e iv. of Execss Profit•
Delhi Flour Mills Ltd. (1), the High Court observed
Ta>, Madras
that in computing net profits Excess Profits Tax could
v.
not be deducted, but on the materials on the record, N. M. Rayaloo
the question whether the commission paid to the
Iyer G Sons
branch managers and other employees was properly
Shah J.
deductible could not be decided, and accordingly the
High Court called for and obtained from the Tribunal
a supplementary statement of facts. The High Court
after considering the supplementary statement observed that the assessees had undoubtedly distributed
substantial sums out of the emergency commission to
its managers and assistant managers in the branches
at rates well above_ the minima recommended_ by the
I. C: I., but the distribution was at rates within the
precentages allowed by the I. C. I., as additional commission and the balance retained by the. appellants
out of the emergency commission was also substantial.
In the view of the High Court, the Tribunal had to
consider three factors, (1) the--!_easonableness of the
commission in tlie light of the conditions laid down
in s. 10(2)(x), (2) the reasonableness of the percentages
above the minima suggested by the I. C. I., and (3)
the_ need for maintaining the reputation of the I. C. I.,
and the distributor in conditions that prevailed during that period when "black-marketing was rampant", but observed the High Court "the Tribunal had
made no real attempt to analyse the evidence before
it to justify its conclusion that only the minima recommended by the LC.I. and nothing in excess satisfied the test of reasonableness under r. 12, Sch. l, of
the Excess Profits Tax Act". They then observed
that, whether the test of reasonableness is that prescribed by s. 10(2)(x) of the Income-tax Act or whether
reasonableness has to be judged in the light of commercial expediency under r. 12, Sch. 1, of the Excess
Profits Tax Act, the expenditure was to be judged
from the point of view of a businessman and not by
the application of any subjective standard of a taxing
(1) [1953] 23 J.T.R. 167.
68
SUPREME COURT REPORTS
[1961]
z960
officer and that on an analysis of the materials fur-
--. .
nished, they were unable to see anything per se unThe Com,nissioner
_
b
.
h
f
. .
of Excess Profits reasona le m t e amounts o comm1ss10n actually
Tax, Madras paid by the assessees to the branch managers and
v.
assistant managers in the branches. The High Court
N. M. Rayaloo also observed that the minima recommended by the
1Y" & Sons
I. C. I. did not provide ~he only or an absolute stand.
shah 1.
ard for judging the reasonableness of the payments
made, and stated:
"No doubt, the employees of the assessee were
in receipt of regular salaries and bonuses. But
then, a sub-distributor if he had not been paid a
salary, would have had to be paid a share of the
basic commission itself. What the assessee got in
the years in question was in the nature of a windfall. It shared it with its employees. It had been
instructed to share it. The emergency commission
was allowed by the Imperial Chemical Industries so
that the distributors could maintain the reputation
of the Imperial Chemical Industries in the market
even under the disturbed conditions that prevailed
in those years. If, to maintain that reputation
and to maintain its own, the assessee paid to its
employees even on a liberal basis, a share of that
emergency commission, it is a little difficult to hold
that, while receipt of the emergency commission was
reasonable, sharing it beyond a particular point
would per se be unreasonable, in the sense that no
prudent businessman in that line of business, in
those years, and in the market condition that pre-
. vailed then, with ample scope for black-niarketting, would have paid out commission on such a
basis".
They then concluded:
"Though, of course, it was for the assessee to show
that it was entitled to the deduction claimed under
s. l0(2)(x) of the Income-tax Act and r. 12 of Sch. 1
of the Excess Profits Tax Act, there was really no
basis on record to show that judged from the point
of view of a businessman, payments in excess of
the minima recommended by the Imperial Chemical Industries were not reasonable.
We are of
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. -·:-· '·
3 S.C.R. SUPREME COURT REPORTS
69
opinion that the entire claim should .. have -been-
~ 1960
allowed both under s. 10(2)(x) of the Income-tax Th c-·-. .
-
e
omm1ss1oner
Act and under r. 12 of Sch. 1 of the Excess Profits of Excess Profits
Tax Act on the ground that the statutory require- . Tax, Mad,as
ments were satisfied by the assessee." -
--
-
.. _
v.
