2025 (6) TMI 1318 - AT - Income Tax

Applicability of provisions of section 80IA(10) for existence / non-existence of arrangement between the eligible unit of assessee and its AE - arrangement before making reference to TPO for computation of arm s length price - conditions precedent to invoke the provisions of section 80IA(10) - definition of Specified Domestic Transaction (SDT) prescribed under section 92BA and section 80IA(10) - HELD THAT - A careful reading of definition of SDT prescribed in section 92BA makes it clear that there must be a transaction it is not an International Transaction within meaning of International Transaction defines in section 92B and it should be covered under one of the six transactions mentioned in the subsection and aggregate value of transactions in the previous year exceed a sum Rs. 20 Crore. By taking care of the above position we shall consider the facts of the present appeal. Before us it was the plea of ld. AR of the assessee that in absence of any arrangement the business transaction between eligible units and its AE do not get covered within the ambit of SDTs defined in section 92BA and eventual transfer pricing analysis and that transfer pricing analysis were made for abundant caution. It was also argued that AO has not proved existence of any arrangement before making reference to TPO for computation of arm s length price. And in absence of such arrangement the adjustment made by TPO would not survive. We find that the assessee has taken such a stand right from the beginning by filing their objection / reply in response to show cause notices issued by TPO in reply dated 12.10.2023 as well as on 07.11.2023 copies of such replies are available on record. We find that despite taking such objection the TPO disregarded such factual objection. The TPO straightway benchmarked the transaction by following Transactional Net Margin Method (TNMM). TPO excluded seven comparable of assessee and included four new comparable. Unit-II of the assessee was considered as tested party. On the basis of his analysis the TPO suggested downward adjustment of Rs. 11.62 Crore on transaction of sales to AE. The DRP in its directions directed AO/TPO to exclude on the comparable which was loss making entity. On exclusion of one such comparable the downward adjustment becomes Rs. 10.98 Crore. We find that in CIT Vs. Schmetz India Private Limited 2012 (9) TMI 407 - BOMBAY HIGH COURT held that where the AO has not been able to prove any arrangement between parties which resulted extraordinary profit denial of deduction under section 10A is not possible. Existence of arrangement between the deduction seeking unit and other AE is a pre-condition for invoking rigor of section 80IA(10). Higher profit per se cannot lead to the conclusion that there is arrangement between the parties. The concept of PLI cannot per se be applied to hold that assessee has earned higher profit. We find that the TPO has no occasion to make any comparative data analysis unless condition of pre-arrangement is satisfied. Thus the assessee succeeded on primary submission of ld. AR of the assessee. As in Mankind Pharma 2024 (5) TMI 162 - ITAT DELHI on relying the decision of Schmetz India Private Limited 2012 (9) TMI 407 - BOMBAY HIGH COURT also held that eexistence of an arrangement is a condition precedent to trigger provisions of section 80IA(10) and in its absence business transacted between eligible units and its AE do not get covered within ambit of Specified Domestic Transactions (SDTs) defined under section 92BA and eventual TP analysis. So far as submissions of ld Sr DR for the revenue that proviso to section 80IA(10) is applicable on the facts of the case in our view once the precondition of existence of an arrangement has not been fulfilled the effect of proviso will not come in to play. Considering the fact that assessee has succeeded on primary submission of ld. AR of assessee therefore adjudication on other grounds of appeal have become academic. In the result the concise ground of appeal of the assessee is allowed.

Summary

The core legal questions considered by the Tribunal in this appeal pertain to the invocation and application of provisions under the Income-tax Act, specifically section 80IA(10), section 10AA, and transfer pricing regulations under sections 92BA, 92CA, and 92F. The principal issues are:

1. Whether the Assessing Officer (AO) was justified in invoking section 80IA(10) and making a reference to the Transfer Pricing Officer (TPO) under section 92CA(1) without first establishing the existence of an arrangement between the assessee and its associated enterprises that results in more than ordinary profits.

2. Whether the adjustments made by the TPO and confirmed by the Dispute Resolution Panel (DRP) in computing the arm's length operating profit (OP) and consequent addition to income were legally sustainable.

