ASHISH PATODIA,NEW DELHI vs. ACIT, NEW DELHI

The assessee filed his return of income for A.Y. 2008-09 on 30.09.2008 disclosing a total income at Rs.19,34,990/-. The return was processed u/s 143(1) of the Income Tax Act, 1961. The return was selected for scrutiny assessment under ‘CASS’. Notice u/s 143(2) of the Act was issued and duly served on the assessee on 13.08.2009. Subsequently, notice u/s 142(1) of the Act, calling for basic details/documents in support of the return, was served on 14.05.2010. In response, assessee’s representative appeared on various occasion and filed documents and gave details as and when asked for by the Assessing Officer. During the previous year relevant to assessment year 2008-09 the assessee was engaged in the business of trading of sulphur, fabrics and shares under the proprietary concern in the name of M/s. Atul International. He has derived Income from Business, Income from Salary, Income from Short Term Capital Gains (loss), Income from long term capital gains and Income from other sources, besides having tax exempt income from dividend and long term capital gains.

During the relevant year under consideration the assessee has claimed commission expenses amounting to Rs.27,04,623/- in the business of trading of sulphur, besides an amount of Rs. 5,27,602/- which was paid as commission to the brother of the assessee, Sh. Manoj Patodia. While the assessee has made payment to all the parties on the basis of quantity of the sulphur traded i.e. at the rate of Rs. 1000 per metric ton, Sh. Manoj Patodia has been paid commission on the basis of percentage of total sale of sulphur i.e. at the rate of 0.2% on the total sale of sulphur. The Assessing Officer disallowed commission expenses to the extent of 2,63,801/-.

The Assessing Officer also made an addition of Rs.37,644/- as notional interest by observing that the assessee charged lesser rate of interest.

The Assessing Officer also disallowed 20% of expenses incurred under the head vehicle repair and maintenance, telephone expenses and business promotion trading the same as incurred for personal purposes.

The assessee filed appeal before the CIT(A). The CIT(A) upheld the order of the Assessing Officer except in respect of personal expenses instead of 20% reduced it to 10% of personal expenses.

Being aggrieved by the order of the CIT(A), the Assessee is before us on the following grounds: “1. That on the facts and circumstances of the case and in law, the order passed by CIT(A) is contrary to facts and bad in law.

The Ld. AR submitted that the transaction agreement has clearly given the mechanism as to how the commission to be fixed. Thus, the commission was not outside the scope of the transaction agreement as well as the documents produced before the lower authorities. Section 40A (2) (b) set out the expenses or payments which are not deductable. In the present case there was no necessity of invoking the same. Though Shri Manish Patodia is brother of the assessee, yet he has actually worked for the assessee. Therefore, the CIT(A) as well as the Assessing Officer was not justified for invoking provisions of Section 40A (2) (b). The incentive of Rs. 5,27,602/- to Shri Manish Patodia was paid on the basis fixed percentage of the total turnover of sulpher at 0.2% on total turnover of sulpher of Rs.26,38,01,114/-. This commission was paid for carrying out the administrative activities and performing managerial activities. Merely because the commission was paid to Shri Manish Patodia was computed on turnover basis as fixed percentage thereof and the commission paid to others on the basis of quantity sold cannot be the basis to hold that the payment as excessive and unreasonable. The observations of Assessing Officer was that the commission paid to Shri Manish Patodia is on the different footing in comparison to the other parties and is thus not derive from the actual fact of the case. It is also to be noted that TDS has been duly deducted and the same was claimed by Shri Manish Patodia is also assessed to the same jurisdiction. By adding the amount in the hands of the assessee would amount to double taxation of the same transaction.

