Deduction u/s.10B cannot be disallowed on ground of excess profits when the international transactions are held to be at arm’s length

Court :Chennai Bench of Income Tax Appellate Tribunal

Citation :  M/s Tweezerman India Private Limited Vs ACIT [2010-TII-45-ITAT-MAD-TP]

Brief : Deduction u/s.10B cannot be disallowed on ground of excess profits when the international transactions are held to be at arm’s length. The Chennai Bench of Income Tax Appellate Tribunal in the case of M/s Tweezerman India Private Limited Vs ACIT [2010-TII-45-ITAT-MAD-TP] has held that deduction of eligible profits under Section 10B cannot be disallowed on ground of excess profits where the international transactions have been held to be at arm’s length by the Transfer Pricing Officer.

Facts of the case:

• The taxpayer is engaged in the manufacture and export of tweezers to its associated enterprise in US. For the AY 2004-05, the taxpayer had claimed deduction under section 1 0B of the Income Tax Act, 1961(‘the Act’). The taxpayer earned a profit margin of 83.1% during the previous year relevant to AY 2004-05.
• The Assessing Officer (‘AO’) in the course of the assessment referred the case to the Transfer Pricing Officer (‘TPO’) and the latter passed the order making no adjustment to the value of the international transactions entered into by the taxpayer.
• In the course of proceedings before the TPO, the taxpayer had filed a computation showing excess profit over the Arms Length Price (‘ALP’) at INR 3.54 crores. Upon questioning by the AO in the course of assessment proceedings, the taxpayer clarified that there were certain errors in computation and filed a revised computation wherein excess was computed at a lower value.
• AO, disregarding the revised computations, invoked the provisions of section 10B(7) read with section 80IA(10) and proposed to tax the excess profits under the head ‘Income from Other Sources’ on the grounds that the entire sales were made to the related company whose major shareholders were also substantial shareholders in the taxpayer.
• Aggrieved by the order passed by the AO, the taxpayer appealed against the aforesaid order before the Commissioner of Income Tax (Appeals) (CIT(A)). CIT(A) held that affairs of the taxpayer were arranged so as to earn more than ordinary profits. However, CIT(A) considered the excess profits as the turnover of the taxpayer and directed that only 83.1 percent of INR 3.54 crores was liable to be reduced while computing deduction under section 1 0B of the Act.

• The aggrieved taxpayer and Revenue filed an appeal with the Tribunal.

Taxpayer’s Contention:

• Taxpayer earned consistent profits in excess of 74% during the years 2001 to 2007, and there was no substantial increase in profits during AY 2004-05 in comparison to earlier or subsequent years. Further, for all the preceding years the assessment has been accepted under Section 143(3) of the Act.
• When the transaction has been accepted as to be at arms length price under Section 92C, it cannot be treated as an arrangement to avoid tax under Section 1 0B(7) of the Act.
• Substantial dividend tax was paid by the taxpayer. If lower profits were earned in India, only lower dividend tax would have been paid which would result in lower tax being paid in the country.
• Substantial shares in the taxpayer were held by Indian shareholders and accordingly no benefit accrued to the foreign shareholder by increasing the taxpayer’s profitability.
• M/s. Rahul Electricals and Electronics was not a relevant comparable as they manufacture tools including tweezers, whereas the taxpayer primarily manufactures tweezers.

Tax Department’s contention:

• Profits disclosed by the taxpayer were abnormally high.
• The turnover of the taxpayer was INR 15.06 crores, while the profits earned was INR 13.05 crores, which showed that the profit declared by the taxpayer were excessive and the affairs have been arranged to claim higher deduction in India and avoid payment of taxes.
• The transfer pricing assessment was a separate proceeding and provisions of section 10B(7) being invoked by the AO was an independent action though the AO had relied on the documents filed before the TPO.

Tribunal’s Ruling:

• The intention of transfer pricing is also on similar lines as 80IA( 10). While the objective of transfer pricing provisions is to verify whether the local country is deprived of any revenue, the objective of section 80IA(10) is to verify and adjust the profits of an eligible business so that under the garb of the eligible business the taxable income of an associated enterprise is not reduced by shifting its income to the eligible business.
• The taxpayer has shown higher margins and hence has complied with the transfer pricing provisions and the TPO has categorically given a finding that the income of the taxpayer is at arm’s length.
• The provisions of Section 80IA(10) do not give an arbitrary power to the AO to determine the profits of the taxpayer. It is incumbent on the AO to show how ordinary profits were computed based on similar comparable case.
• Factors like financial charges, cost of transportation, labour, power, fuel and use of plant machinery affect comparability and need to be duly considered when selecting comparables in the course of a benchmarking analysis. Comparing the taxpayer’s operations with another not in equal term would be a travesty of justice. M/s Rahul Electricals and Electronics cannot be compared due to differences in turnover and product profile.
• In the absence of any comparable to determine ordinary profits, the taxpayer’s own past and future performance would be the best comparable.

Based on above, Tribunal held that disallowance of eligible profits was unsustainable and incorrect.

Our Comments:

The judgment has clearly brought on record that the intention of Section 80IA(10) is only to prevent shifting of profits from non-eligible domestic businesses to eligible businesses.

Further it has been brought out that the phrase “more than ordinary profits” referred in Section 80IA(10) is different from “arm’s length price” as referred under Section 92C of the Act. The AO accordingly has to carry out an independent analysis to prove that the taxpayer earned more than ordinary profits. This would be helpful for taxpayers at large.

NF