IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI “D” BENCH ...

IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI “D” BENCH, - SPECIAL BENCH
BEFORE HON’BLE SHRI D.K. AGARWAL (J.M.),
SHRI. N.V. VASUDEVAN (J.M.) AND SHRI RAJENDRA SINGH,(A.M.)
I.T.A. No.5792/MUM/2009
Assessment Year : 2006-07
M/s. Dalal Broacha Stock Broking Pvt. Ltd.
507, Maker Chambers-V
Nariman Point
Mumbai-400 021.
PAN : AAACD 5662 J
……. Appellant
Vs.
Addl. CIT – Range 4(1),
Aayakar Bhavan,
M.K. Marg,
Mumbai – 400 020.
Appellant by
Respondent by
: Shri Vijay Mehta
: Shri Senthil Kumar
..….Respondent
O R D E R
PER RAJENDRA SINGH, (AM).
The Hon’ble President of the Tribunal has constituted this Special
Bench under the provisions of section 255(3) of the Income tax Act
vide order dated 16.12.2010 and the following question has been
referred to the Special Bench for consideration and decision.
“Whether on the facts and circumstances of the case,
the payment of commission to the extent of
Rs.1,20,00,000/- is disallowable under the provisions
of section 36(1)(ii)”.
1.1 In addition to answering the above question, the Special Bench
is also required to dispose of the appeal in its entirety.

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2. We first deal with the specific question referred to the Special
Bench which is regarding allowability of claim of deduction on account
of payment of commission to the tune of Rs.1.20 crores to the three
employee directors under provisions of section 36(1)(ii). The clause
(ii) of sub section (1) of section 36 of the income tax Act, 1961 allows
deduction of 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.
2.1 The facts of case, in brief, are that 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. The details of salary,
commission and the share holding of the three directors were as under
:-
S.No. Name of director Nature of
Payment
Amount(Rs.)
Share holding
1. Mr. P.K. M. Dalal
2. Mr. Nilesh P. Dalal
3. Mr.Vipul P. Dalal
Salary- 6,00,000
Commission- 40,00,000
Salary 12,00,000
Commission 40,00,000
Salary 12,00,000
Commission 40,00,000
50%
25%
25%
2.2 During the assessment proceedings, the Assessing Officer (AO)
after examining the legal provisions regarding the allowability of bonus
or commission observed that, in case of the assessee, provisions of

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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.
2.3 The assessee further argued that while applying the provisions
of 36(1)(ii), it was required to be seen whether the remuneration paid
to directors was more than the amount payable to other persons in

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open market having similar experience in the same business. It was
pointed out that all three directors had vast experience. It was also
pointed out that in assessee’s own case, Mr. Milind Karmakar, C.A.
who was head of the research department had been paid remuneration
of Rs.46,61,860/-. Therefore, the remuneration including commission
paid to the three directors having manifold experience in the business
compared to Mr. Milind Karmakar could not be said to be excessive
compared to market vale of services. Further the assessee had paid
the same amount of commission for Assessment Years 2004-05 to
2006-07 when the profits had increased substantially in subsequent
years which also showed that the assessee wanted to increase the net
worth for improving the business. The assessee also pointed out that
in Assessment Year 2004-05, 50% of the commission had been
disallowed by the Assessing Officer under the provisions of section
40A(2)(b) holding the same as excessive but the same was deleted by
the CIT(A). In Assessment Year 2005-06 the Assessing Officer had
disallowed the claim under provisions of section 36(1)(ii) which was
also not upheld in appeal.
2.4 The Assessing Officer, 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).
The Assessing Officer also

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observed that the provisions of section 36(1)(ii) were intended to
prevent an escape from taxation by describing a payment as bonus or
commission when, in fact ordinarily it should have reached the
shareholders as profit or dividend as held by the Hon’ble High Court of
Bombay in Loyal Motor Services Company Ltd. vs. CIT (14 ITR 647).
It was pointed out, that had the assessee paid dividend, the income of
the company would have gone up by Rs.1.20 crores on which tax at
the rate of 30% would have been payable which came to Rs.36.00
lacs. In addition, the company would also have to pay dividend
distribution tax at the rate of 12.5% on the entire amount of dividend
which came to Rs.15.00 lacs. Thus total outgoings in the form of tax
in case assessee had paid dividend and not commission was Rs.51.00
lacs. On the contrary, by showing payment as commission, the
directors would have paid tax of only Rs.36.00 lacs on the commission
income. Thus there was tax avoidance of Rs.15.00 lacs. The
Assessing Officer also pointed out that, in this case, the three
employee directors were the only share holders and they were also the
decision making authorities. Therefore, it was clear that commission
payment was a device for tax evasion. As regards the argument of the
assessee that the commission had been paid for services rendered
which was comparable to the market rate, the Assessing Officer
observed that, even if the commission had been paid for any extra
services rendered, the assessee could not escape the provisions of
section 36(1)(ii) in case it was found that commission payment was in
lieu of dividend. The Assessing Officer accordingly held that the
payment of commission by the assessee to the directors was in lieu of
dividend and was not eligible for deduction u/s.36(1)(ii). He therefore,
disallowed the sum and added the same to the total income.

