Economical Life Freedom Pvt. Ltd. Vs ITO (ITAT Mumbai)
SECTION 37(1): AO CANNOT FIX COMMISSION BY INDUSTRY “FEELING”—30% AD HOC DISALLOWANCE DELETED WHEN NOT ONE PAYMENT WAS FOUND BOGUS
Referral business naturally travels with commission
The assessee-company was engaged in trading health cards, magnetic bracelets & gas-safety products.
Its business operated through a referral or multi-level marketing model. Membership was given to purchasers, who earned commission for referring new customers. As the membership chain expanded, commission became payable at different levels.
The assessee filed its return declaring total income of ₹4,41,770. The case was selected for limited scrutiny under CASS principally because of large commission expenditure & comparatively low net profit.
During the year, the assessee debited commission expenditure of ₹68,83,823, representing approximately 35.42% of its sales.
528 recipients—but only four confirmations
During the assessment, the assessee furnished a list of 528 commission recipients.
The assessment order itself recorded that TDS had been deducted in 80 cases involving aggregate commission of ₹55,42,604. In the remaining cases, TDS was not deducted because the individual payments were stated to be below the applicable statutory threshold.
The assessee explained its referral-based business model & furnished details of the commission payments.
The AO nevertheless observed that complete party-wise evidence linking each commission payment with the corresponding referral or business generated had not been produced. He also noted that confirmations from only four recipients were furnished.
According to the AO, payment through banking channels & deduction of TDS did not, by themselves, establish that every payment was genuine or incurred wholly & exclusively for business.
AO invents a 20%-25% industry benchmark
The AO observed that commission expenditure in the multi-marketing sector would “normally” range between 20% & 25% of sales.
Since the assessee’s commission expenditure represented 35.42% of turnover, the AO considered it excessive.
However, instead of identifying any particular recipient as non-existent or any payment as bogus, excessive or unrelated to the assessee’s business, he estimated a disallowance at 30% of the entire commission expenditure.
The resultant disallowance was ₹20,65,147, increasing the assessee’s assessed income to ₹25,06,920.
The CIT(A) confirmed the addition, following which the assessee approached the ITAT.
Documents were already on the record
Before the Tribunal, the assessee produced a paper book running into 119 pages.
It drew attention to the details of commission recipients in respect of whom TDS had been deducted, together with their PAN particulars & Form 26Q.
The assessee also referred to its letter dated 23.07.2018, furnished during the assessment proceedings, containing details of the total commission payments.
Therefore, the observation that particulars of commission recipients were not furnished was inconsistent with the documentary material available before the Revenue authorities.
The payments were made through banking channels & the commission expenditure was integral to the assessee’s referral-driven business model.
Burden lies on assessee—but evidence cannot be ignored
The Revenue relied upon CIT v. Calcutta Agency Ltd. [1951] 19 ITR 191 (SC) for the proposition that the burden of proving the allowability of business expenditure rests upon the assessee.
The ITAT accepted the legal principle but distinguished the decision on facts.
In Calcutta Agency, the assessee had failed to establish the foundational facts supporting the expenditure at any stage.
In the present case, however, the assessee had furnished:
- Party-wise commission details;
- PAN particulars of recipients;
- TDS particulars & Form 26Q;
- Details of the payments submitted to the AO; &
- An explanation of the referral-based business model generating the commission liability.
Thus, this was not a case where the expenditure rested upon a bare ledger entry unsupported by evidence.
Once substantive material was furnished, the AO was required to examine it & identify the particular payments which failed the test of section 37(1). The initial burden upon the assessee did not authorise the AO to disregard the entire documentary record & substitute an arbitrary percentage.
Past ratios contradicted the AO’s suspicion
The assessee’s commission-to-sales ratio was:
- 37.41% in AY 2014-15;
- 29.93% in AY 2015-16; &
- 35.42% in AY 2016-17.
Therefore, the ratio for the year under appeal was not unprecedented in the assessee’s own business history.
A higher percentage in one year might justify scrutiny, but it could not by itself establish inflation or non-genuineness of expenditure.
The AO cited no comparable enterprise, market survey, industry report or other reliable material supporting his assumption that commission in the relevant business should remain between 20% & 25%.
An assumed “normal” percentage cannot become a statutory ceiling under section 37(1).
No specific defect means no percentage disallowance
The ITAT emphasised that the AO had not identified:
- Any fictitious or non-existent recipient;
- Any specific payment unsupported by the records;
- Any amount diverted for a non-business purpose;
- Any commission shown to be excessive by comparable evidence; or
- Any transaction proved to be bogus.
The AO merely doubted the completeness of the supporting evidence & proceeded to disallow 30% of the aggregate amount.
