Crompton Parkinson (Works) Private Ltd. vs Its Workmen and Others

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 756 and 757 of 1957

Decision Date: 6 May 1959

Coram: Natwarlal H. Bhagwati, S.K. Das, P.B. Gajendragadkar, K.N. Wanchoo

The case titled Crompton Parkinson (Works) Private Ltd. versus Its Workmen and Others was decided by the Supreme Court of India on 6 May 1959. The judgment was delivered by a bench consisting of Justices Natwarlal H. Bhagwati, S. K. Das, P. B. Gajendragadkar and K. N. Wanchoo. The petitioner was Crompton Parkinson (Works) Private Ltd., a company incorporated in Bombay, and the respondents were its workmen and other persons. The official citation of the decision is 1959 AIR 1089 and 1959 SCR Supplement (2) 936, with subsequent references including 1960 SC 819, 1969 SC 612 and others. The dispute concerned the applicability of provisions relating to industrial disputes, bonus, gross profits, allowable expenditure, service fees, available surplus and the propriety of deducting bonus as a prior charge. At the time the petitioning company was a wholly owned subsidiary of the British firm Crompton Parkinson Ltd. In 1947 the two companies entered into a Technical Aid Agreement according to which the Indian subsidiary agreed to pay its parent five per cent of the net value of its sales each year as a service fee. The service fee was intended to cover the use of the parent’s patterns, valuable designs, technical assistance, research benefits and other ancillary facilities. Because the subsidiary could rely on the parent’s technical knowledge and research, it did not need to maintain a separate research establishment, which would have required expenditure far greater than the fee it paid. The agreement obtained prior approval from the Government, the income-tax authorities annually allowed the fee as a legitimate business expense, and the Reserve Bank of India sanctioned the remittances. When the workmen claimed bonus, the Industrial Tribunal calculated gross profits and reduced the allowable expenditure on the service fee to one fourth, asserting that the fee was excessive, not commercially necessary, and largely represented capital expenditure. In determining the available surplus, the Tribunal deducted as a first charge bonus equal to four and a half months’ basic wages before accounting for depreciation and income tax, contrary to the Full Bench formula. The Supreme Court held that the entire amount paid as service fee should be treated as a proper and allowable expenditure. The Court explained that unless it is clearly established that a payment is a sham or made with the specific intent of reducing profits to deprive workmen of bonus, the Tribunal cannot replace the commercial judgment of the company and its directors. The service fee was characterized as a genuine expense arising from a binding contractual obligation, breach of which could have serious business consequences for the company. The Court further ruled that the Tribunal erred in treating the bonus as a prior charge before accounting for the recognized items of prior charges. Consequently, the Tribunal’s method of deducting the bonus before the recognized prior charges was deemed improper and contrary to established principles.

In this matter, the Court noted that any departure by a Tribunal from the Full Bench Formula should be discouraged, and it affirmed the principle established in Associated Cement Companies Ltd. v. Its Workmen, Civil Appeals Nos. 459 and 460 of 1957, decided on 5 May 1959. The judgment was delivered in the civil appellate jurisdiction concerning Civil Appeals Nos. 756 and 757 of 1957, which were filed by special leave against the award dated 8 January 1957 rendered by the Industrial Tribunal, Bombay, in References (IT) Nos. 109 and 147 of 1956. The award had been published in the Bombay Government Gazette on 17 January 1957, Part II, pages 351-364. The Court identified the parties as Crompton Parkinson (Works) Private Ltd., referred to as the company, which appealed the portion of the award relating to the workers’ demand for a bonus for the financial year 1954-55. The factual background, as drawn from the evidence placed before the Tribunal, was then set out. The company had been incorporated in India in 1937, with its registered office in Bombay. Its authorized capital amounted to Rs 75 lacs, divided into 75,000 ordinary shares of Rs 100 each, of which Rs 60 lacs had been issued, subscribed and fully paid. At the time of its formation, the company was wholly owned by the British parent, Crompton Parkinson Ltd., hereafter called the Parent company. Commencing operations in 1937, the company’s business involved manufacturing electrical equipment, including transformers, motors, fans, starters, and switch-gears, and selling those products in the market. All goods produced by the company were manufactured entirely in accordance with patterns, designs, specifications and technical processes developed by and belonging to the Parent company, which made these designs available to the company. The products were marketed under the trade names and marks of the Parent company, namely “Crompton Parkinson”, “Crompton”, “Parkinson” and “C. P.” Between 1937 and 1947, the company’s business was described as being in a developmental and progressive stage, and it was acknowledged that the Parent company had not charged the company for a number of services and facilities it provided. In 1947, after the company’s business had become firmly established, the two companies entered into an agreement to provide, on a long-term basis, the continuation of technical assistance, service and other facilities that the Parent company supplied and upon which the company was wholly dependent. The Court recorded that this agreement, described as a technical aid agreement commonly used between Indian manufacturing concerns and their foreign associates, was intended to promote industrial development in the country. The agreement had been executed on 12 August 1947 and provided that for a period of twenty years the Parent company would render various facilities and services to the company, including the use of latest designs and manufacturing information, advice on suitable machinery and equipment, and supply of machinery, equipment, raw materials and manufacturing parts at cost, thereby enabling the company to benefit from bulk-purchase terms secured by the Parent company.

