Saktijit Dey, Judicial Member
1. This appeal of the assessee is directed against order dated 29/11/2013 of ld. CIT(A)-V, Hyderabad pertaining to AY 2007-08. Present name of the assessee was changed from its earlier name i.e. Login Soft India Pvt. Ltd. by Registrar of Company's order dated 13/03/2011.
2.The solitary issue arising for consideration in the aforesaid appeal is related to disallowance of a part of deduction claimed u/s 10A of the Act.
3.Briefly the facts are, assessee a company is engaged in the business of software development and related services. For the AY under consideration, assessee filed its return of income on 08/11/07 declaring total income of Rs. 98,357 after claiming deduction u/s 10A of the Act for an amount of Rs. 148,27,467. During the assessment proceeding, AO noticed that assessee has in the relevant PY exported software developed by it to its Associated Enterprise (AE) M/s Login Soft Inc., USA. Noticing that assessee has entered into international transactions, AO wanted to verify whether the price charged by assessee is at arm's length. On going through the TP documents submitted by assessee, AO noticed that as per comparability analysis made by assessee in the TP document by adopting TNMM, the profit margin earned by assessee on export of software to its AE is 50% of the total revenue as against the average profit margin of 15% of the comparable companies. AO referring to the provisions of sub-section (2) of section 92Cobserved that ALP is to be taken as arithmetical mean of such price or at the option of assessee, a price which may vary from the arithmetical mean by an amount not exceeding 5%. He observed that in view of statutory provision deviation upto 5% of the arithmetical mean can be allowed. He, therefore, held that considering the average margin of the comparable companies at 15%, assessee can be allowed profit margin upto 20% which can be considered to be the ALP for the software exported to AE. Hence, balance 30% of the total turnover is liable to be adjusted as per the TP provisions enumerated under Chapter X. Accordingly, AO taking into consideration the total revenue earned from software export at Rs. 2,91,14,688 worked out 30% of the said amount as the excess profit earned by assessee amounting to Rs. 87,34,406 which according to AO is not at ALP. He, therefore, called upon assessee to explain why such excess profit shall not be reduced from the profit derived from eligible business for the purpose of computing deduction u/s 10A. Though, assessee objected to the proposed disallowance of deduction u/s 10A, but, AO referring to the provision contained u/s 92C finally concluded that arm's length profit computed at 20% of the total turnover would be eligible for deduction u/s 10A. Resultantly, he disallowed an amount of Rs. 87,34,406 being 30% excess profit claimed by assessee. Being aggrieved with the disallowance of part of deduction claimed u/s 10A, assessee preferred appeal before ld. CIT(A).
4.Ld. CIT(A) deleted the addition made by AO on account of disallowance of 10A deduction by observing that 10A deduction can be disallowed in terms with proviso to section 92C(4) only in a case where total income declared by assessee gets enhanced on account of adjustment u/s 92C(4). Ld. CIT(A) observed that since in assessee's case, there is no adjustment to the profit shown and there is no enhancement of income, no disallowance can be made u/s 10A of the Act. Accordingly, he deleted the addition made by AO. Being aggrieved of the aforesaid order of ld. CIT(A), revenue preferred appeal before ITAT. ITAT after considering the submissions, remitted the matter back to ld. CIT(A) with the following directions:
"5. We have heard both the parties and perused the material available on record. In our opinion, the provisions of section 10A(7) are applicable to the facts of the case which has not been considered by the CIT(A). Hence, we direct the CIT(A) to consider the issue in the light of the provisions of section 10A(7) and pass a speaking order in accordance with law."
In pursuance to the direction of ITAT, appeals were again heard by ld. CIT(A). In course of hearing of appeal, though, assessee advanced arguments challenging the applicability of section 10A(7) and 80IA(10) of the Act, but, ld. CIT(A) rejected such contention of assessee. He observed that since as per assessee's own TP documentation, profits earned by assessee is 50% of the turnover as against average profit margin of 15% of the comparable companies, the provisions of section 80IA(10) are clearly applicable as there is close connection between assessee and its AE. He, therefore, concluded that since as per the information available on record profit generally earned in similar business is 15% , adoption of profit rate at 20% by AO is reasonable. Accordingly, he confirmed the disallowance of Rs. 87,34,406 from the deduction claimed u/s 10A of the Act.
