Section 40A(2) of the Income tax Act, 1961 authorise assessing officer to examine transactions with associates and disallow sums or make additions if such transactions are not found to be arm’s length.
In one such case of CIT v. Jain Cables (P.) Ltd. (120TAX63) the assessee made certain purchases from sister concerns. The assessee officer found that higher price was paid for such purchases upon comparison of prices paid to primary producers (third parties) for similar items. The assessee contended that it had to make such purchases since there was inadequate supply by the primary producers and it had to purchases raw materials from open market to fulfill time – bound contractual obligations and avoid penal consequences sine it was supplying goods to the state electricity boards.
The Tribunal found that the sales made by alleged sister concerns to other customers in almost same range at which goods have been sold by the sister concerns and held that no excessive payment has been made than what is prevailing price in the open market. The Rajasthan High Court upheld the finding of the Tribunal in this case.
In yet another case of Commissioner of Income-tax Vs. Andhra Prabha P. Ltd. (123ITR760) the assessing officer alleged payment of higher amount as printing charges to sister concern to siphon off the profit to the advantage of the sister concern. The Tribunal went into this aspect and found that the sister concern company was being taxed at a higher rate than the assessee and that, therefore, there was no question of any tax advantage derived by the assessee company.
The Madras High Court in Mysore Fertiliser Co. Vs. Commissioner of Income-tax (30ITR734) as old as in August 1956 reiterated a well-settled maxim that the reasonableness is to be considered from the point of view of a normal prudent businessman. The reasonableness of any payment has to be judged not on any subjective standard of the assessing authority but from the point of view of commercial expediency. Though the assessing officer is entitled to examine the reasonableness of any payment by the 1961 statute yet he must see it keeping himself in the shoes of a prudent businessman.