The agreement that was entered into on August 12, 1947 is described as a form of contract that is frequently used between manufacturing and industrial enterprises in India and their corresponding parent or affiliate companies located abroad, and such contracts are generally referred to as “Technical Aid Agreements.” The Court noted that this type of agreement had obtained the approval of the Government of India with the purpose of encouraging industrial development in the country. Under the terms of the agreement, which was to remain in force for a period of twenty years, the parent company undertook to supply the Indian company with a range of facilities and services. Among the services enumerated were, first, the permission to use the most recent designs, manufacturing information and production methods that had been discovered or developed by Crompton Parkinson Ltd.; second, the provision of full information and advice concerning the most appropriate machine tools, production machinery and equipment, together with guidance on their correct operation and use; third, the supply, at cost, of machinery, equipment, raw materials and manufacturing components, a benefit that enabled the appellants to enjoy the advantages of bulk-purchase terms that Crompton Parkinson Ltd. obtained for its own raw-material acquisitions; fourth, access to the technical, mechanical and financial management expertise of the parent company’s executives; fifth, the service of the parent company’s technical experts and personnel; sixth, facilities for the training of selected employees of the petitioners at the works of Crompton Parkinson Ltd.; and seventh, a licence to use on the appellants’ products the world-famous trademarks “Crompton Parkinson”, “Crompton”, “Parkinson” and “C. P.” that belong to Crompton Parkinson Limited. In return for all the royalties, licence fees and other considerations that would normally be charged for such services, the Indian company agreed to pay the parent company a service fee calculated at five per cent of the net value of the company’s sales each year. The Court recorded that for the financial year 1954-55 the company actually paid the required service fee, and after deducting Indian income tax, the amount was remitted to the parent company. Shortly after the agreement was executed, 26 % of the company’s shares were acquired by Messrs. Greaves Cotton Co. Ltd., an Indian company, causing the company to cease to be a wholly owned subsidiary of the parent company. It was observed that during the negotiations for the agreement, parallel negotiations were also taking place for the share transfer to the Indian company, and that the Indian company had been informed of the proposed terms, including the payment of five per cent of net sales, and had approved those terms. On August 25, 1955, the General Engineering Employees Union, representing the workmen who are respondents Nos. 1 and 2, presented certain demands to the company. Because no agreement was reached, the dispute was referred to the Conciliation Officer. When conciliation failed to produce a settlement, the Conciliation Officer submitted a report to the Government of Bombay under subsection 4 of section 12 of the Industrial Disputes Act, 1947.

The Government of Bombay examined the report submitted by the Conciliation Officer and, relying on the authority granted to it by sub-section 5 of section 12 of the Industrial Disputes Act, 1947, issued an order on 6 August 1956. That order referred the disputes concerning the company and its workmen—excluding those who were members of the Watch and Ward staff—to the Industrial Tribunal for adjudication. The reference was recorded as Industrial Tribunal case number 109 of 1956. Subsequently, by a separate order dated 10 October 1956, the same Government referred the disputes that involved the Watch and Ward staff to the same Tribunal, and that reference was entered as Industrial Tribunal case number 147 of 1956.

