The Commissioner of Excessprofits Tax, Madras v. N. M. Rayaloo Iyer and Sons

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 494 and 495 of 1958

Decision Date: 8 December 1960

Coram: J.C. Shah, J.L. Kapur, M. Hidayatullah

The case was styled The Commissioner of Excessprofits Tax, Madras v. N. M. Rayaloo Iyer & Sons and was decided on 8 December 1960 by the Supreme Court of India. The judgment was authored by Justice J.C. Shah, with Justices J.L. Kapur and M. Hidayatullah forming the bench. The official citation of the decision is reported as 1961 AIR 692 and 1961 SCR (3) 60. The matters before the Court involved provisions of the Excess Profits Tax Act, 1940 (Act 15 of 1940) relating to deductions for remuneration of a managing agent, the percentage of net profits after deducting outgoings, and the treatment of excess profits tax when included in outgoings. Relevant statutory sections cited included sections 2(16), 19, 21 and Schedule 1, clause (12) of the Excess Profits Tax Act, together with sections 10(2)(XV) and 10(2)(X) of the Income‑Tax Act of 1922. The central issue concerned the construction of an agreement governing commissions paid to branch managers and the admissibility of those commissions as deductions under the applicable tax statutes.

The respondents were a firm conducting business in dyes and chemicals under the name Colours Trading Company, with its head office located in Madurai and thirteen branch offices spread across various towns. The firm acted as the principal representative of the Imperial Chemical Industries (I.C.I.) in South India. Mr M was employed by the respondents as their General Manager. Under his employment contract, he was to receive a fixed remuneration of Rs 3,000 per annum plus a share of 12‑1⁄2 % of the net profits of the company, where net profit meant gross profit after deducting salaries, wages and other outgoings. Each branch was overseen by local managers and assistant managers, who received not only their monthly salaries but also annual and special bonuses and a dearness allowance. The respondents obtained commissions from I.C.I. at varying rates on the different products they sold. Effective 1 April 1944, I.C.I. introduced a special emergency commission of 5 % and recommended that the respondents could pass on 1 % of that commission to their sub‑distributors. The respondents asserted that they distributed commissions to their employees in accordance with I.C.I.’s recommendation, applying rates that ranged from 2 % to 7‑1⁄2 % and, in certain instances, as high as 12 %. Although the service agreement stipulated that commissions were payable to employees only when the net turnover in a year exceeded Rs 1,00,000, the respondents claimed to have paid generous commissions even when turnover fell considerably below that threshold. In the accounting year ending 12 April 1945, the scale of salaries for the employees was revised, resulting in each employee receiving an amount equal to two‑and‑a‑half times the enhanced basic salary, together with commissions that sometimes exceeded twelve times the basic salary. When the total income of the respondents for the financial years 1943‑44 and 1944‑45 was assessed for income‑tax purposes, the income‑tax Officer disallowed the payment of 12‑1⁄2 % of the net profits to Mr M. For the subsequent years 1945‑49, the Officer also disallowed the commissions paid to the branch managers and other employees, holding that such payments could not be allowed as deductions under the relevant tax provisions.

Considering every relevant circumstance, the Court observed that the remuneration paid to the employees was sufficient, and that any additional commission paid exceeded what could be regarded as reasonable or necessary. The Appellate Tribunal affirmed the order of the Income‑tax Officer, except in the case of the employee identified as M. In M’s case the Tribunal held that a payment equal to five per cent of the net profits, calculated without deduction of the Excess Profits Tax or Business Profits Tax, or a payment equal to twelve per cent after deduction of the Excess Profits Tax or Business Profits Tax, whichever amount was higher, was permissible as a deduction. The High Court, when referred for consideration, expressed several views. First, the Court held that, for the purpose of determining the net profits under the agreement with M, the excess profits tax could not be deducted. Second, the Court examined whether the bonus or commission paid to the employees might be allowed as a justified deduction under section 10(2)(X) of the Income‑tax Act and rule 12 of Schedule 1 of the Excess Profits Tax Act. The Court decided that the test of reasonableness of the expenditure must be assessed from the standpoint of a businessman, rather than by applying any subjective standard of a taxing officer. After reviewing the material provided, the Court found that there was nothing inherently unreasonable about the amounts of commission actually paid by the respondents to the branch managers and assistant managers.

