Disallowance u/s 40A(2)(a) without following yardstick of unreasonableness deleted

Disallowance u/s 40A(2)(a) without following yardstick for arriving at unreasonableness cannot be sustained – ITAT

In a recent judgment, ITAT Raipur has held that disallowance u/s 40A(2)(a) without taking recourse to prescribed basis/yardstick, for arriving at unreasonableness cannot be sustained

ABCAUS Case Law Citation:
ABCAUS 4135 (2024) (07) ITAT

In the instant case, the assessee had challenged the order passed by the CIT(A) National Faceless Appeal Center (NFAC) in confirming disallowance u/s 40A(2)(a) of the Income Tax Act, 1961 (the Act).

The appellant assessee was engaged in the business of wholesale and retail trade. The case of the assessee was selected for scrutiny assessment u/s. 143(2) of the Act. During the course of the assessment proceedings, the Assessing Officer (AO), inter alia, observed that the assessee had claimed deduction of commission expenditure paid to her spouse.

The AO observing, that the aforesaid commission was not paid by the assessee on or before filing of the return of income u/s. 139(1) of the Act, called upon the assessee to put forth an explanation as regards the same.

Although, it was the claim of the assessee that the commission payment was dependent on the business arrangement between the principal and the commission agent, which thus, had no bearing on the allowability of the same as a deduction as was claimed by the assessee, but the same did not find favour with the AO.

The AO observed that the commission paid by the assessee to her spouse was unreasonable and, thus, disallowed the same u/s 40A(2)(a) of the Act.

Before the Tribunal, the assessee submitted that as both the assessee and her spouse were in the highest tax bracket, therefore, disallowance u/s. 40A(2)(a) of the Act, being tax neutral, was not called for in the hands of the assessee. Alternatively, it was submitted that though the A.O had disallowed assessee’s claim for deduction of commission expenses u/s. 40A(2)(a) of the Act by treating the same as unreasonable but had failed to refer the fair market value (FMV) of the services that were provided by the commission agent. It was submitted that as the A.O had failed to point out as to on what basis the commission payment was excessive and unreasonable having regard to the FMV of the value of services, for which, the payment was made to him, therefore, there was no justification on his part to have worked out the disallowance u/s. 40A(2)(a) of the Act.

The Tribunal rejected the contention that both assessee and her spouse being in the same tax bracket, no disallowance u/s. 40A(2)(a) of the Act could have validly been made in her hands. The Tribunal observed that income is subject to tax on the basis of progressive tax rates, therefore in view of the income declared by the assessee and her spouse, it can not be said that the amount of commission would be subjected to the same amount of tax in the hands of the assessee and her spouse.

Further, the Tribunal observed that the contention of the assessee that without having regard to the FMV of the services rendered by the commission agent, the disallowance so made by him could not be sustained, has been dealt with in detail by the bench itself and also by Co-ordinate Bench at Mumbai, Bangalore.

It has bee held by the Co-ordinate Benches that the very basis for arriving at the unreasonableness and excessiveness of an expenditure u/s. 40A(2)(a) is only to be weighed in backdrop of the prescribed factors, viz. (i). the fair market value of the goods, services or facilities for which payment is made; or (ii). the legitimate needs of the business of the assessee; or (iii) The benefit derived by or accruing to the assessee.

The Co-ordinate Bench had held, that as the A.O had without pointing out as to why the expenditure claimed by the assessee was unreasonable/excessive by taking recourse to the prescribed basis/yardstick, therefore, the disallowance made by him u/s. 40A(2)(a) of the Act could not be sustained.

Drawing support from the orders of the Co-ordinate Benches, the Tribunal held that as the AO had worked out disallowance u/s. 40A(2)(a) of the Act without taking recourse to the prescribed basis/yardstick, i.e. the very basis for arriving at the unreasonableness of the commission paid by the assessee, therefore, the same cannot be sustained and is liable to be vacated.

Accordingly, the Tribunal we set-aside the order of the CIT(Appeals) and vacated the disallowance made by the A.O.

Download Full Judgment Click Here >>

• Small Company threshold of paid up capital and turnover increased w.e.f 1st December 2025
• For registration u/s 12AA if CIT satisfaction limited to objects or also to activities? SLP admitted
• Over 30 approvals u/s 153D within minutes amounted to total non-application of mind
• When disallowance is made u/s 37(1) section 69C is not applicable – ITAT
• ITAT refuses to accept cash book as source of deposit as assessee was not subject to audit