On 10 September 1956, the General Secretary of the General Engineering Employees Union filed a statement of claim on behalf of the workmen who were not part of the Watch and Ward staff, in the matter identified as Industrial Tribunal case 109 of 1956. The claim sought, among other reliefs, that every workman receive a bonus calculated either as three-and-one-third percent of his earnings for the year 1954-55 or, alternatively, a proportional bonus equal to six months’ basic wages. The basic wage was to be measured on the daily rate that the workmen earned on 30 June 1955, and the bonus was to be awarded without any conditions attached. In supporting the claim, the Union asserted that during 1954-55 the company had recorded huge profits, that its business had expanded dramatically with a corresponding increase in production, and that the wages paid to the employees were far below the standard of a living wage and bore little relation to the very high salaries received by the company’s officers. The Union further urged the Tribunal to consider the company’s practice of writing off substantial sums as service fees payable to the parent company. In response, the company submitted a written statement contesting the Union’s view. While the company acknowledged that it had made reasonable progress, it rejected the assertion that the progress had been unusually rapid or phenomenal. The company stated that it had managed to accumulate only modest reserves, and despite a higher turnover, its profit for the year in question was low because of intense competition. It maintained that the wages paid to the workmen were comparable with those paid by similar enterprises. The company also explained that the service fee paid to the parent company represented consideration for the use of patterns, designs, technical assistance, research benefits and ancillary services. For the purpose of the reference, the company attached a copy of its audited balance-sheet and profit-and-loss account for the fiscal year 1954-55 as a confidential exhibit, showing the 5 percent service fee as an item of expenditure.

In the proceedings, the company presented as a confidential exhibit the audited balance-sheet and profit-and-loss account for the financial year 1954-55. In that profit-and-loss statement the company had displayed a service fee calculated at five per cent of turnover, and it had recorded that amount as an item of expenditure. Subsequently the Union, acting on behalf of the workmen who were part of the Watch and Ward staff, lodged a statement of claim identified as Reference (IT) No. 147 of 1956. That claim concerned certain special demands of those workmen, and the company answered those demands by filing its written statement. The Court noted that neither the Union’s statement of claim nor the company’s written statement needed to be examined further because they did not bear on the specific question of the bonus payable to the workmen. While the references were being heard together, the workmen, through their counsel, submitted to the Tribunal that the service fee paid by the company was unwarranted and that, for the purpose of calculating the bonus for the year 1954-55, the fee should be excluded from the total expenditure. In response, the Tribunal directed the company to bring on record, by way of an affidavit, every fact and circumstance that related to the payment of the service fee. The company objected to the workmen’s request, arguing that the workmen were not entitled to challenge an expense that had actually been incurred in the ordinary course of business, recorded in the audited accounts, and that the expense had already been audited and passed. The company further contended that, irrespective of the workmen’s objection, the payment of the fee was fully justified and reasonable. Nevertheless, adhering to the Tribunal’s order, the company filed on 18 December 1956 an affidavit that had been affirmed on 14 December 1956 by Shri V. V. Dhume, who was the Secretary of the company. The affidavit set out the relevant facts and circumstances concerning the service fee. At the further direction of the Tribunal, the company also produced a copy of the agreement dated 12 August 1947. Shri V. V. Dhume was examined before the Tribunal and his oral testimony was formally recorded. The material provisions of the 1947 agreement, as previously summarised, established that every article manufactured by the company was produced wholly in accordance with the patterns, designs, specifications and technical processes that had been developed by the Parent company and that the Parent company made these intellectual assets available to the company. Moreover, the company sold its products exclusively under the trade names and marks that belonged to the Parent company. There was no dispute that, by virtue of this arrangement, the company enjoyed the benefit of the Parent company’s accumulated knowledge, experience, technical data, goodwill and the reputation that was attached to its products. The evidence on record made it clear that the manufacture of the specialised electrical goods and equipment produced by the company constituted a highly specialised and competitive business, which required the use of the technical expertise and facilities described in the agreement.

