Bombay High Court Sets Aside Cap On Export Unit Tax Deduction Based On Sister Concern Profits

The Bombay High Court has held that deduction under Section 10B of the Income Tax Act, which grants tax relief to export-oriented units on profits derived from exports, cannot be restricted merely by comparing the assessee's profit margins with those of a sister concern, in the absence of any material establishing an arrangement to inflate profits.

“The capping of the profit share of the Assessee on which deduction under Section 10B could be claimed at 19% solely on the basis of the sister concern having earned/disclosed a profit of 19.03%, and holding the remainder to be taxable is arbitrary and does not stand the test of law."

A Bench of Justices M. S. Karnik and S. M. Modak observed that the Income Tax Appellate Tribunal (ITAT) failed to record any categorical finding of an arrangement between Hindustan Essential Oil Company (HEOC) and its sister concern, Pragati Aroma Oil Distillers Pvt. Ltd. (Pragati Aroma), that resulted in inflated profits. The restriction of deduction was based solely on the fact that HEOC's profit margin exceeded that of Pragati Aroma.

The court noted that HEOC reported a net profit margin of 25.09%, as against 19.55% reported by Pragati Aroma. It held that such comparison, by itself, could not justify restriction of deduction.

The court reiterated that while Section 10B is an incentive provision intended to promote exports by granting tax benefits to eligible units, Section 80-IA(10) is an anti-abuse provision. The latter can be invoked only where there exists a close connection between parties, an arrangement between them, and such an arrangement results in more than ordinary profits.

It observed that, in effect, the provision requires the Revenue to establish the existence of such arrangement before determining what constitutes reasonable profits.

The question before the Court was whether the ITAT was justified in comparing the profit margins of HEOC with those of Pragati Aroma and restricting the deduction in the absence of any evidence of such an arrangement.

HEOC, subsequently amalgamated with Pragati Aroma Oil Distillers Private Limited, is engaged in the manufacture and export of perfumery compounds and essential oils. It had established a 100% Export Oriented Unit in Tamil Nadu and claimed deduction of about Rs. 2.32 crore for the relevant assessment year.

The Assessing Officer disallowed the claim on the ground that profits were abnormally high due to related party transactions, interest-free loans, and non-market factors. The ITAT, however, noted that these conclusions were largely presumptive and not supported by cogent evidence or proper comparables.

The Commissioner (Appeals) partly allowed the claim but restricted the deduction to 19.06% of sales by adopting the profit margin of Pragati Aroma. The ITAT upheld this approach.

The High Court held that such comparison was unsustainable in law. It observed that HEOC operated as a 100% Export Oriented Unit in export markets, whereas Pragati Aroma operated in the domestic market under a different statutory and cost framework. In the absence of appropriate comparability, such benchmarking could not form the basis for restricting deduction.

Relying on its earlier decision in Commissioner of Income Tax-7 vs. Schmetz India (P.) Ltd., the Court reiterated that extraordinary profits, by themselves, cannot lead to an inference of an arrangement between related parties.

The court further observed that there was “absolutely no material” on record to show that any arrangement existed that resulted in more than ordinary profits for HEOC.

It also held that the amalgamation of HEOC with Pragati Aroma, which took effect at the end of the relevant assessment year, could not be treated as indicative of any arrangement during the year under consideration.

Accordingly, the court answered the substantial question of law in favour of HEOC, set aside the ITAT's order dated November 25, 2014, and allowed the appeal.

For Appellant: Advocate Naresh Jain along with Advocates Mansvi Singh, Priyanshi Jain and Bhavesh Bhatia

For Respondent: Advocate Sushma Nagaraj (through VC) along with Advocate Abhinav Palshikar