5.The main plank of ld. AR's submission is even assuming that provisions of section 10A(7) are applicable, still AO without satisfying the conditions of section 80IA(1) cannot estimate the profit for computation of deduction u/s 10A of the Act. Ld. AR submitted as per the said provision, AO must bring material on record to prove that there is an arrangement between assessee and the other person in respect of the business transacted between them, which has produced more than ordinary profits to assessee. He submitted that in the present case neither AO nor ld. CIT(A) have given any conclusive finding that there is business arrangement between the parties resulting in higher profit to assessee. He, therefore, submitted that in absence of such conclusive finding disallowance of claim of deduction u/s 10A of the Act is not justified. In support of such contention, he relied on the following decisions:
1. AT Kearney India (P.) Ltd. v. Addl. CIT  66 SOT 140/50 taxmann.com 26 (Delhi - Trib.)
2. CIT v. Schmetz India (P.) Ltd.  211 Taxman 59 (Mag.)/26 taxmann.com 336 (Bom.)
3. Zavata India (P.) Ltd. v. ITO  141 ITD 456/31 taxmann.com 147 (HYD.)
6. Ld. DR, on the other hand, strongly supporting the order of ld. CIT(A) and AO submitted, since assessee and its AE are related parties and facts and materials on record indicate that profit earned by assessee is much more than the average profit earned by comparable companies, the provisions of section 10A(7) read with section 80IA are clearly applicable. Hence, disallowance of deduction u/s 10A on excess profit earned by assessee is reasonable and justified.
7. We have considered the submissions of the parties and perused the orders of revenue authorities as well as other materials on record. As far as the applicability of section 10A(7) is concerned, in our view, the issue has attained finality as the directions of ITAT in the earlier round of litigation has not been challenged by assessee or by revenue. Keeping this in view, we have to decide whether disallowance of deduction u/s 10A of the Act by applying the provisions of section 80IA(1) is valid. As can be seen, section 10A of the Act allows exemption at 100% of the profit earned by assessee from export of software. However, deduction u/s 10A is subject to 10A(7), which in turn refers to section 80IA(8) and 80IA(10) of the Act. Since 80IA(8) is not relevant for our purpose, there is no need to discuss the same. As far as the provisions contained u/s 80IA(10) is concerned, it reads as under:
"Where it appears to the AO 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 AO 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."
On plain reading of the aforesaid provision, it is clear that as per the said provision three conditions have to be fulfilled. Firstly, there must be close connection between assessee carrying on the eligible business and the other person. Secondly, the business between assessee and such other closely connected person should be so arranged that business transacted between them produces more than the ordinary profits to assessee carrying on eligible business. If AO is satisfied with the aforesaid two conditions, then, as per the third condition, he may take the amount of profits as may be reasonably deemed to have been derived from transactions of such business in computing profits of such eligible business for the purpose of deduction under the said section. Considering the facts of the present case in the light of the aforesaid statutory provisions, it is to be seen that the first condition is fulfilled as assessee and its AE are related parties. However, as far as the second condition i.e. existence of arrangement between assessee and its related party by which these transactions so arranged has to produce more than the ordinary profits in the hands of assessee, whether has been fulfilled or not needs to be examined. On perusal of the assessment order, it is very much evident that only relying upon TP document of assessee wherein it is stated that average profit margin of comparable company is 15% as against 50% of assessee, AO has concluded that profit earned by assessee is not at arm's length. AO has not given a conclusive finding as to whether earning of such excess profit is as a result of business arrangement between the parties. Even, ld. CIT(A) has also not given any factual finding on the issue to conclusively prove that assessee and its related party has arranged their business affairs in such a manner that it will result in more than reasonable profit to assessee. Merely relying upon the fact that in the TP documentation the average margin of comparable companies are 15% where as