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Income Tax Appellate Tribunal, RAIPUR BENCH “SMC”, RAIPUR
Before: SHRI RAVISH SOOD
आदेश / ORDER PER RAVISH SOOD, JM
The present appeal filed by the assessee is directed against the order passed by the CIT(Appeals)-II, Raipur dated 08.03.2019, which in turn arises from the order passed by the A.O U/s. 143(3) of the Income-tax Act, 1961 (in short ‘the Act’) dated 11.12.2017 for the assessment year 2015-16. The assessee has assailed the impugned order on the following grounds of appeal before me: “1) That learned CIT(A) erred in adjudicating the legal grounds of appeal regarding issuance of notice u/s 143(2) by the non- jurisdictional Assessing Officer ITO-1(3), Bhilai and non- issuance of fresh notice u/s 143(2) by the jurisdictional Assessing Officer ITO-1(1), Bhilai after transfer of the case within prescribed time by stating that "the Commissioner is empowered to transfer the cases from one AO to another AO and so long as the assessee has been assessed within the jurisdiction of CIT-2, Raipur, the jurisdiction is proper" by ignoring the provisions of section 120 and section 124 of the Act, notification no. 1/2014-15 dt. 15.11.2014 issued by the PCIT-II, Raipur to allocate jurisdiction to various AO's under his jurisdiction and judicial pronouncement referred by the appellant. 2) That learned CIT(A) erred in confirming disallowance of Rs. 13,20,000/-out of Directors Remuneration made by the Assessing Officer by invoking provisions of section 40A(2)(b) of the Act without properly appreciating and fully considering the written submission filed before him and without considering the facts and circumstances of the case properly.
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3) The appellant reserves the right to add, amend, or alter any ground or grounds of appeal at the time of hearing.”
Succinctly stated, the assesee company which is engaged in trading of motor vehicles and spare parts had e-filed its return of income for A.Y.2015-16 on 15.09.2015, declaring an income of Rs. Nil. Subsequently, the case of the assessee was selected for scrutiny assessment u/s.143(2) of the Act.
During the course of the assessment proceedings, it was, inter alia, observed by the A.O that the assessee company during the year under consideration had paid remuneration of Rs.15.60 lac to its directors, viz. (i) Shri Rajesh Batra : Rs. 12 lac; (ii) Shri Vishal Batra Rs. 3.60 lac. The A.O holding a conviction that the aforesaid director’s remuneration of Rs.15.60 lacs was highly pitched as against that of Rs. 1 lac which was paid in the immediately preceding year, thus called upon the assessee company to justify the same. In reply, it was the claim of the assessee that the increase in remuneration was on account of exclusive work done by the directors for the company during the year under consideration. However, the aforesaid claim of the assessee did not find favour with the A.O. It was observed by the A.O that as the exorbitant increase in the director’s remuneration was not commensurate with the miniscule increase in the turnover of the assessee company drin the year under consideration, therefore, the
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explanation given by the assessee in its attempt to justify the same did not merit acceptance. Although, the assessee company tried to impress upon the A.O that it had during the year entered into an arrangement with Shri Rajesh Batra, director, as per which he in lieu of a remuneration of Rs. 1 lac per month was to exclusively attend the affairs of the company on a full time basis, but the said claim did not find favour with the A.O. It was observed by the A.O that not only the manifold increase in the director’s remuneration was not commensurate with the marginal increase of turnover of the company by an amount of Rs.13 lac as in comparison to the preceding year, but even otherwise no copy of the resolution passed in Annual General Meeting (AGM) of the assessee company was placed on record to substantiate the same. The A.O was also of the view that as the Companies Act, 2013 prescribed an upper limit of the director’s remuneration at 10% of the net profit of the company, therefore, the remunerationallowable to the director’s of the assessee company could not have exceeded an amount of Rs.2.4 lac. Accordingly, the A.O on the basis of his aforesaid observations disallowed the director’s remuneration of Rs.13.20 lac [Rs.15,60,000/- (-) Rs.2,40,000/-] u/s.40A(2)(a) of the Act.
