T.R. Ramachandran Nair, J.
1. This appeal is at the instance of the Revenue. The assessment year is 1992-93. The short question is whether the service charges claimed to have been paid by the assessee company to a partnership firm can be allowed.
2. The short facts are the following : The assessee is a private limited company engaged in the business of manufacture and sale of veneers and trading in taurus black board, plywood, etc. The assessee returned an income of Rs. 11,25,466 in the return for the asst. yr. 1992-93. The assessee had paid Rs. 5,96,280 by way of service charges to the consultant firm M/s Team Paarel. It is on the ground that the firm offered consultancy in the areas of general administration, marketing, production, finance and management system. The AO, on a perusal of the agreement dt. 10th March, 1991 executed by the assessee with M/s Team Paarel, found that the partners of the firm include the managing director and a director of the company and their close relatives. The AO, after making a comparative study of the affairs of the immediately preceding assessment year and the assessment year herein, also found that the assessee had not incurred any expenditure on account of service charges in the year 1991-92; the increase in the overall sales in the asst. yr. 1992-93 is due to allowing more discount. It was also noticed that the managing director and other directors of the company were getting salary and commission from the assessee for service rendered by them in general administration, marketing, etc. It was also found that the assessee had made payments to other legal experts without involving the consultants. As regards the finance and management information control system, the AO held that the assessee had paid legal and professional charges independently to the concerned experts and these payments were not made through M/s Team Paarel. Following the decision of the Supreme Court in Lachminarayan Madan Lal v. CIT : [1972]86ITR439(SC) and J.K. Steel & Industries Ltd. v. CIT : [1978]112ITR285(Cal) the AO held that the service charges claimed to have been paid by the assessee is hit by Section 40A(2)(b) of the IT Act, and the entire amount claimed towards service charges was disallowed.
3. The CIT(A) allowed the appeal filed by the assessee and the appeal filed by the Revenue before the Tribunal, was also dismissed. Aggrieved by the above, the Revenue has come up in appeal before us.
4. Shri George K. George, learned standing counsel for the Revenue, contended that the CIT(A) and the Tribunal have not assessed the facts and evidence in the correct perspective and there is no rationale for the conclusions drawn by them. It was argued that the AO had considered all the aspects in the correct perspective. Learned standing counsel pointed out that the company actually consisted of four shareholders and going by the agreement executed with M/s Team Paarel, it shows that the four partners are : the managing director of the company, viz., Shri Thomas Elias Paarel, another director Shri Kuriakose Elias Paarel, another partner viz., Shri Punnoose Elias Paarel is an employee of the company as well as the brother of the managing director and the father of the managing director, Shri P.T. Elias. It is submitted by the learned standing counsel that all these persons are receiving salary and commission from the company. It is also pointed out that there had not been any improvement in the business of the company by employing technical consultants. By relying upon Section 40A(2)(b) of the Act, it is contended that the entire amount has to be disallowed. Learned standing counsel also relied upon the decision of the Supreme Court in McDowell & Co. Ltd. v. CTO : [1985]154ITR148(SC) to contend for the position that it should be looked into whether the transaction is a device to avoid tax and whether the transaction can be approved at all.
5. Shri Joseph Markose, learned senior counsel for the assessee contended that the approach made by the CIT(A) and by the Tribunal is perfectly in order. It was submitted that even though some of the partners of the firm and the shareholders of the company are common, it is clear that only by engaging the firm, the business stood improved and the service charges paid had a close nexus with the activities undertaken by them and the transaction is a real and genuine one. It is contended that the business turnover had increased than the previous year only because of the engagement of the firm and as such the conclusion arrived at by the CIT(A) and the Tribunal is perfectly in order.
6. Section 40A (2)(a) and (2)(b) is in the following terms:
40A(2)(a) : Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in Clause (b) of this sub-section, and the AO is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction.
(b) The persons referred to in Clause (a) are the following, namely:
(i) ...
(ii) where the assessee is a company, any director of the company,firm, association of persons or Hindu partner or the firm, or member Undivided family of the association or family, orany relative of such directorpartner or member;(iii) & (iv) ...
