SAMKEET ARYA HOMES LLP,AHMEDABAD vs. THE ITO, WARD-3(3)(5), AHMEDABAD

PER SIDDHARTHA NAUTIYAL - JUDICIAL MEMBER:

This appeal has been filed by the Assessee against the order passed by the Ld. Commissioner of Income Tax (Appeals), (in short “Ld.
CIT(A)”), National Faceless Appeal Centre (in short “NFAC”), Delhi vide order dated 27.12.2023 passed for A.Y. 2017-18. 2. The assessee has taken the following grounds of appeal:-

“1. The Ld. CIT(A) has erred in law and on facts by considering the non-compete fees amounting to Rs. 38,00,000/- to be a capital expenditure without considering the nature of the expenditure.

Ground Number 1: disallowance of non-business expenditure of ₹38,00,000/-

The size of the restriction zone was found inadequate by the Assessing
Officer and he was of the view that the payment had been made only to divert the assessee firm's income. During the assessment proceedings, the assessee submitted that the payment of Rs. 76,00,000/- was decided based on the business partners' collective experience in the real estate sector. The decision was made by the continuing partners, who considered the significant reputation and past success of Shri Paras Pandit in the field, which the partners of the assessee firm believed could hinder their ongoing project in case he launched a competing project within the area. The assessee submitted that such business decisions, including the terms of the non-compete agreement and the associated payment, were based on the partners' judgment, expertise, and experience in the industry. The assessee further submitted that the Assessing Officer, could not question the business decisions of the assessee firm, which were mutually agreed upon by all partners. However, the Assessing Officer noted that while the assessee mentioned the decision was based on the partners' experience, there was no concrete evidence of the successful projects led by Shri Paras
Pandit to justify the large payment made to him as non-compete fee.
Further, the lack of any valuation process or other evidence indicating that the payment of Rs. 76,00,000/- was genuinely beneficial to the assessee firm raised doubts about the legitimacy of the expense. The Assessing
Officer noted that the assessee firm was incorporated only on 19.11.2014, and during the subsequent Assessment Years (2015-16 and 2016-17), the assessee firm had reported no income. In AY 2017-18, the assessee declared a loss, and in AY 2018-19, the assessee again reported no income.
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Given the assessee firm’s lack of significant business activity, the Assessing Officer was of the view that it seemed unreasonable for the assessee firm to pay such a substantial sum to a retiring partner without any prior business dealings between them that could justify the expense.
After considering all the arguments and facts, the Assessing Officer held that the Rs. 38,00,000/- claimed in AY 2017-18 was non-business expenditure and should not have been allowed as a deduction. Therefore, the amount was disallowed and added back to the total income of the assessee firm.

“7. Heard both the parties and perused all the relevant material available on record.
It is pertinent to note that the assessee being limited liability partnership firm entered into retiring partner Shri Paras C. Pandit and paid total of Rs.70,00,000/- as non- compete charges for two years i.e. A.Y. 2017-18 & 2018- 19 equally Rs.38,00,000/- approximately for each year. From the perusal of the Assessment Order the Assessing
Officer has never disputed that Shri Paras C. Pandit has paid the taxes on the amount received by him through the assessee i.e. Limited Liability Partnership Firm. The non- compete clause was a strategy clause entered by the assessee LLP with Shri Paras C.
Pandit in respect of ensuring the competitive element as well as profit element. The decision relied by the Revenue in case of Gillanders Case has not taken into account the same and in fact the decision of Hon’ble Apex Court in the case of Shiv Raj Gupta clearly set out when the non-compete fee is paid only to the particular person in respect of considerable knowledge, skill, expertise and specialisation of that person in the field of the business of that of the assessee. There is no doubt that this has impact on assessee’s business and its profit for almost two years. The compensation received by Shri Paras C. Pandit for not being the partner to be assessee firm was Revenue receipt whereas compensation received for refraining carried on competitive business was capital receipt but in this case compensation received for refraining from carrying competitive business cannot be taken into account as assessee paid the non-compete fee to the extent of 2 years period and that also on the threshold of retiring of the partner i.e. Shri Paras C. Pandit. Thus, the assessee firm has rightly claimed the same as well. The CIT(A) has totally ignored the unique facts of assessee’s case and relied on the decision of Hon’ble Gujarat High Court in the case of PCIT vs. Ferromatic
Milacron India (P.) Limited (supra) which is totally different set of facts. It is further observed that the Department not only received the tax in the very first year from the assessee but also got higher amount of tax from Shri Paras C. Pandit as surcharge payable was higher in individual compared to the firm and thus there was no revenue loss to the Department on account of this transaction. Non-complete consideration under Section 28(VA) of the Act is considered as income and, therefore, the assessee has rightly claimed the same as expenditure as the source of the profit or income of profit-making apparatus remains untouched and unaltered. The decision of Hon’ble
Gujarat High Court in the case of Smartchem Technologies Limited (supra) categorically mentions that the expenditure incurred for the purpose which is set out primarily and essentially related to the operation or work of the firm (LLP partnership firm) constituted the profit earning apparatus of the assessee is in the nature of revenue expenditure. Thus, in the present case, the assessee paid the non-compete fees to Shri
Paras C. Pandit and, therefore, it is in nature of revenue expenditure. Hence, the disallowance of non-compete fees expenditure by the Assessing Officer and the CIT(A) is not justified. Thus, appeal of the assessee is allowed.”