Aggrieved, the assessee carried the matter in appeal before the CIT(Appeals) but without any success on the aforesaid issue. i.e.,
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sustainability of the disallowance of the assessee’s claim for deduction of director’s remuneration which was sustained by the first appellate authority.
The assessee being aggrieved with the order of the CIT(Appeals) has carried the matter in appeal before me.
I have heard the ld. authorized representatives of both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by them to drive home their respective contentions.
Although the Ld. Authorized Representative (for short ‘AR’) for the assessee had at the very outset of hearing of the appeal assailed the validity of the jurisdiction that was assumed by the A.O, i.e., ITO- 1(1), Bhilai for framing of the impugned assessment in absence of any notice u/s.143(2) of the Act, but after arguing for some time and considering the reply of the A.O dated 14.11.2022, it was submitted by him that he seeks to not press the ground of appeal No.1. Accordingly, as per the concession of the Ld. AR the Ground of appeal No.1 raised by the assessee is dismissed as not pressed.
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The assessee by preferring the present appeal had sought my indulgence for adjudicating a solitary issue, viz. sustainability of part disallowance of its claim for deduction of director’s remuneration of Rs.15.60 lac u/s 40A(2)(a) of the Act, which had been confined by the lower authorities to an amount of Rs.13.20 lac.
It is the claim of the Ld. AR that the A.O had grossly erred in law and facts of the case in triggering the provisions of Section 40A(2)(a) of the Act, and making a consequential part disallowance of the assessee’s claim for deduction of director’s remuneration. Elaborating on his aforesaid contention, it was averred by the ld. A.R that both the lower authorities had made/sustained the impugned disallowance u/s 40A(2)(a) of the Act, without placing on record any material which would reveal that the director’s remuneration paid by the assessee company during the year was found to be excessive or unreasonable in complete disregard of the prescribed basis/yardsticks factored in the said statutory provision, viz. (i). Fair Market Value (FMV) of the services for which the payment was made; or (ii). the legitimate needs of the business or profession of the assessee company; or (iii). the benefit derived by or accruing to the company from rendering of the services by the directors. It was averred by the Ld. AR that the only basis that was adopted by the A.O for working out the impugned part disallowance u/s.40A(2)(a) of the Act was that the director’s
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remuneration of Rs. 15.60 lac paid by the assessee company during the year under consideration was highly pitched, as against that paid in the immediately preceding year. It was submitted by the Ld. AR that the simplicitor reference to the director’s remuneration for the preceding year could by no means form a justifiable basis/yardstick for treating the director’s remuneration for the year under consideration as excessive or unreasonable within the meaning of Sec. 40A(2)(a) of the Act. In support of his aforesaid contention the Ld. AR had relied on the order of the ITAT, Bangalore in the case of S.K Engineering Vs. JCIT (2006) 103 ITD 97 (Bangalore) and that of the ITAT, Mumbai in the case of NAT Steel Equipment (P) Ltd. Vs. DCIT (2018) 171 ITD 482 (Mumbai).
Per contra, the Ld. Departmental Representative (for short ‘DR’) relied on the orders of the lower authorities. It was submitted by the Ld. DR, that as observed by the A.O, the assessee had not only failed to justify the exorbitant increase in the director’s remuneration during the year, but had also not placed on record the company’s resolution to the said effect as passed in its AGM. It was averred by the Ld. DR that as there was an exorbitant rise in the director’s remuneration from an amount of Rs.1 lac in the preceding year to an amount of Rs. 15.60 lac during the year under consideration, therefore, the A.O had on the basis of a feasible comparison and as per the mandate of law restricted
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the same to Rs. 2.40 lac. Apart from that, it was submitted by the Ld. DR, that as observed by the A.O, and, rightly so, now when as per the Companies Act, 2013, the remuneration to the directors of a company is not to exceed 10% of the net profit of the company, therefore, adopting the same as a yardstick the claim of the assessee company was rightly confined to Rs.2.40 lac.
