PETITIONER:
SHAHZADA NAND & SONS
Vs.
RESPONDENT:
THE COMMISSIONER OF INCOME TAX, PATIALA
DATE OF JUDGMENT12/04/1977
BENCH:
BHAGWATI, P.N.
UNTWALIA, N.L.
FAZALALI, SYED MURTAZA
CITATION:
1977 AIR 1182 1977 SCR (3) 529
1977 SCC (3) 432
ACT
Allowable expenditure in computing the profits of the
assessee from business--Whether the commission paid by the
assessee to its employees an allowable expenditure u/s.
36(1)(ii) of Income Tax Act.
HEADNOTE
The appellants were the sole selling agents of the
Oriental Carpet Manufacturers India Pvt. Ltd. in respect
of yarn, cloth and blankets manufactured by them and for the
sales effected by the appellants, as such sole selling
agent’s commission was paid to them by OCM. Since the
appellants showed very satisfactory turnover from year to
year, OCM started giving to them, in addition to the usual
commission, over-riding commission @ 21/2 per cent on the
sales effected by the appellants. Since the turnover of the
sales reached the figure of Rs. 54.28 lacs and over-riding
commission increased to Rs. l,13,449/ during the previous
year corresponding to the assessment year 1963-64, the
appellants paid out of the over-riding commission received
by them a sum of Rs. 22,690/- (i.e. at the rate of 1/2% of
the sales) each to two of their employees viz., Saheb Dayal
and Gurditta Mall since they were primarily responsible for
the increased prosperity of the appellants. The commission
so paid viz. Rs. 45,380/- was claimed by the appellants as
a deductible expenditure in their assessment to income tax
for the assessment year 1963-64. The Income Tax Officer
disallowed the claim on the ground that there was no evi-
dence to show that the increase in sales during the relevant
accounting year was due to the efforts of Saheb Dayal and
Gurditta Mal. The Appellate Assistant Commissioner rejected
the appeal preferred to him and held that since no evidence
had been produced by the assessee to prove that the activi-
ties of Saheb Dayal and Gurditta Mal in the relevant account
year were of a nature different from those: in the earlier
years so that they put in any extra time or energy in the
conduct of the business of the assessee so as to justify the
payment of the commission, it could not be said that the
commission was paid for services rendered by them. The
Tribunal, in further appeal took the same view and held that
since there was no proof to show that any extra services
were rendered by Saheb Dayal and Gurditta Mal for which
payment of commission in addition to salary and bonus could
be justified, commission could not be said to have been paid
for services-rendered so as to attract the applicability of
s. 36(1)(ii) of the Act. The High Court was also of the same
view and answered the reference made to it, in favour of the
Revenue.
Allowing the appeal by special leave, the Court,
HELD: (1) The sum of Rs. 45,380/- paid by the assessee
to Saheb Dayal and Gurditta Mal by way of commission during
the ’relevant accounting year was reasonable, having regard
to all the circumstances of the case and it ought to have
been allowed as a deductible expenditure u/s. 36(1)(ii) of
the Income Tax Act. [537 B]
(2) Section 36, sub-section (1) clause (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. What it requires, is
only this, namely, that commission paid to an employee
should be for some services rendered by him. It is not
necessary that the commission should be paid under a con-
tractual obligation. It may be purely voluntary.
(3) It is immaterial that the services rendered during
the relevant accounting year were in no way greater or more
onerous than the services rendered in the earlier years.
There is no such requirement under the section and it is not
justified by the language of s. 36, sub-section(l), clause
(ii) and indeed if it were pushed to its logical extreme,
even payment of bonus cannot be treated as permissible
deduction under that provision. [534 G-H]
530
(4) It is now well-settled that the mere fact that
commission is paid exgratia would not necessarily mean
that it is unreasonable. Commercial expediency does not
mean that an employer should not make any payment to an
employee unless the employee is entitled to it under a
contract. 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 self-interest 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., as part of it should in all fairness go to
the employees. [536 E-G]
(5) The question whether commercial expediency justified
the payment of commission would have to be judged in the
light of. all the circumstances existing at the material
time. In the instant case, the assessee felt, on grounds of
commercial expediency that a part of the over-riding commis-
sion should be raid besides salary and bonus to its two
employees who had worked so well and contributed to the
prosperity of the assessee and did make the payment. [525
AB]
Laxmandas Sejram v. C.I.T. Gujarat 50 ITR 789 (Gujarat)
approved.