In order to remain current with the most up-to-date techniques for manufacturing specialised electrical equipment, the company would ordinarily have to operate its own research laboratories and employ specialised staff who could devise new methods, innovations and processes. The evidence showed, however, that the company did not maintain a separate research establishment of its own. Instead, the company derived the benefit of the Parent company’s invaluable services pursuant to the Technical Aid Agreement. According to the testimony of Shri V. V. Dhume, the service fee that the company paid to the Parent company was, to a substantial degree, a simple reimbursement of the expenses that the Parent incurred in maintaining and operating its own research department and in providing those facilities to the company. Shri V. V. Dhume further explained that, had the company chosen to maintain its own research department to obtain comparable services and facilities, the annual outlay of the company would have far exceeded the service fee that it actually paid to the Parent. The affidavit of Shri V. V. Dhume also indicated that the independent shareholders who had acquired a twenty-six percent stake in the company around the time the Technical Aid Agreement was executed had willingly accepted that agreement. In addition, the agreement had obtained the approval of the Government of India through the Ministry of Finance as well as the Ministry of Commerce and Industry. Year after year, the income-tax authorities had allowed the full amount of the service fee paid by the company to the Parent company as an expenditure incurred wholly and exclusively for the purposes of the company’s business. Likewise, every payment and remittance representing the service fee had been sanctioned by the Reserve Bank of India since 1947. The payment of the service fee therefore represented a binding contractual obligation on the company, enforceable by law; a breach of that obligation could lead the Parent company to cancel the agreement, depriving the company of the services and facilities it received and possibly preventing the company from continuing its business.

The workmen’s counsel did not conduct a serious cross-examination of Shri V. V. Dhume on these matters, and the workmen themselves did not produce substantive evidence on these questions. The Tribunal rendered its award on both references on 8 January 1957. Regarding the service fee, the Tribunal held that (i) the amount of service fee paid by the company to the Parent company was excessive and beyond the requirements of commercial necessity and was allowable as an expense only to the extent of one quarter of the amount, and (ii) that in any event even if the commercial necessity of the payment could not be challenged, a large part of the payment was in the nature of capital expenditure and that

The Tribunal held that only the remaining portion of the service fee, which in effect represented one-quarter of the total amount, could be treated as a revenue expense for the purpose of calculating the surplus that was available for payment of the bonus to the workmen. Accordingly, the Tribunal described its treatment of the service fee as having “pruned it down.” In the detailed computation that the Tribunal prepared to determine the surplus under the bonus formula, which was set out in a document identified as confidential exhibit T-1, the Tribunal permitted only Rs 2 lacs of the total Rs 7.67 lacs actually paid as service fee to be deducted as an expense. The balance of Rs 5.67 lacs was added back to the profit figure. The same confidential exhibit also shows that the Tribunal, as a first charge, deducted an amount equivalent to four and a half months’ basic wages as a bonus before allowing for depreciation and tax. The Tribunal justified this step on the ground that, in its view, income-tax should not be taken as a prior charge on the gross profits in preference to the bonus. By doing so, the Tribunal did not strictly follow the established bonus formula but introduced variations to it. The formula requires the Tribunal to first determine the surplus after accounting for the specific prior charges mentioned in the formula and then, after considering all material circumstances, to allocate that surplus among three interests: the industry, the shareholders, and the workmen. Deducting the bonus as a prior charge before the recognised prior charges, in the Tribunal’s opinion, reversed the proper order of calculation, effectively “putting the cart before the horse.” This approach, according to the Court, failed to give effect to the bonus formula and amounted to an ad-hoc determination that could differ depending on the length of the proverbial foot of the Lord Chancellor, thereby risking chaos and industrial unrest.

The bonus formula itself was created by the Labour Appellate Tribunal in 1950, and it has been repeatedly endorsed by this Court in numerous decisions, where it has been described as having functioned satisfactorily. In the Court’s earlier judgment in the appeals of Associated Cement Companies Ltd. v. Its Workmen, the Court expressly disapproved of any departure from the formula by individual Tribunals, observing that such departures were not conducive to harmonious and peaceful relations between workmen and their employers. At present, the only remaining issue for decision concerns whether the Tribunal’s award regarding the service fees was correct. The Tribunal based its conclusion on the premise that the “commercial necessity” test, which income-tax authorities apply to decide if an expenditure is allowable under section 10(2)(xv) of the Indian Income-Tax Act, should also be applied by the Tribunal. However, the Tribunal overlooked the fact that the income-tax authorities are expressly empowered by section 10(2)(xv) to employ the commercial necessity test in order to determine taxable income, profits and gains after making appropriate allowances for expenditures.