3. Whether the AO erred in not following the directions of the DRP regarding computation of deduction under section 10AA, particularly in the manner of making additions to income instead of adjusting the deduction.

4. The correctness and appropriateness of the comparables selected by the TPO and DRP for benchmarking the arm's length price under the Transfer Pricing regime.

5. The viability and commercial reasonableness of the operating profit margin determined by the TPO and DRP, and whether the assessee's own historical margins should have been accepted as arm's length.

Issue-wise Detailed Analysis

1. Invocation of Section 80IA(10) and Reference to TPO Without Establishing Arrangement

Legal Framework and Precedents: Section 80IA(10) empowers the AO to deny deduction if it appears that, due to close connection or arrangement between the assessee and any other person, the business produces more than ordinary profits. The proviso mandates that if such arrangement involves a Specified Domestic Transaction (SDT) under section 92BA, profit must be determined at arm's length price as defined in section 92F(ii). Section 92BA defines SDT and requires aggregate transactions exceeding Rs. 20 crore.

Precedents cited include decisions by the Bombay High Court, Rajasthan High Court, Karnataka High Court, and various Tribunals which uniformly hold that existence of an arrangement is a condition precedent to invoking section 80IA(10). Mere showing of higher profit does not suffice; the AO must demonstrate that the business affairs were so arranged to produce more than ordinary profits.

Court's Interpretation and Reasoning: The Tribunal carefully examined the statutory language and judicial pronouncements. It noted that the AO failed to discharge the initial burden of proving the existence of any arrangement between the assessee and its associated enterprises that resulted in excess profits. The invocation of transfer pricing provisions and reference to the TPO was therefore premature and legally untenable.

Key Evidence and Findings: The assessee's submissions and data showed consistent operating profit margins (around 10%) during both the tax holiday period (when deduction under section 10AA was claimed) and subsequent years (when no deduction was claimed). This consistency negated the inference of any arrangement designed to inflate profits artificially.

Application of Law to Facts: The Tribunal applied the settled legal principle that without proof of arrangement, section 80IA(10) cannot be invoked. Since the AO did not establish such an arrangement, the reference to TPO and consequent transfer pricing adjustments were invalid.

Treatment of Competing Arguments: The Revenue's reliance on the proviso to section 80IA(10) and the applicability of transfer pricing provisions was rejected on the ground that the precondition of arrangement was not met. The Tribunal held that the proviso applies only after the AO establishes the arrangement.

Conclusion: The Tribunal allowed the primary contention of the assessee that the invocation of section 80IA(10) and transfer pricing proceedings without establishing an arrangement was improper, and the additions based on such proceedings could not be sustained.

2. Computation of Arm's Length Operating Profit and Selection of Comparables

Legal Framework and Precedents: Transfer pricing provisions require benchmarking of related party transactions against arm's length price determined by comparables. The TPO applied the Transactional Net Margin Method (TNMM) and various filters (turnover, export, related party transactions) to select comparables. The DRP concurred with the TPO's methodology but directed exclusion of one loss-making comparable.

Court's Interpretation and Reasoning: The Tribunal noted that the TPO and DRP rigorously applied statutory filters and case law to exclude inappropriate comparables and include suitable ones. The operating profit margins computed by the TPO (2.13%) and NeAC officer (2.56%) were significantly lower than the assessee's claimed margin (10.02%). The Tribunal observed that the TPO's selection was methodical and consistent with transfer pricing principles.

Key Evidence and Findings: The assessee argued that its own historical margins in subsequent years without deduction under section 10AA should be accepted as arm's length, and that the comparables rejected by the TPO had similar business features. The assessee also contended that the low margins found by TPO were commercially unviable given the high working capital and capital employed in the diamond studded jewellery business.

Application of Law to Facts: While the Tribunal acknowledged the assessee's submissions regarding internal comparables and business consistency, it held that transfer pricing analysis must be based on independent uncontrolled comparables, not internal or related party data. The TPO's application of filters and rejection of related party comparables was justified under the law.

Treatment of Competing Arguments: The Tribunal weighed the assessee's argument on commercial viability and internal consistency but emphasized that transfer pricing law mandates benchmarking against independent comparables, not internal margins. The DRP's direction to exclude a loss-making comparable further refined the comparables set.

