Supreme Court of India
COMMISSIONER OF INCOME TAX, MADRASversusM/S. AMALGAMATION PVT. LTD.
- Citation
- 1997 INSC 436
- Decided
- 25 April 1997
- Disposal
- Dismissed
- Bench
- S C AGRAWAL
Holding
The Court held that the proviso to Section 12B(2) does not apply, the guarantee loss is deductible as a business loss in the year of final receipt, and the remuneration to subsidiary directors is not deductible as it lacks the required nexus with the assessee’s business.
Summary
The Supreme Court examined whether Amalgamation Pvt. Ltd., a bulk shareholder holding investments in numerous subsidiaries, could claim a capital loss on the forced sale of shares to a subsidiary of a subsidiary, whether a loss incurred while guaranteeing a subsidiary's loan qualified as a business loss, and whether remuneration paid to directors of subsidiaries was deductible under the Income Tax statutes. The Court held that the sale was not undertaken to avoid capital gains tax and therefore the proviso to Section 12B(2) of the 1922 Act did not apply, allowing the capital loss claim. It further held that furnishing guarantees to subsidiaries formed part of the assessee's business, so the loss on the guarantee was allowable as a deduction in the year the final receipt was made. However, the payments to subsidiary directors were not incurred wholly and exclusively for the assessee's business of holding investments and thus could not be deducted under Section 10(2)(XV) of the 1922 Act or Section 37 of the 1961 Act. The Court affirmed the High Court’s findings and dismissed both the Revenue’s and the assessee’s appeals. The decision clarifies the application of the connected‑person provisions, the nexus test for deductions, and the treatment of forced sales in capital gains computation.
Issues considered
- Whether the loss on the sale of shares to a subsidiary of a subsidiary is a capital loss or is barred by the proviso to Section 12B(2) of the Income Tax Act, 1922.
- Whether the loss incurred by the assessee in standing guarantee to a subsidiary’s loan is a business loss deductible under Section 23A of the 1922 Act.
- Whether remuneration paid by the assessee to directors of its subsidiaries is deductible under Section 10(2)(XV) of the 1922 Act or Section 37(1) of the 1961 Act.
- Whether the loss on guarantee can be allowed only in the year in which it is finally ascertained.
- Whether the resolution of the Board of Directors creates a sufficient nexus to treat the remuneration as an expense of the assessee’s business.
Legislation cited
- Companies Act, 1956s. 198, s. 295, s. 372
- Income Tax Act, 1922s. 10(2)(XV), s. 12B(2), s. 23A, s. 33B
- Income Tax Act, 1961s. 37(1)
Subjects
capital gainsbusiness lossdeductionguarantee liabilityconnected partiesforced saleSection 12B(2)Section 10(2)(XV)Section 37holding companysubsidiary
Judgment
COMMISSIONER Of INCOME TAX, MADRAS A
v.
MIS. AMALGAMATION PVT. LTD.
APRIL 25, 1997
[S.C. AGRAWAL AND K.S. PARIPOORNAN, JJ.) B
/
Income Tax Act, 1922 :
Section 12-B-Capital gains-Assessee company holding shares of
several companies-Assessee company indebted to a Finance company, a C
subsidiary company of its subsidiary-To liquidate liability, shares were sold
at prices fixed by the Companies Law Department in consultation with
Central Board of Revenue to the Finance
I
company-Object of sale, whether
on facts was avoidance of or resultU in reduction of liability to tar-Held,
object of transaction was not to avoid or reduce liability to capital gain tax
as the sale was made to a company with whom the assessee company was D
directly or indirectly connected and the sale was a farced sale since the price
had been fixed by Company Law Administration-companies Act, 195(r-Ss.
295 and 372.
Section 10(2)(XV}-Business loss-Deductibility-Relevant year-As- E
sessee standing guarantee to loan taken by its subsidiary-Subsidiary going in
liquidation-Dues recovered from guaranto~oss occasioned to assessee is
business loss since its business includes furnishing of guarantee to its sub-
sidiaries-Held, loss could be ascertained but only at the stage of final
payment by the liquidators and deduction allowed in assessment year relevant /
to the year in which last payment was made by liquidator. F
Business expenditure-Test-Nexus between expenditure and business
of assessee necessary-Assessee company holding bulk shares in several
companies and its business was of holding investments-Assessee paying
managerial remuneration to Directors of subsidiary companies and claiming G
deduction of such. payment under Section 10(2) (XV)--However, no part of
payments relatable to any service directly rendered by the Directors to assessee
company-Held, expenditure has no direct and immediate connection with
the business of assessee-Hence, deduction could not be allowed.
The assessee-Company was bulk shareholder in several companies H
1005
1006 SUPREME COURT REPORTS (1997] 3 S.C.R.
A and in the relevant year there were 16 companies. The business of the
assessee-Company was to stand guarantee to the loan taken by its sub-
sidiary companies and to render certain common-services to its sub-
sidiaries and the assessee-company had to pay certain amount to the
directors/Managers for the said services.
B In these appeals, the following questions in respect of the Tax-as-
sessment of the assessee Company arose before this court for considera-
tion:
1. Whether the loss incurred by the assessee Company in selling
C shares of different company to a subsidiary of its subsidiary at the price
fixed by the Company Law Administration in liquidation of its liability
amounts to a capital loss?
2. Whether the loss incurred by the assessee-Company in standing
guarantee to the loan taken by its subsidiary companies amounts to a
D business loss?
3. Whether the amount paid by the assessee Company to the direc-
tors of the subsidiary companies for the common services rendered by
them was deductible under section 10(2) (XV) of the 1922 Act or 37(1) of
E the 1961 Act?
Dismissing the appeals, this Court
HELD : 1. The first requisite for application of the proviso to
Sub-Section 12B(2) that the person to whom sale is made should be a
F person with whom the assessee is directly or indirectly connected was
satisfied because the sale of shares to a subsidiary of a subsidiary is one
to a person with whom the assessee company is directly or indirectly
connected. The second requirement of the proviso, as to whether the sale
was effected with the object of avoidance or reduction of the liability of the
assessee company under that section, the High Court has pointed out that
G the Income Tax Officer had not given a finding that the object with which
the transaction was put through was the avoidance or reduction of the
liability to capital gains tax. The object of the transaction was not to avoid
or reduce such liability to capital gains tax, that the sale was a forced sale
since the assessee company had no option and that the price had been fixed
H by the Company Law Administration. So, the first proviso to section 128
C.I.T. v. AMALGAMATION PVT. LTD. 1007
(2) cannot be attracted. The High Court has rightly construed the A
provisions contained in the proviso to ·section 128(2) of the 1922 Act.
