Payment to related party cannot be disallowed u/s. 40A(2)(b) as AO failed to prove it as unreasonable: ITAT Delhi

Trinity Global Enterprises Ltd. Vs ITO (ITAT Delhi)

ITAT Delhi held that supervision and management charges paid to sister concern (i.e. related parties) doesn’t attract section 40A(2)(b) of the Income Tax Act as AO failed to prove the payment as unreasonable and excessive. Accordingly, charges duly allowed.

Facts- AO observed that the assessee had issued 1500000 shares of Rs.10 each on a premium of Rs.50/- per share and received Rs.90,00,000/- during the year. Based on the information furnished by the assessee, AO the assessee company was failed to furnish confirmation of share money and share premium money received during the course of proceedings. Owing to filing of non-confirmation, AO treated the amount of share application received of Rs. 90,00,000/- u/s. 68 of the Income Tax Act. CIT(A) affirmed the order of AO. Being aggrieved, the present appeal is filed.

Further, assessee incurred supervision and management charges u/s. 40A(2)(b) which were disallowed by AO reasoning that payments has been made to sister concern and payment is not made for doing actual work. CIT(A) allowed ad hoc 30% deduction and disallowed 70%.

Conclusion- Tribunal in the case of Al Anam Agro Foods (P.) Ltd. Vs. CIT has held that since identity of shareholders stood proved on record, amount of share application money could not be added to income of assessee. Thus, held that no addition is called for u/s 68 of the Income Tax Act, 1961.

Tribunal in the case of IKEA Trading (India) (P.) Ltd. Vs. DCIT has held that as per section 40A(2)(b), onus had been cast upon Assessing Officer to bring on record comparable cases to demonstrate that transactions made by assessee with related parties were unreasonable and excessive. Thus, held that the provisions of Section 40A(2)(b) are not attracted in this case and also having examined the payment made to Sh. Harpreet Singh Jolly of Rs.3,50,000/- and consultation charges of Rs.2,50,000/- are also being allowed as eligible expenses.

FULL TEXT OF THE ORDER OF ITAT DELHI

The present appeal has been filed by the Assessee against the order of ld. CIT(A)-9, New Delhi dated 29.03.2016.

2. Following grounds have been raised by the assessee:

“1. Under the facts and circumstances of the case the Learned CIT(A) has erred in confirming the addition of Rs. 90 Lacs u/s 68 of the income Tax Act, 1961 for share application received by the company.

2. Under the facts and circumstances of the case the Learned CIT(A) has erred in confirming the addition to the extent of 70% of supervisory and risk management charges of Rs. 4,46,50,000/- paid to the sister concern u/s 40A(2)(b) of the Income Tax Act, 1961 and Rs. 5,60,500/-paid to others without assigning any reason for allowing only 30% of total expenditure claimed by the assessee.”

Share Application Money:

Excerpts taken from the Assessing Officer:

3. During the assessment proceedings, the Assessing Officer observed that the assessee had issued 1500000 shares of Rs.10 each on a premium of Rs.50/- per share and received Rs.90,00,000/- during the year. The assessee was asked to file the details of increase in share capital and share premiums vide notice u/s 142(1) of the Income Tax Act, 1961 dated 09.04.2013. The assessee had filed its reply vide letter dated 14.05.2013 stating that the company received a share application/share premium money of Rs.90,00,000/- for 150000 equity shares from various companies and issued the share of Rs.10/- each on premium of Rs.50/- per share. The company had received the share application money/share premium money from the following companies:

4. The Assessing Officer held that the assessee company was failed to furnish confirmation of share money and share premium money received during the course of proceedings. Notices u/s 133(6) were issued to all the above said parties to verify the authenticity/genuineness of the transaction and source of investment. The AO held that the reply received pursuant of the above notices from M/s Albatross Share registry Pvt. Ltd and OneZe Solutions India Pvt. Ltd., are without any signature and reply of M/s Sidh Housing Development Co. Ltd. was not been received during the course of proceedings. The Assessing Officer also relied on the statement of Sh. Mukesh M. Choksi, Mumbai whose statement has been recorded by the Investigation Wing of Mumbai wherein Sh. Mukesh M. Choksi has accepted that he is involved in providing bogus entries of share application from the concerns namely, M/s Oshin Investment & Finance Pvt. Ltd. and M/s Albatross Share Registry Pvt. Ltd. owing to filing of non-confirmations and the statement of Sh. Mukesh M. Choksi, the AO treated the amount of share application received of Rs.90,00,000/- u/s 68 of the Income Tax Act, 1961.

