The ACIT, Circle-5, RAJKOT-GUJARAT V. Shri Jayesh Raichand Shah, RAJKOT-GUJARAT

ITA 445/RJT/2011

• Counselvise Citation: 44524914 RSA 2011
• Duration Of Justice: 6 month(s) 5 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 22-05-2012
• Appeal Filed By: Department
• Order Result: Partly Allowed
• Bench Allotted: DB
• Next Hearing Date: 03-05-2012
• Assessment Year: 2008-2009
• Appeal Filed On: 16-11-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: ANKUR GARG
• Assessee Lawyers: KALPESH DOSHI
• Keywords: Gross profit estimation; Gift; Non compliance; Commercial expediency
• Section: 143(3); 37(1)

Judgement Text

, IN THE INCOME TAX APPELLATE TRIBULAL; RAJKOT BENCH, RAJKOT . .. . . . . . , , , , . .. . . . . . , , , , $ $ $ $ BEFORE SHRI T. K. SHARMA, JM AND SHRI D. K. SRIVAST AVA, AM ITA NO. 445/RJT/2011 / ASSESSMENT YEAR 2008-09 ASSTT.CIT, CIRCLE 5, RAJKOT V. SHRI JAYESH RAICH AND SHAH PROP. OF M/S. R. P. ORNAMENTS SILVER SAND, NR. BHOGANI STREET SONI BAZAR, RAJKOT PAN: AEXPS 2934 L. DATE OF HEARING : 03-05-2012. DATE OF PRONOUNCEMENT : 22-05-2012. REVENUE BY: SHRI ANKUR GARG, D.R ASSESSEE BY: SHRI KALPESH DOSHI, C.A. / // / ORDER . .. . . . . . /D. K. SRIVASTAVA: THE APPEAL FILED BY THE DEPARTM ENT IS DIRECTED AGAINST THE ORDER PASSED BY THE CIT(A) ON 29-09-2011. THE APPEAL RELATES TO ASSESSMENT YEAR 2008-09. 2. THE ASSESSEE IS AN INDIVIDUAL. HE WAS ENGAGED IN THE BUSINESS OF DEALING IN GOLD AND SILVER ORNAMENTS THROUGH HIS PROPRIETARY C ONCERN KNOWN AS M/S. R. P. ORNAMENTS AT SONI BAZAR, RAJKOT DURING THE YEAR UND ER APPEAL. HE FILED HIS RETURN OF INCOME ON 29-09-2008 RETURNING TOTAL INCOME AT RS.1 6,04,107/-. AFTER PROCESSING, THE RETURN WAS TAKEN UP FOR A SCRUTINY AS A RESULT OF WHICH ASSESSMENT U/S 143(3) OF THE INCOME-TAX ACT WAS COMPLETED ON 27-12-2010 ASSE SSING HIS TOTAL INCOME AT RS.1,61,39,361/- AFTER MAKING (I) ADDITION AMOUNTIN G TO RS.1,07,39,574/- ON ACCOUNT OF LOW GROSS PROFIT, (II) DISALLOWANCE OF INTEREST AMOUNTING TO RS.7,46,965/- AND (III) DISALLOWANCE OF SALARY AMOUNTING TO RS.30,48,715/- FOR THE DETAILED REASONS GIVEN IN THE ASSESSMENT ORDER. ON APPEAL, THE LD. CIT(A) HAS DELETED ALL THE AFORESAID ADDITIONS/DISALLOWANCES MADE BY THE AO. AGGRIEVED B Y THE ORDER PASSED BY THE CIT(A), THE DEPARTMENT IS NOW IN APPEAL BEFORE THIS TRIBUNAL. 3. GROUND NO.1 TAKEN BY THE DEPARTMENT READS AS UND ER:- 1. THE LD. CIT(A)-IV, RAJKOT HAS ERRED IN LAW AND ON FACTS IN DELETING THE ADDITION MADE BY THE AO OF RS.1,07,39,574/- ON ACCO UNT OF ESTIMATION OF GROSS PROFIT AT THE RATE OF 18.31% AS AGAINST THE R ATE OF 10.59% SHOWN BY THE ASSESSEE. 4. DURING THE COURSE OF SCRUTINY, THE ASSESSING OFF ICER NOTICED THAT THE GROSS PROFIT RATE DISCLOSED BY THE ASSESSEE WAS 10.59% IN THE YEAR UNDER APPEAL AS AGAINST 20.81% DECLARED BY HIM IN ASSESSMENT YEAR 2 007-08 AND 23.53% IN ASSESSMENT YEAR 2006-07. HE ALSO FOUND THAT THE VOL UME OF TURNOVER SHOWN BY THE 2 ITA 445/RJT/2011 ASSESSEE IN THE YEAR UNDER APPEAL WAS IN THE SAME R ANGE AS SHOWN BY THE ASSESSEE IN THE IMMEDIATELY PRECEDING ASSESSMENT YE AR. HE THEREFORE CALLED UPON THE ASSESSEE TO EXPLAIN THE REASONS FOR LOW RATE OF GROSS PROFIT IN THE YEAR UNDER APPEAL AS COMPARED TO EARLIER YEARS. THE EXPLANATIO N GIVEN BY THE ASSESSEE IN THIS BEHALF WAS CONSIDERED BY THE AO. HE WAS HOWEVER NOT SATISFIED WITH THE EXPLANATION GIVEN BY THE ASSESSEE AND THEREFORE PRO CEEDED TO EXAMINE THE CORRECTNESS AND COMPLETENESS OF THE BOOKS OF ACCOUN T REPORTEDLY MAINTAINED BY THE ASSESSEE. ACCORDING TO THE AO, THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE WERE NEITHER CORRECT NOR COMPLETE IN VIEW OF THE DI SCREPANCIES IN THE CLOSING STOCK. THE AO WORKED OUT AVERAGE RATE OF GROSS PROFIT OF L AST THREE YEARS INCLUDING THE YEAR UNDER APPEAL AT 18.31%. AFTER COMING TO THE CONCLUS ION THAT THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE WERE NEITHER CORRECT NOR COMPLETE, THE AO APPLIED GROSS PROFIT RATE OF 18.31% ON THE TURNOVER DECLARE D BY THE ASSESSEE IN THE YEAR UNDER APPEAL AND RESULTANTLY ADDED A SUM OF RS.1,07 ,39,574/- TO THE INCOME OF THE ASSESSEE. THE RELEVANT OBSERVATIONS MADE BY THE AO IN THIS BEHALF ARE AS UNDER:- 2. THE ASSESSEE IS A WHOLESALER OF GOLD & SILVER O RNAMENTS AND ALSO INVOLVED IN LABOUR JOB WORK OF GOLD & SILVER ORNAME NTS, TRADING IN GOLD AND HEDGING IN METAL ON COMMODITY EXCHANGE. ON PERUSAL OF THE RETURN OF INCOME/THE AUDIT REPORT FILED BY THE ASSESSEE FOR A Y 2008-09 AND THE COMPLIANCE MADE BY THE ASSESSEE DURING THE ASSESSME NT PROCEEDING THE FOLLOWING FEATURES ARE NOTED. 