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TMI Blog2019 (9) TMI 727X X X X Extracts X X X X X X X X Extracts X X X X ..... Corporate Tax Grounds: Disallowance under section 10AA of the Act: 2. That on the facts and circumstances of the case and in law, the AO, erred in reducing the deduction under section 10AA of the Act by INR 2,64,12,11,474 by invoking the provisions of section 10AA(9) read with section 80IA(10) of the Act, alleging that the Appellant earned more than 'ordinary profits' to its associated enterprise ('AE') and the DRP erred in affirming said addition. 3. That on the facts and circumstances of the case and in law, the AO / DRP failed to appreciate that once the arm's length price in respect of the international transactions has been determined by the TPO under section 92CA(3) of the Act, and the prices charged by the Appellant have been found to be at arm's length nor an adjustment has been made to the ALP of the international transactions the provisions of section 10AA(9) read with section 80IA(10) of the Act could not be invoked on the premise that Appellant earned 'more than ordinary profits' by way of such international transactions. 4. That on the facts and circumstances of the case and in law, the AO/ DRP ought to have held that the prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t that the comparable chosen were functionally not comparable. 10. Without prejudice to the above, that on facts and circumstances of the case and in law the AO erred in retaining Acropetal Technologies Ltd as a valid comparable despite specific directions by the DRP for its exclusion from the original set of comparable companies proposed in the draft assessment order. 11. Without prejudice to the above, that on facts and circumstances of the case and in law the AO / DRP erred in making an addition of INR 1,98,96,325 to the income of the Appellant as excess exemption claimed under section 10AA of the Act, alleging computational error disregarding the fact that there has already been disallowance of alleged extra ordinary profits, thus leading to double adjustment. Disallowance under section 40(a)(i) of the Act 12. That on facts and circumstances of the case and in law, the AO erred in considering the payments of INR 7,67,38,079 to non-residents for purchase of software as 'royalty' thereby, disallowing the payments made invoking provisions of section 40(a)(i) of the Act, for failure to deduct tax at source. 13. Without prejudice to the above and on facts and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the directions of the DRP to provide working capital adjustment and to adopt correct margins of comparable companies as provided by the Appellant before the DRP. 21. That on the facts and circumstances of the case and in law, the AO / DRP / TPO erred in not providing appropriate economic adjustments, as required under Rule 10B(1)(e)(iii) of the Rules. 22. That on facts and circumstances of the case and in law, the AO / DRP / TPO have erred in ignoring the provisions of Rule 10B(4) of the Rules and judicial pronouncements, which advocate usage of multiple year data of comparable companies for the purpose of determination of the ALP. 23. That on the facts and circumstances of the case and in law, the AO / TPO erred in not providing the Appellant the benefit of range as per the proviso to section 92C(2) of the Act. Levy of interest 24. That on facts and circumstances of the case and in law, the AO erred in proposing to levy interest under sections 234B and 234C of the Act. Each of the above grounds is independent and without prejudice to the other grounds of appeal preferred by the Appellant. 3. The learned Authorized Representative for the assessee pointed out th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssment order, against which the assessee is in appeal before us. 6. The learned Authorized Representative for the assessee in this regard pointed out that the Assessing Officer has compared the OP/OC i.e. margins of assessee at 150.55% with the margins of comparable companies at 27.72%, to come to a conclusion that the assessee has earned super normal profits. However, the concept of OP/OC was relevant only for transfer pricing analysis and not for working out the super normal profits. The learned Authorized Representative for the assessee further pointed out that in fact the net profit of assessee was only 63% and similar net profit was shown in both preceding and succeeding years. The second plea raised by learned Authorized Representative for the assessee was that there was no arrangement to generate more than ordinary profits of eligible units and in the absence of the same, provisions of section 10AA(9) r.w.s. 80IA(1) of the Act were not attracted. He further stated that the issue stands covered by series of decisions of various Benches of Tribunal. In this regard, he placed reliance on the decision of Pune Bench of Tribunal in the case of Eaton Industries Pvt. Ltd. Vs. ACIT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act. The basic condition for application of the said provisions of the Act are an arrangement between the parties, which is so arranged as to enable the assessee to earn super normal profits. The TPO/Assessing Officer/DRP has not pointed out any such arrangement whatsoever between the assessee and the comparable companies selected. In the absence of the same, provisions of section 10AA(9) r.w.s. 80IA(10) of the Act are not attracted. This issue has been elaborated upon by us in various decisions, as also in the case of sister concern i.e. Eaton Industries Pvt. Ltd. The said issue has been decided in turn, relying on the ratio laid down by Tribunal in Honeywell Automation India