Income Tax Appellate Tribunal - Bangalore
Sap India Private Limited, Bangalore vs Assessee on 28 October, 2013
IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCH 'C' SHRI N. BARATHVAJA SANKAR, VICE PRESIDENT and SHRI N.V.VASUDEVAN, JUDICIAL MEMBER ITA Nos.1492 to1495(B)/12 & 265/(B)/2013 (Assessment years : 2004-05 to 2008-09) M/s SAP India Private, Ltd., Wing -A, 2nd Floor, Tower-B, Salarpuria Soft Zone, Sarjapur Outer Ring Road, Bellandur Post, Bangalore-560 103 ... Appellant PAN: AACCS 7483E Vs The Deputy Commissioner of Income-tax, Circle-12(3), ... Respondent Bangalore Assessee by : Shri Rajan Vora, CA & Shri Chavali Narayan, CA Revenue by : Smt Priscilla Singsit, CIT-III Date of Hearing : 28.10.2013 Date of Pronouncement: 13.11.2013 O RD ER PER BENCH:
ITA No. 1492(B)/12 is an appeal by the assessee against the order dated 31-08-2012 of CIT(A)-III Bangalore relating to assessment year 2004-05. ITA No.1493 & 1494(B)/12 are appeals by the assessee against the order of the CIT(A)-III, Bangalore dated 28-08-2012 for the assessment years: 2005-06 to 2007-08. ITA No.1495(B)/12 is also an appeal by the assessee against the order of the CIT(A)-III, Bangalore dated 30-08-2005 relating to assessment year : 2007-08. ITA ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 2 of 51 No.265(B)/2012 is an appeal by the assessee against the order of the CIT(A)-III, Bangalore relating to assessment year : 2008-09.
2. First we shall take up for consideration ITA No.1492(B)/2012 assessee's appeal for the assessment year : 2004-05. Ground no.1 raised by the assessee is general in nature and calls for no specific adjudication. Ground no.2 raised by the assessee reads as follows;
" 2. The learned CIT(A) has erred, in law, and in facts, in confirming the order of the learned AO by upholding the disallowance of the deduction claimed by the assessee u/s 10A of the IT Act, 1961 amounting to Rs.282,595,891/- for the assessment year 2004-05".
We will also take up for consideration Gr.No.2 raised by the Assessee in A.Y.05-06 in ITA No.1493/Bang/12 which is identical to ground No.2 referred to above, for the reason that the facts and circumstances are identical and the reasoning of AO in AY 04-05 has been followed by the AO in AY 05-06, while the reasoning given by the CIT(A) for AY 05-06 has been followed by the CIT(A) in AY 04-05. The sum claimed as deduction u/s.10A of the Act, in AY 05-06 is a sum of Rs.39,22,60,237.
3. SAP AG, headquartered in Germany, is one of the world's leading provider of enterprise resource planning and related application software, with sales and development locations in more than 50 countries worldwide, and customers in more than 120 countries. SAP AG offers standard software like R/3, SAP Business Suite, SAP Business By design, ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 3 of 51 Partner Edge, SAP Business One, my SAP ERP etc, to the customers around the world. SAP AG incorporated two subsidiaries in India, namely, SAP Labs India Private Limited ("SAP Labs") and SAP India Private Limited ("SAP India"), the Assessee in this appeal. SAP Labs was incorporated under the Companies Act, 1956 on 18 September 1998 to carry on the business of rendering software services towards the research and development efforts of SAP AG. The Assessee was incorporated under the Companies Act, 1956 on 14 March 1996 and is engaged in the following separate lines business:
1. Sales segment - Sub-licensing of SAP software to customers in India, Sri Lanka and Bangladesh. The Assessee has obtained a non-exclusive license from SAP AG to use, market and sub-license SAP software products to customers in India, Sri Lanka and Bangladesh. Under separate agreements (known as the "End User License Agreements" or "EULAs") entered into with its Indian/ other customers, the Assessee sub-licenses the SAP software to such customers.
2. Maintenance segment - Software maintenance and after-sales support services to end users of SAP software (which has been sub-licensed to them) in India, Sri Lanka and Bangladesh.
Ancillary to the licensing activity, the Assessee enters into maintenance arrangements with its customers/ end-users (to whom the SAP software has been sub-licensed), under which it provides on-call support services and product upgrades/ updates to them.
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3. Software development/ implementation support - Software implementation support services comprising the following:
− Export division/(GDC) -Software development services rendered to overseas customers from the offshore Software Technology Park unit of the Assessee i.e., the Global Delivery Centre ("GDC"), which is physically separate, distinct and is housed in a separate Customs bonded premises. These services constitute a distinct segment of the Assessee's operations and are not connected or related to the aforesaid software sub-licensing activities or any other domestic activity of the Assessee in India.
- Domestic division -Domestic software implementation and related services rendered to customers in India. These services are not rendered from the STP unit and constitute a different segment of the Appellant.
4. Training services segment In addition to the above, the Assessee provides training services/ facilities to Indian and foreign customers, on the usage and application of SAP software products.
4. The Assessee claimed deduction of Rs.28,25,95,891 u/s.10A of the Income Tax Act, 1961, ('the Act') in respect of profits of its unit which renders Software development/ implementation support services, viz., the Export division/Global Delivery Centre(GDC). It is not in dispute that the software development services rendered to overseas customers ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 5 of 51 from this unit was offshore Software Technology Park unit of the Assessee i.e., the Global Delivery Centre ("GDC"), which is physically separate, distinct and is housed in a separate Customs bonded premises.
5. According to the AO (in A.Y.04-05), deduction u/s.10A of the Act can be allowed only when the Assessee produces manufactures articles or things or computer software. According to the AO as per the details furnished in the return of income, the Assessee was stated to be in the business of sub-licensing computer software and related implementation consulting, maintenance and trading services. The AO referred to the definition of "Computer software as per Explanation-2(i) to Sec.10A of the Act. "Computer software" has been defined to mean any Computer programme recorded on disc, tape, perforated media or any other information storage device or any customized electronic data or any product or service of similar nature, as may be notified by the Board which is transmitted or exported from India to any place outside India by any means. According to the AO the assessee had sub-licensed computer software and implemented it and has acted as an agent by using computer software manufactured by others. The assessee explained before the AO that it was an undertaking set up under the STP Scheme under the Government of India, Customs authorities as well as STPI had approved set up of assessee's technological park unit to render ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 6 of 51 software development and that it rendered Consultancy Services related to Computer Software Development. According to the AO the assessee was only rendering consultancy services.
