2021 (2) TMI 454 - AT - Income Tax

Addition u/s 40A(2)(b) - purchases made by the assessee from related party - at arms length or Fair Market Value (FMV) and making adjustment thereto - HELD THAT - Sale price of the impugned transaction in the hands of the related party is undoubtedly established to be at fair market value and consequently so the purchases in the hands of the assessee. The assessee we find has sufficiently established the reasonableness of the purchases made from sister concern. Reasoning of the Ld. CIT(A) holding the purchases to be inflated, we find, is based on surrounding circumstances and there is no direct evidence establishing the unreasonableness of the purchases. The entire case of the Revenue is that the assessee was unable to justify fall in gross profits during the year and that its explanation of having procured an order from the government which it outsourced to its related party for manufacturing the product, the assessee itself acting as a trader alone, resulting in larger share of the profit in the transaction being given to the related party and the assessee retaining only a small portion, was all unsubstantiated and make believe. The department itself having accepted the price/value of the impugned transaction in the hands of the related party in scrutiny assessment and nothing having been brought before us demonstrating any corrective action being initiated by the department against it in view of the impugned transaction being found to be at inflated prices, we find no force in the argument of the Revenue. Transaction of purchases made by the assessee with its related party stands established to be at fair market value and the addition u/s. 40A(2)(b) - Decided in favour of assessee.

Issues Involved:
1. Addition made by invoking the provision of section 40A(2)(b) of the Income Tax Act, 1961.
2. Whether the purchases made by the assessee from a related party were at arm's length or Fair Market Value (FMV).

Issue-wise Detailed Analysis:

1. Addition Made by Invoking Section 40A(2)(b):
The core issue in the present appeal is the addition of ?82,89,576/- made by the Assessing Officer (AO) under section 40A(2)(b) of the Income Tax Act, 1961. The AO held that the purchases made by the assessee from its sister concern, M/s. Future Technology, were not at arm's length or FMV. The AO noted that the Gross Profit (GP) ratio of the assessee was lower compared to the previous year, attributing this to purchases made at unreasonable rates from the sister concern. The AO applied a profit rate of 5.7%, which was the profit earned by the assessee on the sale of items purchased from the sister concern, to the manufacturing cost of the sister concern. This resulted in the AO determining the FMV of the purchase price to be ?2,55,45,424/- against the actual transaction value of ?3,38,35,000/-, leading to an addition of ?82,89,576/- to the income of the assessee. The CIT(A) upheld the AO's decision, dismissing the assessee's appeal.

2. Whether the Purchases Were at Arm's Length or FMV:
Before the Tribunal, the assessee justified the purchases made from the sister concern on several grounds:
- The GP earned by the sister concern during the impugned year was consistent with that earned in preceding years and had been accepted under regular assessment framed under section 143(3) of the Act.
- The sister concern had the necessary expertise, technology, skill, and facilities to manufacture the goods, while the assessee acted merely as a trader.
- The pricing arrangement was reasonable as the sister concern charged a margin of approximately 24%, which was lower than its usual margin of 30%, thus passing on the balance to the assessee.
- The assessee argued that the purchases were made at reasonable rates and were justified under the legitimate needs of the business.

The Tribunal found considerable strength in the justification provided by the assessee. The Tribunal noted that the value of the transaction in the hands of the related party was consistent with the gross profit returned from year to year, which had been accepted by the department. The Tribunal observed that the factual contentions regarding the reasonableness of the purchases remained unrebutted. The Tribunal held that the sale price of the impugned transaction in the hands of the related party was undoubtedly established to be at FMV, and consequently, the purchases in the hands of the assessee were also at FMV.

The Tribunal found that the reasoning of the CIT(A) was based on surrounding circumstances without direct evidence establishing the unreasonableness of the purchases. The Tribunal pointed out that the department itself had accepted the price/value of the impugned transaction in the hands of the related party in scrutiny assessment and had not initiated any corrective action against it.

Conclusion:
The Tribunal concluded that the transaction of purchases made by the assessee with its related party was at FMV. Consequently, the addition of ?82,89,576/- made under section 40A(2)(b) of the Act was deleted. The appeal of the assessee was allowed, and the order was pronounced on 22/01/2021.

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