An ad hoc disallowance of a fully vouched and verified business expenditure is arbitrary and legally unsustainable.

Issue

Can an Assessing Officer make an ad hoc, estimated disallowance of a business expenditure, even when the taxpayer has furnished all the required supporting documents and the recipients of the payment have confirmed the transaction under a statutory notice?

Facts

An assessee, who was an insurance agent, claimed a deduction for referral commission paid to 14 individuals for helping identify potential customers.
To support the claim, the assessee provided all the necessary bills, vouchers, and payment details.
The Assessing Officer (AO) took the step of cross-verifying the payments by issuing notices under Section 133(6) to all 14 recipients. In response, all 14 individuals confirmed that they had received the payments from the assessee.
Despite the expense being fully documented by the assessee and independently verified from the third parties by the AO himself, the AO proceeded to disallow 30% of the expenditure on a purely ad hoc basis. The AO provided no specific reason or rationale for this disallowance or for the 30% rate he adopted.

Decision

The court ruled in favour of the assessee.

It held that once an expenditure has been substantiated with documentary evidence and, more importantly, has been verified from the third-party recipients, an AO cannot make a disallowance based on mere estimates, suspicion, or guesswork.
The ad hoc disallowance of 30%, being completely without any logical basis or rationality, was held to be arbitrary and legally unsustainable. The addition was therefore deleted.

Key Takeways

No Disallowance without a Specific Reason: An Assessing Officer cannot make a disallowance based on their personal whims or a general feeling that an expense is high. There must be a specific, legally valid reason for disallowing a claimed expenditure.
Verification Confirms Genuineness: When the recipients of a payment confirm the transaction in a response to a statutory notice, it strongly establishes the genuineness of the expenditure. An AO cannot simply ignore the results of their own verification process.
Ad hoc Disallowances are Arbitrary by Nature: Disallowing a flat percentage of a fully vouched expenditure without pointing out any specific defect in the evidence is a hallmark of an arbitrary assessment. Such additions will generally not be upheld by appellate authorities.
The Burden of Proof Shifts After Initial Evidence: Once the assessee provides the primary evidence to support a claim, the burden of proof shifts to the AO to bring on record any material or finding that proves the expenditure is either non-genuine or excessive.

A referral fee paid by an insurance agent to another person for simply providing a lead is not an “insurance commission” and is therefore not subject to TDS under Section 194D.

Issue

Is a “referral commission” paid by an insurance agent to individuals for providing leads considered to be “insurance commission” that would be subject to TDS under Section 194D of the Income-tax Act, 1961?

Facts

An assessee, who was an individual working as an insurance agent, paid a “referral commission” to several individuals for providing him with leads of potential customers. The assessee did not deduct TDS on these payments.
The Assessing Officer (AO) was of the opinion that this payment was in the nature of an “insurance commission” and held that it was subject to TDS under Section 194D.
Consequently, because no TDS was deducted, the AO disallowed the entire payment as an expense under the provisions of Section 40(a)(ia).
It was established as a fact that the recipients of the payment merely provided referrals and had no further role in the actual “solicitation or procurement of insurance business.” They were not licensed insurance agents.

Decision

The court ruled in favour of the assessee.

It held that the payment was not “insurance commission” as defined for the purposes of Section 194D. That section specifically applies to remuneration or rewards paid for the act of soliciting or procuring insurance business, which these individuals did not do.
The court then considered if the payment could be covered by other TDS provisions, such as Section 194H (for general commission) or Section 194C (for contractual payments). However, it found that since the assessee was an individual whose business receipts were below the threshold limit that requires a tax audit, they were not legally required to deduct TDS under those sections either.
As there was no legal obligation on the assessee to deduct TDS under any relevant section, the disallowance made under Section 40(a)(ia) was incorrect and was directed to be deleted.

