Racold Thermo Limited (Formerly ... vs Assessee

Racold Thermo Limited, The Addl. Commissioner of (Formerly Ariston Thermo India Ltd.), Income Tax, Gat No. 265, 374, 376, Range - 8, Pune Vs. Talegaon Road, Kharabwadi, Pune-410501 (Appellant) (Respondent) PAN No. AAECM0766G

Revenue By: Shri A.K. Modi Assessee By: Shri Ashwani Taneja

Date of hearing : 29-04-2015 Date of pronouncement : 26-06-2015

ORDER

PER VIKAS AWASTHY, JM:-

The appeal has been filed by the assessee against the order of

Commissioner of Income Tax (Appeals)-V, Pune dated 24-01-2013 for the

assessment year 2008-09.

2. The brief facts of the case are: The assessee is a 100% export

oriented Unit (EOU), engaged in manufacturing of water heaters. The

assessee filed its return of income for the assessment year 2008-09 on

30-09-2008 declaring total income of Rs.12,49,220/-. The assessee

declared book profit under MAT provisions at Rs.11,79,82,223/- and

paid taxes accordingly. The case of the assessee was selected for

scrutiny and notice u/s. 143(2) was issued to the assessee on 29-09- 2 ITA No. 828/PN/2013, A.Y. 2008-09

2009. A reference u/s. 92CA of the Income Tax Act, 1961 (hereinafter

referred to as "the Act") was made to the Transfer Pricing Officer (TPO)

for determination of Arm's Length Price (ALP) with reference to the

transactions with Associated Enterprise (AE). The assessee entered into

transaction of sale with its AE on which it earned margin of 20.24%.

The assessee justified before TPO the Arm's Length Price (ALP) by

showing the margin of comparables at 5.15%. The TPO accepted ALP of

transaction and passed order dated 07-09-2011 u/s. 92CA of the Act,

without making any Transfer Pricing Adjustment. However, the

Assessing Officer during the course of scrutiny assessment made certain

additions/disallowances by invoking the provisions of section 10B(7)

r.w.s. 80IA(10) of the Act. The Assessing Officer made addition of

Rs.9,56,36,478/-on account of disallowance u/s. 10B of the Act. The

Assessing Officer held that the Operating Profit/Sales of the assessee are

not within +/- 5% range. The assessee has not placed on record

profitability of the AE to whom sales have been made. The assessee has

inflated the profits in India and has claimed deduction u/s. 10B thereon.

The assessee has arranged it's affairs vis-à-vis it's AE in such a manner,

that the entire sale made to the associated concern has become the cost

of the AE, eventually reducing the profit in the foreign country. The

Assessing Officer recomputed the deduction u/s. 10B by adopting profits

at 5.15% and disallowed the claim of deduction u/s. 10B to the tune of

Rs.9,56,36,478/-.

Aggrieved by the assessment order dated 29-12-2011, the assessee

preferred an appeal before the Commissioner of Income Tax (Appeals).

The Commissioner of Income Tax (Appeals) vide impugned order upheld

the findings of the Assessing Officer and dismissed the appeal of the

assessee.

3 ITA No. 828/PN/2013, A.Y. 2008-09

Now, the assessee has come in second appeal before the Tribunal

assailing the findings of the Commissioner of Income Tax (Appeals).

3. In the grounds of appeal the assessee has taken as many as 10

grounds. All the grounds are directed against the disallowance of

deduction u/s. 10B of the Act and misinterpreting transfer pricing

provisions for making addition.

4. Shri Ashwani Taneja appearing on behalf of the assessee

submitted that the Assessing Officer has erred in invoking the provisions

of section 10B(7) r.w.s. 80IA(10). The ld. Counsel for the assessee

submitted that the authorities below have erred in coming to the

conclusion that the assessee is earning more than ordinary profits in the

business dealings with its Associated Enterprises (AE). The Assessing

Officer has erred in calculating deduction u/s. 10B by adopting 5.15%

ordinary profits and reducing/disallowing deduction u/s. 10B in excess

of 5.15%. The ld. Counsel contended that the Assessing Officer has

exceeded his jurisdiction in making addition. Once the TPO suggests

that the operating profit declared by the assessee is comparable to ALP

norms and no adjustment is necessary, the operation of all Transfer

Pricing provisions come to an end. When the TPO has found no case for

treating the good margins earned by the assessee in preceding and

succeeding year, there is no justification for treating the margin of the

year under appeal as more than ordinary profit for the purpose of section

10B(7) r.w.s. 80IA(10). In support of his submissions the ld. AR placed

reliance on following decisions:

1) Tweezerman (India) (P.) Ltd. Vs. ACIT reported as 4 ITR (Trib.) 130

(Chennai).

