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Facts
The Revenue appealed an order by the CIT(A) directing the Assessing Officer (AO) to consider average profit of three preceding years for determining disallowance on purchases from related parties. The assessee, engaged in gold trading, declared a low gross profit rate. The AO disallowed a significant portion of purchases under Section 40A(2)(b) for being excessive.
Held
The Tribunal held that neither the AO nor the CIT(A) sufficiently relied on objective market data to determine the fair market value of the purchases. The approach of disallowing based solely on a drop in gross profit rate without market evidence, or directing an average profit rate without proper justification, is not sustainable.
Key Issues
Whether the AO and CIT(A) correctly determined the fair market value of purchases from related parties without relying on objective market data, and if the disallowance based on profit rate fall is sustainable.
Sections Cited
40A(2), 92BA, 250, 131, 68
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Income Tax Appellate Tribunal, MUMBAI BENCH “E” MUMBAI
Before: SHRI SANDEEP GOSAIN & SHRI OM PRAKASH KANT
This appeal by the Revenue is directed against order dated 18/11/2024 passed by the learned commissioner of Income-tax (Appeals)-National Faceless Appeal Centre, Delhi [in short the Ld. CIT(A)] for assessment year 2013-14, raising following grounds:
"1. On the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in directing the AO to consider average profit of A.Y.2012-13, Α.Υ.2013-14 & Α.Υ.2014-15and adopt the same for arriving at profitability of the assessee and accordingly rework the disallowance on account of purchase from the related parties, especially when the assessee could not demonstrate that the purchases had been made from the related parties at an arm length price." 2. "The Appellant prays that the order of the CIT(A) on the above grounds be set aside and that of the Assessing Officer be restored." 3."The appellant craves leave to amend, or alter any grounds or add a new ground, which necessary."
The brief facts of the case, as emerging from the record, are that the assessee is a company engaged in the business of manufacturing and trading in gold bars and ornaments. For the relevant assessment year, the assessee filed its return of income on 09.07.2014, declaring a total income of ₹6,01,250/-. The said return was selected for scrutiny and statutory notices under the Income-tax Act, 1961 (hereinafter referred to as "the Act") were issued and duly complied with.
2.1 During the course of assessment proceedings, the Assessing Officer observed that the assessee had made purchases aggregating to ₹14,89,58,551/- from two related parties—namely, M/s. Vinayak Jewellers (₹13,80,76,371/-) and M/s. Gajanand Jewels Pvt. Ltd. (₹1,08,82,180/-). In light of the nature of the transactions, the Assessing Officer required the assessee to justify the arm’s length price of the purchases in accordance with the provisions of Section 92BA of the Act, which relate to specified domestic transactions.
2.2 It was further noted that the assessee had declared a gross profit rate of only 0.25% for the year under consideration, as against 4.98% in the immediately preceding assessment year. The Assessing Officer, finding no satisfactory justification from the assessee regarding the pricing of transactions and the significant drop in profitability, proceeded to disallow an amount of ₹2,63,43,587/- under Section 40A(2)(b) of the Act, treating the same as excess expenditure incurred by way of purchases from related parties. The disallowance was computed with reference to the shortfall in the gross profit rate over the declared turnover of ₹55,69,46,287/-.
2.3 In the appellate proceedings before the CIT(A), the assessee did not comply with the notices issued and remained unrepresented. However, the Ld. CIT(A) directed the Assessing Officer to adopt an average gross profit rate for the three assessment years—2012-13 to 2014-15—for determining the extent of excessive payment. Aggrieved by the said direction, the Revenue is in appeal before us.
It is noted from the records that notice of hearing was served upon the assessee through registered post as well as through departmental process. However, there was no appearance on behalf of the assessee and no request for adjournment was received. The matter was, therefore, heard ex parte qua the assessee after hearing the learned Departmental Representative..
The sole issue arising for consideration is the determination of the fair market value of purchases from related parties, for the purposes of disallowance under Section 40A(2)(a) of the Act. The said provision mandates that if any expenditure is found to be excessive or unreasonable having regard to the fair market value of the goods or services, such excess shall be disallowed. For ready reference, the relevant provisions reproduced as under:
Section 40A(2) in The Income Tax Act, 1961 (2)(a)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 therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction; “[Provided that [for an assessment year commencing on or before the 1st day of April, 2016] no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm's length price as defined in clause (ii) of section 92F.]”
On perusal of the record and the applicable provisions, we note that Section 92BA, which defines specified domestic transactions and attracts transfer pricing documentation requirements, was inserted with effect from Assessment Year 2013–14 but was made applicable for certain transactions only from Assessment Year 2017–18 onwards. Therefore, for the year under consideration, the assessee was not mandatorily required to maintain documentation as per transfer pricing regulations. Nonetheless, the transaction remains amenable to scrutiny under Section 40A(2)(a) of the Act.