2.1 ANALYSIS OF GP%-THE ANALYSIS OF GP% OF THE LAST 3 Y EARS OF THE ASSESSEE IS AS UNDER: AY GP 2006-07 23.53% 2007-08 20.81% 2008-09 10.59% FROM THE ABOVE CHART IT IS OBSERVED THAT THERE IS DRASTIC FALL IN GP% IN COMPARISON TO THE PREVIOUS AY. THEREFORE THE A.R. O F THE ASSESSEE VIDE ORDER SHEET DATED 09-12-10 WAS ASKED TO EXPLAIN THE REASON FOR DECREASE IN GP%. THE A.R. OF THE ASSESSEE FILED WRITTEN SUBMISS ION ON 16/12/10 EXPLAINING THE REASON FOR FALL IN GP%. THE ABOVE SU BMISSION FILED BY THE ASSESSEE WAS EXAMINED AND OBSERVED THAT THE MAIN RE ASON QUOTED BY THE A.R. OF THE ASSESSEE PERTAINS TO RISE IN THE PRICE OF GOLD. THE A.R. OF THE ASSESSEE HAS ALSO EXPLAINED THAT THE OPENING STOCK OF THE BUSINESS WAS OF HIGHER RATE WHICH WAS LATER SOLD ON AT A COMPARATIV ELY LOWER PRICE RESULTING INTO FALL IN GP%. THE ABOVE CONTENTION OF THE ASSESSEE WAS EXAMINED IN DETAIL AND IT IS FOUND THAT THE BOOKS OF ACCOUNT OF THE ASSESSEE IS NOT RELIABLE AS THE GROSS 3 ITA 445/RJT/2011 PROFIT HAS BEEN MANAGED BY MANIPULATING THE OPENING AND CLOSING STOCK, WHICH IS DISCUSSED AS UNDER:- 1) VIDE SUBMISSION DATED 28/08/10 AND 16/12/10 THE ASSESSEE HAS FURNISHED THE POSITION OF OPENING & CLOSING STO CK. ON PERUSAL OF THE ABOVE SUBMISSION OF THE ASSESSEE AND THE ANNEXU RE-D TO FOR 3CD OF THE AUDIT REPORT, THE FOLLOWING DISCREPANCY IN T HE STOCK IS NOTICED. DISCREPANCY IN THE CLOSING STOCK SR NO.. PARTICULARS QUANTITY AS PER STOCK STATEMENT DATED 28/08/10 QUANTITY AS PER STOCK STATEMENT DATED16/12/10 QUANTITY AS PER AUDIT REPORT. 1) GOLD ORNAMENTS 74567.58 GM. 74233.58 GM. 74567.5 8 GM 2) PURE GOLD 2496.74 GM - 63806.587 GM 3) PURE SILVER 239596.00 GM. - 91199.00 GM DURING THE ASSESSMENT PROCEEDING THE A.R. OF THE AS SESSEE VIDE ORDER SHEET DATED 16/12/10 WAS SHOW CAUSED TO EXPLAIN THE ABOVE INFIRMITY IN THE BOOKS OF ACCOUNT ON ACCOUNT OF DISCREPANCY IN STOCK. HOWEVER TILL THE DATE OF PASSING OF THE ORDE R NOTHING HAS BEEN HEARD FROM THE ASSESSEE. IN VIEW OF THE ABOVE APPARENT DISCREPANCY IN THE ST OCK, I AM NOT SATISFIED ABOUT THE CORRECTNESS AND COMPLETENES S OF THE BOOKS OF ACCOUNT OF THE ASSESSEE AND THEREFORE I REJECT THE BOOKS OF ACCOUNT OF THE ASSESSEE U/S.145 OF THE IT ACT. ALSO A SUFFICIE NT OPPORTUNITY HAS BEEN GRANTED TO THE ASSESSEE TO SHOW CAUSE HIS EXPL ANATION IN RESPECT OF THE INFIRMITY FOUND IN THE BOOKS OF ACCO UNT, WHICH THE ASSESSEE FAILED TO AVAIL. ON CONTRARY THE ASSESSEE IS ONLY TAKING A CONCOCTED STORY BY TAKING THE SHELTER OF THE RISE I N THE PRICE OF GOLD. THEREFORE I AM COMPELLED TO ASSESS THE TOTAL INCOME OF THE ASSESSEE TO THE BEST OF MY JUDGEMENT U/S.144 OF THE IT ACT. IN MY VIEW THE BEST JUDGEMENT OF THE ASSESSMENT OF THE TOTAL INCOME OF THE ASSESSEE WILL BE THE ESTIMATION OF GP OF THE LAST 3 YEARS, IN ABSENCE OF NON COMPLIANCE MADE BY THE ASSESSEE FOR NOT FURNISHING THE TRUE PICTURE OF THE STOCK AS MENTIONED SUPRA. THE GP% OF THE LAST 3 YEARS AND THE AVERAGE THEREOF IS AS UNDER:- A.Y. GP AVERAGE GP 2006-07 23.53% 18.31% 2007-08 20.81% 2008-09 10.59% THUS THE AVERAGE GP COMES TO 18.31% FOR THE LAST 3 YEARS. THE TURN OVER FOR THE ASSESSMENT YEAR 2008-09 IS AT RS.13,91 ,50,844/- AND THE GROSS 4 ITA 445/RJT/2011 PROFIT @ 18.31% COMES TO RSS.2,54,78,520/-. HOWEVER THE ASSESSEE HAS SHOWN GROSS PROFIT OF THE RS.1,47,38,946/- FOR THE ASSESSMENT YEAR UNDER CONSIDERATION. ACCORDINGLY AS PER THE REASON MENTIO NED SUPRA I AM SATISFIED THAT THE ASSESSEE HAS UNDER STATED HIS TOTAL INCOME TO THE TUNE OF RS.1,07,39,574/-(RS.2,54,78,520/- - 1,47,38,946/-) AND ACCORDINGLY I HEREBY MAKE ADDITION OF RS.1,07,39,574/-. (ADD ITION OF RS.1,47,39,574/-) 5. PERUSAL OF THE AFORESAID OBSERVATIONS MADE BY TH E ASSESSING OFFICER SHOWS THAT THE ASSESSEE DID NOT SUBMIT ANY EXPLANATION BE FORE THE AO TO EXPLAIN THE INFIRMITY AND DISCREPANCY IN STOCK AS NOTICED BY TH E ASSESSING OFFICER IN SPITE OF THE OPPORTUNITY GIVEN BY THE A.O. TO HIM VIDE ORDER SHE ET ENTRY DATED 16-12-2010. 6. ON APPEAL, THE LD. CIT(A) HAS DELETED THE IMPUGN ED ADDITION. THE MAIN REASON GIVEN BY THE CIT(A) FOR DELETING THE IMPUGNE D ADDITION IS THAT THE AO HAS MADE INCORRECT COMPARISON OF QUANTITATIVE DETAILS O F VARIOUS ITEMS OF CLOSING STOCK. IN THE VIEW OF THE CIT(A), THE BOOKS OF ACCOUNT MAI NTAINED BY THE ASSESSEE WERE CORRECT AND COMPLETE AND THEREFORE THE IMPUGNED ADD ITION MADE BY THE AO WAS COMPLETELY UNCALLED FOR 7. AGGRIEVED BY THE ORDER PASSED BY THE CIT(A), THE DEPARTMENT IS NOW IN APPEAL BEFORE THIS TRIBUNAL. IN SUPPORT OF APPEAL, THE LD. DEPARTMENTAL REPRESENTATIVE TOOK US THROUGH THE OBSERVATIONS MAD E BY THE AO IN THE ASSESSMENT ORDER AND SUBMITTED THAT THE ASSESSEE HA D NOT SUBMITTED ANY DETAIL OR EXPLANATION BEFORE THE A.O. TO RECONCILE