2022 (12) TMI 1547 - AT - Income Tax

Disallowance of deduction of director s remuneration u/s 40A(2)(a) - it was the claim of the assessee company before the CIT(Appeals), that the A.O had grossly erred in observing that it was not benefited at all by increasing the director s remuneration during the year under consideration - HELD THAT - As the AO had failed to adopt either of the prescribed basis/yardstick for verifying the reasonableness of the director s remuneration that was paid by the assessee company during the year under consideration, therefore, there was no justification on his part to have confined the assessee s claim for deduction of the same to Rs. 2.40 lac (supra) u/s. 40A(2)(a) of the Act. Apart from that, we are unable to concur with the view of the CIT(Appeals), who despite taking cognizance of the contentions of the assessee that on the basis of services rendered by the directors on full time basis, it was able to scale down its expenses, liquidate its debtors, raise its commission income etc., had upheld the view taken by the A.O on the solitary basis that there was no substantial increase in the turnover and there was a comparative decline in the net profit of the company during the year under consideration. Be that as it may, as the A.O had without adopting ant prescribed basis/yardstick held the director s remuneration as excessive and unreasonable, therefore, unable to uphold his view. Accordingly, set-aside the order of the CIT(Appeals) and vacate the disallowance that had been sustained by him. Thus, the Ground of appeal No.2 raised by the assessee is allowed.

Issues Involved:

1. Jurisdictional validity of the notice issued under Section 143(2) of the Income-tax Act, 1961.
2. Disallowance of director's remuneration under Section 40A(2)(a) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Jurisdictional Validity of the Notice Issued Under Section 143(2):

The first issue raised by the assessee pertained to the jurisdictional validity of the notice issued under Section 143(2) by a non-jurisdictional Assessing Officer (ITO-1(3), Bhilai) and the non-issuance of a fresh notice by the jurisdictional Assessing Officer (ITO-1(1), Bhilai) after the transfer of the case. The assessee argued that the jurisdiction was not proper as per the provisions of Section 120 and Section 124 of the Income-tax Act, 1961, and the relevant notification issued by the Principal Commissioner of Income Tax. However, during the hearing, the Authorized Representative for the assessee chose not to press this ground of appeal. Consequently, this issue was dismissed as not pressed.

2. Disallowance of Director's Remuneration Under Section 40A(2)(a):

The central issue in the appeal was the sustainability of the disallowance of Rs. 13.20 lakh out of the total director's remuneration of Rs. 15.60 lakh, as made by the Assessing Officer under Section 40A(2)(a) of the Act. The Assessing Officer had disallowed the remuneration on the grounds that it was excessive compared to the previous year and not commensurate with the company's marginal increase in turnover. The AO also noted the absence of a resolution from the Annual General Meeting to substantiate the remuneration increase and referenced the Companies Act, 2013, which prescribes an upper limit for director's remuneration.

The assessee contended that the disallowance was made without any material evidence indicating that the remuneration was excessive or unreasonable based on the fair market value of services, legitimate needs of the business, or benefits derived by the company. The assessee argued that the increase in remuneration was justified due to the directors' exclusive work for the company and provided evidence of reduced expenses and increased commission income as a result of the directors' efforts.

The tribunal found that the Assessing Officer had not applied the statutory yardsticks prescribed under Section 40A(2)(a) to determine the excessiveness or unreasonableness of the remuneration. The tribunal noted that merely comparing the remuneration with the previous year was insufficient to justify the disallowance. The tribunal also observed that the reference to the Companies Act, 2013, was misplaced as the restriction on remuneration applied to public companies, not the assessee company. Furthermore, the tribunal acknowledged the efforts of the directors in improving the company's financial metrics, such as reducing expenses and increasing commission income.

In conclusion, the tribunal set aside the order of the CIT(Appeals) and vacated the disallowance of Rs. 13.20 lakh, allowing the assessee's appeal on this ground. The tribunal emphasized the need for the Assessing Officer to adopt the prescribed basis/yardstick for determining the reasonableness of remuneration under Section 40A(2)(a).

Conclusion:

The appeal was partly allowed, with the tribunal vacating the disallowance of director's remuneration, thereby upholding the assessee's claim. The jurisdictional issue was dismissed as not pressed. The tribunal's decision underscored the importance of adhering to statutory provisions and yardsticks when assessing the reasonableness of related-party transactions.

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