2019 (1) TMI 471 - HC - Income Tax

Exemption u/s 10A - Separate and segregated accounts - profit margin of the STPI unit was higher than the profit margin of the non-STPI unit - book results rejection - Held that - On the substantive aspect and reasoning, the Tribunal agreed with the findings recorded by the CIT (A) that AO was not justified in transposing expenditure from non-exempt to exempt unit on the general assumption that net profit in distinct lines cannot be different and must be the same. Separate and segregated accounts cannot be rejected on the ground that the profit margin of the STPI unit was higher than the profit margin of the non-STPI unit, without pointing out any discrepancy, error or mistake in the accounts. The findings are unchallengeable. AO was unable to point out any defects, deficiencies or wrong entry in the books of accounts for the exempt and non-exempt unit. The Act does not prohibit an assessee from having non-STPI unit and STPI unit. This is not the case and the allegation made by the Revenue. It is also not the case and allegation of the Revenue that the business or orders undertaken by the non-STPI unit were transferred to the STPI unit. The two lines of business were separate. The finding that the two lines of business were separate has not been questioned. Expenditure declared and disclosed as incurred for non-exempt unit cannot be treated and transposed as expenditure incurred on exempt unit, on assumptions and surmises by referring to difference in turnover, expenses and net profit rate of exempt and non-exempt units. This cannot justify the AO s direction to shift 90% of the expenditure from the non-exempt unit and treat it as expenditure of the exempt unit, thereby reducing the profit in the STPI unit. Inference and deduction solely based and predicated on net profit rate is nothing but a surmise and conjecture. U/s 144 book results cannot be rejected only on the ground of decrease or difference in gross profit rate compared to other years or another assessee. Neither can the book results be rejected for the reason that gross or net profit rates in the two lines of business are different. The difference can be the starting point of investigation and verification but not the essence to reject the book results and make best judgment assessment. No substantial question of law arises for consideration

Issues Involved:
1. Legitimacy of disallowance of the exemption claim under Section 10A of the Income-tax Act, 1961.
2. Justification for reallocating expenses from non-exempt to exempt units.
3. Validity of the Assessing Officer's (AO) approach to rejecting the books of accounts.
4. Eligibility for deduction under Section 10A concerning specific income items.

Issue-wise Detailed Analysis:

1. Legitimacy of Disallowance of the Exemption Claim under Section 10A:
The respondent-assessee, engaged in software development and support, claimed an exemption under Section 10A for its STPI unit. The AO disallowed the entire claim of ?1,48,89,090, suspecting that the assessee had shifted expenses to the non-exempt unit to inflate profits in the exempt unit. The Commissioner of Income Tax (Appeals) (CIT(A)) overturned this disallowance, noting that the AO failed to identify any dubious or incorrect entries in the books of accounts. The Tribunal upheld the CIT(A)'s decision, emphasizing that separate accounts for exempt and non-exempt units were maintained, and no discrepancies were found.

2. Justification for Reallocating Expenses from Non-exempt to Exempt Units:
The AO observed significant differences in turnover and expenses between the exempt and non-exempt units, operating under the same infrastructure. He inferred that expenses were shifted to the non-exempt unit, leading to a higher profit margin in the exempt unit. The CIT(A) and the Tribunal rejected this inference, stating that separate accounts were maintained, and the AO's assumption lacked evidence. The Tribunal highlighted that merely having different profit margins in distinct business lines does not justify reallocating expenses without concrete discrepancies in the accounts.

3. Validity of the AO's Approach to Rejecting the Books of Accounts:
The AO's approach of reallocating expenses based on assumptions and surmises was deemed incorrect. The CIT(A) noted that the AO resorted to estimation without evidence, while the Tribunal emphasized that book results cannot be rejected solely based on differences in profit margins. The Tribunal reiterated that the AO must point out specific defects or errors in the accounts to justify such reallocation.

4. Eligibility for Deduction under Section 10A Concerning Specific Income Items:
The CIT(A) observed that the assessee credited ?16.59 crores in its Profit & Loss Account, which was not earned through manufacturing or export of software but as a remission of liability under Section 41(1) of the Act. This amount, along with interest on fixed deposits, was deemed ineligible for deduction under Section 10A. The Tribunal corrected these factual inaccuracies, excluding ?16,59,42,925 and ?36,28,383 from the exempt income under Section 10A, while agreeing with the CIT(A) on the substantive reasoning.

Conclusion:
The High Court dismissed the appeal, affirming that no substantial question of law arose. The AO's inability to point out specific defects in the books of accounts and reliance on assumptions to reallocate expenses were key factors in upholding the CIT(A) and Tribunal's decisions. The judgment underscores the importance of concrete evidence and proper verification in tax assessments, particularly concerning exemptions under Section 10A.

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