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Income Tax Appellate Tribunal, CHANDIGARH BENCH ‘A’, CHANDIGARH
Before: SHRI SANJAY GARG & SMT.ANNAPURNA GUPTA
आदेश/ORDER
Per Annapurna Gupta, Accountant Member: The present appeal has been filed by the assessee against the order passed by the Ld. Commissioner of Income Tax (Appeals)-1, Chandigarh(hereinafter referred to as “CIT(A)] u/s 143(3) of the Income Tax Act,1961(in short referred to as “Act”) dt.05/03/2019 relating to assessment years(A.Y)2012-13 & 2013-14.
The solitary issue in the present appeal relates to the addition made by invoking the provision of section 40A(2)(b) of the Act, holding the purchases made by the assessee from related party to be not at arms length or Fair Market Value (FMV) and
making adjustment thereto to the extent of Rs. 82,89,576/- resulting in addition to the said extent to the income of the assessee
The solitary effective ground raised by the assessee in this regard before us, reads as under:
“ 2 . That on law, facts and circumstances of the case, the Worthy CIT(A) has erred in confirming the action of Ld. A.O. in making addition of Rs. 82,89,576/- u/s 40A(2)(b) of the Act in respect of purchases of Rs. 3,38,35,000/- made from a related party even when the purchases were made at reasonable rates under circumstances and complete explanation for the same was filed.”
The brief facts relating to the issue are that the assessee company is engaged in the business of manufacturing of security equipment. During assessment proceedings the Assessing Officer (AO) noted that the Gross Profit (GP) ratio shown by the assessee in the impugned year was lower as compared to the last year and according to the AO the same was on account of purchases made from the sister concern of the assessee, M/s Future Technology, at unreasonable rates. The AO accordingly confronted the same to the assessee in response to which detailed submissions were filed by the assessee justifying both the fall in GP and the reasonableness of the rates at which the purchases were made from the sister concern. The AO was not satisfied with the same and held that the assessee had purchased items at very high and unreasonable rates from the related party. The AO further noted that the assessee had earned profit of only 5.7% on the sale of the said items which were bought from the sister concern. He accordingly held that the sister concern ought to have earned profit to this extent only on the sales made to the assessee and applying this rate of 5.7% to the manufacturing cost of sister concern,he worked out the FMV of the purchase price at Rs. 2,55,45,424/- as against Rs. 3,38,35,000/- at which it was actually transacted by the assessee. The difference of Rs. 82,89,576/- was accordingly treated as unreasonable expenditure on account of inflated purchases in the hands of the assessee as per section 40A(2)(b) of the Act and addition made of the same to the income of the assessee. This addition was vehemently agitated before the Ld. C(A) who was not convinced with the arguments of the assessee and therefore he upheld the order of the AO , dismissing the appeal of the assessee.
Before us, Ld. Counsel for the Assessee referred to the detailed submissions made before the Ld. C(A) reproduced at para 13.1 of his order and justified the purchases made from the sister concern stating as under:
That the GP earned by the sister concern during the impugned year was consistent with that earned in the preceding years and had further been accepted under regular assessment framed under 143 (3) of the Act. Therefore clearly the sales made by the sister concern to the assessee was at arms length / FMV. Our Attention was drawn to the Gross margin earned by the SC M/s M/s Future Technology in the impugned year and the preceding year reproduced at page 13 of CIT(A) order as under:
M/s Future technologies has history & experience of manufacturing & supply of security equipments to ministry of Defence. Its established & accepted GP rate in last 3 years is as under: A. Y. Turnover (in Lacs) GP rate (%) 2011-12 812.93 49.08% 2012-13 474.63 39.42% 2013-14 769.93 35.51%
That the assessee company had only acted as a trader procuring order and supplying goods to the customer ,while the sister concern had manufactured the goods, having the necessary expertise ,technology ,skill and facilities to do so and with a history of accepted margin of the sister concern at 30%,it had charged only 24% passing on the balance i.e approx 5.5 % to the assessee,the GP earned by the assessee during the year, in the impugned transaction, i.e less than the normal margin ,thus justifying the reasonableness of the price at which the transaction was undertaken. The relevant submissions in this regard are as under:
“13.1 Per Contra: In response to the appeal filed by the appellant u/s 250 of the Act, authorized representative (in short "Ld. AR") filed written submission on behalf of the assessee as under:-
"1. The appellant is a company & is engaged in manufacturing of security equipments.
