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TMI Blog1982 (6) TMI 102X X X X Extracts X X X X X X X X Extracts X X X X ..... B(1) of the IT Act, 1961 (hereinafter referred to as 'the Act') forwarded to the assessee a draft order of the proposed assessment on 17th March, 1980. The assessee filed its objections under s. 144B (2) within the statutory period. After receipt of the objections from the assessee, the ITO forwarded to the IAC of Income-tax, Central Range II, Ludhiana, the proposed draft assessment order and objections of the assessee on 27th March, 1980. The ITO received directions form the IAC on 11th March, 1980. 3. As mentioned earlier, the previous year of the assessee is the financial year and 1st April 1975 was the first day of the previous year relevant to the asst. yr. 1976-77. The constitution of the firm of M/s Sudershan Engg. Works prior to 1st April, 1975 was as under: Name of the partner Profit sharing ratio 1. Satish Chander 4 % 2. Jaswant Rai 18 % 3. Gopi Ram 18 % 4. Chiranji Lal 12 % 5. Purshottam Lal (P.L. Singla) 12 % 6. Kulwant Rai 12 % 7. Bhagwant Rai 12 % 8. Om Prakash 12 % There was also in existence another firm working under the name and style of M/s Swastika Traders, carrying on business in bone crushing and had also income from interest and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd marketing of the products of the Principals. This will include appointing of salesmen, either on commission or salary basis, making contracts with dealers and consumers of oil mill machinery and parts, either through correspondence or in person, and organising their own office to handle the work of sales and correspondence with the customers and parties. (b) It will be duty of the Selling Agents to lift the entire products of the principals in toto. In case any goods remain unsold after 60 days from the date of manufacture, the Selling Agents will pay 24 per cent interest on the cost of such goods. (c) The Selling Agents will Sell the goods strictly on rates field by the principals. Any change in prices shall be intimated to them as and when necessary. Selling Agents will charge rates of their own accord. These will always be fixed by the Principals. In case of non-compliance of this condition, the Principals have the right to cancel the selling agency. 3. The Sole Selling Agents will be entitled to a commission of 12.5 per cent on rates fixed by the Principals. This will include all expenses of Excise Duty, Sales-tax, Travelling and Conveyance, Commission and Salaries to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ejection scrap material, rejected goods of defected material or any other material, not meant for sale to customers of the selling agency. The Principals will be at liberty to sell such material directly to any party or person, without allowing any commission to the selling agents. 13. This agreement will be binding on the successor-in-business. 14. The agreement is at Will beginning from 1st April, 1975. The sole selling agents and the Principals have got the option to cancel the agreement by giving six months notice." On the basis of the above agreement, the assessee firm paid Rs. 4,43,918 and Rs. 4,15,013 respectively for the asst. yrs. 1976-77 and 1977-78 to the other party to the above agreement called sole selling agents. In the computation of total income, the assessee claimed these payments as commission paid to M/s. Swastika Traders. As mentioned earlier, the ITO had sent the proposed draft assessment order to the assessee and with the objections received from the assessee had forwarded the draft order to the IAC. The IAC advised the ITO as recorded by the ITO in his impugned assessment orders particularly the order for the asst. yr. 1976-77 dt. 12th Aug., 1980 and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considered by the ITO as not incurred for legitimate needs of the selling agency business were taken at Rs. 52,526. Balance was Rs. 2,63,679. Keeping in view the directions of the IAC for the asst. yr. 1976-77, he further allowed margin of 10 per cent of commission of Rs. 4,15,013 which came to Rs. 41,501. This was added to Rs. 2,63,679. The total came to Rs. 3,05,180. This was deducted from the commission of Rs. 4,15,013. The balance of Rs. 1,09,833 was added as inadmissible. 7. In computation of total income, the assessee had himself disallowed 1/3rd car expenses and 1/3rd depreciation. The ITO in computing the total income, restricted the disallowance to what the assessee had himself surrendered. The assessment for the asst. yr. 1976-77 was completed on total income of Rs. 3,41,530 and for the asst. yr. 1977-78 at Rs. 1,90,806 after the firm's tax. 8. The assessments were challenged in appeal before the CIT (A). The CIT (A), disposed of the appeals by a consolidated order dt. 7th March, 1981. The ld. CIT (A) taking into consideration that, "the four partners who were formerly working in the appellant firm having considerable experience of the sales of the goods being manufa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... further we would like to record that it was conceded that 1/3rd disallowance of expenses on car were in fact made by the assessee himself while making the returns and, therefore not much arguments were addressed on this issue as no further relief was due to the assessee. Sec. 215 interest would be consequential and, therefore no further arguments were addressed. Both the sides, therefore addressed the arguments on the only issue of payments made to the selling agents which were disallowed by the ITO and now partly sustained by the CIT (A). In the cross appeals of the Revenue, the only grievance is with regard to the relief allowed by the CIT (A) by enhancing the amounts payment for entrepreneurial skill. 