Section 40A(2)(b) cannot be invoked merely for Unregistered Agreement: ITAT [Read Order]

Unregistered agreement - ITAT -Taxscan

The Income Tax Appellate Tribunal (ITAT), Delhi Bench held that Section 40A(2)(b) cannot be invoked merely for Unregistered agreement.

The assessee company, DE Diamond Electric India Pvt Limited was engaged in the business of manufacturing and trading of ignition coils for motor vehicle engines. For the year under consideration, the assessee filed return of income declaring total income under normal provisions of the Income Tax Act, 1961, and book profit Rs. 17,11,37,860/-under section 115JB of the 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 Act, after making certain additions/disallowances. One of the disallowances made is of Rs. 3,66,82,337/- under section 40A(2)(b) of the Act on account of the excessive royalty payment made to the related party.  On appeal by the assessee, the CIT(A) upheld the addition.

One of the grounds taken by the AO for invoking section 40A(2)(b) is the agreement between the parties has not been registered.

The assessee contended that in the assessment year 2013-14 the transaction of the royalty expenses was subjected to transfer pricing provisions. He submitted that in the 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.

However, the contention of the assessee was rejected by the tribunal on the grounds that the fair market value of the expenses have to be identified for the relevant year and percentile of the earlier year cannot be made the basis for comparison.

The tribunal consisting of a Judicial Member Bhavnesh Saini and Accountant Member O.P. Kant held that an unregistered agreement cannot be a ground for invoking provisions of section 40A(2)(b) of the Act in absence of requirement of law. If the expenses are not incurred wholly and exclusively for the purpose of the business, then disallowance could be made under section 37(1) of the Act.

The tribunal further stated that 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 the relevant period, which is one of the requirements for invoking the provisions of section 40A(2)(b) of the Act. Under transfer pricing provisions the arm’s-length price is compared with similar transactions,” the tribunal observed.

Therefore, the tribunal was of the view that though the provisions of section 40A(2)(b) of the 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 a basis of expenses paid in earlier years.

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