2023 (5) TMI 35 - AT - Income Tax

Disallowance of expenditure on salary and wages - establishment of nexus between the expenditure and the purpose of business - CIT-A deleted addition on finding it as not sustainable in law - HELD THAT - Trite law that the burden to prove it s return, and the claim/s preferred thereby, is on the assessee, who only is in the intimate know of his affairs - The onus to show so, which is on the assessee, is to be discharged before the assessing authority, i.e., the authority designated and charged by law to frame an assessment under the Act. The assessee s claim in the instant case is wholly unsubstantiated. No explanation, much less material, stands furnished before the AO. How, pray, could his action be faulted within law ? He was accordingly well within his powers to make a reasonable estimate and disallow what he regarded as excessive or as not explained. It is well-settled that while exclusively concerns the purpose for which the expenditure is incurred, the word wholly adverts to its quantum, so that, where called upon to, as in the instant case, the entire of it is shown to have been incurred for purposes of business to merit deduction u/s. 37(1) in its respect. CIT(A) as an appellate authority, as indeed the assessing authority himself, could proceed only on the basis of the material on record, while in the instant case the AO, none of whose findings, we reiterate, are controverted, clearly states that the assessee, despite being called upon to, did not furnish any material or explanation, failing to provide even the basic data, viz., the person-wise details. The same, along with their function ought to have been furnished by the assessee at the minimum; rather, vis- -vis the preceding year, explaining the reasons for the quantum increase therein. It is then said that the expenditure on salary and wages is not liable to vary in direct proportion as well. The same does not help the assessee s case in any manner. It does not, firstly, absolve the assessee from proving the claimed expenditure as having been incurred wholly and exclusively for the purpose of its business. Two, the argument could equally validly be advanced to disallow the entire increase in expenditure (over the preceding year), allowing only that incurred during the preceding year inasmuch as the increase in volume may not translate into an increase in expenditure as well. That is, the argument is neither here nor there, and stands made only to mislead. We have no hesitation in, setting aside the impugned order, vacate the findings by the first appellate authority, and restore that of the AO. The impugned disallowance is sustainable in law, and is accordingly, restored in result. Any consequent change in the exemption u/s. 10AA, if and to the extent exigible, shall be made by the AO. Increase of 27% in the salary and wages expenditure - AY 2011-12 - HELD THAT - As the increase in sales vis-a-vis the preceding year is at 17.38%, and not at 27%, a constancy of material cost w.r.t. the preceding year leads to a presumption of constancy of manufacturing operations. Increase in labour cost, claimed at 1% of sales for AY 2009-10, would require being justified on the basis of new processes added, besides of course the increase in labour rate over time, which may be more or less of that obtaining for the goods sold and the cost of tools, moulds and prototypes, including material and labour cost thereon; with the latter including that incurred in-house as well, may require being capitalised as part of cost of acquisition thereof, where not held as stock-in-trade but as capital asset/s. In view of the foregoing, we only consider it proper to, in the interest of justice, restore the matter of allowance of the assessee s claim for salary and wages for this year (AY 2011-12) back to the file of the AO for fresh determination. The assessee, who shall have to prove the same on the anvil of s. 37(1), would be at liberty to adduce materials in support of it s contentions, as indeed the AO to cause verification, including adducing that in contradiction thereof.The incidental claim for depreciation, where the moulds, prototypes, etc., where found as held as capital assets, shall also be considered as per law.

Summary

Issues Involved:
1. Validity of the disallowance of expenditure on salary and wages.
2. Assessment of the genuineness and reasonableness of the claimed expenditure.
3. Application of legal precedents and principles under Section 37(1) of the Income Tax Act, 1961.

Summary:

Issue 1: Validity of the Disallowance of Expenditure on Salary and Wages

The Revenue challenged the orders by the Commissioner of Income Tax (Appeals)-1, Kochi, which dismissed the appeals contesting the assessments under section 143(3) of the Income Tax Act, 1961, for assessment years 2010-11 and 2011-12. The primary issue was the disallowance of expenditure on salary and wages by the Assessing Officer (AO), which was deleted by the CIT(A) on finding it unsustainable in law. The assessee, a company in Cochin Special Economic Zone, claimed a significant increase in salary and wages expenditure, which the AO found abnormal and disallowed the excess amount due to lack of explanation and supporting materials from the assessee.

Issue 2: Assessment of the Genuineness and Reasonableness of the Claimed Expenditure

The AO allowed an increase of 20% over the previous year's expenditure and disallowed the balance. The CIT(A) allowed the assessee's claim, citing that the AO did not dispute the incurrence of the expense but questioned its reasonableness. The CIT(A) relied on the Supreme Court decision in S.A. Builders vs. CIT, which stated that the Department cannot sit in judgment over the businessman's decision if there is a nexus between the expenditure and the business purpose. The Revenue, however, argued that the CIT(A) failed to consider the genuineness of the transactions and the onus on the assessee to prove the claims.

Issue 3: Application of Legal Precedents and Principles under Section 37(1)

The Tribunal emphasized that the burden of proof lies on the assessee to substantiate its claims under Section 37(1). The AO was within his rights to make a reasonable estimate and disallow the excessive claim due to lack of substantiation. The Tribunal noted that the AO had made a reasonable estimate based on available records, and the CIT(A) erred in accepting the assessee's unsubstantiated claim. The Tribunal restored the AO's disallowance for AY 2010-11, finding it sustainable in law.

AY 2011-12 Specific Findings:

For AY 2011-12, the AO observed a further increase in salary and wages expenditure, which the assessee attributed to outsourced contract labor for development activities. The AO allowed an increase of 30% and disallowed the excess. The Tribunal found the assessment order inconsistent and restored the matter to the AO for fresh determination, allowing the assessee to substantiate its claims with relevant materials.

Conclusion:

The Tribunal allowed the Revenue's appeal for AY 2010-11 and remanded the issue for AY 2011-12 back to the AO for fresh assessment, emphasizing the need for the assessee to substantiate its claims with appropriate evidence.