Income Tax Appellate Tribunal - Bangalore
S.K. Engineering vs The Joint Commissioner Of Income Tax ... on 2 August, 2005
Equivalent citations: [2006]103ITD97(BANG), [2006]286ITR210(BANG), (2006)104TTJ(BANG)764
ORDER
Deepak R. Shah, Accountant Member
1. This appeal by assesseee is directed against the order of learned CIT(A)-IV, Bangalore dated 13.12.2001.
1.1 The only ground of appeal is against disallowance of commission paid to one Mr. SK Sharma, who is the husband of one of the partners of assessee firm. The disallowance is made invoking the provisions of Section 40A(2) of the Act.
2. The appellant is a manufacturer of automobile and engineering components. The appellant firm has two partners, who are females. Shri SK Sharma, the husband of one of the partners, is-an ex-employee of MICO Ltd. He retired from MICO as Senior Vice President in the year 1995. After his retirement, he is serving with the appellant firm. As per the submission by assessee, Shri SK Sharma is a qualified technocrat, past Chairman of Confederation of Indian Industry (Southern Region), past President of Greater Mysore Chamber and Industry and has very wide business contacts, particularly in automobile industry. During the year, apart from the salary of Rs. 60,000/- and conveyance charges of Rs. 24,000/-, Mr. Sharma was also paid commission at the rate of 2.5% of total sales turnover. The Assessing Officer noted that the commission is excessive and unreasonable. He accordingly asked the assessee to show cause as to why the disallowance should not be made in terms of Section 40A(2). The assessee replied that Shri Sharma is highly qualified man and was holding important offices, Shri Sharma rendered the services like procuring orders, follow-up approval, collection etc. It was also explained that due to his high offices held at MICO, he has good relation with other customers also. The payment is absolutely necessary and legitimate. Because of his services, much more benefit has been derived by the firm. Since Mr. Sharma wielded lot of influence on the customers, the firm is getting orders even under difficult and competitive business environment. Apart from the duties that he was earlier carrying on, this year he is also undertaking additional responsibilities such as recovery and approved credit lines etc. The turnover has increased from 424 lakhs to 513 lakhs. All this justifies payment of commission at 21/2%. It was also submitted that the appellant firm is in high tax bracket as well as Mr. Sharma in his individual capacity, is also in the highest tax bracket applicable to individuals. Thus, the commission is not merely to avail any tax advantage but only because of the business expediency and legitimate needs. The AO negatived the contention and held as under:
It appears from the records that in the immediately preceding year, a commission of only Rs. 4 lakhs was paid to Sri Sharma on a total turnover of the assessee at Rs. 4,24,04,012/-. The percentage of commission in the said year works out at 0.9470. During the year, the total turnover including scrap sales has gone upto Rs. 5,13,13,656/-. Going by the standard in the assessee's own case, the commission for the year should have been Rs. 4,82,348/- for the current year. The assessee could not bring forth any additional material justifying the reasons for paying commission to the extent of Rs. 12,83,222/- i.e. almost Rs. 8 lakhs more than what could justifiably be paid by the firm.
The arguments that the recipient of the commission is paying more tax at a rate higher than that paid by the firm is also not correct. In fact, Sri Sharma, the recipient of the commission has claimed substantial expenditure against earning of such commission and paid tax only on the net amount. That apart, the provision contained in Section 40A(2) is a self-contained provision. The fact that Sri Sharma is paying tax on the commission earned cannot act as a deterrent for not invoking the provisions of Section40A(2).
In view of the facts stated above and under the circumstances, it is held that commission paid to Sri Sharma now is unreasonable and in excess of legitimate amount payable to him. The quantum of excess commission is Rs. 8 lakhs which will be disallowed Under Section 40A(2)(a).
