1973 PLP 238 (PTD)

Where therefore, the other conditions are fulfilled the assessee is entitled to pay bonus and claim it as a deduction for the purposes of calculating "profits and gains". S. A. Nusrat for Appellant. Ali Athar for Respondent. Date of hearing : 21st March 1973. FAKHRUDDIN G. EBRAHIM, J.‑On an application made under section 66(1) of the Income‑tax, Act, 1922 by the Commis sioner of Income‑tax Central, Karachi, the Income‑tax Appellate Tribunal, Karachi Bench, Karachi has made this reference to this Court of the following question of law said to arise from the Tribunal's Order dated 3‑2‑1953 in I.T.A. 751/65‑66 in respect of the charge year 1959‑60:‑-- "Whether in the facts and circumstances of the case the Tribunal was justified in holding that the bonus paid to the employees was reasonable with reference to the profits of the business for the years in question within the meaning of para. (b) of the proviso to clause (x) of subsection (2) of section 10 when there was no profit or gain as computed under subsection (2) of section 10 of the Income tax Act, 1922."

2. The facts forming the background to this question are as follows. The respondent is a public limited company which derive income from manufacture and sale of yarn. For the year under consideration, apart from other expenses, it claimed a sum of Rs. 68,510 on account of Bonus paid to its employees at the rate of one month salary to each employee. The returned loss was Rs. 6,54,720.00 which was finally determined by the Income‑tax Officer at Rs, 72,

016. While considering the respondent's claim for Bonus of Rs. 68,510, the Income‑tax Officer observed that this payment could not be allowed as an admissible business expenditure in view of the fact that the three conditions laid down under section 10 (2) (x) of the said Act were not cumulatively fulfilled, specially clause (b) of the proviso to that section which lays down that the payment of Bonus should be a reasonable amount with reference to the profits of the year in question. When the matter went before the Appellate Assistant Commissioner, he found that the returned loss was on account of the claim for depreciation and that after eliminating the same there :could be substantial profits and as such all the three conditions laid down in section 10 (2) (x) were fulfilled. He, accordingly, directed that the entire Bonus payment should be allowed as admissible business expenditure. The Department went in appeal before the Tribunal contending that in the first instance the term profits as used in clause (6) of proviso to section 10 (2) (x) refers to the profits as computed under section 10 of the Income‑tax Act and that is computing this profit depreciation permissible under section 10 (2) (vi) has to be taken into account, and, therefore, the observation of the Appellate Assistant Commissioner that depreciation was to be excluded for determining commercial profits was not correct, Alternatively, it was contented that the resultant profit before adjustment of depreciation would not exceed Rs. 75,000 and the amount of Bonus was out of proportion to these profits which would violate clause (b) of the proviso referred to above. The Appellate Tribunal maintained the decision of the Appellate Assistant Commissioner on the ground that the returned loss ultimately turned out into sufficient profits and the Bonus payments do not appear to be unreasonable with reference to the same. The Tribunal in effect held that in order to arrive at commercial profits of a business the amount of depreciation and Bonus are not to be taken into consideration and looked from that angle the assessee's case in fact represented substantial gains of Rs. 1,43,510.00, from its dealings of the year, and the Bonus paid, considered in the light of this figure of profits, did not appear to be unreasonable. In the statement of the case the Tribunal has reproduced the argument of the Departmental Representative in the following words :‑ "However, the dispute of the Department is, as is apparent from the first argument of the Departmental Representative, that and profits and gains contemplated by para. (b) of the ''` proviso to section 10 (2) (x) of the Act mean profits and gains '" as computed under section 10 (2) and they are obtained only after all the deductions under the later provisions have been allowed and not before as held by the 'Tribunal. This conten tion essentially raises a question of law involving as it does the interpretation of the words 'profits and gains' as used in section 10(2) of the Act, and also whether those words when used in this provision and the aforesaid para. (b) mean the same thing even though the stand now taken is not consistent with the previous treatment given to this case by the Department. We accordingly submit the case as required."

