Payment Of Excessive Or Unreasonable Salary Is Sine Qua Non For Invoking Provision Of Sec 40A(2)(B): Ahmedabad ITAT

The Bench of the ITAT comprising of Madhumita Roy (Judicial Member) and Annapurna Gupta (Accountant Member) observed that “payment of salary and granting of interest free loan are two different transactions and there is no scope of clubbing the same to attract the provision of Section 40A(2)(b) of the Act. The same salary would have been given to any other person recruited by the appellant for the said post. Thus, question of diversion of funds or routing of funds does not and cannot arise as these two transactions i.e. payment of salary as well as loan is through journal entry and the amounts stands payable, on the other hand, in the form of creditor or lender as rightly pointed out by the appellant. As Smt. Palak A Shah did not withdraw salary, the amount was lying as unsecured loan as per normal accounting principle. Had the interest been paid the Revenue would have at loss because the appellant firm attracts 30.9% tax whereas Smt. Palak A shah, an employee falls under 20.6% tax slab.” (Para 7.6)

As per the brief facts of the case, during the assessment proceeding, it was found that the appellant has shown salary payment of Rs.4,20,000/- to the administrative head, and deducted TDS of Rs.43,260/-. Upon deduction of the same, the remaining amount has been shown as an unsecured loan obtained. A show cause notice was issued since the administrative head filed no return of income. The assessee submitted a reply which the AO rejected on the premise the administrative head is a relative of the partner and stands covered within the purview of Section 40A(2)(b). Furthermore, by claiming this particular expenditure, the appellant has got a benefit of 30% as per its taxation rate being a partnership firm. Hence, this is a collusive transaction to evade payment of tax. Apart from that the administrative head has immediately given back the same amount as an interest-free unsecured loan to the appellant particularly when the same was neither made through a bank account nor by any other means the transaction is a paper/sham transaction to claim excess expenditure. The amount debited by the appellant was found to be bogus salary expenses in the P&L account and the same has been disallowed u/s 40A(2)(b).

The Bench noted that the basic and foremost requirement of allowability of expenditure is that it should be incurred wholly or exclusively for business and should not be like capital or personal expenses as per Section 37 r.w.s. 40A.

The Bench observed that only if the sum paid to the persons covered by the provisions of Section 40A(2)(b) was found to be excess or illegitimate though incurred for business or profession was not allowed as a deduction.

The Bench further observed that even if a non-relative person would have been paid the said salary, the tax liability would remain the same and even in such circumstances, the appellant firm would have been eligible to derive benefit @30% as per its taxation rate being a partnership firm.

The Bench stated that merely because the administrative head is a related person the same cannot be ground to disentitle the appellant firm when no extra benefit, is given particularly when the salary was as per the present market rate and the service was rendered by a competent person capable enough to look into allocated responsibility.

The Bench observed while referring to the decision of Madras High Court in the case of CIT vs. Computer Graphic Ltd., reported in 258 ITR 84 that where the appellant incurs any expenditure in respect of which payment has been made or is to be made to any person referred to Clause (b) of Section 40A(2) and the AO believes that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction u/s 40A(2).

The Bench further observed that when the expenditure incurred by the appellant is otherwise deductible but deduction is restricted to a part of the sum by considering such expenditure to be excessive, having regard to the fair market value of the goods or services, etc. and so much part of the expenditure is disallowed or in other words, if the expenditure incurred by the appellant is proved by the AO to be excessive or unreasonable considering the fair market value of the goods or services for which the payment as made the deduction u/s 40A(2)(b) is permissible.

Therefore, ITAT allowed the assessee's appeal.

Counsel for Appellant: Prashant Upadhyay

Counsel for Respondent: Saumya Pandey Jain

Case Title: M S Hostel verses Deputy Commissioner of Income Tax

Case Number: I.T.A. No. 614/Ahd/2023

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