Before the Commissioner, similar arguments were reiterated. Learned CIT(A) upholding the disallowance, held as under:
It is a fact that Sri SK Sharma is a highly qualified man who held different posts including Senior Vice President of MICO. The assessee has contended that their firm had sold a considerable amount of its products to MICO for which Sri Sharma was mainly responsible and they would have had to pay tax at the rate of 26.25% while Sri Sharma in his individual capacity has paid tax at the rate of 30% on the commission received by him. I do not agree with the contentions of the assessee. The reasonableness of any expenditure is to be judged having regard to the services for which the payment is made or the legitimate needs of the business or profession or the benefit derived by the taxpayer from the expenditure. No evidence has been given in support of the contention that Sri Sharma who retired as Vice President of MICO was the main reason for procuring the order from the said company. Assuming for a minute that the assessee has made a statement of fact it is noticed that in the previous year a commission of 0.94% was paid to Shri Sharma. In the year under consideration the total turnover including scraps has gone up by Rs. 5,13,13,656/-. Keeping in mind the commission paid in the previous year an amount of Rs. 4,82,348/- would be considered as reasonable for the year under consideration. Hence the assessee has paid commission of almost Rs. 8 lakhs more than could have justified by the firm. There is no justification whatsoever for the steep increase in the rate of commission paid from 0.94% in the previous year to nearly 2.5% in the year under consideration. The argument about Sri Sharma paying more proportionate tax than the firm is not acceptable factually because he has claimed substantial expenditure against the earning of such income and paid tax only on the net amount. Hence, as per provisions of Section 40A(2) this amount of excess commission of Rs. 8 lakhs has rightly been disallowed by the Assessing Officer under the provisions of Section 40A(2) of the IT Act.
2.1 Learned Counsel for assessee Shri K. A. Hemraj reiterated the arguments placed before the AO. He further submitted that before disallowing the sum Under Section 40A(2), the AO has to satisfy that the amount paid is excessive or unreasonable having regard to the fair market value of services. Since the AO has not worked out what is the, fair market value of services rendered, disallowance Under Section 40A(2) is not called for. It was also submitted that it is not found that the payment is not made towards legitimate needs of the business. No comparable cases have been cited. He further invited our attention to the decision of Hon'ble Supreme Court in the case of Shahzada Nand and Sons v. CIT 108 ITR 358. Shri Hemraj further submitted that the reasonableness of the payment is to be judged from the point of view of businessman and not by the viewpoint laid by the AO. For this purpose, he relied upon the decision of Hon'ble Gujarat High Court in the case of Voltamp Transformers P. Ltd. v. CIT 129 ITR 105.
2.2 Learned DR on the other hand heavily relied upon the appellate order. He further submitted that for immediately preceding year, commission at the rate of 94% only was allowed. There is no justification for increasing the commission from 94% to 21/2%. The onus is upon the assessee to prove the genuineness of the payment. Since the assessee failed to prove the reason for such excessive payment, disallowance has to be upheld.
2.3 We have carefully considered the relevant facts and arguments advanced. We have also perused the decisions cited. It is seen that out of the total commission of Rs. 12.83 lakhs, Rs. 4.83 lakhs has been allowed and Rs. 8 lakhs has been disallowed, invoking the provisions of section 40A(2) of the Act. Section 40A was inserted in the Income-tax Act under Finance Act, 1968. The section imposes restriction and limitation on deductibility of expenses paid to certain categories of person. In the present case, it is not in dispute that the payment made to Shri S K Sharma is falling within the parameters of Section 40A(2)(b) of the Act.
2.4 The Taxpayers carrying on business made excessive and unreasonable expenditure resulting in remuneration and perquisites to their relatives or close associates and on payments for value of goods, services or facilities in dealings with those persons and claimed deduction on the ground that the said expenditure had been laid out wholly and exclusively for the purpose of business and the Courts had held that the taxing authorities were not entitled to consider whether payment of such remuneration was necessary (Ref: Newtone Studios Ltd. v. CIT 28 ITR 378 (Mad.) and that if the expenditure had been made for business purposes he could not make disallowance on the ground that the taxpayer should have incurred less expenditure. Gradually statutory provisions were introduced to disallow such excessive or unreasonable part of the expenditure. The first such provision was sub-section (4A) which was inserted in 1956 in Section 10 of the 1922 Act for disallowance of excessive and unreasonable expenditure resulting in remuneration and perquisites to directors of the company and other close associates having substantial interest in the company. The present Section 40A(2) puts curb on expenditure in respect of which payment has been made to the close associates referred to above, for goods, services and facilities, and it empowers the Assessing Officer to disallow so much of the expenditure in respect of which payment has been made to above categories of persons as is considered by him excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made.
