Commissioner Of Income-Tax, Kerala v. Alagappa Textile (Cochin) Ltd

COMMISSIONER OF INCOME-TAX, KERALA ALAGAPPA -TEXTILE (COCHIN) -LTD. September 19, 1979 [V .. D. TULZAPURKAR' AND R_ S. PATHAK, JJ.] ·t Bu.tiness E·xpenditurY!"-section t0(2)(xv) oi the Income-tax Act, 1922-1· /:ether tlze 1 remuneration tOH'arcls the '111a11ager' Kanzala Mills Ltd . . is falling -(~·ithin the 1neaning _of Section 384 read witll s. 2(24) of the Co1npaiiies Act 1a[[c7"A:able as "business expenditure"-Construction of the terms of Agreement-lVliether the managing company falls l'.:ithin the meaning of. Section 2(24) of · .the Companies Act, 1956. · Respondent, assessee ("!!.Ifs. Alagappa Textiles (Cochin) Limited company i.vas carrying on business of manufacture and sale of yarn. It entered into an Agreement dated November 10, 1955 with Kamala l\lills Ltd., Coimbatore for financing and managing the assessee l\fills at A1agappa Na-gar for a reriod of five years. Clause 8 of the Agreement provided that Kama1a ~fills Ltd. shall be paid for the ser''ices, rendered by it by \-Vay of purchases, sales ·and manage-ment, remuneration at the rite of I% on all purchases made by it for the nssessce Mil1s and at half a percent on all sales of yarn, yarn v.--ast~ and cotton waste and othe-.r products of the l\!iIL C1ause 13 of the agreement w~s to the effect that "'the 'company (assessee), either represented by its managing Agent or Board. of Directors shall not exercise the po\-vers delegated 1'.J th·! !\tanagers (Kamala l\Iills Ltd.) under the foregoing clauses, except by \Vay of genf.r.il supen'ision and advice nor interfere with discretion of the managers in the exettise of their functions and powers vested in them by virtue of thh Agree-ment.., Oause 14, provided that the l\fanagers (Kamala l\lills Ltd.) po·.vers were limited in the manner aforesaid and shall not· be deem~d to be manager in charge of the _\-vhole affairs of the company within the meaning of section 2(9) of tbe companies Act, 1913. Clause 16 provided th::it the agreement shalt be in force for a period of five years commencing from the date thereof and that "this Agreement for management being an Agency coupled \vith interest" CQuld be ·revoked before the expiry of the said period of five years by 12 months• notice in writing being given by one party io the other, but if the i~see were to revoke it the a5sessce shall be Ii-able to compensate Kamala His for.the loss of remuneration for. the unwexpired period of the Agreement f1le average rate at which Kamala ~fiIIs Ltd. had been earning by way of nneration under the Agreement till the date of such notice of ':ermination. Ptlrsuant to the aforesaid termi, Kamala 1Iills Ud. drew remuneration to he tune of Rs. 1,03,547/- and Rs. 18,249 /- respectively for the calendar year1 1957 and 1958 corresponding to the assessment years 1958-59 and 1959w60. ' 1"be&e &mounts \Vere assessed lo tax in the hands of Kamala ~tills Ltd. Respon-:' dent. &iSeSsee in its assessment proceedings. for the said two a'5essment years, claimed deduction in respect of the said two amounts as business expenditure unde< section 10(2)(xv) of the Income-tax· Act. The claim was rlisallowed. by tMi Income Tax Offictr on the ground that under section 384. of the companies Act, 1'56 which had come i•to_ force on April 1, 1956 the continuation of a A body corporate as manager was prohibited foi the period beyond .&ix. months from the comlnz into force of the Act, that the remuneration pa1J to Kamala 1'-Iills Ltd. subsequent to October 1, 1956 \Vas illegal being in violation of s. 384. The Appellclte Assistant Commissioner rejected the Appeal ir.ainly"'on the ground that the assessee by its own conduct had disputed its liability to pay any remuneration to Kamala Mills Ltd. as after October 1, 1956 and in th<it behalf he relied on an admitted fact that the assessee had filed a .;;uit B against Kamala Mills to recover such remuneration which had been paid to it in contravention of secti6n 384 of the Companies Act on the basis that e. l2e-tbe payment was illegal Kamala Mills was holding such amounts of remune~a· tjcn in trust for and on behalf of the assessee. Respondent carried ihe matt~r in further appeals to the Tribunal; but the Tribunal confirmed the view of the taxing allthorities. On a reference, the High Court answered the question in the negative in favour of the assessee and against the Revenue. The High Court c held that Kamala 1fills