TMI Blog2015 (7) TMI 1208X X X X Extracts X X X X X X X X Extracts X X X X ..... the Act, relying on the ratio laid down by the Tribunal in M/s Honeywell Automation India Limited vs. DCIT (2015 (3) TMI 494 - ITAT PUNE). The onus was upon the Department to prove that an arrangement existed between the assessee and its AEs to earn more than ordinary profits and in the absence of the said onus having been discharged by the Department we find no merit in the order of the Commissioner passed under section 263 of the Act in this regard. Earning more than ordinary profits - Held that:- Assessee had consistently earned higher profit margins right from start of its business even before EOUs were set up and where similar trend has shown in the hands of the assessee which, in turn, had been accepted by the TPO, while determining the arm's length price of the international transactions between the assessee and its AEs, then there is no merit in invoking of jurisdiction by the Commissioner under section 263 of the Act. Further, it is to be noted that there was justification for earning higher profit margins due to substantial cost savings i.e. locational advantage, lower infrastructure cost, savings in tooling cost, no cost of investment and know-how/IPR being a res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing disposed of by this consolidated order for the sake of convenience. ITA No.1112/PN/2012 (By Assessee) : 3. The assessee has raised the following grounds of appeal :- 1. On the facts and circumstances of the case and in law the Learned CIT erred in passing order under Section 263 of the Income Tax Act, 1961. 2. The learned CIT erred in the facts and circumstances of the case and in law in directing the Assessing Officer to apply provisions of Section 10B(7) with 80 IA(10) of ]he Income Tax Act for the A.Y. 2006-07 with respect to profit margins reflected In the Transfer Pricing Study Report prepared by a consultant outside India for the Associated Enterprise (A. E ) of the appellant. 3. The learned CIT in directing as aforesaid failed to appreciate that there were no justifiable reasons to satisfy the invocation of provisions of Section 10 B (7) r.w.s. 80 IA (10) and the learned CITA erred in drawing incorrect inferences on presumptive basis and in not appreciating the fact that notional charging of royalty and warranty on export of components to the Associated Enterprise (A.E.) though the technical know-how was given by the A.E. itself, could lead to charging ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Corp., USA. The assessee had set up its unit to manufacture propeller shaft and components at Hubli, Hosur Satara and axles and components at Chakan, Pune. 6. The Commissioner on examination of the assessment records noted that the assessee had claimed deduction of profits from export of components under section 10B of the Act in respect of three Export Oriented Undertakings (EOU) units. The Commissioner further noted that the percentage of gross profit margin to cost of goods sold had been shown at 38% on exports while it was shown at 11% on domestic sales for propeller shafts. Similarly for axles, for export sale it was shown at 34% as compared to 5% on domestic sales. The Commissioner was of the view that the gross profit margin was shown at disproportionately higher profits in the case of sales to AEs as compared to the third parties. Further, the Commissioner noted substantial difference in net operating margin to the total cost being 16% and 9% in respect of propeller shafts and 32% and 1% in respect of axles on exports and domestic sales respectively. The company had shown 23% net profit to cost of goods sold at entity level as compared to 4% on domestic sales. Furth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case of sales to AEs as compared to third parties. Even on entity level the net profit to cost of goods on exports was much higher as compared to the domestic sales. Further, as per the Transfer Pricing Study Report, no comparable uncontrolled transactions could be identified hence the assessee company benchmarked its international transactions on cost plus method. The mark-up on cost of goods sold based on set of comparables was stated to be between 8.2% to 10.50% to Australia and USA and between 8.4% to 10.77% to UK, while the assessee had earned mark-up about 38% on export of propeller shafts components to its AEs. On the export sales of axle components, the mark-up on cost of goods sold was 4.2% to 6.3% to UK and 5.1% to 7.4% to USA. 7. The Commissioner thus was of the view that the selling price between the assessee company and its AEs was so structured to give rise to disproportionately very high profit to the assessee as this profit was tax free being from a 10B unit. Further, the facts that royalty was not payable on exports and warranty liability was borne by Dana in respect of exports clearly showed that the intention of the assessee company was to show higher profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ficer, which was the issue at stake. The Commissioner was of the view that where the assessee had applied cost plus method to comparables selected by the assessee, after the issuance of notice under section 263 of the Act, were not of any relevance as the said evidence was not before the Assessing Officer. As per the Commissioner, the proceedings under section 263 of the Act had been initiated on the basis of non-enquiry and non-application of mind by the Assessing Officer with regard to the provisions of section 10B(7) r.w.s. 80IA(10) of the Act, where prima facie, such enquiry and application was warranted. 