Business expenditure: Payment to related person: Disallowance u/s. 40A(2)(b): A.Y. 1995-96: Payment to subsidiary company: Section 40A(2)(b) not applicable:

The assessee, a manufacturer of insulation paper boards, entered into an agreement with its subsidiary company for manufacture of footwear soles. Under the agreement, the assessee was to pay to the subsidiary management fees of Rs. 4 lakh per month. In the A. Y. 1995-96, the assessee claimed deduction of Rs. 48 lakh so paid to the subsidiary. The Assessing Officer allowed 50% of the claim and disallowed Rs. 24 lakh u/s. 40A(2)(b). The Tribunal held that the genuineness of the agreement and the services rendered by the subsidiary company were not doubted and there being no finding that the payment made by the assessee was excessive u/s. 40A(2)(b) the Tribunal deleted the disallowance.

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

“i) To attract the provisions of section 40A(2), the assessee has to incur an expenditure by making payment to the person referred to in clause (b). The assessee was a company. The person to whom it had to make the payment in order to attract the provision was any director of the company or any relative of director.

ii) Admittedly, the payment was made to the subsidiary company and not to any director or any relative of director. Therefore, the requirement of section 40A(2)(b) was not fulfilled. The Tribunal was justified in directing the deletion of the disallowance.”