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PETITIONER: THE  COMMISSIONER OF INCOME-TAX, DELHI

       Vs.

RESPONDENT: THE  DELHI FLOUR MILLS CO., LTD., DELHI

DATE OF JUDGMENT: 03/10/1958

BENCH: SARKAR, A.K. BENCH: SARKAR, A.K. AIYYAR, T.L. VENKATARAMA GAJENDRAGADKAR, P.B.

CITATION:  1959 AIR  185            1959 SCR  Supl. (1)  28  CITATOR INFO :  RF         1961 SC 692  (12)

ACT:        Excess Profits-Assessment-Assessee company’s agreement  with        managing agents-Commission on net profits-Computation  -Tax,        if can be deducted-- " Net profits ", meaning of.

HEADNOTE: An  agreement between the assessee company and its  managing agents provided : " In consideration for acting as  managing agents  the company should pay to the firm  remuneration  at Rs.  750/-  p.m............. and in  addition  a  commission equal  to of the annual net profits.  Such net profits  will be arrived at after allowing the working expenses,  interest on  loans  and due depreciation, but without  setting  aside anything to reserves or other special funds ". The  question was  whether the excess profits tax payable by  the  company should  be  deducted  from its profits for  the  purpose  of arriving  at  the annual net profits of which  a  percentage should  be paid to the managing agents as  their  commission under the agreement. Held  ’  that,, the words " net profits " in  the  agreement meant  divisible  profits,  profits  divisible  between  the company  and the managing agents, and that  in  ascertaining such  profits, deduction had to be made, besides  the  items expressly mentioned in the agreement, of excess profits  tax payable by the company. James  Finlay  & Co., Ltd. v. Finlay Mills Ltd.,  (1942)  47 Bom.   L.R.  774  and Walchand &  Co.,  Ltd.  v.  Hindusthan Construction   Co.,   Ltd.,  (1943)  45  Bom.    L.R.   951, considered. Ashton  Gas Company v. Attorney-General, [1906] A.C. 10  and Re G. B. Ollivant & Co. Ltd.’s Agreement, [1942] 2 All E. R. 528, distinguished.

JUDGMENT: CIVIL APPELLATE JURISDICTION : Civil Appeal No. 211 of 1955. Appeal from the judgment and order dated.December 30,  1952, of  the Punjab High Court in Civil Reference Case No. 18  of

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1952. H.   J. Umrigar and R. H. Dhebar, for the appellant. Hardayal Hardy, for tile respondents. 1958.  October 3. The Judgment of the Court was delivered by 29 SARKAR J.-By an agreement made in 1936, the assessee company appointed  a  firm as its managing  agents.   The  agreement provided  that the managing agents would be  remunerated  in the manner following: "In consideration for acting as Managing Agents the  Company should pay to, the firm remuneration at Rs. 750 p.m. or such principal sum as may from time to time be deemed  reasonable by  the Directors and in addition a commission equal to  10% of the annual net profits.  Such net profits will be arrived at  after allowing the working expenses, interest  on  loans and due depreciation, but without setting aside anything  to reserves or other special funds." The  question  is  whether the  commission  payable  to  the managing agents under this agreement is to be ten per  cent. of  the  profits of the assessee without  deduction  of  the excess  profits tax payable by it oil its profits  or  after deduction. The  question has arisen in the course of the assessment  of excess  profits  tax payable by the  assessee.   The  Excess Profits  Tax  Officer  held that the commission  has  to  be ascertained  on  the profits remaining  after  deduction  of excess  profits tax.  This view was upheld by the  Appellate Assistant  Commissioner on an appeal being taken to  him  by the  assessee.  On a further appeal by the assessee  to  the Appellate Tribunal it was held that the commission has to be ascertained on the profits without any deduction of the tax. The  revenue authorities then applied for and  obtained,  an order from the Tribunal referring the following question for decision by the High Court: "  Whether  on a true construction of  the  Managing  Agency Agreement  between  the assessee Company  and  its  Managing Agents entered into in 1936, the relevant clause of which is quoted  above,  the  Excess Profits Tax  payable  should  be deducted from the profits of the Company for the purpose  of arriving  at  the annual net profits of which  a  percentage should be paid to the Managing Agents as their commission." The High Court answered the question in the negative. 30 The present appeal is by the revenue authorities against the judgment of the High Court. The  question is a short one.  It is one of construction  of the  managing  agency  agreement.  Of  course,  whatever  is payable under this agreement to the managing agents as their remuneration  is  a proper expense of the  business  of  the assessee and has to be deducted in ascertaining its  profits and  it is upon such profits that excess profits tax has  to be  assessed.  There is no dispute about this.  The  dispute has  arisen because the remuneration of the managing  agents is  we leave out now the minimum and fixed  remuneration  of Rs.  750 per month as to which no question arises  and  with which we are therefore not concerned-itself to be calculated on   the  profits.   The  dispute  is  whether  the   proper construction  of  the  agreement  is  that  the  profits,  a percentage of which is to be paid to the managing agents  as their  remuneration,  are the profits  before  deduction  of excess profits tax or after. What  then is the true construction ? The agreement is  that "the  net  profits  will be arrived at  after  allowing  the working expenses, interest on loans and due depreciation but without  setting  aside  anything  to  reserves  or  special