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3. In appeal the assessee reiterated the same submissions before
the CIT(A) who was also not satisfied with the arguments advanced
and confirmed the disallowance made by the Assessing Officer. The
assessee had also raised an additional ground before the CIT(A) that
commission payment should be allowed u/s.37(1) of the Income tax
Act. The CIT(A) 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 sec.37(1).
4. Before us, the ld. AR for the assessee argued that the intention
of the legislature was always to make allowances for bonafide
expenditure incurred on account of payment of bonus or commission.
However, since the Hon’ble Madras High Court in case of R.E.
Mahomed Kassim Rowther of R.E. Mahomed Kassim Rowther & Co. (2
ITC 482) had held that such expenditure calculated on the basis of
profits was not allowable as profit could be computed only after
deducting all expenditure. Thereafter section 10(2) of the Income tax
Act, 1922 was amended and clause viii(a) was inserted in section
10(2) making provision for allowability of expenditure on account of
bonus or commission. The said clause viii(a), was later renumbered as
clause (x) of section 10(2) which corresponds to the present section
36(1)(ii) of the Income tax Act, 1961. It was also argued that section
36(1)(ii) was an enabling provision to allow expenditure on account of
bonus or commission. It was submitted that head of expenditure was
different from nature of expenditure. It was argued that not all
expenditure incurred under the head ‘bonus or commission’ would be
covered by the section 36(1)(ii). It was submitted that the said

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section covered only commission paid to non-share holder employees
as there was no possibility of paying dividend to such employees.
Therefore, it was further argued that commission paid to share holder
employees will be covered under the provisions of sec.37(1) under
which expenditure incurred wholly and exclusively for the purpose of
business is allowable. It was submitted that there was no dispute in
the present case that the expenditure incurred was wholly and
exclusively for the purpose of business and, therefore, the same
should be allowed u/s.37(1).
4.1 The ld. AR for the assessee also submitted that even if the
expenditure was covered by the provisions of section 36(1)(ii), the
said provisions could be applied only when the commission if not paid,
would not have been payable as dividend. It was pointed out that the
payment of bonus under the Companies Act was discretionary, to be
decided by the management of the company. Therefore, it could not
be said that the commission if it had not been paid, the same would
have been payable as dividend. It was also submitted that the plain
reading of the provisions made it clear that for disallowance of the
claim of commission, the same amount should have been payable as
dividend as held by Hon’ble High Court of Bombay in the case of Loyal
Motor Services Company Ltd. (supra). In this case, it was pointed out,
that the commission had been paid amounting to Rs.40.00 lacs in each
case. But in case, the entire commission of Rs.1.20 crores had been
paid as dividend, the share of each director in the dividend would not
have been the same, as the shareholdings of the directors were not
the same. Therefore, it was argued that the expenditure incurred by
the assessee was not hit by the provisions of section 36(1)(ii). As
regards the finding of the Assessing Officer that the claim of deduction

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on account of commission was for tax avoidance, the ld. AR submitted
that the tax rate applicable in case of directors was 33% whereas the
rate in the case of company was 35.75%. The dividend distribution
tax, it was submitted, could not be taken into account unless it was
established that the assessee would have declared dividend.
Therefore, there was hardly any difference in tax. In any case, it was
submitted that the argument based on tax avoidance was irrelevant
because legitimate and bonafide expenditure incurred for the purpose
of business could not be disallowed on the ground that the assessee
was saving in taxes. The ld. AR also referred to the following
decisions of the Tribunal in support of the case of the assessee.
i) 36 SOT 456 (Delhi) in case of ACIT vs. Bony Polymers (P)
Ltd. dated 23.11.2009,
ii) ITA No.4747/M/10 in the case of DCIT vs. M/s. Celsieus
Refrigeration (P) Ltd. dated 31.12.2010,
iii) ITA No.631/Bang/2010 in the case of ACIT vs. Mandavi
Motors (P) Ltd. dated 12.11.2010 and
iv)
ITA No.4924 & 4925/Raj./09 in the case of M/s. Career
launcher Pvt. Ltd. vs. ACIT dated 27.12.2010
4.2 It was also argued that there was no dispute regarding the
rendering of services by the directors and the reasonableness of
payment made to them. It was pointed out that in Assessment Year
2004-05, disallowance had been made by the Assessing Officer under
section 40A(2)(b) holding the commission payment excessive
compared to market value but the addition had been deleted by the
Tribunal. Therefore, in case the interpretation adopted by the
department was accepted, an expenditure could be disallowed u/s.
36(1)(ii) even if the commission was paid for commensurate services

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rendered by the directors which would lead to absurdity as it could
not be the intention of the legislature. He referred to the judgment of
Hon’ble Supreme Court in the case of K.P. Varghese (131 ITR 597) in
which it was held that statutory provisions should be so interpreted to
avoid absurdity. Further while interpreting statutory provisions, the
scope and object of the provisions must be seen as held by the Hon’ble
Supreme Court in case of Assam Co. Ltd. vs. State of Assam (248 ITR
567). It was submitted that the intention of the legislature was to
allow expenditure on account of commission for services rendered
under the provisions of section 37(1). He referred to the chart, placed
on record, showing turnover and profit of the assessee for Assessment
Years 1999-00 to 2008-09 to point out that there was substantial
improvement in the financial results of the assessee company which
was due to the efforts made by the working directors. It was
accordingly urged that the payment of commission which was for
services rendered by the Directors should be allowed under the
provisions of sec.37(1) and that, in such cases, the provisions of
sec.36(1)(ii) had no application.
4.3 The ld. AR further argued that, both in the prior years and in the
subsequent orders, the claim has been allowed either by the Assessing
Officer himself or in appeal by the Tribunal. It was pointed out that in
the Assessment Year 2004-05, the Assessing Officer had not applied
the provisions of sec.36(1)(ii) and had made disallowance under
sec.40A(2)(b) holding that the claim of expenditure was exclusive
compared to the market value. The addition made was, however, not
upheld by the Tribunal in the order dated 31.3.2010 for Assessment
Year 2004-05 in ITA No.2461/Mum/08 and no further dispute was
raised on this issue by the department before the High Court.
In