(6) The question whether the amount of the commission is
a reasonable amount or not has to be determined with refer-
ence to the three factors laid down in s. 36(1)(ii). Though
described loosely as conditions, they are not really
conditions on the fulfilment of which alone the amount of
commission paid to an employee can be regarded as reasona-
ble. The reasonableness of the amount of commission has to
be considered from the point of view of a normal, prudent
businessman, and not on any subjecting standard of the
assessing authority. [525 C-D]
Observation:
It is high time that the administration of our tax law
recognised the demand of social justice today viz., profit-
sharing by the employees and encouraged it by adopting a
progressive and liberal approach in the applicability of s.
36, subsection (1), clause (ii). [536 H]
JUDGMENT
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1011 of
1972.
Appeal by Special Leave from the Judgment and Order
dated the 18th August, 1971 of the Punjab and Haryana High
Court in Income Tax Reference No. 17 of 1971.
S. T. Desai, (Mrs.) A.K. Verma and Shri Narain for the
Appellant.
T.A. Ramachandran and R.N. Sachthey for Respondent.
The Judgment of the Court was delivered by
BHAGWATI, J.--The short question that arises for
determination in this appeal is whether certain commission
paid by the assessee to two of its employees is an allowable
expenditure in computing the profits of the assessee from
business. The assessee is a registered firm which at all
material times consisted of five partners, namely, Chaman
Lal, Madan Lal, Harbans Lal, Raj Mohan and Saheb Dayal
representing a trust. Chaman Lal was the son of Saheb Daval
and Raj Mohan was the son of one Gurditta Mal. During the
accounting year relevant to the assessment year 1963-64,
Chaman Lal and Harbans Lal had their own independent
factories and hence they were not attending
531
to the business of the assessee and Raj Mohan too was not
actively associated with the conduct of the business of the
assessee as he was working with the Oriental Carpet Manu-
facturers India Pvt. Ltd. (hereinafter referred to as
OCM). Thus, from amongst the partners, only Madan Lal was
looking after the day-to-day management of the business-of
the assessee and he was assisted by Saheb Dayal and
Gurditta Mal who were engaged as employees of the assessee.
Saheb Dayal and Gurditta Mal were .looking after the busi-
ness of the assessee since a long time and they were each
paid remuneration of Rs. 1000/per month. The business of
the assessee consisted of sole selling agency of OCM in
respect of yarn, cloth and blankets manufactured by OCM and
for the sales affected by the assessee as such sole selling
agents, commission was paid to the assessee by OCM. The
figures show that the business of the assessee prospered
from year to year from 1959-60 onwards and there was a
gradual increase in the turnover of the assessee which
jumped from the figure of Rs. 39.99 lacs for the assessment
year 1962-63 to the figures of Rs. 54.28 lacs for the as-
sessment year 1963-64. Since the assessee showed very
satisfactory turnover from year to year, OCM started giving
to the assessee, in addition to the usual commission, over-
riding commission at the rate of 21/2% on the sales affected
by the assessee and the. over-riding commission thus re-
ceived by the assessee during the previous years correspond-
ing to the assessment year 1960-61 to 1963-64 was as fol-
lows:
Assessment year Amount Received
1960-61 Rs. 35,964/-
1961-62 Rs. 61,818/-
1962-63 Rs. 83,922/-
1963-64 Rs. 1,13,449/-
Since the turnover of the sales reached the figure of Rs.
54.28 lacs and overriding commission increased to Rs.
1,13,449/- during the previous year corresponding to
the assessment year 1963-64, the assessee decided to
give to each of Saheb Dayal and Gurdita Mal, who were look-
ing after the business and were primarily responsible for
the increased prosperity of the assessee, commission at the
rate of 1/2% of the sales out of 21/2% overriding commis-
sion received from OCM and each of these two employees was
accordingly paid by the assessee a sum of Rs. 22,690/- by
way of commission. The aggregate amount of commission paid
to Saheb Dayal and Gurditta Mal thus came to Rs. 45,380/-
and this amount of commission was claimed by the assessee as
a deductible expenditure in its assessment to income tax for
the assessment year 1963-64. The Income Tax Officer, disal-
lowed the claim of the assessee on the ground that there was
no material produced by the assessee which would "prove the
nature of services rendered by these two gentlemen in lieu
of which the commission is claimed to have been paid" and
there being no evidence to show that the increase in sales
during the relevant accounting year was due to the efforts
of Saheb Dayal and Gurditta Mal, the claim for deduction of
the amount of commission as a business expenditure remained
unproved. The assessee appealed against the disallowance of
the amount of commission but the Appellate Assistant Commis-
sioner in appeal affirmed the disallowance on the ground
that no evidence had been
532
produced by the assessee to prove that the activities of
Saheb Dayal and Gurditta Mal in the relevant account year
were or a nature different from those in the earlier
years or that they put in any extra time or energy,in the
conduct of the business of the assessee so as to justify the
payment of the commission and hence it could not be said
that the commisson was paid for services rendered by them.
