State of Madhya Pradesh vs Binod Mills Company Ltd

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 228 to 230 of 1960

Decision Date: 3 April 1962

Coram: N. Rajagopala Ayyangar, P.B. Gajendragadkar, A.K. Sarkar, K.N. Wanchoo, K.C. Das Gupta

The case titled State of Madhya Pradesh versus Binod Mills Company Limited was decided on 3 April 1962 by the Supreme Court of India. The judgment was authored by Justice N. Rajagopala Ayyangar and the bench comprised Justices N. Rajagopala Ayyangar, P. B. Gajendragadkar, A. K. Sarkar, K. N. Wanchoo and K. C. Das Gupta.

The petitioner was the State of Madhya Pradesh and the respondent was Binod Mills Company Limited. The official citation for the decision is 1966 AIR 1143 and 1963 SCR (1) 205. The matter concerned the War Profits Tax, specifically the assessment of a company’s profits and the deduction of remuneration paid to a managing agent under the Gwalior War Profits Tax Ordinance, Samvat 2001, including sections 2(5), 2(10), 4(1), 5(1) and Schedule 1, rule 4(1) with proviso (b).

The headnote set out Sub‑rule (1) of rule 4 of Schedule 1 to the Gwalior War Profits Tax Ordinance, Samvat 2001, which provided: “In computing the profits of a business carried on by a company, no deduction shall be made in respect of the remuneration paid to directors if during any part of the accounting period concerned they had a controlling interest in the company; provided that this sub‑rule shall not apply (a)… (b) to the remuneration of any managing agent where such remuneration is included in the profits of the managing agent’s business for the purposes of the War Profits Tax.”

The respondent company was managed by a managing‑agency firm that owned more than fifty percent of the issued share capital of the company, thereby giving the agency a controlling interest. The company was assessed for War Profits Tax under the Gwalior War Profits Tax Ordinance for three chargeable accounting periods covering the years 1944 to 1946. In each of those periods the company paid remuneration to its managing agent and claimed that the amount paid could be deducted from its business profits when computing the tax liability.

The assessing officer rejected the deduction claim. The officer reasoned that the remuneration received by the managing‑agency firm had not been actually assessed in the hands of the managing agent, and therefore proviso (b) to rule 4(1) of Schedule 1 was not applicable. The investigation revealed that the managing agents, in their own profit and loss statements for the relevant years, disclosed the commission they received from the company. However, before the assessing authority they asserted that the commission was not liable to tax, and the authority accepted that assertion.

The Court held that the remuneration paid to the managing agents was a permissible deduction for the purpose of computing the company’s profits under the War Profits Tax Ordinance, even though the agents held a controlling interest in the company. The Court explained that, by virtue of proviso (b) to rule 4(1) of Schedule 1, the managing agent was required to include the remuneration in his own assessable profits. Consequently, the phrase “is included” in proviso (b) referred to inclusion as stipulated by the provisions of the Ordinance, and not to any separate default by the managing agent or the assessing authority.

In this case the Court observed that the default position of the managing agent as an assessee, and the authority of the assessing officer to include the sum in the managing agent’s profits, could not prejudice the rights of the company when its income was being computed. The matter before the Court arose from civil appeals numbered 228 to 230 of 1960, which were filed against a judgment and decree dated 4 February 1957 delivered by the Madhya Pradesh High Court, Indore Bench, in Civil Reference No 15 of 1952. The appellants were represented by counsel, while the respondents were represented by a separate group of counsel. The judgment was pronounced on 3 April 1962, and the opinion was delivered by Justice Ayyangar.

Rule 4(1)(b) of Schedule 1, titled “Rules for the computation of profits for the purposes of War Profits Tax” under the Gwalior War Profits Tax Ordinance, Samvat 2001 (hereinafter referred to as the Ordinance), provided that “In computing the profits of a business carried on by a company, no deduction shall be made in respect of‑ (1) remuneration paid to directors if during any part of the accounting period concerned they had controlling interest in the company; Provided that this sub‑rule shall not apply‑ (a) … (b) to the remuneration of any managing agent where such remuneration is included in the profits of the managing agent’s business for the purposes of the War Profits Tax.” The respondent, Binod Mills Co. Ltd., operated its business at Ujjain in the State of Gwalior and was liable to War Profits Tax under the Ordinance. The company’s affairs were managed by a managing‑agency firm, M/s Binodiram Balchand, which held more than fifty percent of the issued share capital and therefore possessed a controlling interest in the company.

