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Income Tax Appellate Tribunal, “C” BENCH, PUNE
Before: SHRI R.S. SYAL & SHRI S.S. VISWANETHRA RAVI
आदेश / ORDER
PER S.S. VISWANETHRA RAVI, JM :
These two appeals by the assessee and Revenue against the common order dated 27-02-2015 passed by the Commissioner of Income Tax (Appeals)-13, Pune [„CIT(A)‟] for assessment year 2003-04.
Shri Ajit Kumar Jain, the ld. AR submits that the issues raised in both the appeals are based on the same identical facts and prayed to hear both the appeals together. With the consent of both the parties, we proceed to hear both the appeals together and pass consolidated order for the sake of convenience.
First, we shall take up the appeal in ITA No.583/PUN/2015 for A.Y. 2003-04 by the assessee.
Ground No. 1 is general in nature, hence, requires no adjudication.
Ground Nos. 2 to 11 raised by the assessee challenging the action of CIT(A) in enhancing the income thereby consequently enhancing the income of the assessee by invoking the provisions contemplated in sub- section (7) of section 10A of the Act.
Heard both parties and perused the material available on record. The contentions of CIT(A) that the assessee earned more than ordinary profit in the eligible business in respect of Software Design Engineering Services for both the A.Ys. 2003-04 and 2005-06 and the deduction u/s. 10A should be restricted to the ordinary profit earned by the comparable
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companies. The assessee earned net margin of 92.98% and comparable companies is at the average net margin of comparable at 26.62% and by invoking the provisions of sub-section (7) of section 10A proposed to disallow by restricting the deduction to ordinary profit. The contention of assessee is that the AO did not make any addition in terms of sub-section (7) of section 10A of the Act and enhancement proposed by the CIT(A) is not warranted u/s. 251(2) of the Act. The case of CIT(A) is that the deduction u/s. 10A is to be restricted to the extent of ordinary profit earned by the assessee be that of comparable companies by invoking the provisions of sub-section (7) of section 10A of the Act.
The assessee submitted that the provisions of section 10A(7) of the Act is not applicable to the fact that the net profit earned by it is not more than ordinary profit. The CIT(A) observed that section 10A(7) can be applied even if there is no corresponding benefit derived by other party and closely connected enterprises by arranging their international transactions amongst themselves denying the right share of revenue as provide in the statute. Therefore, according to him the closely arranged between the assessee and other parties reducing its domestic tax base and sub-section (7) of section 10A of the Act be denied excessive tax collection i.e. deduction on more than ordinary profit in the eligible business. The ld. AR placed on record the order dated 06-03-2019 passed by this Tribunal in assessee‟s own case in ITA No. 473/PUN/2016 for A.Y. 2011-12 and submitted the similar issue came up before this Tribunal and the Tribunal by placing reliance in the case of CIT Vs. Schmetz India Pvt. Ltd. of Hon‟ble Bombay High Court and directed to delete the addition made thereon by invoking section 10A(7) of the Act. The Tribunal came up such conclusion basing on the order of this Tribunal in assessee‟s own case for A.Y. 2006-
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07 in ITA No. 18/PUN/2011. The relevant portion at para No. 7 is reproduced here-in-below : “7. We have perused the case records and have given thoughtful consideration to the various judicial pronouncements placed before us. On the same issue in assessee‟s own case in ITA No.18/PUN/2011 for assessment year 2006-07, the Tribunal has held as under: “22. Before we proceed further, it would be appropriate to examine the scope and intent of the provisions of section 10A(7) r.w.s. 80-IA(10) of the Act. In this context, a reference has been made to the CBDT Circular No.308 dated 29.06.2008 wherein the reasons for introduction of sub-section (7) to section10A of the Act has been explained. In-particular, reference has been made to the following contents of the Circular :- “The provisions of sub-section (8) and sub-section (9) of section 80-I will also apply in relation to the industrial undertaking referred to in the new section 10A as they apply in relation to an industrial undertaking referred to under section 80-I. Under the applied sub-section (8) of section 80-I, it is provided that where an Assessee has several units, some in the free trade zone and some outside, the profits of the unit in the free trade zone will be computed after taking the cost of the goods transferred to or from the unit on the basis of the market value of such goods. The applied sub-section (9) of section 80-I empowers the Income-tax Officer to determine the reasonable profits that could be attributed to the qualifying undertaking in the free trade zone in cases where, owing to the close connection between the Assessee and any other persons or for any other reason, the course of the business is so arranged that the industrial undertaking set up in the free trade zone derives more than ordinary profits which may be expected to arise in that business. This provision has been made with a view to avoiding abuse of the new tax concessions by manipulation of profits between associate concerns or different units of the same concern.” [underlined for emphasis by us] 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 ordinaryprofits” is significant and its understanding has to be prefaced by the legislative