4 ITA No. 828/PN/2013, A.Y. 2008-09 2) Visual Graphics Computing Services (India) Pvt. Limited Vs. ACIT

reported as 15 ITR (Trib.) 393 (Chennai).

3) ACIT Vs. Handy Waterbase India (P.) Ltd. reported as 140 ITD 112

(Chennai).

4) Digital Computer Equipment Limited Vs. DCIT reported as 103

TTJ 329 (Bangalore ITAT).

5) CIT Vs. Schmetz India Pvt. Ltd. reported as 254 CTR (Bom) 504.

The ld. AR further contended that it is on the basis of assessment

order in the case of Honeywell Automation (I) Ltd. for assessment year

2006-07 that the Assessing Officer had made addition. The Pune Bench

of the Tribunal in ITA No. 18/PN/2011 for assessment year 2006-07 in

the case of M/s. Honeywell Automation India Limited Vs. DCIT decided

on 25-02-2015 has reversed the findings of Assessing Officer on this

issue. Therefore, the impugned order is not sustainable.

5. On the other hand Shri A.K. Modi representing the Department

vehemently supported the impugned order. The ld. DR submitted that

the authorities below have passed well reasoned and detailed order while

restricting the disallowance of the assessee u/s. 10B of the Act. The

assessee has shown operating margin profit of 20.24%, as compared to

arithmetic mean of 5.15% which is very much on the lower side. Since,

the close connection between the assessee and it's AE is clearly

established, therefore, the assessee is clearly hit by the provisions of

section 10B(7) r.w.s. 80IA(10) of the Act. On the decisions cited by the

ld. AR, the ld. DR submitted that all the decisions cited by the assessee

are distinguishable. The authorities below have given reasons

distinguishing the case laws relied upon by the assessee. 5 ITA No. 828/PN/2013, A.Y. 2008-09

6. We have heard the submissions made by the representatives of

both the sides and have perused the orders of the authorities below. It is

an undisputed fact that on reference made to TPO, the TPO has not

made any adjustment in the international transaction with regard to ALP

with it's AE. The sum and substance of the submissions made by ld.

Counsel for the assessee is that once the TPO had accepted the

international transaction at ALP, the Assessing Officer cannot step into

the shoes of the TPO to make disallowance/addition with regard to

international transaction by invoking the provisions of section 10B(7)

r.w.s. 80IA(10) of the Act.

Before we proceed further, let us first examine the provisions of

section 10A(7) and section 80IA(10) of the Act.

Section 10A(7): The provisions of sub-section (8) and sub-section (10) of section 80-IA 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 80-IA.

Section 80IA(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:

[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 arms's length price as defined in clause (ii) of section 92F.].

A bare perusal of the provisions of sub-section 10 of section 80IA

shows that, it is essential to establish that the business of the assessee

and the other person (AE) is so arranged that the business between them 6 ITA No. 828/PN/2013, A.Y. 2008-09

produces more than the ordinary profits. Before invoking the provisions

of section 10A(7) and section 80IA(10) duty is cast upon the Assessing

Officer to show the arrangement of business of assessee and the other

person (AE) resulting in more than ordinary profits in the course of

business between them. In the instant case, we observe that the

Assessing Officer has not been able to demonstrate any 'arrangement'

made by assessee resulting in more than ordinary profits.

7. The Co-ordinate Bench of the Tribunal had occasion to deal with

similar issue in the case of M/s. Honeywell Automation India Ltd. Vs.

DCIT (supra). The Co-ordinate Bench of the Tribunal in an articulate

manner has discussed the provisions of section 10A(7) r.w.s. 80IA(10) of

the Act. The Bench has also in a very elucidate manner has explained

the term 'arranged' used in section 80IA(10). The relevant extract of the

order of Tribunal in the said case are reproduced here-in-under:

"23. Quite clearly, the provisions of section 10A(7) of the Act intend to plug abuse of tax concession by manipulation of profits between associated concerns or between different units of the same concern. The objective of the aforesaid Provision is that the tax concessions are not abused by manipulation of profits. In our considered opinion, the aforesaid explanation in the CBDT Circular (supra) signifies the legislative intent and it is also manifested in the language of section 10A(7) r.w.s. 80- IA(10) of the Act. We say so for the reason that the phraseology of section 80-IA(10) of the Act itself suggests that the profits and gains of an eligible business cannot be tinkered with by the Assessing Officer merely because they are more than the ordinary profits or that they are quite high. The existence of substantial or more than ordinary profits by itself does not sufficiently empower the Assessing Officer to disregard them and determine the profits which he may consider to be reasonably deemed to have been derived therefrom. The presence of the expression "the course of business ............ is so arranged ............. that the business transacted ............... produces to the assessee more than ordinary profits" is significant and its understanding has to be prefaced by the legislative objective of plugging abuse of the tax concessions granted u/s 10A of the Act by manipulation of profits between associated parties. In other words, 7 ITA No. 828/PN/2013, A.Y. 2008-09

the import of the expression "so arranged" has to be read in conjunction with the legislative intent that there should not be any abuse of tax concession by manipulation of profits. Therefore, section 10A(7) r.w.s. 80- IA(10) of the Act can be invoked only where it is shown that the course of business is so arranged which reflects an abuse of tax concession whereby the business transacted between two entities is so arranged, which produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business. The emphasis is to eschew those 'more than the ordinary profits' which are as a result of a business between two closely connected concerns having been arranged with the intent of abuse of the tax concession. Ostensibly, in the present case, the Revenue would have to justify that the course of business between assessee and the associated enterprises has been 'so arranged' which produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business with the intention of abusing the tax concession granted in section 10A of the Act. The mere existence of (i) a close connection between the assessee and the other person; and, (ii) more than ordinary profits is not sufficient to justify invoking of section 80-IA(10) of the Act in the absence of there being any material to say that the course of business between them is "so arranged"

to abuse the tax concessions granted u/s 10A of the Act by manipulating profits between associated persons. Ostensibly, the same is required to be demonstrated on the basis of a cogent material and evidence. In other words, the presence of the expression "so arranged" has to be understood in the context of the abuse of tax concession which is sought to be plugged by the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act.

24. xxxxxxxxxxxxxxxxxxxx

25. We have carefully examined the aforesaid contentions of the Ld. CIT-DR. In our considered opinion, the import of the expression "arranged" in section 80-IA(10) of the Act is not to be understood in its plain language but the same has to be understood in the context in which it is placed in the section. Notably, section 80-IA(10) of the Act restricts the plain meaning of the term "arranged" because it is placed between the words "........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........." . Therefore, it would necessarily mean that the 'arrangement' referred to is an arrangement of the course of business which produces to the assessee more than the ordinary profits with the intent of abusing the tax concession. Thus, the word "arranged" in the 8 ITA No. 828/PN/2013, A.Y. 2008-09

section does not envisage a simple arrangement, but a arrangement of "the course of business transacted" which produces to the assessee more than ordinary profits which might be expected to arise in such a business with the intent of abusing the tax concessions. Therefore, the meaning of the words "so arranged" have to be understood in the context in which they are placed in section 80-IA(10) of the Act. A mere agreement between the assessee and the associated enterprises for transacting business is not enough to invoke section 80-IA(10) of the Act.

26. In-fact, even the Hon'ble Bombay High Court in the case of Bank of India Ltd. (supra) has also appreciated the contextual meaning of the expression "arrangement". The issue before the Hon'ble Bombay High Court was with regard to the scheme of re-construction or arrangement contained in section 391(1) of the Companies Act, 1956. In the context of section 391(1) of the Companies Act, 1956, the Hon'ble High Court was dealing with the meaning of the word "arrangement". After having explained the meaning of the term arrangement in plain language, which we have referred earlier, the Hon'ble High Court went on to say as under

in the context of the word "arrangement" qua section 391(1) of the Companies Act, 1956 :-

"Section 391(1), however, in any opinion somewhat restricts this otherwise unlimited import of the term "arrangement" in so far as the said section applies only to an agreement or understanding between the company and its creditors or any class of them, or between the company and its members or any class of them, or between the company and its members or any class of them, which would necessarily mean that it must be an agreement or understanding which affects their rights"

[underlined for emphasis by us]