12. The ld. Counsel for the assessee submitted that the authorities below erred in treating the payments made by the assessee in the manner done by them. According to him, there was agreement between the two genuinely constituted firms and the agreement was acted upon in good faith. Having accepted this arrangement, the authorities below, it was contended, merely tempered with the payments made by substituting their judgment as to the reasonableness of the expenditure incurred by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the partners of the assessee firm had substantial interest in M/s Swastika Traders, the provisions of s. 40A were not applicable at all. 14. The ld. counsel for the assessee contended further that even if for the sake of argument, the applicability of s. 40A(2)(b)(vi) (B) were to be considered as applicable then there is no reason why the real expenditure, the whole of it incurred by M/s Swastika Traders, should have been allowed. The part of the expenses disallowed by the ITO out of the total expenses before their deduction from the commission paid was wholly unjustified. In this regard, the ld. counsel for the assessee submitted that in appreciating the facts, the ITO erred in referring to the turnover and the profits in the manner done by him. It was stated that during the accounting period relevant to the asst. yr. 1976-77 there was Emergency in the country and, therefore there was fall in the prices. The cost of production of the assessee had merely come down though the production did not come down. Therefore the turnover though more in quantum remains practically in terms of money at levels which have been recorded by the ITO. 15. Rebutting the arguments of the ITO tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 121/2 per cent of the sales by way of rebate or discount was credited to the account of M/s Swastika Traders and, therefore, even the manner of consideration by the authorities below considering the payments as expenditure was wholly erroneous because though the terms of the agreement show as commission yet in substance it was nothing but a trade discount. If it is considered as a trade discount which in fact it is, he contended, the provisions of s. 40A will not be applicable at all because trade discount cannot be considered as expenditure in the ordinary sense. For this proposition he relied on the ratio of the Madras High Court judgment in the case of CIT vs. A.K. Subbaraya Shetty & Sons (1980) 123 ITR 952 (Mad). The ld. counsel for the assessee finally concluded that taking into consideration the terms of the agreement, the genuine expenses of the two firms, the actual conduct of the business of the assessee, the actual performance of the duties by the contracting agents i.e., M/s Swastika Traders, the onerous terms of the agreement, the capital invested by them, the rebate and discount allowed by them to the smaller customers and heads of other expenses which were put to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 40A. 22. We have very carefully considered the rival submissions. We have also peruse the entire evidence placed before us by the parties. The reasons given by the authorities below vide their respective actions have also been weighted. We have also applied our mind to the relevant provisions of law. Before we proceed to deal with the issue brought before us, we would first like to clarify certain concepts so that the contentions raised from either side may be examined in proper perspective. 23. The Hon'ble Supreme Court in the case of CIT vs. Walchand & Co. Private Ltd. (1967) 65 ITR 381 (SC) laid down a broad proposition of law that in applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out of purpose for the business, reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the Revenue. This judgment of the Hon'ble Supreme Court was with regard to the provisions of the IT Act, 1922 particular s. 10(2)(xv). however, the legislature thought it fit to invest the ITO with powers to question the propriety of the expenditure. Hence s. 40A. This section was inserted by s. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve of such director, partner or member; (vi) any person who carries on a business or profession "(A) where the assessee being an individual, or any relative of such assessee has a substantial interest in the business or profession of that person; or (b) where the assessee being a company, firm, AOP or HUF, or any director of such company, partner of such firm or member of such association or family, or any relative of such director, partner or member, has a substantial interest in the business or profession of that person. Explanation—For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if— (a) in a case where the business or profession is carried on by a company, such person is, at time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting powers; and (b) in any other case, such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession." 24. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es, and on different articles or quantities in the same trade, and is not dependent upon payment within a specified time. It is either shown as a deduction on the invoice, or allowed for when pricing the goods and not shown separately, with the result that the sales Day Book or purchase Day Book and the entry in the ledger account, will show the net amount of the transaction. Trade discount will not appear in anyway in the ledger." At page 3 of the Third Edition of Accountancy by William Picklers, there are observations about the method of dealing with the trade discount. The ld. author records that, "particular attention must be paid to the method of dealing with trade discounts. These are adjustments of the listed price of goods, and should be deducted before the sale or purchase is entered in the Day Book in order that this entry may represent the true sale or purchase price". 