5. Aggrieved, the assessee filed appeal before the ld. CIT(A) who affirmed the order of the Assessing Officer.

6. Excerpts taken from the ld. CIT(A):

♦ The assessee failed to furnish confirmation of the share applicants.

♦ Replies received were without signatures and in one case no replies has been received.

♦ Sh. Mukesh M Choksi has accepted that he is involved in providing bogus entries of share application.

♦ Cross examination of Sh. Mukesh M Choksi was not sought by the assessee.

♦ The ld. CIT(A) relied on the judgment of Tarika Properties Investments Pvt. Ltd. (SC) wherein the subscribers bank account statements were forged and fabricated.

7. Aggrieved with the order of the ld. CIT(A), the assessee filed appeal before the Tribunal.

Arguments of ld. AR:

8. The ld. AR argued that in the case of M/s Oshin Investment & Finance Pvt. Ltd. and M/s Sidh Housing Development Co. Ltd., the Assessing Officer has not conveyed the assessee any adverse view with regard to the defective confirmation filed or confirmations not filed. It was argued that the assessee has duly furnished confirmation in three cases hence, the observation of the Assessing Officer that there has been failure   on the part of the assessee to file the confirmation is not correct. With regard to the statement of Sh. Mukesh M. Choksi, it was argued that the statement has not been taken in the case of assessee or in respect of the fact relating to the assessee but with relation to some other assessee namely, Sahakar Global Ltd. It is argued that the purchases and transactions which were inquired by the Revenue pertain to the A.Y. 2009-10, A.Y. 2010-11 but not for the A.Y. 2011-12 which is the instant year. It was argued that the statement pertains to subscription of shares of M/s Sahakar Global Ltd. but not in relation with Trinity Global Enterprises Ltd. In the statement, Sh. Choksi clearly mentioned that “I am only concern with my commission and hence I am never aware of various beneficiaries who have taken entries from me” and Mr. Choksi is not even Director in any of the four companies who have subscribed to the shares in the assessee company and the company namely, Buniyad Chemicals Ltd. wherein Mr. Choksi is the Director has not subscribed any share capital in the assessee company. Further, the assessee has submitted the following details/evidences to prove the receipt of the share application money to the revenue authorities which have not been rebut or found to be confuted:

9. On this issue, the judgments of various authorities have been perused:

Kesha Appliances Pvt. Limited Vs. ITO in ITA No. 2715/D/2016, order dated 09.03.18 (Delhi ITAT)

“Held that the assessee cannot be penalized merely on the ground that the six companies as discussed above failed to reply to the notices issued to them under section 133(6) of the Act.”

Al Anam Agro Foods (P.) Ltd. Vs. CIT [2013] 38 taxmann.com 375 (Allahabad)

“Section 68 of the Income-tax Act, 1961 – Cash credits [Share application money] – Assessment year 2004-05 – In course of assessment, Assessing Officer made addition to assessee’s income under section 68 in respect of share application money received from various persons – Tribunal, however, held that since identity of shareholders stood proved on record, amount of share application money could not be added to income of assessee – According to Tribunal, in such a case amount could be taxed in hands of persons who had invested – Whether in view of decision rendered in cases of CIT v. Divine Leasing & Finance Ltd./Lovely Exports (P.) Ltd. [2008] 299 ITR 268 / [2007] 158 Taxman 440 (Delhi) and Jaya Securities Ltd. v. CIT [2008] 166 Taxman 7 (All.) impugned order passed by Tribunal was to be upheld – Held, yes [In favour of assessee].”

HLT Finance (P.) Ltd. Vs. CIT [2011] 12 taxmann.com 247 (Delhi) /[2011] 201 Taxman 28 (Delhi)

“Section 68 of the Income-tax Act, 1961 – Cash credits – Assessment year 1998-99 – In course of assessment, Assessing Officer made an addition of Rs. 18 lakhs on account of unexplained share application money – On second appeal, Tribunal deleted said addition on ground that share applicants were identified and revenue was at liberty to reopen assessment of all such bogus shareholders.”

