Income Tax Appellate Tribunal - Mumbai
Knik Chemical Engineers (P.) Ltd. vs Income-Tax Officer on 27 October, 1986
Equivalent citations: [1987]20ITD302(MUM)
ORDER
J.P. Bengra, Judicial Member
1. These are the cross-appeals by the assessee and the revenue relating to the assessment year 1980-81. The grounds of appeal in the assessee's appeal are as under :
1. On the facts and circumstances of the case, and in law, the Commissioner (Appeals) has erred in holding that bonus of Rs. 7,000 is payable to directors is not justifiable.
2. On the facts and circumstances of the case the Commissioner (Appeals) has erred in holding that membership fees paid to club of Rs. 4,150 for the director's is not justifiable.
The only ground in the revenue's appeal is as under :
On the facts and in the circumstances of the case and in law, the learned Commissioner (Appeals) erred in deleting the addition made by the ITO on account of the excess remuneration paid to the directors.
2. The assessee is a company. The assessee carries on the profession of rendering services as chemical engineers, importing certain technical know-how developed by it, in collaboration with foreign collaborator Dr. Herman Stage and also erects chemical plant for various parties in India. During the assessment year 1980-81, the assessee-company paid bonus to two directors of the company Dr. B. Bose and Shri S. Aga of Rs. 3,500 each besides increase in their salaries from Rs. 3,500 per month to Rs. 5,000 per month. They have also given commissions. The ITO restricted the allowance by applying Section 36(1) of the Income-tax Act, 1961 ('the Act') that the provisions of Section 36(1) specifically provides for disallowance of any payment to employees, in excess of what is not payable to any employee under the Payment of Bonus Act, 1965. On appeal before the Commissioner (Appeals), the payment of bonus was also considered as unjustifiable and, therefore, the order of the ITO was confirmed by the Commissioner (Appeals) on this point. The assessee is on further appeal before us.
3. The learned Counsel for the assessee submitted that these two directors were obviously directors in Exomet, another company where they were drawing a salary of Rs. 1,500 per month each. From 1-4-1979, the directors resigned the job with Exomet and started devoting their time entirely to the work of the assessee-company. The directors after joining the assessee-company were not allowed any increase in pay and further they have devoted the extra labour to the business of the assessee-company by which there was increase in the profits of the company. Therefore, they have been given bonus in addition to the hike in their pays. The learned Counsel for the assessee filed before us the details of turnover and the profits of the company for the past four years and a copy of judgment in the case of Extrusion Process (P.) Ltd. v. CIT [1979] 119 ITR 287 of the Bombay High Court and relied on the ratio of the decision in the case of Shahzada Nand & Sons v. CIT [1979] 108 ITR 358 (SC).
4. As against this, the learned departmental representative, Shri Prem Kumar submitted that the assessee-company has already given an unreasonable hike in pay of these two directors, further the assessee-company cannot give bonus to the directors in view of the restriction laid down under Section 36(1) and (2).
5. We have considered the rival submissions. It is obvious that during the assessment year under appeal, the salaries of these two directors were increased from Rs. 3,500 per month each to Rs. 5,000 per month each on the ground that they have devoted extra time to the business of the assessee after they had joined the assessee-company. Besides, the hike in their salaries, the assessee-company has given bonus to these two directors which, according to the Commissioner (Appeals), is not justifiable and cannot be held reasonable under Section 36(1)(ii)- Section 36(1)(ii) provides as under:
(ii) 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 :
Provided that the deduction in respect of bonus paid to an employee employed in a factory or other establishment to which the provisions of the payment of Bonus Act, 1965 (21 of 1965), apply shall not exceed the amount of bonus payable under that Act : Provided further that the amount of the bonus (not being bonus referred to in the first proviso) or commission is reasonable with reference to--
(a) the pay of the employee and the conditions of his service ;
(b) the profits of the business or profession for the previous year in question ; and
(c) the general practice in similar business or profession ;
The question is whether the grant of bonus to these two directors qualifies for the deduction as an allowable expenditure under Section 36(1)(ii). According to the assessee-company, these two directors were paid bonus besides the salaries and commission because according to the assessee-company, during the relevant accounting year, there was considerable enhancement in the turnover and profits of the assessee-company. Section 36(1)(ii) postulates three factors on fulfilment alone, the payment of bonus to employee can be regarded as reasonable one. They are :
(a) the pay of the employee and the conditions of his service ;
(b) the profits of the business or profession for the previous year in question ; and
(c) the general practice in similar business or profession ;
While considering these three factors, the Hon'ble Supreme Court in the case of Shahzada Nand & Sons (supra) laid down that the three factors laid down by the proviso to Section 36(1)(ii) are not really conditions on the fulfilment of which alone the amount of commission paid to an employee can be regarded as reasonable. They are merely factors to be taken into account by the revenue authorities in determining the reasonableness of the amount of commission. It may be that one of these factors yields a negative response. To take an example, there may be no general practice in similar business or profession to give commission to an employee, but, yet, having regard to the other circumstances, the amount of commission paid to the employee may be regarded as reasonable. What the proviso requires is merely that the reasonableness of the amount of commission shall be determined with reference to the three factors. But it is well settled that these factors are to be considered from the point of view of a normal prudent businessman. The reasonableness of the payment with reference to these factors has to be judged not on any subjective standard of the assessing authority but from the point of view of commercial expediency. In that case also, there was a question whether certain commission paid by the assessee to two employees is an allowable expenditure in computing the profits of the company from the business. In that case also, the assessee-firm had shown very satisfactory turnover from year to year and the turnover of sales increased to Rs. 54.28 lakhs and overriding commission increased to Rs. 1,13,449 during the assessment year. In that circumstances, it was held by the Supreme Court that Section 36(1)(ii) does not postulate that there should be any extra services rendered by an employee before payment of commission to him can be justified as an 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. On these facts, the Hon'ble Supreme Court justified the payment of commission to two employees of the assessee-company and having regard to all the circumstances of the case, it was held that it was an allowable deduction under Section 36(1)(ii).
