1984 (11) TMI 95 - AT - Income Tax

Issues Involved:
1. Whether the selling agents commission paid to a close associate of the assessee-firm is to be disallowed under section 40A(2) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

Main Issue: Disallowance of Selling Agents Commission under Section 40A(2)

Background:
The assessee-firm manufactures hygienic products and had a selling agency agreement with a close associate company. The commission rates varied from 20% to 25% based on turnover. For the assessment year 1979-80, the turnover was Rs. 2,39,10,396, and the commission paid was Rs. 52,60,287. The assessing authority disallowed a significant portion of this commission, deeming it excessive under section 40A(2).

Assessing Authority's Reasoning:
1. No market survey was conducted by the company.
2. Normal market commission rate is around 5%.
3. The assessee's products faced minimal competition, making high commissions unjustifiable.
4. If the assessee incurred the advertisement expenses, they would be subject to disallowance under section 37(3A).

Commissioner (Appeals) Decision:
The Commissioner (Appeals) agreed with the disallowance but adjusted the reasonable commission rate to 12.5% for established products and 7.5% for new products, calculated on the gross invoice value.

Assessee's Objections:
1. No comparative case justifying the pegged rates of 7.5% and 12.5%.
2. Remuneration must cover the expenses incurred by the selling agent, which were Rs. 47,01,195.
3. The firm lacked a selling organization and relied on the company's experienced sales infrastructure.
4. No tax benefit was derived from this arrangement.
5. Historical trade discount rates were around 35%, justifying the current commission rates.
6. Section 40A(2) requires consideration of market value, business needs, and benefits derived.
7. Profits had increased over the years, indicating the arrangement's effectiveness.
8. Tribunal had previously upheld the calculation on the gross invoice value.

Department's Contentions:
1. Section 40A(2) conditions are disjunctive; failure in one condition warrants disallowance.
2. The company did not fully discharge its obligations.
3. Excessive commission payments resulted in losses for the assessee.
4. The assessee's low profits indicated excessive commission payments.
5. The company's expenses should have decreased after becoming a selling agent.
6. Expenses incurred by the company do not justify the commission rates.
7. Increase in turnover is not a material factor.
8. Comparative cases show much lower commission rates.
9. Profits increased significantly in years without commission payments.

Tribunal's Findings:
1. Selling agency contracts should be commercially profitable for both parties.
2. The expenses incurred by the company are crucial in determining the reasonableness of the commission.
3. The company's expenses were legitimate and necessary for the selling agency.
4. The commission rates were not excessive as they covered the company's expenses.
5. Historical data supported the reasonableness of the commission rates.
6. The company had indeed discharged its obligations under the agreement.
7. The change from trade discount to commission did not necessarily reflect in increased profits due to various market factors.
8. Comparative cases cited by the department were not directly relevant.
9. The department's figures on 'Promise Toothpaste' profits were inaccurate due to an error in the computation for section 80J.

Conclusion:
The Tribunal concluded that no disallowance should be made under section 40A(2) as the commission payments were not excessive and were justified based on the expenses incurred by the company and the historical context of the agreement.

Final Order:
The Tribunal allowed the entire commission paid as a deduction, rejecting the disallowance made by the assessing authority and modified by the Commissioner (Appeals).

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