Ahmedabad Manufacturing And Calico... vs Comissioner Of Excess Profits Tax

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 14 May, 1959

Coram: M. Hidayatullah

In this case the Supreme Court of India considered an appeal filed by special leave against a judgment and order of the Bombay High Court dated 27 August 1954. The appealed judgment involved the Ahmedabad Manufacturing and Calico Printing Co. Ltd., Ahmedabad, which the Court referred to as the assessee company. The High Court had been asked by the Income-tax Appellate Tribunal, Bombay, to answer two questions. It answered the first question in the negative and declined to answer the second question because, in its view, the second question did not arise once the first question was answered. The two questions presented to the High Court were: (1) whether, in law, an employer’s obligation to pay a certain bonus obliges the Excess Profits Tax Officer to allow that bonus as a deduction and thereby prevents the Officer from exercising discretion under rule 10(1) of the First Schedule of the Excess Profits Tax Act; and (2) if the answer to the first question is in the affirmative, whether, on a true construction of the agreement between the assessee and its employees together with the Provident Fund Rules, the assessee company is obliged to pay the bonus without deducting excess profits tax. The factual background from which the reference arose was that the assessee company was a limited liability company engaged in the manufacture of textile goods and that the matters under consideration concerned three chargeable accounting periods corresponding to the calendar years 1943, 1944 and 1945. While assessing the company, the Excess Profits Tax Officer discovered that large payments had been made to five of the company’s employees during those periods and also found that, with respect to fifty-three other employees, the company had made excessive contributions to their provident funds. These payments and contributions were not calculated as a percentage of the profits earned by the assessee in the relevant years. Moreover, in computing the profits on which the statutory percentage was to be determined, the assessee company had not first deducted either income tax or excess profits tax. The Income-tax Officer upheld the action of the assessee, and the Appellate Tribunal likewise upheld the Excess Profits Tax Officer’s decision. However, the Tribunal declined to state a case for the High Court of Bombay. Consequently, the assessee company obtained a rule nisi from the Bombay High Court, which required the Department to show cause why it should not be ordered to state a case on two specific questions. The first of those questions asked whether, on a true and proper construction of the Provident Fund Rules and the five agreements with the five officer-employees, the amounts in question should be deducted first for the purpose of determining the bonus or commission payable to those employees.

In the proceedings before the High Court, two principal questions were put to the Court. The first question asked whether the excess profits tax that was determined to be payable should be deducted at the outset when calculating the amount of bonus or commission that was payable to the regular employees as well as to the five officer-employees. The second question concerned the legality of the Tribunal’s finding that the full amount of commission or bonus paid to the petitioners’ employees under the Provident Fund Rules and the corresponding rules, and also paid to the five officer-employees under their specific agreements, could not be allowed as a deduction in computing the taxable profits of the petitioners for the purpose of the excess profits tax.

The Court observed that when the rule nisi was presented for hearing, the Bombay High Court accepted the arguments advanced by counsel for the Department and altered the questions to the form that now opens this judgment. The Court noted this development because, during the hearing before it, a contention was raised that the proper questions to be considered were those that had arisen from the order of the Appellate Tribunal and that those were the questions originally formulated by the High Court in the rule nisi, rather than the questions that were later set out when the rule was made absolute.

The Court then turned to a few additional facts that were necessary to clarify the exact nature of the arrangement between the assessee company and the five employees concerning the payment of bonuses, as well as the rules that governed the company’s contributions to the provident fund. The Tribunal, in stating its case, had produced five agreements entered into with the employees. Four of those agreements were dated between 1933 and 1935, and a fifth agreement was dated 1944. Each agreement provided that the employees would receive, in addition to any salary, a bonus or remuneration that was calculated as a specified percentage of the profit according to a formula. The formula identified a percentage of the profit of a block of value expressed in rupees for the year in which the bonus or remuneration was payable. Although the exact percentage of the block value differed among the agreements, that variation was not material to the point being examined.

