TaxTMI 
TaxTMI 
2008 (1) TMI 490
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....08 out of addition of Rs. 68,00,000 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 ....
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....ess of the appellant no technical or educational qualifications were necessary. In fact, Shri Suresh Rupeeja, was only SSC passed. He was also the managing director of the company. (b) The working of Shri Deepak Misal, as director, was to see that business was functioning smoothly which meant that he was not involved in the day-to-day business activities of the company. (c) The working assigned to Shri Ganesh Misal, a director, was to timely despatch lottery tickets and to control the despatch staff. He was also only SSC passed. (dl Shri Sudhir Sahani, a director was looking after the sales promotion and maintenance of the sales figures. He was looking after the marketing and distribution of lottery tickets and for that he had to remain in touch with wholesales collecting the figures of sales, unsold tickets, prize winning tickets and timely receipt of payments from the stockists. He was also maintaining 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 Mi....
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....resultant remuneration arrived at by the AO per director was Rs. 3,09,600 and the total remuneration, thus, allowed by him was Rs. 12,38,400 out of the remuneration paid by the assessee of Rs. 80,38,400, resulting into the disallowance of Rs. 68,00,000 under s. 40A(2). 4,3 Aggrieved by the order of the AO, the assessee had carried the matter before the CIT(A). 5. Before the CIT(A), the submission of the assessee was that due to collective effort of all the four directors, the sales of the company had gone up from Rs. 35,09 crores for financial year 1998-99 to Rs. 241.17 crores in the year under consideration. He further submitted that though the sales had gone up by 7 times the remuneration had only gone upto Rs. 80,38,400 as compared to that given in asst. yr. 1999-2000. It was contended that the remuneration paid by the appellant company to its directors was comparatively much lesser than what was paid to the top executives 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 reasonab....
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....g regard to the fair market value of the goods, services or facilities for which the payment was made or the legitimate needs of the business or profession of the assessee or the benefit derived or accruing to him therefrom and so much of the expenses as were considered by him to be excessive or unreasonable was not to be allowed as deduction. This provision was introduced as it was found that the tax liability was sometimes artificially reduced by diverting the business profits to relatives and associate concerns in the form of excessive payment for goods and services. Even earlier, there was a provision under s. 40(c) which has now been omitted, laid down the limit of payments of remuneration to directors. Even upto asst. yr. 1988-89, the payment to directors could not exceed Rs. 1,02,000. Considering the facts on record, the payment of remuneration to the directors made by the appellant company is evidently excessive and the same 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....
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....p; Rs. 50,000 On the next Rs. 75,000 Rs. 45,000 On the balance Rs. 1,10,35,020 Rs. 44,14,008 ------------- Total Rs. 45,09,008 ------------- The reasonability of the payment in this case has to be considered in the light of the services rendered and the reasonableness of the payment considering the market value of the services rendered. The above allowability of the remuneration to directors in a public company and to partners in a firm is a guiding North Star in arriving at the reason....
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....d the four directors are shareholders. The composition of a private limited company is akin to a partnership firm, as the four directors are the shareholders, who have contributed the capital of the company. In the case of a public limited company, there is a limitation imposed by the Companies Act for payment of remuneration to whole time working directors, which is limited to 11 per cent of the net profit. However, there is no such restriction in the case of a private limited company. The reasonableness of the payment of remuneration to the directors in the case in had can be considered in the light of the allowable remuneration to the partners as per s. 40(b) of the IT Act, 1961 and that would be a very fair basis for considering the reasonableness of the remuneration paid by the appellant, which is a private limited company, to its four directors. The nature of job/services rendered by the directors and the remuneration paid to other employees clearly show that the remunerations paid to directors were excessive and unreasonable and were also made a ploy to restrict the tax liability which would have been payable by the company. As discussed above, the basis of s. 40(b) is held ....