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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, 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. On this aspect, the Ld. CIT-DR had vehemently argued, based on the judgement of the Hon‟ble Bombay High Court in the case of Bank of India Ltd. (supra) that the meaning of the word “arranged‟ in section 80-IA(10) of the Act has to be understood to mean an agreement or an understanding between the parties concerned. The relevant portion of the decision of the Hon‟ble Bombay High Court has been reproduced in the earlier part of this order, according to which, it is said that the term arrangement in plain language means any agreement or understanding between the parties concerned. On this basis, the Ld. CIT-DR submitted that undeniably there is an agreement between the assessee and the associated enterprises whereby the services have been provided by the assessee to them and therefore the same is to be understood as an “arrangement” within the meaning of section 10A(7) r.w.s. 80-IA(10) of the Act. Along with the aforesaid, it has also been emphasized, on the basis of the language of section 80-IA(10) of the Act that, the Assessing Officer is not required to be prove that there is an arrangement for producing more than ordinary profits. Whereas, as per the Ld. CIT-DR, section provides that arrangement leading to production of more than ordinary profit will satisfy the necessary condition of section 80-IA(10) of the Act. Thus, according to the Ld. CIT-DR, in the instant case there is an arrangement and it has lead to production of more than the ordinary profits. According to the Ld. CIT-DR, the meaning of the words “so arranged” in section 80-IA(10) of the Act only seeks to ensure that there was an agreement between the assessee and associated enterprise. 25. We have carefully examined the aforesaid contentions of the Ld. CITDR. 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
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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 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 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
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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”. 28. At this stage, we may also address the argument of the Ld. CIT- DR that the burden cast on the Assessing Officer in section 10A(7) r.w.s. 80-IA(10) of the Act is much lighter and even a prima-facie satisfaction of an existence of tax avoidance is sufficient. In this context, we may refer to the decision of the Bangalore Bench of the Tribunal in the case of Digital Equipment India Ltd. (supra), wherein similar argument from the side of the Revenue has been addressed. The Bangalore Bench of the Tribunal was dealing with invoking of section 10A(6) r.w.s. 80-I(9) of the Act for assessment year 1995-96, which are pari-materia to section 10A(7) r.w.s. 80-IA(10) of the Act invoked by the Revenue before us. The following discussion is relevant :- “The requirements under the section are : (a) There must be a close connection between the appellant and other person. (b) The course of business between them should be so arranged that it produces to the appellant more than the ordinary profits from such business. To satisfy the above test the AO has to adduce evidence and reasons cogently and the same is open to verification by the appellate authorities. The primary rule of evidence is that "what is apparent is real" unless proved otherwise by the person alleging it otherwise. The manner of satisfaction outlined in the section should be based on evidence and not on surmise or suspicion. The question is not whether the onus is light or heavy but whether the AO has discussed objectively the conditions mentioned in the section to disturb the results declared by the appellant. In this case, the AO has failed to adduce any evidence or reason to satisfy the invoking of s. 80-1(9). First of all, a mere substantial profit does not give rise to any valid view that there could be any arrangement. It is a case of joint venture listed Indian company, where all arrangements are open for scrutiny and acceptance not only by digital group worldwide but also from joint venture partners and shareholders. Digital group overseas will not pay undue sum, which it cannot recoup entirely to exclusion of others. Hence nothing can be arranged to the exclusive benefit of overseas partner. One cannot presume the existence of close connection or possibility of an arrangement for earning more than ordinary profits. In this case the profits earned is comparable with the profits earned by other companies in the same industry. Hence there is no case for further verification. The AO has compared the profit of software unit with that of hardware unit. Thus the foundation itself is on wrong premise. There cannot be comparison between an orange and an apple. It is known fact that profitability of software units is always higher than hardware unit. The test whether the appellant has earned more than ordinary profits, in this case, the answer is