The appellant procures order for supply of engineering goods.
The only question involved in present appeal is pricing arrangement of goods purchased by appellant from M/s Future Technologies (Sister Concern). Sh. R.K. Gupta is the director of appellant company & his son Sh.Amit Gupta is proprietor of M/s Future Technologies.
M/s Future Technologies is a manufacturing concern whose profit is deductible u/s 4. 80IC of the Act since its unit is in Himachal Pradesh. Its assessment for the year in question
was also completed u/s 143(3) by the same Assessing Officer at or around almost the same time by passing order u/s 143(3). Qua the issue in present appeal, no addition or adverse inference was made in assessment of M/s Future technologies.
M/s Future technologies has history & experience of manufacturing & supply of security equipments to ministry of Defence. Its established & accepted GP rate in last 3 years is as under: A. Y. Turnover (in Lacs) GP rate (%) 2011-12 812.93 49.08% 2012-13 474.63 39.42% 2013-14 769.93 35.51%
During the year in question, the appellant company got some order from Ministry of 6. Defence for supply of certain security equipments. M/s Future technologies had the experience, manufacturing facilities, resources & capability to execute the order within specified limited time. The appellant company completely lacked in all such facilities & resources. Therefore, it outsourced the manufacturing part of the order to M/s Future technologies at agreed price between the parties. A tabulation showing price charged from Ministry of Defence, price paid to M/s future technologies, Margin retained by the assessee, cost of the relevant products of future technologies & gross margin earned by M/s future technologies is enclosed.
It is an undisputed fact that the appellant purchased goods worth Rs.338.35 Lacs from M/s Future technologies & sold them to Ministry of Defence at Rs.357.80 Lacs earning margin of approximately 5.50%. Except form procuring order & getting products manufactured from future technologies, appellant company did not do any value addition to the product & did not incur any expense for supply of this product. In respect of this order, M/s future technologies earned gross margin of approximately 24%.
All the above facts are totally undisputed.
However, Ld. A.O. has held that the appellant with a view to lower its gross margin has passed on higher profit to its sister concern as the profit of said sister concern was eligible of deduction u/s 80IC. He has held that M/s future technologies should have retained only 5.7% as margin & balance should have been earned by appellant company. By way of this, he made the impugned addition of Rs. 82,89,576/-.
Copies of relevant submissions & documents filed before A.O. are enclosed.
The making of above addition is against the provisions of the Act. If A.O. is of opinion that certain purchases made from related party have been made at excessive & unreasonable prices, the only section which gives him power to disallow the excessive & unreasonable portion is sec 40A(2)(a). The relevant extract of this sec is under
" Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him there from, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction "
It is evident that disallowance u/s 40A(2)(a) cannot be made unless the expense is excessive or unreasonable having regard to: a) FMV of goods; b) Legitimate needs of business of assessee; and c) Benefit derived by or accruing to assessee.
Comparing the facts of present case and the relevant provision of sec 40A(2)(a), the impugned addition deserves to be deleted due to following counts:-
1) The total gross margin from order of Ministry of Defence was 30%. out of which 24% was earned by M/s Future technologies & rest by appellant company. The appellant company only acted as a trader wherein it only procured the order & supplied the goods to customer. As against this, M/s Future technologies used its experience, resources, facilities, skills to manufacture the relevant product. It had established & accepted history of charging gross margin in excess of 30% from unrelated customers. It only charged margin of approximately 24% from the appellant company. Therefore, when the appellant only acted as a trader & related party used its infrastructure to manufacture the product & charged a margin which was less than what it was charging from unrelated customers, it is nothing but a case of purchase of goods from related party at even lessor then its Fair Market value of goods. Therefore, no disallowance u/s 40A(2)(a) should have been made.
2) The appellant company got order form Ministry of Defence for supply of relevant items, but did not have relevant experience, resources & manufacturing facilities to supply product in short span of time of less than 2 months. As against this, M/s Future technologies had all such experience, resources, capability & capacity to manufacture such products & execute such high volume of order in such short span of time. Considering all such facts, the pricing arrangement between the parties was more than reasonable as it was the legitimate need of business of the assessee which is one of the situation covered in sec 40(A)(2)(a) also. Therefore, addition u/s 40(A)(2)(a) should not have been made.
