TaxTMI 
TaxTMI 
2008 (1) TMI 490
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....8,00,000 made by the AO. On the facts and in the circumstances of the case, the CIT(A) erred in allowing the directors' remuneration including conveyance at Rs. 45,09,008 as against allowed by the AO at Rs. 12,38,400 though the CIT(A) has accepted that the directors were not wholly and full time involved in the business activities of the company and no educational qualifications or technical expertise was necessary for running this line of business. 2. The order of the CIT(A) may be vacated and that of the AO be restored." 4. The assessee filed the return of income on 31st Oct., 2001 declaring the income at Rs. 31,85,030 along with the auditors' report in Form Nos. 3CA and 3CD. As per the audit report the details of payments made to persons specified under s. 40A(2)(b) were given and sum of Rs. 80,38,400 was shown to be paid to the following directors as under: 1. Shri Suresh H. Rupeeja Rs. 20,09,600 (including conveyance of Rs. 800 per month) 2. Shri Ganesh S. Misal Rs. 20,09,600 -do- 3. Shri Sudhir Sahani Rs. 20,09,600 -do- 4. Shri Deepak D. Misal Rs. 20,09,600 -do- 4.1 On being asked to justify the payments of remuneration to the persons covered under s. 40A(2)(b) by t....
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....ining relations with the suppliers considering the prevailing market conditions. (el Shri Suresh Rupeeja was managing director was looking after entire day-to-day administrative matters of the company, maintenance of accounts, payments to suppliers, etc. (f) Shri Ganesh Misal, one of the directors, was having a separate business of vegetable at Mandal, Pune. whose sale for asst. yr. 2001-02 was Rs. 7,53,642. (g) Similarly, Shri Sudhir Sahani, one of the directors, was having a separate lottery business styles as Sahani Lotteries and during financial year 2000-01 (2001-02). Mr. Sahani had disclosed profit from the business at Rs. 24,30,467. (h) It was admitted by Shri Sudhir Sahani that he was required to devote at least 2 to 2 1/2 hours daily in the morning and 2 hours in the evening for the business of Sahani Lottery. (i) In addition to his own business, Shri Sudhir Sahani was also a partner in M/s Sagar Agency from where he was getting remuneration of Rs. 1,87,000. This showed that he was looking after the business of the said firm as well. (j) Shri Suresh H. Rupeeja, managing director was also a proprietor of Laxmi Marketing which was distributor of weekly lottery of Mizor....
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....ives of the companies in the country. After considering the submissions of the assessee, the CIT(A) restricted the addition to Rs. 35,29,392 as against the addition made by the AO at Rs. 68,00,000 by holding the remuneration to be at Rs. 45,09,008 as reasonable to the directors, by examining the case in hand as under in his impugned order: "2.3 The submissions have been considered. The issue to be considered is whether the payment of remuneration of Rs. 80,38,400 to the four directors of the appellant company was justified as commensurate with the services rendered by them or was excessive in view of s. 40(2)(b) of the IT Act, 1961? The basic nature of the services rendered by the directors was examined by the AO and it has also been noticed that most of the directors were having their own independent business apart from being directors of the appellant company. Even though the appellant's representative has contended that the directors spent little time for their proprietary business, however, the contention cannot be accepted in totality, as it was quite natural and obvious that the directors would have also been spending considerable time for their own business activities. This....
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....me cannot be correlated merely to the turnover of the business of the company. The sales of the appellant company, which is a wholesaler of lottery tickets, have been made to only 65 sub-stockists and sub-wholesalers. The area-wise sub-stockists/dealers with whom the appellant has dealt are namely, Pune 29, Nagpur 5, Mumbai 8, Solapur 4, Nashik 1, Aurangabad 6, Latur 1, Kolhapur 2, Ahmednagar 1, Nanded 1, Jalgaon 2, Satara 1, Goa 1, Ichalkaranji 1 and Sangli 1. It is not a case that the appellant is dealing with too many customers and moreover the area of operation is mainly in Pune city, which is evident from the number of sub-stockists with which the appellant is dealing with. The turnover of the appellant is also approx. Rs. 250 crores. This huge turnover cannot only be the basis for the payment of huge remuneration to the directors, as the sales were only to about 65 parties. In a manufacturing concern with much higher turnover than the turnover of the appellant, the dealing is normally with a large number of buyers and even then in a public limited company, the remuneration to the directors is limited at 11 per cent of the net profit. The reasonability of the payment of remun....
