Loss from a 10A unit is to be adjusted against taxable profit of other units after allowing deduction under section 10A in respect of such eligible unit

IN THE INCOME TAX APPELLATE TRIBUNAL
“C” Bench, Mumbai

Before Shri D. K.Agarwal (JM) and Shri Rajendra Singh(AM)

ITA No. 7729/M/2010

Assessment Year- 2006- 07

PER RAJENDRA SINGH (AM)

This appeal by the assessee is directed against the order dated 30.08.2010 of Additional Commissioner, Range-10(2) for the assessment year 2006-07. Though the assessee in this appeal has raised several grounds of appeal, effectively there were only three grounds which relate to adjustment of loss of 10A unit against profit of other units; exclusion of data line cost from export turnover; and transfer pricing adjustment, while computing total income.

2.  We first take up the dispute relating to adjustment of loss from 1OA unit against the profits of other units. Under the provisions of section 1OA, deduction is allowed in respect of profits and gain derived by an undertaking from the export of articles or things or computer software for a period of 1O consecutive assessment years beginning with the year in which the undertaking begins to manufacture or produce such article or things or computer software while computing the total income. The assessee had four 1OA units – two at Mumbai namely Mumbai-II and Mumbai III units and one each at Bangalore and Kolkata. The assessee also had one non 1OA unit at Mumbai, namely, Mumbai -I unit. The assessee during the relevant year had claimed deductions of Rs. 22,42,O7,255/- Rs. 11,77,O3,498/- and Rs. 6,11,18,437/- in respect of Mumbai-II, Mumbai-III and Bangalore unit respectively. In the Kolkata unit, the assessee had incurred a loss of Rs.22,02,698/-. The assessee had set off the loss from Kolkata unit against income from other units after claiming deduction under section 1OA in respect of each unit. The AO during the assessment proceedings asked the assessee to explain as to why the loss from Kolkata unit should not be ignored as income was exempt or alternatively the claim of deduction under section 1OA should not be reduced to that extent. The assessee explained that, in view of the amended provisions of section 1OA from 1.4.2OO1, it was no longer an exempted provision but only a deduction was allowed under section 1OA and therefore loss from the 1OA unit has to be set off against the taxable profits of other businesses under the provisions of section 7O. It was also submitted that deduction allowable under section 1OA was in respect of a particular undertaking and not from the total income which had also been clarified by the circular issued by the CBDT. The AO however did not accept the arguments advanced and held that total income of the assessee was required to be computed with respect to the various undertaking and thereafter deduction was required to be given in respect of these units from the total income. He accordingly reduced the loss from Kolkata unit from the deduction claimed in respect of Mumbai-II unit and deduction to that extent in respect of Mumbai-II unit was thus reduced. Aggrieved by the said decision the assessee is in appeal before the tribunal.

2.1 Before us the Learned AR for the assessee reiterated the submissions made before the authority below that after the amendment of section 1OA from assessment year 2001-02, only deduction was allowed in respect of profit derived from the undertaking and it was no longer an exemption provision and therefore loss from a 10A unit has to be adjusted against taxable profit of other units. Reliance was placed on the judgement of Honourable High Court of Mumbai in case of Hindustan Uni Liver Ltd. Vs DCIT (325 ITR 1O2) and on the decision of the tribunal in case of Honey Well International India Pvt. Ltd. Vs DCIT (26 SOT 5O3). The Learned DR on the other hand placed reliance on the order of the AO.

