Dalal Broacha Stock Broking Pvt Ltd vs. ACIT (ITAT Mumbai – Special Bench)

S. 36(1)(ii) bars tax avoidance scheme of paying commission instead of dividend

The assessee paid commission of Rs. 1.20 crores to its three employee directors who also held the entire share capital. The AO & CIT (A) rejected u/s 36(1)(ii) the claim for deduction of the commission on the ground that it was in the nature of “dividend”. On appeal by the assessee to the Tribunal, the matter was referred to the Special bench. HELD by the Special bench dismissing the appeal:

(i) The argument that s. 36(1)(ii) is applicable only to employees who are not shareholders is not acceptable because payment of dividend to shareholders is not compulsory. S. 36(1)(ii) applies to all employees including shareholder employees though the disallowability is restricted to partners and shareholders because it is only in those cases that payment can be said to be in lieu of profit or dividend;

(ii) The argument that as no dividend was “payable”, s. 36(1)(ii) does not apply is not acceptable because the word “payable” does not mean that dividend should be statutorily or legally payable. Since payment of dividend is discretionary and not compulsory, any such construction will lead to absurd results. The word “payable” 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. If a reasonable conclusion can be drawn that the dividend ought to have been paid and that instead of paying dividend, commission was paid, s. 36(1)(ii) would be attracted;

(iii) On facts, there is no evidence to show that the directors had rendered any extra services for payment of huge commission in addition to services rendered as an employee for which salary was paid. Further, though the turnover and the profit was exceptionally high as compared to the earlier years, this was because of the stock market boom. The assessee being a share broker gets commission on sale/purchase of shares by investors/traders and its income is assured irrespective of whether the investor/ trader loses or gains in the transaction. The steady rise in performance was due to improved market conditions and not because of any extra service rendered by the directors. Also, no dividend was declared even though any reasonable management would have declared at least about 20% dividend in the years when there were substantial profits;

(iv) The device adopted by the assessee was obviously with the intention to avoid payment of full taxes. There is obvious tax avoidance. S. 36(1)(ii) is intended to prevent escape from taxation by describing the payment as bonus or commission when in fact it should have reached the shareholders as profit or dividend (Loyal Motor 14 ITR 647 (Bom) referred)