Income Tax Appellate Tribunal - Mumbai
Sanghavi Jewellery Mfg. Co. Pvt. Ltd , ... vs Assessee on 13 October, 2011
IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI BENCH 'A' : MUMBAI
BEFORE SHRI R.S. PADVEKAR, ( JUDICIAL MEMBER) AND
SHRI RAJENDRA SINGH,(ACCOUNTANT MEMBER)
ITA No.352/Mum/2008
Assessment Year : 2004-05
M/s. Sanghvi Jewellery Mfg. Co. Pvt. Ltd.
G-41, Gem & Jewellery Complex-III
SEEPZ, SEZ, Andheri(E)
Mumbai-400 096. .....(Appellant)
P.A. No.(AAACS 7836 B)
Vs.
Income Tax Officer
Ward-8(3)(1)
Room No.201, Aayakar Bhavan
M.K. Road, Churchgate
Mumbai-400 020. .....(Respondent)
ITA No.577/Mum/2008
Assessment Year : 2004-05
Income Tax Officer
Mumbai-400 020. .....(Appellant)
Vs.
M/s. Sanghvi Jewellery Mfg. Co. Pvt. Ltd.
Mumbai-400 096. .....(Respondent)
Assessee by : Shri B.V. Jhaveri
Department by : Ms. Kusum Ingale
Date of hearing : 13.10.2011
Date of pronouncement : 30th November, 2011
ORDER
Per RAJENDRA SINGH (AM).
These cross appeals are directed against order dated 16.11.2007 of CIT(A) for the assessment year 2004-05. These appeals which also 2 ITA No.352 & 577/M/08 A.Y:04-05 involve some common issues were heard together and are therefore being disposed of by a single consolidated order for the sake of convenience. The assessee has raised disputes on four different grounds whereas the dispute raised by the revenue are on two grounds. The major issue is regarding adjustment made by AO under section 10A(7) r.w.s. 80IA(10) on which both the parties are on appeal. The grounds raised by the assessee as well as revenue are reproduced below as ready reference.
2. The grounds raised in assessee's appeal are as under :-
"(i) The CIT(A) erred in confirming the action of AO of not increasing /adjusting the profit of business by the disallowable expenditure under section 43B and/or section 40A(7) and /or section 3791) of the Act.
(ii) The CIT(A) erred in upholding the action of AO reducing the rewinding charges from the profit of business for the purpose of computing the exemption under section 10A of the Act.
(iii) The CIT(A) erred in upholding that the interest on deposit kept for the business purpose is income from other sources. He has, further, erred in not allowing the netting off of interest earned against the interest paid.
(iv) The CIT(A) erred in upholding disallowance of the relief claimed under section 10A of the Income tax Act, 1961 by applying section 10A(7) read with section 80IA(10) of the Act to the extent of Rs.61,72,623/-, consisting of :
a. an amount of Rs.41,72,623/-, allegedly attributable to purchases from a related party, although, there was no finding that the increase in gross profit is attributable to the transactions (purchases) with related party; and b. an amount of Rs.20,00,000/- allegedly on account of fall in labour charges, although, there is no transaction or 3 ITA No.352 & 577/M/08 A.Y:04-05 there is no finding that there was a transaction with a related party or suppression of labour charges."
2.1 The grounds raised in the appeal by the department are as under :-
"(i) On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in deleting the disallowance in respect of delayed payment of PF/ESIC of Rs.85,447/- while computing deduction under section 10A.
(ii) On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in deleting the adjustment made by the AO under section 80IA(10) r.w.s. 10A(7) in respect of under reporting of purchases/labour charges from related parties."
3. First we take up the dispute regarding adjustment made by AO under section 10A(7) r.w.s. 80I(10) on which both the parties are in appeal. Briefly stated, facts of the case are that the assessee who was engaged in the business of manufacturing and export of diamonds studded gold jewellery, had declared nil income for the assessment year 2004-05 after claiming deduction under section 10A. The assessee was entitled to deduction under section 10A and this was the last year for claiming deduction under the said section. The AO noted that there was abnormal increase in GP rate declared by the assessee which was 16.80% this year compared to 9.93% in the immediate preceding year i.e. assessment year 2003-04 and 10.89% in assessment year 2002-03. The AO also noted that there was abnormal decline in average purchase price per carat of diamond from 4 ITA No.352 & 577/M/08 A.Y:04-05 Rs.5,276/- per carat in the immediate assessment year to Rs.4,193 in this year. The AO further noted that purchase of diamonds from the group concern M/s. Sanghvi Exports in this year had increased by 10 times i.e. from 5% of total purchase in the immediate preceding year to more than 50% in this year. All the directors of the assessee company were partners in M/s. Sanghvi Exports which also held 52.63% in the assessee company. The purchase of diamonds by the assessee from M/s. Sanghvi Exports this year was 19.96 crores out of total purchase of about Rs.38.55 crores. The AO observed that M/s. Sanghvi Exports was in the diamond trading business for a long time and was also a DTC Sightholder but the assessee had not made much purchases from the said concern in the earlier years. In the earlier years, most of the purchases were from M/s. Dhaval Exports and M/s. Super Diam. Though these two concerns continued to do business in finished diamonds, these were substituted by M/s. Sanghvi Exports during this year from which more than 50% purchases were made. The AO noted that average rate of purchase per carat from M/s. Sanghvi Exports was at Rs.3,445/- compared to over all average purchase price of Rs.4,193/- this year.
