DCIT, CHENNAI vs. M/S. MALABAR HOTELS PVT. LTD., CHENNAI

आदेश/ O R D E R

PER S. JAYARAMAN, ACCOUNTANT MEMBER:

472/2013-14 dated 28.03.2014& 66/2014 dt 30.6.2016, for the assessment years 2010-11 & 2011-12, respectively.

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:-3-: & 2832/Mds/2016 is the only shareholder in the managing company. Mr. S. Sriharan is the only shareholder in the managing company etc. Thus , after considering other factors , the AO was of the view that the impugned expenditure incurred cannot be said to have been incurred wholly and exclusively for the purpose of business and hence proposed to disallow it . After considering the assessee’s explanation etc , the AO , inter alia, held that the expenditure of Rs.96,36,441 incurred by the assessee is not just and in the best interest of the assessee, the assessee failed to prove that the expenditure of hotel management fee has been incurred wholly and exclusively for the purpose of business and disallowed it. Further, the AO denied depreciation on certain business assets in respect of which the relevant purchase bills were not be produced by the assessee before him. In the assessment made for a y 2011- 12, the AO , following his predecessor’s order,on similar grounds , disallowed the entire Management and incentive Fee at Rs.1,76,86,813/-. Aggrieved, the assessee filed appeals before the CIT (A) for both the assessment years.

While disposing the appeal for ay 2010-11, the CIT (A) deleted the addition made on account of management fees and in respect of denial of depreciation directed the assessee to produce the relevant evidences before the AO , who will , after due consideration allow depreciation. For the ay 2011-12, the CIT(A) following his predecessor’s order, deleted the addition made on account of Management and incentive Fee. Aggrieved, the Revenue filed these appeals with following grounds of appeal.

:-4-: & 2832/Mds/2016 For ay 2010-11 :

1. The order of the Learned CIT(A) is contrary to law and facts and circumstances of the case. 2.1. The Learned CIT(A) erred in deleting the disallowance of expenditure of Rs.96,36,441/- made u/s 40A(2)(a) of the Act. 2.2. The Ld.CIT(A) has failed to appreciate various facts like the influence of the recipient of the management fee on the decision of the appellant company for incurring the expenditure and various other surrounding factors leading to the decision of expenditure which provide circumstantial evidence to prove that the transaction is only make-believe in nature. 2.3. The Ld.CIT(A) erred in not following the ratio of judgement in the case of i)CIT Vs Premier Breweries Ltd.(Kerala)(2005)279 ITR 51 where in it is held that the mere fact that payment has been made under contract or agreement is not conclusive that the expenditure is incurred wholly and exclusively for the purpose of business. 2.4 The Ld. CIT(A) ought to have appreciated the language employed in Section 40A(2)(a) which reads thus: 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 the [Assessing] Officer is of 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. 3. For these and other grounds that may be adduced at the time of hearing, it is prayed that the order of the learned CIT(A) may be set aside and that of the Assessing Officer restored.

For ay 2011-12 :

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2. The CIT(A) erred in deleting the disallowance of management and incentive fee of Rs. 1,76,86,813/- made u/s 40A(2)(a). 2.1. The CIT(A) failed to appreciate the findings of the AO that the expenses incurred on management and incentive fee is excessive having regard to the legitimate needs of business and hence the impugned expenditure falls under the ambit of clause(a) of sub-section 2 of Section 40A of Income tax Act 1961. 2.2. The CIT(A) erred in not appreciating the findings of the AO that no registered document on Management Agreement was furnished by the assessee to justify huge payment of management and incentive fee to Mr.Sriharan, who is a founder Director with substantive interest in the assessee company and hence the impugned payment is liable to be disallowed u/s40A(2)(a). 2.3. The CIT(A) erred in allowing relief to the assessee without appreciating the findings of the AO that payment of management and incentive fee was not incurred wholly and exclusively for the purposes of business and the above issue was subject to discretion of revenue authorities to be exercised under section 40A(2)(a) on the basis of material on record. 2.4. Having regard to the Hon'ble Apex Court's decision in the case of Nund&Samonta Co.P.LtdVs.CIT(SC) 78 ITR 268 wherein it is held that reasonableness has to be proved by assessee and not by Department, the CIT(A) ought to have upheld the impugned disallowance made by the AO. 2.5. The CIT(A) failed to note that the excessive expenditure incurred by the assessee reduces the income by equivalent amount and absolves the assessee from payment of taxes to the relevant extent. Therefore the impugned payments were a device adopted to reduce the assessee's taxable income. 2.6. The CIT(A) erred in holding that these expenses were allowed in Assessment year 2011-12 without appreciating that the principle of res judicata is not applicable to decisions of income-tax authorities as each assessment year is a separate proceedings.

