IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH `I', NEW DELHI
Before Sh. R. S. Syal, AM And Sh. George George K., JM
ITA No. 348/Del/2013 : Asstt. Year : 2009-10
M/s A. T. Kearney India Pvt. Ltd., Vs Additional Commissioner of
th
14 Floor, Tower D, Global Business Income-tax, Range-1,
Park, Gurgaon-122002(Haryana) New Delhi
(APPELLANT) (RESPONDENT)
PAN No. AADCA1436G
Assessee by : Sh. Salil Kapoor & Vikas Jain, Advs.
Revenue by : Sh.Peeyush Jain & Yogesh K. Verma, CIT DRs
Date of Hearing : 20.8.2014 Date of Pronouncement : 26.8.2014
ORDER
Per R. S. Syal, AM:
This appeal by the assessee is directed against the order passed by
the CIT(A) on 6.12.2012 in relation to the assessment year 2009-10.
2. The assessee has filed concise grounds. Ground No. 1, 2 & 5 are
not pressed. These, therefore, stand dismissed.
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3. The major issue argued on behalf of the assessee is the subject
matter of ground no. 3 by which challenge has been made to the
reduction in the amount of deduction u/s 10A of the Income-tax Act,
1961 (hereinafter also called `the Act') by a sum of Rs. 5,58,86,784/-.
4. Briefly stated the facts of the case are that the assessee filed its
return declaring income of Rs. 31.14 lac. As the tax payable u/s 115JB
of the Act was more than as per the normal provision, the tax was paid
u/s 115JB. During the course of assessment proceedings, it was
observed by the Assessing Officer that the assessee claimed deduction
u/s 10A of the Act to the tune of Rs. 8,22,78,165/- in respect of revenue
arising from its oversees Associated Enterprises (AEs). The assessee
was called upon to file the Transfer Pricing study report, which was duly
filed. On the perusal of the said Transfer Pricing study report, the A.O
observed that the assessee had shown its margin of profit from the
eligible business at many times higher than that shown by the
comparables. It was seen that the arithmetic mean of the margin of
comparables as per the TP study report was 16.22% as against the
assessee's margin of profit at whopping 101.19%. It was thus opined
that the provisions of sec. 10A(7) r.w.s 80IA(10) were applicable. The
assessee's objections did not persuade the Assessing Officer to hold that
sec.10A(7) was not applicable. It was eventually ruled that the assessee
and its AEs, owing to their close connection, had so arranged the course
of business amongst themselves so that the business transacted between
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them produced to the assessee more than the ordinary profits. Invoking
the provisions of sec. 10A(7) r.w.s 80IA(10) and observing that the
arithmetic mean of the operating margin of the comparables as per the
TP study report was 16.22%, the AO considered profit rate of 20% of
the operating cost as reasonable. Since the assessee had shown operating
profit at 101.19% of the operating costs, the Assessing Officer reduced
the eligible amount of deduction u/s 10A to Rs. 2.63 crore by applying
20% as the reasonable profit. This led to the reduction in the amount of
deduction u/s 10A by Rs. 5.58 crore. The assessee failed to convince the
ld. CIT(A) to its line of reasoning, who echoed the assessment order on
this point.
5. We have heard the rival submissions and perused the relevant
material on record. The Revenue has made out a case that reduction in
the amount of deduction u/s 10A was justified because of the operation
of the provisions of sub-section (10) of section 80IA. Sub-sec. (7) of sec.
10A provides that: `The provisions of sub-sec. (8) and sub-sec. (10) of
section 80IA 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 80IA'. The essence of this provision
is that the disabling provisions contained in sub-secs. (8) and (10) of sec.
80IA have full application to sec. 10A as well, wherever applicable. The
Assessing Officer has applied only sub-sec. (10) of sec. 80IA to restrict
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the amount of deduction u/s 10A to this level. It is clear from the facts
of the case narrated above that the assessee is otherwise entitled to
deduction u/s 10A in respect of export of eligible goods. The fact that
the Assessing Officer himself allowed deduction u/s 10A @ 20% proves
that all the eligible conditions set out in sec. 10A of the Act were
satisfied by the assessee. The sole reason assigned by the AO for
restricting the amount of benefit u/s 10A is the applicability of 80IA(10)
in terms of which the assessee and its foreign AE arranged the course of
business in such a way so as to produce more than ordinary profits to the
assessee carrying on eligible business in India.
