The Commissioner of Income-Tax, Delhi
Vs. The Delhi Flour Mills Co., Ltd.  INSC 92 (3 October 1958)
AIYYAR, T.L. VENKATARAMA GAJENDRAGADKAR, P.B.
CITATION: 1959 AIR 185 1959 SCR Supl. (1) 28
CITATOR INFO :
RF 1961 SC 692 (12)
Excess Profits-Assessment-Assessee company's
agreement with managing agents-Commission on net profits-Computation -Tax, if
can be deducted-- " Net profits ", meaning of.
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,
 A.C. 10 and Re G. B. Ollivant & Co. Ltd.'s Agreement,  2 All
E. R. 528, distinguished.
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 1952.
H. J. Umrigar and R. H. Dhebar, for the
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
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 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 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
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.
....................................... 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 (1)  1 Ch. 639.
(3)  3 K. B. 597.
(5) (1942) 47 Bom. L.R. 774.
(2)  2 Ch. 254.
(4)  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)  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
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 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)  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)  A.C. 10, 12.
(2)  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.
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)
 26 I.T.R. 265. (2)  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 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
The appeal is therefore allowed with costs in
this Court and in the High Court.