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Facts
The assessee engaged in manufacturing iron and steel products paid interest and made purchases from related parties. The AO disallowed 20% of interest payments and 10% of purchases from sister concerns, citing Section 40A(2)(b) of the Income Tax Act.
Held
The Tribunal held that the disallowances made by the AO under Section 40A(2)(b) were not sustainable as the interest paid at 12% was below the market rate and the AO failed to establish the market rate for purchases from related parties. Adhoc disallowances on miscellaneous expenses were also deleted.
Key Issues
Whether disallowances made under Section 40A(2)(b) for interest payments and purchases from related parties were justified without establishing market rates and proper reasoning. Whether adhoc disallowances on miscellaneous expenses are valid without identifying specific defects.
Sections Cited
40A(2)(b)
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Income Tax Appellate Tribunal, DIVISION BENCH, ‘A’ CHANDIGARH
Before: SHRI RAJPAL YADAV & SHRI MANOJ KUMAR AGGARWAL
PHYSICAL HEARING O R D E R PER RAJPAL YADAV, VP
The assessee is in appeal before the Tribunal against the order of the ld. Commissioner of Income Tax (Appeals) [in short ‘the CIT (A)’] dated 28.05.2024 passed for assessment year 2017-18.
The assessee has taken five grounds of appeal out of which Ground No. 1 and 5 are general grounds, which do not call for recording of any specific finding.
ITA No.804/CHD/2024 A.Y.2017-18 2
Ground Nos. 2 and 3 are inter-connected with each other. In these grounds of appeal, assessee has pleaded that ld. CIT(A) has erred in upholding the disallowances made by the AO with the aid of Section 40A(2)(b) of the Income Tax Act out of interest payment and purchases made by it.
4. With the assistance of ld. Representative, we have gone through the record carefully. The assessee at the relevant time was engaged in the business of manufacturing of iron and steel products. It has filed its return of income on 25.08.2017 electronically and declared income of Rs.42,53,740/-. The case of the assessee was selected for scrutiny assessment. On perusal of the accounts, it revealed to the AO that assessee has made interest payments to 11 parties individual/entities. In these 11 parties, 6 are partners, 3 are family members and 2 sister concerns. The AO has recorded that total interest payment was made at Rs.27,58,610/- to these parties. He disallowed 20% of the interest payment and made addition of Rs.5,51,722/-.Similarly, he found that assessee had A.Y.2017-18 3 made purchases from three sister concerns. The total purchases were of Rs.7,52,91,866/-. He disallowed 20% of the interest payments and 10% of the purchases from sister concerns. These disallowances have been made with the aid of Section 40A(2)(b) of the Income Tax Act.
5. Appeal to the ld. CIT(A) did not bring any relief to the assessee.
6. With the assistance of ld. Representative, we have gone through the record carefully. A perusal of Section 40A(2)(b) would indicate that if the assessee has made purchases or availed services from related parties, then AO would disallow any payment which was made over and above the market rate of those materials/services. In other words, if an assessee availed the services or made purchases from related parties by making payment higher than the market rates, then proportionate disallowance would be made from those payments to such parties.
According to the assessee, the interest paid by it to the related parties is @ 12% only. It is not understandable as to how payment of interest at 12% is higher than market A.Y.2017-18 4 rate. In the market, loan can be availed upto the interest rate of 18% or 19%. 12% is below the market rate. The disallowance is not to be made only for the reason that such loans were availed from the related parties but disallowance is to be made if higher rate of interest is being paid to such parties in comparison to the market rate. Similar is the fact with regard to the purchases made by the assessee from related parties. The AO in the assessment order nowhere established what was the market rate for these steel ingots for whom payment was made.
Thus, the impugned orders are not sustainable because there is no reasoning given by both the authorities for making this disallowance and upholding the disallowance.
We allow both the grounds and delete the disallowances.
GROUND NO. 4 :
The grievance of the assessee in this ground is that adhoc disallowances have been made by the AO out of various expenses. A perusal of the record would indicate that in paragraph No. 4 of the assessment order, ld. AO has quoted 12 items namely, electric repairs, miscellaneous A.Y.2017-18 5 expenses, staff welfare expenses etc. He further observed that a total expense of Rs.9,80,778/- has been made by the assessee on these miscellaneous items. Without pointing out any defect as to how bills and vouchers are not kept properly by the assessee, he straight away disallowed 20% of the expenses. We fail to appreciate his logic. He is to first determine whether these expenses were incurred for the purpose of business or not. If not, then only he could estimate the disallowance. The AO has disallowed as if it is the standard disallowance. Therefore, we allow this ground of appeal also and delete the disallowances.
In the result, appeal of the assessee is allowed.
Order pronounced on 22.04.2025.