The
matter discussed in this article focuses on cases of the Income Tax Appellate
Tribunal and various High Courts in the year 2012 which have given decisions in favor of paying
commission to working director-shareholders, not treating such payment as
distribution of dividend. With the help of the following case laws, we wish to
establish that commission paid to
director is not in lieu of dividend and therefore allowed under Section
36(1)(ii) of the Act. It is not a device to reduce overall tax effect.
Coil Company Pvt. Ltd. vs ACIT (ITA No. 1389 Delhi of 2009)
(25th May 2012)
Facts
of the Case
·
The total
share capital of the assessee company (a private limited company) was Rs.
1,00,02,000. The total number of shares were 10,00,200. These shares were
possessed by four individuals and one company- Sucha Singh 40,000, Harjinder
Kaur 16,000, Amardeep Singh 15,020, Paramjeet Singh 25,000, Coil Company INC
4,000.
·
The Board of
Directors had passed a resolution that looking at the advantage of good
business relationship of Shri Sucha Singh, MD, sales promotion commission @ 1%
on the total turnover of the company be paid to him.
·
The AO held
that the assessee company has not distributed the dividend from the very
inception and the amount of commission paid to Sardar Sucha Singh could be paid
as a profit or dividend income. Hence, the amount cannot be allowed to the
assessee as a deduction in accordance with provisions of section 36(1)(ii) of
Income Tax Act, 1961.
Judgment
·
In a private
limited company controlled by family members, a resolution approving the
payment of commission to the working directors may not be a very difficult
task. However, what needs to be seen is whether this arrangement indicates that
if this commission was not paid to the working director then it would be
received in the shape of profit/dividend.
·
If commission
was disguised dividend, then only 39.9% of the commission paid would have been
paid to Shri Sucha Singh on the basis of the shares held by him. The other
shareholders, namely, Harjinder Kaur, Paramjeet Singh who were holding 25% and
16% of the shares would have got the commission though the Board has not
resolved for payment of any extra remuneration to these persons. No commission
was paid to other shareholders in the instant case.
·
Thus,
commission was not paid to Shri Sucha Singh on the basis of the shares held by
him rather it was paid by keeping in view his services towards the company.
·
If an
assessee company failed to distribute dividend, it does not mean that payment
of any commission would take the colour of dividend. The commission paid to
Shri Sucha Singh was linked with the sales turnover of the assessee and to the
performance of the directors. It had nothing to do with the shareholding
pattern.
G.B.
Morrison Travels Pvt. Ltd. vs DCIT (ITA No. 1296, 1297 and 1298/Del/2012) (1st
June 2012)
Facts of the Case
·
The AO held payment of bonus
and commission to the Managing Director as payment in lieu of dividend and
disallowed the same as expense to the assessee company.
·
The assessee
explained that bonus and commission was being paid according to the resolution
passed in the Meeting of the Board of Directors and the same was part of the
salary (also shown in Form 16) and was not otherwise payable as profit or
dividend.
·
The AO refused to
accept the assessee’s explanation on the ground that commission was worked out
as a percentage of profits and so it cannot be said to be a part of salary.
·
The shareholding
of the Managing Director was 17.5%
·
The commission
was being paid to the Managing Director regularly for 20 years.
·
The Assessing
Officer was directed to see that if dividend payable exceeds the amount of
bonus and commission, the assessee will not be eligible for deduction u/s
36(1)(ii) of the Act and on the other hand if bonus and commission paid exceeds
the amount of dividend payable then the difference between the amount of bonus
and commission paid and dividend payable as per law will be allowable as
deduction.
Judgment
The ITAT had followed the case of AMD Metplast
Ltd. (supra) which now with the passing of judgment by Hon’ble Delhi High Court
has been set aside. The Hon’ble Delhi High Court has held that Managing
Director in terms of Board’s resolution was entitled to receive commission for
services rendered to the company. It was a term of an employment on the basis
of which he had rendered services. The operative part of Hon’ble Delhi High
Court judgment is reproduced below:
“Held, allowing
the appeal, that A was the Managing Director and in terms of the board
resolution was entitled to receive commission for services rendered to the
company. It was a term of employment on the basis of which he had rendered
service. Accordingly, he was entitled to the amount. Commission
was treated as a part and parcel of salary and tax had been deducted at
source. A was liable to pay tax on both the salary component and the
commission. The payment of dividend was made in terms of the Companies Act,
1956. The dividend had to be paid to all shareholders equally. This position
could not be disputed by the Revenue. Dividend was a return on investment and
not salary or part thereof.”
Hero Honda Finlease Ltd. (ITAT Mumbai) (2012)
Facts of the case
·
The taxpayer claimed expenditure on account of
commission paid to director amounting to INR 3.9 million at the rate of 1
percent of net profit.
·
The commission was paid as remuneration for the
services rendered by Renu Munjal (Employee-director of company who was also a
shareholder) for running the business and this sum was not otherwise payable as
profit or dividend.
·
The Assessing Officer (AO) and CIT(A) did not
allow the commission paid to director under Section 36(1)(ii) of the Act on the
ground that the profit had been diverted in the form of commission.
·
The assessee contended that Renu Munjal’s terms
of appointment included payment of commission. The commission was paid in
accordance with the terms of employment approved by resolution in annual
general meeting and hence was part of salary. Therefore, the commission was not
distributable as dividend.
