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Commissioner of Income-Tax v/s R.M. Investment and Trading Co.(P.)Ltd.

    Income-Tax Reference 165 of 1991

    Decided On, 29 July 1993

    At, High Court of Judicature at Calcutta

    By, THE HONOURABLE MR. JUSTICE AJIT KUMAR SENGUPTA & THE HONOURABLE MR. JUSTICE SHYAMAL KUMAR SEN

    For the Appearing Parties: R.N. Bajoria, J.P. Khaitan, Advocates.



Judgment Text

AJIT K. SENGUPTA, J.


(1.) In this reference made at the instance of the Revenue, the following question has been referred by the Tribunal for the opinion of this court under Section 256(1) of the Income-tax Act, 1961 : "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the consultancy fee of Rs. 7,25,000 paid by the assessee-company to Shri K.N. Tapuria, a director of the company did not fall within the purview of the Section 40(c)(i) of the Income-tax Act, 1961, and thereby deleting the addition of Rs. 6,53,000 made by the Assessing Officer to the total income of the assessee ?"


(2.) This reference relates to the income-tax assessments of the assessee-company for the previous year being the calendar year 1983 corresponding to the assessment year 1984-85. At all material times, the principal business of the assessee-company was to render consultancy services to Boeing Company of U. S. A. for promotion of their sales of various types of aircraft as per agreement. In return, the assessee-company was to receive a commission on sale of aircraft. The Boeing Company of U. S. A. used to remit substantial amounts to the assessee-company as service charges in order to enable the assessee-company to meet various overhead expenses hi canvassing sale of aircraft in any particular year.


(3.) During the calendar year 1983, the assessee-company received service charges amounting to Rs. 25,50,000 from the Boeing Company of U. S. A. The assessee-company claimed various expenses against the service charges so received. One such expenditure as claimed by the assessee-company was payment of consultancy fee of Rs. 7,25,000 to Sri K.N. Tapuria in terms of an agreement entered into by the assessee-company with Sri Tapuria on January 19, 1983. In fact, Sri Tapuria was also appointed as one of the directors of the assessee-company on the very day on which the agreement for payment of consultancy fee was entered into by the assessee-company with him. The Income-tax Officer applying the provisions of Section 40(c)(i) of the Income-tax Act, 1961, disallowed a sum of Rs. 6,53,000 being the excess of the consultancy fee paid to Sri Tapuria, a director of the assessee-company, in excess of Rs. 72,000, the statutory limit laid down in that section. On appeal by the assessee before the Commissioner of Income-tax (Appeals), it was contended on behalf of the assessee-company that Sri Tapuria was paid the consultancy fee of Rs. 7,25,000 not in his capacity as the director of the assessee-company but as an adviser for rendering specific services to the Boeing Company. Such payment according to the assessee-company was not covered by Section 40(c)(i) of the Income-tax Act, 1961, and the same could at best have been considered by the Income-tax Officer under Section 40A(2)(a) of the said Act. It was explained to the Commissioner of Income-tax (Appeals) that in the later half of the year 1982, the assessee-company received information that the Boeing Company of U. S. A. was in need of some experienced consultancy services in India for providing them necessary assistance with regard to the promotion of their sales of various types of Boeing aircraft. The assessee-company found that Sri K.N. Tapuria, at Calcutta, had considerable experience in the aforesaid line of business and had also good contacts with the officials of the Boeing Company in the U. S. A. In view of the keen competition, the assessee-company approached Sri Tapuria for negotiating with the Boeing Company on its behalf. Sri Tapuria started negotiations with the Boeing Company. Subsequently, the assessee-company was informed by the Boeing Company that it was keen to secure the personal services of Sri Tapuria as a consultant and adviser and if the assessee-company was able to secure the personal services of Sri Tapuria along with the services of other personnel, the Boeing Company was prepared to appoint the assessee-company as its agent in India for promoting the sale of various types of Boeing aircraft. On this understanding, the assessee-company was able to secure from the Boeing Company through Sri Tapuria a draft of the agreement to be executed between the assessee-company and the Boeing Company of U.S.A. containing the broad terms and conditions. At this stage, the assessee-company entered into an agreement with Sri Tapuria on January 29, 1983, under which Sri Tapuria agreed to guide and advise the Boeing Company on behalf of the assessee-company in the promotion of the sale of various types of Boeing aircraft in India. Sri Tapuria agreed to render all possible assistance to the Boeing Company on the assessee's behalf in carrying out negotiations with various prospective purchasers including Air India and Indian Airlines in connection with the sale of Boeing aircraft. Sri Tapuria was also appointed a director of the assessee-company on the same date, i.e., January 19, 1983. This was done with a view to enabling Sri Tapuria to finalise the negotiations with the Boeing Company and execute the formal agreement with them on behalf of the assessee-company. It was clearly understood that Sri Tapuria would be able to secure a final agreement with the Boeing Company within April, 1983, and with retrospective effect from January 1, 1983, as was originally proposed by the Boeing Company. On February 7, 1983, the assessee-company wrote to the Boeing Company confirming, inter alia, that it will be possible for the assessee-company to secure and provide to the Boeing Company the personal services of Sri Tapuria including the benefit of his vast experience and skill in this line of business. Sri Tapuria negotiated with the Boeing Company on behalf of the assessee-company and the final agreement with the Boeing Company was signed by Sri Tapuria on behalf of the assessee-company on April 15, 1983. Under this agreement, the assessee-company was appointed as the agent of the Boeing Company for promotion and sale of different types of Boeing aircraft manufactured by them in the U. S. A.


