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.