Joint Commissioner of Income Tax (OSD) vs Modicare Limited

“1.

The Ld. CIT(A) has erred in accepting the genuineness of the bonus payments despite the fact that during the proceedings, several consultants/parties has failed to respond to statutory notices issued under Section 133(6) & summons issued u/s 131 of the I.T. Act, 1961. The Ld. CIT(A) has erred in allowing the expenditure without appreciating the fact that primary verification through independent investigation could not establish the identity or the factum of services rendered by the recipients.

2.

The Ld. CIT(A) has erred in deleting the disallowance of Marketing and Sales Promotion Expenses. The CIT(A) has failed to appreciate the fact that for a direct selling model where the entire load of selling is claimed to be on independent consultants, the assessee provided no justification or supporting evidence. (bills/vouchers) to substantiate its claim of such huge marketing expenditures. The Ld. CIT(A) has erred in treating these expenses as genuine without requiring independent verification of their genuineness in relation to business operations. Mere confirmation of the parties given by the assessee and that too in earlier survey proceedings, cannot replace the purpose of independent verification u/s 133(6) during the assessment proceedings.

3.

i) Whether on the facts and circumstances of the case, the order of the Ld. CIT(A) is erroneous and not tenable on facts.

(ii)

The appellant craves leave to add, amend any/all the grounds of appeal before or during the course of hearing of the appeal.”

“6.

The learned ADGP invited my attention to G.O.(P) No.6/2023/CAD dated 28.03.2023 issued by the Government of Kerala establishing a monitoring committee to regulate the direct selling entities and direct sellers. As per the said order, the entire working of the direct marketing/selling entities would be under the monitoring committee. The powers of the monitoring authority include referring the contravention or violation of other laws and rules to the law enforcement authorities concerned under the provisions of such Acts and Rules. The learned ADGP submits that in the event the monitoring committee finds any contravention or violation of law on the part of the petitioner company in future, their right to refer the same to the police for initiating appropriate legal action may be reserved.”

“26.

In consideration of the fact that direct selling and multilevel marketing are important industry verticals, the Government of India has issued an Advisory to the State Governments and Union Territories, which contain 'Model Framework for Guidelines on Direct Selling'. The model guidelines clearly indicate that multi-layered network of subscribers to a scheme formed by a direct selling company, which consists of subscribers enrolling one or more further subscribers in order to receive any benefit, directly or indirectly, where the benefit is, as a result of sale of goods or services for such subscribers, is not illegal.”

“18.4

The appellant submitted that

(i)

During post survey proceeding conducted in the year 2020, 97 out 100 consultants duly complied and furnished confirmations along with the requisite documents, including copies of Income-tax Returns with computation of income, bank statements, and signed Balance Sheets and Profit & Loss Accounts for the relevant period.

(ii)

During the assessment proceedings, certain consultants did not respond to the notices issued under section 133(6) as they had already furnished the requisite details and confirmations during the survey proceedings in February-March 2020. Accordingly, fresh compliance by such consultants during the assessment proceedings was not made. Thus, compliance may be considered as complete as the same information was asked again in 133(6) during assessment proceedings.

19.

The appellant submitted the documents as was submitted before AO during survey proceedings and assessment proceedings and is part of record. The appellant has placed on record that in respect of 114 major consultants' evidence were already submitted which includes their ITRs, audited accounts, and fund-flow confirmation during the preceding survey and assessment proceedings. Upon examination of the documents available on record, the following factual position emerges: XXXXXXX”

21.

For the purposes of reference, the facts of the AY 2017-18 are discussed in this order, which shall apply mutatis mutandis to order for other years.

22.

During the previous year, relevant to AY 2017-18, the assessee incurred expenditure of Rs. 92.78 crores towards performance-based bonus paid to consultants as per the MLM Business Model explained above. The assessing officer, however, has disallowed the expenditure in the impugned assessment orders passed under section 143(3) of the Act on the following grounds:

-The bonus was paid not merely for effecting sales but also to various "uplines" in a multi-level structure who did not participate in the actual sale of goods. Their only contribution was enrolling or introducing other consultants (i.e., building the downline).

As per the AO, such payments are not linked to direct efforts or services rendered in relation to the sale of goods, and hence, cannot be treated as commission/ bonus or allowable business expenditure under section 37(1) of the Act.