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Assessment Year 2005-06, the Assessing Officer had made the
disallowance of commission applying the provisions of sec.36(1)(ii)
and disallowance had been confirmed by CIT(A) but the Tribunal vide
order dated 31.3.2010 in ITA No.7194/M/08 deleted the addition
holding that the provisions of sec.36(1)(ii) were not applicable and no
appeal was filed by the department before the High Court. In
Assessment Year 2007-08, the Assessing Officer had made
disallowance in the assessment order dated 19.11.2009 u/s.143(3) but
the addition was deleted by CIT(A) vide order dated 23.11.2010
following the decision of the Tribunal in Assessment Year 2004-05 and
2005-06 (supra) and in Assessment Year 2008-09, the Assessing
Officer himself did not make any disallowance out of commission in the
order dated 1.12.2010 passed u/s.143(3). Thus, the claim of
commission had been allowed in the earlier years and subsequent
years. It was argued that the principle of consistency demanded that
no disallowance should be made in the assessment year under
consideration. Reliance was placed on the judgment of Hon’ble
Supreme Court in the case of Radha Saomi Satsang vs. CIT (193 ITR
321).
5. On the other hand the ld. DR strongly supported the orders of
authorities below. It was argued that there being substantial profits
and cumulative reserves and surplus, the decision of the directors who
were the only share holders and were also related to each other
(father and sons ) to not declare dividend was not reasonable. The
decision of the share holder directors to pay commission instead of
declaring dividend was obviously with the intention to reduce profits
for avoiding payment of taxes as the assessee company had derived
tax advantage as pointed out by the authorities below.
It was

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submitted that the directors had not given any reasons for not paying
dividend although there were substantial profits. The argument that
the dividend was not paid to improve the net worth to attract FII’s was
not supported by any evidence. It was pointed out that
reasonableness of payment or rendering of extra services by directors
were not relevant factors while considering allowability of claim of
deduction on account of payment/commission to the employees under
the provisions of sec.36(1)(ii). It was submitted that the provisions of
section 36(1)(ii) were applicable even when no extra services were
rendered for payment of commission. Reliance was placed on the
judgment of the Hon’ble Supreme Court in the case of Shahzada Nand
& Sons vs. CIT (108 ITR 358). There was also no evidence of any
extra services rendered by the directors. Further the assessee had not
made any payment of commission to any other employee. The
commission had been paid only to the directors who were also the
share holders which clearly showed that the payment of commission
was in lieu of dividend as there were substantial profits and surplus. It
was further argued that there being specific provision in section
36(1)(ii), any expenditure incurred on account of payment of bonus or
commission to employee should be covered by the said section and not
under section 37(1). Reliance was placed on the following judgments
in support of the case :
i) 24 ITR 566 (Bom.) in case of Subodh Chandra Popatlal vs.
CIT
ii)
iii)
54 ITR 763 (Guj.) in case of Laxmandas Sejram vs. CIT
26 ITR 265 (Mad.) in case of N.M. Rayloo Iyer & Sons vs. CIT

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5.1 The ld. DR further argued that provisions of sec.36(1)(ii) were
applicable in case of payment of bonus or commission to all employees
which was clear from the plain reading of the provision and not to only
non share holder employees as argued by the ld. AR of the assessee.
As regards the principle of consistency, the ld.DR argued that no doubt
it was true that in the earlier years and in the subsequent years, the
deduction in respect of commission to the same director employees
had been allowed but the decision was based on the decision of the
Tribunal. Since the issue has now been referred to the Special Bench
which is a Larger Bench, the decision of the Special Bench shall be
binding and the principle of consistency shall not be applicable in such
cases.
6. In reply the ld. AR for the assessee submitted that the
judgments relied upon by the ld.DR were distinguishable as in those
cases, payment of bonus or commission had been made to employees
and not to partner or shareholders. The case of the assessee was
covered by the judgment of Hon’ble High Court of Bombay in the case
of Loyal Motors Service Company. Ltd. vs. CIT (supra).
7. We have perused the records and considered the rival
contentions carefully. The issue raised before us is regarding
allowability of deduction on account of payment of commission of
Rs.1.20 crores to the three employee directors under section 36(1)(ii).
There is no dispute that the three directors were share holder
employees who held the entire share capital of the company and were
also related(father and sons). There is also no dispute that the
commission had been paid to the three director employees only and
not to any other employee. The issue is whether on the facts of the

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case, expenditure on account of commission can be allowed under the
provisions of section 36(1)(ii).
7.1 For answering the question referred, we have to first deal with
the object and scope
of the provisions of section 36(1)(ii) which
allows deduction on account of expenditure on payment of bonus or
commission to employees subject to certain conditions while
computing the income under the head “profits and gains of business or
profession”.
These provisions were first incorporated under the
Income tax Act 1922 (hereinafter referred to as the old Act).
The
provisions were inserted subsequent to the judgment of Hon’ble
Madras High Court in the case of R.E. Mahomed Kassim Rowther of
R.E. Mahomed Kassim Rowther & Co. (2 ITC 482).
The Hon’ble
Madras High Court in the said case had held that payment of any
amount which was directly or indirectly dependent upon the earnings
or the profits of the business, could not be allowed as business
expenditure. The reasoning was that profit is computed only after
deducting all expenses and, therefore, any payment made out of profit
could not be considered as expenditure incurred for the purpose of
earning of the profit. The old Act was amended by Income tax (3 rd
Amendment) Act 1930 and a new clause (viiia) was inserted in section
10(2) to allow expenditure on account of payment of bonus or
commission to an employee and later, the said clause was renumbered
as clause (x) of section 10(2).
The said provisions of
section 10(2)(x) are reproduced below as a ready reference :
(x) 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