The matter was carried in further appeal before the Tribu-
nal, but the Tribunal also took the same view and held that
since there was no proof to show that any services were
rendered by Saheb Dayal and Gurudayal Mal for which payment
of commission in addition to salary and bonus could be
justified, commission could not be said to have been paid
for services rendered so as to attract the applicability of
section 36, subsection (1 ) clause (ii). The Tribunal ob-
served that it was not possible to say "that the increase in
the turnover in the year under appeal was due to the extra
efforts put in by these two employees or that the employees
had worked in the hope of receiving extra commission" and
since bonus equivalent to three months’ salary was paid to
saheb Dayal and Gurditta Mal in addition to their salary
during the relevant accounting year, any extra services
rendered by them, if any, "should be deemed to have been
covered by the payment of this bonus" Since in the view
taken by the Tribunal it was necessary that there should be
some extra services rendered by Saheb Dayal and Gurditta Mal
for which payment of commission could be said to be justi-
fied and there was nothing to show that any such extra
services were rendered by them, the Tribunal came to the
conclusion that the payment of commission could not be said
to be justified on grounds of commercial expediency and
section 36, sub-section (1), clause (ii) had no application.
The assessee being aggrieved by the order made b the tribu-
nal applied for a reference of the question of law arising
out of the order of the Tribunal and on the application of
the assessee, the following question of law was referred
for the opinion of the High Court:
"Whether on the facts and circum-
stances of the case the sum of Rs. 45,380/-
paid to L. Gurandittamal and L. Sahebdiyal,
employees of the applicant firm is permissi-
ble deduction in computing the business
income of the applicant ?"
The High Court answered the question in favour of the
Revenue. The view taken by the High Court was that in order
to attract the applicability of section 36, sub-section
(1), clause (ii), it was necessary that the payment of
commission should be for services rendered and since there
was no evidence led on behalf of the assessee to show that
any extra services were rendered by Saheb Dayal and Gurditta
Mal, which were responsible for increase in the sales and
consequent enlargement of the overriding commission, there
was no justification for payment of commission to them and
the commission paid could not be said to be for services
rendered. The High Court in this view held that section 36,
sub-section (1), clause (ii) was not applicable and no claim
for deduction could be sustained under it. The correctness
of this decision is impinged in the present appeal preferred
by the assessee with special leave obtained from this Court.
533
Now, before we proceed to consider, the question which
arises for determination before us, we must make it clear at
the out set that m the present case the genuineness of the
payment of commission made to Saheb Dayal and Gurditta Mal
was at no time doubted by the Revenue authorities. It was
not the ease of the Revenue that this payment was not made
or that it was sham or bogus. If that had been the finding,
there would have been an end of the case of the assessee. No
question would then have arisen for considering the applica-
bility of section 36, sub-section (1), clause (ii). No
payment having been made, no deduction would have been
permissible. But here the commission was paid: it was a
genuine payment and the only question was whether it was
deductible as an allowable expenditure under section 36,
sub-section (1), clause (ii). Section 36, sub-section (1)
provides for making of various deductions in computing the
income of an assessee under the head: "Profits and Gains
of Business or Profession" and one such deduction is set
out in clause (ii) which, as it stood at the material time
during the assessment year 1963-64, read as follows:
"36(1)(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 profit or dividend if it had not been
paid as bonus or commission:
Provided that the amount of bonus or
commission is reasonable with reference to-
(a) the pay of the employee and the condi-
tions of his service;
(b) the profits of the business or profes-
sion for the previous year in question; and
(c) the general practice in similar busi-
ness or profession."
