2016 (9) TMI 549 - AT - Income Tax

Addition made u/s 40A(2) - payment of salary to assessee s daughter-in-law - Held that - We find that Smt. Seema Bhandari, daughter-in-law of the assessee has been working with the assessee for the financial year 2007-08 onwards. She was paid remuneration at ₹ 4.60 lakhs in the immediately preceding year, but during the year under consideration the increase in remuneration was by 350%, although it is the contention of the ld. Authorized Representative of the assessee that increase in remuneration is due to the services of Smt.Bhandari, which were utilized as part of succession planning in the business due to old age of the assessee and she was also actively working as Chief Executive Officer for the business. We have also noted that she is also paying tax @ 30%. Therefore, there appears no evasion of tax by paying higher amount of remuneration. As in the case of Principal CIT vs. Gujarat Gas Financial Services Limited, (2015 (7) TMI 743 - GUJARAT HIGH COURT) wherein it was held that where the recipient company as well as parent company, both are assessed to income tax at maximum marginal rate and, therefore, it cannot be said that the service charges is paid to the recipient company at unreasonable rate to evade income tax. It was also noted therein that so far as the Circular dated 06.07.1968 is concerned, it makes clear that the provisions of Section 40A(2) and particularly with regard to the transaction between the relatives and associates is concerned, the same shall be treated as bona fide case unless the Officer finds it that one of them is trying to evade payment of tax. In the light of these decisions, we find that the assessee as well as his daughter in law are being assessed at the maximum marginal rate and, therefore, there appears no ground for tax evasion. However, we are also aware of the fact that increase in the turnover at 30% was same as in the increase of turnover of 30% during the preceding year. Therefore, increase in the remuneration @ 350% appears to be on higher side. Considering the nature of services rendered by Smt. Seema Bhandari and increase in turnover due to her efforts, it would be reasonable to consider a sum of ₹ 1 lac per month as reasonable. Therefore, disallowance of ₹ 20,70,833/- (-) 12,00,000/- ₹ 8,70,833/- is confirmed and balance is deleted. Disallowance of the entire amount spent on FOC (Free of Cost ) - Held that - We find that the FOC were given to the non-related party on account of accessories supplied free of cost alongwith the machinery items for which details were filed before the CIT(A) as mentioned above. We also observe that in subsequent assessment year 2013-14 of which assessment was made u/s 143(3) on 16.11.2015. The payment of such FOC amounting to ₹ 9,04,307/-was accepted and no disallowance on the same score has been made. This is the business expenditure, which has been incurred by the assessee by way of adopting sales promotion increase tactics, the genuineness of which has not been doubted by the lower authorities. Therefore, in all fairness, we are of the considered opinion that disallowance of such expenses is not desirable. Accordingly, the disallowance is deleted. Appeal decided partly in favour of assessee

Summary

Issues Involved:
1. Addition made under Section 40A(2) towards payment of salary to assessee’s daughter-in-law.
2. Disallowance of the entire amount spent on Free of Cost (FOC) items.

Issue-wise Detailed Analysis:

1. Addition made under Section 40A(2) towards payment of salary to assessee’s daughter-in-law:

The assessee paid a salary of ?20,70,833 to his daughter-in-law, Smt. Seema Bhandari, during the assessment year 2012-13, compared to ?4,60,000 in the preceding year. The Assessing Officer (AO) restricted the allowable remuneration to ?4,60,000 and disallowed the excess amount of ?16,10,833, citing lack of plausible explanation for the significant increase and potential profit reduction through related-party transactions. The Commissioner of Income-tax (Appeals) [CIT(A)] upheld the AO’s findings, noting that the increase in turnover did not justify the 350% increase in remuneration.

The assessee argued that Smt. Seema Bhandari was taxed at the maximum marginal rate, negating any tax evasion motive. The assessee cited CBDT Circular No. 6-P and various judicial precedents to argue that Section 40A(2) should not apply in bona fide cases where no tax evasion is evident. The assessee also provided details of Smt. Bhandari’s role and the increase in business turnover as justification for the remuneration.

The Tribunal considered the facts and noted that Smt. Bhandari had been working with the assessee since financial year 2007-08 and was actively involved as Chief Executive Officer. Given that both the assessee and Smt. Bhandari were taxed at the maximum marginal rate, the Tribunal found no grounds for tax evasion. However, the Tribunal deemed the 350% increase in remuneration excessive and considered ?1 lakh per month reasonable, resulting in a partial disallowance of ?8,70,833.

2. Disallowance of the entire amount spent on Free of Cost (FOC) items:

The AO disallowed ?16,26,229 claimed as FOC expenses, noting that the assessee failed to provide justification and that such expenses were nil in the preceding year. The CIT(A) upheld the disallowance due to lack of justification during assessment and appellate proceedings.

The assessee argued that FOC items were provided to customers as part of sales promotion tactics in a competitive environment. Detailed evidence, including deal sheets and invoices, was submitted to support the claim. The assessee contended that these transactions were with non-related parties and were part of prudent business practices to increase turnover. It was also noted that similar FOC expenses were accepted in subsequent assessment years.

The Tribunal found that the FOC items were given to non-related parties and were part of sales promotion tactics. The genuineness of the expenses was not doubted by the lower authorities. Considering the acceptance of similar expenses in subsequent years, the Tribunal deemed the disallowance of ?16,29,229 unjustified and deleted it.

Conclusion:

The appeal was partly allowed, with partial relief granted on the disallowed remuneration and full relief on the disallowed FOC expenses. The Tribunal’s order was pronounced in open court on 3rd August, 2016.