1977-VIL-297-BOM-DT

Equivalent Citation: [1979] 119 ITR 900, 1978 CTR 487

BOMBAY HIGH COURT

Date: 08.11.1977

LIFE INSURANCE CORPORATION OF INDIA

Vs

COMMISSIONER OF INCOME-TAX, BOMBAY CITY II

BENCH

Judge(s)  : CHANDURKAR., DESAI

JUDGMENT

The judgment of the court was delivered by

CHANDURKAR J.---The assessee at whose instance three questions have been referred to this court under s. 256(1) of the I.T. Act, 1961, is the Life Insurance Corporation of India. The three questions referred are :

" (1) Whether, on the facts and in the circumstances of the case, the sum of Rs. 8,71,374 being the income-tax deducted at source during the inter-valuation period of 15 months ended March 31, 1963, could be added to the surplus disclosed in the valuation balance-sheet whilst computing the income of the assessee under rule 2(1)(b) of the First Schedule to the Income-tax Act, 1961 ?

(2) Whether, on the facts and in the circumstances of the case, the sum of Rs. 3,64,028 being the amount paid during the inter-valuation period of 15 months ended March 31, 1963, towards compensation payable under section 36 of the said Life Insurance Corporation Act to chief agents and special agents was not expenditure deductible under the provisions of sections 30 to 43 of the Income-tax Act ?

(3) Whether, on the facts and in the circumstances of the case, the sum of Rs.1,31,71,276 being the portion of the surplus statutorily payable to the Central Government under section 28 of the Life Insurance Corporation Act, 1956, and so paid is a permissible deduction from the surplus disclosed for the inter-valuation period ended March 31, 1963 ?"

It was at the outset stated on behalf of the assessee by Mr. Colah that question No. 1 was not being pressed. The arguments before us were, therefore, restricted to questions Nos. 2 and 3.

Before we refer to the facts relevant for the purposes of this reference, it would be convenient to refer to certain provisions of the Life Insurance Corporation Act, 1956, on which arguments of the learned counsel for both the assessee and the revenue are founded.

The LIC of India came into being as a corporation with effect from 1st September, 1956, by virtue of s. 3(1) of the Life Insurance Corporation Act, 1956 (hereinafter referred to as "the Act "). Under s. 6 of the Act the function of the Corporation was stated to be " to carry on life insurance business, whether in or outside India " and the Corporation was to so exercise its powers under the Act as to secure that life insurance business is developed to the best advantage of the community. Under s. 7(1) of the Act it was provided that on the appointed day there shall be transferred to and vested in the Corporation all the assets and liabilities pertaining to the controlled business of insurers. " Controlled business " is defined in s. 2(3) of the Act. The definition is very comprehensive, but in substance it refers to life insurance business and it is sufficient to mention that by virtue of s. 7(1) all life insurance business was to be carried on by the LIC and had ceased to be carried on by other insurers. Section 9 of the Act provided for general effect of vesting of the controlled business. Section 9(1), which is material for the purposes of the present reference, reads as follows :

" Unless otherwise expressly provided by or under this Act, all contracts, agreements and other instruments of whatever nature subsisting or having effect immediately before the appointed day and to which an insurer whose controlled business has been transferred to and vested in the Corporation is a party or which are in favour of such insurer shall in so far as they relate to the controlled business of the insurer be of as full force and effect against or in favour of the Corporation, as the case may be, and may be enforced or acted upon as fully and effectually as if, instead of the insurer, the Corporation had been a party thereto or as if they had been entered into or issued in favour of the Corporation."

Sub-section (2), which is not material, referred to the statutory substitution of the Corporation in any suit, appeal or in any legal proceeding of whatever nature which was pending and which was initiated by or against an insurer. The effect of s. 9(1) was that all contracts, agreements and other instruments which were subsisting and of effect immediately before 1st September, 1956, and to which an insurer whose life insurance business has been transferred to and vested in the Corporation was a party became binding on the Corporation. Provision was made in s. 16 of the Act for payment of compensation to the insurers whose controlled business was acquired by the LIC. It provided that where a controlled business of the insurer has been transferred to and vested in the Corporation under this Act, the compensation shall be given to the insurer by the Corporation in accordance with tbe principles contained in the First Schedule. We are not in this case concerned with the principles for determining compensation which was to be paid under s. 16(1). The obligation to determine the compensation was by s. 16(2) placed on the Corporation and after the amount was so determined in accordance with the principles contained in the First Schedule, the amount had to be approved by the Central Government and then it was to be offered to the insurer in full satisfaction of the compensation payable to him under the Act. However, if the insurer disputed the compensation, then the insurer had the right to take the matter to the Tribunal for this issue.