The High Court accordingly answered the questions N. M. Rayaloo
about the disallowance of commission paid to the emIyer & Sons
ployees of the· assessees being justified under r. 12,
Shah 1.
Sch. 1, of the Excess Profits Tax Act in the negative.
Against those orders, these two appeals have been
preferred with certificates of fitness from the High
Court. ·
.
. ·The first question which falls to be considered is
whether in the computation of taxable income for purposes of Income-tax and Excess .Profits Tax, commission allowed to Mahadevan at--12!% should be
allowed after deducting the Excess Profits Tax paid.
- By the agreement dated April 17, 1940, as modified
by the agreement dated i\Iarch 30, 1943, Mahadevan
was to be paid remuneration at the rate. of Rs. 3,000
per annum and -12! % of the net profits of the Colours
Trading Company. In the view of the High Court
in determining the "net profits" under the agreement
"in accordance with tlie principles of commercial
accountancy and the principles laid down under the
Excess Profits Tax Act" the Excess Profits Tax which
is a tax on profits could ,μ{lt be deducted. In our
judgment thi: question is one· of the true interpretation of the' agreement. Mahadevan, was under the
agreem~t to receive 12!% commission ,6n the net
profits' of the Colours Trading Co. calc'ulated by
. deducting from the gross profits of the business the
·salaries, wages and other outgoings. The ejpression
__ "outgoings" is not restricted to business or commercial outgoings. The agreement specifically disentitles
the employers to make deductions of capital expenditure, but there is no indication that the outgoings are
to be business outgoings only. There. is nothing in
the agreement or in the context justifying the view
that in the expression 'outgoings' is not included the
Excess Profits Tax paid by the assessees.
In Commissioner of Income Tax, Delhi v. Delhi
-
-·----·--
70
SUPREME COURT REPORTS
(1961)
'96°
Flour Mills Co. Ltd. (1), it was observed by this Court
Th c -. .
in construing a similar agreement that the Excess
0/ E,;::;:•:fi",:' Profits Tax was a part of the profits itself, but it was
Tax, Madm
no part of the net profits contemplated by the parties;
v.
if it was a. part which had to be deducted in arriving
N. M. Rayaloo at the net profits, that is to say, the divisible profits
Iyer "" Sons
which alone the parties had in mind, as a matter of
Shah J.
construction the net profits meant divisible profits and
were to be ascertained after deduction of Excess
Profits Tax.
Counsel for the Revenue has not challenged the
decision of the High Court that in computing taxable
income for the purpose of income-tax commission
,paid to the various employees is a permissible deduc-
. tion under s. 10(2)(x) of the Income-tax Act. The
only question which survives on this branch for consideration is, therefore, whether those deductions are
permissible in the assessment of Excess Profits Tax.
By s. 21 of the Excess Profits Tax Act, amongst
other provisions, s. 10 of the Income-tax Act is made
applicable with modifications if any as may be prescribed as if it were a provision of the Excess Profits
Tax Act and refers to the Excess Profits Tax instead
of Income-tax. By s. 2(19), the expression "profits"
means profits determined in accordance with Sch. 1 of
the Act which lays down the rules for computation
of profits for the purpose of Excess Profits Tax Act.
Rule 12 of Sch. 1 (which was added by s. 4 of the
Excess ·Profits Tax Ordinance, 1943 ·provided as
follows:
"(l) In computing the profits of any chargeable
accounting period no deduction shall be allowed in
ri:ispect of expenses in excess of the amount which the
Excess Profits Tax Officer considers reasonable and
necessary 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 by
the person concerned:
Provided that no disallowance under t.his rule shall
be made by the Excess Profits Tax Officer unless he
has obtained the prior authority of the Commissioner
of Excess Profits Tax.
(2) [1959] Supp. I S.C.R. 28.
I
3 S.C.R. SUPREME COURT REPORTS
71
(2) Any person who is dissatisfied with the decision
r96o
of the Excess Profits Tax Officer under this rule may The Commissioner
appeal in the prescribed time and manner to the of Excess Profits
Appellate Tribunal.
Tax, Madras
(3) In relation to chargeable accounting periods
v.
ending after the 31st day of December, 1942, the OenN. M. Hoyaloo
tral Government may make rules for determining the
Iyer & Sons
extent to which deductions shall be allowed in respect
Shan 1.
of bonuses or commissions paid.
