N.K. Karhail, Judicial Member - This appeal of the assessee is directed against the order dt. 12th Feb., 2002 passed by the CIT(A), New Delhi, for the assessment year 1998-99.
2. The first ground of appeal relates to the order sustaining the addition of Rs. 22,80,404 made by the Assessing Officer by invoking the provisions of section 40A(2)(b)( iv) of IT Act, 1961. Briefly stated, facts are that the assessee company converts the mild steel ingots into rolled products called the twisted deformed bars. The factory of the assessee company is located in the Union Territory of Pondicherry, which is notified as an industrially backward area for the purpose of section 80-IA.
3. In the course of verification of purchase of raw material which are steel ingots, it was found by the Assessing Officer that the entire purchase of raw material was made by the assessee from M/s Mittal Ispat Ltd. (MIL) and M/s. Sharda Casting Ltd. (SCL). It was found that the average purchase price from M/s MIL per metric ton was Rs. 10,478 while that from M/s SCL Rs. 11,784. However, the assessee subsequently submitted that there was a mistake and average purchase price from MIL was Rs. 11,651 per metric ton and from M/s SCL, it was Rs. 11,724. On the other hand, the Assessing Officer found that both the suppliers of raw material, namely, MIL and SCL had been selling their products to outsiders at a much lower price. While MIL was selling to outside buyers at an average price of Rs. 11,640 per metric ton and the selling price of SCL to outsiders was Rs. 11,586 per metric ton. Thus the assessee company on average paid Rs. 11 per metric ton extra to MIL and Rs. 138 to SCL. Keeping in view this fact, the Assessing Officer adopted Rs. 11,586 as the reasonable purchase price for the assessee company and the excess payment amounting to Rs. 22,80,404 was held to be payment not necessary for the business and the same was held to have been made to companies in which promoters of the assessee company are having interest for considerations other than the business exigencies. The same was accordingly disallowed and added back to the income of the assessee. On appeal, the learned CIT(A) has confirmed the addition made by the Assessing Officer by invoking the provisions of section 40A(2) of the Act by observing as under:
"7. I have carefully considered all the relevant records and the arguments of the learned Authorised Representative of the appellant company. Regarding the applicability of the provisions of section 40A(2), the Assessing Officer has given clear-cut findings that MIL and SCL are controlled by the promoters of the appellant company along with their friends, relatives, acquaintances and associates. It was also stated by the Assessing Officer that there was unity of command and control by the same management in respect of all the three companies. The appellant company has not challenged these observations of the Assessing Officer made in the assessment order. It has only been stated that none of the shareholders of the appellant company has any substantial interest in SCL. The reply of the appellant company is silent regarding the shareholding in MIL. Reply of the learned Authorized Representative of the appellant company regarding the applicability of section 40A is quite vague. Therefore, in view of the clear-cut finding given by the Assessing Officer in his assessment order, it is held that provisions of section 40A were attracted in the case of the appellant company. Regarding the purchase price paid to MIL and SCL, there is no doubt that purchases were made by the appellant company at rates which were higher than the market rate. The argument of comparing the day-to-day purchase price instead of average price also cannot be accepted because average price paid to these two parties was more only because on at least some dates higher price was paid to them. The argument of bulk purchases by the appellant company from the abovementioned two parties also does not help the appellant company because rates in respect of bulk purchases should generally be less and not more than the market rates. In view of the above discussion, the action of the Assessing Officer in invoking the provisions of section 40A(2) is upheld and accordingly the addition of Rs. 22,80,404 is confirmed."