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Provided that the amount of bonus or commission is
of reasonable amount with respect to :
a) pay of the employee and conditions of his
service.
b) the profits of the business or profession for the
year in question and
c) the general practice in similar business or
profession
7.2 The above provisions of section 10(2)(x) of the old Act were
incorporated in the Income tax Act, 1961 also without any changes as
clause (ii) to section 36(1). Subsequently, the clause was amended
and a new proviso was inserted as the first proviso and the existing
proviso with some modifications was substituted as second proviso
w.e.f. Assessment Year 1976-77.
1976-77 read as under :-
The amended provisions w.e.f.
36(i)(ii) any sum paid to 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 a bonus or commission
Provided that the deduction in respect of bonus paid
to employee employed in factory or other
establishment to which provisions of payment of
Bonus Act (521 of 1965) apply, shall not exceed
the amount of bonus payable under the Act.
Provide further that the amount of bonus (not being
bonus referred to in the first proviso ) or commission
is reasonable with respect to:
a) pay of the employee and conditions of his
service.
b) the profits of the business or profession for the
year in question and

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c) the general practice in similar business or
profession
7.3 The provisions of section 36(1)(ii) were again amended by the
Direct Tax Laws (Amendment) Act, 1987 from Assessment Year 1988-
89 and the two provisos were deleted. Thus, the provisions of section
36(1)(ii) applicable from 1988-89 which remained in force during the
relevant year under consideration were as under :-
36(1)(ii) Any sum paid to the 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
7.4 The object behind the provisions of section 36(1)(ii) is to allow
deduction on account of any expenditure on account of payment of
bonus or commission to an employee even if the said payment is made
out of profits of the assessee subject to the conditions mentioned in
the section. This is an enabling provision which allows deduction on
account of bonus or commission to employees. The reasonableness of
payment or adequacy of services rendered by the employees are not
relevant factors in deciding the allowability of deduction. The section
allows deduction if the expenditure is:
i) on account of bonus or commission;
ii) is paid to an employee;
iii) for services rendered and
iv) is not in lieu of payment of dividend.
7.5 The provisions of section 36(1)(ii) cover only the case of
expenditure on account of bonus or commission paid to an employee.

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Any expenditure incurred on account of payment of commission to a
person who is not an employee is not covered by the said provision.
Such cases of expenditure on account of commission to non employees
will be governed by the provisions of section 37(1) which allow
deduction on account of any expenditure which is incurred wholly and
exclusively for the purpose of business subject to certain conditions.
The criteria of “wholly and exclusively” is not relevant while
considering deduction under section 36(1)(ii). The payment may be
made out of commercial expediency which should be judged in the
light of current socio economic thinking which encourages employers
to share a part of the profits with the employees as held by Hon'ble
Supreme Court in the case of Shazada Nand & Sons (108 ITR 358)
while dealing with the provisions of section 36(1)(ii).
portion of the judgment is reproduced below:
The relevant
“….What is the requirement of commercial expediency
must be judged, not in the light of the 19th century
laissez faire doctrine which regarded man as an economic
being concerned only to protect and advance his selfinterest,
but in the context of current socio-economic
thinking which places the general interest of the
community above the personal interest of the individual
and believes that a business or undertaking is the product
of the combined efforts of the employer and the
employees and where there is sufficiently large profit,
after providing for the salary or remuneration of the
employer and the employees and other prior charges such
as interest on capital, depreciation, reserves, etc., a part
of it should in all fairness go to the employees…”
7.6 The ld. Authorised Representative for the assessee argued that
provisions of section 36(1)(ii) are applicable only in the case of
employees who are not share holders. His argument was that the
provision is not applicable when the payment of commission is in lieu
of dividend and since dividend is payable only in the case of share
holders, the provisions will not be applicable in case of share holder

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employees. We are unable to accept such argument which can be
relevant only when the payment of dividend to shareholders is
compulsory. It is an undisputed fact that payment of dividend by a
company is not compulsory and it is dependent upon the profitability
and other conditions of the business. Therefore, in cases where
dividend is not payable, the payment of bonus or commission can be
allowed as deduction in case of employee share holders also under
section 36(1)(ii) as in that case it could not be said that payment of
bonus or commission is in lieu of dividend. Thus the provisions of
section 36(1)(ii) are also applicable to share holder employees subject
to the condition that payment is not made in lieu of dividend. The
provisions of section 36(1)(ii) can be split into two parts. The first part
viz., “any sum paid to an employee as bonus or commission for
services rendered” is an enabling provision. This part applies to all
employees. The second part is a disabling provision which provides
that “if the sum so paid is in lieu of profit or dividend,” it cannot be
allowed as deduction. This part applies only to employees who are
partners or shareholders. Thus, in so far allowability of expenditure
on account of bonus or commission under section 36(1)(ii) is
concerned, it applies to all employees including shareholder
employees. The disallowability is restricted to only partners and
shareholders as only in those cases, payment could be in lieu of profit
or dividend. We therefore, reject the arguments advanced by the ld.
AR that the provisions of section 36(1)(ii) apply only to nonshareholder
employees.
7.7 As regards the rendering of services by the employees for
payment of bonus/commission, the only requirement of section
36(1)(ii) is that some services should have been rendered. Adequacy

