2018 (8) TMI 384 - HC - Income Tax

Payment of bonus to shareholder employees / directors - allowability u/s 36(1)(ii) - Distribution of profit in lieu of dividend - Held that - The payment of bonus made to the employee directors, it is clear that all the four employee directors own identical number of shares i.e. 12.20% aggregating to 49% shares in respect of company. Nevertheless the bonus which has been paid to each of them is different. This is evidence of the fact that the payment of bonus was a performance based payment and entirely dependent on the performance of the employee. This also explains the fact that employee directors were paid at a much higher rate than the other employees of the company as the payment of the bonus is performance based and not designation based. Thus the payment made to the four employee directors of the company is not a payment made in lieu of dividend as in fact found on facts by the Tribunal. No substantial question of law. TPA - M/s. ICSL is not a comparable to the assessee company under Section 10B(2)(i) and (ii)? - Held that - Tribunal on consideration of all the facts before it has come to the conclusion that ICSL providing services of a merchant/investment banker. This finding of the Tribunal can only be said to be perverse if some material/evidence is placed on record which would establish that the conclusion reached by the Tribunal could not have been reached in the face of the material/evidence which is on record. Whether comparables can be rejected on the ground that the comparables have exceptionally high profit margin as compared to the assessee in transfer pricing analysis? - Held that - This issue does not arise from the impugned order of the Tribunal. The impugned order of the Tribunal excluded ICSL from the list of comparables on the basis of functional test viz. ICSL carries out the function of merchant/investment banker which is different from a function carried out by the assessee of investment advisory. The exclusion of ICSL was not on the basis of a abnormally high profit margin so as to be not comparable with the respondent assessee. The question as proposed is academic in the present facts. Appeal dismissed.

Summary

Issues:
1. Allowability of bonus to shareholder employees under Section 36(1)(ii) of the Income Tax Act, 1961.
2. Comparison of the respondent-assessee with M/s. ICSL under Section 10B(2)(i) and (ii).
3. Rejection of comparables in transfer pricing analysis based on exceptionally high profit margin.

Analysis:

Issue 1: Allowability of bonus to shareholder employees under Section 36(1)(ii)
The appellant challenged the order of the Income Tax Appellate Tribunal (Tribunal) regarding the deduction of bonus paid to shareholder-directors under Section 36(1)(ii) of the Act. The Assessing Officer initially disallowed the claim, treating it as a dividend. However, the Tribunal allowed the appeal, considering the bonus as part of the employment agreement and a performance-based payment. The Tribunal also cited a Supreme Court case where a similar issue was held to be allowable under Section 36(1)(ii). The appellant contended that the bonus was disproportionately high for employee directors compared to other employees, suggesting it was a dividend substitute. The Court found that the varying bonus amounts were performance-based, not dividend-related, and dismissed the appeal, as no substantial question of law arose.

Issue 2: Comparison of the respondent-assessee with M/s. ICSL
The respondent-assessee provided research advisory services to its Associate Enterprises (AE) and used the Transactional Net Margin Method (TNMM) to determine the Arm's Length Price (ALP) in transactions with its AEs. The Revenue included M/s. ICSL as a comparable, but the Tribunal excluded it, noting the functional differences between ICSL's merchant banking activities and the respondent's investment advisory services. The Court upheld the Tribunal's decision, citing a previous case where it was established that merchant/investment banking activities are not comparable to investment advisory services. The Court found the Tribunal's exclusion of ICSL reasonable and declined to interfere, as the decision was based on existing evidence and legal precedents.

Issue 3: Rejection of comparables based on exceptionally high profit margin
The Tribunal excluded ICSL as a comparable based on functional differences, not an abnormally high profit margin. The Court noted that the exclusion was not due to profit margin disparities but rather the distinct nature of services provided by ICSL compared to the respondent-assessee. As the exclusion was not related to profit margins, the Court deemed the issue academic in the present context and found no substantial question of law to entertain. Consequently, the Court dismissed the appeal.

In conclusion, the High Court of Bombay dismissed the appeal, upholding the Tribunal's decisions on the issues raised regarding bonus deduction, comparability with M/s. ICSL, and rejection of comparables based on profit margins.