Karnataka H.C : Whether the Tribunal is right “in setting aside the finding recorded by the Assessing Officer that the expenditure allowed to an extent of Rs.24,00,000/- to Flexsole Raman Limited, which is a subsidiary company out of Rs.48,00,000/- under the head of manufacture and other expenses under Section 40A sub-section 2 clause (b) of the Income Tax Act?

High Court Of Karnataka

CIT, Central Circle vs. Raman Boards Ltd.

Assessment Year : 1995-96

Section : 40A(2)

N. Kumar And B. Manohar, JJ.

IT Appeal No. 8 Of 2007

April 1, 2013

JUDGMENT

N. Kumar, J. – The revenue has preferred this appeal challenging the order passed by the Tribunal directing the deletion of disallowance.

2. The assessee was engaged in the manufacture of insulation paper boards. During the year 1995-96, the assessee entered into an agreement with M/s. Flexsole Raman Limited, a subsidiary company for manufacture of footwear soles. The subsidiary company was supposed to handle and manage the Stiffener division of the company. The project started in November 1993. The assessee entered into an agreement dated 01.12.1993. Under that agreement, the subsidiary company was to undertake manufacture assembly test and quality control of stiffener materials in accordance with the technical data of the ssessee. The other manufacturing related jobs were also to be done by the subsidiary company for which, the assessee shall pay management fee of Rs. 4,00,000/- per month. Accordingly, the assessee claimed Rs. 48,00,000/-payment made to the subsidiary company as expenditure.

3. The Assessing Officer allowed 50% of the claim of the assessee and disallowed Rs.24,00,000/- under Section 40A(2)(b) of the Income Tax Act. Aggrieved by the said order, the assessee preferred an appeal. The appellate authority confirmed the said order. Aggrieved by these two orders, the assessee preferred an appeal before the Tribunal.

4. The Tribunal held that the genuineness of the agreement and the services rendered by the subsidiary company are not doubted. There is no reason as to why 50% of the expenditure is to be allowed. There is no finding that payment made by the assessee is excessive under Section 40A(2)(b). The expenditure incurred by the assessee under the aforesaid provision can be disallowed if the Assessing Authority is of the opinion that such an expenditure is excessive or unreasonable having regard to the fair market value of the goods and services or the facilities for which the payment is made. No comparative date was brought on record by the assessing authority that the payment made by the assessee is excessive. Over and above the services mentioned in the agreement, they might have been given some more services like preparation of feasibility report etc. However, there cannot be a valid reason for making disallowance under Section 40A(2)(b) of the Act. Accordingly, he allowed the appeal and permitted deletion of the disallowance. Aggrieved by the said order, the revenue is in appeal.

5. The learned counsel for the revenue assailing the impugned order contended that the material on record discloses that the subsidiary company incurred an expenditure of Rs.21,05,520/- being the cost of the goods supplied to the assessee. Therefore, the amount paid by the assessee is excessive and accordingly, deduction of 50% is proper and therefore, he submits a case for interference is made out.

6. Per contra, the learned counsel for the assessee supported the impugned order.

7. The appeal was admitted to consider the following substantial question of law on 20.09.2007.

“Whether the Tribunal is right “in setting aside the finding recorded by the Assessing Officer that the expenditure allowed to an extent of Rs.24,00,000/- to Flexsole Raman Limited, which is a subsidiary company out of Rs.48,00,000/- under the head of manufacture and other expenses under Section 40A sub-section 2 clause (b) of the Income Tax Act?”

8. Section 40A (2) on which reliance is placed reads under:

“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 to 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.”

9. In terms of the aforesaid provision, when the assessee incurs an expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of the sub-section and the Assessing Authority is of the opinion that such an 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 it so considered by him to be excessive or unreasonable, shall not be allowed as a deduction. To attract this provision, assessee has to incur an expenditure by making payment to the person referred to in clause (b). Assessee is a company. The person to whom they have to make payment in order to attract the said provision is any Director of the Company or any relative or Director. Admittedly, in this case, payment is made to the subsidiary company and not to any director or any relative of the said Director. Therefore, the requirement to the Section is not fulfilled.

10. The Bombay High Court in the case of CIT v. V.S. Dempo & Co (P.) Ltd. [2011] 196 Taxman 193/[2010] 8 taxmann.com 159 held that when the assessee is a company and the seller is its subsidiary company, the seller i.e., the subsidiary company does not fall in any of the capacities mentioned under sub-clause (ii) of clause (b) Only a director of the company or any relative of such Director falls under sub-clause (ii) of clause (b) of sub-section (2). Another company, even if it is a subsidiary of the assessee is not a related person within the meaning of sub-clause (ii) of clause (b) of Section 40A(2). While the holding company is a member of its subsidiary company, the subsidiary company is not a member of the holding company. As, the subsidiary company was not a member of the assessee sub-clause (iv) of clause (b) of Section 40A(2) of the Act is also not attracted. Alternatively, it was contended the case could fall under Section 37(1) of the Act which reads as under:

Section 37(1) – Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”

11. A reading of the aforesaid provision makes it clear any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’. It was contended as the total amount paid is Rs. 48,00,000/- and the actual expenditure incurred by the subsidiary company is Rs. 25,00,000/-, the entire amount is not laid out or expended wholly and exclusively for the purpose of business and therefore, disallowance is justified. There is no substance in the said contention. In the instant case, the agreement between the assessee and the subsidiary company is not in dispute. Payment of Rs. 48,00,000/- by the assessee to the subsidiary company is admitted. The material on record shows that, the subsidiary company has incurred an expenditure of Rs.21,00,000/- to perform the contract under the agreement. The material on record also discloses that there was labour unrest in the subsidiary company for nearly half of the year which contributed to the lower production, lower sales and poor profitability of the assessee-company. For another four months, the employees of the subsidiary company were employed in Stiffener division who were basically engaged in preparation of feasibility study report for setting up larger independent company of the assessee. Therefore, the aforesaid undisputed facts shows that the subsidiary company was not able to comply with or perform its part of the contract. Merely because, a subsidiary company did not fulfil its obligations, that will not render the transaction illegal and consequently, it cannot be held that the expenditure laid out or incurred is not wholly for the business of the assessee-company. In addition to the aforesaid facts, the profit margin of the subsidiary company is not taken into account at all. In the facts of the case, the subsidiary company is a newly formed company. The assessee has entered into an agreement and a sum of Rs. 4,00,000/- is paid. Subsidiary company has manufactured the goods for the assessee and unfortunately, there was labour trouble and the workers were deployed for the other purpose which benefited the assessee. Profit margin is not taken into account. These facts have not been properly appreciated by the assessing authority as well as the lower appellate authority. The Tribunal was justified in not interfering with the said order and directing the deletion of disallowance. It is just and proper. We do not find any error or any infirmity in the said order. Accordingly, substantial question of law is answered in favour of the assessee and against the revenue. No merits. The appeal is dismissed

[Citation : 355 ITR 305]

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