2014 (4) TMI 1336 - AT - Income Tax

Deduction u/s 10A upheld; no proof of abnormal profits or arranged salaries u/ss 10A(9)/80IA(10)

ITAT Pune upheld the CIT(A)'s order allowing deduction u/s 10A to the assessee's STPI unit and deleting the addition made by the AO. The AO had invoked ... Deduction u/s 10A on the profits earned in the STPI unit of the assessee - AO observed that the salary paid to key persons is lower than normal salaries paid to other employees - onus of establishing that the assessee has earned more than ordinary profits - taxable profit of the STPI unit before adjustment - HELD THAT:- The salaries to the key persons are decided in advance and more or less static in the past few years, owing to personal attachment of these key persons with the company. At the start of the year, it is unlikely for the employees to envisage as to what would be the net profits for the ensuing year. On the contrary, there could be an exemplary case where, for claiming higher deduction u/s 80IA, some business may procure goods from their sister concern at an unfair lower price. Such transactions are on deliberately lowered purchased rate; are the real targets of 80IA(10). In the present case, the pre-decided salaries are not rearranged in anyway so that more than ordinary profits could be earned. We find that in the case of CIT & Another Vs. H.P. Global Soft Ltd [2012 (4) TMI 397 - KARNATAKA HIGH COURT] wherein, it was found that the profit margin as revealed by the assessee is a reasonable profit in comparison to other similar units. AO having failed to show that is it a course of business, so arranged as to result in inflated profit provisions of section 10A(9) could not be to reduce the deduction under the provisions of section 10A. We are not inclined to interfere with the finding of CIT(A) who has deleted the addition which has been made by the Assessing Officer on the ground that profit shown from eligible unit is more than normal. Appeal filed by the revenue is dismissed. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether the conditions for invoking section 10A(7) read with section 80-IA(10) were satisfied so as to permit the Assessing Officer to re-compute the profits of the eligible section 10A unit by making a notional enhancement of director remuneration and reallocating such notional cost to the unit. 1.2 Whether the profit margin of the section 10A eligible unit, at 21.26%, constituted 'more than ordinary profits' so as to justify adjustment under section 10A(7) read with section 80-IA(10). 1.3 On whom lay the burden of establishing that the assessee had earned 'more than ordinary profits' from the eligible unit for the purposes of section 10A(7) read with section 80-IA(10), and whether such burden was discharged by the Assessing Officer. 1.4 Whether lower remuneration paid to key directors, as compared to an employee director and other executives, by itself constituted an arrangement of business 'so as to result in' more than ordinary profits in the eligible unit within the meaning of section 80-IA(10). 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 & 2: Invocation of section 10A(7) r.w.s. 80-IA(10) and characterization of profits as 'more than ordinary' Legal framework (as discussed) 2.1 The Court examined section 10A(7) read with section 80-IA(10), noting that re-computation of profits is permissible only where the Assessing Officer finds that, owing to the close connection between the assessee and any other person, or for any other reason, the course of business is so arranged that the business produces to the assessee 'more than the ordinary profits' which might be expected to arise in such eligible business. Interpretation and reasoning 2.2 The assessee maintained separate unit-wise profit and loss accounts. The Assessing Officer accepted the basis of allocation of technical and non-technical salaries, but noted that remuneration to two key directors had been fully debited to the corporate division and not allocated to the eligible unit. On the premise that these directors were highly qualified and that their remuneration was significantly lower than that of an employee director and another executive, the Assessing Officer substituted higher notional salaries (by adopting the higher executive remuneration figures) and apportioned these notional amounts between units, thereby reducing the eligible unit's profit margin from 21.26% to 19.17% and disallowing deduction under section 10A to the extent of the difference (Rs. 31,27,923). 2.3 The Court noted that, under section 80-IA(10), the jurisdiction to re-compute profits arises only if the Assessing Officer establishes that the unit has earned 'more than ordinary profits'. It held that the Assessing Officer had merely presumed that a margin of about 21.26% was more than ordinary, without bringing any material or comparable cases on record to demonstrate what constituted 'ordinary' profit for similar IT/ITeS units. 