3) The appellant applied for petting the order from Ministry of defence mainly on the strength of experience, resources, capability and capacity of its sister concern as on its own, it was not in a position at all to execute the order. The non-execution of order would have result in black-listing of appellant from ministry of defence and imposition of monetary penalty. By getting the order executed from related party, the appellant still earned approx. Rs.19 Lacs i.e. 5.50% of gross Margin. Keeping in mind the quantum and nature of activity carried out by the appellant company, this margin retained by the appellant was reasonable and margin passed to related party was also more than reasonable. The pricing arrangement was reasonable and was not at all excessive having regard to benefit derived by the assessee from relevant order of ministry of defence. Ld. AO was highly unjustified in making impugned addition of Rs. 82,89,576/- u/s 40 (A)(2)(a) of the Act.
4) In support of our factual arguments, we also relying upon ratio of following judgments:
[NO SUCH JUDGEMENTS ARE FOUND DETAILED BY THE AR IN THIS PARA]
In the light of above facts, circumstances and legal position of the case, it is prayed that this ground of the appellant may please be allowed. We shall be highly obliged."
4.1 Per contra the Ld. DR relied heavily on the findings of the Ld.CIT(A) at para 13.2 of the order as under:
13.2 HELD: I have perused the order of the Assessing Officer and examined the reply of the assessee. It is an undisputed fact that the appellant is a company & is engaged in manufacturing of security equipments. It is claimed that the appellant procures order for supply of engineering goods. The moot question in this appeal is low GP Rate as compared to the last year and pricing arrangement of goods purchased by appellant from M/s Future Technologies (Sister Concern). Sh. R.K. Gupta is the director of appellant company & his son Sh.Amit Gupta is proprietor of M/s Future Technologies. M/s Future
Technologies is a manufacturing concern whose profit is deductible u/s 80IC of the Act since its unit is in Himachal Pradesh. Both assessee and M/s Future technologies claimed to have history & experience of manufacturing & supply of security equipments to Ministry of Defence. The assessee when confronted submits that during the year comparative prices of raw material had increased whereas on perusal of details of party wise purchases, the AO has found that the assessee had opening balance of raw material amounting to Rs.99,10,455/-, which was purchased in the earlier years and used this year. In response of the assessee that the company had manufactured different products every year as per the requirements of the customers it is observed that the assessee has utilized same raw material during the year as well as in the previous year. Hence, the claim of the assessee that the products are totally different in two years is outrightly incorrect. Since, assessee is itself manufacturer of security equipments, it is strange that assessee is reporting low GP as compared to the sister concern M/s Future Technology. The assessee itself stated during assessment proceedings that though the company had manufactured different items but consistently maintained almost same G.P. To claim that assessee purchased items from M/s Future Technology on credit basis and this was one of the reasons for charging of higher rate from related party M/s Lotus Machines (P) Ltd. is not acceptable when AO has observed that the assessee in routine business has purchased items at credit for three months or more than 3 months. The assessee has failed to produce the tender documents against which the supply had been made to Ministry of Defence before the AO as well as during appellate proceedings. The argument that reasons for fall in G.P. was stiff competition in the market faced by the assessee is also not acceptable as the assessee had made purchases from the related party and the rate of sale to the Defence Ministry was already decided as the supply had been made against the tender as claimed by the assessee. To argue that during the year in question, the appellant company got some order from Ministry of Defence for supply of certain security equipments and M/s Future Technologies had the experience, manufacturing facilities, resources & capability to execute the order within specified limited time and the appellant company completely lacked in all such facilities & resources, is also not acceptable in the absence of supporting evidence brought on record. To further argue that the total gross margin from order of Ministry of Defence was 30%, out of which 24% was earned by M/s Future technologies & rest by appellant company is also not acceptable as it is observed that the appellant company as claimed has only acted as a trader wherein it only procured the order & supplied the goods to customer. The appellant has failed to submit any agreement/MOU with sister concern on arbitrarily sharing of profits out of 30% gross margin. It is strange that the appellant company is loudly arguing that it has got order form Ministry of Defence for supply of relevant items, but did not have relevant experience, resources & manufacturing facilities to supply product in short span of time of less than 2 months. Meaning thereby that the appellant company is procuring orders from the Ministry of Defence by misrepresenting the true facts when it has no capability in the form of relevant experience, resources & manufacturing facilities to supply product in short span. There is no such agreement or MOU produced in appellate proceedings which will establish that it has procured the said order by showing collaboration with the sister concern. No tender document was either ever produced to prove the same. If the FMV of the group is in fact so high then why is the assessee satisfied in such low GP. It is in these facts and circumstances, the Ld. AO has held that by entering into this transaction with it's related party and by inflating its purchases, the assessee has made an arrangement by way of which its GP rate has come down by 8.39% in AY 2013-14 as compared to the earlier year and the assessee has been able to show very high rate of G.P in related party M/s Future Technology. Hence, it is clear that the assessee had made purchases from the related party at unreasonable price as the assessee had made purchases of Rs.3,38,35,000/- from M/s Future Technology which is a related party. By this arrangement, M/s Future Technology had earned 40% G.P during the assessment year 2013-14 and accordingly the related party earned unreasonable profit from M/s Lotus Machines Pvt. Ltd. of Rs. 96,67,142/- @ 40% leaving profit for the assessee about @ 6% only. It is a fact that M/s Future Technology is the unit claiming deduction u/s 80IC of the Act and high profit suits the sister concern. There seems a tacit arrangement between both the parties. The AO has rightly disallowed the sum of Rs.82,89,576/- under the provisions of section 40A(2)(a) of the Act. The Ground of Appeal No.2 is dismissed.