THE DISCRE PANCY IN THE STOCK AS REQUIRED BY THE AO VIDE ORDER SHEET ENTRY DATED 16-12-2010. ACC ORDING TO HIM, THE ASSESSEE WAS BOUND TO FIRST FURNISH THE RELEVANT EXPLANATION BEFORE THE ASSESSING OFFICER IN THIS BEHALF SO THAT THE A.O. COULD EXAMINE THE SAME BEFORE COMING TO THE CONCLUSION WHETHER THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE WERE CORRECT AND/OR COMPLETE AND WERE ALSO IN CONFORMITY WITH LA W AND MORE PARTICULARLY THE PROVISIONS OF SECTION 145(3). HE SUBMITTED THAT THE ASSESSEE DID NOT SUBMIT ANY EXPLANATION BEFORE THE AO AND THEREFORE THE CIT(A) WAS NOT JUSTIFIED IN COMING TO THE CONCLUSION THAT THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE WERE CORRECT AND COMPLETE. 8. IN REPLY, THE LD. AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE SUPPORTED THE ORDER PASSED BY THE CIT(A). 9. WE HAVE HEARD BOTH THE PARTIES. IT IS BORNE OUT BY RECORD THAT THERE IS A SHARP DECLINE IN THE RATE OF GROSS PROFIT IN THE YEAR UND ER APPEAL AS COMPARED TO EARLIER YEARS. THE ASSESSING OFFICER PROCEEDED TO EXAMINE T HE CORRECTNESS AND COMPLETENESS OF THE BOOKS OF ACCOUNT. ACCORDING TO HIM, THERE WAS CERTAIN DISCREPANCY IN THE CLOSING STOCK SHOWN BY THE ASSES SEE. HE THEREFORE CALLED UPON THE ASSESSEE TO RECONCILE THE AFORESAID DISCREPANCY . ACCORDING TO THE OBSERVATIONS MADE IN THE ASSESSMENT ORDER, THE ASSESSEE DID NOT APPEAR BEFORE THE ASSESSING 5 ITA 445/RJT/2011 OFFICER. THE ASSESSING OFFICER THEREFORE CONCLUDED THAT THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE WERE NEITHER CORRECT NOR COMPLETE. RESULTANTLY, HE APPLIED GROSS PROFIT RATE AT 18.31% AND ACCORDINGLY MADE THE IMPUGNED ADDITION. 10. IT SEEMS THAT THE ASSESSEE HAS FURNISHED THE RE LEVANT EXPLANATION BEFORE THE CIT(A) BASED ON WHICH THE LD. CIT(A) HAS COME TO TH E CONCLUSION THAT THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE WERE CORRECT AND COMPLETE. THE EXPLANATION WHICH WAS FURNISHED BY THE ASSESSEE BEFORE THE CIT( A) WAS NOT FURNISHED BY HIM BEFORE THE AO IN RESPONSE TO ORDER SHEET ENTRY DATE D 16-12-2010. THE AO HAD THUS NO OPPORTUNITY TO EXAMINE OR REBUT THE SUBMISSIONS MADE BY THE ASSESSEE BEFORE THE CIT(A). THE CIT(A) HAS ALSO NOT GIVEN ANY OPPOR TUNITY TO THE AO IN THIS BEHALF. IN THIS VIEW OF THE MATTER, THE FINDINGS RECORDED B Y THE CIT(A) THAT THE BOOKS OF ACCOUNT MAINTAINED BY THE ASSESSEE ARE COMPLETE AND CORRECT ARE VACATED. THE ISSUE IS RESTORED TO THE FILE OF THE AO FOR CARRYIN G OUT DETAILED EXAMINATION OF THE BOOKS OF ACCOUNT IN TERMS OF THE PROVISIONS OF SECT ION 145(3). THE ASSESSEE SHALL PRODUCE THE BOOKS OF ACCOUNT TOGETHER WITH THE BILL S AND VOUCHERS IN SUPPORT THEREOF BEFORE THE AO. IT IS ONLY WHEN THE CASE OF THE ASSE SSEE FALLS UNDER SUB-SEC.(3) OF SEC.145 THAT THE AO SHALL DISTURB THE TRADING RESUL TS AND APPLY SUITABLE RATE OF GROSS PROFIT. THE AO SHALL HOWEVER ACCEPT THE TRADING RES ULT IF HE FAILS TO REACH THE SATISFACTION CONTEMPLATED BY SECTION 145(3). REASON ABLE OPPORTUNITY OF HEARING SHALL BE GIVEN BY THE A.O. TO THE ASSESSEE. GROUND NO.1 TAKEN BY THE DEPARTMENT IS ALLOWED TO THE AFORESAID EXTENT. 11. GROUND NO.2 TAKEN BY THE DEPARTMENT READS AS UN DER: 2. THE LD. C.I.T.(A)-IV, RAJKOT HAS ERRED IN LAW A ND ON FACTS IN DELETING THE ADDITION MADE BY THE A.O. OF RS.7,46,965/- ON A CCOUNT OF DISALLOWANCE OF INTEREST PAYMENT U/S 40(A)(2)(B) OF THE ACT. 12. THE ASSESSING OFFICER HAS MADE THE IMPUGNED DIS ALLOWANCE WITH THE FOLLOWING OBSERVATIONS IN THE ASSESSMENT ORDER:- 2.1 A DISCUSSION ON INTEREST PAYMENT IN RESPONSE TO THE ABOVE SHOW CAUSE NOTICE THE A.R. OF THE ASSESSEE SUBMITTED A RETURN EXPLANATION ON 16/12/10 WHICH IS REPRODUCED AS UNDER: 1) THE ASSESSEE HAS OBTAINED LOAN FROM MANY FIEND AND RELATIVES INCLUDING THESE THREE PERSONS AND PAYING INTEREST F OR PAST MANY YEARS. 2) THE ASSESSEE HAS GIVEN GIFT TO THESE 3 PERSONS O UT OF NATURAL LOVE AND AFFECTION OUT OF HIS PERSONAL FUNDS. THESE 3 PERSONS ARE ALSO HAVING HIGH NET AND OWN CAPITAL FUNDS OF MORE THAN RS.2 CR. 3) THE GIFT RECEIVED BY THESE 3 PERSONS IS THEIR PR OPERTY AND THEY CAN UTILIZE IT IN THE WAY THEY DESIRE. THE ASSESSEE HAS NO RIGHT OVER IT. 6 ITA 445/RJT/2011 4) DURING THE YEAR UNDER CONSIDERATION, THE ASSESSE E HAS TAKEN LOAN FROM THESE 3 PERSONS WHETHER NEED AND HIS REPA ID WHEN THE ASSESSEE HAS EXCESS FUNDS. DETAILS OF LOAN TAKEN AN D REPAID DURING THE YEAR IS PROVIDED BELOW: NAME LOAN TAKEN LOAN REPAID NET TEJAS R. SHAH 31,05,000/- 71,05,000/- (40,00,000/ -) BHAVIK J. SHAH 31,85,000/- 28,15,000/- 3,70,000 /- JIGNESH R. SHAH 33,35,000/- 15,40,000/- 17,95,000 /- TOTAL 96,25,000/- 1,14,60,000/- 18,35,000/- 5) HENCE, IT IS CLEAR FROM THE ABOVE TABLE THAT THE AMOUNT OF REPAYMENT TO THESE 3 PERSONS IS MORE THAN THE AMOUN T OBTAINED DURING THE YEAR UNDER CONSIDERATION AND NO QUESTION OF DIVERSIFICATION OF FUND ARISES. 