Rebutting the aforesaid claim of the Ld. DR, it was submitted by Shri R.B Doshi, the Ld. AR for the assessee, that reference by the A.O to the provisions of Companies Act, 2013 as regards the upper limit of remuneration which could be paid to the director’s of a company was based on misappreciation of law. In support of his aforesaid contention the Ld. AR had taken me through Section(s) 197 to 199, Schedule (V) of the Companies Act, 2013, and submitted that the restriction placed by Section 197 was in context of the managerial remuneration to the directors of a public company, and thus, the same was not applicable to the case of the present assessee. Apropos, the observation of the A.O that the increase in the director’s remuneration was not supported by a resolution of the Board of Directors, the Ld. AR had taken me through the copy of resolution of the Board of Directors, Page 30 of APB.
I have given a thoughtful consideration to the issue in hand in the backdrop of the contentions advanced by ld. Authorized
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Representatives of both the parties. Admittedly, it is a matter of fact borne from record that the director’s remuneration during the year under consideration had increased from Rs.1 lac per annum that was paid in the immediate preceding year to an amount of Rs.15.60 lac during the year under consideration. Although at the first blush the observation of the A.O that there was an exorbitant rise in the director’s remuneration during the year under consideration appeared to be very convincing, but the said fact on a standalone basis could by no means justify drawing of adverse inferences within the meaning of Sec. 40A(2)(a) of the Act. To sum up, the sustainability of the part disallowance of assessee’s claim for deduction of director’s remuneration u/s. 40A(2)(a) of the Act is to be looked into in the backdrop of satisfaction of the pre-conditions contemplated in the said statutory provision. Before proceeding any further, I deem it fit to cull out Section 40A(2)(a) of the Act, as under :-
“(2)(a) 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.”
On a careful perusal of the aforesaid statutory provision, I find that the same contemplates that where the assessee’s claim for deduction of
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any expenditure incurred in respect of a specified person, when tested in the backdrop of the prescribed basis/yardsticks factored in the said statutory provision, viz. (i). the fair market value of the goods or services or facilities for which the payment is made; or (ii). the legitimate needs of the business or profession of the assessee; or (iii). the benefit derived by or accruing to the assessee, is in the opinion of the Assessing Officer excessive or unreasonable, then, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction. In sum and substance, the element of excessiveness or unreasonableness of the assessee’s claim for deduction of expenditure incurred in respect of specified person is to be strictly looked into in the backdrop of the aforesaid three prescribed basis/yardsticks.
Although, in the case before me, the A.O by referring to the director’s remuneration of Rs.1 lac per annum that was paid by the assessee company in the immediately preceding year had tried to justify the part disallowance of the director’s remuneration during the year u/s. 40A(2)(a) of the Act, but such standalone basis for making the disallowance in my considered view does not satisfy either of the three prescribed basis/yardsticks contemplated in the said statutory provision. I, say so, for the reason that the very basis for arriving at the unreasonableness or excessiveness of the director’s remuneration u/s
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40A(2)(a) is only to be weighed in backdrop of the aforesaid prescribed factors, viz. (i). the fair market value of the services rendered by the director’s for which remuneration is paid to them; or (ii). the legitimate needs of the business of the assessee company; or (iii). the benefit derived by or accruing to the assessee company from rendering of the services by the director’s. In my considered view, as a mere reference to the remuneration paid by the assessee company to its director’s in the immediately preceding year would neither reveal the FMV of the services rendered by the director’s to the assessee company during the year under consideration, nor reflect the value of such services considering the legitimate needs of the business of the assessee company; or the benefit accruing therefrom to the latter, therefore, the unreasonableness or excessiveness of the remuneration paid by the assessee company to its director’s during the year could not have been arrived at on the basis adopted by the A.O. The aforesaid view arrived at by me is fortified by the order of the ITAT, Bangalore in the case of S.K Engineering Vs. JCIT (2006) 103 ITD 97 (Bangalore), wherein it was observed, that merely for the reason that in the earlier years commission was paid by the assessee @ 0.94%, the commission paid in excess during the year could not be to be held as unreasonable for the purpose of Section 40A(2)(a) of the Act. It was observed by the Tribunal that there may be several reasons as to why the assessee had
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paid lower commission in the initial years. Considering that u/s.40A(2)(a) of the Act, it is the reasonableness or excessiveness of the expenditure incurred in respect of the specified parties that is to be looked into the tribunal had vacated the disallowance so made by the A.O, observing as under:
“3. In the present case, neither the AO nor learned CIT(A) has given any finding as to what is the excessive or unreasonable portion in the total commission payment. There is no finding on what is the legitimate need of the business. Both the authorities have gone by the principle that since in the earlier year the amount paid was 94%, the excess becomes unreasonable. In our opinion, this approach is not correct. There is no presumption that whatever was paid in earlier year only becomes reasonable and anything in excess becomes unreasonable. There may be several reasons that the assessee may pay lower commission in initial years. However, the finding, which is required, is what is the reasonableness or excessiveness for the year under appeal. Looking to the background of Shri Sharma and the nature of services rendered by him, we find that payment of commission at 2-1/2% cannot be considered as excessive or unreasonable. The partners of the firm are merely female partners whereas Shri S K Sharma is an influential person, who retired from M/s MICO Ltd. as Senior Vice President and is able to influence the said company, which is one of the top most customers of the appellant firm. We accordingly hold that no part of commission can be disallowed invoking the provision of Section 40A(2) of the Act.”
