A Case Of Tax Exemption vs Avoidance – Analysis Of The Special Bench Decision In Doshi Accounting Services

In Doshi Accounting Services vs. DCIT, the Special Bench of the ITAT has held that the transfer pricing provisions are applicable even to a case in which the income of the assessee is eligible for 100% tax exemption and is not chargeable to tax in India. Advocate Shashi Bekal has conducted an in-depth analysis of the judgement and explained its nuances. He has also argued that the judgement may require reconsideration

1. Introduction

Recently, the Hon’ble President of the Income Tax Appellate tribunal (ITAT) on a reference made by a Division Bench constituted a Special Bench to decide the following question of law (1) :

“Whether or not the provisions of Section 92 can be invoked in a situation in which income of the assessee is eligible for tax exemption or tax holiday and thus not actually chargeable to tax in India, or in a situation in which there cannot be any motive in manipulating the prices at which international transactions have been entered into?”

To understand the decision passed by the Special Bench, it is imperative to analyse the facts, orders of the lower authorities and contention placed by both the parties before the Special Bench. The article aims at a deep dive into the decision, addressing the vital issues and encapsulating the decision in a compact version.

2. Facts

Doshi Accounting Services Private Limited (assessee) is a private limited company, engaged in the activity of business process outsourcing (BPO)services in the field related to accounting & taxation such as book-keeping, VAT, returns, payroll, management accounting, and audit. The major shareholder in thecompany is Mr. Dhiren Doshi, who is also the sole proprietor of the firm M/s Doshi& Co. (AE (2) ) based in the United Kingdom.

The assessee provides these services from the unit situated at Baroda which isaSoftware Technology Parks of India (STPI) unit eligible for deduction/exemption under section 10A of the Income Tax Act, 1961 (Act).

The assessee in the year under consideration (3) provided services equating to1,60,378 hours to its AE and 380 hours services provided to NON-AEs located in Zambia, Africa. The assessee in the year under consideration in the case of AE has charged a rate of GBP 5 per hour from April 2005 to Feb 2006 and in March at the rate of GBP 6 per hour whereas in case of non-AEs it has charged GBP 4.50 to 4.85per hour during the same period. Accordingly, the assessee contended that the similar nature of services was provided to both AE and non-AEs from the same facility, but the rate charged to the AE was higher than the average rate charged to NON-AEs.

The assessee benchmarked its transaction with AE by applying internal comparable uncontrolled price (CUP) method prescribed under section 92C of the Act and claimed that its transactions with theAE are at Arm Length Price (ALP).

3. Proceedings before the Ld. Assessing Officer (Ld. AO)

The assessee during the assessment proceedings made available the details of the external comparables based upon the quotations of Independent Enterprises where the average rate quoted by them figuring at GBP 5.71 per hour was greater than the rate charged from the AE. The assessee contended that difference in the rates arrived in pursuing internal CUP method being GBP 5.09 and external CUP method being GBP 5.71, arose due to the unevenness of the terms and conditions between the subject entities and their clients.

On the other hand, the Ld. Transfer Pricing Officer (TPO) rebutted the rationale proffered by the assessee and was of the view that CUP method requires a high degree of comparability such as the volume, credit terms, timing & geographical area of transaction/services, etc. which is not comparable in the present case, thereby adopting Transactional net margin method (TNMM) as the most appropriate method. Accordingly, theTPO made the upward adjustment of INR 1,48,23,848.

4. Proceedings before the Ld. Dispute Resolution Panel (Ld. DRP)

Aggrieved by the order of Ld. TPO/Ld. AO, assessee referred the matter to Ld. DRP. The assessee placed a contention before the Ld. DRP that the assessee is enjoying the benefit of deduction under section 10A of the Act i.e. exemption on its eligible profit at the rate of hundred percent, therefore there is no reason for the assessee to charge a lower price from its AE. Moreover, the assessee contended that the effective tax rate in the UK would be higher than the effective tax rate in India, thus there was no motive and incentive in shifting the profits from India to the UK, where the rate of tax is comparatively higher. The assessee in support of their contention placed its reliance on the decision of the Hon’ble ITAT (Bangalore Bench) in the case of Philip Software Pvt. Ltd. (4)

However, the Ld. DRP rejected the contention of the assessee after relying on the decision of Hon’ble ITAT (Bangalore 5-member Special Bench) in the case of Aztec software & technology services Ltd and Hon’ble ITAT (Mumbai Bench) in case of Gharda chemicals Ltd. (6)

5. Appeal before the ITAT

Aggrieved by the order of Ld. DRP, the assessee is in appeal before ITAT (Ahmedabad Bench). The assessee took the plea that since, it is eligible for tax exemption and not actually chargeable to tax in India, therefore there cannot be any motive to shift the profit from India to U.K. Therefore, no reference to the Ld. TPO ought to have been made.