2.2 We have perused the records and considered the rival contentions carefully. The dispute is regarding set off of loss of a 1OA unit against the taxable profit of other units. The assessee had four 1OA units in respect of which deduction under section 1OA was allowable and one non 1OA unit. The assessee had incurred loss from one 1OA unit which had been set off against the taxable profit of other 1OA units. The AO however took the view that since income from 1OA unit was exempt, loss from 1OA unit has to be ignored or alternatively the loss has to be adjusted against the profit of another 1OA unit before allowing deduction under section 1OA. We have gone through the provisions of section 1OA and find that as per the provisions in force prior to assessment year 2001-02, the profit and gain from the eligible undertaking was not to be included in the total income which meant that the income from the eligible unit was exempt from tax. However, provisions were amended with effect from assessment year 2001-02 and as per the amended provisions, the profit and gain derived by an eligible undertaking is required to be deducted from the total income. Thus from assessment year 2001-02, section 10A is no longer an exemption provision and it allows only deduction from total income. The deduction is to be allowed in respect of each eligible undertaking separately which has also been clarified by the CBDT. We also note that prior t assessment year 2001-02 when section 10A was an exemption provision, section 10(6) provided restriction on set off and carried forward of business loss and unabsorbed depreciation. However subsequently, section 10(6) was amended by Finance Act 2003 with effect from assessment year 2001-02 and such restriction was withdrawn which was consistent with the new scheme of section 10A which is a deduction provision and not exemption provision from A.Y.2001-02. Therefore the loss from 10A unit has to be adjusted against taxable profits of other units after deduction under section 10A has been allowed in respect of each eligible unit. Same view has been taken by the Hon’ble High Court of Mumbai in case of Hindustan Uni Liver Ltd. Vs DCIT (supra) in which it was held that deduction has to be allowed in respect of three eligible units and loss of the fourth 10A unit has to be set off against the normal business income. The tribunal in case of Honey Well International India Pvt.Ltd. Vs DCIT (supra) has also followed the same view. Therefore respectfully following the above judgements, the order of the Additional CIT cannot be sustained. We accordingly set aside the order of the Additional CIT and allow the claim of the assessee.

3. The second dispute is regarding deduction of data line cost from export turnover while computing deduction under section 10A. The assessee had incurred data line cost amounting to Rs. 1,68,47,257/-; Rs. 1,13,54,505/-; and Rs. 1,07,75,007/- respectively in respect of Mumbai-II unit, Mumbai-III unit and Bangalore unit. The AO asked the assessee to explain as to why the above expenditure should not be deducted from the export turnover in view of the provisions of Explanation 2(iv) of section 10A as per which expenses of freight, telecommunication charges and insurance charges attributable to the delivery of article or things or computer software outside India or expenses incurred in foreign exchange in providing technical services outside India were required to be deducted from export turnover. The assessee explained that it was engaged in the business of development and export of computer software. The software development work was carried out in India at its development centres in India and also in some cases on sites. The assessee was not engaged in providing any technical services outside India. It was also submitted that the assessee had not incurred any freight expenses during the year and that insurance expenditure related only to fire, burglary, theft in relation for various assets of the assessee. Similarly telecommunication charges were also not attributable to the delivery of computer software outside India and had been incurred in the business of software development at the software units of the assessee in India. Thus none of the expenses were attributable to the delivery of computer software outside India and therefore these were not required to be deducted from the export turnover. Alternatively it was also submitted that in case these expenses were excluded from the export turnover these should also be deducted from the total turnover. The assessee placed reliance on the decision of the special bench of the tribunal in case of ITO Vs Sak Soft Ltd. (313 ITR 353). The assessee also drew analogy to the parallel provisions of section 8OHHC in which the total turnover was defined as per which the freight, telecommunication charges or insurance attributable to the delivery of computer software outside India was required to be deducted. The AO however did not accept the explanation given. As regards the alternate claim that such expenses should also deducted from total turnover, the AO observed that there were no provisions in section 1OA as per which these expenses could be excluded from total turnover also. The AO therefore excluded the data line costs from the export turnover only and computed deduction accordingly aggrieved by which the assessee is in appeal before the tribunal.

3.1 Before us, the Learned AR for the assessee reiterated the submissions made before the authority below that under the provisions of Explanation 2(iv) only the freight, telecommunication charges and insurance attributable to the delivery of computer software outside India has to be excluded from export turnover. In case of the assessee, it was pointed out, that the telecommunication expenses had been incurred in the business of software development at the software development centre in India and therefore were not attributable to the delivery of computer software outside India and thus it could not be excluded from the export turnover. Alternatively it was also submitted that in case these are excluded from export turnover, deduction should also be allowed in respect of total turnover. Reliance was placed on the judgement of Honourable High Court of Mumbai in case of CIT Vs Gem Jewellery India Ltd. (330 ITR 175) and on the decision of the special bench of the tribunal in case of ITO Vs Sak Soft Ltd. (313 ITR (AT) 353). The Learned DR on the other hand supported the order of AO and placed reliance on the findings given therein.

