Taxation Law

Ram Pershad v. Commissioner of Income Tax

[1972] 86 ITR 122 (SC); AIR 1973 SC 637

Citation: [1972] 86 ITR 122 (SC); AIR 1973 SC 637
Court: Supreme Court of India
Date: 1972
Bench: Three-judge Bench

Facts

Ram Pershad and his wife held substantial shares in a private company engaged in running hotels.
Under the company’s articles of association and a separate agreement, Ram Pershad became its first managing director for a period of twenty years.
He was entitled to receive:
₹2,000 per month;
a monthly car allowance;
free board and lodging;
commission equal to 10% of the company’s gross profits.
For the relevant year, commission of ₹53,913 became payable to him.
He later gave up that commission because payment would have prevented the company from earning a net profit.
Ram Pershad argued that the commission was not salary.
According to him, a managing director was an agent of the company rather than its servant or employee.
The tax authorities and Delhi High Court treated the commission as salary under section 7 of the Income-tax Act, 1922.
The matter reached the Supreme Court.

Issue

Whether Ram Pershad’s relationship with the company was:
employer and employee; or
principal and agent.
Whether the remuneration and profit-based commission received by a managing director were taxable under the head “Salary.”

Rule

A director is ordinarily an agent through whom a company acts.
However, a managing director may occupy two capacities:
director or agent of the company; and
employee or servant under a contract of service.
The answer depends upon:
the articles of association;
the appointment agreement;
the powers assigned;
the company’s right of control and supervision;
the power to terminate the appointment.
Control does not require continuous instructions regarding every daily act.
Senior employees may possess wide discretion and still remain employees where their powers:
originate from the employer;
are subject to prescribed limits;
remain reviewable by the employer.
Profit-linked or commission-based remuneration does not cease to be salary merely because it is calculated as a percentage of profits.

Application

Ram Pershad’s authority did not arise independently of the company.
Every managerial power exercised by him originated from:
the articles of association; and
the service agreement.
He was required to implement decisions taken by the board of directors.
His powers remained within the boundaries fixed by the company’s constitutional documents.
The board and the company in general meeting retained the right to supervise and control his conduct.
The agreement permitted the company to terminate his services if:
he failed to act in the company’s interests; or
he did not perform his duties diligently.
This termination power was inconsistent with the claim that he operated as an entirely independent agent.
The Court rejected the argument that an employee must receive detailed day-to-day instructions.
Because of the senior nature of his office, Ram Pershad naturally possessed substantial managerial discretion.
Nevertheless, the company had the legal power to control the framework, limits and objectives of his work.
The articles separately permitted him to undertake additional work for the company as an agent on separately agreed terms.
That provision indicated that his principal appointment as managing director was different from an independent agency arrangement.
The commission formed part of the agreed remuneration for performing his managing-director duties.
Its calculation by reference to gross profits did not change the legal source of payment.
It arose from the contract of employment and was therefore salary.

Held

The Supreme Court held that Ram Pershad was an employee of the company in his capacity as managing director.
His remuneration, including the commission calculated on gross profits, was taxable under the head “Salary.”
The Court emphasised that:
a managing director can simultaneously be a director and employee;
extensive authority does not exclude employment;
the real test is found in the articles, agreement and legal right of control.
Since the commission was salary, the Court found it unnecessary to decide the alternative questions relating to business income and deductions.
The appeal was dismissed.