All of the agreements shared a common condition: the term “profits” was defined as the company’s profit for each complete official year as shown in the balance-sheet for that year, before any deduction for depreciation, income-tax, or super-tax. Regarding the provident fund, the Court explained that the Provident Fund Regulations had come into force on 30 June 1935 and had been recognized by the Commissioner of Income-tax in accordance with the Rules relating to Recognised Provident Funds that had been framed by the Governor-General in Council on 15 March 1930. The amount that the company was required to pay under the fund was determined by Regulation 12(b), which provided that if the profits of the company amounted to…

The provision stated that when the cost value of a block, as shown in the balance-sheet for a particular year, was four per cent or more, the bonus payable by the company to an employee would be calculated by multiplying the profit for that year by one hundred, dividing by the block value for that year, and then multiplying by a pre-assigned constant “R’’ that corresponded to each appointment. Regulation thirteen further explained that the term “profits for a year’’ meant the amount shown in the company’s balance-sheet for that year before allowing for depreciation and income-tax charges, but after providing for the bonus. A dispute subsequently arose as to whether the phrase “income-tax and super-tax’’ was intended to include the excess profits tax, which had been introduced in 1940, and whether the Officer responsible for excess profits tax, by virtue of the authority granted under rule twelve (1) of the First Schedule of the Excess Profits Tax Act, 1940, could order that the deduction of excess profits tax be made before applying the percentage stipulated in the bonus formula. Rule twelve (1) provided that, in computing the profits of any chargeable accounting period, no deduction could be allowed for expenses exceeding the amount that the Excess Profits Tax Officer deemed reasonable and necessary, taking into account the requirements of the business and, in the case of directors’ fees or other service payments, the actual services rendered; the rule further required that the Officer obtain prior authority from the Commissioner of Excess Profits Tax before making any disallowance. In the assessment year 1944-45, which corresponded to the chargeable accounting period ending on 31 December 1943, the Income-tax Officer did not allow the company’s claim for excess profits tax in the income-tax assessment. In that same year, the Excess Profits Tax Officer, acting under the quoted rule, also disallowed the claim for excess profits tax. For the two subsequent assessment years, covering the chargeable periods ending on 31 December 1944 and 31 December 1945 respectively, the Income-tax Officer calculated assessable profits by permitting the employee bonus and the contribution to the provident fund on the basis of net profits after deduction of the excess profits tax. The Excess Profits Tax Officer again took the same action, not only accepting the Income-tax Officer’s assessment but also exercising the special power conferred on him by rule twelve (1). The Court then framed two questions: first, whether, in law, an employer’s obligation to pay a specified bonus obliges the Excess Profits Tax Officer to allow that amount as a deduction and thereby bars him from exercising discretion under rule twelve (1) of the First Schedule of the Excess Profits Tax Act; and second, if the answer to the first question is affirmative, whether, on a true construction of the agreement between the assessee and its employees together with the Provident Fund Rules, the company is bound to pay the bonus without deducting excess profits tax.

The question posed to the Court was whether, assuming the affirmative answer to the first issue, a correct interpretation of the agreement between the assessee and its employees together with the Provident Fund Rules required the assessee company to pay the bonus without first deducting the excess profits tax. Mr. Palkhivala, appearing on behalf of the assessee company, maintained that several matters were not contested in the present dispute. He asserted that the authenticity of the agreements and the rules had never been challenged and that those agreements pre-dated the enactment of the Excess Profits Tax Act. He highlighted that the Commissioner of Income-Tax had formally recognized the Provident Fund Regulations at the time they were framed, and he emphasized that there was no disagreement over the meaning of the pertinent conditions set out in the documents between employer and employees. He concluded this part of his submission by observing that the reasonableness of the percentage applied to the bonus was also not contested by the Department. He further argued that the construction adopted by the assessee company—that the excess profits tax should not be deducted before the percentage was worked out—was reasonable, citing several authorities. Among these he referred to the opinion of Viscount Simon, Lord Justice of Appeal, and Lord Macmillan in the case of L.C. Ltd. v. G.B. Ollivant, Ltd., (1945) 13 ITR (Sup.) 23. He also mentioned three decisions of Indian High Courts that endorsed a similar approach: N.M. Rayaloo Iyer and Sons v. Commissioner of Income-Tax, Commissioner of Income-Tax v. Delhi Flour Mills Co. Ltd., and Western Hosiery and General Mills v. Commissioner of Income-Tax. In addition, he cited the Allahabad High Court decision in Shyamlal Pragnarain v. Commissioner of Income-Tax as illustrative of the meaning of “reasonable” and of the considerations required to determine whether a particular deduction is reasonable. The purpose of citing these cases, he explained, was not merely to aid the interpretation of the documents but to demonstrate that the assessee’s practice of refraining from deducting the excess profits tax prior to applying the percentage could not be deemed unreasonable per se. He then moved to the principal contention of the litigation, namely that the order of the Excess Profits Tax Officer failed to explain why the deduction of excess profits tax was deemed necessary before the percentage could be applied. Counsel argued that if the documents could be read in a way that excludes the excess profits tax from the list of deductions to be made before the percentage is calculated, there was no evidence on which the Officer could base a finding of unreasonableness of the payments. Consequently, he maintained that the correct issues for consideration were those initially raised by the High Court, and that the amended questions answered by the High Court did not reflect the true dispute between the parties.

