44 Business expenditure :
Disallowance u/s. 40A(2) of Income-tax Act, 1961 : A.Y. 1985-86 : Assessee-company
purchased goods from its subsidiary company at higher rate in view of assurance
of supply of huge quantity of uniform quality : Assessee and subsidiary in same
tax bracket and paid same rate of tax : No disallowance could be made u/s.40A(2)
: Subsidiary company is not a ‘related person’ u/s.40A(2)(b) : S. 40A(2) not
attracted.
[CIT v. V. S. Dempo & Co.
(P) Ltd., 196 Taxman 193 (Bom.)]
The assessee-company was
engaged in the business of extraction and export of iron ore. During the
relevant assessment year, it purchased iron ore from its subsidiary company. The
Assessing Officer held that the prevailing rates of sale/purchase of the same
grade of iron ore in the State were lower than the rate at which the assessee
had purchased the ore from its subsidiary and, therefore, the provisions of S.
40A(2) were attracted. The Assessing Officer, accordingly, made certain
disallowance. On appeal, the Commissioner (Appeals) held that the rates at which
the iron ore was purchased by the assessee from its subsidiary were determined
under a contract, under which the assessee was assured a huge quantity and
quality of ore and, therefore, the assessee was justified in paying the higher
rate than the rate at which the ore was available during the relevant time on
non-contractual basis. The Commissioner (Appeals) further held that the assessee
was a company and the seller of the goods was also a company and, therefore, the
rate of tax applicable to both of them was identical, namely, the highest rate
of tax. Therefore, by buying ore at rate higher than the market rate, there was
no reduction in the amount of tax payable. The Commissioner (Appeals),
accordingly, deleted the addition. The Tribunal confirmed the order of the
Commissioner (Appeals).
On appeal by the Revenue the Bombay High Court upheld the decision of the Tribunal and held as under:
“(i) In a business of export, consistency of supply as well as quality of supply is important. In order to assure a consistent supply of material of the same quality, the purchaser of a commodity may pay to a seller bound under a contract a little higher than the current rate. Furthermore, in case of yearly contracts by agreeing to buy goods at a specified rate, the exporter is insulated from vagaries of any seasonal rise in the market rate. Therefore, unless the rate agreed is so very much excessive or unreasonable as to doubt the objective behind the agreement, it cannot be said that the rate, a little higher than the seasonal market rate, is unjustified or amounts to diversion of profit. In that connection, the fact that the assessee as well as its subsidiary company, which was the seller, were in the same tax bracket and paid the same rate of tax assumed importance.
(ii) Admittedly, it was not a case of tax evasion inasmuch as if the rate would have been less, the assessee’s profit would have been more, but the profits of the seller would have been less and both being taxable at the same rate, there would be no difference in the aggregate tax payable by the assessee and its subsidiary.
(iii) Further, the object of S. 40A(2) is to prevent diversion of income. An assessee, who has large income and is liable to pay tax at the highest rate prescribed under the Act, often seeks to transfer a part of his income to a related person who is not liable to pay tax at all or liable to pay tax at a rate lower than the rate at which the assessee pays the tax. In order to curb such tendency of diversion of income and thereby reducing the tax liability by illegitimate means, S. 40A was added to the Act by an amendment made by the Finance Act, 1968.
(iv) Clause (b) of S. 40A(2) gives the list of related persons. It is only where the payment is made by the assessee to the related persons mentioned in clause (b) of S. 40A(2), that the Assessing Officer gets jurisdiction to disallow the expenditure or a part of the expenditure which he considers excessive or unreasonable. The Revenue submitted that the instant case fell under sub-clause (ii) or sub-clause (iv) of clause (b) of S. 40A(2). Sub-clause (ii) provides that where the assessee is a company, firm, AOP or HUF, any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member would be a related person. In the instant case, the assessee was a company and the seller was its subsidiary company. The seller, i.e., the subsidiary company did not fall in any of the categories mentioned under sub-clause (ii) of clause (b). Only a director of the company, partner of the firm, or member of the association or family or any relative of such director, partner or member is a related person under sub-clause (ii) of clause (b) of Ss.(2). Another company, even if it is a subsidiary of the assessee, is not a related person within the meaning of sub-clause (ii) of clause (b) of
S. 40A(2). Sub-clause (iv) of clause (b) of S. 40A(2) provides that in case of a company, firm, AOP or HUF having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member is a related person. Again a subsidiary company does not fall in any of the class of persons mentioned in sub-clause (iv) of clause (b) of S. 40A(2). In law, a holding company is a member of subsidiary company and holds more than 50 per cent equity share capital of the subsidiary company (except in cases where it controls the composition of the board of directors without holding majority of the shares). While the holding company is a member of its subsidiary company, the subsidiary company is not a member of the holding company. As the subsidiary company was not a member of the assessee, sub-clause (iv) of clause (b) of S. 40A(2) was also not attracted in the instant case.
(v) Therefore, there was no merit in the appeal and same was to be dismissed.”
