No deduction under section 10B on Transfer Pricing

BDO INDIA
TRANSFER PRICING UPDATE
MAY 2015
NO DEDUCTION UNDER SECTION 10B ON TRANSFER PRICING ADJUSTMENT SUO MOTO MADE BY THE TAX
PAYER
BACKGROUND
The Income Tax Appellate Tribunal, Mumbai (ITAT) has held
that the tax payer shall not be allowed deduction under
Section 10B of the Income Tax Act, 1961 (IT Act) where it
makes a suo moto Transfer Pricing (TP) adjustment which
leads to an addition to the total income.

Section 92C(4) of the IT Act provides that, in a case where
the ALP is determined by the AO under Section 92C(3) as
mentioned above, the AO may compute the total income
of the tax payer.

Further, as per the proviso to Section 92C(4), no
deduction under Section 10B of the IT Act will be allowed
in respect of the amount which has been enhanced by the
AO after the computation of income under Section 92C(4).

In light of the above, the tax payer pointed out the fact
that, TP adjustment was suo moto made, as a result of
which the total income increased. This adjustment was
accepted in totality by the Transfer Pricing officer and
hence, there was no enhancement of total income by the
AO per se.

Accordingly, the proviso to Section 92C(4) does not apply
in the instant case and therefore, there arises no question
of denying deduction under Section 10B of the IT Act.

Reliance placed upon the decision of the Bangalore
Tribunal in the case of I Gate Global Solutions Ltd. Vs.
ACIT (ITA No. 248 & 249 of 2007) wherein the tax payer
was allowed deduction under Section 10A of the IT Act in
respect of the income declared in the return of income on
the basis of computation of arm’s length price.

On a separate ground, the tax payer also claimed that the
amount eligible for deduction under Section 10B of the IT
Act should be computed with regard to profits without
setting off the brought forward losses.
THE CASE

The tax payer is a registered 100% EOU engaged in the
business of software development and export of software.

The tax payer made an addition to its total income in the
return of income on account of a suo moto transfer
pricing adjustment and considered the same for deduction
under Section 10B of the IT Act.

The assessment was completed by the Assessing Officer
(AO) under Section 143(3) of the IT Act.

However, the Commissioner of Income Tax – 1 (CIT – 1)
noticed that the abovementioned addition to the total
income was not brought into India in convertible foreign
exchange. This additional amount should not have been
considered while computing deduction under Section 10B
of the IT Act. Therefore, the order of the AO was treated
as prejudicial to the interest of the Revenue.

The CIT – 1 passed an order under Section 263 of the IT
Act thereby directing the AO to refer the matter to the
Transfer Pricing Officer for determination of Arm’s Length
Price (ALP) as per Instruction No. 3 of CBDT Circular dated
20-05-2003 and also, to determine the amount for
deduction under Section 10B of the Act.

The AO passed an order pursuant to the directions of the
CIT – 1. Firstly, disallowing the claim for deduction under
Section 10B of the IT Act keeping in mind the provisions of
Section 10B(3) of the IT Act in respect of the amount of
suo moto addition made by the tax payer to the total
income. Secondly, referred the matter to the Transfer
Pricing Officer (TPO) for determining the ALP.
Assessing Officer’s Observation

On scrutinising the Return of Income of the tax payer, the
AO observed that the tax payer made an export turnover
out of which he derived profits amounting to Rs.
4,69,58,722 from its unit in the Special Economic Zone.

Further, it was also observed that the tax payer had set
off total income for the year under consideration against
brought forward losses of previous years.

Also, it was noticed by the AO that the tax payer had by
itself admitted that convertible foreign exchange of Rs.
4,09,45,804 was not realised in India as required under
Section 10B of the IT Act.

When the tax payer was asked to explain its abovementioned claim, the tax payer stated that all the export
turnover reported in the books has been received in India
within 6 months.

On the basis of the above findings, the AO was of the view
that the amount of Rs. 4,09,45,804 which was an addition
on account of the suo moto TP adjustment made by the
tax payer, was not brought into India in convertible
foreign exchange. Therefore, it should not be considered
for calculating deduction under Section 10B.
CIT(A)’s DECISION
Aggrieved with the order of the AO, the Taxpayer approached
the Commissioner of Income Tax (Appeals) [CIT(A)]. The
CIT(A) agreed with the AO’s observations and views and
therefore, the tax payer preferred an appeal before the ITAT.
APPEAL BEFORE THE INCOME TAX APELLATE TRIBUNAL
Issue before the ITAT

