A payment made by an assessee-company to a managed company of salary paid to an employee in contravention of Section 360 of the Companies Act, 1956, is allowable as business expenditure if the appointment of the employee by the assessee-company is valid under Section 314 of the Companies Act, 1956, and the payment of his salary is a necessary expenditure for the purpose of carrying on the business of the assessee-company.

( 1 ) THIS reference, under Section 256 (2) of the Income-tax Act, 1961, relates to the assessment year 1964-65, The assessee-company was floated on October 27, 1960, with the object of acquiring the managing agency of India Forge and Drop Stampings Ltd. , hereinafter referred to as "the managed company ". The managed company was floated on June 27, 1960. One Sri Baldev Raj was appointed by the managed company as an employee on a salary of Rs. 2,000 per month with effect from 1st July, 1960. The said Baldev Raj was a relation of the two directors of the assessee-company. Hence, when the assessee-company took over the managing agency of the managed company, the said Baldev Raj became an associate within the meaning of that expression used in Section 360 of the Companies Act. The managed company, however, obtained permission from the Central Government for payment of remuneration of Baldev Raj for the years 1961 and 1962. The managed company, however, failed to secure the sanction of the Central Government for the continuation of the employment of Baldev Raj with effect from 22nd February, 1963, and, therefore, the managed company withdrew a resolution from its extraordinary general meeting regarding the continuation of his appointment.

( 2 ) THE assessee-company, however, on February 25, 1964, passed a special resolution in its extraordinary general meeting appointing Baldev Raj as its employee from 27th February, 1963, to 31st October, 1963. In the said meeting another resolution was passed by the assessee-company to pay the managed company the sums that were payable by Baldev Raj to the managed company which were paid to him by the managed company in contravention of Section 360 of the Companies Act, 1956, In terms of that resolution, the assessee-company paid Rs. 16,482 to the managed company being the sum payable by Baldev Raj to the managed company. The assessee-company has also paid Rs. 4,000 to Baldev Raj as his salary for working under the assessee-company for the subsequent period.

( 3 ) THE Income-tax Officer has disallowed the deduction claimed by the assessee in respect of this total sum of Rs. 20,482 on the ground that since the managed company has paid Rs. 16,482 to Baldev Raj in contravention of Section 360 of the Companies Act, 1956, the said sums paid by the assessee-company to the managed company was an illegal expenditure. The Income-tax Officer was also of the opinion that Rs. 4,000 paid to Baldev Raj by the assessee-company was in contravention of Section 360 of the Companies Act and, therefore, this payment was also an illegal payment.

( 4 ) THE first appeal filed by the assessee was dismissed by the Appellate Assistant Commissioner on the ground that the employment of Baldev Raj required the prior approval of the Government of India under the Companies Act, and since such sanction was not granted his continuance in the service of the managed company was illegal and that the assessee-company being a party to the infraction of law was not entitled to this deduction. The second appeal filed by the assessee-company has, however, been allowed by the Appellate Tribunal in whose opinion the managed company has committed no illegality and, in any event, the assessee-company was not a party to any such illegality. It has also been held by the Tribunal that these sums have been expended by the assessee-company for the purpose of its business and these expenditures were revenue expenditures. The Tribunal has also rejected the application made by the Commissioner under Section 256 (1) of the Act and, thereafter, at the instance of the Commissioner, the court has framed the following question under Section 256 (2) of the Act for its determination :" Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 20,482 was allowable as business expenditure ? "

( 5 ) MR. B. L. Pal, the learned counsel for the revenue, has contended before us that the assesse