Ltd. Vs. DCIT in ITA No.18/PN/2011, order dated 25.02.2015. The said decision was in an appeal filed by assessee against exercise of jurisdiction under section 263 of the Act. The relevant findings are in paras 17 to 24, which read as under:- "17. We have heard the rival contentions and perused the record. The issue which arises in the present appeal is against the jurisdiction exercised by the Commissioner under section 263 of the Act wherein he has observed that the assessment order passed by the Assessi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ition to the Arm's Length price of the said international transaction. However, in respect of the Engineering Design Services, no addition was made under the transfer pricing provisions. Further, the assessee had claimed deduction under section 10A of the Act in respect of the Engineering Design and Development Services provided to its Associated Enterprises which was allowed by the Assessing Officer. The Commissioner was of the view was that because of the high operating profit margin on total cost at 270%, when compared to the operating margin on total cost of the other division of the assessee at 7.39%, the Assessing Officer had not applied his mind in allowing the deduction under section 10A of the Act in view of the provisions of section 10A(7) r.w.s. 80IA(8) and 80IA(10) of the Act. The transactions which have been undertaken by the assessee in the Engineering Design Services with its Associated Enterprises was accepted to be at Arm's Length price by the TPO and no adjustment was made. The TPO has also not given any finding that the profit markup on cost, reported by the assessee, in its transaction with its Associated Enterprises was in excess of the profit markup of externa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ind that similar issue for grant of deduction u/s 10A of the Act by invoking provisions of section 10A(7) r.w.s. 80-IA(10) of the Act, arose before the Tribunal in M/s. Honeywell Automation India Ltd. Vs. DCIT (supra). The Tribunal had considered the provisions of section 10A(7) of the Act and it was observed that the said provisions are attracted where closely connected party are taxable in India. In this regard, the relevant portions of the order of the Tribunal dated 25.02.2015 (supra) read as under :- "7. Before proceeding further, we may briefly touch-upon the relevant provisions of the Act, which have a bearing on the controversy before us. Sub-section (7) of section 10A of the Act reads as under :- " (7) The provisions of sub-section (8) and sub-section (10) of section 80-IA 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 80-IA. 8. Further, sub-sections (8) and (10) of section 80-IA of the Act referred to in section 10A(7) read as under :- "(8) Where any goods [or services] held for the purposes of the eligible business are transferred to any other bus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esent it would suffice to note that the three units of the assessee, namely, Unit No.I & II at Pune and Unit at Chennai are recognized as STPI Units in accordance with the Software Technology Park Scheme of the Government of India and they are eligible for the benefits of section 10A of the Act. 10. The bone of contention in the present case between the assessee and the Revenue is invoking of section 10A(7) r.w.s. 80-IA(10) of the Act. Section 80-IA(10) of the Act, reproduced above, empowers the Assessing Officer to re-compute the profits and gains of the eligible business for the purposes of deduction u/s 10A of the Act if it appears to him that the profits declared by the assessee are more than the ordinary profits which might be expected to arise in such an eligible business. So however, the aforesaid power of the Assessing Officer is subject to the pre-requisites contained in sub-section (10) of section 80-IA of the Act itself. The circumstances in which such a course is available to the Assessing Officer is contained in section 80-IA(10) itself. A perusal of section 10A(7) r.w.s. 80-IA(10) of the Act would show that the two essential conditions are to be established before ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... between the assessee and the other person, which may be a reason for the assessee to earn higher profits but, more importantly there should be material to indicate that assessee had indulged in an arrangement with the other person so as to produce to the assessee more profits than ordinarily what profits the assessee might have expected to arise from such business. As per the Hon'ble Karnataka High Court, it was for the Assessing Officer to indicate any material or evidence to disclose any such arrangement between the assessee and the other person. The aforesaid judgement of the Hon'ble Karnataka High Court justifies the assertion of the assessee before us that the onus for justifying the invoking of section 80-IA(10) r.w.s. 10A(7) of the Act is on the Revenue based on cogent material. At this point, we may also make a reference to the judgement of the Hon'ble Bombay High Court in the case of CIT vs. M/s Schmetz India Pvt. Ltd. vide Income Tax Appeal No.4508 of 2010 dated 04.09.2012, which is also to the similar effect. In the case before the Hon'ble Bombay High Court assessee was a wholly owned subsidiary of a German Company. It had two divisions - one at Kandla in the Kandla Free ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee was charging the same rate for services rendered to associated enterprises as well as to the non-related parties. The details of rates charged by the assessee to the third parties vis-à-vis the related parties have also been placed in the Paper Book along with sample copies of invoices raised on the and non-related parties. It was also pointed out with reference to the submissions made to the Assessing Officer, which have been reproduced in para 2.6 of the assessment order, that the assessee has continued to charge similar rates even after the tax holiday period of STPI Unit had ended. 