We were informed at the bar that though authorised, the Central Government did not make rules for
determining the extent to which deductions shall be
allowed in respect of bonuses or commissions paid.
The Excess Profits Tax Act was substituted as from
the year 1946 by the Business Profits Tax Act, 1947.
That Act also defined by s. 2, cl. (16), the expression
"profits" as meaning profits determined in accordance
with Sch. 1 and by s. 19, the provisions of the sections of the Indian Income-tax Act as applied to the
Excess Profits Tax Act by virtue of ss. 21 and 21A in
so far they were not repugnant to the provisions of
the Business Profits Tax Act applied to that Act as
they applied to Excess Profits Tax Act and by cl. (3)
of Sch. 1, a provision substantially similar to els. (1)
& (2) of cl. 12, Sch. l, of the Excess Profits Tax Act
was incorporated.
Profits of a business for purposes of Excess Profits
Tax Act have to be asdertained by reference to s. 10
of the Income-tax Act modified to the extent directed
by Sch. 1 of the Excess Profits Tax Act. By cl. (12)
of Sch. 1 of the Excess Profits Tax Act, a deduction
in respect of expenses in excess of the amounts which
the Excess Profits Tax Officer considers reasonable
and necessary having regard to the requirements of
the business and in the case of payments for services to the actual services rendered by the persons
concerned, is not to be allowed. The deduction to be
allowed, it is true, does not depend upon any subjective satisfaction of the Excess Profits Tax Officer, but
on objective standards as to what is reasonable and
necessary having regard to the requirements of the
business and in the case of payments for services
72
SUPREME COURT REPORTS
[1961]
196o
to the actual services rendered by the persons con-
- -. .
cerned. The order passed by the Excess Profits Tax
The Commissioner Offi
·
·
b
h T 'b
·
of Excess Profits
cer lS o~en to review
y t e
r1 unal to which
Ta., Madras
appeal agamst the order of the Excess Profits Tax
v.
Officer lies. · But in considering whether the deduc.
N. M. Rayaloo tion is properly claimed, the primary duty is vested
Iyer & Sons
by the Legislature in the Excess Profits Tax Officer.
Shah ].
It is for him subject to review by the Tribunal to
decide whether the deduction is reasonable and necessary, having regard to the requirements of the business and in case of payments for services to the actual
services rendered. The jurisdiction which the High
Court exercises on questions referred to it under the
Excess Profits Tax Act is merely advisory; the High
Court is not sitting in appeal over the judgment of the
taxing authorities. If the taxing authorities having
regard to the circumstances come to a conclusion that
expenditure claimed as a deduction is not reasonable
and necessary, it is not open to the High Court to
substitute its own view as to what may be regarded
as reasonable and necessary. Even if the High Court
holds that the taxing authorities have committed an
error in law by misconceiving the evidence, or by
applying erroneous tests, or otherwise by acting perversely, the High Court may in answering the questions submitted, lay down the true principles applicable to the ascertainment of the permissible deductions and leave it to the taxing authorities to adjudicate upon the reasonableness and necessity of the
expenses in the light of the requirements of the business.
In the case in hand, the Excess Profits Tax Officer
held, (a) that the employees of the assessees were
being amply remunerated for services rendered by
adequate salary, generous dearness allowance and
annual bonus equal to the basic salary, (b) that the
emoluments of the employees had been increased year
after year and there was no material to show that the
employees had made a persistent demand for increased emoluments, (c) that the commission was credited
to the employees' account at the end of the year and
was carried forward but no payments were made to
ll
6~'
••
,,
~~
l!
@'
I
,
-
,.
3 S.C.R. SUPREME COURT REPORTS
73
them, (d) that the agreements which had been pro-
'960
duced by the assessees were fabricated with a view to Th c -. .
