Vildirect: IncomeTax-caselaws-2014-VIL-911-ITAT-DEL

2014-VIL-911-ITAT-DEL

Equivalent Citation: [2014] 35 ITR (Trib) 100 (ITAT [Del])

Income Tax Appellate Tribunal DELHI

ITA No. 348/Del/2013

Date: 26.08.2014

M/s . AT. KEARNEY INDIA PVT. LTD.

ADDITIONAL COMMISSIONER OF INCOME-TAX

For the Petitioner : Sh. Salil Kapoor & Vikas Jain, Advs.
For the Respondent : Sh.Peeyush Jain & Yogesh K. Verma, CIT DRs

BENCH

Sh. R. S. Syal, AM And Sh. George George K., JM,JJ.

JUDGMENT

Per R. S. Syal, AM:

This appeal by the assessee is directed against the order passed by the CIT(A) on 6.12.2012 in relation to the assessment year 2009-10.

2. The assessee has filed concise grounds. Ground No. 1, 2 & 5 are not pressed. These, therefore, stand dismissed.

3. The major issue argued on behalf of the assessee is the subject matter of ground no. 3 by which challenge has been made to the reduction in the amount of deduction u/s 10A of the Income-tax Act, 1961 (hereinafter also called ‘the Act’) by a sum of Rs. 5,58,86,784/-.

4. Briefly stated the facts of the case are that the assessee filed its return declaring income of Rs. 31.14 lac. As the tax payable u/s 115JB of the Act was more than as per the normal provision, the tax was paid u/s 115JB. During the course of assessment proceedings, it was observed by the Assessing Officer that the assessee claimed deduction u/s 10A of the Act to the tune of Rs. 8,22,78,165/- in respect of revenue arising from its oversees Associated Enterprises (AEs). The assessee was called upon to file the Transfer Pricing study report, which was duly filed. On the perusal of the said Transfer Pricing study report, the A.O observed that the assessee had shown its margin of profit from the eligible business at many times higher than that shown by the comparables. It was seen that the arithmetic mean of the margin of comparables as per the TP study report was 16.22% as against the assessee’s margin of profit at whopping 101.19%. It was thus opined that the provisions of sec. 10A(7) r.w.s 80IA(10) were applicable. The assessee’s objections did not persuade the Assessing Officer to hold that sec.10A(7) was not applicable. It was eventually ruled that the assessee and its AEs, owing to their close connection, had so arranged the course of business amongst themselves so that the business transacted between them produced to the assessee more than the ordinary profits. Invoking the provisions of sec. 10A(7) r.w.s 80IA(10) and observing that the arithmetic mean of the operating margin of the comparables as per the TP study report was 16.22%, the AO considered profit rate of 20% of the operating cost as reasonable. Since the assessee had shown operating profit at 101.19% of the operating costs, the Assessing Officer reduced the eligible amount of deduction u/s 10A to Rs. 2.63 crore by applying 20% as the reasonable profit. This led to the reduction in the amount of deduction u/s 10A by Rs. 5.58 crore. The assessee failed to convince the ld. CIT(A) to its line of reasoning, who echoed the assessment order on this point.

5. We have heard the rival submissions and perused the relevant material on record. The Revenue has made out a case that reduction in the amount of deduction u/s 10A was justified because of the operation of the provisions of sub-section (10) of section 80IA. Sub-sec. (7) of sec. 10A provides that: ‘The provisions of sub-sec. (8) and sub-sec. (10) of section 80IA shall, so far as may be, apply in relation to the undertaking referred to in this section as they apply for the purposes of the undertaking referred to in section 80IA’. The essence of this provision is that the disabling provisions contained in sub-secs. (8) and (10) of sec. 80IA have full application to sec. 10A as well, wherever applicable. The Assessing Officer has applied only sub-sec. (10) of sec. 80IA to restrict the amount of deduction u/s 10A to this level. It is clear from the facts of the case narrated above that the assessee is otherwise entitled to deduction u/s 10A in respect of export of eligible goods. The fact that the Assessing Officer himself allowed deduction u/s 10A @ 20% proves that all the eligible conditions set out in sec. 10A of the Act were satisfied by the assessee. The sole reason assigned by the AO for restricting the amount of benefit u/s 10A is the applicability of 80IA(10) in terms of which the assessee and its foreign AE arranged the course of business in such a way so as to produce more than ordinary profits to the assessee carrying on eligible business in India.