(4.) Sri Tapuria in pursuance of the agreement dated January 19, 1983, worked as an adviser and consultant and rendered various services to the Boeing Company for and on behalf of the assessee-company. Sri Tapuria had to visit frequently Delhi and Bombay where the headquarters of Air India and Indian Airlines are located and also undertook several trips to Europe and the U. S. A. At the specific request of the Boeing Company, Sri Tapuria had to devote substantial attention in connection with specific services rendered by him to the Boeing Company for and on behalf of the assessee-company. It was because of the valuable services rendered by Sri Tapuria that the assessee-company was able to renew its agreement with the Boeing Company from time to time in subsequent years. In fact, the Boeing Company again addressed a letter to the assessee-company on February 15, 1986, appreciating the valuable services rendered by Sri Tapuria and stating very clearly that in case of further renewal of their agreement, they would like to ensure that the personal services of Sri Tapuria would continue to be available to them for and on behalf of the assessee-company. On the basis of the aforesaid facts, the Commissioner of Income-tax (Appeals) came to the conclusion that it was entirely through the efforts of Sri Tapuria that the assessee-company was able to make the agreement with the Boeing Company and that Sri Tapuria rendered the personal services to the assessee-company as an adviser and consultant without which the assessee-company would not have been able to receive service charges amounting to Rs. 25,50,000 from the Boeing Company during the relevant previous year. The Commissioner of Income-tax (Appeals) was of the view that the payment of Rs. 7,25,000 made by the assessee-company to Sri Tapuria was made to him not in his capacity as a director of the company but solely for his being adviser and consultant and for rendering such services to the Boeing Company for and on behalf of the assessee-company. The appointment of Sri Tapuria as a director on January 19, 1983, was only for the sake of convenience to enable him to finalise the negotiations and execute the final agreement for and on behalf of the assessee-company under which the Boeing Company paid Rs. 25,50,000 to the assessee-company for rendering various services. The Commissioner of Income-tax (Appeals) noted that the object of Section 40(c) of the Act is to prevent the directors from misusing their influence over the company to their advantage. He noted that Sri Tapuria was not a director of the company when negotiations were made with him for rendering specific services to the Boeing Company. The Commissioner of Income-tax (Appeals) also noted that the assessee-company did not pay any remuneration to any of its other directors for looking after the day to day business of the assessee-company. The Commissioner of Income-tax (Appeals) was of the opinion that the assessee-company was able to enter into the consultancy agreement with the Boeing Company of U. S. A. only because it was able to ensure the personal services of Sri Tapuria as an adviser and consultant being made available to the Boeing Company. The Commissioner of Income-tax (Appeals) felt that the payment of Rs. 7,25,000 to Sri Tapuria was not an ordinary payment in his capacity as a director of the company but it was a specific payment for certain special services rendered by him as an adviser and consultant to the Boeing Company. The Commissioner of Income-tax (Appeals) was, therefore, of the view that Section 40(c)(i) of the Income-tax Act, 1961, was not applicable in regard to the payment of Rs. 7,25,000 made by the assessee-company to Sri Tapuria. The Commissioner of Income-tax (Appeals) thereafter proceeded to consider whether the payment of Rs. 7,25,000 to Sri Tapuria could be disallowed under Section 40A(2)(a) of the said Act. The Commissioner of Income-tax (Appeals) noted that the question of reasonableness of the quantum of any expenditure has to be judged from the point of view of a prudent businessman and not by any subjective consideration. It was seen in this case that the payment had been made by the assessee-company to Sri Tapuria with a view to getting consultancy. Having regard to the fact that the assessee-company may not have been able to secure the consultancy contract with the Boeing Company without the personal services of Sri Tapuria, the Commissioner of Income-tax (Appeals) held that the payment of Rs. 7,25,000 to Sri Tapuria could not be said to be unreasonable and/or excessive having regard to the legitimate business needs of the assessee-company and the benefits derived by the assessee-company by incurring such expenditure. He, therefore, held that such payment of Rs. 7,25,000 was also not hit by the provisions of Section 40A(2)(a) of the said Act. On appeal by the Revenue before the Income-tax Appellate Tribunal the order passed by the Commissioner of Income-tax (Appeals) was upheld.