The respondent company was assessed for War Profits Tax for three chargeable accounting periods: 1 July 1944 to 31 December 1944; 1 January 1945 to 31 December 1945; and 1 January 1946 to 30 June 1946. In each of these periods the company paid remuneration to its managing agents and sought to deduct the amount paid in computing its business profits. The assessing officer disallowed each deduction on the ground that the remuneration received by the managing‑agency firm had not been factually assessed in the hands of the managing agent, and therefore the exception in rule 4(1)(b) did not apply. The disallowance was upheld by the appellate authority and subsequently by the Commissioner of War Profits Tax on revision.

At the request of the respondent, the Commissioner referred a question to the Madhya Pradesh High Court under section 46(1) of the Ordinance, asking whether, in computing the profits of a business carried on by a company, a deduction may be made for remuneration paid to a managing‑agent when that remuneration is included in the managing agent’s profits for War Profits Tax purposes. The reference covered all three chargeable periods. The High Court answered the question in favour of the respondent, holding that the remuneration, although paid to a managing‑agent with a controlling interest, was a permissible deduction for the company’s profit computation under the War Profits Tax. The appellant then applied for certificates of fitness for appeal to this Court under section 47 of the Ordinance, the certificates were granted, and the three appeals concerning the three accounting periods were filed before this Court.

In this case the question submitted to the High Court under section 46(1) of the Ordinance asked whether, for the purpose of computing the profits of a business carried on by a company, a deduction could be allowed for any remuneration paid to a managing‑agent when such remuneration was included in the profits of the managing‑agent’s business for the War Profits Tax. The reference covered three chargeable accounting periods. The learned judges of the High Court answered the question in favour of the respondent, holding that the remuneration, although paid to a managing‑agent who possessed a controlling interest in the company, was a permissible deduction when computing the company’s profits for the War Profits Tax. After the High Court decision, the appellant applied for certificates of fitness for appeals to this Court under section 47 of the Ordinance. Those certificates were granted, and the three appeals, each relating to one of the chargeable accounting periods, were consequently preferred before this Court.

Before analysing the substantive issue, it was necessary to set out certain facts to appreciate the form of the question that might invite further enquiry. There was little dispute, and any dispute that may have arisen was abandoned early, that the firm of Binodiram Balchand were “directors” of the company within the meaning of the Ordinance and that they held a controlling interest in the company. The definition of “director” in section 2(10) of the Ordinance states that the term includes any person occupying the position of a director by any name, any manager of the company, anyone concerned in the management of the business, any person remunerated out of the funds of the business, and any beneficial owner of not less than twenty per cent of the ordinary share capital of the company. Having established the controlling interest, it was common ground that the remuneration paid to the managing‑agent could not be deducted in computing the company’s profits unless it fell within proviso (b) of rule 4(1).

Before the departmental authorities, the company suggested that the expression “included” in proviso (b) meant “disclosed in the return of the director”. On that basis the company contended that, because Binodiram Balchand had disclosed the managing‑agency commission received by them in the statement of their own profit and loss account for the Samvat years 2000, 2001 and 2002, the remuneration had been “included” in their profits for the purposes of the War Profits Tax. The company further claimed that, for reasons not necessary to discuss, the sum was not liable to be brought to tax and that this claim had been accepted. The departmental authorities rejected this argument, and the rejection gave rise to the form of the question referred to the High Court. The contention concerning the meaning of “included” was not apparently repeated before the High Court, did not form part of the learned judges’ reasoning in the judgment now under appeal, and was not relied upon before this Court. Accordingly, the Court observed that it would not consider that argument further.

