2003 (12) TMI 308 - AT - Income Tax

Summary

Issues Involved:
1. Disallowance of Rs. 4,20,000 as commission paid to directors.
2. Disallowance of Rs. 13,47,894 as interest payable in respect of investments made in M/s Virgo Polymers India Ltd.

Detailed Analysis:

Issue 1: Disallowance of Rs. 4,20,000 as Commission Paid to Directors

The appellant-company, a private limited company manufacturing HDE pipes, filed its return of income admitting 'Nil' income. The assessment was framed under section 143(3). The first issue contested by the appellant is the disallowance of Rs. 4,20,000 as commission paid to three directors, which was confirmed by the CIT(A).

The appellant-company claimed the commission was paid at 5% of the total value of orders secured from M/s Shree Balaji Poly Packs. The company argued that the directors provided personal guarantees for the performance and value of goods, which justified the commission. The directors had declared this commission in their respective returns of income.

The AO disallowed the commission, stating that no specific evidence was provided to support the services rendered by the directors. The CIT(A) upheld this disallowance, suggesting that the commission should have been shown under "guarantee commission" rather than "sales commission."

Upon review, it was noted that the payments were reasonable and declared in the directors' returns. The CIT(A) admitted that the directors offered personal guarantees, which was a common business practice. The AO did not invoke section 40A(2)(a), which deals with excessive or unreasonable payments. The tribunal concluded that the appellant was justified in paying the commission for the guarantees provided, and thus, the disallowance was set aside.

Issue 2: Disallowance of Rs. 13,47,894 as Interest Payable in Respect of Investments in M/s Virgo Polymers India Ltd.

The second issue involved the disallowance of Rs. 13,47,894 as interest payable on investments in M/s Virgo Polymers India Ltd. The AO observed that the appellant claimed a loss in the P&L account due to this investment and disallowed the interest, assuming it was related to borrowed funds.

The appellant argued that the investment was not made from borrowed funds and had no nexus with interest-bearing loans. The CIT(A) upheld the AO's decision, linking the investment with business borrowings.

The tribunal reviewed the submissions and noted that the investment was made before the loan from TIIC was received. There was no evidence that the investment was made from borrowed funds. The tribunal also considered the commercial interest of the appellant, as the investment was made to secure orders from M/s Virgo Polymers, which constituted a significant portion of the appellant's business.

The tribunal found that the investment was a business activity as per the memorandum of association and should not be disallowed. The CIT(A) failed to prove a direct nexus between the borrowed funds and the investment. Additionally, the tribunal considered the alternative plea that the interest should be allowed under section 57(iii) as expenditure for earning income from other sources.

The tribunal concluded that the disallowance of interest was unjustified and quashed the CIT(A)'s order, allowing the appeal in favor of the appellant.

Conclusion:
The tribunal allowed the appeal, setting aside the disallowance of Rs. 4,20,000 as commission paid to directors and Rs. 13,47,894 as interest payable on investments, favoring the appellant-company.