The Court then articulated its holdings. First, it held that the question of whether, in computing taxable income, the commission payable to M under the agreement entered into with the respondents should be allowed before deducting the excess profits tax depended on the proper interpretation of the agreement. The Court explained that the expression “outgoing” in the agreement was not limited to ordinary business or commercial outgoings; it also encompassed the excess profits tax paid by the assessors. Consequently, the net profits on which M’s commission was to be calculated had to be computed after deducting the excess profits tax paid. The Court relied on the decision in Commissioner of Income‑tax, Delhi v. Delhi Flour Mills Co., Ltd., [1959] SUPP. 1 S.C.R. 28 for this principle. Second, the Court held that under clause 12 of Schedule 1 of the Excess Profits Tax Act, 1940, the responsibility to decide whether a deduction was reasonable and necessary rested with the Excess Profits Tax Officer, subject to review by the Tribunal. This decision must consider the requirements of the business and, where payments are for services, the actual services rendered by the persons concerned. The Court emphasized that the High Court could not, in exercising its jurisdiction on questions referred under the Excess Profits Tax Act, replace the officer’s judgment on what is reasonable and necessary, nor could it set aside the taxing authority’s decision merely by re‑appraising the evidence. If the High Court believed that the taxing authorities had erred in law by misinterpreting the evidence, applying an incorrect test, or acting perversely, the appropriate response was to state the correct legal principle in answer to the questions posed, leaving the factual determination of reasonableness to the taxing authorities.

The Court observed that the proper approach was to apply the genuine principles relevant to determining which deductions could be allowed, and to permit the tax authorities to decide whether the expenses were reasonable and necessary in view of the business’s needs. The Court further noted that there was substantial evidence supporting the conclusion reached by the Excess Profits Tax Officer, a conclusion that the Tribunal had also affirmed. Consequently, the Court held that the issue of whether the disallowance by the excess profits tax authorities of the commission paid to branch managers was justified under rule 12 of Schedule 1 of the Excess Profits Tax Act should have been answered affirmatively.

The judgment concerned two civil appeals, numbered 494 and 495 of 1958, filed under the civil appellate jurisdiction. Both appeals arose from the judgment and order dated 18 April 1955 of the Madras High Court in cases referred to as No. 53 of 1952 and No. 44 of 1953. Counsel for the appellant were represented by legal practitioners, while the respondent was represented by a team of counsel. The judgment was delivered on 8 December 1960 by Justice Shah.

The matters before the Court involved two appeals that had been granted certificates of fitness by the High Court of Judicature at Madras. Appeal No. 494 of 1958 stemmed from orders issued in certain excess profits tax appeals, whereas Appeal No. 495 of 1958 originated from orders issued in several income‑tax references, excess profits tax appeals, and business profits tax appeals. The respondents, the firm M/s N. M. Rayaloo Iyer & Sons, were identified as the assessees. This firm conducted its business principally in dyes and chemicals and acted as the chief representative in South India for the products of Imperial Chemical Industries Company (India) Ltd., hereinafter referred to as “I.C.I.”. During the period that was material to the appeals, the business operated under the name “Colours Trading Company”, with its head office at Madura and thirteen branch offices located in various towns throughout South India.

The firm had originally been organised as a partnership among three brothers: N. M. R. Venkatakrishna Iyer, N. M. R. Subbaraman, and N. M. R. Krishnamurti. On 13 April 1946, N. M. R. Subbaraman retired, and the share of N. M. R. Venkatakrishna Iyer was transferred to a private limited company named N. M. R. Venkatakrishna Iyer & Sons Ltd. Despite these changes in personnel, the business continued to operate under its original name and style. One of the sons, N. M. R. Mahadevan, was employed as the General Manager of the Colours Trading Company. By a letter dated 17 April 1940, the assessees agreed to pay Mahadevan a remuneration of Rs. 1,800 per annum together with a commission of 5 percent of the net profits of the Colours Trading Company, the net profit being calculated by deducting salaries, wages and other outgoings from the gross profit, without any deduction for capital. A subsequent letter dated 30 March 1943 fixed Mahadevan’s salary at Rs.