Andaman Timber Industries 281 CTR 241 (SC)

“Denial of opportunity to the assessee to cross -examine the witnesses whose statements were made the sole basis of the assessment is a serious flaw rendering the order a nullity in as much as it amounted to violation of principles of natural justice, impugned order as passed by the Tribunal is set aside.”

Pratik Suryakant Shah Vs. ITO in ITA No. 810/Ahd./2015 dated 21.10.2016 (Ahd. ITAT)

“In this case also there is a issue of bogus LTCG. In this case, on the basis of statement of broker case was re-opened U/s. 148. Hon’ble Tribunal Held that since the statement of broker neither supplied nor opportunity of cross examination has been provided entire re­assessment proceedings liable to be quashed. Relied on the decision in case of Andaman Timber.”

10. Hence, keeping in view the entire facts of the instant case, we hold that no addition is called for u/s 68 of the Income Tax Act, 1961.

11. In the result, the appeal of the assessee on this ground is allowed.

Disallowance – 70% of expenses Rs.4,46,50,000 –  Supervision and management charges – u/s 40A(2)(b):

12. The assessee incurred expense of Rs.4,46,50,000/- on account of supervision and risk management charges which have been paid to related concern “M.M. Carpet & Inds. Pvt. Ltd.” The Assessing Officer held that payment has been made to sister concern for not doing actual work, therefore he disallowed 100% thereof being Rs.4,46,50,000/-. The ld. CIT(A), allowed on ad-hoc basis 30% on the ground that expn. have been incurred, circumstances for application of Sec.40A(2)(b) are not established by A.O., however in the absence of complete details and documentary evidence, only 30% is allowed, 70% disallowed.

13. The relevant background of addition is as under:

Flagship Co. Trinity Insurance Broker Pvt. Ltd. is working as an insurance broker and procures the insurance covers from various general insurance companies for its clients mainly for Food Corporation of India (FCI) and for other clients. Against insurance policy, the flagship Co. receives brokerage from the insurance companies. For convincing and procuring the insurance cover from the clients like FCI, the flagship Co. gives them assurance of getting maximum risk coverage at minimum premium. These insurance covers are for the reimbursement of losses incurred by FCI etc. in transportation of food grains etc. from one place to another places, mainly through railways. The quantity at the time of loading the food grain on the trains and the quantity at the time of unloading at the destination shows a huge shortage due to which the FCI etc. had been suffering big losses. It is for covering this type of loss that the insurance covers are being taken by FCI etc. For this, the flagship Co. namely Trinity Insurance Broker Pvt. Ltd. commits to the clients (FCI Etc.) for doing all needful works so as to minimize the loss mainly in transportation and to get the insurance cover from the insurance Cos. by convincing them for such minimum losses so that the insurance premium amount is minimized. Thus, by getting the insurance policies for FCI etc. at the minimum premium cost, the flagship Co. prepares them to purchase insurance covers through flagship Co. The flagship Co. has to ensure the minimum possible such transport losses so that, the losses should not exceed beyond the payments covered in the insurance policy. For this, the flagship Co. needs to have a proper control and checking at the loading points and unloading points and also to work out the methods so as to minimize the risk of such losses which are covered in the insurance cover. The flagship Co. has to outsource for the services for administering, managing and achieving the targets of minimization of such transport losses.

This work is being given to two related concerns namely:-

• Trinity Global Enterprise Ltd. (the Assessee) and
• M. Carpet & Industries Ltd.

There are only few common directors in flagship Co. as well as in above two Cos.

The assessee company for the activity of minimizing the loss, has to undertake mainly the following steps, mainly in case of FCI:-

• Weighment of food Grains at the point of loading
• Weighment of food grain at the point of unloading
• Counting No. of bags with the racks at the time of loading
• Counting No. of bags with the racks at the time of unloading
• Checking the seal on the railway wagons at the time of loading
• Checking the seal on the railway wagons at the time of unloading
• To submit reports of loading and unloading to FCI for all transportations and to report them the shortage to FCI.