6. The facts of the present case are similar to the case of Shahzada Nand & Sons (supra). In the present case also, it is evident from the turnover and profits of the assessee-company for the last four years that it is increased from Rs. 9,83,579 in the year 1978-79 to Rs. 22,29,649 in the year under appeal and net profits increased from Rs. 30,417 in the year 1978-79 to Rs. 35,985 in the year under appeal. There is further increase in the net profits in the assessment year 1981-82. In this way, there is sufficient increase in the turnover and the profits during the relevant accounting year which may be taken as a result of any extra work made by these two directors as argued by the learned Counsel for the assessee. Hence, applying the ratio of the case of Shahzada Nand & Sons (supra), we are also of the opinion that the payment of bonus to these two directors to the tune of Rs. 7,000 in addition to hike in their salaries is also justifiable.
7. Similarly, in the case of Extrusion Process (P.) Ltd. (supra), the Bombay High Court has held that the test of reasonableness has to be considered from the point of view of a businessman. In that case also, increase in remuneration was held justifiable. We, therefore, hold that it is an allowable deduction under Section 36(1)(ii). The Commissioner (Appeals) had wrongly disallowed the same. We, therefore, set aside the order of the Commissioner (Appeals) and direct the ITO to allow deduction of bonus paid to two directors of Rs. 7,000.
8. The next ground in the assessee's appeal is against the disallowance of Rs. 4,150 paid as membership fees of Shri K.L. Khanna, a director paid to the Golf Club, Chembur.
9. The contention of the learned Counsel for the assessee was that the Tribunal in IT Appeal No. 2706 (Bom.) of 1982 (order dated 19-1-1984) has allowed the deduction of amount spent on life membership of sport club of a managing director of a company while computing the income. On the basis of the ratio of the aforesaid case, membership fees paid to Golf Club, for the directors should be allowed as deduction.
10. As against this, the contention of the learned departmental representative was that joining of club is principally for the purpose of entertainment and amusement. The burden was on the assessee to show how the membership of the club is beneficial to the business of the assessee-company. Personal benefit and recreation of the director has nothing to do with the business of the company.
11. We have considered the rival submissions and have gone through the facts of the case on this point. At the very outset, we would like to mention that there is mentioning of various Tribunal decisions but the learned Counsel for the assessee has produced an extract of the Judgment of Tribunal Bombay Bench 'A' judgment mentioned (supra) in which no full facts have been given. Therefore, it is impossible to apply the ratio of that case in the present case unless full facts and circumstances of that case are available.
12. It is clear that the section itself that the word 'perquisite' includes the value of any benefit or amenity granted or provided free of cost or at concessional rate by the company to any employee, shall be taken as 'perquisite'. Further, any sum paid by the employer in respect of any obligation which would have been payable by the assessee shall be treated as 'perquisite'. The 'perquisite' is defined in the Oxford English Dictionary as 'any casual emolument, fee, or profit, attached to an office or position in addition to salary or wages'. 'Perquisites' denote a personal advantage; it is something that benefits a man by going 'into his own pocket'. (Kanga & Palkhiwala Law and Practice on income-tax Seventh edn., Vol. 1, page 311). To substantiate a claim that Section 17(2)(iii) or (iv) of the Act did not apply, the assessee has to show that the amount he pays towards the entrance fees and subscription is the sum paid necessarily for the performance of his duties as a director and as a member of this club, he has derived any benefit for the business of the assessee-company. If any employee or director of the company is a member of such club for the purpose of his private enjoyment or for recreation, or for partly performance of his employment or office as a director and partly for the purpose of his private enjoyment, namely, facilities provided by the club, this will not mean that the amount spent is necessarily for the performance of his duties and it is beneficial for the purpose of the assessee-company.
