Facts of the case:
Assessee co: V.S. DEMPO & CO. (P) LTD [hereinafter referred to as "H"]
Subsidirary Co: M/s Dempo Mining Corporation (P) Ltd [hereinafter referred to as "S"]
Transaction : Purchase of iron ore of particular quality for Rs. 8,66,75,390 by "H" from "S"
Transaction rate: Rs. 80/DLT of Lump oil and Rs. 85/ DLT for high grade lump iron ore.
Ld AO's finding: One "M/s Orient Goa (P) Ltd" had purchased high grade iron ore at Rs. 62.30 and high grade lumpy ore at Rs. 59.64 per DLT
Ld AO's conclusion: The assessee had purchased the ore from its subsidiary were higher than the market rate and, therefore, the provisions of s. 40A(2) of the Act were attracted. Hence, the AO disallowed the expenditure to the extent of Rs. 49,30,488, under s.40A(2) of the Act.
Assessee filed appeal with CIT(A) who allowed the appeal
Revenue challenged CIT (A) order with ITAT, who also confirmed CIT (A) order
Revenue further challenged ITAT order with Bombay High Court which held as under:
4. Clause (a) of sub-s. (2) of s. 40A of the income-tax provides that where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of the sub-section and the AO is of the 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. Clause (b) of sub-s. (2) of s. 40A of the income-tax mentions the class of persons in respect of whom cl. (a) is attracted. Learned counsel for the respondent submits that M/s Dempo Mining Corporation (P) Ltd., (hereinafter referred to as "the subsidiary company") from which the assessee purchased the iron ore is not one of the persons mentioned in cl. (b) of sub-s. (2) of s. 40A and, therefore, sub-s. 2(a) was not attracted. In the alternative he submitted that the finding recorded by the CIT(A) as well as the Tribunal that the assessee had paid a little higher than the usual rate taking into consideration the fact that the assessee was assured a huge quantity of supply, as well as the quality of supply that it cannot be said that the rate was unjustified, was a finding of fact. In the absence of any perversity, the finding of fact recorded by the CIT(A) and confirmed by the Tribunal cannot be interfered with in an appeal under s. 260A of the Act. He further submitted that both the assessee, as well as the subsidiary were registered companies under the Companies Act, 1956 liable to pay the income-tax at the same rate. Therefore, there was no question of diversion of any funds. He invited our attention to the CBDT Circular No. 6-P dt. 6th July, 1968, which states that no disallowance is to be made under s. 40A(2) in respect of the payments made to the relatives and sister concerns where there is no attempt to evade tax. He submitted that the CIT(A) as well as the Tribunal have also recorded a finding of fact that there was no attempt of evasion of tax and, therefore, in view of the CBDT circular dt. 6th July, 1968, s. 40A(2) was not attracted and should not have been applied by the AO. The circular is binding on the Department and on this ground also the appeal should be dismissed.
The CIT(A), on appreciation of the material available before him, has come to the conclusion that the assessee, as an exporter, was exporting huge quantity of iron ore. It was assured of supply of huge quantity of iron ore as well as quality of iron ore by a reason of the fact that it had entered into a contract with its subsidiary. He has also held that both the assessee and its subsidiary were companies paying tax at the same rate and, therefore, there was no question of tax evasion. These findings are not open for challenge in this appeal.
In our view, in a business of export consistency of supply as well as quality of supply is important. In order to assure a consistent supply of material of the same quality the purchaser of a commodity may pay to a seller bound under a contract a little higher than the current rate. Furthermore, in case of yearly contracts by agreeing to buy goods at a specified rate the exporter is insulated from vagaries of any seasonal rise in the market rate. Therefore,
unless the rate agreed is so very much excessive or unreasonable as to doubt the objective behind the agreement, it cannot be said that the rate, a little higher than the seasonal market rate is unjustified or amounts to diversion of profit. In this connection, the fact that the assessee as well as its subsidiary which is the seller are in the same tax bracket and pay same rate of tax is a fact which assumes importance. Admittedly, it is not a case of tax evasion in as much as if the rate would have been less, the assessee’s profit would have been more, but the profits of the seller would have been less and both being taxable at the same rate, there would be no difference in the aggregate tax payable by the assessee and its subsidiary.
