Commission paid to directors for promoting sales allowable if it is in terms of board resolution: ITAT
While computing the income of an assessee, there are certain expenditures which are disallowed. This means that the income tax department does not allow the benefit of such expenditures and the assesses are required to pay taxes on such expenditures by adding it back to the net profits. Expenses which are allowed as a deduction while computing Profits or Gains from Business or Profession are covered from Section 28 to 37 of the Income Tax Act.
According to Section 36(1)(ii), any sum paid to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission shall be allowed as deduction under the Income Tax Act.
In the case of Deputy Commissioner of Income-tax v.Abro Technologies (P.) Ltd, the AO was of the opinion that as the directors would be entitled to receive profit or dividend by virtue of their shareholding, if the company has accumulated profits, then the bonus or commission given cannot be allowed. Let us refer to this case in detail.
Facts of the Case:-
- The assessee-company was engaged in the business of manufacturing of software sophisticated dynamic balancing equipment different in sizes and performance capabilities.
- Assessing Officer (AO) from the perusal of the tax audit report, noted that assessee has paid commission to its directors.
- AO held that in view of said provision of section 36(1)(ii), employees who would otherwise be entitled to receive profit or dividend by virtue of their shareholding and if the company has accumulated profits, then the practice of giving bonus or commission cannot be allowed.
- Accordingly, he made the disallowance of entire commission paid to the Directors.
- Aggrieved with the order of the AO, assessee filed an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)].
Submissions before the CIT(A) and Order passed by CIT(A)
1.Before the CIT(A), it was explained that the commission paid to the Directors was based on percentage of sales turnover and same was approved by the Board of Directors that in accordance with Schedule-V of the Companies Act, 1956.
2. Further, copy of agreement entered into by the assessee company with the directors wherein it was observed that the following functions were to be performed by the Directors:
i. Development of business to achieve the growth, sustainability and smooth running
ii. Designing of the Machinery according to customer requirement are most economical function to perform smooth running and successful implementation of organization
iii. Develop the market base and customer base
iv. Develop the Indian as well as overseas market to increase the turnover of the company
v. Development of Public Relations for increase the visibility of company in public at large
vi. Conduct the seminar on Balancing Machine on behalf of company
vii. Conduct Research on development of business and products
viii. Promote the success of the company for the benefit of its members
ix. Supervisor of office staff and technical assistance (including conducting staff evaluations)
3. In lieu of said duties and functions assessee-company had agreed to pay, additional compensation apart from their regular compensation, based on turnover
4. The Full Time Working Technical Director were to be paid a Commission based on Sales Turnover as well as Export Turnover with a predefined condition of achieving sales turnover.
5. Initially company agreed to pay the commission at the rate of 1% of the sales and 10% of export turnover.
6. Further the commission would be increased at the rate of 3% of the sales and 10% of export turnover if the company successfully achieved total turnover of Rs. 10 crore within 2 years, Rs. 20 crore within 4 years and Rs. 30 crore within 6 years to the base year.
7. It was further submitted that during the year, the sales of the company had increased by 44% in comparison to last year and profit of the company has increased by 186%.
8. Therefore, on achieving the target, the directors were entitled for the commission @ 3% of the sales and 10% of the export turnover. However, the total commission was restricted to 5% of the total turnover.
9. CIT (A) also noted that the company had paid similar commission to the directors for the previous years and similar commission payment was allowed in the assessment order passed u/s. 143(3) for those years by the AO.
10. CIT (A) after looking to the entire facts, past history commission will be allowable as a deduction.
11. Aggrieved with the order of the CIT(A), revenue appealed before the Income Tax Appellate Tribunal (ITAT).
Grounds of Appeal before the ITAT
The appeal was been filed by the Revenue against the order passed by CIT(A), on the grounds that:-
- The CIT (A) has erred in deleting the disallowance being commission on sales paid to the shareholder Director(s)
- The CIT (A) has failed to appreciate that the shareholder director was entitled to dividend in view of accumulated profit available and the commission so paid is clearly prohibited by the provisions of section 36(l)(ii) of Income-tax Act, 1961
Observations of the ITAT
- Departmental Representative relied upon the observation of the AO, that in terms of Section 36(1)(ii) any kind of commission paid to the Directors who were shareholders cannot be allowed where they are entitled for dividend and profits of the company.
- On the other hand, assessee has strongly relied upon the order of the CIT (A)
- According to ITAT, there was no dispute on fact that the Directors were given commission for promoting sales and increasing the sale of the company by their efforts and over the period of time the assessee’s turnover has increased manifold and also the profit.
- Further, similar commission paid to the Directors in terms of same agreement was allowed in the past by the AO himself in orders passed in scrutiny proceedings u/s 143(3).
- If directors in terms of Board resolution were entitled to receive commission for rendering services to the company and if it was in terms of employment on the basis of which they have been rendering services, then such remuneration/commission was part and parcel of salary.
- It was also not disputed that TDS was being deducted on such commission as salary.
- Otherwise also, the payment of dividend is made in terms of Companies Act, 1956 which has to be paid to all the shareholders equally and dividend is basically a return of investment and not salary or part thereof.
- This proposition was upheld by Jurisdictional High Court in the case of AMD Metplast (P.) Ltd. v. DCIT.
The AMD Metplast (P.) Ltd. v. DCIT Case:
- In this case the Jurisdictional High Court was required to answer the following substantial question of law -Whether, the Tribunal was, right in holding that commission paid to the managing director of the assessee cannot be allowed as a deduction in view of section 36(1)(ii) of the Income-tax Act, 1961, and the said amount can be only allowed under section 36(1)(ii) if dividend was not paid to him.
- The High Court after considering the various judgments and the position of law, observed and held that they failed to understand how the aforesaid observations assisted and helped the Revenue in the facts of the present case.
- The managing director 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 said amount.
- Commission was treated as a part and parcel of salary and TDS has been deducted. Therefore liability to pay tax on both the salary component and the commission was paid.
- Payment of dividend was made in terms of the Companies Act, 1956 and dividend has to be paid to all shareholders equally. This position cannot be disputed by the Revenue.
- Dividend is a return on investment and not salary or part thereof.
- The consideration in the form of commission which, was, paid to the director was for services rendered by him as per terms of appointment as a managing director and hence the same was allowed
Similar view was taken on the concept of bonus payment following the judgment of AMD Metplast (P.) Ltd. (supra) in the case of CIT v. Carrer Launcher India Ltd which was decided in favour of the assessee, interpreting section 36(1)(ii).
ITAT thus upheld the order of CIT(A) in the current case and dismissed the appeal of Revenue. Thus, If directors, in terms of Board resolution, were entitled to receive commission for rendering services to company and if it was in terms of employment on basis of which they had been rendering services, then such remuneration/commission would be part and parcel of salary and the same cannot be disallowed under Section 36(1)(ii).