Bonus deduction under tax law must be tested separately for employees outside the Bonus Act, not disallowed mechanically.

Bonus paid to employees outside the Payment of Bonus Act cannot be rejected by mechanically applying the first proviso to section 36(1)(ii) of the Income-tax Act. The payment must be examined separately for employees covered by the Bonus Act and for those whose salary exceeds the statutory ceiling and are outside its scope; for the latter group, deductibility falls to be tested under the second proviso on its own merits, and in appropriate cases as business expenditure. On that basis, the revisional order under section 263 was held unsustainable because it proceeded on the incorrect premise that the entire bonus amount was disallowable.

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Issues: Whether the Commissioner was justified in invoking revisional jurisdiction under section 263 to disallow bonus payments as excessive under section 36(1)(ii) of the Income-tax Act, 1961, and whether the second proviso to section 36(1)(ii) applied to employees not covered by the Payment of Bonus Act, 1965.

Analysis: The payment of bonus had to be examined separately for employees covered by the Payment of Bonus Act and for those whose salary exceeded the statutory ceiling and were therefore outside that Act. The CBDT circular clarified that where the establishment is governed by the Bonus Act but the particular employees are not covered by it, the restriction in the first proviso to section 36(1)(ii) does not apply and deductibility is to be tested under the second proviso. The revisional order proceeded on the incorrect premise that only the first proviso applied and that the entire amount was disallowable. The cited High Court decisions also supported the view that such payment could be considered under the second proviso and, where appropriate, as business expenditure.

Conclusion: The invocation of section 263 was not justified and the disallowance of bonus was unsustainable; the assessee succeeded.

Ratio Decidendi: Bonus paid to employees outside the scope of the Payment of Bonus Act cannot be disallowed merely by applying the first proviso to section 36(1)(ii); it must be tested under the second proviso on its own merits.

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