Section 40A(3) will not hit if purchase from single person and value of each invoice is less than Rs 20000

T.M. Sreedharan for the Appellant. Smt. Susan George Varghese for the Respondent.

ORDER

B.R. Baskaran, Accountant Member – The appeal of the assessee is directed against the order dated 23-09-2010 passed by Ld. CIT(A)-I, Kochi and it relates to the assessment year 2007-08.

2. The appeal is barred by limitation by 198 days. The assessee has moved a petition requesting the bench to condone the delay. In the said petition, it is stated that the assessee, upon receipt of the appellate order of Ld. CIT(A) by 26.10.2010, filed a rectification petition before the first appellate authority on 31.12.2010 pointing out mistakes apparent from record in the appellate order. However, the Ld. CIT(A) rejected the petition and the relevant order was received by it on 19.5.2011. Thereafter the assessee has filed the present appeal before the Tribunal within 60 days of receipt of the rectification order, i.e. on 11.07.2011. However, since the present appeal is filed against the original order, the time limit is calculated from the date of receipt of the same and hence there was a delay of 198 days. It is further stated that the delay was caused on account of the above cited reasons and is not due to any wilful omission on the part of the assessee and the assessee was under bonafide belief that the appeal before Tribunal could be filed only after receipt of the rectification order. Accordingly, it is prayed that the delay in filing the present appeal be condoned.

3. The Ld. D.R objected to the plea made by the assessee by stating that the assessee had moved a rectification order seeking rectification of only one issue, viz., disallowance made u/s 40A(3) of the Act. However, the present appeal has been filed on many other issues, meaning thereby, the assessee had initially accepted the decision of the Ld. CIT(A) in respect of other issues. Accordingly, the Ld. D.R submitted that the Tribunal should consider only the issue relating to the disallowance made u/s 40A(3) of the Act, if it chooses to condone the delay.

4. We have heard the parties on this preliminary issue. There is no dispute that the appeal filed by the assessee will not become time barred if the date of receipt of the rectification order passed by Ld. CIT(A) is considered. However, since the present appeal is preferred against the original order, the time limit is required to be computed from the date of receipt of the same. However, we notice that the assessee was not keeping quiet after receipt of the original appellate order, but pursuing the matter by filing a rectification petition before the first appellate authority. Thus the assessee was pursuing some other available remedy available under the Act, which, in our view, can be considered as sufficient reason. Thus, in our view, the delay has occurred on account of sufficient reasons and hence the same deserves to be condoned. Accordingly, we condone the delay in filing the appeal and admit the same. The Ld. D.R submitted that the issue relating to disallowance made u/s 40A(3) alone should be considered by the Tribunal, if the delay is condoned, i.e., according to Ld. D.R, the delay should be considered only in respect of one of the issues contested in the appeal and the delay should not be condoned in respect of other issues. In our view, the said contention of Ld. D.R may not be legally tenable. The delay has occurred in filing the appeal itself and at this stage, the Tribunal is only considering whether there was sufficient cause for the delay. The question of considering the various grounds urged in the appeal would arise only if the delay is condoned and the appeal is admitted. Hence, in our view, the Tribunal is not obliged to look into the grounds urged in the appeal before admitting the appeal for hearing. Even otherwise, we do not think that the statute permits dissecting of the grounds of appeal in the matter of condoning delay in filing the appeal.

5. In view of the foregoing discussions, we are of the view that there was sufficient cause for the delay. Accordingly, we condone the delay in preferring the present appeal before us and admit the same.

6. The grounds urged by the assessee give rise to the following issues:-

At the time of hearing, the Ld. Counsel for the assessee did not press the ground relating to the disallowance of loss on sale of car. Accordingly, the ground relating to the same is dismissed as not pressed.

7. The facts relating to the case are stated in brief. The assessee is a partnership firm and is engaged in the business of trading in rice. In the scrutiny proceedings, the assessing officer made various disallowances and determined the total income at Rs. 65,29,550/- as against the returned income of Rs. 6,77,260/-. The assessee could get only partial relief in the appeal filed before Ld. CIT(A) and hence it has preferred the present appeal before us.

8. The first issue relates to the disallowance made u/s 40A(3) of the Act in respect of purchase of rice. The assessing officer noticed that the assessee had purchased rice by paying cash in excess of Rs. 20,000/- in violation of provisions of sec. 40A(3) of the Act. The aggregate amount of such kind of payments was quantified by the assessing officer at Rs. 1,04,66,883/- and 20% thereof was disallowed as per the mandate of the provisions of sec.40A(3) existing at the relevant point of time. The Ld. CIT(A) also confirmed the said disallowance.