6. In order to evaluate and examine the rival contentions on the action of the authorities below in restricting the amount of deduction u/s 10A, it would be apposite to consider the mandate of sub-sec. (10) of sec. 80IA as applicable at the relevant time, as under:-

‘(10) Where it appears to the Assessing Officer that, owing to the close connection between the assessee carrying on the eligible business to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom:’

With this backdrop, we will deal with the issues taken up before us, one by one.

I. Whether sec. 80IA(10) applies when the second party to the transaction is a non-resident.

7.1. The ld. AR vehemently argued that sub-sec (10) of sec. 80IA cannot be applied to transactions between two enterprises, one of which is not a resident of India. In support of this contention, he sought to rely on Circular No. 308 dated 29.6.1981 explaining the provisions of sec. 10A. Referring to para 6.10 of the Circular, dealing with the applicability of sub-sec. (8) and (9) of sec. 80I to sec. 10A, the ld. AR argued that its last line clearly provides that this provision has been made with a view to avoid abuse of the tax concession by manipulation of profits between associate concerns or different units of the same concern. Drawing strength from these lines, the ld. AR canvassed a view that the manipulation of profits between two enterprises can only be in a situation where both such enterprises are residents of India, so that the increase in profit of the eligible business results in a corresponding decrease in the profit of the other non-eligible business. If an assessee having eligible assessee is resident of India and the other person having non-eligible business is resident of another country, there can be no question of manipulation of profit, as in such a scenario it is only the resident assessee whose profits are taxable in India and there can be no corresponding decrease in the profits of the assessee having non-eligible business.

7.2. We do not find any force in this contention made on behalf of the assessee. A plain reading of sub-sec. (10) of sec. 80IA makes it explicit that the Assessing Officer of the assessee having eligible business is empowered to scale down the profits where it appears to him that owing to the close connection between the assessee carrying on eligible business and ‘any other person’, the course of business is so arranged that the business transacted between them produces to the assessee more than the ordinary profits, which might be expected to arise in such eligible business. The essential requirement for invoking sub-sec. (10) of sec. 80IA is that the course of business between the assessee having eligible business and the closely connected ‘any other person’ should be arranged. The expression `any other person’ has not been qualified by the phrase `resident of India’. It has no where been provided in any part of this provision that such connected person also must be a resident of India. The essence of this disabling provision is that when the close connection between two related persons artificially produces more than ordinary profits to the assessee having eligible business, then the same should be set right. It does not matter that such other related person assisting in artificially increasing the profits of the eligible assessee, is resident of India or of any other country. Further, we are unable to comprehend from the unambiguous language of the provision that there should be shifting of profits from one taxable entity in India to another taxable entity in India, as a pre-condition for invoking sub-section (10). There is no such stipulation in the provision that the increase in the profits of the assessee having eligible business must correspond with the decrease in the taxable profits in India of the person carrying noneligible business. This provision is simply concerned with the increase in the profits of the assessee having eligible business. To argue that unless there is corresponding decrease in the profits of the other assessee, also a resident of India, the mandate of sub-sec. (10) is not activated, is akin to reading more than the actual content of the provision, which is obviously impermissible. We, therefore, hold that section 80IA(10) applies notwithstanding the fact that the other related person is resident or non-resident. This contention is thus rejected as devoid of any merit.

