2015 (7) TMI 1208 - AT - Income Tax

Revision u/s 263 - CIT-A directed the Assessing Officer to apply the provisions of section 10B(7) r.w.s. 80IA(10)with respect to the profit margins reflected in the Transfer Pricing Study Report - Held that - Provisions of section 10B are pari-materia to the provisions of section 10A of the Act. The assessee had shown profits from export of propeller shaft components and light axle components earned by EOUs at 38% and 34% as against the average profit mark-up range of 8.4% to 10.77% in case of propeller shaft components and 4.2% to 7.5% in case of axle components of external overseas comparables, which was accepted by the TPO in his report under section 92CA(4) of the Act. In the above said circumstances, where the profit margins declared by the assessee have been accepted to be at arm s length by the TPO, no curtailment of deduction under section 10B can be made by invoking the provisions of section 10B(7) r.w.s. 80IA(8) and 80IA(10) of the Act, relying on the ratio laid down by the Tribunal in M/s Honeywell Automation India Limited vs. DCIT (2015 (3) TMI 494 - ITAT PUNE). The onus was upon the Department to prove that an arrangement existed between the assessee and its AEs to earn more than ordinary profits and in the absence of the said onus having been discharged by the Department we find no merit in the order of the Commissioner passed under section 263 of the Act in this regard. Earning more than ordinary profits - Held that - Assessee had consistently earned higher profit margins right from start of its business even before EOUs were set up and where similar trend has shown in the hands of the assessee which, in turn, had been accepted by the TPO, while determining the arm s length price of the international transactions between the assessee and its AEs, then there is no merit in invoking of jurisdiction by the Commissioner under section 263 of the Act. Further, it is to be noted that there was justification for earning higher profit margins due to substantial cost savings i.e. locational advantage, lower infrastructure cost, savings in tooling cost, no cost of investment and know-how/IPR being a restricted scope supplier of components. Where the assessee is getting the designs and the know-how from its AEs and was supplying the components, in turn, to its AEs i.e. where the assessee was a limited scope manufacturer, then we find no merit in the observations of the Commissioner in this regard that the assessee had earned more than ordinary profits, which in any case have been justifiably explained. Royalty of 2.85% not payable on export of components supplied to the AE and warranty not borne by the assessee - As per the Commissioner, the same reflected the intention of the assessee to show higher profits from the 10B units - Held that - In the present case, where the assessee was restricted scope and limited risk manufacturer of components exported to its AE, where the licensed know-how and designs owned by the AE were made available to the assessee only for it use itself reflects that in such circumstances question of royalty payment to AE does not arise and in the absence of any agreement between the parties for payment of royalty, we find no merit in the observation of the Commissioner in this regard. Further, where the assessee was only exporting components of propeller shaft and axles and the finished products were assembled by the AE, there is no scope for providing warranty on export of such components. The finding of the Commissioner in this regard that the assessee had shown higher profits to claim deduction under 10B units is thus misplaced. No merit in the order of the Commissioner passed under section 263 - Decided in favour of assessee

Issues Involved:
1. Invoking of jurisdiction under section 263 of the Income Tax Act, 1961.
2. Application of provisions of section 10B(7) read with section 80IA(10) of the Income Tax Act, 1961.
3. Justification for higher profit margins in the Transfer Pricing Study Report.
4. Non-application of mind by the Assessing Officer.
5. Acceptance of Transfer Pricing Officer's findings.
6. Application of section 10A(7) read with section 80IA(10) of the Income Tax Act, 1961.
7. Allowability of deduction under section 10B of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Invoking of Jurisdiction under Section 263:
The Commissioner invoked section 263, directing the Assessing Officer to apply section 10B(7) read with section 80IA(10) due to disproportionately higher profit margins in the Transfer Pricing Study Report. The Commissioner noted that the gross profit margins on exports were significantly higher than domestic sales, indicating an arrangement to show higher profits in tax-free units.

2. Application of Provisions of Section 10B(7) read with Section 80IA(10):
The Commissioner directed the Assessing Officer to apply these provisions, suggesting that the profits from export sales to Associated Enterprises (AEs) were structured to show disproportionately high profits, which were tax-free under section 10B. The Commissioner believed that the Assessing Officer failed to apply his mind to these provisions, leading to an erroneous and prejudicial order to the Revenue.

3. Justification for Higher Profit Margins in the Transfer Pricing Study Report:
The Commissioner referred to the Transfer Pricing Study Report, which showed higher profit margins for export sales compared to domestic sales. The Commissioner inferred that the arrangement between the assessee and its AEs resulted in higher profits for the tax-free units, thus invoking the provisions of section 10B(7) read with section 80IA(10).

4. Non-application of Mind by the Assessing Officer:
The Commissioner held that the Assessing Officer did not apply his mind to the issue of higher profit margins and the applicability of section 10B(7) read with section 80IA(10). The Commissioner noted that there was no mention of these provisions in the assessment order, indicating a lack of inquiry and application of mind, thus making the order erroneous and prejudicial to the Revenue.

5. Acceptance of Transfer Pricing Officer's Findings:
The assessee argued that the Transfer Pricing Officer (TPO) had accepted the arm's length price of the international transactions without any adjustments. The Tribunal noted that the TPO's acceptance of the transactions at arm's length price meant that the Assessing Officer had to accept the TPO's findings without re-evaluating the profit margins.

6. Application of Section 10A(7) read with Section 80IA(10):
The Tribunal referred to the case of M/s Honeywell Automation India Limited vs. DCIT, where it was held that in the absence of any arrangement resulting in higher profits, there was no merit in re-working the profits by invoking section 10A(7) read with section 80IA(10). The Tribunal emphasized that the onus was on the Revenue to prove any arrangement that resulted in higher profits, which was not established in this case.

7. Allowability of Deduction under Section 10B:
The Tribunal held that the assessee was entitled to the deduction under section 10B in entirety. It was noted that the higher profit margins were justified due to substantial cost savings and the nature of the assessee's business as a limited scope manufacturer. The Tribunal found no merit in the Commissioner's order under section 263 and allowed the assessee's appeal, directing the Assessing Officer to allow the deduction under section 10B without invoking section 10B(7) read with section 80IA(10).

Conclusion:
The Tribunal allowed the assessee's appeals, holding that the Commissioner's order under section 263 was not justified. The Tribunal directed the Assessing Officer to allow the deduction under section 10B in entirety, dismissing the Revenue's appeal. The Tribunal emphasized the need for cogent evidence to invoke section 10B(7) read with section 80IA(10) and found that the onus was not discharged by the Revenue.

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