9. The assessee has challenged the said disallowance before us on the following grounds:-

10. With regard to the claim of the assessee that the rice is an agricultural produce, the Ld. D.R submitted that the rice cannot be considered as an agricultural produce and in this regard, she placed reliance on the decision of Hon’ble Madhya Pradesh High Court in the case of CIT v. Kissan Co-operative Rice Mills Ltd. [1976] 103 ITR 264. Further she submitted that exception provided in Rule 6DD shall apply only if the agricultural produce is purchased from growers or producer of forest produce. Accordingly she submitted that the purchases agricultural produce by making payment in cash would not be covered by the exception, if it is purchased from the suppliers instead of the growers. In this regard, she placed reliance on the following decisions:-

With regard to the claim that the purchases were made through agents, the Ld. D.R submitted that the Ld. CIT(A) and the AO has clearly recorded a finding that the assessee has effected purchases only through registered dealers, even though some of the dealers describe themselves as “commission agents”. She further submitted that the amendment made to sec. 40A(3) with effect from the assessment year 2009-10 could be applied to the year under consideration, as the amendment is clarificatory in nature, as it has brought out the legislative intention and hence it will have retrospective effect.

11. We have heard the rival contentions on this issue and perused the record. The first contention of Ld A.R is that the rice purchased by the assessee is an agricultural produce and hence it is covered by the exceptions given in Rule 6DD of the I.T Rules. For the sake of convenience, we extract below clause (e) of Rule 6DD of IT Rules.

“(e) where the payment is made for the purchase of-

A careful perusal of the above said rule would show that there are two cumulative conditions specified therein viz., (a) payment should be made for the purchase of agricultural or forest produce and (b) it should be paid to the cultivator, grower or producer of such produce. In this regard a gainful reference may be made to the decision of the Special bench rendered in the case of ITO v. Kenaram Saha & Subhash Saha [2009] 116 ITD 1 (Kol.-SB) and the decision rendered by Hon’ble Allahabad High Court in the case of Pehlaj Rai Daryanmal(supra). In the instant case, the tax authorities have recorded a finding that the payment for the purchase of rice was made to the dealers and not to the cultivators or growers. Thus, in view of the failure of the second condition, we need not go into the controversy as to whether the rice is an agricultural produce or not. The assessee placed reliance on the decision rendered by Hon’ble Jurisdictional High Court in the case of Interseas Sea Food Exporters (supra). However, in our view, the said decision shall not apply to the facts of the instant case. In the case of Interseas Sea Food Exporters (supra), the court was interpreting the term “fish products”. It is pertinent to mention that the Rule 6DD(e) provides exception in respect of “fish or fish products”. However, the same Rule provides exception only in respect of “agricultural or forest produce” and not to “agricultural products”.

12. The next contention of the assessee was that the purchases were effected through agents. The assessee has placed reliance in this regard to the following clause of Rule 6DD:-

(k) where the payment is made by any person to his agent who is required to make payment in cash for goods or services on behalf of such person”

However, we notice that the assessing officer has recorded a finding that the purchases were effected by the assessee from registered traders/commission agents, meaning thereby those dealers are independent businessmen acting in their own capacity and not as an agent of the assessee. Hence, we do not find any merit in the said contention also.

13. The next contention of the assessee was that the purchases effected by it were found to be genuine and they are supported by proper documentary evidences. In our view, there is no merit in this contention also, as the provisions of sec. 40A(3) shall come into play only in respect of genuine expenses.

14. The last contention of the assessee was that the tax authorities have made disallowance u/s 40A(3) in respect of purchases supported by individual bills having value of less than Rs. 20,000/-. We notice that the tax authorities have considered the aggregate amount of payments effected to a single person in a day and wherever the aggregate payments exceeded the monetary limit of Rs. 20,000/-, disallowance u/s 40A(3) has been made. The tax authorities have gone on the reasoning that the amendment made to Sec. 40A(3) by the Finance Act, 2008 with effect from 1.4.2009 does not permit splitting of payments and since the said amendment is clarificatory in nature, it will have retrospective operation. Accordingly, the tax authorities have ignored the value of each bill and instead gone by the aggregate amount of payments made to a single person in a day.