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3. The DR submitted that the CIT(A) erred in giving a finding that the AO has not disputed the services rendered by Shri Sriharan and also the business expediency of the assessee company for availing the services of an expert to run the five star hotel. Merely for the reason that the management agreement is unregistered, the same cannot be summarily dismissed as fictitious or not genuine etc. The DR submitted that the assessee has not established that it has incurred the impugned expenditure wholly and exclusively for the purpose of business. The DR also invited our attention to the fact that while examining the expenditures claimed to have been paid to related parties, the AO has to examine whether the expenditure is excessive or unreasonable in relation to any of the requirements prescribed in the sections which are independent and alternative to each other and hence, the AO can examine the expenditure u/s. 37 as well as u/s. 40A(2) also. Per contra, the AR relied on the orders of the CIT(A).

“ 2.1 It is observed that the assessee company has entered into a 'hotel management agreement' with 'Asiana hotel management (Labuan), Malaysia; on account of which incurred an expenditure of Rs.96,36,441, during the relevant previous year. The assessee is called 'Owner Company' and the other Malaysian company is called 'managing company'. Following observations are made with regard to this transaction:

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• The expenditure incurred is in pursuance of a contract (hotel management agreement) dated 9th November 2007, between the assessee company (owner) and a company by name 'Asiana hotel management (Labuan) Inc. (manager)' incorporated in the country, 'Malaysia'. • The expenditure falls under the ambit of clause (a) of sub-section-2 of Section 40A of the Income Tax Act, 1961. But, the auditors have not reported about this transaction in the report submitted in form 3CD. • The expenditure falls under the provisions of Chapter- X of the Income Tax Act, 1961. But, no study has been conducted as required under chapter- X of the Income Tax Act, 1961 and obviously report of the auditors/ accountant on this transaction is not filed. • Mr.S.Sriharan is the only shareholder in the managing company. • Mr.Sriharan holds 1.47% shares in the owner company. • The company 'asiana hotel management company private Limited , India holds 23.09% of shares in the assessee company. In turn, 'asiana hotel management company pte limited', Singapore holds 98.84% of shares in asiana hotel management company private limited, India' and Mr.Sriharan holds substantial interest in the company 'asiana hotel management company pte limited' Singapore. Thereby, Mr.Sriharan, sole owner of the shares of company' holds the decision making authority in the owner company. Mr.Sriharan is one of the founder shareholder and director of the company a was having a substantial interest in the assessee company at the time of taking decision of entering into management agreement also. • The 'manager company' does not maintain any books of accounts and the taxes paid by the said company in it's native country are only nominal. Therefore, the income earned by the managing company is almost tax-free. • In turn, the expenditure incurred by the assessee company on this count reduces the income by equivalent amount and absolves the assessee company (owner Company) from payment of taxes, to the relevant extent. • All the receipts earned by the 'managing company' is straight away p refit of Mr.Sriharan, sans meagre costs incurred by the managing company, if any; as he is the sole owner of the shares. • The only employee of the managing company, deputed for managing the company is Mr.Sriharan.

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• The services that are rendered by the managing company are said to be 'professional and advisory' in nature. • The managing company does not undertake any other job other than managing the owner company. • Even if the assessee company has availed of any services from Mr.Sriharan, it is only as it's right as Mr.Sriharan is a Director even without this management agreement and needs to offer services to the assessee company. • Mr .Sriharan has not filed his return of income for the assessment year 2010-2011. 2.2 In view of the above, it is evident that the entire transaction is 'coloured' and made under influence; and is designed to provide' for expenditure in the books of the assessee company to reduce the tax liability and to transfer the profit into the hands of an individual (having substantial interest in the assessee company), which is tax free. Hence, it was opined that the expenditure incurred can not be said to have been incurred wholly and exclusively for the purpose of business. Therefore, it was proposed to disallow the said expenditure of Rs.96,36,441. The assessee was given an opportunity to show-cause as to why the said expenditure shall not be disallowed. 2.3. In response to the showcause notice, written submissions were made on 8.3.2013 objecting for the proposed disallowance of expenditure. It was argued that in the industry of the hospitality (hotel), it is mandatory to have a management consultant for effective maintenance of standards prescribed for star rated hotels. It was also argued that even if the contract of managing the hotel was not given to 'Asiana Hotel Management Inc': it should have been given to some other managing company. It was further put- forth that the fee agreed with the managing company is well within the fair market value of the services, generally adopted in the industry. It was also brought out that this expenditure of management consultant fee has been incurred in pursuance of a written agreement dated 9.11.2007. 2.4 The assesssee's argument is well taken. It might be correct that some of the top rated hotels of the country engage the services of the management consultant. But, it is neither compulsory, nor mandatory for every hotel to engage a management consultant. There might be equal number of hotels those who engage or do not engage management consultants. Each and every