Hence, the finding of the Higb Court does not suffer from any legal
infirmity. (1013-F-H; 1014-B-C; 1015-B-C]
2. The business of the assessee Company included furnishing
guarantee to debts borrowed by its subsidiary companies. The assessee B
Company had incurred loss in carrying on its own business which included
furnishing guarantees to the debts borrowed by its subsidiary companies.
So, the loss was allowable as a deduction in the year in which it came to
be ascertained and in the instant case the loss in the transaction of the
guarantee could have been ascertained only at the stage of final payment
by the liquidators which was received in the relevant assessment year. As
c
such High Court was right in upholding the same. (1017-E-G)
Amalgamations P. Ltd. v. Commissioner of Income Tax, (1996) 73 ITR
380 Mad, referred to.
D
3. The amounts paid by the assessee Company to the directors of its
subsidiary companies can be admissible as deduction under Section 10(2)
(XV) of the 1922 Act or 37(1) of the 1961 Act only if they can be regarded
as expenditure "laid out or expended wholly and exclusively for the pur-
poses of the business" of the assessee Company. There must be nexus
between expenditure and business of the assessee. The expenditure in-
E
curred in payment of managerial remuneration to the directors of the
subsidiary companies cannot be said to be expenditure incurred in carry-
ing on the business of the assessee Company of holding its investments.
Since the subsidiary companies were not obliged to distribute by way of
dividends the entire profits earned on account of their managerial F
remuneration paid by the assessee Company and the assessee company
only entitled to dividend from the subsidiary company as and when
declared, it could not be said that there was a direct and immediate
connection between the expenditure incurred and the business of the
assessee company. As such, the High Court rightly held that the deduction G
could not be allowed. [1021-G-H; 1023-B-C; 1024-A-B]
Athe1to11 v. British Insulated and Helsby Cables Ltd., (1925) 10 TC 155
(HL); Eastem Investments Ltd. v. Commissioner of !11come Tax, (1951) ITR
1; Commissioner of Income Tax v. Chandulal Keshavalal & Co. Ltd., (1960)
38 ITR 601, relied on. H
1008 SUPREME COURT REPORTS (1997) 3 S.C.R.
A Travancore Titanium Product Ltd. v. Commissioner of Income Tax,
(1966) 60 ITR 277 and Indian Aluminium Co. Ltd. v. Commissioner of
Income Tax, (1972) 84 ITR 735, referred to.
Tata Sons Ltd. v. Commissioner of Income Tax, (1950) 18 ITR 460
and J.R. Patel and Sons (P) Ltd. v. Commissioner of Income Tax, (1968) 69
B ITR 782, distinguished.
CIVIL APPELLATE JURISDICTION: Civil Appeal Nos. 139-142
of 1980 Etc.
From the Judgment and Order dated 23.8.79 of the Madras High
C Court in T.C. Nos. 160/69 and 239 of 1971.
K.N. Shukla, T.A. Ramachandran, K. B. Ramamani, B.K. Prasad, C.
Radha Krisna, Anil Srivastava and Janki Ramachandran for the appearing
-
parties.
D The Judgment of the Court was delivered by
S.C. AGRAWAL, J. These appeals, by certificate of fitness granted
by the Madras High Court under Section 66(A) (2) of the Income Tax Act,
1922 (hereinafter referred to as 'the 1922 Act') and Section 261 of the
Income Tax Act, 1961 (hereinafter referred to as 'the 1961 Act') read with
E Article 133 of the Constitution of India, are directed against the judgment
of the said High Court dated March 1, 1976 in Tax Cases Nos. 160 0(1969
and 239 of 1971 (References Nos. 52 of 1969 and 1 of 1971). T.C. No. 160
of 1969 related to the assessment year 1958-59 wherein two questions were
referred by the Income Tax Appellate Tribunal (hereinafter referred to as
p 'the Tribunal') for the opinion of the High Court. T.C. No. 239 of 1971
related to the assessment years 1958-59 to 1962-63 wherein the Tribunal
referred six questions for the opinion of the High Court. By the impugned
judgment both the questions in T.C. No. 160 of 1969 and all the questions,
except question No. 3, in T.C. No. 239 of 1971 were answered by the High
Court against the Revenue and in favour of the assessee. Question No. 3
G in T.C. No. 239 of 1971 was answered in favour of the Revenue and against
the assessee. Civil Appeals Nos. 139-142 of 1980 have been filed by the
Revenue in respect of the questions that have been answered against the
Revenue and Civil Appeals Nos. 7-11 of 1980 have been filed by the
assessee in respect of question No. 3 in T.C. No. 239 of 1971 which has
--
H been answered against the assessee.
C.I.T. v. AMALGAMATION PVT. LTD. [S.C. AGGARWAL,J.) 1009
V>{e will first take up Civil Appeals No. 139-142 of 1980 filed by the A
Revenue. These appeals can be split up into two parts, one relating to the
answers to the two questions in T.C. No. 160 of 1969 and question Nos. 1
and 2 in T.C. No. 239 of 1971, and the other relating to answers to
questions Nos. 4, 5 and 6 in T.C. 239 of 1971. The two questions in T.C.
160 of 1969 and questions Nos. 1 and 2 in T.C. No. 239 of 1971 were as
follows: B
T.C. No. 160 of 1969
"(1) Whether, on the facts and in the circumstances of the case,
the Tribunal was right in upholding the basis of valuation adopted
by the Income-Tax Officer for the shares in Messrs. Sri Rama Vilas C
Service (Private) Ltd. as on January 1, 1954?
(2) Whether, on the facts and in the circumstanses of the_ case, the
Tribunal was right in holding that the proviso to section 12B(2)
has no application in regard to the sale of shares to. M/s. Simpson D
& Company Ltd.?"