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funds."  We  can  leave out the things  expressly  made  not deductible for as to these no question arises, the  question being  whether something more, namely, excess  profits  tax, can be deducted. Working expenses, interest on loans and due depreciation have however been expressly made deductible  in ascertaining  the  net  profits.   If  these  are  all   the deductions  that can be made, excess profits tax  cannot  be deducted for it does not come under any one of them.  But it seems to us that the agreement was not intended to lay  down all  the deductions that can be made.  It is not in  dispute that  expenses like overhead expenses,  litigation  expenses and similar other expenses properly incurred for carrying on the business can be deducted in arriving at the net profits. These  would not be included within "working expenses "  for that  expression  is  usually  understood  as  referring  to expenses debitable to the trading account 31 as having been incurred directly in making the income  shown there.  If this were not the sense in which the expression " working  expenses " was used and it was meant to  cover  all revenue  expenses  incurred, then there would have  been  no need   to  mention  interest  on  loans   and   depreciation separately,  for, these latter would have been  included  as revenue expenses in the expression " working expenses ".  We are  therefore inclined to think that there are other  items besides those expressly mentioned, which have to be deducted before the net profits can be arrived at. What  then are these other items?  That will depend on  what the parties must be taken to have had in mind when they used the  words " net profits ". The intention of the parties  as to  what they meant by these words can be best  gathered  by trying  to  find  out what they were  about  in  making  the agreement.  The parties were a master and a servant and they were  fixing the remuneration of the servant.  They  decided that profits or no profits, the servant would have a certain fixed  sum  per month.  They also agreed  that  the  servant would  besides the fixed sum, have a certain portion of  the net profits.  The net profits, whatever they were, would  of course  be  a variable figure; in some years they  would  be more  or  less than in other years.  The  parties  therefore agreed  that the remuneration of the servant would  increase or decrease as the net profits were larger or smaller.   But why did they do so ? Obviously because they thought that  it was   fair  that  the  servant’s  remuneration   should   be commensurate with the benefit that his work produced for the master;  the  larger  such  benefit  was,  the  larger   the servant’s  remuneration and vice versa.  It is difficult  to imagine  that the parties agreed that remuneration would  be paid  for profits earned by the servant’s efforts  of  which the master did not get the benefit.  This view of the matter becomes clearer when one remembers that besides the variable remuneration  dependent oil the profits, the servant  had  a fixed  minimum remuneration.  The agreement, therefore,  was essentially one to share the profits; the agreement was that part of the profits was 32 to  go  to  the  servant and part  enure  for  the  master’s benefit.  If this is the true construction of the agreement, as  we  think it is, then it follows that  the  net  profits contemplated  by  the  parties are such profits  as  can  be divided between the master and the servant; they are such of which  both the master and the servant get the enjoyment  in stated proportions.  In other words, they are the  divisible profits  of the company, divisible, that is to say,  between the  master  and the servant.  In order that  the  divisible