A decision of a Division Bench of this Court in CIT vs. Indo Saudi Services (Travel) (P) Ltd. (2008) 219 CTR (Bom) 562 : (2008) 12 DTR (Bom) 304 is a case in point. Therein the
assessee was a general sales agent of Saudi Arabian Airlines. The assessee earned commission at 12 per cent from Saudi Arabian Airlines. The assessee had appointed several agents, including its sister concern as sub-agents and was paying commission to each such sub-agent. While the assessee was paying a commission of 9 per cent to all its agents, it was paying additional 1/2 per cent to its sister concern which was also acting as a sub-agent. The AO disallowed the 1/2 per cent commission paid to the assessee’s sister concern under s. 40A(2) of the IT Act. The order was confirmed by the CIT(A) as well as by the Tribunal. On an appeal at the instance of the assessee, this Court noted that the sister concern to which the assessee was paying extra 1/2 per cent commission was also assessed to tax and was paying tax. Relying upon the Circular No. 6-P, dt. 6th July, 1968 of the CBDT, it is held
that no disallowance should be made under s. 40A(2) of the IT Act in respect of the payments made to the relatives and sister concerns where there is no attempt to evade tax. This Court while allowing the appeal, set aside the addition made under s. 40A(2) of the Act.
In our view, in the facts and circumstances of the case, the ratio of decision of this Court in Indo Saudi Services (Travel) (P) Ltd.’s case (supra) squarely applies to the facts
of the case at hand.
8. Ms. Dessai, learned counsel appearing for the Revenue, invited our attention to another decision of a Division Bench of this Court in CIT vs. Shatrunjay Diamonds (2003) 183 CTR (Bom) 86 : (2003) 261 ITR 258 (Bom), and to the observations made in paras 10 and 11 of the decision. She submitted that once it was held that the payment was made to a related person mentioned in cl. (b) of s. 40A(2) of the Act, the burden shifted on the assessee and it was the duty of the assessee to discharge the burden by leading proper evidence that the provisions of s. 40A(2) were not attracted to the assessee’s case. The basic requirement for the applicability of s. 40A(2) of the Act is that the payment must be made to a related person i.e., to a person referred to in cl. (b), of sub-s. (2) of s. 40A of the Act. In the facts and circumstances of the case, we are of the view that the payment in the case at hand was not
made to a person mentioned in cl. (b) of s. 40A(2) of the Act for the reasons indicated below.
9. Clause (a) of sub-s. (2) of s. 40A of the Act provides that where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of the sub-section and the AO is of the 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. The object of s. 40A(2) is to prevent diversion of income. An assessee who has large income and is liable to pay tax at the highest rate prescribed under the Act often seeks to transfer a part of his income to a related person who is not liable to pay tax at all or liable to pay tax at a rate lower than the rate at which the assessee pays the tax. In order to curb such tendency of diversion of income and thereby reducing the tax liability by illegitimate means, s. 40A was added to the Act by an amendment made by the Finance Act, 1968. Clause (b) of s. 40A(2) gives the list of related persons.
It is only where the payment is made by the assessee to the related persons mentioned in cl. (b) of s. 40A (2) of the Act that the AO gets jurisdiction to disallow the expenditure or a part of the expenditure which he considers excessive or unreasonable. Clause (b) of s. 40A(2) reads as under : "40A(2)(b)
The persons referred to in cl. (a) are the following, namely :
(i) where the assessee is an individual - any relative of the assessee;
(ii) where the assessee is a company -any director of the company, partner of the firm firm, association of persons or Hindu or member of the association or family, or any undivided family relative of such director, partner or member;
(iii) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;
(iv) a company, firm, AOP or HUF having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member;
(v) a company, firm, AOP or HUF of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member;
(vi) any person who carries on a business or profession,—
(A) where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or
(B) where the assessee being a company, firm, AOP or HUF, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner, or member, has a substantial interest in the business or profession of that
person.
