Income Tax--Current Issues
Practice Update
CA V.K. Subramani
PAYMENT OF BONUS OR COMMISSION WHICH IS OTHERWISE
PAYABLE AS DIVIDEND NOT ALLOWABLE?
Section 36(1)(ii) says that 'any sum paid to an
employee as bonus or commission for services rendered, where such sum would not
have been payable to him as profit or dividend if it had not been paid as bonus
or commission'. One may come across such situation of payment of bonus
being disallowed for the reason that but for such payment it would have been
paid as dividend. When dividend is paid, the company has to add-back such
dividend and pay income-tax thereon. Also, dividend distribution tax has to be
paid. Now, with DDT not applicable, the company has to pay income tax by
treating dividend as appropriation of profit. The same amount when paid as
bonus or commission, it is a deductible expenditure though the recipient has to
pay tax thereon but the payer-company would reduce its total income and the
resultant income-tax liability.
In Loyal Motor Service Co. Ltd v. CIT (1946) 14 ITR 647
(Bom) : 1946 TaxPub(DT) 0067 (Bom-HC) such instance came up before the
court. The court in page 652 gave an illustration to make this provision easily
intelligible. It said 'five persons in a firm realizing that the profits
of the year were Rs. 50,000 and they had an equal share in the profits of the
business decide that instead of receiving Rs.10,000 each as the share of
profits each of them will be paid Rs.10,000 as bonus or commission. In such a
case the firm, when sought to be assessed, may contend that Rs. 10,000 were
paid as bonus. The contention will be clearly rejected. But the safeguards do
not end there. The firm will have to prove to the satisfaction of the taxing
authority that five partners were employees, in the first instance. Secondly,
that the bonus was a reasonable amount having regard to the pay of the employee
and the conditions of his service. Thirdly, that the profits of the business
for the year in question made it reasonable to pay the amount granted as allowance
and lastly, the general practice in similar business or trade justified the
payment of the amount as bonus. It seems to me that the plain reading of the
clause means that the profits of a business will not be allowed to be dwindled
by merely describing the payment as bonus, if the payment is in lieu of
dividend or profit'.
If the terms of employment of the directors contains a
clause for payment of bonus or commission and there is some nexus between the
payment and terms of employment, it is eligible for deduction. On the other
hand, if there is no clause in terms of employment agreement and does not
satisfy the test of reasonableness cum trade practice, it would not pass the
test for allowance for deduction.