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Facts
Khyati Chemicals Private Limited, the assessee, filed its return for AY 2018-19. During scrutiny, the AO disallowed Rs. 2.4 crore for excess remuneration to directors u/s 40A(2)(b) and expenses for Spray Dryer (Rs. 9.23 lacs) and Computer Software (Rs. 3.29 lacs) u/s 37(1). The CIT(A) subsequently deleted the remuneration disallowance and partly allowed depreciation on the Spray Dryer and software expenses, converting them from revenue to capital expenditure.
Held
The ITAT allowed the Revenue's appeal, setting aside the CIT(A)'s deletion of the Rs. 2.4 crore disallowance for excess salary to directors, thus restoring the AO's order, finding it to be a clear method of tax evasion. The assessee's cross-objection was dismissed, upholding the CIT(A)'s finding that expenses for Spray Dryer and computer software were capital in nature, eligible only for depreciation.
Key Issues
1. Whether excess remuneration paid to whole-time directors constituted a device for tax evasion, justifying disallowance u/s 40A(2)(b). 2. Whether expenses for Spray Dryer and Computer Software were revenue expenditure u/s 37(1) or capital in nature, eligible only for depreciation.
Sections Cited
143(3), 40A(2)(b), 37(1), 32(1)(ii), 32(1)(iia), 250, 198 (Companies Act), 144B
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Income Tax Appellate Tribunal, AHMEDABAD “A” BENCH
Before: DR. BRR Kumar & Shri T. R. Senthil Kumar
Deputy Commissioner Khyati Chemicals of Income Tax Vs Private Limited Circle-2(1)(1), A/4 4th Floor, Ahmedabad Safal Profitare, Opp: Auda Garden, Auda Garden Prahad Nagar Road, Ahmedabad-380015 Gujarat PAN: AAACK6277E Khyati Chemicals Deputy Commissioner Private Limited Vs of Income Tax A/4 4th Floor, Circle-2(1)(1), Safal Profitare, Ahmedabad Opp: Auda Garden, Auda Garden Prahad Nagar Road, Ahmedabad-380015 Gujarat PAN: AAACK6277E (Respondent) (Appellant) Assessee Represented: Ms. Palak Kshatriya, A.R. Revenue Represented: Shri Rajenkumar M Vasavda, Sr.D.R. Date of hearing : 06-01-2026 Date of pronouncement : 16-01-2026 आदेश/ORDER PER : T.R. SENTHIL KUMAR, JUDICIAL MEMBER:-
This appeal is filed by the Revenue as against the appellate order dated 21-08-2025 passed by the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi, (in short referred to as “CIT(A)”), arising out of the assessment order passed under section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) relating to the Assessment Year 2018-19. Cross Objection No. 86/Ahd/2025 is filed by the assessee as against the above Revenue appeal.
Brief facts of the case is that the assessee is a Private Limited Company engaged in the manufacture of chemicals, filed its Return of Income on 30-09-2018 for the Asst. Year 2018-19 declaring total income of Rs.17,84,76,810/- and lateron filed a revised return on 08-02-2019 declaring the same income. The return was taken for complete scrutiny assessment and issued various notices calling for details and made the following disallowances: (i) Disallowance u/s. 40A(2)(b) of Rs. 2,40,00,000/- being excess remuneration paid to the two whole time directors (ii) Disallowance u/s. 37(1) on Spray Dryer of Rs.9,23,994/- (iii) Disallowance u/s. 37(1) on Computer software expenses Rs.3,29,520/- 3. Aggrieved against the assessment order, assessee filed an appeal before Ld. CIT(A) who deleted the addition made u/s. 40A(2)(b) of the Act by observing as follows: “6.2.1 On perusal of P & L Account, A.O. found that there was net profit of Rs.16,81,64,030/- after claiming deduction on account of salary, which had been carried forward in the balance sheet as reserve and surplus. The company had not declared dividend as against 64,27,32,153/- crore as retained /accumulated profit. Hence, A.O. concluded that company had paid distributed dividend in the form of unreasonable salary to avoid payment of tax. A.O. applied specific provision under section 40A (2) (b) regarding allowability of salary as per fair market value. Appellant being private limited company, not liable to pay salary more than 11% of the net profit as calculated in a manner laid down in section 198 of the companies act whether it is a managing director or whole-time directors. Only i.e.11% of net profit of Rs. (16,81,64,030/- 5,40,00,000) = Rs22,21,64,030/- including remuneration of Rs.5.40 Crores that came out to be Rs.2.44,38,043/- was eligible amount for payment of salary to two directors. Thus, A.O. found reasonable payment made to directors was Rs.3 Crores (Rs. 2 Crore to Mr. Rajiv Bhandari and Rs.1 Crore to Mrs. Shubha Bhandari and Rs.2,40,00,000/- was disallowed u/s 40A(2)(b) of the Act. 6.2.2. I have considered the submission made by appellant, assessment order and found that Shri Rajiv Bhandari and Smt. Subha Bhandari were full time working director. Shri Rajiv N Bhandari is looking after all the aspects of the company and has been working as a Working Director since more than 30 years and qualified Chartered Accountant and has a wide experience in the management of the company. Further, Smt. Subha Bhandari is also an Executive Director of the company who has done MA in Economics has also