N.Y. TAMHANE, A.M. ORDER This is appeal by Department against CIT(A)'s order dt. 20th Dec., 19 8 2 in 1979- 8income-tax assessment proceedings of registered firm. 2 . appeal raises two disputes. first relates to action of CIT(A) holding that amount of Rs. 5,42, 8 72 could not be disallowed under s. 40(b) of IT Act, 1961 (' Act '). second dispute relates to decision by CIT(A) that amount of Rs. 8 9,606 could not be disallowed under s. 40A(5) of Act. 3 . In assessee-firm, there are three partners. first partner is limited company, Sapulchre Bros. (India) Ltd., with 60 per cent share and other two are ladies, Mrs. Chandravati D. Ghorpade and Mrs. Shivamala Urs, each with 20 per cent share each. partnership agreement is dt. 24th June, 1965. recital of agreement states that Mrs. Chandravati D. Ghorpade n d Mrs. Shivamala Urs were parties of first and second part and Sapulchre Bros. (India) Ltd. was party of third part to partnership deed dt. 21st June, 1965. Prior to commencement of business by firm, business was carried on by parties of first and second parts in partnership with one Mr. Christopher George Beard under name and style of Mysore Company (1961). Mysore Company (1961) had certain arrangements with Indian Oxygen Ltd., terms of which were recorded by agreement dt. 20th March, 1962. Under that arrangement, Mysore Company (1961) had appointed Sapulchre Bros. (India) Ltd., party of third part, as agent for operation of agreement that Mysore Company (1961) had with Indian Oxygen Ltd. earlier referred Mr. Beard retired from Mysore Company (1961) from 1st April, 1964 and business of Mysore Company (1961) was then decided to be carried on by two ladies and limited company in partnership. According to cl. 10 of partnership deed dt. 21st June, 1965, it was provided that : " (10) management of business of firm shall be vested in party of third part who shall be solely responsible for carrying on business of firm and to promote interests of firm to best of their ability." Clause 14 of partnership deed further provided. " (14) net profits shall be arrived at after taking into account all expenses, outgoings and interest paid or payable by firm and in particular but without prejudice to generality of foregoing, salaries or wages of employees who may be on roll of party of third part but employed in connection with work of firm with approval of parties of first and second part." It appears that in accordance with manner of carrying on business, supervisory staff for firm's business was engaged by limited company who naturally used to make salary payments. limited company used to allot for purposes of partnership different staff members and entire expenditure incurred by limited company in respect of such staff members used to be reimbursed by firm. Records disclose that from asst. yrs. 1966-67 to 1976-77, ITO had not initiated any action under s. 40(b) for processing any amount that was reimbursed by firm to limited company. In s. 144B of Act proceedings for asst. yr. 1976-77, it is seen for first time that IAC had to consider this issue of reimbursement of sum of Rs. 3,46, 8 12 which were proposed to be disallowed by ITO under s. 40(b). In terms of his directions vide paras 5 and 6, dt. 24th Sept., 1979, IAC did not agree with finding of ITO that reimbursement could be disallowed under s. 40(b). Same was position for asst. yr. 1977-7 8 . 4 . For asst. yr. 1979- 8 , year under consideration, ITO proposed to disallow amount of Rs. 5,42, 8 71 which was reimbursement of expenses. According to ITO, disallowance was necessary in terms of s. 40(b). According to ITO, partner has to manage business of firm. 5. It appears that ITO was further of view that since partner was limited company, limited company as partner might have some persons to look after management of business of firm. However, if for managing business of firm, partner, if it be limited company, incurred any expenditure and was reimbursed that of necessity has to be considered in nature of remuneration to that partner and as such that amount has to be disallowed under provisions of s. 40(b). In terms of letter, dt. 14th April, 19 8 2 assessee raised objections against ITO's proposed action to disallow amount of Rs. 5,42, 8 71. It was pointed out that this was addition which was considered in details by Department in earlier years and that as such ITO was not justified in re-agitating same issue. ITO's attention was specifically drawn