By TIOL News Service

AHMEDABAD, JAN 21, 2014: THE issues before the Bench are - Whether any adhoc disallowance of payment made u/s 40A(2)(b) to a sister concern is warranted merely on the basis that it was run by the wife of the Director of the assessee company and Whether in such a case there would be a presumption of excessive claim. And the verdict goes against the Revenue.

Facts of the case

The assessee, a company, was engaged in the business of development of infrastructure facilities mainly relating to water and sewage treatment on turnkey basis. It had filed return of income for AY 2005-06 declaring total income at Rs. NIL. Notice u/s 143(2) and 142(1) were issued. Assessee claimed deduction u/s 40A(2)(b) of Rs. 1.50 crore paid to the persons specified u/s 40A(2)(b) viz M/s. Pollucon Engineers, the proprietor of which was wife of Shri Anand Vashi, Director of the assessee company with respect to supply of labour for operating and maintenance work. By a office letter, assessee was requested to justify the said claim. The assessee had submitted that the business of the proprietor was looked after with the help of Engineers and other employees. It was submitted that the job was awarded to M/s. Pollucon Engineers after inviting offer from other parties. It was further submitted that since the offer of M/s. Pollucon Engineers was found loweset and favourable, the offer was accepted. That AO was not convinced with the explanation given by the assessee and disallowed 10% payment of Rs. 1.50 crores and added to the total income of the assessee by observing that the assessee had failed to produce any supporting evidence against the claim; the proprietor of M/s. Pollucon Engineers was the wife of the Director of the assessee company and therefore, element of excessive payment cannot be denied. On appeal, CIT(A) had deleted 10% disallowance out of the payment to specified person u/s 40A(2)(b) i.e. payment to M/s M/s. Pollucon Engineers. On further appeal, Tribunal had dismissed the said appeal confirming the deletion of 10% disallowance made by AO. Before HC, the Revenue's counsel had submitted that ITAT had materially erred in rejecting the findings of AO, more particularly, when AO noticed that the assessee had made payment Rs. 1.50 crores to M/s. Pollucon Engineers a sister concern of the assessee against the supply of labour for operation and maintenance work being done by the assessee. It was submitted that in the facts and circumstances of the case, AO rightly disallowed the 10% of the payment made to M/s. Pollucon Engineers which was made by AO by observing that element of excessive payment cannot be denied. It was further submitted that ITAT had not properly appreciated fact that M/s. Pollucon Engineers to whom the payment was made u/s 40A(2)(b) was a sister concern run by the wife of the Director of the assessee company and therefore, element of excessive payment cannot be denied. It was submitted that as such the assesssee failed to produce any evidence which may suggest that the payment was reasonable or was necessitated out of the business need or payee was the only person who could have only handled the project of plant operation on contract basis. It was submitted that therefore, in absence of any evidence produced by the assessee, the AO was justified in making disallowance of 10% made to M/s. Pollucon Engineers.

Held that,

++ at the outset, it is required to be noted that Assessing Officer directed to make disallowance of 10% of the payment made under Section 40A(2)(b) of the Act to M/s. Pollucon Engineers and added to the total income of the assessee on adhoc basis and solely on the ground that as M/s. Pollucon Engineers whom the payment was made u/s 40A(2)(b) was a sister concern run by the wife of the Director of the assessee company and therefore, element of excessive payment cannot be denied. However, it is required to be noted that there was no other material before the AO that any excessive payment was made to M/s. Pollucon Engineers. It is required to be noted that it was not the case on behalf of the AO and as such there was no finding by the AO that the transaction / contract with M/s. Pollucon Engineers was not genuine one. As such there was no material before the AO such as comparable rates etc. to come to the conclusion that excessive payment was made to the aforesaid firm which warranted disallowance / adhoc disallowance. CIT(A) had observed that disallowance made by the A.O. u/s 40A(2)(b) is adhoc and without any basis. Disallowance u/s 40A(2)(b) by saying that the assessee has not followed due diligence and has not floated tender or obtaining the lowest rate is not correct. Various courts have held that the AO cannot dictate to the assessee as to how the business should be done. ITAT in the case of Binit Corporation (24 TTJ 571) has after considering various judicial pronouncement stated that first of all the AO has to satisfy himself whether the expenditure itself is genuine or not and if it is genuine then for the purpose of finding out the portion of disallowance he shall have to find out the fair market value of the services and this would presuppose that services are commonly available for which market value can be known. Thereafter, the AO shall have to evaluate the legitimate needs of the business at a point of time when the services were rendered and this would involve in inquiry as a businessman because in times of dire need services are obtained even at higher cost, the ultimate aim being to earn profit or to maintain the business relations. According to the ITAT, the AO shall have to find out what benefit is derived by the assessee and this would not necessarily confine to the year in question but shall have to take overall picture depending upon the facts of each case. Even the benefit accruing to the assessee shall have to be evaluated. This again may not be confirmed to the period of accounting year only and again it would not be essential that benefit must be in the revenue field. Thereafter according to the ITAT the AO shall have to give reasonable opportunity to the assessee to rebut his finding. If comparable instances of other parties are not available at least compare with earlier year, adhoc disallowance cannot stand the test of appeal. In view of the above, the disallowance made by the A.O is deleted. Therefore, this ground of appeal is allowed;

++ ITAT has confirmed the deletion made by CIT(A) and observed that the provisions of Section 40A(2)(b) are to be applied when the AO is of the opinion that an expenditure is excessive or unreasonable having regard to the fair market value of the services for which the payment is made. In the present case, the genuineness of the expenditure has not been doubted by the A.O. The only reason for the impugned addition was that the payments was excessive in nature. But before arriving to a conclusion that the payment was excessive, the AO was expected to place on record the reason for holding such opinion. We have noted that no such comparable instance was quoted by the AO. Additionally, it has also been argued before us that the payment made to the wife of the Director was a business requirement of the assessee and that lady is also subject to tax at the maximum rate. Hence, it is pleaded that there was no intention to save the tax. It has also been pleaded that there was no motive to divert the income because the assessee is entitled for the claim of 100% deduction on the income u/s 80IA(4). Thus, the totality of the circumstances demonstrates that there was no justification on the part of the AO to make such an adhoc addition. Resultantly, we hereby confirm the findings of the CIT(A) and dismiss this ground of the Revenue for the years under consideration;

++ we are in complete agreement with the reasoning and observations made by the CIT(A) confirmed by the ITAT. In absence of any material before the Assessing Officer, such as comparative chart etc. to suggest that any excessive payment was made to M/s. Pollucon Engineers and the 10% ad hoc disallowance was made on the payment made under Section 40A(2)(b) of the Act to M/s. Pollucon Engineers solely on the ground that M/s. Pollucon Engineers to whom the payment was made, was run by the wife of the Director of the assessee company and therefore, there was an element of excessive claim, we are of the opinion that the AO was not justified in adopting disallowance to the extent of 10% payment under Section 40A(2)(b) . Under the circumstances, disallowance made by the AO is rightly deleted by the CIT(A) confirmed by the ITAT. In view of the above, we see no reason to interfere with the impugned common judgment and order passed by the learned ITAT. No question much less substantial question of law arise in the present tax appeals. Hence, all these appeals deserve to be dismissed and are accordingly dismissed.

(See 2014-TIOL-82-HC-AHM-IT)