(notably the assessee firm had paid non-compete fee to the retiring partner over two assessment years i.e. 2017-18 and 2018-19) and for assessment year 2018-19, the Ahmedabad Tribunal in assessee’s own case has held that the aforesaid payment is allowable to the assessee firm, as revenue expenditure. Respectfully following the above decision of Ahmedabad
Tribunal in assessee’s own case, Ground Number 1 of the assessee’s appeal is allowed.

Ground Number 2: Addition towards unexplained credit u/s 68 of the Act

18, Rs. 1,56,000/- for AY 2016-17, and did not file return of income for AY 2015-16. On review of her bank statement Assessing Officer observed that she received an amount of Rs. 15,00,000/- on 21.07.2016, and transferred the same amount to the assessee the following day. Despite a summons being issued to her, she failed to appear before the Ld.
Assessing Officer. The assessee did not submit any further documentation to prove Bhartiben Patel’s creditworthiness. Her only declared income was Rs. 1,02,000/- from tuition and Rs. 1,578/- from bank interest, aside from the interest paid by the assessee. Further Assessing Officer noted that an examination of her bank statement showed that her average balance ranged from Rs. 1,400/- to Rs. 12,000/-, and no significant transactions were found apart from the loan to the assessee. Moreover, she did not show any repayment on an unsecured loan she had allegedly received, casting serious doubt on her financial capacity. Given these facts, the creditworthiness of Bhartiben Patel could not be proved, and thus the interest paid to her was disallowed. The Assessing Officer further observed that Pravinbhai M. Makwana (HUF) gave a loan of Rs. 27,00,000/- to the assessee firm, however, the reported income was only Rs. 3,58,930/- in AY 2017-18. On reviewing his income computation, it was evident that most of the income consisted of interest credited by the assessee firm, amounting to Rs. 2,75,441/-. As a result, the creditworthiness of the HUF was not established, and the interest paid to them was disallowed. Further, the Assessing Officer observed that Ms. Preeti Nilam Doshi provided a loan of Rs. 6,80,000/- to the assessee firm, despite reporting only Rs.
62,920/- in income for AY 2017-18. Her bank statement indicated a Samkeet Arya Homes LLP vs. ITO
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minimal opening balance of Rs. 655/- and no significant transactions until she received Rs. 6,70,144/- on 04.05.2016, which was transferred to the assessee on the same day. Furthermore, there was a cash deposit of Rs.
2,00,000/- on 21.12.2016, which was transferred the next day, but there were no substantial other transactions. Her only reported income was interest of Rs. 73,038/-, of which Rs. 65,629/- was credited by the assessee firm itself. Given the lack of proof regarding her financial standing, the creditworthiness could not be established, and the interest paid was not allowed. The Assessing Officer noted that Shri Darshit Dilip
Patel lent a sum of Rs. 53,75,000/- to the assessee firm, however, his declared income for AY 2017-18 was a mere Rs. 10,290/-. A review of his bank statement revealed that he received Rs. 42,00,000/- on 19.04.2016, which he transferred to the assessee on 21.04.2016. Despite the summons issued to him, he did not appear to verify the source of these funds. His bank records also indicated cash deposits of Rs. 2,00,000/- in March 2016
and November 2016, which were not reflected in his tax returns. As the creditworthiness of Darshit Patel could not be proved, the interest paid to him was also disallowed by Ld. Assessing Officer. The Assessing Officer noted that Shri Raj Swetalbhai Shah gave Rs. 13,20,000/- as a loan to the assessee firm, but he did not file income tax returns. His bank statement showed that he received Rs. 13,18,724/- on 20.04.2016 and transferred almost the same amount to the assessee the next day. Despite being issued a summons, he did not appear to provide any clarification on the transaction. His average bank balance was found to be minimal, between
Rs. 1,500/- and Rs. 10,000/-, and he did not have a PAN number. Since
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Raj Swetalbhai Shah did not provide any evidence to prove the legitimacy of the loan, his creditworthiness was unproven, and the interest paid to him was disallowed. The Assessing Officer made similar observations with regards to other lenders as well and was of the view that their creditworthiness was not adequately proven by the assessee. Accordingly, the Assessing Officer was of the view that the assessee failed to establish the creditworthiness of the persons who provided unsecured loan to the assessee, since the persons had either meagre income or were having no regular source of income and were not in a position to give such huge loans to the assessee. Accordingly, the amount of unsecured loans taken from the above persons and the interest paid/credited thereon to them by the assessee, amounting to ₹1.77 crores were added as unexplained income of the assessee under section 68 of the Act.

