2015 (7) TMI 106 - AT - Income Tax

Disallowance of interest under the provisions of section 36(1)(iii) - Held that - We find support from the ratio laid down by the Mumbai Bench of Tribunal in DCIT Vs MTZ Polyfilms Ltd. (2013 (3) TMI 459 - ITAT MUMBAI ) wherein it has been proposed that for disallowing interest under section 36 (1)(iii), the total funds i.e. owned funds and borrowed funds, should have been considered for working out the disallowance of interest. Following the abovesaid proposition, we direct the Assessing Officer to recompute the disallowance under section 36(1)(iii) of the Act by adopting the average cost of debt for the year under appeal and applying the same to the interest free advances made by the assessee. Following the abovesaid proposition, we direct the Assessing Officer to recompute the disallowance under section 36(1)(iii) of the Act by adopting the average cost of debt for the year under appeal and applying the same to the interest free advances made by the assessee. Reasonable opportunity of hearing shall be afforded to the assessee by the Assessing Officer - Decided in favour of assessee for statistical purposes. Salary paid to Shri G.S. Saluja, father of one of the partners - AO disallowed claim under section 40A(2)(b) - CIT(A) deleted the addition - Held that - From the perusal of the assessment order, we find that the Assessing Officer except for doubting genuineness of the said expenditure, has not given a finding that the expenditure was excessive or unreasonable, having regard to the fair market value of goods, services or facilities provided. The excessiveness or unreasonableness of the expenditure cannot be seen apart from the market conditions while invoking the provisions of section 40A(2)(a) of the Act. - Decided against revenue.

Summary

Issues:
1. Disallowance of interest under section 36(1)(iii) of the Income Tax Act, 1961.
2. Disallowance of excess salary paid to a specified person under section 40A(2)(b) of the Act.

Issue 1: Disallowance of Interest under Section 36(1)(iii):
The case involved the disallowance of interest under section 36(1)(iii) of the Income Tax Act, 1961, related to interest-free advances made by the assessee. The Assessing Officer disallowed interest accrued on such advances, citing the common kitty of funds. The CIT(Appeals) upheld this disallowance based on a judgment by the Punjab & Haryana High Court. The assessee argued that interest expenditure on term loans was specific and had interest-free funds from partners' capital. The Tribunal found merit in the assessee's plea, stating that disallowance should be limited to the average cost of debt to the assessee. Referring to a Mumbai Tribunal case, the Tribunal directed the Assessing Officer to recompute the disallowance using the average cost of debt for the year.

Issue 2: Disallowance of Excess Salary under Section 40A(2)(b):
The second issue concerned the disallowance of excess salary paid to a specified person under section 40A(2)(b) of the Act. The Assessing Officer disallowed a portion of the salary paid to the father of one of the partners, considering it a family arrangement to reduce profits. The CIT(Appeals) disagreed, highlighting that the person's expertise was crucial for the firm's growth and there was no tax motive. The Tribunal upheld the CIT(Appeals)' decision, emphasizing that the expenditure should be reasonable concerning the business needs and benefits. It noted that the Assessing Officer did not establish the salary as excessive or unreasonable based on market value. Consequently, the Tribunal dismissed the revenue's appeal on this issue.

In conclusion, the Tribunal partly allowed the assessee's appeal regarding interest disallowance and dismissed the revenue's appeal on the excess salary disallowance. The judgment provided detailed analysis and interpretations of the relevant sections of the Income Tax Act, emphasizing the importance of reasonableness and market conditions in determining disallowances.