•
•
,
e
ommissioner
reduce tax habihty, and (e) that the expenditure of Excess Profits
claimed was not proved to have been laid out wholly
Ta., Madras
and exclusively for the purpose of the business_ Tak-
•·
ing into account these circumstances, the Excess N. M. Jlayaloo
Profits Tax Officer held that the remuneration paid to
Iyer <>- Sons
the employees was adequate and any additional comShah J.
mission ·paid was in excess of what was reasonable
and necessary.· The only criticism urged by counsel
for the assessees against the grounds given is that the
Excess Profits Tax Officer observed .that while the net
profit according to the Profit & Loss Account of the
firm was Rs. 20,487 leaving•a share of Rs. 6,800 only
to each of the partners, some of the managers got
more than this amount. It appears that the Excess
ProfitR Tax Officer committed an error in so observing. The profits of the Colours Trading Co. as disclosed by the order of assessment for the year 1945-46
were Rs. 99,435 and not Rs. 20,487; but that error
did not affect the ultimate conclusion recorded by the
Excess Profits Tax Officer. According to the books of
account of the assessees for the year 1943-44 of the
business in dyes, the profits were Rs. 99,435 and
they claimed to have distributed a commission of
Rs.1,00,715 to their employees out of the emergency
commission, which was prima facie wholly disproportionate to the amount received by them.
The order passed by tbe Excess Profits Tax Officer
was confirmed in appeal by the Appellate Tribunal.
In the view of the Appellate Tribunal, no additional
incentive was required to sell dyes and chemicals
in the years in question because dyes and chemicals were in short supply and there was a rise in
demand. The Tribunal also referred to the table setting out tho distribution among the employees of
dearness allowance, bonus and salary in the relevant
years, and observed:
"In addition to the generous allowances, the payment of this sum appears to us a payment made
in order to dissipate the profits. It would be sufficient to say that including the commission alleged
10
I960
The Con1missioner
of Excess Profits
Tax, Madras
v.
N. M .. Rayaloo
Iyer &- Sons
Shah ].
74
SUPREME COURT REPORTS
[1961)
to have been paid, the total emoluments would be
something like 1200% and in some cases even more
than the basic annual salary. There is no doubt in
our mind, that this was wholly unnecessary for
business purposes."
Observing that the assessees having no sub-distributors, the direction given by the LC.I. did not require
the assessees to "pass on" the commission to their
employees, they concluded that the expenditure alleged
to have been incurred was not reasonable and necessary within the meaning of r. 12, Sch. 1, of the Excess
Profits Tax Act.
The following table which is incorporated in the
statement of case of the Tribunal sets out for the four
years in question the emergency commission received
by the assessees and the aggregate amount paid by
them to their employees.
Assessment
year.
Extra commisAmount of commission received
sion paid by the
by the assessee.
assessee.
Rs.
Rs.
1945-46
1,28,533
1,00, 715
1946-47
3,20,391
2,44,698
1947-48
3,15,934
1,28,506
1948-49
3, 70,964
1, 75,079
This distribution out of the emergency commission
to the employees has to be viewed in the context of
the following circumstances set out by the Tribunal:
(1) that even though the LC.I. recommended payment to sub-distributors and the assessees had no subdistributors, they claimed to have paid commission to
their employees at rates in excess of the minimum
rates recommended by LC.I.
(2) that this commission was paid to the employees
in branches in which the annual turnover did not
exceed Rs. 1,00,000 even though the agreements which
the assessees had executed expressly provided that the
commission was to be paid only if the annual turnover
in a branch exceeded Rs. 1 lakh and
(3) that the basic ~laries of the employees had
been substantially increased from time to time· and
generous dearness allowance and Deepava!F• bonu~
,
'
-
3 S.C.R. SUPREME COURT REPORTS
75
were given besides the annual bonus to the emploi96o
yees.
Th c-· ·
A
1 ,
f
"L" t
th
1
l
'
om•umoner
n ana ys1s o annexure
o
e supp ementa of E•etss Profits
statement of case made by the Tribunal discloses some
Ta., Madras
striking instances of payments to employees. One
v.
Themaswamy was paid annually commission varying N. M. Rayalo<
~
from Rs. 15,000 to Rs. 23,000 when his basic salary
Iyer .s. 50"'
was Rs. 2,100 per annum; one K. N. Rajagopalachari
Shah 1.
was paid commission varying from Rs. 16,000 to
Rs. 12,000 when his basic salary was Rs. 1,260 per
annum; one S. L. Radhakrishnan was paid commission varying from Rs. 5,700 to Rs. 13,000 when his
salary varied between Rs. 516 and Rs. 636 per annum
and one K. R. Rama Rao was paid commission varying from .Rs. 4,600 to Rs. 10,520 his salary being
Rs. 492 and later increased to Rs. 612 per annum.