3.1 The AO therefore proceeded to examine the matter in detail. He asked the assessee to produce the following details:- 5 ITA No.352 & 577/M/08
A.Y:04-05
i) Cost of diamonds of Rs.19,96,51,322/- in the hands of M/s.
Sanghvi Exports.
ii) Copy of bills and packing list of purchase from M/s. Sanghvi Exports.
iii) Return of income, Balance Sheet and Profit & Loss Account of M/s. Sanghvi Exports for the assessment year 2004-05.
iv) Piecewise details of diamonds (a) Opening stock (b) purchase/import invoice wise (c) utilization of diamonds (d) closing stock
v) It is seen that labour charges of Rs.72 lacs paid for consumption of raw material of Rs.66.10 crores in FY 2002-03 while Rs.15 lacs was paid for consumption of raw material of Rs.55.11 crores (in FY 2003-04).
vi) Name, address, qualification and salary of employees 3.2 The assessee, however, did not file any details in relation to cost of diamonds purchased in case of M/s. Sanghvi Exports, copy of bills and packing list of purchase from M/s. Sanghvi Exports, the piecewise details of diamonds in opening stock, purchases, utilization and closing stock. The AO, therefore, examined the General Manager (GM) Shri Chitranjan Mahadadalkar of the company under section 131 of the Income tax Act. He asked him to give reasons for substantial increase in GP rate but he could not pinpoint any specific reasons. He also could not give the reason for substituting M/s. Sanghvi Exports in place of non related parties in the answer to Q.No.15. The GM in response to Q.No.23 replied that the assessee was not maintaining piecewise record of diamonds. In regard to drastic fall in average 6 ITA No.352 & 577/M/08 A.Y:04-05 purchase price of polished diamonds, the GM in response to Q.No.19 stated that it could be due to general fall in price of diamonds or change of quality of diamonds used. Further the GM in response to Q.No.26 stated that the assessee was maintaining reference numbers for identification of diamonds. The AO observed that the assessee did not produce reference numbers during assessment proceedings. It was also observed by him that the reply of the GM that fall in average purchase price was due to fall in prices of diamonds or quality of diamonds was not satisfactory as had it been so, the prices of jewellery had also fallen and over all GP would have remained the same. The AO also noted that average sale rate per carat in case of M/s. Sanghvi Exports in the relevant year was Rs.7,310/- as per details in the audit report of that concern. But the average rate for supply made to the assessee company was Rs.3,445/-. The AO, therefore, asked the assessee to explain as to why provisions of section 10A(7) r.w.s. 80IA(10) should not be applied and adjustment be made on account of purchases from the group concern. 3.3 The assessee submitted that the increase in GP rate was because of purchase of lower quality diamond which resulted in much lower average purchase price. It was also submitted that the assessee was operating from SEEPZ in which each and every import and export 7 ITA No.352 & 577/M/08 A.Y:04-05 had to be submitted to customs department who had not found any discrepancy. It was also submitted that transfer pricing provisions of chapter-X of Income tax Act were applicable in the case of assessee and no transfer pricing adjustments had been made which shows that the purchases had been made at arms length. The AO, however, observed that customs authorities were mainly concerned with addition to exports and do not make any checks from income tax angle. Further, GM in response to Q.No.24 had stated that customs authorities accepted the purchases and sales invoice at face value and no special scrutiny was done during the year. As regards transfer pricing adjustment, the AO observed that these were applicable to international transactions with non-resident associate enterprises and, therefore, merely because no adjustment was made, it could not be argued that provisions of Section 10A(7) were not applicable. The assessee also explained that M/s. classic diamond India Ltd. which was also in similar business had declared profit margin of 19.42% in the relevant year and, therefore, profit declared by the assessee could not be said to be excessive. The AO, however, observed that the assessee's own case was best comparison and the assessee had not been able to explain satisfactorily the substantial rise in GP rate this year. The AO, further observed, that M/s. Sanghvi Exports had provided credit facilities to the assessee which was clear from the fact 8 ITA No.352 & 577/M/08 A.Y:04-05 that the sundry creditors in case of the assessee had increased to Rs.4.27 crores in this year compared to Rs.1.65 crores in the immediate preceding year and the major portion of the credit was in the name of M/s. Sanghvi Exports. Therefore, the purchase rate from M/s. Sanghvi Exports was expected to be higher than the normal rate. But in this case, it was actually substantially lower which was not explained. The assessee by showing lower purchase rate from M/s. Sanghvi Exports had shifted the profit of that concern to itself because of the close connection with the said party. The provision of section 10A(7) were, therefore, applicable as profits shown by the assessee were more than the ordinary profits because of the transactions with the group concern. The ordinary GP rate should have been 10% but the same was shown as 16.8%. The AO, therefore, adopted GP rate of 10% and the extra profit declared by the assessee to the tune of Rs.4,98,18,823/- was reduced from the profit and deduction under section 10A was allowed at Rs.1,89,37,109/-.
