M/S KEMPSZ TRADING PRIVATE LIMITED ,BANGALORE vs. THE DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-4(1)(1), BANGALORE

The appeal filed by the assessee is directed against the order dated 31/1/2018 passed by ld CIT(A)-9, Bengaluru and it relates to the asst. year 2012-13.

The grounds urged by the assessee relates to the single issue viz., disallowance by AO u/s 37(1) and also u/s 40A(3) of the Act.

The assessee is engaged in the business of quarrying, processing/selling exporting of a granite block and slabs. During the course of scrutiny proceedings, the AO noticed that the assessee has incurred following expenses by way of cash

The AO asked the assessee to explain as to why the payments have been made in violation of provisions of sec.40A(3) of the Act. The assessee submitted that the royalty & quarry expenses of Rs.11,86,318/- represents amount paid for obtaining demand draft for remitting the same to the Government. It was further submitted that the assessee’s quarry is located in remote place and it is not serviced by any bank within 15 k.m radius. Accordingly it was submitted that the impugned payments are covered by exceptions provided under Rule 6DD of the Income-tax Rules.

The AO also noticed that the assessee has not furnished any credible material evidencing these payments. Accordingly he treated these expenses as not genuine and disallowed the same u/s 37 of the Act. The AO also invoked provision of sec. 40A(3) of the Act protectively, since the disallowance has been made on substantive basis u/s 37 of the Act. Accordingly he disallowed a sum of Rs.3,02,74,912/- and added the same to the total income of the assessee.

Before the ld CIT(A) the assesee submitted that the disallowance of Rs.1,16,51,853/- which is included in the aggregate disallowance of Rs.3,02,74,912/- actually represents advance payments made by the assessee and the same has been not been claimed as expenditure in the profit and loss account. The Ld CIT(A) examined the profit and loss account of the assessee and was convinced with the explanations of the assessee. Accordingly he deleted the disallowance of Rs.1,16,51,853/-. With regard to the remaining disallowances the assessee submitted before Ld CIT(A) that it has maintained vouchers for all expenses and the AO has made disallowance without examining those vouchers. The assessee also produced some of the vouchers before ld CIT(A), but the first appellate authority rejected the same by observing that the additional evidences cannot be admitted at that stage. However, after rejecting the evidences, the ld CIT(A) proceeded to examine some of the vouchers. He has also scanned 3 vouchers in his order. The ld CIT(A) found fault with the way the vouchers have been maintained by the assessee. Some of the faults noticed by Ld CIT(A) are:-

The ld AR submitted that the expenditure sustained by the ld CIT(A) consists of 2 items viz., royalty payment made to the Govt. amounting to Rs.11.80 lakhs and quarry expenses amounting to Rs.174.36 lakhs. The ld AR submitted that the royalty amount of Rs.11.80 lakhs have not actually been paid by way of cash. The assessee has paid cash to purchase demand drafts from the banks, which has in turn been deposited into Government Account. She further submitted that the assessee has remitted cash to the treasury directly on two occasions towards permit fee. Since these payment have made to the Government, the same is covered by the exceptions provided under clause(b) of Rule 6DD of Income-tax Rules. With regard to remaining payments, the ld AR submitted that the quarries of the assessee are located in a remote place and the said place is not serviced by any bank within 15 kms radius. She submitted that the assessee has furnished a certificate obtained from Village Administrative Officer in this regard. Accordingly, she submitted that those payments are covered by clause (g) of Rule 6DD of Income-tax Rules. The ld AR further submitted that these expenses are the routine expense incurred by the assessee in the quarry business year after year. In the past, all these expenses have been allowed by the AO. The royalty expenses have been remitted to Government. Accordingly she submitted that there is no reason to suspect the genuineness of the expenses. The Ld A.R placed her reliance on the decisions rendered by Hon’ble Karnataka High Court in the following cases:-

On the contrary the ld DR submitted that the royalty amount can be paid by way of cash only if the rules framed there under provide for making payment in legal tender. With regard to other expenses, the ld DR submitted that the assessee has not furnished any reason as to why the payments could not be made by way of crossed cheque or demand draft. He further submitted that all these expenses are supported by self made vouchers only and hence the genuineness of these expenses have also not been established.

We have heard rival contentions and perused the record. We shall first take up the disallowance relating to Royalty payments made to the Government. Though the assessee has explained before the AO that the cash payments were made only to purchase Demand Drafts and further the area, where the quarry is located is not serviced by any bank, yet the AO has disallowed the royalty expenses to the tune of Rs.11,86,318/- by treating the same as non-genuine expenses and also by invoking the provisions of sec.40A(3) of the Act. We notice that the assessee has furnished the full details of Royalty expenses in pages 57 to 59 of the paper book. A perusal of the same would show that the assessee has paid aggregate amount of Rs.2.57 crores, out of which a sum of Rs.2.45 crores was paid by way of cheque. Out of the remaining amount, a sum of Rs.17,500/- was paid by way of cash. The balance amount of Rs.11.86 lakhs, which is subject matter of dispute, is claimed to have been paid by way of Demand Drafts/ deposit into treasury directly. We notice that the assessee has remitted an aggregate amount of Rs.1,30,900/- in cash directly to the Government and the assessee has purchased Demand Drafts in respect of remaining amount. The assessee has also enclosed copies of some of the bank payment challans evidencing purchase of demand drafts. It is stated that the amount of Rs.1,30,900/- remitted into the Treasury was for the purpose of obtaining permit and as per the assessee, the same is required to be remitted into the Treasury only. The remaining payments were made towards royalty and they have been paid by way of Demand draft only.