6. In AY 05-06, the AO has given almost identical reasons for rejecting the claim of the Assessee for deduction u/s.10A of the Act. In AY 05-06 the AO has called upon the Assessee to explain as to how the activity performed by the Assessee would amount to manufacture or production of "Computer Software". The Assessee had taken the AO to the GDC unit and also explained the nature of the activity performed in the GDC unit. The AO has recorded the following facts in the Assessment order for AY 05-06:
"8.6 SAP AG has developed a very prominent package known as SAP-ERSP (enterprise resource systems package). This package is widely used by the industries at large. Apparently this package has been sold by the assessee company on behalf of SAP AG to different customers in India. As stated by the company, their share of profit on sale of software is about 50%. On the day of presentations on 10.12.2008, the representatives of the assessee company tried to emphasize that they develop certain modules in respect of the above package. It appears that the assessee company may have made certain modifications/changes in the ERSP package so as to make it customer convenient viz., need of a retail unit will be different from manufacturing unit and need of a steel unit will be different from the chemical unit. Probably, the Assessee company might have done customization of that nature to the clients in India and there may not be necessarily any export of software.
8.7 It is important to mention over here that the SAP AG group has bifurcated its activities of development of software and marketing and sale of software. While development is looked after by a separate company known as SAP labs having its R& D Centre in Whitefield, Bangalore, the marketing and sales of SAP software ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 7 of 51 is looked after by SAP India. In fact, during the course of visit of SAP labs premises, this fact was mentioned by the Authorities of SAP labs. Accordingly, the claim of the Assessee company towards development of software appears to be farfetched and thus unacceptable."
7. The claim of the Assessee for deduction u/s.10A of the Act was rejected for the aforesaid reasons in AY 04-05 and 05-06. It would be appropriate to mention that apart from the above reasons given for rejecting the claim of the Assessee for deduction u/s.10A of the Act, certain other reasons were given in A.Y. 06-07 to 08-09. The same are as follows;
1. No specific software product was being developed by the GDC unit. The GDC unit was only rendering some unspecified services to group entities.
2. SAP India was charging other group entities for such services on hourly basis at specific rate applicable to each of its employees and not on a cost plus basis. Any software development requires engineering expertise which is charged on the basis of software product or solution delivered. It cannot be charged on hourly basis unless the consultant is dedicated for some period for development of a module. Hence, it cannot be concluded that SAP India has rendered any software development.
3. There were no overseas onsite development charges of services for development of software outside India since some of its employees were stationed overseas.
4. SAP India did not identify a specific process undertaken by it for which it was charging the group entities and that not all activities connected with software can be stated as software development.
8. Aggrieved by the order of the AO, the assessee preferred appeal before the CIT(A). Before CIT(A) the Assessee highlighted the nature of services rendered by the GDC unit. The Assessee submitted that SAP ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 8 of 51 ERP (Enterprise Resource Planning) software is standard software. It has the capacity to adapt to the requirements of different customers in different type of industry and different sectors in the same industry. Besides the above, the existing software system used by a customer can be altered so as to use the SAP ERP Software. For the purpose of adapting SAP ERP Software to suit a particular customers requirement or to integrate an existing software system used by a customer with SAP ERP Software system, some customization is required to be done. Such customization could also involve corrections to the standard SAP ERP software or even developing new software module. Such customization can also extend to fixing corrections arising out of errors/discrepancies/bugs in the working of customized software. The GDC division does such corrections or customization and has to be considered as "Developing Software" within the meaning of Sec.10A of the Act.
9. Alternatively the Assessee pointed out that the Assessee can be considered to have rendered computer software development as defined under the extended definition of software development as given in Expln.2 to Sec.10A of the Act. Sec.10A of the Act and Expln.-2 thereto reads thus:
"SECTION 10A: Special provision in respect of newly established undertakings in free trade zone, etc. (1) Subject to the provisions of this section, a deduction of such profits and gains as are derived by an undertaking from the ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 9 of 51 export of articles or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee ..........
Explanation 2 : For the purposes of this section,--
(i) "computer software" means,--
(a) any computer programme recorded on any disc, tape, perforated media or other information storage device; or
(b) any customized electronic data or any product or service of similar nature, as may be notified by the Board, which is transmitted or exported from India to any place outside India by any means;
10. As can be seen from Expln.-2 (b) to Sec.10A of the Act even customization of electronic data or any product or service of similar nature which are notified by the CBDT are also considered as development of computer software. The CBDT has specified an exhaustive list of certain Information Technology enabled ("IT enabled") services [vide Notification No SO 890(E), dated 26 September 2000], which are as under:
• Back-office Operations
• Call Centres
• Content Development and Animation
• Data Processing
• Engineering and Design
• Geographic Information System Services
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ITA No.265(B)/13
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• Human Resource Services
• Insurance Claim Processing
• Legal Databases
• Medical Transcription
• Payroll
• Remote Maintenance
• Revenue Accounting
• Support Centres
• Web-site Services
11. Without prejudice to its contention that the Assessee was in fact carrying out software development, the Assessee pleaded that GDC's activities can nevertheless be considered to fall under one or more categories of IT enabled services as per Notification No SO 890(E), dated 26 September 2000 (supra), viz "Data Processing", "Engineering and Design", "Support Centre" and "Remote maintenance".