In this case, the Court recorded that Mahadevan’s annual salary was fixed at Rs 3,000 and that his commission was raised to twelve and one‑half per cent of the net profits of the Colours Trading Company. The Court further explained that the branch offices were run by local managers and assistant managers, each of whom received, besides their monthly salary, an annual bonus, a special bonus and dearness allowance. According to the Court, the assessees obtained from the Imperial Chemical Industries commission at rates that varied between seven and one‑half per cent and twelve per cent on different products sold to them. With effect from 1 April 1944, the I.C.I. permitted a special emergency commission of five per cent on all dyes and dye‑stuffs sold to the assessees. The Court noted that this special emergency commission was increased to fifteen per cent on all sales on or after 1 March 1945, but was later reduced to ten per cent on sales on and after 1 September 1946.

The Court stated that the appeals concerned the liability of the assessees to Excess Profits Tax for the chargeable accounting periods ending 13 April 1943, 12 April 1944, 12 April 1945 and 31 March 1946, and to Business Profits Tax for the chargeable accounting periods ending 12 April 1946, 31 March 1947, 13 April 1947, 31 March 1948 and 12 April 1948. The assessees contended that, under agreements executed from time to time for the accounts of the years 1942‑43 to 1947‑48, they had paid their employees a share in the special emergency commission received from the I.C.I., in addition to monthly salary, dearness allowance and both general and special bonuses. The Court recorded that the I.C.I., in its letter dated 24 January 1944 authorising the emergency commission, recommended that one per cent of the five per cent commission allowed could be “passed on” by the assessees to their “sub‑distributors”. Accordingly, the assessees claimed that, following this recommendation, they paid commissions to employees ranging from one and one‑half per cent to four per cent. When the emergency commission was raised to fifteen per cent, the I.C.I., by a letter dated 23 February 1945, advised that six per cent of this commission could be passed on to sub‑distributors; the assessees asserted that they then distributed commissions ranging from two per cent to seven and one‑half per cent, and in some instances as high as twelve per cent.

The Court further observed that, under the service agreements, commission was payable to employees only if the turnover in dyes exceeded Rs 1,00,000 net in any year. Nevertheless, the assessees claimed that they paid commissions at generous rates to employees in several branches even when the turnover fell far short of that amount. The Court noted that, for the accounting year ending 12 April 1945, the assessees revised the salary scales of their employees and began granting dearness allowance and special bonus that together exceeded fifty per cent of the basic annual salary, together with an annual bonus equal to the basic salary. As a result of this revision, each employee received remuneration amounting to at least twenty‑one times his enhanced basic salary. In addition to this remuneration, the assessees asserted that they had paid a share in the commission which, in some cases, exceeded the amount already described.

In the assessment of the assessees’ total income for the financial years 1943‑44 and 1944‑45, the Income‑Tax Officer refused to allow the payment of a commission equal to twelve and one‑half percent of the net profits of the Colours Trading Company that had been paid to Mahadevan. For the subsequent assessment years 1945‑46, 1946‑47, 1947‑48 and 1948‑49 the same officer also disallowed the commissions that had been paid to the branch managers and other employees. The assessees appealed this disallowance, and the Appellate Assistant Commissioner set aside the order that had excluded the commission paid to Mahadevan. Following a decision of the Income‑Tax Appellate Tribunal in certain Excess Profits Tax appeals, the Commissioner allowed either five percent of the net profits without deduction of Excess Profits Tax or Business Profits Tax, or one hundred twenty‑one percent after deduction of those taxes, whichever amount was higher. The Income‑Tax Appellate Tribunal affirmed this order on further appeal. The Tribunal also affirmed the order that disallowed the emergency commissions paid to the branch managers and other employees and, in computing taxable income for the purposes of Income‑Tax, Excess Profits Tax and Business Profits Tax, added back all of those payments to the assessable total.