(5.) We find that the facts as recorded by the Commissioner of Income-tax (Appeals) and which have been upheld and reiterated by the Tribunal have not been challenged in this reference by the Revenue. Section 40(c) of the Income-tax Act, 1961, applies in the case of companies only. This section has since been deleted by the Direct Tax Laws (Amendment) Act, 1987, with effect from April 1, 1989. Prior to its omission, Clause (c) of Section 40 empowered the Income-tax Officer to disallow the whole or part of any expenditure incurred by a company, which resulted directly or indirectly in the provision of any remuneration, benefit or amenity to a director or to a person who had a substantial interest in the company or to a relative of the director or of such person, if in the opinion of the Income-tax Officer any such expenditure is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom. The opinion should be formed objectively from the point of view of a prudent businessman and after taking into account the statutory criteria and all relevant circumstances, and should not be influenced by immaterial considerations. The Income-tax Officer may under this clause disallow the expenditure in computing the profits of the company notwithstanding that any amount so disallowed is included in the total income of the recipient. In a case covered by this clause, the aggregate of the expenditure and allowance deductible in the assessment on the company cannot exceed Rs. 72,000 per annum. The object behind the provisions of Clause (c) of Section 40 was to discharge and disallow payment of high salaries and remunerations which go ill with the norms of an egalitarian society. The Supreme Court in Bharat Beedi Works Pvt. Ltd. v. CIT (C. A. No. 1452 of 1987)--[1993] 201 ITR 1063 had occasion to consider the question whether payment of royalty by a company to a partnership firm whose all the three partners were directors of the company, was hit by Section 40(c) of the Income-tax Act, 1961. In that case it was found that under an agreement between the company and the said partnership firm, the company had taken over the beedi business and the payment of such royalty was made by the company to the firm by way of consideration for allowing the company to use the brand name belonging to the firm. The court found that the genuineness or the validity of the agreement between the assessee-company and the firm was not disputed. The Supreme Court observed that so long as the agreement whereunder the said payment was made was not held to be a mere device or a mere screen, the payments in question could not be treated as payment made to the directors as directors. The payments were made by way of consideration for allowing the assessee-company to use the valuable right belonging to them, namely, the brand name. Such a payment, the court observed, could be liable to be scrutinised under Sub-section (2) of Section 40A but certainly did not fall within the four corners of Section 40(c) of the said Act.