to assessment for years 1976-77 and 1977-7 8 . Vide para 1(c) of that letter it was represented that : " 1(c) amount of Rs. 5,42, 8 71 in question is expense reimbursed t o managing partners, Sapulchre Bros. (India) Ltd., for employees' costs incurred by them in loaning services of their staff for work of Indian Lime Corporation. As is evident from operations of firm its turnover is in region of Rs. 57, 8 ,000 and we have operations (inter alia, consisting of depots, transportations, sales, etc) all over India which necessitated use of services of persons without which operations would not have been possible. Had firm employed its own employees, it would have been likely incurred much larger expenditure by employment of persons with same experience and qualifications and ability. Therefore, it is not practical or economical for firm to engage its own employees and, hence, firm uses service and reimburses to managing partner company expenditure incurred by it on those employees whose services were loaned for work of firm. Such expenditure can by no stretch of imagination be deemed to be remuneration (by way of profit, benefit or otherwise) to managing partner and, consequently, constituting non-business expenditure. In fact, there cannot be in this case anything like ' non-business expenditure ' as held by you. Once payment is held by you to be expenditure of firm, it cannot be treated as ' non-business ' nor can it be disallowed. Besides, it is of importance to understand difference between payment made to partner for services rendered to firm by him and services rendered by third parties (for remuneration paid to such third parties) which are arranged by partner." On this issue by his direction under s. 144B dt. 15th Sept., 19 8 2 vide page (2) IAC observed as under : " It, thus, follows that any remuneration paid by assessee firm to Sapulchre Bros. (India) Ltd. by whatever name called, partakes of nature of remuneration to partner and, therefore, it has to be treated as such under law. attempt to make distinction that this remuneration is compensation for payments made by company to its employees and not remuneration received by partner from assessee is certainly not founded on sound basis. In effect company being artificial person has rendered services to assessee-firm through its employees and has received remuneration for rendering these services." As such, IAC upheld ITO's action. 6. On appeal vide para (4) of his order CIT(A) has observed : " In present case, however, partner, i.e., company, employ staff, who are loaned to firm and, hence, to confuse salary paid to employees of company as being salary paid to company is obviously error. reimbursement to partner is only of actual expenditure incurred on employment of staff and nothing more. There is no extra charge paid to partner which can be termed as remuneration or benefits to partners. There was no such payment made by assessee to any of partners which is prohibited by s. 40(b). partner incurred initially expenses on staff loaned by it to firm, paid postal charges, etc., and got actual expenditure reimbursed to it. This arrangement was only for efficient and smooth conduct of assessee's business. Clearly, this did not extend any benefit or pay any remuneration to partner." It is against this decision of CIT(A) that ITO has come up in appeal urging that AAC erred in deleting addition of Rs. 5,42, 8 71 made under s. 40(b). 7. Roy Alphonso for Department strongly relies on order of ITO 7. Roy Alphonso for Department strongly relies on order of ITO and direction of IAC. Since Alphonso had not received full records, Pooran, assessee's advocate, filed copies of various documents as filed before lower authorities. On examination of these numerous documents and in particular P&L A/c for year under consideration and details thereof, all what Alphonso submits is that assessee has incurred expenses of Rs. 7,12,409 of which amount of Rs. 5,42, 8 71.3 8 has been paid as management expenses to Sapulchre Bros. (India) Ltd. Alphonso is not in position to challenge correctness of primary facts stated by CIT(A) when CIT(A) observed that " reimbursement to partner is only of actual expenditure incurred on employment of staff and nothing more. There is no extra charge paid to partner which can be termed as remuneration or benefits to partner ". On this issue of Rs. 5,42, 8 71 Pooran supports order of CIT(A). 