At the request of the assessees, the Tribunal referred two sets of questions to the High Court under section 66(1) of the Income‑Tax Act read with section 21 of the Excess Profits Tax Act. In Referred Case No. 44 of 1953, the questions were: (1) whether, in allowing a deduction under section 10(2)(xv) of the Income‑Tax Act, the Income‑Tax Officer is barred from examining whether the amount was paid wholly and exclusively for the purpose of the assessee’s business; (2) whether any material existed before the Tribunal to conclude that the commission paid to N. M. R. Mahadevan at one hundred twenty‑one percent before deduction of Excess Profits Tax or Business Profits Tax was not wholly and exclusively laid out for the purpose of the assessee’s business; and (3) whether the commission paid to the branch managers, assistant managers and other employees constitutes an expenditure laid out wholly and exclusively for the purpose of the business. In Referred Case No. 53 of 1952, the questions posed were: (1) whether the Appellate Tribunal erred in law in holding, based on letters dated 17 April 1940 and 30 March 1943 and the parties’ conduct, that the Excess Profits Tax payable by the assessee should be deducted from profits before calculating the twelve and one‑half percent commission payable to M. N. R. Mahadevan; (2) whether there was sufficient evidentiary material for the Tribunal to deem the twelve and one‑half percent commission on profits paid to Mahadevan unreasonable within the meaning of Rule 12 of Schedule 1 of the Excess Profits Tax Act; and (3) whether, given the facts and circumstances of the case, the disallowance by the Excess Profits Tax authorities of the commission paid to branch managers was justified under Rule 12 of Schedule 1 of the Excess Profits Tax Act.

In this case the Court noted that the substantive provisions dealing with allowances under the Excess Profits Tax Act and those under the Business Profits Tax Act – which replaced the former as of 30 March 1946 – were essentially identical for the questions presented. Consequently, any reference to the Excess Profits Tax Act for the period after that date was to be treated as a reference to the Business Profits Tax Act. The Court explained that, in the view of the High Court, the deductions claimed by the assessee should not be examined under section 10(2)(xv) of the Income‑Tax Act but rather under section 10(2)(x), which is a specific provision dealing with the deduction of commissions or bonuses paid to employees. The High Court further observed that, when assessing liability to Excess Profits Tax, the bonus or commission paid to the taxpayer’s employees could be allowed as a deduction pursuant to section 10(2)(x) of the Income‑Tax Act and rule 12 of Schedule 1 to the Excess Profits Tax Act. The High Court held that the case of Mahadevan presented no major difficulty; the only issue to be resolved was whether, in allowing a deduction of commission at the rate of 12½ per cent on net profits, the Excess Profits Tax paid by the assessee should be taken into account. Relying on a decision of the Punjab High Court in Commissioner of Income‑Tax, Delhi v. Delhi Flour Mills Ltd. (1), the High Court stated that Excess Profits Tax could not be deducted in computing net profits. However, based on the record, the question of whether the commission paid to branch managers and other employees was properly deductible could not be finally decided, so the High Court ordered a supplementary statement of facts from the Tribunal. After reviewing that supplementary statement, the High Court observed that the assessee had indeed distributed large sums from the emergency commission to its branch managers and assistant managers at rates considerably above the minimums recommended by the I.C.I., yet those rates remained within the percentages permitted by the I.C.I. as additional commission. The balance of the emergency commission retained by the appellants was also substantial. The Court concluded that the Tribunal needed to consider three factors: (i) the reasonableness of the commission in light of the conditions set out in section 10(2)(x); (ii) the reasonableness of percentages exceeding the I.C.I. minimums; and (iii) the necessity of preserving the reputation of the I.C.I. and the distributor in a period marked by rampant black‑marketing. The High Court further remarked that the Tribunal had not made a genuine attempt to analyse the evidence to justify its conclusion that only the I.C.I. minima were permissible and that nothing in the record demonstrated an unreasonable excess.

In its judgment, the High Court observed that the excess commissions paid by the assessors complied with the test of reasonableness prescribed by rule 12 of Schedule 1 of the Excess Profits Tax Act. The Court then considered whether the applicable test of reasonableness should be the one set out in section 10(2)(x) of the Income‑Tax Act or whether it ought to be assessed in the light of commercial expediency as provided by rule 12 of Schedule 1 of the Excess Profits Tax Act. It held that the expenditure had to be examined from the standpoint of a businessman rather than by applying any subjective standard that a taxing officer might employ. After reviewing the material placed before it, the Court found no element that was intrinsically unreasonable in the amount of commission actually paid by the assessors to the branch managers and assistant managers.