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.... the rates of 10 per cent on income above Rs. 50,000 upto Rs. 60,000, 20 per cent plus 12 per cent. surcharge on income from Rs. 60,000 to 1,51,460 and 30 per cent plus 17 per cent surcharge on income from Rs. 1,51,470 to Rs. 10,00,000. Further, in spite of the fact that the company had huge turnover, no dividend was paid to the shareholders (the four directors were the only shareholders). If dividend was actually paid to the directors, who were the shareholders, then the company was further liable to pay tax under s. 115-O of the IT Act, 1961 @ 7.5 per cent plus surcharge of 13 per cent). By paying excessive and huge remuneration to the directors, the appellant company was able to decrease its incidence of tax by almost 13 per cent to 14 per cent. Obviously, it was a ploy not to give dividend to the directors, who were the shareholders of the company, and thereby transferring huge profits of the company to the directors in the form of remuneration, the company was able to avoid paying tax at higher rate. Looking into the nature of the business of the company and the services rendered by the directors, the technical qualification required in this line of business and independent pr....
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....he reasonable remuneration payable to the four directors and the resultant addition of Rs. 68,00,000 is substituted by the addition of Rs. 35,29,392. This is considered as not deductible under s. 40A(2)(a). The appellant would accordingly get a relief of Rs. 32,70,608." 5.1 Aggrieved by the order of the CIT(A), the assessee is in further appeal before us in sustaining the addition to the extent of Rs. 35,29,392 and the Revenue is in appeal in restricting the addition to the extent of Rs. 35,29,392 as against the addition of Rs. 68,00,000 made by the AO under s. 40A(2)(b). 6. Before us, the learned counsel for the assessee has contended that the company was formed under the Indian Companies Act, 1956, which governs the whole affairs of the company, does not put any restriction on the amount of remuneration payable to the directors by the company in respect of private limited companies. He also contended that the CIT(A) has overlooked the efforts taken by all the four directors as their responsibilities, nature of work done, services rendered, time devoted by each one and post each one is holding and their respective experience in the line of lottery business, etc. have got much im....
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....ned counsel for the assessee has contended that the remuneration paid to the directors should be allowed as deductible expenditure to the appellant company. 7. On the other hand, the learned Departmental Representative has strongly relied on the order of the AO and contended that the CIT(A) was not justified in restricting the disallowance to Rs. 35,29,392 as against the disallowance of Rs. 68,00,000 made by the AO on account of excessive remuneration paid to the directors of the assessee company under s. 40A(2)(a). Therefore, he prayed that the order of the AO may be restored and that of the CIT(A) be set aside. The learned Departmental Representative, has pointed out the legal proposition that merely because of the existence of an agreement between the assessee and his directors for payment of certain remuneration and fact of the actual payment of the remuneration, the AO is not bound to hold that the payment was reasonable and not excessive and was made exclusively and wholly for the purpose of business. In this connection he relied on preposition laid down by the different Courts, which shall be discussed by us in latter part of this order. He further contended that the steep ....
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....be excessive or unreasonable. The reasonableness of any expenditure is to be judged 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 the taxpayer from the expenditure. Such portion of the expenditure which, in the opinion of the AO is excessive or unreasonable according to these criteria is to be disallowed in computing the profits of the business or profession. It may be noted that this provision is applicable to all the categories of expenditure incurred in business or profession including expenditure on purchase of raw materials, stores or goods, salary to employees or directors and also any other expenditure or professional services or by way of brokerage, commission, interest, etc. Where the payment for any expenditure is found to have been made to a relative or associate concern falling within the specified categories, as specified in cl. (b) of sub-s. (2) of s. 40A, it will be necessary for the AO to scrutinize the reasonableness of the expenditure with reference to the criteria mentioned in s. 40A(2) of the A....
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....to the duties of the managing director and the Dy. managing director, the services rendered by them, the manner in which the profits of the appellant were enhanced by reason of their special aptitude or qualifications, the legitimate business needs of the appellant, and the benefit derived by the appellant in consequence of the services rendered by them, the finding recorded by the ITO and confirmed by the Tribunal had to be accepted." 12. In the light of the decision of Hon'ble Bombay High Court in the case of CIT vs. Shatrunjay Diamonds and the decision of Hon'ble Supreme Court in the case of Nund & Samonta Co. (P) Ltd. vs. CIT, we may say that when the expenditure claimed by the assessee company is hit by s. 40A(2) of the Act, it is for the assessee to establish by proper evidences that the particular deduction of expenses is justifiable and not excessive or unreasonable. 13. The present assessee company is a private limited company in which public are not substantially interested. There are only four shareholders of this private limited company. All the four shareholders are four directors of the present company. Each director has been paid annual remuneration of Rs. 20 lakhs....
