2009 (6) TMI 50 - HC - Income Tax

Disallowance u/s 40A(2) - Assessing Officer found that the payment made as per the agreement was excessive in nature and by applying Section 40A(2)(a) of the Income Tax Act, disallowed those payments made to the company for the assessment year 1987-88 to the tune of Rs.9,92,496/-. Similar disallowance of Rs.10,50,000/-, Rs.1161,844/-, Rs.6,54,484/- and Rs.2,89,460/- were made for the assessment years 1988-89, 1990-91, 1991-92 and 1992-93 respectively CIT(A) disallowed the deduction for the AY 1997-88 and 1988-89 Successor CIT(A) allowed the deduction for the AY 1990-91, 1991-92 and 1992-93 Therefore two contradictory sets of orders - ITAT held that the disallowance made under Section 40A(2) in respect of services charges could not be disallowed u/s 40A(2) of the Income Tax Act for the assessment years 1987-88, 1988-89, 1990-91, 1991-92 and 1992-93 Held that the issue is in respect of finding of fact the finding is reasonable one ITAT order maintained.

Issues Involved:
1. Disallowance of service charges under Section 40A(2) of the Income Tax Act.
2. Relationship between the assessee firm and the service provider company.
3. Reasonableness and excessiveness of the expenditure incurred by the assessee firm.

Detailed Analysis:

1. Disallowance of Service Charges under Section 40A(2) of the Income Tax Act:

The primary issue revolves around whether the service charges paid by the assessee firm to M/s. Forbes Ewart & Figgis (P) Ltd., Cochin, could be disallowed under Section 40A(2) of the Income Tax Act for the assessment years 1987-88, 1988-89, 1990-91, 1991-92, and 1992-93. The arrangement between the assessee and the company specified that 30% of the gross earnings of the firm would be paid to the company for various services, including auctioning tea, tasting and evaluating samples, and managing affairs.

The Assessing Officer (AO) invoked Section 40A(2)(a), which allows disallowance of expenditure deemed excessive or unreasonable. The AO found the services rendered by the company vague and difficult to verify, citing the close familial relationships between the firm's partners and the company's directors. Consequently, the AO disallowed significant portions of the payments made to the company for the relevant assessment years.

2. Relationship Between the Assessee Firm and the Service Provider Company:

The AO noted that the partners of the assessee firm and the directors of the service provider company were closely related. Mr. O. Thomas, the Chief Executive of the assessee firm, was also a director of the service provider company. This led the AO to suspect that the payments were not at arm's length and were influenced by the familial relationships.

The CIT (Appeals) initially supported the AO's view for the assessment years 1987-88 and 1988-89, treating the Coimbatore firm as a mere facade for the Cochin company. However, for the assessment years 1990-91, 1991-92, and 1992-93, another CIT (Appeals) found that the service charges were fully allowable, noting that the company had the professional expertise required and had declared the service charges as income, paying taxes accordingly.

3. Reasonableness and Excessiveness of the Expenditure Incurred by the Assessee Firm:

The Tribunal, after considering the appeals from both the revenue and the assessee, upheld the findings of the CIT (Appeals) for the later years, affirming that the service charges were reasonable and justified. The Tribunal noted that the services provided by the company contributed to the increased turnover of the assessee firm, thus justifying the payments.

The Tribunal emphasized that the AO's assessment lacked concrete evidence to prove that the payments were excessive or unreasonable. The Tribunal also highlighted that the company had declared the service charges as income and paid taxes at a higher rate, indicating no intent to evade taxes.

Conclusion:

The Tribunal's decision was based on a thorough examination of the facts, including the professional expertise provided by the company and the resultant increase in the firm's turnover. The Tribunal found no basis for the AO's disallowance under Section 40A(2), as the payments were deemed reasonable and necessary for the business.

The High Court, relying on the Tribunal's findings and previous judgments, concluded that the revenue had not substantiated its claim that the expenditure was excessive or unreasonable. Therefore, the appeals filed by the revenue were dismissed, affirming the Tribunal's decision that the service charges paid by the assessee firm were allowable deductions.

← Previous Next →