INCOME TAX ACT, 1961

--Business deduction under section 36(1)(ii)--Bonus or commission Commission paid to whole-time directors--The assessee-company during the relevant year had paid commission to the tune of Rs. 40.00 lacs each to the three working directors. The three employee-directors were the only shareholders of the company and owned the entire share capital of Rs. 6.5 crores of the company. During the assessment proceedings, the AO after examining the legal provisions regarding the allowability of bonus or commission observed that, in case of the assessee, provisions of section 36(1)(ii) which specifically dealt with allowability of expenditure on account of bonus or commission were applicable and not the provisions of section 40A(2)(b) which provides for disallowance of expenditure incurred on account of related persons to the extent found excessive compared to the market value. He, therefore, asked the assessee to explain as to why the claim of the expenditure on account of commission should not be disallowed as the assessee had earned substantial profits and the said amount could have been distributed as dividend. The assessee submitted that the payment of commission was not in lieu of profit or dividend as payment had been made to the directors for the hard work they had put in improving the profits of the company. The assessee had not paid any commission during assessment years 2001-02 to 2003-04 and commission was paid in the assessment year 2000-01 and again from assessment year 2004-05 onwards when the efforts made by the directors had resulted into substantial profits. It was also submitted that the assessee company was not bound to declare dividend compulsorily and therefore, the directors / share holders could not force the assessee to declare dividend. The assessee was not declaring dividend because it wanted to improve its net worth to attract FIIs. It was also pointed out that the three directors were holding shares at 50%, 25% and 25% and therefore in case the amount of commission had been distributed as dividend, they would not have got the same amount as dividend. Therefore it could not be said that the commission paid was in lieu of dividend. The AO, however, did not accept the contentions raised by the assessee. It was observed by him that in the profit & loss account of the relevant year, there was net profit of Rs. 15.55 (before tax) crores after claiming deduction on account of commission of Rs. 1.20 crores, which had been carried forward in the balance sheet as reserve and surplus. The directors however did not declare any dividend and no reasons were given for not declaring the dividend. It was, thus, clear that the directors had distributed dividend in the form of commission and therefore, payment was covered by the exceptions provided in section 36(1)(ii). In appeal the assessee reiterated the same submissions before the Commissioner (Appeals) who was also not satisfied with the arguments advanced and confirmed the disallowance made by the AO. The Commissioner (Appeals), however, rejected the additional ground also after observing that there being specific provision under section 36(1)(ii) regarding allowability of bonus or commission, the claim will be governed by the said section and not by the provisions of section 37(1). Held: After considering the entirety of the facts and circumstances of the case if a reasonable conclusion can be drawn that the dividend was payable by the company and if the assessee-company instead of paying dividend had paid commission to their employee share holders, such payment of commission will be in lieu of dividend and the claim of deduction will not be allowable under section 36(1)(ii).