6) FURTHER, DURING THE ABOVE SUBMISSION OF THE ASSESSEE WAS DULY EXAM INED. HERE IT IS IMPORTANT TO MENTION THAT BUSINESS EXIGENCY AND PRU DENCY ARE THE TWO BASIC PARAMETERS TO DETERMINE THE ALLOWABILITY OF ANY EXP ENDITURE. THEREFORE, NO PRUDENT BUSINESSMAN WILL GIFT HIS MONEY WHEN THERE IS CERTAIN EXIGENCY OF MONEY. IN THE INSTANT CASE IT IS SEEN THAT THE ASSE SSEE HAS MADE GIFT OF RS.20,00,000/- EACH TO SHRI BHAVIK J. SHAH, SHRI TE JAS SHAH AND SHRI JIGNESH SHAH ON 19/06/07, 19/06/07 AND 16/06/07 RES PECTIVELY AND ALMOST THE SAME AMOUNT IS RECEIVED AS LOAN FROM THESE PERS ONS JUST AFTER 3 DAYS THAT IS ON 22/06/07. THIS ACTION OF THE ASSESSEE CL EARLY TRANSPIRES THAT BUSINESS EXIGENCY WAS OVER LOOKED AND UNREASONABLE INTEREST WAS PAID TO THE ABOVE PERSONS. THEREFORE, THE INTEREST PAID TO THE ABOVE PERSONS ON THE AMOUNT GIFTED IS NOT ALLOWABLE AS PER 40(A)(2)(B) O F THE IT ACT. ACCORDINGLY I CALCULATE THE EXCESSIVE PAYMENT OF INTEREST ON THE AMOUNT GIFTED, AS UNDER NAME OF THE PERSON AMOUNT OF GIFT GIFT MADE ON PERIOD UPTO MARCH 2008 INTEREST @ 16% BHAVIK J.SHAH RS.20,00,000/- 19/06/07 285 DAYS RS.2 ,49,863/- TEJAS R,.SHAH RS.20,00,000/- 19/06/07 285 DAYS RS.2 ,49,863/- JIGNESH.SHAH RS.20,00,000/- 16/06/07 282 DAYS RS.2, 47,239/- TOTAL RS.7,46,965/- IN VIEW OF THE ABOVE I MAKE ADDITION OF RS.7,46,96 5/- TO THE TOTAL INCOME. (ADDITION OF RS.7,46,965/-) . 13. IT IS EVIDENT FROM THE FACTS BROUGHT ON RECORD BY THE AO THAT THE ASSESSEE FIRST GIFTED A SUM OF RS.20,00,000/- EACH TO BHAVIK J. SHAH, TEJAS SHAH AND JIGNESH SHAH AND IMMEDIATELY THEREAFTER THE AFORESAID PERSO NS PLACED THE SAME AMOUNT IN THE HANDS OF THE ASSESSEE ON WHICH INTEREST @ 16% A GGREGATING TO RS.7,46,965/- WAS CLAIMED AS DEDUCTION BY THE ASSESSEE. ACCORDING TO THE AO, THE IMPUGNED 7 ITA 445/RJT/2011 TRANSACTIONS WERE COMPLETELY COLLUSIVE IN NATURE. H E THEREFORE DISALLOWED THE INTEREST PAID TO THEM. 14. ON APPEAL, THE LD. CIT(A) DELETED THE DISALLOWA NCE MADE BY THE AO WITH THE FOLLOWING OBSERVATIONS:- 4. I HAVE GONE THROUGH THE ASSESSMENT ORDER AND SU BMISSIONS OF APPELLANT. I FIND THAT APPELLANT HAD A RUNNING BUSI NESS ACCOUNTS WITH THREE PERSONS SHRI BHAVIK J. SHAH, TEJAS J. SHAH AND JIGN ESH R. SHAH WHICH EXISTED BEFORE THE GIFT OF RS.20 LAKH EACH WAS MADE BY APPELLANT TO THESE THREE PERSONS. SHRI BHAVIK J. SHAH IS SON OF APPELL ANT AND TEJAS J. SHAH AND JIGNESH R. SHAH ARE APPELLANTS BROTHERS SONS, IE NEPHEW. THESE PERSONS ADVANCED LOAN OF RS.18 LAKH IMMEDIATELY AFTER RECEI VING THE GIFT FROM APPELLANT. THOUGH IT LOOKS STRANGE STILL I FIND THA T THE LOANS WERE REPAID TO THE THREE PERSONS DURING THE YEAR ITSELF AND THE LOANS RECEIVED FROM THESE PERSONS CANNOT BE SAID TO BE OUT OF THIS GIFT OF RS .20 LAKH BECAUSE THE LOANS EXISTED AS OPENING BALANCES AT THE START OF THE YEA R AND THERE ARE OTHER INSTANCES ALSO DURING THE YEAR WHEN APPELLANT TOOK LOANS FROM THESE THREE PERSONS. THEREFORE THE LOANS OF RS.18 LAKH RECEIVED BY APPELLANT IN JUNE 2007 FROM SON AND 2 NEPHEWS WAS NOT AN ABNORMAL TRA NSACTION BECAUSE APPELLANT WAS RECEIVING LOANS FROM THESE THREE PERS ONS REGULARLY PRIOR TO JUNE 2007AND AFTER JUNE 2007 WAS MAKING REGULAR PAY MENT OF LOANS TO THEM. THE GIST OF RS.20 LAKH MADE BY APPELLANT TO S ON AND 2 NEPHEWS IS NON-BUSINESS PERSONAL TRANSACTION AND THE LOANS SUB SEQUENTLY MADE BY THESE PERSONS TO APPELLANT MAY NOT BE CONSIDERED AS NON-GENUINE BECAUSE THE LOAN TRANSACTIONS BETWEEN APPELLANT AND THESE T HREE PERSONS EXISTED PRIOR TO THIS GIFT WAS MADE, THEY EXISTED AFTER THE GIFT WAS MADE AND REGULAR REPAYMENT OF LOAN WAS MADE BY APPELLANT TO THESE PE RSONS IN RESPECT OF SUCH LOANS RECEIVED FROM THEM. AFTER TREATING THE L OANS AS GENUINE, I FIND THAT IN TAX AUDIT REPORT, ONLY THE SON OF APPELLANT, SHR I BHAVIK J. SHAH HAS BEEN NAMED AS RELATED PERSON U/S.40A(2)(B) OF THE I. T. ACT IN PARA 18, ANNEXURE- B OF THIS REPORT. THE OTHER TWO PERSONS, TEJAS J. S HAH AND JIGNESH R. SHAH ARE NOT COVERED WITHIN THE PROVISION OF SECTION 40A (2)(B) OF THE I.T. ACT. THEREFORE THE INTEREST OF RS.11,20,837/- AND RS.6,6 3,935/- PAID TO THEM AT 16% RATE OF INTEREST CANNOT BE DISALLOWED AS EXCESS IVE U/S.40A(2)(B) OF THE I. T. ACT. AS FAR AS INTEREST OF RS.8,24,163/- PAID TO SHRI BHAVIK J. SHAH IS CONCERNED, ASSESSING OFFICER HAS NOT FOUND OUT THE MARKET RATE OF INTEREST TO HOLD THAT 16% RATE OF INTEREST IS EXCESSIVE. MOREOV ER, ASSESSING OFFICER HAS DISALLOWED ENTIRE INTEREST PAID AT THE RATE OF 16% THEREFORE ASSUMING THAT THE MARKET RATE OF INTEREST IS 0%, WHICH IS AN ABSURD A SSUMPTION. I FIND THAT 16% IS QUITE A REASONABLE RATE OF INTEREST IN RESPECT O F UNSECURED LOANS AND WHEN PERSONS WHO ARE NOT RELATED AS PER INCOME TAX ACT A RE ALSO PAID AT THE RATE OF 16% THEN THE RATE OF INTEREST OF 16% FOR PAYMENT OF INTEREST TO HIS SON BY 8 ITA 445/RJT/2011 APPELLANT IS ALSO REASONABLE AND NOT EXCESSIVE. IN VIEW OF THIS DISCUSSION I DIRECT THE ASSESSING OFFICER TO ALLOW THE EXPENDITU RE OF INTEREST OF RS.7,46,965/- PAID TO THE THREE PERSONS AND REDUCE THE TOTAL INCOME OF APPELLANT ACCORDINGLY. 