No addition can be made u/s 40A(2) unless AO finds out Fair Market Value of the concerned goods or services and compares the same with payment made by assessee to related parties:

AO made disallowance u/s 40A(2) of part of the job charges paid by the assessee to a person covered vide S.40A(2)(b) since he considered it to be excessive. Hon’ble ITAT found that the appellant had paid texturizing labour charges at 15/kg to its sister concerns whereas its own cost of production was Rs.9.71/kg. Hence, AO took a view that the assessee had made excess payment of Rs.5.29/kg (i.e. Rs.15 – Rs.9.71) and hence, he disallowed corresponding labour charges. For working out such a disallowance, AO firstly needs to compare payment made by assessee with “Fair Market Value” (FMV) of such goods or services and then, if payment is found to be excessive or unreasonable as compared to FMV, then disallowance can be made to the extent of excessive or unreasonable sum paid. In the given case, AO compared the payment of labour charges with “Cost of production” of the assessee and not the “FMV”. Further, Revenue couldn’t controvert the fact that if octroi, freight and cartage are added to cost of production, assessee’s average cost works out to Rs.15.02/kg. In light of the aforesaid facts, the addition made u/s 40A(2) was deleted.

[M/S. J.J. TEXTURISERS Vs. ITO – ITA No.978/Ahd/2010]