Explanation.—For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if,—
(a) in a case where the business or profession is carried on by a company, such
person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profit) carrying not less than twenty per cent of the voting power; and
(b) in any other case, such person is, at any time during the previous year, beneficially
entitled to not less than twenty per cent of the profits of such business or profession."
10. Learned counsel for the appellant submitted that the present case falls under sub-cl. (ii) or sub-cl. (iv) of cl. (b) of s. 40A(2). Sub-cl. (ii) provides that where the assessee is a company, firm, AOP or HUF, any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member would be a related person.
In the present case, the assessee is a company and the seller is its subsidiary
company. The seller i.e., the subsidiary company does not fall in any of the capacities mentioned under sub-cl. (ii) of cl. (b). Only a director of the company, partner of the firm, or member of the association or family or any relative of such director, partner or member is a related person, under sub-cl. (ii) of cl. (b) of subs. (2). Another company, even if it is a subsidiary of the assessee is not a related person within the meaning of sub-cl. (ii) of cl.(b) of s. 40A(2). Sub-cl. (iv) of cl. (b) of s. 40A(2) provides that in case of a company, firm, AOP or HUF having a ‘substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member is a related person.
Again a subsidiary company does not fall in any of the class of persons mentioned in sub-cl. (iv) of cl. (b) of s.40A(2). In law, a holding company is a member of subsidiary company and holds more than 50 per cent equity share capital of the subsidiary company (except in cases where it controls the composition of the board of directors without holding majority of the shares). While the holding company is a member of its subsidiary company, the subsidiary company is not a member of the holding company. As, the subsidiary company was not a member of the assessee, sub-cl. (iv) of cl. (b) of s. 40A(2) of the Act is also not attracted in the present case.
In Shatrunjay Diamonds (supra), the Division Bench of this Court held that the burden of proving that the case does not fall under s. 40A(2)(b) would shift on the assessee if the supplier of the goods is a related person as mentioned under cl. (b).
In the present case, as we have held that the subsidiary company is not a related person of the assessee within the meaning of cl. (b) of s. 40A(2) of the Act, the decision has no application to the facts of the present case.
For these reasons, there is no merit in the appeal which is hereby dismissed.
Assessee co: V.S. DEMPO & CO. (P) LTD [hereinafter referred to as "H"]
Subsidirary Co: M/s Dempo Mining Corporation (P) Ltd [hereinafter referred to as "S"]
Transaction : Purchase of iron ore of particular quality for Rs. 8,66,75,390 by "H" from "S"
Transaction rate: Rs. 80/DLT of Lump oil and Rs. 85/ DLT for high grade lump iron ore.
Ld AO's finding: One "M/s Orient Goa (P) Ltd" had purchased high grade iron ore at Rs. 62.30 and high grade lumpy ore at Rs. 59.64 per DLT
Ld AO's conclusion: The assessee had purchased the ore from its subsidiary were higher than the market rate and, therefore, the provisions of s. 40A(2) of the Act were attracted. Hence, the AO disallowed the expenditure to the extent of Rs. 49,30,488, under s.40A(2) of the Act.
Assessee filed appeal with CIT(A) who allowed the appeal
Revenue challenged CIT (A) order with ITAT, who also confirmed CIT (A) order
Revenue further challenged ITAT order with Bombay High Court which held as under:
4. Clause (a) of sub-s. (2) of s. 40A of the income-tax provides that where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of the sub-section and the AO is of the 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. Clause (b) of sub-s. (2) of s. 40A of the income-tax mentions the class of persons in respect of whom cl. (a) is attracted. Learned counsel for the respondent submits that M/s Dempo Mining Corporation (P) Ltd., (hereinafter referred to as "the subsidiary company") from which the assessee purchased the iron ore is not one of the persons mentioned in cl. (b) of sub-s. (2) of s. 40A and, therefore, sub-s. 2(a) was not attracted. In the alternative he submitted that the finding recorded by the CIT(A) as well as the Tribunal that the assessee had paid a little higher than the usual rate taking into consideration the fact that the assessee was assured a huge quantity of supply, as well as the quality of supply that it cannot be said that the rate was unjustified, was a finding of fact. In the absence of any perversity, the finding of fact recorded by the CIT(A) and confirmed by the Tribunal cannot be interfered with in an appeal under s. 260A of the Act. He further submitted that both the assessee, as well as the subsidiary were registered companies under the Companies Act, 1956 liable to pay the income-tax at the same rate. Therefore, there was no question of diversion of any funds. He invited our attention to the CBDT Circular No. 6-P dt. 6th July, 1968, which states that no disallowance is to be made under s. 40A(2) in respect of the payments made to the relatives and sister concerns where there is no attempt to evade tax. He submitted that the CIT(A) as well as the Tribunal have also recorded a finding of fact that there was no attempt of evasion of tax and, therefore, in view of the CBDT circular dt. 6th July, 1968, s. 40A(2) was not attracted and should not have been applied by the AO. The circular is binding on the Department and on this ground also the appeal should be dismissed.