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....of the company, the assessee company has been able to reduce its tax liability by at least 13 to 15 per cent though in fact there was a reduction in the tax liability of the assessee company only to the extent of 4.45 per cent. In support of its case, the learned counsel for assessee has also placed reliance on the following decisions: (i) Extrusion Process (P) Ltd. vs. CIT (1979) 13 CTR (Bom) 64 : (1979) 119 ITR 287 (Bom); (ii) Mahil1dra & Mahindra Ltd. vs. CIT (2005) 199 CTR (Bom) 602 : (2005) 278 ITR 138 (Bom); (iii) CIT vs. Edward Keventer (P) Ltd. (1972) 86 ITR 370 (Cal); (iv) Pioneer Spring & Steel Concern (P) Ltd. vs. CIT (1979) 10 CTR (Cal) 322 : (1982) 135 ITR 522 (Cal); (v) CIT vs. Dalmia Cement (Bharat) Ltd. (2002) 174 CTR (Del) 188 : (2002) 254 ITR 377 (Del); (vi) S.A. Builders Ltd. vs. CIT (2006) 206 CTR (SC) 631; (vii) Abbas Wazir (P) Ltd. vs. CIT (2003) 185 CTR (All) 152; (viii) Calcutta Art Studio (P) Ltd. vs. CIT (1979) 118 ITR 752 (Cal); (ix) Sonar Airotech (P) Ltd. vs. CIT (1994) 117 CTR (Cal) 147; (x) Annamalai Cotton Mills (P) Ltd. vs. ITO (1980) 9 TTJ (Mad) 175; (xi) L.J. (P) Ltd. vs. ITO (1982) 13 TTJ (Ahd) 590; (xii) S.L. ....
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....rial on record. 9. The AO has made the disallowance based on s. 40A(2)(a) which reads as under: "Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of this sub-section and the AO is of 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 profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction." 10. Sec. 40A contains a non obstante clause. As pointed out by the Hon'ble Supreme Court in the case of Shree Sajjan Mills Ltd. vs. CIT (1985) 49 CTR (SC) 193 : (1985) 156 ITR 585 (SC), s. 40A, which contains a non obstante clause in sub-s. (1), is an overriding provision which operates in spite of anything to the contrary contained in any other provision of the Act relating to the computation of income under the head "Profits and gains of business or profession". In other words, the legislature has made....
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....2)(b) of the Act, the burden is upon the assessee to establish that the price paid by it, is not excessive or unreasonable. In cases falling under s. 40A(2)(b) it is the duty of the assessee to prove and discharge its burden by leading proper evidences subject to cross-examination by the Department. 11. Further, in the case of Nund & Samonta Co. (P) Ltd. vs. CIT (1970) 78 ITR 268 (SC). Hon'ble Supreme Court has ruled out as under: "In an enquiry under s. 10(4A) of the IT Act, 1922, into the excessiveness or unreasonableness of an allowance resulting in the provision of any remuneration or benefit or amenity to a director or a person who has a substantial interest in the assessee company, it is for the taxpayer to establish by evidence that the particular allowance is justifiable. If the taxpayer does not produce any evidence in support of the claim for allowance, the ITO is not bound independently to collect evidence and decide that the allowance claimed is excessive or unreasonable having regard to the legitimate business needs of the assessee company before the power under s. 10(4A) may be exercised. The appellant company had provided towards remuneration for its managin....
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.... year 2000-01 relevant to the asst. yr. 2001-02 along with the additional amount of Rs. 38,400 towards conveyance allowance. The remuneration has been paid to the directors, and, as such, the assessee's claim of deduction on account of remuneration paid to directors is covered by the provisions contained in s. 40A(2) of the Act. It is not in dispute that the directors to whom the remuneration has been paid by the assessee company are the persons specified under s. 40A(2)(b) of the Act. It was, therefore, incumbent on the part of the AO to make an enquiry as to the reasonability of the payment of remuneration paid to the directors. Once the remunerations were paid by the assessee company to the directors falling under the category of persons specified under s. 40A(2)(b) of the Act, and since the AO required the assessee company to prove the reasonability of the payment of remuneration paid to the directors, it was the burden of the assessee to prove and establish by proper evidence that the remuneration paid to the directors was not excessive or unreasonable having regard to the fair market value of the services rendered by the directors for which the payment is made or the legitima....
