Related party transaction u/s 40A(2) shall be treated as bona fide, unless evading tax

Related party transaction u/s 40A(2) shall be treated as bona fide, unless AO finds that one of them is trying to evade the payment of tax – ITAT

In a recent judgment, ITAT Rajkot has held that as per CBDT Circular, provisions u/s 40A(2) and particularly with regard to the transaction between the relatives and associates is concerned, the same shall be treated as bona fide, unless the AO finds that one of them is trying to evade the payment of tax.

ABCAUS Case Law Citation:
5103 (2026) (04) abacus.in ITAT

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

The assessment of the appellant assessee u/s 143(3) was completed after making inter alia disallowance under section 40A(2)(b) in respect of professional fees paid to related persons.

The CIT(A) upheld the addition.

Before the Tribunal the assessee submitted that the entire details were submitted before the assessing officer, therefore, disallowances made u/s. 40A(2)(b) was to be allowed.

The Tribunal noted that the Assessing Officer found that professional fees of Rs. 9,00,000/- was paid to two females and both persons were covered under section 40A(2)(b). The Assessing Officer considered part of the remuneration as reasonable and disallowed the balance holding the payments to be excessive and unreasonable.

The Tribunal further observed that it was also stated by the AO that during the appellate proceedings, the assessee failed to furnish the comparative analysis. The AO observed that the test u/s 40A(2)(b) was whether expenditure was excessive having regard to fair market value and legitimate business needs. Further, the qualifications and experience of the payees were not established to be of such nature as to justify the high remuneration claimed.

The Tribunal further noted that during the course of assessment proceedings the assessee had furnished qualification certificates of the employee. The assessee had submitted that similar payments were made in the succeeding year and the same were accepted as reasonable in the assessment proceedings u/s. 143(3).

The Tribunal found that the assessee had also submitted the copy of return of income of the two employees, and their computation of income especially that the assessee as well as employees both were assessed to Income Tax. There was no loss to the revenue, government ex-chequer, so the transaction for payment to employee became revenue neutral.

The Tribunal noted that AR of the assessee had relied on the decision of Gujarat High Court that for making a disallowance under section 40(A)(2), onus to prove unreasonableness is on Assessing Officer.

The Tribunal further referred to the CBDT Circular No. 6-P(LXXVI – 66) dated 6th July, 1968 wherein revenue neutral transactions are held to be outside the purview of section 40A(2)(b) of the Act.

The Tribunal observed that that so far as the Circular dated 6.7.1968 is concerned, it makes clear that the provisions u/s 40A(2) and particularly with regard to the transaction between the relatives and associates is concerned, the same shall be treated as bona fide, unless the AO finds that one of them is trying to evade the payment of tax. 

Accordingly, the appeal of the assessee was allowed.

Download Full Judgment Click Here >>

• Penalty u/s 270A deleted as assessee filed revised computation during scrutiny
• Penalty u/s 271B for unfilled column 40 in Tax Audit Report Form 3CD deleted by ITAT
• Merely ex-parte rectifying computation without amending assessment order not make it nullity- ITAT
• Once assessee discharges primary onus, it shifts to AO to bring evidence to contrary – ITAT
• Cost Inflation Index for FY/Tax Year 2026-27 notified by CBDT. See Up-to-date Table of CII