JUDGMENT
1. The following question of law has been referred for opinion to this court:
"Whether the finding of the Income-tax Appellate Tribunal that the increase of only Rs. 100 per month in the salaries of three employees, namely, Shri Ali Ahmed, Mohd. Ali and Ajaz Ahmad, shall be reasonable or is arbitrary and in ignorance of the conditions laid down in Section 40A(2) of the Income-tax Act ?"
2. The above question arises out of the facts that the applicant is a registered firm. It employed various persons in its firm for carrying out its activities. It enhanced the salary of three employees, namely, Sri Ajaz Ahmad from Rs. 800 to Rs. 900 per month, Ali Ahmad from Rs. 1,000 to Rs. 1,200 per month and Mohammad Ali from Rs. 500 to Rs. 900 per month in the assessment year 1975-76.
3. The Income-tax Officer took the view that the increase in the salary of these persons was not on the grounds of commercial expediency and was unreasonable, having regard to the fair market value of their services, the legitimate needs of the business and the benefits derived by the assessee-firm from their services.
4. The assessee preferred appeal before the Commissioner of Income-tax (Appeals). The Commissioner of Income-tax (Appeals), however, agreed with the Income-tax Officer on this issue and refused to interfere except for the observation that there appears to be a typographical error in working out these additions.
5. The assessee preferred further appeal before the Appellate Tribunal. The Appellate Tribunal took the view that the increase in the salary of Ajaz Ahmad from Rs. 800 to Rs. 900 per month was reasonable but the increase in the salary of Ali Ahmad and Mohammad Ali was unreasonable and unjustified. On an application being filed, the above question of law has been referred to this court.
6. Clause (a) of Sub-section (2) of Section 40A of the Income-tax Act, 1961 (in short" the Act"), provides that 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) of this sub-section, and the Income-tax 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.
7. The reasonableness is to be determined after taking into account the legitimate needs of the business or profession of the assessee and the fair market value of the services rendered by such persons. The necessary material is to be placed by the employer before the Income-tax Officer when it increases the salary of any employee. The salary is normally raised either with the passage of time after taking into account the market value of the services and if such increase in the salary is made after taking into account these factors, the increase in the salary will be reasonable and the Assessing Officer without any material cannot hold that the increase in the salary is unreasonable.
8. It is, however, to be examined that the ratio of increase in the salary is reasonable. If the ratio of the increase in the salary is higher, the assessee must establish by producing cogent material that there were exceptional circumstances, which compelled him to increase the salary of the employees disproportionately.
9. On the facts of the present case, it has been found that the increase of salary of Ajaz Ahmad from Rs. 800 to Rs. 900 per month was reasonable but in the case of Ali Ahmad from Rs. 1,000 to Rs. 1,200 per month and that of Mohammed Ali from Rs. 500 to Rs. 900 per month for the assessment year 1975-76 was unreasonable. The increase of salary of Ajaz Ahmad from Rs. 800 to Rs. 900 per month comes to 12.5 per cent, increase. The increase of salary of Ali Ahmad from Rs. 1,000 to Rs. 1,200 per month comes to 20 per cent., the increase, in the salary of Mohammed Ali from Rs. 500 to Rs. 900 per month comes to 80 per cent. The increase of salary of Ali Ahmad from Rs. 1,000 to Rs. 1,200 per month cannot be taken as unreasonable as it would be enhancement of salary by 20 per cent, but in the case of Mohammed Ali, the increase of salary would be 80 per cent. The assessee did not produce any material to show that the disproportionate increase of salary of Mohammad Ali was on the basis of some exceptional circumstances.
10. In view of the above discussion, we hold that the increase in the salary of employees, namely, Ajaz Ahmad and Ali Ahmad, is reasonable and that of Mohammad Ali is unreasonable taking into account the provisions of Clause (a) of Sub-section (2) of Section 40A of the Act.
11. Our answer to the question referred to above is decided partly in favour of the assessee and partly in favour of the Revenue.
12. The parties shall, however, in the facts and circumstances of the case, bear their own costs.