TaxTMI 
TaxTMI 
2015 (3) TMI 494
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.... pursuance of the directions issued by Dispute Resolution Panel ('DRP'), Pune, dated 29 September 2010 under section 253 of the Income-tax Act, 1961 ('Act') on the following grounds, which are without prejudice to each other: On the facts and in the circumstances of the case and in law, the Hon'ble DRP and consequentially the learned AO has: General 1. erred in assessing the total income at Rs. 746,351,790 as against income of Rs. 214,085,274. Denial of deduction of Rs. 286,049,101 under section 10A of the Act 2. erred in recomputing the deduction under section 10A at Rs. 77,460,281 as against Rs. 363,509,382 claimed by the Appellant, thereby denying deduction under section 10A to the extent of Rs. 286,049,101; Invoking the provisions of section 10A(7) read with section 80IA(10) in the Appellant's case 3. erred in invoking the provisions of section 10A(7) read with section 80IA(10) in the Appellant's case, on the ground that transactions between the Appellant and its associated enterprises are arranged to produce more than ordinary profits. 4. failed to appreciate that provisions of section 10A(7) r.w.s 80IA (10) could only be invoked where bot....
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....stem integration segment of the Appellant, with its Associated Enterprises (hereinafter referred to as "AEs") aggregating Rs. 229,017,412. 12. On the facts and in the circumstances of the case and in law, the learned Transfer Pricing Officer (TPO) and the learned AO under directions issued by the Hon'ble DRP, erred in making an addition to the Appellant's total income of Rs. 229,017,412 based on the provisions of Chapter X of the Act. 13. On the facts and in the circumstances of the case and in law, the learned TPO erred and the Hon'ble DRP further erred in upholding / confirming the action of the TPO rejecting the segmental profit and loss account prepared by the Appellant in respect of IS-Infra segment and Balance System Segment of the Appellant. 14. On the facts and in the circumstances of the case and in law, the learned TPO erred and the Hon'ble DRP further erred in upholding / confirming the action of the TPO of disregarding the fact that during the year under consideration, the assessee had provided for an extraordinary expense item being bad debts/ provision for bad and doubtful debts in its books of accounts amounting to 2.45% of operating cost and acco....
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....ennai. The profits derived by the aforesaid three units are entitled for deduction u/s 10A of the Act and accordingly, assessee claimed deduction amounting to Rs. 36,36,09,382/- with respect to the profits of the aforesaid three units. The details of such claim have been noted by the Assessing Officer in para 2.5 of his order whereby the claim of deduction u/s 10A of the Act in respect of STPI Unit-I was Rs. 30,75,65,637/-; with respect to the STPI Unit-II was Rs. 1,52,11,386/-; and, with respect to the STPI Unit, Chennai was Rs. 4,07,32,359/-. 5. In-principle, the Assessing Officer has not disputed the entitlement of the assessee for the claim of deduction u/s 10A of the Act. So however, the deduction u/s 10A of the Act has been restricted to Rs. 7,74,60,281/- as against the claim of Rs. 36,35,09,382/- above thereby denying the deduction to the extent of Rs. 28,60,49,101/-. The aforesaid action of the income-tax authorities is based on the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act. As per the Assessing Officer, the profits in relation to section 10A Units are more than the 'ordinary profits' and therefore he has restricted such profits for the purposes of the deduc....
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.... on the operating profit margin of the comparables selected by the assessee in the TNM Method while carrying out the Transfer Pricing Study. 6. In the above background, the rival parties have made their submissions in extenso. The rival submissions have been heard and the relevant material and record perused. 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 business carried on by the assessee, or where any goods [or services] held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the co....
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....vernment 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 recompute 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 the Assessing Officer can proceed to disregard the profits declared by the assessee and determine the amount of profits which may reasonably deemed to have been derived from such business. Notably, such conditions ar....
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....e 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 Trade Zone, engaged in the manufacture and export of industrial sewing machine needless; and other at Mumbai, engaged in trading in industrial sewing machine needless. The manufacturing division at Kandla exported i....
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.... 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 reference has also been made to the commercial reasons explained before the Assessing Officer for the high profits earned by the assessee's STPI Unit. From the submissions furnished to the Assessing Officer, which have been rep....