II. It should be an arranged course of business between the related persons to produce more than ordinary profits.

8.1. We have set out sub-section (10) above as was applicable at the material time. As the AO has made out a case that owing to the close connection between the assessee and the foreign AE, the course of business between them was so arranged as to produce more than ordinary profit to the assessee, thus, the part of the provision stipulating -‘or for any other reason’-, is not applicable to the facts of the instant case. Thus on an analysis of the parts of sub-section (10), as are relevant and applicable to the factual matrix under consideration, it can be seen that it has the following ingredients : -

i. There should be close connection between the assessee carrying on the eligible business and any other person ; and

ii. The course of business between the assessee and such other closely connected person should be so arranged that the business transacted between them produces more than the ordinary profits to the assessee carrying on eligible business. If the above i. and ii. are cumulatively satisfied, then

iii. The Assessing Officer shall take the amount of profits as may be reasonably deemed to have been derived from the transactions of such arranged course of business in computing the profits of such eligible business for the purposes of the deduction under this section.

8.2. There is no dispute as regards the applicability of i. above inasmuch as there is a close connection between the assessee carrying on the eligible business in India and its associated enterprise, being any other person, carrying on business outside India.

8.3. Now we espouse ii. above, which is crucial for our decision and the major thrust of arguments has been on it. This ingredient provides that the course of business between the assessee and such other closely connected person should be so arranged that it produces more than the ordinary profits to the assessee carrying on eligible business. A bare reading of the relevant part of the provision indicates that in order to invoke this provision, it is of utmost importance on the part of the AO to first demonstrate that the transactions between the assessee and the other related person were `arranged’ with a view to produce more profit to the assessee carrying on eligible business.

8.4. At this juncture, it is of significant to note from iii. above that sub-section (10) is a fictional provision, deeming reasonable profits as actual profits for the purposes of computing the amount of the eligible deduction u/s 10A in case the conditions under i. and ii. above are satisfied. The noteworthy point is that instantly we are dealing with a deeming provision. A deeming provision or a legal fiction is one whose mandate does not exist but for such provision. Because of such deeming provision alone, the given imaginary state of affairs is taken as reality notwithstanding the fact that it is at variance with the reality and the other relevant provision of the enactment. It has been fairly settled that the scope of a deeming provision should be restricted to what is expressly stated in such a provision. There can be no inference or intendment as regards such a provision. The Hon’ble Supreme Court in CIT Vs. Amarchand N. Shroff (1963) 48 ITR 59 (SC) and CIT Vs. Mother India Refrigeration Industries P. Ltd. (1985) 155 ITR 711 (SC) considered the ambit of deeming provisions and held that the fiction cannot be extended beyond the object for which these were enacted. The Hon’ble Bombay High Court in CIT Vs. Ace Builders P. Ltd. (2006) 281 ITR 210 (Bom.) has also taken similar view. On an appraisal of the above judgments, the position which emerges is that whenever a legal fiction is created by way of a deeming provision, it is vital to go strictly by the express prescription of this provision. Such a deeming provision cannot be extended beyond what is expressly stated therein. If certain consequences have been made to follow on the fulfillment of certain set out conditions in a deeming provision, then unless such conditions are strictly fulfilled, the consequences cannot be deduced. In other words, a deeming provision is to be strictly construed.

