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TMI Blog1995 (4) TMI 24X X X X Extracts X X X X X X X X Extracts X X X X ..... ical services constitute revenue expenditure allowable under section 37 of the Income-tax Act, 1961 ? " Questions Nos. 3, 4 and 5 in R. A. No. 318/(Hyd) of 1983 : " II (3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the commission paid to the managing director, Dr. W. R. Carrea, should not be taken into consideration for purposes of computing the disallowance under section 40(c) of the Income-tax Act, 1961 ? (III) (4) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the assessee is entitled for deduction under section 80V in respect of the interest disallowed under section 40A(8) of the Income-tax Act ? (IV) (5) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the amount of Rs. 74,124 was deductible ? " This matter pertains to the assessment year 1978-79. The assessee is one, Bakelite Hylam Limited, Hyderabad. It is a registered company. Learned counsel appearing on both sides do not dispute that the question No. 2(1) R. A. No. 317/(Hyd) of 1983, has already been answered by a Full ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... points. Section 40(b) and (c) of the Income-tax Act reads as under : " 40. Amounts not deductible. --- Notwithstanding anything to the contrary in sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession', ---.... (b) in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm ; (c) in the case of any company, --- (i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be, (ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in sub-clause (i) either wholly or partly for his own purposes or benefit, if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to a director. In order to understand the scope of section 40(b) and (c) of the Act, we have to notice the concept of the firm as a legal entity different from the company. A person becomes a partner in the firm mainly for sharing the profits of the firm. Whenever the interest, salary, bonus, commission, etc., are paid to him, they are necessarily towards his share of the profit. So far as the company is concerned, either a director or an employee gets only a remuneration or a recompense for the services rendered by such employee or director to the company. In certain cases, such director or employee may be entitled to certain other benefits or amenities. From this analysis, it is clear that the Legislature has used the word " remuneration " in section 40(c) of the Act pertaining to the company. Such remuneration or a recompense paid to a director may be in different forms or under different names. The director may be paid remuneration in the form of salary or commission. Section 40(c) of the Act has three important limbs : (i) there must be an expenditure incurred by the company ; (ii) such an expenditure must have resulted directly or indirectly in the provision of any remunerat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h salesman belonged. In that context, the Supreme Court held as under : " The definition of 'salary' in rule 2(h) includes dearness allowance if the terms of employment so provide and excludes all other allowances and perquisites. It does not in terms exclude 'commission' as such and, in our view rightly, for, though ordinarily according to the Shorter Oxford English Dictionary 'commission' means 'a pro rata remuneration for work done as agent', in business practice commission covers various kinds of payments made under different circumstances. In Raja Ram Kumar, Bhargava v. CIT [1963] 47 ITR 680, the Allahabad High Court has pointed out how in certain circumstances commission payable to an employee may, in fact, represent the salary receivable by him for the services rendered to the employer. At page 694 of the report, the relevant observation run thus : ' The word "commission", in business practice, covers various kinds of payments made under different circumstances. There are cases where a servant is employed by a businessman and, as a condition of his employment, it is agreed prior to the services having been rendered that he would be paid for his services at a fixed rate of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by which the provisions of section 40(c) of the Act were sought to be amended in the following words : ' I am firmly of the view that the fiscal instrument must be deployed to discourage payment of high salaries and remunerations which go ill with the norms of egalitarian society. I, accordingly, propose to impose a ceiling on the remuneration of company employees which would be deductible in the computation of taxable profits. The ceiling is being set at Rs. 5,000 per month. Together with the existing ceiling of Rs. 1,000 per month. in the case of perquisites, the allowable overall ceiling on remuneration and perquisites, for the purposes of taxation, will be at Rs. 6,000 per month. In addition, I am proposing to reduce the tax deductible limits of daily allowance to employees while on tour.' The note on this clause of the Finance (No. 2) Bill, 1971, is as follows : ' Sub-clause (b) seeks to amend section 40(c) under which expenditure incurred by a company on. the provision of any remuneration or benefit or amenity to directors, persons who have a substantial interest in the company and their relatives and the expenditure or allowance in respect of any assets of the company whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the High Court of Punjab and Haryana held that a " commission " paid to a third party under contractual obligation of the company would not be a remuneration. This decision would be relevant for this case, since it was held in that case " remuneration " includes " commission " also. In fact, the principle laid down in that case has been approved by the Supreme Court in CIT v. Avon Cycles