Disallowance u/s 13(1)(c) can’t be made primarily that specified concerns earned higher profits.

Mere higher profit margins would not make payments made by Trust as diversion of funds for the benefit of the specified persons for invocation of Section 13(1)(c)

In a recent judgment Hon’ble High Court has held that mere existence of higher profit margins, in the absence of material to establish that the payments made by the Trust constitute diversion of funds for the benefit of the specified persons, would not by itself justify invocation of Section 13(1)(c) of the Income Tax Act, 1961.

ABCAUS Case Law Citation:
5069 (2026) (03) abcaus.in HC

In the instant case, the appeals were filed by the Revenue challenging the order passed by the Income Tax Appellate Tribunal.

The respondent assessee was a Trust registered under Section 12A of the Act and had filed its returns of income claiming exemption under Section 11 of the Act. The Assessing Officer issued notice under Section 143(2) of the Act and, upon scrutiny, examined the transactions/payments made to certain concerns (specified persons) in which the trustees and/or their relatives had substantial interest.

The Assessing Officer held that the payments made to specified persons were either excessive or unreasonable. It was further held that such excessive and unreasonable payments amounted to diversion of the income of the Trust and were in violation of Section 13(1)(c) of the Act.

The CIT(A)/National Faceless Appeal Centre (‘NFAC’) by following the earlier order of the Tribunal involving an identical set of facts, transactions and concerns, allowed the appeal.

On further appeal the Tribunal recorded that for the two preceding Assessment Years, involving identical facts, the Assessing Officer had not invoked Section 13(1)(c) of the Act in the assessment orders passed under Section 143(3) of the Act.

The Tribunal further recorded that there was no change either in the facts or in the legal position so as to take a different view for the assessment years under consideration. Accordingly, the Tribunal rejected the appeals filed by the Revenue.

Before the Hon’ble High Court, the Revenue stated that the said specified concerns were wholly controlled by the trustees of the assessee–Trust in their capacity as Directors. It was further submitted that the said concerns had no independent business activity apart from the revenue receipts received from the assessee–Trust.

It was further contended that the concerns did not possess any requisite expertise to render assistance to the Trust and that the payments made to them were disproportionate and not commensurate with the services allegedly rendered.

It was also the contention that these concerns had reflected abnormal profit margins, going up to 85%, which, according to AO, was inconceivable in any legitimate line of business. It was contended that these entities had been created solely for the purpose of diverting the funds of the Trust into the hands of the Directors, who were none other than the trustees of the assessee–Trust.

On the other hand, the assessee submitted that the entities were engaged in independent business activities apart from their transactions with the Trust. It was contended that a higher profit margin, by itself, cannot constitute a ground to question the commercial expediency of the transactions or to invoke Section 13(1)(c) of the Act.

It was further submitted that, on identical facts, the Assessing Officer, in the previous assessment proceedings concluded under Section 143(3) of the Act, after examining the relevant details, had accepted the payments made without invoking Section 13(1)(c) of the Act. It was therefore contended that, in the absence of any change either in the factual matrix or in the legal position, it is not open to the Assessing Officer to take a divergent view for the assessment years under consideration.

The Hon’ble High Court observed that Section 13(1)(c) mandates that, in the case of a Trust, if any part of its income or property is applied, directly or indirectly, for the benefit of the persons referred to in subsection (3), such part of the income, as contemplated under the relevant sub-clauses, would not be eligible for exemption and is liable to be disallowed. However, it does not follow that every transaction with a concern in which such persons have interest would automatically attract the rigour of Section 13(1)(c).

The Hon’ble High Court noted that in the present case, the payments had been made to related concerns in the course of carrying out the activities of the Trust. The genuineness of the said concerns and the nature of their activities had not been doubted by the Assessing Officer. The disallowance was sought to be made by invoking Section 13(1)(c) primarily on the ground that the concerns had earned higher profits, as reflected in their statements of profit and loss.

The Hon’ble High Court further observed that though the Revenue had contended that the said concerns in turn had paid higher remuneration to their Directors who were trustees of the assessee. However, there was no comparative material placed on record to demonstrate that such remuneration was excessive or unreasonable having regard to the services rendered. On the contrary, the corresponding expenditure reflected against the revenue from operations indicated that the concerns are carrying on substantive activities.

The Hon’ble High Court held that mere existence of higher profit margins, in the absence of material to establish that the payments made by the Trust constitute diversion of funds for the benefit of the specified persons, would not by itself justify invocation of Section 13(1)(c) of the Act. Further the CIT(A) and the Tribunal had recorded that, for the earlier Assessment Years, involving an identical set of facts and transactions with the very same concerns, the Assessing Officer, upon scrutiny under Section 143(3) of the Act, had accepted the payments and had not invoked Section 13(1)(c) of the Act.

Accordingly, the Hon’ble High Court held that Tribunal was justified in rejecting the appeals filed by the Revenue, both on a proper interpretation of Section 13(1)(c) of the Act and on the ground of consistency.

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