2.5 Section 40A(2)(a) provides as under:.
Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in Clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him there from, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction.
The Scope of the section has been set out in the Circular of CBDT vide circular No. 6P (LXXVT-66) of 1968 dated 6th July, 1968 in which at paras 72 and 74 it is stated thus:
Para 72 : The Finance Act, 1968, has introduced a new Section 40A in the Income-Tax Act with effect from the 1st April, 1968. Under Sub-section(2) of new Section 40A, expenditure incurred in a business or profession for which payment has been or is to be made to the taxpayer's relatives or associate concerns is liable to be disallowed in computing the profits of the business or profession to the extent the expenditure is considered to. be excessive or unreasonable. The reasonableness of any expenditure is to be judged having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession or the benefit derived by, or accruing to, the tax-payer from the expenditure. Such portion of the expenditure, which, in the opinion of the Income Tax Officer, is excessive or unreasonable according to these criteria, is to be disallowed in computing the profits of the business or profession.
Para 74 : It may be noted that the new provision is applicable to all categories of expenditure incurred in businesses and professions, including expenditure on purchase of raw materials, stores or goods, salaries to employees and also other expenditure on professional services, or by way of brokerage, commission, interest etc. Where payment for any expenditure is found to have been made to a relative or associate concern falling within the specified categories, it will be necessary for the Income Tax Officer to scrutinize the reasonableness of the expenditure with reference to the criteria mentioned in the section. The Income Tax Officer is expected to exercise his judgement in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.
2.6 It would be clear from the above Circular that the reasonableness of the expenditure has to be judged having regard to (a) fair market value of the goods, services or facilities for which the payment is made (b) the legitimate needs of the business or profession (c) the benefit derived by or accruing to the taxpayer from the expenditure. These three are alternative tests and the same do not necessarily prohibit consideration of other circumstances.
Under the provisions of Section 40A(2), the assessing officer can disallow only that portion of the total expenditure, which in his opinion is excessive or unreasonable. He cannot disallow the total expenditure by invoking the provisions of Section 40A(2) read with Section 37. Section 40A(2) and Section 37 cannot go together because Section 40A(2) is of overriding nature which would come into operation if the payment is otherwise found to be allowable Under Section 37(1) of the Act. In other words, Section 40A(2) provides for subjective satisfaction of the assessing authority qua allowability of the payment irrespective of the fact that the payment is otherwise found to be allowable as bona fide Under Section 37(1) of the Act. This view is supported by the decisions in the case of N M Anniah v. CIT 101 ITR 348 (Kar), Hathiwala Silk Mills v. ITO 19 TTJ 284 (Ahd) M & Co. v. ITO 23 Taxman 37 (Ahd) (Mag.) and ITO v. Swamy Industries 12 TTJ 370 (Coch).
Reasonableness is to be decided on the basis of fair market value of the goods, services or facilities. The reasonableness of any expenditure is to be seen from the viewpoint of the businessman and not from the view point of the revenue authorities. Refer : Voltamp Transformers P. Ltd. v. CIT 129 ITR 105 (Guj.).
2.7 The provision of Section 40A(2) is intended to prevent evasion of tax in the like manner as Section 104 of the Act or Section 23A of the Act of 1922. In considering the scope of reasonableness their Lordships in CIT v. Gangadhar Banerjee and Co. Pvt. Ltd. 57 ITR 176 (SC) have observed:
Though the object of the section is to prevent evasion of tax, the provision must be worked not from the standpoint of the tax collector but from that of a businessman,...The Income Tax Officer must take an overall picture of the financial position of the business. He should put himself in the position of the prudent businessman or the director of the company and deal with a sympathetic and objective approach.
In this regard, it is also worthwhile to note the decision of Hon'ble 5upreme Court in CIT v. Asiatic Textiles Ltd. 82 ITR 816 wherein the earlier decision in the case of Gangadhar Banerjee is followed.
