M.& CO. v. INCOME TAX OFFICER
[Citation -1984-LL-0304]

Citation 1984-LL-0304
Appellant Name M.& CO.
Respondent Name INCOME TAX OFFICER
Court ITAT
Relevant Act Income-tax
Date of Order 04/03/1984
Assessment Year 1979-80
Judgment View Judgment
Keyword Tags proportionate disallowance • disallowance of interest • personal expenditure • interest expenditure • personal purpose • income returned • interest paid • market value • flat rate
Bot Summary: 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 considered Rs. 1,200 per year as reasonable payment. Counsel appearing on behalf of the assessee submitted as paper books containing 63 pages and 4 pages and submitted as follows: 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, the partner could be deemed to have substantial interest only if he was entitled to net less than 20 per cent of the profits. In respect of the interest disallowance, he brought to our notice that partners had withdrawn the amount of Rs. 1,48,000 out of total capital of the partners which stood at Rs. 2,08,513. Department al representative made the submission as under: 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. 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. 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 was an obligation on the part of the partners to contribute certain amount of capital. We retain the disallowance of Rs. 4555 in place of Rs. 26,943 made by the ITO and confirmed by the CIT The ITO is directed to modify the assessment of the firm and also pass appropriate orders in the cases of the partners.


P. J. GORADIS, M. This appeal filed by assessee is directed against it order of CUT (A) Rajkot, confirming following disallowance: (i) Payment of salary of Rs. 5,195 to son of partner. (ii) Rs. 8,700 paid by way of commission to 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 interest debited in books. assessee is registered partnership firm closes books of accounts as per financial year maintained on mercantile system of accounting. ITO disallowed Rs. 5,195 paid to S. R., son of one of partners, under s. 40A(2) holding that he was school going boy, attending office casually after school hours and, therefore, considered Rs. 1,200 per year as reasonable payment. assessee paid commission of Rs. 8,700 to employee S. S., working as salesman over and above regular salary. ITO invoked provisions of s. 40A(3) and disallowed same. Similarly, ITO invoked provisions of s. 40A(3)) in respect of commission paid in cash to Shri S. employee salesman of assessee. ITO also found that two of partners had withdrawn in aggregate sum of Rs. 1,48,000 for construction of property. Since assessee firm was paying interest to outside parties on bank loans, according to him, borrowings were diverted for personal purpose of partners and accordingly on estimate flat rate of 12 per cent on Rs. 1,48,000 worked out amount to be disallowed at R s . 27,760. But since interest paid was limited to Rs. 26,943 disallowance was limited to said amount. On appeal, CIT (A) dismissed application after observing as under: Since son of partner was doing part-time work salary at rate of Rs. 100 per month was properly estimated. In respect of disallowance of commission to both employees in view of provisions of s. 40A( 3), expenditure required to be disallowed. In respect of proportionate disallowance out of interest expenditure, he observed that assessee did not dispute facts that amount was withdrawn for construction of property by partners. At time of hearing, ld. counsel appearing on behalf of assessee submitted as paper books containing 63 pages and 4 pages and submitted as follows: In respect of disallowance of Rs. 5,195 according to him, s. 40A(2) did not apply because relevant partner had only 15 per cent share and according; to Explanation to sub-section (2), partner could be deemed to have substantial interest only if he was entitled to net less than 20 per cent of profits. Besides, during past years also, son was attending to business of assessee firm and thus paid salary for which no disallowance was made. In respect of disallowance of commission paid to two employees of assessee firm, be drew our attention to circular of Board u/r 6DD(J)) dt. 31st May, 1977 appearing on pp. 16 and 17. In respect of interest disallowance, he brought to our notice that partners had withdrawn amount of Rs. 1,48,000 out of total capital of partners which stood at Rs. 2,08,513. He drew our attention at p. 42 of paperbook wherein necessary details in respect of opening balances of capital accounts of partners standing at Rs. 76,000 approximately and additions made by partners to 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, aggregate balance stood at Rs. 1,66.780 which was sufficient to cover Rs. 1,48,000 withdrawn by partners. Reliance was placed on various decisions of Tribunal and High Courts. Alternatively, it was submitted that as per details of