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obvious NO, even as found by the AO. When the profits earned are reasonable and not excessive, there is no reason to sustain the addition Further there is no evidence of existence of any arrangement as contemplated under s. 80-1(9).” 29. Quite clearly, as per the Tribunal the question is not whether the onus is light or heavy but whether the Assessing Officer has discussed objectively the conditions mentioned in the section to disturb the results declared by the appellant. 30. Now, the case of the Assessing Officer is that the profits derived by the assessee from the eligible business are more than the ordinary profits and therefore he is empowered to arrive at what could be a reasonable profit from such eligible business and such profit be taken as reasonably deemed to have been derived from the eligible business for the purposes of computing the deduction u/s 10A of the Act. We find that in the entire assessment order, there is no material or any evidence which has been brought out to say that the course of business between assessee and the associated enterprises has been so arranged that the business transacted has produced to the assessee more than the ordinary profits. 31. No doubt, there is a close connection between assessee and the associated enterprises and to that extent section 10A(7) r.w.s. 80- IA(10) of the Act has been rightly examined by the income-tax authorities. The second aspect that the course of business was so arranged so as to result in more than ordinary profits is not at all forthcoming from the order of the Assessing Officer. There is no material or evidence referred to in the assessment order to indicate that the course of business has been so arranged so as to inflate profits with the intent to abuse tax concession u/s 10A of the Act. At this point, we may make a reference to the stand of the Assessing Officer that the operating profit margins of the assessee are substantially higher than the average operating margin of the comparables selected by the assessee in its Transfer Pricing Study. This has formed the basis for the Assessing Officer to say that assessee has earned more than ordinary profits which might be expected to arise in such a business. Be that as it may, the aforesaid is not enough to say that the course of business has been so arranged to result in more than ordinary profits. However, from the side of the Revenue, it was pointed out that the Transfer Pricing comparability analysis itself suggests that the profit margins of the assessee are more than the ordinarily accepted margin in this line of business. The moot question is as to whether the same can be considered as a material to indicate that the course of business between the assessee and the associated enterprises has been so arranged, so as to result in „more than the ordinary profits‟ within the meaning of section 10A(7) r.w.s. 80-IA(10) of the Act. In this context, we may refer to the decision of the Chennai Bench of the Tribunal in the case of Visual Graphics Computing Services India (P) Ltd. vs. ACIT, 148 TTJ 621 (Chennai), wherein following discussion is relevant :- “We heard both sides in detail and considered the issue. As far as the present case is concerned, the Transfer Pricing Officer has made a categorical finding that the operating profit reported by the assessee is higher than the profit worked out on the basis of arm's length price. The Transfer Pricing Officer, therefore, concluded that no transfer pricing adjustment is called for in the present case. The Assessing Officer has made the reference to the Transfer Pricing Officer under section 92CA. The reference is made for the purpose of computing
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income arising from an international transaction with regard to the arm's length price as provided in section 92. Therefore, it is to be seen that the scope and extent of reference made by the Assessing Officer to the Transfer Pricing Officer is confined to the singular purpose stated in section 92. Sections 92A, 92B, 92C, 92CB, 92D, 92E and section 92F are all precisely defining and facilitating provisions ultimately for the purpose of computing the income as stated in section 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 the arm's length price so as to confirm that there is no avoidance of tax by an assessee. Therefore, where in a case, the Transfer Pricing Officer suggests that the operating profit declared by an assessee is compatible to the arm's length price 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 section 10A, the computation has to be made in the context of section 10A(7) read with section 80-IA(10). 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 associate enterprises on the basis of the arm's length price. The second segment relating to computation of the arm's length price, 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 section 92. When the Transfer Pricing Officer states that there is no need of transfer pricing 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 Transfer Pricing Office under section 92CA. To state in simple terms, the transfer pricing regime is different from regular computation of income. Section 10A belongs to that part of regular computation of income and it should be computed independent of transfer pricing regulations and transfer pricing orders. It is not therefore, permissible for the Assessing Officer to work out section 10A deduction on the basis of arm's length price profit generated out of the order of the Transfer Pricing Officer. In fact these issues have already been considered in various orders of the Tribunal. The Income-tax Appellate Tribunal, Chennai "A" Bench in the case of Tweezerman (India) P. Ltd. v. Addl. CIT [2010] 4 ITR (Trib) 130 (Chennai) (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 section 80-IA(10) read with section 10B(7), in the context of the Transfer Pricing Officer's order is unsustainable. The Tribunal has held that the Assessing Officer was not justified to invoke the provisions of section 80-IA(10) read with section 10B(7) so as to reduce the eligible profits on the basis of the arm's length price computed