Chapter VI of the Act is headed as " Finance, Accounts and Audit ". Since the provisions of ss. 26 and 28 have been relied upon by the assessee, it is necessary to reproduce them in full. They read as follows :

" 26. The Corporation shall, once at least in every two years, cause an investigation to be made by actuaries into the financial condition of the life insurance business of the Corporation, including a valuation of the liabilities of the Corporation in respect thereto, and submit the report of the actuaries to the Central Government."

" 28. If as a result of any investigation undertaken by the Corporation under section 26 any surplus emerges, ninety-five per cent. of such surplus or such higher percentage thereof as the Central Government may approve shall be allocated to or reserved for the life insurance policyholders of the Corporation and after meeting the liabilities of the Corporation, if any, which may arise under section 9, the remainder shall be paid to the Central Government or, if that Government so directs, be utilised for such purposes and in such manner as that Government may determine."

The insurers whose business vested in the Corporation were entitled to appoint chief agents and special agents for securing the life insurance business under the provisions of the Insurance Act, 1938. Under s. 2(5A) of the Insurance Act, 1938, it was provided :

" ' Chief agent ' means a person who, not being a salaried employee of an insurer, in consideration of any commission---

(i) performs any administrative and organising functions for the insurer, and

(ii) procures life insurance business for the insurer by employing or causing to be employed insurance agents on behalf of the insurer."

" Special agent " is one of the categories of agents with which we are concerned and s.2(17) defines a special agent as meaning a person who, not being a salaried employee of an insurer, in consideration of any commission, procures life insurance business for the insurer whether wholly or in part by employing or causing to be employed insurance agents on behalf of the insurer, but does not include a chief agent. Thus, both the chief agent and the special agent work for the insurer in consideration of commission paid by the insurer.

The Sixth Schedule to the Insurance Act sets out in Part B the terms which were deemed to be included in every contract between an insurer carrying on life insurance business and a chief agent and Part C contains terms which are deemed to be included in every contract between an insurer carrying on life insurance business and a special agent or between a chief agent and a special agent. Some of those terms refer to the remuneration in the nature of commission payable to the chief agent and the special agent.

When the Life Insurance Corporation Act came into force the contracts between the insurer on the one hand and the chief agent and special agent on the other were put an end to statutorily by s. 36 of the Act, which reads as follows :

" Notwithstanding anything contained in the Insurance Act or in any other law for the time being in force, every contract appertaining to controlled business subsisting immediately before the appointed day,---

(a) between an insurer and his chief agent or between an insurer and a special agent ; or

(b) between the chief agent of an insurer and a special agent ;

shall, as from the appointed day, cease to have effect and all rights accruing to the chief agent or the special agent under any such contract shall terminate on that day :

Provided that in every such case compensation shall be given by the Corporation to the chief agent or the special agent, as the case may be, in accordance with the principles contained in the Third Schedule, and the provisions of sub-section (2) of section 16 shall, so far as may be, apply in every such case."

If we now refer to the Third Schedule, it prescribes separately principles for determining compensation payable to chief agents and to special agents. The provision in the case of chief agents was as follows :

" The compensation payable to a chief agent shall consist of seventy-five per cent. of the overriding commission specified in the contract relating to chief agency with the insurer on the renewal premiums received by the Corporation during a period of ten years from the appointed day in respect of the business procured by the chief agent before the appointed day ; and such compensation shall be determined and paid annually for the said period."

In the case of special agents it is provided as follows :

" The compensation payable to a special agent shall consist of one-eighth of his annual average earnings during the period beginning on the 1st day of January, 1952, and ending on the 31st day of December, 1955, in the form of overriding commissions in respect of business procured by him through insurance agents."

Apart from the mode of computation of compensation, the provisions of the Third Schedule show that compensation was to be paid annually for a period of 10 years in the case of chief agents while in the case of special agents the compensation was to be in the form of a lump sum.

Having thus referred to the relevant provisions of the Act, it is now necessary to refer to the facts which give rise to the present reference. In respect of the assessment year in question the surplus as per valuation in Form I in Sch. IV of the Insurance Act, 1938, was found to be Rs. 23,41,03,423. The Corporation claimed a deduction of Rs. 3,64,026 on account of compensation paid to special and chief agents. The Corporation also claimed that in accordance with the directions of the Central Government under s. 28 of the Act, a sum of Rs. 1,31,71,276 was paid to the Central Government and this amount was, therefore, not liable to be included in the income of the Corporation for the purposes of assessment of income-tax. The ITO held that the amount paid to the chief agents and special agents was in the nature of a capital disbursement. No specific reason was given for disallowing the deduction claimed in respect of a portion of the surplus paid to the Central Government.