The CIT(A), on appreciation of the material available before him, has come to the conclusion that the assessee, as an exporter, was exporting huge quantity of iron ore. It was assured of supply of huge quantity of iron ore as well as quality of iron ore by a reason of the fact that it had entered into a contract with its subsidiary. He has also held that both the assessee and its subsidiary were companies paying tax at the same rate and, therefore, there was no question of tax evasion. These findings are not open for challenge in this appeal.
In our view, in a business of export consistency of supply as well as quality of supply is important. In order to assure a consistent supply of material of the same quality the purchaser of a commodity may pay to a seller bound under a contract a little higher than the current rate. Furthermore, in case of yearly contracts by agreeing to buy goods at a specified rate the exporter is insulated from vagaries of any seasonal rise in the market rate. Therefore,
unless the rate agreed is so very much excessive or unreasonable as to doubt the objective behind the agreement, it cannot be said that the rate, a little higher than the seasonal market rate is unjustified or amounts to diversion of profit. In this connection, the fact that the assessee as well as its subsidiary which is the seller are in the same tax bracket and pay same rate of tax is a fact which assumes importance. Admittedly, it is not a case of tax evasion in as much as if the rate would have been less, the assessee’s profit would have been more, but the profits of the seller would have been less and both being taxable at the same rate, there would be no difference in the aggregate tax payable by the assessee and its subsidiary.
A decision of a Division Bench of this Court in CIT vs. Indo Saudi Services (Travel) (P) Ltd. (2008) 219 CTR (Bom) 562 : (2008) 12 DTR (Bom) 304 is a case in point. Therein the
assessee was a general sales agent of Saudi Arabian Airlines. The assessee earned commission at 12 per cent from Saudi Arabian Airlines. The assessee had appointed several agents, including its sister concern as sub-agents and was paying commission to each such sub-agent. While the assessee was paying a commission of 9 per cent to all its agents, it was paying additional 1/2 per cent to its sister concern which was also acting as a sub-agent. The AO disallowed the 1/2 per cent commission paid to the assessee’s sister concern under s. 40A(2) of the IT Act. The order was confirmed by the CIT(A) as well as by the Tribunal. On an appeal at the instance of the assessee, this Court noted that the sister concern to which the assessee was paying extra 1/2 per cent commission was also assessed to tax and was paying tax. Relying upon the Circular No. 6-P, dt. 6th July, 1968 of the CBDT, it is held
that no disallowance should be made under s. 40A(2) of the IT Act in respect of the payments made to the relatives and sister concerns where there is no attempt to evade tax. This Court while allowing the appeal, set aside the addition made under s. 40A(2) of the Act.
In our view, in the facts and circumstances of the case, the ratio of decision of this Court in Indo Saudi Services (Travel) (P) Ltd.’s case (supra) squarely applies to the facts
of the case at hand.
8. Ms. Dessai, learned counsel appearing for the Revenue, invited our attention to another decision of a Division Bench of this Court in CIT vs. Shatrunjay Diamonds (2003) 183 CTR (Bom) 86 : (2003) 261 ITR 258 (Bom), and to the observations made in paras 10 and 11 of the decision. She submitted that once it was held that the payment was made to a related person mentioned in cl. (b) of s. 40A(2) of the Act, the burden shifted on the assessee and it was the duty of the assessee to discharge the burden by leading proper evidence that the provisions of s. 40A(2) were not attracted to the assessee’s case. The basic requirement for the applicability of s. 40A(2) of the Act is that the payment must be made to a related person i.e., to a person referred to in cl. (b), of sub-s. (2) of s. 40A of the Act. In the facts and circumstances of the case, we are of the view that the payment in the case at hand was not
made to a person mentioned in cl. (b) of s. 40A(2) of the Act for the reasons indicated below.