12. The CIT(A) however rejected the plea of the Assessee and concurred with the view of the AO and in doing so, the CIT(A) followed his own order in assessee's case for the assessment year 2005-06. In AY 05-06, the CIT(A) called for a remand report from the AO who gave his report dated 21.2.2012 to the CIT(A). In the remand report the AO relied on facts as it emanated before him on the issue of deduction in Assessee's ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 11 of 51 own case in the assessment for AY 06-07. In AY 06-07, the Assessee had filed before AO detailed charts explaining the activities carried out in GDC unit and the various phases in the course of developing software. The Assessee had claimed that it was modifying/implementing changes to Software code for SAP group entitles. The Assessee filed E- mail correspondences between consultants of SAP with overseas customers. The A0 called for sample invoices and softex forms. On perusal of the same the AO was of the view that the invoices are essentially raised against overseas SAP group entitles and SAP AG. Softex forms only state that software exports are made pursuant to agreement dated 8.4.2004 which is Cross Service Agreement between the Assessee and SAP AG. The payments were found to be made to individuals depending upon the man hours spent. Based on the above, the AO in AY 06-07 held in the order of assessment that the Assessee was not entitled to deduction u/s.10A of the Act for the following reasons:
1. The assessee's STP Unit is not developing any specific software product to any overseas customer directly or any specific software product to SAP AG or any SAP Group entity.
2. The bills raised by the Assessee show that the assessee's employees are rendering some unspecified services to group entities and assessee is charging those entities for such services on hour basis at specific rate applicable to each of its employees.
The charges in the invoice are not the earnings of those employees but it is only a basis for charging other entities. Such charges were not for any overseas onsite development charges or services for development of software overseas.
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3. Software development contracts/projects are actually taken up by SAP AG and other Group entities and in fact they are actually executing those projects. In the course of executing those projects, they may be borrowing some services of other group entities including the assessee.
4. The Assessee could not identify a specific process undertaken by it for which it is charging the group entities. Not that all activities connected with software implementation at the customer's premises and delivery and testing and training can be termed as development activity.
5. As per the Cross Service Agreement for software development the invoicing should have been made at specific development cost plus 6% margin as provided in Article(9) of the agreement. As per the invoices, the services are charged not on cost plus 6%.
6. Any software development requires engineering expertise which is charged on the basis of software product or solution delivered. It cannot be charged on hourly basis unless the consultant is dedicated for some period for development of a module. However, from the bills it is clear that the ICO hours devoted by the employees are few hours a day and it is not a continuous rendering of the service.
7. From all these circumstances, it can be inferred that the assessee failed to prove its activity as software development per se.
8. It has neither proved that its services to the group entities fall in the categories mentioned in Notification S.O.No.890(E) dated 26-09-2000.
In the remand report the AO requested the CIT(A) to reject the claim of the Assessee for the reasons set out above and in particular the findings given in the assessment proceedings for AY 06-07.
13. On a consideration of the rival contentions the CIT(A) held that the Assessee was not entitled to the benefit of deduction u/s.10A of the Act for the following reasons:
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1. Though, the assessee insists that it is involved in production of software, it was unable to specify the exact software product it manufactures at its STP.
2. The claim of the Assessee that even if unspecified software is produced the benefit of deduction u/s.10A of the Act should be extended to the Assessee cannot be accepted.
3. The method of invoicing and billing serves to confirm the presumption that the assessee is not actually producing software but only rendering support services, on a 'borrowal of services' basis to its group entities and billing for these by the hour on the basis of the manpower rate for the same.
4. The requirements of sec.10A cannot be said to be satisfied by the Assessee merely carrying out a "process", but should manufacture or produce a "product". Sec.10A specifies clearly that an 'article or thing' has to be produced and exported, and includes within this requirement computer software also, it is obvious that the law requires that a particular software product should emerge from the process, unless the activity is restricted to one of the specified IT enables services as per CBDT Notification. The latter not being the case here as per the assessee's own admission, and no defined software product having emerged from the services rendered (also admitted by the assessee in the Rejoinder to the remand report), the STPI activities of the assessee do not fall within the eligibility requirements of sec.10A.
14. The conclusion of the CIT(A) in short is that the Assessee was not able to show the software product developed by it and therefore cannot be said to be engaged in manufacture or production of computer software. Since the Assessee maintained that it was manufacturing or producing Computer Software, by Assessee's own admission, the ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 14 of 51 alternative case of the Assessee that it was rendering IT enabled services as per CBDT notification is deemed to have been given up.
15. The other reasons given by the revenue for denying the assessee deduction u/s 10A of the IT Act, in the orders passed for AY 06-07 to 08- 09 can be summarized as follows;
1. Sec.10A requirements cannot be deemed to be satisfied by a process but requires that a particular software product should emerge from the process.
2. The services provided by GDC were not one of the specified IT enabled services as per Central Board of Direct Tax(CBDT) Notification.
3. The STP unit is located within the same premises housing the non-STP unit and it is not clarified as to what distinguishes the product transmitted by the STP and non-STP unit.
16. Aggrieved by the order of the CIT(A) the assessee has raised ground no.2 before the Tribunal. The learned counsel for the Assessee has filed before us brief proposition running to about 43 pages on the issue that arises for consideration in Ground No.2. The learned counsel for the Assessee took us through the said write up. The contentions put forth in the write up filed by the Assessee describe the operations of the GDC ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 15 of 51 units in respect of whose profit the Assessee had claimed deduction u/s.10A of the Act.
17. The learned counsel for the Assessee submitted that SAP AG makes various software products for varied uses. These software products are standard products which would need to be adapted to fit into the customer's existing IT environment and the customer's requirements/ operational needs. For carrying on the software implementation support services for overseas customers, SAP India established a physically separate and independent unit in May 2002 i.e., GDC unit, consisting of one STP unit in Bangalore and (another STP unit in Gurgaon in December 2006). The implementation support services carried out by GDC comprises mainly modifying/enhance the existing functions of SAP's software like SAP Business Suite, SAP Business By design, Partner Edge, SAP Business One, my SAP ERP etc, to suit the requirements of overseas customers who have purchased these SAP software. This work is outsourced by overseas SAP entities to the GDC unit after the sale of the SAP software to overseas customers. For these services, SAP India is remunerated by the respective overseas SAP entities on a man-hour basis under a Cross Services Agreement entered between SAP AG (for itself and on behalf of its subsidiaries) and SAP India ( copies of the said agreement is at Page 77 to 90 of Paper book for AY 2005-06).