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of services is not a relevant consideration. It is not necessary that
payment should be made commensurate to the rendering of services
or there should be some extra services rendered for payment on
account of bonus or commission. This proposition is supported by the
judgment of Hon’ble Supreme Court in case of Shazada Nand & Sons
(108 ITR 358). Relevant portion of the judgment is reproduced for
ready reference:
“Section 36(1)(ii) of the Income tax Act, 1961 does
not postulate that there should be any extra services
rendered by an employee before payment of
commission to him can be justified as allowable
expenditure. If services were in fact rendered by the
employee, it is immaterial that the services rendered
by the employee was in no way greater or more
onerous than the services rendered by him in the
earlier years. Of course, the circumstances that no
additional services were rendered by the employee,
would undoubtedly be of some relevance in
determining the reasonableness of the amount of
commission but it would have to be considered
along with other circumstances.”
7.8 Thus any expenditure on account of payment of bonus or
commission to an employee for some services rendered will be an
allowable deduction subject to the condition that the payment of bonus
or commission should not be in lieu of dividend. This condition, as
pointed out earlier, is relevant only in case of share holder employees
as dividend is payable only in case of share holders. Further,
reasonableness of the payment is no longer a requirement as per the
amended provisions of section 36(1)(ii) applicable from Assessment
Year 1988-89. The ld. AR for the assessee has argued that the
expression “payable” used in section 36(1)(ii) meant that the
shareholder should have right to receive the dividend. It was
submitted that payment of dividend was discretionary to be decided by

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Assessment Year:06-07
the management of the company and not compulsory. Therefore, it
could not be said that the dividend was payable in case of the
employee directors. Accordingly it was argued that since the dividend
was not payable in case of the assessee company, the claim could not
be disallowed under section 36(1)(ii). We are unable to accept the
arguments advanced. In our view the word “payable” used in section
36(1)(ii) does not mean statutorily payable or legally payable. Since
payment of dividend is discretionary and not compulsory, any such
construction will lead to absurd results. The word “payable” in our
view means that dividend would have been declared by any reasonable
management, on the facts and circumstances of the case considering
the profitability and other relevant factors and become payable to
shareholders. Therefore, 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).
7.9 For deciding the issue whether dividend in case of the assessee
would have been payable, we have to consider the profitability of the
company and all other relevant factors. In this case, the position
regarding the business turnover, the profit and payment of salary and
commission to director employees from Assessment Year 1999-00 to
Assessment Year 2008-09 which has been placed on record by the
assessee was as under :-
Assessment
Year
Turnover
Income as per
P&L A/c.
Salary
Directors
to
Commission
to Directors

20
5792/Mum/09
Assessment Year:06-07
1999-00 4,97,93,940/- 2,69,77,012/- 30,00,000/-
-
2000-01 11,78,42,787/- 6,71,14,638/- 30,00,000/- 1,05,00,000/
-
2001-02 4,77,03,584/- 57,26,229/- 30,00,000/-
-
2002-03 5,95,29,967/- 2,44,95,962/- 30,00,000/-
-
2003-04 4,58,18,043/- 1,04,13,105/- 30,00,000/-
-
2004-05 10,51,26,344/- 4,55,44,868/- 30,00,000/- 1,20,00,000/
-
2005-06 12,74,11,457/- 6,69,78,205/- 30,00,000/- 1,20,00,000/
-
2006-07 17,86,29,800/- 10,57,96,305/- 30,00,000/- 1,20,00,000/-
2007-08 18,86,71,578/- 10,81,16,140/- 30,00,000/- 1,50,00,000/-
2008-09 32,21,66,934/- 22,42,87,992/- 30,00,000/- 1,50,00,000/-
7.10 Referring to the financial performance mentioned above, it was
argued on behalf of the assessee that from Assessment Year 2004-05
onwards, the performance of the company had improved progressively
and that it had been due to the extra efforts made by the directors.
The Board, therefore, vide resolution dated 3.3.2003 allowed payment
of commission to the directors @ 10% of profit before tax subject to a
limit of Rs.40.00 lacs per year in each case for extra services. It was
pointed out that the turnover of the business increased from Rs.10.51
crores in 2004-05 to Rs.32.21 crores in Assessment Year 2008-09 and
profit before tax after claiming deduction on account of commission,
improved from Rs.4.55 crores in Assessment Year 2004-05 to 22.42
crores in Assessment Year 2008-09. It has been submitted that
payment of salary and commission was commensurate to market value
of the services rendered by the director and therefore in such cases no
disallowance could be made u/s.36(1)(ii). Comparison has been made

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5792/Mum/09
Assessment Year:06-07
to the payment of remuneration of Rs.46,61,860/- to an employee of
the assessee company namely Shri Milind Karmakar who was heading
the research division. Reference has also been made to the case of
M/s. Motilal Oswal Securities who was in the same business and in
which case also commission aggregating to Rs.7.44 crores had been
paid to directors in addition to the aggregate salary of Rs.2.54 crores.
It has also been submitted that non-declaration of dividend by
directors was to improve the net worth of the company so as to attract
FIIs who select brokers based on their net worth.
7.11 On careful consideration of various aspects of the matter, we are
not convinced by the arguments advanced. The legal position as we
have discussed earlier is that any expenditure on account of payment
of commission to an employee will be allowable as deduction under the
provisions of section 36(1)(ii) irrespective of the fact whether the
employee is a shareholder or not or whether the commission has been
paid for some extra services or for the some services subject to the
condition that the payment is not in lieu of dividend. However, in case
extra services have been rendered for payment of commission, it will
be one of the relevant factors to consider while deciding whether the
case is covered by the exception provided in the section 36(1)(ii) i.e.
whether the payment of commission is in lieu of dividend. In the
present case, no evidence is available on record to support the plea
that the directors had rendered any extra services for payment of huge
commission in addition to services rendered as an employee for which
salary has been paid. No such evidence has been placed even before
us nor even the details of any such extra services have been given.
The ld. AR for the assessee has referred to the decision of the
Tribunal in assessee’s own case in Assessment Year 2004-05 (supra),

