2025 (7) TMI 1281 - AT - Income Tax

Denial of exemption u/s 11 - violation of the provisions of section 13(1)(c) r.w.s.13(2)(c) 13(2)(g) and 13(2)(h) of the Act by the assessee society - payment made to the related-persons specified u/sec.13(3) of the Act for rendering any services - CIT(A) deleted addition - assessee-society is registered under the Societies Registration Act and registered with Register of Societies Machilipatnam Krishna District in the year 1987 with the predominant object of establishing running aiding educational institutions and hostel for them Appellant-society is operating 186 colleges/ institutions for imparting education at Intermediate level. Out of the 186 colleges 80 colleges/institutions were established by the appellant-society and the remaining 106 colleges/ institutions were established by various Societies and Trusts but these colleges are being run and managed by the appellant-society. AO observed that the appellant-society had entered into service contract agreement with the two companies owned by the related parties as defined u/sec.13(3) of the Act and observed that since the service contract payments were made to companies owned by the related parties the provisions of sec.13(1)(c) r.w.s.13(3) of the Act are applicable. HELD THAT - In the present case the AO has considered service agreement between the appellant society and M/s. SKCMET and further sub-contract agreement between the two companies for rendering services to the appellant society for operation maintenance and administration of colleges/institutions run by the appellant society and consequent payment made to the above two companies as excessive and unreasonable and also computed excessive amount in terms of 40A(2)(a) of the Income Tax Act 1961. There is no dispute with regard to the fact that the service agreement with M/s. SKCMET and further agreement with the above two companies falls under the provisions of section 13(1)(c) r.w.s.13(2) r.w.s.13(3) of the Income Tax Act 1961 because the transaction is between the related parties. Appellant society never disputed the fact that the transaction is between the related parties. But what has to be seen whether payment made to the related-persons specified u/sec.13(3) of the Act for rendering any services is commensurate with such services or excessive payment when compared to similar services provided by the third party needs to be examined. In case the payment made by the appellant-society/trust is commensurate with services rendered by the said persons when compared to third party transactions under similar uncontrolled circumstances then merely for the reason of entering into agreement with related-parties it cannot be alleged that said payment falls under the purview of sec.13(2)(c) r.w.s.13(2) r.w.s.13(3) of the Act. In the present case the Assessing Officer examined the payments under the provisions of section 13(1)(c) because the appellant-society has made payment to the related parties specified under sub-section 13(3) of the Act. But the AO erred in computing excessive and unreasonable amount by invoking the provisions of section 13(2)(c) without bringing on record any comparable cases of similar nature. AO has simply taken total expenditure incurred by the appellant society for the financial year 2010-2011 as base expenditure but arrived at a reasonable amount to be payable for the above services and then compared with payment made by the appellant society for the year under consideration to allege that the payment made by the appellant society is excessive and unreasonable. In our considered view the action of the AO in making adhoc disallowance of expenditure is purely on suspicion and surmises manner without there being any evidence to suggest that expenditure incurred by the appellant society is excessive and unreasonable which fall under section 40A(2)(a) of the Act. In our considered view unless the Assessing Officer brings on record certain evidences to prove that payment made by the appellant society to the above two companies is excessive and unreasonable going by the evidences which suggest that for similar services third party would have rendered services for such an amount referred to by the Assessing Officer in our considered view merely on suspicion and surmises adhoc disallowance cannot be made. Assessing Officer by making a jugglery of figures has arrived at excessive amount of Rs. 25, 76, 43, 593/- even though there is no evidence with the Assessing Officer to allege that services rendered by the above two companies to appellant society is not commensurate with the payment made by the appellant society. Therefore we are of the considered view that the reasons given by the Assessing Officer to allege that appellant society has made excessive and unreasonable payment in terms of section 40A(2)(a) to the above two companies for rendering services is devoid of merits and cannot be accepted. Further the Assessing Officer has ignored the fact that the above two companies have rendered services to the appellant society for which the appellant society has paid remuneration which is commensurate with the services provided by the above two companies. Therefore Assessing Officer should have verified the payment with any comparable cases of similar nature or the industrial average of this kind of services provided by third party. In absence of any comparable case of similar nature or industrial average the reasons given by the Assessing Officer to compute excessive and unreasonable payment cannot be up upheld. The learned CIT(A) after considering the relevant facts has rightly deleted the addition made by the Assessing Officer Thus we are inclined to uphold the findings of the learned CIT(A) and dismiss the appeal filed by the Revenue.