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18. The learned counsel for the Assessee brought to our notice the terms of the Cross Service Agreement. This agreement describes Assessee as ND and the parent company as SAP AG. Under this agreement, the Assessee has agreed to provide services to SAP AG. Article 3 of the cross services agreement describes the nature of services thus:
"Art-3 ND's Services ND hereby agrees to provide SAP AG with Services as explicitly required by SAP AG on a case to case basis to assist SAP AG in the design and development of SAP AG's Products for marketing and sales. Furthermore ND agrees to provide other subsidiaries of SAP AG which have entered into cross services agreement with SAP AG with services as explicitly requested by the respective other subsidiary of SAP AG. The Services to be provided by ND either to SAP AG or to another subsidiary can include the following:
a) The entire development of a version of a Product, including but not limited to, translation from English/ German to the local language of the Product and its testing; enhancements of and, if necessary, extensions to Products, so as to meet the special requirements of the certain market segments
b) All research and development activities in the areas of the Products which is in connection with and necessary to perform a particular development
c) Consulting
d) Training
e) Sales, including but not limited to, pre-sales activities
f) All other services, including but not limited to, marketing and management services.
Travel costs and expenses according to SAP group guidelines may be charged additionally.
Further details can be laid down from time to time by mutual agreement."
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 17 of 51 Article-4 SAP AG Services 4.1 ND will be billed for all R/2 End User problems forwarded for resolution to SAP AG support centres at a flat rate for each problem (the Regional Support Rate) The rates shall be determined in accordance with the provisions of Exhibit-1 to this agreement ND may offer its End Users SAP AG's pro- active support services, such as Early watch, GoingLive Check and/or GoingLive functional upgrade check service for routine analysis of the End User's installed Software under individual service contracts. ND shall remit to SAP AG for providing these services under individual services contracts to its Eng Users a fee determined according to the provisions of Exhibit-3 to this agreement. The fee to be paid for providing these services not rendered under individual service contracts is determined according to the terms of the Software Distribution Agreement. The respective pro-active support service will be performance directly for End Users by SAP AG or its sub-contractors.
4.2 SAP AG may certify ND's service partners as competent to render support services for the Software. The fee for such certification are to be borne by ND in accordance with Exhibit-
2. 4.3 Other services, including but not limited to, global projects initiated by SAP AG and/or global initiatives to support the marketing and distribution of the Software as well as to enhance the network and conditions for other services, eg. Consulting and/or training may be agreed from time to time between SAP AG and ND.
Unless otherwise signed between the parties, the remuneration for said global projects and/or global initiatives shall be determined in accordance with the provisions of Exhibit-4 to this agreement.
4.4 Except as otherwise expressly provided herein, the provisions of Article-7 ( Proprietary information) 9 ( Limitation of liability) and 10 (Indemnification) of the Software Distribution Agreement shall apply to the SAP AG services and are incorporated by reference herein.
Article -5 Development Projects 5.1 ND may from time to time ask for the development of ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 18 of 51 Modifications and/or extensions to products required by an End User (Development Project) 5.2 Upon receipt of a request for a Development Project SAP AG shall decide by its Development Management, within reasonable time and before the project is started whether and to what extent the results of such Development Project will become part of the Products without limitation of ND's Territory ("Standard")In such case, this Agreement and in particular, Articles-8 and 9 apply for the eservices rendered by ND.
5.3 If SAP AG decides that the result of a Development Project will not automatically become a Standard, the following applies; After termination of the Development Project SAP AG will test the result and determine its quality, in the light of the outcome of such test. SAP AG will decide whether the results of the Development will become Standard. If SAP AG decides that the result of the Development becomes Standard, this Agreement and, in particular, Article-8 and 9 apply. If SAP AG decides that the result of the Development Project will not become Standard, ND is already hereby notified that SAP AG assumes no maintenance fro such result and the ND is solely responsible and liable for any such result for reasonable compensation, upon mutual agreement.
Article-6 Sub-contracts ND is empowered to appoint sub-contractors with SAP AG's consent to provide ND with the services as defined inARticle-3 above. However, ND is allowed to appoint sub-contractors only if it is not able to provide SAP AG with the services by itself or if there are reasonable economical reasons to believe that an appointment is necessary. Nevertheless, the subcontractors shall covenant, in a written statement made to ND to observe the obligations under this agreement (especially the duties according to Article-8 and 10) with respect of SAP AG".
19. As already stated the software development work/implementation support services carried out in the GDC under the aforesaid agreement is separate from the other lines of business carried out by the Assessee ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 19 of 51 viz, licensing and training. It is also different from software development services provided by SAP Labs to SAP AG since the Assessee which is SAP India Pvt. Ltd. in its GDC unit provides software modification/development services to the end-user customer post sales of SAP's software products, and are based on the customer's requirements, while SAP Labs provides software research and development services to SAP AG to develop its proprietary software.
20. The learned Counsel for the Assessee drew our attention to the broad overview of the process involved in the implementation services undertaken by the Assessee whenever a customization request is made by the customer after the sale of the SAP software:
1. SAP's overseas entity sells the SAP software to overseas customer.
2. Customer provides his customization requirements/ modifications on the SAP software to SAP's overseas entity.
3. SAP's overseas entity along with GDC personnel, discusses the modification and customization requirements with the overseas customer. For this meeting, sometimes, GDC personnel are required to visit the overseas customer's premises along with personnel from the overseas SAP entity to understand the systems/IT operating environment of customer and finalize the modifications to be made to the SAP software.
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4. A Project Charter is drawn up between SAP's overseas entity and GDC detailing the project overview, the implementation strategy, the technical specifications, the project related software modules to be developed, the quality testing process, the deliverable reports and the timelines. The GDC team carries out the agreed steps in its STP units in Bangalore or Gurgaon, as per the project charter in coordination with SAP's overseas project.
5. Once the software modules are developed, GDC tests the software and then exports the software modules to the SAP overseas entity or directly to the customer.
6. The customer then tests the software module and confirms acceptance. If there are any errors, the customer intimates the SAP team/GDC to modify the software to remove the errors.