6. In order to evaluate and examine the rival contentions on the action
of the authorities below in restricting the amount of deduction u/s 10A, it
would be apposite to consider the mandate of sub-sec. (10) of sec. 80IA
as applicable at the relevant time, as under:-
`(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:'
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With this backdrop, we will deal with the issues taken up before
us, one by one.
I. Whether sec. 80IA(10) applies when the second party to the
transaction is a non-resident.
7.1. The ld. AR vehemently argued that sub-sec (10) of sec. 80IA
cannot be applied to transactions between two enterprises, one of which
is not a resident of India. In support of this contention, he sought to rely
on Circular No. 308 dated 29.6.1981 explaining the provisions of sec.
10A. Referring to para 6.10 of the Circular, dealing with the
applicability of sub-sec. (8) and (9) of sec. 80I to sec. 10A, the ld. AR
argued that its last line clearly provides that this provision has been
made with a view to avoid abuse of the tax concession by manipulation
of profits between associate concerns or different units of the same
concern. Drawing strength from these lines, the ld. AR canvassed a view
that the manipulation of profits between two enterprises can only be in a
situation where both such enterprises are residents of India, so that the
increase in profit of the eligible business results in a corresponding
decrease in the profit of the other non-eligible business. If an assessee
having eligible assessee is resident of India and the other person having
non-eligible business is resident of another country, there can be no
question of manipulation of profit, as in such a scenario it is only the
resident assessee whose profits are taxable in India and there can be no
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corresponding decrease in the profits of the assessee having non-eligible
business.
7.2. We do not find any force in this contention made on behalf of the
assessee. A plain reading of sub-sec. (10) of sec. 80IA makes it explicit
that the Assessing Officer of the assessee having eligible business is
empowered to scale down the profits where it appears to him that owing
to the close connection between the assessee carrying on eligible
business and `any other person', the course of business 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 essential requirement for invoking sub-sec. (10)
of sec. 80IA is that the course of business between the assessee having
eligible business and the closely connected `any other person' should be
arranged. The expression `any other person' has not been qualified by
the phrase `resident of India'. It has no where been provided in any part
of this provision that such connected person also must be a resident of
India. The essence of this disabling provision is that when the close
connection between two related persons artificially produces more than
ordinary profits to the assessee having eligible business, then the same
should be set right. It does not matter that such other related person
assisting in artificially increasing the profits of the eligible assessee, is
resident of India or of any other country. Further, we are unable to
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comprehend from the unambiguous language of the provision that there
should be shifting of profits from one taxable entity in India to another
taxable entity in India, as a pre-condition for invoking sub-section (10).
There is no such stipulation in the provision that the increase in the
profits of the assessee having eligible business must correspond with the
decrease in the taxable profits in India of the person carrying non-
eligible business. This provision is simply concerned with the increase in
the profits of the assessee having eligible business. To argue that unless
there is corresponding decrease in the profits of the other assessee, also
a resident of India, the mandate of sub-sec. (10) is not activated, is
akin to reading more than the actual content of the provision, which is
obviously impermissible. We, therefore, hold that section 80IA(10)
applies notwithstanding the fact that the other related person is resident
or non-resident. This contention is thus rejected as devoid of any merit.
II. It should be an arranged course of business between the related
persons to produce more than ordinary profits.
8.1. We have set out sub-section (10) above as was applicable at the
material time. As the AO has made out a case that owing to the close
connection between the assessee and the foreign AE, the course of
business between them was so arranged as to produce more than
ordinary profit to the assessee, thus, the part of the provision stipulating
-`or for any other reason'-, is not applicable to the facts of the instant
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case. Thus on an analysis of the parts of sub-section (10), as are relevant
and applicable to the factual matrix under consideration, it can be seen
that it has the following ingredients : -
i. There should be close connection between the assessee carrying on
the eligible business and any other person ; and
ii. The course of business between the assessee and such other closely
connected person should be so arranged that the business
transacted between them produces more than the ordinary
profits to the assessee carrying on eligible business.