In appeal, the AAC hold that the amount paid to the chief agents was not related to the carrying on of the business by the Corporation notwithstanding that compensation was payable with reference to renewal premiums received by the Corporation in the first 10 years. With regard to the portion of the surplus paid to the Central Government also, the AAC rejected the contention of the Corporation that the said amount was liable to be deducted because it was not at all the income of the Corporation, there being an overriding title of the Central Government to that portion of the surplus.

The Corporation, thereafter, filed an appeal before the Tribunal. The Tribunal held that the compensation paid to the chief and the special agents under s. 36 of the Act was of the same nature as the compensation paid to the insurers whose business had vested in the Corporation and which required to be paid under s. 16 of the Act and that the compensation was in fact a price for taking over the business of the insurers along with the obligation. The Tribunal also negatived the contention of the Corporation that there was an overriding title of the Government to the remainder of the surplus under s. 28 of the Act. The Tribunal took the view that what was in effect required to be done under s. 28 was an allocation or an appropriation of the surplus and that there was nothing to suggest that the amount of Rs. 1,31,71,276 which formed part of the actuarial surplus was never the income of the assessee. On these facts, the three questions reproduced earlier have been referred and, as already stated, we are now concerned only with questions Nos. 2 and 3.

Mr. Colah, on behalf of the assessee, has contended that the amount which is required to be paid to the chief agents and the special agents under s. 36 was clearly permissible as a revenue expenditure because, according to Mr. Colah, in view of the provisions of s. 9 of the Act, the Corporation had already incurred a liability to pay the commission which was otherwise required to be paid by the insurers in pursuance of the contract between the insurers and the chief agents and the special agents. That liability, according to the counsel, could be enforced against the Corporation and it was in order to get rid of the recurring liability that, by virtue of the statutory provision, the compensation had to be paid. Mr. Colah has placed reliance on the decision of the Supreme Court in CIT v. Ashok Leyland Ltd. [1972] 86 ITR 549.

On the other hand, it is vehemently contended by Mr. Joshi appearing on behalf of the revenue that the payment of compensation to the chief agent and the special agent was nothing more than an integral part of the scheme of the taking over of the business of insurance by the LIC and it was not necessitated or justified by any commercial expediency. It was contended that the commission has not been paid in the process of profit earning nor had it been paid in regard to any transaction of business of life insurance. Thus, according to the learned counsel, the payment of commission to the chief agents and the special agents cannot be said to be wholly or exclusively laid out for the purpose of business and the expenditure was, therefore, clearly of a capital nature and the Tribunal was, therefore, right in not allowing that expenditure to be deducted for the purposes of computing the taxable income of the Corporation.

Now, at the outset, it must be made clear that the fact that payment to the chief agents had to be spread over annually for a period of 10 years or the fact that the payment had to be made in lump sum to the special agents would by itself be of no consequence while determining whether the expenditure was of a capital nature or of a revenue nature. It is also apparent that so far as the Corporation was concerned, the Corporation had no choice in the matter. It was by virtue of a statute of Parliament that the life insurance business, which was originally carried on by other insurers, was vested in the LIC. But while providing for vesting of the business of the other insurers in the LIC, Parliament had safeguarded the rights of persons who had entered into different agreements or contracts with the insurers whose business was to vest in the LIC. Thus, any obligation which an insurer was to perform and any liability which was already incurred by an insurer had to be performed or discharged by the LIC after 1st September, 1956. Therefore, if the special agents or the chief agents were entitled to recover overriding commission from the insurers with whom they had entered into an agreement and for whom they had collected life insurance business throughout the length of time during which they were entitled to recover that commission from the insurer by virtue of s. 9 of the Act, that became the liability of the LIC statutorily. Parliament also, however, has provided that the liability should be discharged and that the agreements between the insurers and the chief agents and the special agents should be put an end to by making a statutory provision in respect thereof which is to be found in s. 36 of the Act. It was on account of the termination of the contracts with the chief agents or the special agents that compensation was made payable in accordance with the provisions in the Third Schedule. The effect of s. 36 and the proviso read together was that the recurring liability which would otherwise have been incurred by the Corporation for payment of overriding commission under the contract has been done away with by payment of compensation. The Corporation thus stood relieved from the liability to make recurring payments to the chief agents and the special agents by making lump sum payment in the case of special agents and by making certain payments spread over a period in the case of chief agents. It is difficult to see why when such payment is made to get rid of a recurring liability which arises out of business, it should not be considered to be in the nature of revenue expenditure. The distinction between capital expenditure and revenue expenditure is now well established, but the difficulty always arises when the principles have to be applied to a given case. We may refer to the following observations in M. K. Brothers P. Ltd. v. CIT [1972] 86 ITR 38, by the Supreme Court :

" The answer to the question as to whether the money paid is a revenue expenditure or capital expenditure depends not so much upon the fact as to whether the amount paid is large or small or whether it has been paid in lump sum or by instalments, as it does upon the purpose for which the payment has been made and expenditure incurred. It is the real nature and quality of the payment and not the quantum or the manner of the payment which would prove decisive. If the object of making the payment is to acquire a capital asset, the payment would partake of the character of a capital payment even though it is made not in lump sum but by instalments over a period of time. On the contrary, payment made in the course of and for the purpose of carrying on business or trading activity would be revenue expenditure even though the payment is of a large amount and has not to be made periodically. As observed by this court in the case of Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax [1955] 27 ITR 34, 45, if the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure ...... The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence."

