2016 (8) TMI 605 - AT - Income Tax

Disallowance made u/s 40A(2)(b) - excessive or unreasonable expenditure - transactions with relative or associate concern - Held that - In the case on hand the adhoc disallowance made by the A.O. in our view is arbitrary and without any basis. The A.O. has not given a finding as to what as per him, is the fair market value. Even if it is assumed that the payment made is excessive and unreasonable, such arbitrary and baseless, adhoc disallowances cannot be upheld. On this ground also the assessee has to succeed. Taking up the issue as to whether the assessee has discharged the burden of proof that lay on it that, the expenditure paid by it to its sister concern, is not excessive or unreasonable. In this case the assessee has filed Transfer Pricing Reports in both the cases justifying the price paid by it for the services obtained, after conducting a Transfer Pricing Study. The Revenue authorities have not uttered a whisper as to why the transfer pricing report is not acceptable. The methodology of determining the ALP has been laid down in the Act and has been made mandatory for international transactions with Associated Enterprises (A.E.). Simply saying that these provisions do not apply to a domestic company transactions with its A.Es. for this particular A.Y. does not suffice. When the assessee has chosen to use these transfer pricing provisions to demonstrate its claim that the expenditure in question is at arm s length and that the same is not excessive or unreasonable, the revenue authorities are bound to rebut this claim of the assessee with reasons before coming to a conclusion to the contrary. When these transfer pricing reports submitted by the assessee are not rejected, we have to conclude that the assessee has discharged the burden of proof that lay on it on this issue. On this ground also the assessee succeeds. In both the cases the assesses have filed detailed alternative submissions in support of its contentions as to why the payment made to Amway is reasonable and commensurate with the nature of services provided by them and to demonstrate that the disallowance is bad in law. We allow the appeals of the assessees in both the cases by deleting the disallowance made u/s 40A(2)(b) of the Act for the reason that the assessee has proved that the price paid is at arm s length and not excessive or unreasonable and as the disallowance made on ad-hoc basis is arbitrary. There is no evasion of tax also warranting invocation of S.40A(1) of the Act. Hence we delete the disallowance in both the cases to the extent confirmed by the Ld.CIT(A). - Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance under Section 40A(2)(b) of the Income Tax Act.
2. Fair market value and reasonableness of expenses.
3. Tax neutrality and evasion considerations.
4. Burden of proof regarding excessive or unreasonable expenditure.
5. Applicability of Transfer Pricing provisions to domestic transactions.

Detailed Analysis:

1. Disallowance under Section 40A(2)(b) of the Income Tax Act:
The Assessing Officer (AO) disallowed a portion of data processing charges paid by the assessee to its related party, Amway India Enterprises Pvt. Ltd., under Section 40A(2)(b) of the Income Tax Act, citing that the payments were excessive and unreasonable. The AO's reasons included the lack of additional expenditure by Amway, the absence of a break-up of services, and the impossibility of comparison with unrelated parties. The First Appellate Authority upheld the AO's decision, stating that the payments were excessive and unreasonable.

2. Fair Market Value and Reasonableness of Expenses:
The assessee argued that the AO did not establish the fair market value of the services and made arbitrary disallowances without valid material. The assessee also submitted a Transfer Pricing report to justify the arm's length nature of the transaction. The Tribunal noted that the AO did not provide a benchmark for fair market value and made ad-hoc disallowances without factual justification. The Tribunal emphasized that reasonableness should be judged from the businessman's point of view and not by the Revenue.

3. Tax Neutrality and Evasion Considerations:
The assessee contended that the transaction was tax-neutral as both the assessee and Amway India were taxed at the maximum marginal rate, and there was no intention to evade tax. The Tribunal agreed, referencing CBDT Circular No. 6-P, which states that no disallowance should be made under Section 40A(2) if there is no attempt to evade tax. The Tribunal found no evidence of tax evasion and noted that the income of the payee company was higher than that of the assessee.

4. Burden of Proof Regarding Excessive or Unreasonable Expenditure:
The Tribunal held that the burden of proof to establish that the expenditure was not excessive or unreasonable lies with the assessee, as per the jurisdictional High Court's decision in Hive Communications P.Ltd. vs. CIT. The assessee provided a Transfer Pricing report, which was not rebutted by the Revenue, thereby discharging its burden of proof. The Tribunal concluded that the Revenue failed to provide a valid basis for the disallowance.

5. Applicability of Transfer Pricing Provisions to Domestic Transactions:
The Tribunal referred to the Supreme Court's suggestion in CIT vs. Glaxo Smithkline Asia P.Ltd. that Transfer Pricing regulations could be applied to domestic transactions to determine fair market value. Although these provisions were not mandatory for domestic transactions during the assessment year in question, the assessee's use of a Transfer Pricing report to justify the payments was considered valid. The Tribunal criticized the Revenue for not addressing the Transfer Pricing report and upheld the assessee's claim that the payments were at arm's length.

Conclusion:
The Tribunal allowed the appeals, deleting the disallowances made under Section 40A(2)(b) of the Act. It held that the assessee had demonstrated that the payments were at arm's length and not excessive or unreasonable. The Tribunal emphasized that the disallowances were arbitrary and lacked a factual basis, and there was no evidence of tax evasion to warrant the invocation of Section 40A(1).