3.4 Similar, adjustment was made by the AO in respect of labour charges also. The AO noted that expenditure on own employees this year had increased to Rs.4.10 crores as compared to Rs.3.47 crores in assessment year 2003-04. However, the labour charges decreased to only Rs.15.00 lacs as compared to Rs. 73.00 lacs in assessment year 9 ITA No.352 & 577/M/08 A.Y:04-05 2003-04, though the raw material consumption had declined to 20%. Comparitive position was noted as under :-
Particulars IX th year of Xth year of No
deduction A.Y. deduction A.Y. deduction
2003-04 in lacs 2004-05 in lacs A.Y. 2005-
06
Employment cost 347 410 526
Labour charges 73 15 75
Raw material 6676 5511 3979
consumption
3.5 The AO observed that the assessee was asked to provide details of
employees which were not given. The assessee also did not provide details of overtime work done by the employees. The AO also noted that the assessee had started a designing centre in Prince Arcade outside SEEPZ but the assessee did not give employees cost for this centre and the details of designing work done at the centre. The AO, therefore, observed that there was possibility of diversion of labour cost to assessee's sister concern M/s. Sanghvi Star and other concerns. It was also observed by him that increase in own employee cost was because of normal increment. It was noted by him that in next assessment year i.e. assessment year 2005-06, the labour charges again increased to Rs.75.00 lacs though consumption of raw material had declined substantially. The AO, therefore, concluded that lower labour charges this year were due to diversion of labour to other concerns. The assessee had manipulated labour charges by having the sharing arrangement on assortment 10 ITA No.352 & 577/M/08 A.Y:04-05 activity in the premises of M/s. Sanghvi Exports and designing activities in the new premises at Prince Arcade outside SEEPZ. The AO, therefore, applied the provisions of section 40A(7) to the labour charges also and reduced profit by Rs.60.00 lacs.
3.6 The AO thus made total adjustment under section 10A(7) of Rs.5,58,18,823/-, Rs.4,98,18,823/- + Rs.60,00,000/- after reducing the profit by the above amount. The AO computed eligible profit under section 10A at Rs.1,89,37,109/- and deduction under section 10A was computed at Rs.1,89,37,109/- as the entire sales of the assessee were export sales. The total income was thus computed at Rs.6,10,05,440/- in place of nil income returned by the assessee.
3.7 The assessee disputed the decision of AO and submitted before CIT(A) that AO had not brought on record any specific instance to show that the transactions with the sister concern had resulted in higher income to the assessee. It was pointed out that the AO had wrongly computed average purchase price of per carat by using the figures for diamonds consumption instead of actual purchase. In case the correct figures were adopted, the average purchase rate per carat this year was Rs.4,205/- compared to Rs.4,620/- in assessment year 2003-04. The detailed computation was given as under :-
Computation made by AO A.Y.2004-05 A.Y. 2003-04 11 ITA No.352 & 577/M/08 A.Y:04-05 Total polished diamonds 3,662.34 4,772.11 consumed (Rs.in lakhs) Total polished diamonds 87,336.43 90,443.91 consumed in Cts.
Average rate per carat 4,193 5,276
CORRECT COMPUTATION
A.Y. 2004-05 A.Y. 2003-04
Total polished diamonds 3,855.96 4,661.65
purchased (Rs. in lakhs)
Total polished diamonds 91,691.35 100.909.18
purchased in Cts.
Average rate per carat 4,205 4,620
3.8 The assessee argued that only on the basis of average price, it could
not be concluded that the assessee had diverted profit from group concern as there were substantial differences in selling rates in respect of the same grade of diamond. The actual selling price depended on several factors such as number of pieces of diamonds per carat used, their quality etc. Therefore, for the same carats of diamonds used prices could vary steeply depending upon the number of pieces used and their quality. It was also submitted that lower quality of diamonds consumption was the main reason for the increase in GP rate. It was pointed out that product mix this year was different from that in the earlier year in which the items manufactured were more high valued than lower value items like rings, and ear tops. It was also pointed out that items like ear tops, pendants and rings which had lower diamond content, had better realization by way of increase in average unit price.
Comparative details of product mix was given as under :-12 ITA No.352 & 577/M/08
A.Y:04-05 Type of Assessment Year Assessment Year jewelery 2004-05 2003-04 Qty. Value Pieces Qty. Value A.U.P No./Units Rs. Lacs No./Units Rs. Lacs Bangles 684 56.19 8,215 509 83.12 16,331 Bracelets 11,417 1,138.42 9,971 17,535 2,712.44 15,469 Ear 47,457 1,823.76 3,843 8,090 635.87 3,515 Topes Necklaces 1,914 228.47 11,937 1,040 238.93 22,974 Pendants 43,493 1,572.53 3,616 41,314 1,256.22 3,041 Rings 58,988 2,535.82 4,299 44,113 2,937.58 6,659 Total 7,355.19 7,864.16 3.9 The assessee also submitted that the onus was on the revenue to prove that the profit of the assessee had been inflated. The assessee also reiterated the submissions made before the AO that no adjustment had been made by the TPO which shows that price were at arms' length. Further, transaction at SEEPZ were checked by customs authorities and there was no scope of manipulation. As regards the transfer of profits, it was also submitted that M/s. Sanghvi Exports had earned net profit before depreciation of Rs.18.24 crores in assessment year 2004-05 on turnover of Rs.502 crores compared to profit of Rs.18.34 crores on turnover of Rs.445.75 crores in assessment year 2003-04. It was, further, pointed out that similar gross profit of Rs.19.4% had been shown by M/s. Classic Diamond India Ltd.