It is difficult to hold in the instant case that the amount paid to the chief agents and the special agents was paid with a view to acquire an asset or advantage for the enduring benefit of the business. It is, no doubt, true that as a result of the provisions of the Act, the life insurance business of various insurers vested in the Corporation. For the vesting of that business in the Corporation, the payment made to the chief agents or the special agents could not be said to form any part of the consideration. If these payments were not made by way of compensation as provided by the proviso to s. 36, the Corporation would have been required to continue to discharge those liabilities which are statutorily fastened on it by the provisions of s. 9 of the Act. Those payments would then clearly have been in the nature of commission in respect of life insurance business of the insurers which had now vested in the Corporation. Parliament wanted to absolve the Corporation from such a recurring liability and that was why payment of a lump sum in the case of certain agents and payments spread over a period in the case of special agents was provided for by s. 36 read with the Schedule. In our view, the present case would squarely be covered by the decision of the Supreme Court in the case of Ashok Leyland Ltd. [1972] 86 ITR 549 (SC). The facts of that case show that the assessee-company, which was originally importing and assembling motor parts manufactured by Austin of England, had appointed a firm called Car Builders Ltd. as their managing agents under an agreement dated 18th October, 1948, for a period of 14 years from the date of its registration. The managing agents were to be paid at the rate of Rs. 2,000 per month as office allowance and 10% of the annual profits with a minimum of Rs. 18,000 per annum in case of inadequacy or absence of profits. The Government of India persuaded the assessee-company to take up the manufacture of Leyland commercial vehicles and when it was decided to take up the manufacture of the Leyland vehicles, the managing agency agreement was terminated subject to the condition that the managing agents were to be paid compensation in a sum of Rs. 2,50,000. This amount having been paid during the accounting year which ended on 31st October, 1955, the company claimed a deduction of the sum in its assessment as being revenue expenditure laid out wholly and exclusively for the purpose of the business in the relevant previous year and the question which arose was whether the compensation paid to the managing agents could be considered as an expenditure wholly and exclusively laid out for the purpose of the business or whether the same can be considered as a capital expenditure. It was contended on behalf of the revenue before the Supreme Court that the termination of the managing agency had led to reorientation of the business of the company, that the termination facilitated the company to enter into collaboration with Leylands, that it made possible for the company to get financial assistance from the Government if there be need and that compensation was paid at the behest of the Government and was for a non-business purpose. The Tribunal found as a fact that, in view of the change in the business activities of the company, the continuance of the managing agency became superfluous and would have meant unnecessary business expenditure to the company and hence commercial expediency required the company to terminate the service of the managing agents and the managing agents could be got rid of only by paying reasonable compensation. The Supreme Court in that case, while accepting the contention that the expenditure was in the nature of revenue expenditure, observed as follows :

There is no doubt that, as a result of the termination of the services of the managing agents, the company got rid of its liability to pay office allowance as well as the commission it was required to pay under the managing agency agreement not only during the accounting year but also for a few years more. The expenditure thus saved undoubtedly swelled the profits of the company. From the facts found, it is clear that the managing agency was terminated on business considerations and as a matter of commercial expediency. There is no basis for holding that by terminating the managing agency, the company acquired any enduring benefit or any income yielding asset. It is true that by terminating the services of the managing agents, the company not only saved the expense that it would have had to incur in the relevant previous year but also for few more years to come. It will not be correct to say that by avoiding certain business expenditure, the company can be said to have acquired enduring benefits or acquired any income-yielding asset."

While concluding the judgment, the Supreme Court observed :

" It is obvious from the facts set out earlier that the compensation paid for termination of the services of the managing agents was a payment made with a view to save business expenditure in the relevant accounting year as well as for a few more years. It was not made for acquiring any enduring benefit or income-yielding asset. We agree with the High Court that the Tribunal was right in its conclusion that the expenditure in question was a revenue expenditure."

In our view, the ratio of this decision appears to be that where services are terminated by payment of compensation with the result that a recurring liability is got rid of, the amount paid by way of compensation is in the nature of revenue expenditure and that such compensation does not result in the acquisition of any enduring benefit or income-yielding asset.

