1984-VIL-68-ITAT-AHM

Equivalent Citation: TTJ 020, 246,

Income Tax Appellate Tribunal AHMEDABAD

Date: 04.03.1984

M & CO.

Vs

INCOME TAX OFFICER.

BENCH

Member(s)  : K. R. DIXIT., P. J. GORADIA.

JUDGMENT

This appeal filed by the assessee is directed against the it order of the CUT (A) Rajkot, confirming following disallowance:

(i) Payment of salary of Rs. 5,195 to son of a partner.

(ii) Rs. 8,700 paid by way of commission to an employee salesman Shri C under s. 40A(3).

(iii) Rs. 7,000 being commission paid to employee S. Shri S. under s. 40A13),

(iv) Disallowance of Rs. 26,943 in respect of the interest debited in the books.

2. The assessee is a registered partnership firm closes the books of accounts as per financial year maintained on mercantile system of accounting.

3. The ITO disallowed Rs. 5,195 paid to S. R., son of one of the partners, under s. 40A(2) holding that he was school going boy, attending the office casually after school hours and, therefore, considered Rs. 1,200 per year as reasonable payment.

4. The assessee paid commission of Rs. 8,700 to an employee S. S., working as salesman over and above regular salary. The ITO invoked the provisions of s. 40A(3) and disallowed the same.

5. Similarly, the ITO invoked the provisions of s. 40A(3)) in respect of commission paid in cash to Shri S. an employee salesman of the assessee.

6. The ITO also found that two of the partners had withdrawn in aggregate sum of Rs. 1,48,000 for construction of property. Since the assessee firm was paying interest to outside parties on bank loans, according to him, borrowings were diverted for personal purpose of the partners and accordingly on estimate flat rate of 12 per cent on Rs. 1,48,000 worked out amount to be disallowed at Rs. 27,760. But since the interest paid was limited to Rs. 26,943 the disallowance was limited to the said amount.

7. On appeal, the CIT (A) dismissed the application after observing as under:

7.1. Since the son of a partner was doing part-time work the salary at the rate of Rs. 100 per month was properly estimated.

7.2. In respect of the disallowance of commission to both the employees in view of provisions of s. 40A(3), the expenditure required to be disallowed.

7.3. In respect of the proportionate disallowance out of interest expenditure, he observed that assessee did not dispute the facts that amount was withdrawn for construction of the property by the partners.

8. At the time of hearing, the ld. counsel appearing on behalf of the assessee submitted as paper books containing 63 pages and 4 pages and submitted as follows:

8.1. In respect of the disallowance of Rs. 5,195 according to him, s. 40A(2) did not apply because the relevant partner had only 15 per cent share and according; to the Explanation to sub-section (2), the partner could be deemed to have substantial interest only if he was entitled to net less than 20 per cent of the profits. Besides, during the past years also, the son was attending to the business of the assessee firm and thus paid salary for which no disallowance was made.

8.2. In respect of the disallowance of commission paid to two employees of the assessee firm, be drew our attention to the circular of the Board u/r 6DD(J) dt. 31st May, 1977 appearing on pp. 16 and 17.

8.3. In respect of the interest disallowance, he brought to our notice that partners had withdrawn the amount of Rs. 1,48,000 out of total capital of the partners which stood at Rs. 2,08,513. He drew our attention at p. 42 of the paperbook wherein necessary details in respect of the opening balances of the capital accounts of partners standing at Rs. 76,000 approximately and additions made by the partners to the extent of Rs. 1,94,700 because of sale of properties profits, etc., were shown. Even if withdrawals other than those for property were considered, the aggregate balance stood at Rs. 1,66,780 which was sufficient to cover Rs. 1,48,000 withdrawn by the partners. Reliance was placed on various decisions of the Tribunal and High Courts. Alternatively, it was submitted that as per the details of withdrawals given in the statement containing grounds of appeal, disallowance could be made only to the extent of Rs. 4,555. Besides there were also some loans from the relatives of the partners of the firm on which the interest was paid by the assessee firm.

