2017 (3) TMI 663 - AT - Income Tax

Disallowance of salary paid to the employees, relatives of the partners of the assessee - Held that - Both AO as well as CIT(A) have estimated the salary for determining the excess / unreasonable payment without considering the FMV of the services provided by these persons. The AO while invoking the provisions of section 40A(2)(a) considered the FMV of the services by comparing the salary paid to the partners. Whereas it is not ascertainable from the record whether the services rendered by these persons can be compared with the services of the partners to whom the salaries were paid by the assessee firm. It is pertinent to note that the comparison would have been more proper if the salary paid to the unrelated employees of the assessee firm was to be considered as FMV of the services provided by these persons. Therefore this issue has not been properly examined by the authorities below and requires to be reconsidered in the light of the above observation. Hence this issue is set aside to the record of AO for re-computation of the FMV of the services provided by these persons having regard to the salaries paid to the non-related employees of the assessee firm instead of the partners of the assessee firm who cannot be considered as unrelated party. Disallowance u/s. 40A(3) - assessee has made cash payment of ₹ 2 Lakhs to a sister concern - Held that - It appears that this amount of ₹ 2 Lakhs was paid to the sister concern through the partners account. However, the assessee has not claimed this amount as an expenditure. Therefore the provisions of section 40A(3) cannot be invoked in the absence of any claim of expenditure. In view of the above fact that this amount was not claimed as an expenditure, no disallowance is called for u/s. 40A(3). Accordingly, this disallowance made by the AO is deleted.

Summary

Issues:
1. Disallowance of salary paid to employees under section 40A(2)(a).
2. Disallowance of payment made to relatives of partners under section 40A(2)(b).
3. Rejection of claim under section 40A(3) for cash payment to a sister concern.

Issue 1: Disallowance of salary paid to employees under section 40A(2)(a):
The Assessing Officer (AO) disallowed excess salary payment to certain employees who were relatives of the partners of the assessee firm under section 40A(2)(a). The AO found the payment excessive and restricted it, leading to an addition of ?15,10,000. The CIT(A) reduced the disallowed amount to ?6,00,000. However, both authorities did not consider the Fair Market Value (FMV) of services provided by these employees in comparison to unrelated employees. The Tribunal set aside the issue for re-computation of FMV based on salaries paid to unrelated employees, emphasizing a proper examination of the services provided.

Issue 2: Disallowance of payment made to relatives of partners under section 40A(2)(b):
The AO disallowed salary payments to relatives of partners under section 40A(2)(b) as excessive compared to services rendered. The CIT(A) sustained the disallowance of ?6,00,000. The Tribunal noted the lack of consideration for FMV and directed a re-examination based on salaries of unrelated employees. The Tribunal emphasized the need for a proper assessment of services provided by the relatives of partners.

Issue 3: Rejection of claim under section 40A(3) for cash payment to a sister concern:
The AO disallowed a cash payment of ?2,00,000 to a sister concern under section 40A(3), considering it non-expenditure. The CIT(A) upheld this disallowance. However, the Tribunal observed that since the amount was not claimed as an expenditure, section 40A(3) could not be invoked. Consequently, the disallowance made by the AO was deleted, and the appeal of the assessee was partly allowed.

This judgment highlights the meticulous scrutiny required in assessing salary payments to employees, especially relatives of partners, under relevant sections of the Income Tax Act. It underscores the importance of considering the Fair Market Value of services rendered and the need for a comprehensive evaluation based on comparable salaries. Additionally, the judgment clarifies the application of section 40A(3) concerning cash payments, emphasizing the necessity of proper expenditure claims for invoking disallowance provisions.