2019 (4) TMI 290 - HC - Income Tax

Disallowance u/s 40A(2) - payment to related persons - salary and advisory fee paid to the director as excessive and unreasonable expenditure - HELD THAT - Tribunal has failed to apply test of prudent and reasonable business person. The disallowance was solely predicated on percentage of increase in the payments made to the directors and not whether payments made were reasonable, fair and commensurate with the market value of the work and services rendered or benefit accrued. Further several aspects and findings recorded and highlighted by the Commissioner of Income Tax (Appeals) relevant and important for deciding the issue and question have not been noticed and ignored. Tribunal should not have discarded independent evidence in the form of TDS certificates showing the salary/remuneration drawn by Dr. U.V. Somayajulu and Tilak Mukherji when they were working with a third party. These were arms-length payments market driven and for market value. This was the best evidence. Educational qualifications and work experience of the directors were ignored as irrelevant because of the low salary/remuneration benevolently and magnanimously accepted by them in the earlier years. Professional and fair conduct in earlier years should have been appreciated and not frowned to be treated as a ground to disallow fair and genuine payment under Section 40A(2)(a) read with Clause (b) of the Act. A provision which requires a just and fair approach by the assessee must be interpreted and applied in a just and fair manner by the authorities. CIT(Appeals) had also pointed out that these three directors had earned income which was taxable at the maximum rate of tax. Therefore, this was not a case where an attempt was made to evade taxes. The salary/remuneration paid was taxed in the hands of the recipients at the highest slab. Expenditure incurred was income earned. Former was allowed as a deduction and the latter was taxed as taxable income. This is an added factor which should have been considered, but was ignored and not treated as relevant. - Decided in favour of assessee.

Summary

Issues:
1. Condonation of delay in re-filing the appeal.
2. Disallowance under Section 40A(2) of the Income Tax Act, 1961.

Condonation of Delay:
The court allowed the delay of 03 days in re-filing the appeal, as per the reasons explained in the application. The application for condonation of delay was granted.

Disallowance under Section 40A(2) of the Income Tax Act, 1961:
The appeal under Section 260A of the Income Tax Act, 1961, by the appellant-assessee, related to the assessment year 2011-2012. The issue revolved around the disallowance under Section 40A(2) concerning payments made by the appellant-assessee to its directors. The Assessing Officer had disallowed payments to the directors as excessive and unreasonable expenditure, which was later deleted by the Commissioner of Income Tax (Appeals) but reinstated by the Tribunal.

The Tribunal upheld the disallowance citing that the salary increments of the directors were not based on objective criteria but on subjective satisfaction. The Tribunal noted significant salary increases without justification related to changes in work nature, qualifications, or expertise. The Tribunal emphasized that salary increments should be commensurate with the nature of work and services rendered, not based on company profits.

Section 40A(2)(a) empowers the Assessing Officer to disallow excessive or unreasonable expenditure incurred in transactions between related persons. The onus is on the assessee to provide evidence justifying the quantum of payment, and the Assessing Officer must objectively assess the evidence to determine any justified disallowance under the section.

The court referred to the case law emphasizing that the determination of reasonableness and excessiveness must consider various facets, with a focus on fair market value and legitimate business needs. The judgment should be objective and fair, aiming to prevent tax evasion without causing hardship in genuine cases.

In this case, the Tribunal failed to apply the test of a prudent and reasonable business person. The disallowance was solely based on percentage increases in payments to directors, overlooking whether the payments were reasonable, fair, and commensurate with market value or benefit accrued. The Tribunal ignored crucial findings highlighted by the Commissioner of Income Tax (Appeals).

The court highlighted that the directors' low salary in earlier years was due to their role as promoters of the company, and the Tribunal's approach of using earlier salary as a benchmark was incorrect. The court emphasized that fair and genuine payments should not be disallowed based on past benevolence. The court also noted that the directors' income was taxed at the maximum rate, indicating no attempt to evade taxes.

Ultimately, the court ruled in favor of the appellant-assessee, directing the deletion of the addition made under Section 40A(2)(a) of the Act, with no order as to costs.

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