(6.) In this case both the Commissioner of Income-tax (Appeals) as well as the Tribunal have found as a matter of fact that the assessee-company was able to secure the consultancy agreement with the Boeing Company of U. S. A. only because it was able to secure and make available to the Boeing Company the personal services of Sri K.N. Tapuria. It was also found as a matter of fact that Sri Tapuria was never a director of the company. Sri Tapuria became a director of the company only on January 19, 1983, on which date the assessee-company entered into an agreement with Sri Tapuria to ensure and make available the personal services of Sri Tapuria to the Boeing Company. It was clearly understood between the assessee-company and Sri Tapuria that Sri Tapuria will negotiate for and on behalf of the assessee with the Boeing Company of U. S. A. and arrange to get a consultancy agreement executed in favour of the assessee-company. It was under this agreement that the assessee-company was able to receive service charges of Rs. 25,50,000 in the previous year under reference and much higher amounts in the later years. It has been found as a matter of fact that the Boeing Company would not have appointed the assessee-company for rendering necessary services in India unless the assessee-company was able to ensure the personal services of Sri Tapuria being made available to the Boeing Company as an adviser and consultant. It is also an admitted fact that Sri Tapuria had considerable experience in the aforesaid line of business and had also good contact with the officials of the Boeing Company in the U. S. A. and it was with his personal efforts that in spite of keen competition the company was able to secure the consultancy contract for rendering various services with the Boeing Company of U. S. A. The subsequent letter of the Boeing Company addressed to the assessee-company on February 15, 1986, makes it quite clear that they were highly appreciative of the valuable services rendered by Sri Tapuria and they expressed their desire to further renew the agreement only on the understanding with the assessee-company to the effect that the assessee-company must ensure the continued personal services of Sri Tapuria being made available to the Boeing Company. These facts found by the Commissioner of Income-tax (Appeals) and upheld by the Tribunal, make it quite clear that Rs. 7,25,000 was paid by the assessee-company to Sri Tapuria not in his capacity as a director of the company but as an adviser and consultant and for rendering specific and valuable services to the Boeing Company of U. S. A. Such a payment, in our view, does not fall within the four corners of the Section 40(c) of the said Act. It is nobody's case that the payment of Rs. 7,25,000 was either excessive and unreasonable having regard to the legitimate business needs of the assessee-company or the benefits derived by it or accruing to it therefrom.


(7.) It is judicially settled that a director may have transactions with the company in his capacity other than that of a director. Such dual capacities are not alien to the concept of the corporate entity of the company and its relation with its directors. Where the director deals with the company not as a director but as a person otherwise than in his role as a director, the provisions of Section 40(c) shall not touch such transactions. Here, the question is not a question of excessiveness or unreasonableness. The question is whether the consultant with whom the company entered into an independent contract for rendering consultancy service as an expert could be said to have received the same consultancy fee paid to him by the company as director's remuneration after his appointment as a director. The answer appears to be in the negative. His becoming a director does not alter his original character as consultant to the company rendering services as such.


(8.) He donned the office of director only for facility of operation of the agency agreement with the foreign principal. Being a director, the consultant, besides rendering consultancy service as per his consultancy agreement with the company, could have the authority of dealing and negotiating with the foreign principal on behalf of the company. The source of his receipt of the consultancy fee is, however, not his relation with the company as one of its directors, the source is the consultancy agreement with the company which subsisted notw

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ithstanding his appointment as the director. (9.) The services rendered in his capacity as a consultant are extraneous to the office of director that he has been holding. If the payment is extraneous to his function as a director then the overall ceiling limit of Rs. 72,000 is not to operate. This principle has analogy with the principle which the Supreme Court has enunciated in Bharat Beedi Works Pvt. Ltd. 's case [1993] 201 ITR 1063. (10.) It is an admitted fact that the retention of Mr. Tapuria was a necessary condition of the agreement which the foreign party entered into with the assessee-company. His appointment as a director, therefore, could be said to be a step taken by the company towards ensuring direct and closer association with Mr. Tapurin who is pivotal to the entire business of the company. (11.) The fact that the same amount of consultancy fee was to he paid to him even if he was not brought in as the director clearly shows that the fee paid has nothing to do with his holding the office of director. The appointment as director would have conceivably the only object of securing the consultant as an insider as well to eliminate the element of uncertainty for the success of the business but whatever further benefit or services the company received by having Mr. Tapuria as a director is not in effect remunerated by any extra sum. This is also a pointer that the payments received by him from the company were not for the services that he rendered as its director but as its consultant which the company would have to pay even without his appointment as a director. (12.) It is not a case that excessive generosity at the expense of the revenue as practised by some erring companies for the benefit of the directors or persons controlling their affairs, has been shown to the said director. (13.) In this view of the matter, we answer the question referred to us by the Tribunal in the affirmative and in favour of the assessee. There will be no order as to costs.
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