By TIOL News Service

CHENNAI, FEB 28, 2017: THE issue is - Whether the mere fact that the settlement commission had been approached cannot mean that every act of the assessee has to be dubious or colourable, except if supported by collaborative material. YES is the verdict.

Facts of the case:

The assessees are engaged in the trading of dyes and chemicals. Pursuant to search operations in the business and residential premises of one E.K. Lingamurthy, assessments were made on E.K.Lingamurthy, L.Parameswari, Kasi Chemicals, Swastic Dye Stuff Corporation and Swastic Chem (P) Ltd which are related concerns controlled by the same group of assessees. The financials of M/s Swastic Corporation Limited for the year ending Mar 31, 1998 revealed a credit of an amount of Rs.1,37,46,000/- representing commission paid to it by Kasi Chemicals, Swastic Dye Stuff Corporation, Swastic Corporation Limited, E.K.Lingamurthy and L.Parameswari Prop.Swastic Corporation. The AO was of the view that no services had been rendered by Swastic Corporation Limited and that the payment of commission was a colourable exercise. The claim of expenditure by the five assesses was thus proposed to be disallowed. The assessees sought to explain that with effect from April 1996 the operations of all the entities owned and managed by the family of E.K. Lingamurthy had been streamlined and Swastic Corporation Limited earmarked as the sole selling agent for the group. Notwithstanding the objections raised by the assessees, the AO disallowed the payments being of the view that the same were non-genuine. According to the officer, the relationship between the parties militated against the claim being bonafide, particularly in the absence of proof of rendition of service by the sales agent. On appeal, the CIT noted that Swastic Corporation Limited had been appointed as sales agent for the sake of maintaining uniformity in sale prices and to avoid unnecessary and uneconomical competition between the sister concerns.

On appeal, the HC held that,

++ the AO appears to have been swayed by the fact that the assessees approached the settlement commission after the search with a large disclosure. The agreement produced by the assessee was disregarded by the AO on the ground that it had not been located or noted in the course of search proceedings in the business and residential premises of A.K.Lingamurthy and was thus an afterthought. While these facts can, at best, lead to a suspicion, it cannot lead to a disallowance that requires the support of positive material. A conclusion of colourability has to be based on hard facts and not on assumptions and presumptions. The fact that the document was not noticed at the time of search cannot be conclusive in leading to an adverse inference against the assessee as the possibility that it escaped the attention of the investigating authorities cannot be ruled out. Then again, the mere fact that the settlement commission had been approached cannot mean that every act of the assessee has to be dubious or colourable, except if supported by collaborative material. In the present case, a plausible explanation has been offered that has found favour with the appellate authorities. There is no prohibition that related parties cannot engage in business transactions. Such an interpretation would render the provisions of Section 40A (2) redundant. Section 40A(2) empowers the AO to effect a disallowance of payments that are, "in his opinion" excessive or unreasonable giving regard to 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 him or accruing to him. Such "opinion" has to be based on tangible material and not assumptions and suspicions;

++ the provisions of section 40A(2) are not automatic and can be called into play only if the assessing officer establishes that the expenditure incurred is, in fact, in excess of fair market value. This had not been done in the present case. The quantum of commission paid is thus at arms length. The decision to streamline business activities and establish a division of labour or hierarchy of operations is within the domain of the entities and cannot be trespassed upon by the AO except where the officer establishes that such design or method is a ruse to circumvent legitimate payment of tax. The Supreme Court in the case of Vodafone International Holdings BV. Vs. Union of India and another, points out the difference between "looking through" a transaction and looking at a transaction settling the position that a conclusion of colourable /sham can be arrived at by viewing the transaction in a commercially realistic and wholistic perspective, not adopting a truncated and dissecting approach. In the present case, there is a consistent finding of fact that the transaction was bonafide and acceptable. Nothing is placed before us to indicate that the findings are perverse. We are thus not inclined to interfere with the concurrent findings of the authorities.

(See 2017-TIOL-392-HC-MAD-IT)