25. Now we proceed to examine the issue before us in the light of the above position. We have abstracted the substantive clauses of the agreement entered between the assessee and the Sole Selling Agents, namely, M/s Swastika Traders in order to project the import thereof. These clauses of the agreement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment also provided that within 30 days from the date of lifting the goods, all the bills of the principals shall be paid by the selling agents and in case of failure to do so, the agents were liable to pay interest at 12 per cent per annum. The principals were obliged under cl. 7 of the agreement to pay the commission to the selling agents as mentioned in para 3 periodically and this amount of commission was to be credited in their account against the supply of goods. Clause 8 provided that the sale of the products manufactured by the principals will be between the Selling Agents and the buyers and the principals shall not be liable in any way to this account. 27. Both the sides were obliged to put in efforts to sell the products manufactured by the principals through proper publicity and expenses on such advertisements and publication were to be borne 90 per cent by the selling agents and 10 per cent by the principals. The actual expenditure on this account for purpose of publicity had to be made according to necessity which was, however, to be adjusted in the above ratio at the end of the year. 28. However, in case the selling agents got complaint from the customers and the g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the provisions of s. 40A(2)(a) the commission of 12 1/2 per cent is expenditure and if so, whether it is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legislature needs of the business or profession of the assessee or the benefit derived by or according to the assessee therefrom. We have, therefore, to decide first whether the commission is expenditure. In this regard, we have to revert back to the argument of the ld. counsel for the assessee that it is not expenditure but a payment in the form of a trade discount or rebate and as such s. 40A is not applicable. We have with a purpose on mind, therefore, already incorporated in the body of this order as to what such a trade discount can be. From that point of view if we examine the entries in the books of account of the assessee, we find that the claim of the assessee that the amount of 12 1/2 per cent was a trade discount cannot be upheld. At page 1 there is the assessee's trading discount. At pages 2 and 3 i.e., the assessee's profit and loss account. In the trading account for the year ended 31st March, 1976, the sale of finished goods ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he firm of M/s Swastika Traders alongwith others had in fact employed their entrepreneurial skill and capital in running the firm of M/s Swastika Traders and, therefore, allowed them the sum of Rs. 44,392 on that account. In other words, the Revenue thought that expenses of Rs. 2,91,777 had been incurred by M/s Swastika Traders on which there was no doubt. It is thus clear that the terms of the agreement were actually acted upon and the parties genuinely and bona fide executed the agreement and in the process M/s Swastika Traders earned the disputed amount of commission. 32. In earning this commission, not only the partners of M/s Swastika Traders put in their entrepreneurial skill but there was investment in specific terms. At pages 14 and 15 of the assessee's paper book is a letter dt. 2nd Feb., 1979 written to the ITO, Central Circle V, Ludhiana pointing out, inter alia, that, "M/s Swastika Traders have earned the sum of Rs. 1,39,120 only against the capital investment of Rs. 5,00,000." The ITO has nowhere denied that M/s Swastika Traders made investment of substantial sums in terms of the agreement. At page 61 is the balance sheet of M/s Swastika Traders as on 31st March, 197 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es clear that different considerations will follow if in that sub-cls. (i) to (vi) of cl.(b) of sub-s.(2) were to be invoked. We do not find any material on record to justify the invocation of any of these clauses r/w sub-cl.(a) of sub-s. (2) of s. 40A. Therefore, we do not find any justification firstly to invoke the provisions of s. 40A(2) and secondly, a justification by way of independent evidence that the expenditure was excessive or unreasonable. In our considered opinion, the assessee paid for commercial consideration the commission of 12 1/2 per cent and passed over to these selling agents most of the liabilities that a manufacturer has in disposing of the products. 34. Under the terms of the agreement, the selling agents were to lift the entire products of the principals within 60 days of the manufacture failing which they incurred the heavy penal interest of 24 per cent. Out of the commission of 12 1/2 per cent, the selling agents were obliged to spend amounts on publicity, out of which 90 per cent was to be their responsibility and only 10 per cent was to be borne by the principals. If this is examined with the letter of the assessee dt. 2nd Feb., 1979, it is found tha ..... X X X X Extracts X X X X X X X X Extracts X X X X
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