5.1 It is further observed that the determination of fair market value under Section 40A(2)(a) requires a factual inquiry into the prevailing market rates of the relevant goods during the period of transaction. Considering that the assessee deals in precious metals and ornaments, the prices of which are subject to daily fluctuations, it was incumbent upon the Assessing Officer to examine relevant market data available in the public domain or through comparable independent transactions before arriving at a conclusion regarding excessiveness.
5.2 The lower authorities have neither referred to nor relied upon such objective market data to determine the fair value of the purchases in question. The approach adopted by the Assessing Officer in computing disallowance solely based on the fall in gross profit rate, without corroborating the same with market evidence, cannot be sustained in law. The direction of the CIT(A) to apply an average gross profit rate over a three-year period, in the absence of representation from the assessee and without due analysis of comparable market prices, also lacks adequate justification.
5.3 We find that Hon’ble Delhi High Court in the case of CIT-II vs Jansampark Advertising and Marketing P Ltd in observed as under:
“38. The provision of appeal, before the CIT (Appeals) and then before the ITAT, is made more as a check on the abuse of power and authority by the AO. Whilst it is true that it is the obligation of the AO to conduct proper scrutiny of the material, given the fact that the two appellate authorities above are also forums for fact-finding, in the event of AO failing to discharge his functions properly, the obligation to conduct proper inquiry on facts would naturally shift to the door of the said appellate authority. For such purposes, we only need to point out one step in the procedure in appeal as prescribed in Section 250 of the Income Tax Act wherein, besides it being obligatory for the right of hearing to be afforded not only to the assessee but also the AO, the first appellate authority is given the liberty to make, or cause to be made, "further inquiry", in terms of sub-section (4) which reads as under:- ―The Commissioner (Appeals) may, before disposing of any appeal, make such further inquiry as he thinks fit, or may direct the Assessing Officer to make further inquiry and report the result of the same to the Commissioner (Appeals).‖ 39. The further inquiry envisaged under Section 250(4) quoted above is generally by calling what is known as "remand report". The purpose of this enabling clause is essentially to ensure that the matter of assessment reaches finality with all the requisite facts found. The assessment proceedings re- opened on the basis of preliminary satisfaction that some part of the income has escaped assessment, particularly when some unexplained credit entries have come to the notice (as in Section 68), cannot conclude, save and except by reaching satisfaction on the touchstone of the three tests mentioned earlier; viz. the identity of the third party making the payment, its creditworthiness and genuineness of the transaction. Whilst it is true that the assessee cannot be called upon to adduce conclusive proof on all these three questions, it is nonetheless legitimate expectation of the process that he would bring in some proof so as to discharge the initial burden placed on him. Since Section 68 itself declares that the credited sum would have to be included in the income of the assessee in the absence of explanation, or in the event of explanation being not satisfactory, it naturally follows that the material submitted by the assessee with his explanation must itself be wholesome or not untrue. It is only when the explanation and the material offered by the assessee at this stage passes this muster that the initial onus placed on him would shift leaving it to the AO to start inquiring into the affairs of the third party.
The CIT (Appeals), as also the ITAT, in the case at hand, in our view, unjustifiably criticized the AO for not having confronted the assessee with the facts regarding return of some of the summons under Section 131 or not having given opportunity for the identity of all the share applicants to be properly established. The order sheet entries taken note of in the order of CIT (Appeals) seem to indicate otherwise. The order of CIT (Appeals), which was confirmed by ITAT in the second appeal, does not demonstrate as to on the basis of which material it had been concluded that the genuineness of the transactions had been duly established. There is virtually no discussion in the said orders on such score, except for vague description of the material submitted by the assessee at the appellate stage. Whilst it does appear that the time given to the assessee for proving the identity of the third party was too short, and further that it is probably not always possible for the assessee placed in such situation to be able to enforce the physical attendance of such third party (who, in the case of share applicants vis-à-vis a company, would be individuals at large and may not be even in direct or personal contact), the curtains on such exercise at verification may not be drawn and adverse inferences reached only on the basis of returning undelivered of the summonses under Section 131. Conversely, with doubts as to the genuineness of some of the parties persisting on account of non-delivery of the processes, the initial burden on the assessee to adduce proof of identity cannot be treated as discharged.” 5.4 In view of aforesaid discussion and having regard to the principles of natural justice, we are of the considered view that the matter requires re-examination. Accordingly, the matter is restored to the file of the Ld. CIT(A) with a direction to re-adjudicate the issue afresh after examining the fair market value of the purchases made from the related parties during the relevant period, based on contemporaneous data. The assessee shall be afforded adequate opportunity to present its case and file relevant evidence. The grounds of the appeal of the Revenue are accordingly allowed for statistical purposes.
In the result appeal of the revenue is allowed for statistical purposes.
Order pronounced in the open Court on 30/06/2025.