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Assessment Year:06-07
in which disallowance made by the Assessing Officer of 50% of
remuneration and commission under section 40A(2)(b) has been
deleted to point out that the Tribunal accepted the case of the
assessee that payment of salary and commission was comparable to
market value of services. We have gone through the said decision of
the Tribunal. The finding recorded by the Tribunal in para-9 on this
issue is reproduced below as ready reference :-
“9 We have heard the rival submissions and
considered them carefully. After considering the
submissions and perusing the relevant material on
record, we do not find any infirmity in the findings of
the ld CIT(A) in respect of the deletion of Rs. 75 lacs u/s
40A(a)(b). It is seen that in earlier, the remuneration
paid by the assessee has been allowed by the AO. It is
further seen that the company has passed resolution
that the Directors of the assessee company will be paid
commission over and above the salary amount. In
accordance with the resolution, the company has paid
remuneration plus commission. It is further seen that
the Directors of the company are assessed to tax and
their taxable income is subject to payment of maximum
marginal rate of tax which is 33% including surcharge.
The company is liable to pay tax @ 35.75%; therefore, it
cannot be said that the commission and remuneration
aid to the Directors was on account of tax planning.
9.1 The findings of the ld CIT(A) have been
reproduced somewhere above in this order. In our view,
the findings of the ld CIT(A) does not suffer from any
infirmity. The decision relied upon by the ld counsel of
the assessee are also in favour of the assessee.
Therefore, keeping in view of these facts and
circumstances and in view of the detailed findings given
by the ld CIT(A), we hold that the ld CIT(A) was justified
in deleting the addition of Rs. 75 lacs on account of
remuneration paid to the Directors. Accordingly, we
confirm the findings of the ld CIT(A) on this issue.”

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Assessment Year:06-07
7.12. The Assessment Year 2004-05 was the first year when the
assessee started paying commission of Rs.40.00 lacs to each working
director in addition to salary. In the immediately preceding year, the
directors had been paid only salary which was Rs.6.00 lacs per annum
in case of Chairman and Rs.12.00 lacs per annum in case of the other
two directors. The Tribunal in the said order has not given any finding
whether substantial payment of Rs.40.00 lacs was for any extra
services rendered. The Tribunal basically allowed the claim on the
ground that in the immediate preceding year, salary expenditure had
been allowed and payment of commission was supported by the Board
Resolution and that there was no tax advantage to the assessee. The
Tribunal confirmed the finding of the CIT(A) which had been
reproduced in para-7 of the order of the Tribunal as per which the
CIT(A) deleted the addition made by the Assessing Officer on the
ground that the directors were competent to undertake the activities of
the company which had yielded huge profits. The education of the
directors was of not great significance. CIT(A) thus deleted the
addition on account of estimated disallowance. Thus even CIT(A)
whose finding has been confirmed by the Tribunal has not given any
finding that huge payment of commission was linked to any extra
services. The board resolution cannot be considered as an evidence of
extra service particularly when the board is constituted by the director
employees to whom payments have been made. There is also no
finding by the Tribunal to the effect that payment of commission was
commensurate to the market value of the services. Thus, the decision
of the Tribunal in Assessment Year 2004-05 (supra), cannot be
considered as precedent for the plea that huge commission had been
paid for extra services or that payment was commensurate to market

24
5792/Mum/09
Assessment Year:06-07
value of services. As pointed out earlier, no evidence of any extra
services to justify huge commission payments has been produced
before the lower authorities or even before us.
7.13 We have to evaluate the case on basis of material available on
record. On careful perusal of financial performance statistics tabulated
earlier, we note that both the turnover and the profit was exceptionally
high in Assessment Year 2000-01 compared to the earlier year and
subsequent three year period. But this was because of the reason that
there was stock market boom which had peaked in Assessment Year
2000-01 and the bubble had burst only towards the fag end of that
year, which was the reason for exceptional performance in that year.
The assessee is a share broker who gets commission on sale/purchase
of shares by investors/traders. The income of the assessee is assured
irrespective of the fact whether the investor/trader loses or gains in
the transaction. The commission, will, however, depend upon the
market conditions. In case of boom when the market is flooded with
investors/traders, income will rise as volume increases but in case of
slump when investors/traders desert the market, there will be fall in
volume and income. After the Assessment Year 2000-01 when the
stock market crashed, there was slump in the market for three years
which resulted in sharp fall in both turnover and profit from
Assessment Year 2001-02 to 2003-04. The turnover fell to 50% or
even less and the profit declined more steeply.
7.14 Therefore, the only reasonable conclusion which can be drawn is
that the payment of Rs.1.05 crores shown as commission in
Assessment Year 2000-01 when there was exceptional profit was
nothing but dividend because had it been a genuine commission, the

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5792/Mum/09
Assessment Year:06-07
assessee would have continued the payment of commission and even
may have increased in the subsequent three year period to improve
performance but no commission was paid in these years eventhough
turnover and profit were both declining. Obviously, sharp fall in profits
had forced the company management not to pay dividend in the garb
of commission in the next three years. The stock market started
recovery from Assessment Year 2004-05 and had steadily gained till
Assessment Year 2008-09 which is reflected in steady increase in both
turnover and profit. The assessee again started showing payment of
commission from Assessment Year 2004-05. The profit before tax but
after deduction on account of commission was Rs.4.55 crores in
Assessment Year 2004-05 which steadily rose to Rs.22.42 crores in
Assessment Year 2008-09. In our view the steady rise in performance
was due to improved market conditions and not because of any extra
service rendered by the directors as no evidence has been produced
for rendering of extra services. The equity capital of the company
which is entirely owned by the three directors was Rs.6.50 crores.
Investors in equity shares expect a reasonable return on the share
investment and in our view any reasonable management would have
declared at least about 20% dividend in the above years to the share
holders when there were substantial profits. No doubt it is true that
dividend is not mandatory and is discretionary to be decided by the
management after considering the profitability and other factors. The
management may not declare dividend even when there are
substantial profits because of business exigency such as requirement
of fund for any expansion or diversification programme but no such
exigencies have been shown. The assessee company is a share broker
and only executes orders on behalf of investors on commission basis.
No funds are therefore required for any expansion etc. nor any such

