2020 (11) TMI 735 - AT - Income Tax

Disallowance of interest on borrowed capital - HELD THAT - ICDS II issued on valuation of inventories (though relevant to the subsequent years) also supports the aforesaid claim of deduction of the assessee. As the interest bearing borrowed funds had been raised by the assessee for the purpose of its business, and used for the said purpose, therefore, the interest expenditure pertaining to such borrowed funds was rightly claimed by the assessee and allowed as a deduction by the CIT(A).No infirmity in the view taken by the CIT(A) in context of the aforesaid issue under consideration uphold his order to the said extent. The Ground of appeal No. 2 is dismissed. Disallowance of directors remuneration u/s 40A(2)(a) - HELD THAT - Basis for gauging the excessiveness or unreasonableness of such expenditure incurred by the assessee in respect of related parties has to be carried out in the backdrop of the fair market value of the goods, services or facilities for which the payment is made. We find that the A.O by misconstruing the scope and gamut of Sec. 40A(2)(a) had disallowed the entire amount of the directors remuneration. Aforesaid disallowance carried out by the A.O by pressing into service the provisions of Sec. 40A(2)(a), therein principally suffer from two serious infirmities, viz. (i). that the A.O had lost sight of the fact that the disallowance of the related party expenditure u/s 40A(2)(a) could have been made only to the extent the same was found to be excessive or unreasonable; and (ii). that as per the mandate of Sec. 40A(2)(a) the A.O remained under a statutory obligation to benchmark the excessiveness or unreasonableness of the expenditure keeping in view the fair market value of the goods, services or facilities for which the payment was made or was to be made to the specified related party. In the backdrop of our aforesaid observations, we are of the considered view that the A.O had traversed beyond the jurisdiction that was vested with him u/s 40A(2)(a) - remuneration paid by the assessee to its directors can by no means be stamped as exorbitant, and therein disallowed by invoking the provisions of Sec. 40A(2)(a) . As such, finding no infirmity in the view taken by the CIT(A) in context of the aforesaid issue under consideration, we uphold his order therein vacating the disallowance of ₹ 3.63 crores made by the A.O u/s 40A(2)(A) of the Act. The Ground of appeal No. 1 is dismissed.

Summary

Issues Involved:
1. Deletion of addition on account of directors' remuneration.
2. Classification of interest expenditure as revenue or capital in nature.

Detailed Analysis:

1. Deletion of Addition on Account of Directors' Remuneration:

The revenue challenged the deletion of an addition of ?3,60,00,000/- made on account of directors' remuneration. The Assessing Officer (A.O) had disallowed this amount under Sec. 40A(2)(b) of the Income Tax Act, 1961, asserting that the remuneration was exorbitant and aimed at suppressing profits. The A.O noted that a major portion of the remuneration was shown as an outstanding liability in the balance sheet and that the directors had advanced unsecured loans to the company, suggesting a circular transaction to evade taxes.

The CIT(A) observed that the remuneration paid to directors in earlier years, which were subjected to scrutiny assessments, was allowed without dispute. The directors had shown the remuneration in their respective returns and paid tax at the maximum marginal rate. The CIT(A) concluded that there was no loss to the revenue or tax evasion.

The ITAT upheld the CIT(A)’s decision, noting that the assessee had consistently paid remuneration to its directors in preceding years, which was accepted by the department. The directors had significant experience and responsibilities, and the company had successfully developed projects under their direction. The ITAT found no justification for the A.O’s deviation from the accepted practice and noted that the provisions of Sec. 40A(2)(a) were misapplied, as they are meant to disallow only the excessive or unreasonable part of the expenditure, not the entire amount. The ITAT also highlighted that the remuneration was subjected to tax at the maximum marginal rate in the hands of the directors, negating any revenue loss.

2. Classification of Interest Expenditure as Revenue or Capital in Nature:

The A.O disallowed the interest expenditure of ?66,72,179/- related to bank overdraft and unsecured loans, asserting that it should be capitalized to work-in-progress (WIP) as the funds were used for developing projects. The assessee argued that the interest expenditure was a periodic cost and should be allowed as a revenue expense.

The CIT(A) observed that the assessee had consistently treated finance costs as periodic costs, which was accepted by the A.O in earlier years. The CIT(A) referenced the judgment of the Bombay High Court in ACIT Vs. Lokhandwala Constructions Industries Ltd., which supported the treatment of interest costs as revenue expenditure. The CIT(A) also noted that the A.O had not provided any reason for deviating from the regular method of accounting followed by the assessee.

The ITAT concurred with the CIT(A), emphasizing that a consistent method of accounting accepted in previous years should not be arbitrarily changed. The ITAT cited the judgment of the Bombay High Court in CIT Vs. Tata Iron & Steel Co. Ltd., which held that a consistent method of accounting should be followed unless it results in distortion of profits. The ITAT also referenced the Supreme Court’s judgment in CIT Vs. Bill Hari Investment Ltd., which stated that the department could only insist on a change in the method of accounting if it resulted in distortion of profits. The ITAT concluded that the interest expenditure was rightly treated as a revenue expense and upheld the CIT(A)’s decision.

Conclusion:

The ITAT dismissed the revenue’s appeal, upholding the CIT(A)’s decisions on both issues. The directors' remuneration was deemed reasonable and consistent with previous years, and the interest expenditure was correctly classified as a revenue expense. The ITAT emphasized the importance of consistency in accounting methods and the need for cogent reasons to deviate from established practices.