Key Takeways

The Definition of “Insurance Commission” is Specific: There is a clear legal distinction between a simple fee paid for a referral or a lead, and a commission paid for actively soliciting and procuring insurance business. Section 194D applies only to the latter. The nature of the service is key.
Always Read the Definitions Carefully: The applicability of any TDS section depends on the precise definition of the terms used in that section. “Insurance commission” is specifically defined in the Act and is linked to the act of selling insurance.
Check the Status of the Payer: The liability to deduct TDS under several key sections (like 194C, 194H, and 194J) depends not only on the nature of the payment but also on the legal status of the person making the payment. Individuals and HUFs are generally exempt from these TDS provisions unless their turnover or receipts in the preceding year exceed the limit that mandates a tax audit.

IN THE ITAT MUMBAI BENCH ‘B’

Bhavesh Karamshi Thakkar

Deputy Commissioner of Income-tax

SAKTIJIT DEY, Vice President
and Narendra Kumar Billaiya, Accountant Member

IT Appeal No. 148 (Mum.) of 2025
[Assessment year 2015-16]

SEPTEMBER 23, 2025

Devendr Jain for the Appellant. Leyaqat Ali Aafaqui, Sr. AR for the Respondent.

ORDER

Saktijit Dey, Vice President.- This is an appeal by the assessee against the order dated 19.11.2024 of learned Additional Commissioner of Income Tax-6, Chennai (‘ld. Addl.CIT’ for short), pertaining to the assessment year (A.Y.) 2015-16.

2. The effective grounds in the appeal are ground nos. 1 & 2. In ground no. 1, the assessee has challenged the disallowance of Rs.8,55,028/- out of the commission paid of Rs.28,50,093/-.

3. Briefly the facts are, the assessee is a resident individual and as stated by the Assessing Officer (‘A.O.’ for short), the assessee is a qualified Chartered Accountant and is an Insurance Agent of LIC of India, Reliance General Insurance Company Ltd., etc. For the assessment year under dispute, the assessee had filed his return of income on 21.08.2015, declaring total income of Rs.48,47,710/-. The return of income so filed was selected for scrutiny. In course of assessment proceedings, the A.O. while verifying the return of income and financial statements noticed that the assessee has debited an amount of Rs.29,96,390/- towards sales promotion expenses. After calling for necessary details and verifying them, he found that out of such sales promotion expenses, an amount of Rs.28,50,093/- was paid to 14 persons towards commission. When called upon to explain the nature of such expenses, the assessee submitted that he has tied up with certain persons who procure potential customers for buying insurance policies. The assessee submitted that the job of such sub agents are limited to identifying potential customers and not beyond that. He submitted, it is the assessee who undertakes the entire exercise of convincing the customers and making them agree to buy insurance policies through him. He submitted, only for identifying and referring the customers to the assessee, some amount is paid to those persons. Hence, the expenditure being for the purpose of business, is allowable. After taking note of the submissions of the assessee, the A.O. conducted independent enquiry by issuing notice u/s. 133(6) of the Act to all the 14 persons. In response to the notices issued u/s. 133(6) of the Act, the concerned parties furnished their reply, accepting that they have received payment from the assessee. Still being not satisfied, the A.O. issued summons u/s.131 of the Act to four parties. The parties responded to the summons and statements were recorded. Ultimately, the A.O. concluded that since the genuineness of the payment made to the parties could not be fully established by the assessee, the entire expenditure cannot be allowed. Thereafter, he proceeded to disallow 30% of such expenditure, which worked out to Rs.8,55,028/- and made the addition accordingly.

4. Though the assessee contested the aforesaid addition before ld. First appellate authority, however, he was unsuccessful.

5. We have considered rival submissions and perused the materials on record. Undisputedly, the assessee has paid an amount of Rs.28,59,093/- to 14 individuals who were engaged by the assessee to search and identify potential customers for buying insurance policies. There is no dispute even with regard to the fact that an amount of Rs.28,59,093/- was paid to these 14 individuals. In fact, in course of the assessment proceedings, the A.O. had issued notices u/s. 133(6) of the Act to all these persons who had responded to such notices and confirmed of having received the payments. Further, in response to summons issued u/s.131 of the Act on random basis, some persons out of 14 individuals appeared and confirmed of having received payments. Even, supporting bills and vouchers as well as payment details have been furnished before the A.O. Despite availability of such materials on record, the A.O. has proceeded to disallow 30% of the referral commission purely on adhoc basis. There is nothing on record to demonstrate the basis and rationality of adopting the rate of 30%. In view of the aforesaid, we hold that the disallowance made by the A.O. on adhoc basis is unsustainable. Accordingly, we allow this ground.

