2025 (1) TMI 92 - AT - Income Tax

Disallowance u/s 40A(2)(b) - excessive payments made to related or associate concerns - HELD THAT - We hereby quote CBDT landmark Circular 6-P dated 6.7.1968 that the purpose of the impugned statutory provision is to check evasion of tax through excessive or unreasonable payments to related or associate concerns. Cas law in Sigma Research Consulting Pvt. Ltd. 2019 (4) TMI 290 - DELHI HIGH COURT as well as Indo Saudi Services (Travel) (P) Ltd. 2008 (8) TMI 208 - BOMBAY HIGH COURT also settle the issue against the department that the impugned disallowance is not sustainable when both the payer and payee are assessed at the same rate in light of the foregoing circular. We accordingly delete the impugned section 40A(2)(b) disallowance in very terms. Assessee in favour of assessee.

1. ISSUES PRESENTED and CONSIDERED

The legal judgment presented involves the following core legal questions:

Whether the disallowance of Rs. 1,26,54,000/- under Section 40A(2)(b) of the Income-tax Act, 1961, by the Assessing Officer (AO) was justified, and whether the Commissioner of Income-tax (Appeals) [CIT(A)] erred in restricting the disallowance to Rs. 82,80,000/-.
Whether the transaction of purchasing poppy seeds from a related party was at Arm's Length Price (ALP) as per Indian transfer pricing regulations.
Whether the AO had jurisdiction to determine the Fair Market Value (FMV) of the purchase transaction with the related party.
Whether the comparison of domestic purchase prices with international market prices was appropriate.
Whether the CIT(A) erred in dismissing the issue of tax arbitrage as 'general in nature' without adjudication.
Whether the interest charged under Sections 244A and 234D was correct.
Whether the assessment and the order of the CIT(A) were against the law and facts of the case.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Disallowance under Section 40A(2)(b)

Relevant Legal Framework and Precedents: Section 40A(2)(b) of the Income-tax Act, 1961, deals with disallowance of excessive or unreasonable payments to related parties. The CBDT Circular 6-P dated 6.7.1968 aims to prevent tax evasion through such payments.
Court's Interpretation and Reasoning: The court considered whether the payments exceeded the market price and whether the payer and payee were assessed at the same tax rate.
Key Evidence and Findings: The AO compared the purchase price of poppy seeds from a related party with the price from Turkey, finding a discrepancy. The CIT(A) adjusted the disallowance based on additional costs.
Application of Law to Facts: The court noted that both parties were assessed at similar tax rates, negating the purpose of Section 40A(2)(b) disallowance.
Treatment of Competing Arguments: The assessee argued that the FMV should be based on domestic market prices, not international prices. The court agreed, citing the CBDT Circular and relevant case law.
Conclusions: The court deleted the disallowance, emphasizing that both parties were assessed at the same rate, and the transaction was at FMV.

Issue 2: Arm's Length Price and Jurisdiction

Relevant Legal Framework and Precedents: Indian transfer pricing regulations require transactions with related parties to be at ALP.
Court's Interpretation and Reasoning: The court examined whether the AO had the jurisdiction to determine ALP without referring to the Transfer Pricing Officer (TPO).
Key Evidence and Findings: The AO's determination of FMV without TPO reference was challenged based on CBDT Instruction No. 3/2016.
Application of Law to Facts: The court found that the AO lacked jurisdiction to determine ALP without TPO involvement.
Treatment of Competing Arguments: The assessee's argument that the AO's action was against binding instructions was upheld.
Conclusions: The court concluded that the AO's determination of FMV was without jurisdiction.

Issue 3: Comparison with International Market Prices

Relevant Legal Framework and Precedents: The FMV should be based on domestic market prices.
Court's Interpretation and Reasoning: The court found the AO's comparison with international prices inappropriate.
Key Evidence and Findings: The assessee provided evidence of domestic sales at similar prices.
Application of Law to Facts: The court agreed that domestic market prices were the correct basis for FMV.
Treatment of Competing Arguments: The court sided with the assessee's view on FMV determination.
Conclusions: The court found the AO's comparison method flawed.

Issue 4: Tax Arbitrage

Relevant Legal Framework and Precedents: Tax arbitrage involves exploiting differences in tax rates.
Court's Interpretation and Reasoning: The court considered whether tax arbitrage was involved.
Key Evidence and Findings: The assessee argued no tax arbitrage was present.
Application of Law to Facts: The court found no evidence of tax arbitrage.
Treatment of Competing Arguments: The court accepted the assessee's argument.
Conclusions: The court dismissed the tax arbitrage issue as irrelevant.

3. SIGNIFICANT HOLDINGS

Preserve Verbatim Quotes of Crucial Legal Reasoning: "The purpose of the impugned statutory provision is to check evasion of tax through excessive or unreasonable payments to related or associate concerns."
Core Principles Established: Disallowance under Section 40A(2)(b) is not warranted when both parties are assessed at the same tax rate.
Final Determinations on Each Issue: The court allowed the assessee's appeal, deleting the disallowance under Section 40A(2)(b) and finding the AO's determination of FMV without jurisdiction.

← Previous Next →