2024 (2) TMI 528 - AT - Income Tax

Section 40A(2) disallowance deleted as revenue failed to prove payments to group consultant exceeded fair market value

ITAT Bangalore ruled in favor of the assessee regarding disallowance under section 40A(2). The AO had disallowed 50% of back office charges paid to a ... Disallowance u/s. 40A(2) - addition being 50% of the total back office charges paid to group consultant - as per AO payment made by the assessee is in excess of fair market value HELD THAT:- As the assessee has entered into agreement with to group consultant to the agreement states the services offered and the schedule of fees @ 0.5% of total income. AO has not brought any material on record to show that the payment made to group consultant is unreasonable and excessive and has made disallowance on adhoc basis, merely stating that the order of the ITAT in group case has not been accepted by the revenue. AO has observed that the assessee may have benefitted from the bulk or centralized purchasing done though to group consultant but it does not justify the entire payment. Once it is accepted by the AO that the assessee is benefited through to group consultant , no adhoc disallowance is called for - we delete the disallowance u/s. 40A(2) of the Act. Decided in favour of assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether the delay in filing the appeal of 660 days constituted sufficient cause to warrant condonation under the relevant procedural law. 2. Whether payment of back-office/service charges equal to 0.5% of turnover to a group holding company is allowable expenditure, or whether 50% of such payment is exigible to disallowance under section 40A(2) on the ground that it is excessive or unreasonable. 3. Relatedly, whether the Assessing Officer discharged the onus under section 40A(2) by adducing comparable evidence, determining fair market value, or otherwise demonstrating that the payment exceeded legitimate business needs. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Condonation of Delay Legal framework: Procedural provisions allow appellate delay to be condoned where sufficient cause is shown; established authority requires demonstration of bona fide and reasonable cause for delay. Precedent Treatment: The Court referred to binding higher-court authority holding that bona fide and reasonable cause justify condonation and applied that principle. Interpretation and reasoning: The Tribunal accepted factual assertions that the company official responsible was on prolonged leave due to confinement, the appellate order was not downloaded or placed before the competent authority, and the delay was discovered only later when preparing a subsequent year's return; appeal was filed immediately thereafter. On these facts the Tribunal found the delay unintentional and bona fide. Ratio vs. Obiter: Ratio - where a party demonstrates continuous absence of responsible officer, failure to procure the order from the portal, and prompt filing once discovered, such circumstances constitute sufficient cause to condone delay. Conclusion: The Tribunal condoned the delay of 660 days and admitted the appeal. Issue 2 - Disallowance under Section 40A(2) of Group Service Fees Legal framework: Section 40A(2) permits disallowance of payments to related parties if expenditure is excessive or not for legitimate business needs; the AO must first form an opinion that payment is excessive and then determine fair market value to quantify disallowance. Precedent Treatment: The Tribunal followed earlier Tribunal and High Court rulings which require the AO to bring comparable cases, determine fair market value, and not apply section 40A(2) mechanically; those precedents were treated as binding in the facts of this appeal and were applied to the present factual matrix. Interpretation and reasoning: The assessee had a written service agreement specifying services and a schedule fixing fees at 0.5% of turnover. The Tribunal noted the AO did not dispute that services were rendered, nor did the AO produce comparable market evidence or a determination of fair market value. The AO applied a flat 50% disallowance ad hoc and relied on the existence of in-house capabilities and generic observations about banks' lending practices without quantifying excess or pointing to comparables. The Tribunal observed inconsistency in AO's historical treatment (different ad hoc percentages across years) and stressed that mere affiliation or intra-group nature of payment does not automatically render expenditure excessive under section 40A(2). Once the AO accepted that the assessee derived benefit from group services, an adhoc reduction could not be sustained without cogent material showing excess over fair market value. Ratio vs. Obiter: Ratio - Section 40A(2) disallowance cannot be sustained where the AO fails to (a) form a reasoned finding that payment is excessive, (b) adduce comparable market evidence or other cogent material to establish excess, or (c) determine fair market value; in such circumstances intra-group service fees fixed by agreement and supported by records are allowable. Obiter - remarks regarding typical market syndication fees and qualitative benefits of brand usage (not quantified) are explanatory but non-decisive where no market valuation was undertaken. Conclusion: The Tribunal deleted the disallowance of Rs. 17,05,381 under section 40A(2), holding that the AO did not discharge the statutory onus to show excess or determine fair market value, and that acceptance of benefit by the AO precluded adhoc reduction. Issue 3 - Role of Prior Decisions on Identical Group Arrangement Legal framework: Precedents of co-ordinate tribunals and higher courts on identical or substantially similar arrangements are persuasive and, where applicable, control the outcome absent distinguishing facts. Precedent Treatment: A prior Tribunal decision on a group company with the same holding company and an identical service agreement, which had been affirmed by the High Court, was followed by the Tribunal as directly relevant and instructive. Interpretation and reasoning: The Tribunal treated the prior decision and its subsequent confirmation by the High Court as demonstrating the legal principle that the AO must establish excess and fair market value. The present agreement was materially similar (same services, same fee schedule), and the AO's inability to produce distinguishing material or comparables meant the prior rulings applied to the present facts. Ratio vs. Obiter: Ratio - Where a prior adjudicatory finding on materially identical agreement and facts holds that AO failed to establish excess, the same legal conclusion follows for a subsequent assessee under the same terms unless material distinctions are shown. Obiter - procedural observations about benefits of centralized purchasing and brand usage are contextual but not determinative absent valuation. Conclusion: The Tribunal respectfully followed the prior Tribunal and High Court treatment and allowed the appeal on the merits, deleting the 40A(2) addition. Cross-references Reference to Issue 1: Condonation of delay was a threshold procedural determination enabling adjudication on Issues 2-3. Reference to Issue 2 & 3: The merits decision on section 40A(2) rests on both (a) failure of the AO to discharge the evidentiary onus and (b) applicability of prior adjudicatory rulings on materially identical group service agreements.