9. Another point raised by the assessee before the Commissioner was that the Assessing Officer raised this point during the assessment proceedings against which the assessee had filed a reply was also commented upon by the Commissioner and it was stated that from the details of the query raised by the Assessing Officer it was evident that the application of mind was only on the huge difference between GP and NP margins of the EOU unit and DTA, but neither any query was raised nor any application of mind by Assessing Officer was on the main issue. In conclusion, the Commissi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing to assessment year 2006-07, wherein vide order dated 25.02.2015 the Tribunal had held that in the absence of any arrangement arrived at between the parties, which resulted in higher profits, there was no merit in re-working the profits by invoking the provisions of section 10A r.w.s. 80IA(10) of the Act. The Ld. Authorized Representative for the assessee pointed out that the deduction under section 10B of the Act which, in turn, has been curtailed by invoking the provisions of section 10B(7) of the Act were in pari-materia with section 10A(7) of the Act and the said provisions has been applied along with the provisions of section 80IA(10) of the Act. It was further pointed out by the Ld. Authorized Representative for the assessee that the deduction under section 10B of the Act was claimed on propeller shaft components and light axle components earned by EOU and there was no merit in the said curtailment of deduction under section 10B of the Act, where the TPO accepted the arm's length price of the international transactions with AE in the year under appeal. The Ld. Authorized Representative for the assessee pointed out that the assessee was engaged in limited scope of manuf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was the claim of deduction under section 10B of the Act. It was further pointed out by him that the margin of domestic sales was much lower and on the other hand the assessee decided to enhance margins on the export sales and this aspect was not considered by the Assessing Officer, hence invoking of section 263 of the Act was justified. 14. Our attention was drawn to the observations of the Commissioner in para 3 and para 10, the arrangement between the parties was because of close connection and because of the range suggested by the Transfer Pricing Study. The Ld. Authorized Representative for the assessee in rejoinder pointed out that the Transfer Pricing Study suggested mark-up for the assessment year 2007-08 and was not relevant for the year under consideration. 15. We have heard the rival contentions and perused the record. The issue arising in the present appeal filed by the assessee is against the invoking of jurisdiction by the Commissioner under section 263 of the Act in holding that the assessment order passed by the Assessing Officer was without any enquiry and also there was non-application of mind by the Assessing Officer on the issue of grant of deduction und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income of the assessee inconformity with the order of the TPO. The issue arising before us in such circumstances is that where the assessee had claimed deduction under section 10B of the Act on such exports to its AE, can the same be curtailed by invoking the provisions of section 10B(7) r.w.s. 80IA(10) of the Act on the premise that the assessee had earned higher profits than normal on exports made to its AEs. 17. In the facts before the Tribunal in M/s Honeywell Automation India Limited vs. DCIT (supra), the dispute arose vis- -vis the entitlement of the assessee for the claim of deduction under section 10A of the Act which was curtailed based on the provisions of section 10A(7) r.w.s. 80IA(10) of the Act. The TPO in the said case had restricted the profits eligible for the claim of deduction under section 10A of the Act, as the profits in relation to the 10A units were more than the ordinary profits. The Assessing Officer accordingly re-computed the amounts of profit which he considered as reasonable to have been derived in terms of section 10A(7) r.w.s. 80IA(10) of the Act. The assessee in its Transfer Pricing Study in the said case had benchmarked the international transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods [or services] as on that date : Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit. [Explanation.-For the purposes of this sub-section, market value , in relation to any goods or services, means the price that such goods or services would ordinarily fetch in the open market.] (9) xxxxxxxxxx (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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... At the outset, it is to be noted that the opening sentence in section 80- IA(10) of the Act contains the expression where it appears to the Assessing Officer that . This would show that the onus is on the Assessing Officer to justify invoking of section 10A(7) r.w.s. 80-IA(10) of the Act, having regard to the facts circumstances of a given case. Evidently, the primary rule of evidence is that what is apparent is real unless proved otherwise by the person alleging it so. Ostensibly, if the Assessing Officer is to invoke the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act then the onus is on him to justify such invocation having regard to the cogent material and evidence on record. On this aspect of the matter, there was no dispute between the rival counsels inasmuch as the Ld. CIT-DR quite fairly agreed that the onus was on the Assessing Officer to justify invoking of section 10A(7) r.w.s. 80-IA(10) of the Act in the facts of a given case. Nevertheless, on this aspect, we may also make a reference to the judgement of the Hon ble Karnataka High Court in the case of CIT vs. H.P. Global Soft Ltd., 342 ITR 263, which was referred to in the course of hearing before us. