2011 (6) TMI 251 - AT - Income Tax

Disallowance of payment of commission to the three working directors / share holder employees - It was pointed out that in Assessment Year 2004-05, disallowance had been made by the Assessing Officer under section 40A(2)(b) holding the commission payment excessive compared to market value but the addition had been deleted by the Tribunal - Held that - The provisions of section 36(1)(ii) cover only the case of expenditure on account of bonus or commission paid to an employee. Any expenditure incurred on account of payment of commission to a person who is not an employee is not covered by the said provision. Such cases of expenditure on account of commission to non employees will be governed by the provisions of section 37(1). - the payment of ₹ 1.05 crores shown as commission paid to shareholder employees in Assessment Year 2000-01 when there was exceptional profit was nothing but dividend Regarding deduction u/s 37(1) - It was also argued that commission paid for any extra services rendered by the share holder employees will be covered by the provisions of section 37(1) which allows deduction on account of any expenditure incurred wholly and exclusively for the purpose of business subject to the conditions mentioned in the section - payment of commission of ₹ 1.20 crores to the three working directors was in lieu of dividend and the same is not allowable as deduction under section 36(1)(ii).

Issues Involved:
1. Allowability of deduction on account of payment of commission to the extent of Rs. 1,20,00,000/- under the provisions of section 36(1)(ii) of the Income Tax Act.
2. Allowability of deduction on account of commission paid to directors under section 37(1) of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Allowability of Deduction Under Section 36(1)(ii):
Facts and Arguments:
- The assessee company paid Rs. 40.00 lakhs each as commission to three working directors who were also the only shareholders.
- The Assessing Officer (AO) disallowed the commission, arguing it could have been distributed as dividends.
- The assessee contended that the commission was for the directors' hard work and not in lieu of dividends, emphasizing that the company was not obligated to declare dividends.
- The AO noted the substantial profits and argued that the commission was a device for tax evasion, as the tax on dividends would have been higher.
- The CIT(A) upheld the AO's decision, rejecting the additional ground that the commission should be allowed under section 37(1).

Tribunal's Analysis:
- Section 36(1)(ii) allows deduction for bonus or commission paid to employees if it would not have been payable as profits or dividends.
- The Tribunal emphasized that the provision applies to all employees, including shareholder employees, provided the payment is not in lieu of dividends.
- The Tribunal rejected the argument that section 36(1)(ii) applies only to non-shareholder employees.
- The Tribunal found no evidence of extra services rendered by the directors to justify the commission.
- The Tribunal concluded that the commission was in lieu of dividends, noting the substantial profits and the lack of dividend payments despite significant reserves.
- The Tribunal dismissed the principle of consistency argument, noting that the issue had been referred to a larger bench.

Conclusion:
- The payment of Rs. 1.20 crores as commission to the directors was in lieu of dividends and not allowable under section 36(1)(ii).

2. Allowability of Deduction Under Section 37(1):
Facts and Arguments:
- The assessee argued that even if the commission was disallowed under section 36(1)(ii), it should be allowed under section 37(1) as it was incurred wholly and exclusively for business purposes.
- The CIT(A) rejected this argument, holding that specific provisions of section 36(1)(ii) would govern the claim.

Tribunal's Analysis:
- The Tribunal reiterated that section 36(1)(ii) covers all employees, including shareholder employees, and applies irrespective of extra services rendered.
- The Tribunal relied on the judgment of the Hon'ble Jurisdictional High Court in Subodh Chandra Poppatlal vs. CIT, which held that when an expenditure falls under section 10(2)(x) (corresponding to section 36(1)(ii)), its validity must be determined by that section and not by section 10(2)(xv) (corresponding to section 37(1)).

Conclusion:
- The payment of commission to the directors was rightly considered under section 36(1)(ii) and not under section 37(1).

Final Decision:
- The appeal of the assessee was dismissed, and the payment of Rs. 1.20 crores as commission to the directors was not allowable as a deduction under either section 36(1)(ii) or section 37(1).

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