The decision in the case of Gangadhar Banerjee is an authority for the proposition that the entire question has to be considered from the businessman's point of view and not necessarily from the view of the revenue. To the like effect is the decision of the Hon'ble Calcutta High Court in the case of CIT v. Edward Keventer (P) Ltd. 86 ITR 370 (since approved by the Hon'ble Supreme Court in 115 ITR 149). In this case it is observed:
In other words, even if the qualitative characteristics of Section 10(2)(xv) justify and item of expenditure as wholly and exclusively laid for the business of the company, the Income Tax Officer is enjoined and empowered to consider the reasonableness or otherwise of the quantum or the amount expended on the item, if the item of expenditure comes within the purview of Section 10(4A) and the Income Tax Officer is not to allow the entire amount so spent, if the provisions of Section 10(4A) are attracted and the sum spent comes within the mischief of the said provisions. The Income Tax Officer must, however, consider the entire position dispassionately and objectively and from the view point of a prudent businessman. The Income Tax Officer must appreciate that Section 10(4A) is not to be applied capriciously as a matter of routine and he must realize that the said section is to be applied judiciously and can only be applied, if the necessary conditions of the said section are satisfied. The opinion of the Income Tax Officer as to the reasonableness or otherwise of the amount spent must not be arbitrary and is not to be the subjective and prejudiced opinion of an officer interested in collecting more revenue....It is not for the Income Tax Officer to dictate what the business needs of the company should be and he is only to judge the legitimacy of the business needs of the company from the point of view of a prudent businessman. The benefit derived or accruing to the company must also be considered from the angle of a prudent businessman. The term "benefit" to a company in relation to its business, it must be remembered, has a very wide connotation and may not necessarily be capable of being accurately measured in terms of pound, shillings and pence in all cases. Both these aspects have to be considered judiciously, dispassionately without any bias of any kind from the view point of a reasonable and honest person in business.
Though, these provisions were laid down in the context of provisions of Section 10(4A) of the Act of 1922 which is analogous to Section 40A(2) of the Act of 1961, they would apply with equal force.
2.8 When an assessee claims expenditure, the onus lies upon him to prove the sum is allowable under the provision of the Act. Thus, it is true that for the purpose of claiming deduction Under Section 37(1), the onus lies upon the assessee to prove that the expenses are incurred wholly and exclusively for the purpose of business. However, the question whether the expenses are "wholly and exclusively for the purpose of business" is not the question before us. For invoking the provisions of Section 40A(2), the onus lies upon the AO that the payment is excessive or unreasonable having regard to the fair market value of goods or legitimate needs of the business.
2.9 Under the general law, transactions even with the relatives and associate concerns cannot be discarded. The onus is on the department to prove that the transaction was sham or not bona fide or the value shown in the books was not the value really paid. In this regard the Hon'ble Gujarat High Court in the case of Marghabhai Kishabhai Patel & Co. v. CIT 108 ITR 54 has held:
that unless it has been shown that the transaction in question was a sham one or unless the value shown was not the value in the books of account or unless it was not a bona fide transaction, it is not open to the taxing authorities to disregard the figures of the transactions shown in the books of account of the firm.
The assessing officer must establish that the payment is excessive or unreasonable. ITO cannot proceed merely on the basis of surmises and conjectures. Revenue has to place on record evidence as regards excessiveness or unreasonableness.
3. In the present case, neither the AO nor learned CIT(A) has given any finding as to what is the excessive or unreasonable portion in the total commission payment. There is no finding on what is the legitimate need of the business. Both the authorities have gone by the principle that since in the earlier year the amount paid was 94%, the excess becomes unreasonable. In our opinion, this approach is not correct. There is no presumption that whatever was paid in earlier year only becomes reasonable and anything in excess becomes unreasonable. There may be several reasons that the assessee may pay lower commission in initial years. However, the finding, which is required, is what is the reasonableness or excessiveness for the year under appeal. Looking to the background of Shri Sharma and the nature of services rendered by him, we find that payment of commission at 21/2% cannot be considered as excessive or unreasonable. The partners of the firm are merely female partners whereas Shri S K Sharma is an influential person, who retired from M/s MICO Ltd. as Senior Vice President and is able to influence the said company, which is one of the top most customers of the appellant firm. We accordingly hold that no part of commission can be disallowed invoking the provision of Section 40A(2) of the Act.
In the result, the appeal is allowed.