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Carmel Softech (P) Ltd. v. Cit

Income Tax Appellate Tribunal

May 18, 2022

Judgment

Subsequent
References

CaseIQ

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Summary of Opinion: Carmel Softech Pvt. Ltd. v. ITO (ITA No. 724/CHNY/2018) — ITAT 'D' Bench, Chennai (dated 18.05.2022)

Factual and Procedural Background

The appeal arises from the order of the Commissioner of Income Tax (Appeals)-3, Chennai in ITA No.49/2015-16/A-1 dated 29.12.2017, challenging the assessment framed by the Income Tax Officer, Corporate Ward 1(3), Chennai for Assessment Year 2012-13 under section 143(3) of the Income Tax Act, 1961 by order dated 25.03.2015.

The Assessing Officer (AO) observed that the assessee, Carmel Softech Pvt. Ltd., a resident domestic company engaged in software development and engineering designs, paid directors' remuneration aggregating Rs.75,07,380/-, which represented a large portion of the declared net profit of Rs.84,40,020/- (turnover Rs.1,42,13,393/-). The AO applied principles derived from the Companies Act (Schedule XIV and section 198 as understood by the AO) and restricted allowable directors' remuneration to Rs.16,88,004/- (treated as 20% of net profit), disallowing the balance of Rs.58,19,376/-.

The Commissioner (Appeals) confirmed the AO's disallowance on identical grounds, invoking section 40A(2)(b) of the Income Tax Act and reliance on managerial remuneration principles applicable under the Companies Act. The assessee appealed to the Income Tax Appellate Tribunal (ITAT), which heard the matter and pronounced the order on 18th May 2022.

Legal Issues Presented

Whether the directors' remuneration of Rs.75,07,380/- paid by the assessee is excessive and, therefore, liable to be disallowed in part (Rs.58,19,376/-) by applying section 40A(2)(b) of the Income Tax Act?
Whether principles or limits derived from section 198 and Schedule XIV of the Companies Act (as applied by the AO/CIT(A)) are applicable to the assessee (a private limited company) for the purpose of determining allowable directors' remuneration for income tax assessment?
Whether the AO/CIT(A) fulfilled the evidentiary and analytical requirement to demonstrate that the payments to directors were unreasonable or excessive having regard to market rates, business needs or benefit derived by the assessee?

Arguments of the Parties

Appellant's (Assessee's) Arguments

The assessee paid three directors Rs.25,02,460/- each (total Rs.75,07,380/-) who were actively involved in the affairs and day-to-day business of the company.
The AO and CIT(A) wrongly invoked section 40A(2)(b) and relied on section 198 of the Companies Act; section 198 (and Schedule XIII/XIV principles invoked) applies to public limited companies and only in circumstances such as inadequacy of profits — it does not apply to a private limited company unless it is a subsidiary of a public company. The assessee is a private limited company and not such a subsidiary.
The directors had included the remuneration in their individual income-tax returns and paid tax at the maximum marginal rate; therefore, there is no revenue loss to the Department.
The assessee relied on Tribunal precedents (Benninger India Pvt. Ltd. and The Bombay Samachar Pvt. Ltd.) to support that such payments are allowable where no material shows excessiveness or tax-avoidance intent.

Respondent's (Revenue's) Arguments

The Assessing Officer and CIT(A) relied on the Companies Act limits (Schedule XIV/section 198) and section 40A(2)(b) of the Income Tax Act to restrict and disallow excess directors' remuneration.
The Senior Departmental Representative emphasized that in earlier year(s), when profits and turnover were higher, these three directors did not receive similar remunerations; the turnover and profits decreased in the relevant year, suggesting the payments were not commensurate with business performance. On this basis, the AO/CIT(A)'s disallowance should be confirmed.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Benninger India Private Limited vs. DCIT, ITA No.2360/Mum/2017 (Mumbai Bench), order dated 28.09.2018	Applied to hold that managerial remuneration can be reasonable and allowable where there is no tax evasion and managerial remuneration is justified by facts; approval requirement (for higher remuneration) not necessary for unlisted companies in the same manner.	The assessee relied on this decision to support that remuneration paid to directors was reasonable and allowable. The Tribunal recorded the decision and considered it among authorities supporting the assessee's case.
The Bombay Samachar Pvt. Ltd. vs. ACIT, ITA No.7171/Mum/2010 & others (Mumbai Bench), order dated 24.10.2018	Held that invoking section 40A(2)(a)/(b) requires material by AO to demonstrate that payment is excessive or unreasonable with reference to market rates, business needs or benefit derived; where no such material exists and directors have offered remuneration to tax, the disallowance is unsustainable.	The Tribunal relied on this authority as directly applicable. It found that the AO did not bring material to demonstrate excessiveness/unreasonableness and that directors had taxed the remuneration; applying the same reasoning, the Tribunal reversed the lower authorities' disallowance.

