KBS CREATION LTD ,MUMBAI vs. DY COMM. OF INCOME TAX -CIRCLE 24(1), MUMBAI

Before the DRP the assessee file detailed written submission. The assessee before DRP submitted that AO has erred in making reference to TPO by invoking provisions of section 80IA(10) without determining and establishing 4 KBS Creations(AY: 2021-22) existence of an arrangement between the concerned parties which results in more than ordinary profit and therefore, whole proceedings initiated under transfer pricing provisions is bad in law. The assessee is also stated that AO referred the matter to TPO in respect of SDT without demonstrating that business affairs of the assessee with the closely connected entity has been so arranged having risen to more than the ordinary profit of the assessee. The assessee by refereeing sub-section (10) of section 80IA submitted that such section casts responsibilities upon the AO to demonstrate that business affairs of the assessee with the closely connected entity have been so arranged even raised to more than ordinary profit to the assessee, which is missing in the assessment and TP proceedings, and determine what is normal profit. The AO has not discharged his duty by demonstrating the existence of such arrangement. The proviso to section 80I(10) states that in case the aforesaid transactioninvolvesSDT, the amount of profit from such transactions shall be determined having regard to the arm’s length price, as define in section 92F(ii).

The DRP after considering the submission of assessee recorded that one of the objections of assessee is that proceedings were void ab initioas pre- requisite in section 80IA(10) of having made more than ordinary profit because of close connection between the assessee and its AE has not been established by the AO. The DRP held that proviso to said section is clear that if aforesaid arrangement involves a SDT, as referred in section 92BA, the amount of profit therefrom shall be determined in accordance with section 92F(ii). The assessee has reported SDT in its report under Form No. 3CEB. 5 KBS Creations(AY: 2021-22) The DRP by referringthe Circular No.3 of 2016 of Central Board of Direct Tax (CBDT) held that AO was right in referring the matter to TPO as one of the reasons is a TP risk parameter and rejected such objection of assessee.

On the other objection of assessee that TPO erred in adjusting Rs.11.62 crores to sales transaction, thereby reducing profit of undertaking to that extent for the purpose of computation of deduction under section 10AA.The ld. DRP recorded that the assessee in its written submission stated that objective of section 80IA(10) is to ensure that owing to tax holiday, the taxpayer does not claim extra benefits by showing profit which is more than the ordinary profits. Data for subsequent years as given makes it very clear that assessee’s own case comparison of profit before the tax holiday and after tax holiday period are both. The assessee explained that in AY 2021-22 operating profit of unit under consideration situated in SEEPZ-SEZ wherein deduction under section 10AA was claimed, was 10.02%, in AY 2022-23 when no deduction under section10AA claimed it was 11.95%, in AY 2023- 24, in no deduction under section 10AA was claimedoperating profit of assessee was 10.58%. It was further submitted that, in any business except due to extra ordinary circumstances, profit/loss of the taxpayer is consistent over a period of time. Therefore, comparing margin of business unit over a range of profit provides more realistic guidance above its ordinary profit than comparing for applying profit margin of other parties, who operates in altogether different business. The assessee by referring the CBDT CircularNo. 2 of 2008 submitted that net profit in the diamond trade is at 6.00% is acceptableto the department without detailed scrutiny. On the basis of 6 KBS Creations(AY: 2021-22) aforesaid submissions,the assessee submitted that profit of assessee is consistent with the period of tax holiday as well as non-tax holiday. The DRP after considering the submission of assessee held that TPO has dealt this issue and address that being controlled transaction; this cannot be taken as bench mark. Transfer pricing analysis is done with the help of uncontrolled transaction. The DRP agreed with the stand of TPO that business contention vary from year to year and margins of comparable of current year or the weighted average of three years should be taken rather than figures of later years. The transactions of assessee are with the relatedparties cannot be considered as uncontrolled transactions. On the reliance on CBDT Circular No.2 of 2008, the DRP held that such Circular is applicable for assessment made during FY 2008-09 and not applicable for AY 2021-22.