The Bench found contradictory orders of the ITAT on the above plea and therefore, recommended the question for determination by the Special Bench.

6. Proceedings before the Special Bench

A Special Bench was constituted to examine the above-mentioned issue.

6.1. Contentions placed by the Assessee

The assessee placed 5 contentions before the Special Bench viz.

(a) Purposive of interpretation of Transfer Pricing (TP)provisions.

(b) Purpose of introducing TP provisions.

(c) Why the Decision of the ITAT (Bangalore 5-member Special Bench) in the case of Aztec Software & Technology Services Ltd. (7) is no more a good law.

(d) Income is sine qua non to apply the provisions of Chapter X of the Act.

(e) other arguments in support of this interpretation.

Elaborating the above-mentioned contentions placed by the assessee as follows:

(a) & (b) Purposive of interpretation & Purpose of TP provisions

That the TP regulations in Chapter x of the Act were introduced via amendments in Finance Act, 2001 and 2002. The then Hon’ble Finance Minister had explained (8) that since participation of multinational group companies in the economic activities of the country has arisen, and new complex issues have emerged from the transactions entered between two or more enterprises belonging to the same multinational group, therefore, possibility of manipulation of price charged or paid as such in their group concerns, cannot be ruled out, and can lead to erosion of tax revenue to the country. With a view to provide statutory framework, which can lead to computation of reasonable, fair and equitable profits and tax in India, in the cases of such multi-national enterprises, new provisions were introduced in the Income Tax Act.

Further reliance was placed on numerous Circulars viz. 12 of 2001 dated August 23, 2001 (9), Circular No.14 of 2001 (10) , and Circular No. 8 of 2002 dated August 27, 2002 (11) to contend that TP provisions have been incorporated with a view to provide a statutory framework to prevent profit shifting from India leading to erosion of tax revenue. Reliance to this effect was placed on the decision of the Hon’ble Supreme Court in the case of Morgan Stanley & Co. (12)

Since, the assessee was eligible for exemption under section 10A of the Act on its eligible profit at the rate of hundred percent, therefore, there is no chance of avoidance of any taxes, hence the provisions of Chapter X i.e. TP Provisions should not be attracted.

For the purpose of applying the rule of reasonable interpretation, reliance was placed on decisions of the Hon’ble Supreme Court in the case of Goodyear India Ltd (13) . and Allied Motors P.Ltd. (14)

(c) Why the decision of the ITAT (Bangalore Special Bench) (15) is no more a good law

The decision of the ITAT (Bangalore 5-member Special Bench) in the case of Aztec Software & Technology Services Ltd where on a similar issue the question has been decided in the favour of the revenue has been expressly over ruled by the decision of the Bombay High Court in the case of Vodafone India Services P. Ltd. (16)

(d) Income is sine qua non to apply the provisions of Chapter X of the Act.

That, the Ld. AO ought to have not made reference blindly to the TPO for determination of ALP of international transaction, as prima facie it is evident that there is no element of income or loss involved in such transaction.

Further, that Chapter X of the Act is a machinery provisions and not a charging one. Once the income of the assessee is eligible for hundred percent deduction under section 10A of the Act then by applying the machinery provision an artificial chargeabilty cannot be invoked.

(e) other arguments in support of this interpretation

That, sections 10A/10B/10AA of the Act and the TP provisions operate in separate and mutually exclusive sphere. On plain reading of these provisions, it would reveal that neither supersede nor overrule the other one. There is no legislative or judicial clarity as to which will prevail over the other.

In order to determine eligible business for the purpose of computing eligible profits under section 10 A of the Act, the Legislature have put various restrictions i.e. section 80IA (8) and (10) which have been made applicable to section 10A of the Act.