8.5. With this background that sub-section (10) is a deeming provision and it must be strictly construed, we revert to the point under consideration that the Assessing Officer must show at the first instance that the course of business between these closely connected persons was arranged so as to produce more than ordinary profits in the hands of a person carrying on the eligible business. Such a position has to be necessarily proved. There can be no inference as to the fulfillment of such a condition. Thus, it is vivid that unless such `arrangement’ or manipulation is shown to exist, there can be no question of discarding the declared actual profit and substituting it with a reasonable profit. It is manifest that there are two components of this. First is the `arrangement’ between the related parties and second, such arrangement should lead to higher profit. High profit must necessarily be the consequence of such an arrangement. To put it simply, if such an `arrangement’ is a cause, the higher profit is its `effect’. It is well known that higher or lower profit of a business can be as a result of the cumulative effect of several factors. To cite an example, if one person succeeds in cutting down its costs without affecting the quality of output, he will naturally earn more profit than others in the same line of business. Similarly, economies of scale also affect the profit. In the like manner, the extent of administrative, marketing and selling expenses also has a bearing on the overall profit of a business. Other factors for the increase in the profits may be economical purchases or costly sales. If a businessman manages to make economical purchases from the market, he will naturally earn more profit. On the other hand, if the purchases are not actually economical, but because of the close connection with the seller, the arrangement is such so as to show low purchase price in the accounts of the person carrying on eligible business, the apparent profit will still be high. Though in both such cases, the profit of the eligible business has shot up, but in the first instance, it is higher due to efficiencies and in the second, it is higher due to `arrangement’. Similarly, if a businessman manages to make sales in the market at a higher price because of its effective selling techniques, he will earn more profit. On the other hand, if the sales are not at high price because of the effective marketing strategy, but because of the close connection with the buyer, the arrangement is such so as to show higher sale price in the accounts of the person carrying on eligible business, the profit will still be high. Though in both the cases the profit of the eligible business will be higher, but in the first instance it will be higher due to better marketing strategy and in the second, it will be higher due to `arrangement’. What is relevant for invoking subsection (10) is the prevalence of the second situation above where the higher profit has resulted due to ‘arrangement’ between the assessee and its closely connected person and not the first, where the higher profit resulted due to the assessee’s effectively managing the business. Thus it is evident that though in both the situations, the profit is higher, but recourse to sub-section (10) can be taken only in the case of `arrangement’ between the assessee and the closely connected person. In other words, the mere higher profit of the person carrying on the eligible business is no criteria to press into service this provision, unless the `arrangement’ is proved in the first instance. The `arrangement’ needs to be specifically proved by the AO by showing that the assessee intentionally made purchases at a relatively lower rate from the closely connected person vis-à-vis that available in the market for the same products or the assessee made sales to the closely connected person at a relatively higher rate vis-à-vis the prevailing market price of the similar products etc. or that the assessee having eligible income booked relatively less expenses or showed relatively more income on other counts in transactions with closely connected person. It is only when the existence of` `arrangement’ is proved in this manner that the provisions of sub-section (10) can be employed to reduce the extraordinary profits resulting from such lower payments or excess recoveries to/from the related person. To put it simply, the higher profit shown by the eligible assessee is the end point of the exercise to be undertaken by the AO in this regard, starting with expressly showing as to how the transactions were specifically arranged to produce more than ordinary profits to the assessee carrying on the eligible business. The mere higher profit earned by such eligible assessee can be no reason to conclude that the assessee transacted in such an `arranged’ manner with its related persons so as to produce more profits to it. At the cost of repetition, we reiterate that the higher profit should be the `effect’ of such an `arrangement’ and cannot be a substitute of such `arrangement’ itself, which is a `cause’, for invoking sub-section (10) of section 80IA.

8.6. It can be seen from the facts of the instant case that the AO has simply treated high profit earned by the assessee as a reason to summon sub-section (10), without even remotely demonstrating the existence of any `arrangement’ between the assessee and its AEs aimed at producing extra ordinary profits in the hands of the assessee. The conclusion drawn by the authorities below in such circumstances cannot be ex consequenti sustained.

III. Effect of insertion of proviso to sub-section (10) w.e.f. 1.4.2013

9.1. It can be seen that the Assessing Officer simply took support of the Transfer Pricing study report furnished by the assessee for coming to the conclusion that the A.Es. and the assessee company, owing to their close connection, had so arranged the course of business amongst themselves so that the business transacted between them produced more than ordinary profits to the assessee. Now the question arises as to whether the TP study report can be construed as a sufficient evidence to prove that the course of business was arranged between the assessee and its foreign A.Es to produce more profits in the hands of the assessee. The ld. DR strongly argued that the Transfer pricing study report submitted by the assessee clearly proved that the assessee charged higher profit from its associated enterprises. In his opinion, the lower profits earned by the other comparable cases in similar circumstances was sufficiently indicative of the fact that the assessee arranged transactions with its related parties so as to produce more profits in its accounts. He forcefully relied on proviso to sub-section (10) of section 80IA, which talks of computing ordinary profits having regard to the arm’s length price.