14. In case of other insurance clients like Jindals, Lanco Etc., insurance of plant & machinery are secured and by presentations showing the minimum losses, the insurance covers are pre-cured by the flagship Co. at the minimum cost to such Cos. Thereafter to justify and to maintain the workings of the minimum losses as presented to such clients, periodical visits and inspections of the plants and to furnish reports to such clients for minimizing the losses due to plant defects, replacements needed and other timely actions to be taken so that, the loss to the plants/machinery is minimum and is within the limits for which the insurance cover is secured. The assessee Co., carries out the above activities at its own end and also outsource the same to another related concern namely M/s M.M. Carpet & Industries Ltd. M.M. Carpet also has to keep the skilled, semi-skilled and other workforce for performing various functions mentioned above. These expenses paid to M/s M.M. Carpet & Industries Ltd. by the assessee are booked under the head “Risk Management & Supervision Charges”.

14. The Assessing Officer sought the explanation of the assessee with regard to the work done by M.M. Carpet & Industries Ltd. The assessee submitted to the Assessing Officer that M/s M & M Carpet and Industries Ltd. is in the business of Risk Management and Supervisory work over the years and become pioneer in its field over the period based on its experience and expertise. Company has worked for various big government organizations over the periods. The company was involved in various activities and one of the major activities is supervision and risk management. The company is performing this activity since financial year 2007-08, primarily for one of the large government organization. Over the period, the company has experienced the supervision work through which the loss minimization programme is carried out. It was submitted that supervision and risk management is a technical subject and it has carried out on a fixed format basis. The expertise has been developed by the promoters of the company specifically for servicing their own, clients and supervision is one of the services which is exclusively used for our group companies.

15. Not satisfied with the submission of the assessee, the Assessing Officer has disallowed 100% of the amount paid to the sister concerns holding that M/s M & M Carpet and Industries Ltd. has not actually doing any work for the assessee but only raising the bills for avoidance of tax.

16. The ld. CIT(A) allowed the expenses to the extent of 30% and confirmed the remaining amount on the grounds that the assessee has to be incurred some expenses to run the business.

Before us, the ld. AR relied upon the submissions given before the authorities below and the ld. DR relied on the order of the ld. CIT(A).

17. Heard the arguments of both the parties and perused the material available on record.

18. The assessee furnished all relevant details to A.O./CIT(A) to justify the incurrence of such expenses in the paper book from 202 to 249. The assessee submitted the Details of steps involved in insurance brokering business, party wise details of Risk Management & Supervision charges expenses, ledger A/c of Risk Mgmt Supervision Charges, ledger of M. M. Carpets, supervisory Reports of Work done by M. M. Carpets, invoices issued by M. M. Carpets, ITR Ack. of M. M. Carpets for A.Y 2011-12 and audited Balance Sheet of M. M. Carpets ending as on 31.03.11. The assessee also replied all the queries of the Revenue wherein no discrepancy has been noticed. The similar expenses have been disallowed by the AO in A.Y. 2012-13 which has been allowed by the ld. CIT(A). Hence, the issue rest there. Further, we find that the Assessing Officer or the ld. CIT(A) have not brought any comparable cases to prove that the payments made to M.M. Carpets are more than the market averages. Thus, we find that the expenses have been indeed payable and paid, no comparable cases have been brought on record, the M. M. carpets recipient company is also a tax paying company in the highest bracket, hence the revenue’s allegation that this is ploy for tax avoidance holds no good.

19. The judicial pronouncements on this issue are as under:

IKEA Trading (India) (P.) Ltd. Vs. DCIT [2021] 123 taxmann.com 129 (Delhi -Trib.)

