1977 (12) TMI 52 - AT - Income Tax

Tribunal directs ITO to allow payments to financiers, deems them justified under trade practices.

The Tribunal allowed the appeal in part, directing the ITO to allow the entire payments to the financiers and adjust the partners' assessments ... - Issues Involved:1. Disallowance of Rs. 1,164 under the head 'trading account as entertainment expenses'.2. Disallowance of Rs. 1,13,125 under the head 'trading account'.Issue 1: Disallowance of Rs. 1,164 under the head 'trading account as entertainment expenses'The ground relating to the disallowance of Rs. 1,164 under the head 'trading account as entertainment expenses' was not urged by the assessee at the time of hearing. Consequently, this ground was dismissed as not pressed.Issue 2: Disallowance of Rs. 1,13,125 under the head 'trading account'Facts:- The assessee, a registered firm, maintained books of account on a mercantile system of accounting. The previous year for the assessment year 1974-75 ended on 31st March 1974.- The business of the assessee, in its first year, involved film distribution.- On 12th March 1973, the assessee entered into an agreement with M/s. Neptune Pictures (P) Ltd., Calcutta, for distribution and exploitation rights in the eastern circuit, sharing profits and losses equally.- The assessee agreed to meet the capital cost for acquiring the film 'Bobby' to the extent of Rs. 3,32,500 and remitted Rs. 2,00,000 as part of their share.Breakdown of Rs. 2,00,000:- Out of share capital: Rs. 14,000- By M/s. R.B. Films: Rs. 65,000- From financiers: Rs. 1,21,000Agreements with Financiers:- The financiers were Smt. Sushmita Nath, Smt. Margaret Rose Ryndem, Mr. Esther Joycee Ryndem, and Shri Bejoy Ryndem.- Agreements were made on various dates in March and April 1973, with commission rates ranging from 4% to 7%.Assessment and Disallowance:- The assessee earned Rs. 7,95,782, out of which Rs. 1,50,385 was paid to the financiers.- The ITO disallowed Rs. 1,37,125 out of Rs. 1,50,386, considering it 'excessive and unreasonable under s. 40A (2a) of the IT Act, 1961'.- The ITO allowed interest on the loans at 12% per annum, amounting to Rs. 13,261, and disallowed the balance.Appeal to AAC:- The AAC confirmed the addition, agreeing with the ITO that the commission payments were 'over excessive and totally unrelated to prevailing market conditions'.Arguments by Assessee:- The assessee argued that the payments to financiers were loans in the ordinary course of business.- The agreements and payments were not disputed, and the only question was whether they should be allowed in full or part.- The assessee cited trade practices and previous agreements where similar commissions were paid and accepted by the Revenue.- The terms of agreements with financiers were risky, and the commission was justified based on the nature and success of the film.- The assessee pointed out that the financiers' capital was at risk and highlighted the substantial benefit derived from the arrangement.Arguments by Revenue:- The Revenue supported the lower orders, arguing that the return was excessive and unreasonable.- It was suggested that the money might have belonged to the partners and found its way into the business through financiers.- The Revenue contended that finance could have been arranged from other sources at lower costs.Tribunal's Analysis:- The Tribunal rejected the Revenue's new angle suggesting the transactions were sham, as the ITO had treated the loans as genuine and allowed interest.- The Tribunal examined whether the payments were excessive or unreasonable under s. 40A (2a).- The assessee demonstrated that there was a trade custom for such agreements and that the payments were in line with legitimate business needs.- The Tribunal found that the assessee acted as a prudent businessman, and the substantial benefit derived justified the payments.- The Tribunal concluded that the Revenue's arguments were untenable and reversed the AAC's order, directing the ITO to allow the entire payments to the financiers and recompute the income accordingly.Conclusion:The appeal was allowed in part, with the Tribunal directing the ITO to allow the entire payments to the financiers and amend the assessments of the partners accordingly.