2025 (10) TMI 477 - HC - Income Tax

Transfer pricing adjustments under CBDT-approved APA bind parties; ALP income qualifies for Section 10AA exemption; Section 14A disallowance set aside

Pr. Commissioner of Income Tax-2 Bangalore, The Deputy Commissioner of Income Tax, Circle-4 (1) (1) Bengaluru Versus M/s. Eygbs (India) Pvt. Ltd.

HC upheld the CIT(A) and Tribunal, holding that TP adjustments made pursuant to a CBDT-approved APA are binding and income computed on the ALP basis ... Disallowance of Section 10AA in respect of the TP adjustments made pursuant to the APA entered into by the assessee with the Central Board of Direct Taxes - AO had denied the exemption under Section 10-AA on the ground that the same was occasioned by TP adjustment - HELD THAT:- It is material to note that the TP adjustments are made pursuant to the APA entered into by the Assessee with CBDT. Section 92CC of the Act empowers the CBDT (Central Board of Direct Taxes) to enter into an APA (Advance Pricing Agreement) with any person for determining an ALP or specify the manner in which the ALP is to be determined, in relation to an international transaction to be entered into by that person and income referred to in Section 9(1)(i) of the Act or the manner in which said income is to be determined as is reasonably attributable to the operations carried out in India. The provisions of Sections 92CD(1) of the Act are unambiguous and even if a return has been filed prior to an Assessee entering into an APA, he is entitled to furnish a modified return declaring his income in accordance with the terms of the APA. Subject to certain exceptions, the APA is binding both on the Assessee and the Revenue. It is clear that the scheme of providing for an APA is to remove any uncertainty as to the determination of an income of an Assessee engaged in international transactions with associated enterprises. The Assessee is required to declare his income in accordance with the APA. Except in certain cases, where there is a change in law and facts or the agreement is occasioned by fraud or misrepresentation, the APA would be binding. Sub-sections (5), (6) and (7) of Section 92CC of the Act provide for the same in unambiguous terms. ALP is imputed to transactions to determine the profits and gains that are derived by the assessee from any international transactions (or specified domestic transactions) in order to assess the real income of the assessee after eliminating any bias or element of transfer of profits. Thus, indisputably, the income computed on the basis of ALP would provide a measure of the profits or income derived by the activities carried on by an Assessee. The proviso to Section 92C(4) essentially limits exemption under Section 10AA in cases where the income computed is enhanced by the AO under Section 92C of the Act. In the present case, the AO has not enhanced the income declared by the assessee. The assessee had voluntarily factored in the ALP pursuant to the APA entered into with the CBDT, for computing the income as declared in its returns. No infirmity in the finding of the learned CIT(A) as well as the learned Tribunal in rejecting the Revenue's contention that exemption u/s 10AA of Chapter VI-A of the Act, is not available in respect of declared income of the assessee insofar as it relates to the TP adjustments made pursuant to the APA. Disallowance u/s 14A - AO has not provided any tangible basis for making the adhoc disallowance of 10% of the dividend income from mutual funds. The Tribunal had also noted that in Assessee's own case for earlier assessment years, the Revenue had accepted the deletion of such allowances as made by the CIT(A) and it had not appealed against the said decision before the Tribunal - No substantial question of law arises for consideration in these appeals. ISSUES PRESENTED AND CONSIDERED 1. Whether voluntary transfer pricing (TP) adjustments made pursuant to an Advance Pricing Agreement (APA) and declared in a modified/return are excluded from deduction under Section 10AA of the Income Tax Act by operation of the proviso to Section 92C(4) when no enhancement is made by the Assessing Officer. 2. Whether an assessee who has voluntarily adjusted income pursuant to an APA must further substantiate that the TP adjustments relate specifically to the eligible SEZ unit for the purpose of claiming deduction under Section 10AA, and whether such claimed amounts fall within the definition of profits and gains for Section 10AA computation. 3. Whether the proviso to Section 92C(4) applies where the arm's length price (ALP) is determined by the assessee pursuant to an APA rather than determined or enhanced by the Assessing Officer under Section 92C(3)-(4). 4. Whether an adhoc disallowance of 10% of dividend income under Section 14A of the Act is sustainable where there is no opening or closing balance of investments and Rule 8D is inapplicable. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of proviso to Section 92C(4) to voluntary APA-driven TP adjustments for claim under Section 10AA Legal framework: Sections 92CC (power to enter into APA), 92CD (duty to file modified return within three months when APA entered into), 92C(1)-(4) (methods for determining ALP; Assessing Officer's power under sub-section (3) to determine ALP on specified grounds; sub-section (4) permitting AO to compute total income having regard to ALP and proviso disallowing specified deductions in case of enhancement), and Section 10AA (deduction of profits and gains of SEZ units derived from export of articles or things) govern the issue. Precedent treatment: The Tribunal and the first appellate authority allowed the deduction where the assessee voluntarily declared TP adjustments pursuant to an APA and there was no AO enhancement. A prior coordinate-bench decision was noted by the Court as holding that Section 92C(4) applies where ALP is determined by the Assessing Officer, not where ALP is determined by the assessee. Interpretation and reasoning: Section 92CD(1) unequivocally permits filing of a modified return to reflect income in accordance with an APA entered into after the original return. Section 92CC(5) makes an APA binding on both the taxpayer and the revenue except in limited circumstances. Section 92C(3) sets out specific factual predicates under which the AO may determine ALP (e.g., AO has material to opine that price was not determined in accordance with sub-sections (1)-(2), documentation defects, unreliability of data, or failure to furnish information). Sub-section (4) of Section 92C and its proviso operate where the AO determines ALP and thereby computes an enhanced total income. If