Interpretation of sec 40a(2)(b)(vi)(b)

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Aniruddh Shenvi (Querist)
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05 July 2013 Sir,
The relevant extract of the act with respect to the above section reads as follows:
40A(2)(a): "Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person90 referred to in clause (b) of this sub-section, and the 91[Assessing] Officer 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"
40A(2)(b)(vi): "any person who carries on a business or profession,—

(B) where the assessee being a company, firm, association of persons or Hindu undivided family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner or member, has a substantial interest in the business or profession of that person."

My Question was whether the shareholding in the assessee company of the common directors and their relatives is to be calculated cumulatively or each common shareholder should be considered as a seperate person for determining the status of another company as a relative of the assessee.

I have tried to put forth my query as clearly as possible. Hope it helps.

Awaiting a reply.

CA PARAS BAFNA

CA PARAS BAFNA (Expert)
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05 July 2013 Suppose X is a director( Y & Z are also directors in the same company), then shareholding of X and his relatives will be taken account for calculating the percentage of holding.
.

Aniruddh Shenvi

Aniruddh Shenvi (Querist)
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05 July 2013 The section uses the words "or". Which may give encouragement to an arguement that the section does not expressly say that the director (x) and his relatives should be treated as one unit. By using the word "or" the interpretation of treating each director and each relative as a seperate unit while calculating the shareholding.

Is the above arguement logical?

Asha Kanta Sharma

Asha Kanta Sharma (Expert)
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01 August 2024 The interpretation of Section 40A(2)(b)(vi) of the Income Tax Act revolves around determining whether an expenditure is excessive or unreasonable when paid to a person who has a substantial interest in the business or profession of the assessee.

### **Understanding Section 40A(2)**

**Section 40A(2) Explanation:**

- **Section 40A(2)(a):** This section disallows expenditures that are excessive or unreasonable in the context of fair market value, the legitimate needs of the business, and the benefits derived from such expenditure.

- **Section 40A(2)(b)(vi):** Defines the term "person" for whom this provision is applicable. It includes:
- **A company, firm, association of persons, Hindu Undivided Family (HUF),** or any **director, partner, or member** of these entities.
- **Any relative** of such director, partner, or member who has a substantial interest in the business or profession of the person to whom payment is made.

### **Cumulative or Separate Calculation of Shareholding:**

**1. Determining Substantial Interest:**
- **Substantial Interest** refers to holding 20% or more of the shareholding in a company or 20% of the interest in a firm or HUF.

**2. Interpretation of "Or":**
- The word **"or"** in legal texts typically means that each clause or condition is independent and should be considered separately.

**3. Application to Shareholding:**
- **Each director and relative is assessed individually.** The shareholding of each director or relative is considered separately to determine if they have a substantial interest in the business or profession.

### **Logical Argument:**

- **Using "Or"**: The argument that the use of "or" allows treating each director and their relatives as separate units is **logical**. This means you do not need to aggregate the shareholding of all directors and their relatives. Instead, you check each individual separately to determine if they hold a substantial interest.

### **Illustration:**

1. **Company A:**
- **Director X:** Holds 15% of the shares.
- **Relative Y:** Holds 10% of the shares.
- **Director Z:** Holds 10% of the shares.
- **Relative W:** Holds 5% of the shares.

In this scenario, if **Director X** and **Relative Y** are both involved, you assess their individual shareholdings:
- **Director X**: Does not have substantial interest alone.
- **Relative Y**: Does not have substantial interest alone.

Neither has substantial interest individually, so you don’t aggregate their shareholdings for the assessment.

2. **Company B:**
- **Director X**: Holds 25% of the shares.
- **Relative Y**: Holds 30% of the shares.

**Director X** and **Relative Y** each have substantial interests individually.

### **Conclusion:**

Yes, the argument that each director and relative should be treated as separate entities when determining substantial interest is **valid**. The "or" suggests that each person’s shareholding should be assessed independently to check if they have a substantial interest.

This approach aligns with the interpretation that individual interests and shareholdings are considered separately under Section 40A(2)(b)(vi), not cumulatively.

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