Saheb Dayal and Gurditta Mal were admittedly employees of
the assessee. They were each paid a salary of Rs. 1000/-
per month and for the previous year relevant to the assess-
ment year 1963-64 bonus equivalent to three months’ salary
was also paid to each of them. The income Tax Officer disal-
lowed even this salary and bonus paid to Saheb Dayal and
Gurditta Mal on the ground that there was nothing to show
that any services were rendered by them and the payment of
salary and bonus appeared to be ex-gratia. But this deci-
sion was reversed in appeal by the Appellate Assistant
Commissioner who, following his earlier order dated 12th
December, 1967 in the appeal against the assessment to tax
for the assessment year 1962-63, allowed the payment of
salary and bonus as a deductible -expenditure. The Appel-
late Assistant Commissioner c:early recognised that
Saheb Dayal and Gurditta Mal were employees of the assessee
and were attending to the business of the assessee as such
employees since a long time and Gurditta Mal was in fact
"a seasoned and experienced businessman" and he looked after
the assessee’s transactions with OCM and on behalf of ’he
assessee advised OCM in connection with designs etc. The
Tribunal also found that Saheb Dayal and Gurditta Mal
534
"were looking after the business of the assessee firm for
a long time". Thus, there can be no doubt that services
were rendered by Saheb Dayal and Gurditta Mal to the asses-
see and for these services, besides Salary and bonus, com-
mission was paid to them, because, according to the asses-
see, during the relevant accounting year, there was consid-
erable enlargement in the turnover of the sales with
consequent increase in the amount of overriding commis-
sion and the assessee felt, on grounds of commercial
expediency, that a part of the overriding commission should
be paid to the two employees who had worked so well and
contributed to the prosperity of the assessee. The question
is whether this commission qualifies for deduction as an
allowable expenditure under section 36, sub-section (1),
cause (ii).
The only ground on which the High Court negatived the ap-
plicability of section 36, sub-section (1), clause (ii) was
that during the relevant accounting year Saheb Dayal and
Gurditta Mal rendered the same services which they were
rendering in earlier years and no extra services were ren-
dered by them which could justify payment of commission in
addition to salary and bonus. The High Court appeared to
take the view that there must be correlation between the
payment of commission and the services rendered and since
commission was paid by the assessee for the first time
during the relevant accounting year, there must be some
extra services rendered by Saheb Dayal and Gurditta Mal in
that year over and above the usual services rendered by
them in the earlier years. Since, according to the High
Court, there was no proof that any extra services were
rendered by Saheb Dayal and Gurditta Mal, the High
Court held that the payment of commission could not be
said to be for services rendered within the meaning of
section 36, sub-section (1), clause (ii). This view taken
by the High Court is, in our opinion, plainly erroneous.
Section 36, sub-section (1 ), clause (ii) does not postulate
that there should be any extra services rendered by an
employee before payment of commission to him can be justi-
fied as on allowable expenditure. What it requires is only
this, namely, that commission paid to an employee should
be for services rendered by him. For example, if an employ-
ee has not rendered any services at all during the relevant
accounting year, no commission can be paid to him which
would be an allowable expenditure. There must be some
services rendered by an employee and where commission is
paid for the services so rendered, section 36 sub-section
(1), clause (ii) would apply and the commission to the
extent to which it is found reasonable would be an allowable
expenditure under that provision. It is not necessary that
the commission should be paid under a contractual obliga-
tion. It may be purely voluntary. But it must be for
services rendered and here services were in fact rendered by
Saheb Dayal and Gurditta Mal during the relevant account-
ing year. It is true that the services rendered by
these two employees during the relevant accounting year were
in no way greater or more onerous than the services ren-
dered by them in the earlier years, but that is immaterial.
There is no such requirement and the argument based on it
cannot be sustained. It is not justified by the language
of section 36. sub-section (1), clause (ii) and indeed, if
it were pushed to its logical extreme, it would be difficult
to support even payment of bonus as a permissible deduction
under that provision. Of course. the circumstance that no
additional services are rendered
535
by an 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 circum-
stances and the question whether commercial expediency
justified the payment of commission would have to be judged
in the light of all the circumstances existing at the mate-
rial time. This was the view taken by the Gujarat High
Court in Laxmandas Sejram v. Commissioner of Income-
Tax, Gujarat, (1) and we wholly accept that view. It is,
therefore, no answer to the applicability of section 36,
sub-section (1), clause (ii) to say that no extra services
were rendered by Saheb Dayal and Gurditta Mal during
the relevant accounting year. The amount of commission
having been paid for services admittedly rendered by
them, the only question would be whether it was reasonable
under section 36, sub-section (1), clause (ii).