the assessee has shown profit at 50%, the departmental authorities have reduced the deduction claimed u/s 10A by restricting the profit from the eligible business of assessee to 20% of the turnover. In our view, the Department having not fulfilled the conditions of section 80IA(10), disallowance in the present case is not justified. At the cost of repetition, it needs to be stated that only relying upon TP documentation, AO has inferred that the profit earned by assessee at 50% is more than the arm's length profit. However, without bringing material on record that the profit earned by assessee at 50% is not the profit ordinarily earned in similar line of business, it cannot be said that it is not at arm's length. Moreover, excess profit may be due to various reasons. Therefore, without analysing those factors, it cannot be said that only because average profit earned by comparables is 15%, the profit earned by assessee at 50% is not reasonable. The Chennai Bench of the Tribunal in case of Tweezmen India (P.) Ltd. v. Addl. CIT  133 TTJ 308 while considering similar issue held that the provisions of section 80IA(10) do not give arbitrary power to AO to fix the profits of assessee. AO has to specify as to why he feels that profits of assessee are being shown at higher figure. AO has to further show as to how he has computed ordinary profits which he deems to be profit which assessee might be reasonably expected to generate. The Bench held that AO would be expected to use a comparable case to determine the possible ordinary profit which assessee could be expected to generate from his business. In the absence of any other substantial evidence with him, when using a comparable, assessee's own past and future performance would obviously be the best comparable. Comparing assessee's modus operandi of conducting its business with another when the same are not of equal terms would be a travesty of justice in so far as the financial charges. The use of plant & machinery, depreciation thereon, the location which would affect the cost of transportation as also the cost of labour, cost of power and fuel would have to be seen. The ITAT, Delhi Bench in case of AT Keatney India Ltd. (supra), the facts of which are more or less identical to the facts of the present case, while deciding similar issue held as under:
"11. Adverting to the facts of the extant case, we find that the AO simply relied on the TP study report submitted by the assessee to form a bedrock for the disallowance of the part of the amount of deduction u/s 10A, without firstly showing that there existed any arrangement between the assessee and its overseas related party, by which the transactions were so arranged as to produce more than the ordinary profits in the hands of the assessee. The assessment year under consideration is 2009-10. Neither the proviso to sub-section (10) existed at that time, nor such a proviso can be applied as we are dealing with an international transaction and not specified domestic transaction. Under these circumstances, we are of the considered opinion that the impugned order upholding the invocation of sub-sec. (10) of sec. 80IA cannot be
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countenanced to this extent. Ergo, it is held that the ld. CIT(A) erred in sustaining the disallowance made by the Assessing Officer by restricting the amount of deduction u/s 10A of the Act to Rs. 2.63 crore as against Rs. 8.22 crore claimed by the assessee. The impugned order on this issue is overturned and it is directed to allow deduction as claimed." Examining the facts of the present case in the light of the decisions referred to hereinabove, it is noticed that in the present case also AO has simply relied on the TP study report of assessee to conclude that the profit earned by assessee cannot be considered to be reasonable profit earned from eligible business and on that basis has disallowed part of the deduction u/s 10A. Therefore, since AO has not conclusively proved the fact that there is an arrangement between assessee and its AE by which the transactions were so arranged as to produce more than the ordinary profits in the hands of assessee, disallowance of part deduction claimed by applying the provisions of section 80IA(10), in our view is not justified. Since ld. CIT(A) upheld the disallowance without examining the aforesaid aspect, order of ld. CIT(A) deserves to be set aside. The conditions of section 80IA(1) having not been fully complied by AO, disallowance of deduction claimed u/s 80IA(10), in our view is not justified. Accordingly, we delete the addition made by AO in this regard. 8. In the result, assessee's appeal is allowed.