P. Ltd. S. L. P. (Civil) No. 7477 of 1981 under the heading " From our reporter at the Supreme Court " under " Amounts not deductible " : Amount paid by company to sole selling agent whose partners are its directors, which reads as under : " 26-9-1983 : Their Lordships, P. N. Bhagwati and V. Balakrishna Eradi JJ., dismissed a special leave petition by the Department against the judgment dated May 12, 1980, of the Punjab and Haryana High Court in Income-tax Reference No. 56 of 1979, reported in [1980] 126 ITR 448, whereby the High Court, on a reference, held that the commission paid by the assessee-company to its sole selling agent, a firm whose partners were also the directors of the assessee, was not paid to the directors of the assessee, but as commission to its sole selling agent and the partn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the Income-tax Officer and, therefore, he preferred an appeal before the Income-tax Appellate Commissioner, who confirmed the finding of the Income-tax Officer. It is in these circumstances, the assessee preferred an appeal before the Income-tax Appellate Tribunal, which allowed the appeal, by holding that the gratuity fund was recognised by the Commissioner and the assessee was eligible on the basis of the provision made by it and also on the fact that the amount was actually paid during the year. The Appellate Tribunal took the view that when the assessee has actually paid towards recognised gratuity fund, the same is allowable under section 36(1)(v) of the Act and if such gratuity is towards liability of the previous year and a provision was made in the accounting year, the same also was allowable under section 40A(7)(b)(i) of the Act, on the basis of the mercantile system, which the assessee was following. Learned counsel for the Revenue contended that the gratuity amount of Rs. 74,124 pertaining to the year 1976 was not allowable, since the same did not accrue in that year. The assessee could have provided for the same in the year 1976 itself. But, on the other hand, lear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... endment wherein paragraph 46, after referring to the provisions of section 37(1) and section 36(1)(v) of the Act, it was observed inter alia, as follows : 'A reading of these two provisions clearly shows that the intention has always been that the deduction in respect of gratuities should be allowed either in the year in which the gratuity is actually paid or in the year in which contributions are made to an approved gratuity fund. A doubt has been expressed that the relevant provisions, as presently worded, do not secure the underlying objective and that a provision made by a taxpayer in his accounts in respect of estimated service gratuity payable to employees will be deductible in computing the taxable income in a case where the provision has been made on a scientific basis in the form of an actuarial valuation. In order to remove uncertainty in the matter, it is proposed to specifically provide in the law that no deduction will be allowed, in the computation of profits and gains of a business or profession, in respect of any reserve created or provision made for the payment of gratuity to the employees on retirement or on termination of employment for any reason. This restrict ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hree conditions laid down by the sub-clauses are satisfied. The submission of the assessee that if no provision is made by the assessee for gratuity, still the same will be deductible and section 40A(7) will have no application, would defeat the very purpose and object of section 40A(7) and render it nugatory." From this law declared by the Supreme Court, it is clear that wherever a " provision " is made in the accounting year, towards the gratuity payable, the same is allowable under section 40A(7) of the Act. The same principle was followed by this court in CIT v. D. B. R. Mills Ltd. [1988] 174 ITR 442, wherein it was held that when a provision is made in the accounting year for such liability, the same is allowable. This court further made a distinction between any sum paid under section 36(1)(v) and any provision made under section 40A(7)(b)(i) of the Act and ultimately held that the assessee cannot claim such payment as allowable, without making any provision in the accounting year. In a similar case in CIT v. G. T. N. Textiles Ltd. [1985] 155 ITR 5, the High Court of Kerala held as under (at page 9) : " Clause (a) of sub-section (7) contains, subject to clause (b), a gener ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctually paid by way of contribution to an approved gratuity fund created by the employer while section 40A(7) introduced by the Finance Act, 1975, with effect from April 1, 1973, prohibited deduction of a provision for gratuity, the prohibition, however, not extending to, (a) provision for contribution to an approved gratuity fund, or (b) provision for payment of gratuity for which a liability has arisen during the year. These two provisions did not cover the case where a provision was made for a future payment on a " scientific " method of calculation. The present claim being of a provision made for a future payment calculated on scientific basis, the amount was not covered by any of the specific provisions of the statute and hence, was allowable in the computation of the profits under section 28 itself.' This decision was confirmed by the Supreme Court in CIT v. Andhra Prabha P. Ltd. [1986] 158 ITR 416. The Supreme Court in CIT v. Andhra Prabha P. Ltd. [1986] 158 ITR 416, pointed out that the legal position on this point has been analysed by this court in its recent decision in Shree Sajan Mills Ltd. v. CIT [1985] 156 ITR 585 (SC). Thus, the Supreme Court in 156 ITR 585, after c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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