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TMI Blog2015 (9) TMI 552X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ordi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vices (ITES), which otherwise, is known as Knowledge Process Outsourcing (KPO). For the AY under consideration, assessee filed its return of income on 29/09/2011 declaring total income of ₹ 11,37,130 after claiming exemption u/s 10A of the Act for an amount of ₹ 81,36,35,886. Since assessee s international transaction with its AE exceeded threshold limit of ₹ 15 crores, AO made a reference u/s 92CA(3) to the Transfer Pricing Officer (TPO) for determining Arm s Length Price (ALP) of the international transaction. In course of proceeding before TPO, he examined the TP study submitted by assessee along with other information and materials available on record. He noticed that assessee has carried out TP study through an external consultant for bench marking the price charged for international transaction with AE. Assessee for the purpose of TP analysis has adopted Transaction Net Margin Method (TNMM) as most appropriate method with Operating Profit (OP) to sales as Profit Level Indicator (PLI). After conducting a search in the data bases by applying certain filters, seven companies have been selected as comparables having average arithmetic mean of 36.53%. However, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the average profit declared by other companies in similar line of business for the purpose of computing deduction u/s 10A of the Act. 4. In response to the query raised by AO, assessee submitted a reply vide letter dated 18/03/2013 objecting to the proposed action of AO in restricting the profit of assessee to a lesser percentage. It was submitted by assessee that the excess profit earned by assessee is for varied reasons, such as, exposure of higher profit liability risk, premium pricing, niche area segment etc. AO, however, did not find merit in the submissions of assessee. He observed that expenses claimed by assessee is very low when compared with other comparables. He also noted that agreement between assessee and its AE are not as per the market norms. AO noted, when the entire content is developed by assessee and are charged at $ 50 per man hour from its AE, proportionate expenses were not taken to the books of account. He observed that for a turnover of ₹ 83.49 crores, assessee has incurred salary expenditure of ₹ 80.41 lakhs, which is only 0.96% of the turnover. He, therefore, concluded that books of account maintained by assessee cannot be relied upon. AO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otally irrelevant. He, therefore, submitted, order of ld. CIT(A) should be set aside and disallowance made by AO should be restored. 7. Ld. AR, on the other hand, strongly supporting the order of ld. CIT(A), submitted, AO while restricting the profit margin of assessee to 74% has not complied to the provisions of section 80IA(10) of the Act. He submitted, the primary condition for invoking section 80IA(10) is AO must be satisfied that assessee and the related party must have arranged their business transactions in such a manner so as to derive excess profit. Ld. AR submitted, unless AO establishes on record such an arrangement made by assessee, no disallowance of assessee s claim of deduction u/s 10A can be made by invoking provisions of section 10A(7) read with section 80IA(10) of the Act. Ld. AR explaining the reason behind profit declared by assessee submitted, assessee hardly incurred expenses towards salary as it has employed only three persons for creating the contents. It was submitted, one of the partners of assessee, who is also a professional, renders services to the firm in preparing content and other related activities without charging any remuneration. Therefore, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nreasonably high rate of profit only for the purpose of claiming exemption u/s 10A of the Act. Therefore, invoking the provisions of section 10A(7) read with section 80IA(10) of the Act, AO has restricted the profit margin of assessee to 74% and computed exemption u/s 10A accordingly. However, as can be seen from the facts on record, assessee for bench marking price charged for international transactions with AE has conducted a TP study, wherein certain comparable companies having average arithmetic mean of 36.53% have been selected. TPO has also independently conducted analysis by selecting comparables on his own. The average arithmetic mean of comparables selected by TPO worked out to 52.69%. On a careful examination of the comparables selected by assessee, it is found that OP to sale ratio of the comparable companies fluctuates from as low as 11.88% to a high of 74.26%. Similarly OP to OC ratio of comparable companies selected by TPO indicates lowest OP to OC of 7.42% as against the highest OP to OC of 289.50%. Even, the comparable companies considered by AO indicate that OP to sales ratio of two companies is 85% and 88%, whereas, margin of another company is 51%. Thus, analysis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... la Software Services Hyderabad Pvt Ltd. Vs. DCIT, ITA No. 423/Hyd/14, dated 30/06/2015, held as under: 7. We have considered the submissions of the parties and perused the orders of revenue authorities as well as other materials on record. As far as the applicability of section 10A(7) is concerned, in our view, the issue has attained finality as the directions of ITAT in the earlier round of litigation has not been challenged by assessee or by revenue. Keeping this in view, we have to decide whether disallowance of deduction u/s 10A of the Act by applying the provisions of section 80IA(1) is valid. As can be seen, section 10A of the Act allows exemption at 100% of the profit earned by assessee from export of software. However, deduction u/s 10A is subject to 10A(7), which in turn refers to section 80IA(8) and 80IA(10) of the Act. Since 80IA(8) is not relevant for our purpose, there is no need to discuss the same. As far as the provisions contained u/s 80IA(10) is concerned, it reads as under: Where it appears to the AO 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cumentation the average margin of comparable companies are 15% where as the assessee has shown profit at 50%, the departmental authorities have reduced the deduction claimed u/s 10A by restricting the profit from the eligible business of assessee to 20% of the turnover. In our view, the Department having not fulfilled the conditions of section 80IA(10), disallowance in the present case is not justified. At the cost of repetition, it needs to be stated that only relying upon TP documentation, AO has inferred that the profit earned by assessee at 50% is more than the arm s length profit. However, without bringing material on record that the profit earned by assessee at 50% is not the profit ordinarily earned in similar line of business, it cannot be said that it is not at arm s length. Moreover, excess profit may be due to various reasons. Therefore, without analysing those factors, it cannot be said that only because average profit earned by comparables is 15%, the profit earned by assessee at 50% is not reasonable. The Chennai Bench of the Tribunal in case of Tweezmen India Pvt. Ltd., Vs. Addl. CIT, 133 TTJ 308 while considering similar issue held that the provisions of section 80I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to allow deduction as claimed. Examining the facts of the present case in the light of the decisions referred to hereinabove, it is noticed that in the present case also AO has simply relied on the TP study report of assessee to conclude that the profit earned by assessee cannot be considered to be reasonable profit earned from eligible business and on that basis has disallowed part of the deduction u/s 10A. Therefore, since AO has not conclusively proved the fact that there is an arrangement between assessee and its AE by which the transactions were so arranged as to produce more than the ordinary profits in the hands of assessee, disallowance of part deduction claimed by applying the provisions of section 80IA(10), in our view is not justified. Since ld. CIT(A) upheld the disallowance without examining the aforesaid aspect, order of ld. CIT(A) deserves to be set aside. The conditions of section 80IA(1) having not been fully complied by AO, disallowance of deduction claimed u/s 80IA(10), in our view is not justified. Accordingly, we delete the addition made by AO in this regard. 8.2 The principle decided as aforesaid by the coordinate bench clearly applies to the facts ..... X X X X Extracts X X X X X X X X Extracts X X X X
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