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by the Transfer Pricing Officer without showing how he determined that the assessee had shown more than "ordinary profits". As rightly argued by learned senior counsel the arm's length price is determined on the basis of the most appropriate method. The most appropriate method is chosen either on profit basis method or price basis method. In the latter ease, profits are not at all considered. In that method, profit is only a derivative of prices. When profits itself is not worked out, how is it justified to adopt the arm's length price profits to determine what is "ordinary profits" for the purpose of section 10A(7)? 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 section 10A. The said adjustment made by the assessing authority in computing the deduction under section 10A is accordingly, deleted.” 32. In our considered opinion, the result of the Transfer Pricing assessment can at best be taken as an indicator for the Assessing Officer to investigate as to whether or not there exists any arrangement which has resulted in more than ordinary profits qua the requirements of section 10A(7) r.w.s. 80-IA(10) of the Act. Even if it is accepted that the difference between the operating margins of the assessee and the comparables show existence of more than the ordinary profits in the hands of the assessee, so however, it was still imperative for the Assessing Officer to establish on the basis of substantive evidence and corroborative material that qua section 10A r.w.s. 80-IA(10) of the Act, the course of business between the assessee and the associated enterprises is so arranged that the business transacted between them produces to the assessee more than the ordinary profits with the intent of abusing tax concession. Quite clearly, in the entire assessment order, there is no whisper of any material or evidence in this regard. In-fact, the approach of the Assessing Officer is quite misdirected as the following discussion in his order shows :- “Accordingly, the section only encumbers the A.O. to examine if the profits derived from the eligible business by the assessee is more than the ordinary profits, then the A.O. has to arrive as to what could be the reasonable profit from the such eligible business and such profit has to be then taken as reasonably deemed to have been derived from the eligible business for the purposes of computing deduction under the section. 33. The aforesaid discussion in the assessment order reveals that as per the Assessing Officer, the existence of close connection and more than ordinary profits is enough to assume an arrangement as contemplated u/s 80- IA(10) of the Act. The aforesaid understanding, in our view, is directly contrary to the judgement of the Hon‟ble Karnataka High Court in the case of H.P. Global Soft Ltd. (supra) and our discussion in the earlier part of this order. 34. In view of the aforesaid, we conclude by holding that in the present case, the Assessing Officer has not proved that any arrangement had been arrived between the parties which
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resulted in higher profits. Consequently, the re-working of the profits by Assessing Officer by invoking section 10A r.w.s. 80- IA(10) of the Act is not justified. The action of the Assessing Officer to restrict the deduction u/s 10A of the Act to Rs.7,74,60,281/- as against the claim of Rs.36,35,09,382/- is hereby set-aside. Thus, assessee succeeds on this aspect.”
Thus, in view of the above, ground Nos. 1 to 11 raised by the assessee are allowed.
Ground No. 12 raised by the assessee challenging the action of CIT(A) in confirming transfer pricing adjustment in respect of system integration segment.
Heard both parties and perused the material available on record. During the year under consideration the assessee reported international transactions regarding system integration division and bifurcated the same in two sub-business segments namely IS-Infra and Balance Systems. The Balance Systems was benchmarked with external comparables to show arm‟s length price and with internal TNMM comparables for IS-Infra Business. According to TPO, the services of system integration cannot be bifurcated in two sub-segments and they are functionally comparable to each other in terms of system integration activity and combined both the sub-segments for the computation of arm‟s length price in its report noted 7 comparable companies at mean margin 7.26%, which are below :
S. No. Company Name Operating Profit Margin 1 Aimil Ltd. 4.00% 2 Alstom Projects India Ltd. 2.00% 3 Continental Controls Ltd. 6.00% 4 Eurotherm Del India Ltd. 8.00% 5 Nelco Ltd. (Segmental Data) 12.32%
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6 Utility Powertech Ltd. 8.00% 7 Wellwin Industry Ltd. (Segmental Data) 10.48%
Mean 7.26%
The assessee was asked to explain the difference in the operating profit margins of comparable companies. Operating Profit Margin (Loss) of the assessee is (2.31)% for the aggregated system integration segment and (3.1)% for the aggregated distribution segment.