·
The taxpayer had declared dividend of Rs. 15
per Equity Share on 90,50,000 Equity Shares of Rs. 10 each for the Financial
Year 2004-05.
·
Renu Munjal was holding only 1 percent share,
therefore, in any case, Rs. 3.9 million could not have been paid as dividend,
which clearly shows that the commission had been paid for services rendered and
not in lieu of dividend.
·
Renu Munjal was the only director to whom
commission had been paid.
·
As per the policy of the taxpayer,
remuneration was fixed considering the various factors such as qualification,
experience, etc. in the corporate world and the current financial position of
the company. However, the remuneration fixed by the company was not
commensurate with the services which Renu Munjal was to render to the taxpayer.
·
Renu Munjal was the only director to whom
commission had been paid.
Judgment
·
The Tribunal observed that the commission paid
was disallowed by invoking provisions under Section 36(1)(ii) and not by
invoking Section 40A(2)(b)(ii) of the Act. This implies that the AO had not
disputed the services rendered by Renu Munjal but he was of the opinion that
dividend had been paid in the garb of commission because it actually reduced
the corpus available for distribution as dividend.
·
Section 36(1)(ii) of the Act had been
incorporated to check, inter-alia, private companies from avoiding tax by
distributing their profits to their members (showing them to be their
employees) by way of commission and not by way of dividend.
·
The AO was not correct in holding that the
corpus for paying the dividend had reduced as it does not reflect the correct
legal position with reference to section 36(1)(ii) of the Act.
·
Whenever any commission is paid to an employee
it is bound to reduce the corpus available for distribution as dividend. But
that ipso-facto cannot be the basis for holding that commission is in lieu of
dividend.
·
The taxpayer had declared profits of Rs. 420
million and dividend had also been paid to all the shareholders including Renu
Munjal.
·
The taxpayer as well as Renu Munjal was
bracketed in the highest income tax slab and the only effect was on account of
saving dividend distribution tax to the taxpayer which was very minimum keeping
in view the overall profits of the company. Therefore, this cannot be held to
be device for reducing the overall tax effect in the case of taxpayer.
·
Since the shareholding of Renu Munjal was 1
percent only, the dividend would have been much less than the commission
actually paid to Renu Munjal. Therefore, sum of Rs. 3.9 million, in any case,
would not have been paid to Renu Munjal as profits or dividend if it had not
been paid as commission.
·
Accordingly, the Tribunal held that the
commission paid to the director was allowed under Section 36(1)(ii) of the Act.
Commissioner Of
Income Tax vs Career Launcher India Ltd (Delhi High Court) (19th April 2012)
Facts of the Case
·
The
AO took the view that Sec 36(1)(ii) was applicable to the payment of bonus of
Rs.32,22,000/- to the directors of the company and it was to be disallowed
because it would have been payable to the directors as dividends had it not
been paid as bonus.
·
Payment
of bonus was supported by board resolutions
·
The
directors were full-time employees of the company drawing salary, and all of
them were management graduates from IIM, Bangalore.
·
The
payment of bonus was not in any way related to the shareholding of the
directors.
·
No
dividend was declared by the company despite substantial profits.
Judgment
·
ITAT: In the further appeals preferred
by the assessee before the Tribunal, it was held, agreeing with the assessee,
that if the assessee had paid dividend on the shareholding of the directors
then such payment would have been more than the bonus paid and therefore Sec 36(1)(ii)
was not applicable. The Tribunal referred to two directors specifically and
noted that having regard to their shareholding, they would have been entitled
much higher amounts as dividends than the amounts paid to them as bonus. It
also recorded a finding that none of the directors would have received bonus as
dividend in case bonus was not paid.
·
Delhi High Court: The issue has been considered Delhi
High Court in AMD Metplast Pvt. Ltd vs DCIT (2012) 341 ITR 563 in the light
of the judgment of the Bombay High Court in Loyal Motor Service Co. Ltd vs
CIT (1946) 14 ITR 647. It was observed that the judgment of the Bombay
High Court (supra) does not assist the revenue and that so long as the bonus or
commission is paid to the directors for services rendered and as part of their
terms of employment it has to be allowed and Sec 36(1)(ii) does not apply. Having
regard to the above legal position and the factual findings recorded by the
Tribunal, we are unable to say that the Tribunal erred in holding that the bonus
payment was allowable u/s 36(1)(ii) of the Act. The substantial questions of
law are answered in the affirmative, against the revenue and in favour of the
assessee for both the years.
Other Case Laws for
Reference
AMD
Metplast Pvt. Ltd vs DCIT (2012) 341 ITR 563
Loyal
Motor Service Co. Ltd vs CIT (1946) 14 ITR 647
CIT
vs Bony Polymers Pvt. Ltd. ITA No. 69/2011
Creative
Travels Pvt. Ltd. vs DCIT ITA No. 394/Del/09
115
IR 149 in CIT v. Edward Keventer Private Ltd. (SC)
86
ITR 370 CIT v. Edward Keventer Private Limited (Cal.)
54
ITR 763 in Laxmandas Serjram v. CIT (Guj.)
108
ITR 358 Shahzada Nand & sons v. CIT (SC)
148 ITR 710 in Kashi Prasad Carpets Pvt. Ltd. v.
CIT (Alld.)