Such an estimated disallowance cannot be sustained where substantial documentary evidence exists & the Revenue has failed to locate a specific defect.
The allowability of expenditure must be decided on facts concerning the actual payments—not through an arbitrary haircut applied to the total claim.
Decision
Considering the recipient-wise details, PANs, Form 26Q, TDS deducted on commission of ₹55.43 lakh, payment particulars, referral-based business model & absence of any specific finding of bogus or non-business expenditure, the ITAT held that the 30% ad hoc disallowance had no sustainable basis.
The entire addition of ₹20,65,147 u/s 37(1) was deleted & the assessee’s appeal was allowed.
Cases Discussed
FULL TEXT OF THE JUDGMENT/ORDER OF ITAT, MUMBAI
This appeal by the assessee is directed against the order passed by the Ld. Commissioner of Income tax, Addl./JCIT(A), Panaji [in short, “Ld. CIT(A)], under section 250 of the Income-tax Act, 1961 (in short, “the Act”) dated 10.02.2026, for Assessment Year 2016-17, arising out of the assessment order passed by Ld. Income Tax Officer, ward 1(2), Thane (in short, “Ld. AO”), under section 143(3) of the Act dated 25.12.2018.
2. The assessee is a company engaged in the business of trading in health cards, magnetic bracelets and gas safety products. Under its business model, membership is given to purchasers and commission is paid to members on referrals at different levels. The assessee filed its return of income on 16.10.2016 declaring total income of Rs.4,41,770/-. The case was selected for limited scrutiny under CASS, inter alia, on account of large commission expenditure and low net profit. During the relevant year, the assessee debited commission expenditure of Rs.68,83,823/-. During the assessment proceedings, the assessee furnished a list of 528 persons to whom commission was stated to have been paid. The assessment order itself records that in 80 cases, TDS was deducted on commission aggregating to Rs.55,42,604/-, whereas in the remaining cases no TDS was deducted on the ground that individual payments were below the applicable threshold. The assessee also explained its referral-based business model. The Ld. AO, however, observed that complete party-wise evidence linking the commission with individual referrals and confirmations from all the recipients had not been furnished. The Ld. AO further observed that only four confirmations had been filed and held that payment through banking channels and deduction of TDS, by themselves, were insufficient to establish the entire claim. Accordingly, without identifying any particular commission payment as non-genuine, the Ld. AO estimated a disallowance at 30% of Rs.68,83,823/-, amounting to Rs.20,65,147/-, observing that commission in the multi-marketing sector would normally be around 20% to 25% whereas the assessee’s commission expenditure represented 35.42% of sales. The total income was consequently assessed at Rs.25,06,920/-. Aggrieved, the assessee preferred an appeal before the Ld. CIT(A). The Ld. CIT(A) confirmed the disallowance. Hence, the assessee is in appeal before us.
3. The Ld. AR submitted that the authorities below have erred in sustaining an ad hoc disallowance of 30% of the commission expenditure despite substantial documentary evidence being available on record. The Ld. AR submitted that the assessee has filed before the Bench a paper book comprising pages 1 to 119. The Ld. AR specifically drew our attention to APB pages 07 to 21, containing the details/list of commission payments in respect of the recipients from whose commission TDS was deducted, together with their PAN particulars and Form No.26Q. It was submitted that these documents establish the identity of the recipients as well as the fact of deduction and reporting of tax at source.
4. The Ld. AR further drew our attention to APB pages 76 to 90, being the copy of the assessee’s letter dated 23.07.2018 submitted before the Ld. AO, along with the details of the total commission payments. Thus, according to the Ld. AR, the observation that the assessee had not furnished details of the commission recipients is contrary to the documentary material placed before the revenue authorities. The Ld. AR further submitted that the payments were made through banking channels and the business itself operated on a referral/multi-level commission model. Even the assessment order records that TDS had been deducted on commission payments aggregating to Rs.55,42,604/-. It was argued that once the Ld. AO had not identified any specific payment as bogus, excessive or unrelated to the assessee’s business, an estimated disallowance of 30% merely on the basis of an assumed industry percentage was unsustainable.
5. Per contra, the Ld. DR relied upon the orders of the revenue authorities and strongly supported the impugned addition. The Ld. DR specifically drew our attention to page 17, paragraph 7.1 of the appellate order and submitted that the Ld. CIT(A) had recorded that the assessee failed to furnish complete and reliable evidence, including confirmations, proof of services rendered, referral linkage and justification of the commission vis-à-vis business generated.
