2011 (7) TMI 82 - HC - Income Tax

Section 40A(2) disallowance on director remuneration quashed; media consultancy role justified higher pay, bona fide payments upheld

HC held that disallowance under Section 40A(2) on account of alleged excessive remuneration to the majority shareholder-director (Director A) was ... Disallowance - Excessive remuneration paid to Director - invoking the provisions of Section 40A (2) - Mr. Sushil Pandit holds 65% share holding in the assessee company as against 20% and 15% held by Mr. R.P. Singh and Mr. Vishal Sharma respectively - HELD THAT:- In the process the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to the assessee from such services is also to be kept in mind. After applying this test if it is found that the expenditure is excessive or unreasonable excess, excess or unreasonable portion of the expenditure is to be disallowed. We have also kept in mind the provisions of sub Section 2 (b) of Section 40-A of the Act as per which the burden is upon the assessee to establish that the price paid by it is not excessive or unreasonable as in this case Mr. Sushil Pandit was holding substantial portion of share namely 65% in the assessee company. It is to be kept in mind that the assessee is in the business of advertising and media. In such a business, the role of a media consultant is much more important than of the role of a client management. In fact, considering the nature of business, media consultancy is the back bone of such business and plays much more pivotal role then the persons handling client management. For this reason, if Mr. Sushil Pandit was paid higher remuneration then Mr. R.P. Singh, it could not be treated as excessive or unreasonable, more so, when the two cases were not at par and could be treated as comparable by any standards. The scope of Section 40A (2) as explained by CBDT in Circular No. 6P, dated 6th July, 1968. The CBDT clarified that while examining the reasonableness of expenditure the Assessing Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases. We thus answer the question in favour of the assessee and in the negative holding that the Tribunal was not correct in law in upholding disallowance out of remuneration paid to Mr. Sushil Pandit by invoking the provisions of Section 40A(2) of the Act. The disallowance made is thus deleted and this appeal is allowed. Issues:1. Disallowance of excessive remuneration to directors under Section 40A(2) of the Income-Tax Act.2. Tribunal's decision on the reasonableness of remuneration paid to a director.3. Interpretation of Section 40A(2) and its application in the case.Issue 1: Disallowance of Excessive Remuneration to Directors:The case involved the assessment of an assessee engaged in advertising and media for the assessment year 2005-06. The Assessing Officer (AO) disallowed a portion of the remuneration paid to two directors, citing excessive payment to one director compared to another under Section 40A(2) of the Income-Tax Act. The AO also disallowed a significant amount of remuneration to another director based on a comparison with a third-party consultancy fee. The Tribunal upheld the disallowance in one case but deleted it in the other. The High Court admitted the appeal challenging the disallowance of remuneration to the second director.Issue 2: Tribunal's Decision on Reasonableness of Remuneration:The Tribunal upheld the disallowance of remuneration to one director but deleted it for another. It considered the shareholding of the directors and found the remuneration paid to the director with a majority shareholding to be excessive and unreasonable. The Tribunal's decision was based on comparing the remuneration with a third-party consultancy fee. However, the High Court disagreed with the Tribunal's reasoning and found that the comparison was not valid as the consultancy fee was for a specific project, unlike the ongoing services provided by the director.Issue 3: Interpretation of Section 40A(2) and its Application:The High Court analyzed the provisions of Section 40A(2) of the Income-Tax Act, which allow the disallowance of excessive or unreasonable expenditure. The Court emphasized that the reasonableness of expenditure should be judged from the viewpoint of a prudent businessman, considering the legitimate business needs and benefits accruing to the company. The burden of proof lies with the assessee to show that the expenditure is not excessive or unreasonable. The Court also referred to relevant case laws to support its interpretation of the section and concluded that the disallowance of remuneration was not justified in this case.In conclusion, the High Court ruled in favor of the assessee, holding that the disallowance of remuneration under Section 40A(2) was not justified. The Court emphasized the importance of considering the nature of services provided and the legitimate business needs while assessing the reasonableness of expenditure.