Expenses cannot be disallowed on the ground that ratio of sharing of expenses by the parent/associate company is lower than the preceding year
It is held that expenses incurred by the assessee wholly and exclusively for the purpose of business could not be disallowed on the ground that there was a reduction in the ratio in which the expenses were shared by the assessee’s parent/associate company.
• The assessee was engaged in the business of providing services for telecom networks, implementation and technology solutions and management services.
• The Assessing Officer (“AO”) observed that the administrative expenditure was shared by the parent/associate company of the assessee.
• The AO also observed that there was a reduction in the ratio of sharing of expenses compared to earlier years and disallowed proportionate expenditure incurred by the assessee on the grounds that the expenses should have been borne by the parent or the associate company.
• The Commissioner of Income-tax (“CIT(A)”) upheld the order of the AO on the ground that the assessee failed to furnish the details regarding revenue generated by the parent/associate company in relation to the revenue generated by the assessee for ascertaining the breakdown of the administrative expenses.
Issue:- Whether the expenses incurred wholly and exclusively for the purpose of business would be disallowed due to the reduction in ratio of sharing of expenses by the parent/associate company.
Assessee’s contentions: – The assessee contended that,
• The assessee’s income had gone up during the relevant assessment year due to which the assessee could bear a higher share of the administrative expenses in relation to the preceding year.
• There was no formal contract with the parent company to share the administrative expenses except a letter of 15 April, 2003. Also, no right to share expenses had accrued in favour of the assessee. Reimbursement was at the sole discretion of the parent/associate company.
• The main objective of reimbursement was to ensure a minimum return of 5% of the gross revenue to the assessee and the sharing of expenses was incidental to that objective. The actual reimbursement during the relevant assessment year had resulted in a return in excess of 5% of the gross revenue.
• The entire expense incurred by the assessee firm pertained to the assessee firm only and not to the parent company.
Revenue’s contentions :- The revenue contended that,
• the assessee could not follow one method of revenue/expense sharing and change it in another year without any business rationale.
• the assessee could not suo moto take the responsibility of the parent company and claim the expense as its own expense.
Tribunal Ruling:-After considering the contentions of the assessee and the revenue, the Tribunal observed and held that,
• The expenses incurred were wholly and exclusively for the purpose of assessee’s business.
• If the sharing of expenses by the parent company had resulted in earning of 5% or more of gross revenue, no objection could be raised by the revenue authorities against the decline in proportion of the total expenses shared.
• As a result, the expenses incurred by the assessee could not be disallowed.
Conclusion :-The Tribunal held that the expenditure incurred by the assessee could not be disallowed merely on the ground that there was a reduction in the expenses reimbursed by the parent/associate company, particularly when the assessee had earned minimum return on the gross revenue and the parent company had no further liability to reimburse the cost. The decision provides guidance in cases where minimum return is guaranteed to the Indian subsidiary/associate company and there is fluctuation in the expenditure shared by the parent company to maintain the minimum return.
In the case of Avion Systems Inc
Mumbai Income-tax Appellate Tribunal