2025 (6) TMI 226 - AT - Income Tax

Reduction of exemption claimed U/sec 10AA - whether AO erred in calculating the exemption amount U/sec 10AA based on original ratio as against the revised ratio after adjustment to profit of the SEZ unit? - HELD THAT - From the perusal of the assessment order it is seen that ld. AO has removed the sales incurred on the sales to other SEZ units however he has not reduced the corresponding cost. In other words when ld. AO has taken the sales of Rs. 42, 83, 757/- not covered under the export sales then corresponding cost of Rs. 34, 15, 260/- which is derived at the cost of sales of SEZ units should have been reduced. We agree with the contention of the ld. Counsel for the assessee and direct the ld. AO to verify the figures and allow the additional amount of exemption as per the working given above. With this direction appeal of the assessee is allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Appellate Tribunal (AT) in this appeal relate to the correct computation and allowance of exemption claimed under Section 10AA of the Income Tax Act for the Assessment Year 2015-16. Specifically, the issues include:

• Whether the Additional/Joint Commissioner of Income Tax (Appeals) erred in confirming the reduction of exemption claimed under Section 10AA by Rs. 46,23,130/- by ignoring the assessee's revised computation based on adjusted profit of the SEZ unit;
• Whether the AO and CIT(A) erred in not reducing the direct expenses of Rs. 34,15,260/- allocable to sales of Rs. 42,83,756/- made to other SEZ units, thereby incorrectly reducing the exemption allowable under Section 10AA;
• Whether the allocation of computer software expenses and sundry expenses amounting to Rs. 6,73,042/- to the SEZ unit was justified, given the assessee's claim that these expenses were exclusively incurred for non-SEZ units;
• Whether the allocation of common expenses and other expenses should be made on the revised ratio of 24.85% (based on adjusted turnover) instead of the original ratio of 26.10% while computing exemption under Section 10AA;
• Whether sales made to other SEZ units should be excluded from export turnover for the purpose of claiming exemption under Section 10AA, and if so, whether the corresponding cost of sales should also be excluded.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of reduction of exemption under Section 10AA ignoring revised computation by the assessee

Relevant legal framework and precedents: Section 10AA of the Income Tax Act grants exemption to units located in Special Economic Zones (SEZ) in respect of profits derived from export of goods or services. The exemption is computed based on profits attributable to export turnover. The Special Economic Zone Act, 2005 and Explanation 1 to Section 10AA guide the determination of eligible turnover and profits.

Court's interpretation and reasoning: The AO excluded sales made to other SEZ units from export turnover, holding that such sales are not exports under the SEZ Act and hence not eligible for exemption under Section 10AA. The AO also rejected the assessee's revised computation which adjusted the exemption claim by excluding corresponding cost of sales related to such sales. The CIT(A) confirmed the AO's order without independent reasoning.

Key evidence and findings: The assessee filed a revised computation reducing the margin on sales to other SEZ units by Rs. 8,68,497/- and adjusted the exemption claim accordingly. The AO, however, excluded the entire sales amount of Rs. 42,83,756/- without reducing the corresponding cost of sales of Rs. 34,15,260/-, which distorted the profit calculation of the SEZ unit.

Application of law to facts: The Tribunal noted that if sales to other SEZ units are excluded from export turnover, the corresponding cost of sales must also be excluded to correctly compute the net profit eligible for exemption under Section 10AA. Ignoring the cost component results in an incorrect reduction in profit and thus exemption.

Treatment of competing arguments: The Revenue argued that sales to other SEZ units are not export sales and should be excluded, and that the revised profit computation should be verified by the AO. The assessee contended that the AO erred in not reducing the corresponding cost of sales and that the revised ratio for allocation of expenses should be applied.

Conclusions: The Tribunal accepted the assessee's contention that the corresponding cost of sales should be reduced along with sales to other SEZ units and directed the AO to verify and allow the revised exemption claim accordingly.

