Consistent accounting method and related-party remuneration rules prevented capitalisation and full disallowance of business

Interest on borrowed funds used in project business was treated as a periodic business cost and, because the assessee had consistently followed that accounting method and it had been accepted in earlier scrutiny years, it was not required to be capitalised to work-in-progress. Remuneration paid to directors was also protected from full disallowance under section 40A(2)(a), since the provision permits only the excessive or unreasonable component to be disallowed on a proper benchmark of fair market value, business need and benefit derived; the directors had rendered substantial services and the payments had been accepted in earlier years. The additions were deleted.

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Issues: (i) Whether interest on borrowed funds used in the assessee's project business was liable to be capitalised to work-in-progress or allowed as a revenue deduction as periodic cost; (ii) Whether remuneration paid to directors could be disallowed in full as excessive or unreasonable under section 40A(2)(a) of the Income-tax Act, 1961.

Issue (i): Whether interest on borrowed funds used in the assessee's project business was liable to be capitalised to work-in-progress or allowed as a revenue deduction as periodic cost.

Analysis: The assessee had consistently treated finance cost as a periodic expense and the department had accepted that method in earlier scrutiny assessments. No cogent reason was shown for departing from the accepted method in the year under appeal. The borrowed funds were used for business purposes, and the claim was supported by the principle that a consistent method of accounting, if not shown to be unreasonable or distortive of profits, should not ordinarily be displaced. The claim also accorded with the treatment of such interest as a periodic cost in the context of project business.

Conclusion: The interest expenditure was rightly allowed as a revenue deduction and was not required to be capitalised to work-in-progress.

Issue (ii): Whether remuneration paid to directors could be disallowed in full as excessive or unreasonable under section 40A(2)(a) of the Income-tax Act, 1961.

Analysis: The remuneration had been paid to the same directors in earlier years and had been accepted in scrutiny assessments. The directors had rendered long-standing and substantial services to the company, the business was active and project-oriented, and the amounts were disclosed in the directors' own returns and taxed at the maximum marginal rate. Section 40A(2)(a) authorises disallowance only of the excessive or unreasonable component having regard to fair market value, business need, and benefit derived; it does not permit disallowance of the entire payment absent a proper benchmark. The record also showed that the outstanding remuneration liability was subsequently discharged, negating the suspicion that the claim lacked genuineness.

Conclusion: The full disallowance of directors' remuneration was not justified and the allowance made by the appellate authority was sustained.

Final Conclusion: The additions made by the assessing authority were deleted, and the revenue's challenge to the deletion of both disallowances failed.

Ratio Decidendi: A consistently followed accounting method accepted in earlier years should not be displaced without cogent reasons, and section 40A(2)(a) permits disallowance only of the excessive or unreasonable part of a related-party payment, not the entire expenditure, unless fair market value and excessiveness are properly established.

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