“Section 40(A)(2) of the Income-tax Act, 1961 – Business disallowance – Excessive or unreasonable payments (Payments to directors) – Assessment year 2004-05 – During course of scrutiny assessment proceedings, Assessing Officer asked assessee to explain payment made to two persons covered under section 40(A)(2)(b) – Assessee furnished details of remuneration paid to Director and claimed same to be in prescribed limits as per Industry Norms – Assessing Officer was of opinion that assessee failed to justify nature of services rendered by Directors so as to command such a huge remuneration – Accordingly Assessing Officer restricted remuneration to Rs. 50 lakhs and added balance of Rs. 56 lakhs to income of assessee – Commissioner (Appeals) observed that Assessing Officer had failed to bring on record or substantiate that how such salary payments were actually excessive and accordingly deleted addition – As per section 40A(2)(b), onus had been cast upon Assessing Officer to bring on record comparable cases to demonstrate that transactions made by assessee with related parties were unreasonable and excessive – Further, CBDT Circular No. 6-P, dated 06.07.1968 states that no disallowance is to be made under section 40A(2) in respect of payments made to relatives and sister concerns where there is no attempt to evade tax – Whether since Assessing Officer had not brought any comparable case to demonstrate that payments made by assessee were excessive/unreasonable and fact that payees were also assessed to tax at same rate of tax, Commissioner (Appeals) had rightly deleted addition – Held, yes”

Amit Mehra Vs. ITO [2020] 116 taxmann.com 870 (Delhi – Trib.)

“Section 40A(2) of the Income-tax Act, 1961 – Business disallowance – Excessive or unreasonable payment (Applicability of) – Assessment year 2012-13 – Whether section 40A(2)(b) does not envisage complete disallowance of expenditure unless it is proved to be excessive or unreasonable having regard to fair market value – Held, yes – Whether where assessee had made payments to related parties, however, no such finding with regard to excess payment had been established by revenue while invoking provisions of section 40A(2)(b), disallowance so made was to be deleted.”

Aradhana Beverages & Foods Co. (P.) Ltd. Vs. DCIT [2012] 21 taxmann.com 135 (Delhi)

“It should be borne in mind that provisions of s. 40A(2)(b) are meant to check evasion of tax through excessive or unreasonable payments to relatives or associate concerns and should not be applied in a manner, which will cause hardship in bona fide cases.”

PCIT Vs BMO Advisors Pvt. Ltd. [2022] 138 taxmann.com 563 (Del. HC)

“Section 40A(2) of the Income-tax Act, 1961 – Business disallowance – Excessive or unreasonable payments (Remuneration to director) – Assessment year 2015-16 – Huge amount was paid by assessee company as a bonus to directors, however, no justification was given by respondent/assessee regarding kind of services rendered by person specified under section 40A(2)(b) to earn such a huge amount of bonus and no business correlation in terms of business output or growth of business relating to payment was shown by respondent/assessee – Accordingly, grant of bonus by assessee to its directors was disallowed – However, none of authorities below had opined that grant of bonus to directors would either endanger existence of corporate entity or was prohibited under Payment of Bonus Act, 1965 or was not proportionate to services rendered by directors – In fact in previous assessment years, similar payment of bonus to directors had been upheld and no distinguishing feature had been brought to notice of Tribunal – Whether therefore, in view of consistency of approach, uniformity and certainty, direction to delete disallowance in previous assessment years was to be followed.”

Patel Alloy Steel Co. (P.) Ltd. Vs. PCIT [2019] 103 taxmann.com 432 (SC)

“Section 40A(2) of the Income-tax Act, 1961 – Business disallowance – Excessive or unreasonable payments (Salaries to directors) – Assessment year 2008-09 – For relevant year, assessee filed its return declaring certain taxable income – In course of assessment, Assessing Officer noted that there was an extraordinary increase in salary paid to Directors as compared to said payments made in assessment year 2004-05 – Assessing Officer thus made certain disallowance under section 40A(2)(b) out of remuneration paid to directors of assessee-company – Tribunal took a view that once remuneration paid in preceding year was accepted by revenue, Assessing Officer was not justified in considering and comparing remuneration paid in assessment year 2004-05 – Tribunal thus deleted disallowance made under section 40A(2) – High Court upheld order passed by Tribunal – Whether, on facts, SLP filed against decision of High Court was to be dismissed.”

20. Hence, keeping in view the entire facts and circumstance of the case, we hold that the provisions of Section 40A(2)(b) are not attracted in this case and also having examined the payment made to Sh. Harpreet Singh Jolly of Rs.3,50,000/- and consultation charges of Rs.2,50,000/- are also being allowed as eligible expenses.

21. In the result, the appeal of the assessee is allowed.

Order Pronounced in the Open Court on 12/01/2024.