2025 (6) TMI 1713 - AT - Income Tax

Applicability of section 40(A)(2)(b) - payments made on account on consultancy and development charges - excessive or unreasonable payments - HELD THAT - In the case of IKEA Trading (India) (P.) Ltd. 2020 (7) TMI 48 - ITAT DELHI the ITAT held that where Assessing Officer had not brought any comparable case to demonstrate that payments made by assessee to directors were excessive/unreasonable Commissioner (Appeals) had rightly deleted addition. As initial onus is on the AO to assess fair market price and give comparable instances and looking into the instant facts where no such exercise was done by the AO and no attempt was made by the AO to establish that the professional fees paid by the assessee to the concerned parties was excessive we are of the considered view that there was no discharge of burden by the Revenue u/s 40(A)(2)(b) of the Act and hence no disallowance is called for in the instant case. Appeal of the assessee is allowed.

Summary

The primary legal issues considered in this appeal revolve around the validity and correctness of disallowances made under section 40A(2)(b) of the Income Tax Act concerning payments made by the assessee to related parties. Specifically, the Tribunal examined whether the Assessing Officer and the Commissioner of Income Tax (Appeals) were justified in disallowing portions of consultancy and development expenses paid to related parties on the ground that such payments were excessive and unreasonable.

The core legal questions addressed include:

• Whether the Assessing Officer correctly applied the provisions of section 40A(2)(b) in disallowing expenses on account of consultancy fees and development charges paid to related parties.
• Who bears the onus of proof to demonstrate that payments made to related parties are excessive or unreasonable under section 40A(2)(b).
• Whether the Assessing Officer conducted a proper inquiry and placed on record any comparable market data or evidence to justify the disallowance.
• The applicability of judicial precedents regarding the burden of proof and the assessment of fair market value in cases involving related party transactions under section 40A(2)(b).

Issue-wise Detailed Analysis

Issue 1: Validity of Disallowance under Section 40A(2)(b) for Consultancy Fees Paid to M/s. Mangala Properties Pvt. Ltd. (MPPL)

Legal Framework and Precedents: Section 40A(2)(b) empowers the Assessing Officer to disallow expenditure if payments made to specified persons (including related parties) are found to be excessive or unreasonable having regard to the fair market value of goods or services. The burden of establishing excessiveness lies initially with the Revenue, who must justify the disallowance by adducing relevant evidence or comparable market data.

Several judicial decisions emphasize this principle, including:

• Commissioner of Income-tax-III vs. Ashok J. Patel, where the Gujarat High Court held that the burden is on the Assessing Officer to assess fair market price and produce comparable instances before making disallowance.
• Commissioner of Income-tax vs. Johnson & Johnson Ltd., which held that in absence of any attempt by Revenue to establish excessiveness, disallowance under section 40A(2)(b) cannot be sustained.
• Nat Steel Equipment (P.) Ltd. vs. Deputy Commissioner of Income-tax, where ITAT ruled that disallowance without material proving excessiveness or unreasonableness is unsustainable.

Court's Interpretation and Reasoning: The Tribunal observed that the Assessing Officer restricted the consultancy fees paid to MPPL to 20% of the sale value of land, disallowing the balance amount as excessive. However, the Assessing Officer did not place any evidence on record to demonstrate that the payments were excessive compared to fair market value, nor did he produce any comparable market data or conduct an independent assessment of the reasonableness of the fees.

The Tribunal further noted that the Assessing Officer erroneously placed the entire onus of proving excessiveness on the assessee, which is contrary to established legal principles. The assessee had explained the nature of services rendered by MPPL, including land measurement, appointment of architects and engineers, preparation of layouts and building plans, and had submitted relevant agreements.

On factual scrutiny, the Tribunal also found that the Assessing Officer incorrectly aggregated consultancy charges and service tax liability, thereby inflating the amount paid to MPPL. The correct consultancy fee paid was Rs. 1,40,00,000, not Rs. 1,57,30,400 as noted by the Assessing Officer.

Application of Law to Facts: Applying the legal framework, the Tribunal held that since the Assessing Officer failed to discharge the initial burden of proving excessiveness and did not produce any comparable evidence, the disallowance under section 40A(2)(b) was not justified. The assessee's explanation and documentary evidence were sufficient to rebut the presumption of excessiveness.