6. In ground no. 2, the assessee has contested the disallowance of Rs.2,92,102/- u/s. 40(a)(ia) of the Act for alleged violation in deducting tax u/s. 194D of the Act.

7. Briefly the facts are, in course of assessment proceeding, the A.O. noticed that the assessee has paid an amount of Rs.13,90,961/- to five individuals without deducting tax at source. Being of the view that amount paid is in the nature of insurance commission, provision of section 194D of the Act is attracted. Since the assessee had failed to deduct tax in terms with section 194D of the Act, the A.O. disallowed an amount of Rs.2,92,102/-u/s. 40(a)(ia) of the Act, being 30% of the referral commission allowed as expenditure to the assessee after the adhoc disallowance of 30% out of the amount of Rs.13,90,961/-.

8. Though the assessee contested, the aforesaid disallowance before learned first appellate authority, however, he was unsuccessful.

9. Before us, ld. Counsel appearing for the assessee submitted that section 194D of the Act is not at all applicable to the assessee as it is applicable to insurance commission paid by an insurance company to registered agents. In this context, he drew our attention to section 42 of The Insurance Act, 1938. Drawing our attention to the said provision, he submitted that a person can become an Insurance Agent only if he is not disqualified for any of the reasons mentioned fulfills all the criteria under sub section (3) of section 42 of the Insurance Act. He submitted, one of the criteria is, a person who does not possess the requisite qualification, practical training or has passed the examination, cannot become an Insurance Agent. Thus, he submitted, the individuals to whom the assessee has paid referral commission having not been appointed as Insurance Agents in terms with section 42 of the Insurance Act, provisions of section 194D would not be applicable. He submitted, the payment made, if at all, would be covered u/s. 194H of the Act. However, the assessee being an individual and the total receipts having not exceeded Rs.1 crore, the provision would not be applicable. Thus, he submitted, there being no obligation on the part of the assessee to deduct tax at source, the disallowance made u/s. 40(a)(ia) of the Act is unsustainable. In support of such contention, ld. Counsel relied upon a decision of the Hon’ble Bombay High Court in case of Pr. CIT v. Tata AIG General Insurance Co. Ltd. 92 (Bom).

10. Per contra, ld. Departmental Representative submitted since section 194D of the Act begins with the word ‘Any person.’, it cannot be restricted to insurance companies alone. He submitted, once it is accepted that the payment made was in the nature of commission, then provision of section 194D of the Act gets attracted.

11. We have considered rival submissions in light of the decision relied upon and perused the materials on record. The crucial issue is, whether the payment made by the assessee to certain individuals towards so called referral commission is in the nature of insurance commission falling u/s. 194D of the Act. A perusal of the assessment would reveal that in course of assessment proceedings, in response to summons issued u/s. 131 of the Act, certain parties appeared before the A.O. and statements were recorded from them. The A.O. himself has stated that the parties who have been given sales promotion expenses (referral commission) have only made references to the assessee, after which the assessee himself goes and meets the clients. The parties do not have any other role in the entire process. Further, the parties have no knowledge about the various types of insurance policies, nuances involved.

12. From the aforesaid observations of the A.O., it can be countenanced that the individuals to whom the so called referral commission was paid, have merely provided the reference of the assessee to some persons who may be interested to take out life insurance policy. There role is to that limited extent. Keeping in perspective the aforesaid position, if we examine section 194D of the Act, it speaks of insurance commission paid for soliciting or procuring insurance business (including business relating to the continuance, renewal or revival of policies of insurance). If we consider the role played by the individuals to whom the assessee has paid the referral commission, keeping in perspective the specific provision of section 194D of the Act, it can be seen that such individuals are nowhere involved in soliciting or procuring insurance business or has played any role in continuance, renewal or revival of policies of insurance. Section 42 of the Insurance Act lays down the procedure for appointment of Insurance Agents, which reads as under:

Section 42 in The Insurance Act, 1938

42. Appointment of insurance agents

(1)An insurer may appoint any person to act as insurance agent for the purpose of soliciting and procuring insurance business:Provided that such person does not suffer from any of the disqualifications mentioned in sub-section (3).

