No disallowance u/s 40A(2)(b) when payees assessed at maximum rate. Excessive directors remuneration disallowance quashed

In a recent judgment, Ahmedabad ITAT quashed disallowance for excessive directors remuneration stating that section 40A(2)(b) disallowance is not to be invoked when the payees already stand assessed at maximum rate.

Case law Details:
ITA 857/Ahd/2012 Assessment year 2008-09 
ACIT vs. M/s. Patel Alloy Steel Pvt. Ltd
Date of Judgment/Order: 08/04/2016

Brief facts of the Case:
In this appeal, the assessee’s challenged the CIT(Appeals) order partly confirming section 40A(2)(b) disallowance from Rs. 3,21,96,765/- to Rs. 1,81,24,570/- for remuneration paid to directors.

During the course of the scrutiny proceedings, the Assessing Officer (AO) found that the assessee company had paid following remuneration to its managing director, director and executive director having experience of 36, 14 and 7 years as under:-

Designation 2007-08 2006-07 2005-06 2004-05 2003-04
Managing Director 40031600 32565315 30000000 20921780 9497449
Director 1800000 1800000 1800000 1800000 1342697
Executive Director 6001570 5746575 450000

 The AO sought explanation on extra-ordinary increase in first and third remuneration. The AO observed that the remunerations had been enhanced @ 421% and 133% from assessment year 2004-05 to 2008-09 without any qualitative improvement in payees’ eligibility and their services rendered. He proceeded on inflation benchmark @ 10% each year since assessment year 2004-05 and arrived at appropriate salary figures and disallowed gross sum of Rs. 3,21,96,741/- u/s. 40A(2)(b).

CIT(A) also upheld the disallowance holding that excessive directors remuneration can always be disallowed as per the provisions of section 40A(2). However he partly allowed the appellant’s claim by giving a relief of Rs. 1,40,99,171/-. 

Assessee’s Contention:

The assessee contended that there was no dispute about genuineness of the impugned remunerations. except the excessiveness element. It was submitted that director had already paid taxes on the remuneration at the maximum marginal rate. Further the assessee explained that the benchmarking was drawn w.e.f. financial year 2003-04 and not from preceding assessment year and that no comparable instance had been quoted as well in the lower order except following inflation rate @ 10% .

Excerpts from ITAT Judgment:

………. There is no dispute that the Assessing Officer has compared the impugned remuneration with that paid in FY 2003-04. He gives annual 10% increase. We find this approach to be entirely unsustainable. Assessee’s remunerations in preceding assessment years already stand accepted. There is no justification to draw the clock back to financial year 2003-04 in such a case. We further do not notice comparison of the impugned remuneration vis-a-vis market rate either in assessment or in the lower appellate order so as to point out any excessiveness element. Hon’ble jurisdictional high court in its decision hereinabove has already held that section 40A(2)(b) disallowance is not to be invoked when the payees already stand assessed at maximum rate. The Central Board of Direct Taxes has also issued a circular on 06-07-1968 directing the assessing authority not to invoke the impugned disallowance in absence of any tax evasion being noticed. We quote all this reasoning for accepting assessee’s arguments against the impugned section 40A(2)(b) disallowance. 

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