2015 (9) TMI 552 - AT - Income Tax

Applicability of provisions of 10A(7) - AO is of the view that assessee has declared unreasonably high rate of profit only for the purpose of claiming exemption u/s 10A - arrangement between assessee and its AE resulting in higher margin of profit, disallowance of part of deduction u/s 10A by invoking the provisions of section 10A(7) read with section 80IA(10) - Held that - Profit margin declared by assessee at 97.40% cannot be considered to be unreasonable or unbelievable considering other factors pointed out by assessee like limited nature of expenditure incurred by assessee and the amount of risk involved as well as niche business area. Moreover, when comparable companies selected by AO himself show profit margin of 88% and 85%, there is not much variance between profit margin shown by assessee. Further, it has been brought to our notice by ld. AR, which has not been controverted by ld. DR, in the subsequent AY also assessee has declared profit at 96% and has also paid taxes of about 15 crores since the tax holiday has already expired. Considered in the aforesaid perspective, AO s conclusion that only for the purpose of claiming higher exemption u/s 10A, assessee enhanced its profit margin, cannot be accepted. On plain reading of section 80IA(10), which is referred to in section 10A(7) of the Act, it is very much clear that the basic condition to be satisfied by AO is, he must establish it on record that assessee and its related party have arranged the business transaction in such a way that it produces more than the ordinary profit to the assessee carrying on the eligible business. Only when AO establishes on record such arrangement, he can proceed to estimate the profit of assessee at a reasonable rate. In the facts of the present case, on careful reading of the assessment order, we do not find any conclusive finding of AO that assessee and its AE have arranged business transactions in a manner to generate more than ordinary profit to assessee. At least, there is nothing mentioned in the assessment order to suggest that AO has satisfied such condition. Therefore, without establishing through positive evidence that assessee and its related party have arranged their business transaction in a manner to produce more than ordinary profit to assessee, AO cannot invoke the provisions of section 10A(7) read with section 80IA(10) on mere presumptions and surmises. See Aquila Software Services Hyderabad Pvt Ltd. Vs. DCIT 2015 (7) TMI 864 - ITAT HYDERABAD - Decided in favor of assessee.

Summary

Issues Involved:
1. Whether the Assessing Officer (AO) erred in restricting the claim of deduction under section 10A by applying the provisions of section 10A(7).
2. Whether the AO improperly ventured into the domain of the Transfer Pricing Officer (TPO).
3. Whether the disallowance of part of the deduction under section 10A was justified.

Detailed Analysis:

Issue 1: Restriction of Deduction under Section 10A by Applying Section 10A(7)
The AO restricted the assessee's claim of deduction under section 10A by applying section 10A(7) read with section 80IA(10). The AO argued that the profit margin declared by the assessee at 97.32% was abnormal compared to other companies in a similar line of business, which showed an average profit margin of 74.66%. The AO concluded that the books of accounts maintained by the assessee could not be relied upon and restricted the profit margin to 74% of the gross turnover.

The CIT(A) deleted the addition made by the AO, observing that the AO is bound by the findings of the TPO and should not have ventured into the domain of the TPO after receiving the TPO's order. The CIT(A) found the AO's action devoid of merit and allowed the assessee's appeal.

The Tribunal upheld the CIT(A)'s decision, noting that the AO failed to establish that the assessee and its AE arranged their business transactions to derive excess profit. The Tribunal emphasized that section 80IA(10) requires the AO to establish on record that there was an arrangement between the assessee and its AE to produce more than ordinary profits. Since the AO did not provide any conclusive finding or positive evidence to this effect, the disallowance was deemed unjustified.

Issue 2: AO Venturing into the Domain of the TPO
The AO accepted the TPO's determination of the Arm's Length Price (ALP) but proceeded to restrict the profit margin for the purpose of computing deduction under section 10A. The CIT(A) observed that the AO had ventured into the domain of the TPO, which was not appropriate.

The Tribunal agreed with the CIT(A), noting that the AO's action was not justified. The Tribunal highlighted that the AO should not have disturbed the TPO's findings regarding the ALP and should have restricted his assessment to the determination of the deduction under section 10A.

Issue 3: Justification of Disallowance of Part of the Deduction under Section 10A
The AO disallowed part of the deduction under section 10A, arguing that the profit margin declared by the assessee was unreasonably high. The CIT(A) deleted the disallowance, and the Tribunal upheld this decision.

The Tribunal emphasized that the AO must establish that there was an arrangement between the assessee and its AE to produce more than ordinary profits. The Tribunal noted that the AO's reliance on the Transfer Pricing (TP) study and the profit margins of comparable companies was insufficient to justify the disallowance. The Tribunal observed that the AO did not provide any conclusive evidence of an arrangement between the assessee and its AE.

The Tribunal referred to several judicial decisions supporting the view that the AO must provide substantial evidence to justify the disallowance under section 80IA(10). The Tribunal concluded that the AO's disallowance was based on mere presumptions and surmises, and therefore, the disallowance was not justified.

Conclusion:
The Tribunal dismissed the department's appeal, upholding the CIT(A)'s decision to delete the disallowance of part of the deduction under section 10A. The Tribunal found that the AO's actions were not justified, as the AO failed to establish that there was an arrangement between the assessee and its AE to produce more than ordinary profits. The Tribunal emphasized the importance of providing conclusive evidence and not relying on mere presumptions and surmises.