Disallowance for tax deduction and transfer pricing adjustment rejected where books, contracts, and accounting method supported the assessee.

Disallowance under section 40(a)(i) was treated as unwarranted where tax had in substance been deducted, part payment had been made within time, and the books were verified to reflect the deduction; the later amendment was not applied to the year in question, so the technical service fee issue was resolved in favour of the assessee. On transfer pricing, the addition for professional fees and pre-FID expenses was rejected because the TPO had impermissibly mixed separate contracts and attempted to override the assessee's accounting method, while the mark-up and corresponding income had already been accepted. Both additions were deleted.

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Issues: (i) Whether disallowance under section 40(a)(i) of the Income-tax Act, 1961 was justified in respect of technical service fees paid to a non-resident; (ii) Whether the addition made on account of professional fees / pre-FID expenses on transfer pricing grounds was sustainable.

Issue (i): Whether disallowance under section 40(a)(i) of the Income-tax Act, 1961 was justified in respect of technical service fees paid to a non-resident.

Analysis: The assessee had made book entries for tax deducted at source and part payment of the tax was found to have been made within the relevant time. The appellate authority had not accepted the disallowance outright, but had directed verification of the factual position regarding deduction and credit in the books. The record also showed that while giving effect to the appellate order, no disallowance was made. The proviso to section 40(a)(i), as discussed in the judgment, was treated as supporting the view that deduction and payment were the relevant conditions, and the later amendment was held not to govern the year in question.

Conclusion: The disallowance under section 40(a)(i) was not sustainable and the issue was decided in favour of the assessee.

Issue (ii): Whether the addition made on account of professional fees / pre-FID expenses on transfer pricing grounds was sustainable.

Analysis: The assessee had entered into separate arrangements for receipt of fees and for incurring expenditure, and the transfer pricing adjustment proceeded on an erroneous mixing of those independent contracts. The Transfer Pricing Officer's function was limited to determining whether the international transaction was at arm's length, and not to recast the assessee's accounting method or restrict expenditure by matching it only with recognized income. The appellate authority found that the assessee followed the percentage completion method, that the corresponding income had been offered, and that the mark-up accepted by the TPO was not disturbed by any demonstrated defect.

Conclusion: The addition on transfer pricing grounds was not justified and the issue was decided in favour of the assessee.

Final Conclusion: Both additions were deleted, and the Revenue's appeal failed in full.

Ratio Decidendi: Where tax has in substance been deducted and the factual position is verified in the books, disallowance under section 40(a)(i) is not attracted; similarly, a transfer pricing authority cannot substitute itself for the assessing authority or override a valid accounting method by disregarding independent contractual obligations.

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