In considering disallowance u/s 40A(2) genuineness of expenditure not relevant issue

In considering disallowance u/s 40A(2) for payments to specified persons, genuineness of expenditure is not a relevant issue.

In a recent judgment, ITAT Lucknow has held that when a disallowance u/s 40A(2) of towards payments made to specified persons is under consideration, the genuineness of the expenditure is not a relevant issue.

ABCAUS Case Law Citation:
5009 (2026) (01) abcaus.in ITAT

In the instant case, the assessee had challenged the order passed by the CIT(A) in inter alia confirming disallowance u/s 40A(2)(b) of the Income Tax Act, 1961 (the Act)   towards salary paid by the assessee to relatives as persons specified u/s 40A(2)(b) of the Act.

The appellant was an individual and engaged in the business of trading of gold and diamond ornaments. A  partial disallowance of salary paid to relatives specified u/s 40A(2)(b) of the Act had been made by the Assessing Officer, whereas partly the claim had been allowed.

Before the Tribunal the assessee submitted that the AO had disallowed salary by estimate paid to five family members persons holding that total salary of 38 lacs paid to said five family members were excessive and estimating that Rs. 3 lacs per person per year was reasonable.

It was submitted that AO had not given any comparable cases of market. Also, the AO had not doubted the services rendered by them and bonafide payment of salary expenses.

It was submitted that it is an accepted practice that the jewellery business is run by family members themselves and salary is paid in the form of remuneration for their work in the business.

With respect to each family member / relative, the assessee submitted that all family members have skills in the jewellery business, were regular income tax payer and regular employee and they have also introduced interest free capital.

It was submitted that the remuneration had link with the turnover / profit of the entity. The AO had not issued any show cause notice. He himself raised the query and draws the question without any investigation or opportunity of being heard. Also, the AO had not disputed the rendering of services of the employees.

It was also argued that Madras High Court had held that matter of commercial expediency should be left to the business concern.

It was also the contention of the assessee that the recipients were identified and payment of salary to relatives was also taxed in their hands they assessed in higher bracket of tax slab. The disallowance was purely based on surmises and conjuncture. The AO had not brought any material on record, any cognizance basis as to why the business expenditure was disallowed. It was not the case that the expenditure was considered as bogus. It was an estimation without any basis. No such disallowance had been made in preceding year.

It was also submitted that assessee was doing business in his all segments and this was undisputed fact, which was not possible without services of employee. Once the services are undisputed remuneration cannot be disallowed. In the light of decision of Hon’ble Supreme Court where it was held that onus is on the revenue to prove that the expenditure incurred by the business man is unreasonable then the provision of section 40A(2)(b) can be applied.

The assessee also relied upon judgment wherein it was held that that AO had to record it is finding as to whether the expenditure is excessive or unreasonable on the basis of three basic requirement/section (like a fair market price of the goods, services for which the payment is made, legitimate need of business and benefit derived to the assessee on receipt of services,) In the instant case this exercise was missing and the disallowances made purely on the basis of assumption and presumption which was unjustified.

The Tribunal opined that when a disallowance u/s 40A(2) of the Act is under consideration, the genuineness of the expenditure is not a relevant issue. In the instant case, the genuineness was accepted by Revenue and only the quantum of expenditure was disputed.

Further, the Tribunal observed that whether one or more of the recipients is paying tax at a high rate, or even at the highest rate, was also not decisive. Under section 40A(2) of the Act, typically the whole amount of claim is not disallowed. The claim is partly disallowed, because the claim of payments made to relatives specified u/s 40A(2)(b) of the Act is found to be excessive or unreasonable having regard to fair market value or the legitimate needs.

The Tribunal observed that after examination of the facts and circumstances, the CIT(A) confirmed the action of the Assessing Officer. No material was brought to persuade that the amount allowed by the Assessing Officer was insufficient or inadequate, having regard to fair market, value, or legitimate needs of assessee’s business; having regard to facts and circumstances of the case.

Accordingly, disallowance made u/s 40A(2) of the Act is confirmed.

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