4. Being aggrieved, the assessee company preferred an appeal before the Tribunal. The learned counsel for the assessee company has submitted that there is no justification to apply the average purchase rate, as the market rate of purchase keeps on fluctuating from time to time, therefore before an adverse inferences is drawn that the assessee had paid any extra amount, as alleged, it must have been established that on the date, purchases were made, the payments made by the assessee were in excess of the fair market price of the merchandise purchased. The prices paid to M/s MIL and M/s SCL were the same on the given date and the calculation of average price is just a mathematical absurdity. However, M/s MIL has sold M.S. ingots to other parties during the financial year and the average selling price (party-wise) varied from Rs. 9,000 per metric ton to Rs. 12,248 per metric ton depending upon market forces such as the quantity supplied to them, time of delivery, as the price of M.S. ingots varies from day-to-day basis, terms of payments. Similar is the case with M/s SCL. The learned counsel has further submitted that sales to parties other than assessee included sale of rejected ingots for which the rates were lower by more than Rs. 2,000 per metric ton, which in turn should have brought down the average sale price to other parties. He has pointed out that in the case of M/s MIL, sale of such material is around 70,615 MTs amounting to Rs. 6,48,315, sold to Coastal Steel/Indian Steel & Allied Products/Majri Steels. If the above quantity/value is adjusted from the total sale to other parties, the outside market average will amount to Rs. 11,666 as against the purchase rate of Rs. 11,651. He has further submitted that unless it is shown that transaction is not bona fide, the transaction recorded in books should be accepted. A reliance was placed on the decision in the case of Marghabhai Kishabhai Patel & Co. v. Commissioner Of Income-Tax, Gujarat. [1977] 108 ITR 54 (Guj.). Without prejudice to the above submissions, the learned counsel has submitted that aforesaid disallowances made otherwise is also not sustainable, since the purchases have been made from such companies who were liable to higher taxes since the assessee company was entitled to deduction under section 80-IA and as such this would have caused hardship in bona fide cases. A reliance is also placed on the CBDT Circular No. 6-P(LXXXVI-66) of 1968, dt. 6th July, 1968. Thus, he has urged that the impugned addition may be deleted.
5. On the other hand, the learned Departmental Representative has submitted that the assessee is not manufacturing ingots, rather assessee is buying the ingots from the sister-concerns, and if there is fluctuation in price of ingots that should occur in the hands of sister-concerns and not in the hands of the assessee. Assessee being a bulk buyer, hence he should have got preferential treatment as compared to other buyers of ingots of the sister-concerns. He has further argued that the assessee and the sister-concerns since being situated in the same complex, the cost of material/ingots purchased from the sister-concerns should have been less to the assessee. He has further relied upon the orders of authorities below. Thus, he has argued that the Assessing Officer has correctly invoked the provisions of section 40A(2) of the Act.
6. We have heard the parties and perused the material to which our attention was drawn during the course of hearing. Section 40A(2)(a) inter alia provides that where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to clause (b) of the sub-section, and the Assessing Officer is of the opinion that such expenditure is excessive or unreasonable having regard to the 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 or accruing to him, therefrom, so much of the expenditure as is to be considered by him to be excessive or unreasonable and shall not be allowed as a deduction.
7. The scope of the section has been explained in the circular of CBDT No. 6P(LXXXVI-66) of 1968, dt. 6th July, 1968 in which in paras 72 and 74, it is stated thus :
"Para 72 : The Finance Act, 1968, has introduced a new section 40A in the IT Act w.e.f. 1st April, 1968. Under sub-section (2) of new section 40A, expenditure incurred in a business of profession for which payment has been or is to be made to the taxpayer’s relatives or associate concerns is liable to be disallowed in computing the profits of the business or profession to the extent the expenditure is considered to be excessive or unreasonable. The reasonableness of any expenditure is to be judged having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business of profession or the benefit derived by, or accruing to, the taxpayer from the expenditure. Such portion of the expenditure, which, in the opinion of the ITO, is excessive or unreasonable according to these criteria, is to be disallowed in computing the profits of the business of profession.
Para 74 : It may be noted that the new provision is applicable to all categories of expenditure incurred in businesses and professions, including expenditure on purchase of raw materials, stores or goods, salaries to employees and also other expenditure on professional services, or by way of brokerage, commission, interest, etc. Where payment for any expenditure is found to have been made to a relative or an associate concern falling within the specified categories, it will be necessary for the ITO to scrutinize the reasonableness of the expenditure with reference to the criteria mentioned in the section. The ITO is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases."