3. Mr. Ali Ather the learned counsel for the respondents contended that the question referred was based on an incorrect assumption that under proviso to clause (x) of subsection (2) of section 10 the existence of profits was a pre‑condition before bonus can be regarded as an item of deductable expenditure, He pointed out that even according to the Tribunal the three considerations, namely, (i) the pay of the employees and conditions of their services, (ii) the profits of the business for the year in question and (iii) the general practice in similar business, for determining the reasonableness of the bonus are to be considered cumulatively and not by reference to only one of them. He contended that all the three factors should at the same time be taken into consideration and it is after such a considera tion that a determination must be arrived at as to the reasonable ness is not to be determined with reference to each one of the aforementioned considerations mentioned in clauses (a), (G) and (c) of the proviso to section 10(2)(x) and that even if the considera tion specified in one of the clauses makes the bonus unreasonable it would not be open to the Department to hold it to be unreason able without taking into consideration other factors, and that it was not a proper and legal approach for determining the reasonableness of bonus to consider one or the two of the three factors mentioned by the Legislature separately without considering all of them together. The learned counsel appeared to me to be right in his interpretation of section 10(2) (x) and it will, therefore. follow that the existence of the profit is not the only factor to be considered in coming to the conclusion whether or not bonus paid was a deductable item of expenditure and it is the cumulative effect of all the three considerations which ` should govern the determination of reasonableness under that clause and, therefore, the test of commercial expediency is strictly germane to the consideration of the reasonableness of the deduc tion claimed for the amount paid out as bonus.

4. The result of the aforesaid discussion, therefore, is that the "profits" of the business for the year in question is one of the three considerations to which the assessing authority will apply its mind in determining whether or not the amount claimed as bonus was reasonable.

5. The next question that arises for determination is the connotation of the word "profits" of the business as appearing in clause (b) of the proviso to section 10(2)(x). Mr. S. A. Nusrat, the learned counsel for the applicant contended that it should be "profits" as computed under subsection (2) of section 10 i.e. assessed income and net profits as ordinarily understood. I am not inclined to agree with the learned counsel for more than one reason. Now the word "profits" has not been defined in the Income‑tax Act. Firstly the word "profits" as occurring in the said proviso must be understood in its context, and that is, in relation to the bonus paid to the employees and the requirement of reasonableness between profits and bonus, including, as aforesaid, commercial expediency. It has also to be understood from the point of view of the employees to whom bonus is payable. Looked at In this context the word "profits" would not be the profits arrived at after deducting depreciation more so, as the Legislature is known to permit substantial depre ciation deductions over and above the normal depreciation to encourage new industries. Such large deductions towards depreciation may result in no taxable income, and not, no profits as contended by Mr. Nusrat and thus depriving the employees of the now well recognised right to share in the profits to which they have, by their labour contributed. If the intention of the Legislature was to give the word "profits" occurring in the proviso a restricted meaning the more appropriate words would have been "taxable income" or "assessed income". The other fallacy in the argument is the assumption that in order that bonus is payable at all, it should be payable if there is a profit even after such payment i.e. if the payment of bonus converts the profit into a loss it is not payable. But this entirely overlooks the fact that for the purpose of determining whether there is a profit, the Income‑tax Act itself makes bonus a properly deductible, item of expenditure. Whatever other consideration may, there‑I fore, properly apply to the payment of bonus, they must be taken into account and the profit then determined after deducting all legitimate items of which bonus is one. Bonus may or may not be an ex gratis payment so far as the worker is concerned (though the point not really arising and not having been argued from that point of view I express no opinion thereon) but the assessee's right to pay it has to be determined, apart from other relevant statutory criteria, upon the existence of profit before bonus is accounted for. Where, therefore, the other conditional are fulfilled the assessee Is entitled to pay bonus and claim it as a deduction for the purposes of calculating "profits and gains".

6. For reasons aforesaid I will answer the questions in the affirmative. The respondents will be entitled to cost of these proceedings. TUFAIL ALI A. RAHMAN, C. J.‑--I agree. Reference answered in affirmative.