could not be said to be "subject to the superinten-dence, control and directions of the Board of Directors" of the respondent and therefore wa.S not a "manager'' of the assessee within the meaning of section 2(14) of the Companies Act, so as to attract the illegality under section 384 ibid. and (b) that in view of the provisions of section 41 ( 1) of the Income-tax. Act, the pendency of an appeal against the Judgment the suit for recovery could not be a valid ground for disallowing the deduction permissible under· D section 10(2) (xv) of the Income-tax Act. Dismissing the appeal by Revenue by special leave, the Court HEID: 1. Section 384 of ·the Companies Act, 1956 in express· terms prohibits, after ·the commencement of the Act, the appointment Of a firm or a body corporate or an association of persons as manager as also the conti-nuation of such employment after expiry of six months from such commence-ment. To attract the piohibition or disqualification, under this section, a firm, body corporate or association must be a "manager" within the meaning of section 2(24), that is to say, it should be in management of the whole or substantially the whole of the affairs of a company and should be under superintendence, control and direction of the Board of Directors of the company. [730 C·D, E·F) 2. Section 2(24) of the Companies Act requires three conditionS to be satisfied: (a) the Manager must be an individual~ '\Vhich means that a·· furn or body corporate or an association is excluded and cannot be a· Mana·~ (a fact which is expressly made clear in section 3_84), (b) he should hav.~ ' management of the whole or substantially the whole affairs of the companY;_~ (c) he should be subject to the superintendence, control arid direction3" the Board of Directors in the matter of managing the affairs of the comp Subject to, the changes made in the aspect covered by (a) and (b), in b -the definitions [s. 2(9) of 1913 Act and s. 2(24) of the 1956 Act], the aspe that a itanager has to work or exercise , his powers under !he· control an directions of the Board of Directors is common ·and essential. In · fact. it i~ this aspect which distinguishes '1Ianager' from "Managing Agent":.. A comparison of the defin:tion of "~Ianager" as given in s. 2(24) of the ·1956 Act with that of "Managing Agent" in s. 2(25) makes it clear that though there is an ovedapping of the functions of the Manager as well as the Managing · Agent of the company the essential distinctioil 'is that whereas the Mana&er has to be subject to the superintendence, conlrol and direction of the Board of Directors, the managing Agen~ is, not so •ubject. [729 G-H, 730 A-Cl 3. On a perusal of the clauses and in particulax clauses 8, 13, 14 and 16 oi the Agreement dated November 10, 1955 in the instant case, two or three things statid out very clearly. It is true that-at the commencexnent of the deed Kan1ala. Mills Ltd. has been described and referred to as the "Managers" of the asses~ .sec throughout the document but mere label or nomenclature given to a party in thC document will not be decisive. It is also true that the several powers .... ..:md functions were entrusted to Kamala Mills Ltd. under clause 1 of the Agreelrient to enable it "to manage or run the Mill" of the assessee. But simply because powers and functions ~rere given to Kamala Mills Ltd. for the purpose of "managing and running the ~fills" of the assessee, it could not follow that Kamala. Mills Ltd. was in truth .and substance a 'manager' of the assessee within the meaning of s. 2(24) of the 1956 Act. For this purpose the Agreement will have to be read as a ~·hole and the Court will have to decide what was the· true· intention· of· thC partieS ·in entering into such Agreement. [733 E-Gl 4. The dominant object \Vith which the Agreement was entered into \vas thaf K:aTnala Mills Ltd. should really act as a :tin3-ncier so that the assessee Mill could• :n;i.n and since heavy finances were to be procured by Kamala Mills Ltd. large powers and functions connected 'Yith. the wor~ing of the mill were en-trusted to it. This aspect become abundantly clear from cl. 16 of the Agree-ment. wherein the parties expressly provided .that this Agreement for manage-ment. was. by way of and amounted to an Agency coupled with interest so far as K~inala Mills Ltd. was concerned and, therefore, revocation of the Agree-ment before the expiry of five years' period was made dependent upon 12 months' notice