9.2. In order to scrutinize this contention, it is relevant to note the text of proviso to sub-sec. (10) which has been inserted by the Finance Act, 2012 w.e.f. 1.4.2013. This proviso reads as under:- `Provided that in case the aforesaid arrangement involves a specified domestic transaction referred to in section 92BA, the amount of profits from such transaction shall be determined having regard to arm's length price as defined in clause (ii) of section 92F.’

9.3. A close scrutiny of the above proviso transpires that in case `the aforesaid arrangement’ (that is, the arrangement referred to in main sub-section (10) between the eligible assessee and the related person under which transactions are so arranged as to produce more than ordinary profits to the eligible assessee) involves a specified domestic transaction, then the amount of reasonable profits from such transactions between the eligible assessee and the related person shall be determined having regard to arm’s length price of such transactions. Meaning of `Specified domestic transaction’ has been given in section 92BA of the Act as any of the given five specific and one general transaction, not being an international transaction, including, inter alia, (iv) any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA, where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of five crore rupees. When we read the proviso in entirety, it divulges the following components :-

i. There should be arrangement between the eligible assessee and the other related person under which transactions are so recorded as to produce more than ordinary profits in the hands of the eligible assessee; and

ii. Such arrangement should involve a specified domestic transaction, that is, the aggregate of all the six types of given transactions should exceed a sum of five crore rupees.

iii. In such a case, the reasonable profits to be substituted with the declared profits, is the one determined having regard to the ALP.

9.4. It is only when i. and ii. above are collectively satisfied that the iii. above is set in motion so as to determine the amount of reasonable profits, as determined having regard to the ALP, to be substituted with the declared profit of the eligible assessee. If the aggregate of all the given six transactions does not exceed a sum of five crore rupees, then it would not become specified domestic transactions. But in such a case also, wherever the relevant provisions are applicable, those will hold the field. The mandate of the main part of section 80IA(10) will also continue to apply in case the aggregate of six transactions is less than a sum of five crore rupees, in which case the amount of reasonable profit will still have to be computed by the AO himself but without taking recourse to the ALP, which in any case will not be available as the assessee will not be required in that situation to make its Transfer pricing study report. However, the important factor, which needs to be highlighted here is that in a case of specified domestic transaction, that is, where the aggregate of six transactions exceeds a sum of five crore rupees, the proviso simply provides a mechanism for the computation of reasonable profit to be determined having regard to the ALP. This is the only mandate of the proviso. Even in that case also, the existence of the ‘arrangement’ between the assessee and its related party, aiming to increase the profits of the eligible assessee, is a pre-requisite for resorting to sub-section (10). Notwithstanding the fact that the profit of the eligible assessee is higher in comparison with the profit computed having regard to ALP of the specified domestic transactions, still the substitution of such profits with that computed having regard to ALP, will be possible only if the AO firstly demonstrates the existence of such `arrangement’. The only change which has been made by the insertion of this proviso is that in case of the `arranged’ specified domestic transaction, the AO now need not separately find out and establish the genuineness of the `reasonable profits’ to be substituted for the declared profits. In such a scenario, the profit determined having regard to the ALP shall be automatically considered as `reasonable profits’ to be substituted with the declared profits by the eligible assessee. To contend that the proviso has dispensed with the need on the part of the AO to establish such `arrangement’, is not correct. What has been dispensed with is the calculation of the `reasonable profits’. The existence of such an `arrangement’ is still required to be proved by the AO. The crux of the insertion of the proviso to sub-sec. (10) is that where the course of business between two connected resident assessees is so arranged that the business transacted between them produces more than the ordinary profits to the assessee carrying on the eligible business, then the reasonableness of the profits so charged shall be judged with reference to ALP of such transaction.

