High profit margins alone cannot justify invoking Section 80-IA(10) without evidence of a profit-inflating arrangement.

The Appellant, a private limited company (formerly M/s. Hindustan Essential Oil Company), established a 100% Export Oriented Unit (EOU) in Tamil Nadu for manufacturing perfumery compounds.

For Assessment Year (AY) 2009-10, the Appellant claimed a deduction of ₹2,32,48,056 under Section 10B of the Income Tax (IT) Act.

The Assessing Officer (AO) disallowed the claim, alleging that the Appellant inflated profits of the eligible unit through non-market factors and "arrangements" with sister concerns to claim higher deductions, citing Section 10B(7) read with Section 80-IA(10).

The CIT(A) and the ITAT partially upheld the AO’s view, capping the allowable profit at 19.06%—matching the profit margin of a domestic sister concern, Pragati Aroma Oil Distillers Pvt. Ltd.—and taxing the excess.

Whether the Appellate Tribunal was justified in comparing and adopting the net profit margin of a sister concern even in the absence of any arrangement as contemplated in Section 10B(7) read with Section 80-IA(10) of the Income Tax Act, 1961?

The court applied Section 10B of the IT Act, which provides tax incentives to 100% EOUs to promote exports.

It strictly interpreted Section 80-IA(10), an anti-abuse provision that allows recomputation of profits only if a "close connection" and a specific "arrangement" between parties result in "more than ordinary profits".

The court relied on the precedent CIT-7 v. Schmetz India (P.) Ltd. [2012] 26 taxmann.com 336 (Bom.), which established that extraordinary profits alone do not prove an "arrangement" and that penalizing high efficiency is impermissible.

The Court observed that Section 80-IA(10) requires three cumulative findings: a close connection, an arrangement, and resulting extraordinary profits.

It found that the ITAT failed to identify any specific "arrangement" that led to the supposed profit inflation.

The Court rejected the Revenue's reliance on the company’s amalgamation, noting it occurred at the end of the financial year and could not constitute a retrospective "arrangement" for the relevant period.

Furthermore, the Court held that comparing an EOU (operating in foreign markets with duty-free benefits) to a domestic sister concern (subject to different cost structures like custom duties) was legally untenable and arbitrary.

The Revenue failed to provide material evidence regarding the specific transactions or entities that facilitated the alleged profit shifting.

It held that the ITAT was not justified in capping the profits based on a sister concern's margin without proving a specific arrangement designed to inflate profits.

High profit margins, by themselves, do not trigger Section 80-IA(10).

The High Court quashed and set aside the ITAT order dated 25th November 2014 and allowed the appeal.