27. The aforesaid clearly points out that the Hon'ble High Court imparted meaning to the word "arrangement" in the context of section 391(1) of the Companies Act, 1956 to mean that it must be an agreement or understanding which affects the rights between the company and its creditors or any class of them and between the company and its members or any class of them. By the same analogy in the present context, we have to understand the meaning of the expression "as arranged" in section 10A(7) r.w.s. 80-IA(10) of the Act to mean a situation whereby the course of business has been so arranged that the business transacted produces to the assessee more that the ordinary profits with an intent to abuse the tax concessions granted in section 10A of the Act. Moreover, if one is to understand the import of the expression "so arranged" in section 80-IA(10) of the Act as canvassed by the Ld. CIT-DR, it would mean that 9 ITA No. 828/PN/2013, A.Y. 2008-09

for the purposes of fulfillment of the conditions prescribed in section 10A(7) r.w.s. 80-IA(10) of the Act, existence of mere close connection and more than the ordinary profits would suffice. In other words, as per the Revenue, the existence of close connection and high profits would lead to a presumption that there is an "arrangement" within the meaning of section 80-IA(10) of the Act. The aforesaid plea, in our view, not only belies the language of section 80-IA(10) but also the legislative intent which seeks to curtail the abuse of tax concession by manipulation of profits between associated concerns. Therefore, an arrangement which is referred to in section 10A(7) r.w.s. 80-IA(10) of the Act has to be one which is prefaced by an intention to abuse the tax concessions, as per the intendment of the legislature. Therefore, existence of a mere agreement to do business is not enough to fulfill the requirement of section 10A(7) r.w.s. 80-IA(10) of the Act in the context of the words "the course of business between them is so arranged".

The Co-ordinate Bench after appreciating the facts of the case and

the provisions of sections concluded that the Assessing Officer has not

been able to prove any arrangement arrived at between the parties which

resulted in higher profits. Consequently, the re-working of profits by

Assessing Officer by invoking section 10A r.w.s. 80IA(10) of the Act is not

justified.

8. Before the Chennai Bench of the Tribunal in the case of

Tweezerman (Indida) (P.) Ltd. Vs. ACIT (supra), the assessee had

challenged the action of Revenue in denying deduction u/s. 10B of the

profits in excess of the ALP by invoking the provisions of section 10B(7)

r.w.s. 80IA(10) of the Act.

The Tribunal rejected the contentions of Revenue and held that the

Assessing Officer was not justified in invoking the provisions of section

80IA(10) r.w.s. 10B(7) so as to reduce the eligible profits on the basis of

reduction of arm's length profit reported by TPO without showing how he

deemed that assessee has shown more than ordinary profit and without 10 ITA No. 828/PN/2013, A.Y. 2008-09

giving any calculation on the basis of which excess profit was determined

by him.

9. The Chennai Bench of the Tribunal in the case of Visual Graphics

Computing Services (India) Pvt. Limited Vs. ACIT (supra) while dealing

with a similar issue followed the decision of Tweezerman (India) (P.) Ltd.

Vs. ACIT (supra) and held as under:

"24. We heard both sides in detail and considered the issue. As far as the present case is concerned, the TPO has made a categorical finding that the operating profit reported by the assessee is higher than the profit worked out on the basis of ALP. The TPO, therefore, concluded that no TP adjustment is called for in the present case. The Assessing Officer has made the reference to the TPO under sec.92CA. The reference is made for the purpose of computing income arising from an international transaction with regard to ALP as provided in sec.92. Therefore, it is to be seen that the scope and extent of reference made by the Assessing Officer to the TPO is confined to the singular purpose stated in sec.92. Sections 92A, 92B, 92C, 92CB, 92D, 92E and sec.92F are all, precisely defining and facilitating provisions ultimately for the purpose of computing the income as stated in sec.92. All the above stated sections provided in Chapter X of the Income-tax Act, 1961 belong to a separate code as such, enacted for the purpose of computing income from international transactions having regard to ALP so as to confirm that there is no avoidance of tax by an assessee. Therefore, where in a case, the TPO suggests that the operating profit declared by an assessee is compatible to ALP norms and no adjustment is necessary, the operation of all those provisions come to an end. If the Assessing Officer has to make any other adjustment towards computing deduction available under sec.10A, the computation has to be made in the context of sec.10A(7) read with sec.80IA(10).

25. It is clear that in a case of Transfer Pricing assessment, it has got two segments. The first segment consists of rules and procedures for computing the income other than the income arising out of international transactions with Associate Enterprise. The second segment consists of rules and procedures in connection with computation of income from international transactions with AE on the basis of ALP. The second segment relating to computation of ALP, is a set of rules for the purposes of Transfer Pricing matters and those procedures and rules can be used only for the purpose serving the object of sec.92. When the TPO states that 11 ITA No. 828/PN/2013, A.Y. 2008-09

there is no need of TP adjustment, the matter should end there and any other adjustment that the Assessing Officer would like to make with reference to the first segment must be made independent of the order of the TPO under sec. 92CA.