Whether the suo moto TP adjustment made by the tax
payer amounts to enhancement of income so that the
proviso under Section 92C(4) can be applied thus denying
deduction under Section 10B to the tax payer.
Taxpayer’s Arguments
The arguments of the Taxpayer before the ITAT are
summarized as under:

Section 92C(3) of the IT Act provides for computation of
ALP for an International Transaction by the AO in a few
cases.
THE RULING
in his order, the ITAT held that the AO and CIT(A) cannot
enlarge the scope of directions of the CIT issued under
Section 263 of the IT Act, thereby setting aside the
findings of the CIT(A).
The ITAT ruled against the Taxpayer on the basis of the
following observations:

The emphasis is on enhancement of total income through
a TP adjustment. However, there is no clarity in a case
where the adjustment is made suo moto by the tax payer.

The provisions of Section 92C of the IT Act cannot be read
in isolation to the other provisions of the IT Act to
interpret the word ‘enhance’. It has to be read along with
the provisions of Section 10B of the IT Act to derive any
interpretation.


The intention under Section 10B of the IT Act is to bring
the sale proceeds (in the form of convertible foreign
exchange) of a 100% export oriented unit into India within
a period of 6 months within the end of the previous year.
If the tax payer is allowed benefit under Section 10B of
the IT Act taking into consideration its suo moto
adjustment made, then every tax payer will initially under
price its sale with associated enterprises and thereafter
suo moto enhance the price by making suo moto transfer
pricing adjustment. As a result, the tax payer will claim
deduction under Section 10B of the IT Act, on the basis
that the initial under price sale declared by the tax payer
in the books of account has been brought in India in
convertible foreign exchange within 6 months.
Consequently, a portion of the sale will be purposely kept
abroad which will later be adjusted suo moto by the tax
payer.

In this regard, the tax payer cannot be granted benefit of
the provision which the legislation never intended to.

Accordingly, the ITAT held that the tax payer cannot be
allowed deduction under Section 10B of the IT Act, in
respect of the amount suo moto adjusted by the tax
payer.

Our Comments

Global transfer pricing challenges may lead to charging of
lower margins and consequential adjustments to comply
with local transfer pricing regulations.

In this case the taxpayer made suo moto adjustment to its
income to align with the Indian Arm’s length
expectations.

Generally, a Multinational company adopts such an
approach to achieve dual objectives, compliance with its
own global policy and meeting Indian Transfer Pricing
requirements.

Offering additional income as a suo moto TP adjustment
has not been adversely viewed, either by the Tax
Authorities or the Appellate Authorities.

It is the claim of deduction in relation to suo moto TP
adjustment, which has been denied in the present case.

The denial is also a view of one of the ITAT, as there is a
contrary decision on this issue.
Way Forward

The ratio of this decision could be relevant to taxpayers,
having units located in Special Economic Zones (SEZs) and
claiming deduction under Section 10AA of the Act.

Taxpayers having SEZ units eligible for deduction under
Section 10AA would need to evaluate whether or not a suo
moto transfer pricing adjustment would be eligible for the
said deduction.
The ITAT ruled in favour of the Taxpayer on the following
grounds:

Following the decision of the Bombay High Court in the
case of CIT vs. Black Veatch Consulting Pvt. Ltd. [2012]
(348 ITR 72), the ITAT directed the AO to compute the
amount eligible for deduction under Section 10B of the IT
Act before setting off brought forward losses.
In connection with the additional issues beyond the scope
of the directions issued by the CIT – 1, included by the AO
How BDO can help
We assist Indian and Foreign companies in developing international tax planning strategies as well as Transfer Pricing strategies in
line with the business requirement and regulatory environment. For more information, please contact one of the following:
Jiger Saiya
Partho Dasgupta
Pradeep Kasthala
Partner – Mumbai
+91-22-24393605
jigersaiya@bdo.in
Partner – New Delhi
+91- 98106 45464
parthodasgupta@bdo.in
Partner – Hyderabad
+ 91 99 4924 8880
pradeepkasthala@bdo.in
Note: This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication
cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining
specific professional advice. Please contact BDO India LLP to discuss these matters in the context of your particular circumstances. BDO India LLP and
each BDO member firm in India, their partners and/or directors, employees and agents do not accept or assume any liability or duty of care for any loss
arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.
BDO India LLP, a limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the
international BDO network of independent member firms.
BDO is the brand name for the international BDO network and for each of the BDO Member Firms.
Copyright ©2015 BDO India LLP. All rights reserved.
Website: www.bdo.in
OFFICES IN: MUMBAI | PUNE | GURGAON | HYDERABAD | AURANGABAD