TMI Blog2019 (9) TMI 727X X X X Extracts X X X X X X X X Extracts X X X X ..... ion 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 [ 2017 (10) TMI 1384 - ITAT PUNE] There is no merit in invoking provisions of section 10AA(9) r.w.s. 80IA(10)of the Act in the case of assessee. The TPO having accepted the transactions to be at arm's length and where the assessee was raising invoices on man hour basis, in line with the third party agreement and where net profit was shown by the assessee at 63%, there is no merit in applying the concept of OP/OC, which cannot be the basis for benchmarking the profits of any business. Hence, we direct the Assessing Officer to allow the deduction claimed under section 10AA of the Act in entirety Disallowance u/s 40(a)(i) - payment of software on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o.1002/PUN/2017 - - - Dated:- 12-9-2019 - D.KARUNAKARA RAO, ACCOUNTANT MEMBER AND SUSHMA CHOWLA, JUDICIAL MEMBER Assessee by : S/Shri Vishal Kalra S.S. Tomar Revenue by : Ms. Amrita Misra, CIT ORDER The appeal filed by assessee is against the order of DCIT, Circle-1(2), Pune, dated 24.02.2017 relating to assessment year 2012-13 passed under section 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961 (in short the Act ). 2. The assessee has raised the following grounds of appeal:- 1. That on facts and circumstances of the case and in law, the AO / DRP erred in assessing the income of the Appellant under the normal provisions of the Act at INR 289,73,57,080 against an income of INR 14,25,88,220 declared in the return based on the directions received from DRP upholding adjustment under section 10AA of the Act; and the adjustment to the transfer price proposed by the Transfer Pricing Officer ( TPO ) in respect of Information Technology Enables Services ( ITeS ) Corporate Tax Grounds: Disallowance under section 10AA of the Act: 2. That on the facts and circumstances ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e taxes by way of buy-back of shares by the Appellant, based on conjectures and surmises, without bring on record any iota of evidence to prove the same. The DRP further erred in not appreciating that such buy-back did not impact the taxability of the Appellant in terms of section 10AA(9) r.w.s 80IA(10) of the Act. 7.2. That on facts and circumstances of the case and in law, the order of the DRP is bad in law as it erred in baldly alleging that the there is an 'arrangement to evade taxes by way of buy-back of shares without issuing any show-cause or providing an opportunity in this regard. 8. That on facts and circumstances of the case and in law, the DRP erred in setting aside the issue to the AO for afresh selection of comparable companies, which specifically impermissible under section 144C(8) of the Act, thereby, exceeding its jurisdiction and rendering the proceedings void and bad in law and liable to be quashed. 9. Without prejudice to the above, that on facts and circumstances of the case and in law, the AO erred in arbitrarily selecting comparable companies pursuant to DRP directions, disregarding the fact that the comparable chosen w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pose of benchmarking its international transactions pertaining to ITeS segment. 17. That on the facts and circumstances of the case and in law, the AO / DRP / TPO have erred in arbitrarily rejecting certain functionally comparable companies / segments selected by the Appellant for the purpose of benchmarking its international transactions pertaining to ITeS segment and further erred in arbitrary selecting functionally incomparable companies / segments on the basis of arbitrary search filters and incorrect appreciation of functional, asset and risk profile of the Appellant. 18. That on the facts and circumstances of the case and in law the AO / DRP / TPO erred in selecting following comparable companies for the purpose of benchmarking ITeS segment Excel Infoways Ltd. Ninestars Information Technologies Ltd. Microgenetic Systems Ltd. Universal Print Systems Ltd. 19. That on the facts and circumstances of the case and in law, the AO / TPO erred in not including comparable companies, namely, Microland Ltd and Caletech Services Pvt. Ltd. despite specified directions by the DRP for inclusion of said compara ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price of various international transactions undertaken by it. The TPO made no adjustment to international transactions pertaining to engineering and design services to associated enterprises. However, the TPO made an adjustment of ₹ 2.46 crores to the segment ITES and BSS. The Assessing Officer in the draft assessment order proposed an addition of ₹ 2.53 crores alleging that the assessee had claimed excess deduction under section 10AA of the Act, on the ground that operating profit / operating cost of assessee was 150.55% as against 27.72% OP / OC of comparable companies. The assessee filed objections before the Dispute Resolution Panel (DRP). The DRP gave directions in respect of TP adjustment with regard to ITES and BSS segments. The DRP directed the TPO to include certain comparable companies and also to allow certain expenditure as operating cost for the