2026 (2) TMI 1366 - AT - Income Tax

Recorded finding of excessiveness required under section 40A(2): absence defeats disallowance for salary recharge reimbursements and sustains deductions.

Section 40A(2) requires a recorded finding that an expenditure is excessive or unreasonable relative to fair market value or business need before ... Disallowance of salary recharge and reimbursement of expenses u/s 37(1) r/w section 40A(2)(b) - arrangement of sharing common employees - disallowance has been made primarily on the ground that the assessee failed to furnish details of specific services rendered by the two personnels and that the cost sharing agreements were executed on plain paper without specifying the mechanism for allocation of salary cost - also the assessee had already claimed substantial salary and bonus expenditure in its own books and had not established the necessity of further salary recharge and further invoked section 40A(2)(b) on the footing that the payments were made to related concerns. CIT(A), while confirming the disallowance, recorded that despite specific requisition, the assessee could not bring on record material to demonstrate the actual nature of services rendered by such employees or the basis of quantification and charging of such services HELD THAT:- As referring to scope of section 40A(2) it permits disallowance of expenditure only where the AO is of the 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, or the legitimate needs of the business, or the benefit derived by the assessee therefrom. Thus, the formation of an opinion that the expenditure is excessive or unreasonable is a sine qua non for invoking section 40A(2). AO has not recorded any finding that the amount of salary recharge is excessive or unreasonable with reference to the fair market value of services or the benefit derived by the assessee. Disallowance has been made on the basis that the assessee failed to demonstrate the exact nature of services and the basis of allocation. Section 37(1) is concerned, it is settled law that the onus is on the assessee to establish that the expenditure was incurred wholly and exclusively for the purposes of business. In the present case, the assessee has explained that the arrangement was one of sharing of common personnel for centralised functions and that allocation was made on the basis of revenue. The lower authorities have disbelieved the claim mainly on the ground that the assessee could not identify specific personnel deputed exclusively for it and could not furnish minute details of services rendered by each employee. Arrangement pleaded by the assessee is not one of deputation of specific employees but of sharing of common resources for group functions. The absence of exclusive deputation, by itself, does not establish that no services were rendered. AO has not recorded any finding that the impugned payments resulted in any tax evasion or that the amounts were excessive or unreasonable with reference to fair market value or benefit derived. The disallowance has been made essentially on the ground of insufficiency of evidence regarding the nature of services and the basis of allocation. Such an approach does not satisfy the statutory requirement of section 40A(2), which mandates a finding on excessiveness or unreasonableness. Once the existence of an arrangement for sharing of common employees and incurring of expenditure is not disputed, and there is no finding that the payment is excessive, mere inability to furnish minute details of services rendered by each employee cannot, by itself, justify disallowance of the entire expenditure. Thus, respectfully following the ratio laid down in CIT v. Indo Saudi Services (Travel) (P.) Ltd.[2008 (8) TMI 208 - BOMBAY HIGH COURT] we hold that the disallowance made u/s 37(1) r/w section 40A(2)(b) is not sustainable in law. Appeal of the assessee is allowed. Issues: Whether the disallowance of salary recharge and reimbursement of expenses amounting to Rs. 62,50,720/- under section 37(1) read with section 40A(2)(b) of the Income-tax Act, 1961 is sustainable in law.Analysis: The statutory requirement under section 40A(2) mandates a recorded opinion that the expenditure is excessive or unreasonable with regard to fair market value, legitimate business needs or benefit derived; such a finding is a prerequisite before invoking disallowance. The onus under section 37(1) is on the assessee to establish that the expenditure was incurred wholly and exclusively for business purposes. The material shows the existence of cost sharing agreements, accounting entries evidencing reimbursements, and that the payee entities are domestic companies taxed at the same rate. The assessing authority and the appellate authority disallowed the expenditure primarily because minute individual deputation details and a formal mechanism of apportionment were not produced, but they did not record any finding that the payments were excessive or that tax evasion was intended or occurred. Where there is no finding of excessiveness or tax arbitrage and an arrangement for sharing personnel and corresponding reimbursements is not disputed, mere absence of granular deputation particulars does not satisfy the statutory threshold for disallowance under section 40A(2) nor negate the assessee's case under section 37(1).Conclusion: The disallowance of Rs. 62,50,720/- under section 37(1) read with section 40A(2)(b) is not sustainable and is deleted; the appeal is allowed in favour of the assessee.