21. The learned counsel for the Assessee also gave us a detailed process flow of the actual software development activities that is carried out in the GDC once the work is transferred to the GDC by SAP's overseas entity.
Phase-I: Functional Specifications Phase:
Under this phase, the GDC team undertakes the following-
− Preparation of the functional specifications in consultation with the customer;
− Approval of the functional specifications by the customer;
− Estimate of effort and plan work schedule; and − Assign the work-plan to the GDC team members.
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Phase-II Technical specifications Phase
Under this phase, the GDC team undertakes the following steps − Adopt technical standards;
− Create the technical specifications;
− Ensure the approval of the technical specifications.
Phase-III Development Phase
Under this phase, the key steps involved are − Develop and review the code: develop/write the software code based on technical specifications. Typically, the key types of software development work carried out by the GDC team would be -
o Workflow module: Workflows are programs and objects that enable a multi-step process. They can be simple alerts or may involve user decision, action, review or a background process involving an update.
o Report module: Reports are programs that generate information from the SAP database. Mostly, reports are viewed online, on the screen. But often, these reports maybe downloaded or sent as attachment in emails (usually spreadsheets or xls) or may be printed.
o Interface module: Interfaces are programs that enable the transfer and exchange of data and information between two or more systems. Usually, interface fetch data from the source system and send them to target systems (outbound) or update the target system with the data sent from the source system (inbound), without any user intervention. In these cases, the data may be extracted from the source by the user manually or the user may generate the data on their own.
o Conversion module: Conversions are programs that enable the transfer of data to the new system being implemented, from a previously live system (legacy ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 22 of 51 system). The source system (which was holding the data) may retire or co-exist after the conversion.
Conversions are also known popularly as 'data migration' programs. Conversion may involve a lot of manual or programmatic corrections and changes to data, in order to make it fit the new system. If the source system will not be retired at the end of the conversion, an interface may be built instead of a conversion. In which case, all necessary data is loaded at the time of 'cutover' using the interface.
o Enhancement module: Enhancements are programs that control, change or create data that is generated by the standard SAP system. Enhancements are required wherever the configurations provided by the standard SAP system are not sufficient to realize the requirements of the implementation or the system. These can be validations, extra user inputs, additionally captured data, additionally created data, alerts etc. In general, when the program/object affects the update of data and the target system is the same as the source system, then the program/object can be classified as an enhancement.
o Form module: Forms are programs that create readable, formatted and printable outputs that are often exchanged with partners (customers, vendors, banks, employees, benefit providers, governments, etc.). The outputs can be printed or sent via fax or sent in an email as an attachment (pdf, otf, rtf, doc) or even simply displayed on the screen (and a user can choose to print, fax or email it).
− Perform unit acceptance test: prepare the unit test environment, conduct the unit test and issue the unit test report. If there are defects, rewrite the software code and test again.
Phase- IV Integration test Phase Under this phase, the key steps involved are − Prepare the quality assurance environment;
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− Prepare and send delivery document;
− Perform integration test; and
− Sign off delivery document.
Phase-V Customer Acceptance Phase
Under this phase, the key steps involved are − Release transport request to Production; and − Perform Customer Acceptance testing and inform the customer of the results Phase-VI Post go-live support phase Under this phase, the key steps involved are − Post integration testing if there are any defects, rectify the same and release correction from development to quality assurance and from quality assurance to production team;
and
− End of GDC involvement.
22. The learned counsel for the Assessee thus submitted that:
• The Assessee provides software modification services to the end-
user customer post sales of SAP software • These services are based on functional and technical specifications of the customer which are outlined in the Project Charter drawn up between SAP's overseas entity and the Assessee • Assessee's employees then develop/ write the software code and perform unit acceptance test to check for defects in modules prepared during the development phase such as workflow modules, interface module, conversion module, etc ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 24 of 51 • Once the software modules are developed, the Assessee tests the software and then installs it in the SAP software in the customer's office overseas.
23. The learned counsel for the Assessee submitted that the assessee had complied with all the conditions for claiming deduction u/s 10A of the IT Act, namely;
a) The undertaking was set up under the STPI Scheme under the Government of India
b) The undertaking manufactures or produced computer software and
c) In the alternative it can be said the assessee had rendered IT- enabled services by exporting/transmitting them outside India. Our attention was also drawn to certain judicial pronouncements in support of the plea put forth by the assessee, to which we will make a reference in the later part of this order.
24. The learned DR reiterated the stand of the revenue as reflected in the order of the AO/CIT(A). It was her submission that there was no proof of export of computer software and in this regard she drew our attention to the observation of the AO in pare-13 for the assessment year 2005-06. She also placed reliance on the decision of the Cochin Bench of the ITAT in the case of DCIT Vs Girnar Industries 124 TTJ 517(Coch.) wherein it was held that blending of Tea and exporting the different ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 25 of 51 grades so blended would not amount to manufacture so as to claim the benefit of deduction u/s 10A of the IT Act, 1961.
25. The learned counsel for the assessee in his rejoinder brought to our notice that it is not correct to say that the assessee did not export any computer software. In this regard, our attention was drawn to page-23 & 24 of the paper book filed for the assessment year 2004-05 in which the particulars of exports out of India have been given. Our attention was also drawn to page-110 of the paper book which is the report of the Chartered Accountant in Form-56F certifying that the assessee had developed and exported software and was entitled to claim deduction u/s 10A of the IT Act, 1961. Our attention was also drawn to page-92 of the paper book which contained the softex form which is a form be given under the STPI Scheme, when the software is exported. The softex form gives the details of software exports and the amount realised on such exports. It was pointed out by the learned counsel for the assessee that the assessee had exported computer software. The AO in his remand report filed before the CIT(A), a copy of which is placed at page-62 of the assessee's paper book has not chosen either deny or affirm the contentions put forth by the assessee before the CIT(A) and the evident filed by the assessee in support of its contention. The learned counsel therefore, submitted that it is too late in the day for the DR to contend that the assessee has not exported computer software. It was also ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 26 of 51 submitted that the learned counsel for the Assessee that the decision of the ITAT Cochin Bench in the case of Girnar Industries (supra) relied upon by the learned DR is no longer good law in the view of the decision of the Hon'ble Kerala High Court in the case of TATA Tea Ltd. Vs. ACIT 338 ITR 285 (Ker) taking a contrary view.