purpose of determining OP/OC. Pursuant to the directions of DRP, addition in the BSS segment was reduced to nil. However, the TP adjustment in ITES segment was revised to ₹ 1.69 crores. The DRP upheld the reduction of deduction under section 10AA of the Act. The DRP also upheld the disallowance of expenditure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d various other Eaton group companies. For the year under consideration, the Assessing Officer made reference to TPO for benchmarking international transactions undertaken by assessee in different fields. The TPO made no adjustment in respect of engineering and design services. Consequent to the directions of DRP, no TP adjustment has been made in BSS segment. However, TP adjustment was made in ITES segment, which we shall deal in the paras below. The TPO in other words, had accepted the PLI shown by assessee at 150.55% when compared with mean margins of comparable companies at 27.72%. However, the Assessing Officer was of the view that the assessee by showing such high OP/OC had earned super normal profits when compared with the margins of comparable companies. We find no merit in the observations of Assessing Officer in this regard as the concept of PLI i.e. OP/OC which has been adopted by Assessing Officer was relevant for comparability for transfer pricing analysis. The same cannot be used for holding the assessee to have earned super normal profits in carrying on its business for that. He has to look at net profits shown by assessee, which in the present year is 63% only. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hile benchmarking its international transaction of Engineering Design Services had applied CUP method and the same was also applied by the TPO and the said international transaction was accepted to be at Arm s Length. It may be clarified herein itself that the net profit shown by the assessee for the year under consideration was 72.98% in the Engineering Design Services. The working of operating margin on total cost is to be adopted if TNM method is used as the most appropriate methods. However, both the assessee and the TPO applied the CUP method and the said working of operating margin on total cost at 270% had no application and was not used for determining the Arm s Length price of the international transaction undertaken by the assessee in the said division. The assessee had explained that it was providing complex engineering activities such as advance technological and product development services to its Associated Enterprises and because the cost provided by the assessee were controlled, the assessee had shown net profit of ₹ 44.27 crores on total value of services provided at ₹ 60.67 crores. In addition, the assessee had another unit which was a non STPI unit, u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. 20. 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 transaction by selecting the TNM Method. The TPO on a reference by the Assessing Officer passed an order under section 92CA(3) of the Act accepting the international transaction with respect to the software engineering services segment to be at arm's length. However, the Assessing Officer was of the view that the profit margins in respect of the 10A unit was substantially higher than the profit margin of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ties, 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 for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom. 9. Section 10A of the Act is a special provision in respect of newly established undertakings in free trade zone, etc.. Section 10A postulates a deduction of such profits and gains as are deri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cts 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. In the case before the Karnataka High Court, the issue was similar inasmuch as therein, the Assessing Officer had invoked the provisions of section 80-I(9) r.w.s. 10A(6) of the Act while re-determining the claim of exemption in terms of the then prevailing section 10A(4) of the Act, and the assessment years were 1995-9 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er 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. At the time of hearing, the Ld. Representative for the assessee vehemently argued that the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act are inapplicable in the present case because there is no material lead by the Revenue to say that there was any arrangement between the assessee and the associated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tomation 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 costs, work permit costs, etc. and therefore the cost of sales was on lower side, as a result of which the percentage of Operating profit to total cost shows a higher percentage, although the impact on profit remains unaltered. All these points, which were raised before the Assessing Officer, have been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 was emphasized ..the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived to say that it does not requi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) 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 Assessing