The business model of incentivizing the recruitment of new consultants was characterized by the AO as akin to a money circulation scheme, which is specifically prohibited under the Prize Chits and Money Circulation Schemes (Banning) Act, 1978.

The AO was of the view that these payments are made not for generating legitimate business income through sale of products but for expanding a recruitment chain. As such, the nature of this expenditure was considered not in line with a lawful and genuine business purpose, thereby attracting disallowance.

The assessee has challenged the addition and the reasons adopted by the AO for making disallowance.

23.

It was submitted that, in the assessee's business model of direct selling of consumer products through a wide network of independent consultants, the consultants are incentivized through a structured consultant compensation plan, which includes performance-based bonuses. These bonuses are payable not only for personal sales but also for sales made by their team members (downlines), in line with global industry practices.

24.

This incentive framework is fundamental to the assessee's business model, ensuring motivation, retention, and scalability across its consultant base. The expenditure incurred on such bonus payouts is a matter of commercial expediency and business necessity and is directly linked to increase in sale of the products, thus, clearly justifies the test of business purposes. The assessee relied upon several important case laws to the aforesaid effect, that the commercial expediency of the business cannot be dictated by the assessing officer.

25.

In view of the above, it was argued that the impugned expense, having been incurred for the purposes of business, was clearly allowable business deduction under section 37(1) of the Act.

26.

The assessee submitted that the said incentive model is not only commercially rational but is also in accordance with law. The assessee has justified the commercial rationale behind the business model and explained that the aforesaid expense was firstly incurred wholly and exclusively for the purposes of business warranting allowance under section 37(1) and was not disallowable for the reason of illegality contended by the AO.

27.

The appellant submitted and explained in detail as to how the aforesaid business model was accepted/ established by the Government through Direct Selling Guidelines, 2016, issued by the Ministry of Consumer Affairs, Government of India explicitly recognizing:

-The legitimacy of multi-level direct selling models,

-The right of consultants to earn income from both personal sales and team performance;

-The need for a transparent, performance-based incentive structure.

28.

It was pointed out that the aforesaid aforesaid guidelines warranted several compliances which were duly made by the appellant and no non-compliance has been pointed in the above guidelines against the assessee. It was further submitted that activities of assessee were not covered in the definition of Pyramid Scheme, as the assessee is engaged in the sale of goods by the subscribers (consultants/direct sellers).

29.

With respect to AO's reliance on Amway India Enterprises vs UOI (2007 (4) ALT 808)) the appellant has submitted that the issues in Amway were fundamentally distinct-limited to whether preliminary police raids and sealing under Section 7 of the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, were arbitrary, with the court refusing merits adjudication at a pre-trial stage without any discussion on tax deductibility of business expenses. In contrast, the Appellant's case involves legitimate direct selling operations, where commissions represent standard expenditure on product sales through multi-level networks, fully allowable under Section 37(1) of the Income Tax Act, as affirmed by Naresh Balasubramaniam vs State of Karnataka (2017 (3) AKR 825) recognizing such models as non-violative of the 1978 Act per Government Guidelines.

30.

It was further argued that the AO's comparison of this structure to a money circulation scheme under the Prize Chits and Money Circulation Schemes (Banning) Act, 1978 is legally and factually incorrect. The Direct Selling Guidelines demarcate legitimate direct selling from illegal schemes and clearly endorse the model followed by the assessee. The assessee also distinguished the case laws relied upon by the assessing officer as detailed at para 8 above wherein it has been explained that the said decisions were on a different context and did not adjudicate upon the issue raised by the AO.

31.

I have considered the submission made by the appellant in this respect and I have gone through the facts and it is seen that there is merit in the submission of the appellant and the issue which was dealt by the Hon'ble Court in the case of Amway India Enterprises vs UOI is different and distinguishable from the issues raised in the case of the appellant.

32.

Further in respect of the expenses incurred the appellant has submitted that, the expenditure incurred is fully documented and verifiable, in as much as, the assessee has;

-the assessee did not furnish full and verifiable details substantiating the business necessity, genuineness, or nexus of the said expenses with the assessee's business operations.

-In the absence of documentary evidence and explanation, the AO concluded that the claim lacked credibility and failed the test of wholly and exclusively incurred for the purpose of business under section 37(1).