:-9-: & 2832/Mds/2016 case, the facts and circumstances needs to be studied and analysed independently about the requirement of a hotel to engage a management consultant and the genuinity and correctness of the fee being fixed in this context. As has been already discussed in the earlier paragraphs, Mr Sriharan, the founder Director of the assessee company is the only shareholder and director of the managing company, Asiana Hotel Management, Malasiya. It is learnt through the assessment proceedings that he is a veteran in the industry and worked in various capacities across the globe. He, being the shareholder with a substantial interest in the assessee company through his investment in other companies and also being the promoter Director, it is definitely not necessary for the assessee to engage the services of another professional to manage the affairs of the hotel. Presuming that the hotel of the assessee company needs to be managed by another managing company, as argued; as can be seen from the records and understood during the course of the proceedings, the managing company in the present case has got a single shareholder with 100% share holding and single director whose is none other than Mr Sriharan, the promoter director of the assessee company, with no employees and with no books of accounts and with no proven record of doing anything else other than managing the assessee company's hotel. Ultimately, it is only Mr Sriharan, if at all to be believed about the facts, is managing the company single handed. It is important to know that apart from Mr Sriharan, no other person has been deputed on the particular job of managing the assessee company. The whole of the staff of the assessee company are paid remuneration by the assessee company. There is virtually no difference between Mr Sriharan, the founder Director with substantive interest in the Assessee Company and Asiana Hotel Management Private Limited, Malasyia. The so called management agreement is only an unregistered document created for the purpose of making the assessee company to pay a fee towards the hotel management to the benefit of Mr Sriharan. This document is only a self serving document executed under the influence of Mr Sriharan. 2.5 In view of above reasons, I am of the opinion that the expenditure of Rs.96,36,441 incurred by the assessee company is not, just and in the best interest of the assessee company. Therefore, the assessee company failed to prove that the expenditure of hotel management fee has been incurred wholly

:-10-: & 2832/Mds/2016 and exclusively for the purpose of business. In view of the facts and circumstances narrated in the prior paragraphs, expenditure of hotel management fee incurred by the assessee company amounting to Rs.96,36,441 is disallowed.”

Shriharan’s profile. Thereafter, the Assessing Officer has arrived the conclusion as extracted, above.

5.1 As per the copy of the agreement available on record, the following are seen to be the main services to be rendered by M/s. Asiana Hotel Management (Labuan) Inc, Malaysia

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(i) Advise to the Board of Directors of the appellant company, its officers and staff about the best and most productive methods of managing, operating, marketing, promoting and expanding the business of the hotel.

(ii) Engaging all employees required for the operation of the hotel and enter into contracts necessary for the continuous operation of the hotel.

(iii) Coordinating and conducting all phases of marketing, promotion and publicity relating to the hotel

(iv) Providing information, statistics and key performance indicators to enable the Board of Directors to assess the performance of the hotel.

(v) Ensure compliance with the law relating to hotel business and premises.

It is clear from the above, that the assessee has not laid any material to prove as to whether it has received the services mentioned above and if it is so, to what extent etc. Thus, it is clear that there is no finding as to whether the assessee has received such services or not and if yes, then to what extent.

Further, it is not known whether Shri. Sriharan was in receipt of any payment or perquisite from the assessee as a director of the assessee company. It is clear from the assessment order that Shri Sriharan is an interested party. The assesseee claimed the above sum as an expenditure and hence, the burden of proving the necessary facts viz

:-12-: & 2832/Mds/2016 (1) It should be an expenditure, (2) that expenditure should be laid out or expended,

(3) it should be so laid out or expended wholly and exclusively for a certain purpose, and (4) the purpose should be the purpose of the assessee's business, is on it.

:-13-: & 2832/Mds/2016 the extent of the business, (3) the particulars of service rendered, (4) whether the service was such as to require special remuneration, (5) what was the quantum of payment, (6) whether the payment was or was not grossly out of proportion to the work done by the person. To this list of circumstances might be added other circumstances, e.g., (7) what was the practice in the trade for payment to the person in similar circumstances, (8) what were the qualifications of the person, (9) what was the amount paid to a predecessor or a successor rendering the same service, (10) whether the allowance of a certain percentage was a normal allowance or was extraordinary having regard to, the profits and the practice in the trade, (11) whether the method of working out profits for calculating the percentage of commission was the normal method or an abnormal method, and (12) if there was any extraordinariness or abnormality in the arrangement, was there any special reason or circumstances for such extraordinariness or abnormality.If after taking these factors into consideration the AO comes to the conclusion that the payment was not made wholly and exclusively for the purpose of the business of the assessee, it would be open to him either to disallow the whole sum or a part of the sum paid.Thus, in order to claim this deduction as expenditure, the assessee has not only to prove that the expense was incidental to the business but to show that the expenses were laid out or expended wholly and exclusively for the purpose of the business. Since, the required facts are not available on record, we deem it fit to set aside the :-14-: & 2832/Mds/2016 orders of the CIT (A) and remit the issues to the AO for re-examination and after giving adequate opportunity to the assessee to decide the issues on the above lines. The Revenue’s appeals are treated as allowed for statistical purposes.

Order pronounced on Thursday, the 23rd day of November, 2017 at Chennai.