1. These are the appeals filed by the assessee and the department aggrieved by the order of the Commissioner (Appeals) by which he directed certain reliefs and confirmed certain additions made by the ITO. In the assessee's appeal the basic objection taken to was to an addition of Rs. 90,000 maintained by the Commissioner (Appeals) and also to the rejection of allowance of weighted deduction under Section 35B of the Income-tax Act, 1961 ('the Act') in respect of certain items. In the departmental appeal the objection is taken to certain reliefs granted by the Commissioner (Appeals) which we will come to a little later.
2. We shall first take up the assessee's appeal. The relevant facts relating to the addition of Rs. 90,000 are: The assessee as is seen from the records is a manufacturer of various garments for export. The total turnover as seen from the assessment order is of the order of Rs. 99.42 lakhs. The accounts maintained by the assessee show, inter alia, that it paid a total sum of about Rs. 18.83 lakhs towards fabrication charges of these garments. Of these Rs. 11.61 lakhs were paid to the following three parties:Sanjana Enterprises 37,575 2.55 7.80 11.61 The partners of the assessee-firm are found to be interested very substantially either by themselves or through their relatives in the first three concerns. We will not at this moment go into the question as to how they are related. The ITO came to the conclusion that the payments to these parties were excessive and unreasonable having regard to the legitimate business needs of the assessee-firm. He proposed a total disallowance of the payments made to Sunil International and Sanjana Enterprises of Rs. 1.36 lakhs and Rs. 2.55 lakhs, respectively.
He even referred to Pavit India being a relative but no disallowance as such was proposed. However, when the matter went before the IAC under Section 144B of the Act, he Was not convinced with the reasons given by the ITO for the disallowance of the total sum paid to the above two parties but out of the payment made to Pavit India, he suggested a disallowance of Rs. 1.50 lakhs mainly on the ground that the average price per piece paid to Pavit India was more than the average price per piece paid to the other fabricators and that a disallowance of Rs. 1 per piece would meet the ends of justice. Aggrieved by this addition, an appeal was filed before the Commissioner (Appeals). The major contentions raised were: (a) that when the ITO did not propose any addition in the draft order out of the payments made to Pavit India, it was not open to the IAC to direct an addition suo motu and as such that addition directed by the IAC was illegal, and (b) on a comparative basis the payment made to Pavit India could not be said to be excessive or unreasonable having regard to the legitimate needs of the business particularly in the case of manufacture of garments where different styles of stitching of garments would determine the amount of fabrication charges to be paid as well as the inputs like buttons, laces, covering cloth and their quality. There were more than 200 styles of fashions exported by the assessee and the price of garments ranged between Rs. 20 to Rs. 80 per piece and this showed the variation in the fabrication charges and unless a total garments along with style and input material was compared with a like styled garments fabricated by other fabricators, it would not be possible to determine whether the charges paid to Pavit India was excessive or unreasonable. The Commissioner (Appeals) did not feel convinced of these arguments.
Insofar as the first point was concerned, while he agreed with the contention that the ITO did not propose this addition in the draft order submitted to the IAC and that the IAC suo motu made this addition, still the ITO's assessment order showed that the payments made to Pavit India also was in the contemplation of the ITO for disallowance and consequently could not be considered to be an item not considered by the ITO even though no addition was proposed on that account. However, he held alternatively that if the IAC's instructions in this regard were considered as without jurisdiction, he had the power coterminous with that of the assessing officer and in exercise of that power, he could go into every question that was processed by the ITO and decide whether there was any justification for the addition made. Then he went into the question of reasonableness and after picking out certain items of garments manufactured by Pavit India as listed by him in his order in paragraph 2.11, he held that there was probability of the payments made to Pavit India being not reasonable and excessive having regard to the fair market value of the services rendered. Then again like the IAC, he also compared the average rates and considered that excess rate paid was Re. 1 per piece and on that basis, sustained an addition of Rs. 90,000 by deleting the balance of Rs. 60,000 which is now contested before us.
3. We have carefully considered the various objections raised by the learned chartered accountant for the assessee and the arguments by the learned departmental representative. What is most striking in this case is, as against an effort to prove that there was excessive payment made to the fabricators having regard to the fair market value or the services to the assessee, there was any amount of suspicion running through the entire conclusions and the discussions of the ITO, the IAC and the Commissioner (Appeals) in proposing the addition and in confirming the same to some extent. The basis for the addition is the application of Section 40A(2)(a) of the Act which provides for expenses or payments, which are not to be deducted in certain circumstances.