In this case, the Court observed that it would not discuss matters already touched upon and would instead address the main issue that had been raised. The facts set out earlier led to the conclusion that the whole dispute in the appeals depended on the meaning of the phrase “is included in the profits of the managing Agency business” appearing in rule 4(1) proviso (b) of Schedule 1 of the Ordinance. Before analysing that particular phrase, the Court considered it necessary to outline the overall scheme that underlies the levy of the tax imposed by the Ordinance. Section 4(1) of the Ordinance constitutes the charging provision and provides that: “Subject to the provisions of this Ordinance, there shall, in respect of any business to which this Ordinance applies, be charged, levied and paid on the amount by which the profits during any chargeable period exceed the standard profits, an excess profit tax (in this Ordinance referred to as the ‘War Profits Tax’) which shall be equal to 60 per cent. of the aforesaid amount.” The term “business” to which the Ordinance applies must be understood from the definition contained in section 2(5). That definition states that “‘business’ includes any trade, commerce or manufacture or any adventure in the nature of trade, commerce or manufacture or any profession or vocation’ but does not include a profession carried on by an individual or by individuals in partnership if the profits of the profession depend wholly or mainly on his or their personal qualifications, unless such profession consists wholly or mainly in the making of contracts on behalf of other persons or the giving to other persons of advice of a commercial nature in connection with the making of contracts. Provided that where the functions of a company or of a society incorporated by or under any enactment consist wholly or mainly in the holding of investments or other property or both, the holding thereof shall be deemed for the purpose of this definition to be a business carried on by such company or society. Provided further that all businesses to which this Ordinance applies carried on by the same person shall be treated as one business for the purposes of this Ordinance.” The second proviso refers to the word “person,” which is defined by section 2(13) to include “any company or body of individuals or any other association of persons whether incorporated or not and also includes a Hindu undivided family.” The expression “profits” used in the charging provision is, by virtue of the definition in section 2(16), meant to be “profits as determined in accordance with the provisions of this Ordinance and its First Schedule.” While the provisions of the Ordinance that deal with the computation of profits are not directly relevant to the point presently in dispute, certain rules relating to the computation of profits contained in Schedule 1 are material. Accordingly, the Court examined the meaning of the charging provision together with the other relevant provisions of the Ordinance.

The Court observed that the Ordinance makes clear that chargeable income consists of the profits that arise from any business activity, and that every person – whether an individual or an entity falling within the inclusive definition of “person” – is treated as a separate unit for tax assessment. The profit of each such unit is calculated by adding together all sources of income that the unit derives from every business it conducts. To determine how the profit of each unit must be worked out for tax purposes, the Court noted that one must look not to the general provisions of the Ordinance – which the Court had already said are irrelevant to the present dispute – but to Schedule 1, which is titled “Rules for the computation of profits for the purposes of War Profits Tax.”

Rule 1 of those Rules, which follows the pattern of the Indian Income‑Tax Act, sets out the list of deductions that may be allowed. Under clause 1(1)(xi) the Rule permits any expenditure that is neither capital in nature nor a personal expense of the person to whose business the Ordinance applies, and that is spent wholly and exclusively for the purposes of that business, to be deducted from profit. The Court explained that if this provision is applied to a company that is itself the assessment unit, there can be no disagreement that, as a matter of general principle, the remuneration paid to a managing‑agent qualifies as a deductible expense. It further noted that the remuneration received by a managing‑agent is itself profit arising from a business, and therefore the managing‑agent is liable to tax on that amount under the Ordinance, being profit from business as defined in section 2(5), provided that the amount of profit brought it within the taxable threshold.

The Court then turned to Rule 4, which introduces an exception for companies in which the directors hold a controlling interest. However, the Court stressed that the operation of this special rule is conditioned, among other things, on the proviso identified as “(b)” not applying to the case. In other words, if proviso (b) were to apply, the special rule for companies with controlling directors would cease to operate, and the remuneration paid to the managing‑agent would remain deductible in computing the company’s profit. The decisive issue, the Court said, is whether the remuneration paid to the managing‑agent “is included in the profits of the managing‑agent’s business.” The wording “is included” unmistakably points to an actual inclusion, but the Court warned that this does not resolve the matter because the phrase “inclusion in the profits” may be understood in three separate ways. First, it could mean the inclusion of the remuneration in the managing‑agent’s own tax return as an assessee. Second, it could refer to the inclusion of the remuneration by the assessing authority in the assessment order made against the managing‑agent. Third, it could denote the inclusion of the remuneration under the terms of the Ordinance as an amount chargeable to tax as part of the managing‑agent’s profits.

