1946 (3) TMI 17 - HC - Income Tax

DEDUCTIONS-BONUS-SHAREHOLDER EMPLOYEES-BONUS BASED ON SALARY-WHETHER ALLOWABLE DEDUCTION- SUCH SUM MEANING OF.

Summary

Issues:
1. Deductibility of bonus paid to shareholder employees under Section 10(2)(x) of the Indian Income-tax Act, 1922.

Analysis:
The judgment by the Bombay High Court involved a reference under Section 66(1) of the Indian Income-tax Act regarding the deductibility of a bonus paid to shareholder employees of a company for the financial year 1943-44. The central issue was whether the sum of Rs. 4,130 paid as a bonus to thirteen shareholder employees of the company was allowable as a deduction under Section 10(2)(x) of the Act. The section allows for the deduction of "any sum paid to an employee as bonus or commission for services rendered" if such sum would not have been payable as profits or dividends. The court had to interpret this provision to determine the deductibility of the bonus paid to the shareholder employees.

The company in question, Loyal Motor Service Co., Ltd., was formed by fourteen individuals, with thirteen of them being owner-drivers who became employees of the company. In the year under consideration, the company granted a bonus to all forty-one employees, with a total of Rs. 6,084, out of which Rs. 4,130 was paid to the thirteen shareholder employees. The bonus amount was based on the employees' salaries, not their stakes in the company. The court had to analyze whether this bonus payment to shareholder employees could be considered for deduction under Section 10(2)(x) of the Act.

The court examined the language of Section 10(2)(x) and emphasized that the exception to the allowance provided in the section should be strictly construed. The court noted that the exception applies only if the bonus or commission would have been paid as profits or dividends if not paid as a bonus. The judges deliberated on various scenarios, including one-man companies and partnerships, to determine the scope of the exception. Ultimately, the court held that the sum paid as a bonus to the shareholder employees was allowable as a deduction under Section 10(2)(x) as the bonus was not equivalent to what would have been paid as dividends. The court ruled in favor of the assessee, stating that the entire sum of Rs. 4,130 paid as a bonus to the shareholder employees was deductible under the Act.

In a separate judgment delivered by another judge, it was reiterated that the construction of Section 10(2)(x) should focus on preventing an escape from taxation by wrongly characterizing payments as bonuses instead of dividends or profits. The judge emphasized that the clause aims to ensure that profits of a business are not reduced by mislabeling payments as bonuses. The judgment highlighted that the clause includes conditions for reasonableness of the bonus amount concerning the employee's pay, business profits, and general industry practices. The judge concurred with the interpretation provided by the Chief Justice, affirming that the bonus paid to shareholder employees in this case was deductible under Section 10(2)(x) as it did not amount to what would have been paid as dividends or profits.

In conclusion, the Bombay High Court ruled in favor of the assessee, allowing the deduction of the bonus paid to shareholder employees under Section 10(2)(x) of the Indian Income-tax Act, 1922. The judgment clarified the interpretation of the provision to prevent tax evasion and ensure the reasonableness of bonus payments in relation to profits and industry practices.