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....TA 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 support of such proposition, reliance has been placed on the decisions of the Mumbai Bench of the Tribunal in the case of ITO vs. Zydus Nycomed Healthcare (ITA Nos.4013/Mum/208, 4206/Mum/2009 and 4343/Mum/2009 dated 31.10.201....
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....igh 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 (BomXDPBp- 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, "the action of arranging". As a matter of plain language it would, therefore, follow that the term "arrangement" means any agreement or understanding between the parties concerned." 19. As per the Ld. CIT-DR, since there is ....
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....lthy 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 further, it would be appropriate to examine the scope and intent of the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act. In this context, a reference has been made to the CBDT Circular No.308 dated 29.06.2008 wherein the ....
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....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 produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business. The emphasis is to eschew those 'more than the ordinary profits' which are as a result of a business between two closely ....
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....at 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. CITDR. 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 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........." . Therefore, it would necessarily mean that the 'arrangement....
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....t, 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 language of section 80-IA(10) but also the legislative intent which seeks to curtail the abuse of tax concession by manipulation of profits between associated concerns. Therefore, an arrangement which is referred to in section 10A(7) r.w.s. 80-....
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....verseas 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 addition Further there is no evidence of existence of any arrangement as contemplated under s. 80-1(9)." 29. Quite clearly, as per the Tribunal the question is not whether the onus is light or heavy but whether the Assessing Officer has discussed o....
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....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 transfer pricing adjustment is called for in the present case. The Assessing Officer has made the reference to the Transfer Pricing Officer under section 92CA. The reference is made for the purpose of computing income arising from an international transaction with regard to the arm's length price as provided in section 92. Therefore, it is to be seen that the scope and extent of reference made by the Assessing Officer to the Transfer Pricing Officer is confined to the singular purpose stated ....
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.... 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 10B(7) so as to reduce the eligible profits on the basis of the arm's length price computed by the Transfer Pricing Officer without showing how he determined that the assessee had shown more than "ordinary profits". As rightly argued by learned senior counsel the arm's length price is determined on the basis of the most appropriate method. The most appropriate method is chosen either on profit basis method or price basis method. In the latter ease, profits are not at all considered. In that metho....
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....ectly 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, assessee succeeds on this aspect. 35. Now, we may take-up the Ground of Appeal Nos.12 to 17 which relate to an addition of Rs. 22,90,17,412/- made by the Assessing Officer on account of computation of arm's length price in respect of the international transactions entered by the assessee with its associated enterprises in respect of System Integration segment of the assessee. 36. In brief, the relevant facts are that assessee company is a subsidiary of Honeywell Asia Pacific Inc, USA, which, in turn,....
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....to the international transactions carried out by the assessee with its associated enterprises. The TPO has passed an order u/s 92CA(3) dated 12.10.2009 determining the arm's length price of the international transactions entered by the assessee with its associated enterprises. So far as the segments of Distribution and Software Engineering Services are concerned, the TPO has accepted that the stated value of the transactions are at an arm's length price and no adjustment thereon is required. However, he has differed with the assessee with regard to the System Integration Segment and therefore, we may confine the discussion with regard to the said dispute, which is the subject matter of Grounds of Appeal before us. 38. In its System Integration business unit, assessee segregated the activities into two segments i.e. Manufacturing system segment and Infrastructure System (IS-Infra) segment. In the Manufacturing system segment, assessee included Honeywell & Building Control unit's activities wherein it was providing a spectrum of building services including heating, ventilation and air conditioning controls, fire, alarm and security systems and integrated building management ....
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.... reasons for the losses, was canvassed to be the key reasons for which it was considered appropriate to evaluate the IS-Infra segment separately. On the basis of the above explanation, it was contended that pricing of the international transactions pertaining to the IS-Infra segment were consistent with the arm's length price. 42. Another area of difference between assessee and TPO was the computation assessee's margins in the Manufacturing System Segment. It was noted that in November, 2004, the 40% shareholding of TATAs in the assessee company was taken over by the Honeywell Group entities. Consequent to the acquisition of the TATA Group shareholding by the Honeywell Group, stringent policies and procedure with respect to the preparation of financial accounts were formulated which were in accordance with the policies and procedure adopted across the Honeywell Group. As a consequence, assessee adopted a more stringent policy for making Provision of bad debts, liquidated damages and obsolete inventory. On account of the aforesaid, assessee canvassed that for the financial year ending 31st March, 2006, significantly higher Provisions and write-off of bad debts was made in the P....
