TMI Blog1982 (6) TMI 102X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... become and act as the Sale Agents of M/s Sudershan Engg. Works, and the said offer had been accepted by the principal to appoint them as Selling Agents and whereas the term 'agency' will also include to make the arrangement for financial facilities for the principals, the agreement between the principals and the Sole Selling Agents witnesseth as follows: "1. This agreement is made between Sudershan Engineering Works and M/s Swastika Traders. 2. The duties, powers and function of the Sole Selling Agents are: (a) The Sole Selling Agents will organise the sales and 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 S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the market through their good service and satisfaction to customers. As such they expect from the selling agents to keep it up lest the Principals lose their business. The continuity and extension of agreement will depend on the services and efforts of the selling agents put in by them in their work. 12. If at any time due to any reason the Principals sell any goods direct to any customers, the selling agents shall be entitled to their normal commission of 121/2 per cent on such sales also. This condition will, however, not be applicable when the Principals sell any machine rejection 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... round figures. This was added to Rs. 2,47,385 to arrive at the figure of Rs. 2,91,777. Thus the total deduction of Rs. 2,291,777 which he made from the commission of Rs. 4,43,918 was constituted of expenses to the extent of Rs. 2,47,385 and 10 per cent of the total commission for entrepreneurial skill and capital Rs. 44,392. The balance of Rs. 1,52,141 came to be disallowed for the asst. yr. 1976-77. 6. Similarly for the asst. yr. 1977-78, the total expenses incurred by M/s Swastika Traders were Rs. 3,16,205. Out of the above, on account of salary, bonus and other expenses on estimate 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 IT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of assessee, there is a grievance that the ld. CIT (A) erred in sustaining the disallowance of the sum of Rs. 1,24,483 and Rs. 80,534 respectively out of commission and/or rebate paid to M/s Swastika Traders by the assessee. There are large number of grounds but at the time of hearing the ld. counsel for the assessee crystallised the relief claimed on this issue only to the above extent. 11. The assessee has also objected to the disallowance of 1/3rd car expenses and depreciation as being unreasonable and has again raised the issue of charging of interest under s. 215. Before we proceed 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... M/s Swastika Traders. However, if viewed individually, none of the partners of the assessee firm and had substantial interest in the firm M/s Swastika Traders within the meaning of cl. (b) of the Expln. to s. 40A(2). In order to stress this point, the ld. Counsel for the assessee went through the profit sharing ratio of each one of the partners in these two concerns and endeavoured to show that taken individually, none of them had substantial interest in either of the firms. Further, he emphasised that substantial interest of the partners of the assessee-firm was only to be seen and since none 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 regar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome of the assessee for any of the years under appeal it would tantamount to double taxation which is prohibited by law. He further contended that M/s Swastika Traders had incurred expenses in the asst. yr. 1975-76 and taking into consideration those expenses, the assessee was entitled to further relief if the method adopted by the authorities below even was to be considered. 17. Before closing the ld. counsel for the assessee emphasised that in terms of the agreement, the assessee used to prepare sale bills in the name of M/s Swastika Traders for the goods sold to them. Thereafter periodically 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith s. 40A(1), it is clear that the provisions were rightly applied because the judgment cited by the assessee of the Madras High Court is distinguishable on facts. 21. He contended that the ld. counsel for the assessee had erroneously referred to the provisions of s. 40A(2)(b)(vi)(B) because that has not been applied by the authorities below. He again reiterated that the Revenue was entitled to consider even the substantial interest of the assessee-firm in the firm of the Selling Agents, even if it is considered that none of the assessee's partners had substantial interest within the meaning of s. 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l who has a substantial interest in the business of profession of the assessee, or any relative of such individuals; (iv) a company, firm, AOP or HUF having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member; (v) a company firm, AOP or HUF of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director partner or member of such company, firm. association or family or any relative 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on merits, we would like further to clarify a concept to which both the sides made a reference though in passing. This is what in accountancy known as trade discount. In order to appreciate the nature of trade discount, we may have the benefit of the following. At page 31 of Spices Pegler's "Practical Book Keeping and Commercial Knowledge", Eleventh Edition by W.W. Bigg P.C.A.., it is noted as under: "Trade Discount: Trade discount is an allowance made by one firm to another in the same trade, which takes the form of a percentage of the catalogue or list price of the article concerned. It varies greatly in different trades, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t commission received by them. Clause 4 stipulated that before the enforcement of this agreement, commitments already made by the principals had to be honoured by the selling agents. The principals were to supply the goods to the Selling Agents as they were required to lift their entire products and even were liable to penal interest at 24 per cent on the cost of such goods which were not lifted after sixty days from the date of manufacture. Therefore, cl. 5 provided that the principals will pay 5 per cent interest on such facilities as may be provided by the selling agents and availed of by the principals from time to time. The agreement 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 b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e parties he took into consideration to come to the conclusion that such a party was, "any person" referred to in cl.(b) of sub-s. (2) whom he was considering as a person having substantial interest in terms of the Expln., cl.(b) because cl.(a) of the Explanation is applicable only in cases of business or profession carried on by a company. Thus there is a confusion before the application of the law is brought to the facts of the case. This itself is sufficient to stop the Revenue from proceeding further but it did not come up before us after crossing the first stage of the appeal. 30. Even at this stage, we have to see whether in view of 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... authorities below. The disallowance has been made on the conjecture that all this was done by the assessee only with a purpose to reduce the incidence of tax. However, in the entire orders of the authorities below there is no indication as to how, in what manner and to what extent, there was reduction in the incidence of tax affected by the assessee. On the other hand, according to the ITO himself, undoubtedly, M/s Swastika Traders incurred expenditure on salaries, rents, rates and taxes, conveyance, etc. to the extent of Rs. 2,47,385. He was also convinced alongwith his IAC that the erstwhile partners of the assessee firm who constituted the 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 disp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ther the expenditure was excessive or unreasonable is concerned, there is nothing to show that it was either excessive or unreasonable. The very fact that the amounts of commission were substantial would not per se justify a surmise that the assessee diverted huge amounts for purposes of 'legal avoidance' of tax as pointed out by the IAC to the ITO in one of his communications and which formed part of the assessment order. As we have already mentioned, the authorities below nowhere mentioned what limb of sub-s. (2) of s. 40A they were involving to justify their action. From the reading of this limb of s. 40A which is reproduced above, it becomes 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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