T.C. No. 239 of 1971
"(1) Whether, on the facts and in the circumstances of the case,
the Tribunal was right in holding that the proviso to section 12B(2)
has no application in regard to the sale of various shares by the E
assessee-company to M/s. Simpson & Company Ltd. through M/s.
Simpson & General Finance Co. (Private) Ltd. and that the asses-
see was entitled to a capital loss of Rs. 9,47, 541 in the assessment
year 1958-59?
F
(2) Whether, on the fact and in the circumstances of the case, the
Tribunal was right in law in holding that the second proviso to
section 12B(2) had no application and that the full value of the
consideration accounted for by the assessee should not be altered?"
These questions arise in the following facts and circumstances. G
•
M/s. Amalgamation Private Limited (hereinafter referred to as 'the
assessee-company') is a company incorporated on December 22, 1938 as a
private limited company. The assesee-company held shares in several
companies, such as Simpson and Company Ltd., Acldison & Company Pvt.
Ltd., George Oakes (Private) Ltd., Addison Paints & Chemicals Private H
(
'
1010 SUPREME COURT REPORTS [1997] 3 S.C.R.
A Ltd., India Pistons Private Ltd., etc. Out of the issued capital of Rs.
7,50,000 shares of Rs. 10 in Simpson and Company Ltd. the assessee-com-
pany held, at the material time, 7,06,933 ordinary shares. Simpson and
Company Ltd. had a subsidiary by name Simpson and General Finance
Company (Private) Ltd. carrying on the business of financing by way of
B hire purchase transactions to outsiders and by way of loans and advances
to the companies of this group. As on July 1, 1956 a sum of Rs. 1,85,16,000
was due to Simpson and General Finance Company (Private) Ltd. from
the assessee-company. Under Section 295 of the Companies Act, 1956,
which came into force on April 1, 1956, no company could, without
obtaining the previous approval of the Central Government in that behalf,
C directly or indirectly, make any loan to a company, which is its holding
company. In sub- section (3) of Section 295 it was provided that where any
loan made by the lending company and outstanding al the commencement
of the Companies Act, 1956, could not have been made without the
previous approval of the Central Government if that Section had then been
D in force, then the lending company had to, within six months from the
commencement of the Act or such further time not exceeding six months
as the Central Government might grant for that purpose, either obtain the
approval of the Central Government to the transaction or enforce the
repayment of the loan made. The liability of Rs. 1,85,16,000 to Simpson
and General Finance Company (Private) Ltd. by the assessee-company was
E affected by the afores;::id provision and, therefore, it became necessary for
the assessee-company to liquidate this liability. Simpson and General
Finance Company (Private) Ltd. owed a sum of Rs. 1,05,21,750 to Simpson
and Company Ltd. The assesscc-company approached the Government of
India for necessary approval to put through certain transactions of sale of
shares held by it to Simpson and General Finance Company (Private) Ltd. in
F liquidation of the liability. Simpson and General Finance Company (Private)
Ltd., in its turn, would discharge its liability to Simpson and Company Ltd. by
selling its holdings to Simpson and General Fmance Company (Private) Ud.
The assessee-company as well as Simpson and General Fmance Company
(Private) Ltd. proposed to sell the shares at certain specified price per share
G and sought the approval of the Central Government for such sale. The Central
Government, in approving the sale, fixed its own prices and stated that the
said fixation was without prejudice to any valuation of shares for purposes of
capital gains. Thereafter the shares held by the assessce;company in various
companies in respect of which approval had been granted by the Central
'
Government were transferred by the assessee-company to Simpson and
H General Finance Company (Private) Ltd. with effect from June 13, 1957 at
C.I.T. v. AMALGAMATION PVT. LTD. [S.C. AGGARWAL,J.) 1011
the prices foo:d by the Company Law Administration and Simpson and General A
Finance Company (Private) Ltd. sold part thereof to Simpson and Company
Ltd. The transaction between Simpson and General Finance Company (Private)
Ltd. and Simpson and Company Ltd. was also at the same prices.
In submitting its income tax return for the assessment year 1958-59,
the relevant previous year ending June 30, 1957, the assessee-company B
claimed a capital loss of Rs. 4,37,703 in respect of the above transactions.
In arriving at this loss the assessee-company opted for the substitution of
the market value as on June 1, 1954 in respect of shares in (1) S.R.V.S.
(Private) Ltd., (2) Addison & Company Ltd., (3) George Oakes (Private)
Ltd., and (4) India Pistons (Private) Ltd. As regards the rest of the shares, c
the assessee-company adopted the cost prices. The Income Tax Officer,
while making the assessment, proceeded on the basis that the price struc-
ture approved by the department of Company Law Administration for the
transfer of the aforesaid shares was pure and simple on an ad hoc basis
and meant to serve the limited purpose of approval to be given under
Section 372 of the Companies Act, 1956 and that the price at which the D
sales took place could not, therefore, be taken to represent the fair market
value of the shares. He took the break-up value as on January 1, 1954 for
the purpose of computation of capital gains and revised the sale prices and
arrived at Rs. 6,95,082 as the net capital gains. Even according to his
computation there were certain capital losses which were adjusted as E
against the capital gains determined by him. In the casc of S.R.V.S.
(Private) Ltd. the Income Tax Officer took the break-up value as on
January 1, 1954 at Rs. 36,35,350 and their sale value at Rs. 21,88,395
resulting in the capital loss of Rs. 14,46,955.
F
The assessee-company appealed against the assessment of the capital
gains to the Appellate Assistant Commissioner. While the said appeal was
pending, the Commissioner of Income Tax proceeded under Section 33B
of the 1922 Act as he was of the view that the order of the Income Tax
Officer was erroneous and prejudicial to the interest of revenue in so far
as he had wrongly allowed the capital loss amounting-to Rs. 14,46,955 on G
the sale of the shares in S.R.V.S. (Private) Ltd. After considering the
submission of the assessee-company, the Commissioner held that the ap-
preciation in value of the shares of Simpson and Company Ltd. held by
S.R.V.S. (Private) Ltd. should not have been taken into account and if the
value of the shares held by S.R.V.S. (Private) Ltd. in Simpson and Com- H
1012 SUPREME COURT REPORTS [1997] 3 S.C.R.
A pany Ltd., as on January 1, 1954, had been Rs. 24,38,578 S.R.V.S. (Private)
Ltd. would not have parted with these shares at cost on July 31, 1955. The
Commissioner revised the capital 10ss of Rs. 14,46,955 allowed by the
Income Tax Officer and considered that there was capital gain liable for
assessment of Rs. 3,91,579. This figure was directed to be substituted and
B the assessment of capital gains was revised accordingly.