15. IN SUPPORT OF APPEAL, THE LD. DEPARTMENTAL REPR ESENTATIVE INVITED OUR ATTENTION TO THE OBSERVATIONS MADE BY THE ASSESSING OFFICER IN THE ASSESSMENT ORDER. HE SUBMITTED THAT ALL THE AFORESAID THREE PE RSONS WERE CLOSE RELATIVES OF THE ASSESSEE AND THEREFORE THE ACTION OF THE ASSESSEE I N FIRST GIFTING RS.20,00,000/- TO EACH OF THEM AND THEREAFTER OBTAINING BACK THE SAME AMOUNT FROM THEM AGAINST PAYMENT OF INTEREST @16% WAS COLLUSIVE IN NATURE AN D THEREFORE THE CIT(A) OUGHT TO HAVE CONFIRMED THE ACTION OF THE AO IN MAKING THE I MPUGNED DISALLOWANCE. 16. IN REPLY, THE LD. AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE SUPPORTED THE ORDER PASSED BY THE CIT(A). HE SUBMITTED THAT INTER EST RATE @16% HAS BEEN PAID TO OTHERS AS WELL AND THEREFORE INTEREST PAID @ 16% TO THE AFORESAID 3 PERSONS COULD NOT BE SAID TO BE EXCESSIVE OR UNREASONABLE. HE FUR THER SUBMITTED THAT TEJAS R. SHAH AND JIGNESH R. SHAH WERE NOT RELATED TO THE AS SESSEE WITHIN THE MEANING OF SECTION 40A(2)(B) AND THEREFORE THE AO WAS NOT JUST IFIED IN MAKING THE IMPUGNED DISALLOWANCE. 17. WE HAVE HEARD BOTH THE PARTIES. OBSERVATIONS MA DE THE ASSESSMENT ORDER INDICATE THAT RS.60,00,000/- WERE DIVERTED BY THE A SSESSEE FROM HIS BUSINESS IN FAVOUR OF THREE PERSONS, NAMELY, SHRI BHAVIK J. SHA H, SHRI TEJAS R. SHAH AND SHRI JIGNESH R. SHAH ALLEGEDLY BY WAY OF GIFT. AFTER THE SO-CALLED GIFT, THE ASSESSEE GOT BACK THE SAME MONEY FROM ALL THE AFORESAID THREE PE RSONS ON WHICH THE ASSESSEE CHOSE TO PAY INTEREST @ 16% WHICH AGGREGATED TO RS. 7,46,965/-. NONE OF THE AFORESAID PERSONS COULD HAVE GOT INTEREST @ 16% AS THE RATE OF INTEREST GIVEN BY THE BANKS AND FINANCIAL INSTITUTIONS EVEN ON FIXED DEPOSIT WAS NOT AS HIGH AS 16% IN THE YEAR UNDER APPEAL. THE ASSESSEE CLAIMS THAT SHR I BHAVIK J. SHAH ALONE WAS RELATED TO THE ASSESSEE WITHIN THE MEANING OF SECTI ON 40A(2)(B) AND REMAINING TWO PERSONS WERE NOT RELATED TO THE ASSESSEE WITHIN THE MEANING OF SEC.40A(2). IT IS HOWEVER NOT IN DISPUTE THAT ALL THE THREE PERSONS W ERE RELATED TO THE ASSESSEE WHICH MAY OR MAY NOT BE COVERED BY SECTION 40A(2)(B). 18. SECTION 36(1)(III) ALLOWS DEDUCTION FOR PAYMENT OF INTEREST ON CAPITAL BORROWED FOR THE PURPOSES OF BUSINESS. IN THE PRESENT CASE, THE MONEY WAS FIRST DIVERTED BY THE ASSESSEE FROM HIS BUSINESS DISGUISING IT AS GIF T TO THE AFORESAID THREE PERSONS AND THEREAFTER THE SAME MONEY WAS TAKEN BACK BY THE ASSESSEE FROM THE AFORESAID 3 PERSONS ON WHICH THE IMPUGNED INTEREST WAS CLAIME D BY THE ASSESSEE TO HAVE BEEN PAID TO THEM. ON THE FACTS OF THE CASE, THERE IS NO BORROWING OF CAPITAL AND THEREFORE THE REQUIREMENT OF SECTION 36(1)(III) IS NOT FULFILLED. WITHOUT PREJUDICE TO THE AFORESAID, THE ENTIRE SERIES OF TRANSACTIONS ARE IL LUSORY, COLOURABLE AND NOT GENUINELY FOR THE PURPOSES OF THE BUSINESS. IN THIS VIEW OF T HE MATTER, THE ASSESSEE IS NOT 9 ITA 445/RJT/2011 ENTITLED TO DEDUCTION U/S 36(1)(III). THE ORDER OF THE AO MAKING THE IMPUGNED DISALLOWANCE IS THEREFORE RESTORED. 19. RELIANCE PLACED BY THE LD. CIT(A) ON SECTION 40 A(2)(B) IS COMPLETELY MISPLACED FOR THE REASON THAT THE DEDUCTION TOWARDS THE INTEREST PAID ON BORROWED CAPITAL HAS TO BE EXAMINED FIRSTLY WITH REFERENCE T O THE PROVISIONS OF SEC.36(1)(III) AND THEREAFTER WITH REFERENCE TO THE PROVISIONS OF SECTION 40A(2). IN THE PRESENT CASE, THE SERIES OF TRANSACTIONS CARRIED OUT BY THE ASSESSEE SIMPLY INDICATE A COLOURABLE DEVICE TO ENSURE DEDUCTION OF INTEREST F ROM TAXABLE INCOME. THEY DO NOT ESTABLISH ANY GENUINE BORROWING. IT IS QUITE WELL S ETTLED THAT ILLEGAL OR COLOURABLE DEVICES HAVE TO BE IGNORED. THE CIT(A) OUGHT TO HAV E IGNORED THEM AND DECIDED THE ISSUE IN ACCORDANCE WITH THE PROVISIONS OF SEC. 36(1)(III) WHICH WAS RELEVANT FOR DECIDING THE ISSUE UNDER APPEAL. GROUND NO.2 IS ALL OWED. 20. GROUND NO.3 TAKEN BY THE DEPARTMENT READS AS UN DER:- 3. THE LD. CIT(A)-IV, RAJKOT HAS ERRED IN LAW AD O N FACTS IN DELETING THE ADDITION MADE BY THE AO OF RS.30,48,715/- ON ACCOUN T OF DISALLOWANCE OF SALARY PAYMENT U/S.40(A)(2)(B) OF THE ACT. 21. THE AO HAS MADE THE IMPUGNED DISALLOWANCE WITH THE FOLLOWING OBSERVATIONS:- 2.1.B. DISCUSSION ON PAYMENT OF SALARY IN RESPONSE TO THE ABOVE SHOW CAUSE NOTICE THE A .R. OF THE ASSESSEE SUBMITTED A RETURN EXPLANATION ON 16/12/10 WHICH IS EXAMINED CAREFULLY. ON PERUSAL OF THE SUBMISSION OF THE A.R. OF THE ASSESSEE IT IS OBSERVED THAT THE MAIN REASON FOR INCREASE IN SALAR Y OF THE ABOVE 3 PERSONS IS THE INCREASE IN TURN OVER. HOWEVER AS ELABORATED SUPRA AND THE RECORDS AVAILABLE IT IS SEEN THAT TURN OVER DURING AY 2007- 08 AND 2008-09 IS ALMOST AT THE LEVEL I.E. RS.12 CR.