On the objection against downward adjustment of Rs.11.62 crore. The assessee stated that TPO erred in considering inappropriate comparables and rejecting/ suggested comparables based on filters and thereby applying filters in a mechanical manner, leading to determination of abnormally low level of operating profit level at 2.13% which is commercially unviable and that TPO erred in not making adjustment for qualitative aspects. The assessee also objected for not utilizing data available in respect of unit being listed, unlisted companies and firm located in SEEPZ-SEZ having TP jurisdiction in the TP circle for Mumbai to determine ALP.To support such submission, the assessee stated that such low level of operating profit computed at 2.13% for a fully integrated export oriented unit manufacturing 7 KBS Creations(AY: 2021-22) diamond,studded Jewellery will result arriving at non-economic profit at net level from the angel of a prudent businessman and also revenue authorities. The taxable profit will be in the range of 0.50% to 2.00% based on the borrowing cost incurred, if any, and many times, will be a cost which is demonstrated hereinunder as can we seen wherein specifically in cases of comparables selected by TPO. To arrive at net profit, interest or cost needs to factoredfor the reasons that high working capital requirement of thebusiness income and expectation of reasonable return of capital employed. The assessee by giving examples of various entities (seven comparables as recorded in table on page 15 & 16 of DRP order) that their profit has been accepted by department which is much below 6.00%. The assessee also objected that various comparable were rejected by TPO due to application of Related Party Transaction (RPT) filter even though these parties have broadly same feature as that of assessee. The TPO rejected Uni- design Jewellery Pvt Limited and Uni-design Elite Jewellery Pvt. Limited. Reasons for rejection of RPT in case of these two parties relates to expenses. In case of assessee TP study relates to expenses by way of purchase diamond, which has been considered by TPO as at ALP and since two parities having close connection. Thus, removal of such comparable is not correct the assessee also objected on other filters. The assessee also objected that equating RPT transaction with unrelated parties and party with close connection is also incorrect. The assessee also stated that they have declared operating profit around 2.50%, which is near to proposed operating profit of 2.13%. It was submitted that operating profit of 8.00 to 11.00% as well as 8 KBS Creations(AY: 2021-22) net profit from SEZ unit every year including in the years, when no deduction of section 10AA is availed. If the assessee has declared operating profit of 2.00 to 2.50%, in subsequent years, resulting into net profit of 1.00 to 1.50% such result will not pass test of assessment scrutiny. The assessee also objected to the inclusion of inappropriate comparables and rejecting of appropriate comparables. Objection of assessee to inclusion of inappropriate comparables and rejecting of appropriate comparable are recorded at page no. 18 to 24 of order of DRP. The assessee also objected that comparables mentioned in show cause notice and finally considered for benchmarking are inappropriate when compare to business of assessee as limited data is available. Such objections of assessee are recorded at page no. 25 to 28 of order of DRP. The DRP on considering the aforesaid objection recorded that assessee has benchmarked its transaction of sale of Jewellery to its AE by using TNMM method and arrived at net margin of 10.02%. The TPO applied various filters like turnover filter, export filter and RPT filter, removed/ excluded following seven comparable. i) Uni Design Jewellery Pvt. Ltd. ii) Jewelex India Pvt. Ltd. iii) Uni Design Elite Pvt. Ltd. iv) Goldiam International Ltd. v) Flawless Jewellery Pvt. Ltd. vi) Global Jewellery Pvt. Ltd. vii) Stellary Jewellery (S. Narendra) 8. The TPO added/ included four following new comparable, i) Sidds Jewellels Pvt. Ltd. 9 KBS Creations(AY: 2021-22) ii) Neysa Jewellery Ltd. iii) Kannai Industries Ltd. iv) Shantivijay Jewels Ltd.

It was the observation of DRP that the TPO on the basis of seven following final set of following comparable arrived at net margin at 2.13%. (i) Neysa Jewellery Ltd, (ii) Golkunda Dimamonds & Jewellery Ltd. (iii) Kanani Industries Ltd., (iv) Shantivijay Jewels Pvt Ltd, (v) Sidds Jewellels Pvt. Ltd. (vi) Shangold India Ltd, (vii) Fine Jewelry Mfg Ltd 10. The DRP by recording of objection of assessee that a very low net margin arrived at by TPO which is uneconomical and unattractive for the industry, which is having high working capital and expectation of reasonable return on capital employed. If finance cost is factored into working of the profit will be further reduced, thus, concept of making more than ordinary profit as pre- requisite is not met in the case. The DRP was of the view that net margin arrived by assessee is apparently low and will be further lowered if cost of finance is factored in, the provisions of section 80IA(10) as well as other various transfer pricing provisions prescribed procedure for arriving at arm’s length price in a systematic manner in the Act. The TPO has rigorously applied various filters as applicable. There cannot be exceptions on application of filters as to industry class or to any specific assessee. The DRP justified turn over filter, export turnover filter, RPT filter by referring various case laws. However, the DRP directed to remove Neysa Jewellery Limitedfrom the list of final comparables by holding that Neysa Jewellery 10 KBS Creations(AY: 2021-22) Limited is a loss making company. This comparable has shown consistent loss in FY 2018-19 and 2020-21.

