1994 (11) TMI 38 - HC - Income Tax

Compensation to former sole selling agents deductible under section 37; not disallowed under sections 40(c) or 40A(5)

HC held that compensation paid to erstwhile sole selling agents for loss of agency was deductible under section 37, not hit by disallowance under section ... Compensation paid to sole selling agents on the termination of the agency - Applicability of section 40(c) vs. section 40A(5) for a director who is also an employee - HELD THAT:- The only conditions are that : (i) it is not an expenditure, (a) in the nature of capital expenditure, or (b) personal expenses of the assessee, and (ii) it is laid out or expended wholly and exclusively for the purposes of the business or profession. Various tests have been evolved by the courts from time to time to decide whether an expenditure is incurred for the purposes of business. One of the tests often applied is whether it is incurred by the assessee in his character as a trader. To hold it to be an expenditure allowable as a deduction under section 37, it is not essential that it should be necessary, legally or otherwise, to incur the same or that it should directly and immediately benefit the business of the assessee. Even expenditure incurred voluntarily on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business would be deductible under this section. It is clear that the payment of compensation made by the assessee to its erstwhile sole selling agents for loss of the sole selling agency is allowable as a deduction under section 37 of the Act in the computation of the income of the assessee. This is particularly so in view of the following findings of fact arrived at by the Tribunal which are not the subject-matter of challenge in this reference application On the facts also, there does not appear to be anything wrong or unusual in the payment of the sum by way of compensation to the sole selling agents for loss of office which they had been holding for more than three decades and in claiming deduction of the same in the computation of its total income. We, therefore, answer the first question also in the affirmative and in favour of the assessee. Issues involved:1. Allowability of compensation paid to sole selling agents on termination of agency.2. Applicability of section 40(c) vs. section 40A(5) for a director who is also an employee.Issue 1: Allowability of compensation paid to sole selling agents on termination of agency:The High Court of Bombay considered a case involving the deduction of compensation paid to sole selling agents upon termination of the agency agreement. The Tribunal found that the payment was made after due consideration and based on legal advice, indicating commercial expediency. The Court noted that the payment was for business purposes and satisfied the conditions for deduction under section 37 of the Income-tax Act, being laid out wholly and exclusively for business. Various tests were applied to determine the commercial necessity of the payment, and it was concluded that the payment was allowable as a business deduction. The Court emphasized that the payment was not illusory, mala fide, or made for extra-commercial considerations, as established by the Tribunal's findings.Issue 2: Applicability of section 40(c) vs. section 40A(5) for a director who is also an employee:The Court referred to a previous decision regarding the applicability of section 40(c) over section 40A(5) in cases of directors who are also employees of the company. It was held that section 40(c) would apply in such instances, as confirmed by the Court's earlier ruling. The Court upheld this interpretation, stating that the provisions of section 40(c) were applicable in the case of a director who is also an employee, rather than section 40A(5) of the Income-tax Act.In conclusion, the High Court of Bombay ruled in favor of the assessee on both issues, allowing the deduction of compensation paid to sole selling agents and affirming the applicability of section 40(c) for directors who are also employees. The Court found that the payments were made for business reasons and met the criteria for allowable deductions under the Income-tax Act.