MUHAMMAD ZAHOORUL HAQ, J.- 1. The following question has been referred to us under Section 66(1) of the Income-tax Act:- "Whether in the circumstances of the case the sum of Rs. 4,500 paid as bonus to the shareholder employee of the assessee-Company is allowable as deduction under the provisions of Section 10(2)(x) of the Income-tax Act?".
The material facts are that the applicant is a private Limited Company and it had paid bonus to its employees. The Managing Director was paid Rs. 4,500 which was a sum equal to his three months salary. The I.T.O, disallowed the claim of bonus paid to the Managing Director for the assessment year 1967-68. The appellate Tribunal upheld the order of the I. T.O. The applicant company had relied upon the case of Loyal Motor Service Co. v. Commissioner of Income-tax, Bombay (1946) 14 1 T R 647, but the Tribunal followed its own judgement in the previous case of the same company (1969) 19 Taxation 84 where they had disagreed with the view in (1946) 14 ITR 647. In that case it was observed that the bonus paid to the Managing Director, if it had been so disbursed, a part of it or whole of it would have been receivable by the Managing Director as dividend and in such an event the second half of clause (x) of Section 10(2) of the Income-tax Act set up a clear bar to the allowance provided in the first half thereof. The Tribunal had further observed that in their view the second half of the clause completely negative the claim of bonus payment when made to persons entitled to receive profits or dividend. They had argued that if bonus payments are allowed to the recipients of profits or dividend, then by the device of this payment, if not the whole, bulk of the income can be washed of for the purposes of the tax.
2. It had been argued before the Tribunal that the Managing Director was holding only 185 out of 1,000 shares of the Company and as such he could not be entitled to as high a sum of dividend as the bonus payment of Rs. 4,500 calculated on the basis of his three months salary and hence the amount should be deducted as an expense.
3. It would be relevant to refer to Paper Book where it has been stated on page 11 in the statement of the case submitted by the applicant-Company before the Tribunal that Mr. Saleemuddin, Director employee of the Private Limited Company was paid three months salary by way of bonus together with other employees over and above their emoluments. This position has not been denied nor controverted in the statement of the case sent to us by the Tribunal. The reference itself in its appendix refers to reference application Exh. 'D' and mentions in the reference that the documents mentioned in the appendix will form part of the Paper Book and hence we can legitimately refer to page 11 of the Paper Book.
4. To appreciate the question sent to us it would be relevant to refer to Section 10(2)(x) of the Income-tax Act which has to be interpreted by us in context with the facts disclosed above:- "10(2) subject to the provisions of this Act, such profits or gains shall be computed after making following allowances, namely:- 1 to IX........................................................................
(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; provided that the amount of the bonus or commission is of a reasonable amount with reference to (a) (b) (c) etc "
The purport of the view taken by the appellate Tribunal appears to be that in case an employee is a shareholder of the Company and is, therefore, entitled to seek profits or dividend of the Company, then any bonus paid to him should not be allowed to be deducted as an expense. The appellate Tribunal has not agreed with the view expressed in AIR 1944 Bom. 15 on the ground that if such view was adopted then the bulk of the income can be washed of for the purpose of the tax.
5. In that Bombay judgement clause (x) of Section 1CK2) was interpret- ted in the following manner by Stone, C. J.:- "Now the answer to the question referred to us depends on the construction that is to be placed upon para, (x) of sub-section (2) of Section 10. It should be noted that the body of this sub-section provides an allowance and the qualifying part of it is by way of exception of that allowance. What is to be allowed is "any sum" paid to an employee as bonus or commission for services rendered and the exception, where "such sum" would not have been paid to him as profits or dividends if it had not been paid as bonus or commission, In the exception the words "such sum" can, in my opinion, only refer to the last and the only antecedent which is "any sum" paid as commission or bonus.
Therefore, unless the commission or bonus would be paid to the assessee as profits or dividends the exception to the allowance does not operate."
His Lordship has further observed as under:- "We are construing a taxation statute and the subject is entitled to have such a statute strictly construed in his favour. In my opinion in placing a strict construction on this sub-section, the sum excepted under the expression "such sum" must be the same sum as is described by the expression "any sum paid as bonus Or commission", and that an equivalent sum even in the 2 cases where by accident the bonus and the prospective dividend are that same, is not included in that construction." . _ In the same judgement Kania, J. Had observed as under:- "The word "such" must refer to what had been previously mentioned in the same clause, in connection with the word "sum". To find that out we must look to the first part of the clause. That refers to "any" sum. Reading the clause in that way the plain meaning appears to be that when a particular amount' was paid by way of bonus to an employee, if the same amount would have been paid to him as a shareholder as dividend or profit, the Company cannot be allowed a deduction on the ground of payment of bonus. To put it in other words the clause is intended to prevent an escape from taxation by describing payment as bonus, when in fact ordinarily it should have reached the shareholder as profit or dividend. The argument would be equally applicable in the case of a partnership as in the case of a Limited Company. This construction leads to no hardship. It does not allow a wrong payment of bonus to escape taxation, In the first instance, the bonus in the hands of the employee is liable to be taxed, unless exempted by a special notification.