This section says that notwithstanding anything to the contrary contained in any other provision of this Act relating to computation of income under the head 'Profits and gains of business or profession' 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), i.e., relatives, the ITO 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. The most important ingredient for the application of this section is the expenditure must be considered by the ITO to be excessive or unreasonable having regard to the fair market value of the goods or services or the legitimate needs of the business or the benefit derived or accruing to the assessee. In other words, what is first to be determined by the ITO, which is imperative, is the fair market value of the goods or services for which the payment is made. Unless the fair market value of the goods or services is established, no comparison can be possible and be made of the payment made by the assessee with the fair market value of the goods or services. Thus, we have tried to find out whether the fair market value of the services determined by the ITO is really fair and represented the fair market value. What we found on examination of the data collected by the ITO which was only appraised and reappraised by the IAC and the Commissioner (Appeals) is the comparison of the rates paid to Pavit India with the rates paid to the other fabricators by the assessee and that too by averaging. The difficulty in this kind of comparison is to ensure that like was compared with the like. The average fabrication price paid to other fabricators as noted by the authorities below was Rs. 6.80 per piece whereas the average price paid to Pavit India, according to the Commissioner (Appeals), is Rs? 8.20 per piece. This was considered as a fair comparison so as to arrive at the conclusion that the payment made to Pavit India was excessive. But what was missed is as we have observed a short-while ago was comparison of like with the like. It is not shown that the fabrication charges paid to other parties in respect of the same style of cloth with same quantity of inputs was compared. The data collected by the Commissioner (Appeals) to come to that conclusion as mentioned in paragraph No. 2.11 of his order clearly demonstrate that such a comparison was not made and perhaps could not have been made, e.g., the first item taken for comparison was of stitching charges paid for garments style No. 5471.
The rate paid was Rs. 8.35 per piece. In the remarks column it was said that this garment was exclusively made by Pavit India. Now when this garment was exclusively made by Pavit India, which means not by others, how it is possible to come to the conclusion that the fabrication charge paid for this garment was excessive or unreasonable having regard to the fair market value of the services. It can only be said that this expenditure was excessive or unreasonable. Only when it was compared with the fair market value of the services, which means that there is another market value or in the absence of market value, the fairness of the market value must have to be assessed and adjudged with reference to the relevant material. What is the material that is available to show that the payment made in respect of this garment was excessive or unreasonable, except suspicion perhaps very strong.
Similarly, in another item of style No. 7906 the payment was made at Rs. 8 per piece and it was also pointed out in the remarks column that this particular style was made by another fabricator Simisan, to whom Rs. 8.10 per piece was paid, the excess being 10 paise. Can we say that the 10 paise excess paid was unreasonable or unfair or excessive Then there is another style No. ITC-02 for which fabrication charge of Rs. 6.25 per piece was paid. Here it is shown the same style was made by Pavit India to whom Rs. 8.50 per piece was paid. When to Pavit India Rs. 6.25 per piece was paid at one time and Rs. 8.50 per piece was paid at another time, will it not become necessary to show whether the inputs are one and the same. A shirt is a shirt. Different tailors will charge differently depending upon their style, workmenship, material used and even the overheads depending upon again the location. Unless these comparisons are made and a fair assessment is made how can one arrive at the fair market value. Merely on the ipse dixit of the ITO it will be very unsafe to use this provision to make disallowances out of payments made to relatives and persons referred to in Section 40A(2)(b) without first establishing the fair market value. To repeat our finding here is that the fair market value was not established except raising strong suspicions. There is another style No. 7904 for which fabrication charges of Rs. 10.25 per piece were paid and it was shown in the remarks column that Rs. 7.02 per piece Was paid for PC without buttoning and Rs. 7.43 paid for button stitched. There are also some other processes to be gone through before a garment is ready for delivery which covers the fabrication charges, i.e., buttoning, cleaning, thread-cutting, pressing and finishing. The charges of fabrication will depend upon the performance of these processes. If some of these processes are not included in the agreement of fabrication, the charges might be lower. Otherwise, they might be higher. This important consideration also does not seem to have been taken into account. Then there are three other items, which show that those garments were exclusively made by Pavit India. In respect of those garments, which were exclusively made by Pavit India, our comments in regard to the very first item apply with equal force to these items also, i.e., to say that the items picked up by the Commissioner (Appeals) as examples, as representative items, do not go to prove the department's case any amount of vagueness in the conclusion and unsatis-factoriness of the basis in arriving at the conclusion is very much manifest in the observations that he made in the succeeding paragraph. The Commissioner (Appeals) points out in paragraph No. 2.12 that most of the items could not find any comparison as such style was not got fabricated by the assessee-firm from other fabricators. Then the assessee's explanation was that Pavit India possessed the necessary strength and capability of fabrication in a much better way than others and that was why they were preferred. The Commissioner (Appeals) held that this explanation was not satisfactory.