(APPROXIMATELY). THEREFORE THE EXPLANATION PUT FORTH BY THE A.R. OF THE V DOES NOT HOLD MUCH WATER, ON THE CONTRARY THE EXPLANATION OF THE A.R. OF THE ASSESSEE SEEMS TO BE GIVEN ONLY FOR THE SAKE OF LOGIC. AS DISCUSSED ABOVE BUSINESS EXIGENCY AND PRUDENCY ARE THE BASIC PARAMETERS TO GAZE THE ALLOWABILITY OF AN EXPENDITU RE THEREFORE IT IS ONCE AGAIN REITERATED THAT NO PRUDENT BUSINESSMAN WILL H IKE ANYONES SALARY WHEN THERE IS ALMOST NO INCREASE IN THE TURN OVER. IN VI EW OF THE ABOVE IT IS QUITE EVIDENT THAT THE ASSESSEE HAS DEVISED A COLOURFUL M ECHANISM TO AVOID TAX LIABILITY IN THE HANDS OF HIS PROPRIETARY BUSINESS. IN VIEW OF THE ABOVE THE SALARY PAID IN EXCESS TO 1.8 LAC P.A. TO THE ABOVE 3 PERSONS ARE CERTAINLY UNREASONABLE AS PER SECTION 40(A)(2)(B) OF THE IT A CT. ACCORDINGLY I DISALLOW THE FOLLOWING EXCESSIVE PAYMENT OF SALARY PAID TO T HE FOLLOWING PERSON. 10 ITA 445/RJT/2011 NAME OF THE PERSON SALARY PAID IN AY 2007-08 SALARY PAID IN A.Y. 2008-09 EXCESS SALARY PAID. SHRI BHAVIK J.SHAH RS.1,80,000/- RS.14,04,924/- RS. 12,24,924/- SHRI TEJAS R,.SHAH RS.1,80,000/- RS.14,04,924/- RS. 12,24,924/- SHRI JIGNESH R SHAH RS.1,80,000/- RS. 7,78,867/- RS . 5,98,867/- TOTAL RS.30,48,715/- THEREFORE I DISALLOW THE ABOVE EXCESS SALARY PAYME NT OF RS.30,48,715/- U/S.40(A)(2)(B) OF THE IT ACT AND TH E SAME IS ADDED TO THE TOTAL INCOME OF THE ASSESSEE. (ADDITION OF RS.30,48,715/) 22. ON APPEAL, THE LD. CIT(A) HAS DELETED THE IMPUG NED DISALLOWANCE WITH THE FOLLOWING OBSERVATIONS:- 4. I HAVE GONE THROUGH THE ASSESSMENT ORDER AND S UBMISSIONS OF APPELLANT. APPELLANT HAS ENTERED INTO AGREEMENT WIT H SHRI BHAVIK J. SHAH, SHRI TEJAS R. SHAH AND SHRI JIGNESH R. SHAH ON 15/3 /2007 IN RESPECT OF FINANCIAL YEAR 2007-08, WHERE REMUNERATION OF THESE THREE PERSONS WAS FIXED AT MINIMUM OF RS.1.8 LAKH PER MONTH WITH INCE NTIVE OF RS.1.15% OF TURNOVER FOR SHRI BHAVIK J. SHAH AND SHRI TEJAS R. SHAH AND INCENTIVE OF 0.7% FOR SHRI JIGNESH R. SHAH. THIS AGREEMENT WAS E NTERED ON 15-03-2007, IE. BEFORE THE START OF THE FINANCIAL YEAR 2007-08 RATHER THAN AT THE END OF THE FINANCIAL YEAR 2007-08, WHICH SHOWS HAT THE DECISIO N TO PAY INCENTIVES TO 3 KEY PERSONS, IF THE TURNOVER EXCEEDS RS.10 CRORE, W AS TAKEN FOR THE FINANCIAL YEAR WHICH WAS YET TO BEGIN AND THEREFORE IT CANNOT BE A THOUGHT AFTER THE INCOME HAS BEEN EARNED. THE TURNOVER OF FINANCIAL Y EAR 2006-07 WAS ALSO MORE THAN RS.10 CRORES, HOWEVER, NO AGREEMENT TO PA Y INCENTIVE TO THE 3 KEY PERSONS WAS IN EXISTENCE IN THAT FINANCIAL YEAR AND THEREFORE THE 3 KEY PERSONS WERE NOT PAID THE INCENTIVES IN THAT FINANC IAL YEAR AS THEY WERE PAID FOR FINANCIAL YEAR 2007-08 ONWARD BECAUSE THE AGREE MENT EXISTED FOR FINANCIAL YEAR 2007-08 AND ONWARDS RIGHT FROM THE B EGINNING OF FINANCIAL YEAR 2007-08. THE AGREEMENT FOR PAYING INCENTIVE IS ON THE BASIS OF ACHIEVING TURNOVER OF MORE THAN 10 CRORE. I FIND TH AT ALL THE THREE PERSONS SHRI BHAVIK J. SHAH. SHRI TEJAS R. SHAH AND SHRI JIGNESH R. SHAH HAVE RETURNED A TOTAL INCOME OF RS.27 LAKH, 29 LAKH AND 41.2 LACK RESPECTIVELY AFTER INCLUDING THE INCENTIVE RECEIVED FROM APPELLANT AS SALARY. EVEN WITHOUT THE PAYMENT OF THESE INCENTIVES TO THE 3 KEY PERSONS, T HESE THREE KEY PERSONS HAD TOTAL INCOME OF MORE THAN RS.10 LAKH. THEREFORE , THE TAX PLANNING IN RESPECT OF DIVERTING INCOME OF APPELLANT IN THE HAN DS OF A RELATIVE WHO IS NONTAXABLE OR TAXABLE AT LOWER RATE IS NOT PRESENT IN PRESENT CASE. THE APPLICATION OF SECTION 40A(2) HAS MORE SIGNIFICANCE WHEN THE ASSESSEE HAS RESORTED TO SUCH TAX PLANNING. IN ABSENCE OF SUCH T AX PLANNING IN THE PRESENT CASE, IT APPEARS THAT THE AGREEMENT DATED 15-03-200 7 WAS ENTERED WITH BUSINESS CONSIDERATION RATHER THAN TAX CONSIDERATIO NS. MOREOVER APPELLANT HAS BEEN ABLE TO EXPLAIN AS WHY INCENTIVE WAS REQUI RED TO BE PAID TO 3 KEY 11 ITA 445/RJT/2011 PERSONS WHO WERE MANAGING ALMOST THE ENTIRE BUSINES S OF APPELLANT INCLUDING MARKETING, PRODUCTION AND FINANCE AND INS UFFICIENT REMUNERATION MAY MAKE THESE PERSONS TO START THEIR OWN