2005 (8) TMI 285 - AT - Income Tax

Disallowance of commission - excessive and unreasonable portion in the total commission payment - legitimate need of the business - HELD THAT - In the present case, neither the Assessing Officer nor learned CIT(A) has given any finding as to what is the excessive or unreasonable portion in the total commission payment. There is no finding on what is the legitimate need of the business. Both the authorities have gone by the principle that since in the earlier year the amount paid was .94 per cent, the excess becomes unreasonable. In our opinion, this approach is not correct. There is no presumption that whatever was paid in earlier year only becomes reasonable and anything in excess becomes unreasonable. There may be several reasons that the assessee may pay lower commission in initial years. However, the finding, which is required, is what is the reasonableness or excessiveness for the year under appeal. Looking to the background of Shri Sharma and the nature of services rendered by him, we find that payment of commission at 2 1/2 per cent cannot be considered as excessive or unreasonable. The partners of the firm are merely female partners whereas Shri S.K, Sharma is an influential person, who retired from M/s. MICO Ltd. as Senior Vice President and is able to influence the said company, which is one of the top most customers of the appellant-firm. We accordingly hold that no part of commission can be disallowed invoking the provision of section 40A(2) of the Act. In the result, the appeal is allowed.

Issues Involved:

1. Disallowance of commission paid to Mr. S.K. Sharma under section 40A(2) of the Income Tax Act.

Detailed Analysis:

1. Disallowance of Commission Paid to Mr. S.K. Sharma:

The appeal concerns the disallowance of commission paid to Mr. S.K. Sharma, the husband of one of the partners of the assessee-firm, invoking section 40A(2) of the Income Tax Act. The appellant firm, a manufacturer of automobile and engineering components, paid Mr. Sharma a commission at 2.5% of the total sales turnover, in addition to his salary and conveyance charges. The Assessing Officer (AO) deemed this commission excessive and unreasonable, comparing it to the previous year's commission rate of 0.94%. Consequently, the AO disallowed Rs. 8 lakhs of the total Rs. 12.83 lakhs commission paid, asserting that the payment was not justified by the firm's legitimate needs or the services rendered.

The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, emphasizing the lack of evidence supporting the claim that Mr. Sharma's influence and services justified the increased commission rate. The CIT(A) reiterated that the reasonableness of expenditure should be judged based on the services rendered, the legitimate needs of the business, and the benefit derived by the taxpayer.

Arguments by the Assessee:

The assessee argued that Mr. Sharma, a highly qualified technocrat with significant influence and contacts in the automobile industry, provided essential services that justified the commission. They contended that the AO failed to determine the fair market value of the services rendered and did not find the payment illegitimate. The assessee cited judicial precedents, including the Supreme Court's decision in Shahzada Nand & Sons v. CIT and the Gujarat High Court's decision in Voltamp Transformers (P.) Ltd. v. CIT, arguing that the reasonableness of payment should be judged from a businessman's perspective, not the revenue authorities' viewpoint.

Arguments by the Revenue:

The Department's representative supported the disallowance, arguing that the assessee failed to justify the significant increase in the commission rate from 0.94% to 2.5%. The onus was on the assessee to prove the genuineness of the payment, which they failed to do.

Tribunal's Analysis:

The Tribunal analyzed the provisions of section 40A(2), which restricts the deductibility of expenses paid to certain related persons if deemed excessive or unreasonable. The Tribunal noted that the AO must determine the fair market value of the services, the legitimate needs of the business, and the benefit derived by the taxpayer. The Tribunal emphasized that the reasonableness should be judged from a businessman's perspective, not merely based on the previous year's commission rate.

The Tribunal observed that neither the AO nor the CIT(A) provided specific findings on the excessive or unreasonable portion of the commission. Both authorities relied on the previous year's commission rate without considering the legitimate needs of the business or the services rendered by Mr. Sharma. The Tribunal acknowledged Mr. Sharma's influential background and the significant role he played in securing orders and managing business relations, particularly with MICO Ltd., a key customer.

Conclusion:

The Tribunal concluded that the payment of commission at 2.5% was not excessive or unreasonable, given Mr. Sharma's qualifications and the services he rendered. The Tribunal held that no part of the commission should be disallowed under section 40A(2) and allowed the appeal in favor of the assessee.

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