26. To state in simple terms, the TP regime is different from regular computation of income. Sec.10A belongs to that part of regular computation of income and it should be computed independent of TP regulations and TP orders. It is not therefore, permissible for the Assessing Officer to work out sec.10A deduction on the basis of ALP profit generated out of the order of the TPO.

[Emphasized by us]

27. In fact these issues have already been considered in various orders of the Tribunal. The ITAT, Chennai 'A' Bench in the case of TweezerMAN (India) (P) Ltd. v. ACIT (133 TTJ 308) has considered the matter in detail and held that the reduction of eligible profits of an assessee as done by the Assessing Officer by invoking the provisions of sec.80IA(10) read with sec.10B(7), in the context of TPO's order is unsustainable. The Tribunal has held that the Assessing Officer was not justified to invoke the provisions of sec.80IA(10) read with sec.10B(7) so as to reduce the eligible profits on the basis of the ALP computed by the TPO without showing how he determined that the assessee had shown more than "ordinary profits".

28. As rightly argued by the learned senior counsel, ALP is determined on the basis of the most appropriate method. Most appropriate method is chosen either on profit basis method or price basis method. In the latter case, profits are not at all considered. In that method, profit is only a derivative of prices. When profits itself not worked out, how it is justified to adopt ALP profits to determine what is "ordinary profits" for the purpose of sec.10A(7)?

29. In the facts and circumstances of the case, we hold that the Assessing Officer has erred in reducing Rs.4,48,50,795/- from the eligible profits of the assessee under sec.10A. The said adjustment made by the assessing authority in computing the deduction under sec.10A is accordingly, deleted."

Similar view has been taken in the case of ACIT Vs. Handy

Waterbase India Pvt. Ltd. (supra).

12 ITA No. 828/PN/2013, A.Y. 2008-09

10. A perusal of the assessment order shows that the Assessing Officer

has followed his own order in the case of Honeywell Automation (I) Ltd.

(supra) for assessment year 2006-07 to make disallowance/deduction

u/s. 10B(7) r.w.s. 80IA(10) of the Act in the case of assessee. The

findings of the Assessing Officer on the issue in the case of Honeywell

Automation (I) Ltd. (supra) have been reversed by the Tribunal in ITA No.

18/PN/2011 decided on 25-02-2015. The relevant extract of the order of

Co-ordinate Bench of the Tribunal have clearly been reproduced in

paragraph 7 here-in-above. Since, the substratum for making addition

has been eroded, the disallowance will not sustain.

11. The Commissioner of Income Tax (Appeals) has upheld the

findings of Assessing Officer by stating that there is a close connection

between the appellant and the AE and the entire sales have been made

by assessee to AE and not to other independent parties. However,

nothing has been brought on record to show that the assessee has

arranged his business with its AE that has produced more than the

ordinary profits. Once TPO in his study has accepted the international

transaction at ALP without making addition, the Assessing Officer in our

opinion has exceeded his jurisdiction in invoking the provisions of

section 10A(7) r.w.s. 80IA(10) with respect to same transaction for

making disallowance. The ld. AR of the assessee has pointed out that in

the preceding and subsequent assessment years the assessee had good

margins as against the comparables.

Assessment year Margin of Assessee Margin of Comparables 2007-08 30.92% 6.19% 2008-09 20.24% 5.15% 2009-10 28.20% 7.26% 13 ITA No. 828/PN/2013, A.Y. 2008-09

In all the three assessment years the TPO found that no

adjustment is required to be made in ALP of international transaction.

The Assessing Officer in assessment proceedings u/s. 143(3) in the

preceding and succeeding assessment years did not make any

disallowance of deduction u/s. 10B. No cogent reason has been deduced

by the Assessing Officer in the impugned assessment year to make

disallowance.

In view of the facts of the case and various decisions of the

Tribunal discussed above, we accept the appeal of the assessee. The

impugned order is set aside and the appeal of the assessee is allowed.

Order pronounced on Friday, the 26th day of June, 2015

at Pune

Sd/- Sd/-

(R.K. PANDA) (VIKAS AWASTHY) ACCOUNTANT MEMBER JUDICIAL MEMBER

Pune, Dated: 26th June, 2015 RK/PS

Copy to

1 Assessee 2 Department 3 The CIT(A)-V, Pune 4 The CIT-V, Pune 5 The DR, ITAT, "B" Bench, Pune. 6 Guard file.

//True Copy//

By Order

Private Secretary, Income Tax Appellate Tribunal, Pune