Issue 2: Allocation of direct and common expenses including computer software and sundry expenses to SEZ unit

Relevant legal framework and precedents: For claiming exemption under Section 10AA, expenses must be appropriately allocated between SEZ and non-SEZ units based on a reasonable and justifiable method, typically turnover ratio, to determine profits attributable to SEZ operations.

Court's interpretation and reasoning: The AO allocated legal and professional expenses (including monthly software subscription) and sundry expenses to the SEZ unit on the basis of turnover ratio (26.10%), rejecting the assessee's claim that these expenses were exclusively for non-SEZ units due to lack of supporting documents. The CIT(A) confirmed this allocation.

Key evidence and findings: The assessee failed to provide documentary evidence to substantiate exclusive incurrence of software and sundry expenses for non-SEZ units. The AO's approach to allocate these expenses on turnover basis was deemed reasonable.

Application of law to facts: The Tribunal recognized the necessity of allocating common expenses proportionately to accurately compute SEZ unit profits. Since the assessee did not establish exclusivity of expenses to non-SEZ units, allocation on turnover basis was justified.

Treatment of competing arguments: The assessee argued for no allocation or allocation on revised ratio (24.85%), while Revenue maintained allocation on original ratio (26.10%). The Tribunal agreed with the assessee that if the revised turnover ratio is accepted, allocation should correspondingly be adjusted.

Conclusions: The Tribunal directed that allocation of expenses, including computer software and sundry expenses, be made on the revised ratio of 24.85% rather than 26.10%, as this reflects the adjusted turnover after excluding sales to other SEZ units.

Issue 3: Exclusion of sales to other SEZ units from export turnover and corresponding impact on exemption computation

Relevant legal framework and precedents: Section 10AA exemption applies to profits derived from export turnover. Sales to other SEZ units are intra-SEZ and do not constitute export outside India. The Special Economic Zone Act, 2005 defines export turnover for this purpose.

Court's interpretation and reasoning: The AO correctly excluded sales to other SEZ units (Rs. 42,83,756/-) from export turnover. However, the AO erred in not reducing the corresponding cost of sales, which inflated the profit figure and led to incorrect exemption calculation.

Key evidence and findings: The assessee's detailed working showed that cost of sales related to these excluded sales amounted to Rs. 34,15,260/-, which should have been deducted to arrive at net profit eligible for exemption.

Application of law to facts: The Tribunal emphasized the principle that exclusion of certain sales from turnover must be accompanied by exclusion of related expenses to maintain consistency and fairness in profit computation under Section 10AA.

Treatment of competing arguments: Revenue accepted the exclusion of sales but resisted corresponding cost reduction. The assessee insisted on reduction of both sales and related cost. The Tribunal sided with the assessee.

Conclusions: The Tribunal held that both sales to other SEZ units and corresponding cost of sales must be excluded from the computation of profits for Section 10AA exemption.

3. SIGNIFICANT HOLDINGS

"When sales to other SEZ units are excluded from export turnover, the corresponding cost of sales incurred on such sales must also be excluded to correctly compute the net profit eligible for exemption under Section 10AA. Ignoring the cost component results in an incorrect reduction in exemption."

"Allocation of common expenses, including computer software and sundry expenses, must be made on a revised ratio reflecting adjusted turnover after exclusion of sales not qualifying as export turnover, to ensure fair and accurate computation of profits attributable to the SEZ unit."

"The assessee's revised computation reducing the exemption claim by the net margin on sales to other SEZ units, rather than the entire sales amount, is justified and should be accepted subject to verification by the Assessing Officer."

Final determinations:

• The reduction of exemption under Section 10AA by excluding entire sales to other SEZ units without reducing corresponding cost of sales was erroneous.
• The allocation of expenses should be made on the revised ratio of 24.85%, reflecting adjusted turnover after exclusion of non-export sales.
• The computer software and sundry expenses, not proven to be exclusively for non-SEZ units, are to be allocated proportionately to the SEZ unit.
• The appeal of the assessee is allowed with directions to the AO to verify and allow exemption as per the revised computations submitted by the assessee.