The assessee explained that the IS-Infra business should not be taken into consideration for the purposes of benchmarking the profitability of the systems integration business. The IS-Infra business was a new initiative that the company was exploring from the perspective of business expansion. This new business initiative involved working on infrastructure related projects, involving projects largely from Government/semi- government organizations. The assessee did not have any previous experience or expertise in this new business, that losses incurred in the IS- Infra business were on account of overall cost overruns that occurred on account of inadequate expertise essential to handle such new projects. One of the key projects in this IS-Infra business, on which losses were incurred, was the National Thermal Power Corporation („NTPC‟) project and the losses incurred in this project were primarily on account of lack of technological expertise on the part of the assessee, to appropriately ascertain the costs and efforts, which would be involved in this project and contended that such newly started business activities are not economically comparable with established companies having a well set business model and any such comparison would result in incorrect conclusions.
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That the 'Transfer pricing guidelines for multinational enterprises and tax administrations' published by the Organisation for Economic Cooperation and Development clearly mention that business strategies being adopted by a business is a relevant factor in doing a comparability analysis. Business strategies must also be examined in determining comparability for transfer pricing purposes. Business strategies would take into account many aspects of an enterprise, such as innovation and new product development, degree of diversification, risk aversion, assessment of political changes, input of existing and planned labour laws, and other factors bearing upon the daily conduct of business. Such business strategies may need to be taken into account when determining the comparability of controlled and uncontrolled transactions and enterprises that the IS-Infra business should not be compared with external comparables, which are well-established companies, having a set business model, and which have been working in their areas of core competency.
The IS-Infra business itself consists of a number of different projects, whereas certain projects in the IS-Infra business involve related party transactions, there are certain projects in this business, which did not involve any significant related party transactions and contended that the IS-Infra projects having related party transaction should be benchmarked with IS-Infra projects which do not have significant related party transactions, and not with external comparables. Such an internal comparison is well recognised in accordance with established transfer pricing principles, and provides a more reliable comparable analysis as compared to comparison with external comparables. We note that the Assessing Officer/TPO did not accept the contentions of assessee, made
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upward adjustment of Rs.2,44,04,000/- by taking margin at 7.26% of operating profit of Rs.8,26,04,000/-.
Before the CIT(A) the assessee prayed that the AO be directed to benchmark its international transactions of the IS-Infra business with the internal comparables rather than external comparables.
For incorrect inclusion of the Nelco as comparable company.
On the basis of Annual Report of Nelco, the assessee contended that Automation and Control segment, which is taken as comparable by the TPO to the Systems Integration segment of the assessee, comprises of revenue from software services as well. Supervisory control and Data Acquisition (SCADA) which cater to Power Sector, Railways and Oil and Gas Production. Drives Automation and Traction Electronic the markets for which are industrial automation in steel and cement industries and the railways. Software and engineering services. The assessee contended that the business operation of Nelco under Automation and Control segment comprises of various business activities which are not comparable to the business activities carried out by the assessee under System Integration segment and that Nelco should be rejected as non-comparable to the System Integration segment of the assessee and should be removed from the final set of the comparable companies.
The CIT(A) observed that the System Integration segment designs and executes projects involving automation of manufacturing plant, storage and distribution network for the products according to the requirements of the customer. The assessee automation also includes heating, ventilation, fire system controls and security system controls
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including video surveillance and provides total solution to the customer. Nelco‟s automation and control it is further sub structured four lines of business: Strategic Electronics the market for which is mainly Defence. Supervisory control and Data Acquisition (SCADA) which cater to Power Sector. Railways and Oil and Gas Production. Drives Automation and Traction Electronic the markets for which are industrial automation in steel and cement industries and the railways Software and engineering services is similar to the system integration of assessee. The CIT(A) held that Automation and Control segment of Nelco Limited is comparable with the assessee basing on segmental accounts and confirmed the decision of the TPO to select Nelco in the final list of the comparable companies.
