Calcutta HC confirms disallowance of payments to group's central company made on pre-determined basis treating them as Contractual Payments and not Reimbursements

 The Calcutta High Court upheld the Tribunal’s disallowance of payments made by the taxpayer that were labelled as reimbursements but were pre-decided irrespective of actual expenditure. The Court held that since the payments were fixed percentages of net sales and not linked to actual costs, they were in substance contractual payments for services and attracted tax deduction at source. As the taxpayer did not deduct tax at source, the disallowance was sustained. Typically, no tax is required to be deducted on genuine reimbursements made on the basis of actual expenses.

 

Background

 

*            The taxpayer made regular payments to group companies for services such as advertisement, sales promotion, marketing, handling, storage, and collection.

*            The payments were pre-determined as percentages of net sales and were not tied to actual expenditure incurred.

*            The taxpayer maintained written agreements and internal records for the payments, claiming them as business reimbursements.

*            The Assessing Officer (AO) disallowed the expenditure on the ground that the payments were contractual in nature and tax had not been deducted at source.

*            The CIT(A) reversed the disallowance, accepting taxpayer’s contention that the payments were reimbursement for expenses incurred by group companies.

*            The revenue appealed before the Tribunal, which upheld the AO’s disallowance in respect of the aforesaid payments.

*            Normally, TDS is not

 

 

Tribunal’s Findings

 

*            The payments were pre-decided percentages of net sales and not linked to actual expenses, hence, they could not be regarded as genuine reimbursements.

*            The agreements demonstrated that the payments were effectively consideration for services rendered by the group companies.

*            The payments were, in substance, consideration for services rendered and accordingly attracted tax deduction at source obligations, which the taxpayer failed to comply with.

*            Based on this analysis, the Tribunal concluded that the disallowance for the payments (advertisement, marketing, sales promotion) was justified.

 

 

Taxpayer’s Contention

 

*            The taxpayer argued that the payments were legitimate business reimbursements supported by agreements and internal records.

*            It contended that the pre-decided methodology did not change the nature of the payments and that the payments were incurred wholly for the purposes of business operations.

*            It was further submitted that the recipient entities had deducted tax on the underlying payments made by them and had included the reimbursements in their taxable income and paid due taxes.

*            Accordingly, disallowance in the hands of the taxpayer was unwarranted.

 

High Court Analysis and Findings

 

*            The Court agreed with the Tribunal that pre-decided payments not linked to actual expenditure cannot qualify as genuine reimbursements.

*            Payments must be substantiated and directly connected to actual expenses to qualify as deductible business expenditure.

*            Even though the taxpayer maintained agreements and internal records, the Court held that the payments were contractual in nature for services rendered.

*            Compliance by the recipient entities or inclusion of amounts in their taxable income did not absolve the taxpayer of its independent obligation to deduct tax at source.

*            The Tribunal’s disallowance was therefore upheld.

 

 Key Takeaway

Payments labelled as reimbursements which are pre-decided irrespective of actual expenditure cannot be treated as allowable business expenses, unless they are linked to actual costs incurred and properly substantiated. Pre-determined payments are effectively contractual in nature and thus attracts withholding tax obligations, and failure to comply with it may result in disallowance.