2011 (7) TMI 1253 - AT - Income Tax

Tribunal affirms deletion of commission/bonus, emphasizing business expediency.

The Tribunal upheld the decision of the Ld. CIT(A) and dismissed the appeal by the revenue, affirming that the addition of `30,00,000/- on account of ... - ISSUES PRESENTED AND CONSIDERED 1. Whether commission/bonus of Rs. 30,00,000 paid to a director who is also a shareholder is disallowable under section 36(1)(ii) as amounts which, if not paid as commission, would have been paid as profits or dividend. 2. Whether payments characterized as commission/bonus to a whole-time working director/shareholder constitute allowable revenue expenditure incurred for business expediency (and therefore deductible), rather than distribution of profits, having regard to board approvals, relation to company profitability, past practice and tax treatment by the recipient. 3. Whether applicable precedents and statutory interpretation require treating commission/bonus paid to directors as part of remuneration (salarial assessment) and thus outside the scope of section 36(1)(ii), or whether Section 40A(2) or other provisions address excessiveness. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of section 36(1)(ii) to commission/bonus paid to director-shareholder Legal framework: Section 36(1)(ii) disallows as deduction any commission paid to a member of a company if it would, had it not been paid, have been paid by way of profits or dividend. Section 37 covers revenue expenditures incurred for business expediency. Section 40A(2) addresses reasonableness of payments to related parties. Precedent treatment: The Court relied on tribunal and High Court decisions which held that commission/bonus paid to whole-time working directors, approved by company authorities and linked to business performance, are not automatically hit by section 36(1)(ii). Earlier authorities cited include decisions treating commission as remuneration (and assessable as salary) and decisions holding ex gratia/bonus payments allowable as revenue expenditure. Interpretation and reasoning: The Tribunal examined objective indicia - (a) the director was a whole-time working director receiving fixed salary; (b) commission/bonus payments were approved by board/shareholders' resolutions; (c) payments were directly linked to an increase in profitability and paid as incentive; (d) tax was deducted at source by the company and the director paid tax on such income; and (e) similar payments had been made and previously accepted in assessments. The Tribunal rejected the Assessing Officer's presumption that, absent payment as commission, the sums would necessarily have been distributed as dividend. The Companies Act restrictions on dividend declaration and the corporate discretion not to pay dividends were held to undermine any automatic inference that unpaid commission would become dividend. The Tribunal also noted that section 36(1)(ii) contemplates a factual connection showing that the payment would otherwise have been a dividend; mere shareholder status of recipient is insufficient without supporting material. Ratio vs. Obiter: Ratio - where commission/bonus is paid to a whole-time working director as an incentive, governed by board/shareholder approvals, linked to profitability, subject to TDS and previously recognised as business expenditure, section 36(1)(ii) does not apply. Obiter - discussions on comparative industry salary levels and historical acceptance of payments provide context but are not essential to the statutory holding. Conclusion: Section 36(1)(ii) cannot be invoked to disallow the commission/bonus in the absence of material demonstrating that the payment would have been paid as dividend; the addition under section 36(1)(ii) is unsustainable on the facts. Issue 2 - Characterisation of commission/bonus as revenue expenditure/remuneration assessable as salary Legal framework: Expenditure incurred for business expediency is deductible under section 37 as revenue expenditure. Commission paid as a fixed percentage of turnover to whole-time directors has been held to be part of remuneration and assessable as salary in relevant precedents. Payment of bonuses or ex gratia to employees may fall outside the ambit of the Payment of Bonus Act and still be allowable under section 37. Precedent treatment: The Tribunal followed authorities holding that commission payable as a percentage of turnover to whole-time directors is remuneration (and not a disguised profit distribution), and that ex gratia/bonus payments intended as rewards or incentives are deductible as revenue expenditure. It relied on decisions that require assessment of commercial expediency from the assessee's viewpoint and not the revenue's. Interpretation and reasoning: Applying these principles, the Tribunal treated the commission/bonus as an incentive tied to company performance and part of the director's remuneration package. Board resolutions, the pattern of payments in earlier years, and taxation of the recipient strengthened the characterisation as remuneration/revenue expenditure. The Tribunal emphasized that excessiveness (if contested) should be addressed under section 40A(2) or specific evidence rather than by assuming dividend substitution under section 36(1)(ii). Ratio vs. Obiter: Ratio - commission/bonus, when paid to whole-time working directors as a fixed percentage of turnover or as profit-linked incentive and properly authorised, is a remuneration expense allowable under section 37 (and assessed as salary), not a distribution of profits under section 36(1)(ii). Obiter - references to the Payment of Bonus Act and comparative salary levels are supportive context rather than essential to the legal rule. Conclusion: The commission/bonus payments are allowable revenue expenditure as part of remuneration; they were not rightly disallowed by treating them as distributable profits. Issue 3 - Burden of proof and limits on Assessing Officer's presumption; role of Section 40A(2) Legal framework: Tax disallowances based on presumption that payments would otherwise be dividends require supporting material. Section 40A(2) permits disallowance of unreasonable payments to related parties but is distinct from section 36(1)(ii). Precedent treatment: Authorities emphasise that Assessing Officer must bring material to show that payments would have been made as dividends; discretionary corporate decisions about dividend declaration cannot be presumed. CBDT circulars and case law indicate that excessiveness is governed by section 40A(2) post-amendment. Interpretation and reasoning: The Tribunal held that absent evidence that the company would have distributed the disputed amount as dividend, the Assessing Officer's contention fails. The Tribunal noted that the Assessing Officer did not invoke section 40A(2) or produce material to justify treating the payments as unreasonable or as disguised profits. Ratio vs. Obiter: Ratio - Assessing Officer cannot disallow payments under section 36(1)(ii) merely by asserting the recipient's shareholder status without material showing substitution by dividend; excessiveness issues should be pursued, if at all, under appropriate provisions such as section 40A(2). Conclusion: The Assessing Officer's presumption was legally insufficient; absent supporting material or invocation of section 40A(2), the disallowance cannot be sustained. Final outcome The Tribunal upheld the appellate authority's deletion of the addition of Rs. 30,00,000, finding that section 36(1)(ii) did not apply and that the payments were allowable revenue expenditure/remuneration given board approvals, link to profitability, TDS compliance and supporting precedent. The revenue's appeal was dismissed.