We note that, for exclusion of Mahindra Ashtec Limited and Artson Engineering, that the assessee contended that these companies are not persistent loss making companies and submitted that the TPO has incorrectly not considered Mahindra Ashtec Limited and Artson Engineering as comparable companies on the basis that these are loss making companies. Further, use of multiple year data should be used to compute the weighted average operating margin of comparable companies and furnished the updated margin of said companies for F.Y. 2002-03. While determining the average price margin of an industry, all the companies in the industry (whether incurring losses or earning profits) need to be considered. Arithmetic mean is a representative of the normal profits/losses earned by the companies operating in that industry. Para 3.45 of OECD guidelines states to consider a range of results when using TNMM. OECD Guidelines do not prescribe considering the range of results of only profit making companies and ignoring companies incurring losses. Proviso to sub-section (2) of section 92C of the Act considers the entire
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range of results where more than one result is obtained and there is no rule under the Indian transfer pricing legislation for a blanket rejection of loss making companies but however, the TPO noted that at the time of transfer pricing documentation, assessee applied filter to reject the companies having negative worth showing that the assessee has rejected companies whose capital has been eroded as a result of continuous losses, that persistent operating loss makers have been rejected by assessee on the most conservative approach and requested to include Mahindra Ashtec Limited and Artson Engineering Ltd. as comparables as they are not persistent loss making companies.
The TPO/CIT(A) rejected Mahindra Ashtec Limited as non- comparable on account of showing minimal profitability for FY 2001-2002 to FY 2003-04 and Artson on account of incurring losses for the years FY 2000-01 to FY 2003-04 by holding that there is drop in the turnover of these companies which also indicated abnormal business conditions.
The CIT(A) observed that any company can be rejected as comparable only if it is a persistently loss making company, the Artson Engineering has declared loss of (-) 1.92% in the FY 2001-02, of (-) 24.51% in the FY 2002-03 and on vide its P & L account that it has incurred loss of Rs.4,42,64,000/- in the FY 2000-01. If other income of Rs.1,68,63,000/- is excluded for the computation of profit being non-operating income, then the company‟s operating loss will increase, did not accept that Artson Engineering is not a persistent loss making company. Further, according to the information provided in the para 16 of Notes to accounts to the Annual Report, the CIT(A) held that the company earns income from construction, trading and manufacturing activities and vide para 3 of the
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Director‟s Report, the company is into the fabrication activities for the refineries, which are totally different than the business activities performed by the assessee, held not functionally comparable with the assessee and accordingly, confirmed the decision of the Assessing Officer/TPO to exclude Artson Engineering from the list of the comparable companies on the grounds of it being functionally non-comparable and it is a persistent loss making company.
Regarding Mahindra Ashtec Ltd. the CIT(A) held that according to para D and E of the 'Notes to schedule- O' to accounts and the product description given in the 'Balance Sheet abstract and company's General Business profile', the company is on to erection and commissioning of hydro pneumatic Ash handling system plant and travelling water Systems and its business activities are totally different than that of the assessee and confirmed the decision of the TPO to exclude the Mahindra Ashtec from the list of the comparable companies.
Regarding the inclusion of Nelco, the ld. AR reiterated the same submissions as made before the TPO and DRP. The contention of ld. AR is that Nelco is a diversified company and it cannot be a comparable to assessee. We note that on the Director‟s report which is at page 547 of the paper book vide para 3 that the business overview of Nelco is divided into three divisions, one is automation and control, network systems and property development. The first division of automation and control is further divided into four structures which is already reproduced by us in the aforementioned paragraphs. The ld. DR contended that the automation and control division is inclusive of software which is similar to the business overview performed by the assessee in system integration.
