TMI Blog2011 (6) TMI 251X X X X Extracts X X X X X X X X Extracts X X X X ..... provisions of section 37(1) which allows deduction on account of any expenditure incurred wholly and exclusively for the purpose of business subject to the conditions mentioned in the section - payment of commission of ₹ 1.20 crores to the three working directors was in lieu of dividend and the same is not allowable as deduction under section 36(1)(ii). - I.T.A. No.5792/MUM/2009 - - - Dated:- 22-6-2011 - SHRI D.K. AGARWAL, SHRI. N.V. VASUDEVAN, SHRI RAJENDRA SINGH, JJ. For the Appellant: Shri Vijay Mehta For the Respondent: Shri Senthil Kumar O R D E R PER RAJENDRA SINGH, (AM). The Hon ble President of the Tribunal has constituted this Special Bench under the provisions of section 255(3) of the Income tax Act vide order dated 16.12.2010 and the following question has been referred to the Special Bench for consideration and decision. Whether on the facts and circumstances of the case, the payment of commission to the extent of ₹ 1,20,00,000/- is disallowable under the provisions of section 36(1)(ii) . 1.1 In addition to answering the above question, the Special Bench is also required to dispose of the appeal in its entiret ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d earned substantial profits and the said amount could have been distributed as dividend. The assessee submitted that the payment of commission was not in lieu of profit or dividend as payment had been made to the directors for the hard work they had put in improving the profits of the company. The assessee had not paid any commission during Assessment Years 2001-02 to 2003-04 and commission was paid in the Assessment Year 2000-01 and again from Assessment Year 2004-05 onwards when the efforts made by the directors had resulted into substantial profits. It was also submitted that the assessee company was not bound to declare dividend compulsorily and therefore, the directors / share holders could not force the assessee to declare dividend. The assessee was not declaring dividend because it wanted to improve its net worth to attract FIIs. It was also pointed out that the three directors were holding shares at 50%, 25% and 25% and therefore in case the amount of commission had been distributed as dividend, they would not have got the same amount as dividend. Therefore it could not be said that the commission paid was in lieu of dividend. 2.3 The assessee further argued that whil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee paid dividend, the income of the company would have gone up by ₹ 1.20 crores on which tax at the rate of 30% would have been payable which came to ₹ 36.00 lacs. In addition, the company would also have to pay dividend distribution tax at the rate of 12.5% on the entire amount of dividend which came to ₹ 15.00 lacs. Thus total outgoings in the form of tax in case assessee had paid dividend and not commission was ₹ 51.00 lacs. On the contrary, by showing payment as commission, the directors would have paid tax of only ₹ 36.00 lacs on the commission income. Thus there was tax avoidance of ₹ 15.00 lacs. The Assessing Officer also pointed out that, in this case, the three employee directors were the only share holders and they were also the decision making authorities. Therefore, it was clear that commission payment was a device for tax evasion. As regards the argument of the assessee that the commission had been paid for services rendered which was comparable to the market rate, the Assessing Officer observed that, even if the commission had been paid for any extra services rendered, the assessee could not escape the provisions of section 36( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sec.37(1) under which expenditure incurred wholly and exclusively for the purpose of business is allowable. It was submitted that there was no dispute in the present case that the expenditure incurred was wholly and exclusively for the purpose of business and, therefore, the same should be allowed u/s.37(1). 4.1 The ld. AR for the assessee also submitted that even if the expenditure was covered by the provisions of section 36(1)(ii), the said provisions could be applied only when the commission if not paid, would not have been payable as dividend. It was pointed out that the payment of bonus under the Companies Act was discretionary, to be decided by the management of the company. Therefore, it could not be said that the commission if it had not been paid, the same would have been payable as dividend. It was also submitted that the plain reading of the provisions made it clear that for disallowance of the claim of commission, the same amount should have been payable as dividend as held by Hon ble High Court of Bombay in the case of Loyal Motor Services Company Ltd. (supra). In this case, it was pointed out, that the commission had been paid amounting to ₹ 40.00 lacs in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provisions should be so interpreted to avoid absurdity. Further while interpreting statutory provisions, the scope and object of the provisions must be seen as held by the Hon ble Supreme Court in case of Assam Co. Ltd. vs. State of Assam (248 ITR 567). It was submitted that the intention of the legislature was to allow expenditure on account of commission for services rendered under the provisions of section 37(1). He referred to the chart, placed on record, showing turnover and profit of the assessee for Assessment Years 1999-00 to 2008-09 to point out that there was substantial improvement in the financial results of the assessee company which was due to the efforts made by the working directors. It was accordingly urged that the payment of commission which was for services rendered by the Directors should be allowed under the provisions of sec.37(1) and that, in such cases, the provisions of sec.36(1)(ii) had no application. 