Merely possessing invoices of particular expenses, payment proof, copy of agreements, vouchers etc, may not be sufficient for the expense to be allowed under the Income Tax Act. As per section 40 where certain transactions are made with specified persons these transactions can be looked into from the angle of being unreasonable or excessive by the assessing officer and the assessing officer also has the power to disallow the expenditure which in his opinion or which to his satisfaction is unreasonable or is in excess of fair market value.
"40A. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head "Profits and gains of business or profession".
(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of 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 :
Provided that for an assessment year commencing on or before the 1st day of April, 2016 no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm`s length price as defined in clause (ii) of section 92F."
Where payment has been made to a person referred in clause (b) of this sub-section and such expenditure in the opinion of assessing officer is excessive or unreasonable the same cannot be disallowed. While determining whether an expenditure is excessive or unreasonable the following must be looked into-
the fair market value of the goods, services or facilities for which the payment is made.
the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom
The careful drafting of the subsection takes care of circumstances wherein the assessee is required to make payments in excess of its fair value on account of emergency or urgent business needs. So even if value of transactions made is in excess of fair market value of such good or services the same can be allowed if the assessee is able to prove that due to some legitimate urgent requirements the assessee was required to pay such unreasonable sum of money.
Through the proviso to this sub-section it has been provided that in case of the specified domestic transaction which is made at arm’s length price in accordance with section 92F no disallowance under this subsection can be made.
"40A(b) The persons referred to in clause (a) are the following, namely :—
where the assessee is an individual
any relative of the assessee;
where the assessee is a company, firm, association of persons or Hindu undivided family
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;
(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, association of persons or Hindu undivided family 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 or any other company carrying on business or profession in which the first mentioned company has substantial interest;
(v) a company, firm, association of persons or Hindu undivided family 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, association of persons or Hindu undivided family, 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 profits) 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."
It is interesting to note that this section applies only on expenditure made and not to income derived from the persons specified in Clause (b). So even if assessing officer is under the impression that income booked from persons specified above is not at its fair market value no action can be made under this section.
Further the onus or the burden in this case lies on the assessing officer to prove that the transaction made is not at fair market value. This can also be inferred from a recent decision of Delhi High Court in case of Mehra Jewel Palace Pvt Ltd Vs PCIT.
"8. The provision under Section 40A(2)(a) of the Act, as extracted above, clearly shows that before recording disallowance, the Assessing Officer has to form an opinion; and that opinion has to be having regard to inter alia legitimate needs of the business or benefit derived or even what would be the fair payment outgo for services rendered. Such an opinion cannot be arrived at without adducing necessary evidence. That being so, the Assessing Officer was duty bound to provide an opportunity to the appellant/assessee to place on record the requisite evidence to justify its claim. But all that the Assessing Officer did was to ask the appellant/assessee to justify the salaries paid, and without seeking relevant evidence, simply rejected claim."
CA Pranay Jain is a young and aspiring Chartered Accountant. He qualified Chartered Accountancy Course in 2021 and has a well-established practice in various fields of taxation and auditing, with his core area of practice being in the field of litigation i.e., handling assessment and appeal-related matters and representing assesses before various tax departments.
He is also socially active on LinkedIn at linkedin.com/in/capranayjain
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