in writing being given by one party to the other and further if such .revocation was done· by the assessee suit~ble compensation Was made payable to Kamala Mills Ltd. In other words, managerial functions were incidental and had to be entrusted to Kamala Mills because of the financier's role undertaken by it. The large powers and functions entrusted to Kamala Mills Ltd. under the several sub-clauses of cl.1 of the Agreement do show that management of substantially the whole, if not the whole, of the affairs of the assessee company had been made over to Kamala lllills Ltd. l734 B-EJ 5. Clause 13 of the Agreement which is very eloquent, provided that so far as the poweis conferred and the functions entrusted to Kamala Mills Ltd. were concerl,led, the Board of directors shall not exercise or perform the same except by way of general supervision and advice and it was further made. clear that the Board, of Directors shall not interfere with the discretion of Kemala Mills Ltd in the exercise of their functions and powers vested in it ~ virtue of the Agreement. In other words, the general supervisiob or advice of· the Board of directors was o:f such character that the Board had no way. whatsoever nor could .it interfere with the . dis.cretion of . Kamala Mills Ltd. in the matter of the exercise of the powers and the discharge of the function~ elltrusted to Kamala Mills Ltd. under the Agreement. It is thus olear that the dominant object of the Agreement was that Kamala Mills ltd. •sliould act as financiers Of the assessee !llill antl in the matter of the exerc.ise. ·of _its powers and discharge of its functions Kaniala Mills Ltd. was uc¥er .- "stJ.bject to the superintendence; control· or direction" of the Board of 10-625 SCI/79 directors of the assessee. This ls the position which clearly emerges 011 true construction of the Agreement. [734 F-H, 73SAJ 6. Therefore, Kamala Mills Ltd. was no/ acting or working as the "Manager" pf the assessee within the me.'Uling of s. 2(24) of the Companies Act, 1956 and as such the illegality of section 384 of the Act was not attracted. In this view of the matter, the remuneration paid by the assessee to Kamala Mills Ltd. for the two calendar years 1957 & 1958 relevant to the assessment years 1958-59 and 1959-60 could not be rejlllrded as being in violation of s. 384 of the companies Act,· 1956 and as such the expenditure incurred by way of paying such remuneration would be deductible as "Business Expenditure" under section 10(2) (xv) of the Income-tax Act, 1922. (735 A-DI CIVIL APPELLATE JURISDICTION :' Civil Appeals Nos. 2001-2002 of 1978. Appeals by Special Leave from the Judgment and Ordec dated 14-12-1971 of the Kerala High Court in Income Tax Reference No. 19 of 1969. V. S. Desai, S. P. Nayar and Miss A. Subhoshini for the Appellant. S. T. Desai, N. Sudhxzkaran and P. K. Pillai for the Respondent. The Judgment of the Court vlas delivered by TuLZAPURKAR, J. These appeals by special leave raise a collll!IOn question whether on proper coostruction of the Agreement dated November 10, 1955, entered ,into by the assessee with Kamala 'Mills Ltd., the latter was the "maaager" of the assessee within the meaning of s. 384 read with s. 2(24) of the Companies Act, 1956 and if so, whether the remuneration paid by the assessee to the latt~r in the two· calendar years 1957 and 1958 relevant to the assessment years 1958-59 and 1959-60 cannot be allowed as business expenditure under s. 10(2) (xv) of the Indian Income-Tax Act, 1922? The facts giving rise to the question may briefly be stated as follows : ·Tue assessee (M/s Alagappa Textiles (Cochin) Ltd.) is a public. limited company carrying on bus.iness of manufacture and sale of yarn and has its registered office at Alagappa Nagar in Kerala State. It entered into an Agreement dated November 10, 1955 with Kamala Mills Ltd, Coimbatore for financing and managing the assessee mills at Alagappa Nagar for a period of five years. Clause 8 of the Agreement provided that Kamala Mills Ltd. shall be paid, for the services rendered by it by way of. purchases, sales and management, remunera-tion at the rate of 1 % oil all purchases made by it for the assessee mills and at half a per cent on alJ sales of yarn, yarn waste and cotton waste and other products of the mill. Pursuant to the aforesaid teem Kamala Mills Ltd. drew remuneration to the tune of Rs. 1,03,547 /" and Rs. 18,294/- respectively for the calendar years 1957 and 19SS