The observations made by the Commissioner (Appeals), to quote, are very interesting, from paragraph No. 2.13: I have carefully considered the submissions of the learned authorised representative. Apart from the general observations made by him in order to justify the high rates of more than Rs. 10 per piece to Pavit India, and in the absence of any comparable instances of payment to other fabricators, there is no evidence to prove that such high rates paid to Pavit India were commensurate with the fair market value of the services.
This observation will show that there were no comparable instances and that the fair market value of the services was taken for granted without establishing it. The concluding part of the order of the Commissioner (Appeals) says that the payments made to Pavit India in some measure were not commensurate with the fair market value of the services. He therefore, made comparison with the average rate paid to Pavit India with the average rate paid to others and disallowed Rs. 90,000 at the rate of Re. 1 per piece. We are unable to suscribe to this view that the payments made to Pavit India were excessive when as pointed out earlier the comparative instances were lacking and the garments were exclusively fabricated by Pavit India more so when Pavit India received the payments and fully accounted for them in their books of account and the payments were supported by vouchers and other materials. This circumstance may not be so relevant, if Section 40A(2)(6) is attracted. It is further pointed out that in none of the earlier years payment made towards fabrication charges were disallowed.
Another aspect to be considered is the rate of gross profit. The rate of gross profit shown by the assessee though was found to be inadequate by the ITO was found satisfactory by the IAC and the addition proposed by the ITO on that score was disapproved of, i.e., the gross profit disclosed was found to be proper. It is to be remembered that the fabrication charges formed part of the trading account. When the fabrication charges are inflated, as pointed out by the department, the gross profit rate would be lower, but which was not found to be lower.
It was found to be reasonable and adequate. Thus, to say that there was inflation in the fabrication charges and at the same time to say that the rate of gross profit was reasonable, is mutually contradictory.
This contention of inflation does not fit in the other. Even though Section 40A can be made use of to disallow the ultimate effect of the excessiveness or unreasonableness of the expenditure incurred would reflect in the lowering of the gross profit by the inflation of fabrication charges. This test also does not lend support to the view taken by the department. Thus, looked at from any angle it is difficult to agree with the conclusion of the department that the assessee paid higher charges to Pavit India, which could be considered as excessive or unreasonable having regard to the fair market value of the services or can it be said that the legitimate needs of the business do not require such payments. Here, the legitimate needs and benefit accruing to the business referred to in Section 40A(2) will take in the exclusive nature of the work to be performed by Pavit India. This disallowance, is therefore, uncalled for and we delete it. Here, we may say that in the departmental appeal objection was taken to the deletion of the disallowance of Rs. 60,000. Since we are of the view that there is no justification for the view that the payment of fabrication charges were excessive or unreasonable, the deletion of Rs. 60,000 by the Commissioner (Appeals) cannot be said to be incorrect. The ground in the departmental appeal, thus, stands covered by this conclusion.
4. The next objection in the assessee's appeal is against non-allowance of weighted deduction under Section 35B in respect of the following items: In respect of bank interest, the learned counsel for the assessee invited our attention to an order passed by the Delhi Bench 'C in the case of IAC v. Smt. Sudesh Madhok [IT Appeal No. 1110 (Delhi) of 1983] by which the Tribunal allowed weighted deduction on interest paid to the bank. Following with respect that order, we hold that the assessee is entitled to weighted deduction in respect of bank interest. The bank interest and bank commission are, in our view stand on the same footing and if bank interest is qualified for weighted deduction under Section 35B, a fortiorari the bank commission also should be entitled to the weighted deduction. However, we may point out that the department relied upon the decisions of the Special Benches of the Tribunal in the case of J. H. & Co. v. Second ITO  1 SOT 150 and in the case of ITO v. Happy Sound Industries  1 SOT 172. These Special Bench decisions were considered by the Delhi Bench 'C when the above decision was arrived at. We would, therefore, like to follow the order of the Tribunal referred to above. In respect of export division, the department allowed weighted deduction at 50 per cent of the salaries paid to the staff engaged in the export division. The Commissioner (Appeals) pointed out that the details filed before him showed that weighted deduction was claimed even in respect of wages paid to employees and workers like button operator, over-locker, cutter, etc., which go to add to the lost of manufacture, but not for development of export markets. In view of this position, he found it difficult to quantify the amount entitled to the deduction under Section 35B. On an estimate, he arrived at 50 per cent. The claim of the assessee was that at least 75 per cent should be allowed but we are unable to agree with this submission for lack of necessary details. The order of the Commissioner (Appeals) on this point is, in our opinion, reasonable and we confirm the same.
