Case Note & Summary
The appeals arose from a reference under Section 21 of the Excess Profits Tax Act, 1940 read with Section 66(2) of the Indian Income-tax Act, 1922. The assessee, a public limited company with several branches and subsidiaries, had a board of directors overseeing its business; branch managers were members of the board. For a long time, even before the Act, the company remunerated its directors including managing director and branch managers by commission based on a fixed percentage of net audited profits, in addition to directors' fees or monthly salary. The commission was calculated on branch profits for branch managers and on company-wide profits for others. By resolution dated February 24, 1940, the company clarified that commission would be payable on net audited profits after depreciation but prior to any allocation or appropriation including provision for taxation. The Excess Profits Tax Bill was introduced on January 27, 1940 and the Act came into force on April 5, 1940. On July 27, 1940, the board further resolved that 'including provision for taxation' covered all forms of taxation including excess profits tax, so no deduction of excess profits tax was to be made before calculating managerial commission; this ruling was to have retrospective effect for 1939. For the chargeable accounting periods ending December 31, 1945 and March 31, 1946, the Excess Profits Tax Officer found the assessee had made large profits. He held that if commission was paid on net audited profits, the entire excess profits would be taken into account for commission. He concluded that the portion of commission attributable to excess profits, which arose from war conditions, was not reasonable and necessary within Rule 12(1) of Schedule I to the Act. He disallowed the proportion of commission corresponding to the excess profits tax liability, specifically Rs.5,39,057 and Rs.1,28,743 for the two periods. The Income-tax Appellate Tribunal and the Allahabad High Court upheld the disallowance, answering the reference questions in the affirmative. The Supreme Court dismissed the appeals, holding that Rule 12(1) was designed to prevent dissipation of excess profits by inflating expenditure having no relation to business requirements. The test is whether the expenditure is unreasonable and unnecessary having regard to the requirements of the business and actual services rendered. All relevant facts, especially commercial expediency or commercial practice, must be considered. However, when huge profits are earned not due to managerial activity but due to national emergencies like war, the government is entitled to a share of excess profits computed under the Act. Any commission paid on excess profits for which managers made no contribution is ex facie unreasonable and unnecessary, and the Excess Profits Tax Officer is justified in disallowing that proportion. The Court followed Ahmedabad Manufacturing & Calico Printing Co. v. Commr of E.P.T. and referred to other precedents. Thus, the appeals were dismissed and the disallowance affirmed.
Headnote
A) Direct Taxation - Excess Profits Tax - Disallowance of Managerial Commission - Excess Profits Tax Act, 1940, Schedule I, Rule 12(1) - Rule 12(1) is designed to prevent dissipation of excess profits by inflating expenditure which has no relation to business requirements; the test is whether expenditure is unreasonable and unnecessary having regard to business requirements and actual services rendered; commercial expediency and practice must be considered; but commission on excess profits due to war conditions for which managers made no contribution is ex facie unreasonable and unnecessary and the Excess Profits Tax Officer may disallow the proportion attributable to such excess profits (Paras 530A-D, 531G-H, 532A).
Issue of Consideration
Whether the disallowance of managerial commission amounts under Rule 12(1) of Schedule I to Excess Profits Tax Act, 1940 was justified for the chargeable accounting periods 1945 and 1946.
Final Decision
The Supreme Court dismissed the appeals and affirmed the disallowance of the amounts under Rule 12(1) of Schedule I to the Excess Profits Tax Act, 1940. The questions referred were answered in the affirmative.
Law Points
- Rule 12(1) of Schedule I to Excess Profits Tax Act
- 1940 prevents dissipation of excess profits by inflating expenditure
- Test is reasonableness and necessity of expenditure having regard to business requirements and actual services rendered
- Commercial expediency or practice must be considered
- Commission on excess profits from war conditions without managerial contribution is ex facie unreasonable and unnecessary
- Excess Profits Tax Officer may disallow proportion attributable to excess profits