6. The Ld. DR submitted that mere payment through banking channels or deduction of TDS would not, by itself, establish that the expenditure was incurred wholly and exclusively for the purpose of business. The Ld. CIT(A), in paragraph 7.1, also referred to the principle laid down by the Hon’ble Supreme Court in CIT v. Calcutta Agency Ltd. reported in [1951] 19 ITR 191 (SC) that the burden to establish the admissibility of expenditure is upon the assessee. Accordingly, the Ld. DR prayed that the order of the Ld. CIT(A) be sustained.
7. We have heard the rival submissions and perused the material available on record, including the paper book filed by the assessee. The limited issue before us is whether the 30% ad hoc disallowance out of the commission expenditure of Rs.68,83,823/- can be sustained on the facts of the present case. It is undisputed that commission expenditure is an integral component of the assessee’s referral-based business model. The assessment order itself records that the assessee furnished a list of commission recipients and that TDS had been deducted in 80 cases involving aggregate commission of Rs.55,42,604/-. It also records the assessee’s explanation that commission is paid to members on referrals and, as the membership chain increases, commission is payable at multiple levels.
8. Further, before us, the assessee has placed a paper book comprising pages 1 to 119. In particular, APB pages 07 to 21 contain the list/details of commission payments in respect of which TDS was deducted, along with PAN particulars and Form No.26Q. Further, APB pages 76 to 90 contain the letter dated 23.07.2018 submitted before the Ld. AO along with details of the total commission payments. These documents assume significance because the principal objection of the revenue authorities is regarding the lack of particulars concerning the recipients and the commission payments.
9. We are conscious of the principle referred to by the Ld. CIT(A) that the initial burden to establish the allowability of expenditure claimed under section 37(1) rests upon the assessee. However, the material available on record has to be considered in its entirety. In the present case, the Ld. AO has not brought on record any material identifying any particular commission recipient as non-existent or any specified payment as bogus or not incurred for the purpose of business. Rather, after expressing doubts regarding the completeness of the evidence, the Ld. AO proceeded to estimate and disallow 30% of the entire commission expenditure.
10. Significantly, the basis adopted for such estimation was that commission in the multi-marketing sector would “normally” be between 20% and 25%, whereas the assessee had incurred commission at 35.42% of turnover. No comparable case, market data, industry material or other cogent basis for adopting the benchmark of 20% to 25% has been referred to in the assessment order. The assessment order merely treats 30% of the expenditure as unreasonable and thereby allows commission equivalent to approximately 25% of turnover.
11. We further notice that the assessee’s commission-to-sales ratio was not wholly unprecedented in its own business. The assessment order records the ratio at 35.42% for A.Y. 2016-17, 29.93% for A.Y. 2015-16 and 37.41% for A.Y. 2014-15. Therefore, the percentage of commission in the year under consideration, by itself, cannot constitute a sufficient basis for an estimated disallowance without demonstrating defects in specific transactions or bringing relevant comparative material on record.
12. The reliance placed on Calcutta Agency Ltd. (supra) is distinguishable on facts. In that case, the Hon’ble Supreme Court found that the necessary facts supporting the claim of business expenditure had not been established by the assessee at any stage, and therefore held that the burden of proving the admissibility of the expenditure was not discharged. In the present case, however, the assessee has furnished substantive documentary evidence in support of the commission expenditure, including party-wise details, PAN particulars, TDS details/Form No.26Q and details of commission payments submitted before the Ld. AO. Even the assessment order records that TDS was deducted in 80 cases on commission aggregating to Rs.55,42,604/-. The Ld. AO has not identified any specific payment as bogus or non-business expenditure but has merely disallowed 30% of the total commission expenditure on an estimated basis. Therefore, while the principle that the initial burden of proving the expenditure lies upon the assessee is not disputed, the factual foundation on which Calcutta Agency Ltd.(supra) was decided is materially different from the facts of the present appeal. Accordingly, the said decision does not justify the impugned ad hoc disallowance.
13. In these circumstances, considering the documentary material furnished by the assessee, the details of recipients, PAN and TDS particulars, Form No.26Q, the details furnished before the Ld. AO through letter dated 23.07.2018, the nature of the assessee’s referral-based business and, importantly, the absence of any specific finding that an identified commission payment was bogus or not incurred for business purposes, we find that the ad hoc disallowance of 30% amounting to Rs.20,65,147/- cannot be sustained merely on estimation. Accordingly, the addition of Rs.20,65,147/- is deleted and Ground No.1 raised by the assessee is allowed. Ground No.2 being general in nature requires no separate adjudication.
14. In the result, the appeal of the assessee bearing ITA No. 5270/Mum/2026 is allowed.
Order pronounced in the open court on 08th day of September 2026.