Under this section wherein it has been contemplated that value of all goods and services undertaken by any assessee from the eligible business should correspond equivalent to the market value. The expression “market value” used in section (8) has been explained by way of an explanation. According to this explanation, the expression “market value” in relation to any goods and services means the price that such goods or services would ordinarily fetch in the market. After Assessment Year 2013-14, the scope of expression “market value” used in sub-section(8) has been enhanced and it has been provided that it should be at an arm’s length price as defined in clause (ii) of section 92F where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA.

Thus, section 10A is a complete code in itself, which authorise the AO to determine the eligible profit for grant of exemption at the rates specified in section. It takes care of any unreasonable profit if computed by the assessee.

Further since none of the provisions starts with non obstante clause exhibiting the overriding effect given to any of the provisions, then section 10A of the Act being substantive provisions provide incentive from taxation and also a machinery provisions providing the mode of computation, it should be given preference over the TP provisions.

Therefore, once it is held that the assessee is entitled for hundred percent exemption of its profit under section 10A, then TP provision ought not to be applied. Reliance was placed upon the decision of Hon’ble Karnataka High Court in the case of Hewlett Packard Global Soft Ltd (17) .

Further on the strength of Hon’ble Supreme Court decision in the case of Bajaj Tempo Ltd. (18) , it was submitted that section 10A of the Act being a provision intended to promote for economic growth it should be construed liberally with an idea to achieve both these sections and not to frustrate such objects.

Pursuant to that another contention was placed on clause (4) of Article 26 of the Indo-UK DTA; India cannot subject the assessee to taxation or requirements more onerous than the similar enterprises in India. In other words, tax authorities in India cannot discriminate between the assessee vis-à-vis an identical assessee situated in India dealing with identical transaction to other residents in India. The fact that when an eligible unit under section 10A of the Act transacts with a related resident, the only action that can be taken is to deduce profit as per section80IA(8) and (10) of the Act. However, when an eligible unit under section 10 of the Act transacts with a related non-resident, its profit can be re-determined, reduced as per 80IA(10) of the Act, and the transaction price can also be replaced and theassessee’s income enhanced under the TP provisions. Section 92C(4) of the Act wherein it has been provided that if there is an upward adjustment in the ALP of an international transaction, then deduction under section 10A of the Act will not be granted on such adjustment. This creates a discrimination between the resident vis-à-vis non-resident and in view of Article26 of Indo-UK DTA. Reference was made to the decision of Hon’ble Delhi High Court in the case of Herbalife International India P. Ltd (19) .

6.2. Contentions placed by the Department

That the literal interpretation of section 92C(4) of the Act is unambiguous in the interpretation of the provisions of the law, and there is no need to take any aid from the rule of the interpretation.

That, there are incomes which are chargeable to tax, albeit they do not form part of the total income as understood under section 4 read with section 5 of the Act. These Incomes are specified under section 158BA read with section 113 of the Act, section 68 read with section 115BBE of the Act. Similarly, when the proviso to section 92C(4) of the Act comes into play resulting in a disallowance out of the exempted part of income, allowed under section 10A of the Act, will be subject to tax.

Further, the facts of Vodafone India Services P. Ltd (20) are distinguished from the current case and that the precedent should not impact the invocation of Chapter X of the Act.

Further, that the notional/book adjustment on account of the transfer pricing provisions. As such, there will not be any inflow of the foreign currency even whenthe exemption is denied by virtue of the proviso to section 92C of the Act.

6.3. Order of the Special Bench

The Special Bench relying on a catena of decision of both the Hon’ble Supreme Court and various Hon’ble High Courts held that it is cardinal rule of interpretation that where the language used by the legislature is clear and unambiguous then plain and natural meaning of those words should be applied to the language and resort to any rule of interpretation to unfold intentions is permissible where the language is ambiguous.

Section 92C of the Act has a direct bearing on the controversy on hand, perusal of the same makes it clear that it is very clear that the purpose behind the provision of transfer pricing is to determine true profits/income as if such international transaction has been entered with an unrelated party or non-AE, irrespective of the fact that the income of the assessee was eligible for exemption. On the other hand, there is no express provision under the Act restricting the application of section 92C of the Act for determining the income at arm’s length where such income is eligible for deduction u/s 10A of the Act. On the contrary, there is a proviso to section 92C(4) of the Act which prohibits the deduction under section 10A of the Act on the income to the extent enhanced as an effect of a determination of ALP.

