2008 (10) TMI 237 - HC - Income Tax

Commission paid for obtaining contract payment prohibited by law - assessee had inflated the steel purchases debited in its books and claimed it as an allowable expenditure. The assessee admitted that he had obtained the computation bills from steel vendors and, therefore, the assessments were reopened under sections 147 and 148 assessee claimed that that it had paid commission in cash to the Mehta group who were allegedly instrumental in having the contract awarded to the assessee held that - Tribunal has failed to consider the case in the light of the Explanation to sub-section (1) of section 37. Further, the Tribunal in its order dated July 8, 1996, has held that there was no loss caused to the Revenue inasmuch as the recipients of the commission had offered the said commission amount for payment of tax in their individual accounts and, therefore, the commission paid by the assessee ought to be deducted for the purpose of computing business income of the assessee matter remanded

Summary

Issues Involved:
1. Validity of commission payment to the Mehtas.
2. Allowability of camouflaged payments as business expenditure.
3. Applicability of Section 40A(3) of the Income-tax Act to cash payments.
4. Timing of liability for commission payment.
5. Nature of commission payment: expenditure vs. income sharing.

Issue-wise Detailed Analysis:

1. Validity of Commission Payment to the Mehtas:
The court examined whether the Income Appellate Tribunal's conclusion that the commission payment by the assessee to the Mehtas was proved beyond reasonable doubt was based on flawed logic. The Tribunal had found that the payment of Rs. 48,00,000 as commission to the Mehtas was substantiated by evidence, including the Mehtas' acknowledgment of the commission in their tax returns. The Tribunal determined that the commission was indeed paid and should be allowed as a business expenditure. However, the court noted that the Tribunal failed to consider the implications of the Explanation to Section 37(1) of the Income-tax Act, which disallows deductions for expenditures incurred for purposes that are offenses or prohibited by law.

2. Allowability of Camouflaged Payments as Business Expenditure:
The court scrutinized whether camouflaged payments made under a tainted contract could be considered allowable expenditures. The Tribunal had allowed the commission as a deductible expense, reasoning that the payments were made for business purposes. The court, however, highlighted the need to assess the legality of such payments under the Explanation to Section 37(1), which prohibits deductions for expenditures related to illegal activities or offenses.

3. Applicability of Section 40A(3) of the Income-tax Act to Cash Payments:
The court evaluated whether the Tribunal was correct in concluding that cash payments of commission were not subject to the provisions of Section 40A(3), which restricts cash transactions above a certain threshold. The Tribunal had ruled that the cash payments did not violate Section 40A(3). The court did not specifically address this issue in detail but implied that the legality of the payments under the Explanation to Section 37(1) needed to be reconsidered.

4. Timing of Liability for Commission Payment:
The court examined the Tribunal's conclusion that the liability for the commission payment arose when the assessee recorded the debit for bogus steel purchases, rather than when the agreement was made or when the payment was actually disbursed. The Tribunal had found that the commission liability was linked to the bogus steel purchases recorded in the books. The court did not explicitly challenge this timing but emphasized the need to reassess the entire matter in light of the Explanation to Section 37(1).

5. Nature of Commission Payment: Expenditure vs. Income Sharing:
The court considered whether the commission payment was an allowable business expenditure or a sharing of income obtained through a conspiracy to defraud Karnataka Ball Bearings Ltd. The Tribunal had treated the commission as a business expenditure. The court directed the Tribunal to reassess this determination, particularly considering whether the payment constituted an offense or was prohibited by law under the Explanation to Section 37(1).

Conclusion:
The court remanded the case back to the Income-tax Appellate Tribunal to reconsider the issues, particularly in light of the Explanation to Section 37(1) of the Income-tax Act. The Tribunal was instructed to evaluate whether the commission payments constituted an offense or were prohibited by law, which would disqualify them as deductible business expenditures. The court cited relevant case law to support its decision to remand the matter for further consideration.