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profits can be ascertained, excess profits tax has of course to  be deducted.  As to that there does not seem to  be  any doubt, for, that part of the profits which is taken away  by the State as excess profits tax, is not available either  to the  master or the servant and cannot therefore  be  divided between them. It  is said that the agreement cannot be construed  in  this way  because  that would be adding a word to  it;  the  word ’divisible not being there, is introduced into the agreement to  support this construction.  This however is not so.   No word  is being introduced but the words used are only  being explained.   It is only stating that the parties meant by  " net profits ", the divisible profits.  It is really  stating the same thing in different words. It  is  also  no objection to the view that  we  take,  that excess  profits  tax  is a part of  the  profits  itself  It perhaps  is  so  but it is no part of the "  net  profits  " contemplated  by the parties.  It is a part which has to  be deducted in arriving at the net profits, that is to say, the divisible profits which alone the parties had in mind.  As a matter of construction of the agreement before us,-and we do not think that the question involved in this case  can be  decided  in  any other way-therefore,  we  come  to  the conclusion  that  the  " net profits "  mean  the  divisible profits and are to be ascertained after deduction of  excess profits tax which is payable by the assessee. That is how the matter strikes us apart from any  authority. We  now turn to some of the authorities which were cited  at the bar.  They are In re Condran,                           33 Condran  v.  Stark (1), Patent Castings  Syndicate  Ltd.  v. Etherington (2), Vulcan Motor and Engineering Co. v. Hampson (3 ), Re G. B. Ollivant & Co. Ltd.’s Agreement    James Finlay & Co. Ltd. v. Finlay Mills Ltd.  and  Walchand &  Co. Ltd.  v. Hindusthan Construction Co. Ltd. (6).  These  cases however  all  turn  on the construction  of  the  agreements involved in them.  They are therefore not of much assistance in  construing  the agreement that we have before  us,  for, each  agreement has to be construed according to  the  words contained in it and the circumstances in which it was  made. The  judgment in Re G. B. Ollivant & Co.   Ltd.’s  Agreement (supra)  referred to earlier is that of the House of  Lords. In  the judgment delivered in this case by the Court  Appeal reported in (1942) 2 All E. R. 528 which was affirmed by the majority  of  the House of Lords, Lord Greene M.  R.  warned that  in  questions  of this kind  authorities  were  of  no assistance.    Referring  to  the  earlier   English   cases mentioned above, he said (p. 532): "  They  decide  that  on  the  true  construction  of   the agreements there in controversy, the phrase " net profits  " in  Etherington’s case, the phrase " profits earned  by  the company " in Vulcan’s case and the phrase " net profits " in Condran’s  case,  all  meant the divisible  profits  of  the company in the first two cases and of the partnership in the third.  They went on to decide a matter which I should  have thought   was  not  open  to  question,  namely,   that   in ascertaining divisible profits excess profits duty fell  to. be   deducted  .......................................   But beyond that, those authorities do not appear to me to afford any assistance.  The first part of the decisions, as to  the meaning  of " profits " or net profits in  those  particular agreements, does not help, because the language is  entirely different from that used in the present case; and the second part   of  the  decisions,  namely,  that  in   ascertaining divisible profits excess profits duty is to