Provisio to section 92C(4) vividly reflects the intent of lawmakers that the provisions of chapter X of the Act shall prevail in all the cases of international transactions falling under the umbrella of section 92 of the Act including the income-qualified for exemption under section 10A of the Act.

Thus sections 92 of the Act is clear, unambiguous, and do not lead to any absurd meaning. Further regarding the budget speech & memorandum explaining the provisions, it is also a settled legal position that headings or marginal notes do not govern a provision where the legislature has used plain and unambiguous language. It is when the language is equivocal only then, help can be taken from the circulars, marginal notes or the Finance Minister speech or memorandum explaining the provisions to interpret the provision of the Act. Reliance is placed on the decision of the Hon’ble Supreme Court in the case of Anandji Haridas& Co. Pvt. Ltd vs. Engineering Mazdoor Sangh & Anr (21)

Further, that department Circulars as mentioned by the assessee are not binding on the Tribunal and circulars cannot be used to usurp the power of a judicial body while exercising its jurisdiction, including interpreting the statutory provisions. Reliance is placed on the decision of the Hon’ble Supreme Court in the case of Sanjeev coke manufacturing company vs. Bharat coking coal Ltd and another (22)

Further, the spirit behind introducing section 10A of the Act was to bring foreign exchange in India. Granting exemption from Tax under section 10Aof the Act was incidental and not the main object. Furthermore, where amount fetched by the Indian AE as revenue and/or the amount paid to its counter-part,AE outside India, as expenditure is lower and higher respectively and does not correspond to an ALP, the same will adversely affect the inflow of foreign exchange in India, and that could be one of the reason to insert the proviso in section 92C(4) of the Act.

For example, assessee though claiming the exemption under section10A of the Act can also manipulate the ALP with an objective to avoid corporate dividend tax by shifting its profits to AE. This also might be the reason for inserting a proviso to section 92C(4) of the Act.

Further, with regard to whether the tax levied in pursuance of the provisions laid down in article 265 of the constitution of India can be the subjected to foreign tax laws. Reliance is placed on OECD guidelines which states that the arm’s length principle promotes the growth of international trade and investment amongst OECD member countries and other countries. to maintain harmony and avoid double taxation, there have been made various treaties with different countries under section 90 of the Act. Thus, the taxes levied under Article 265 of the constitution of India will be subject to such treaties which do not even connote being subject to foreign tax law.

The provisions of Chapter X of the Act are not impeding with the manner of the computation of exemption under section 10A of the Act, but it is to work out the true ALP qua the sale price of the impugned international transaction. Therefore, even if an assessee is eligible for tax exemption at the rate of hundred percent under section 10A/10Bof the Act, even then the arm’s length price on international transactions deserve to be determined under section 92C of the Act.

7. Our Views

Appreciating the decision of the Special Bench, especially where the Bench has examined the possible impact on corporate dividend tax on manipulation of ALP.

However, since the Bench relied heavily on literal interpretation of the statutes. They ought to have provided further clarification in the event the assessee would have been located in a SEZ or the free trade zone was converted into an SEZ. Section 51(1) of The Special Economic Zones Act, 2005 (SEZ Act) gives an overriding provision over other laws.

The rule of generalia specialibus non derogantit is a well settled position in law. i.e. the provisions of a general statute must yield to those of a special one. The same has been upheld by the Hon’ble Supreme Court in the case of India Fisheries (23) wherein it was held that If there is an apparent conflict between two independent provisions of law, the special provision must prevail.

Section 51(1) of the SEZ Act is usefully extracted as under:

“51(1) The provisions of this Act shall have effect notwithstanding anything inconsistent, therewith contained in any other law for the time being in force or in any instrument having effect by virtue of any law other than this Act.”
(Emphasis supplied)

The reading of the provisions expressly clarifies that the provisions as specified under The Special Economic Zones Act, 2005 would have overriding effect on the Income Tax Act, 1961, because Special Economic Zone Act, 2005 is a Special Act and a later Act of the Parliament.

Would the question of law before the Special Bench be answered differently in this case?

Disclaimer: The contents of this document are solely for informational purpose. It does not constitute professional advice or a formal recommendation. While due care has been taken in preparing this document, the existence of mistakes and omissions herein is not ruled out. Neither the author nor itatonline.org and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon. No part of this document should be distributed or copied (except for personal, non-commercial use) without express written permission of itatonline.org