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We note that from page 26 of the of the paper book where the business overview of assessee is provided to say that the assessee is a leading performer in the Indian Automation and Control Industry. System integration is the largest of the three broad segments into which the operations of assessee have been classified to say 60% of assessee‟s total turnover is in the division of system integration. The said system integration is engaged in the manufacture, system design, integration, installation and commissioning of integrated automation solutions. Further, we note that industrial automation control is the highest Strategic Business Units of assessee which provides integrated automation solutions including systems products and services to process industries. That is to say the ultimate objective of solutions is to provide automation solution, improve plant, throughput, reduce input costs, prevent accidents. The CIT(A) in its finding at page 83 observed that the functional profile in automation and control segment of Nelco is similar to the system integration segment of assessee and in our opinion the system integration segment of assessee involves into designs and executes projects involving automation of manufacturing plant, storage and distribution network which includes heating, ventilation, fire system controls and security system controls including video surveillance is different from assessee‟s function.
On perusal of the profit and loss accounts of assessee at page 223 of the paper book explains that the gross sales at Rs.2,691,582/-. The breakup of sales is at page 228 under Schedule 13 for products and jobs at Rs.2,264,638/- and Rs.426,944/- for services rendered. Whereas, the details of sales and details of raw materials in services and sales are
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provided at page 234 of the paper book whereas we note that process control systems & Instruments at Rs.22,64,638/- as on 31-03-2003.
Regarding financial statements of Nelco, specifically, the profit and loss accounts is provided at page 553 of the paper book wherein we note that income from operations in Schedule 1 is Rs.1,921,666/-. The breakup of which is at page 560 under sales and licence fees of Rs.1,747,502/- and Rs.174,164/-, respectively. We find the functional profile of automation and control of Nelco and system integration of assessee are not similar in view of the business overview of both the companies as discussed by us in the aforementioned paragraphs. Thus, the discussions made by the TPO/CIT(A) in response to the submissions of assessee are requires interference from us and findings thereon including Nelco as comparable is to be set aside. Thus, the findings of CIT(A) regarding inclusion of Nelco in the final list of comparables in respect of system integration division of assessee is set aside and we hold that the Nelco is not comparable in this regard.
Regarding the exclusion of Mahindra Ashtec Ltd. and Artson Engineering Ltd. in the TP proceedings that the assessee claimed that both these companies are not consistently loss making companies. The TPO held that Mahindra Ashtec Ltd. is either incurring losses or showing minimal profitability during the years 2002, 2003 and 2004 and Artson Engineering Ltd. also continuously incurred losses for the years 2002 to 2004. Further, he observed that there is a drop in the turnover of these companies indicating abnormal business situation, considering the same, the TPO held these two companies cannot be accepted as comparable companies. The ld. AR contended that the assessee supplied detailed
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information regarding these two companies supporting its view that these are not continuously loss making companies, in spite of having furnishing the information to TPO without discussing the same excluded both the companies from final list of comparables.
Before the CIT(A), the assessee contended that to determine margin of an industry, all the companies including loss making companies requires to be considered. The OECD guidelines do not prescribe considering the range of results of only profit making companies and sub- section (2) of section 92C considering the entire range of results where more than one result is obtained. The CIT(A) observed that the assessee itself applied filter to reject the companies having negative worth which clearly shows persistent operating loss making companies have been rejected by the assessee itself. The CIT(A) in its order at page 94 vide para 3.7.6 discussed the comparability of Mahindra Ashtec held that the activities of that company are totally different from the assessee by stating that the company is onto erection and commissioning of hydro pneumatic Ash handling system plant and travelling water systems, in accordance with para D and E of Notes to schedule O to accounts and under product description and confirmed the order of TPO in excluding the said company from the list of the comparable companies.
Regarding profitability of Artson Engineering Ltd. the CIT(A) observed that it has declared loss of (-) 1.92% in the F.Y. 2001-02, (-) 24.51% in the F.Y. 2002-03 and loss of Rs.4,42,64,000/- in F.Y. 2000-01. According to him the Artson Engineering Ltd. is a persistent loss making company. According to the review of operations of Mahindra Ashtech Ltd. which is at page 4 of the paper book that due to reforms and slowdown in the power
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sector major tenders would not be finalised in respect of final stages of NTPC‟s project at Simhadri. Further, as on 31-03-2003, the income has been shown at Rs.3,333.40 lakhs and loss was claimed at Rs.413.64 lakhs. We find that in Director‟s Report as on 31-03-2002 and 31-03-2003 the Mahindra Ashtech Ltd. declared a loss. Therefore, we find no infirmity in the order of CIT(A) in confirming the order of Assessing Officer/TPO in excluding Mahindra Ashtech Ltd. as comparable in the final list of comparable companies.