the assessee, instead, voluntarily computes income based on an APA (and files a modified return under Section 92CD), none of the conditions in Section 92C(3) leading to AO determination are attracted and there is no AO-driven enhancement of income. The proviso to Section 92C(4) is therefore not attracted because its language is confined to cases where the AO's computation results in a higher total income than declared by the assessee. Ratio vs. Obiter: Ratio - The proviso to Section 92C(4) disallowing deductions under Section 10AA applies only where the Assessing Officer enhances the assessee's income under Section 92C(4); it does not apply where the assessee has voluntarily adjusted income pursuant to an APA and filed a modified return under Section 92CD(1). Obiter - Observations on the policy aim of APAs to remove uncertainty and the binding nature of APAs are explanatory but support the ratio. Conclusions: Voluntary TP adjustments pursuant to a valid APA, reflected in a modified/returned income under Section 92CD(1), do not fall within the ambit of the proviso to Section 92C(4); such adjustments do not attract the disallowance of Section 10AA merely because they arise from ALP corrections effected by the taxpayer under an APA. Issue 2 - Requirement to substantiate that TP adjustments relate to the eligible SEZ unit for Section 10AA Legal framework: Section 10AA exempts profits and gains of an enterprise derived from export of articles or things by an eligible SEZ unit. The ALP determines profits attributable to international transactions; Section 92CD(1) mandates modification of returns to conform to APA-determined ALP. Precedent treatment: The first appellate authority and the Tribunal accepted that the TP adjustments, as declared pursuant to the APA, were correctly included in the SEZ unit's income for Section 10AA. The AO required additional substantiation but did not identify conditions under Section 92C(3) that would justify AO determination. Interpretation and reasoning: The ALP, whether determined by the AO or by the APA, provides the measure of profits attributable to international transactions. Once an APA binds the parties and the assessee declares income in accordance with the APA via a modified return, the income computed on that basis is the relevant measure of profits derived by the SEZ undertaking. The AO did not point to any material or failure in documentation under Section 92C(3) that would permit rejecting the APA-based computation; mere assertion that the assessee had anticipated TP adjustments or failed to furnish details is insufficient where the APA process and Section 92CD compliance permit modification of the return. Ratio vs. Obiter: Ratio - Where TP adjustments arise pursuant to an APA and the assessee files the modified return as mandated, those adjustments will be part of the profits and gains of the eligible unit for Section 10AA unless the AO can invoke the specific grounds in Section 92C(3) to determine ALP. Obiter - Comments on sufficiency of record and the nature of evidence required to challenge an APA-based declaration. Conclusions: The assessee need not be denied Section 10AA deduction for APA-driven TP adjustments where the APA is binding and the modified return is filed; absent AO-based enhancement or specific deficiencies under Section 92C(3), the declared APA adjustments are allowable as part of eligible profits. Issue 3 - Effect of pending higher-court proceedings on applicability of precedent relied upon by assessee Legal framework and reasoning: A pending special leave petition or non-finality of decisions relied upon by the assessee does not, by itself, render the Tribunal's reliance on such decisions impermissible. The relevant statutory provisions (Sections 92CC/92CD/92C and Section 10AA) and applicable coordinate-bench jurisprudence provide direct guidance on the scope of the proviso to Section 92C(4) and its inapplicability to APA-based voluntary adjustments. Precedent treatment: The Court relied upon prior coordinate-bench reasoning to the effect that Section 92C(4) is misapplied where ALP is determined by the assessee and not by the Assessing Officer. Ratio vs. Obiter: Obiter in part - Noting pendency of third-party litigation does not alter statutory interpretation; the dispositive reasoning is statutory. Conclusions: Pendency of a higher-court challenge to a precedent does not preclude application of the statutory interpretation that the proviso to Section 92C(4) applies only where AO enhancement occurs. Issue 4 - Validity of adhoc 10% disallowance under Section 14A where no opening/closing investment balance and Rule 8D inapplicable Legal framework: Section 14A disallows expenditure incurred in relation to exempt income; Rule 8D prescribes a formulaic disallowance where investments generating exempt income exist as opening/closing balances or are retained through the year. Precedent treatment: The first appellate authority and the Tribunal deleted the adhoc 10% disallowance; the Revenue had not appealed against deletion in earlier years and had accepted deletion in prior assessments. Interpretation and reasoning: The AO made an adhoc 10% disallowance without providing tangible basis or demonstrating that the conditions for Rule 8D or substantive Section 14A disallowance were satisfied. Absence of opening or closing balance of investments indicates that Rule 8D is not applicable; adhoc disallowance requires justification and cannot be sustained merely because exempt income was earned. Prior acceptance of deletion in earlier years by the Revenue further weakens the case for adhoc addition in the present assessments. Ratio vs. Obiter: Ratio - An adhoc disallowance under Section 14A unsupported by tangible basis and made despite inapplicability of Rule 8D is unsustainable. Obiter - Reliance on administrative acceptance in earlier years is a factor but not determinative where fresh evidence justifies different treatment. Conclusions: The adhoc 10% disallowance under Section 14A is unjustified and properly deleted where there is no opening or closing balance of investments, Rule 8D does not apply, and the AO provides no independent basis for the ad hoc addition. OVERALL CONCLUSION The Tribunal's confirmation of allowance of Section 10AA deductions in respect of voluntary TP adjustments made pursuant to an APA and reflected in the modified return is correct as the proviso to Section 92C(4) applies only where the Assessing Officer enhances income; the adhoc Section 14A disallowances lack tangible basis and were rightly deleted. No substantial question of law arises warranting interference with the Tribunal's order.