The Bombay High Court has clarified that Section 80-IA(10) read with Section 10B(7) of the Income Tax Act, can be invoked only where there is a categorical finding of close connection, an arrangement between the taxpayer (appellant) and its sister concern, and that such arrangement produced more than ordinary profits. Mere existence of higher profits, common management, or subsequent amalgamation is not sufficient to infer such arrangement.
The Court held that extraordinary profits alone cannot justify restriction of Section 10B deduction, and comparison with a sister concern is not legally sustainable where the taxpayer is a 100% Export Oriented Unit (EOU) in the export market and the sister concern operates in the domestic market, unless material differences in statutory benefits and cost structures are accounted for and reasonable profit is properly ascertained. Accordingly, the ITAT’s order was quashed and the substantial question of law was decided in favour of the appellant.
The Division Bench comprising Justice M. S. Karnik and Justice S. M. Modak observed on a plain reading of Section 80-IA(10), that the provision requires findings on three elements: close connection between the parties, an arrangement between them, and a result whereby such arrangement produces more than ordinary profits.
The Bench noted that the AO had referred to common management, related-party purchases, interest-free loans, and arbitrary pricing to conclude that the business was arranged to show more than ordinary profits. However, the CIT(A) itself recorded that the AO had failed to substantiate allegations regarding non-market purchases or related-party transactions, though it still invoked Section 80-IA(10) and adopted the sister concern as a comparable.
The Bench observed that the ITAT also found that the AO’s conclusions were largely presumptive and unsupported by proper evidence or comparables, yet still upheld the approach of benchmarking the appellant against its sister concern and sustaining the restriction of profits to about 19%.
The Bench thus held that the ITAT failed to give any categorical finding as to the arrangement between the parties that led to inflation of profits beyond what could ordinarily be expected. It further held that extraordinary profits alone cannot lead to the conclusion that there is an arrangement between the parties, as that would penalise efficient functioning. The Bench also accepted the appellant’s submission that mere amalgamation with the sister concern, effective from April 01, 2009 and occurring at the end of the relevant assessment year, did not automatically indicate an arrangement so as to attract Section 80-IA(10).
The Bench further observed that comparing the profits of a 100% EOU operating in the export market with those of a sister concern operating in the domestic market, without accounting for differences in statutory benefits and cost structures, was untenable in law. It held that capping the appellant’s eligible profit at 19% solely because the sister concern had earned about 19.03% profit was arbitrary and did not stand the test of law.
Briefly, the appellant, engaged in the manufacture and export of perfumery compounds and essential oils, had set up a new 100% Export Oriented Unit at Nilakottai, Tamil Nadu in FY 2002-03 for producing perfumes/fragrances, and for AY 2009-10 claimed deduction of Rs. 2.32 crores under Section 10B of the Income-tax Act. The return filed on September 29, 2009 declared total income of Rs. 7.13 lakhs, but the Assessing Officer assessed the income at Rs. 3.78 cores, by order dated December 09, 2011.
The Assessing Officer disallowed the Section 10B claim on the ground that the claim was contrary to Section 10B(7) read with Sections 80-IA(8) and 80-IA(10), alleging that the appellant had used non-market factors to inflate profits of the eligible unit. The grounds recorded included non-charging of arm’s length interest on loans advanced by partners, abnormally high gross profit, substantial purchases from group entities or related concerns, and lack of clear correlation between inputs and outputs.
On appeal, the CIT(A) partly allowed the appellant’s case and held that the deduction under Section 10B should be capped at 19.06% of sales, being the profit earned/disclosed by the sister concern Pragati Aroma Oil Distillers Pvt Ltd., and the balance profit would be taxable at normal rates. Later, the ITAT upheld the restriction broadly on the basis that the sister concern’s net profit was around 19.03% and that the appellant had disclosed profits in excess of what could reasonably be expected.
Appearances:
Advocates Naresh Jain, Mansvi Singh, Priyanshi Jain and Bhavesh Bhatia, for the Appellant/ Taxpayer
Advocates Sushma Nagaraj and Abhinav Palshikar, for the Respondent/ Revenue