in similar business. Accordingly, it was urged that no adjustment should be made on account of purchases. As regards the labour cost it was submitted that reduced labour expenses were on account of the following factors:-
i) on account of lower content of diamonds;
ii) on account of product mix;
13 ITA No.352 & 577/M/08
A.Y:04-05
iii) on account of number of employees increased during the year and
iv) on account of double shift work during part of the year 3.10 CIT(A) after considering the submissions of the assessee observed that there was no dispute that for the relevant year the assessee had shown excessive high GP rate of 16.80%. It was also an accepted fact that substantial purchases had been made from a group concern. CIT(A), therefore, observed that, in principle, the provisions of section 10A(7) could be invoked. However, he further observed that the said provision could be invoked only to the extent of increase in profits which is directly referable to collusive transactions with the group transactions. CIT(A) noted that the average purchase price per carat from M/s. Sanghvi Exports was Rs.3,445/- and the average rate in respect of similar diamonds purchased from non associate concern was Rs.3,517/-. Thus the average purchase price from the sister concern was lower by Rs.72/- per carat. The assessee had purchased 57953.10 carats from M/s. Sanghvi Exports for a sum of Rs.19,96,51,322/-. Applying the difference of 72 per carat to the total purchase of 57953.10 from M/s. Sanghvi Exports the excess profit transferred to the assessee came to Rs.41,72,623/-. CIT(A) thus confirming adjustment on account of purchase from sister concern to the above extent. As regard the labour charges, CIT(A) observed that though the employee cost had increased from Rs.3.47 crores to Rs.4.10 crores, a part of it could be attributed to regular annual increment. CIT(A) further observed that considering the factors like change in product mix etc. the total disallowance made by AO at Rs.60.00 lacs was on the higher side. He, therefore, restricted the disallowance to 14 ITA No.352 & 577/M/08 A.Y:04-05 Rs.20.00 lacs. CIT(A) thus upheld, total adjustment on account of purchases and labour charges at Rs.61,72,623/-. Aggrieved by the said decision both the parties are in appeal before the Tribunal.
3.11 Before us, the ld. AR for the assessee reiterated the submissions made before lower authorities. It was argued that comparison could not be made on the basis of average purchase rate. It was submitted that the diamonds purchased by the assessee consisted of several grades and therefore comparison should be made only with respect to the same or similar grades and, in case, this process was adopted, the purchases from M/s. Sanghvi Exports were at a higher rate. He referred to details of purchase for different grade of diamonds placed at page-187 of the paper book which gave average purchase price per carat in respect of these grades at Rs.3,697/- per carat. The comparative details of purchases in respect of same grades in case of M/s. Dhaval Exports and M/s. Super Diam were placed at page-202 of the paper book which gave the average purchase rate per carat of Rs.3,518/-. It was thus submitted that in respect of purchase of same grades, the average purchase price in case of purchase from M/s. Sanghvi Exports were more. The other purchases from M/s. Sanghvi Exports which were non-comparable were given at page-186 of the paper book as per which average purchase rate was Rs.2,847/-, but the same was not comparable. It was pointed out that CIT(A) had made a mistake in upholding addition @ 72 per carat by making wrong comparison. He had compared the over all average rate in respect of entire purchases of diamonds from M/s. Sanghvi Exports of Rs.3,445/- per carat to the average purchases from M/s. 15 ITA No.352 & 577/M/08
A.Y:04-05 super Diam and M/s. Dhaval Exports in respect of comparable grade of Rs.3,518/- per carat. It was pointed out that the average rate of Rs.3,518/- per carat in respect of M/s. Dhawal Exports and M/s. Super Diam could be compared only to comparable grades in respect of M/s. Sanghvi Exports in respect of which average rate was Rs.3,697/- per carat. The adjustment upheld by CIT(A) on account of purchase from sister concern was thus not correct and should be deleted.
3.12 In relation to labour charges, it was submitted that provisions of section 80IA(8) were not applicable which applied only to the cases where goods or services were transferred between the eligible businesses and other businesses carried on by the assessee. In the present case, there was no transfer of goods or services. It was also submitted that labour charges had been reduced during the year because of increase in number of employees which had gone up to 379 compared to 328 in assessment year 2003-04. It was pointed out that details were given before AO which are placed at page- 130 of the paper book. As regards the allegation by AO of transfer of labour charges to M/s. Sanghvi Exports, the details given at page-131 of the paper book show that labour cost as percentage of sales of jewellery in assessment year 2004-05 was 10.2% compared to 9.49% in assessment year 2003-04. There was thus no diversion of labour. As regards M/s. Sanghvi Star, it was pointed out that total sale was only 76.85 lacs which was too small to absorb substantial labour charges. Moreover, the assessee from that concern had recovered Rs.8,57,641/- on account of work done for them by its employees. It was also submitted that in case employee cost and labour charges were 16 ITA No.352 & 577/M/08 A.Y:04-05 considered together, there was no difference as this year total expenditure was Rs.4.24 crores compared to Rs.4.20 crores in the immediate preceding year. It was accordingly urged that adjustment on account of labour charges should be deleted.