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....ased from Rs. 36 lakhs to Rs. 80 lakhs. It was stated by the assessee that this resolution was taken in the meeting of the board of directors at the beginning of the year and not at the end of the year. In other words, it was stated that the resolution was taken in the month of April, 2000. It has also been stated by the assessee that the directors to whom the remuneration has been paid has not voted on the issue, which in our considered opinion, is very difficult to believe in the light of the fact that there were no other directors or shareholders other than these four directors, who are the only shareholders of the assessee company. The resolution taken in the board of directors' meeting to increase the remuneration of four directors from Rs. 36 lakhs to Rs. 80 lakhs in addition to the conveyance allowance of Rs. 38,400 is not at arm's length, but it is taken by the directors of the assessee company in their favour. 16. Moreover, it is well-settled that merely because of the existence of a resolution passed in the board of directors' meeting in the case of this private limited company, where the directors are only shareholders, and the fact that the actual payment of remunera....
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....ases where the transactions are not at arm's length as so observed by the Hon'ble Bombay High Court in the case of CIT vs. Shatrunjay Diamonds. In this case, the fact that all the four directors are the shareholders of the assessee company is not in dispute and, as such, the intricacy of the resolution taken in the board of directors' meeting and transaction of payment of remuneration to the directors were required to be explained by the assessee. The assessee has not explained as to what was the criteria adopted in a meeting of the board of directors for determining the total remuneration payable to the four directors @ Rs. 20 lakhs each against Rs. 9 lakhs each paid in the immediate preceding assessment year. However, in the course of the hearing, the learned counsel for the assessee has submitted that the remuneration has been increased from Rs. 36 lakhs to Rs. 80 lakhs because of increase in the turnover of the assessee company from year to year. It is the assessee's case that the resolution in the meeting of the board of directors was taken at the beginning of the year, which goes to prove that the figures of the turnover of this current assessment year were or could not be av....
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....nt of facts that after formation of this private limited company on 24th June, 1998, the company has started its "activity of marketing of State lottery tickets. M/s N.V. Marketing (P) Ltd., New Delhi, has appointed the assessee company as sole stockist for Parasmani set of weekly lotteries of Arunachal State Government. It was also the authorized stockist of Shri Laxmi Marketing, Pune, for Mizoram State Government lotteries. Be it mentioned here that Shri Laxmi Marketing, Pune, by which the assessee has been appointed as authorized stockist in respect of Mizoram State Government lotteries is a proprietary concern of its one of directors viz., Shri Suresh H. Rupeeja. The assessee is, thus, engaged in the business of marketing of lottery tickets as sole stockist for Parasmani set of weekly lotteries of Arunachal State Government and as authorized stockist of Shri Laxmi Marketing, Pune, for Mizoram State Government lottery. This business was being carried on by the assessee in the earlier years. The business of marketing of lottery tickets was looked after by the directors with the help and aid of its employees who were being paid salary in the range of Rs. 35,600 to Rs. 86,000 per a....
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....er of dispute. Dispute is only with regard to the quantum of remuneration paid by this private limited company to the four directors, who are at the same time only shareholders of the assessee company. We find that the various nature of services rendered by these four directors in the current year as explained by the assessee are not sufficient to justify the increase of remuneration from Rs. 36 lakhs to Rs. 80 lakhs inasmuch as the nature and volume of services and functions undertaken by these four directors in the current assessment year are similar and akin to that of the services rendered in the earlier years. 18. We must also bear in mind that the sale of lottery tickets of any State Government always depends upon the amount and number of the prizes given in a particular draw of the lottery of that Government. Purchaser who wishes to purchase the lottery ticket, purchases the lottery ticket of such a draw where the amount of the prize as well as the number of the prizes are on higher side. In the present case, the assessee is a sole stockist of Parasmani set of weekly lotteries of Arunachal State Government and if the prizes given in Parasmani set of weekly lotteries of Ar....
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....f the lottery tickets was very much substantial. We may therefore, say that increase in the turnover in the sale of lottery tickets cannot be therefore a solitary criteria for steep increase in the remuneration payable to the director. 19. It is further observed by us that after claiming the deduction of remuneration amounting to Rs. 80 lakhs plus Rs. 38,400 and other expenditures, the assessee has declared income only of Rs. 31,85,030 which is far less than the total remuneration of Rs. 80,38,400 paid to the four directors. Out of the total net profit of Rs. 1,12,23,422 before deducting directors' remuneration, the assessee has paid remuneration to the directors to the extent of Rs. 80,38,400, leaving the net profit only of Rs. 31,85,030 as income declared in the return of income filed by the assessee. The total remuneration paid to the four directors amounting to Rs. 80,38,400 is 71.62 per cent of the net profit of Rs. 1,12,23,422 determined before allowing the directors' remuneration, which in our considered opinion, found to be very unreasonable and excessive having regard to the fact that the remuneration paid in immediate preceding assessment year to all the directors was ....