Applying this ratio to the case before us, as already pointed out, the Corporation was statutorily relieved of the obligation to make repeated payments to the special agents and the chief agents by providing for payment of compensation. By such payment of compensation it was not the case of the revenue that any enduring benefit or income-yielding asset was acquired. It is obvious, therefore, that the amounts paid to the special agents and the chief agents had to partake of the nature of revenue expenditure and not capital expenditure.

Now, in support of the contention that this payment really forms part of the whole scheme of acquisition and, therefore, such an amount could not be permitted to be treated as revenue expenditure, Mr. Joshi for the revenue has relied on three decisions in James Snook Co. Ltd. v. IRC [1952] 33 TC 244, 249 (CA), George Peters & Co. Ltd. v. Smith (H. M. Inspector of Taxes) [1963] 41 TC 264, 283 (Ch D) and George J. Smith & Co. Ltd. v. Furlong (H. M. Inspector of Taxes) [1968] 45 TC 384 (Ch D). All these three cases deal with the question as to whether certain payments made to the directors to secure their retirement as a part of the scheme of acquisition of the shares of the company could be treated as revenue expenditure. The particular passage which is relied upon by Mr. Joshi from the case of James Snook & Co. Ltd. [1952] 33 TC 244 (CA) has to be read in the context of the fact that the payment in that case was in pursuance of a term of an agreement regarding the purchase of shareholding and the payment was not shown to have been made in the interest of trade. An agreement of sale of shares of the appellant company, that is, James Snook & Co. Ltd. provided, inter alia, that the purchaser would procure the appellant-company to pay compensation for loss of office to the directors of the appellant- company and to the auditor of the company who under the agreement were to resign. This payment was held by the General Commissioners as not being an allowable deduction in computing the company's profits and that decision was upheld by Donovan J. in the High Court. While upholding the view of the General Commissioners, Donovan J. observed :

" The mere circumstance that compensation to retiring directors is paid on a change of shareholding control does not of itself involve the consequence that such compensation can never be a deductible trading expense. So much is common ground. But it is essential in such cases that the company should prove to the Commissioners' satisfaction that it considered the question of payment wholly untrammelled by the terms of the bargain its shareholders had struck with those who were to buy their shares and came to a decision to pay solely in the interests of its trade. "

This view was confirmed in the Court of Appeal. Now, this decision will, therefore, show that the payment was disallowed because the payment was not shown to have been independently made on a decision taken in that behalf in respect of the interests of the trade but that it was a part of the bargain of aquisition of the shareholding. The decision in the case of James Snook & Co. Ltd. [1952] 33 TC 244 (CA) thus goes to show that in all cases it cannot be laid down as a rule of law that where payment is made by way of compensation to retiring directors, it can never be a deductible trading expense. It is this decision which has been followed in the case of George Peters & Co. Ltd. [1963] 41 TC 264 (Ch D) as well as in the other case of George J. Smith & Co. Ltd. [1968] 45 TC 384 (Ch D), where also the question related to payments made to the directors as compensation for loss of office under the terms of the respective agreements. A detailed reference to the facts of those two decisions is, therefore, not necessary.

So far as the Corporation is concerned, it must be noticed that the payment is being made to persons who have independent rights against the insurers whose business was to vest in the Corporation. The Corporation was not going to acquire any business of the special agents or the chief agents. A question of bargain will not arise in the instant case because the Corporation had no choice in the matter. It being a statutory Corporation it had to comply with the statute which had created it. The three authorities relied upon by Mr.Joshi, therefore, will be clearly distinguishable inasmuch as payment in those cases, in respect of which deduction was asked, was a part of the bargain of acquisition of the shareholding. When the payment is made as directed by a statutory provision like s.36 made in the Act, such payment cannot be considered analogous to the payment of compensation to retiring directors in pursuance of an agreement to acquire the shareholdings.

It appears that the Tribunal has treated the payment of compensation under s. 36 to the agents on the same footing as compensation paid to the insurers under s. 16. It must be mentioned that this part of the reasoning of the Tribunal was not supported on behalf of the revenue and, in our opinion, rightly so, because the two provisions are hardly comparable except that they provide for payment of compensation. The Tribunal was, therefore, in our view, in error in holding that the amount paid to the chief agents and the special agents was in the nature of capital expenditure and not revenue expenditure.

Taking up question No. 3 now, the contention of Mr. Colah appearing on behalf of the assessee, is that having regard to the provisions of s. 28 of the Act, which we have reproduced above, this was a case of diversion of income by an overriding charge in so far as a part of the surplus was compulsorily required to be paid to the Central Government. According to the learned counsel, there was an overriding charge to the extent of 5% in favour of the Central Government and, in view of the overriding charge, it can never be said that the amount which is statutorily required to be paid to the Central Government was the income of the Corporation. In other words, according to the counsel, the amount which is required to be paid to the Central Government out of the surplus can never be treated as part of the income of the Corporation and was, therefore, liable to be wholly excluded for the purposes of computation of the income of the Corporation. The argument based on the diversion of income by an overriding charge was sought to be supported by certain decisions of the Supreme Court.

