AO to disallow under sec 40A((2)(b) should establish that the benefits given to the related party more than the faire market value

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI ‘G’ BENCH

BEFORE SHRI G.C. GUPTA,VP AND SHRI A.N. PAHUJA,AM

ITA no.4631/Del. /2011

Assessment year: 2008-09

DCIT,Ci rcle-9(1),Room

no.163, C.R. Bui lding, IP

Estate, New Delhi

(Appellant)

Vs.

M/s Spark Hotels Pvt . Ltd. ,

B-6/17, Safdarjang Enclave,

New Delhi

[PAN AAJCS 6454 Q]

 (Respondent)

Assessee by None

Revenue by Smt. Surjani Mohanty,DR

Date of hearing 07-06-2012

Date of pronouncement 22-06-2012

O R D E R

A.N. PAHUJA:-

This appeal filed on 20.10.2011 by the Revenue against an order dated 29.06.2011 of the CIT(A)-XII, New Delhi, raises the following grounds:-

1) “The ld. CIT(A) erred in law and on facts of the case in deleting the addition of ``30 lacs on account of Directors remuneration by invoking the provisions of section 40A(2)(b).

2) The appellant craves to amend, modify, alter, add or forgo any ground of appeal at any time before or during the hearing of this appeal.”

2. At the outset, none appeared before us on behalf of the assessee nor submitted any request for adjournment. Considering the nature of issue and findings of the ld. CIT(A), the Bench proceeded to dispose of the appeal after hearing the ld. DR.

3. Facts, in brief, as per relevant orders are that return declaring nil income after adjusting brought forward loss of ``10,74,016/-. under the normal provisions and book profits of `8,67,496/- in terms of the provisions of section 115JB of the Income-tax Act, 1961 (hereinafter referred to as the Act) filed on 22.09.2008 by the assessee, running a hotel, was selected for scrutiny with the service of a notice u/s 143(2) of the Act. During the course of assessment proceedings, the Assessing Officer[AO in short] noticed that even though the assessee was engaged in the business of hotel, the assessee derived income only from interest-``50,06,561/- and dividend- ``96,21,236/- in the year under consideration while the assessee paid salary of `36 lacs to its director Shri Patanjali Keswani, Director @ `3 lacs per month. Total expenses claimed against interest income were `41,37,764/-. In the light of these facts, to a query by the AO, seeking explanation as to reasonableness of salary paid to the director in terms of provisions of the section 40A(2)(a) of the Act, the assessee replied that Shri Patanjali Keswani was a highly qualified individual, having B.Tech. from IIT and MBA from IIM beside having a experience of 15 years in Taj Group Hotels as chief operating Officer and Vice President with A.T. Kearney Inc. as their Director India. The remuneration paid to shri Keshwani was due to business exigencies and substantial profits were earned by the assessee company. Moreover, the assessee raised funds to the tune of ``28.93 crores, deployed in giving loans, making investment in mutual funds and setting up of hotels. Since shri Keshwani was paying tax at maximum rates, it could not be said that payment of remuneration was made to avoid taxes. However, the AO did not accept the submissions of the assessee and disallowed an amount of ``30 lacs, invoking the provisions of sec. 40A(2)(a) of the Act, considering the salary of ``50,000/-pm paid to shri Keshwani, reasonable.

4. On appeal, the assessee reiterated their submissions before the AO while relying upon decisions in Beta Naphthol (P) Ltd. Vs. Dy. CIT, 50 TTJ (Ind.) 375; Hathiwala Silk Mills Vs. Income-tax Officer,19 TTJ (Ahd.) 284; Shriram Pistons & Rings Ltd. Vs. IAC,39TTJ (Delhi) 132 and CIT Vs. Walchand & Co. (P) Ltd., 65 ITR 381 (SC).Inter alia, it was contended that an employer fixing the remuneration, is entitled to consider the extent of business, the nature of duties to be performed, the special aptitude of the employee, future prospects of extension of the business and a host of other related circumstances. It is erroneous to think that increased remuneration can only be justified if there is a corresponding increase in the profits of the employer. Accordingly, it was argued that disallowance made by the AO be deleted. In the light of these submissions, the ld. CIT(A) deleted the addition, holding as under:-

“After considering the submissions given by the appellant as well as observations made by the Assessing Officer I am of the opinion that in order to make disallowance u/s 40A(2)(b) it is necessary that the Assessing Officer should establish that benefits given to the related parties are more than the fair market value. In this case the Director Keshwani himself is a professional as he is B-Tech from IIT and as well as MBA from IIM along with experience in Taj Group of Hotel

as Chief Operating Officer and Vice President with A.T. Kearney Inc. as their Director India. The Director himself is a professional who with his professional expertise steered the company and earned profits well while comparing with the last two years.Hence, the addition of 30 lacs is deleted”

5. The Revenue is now in appeal before us against the aforesaid findings of the ld. CIT(A).The ld. DR supported the assessment order while relying upon the decision in CIT vs. Eastern Condiments (P) Ltd., 325 ITR 251 (Kerala).

6 We have heard the learned DR and gone through the facts of the case. As is apparent from the aforesaid facts, the issue before us is as to whether remuneration paid to director of the company is excessive and unreasonable and therefore ,could be disallowed u/s 40A(2)(a) of the Act. The AO disallowed an amount of `30 lacs out of total salary of `36 lacs, in terms of provisions of sec. 40A(2)(a) of the Act while the ld. CIT(A) deleted the disallowance. Before proceeding further, we may refer to the provisions of section 40A(2) (a) of the Act, the relevant portion of which read as follows:

"40A(2)(a). Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and theAssessing Officer is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing, to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction."