26. We have considered the rival submissions. Sec.10A of the Act in so far as it is material for the present case reads thus:
"SECTION 10A: Special provision in respect of newly established undertakings in free trade zone, etc. (1) Subject to the provisions of this section, a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee ..........
Explanation 2 : For the purposes of this section,--
(i) "computer software" means,--
(a) any computer programme recorded on any disc, tape, perforated media or other information storage device; or
(b) any customized electronic data or any product or service of similar nature, as may be notified by the Board, which is transmitted or exported from India to any place outside India by any means;"
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 27 of 51
27. The following conditions should be independently and cumulatively met, to enable an undertaking to claim deduction under Section 10A of the Act:
• The undertaking is set up under the STP scheme of the Government of India;
• The undertaking manufactures or produces computer software;
and • The computer software or IT enabled services are exported/ transmitted out of India.
28. It is not disputed by the Revenue that the GDC unit of the Assessee is not an undertaking set up under the STP scheme of the Government of India. In fact the necessary approval of the STPI is at page-68 to 74 of Assessee's paper book filed for AY 05-06. The approval mentions that the same is for development/manufacture of Computer Software.
29. As far as the condition as to whether the Assessee manufactures or produces "Computer Software", it has been the contention of the learned counsel for the Assessee before us that the Assessee manufactures or produces articles or things or computer software. In this regard reference was made to the definition of the term "manufacture" as has been defined under Section 2(29BA) of the Act and certain judicial pronouncements rendered thereunder. It was contended that the Assessee's GDC unit modifies the SAP software as per the requirements of the end-user customer post sales of SAP software made by the ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 28 of 51 overseas SAP entities. These services include development/ writing of additional software codes and software programs which is then added to the SAP software. Without prejudice it was submitted that activities of GDC unit would nevertheless also qualify as "production" of any article or thing. While the terms "produce" or "production" have not been defined under the Act, they are generally understood to mean "something that is brought forth either naturally or as a result of effort and work; a result produced" or to "bring into view or notice; to bring to surface". Reliance in this regard was placed on the decision of Hon'ble Supreme Court in the case of India Cine Agencies Vs CIT (308 ITR 98) (SC); CIT Vs Oracle Software (2010) [320 ITR 546] (SC); CIT Vs Business Information Processing Services (2012) [345 ITR 548] (SC); CIT Vs Sterling Foods (Goa) [213 ITR 851] (Mumbai HC). Based on the ratio laid down in the above decisions, it was argued that it is a settled legal position that the word "production" has a wider connotation than the word "manufacture". While every manufacture can be characterised as production, every production need not amount to manufacture. The word "production" or "produce" when used in juxtaposition with the word "manufacture" means bringing into existence new goods by a process, which may or may not amount to manufacture.
30. It was also argued that GDC unit is engaged to develop computer software programs that bring about additional functionalities/ modify ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 29 of 51 the existing SAP software as per the requirements of the overseas customer. In the real world, one could compare the above software development activity carried out in the GDC unit similar to the stitching of new upholstery on a standard bought furniture. Once furniture is bought by the customer from the shop, if the customer wants new upholstery put on the furniture, a tailor would need to engaged, and he would after taking appropriate measurements, have to stitch the new upholstery and fix it on to the furniture as per the requirements of the customer. A typical software development process and the similarities between a typical development process and the process carried out in the GDC unit was also narrated.
31. To appreciate the rival contentions, a perusal of the evidence on record is necessary. In AY 04-05 the Assessee has filed before the CIT(A) two Project Charter. As a sample we will consider the first project charter which is at page 66 to 88 of Assessee's paper book filed for AY 04-05. As can be seen from the project charter, British Council had approached SAP UK for implementing R/3 Solution. The scope of the work is to prepare technical specification for customer developments (interfaces), ABAP Program development, unit testing, support (bug fixing) for specified period. Scope of the work includes development of 22 interface objects in the area of MM, PS, FI/CO and Campus Management as listed in the worksheet attached to the Charter. The ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 30 of 51 Assessee is to implement the work. The person in-charge of the project at SAP-UK, British Council and the Assessee has been set out in the Project Charter. As far as the Assessee is concerned one Mr.Vijay Reddy, Ramesh Kumar and Sundara Iyer have been assigned the responsibility of carrying out the project. The Charter was initially settled on 28.11.2003 and changed on 9.12.2003, after discussion by Mr.Sundara Iyer at London. The schedule for completion is from Dec. 2003 to June, 2004. The number of man hours on site and off-shore are all set out in the charter.
32. Softex Forms is a declaration given by the Assessee for Exchange Control purposes, duly certified by STPI authorities regarding software export through data-communication links. The invoice No. and date of invoice are also given in the Softex Forms. By way of sample we may have a look at Softex Form dated 25.10.2004 together with ten invoices referred to in the said form. Copies of these documents are placed at pages-92 to 105 of Assessee's paper book filed for AY 05-06. The Assessee has to realise 643499.68 Euros on the basis of Softex copy of which is at page 91 to 94. Let us look at Invoice at Sl.No.1 referred to in column-6 of the said Softex form viz., Invoice No.8999000327 dated 25.4.2003. This invoice has been raised on SAP AG. This is apparently because of the Cross Agreement which we have already referred to in the earlier part of this order. As per the Cross Agreement, the subsidiaries ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 31 of 51 of SAP AG all over the world approach the Assessee for carrying out work through SAP AG. The Assessee bills SAP AG for these services. In this invoice there is a column "Agreement No./Contract/Purchase order No. and Date. In this column a number "4500438518 dated 30.10.2002 is given. By looking at this agreement/contract/purchaser order it is possible to know the scope of work performed by the Assessee for which invoice has been raised.
