INCOME TAX ACT, 1961

Section 40A(2)(b)

Business disallowance under section 40A(2)(b) - Excessive or unreasonable payment - Royalty paid to related parties - Disallowance based on royalty paid in preceding assessment year without comparing royalty expenses paid in case of similar products by other companies during relevant period

Assessee-company engaged in manufacturing and trading of ignition coils for motor vehicle engines claimed deduction of royalty paid to related parties. AO taking note of the fact that agreement between the parties had not been registered claimed deduction of royalty paid to related parties. AO taking note of the fact that unregistered agreement could not be a ground for invoking section 40A(2)(b) in absence of requirement of law. If expenses were not incurred wholly and exclusively for the purpose of the business, then disallowance could be made under section 37(1). For invoking the provision of section 40A(2)(b) had to form an opinion of expenses more than the fair market value or not according to the legitimate needs of business or no benefit derived. In the instant case, AO only compared royalty expenses of preceding assessment year and no efforts had been made for identifying fair market value of such expenses during relevant period, which is one of the requirement for invoking the provisions of section 40A(2)(b). Under transfer pricing provisions arm's-length price is compared with similar transactions. Though section 40A(2)(b) general provision as compared the specific provisions of transfer pricing, AO was required to compare royalty expenses paid in case of similar product by other companies during the relevant period. As AO had not done any such exercise and only made basis of expenses paid in earlier years, invoked section 40A(20(b) and made disallowance based on royalty expenses paid in preceding assessment year holding royalty paid during the year as excessive or unreasonable. Held: Unregistered agreement cannot be a ground for invoking section 40A(2)(b) 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). For invoking the provision of section 40A(2)(b), the AO 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 AO had only compared royalty expenses of preceding assessment year and no efforts have been made for identifying fair market value of such expenses during relevant period, which is one of the requirement for invoking provisions of section 40A(2)(b). Under transfer pricing provisions the arm's-length price is compared with similar transactions. Though provisions of section 40A(2)(b) are general provision as compared to the specific provisions of the transfer pricing, the AO was required to compare the royalty expenses paid in case of the similar product by other companies during the relevant period. The AO has not done any such exercise and only made basis of expenses paid in earlier years. Disallowance made out of royalty expenses was deleted.

REFERRED : Coronation Flour Mills v. Asstt. CIT (2009) 314 ITR 1 (Guj.) : 2009 TaxPub(DT) 1524 (Guj-HC).

FAVOUR : In assessee's favour.

A.Y. : 2016-17

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