If the above i. and ii. are cumulatively satisfied, then
iii. The Assessing Officer shall take the amount of profits as may be
reasonably deemed to have been derived from the transactions
of such arranged course of business in computing the profits of
such eligible business for the purposes of the deduction under
this section.
8.2. There is no dispute as regards the applicability of i. above
inasmuch as there is a close connection between the assessee carrying on
the eligible business in India and its associated enterprise, being any
other person, carrying on business outside India.
8.3. Now we espouse ii. above, which is crucial for our decision and
the major thrust of arguments has been on it. This ingredient provides
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that the course of business between the assessee and such other closely
connected person should be so arranged that it produces more than the
ordinary profits to the assessee carrying on eligible business. A bare
reading of the relevant part of the provision indicates that in order to
invoke this provision, it is of utmost importance on the part of the AO to
first demonstrate that the transactions between the assessee and the other
related person were `arranged' with a view to produce more profit to the
assessee carrying on eligible business.
8.4. At this juncture, it is of significant to note from iii. above that
sub-section (10) is a fictional provision, deeming reasonable profits as
actual profits for the purposes of computing the amount of the eligible
deduction u/s 10A in case the conditions under i. and ii. above are
satisfied. The noteworthy point is that instantly we are dealing with a
deeming provision. A deeming provision or a legal fiction is one whose
mandate does not exist but for such provision. Because of such deeming
provision alone, the given imaginary state of affairs is taken as reality
notwithstanding the fact that it is at variance with the reality and the
other relevant provision of the enactment. It has been fairly settled that
the scope of a deeming provision should be restricted to what is
expressly stated in such a provision. There can be no inference or
intendment as regards such a provision. The Hon'ble Supreme Court in
CIT Vs. Amarchand N. Shroff (1963) 48 ITR 59 (SC) and CIT Vs.
Mother India Refrigeration Industries P. Ltd. (1985) 155 ITR 711 (SC)
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considered the ambit of deeming provisions and held that the fiction
cannot be extended beyond the object for which these were enacted.
The Hon'ble Bombay High Court in CIT Vs. Ace Builders P. Ltd.
(2006) 281 ITR 210 (Bom.) has also taken similar view. On an appraisal
of the above judgments, the position which emerges is that whenever a
legal fiction is created by way of a deeming provision, it is vital to go
strictly by the express prescription of this provision. Such a deeming
provision cannot be extended beyond what is expressly stated therein. If
certain consequences have been made to follow on the fulfillment of
certain set out conditions in a deeming provision, then unless such
conditions are strictly fulfilled, the consequences cannot be deduced. In
other words, a deeming provision is to be strictly construed.
8.5. With this background that sub-section (10) is a deeming
provision and it must be strictly construed, we revert to the point under
consideration that the Assessing Officer must show at the first instance
that the course of business between these closely connected persons was
arranged so as to produce more than ordinary profits in the hands of a
person carrying on the eligible business. Such a position has to be
necessarily proved. There can be no inference as to the fulfillment of
such a condition. Thus, it is vivid that unless such `arrangement' or
manipulation is shown to exist, there can be no question of discarding
the declared actual profit and substituting it with a reasonable profit. It
is manifest that there are two components of this. First is the
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`arrangement' between the related parties and second, such arrangement
should lead to higher profit. High profit must necessarily be the
consequence of such an arrangement. To put it simply, if such an
`arrangement' is a cause, the higher profit is its `effect'. It is well
known that higher or lower profit of a business can be as a result of the
cumulative effect of several factors. To cite an example, if one person
succeeds in cutting down its costs without affecting the quality of
output, he will naturally earn more profit than others in the same line of
business. Similarly, economies of scale also affect the profit. In the like
manner, the extent of administrative, marketing and selling expenses
also has a bearing on the overall profit of a business. Other factors for
the increase in the profits may be economical purchases or costly sales.