The Court further noted that the minimum rates recommended by Imperial Chemical Industries (I.C.I.) did not constitute the sole or an absolute benchmark for determining the reasonableness of the payments. It pointed out that the employees of the assessors already received regular salaries and bonuses. Consequently, a sub‑distributor who did not draw a salary would have been required to receive a portion of the basic commission itself. The Court explained that during the years in question the assessors obtained a windfall profit, which they were instructed to share with their employees. The emergency commission had been permitted by I.C.I. so that distributors could preserve I.C.I.’s reputation in the market despite the disturbed conditions prevailing at that time.

The Court observed that if the assessors, in order to protect both the reputation of I.C.I. and their own, distributed a liberal share of the emergency commission to their employees, it would be difficult to assert that such sharing was per se unreasonable. It emphasized that no prudent businessman engaged in that line of business, operating in those years and under the market conditions that existed—including extensive black‑marketing—would have refused to pay commission on such a basis. The Court then concluded that, although the assessors bore the burden of demonstrating entitlement to the deduction claimed under section 10(2)(x) of the Income‑Tax Act and rule 12 of Schedule 1 of the Excess Profits Tax Act, there was no evidence on record showing that, when viewed from a business perspective, payments exceeding the minima recommended by I.C.I. were unreasonable.

Accordingly, the High Court was of the opinion that the entire claim should have been allowed under both section 10(2)(x) of the Income‑Tax Act and rule 12 of Schedule 1 of the Excess Profits Tax Act, because the statutory requirements had been satisfied by the assessors. The Court therefore answered the questions concerning the disallowance of the commission paid to the assessors’ employees in the negative, holding that the disallowance was not justified under rule 12 of Schedule 1 of the Excess Profits Tax Act.

The two appeals, each accompanied by a certificate of fitness issued by the High Court, were filed against the orders that held the commission paid to an employee named Mahadevan to be unjustified under rule 12 of Schedule 1 of the Excess Profits Tax Act. The foremost issue that the Court had to determine was whether, in computing taxable income for the purposes of both the ordinary Income‑Tax Act and the Excess Profits Tax Act, the commission allowed to Mahadevan at twelve and one‑half per cent should be taken into account after reducing it by the amount of Excess Profits Tax that had already been paid. Under an agreement dated 17 April 1940, which was subsequently altered by an amendment dated 30 March 1943, Mahadevan was to receive a fixed remuneration of Rs 3,000 per year together with a commission equal to 121 per cent of the net profits earned by the Colours Trading Company. The High Court, when interpreting the phrase “net profits” in that agreement, held that the calculation must be made in accordance with commercial accounting principles and the principles laid down under the Excess Profits Tax Act, and consequently concluded that the Excess Profits Tax—a tax levied on profits—could not be deducted in arriving at the net profit figure.

In the present judgment the Court regarded the matter as one of proper construction of the contractual terms. It observed that the agreement placed Mahadevan on a basis of receiving a commission of 121 per cent on the net profits of the Colours Trading Company, where “net profits” were to be determined by subtracting from the gross profits of the business such items as salaries, wages and other outgoings. The term “outgoings” was not limited to ordinary business or commercial outgoings; the agreement expressly prohibited deductions for capital expenditure but did not contain any language indicating that “outgoings” should exclude the Excess Profits Tax paid by the assessee. Accordingly, there was no contractual or contextual basis for excluding the tax from the calculation of net profits. The Court also referred to the decision in Commissioner of Income Tax, Delhi v. Delhi Flour Mills Co. Ltd., wherein it had previously held that while the Excess Profits Tax formed part of the overall profit figure, it was not intended to be part of the “net profits” contemplated by the parties, because the parties envisaged net profits as the divisible profits after deduction of the tax.

Counsel for the Revenue did not dispute the High Court’s finding that, for the purpose of computing taxable income under the Income‑Tax Act, the commission paid to various employees was a permissible deduction under section 10(2)(x) of that Act. The only remaining question, therefore, was whether the same deduction could be allowed when assessing the Excess Profits Tax. Section 21 of the Excess Profits Tax Act provides that, among other provisions, the provisions of section 10 of the Income‑Tax Act shall apply to the Excess Profits Tax with any modifications that may be prescribed, and that references to “Income‑Tax” in that provision are to be read as references to the Excess Profits Tax. Moreover, section 2(19) defines the expression “profits” as the profits determined in accordance with Schedule 1 of the Act, which sets out the rules for computing profits for the purpose of the Excess Profits Tax.