33. From the above documents which have been taken on a test basis it is clear that the nature of services rendered for which the Assessee receives foreign exchange can be established by the Assessee by tracing back each payment with the purpose for which the payment is received. There is no such correlation established by the Assessee. Rather the assertions made by the Assessee are general. For example the Project Chartered for the work to be done for British Council finds no mention in any of the invoices. We may however observe that the nature of work to be performed for British Council, would be in the nature of, if not "manufacture or production of computer software", at least in the nature of "Data Processing" or "Engineering" or "Support Centre" which are all notified services for available the benefit of deduction u/s.10A of the Act. The revenue authorities rejected the claim of the Assessee for the reason that no specific head has been pointed out by the Assessee when in fact the Assessee claimed that the nature of work done by it would fall within ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 32 of 51 either one or the other of the three categories of service referred to above. This again will depend on the nature of service to be rendered for which the foreign exchange was received.
34. The same is the position with regard to factual position in AY 05-06 also. The Assessee has not established correlation between the receipts in foreign exchange and the nature of services rendered for which the payment was received. Let us take a Project Charter at page-91 of the paper book of Assessee filed for AY 05-06. This project charter relates to a client by name Shell of Nederland which had approached SAP Nederland who in turn have approached the Assessee. The scope of the work is development of two Business application Programming interfaces.
35. Softex forms at Page-197 refers to about 12 invoices and is in respect of total foreign exchange receivable of 1158021.09 Euros. Invoice No.9071001535 dated 30.4.2004 is referred to in the softex form. As usual the invoice is raised on SAP AG. The invoice relates to Agreement dated 8.4.2004. The invoice also refers to the man hour charges in respect of 9 software professionals who are employees of the Assessee. As to what is the nature of services performed by the Assessee for which the payments were to be received cannot be correlated. The Assessee has not made any such attempts to demonstrate that it was ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 33 of 51 engaged in production or manufacture of Computer Software or was rendering notified IT-Enabled Services.
36. We are of the view that it would be just and appropriate to decide the issue raised by the Assessee in Gr.No.2 in AY 04-05 and 05-06 by restoring the issue to the AO for fresh consideration and by directing the Assessee to establish the nature of service rendered for which payments were received in foreign exchange and in respect of which deduction u/s.10A has been claimed. This can be done on a test check basis to the satisfaction of the AO. We are also of the prima facie view that the nature of service performed by the Assessee going by the Job Charter would be in the nature of, if not, manufacture or production of "Computer Software" at least one of the notified IT enabled Services for the purpose of Sec.10A of the Act. In fact even CIT(A) accepts that these services were in the nature of "Support Services" which is a notified IT Enabled service. Nevertheless it would be just and fair to direct the Assessee to furnish the correlation between the foreign exchange receipts and the purpose of which the same was received with reference to the job charter. The AO on showing such correlation decide as to whether the nature of service rendered would be such as to fall within the parameters of Sec.10A of the Act. The AO will afford opportunity to the Assessee to furnish such further evidence as may be necessary and ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 34 of 51 decide the issue after affording opportunity of being heard to the Assessee.
37. As far as the third condition viz., as to whether the Assessee exported computer software/ITES out of India, we are of the view that there can be no doubt on the satisfaction of this condition. Sample copies of Software Export Declaration (Softex) forms filed with the STPI (relating to/ corresponding to the invoices raised by the Assessee on overseas SAP entities) have been filed before the Revenue authorities. These Softex forms are certified by the STPI authorities as being exported out of the country.
38. The learned counsel for the Assessee has also made submission with regard to billing mechanism adopted by the Assessee. It was submitted that the revenue has concluded that the Assessee was raising bills for hourly charges and not on the basis of cost plus or product/solution based bills and therefore the Assessee is not engaged in any software development. Our attention was drawn to the Assessee billing mechanism by referring to Article 9 of Cross Services Agreement which provides for compensation arrangement between SAP India and its holding company, SAP AG, where in it has been provided that if the services are rendered as per Article 3(a) and (b) i.e., development of version of product, translation, testing, research and development, etc ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 35 of 51 (including assessment for administration and facilities), then the same would be charged at cost plus six percent. However, if the services are as per Article 3(c) which involves consulting services of the STPI unit, then the payment would be in according to SAP India's rates for consultants determined as average realised market rate of such consultant. It was argued that from the above, it would be clear that SAP India, has invoices of both kinds i.e., which are invoiced on man-hour basis and also those which are invoiced on cost plus 6%. It was submitted that it was a common practice in the software services industry to invoice customers on a time and material basis, i.e., in accordance with the billing/ charge-out rates of the personnel incurring time on the particular software development assignment. It was further submitted that the billing mechanism adopted was completely irrelevant while determining whether the Assessee is carrying on software development & related services and the same should not, in any way impact the eligibility to claim deduction under Section 10A of the Act.
39. It was submitted that even activities such as software consulting/ implementation/ maintenance services have been held to qualify for a deduction under Section 10A of the Act and in this regard our attention was drawn to the following decisions:
• CIT Vs EDS Electronic Data Systems (India) Pvt Ltd (ITA 474/2009)(Delhi HC) • Direction Software Solutions Vs ITO [116 TTJ 841 (2008)] (Mumbai) ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 36 of 51 • ISBC Consultancy Services Ltd Vs DCIT (83 TTJ 597) (Mumbai)
40. Without prejudice to submissions that the GDC unit of the Assessee is engaged in computer software development, it was also submitted that SAP India's GDC unit's activities can nevertheless be considered to also be covered by CBDT's Notification on IT enabled services. It was argued that the second limb of the definition of computer software would mean "any customized electronic data or any product or service of similar nature, as may be notified by the CBDT. The CBDT's Notification No SO 890(E), dated 26 September 2000], notifying certain activities as ITES was placed before us and it was argued GDC's activities can nevertheless be considered to fall under one or more categories of IT enabled services as per Notification No SO 890(E), dated 26 September 2000 (supra), viz "Data Processing", "Engineering and Design", "Support Centre" and "Remote maintenance". Arguments were advanced as to what is data processing, Engineering and Design, Support Centre and Remote maintenance and certain judicial pronouncements in this regard were also referred to before us.