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....ntended that the increase in remuneration was made, having regard to the legitimate needs of the business and the benefit derived by the assessee from the services rendered by the directors. It was also submitted that the directors had put various efforts and given various services to the company as a result of which, the assessee's turnover has increased from year to year. It was also submitted that the increase in the remuneration of the directors is not in the same proportion as increase in the turnover of the assessee company and, as such, it cannot be said that the increase of remuneration Lo directors in the year is excessive or unreasonable. 15. Insofar as the assessee's contention that as the remunerations paid to the directors were increased in a properly called meeting of the board of directors, such payment is to be considered as reasonable and not excessive, we are of the view that this contention of the assessee would be of no much assistance to the assessee as discussed hereafter. There is no dispute in the fact that the board of directors consist of only four directors, to all of whom the remunerations at the same rate have been paid by the assessee company. It is a....
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....ion paid by the company to their directors or any person thereof is reasonable and allowable. In this connection, we may refer to a decision of Hon'ble Supreme Court in the case of Swadeshi Cotton Mills Co. Ltd. vs. CIT (1967) 63 ITR 57 (SC) where it has been held that merely because of the existence of an agreement between the assessee and his employee for payment of a certain remuneration and the fact of the actual payment, the ITO is not bound to hold that the payment was made exclusively or wholly for the purpose of the assessee's business. Although there might be such an agreement in existence and the payment might have been made, it is still open to the ITO to consider all the relevant factors and determine for himself whether the remuneration paid to the employee or any portion thereof is properly deductible under s. 10(2)(xv) of the IT Act. Further, the Hon'ble Calcutta High in the case of CIT vs. Edward Keventer (P) Ltd., while dealing with the question as to the disallowance of the amount out of the remuneration and commission paid to the directors of the company under s. 10 (4A) of the Indian IT Act, 1922 has made it clear that they were not allowing the amounts paid to ....
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....inning of the year when the resolution was taken. When the resolution was taken at the beginning of the year in the month of April, 2000, the turnover of immediate preceding financial year i.e. financial year 1999-2000 could be available with the board of directors. which was at Rs. 77.34 crores as compared to Rs. 35.09 crores pertaining to the financial year 1998-99. The total remuneration paid to the directors in financial year 1998-99 was of Rs. 30 lakhs which was increased to Rs. 36 lakhs in the financial year 1999-2000 as against the turnover of Rs. 35.09 crores of financial year 1998-99 and Rs. 77.34 crores for financial year 1999-2000, respectively. It is well known that every increase in the turnover would not justify the increase in the salary or remuneration payable to the directors in the same proportion as the turnover in respect of one year bears to the total turnover of the earlier year. An employer in fixing the remuneration of his employees would consider the extent of his business, the nature of the duties to be performed, and the special attitude of the employee, future prospectus of extent of the business and host of other related circumstances. It is erroneous t....
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....kets. The nature of the services rendered by these four directors in the year under consideration is same and identical as that of services rendered in earlier years. The assessee has not pointed out any extra or additional endeavour or services rendered by these four directors to the assessee company in the current financial year as compared to the earlier years, so as to justify the increase in their remuneration from Rs. 36 lakhs in the immediate preceding year to Rs. 80 lakhs in the current year. The case before us is not the case where the Department has taken a stand that the directors have not rendered any services at all. The issue before us is as to whether the payment of Rs. 80 lakhs as compared to Rs. 36 lakhs in the immediate preceding assessment year can be considered to be reasonable having regard to the fair market value of the services rendered by the directors for which the payment is made or having regard to the legitimate need of the business of the assessee, and the benefits derived by the assessee on acquiring the services so rendered by the directors to the assessee company. The AO had proceeded to enquire whether the remuneration of Rs. 80 lakhs and conveyanc....
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.... and establish that any new stockistship or distributorship of any other State Government was acquired by the assessee in the current year because of any endeavour undertaken by the four directors. Therefore, the increase in the turnover from one year to another that by itself would not be sufficient to justify the so much increase of remuneration from Rs. 36 lakhs in the immediate preceding year to Rs. 80 lakhs in the current year. There is no doubt that some increase in remuneration to the directors may be warranted having regard to the increase in the turnover of the assessee's business as well as having regard to the fact that some increase in wages of employees is made from year to year by any business organization or any other institutions. However, the dispute is with regard to the extent of increase of remuneration from Rs. 36 lakhs to Rs. 80 lakhs in the light of the provisions contained in s. 40A(2) of the Act. At this stage, it is pertinent to note that the assessee has contended that one of its directors viz. Shri Suresh H. Rupeeja was looking after the day-to-day administration, financial accounts, banking, etc., and was experienced in this line for last 18 years and w....