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....fforts put up by the directors while giving various services to the assessee company could justify the payment of remuneration to the directors in the range of remuneration paid in earlier years, but there is no justifiability on part of any prudent businessman to make steep increase in remuneration from Rs. 36 lakhs to Rs. 80 lakhs, when the case is undoubtedly covered by the non obstante clause of s. 40A(2) of the Act. The assessee has contended that the remunerations paid to certain directors by certain other companies are many times higher than the remunerations paid by the assessee company to its directors, but the assessee has failed to take a note of the fact that the nature of the business undertaken by those companies and nature of services rendered by their directors are quite different to that of the nature of the business carried on by the present company. Therefore, the assessee's contention that since because some companies were paying the higher remuneration to their directors, the payment of remuneration paid by the assessee company to its directors at Rs. 80 lakhs as compared to Rs. 36 lakhs paid in the immediate preceding year is to be considered as reasonable, is....
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....ng regard to the service rendered by the director. Therefore, this case does not support the assessee's case. Similarly, the other decision relied upon by the learned counsel for the assessee was also on the same footing holding that the remuneration reasonably payable to the director is to be decided objectively, having regard to the business point of view, and not on a subjective standard of the AO. It is well-settled proposition that reasonableness and excessiveness of the remuneration paid to the directors arc to be decided objectively and from the point of view of business need of the assessee company, but it has also been held at the same time that payment of any remuneration to the director only on the basis of the agreement and the provision contained in the article does not consist sufficient justification and does not bar the jurisdiction of the AO to decide the excessiveness and un-reasonability of the amount of remuneration paid to the directors as contemplated under s. 40A(2) of the Act. 22. The CIT(A) in his order pointed out that by paying the higher and excessive remuneration to the directors by the assessee company, the assessee company has reduced its tax liabi....
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....ct, and if the taxpayer does not produce any evidence in support of the claim for allowance, the AO is not bound independently to collect evidence and decide that the allowance claimed is excessive and unreasonable having regard to the legitimate business needs of the assessee company before the power under s. 40A(2) may be exercised by the AO as so held by the Hon'ble Supreme Court in the case of Nund & Samonta Co. (P). Ltd. vs. CIT and by the jurisdictional Bombay High Court in the case of CIT vs. Shatrunjay Diamonds. 23. The learned counsel for the assessee has also contended that the learned CIT(A) was not justified in treating the assessee as private limited company as registered partnership firm while allowing the deduction of remuneration of payable to the directors to the extent of Rs. 45,09,008 as against Rs. 80,38,400 claimed by the assessee. This contention of the assessee seems to be misconceived. The CIT(A) has not treated the present assessee company as a registered partnership firm. The CIT(A) has only taken into account the basis provided under s. 40(b) for allowing remuneration to the working partners while determining the reasonable amount of remuneration paid ....
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....tored, is not found acceptable to us. However, with regard to the assessee's claim that director's remuneration is to be allowed at Rs. 80,38,400 as against Rs. 45,09,800 allowed by the CIT(A), we find that the assessee has not been able to prove by proper evidence that steep increase in payment of remuneration to all the four directors at Rs. 80,38,400 as against reasonable remuneration paid at Rs. 36,00,000 in immediate preceding year is justifiable having regard to the legitimate business needs of the assessee company and the benefit derived therefrom and the fair market value of the services rendered by the directors in the current year. Apparently, no evidence was tendered by the assessee relating to the duties and functions of the directors and the services rendered by them over and above the duties and services rendered by them in the immediate preceding year so as to justify steep increase of remuneration from Rs. 36 lakhs paid in the immediate preceding year to Rs. 80,38,400 paid in the current year. The assessee has also not tendered any evidence relating to the manner in which the sales were increased by reason of directors' special endeavour, aptitude or qualifications.....