2014 (9) TMI 128 - AT - Income Tax

Deduction u/s 10A - Application of section 80IA(10) - claim excess deduction showing excessive (extra ordinary) profit - revenue arising from its oversees Associated Enterprises (AEs) - Whether sec. 80IA(10) applies when the second party to the transaction is a non-resident Held that - Plain reading of sub-sec.(10) of sec. 80IA makes it explicit that the AO 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 - 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 - section 80IA(10) applies notwithstanding the fact that the other related person is resident or non-resident. Whether it should be an arranged course of business between the related persons to produce more than ordinary profits Held that - 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 - 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, the higher profit should be the effect of an arrangement and cannot be a substitute of such arrangement itself, which is a cause for invoking sub-section (10) of section 80IA - 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. Effect of insertion of proviso to sub-section (10) w.e.f. 1.4.2013 Held 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, the order upholding the invocation of sub-sec. (10) of sec. 80IA cannot be countenanced to this extent - it is held that the CIT(A) erred in sustaining the disallowance made by the AO by restricting the amount of deduction u/s 10A of the Act as claimed by the assessee the deduction is allowed to be claimed - Decided partly in favour of assessee.

Issues Involved:
1. Applicability of Section 80IA(10) when the second party to the transaction is a non-resident.
2. Requirement of an arranged course of business between related persons to produce more than ordinary profits.
3. Effect of insertion of proviso to sub-section (10) w.e.f. 1.4.2013.
4. Non-grant of the set off of brought forward unabsorbed depreciation.

Detailed Analysis:

I. Applicability of Section 80IA(10) when the second party to the transaction is a non-resident:
The primary contention by the petitioner was that Section 80IA(10) of the Income-tax Act, 1961, cannot be applied to transactions between two enterprises if one is not a resident of India. The petitioner argued that manipulation of profits could only occur when both enterprises are residents of India. However, the tribunal rejected this contention, stating that the language of Section 80IA(10) does not specify that the other person must be a resident of India. The provision aims to correct artificially inflated profits regardless of the residency status of the related person. The tribunal held that Section 80IA(10) applies even if the other related person is a non-resident.

II. Requirement of an arranged course of business between related persons to produce more than ordinary profits:
The tribunal emphasized that for Section 80IA(10) to be invoked, it must be demonstrated that the course of business between the assessee and the related person was "arranged" to produce more than ordinary profits. The tribunal noted that higher profits could result from various factors like cost-cutting, economies of scale, or effective marketing strategies, and not necessarily from an "arrangement." The tribunal stressed that the Assessing Officer (AO) must explicitly prove that the transactions were arranged to produce higher profits. In this case, the AO failed to demonstrate any such arrangement, relying solely on the higher profit margins shown in the Transfer Pricing study report. Therefore, the tribunal found the AO's conclusion unsustainable.

III. Effect of insertion of proviso to sub-section (10) w.e.f. 1.4.2013:
The tribunal examined the proviso to Section 80IA(10) inserted by the Finance Act, 2012, effective from 1.4.2013, which mandates that profits from specified domestic transactions should be determined with regard to the arm's length price (ALP). The tribunal clarified that this proviso applies to specified domestic transactions exceeding five crore rupees and not to international transactions. The tribunal noted that the AO relied on the Transfer Pricing study report to conclude that the transactions were arranged to produce higher profits. However, the tribunal highlighted that the proviso did not exist during the assessment year 2009-10, and even if it did, it would not apply to international transactions. Consequently, the tribunal held that the AO's reliance on the Transfer Pricing study report was misplaced, and the assessee's higher profits could not be deemed unreasonable without proving an arrangement.

IV. Non-grant of the set off of brought forward unabsorbed depreciation:
The assessee challenged the non-grant of set off for brought forward unabsorbed depreciation amounting to Rs. 10,73,780. The tribunal noted that there was no discussion on this issue in the assessment order. The Commissioner of Income Tax (Appeals) [CIT(A)] had rejected the ground, stating that the matter was sub judice before the tribunal for the assessment year 2006-07. The tribunal directed the AO to allow the relief if the tribunal eventually decides the issue in the assessee's favor for the assessment year 2006-07.

Conclusion:
The appeal was partly allowed, with the tribunal overturning the CIT(A)'s order on the reduction of the deduction under Section 10A and directing the AO to allow the deduction as claimed. The tribunal also directed the AO to grant the set off of brought forward unabsorbed depreciation if the issue is decided in favor of the assessee for the assessment year 2006-07. The order was pronounced in open court on 26/8/2014.

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