Facts of the Case

The assessee, Astra Management Services Pvt. Ltd., was engaged in trading activities including purchase and sale of poppy seeds. During the relevant assessment year, the assessee purchased poppy seeds from its related party M/s Arushi Exports at a rate of ₹300 per kg.

The Assessing Officer observed that the related party had imported poppy seeds from Yumurtacilar, Turkey at a lower price. On this basis, the Assessing Officer concluded that the assessee had purchased the goods at an excessive and unreasonable price from the related party.

Accordingly, the Assessing Officer invoked Section 40A(2)(b) of the Income Tax Act, 1961 and made a disallowance of ₹1,26,54,000 on the ground that the assessee paid an excessive amount to a related party.

During appellate proceedings, the Commissioner of Income Tax (Appeals) accepted that the Assessing Officer had not considered certain import-related costs such as port expenses, transportation, and storage. After considering these costs, the CIT(A) restricted the disallowance to ₹82,80,000 instead of the amount originally added by the Assessing Officer.

 

Issues Involved

  1. Whether the Assessing Officer was justified in invoking Section 40A(2)(b) on the purchase of goods from a related party.
  2. Whether comparison of domestic purchase price with international import price was appropriate for determining excessive payment.
  3. Whether disallowance under Section 40A(2)(b) can be sustained where both the assessee and the related party are taxed at similar or higher tax rates and no tax avoidance is involved.

Petitioner’s Arguments

  • The comparison made by the Assessing Officer between domestic purchase price and international import price was incorrect because fair market value must be determined with reference to the domestic market.
  • The related party had sold the same goods to unrelated parties at the same rate of ₹300 per kg, proving that the price was not excessive.
  • The assessee sold the same goods to third parties at ₹310 per kg, showing that the purchase price was commercially reasonable.
  • The Assessing Officer failed to consider the direct costs associated with imports, including insurance, freight, clearing charges, and transportation.
  • Both the assessee and the related party were taxed at comparable rates; therefore, there was no tax arbitrage or tax evasion motive.

Respondent’s Arguments

  • The related party had purchased poppy seeds from the Turkish supplier at a significantly lower price.
  • The assessee purchased the same goods from the related party at a higher price, indicating excessive payment to a related party.
  • The difference in prices demonstrated that the assessee had violated the provisions of Section 40A(2)(b) by making unreasonable payments.

 

Court Findings

The ITAT observed that the purpose of Section 40A(2)(b) is to prevent tax evasion through excessive or unreasonable payments to related parties.

The Tribunal noted an important fact that both the assessee and the related party were taxed at maximum marginal tax rates, and this fact was not disputed by the Revenue.

Relying on CBDT Circular No. 6-P dated 06.07.1968 and judicial precedents, the Tribunal held that where both payer and payee are taxed at the same or similar rates, the possibility of tax avoidance does not arise.

The Tribunal relied on the following decisions:

  • Sigma Research & Consulting Pvt. Ltd. vs CIT (2019) 103 taxmann.com 397 (Delhi)
  • CIT vs Indo Saudi Services (Travel) Pvt. Ltd. (2009) 310 ITR 306 (Bom.)

These decisions clarify that disallowance under Section 40A(2)(b) is not justified when there is no tax advantage gained through related-party payments.

 

Court Order

The Income Tax Appellate Tribunal held that the disallowance made under Section 40A(2)(b) was not sustainable in the present case.

Accordingly, the Tribunal deleted the entire disallowance and allowed the assessee’s appeal.

 

Important Clarification

The ruling reiterates that Section 40A(2)(b) is aimed at preventing tax evasion through profit shifting. If both parties involved in the transaction are taxed at similar or higher rates and no tax benefit arises, the provision should generally not be invoked.

The decision also emphasizes that fair market value comparisons must be made appropriately and with proper cost considerations.

Link to download the order -  https://itat.gov.in/public/files/upload/1735642556-uUmehT-1-TO.pdf

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