1977 (4) TMI 4 - SC - Income Tax

Supreme Court allows employee commissions as business expense under Income-tax Act

The Supreme Court held that the commission paid to employees was an allowable expenditure under section 36(1)(ii) of the Income-tax Act. The court found ... Allowability of commission as business expenditure - commission or bonus for services rendered - reasonableness of commission judged by commercial expediency - factors for determining reasonableness - interpretation of section 36(1)(ii)Commission or bonus for services rendered - allowability of commission as business expenditure - interpretation of section 36(1)(ii) - reasonableness of commission judged by commercial expediency - factors for determining reasonableness - Deductibility of the aggregate sum of commission paid to two employees as an allowable business expenditure under section 36(1)(ii) for the assessment year 1963-64. - HELD THAT: - The Court held that the payments were genuine and that section 36(1)(ii) requires only that the sum paid as commission or bonus be for services rendered by the employee; there is no statutory requirement that such services be additional or over and above those rendered in earlier years. The proviso to clause (ii) prescribes three factors to be taken into account in judging reasonableness-pay and conditions of service, profits of the business for the previous year, and general practice in similar business-but these are factors for a prudent commercial judgment and not absolute conditions barring deduction if one factor is absent. The reasonableness enquiry must be conducted from the viewpoint of a normal prudent businessman assessing commercial expediency, not by a narrow formalistic test requiring extra services or contractual entitlement. Applying these principles to the facts-that the employees were long-serving, rendered services in connection with the flourishing business and substantial overriding commission, received fixed salary and limited perquisites, and that the aggregate commission constituted a reasonable share of profits-the Court concluded that the payment was commercially expedient and reasonable and therefore deductible under section 36(1)(ii). The Court also endorsed a liberal approach encouraging sharing of profits with employees as a matter of commercial expediency consistent with modern socio-economic considerations.The commission of Rs.45,380 paid to the two employees for the relevant accounting year qualifies as a reasonable deduction under section 36(1)(ii) and is allowable in computing the assessee's business income for 1963-64.Final Conclusion: Appeal allowed; the tribunal and High Court judgments were set aside and the referred question answered in favour of the assessee - the commission paid to the two employees is deductible under section 36(1)(ii) for assessment year 1963-64. Issues Involved:1. Whether the commission paid by the assessee to its employees is an allowable expenditure under section 36(1)(ii) of the Income-tax Act.2. The reasonableness of the commission paid to the employees.3. The requirement of extra services for the justification of commission payment.Issue-wise Detailed Analysis:1. Allowability of Commission under Section 36(1)(ii):The primary issue was whether the commission paid by the assessee to its employees, Saheb Dayal and Gurditta Mal, was an allowable expenditure in computing the profits of the assessee from business. The assessee, a registered firm with five partners, paid a commission to these employees due to their significant contribution to the business's increased prosperity. The Income-tax Officer disallowed the claim, stating there was no evidence of services rendered by these employees justifying the commission. The Appellate Assistant Commissioner and the Tribunal upheld this view, emphasizing the lack of proof of extra services rendered by the employees during the relevant accounting year. The High Court also supported this view, stating that the commission payment must be for services rendered, and no extra services were proven.2. Reasonableness of the Commission:The Supreme Court analyzed whether the commission paid was reasonable under section 36(1)(ii). The court noted that the genuineness of the payment was never doubted by the revenue authorities. Section 36(1)(ii) allows deductions for any sum paid to an employee as bonus or commission for services rendered, provided it is reasonable with reference to the pay of the employee, the profits of the business, and the general practice in similar businesses. The court found that the commission paid was reasonable given the substantial increase in the business's turnover and profits, largely attributed to the employees' efforts. The court emphasized that commercial expediency justified the payment, even if it was ex gratia.3. Requirement of Extra Services:The High Court's view that extra services must be rendered to justify the commission was deemed erroneous by the Supreme Court. The court clarified that section 36(1)(ii) does not require extra services for commission payment to be justified. It only requires that the commission be for services rendered. The court highlighted that the employees had rendered services during the relevant accounting year, and the payment of commission was a commercial decision to reward their contribution to the business's success. The court supported the view that commercial expediency, not contractual obligation, should guide the reasonableness of such payments.Conclusion:The Supreme Court concluded that the commission paid to Saheb Dayal and Gurditta Mal was an allowable expenditure under section 36(1)(ii). The court emphasized that the payment was reasonable and justified by commercial expediency, considering the employees' significant contribution to the business's increased turnover and profits. The appeal was allowed, the High Court's judgment was set aside, and the question referred by the Tribunal was answered in the affirmative, in favor of the assessee. The Commissioner was directed to pay the costs of the appeal and the reference to the assessee.