(v) a company, firm, AOP or HUF or which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member;
Therefore, the AO is obliged to consider whether the payments made to persons made mention in Clause (b) towards service charges are for the legitimate needs of the business or profession of the assessee. Herein, the facts show that the company consists of four shareholders, viz. (1) Mr. Thomas Elias Parrel, (2) Mrs. Ponnamma Elias, (3) Mr. Kuriakose Elias Paarel and (4) Mrs. Roshini Punnoose. The managing director is sl. No. 1 and sl. Nos. 3 and 4 were directors. The names of the partners show that they are the managing director of the company, another director of the company, brother of the managing director who is an employee of the company and father of the managing director. The managing director had received salary and commission amounting to Rs. 1,21,730, Shri Kuriakose Elias Paarel, who is a director, had received remuneration and commission of Rs. 1,60,730, Shri Punnoose Elias Paarel who is the brother of the managing director and employee of the company, has been paid salary of Rs. 71,090 and commission of Rs. 12,331 by the company during the relevant period. During the period relevant for the asst. yr. 1991-92, the assessee had not incurred any expenditure on account of service charges. During the year ended on 31st March, 1991 the total sales stood at Rs. 2,57,72,289, whereas for the year which ended on 31st March, 1992 the total sales stood at Rs. 3,24,60,746. It was noticed by the AO that during the year 1992-93 the percentage of discount was 3.81 percent, whereas during the year which ended on 31st March, 1991 the percentage of discount was 1.88 per cent and therefore the increase in the overall sales is only due to the increase in the amount of discount. In fact, the above finding rendered by the AO is based on the correct appreciation of the actual factual position. The increase in sales turnover is not due to any extra effort done by the consulting firm.
In fact, the managing director and other directors have received remuneration from the company and they have rendered services in general administration, marketing, etc., to the company. For the very same functions service charges have been paid to the firm M/s Team Paarel. It really shows that the persons concerned are the same and the remuneration actually received from the company reflects the service rendered by them to the company and it is not due to any extra service rendered by them as partners of M/s Team Paarel.
7. The assessee has got a case that a chartered accountant, viz., Mr. Stanly Kunjipalu was retained by M/s Team Paarel for giving advice on financial and accounts matters and he was also giving services on management and information system to the company and whose charges were paid by M/s Team Paarel, The AO found that this claim is not correct. The letter dt. 1st Nov., 1993 by which details are furnished by the assessee shows that the said chartered accountant had received professional charges from the company which have been remitted by the company in its accounts. The company had also paid charges to advocate, chartered engineer, etc. Therefore, the service charges have already been met by the company which are reflected in their accounts wherein the firm Team Paarel does not come into the picture at all.
8. Thus, it is a case where the real nature of the payment shows that the very same persons who are managing the company, have been shown as in receipt of remuneration being the partners of the firm. While considering this question, the dictum laid down in McDowell & Co. Ltd. (supra) is relevant. Chinnappa Reddy, J. in the concurring judgment, reiterated that 'in our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax and whether the transaction is such that the judicial process may accord its approval to it'. In the light of the above dictum, we are of the view that the transaction herein is clearly a device to avoid tax and the same is not convincing.
9. The CIT(A) reversed the order passed by the AO only on the ground that to have the application of Section 40A(2)(b) of the Act, it should have been established that the fair market value of services for which the payment is made Is less than the amount paid by the assessee. The real issue was not at all considered by the CIT(A). The approach made is totally erroneous. The Tribunal after noticing that the managing director or some of the directors of the assessee-company are related to the partners of the firm, referred to the claim of the assessee that specialised services rendered by them are those which the assesses company could not do and they helped to increase the export market. The Tribunal assumed that they also introduced some innovation in the working of the company to boost production and it was presumed that the payment of service charges paid by the assessee was not (for) business expediency and hence an allowable deduction. We are of the view that none of the aspects relevant have been considered by the Tribunal and the import of Section 40A(2)(b) has not been discussed. The fact that there was no business increase actually, because of the services rendered by them, was also not considered and the fact that the company has been paying salary and commission to them for some service was also not considered, The approach made is totally perverse and there is no rationale in it.
We, therefore, answer the questions in favour of the Revenue and against the assessee and consequently allow the appeal by setting aside the orders of the CIT(A) and the Tribunal and restore the order passed by the AO.