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....tors is to be seen with regard to the extent of legitimate need of the business. In the present case, the assessee was paying total remuneration to four directors at Rs. 30 lakhs in financial year 1998-99 and Rs. 36 lakhs in the financial year 1999-2000, which has been increased to Rs. 80 lakhs in the current financial year. The assessee has not been able to show that there were any such legitimate needs of the business to increase the remuneration to the directors from Rs. 36 lakhs to Rs. 80 lakhs when the nature and volume of the services rendered by these four directors in the current year were more or less identical or similar in the earlier years. The assessee has not been able to explain and demonstrate as to what more benefit was derived by the assessee by increasing salary from Rs. 36 lakhs to Rs. 80 lakhs in the current year. The assessee has been paying salary to all its employees in the range of Rs. 35,600 per annum to Rs. 86,000 per annum only. The assessee is in the business of marketing lottery tickets as sole stockist as well as authorized stockist and not as a retailer. All the lottery tickets in Parasmani set of weekly lotteries of Arunachal State Government were t....
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....ile determining the amount of remuneration payable to the directors as discussed by us herein. 21. The next decision relied by the learned counsel for the assessee in the case of Mahindra & Mahindra Ltd. vs. CIT wherein it was held that remuneration paid to the director without sanction of Central Government is valid, has no relevancy to the present case, where the disallowance has been made on the ground of excessiveness and the unreasonableness of the amount of remuneration paid to the directors. The decision in the case of CIT vs. Edward Keventer (P) Ltd. of Calcutta High Court would also be of no help to the assessee inasmuch as in that case the remuneration amount payable Lo the director was found to be reasonable and justified by the Hon'ble High Court and the Hon'ble High Court has made it clear that they were not allowing the amount paid to the directors including the Rani, merely because such payments are made on the basis of the provisions contained in the articles. They made it clear that payment of any remuneration payable to the director only on the basis of the provision contained in the articles, docs not constitute sufficient justification and does not bar the juri....
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.... out attention to the observation of the CIT(A) where the CIT(A) has worked out the decrease in the instance of tax payable by the assessee company to almost 13 to 14 per cent While working out the tax effect at 13 to 14 per cent, the CIT(A) has taken into account that if the surplus lying with the assessee company out of the profits were to be paid to the directors as a dividend, the assessee company would have been liable to pay tax under s. 115-O of the IT Act, @ 7.5 per cent plus surcharge of 13 per cent. This aspect of the matter as to the payment of tax under s. 115-O on distribution of dividend pointed out by the CIT(A) in his order has not been commented upon or refuted by the learned counsel for the assessee either in the course of hearing of this appeal or in the written note filed subsequently. The learned counsel for the assessee has only made a reference to the difference in the tax rate payable by the assessee on its total income and the tax payable by the directors on their remuneration, and thus, worked out the difference at 4.45 per cent. The learned counsel has not taken into account the savings of tax made by the assessee company by way of avoiding the payment of....
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....hile determining the reasonableness of the amount of remuneration payable by the assessee company to the directors, the CIT(A) has adopted the method or the basis of allowing of remuneration to the partners of a firm under s. 40(b) of the Act considering the same as a rational basis, and he has not treated the assessee company as registered firm as such. 24. In the light of the above discussion made above, we are of the considered view that there could be a some bona fideness in increasing the remuneration payable to the directors from one year to another, having regard to the practice prevalent in the business world and having regard to the criteria laid down under s. 40A(2)(b) of the Act. We are not rejecting the assessee's case at all by saying that the assessee should not have increased at all the remuner8.[ion payable to the directors. The real dispute in the present case can only be with regard to the steep increase in the remuneration payable to the directors from Rs. 36 lakhs in the immediate preceding year to Rs. 80 lakhs in the current year. The AO has allowed deduction of remuneration payable to the directors only at Rs. 12,38,400, worked out with reference to the salar....
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....dependently collecting evidence that the remuneration claimed is excessive and unreasonable before the power under s. 40A(2) is exercised by the AO. On the facts of the case, the steep increase in the remuneration from Rs. 36 lakhs to Rs. 80,38,400 cannot be said to be influenced by any commercial consideration but is found to be influenced by extra commercial considerations as it is found by us above that by paying higher and excessive remuneration to the directors, the assessee has made an attempt to avoid incidence of tax payable by it. 25. However, having regard to the facts that the remuneration paid to the directors in the immediate preceding year was Rs. 36 lakhs which was considered to be reasonable and not excessive. The remuneration to the directors were increased from Rs. 30 lakhs in financial year 1998-99 to Rs. 36 lakhs in the financial year 1999-2000. the services rendered by the directors in the current year are of the same nature and magnitude as were so rendered in the immediate preceding year when the directors' remuneration was paid at Rs. 36 lakhs, it is very common practice to make some reasonable increment in the salary and wages of the staff and employees fr....