Court's Reasoning and Analysis

The Tribunal heard rival submissions and examined the record and relevant precedents. Its reasoning proceeded in the following steps, based strictly on the material and arguments recorded in the opinion:

Identification of evidentiary gap: The Tribunal noted that the AO had not carried out any specific exercise or brought material on record to demonstrate that the directors' remuneration paid by the assessee was excessive or unreasonable. The Tribunal emphasized that to invoke section 40A(2)(b), the AO must show excessiveness with reference to market rates, business needs, or benefit derived.
Reliance on Tribunal precedent: The Tribunal referred to the decision in The Bombay Samachar (Mumbai Bench) which elaborated that an AO must demonstrate reasonableness or excessiveness through material; in absence thereof, disallowances under section 40A(2) are unsustainable. The Tribunal treated that decision as persuasive and directly relevant.
Examination of factual markers: The Tribunal summarized the key facts from the assessment record — turnover of Rs.1,42,13,393/-, declared profit of Rs.84,40,020/-, directors' remuneration paid Rs.75,07,380/-, and that the directors had offered the remuneration for taxation individually and paid tax at the maximum marginal rate — and observed there was no showing of revenue loss to the Department.
Application of principle to facts: Given the absence of any finding or material by the AO demonstrating that payments were excessive or unreasonable, and considering that the directors were assessed and taxed individually, the Tribunal concluded that the statutory test for disallowance under section 40A(2) and the AO's use of Companies Act limits were not properly applied or supported by evidence in this case.
Conclusion: On that basis, and after considering the precedents relied upon by the assessee, the Tribunal reversed the orders of the AO and CIT(A) and allowed the appeal.

Holding and Implications

APPEAL ALLOWED.

Direct effect on the parties:

The Tribunal reversed the disallowance of Rs.58,19,376/- made by the AO and confirmed by the CIT(A), thereby allowing the full directors' remuneration of Rs.75,07,380/- as an allowable expense for Assessment Year 2012-13 in the assessee's hands.
The Tribunal's decision relied on the absence of material to show excessiveness/unreasonableness and the fact that the directors had declared and paid tax on the remuneration — matters which the Tribunal found significant in concluding there was no revenue loss or tax-avoidance motive shown by the AO.

Broader implications:

The opinion does not purport to lay down a new legal principle; it applied existing Tribunal precedents (as cited) and emphasized the evidentiary requirement on the AO when invoking section 40A(2). The decision is confined to the facts of the case and the direct consequence is reversal of the disallowance for the assessment year under consideration.

Court and Order Details: ITAT 'D' Bench, Chennai; Members: Shri Mahavir Singh (Vice President) and Shri Manoj Kumar Aggarwal (Accountant Member); Order pronounced on 18th May 2022. Appeal by Carmel Softech Pvt. Ltd. against ITO, Corporate Ward 1(3), Chennai; Assessment Year 2012-13; ITA No. 724/CHNY/2018.

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आयकर अपीलीय अिधकरण, 'डी' यायपीठ, चे ई

IN THE INCOME TAX APPELLATE TRIBUNAL

'D' BENCH, CHENNAI

ी महावीर सहं, उपा य एवं ी मनोज कुमार अ वाल, लेखा सद य के सम

BEFORE SHRI MAHAVIR SINGH, VICE PRESIDENTAND

SHRI MANOJ KUMAR AGGARWAL, ACCOUNTANT MEMBER

आयकर अपील सं./ITA No.: 724/CHNY/2018 िनधारण वष /Assessment Year:2012-13 Carmel Softech Pvt. Ltd., The Income Tax Officer, Plot No.1050, 2^nd Floor, v. Corporate Ward 1(3), I Block, 18^th Main Road, Chennai.

Anna Nagar West,

Chennai - 600 040.

PAN: AABCC 5177A

(अपीलाथ /Appellant) ( यथ /Respondent) अपीलाथ क ओर से/Appellant by : Shri D. Anand, Advocate यथ क ओर से/Respondent by : Shri G. Johnson, Addl.CIT सनुवाई क तार ख/Date of Hearing : 12.05.2022 घोषणा क तार ख/Date of Pronouncement : 18.05.2022

आदेश /O R D E R

PER MAHAVIR SINGH, VP:

This appeal by the assessee is arising out of the order of Commissioner of Income Tax (Appeals)-3, Chennai in ITA No.49/2015-16/A-1 dated 29.12.2017. The assessment was framed by the ITO, Corporate Ward 1(3), Chennai for the assessment year

2012-13 u/s.143(3) of the Income Tax Act, 1961 (hereinafter the 'Act') vide order dated 25.03.2015.

