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Commissioner Of Income-Tax, Tamil Nadu Iii v. A.K Subbaraya Chetty & Sons.
Factual and Procedural Background
The references arise from two identical questions concerning whether section 40A of the Income-tax Act, 1961 could be invoked to add back discounts allowed by the assessee to M/s. Somasundaram & Brothers. The opinion sets out the facts relating to T.C. No. 28 of 1976 (the facts for T.C. No. 397 of 1976 were stated to be identical).
The assessee was a registered firm manufacturing and selling silk cloth at Arni with five partners (Thiagarajan, Jagadeesan, Balasundaram, Alagesan and Smt. Pattammal). M/s. Somasundaram & Brothers was another firm consisting of Alagesan (one partner of the assessee-firm), Manivannan and five minor sons of three partners; the minors had been admitted to the benefits of that partnership. The assessee made substantial sales to Somasundaram & Brothers. In the bills to that firm a discount of 6% was shown and the net amount (after discount) was carried to the sales account; the aggregate discounts did not appear in the trading account or profit & loss account.
For the assessment year 1971–72 (T.C. No. 28 of 1976) the ITO treated Rs. 34,546 as discount and disallowed it under s. 40A because of the close connection between the firms. The assessee claimed cost savings (showroom, salesmen's salary, etc.) from such sales. The ITO accepted only Rs. 1,800 as savings. The assessee appealed to the AAC, who observed the large off-take by Somasundaram & Brothers, that the rebate was only slightly higher than that granted to others and that credit periods were slightly longer, and directed allowance of the claim. On appeal by the revenue the Tribunal held that the assessee was charged on the net price and that s. 40A did not apply, thereby confirming the AAC's order. The present reference raises the question quoted below arising from those orders.
Legal Issues Presented
- “Whether, on the facts and in the circumstances of the case, the provisions of section 40A of the Income-tax Act, 1961, can be invoked to add back the discount allowed by the assessee to M/s. Somasundaram and Brothers?”
Arguments of the Parties
Revenue / Income-tax Officer (ITO)
- Contended that the sum of Rs. 34,546 represented discounts allowed to Somasundaram & Brothers and should be disallowed under s. 40A because of the close connection between the partners of the two firms.
- Implicitly relied on the proposition that payments or concessions to related parties could be excessive or unreasonable and therefore not allowable as deductions under s. 40A(2)(a).
Assessee
- Contended that sales to Somasundaram & Brothers produced savings (showroom, salesmen's salary, etc.) which justified the net price charged and that these savings were the economic reason for the lower net price.
- Argued that the sales were bona fide and that only the net amount charged was income; there was no separate expenditure paid out by the assessee.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Sri Ramalinga Choodambikai Mills Ltd. v. CIT, [1955] 28 ITR 952 | In the absence of evidence that sales were sham or that market prices were not in fact paid, a sale at a concessional rate to benefit purchasers at the expense of the company does not entitle the department to assess the difference between market price and price paid as the seller's profit. | The court relied on this principle to accept the Tribunal's factual finding that the assessee had charged only the net price and that there was no separate expenditure paid out by the assessee which could be disallowed under s. 40A(2)(a). |
| Harihar Cotton Pressing Factory v. CIT, [1960] 39 ITR 594 (Bom) | Discusses the concept of commission or rebate (as a legal concept relevant to taxation disputes). | The court found it unnecessary to go into the concept of commission or rebate discussed in that decision because, on the Tribunal's factual findings, there was no expenditure within the meaning of s. 40A(2)(a) to be disallowed. |
Court's Reasoning and Analysis
The court began by identifying s. 40A(2)(a) (quoted in the opinion) as the provision invoked and noted that clause (b) applies to dealings between firms and partners (which factual connection existed here). The core statutory test under s. 40A(2)(a) requires (i) that the assessee incur an expenditure in respect of which payment is or will be made to a person referred to in cl. (b), and (ii) that the ITO be of opinion that such expenditure is excessive or unreasonable with reference to market value, legitimate needs or benefit derived.
The court therefore examined whether, on the facts, there was any "expenditure" of the type contemplated by s. 40A(2)(a). It relied on the Tribunal's factual findings (paras. 7 and 8 of the Tribunal's order) that: (a) the assessee in effect charged a lower sale rate to Somasundaram & Brothers (i.e., sold at a lower net price), and (b) there was nothing which was "paid out or away" by the assessee from the sale price or from income that had already accrued to it.
Applying the principle from Sri Ramalinga Choodambikai Mills Ltd. v. CIT, the court observed that, absent evidence of sham transactions or that market prices were not in fact paid, a concessional sale to benefit purchasers does not permit the department to treat the difference as the seller's profit. On the Tribunal's factual findings that the transaction was bona fide and that only the net price was charged, the court concluded there was no separate expenditure which could be characterized as excessive or unreasonable under s. 40A(2)(a).
Because the court accepted the Tribunal's factual conclusions that no expenditure had been incurred in the relevant sense, it held that it was unnecessary to examine further doctrinal issues such as the commission/rebate analysis in Harihar Cotton Pressing Factory.
Holding and Implications
The question referred to this court in each of the years is answered in the negative and against the revenue.
Implications:
- The provisions of s. 40A(2)(a) were held not to be applicable to the discounts in question because, on the Tribunal's findings, there was no expenditure paid out by the assessee that could be disallowed under that provision.
- The assessee's position as accepted by the Tribunal and the AAC was sustained; the revenue's challenge failed.
- The assessee was awarded costs (counsel's fee Rs. 500 and one set). The opinion does not purport to lay down any broader new precedent beyond applying the cited authorities to the facts; its effect is the direct resolution of the disputes between the parties in favour of the assessee.