The Court observed that the amount of remuneration payable to the managing agent formed part of the tax‑chargeable profit of that agent. It noted that rule 7 (2)(b) of Schedule 1 to the Excess Profits Tax Act, 1940 – the statute on which the present Ordinance is based – uses language identical to proviso (b) of rule 4(1) of the Ordinance. However, the proper construction of that rule in the 1940 Act had never been examined by the courts. Before the High Court, the appellant argued that the term “is included” meant that the assessment officer must actually include the remuneration in the managing‑agent’s assessment, and that unless such inclusion occurred the company could not invoke the benefit of proviso (b). The learned High Court judges rejected this view. They held that proviso (b) could not be read as granting the assessing authority an unfettered discretion to decide whether to assess the company or the managing‑agent. The judges interpreted the phrase “is included” as meaning “is liable to be included”. Since the appellant had not contested the possibility that the assessment officer could, if he chose, include the sum in the managing‑agent’s profits, the Court concluded that the conditions of proviso (b) were satisfied. Counsel for the appellant, identified only as the senior counsel, did not continue to advance this argument at the appellate stage. The Court added that this was appropriate, because the argument had already been rejected by the High Court.

The Court further explained that, although tax statutes sometimes allow the assessing authority to pursue alternative bases of assessment against a particular unit, such a power must be expressed in very clear and unambiguous terms. In the present situation there was no provision allowing the authority to select between assessing the company or the managing‑agent, especially where there was no mechanism for adjusting rights and liabilities between the two units when one benefited at the expense of the other. Moreover, if the company were assessed first – for example because its return was filed earlier or its enquiry was completed earlier – there is no provision in the Ordinance or its Rules that permits the remuneration to be excluded from the personal assessment of the managing‑agent. Consequently, the assessing authority could not be said to have a choice to tax either the company or the managing‑agent. If the managing‑agent is by operation of law liable to have his remuneration taken into account in his own tax assessment, unless the income falls outside the scope of the Ordinance, it would be anomalous to suggest that the benefit of proviso (b) could depend on the order in which assessments are made.

The Court noted that, for the benefit of proviso (b) to apply to a company, the assessment of the managing agent would first have to be completed, a circumstance that is not always within the company’s control. The Court considered it unnecessary to elaborate further on that construction because the submission of counsel Mr Sen was not pressed for acceptance. Counsel Mr Sen, however, argued that the provision was a special rule intended to address situations involving companies whose directors held a controlling interest. In such circumstances, those directors were required to file the return on behalf of the company and, at the same time, to file their own individual returns as persons receiving taxable profits. According to his argument, the proviso should be interpreted as giving the directors a choice: they could either include their remuneration in their personal returns, thereby paying tax on it themselves, or they could include the remuneration in the company’s return, causing the amount to be taxed in the company’s assessment. He further contended that, given the wording of the proviso, if the managing‑agent failed to include his remuneration in his own return and thus did not have it assessed as part of his profits, the result would be identical to an election to have the sum taxed in the company’s assessment. The option, he said, belonged to the managing‑agent who controlled the affairs of the company, representing the company in one capacity while acting for himself in another. In effect, counsel’s submission was that the provision was designed to prevent double taxation of the same income, and that it vested the controlling director with a discretion to make the company immune from tax where the sum was included in the director’s personal return and taxed in his hands. The Court observed that this theory of avoiding double taxation by granting a discretion to the controlling director collapses on a simple examination. To illustrate, the Court assumed a scenario where the managing‑agent elects to have the company taxed, files a return for the company without claiming any deduction for the remuneration, and the assessment accepts that return. Under the Ordinance, such an outcome would provide no relief to the managing‑agent in his personal assessment, because, as previously noted, there is no provision in the Ordinance or its Schedule that exempts the managing‑agent from including that remuneration in his taxable profits. Consequently, for the purposes of the charging provision, the managing‑agent is treated as an independent unit of assessment and must incorporate the remuneration received into his personal income computation for the War Profits Tax, a result that could be expressed in slightly different wording.