Treatment of Competing Arguments: The Revenue relied on the Assessing Officer's and CIT(A)'s orders to support the disallowance. However, the Tribunal found these orders lacked substantive evidentiary support and did not comply with the legal requirement of establishing excessiveness. The assessee's argument that the disallowance was arbitrary and without basis was accepted.

Conclusion: The Tribunal allowed the appeal on this issue, setting aside the disallowance of Rs. 50,75,784/- on consultancy fees paid to MPPL.

Issue 2: Validity of Disallowance under Section 40A(2)(b) for Development Charges Paid to M/s. Chetan Builders

Legal Framework and Precedents: The same principles under section 40A(2)(b) apply to payments made to M/s. Chetan Builders. The Assessing Officer must establish that payments are excessive or unreasonable compared to the fair market value of services rendered.

Judicial precedents cited above equally apply, emphasizing the Revenue's burden to justify disallowance.

Court's Interpretation and Reasoning: The Assessing Officer disallowed 20% of the development charges paid to M/s. Chetan Builders on the ground of excessiveness but did not produce any comparable market evidence or conduct a detailed inquiry to substantiate this claim.

The Tribunal noted that the assessee had produced bills and explanations for the payments made for cleaning land, fencing, and construction of labor quarters. No evidence was presented by the Revenue to demonstrate that these payments were beyond fair market value.

Application of Law to Facts: Given the lack of evidence or inquiry by the Assessing Officer, the Tribunal found the disallowance to be arbitrary and unsupported by law.

Treatment of Competing Arguments: The Revenue's reliance on the Assessing Officer's and CIT(A)'s orders was insufficient to uphold the disallowance. The assessee's contention that no comparable cases or market data were brought on record was accepted.

Conclusion: The Tribunal allowed the appeal with respect to the disallowance of Rs. 5,92,200/- on development charges.

Issue 3: Burden of Proof and Applicability of Section 40A(2)(b) in Revenue-Neutral Situations

Legal Framework and Precedents: It is a settled legal position that the initial burden to establish excessiveness of payments under section 40A(2)(b) lies on the Revenue. The assessee is not required to prove the reasonableness of payments unless the Revenue first discharges its burden by adducing evidence.

Precedents reinforce that in revenue-neutral situations-where the total income is not affected by the disallowance-no adverse inference can be drawn against the assessee.

Court's Interpretation and Reasoning: The Tribunal reiterated that the Assessing Officer's failure to discharge the initial burden of proof rendered the disallowance unsustainable. The Tribunal relied on multiple judicial pronouncements to emphasize that the Assessing Officer must conduct a proper inquiry and provide cogent reasons before invoking section 40A(2)(b).

Application of Law to Facts: Since the Assessing Officer did not produce any material to establish excessiveness and merely restricted expenses arbitrarily, the invocation of section 40A(2)(b) was improper.

Treatment of Competing Arguments: The Revenue's argument that the assessee failed to justify payments was rejected, as the legal burden was misplaced.

Conclusion: The Tribunal concluded that no disallowance under section 40A(2)(b) was warranted in the instant case.

Significant Holdings

The Tribunal held:

"Looking into the judicial precedents on the subject which have held that the initial onus is on the Assessing Officer to assess fair market price and give comparable instances and looking into the instant facts, where no such exercise was done by the Assessing Officer and no attempt was made by the Assessing Officer to establish that the professional fees paid by the assessee to the concerned parties was excessive, we are of the considered view that there was no discharge of burden by the Revenue under Section 40(A)(2)(b) of the Act and hence, no disallowance is called for in the instant case."

Core principles established include:

• The initial burden to prove excessiveness or unreasonableness of payments under section 40A(2)(b) lies on the Revenue.
• The Assessing Officer must conduct a proper inquiry, produce comparable market data, or evidence before making disallowance.
• Failure of the Revenue to discharge this burden renders the disallowance unsustainable.
• Payments to related parties cannot be disallowed merely on suspicion or arbitrary restriction without evidentiary support.

Final determinations on each issue were in favor of the assessee, with the Tribunal setting aside the disallowances of Rs. 50,75,784/- on consultancy fees and Rs. 5,92,200/- on development charges, thereby allowing the appeal.