The assessee-company appealed against the said order of the Com-
missioner to the Tribunal contending that the sale value fixed by the
Company Law Administration represented the correct value of the shares
and the transac~ions were without any motive to avoid capital gain and they
C had been necessitated by the various provisions of the Companies Act
which prohibited inter-company loans and that the method adopted by the
Income Tax Officer, viz., the secondary valuation, was proper. The said
appeal was allowed by the Tribunal and the order of the Commissioner of
Income Tax was set aside and the method adopted by the Income Tax
D Officer of secondary valuation was held to be proper. The Appellant
Assistant Commissioner took up the appeals of the assessee-company for
this and other years subsequent to the order of the Tribunal and following
the Tribunal's order he worked out the capital loss in respect of the other
shares under consideration and in effect accepted the assessee-company's
E claim of capital loss of Rs. 4,37,703. The said order led to appeals both by
the assessee-company and the Revenue to the Tribunal. The assessee-
company's appeal related to computation of the capital loss of Rs. 4,37,703
as emerging from the order of the Appellate Assistant Commissioner
instead of Rs. 4,90,244 which would be the correct figure. The Revenue
contested the acceptance of the claim of the assessee-company with refer-
F ence to the capital loss of Rs. 4,37,703 as shown in the returns.
On the first occasion when the matter came before the Tribunal, it
remanded the case to the Appellate Assistant Commissioner and called for
a specific finding whether the sales under 'consideration were effected with
G the object of avoidance of tax or reduction of liability to tax and also
wanted the full value of consideration to be worked out, in case the first
proviso to Section 128(2) of the 1922 Act was held to be applicable. The
Appellate Assistant Commissioner observed that there was ample evidence
to show that the sale of shares was a forced one and that the assessee-com-
H pany had no option but to comply with the statutory provisions and that
C.I.T. v. AMALGAMATION PVf. LTD. (S.C. AGGARWAL,J.) 1013
the evidence produced clearly established the assessee-company's conten- A
tion that the sale was not motivated by any desire to avoid capital gains
and that the Revenue had not proved by any conclusive evidence that the
motive underlying the transaction was the avoidance or reduction of the
liability to capital gains tax. He worked out the figures in accordance with
the rules framed under the Wealth Tax Act and found that the prices fixed B
by the Company Law Administration were not very much different from
the figures worked out by him. After receiving the report of the Appellate
Assistant Commissioner, the Tribunal considered the matter again and
held that the proviso to section 12B of the 1922 Act could not be invoked
in the instant case as there was no evidence to support the view that the C
sales were effected with a view to avoid the provisions of Section 12B. The
Tribunal accepted the contention of the assessee-company and held that
the Revenue was not justified in computing the capital gains and disturbing
the figures fixed by the Government of India. The two questions referred
in T.C. No. 160 of 1969 arise out of proceedings under Section 33B of the D
1922 Act, while questions Nos. 1 and 2 referred in T.C. No. 239 of 1971
arise out of the order of the Tribunal in the appeal against the order of
the Appellate Assistant Commissioner in respect of the assessment year
1958-59.
Since the second question in T.C. No. 160of1%9 and questions Nos. E
1 and 2 in T.C. No. 239 of 1971 raised more or less the same issue, they
were taken up together by the High Court. After referring to the provisions
of Section 12B(2) and more particularly the first proviso to the said
sub-section, the High Court has observed that the first requisite for the
application of the said proviso, namely, that the person to whom the sale F
is made should be a person with whom the assessee is directly or indirectly
connected, was satisfied in the present case because the sale of shares to
a subsidiary of a subsidiary is one to a person with whom the assessee-com-
pany is directly or indirectly connected. As regards the second requirement
of the proviso, as to whether the sale was effected with the object of
avoidance or reduction of the liability of the assessee-company under that G
Section, the High Court has pointed out that the Income Tax Officer had
not given a finding that the object with which the transaction was put
through was the avoidance or reduction of the liability to capital gains tax
and the only observation that he had made in his order was that there was
a reduction of liability to capital gains. According to the High Court, such H
1014 SUPREME COURT REPORTS [1997] 3 S.C.R.
A a finding of taking the result as if it was the object would not satisfy the
requirement of the first proviso to Section 12B(2) of the 1922 Act. The
High Court was of the view that the Tribunal had rightly called for a finding
on this point specifically from the Appellate Assistant Commissioner. After
referring to the finding recorded by the Appellate Assistant Commissioner,
B which was accepted by the Tribunal, that the object of the transaction was
not to avoid or reduce such liability to capital gains tax, that the sale was
a forced sale since the assessee-company had no option and that the prices
had been fixed by the Company Law Administration, the High Court held
that the first proviso to Section 12B(2) cannot be attracted to the present
case. The High Court did not accept the contention urged on behalf of the
C Revenue that the sale price had been fixed by the Company Law Ad-
ministration on ad hoc basis and, in this context, it has observed that the
letter dated May 18 of 1957 (Annexure G.VII.A to the remand report of
the Appellate Assistant Commissioner) clearly shows that the Company
Law Administration worked out the figures in consultation with the Central
D Board of Revenue and when the assessee-company sold the shares at those
prices, it could not be validly contended that the assessee-company trans-
ferred the shares at certain prices with the object of avoidance or reduction
of liability to capital gains. On that view the High Court answered the
second question in T.C. No. 160 of 1969 and the second question in T.C.
No. 239 of 1971 in the affirmative and against the Revenue.
E
As regards the first question in T.C. No. 160 of 1969 which raises the
question of valuation, the High Court felt that on the view it had taken as
regards the second question it would not survive for consideration because
the question of valuation would be material only if the proviso applied. The
F High Court has, however, considered the said question and has indicated
the answer to that question also. The High Court has expressed the view
that this is a case of substantial holding and that there is textual backing
to the method adopted by the Income Tax Officer and that the Commis-
sioner had found fault with it without any valid reason. The High Court,
therefore, answered the first question in T.C. No. 160 of 1969 in affirmative
G and in favour of the assessee-company.
