Viability of commission and bonus

Written by HP Ranina | Updated: Sep 30 2007, 09:03am hrs
Payments of incentive commission and performance-linked bonus are common in this day and age. However, the tax department is reluctant to grant deduction in respect of business expenditure. Unfortunately, at times, courts uphold the disallowances, especially where the relevant judgments of the Supreme Court are not brought to their notice.

The Delhi High Court has taken an erroneous view for disallowing commission paid. In Sawhney Rubber Industries versus C.I.T. (162 Taxman 378), the assessee was in the business of manufacturing cycle tyres and tubes. The assessing officer on scrutiny of the profit and loss account of the assessee notified that the commission paid to selling agents by the assessee had increased to Rs 55,68,854 from Rs 33,34,235 in the last year. It was found by the assessing officer that the assessee paid a substantial commission to two parties at the rate of 3%. The Assessing Officer observed that the assessee had increased the rate of commission from 2.5% to 3% for the relevant previous year only, and after the end of the closing year, the same was reverted back to 2.5%. He held that the increase was unjustified and made an addition.

On appeal, the Delhi High Court held that the increased rate of commission remained effective only for the year under consideration, and if the intention of the assessee was to compensate its agents for increased expenditure incurred by them on account of opening of new branches at Calcutta and Lucknow, then there would have been no ground for the assessee to have reverted back to the old rate of commission. Therefore, there appeared to be no justification to increase the commission from 2.5% to 3% only for the year under consideration and thereafter when the sales increased, there was no justification for reducing the rate of commission.

On the other hand, in C.I.T. versus Dalmia Cement (B.) Ltd (254 I.T.R. 377), the Delhi High Court held that under section 37(1) of the Income-tax Act, 1961, the jurisdiction of the Revenue is confined to deciding the reality of the business expenditure, namely, whether the amount claimed as deduction was factually expended or laid out and whether it was wholly and exclusively for the purpose of business. It must not, however, suffer from the vice of collusiveness or colourable device.

The reasonableness of the expenditure could be gone into only for the purpose of determining whether, in fact, the amount was spent. Once it is established that there was a nexus between the expenditure and the purpose of the business, the revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the board of directors, and assume the role to decide how much is reasonable expenditure, having regard to the circumstances of the case. No businessman can be compelled to maximise his profits.

The facts in this case were that the assessee, a manufacturer of cement, claimed payment to its sole selling agent commission at the rate of Rs 1.75 per MT as a deduction. The assessing officer; on a comparison with the commission paid by the assessee under an arrangement with another agent, held that the amount paid was on a higher scale and Re 1 per MT would be the permissible deduction, and disallowed the balance. Both the commissioner (appeals) and the Appellate Tribunal upheld the claim of the assessee. On a reference, the Delhi High Court held that the commission paid to the sole selling agent was incurred for commercial expediency.

The question of reasonableness of commission paid to employees was decided by the Supreme Court in Shahzada Nand and Sons versus C.I.T. (108 I.T.R. 358). In this case, the assessee was a registered firm having five partners. The business of the firm consisted of the sole selling agency of yarn, cloth, and blankets manufactured by a private limited company and commission was earned by the assessee-firm in respect of such sales. Only one of the five partners was actually looking after the affairs of the firm and two employees; who were related to the partners, were employed by the firm.

The company started paying a higher rate of commission to the assessee-firm, in view of the increasing sales made by the firm, and the two employees who were primarily responsible for the increasing prosperity were paid 20% of the extra commission earned by the firm as selling agents. Such extra commission was claimed by the firm as deductible expenditure from its business income.

The Supreme Court held that the commission paid to an employee could not be treated as unreasonable, merely because the employee had rendered some services in the relevant accounting year as he had done in earlier years. Even where the nature of the work had remained the same, commercial expediency might require payment of commission to an employee. The Court pointed out that the turnover of the assessee had increased and the commission earned by it had steadily gone up. Such progress was due to the services rendered by the two employees, and therefore, a part of the additional commission was paid to them so that they would have a sense of satisfaction that their efforts had been suitably rewarded, so that they would be spurred to greater efficiency and harder work.

Secondly, the Supreme Court held that merely because there was no contractual obligation to pay the additional commission and that it was paid ex-gratia, would not necessarily mean that it was unreasonable. Even where there was no contract, an employer may pay commission if he thinks that it would be in the interest of the business to do so.

In C.I.T. versus Maheshwari Builders (292 I.T.R. 468), the amount paid as bonus by the assessee in the assessment years 1985-86 and 1986-87 was disallowed by the assessing officer. The commissioner (appeals) found that the assessee was under no statutory obligation to pay bonus under the Bonus Act. It had not paid bonus to the workers in the earlier years.

However, there being shortage of local labourers and due to anxiety to complete the contract work within time, the firm had to agree to make payment of bonus to the workers during the year under consideration.

On a reference, the Rajasthan High Court held that the finding reached by the tribunal, about the special nature of expenditure incurred on payment of bonus during the assessment year in question, was a finding of fact. The assessee was entitled to the deduction of the amount paid as bonus.

The aforesaid decisions of the courts clearly show that the element of commercial expediency is relevant for deciding whether the commission or bonus paid to employees is deductible or not. The assessing authority must take a view based on the same considerations as are prevalent in the present era of competitive business.

The author is advocate, Supreme Court