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uring the course of the assessment proceedings, Assessing Officer was of the view that abnormal profits had been declared in respect of the Kandla division, only in view of the income therefrom being exempt u/s 10A of the Act, and that the trading division at Mumbai showed a loss of ₹ 70.29 lacs. The Assessing Officer invoked the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act to hold that profits of Kandla Division were abnormal profits. The Tribunal disagreed with the Assessing Officer. The Tribunal, inter-alia, held that the Assessing Officer has not been able to prove that any arrangement had been arrived between the parties which resulted in extraordinary profits to the respondent-assessee s manufacturing division at Kandla. Consequently, the working of the profits by the Assessing Officer was not approved. The aforesaid action of the Tribunal was upheld by the Hon ble Bombay High Court. On this aspect, the Bangalore Bench of the Tribunal in the case of Digital Equipment India Ltd. vs. DCIT, 103 TTJ 329 (Bang.) has also held that the conditions of the section have to be objectively satisfied by the Assessing Officer, based on cogent reasoning and evidence. 12 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on and advertisement because majority of the business in the engineering services segment was with affiliates only. Secondly, it was pointed out that assessee is in the business of IT enabled services rendering engineering consultancy services in execution of industrial automation and building automation and control projects and it does not incur much product development costs or investments which are usually incurred by other software companies. Thirdly, it was pointed out that the salary levels in the case of the assessee are much lower than other software companies because assessee was hiring electronics and process engineering Graduates/Diploma holders and not software professionals. It is also pointed out that assessee has a lower rate of idle staff as it works mostly on in-house Honeywell Technology and therefore the productivity of the employees is much higher than other software companies. Further, it was also pointed out that assessee was reimbursed all the costs, like foreign travel and living expenses incurred abroad by its employees in the course of rendering engineering/software services. Assessee was also reimbursed incidental expenses incurred by it viz. visa cost ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Representative pointed out that having regard to the intention of the Transfer Pricing Provisions, the margins determined under the TNM Method are to be taken as indicative of the least profits that must be retained in India and it cannot be used to benchmark the ordinary profits as referred to in section 10A(7) r.w.s. 80-IA(10) of the Act. The sum and substance of the plea setup by the assessee is that the legislative intent behind the Transfer Pricing Provisions is different from the intent behind section 10A(7) r.w.s. 80-IA(10) of the Act. 17. The Ld. CIT-DR has made detailed submissions in support of the invoking of section 10A(7) r.w.s. 80-IA(10) of the Act in the present case. The Ld. CIT-DR submitted that section 80-IA(10) of the Act placed much lighter burden of proof on the Assessing Officer because of the presence of the expression it appears in section 80-IA(10) of the Act. According to the Ld. CIT-DR, section 80-IA(10) can be invoked by the Assessing Officer when it appears to him, and it is not subject to the Assessing Officer s belief or satisfaction as is the case with invoking of section 147/148, etc.. The following portion of section 80-IA(10) of the Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 80-IA(10) of the Act are satisfied if there exists an arrangement which leads to production of more than ordinary profits. Therefore, according to him, in the present case, the Assessing Officer is justified to invoke section 10A(7) r.w.s. 80-IA(10) of the Act inasmuch as the profit margin of the assessee s STPI Units is 80.06% as against 17.06% of the comparable selected by the assessee itself in its Transfer Pricing Study. As per the Ld. CIT-DR, when the arrangement has led to resulting into more than ordinary profits, necessary condition for invoking section 80-IA(10) of the Act is satisfied. 20. Apart from the aforesaid submissions, the Ld. CIT-DR has made other pleas also to justify the restriction of deduction u/s 10A of the Act. In this context, he has pointed out that even the Safe Harbor Rules issued by the CBDT with respect to the Transfer Pricing assessment provide for 20% operating profit as an acceptable profit in IT enabled services segment and therefore that was a good benchmark as to what constitutes ordinary profits in the assessee s impugned line of business. The Ld. CIT-DR also made a submission that even if the computation of excess profits done by the Ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apply in relation to the industrial undertaking referred to in the new section 10A as they apply in relation to an industrial undertaking referred to under section 80-I. Under the applied sub-section (8) of section 80-I, it is provided that where an Assessee has several units, some in the free trade zone and some outside, the profits of the unit in the free trade zone will be computed after taking the cost of the goods transferred to or from the unit on the basis of the market value of such goods. The applied sub-section (9) of section 80-I empowers the Income-tax Officer to determine the reasonable profits that could be attributed to the qualifying undertaking in the free trade zone in cases where, owing to the close connection between the Assessee and any other persons or for any other