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.
· 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) (1stJune 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.
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.
· 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.
· 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.)