2016 (2) TMI 748 - AT - Income Tax

Disallowance u/s 40(a)(ia) - TDS u/s 194C OR 192 - payment to individual workers - Held that - This is an accepted fact by the assessee that individual workers to whom payment has been made by the assessee are not on the payroll of the employees meaning thereby that the workers were not employees of the company. These individual workers were working for the assessee company on behalf of labour contractor M/s Surgi Pharm Industries. Going through the Tax Audit report we find that assessee has not claimed the payment to labour contractor as salary payment and the Tax Auditor has certified that the payments made to individual workers were actually the payment on behalf of the labour contractor M/s Surgi Pharm Industries and such payment was duly covered within the ambit of the provisions of section 194C of the Act and TDS was required to be deducted by the assessee. It seems that at a later stage (during the course of assessment proceedings) assessee has taken plea that the payment was actually made to individual workers but the actual position at the time of finalization of books of accounts as well as upto the completion of Tax Audit u/s 44AB of the Act was that the payment was made to individual workers was a payment on behalf of labour contractor to whom assessee has been paying the labour contract charges in preceding years and, therefore, the submission of the assessee that the payment to individual workers is covered u/s 192 of the Act cannot be accepted - Decided against assessee Disallowance of interest expenditure - Held that - CIT(A) has duly accepted the submissions of the assessee and has, therefore, reduced the addition of disallowance of interest expenditure by restricting it to 3.5% being average interest cost of total fund given as interest free funds. We are, therefore, of the view that as a total fund of the assessee comprising of own capital, interest free unsecured loans as well as interest bearing funds are all moving through a common bank account and the application of this fund is for business as well as at sometimes interest free loan & advance use and ld. CIT(A) has rightly applied 3.5% rate of interest on the average balance of interest free loans and advances. We, therefore, uphold the order of CIT(A) and dismiss this ground of assessee.

Summary

Issues Involved:
1. Disallowance under Section 40(a)(ia) of the Income Tax Act.
2. Disallowance of interest expenses.
3. Initiation of penalty proceedings under Section 271(1)(c) of the Income Tax Act.
4. Allowance of employees' contribution to PF & ESI.
5. Application of average cost of funds for disallowance under Section 36(1)(iii).

Detailed Analysis:

1. Disallowance under Section 40(a)(ia):
The assessee, a Private Limited Company engaged in manufacturing and trading of Hospital & Orthopedic products, was disallowed Rs. 6,93,235/- under Section 40(a)(ia) for non-compliance with TDS provisions. The CIT(A) confirmed the disallowance, stating that payments to contractors and professional fees were made without deducting TDS, thus falling under Section 194C. The Tribunal upheld this decision, noting that the payments were made to individual workers on behalf of a labor contractor, and the Tax Auditor certified these payments as covered under Section 194C, necessitating TDS deduction.

2. Disallowance of Interest Expenses:
The Assessing Officer disallowed Rs. 13,18,277/- in interest expenses, applying a 12% interest rate on the average balance of interest-free advances given to certain parties, including Medtek Asia Ltd. The CIT(A) partly allowed the appeal, reducing the disallowance to 3.5%, representing the average cost of total funds. The Tribunal upheld this decision, agreeing with the CIT(A) that the average cost of funds should be applied due to the mingling of borrowed and own funds in a common bank account.

3. Initiation of Penalty Proceedings under Section 271(1)(c):
The Tribunal noted that the issue of initiating penalty proceedings under Section 271(1)(c) was premature and did not require adjudication at this stage.

4. Allowance of Employees' Contribution to PF & ESI:
The Revenue appealed against the CIT(A)'s direction to allow employees' contributions to PF & ESI if paid before the due date of filing the return. The Tribunal dismissed the Revenue's appeal, citing CBDT Instruction No. 21/2015, which prohibits filing appeals where the tax effect is less than Rs. 10 lakhs. The Tribunal noted that the tax effect in this case was below the threshold and did not fall within the exceptions provided in the instructions.

5. Application of Average Cost of Funds for Disallowance under Section 36(1)(iii):
The Revenue also contested the CIT(A)'s decision to apply an average cost of funds (3.5%) instead of the actual borrowing rate (12%) for disallowance under Section 36(1)(iii). The Tribunal upheld the CIT(A)'s application of the average cost of funds, agreeing that the disallowance should be based on the average cost due to the mixing of borrowed and own funds.

Conclusion:
The Tribunal dismissed both the assessee's and the Revenue's appeals, upholding the CIT(A)'s decisions on the disallowance under Section 40(a)(ia), the partial relief on interest disallowance, and the allowance of employees' contributions to PF & ESI. The initiation of penalty proceedings under Section 271(1)(c) was deemed premature, and the application of the average cost of funds for disallowance under Section 36(1)(iii) was affirmed.