experience of more than 30 years and has expertise in human resource matters, marketing matters and general administrative matters at the office. She normally attends the office between 10’0 clock in the morning and is available till 6'0 clock in the evening on regular basis, Her devotion to the work is more than 8 hours. Smt. Subha Bhandari is a regular participant at the seminars on business operation at the national level and she is also active member of FICCI, FLO Ahmedabad Chapter. Considering the devotion of the time, vide experience of the working directors their qualifications business background, their sincerity and innovative ideas, the payment of remuneration of Rs.5,40,00,000/- is absolutely reasonable and neither the remuneration is huge nor or it is unreasonable. The payments have been made after considering the legitimate needs of business of the company. Therefore, the disallowance of Rs.2,40,00,000/-is not warranted and also there is no loss of revenue to the Government and on the contrary considering the tax payments made by the company and the Working Directors there is excess tax collection in the hands of Government of India. Again, disallowance of Rs.2,40,00,000/- from the account of the company will tantamount double taxation. Hence, addition made on account of disallowance of salary expense is deleted and Ground No. 6 to 17 raised by appellant are allowed.” 3.1. Regarding disallowance made u/s. 37(1) on Spray Dryer, Ld. CIT(A) partly allowed the claim of depreciation by observing as follows:
“6.4.1. I have gone through the submission made by the appellant, assessment order and all materials available on records. During assessment proceedings, A.O. issued show- cause notice thereby stating that purchase of spray dryer comes in the definition of capital asset and same is not allowed as revenue expenditure. In response thereto, appellant contended that the treatment of the expenditure as capital expenditure was grossly erroneous because in earlier years also during assessment proceedings under section 143(3), this question was raised by A.O. and contention of appellant was accepted by A.O. and the expenditure were allowed as revenue expenditure. In support of its contention, appellant submitted the copy of certificate issued by AC Mefil Engineering Pvt. Ltd. who had supplied spray dryer thereby certified that life of spray dryer was hardly for a period of 12 months, hence expenditure on current repairs are deductible u/s 31 and or 37 of the Act. A.O. did not find certificate as fully evident that dryer to be discarded after 12-15 months. Moreover, appellant failed to submit corroborative evidence that spray dryer was changed every year and disposed off by way of scrap sale. Vide para 8.7 of the assessment order, A.O. further stated that the appellant case has not been scrutinized for preceding 5 assessment years and every assessment year is a separate assessment year and also facts of the case is different. I am in view of that the A.O. was justified for making disallowance on account of this expenditure as if no addition is made in any year, then it is not required that no addition can be made in subsequent assessment years. Therefore, I am satisfied with the addition made by the AO on account of disallowance of Rs. 9,23,994/-u/s 37(1) on account of expense of spray dryers and of the considered view that the AO has applied his mind judiciously while examining this issue in detail. Hence, Ground No. 20, 22 & 23 raised by appellant are dismissed. However, Ground No. 21 raised by the appellant is allowed and the assessing officer is directed to allow depreciation thereon including additional depreciation in accordance with provisions of section 32(1)(ii) r.w.s. Rule 5(1) and Appendix 1 and section 32(1)(iia) at the time of giving appeal effect.”
3.2. Regarding disallowance u/s. 37(1) on Computer Software expenses, Ld. CIT(A) partly allowed the claim of depreciation by observing as follows: “6.5.3 I have gone through the submission made by the appellant, assessment order and all materials available on records. I am in view of that the A.O. was justified for making disallowance on account of this expenditure. The decision of the Hon'ble Supreme Court in the case of TCS supports the view that software contained in a disk is tangible property by itself. As per Income Tax Rules vide Finance Act, 2004 whereby definition of the assets under head "Computer" have been amended and now it stated as "Computer including "computer software". Therefore, appellant can claim depreciation on software license @ 60%. I am satisfied with the addition made by the AO on account of disallowance u/s 37(1) of Rs.3,29,520/-, and of the considered view that the AO has applied his mind judiciously while examining this issue in detail. Hence, Ground No. 24, 25, 27 and 28raised by appellant are dismissed. However, Ground No. 26 raised by the appellant is allowed and the assessing officer is directed to allow depreciation thereon including additional depreciation in accordance with provisions of section 32(1)(ii) r.w.s. Rule 5(1) and Appendix 1 and section 32(1)(iia) at the time of giving appeal effect.”
