Business expenditure: Section 36(1)(ii): A. Y. 2006-07: Commission paid to directors for providing personal guarantee to bank as precondition for grant of credit facilities cannot be disallowed stating that otherwise it would have been payable to the directors as dividend;

In the A. Y. 2006-07, the assessee company had claimed deduction of Rs. 24,37,500/- being commission paid to the directors for providing personal guarantees to the bank for grant of credit facilities to the company. The Assessing Officer disallowed the claim for deduction holding that the same would have been otherwise payable to the directors as dividend. The Tribunal upheld the disallowance. Assessee’s rectification application was rejected by the Tribunal.

The Delhi High Court allowed the writ petition filed by the assessee, reversed the decision of the Tribunal and held as under:

“i) The directors having provided personal guarantees had acted beyond the call of duty as employees of the assessee. It was not within the jurisdiction of the Assessing Officer to impose his views with regard to the necessity or the quantum of the expenditure undertaken by the assessee. The Assessing Officer had only to determine whether the transactions were genuine or real.

ii) The directors would not be entitled to receive the amount paid to them as commission, as dividends because even if it was assumed that non-payment of commission would add to the kitty of distributable profits these would have to be distributed pro rata to all the shareholders and not selectively to the directors. Dividend is paid by a company as distribution of profits to its shareholders in the ratio of their shareholding in the company. The directors were not the only shareholders of the company and, therefore, in the event the commission had not been paid by the assessee it could not have been distributed to them as dividend.

iii) The writ petition is allowed. The said disallowance and the additions made on this count are set aside.”