1987 (7) TMI 126 - AT - Income Tax

Summary

Issues Involved:
1. Legitimacy of the deduction claimed by the assessee for payments made to outgoing partners.
2. Applicability of Section 40A(2) and Section 40A(8) of the IT Act, 1961.
3. Business expediency and commercial rationale behind the payment arrangement.
4. Tax evasion and the genuineness of the transaction.
5. The proper exercise of jurisdiction by the CIT under Section 263 of the IT Act, 1961.

Detailed Analysis:

1. Legitimacy of the Deduction Claimed by the Assessee:
The core issue revolves around the deduction of Rs. 7,93,187 paid to the outgoing partners. The CIT argued that the payment was not justified and was prejudicial to the interests of the revenue. The CIT believed that the payment was essentially a sharing of profits and not a deductible business expense. The assessee, on the other hand, contended that the payment was made as per the dissolution deed and was a legitimate business expense.

2. Applicability of Section 40A(2) and Section 40A(8):
The CIT considered the payment excessive and unreasonable under Section 40A(2), given the close relationship between the payer (the company) and the payees (the outgoing partners who were also directors). Additionally, the CIT argued that Section 40A(8) was applicable, treating the retained amount as a "deposit". The Tribunal, however, found that Section 40A(8) was not applicable since the payment was based on a percentage of profits rather than interest on deposits.

3. Business Expediency and Commercial Rationale:
The CIT questioned the commercial rationale behind retaining Rs. 6 lakhs at a high cost. The CIT noted that the company had sufficient funds and could have raised money through other means, such as bank loans or issuing shares. The assessee countered by highlighting its financial constraints and the necessity to retain funds for business operations. The Tribunal acknowledged the financial constraints but found the terms of the arrangement unreasonable and irrational, ultimately allowing only 50% of the claimed deduction.

4. Tax Evasion and Genuineness of the Transaction:
The CIT implied that the arrangement might be a device to evade tax. However, the Tribunal found no evidence of tax evasion, noting that the outgoing partners were already in a high tax bracket. The Tribunal ruled that the transaction was genuine and not a colorable device to avoid tax.

5. Proper Exercise of Jurisdiction by the CIT under Section 263:
The Tribunal agreed that the CIT had rightly invoked his powers under Section 263, as the ITO had not exercised due diligence in examining the high-value deduction claim. The Tribunal, however, criticized the CIT for not pinpointing the exact provision under which the disallowance was made, ultimately deciding the issue on merits to cut short the litigation.

Conclusion:
The Tribunal upheld the CIT's jurisdiction under Section 263 but modified the disallowance. It allowed 50% of the claimed deduction, disallowing the remaining 50% as excessive under Section 40A(2). The Tribunal found that Section 40A(8) was not applicable and directed the ITO to verify the correct figure while giving effect to the order. The assessee's appeal was partly allowed.