2.4 The Court recorded the assessee's justification that: (a) in the immediately preceding year, its profit margin was 45.29% and was never disturbed; (b) in transfer pricing assessments, arm's length margins for IT-enabled services are typically around 30%; (c) MAP profit levels for India-USA transactions for earlier periods had been fixed at 17.5%; and (d) safe harbour norms indicated margins of about 20% for IT-enabled services. On this basis, the assessee's margin of 21.26% was claimed to be within a reasonable band and not excessive. 2.5 The Court found that the Assessing Officer had not refuted these comparative indicators nor produced any independent benchmarks or comparable instances to demonstrate that 21.26% was 'more than ordinary'. The adjustment was held to be based on assumption, not evidence. 2.6 The Court relied on judicial precedents which held that, in the absence of efforts by the Assessing Officer to ascertain profit rates from comparable cases, recourse to provisions analogous to section 80-IA(10) is not justified, and that unless it is shown that the course of business is so arranged as to inflate profits, the deduction under section 10A cannot be reduced. Conclusions 2.7 The statutory precondition for invoking section 10A(7) read with section 80-IA(10) - namely, a finding based on material that the eligible unit earned 'more than ordinary profits' - was not satisfied. The profit margin of 21.26% could not be treated as excessive or abnormal in the absence of cogent comparative evidence. The re-computation of profits and consequent disallowance were therefore unsustainable, and the deletion of the addition by the first appellate authority was upheld. Issue 3: Burden of proof regarding 'more than ordinary profits' Legal framework (as discussed) 3.1 The Court examined the text and scheme of section 80-IA(10), emphasizing that it casts an onus on the Assessing Officer to establish that, due to the manner in which the business is arranged, the eligible business yields more than ordinary profits. Interpretation and reasoning 3.2 The Court observed that the Assessing Officer did not discharge this statutory onus. No industry data, comparable cases, or other objective material were brought on record to demonstrate what an 'ordinary' profit margin would be in comparable circumstances, nor was any analysis made to show that the assessee's margin was abnormally high. 3.3 Instead, the Assessing Officer proceeded directly to a notional reallocation of director remuneration and applied section 10A(7) read with section 80-IA(10) solely on the assumption that the reported margin was more than ordinary, thereby reversing the burden of proof contemplated by the provision. Conclusions 3.4 The onus to show that the assessee earned more than ordinary profits lay on the Assessing Officer and was not discharged. In the absence of such proof, the conditions for invoking section 10A(7) read with section 80-IA(10) were not met, and the addition could not be sustained. Issue 4: Effect of lower remuneration to key directors and allegation of arranged transactions Interpretation and reasoning 4.1 The Assessing Officer treated the relatively low remuneration paid to two key directors (as compared to the employee director and another executive) as evidence that transactions relating to salaries had been 'so arranged' as to inflate the profits of the eligible unit, by keeping major remuneration outside the unit's accounts. 4.2 The Court noted that the directors' salaries were fixed in advance and had been more or less static in prior years, influenced by personal attachment to the company. At the time of fixing remuneration, it would not be possible to foresee the exact profits for the year, and there was no material to show that remuneration was manipulated during the year to secure higher deduction. 4.3 The Court distinguished this situation from the typical mischief covered by section 80-IA(10), such as deliberately lowering purchase prices or other inter-unit arrangements to shift profits to the eligible undertaking. In the present case, there was no evidence of any such rearrangement of business transactions; the mere fact of lower salaries, without more, did not establish that the course of business was so arranged as to yield more than ordinary profits. 4.4 The Court referred to precedents which held that, in the absence of material showing a business arrangement designed to inflate profits, provisions analogous to section 80-IA(10) cannot be invoked to curtail statutory deductions. Conclusions 4.5 Lower remuneration to key directors, standing alone and without demonstrable nexus to inflated profits of the eligible unit, did not constitute an 'arrangement' of business within the meaning of section 80-IA(10). The notional substitution of higher salaries and their apportionment to the eligible unit was therefore unjustified. The deletion of the resulting addition was correctly upheld.