4.2 Referring to the same ,Ld. DR contended that the assesses explanation for fall in G.P was totally unfounded and not supported by facts as pointed out by the Ld.CIT(A) so also the assesses explanation justifying the reasonableness of the purchases made from its sister concern .That no evidence of procuring order from the government by the assessee was filed nor regarding arrangement for sharing profits earned from the said order. That this was just a tacit arrangement by the assessee of siphoning off substantial profits earned from the order to the sister concern whose profits were exempt under the Act .
We have heard both the parties and have also gone through the orders of the authorities below. The moot question is whether the purchases made by the assessee from its sister concern of Rs.3,38,35,000/- during the year were at fair market price/arms length.
We find considerable strength in the justification given by the Ld. Counsel for the assessee for the reasonableness of the price of the related party transaction which rests on the premise that the value of the transaction in the hands of the related party was at consistently returned gross profit from year to year which stood accepted by the department also. All the factual contentions of the Ld. Counsel for the assessee with regard to the same have remained unrebutted before us. In view of the same the sale price of the impugned transaction in the hands of the related party is undoubtedly established to be at fair market value and consequently so the purchases in the hands of the assessee. The assessee we find has sufficiently established the reasonableness of the purchases made from sister concern. On the other hand the reasoning of the Ld.CIT(A) holding the purchases to be inflated , we find,is based on surrounding circumstances and there is no direct evidence establishing the unreasonableness of the purchases . The entire case of the Revenue is that the assessee was unable to justify fall in gross profits during the year and that its explanation of having procured an order from the government which it outsourced to its related party for manufacturing the product ,the assessee itself acting as a trader alone, resulting in larger share of the profit in the transaction being given to the related party and the assessee retaining only a small portion, was all unsubstantiated and make believe .That the assessee had so managed and arranged its affairs that it siphoned off larger share of the profits to its related concern which was a tax exempt unit retaining only a small portion of the
profits. To put it succinctly ,failure to explain satisfactorily fall in G.P is the main plank for holding the transaction of purchase of the assessee with the related party as being inflated and not at fair value. The department itself having accepted the price/value of the impugned transaction in the hands of the related party in scrutiny assessment and nothing having been brought before us demonstrating any corrective action being initiated by the department against it in view of the impugned transaction being found to be at inflated prices,we find no force in the argument of the Revenue.
In view of the above, we hold that the transaction of purchases made by the assessee with its related party stands established to be at fair market value and the addition made of Rs. 82,89,576/- u/s 40A(2)(b) of the Act ,is therefore deleted.
Ground of appeal raised by the assessee is allowed.
In effect appeal of the assessee is allowed.
Order pronounced on 22/01/2021.
Sd/- Sd/- संजय गग� अ�नपूणा� गु�ता (ANNAPURNA GUPTA) (SANJAY GARG) �याय�क सद�य/Judicial Member लेखा सद�य/Accountant Member �दनांक /Dated: 22/01/2021 AG आदेश क� ��त�ल�प अ�े�षत/ Copy of the order forwarded to :
अपीलाथ�/ The Appellant 2. ��यथ�/ The Respondent 3. आयकर आयु�त/ CIT 4. आयकर आयु�त (अपील)/ The CIT(A) 5. �वभागीय ��त�न�ध, आयकर अपील�य आ�धकरण, च�डीगढ़/ DR, ITAT, CHANDIGARH 6. गाड� फाईल/ Guard File