Summary

ISSUES:

Whether payments made by a charitable society to related parties for services rendered violate provisions of section 13(1)(c) read with sections 13(2)(c), 13(2)(g), and 13(2)(h) of the Income Tax Act, 1961.Whether the service agreements entered into between the society, a related trust, and companies owned by specified persons constitute sham transactions intended to benefit interested persons under section 13(3) of the Act.Whether the Assessing Officer was justified in disallowing expenditure under section 40A(2)(a) of the Act on the ground that payments to related parties were excessive and unreasonable.Whether the Assessing Officer correctly computed the value of benefit conferred on related parties by comparing payments made with expenditure incurred in the preceding year and applying adjustments for inflation and profit margin.Whether the CIT(A) erred in deleting the disallowance of expenditure and holding that no violation of section 13(1)(c) and related provisions occurred.Whether income forfeited exemption under section 13(1)(c) is taxable at maximum marginal rate and other income is taxable under the head "profits and gains of business or profession."

RULINGS / HOLDINGS:

The Court held that the payments made by the society to related parties under the service agreements are subject to scrutiny under section 13(1)(c) read with sections 13(2)(c), 13(2)(g), and 13(2)(h), but mere existence of related party transactions does not ipso facto establish violation unless payments are excessive or unreasonable.The Court found no evidence that the service agreements were sham transactions; the society received services from the related companies, and the transactions were bona fide.The Assessing Officer's disallowance under section 40A(2)(a) was held to be unjustified as it was based on an ad hoc computation without bringing on record any comparable cases or industry benchmarks to establish that payments were excessive or unreasonable.The method adopted by the Assessing Officer-using preceding year's expenditure as a base, adjusting for inflation and profit margin to determine excessive payment-was rejected as speculative and unsupported by evidence.The CIT(A) rightly deleted the disallowance of Rs. 25,76,43,593/- and held that there was no violation of section 13(1)(c) and related provisions, given the absence of proof that payments exceeded reasonable compensation for services rendered.Income forfeited exemption under section 13(1)(c) is taxable at maximum marginal rate, and other income of the society is taxable under the head "profits and gains of business or profession" in accordance with sections 28 to 44DB of the Act.

RATIONALE:

The Court applied the statutory framework of sections 11, 12, and 13 of the Income Tax Act, 1961, which govern exemption for charitable societies and conditions for denial of exemption where income or property benefits specified persons under section 13(3).Section 13(1)(c) prohibits income or property of the trust being used for benefit of specified persons except for reasonable compensation for services rendered, as clarified by section 13(2)(c).The Court emphasized that invoking section 40A(2)(a) to disallow expenditure requires evidence that payments to related parties are excessive or unreasonable compared to fair market value; mere related party status is insufficient.The Assessing Officer's reliance on prior year expenditure and arbitrary profit margin to determine excess payment was characterized as a "jugglery of figures" lacking evidentiary basis.The Court noted the absence of comparable industry data or benchmarks brought by the Assessing Officer to justify disallowance, underscoring the necessity of concrete evidence to support such findings.The Court acknowledged the principle that reasonable compensation paid to interested persons for bona fide services is not a violation of section 13(1)(c), consistent with the proviso to that section.The decision aligns with precedent requiring the assessee to prove reasonableness of payments to related parties and rejects disallowance based on mere suspicion or surmise.