In this case, the Court explained that the term “profits” meant the profits calculated in accordance with Schedule 1 of the Act, which set out the rules for computing profits for the purpose of the Excess Profits Tax Act. Schedule 1 contained Rule 12, which had been inserted by section 4 of the Excess Profits Tax Ordinance, 1943. Rule 12 provided that, in computing the profits of any chargeable accounting period, no deduction could be allowed for any expense that exceeded the amount the Excess Profits Tax Officer considered reasonable and necessary having regard to the requirements of the business, and, in the case of directors’ fees or other payments for services, the deduction could be allowed only to the extent of the actual services rendered by the person concerned. The rule further required that the Officer could not disallow any amount unless he had first obtained the prior authority of the Commissioner of Excess Profits Tax. Rule 12 also stated that any person dissatisfied with the Officer’s decision could appeal, within the prescribed time and manner, to the Appellate Tribunal. Finally, the rule authorised the Central Government, for chargeable accounting periods ending after 31 December 1942, to make rules for determining the extent to which deductions should be allowed in respect of bonuses or commissions paid. The Court was told at the bar that although the statute authorised the Central Government to make such rules, no such rules had actually been made. The Court noted that the Excess Profits Tax Act had been replaced, with effect from the year 1946, by the Business Profits Tax Act, 1947. That Act, by section 2, clause 16, likewise defined “profits” as profits determined in accordance with Schedule 1. By section 19, the provisions of the Indian Income‑Tax Act that were applied to the Excess Profits Tax Act under sections 21 and 21A continued to apply, provided that they were not inconsistent with the provisions of the Business Profits Tax Act as applied to the former Act. Clause 3 of Schedule 1 introduced a provision that was substantially similar to clauses 1 and 2 of clause 12 of Schedule 1 of the earlier Excess Profits Tax Act. Accordingly, for the purpose of the Business Profits Tax Act, the profits of a business had to be ascertained by reference to section 10 of the Income‑Tax Act, as modified by the directions contained in Schedule 1 of the Excess Profits Tax Act. By clause 12 of Schedule 1 of the Excess Profits Tax Act, a deduction in respect of expenses that exceeded the amount the Officer considered reasonable and necessary, having regard to the requirements of the business, and, in the case of payments for services, to the actual services rendered by the persons concerned, was not to be allowed. The Court observed that the amount of deduction to be allowed did not rest on any subjective satisfaction of the Officer.

In this case the Court explained that the test for allowing a deduction is based on objective standards of what is reasonable and necessary, taking into account the requirements of the business, and, where the deduction relates to payments for services, on whether the amount corresponds to the actual services rendered by the persons concerned.

The order issued by the Excess Profits Tax Officer may be examined by the Tribunal that has jurisdiction to hear appeals against the Officer’s order. Nevertheless, when the question is whether a deduction has been properly claimed, the primary responsibility lies with the Legislature, which has entrusted that duty to the Excess Profits Tax Officer. It is for the Officer, subject to possible review by the Tribunal, to decide if the deduction is reasonable and necessary in light of the business requirements and, in the case of service payments, whether the amount matches the actual services performed.

The High Court’s role under the Excess Profits Tax Act is only advisory. The High Court does not sit in appeal over the judgment of the taxing authorities. Consequently, if the taxing authorities, after considering the facts, conclude that an expense claimed as a deduction is not reasonable or necessary, the High Court cannot replace that judgment with its own view of what might be reasonable or necessary. Even where the High Court finds that the taxing authorities have erred in law—for example, by misinterpreting evidence, applying an incorrect test, or acting perversely—the Court may, in answering the questions referred to it, set out the correct principles governing the determination of permissible deductions. The Court then leaves it to the taxing authorities to apply those principles to decide the reasonableness and necessity of the expenses in the context of the business.

The Excess Profits Tax Officer, after a detailed examination, made several findings. First, the Officer held that the employees of the assessee firms were being amply remunerated through a combination of salary, a generous dearness allowance and an annual bonus equal to the basic salary. Second, the Officer observed that the emoluments of the employees had been increased year after year and that there was no material showing that the employees had persistently demanded higher emoluments. Third, the Officer noted that commissions were credited to the employees’ accounts at the end of the year and carried forward, but no actual payments were made to them. Fourth, the Officer concluded that the agreements produced by the assessee parties were fabricated with the intention of reducing tax liability. Fifth, the Officer found that the expenditure claimed as a deduction was not proved to have been laid out wholly and exclusively for the purpose of the business.