The Ld. DR relied upon the orders of the Assessing Officer and the CIT(A). The Assessing Officer has rightly disallowed 50% of the commission paid to Shri Manish Patodia on the basis that same is covered under Section 40A(2)(b) of the Act, the payment was excessive and he was neither employee nor a shareholder in the business of the assessee. During the appellate proceedings, the assessee has reiterated that the incentive of Rs. 5,27,602/- to Sh. Manish Patodia was paid on the basis of fixed percentage of the total turnover of sulphur @ 0.2% on total turnover of sulphur of Rs. 26,38,01,114/-. This commission was paid for carrying out the administrative activities and performing managerial functions. The basis for payment of commission by the assessee is vague and not as per accepted business practices. Commission/incentive is paid for increasing the sales turnover of a business. Nothing was brought on record to show that any such services were rendered by Sh. Manish Patodia. In regard to other persons the payment was directly as a percentage of the total sales. The contribution of Shri Manish Patodia to the turnover or of providing administrative and managerial function was not proved by the assessee. Therefore, the CIT(A) rightly sustained the addition made by the Assessing Officer.

We have heard both the parties and perused relevant documents annexed to the paper book which was produced before the lower authorities as well. Ground No. 1 is general in nature. As regards to Ground No. 2, it is found that the transaction agreement has clearly given the mechanism as to how the commission to be fixed. Thus, the commission was not outside the scope of the transaction agreement as well as the documents produced before the lower authorities. Section 40A (2) (b) set out the circumstances in which certain expenses or payments are not deductable. In the present case there were no circumstances for invoking the same. Though Shri Manish Patodia is brother of the assessee, he has actually worked for the assessee. Therefore, the CIT(A) as well as the Assessing Officer was not justified for invoking provisions of Section 40A (2) (b). The incentive of Rs. 5,27,602/- to Shri Manish Patodia was paid on the basis fixed percentage of the total turnover of sulpher at 0.2% on total turnover of sulpher of Rs.26,38,01,114/-. This commission was paid as services, both administrative and managerial rendered by Mr. Manish Patodia for their sales. Merely because the commission was paid to Shri Manish Patodia was computed on turnover basis as fixed percentage thereof and the commission paid to others were on the basis of quantity sold cannot be the basis to hold that the payment as excessive and unreasonable. The observations of Assessing Officer was that the commission paid to Shri Manish Patodia is on the different footing in comparison to the other parties and is thus not genuine in correct facts of this case. It is also to be noted that TDS has been duly deducted and the same was claimed by Shri Manish Patodia is also assessed to the same jurisdiction. Merely because a person is not an employee but rendered the professional services cannot be the basis to hold that the payment made to such person is excessive and unreasonable. The 0.2 % commission for the turnover of Rs.26,38,01,114/- cannot be held as excessive or unreasonable payment. In result, Ground No. 2 is allowed.

As relates to Ground No. 3, the Ld. AR submitted that the funds borrowed were mainly brought forwarded from previous assessment year and no disallowance of interest was made in past. The interest bearing funds were brought forward from previous year and were cross verifiable from the Schedule of unsecured loans attached to the Audited Balance Sheet of the Proprietary Firm M/s. Atul International as on 31.03.2008 wherein party wise details of funds borrowed are appearing with the corresponding outstandings as on 31.03.2007. Similarly borrowed funds taken in personal capacity are duly appearing in the personal Statement of Affairs of the assessee as on 31.03.2007 and 31.03.2008. The borrowed funds were mainly availed during the previous assessment years and brought forward to the year under assessment. During the year under consideration loans were given to Smt. Jaya Patodia and Mr. Manish Patodia (HUF) from the funds available in personal capacity and not out of the funds borrowed which is evident from the personal statement of affairs.

The Ld. DR relied upon the assessment order and order of CIT(A). The Ld. DR further submitted that the assessee has shown interest income from related parties at 9% and paid interest on loans received from related parties at 12%. In case of unrelated parties the interest charged is 12%. The Assessing Officer made addition of Rs. 37,644/- as notional interest received from related parties. There is no provision of charging notional interest under Income Tax Act, 1961. However, the interest expense which was claimed as incurred for the purpose of business may be disallowed under Section 37(1) of the Act. The assessee claimed that the loans were brought forward from previous year and therefore there was no direct nexus between the taking of loans and advancing loans. However, the mere fact that these were brought forward balances cannot be a ground for lack of nexus between the loans received and loans given. The copy of the bank account filed by the assessee shows that the assessee has mixed funds that is in the same bank account the sale proceeds as well as loans taken by the assessee are deposited. There is no demarcation of the nature of funds. The assessee charged a lesser rate of interest from his relatives compared to the interest being paid by him on the loans taken. Proportionate amount of interest i.e. Rs. 37,644/- was rightly disallowed by the Assessing Officer.

