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 ... Allowability of commission paid to directors as business expenditure - application of the exclusionary limb of Section 36(1)(ii) of the Income Tax Act, 1961 - genuine transaction test for deductible business expenditure - distinction between dividend and remunerationAllowability of commission paid to directors as business expenditure - genuine transaction test for deductible business expenditure - distinction between dividend and remuneration - Payment of commission to directors for furnishing personal guarantees is an allowable business expenditure and is not hit by the exclusion in Section 36(1)(ii). - HELD THAT: - The court found as fact that directors, though employees, provided personal guarantees and thereby acted beyond the scope of their ordinary employment. The company had passed the requisite corporate resolutions, tax was deducted at source and the payments were reflected in the directors' returns, indicating the transactions were real and bona fide. Section 36(1)(ii) permits deduction of bonus or commission paid to an employee except where such sum would otherwise have been payable to him as profits or dividend. The exclusion applies only if the employee would be entitled to receive the amount as profits or dividends; dividends are distributable to all shareholders in proportion to shareholding and are not selectively payable to particular directors. Consequently, the commissions paid for guarantees cannot be characterised as amounts that would have been payable as dividends and therefore do not fall within the exception in Section 36(1)(ii). Relying on the reasoning in AMD Metplast Pvt. Ltd., the court emphasised the legal distinction between payment for services and distribution of profits by way of dividend. [Paras 6, 8, 9, 10]The disallowance of the commission paid to the directors was erroneous and such payments are allowable as business expenditure; the Tribunal and authorities erred in applying Section 36(1)(ii).Remand for consequential orders - The matter is remitted to the Tribunal for passing consequential orders arising from the allowance of the commission. - HELD THAT: - Having set aside the disallowance and determined that the commission is allowable, the court directed rectification of the Tribunal's order to the limited extent necessary and remitted the matter for consequential adjudication and computation in light of the determination on deductibility. [Paras 11]The impugned Tribunal order is to be rectified and the matter remitted to the Tribunal to pass consequential orders.Final Conclusion: Writ petition allowed; the Tribunal's order rejecting rectification is set aside insofar as it upheld disallowance of the guarantee commission; the disallowance is deleted and the matter remitted to the Tribunal for consequential orders. 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.