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(1)  [1917] 1 Ch. 639.    (3) [1921] 3 K. B. 597.                           (5) (1942) 47 Bom.  L.R. 774. (2)  [1919] 2 Ch. 254. (4)  [1942] 2 All E. R. 528. (6)  (1943) 45 Bom.  L.R. 951. 5 34 be deducted, is, as I say, a matter for which I should  have thought authority was not required......... Like  the  earlier  cases, Re O. B. Ollivant  &  Co.  Ltd.’s Agreement (1) also ’turned on the language of the ;agreement involved in it and is not therefore of any great assistance. The Indian cases mentioned earlier were also decided on  the agreements  with  which they were concerned.  In  the  James Finlay & Co. Ltd. case (2) the agreement provided that the " net profits" were to be ascertained before setting aside any sum " for payment of income-tax, super-tax or any other  tax on  income ". It was held that " any other tax on  income  " included  excess  profits tax which could not  therefore  be deducted.   Beaumont  C. J. observed in this  case  that  it having  been held that income-tax being something  which  is payable  out  of  the  profits and not  a  liability  to  be deducted  in ascertaining the profits, it was  difficult  to explain  why the same’ principle should not apply to  excess profits duty.  He also said that a distinction had been made between the two taxes in the English cases, to some of which we have earlier referred, but he did not think it  necessary to  consider  whether all the grounds  of  distinction  were sound, because in the case before him he thought that excess profits tax had been expressly dealt with.  In the  Walchand &  Co.  Ltd.  case  the agreement was  very  much  like  the agreement  that  we  have before us. It  provided  that  the managing  agents would be paid ten per-cent. of  the  annual net  profits earned by the company and also stated  that  in arriving at the net profits certain deductions would be made which  included the working expenses and that certain  other deductions  would  not be made, but no mention was  made  of excess  profits  tax  as  being  deductible  or   otherwise. Beaumont  C.  J. who was a member also of  the  bench  which decided  this  case, held that the agreement  was  a  profit sharing agreement and the net profits had to be  ascertained after deducting excess profits tax.  Now we do not refer  to these judgments (1) [1942] 2 All E. R. 528.  (2) (1942) 47 Bom.  L.R. 774.                (3) (1943) 45 Bom.  L.R. 951. 35 as  supporting  anything that we say but  because  the  High Court  unwittingly fell into the error of thinking that  the Walchand & Co. Ltd. case (1) came before the James Finlay  & Co. Ltd. case (2) and that in the latter case Beaumont C. J. had  doubted  the  correctness of what he had  said  in  the former.   These observations are wholly wrong  because,  the James  Finlay & Co.  Ltd. case (2) was decided  long  before the Walchand & Co. Ltd. case (1) had been decided.   Neither do we find that there is any conflict between the two cases. In  the  Walchand & Co. Ltd. case (1), Beaumont C.  J.  gave reasons  for  making a distinction  between  income-tax  and excess profits tax and thought that the distinction  between them  made in the English cases to which we  have  referred, was  not of substance.  We do not think it necessary to  say anything  as  to whether Beaumont C. J. was  right  in  this view. Oil  behalf  of the assessee we were pressed with  the  same contention  that  as it has long been held  that  income-tax could  not be deducted in ascertaining the net profits of  a

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company, excess profits tax could not also be deducted, for, they were substantially of the same nature each being a  tax on  the profits.  Indeed in Ashton Gas Company v.  Attorney- General  (3), where the House of Lords had to  construe  the provision  in the incorporating statute of the  Gas  Company which provided that the profits to be distributed among  the shareholders in any year should not exceed a given rate, the following  observation  occurs in the opinion  delivered  by Lord Halsbury L. C. at p. 12: "  Income-tax is a charge upon the profits; the thing  which is taxed is the profit that is made, and you must  ascertain what  is the profit that is made before you deduct the  tax- You  have  no  right to deduct  the  income-tax  before  you ascertain  what the profit is, I cannot understand  how  you can make the income-tax part of the expenditure." Now  it seems to us that there is nothing in the Ashton  Gas Co. case(3)  which prevents us from (1) (1943) 45 Bom.  L.R. 951.  (2) (1942) 47 Bom.  L.R. 774. (3)  [1906] A. C. 10, 12. 36 holding that in ascertaining the net profits for the purpose of  the agreement that is before us, excess profits tax  has to be excluded.  That was not a case of profit sharing.   It was not concerned with deciding what sums are deductible  in arriving  at  the  divisible profits  in  a  profit  sharing agreement.   That is what we have to decide.   Therefore  we think  that the Ashton Gas Co. case (1) does not  assist  in answering the question that has arisen in this case. Nor do we think it necessary in the present case, as we have said  earlier,  to  decide whether  there  are  distinctions between  income-tax  and  excess profits tax.   We  are  not concerned  with  the question whether income-tax  should  be deducted  before the net profits under the agreement can  be ascertained.   We  will  assume that it cannot  be.   It  is common sense and also firmly established on the  authorities to which reference has already been made, that in ascertain- ing  the  divisible  profits excess profits tax  has  to  be deducted.  As we have construed the agreement in this  case, net  profits mean the divisible profits and  therefore  they can  be  arrived at only after deduction of  excess  profits tax. We  wish now to refer to the minority opinions in the  House of Lords in Re G. B. Ollivant & Co. Ltd.’s Agreement (2)  on which  the  High  Court  seems largely  to  have  based  its decision.   The dissenting opinion of Viscount Simon  L.  C. arose  from  the fact that he did not think  that  the  word profits  in  the agreement then before the House  meant  the divisible  profits.  With the reasons for this view  we  are not  concerned  for  these turned on  the  wording  of  that agreement.   Having held that the word profits did not  mean the  divisible  profits, he proceeded  to  consider  whether excess profits tax could be deducted in ascertaining the net profits and in doing so said that as income-tax could not be deducted  as  held in the Ashton Gas Co. case  (1),  neither could  excess  profits  tax, for, both  were  parts  of  the profits.  He also said that the Court of Appeal was wrong in thinking  that  excess profits tax could be debited  to  the profit  and  loss account and therefore held  that  the  net profit (1) [1906] A.C. 10, 12. (2) [1942] 2 All E. R. 528. 37 which is usually shown in that account has to be ascertained without deducting excess profits tax.  We are not  concerned with this part of the opinion of the Lord Chancellor either.

