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DE Diamond Electric India Pvt. Ltd. vs. ACIT - (Income Tax Appellate Tribunal) (23 Jul 2020)

An unregistered agreement cannot be a ground for invoking provisions of Section 40A(2)(b) of the IT Act in absence of requirement of law

MANU/ID/0574/2020

Direct Taxation

The Assessee Company was engaged in business of manufacturing and trading of ignition coils for motor vehicle engines. For the year under consideration, the assessee filed return of income under normal provisions of the Income Tax Act, 1961 (IT Act) and book profit under Section 115JB of the IT Act. The case was selected for scrutiny assessment and statutory notices were issued and complied with. The scrutiny assessment was completed under Section 143(3) of the IT Act, after making certain additions/disallowances. One of the disallowance made is under Section 40A(2)(b) of the IT Act on account of the excessive royalty payment made to related party. On appeal by the assessee, the Learned CIT(A) upheld this addition. Aggrieved with the finding of the CIT(A), the Assessee is in appeal before the Income Tax Appellate Tribunal.

As regard to addition on merit is concerned, disallowance under Section 40A(2)(b) of the IT Act can be made by the Assessing Officer, if he is of the opinion that such expenditure is excessive or unreasonable having regard to: (i) the fair market value of the goods, services or facilities for which payment is made or; (ii) the legitimate needs of the business of profession of the assessee or; (iii) the benefit derived by or accruing to him therefrom. In above circumstances, the Assessing Officer shall disallow the excessive or reasonable expenditure.

One of the ground taken by the AO for invoking Section 40A(2)(b) of the IT Act is the agreement between the parties has not been registered. An unregistered agreement cannot be a ground for invoking provisions of Section 40A(2)(b) of the IT Act in absence of requirement of law. For invoking the provision of section 40A(2)(b) of the Act, the Assessing Officer has to form an opinion of expenses more than the fair market value or not according to the legitimate needs of the business or no benefit derived.

In the instant case, the Assessing Officer has only compared royalty expenses of the preceding assessment year and no efforts have been made for identifying the fair market value of such expenses during relevant period, which is one of the requirement for invoking the provisions of Section 40A(2)(b) of the IT Act. Under transfer pricing provisions, the arm’s-length price is compared with similar transactions. Though the provisions of Section 40A(2)(b) of the IT Act are general provision as compared to the specific provisions of the transfer pricing, the Assessing Officer was required to compare the royalty expenses paid in case of the similar product by other companies during the relevant period. The Assessing Officer has not done any such exercise and only made basis of expenses paid in earlier years.

The Learned Counsel of the Assessee submitted that, in assessment year 2013-14 the transaction of the royalty expenses were subjected to transfer pricing provisions. He submitted that in assessment year 2013-14 average royalty payment was 2.99% of the sales, which stands accepted by the Department and therefore, no disallowance should be made in the year under consideration, where the royalty expenses are only 2.77% of the sales. This contention of the learned Counsel is rejected as the fair market value of the expenses have to be identified for the relevant year and percentile of the earlier year cannot be made basis for comparison. The disallowance made out of royalty expenses is deleted. The appeal of the Assessee is allowed.

Tags : ADDITIONS   PROVISION   APPLICABILITY  

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