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2016 (2) TMI 834 - HC - Income TaxDisallowance of secret commission - CIT(Appeals) has not disallowed the entire claim but limited it to 1% of the turnover of the assessee - ITAT confirmed disallowance - Held that -CIT(Appeals) making the disallowance limited it to 1% of the turnover of the assessee noticing that the claim of secret commission, had shot up to 7.03% of the turnover for the year under consideration whereas the gross profit rate had gone down from 13.26% to 10.26%. More importantly, it was noticed that as against the net profit of ₹ 6.14 lacs, the assessee claimed to have paid secret commission of ₹ 19.85 lacs. The revenue authorities also noted that the assessee had not kept any accounts or receipts of where and to whom such commission was paid. When these are the parameters which the CIT(Appeals) considered, for restricting the claim, we do not see any reason to interfere in exercise of our jurisdiction to consider substantial question of law - Decided against the assessee.
Issues Involved:
1. Disallowance of Rs. 17,03,055/- claimed as secret commission. 2. Applicability of explanation appended below Section 37(1) of the Income Tax Act to the facts of the case. Detailed Analysis: Issue 1: Disallowance of Rs. 17,03,055/- as Secret Commission Facts and Background: The assessee, a partnership firm engaged in the business of electrical contracting, filed a return of income for the assessment year 1997-98. During scrutiny, the assessee's claim for deduction of Rs. 19.85 lacs as secret commission was questioned by the Assessing Officer (AO). The assessee contended that this commission was paid to employees of different companies to enhance turnover. However, the assessee failed to produce names, addresses, details, or receipts of the recipients, asserting that the entire amount was paid in cash. Assessing Officer's Findings: The AO disallowed the entire claim of Rs. 19.85 lacs, concluding that: - The assessee did not maintain accounts or provide evidence of the payments. - There was a significant rise in the commission rate compared to previous years. - The gross profit ratio had dropped. - The expenditure did not fulfill conditions for deduction under Section 37 of the Income Tax Act, 1961, as it was not established that such payments were made wholly and exclusively for business purposes. CIT(Appeals) Decision: The CIT(Appeals) partially allowed the claim, restricting the allowable expenditure to 1% of total sales, amounting to Rs. 2.82 lacs. The CIT(A) noted: - The expenditure was excessive and not justified. - The gross profit had reduced significantly. - The high expenditure claim without recipient details was against the spirit of taxation policy. Tribunal's Decision: The Tribunal upheld the CIT(A)'s decision, stating that the entire expenditure was not allowable and referred to the explanation to Section 37(1) of the Act, added by Finance (No.2) Act, 1998, with retrospective effect from 01.04.1962. The Tribunal concluded that the secret commission did not constitute permissible business expenditure under Section 37(1). High Court's Analysis: The High Court examined the consistency of the assessee's practice and the principles laid out in previous judgments. It was noted that: - Courts have recognized the allowability of secret commission deductions but placed a heavy burden on the assessee to establish such payments were made for business purposes. - The assessee failed to establish a nexus between the expenditure and business purpose. - The CIT(A) reasonably restricted the claim to 1% of turnover, considering the significant rise in commission and drop in gross profit ratio. Issue 2: Applicability of Explanation to Section 37(1) Assessee's Argument: The assessee argued that the Tribunal erred in applying concepts of morality and expanding the scope of Section 37(1). The explanation to Section 37(1) was not applicable as the recipients were employees of private companies, not government employees, and the commission was not barred by law. Revenue's Argument: The Revenue contended that the entire expenditure was not allowable as the assessee failed to prove that the expenditure was made exclusively for business purposes. High Court's Conclusion: The High Court found that the Tribunal's reference to the explanation of Section 37(1) might not be warranted. However, the final outcome of confirming the CIT(A)'s decision to restrict the deduction to Rs. 2.82 lacs was upheld. The High Court did not interfere with the CIT(A)'s parameters and reasoning, thus answering the substantial question of law in the negative and dismissing the tax appeal. Conclusion: The High Court upheld the CIT(A)'s decision to restrict the secret commission deduction to Rs. 2.82 lacs, confirming that the assessee failed to establish the expenditure as wholly and exclusively for business purposes. The Tribunal's broader reasoning was not approved, but the final outcome was affirmed. The tax appeal was dismissed.
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