As regards the first question in T.C. No. 239of1971, the High Court
felt that it did not require any independent treatment in view of the answer
given with regard to second question in T.C. No. 160 of 1969 which would
H answer that question also. Therefore, that question also was answered in
C.l.T. v. AMALGAMATION PVT. LTD. [S.C. AGGARWAL, J.) 1015
the affirmative and in favour of the assessee-company. A
We have heard Shri K.N. Shukla, the learned senior counsel appear-
ing for the Revenue in support of the appeals in respect of the answers
given by the High Court to these questions. Having considered the submis-
sions of the learned counse~ we are of the view that the High Court has
rightly construed the provisions contained in the proviso to Section 12B(2) B
of the 1922 Act and, in view of the finding recorded by the Appellate
Assistant Commissioner, which finding was accepted by the Tribunal, that
the object of the transaction was not to avoid or reduce the liability to
capital gains, the said proviso was not attracted. In our opinion, the said
finding of the High Court does not suffer from any legal infirmity and there c
is no ground to interfere with the judgment of the High Court on this
aspect of the case.
We may now take up the appeals of the Revenue in respect of
questions Nos. 4, 5 and 6 in T.C. No. 239 of 1971. D
The said questions were as follows :
"(4) Whether, on the facts and in the circumstances of the case,
the Appellate Tribunal was right in law in holding that the loss
sustained by the assessee on account of standing guarantee to E
Sembiam Saw Mills (Private) Ltd. (in voluntary liquidation) should
be allowed in 1962-63 assessment after taking into account the
amounts received from the liquidators during the years 1959-60 to
1962-63?
F
(5) Whether, on the facts and in the circumstances of the case,
the Tribunal was right in law in deleting the receipts of Rs. 1,41,000,
Rs. 2,29,627, Rs. 1,10,500 and Rs. 4,381 from the liquidators of
Sembiam Saw Mills (Private) Ltd. (in voluntary liquidation), from
the assessments for 1959-60, 1960-61, 1961-62 and 1962-63 respec-.
tively? G
(6) Whether, on the facts and in the circumstances of the case,
the Appellate Tribunal was right in law in holding that an amount
of Rs. 4,23,256 representing the real loss sustained by the assessee
on account of standing guarantee of Sembiam Saw Mills (Private) H
1016 SUPREME COURT REPORTS (1997] 3 S.C.R.
A Ltd. (in voluntary liquidation) should be allowed in the assessment
year 1962-63?"
There was a company by name Sembiam Saw Mills (Private) Ltd.
(for short 'SSM'), which was originally a subsidiary of Addison & Company
B (Private) Ltd. On and from February 1, 1954 the assessee-company pur-
chased all the shares of SSM from M/s. Addison & Company (Private) Ltd.
and SSM thus became the direct subsidiary of the assessee-company. SSM
had borrowed monies from the National Bank of India Ltd. and the
assessee-company had guaranteed the loan to the said company by the said
Bank. SSM went into liquidation some time in 1955. For the purpose of
C overdraft facilities SSM executed a promissory note in favour of the asses-
see-company which was endorsed by the assessee-company to the Bank
along with a separate guarantee letter in favour of the Bank. When SSM
went into liquidation, the assessee-company, as guarantor, was required to
clear those overdrafts in accordance with the terms of the guarantee. After,
D adjusting the amount recovered from the liquidators, the sum due to the
assessee-company from the liquidated company on account of the said
overdraft was Rs. 9,08,764. The assessee-company claimed this amount as
a loss which arose in the course of and incidental to its business in the
assessment for the year 1958-59. There were receipts by the assessee-com-
pany in the course of the liquidation of SSM in the later years. The total
E amount received came to Rs. 4,85,508.28 spread over the relevant account-
ing years for the assessment years 1959-60 to 1962-63. The assessee-com-
pany relied on the clause in the memorandum of association authorising it
to be the guarantor for the loans and contended that the transactions in
question sprang out of normal business transactions and hence the loss was
F an allowable deduction in the assessment for 1958 59. The Income Tax
Officer held that the loss in question did not arise during the course of or
incidental to the business of the assessee-company and in his view it was
at best a capital loss which did not come within the scope of Section 12B
of the 1922 Act. In making the assessments for the years 1959-60 to 1962-63
the Income Tax Officer treated the receipts from the liquidator as income
G as a protective measure. In appeal the Appellate Assistant Commissioner
did not accept the claim of the assessee-company for allowance of the Joss
in 1958-59 as he was of the view that it was not a loss which arose during
the course of or was incidental to its business. But the appeals for the years
1959-60 to 1962-63 were allowed in so far as they related to the question
H of the receipts in the respective years from the liquidator. As the guarantee
C.l.T. v. AMALGAMATION PVT. LTD. (S.C. AGGARWAL,J.] 1017
--- loss had not been allowed as a deduction in 1958-59, the Appellate Assis- A
tant Commissioner held that the subsequent recoveries could not be in-
cluded in the total income in the later years. The assessee-company as well
as the Revenue preferred appeals against the said order of the Appellate
Assistant Commissioner before the Tribunal. The Tribunal held that the
assessee-company had guaranteed the loan in the course of carrying on its
own business and that the loss was clearly admissible as a deduction. But
B
.. since the assessee-company had received the last of the payments from the
liquidator in the previous year relevant to the assessment year 1962-63 it
was held that the balance of Rs. 4,23,256 remaining unrecoverable repre-
sented the real business loss allowable for the assessment year 1962-63. At
the instance of the Revenue the Tribunal referred the aforementioned c
questions Nos. 4, 5 and 6 for the opinion of the High Court.
The High Court, while dealing with said questions, has observed that
the real point in issue was whether the guarantee that was executed in
favour of the Bank in respect of the loan to SSM, the subsidiary of the D
assessee-company, was done in the course of its own business. The High
Court has referred to its earlier judgment in Amalgamations P. Ltd. v.
