TMI Blog2008 (1) TMI 490X X X X Extracts X X X X X X X X Extracts X X X X ..... cts and in the circumstances of the case, the CIT(A) erred in allowing the directors' remuneration including conveyance at Rs. 45,09,008 as against allowed by the AO at Rs. 12,38,400 though the CIT(A) has accepted that the directors were not wholly and full time involved in the business activities of the company and no educational qualifications or technical expertise was necessary for running this line of business. 2. The order of the CIT(A) may be vacated and that of the AO be restored." 4. The assessee filed the return of income on 31st Oct., 2001 declaring the income at Rs. 31,85,030 along with the auditors' report in Form Nos. 3CA and 3CD. As per the audit report the details of payments made to persons specified under s. 40A(2)(b) were given and sum of Rs. 80,38,400 was shown to be paid to the following directors as under: 1. Shri Suresh H. Rupeeja Rs. 20,09,600 (including conveyance of Rs. 800 per month) 2. Shri Ganesh S. Misal Rs. 20,09,600 -do- 3. Shri Sudhir Sahani Rs. 20,09,600 -do- 4. Shri Deepak D. Misal Rs. 20,09,600 -do- 4.1 On being asked to justify the payments of remun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... figures of sales, unsold tickets, prize winning tickets and timely receipt of payments from the stockists. He was also maintaining relations with the suppliers considering the prevailing market conditions. (el Shri Suresh Rupeeja was managing director was looking after entire day-to-day administrative matters of the company, maintenance of accounts, payments to suppliers, etc. (f) Shri Ganesh Misal, one of the directors, was having a separate business of vegetable at Mandal, Pune. whose sale for asst. yr. 2001-02 was Rs. 7,53,642. (g) Similarly, Shri Sudhir Sahani, one of the directors, was having a separate lottery business styles as Sahani Lotteries and during financial year 2000-01 (2001-02). Mr. Sahani had disclosed profit from the business at Rs. 24,30,467. (h) It was admitted by Shri Sudhir Sahani that he was required to devote at least 2 to 2 1/2 hours daily in the morning and 2 hours in the evening for the business of Sahani Lottery. (i) In addition to his own business, Shri Sudhir Sahani was also a partner in M/s Sagar Agency from where he was getting remuneration of Rs. 1,87,000. This showed that he was looking after the business of the said firm as well. (j) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the remuneration paid by the appellant company to its directors was comparatively much lesser than what was paid to the top executives of the companies in the country. After considering the submissions of the assessee, the CIT(A) restricted the addition to Rs. 35,29,392 as against the addition made by the AO at Rs. 68,00,000 by holding the remuneration to be at Rs. 45,09,008 as reasonable to the directors, by examining the case in hand as under in his impugned order: "2.3 The submissions have been considered. The issue to be considered is whether the payment of remuneration of Rs. 80,38,400 to the four directors of the appellant company was justified as commensurate with the services rendered by them or was excessive in view of s. 40(2)(b) of the IT Act, 1961? The basic nature of the services rendered by the directors was examined by the AO and it has also been noticed that most of the directors were having their own independent business apart from being directors of the appellant company. Even though the appellant's representative has contended that the directors spent little time for their proprietary business, however, the contention cannot be accepted in totality, as it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sidering the facts on record, the payment of remuneration to the directors made by the appellant company is evidently excessive and the same cannot be correlated merely to the turnover of the business of the company. The sales of the appellant company, which is a wholesaler of lottery tickets, have been made to only 65 sub-stockists and sub-wholesalers. The area-wise sub-stockists/dealers with whom the appellant has dealt are namely, Pune 29, Nagpur 5, Mumbai 8, Solapur 4, Nashik 1, Aurangabad 6, Latur 1, Kolhapur 2, Ahmednagar 1, Nanded 1, Jalgaon 2, Satara 1, Goa 1, Ichalkaranji 1 and Sangli 1. It is not a case that the appellant is dealing with too many customers and moreover the area of operation is mainly in Pune city, which is evident from the number of sub-stockists with which the appellant is dealing with. The turnover of the appellant is also approx. Rs. 250 crores. This huge turnover cannot only be the basis for the payment of huge remuneration to the directors, as the sales were only to about 65 parties. In a manufacturing concern with much higher turnover than the turnover of the appellant, the dealing is normally with a large number of buyers and even then in a publi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly for the fact that the rate of tax leviable on an individual is much lesser than the rate of tax leviable on a company. For this assessment year, a company was to pay tax at flat rate of 35 per cent plus surcharge @ 13 per cent. whereas an individual was liable to tax at the rates of 10 per cent on income above Rs. 50,000 upto Rs. 60,000, 20 per cent plus 12 per cent. surcharge on income from Rs. 60,000 to 1,51,460 and 30 per cent plus 17 per cent surcharge on income from Rs. 1,51,470 to Rs. 10,00,000. Further, in spite of the fact that the company had huge turnover, no dividend was paid to the shareholders (the four directors were the only shareholders). If dividend was actually paid to the directors, who were the shareholders, then the company was further liable to pay tax under s. 115-O of the IT Act, 1961 @ 7.5 per cent plus surcharge of 13 per cent). By paying excessive and huge