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5792/Mum/09
Assessment Year:06-07
case has been made. The directors in the annual report have not
given any reason for not declaring dividend. The reason given before
us is that the assessee did not declare dividend to improve net worth
to attract FIIs who do transactions only through high net worth
brokers. This argument is not convincing at all because whether the
assessee pays commission or dividend the net worth is reduced by the
same amount. It is also to be noted that commission has been paid
only to the director employees and commission has been paid as 10%
of profits subject to a limit of Rs.40.00 lacs which also shows that the
assessee company distributed part of the profits to the director
employees who were the only shareholders. Therefore, on the facts
and circumstances of the case as discussed above we have no
hesitation in coming to the conclusion that dividend in case of the
assessee company was payable and that the same has been paid in
the garb of commission.
7.15 The comparison made by the assessee to the high remuneration
of Rs.46.61 lacs paid to a non share holder employee is not very
relevant in our opinion. The three directors are the owners of the
company. The owners of business if they are not technically qualified
may have to engage highly qualified employees for doing specialized
jobs and may have to pay high remuneration more than the salary
payable to them for the services rendered. The stock market is a
highly specialized field and requires adequate research to attract
investors. The quality and reliability of research is back-bone of stock
broking business. Therefore, obviously the assessee company had to
engage a highly qualified CA to head research division on high
remuneration which cannot be compared to the remuneration payable
to the assessee. The Assessing Officer has also pointed out that the

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5792/Mum/09
Assessment Year:06-07
assessee company had other B.Com employees who have been paid
remuneration of only Rs.3.00 lacs per annum. Further, no commission
is paid to any employee other than the three share holder directors.
As regards, the case of Motilal Oswal Securities which has been quoted
in comparison, no details such as qualifications of the directors,
profitability and payment made to other employees has been placed on
record. We are therefore not in a position to comment as to whether
in that case it was a genuine payment of commission or payment in
lieu of dividend. Moreover, merely because commission has been
claimed and allowed in another case wrongly, cannot be the ground to
allow a claim of deduction in case of the assessee. Each case has to
be viewed on the facts of the case.
7.16 The ld. AR for the assessee has also argued vehemently that the
case of the assessee is supported by the judgment of Hon’ble high
Court of Bombay in case of Loyal Motor Service Company.
Ltd.(supra), in which case it has been held that for disallowance of
bonus or commission under section 36(1)(ii), the same amount if not
paid as commission should have been payable as dividend. In the
present case, it has been pointed out that the directors had been paid
commission of Rs.40.00 lacs each but in case the entire amount of
commission of Rs.1.20 crores had been paid as dividend, the payment
of dividend would not have come to Rs.40.00 lacs in each case
because share holding of the three directors was not the same. The
chairman held 50% of the shares whereas the other two directors held
25% each.
7.17 We have carefully gone through the said judgment. That was
the case of a public limited company and the issue was allowability of

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5792/Mum/09
Assessment Year:06-07
deduction on account of bonus under section 10(2)(x) which
corresponds to section 36(1)(ii). In that case bonus had been paid not
only to thirteen share holder employees but also to twenty-eight non
share holder employees at the same rate and therefore, payment of
bonus to the shareholder employee could not be said to be
unreasonable. In case of public companies having large number of
shareholders which are unrelated, it may not be possible to use a
device. The present case involves a family business owned by the
three directors who were not only shareholders but were also decision
makers. They are also blood relations (father and sons). Therefore,
they could easily show payment of dividend as commission and take
the payment in such a manner that the same amount does not become
payable as dividend though the total amount remains within the
family. Therefore, in our view, the judgment cited above cannot be
applied to a case where a device is adopted by closely held private
companies to distribute dividend in the garb of commission in such a
manner to take advantage of judgment in the case of Loyal Motor
Service Company Ltd. (supra). We have already held earlier that,
considering the facts and circumstances of the case, the commission
payment in this case was in lieu of dividend and therefore, the claim
cannot be allowed only on the ground that the payment taken by the
directors is not in the share holding ratio. The device adopted by the
assessee is obviously with the intention to avoid payment of full taxes.
There is obvious tax avoidance. In case dividend is paid, the tax
payable at the rate of 35.75% in case of a company on the amount of
Rs.1.20 crores comes to Rs.42.90 lacs and in that case the company
would have also to pay dividend distribution tax @12.5% which comes
to Rs.15.00 lacs. The total tax payment in case of dividend payment
would come to Rs.57.90 lacs whereas in case commission was paid,

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5792/Mum/09
Assessment Year:06-07
the tax payable comes to Rs.39.60 lacs. There is thus tax avoidance
of Rs. 18.30 lacs. The provisions of section 36(1)(ii) are intended to
prevent an escape from taxation by describing the payment as bonus
or commission when in fact ordinarily it should have reached the
shareholders as profit or dividend as held by the Hon’ble High Court of
Bombay in the case of Loyal Motor Service Company Ltd. (supra). In
this case we are convinced in view of the discussion made earlier that
it is a case of paying commission which was otherwise payable as
dividend, to escape taxation.
7.18 The ld. AR for the assessee has also relied on certain decisions
of the Tribunal as mentioned earlier in para 4.1. These cases in our
view are distinguishable. Moreover these are decisions of division
Bench of the Tribunal which cannot act as binding precedent for the
Special Bench which is a larger Bench. In case of ACIT vs. Bony
Polymer Pvt. Ltd. (supra), two whole time working directors had been
paid commission @ .5% of turnover. The divisional Bench of the
Tribunal on facts of that case held that there was no material to
support the proposition that had commission been not paid, it would
have been payable as dividend. The case of DCIT vs. M/s. Celsius
Refrigeration P. Ltd. (supra), was identical in which case, the decision
in case of Bony Polymers (supra) was followed. In case of ACIT vs.
Mandavi Motors Pvt. Ltd. (supra), the directors who had been paid
bonus held only few shares and therefore, the dividend payable would
have been negligible. In case of M/s. Carrier Launcher P. Ltd. (supra),
there was a wide gap between the share holdings of the two directors
which were 40.93% and 1.09%. Moreover the directors were also not
related and therefore it could not have been a case of device. These