Commissioner of Income Tax, (1969) 73 ITR 380, wherein the nature of the
business of the assessee-company has been considered and it has been held
that the provisions of Section 23A of the 1922 Act were applicable to the
assessee-company since the assessee-company's business includes furnish- E
ing guarantee to debts borrowed by subsidiary companies. The High Court
has held that the said finding given in that case is clearly applicable to the
questions under consideration before it and that the assessee-company had
incurred the loss in carrying on its own business which includes furnishing
guarantees to debts borrowed by its subsidiary companies. According to
F
the High Court, the loss was allowable as a deduction in the year in which
it came to be ascertained and in the instant case the High Court held that
the assessee-company could have ascertained whether there was loss in the
transaction of guarantee only at the stage of final payment by the liquida-
tors which was received in the relevant previous year for the assessment
year 1962-63 and that the Tribunal was right in allowing it in that year. The G
High Court, therefore, answered questions Nos. 4, 5 and 6 in the affirm-
ative and against the Revenue.
After hearing Shri Shukla on the appeals fileJ by the Revenue in
respect of these questions, we are unable to hold that the judgment of the H
1018 SUPREME COURT REPORTS (1997) 3 S.C.R.
A High Court in respect of these questions suffers from any legal infirmity.
We, therefore, affirm the answer given by the High Court to questions Nos.
4, 5 and 6 referred to it. In the circumstances, it must be held that Civil
Appeal Nos. 139-142 of 1980 filed by the Revenue are liable to be dis-
missed.
B We would now come to Civil Appeals Nos. 7-11of1980 filed by the
assessee-company in relation to question No. 3 in T.C. No. 239 of 1971,
which was as under :
"(3) Whether, on the facts and in the circumstances of the case,
c the Appellate Tribunal was right in law in holding that the
sums of Rs. 4,37,066, Rs. 90,896, Rs. 1,08,978, Rs. 1,18,102 and
Rs. 1, 11, 740 are admissible as a deduction in the assessments
of the assessee for the assessment years 1958-59 to 1962-63
respectively ?"
D
The assessee-company was a bulk shareholder in several companies
and in the relevant year there were sixteen companies. The assessee-com-
pany was rendering certain common services to i'ts subsidiaries by having
(1) a finance committee; (2) a liaison office in Delhi (3) an export promo-
tion department; and (4) an internal audit department. The expenditure on
E account of maintenance of liaison office in Delhi1 and the departments of
export promotion and internal audit was borne by the assessee-company
and was recovered from the subsidiaries. The finance committee was
working in an advisory capacity to the various subsidiary companies to help
them to carry on their business more efficiently. All purchase requisitions
F for the purchase of capital equipment beyond Rs. 500 of each purchase
and Rs. 2,500 with reference to purchase of raw materials were submitted
to the finance committee for their approval. The purpose of such control
was to judiciously use the funds of the company to the best advantage of
each company. Various data were gathered before such sanction was
accorded or refused. Technical matters or other matters of management
G were also referred to the members of the finance committee who were
experienced in their respective fields. The finance committee went through
the financial position of each company daily. The directors of the assessee-
company were also directors/managers in the subsidiary companies. As per
the service agreements between them and the concerned subsidiary com-
H pany they were entitled to payment of remuneration and also a certain
C.I.T. v. AMALGAMATION PVf. LTD. [S.C. AGGARWAL, J.] 1019
percentage of the profits as commission. Similar service agreements A
had been entered by other directors of the subsidiary companies who
were not the directors of the assessee-company. In view of the
provisions of section 198 of the Companies Act, 1956, fixing a ceiling
on the overall managerial remuneration at 11 % of the net profits of
1
the company, it was not possible for the subsidiary companies to pay the
B
contracted remuneration to the persons concerned. On April 4, 1959 the
Board of Directors of the assessee-company passed a resolution whereby
it was resolved that the remuneration payable to nine directors of the
subsidiary companies would be paid to them in full in accordance with the
terms of the contract respectively entered into by them and the amount in
excess of the maximum amount permissible under-the Companies Act, 1956 c
would be met by the assessee-company. Out of these nine directors three
were directors of the assessee-company and out of these three directors
two were members of the finance committee. None of the other six direc-
tors of the subsidiary companies was a member of the finance committee.
In accordance with the said resolution the assessee-company paid diverse D
amounts to the said directors. The total amounts so paid to the several
persons for the different years are mentioned in question No. 3. The
assessee-company claimed the said amounts as deduction under Section
10(2)(xv) of the 1922 Act for the assessment years 1958-59 to 1961-62 and
under Section 37 of the 1961 Act for the assessment year 1962-63. Before E
the Income Tax Officer it was not disouted that these payments were in
respect of services rendered by respective persons to the various subsidiary
companies of which they were directors/managers and that no part of the
payment could be related to any service directly rendered by them to the
assessee-company. It was submitted that though the services were
rendered by them to other companies, they should be deemed to have F
rendered the service to the assessee-company in view of the nexus
between the holding company and its subsidiaries. The Income Tax
Officer did not accept this submission and held that the excess
remuneration over and above what was admissible under Section 198
of the Companies Act, which was not borne by the respective com- G
parries, could not be allowed as deduction under Section 10(2)(xv) of the
1922 Act and Section 37 of the 1961 Act as expenditure wholly and
exclusively incurred for the purpose of the business of the assessee-com-
pany. It was also stressed that the resolution of the Board of directors of
the assessee-company was passed on April 4, 1959, after the previous years H
1020 SUPREME COURT REPORTS [1997] 3 S.C.R.
A relevant to the assessment years 1958-59 and 1959-60. On appeal the
Appellate Assistant Commissioner took the same view. The matter was
remanded by the Tribunal to the Appellate Assistant Commissioner for
consideration and submission of report on the points mentioned in the
order of remand. The Appellate Assistant Commissioner after taking
further evidence submitted his report wherein he reported that deduc-
B tion may be allowed in respect of remuneration paid to persons who
were directors of the assessee-company and were members of the
finance committee, but such deduction could not be allowed in respect
of remuneration paid by the assessee-company in respect of persons
who were only directors and employees of the subsidiaries but neither
c directors of the assessee-company nor members of the finance commit-
tee. The Tribunal was of the view that looking to the nature of the
business of the assessee-company of holding shares uf a number of
subsidiary companies and that it was looking after the interest and
welfare of those companies with a view to earn dividc:nds, the whole of
D the expenditure referable to the remuneration paid by the assessee-com-
pany was admissible as a deduction.
