Estimated and adhock disallowances are not proper- must be avoided to avoid un-necessary litigation.

[CA DEV KUMAR KOTHARI]

Reference of recent judgment:

Commissioner of Income Tax Versus The Lakshmi Vilas Bank Ltd. Tax Case (Appeal) No. 896 of 2013 Dated - 16 April 2014  2014 (4) TMI 827 - MADRAS HIGH COURT

Estimated disallowances:

In scrutiny assessment it is general tendency of some tax authorities , including appellate authorities to disallow / confirm disallowance of certain expenses just on estimated or adhock  basis for several reasons like some vouchers are self made vouchers or claim for expenses, expenses are excessive or unreasonable,  some expenses are not fully supported,  to plug any lacunae in spending, personal element, capital element, …. etc.

Certain specific heads of general nature:

We find disallowances  under different heads like out of repairs expenses, telephone expenses, advertisement expenses, miscellaneous expenses, general expenses, other expenses etc.

Miscellaneous expenses or   general expenses are residual type of accounting heads. When an expenditure is of petty nature and there is no specific accounting head for the same, it is generally debited to such residuary head of expenses.

Expenses claimed by recipient:

Some expenses are claimed by recipient in form of a claim for costs, or reimbursement or privilege receivable, expenses for having any work done or supply made or expenses incurred or for some entitlements under contact of employment etc. When a claim is made by a person who is entitled to receive certain payment, the claim is verified by concerned persons and then payment is made. In this way expense are verified to be payable by the organization.

Internal check and control:

In large organizations where work is carried through employees, suitable system of internal check and control is in place. Any expenditure incurred and claimed by another is verified by concerned staff and officers. Depending on nature and amount different officers may be authorized to pass such claims for payment. Therefore, even small sums of expenses are checked and then accounted for and paid.   For all expenses there cannot be perfect document however, even a claim on plain paper which gives details of claim or expenses, work done/ goods supplied which is verified and paid and is accounted for can be considered a  reasonable evidence, depending on its nature and amount at a time or at several times.   

Petty disallowances are just for making disallowances:It can be said that some petty disallowances out of larger part of expenses is just for making disallowances. When a major part of expenses say 1485 lakh is allowed a disallowance of 15 lakh or 1% can only be considered as disallowance made just for sake of disallowing something. If we look at from other point of view, then we find that when 99% of expenses are allowed, why a 1% disallowance is made. If the tax authority rely for 1485 lakh on books of account and internal check and control , then  disallowing 1% on adhock and estimated basis is nothing but making a disallowance just for sake of disallowance.

Case of The Lakshmi Vilas Bank Ltd.

As is clear from the name of assessee, and is known to commercial persons The assessee is a banking company and have many branches spread over all over India. Some branches are  big , some small and some medium sized branches. Generally  banks have branches in all type of cities and some villages also.

As per recent report on website of bank at present bank is working with a network of 362 branches and 8 extension counters, spread over 15 states and the union territory of Puducherry. The Bank also has an ATM network of 688.

For assessment year 2004-05  (Previous year ended 31.03.2004) the Assessing Officer found that the assessee had claimed deduction of a sum of Rs.8,43,35,691/- (  per author- such expenses were charged  under residuary head of expenditure as petty expenses).

The assessee explained that the expenditure is of petty cash nature like data entry charges at some of the branches, ticket collection charges, branch cleaning charges, wax, candle, paper cups, plates, bags for carrying cheque/cash etc., which could not included under the other broad heads.

At relevant time the bank had 224 branches, 8 divisional offices and Head Office and the amount per branch/office would be insignificant.

The Assessing Officer considered this claim and disallowed 10% of the total expenditure claimed holding that it would be of personal nature not exclusively necessary for business.

Thus The AO disallowed  a sum of Rs.84,33,569/- on estimated basis and added to the total income of the assessee.

On appeal  before the Commissioner of Income Tax (Appeals) the disallowance was confirmed for the reasons that  the authorised representative could not produce any vouchers or account for the expenditure maintained at the branch level or head office level.

The assessee went on appeal before the Income Tax Appellate Tribunal.

Tribunal allowed the appeal, the Tribunal pointed out that while disallowing 10%, the First Appellate Authority and the Assessing Officer held that the possibility of personal expenditure could not be ruled out.

The Tribunal held that neither the Assessing Officer nor the Commissioner of Income Tax (Appeals) had any material on record to reject the claim of the assessee. Once the Assessing Officer held that 90% of the expenditure of this nature was liable to be accepted, there was no reason for restricting the claim to 90% alone and disallow 10%.

Taking such view,  the Income Tax Appellate Tribunal accepted the case of the assessee and allowed the appeal.

The revenue preferred appeal before the High Court  seeking admission on the question of law as follows:

       "Whether, on the facts and in the circumstances of the case the Tribunal was right in deleting the disallowance of 10% of the assessee's claim of other expenses amounting to Rs. 84,33,561/- on the ground that there is no specific rejection of details placed by the assessee on record when the assessee had not produced any vouchers in support of the claim?"

High Courts view:

The honorable High Court observed and held on the following lines:

1. We do not find any ground to admit this Tax Case (Appeal) since the issue herein is purely a factual one.
2.  It is not denied by the Revenue that the assessee has 24 (sic 224)  branches, 8 divisional office and a head office.
3. The expenditure claimed by the assessee related to petty cash expenditure.
4. When the Revenue had thought fit to allow 90% of the claim, there was no reason to reject the balance 10% attributing it to the possibility of having the shade of a personal expenditure.
5.  Except for this reasoning, we do not find any justification in the Revenue's contention that the disallowance of 10% is warranted in the facts of the case.
6. The order of Tribunal , being a pure factual issue the court  rejected  the appeal at the admission stage itself and in the result, the Tax Case (Appeal) was  dismissed.

Observations of author:

In this case we see that the assessee is a bank and an organized and large entity. The banks maintain proper books of account and suitable evidences for all expenses incurred. Suitable evidence depends on various factors like nature of payment, nature of claimant, nature of payee, place of payment, amount of payment etc. IN such an organization there is suitable internal check and control. Business is carried in a professional manner. There is delegation of powers for incurring of expenditure, approval of the same and then payment is made by authorized cashiers.  Therefore, in such a case, disallowance of any expenses is not justified.

It is true that there can be some personal element of expenses, but such expenses are incurred by employees. For example while entertaining bank customers with tea and snacks, a bank officer also participate, some phone calls may be made to home by officers, sometime banks car may be used for personal purposes. However, all such personal use or expenses  are in the course of business and are normal  business expenses. Some benefits or privilege might have been derived by officers, staff etc. that does not make expenses incurred by a large organization as personal expenses.  

Similar will be case of telephone and car expenses, even if some personal used is made, it is for saving of time. Time saved can be used more profitably for business purposes.

The tax authorities must also consider claims and allow expenditure in a businesslike manner considering ground realities. They should not have tendency of always having some suspicion, doubt and should not draw unreasonable inferences based on some unreasonable apprehensions. They must place themselves in position of assessee and consider the claims in a reasonable and practical manner.  Disallowances of petty nature of expenses makes hardly any impact on overall revenue collection, but such disallowances creates lot of dissatisfaction amongst tax payers, lot of litigation which causes wasteful expenditure from public funds also.

Let us hope that the revenue will not challenge the order of the High Court – however,  such hopes are always belied and we should not be surprised if the revenue prefer an appeal against order of Madras high Court.    

The judgment is reproduced below with highlights added.

Commissioner of Income Tax Versus The Lakshmi Vilas Bank Ltd. - 2014 (4) TMI 827 - MADRAS HIGH COURT