DEPUTY COMMISSIONER OF INCOME TAX, CENTRAL CIRCLE-19, NEW DELHI vs. KOYA AND COMPANY CONSTRUCTION LIMITED, HYDERABAD

The Revenue has filed appeal against the order of the Learned Commissioner of Income-tax (Appeals)-27, Delhi [“Ld. CIT(A)”, for short] dated 22.05.2023 for the Assessment Year 2017-18.

Brief facts of the case are, the assessee is a company limited by shares is specialized in the manufacture and execution of Infrastructure projects on contract basis and specialize in medium and large diameter turnkey pipeline contracts and allied Civil work.

The assessee has maintained the TP documentation as prescribed under the Section 92D of the Income Tax Act, 1961 (‘the Act’) and considered Transactional Net Margin Method as the "most appropriate method" under Section 92C(l) of the Act and has filed the accountants report in Form 3CEB as prescribed under the Act, within the statutory time limit. The assessee has considered Operating Profit/ Operating Revenue ('OP/OR') as the Profit Level Indicator ('PLI') and computed the margin of the Company at 9.10%. The weighted average range of the comparable companies was in the range of 8.04% to 10.95%. Thus, the specified domestic transactions of the assessee were considered to be at arm's length. The assessee has selected a set of 15 Comparable companies, which were functionally similar to the assessee.

The assessee filed its return of income in ITR-6 for Assessment Year 2017-18 under section 139(1) of the Act declaring total Income of Rs.18,41,78,800/-. The return of income was selected for scrutiny under CASS and notice u/s 143(2) of the Act dated 17.08.2018 was issued and served on the assessee through the Income tax business application portal. Thereafter, notice u/s 142(1) of the Act calling for information was issued on 21.01.2019 and at various dates as well.

The AO has referred the case of the assessee under section 92CA(l) of the Act for determination of Arm's length price in respect of the specified domestic transactions reported by the assessee for the assessment year under consideration.

The Additional DIT (TP), Hyderabad (TPO) initiated the transfer pricing proceedings and issued notice on November 26, 2019 and January 5, 2021. The assessee filed the details as called for by the TPO time to time on December 28, 2020 and January 12, 2021 respectively. The TPO, vide notice dated January 5, 2021 sought the details of the sub-contract payments made to the associated enterprise namely Megha Engineering and Infrastructure Limited. The assessee compiled the details called for and submitted the same vide submission dated January12, 2021.

During the course of the TP assessment proceedings, the TPO has issued a show-cause notice dated January 15, 2021 ('SCN'). As per the said SCN, the TPO requested the assessee to file its objections against the proposed transfer pricing ("TP") adjustment in respect of the specified domestic transactions undertaken by the Assessee for the financial year ("FY") ended March 31, 2017 as regards the APSIDC Choutupalli project.

The TPO proposed to consider the arm's length margin at 11.49% in the SCN with the following reasons :  Rejected the TP documentation maintained by the Assessee and thereby the economic analysis, by stating that the search process is not in conformity with the TP regulations as also the choice of the filters which resulted in the selection of inappropriate filters.  Undertaken a fresh economic analysis, by applying certain qualitative and quantitative filters. In doing so, the Ld. TPO has arrived at a set of 8 companies (retaining 3 from the TP study) and proposing a set of 5 additional companies.  Proposed to consider APSIDC Choutapalli Project, being eligible project, which is claiming deduction u/ s 80IA and having specified domestic transactions with Megha Engineering and Infrastructure Limited as the tested party, ignoring the entity level benchmarking carried out by the Assessee.  Proposed that the margin of the APSIDC Choutapalli Project at 48.90% was more than ordinary in comparison to the arm's length margin at 11.49% determined by the .Ld. TPO and proposed an adjustment of Rs. 2,57,05,203 to the specified domestic transactions.

The Assessee submitted its response to the SCN on January 22, 2021 and objected to the approach followed by the Ld. TPO and thereby proposing the adjustment on the specified domestic transactions carried out by the Assessee.

The Ld. TPO however rejected the objections raised by the assessee and passed the order dated January 31, 2021, wherein the Ld. TPO :  rejected the TP documentation of the Assessee as well as the economic analysis and undertaken a fresh economic analysis and determined the arm's length margin at 11.49% in respect of the specified domestic transaction of the Assessee. In doing so, the Ld. TPO has not disputed the application of the TNMM as the most appropriate method as used in the TP study as well as the Profit Level Indicator ("PU") of Operating Profit/Operating Revenue ("OP/OR").  Considered APSIDC Choutapalli Project, being eligible project, which is claiming deduction u/s 801A and having specified domestic transactions with MEIL as the tested party, ignoring the entity level benchmarking carried out by the Assessee.  Considered that the margin of the APSIDC Choutapalli Project at 48.90% was more than ordinary in comparison to the arm's length margin at 11.49% determined by the Ld. TPO and carried out an adjustment of Rs. 2,57,05,203 to the specified domestic transactions, without establishing the existence of any 'arrangement' to manipulate profits of the eligible unit between Assessee and its MEIL more so when the profit retained by the Assessee is a mere 2% of the sub-contract amount paid to the related party.