There was thus ample evidence in support of the
conclusion of the Excess Profits Tax Officer which
was confirmed by the Tribunal. As we have already
observed, it is the province of the Excess Profits Tax
Officer and the Tribunal to assess the permissible
deductions in the context of reasonableness and necessity having regard to the requirements of the business
and interference with the conclusion is permissible if
the view of the taxing authorities is vitiated by an
error of law or is not based on any materials, or the
conclusion is such that no man instructed in law could
have arrived at.. It is true that in considering
whether the deduction claimed by the assessees for
payments made as bonus or commission paid to an employee is to be allowed, the taxing officer must have
regard to the provisions of s.10(2)(x) of the Income-tax
Act and cl. ( 12) of Sch. 1 of the Excess Profits Tax Act;
and in assessing the reasonableness, consideration of
commercial expediency must undoubtedly be taken
into account. But commercial expediency must be
viewed in the light of the requirements of the business
and the actual services rendered by the persons concerned. Any abstract consideration of commercial
expediency is out of place.
In our view, the High Court was not justified in
seeking to reappreciate the evidence on which the
76
SUPREME COURT REPORTS
(1961]
'960
conclusion of tb.e Excess Profits Tax Officer which
Th c --. .
was confirmed by the Tribunal was based. Their
0/£,;:~;:•:;1:' jurisdiction being advisory, the High Court had to
Ta>. Madras
answer the questions submitted for opinion on the
v.
facts found; if the High Court held the view that
N. M. Rayaloo the taxing authorities had misdirected themselves
Iyer & Sons
in law or had made a wrong inference in law or
Shah ].
had failed to apply the correct tests or had misconceived the evidence, it was open to them to
invite the attention of taxing authorities to the
error committed by them; but the High Court
could not set aside the decision of the taxing
·authorities on a reappreciation of the evidence. We
may also point out that even if the High Court concluded that the total disallowance of the deduction
claimed was not justified, the High Court could not
substitute its own view as to what was reasonable
and necessary. The High Court had, if it disagreed
with the taxing authorities, still to answer the questions submitted and leave to the consideration of the
Excess Profits Tax Officer what in the circumstances
was reasonable and necessary.
Counsel for the assessees submitted that in any
event, the Tribunal having in its supplementary statement of case stated that payment in excess of what was
recommended by the I.C.I. was unjustified, this court
may so modify the order of t,he High Court that
deductions of the amounts which were recommended
by the LC.I. may be regarded as permissible deductions. The LC.I. recommended distribution of a certain
percentage out of the emergency commission to the
sub-distributors; but in the administrative set up of
the assessees, the sub-distributors did not find a place.
The assessees carried on their business through paid
employees. In terms therefore the recommendation
by the LC.I. had no application to the assessees. It
is true that· even if the assessees did not carry on the
business through sub-distributors, payment made to
its employees if reasonable and necessary having
regard to the requirements of the business, may still
be deductible, b11t that in our judgment is a matter to
be decided by the taxing authorities and not by us.
...
I
I (
3 S.C.R. SUPREME COURT REPORTS
77
The Tribunal had come to the conclusion that no pay.
r96o
ment in addition to the salary, annual bonus and rh c
. .
· 1 b
·
"fi d
d
.
f
'
ommirnoner
specia
onus was JUStI e
an
any express10n 0
of Exms Profits
opinion to the contrary in the supplementary stateJax, Madras
ment pursuant to the order for statement of case
v.
could not in our judgment affect the conclusion origiN. M. 11ayaloo
nally recorded.
Iy" & Sons
In our view the answer to the question whether the
disa.llowance by the Excess Profits Tax authorities of
the commission paid to branch managers was justified
under r. 12, Sch. 1, of the Excess Profits Tax Act
should have been answered in the affirmative. On the
view taken by us, Appeal No. 494/1958 will be allowed, but there will be no order as to costs.
Appeal No. 495 of 1958 will be allowed with costs.
Appeals allowed.
KUNNATHAT THATHUNNI MOOPIL NAIR
v.
THE STATE O:E' KERALA AND ANOTHER
(with connected petitions)
(B. P. SINHA, c. J., JAFER IMAM, A. K. SARKAR,
K. SUBBA RAO and J.C.