3.2 We have perused the records and considered the matter carefully. The dispute is regarding exclusion of data line cost incurred by the assessee from the export turnover. Under the provisions of Explanation 2(iv) of section 10A, expenses on freight, telecommunication charges and insurance attributable to the delivery of article or things or computer software outside India or expenses incurred in foreign exchange in providing technical services outside India are required to be excluded from the export turnover. In this case the data line cost being the telecommunication expenses have been excluded by the AO from the export turnover. The case of the assessee is that the telecommunication expenses had been incurred in the business of software development at the software undertakings of the assessee in India. This claim has not been contraverted by the AO by placing any material on record. The expenses incurred on development of software in India cannot be considered as expenses attributable to the delivery of computer software outside India. Therefore in our view such expenses cannot be excluded from the export turnover and in case these are excluded, these have to be excluded from total turnover also following the judgement of Honourable High Court of Mumbai in case of CIT Vs Gem Plus Jewellery India Ltd. (supra) and decision of the tribunal in case of ITO Vs Sak Soft Ltd. (supra). In any case since we have held that these expenses have been incurred in the business of software development in India, these could not be considered as expenditure attributable to delivery of computer software outside India. We therefore set aside the order of AO on this point and hold that these expenses are not to be excluded from the export turnover.

4. The third dispute is regarding transfer pricing adjustment amounting to Rs. 18,46,75,062/- made by the AO. The assessee during the year had entered into certain international transactions with its associated enterprises. Under the provisions of section 92(1), income from international transactions has to be determined having regard to the arm’s length price (ALP). Section 92 C prescribes various methods of computation of ALP;

(i) comparable uncontrolled price method;

(ii) resale price method ;

(iii) cost plus method;

(iv) profit split method;

(v) transactional net margin method (TNNM) and

(vi) such other methods as may be prescribed by the Board and it also says that ALP must be determined by applying the most appropriate method.

Further, in terms of the proviso inserted from 1.4.2002, where more than one price is determined by the most appropriate method the ALP has to be taken as arithmetic mean of all such prices or at the option of the assessee, a price which may vary from the arithmetic mean by an amount not exceeding 5%.

4.1 The AO referred the issue of determination of ALP to the Transfer Pricing Officer (TPO) The TPO in this case selected the TNNM method for computation of arm’s length price. A search for comparable cases was conducted and a set of 36 companies were selected as com parables to which some more companies were added later and finally the AO short listed 20 companies, the arithmetic mean of which was computed at 20.68%. After making adjustment on account of working capital of 1.42%, the AO determined the adjusted arithmetic mean at 19.26% as per details given below.

4.2 The assessee filed objections against the proposed transfer pricing adjustments by the TPO on the basis of 20 com parables mentioned above before the Dispute Resolution Panel (DRP). The DRP after consideration of records at the submissions of the assessee observed that the assessee which was a subsidiary of CAP Gemini was engaged in the business of providing information technology services and main area of operation was software development and integration, business strategy and transformation and implementation of enterprises resource planning. DRP also observed that the information collected by the TPO regarding the com parables had been confronted to the assessee. DRP considered the plea of the assessee regarding exclusion of Mega Soft Ltd. and Accel Transmatics Ltd. from the list of com parables. The assessee submitted that Mega Soft Ltd was engaged in a different line of business and enclosed the Directors report of the company in support of the claim. The DRP noted from the report that the company had made a transition from Generic Software Services provider to product development company during the current financial year and that during the financial year ending 2006, it was only a generic software company. Therefore DRP rejected the plea of the assessee that Mega Soft was not a comparable case. In regard to Accel Transmatics Ltd. the assessee submitted the company profile and its annual report for financial year 2005-06 from which the DRP noted that the business activities of the company were as under.

(i) Transmatic system – design, development and manufacture of multi function kiosks Queue management system, ticket vending system

(ii) USHUS TECHNOLGIES- offshore development centre for embedded software, net work system, imaging technologies, outsourced product development

(iii) ACCEL IT ACADEMY (the net stop for engineers)- training services in hardware and networking, enterprise system management, embedded system, VLSI designs, CAD! CAM! BPO

(iv) ACCEL ANIMATION STUDIES software services for 2D! 3D animation, special effect, erection, game asset development.

 4.3 On careful perusal of the business activities of ACCEL TRANSMATIC Ltd. DRP agreed with the assessee that the company was functionally different from the assessee company as it was engaged in the services in the form of ACCEL IT and ACCEL animation services for 2D and 3D animation and therefore assessee’s claim that this company was functionally different was accepted. DRP therefore directed the AO to exclude ACCEL TRANSMATIC Ltd. from the final list of com parables for the purpose of determining TNNM margin.