We have heard both the parties and perused relevant documents. The funds borrowed were mainly brought forwarded from previous assessment year and no disallowance of interest was made in past. The interest bearing funds were brought forward from previous year and were cross verifiable from the Schedule of unsecured loans attached to the Audited Balance Sheet of the Proprietary Firm M/s. Atul International as on 31.03.2008 wherein party wise details of funds borrowed are appearing with the corresponding outstanding as on 31.03.2007. Similarly borrowed funds taken in personal capacity are duly appearing in the personal Statement of Affairs of the assessee as on 31.03.2007 and 31.03.2008. The borrowed funds were mainly availed during the previous assessment years and brought forward to the year under assessment. During the year under consideration loans were given to Smt. Jaya Patodia and Mr. Manish Patodia (HUF) from the funds available in personal capacity and not out of the funds borrowed which is evident from the personal statement of affairs. When the assessee has both interest free funds and interest bearing funds, the presumption is that interest free funds are utilized for interest free loans. Hence, there is no justification for making the proportionate disallowance. The Assessing Officer failed to establish the nexus between the interest bearing borrowed funds and their utilization for loan given at a lesser rate of interest. The addition was made purely on notional interest income which neither was charged nor the same accrued to the assessee. In result, Ground No. 3 is allowed.

As relates to Ground No.4, the Ld. AR submits that neither the assessee was confronted nor any show cause notice was issued to the assessee, before making the addition of Rs.56,052/- for disallowance on ad-hoc basis, being 20% expenses incurred under the head vehicle repair and maintain, telephone expenses and business promotion while holding the same as personal in nature, by the Ld. A.O. The Assessing Officer has not pointed out any specific expenses which as per him were incurred for personal purposes. The expenses were fully vouched and duly recorded in the regular books of accounts maintained by the assessee separately for his proprietary concern namely M/s Atul International. The books of accounts were duly audited u/s 44AB of the Act and nothing adverse was reported by the tax auditor regarding personal use of the business assets.

The Ld. DR relied on the assessment order and CIT (A)’s order. The Ld. DR further submitted that the assessee had claimed an expense of Rs. 86,908/- under the head vehicle running and maintenance and Rs. 58,113/- under the head Telephone and Telex and Rs. 1,35,239/- as Business Promotion Expenses. On the basis that no record had been maintained regarding details of the use of vehicle and telephone, it was held that some element of personal use could not be ruled out, the Assessing Officer made a disallowance of 20% of the total claim. The assessee’s business concern is a proprietorship concern. In such a scenario the CIT(A) has rightly restricted it to 10% of the total claim.

We have heard both the parties. The expenses incurred by the assessee are properly justified by the Assessee through vouchers. Neither the assessee was confronted nor any show cause notice was issued to the assessee before making the addition of Rs.56,052/- for disallowance on ad-hoc basis being 20% expenses incurred under the head vehicle repair and maintainance, telephone expenses and business promotion while holding the same as personal in nature by the Ld. A.O. The Assessing Officer has not pointed out any specific expenses which as per him are personal expenses. The expenses were fully vouched and duly recorded in the regular books of accounts maintained by the assessee separately for his proprietary concern namely M/s Atul International. The books of accounts were duly audited u/s 44AB of the Act and nothing adverse was reported by the tax auditor regarding personal use of the business assets. All expenses were supported by the bills and vouchers. The same were before the Assessing Officer. The disallowance on Ad-hoc basis cannot be sustained in the fact and circumstances of this case. Hence the same is dleted. In result, Ground No.4 is allowed.

In result, appeal of the assessee is allowed.