Taking these circumstances into account, the Officer held that the remuneration already paid to the employees was adequate and that any additional commission paid was in excess of what could be regarded as reasonable and necessary. The only criticism raised by counsel for the assessee firms concerned the Officer’s observation that, according to the profit and loss account of the firm, the net profit was Rs 20,487, leaving a share of Rs 6,800 for each of the partners, while some managers received amounts exceeding this figure.

In the present matter the Excess Profits Tax Officer had originally recorded the net profit of the firm as Rs 20,487, which would have left a share of only Rs 6,800 for each of the partners and, according to the officer, some of the managers received amounts in excess of that share. The Court observed that this calculation was based on a mistake, because the assessment order for the year 1945‑46 actually showed that the profit of the Colours Trading Co. was Rs 99,435, not Rs 20,487. Although the officer’s error in stating the profit figure was acknowledged, the Court held that the error did not alter the officer’s final conclusion. The assessees’ books of account for the year 1943‑44, which dealt with the dye‑business, also reflected a profit of Rs 99,435. From that profit the assessee claimed to have paid a commission of Rs 1,00,715 to its employees out of the emergency commission, a sum that appeared prima facie to be wholly disproportionate to the amount actually received by the firm. The order of the Excess Profits Tax Officer was upheld on appeal by the Appellate Tribunal. The Tribunal, however, expressed the view that during the years in question no additional incentive was required to sell dyes and chemicals because those articles were in short supply and demand had risen. Referring to a table showing the distribution among employees of dearness allowance, bonus and salary for the relevant years, the Tribunal observed that, in addition to the generous allowances, the payment of the commission seemed to be a means of dissipating profits. It estimated that, when the alleged commission was included, total emoluments amounted to about 1200 percent of basic annual salary and, in some cases, even more. The Tribunal concluded that such payments were wholly unnecessary for business purposes. Further, because the assessees did not have any sub‑distributors, the direction issued by the Imperial Chemical Industries Ltd. did not oblige the assessees to “pass on” the commission to their employees, and consequently the expenditure claimed could not be regarded as reasonable and necessary within the meaning of rule 12, schedule 1, of the Excess Profits Tax Act.

The Tribunal’s statement of case incorporated a table setting out, for each of the four years under consideration, the amount of emergency commission received by the assessees and the aggregate amount paid by them to their employees. The figures were as follows: for 1945‑46 the emergency commission received was Rs 1,28,533 and the amount paid to employees was Rs 1,00,715; for 1946‑47 the commission received was Rs 3,20,391 and the amount paid was Rs 2,44,698; for 1947‑48 the commission received was Rs 3,15,934 and the amount paid was Rs 1,28,506; and for 1948‑49 the commission received was Rs 3,70,964 and the amount paid was Rs 1,75,079. The Tribunal examined this distribution in the context of several circumstances. First, although I.C.I. had recommended that commissions be paid to sub‑distributors and the assessees had no such sub‑distributors, the assessees nonetheless claimed to have paid commissions to their employees at rates exceeding the minimum rates recommended by I.C.I. Second, the commissions were paid to employees in branches whose annual turnover did not exceed Rs 1,00,000, even though the agreements executed by the assessees expressly provided that commission would be payable only where a branch’s annual turnover exceeded Rs 1,00,000. These observations supported the Tribunal’s conclusion that the commission payments were excessive and not justified by any genuine business necessity.