4.3 The ld. AR further argued that, both in the prior years and in the subsequent orders, the claim has been allowed either by the Assessing Officer himself or in appeal by the Tribunal. It was pointed out that in the Assessment Year 2004-05, the Asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... I s was not supported by any evidence. It was pointed out that reasonableness of payment or rendering of extra services by directors were not relevant factors while considering allowability of claim of deduction on account of payment/commission to the employees under the provisions of sec.36(1)(ii). It was submitted that the provisions of section 36(1)(ii) were applicable even when no extra services were rendered for payment of commission. Reliance was placed on the judgment of the Hon ble Supreme Court in the case of Shahzada Nand Sons vs. CIT (108 ITR 358). There was also no evidence of any extra services rendered by the directors. Further the assessee had not made any payment of commission to any other employee. The commission had been paid only to the directors who were also the share holders which clearly showed that the payment of commission was in lieu of dividend as there were substantial profits and surplus. It was further argued that there being specific provision in section 36(1)(ii), any expenditure incurred on account of payment of bonus or commission to employee should be covered by the said section and not under section 37(1). Reliance was placed on the following j ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profits and gains of business or profession . These provisions were first incorporated under the Income tax Act 1922 (hereinafter referred to as the old Act). The provisions were inserted subsequent to the judgment of Hon ble Madras High Court in the case of R.E. Mahomed Kassim Rowther of R.E. Mahomed Kassim Rowther Co. (2 ITC 482). The Hon ble Madras High Court in the said case had held that payment of any amount which was directly or indirectly dependent upon the earnings or the profits of the business, could not be allowed as business expenditure. The reasoning was that profit is computed only after deducting all expenses and, therefore, any payment made out of profit could not be considered as expenditure incurred for the purpose of earning of the profit. The old Act was amended by Income tax (3rd Amendment) Act 1930 and a new clause (viiia) was inserted in section 10(2) to allow expenditure on account of payment of bonus or commission to an employee and later, the said clause was renumbered as clause (x) of section 10(2). The said provisions of section 10(2)(x) are reproduced below as a ready reference : (x) Any sum paid to an employee as bonus or commission for servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee subject to the conditions mentioned in the section. This is an enabling provision which allows deduction on account of bonus or commission to employees. The reasonableness of payment or adequacy of services rendered by the employees are not relevant factors in deciding the allowability of deduction. The section allows deduction if the expenditure is: i) on account of bonus or commission; ii) is paid to an employee; iii) for services rendered and iv) is not in lieu of payment of dividend. 7.5 The provisions of section 36(1)(ii) cover only the case of expenditure on account of bonus or commission paid to an employee. Any expenditure incurred on account of payment of commission to a person who is not an employee is not covered by the said provision. Such cases of expenditure on account of commission to non employees will be governed by the provisions of section 37(1) which allow deduction on account of any expenditure which is incurred wholly and exclusively for the purpose of business subject to certain conditions. The criteria of wholly and exclusively is not relevant while considering deduction under section 36(1)(ii). The payment may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... loyee as bonus or commission for services rendered is an enabling provision. This part applies to all employees. The second part is a disabling provision which provides that if the sum so paid is in lieu of profit or dividend, it cannot be allowed as deduction. This part applies only to employees who are partners or shareholders. Thus, in so far allowability of expenditure on account of bonus or commission under section 36(1)(ii) is concerned, it applies to all employees including shareholder employees. The disallowability is restricted to only partners and shareholders as only in those cases, payment could be in lieu of profit or dividend. We therefore, reject the arguments advanced by the ld. AR that the provisions of section 36(1)(ii) apply only to nonshareholder employees. 7.7 As regards the rendering of services by the employees for payment of bonus/commission, the only requirement of section 36(1)(ii) is that some services should have been rendered. Adequacy of services is not a relevant consideration. It is not necessary that payment should be made commensurate to the rendering of services or there should be some extra services rendered for payment on account of bonu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considering the profitability and other relevant factors and become payable to shareholders. Therefore, after considering the entirety of the facts and circumstances of the case if a reasonable conclusion can be drawn that the dividend was payable by the company and if the assessee company instead of paying dividend had paid commission to their employee share holders, such payment of commission will be in lieu of dividend and the claim of deduction will not be allowable under section 36(1)(ii). 7.9 For deciding the issue whether dividend in case of the assessee would have been payable, we have to consider the profitability of the company and all other relevant factors. In this case, the position regarding the business turnover, the profit and payment of salary and commission to director employees from Assessment Year 1999-00 to Assessment Year 2008-09 which has been placed on record by the assessee was as under :- Assessment Year Turnover Income as per P L A/c. Salary to Directors Commission to Directors 1999-00 4,97,93,940/- 2,69,77,01 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of remuneration of ₹ 46,61,860/- to an employee of the assessee company namely Shri Milind Karmakar who was heading the research division. Reference has also been made to the case of M/s. Motilal Oswal Securities who was in the same business and in which case also commission aggregating to ₹ 7.44 crores had been paid to directors in addition to the aggregate salary of ₹ 2.54 crores. It has also been submitted that non-declaration of dividend by directors was to improve the net worth of the company so as to attract FIIs who select brokers based on their net worth. 