2. The only issue in this appeal of assessee is as regards to the order of CIT(A) and that of the AO in holding that the directors remuneration is excessive and thereby disallowing excess directors remuneration amounting to Rs.58,19,376/-. For this, assessee has raised various grounds which are argumentative and hence need not be reproduced.

3. Brief facts are that the assessee is a resident domestic company involved in software development and engineering designs. During the course of assessment proceedings, the AO required the assessee to reconcile the income declared in profit & loss account and the amount credited as per Form No.26AS. The AO noted that the assessee company has paid a sum of Rs.75,07,380/- towards directors remuneration and that is to the extent of 80% of the net profit. The AO noted that the directors remuneration are to the extent of Rs.75,07,380/- as against the net profit declared at Rs.84,40,020/-. The assessee's turnover is at Rs.1,42,13,393/-. The AO also brought out a comparative remuneration of last year which is 'nil' as against the profit of

Rs.1,28,55,033/- on a total turnover of Rs.1,85,54,513/-. The AO taking help of Companies Act, 1956, Schedule XIV which prescribes maximum remuneration payable to the directors i.e., managerial personnels which cannot exceed 11% of net profit, restricted the allowance of remuneration at 20% of the net profit that comes to Rs.16,88,004/- and disallowed the differential amount of Rs.58,19,376/-. The CIT(A) also confirmed the action of AO exactly on identical ground that the AO has rightly adopted remuneration fixed for managerial of the company fixed for public limited companies as per the Companies Act and that should be taken as the base for private limited companies also. The CIT(A) also invoked the provisions of Section 40A(2)(b) of the Act. Aggrieved, assessee came in appeal before the Tribunal.

4. Before us, the ld.counsel for the assessee stated that the assessee has made payment to three directors of Rs.25,02,460/- each and the total comes to Rs.75,07,380/-, who are actively involved in the affairs of the company. The AO and CIT(A) firstly have wrongly invoked the provisions of section 40A(2)(b) of the Act on the ground that only 20% of the net profit is allowable as expenditure and further, drawing inference from the provisions of section 198 of the Companies Act, which is applicable only to the

public limited companies. The ld.counsel for the assessee referred to the provisions of section 198(1) of the Companies Act. The ld.counsel stated that the provision is applicable in the event of inadequacy of profits and only then remunerations paid to directors by Schedule XIII of the Companies Act, will apply and the provisions of section 198 of the Companies Act has laid down the manner in section 349 & 350 of the Companies Act for computation of net profit. The ld.counsel stated that the above provision will not apply to a private limited company unless it is a subsidiary of a public limited company. The ld.counsel contended that the assessee is a private limited company and it is not subsidiary of any public limited company. Further, it was contended that all the three directors are tax assessees and have included the remuneration in the respective returns of income filed by them and paid the taxes at the maximum margin and hence, there is no revenue loss to the Department. The ld.counsel for the assessee also stated that these three directors are main directors and they are actively participating in the day to day business of the company. The ld.counsel also relied on the decision of Mumbai Bench of this Tribunal in the case of Benninger India Private Limited vs. DCIT in ITA No.2360/Mum/2017, order dated 28.09.2018, wherein the Tribunal after considering the facts of the case held as under:-

"9. After hearing rival contentions and going through the facts and circumstances of the case narrated in detail above, we are of the view that there is no tax evasion and there is reasonableness of managerial remuneration. Now no approval is required from the Central Government for making payment of higher remuneration even in case of loss in the case of unlisted public company. In view of these facts, we are of the view that this is allowable expenditure and we allow the same accordingly. Orders of the lower authorities are reversed and this issue of assessee's appeal is allowed."

4.1 The ld.counsel also relied on another decision of the Mumbai Bench of the Tribunal in the case of The Bombay Samachar Pvt. Ltd., vs. ACIT in ITA No.7171/Mum/2010 & others, order dated 24.10.2018 and the relevant findings in para 8 reads as under:-