On the other hand, it is contended by Mr. Joshi for the revenue that the question of real income does not arise so far as the LIC is concerned because the computation of income of the LIC is provided to be artificially determined by the special provision in s. 44 of the I.T. Act, 1961, read with Sch. I of that Act. What is contended on behalf of the revenue, therefore, is that the ITO has to operate strictly within the limits set out in the First Schedule and since the income has to be determined on the basis of the surplus which is to be determined in accordance with the mode of maintenance of accounts in the case of an insurance company provided in the Fourth Schedule to the Insurance Act, the ITO could not have allowed a deduction of the amount of the surplus which is required statutorily to be paid to the Central Government under s. 28. Mr. Joshi has also contended that this is not a case of an overriding title to any part of the income of the Corporation but that s. 28 of the Act is merely a provision relating to the application of the income of the Corporation.

Under s. 26 of the Act it is obligatory on the Corporation once in at least over two years to cause an investigation to be made by actuaries into the financial condition of the life insurance business of the Corporation including a valuation of the liabilities of the Corporation in respect thereto and submit the report of the actuaries to the Central Government. How this valuation is to be made is provided in s. 13(1) of the Insurance Act, 1938, read with the provisions of the Schedule. It is not necessary for our purpose in this case to refer to the details of the mode of valuation and the different parts of the report which the actuary is required to submit. It is sufficient to point out that Form I in the Fourth Schedule provides for a valuation balance-sheet, one side of which refers to " the net liability under business as shown in the summary and valuation of policies " and the other side refers to the " balance of life insurance fund as shown in the balance-sheet ". On the basis of these two figures, the surplus or the deficiency, as the case may be, has to be worked out. Where the balance of the insurance fund is more than the net liabilities, there will be surplus. If the net liabilities are more than the balance of the life insurance fund. there will be deficiency.

Now, s. 28 operates in a case where there is a surplus. There is no dispute that the surplus referred to here is the surplus indicated in Form I of the Fourth Schedule of the Insurance Act. If there is a surplus, then this surplus has to be allocated in the manner provided in s. 28. The allocation is that 95% of the surplus or, if a higher percentage is approved by the Central Government, that higher percentage, has to be allocated to or reserved for the life insurance policy-holders of the Corporation. Out of the balance that is left, any liabilities which have to be discharged by the Corporation under s. 9 have to be met. The balance or the remainder as it is described in s. 28 has to be paid compulsorily to the Central Government or, if the Central Government so directs, it has to be utilised for such purposes and in such manner as the Government may determine. Thus in respect of whatever remains after allocating 95% or such larger percentage as the Central Government may have approved and after meeting the liabilities of the Corporation under s. 9, the balance need not be paid to the Central Government if there is any particular direction with regard to its utilisation given by that Government.

Now, the question is whether this allocation is of any consequence while giving effect to the provisions of the I.T. Act. It is now well known that so far as the life insurance business is concerned, the computation of the profits has to be made not in the manner in which it is normally done in the case of an ordinary assessee but according to the special and artificial mode prescribed in the First Schedule, having regard to the provisions of s. 44 of the I.T. Act, 1961. The effect of s. 44 of the I.T. Act, 1961, is that the provisions relating to interest on securities, income from house property, capital gains, and income from other sources are not made applicable in the case of an insurance company and the profits are to be computed in accordance with rr. 2, 3 and 4 in the First Schedule so far as life insurance business is concerned. Thus, so far as the proceedings regarding assessment to tax under the I.T. Act are concerned, they will be controlled solely by the provisions of s.44 and the First Schedule which, as already pointed out, is an artificial mode of computation of income. The basic figure which is required to be taken for the purposes of computation of income from insurance business is the annual average of the surplus. Rule2(b), which is the only material rule so far as the present case is concerned, provides for the annual average of the surplus. The surplus contemplated is the surplus as determined actuarially in accordance with s. 13 read with Sch. IV of the Insurance Act. It is difficult to see how in the face of the express provision in r. 2(b) of the First Schedule that what has to be taken into account initially is the surplus, merely because s. 28 of the LIC Act requires a part of the surplus to be handed over to the Central Government, that part of it must be deducted from the actual surplus for the purposes of r. 2(b). The provisions of the I.T. Act and the provisions of s. 28 of the Life Insurance Corporation Act operate in entirely different fields. While s. 28 deals with allocation of the surplus and its application for different purposes, so far as the computation of income is concerned, that is a matter dealt with by rr. 2(b), 3 and 4 in the First Schedule to the I.T. Act. In view of the artificial mode of computation, unless there is a special power vested in the ITO under the provisions of the I.T. Act, it will be difficult to hold that instead of taking the statutory surplus as the starting point for the computation of the profit of the life insurance business, he should take a figure different from the one which represents the actual surplus ascertained on the basis of Form I in the Fourth Schedule of the Insurance Act, 1938.