8. It would be clear from the above circular that reasonableness of the expenditure has to be judged having regard to (a) fair market value of the goods, services or facilities for which the payment is made (b) the legitimate needs of the business or profession ;(c) the benefit derived by or accruing to the taxpayer from the expenditure. These are the three alternative tests and the same do not prohibit consideration of other circumstances. Thus, under section 40A(2), the Assessing Officer can disallow only that portion of the total expenditure which in his opinion is excessive or unreasonable. The reasonableness is to be decided on the basis of fair market value of the goods, services or facilities. The reasonableness it to be seen from the viewpoint of the businessman not from the viewpoint of the Revenue authorities. A reference it made to the decision in the case of Voltamp Transformers P. Ltd. v. Commissioner Of Income-Tax, Gujarat-I [1981] 129 ITR 105 (Guj.).
9. In the instant case, the case of the Revenue is that the assessee has purchased the raw material from the two sister-concerns viz., M/s MIL and M/s SCL which are situated in the same premises, at a price higher than the prices charged by these concerns from the other parties by working out the average purchase rate of the raw material purchased by the assessee from time to time. We find that there is no justification to apply the average purchase rate, as the market rate of purchase keeps on fluctuating from time to time. The expression used in section 40A(2) is ‘any expenditure’ which means that each expenditure has to be judged in relation to its market rate on the date of expenditure. Thus, it must be established before invoking section 40A(2) that on the date the purchases were made, payments by the assessee were in excess of the fair market price of goods purchased by the assessee. The claim of the assessee that sales by the said concerns to the parties other than assessee included sale or rejected ingots for which the rates were lower by more than Rs. 2,000 per metric ton has not been disputed/rebutted by the Revenue. Therefore, price for such material has to be on lower side. The Revenue has not compared the price of raw material purchased by the assessee with the prices charged for the same material by other parties in the open market other than these two concerns. The legitimate needs of the business of the assessee to buy bulk purchase from these concerns has not been properly appreciated by the authorities. The rates fixed for the raw material between the assessee and these two concerns even if it were on a bit higher side, it would have satisfied the legitimate needs of the assessee in buying the raw material in bulk. It would appear that there is a marginal difference of Rs. 11 in payment made by the assessee and outside parties in the case of M/s MIL, as worked by the Assessing Officer. Besides, the provision of section 40A(2) is meant to check evasion of tax through excessive or unreasonable payments to relatives and the associate concerns. However, in the instant case, it is seen that the assessee is entitled to claim deductions under section 80-IA of the Act whereas the parties from whom the purchases have been made are subject to high taxes, therefore, to invoke the provision of section 40A(2) in the case of assessee would not be just and proper. Thus, we are of the view that the Assessing Officer has failed to prove that the expenditure is excessive or unreasonable having regard to the fair market value of goods or the legitimate needs of business of the assessee. In the facts and circumstances of the case, we are of the view that the Assessing Officer is not justified to invoke the provisions of section 40A(2) of the Act in the case of the assessee. Hence, we direct to delete the same.
10. The second and third grounds of appeal relate to the order sustaining the addition of Rs. 17,22,668 on account of suppression of production and addition of Rs. 43,06,669 made on account of unaccounted investment in respect of suppressed production. Briefly stated, facts are that during the assessment proceedings the Assessing Officer noticed that the average amount of power consumed per metric ton for production during the period relevant to assessment year 1998-99 was 182 units as compared to 167 of the preceding year. Thus, the average power consumption per metric ton for production was increased by about 9 per cent this year as compared to the preceding year. The Assessing Officer, therefore, required the assessee company to explain this wide variation in the power consumption. The assessee was also asked to explain as to why it should not be presumed that the excess power consumed was the power consumption for undisclosed production. The assessee in its response stated that the consumption of power was a variable of the following conditions :
1.Furnace conditions as power consumption increases with the age of furnace;
2.Quality of raw materials;
3.Labour productivity;
4.Incoming voltage;
5.Breakdown maintenance time;
6.Size of finished goods;
7.Climatic conditions.