15. In order to adjudicate this issue, we feel it pertinent to extract below both the provisions of sec. 40A(3) applicable to the year under consideration and the amended provisions.

(A) Sec. 40A(3) applicable to the year under consideration:—

“Where the assessee incurs any expenditure in respect of which payment is made, after such date (not being later than the 31st day of March, 1969) as may be specified in this behalf by the Central Government by notification in the official Gazette, in a sum exceeding twenty thousand rupees otherwise than by an account payee cheque drawn on a bank or account payee bank draft, twenty percent of such expenditure shall not be allowed as a deduction”.

(B) Sec. 40A(3) as amended by Finance Act 2008 w.e.f. 1.4.2009:—

“Where the assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, exceeds twenty thousand rupees, no deduction shall be allowed in respect of such expenditure”.

The purpose of amendment was explained by the CBDT as under:—

“13.1 Clause (a) of sub-section (3) of section 40A of the Income tax Act, 1961 provides that any expenditure incurred in respect of which payment is made in a sum exceeding Rs. 20,000/- otherwise than by an account payee cheque drawn on a bank or by an account payee bank draft, shall not be allowed as a deduction. Clause (b) of sub-section (3) of section 40A also provides for deeming a payment as profits and gains of business or profession if the expenditure is incurred in a particular year but the payment is made in any subsequent year in a sum exceeding Rs. 20,000/-otherwise than by an account payee cheque or by an account payee bank draft. However, the provisions of this section are subject to exceptions as provided in rule 6DD of the Income tax Rules, 1962.

13.2 Sub-section (3) of section 40A is an anti tax evasion measure. By requiring payments to be made by an account payee instrument, it is possible to verify the genuineness of the transaction. Thereby the risk of evasion is substantially mitigated. Field formations have reported that assessees tend to circumvent the provisions of sub-section (3) of section 40A by splitting a particular high value payment to one person into several cash payments, each below Rs. 20,000/-. This splitting is also resorted to for payments made in the course of a single day. The courts have approved such splitting by interpreting the words “in a sum” used in the section to mean a single sum thereby applying the limit to each transaction. This interpretation is against the legislative intent and has, consequently, adversely affected the efficacy of this anti-abuse provision.

13.3 Therefore, the provisions of sub-section (3) of section 40A have been amended providing that the provisions of sub-section (3) shall also be attracted where the aggregate of payments made to a single party otherwise than by an account payee cheque drawn on a bank or account payee draft exceeds twenty thousand rupees in a day.

13.4 Applicability:- This amendment has been made applicable with effect from 1st April 2009 and shall accordingly apply for the assessment year 2009-2010 and subsequent years”

16. It is pertinent to note here that the rate of disallowance was 20% for the year under consideration, i.e., assessment year 2007-08. The Finance Act, 2007 enhanced the disallowance to 100% w.e.f. 1.4.2008. Again the amendment cited above was brought by Finance Act, 2008 w.e.f. 1.4.2009. The Ld. CIT(A) has taken the view that the amendment made by Finance Act, 2008 w.e.f. 1.4.2009 shall apply to the year under consideration also, as the said amendment is clarificatory in nature. In our view, there are two major differences between the provisions as applicable to the year under consideration and the provisions amended by Finance Act, 2008.

The question that arises is whether the amendment brought out by Finance Act, 2008 w.e.f. 1.4.2009 can be considered as clarificatory in nature so that it shall have retrospective operation? As discussed earlier, the amendment only debars making several payments of less than or equal to Rs. 20,000/- in a day to a single person, but does not debar making several payments of less than or equal to Rs. 20,000/- on different dates to a single person, meaning thereby, the splitting up of payments during the course of a day to a single person is only debarred. Further, as stated earlier, there is significant variance in the quantum of disallowance to be made for violation of sec. 40A(3) of the Act. We notice that the Ld. CIT(A), though held that the amendment is retrospective in operation, however, has restricted to disallowance only to 20% of the expenditure as per the old provisions., i.e., the Ld. CIT(A) has applied the amended provisions only in part. In our view, an amendment cannot have retrospective operation in part. Since the amendment only debars splitting up of payments made to a person during the course of a day and did not debar splitting up in toto and since there is significant variance in the rate of disallowance, in our view, the amendment brought out by Finance Act, 2008 can only be considered as substantive in nature and shall have prospective operation only.