3.13 The ld. DR on the other hand strongly supported the order of AO. It was pointed out that average sale rate per carat by M/s. Sanghvi Exports was Rs.7,310/-. Sale made by M/s. Sanghvi Exports to the assessee was at average rate of Rs.3,445/- which was not explained. The assessee did not give cost of purchases in case of M/s. Sanghvi Exports. It was also submitted that M/s. Sanghvi Exports was not 100% tax exempt and, therefore, by transferring profit to the assessee there was tax advantage. The GP rate of the assessee had increased abnormally during the year which was not explained properly though turnover had declined. It was further submitted that the grade wise comparison given by the assessee was not reliable as within the same grade there was steep variation in prices which was clear from the details given in paper book. It was pointed out that the assessee had not given piece-wise details per carat which had major impact on the prices. It was further argued that in respect of purchases from the group concern, on average, there were 20 pieces per carat whereas in respect of other purchases there were 350 per carat which shows that the size of diamond purchased from the group concern was bigger and, therefore, price should have been higher. But it was just reverse. The Ld. AR also pointed out that in assessment year 2002-03, in assessee's own case, 17 ITA No.352 & 577/M/08 A.Y:04-05 similar adjustment had been made by AO under section 10A(7) which had been upheld by the Tribunal in ITA No.89/M/2006.
3.14 As regards labour charges, it was submitted that the provisions of section 80IA(8) also applied to services and, therefore, labour charges were also covered by the provisions. It was also pointed out that the various details mentioned by the ld. AR had not been given before the AO and therefore it could not be verified. It was accordingly submitted that the adjustment made by the AO was justified.
3.15 In reply, the ld. AR for the assessee submitted that the GP rate was not only high in this year but also in earlier years. It was pointed out that in assessment year 1999-00 to 2001-02, the assessee had shown GP rates varying from 14.96% to 18.50%. It was also pointed out that the AO was not correct in stating that in respect of purchases from other concerns the average number of pieces per carat was 350 which was wrong and the actual figure was only 35. As regard the average sale rate in case of M/s. Sanghvi Exports of Rs.7,310 per carat, it was submitted that the comparison was not relevant as sale to the assessee by M/s. Sanghvi Exports constituted only 4% of total sales made by them. In case grade wise comparison was made, the purchase rate from M/s. Sanghvi Exports was higher. In relation to the decision of the Tribunal in assessment year 2002-03, it was submitted that the case was different as adjustment had been made on the basis of sale rate and not GP rate.
18 ITA No.352 & 577/M/08
A.Y:04-05 3.16 We have perused the records and considered the rival contentions carefully. The dispute is regarding adjustments made by the AO to the profit of the assessee on account of transactions made with the group concerns under the provisions of section 10A(7) read with section 80A(10) and 80A(8). The assessee is in the business of manufacturing and exporting of diamond studded gold jewellery. The assessee for the assessment year 2004-05 had declared GP rate of 16.80% of turnover of Rs.73.26 crores compared with GP rate of 9.93% in the immediate preceding year i.e. assessment year 2003-
04.On turnover of Rs. 79 crores. even in assessment year 2002-03, GP rate declared by the assessee was only 10.89%. There are no disputes about these facts. There is also no dispute that purchases during the year from assessee concern i.e. M/s. Saghvi Exports had increased abnormally to more than 50% of the total purchases compared to 5% of total purchases in the immediate preceding year and that purchases from unrelated parties i.e. Dhaval Exports and M/s. Super Diam had declined substantially. Other undisputed facts are that average purchase rate per carat of diamonds during the year declined substantially to Rs.4,205/- per carat from Rs.4,602/- per carat in the immediate preceding year and that the average purchase rate of diamonds per carat during the year from M/s. Saghvi Exports was Rs.3,445/- against the over all average rate of purchases of 19 ITA No.352 & 577/M/08 A.Y:04-05 Rs.4,205/-. The diamond pieces on average were larger in size in case of purchases from group concern at 20 pieces per carat as compared to 35 pieces per carat in case of noon-related purchases and, therefore, rate should have been higher from group concerns. Further, AO also noted from audited accounts of M/s. Saghvi Exports and about which there is no dispute that average sale rate of diamond per carat in case of that concern was Rs.7,310/- whereas the average sale rate to the assessee was only Rs.3,445/-. There is also no dispute that M/s. Saghvi Exports is a group concern in which all the directors of the assessee company are partners and that the said concern holds 52.63% of equity capital of the company. The income of the assessee is exempt under section 10A of the Income tax Act and the assessment year 2004-05 was the last year for claiming deduction under section 10A. Further, the income of M/s. Saghvi Exports is exempt under section 80HHC only to the extent of 30% and, therefore, any transfer of profit from M/s. Saghvi Exports to the assessee firm has tax advantage for the group.
3.17 In the back drop of above factual position it is required to be examined whether the profits of M/s. Saghvi Exports were diverted to the assessee company and the provisions of section 10A(7) r.w.s. 80IA were applicable. But provisions of section 10A provide that provisions contained in Sec.80IA(10) and Section 80IA(8) as far as would apply 20 ITA No.352 & 577/M/08 A.Y:04-05 to section 10A also. Section 80IA(10) provides that in case due to close connection between assessee and any other person, business transactions are so arranged that they produce more than ordinary profit in case of the assessee, then AO while computing the profit and gains of eligible business for the purpose of deduction under said section, shall take the amount of profit as may be reasonable deemed to have been derived there from. Similar provision exists under section 80IA(8) in relation to transfer of goods or services between the connected concerns and in case the transfer is not at the market value the AO may compute the profit and gains of eligible business treating the transfer value of goods and services at market value the said provisions of section 80IA(10) and 80IA(8) are reproduced below for ready reference:-
"Section 80IA(10) : Where it appears to the Assessing Officer 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 ordinary profits which might be expected to arise in such eligible business, the Assessing Officer 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.