"8…………. Further, while invoking the provisions of section 40A(2)(a) of the Act, the Assessing Officer must bring material on record to demonstrate that the payment made by the assessee is excessive or unreasonable having regard to the market rate for the goods, services, facilities availed or the business needs of the assessee or commensurate with the benefit derived by the assessee. On scanning through the assessment order passed for the impugned assessment year, we do not find any material brought on record by the Assessing Officer to demonstrate that the payment made by the assessee is excessive and unreasonable having regard to the market rate or business needs or benefit derived by the assessee. As could be seen, the Assessing Officer by simply taking the remuneration paid in assessment year 2003-04 as a base has determined the reasonable remuneration payable to directors. This, in our view, is purely on estimate basis without having any relevance to the actual facts on record including the fact that in the immediately preceding assessment year the assessee has not only paid remuneration of Rs.1.56 crore to the concerned directors but the Assessing Officer has also allowed such payment in scrutiny assessment. As regards the observations of the Assessing Officer that to avoid the mischief of section 2(22)(e) of the Act, the assessee has camouflaged loan / advances to the directors as remuneration, we do not find any substance in such allegation. Undisputedly, the assessee had been paying remuneration to the

concerned directors from past several years. Moreover, from the shareholding pattern of the company, it appears that the total share holding of the aforesaid three directors combined together constitutes only 15%. Therefore, it cannot be said that for escaping the rigors of section 2(22)(e) of the Act the assessee has paid remuneration to the directors. The object behind introduction of section 40A(2) of the Act is for preventing evasion of tax through shifting of profit by making payment to related parties. Therefore, it is of paramount importance to examine whether the assessee has made payment for evading tax through shifting of profit. In the facts of the present case, it is evident that the assessee had been showing loss continuously for past several years and the Assessing Officer has also accepted loss shown by the assessee. That being the case, there cannot be any intention on the part of the assessee to evade tax by shifting profit. It is equally important to note that the remuneration paid to the directors have been offered by them to tax while filing their individual tax returns for the respective assessment years. This fact is evident from the copies of the income tax returns of the concerned directors filed before us by the learned Sr. Counsel. It is also not disputed that the concerned directors are assessed to tax at the maximum rate of 30%. In the aforesaid facts and circumstances, we are of the considered view that the provisions of section 40A(2) of the Act are not attracted to the payment made to the directors. The decisions relied upon by the learned Sr. Counsel also support our aforesaid view. Whereas, the decisions cited by the learned Departmental Representative are factually distinguishable. Thus, on overall consideration of facts and circumstances of the case, we are of the view that the disallowance made under section 40A(2)(a) of the Act in the impugned assessment years are unsustainable. Accordingly, we deleted the disallowances made in all the assessment years under appeal. Grounds raised are allowed."

5. On the other hand, the ld. Senior DR relied on the assessment order and that of the CIT(A) and argued that in earlier year when there was comparatively more profit than this year, no remunerations were paid to these three directors. Even the turnover was more than this year and this year there is decrease in

turnover. According to him, the CIT(A) as well as the AO has rightly invoked the provisions of section 40A(2)(b) of the Act and also the provisions of Companies Act, whereby maximum remuneration payable to managerial personnel is restricted. In these lines, he requested the Bench to confirm the order of CIT(A).

6. We have heard rival contentions and gone through facts and circumstances of the case. We noted that the Tribunal in the case of The Bombay Samachar Pvt. Ltd., supra, has considered the issue of applicability of provisions of section 40A(2)(b) of the Act to the directors remuneration and held that this provision will not apply to the directors payment for holding that the payment is excessive or unreasonable in the absence of any material brought on record to demonstrate that the payment is actually excessive or unreasonable having regard to market rate for the goods, services or facilities availed or the business need of the assessee or commensurate with the benefit derived by the assessee. In the present case before us also the AO has not carried out any exercise for holding the payment of remuneration to the directors that the same is unreasonable or not in consonance with the payment of directors or remuneration. We note that in this year the turnover is at Rs.1,42,13,393/- and profit earned is at Rs.84,40,020/- and

remuneration paid to these three directors are at Rs.75,07,380/-. Even it is accepted position that the directors have paid taxes on these remunerations on maximum margin rate and there is no revenue loss to the Department. In view of the above, we are of the view that in the absence of any findings by the AO that the directors remunerations are excessive and unreasonable, we reverse the orders of lower authorities and allow the appeal of assessee.

7. In the result, the appeal filed by the assessee is allowed. Order pronounced in the court on 18^th May, 2022 at Chennai. Sd/- Sd/-

(मनोज कुमार अ वाल) (महावीर सह )

(MANOJ KUMAR AGGARWAL) (MAHAVIR SINGH)

लखे ा सद य /ACCOUNTANT MEMBER उपा य /VICE PRESIDENT चे ई/Chennai,

दनांक/Dated, the 18^th May, 2022

RSR

आदेश क ितिलिप अ ेिषत/Copy to:

1. अपीलाथ /Appellant 2. यथ /Respondent 3. आयकर आयु (अपील)/CIT(A)

4. आयकर आयु /CIT 5. िवभागीय ितिनिध/DR 6. गाड फाईल/GF.