6.1 A mere glance at the aforesaid provision reveals that the expenditure mentioned therein is in relation to any person referred to in clause (b) of the subsection and the expenditure has to be considered in relation to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to the assessee therefrom. Hon’ble Gujrat High Court observed in Coronation Flour Mills vs. ACIT,188 Taxman 257 that in relation to the disallowance under the provisions of section 40A(2)(a) of the Act, a plain reading of the provision reveals that where an assessee incurs any expenditure in respect of which payment is required to be made or has been made to any person referred to in clause (b) of section 40A(2) of the Act and the AO is of the opinion that such expenditure is excessive or unreasonable having regard to (a) fair market value of the goods, services or facilities for which the payment is made; or (b) the legitimate needs of the business of the assessee; or (c) the benefits derived by or accruing to the assessee on receipt of such goods, services or facilities, then the AO shall not allow as a deduction so much of the expenditure as is so considered by the AO to be excessive or unreasonable. Therefore, it becomes apparent that the AO is required to record a finding as to whether the expenditure is excessive or unreasonable in relation to any one of the three requirements prescribed, which are independent and alternative to each other. All the three requirements need not exist simultaneously. In a given case, if any one condition is shown to be satisfied the provision can be invoked and applied, if the facts so warrant. Thus, only so much of the expenses, if paid to a person referred to in clause (b), are allowable which are found to be not excessive and unreasonable and the excessive or unreasonable portion has to be disallowed. It is well settled that the provisions of section. 40A(2)(a) of the Act cannot have any application unless it is first concluded that the expenditure was excessive or unreasonable, as held in the case of Upper India Steel Manufacturing And Engineering Co. Private Limited, 117 ITR 569(SC). In the instant case, there is nothing to suggest that the AO found the payment of remuneration to director excessive having regard to either (a) fair market value of the services or facilities; or (b) the legitimate needs of the business of the assessee; or (c) the benefits derived by or accruing to the assessee on receipt of such services or facilities. The AO while making the disallowance observed that isallowance was made keeping in view quantum and nature of business of the assessee. But how quantum or nature of business affected payment of salary to its director, has not been elaborated. No businessman can be compelled to maximize his profit. The income-tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. Not a whisper has been made by the AO in respect of any of these three ingredients in his assessment order. There is nothing to suggest that the AO ever brought any material on record on this aspect before concluding that remuneration @ `3 lacs pm was excessive or unreasonable nor even cited any comparable instances in respect of the fair market value of the services rendered by the director.

6.2 Now we may have a look at the decision in Eastern Condiments (P) Ltd(supra) relied upon by the ld. DR. In the said case, the assessee-company was engaged in the manufacture and export of spices. Export was done by a proprietorship concern of the managing director of the assessee-company. Though normal commission paid by the assessee for marketing its products was at 5 per cent, for the sales effected to the proprietorship concern of the managing director, the assessee paid commission at 10 per cent and claimed the same as deduction on the ground that additional commission was attributable to the packing cost incurred by the managing director. The AO noticed that the managing director had purchased machinery for packing in December, 2000 whereas exports were made by him from April, 2000 onwards. He further noted that goods, while in transit from the assessee to the managing director, straightway went to the export stream. Therefore, he disallowed additional 5 per cent commission paid to the managing director which was confirmed by the Commissioner (Appeals). On second appeal, the Tribunal, however, allowed the claim of the assessee. On further appeal, the Hon’ble High Court found that the Tribunal had not cared to consider any of the findings of the AO and had assumed the claim of the assessee that the additional discount was attributable to the packing cost incurred by the managing director, as true. In order to prove that the managing director was left with packing for export and sale of the commodity locally, it was for the assessee to prove that sales were in bulk quantity and the managing director was engaged in the packing. The finding of the AO was that the managing director had purchased certain machinery only in December, 2000 whereas goods purchased from the assessee were from April, 2000 onwards. It was the further finding of the AO that the goods, while in transit from the assessee to the managing director, straightway went to the export stream which was impossible unless the goods were in packed condition., nor was there any finding by the Tribunal that the managing director had maintained even a single facility for packing. In the light of these observations, the Hon’ble High Court remanded the matter to the AO for giving an opportunity to the assessee as well as to the managing director to prove that packing was done by the managing director to justify additional discount granted and if the assessee failed to do so, disallowance could be made in the assessment. Now how this decision helps the Revenue ,has not been explained by the ld. DR.A mere glance at this decision reveals that facts and circumstances in the said decision are altogether different from the facts and circumstances of the case, especially when the AO nowhere established that the remuneration to director was excessive having regard to either (a) fair market value of the services or facilities; or (b) the legitimate needs of the business of the assessee; or (c) the benefits derived by or accruing to the assessee on receipt of such services or facilities. Thus, reliance on the aforesaid decision is misplaced.

6.3 In view the foregoing, especially when there is no material on record to hold that payment of remuneration @ `3 lacs pm to the director was excessive or unreasonable, we have no hesitation in upholding the findings of the ld. CIT(A). Therefore, ground no. 1 in the appeal of the Revenue is dismissed.

7. No additional ground having been raised before us in terms of residuary ground no. 2 in the appeal, accordingly, this ground is dismissed.

8. No other plea or argument was made before us.

9. In the result, appeal is dismissed.

Order pronounced in open Court

                                                        Sd/-                          Sd/-

                                               (G.C. GUPTA)        (A.N. PAHUJA)

                                            VICE PRESIDENT ACCOUNTANT MEMBER

NS

Copy of the Order forwarded to:-

1. Assessee

2. DCIT,Ci rcle-9(1) ,Room no.163, C.R. Building, New Delhi

3. CIT concerned

4. CIT(Appeals)-XII, New Delhi

5. DR, ITAT,’G’ Bench, New Delhi

6. Guard File.

By Order,

Deputy/Asstt.Registrar

ITAT, Delhi