17. The CBDT circular (referred supra) refers to “a particular high value payment”. The necessity to make payment to a party would arise only after conclusion of a transaction, say a “purchase” and the said deal would culminate into rising of a bill/invoice. Hence the term “high value payment” apparently refers to the concerned bill/invoice in respect of which the payment is required to be made, meaning thereby, the concerned bill/invoice should also be of a higher value. However, if the value of bill/invoice itself is less than Rs. 20,000/-, it cannot be considered as a high value transaction in the context of sec. 40A(3) and hence the payment effected in respect of that kind of bill/invoice cannot be considered as high value payment. Accordingly, in our view, if the purchase is effected from a single person by way of several bills/invoices and if the value of each bill/invoice is less than Rs. 20,000/-, then payments made to settle each bill/invoice would not be hit by the provisions of sec. 40A(3), as each bill/invoice has to be considered as a separate contract. The question of splitting up of the payment also does not arise in respect of such type of bills/invoices, as the value of each bill is less than Rs. 20,000/-. In view of the above, we are unable to agree with the decision of Ld. CIT(A) in holding that the purchases effected through several bills/invoices from a person shall also be hit by the provisions of sec. 40A(3) and accordingly set aside the said view of the tax authorities.

18. The assessee has submitted that the aggregate amount of purchases effected by way of individual bills having value of less than Rs. 20,000/- was Rs. 63,73,755/-. In view of the foregoing discussions, in our view, such kind of purchases are not hit by the provisions of sec. 40A(3). However, the said claim of the assessee requires verification at the end of the assessing officer. Further, we have held that the amendment brought out by Finance Act, 2008 cannot be applied to the year under consideration. In view of the above, the whole issue requires fresh examination at the end of the assessing officer. Accordingly, we set aside the order of Ld. CIT(A) on this issue and restore the same to the file of the assessing officer with the direction to examine the issue afresh in the light of the discussions made above and take appropriate decision after affording necessary opportunity of being heard to the assessee.

19. The next issue relates to the disallowance of freight charges under section 40A(3) and u/s. 40(a)(ia) of the Act. It is pertinent to note that the Ld. CIT(A) has granted partial relief on this issue and since the department has not challenged the relief granted by Ld. CIT(A), the order of first appellate authority in respect of the said relief attains finality.

20. With regard to the disallowance made u/s. 40A(3) of the Act, the discussions made in the preceding paragraphs on various principles relating to that section shall apply to the payment of freight charges also. With regard to the disallowance u/s. 40(a)(ia) of the Act, the Ld. Counsel submitted that the assessee company did not engage any lorries and they were engaged by the suppliers of rice. Accordingly, he submitted that there is no privity of contract between the assessee and the lorry owners and hence, the provisions of section 40(a)(ia) of the Act shall not apply to the freight payments. He further submitted that the Assessing Officer has applied the provisions of section 40(a)(ia) even to the payments which are not required to be subjected to TDS u/s. 194C of the Act.

21. On the contrary, the Ld. DR submitted that the contract is implicit in respect of freight charges paid by the assessee in as much as the assessee has agreed to pay the freight charges at the time of delivery of goods, even if the lorry is engaged by the suppliers. The Ld. DR further submitted that the Ld. CIT(A) has already directed the Assessing Officer to exclude the freight payments which are not covered by the provisions of section 194C of the Act.

22. We have heard the rival contentions on this issue and perused the record. The assessee has claimed that there is no privity of contract with the lorry owners, since it has not engaged the lorries. In our view, the nature of contract has to be ascertained on the basis of surrounding circumstances. In that regard, in our view, one has to refer to the terms of agreement entered between the supplier and the assessee, particularly with regard to the responsibility of delivery of the product. If the supplier takes the responsibility to deliver the goods to the doorsteps of the assessee, then it can be inferred that the contract exists between the lorry owners and the supplier. In that case, even if the assessee makes payment of freight charges, it would be considered as payment made to the concerned supplier. On the other hand, if the assessee is responsible to take delivery from the doorsteps of the supplier, then it can be inferred that the contract exists between the assessee and the lorry owners. In that kind of situation, even if the supplier engages the lorry, it has to be construed that the supplier is acting as the agent of the assessee in the process of booking of lorry for the purpose of transportation of the goods to the assessee. Hence, the responsibility to deduct tax at source on freight payments would depend upon the terms of agreement entered/available between the assessee and the suppliers. We notice that the tax authorities have taken the view that the assessee is liable to deduct tax at source on lorry freight payments without examining the terms of agreement between the assessee and the suppliers. The assessee has also failed to produce any evidence to show that the responsibility to make delivery of goods to the doorsteps of the assessee lies upon the suppliers. Under these circumstances, in our view, the liability to deduct tax at source on freight payments has to be considered afresh at the end of the assessing officer by duly considering the terms of agreement available between the supplier and the assessee. We have already stated that the applicability of the provisions of section 40A(3) also needs to be examined afresh in the light of the discussions made in the preceding paragraphs. Accordingly, we modify the order passed by the Ld. CIT(A) on this issue and restore the same to the file of the Assessing Officer with a direction to examine the issue afresh in the light of the discussions made supra. Since the Ld. CIT(A) has already directed to examine the claim of the assessee in respect of freight payments of less than Rs. 20,000/-, we do not incline to repeat the said direction here. We may also make it clear that the relief already granted by the Ld. CIT(A) on this issue shall stand intact.