8 . Having heard parties and examined record so far as this ground of appeal is concerned, we find that there is merit in assessee's submission that ITO had examined this issue earlier on more than one occasion. Even examination during assessment year under consideration does not remotely suggest that by paying to Sapulchre Bros. (India) Ltd. amount of Rs. 5,32, 8 71.3 8 , firm was making any payment to limited company which would remotely be called as remuneration to partner. We are satisfied that it is merely reimbursement of expenses incurred in running business of partnership firm. As such, we do not find any reason justifying any interference with decision of CIT(A). 9 . second dispute in appeal relates to action of CIT(A) in deleting disallowance of Rs. 8 9,606 made by ITO in terms of s. 40A(5). As on first point on this issue as well, detailed facts were given initially by Pooran, which facts were got checked by Alphonso, with reference to various letters written to lower authorities during assessment proceedings. On that basis, facts relating to employment of Mr. Shivram out of whose remuneration ITO disallowed amount of Rs. 8 9,606 are to be seen as under : " 1. Mr. Shivram was in employment of Sapulchre Bros. (India) Ltd. from 1947. From 1962, Sapulchre Bros. (India) Ltd. acted as agent of Mysore Company (1961) as recited in partnership deed being at pp. 1-7 of compilation No. II. From 1965, Mysore Company (19 8 1) was dissolved and Indian Lime Corporation was formed in which Sapulchre Bros. (India) Ltd. became partner. At that time Mr. Shivram was appointed as manager to look after lim e operation in Bombay. He was already manager of Glass & Export Division. He continued to be in employment of Sapulchre Bros. (India) Ltd.. He received commission of 5 per cent from Indian Lime Corporation in respect of Bombay operations and in later years on Ahmedabad and Delhi operations ; commission on Delhi operations being restricted to 2 1/2 per cent. He also received commission at 3 per cent on Glass indenting business from Sapulchre Bros. (India) Ltd. which was Rs. 4 8 3 in accounting year 197 8 -79. ITO's computation under s. 40A(5) is marked as Annexure ' '. 2. From very first year of Indian Lime Corporation, he received commission as aforesaid till he retired on 30th Nov., 19 8 2. 3. From 1st April, 1973, his terms of remuneration were revised as per letter dt. 21st Sept., 1973 as per copy enclosed and marked Annexure ' B '. This letter, no doubt refers to commission being paid by Indian Lime Corporation to Mr. Shivram apparently through mistake. This mistake occurred because Sapulchre Bros. (India) Ltd. was managing partners and combined two letters, one regarding salary paid by SBIL and other regarding commission paid by Indian Lime Corporation in one letter. In broad sense letter reflects total emoluments Mr. Shivram received in his two capacities. However, employer-employee relationship existed only between Sapulchre Bros. (India) Ltd. and Mr. Shivram and further Mr. Shivram received commission directly from Indian Lime Corporation by ILC cheques drawn on Indian Lime Corporation account as per particulars given hereunder and not through Sapulchre Bros. (India) Ltd. Date of payment Amount paid . Rs. 16-4-1979 30,000.00 9-5-1979 30,000.00 12-11-1979 46,251.46 . 1,06,251.46 commission being calculated on year's workings, is debited on 31st March, in this case 31st March, 1979. However, it is paid in previous year 1979- 8through expenses payable account." On this issue, in terms of his direction on facts, IAC considered it proper to conclude that: " Mr. P.S. Shivram is actually employee of Indian Lime Corporation and facade of his appointment with Sapulchre Bros. (India) Ltd. has been created only to avoid applicability of s. 40A(5) of IT Act. On behalf of assessee it has been stated that Mr. P.S. Shivram is employee of Sapulchre Bros. (India) Ltd. since 1947 and managing partners of firm thought it fit to provide this gentleman's services for management of various activities of assessee- firm." Alphonso relied on fact that Shivram is main functionary of assessee-firm and as regards his remuneration, ' salary part is received by him from Sapulchre Bros. (India) Ltd. while commission is received from this assessee-firm. However, one need not be swayed by more form of this arrangement. In substance Mr. Shivram is discharging all functions of employee of Indian Lime Corporation, assessee-firm '. On this basis, IAC upheld ITO's action. On appeal, CIT(A) agreed with assessee's submission that there is no employer-employee relationship between Shivram and appellant-firm. He has been deputed by Sapulchre Bros. (India) Ltd. to attend to lime business which he attends as employee of Sapulchre Bros. (India) Ltd. He could be removed from this job and entrusted with other duties. He is not under control of appellant-firm. Since Mr. Shivram is in receipt of salary from Sapulchre Bros. (India) Ltd., when question of applying provisions of s. 40A(5) cannot arise. 