(2)No person shall act as an insurance agent for more than one life insurer, one general insurer, one health insurer and one of each of the other mono-line insurers:Provided that the Authority shall, while framing regulations, ensure that no conflict of interest is allowed to arise for any agent in representing two or more insurers for whom hemay be an agent.

(3)The disqualifications referred to in the proviso to sub-section (1) shall be the following:–

(a) that the person is a minor;

(b)that he is found to be of unsound mind by a court of competent jurisdiction;

(c)that he has been found guilty of criminal misappropriation or criminal breach of trust or cheating or forgery or an abetment of or attempt to commit any such offence by a court of competent jurisdiction:

(d)that in the course of any judicial proceeding relating to any policy of insurance or the winding up of an insurer or in the course of an investigation of the affairs of an insurer it has been found that he has been guilty of or has knowingly participated in or connived at any fraud, dishonesty or misrepresentation against an insurer or insured;

(e)that in the case of an individual, who does not possess the requisite qualifications or practical training or passed the examination, as may be specified by the regulations;

(f)that in the case of a company or firm making, a director or a partner or one or more of its officers or other employees so designated by it and in the case of any other person the chief executive, by whatever name called, or one or more of his employees designated by him, do not possess the requisite qualifications or practical training and have not passed such an examination as required under clauses (e) and (g);

(g)that he has not passed such examination as may be specified by the regulations;

(h)that he has violated the code of conduct as may be specified by the regulations.

(4)Any person who acts as an insurance agent in contravention of the provision of this Act, shall be liable to a penalty which may extend to ten thousand rupees and any insurer or any person acting on behalfof an insurer, who appoints any person as an insurance agent not permitted to act as such or transacts any insurance business in India through any such person shall be liable to penalty which may extend to one crore rupees.

(5)The insurer shall be responsible for all the acts and omissions of its agents including violation of code of conduct specified under clause (h) of sub-section (3) and liable to a penalty which may extend to one crore rupees.

(1)The Authority or an officer authorised by it in this behalfshall, in the manner determined by the regulations made by it and on payment of the fee determined by the regulations, which shall not be more than two hundred and fifty rupees, issue to any person making an application in the manner determined by the regulations, a licence to act as an insurance agent for the purpose of soliciting or procuring insurance business:

Provided that,–(i)in the case of an individual, he does not suffer from any of the disqualifications mentioned in sub-section (4); and(ii)in the case of a company or firm, any of its directors or partners does not suffer from any of the said disqualifications:Provided further that any licence issued immediately before the commencement of the Insurance Regulatory and Development Authority Act, 1999 shall be deemed to have been issued in accordance with the regulations which provide for such licence.

(2)A licence issued under this section shall entitle the holder to act as an insurance agent for any insurer.

(3)A licence issued under this section, after the date of the commencement of the Insurance Regulatory and Development Authority Act, 1999, shall remain in force for a period of three years only from the date of issue, but shall, if the applicant, being an individual does not, or being a company or firm any of its directors or partners does not, suffer from any of the disqualification mentioned in clauses (b), (c), (d), (e), (ea) and (f) ofsub-section (4) and the application for renewal of licence reaches the issuing authority at least thirty days before the date on which the licence ceases to remain in force, be renewedfor a period ofthree years at any one time on payment ofthe fee determined by the regulations made by the Authority which shall not be more than rupees two hundred and fifty, and additional fee of an amount determined by the regulations not exceeding rupees one hundred by way ofpenalty, if the application for renewal of the licence does not reach the issuing authority at least thirty days before the date on which the licence ceases to remain in force.(3A)No application for the renewal of a licence under this section shall be entertained if the application does not reach the issuing authority before the licence ceases to remain in force:

Provided that the Authority may, ifsatisfied that undue hardship would be caused otherwise, accept any application in contravention of this sub-section on payment by the applicant of a penalty of seven hundred andfifty rupees.