BUSINESS OR JOIN SOME OTHER PERSON. MOREOVER, THE DEFINITION OF RELATIVE U/S. 40A(2)(B) APPLIES TO ONLY BHAVIK J. SHAH AS MENTIONED IN THE TAX AUDIT REPORT AND THE PAYMENTS TO OTHER TWO PERSONS, SHRI TEJAS R. SHAH AND SHRI JIGN ESH R. SHAH IS NOT COVERED U/S.40A(2) OF THE I.T. ACT. THE PAYMENTS MA DE TO SHRI TEJAS R. SHAH AND SHRI JIGNESH R. SHAH CANNOT BE DISALLOWED U/S.4 0A(2) OF THE I.T. ACT. IN THE PRESENT CASE, IN ABSENCE OF ANY OTHER MATERIAL AVAILABLE THE RATE OF INCENTIVE PAID TO UNRELATED PERSON SHRI TEJAS R. SH AH AS PER THE PROVISIONS OF SECTION 40A(2)(B), MAY BE CONSIDERED AS FAIR MAR KET RATE. THE RATE OF INCENTIVE OF 1.15% TO BHAVIK J. SHAH IS NOT DIFFERE NT FROM THE RATE OF INCENTIVE PAID TO SHRI TEJAS R. SHAH AND THEREFORE THE INCENT IVES PAID BY APPELLANT TO BHAVIK J. SHAH IS SAME AS THE FAIR MARKET RATE AND THEREFORE IT CANNOT BE SAID THAT ANY EXCESSIVE PAYMENT OF INCENTIVE IS MADE TO BHAVIK J. SHAH. I THEREFORE DIRECT THE ASSESSING OFFICER TO ALLOW THE CLAIM OF DEDUCTION OF RS.30,48,715/- OF INCENTIVE PAID TO THE 3 KEY PERSO NS AND REDUCE THE TOTAL INCOME ACCORDINGLY. 23. IN SUPPORT OF APPEAL, THE LD. DEPARTMENTAL REPR ESENTATIVE RELIED UPON THE FINDINGS RECORDED BY THE ASSESSING OFFICER IN THE A SSESSMENT ORDER. 24. IN REPLY, THE LD. AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE RELIED UPON THE ORDER PASSED BY THE CIT(A). 25. WE HAVE HEARD BOTH THE PARTIES AND CAREFULLY CO NSIDERED THEIR SUBMISSIONS. THE IMPUGNED DISALLOWANCE HAS BEEN MADE BY THE AO O UT OF SALARY PAID IN THE YEAR UNDER APPEAL TO SHRI BHAVIK J. SHAH, SHRI TEJAS J. SHAH AND SHRI JIGNESH R. SHAH. THE ASSESSEE CLAIMS THAT ONLY SHRI BHAVIK J. SHAH I S RELATED TO THE ASSESSEE WITHIN THE MEANING OF SECTION 40A(2)(B) AND NOT OTHERS. HE HOWEVER DOES NOT DISPUTE THAT ALL THE THREE PERSONS ARE CLOSELY RELATED TO THE AS SESSEE WHICH MAY OR MAY NOT BE COVERED BY SECTION 40A(2)(B). 26. RELATIONSHIP BY ITSELF, WITHOUT MORE, CANNOT LE AD TO THE INFERENCE OF EXCLUDING THE POSSIBILITY OF A PAYMENT BEING WHOLLY AND EXCLU SIVELY FOR THE PURPOSE OF BUSINESS. DEALING WITH RELATIVES IN CONTRAST WITH O R IN PREFERENCE TO STRANGER IS NEITHER PROHIBITED BY LAW NOR CAN BE TABOOED. INDEE D, IT IS NATURAL TO DO SO BUT THIS DOES NOT GIVE A LICENCE TO COVER UP DISHONEST TRANS ACTIONS OR IMPERMISSIBLE TRANSFERS. THE COURTS AND AUTHORITIES ARE NOT EXPEC TED TO WEAR BLINKERS TO OVERLOOK OR CONDONE THE PASSING OFF OF PUBLIC REVENUE TO ONE S OWN KITH AND KIN BY SUBTERFUGE OR CLANDESTINE OR CLEVER DEVICES CLOTHES IN LEGALISTIC JARGON, INSTEAD IT IS THEIR DUTY TO LIFT THE VEIL OF APPARENT LEGALITY AN D GET TO THE TRUTH OR SUBSTANCE OF A TRANSACTION TO DEAL WITH IT IN ACCORDANCE WITH LAW. IT IS ONLY APPROPRIATE, INDEED NORMAL, THAT DEALINGS INVOLVING TRANSFER OF FUNDS T O NEAR AND DEAR ONES NEED TO BE 12 ITA 445/RJT/2011 LOOKED INTO WITH CARE AND CAUTION AND NECESSARY INF ERENCES DRAWN IF THERE ARE ABNORMALITIES ATTACHING TO SUCH TRANSACTIONS. 27. THE RELATIONSHIP CONTEMPLATED BY SECTION 40A(2) (B) IS RELEVANT FOR THE PURPOSES OF THAT SECTION ONLY. THE FACT THAT THE AS SESSEE IS CLOSELY RELATED TO THE AFORESAID THREE PERSONS IS NOT DENIED BY THE ASSESS EE. SECTION 37(1) PERMITS DEDUCTION FOR EXPENDITURE ONLY IF IT IS INCURRED WH OLLY AND EXCLUSIVELY FOR THE PURPOSES OF THE BUSINESS. THE WORD WHOLLY REFERS TO QUANTUM OF EXPENDITURE WHILE THE WORD EXCLUSIVELY REFERENCE TO THE MOTIVE, OBJ ECTIVE AND THE PURPOSES OF EXPENDITURE AND GIVES JURISDICTION TO THE TAXING AU THORITIES TO EXAMINE THIS MATTER. EXPENDITURE IS TO BE ALLOWED ONLY IF IT IS INCURRED WHOLLY AND EXCLUSIVELY FOR THE PURPOSES OF BUSINESS AND FOR NO OTHER PURPOSE OR WI TH NO OTHER MOTIVE. IN ORDER TO BE ALLOWABLE U/S 37(1), THE EXPENDITURE MUST THEREF ORE SATISFY THE TEST OF COMMERCIAL EXPEDIENCY. COMMERCIAL EXPEDIENCY HAS TO BE FROM TH E POINT OF VIEW OF AN ASSESSEE WHO KNOWS BEST HOW HIS BUSINESS HAS TO BE RUN BUT SUCH A POINT OF VIEW HAS TO BE REASONABLE POINT OF VIEW WHICH IS FREE FR OM TAINT OF EXCESSIVENESS, COLLUSIVENESS OR COLOURABLE DISCRETION. 