Rejecting the contention urged on behalf of the Revenue thM the
assessee-company was not carrying on any business because merely holding
of investments would not constitute business, the High Court has held that
E in view of Section 23A of the 1922 Act holding of investments, in ap-
propriate cases, would equally be a business a.~ dealing in them and what
is required is that there must be a real substantial and systematic or
organised course of activity or conduct with the set purpose of earning
profit which is the test for a business. The High Court has observed that
F the assesce-company is not a mere investor in a single company but has
investment.. in sixteen companies and had taken active interest in the
business of these companies as is clear from the services that had been
rendered in the shape of export promotion, liaison office at Delhi and
internal audit and it also rendered consultation in respect of finance by its
directors meeting every day with reference to the needs and requirements
G of each company and that it is not a case where the assessee-company
contented itself with merely making an investment and looking for the
· dividend. The High Court has, therefore, held that there was a business
activity in the matter of holding of investments. While dealing with the
question whether the expenditure that has been incurred was wholly and
H exclusively laid out for the purpose of the assessee-company's business, the
C.l.T. v. AMALGAMATION PVT. LTD. [S.C. AGGARWAL,J.] 1021
High Court has negatived the contention that the said question is purely A
factual because in order to be deductible the expenditure must satisfy two
tests; (1) the expenditure must be incurred by the assessee in his capacity
as a trader; and (ii) it must be incidental to the carrying on of his business.
The High Court was of the view that there must be a nexus between the
expenditure and the business of the assessee. Applying these tests the High
Court has held that the purpose of the payment in the present case was
B
only to take out the subsidiary from an inconvenient situation in which it
found itself as a result of statutory change restricting the remuneration
payable to its director and that the expenditure had not been incurred
wholly and exclusively for the business of the assessee-company and it
could not be allowed as deduction. The alternative claim put forward on c
behalf of the assessec-company that at any rate the expenditure incurred
by the assessee-company in remunerating its own directors who 'were also
members of the finance committee should be allowed as deduction as there
is a nexus between the expenditure and the business of the assessee-com-
pany in rendering services to its subsidiaries, was not accepted by the High D
Court for the reason that the resolution passed by the assessee-company
does not say that the expenditure was incurred for the purpose of
remunerating its own directors in so far as they rendered services to it as
members of the finance committee. The High Court has observed that the
resolution treated the directors, whether they be the members of the
finance committee or not, as a class and with reference to all of them the E
assessee-company incurred the expenditure only because they could not be
remunerated to that extent by the subsidiary companies and the fact that
they were directors of the assessee-company and that they were members
of the finance committee had not been taken into account in taking over
the remuneration payable to them. Question No. 3 was, therefore, F
answered in the negative and against the assessee-company.
The amounts paid by the assessee-company to the directors of its
subsidiary companies can be admissible as a deduction under Section
10(2)(xv) of the 1922 Act or Section 37(1) of the 1961 Act only if they can
be regarded as expenditure "laid out or expended wholly and exclusively G
for the purposes of the business" of the assessee-company. This expression
was also used in the Income Tax Act, 1918 in U .K. In Atherton v. British
Insula•cd and He/sby Cables Limited, (1925) 10 TC 155 (HL), Viscount
Cave, L.C., has thus explained the said expression :
H
1022 SUPREME COURT REPORTS (1997] 3 S.C.R.
A "........ a sum of money expended, not of necessity and with a view
to a direct and immediate benefit to the trade, but voluntarily and
on the grounds of commercial expediency, and in order indirectly
to facilitate the carrying on of the business, may yet be expended
wholly and exclusively for the purposes of the trade."
B (P.191)
These observations have been referred to with approval by this Court
while construing Section 10(2)(xv) of the 1922 Act. Sec : Eastern Invest-
ments Ltd. v. Commissioner of Income Tax, (1951) 20 rTR 1 and Commis-
C sioner of Income Tax v. Chandu/al Keshav/al & Co., (1960) 38 ITR 601.
In Travancore Titanium Products Ltd. v. Commissioner of Income
Tax, Kera/a, (1966) 60 ITR 227, this Court, while construing the expres-
sion "for the purpose of business" in Section 10(2)(xv) of the 1922 Act,
has said :
D
"The expenditure must be incidental to the business and must be
necessitated or justified by commercial expediency. It must be
directly and intimately connected with the business and be laid out
by the Taxpayer in his character as a trader. To be a permissible
deduction, there must be a direct and intimate connection between
E the expenditure and the business i.e. between the expenditure and
the character of the assessce as a trader, and not as owner of assets,
even if they are assets of the business."
In The Indian Aluminium Co. Ltd. v. Commissioner of Income Tax,
F (1972) 84 ITR 735, decided by a Constitution Bench of this Court, the
aforementioned test laid down in Travancore Titanium Products Ltd. v.
Commissioner of Income Tax, Kera/a (supra), was qualified in these
terms :
"In our view, the test adopted by this Court in Travancore Titanium
G case that 'to be a permissible deduction, there must be a direct
and intimate connection between the expenditure and the business,
i.e., between the expenditure and the character of the assessee as
a trader, and not as owner of assets, even if they are assets of the
business' needs to be qualified by stating that if the expenditure is
H laid out by the assessee as owner-cum-trader, and the expenditure
C.l.T. v. AMALGAMATION PVT. LTD. [S.C. AGGARWAL,J.] 1023
is really incidental to the carrying on of his business, it must be A
treated to have been laid out by him as a trader and as incidental
to his business."
(p. 747)
The High Court, in our opinion, has rightly proceeded on the basis B
that there must be a nexus between expenditure and business of the
assessee.
Shri T.A. Ramachandran, the learned senior counsel appearing for
the assessee-company, has submitted that the said test is satisfied in the
present case since the purpose of the payment of remuneration to the c
directors of the subsidiary companies was to enable these companies to
earn higher profits which would be passed on to the asscssee-company as
and by way of dividends. The learned counsel has placed strong reliance
on the decision of Bombay High Court in Tata Sons Ltd. v. Commissioner
of Income Tax, Bombay City, 18 ITR 460, and the decision of the Gujarat D
High Court inJ.R. Patel and Sons (P) Ltd. v. Commissioner of Income Tax,
Gujarat, 69 ITR 782, and has urged that the High Court has committed an
error in distinguishing these cases on the ground that they related to
managing agents whereas the present case relates to a holding company
and its subsidiaries. Shri Ramachandran has contended that the principle
laid down in the said decisions is equally applicable to a case of a holding
E
company.