23. The next issue relates to the disallowance of interest of Rs. 92,668/-. The Assessing Officer noticed that the assessee paid interest of Rs. 92,668/- to one of the partners, Smt. Durgadevi, since she was having credit balance in her capital account. However, the Assessing Officer noticed that other partners were having debit balances and hence the aggregation of the capital balances of all partners has resulted in a net debit balance. Hence, the Assessing Officer took the view that the interest is not payable on the capital account of one of the partners and accordingly disallowed the interest amount of Rs. 92,668/- referred above. The Ld. CIT(A) confirmed the addition with the following observations:

“22. I have carefully considered the relevant facts and provisions of law with regard to the issue involved. I find that as per partnership deed itself interest was payable to partners only when there was a credit balance in the capital account. It is imperative that when interest is payable on credit balance to a partner, interest was also be payable by a partner on the debit balance. It is undisputed fact that there was a net debit balance in the capital account of partners on account of substantial withdrawals by two partners and therefore, in the least, no interest can be debited and charged to the P&L account to reduce taxable income. Interest, if any, payable to one partner has to come from other two partners having debit balance. I, therefore, find that Assessing Officer was fully justified in disallowing the claim of interest of Rs. 92,668/- on capital the same is accordingly confirmed”.

24. We have carefully considered the rival submissions on this issue and also the decision taken by the Ld. CIT(A). Since the assessee did not deny the fact of availability of net debit balance in the aggregate capital account of the partners, we do not find any infirmity in the decision of the Ld. CIT(A) in upholding this disallowance. Accordingly, we confirm the order of the Ld. CIT(A) on this issue.

25. The next issue relates to the partial confirmation of interest disallowance to the extent of Rs. 59,441/-. The Assessing Officer also noticed that the assessee had claimed interest payment to bank to the tune of Rs. 59,441/-. Since there was net debit balance in the aggregate capital account of the partners, the Assessing Officer proceeded to compute interest at the rate of 12% on the net debit balance in the capital account of the partners on notional basis and assessed the same. The assessing officer computed notional interest at Rs. 1,99,264/- . The Ld. CIT(A) took the view that the law does not provide for taxing interest income on notional basis. However, since the assessee had paid interest to bank to the extent of Rs. 59,441/-, the Ld. CIT(A) restricted the addition to the extent of interest paid to the bank and deleted the balance amount. The observations made by the Ld. CIT(A) in this regard are extracted below:

“22.1 With regard to addition of Rs. 1,99,264 by working out notional interest on debit balance of partners, I find merit in the claim of the appellant that law does not provide for taxing any interest income on notional basis. I however, find that interest paid to banks of Rs. 59,441/-was attributable to huge debit balance in the accounts of partners and therefore could not be allowed as business expenditure. The expenditure made by the Assessing Officer is therefore confirmed to the extent of Rs. 59,441/- being interest claimed as deduction and balance is directed to be withdrawn. The Assessing Officer shall accordingly grant appropriate relief to the appellant. This ground of appeal is accordingly partly allowed”

It is a fact that the assessee had net debit balance in aggregate capital account of the partners and it did not collect any interest on the debit balance cited above. At the same time, it is also a fact that the assessee has paid interest of Rs. 59,441/- to a bank. Under these circumstance, in our view, the Ld. CIT(A) was justified in confirming the addition to the extent of Rs. 59,441/-, apparently on the ground of diversion of interest bearing funds.

26. In the result, the appeal filed by the assessee is treated as partly allowed for statistical purposes.