[Opinion] AO Cannot Casually Disallow Payments to Relatives

Meenakshi Subramaniam – [2023] 156 taxmann.com 538 (Article)

Income Tax Officer:

” You have appointed a relative, who has no qualifications. I will add his income as being excessive and unreasonable under Section 40A clauses of Income Tax Act, at once.”

Assessee:

“Sir, we had advertised for a person, who has imagination. My brother-in-law said he could imagine a lot of things like that he is an IIM graduate, has 9 years experience and could manage finances very well.”

Recently, in Mehra Jewel Palace v. Pr. CIT [2023] 155 taxmann.com 270 the Delhi High Court brought forth a very important remark that the AO must not straightway disallow payments to relatives but form a opinion, as statute says so.

[2023] 155 taxmann.com 270 (Delhi High Court)
Mehra Jewel Palace (P.) Ltd
v.
Pr. Commissioner of income tax

The solitary substantial question of law arising in the present appeal is whether the Income Tax Appellate Tribunal had rightly upheld the disallowance of salary by the Assessing Officer (AO) by taking recourse to Section 40A(2)(b) of the Income Tax Act?

The only aspect is the substantial question of law framed for consideration by the Court

Whether the Tribunal erred in not appreciating that before the Assessing Officer could have taken recourse to the provisions of Section 40A(2)(b) of the Act, he ought to have given an opportunity to the appellant/assessee to produce the relevant evidence?

The Learned counsel for appellant/assessee contended that the orders impugned in these appeals are not sustainable in the eyes of law because the appellant had described in detail circumstances under which no salary was paid to the persons concerned i.e. Shri Charanjeet Lal Mehra, Smt. Lata Rani Mehra, Smt. Namita Mehra and Ms. Sakshi Mehra in Financial Years 2008-09 and 2009-10 as well as circumstances under which a meagre salary was paid to them for subsequent years.

The judge said that in an effort to justify the payment of salary to the persons concerned, learned counsel for appellant/assessee took the bench through the detailed profile of the said persons including their educational qualifications, experience and job contribution in the business of the assessee company.

Submission of the assessee

Shri Chand Mehra has a BA (Economics) from Claremont McKenna College, California, which is ranked # 6 among the liberal arts colleges in United States. He further has a MBA from Peter F. Drucker School of Management, Claremont.. Shri Chand Mehra did a lot of work for the Company, provided assistance in handling disputes, negotiations with banks, etc.

For, Chand Mehra, the salary advance increased from Rs 9,95,907.60 as on 31.3.2010 to Rs 18,94,492.60 as on 31.3.2011. An increase of Rs 8,98,585/-.

The income tax department said, ‘Leave alone the benefit to the assessee because of Mr Chand Mehra, the assessee failed to prove with evidence any services at all rendered by Mr. Chand Mehra to the assessee.

Smt. Namita Mehra was an employee of the Company and the Company was duly paying her salary. In previous years, she was extended an advance against her salary. However, as the Company ran into losses owing to global financial crisis, it could not afford her a salary: The amount continued to be shown as an advance.

For Namita Mehra, the sum of Rs 6,94,914/-.is the amount of advance, which is the same as on 31.3.2010 and there has not been any increase.

This is treated as advance for business purpose and assessee’s contention is accepted.

Smt. Sakshi Mehra was given an advance against salary; and the said amount was being paid back gradually.

For, Sakshi Mehra the amount decreased from Rs5,39,449/- as on 31.3.2010, i.e. a decrease of Rs 2,88,650/-.

This is also treated as advance for salary purpose and assessee’s contention is accepted.

Shri Vinay Mehra has a B. Com (Hons) degree from Sri Ram College of Commerce, Delhi University and the Company consulted on matter pertaining to commerce, trade, finance, etc.

For Vinay Mehra the amount has increased from Rs 5,40,237.30 as on 31.3.2010, i.e. an increase of Rs. 6,31,628/-.

The assessee failed to prove with evidence whether any services at all were rendered by Mr. Vinay Mehara. Hence these advances are treated diversion of business funds and interest disallowance is also upheld on this ground.

In all the above cases, AO was directed to calculate the disallowance of interest only for the period concerned, which relates to diversion of business funds.

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