11. The Assessing Officer examined the above submissions of the assessee company. He agreed that the power consumption may vary a little bit with the aging of the furnace. Regarding all other factors the Assessing Officer concluded that there was no abrupt change as compared to the preceding year. The Assessing Officer also examined and rejected the arguments of the appellant company regarding the checking by excise authorities and also regarding the installed capacity of the plant. Giving benefit of the furnace getting old and therefore consuming more power, average consumption of power per metric ton of production was taken at 172 units as against 182 units claimed by the appellant company. At this rate of consumption of power, total production worked out was at 22,110.267 mt. Thus, the assessee was held to have declared the production short by 1,220.267 mt. The selling price of the same was calculated at Rs. 1,72,26,675. The GP @ 10 per cent of this amount was taken as income component and added back to the total income of the assessee company. Accordingly, an addition of Rs. 17,22,668 was made on this account. Further, an amount of Rs. 43,06,669 was also added back as unaccounted investments to achieve this unaccounted production. On appeal, the CIT(A) has held thus :
"11. I have considered all the relevant material on record and the arguments of the learned Authorised Representative of the appellant company. There is no doubt that there was a substantial increase of 9 per cent in power consumption during this year as compared to the last year. The appellant company has failed to justify this increase. The factors of variation of consumption detailed by the appellant company were same as in the preceding year. Benefit for aging of the plant has already been granted by the Assessing Officer. Regarding the acceptance of production by the Excise Department, the Assessing Officer has mentioned in his assessment order that excise duty was levied not on actual production but on estimate basis calculated by the Excise authorities. The appellant company has not pointed out any specific instance of verification of actual production by the Excise authorities. Even though the Assessing Officer has not pointed out any specific defect in the books of account of the appellant company, he has given reasonable opportunities to the appellant to explain the substantial increase in poor consumption. The Assessing Officer has also examined in detail all the factors mentioned by the appellant company and wherever benefit was called for, same has been granted. Therefore, the action of the Assessing Officer in making addition of Rs. 17,22,668 on account of sale of undisclosed production and Rs. 43,06,669 on account of unaccounted investment is upheld. This takes care of grounds of appeal Nos. 11,12 and 13."
12. Before us, learned counsel for the assessee has submitted that the reason for variation in power consumed in comparison to the production of earlier year was explained to the Assessing Officer in relation to furnance condition, quality of raw material used, labour productivity, incoming voltage, breakdown/meant time, size of finished goods rolled and climatical condition, etc. Due to the above reasons, monthly consumption of power varied between 141.41 units to 223.99 units in the instant year as compared to 117 units to 287 units in the immediately preceding year. He has submitted that the similar variation existed in the preceding year also, but no adverse inference had been drawn in those years. The learned counsel has further submitted that the assessee had maintained regular books of account and all sales/purchases were fully vouched, recorded and supported by raw material consumption register and production register and finished goods register and was also subjected to excise duty and its production declared for the instant year at 2089.098 mt had duly been accepted by the Excise Department after verification. He has further argued that merely because variation in consumption in electricity cannot be regarded as a ground to disregard the declared version of the assessee. A reliance in this regard has been placed upon the decision in the case of N. Raja Pullaiah v. Dy. CTO [1969] 73 ITR 224 (AP) wherein the Hon’ble High Court has held thus :
"The assessing authority rejected the account books of the assessee, a groundnut oil miller, and estimated the turnover on the basis of consumption of electricity and the result of tests conducted in other mills. No test, however, was conducted in that very mill to find out the rate of consumption of electricity for a definite quantity of seeds to be converted into oil. The assessee questioned the assessment in writ proceedings :
13. A reliance has also been placed upon the decision in the case of Mahabir Prasad Jagdish Prasad v. CST [] 27 STC 337 (All.), wherein the Hon’ble High Court has held thus :
"The account books of an assessee cannot be rejected on mere suspicion or conjecture unless the accounts are kept in such a way that reliance cannot be placed upon them. If the method of accounting followed by the assessee is so defective that there is a possibility of suppression and leakage, the accounts can be rejected without any further material. But, if the accounts are properly maintained with all the relevant details it is necessary for the assessing authority to place on record some material to show that the accounts are not reliable. The fact that the consumption of electricity shown by the assessee was unduly high can give rise to a strong suspicion that the assessee might have suppressed its production and thereby might have understated its sales. But, suspicion, howsoever strong it may be, cannot take the place of positive material. Even if the Sales-tax Officer is able to detect one instance where the assessee might have understated its sales he would be justified in rejecting the accounts and making an estimate of the escaped turnover. But, the high consumption of electricity alone cannot be held to be a material justifying the rejection of the accounts particularly when the assessee’s accounts had once been accepted during the regular assessment proceedings."