In this case, the Court observed that the rule nisi and the amended questions presented before the High Court did not capture the true dispute between the parties, yet the High Court proceeded to answer those questions. The order issued by the Excess Profits Tax Officer was based on a decision of the Bombay High Court reported in Walchand & Co. Ltd. v. Hindustan Construction Co. Ltd., where the excess profits tax was examined by Chief Justice Chagla. Citing the judgment of Chief Justice Chagla, the Officer extracted rule 12 of the first Schedule of the Excess Profits Tax Act and stated: “In the light of the observations of the Chief Justice in the case of Walchand & Co. Ltd., quoted above, the payments of bonuses on the basis of net profits as per the balance sheet without deducting excess profits tax is clearly both unreasonable and unnecessary within the meaning of rule 12 of Schedule I of the Act. The employer and the employee cannot divide the profits including the item of excess profits tax payable which the employer himself is not allowed to retain. As required by the proviso to rule 12 of Schedule I after obtaining the prior authority of the Commissioner of Excess Profits Tax, the excess of bonuses payable arrived at on the basis of excess profits tax payable on balance-sheet profits without deduction of excess profits tax has been disallowed under rule 12 of Schedule I as follows.” The Officer then presented a detailed table showing the bonuses that would have been payable to six officers and the amounts that were disallowed under rule 12. The entries were as follows: S. No. 1, S. H. Gidwani, bonus claimed Rs 2,46,260, bonus disallowed Rs 1,06,583, excess Rs 1,39,427; S. No. 2, Bhogilal B. Shah, bonus claimed Rs 74,251, disallowed Rs 32,410, excess Rs 41,841; S. No. 3, J. A. Gandhi, bonus claimed Rs 64,621, disallowed Rs 25,449, excess Rs 39,172; S. No. 4, A. C. Shah, bonus claimed Rs 29,700, disallowed Rs 12,964, excess Rs 16,742; S. No. 5, A. N. Tankaria, bonus claimed Rs 14,850, disallowed Rs 6,482, excess Rs 8,386. In addition, the Officer noted that fifty-three employees were admitted to the benefits of the Provident Funds Scheme as per a list attached to the record, with contributions of Rs 2,45,550, disallowed Rs 1,04,043, resulting in an excess of Rs 1,36,690. The total amount disallowed under rule 12 of Schedule I was therefore Rs 3,82,240.

When the dispute was brought before the Appellate Tribunal, the Tribunal requested a further report from the Excess Profits Tax Officer. The Officer complied by submitting his findings and the reasons for concluding that the payments and contributions made by the assessee company were unreasonable and unnecessary. He explained that, unlike sections 10 and 10A of the Excess Profits Tax Act, the Officer was not required to prove the motive behind the payments. He asserted that if the payments are excessive in relation to the business requirements and the services rendered, rule 12 mandates that such excess amounts be disallowed. The Officer further observed that, in other textile mills located in Ahmedabad, no payments of a similar nature are made, and where bonuses are paid, they do not exceed three to six months’ salaries. He therefore argued that, based on this prevailing practice, there was no doubt that the bonus payments claimed in the present case were clearly excessive. The Officer also attached a detailed schedule of the payments made to the five officer-employees and to the fifty-three employees whose provident-fund contributions were made by the assessee company. He highlighted that, for four of the officers, the percentage of bonus to salary ranged from 412 per cent to 884 per cent when the bonus was calculated before deducting the excess profits tax, and that a fifth officer, who received no salary in the relevant year, was awarded a bonus of Rs 2,46,260. Moreover, the percentage of the provident-fund contribution to salary varied from 56 per cent to 553 per cent, which the Officer also described as excessive. He concluded his report with a definitive statement that the payments were unreasonable and unnecessary within the meaning of the statutory provisions.

