The Hindu Business Line : Enhanced interest in ‘enhanced’ income

The last grievance of iGate, in a recent case before the Bangalore ITAT (Income Tax Appellate Tribunal), was about the non-allowing of deduction under Section 10A on the adjustment it had made to the arm’s length price.

The company had entered into transactions with an associated enterprise, and it found that the arm’s length price was more than the consideration at which the transactions were shown in the books of account.

The other grievances were about whether up-linking charges reduced from the export turnover should also be reduced from the total turnover, and about setting off loss of one unit against the profit of other two units.

Point of dispute

Now, the point of dispute about the adjustment was that the income had been ‘enhanced’ in the process, and accordingly, a higher amount was pitched for Section 10A benefit. The taxman was of the view that deduction is not permissible for the enhanced income.

And he had this reason to back his stand: The law says that where the total income of the assessee computed by the AO (assessing officer) is higher than the income declared by the assessee, no deduction under Section 10A or Section 10B or under Chapter VIA will be allowed in respect of the amount of income, by which the total income of the assessee is enhanced after computation of income under the sub-section.

In the instant case, the assessee had computed the arm’s length price and disclosed the income on that basis, observed the Tribunal. “It is not a case where there is an enhancement of income due to determination of arm’s length price. Hence, it is held that the assessee was entitled to deduction under Section 10A in respect of income declared in the return of income on the basis of computation of arm’s length price,” reads the text of the order dated November 27, 2007 on www.taxindiaonline.com .

‘First of its kind’

According to Mr N. Ramachandran, the company’s CFO, “This is a first of its kind verdict on transfer pricing (TP) in the IT industry.” This judgment has far-reaching implications and will become a precedent for other such cases, he says, interacting with Business Line over the e-mail.

“Every captive unit in India would be rendering business services to its parent in other parts of the world. We expect other such cases on TP and ‘enhanced income’ to be guided by this judgment.”

Elaborating on the ‘enhancement’, the CFO says that the company had voluntarily enhanced the income well before filing the returns and the same was included in the income-tax returns. “As we are governed by Sections 10A and 10B (tax exemption), we claimed this enhanced income as tax exempt,” he adds.

Transfer pricing adjustment

“One important point that the ITAT has not addressed in this decision is the impact of the TP adjustment on the computation of the deduction under Section 10A,” opines Mr K. R. Girish, a Bangalore-based chartered accountant.

“While the TP adjustment may figure in the profits of the business eligible for the deduction, the ITAT has not dealt with the issue of whether and how the same will be included in the ‘export turnover’ and the ‘total turnover’, especially when one needs to realise the foreign exchange within six months,” he says, after an analysis of the order.

This is of utmost importance as the deduction under Section 10A is subject to realisation of foreign exchange proceeds in respect of exports, argues Mr Girish.

“In the event of failure to realise the same, the same would not be included as export turnover, but taken as part of total turnover thus leading to taxability of the same.”

He also emphasises the need to study the implications under FEMA (Foreign Exchange Management Act) in respect of declarations of fair value of goods being recorded in the books of account being different from the arm’s length price. “However this aspect is not within the purview of the taxing statue,” concludes Mr Girish.

D. M.

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