10. On above facts, Alphonso submits that technically it may be fact that Shivram is employee, not of assessee but of Sapulchre Bros. (India) Ltd. However, Alphonso urges that on basis of facts stated by assessee almost 90 per cent of work which Shivram does, he does it for assessee. Alphonso supports this statement on basis of Annexure ' ' as given by Pooran. Annexure ' ' is as under : Payments to Mr. P.S. Shivram Income-tax Department's ground : Paid by Sapulchre Reimbursement from . Bros. (India) Ltd. Indian Lime Corporation . Rs. Rs. Salary 31,9 8 2 8 ,0 8 Special allowance 6,000 5,275 Commission on 483 glass business Leave travel 3,600 3,160 assistance . 42,063 36,515 For s. 40A(5), if reimbursement to Sapulchre Bros. (India) Ltd. is also considered : . . Rs. Rs. = Reimbursement 36,515 3,160 33,355 Commission paid directly . 1,06,251 by ILC . . 1,39,606 Less: Allowable . 60,000 Disallowable . 79,606 Alphonso submits that IAC was justified in coming to conclusion that in manner in which Sapulchre Bros. (India) Ltd. and assessee-firm h v e arranged their affairs and made payments for services rendered by Shivram, neither in case of Sapulchre Bros. (India) Ltd. nor in case of assessee, restrictive provision of s. 40A(5) could apply. Alphonso submits that if on first ground Department fails, it should follow that Sapulchre Bros. (India) Ltd. was merely conduit pipe for assessee to incur expenditure of amount of Rs. 5,42, 8 71, it being added that amount of Rs. 36,575 and other amount of commission paid to Shivram but part of larger amount. Alphonso submits that as such transaction be considered from larger point of view and not that restricted view be taken. Proceeding on that basis, in assessment of present firm, Alphonso urges that amount of Rs. 79,606 at least has to be disallowed. working of Rs. 79,606 is given at under : . . Rs. Rs. = "Reimbursement 36,515 3,160 33,355 Commission paid directly . 1,06,251 by ILC . . 1,39,606 Less: Allowable . 60,000 Disallowable . 79,606 11. Pooran for assessee relies on circumstances in which Shivram was employed and was remunerated. It was added by Pooran that as observed by IAC in fact Shivram was managing, if not wholly, substantially business of firm. It was submitted that as such partners of assessee- firm considered it advisable to remunerate Shivram. In reply to query, Pooran accepted fact that in assessment of Sapulchre Bros. (India) Ltd. for purposes of processing expenditure incurred on providing remuneration to Shivram, commission paid to Shivram by assessee-firm has not been taken into account. 1 2 . Having heard parties and examined record, we find even though directly assessee may not have arranged its affairs with view to avoid applicability of s. 40A(5), we find merit in observations of IAC to which our attention was drawn by Alphonso and to which we have made reference earlier that in manner in which Shivram is remunerated, neither in case of assessee-firm nor in case of Sapulchre Bros. (India) Ltd. of which Shivram is officially employee, provision of s. 40A(5) would be ignored if one were to accept Pooran's submission. Considering from that angle, we find that in present case, form must be overlooked and substance must be considered. We find merit in IAC's observation that firm has been adopting particular mode of operations to reduce taxation. In circumstances, we do not find justification in CIT(A)'s decision to accept assessee's submission that Rs. 8 9,606 cannot be disallowed under s. 40A(5). Since up to stage of appeal before CIT(A), figure mentioned in dispute is Rs. 8 9,606 and it was only before us that it was clarified that correct figure is not Rs. 8 9,606 but Rs. 79,606, we will restore ITO's order on this part, subject to arithmetical examination of amount to be disallowed. 13. In result, appeal is partly allowed. *** INSPECTING ASSISTANT COMMISSIONER v. INDIAN LIME CORPORATION