Sethuraman, J.:— The questions referred in both these cases are identical and runs as follows:
“Whether, on the facts and in the circumstances of the case, the provisions of section 40A of the Income-tax Act, 1961, can be invoked to add back the discount allowed by the assessee to M/s. Somasundaram and Brothers?”
2. It is enough if we set out the facts relating to T.C No. 28 of 1976 as in the relevant appellate order giving rise to the other reference, the Tribunal merely followed the appellate order annexed in T.C No. 28 of 1976.
3. The assessee is a registered firm carrying on the business of manufacture and sale of silk cloth at Arni. There were five partners in this firm, namely, (i) Thiagarajan, (ii) Jagadeesan, (iii) Balasundaram, (iv) Alagesan and (v) Smt. Pattammal, each having an equal share. The first four are bothers and Smt. Pattammal is their mother. There was another firm known as M/s. Somasundaram and Brothers at Ami consisting of Alagesan, one of the partners of the assessee-firm, one Manivannan and five minor sons of Jagadeesan, Thiagarajan and Balasundaram. The minors have been admitted to the benefits of the partnership. The assessee-firm had a substantial turnover in the sales of silk sarees. One of its customers was Somasundaram and Brothers. In the bills raised on Somasundaram & Brothers, the purchasing firm, after setting out the sale price, a discount of 6% was given and the actual price payable was only the net amount. This net amount was carried over to the sales account. As the sales account showed only the net figure, the total amount of discount in the several bills raised on Somasundaram & Brothers did not find a place either in the trading account or in the profit and loss account of the assessee-firm.
4. In completing the assessment of the assessee-firm for the assessment year 1971-72, the year relevant for T.C No. 28 of 1976, the ITO considered that the sum of Rs. 34,546 was the discount allowed to Somasundaram & Brothers and that it should be disallowed because of the close connection between the partners of the assessee-firm and the partners of the other firm. The assessee-claimed that by reason of the sale made to Somasundaram & Brothers it was able to effect savings on show room, salesmen's salary, etc. This claim was not accepted by the ITO. He found that there were savings only to the extent of Rs. 1,800 as a result of the sales to Somasundaram & Brothers as against the discount of Rs. 34,546. The assessee appealed to the AAC. He found that: the sales to Somasundaram & Brothers were to the tune of more than Rs. 5 lakhs, that the rebate given to the firm was only a little higher than what; had been granted to Others and that the time for clearing the bills Was also a little larger in this case than in the other cases. The Assistant Commissioner was of the opinion that considering the off-take by Somasundaram & Brothers, even the rebate of 9% could not be described as unreasonable or excessive. He, therefore, directed the allowance of the claim made by the assessee. The Tribunal on appeal at the instance of the ITO came to the conclusion that the assessee was charged only on the basis of the net price realised from Somasundaram & Brothers and that the assumption that the entire sale proceeds were taxable subject to an allowance by way of a deduction of the discount was incorrect. It was, therefore, held that the provisions of s. 40A did not at all come into the picture in such a case. The result was that the order of the AAC was confirmed. It is this order which has given rise to the question extracted above. As mentioned already, the facts relating to the assessment year 1972-73, relevant to T.C No. 397 of 1976 are identical and do not need to be reproduced here.
5. Sub-section (2)(a) of s. 40A is the provision invoked here which runs as follows:
“Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Income-tax Officer is of opinion that such expenditure 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 legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction:……”
6. Clause (b) of s. 40A(2) refers to dealings between a firm and a partner, etc., and in respect of such dealings, the application of s. 40A(2)(a) would have to be considered. In the present case, having regard to the constitution of the two firms, it is clear that there is some kind of connection between the two firms and the partners of the assessee-firm are closely related to the partners of the other firm. Therefore, we can take it that s. 40A(2)(b) would apply here.
7. Section 40A(2)(a) contemplates an assessee incurring any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of s. 40A(2). If there were any such expenditure, and if the ITO was of opinion that such expenditure was excessive or unreasonable, then so much of the expenditure as was considered by him as excessive or unreasonable was not to be allowed as deduction. We have, therefore, to consider whether there was any expenditure in the present case. It is in this context that we have to refer to the findings of the Appellate Tribunal in its order.
8. In para. 7 of its order, the Tribunal has stated:
“What happened actually was that the assessee sold the goods to Somasundaram and Brothers at a discount. This means that so far as the sales to Somasundaram & Brothers were concerned, the assessee charged a lower sale rate in effect.”
9. Again, in para. 8, the Tribunal found:
“The present case is one where a certain portion of the normal sale price is given up, there is nothing which is paid out or away by the assessee from the sale price or the income that had accrued to it.”
10. The Tribunal has also referred to a decision of this court in Sri Ramalinga Choodambikai Mills Ltd. v. CIT, [1955] 28 ITR 952. In that case it was pointed out that in the absence of evidence to show that either the sales were sham transactions or that the market prices were in fact not paid by the purchasers, the mere fact that the goods were sold at a concessional rate to benefit the purchasers at the expense of the company would not entitle the income-tax department to assess the difference between the market price and the price paid by the purchasers as profit of the seller. The Tribunal has pointed out that that was exactly what happened in the present case. In other words, the Tribunal's finding on the facts was that the assessee had charged only the net price and that there was no discount or rebate given to the purchasers. The bona fides of the transaction are not in dispute. In these circumstances and in view of the finding of the Tribunal as to what happened between the seller and the purchaser in the present case, it has to be held that there was no expenditure which could be disallowed by reference to s. 40A(2)(a). In this view, it is unnecessary to go into the concept of commission or rebate discussed in Harihar Cotton Pressing Factory v. CIT, [1960] 39 ITR 594 (Bom). The result is that the question referred to this court in each of the years is answered in the negative and against the revenue. The assessee will be entitled to its costs. Counsel's fee Rs. 500 one set.
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