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CMA Intermediate · Direct and Indirect Taxation · Profits and Gains of Business or Profession

A company pays Rs. 9,00,000 to a firm for services during the tax year. One director of the company holds 25% of the profits of that firm. The Assessing Officer finds Rs. 6,00,000 to be the reasonable market value. Which statement is correct under section 36 of the Income-tax Act, 2025?

Rs. 3,00,000 can be disallowed. The director's 25% profit share meets the 20% substantial interest test, making the firm a specified person, and the excess over the Rs. 6,00,000 fair value is excessive or unreasonable under section 36(2), so only that excess is disallowed.

  1. ARs. 3,00,000 can be disallowed, as the firm is a specified person through the director's substantial interestCorrect
  2. BNothing can be disallowed because the firm is not a director or relative
  3. CThe entire Rs. 9,00,000 must be disallowed
  4. DRs. 3,00,000 can be disallowed only if the director holds over 50% of profits

Explanation

Substantial interest in a non-company business means being entitled to at least 20% of the profits. The director holds 25%, so the firm is a specified person under section 36(3)(a)(iii). The excess over fair value, Rs. 9,00,000 minus Rs. 6,00,000 = Rs. 3,00,000, may be disallowed as excessive or unreasonable. Only the excess goes, not the whole amount.

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