Conclusion: The Tribunal did not find merit in the assessee's challenge to the comparables selected by the TPO and DRP, upholding the methodology and the resulting operating profit margin determination.

3. Computation of Deduction Under Section 10AA and Compliance with DRP Directions

Legal Framework and Precedents: Section 10AA provides deduction for profits of units in Special Economic Zones (SEZ). Section 80IA(10) requires adjustment of profits if more than ordinary profits are earned. The DRP directed the AO to recompute the deduction under section 10AA by adjusting the profit figures after transfer pricing adjustments rather than making a straight addition to income.

Court's Interpretation and Reasoning: The Tribunal found that the AO did not comply with the DRP's directions and made a direct addition of Rs. 10.98 crore to the income instead of reducing the deduction under section 10AA accordingly. The assessee's detailed computations showed that after adjusting for the transfer pricing variation, the deduction under section 10AA would reduce, resulting in a revised taxable income of Rs. 56.80 crore rather than Rs. 61.96 crore.

Key Evidence and Findings: The working of the assessee, as recorded in the DRP order, demonstrated the correct approach to recomputing the deduction and taxable income. The AO's failure to follow this approach was a procedural and substantive error.

Application of Law to Facts: The Tribunal emphasized that the AO is bound to follow DRP directions unless legally unsustainable. The AO's non-compliance warranted setting aside the assessment order on this ground.

Treatment of Competing Arguments: The Revenue did not contest the procedural lapse but supported the quantum of adjustment. The Tribunal held that procedural correctness is integral to fair adjudication.

Conclusion: The Tribunal held that the AO's assessment order was not passed in accordance with the DRP's directions and was liable to be set aside on this ground.

4. Commercial Viability of Operating Profit Margins

Legal Framework and Precedents: The assessee contended that the operating profit margin of 2.13%/2.56% determined by the TPO and NeAC officer was commercially unviable for a fully integrated export-oriented diamond studded jewellery unit, given the high working capital and capital employed.

Court's Interpretation and Reasoning: The Tribunal acknowledged the assessee's contention regarding commercial viability and the need to factor in interest costs and capital employed. However, it observed that transfer pricing provisions require benchmarking with independent comparables, and the low margins were the result of applying rigorous filters and adjustments.

Key Evidence and Findings: The assessee's internal profit margins in subsequent years without claiming section 10AA deduction were higher, but these could not substitute for independent comparables. The DRP also noted that net margins arrived at were low but consistent with the methodology.

Application of Law to Facts: The Tribunal held that commercial viability concerns, while relevant, do not override statutory transfer pricing methodology and the need for objective benchmarking.

Treatment of Competing Arguments: The Tribunal balanced the assessee's commercial arguments against the statutory framework and upheld the transfer pricing analysis.

Conclusion: The Tribunal did not accept the assessee's argument that the low operating profit margin was unviable or that internal margins should be preferred.

Significant Holdings

"Existence of an arrangement between the deduction seeking unit and other associated enterprises is a pre-condition for invoking the rigour of section 80IA(10). Higher profit per se cannot lead to the conclusion that there is an arrangement between the parties."

"The Assessing Officer must first establish the existence of such arrangement before making reference to the Transfer Pricing Officer under section 92CA(1). In absence of such demonstration, the reference and consequent transfer pricing adjustment are not sustainable."

"Transfer pricing analysis must be based on independent uncontrolled comparables selected through rigorous application of statutory filters; internal margins or related party transactions cannot be used as comparables."

"The Assessing Officer is bound to follow the directions of the Dispute Resolution Panel in recomputing deductions and taxable income; failure to do so renders the assessment order liable to be set aside."p>

"The proviso to section 80IA(10) applies only after the precondition of existence of an arrangement is satisfied; otherwise, it does not come into play."

Final determination on the principal issue was in favour of the assessee, allowing the appeal on the ground that the AO failed to establish the existence of arrangement required under section 80IA(10) before invoking transfer pricing provisions and making additions. Consequently, the other grounds became academic and were not adjudicated upon.