We are unable to accept this contention. The High Court, in our
opinion, has rightly pointed out that the business of the assessee-company
is the holding of investments and if with reference to the business of F
holding investments any expenditure had been incurred that could have
been allowed as deduction. The expenditure incurred in payment of
managerial remuneration to the directors of the subsidiary companies
cannot be said to be expenditure incurred in carrying on the business of
the assessee-company of holding its investments. The assessee-company
could hold its investments and earn its dividends without incurring this G
expenditure. Since the subsidiary company was not obliged to distribute by
way of dividends the entire profits earned on account of their managerial
remuneration paid by the assessee-company and the assessee-company was
only entitled to dividend from the subsidiary company as and when
declared, it cannot be said that there was a direct and immediate connec- H
1024 SUPREME COURT REPORTS [1997] 3 S.C.R.
A tion between the expenditure incurred and the business of the assessee-
company. The decisions in Tata Sons Ltd. v. Commissioner of Income Tax,
Bombay City (supra) and J.R. Patel and Sons (P) Ltd. v. Commissioner of
Income Tax, .Gujarat, (supra) are not applicable in the facts of this case.
In Tata Sons Ltd. v. Commissioner of Income Tax, Bombay City
B (supra) the assessee was the managing agent of another company and
under the managing agency agreement that assessee was to be paid a
commission at a certain rate which was to be computed upon the net profits
of the managed company. During the relevant years the assessee paid
voluntarily certain sums as half share of the bonus which the managed
C company paid to some of its officers and it claimed deduction of the said
amounts under Section 10(2)(xv) of the 1922 Act. The Bombay High Court
upheld the claim of the assessee for such a deduction on the view that from
the point of view of commercial principles what the assessee had done was
something which had as its object increasing the profit of the managed
D company and thereby increasing its own shares on commission and, there-
fore, the deduction claimed by the assessee was wholly and exclusively for
the purposes of its business and was an allowable deduction under Section
10(2)(xv) of the 1922 Act. While dealing with the contention urged on
behalf of the Revenue that the payment had been made not to the
employees of the assessee but to the employee of a managed company - a
E different entity altogether - the High Court has observed :
"Here again if it can be shown that there was a very important
nexus between the assessee company and the managed company
which necessitated the asscssee company making the payment to
F the employees of the managed company, then again it would be
possible for the assessee company to satisfy us that the expenditure
was one which fell within the ambit of Section 10(2)(xv). Now it
cannot be seriously disputed that the bonus was paid by the
managed company to their employees in order to increase the
efficiency of the working of the company. An increased efficiency
G of that company would incidentally result in higher and better
profits, and the assessee company would be as much interested in
the working of the managed company being more efficient as the
managed company itself. Whatever tended to increase the profits
of the managed company would also tend to increase the income
H and profits of the assessee company. Therefore it cannot be sug-
C.LT. v. AMALGAMATION PVT. LTD. [S.C. AGGARWAL,J.) 1025
gested that the assessee company had an indirect or ulterior motive A
in making this payment. The only motive by which it was actuated
was a purely commercial and pecunniary one and that was to see
that more profits were made by the managed company so that its
own commission should thereby be increased." (p.468)
In that case there was a direct nexus between the increased profits B
of the managed company and the managerial commission payable to the
assessee since the managing agency commission was a prescribed percent-
age of the net profits of the managed company. As indicated earlier, there
was no such nexus between the increased profit of the subsidiary company
and the profit earned by the assessee-company by way of dividend on the c
shares held by it in the subsidiary company.
In J.R. Patel and Sons (P) Ltd. v. Commissioner of Income Tax,
Gujarat (supra) the assessee was the managing agent and its managing
director was also the director of the managed company. Prior to coming D
into force of the Companies Act, 1956 on April 1, 1956, he was getting
monthly salary from the assessee and in addition he was getting monthly
remuneration as technical adviser of the managed company as well as
commission at a prescribed rate on the sale price of healds and reeds
manufactured and sold by the managed company. After the passing of the
Companies Act, 1956, the remuneration that could be received by him was E
reduced and he could not also be paid the commission. The assessee,
therefore, increased the emoluments. The said excess payment made by the
assessee was disallowed and the expenditure incurred was restricted to the
amount that was being paid prior to coming into force of the Companies
Act, 1956. The Gujarat High Court held that the assessee had paid extra F
payment to its managing director so that the affairs of the managed
company could be properly looked after and that as a result of the
remuneration the profits of the managed company and the share of the
commission of the assessee increased and, therefore, the excess amount
paid by the assessee to its managing director was expended wholly and
exclusively for the purpose of its business and was an allowable deduction G
under Section 10(2)(xv) of the 1922 Act. Reliance was placed on the
decision in Tata Sons Ltd. (supra). This was also a case where the profits
of the assessee in the form of managing agency commission were directly
linked to the profit of the managed company which is not the position in
the present case. H
1026 SUPREME COURT REPORTS [1997] 3 S.C.R.
A The alternative claim by the assessee-company for deduction in
respect of the expenditure incurred by the assessee-company in respect of
--
amounts paid to its own directors who were also the members of the
finance committee has been rightly rejected by the High Court in view of
the resolution passed by the assessee-company wherein the directors,
B whether they be the members of the finance committee or not, have been
treated as a class and with reference to all of them the assessee-company
incurred the expenditure only because they could not be remunerated to
that extent by the subsidiary companies. The fact that they were directors
of the assessee-company and members of the finance committee was not
taken into account in taking over the remuneration payable to them. In the
C circumstances, Civil Appeals Nos. 7-11 of 1980 filed by the assessee-com-
pany are also liable to be dismissed.
In the result, Civil Appeals Nos. 139-142of1980 filed by the Revenue
and Civil Appeals Nos. 7-11 of 1980 filed by the assessee-company are
dismissed. No order as to costs.
D
B.K. Appeals dismissed.
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