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It  was  given on the basis that the profits  were  not  the divisible  profits and we are concerned only with  divisible profits.    The  other  dissentient  speech  was   by   Lord Macmillan.   He said substantially what Viscount  Simon  had said, and therefore it is unnecessary to deal with his  view separate  y.  It  does not however appear  to  us  that  the dissentient  Judges in the House of Lords held that  if  the profits were the divisible profits, excess profits tax could not  be deducted before these could be ascertained.  In  the view  that  we  have taken of the agreement  before  us,  we cannot,   therefore,   derive  any   assistance   from   the dissentient opinions. One  other  case, namely, N. M. Rayaloo Iyer & Sons  v.  The Commissioner  of Income-tax, Madras (1), was brought to  our attention.  This case also purports to follow the  reasoning adopted in the minority judgments in Re G. B. Ollivant & Co. Ltd.’s Agreement (2) and actually relied on the authority of the  judgment under appeal.  It is therefore unnecessary  to refer to it further. It  had  been  contended by the  learned  advocate  for  the appellant  that  even if the net profits  mentioned  in  the agreement were not the divisible profits and even if income- tax could not be deducted to ascertain these profits, excess profits tax was a proper deduction to be made.  It was  said that  excess profits tax was for this purpose  different  in nature  from income-tax, for, (a) under s. 12 of the  Excess Profits Tax Act, 1940, excess profits tax was deductible  as an  expense  for the purpose of income-tax  assessment;  (b) that  where  the employer is a company, as  in  the  present case, the income-tax paid is refundable to the  shareholders which excess profits tax is not; (c) that excess profits tax is a " debt " of the business and therefore an outgoing, and (d)  that  it was in the nature of a licence  fee  upon  the payment of which alone the business could be carried on.  It is  unnecessary to consider these points as in our view  the net profits in this case were (1) [1954] 26 I.T.R. 265. (2) [1942] 2 All E. R. 528. 38 the  divisible  profits and whether excess  profits  tax  is distinguishable from income-tax for any of these reasons  or not, it is properly deductible. We should also refer to an argument advanced by the assessee which  was founded on s. 87-C of the Indian  Companies  Act, 1913,  introduced  by  an  amendment  made  in  1936,  which provides  that the remuneration of the managing agents of  a company  shall  be  a fixed percentage  of  its  net  annual profits,  and  that  in  calculating  the  net  profits   no deduction  in respect of any tax or duty on income is to  be made.   It  is  said  that  the  statute  incorporates   the universal  commercial practice and therefore  in  construing the present agreement excess profits tax cannot be deducted. We  are  not  aware whether  the  section  incorporates  any practice  but  we  think that this  contention  is  entirely unfounded  for  the section was applied only to  a  managing agency  agreement  made  after the amending  Act  came  into force,  while  the agreement in the present  case  was  made before that date. Lastly, we have to point out that nothing turns on the  fact that at the date the agreement under consideration was made, Excess Profits Tax Act had not come on the statute book  nor perhaps  been thought of, and therefore could not have  been in  the contemplation of the parties.  If the  net  profits, are  the  divisible  profits,  everything  necessary  to  be excluded  to  arrive  at the divisible  profits  has  to  be deducted whether it was in the contemplation of the  parties

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or not.  It is easy to imagine instances.  Suppose after the agreement  the  Government  imposed a  licence  fee  on  the payment of which alone the business could have been  carried on and that licence fee was not in the contemplation of  the parties when the agreement had been made.  None the less  it has  clearly  to be deducted in finding  out  the  divisible profits.  In the result we would answer the question  framed in the affirmative. The  appeal is therefore allowed with  costs in  this  Court and in the High Court.                             Appeal allowed. 39