2014 (6) TMI 46 - HC - Income Tax

Court allows commission paid to Directors for personal guarantees as legitimate business expense

The High Court allowed the writ petition challenging the Income Tax Appellate Tribunal's order that disallowed commission paid to Directors for personal ... Disallowance of commission paid to directors u/s 36(1)(ii) of the Act - Personal guarantee furnished to bank for facilitating loan – Rejection of application u/s 254(2) of the Act – Rectification of order – Held that:- The act of the Directors in providing their personal guarantees and undertaking the attendant risks is clearly beyond the scope of their services as employees of the assessee - the transactions is for which commissions were paid by the assessee to its Directors are real - the Directors have provided their personal guarantee have acted beyond the call of duty as employees of the assessee - the assessee in its commercial wisdom has agreed to pay a commission for the furnishing of such guarantees cannot be flawed - it is assessee’s discretion as to which expenditure is necessary and to what extent - it is not within the jurisdiction of the AO to impose his views with regard to the necessity or the quantum of the expenditure undertaken by an assessee. The Directors would not be entitled to receive the amount paid to them as commission, as dividends because even if it is assumed that nonpayment of commission would add to the kitty of distributable profits the same would have to be distributed pro-rata to all the shareholders and not selectively to the Directors - Dividend is paid by a company as distribution of profits to its shareholders in the ratio of their shareholding in the company - the Directors were not the only shareholders of the company – thus, in the event the Commission had not been paid by the assessee it could not have been distributed to them as dividends - Relying upon AMD Metplast P. Ltd. Versus Deputy Commissioner of Income-tax [2011 (12) TMI 320 - Delhi High Court] - the Tribunal erred in holding that the payments of commission to the Directors fell within the exclusionary limb of Section of 36(1)(ii) of the Act – thus, the order is rectified to the limited extent that it upholds the disallowance of expense paid as commission to the Directors – the disallowance and the additions made is set aside – Decided partly in favour of Assessee. Issues:Challenge to order of Income Tax Appellate Tribunal under Section 254(2) of the Income Tax Act, 1961 regarding disallowance of commission paid to Directors for personal guarantees.Analysis:1. The petitioner contested the disallowance of commission paid to its Directors for providing personal guarantees to a bank for a loan. The Assessing Officer disallowed the commission under Section 36(1)(ii) of the Act, alleging it was not allowable as per the Act.2. The petitioner, a listed company, paid commission to Directors for personal guarantees necessary for credit facilities. The Assessing Officer held that the commission was not deductible under Section 36(1)(ii) as it could have been distributable as dividends if not paid.3. The Tribunal rejected the petitioner's appeal, leading to a petition under Article 226/227 of the Constitution. The petitioner argued that a precedent supported their case, but the Tribunal found the facts distinguishable. The High Court considered whether the commission paid to Directors was a legitimate business expense.4. The High Court noted that the Directors provided personal guarantees beyond their employee roles, justifying the commission. It emphasized that the Assessing Officer's role is to verify the genuineness of transactions, not dictate an entity's expenditure decisions.5. Examining Section 36(1)(ii) of the Act, the Court clarified that bonus or commission to employees is deductible unless it would have been payable as profits or dividends. In this case, the Directors would not receive the commission as dividends due to their shareholding structure.6. Referring to a prior case, the Court highlighted the distinction between dividend distribution and payment for services. It concluded that the Tribunal and lower authorities erred in disallowing the commission under Section 36(1)(ii) of the Act.7. Consequently, the High Court allowed the writ petition, setting aside the Tribunal's order and directing rectification of the decision to uphold the commission's disallowance. The matter was remitted to the Tribunal for further action.