Aggrieved against the appellate order, the Revenue is in appeal before us raising the following Grounds of Appeal:
1. Whether on facts and circumstances of the case and in law, the Ld. CIT(A) has erred in law and on facts in deleting the addition made on account of disallowance of excess salary paid to directors’ u/s. 40A(2)(b) of the Act amounting to Rs. 2,40,00,000/- being remuneration paid to the related directors which was clearly unreasonable having regard to the fact that the company had not declared dividend in spite of accumulated profit, thereby squarely attracting the mischief of section 40A(2)(b) of the Act?
2. The appellant craves leave to amend or alter any ground or add a new ground which may be necessary.
3. It is therefore, prayed that the order of Ld. CIT(A) may be set aside and that of the Assessing Officer be restored.
The assessee filed Cross Objection raising the following Grounds of Appeal: The assessee being dissatisfied with the order under section 250 passed by the Commissioner of Income tax (Appeals) on 21st August, 2025 presents these grounds of cross objection against the same on the following amongst other grounds. 1.0 The Commissioner of Income tax, Appeals erred in not quashing the order under section 143(3) r.w.s. 144B framed by the assessing officer on 27th September, 2021 which was contrary to the facts and the provisions of law. The order be quashed. 2.0 The Commissioner of Income tax, Appeals has correctly quashed action of the assessing officer in invoking provisions of section 40A(2)(b) and making disallowance of Rs. 2,40,00,000/-. The appellant submits that disallowance was arbitrary, contrary to the facts and provisions of law. The order passed by the CIT(A) deleting the disallowance be upheld.
2.1 The observations made by the assessing officer in the paragraphs from 6.0 to 6.38 are contrary to the facts and/our contrary to the provisions of law and/or purely repetitive in nature and are irrelevant and have been made by the assessing officer only for the purpose of making arbitrary unjustified, illegal and erroneous disallowance of Rs. 2,40,00,000/-. 2.2 Disallowance of Rs. 2,40,00,000/-, without prejudice to above, is erroneous and contrary to the facts even in view of the CBDT circular No. 6-P dated 6th July, 1968. The assessee submits that admittedly there is no loss of revenue to the Government and on the contrary considering the tax payments made by the company and the Working Directors there is excess tax collection in the hands of Government of India. 3.0 The Commissioner of Income tax (Appeals) erred in upholding that Rs.9,98,912/- being expenditure on repairs was of capital nature. The appellant submits that the expenses of Rs. 9,98,912/- was revenue in nature and was incurred wholly and exclusively for the purpose of the business. The disallowance of Rs. 9,98,912/- be quashed. 4.0 The Commissioner of Income tax (Appeals) erred in upholding that Rs. 8,23,800/- being expenditure on licence for use of software is expenditure of capital nature and accordingly not allowing as deduction under section 37(1), 4.1 The appellant submits that the expenses of Rs. 8,23,800/- was of revenue in nature and was incurred wholly and exclusively for the purpose of the business. The appellant submits that disallowance of Rs. 8,23,800/- be quashed. 4.2 The appellant without prejudice to above submits disallowance of Rs.8,23,800/- Is excessive. The appellant submits that disallowance of Rs.8,23,800/- be substantially reduced. The assessee prays for leave to add, alter, amend and/or withdraw all or any of the grounds of cross objection before the final hearing of the appeal.
Heard rival submissions and perused the materials available on record. Regarding disallowance u/s. 40A(2)(b) of the Act, the assessing officer had made thorough enquiry of the salary paid to one of its Vice President-Corporate and Chief Financial Officer Mr. Madan Sancheti who was paid annual salary to Rs. 20 to 30 lakhs namely Rs. 2,20,340/- per month salary whose having 35 years experience as Chartered Accountant. Whereas the Managing Director Shri Rajiv Bhandari having 30 years experience as Chartered Accountant was given annual payment of Rs. 3.6 crores. Similarly Smt. Shubha Bhandari another full time Director was paid Rs. 1.8 crores who has done M.A.-Economics and said to be expertise in Human Resource, Marketing and General Administrative matters at the office. The A.O. also made comparison with the Chief Production in-charge Shri Yatindra Karan whose having more than 40 years experience, was paid less than Rs. 20 lakhs per annum as salary. Thus the assessing officer has justified that the assessee company had distributed the dividend in the form of unreasonable salary paid to the two full time Directors, which as a device for tax evasion and the payments were covered by the exceptions provided in section 40A(2)(b) of the Act by observing as follows: “….6.7. While applying the provisions of 40A(2)(b), it was required to be seen whether the remuneration paid to directors was more than the amount payable to other persons in open market having similar experience in the same business. It was also pointed out that