13. In common parlance, admission to club is principally for the purpose of private enjoyment, amusement and entertainment because employee of high status in a company is busy in business during the working hours of the company but after that he requires some time for enjoyment and entertainment or amusement where he is not expected to discuss the business matters. In any case, if he became the member of the club, contrary to the presumption of amusement and entertainment and for purpose of promotion of his business, he should lead evidence to show that by his becoming a member of this club, he had gained so much business for the assessee-company.
14. In the case of Brown v. Bullock (H.M. Inspector of Taxes) [1959-65] 40 TC 1 before the High Court of Justice (Chancery Division) where the facts were that the assessee on appointment as manager of a West End branch of a bank, became a member of a West End Club. It was virtually a condition of appointment that a manager should join a club suited to the purpose of fostering local contacts and the bank paid the annual subscription of £21. The appellant was already a member of another club at an annual subscription of £12.12, but some personal advantage from this membership was admitted and the bank paid only one-half of the subscription. The amount paid by the bank was assessed on the assessee under Schedule E of (UK) Income-tax Act, 1952. It was also not disputed that the payments formed part of the emoluments of the office or employment, their Lordships had held that no deduction under paragraph 7 can be allowed.
15. It is pertinent to mention here that in that case, on appointment as manager of the branch of the bank, it was essential that he must foster local contacts and for that he should join the club or clubs best suited for that purpose. Membership of such clubs, was in almost every case, passed from the manager to the succeeding manager as a matter of course. If a prospective manager refused to join a club, his refusal would not be accepted without very good reason, but would necessarily mean that he would lose the appointment. Club membership is virtually a condition or requisite of managerial appointment and it would be unlikely that a manager would be appointed who would refuse to join the appropriate club or clubs. He was expected to be in touch with the members of the club, some of whom, were the customers of the bank.
16. In that case, their Lordships observed that when he visits the club to have lunch there, possibly to entertain customers, he was not really acting in the performance of his duties as manager of the bank. He is no doubt adding to his usefulness as a bank manager and he belongs to the club and attends the club from time to time for the purpose of his position as bank manager. Nevertheless, this expenditure was not exclusively and necessarily made for the performance of his duties as bank manager. In the context, a reference is given of another decision of Vaisey, J. In Lomax (Inspector of Taxes) v. Newton 34 TC 558, the facts of that case were similar to the case discussed above wherein an army officer because of his duties was compelled to sustain the expenditure in question which was obligatory upon him under the conditions in which he served. Their Lordships has held that these expenses are not deductible because they were not incurred for the performance of his duties as an officer in the army. Applying the ratio of the said decisions, we can say that the case of the present assessee is on much lower footing than these two cases. There is no such condition or compulsion in the appointment of director in the present case. Hence, we can hold that the subscription and entrance fees are perquisites in the hands of the assessee.
17. It is obvious that if the assessee was a member of this club, he was the sort of a man who would be acceptable in that sort of social circle and that, no doubt, would be useful to him and to the company because he would thereby meet people who might, as a result of meeting him and liking him, tend to have business relations with him or with the company. But then it was not wholly and exclusively for the business of the company or necessarily for performance of his duties. In that circumstances, heavy burden lies upon the assessee to show that he had never used the club except directly in connection with the company's business and he has to show that he has gained so much business for the company. In the instant case, we find that the assessee has not placed an iota of evidence to show that the company was benefited by his membership in this club. Therefore, we cannot agree with the contention of the learned Counsel for the assessee that the membership of the assessee to this club was in any way beneficial to the business of the company or he has paid subscription and entrance fees, it was incurred for the performance of his duties as a director of the assessee-company.
18. Regarding ratio of the case cited by the learned Counsel for the assessee is concerned, full facts have not been given by the assessee's counsel and, therefore, the ratio of that case, cannot be applied to the facts of the present case. In the circumstances, we are of the opinion that the Commissioner (Appeals) has rightly disallowed the claim of the assessee, on this score.
19. In the result, the appeal of the assessee is partly allowed.
20. As regards the ground in the revenue's appeal, the Commissioner (Appeals), while considering the payment of excess remuneration to the directors have mentioned that the directors were highly qualified persons and they had come to the assessee-company after resigning from Exomet and no increase in pay was given to them for last two and a half years. In addition to that they had devoted extra time to the business of the assessee-company which resulted in an increase in the profits of the company. Therefore, justification given by the company for excess remuneration to the directors is justifiable. We agree with the reasoning given by the Commissioner (Appeals). The department's appeal has no merit and deserve to be dismissed and it is hereby dismissed.