1957 (3) TMI 70 - HC - Income Tax

Summary

Issues Involved:
1. Disallowance of commission payments to directors under rule 12(1) of Schedule I of the Excess Profits Tax Act.
2. Reasonableness and necessity of payments made to directors in relation to the business requirements and services rendered.
3. Applicability of the Full Bench decision in Shyamlal Pragnarain v. Commissioner of Income-tax to the present case.

Issue-wise Detailed Analysis:

1. Disallowance of Commission Payments to Directors:
The primary issue revolves around whether the amounts of Rs. 6,15,000 for the accounting period from January 1, 1943, to December 31, 1943, and Rs. 3,87,400 for the period from January 1, 1944, to December 31, 1944, were rightly disallowed under rule 12(1) of Schedule I of the Excess Profits Tax Act. The assessee had paid commissions to its directors based on the profits earned, calculated at a fixed rate. The Excess Profits Tax Officer disallowed these amounts, reasoning that the commissions were calculated on net profits without deducting the excess profits tax, which was contrary to the terms of the agreement between the assessee and the directors.

2. Reasonableness and Necessity of Payments:
The Excess Profits Tax Officer and the Income-tax Appellate Tribunal disallowed the payments on the grounds that they were not justified under the agreement and were beyond the terms of the agreement. The Tribunal did not record any findings on whether the payments were necessary for the business or commensurate with the services rendered by the directors. The judgment emphasized that the question of reasonableness and necessity should be judged in accordance with business principles and commercial expediency, keeping in view ordinary commercial practice. The Full Bench decision in Shyamlal Pragnarain v. Commissioner of Income-tax established that even ex gratia payments could be considered allowable deductions if they were reasonable and necessary for the business.

3. Applicability of the Full Bench Decision:
The judgment referred to the Full Bench decision in Shyamlal Pragnarain v. Commissioner of Income-tax, which held that the reasonableness and necessity of payments should be judged based on business requirements and services rendered, irrespective of whether the payments were made under a legal liability or as ex gratia payments. The Excess Profits Tax Officer and the Tribunal's focus on the terms of the agreement was deemed insufficient. The judgment clarified that the considerations for disallowing payments under rule 12 of Schedule I of the Excess Profits Tax Act apply equally to payments made to directors and employees. The distinction between payments made by a company or a firm, or to directors or employees, was considered irrelevant to the assessment of reasonableness and necessity.

Conclusion:
The High Court concluded that the Excess Profits Tax Officer and the Income-tax Appellate Tribunal erred in disallowing the commission payments solely based on the terms of the agreement without considering the reasonableness and necessity of the payments in relation to the business requirements and services rendered. The question referred to the court was answered in the negative, indicating that the disallowance of the amounts was not justified.