13. At the time of hearing, it was explained that the tax holiday u/s 10A of the Act was available for Unit No.I at Pune upto assessment year 2007-08; that for Unit No.II at Pune upto assessment year 2011-12; and, that for Chennai Unit upto assessment year 2009-10. A statement showing operating margins to total cost earned by the assessee from the STPI Units relatable to the software engineering services segment was furnished to show that even after the expiry of the tax holiday period the profits of the Units is higher than the other Units of the assessee. 14. In this context, a refer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly TATA group was also owning shares in the assessee company to the extent of 40% and Honeywell entities held 41% and the balance 19% was held by the public. This pattern had changed from November, 2004 onwards when the TATA group gave up its shareholding in the assessee company. On the basis of the aforesaid shareholding pattern, a plea setup by the assessee is that if there was any manipulation of profits by assessee charging higher rates to its overseas Honeywell group entities resulting in shifting of profits from overseas entities to the assessee-company, it would not be a prudent exercise by the Honeywell group because it does benefit the Honeywell group as a whole. Since there is a significant public shareholding in the assessee company, it would mean that the any extraordinary benefit passed on by overseas Honeywell group entities to assessee would result in a loss for Honeywell group on an overall basis to the extent of public shareholding in the assessee company. It was, therefore, contended that in such a scenario, it could not be said that there was any arrangement between the assessee and the overseas Honeywell entities to produce higher profits to the assessee. In su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ld. CIT-DR, similar to the Transfer Pricing Provisions, the said Provision does not require a precise accuracy on the part of the Assessing Officer. At this point, the Ld. CIT-DR relied upon the decision of the Hon'ble Kerala High Court in the case of Abdul Vahab P. vs. ACIT, (2012) 249 CTR 102 (Kerala) wherein the word "appears" has been understood to imply a 'prima-facie' satisfaction of the Assessing Officer. Therefore, it is sought to be made out that a prima-facie satisfaction of the Assessing Officer is enough to apply the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act. 18. It is further submitted that the word "arrangement" used in section 80-IA(10) of the Act is to be understood as any agreement with the associated enterprise and in support of the same reliance has been placed on the decision of the Hon'ble Bombay High Court in the case of Bank of India Ltd. vs. Ahmedabad Manufacturing & Calico, (1972) 42 CompCas 211 (BomXDPB-p-42), wherein it has been held as under :- "The word "arrange" has, as one of its meaning, in the Shorter Oxford Dictionary, edition, "to come to an agreement or understanding", and the word "arrangement" has, as its primary meaning, "t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anies are carrying on eligible business, and thus the profits margin of comparable reflect ordinary profits. 21. With regard to the assessee's plea that even after the expiry of section 10A benefits, assessee was declaring healthy profits, the Ld. CIT-DR pointed out that what matters in future years is the actual amount of the taxes paid and not merely the profits generated in the Unit. It was also contended that the fact that assessee has rendered services to the non-related parties at the same rates is also not relevant for the purposes of application of section 10A(7) r.w.s. 80-IA(10) of the Act. It was also submitted by him that fact of the assessee being reimbursed the travelling costs, etc. cannot be responsible for assessee's high profit which are not of an ordinary level. The Ld. CIT-DR pointed out that if certain part of the expenditure is being incurred by the other parties then the cost of such expenditure would certainly be reduced from the price charged by the assessee for the services rendered. In any case, it is pointed out that reimbursement of expenses is a profit neutral transaction and does not impact the profitability of the assessee. 22. Before we proceed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssing Officer merely because they are more than the ordinary profits or that they are quite high. The existence of substantial or more than ordinary profits by itself does not sufficiently empower the Assessing Officer to disregard them and determine the profits which he may consider to be reasonably deemed to have been derived therefrom. The presence of the expression "the course of business ............ is so arranged ............. that the business transacted ............... produces to the assessee more than ordinary profits" is significant and its understanding has to be prefaced by the legislative objective of plugging abuse of the tax concessions granted u/s 10A of the Act by manipulation of profits between associated parties. In other words, the import of the expression "so arranged" has to be read in conjunction with the legislative intent that there should not be any abuse of tax concession by manipulation of profits. Therefore, section 10A(7) r.w.s. 80-IA(10) of the Act can be invoked only where it is shown that the course of business is so arranged which reflects an abuse of tax concession whereby the business transacted between two entities is so arranged, which produc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... basis of the language of section 80-IA(10) of the Act that, the Assessing Officer is not required to be prove that there is an arrangement for producing more than ordinary profits. Whereas, as per the Ld. CIT-DR, section provides that arrangement leading to production of more than ordinary profit will satisfy the necessary condition of section 80-IA(10) of the Act. Thus, according to the Ld. CIT-DR, in the instant case there is an arrangement and it has lead to production of more than the ordinary profits. According to the Ld. CIT-DR, the meaning of the words "so arranged" in section 80-IA(10) of the Act only seeks to ensure that there was an agreement between the assessee and associated enterprise. 25. We have carefully examined the aforesaid contentions of the Ld. CIT-DR. In our considered opinion, the import of the expression "arranged" in section 80-IA(10) of the Act is not to be understood in its plain language but the same has to be understood in the context in which it is placed in the section. Notably, section 80-IA(10) of the Act restricts the plain meaning of the term "arranged" because it is placed between the words "........the course of business between them is so a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6 to mean that it must be an agreement or understanding which affects the rights between the company and its creditors or any class of them and between the company and its members or any class of them. By the same analogy in the present context, we have to understand the meaning of the expression "as arranged" in section 10A(7) r.w.s. 80-IA(10) of the Act to mean a situation whereby the course of business has been so arranged that the business transacted produces to the assessee more that the ordinary profits with an intent to abuse the tax concessions granted in section 10A of the Act. Moreover, if one is to understand the import of the expression "so arranged" in section 80-IA(10) of the Act as canvassed by the Ld. CIT-DR, it would mean that for the purposes of fulfillment of the conditions prescribed in section 10A(7) r.w.s. 80-IA(10) of the Act, existence of mere close connection and more than the ordinary profits would suffice. In other words, as per the Revenue, the existence of close connection and high profits would lead to a presumption that there is an "arrangement" within the meaning of section 80-IA(10) of the Act. The aforesaid plea, in our view, not only belies the la ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere could be any arrangement. It is a case of joint venture listed Indian company, where all arrangements are open for scrutiny and acceptance not only by digital group worldwide but also from joint venture partners and shareholders. Digital group overseas will not pay undue sum, which it cannot recoup entirely to exclusion of others. Hence nothing can be arranged to the exclusive benefit of overseas partner. One cannot presume the existence of close connection or possibility of an arrangement for earning more than ordinary profits. In this case the profits earned is comparable with the profits earned by other companies in the same industry. Hence there is no case for further verification. The AO has compared the profit of software unit with that of hardware unit. Thus the foundation itself is on wrong premise. There cannot be comparison between an orange and an apple. It is known fact that profitability of software units is always higher than hardware unit. The test whether the appellant has earned more than ordinary profits, in this case, the answer is obvious NO, even as found by the AO. When the profits earned are reasonable and not excessive, there is no reason to sustain the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the course of business has been so arranged to result in more than ordinary profits. However, from the side of the Revenue, it was pointed out that the Transfer Pricing comparability analysis itself suggests that the profit margins of the assessee are more than the ordinarily accepted margin in this line of business. The moot question is as to whether the same can be considered as a material to indicate that the course of business between the assessee and the associated enterprises has been so arranged, so as to result in 'more than the ordinary profits' within the meaning of section 10A(7) r.w.s. 80-IA(10) of the Act. In this context, we may refer to the decision of the Chennai Bench of the Tribunal in the case of Visual Graphics Computing Services India (P) Ltd. vs. ACIT, 148 TTJ 621 (Chennai), wherein following discussion is relevant :- "We heard both sides in detail and considered the issue. As far as the present case is concerned, the Transfer Pricing Officer has made a categorical finding that the operating profit reported by the assessee is higher than the profit worked out on the basis of arm's length price. The Transfer Pricing Officer, therefore, concluded that no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndent of the order of the Transfer Pricing Office under section 92CA. To state in simple terms, the transfer pricing regime is different from regular computation of income. Section 10A belongs to that part of regular computation of income and it should be computed independent of transfer pricing regulations and transfer pricing orders. It is not therefore, permissible for the Assessing Officer to work out section 10A deduction on the basis of arm's length price profit generated out of the order of the Transfer Pricing Officer. In