28. TURNING TO THE FACTS OF THE PRESENT CASE, SHRI BHAVIK J. SHAH WAS PAID SALARY AMOUNTING TO RS.14,04,924/- IN THE YEAR UNDER APPEA L AS AGAINST RS.1,80,000/- IN THE IMMEDIATELY PRECEDING YEAR. SHRI TEJAS R. SHAH WAS PAID SALARY AMOUNTING TO RS.14,04,924/- IN THE YEAR UNDER APPEAL AS AGAINST RS.1,80,000/- IN THE IMMEDIATELY PRECEDING YEAR WHILE SHRI JIGNESH R. SHAH WAS PAID SALARY AMOUNTING TO RS.7,78,867/- IN THE YEAR UNDER APPEAL AS AGAINST R S.1,80,000/- IN THE IMMEDIATELY PRECEDING YEAR. PERUSAL OF PART-B OF ANNEXURE TO TH E TAX AUDIT REPORT FOR THE YEAR UNDER APPEAL SHOWS THAT THE GROSS TURNOVER OF THE A SSESSEE IN THE YEAR UNDER APPEAL WAS RS.13,91,50,844/- AS AGAINST RS.12,29,62 ,797/- IN THE IMMEDIATELY PRECEDING YEAR. THUS, THERE WAS MARGINAL INCREASE I N THE TURNOVER IN THE YEAR UNDER APPEAL. HOWEVER, GROSS PROFIT IN THE YEAR UNDER APP EAL DECLINED TO RS.1,47,38,946/- FROM RS.2,70,59,941/- IN THE IMMEDIATELY PRECEDING YEAR. SIMILARLY, NET PROFIT BEFORE TAX ALSO DECLINED TO RS.15,37,950/- IN THE YEAR UND ER APPEAL FROM RS.1,95,38,568/- IN THE IMMEDIATELY PRECEDING YEAR. THUS, THE SUBMIS SION OF THE ASSESSEE THAT THE AFORESAID THREE PERSONS HAD ENORMOUSLY CONTRIBUTED TO THE GROWTH IN SALES IN THE YEAR UNDER APPEAL OVER THE IMMEDIATELY PRECEDING YE AR IS NOT SUPPORTED BY THE RECORD. IT IS FURTHER NOTICED THAT THE SALARY PAID TO THE AFORESAID THREE PERSONS HAS INCREASED BY ABOUT 7 TIMES. ON BEING ASKED AS TO WH ETHER SIMILAR INCREASE (MORE THAN 7 TIMES OVER THE PRECEDING YEAR) IN SALARY WAS GIVEN TO OTHER STAFF MEMBERS, THE REPLY OF ASSESSEE WAS IN NEGATIVE. THE TEST OF COMMERCIAL EXPEDIENCY IN GIVING SEVEN TIMES INCREASE IN THEIR SALARY IS NOT SATISFI ED. THERE IS NOTHING ON RECORD TO SHOW THAT THE AFORESAID THREE PERSONS CONTRIBUTED M ORE TOWARDS THE SALES OR THE PROFITS OR THE WELL-BEING OF THE BUSINESS OF THE AS SESSEE THAN WHAT THEY HAD CONTRIBUTED IN THE PAST SO AS TO JUSTIFY MORE THAN SEVEN TIMES INCREASE IN THEIR SALARY IN THE YEAR UNDER APPEAL. ON THE FACTS OF THE CASE, WE ARE SATISFIED THAT THE INCREASE 13 ITA 445/RJT/2011 IN THEIR SALARY IN THE YEAR UNDER APPEAL WAS NOT MO TIVATED BY CONSIDERATIONS OF COMMERCIAL EXPEDIENCY BUT BY CONSIDERATIONS EXTRANE OUS TO THE BUSINESS. IN THIS VIEW OF THE MATTER, THE DISALLOWANCE MADE BY THE AO IS RESTORED. 29. RELIANCE PLACED BY THE LD. CIT(A) ON THE AGREEM ENT DATED 15-03-2007 BETWEEN THE AFORESAID THREE PERSONS AND ASSESSEE IS COMPLETELY MISPLACED FOR TWO MAIN REASONS. ONE, NO SUCH AGREEMENT HAS BEEN REFER RED TO BY THE A.O. IN HIS ASSESSMENT ORDER OR BY THE ASSESSEE IN HIS SEVERAL LETTERS ADDRESSED TO THE A.O. DURING THE COURSE OF ASSESSMENT PROCEEDINGS. THE AS SESSEE HAS FILED PAPER BOOK BEFORE US WHICH CONTAINS COPIES OF WRITTEN SUBMISSI ONS FILED BY THE ASSESSEE BEFORE THE AO VIDE HIS LETTERS DATED 23-08-2010, 30-08-201 0, 26-11-2010, 03-12-2010 AND 16-12-2010. HOWEVER, THERE IS NO REFERENCE IN ANY O F THE AFORESAID LETTERS ADDRESSED BY THE ASSESSEE TO THE AO TO THE AGREEMEN T REFERRED TO BY THE C.I.T.(A) IN HIS APPELLATE ORDER. TWO, MERE EXECUTION OF AGRE EMENT BY ITSELF IS NOT SUFFICIENT TO ALLOW THE DEDUCTION CLAIMED BY THE ASSESSEE. IT IS INCORRECT TO SAY THAT SINCE THE ASSESSEE HAS ESTABLISHED THE EXISTENCE OF AN AGREEM ENT BETWEEN THE EMPLOYER AND THE EMPLOYEE AND THE FACT OF ACTUAL PAYMENT, NO DISCRETION IS LEFT TO THE ASSESSING OFFICER EXCEPT TO HOLD THAT THE PAYMENT H AS BEEN MADE WHOLLY AND EXCLUSIVELY FOR THE PURPOSES OF THE BUSINESS. ALTHO UGH THE PAYMENT MIGHT HAVE BEEN MADE AND ALTHOUGH THERE MIGHT HAVE BEAN AN AGR EEMENT IN EXISTENCE, IT WOULD STILL BE OPEN TO THE AO TO TAKE INTO CONSIDER ATION VARIOUS FACTORS WHICH WOULD GO TO SHOW WHETHER THE AMOUNT WAS PAID AS REQUIRED BY THE SECTION, E.G., 37. THE CLAIM FOR DEDUCTION HAS TO BE ALLOWED IN CONFORMITY WITH LAW AND NOT ON THE BASIS OF AGREEMENT. IF THE A.O., AFTER TAKING THE RELEVANT F ACTORS INTO CONSIDERATION, COMES TO THE CONCLUSION THAT THE PAYMENT WAS NOT MADE WHOLLY OR EXCLUSIVELY FOR THE PURPOSES OF THE BUSINESS OF THE ASSESSEE, IT WOULD BE OPEN TO HIM EITHER TO DISALLOW THE WHOLE SUM OR A PART OF THE SUM PAID. IN THE PRE SENT CASE, THE IMPUGNED SALARY PAYMENT WAS NOT MADE WHOLLY AND EXCLUSIVELY FOR THE PURPOSES OF BUSINESS BUT WAS MOTIVATED BY CONSIDERATIONS EXTRANEOUS TO THE BUSIN ESS AND THEREFORE THE ORDER OF THE A.O. DISALLOWING IMPUGNED INCREASE IN SALARY DE SERVES TO BE RESTORED AND IS ACCORDINGLY RESTORED. GROUND NO.3 IS ALLOWED. 30. GROUND NOS. 4 TO 6 ARE GENERAL AND THEREFORE DO NOT REQUIRE ADJUDICATION. 31. IN VIEW OF THE FOREGOING, THE APPEAL FILED BY T HE DEPARTMENT IS PARTLY ALLOWED. ) + 22-05-2012 - ) THIS ORDER PRONOUNCED IN THE OPEN COURT ON 22-05-2012 SD/- SD/- ( .. / T. K. SHARMA) ( .. / D. K. SRIVASTAVA) /JUDICIAL MEMBER / ACCOUNTANT MEMBER +/ DATE 22-05-2012 /RAJKOT 14 ITA 445/RJT/2011 ) 01 21 ) 01 21 ) 01 21 ) 01 21 / COPY OF ORDER FORWARDED TO:- 1. 5 / APPELLANT-. THE ASSTT. COMMISSIONER OF INCOME-TA X, CIR.-5, RAJKOT. 2. 075 / RESPONDENT-SHRI JAYESH RAICHAND SHAH, RAJKOT.. 3. : / CONCERNED CIT-III, RAJKOT. 4. :- / ADDL. CIT, RANGE-5, RAJKOT.. 5. 1 0, , / DR, ITAT, RAJKOT 6. / GUARD FILE. / BY ORDER , ASSTT. REGISTRAR/ , / ITAT, RAJKOT