Section 80IA(8) : Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods and services as 21 ITA No.352 & 577/M/08 A.Y:04-05 on the date of the transfer, then for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date:
Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit.
Explanation - For the purposes of this sub-section, "market value", in relation to any goods or services, means the price that such goods or services would ordinarily fetch in the open market."
3.18 No doubt it is true that burden is on the revenue to show that the assessee had so arranged the transactions with the sister concern that it provided more than ordinary profit in the case of the assessee. However, once the AO demonstrated that GP rate had increased during the year abnormally and transactions with the sister concern had also increased substantially during the year and purchase rate from the sister concern was much lower than the average sale rate of that concern, the initial onus placed on the revenue is discharged and the assessee is required to explain the matter satisfactorily as all material facts are under the control of the assessee. The GM when asked about the sudden and substantial increase in GP rate could not point out any specific reason. Subsequently, the assessee explained that high GP rate was because of lower quality of diamonds purchased and fall in value of diamonds but the same was not substantiated by any evidence. In case, lower quality diamonds were used or diamond 22 ITA No.352 & 577/M/08 A.Y:04-05 prices had fallen, this would have also resulted in fall of jewellery prices and over all GP rate would have been the same. Moreover, in the subsequent year when the assessee was not entitled for deduction under section 10A, GP rate again came down to the normal figure of about 10%. The assessee also explained that high GP rate was because of different product mix as during the year lower value items such as pendants, rings and ear tops had increased substantially on which profit margin was lower. However, the explanation is not supported by any evidence. It is common knowledge that the more specialized is an item, profit margin becomes more. Therefore, profit margin in respect of simpler items like ear tops etc. are supposed to be lower than the profit in respect of specialized items such as necklace, bangles etc. The diamond content will not have much impact on GP rate as profit margin in respect of diamond will be the same irrespective of the quantity. Moreover total consumption of diamond this year was almost same at 87336.43 carat compared to 90,443 carat last year. As regard the labour charges, the profit margin will be more in respect of specialized items like necklaces, bangles etc. which have been produced in larger number this year. Therefore, in our view, product mix will not have much impact on GP rate. There is thus no satisfactory explanation regarding exceptional GP rate this year. The explanation of the assessee that GP rate was 23 ITA No.352 & 577/M/08 A.Y:04-05 also high a few years back in assessment years 1999-00 to 2001-02 is not relevant as comparison has to be made with figures in the immediate preceding year and it was found that not only in the immediate preceding year but also in assessment year 2002-03, the GP rate was around 10%. It is also not explained satisfactorily as to how GP rate suddenly came back to normal in the immediate succeeding year.
3.19 The assessee also could not give any satisfactory explanation as to why in this year purchases from M/s. Sanghvi Exports increased substantially when the other parties from whom purchases were made till last year remained in the same business and that M/s. Sanghvi Exports was also in the same business in the earlier year when purchases made from this concern were nominal. Further, there is no satisfactory explanation for M/s. Sanghvi Exports selling diamonds to the assessee at a very low average rate of Rs.3,445/- per carat where the overall average sale rate of that concern was Rs.7,310/- per carat. The claim that lower quality diamonds had been purchased is not supported by any evidence. The assessee could have easily given the cost of purchases made from M/s. Sanghvi Exports in their books to show that there was no concession made to the assessee as M/s. Sanghvi Exports was under its control. The assessee, however did not give details despite repeated queries made 24 ITA No.352 & 577/M/08 A.Y:04-05 by the AO. It did not even produce the copy of bills and packing list of purchases made from M/s. Sanghvi Exports despite repeated requests. These details have not been produced either before CIT(A) or even before us. It has been submitted that NP rate of M/s. Sanghvi Exports was almost the same at 18.24% compared to 18.34% in the immediate preceding year. This, however, does not explain the lower sale rate of diamonds to the assessee. Moreover, purchases from M/s. Sanghvi Exports constituted only 4% of total sales of that concern and, therefore, lower sale rate to the assessee would not have much impact on the overall net profit rate of that concern.