In LIC of India v. CIT [1964] 51 ITR 773, the Supreme Court was dealing with the scope of the powers of the ITO in the case of life insurance business. Two separate judgments were delivered in that case, one by Sarkar and Shah JJ. and the other by Hidayatullah J. In the judgment delivered by Sarkar J., as he then was, it was pointed out that the assessment of the profits of an insurance business is completely governed by the rules in the Schedule and there is no power to do anything not contained in it. It was then observed :

" The reason may be that the accounts of an insurance business are fully controlled by the Controller of Insurance under the provisions of the Insurance Act. They are checked by him. He has power to see that various provisions of the Insurance Act are complied with by an insurer so that the persons who have insured with it are not made to suffer by mismanagement. A tampering with the accounts of an insurer by an Income- tax Officer may seriously affect the working of insurance companies. Bat apart from this consideration, we feel no doubt that the language of section 10(7) and the Schedule to the Income-tax Act makes it perfectly certain that the Income-tax Officer could not make the adjustment that he did in these cases."

Referring to the mode of computation of an income of an insurance company, Hidayatullah J., as he then was, in his judgment, observed as follows :

" It is clear that the Income-tax Act contemplates that the assessment of insurance companies should be carried out not according to the ordinary principles applicable to business concerns as laid down in section 10, but in quite a different manner. Insurance companies do not compute their profits in the ordinary way because premiums cover risks which run into future years and loss includes losses from previous years. The method prescribed ensures that by taking the average of several years a fair and reasonable conclusion is reached. Actuarial estimation plays an important part and surplus only results when there is an excess of the fund over the liability after all other charges are met. The rules which have been quoted lay down two different methods of ascertaining profits ...... So the annual average of the surplus found by the actuary had to be taken and from it the surplus of the last inter-valuation period had to be deducted as also expenditure allowable under section 10 of the Income-tax Act. This is the basic calculation and they were followed."

Thus, so far as the basis of computation is concerned, it must be the surplus which is found on the actuarial valuation that is to be taken into account for the purposes of r. 2(b). There is, therefore, no scope for interfering with the mode of computation by substituting in place of the surplus the surplus as reduced by the amount which was required to be paid under s. 28 of the LIC Act.

It is also difficult for us to accept the contention of Mr. Colah that when s. 28 provides for payment of the remainder to the Central Government or for the remainder to be utilised for such purposes and in such manner as that Government may determine, there is a diversion of income by an overriding charge. Even on a plain construction of s. 28, it is clear that s. 28 operates on the surplus and what is first required to be done is that, in the absence of any higher percentage approved by the Government, 95% of the surplus has to be allocated to or reserved for the life insurance policy-holders. After this allocation has been made, the Corporation has to find out whether any liabilities have to be met which may arise under s. 9 and it is only in respect of the remainder that it is provided that it shall be paid to the Central Government. If s. 28 operates after the surplus is determined and s. 28 is construed as one providing for allocation of the surplus as between the insurance policy-holders and the Central Government as also for meeting certain liabilities, it is obvious that s. 28 is a provision providing for application of the surplus. Put simply, it provides for the manner in which the surplus is to be distributed after it has been properly determined.

The tests for determining whether income can be said to have been divided at the source on account of an overriding charge or whether in a given case there is a mere application or allocation of income to satisfy an obligation of payment have been noticed by the Supreme Court in CIT v. Travancore Sugars and Chemicals Ltd. [1973] 88 ITR 1. The first stage of that litigation is to be found in CIT v. Travancore Sugars and Chemicals Ltd. [1964] 51 ITR 24, which is a judgment of the Kerala High Court. That was a case in which a certain sugar company in which the Government of Travancore held the largest number of shares along with a distillery, and a tincture factory run by the Government was agreed to be sold to the assessee-company. Apart from other terms and the cash consideration which was to be paid for the factory, the distillery and the tincture factory, cl. 7 of the agreement provided that the Government shall be entitled to 20% of the annual net profits subject to a maximum of Rs. 40,000 after providing for depreciation and remuneration of the secretaries and the treasurers. In respect of the assessment year 1958-59, a sum of Rs. 42,480 was the amount payable to the Government and the question was whether that amount was allowable under s. 10 of the Indian I.T. Act, 1922. The amount was held to be in the nature of capital expenditure, but this decision was reversed by the Supreme Court in Travancore Sugars and Chemicals Ltd. v. CIT [1966] 62 ITR 566, and it was held that the expenditure was in the nature of revenue expenditure, but the matter was sent back to the High Court for determining certain other questions, one of the questions being whether the payment was tantamount to diversion of profits by a paramount title. On remand, the High Court held that the amount could be said to be diverted by paramount title and was an allowable deduction under s. 10(2)(xv) of the Indian I.T. Act, 1922 (see CIT v. Travancore Sugars and Chemicals Ltd. [1969] 71 ITR 385 (Ker)). While considering this question the Supreme Court, to which the matter was taken in a second round of appeal, made the following observations in CIT v. Travancore Sugars and Chemicals Ltd. [1973] 88 ITR 1, 13 :