On the other objection of assessee that jurisdictional assessing officer (JAO) erred in proposing of variation of Rs. 11.62 crore to the total income on the report of TPO as additional income, instead of considering TP adjustment as amount to be reduced from profits of undertaking enjoying deduction under section 10AA and thereafter compute revised amount of deduction under section 10AA. The assessee explained that they have returned income of Rs. 50.97 crore, variation in respect of issue on account of TP adjustment is Rs. 11.62 crore, thus, total income determined Rs. 62.59 crore. This is high handed approach of AO in making addition of Rs. 11.62 crore to the taxable income instead of reduction of Rs. 11.62 crore from profit of unit for recomputing deduction under section 10AA. The assessee explained that they have given working to the JAO that total return income of assessee is of Rs. 50.97 crore, the assessee claimed deduction of Rs. 8.38 crore, thus, revised return before deduction under section 10AA is Rs. 59.35 crore and income entitled for deduction under section 10AA as per ITR is Rs. 16.77 crore, and if the proposed variations as suggested by TPO of Rs 11.62 crore is reduced, revised income eligible for deduction under section 10AA is Rs. 5.15 crore. Export turnover of unit is Rs 171.78 crore, total turnover of the unit is Rs. 173.20 crore, revised profit eligible for deduction under section 10AA is Rs. 5.11 crore, thus, deduction under section 10AA being 50% of Rs. 5.11 crore, would be 2.55 crore. As return of income of assessee before claiming deduction under section 10AA is Rs. 59.35 crore and revised deduction (Rs. 11 KBS Creations(AY: 2021-22) 2.55 crore) thus revised taxable income is Rs. 56.80 crore. The assessee also furnished basis of aforesaid working. The working of assessee is recorded on page no. 43 & 44 of order of DRP, is extracted below; Particulars Amount in Rs. Returned income 50,97,47,100/- Add: Deduction under section 10AA 8,83,48,870/- Revised return of income before deduction u/s 10AA 59,35,95,970/- Income entitled for deduction u/s 10AA as per ITR 16,77,41,466/- Less: Proposed variation as per order of TPO (11,62,05,996/-) Revised income entitled for deduction u/s 10AA 5,15,35,470/- Export turnover of the Unit 1,71,78,74,476/- Total turnover of the Unit 1,73,20,26,557/- Revised profit entitled for deduction 5,11,14,383/- Deduction u/s 10AA (50% of 5,11,14,3830) 2,55,57,192/- Returned income before deduction claimed u/s10AA 59,35,95,970/- Less: Revised deduction u/s 10AA (2,55,57,192) Revised taxable income 56,80,38,778/- 12. The assessee also furnished basis of the above working as recorded in para 8.4 on page No. 44 & 45 of order of DRP.

The DRP on considering the submissions of assessee directed “the panel directs assessing officer to work out on above lines the revised adjustment as communicated by TPO after giving effect on the panels direction to TP grounds herein above.”

On receipt of direction of DRP, the assessing officer passed final assessment order under section 143(3) r.w.s 144C (13) read with section 144B on 25.02.2024. The assessing officer by referring the final set of six comparables computed the final adjustment on account of sale transaction to its AE at Rs. 10.98 crore and straightway added the same to the income of assessee in the following manner: S No Description Amount (in Rs.) 1 Income as per return of income filed 50,97,47,100/- 2 Income as computed u/s 143(1)(a) 50,97,47,100/- KBS Creations(AY: 2021-22) 3 Variation in respect of issue of (if any) TP 10,98,72,843/- adjustment as above 4 Total income determined 61,96,19,943/- 15. Aggrieved by the additions in the assessment order the assessee has filed present appeal before Tribunal.

