AO Must Form Opinion As To What Would Be Fair Payment Outgo For Services Rendered Before Recording Disallowance U/s. 40A(2)(A) IT Act: Delhi HC

While deciding on the central issue as to whether the Income Tax Appellate Tribunal (ITAT) had rightly upheld the disallowance of salary made by the Assessing Officer (AO) under Section 40A(2)(b) of the Income Tax Act, 1961, the Delhi High Court has remanded an income tax case back to the AO directing him to provide the taxpayer (Mehra Jewel Palace) with a fair opportunity to present evidence to substantiate their claims regarding the salary paid to family members.

The Division Bench comprising of Justice Rajiv Shakdher and Justice Girish Kathpalia observed that “The provision under Section 40A(2)(a) of the Act, as extracted above, clearly shows that before recording disallowance, the Assessing Officer has to form an opinion; and that opinion has to be having regard to inter alia legitimate needs of the business or benefit derived or even what would be the fair payment outgo for services rendered. Such an opinion cannot be arrived at without adducing necessary evidence. That being so, the Assessing Officer was duty bound to provide an opportunity to the appellant/assessee to place on record the requisite evidence to justify its claim. But all that the Assessing Officer did was to ask the appellant/assessee to justify the salaries paid, and without seeking relevant evidence, simply rejected claim”.

Senior Advocate Salil Aggarwal appeared for the Appellant, whereas Advocate Sunil Agarwal appeared for the Respondent.

The counsel for the appellant/assessee had contended that the orders under appeal were not sustainable in the eyes of the law because the appellant had described in detail the circumstances under which no salary was paid to the individuals in question during the Financial Years 2008-09 and 2009-10. They also explained the circumstances under which nominal salaries were paid to them in subsequent years relevant to the present case. On the other hand, the counsel for the respondent/revenue supported the impugned orders and argued that, since the appellant/assessee had failed to produce any corroborating evidence to support their contentions, there was no illegality in the impugned orders.

After considering the submission, the Bench observed that there was no dispute that the individuals fell within the purview of Section 40A(2)(b), and as per the records, the appellant/assessee was not afforded a fair opportunity to present evidence to substantiate their reasons for paying salaries to these individuals.

The Bench clarified that the ITAT in the impugned orders had merely recorded the CIT(A)'s findings and concurred with them without providing additional or independent arguments or findings.

The Bench further observed that the AO had a duty to provide the appellant/assessee with an opportunity to submit the necessary evidence to substantiate its claims. However, all the AO did was ask the appellant/assessee to justify the salaries paid, and without requesting relevant evidence, simply dismissed the claim, added the Bench.

Resultantly, the Bench decided that the most appropriate course of action would be to provide the appellant/assessee with an opportunity to present relevant evidence, whether in the form of documents or otherwise, before the AO.

Such evidence should be aimed at substantiating the appellant/assessee's claims regarding the educational qualifications, experience, work profiles, and, most importantly, the duties performed by the individuals in question, added the Bench.

Consequently, the High Court set aside the orders and remanded it back to the AO with liberty to the assessee to adduce additional evidence.

Cause Title: Mehra Jewel Palace Pvt. Ltd. v. Pr. Commissioner of Income Tax [Neutral Citation: 2023: DHC: 7467-DB]

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