Tax department must have respect of taxpayers -estimated disallowance of expenses in case of professionally managed companies- a serious issue.

[DEV KUMAR KOTHARI]

Tax department must have respect of taxpayers -estimated disallowance of expenses in case of professionally managed companies- a serious issue.

The Assistant Commission of Income Tax, Company Circle IV (2) , Coimbatore Versus M/s. Lakshmi Machine Works Ltd. 2015 (8) TMI 358 - ITAT CHENNAI Other Citation: [2015] 38 ITR (Trib) 61 (ITAT [Chen])

About the assesse company:

Before discussing the issue of estimated disallowance, with reference to a reported judgment, it is desirable to know about the assesse in the case M/s. Lakshmi Machine Works Ltd, which is a well-known, popular, very old (ESTABLISHED IN 1962) company which enjoy lot of goodwill amongst all stake holders and others related in any manner.

 Its shares are listed on BSE and NSE. Share of ₹ 10/- each paid-up value is quoted above ₹ 6000/- per share as on 22.02.18 while author is writing this article.

 On BSE, recent share price history is as follows:

52 Week High (adjusted)	6,628.15(08/01/2018)
52 Week Low (adjusted)	3,638.00(22/02/2017)
52 Week High (Unadjusted)	6,628.15(08/01/2018)
52 Week Low (Unadjusted)	3,638.00(22/02/2017)
Month H/L	6,299.00/5,500.00
Week H/L	6,190.00/5,794.00

Recent corporate actions, as seen on BSE website  are as follows:

28/07/2017	Dividend 35.00
07/11/2016	Buy Back of Shares
27/07/2016	Dividend 40.00
31/07/2015	Dividend 37.50
30/07/2014	Dividend 30.00

As per annual reports of company for 2016-17, it has good corporate governance and company is professionally managed company. The prompter’s stake is about 30%. This shows that it is in fact widely held public company. Company has five independent directors and three non-independent directors and one nominee directors of Financial Institutions (as per report of 2017 nominated by LICI).

Company has good system of internal check and control, audits and management information system etc. Company declare periodical reports (quarterly) and file with Stock Exchanges.

The assesse and any other body corporate has to rely on decisions taken by its agents, as it is run through human agency. Where its agents have authorised payment and made the same, it is expenditure of company, in such a situation, the tax authorities must have due regard to the decision making process and spending made by company through its human agents who acted on behalf of company. Even if there is mistake of judgment on part of agent, company has to honour it. Only in rare cases of frauds, company can deny liability incurred by its agents.

Companies must have reasonable documentary evidence for expenses incurred. Reasonableness can be decided in view of amount, place of incurring, nature of expenses, practical aspects etc.

Therefore, in case of companies, having reasonable system of internal check and control, there should not be disallowances of expenses on estimated basis or due to doubts.

Case of    M/s. Lakshmi Machine Works Ltd.

This case involves estimated and adhock disallowances made by the AO. Part of which were deleted by CIT(A) and part of the disallowances were confirmed by the CIT(A). From available information, it appears that the assesse had not challenged disallowance confirmed by the CIT(A) either by filing  independent cross appeal or appeal by way of cross objections. The case was represented by assesse and the A/R has not pointed out any such related appeal which should have been clubbed. Therefore, it can be safely assumed that the assesse has not challenged disallowan On appeal of revenue, Tribunal has confirmed order of CIT(A) allowing some relief and has also  reversed order of CIT(A) and disallowed  some relief allowed by the CIT(A). Tribunal being final fact finding authority, it is finalised that business promotion expenses are disallowed, area development expense are allowed to the extent of 50%. That means some expenses have been disallowed for the reason that assesse could not produce reasonable evidence of such expenses. The assesse did not file appeal against disallowance confirmed by the CIT(A). This may create some doubt about doubtful nature of expenditure or the negligence of concerned persons in not making proper representation and then in not filing appeal.

For the assesse the amount may not be large, but larger aspect is that how expenses have been incurred without proper details and supporting. This also raises doubt about internal check, control and efficiency of audit system in vogue in the assesse company which includes statutory financial audit, Cost audit, and internal under the Companies Act and Tax audit under the Income-tax Act.

The AO has found that any details and supporting were not furnished for business promotion expenses hence he made disallowance.  CIT (A) deleted 50% on estimated basis and confirmed 50% disallowance. On appeal of revenue, full amount has been disallowed.

In relation to disallowance of business promotion expenses Tribunal observed that while allowing 50 per cent. expenditure, the Commissioner of Income-tax (Appeals) has not given any reason. The contention of the assessee is that business promotion expenditure is towards incentives/gifts given to the representatives of customer companies to maintain cordial business relations. However, the assessee has not placed on record the details of the persons to whom such incentives were given. We do not find any reason in allowing even 50 per cent. of such expenditure in the absence of any document or any other evidence. Thus Tribunal decided  the issue against assessee.

It appears to be a case of gross negligence on part of concerned persons. If  order of CIT(A) was challenged and assesse provided details and evidence perhaps disallowance could be deleted.

 Regarding local area development expenditure:

CIT(A) allowed 50 per cent of expenses  on the basis of his personal visit to the site where he made on spot observations and made some enquiries and he has not raised any doubt over the expenditure incurred by the assesse on local area development. Therefore the tribunal held that ‘in the facts of the case, we are not inclined to interfere with the findings of the first appellate authority on this issue and dismissed ground raised by revenue.

It appears that if assesse had challenged order of CIT(A), it was likely that Tribunal could have allowed full expenditure, because CIT(A) had not raised any doubt about expenditure having been incurred.

About accounting, internal check and control and audit systems:

This case places a serious question mark about these aspects. How the details and evidence of certain expenses, which are substantial (not trivial)   could not be produced before the AO and CIT(A). Why the CIT(A) had to visit site and then also he allowed only 50% of expenses and not full expenses on account of local area development?

Why the assesse did not challenge order of CIT(A) and to take a last chance to produce details and evidence so as to justify full allowance of such expenses.

These are serious questions even in case of professionally managed, and highly respected assesse company.

This also emphasises that accounting, internal check and audit systems need to be stronger.