3.20 It has also been explained that another concern M/s. classic Diamond had shown GP rate of 19.4% in the same business. However, full details of that concern are not available to show that there were no transactions with associate concerns in that case and that the business done by that concern was identical. In the absence of full details, no proper comparison is possible. The argument that the transactions were checked by custom authority is also not relevant as custom authorities do not make any examination from income tax angle and, moreover M/s. Sanghvi Exports also admitted that they had not made any special scrutiny. Similarly, not making any pricing adjustment by the TPO is also not irrelevant as TP adjustment are required to be made in case of international transactions with non 25 ITA No.352 & 577/M/08 A.Y:04-05 resident associate concerns whereas in the present case, we are concerned with transactions between two domestic parties. 3.21 The ld. Authorised Representative also submitted that in case comparison was made with same grade of diamonds, purchase rate in case of M/s. Sanghvi Exports was higher. It has been pointed out that average purchase rate in case of comparable grades from M/s. Sanghvi Exports was Rs.3,697/- whereas for similar grades, average purchase rate in case of unrelated purchases was Rs.3,518/-. However, a careful perusal of the record shows that such comparison could be misleading. We find that within the same colour and cut, there is steep variation in the prices. For example, diamond prices in case of grade, D-cut OWLB / N varied from, Rs.2,255/- to Rs.14,883/- per carat and similarly, in case of D-cut OWLB prices varied from Rs.1,780 per carat to Rs.17,364/- per carat and in case of D-cut OW/N, from Rs.2,250/- to Rs.8,034/- per carat, which is clear from the details given at page 188 to 189 of the paper book. When there is so steep variation within the same grade, any comparison based on grade is not reliable. Diamond prices are heavily influenced by the size of diamonds but the assessee is not maintaining piece-wise details of diamonds used. It is also to be noted, that on average diamonds purchased from the group concern were larger in size than those from other concerns as average number of pieces per carat in case of group 26 ITA No.352 & 577/M/08 A.Y:04-05 concern was 20 whereas in case of others, it was 35. Therefore, on this account also, purchase price from the group concern should have been higher. We further note from details at page 186 of the paper book that purchase rate from M/s. Sanghvi Exports in case of other grades was only Rs.2,847/- per carat. Therefore, in our view explanation based on comparable grade is not reliable. The GM at the time of examination admitted that the assessee was maintaining reference numbers of diamonds but the same was not produced during the assessment proceedings. The assessee could easily give the cost of purchase in case of M/s. Sanghvi Exports to show that there was no concessional rate of sale to the assessee which has not been done. Under these circumstances, the authorities will be justified to go by the average rate. Identical issue had arisen in the case of the assessee in the assessment year 2002-03. The assessee in that year had sold goods at higher rate to the sister concerns M/s. Sanghvi Diamonds to generate more profits. In the present case, purchase has been made from sister concern at lower rate but the effect is the same i.e.; shifting of profits from sister concern to itself. In that year, the assessee had explained the higher sale rate to sister concern on the ground of longer credit period allowed and on the grounds of supply of uneconomical quantity jewellery. The Tribunal in that year in ITA No.89/Mum/2006 held that the explanation of the assessee was not 27 ITA No.352 & 577/M/08 A.Y:04-05 supported by proper evidence. The Tribunal also observed that in case of uneconomical quantities, the profit margin should have been lower and accordingly confirmed the adjustment made by AO under section 10(7) r.w.s. 80IA(10). The average rate of sales in case of M/s. Sanghvi Exports is Rs.7,310/- whereas, average sale rate per carat to the assessee was only Rs.3,445/-. The authorities will, therefore, be justified in working out the shifting of the profit from M/s. Sanghvi Exports to assessee at average sale rate of that concern. There is thus rate difference of about Rs.3,865/- per carat on sales made to the assessee. The total purchases from M/s. Sanghvi Exports was 57953.10 carat of diamonds and, therefore, the profit transferred from M/s. Sanghvi Exports to the assessee would be Rs.3865 x 57953.10 which comes to about Rs.22.39 crores. The profit transferred to the assessee computed on the basis of average rate may not give the exact figure. Therefore, in our view, profit transferred has to be limited to the excess profit shown by the assessee compared to the profit computed at the normal GP rate of 10% shown by the assessee in the immediate preceding year as sharp rise in GP rate has not been explained satisfactorily. The excess profit computed on the basis of normal GP rate is Rs.4,98,18,823/-. Therefore, in our view, adjustment of Rs.4,98,18,823/- made by the AO under section 10A(7) read with section 80IA(10) is justified on the facts of the case. We, 28 ITA No.352 & 577/M/08 A.Y:04-05 therefore, set aside the order of CIT(A) on this point and confirm the order of the AO.
3.22 As regards the transfer of profit on account of labour charges, the ld. AR has argued that provisions of section 80I(8) are not applicable as same relate to transfer of goods. However the ld. DR rightly pointed out that section 80IA(8) would also apply to transfer of services therefore, in case services are provided to group concern, the provisions would apply. The details of employee cost and labour charges for this year as well as immediate preceding and immediate succeeding year have been given in para 3.4 earlier. The employee cost had gone up by about 20% this year but labour charges have declined steeply from Rs.73.00 lacs to only Rs.15.00 lacs though raw material consumption has declined only by 20%. The assessee has explained that employee cost went up because of increase in number of employees but details of employees was not given before the AO. The claim of overtime work was also not supported by any evidence. There is no dispute that group concern of the assessee i.e. Sanghavi Star was running a design centre at Prince Arcade outside SEEPZ where employees of the assessee were also working. The employee details of that centre were not given to the AO. Though the assessee has claimed that they had recovered the cost from Sanghvi Star complete working details are not given. Further, the assessee had 29 ITA No.352 & 577/M/08 A.Y:04-05 staff sharing arrangements in relation to assortment activity at M/s. Sanghvi Exports where there is strong possibility of transfer of services of the staff of the assessee company.
3.23 We also note that in the immediate succeeding year labour charges have increased from Rs.15.00 lacs to Rs.75.00 lacs and the employee cost has also increased by about 25% though the consumption of raw material declined sharply. The AO has treated the increase in employee cost as normal increase due to annual increments which appears reasonable as similar increase is there in the subsequent year also when the consumption of raw material declined. Only in this assessment year, labour charges are lowest whereas in the immediate preceding year and in the subsequent year, is very high. The assessee, as pointed out earlier, had not given full details. Under these circumstances it is quite reasonable to conclude that the assessee had transferred the services of employees to the group concerns. The value of such transfer of services has to be computed on the basis of consumption of raw material. Since raw material consumption had declined this year by about 20%, the labour charges were expected to be around Rs.58.00 lacs this year against only Rs.15.00 lacs shown. Therefore, in our view, the value of services transferred comes to around Rs.43.00 lacs. The transfer 30 ITA No.352 & 577/M/08 A.Y:04-05 value adopted by AO was Rs.60.00 lacs whereas CIT(A) has taken the value at 20 lacs. In our view, on the facts of the case it will be reasonable to estimate value at Rs.40.00 lacs. Accordingly, we confirm the adjustment of Rs.40.00 lacs to the profit on account of labour charges.