In this case, the Court explained that the agreements executed by the assessee expressly stipulated that commission could be paid only when the annual turnover of a branch exceeded one lakh rupees. The Court further noted that the basic salaries of the employees had been substantially increased periodically and that the employees received generous dearness allowances, Deepavali bonuses, and annual bonuses in addition to their basic pay. An examination of annexure “II” to the supplemental statement of case prepared by the Tribunal revealed several striking examples of payments made to employees. For instance, an employee named Themaswamy received an annual commission that varied between fifteen thousand rupees and twenty‑three thousand rupees while his basic salary was only two thousand one hundred rupees per year. Similarly, an employee identified as K. N. Rajagopalachari was paid commissions ranging from sixteen thousand rupees down to twelve thousand rupees although his basic salary was one thousand two hundred sixty rupees per annum. Another employee, S. L. Radhakrishnan, received commissions ranging from five thousand seven hundred rupees to thirteen thousand rupees while his salary fluctuated between five hundred sixteen rupees and six hundred thirty‑six rupees per year. Finally, K. R. Rama Rao was paid commissions varying from four thousand six hundred rupees to ten thousand five hundred twenty rupees, with his salary being four hundred ninety‑two rupees and later increased to six hundred twelve rupees per annum. The Court observed that these facts provided ample support for the conclusion reached by the Excess Profits Tax Officer, a conclusion that was subsequently affirmed by the Tribunal.

The Court reiterated that it is within the province of the Excess Profits Tax Officer and the Tribunal to assess permissible deductions by applying the standards of reasonableness and necessity, taking into account the requirements of the business. Interference with their conclusions is warranted only where the view of the taxing authorities is affected by an error of law, is not based on any material, or is so unreasonable that no person instructed in law could have arrived at it. The Court acknowledged that, in determining whether a deduction claimed for payments classified as bonuses or commissions to employees should be allowed, the taxing officer must consider section ten, sub‑section two, clause (x) of the Income‑Tax Act and clause twelve of Schedule 1 of the Excess Profits Tax Act. While commercial expediency is a relevant factor in assessing reasonableness, the Court emphasized that such expediency must be examined in light of the actual business requirements and the specific services rendered by the employees. An abstract consideration of commercial expediency, divorced from the factual context, is misplaced.

In its assessment, the Court concluded that the High Court was not justified in re‑appraising the evidence that underpinned the conclusion of the Excess Profits Tax Officer, which the Tribunal had confirmed. The Court explained that the High Court’s jurisdiction in this matter was advisory; therefore, it was required only to answer the questions that were submitted for opinion based on the facts that had been found. If the High Court believed that the taxing authorities had erred in law, had drawn an incorrect legal inference, had failed to apply the appropriate legal tests, or had misinterpreted the evidence, it was within its power to draw the attention of the taxing authorities to such errors. However, the High Court could not set aside the decision of the taxing authorities by undertaking a fresh re‑appraisal of the evidence. The Court held that the High Court’s role did not extend to substituting its own view of what was reasonable and necessary, even if it disagreed with the assessment made by the taxing authorities.

In this case, the Court observed that the High Court did not have authority to overturn the decision of the taxing authorities by re‑appraising the evidence. The Court further pointed out that even if the High Court had found that the complete disallowance of the deduction claimed was not justified, the High Court could not replace the taxing authorities’ judgment on what was reasonable and necessary. Accordingly, if the High Court disagreed with the taxing authorities, it was still required to answer only the questions that had been presented and to leave it to the Excess Profits Tax Officer to determine, in the circumstances, what was reasonable and necessary. Counsel for the assessees argued that, because the Tribunal in its supplementary statement of case had said that any payment exceeding the amount recommended by the Indian Copper Industries (I.C.I.) was unjustified, the Court might modify the High Court’s order so that deductions of the amounts recommended by I.C.I. could be treated as permissible. The I.C.I. had recommended that a certain percentage of the emergency commission be distributed to sub‑distributors; however, in the assessees’ administrative structure, sub‑distributors did not exist. The assessees conducted their business through paid employees, and therefore the I.C.I. recommendation had no application to them. While it is true that, even in the absence of sub‑distributors, payments to employees that are reasonable and necessary for the business may be deductible, the Court held that this determination was for the taxing authorities, not for the Court. The Tribunal had concluded that no payment beyond salary, annual bonus, and special bonus was justified, and any contrary opinion expressed in the supplementary statement could not, in the Court’s view, alter the original conclusion. The Court therefore held that the question of whether the disallowance by the Excess Profits Tax authorities of the commission paid to branch managers was justified under rule 12, schedule 1 of the Excess Profits Tax Act should be answered affirmatively. On that basis, Appeal No. 494/1958 was allowed without any order as to costs, and Appeal No. 495/1958 was allowed with costs. Both appeals were allowed.