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1998 Supreme(Mad) 1089
High Court of Judicature at Madras
THE HONOURABLE MRS. JUSTICE A. SUBBULAKSHMY & THE HONOURABLE MR. JUSTICE R. JAYASIMHA BABU
Commissioner of Income Tax - Appellant
Versus
India Cements Limited - Respondents
Tax Case Nos. 1554 to 1556 of 1985 & 1136 & 1137 of 1986
Decided On : 17 August 1998
Expenditure incurred in violation of other applicable laws cannot be allowed as a deduction under the Income Tax Act.
Headnote:
COMPANIES ACT - SECTION 348 AND 349 - MANAGING AGENT'S REMUNERATION - DEDUCTION OF INTEREST ON BORROWINGS - VIOLATION OF COMPANIES ACT - ALLOWABILITY OF DEDUCTION UNDER INCOME TAX ACT - PUBLIC POLICY.
Fact of the Case:
The assessee-company paid remuneration to its managing agent, which was a percentage of the net profits as per the Companies Act. However, the company did not deduct interest on borrowings while calculating the net profits, resulting in excess remuneration paid to the managing agent. The assessee claimed the entire amount of remuneration as a deduction under the Income Tax Act, despite the violation of the Companies Act.
Finding of the Court:
The court held that the assessee was not entitled to the deduction of the entire amount paid as remuneration to the managing agent. The excess amount paid in contravention of the Companies Act was disallowed as it was against public policy to allow the benefit of deduction under one statute for expenditure incurred in violation of another statute.
Issues: 1. Whether the managing agent's remuneration should be allowed as per the profits arrived at by the assessee in the books before deduction of interest capitalised, which was allowed as a deduction in computing the assessee's income? 2. Whether there can be two different methods for arriving at the profits for income-tax purposes and for allowances of managing agent's remuneration, especially when the interest capitalised was clearly a revenue expenditure? 3. Whether, on the facts and in the circumstances of the case, and having regard to the provisions of s. 349(4) of the Companies Act, 1956 4. Whether, on the facts and in the circumstances of the case, the ITO was not justified in invoking the provisions of s. 154 of the IT Act, 1961, for withdrawing the excess managing agent's remuneration allowed by the assessee for the asst. yr. 1967-68?
Ratio Decidendi: The court relied on the decision of the Supreme Court in Maddi Venkataraman & Co. (P) Ltd. vs. CIT, which held that it would be against public policy to allow the benefit of deduction under one statute for expenditure incurred in violation of another statute. The court also observed that the assessee is expected to carry on its trade or business in accordance with law and that the IT Act does not require the authorities to ignore the provisions of other statutes and the blatant violation thereof by the assessee.
Final Decision: The court answered the first three questions in favor of the Revenue and against the assessee, holding that the excess remuneration paid to the managing agent was not allowable as a deduction under the Income Tax Act. The court answered the fourth question in favor of the assessee, holding that the reopening of the assessment for the year 1967-68 under section 154 of the Income Tax Act was not justified.
R. JAYASIMHA BABU, J.
The substantive question requiring our answer is, as to whether the infraction by the assessee-company of the provisions of s. 349 of the Companies Act, in not deducting the interest on the borrowings while computing the net profits, a percentage of which was paid to the managing agents as remuneration, was required to be ignored, and the amount of remuneration paid by the assessee allowed in full as an item of expenditure under s. 37 of the IT Act, even after the amount of interest admittedly paid by the assessee-company, and which had been ignored while calculating the net profit for determining the remuneration of the managing agent, had been claimed as a deduction and allowed as such in the assessment of the company's income in these assessment years. The assessment years are 1967-68, 1968-69, 1969-70, 1970-71 and 1971-72. With regard to asst. yr. 1967-68, the tenability of the reopening of the assessment under s. 154 of the IT Act is an additional question, which also requires our answer.
2. The facts are not in dispute. The assessee is a public limited company, which, during the relevant assessment years, was managed by a managing agent. Remuneration payable to the managing agent was a percentage of the net profits of the company, such net profits being computed in accordance with the provisions of the Companies Act. The manner of computing the net profits is laid down in s. 349 of the Companies Act. Interest on debentures issued by the company, interest on mortgages executed by the company and on loans and advances secured by a charge on its fixed or floating assets, interest on unsecured loans and advances are required to be deducted under sub-cls. (f), (g) and (h) of s. 349(4) of the Companies Act, while determining the net profits of the company. The remuneration payable to the managing agent is subject to a ceiling of 10 per cent of the net profits of the company for that financial year, as provided by s. 348 of the Companies Act. That section provides that the company shall not pay to its managing agent, in respect of any financial year beginning at or after the commencement of this Act, by way of remuneration, whether in respect of his services as managing agent, or in any other capacity, any sum in excess of 10 per cent of the net profits of the company for that financial year. The language of s. 348 of the Act is emphatic. It provides that the company "shall not pay" the amount in excess of that specified in the section. The percentage referred to in s. 348 of the Act is a percentage of the net profits, which is required to be calculated in accordance with s. 349 of the Act.
3. In all these assessment years, it is admitted that the company had paid interest on its borrowings, and the entire amount of interest so paid had been claimed as a deduction in the income-tax assessment for the relevant years and such claim had also been allowed. It is also not in dispute that in all these years, while calculating the remuneration payable to the managing agent, the interest paid on borrowings for acquisition of machinery had not been deducted while calculating the net profits, and as a consequence, the amount paid to the managing agent as remuneration was much in excess of what would have been payable had the net profits been calculated strictly in the manner provided in s. 349 of the Act. The AO had disallowed that excess amount, while the Tribunal has held that such excess is also to be allowed as a deduction ignoring the infraction of provisions of the Companies Act, solely on the ground that the payment had been made, and that the books of accounts disclosed such payments having been made to the managing agent.
4. In reaching the conclusion that it did, the Tribunal relied upon the decision of this Court in the case of CIT vs. Ramakrishna Mills (Coimbatore) Ltd. and in the case of CIT vs. Sree Rajendra Mills Ltd. The Court, in these decisions, observed that payment made in violation of s.
