Section 40A(2) – Where AO made disallowance u/s. 40A(2)(a) without placing on record any material which could prove that payments made by assessee were excessive or unreasonable, having regard to fair market value of services for which same were made or keeping in view legitimate needs of business of assesee or benefit derived by or accruing to assessee therefrom, said disallowance could not be sustained.

Section 40A(2) – Where AO made disallowance
u/s. 40A(2)(a) without placing on record any material which could prove that
payments made by assessee were excessive or unreasonable, having regard to fair
market value of services for which same were made or keeping in view legitimate
needs of business of assesee or benefit derived by or accruing to assessee
therefrom, said disallowance could not be sustained.   

FACTS 

The assessee
had made an aggregate payment to its related parties by way of commission/legal
and professional charges. However, the assessee had failed to place on record
any documentary evidence in support thereof. The AO was of the view that the
assessee had paid commission to its related parties at an exorbitant rate of 10
per cent of the sale value. It was further observed by the AO that not only the
payments made by the assessee to its related parties appeared to be
unreasonable, but rather 90 per cent of the total payments were found to have
been made to such related parties. After characterising the payments made by
the assessee to its related parties as unreasonable and excessive, the AO had
disallowed 30 per cent of such payments and made a consequential addition in
its hands.

Aggrieved, the assessee preferred an appeal
to the CIT(A). The CIT(A) confirmed the disallowance of 30 per cent of total
commission.

HELD

The Tribunal held that once the AO formed an
opinion that the expenditure incurred by the assessee in respect of the goods,
services or facilities for which the payment was made or was to be made to the
related party was found to be excessive or unreasonable, then the onus was cast
upon the assessee to rebut the same and prove the reasonableness of such
related party expenses. However, the Legislature had in all its wisdom in order
to avoid any arbitrary exercise of powers by the AO in the garb of the
aforesaid statutory provision, specifically provided that such formation of
opinion on the part of the AO had to be arrived at having regard to the fair
market value of the goods, services or facilities for which the payment was
made by the assessee.

In the case of the assessee, the CIT(A)  had upheld the ad hoc disallowance of 30 per
cent of the payments made by the assessee to its related parties, without
uttering a word as to on what basis the respective expenditure incurred by the
assessee in context of the related party services was found to be excessive or
unreasonable, having regard to either the fair market value of the services for
which the payment was made by the assessee or the legitimate needs of its
business or the benefit derived by or accruing to the assessee therefrom. The
lower authorities had carried out the disallowance u/s. 40A(2)(a) on an ad hoc
basis viz. 30 per cent of the payments made to the related parties and made a
disallowance without placing on record any material which could prove to the
hilt that the payments were excessive or unreasonable, having regard to the
fair market value of the services for which the same were made or keeping in
view the legitimate needs of the business of the assessee or the benefit
derived by or accruing to the assessee therefrom.

In the absence
of satisfaction of the basic condition for invoking of section 40A(2)(a), the
Tribunal held that the disallowance of 30 per cent of the related party
expenses i.e.Rs.38,87,705 made u/s. 40A(2)(a) could not be sustained.