Moreover, the proviso contains conditions under which if a wrong claim is made, the same can be investigated and disallowed."
With respect we agree with the view adopted by the Bombay High Court in this respect. The language of clause (x) of Section 10(2) of Income Tax Act, 1922 clearly stipulates that the payments of bonus to the employees are deductible items. The exception is that this sum paid to an employee would not have been payable to him as profits or dividend if it has not been paid as bonus or commission and, therefore, merely because an employee is shareholder in a Company and is entitled to receive some amount on that basis, this would not be enough to attract the exception. It is an admitted position that a Managing" Director of a Company can be an employee of the Company of which he is a Managing Director and if authority is needed then reference be made to (1947) 14 ITR 606 where a Division Bench of Bombay High Court held that a Director of the Company as such is not a servant of the Company but that does not prevent a Director or a Managing Director from entering into a contractual relationship with the Company, so that, quite apart from his office of Director he becomes entitled to remuneration as an employee of the Company. Therefore, the position that emerges is that a Managing Director of the Company can be an employee of a Company and as such the bonus or commission which is paid to him for the service rendered, which bonus is proportionate to that of the other employees of the Company, would attract the application of the first part of clause (x) of Section 10(2). In the present case before us no one has alleged that the other employees of the Company were not paid similar bonus of three months salary which was paid to their Managing Director by this applicant and therefore, bonus had been paid by the applicant to all the employees including the Managing Director and hence ordinarily it should be treated as a deductible item. It has not been established before us that the sum of Rs. 4,500 would have been payable to the Managing Director as profits or dividend in this case and therefore, the exception part of clause (x) is not attracted.
6- Mr. Waheed farooqui wanted us to construe the words "any sum" and "such sum" in clause (x) as referring to the nature of payment and not to the quantum of payment made to an employee. We do not find any justification to treat these phrases as referring to the nature of payment. This construction would not be in consonance with the apparent meaning of these expressions. The same appears to be referring to the quantum of payment and not in the nature of payment.
Consequently we are of the opinion that even those employees who are entitled to share in the profits or dividend of the assessee can be paid bonus as employees if they are actually employee of the assessee and the payments of the bonus made to them is not such which would have been paid to them as profits or dividend.
7. In fact we are of the view that the said clause (x) does not make any distinction between different type of employees and it treats the shareholder employees and non-shareholder employees in the same position. But it only provides one safeguard against the misuse of the provision of clause (x) by providing that if any amount is paid to an employee as bonus, and the same is only a substitute to change the nature of profits or dividend into a bonus and is thus the device to escape the payment of tax, then alone deduction would not be allowed to be made. We are clear in our mind that if there are a good number of employees in the firm or Company and every one of them is being paid a bonus similar to the bonus paid to a shareholder employee then, merely because a shareholder employee is entitled to receive some profits as well, this alone would not be sufficient to disentitle the Company or firm from claiming the deduction in respect of bonus paid to such an employee.
8. In this respect it would be useful to take into consideration the present trend in social legislation that every employee is being encouraged to become a shareholder in the Company which employs him. If every one of the employees takes nominal 5 to 10 shares in the Company and becomes a shareholder employee then, by the reasoning of the appellate Tribunal, the bonus paid to every one of such shareholder employees would become a nondeductible item which would ultimately lead to non-declaration of bonus for the employees and would be destructive of social justice. Merely because a shareholder employee holds 5 shares of Rs. 10 each for which he would be paid a maximum profit of between 5 and 10 rupees would not be enough to disentitle the Company from claiming deduction in respect of the bonus of three months salary paid to the shareholder employee which would, according to present day rates of salary, would be about at least Rs. 2,100. We are, therefore, of the view that the Appellate Tribunal should have followed the cited Bombay judgement in AIR 1947 Bom 15. We may point out here that specially in the Province of Sind the judgements of the Bombay High Court were entitled to respect before partition. We would observe that the income-tax provisions have to be construed and should be interpreted in a manner which is more favourable to the subject. The language of the clause being clear it was not open to the appellate tribunal to take a view of the clause which was more favourable to the State merely on the consideration that if such an interpretation was followed then the bulk of the income was to be washed of. We may observe here that the Appellate Tribunal or the Courts can hardly assume themselves the position of saving the income from escaping assessment. That jurisdiction vests in the Legislature and those problems are, therefore, really for the Legislature to solve and not for the Courts and Tribunals to worry about. We, therefore, answered the question in the affirmative by a short order dated 9-1-1984 and these are the reasons for the same.