Also, a similar view had been taken by a division bench of the ITAT, Mumbai in the case of NAT Steel Equipment (P) Ltd. Vs. DCIT (2018) 171 ITD 482 (Mum.) (to which undersigned was a party). It was observed by the tribunal that the legislature had in all its wisdom, and in order to avoid any arbitrary exercise of powers by the A.O by triggering Section 40A(2)(a) of the Act, had specifically provided that it
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is only where the A.O had formed an opinion that the expenditure incurred in respect of related party payment is excessive or unreasonable having regard to the FMV of the goods or services or facilities for which payment was made by the assessee; or keeping in view the legitimate needs of the business or profession of the assessee; or the benefit derived by or accruing to him therefrom, disallow such part of excess or unreasonable amount of expenditure incurred in respect of specified parties by taking recourse to Section 40A(2)(a) of the Act. As the A.O in the said case had not uttered a word as to on what basis the expenditure incurred by the assessee before them in context of related/specified parties was found to be excessive or unreasonable, as tested in the backdrop of the prescribed factors/yardsticks, viz., (i). the FMV of the services for which the payment was made by the assessee; or (ii). the legitimate needs of its business or; (iii). the benefit derived by or accruing to the assessee therefrom, therefore, the tribunal had vacated the disallowance so made by the A.O.
On the basis of my aforesaid observations, I am of the considered view, that as the very basis for holding the director’s remuneration paid by the assessee company during the year under consideration as unreasonable/excessive by the A.O u/s 40A(2)(a) of the Act, i.e., a simpliciter reference to the director’s remuneration that was paid in
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the immediately preceding year is not in conformity with the mandate of law, therefore, the consequential disallowance of Rs. 13.20 lac (supra) so made/sustained by the lower authorities cannot be subscribed on my part. Also, the observation of the A.O that as per Section 197 of the Companies Act, 2013, the upper limit of the director’s remuneration was fixed at 10% of net profit of the assessee company, the same, as stated by the Ld. AR, and, rightly so, being in the context of a public company would thus not be applicable to the case of the assessee company before me. Apropos, the claim of the assessee that the steep rise in the director remuneration was for the reason that the company had entered into an arrangement with them, as per which, unlike as in the preceding years, they had agreed to remain exclusively associated with the company and render their services, I find had not been dislodged by the A.O by placing on record any material proving to the contrary. As regards the view taken by the A.O that the steep rise in the directors remuneration was not commensurate with the miniscule rise of Rs.13 lac in the turnover of the assessee company during the year, the said fact, in my considered view, could have by no means formed a justifiable basis for drawing of adverse inferences as regards the increase in the director’s remuneration during the year under consideration. I, say so, for the reason that the fact that efforts of the directors could not have been be
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expected to have resulted result to a spontaneous increase in the turnover of the assessee company. In fact, I find that the claim of the assessee that as both the directors, viz. S/sh. Rajesh Batra and Vishal Batra who were not exclusively involved in the business in the assesee company in the preceding years and had their independent businesses. had however during the year agreed to render their services as full time directors had been lost sight of by both the lower authorities while making/sustaining the disallowance u/s.40A(2)(a) of the Act. The fact that the aforesaid claim of the assessee company was not a mere eye wash was duly demonstrated by the latter by placing on record the respective income-tax returns of the directors, viz. S/sh. Rajesh Batra and Vishal Batra, which revealed that during