We have heard the submissions of learned authorized representative (ld AR) of the assessee and the learned Senior departmental representative (Sr DR) for the revenue and have gone through the orders of lower authorities carefully. The ld AR of the assessee submits that manufacturing unit of assessee is situated in SEZ. The unit in SEZ purchased cut and polished diamond mainly from another unit located outside SEZ. On reporting SDT on account of sale of Jewellery to its AE, the Jurisdictional Assessing Officer (JAE) made reference to TPO on reporting such transaction in Form 3CEB explaining the fact that profit earned from sales to such parties are not more than ordinary profits. Report in Form 3CEB is filed out of abandoned caution so as to avoid provisions related to non-filing / non-disclosure of transactions under transfer pricing provisions. The assessing officer failed to establish close connection and arrangement of business transaction to produce more than ordinary profit before making reference to TPO. The AO without demonstrating that business affair of assessee with the closely connected entity has been so arranged giving rise to more than ordinary profit to the assessee. The ld. AR of the assessee by referring provisions of section 80IA(10) submits that plain reading of this section prescribed that first the AO has to establish, close connection between the assessee and the other person and having established close connection he has reason to believe that KBS Creations(AY: 2021-22) business transaction is so arranged with the other person so as to produce more than ordinary profit to the assessee. Before making reference to TPO vide reference letter dated 24.10.2024, the JAO did not discharge his duty of demonstrating the existence the such arrangement. The objective of section 80IA(10) is to ensure that owing to tax holiday, the assessee does not claim more benefit by showing profit which is more than ordinary profits. The assessee is consistently showing operating profit of the unit located in SEZ at more than 10% during the currency of benefit available under section 10AA or in subsequent year when deduction under section 10AA is not claimed. In AY 2021-22, the year under consideration, the assessee has shown operating profit at 10.02% and claim deduction under section 10AA. In AY 2022-23, the assessee has shown operating profit at 11.95% and no deduction under section 10AA is claimed, similarly in AY 2023-24, the assessee has shown operating profit at 10.58%. Thus, the operating profit remains more or less consistent during the tax holiday period or thereafter. The quantum of deduction under section 10AA for preceding year has been accepted by TPO, in assessee’s own case as well as its AE in earlier years, which proves that there is no arrangement. To support her submissions, the ld. AR of the assessee relied on the decision of Delhi Tribunal in Mankind Pharma Limited Vs. DCIT in dated 01.05.2024, A.T. Kearney India Pvt. Ltd. Vs. ACIT in dated 26.08.2014 and DCIT Vs. Halliburton Technology Industries Pvt. Ltd. in ITA No. 277/Pun/2021 dated 10.06.2022.

In other without prejudice and in alternative submissions the ld. AR of the assessee submits that JAO has not passed final assessment order as per direction of DRP. The DRP in its direction direct the assessing officer to revise the adjustment figure. The ld. AR of the assessee submits that assessee has given working of revised taxable income and after exclusion of Neysa Jewellery Ltd. variation in respect of issue on account of TP adjustment is Rs. 10.98 crore, thus, total income determined. The AO made addition of Rs. 10.98 crore to the taxable income instead of reduction of Rs. 10.98 crore from profit of unit for recomputing deduction under section 10AA. The assessee explained that they have given working to the JAO that total return income of assessee. And if the proposed variations as direction of DRP Rs 10.98 crore is reduced, revised income eligible for deduction under section 10AA would be reduced. The assessment order is not passed as per the direction of DRP, therefore, same is also liable to be quashed / set aside.

On the other hand, the learned Senior Departmental Representative (ld. Sr. DR) for the Revenue supported the order of lower authorities. He submits that as per proviso to section 80IA(10) if the assessee made a specific domestic transaction as referred to in section 92BA, the amount of profit from such transaction shall be determined having regard to arm’s length 15 KBS Creations(AY: 2021-22) price as defined in 92F(ii). The DRP in para 6.3.2 as specifically held that Circular No. 3 of 2016 prescribed the procedure for reference to transfer pricing adjustment. The TPO carried out transfer pricing adjustment on the basis of method prescribed under section 92C. The TPO applied various filters for testing the comparability of various comparables selected by assessee. The comparable which were not comparable with the assessee were excluded and TPO introduced his own comparable on the basis of various parameters and suggested the adjustment. However, the ld. DRP on considering the submission of assessee directed the AO/TPO to exclude Neysa Jewellery Limited from the set of final comparable. The assessing officer accordingly passed a final assessment order by making adjustment of Rs. 10.98 crore.

We have considered the rival submissions of both the parties and have gone through the orders of lower authorities carefully. We have also deliberated on various case laws relied by ld. AR of the assessee. Firstly, we are considering the contention of ld. AR of the assessee about the applicability of provisions of section 80IA(10) for existence / non-existence of arrangement between the eligible unit of assessee and its AE, which according to her is a condition precedent to invoke the provisions of section 80IA(10). For better appreciation of issue under consideration, the definition of Specified Domestic Transaction (SDT) prescribed under section 92BA and section 80IA(10) is read as under; Section 92BA.For the purposes of this section and sections 92, 92C, 92D and 92E, specified domestic transaction in case of an assessee means any of the KBS Creations(AY: 2021-22) following transactions, not being an international transaction, namely: (i) any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A; (has been omitted Fin Act,2017) (ii) any transaction referred to in section 80A; (iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA; (iv) (any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA; (v) any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or (vi) any other transaction as may be prescribed, and where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of Rs. 20 crore." Section 80IA (deduction in respect of profit and gains from industrial undertakings after a certain dates etc) (1) xxxx ***** (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 arm’s length price as defined in clause (ii) of section 92F.