If a businessman manages to make economical purchases from the
market, he will naturally earn more profit. On the other hand, if the
purchases are not actually economical, but because of the close
connection with the seller, the arrangement is such so as to show low
purchase price in the accounts of the person carrying on eligible
business, the apparent profit will still be high. Though in both such
cases, the profit of the eligible business has shot up, but in the first
instance, it is higher due to efficiencies and in the second, it is higher
due to `arrangement'. Similarly, if a businessman manages to make
sales in the market at a higher price because of its effective selling
techniques, he will earn more profit. On the other hand, if the sales are
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not at high price because of the effective marketing strategy, but
because of the close connection with the buyer, the arrangement is such
so as to show higher sale price in the accounts of the person carrying on
eligible business, the profit will still be high. Though in both the cases
the profit of the eligible business will be higher, but in the first instance
it will be higher due to better marketing strategy and in the second, it
will be higher due to `arrangement'. What is relevant for invoking sub-
section (10) is the prevalence of the second situation above where the
higher profit has resulted due to `arrangement' between the assessee and
its closely connected person and not the first, where the higher profit
resulted due to the assessee's effectively managing the business. Thus it
is evident that though in both the situations, the profit is higher, but
recourse to sub-section (10) can be taken only in the case of
`arrangement' between the assessee and the closely connected person.
In other words, the mere higher profit of the person carrying on the
eligible business is no criteria to press into service this provision, unless
the `arrangement' is proved in the first instance. The `arrangement'
needs to be specifically proved by the AO by showing that the assessee
intentionally made purchases at a relatively lower rate from the closely
connected person vis-à-vis that available in the market for the same
products or the assessee made sales to the closely connected person at a
relatively higher rate vis-à-vis the prevailing market price of the similar
products etc. or that the assessee having eligible income booked
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relatively less expenses or showed relatively more income on other
counts in transactions with closely connected person. It is only when
the existence of` `arrangement' is proved in this manner that the
provisions of sub-section (10) can be employed to reduce the
extraordinary profits resulting from such lower payments or excess
recoveries to/from the related person. To put it simply, the higher profit
shown by the eligible assessee is the end point of the exercise to be
undertaken by the AO in this regard, starting with expressly showing
as to how the transactions were specifically arranged to produce more
than ordinary profits to the assessee carrying on the eligible business.
The mere higher profit earned by such eligible assessee can be no reason
to conclude that the assessee transacted in such an `arranged' manner
with its related persons so as to produce more profits to it. At the cost of
repetition, we reiterate that the higher profit should be the `effect' of
such an `arrangement' and cannot be a substitute of such `arrangement'
itself, which is a `cause', for invoking sub-section (10) of section 80IA.
8.6. It can be seen from the facts of the instant case that the AO has
simply treated high profit earned by the assessee as a reason to summon
sub-section (10), without even remotely demonstrating the existence of
any `arrangement' between the assessee and its AEs aimed at producing
extra ordinary profits in the hands of the assessee. The conclusion
drawn by the authorities below in such circumstances cannot be ex
consequenti sustained.
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III. Effect of insertion of proviso to sub-section (10) w.e.f. 1.4.2013
9.1. It can be seen that the Assessing Officer simply took support of the
Transfer Pricing study report furnished by the assessee for coming to the
conclusion that the A.Es. and the assessee company, owing to their
close connection, had so arranged the course of business amongst
themselves so that the business transacted between them produced more
than ordinary profits to the assessee. Now the question arises as to
whether the TP study report can be construed as a sufficient evidence to
prove that the course of business was arranged between the assessee and
its foreign A.Es to produce more profits in the hands of the assessee.
The ld. DR strongly argued that the Transfer pricing study report
submitted by the assessee clearly proved that the assessee charged
higher profit from its associated enterprises. In his opinion, the lower
profits earned by the other comparable cases in similar circumstances
was sufficiently indicative of the fact that the assessee arranged
transactions with its related parties so as to produce more profits in its
accounts. He forcefully relied on proviso to sub-section (10) of section
80IA, which talks of computing ordinary profits having regard to the
arm's length price.