in assessee's own case, There is only one executive/ employees whose annual salary is more than 20 lakhs having monthly salary at Rs. 2,20,340/-i.e. MADAN SANCHETI (V.P. Corporate i.e. Chief Financial Officer" DCOM FCA, CHARTERED. CHARTERED ACCOUNTANT, EXPERIENCE OF MORE THAN 35 YEARS and another one employee having salary less than Rs. 2 lakh per month but more than one lakh i.e. Rs. 1,13,510/- Shri Yatindra Karan, CHIEF PRODUCTION IN CHARGE, BSE CHEMISTRY (HONOURS) EXPERIENCE OF MORE THAN 40 YEARS Therefore, the remuneration to the tune of Rs. 5,40,00,000/- paid to two directors having similar qualification could be said to be excessive compared to market value of services as one of director Rajiv Bhandari have qualification as CHARTERED ACCOUNTANT AND OTHE DIRECTOR Smt. Shubha Bhandari having qualification as MASTER of ARTS in History. 6.8. It was further observed that in the profit & loss account of the relevant year, there was net profit of Rs. 16,81,64,030 (before tax) after claiming deduction on account of salary, which had been carried forward in the balance sheet as reserve and surplus. The company has not declared
dividend as against 64,27,32,153/- crore as retained/accumulated profit and no reasons were given for not declaring the dividend to the extent of excess salary. Even though the assessee has created the Provision for gratuity for earlier years of Managerial Remuneration of Rs. 5,62,50,000/- which is directly reduced from Balance Sheet (Reserve & Surplus-P&L) in AY. 2017-18. It was thus clear that the company had distributed dividend in the form of unreasonable salary and therefore, payment was covered by the exceptions provided in Section 40A(2)(b)of the Act. It is observed that the provisions of Section 40A(2)(b) were intended to prevent an escape from taxation by describing a payment as remuneration when, in fact ordinarily it should have reached the shareholders as profit or dividend as held by the Hon'ble High Court of Bombay in Loyal Motor Services Company Ltd. vs. CIT (14 ITR 647). It is pointed out, that had the assessee paid dividend 2.40 crore, the income of the company would have gone up by Rs.2.40 crore on which tax at the rate of 33% would have been payable which came to Rs. 80. 00 lacs. In addition, the company would also have to pay dividend distribution tax at the rate of 20.36% on the entire amount of dividend which came to Rs.48.86 lacs. Thus total outgoings in the form of tax in case assessee had paid dividend and not excess salary was Rs.128.86 lacs. On the contrary, by showing payment as salary, the directors would have paid tax of only Rs.80.00 lacs on salary income. Thus, there is a clear tax avoidance of Rs. 48.86 lacs in the hands of the assessee company. Therefore, was clear that excessive salary/remuneration to directors is a device for tax evasion.”
Further when the assessee made a comparison for an advertisement for the post of Chief Financial Officer where a Chartered Accountant was offered a remuneration in Indian Rupees 4 to 10 crores by relying upon Economic Times Page No. 9 dated 23-02-2021 to defend that the salary paid to the whole time directors was reasonable. The Ld. A.O. brought out that assessee’s Chief Financial Officer Mr. Madan Sancheti was given salary of less than Rs. 30 lakhs per annum. The assessing officer also discussed the non-payment of dividend by the Company, whereas fanciful salaries paid only to its whole time Directors. Thereby Ld. A.O. justified that the excess payment of Rs. 2.4 crores as salary to whole time Directors. Whereas Ld. CIT(A) without valid reasons simply held that the disallowance made by the assessing officer as unwarranted and also observed that there is no loss of Revenue to the Government and on the contrary considering the tax payment paid by the Company and working Director, there is no excess tax collection in hands of the Government of India. This observation of the Ld. CIT(A) is contrary to the facts of the case and clear cut findings of tax evasion method adopted by the assessee company and its directors. Thus the findings arrived by ld. CIT(A) is hereby set-aside and restore the disallowance made by the assessing officer u/s. 40A(2)(b) of Rs. 2.4 crores. Thus the ground raised by the Revenue is hereby allowed.
In the result, the appeal filed by the Revenue is hereby allowed.
C.O. No. 86/Ahd/2025
The Cross Objection filed by the assessee are without any documentary evidences but only simple grounds raised by the assessee. Thus Grounds Nos. 1 & 2 raised by the assessee u/s. 40A(2)(b) of the Act are hereby dismissed following the observation made in Paragraphs 6 & 7 of the order passed in .
Regarding Ground No. 3 namely addition of Rs. 9,98,912/- being disallowance u/s. 37 (1)on Spray Dryer as well as Ground No. 4 of disallowance of Rs. 8,23,800/- on Computer Software expenses, No details or materials placed before us contravening the findings arrived by Ld. CIT(A). In the absence of same, Ground Nos.
3 & 4 raised by the assessee are devoid of merits. Thus the same are hereby dismissed. 11. In the result, the Cross Objection filed by the assesse is hereby dismissed.
Order pronounced in the open court on 16-01-2026