5. In respect of ground No. 1 in the assessee's appeal, since we have discussed the merits, we thought it unnecessary to go into the legal question raised as to whether it is open to the IAC to give directions under Section 144B when the ITO did not propose any particular addition. We find force in the view taken by the Commissioner (Appeals) that as an appellate authority it is open to him to go into all those questions, which were gone into by the ITO and adjudicate upon them even if not appealed against and that power was properly exercised in this case. The assessee's representative did not address us any argument on this question. This will dispose of the assessee's appeal.
6. Coming now to the departmental appeal, here as in the case of fabrication charges, the ITO has proposed disallowance of Rs. 2 lakhs on the instructions of the IAC under Section 144B. The same ground that the IAC had given this direction suo motu without being raised by the ITO was taken up before the Commissioner (Appeals) but the Commissioner (Appeals) overruled this objection and decided the matter on merits in favour of the assessee. Since we are of the view that that power has been properly exercised, we do not like to go into that question. In any case we find that the Commissioner (Appeals) was justified on merits. There is one concern called Sonu International to which average price of Rs. 7.45 per piece for embroidery work was paid. That was considered to be excessive when compared with the rates to the other parties, i.e., Kalakriti Sohan Ganj, New Delhi and Manmohan Embroidery Works, Delhi. The average price paid to these parties was, respectively, Rs. 3.85 per piece and Rs. 2.42 per piece. It is the excessiveness of the payment made to Sonu International that gave rise to the suspicion in the mind of the ITO who disallowed a sum of Rs. 2,18,000. It was contended before the Commissioner (Appeals) that the matter could not be decided merely on the basis of comparison of rates without anything more. The Commissioner (Appeals) in his order summed up the contentions raised before him,thus: The learned authorised representative pointed out that Shri Satish Chand partner of Sonu International, had appeared and his statement had been recorded by the ITO. The account books called for could not be produced by him because of loss due to theft and for that necessary evidence in the form of FIR had been filed before the ITO. Then, he pointed out that on the basis of the description of the type of embroidery carried out by Sonu International given in their bills, it would be clear that the work so carried was embroidery and crochet work. The rates for embroidery varied from 1.50 to 8.50 depending upon the design, quality and quantity of work, and crochet work was costlier as compared to ordinary embroidery. Moreover, crochet work was done at cheaper rates at Ghaziabad where Sonu International existed. He showed from the bills of the embroidery of Kalakriti whose payments have not been doubted that with regard to embroidery and crochet work they were also paid at the same rate. He also produced the bills of Sachitra Hast Kala Kendra, Modi Nagar for the subsequent year to show that the rates paid to outside parties were cheaper.
Then he observed that no disallowance could be made merely on comparison of rates more particularly in a case where Section 40A does not apply. Incidentally this finding which is correct, is at variance with the conclusion reached in fabrication charges. He found that the ITG except comparing the average rates did not bring any material to show that the payments made to this party was excessive or unreasonable. He found force with the submission made that more embroidery work was involved in the garments handled by Sonu International. He also did not see any extra commercial considerations in making these payments. With no relationship and without any extra commercial consideration, he observed that it is not open to the ITO to disallow any portion of the payment. He should have regard to the nature of work to be done. Again as we observed earlier, while dealing with the assessee's appeal the Commissioner (Appeals) has taken the line of comparing the like with the like to arrive at the conclusion of reasonableness or excessiveness in the payments. For the reasons which we have discussed earlier and also with regard to the point that gross profit disclosed was found to be reasonable, just like fabrication charges, embroidery charges also formed part of the trading account, to say that there was inflation in embroidery work would be inconsistent with the finding that the rate of gross profit is reasonable. We, therefore, agree with the Commissioner (Appeals)'s view that there was absolutely no justification for the addition of the sum of Rs. 2 lakhs.
The deletion is justified and we confirm it.
7 and 8. [These paras are not reproduced here as they involve minor issues.] 9. In the result, the appeal filed by the assessee is allowed in part while the appeal filed by the department stands dismissed.