From the explanations and evidences furnished by the assessee, we notice that the provisions of sec.40A(3) are not attracted, since all the payments except two have been made by way of demand drafts only and not by way of cash. The two payments have also been stated as payment made to the Government in the treasury, which is covered by clause (b) of Rule 6DD. Since these are payments have been made to the Government, the genuineness of these expenses cannot be doubted with. There is one more reason for accepting the genuineness of expenses, i.e., The aggregate amount of royalty expenses claimed by the assessee is Rs.2.58 crores, out of which the AO is doubting genuineness to the extent of Rs.11.86 lakhs, that too only for the reason that they have been incurred by way of cash. However, we have seen that the assessee has either purchased demand drafts or remitted the amount into treasury. Hence we are of the view that the genuineness of these expenses cannot be doubted with. Accordingly, we set aside the order passed by Ld CIT(A) on this addition and direct the AO to delete the disallowance of Rs.11.86 lakhs, referred above.

The AO has also disallowed a sum of Rs.1,74,36,731/- out of Quarry expenses u/s 37(1) of the Act on the reasoning that these payments have been incurred by way of cash and hence genuineness of these expenses cannot be proved. He has also made disallowance u/s 40A(3) of the Act protectively. The assessee has furnished the details of Quarry expenses at pages 25 to 54 of the Paper Book. On a perusal of the same, we notice that the assessee has incurred a sum of Rs.10.60 crores as quarry expenses. The break-up details of this expenditure is placed at page 25 of the paper book. This expenditure, inter alia, includes a sum of Rs.1,75,05,218/- towards quarry expenses. The date-wise break- up this amount is placed in pages 26 to 54 of the paper book. We notice that the break-up on aggregate basis is given as under:- Expenses incurred by way of Cheque - Rs. 23,39,318 Expenses by cash exceeding Rs.20,000/- - Rs.1,11,32,697 Expenses by cash less than Rs.20,000/- - Rs. 40,33,203 ------------------- - Rs.1,75,05,218

A perusal of individual break-up details would show that the assessee has incurred expenses at quarry and also through its employees. The assessee has also furnished certificates obtained from two Village Administrative Officers to substantiate its contentions that the areas, where the quarries of the assessee are located are not serviced by any bank within 15 Km radius. Accordingly it has been submitted that the payments made by the assessee are covered by the exception provided under Clause (g) of Rule 6DD. We notice that this explanation of the assessee and the certificate of the VAOs explaining the factual situation have not been controverted by the Assessing officer. We have earlier noticed that the aggregate amount of quarry expenses incurred by the assessee was Rs.10.60 crores, out of which a sum of Rs.1.11 crores was paid in violation of sec.40A(3) of the Act, meaning thereby, the assessee has incurred almost 90% of expenses in compliance with the provisions of sec.40A(3) of the Act. Hence, we are of the view that there is merit in the explanations of the assessee that the expenses of Rs.1.11 crores were incurred at quarry site, where there is no banking facility. Hence they are covered by Clause (g) of Rule 6DD. Accordingly, we are of the view that the provisions of sec.40A(3) of the Act shall not be applied to the impugned expenses.

The AO has disallowed the above said expenses u/s 37 only for the reason that they have been incurred by way of cash. For making disallowance under the provisions of sec.37(1) of the Act, the AO has to show that the impugned expenses are either (a) Capital expenditure (or) (b) personal expenses (or) (c) not laid out or expended wholly and exclusively for the purpose of business (or) (d) expenditure of nature specified in sec. 30 to 36 (or) (e) Explanation 1 & 2 to sec.37(1) are attracted.

It is the submission of the assessee that these kinds of expenses are incurred year after year. We have also seen that the assessee has incurred 90% of expenses by way of cheque, meaning thereby, in case of business necessity only the assessee has been incurring expenses by way of cash. There is no doubt that the expenses incurred by way of cash may not be amenable for cross verification. But the vouchers scanned by Ld CIT(A) would show that the recipients have signed the vouchers. Since the vouchers form part of regular books of accounts maintained by the assessee, the same cannot be considered as additional evidences. Hence we are of the view that the Ld CIT(A) was not justified in treating them as additional evidences. In any case, he has examined the same and has also scanned three vouchers in his order, meaning thereby, he has admitted them, even though the same does not constitute additional evidence. From the assessment order, we notice that the assessing officer has not found fault with any of the vouchers, nor did he attempt to examine the recipients of cash paid towards expenses in order to verify the veracity of expenses. Hence we are of the view that the AO has disallowed the expenses on surmises only.

However, there is merit in the submission of Ld D.R that the expenses incurred by way of cash is not amenable for cross verification. The Ld CIT(A) has also pointed out certain deficiencies in the manner of maintenance of vouchers. Accordingly, we are of the view that this issue may be put to rest by disallowing 5% of expenses incurred by way of cash exceeding Rs.20,000/-, i.e., 5% of Rs.1,11,32,697/- in order to take care of deficiencies, if any, in incurring expenses by way of cash & maintenance of vouchers. We order accordingly. Accordingly, the order passed by Ld CIT(A) on this issue stands modified.

In the result, the appeal of the assessee is partly allowed.