the year under consideration their only source of income was director remuneration and interest on deposits. Apart from that, it was the claim of the assessee company before the CIT(Appeals) that though its turnover had not substantially increased, but pursuant to the services rendered by the directors the expenses towards discounts to customers were substantially scaled down from Rs.43.15 lac as were incurred in the preceding year to Rs.20.19 lac during the year under consideration. Also, it was the claim of the assessee company that due to the efforts put in by the directors its sundry debtors were scaled down from Rs.70.46 lacs in A.Y.2014-15 to Rs.43.16 lac during the year under
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consideration. It was also the claim of the assessee that on account of the services of the directors its commission income had increased substantially from Rs.17.83 lac in A.Y.2014-15 to Rs.34.05 lac during the year. Also, the assessee had stated before the CIT(Appeals) that it was due to change of companies policy that was brought in by the directors that its claim of expenses of Rs.64.84 lac in A.Y.2014-15 was scaled down to Rs.45.39 lac during the year under consideration. Apart from that, I find that the assessee in order to justify the increase in the director’s remuneration, had stated that considering their services the amount of salary that was paid to staff (other than directors) was also reduced from Rs.47.87 lac as was incurred in A.Y.2014-15 to Rs.42.36 lac during the year, which, thus, had resulted to savings of Rs.5.51 lac. To sum up, I find that it was the claim of the assessee company before the CIT(Appeals), that the A.O had grossly erred in observing that it was not benefited at all by increasing the director’s remuneration during the year under consideration.
I have given a thoughtful consideration to the issue in hand and is unable to persuade myself to subscribe to the view taken by the lower authorities. As the A.O had failed to adopt either of the prescribed basis/yardstick for verifying the reasonableness of the director’s remuneration that was paid by the assessee company during the year under consideration, therefore, there was no justification on
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his part to have confined the assessee’s claim for deduction of the same to Rs. 2.40 lac (supra) u/s.40A(2)(a) of the Act. Apart from that, I am unable to concur with the view of the CIT(Appeals), who despite taking cognizance of the contentions of the assesee that on the basis of services rendered by the directors on full time basis, it was able to scale down its expenses, liquidate its debtors, raise its commission income etc., had upheld the view taken by the A.O on the solitary basis that there was no substantial increase in the turnover and there was a comparative decline in the net profit of the company during the year under consideration. Be that as it may, as the A.O had without adopting ant prescribed basis/yardstick held the director’s remuneration as excessive and unreasonable, therefore, I am unable to uphold his view. Accordingly, on the basis of my aforesaid observations, I set-aside the order of the CIT(Appeals) and vacate the disallowance of Rs.13.20 lac (supra) that had been sustained by him. Thus, the Ground of appeal No.2 raised by the assessee is allowed in terms of the aforesaid observations.
Ground of appeal No.3 being general in nature is dismissed as 16. not pressed.
In the result, appeal of the assessee is partly allowed in terms of the aforesaid observations.
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Order pronounced under Rule 34(4) of the Appellate Tribunal Rules, 1963 by placing the details on the notice board. Sd/- (रवीश सूद /RAVISH SOOD) �या�यक सद�य/JUDICIAL MEMBER रायपुर / Raipur; �दनांक / Dated : 27th December, 2022 #***SB आदेश क� ��त�ल�प अ�े�षत / Copy of the Order forwarded to : अपीलाथ� / The Appellant. 1. ��यथ� / The Respondent. 2. 3. The CIT(Appeals)-II, Raipur (C.G.) 4. The Pr. CIT-1, Raipur (C.G.) 5. �वभागीय ��त�न�ध, आयकर अपील�य अ�धकरण, “एक-सद�य” ब�च, रायपुर / DR, ITAT, “SMC” Bench, Raipur. गाड� फ़ाइल / Guard File. 6.
आदेशानुसार / BY ORDER, // True Copy // �नजी स�चव /Private Secretary आयकर अपील�य अ�धकरण, रायपुर / ITAT, Raipur