A careful reading of definition of SDT prescribed in section 92BA makes it clear that there must be a transaction, it is not an International Transaction within meaning of 'International Transaction' defines in section 92B, and it should be covered under one of the six transactions mentioned in the sub- section and aggregate value of transactions in the previous year exceed a KBS Creations(AY: 2021-22) sum Rs. 20 Crore. By taking care of the above position, we shall consider the facts of the present appeal. Before us, it was the plea of ld. AR of the assessee that in absence of any arrangement, the business transaction between eligible units and its AE do not get covered within the ambit of SDTs defined in section 92BA and eventual transfer pricing analysis and that transfer pricing analysis were made for abundant caution. It was also argued that AO has not proved existence of any arrangement before making reference to TPO for computation of arm’s length price. And in absence of such arrangement, the adjustment made by TPO would not survive. We find that the assessee has taken such a stand right from the beginning by filing their objection / reply in response to show cause notices issued by TPO in reply dated 12.10.2023 as well as on 07.11.2023, copies of such replies are available on record. We find that despite taking such objection, the TPO disregarded such factual objection. The TPO straightway benchmarked the transaction by following Transactional Net Margin Method (TNMM). The TPO excluded seven comparable of assessee and included four new comparable. Unit-II of the assessee was considered as tested party. On the basis of his analysis, the TPO suggested downward adjustment of Rs. 11.62 Crore on transaction of sales to AE. The DRP in its directions directed AO/TPO to exclude on the comparable which was loss making entity. On exclusion ofone such comparable the downward adjustment becomes Rs. 10.98 Crore.

We find that Hon’ble Jurisdictional High Court in CIT Vs. Schmetz India Private Limited (2012) 26 taxmann.com 336 (Bom) held that where the AO has not been able to prove any arrangement between parties which resulted 18 KBS Creations(AY: 2021-22) extraordinary profit, denial of deduction under section 10A is not possible. Similar view was taken by Rajasthan High Court PCIT Vs. Vedansh Jewels Private Limited (2018) 97 taxmann.com 521 (Raj). Karnataka High Court in CIT Vs. H.P. Global Soft Ltd. 342 ITR 263 (Kar) also held that there should be material to indicate that assessee had indulged in arrangements with other person so as to give more profit to the assessee than what the assessee might have been ordinarily expected to earn from such business. Pune Tribunal in DCIT Vs. Halliburton Technology Industries Pvt. Ltd. (supra) by relying upon the decision of Bombay High Court in Schmetz India Pvt. Ltd. (supra) held that when AO was not able to prove that there was an arrangement between the assessee and its parent company resulting into extra ordinary profit, and the assessee had concentrated on export to its parent company, only which had resulted in higher profit. The AO has not demonstrated any proof of arrangement for disallowance under the provisions of section 10B(7) r.w.s. 80IA(10) for which judicial pronouncement made it mandatory. Further coordinate bench of Delhi Tribunal in Mankind Pharma Vs DCIT (supra) on relying the decision of Delhi High Court in CIT Vs. Schmetz India Private Limited (supra) also held that eexistence of an 'arrangement' is a condition precedent to trigger provisions of section 80IA(10) and in its absence, business transacted between eligible units and its AE do not get covered within ambit of Specified Domestic Transactions (SDTs) defined under section 92BA and eventual TP analysis.

On considering the aforesaid decision we find merit in the submission of ld. AR of the assessee which is supported by the aforesaid case laws that 19 KBS Creations(AY: 2021-22) existence of arrangement between the deduction seeking unit and other AE is a pre-condition for invoking rigor of section 80IA(10). Higher profit per se cannot lead to the conclusion that there is arrangement between the parties. The concept of PLI cannot per se be applied to hold that assessee has earned higher profit. We find that the TPO has no occasion to make any comparative data analysis unless condition of pre-arrangement is satisfied. Thus, the assessee succeeded on primary submission of ld. AR of the assessee.

So far as submissions of ld Sr DR for the revenue that proviso to section 80IA(10) is applicable on the facts of the case, in our view once, the precondition of existence of an arrangement has not been fulfilled, the effect of proviso will not come in to play. Considering the fact that assessee has succeeded on primary submission of ld. AR of assessee, therefore, adjudication on other grounds of appeal