fact these issues have already been considered in various orders of the Tribunal. The Income-tax Appellate Tribunal, Chennai "A" Bench in the case of Tweezerman (India) P. Ltd. v. Addl. CIT [2010] 4 ITR (Trib) 130 (Chennai) (133 TTJ 308) has considered the matter in detail and held that the reduction of eligible profits of an assessee as done by the Assessing Officer by invoking the provisions of section 80-IA(10) read with section 10B(7), in the context of the Transfer Pricing Officer's order is unsustainable. The Tribunal has held that the Assessing Officer was not justified to invoke the provisions of section 80-IA(10) read with section 10 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be the reasonable profit from the such eligible business and such profit has to be then taken as reasonably deemed to have been derived from the eligible business for the purposes of computing deduction under the section." 33. The aforesaid discussion in the assessment order reveals that as per the Assessing Officer, the existence of close connection and more than ordinary profits is enough to assume an arrangement as contemplated u/s 80-IA(10) of the Act. The aforesaid understanding, in our view, is directly contrary to the judgement of the Hon'ble Karnataka High Court in the case of H.P. Global Soft Ltd. (supra) and our discussion in the earlier part of this order. 34. In view of the aforesaid, we conclude by holding that in the present case, the Assessing Officer has not proved that any arrangement had been arrived between the parties which resulted in higher profits. Consequently, the re-working of the profits by Assessing Officer by invoking section 10A r.w.s. 80-IA(10) of the Act is not justified. The action of the Assessing Officer to restrict the deduction u/s 10A of the Act to Rs. 7,74,60,281/- as against the claim of Rs. 36,35,09,382/- is hereby set-aside. Thus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on'ble Supreme Court in the case of Malabar Industrial Company Ltd. Vs. CIT 243 ITR 83 (SC) and CIT Vs. Max India Ltd. 295 ITR 282 (SC). In order to invoke the provisions of section 263 of the Act, the order must be both erroneous and prejudicial to the interest of revenue. Where the Commissioner does not agree with the view of the Assessing Officer the same cannot be basis/justification for invoking the provisions of section 263 of the Act. Further, the opinion of the Commissioner was not formed on any other material but on the basis of the order passed by the TPO under section 92CA of the Act, without making any adjustments. Accordingly, there is no merit in the exercise of jurisdiction under section 263 of the Act and we hold so. In this regard, we find support from the ratio laid down by the Pune Bench of the Tribunal in M/s. Semco Electric Pvt. Ltd. Vs. ACIT (supra)." 10. Further, the Hon'ble Bombay High Court in CIT Vs. Schmetz India (P) Ltd. in Income Tax Appeal No.1382 of 2013, judgment dated 24.06.2015 has laid down similar proposition and the appeal filed by Revenue has been dismissed. 11. In view thereof, we hold that there is no merit in invoking provisions of sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee being copyrighted article is not covered by the term 'royalty' under section 9(1)(vi) of the Act. Where the assessee did not acquire any copyright in the software, is not covered under Explanation 2 to section 9(1)(vi) of the Act. We further hold that amended definition of 'royalty' under the domestic law cannot be extended to the definition of 'royalty' under DTAA, where the term 'royalty' originally defined has not been amended. As per definition of 'royalty' under DTAA, it is payment received in consideration for use or right to use any copyright of literary, artistic or scientific work, etc.; thus, purchase of copyrighted article does not fall in realm of 'royalty'. We also hold that since the provisions of DTAA overrides the provisions of Income Tax Act and are more beneficial and the definition of 'royalty' having not undergone any amendment in DTAA, the assessee was not liable to deduct tax for payments made for purchase of software. In such scenario, the assessee cannot be held to be in default and the demand created under section 201(1) and interest charged under section 201(1A) of the Act is thus, cancelled. 14. Following the same parity of reasoning, we hold that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ucceeding years. In all the years under consideration, the OP/OC on segmental level is positive and it is not loss making concern. The Assessing Officer / TPO in such circumstances, directed to include the segmental results of Microgenetics Systems Ltd. for benchmarking the transactions of assessee in ITES segment. 19. Now, coming to the next concern i.e. Universal Print Systems Ltd., wherein the plea of assessee before us is that it is functionally not comparable. The learned Authorized Representative for the assessee has pointed out that the segment which was held to be comparable to the assessee's ITES segment was pre-pressed services. So, he explained that pre-pressed services include procedure between creation of content and final printing, whereas the assessee under ITES segment undertakes back office accounting in HR services, which in no manner can be equated with pre-pressed services. Just because, it was an outsourced business source, we find merit in the plea of assessee in this regard and accordingly, hold that the said concern Universal Print Systems Ltd. was not functionally comparable to the assessee and hence, could not be included in the final set of comparables. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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