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....e bad debts, which as under :- "Systems Integration Segment Sr. No. Dataflag Name of the Company OP/Sales(Before bad debts adjustment) Adjusted OP/Sales (After bad debts adjustment) 1. Prowess Aplab Limited 10.07% 11.13% 2. Prowess Ador Powertron Limited 11.93% 11.93% 3. Prowess Hindustan Dorr-Oliver Ltd. 5.55% 5.55% 4. Prowess Raunaq International Ltd. 6.95% 6.95% 5. Prowess Petron Engineering Construction Ltd. 9.66% 10.17% 6. Prowess Continental Controls Ltd. 2.79% 2.79% 7. C-line Tata Projects Limited N.A. N.A. Average 7.82% 8.09% N.A. " Not available in the database." 45. From the aforesaid, the TPO inferred that operating margins of four concerns did not change before and after the bad debts adjustment. According to the TPO, this indicated that the four concerns did not have any bad debts at all and therefore there was no change in the ratio of the operating profits to sales before or after the bad debts adjustment. The TPO noted that assessee company had indeed incurred bad debts, which have been writtenoff, though such amounts were excluded for computing the adjusted operating profits for th....
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....t over the sales and not the adjusted profit over the sales as submitted by the assessee and the set of comparables is adopted as given in the show cause notice with the mean operating profit to sales of two comparables at 9.87% against the operating profit margin of the assessee at 3.89%. Considering the above, an adjustment as worked out under is necessary to be made to the total income of the company so that the international transactions grouped under the Systems Integration Segment viz. import of raw material/components; export of finished goods; Import of capital goods; payment of technical assistance services received for projects of the Honeywell Group; payment of commission for marketing services; and payment of royalty to HI for licensed products and parts; are at arm's length: Gross Sales for the segment = Rs.382,97,22,612/- The mean operating profit margin of comparables is 9.87%; The operating profit margin of the assessee for the segment is 3.89%; The adjustment required t....
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.... the shortfall in the margin was required to be applied to total transactions including those with nonrelated parties in order to determine the Transfer Pricing adjustment. 51. On this aspect, in the earlier part of this order, we have reproduced the conclusion of the TPO as well as the manner in which he has computed the adjustment of Rs. 22,90,17,412/-, which according to him is required to be made to the international transactions of System Integration segment of the assessee in order to be bring it to the level of arm's length price. Pertinently, the mean operating profit of the comparables was deduced at 9.87% and the operating margin of the assessee's System Integration segment was adopted at 3.89%. The shortfall between the mean operating margin of the comparables and the profit margin of the assessee's System Integration segment was applied to the gross sales of the assessee in the System Integration segment amounting to Rs. 3,82,97,22,612/-. Accordingly, the adjustment has been worked. It is undeniable that so far as the gross sales of Rs. 3,82,97,22,612/- is concerned, it is inclusive of the transactions with associated enterprises as well as with non-related parties....
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....ed that such concerns did not have any bad debts at all. Since assessee had incurred bad debts, the TPO considered only those concerns as comparables who had incurred bad debts and thereby excluded such concerns from the list of comparables which did not have any bad debts at all. Hindustan Dorr-Oliver Ltd. was excluded from the list of comparables by the TPO on this count. 54. Though the Ld. Representative for the assessee contended that the action of the TPO was unjustified in-principle, so however, it is pointed out that by applying the filter adopted by the TPO himself, the said concern could not have been excluded from the list of comparables as it had incurred bad debts related expenditure. In this context, the Ld. Representative for the assessee furnished Annual Reports of the said concern for the financial years ending 31.03.2004 and 31.03.2007 which indicated that the said concern has indeed accounted for the bad debts. It is pointed out that the said concern has over the years incurred bad debts and therefore on the basis of the said filter, it could not be excluded from the final set of comparables. The Ld. CIT-DR has reiterated the stand of the TPO, which we have alrea....