remuneration to the directors, the appellant company was able to decrease its incidence of tax by almost 13 per cent to 14 per cent. Obviously, it was a ploy not to give dividend to the directors, who were the shareholders of the company, and thereby transferring huge profits of the company to the di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es at Rs. 45,09,008. Thus, the working given above in view of the findings given in the foregoing paras, the total remuneration payable to the four directors of the appellant company is held to be reasonable at Rs. 45,09,008 as against Rs. 12,38,400 held by the AO to be the reasonable remuneration payable to the four directors and the resultant addition of Rs. 68,00,000 is substituted by the addition of Rs. 35,29,392. This is considered as not deductible under s. 40A(2)(a). The appellant would accordingly get a relief of Rs. 32,70,608." 5.1 Aggrieved by the order of the CIT(A), the assessee is in further appeal before us in sustaining the addition to the extent of Rs. 35,29,392 and the Revenue is in appeal in restricting the addition to the extent of Rs. 35,29,392 as against the addition of Rs. 68,00,000 made by the AO under s. 40A(2)(b). 6. Before us, the learned counsel for the assessee has contended that the company was formed under the Indian Companies Act, 1956, which governs the whole affairs of the company, does not put any restriction on the amount of remuneration payable to the directors by the company in respect of private limited companies. He also contended that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... int of view of a businessman and not from the point of view of a tax collector, and an objective standard is to be adopted for determining the proper and reasonable remuneration which should have been paid by any company to its director. Therefore, in the light of these decisions, the learned counsel for the assessee has contended that the remuneration paid to the directors should be allowed as deductible expenditure to the appellant company. 7. On the other hand, the learned Departmental Representative has strongly relied on the order of the AO and contended that the CIT(A) was not justified in restricting the disallowance to Rs. 35,29,392 as against the disallowance of Rs. 68,00,000 made by the AO on account of excessive remuneration paid to the directors of the assessee company under s. 40A(2)(a). Therefore, he prayed that the order of the AO may be restored and that of the CIT(A) be set aside. The learned Departmental Representative, has pointed out the legal proposition that merely because of the existence of an agreement between the assessee and his directors for payment of certain remuneration and fact of the actual payment of the remuneration, the AO is not bound to hold ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payment has been or is to be made to the taxpayer's relatives or any directors of the company or any relatives of such director as specified in cl. (b) of s. 40A(2) is liable to be disallowed in computing the profits of the business or profession to the extent the expenditure is considered to be excessive or unreasonable. The reasonableness of any expenditure is to be judged having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to the taxpayer from the expenditure. Such portion of the expenditure which, in the opinion of the AO is excessive or unreasonable according to these criteria is to be disallowed in computing the profits of the business or profession. It may be noted that this provision is applicable to all the categories of expenditure incurred in business or profession including expenditure on purchase of raw materials, stores or goods, salary to employees or directors and also any other expenditure or professional services or by way of brokerage, commission, interest, etc. Where the payment for any expenditure is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the last three years and disallowed the balance under s. 10(4A) of the IT Act, 1922. The Tribunal confirmed the order of the ITO even though it was not proved that the payment of the remuneration was influenced by extra-commercial considerations: Held, that in the absence of evidence relating to the duties of the managing director and the Dy. managing director, the services rendered by them, the manner in which the profits of the appellant were enhanced by reason of their special aptitude or qualifications, the legitimate business needs of the appellant, and the benefit derived by the appellant in consequence of the services rendered by them, the finding recorded by the ITO and confirmed by the Tribunal had to be accepted." 12. In the light of the decision of Hon'ble Bombay High Court in the case of CIT vs. Shatrunjay Diamonds and the decision of Hon'ble Supreme Court in the case of Nund Samonta Co. (P) Ltd. vs. CIT, we may say that when the expenditure claimed by the assessee company is hit by s. 40A(2) of the Act, it is for the assessee to establish by proper evidences that the particular deduction of expenses is justifiable and not excessive or unreasonable. 13. The p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee has stated that the directors' remunerations were increased vide resolution taken in a properly called board of director's meeting. It was further submitted by the assessee that all the four directors were working as directors, shouldering with various business responsibilities. It was contended that the increase in remuneration was made, having regard to the legitimate needs of the business and the benefit derived by the assessee from the services rendered by the directors. It was also submitted that the directors had put various efforts and given various services to the company as a result of which, the assessee's turnover has increased from year to year. It was also submitted that the increase in the remuneration of the directors is not in the same proportion as increase in the turnover of the assessee company and, as such, it cannot be said that the increase of remuneration Lo directors in the year is excessive or unreasonable. 