14. Thus, he has argued that the impugned additions made on the basis of variation in consumption of electricity is not legally sustainable.
15. On the other hand, learned Departmental Representative relied upon the orders passed by the authorities below. He has further submitted that there is no material on record to show that there was breakdown in the electricity supply during the year under consideration. Thus, he has supported the order passed by the Assessing Officer.
16. We have heard the parties and have perused the material to which our attention was drawn. It is seen that the assessee has maintained its regular books of account and all the sale and purchase vouchers are duly vouched and supported by raw material register. The fact that the assessee has maintained regular books of account and the Assessing Officer has not pointed out any defect in the books of account of the assessee has, itself been admitted by the CIT(A) in the impugned order. The fact that all the sale and purchase vouchers were fully vouched/recorded and supported by the raw material consumption register, production register and finished goods register and also subjected to excise duty has also not been disputed by the Revenue Department. The fact that the consumption of electricity shown by the assessee was higher can give rise to a strong suspicion that the assessee might have suppressed its production and thereby might have understated its sales. But suspicion, however, strong it may be, cannot take the place of positive material. It may be mentioned that the consumption of electricity by itself cannot form a reliable test for determining the production. Production depends upon various factors, namely quality of raw material, condition of machine, etc. Therefore, in view of decisions referred to above, the impugned addition made only on account of variation in consumption of electricity is not legally sustainable. Therefore the addition of Rs. 17,22,668 made on account of sale of undisclosed production and Rs. 43,669 made on account of unaccounted investment for the undisclosed production are directed to be deleted.
17. The fourth ground of appeal states that there was no justification on the part of the learned CIT(A) in not allowing the depreciation claim of Rs. 14,64,948 and has erred in merely directing the learned Assessing Officer to pass a speaking order. In doing so, he has failed to appreciate that after the amendment made order section 250 of the IT Act, he had no such power to do so.
18. Briefly stated, facts are that the Assessing Officer disallowed the claim of depreciation aggregating to Rs. 14,64,948. On appeal, the CIT(A) held as under :
"12. Vide ground No. 14, the appellant company has challenged the action of the Assessing Officer in not allowing statutory deduction pertaining to depreciation aggregating to Rs. 14,64,948 which as per the learned Authorised Representative was duly claimed and was supported by necessary evidence. During the appellate proceedings, it was stated that the Assessing Officer has not given any reason for non-allowance of the set off of the determined unabsorbed depreciation. The Assessing Officer is directed to pass a speaking order in this regard and the determined unabsorbed depreciation if any should be allowed."
19. During the course of hearing, the learned counsel for the assessee has not made any submission with regard to this ground of the appeal. Therefore, the same is deemed to have been not pressed.
20. In the result, the appeal filed by the assessee is partly allowed.