Further, the AO disallowed an amount of Rs.12,72,104, being 10% of the total of conveyance expenses, travelling expenses and vehicle maintenance by observing that assessee failed to furnish/produce supporting documents and failed to elaborate the expenses incurred for the purpose of business/no personal elements are involved.

Aggrieved by the order of the AO, the assessee filed appeal before the ld. Commissioner of Income Tax (Appeals) and raised various grounds against the additions made by the AO and TPO.

The Ld. CIT(A) after considering the submission made by the assessee, deleted the additions made by observing as under :  MEIL has billed the total contract amount of Rs.23,89,00,406/- during the cycle of the project which is more than the agreed contract amount of Rs.23,72,52,106/- and therefore it is not the case of under billing and thus allowing the Appellant to claim higher deduction u/s 80IA of the Act.  Each year the profit element on the work done by MEIL is 2% only and therefore the Appellant has not earned any extraordinary profit from the work done by MEIL.  During the year under consideration i.e. AY 2017-18, the scope of work of MEIL was only of Rs.1,05,01,516/- as against which it has raised the bills of Rs.1,02,91,486/- after allowing the profit of the appellant of Rs.2,10,030/- (2%).  The balance profit of Rs. 3,33,91,101/- out of the total profit from this project amounting to Rs. 3,36,01,131/- was from the work done by the Appellant including some profit adjustment for the previous two year. The reasonableness of profit adjustment is not under dispute.  Therefore, the conclusion by the Ld. AO that profit of Rs.3,36,01,131/- is from the work done by MEIL is not correct as the scope of work of MEIL for the year under consideration was limited to Rs. 1,05,01,516/-.  In other years also this kind of adjustment has not been made by the Assessing Officers.

Ld. CIT (A) with the above observations held that the TPO/ AO have wrongly assumed the profit of Rs.3,36,01,131/- is from the work done by MEIL which is not correct. The profit margin of the assessee from the work done by MEIL was only 2% which is much below the ratio of 11.49 taken by the TPO /AO. Therefore, the addition of Rs.2,57,05,203/- made by the AO u/s 92CA(3)/80IA of the Act is deleted and these grounds of appeal

Whether on the facts and circumstances of the case. the Ld. CIT(A) is correct in deleting the TP adjustment ignoring the fact that assessee shown large difference in profit margin in the transactions made with the related party and non-related party? 4. Whether on the facts and circumstances of the case, the Ld. CIT(A) is correct in ignoring the findings of the AO that profit element of 2% with MIEIL (related party) is significantly lower than the profit margin of the assessee from transactions with other parties? 5. Whether on the facts and circumstances of the case, the Ld. CIT(A) has erred in considering 2% profit element (in transaction with MEIL on given project), on the basis of the fact that profit element in previous year was also 27% ignoring the fact that assessee had earned profit margin of 12.20 %, 6.07% and 57.35% in last 3 years from FY 2014-15 to FY 2016-17 on the same project.

At the time of hearing, ld. DR of the Revenue submitted that the assessee had reported less expenses in order to claim inflated profits in the eligible units to claim deduction u/s 80A. Further he submitted by bringing to our notice page 3 of TPO order that there is large difference in profit margin in the transactions made with related and unrelated parties. Further, he brought to our notice pages 45 & 46 of ld. CIT (A) order to submit that profit element of 2% with MIEL is significantly lower that profit of the assessee. Ld. CIT (A) also ignored the fact that assessee has declared higher profits on the same projects in the last 3 years. He also overlooked the fact that the assessee had awarded 31.84% of its total tenders. With regard to expenses disallowed by Assessing Officer, he submitted that the assessee had not produced any documents and established the relevance of claim of such huge expenses.

On the other hand, ld. AR of the assessee submitted ground wise submissions as under :- 19.1 During the year 2014, the Assessee Company got the tender for the APSIDC Choutupalli project which is for construction and development of Lift irrigation scheme From Pulichintala reservoir. In order to execute the civil works of the project, the Assessee Company had sub-contracted to MEIL for ease of execution only to the extent of civil works. The balance pipe lines and engineering work was executed by the Assessee Company.