" It appears to us that the amount to be paid by reference to profits can either be that it is paid after the profits become divisible or distributable or that the amount is payable prior to such distribution or division to be computed by a reference to notional or as in some decisions what is termed as apparent net profits. In the former instance it will certainly be a distribution of profits and not deductible as an expenditure incurred in running the business but in the latter it may, on the facts and circumstances of the case, and the agreement or the nature of the obligation under the particular instrument, which governs the obligation, be an expenditure incurred as a contribution to the profit-earning apparatus or, as it is said, incurred at the inception and deductible as an overriding charge of the profit- making apparatus or is one laid out and expended wholly and exclusively for the purpose of such business. It is true that sub-s. (1) of section 10 of the Indian Income-tax Act, 1922, imposes a charge on the profits and gains of a business which accrues to the assessee while sub-section (2) of the said section enumerates various items which are admissible as deduction. Where income which accrues to the assessee is not his income, the question of admissible deductions would not arise. Therefore, where income is diverted at source so that when it accrues it is really not his income but is somebody else's income the question as to whether that income falls under sub-section (2) of section 10 does not arise. Again, income can be said to be diverted only when it is diverted at source so that when it accrues it is really not the income of the assessee but is somebody else's income. It is thus clear that where by the obligation income is diverted before it reaches the assessee, it is deductible. But, where the income is required to be applied to discharge an obligation after such income reaches the assessee it is merely a case of application of income to satisfy an obligation of payment and is, therefore, not deductible. "

In that case the Supreme Court took the view that when the assessee-company had taken over the Government sugar company, it had no alternative and the Government "were willing to part with them at a certain price plus certain stipulations" which formed the conditions of transfer. The payment of 20% was construed as payment of an amount for a concession granted to it and that was why it was held deductible at its inception. As already pointed out by us, the considerations which are relevant for determining the income of the Corporation are entirely different as compared with an ordinary assessee who is governed by the general provisions in the I.T. Act and, therefore, the concept of real income cannot be properly imported in the case of the Corporation. It is, therefore, difficult for us to hold that the present case is governed by the ratio of the decision in Travancore Sugars and Chemicals Ltd.'s case [1973] 88 ITR 1 (SC).

The amount which is required to be paid to the Central Government is only in pursuance of the obligation imposed upon the Corporation by a statute and if that obligation has to be discharged after the income has been received by the Corporation, there was no question of any overriding charge so as to result in diversion of any income to the Central Government. It is obvious that s. 28 is in the nature of a provision enabling the Central Government to exercise a financial control over the affairs of the Corporation. It is not a provision which can be construed as providing for setting apart any particular part of the income of the Corporation so as to earn it for the purposes of the Central Government. The surplus earned is the surplus of the Corporation and it is only when the question of application thereof arises that s. 28 starts operating. If s. 28 operates after the surplus has reached the hands of the Corporation, in our view, there is hardly any substance in the argument of the Corporation that there was a diversion of any income by an overriding charge.

In the view which we have taken, it is not necessary for us to deal with the other decisions which were relied upon by Mr. Colah in support of his argument that there was a diversion by an overriding charge. We may, however, mention those decisions which are Raja, Bejoy Singh Dudhuria v. CIT [1933] 1 ITR 135 (PC), Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521 (SC) and Amalgamated Electricity Co. Ltd. v. CIT [1974] 97 ITR 334 (Bom) in which the case of Poona Electric Supply Co. Ltd. [1965] 57 ITR 521 (SC) was followed.

In this view of the matter, it is not possible to accept the contention that the amount of Rs. 1,31,71,276 was a permissible deduction from the surplus disclosed for the inter-valuation period ending 31st March, 1963. The answers to the question referred thus are :

Question No. 1 :

Need not be decided as not pressed.

Question No. 2 :

Compensation paid to chief agents and special agents was expenditure deductible as revenue expenditure and in favour of the assessee.

Question No. 3 :

Negative and against the assessee.

In view of the partial success and failure of the parties, parties to bear their own costs.

 

 

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