In this case, the Court observed that proviso (b) to rule 4(1) does not operate in the reverse direction, meaning that it does not exempt the managing‑agent from tax on the remuneration he receives merely because the deduction of that item has been denied to the company. Consequently, rule 4(1)(b) is not a provision intended to avoid double taxation in the sense suggested by counsel for the appellant. The Court also found it impossible to accept Mr Sen’s submission that the words “is included” should be understood to mean inclusion in the return filed by the managing‑agent, which would, according to that view, prevent the company from claiming a deduction where the managing‑agent fails to include the amount. Mr Sen had proposed that the managing‑agent could either elect to pay the tax himself or cause the company to pay it. It would invariably be in the managing‑agent’s interest to have the company pay the tax, because, as Mr Sen argued, the loss arising from the tax payment would fall on the managing‑agent only to the extent of his shareholding, the remainder being borne by the other shareholders. The Court said it was difficult to conceive a principle that would allow a managing‑agent holding, for example, 51 percent of the share capital to shift 49 percent of the tax burden—normally expected to be his—to the other shareholders merely because he is the controlling managing‑agent. The construction proposed by Mr Sen therefore leads to an unreasonable result and inflicts an unjust injury on the other shareholders, and cannot be regarded as a proper interpretation of the provision. Moreover, the Court noted further reasons why the meaning of “is included” cannot be limited to inclusion by the managing‑agent. For instance, if the managing‑agent includes the amount in his return but the assessing authority does not reflect it in the computation and instead disallows the company’s deduction, it is unclear whether this constitutes “inclusion in his profits.” Similarly, if the managing‑agent omits the amount from his return but the assessing authority includes it and the tax is paid by the managing‑agent, the question of exclusion arises. These hypothetical situations reveal anomalies that would ensue if “is included” were read as “included in his return by the managing‑agent.” The Court therefore turned to the alternative interpretation that “is included” refers to inclusion under the provisions of the Ordinance. Under that reading, the matter does not depend on whether the managing‑agent has actually included the sum in his return or whether the assessing authorities have performed the inclusion, as the statutory duty to include the sum would govern regardless of the parties’ actions.

The Court explained that it did not matter whether the managing‑agent had actually entered the remuneration in his tax return or whether the assessing authority had included the amount in the taxable profits of the managing‑agent. If the managing‑agent failed to include the sum despite a legal duty to do so, the assessing officer was empowered to revise the return, and the managing‑agent would face penalties for filing a willfully incorrect return in addition to having the sum added to his assessable profits. Likewise, the assessing officer himself was under a statutory duty to incorporate the sum in the assessment of the managing‑agent; a failure on his part would render the assessment order open to revision. Consequently, the Court held that the appropriate remedy for any default—whether by the managing‑agent or by the assessing authority—could not be the disallowance of the amount in computing the company’s profits. This line of reasoning rested on the premise that the managing‑agent was liable to include his remuneration in his assessable income. Under that premise, neither the managing‑agent’s omission nor the assessing authority’s error could prejudice the company’s right to compute its income.

The Court further noted that the situation would change if the remuneration of the managing‑agent were not taxable under the Ordinance. It cited Section 5(1) of the Ordinance, which excluded from its scope profits derived from a business carried on wholly on behalf of a religious or charitable institution, provided that the business furthered the primary purpose of the institution and was performed by its beneficiaries. In such a circumstance, where the managing‑agent’s business was conducted for a trust or similar charitable entity as described, the remuneration would fall outside the ambit of the Ordinance and therefore would not be taxable. As a result, the proviso to Rule 4(1) would not apply, and the managing‑agent would not be liable to tax on that remuneration. Consequently, a controlled company could not claim a deduction for the remuneration in its profit computation, except where the remuneration was subject to tax under the War Profits Tax. In the present case, the Court observed that it was already admitted that the managing‑agent’s remuneration was liable to be included in his profits for the purposes of the War Profits Tax, making any omission by the agent or failure by the assessing authority immaterial to the company’s right to the deduction.

In this case the Court explained that if the remuneration received by a managing agent is not subject to tax under the Ordinance, the liability to pay tax falls on the managing agent himself. Accordingly, even though the company making the payment is a controlled company, the amount paid to the managing agent can still be deducted as an allowable expense because the deduction is permitted by the exception contained in proviso (b) to rule 4(1), which modifies the opening words of that rule. The Court observed that it was not necessary for the present decision to examine whether, apart from section 5(1)(b) which had already been discussed, there might be other situations in which remuneration received by a director could be considered excluded from that director’s profits under the Ordinance. The reason for this is that, in the matter before the Court, it was admitted that the remuneration earned by the managing agent had to be taken into account in computing his profits for the purpose of the War Profits Tax. Consequently, the fact that the managing agent failed to include the sum in his tax return, and the failure of the assessing authority to correct that omission by adding the sum to his assessment, could not be used as a basis for denying the respondent company the benefit of proviso (b) to rule 4(1). On this basis the Court held that the learned judges of the High Court had correctly answered the question referred to them. The appeals were therefore dismissed with costs, and the orders of the lower court were affirmed.