In the matter before the Tribunal, the expenditure under dispute had been laid out and expended wholly and exclusively for the purpose of the business, but the Industrial Disputes Act contained no provision that required the Tribunal to examine such expenditure in the manner it chose. In the absence of cogent and compelling evidence that would lead to a definite finding that the alleged expenditure was a sham or that it had been made with the express purpose of minimizing profits so as to deprive the workmen of their bonus, the Tribunal was not empowered to substitute its own judgment about what was commercially justified for the judgment exercised by the company’s directors, to whom the law entrusts the management of the enterprise. The Tribunal had entirely overlooked the fact that the company’s accounts had been duly audited by auditors appointed by the company and that those auditors had, in accordance with the Indian Companies Act, certified that the accounts were prepared in conformity with law and presented a true and correct view of the state of the company’s affairs (1) [1950].S.C.R 925. Moreover, the Tribunal paid no regard to the evidence on record showing that the income-tax department had treated the service fee as a legitimate revenue expense and had allowed the whole amount of the fee as a deduction each year on the ground that it was wholly and exclusively incurred as a matter of commercial necessity of the company’s business. The Tribunal also failed to notice that the remittances to the parent company had been authorized by the Reserve Bank, which constantly scrutinises payments to non-residents to prevent unjustified outflows, and that both the Ministry of Finance and the Ministry of Commerce and Industry had approved the payment of the service fee as provided in the agreement. A conclusion drawn by the Tribunal without having considered this evidence amounted to an error of law and could not be sustained. In addition, the Tribunal appeared to have been influenced by three particular facts: first, that the company had not paid any service fee during the period 1937-1947; second, that the agreement was executed on 12 August 1947, three days before the attainment of independence; and third, that at the date of the agreement the company was a wholly owned subsidiary of the parent company. Regarding the first point, the explanation could be that the business was still in a developmental stage during that decade, and the absence of fees in that period could not reasonably be taken as a reason to disallow them in later years, especially when negotiations for a substantial share acquisition by an Indian company were ongoing at the time of the agreement’s execution. The fact that no fees were charged while the company was a 100 percent subsidiary therefore did not justify their future denial.

The Court observed that negotiations for acquiring a substantial block of shares by an Indian company were proceeding simultaneously with the negotiations for executing the service agreement, and that, in fact, twenty-six percent of the shares were acquired by Messrs. Greaves Cotton Co. Ltd. The Court further noted that the service fee under the agreement had been paid year after year from 1947 up to the bonus year that was the subject of the present dispute. The Court rejected the second reason advanced by the Tribunal as untenable; it held that the anticipation of a major constitutional change could legitimately have motivated the parties to place the legal relationship between the company and its Parent on a firmer and more permanent footing. The Court pointed out that the Tribunal had overlooked the observation of Shri V. V. Dhume, namely that the payment of a service fee for services of this nature is a common feature in India. Moreover, the Court found that the reasonableness and legality of such payments were reinforced by the fact that neither the income-tax authorities nor the Reserve Bank of India had raised any objection to the fee. Regarding the third reason relied upon by the Tribunal, the Court emphasized that shortly after the execution of the agreement an Indian company acquired approximately twenty-six percent of the shares, and that from that time onward the independent shareholders of that Indian company had continuously accepted the service agreement without protest. The Court also observed that the award failed to disclose any justification for the Tribunal’s reduction of the claimed amount to one quarter of the sum actually paid by the company. After carefully considering the evidence on record, the Court concluded that the portion of the award that disallowed the majority of the service fees could not be supported or upheld. The Court referred to the Tribunal’s own finding that, if the entire service fee were allowed, the surplus thus created would be sufficient to pay a bonus of one month’s basic wages to the workmen. The Court noted that the company had raised no objection to the payment of a bonus equal to one month’s basic wages, subject to the conditions stipulated in the award, and that the company had, in fact, made such payment since the date of the award. Consequently, the Court allowed the appeals in part, directing that the Tribunal’s award be varied and modified so that the workmen who are respondents to the appeals would receive only one month’s basic wages as bonus instead of the two and one-half months’ basic wages originally ordered, subject to the conditions laid down in the award. The Court further recorded that the company had already paid this bonus to the respondents and that no further bonus remained payable for the year 1954-55. Finally, the Court ordered that each party bear its own costs of the appeals.