2024 (3) TMI 1151 - AT - Income Tax

Addition u/s 40A(2)(b) - Allegation of excessive and unreasonable salary paid to the relative of partner acting as administrative head - appellant has shown salary payment to the Specified Period and deducted TDS, upon deduction of the same, the remaining amount has been shown as unsecured loan obtained from her - She is the Administrative Head, possesses the degree of Masters in Business Administration from University of Houston-Downtown engaged in looking upon areas related to students like accommodation, food facility, water supply, disciplinary actions etc. of the hostel - HELD THAT - Payment of salary and granting of interest free loan are two different transactions and there is no scope of clubbing the same to attract the provision of Section 40A(2)(b). The same salary would have been given to any other person recruited by the appellant for the said post. Thus, question of diversion of funds or routing of funds does not and cannot arise as these two transactions i.e. payment of salary as well as loan is through journal entry and the amounts stands payable, on the other hand, in the form of creditor or lender as rightly pointed out by the appellant. As Smt. Palak A Shah did not withdraw salary, the amount was lying as unsecured loan as per normal accounting principle. Had the interest been paid the Revenue would have at loss because the appellant firm attracts 30.9% tax whereas Smt. Palak A shah, an employee falls under 20.6% tax slab. Income Tax Authority must put themselves in the shoes of the appellant and to see as to how a prudent businessman would act. The authorities must not look at the matter from their own view point but of a prudent businessman. When the expenditure incurred by the appellant is otherwise deductible but deduction is restricted to a part of the sum by considering such expenditure to be excessive, having regard to the fair market value of the goods or services etc. and so much part of the expenditure is disallowed or in other words, if the expenditure incurred by the appellant is proved by the Ld. AO to be excessive or unreasonable considering the fair market value of the goods or services for which the payment as made the deduction under Section 40A(2)(b) of the Act is permissible. None of the order passed by the authorities below doubted the services so rendered by Smt. Palak A Shah nor alleged to have been paid salary excessive or unreasonable which is sine qua non in invoking the provision of Section 40A(2)(b) of the Act, in the absence of which, the order of disallowance is found to be not sustainable, bad in law and therefore, quashed. Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance of salary expenses u/s 40A(2)(b) of the Income Tax Act, 1961.
2. Allegation of sham transaction and tax evasion.

Summary:

Issue 1: Disallowance of Salary Expenses u/s 40A(2)(b)
The appellant firm paid a salary of Rs. 4,20,000 to Smt. Palak A. Shah, who is a relative of the partner and holds an MBA degree. The Assessing Officer (AO) disallowed this salary expense under Section 40A(2)(b) of the Income Tax Act, 1961, on the grounds that the transaction was collusive and aimed at evading tax. The AO argued that the salary was not paid through bank transactions but was a journal entry, and the amount was later given back as an interest-free unsecured loan to the appellant firm. The AO relied on various judgments to support the claim that the transaction was a sham.

The appellant argued that the salary was paid for genuine administrative work handled by Smt. Palak A. Shah, and the expenditure was incurred wholly and exclusively for business purposes. The appellant also contended that the provisions of Section 37 and Section 40A(2)(b) were not applicable as the salary was not excessive or unreasonable compared to the fair market value.

The Tribunal found that the basic requirement for disallowance u/s 40A(2)(b) is that the expenditure should be excessive or unreasonable, which was not proven by the AO. The Tribunal noted that the salary was paid for actual services rendered, and the appellant firm had deducted and paid the appropriate tax on it. The Tribunal also observed that the payment of salary and granting of an interest-free loan are two different transactions and cannot be clubbed to invoke Section 40A(2)(b).

Issue 2: Allegation of Sham Transaction and Tax Evasion
The AO alleged that the transaction was a sham intended to evade tax, as the salary was not paid through a bank but was a journal entry, and the same amount was given back as an interest-free loan. The appellant countered that the salary was paid for genuine services rendered, and the non-payment through a bank does not determine the allowability of the expense. The appellant also provided details of the total income earned by Smt. Palak A. Shah and the taxes paid, arguing that there was no tax evasion.

The Tribunal referred to multiple judgments, including those by the Hon'ble Supreme Court and various High Courts, which emphasize that the reasonableness of the expenditure should be judged from the point of view of a prudent businessman and not from the AO's perspective. The Tribunal concluded that the AO failed to prove that the salary was excessive or unreasonable and that the disallowance was not sustainable.

Conclusion:
The Tribunal allowed the appeal, quashing the disallowance of salary expenses u/s 40A(2)(b) and ruling that the transaction was genuine and not aimed at tax evasion. The order of disallowance was found to be not sustainable and bad in law. The appeal was allowed in favor of the assessee.