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9.2. In order to scrutinize this contention, it is relevant to note the text
of proviso to sub-sec. (10) which has been inserted by the Finance Act,
2012 w.e.f. 1.4.2013. This proviso reads as under:-
`Provided that in case the aforesaid arrangement involves a
specified domestic transaction referred to in section 92BA, the
amount of profits from such transaction shall be determined
having regard to arm's length price as defined in clause (ii)
of section 92F.'
9.3. A close scrutiny of the above proviso transpires that in case
`the aforesaid arrangement' (that is, the arrangement referred to in
main sub-section (10) between the eligible assessee and the related
person under which transactions are so arranged as to produce more than
ordinary profits to the eligible assessee) involves a specified domestic
transaction, then the amount of reasonable profits from such transactions
between the eligible assessee and the related person shall be determined
having regard to arm's length price of such transactions. Meaning of
`Specified domestic transaction' has been given in section 92BA of the
Act as any of the given five specific and one general transaction, not
being an international transaction, including, inter alia, (iv) any
business transacted between the assessee and other person as referred
to in sub-section (10) of section 80-IA, where the aggregate of such
transactions entered into by the assessee in the previous year exceeds a
sum of five crore rupees. When we read the proviso in entirety, it
divulges the following components :-
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i. There should be arrangement between the eligible assessee and
the other related person under which transactions are so recorded as
to produce more than ordinary profits in the hands of the eligible
assessee; and
ii. Such arrangement should involve a specified domestic
transaction, that is, the aggregate of all the six types of given
transactions should exceed a sum of five crore rupees.
iii. In such a case, the reasonable profits to be substituted with the
declared profits, is the one determined having regard to the ALP.
9.4. It is only when i. and ii. above are collectively satisfied that the
iii. above is set in motion so as to determine the amount of reasonable
profits, as determined having regard to the ALP, to be substituted with
the declared profit of the eligible assessee. If the aggregate of all the
given six transactions does not exceed a sum of five crore rupees, then it
would not become specified domestic transactions. But in such a case
also, wherever the relevant provisions are applicable, those will hold the
field. The mandate of the main part of section 80IA(10) will also
continue to apply in case the aggregate of six transactions is less than a
sum of five crore rupees, in which case the amount of reasonable profit
will still have to be computed by the AO himself but without taking
recourse to the ALP, which in any case will not be available as the
assessee will not be required in that situation to make its Transfer
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pricing study report. However, the important factor, which needs to be
highlighted here is that in a case of specified domestic transaction, that
is, where the aggregate of six transactions exceeds a sum of five crore
rupees, the proviso simply provides a mechanism for the computation of
reasonable profit to be determined having regard to the ALP. This is the
only mandate of the proviso. Even in that case also, the existence of the
`arrangement' between the assessee and its related party, aiming to
increase the profits of the eligible assessee, is a pre-requisite for
resorting to sub-section (10). Notwithstanding the fact that the profit of
the eligible assessee is higher in comparison with the profit computed
having regard to ALP of the specified domestic transactions, still the
substitution of such profits with that computed having regard to ALP,
will be possible only if the AO firstly demonstrates the existence of
such `arrangement'. The only change which has been made by the
insertion of this proviso is that in case of the `arranged' specified
domestic transaction, the AO now need not separately find out and
establish the genuineness of the `reasonable profits' to be substituted for
the declared profits. In such a scenario, the profit determined having
regard to the ALP shall be automatically considered as `reasonable
profits' to be substituted with the declared profits by the eligible
assessee. To contend that the proviso has dispensed with the need on the
part of the AO to establish such `arrangement', is not correct. What has
been dispensed with is the calculation of the `reasonable profits'. The
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existence of such an `arrangement' is still required to be proved by the
AO. The crux of the insertion of the proviso to sub-sec. (10) is that
where the course of business between two connected resident assessees
is so arranged that the business transacted between them produces more
than the ordinary profits to the assessee carrying on the eligible business,
then the reasonableness of the profits so charged shall be judged with
reference to ALP of such transaction.
