Section 40A(2)(b) cannot be invoked merely for Unregistered agreement

DE Diamond Electric India Pvt Limited Vs ACIT (ITAT Delhi)

One of the ground taken by the AO for invoking section 40A(2)(b) is the agreement between the parties has not been registered. In our opinion, an unregistered agreement cannot be a ground for invoking provisions of section 40A(2)(b) of the Act 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) of the Act. For invoking the provision of section 40A(2)(b) of the Act, the Assessing Officer 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 the Assessing Officer has only compared royalty expenses of the preceding assessment year and no efforts have been made for identifying the fair market value of such expenses during relevant period, which is one of the requirement for invoking the provisions of section 40A(2)(b) of the Act. Under transfer pricing provisions the arm’s-length price is compared with similar transactions. Though the provisions of section 40A(2)(b) of the Act are general provision as compared to the specific provisions of the transfer pricing, the Assessing Officer was required to compare the royalty expenses paid in case of the similar product by other companies during the relevant period. The Assessing Officer has not done any such exercise and only made basis of expenses paid in earlier years.

The Learned Counsel of the assessee contended that in assessment year 2013-14 the transaction of the royalty expenses were subjected to transfer pricing provisions. He submitted that in assessment year 2013-14 average royalty payment was 2.99% of the sales, which stands accepted by the Department and therefore, no disallowance should be made in the year under consideration, where the royalty expenses are only 2.77% of the sales. This contention of the learned Counsel is rejected as the fair market value of the expenses have to be identified for the relevant year and percentile of the earlier year cannot be made basis for comparison.

In view of the above discussion, the disallowance made out of royalty expenses amounting to ₹ 3,66,82,337/-is deleted.

FULL TEXT OF THE ITAT JUDGEMENT

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