2010 (4) TMI 905 - AT - Income Tax

Maintainability of the disallowance u/s 40A(3) - relationship between principal and agent - the assessee is a distributor for Bharat Sanchar Nigam Ltd. (BSNL) in its card division (India Telephone Card), and also engaged in foreign exchange business. The assessee made payments in cash and, thus, having apparently contravened the provisions of section 40A(3), disallowance at the rate of twenty per cent. of the impugned expenditure stood proposed during the assessment proceedings u/s 143(3). The ld CIT (A) upheld the disallowance. Aggrieved, the assessee is in appeal. HELD THAT - We find the assessee's case as totally unsubstantiated. It has failed to explain as to how its case falls under rule 6DD(k), so as to preclude the operation of the mandate of the non obstante provision of section 40A(3). The fact of purchases from the open market has not been demonstrated and, besides, is contrary to the assessee's claim of the impugned payments as having been made only to a Government organisation, and which we have explained as of no moment. Rather, we are inclined to take the view that the fact that a good percentage of the purchase payments stand effected other than in cash defeats the assessee's case inasmuch as it clearly shows that its business could be conducted through the banking channel. None of the payments have been shown before any authority to have been made on a banking holiday or on account of dislocation of work in the said industry, for clause (k) of rule 6DD to be applicable, with reference to which the assessee seeks to advance its case. As regards the payments toward open market purchases, if and to the extent these are in cash, the same could hardly be considered as falling within the ambit of the clause. It is, thus, abundantly clear from the foregoing, that the assessee's case does not fall within the specific clause of rule 6DD. The provision of section 40A(3), which is a non obstante provision, would thus hold, and operate to deem twenty per cent., of the impugned expenditure as the assessee's profit from its business and liable to be disallowed thereunder. Again, the pleading or the argument that the assessee operates at a nominal commission or trade margin, which is largely fixed, even if true, would be of no consequence in view of the statutory mandate of section 40A(3). In view of the decision by the Tribunal in the case of Vodafone Essar Cellular Ltd. 2009 (4) TMI 209 - ITAT COCHIN , we are of the clear view that the provision of section 40A(3) would not be applicable in the facts and circumstances of the case. The earlier part of the order, which suggests otherwise, is on the premise that the transfer of the cards by the service-provider to the assessee-distributor represents the latter's purchase thereof, and thus, as being only an expenditure incurred by it in the normal course of its business, meeting the arguments of the opposing parties and their respective cases as made before us. The same is de hors the aforesaid decision by the Tribunal, which stands rendered following the decisions by the hon'ble jurisdictional High Court and the hon'ble apex court on an aspect of the matter which is integral to the issue under consideration. once the Tribunal found the relationship between the franchisee-distributor and the service-provider to be one of principal and agent, there is no question of any purchase by the latter, and the income arising thereto is only in the nature of a commission or remuneration against services rendered. As such, there is no question of allowance of any expenditure in respect of purchases qua which section 40A(3) could apply, irrespective of the mode of payment thereof. The assessee succeeds on grounds of its appeal.

Issues Involved:
1. Maintainability of the disallowance under section 40A(3) of the Income-tax Act, 1961.
2. Applicability of Rule 6DD(k) of the Income-tax Rules, 1962.
3. Interpretation of section 194H of the Income-tax Act, 1961.
4. Levy of interest under section 234B of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Maintainability of the Disallowance under Section 40A(3) of the Income-tax Act, 1961:
The primary issue in the appeal concerns the maintainability of the disallowance under section 40A(3) of the Income-tax Act, 1961. The assessee, a distributor for BSNL and engaged in foreign exchange business, made cash payments amounting to Rs. 187.73 lakhs for the purchase of India Telephone Cards, which contravened section 40A(3). Consequently, a disallowance of 20% of the expenditure (Rs. 37,54,695) was proposed and effected during the assessment proceedings. The assessee argued that the cash payments were necessitated by business exigencies due to the sellers' refusal to accept payments through banking channels. However, the Commissioner of Income-tax (Appeals) upheld the disallowance, stating that the statutory prescription of section 40A(3) must prevail.

2. Applicability of Rule 6DD(k) of the Income-tax Rules, 1962:
The assessee contended that the payments should be covered under Rule 6DD(k) of the Income-tax Rules, 1962, which exempts certain payments from disallowance under section 40A(3). Rule 6DD(k) exempts payments made on a day when banks were closed due to a holiday or strike. However, the Tribunal found that the assessee failed to substantiate its claim under Rule 6DD(k). No evidence was provided to show that the payments were made on banking holidays or due to dislocation of work. The Tribunal also noted that the fact that a significant portion of the payments was made through banking channels undermined the assessee's argument.

3. Interpretation of Section 194H of the Income-tax Act, 1961:
The Tribunal referred to its earlier decision in Vodafone Essar Cellular Ltd. v. Asst. CIT, where it was held that payments made by the service provider to the distributor for SIM cards and recharge coupons are not for the sale of goods but for services rendered, thus attracting section 194H of the Act. The Tribunal found that the relationship between the service provider and the distributor is one of principal and agent. Consequently, the payments made by the distributor to the service provider are not considered purchases but adjustments of values exchanged. Therefore, section 40A(3) does not apply as there is no actual purchase of goods or services by the distributor.

4. Levy of Interest under Section 234B of the Income-tax Act, 1961:
The assessee also contested the levy of interest under section 234B. However, this ground was not pressed during the hearing. The Tribunal noted that the levy of interest under section 234B is mandatory, as established in CIT v. Anjum M. H. Ghaswala. Therefore, the assessee's appeal on this ground was dismissed.

Conclusion:
The Tribunal concluded that the provision of section 40A(3) would not be applicable in the facts and circumstances of the case, given the nature of the relationship between the service provider and the distributor. The assessee's appeal was partly allowed, with the Tribunal ruling in favor of the assessee on the disallowance under section 40A(3) but upholding the levy of interest under section 234B.

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