15. Insofar as the assessee's contention that as the remunerations paid to the directors were increased in a properly called meeting of the board of directors, such payment is to be considered as reasonable and not excessive, we are of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in s. 40A(2) of the Act. Although there might be such a resolution in existence allowing the company to increase the remuneration payable to the directors and the payment might have been made, it is still open to the AO to consider all the relevant factors and determine for himself whether the remuneration paid by the company to their directors or any person thereof is reasonable and allowable. In this connection, we may refer to a decision of Hon'ble Supreme Court in the case of Swadeshi Cotton Mills Co. Ltd. vs. CIT (1967) 63 ITR 57 (SC) where it has been held that merely because of the existence of an agreement between the assessee and his employee for payment of a certain remuneration and the fact of the actual payment, the ITO is not bound to hold that the payment was made exclusively or wholly for the purpose of the assessee's business. Although there might be such an agreement in existence and the payment might have been made, it is still open to the ITO to consider all the relevant factors and determine for himself whether the remuneration paid to the employee or any portion thereof is properly deductible under s. 10(2)(xv) of the IT Act. Further, the Hon'ble Calcutta High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s tried to establish the reasonability of the remuneration paid to the directors with reference to the increase in the turnover. But, the fact remains that the turnover of Rs. 241.17 crores is in the current financial year 2000-01, which could be ascertained only at the end of the year and not at the beginning of the year when the resolution was taken. When the resolution was taken at the beginning of the year in the month of April, 2000, the turnover of immediate preceding financial year i.e. financial year 1999-2000 could be available with the board of directors. which was at Rs. 77.34 crores as compared to Rs. 35.09 crores pertaining to the financial year 1998-99. The total remuneration paid to the directors in financial year 1998-99 was of Rs. 30 lakhs which was increased to Rs. 36 lakhs in the financial year 1999-2000 as against the turnover of Rs. 35.09 crores of financial year 1998-99 and Rs. 77.34 crores for financial year 1999-2000, respectively. It is well known that every increase in the turnover would not justify the increase in the salary or remuneration payable to the directors in the same proportion as the turnover in respect of one year bears to the total turnover o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r under consideration in the manner as the same was being looked after by these four directors in earlier year also. The learned counsel for the assessee has referred various duties and functions assigned to each and every director for the purpose of carrying on assessee's business of sale of lottery tickets. The nature of the services rendered by these four directors in the year under consideration is same and identical as that of services rendered in earlier years. The assessee has not pointed out any extra or additional endeavour or services rendered by these four directors to the assessee company in the current financial year as compared to the earlier years, so as to justify the increase in their remuneration from Rs. 36 lakhs in the immediate preceding year to Rs. 80 lakhs in the current year. The case before us is not the case where the Department has taken a stand that the directors have not rendered any services at all. The issue before us is as to whether the payment of Rs. 80 lakhs as compared to Rs. 36 lakhs in the immediate preceding assessment year can be considered to be reasonable having regard to the fair market value of the services rendered by the directors for w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... during the year under consideration, the assessee has acquired any new stockistship or distributorship of other State Government in addition to the distributorship or stockistship of other State Government already held by the assessee in earlier years. There is no material produced by the assessee to show and establish that any new stockistship or distributorship of any other State Government was acquired by the assessee in the current year because of any endeavour undertaken by the four directors. Therefore, the increase in the turnover from one year to another that by itself would not be sufficient to justify the so much increase of remuneration from Rs. 36 lakhs in the immediate preceding year to Rs. 80 lakhs in the current year. There is no doubt that some increase in remuneration to the directors may be warranted having regard to the increase in the turnover of the assessee's business as well as having regard to the fact that some increase in wages of employees is made from year to year by any business organization or any other institutions. However, the dispute is with regard to the extent of increase of remuneration from Rs. 36 lakhs to Rs. 80 lakhs in the light of the provi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to the assessee therefrom. Payment of remuneration to the directors is undoubtedly for the legitimate need of the business, but the amount of the remuneration paid to the directors is to be seen with regard to the extent of legitimate need of the business. In the present case, the assessee was paying total