reason, the course of the business is so arranged that the industrial undertaking set up in the free trade zone derives more than ordinary profits which may be expected to arise in that business. This provision has been made with a view to avoiding abuse of the new tax concessions by manipulation of profits between associate concerns or different units of the same concern. [underlined for emphasis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee more than the ordinary profits which might be expected to arise in such eligible business with the intention of abusing the tax concession granted in section 10A of the Act. The mere existence of (i) a close connection between the assessee and the other person; and, (ii) more than ordinary profits is not sufficient to justify invoking of section 80-IA(10) of the Act in the absence of there being any material to say that the course of business between them is so arranged to abuse the tax concessions granted u/s 10A of the Act by manipulating profits between associated persons. Ostensibly, the same is required to be demonstrated on the basis of a cogent material and evidence. In other words, the presence of the expression so arranged has to be understood in the context of the abuse of tax concession which is sought to be plugged by the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act. 24. On this aspect, the Ld. CIT-DR had vehemently argued, based on the judgement of the Hon ble Bombay High Court in the case of Bank of India Ltd. (supra) that the meaning of the word arranged in section 80-IA(10) of the Act has to be understood to mean an agreement or an understa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business transacted which produces to the assessee more than ordinary profits which might be expected to arise in such a business with the intent of abusing the tax concessions. Therefore, the meaning of the words so arranged have to be understood in the context in which they are placed in section 80-IA(10) of the Act. A mere agreement between the assessee and the associated enterprises for transacting business is not enough to invoke section 80- IA(10) of the Act. 26. In-fact, even the Hon ble Bombay High Court in the case of Bank of India Ltd. (supra) has also appreciated the contextual meaning of the expression arrangement . The issue before the Hon ble Bombay High Court was with regard to the scheme of re-construction or arrangement contained in section 391(1) of the Companies Act, 1956. In the context of section 391(1) of the Companies Act, 1956, the Hon ble High Court was dealing with the meaning of the word arrangement . After having explained the meaning of the term arrangement in plain language, which we have referred earlier, the Hon ble High Court went on to say as under in the context of the word arrangement qua section 391(1) of the Companies Act, 1956 :- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act in the context of the words the course of business between them is so arranged . 28. At this stage, we may also address the argument of the Ld. CIT-DR that the burden cast on the Assessing Officer in section 10A(7) r.w.s. 80- IA(10) of the Act is much lighter and even a prima-facie satisfaction of an existence of tax avoidance is sufficient. In this context, we may refer to the decision of the Bangalore Bench of the Tribunal in the case of Digital Equipment India Ltd. (supra), wherein similar argument from the side of the Revenue has been addressed. The Bangalore Bench of the Tribunal was dealing with invoking of section 10A(6) r.w.s. 80-I(9) of the Act for assessment year 1995-96, which are pari-materia to section 10A(7) r.w.s. 80-IA(10) of the Act invoked by the Revenue before us. The following discussion is relevant :- The requirements under the section are : (a) There must be a close connection between the appellant and other person. (b) The course of business between them should be so arranged that it produces to the appellant more than the ordinary profits from such business. To satisfy the above test the AO has to adduce evidence and reasons cogently and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that an arrangement existed. The findings of the Tribunal are as under :- 30. Now, the case of the Assessing Officer is that the profits derived by the assessee from the eligible business are more than the ordinary profits and therefore he is empowered to arrive at what could be a reasonable profit from such eligible business and such profit be taken as reasonably deemed to have been derived from the eligible business for the purposes of computing the deduction u/s 10A of the Act. We find that in the entire assessment order, there is no material or any evidence which has been brought out to say that the course of business between assessee and the associated enterprises has been so arranged that the business transacted has produced to the assessee more than the ordinary profits. 31. No doubt, there is a close connection between assessee and the associated enterprises and to that extent section 10A(7) r.w.s. 80-IA(10) of the Act has been rightly examined by the income-tax authorities. The second aspect that the course of business was so arranged so as to result in more than ordinary profits is not at all forthcoming from the order of the Assessing Officer. There is no materia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions 92A, 92B, 92C, 92CB, 92D, 92E and section 92F are all precisely defining and facilitating provisions ultimately for the purpose of computing the income as stated in section 92. All the above stated sections provided in Chapter X of the Income-tax Act, 1961 belong to a separate code as such, enacted for the purpose of computing income from international transactions having regard to the arm's length price so as to confirm that there is no avoidance of tax by an assessee. Therefore, where in a case, the Transfer Pricing Officer suggests that the operating profit declared by an assessee is compatible to the arm's length price norms and no adjustment is necessary, the operation of all those provisions come to an end. If the, Assessing Officer has to make any other adjustment towards computing deduction available under section 10A, the computation has to be made in the context of section 10A(7) read with section 80-IA(10). It is clear that in a case of transfer pricing assessment, it has got two segments. The first segment consists of rules and procedures for computing the income other than the income arising out of international transactions with associate enterprise. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s only a derivative of prices. When profits itself is not worked out, how is it justified to adopt the arm's length price profits to determine what is ordinary profits for the purpose of section 10A(7)? In the facts and circumstances of the case, we hold that the Assessing Officer has erred in reducing ₹ 4,48,50,795 from the eligible profits of the assessee under section 10A. The said adjustment made by the assessing authority in computing the deduction under section 10A is accordingly, deleted. 32. In our considered opinion, the result of the Transfer Pricing assessment can at best be taken as an indicator for the Assessing Officer to investigate as to whether or not there exists any arrangement which has resulted in more than ordinary profits qua the requirements of section 10A(7) r.w.s. 80-IA(10) of the Act. Even if it is accepted that the difference between the operating margins of the assessee and the comparables show existence of more than the ordinary profits in the hands of the assessee, so however, it was still imperative for the Assessing Officer to establish on the basis of substantive evidence and corroborative material that qua section 10A r.w.s. 80- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 38% and 34% as against the average profit mark-up range of 8.4% to 10.77% in case of propeller shaft components and 4.2% to 7.5% in case of axle components of external overseas comparables, which was accepted by the TPO in his report under section 92CA(4) of the Act. In the above said circumstances, where the profit margins declared by the assessee have been accepted to be at arm's length by the TPO, no curtailment of deduction under section 10B can be made by invoking the provisions of section 10B(7) r.w.s. 80IA(8) and 80IA(10) of the Act, relying on the ratio laid down by the Tribunal in M/s Honeywell Automation India Limited vs. DCIT (supra). The onus was upon the Department to prove that an arrangement existed between the assessee and its AEs to earn more than ordinary profits and in the absence of the said onus having been discharged by the Department and following the same parity of reasoning as laid down by the Tribunal in M/s Honeywell Automation India Limited vs. DCIT (supra) and also following the similar proposition laid down by the Delhi Bench of the Tribunal in M/s A.T. Kearney India Pvt. Ltd. (supra), we find no merit in the order of the Commissioner passed un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alty, we find no merit in the observation of the Commissioner in this regard. Further, where the assessee was only exporting components of propeller shaft and axles and the finished products were assembled by the AE, there is no scope for providing warranty on export of such components. The finding of the Commissioner in this regard that the assessee had shown higher profits to claim deduction under 10B units is thus misplaced. In view thereof, we find no merit in the order of the Commissioner passed under section 263 of the Act and reversing the same we hold that the assessee is entitled to claim of deduction under section 10B of the Act in entirety. The grounds of appeal raised by the assessee are allowed. 21. In the result, the appeal of the assessee in ITA No.1112/PN/2012 relating to assessment year 2006-07 is allowed. ITA No.1113/PN/2012 (By Assessee) : 22. The assessee in its appeal has raised the following grounds of appeal :- 1. The learned CIT-A erred in the facts and circumstances of the case and in law in confirming the disallowance of ₹ 12,05,00,000/- and thereby reducing the deduction claimed by the appellant under Section 10 B of the Income Tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 25. In the result, the appeal of the assessee in ITA No.1113/PN/2012 relating to assessment year 2007-08 is allowed. ITA No.1280/PN/2012 (By Revenue) : 26. The Revenue in its appeal has raised the following grounds of appeal :- 1. The Ld. CIT(A) grossly erred in allowing the assessee to produce additional evidence in the shape of an incomplete chart, without, producing the complete transfer pricing study report, and then computing the profitability on the basis of that erroneous chart prepared by the assessee, 2. The Learned CIT(A) erred in holding that the TP report for the year 2006 was given by the assessee to the AO, when, the AO had specifically noted in the assessment order (Page 19) that TP study report for the year 2007 only was produced and therefore, the AO made the computation of deduction u/s 10B on that basis only. 3. The learned CIT(A) grossly erred in law and fact, in any case, in computing the allowability of deduction on the basis of margins as per Global TP Consultants report at 15.60%, 20%, 20% and 20% when such global Transfer Pricing report for the year 2006 was never produced before the AO, which the AO has again reiterated in the remand re ..... X X X X Extracts X X X X X X X X Extracts X X X X
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