Officer based on the margin of the comparable is not found to be a good methodology, yet the failure of computation process by the Assessing Officer would not vitiate the invoking section 10A(7) r.w.s. 80-IA(10) of the Act in the pre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 by us] 23. Quite clearly, the provisions of section 10A(7) of the Act intend to plug abuse of tax concession by manipulation of profits between associated concerns or between different unit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 understanding between the parties concerned. The relevant portion of the decision of the Hon ble Bombay High Court has been reproduced in the earlier part of this order, according to which, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herefore, 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 :- Section 391(1) , however, in any opinion somewhat restricts this otherwise unlimited import of the term arrangement in so far as the said section applies only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the same is open to verification by the appellate authorities. The primary rule of evidence ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 material or evidence referred to in the assessment order to ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2F 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. The second segment consists of rules and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vative 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit margins and after verification had allowed the claim of deduction under section 10A of the Act in respect of the activity of rendering Engineering Design Services. The question is whether deduction claimed under section 10A of the Act could be curtailed. The answer is No in view of the ratio laid down by the Tribunal in Honeywell Turbo Technologies (India) Pvt. Ltd. Vs. DCIT in ITA No.2584/PUN/2012 order dated 10-02-2017 which has been applied by the Tribunal further in Tata Johnson Controls Automotive Limited Vs. DCIT (supra). The onus is upon the department to prove that there existed an arrangement between the assessee and its Associated Enterprises to earn more than ordinary profits and in the absence of the said onus having been discharged by the department and following the parity of reasoning as in Honeywell Turbo Technologies (India) Pvt. Ltd. Vs. DCIT and Tata Johnson Controls Automotive Limited Vs. DCIT (supra), we find no merit in the order of the Commissioner passed under section 263 of the Act in holding that the Assessing Officer while granting deduction under section 10A of the Act has passed the said order without any application of mind. Similar issue of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fficer to allow the deduction claimed under section 10AA of the Act in entirety. The grounds of appeal No.2 to 7.2 are thus, allowed. The learned Authorized Representative for the assessee fairly pointed out that in case the above grounds of appeal are allowed, the grounds of appeal No.8 to 11 would become academic. Hence, the same are dismissed. 12. The next issue raised vide ground of appeal No.12 is against disallowance made under section 40(a)(i) of the Act on account of payment of software on the ground that the assessee had purchased copyright in the said software. However, the plea of assessee before the authorities below and even before us is that it had only made payment for purchase of copyrighted software i.e. off-the-shelf software and there was no merit in holding the said payment to be in the nature of royalty. The learned Authorized Representative for the assessee before us has pointed out that the issue stands covered by the decision of Pune Bench of Tribunal in the case of John Deere India Pvt. Ltd. (2019) 70 ITR (Trib) 73 (Pune). He also pointed out that the DRP had decided the issue in turn, relying on the ratio laid down in the case of Cummins Inc for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee pointed out that ground of appeal No.13 would become academic, hence the same is dismissed. 16. The grounds of appeal No.14 to 16 are general in nature and the same do not require any adjudication. 17. Now, coming to the grounds of appeal No.17 and 18, wherein the assessee has raised the issue in respect of benchmarking of ITES segment. Here, the learned Authorized Representative for the assessee pointed out that the limited issue was in respect of final order of TPO in including Universal Print Systems Ltd., which is not functionally comparable to the assessee and also in excluding Microgenetics Systems Ltd. on the ground that it is loss making concern. In respect of Microgenetics Systems Ltd., the learned Authorized Representative for the assessee pointed out that segmental level, net profits has to be considered and if the same is considered, it is not persistent loss making concern. The learned Authorized Representative for the assessee fairly pointed out that the DRP had directed inclusion of said comparable at segmental level, subject to verification of filters applied by TPO. However, the Assessing Officer/TPO, post directions of DRP has held the ..... 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