remuneration to four directors at Rs. 30 lakhs in financial year 1998-99 and Rs. 36 lakhs in the financial year 1999-2000, which has been increased to Rs. 80 lakhs in the current financial year. The assessee has not been able to show that there were any such legitimate needs of the business to increase the remuneration to the directors from Rs. 36 lakhs to Rs. 80 lakhs when the nature and volume of the services rendered by these four directors in the current year were more or less identical or similar in the earlier years. The assessee has not been able to explain and demonstrate as to what more benefit was derived by the assessee by increasing salary from Rs. 36 lakhs to Rs. 80 lakhs in the current year. The assessee has been paying salary to all its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt of view of businessman, and it is not open to the AO to adopt subjective standard with regard to the proper remuneration which should have been paid to the managing director. There is no quarrel as to this proposition and on the facts of the present case. the CIT(A) has adopted very objective standard while determining the amount of remuneration payable to the directors as discussed by us herein. 21. The next decision relied by the learned counsel for the assessee in the case of Mahindra Mahindra Ltd. vs. CIT wherein it was held that remuneration paid to the director without sanction of Central Government is valid, has no relevancy to the present case, where the disallowance has been made on the ground of excessiveness and the unreasonableness of the amount of remuneration paid to the directors. The decision in the case of CIT vs. Edward Keventer (P) Ltd. of Calcutta High Court would also be of no help to the assessee inasmuch as in that case the remuneration amount payable Lo the director was found to be reasonable and justified by the Hon'ble High Court and the Hon'ble High Court has made it clear that they were not allowing the amount paid to the directors including the R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4.45 per cent. which is to be considered as very meagre. However, per contra, the learned Departmental Representative, has pointed out that the assessee company has saved tax of 15 per cent by way of paying huge remuneration to the directors. In this connection, the learned Departmental Representative invited out attention to the observation of the CIT(A) where the CIT(A) has worked out the decrease in the instance of tax payable by the assessee company to almost 13 to 14 per cent While working out the tax effect at 13 to 14 per cent, the CIT(A) has taken into account that if the surplus lying with the assessee company out of the profits were to be paid to the directors as a dividend, the assessee company would have been liable to pay tax under s. 115-O of the IT Act, @ 7.5 per cent plus surcharge of 13 per cent. This aspect of the matter as to the payment of tax under s. 115-O on distribution of dividend pointed out by the CIT(A) in his order has not been commented upon or refuted by the learned counsel for the assessee either in the course of hearing of this appeal or in the written note filed subsequently. The learned counsel for the assessee has only made a reference to the dif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... remuneration to the directors, one cannot adopt the subjective standard, but it is to be considered on rational basis having regard to the business need of a businessman and the benefit derived by the businessman from the services so rendered by the directors and fair market value of the services. Therefore, while determining the reasonableness of the amount of remuneration payable by the assessee company to the directors, the CIT(A) has adopted the method or the basis of allowing of remuneration to the partners of a firm under s. 40(b) of the Act considering the same as a rational basis, and he has not treated the assessee company as registered firm as such. 24. In the light of the above discussion made above, we are of the considered view that there could be a some bona fideness in increasing the remuneration payable to the directors from one year to another, having regard to the practice prevalent in the business world and having regard to the criteria laid down under s. 40A(2)(b) of the Act. We are not rejecting the assessee's case at all by saying that the assessee should not have increased at all the remuner8.[ion payable to the directors. The real dispute in the present ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal remuneration paid to four directors from Rs. 36 lakhs to Rs. 80,38,400. In the absence of such evidence and satisfactory explanation, we are unable to agree with the learned counsel for the assessee that the remuneration so paid to the directors was reasonable and not excessive and the AO should prove by independently collecting evidence that the remuneration claimed is excessive and unreasonable before the power under s. 40A(2) is exercised by the AO. On the facts of the case, the steep increase in the remuneration from Rs. 36 lakhs to Rs. 80,38,400 cannot be said to be influenced by any commercial consideration but is found to be influenced by extra commercial considerations as it is found by us above that by paying higher and excessive remuneration to the directors, the assessee has made an attempt to avoid incidence of tax payable by it. 25. However, having regard to the facts that the remuneration paid to the directors in the immediate preceding year was Rs. 36 lakhs which was considered to be reasonable and not excessive. The remuneration to the directors were increased from Rs. 30 lakhs in financial year 1998-99 to Rs. 36 lakhs in the financial year 1999-2000. the serv ..... X X X X Extracts X X X X X X X X Extracts X X X X
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