withdrawals given in statement containing grounds of appeal, disallowance could be made only to extent of Rs. 4,555. Besides there were also some loans from relatives of partners of firm on which interest was paid by assessee firm. ld. Department al representative made submission as under: In respect of salary paid to son of partner, according to him, s. 40A(2)(b(ii) of Act was applicable and according to that even son of partner was to be considered and 20 per cent test was not applicable. In past whether salary was paid to son of Partner or whether disallowance was made cannot be basis for considering deduction because each year is separate gear. In respect of disallowance by invoking provisions of s. 40A(3) of Act, it was submitted that interpretation of Board's Circular should not be made too wide. Regarding disallowance of interest, same is on basis of balance- sheet, etc., and ratio of income earning assets and non-income earning assets should always be borne. We have considered submissions and materials to which our attention was drawn. Regarding disallowance of Rs. 5,195 out of salary paid to son of partner, sought to be justified under s. 40A(2) of Act, we hold that same is required to be deleted. Merely because payment is made to relative of partner would not itself justify disallowance. disallowance has to be considered after finding that expenditure was excessive or unreasonable having regard to l () Market value of services,(ii) legitimate needs of business, and (iii) benefit derived by or accruing to assessee therefrom. Unless findings are recorded on basis of above tests disallowance sought to be made as is confirmed by CIT (A) cannot stand test of law. Invoking of such provision has to be resorted to very sparingly. Merely because son of partner was attending part-time cannot give one any idea of what benefits were derived by assessee firm or were accruing to firm. letter by assessee that while salesman were on tour son of 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 statement made by ld. counsel for assessee that s. 40A(2) is not applicable to facts of case. As pointed out by ld. Departmental representative correct section, viz. s. 40A(2)(b)(ii) of Act is applicable. Because test regarding 20 per cent profit would apply to sub-cls (iii) to (v) of cl. (b). In other words 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 partner which is defined in s. 2(41) of Act and that would includes any lineally descendent of partner. Therefore, submission of ld. counsel is rejected on this aspect. In respect of disallowance made under s. 40A(3) of Act in respect of commission paid to two employees also disallowance is not called for. Because. circular issued by Central Board of Direct Taxes appearing at p. 17 of paper-book gives instances where disallowance is not to be made. Para 6 of said circular issued u/r 6DD (j) specifically mentions that apart from cases and circumstances stated in circular, which are not exhaustive but illustrative, there could be cases other than falling within categories which would satisfy requirements of r. 6DD (j). main purpose of section is to ensure identity of receiver so that if necessary payment made can be cross-checked with income returned by payee. In this case it is not case Revenue that employees did not show receipt by way of commission or that commission paid to employees were excessive. In respect of interest disallowance, we find that CIT (A) has confirmed disallowance without applying amount to facts of case. There is no law that partner must contribute capital for business of firm. No Provision in partnership deed is brought on record justifying that there was obligation on part of partners to contribute certain amount of was obligation on part of partners to contribute certain amount of capital. This being so, even business could be carried on by firm on basis of borrowed capital. Therefore, there is no specific finding in respect of diversion of borrowing for purpose of personal expenditure of partners and it could not be said that borrowings were not utilised for purpose of business. However, assessee has submitted necessary details in respect of withdrawls from time to time in connection with construction of property by partners on various dates and has calculated quite fairly amount of Rs. 4555 as interest that could be, at maximum, related to diversion of borrowings. Though this is alternative submission by Id. Counsel, from details in respect of withdrawals, capital of partners, loans and considering all relevant facts, we find that disallowance of interest to extent of Rs. 4555 would meet end of justice. We, therefore, retain disallowance of Rs. 4555 in place of Rs. 26,943 made by ITO and confirmed by CIT (appeal) ITO is directed to modify assessment of firm and also pass appropriate orders in cases of partners. In result, appeal is allowed in part. *** M.& CO. v. INCOME TAX OFFICER
Report Error