4.4 The AO thereafter excluded Accel Transmatic Ltd. from the list of com-parables and computed the final comparable margin at 18.03% on the basis of 19 comparable as per details given below.

 4.5 After the DRP issued directions to the AO, the assessee filed a letter dated 26.10.10 before the AO which was not considered by the AO on the ground that under the provisions of section 144C(13), the AO on receipt of directions from DRP was required to complete the assessment without providing any further opportunity of being heard to the assessee. The AO accordingly computed the transfer price adjustments at Rs.18,46,75,062/- as per the computation mentioned below:

4.6 AO accordingly made addition of Rs. 18,46,75,062/- to the total income on account of transfer pricing adjustments. Aggrieved by the said decision the assessee is in appeal before the tribunal.

4.7 Before us, the Learned AR for the assessee submitted that the TPO had obtained certain information under the provisions of section 133(6) and the assessee was not confronted with the complete information obtained. It was pointed out that DRP was not correct in stating that the assessee had been confronted with the information obtained by the TPO. It was also submitted that the assessee had pointed out to DRP that 12 com parables selected by the TPO were functionally different. But the DRP considered only two com parables out of 12 com parables pointed out by the assessee. It was also submitted that various contentions raised by the assessee before the DRP were not considered which were placed at pages 166 onwards in the paper book. The Learned AR also submitted that even on the basis of directions of DRP to exclude ACCEL TRANSMATIC Ltd. the price charged by the assessee came within plus/minus 5% of the ALP computed on the basis of 19 com parables and therefore under the provisions of the Act, no adjustment was required to be made. It was argued that A.O was required to compute the TP adjustments on the basis of directions of DRP correctly under the provisions of law which had not been done. The Learned AR gave the following working of the ALP on the basis of arm’s length margin of 18.02% based on 19 comparable which showed that price charged by the assessee was within the 5% variation below the arm’s length price.

4.8 It was accordingly urged by the Learned AR that addition made on account of TP adjustment should be deleted. The Learned DR on the other hand placed reliance on the order of the AO and the TPO.

4.9 We have perused the records and considered the rival contentions carefully. The dispute raised in this ground is regarding addition on account of TP adjustment. The assessee which is a subsidiary of CAP GEMINI, was engaged in the business of providing information technology services. The assessee had transactions with it associate enterprise income from which under the provisions of Act has to be computed on the basis of arm’s length price. The AO selected TNNM method for determination of ALP and there is no dispute regarding the method selected by the TPO. TPO also selected 20 com parables which have been listed in para 4.1 earlier and on the basis of which arithmetic mean margin of the com parables was computed at Rs.19.26% and based on that TPO proposed transfer pricing adjustment of Rs.22,69,81,000. The assessee filed objections before the DRP against the order of the TPO and DRP after considering the submissions of the assessee agreed for exclusion of ACCEL TRANSMATIC Ltd. from the list of com parables and directed the AO t compute the transfer pricing adjustment after excluding Accel Transmatic Ltd. as a comparable. The AO computed the final comparable margin on the basis of remaining 19 comparable at 18.03% and on that basis arm’s length price was computed at Rs. 405,96,89,062/-. Since the price charged by the assessee was Rs. 387,50,14,000/-, the AO made adjustment of Rs. 18,46,75,062/- under section 92CA to the total income. The Learned AR for the assessee has pointed out that even if the ALP was computed on the basis of average margin of 19 com parables, the price charged by the assessee is within plus/ minus 5% margin of the ALP. It has been pointed out that ALP comes to Rs. 405,93,45,108/- and 5% variation below arm’s length price comes to Rs.385,63,77,853/- and the price charged by the assessee was Rs. 387,50,14,000/- and therefore the same was within the 5% margin. We find that AO while giving effect to the directions of the DRP has not considered the plus/minus 5% variations which is allowable under the provisions of law. AO is required to compute the TP adjustment correctly under the provisions of law on the basis of directions of the DRP which it appears has not been done. The computation filed by the assessee before us prima facie, shows that the price charged by the assessee was within 5% variation of the mean ALP and in such a case, no addition is required to be made. We therefore direct the AO to recomputed the TP adjustment after allowing the benefit of plus/ minus 5% variation from the mean ALP and make addition only, if the price charged by the assessee is beyond the 5% variation allowed under law. The AO will allow opportunity of hearing to the assessee in case any discrepancy is found in the computation given by the assessee before us as mentioned above.