In this case, the Court recorded that the Excess Profits Tax Officer had examined the practice of bonus payments in other textile mills located in Ahmedabad and observed that, where bonuses were actually paid, they never exceeded an amount equivalent to three to six months’ salary. From that observation the Officer concluded that the bonus payments claimed by the assessee company were manifestly excessive. He then attached a detailed schedule of payments made to five officer-employees as well as to fifty-three other employees whose provident-fund contributions had been made by the company. The schedule showed that for four of the employees who received a salary, the bonus expressed as a percentage of salary – calculated before deducting the excess-profits tax – ranged from four hundred and twelve percent to eight hundred and eighty-four percent. For the fifth employee, who did not receive any salary during the year, the Officer indicated that a bonus of at least Rs 2,46,260 had been paid in the relevant year. In addition, the Officer demonstrated that the contributions made by the company to the provident fund, when expressed as a percentage of salary, varied from fifty-six percent to five hundred and fifty-three percent, and he characterised these contributions as likewise excessive. He then reasoned that, based on the figures supplied in the attached lists, the company’s bonus contributions not only exceeded the contributions made by the employees themselves but were also several times greater than the total annual salaries paid to those employees. The Officer stated that had such excessive payments been foreseen at the time the fund was recognised, the Commissioner of Income-Tax would not have allowed the recognition of the fund without invoking rule 10 of the Provident Fund Rules, and the basis of the fund would have been altered. Consequently, the Officer concluded that, having regard to the requirements of the business and the actual services rendered by the persons concerned, the payments made to the five officers and to the fifty-three employees admitted to the benefits of the provident fund were clearly excessive within the meaning of rule 12(1) of Schedule 1. Counsel for the assessee company, however, contended that there was no evidence upon which the conclusion that the payments were unreasonable could be justified, and that the matter had been wrongly apprehended by the authorities. He argued that the Excess Profits Tax Officer could have acted only on one of two grounds: first, that a payment calculated without deducting the excess-profits tax was per se unreasonable and unnecessary; or second, that a payment to an individual employee or to his provident fund was unreasonable or unnecessarily large in view of the business requirements. The counsel maintained that the Officer had relied solely on the first ground, thereby not applying rule 12 of Schedule I but rather an informal “rule of thumb,” which produced inconsistent and startling results – for example, a few hundred rupees paid to one employee being deemed unreasonable while tens of thousands paid to another employee were not. He further submitted that no enquiry had been made as to whether the emoluments paid to any of the employees were unreasonable.

The Court observed that the enquiry did not raise the question of whether the emoluments paid to any of the employees were unreasonable. In the Court’s view none of the submissions advanced by the assessee company could be successful. Firstly, the contention that there was no evidence to support the Tribunal’s findings was misplaced. The thirteen questions forwarded by the assessee company never addressed the existence or the amount of any evidence; instead the company sought to rely on arguments that the regulations required deduction of income-tax, super-tax and excess profits tax before the percentages were applied, or alternatively that the term “profits” referred to ordinary trading profits and not to the residual amount after the payment of those taxes. Even question number eight, as drafted by the assessee, failed to consider whether the Tribunal’s decision was based on evidence or material facts.

Secondly, the Court noted that the assessee company appeared to have accepted the modified set of questions because it did not apply for special leave of the Court at that stage. Moreover, the statement of the case filed by the company made no reference to any allegation that the Tribunal had acted without evidence. The Court was of the opinion that there was indeed evidence upon which the Tribunal could conclude that the payments were unreasonably high in relation to the requirements of the business. The Excess Profits Tax Officer had prepared schedules showing the ratio of bonuses or additional payments to the salaries of the employees and the ratio of provident-fund contributions to salary, and had pointed out that no other concern made such extraordinarily high payments. The Tribunal also examined one employee who was present and gathered data concerning typical cases. All of this material was before the Tribunal when it rendered its finding.

The schedules annexed to the Excess Profits Tax Officer’s remand report were described by the Court as highly significant. Even the lowest payments appeared extraordinarily high and could not be justified as necessary for the business. A comparative study of similarly situated concerns was also made. The Officer concluded that it was unreasonable to apply the percentage before deducting the taxes. His reasoning was that, based on the facts set out, the payments to the five employees and the provident-fund contributions were unnecessarily large and unreasonable given the business requirements. Rather than analysing each individual case, the Officer insisted that the percentage should be applied only after all taxes had been paid by the assessee company. It was within the Officer’s discretion to hold that payments to an employee or contributions to the provident fund were unreasonable.

In this case the Court affirmed that the decision of the lower tribunal was correct. The Court explained that it had not been called upon to interpret the contracts that existed between the parties nor the statutory regulations that governed the matter. Because the Court was not invited to undertake that interpretative exercise, and because any conclusion reached that might have been unfavorable to the assessee company would have required such interpretation, the Court chose not to proceed with it. The Court further noted that even if it had been asked to interpret the agreements and regulations, it regarded such a step as unnecessary. The reason for this view was that the action of the Excess Profits Tax Officer was plainly founded on the specific rule under which the officer was authorized to act. Since the officer’s conduct fell within the scope of that rule, there was no basis for the Court to interfere with the officer’s determination. Accordingly, the Court held that the appeal could not succeed and therefore dismissed the appeal. The Court ordered that the costs of the proceedings be borne by the appellant, and it confirmed that the appeal was dismissed with costs.