“6.4 Grounds no. 2 and 3 are against the addition of Rs. 1,77,24,909/- u/s 68, comprising of unsecured loans received from (and interest paid disallowance) 7
parties. The details of these parties and the reasons for holding that loans shown from these parties are not genuine are reproduced at Para 4.4 to 4.6 above. The appellant has stated that it has discharged the primary onus cast upon it u/s 68 as it has furnished the confirmations from these parties, filed their PAN and ITR details and shown transfer of loan amount from their bank accounts. Section 68 requires three limbs to be proved for any credit entry appearing the books of an assessee: (i) identity of the creditor (ii) creditworthiness and (iii) genuineness of the transaction. It is true that the prima facie onus has been sought to be discharged by furnishing confirmations, PANs,
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entry appears and cheque of the same or very similar amount of then drawn in the name of the appellant and the bank balance then goes back to its previous nominal amount thereafter.”

The absence of evidence linking the loan to the assessee’s unreported income renders an addition under Section 68 unwarranted. It was submitted that the assessee has complied by providing statements of income and bank details showing sufficient funds available with the lenders at the time of the loan. The average bank balance of the lenders is not determinative of the creditworthiness of the lenders, as the lenders may have had access to other sources of funds. Further, the Counsel for the assessee submitted that the assessee’s LLP, which was formed in FY 2014-
15, had not engaged in business activities prior to the relevant real estate project starting in 2016. Therefore, the question of unreported income prior to FY 2016-17 does not arise, as no customer funds were received before that period. The AO accepted the assessee's details regarding the project and revenue during the assessment stage without raising any doubts about the sales values or collections from members. Thus, the assumption that the loan amounts represent undisclosed income is unsupported by any evidence.

on several judicial precedents in support of his contention. Section 68 of the Act mandates that three key aspects must be proven for any credit entry in the books of an assessee: first, the identity of the creditor; second, the creditworthiness of the creditor; and third, the genuineness of the transaction. While the assessee submitted that it has met the initial onus by giving the relevant documentation, in our view, the creditworthiness of the creditors has not been sufficiently established. We note that the Assessing
Officer reviewed the ITRs and bank statements of these creditors and held that they are individuals with limited financial means, making it questionable that they could have lent the amounts reflected in the assessee's books. The A.O. and Ld. CIT(Appeals) did not issue a blanket judgment but instead provided detailed findings on the financial status of each of the creditors. Additionally, the common trend amongst the lenders was that the bank statements of all creditors displayed a similar pattern: the credit balances were modest, a credit entry appeared, followed by the withdrawal of a cheque for nearly the same amount made out to the assessee, after which the bank balances reverted to their previous minimal levels. This recurring sequence in all creditors cases raises serious doubts about the authenticity of the transactions, as such patterns are unlikely to be coincidental. Therefore, we find no infirmity in the order of Ld. CIT(Appeals) in holding that the assessee’s claim that it has satisfied the requirements of Section 68 of the Act, remains unsubstantiated, particularly concerning the creditworthiness and genuineness of the loan transactions.
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“This Court in the land mark case of Kale Khan Mohammad Hanif v. CIT [1963] 50
ITR 1 (SC) and, Roshan Di Hatti v. CIT [1977] 107 ITR 938 (SC) laid down that the onus of proving the source of a sum of money found to have been received by an assessee, is on the assessee. Once the assessee has submitted the documents relating to identity, genuineness of the transaction, and creditworthiness, then the Assessing
Officer must conduct an inquiry, and call for more details before invoking section 68. If the assessee is not able to provide a satisfactory explanation of the nature and source, of the investments made, it is open to the revenue to hold that it is the income of the assessee, and there would be no further burden on the revenue to show that the income is from any particular source.[Para 8.2]

With respect to the issue of genuineness of transaction, it is for the assessee to prove by cogent and credible evidence, that the investments made in share capital are genuine borrowings, since the facts are exclusively within the assessee's knowledge.
Merely, proving the identity of the investors does not discharge the onus of the assessee, if the capacity or credit-worthiness has not been established[Para 8.3]

The lower appellate authorities failed to appreciate that the investor companies which had filed income tax returns with a meagre or nil income had to explain how they had invested such huge sums of money in the Assesse Company -Respondent.
Clearly the onus to establish the credit worthiness of the investor companies was not discharged. The entire transaction seemed bogus, and lacked credibility.”

argument of the counsel for the assessee that it was established only in the earlier previous year and hence, no income can be attributed in its hand is also not acceptable, for the simple reason that the assessee firm was incorporated on 19-11-2014 and during the impugned year under consideration, the assessee firm was fully operational and had also claimed various expenses, with respect of its operations. Accordingly, in light of the above observations, we find no infirmity in the order of Ld.
CIT(Appeals) so as to call for any interference.

TANMAY, Sr. PSआदेश की Ůितिलिप अŤेिषत/Copy of the Order forwarded to :
1. अपीलाथŎ / The Appellant
2. ŮȑथŎ / The Respondent.
3. संबंिधत आयकर आयुƅ / Concerned CIT
4. आयकर आयुƅ(अपील) / The CIT(A)-
5. िवभागीय Ůितिनिध, आयकर अपीलीय अिधकरण, अहमदाबाद / DR, ITAT, Ahmedabad
6. गाडŊ फाईल / Guard file.

आदेशानुसार/ BY ORDER,

उप/सहायक पंजीकार (Dy./Asstt.