4. The second dispute which is relevant only to appeal of the revenue is regarding disallowance of Rs.85,447/-, in respect of delayed payment of PF/ESIC. The AO noted that employees contribution in respect of PF & ESIC was Rs.85,447/- which had been paid after due date. He, therefore, disallowed the same. In appeal CIT(A) held that employees contribution paid within the grace period has to be allowed and those after grace period have to be disallowed. Aggrieved by the said decision revenue is in appeal. 4.1 We have heard both the parties, perused the records and considered the matter carefully. Under internal Instructions of PF and ESIC authorities, a grace period of 5 days has been, allowed from the due date for making payments and therefore, employees contribution paid within grace period has to be allowed as deduction under section 36(va). We, therefore, see no infirmity in the order of CIT(A) and the same is, therefore, upheld.
31 ITA No.352 & 577/M/08
A.Y:04-05
5. The third dispute which is relevant only to the appeal of the assessee is regarding non adjusting profit of the business by the expenses disallowed under section 43B, 40A(7) and 37(1). The AO had made following disallowance which had not been considered for the purpose of section 10A:-
Ex-gratia Rs.11,10,719/-
Unpaid bonus Rs.7,47,341/-
Unpaid leave encashment Rs.1,92,138/-
Unpaid sales-tax Rs.23,868/-
Provisions of gratuity u/s.40A(7) Rs.2,90,553/-
Fines & Penalties Rs.4,602/-
Total : Rs.23,69,221/-
Rs.23,69,221/-
The AO held that the amounts added as mentioned above would not qualify for deduction under section 10A as deduction was allowable only in respect of profit derived from export of article or things or computer software and the additions made were not the profit derived from export. In appeal CIT(A) agreed that enhancement of income by disallowance of expenses under the statutory provisions was not from exports as the source of additional profit was statutory disallowance. He, therefore, confirmed the action of the AO.
5.1 We have heard both the parties, perused the records and considered the matter carefully. The deduction under section 10A is allowable on the basis of profit of the business of the undertaking. The profit of the business is reflected in the P&L account in which the 32 ITA No.352 & 577/M/08 A.Y:04-05 assessee claims various expenses. In case, any expenses are disallowed under the provisions of the statute or otherwise for want of evidence, this would only go to increase profit of the business. Therefore, in our view, if any addition has been made to the profit of business by was of disallowance of expenses, the amount added will very much form part of the profit of the business and therefore, it has to be considered while working out deduction under section 10A as per method prescribed in the section. We are, therefore, unable to sustain the order of CIT(A) on this point. The order of CIT(A) is therefore, set aside and the claim of the assessee is allowed.
6. The fourth dispute which is again is relevant only to the appeal of the assessee is regarding reduction of rewinding charges from the profit of the business while computing deduction under section 10A. The ld. AR for the assessee at the time of hearing of the appeal did not press this ground and, therefore, the ground raised by the assessee is dismissed as not pressed.
7. The fifth dispute which is also relevant only to the appeal of the assessee is regarding the interest on deposits treated by the AO as income from other sources. The assessee in the P&L account had credited the interest income of Rs.19,76,482/- on account of bank and Rs.33,250/- on account of other parties. The assessee had treated 33 ITA No.352 & 577/M/08 A.Y:04-05 interest income as business income on the ground that the interest income had been received from deposits which had been used as collateral security for the purpose of business. The AO did not accept the claim and assessed the income as income from other sources. In appeal, CIT(A) had confirmed the order of AO, aggrieved by which the assessee is in appeal before Tribunal.
7.1 The ld. Authorised Representative for the assessee submitted that he was not pressing the issue regarding treatment of interest income as income from other sources. It was submitted by him that only grievance of the assessee was that AO had not taken the net interest income after deducting the expenses incurred. He, therefore, pressed the issue of netting. The ld. DR placed reliance on the orders of authorities below.
7.2 We have perused the records and considered the rival contentions carefully. The only issue raised is regarding netting of interest income which has been treated by the authorities below as income from other sources. It is settled legal position that in case some expenses have been incurred for earning of interest income, deduction has to be allowed under section 57(iii). We, therefore, see no reason in not acceding to the claim of the assessee. We, therefore, restore this issue to the file of AO with the direction to examine the 34 ITA No.352 & 577/M/08 A.Y:04-05 claim of the assessee and allow the expenses having nexus with earning of interest income. The ground is, therefore, allowed for statistical purposes.
8. In the result, both the appeals are partly allowed. Order pronounced in the open court on 30.11.2011.
Sd/- Sd/-
(R.S. PADVEKAR) (RAJENDRA SINGH )
JUDICIAL MEMBER ACCOUNTANT MEMBER
Mumbai, Dated: 30/11/2011.
Jv.
Copy to: The Appellant
The Respondent
The CIT, Concerned, Mumbai
The CIT(A) Concerned, Mumbai
The DR " " Bench
True Copy
By Order
Dy/Asstt. Registrar, ITAT, Mumbai.