Regarding Artson Engineering Ltd. the CIT(A) held that the activities of this company is not similar to the activity of assessee. He observed basing on the information provided in para 16 of Notes to accounts to the Annual Report, the company earns income from construction, trading and manufacturing activities. Further, the company is into the fabrication activities for the refineries. Therefore, we find the said activities of Artson Engineering Ltd. are entirely different from the business overview of assessee. Further, as discussed above, the Assessing Officer/TPO held that this company is persistently loss making company and we note that the CIT(A) discussed the same vide para 3.7.4 of its order. Therefore, when the functions are different and that persistently loss making company cannot be compared with the assessee. Therefore, we find no infirmity in the order of CIT(A) and it is justified. 29. In the result, the appeal of assessee is partly allowed.
ITA No. 619/PUN/2015, A.Y. 2003-04 (Revenue’s Appeal)
The ground No. 1 is relating to deleting the disallowance made by the Assessing Officer regarding deduction claimed u/s. 10A by invoking section 145 of the Act. We find ground No. 1 raised by the Revenue is
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interlinked with ground Nos. 2 and 3 raised by the assessee in its appeal in ITA No. 583/PUN/2015. In the aforementioned paragraphs by placing reliance in assessee‟s own case for earlier year i.e. A.Y. 2011-12 allowed the claim of deduction made by the assessee u/s. 10A(7) and 10AA(9) of the Act. Therefore, ground No. 1 raised by the Revenue becomes infructuous in view of our decision in assessee‟s appeal. Thus, ground No. 1 raised by the Revenue is dismissed.
Ground No. 2 raised by the Revenue challenging the action of CIT(A) in deleting the addition made on account of prior period expense. We note that the assessee incurred certain expenses on travelling, conveyance, vehicle hire charges, hotel expenses, bank guarantee commission, expenses at customer site etc. have been discharged by the company in A.Y. 2002-03. The AO observed that the same identical expenditures have been disallowed in A.Ys. 2000-01, 2001-02 and 2002-03 on an admission made by the assessee, but however, the CIT(A) for A.Ys. 2001-02 and 2002-03 deleted the said additions. Taking into consideration the same, the CIT(A) in the present year under consideration deleted the addition made by the Assessing Officer. The ld. DR did not bring on record any evidence regarding disallowability of addition against the findings of CIT(A). Therefore, we find no infirmity in the order of CIT and it is justified. Thus, ground No. 2 raised by the Revenue is dismissed. 32. Ground No. 3 raised by the Revenue regarding applicability of TNMM against RPM in computing ALP of total security solutions. This ground attains no significance in view of our discussion in respect of issue raised in ground No. 12 and therefore, which requires no adjudication. Accordingly, ground No. 3 raised by the Revenue is dismissed.
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In the result, the appeal of Revenue is dismissed.
To sum up, the appeal of assessee is partly allowed and the appeal by the Revenue is dismissed.
Order pronounced in the open court on 3rd March, 2020.
Sd/- Sd/- (R.S. Syal) (S.S. Viswanethra Ravi) VICE PRESIDENT JUDICIAL MEMBER ऩुणे / Pune; ददनाांक / Dated : 3rd March, 2020. RK आदेश की प्रनिलऱपप अग्रेपषि / Copy of the Order forwarded to : अऩीऱाथी / The Appellant. 1. प्रत्यथी / The Respondent. 2. 3. The CIT(A)-13, Pune 4. The CIT (IT& TP), Pune ववभागीय प्रतततनधध, आयकर अऩीऱीय अधधकरण, “सी” बेंच, 5. ऩुणे / DR, ITAT, “C” Bench, Pune. गार्ड फ़ाइऱ / Guard File. 6. //सत्यावऩत प्रतत// True Copy// आदेशानुसार / BY ORDER,
तनजी सधचव / Private Secretary, आयकर अऩीऱीय अधधकरण, ऩुणे / ITAT, Pune