(4)The disqualifications above referred to shall be the following:–(a)that the person is a minor;(b)that he is found to be ofunsound mind by a Court ofcompetent jurisdiction;(c)that he has been found guilty of criminal misappropriation or criminal breach of trust or cheating or forgery or an abetment of or attempt to commit any such offence by a Court of competent jurisdiction:

Provided that where at least five years have elapsed since the completion of the sentence imposed on any person in respect of any such offence, the Authority shall ordinarily declare in respect of such person that his conviction shall cease to operate as a disqualification under this clause;(d)that in the course of any judicial proceeding relating to any policy of insurance or the winding up of an insurance company or in the course of an investigation of the affairs ofan insurer it has been found that he has been guilty of or has knowingly participated in or connived at any fraud, dishonesty or misrepresentation against an insurer or an insured.(e)that he does not possess the requisite qualifications and practical trainingfor a period not exceeding, twelve months, as may be specified by the regulations made by the Authority in this behalf;(ea)that in the case of a company or firm making an application under sub-section (1) or sub-section (3), a director or a partner or one or more of its officers or other employees so designated by it and in the case of any other person, the chief executive, by whatever name called, or one or more of his employees designated by him, do not possess the requisite qualifications and practical training and have not passed such an examination as required under clauses (e) and (f);(f)that he has not passed such examination as may be specified by the regulations made by the Authority in this behalf:

Provided that a person who had been issued a licence under sub-section (1) of this section or subsection (1) of section 64UM shall not be required to possess the requisite qualifications, practical training and pass such examination as required by clauses (e) and (f);(g)that he violates the code of conduct as may be specified by the regulations made by the Authority.(5)If it be found that an insurance agent being an individual is, or being a company or firm contains a director or partner who is suffering from any of the disqualifications mentioned in sub-section (4), then, without prejudice to any other penalty to which he may be liable, the Authority shall, and if the insurance agent has knowingly contravened any of the provisions of this Act may, cancel the licence issued to the agent under this section.

(6)The Authority may issue a duplicate licence to replace a licence lost, destroyed or mutilated, on payment of such fee not exceeding fifty rupees as may be determined by the regulations.

(7)Any person who acts as an insurance agent without holding a licence issued under this section to act as such shall be punishable with fine which may extend to five hundred rupees, and any insurer or any person acting on behalf of an insurer, who appoints as an insurance agent any person not licensed to act as such or transacts any insurance business in India through any such person, shall be punishable with fine which may extend to one thousand rupees.

(8)Where the person contravening sub-section (7) is a company or a firm, then, without prejudice to any other proceedings which may be taken against the company orfirm, every director, manager, secretary or other officer of the company, and every partner of the firm who is knowingly a party to such contravention shall be punishable with fine which may extend to five thousand rupees.”

13. As could be seen from the aforesaid provision, an insurer may appoint any person to act as insurance agent for the purpose of soliciting or procuring business. Undisputedly, the assessee has been appointed as an insurance agent by the insurance company, as assessee’s role is of soliciting and procuring the insurance business. Further, sub section (3) of section 42 of the Insurance Act, prescribes the disqualification conditions, one amongst them being an individual who does not qualify or pass practical training or pass the examination, as may be specified by the regulations framed by the insurer, cannot be appointed as an Insurance Agent. In the facts of the present appeal, undoubtedly, the individuals to whom the assessee has paid referral commission are not Insurance Agents appointed by the Insurer. There is no principal-agent relationship between the insurance companies and those individuals. It is the assessee, who being an Insurance Agent has engaged these persons for benefiting his business. Therefore, in our considered opinion, the payment made by the assessee to those individuals as sales promotion expenses/referral commission, are not covered u/s. 194D of the Act. At best, the payment can either be covered u/s. 194H or section 194C of the Act. In either case, the assessee is not obliged to deduct tax, as the assessee being an individual and the receipts being below the threshold limit, the provisions would not get attracted. In view of the aforesaid, we hold that the disallowance made u/s. 40(a)(ia) of the Act is unsustainable. Accordingly, the A.O. is directed to delete it.

14. In the result, the appeal is allowed.