30
5792/Mum/09
Assessment Year:06-07
cases therefore are distinguishable and cannot come to the rescue of
the assessee.
7.19 Arguments have also been advanced by the ld. AR based on the
principle of consistency. It has been submitted that in earlier years
and subsequent years the claim has been allowed and therefore, it
could not be disallowed in the present year. Reliance has been placed
on the judgment of Hon'ble Supreme Court in the case of Radha Saomi
Satsang (supra). No doubt, the revenue authorities are expected to
adopt a consistent approach in allowing or disallowing a claim and if a
claim has been allowed in an earlier year, any disallowance in
subsequent year cannot be justified if factual and legal position
remains the same. But in this case we note that the claim has been
allowed in the earlier and subsequent year based on the decisions of
divisional Bench of the Tribunal. The Bench which originally heard the
appeal for this year had reservations regarding correctness of the
decision of the divisional bench and accordingly matter was referred to
a Larger Bench. The decision of the divisional Bench in earlier year
cannot act as a binding precedent for the Special Bench which is a
Larger Bench. Further in case the decision of the division Bench was
to be followed, there was no need to refer the issue to a larger Bench.
Therefore, in our view, on the facts of the case, the principle of
consistency will be of no help and the argument raised has to be
rejected. Even in case of Radha Saomi Satsang(supra), Hon’ble
Supreme Court had held that the decision was confined to facts of that
case only.

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5792/Mum/09
Assessment Year:06-07
7.20 In view of the foregoing discussion and for the reasons given
earlier, we are of the view that the payment of commission of Rs.1.20
crores to the three working directors was in lieu of dividend and the
same is not allowable as deduction under section 36(1)(ii). We answer
the reference accordingly.
8. We now take up the appeal of the assessee. In the appeal, the
assessee has raised disputes on two grounds which are as under :-
i) On the facts and circumstances of the case and in
law the ld. Assessing Officer erred and ld. CIT(A)
confirmed the disallowance of Rs.1,20,00,000/- under
section 36(1)(ii) of the I.T. Act being commission paid to
executive working directors.
ii) Alternatively, on the facts and circumstances of the
case and in law the ld. Assessing Officer and the ld. CIT(A)
VIII did not consider the appellant’s claim of
Rs.1,20,00,000/- being commission paid to three director
as allowable under section 37(1).
8.1 The dispute raised in ground No.1 is the same as the question
referred before the Special Bench i.e. whether on the facts and
circumstances of the case, payment of commission to the extent of
Rs.1.20 crores is allowable under provisions of section 36(1)(ii). We
have already answered the question vide para 7.20 of this order and
held that the payment of commission of Rs.1.20 crores was in lieu of
dividend and the same is not allowable under section 36(1)(ii). The
ground is therefore, decided against the assessee.

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Assessment Year:06-07
8.2. The second ground is regarding alternate claim of allowability of
deduction on account of commission of Rs.1.20 crores paid to the
three director employees under provisions of section 37(1) of the I.T.
Act. The ld. AR for the assessee argued that provisions of section
36(1)(ii) were applicable only in the case of non-share holder
employees. It was also argued that commission paid for any extra
services rendered by the share holder employees will be covered by
the provisions of section 37(1) which allows deduction on account of
any expenditure incurred wholly and exclusively for the purpose of
business subject to the conditions mentioned in the section. We have
already considered these aspects while considering the question
referred to the Special Bench and vide para 7.6 and 7.7 have held that
the provisions of section 36(1)(ii) will apply in case of all employees
including share holder employees irrespective of the fact whether any
extra services have been rendered or not. The issue whether payment
of bonus or commission to an employee will be covered by the
provisions of section 36(1)(ii) or section 37(1) is also settled by the
judgment of Hon’ble Jurisdictional High Court in case of Subodh
Chandra Poppatlal vs. CIT (24 ITR 586) in which the Hon’ble High
Court while dealing with similar provisions of the old Act held that
when an expenditure fell under section 10(2)(x) [which corresponds to
section 36(1)(ii)], in the sense that it is an expenditure in the nature
of bonus or commission paid to an employee for services rendered
then its validity can only be determined by the tests laid down in
section 10(2)(x) and not by the tests laid down in section 10(2)(xv)
which corresponds to section 37(1). Respectively following the said
judgment, we hold that the payment of commission to the three
director employees had been rightly considered by the authorities

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5792/Mum/09
Assessment Year:06-07
below under the provisions of section 36(1)(ii) and that the provisions
of section 37(1) will not be applicable in such cases.
8.3 In the result, the appeal of the assessee is dismissed.
Order pronounced in open court on 22.6.2011.
Sd/- Sd/- Sd/-
(D.K. AGARWAL) (N.V. VASUDEVAN) (RAJENDRA SINGH)
JUDICIAL MEMBER JUDICIAL MEMBER ACCOUNTANT MEMBER
Mumbai,
Dated : 22.6.2011
Jv.
Copy to: The Appellant
The Respondent
The CIT, Concerned, Mumbai
The CIT(A) Concerned, Mumbai
The DR “ ” Bench
True Copy
By Order
Dy/Asstt. Registrar, ITAT, Mumbai.