Turning to the provisions of section 36, sub-section
(1), clause (ii), we find that the proviso to that clause
lays down three factors for the purpose of determining the
reasonableness of the commission paid to an employee. The
question whether the amount of the commission is a reasona-
ble amount or not has to be determined with reference to
these three factors. Sometimes these three factors are
loosely described as conditions but they are not really
conditions on the fulfilment of which alone the amount of
commission paid to an employee can be regarded as reasona-
ble. They are merely factors to be taken into account by
the Revenue authorities in determining the reasonable-
ness of the amount of commission. It may be that one of
these factors yields a negative response. To take an exam-
ple, 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 reasona-
ble. What the proviso requires is merely that the reason-
ableness 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 those factors has to be
judged not on any subjective standard of the assessing
authority but from the point of view of commercial expedien-
cy. Let us see whether the amount of commission paid to
Saheb Dayal and Gurditta Mal in the present case can be said
to be reasonable from this stand point. It is clear from
the order of the Tribunal that reliance was placed by the
Tribunal mainly and substantially on the fact that the
nature of the work done by Saheb Dayal and Gurditra Mal
remained unchanged in the relevant accounting year and there
was nothing to show that the increase in the turnover during
the relevant accounting year was as a result of any extra
efforts made by these two employees and hence it could not
be said that there were any special circumstances which
warranted the payment of commission to them. But, as al-
ready pointed out above the commission aid to an employee
cannot be branded as unreasonable merely because the employ-
ee has done m the relevant accounting year the same work
which he was doing in the earlier years. Even where the
nature of the work has remained the same, commercial expedi-
ency may require payment of commission to an employee.
Here, Saheb Dayal and Gurditta
(1) 50 I.T.R. 763.
536
Mal were each receiving a salary of Rs. 1000/- per month and
besides this salary, there were admittedly no other perqui-
sites given to them. They were the persons attending to the
business of the assessee and in fact Gurditta Mal was an
experienced and seasoned businessman and it was he who was
advising OCM in regard to designs etc. and he and Saheb
Dayal were primarily responsible for the flourishing state
of the business. The turnover of the sales of the assessee
steadily rose from 1960-61 and in the relevant accounting
year, it reached the exciting figure of Rs. 54.28 lacs. So
also the overriding commission which started with the modest
figure of Rs. 35,964/- in the accounting year relevant to
the assessment year 1960-61 went on steadily increasing
from year to year until it reached the figure of Rs.
1,13,449/-in the relevant accounting year. The assessee,
therefore, felt that in view of the tremendous progress in
the business which was largely the result of the services
rendered by Saheb Dayal and Gurditta Mal, apart of the
overriding commission should be paid to them, so than they
may carry a sense of satisfaction that their efforts have
been suitably rewarded and they may have an added incentive
to work and may be spurred to greater efficiency in the
future. It may be noted that the overriding commission of
the assessee during the relevant accounting year was Rs.
1,13,449/- and the total profit was Rs. 3,08,034/- and if
out of this total profit of Rs. 3,08,034/-, an aggregate
sum of Rs. 45,380/- was paid to Saheb Dayal and Gurditta Mal
as commission, it is difficult to see how such payment
could be regarded as unreasonable. It is true that there
was no obligation on the assessee to make payment of this
commission to Saheb Dayal and Gurditta Mal, but it is now
well settled that the mere fact that commission is paid ex-
gratia would not necessarily mean that it is unreasona-
ble.Commercial expediency does not mean that an employer
should not make any payment to all employee unless the
employee is entitled to it under a contract. Even where
there is no contract, an employer may pay commission to an
employee if he thinks that it would be in the interest of
his business to do so. It is obvious that no business can
prosper unless the employees engaged in it are satisfied and
contented and they feel a sense of involvement and identifi-
cation and this can be best secured by giving them a stake
in the business and allowing them to share in the prof-
its. It would indeed be a wise step on the part of an
employer to offer incentive to his employees by sharing a
part of his profits with them. This would not only be good
business but also good ethics. It would be in consonance
with Gandhian concept as also modern socialistic thought
which, with its deeply rooted faith in social and economic
democracy, regards; the employees as much as the employer
as co-sharers in the business. If an employer earns profits
to which the employees have necessarily contributed by
putting in their labour, there is no reason why the
employer should not share a part of these profits with the
employees.That is the demand of social justice today and it
is high time that the administration of our tax law recog-
nised it and encouraged sharing of profits by employers with
employees by adopting a progressive and liberal approach in
the applicability of section 36, sub-section (1), clause
(ii) What is the requirement of commercial expediency must
bejudged not in the light of the 19th Century laissez faire
doctrine which regarded man as an economic being concerned
only to protect and
537
advance his serf-interest but in the context of current
socio-economithinking which places the general interest of
the community above the personal interest of the individu-
al 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. We are, there-
fore, of the view that the sum of R.s. 45,380/- paid by
the assessee to Saheb Dayal and Gurditta Mal by way of
commission during the relevant accounting year was reasona-
ble having regard to all the circumstances of the case and
it ought to have been allowed as a deductible expenditure
under section 36, sub-section (1), clause(ii).
We accordingly allow the appeal, set aside the judgment of
the High Court and answer the question referred by the
Tribunal in the affirmative in favour of the assessee. The
Commissioner will pay the costs of the appeal as also of the
reference to the assessee.
S.R. Appeal allowed.
538