9.5. It is paramount to note that proviso to sub-sec. (10) has been inserted w.e.f. 1.4.2013 simultaneous with the inclusion of `specified domestic transaction’ within the ambit of transfer pricing provision, whereas Chapter-X dealing with the computation of income from international transaction having regard to Arm’s Length Price was inserted by the Finance Act, 2001 w.e.f. 1.4.2002. At that time, subsec. (10) of sec. 80IA was very much on the statute. The legislature did not consider it expedient to deem profit from international transaction having regard to ALP as reasonable profit in the course of the arranged course of business between the Indian assessee carrying on the eligible business and foreign A.E. The fact that only the profit from specified domestic transaction determined having regard to the ALP has been considered as reasonable for the purposes of sec. 10A w.e.f. 1.4.2013, goes to prove that the legislature did not intend to consider profit from an international transaction computed having regard to ALP, as relevant for sub-sec. 10A from 1.4.2002. The further fact that the proviso to subsec. (10) of sec. 80IA inserted by the Finance Act, 2012 encompasses only the specified domestic transaction and not the international transaction, as is the case under consideration, amply proves that the legislature neither intended nor intends to have recourse to the profits from international transaction having regard to their ALP as a yardstick of `reasonable profits’ to be substituted for the declared profits as per sub-section (10) of section 80IA.

10. The ld. AR has commended to us the judgment of the Hon’ble Bombay High Court in CIT Vs Schmetz India Pvt. Ltd. (2012) 254 CTR (Bom.) 504 in which it has been held that merely because an assessee makes extra ordinary profit, it would not lead to the conclusion that the same was organized/arranged for the purpose of claiming higher deduction u/s 10A of the Act. Our attention has also been drawn towards an order passed by the Hyderabad Bench of the Tribunal in Zavata India Pvt. Ltd. Vs ITO (ITA No. 628/Hyd./2008) and another passed by the Chennai Bench of the Tribunal in M/s Visual Graphics Computing Services (India) Pvt. Ltd. Vs ACIT (2073/Mds/2011) in which it has been held that the TP study report cannot be considered for determining excess profit and thereby denying/restricting the amount of deduction u/s 10A. No contrary precedent has been brought to our notice by the ld. DR.

11. Adverting to the facts of the extant case, we find that the AO simply relied on the TP study report submitted by the assessee to form a bedrock for the disallowance of the part of the amount of deduction u/s 10A, without firstly showing that there existed any arrangement between the assessee and its overseas related party, by which the transactions were so arranged as to produce more than the ordinary profits in the hands of the assessee. The assessment year under consideration is 2009-10. Neither the proviso to sub-section (10) existed at that time, nor such a proviso can be applied as we are dealing with an international transaction and not specified domestic transaction. Under these circumstances, we are of the considered opinion that the impugned order upholding the invocation of sub-sec. (10) of sec. 80IA cannot be countenanced to this extent. Ergo, it is held that the ld. CIT(A) erred in sustaining the disallowance made by the Assessing Officer by restricting the amount of deduction u/s 10A of the Act to Rs. 2.63 crore as against Rs. 8.22 crore claimed by the assessee. The impugned order on this issue is overturned and it is directed to allow deduction as claimed.

12. The only other ground which survives for our consideration is challenging non-grant of the set off of brought forward unabsorbed depreciation amounting to Rs. 10,73,780/- as claimed by the assessee in its return of income. There is no discussion in the assessment order on this issue. The ld. CIT(A) vide para 6.1 of the impugned order held that since the matter is sub judice before the Tribunal for the assessment year 2006-07 hence the ground was liable to be rejected. The ld. AR was fair enough to state that the Assessing Officer may be directed to allow the relief as claimed in the present ground, if the Tribunal eventually decides this issue in assessee’s favour in appeal for the assessment year 2006-07. We agree with the contention of the ld. AR and direct the Assessing Officer to do so.

13. In the result, the appeal is partly allowed.

Order pronounced in the open Court on 26/8/2014.

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