The course of business was so arranged that the business transaction between two units of the Assessee which might expected to arise in the business undertaking or the hotel. The word ‘appears' cannot be taken in isolation de hors the qualifying words of 'so arranged' with the business more than the ordinary profits. While on the first aspect there is not much dispute. The second requirement viz., it is a course of business is so arranged as to result in an inflated profit is not forthcoming from the order of the Assessing Officer and unfortunately for the Revenue the findings of the Appellate Authority which also go into the facts is that the profit margin as revealed by the Assessee is a reasonable profit margin in comparison to other similar units. Ultimately, there being no material to indicate that the course of business had been so arranged as to inflate profits, i.e. to show a. higher profit margin to the two export units of the Assessee, we are unable to answer the question in favor of the Revenue, but the only answer can be that the Tribunal was justified in taking this view and therefore, the first question is answered in the affirmative and in favor of the Assessee and against the Revenue”  Hon'ble Bombay High Court in OT Vs. M/s. Schmetz India Pvt. Ltd. in Income Tax Appeal No.1382 of 2013, judgment dated 24.06.2015 had while deciding the issue of claim of deduction under section 10A of the Act in respect of profits derived from an eligible unit engaged in the business of manufacturing industrial sewing machine needles and export the same to its German parent company, where the Assessee was earning margins of 77.91% as against those of the comparables being 60% had upheld the order of Tribunal. The Tribunal had held that the Assessing Officer was not able to prove that there was an arrangement between the Assessee and its parent company resulting in extraordinary profits, where the Assessee had concentrated on exports to its parent company only, which had resulted in higher profits. The Hon'ble High Court affirming the decision of the Tribunal held that extraordinary profits earned by the Assessee could not lead to the conclusion that there was an arrangement between the Assessee and its associated enterprises. The relevant extract of the decision of the Hon'ble Bombay High Court is as under:- “8. So far as questions (a) & (b) are concerned, we find that the Tribunal has considered the entire evidence and on facts come to the conclusion that the profits earned by Kandla division of the respondent-Assessee is not abnormally high due to any arrangement between the respondent-Assessee and its German Principal. The Tribunal correctly held that extraordinary profits cannot lead to the conclusion that this is an arrangement between the parties. This would penalize efficient functioning. Further, the authorities have also recorded a finding that the industrial sewing machine needles imported and traded by the Mumbai division are different from those manufactured & exported by the Kandla division. Consequently, this also negatives any arrangement between the parties to show extraordinary profits in respect of its Kandla division so as to claim deduction under Section 10A of the Act. These are findings one of fact. The appellant-revenue have not been able to show that the findings are perverse or arbitrary. In the circumstances, questions (a) and (b) as formulated by the appellant/revenue do not raise substantial questions of law in the present facts and are therefore dismissed”  Honeywell Automation India Limited (ITA No.18/PN/2011) “11 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 the produces to the assessee more than the ordinary, profits with the intent of abusing tax concession"  Digital Equipment India Ltd. 1(2006)103 TTJ 329 (Bang)] "In this case, the AO has failed to adduce any evidence or ea on to satisfy the invoking of s. 80-1 (9). First of all, a mere substantial profit does not give rise to a valid view that there could be any arrangement. It is a case of joint venture lzstedI 1an company, w ere all arrangements are open for scrutiny and acceptance not only by d1gztal 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 by other companies in the same industry. Hence there is no case for further verification. "

The assessee further submits that an adhoc basis of disallowance of expenses without rejecting the books of account is not sustainable. The Ld. AO has not given any identified particular bill / entry in the books of account which is either bogus or involves personal element. Without identifying any such discrepancy, the disallowance made by the Ld. AO is not sustainable. The Ld. CIT(A) considering the submission made by the assessee had deleted the addition of Rs. 12,72,014/- on this account.

Based on the above submission, the assessee submits that the appeal filed by the Department may be dismissed.

Considered the rival submissions and material placed on record. We observe that during the year 2014, the assessee Company got the tender for the APSIDC Choutupalli project which is for construction and development of Lift irrigation scheme From Pulichintala reservoir. In order to execute the civil works of the project, the Assessee Company had sub-contracted to MEIL for ease of execution only to the extent of civil works. The balance pipe lines and engineering work was executed by the Assessee Company. The entire civil work was awarded to MEIL on back to back contract basis and assessee had retained only 2% of the contract value. The above arrangement was made with the conscious decision with the awareness that the assessee is claiming deduction u/s 80IA. From the information submitted before us on the turnover and profit margin earned by the assessee with the related and unrelated parties in both 80IA projects and non-80IA projects, where the assessee had achieved lesser margin with the related party transactions, this evidence completely demolishes the views of the tax authorities that the assessee had inflated the profit. With related party transactions achieved only 5.94% whereas in other projects, it has achieved 10.02%.

Coming to the MIEL project, we observe that this project was awarded to MIEL with the conscious decision to allot only the civil work and retained only 2% of the sub contract. Accordingly, assessee retained only 2%, even though the assessee is claiming 80IA deductions. Further, it is back to back contract and there is no evidence with the Revenue to establish that the assessee had involved in any of the civil construction. The assessee had achieved margins in the earlier years as well as in this year from the other part of the project other than civil works. Since it is large project, the assessee is expected to declare the profit based on the stage completion of the project. It was submitted that in last two years, the assessee had not estimated the project completion properly, the relevant difference was declared in FY 2016-17.

There is no material brought on record to show that the assessee had involved in any under billing. The assessee had consistently declared 2% margin in this project. Therefore, the addition proposed by Assessing Officer/TPO is not reasonable and not appreciated the relevant facts in record. Hence, we are inclined to accept the detailed findings of ld. CIT(A). Accordingly, ground nos.1 to 6 are dismissed.

In the result, the appeal filed by the Revenue is dismissed. Order pronounced in the open court on this 26th day of November, 2025.