9.5. It is paramount to note that proviso to sub-sec. (10) has been
inserted w.e.f. 1.4.2013 simultaneous with the inclusion of `specified
domestic transaction' within the ambit of transfer pricing provision,
whereas Chapter-X dealing with the computation of income from
international transaction having regard to Arm's Length Price was
inserted by the Finance Act, 2001 w.e.f. 1.4.2002. At that time, sub-
sec. (10) of sec. 80IA was very much on the statute. The legislature did
not consider it expedient to deem profit from international transaction
having regard to ALP as reasonable profit in the course of the arranged
course of business between the Indian assessee carrying on the eligible
business and foreign A.E. The fact that only the profit from specified
domestic transaction determined having regard to the ALP has been
considered as reasonable for the purposes of sec. 10A w.e.f. 1.4.2013,
goes to prove that the legislature did not intend to consider profit from
an international transaction computed having regard to ALP, as relevant
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for sub-sec. 10A from 1.4.2002. The further fact that the proviso to sub-
sec. (10) of sec. 80IA inserted by the Finance Act, 2012 encompasses
only the specified domestic transaction and not the international
transaction, as is the case under consideration, amply proves that the
legislature neither intended nor intends to have recourse to the profits
from international transaction having regard to their ALP as a yardstick
of `reasonable profits' to be substituted for the declared profits as per
sub-section (10) of section 80IA.
10. The ld. AR has commended to us the judgment of the Hon'ble
Bombay High Court in CIT Vs Schmetz India Pvt. Ltd. (2012) 254 CTR
(Bom.) 504 in which it has been held that merely because an assessee
makes extra ordinary profit, it would not lead to the conclusion that the
same was organized/arranged for the purpose of claiming higher
deduction u/s 10A of the Act. Our attention has also been drawn towards
an order passed by the Hyderabad Bench of the Tribunal in Zavata India
Pvt. Ltd. Vs ITO (ITA No. 628/Hyd./2008) and another passed by the
Chennai Bench of the Tribunal in M/s Visual Graphics Computing
Services (India) Pvt. Ltd. Vs ACIT (2073/Mds/2011) in which it has been
held that the TP study report cannot be considered for determining
excess profit and thereby denying/restricting the amount of deduction u/s
10A. No contrary precedent has been brought to our notice by the ld.
DR.
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11. Adverting to the facts of the extant case, we find that the AO
simply relied on the TP study report submitted by the assessee to form a
bedrock for the disallowance of the part of the amount of deduction u/s
10A, without firstly showing that there existed any arrangement
between the assessee and its overseas related party, by which the
transactions were so arranged as to produce more than the ordinary
profits in the hands of the assessee. The assessment year under
consideration is 2009-10. Neither the proviso to sub-section (10) existed
at that time, nor such a proviso can be applied as we are dealing with an
international transaction and not specified domestic transaction. Under
these circumstances, we are of the considered opinion that the impugned
order upholding the invocation of sub-sec. (10) of sec. 80IA cannot be
countenanced to this extent. Ergo, it is held that the ld. CIT(A) erred in
sustaining the disallowance made by the Assessing Officer by
restricting the amount of deduction u/s 10A of the Act to Rs. 2.63 crore
as against Rs. 8.22 crore claimed by the assessee. The impugned order
on this issue is overturned and it is directed to allow deduction as
claimed.
12. The only other ground which survives for our consideration is
challenging non-grant of the set off of brought forward unabsorbed
depreciation amounting to Rs. 10,73,780/- as claimed by the assessee in
its return of income. There is no discussion in the assessment order on
this issue. The ld. CIT(A) vide para 6.1 of the impugned order held that
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since the matter is sub judice before the Tribunal for the assessment year
2006-07 hence the ground was liable to be rejected. The ld. AR was fair
enough to state that the Assessing Officer may be directed to allow the
relief as claimed in the present ground, if the Tribunal eventually
decides this issue in assessee's favour in appeal for the assessment year
2006-07. We agree with the contention of the ld. AR and direct the
Assessing Officer to do so.
13. In the result, the appeal is partly allowed.
Order pronounced in the open Court on 26/8/2014.
Sd/- Sd/-
(George George K.) (R. S. Syal)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated: 26/8/2014
*Subodh*
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(Appeals)
5.DR: ITAT
ASSISTANT REGISTRAR
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