9. Clause (a) of sub-s. (2) of s. 40A of the Act provides that where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of the sub-section and the AO is of the 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. The object of s. 40A(2) is to prevent diversion of income. An assessee who has large income and is liable to pay tax at the highest rate prescribed under the Act often seeks to transfer a part of his income to a related person who is not liable to pay tax at all or liable to pay tax at a rate lower than the rate at which the assessee pays the tax. In order to curb such tendency of diversion of income and thereby reducing the tax liability by illegitimate means, s. 40A was added to the Act by an amendment made by the Finance Act, 1968. Clause (b) of s. 40A(2) gives the list of related persons.
It is only where the payment is made by the assessee to the related persons mentioned in cl. (b) of s. 40A (2) of the Act that the AO gets jurisdiction to disallow the expenditure or a part of the expenditure which he considers excessive or unreasonable. Clause (b) of s. 40A(2) reads as under : "40A(2)(b)
The persons referred to in cl. (a) are the following, namely :
(i) where the assessee is an individual - any relative of the assessee;
(ii) where the assessee is a company -any director of the company, partner of the firm firm, association of persons or Hindu or member of the association or family, or any undivided family relative of such director, partner or member;
(iii) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;
(iv) a company, firm, AOP or HUF having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member;
(v) a company, firm, AOP or HUF of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or member of such company, firm, association or family or any relative of such director, partner or member;
(vi) any person who carries on a business or profession,—
(A) where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or
(B) where the assessee being a company, firm, AOP or HUF, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner, or member, has a substantial interest in the business or profession of that
person.
Explanation.—For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if,—
(a) in a case where the business or profession is carried on by a company, such
person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profit) carrying not less than twenty per cent of the voting power; and
(b) in any other case, such person is, at any time during the previous year, beneficially
entitled to not less than twenty per cent of the profits of such business or profession."
10. Learned counsel for the appellant submitted that the present case falls under sub-cl. (ii) or sub-cl. (iv) of cl. (b) of s. 40A(2). Sub-cl. (ii) provides that where the assessee is a company, firm, AOP or HUF, any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member would be a related person.
In the present case, the assessee is a company and the seller is its subsidiary
company. The seller i.e., the subsidiary company does not fall in any of the capacities mentioned under sub-cl. (ii) of cl. (b). Only a director of the company, partner of the firm, or member of the association or family or any relative of such director, partner or member is a related person, under sub-cl. (ii) of cl. (b) of subs. (2). Another company, even if it is a subsidiary of the assessee is not a related person within the meaning of sub-cl. (ii) of cl.(b) of s. 40A(2). Sub-cl. (iv) of cl. (b) of s. 40A(2) provides that in case of a company, firm, AOP or HUF having a ‘substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member is a related person.
Again a subsidiary company does not fall in any of the class of persons mentioned in sub-cl. (iv) of cl. (b) of s.40A(2). In law, a holding company is a member of subsidiary company and holds more than 50 per cent equity share capital of the subsidiary company (except in cases where it controls the composition of the board of directors without holding majority of the shares). While the holding company is a member of its subsidiary company, the subsidiary company is not a member of the holding company. As, the subsidiary company was not a member of the assessee, sub-cl. (iv) of cl. (b) of s. 40A(2) of the Act is also not attracted in the present case.
In Shatrunjay Diamonds (supra), the Division Bench of this Court held that the burden of proving that the case does not fall under s. 40A(2)(b) would shift on the assessee if the supplier of the goods is a related person as mentioned under cl. (b).
In the present case, as we have held that the subsidiary company is not a related person of the assessee within the meaning of cl. (b) of s. 40A(2) of the Act, the decision has no application to the facts of the present case.
For these reasons, there is no merit in the appeal which is hereby dismissed.