9. The ld. Department al representative made the submission as under:

9.1 In respect of salary paid to the son of a partner, according to him, s. 40A(2)(b(ii) of the Act was applicable and according to that even son of a partner was to be considered and 20 per cent test was not applicable. In past whether the salary was paid to the son of a Partner or whether disallowance was made cannot be the basis for considering the deduction because each year is a separate gear.

9.2. In respect of disallowance by invoking provisions of s. 40A(3) of the Act, it was submitted that the interpretation of the Board's Circular should not be made too wide.

9.3. Regarding disallowance of interest, the same is on the basis of balance-sheet, etc., and the ratio of income earning assets and non-income earning assets should always be borne.

10. We have considered the submissions and materials to which our attention was drawn.

10.1. Regarding disallowance of Rs. 5,195 out of salary paid to son of a partner, sought to be justified under s. 40A(2) of the Act, we hold that the same is required to be deleted. Merely because the payment is made to a relative of partner would not itself justify disallowance. The disallowance has to be considered after finding that expenditure was excessive or unreasonable having regard to (i) Market value of services,(ii) legitimate needs of the business, and (iii) benefit derived by or accruing to assessee therefrom. Unless the findings are recorded on the basis of above tests disallowance sought to be made as is confirmed by CIT (A) cannot stand the test of law. Invoking of such provision has to be resorted to very sparingly. Merely because the son of a partner was attending part-time cannot give one any idea of what benefits were derived by the assessee firm or were accruing to the firm. The letter by the assessee that while the salesman were on tour the son of a partner was required to put in more amount of work is not even considered by Authorities below. Without elaborating much we are stating that disallowance was not at all called for. However, we are not in agreement with the statement made by the ld. counsel for the assessee that s. 40A(2) is not applicable to the facts of the case. As pointed out by the ld. Departmental representative the correct section, viz. s. 40A(2)(b)(ii) of the Act is applicable. Because the test regarding 20 per cent profit would apply to sub-cls (iii) to (v) of cl. (b). In other words the test is not applicable to cls. (i) and (ii) of sub-cl. (b) of s. 40A(2) Sub-cl. (ii) applies to any relative of a partner which is defined in s. 2(41) of the Act and that would includes any lineally descendent of a partner. Therefore, the submission of the ld. counsel is rejected on this aspect.

10.2. In respect of disallowance made under s. 40A(3) of the Act in respect of commission paid to two employees also the disallowance is not called for. Because. the circular issued by the Central Board of Direct Taxes appearing at p. 17 of the paper-book gives the instances where the disallowance is not to be made. Para 6 of the said circular issued u/r 6DD (j) specifically mentions that apart from the cases and circumstances stated in the circular, which are not exhaustive but illustrative, there could be cases other than falling within the categories which would satisfy the requirements of r. 6DD (j). The main purpose of the section is to ensure an identity of the receiver so that if necessary the payment made can be cross-checked with the income returned by the payee. In this case it is not the case the Revenue that the employees did not show the receipt by way of commission or that commission paid to the employees were excessive.

10.3. In respect of interest disallowance, we find that the CIT (A) has confirmed the disallowance without applying the amount to the facts of the case. There is no law that partner must contribute capital for the business of the firm. No Provision in the partnership deed is brought on the record justifying that there was an obligation on the part of the partners to contribute certain amount of capital. This being so, even the business could be carried on by the firm on the basis of borrowed capital. Therefore, there is no specific finding in respect of diversion of borrowing for the purpose of personal expenditure of the partners and it could not be said that borrowings were not utilised for the purpose of business. However, the assessee has submitted the necessary details in respect of withdrawls from time to time in connection with construction of property by the partners on various dates and has calculated quite fairly an amount of Rs. 4555 as the interest that could be, at the maximum, related to the diversion of borrowings. Though this is an alternative submission by the ld. Counsel, from the details in respect of the withdrawals, capital of the partners, loans and considering all the relevant facts, we find that disallowance of interest to the extent of Rs. 4555 would meet the end of justice. We, therefore, retain the disallowance of Rs. 4555 in place of Rs. 26,943 made by the ITO and confirmed by the CIT (appeal)

10.4 The ITO is directed to modify the assessment of the firm and also pass appropriate orders in the cases of the partners.

11. In the result, the appeal is allowed in part.

 

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