7.11 On careful consideration of various aspects of the matter, we are not convinced by the arguments advanced. The legal position as we have discussed earlier is that any expenditure on account of payment of commission to an employee will be allowable as deduction under the provisions of section 36(1)(ii) irrespective of the fact whether the employee is a shareholder or not or whether the commission has been paid for some extra services or for the some services subject to the condition that the payment is not in lieu of dividend. However, in case extra services have been rendered for payment of co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... these facts and circumstances and in view of the detailed findings given by the ld CIT(A), we hold that the ld CIT(A) was justified in deleting the addition of ₹ 75 lacs on account of remuneration paid to the Directors. Accordingly, we confirm the findings of the ld CIT(A) on this issue. 7.12. The Assessment Year 2004-05 was the first year when the assessee started paying commission of ₹ 40.00 lacs to each working director in addition to salary. In the immediately preceding year, the directors had been paid only salary which was ₹ 6.00 lacs per annum in case of Chairman and ₹ 12.00 lacs per annum in case of the other two directors. The Tribunal in the said order has not given any finding whether substantial payment of ₹ 40.00 lacs was for any extra services rendered. The Tribunal basically allowed the claim on the ground that in the immediate preceding year, salary expenditure had been allowed and payment of commission was supported by the Board Resolution and that there was no tax advantage to the assessee. The Tribunal confirmed the finding of the CIT(A) which had been reproduced in para-7 of the order of the Tribunal as per which the CIT(A) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essment Year 2001-02 to 2003-04. The turnover fell to 50% or even less and the profit declined more steeply. 7.14 Therefore, the only reasonable conclusion which can be drawn is that the payment of ₹ 1.05 crores shown as commission in Assessment Year 2000-01 when there was exceptional profit was nothing but dividend because had it been a genuine commission, the assessee would have continued the payment of commission and even may have increased in the subsequent three year period to improve performance but no commission was paid in these years eventhough turnover and profit were both declining. Obviously, sharp fall in profits had forced the company management not to pay dividend in the garb of commission in the next three years. The stock market started recovery from Assessment Year 2004-05 and had steadily gained till Assessment Year 2008-09 which is reflected in steady increase in both turnover and profit. The assessee again started showing payment of commission from Assessment Year 2004-05. The profit before tax but after deduction on account of commission was ₹ 4.55 crores in Assessment Year 2004-05 which steadily rose to ₹ 22.42 crores in Assessment Year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ualified employees for doing specialized jobs and may have to pay high remuneration more than the salary payable to them for the services rendered. The stock market is a highly specialized field and requires adequate research to attract investors. The quality and reliability of research is back-bone of stock broking business. Therefore, obviously the assessee company had to engage a highly qualified CA to head research division on high remuneration which cannot be compared to the remuneration payable to the assessee. The Assessing Officer has also pointed out that the assessee company had other B.Com employees who have been paid remuneration of only ₹ 3.00 lacs per annum. Further, no commission is paid to any employee other than the three share holder directors. As regards, the case of Motilal Oswal Securities which has been quoted in comparison, no details such as qualifications of the directors, profitability and payment made to other employees has been placed on record. We are therefore not in a position to comment as to whether in that case it was a genuine payment of commission or payment in lieu of dividend. Moreover, merely because commission has been claimed and al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as in lieu of dividend and therefore, the claim cannot be allowed only on the ground that the payment taken by the directors is not in the share holding ratio. The device adopted by the assessee is obviously with the intention to avoid payment of full taxes. There is obvious tax avoidance. In case dividend is paid, the tax payable at the rate of 35.75% in case of a company on the amount of ₹ 1.20 crores comes to ₹ 42.90 lacs and in that case the company would have also to pay dividend distribution tax @12.5% which comes to ₹ 15.00 lacs. The total tax payment in case of dividend payment would come to ₹ 57.90 lacs whereas in case commission was paid, the tax payable comes to ₹ 39.60 lacs. There is thus tax avoidance of ₹ 18.30 lacs. The provisions of section 36(1)(ii) are intended to prevent an escape from taxation by describing the payment as bonus or commission when in fact ordinarily it should have reached the shareholders as profit or dividend as held by the Hon ble High Court of Bombay in the case of Loyal Motor Service Company Ltd. (supra). In this case we are convinced in view of the discussion made earlier that it is a case of paying c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rlier year cannot act as a binding precedent for the Special Bench which is a Larger Bench. Further in case the decision of the division Bench was to be followed, there was no need to refer the issue to a larger Bench. Therefore, in our view, on the facts of the case, the principle of consistency will be of no help and the argument raised has to be rejected. Even in case of Radha Saomi Satsang(supra), Hon ble Supreme Court had held that the decision was confined to facts of that case only. 7.20 In view of the foregoing discussion and for the reasons given earlier, we are of the view that the payment of commission of ₹ 1.20 crores to the three working directors was in lieu of dividend and the same is not allowable as deduction under section 36(1)(ii). We answer the reference accordingly. 8. We now take up the appeal of the assessee. In the appeal, the assessee has raised disputes on two grounds which are as under :- i) On the facts and circumstances of the case and in law the ld. Assessing Officer erred and ld. CIT(A) confirmed the disallowance of ₹ 1,20,00,000/- under section 36(1)(ii) of the I.T. Act being commission paid to executive working direc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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