41. The arguments raised by the learned counsel for the Assessee in para 35 to 37 above are not being considered elaborately for the reason that the nature of services rendered needs to be ascertained first and in this regard we have already held in para 33 that the AO will examine the ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 37 of 51 issue afresh. We give liberty to raise all these arguments before the AO after placing before him the nature of services rendered by the Assessee. Thus Gr.No.2 raised by the Assessee in A.Y. 04-05 & 05-06 are treated as allowed for statistical purposes.
42. Ground no.3 with regard to the plea of the assessee for allowing credit in respect of foreign taxes paid by the assessee on an income earned in foreign jurisdictions. The learned counsel for the assessee did not press for adjudication of the ground as the assessee has got necessary relief from the AO, pursuant to an application filed by the assessee u/s 154 of the IT Act, 1961. Therefore, ground no.3 is dismissed as not pressed.
43. Ground no.4 raised by the assessee is with regard to levy of interest u/s 234D of the IT Act, 1961. On this issue, the CIT(A) held as under;
" With regard to the ground relating to charging of interest u/s 234B & 234C, it may be noted that charging of interest u/s 234B & 234C is mandatory & according chargeable wherever there is incidence of the same. Therefore, no appeal can lie against the order charging interest if there is incidence, unless it concerns a perceived and apparent misapplication of mind. The assessee has not pointed out any such circumstances in his grounds. The AO is accordingly directed to levy the interest applicable as per law after taking into consideration the findings of this appellate order. Accordingly, this ground of appeal is not adjudicated upon".
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 38 of 51
44. In this regard, we find that the grievance of the assessee as projected before the CIT(A) was that interest u/s 234C of the Act, can be levied only when there is a shortfall in payment of advance tax instalment by considering the advance taxes paid on the tax due on the "returned income" and not the "assessed income". This grievance has probably not been properly projected by the assessee nor appreciated by the CIT(A) in proper perspective.
45. We have considered the provisions of sec.234C of the IT Act we find that the liability to pay interest for deferment of advance tax is based on the advance tax payable on the returned income and not on the assessed income. The AO is directed to charge interest accordingly.
46. Ground no.5 raised by the assessee with regard to levy of interest u/s 234D of the IT Act, 1961 is purely consequential and the AO is directed to give consequential relief.
47. In the result, ITA No.1492(B)/13 is partly allowed. ITA No.1493(B)/13(AY: 2005-06)
48. Ground no.1 is general in nature and calls for no adjudication. Ground no.2 raised by the assessee reads as follows;
" The learned CIT(A) has erred in law and in facts in confirming the order of the learned AO by upholding the ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 39 of 51 disallowance of the deduction claimed by the assessee u/s 10A of the IT Act amounting to Rs.392,260,237 for AY: 2005-06".
49. This ground of appeal is identical to ground no.2 decided by us for the assessment year 2004-05 for the reasons stated therein. This ground of appeal is treated as allowed for statistical purpose.
50. Ground no.3 & 4 raised by the assessee reads as follows;
" 3. The learned CIT(A) has erred in law and in facts in confirming the order of the AO by holding the ad hoc disallowance of staff welfare expenses of Rs.3,000,000 incurred by the assessee during the AY: 2005-06.
4. The learned CIT(A) has erred in law and in facts in confirming the order of the AO by upholding the ad hoc disallowance of sales promotion expenses of Rs.11,307,150/- incurred by the assessee during AY:
2005-06".
51. The Assessee had claimed a deduction in respect of certain employee costs and operating expenses incurred by it for the AY 2005- 06, in the course of its business. These expenses consist of Staff welfare expenses of Rs 43,448,120 and Advertising & sales promotion of Rs 113,071,570. The above expenses, which were debited to the Profit and Loss Account of the Assessee, for the year ended 31 March 2005, were claimed as a deduction by the Appellant in accordance with the provisions of Section 37(1) of the Act. A detailed break-up of these expenses was called for by the AO and were adequately provided by the Assessee. The Assessee claimed that these expenses were incurred ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 40 of 51 wholly and exclusively for its business purposes and satisfy the test of commercial expediency. However, the AO, while computing the total income of the Assessee disallowed a portion of the employee costs and operating expenses as under:
Staff Welfare expenses: (Gr.No.3)
52. The Assessee incurred a sum of Rs 1,02,37,186 towards food and refreshments, which was included in the expenditure claimed under the head "Staff Welfare expenses". The AO was of the view that expenses incurred towards free meals to employees during office hours, cannot be treated as allowable expenditure. The AO therefore disallowed Rs 25,59,297, viz., 25 per cent of the said expenses. The AO also disallowed a sum of Rs 2,00,000 (out of the total sum of Rs 7,41,660) incurred by the Assessee towards giving of gifts to the employees, on an ad-hoc basis. Further the AO disallowed a sum of Rs 24,18,622 (being 25% of other staff welfare expenses), while computing the taxable income of the Assessee. In aggregate, the AO made a disallowance of Rs 51,77,919 in respect of Staff Welfare expenses incurred by the assessee, on the ground that there was no Fringe Benefit Tax during the FY 2004
05.
53. The CIT(A) concurred with the view of the AO that the amounts disallowed by the AO would fall within the ambit of Fringe Benefit Tax ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 41 of 51 though those provisions were not applicable for AY 05-06. He was of the view that the benefits of the above expenditure would accrue to the SAP Group as a whole which has global presence. The CIT(A) however reduced the disallowance made by the AO from Rs 51,77,919 to Rs 30,00,000.
54. Aggrieved by the order of CIT(A), the Assessee has raised Gr.No.3 before the Tribunal. We have heard the rival submissions. The test that has to be applied in allowing the above expenses is to see whether expenses were incurred wholly and exclusively for the purpose of business and whether incurring of such expenses is commercially expedient. The Hon'ble Supreme Court [in the cases of Sri VenkataSatyanarayana Rice Mill Contractors Co Vs CIT(223 ITR 101), CIT Vs Walchand & Co Pvt Ltd (65 ITR 381), CIT Vs Dhanrajgirji Raja Narasingirji (91 ITR 544)], has held that expenditure incurred wholly and exclusively for business purposes and satisfying the test of commercial expediency, should be allowed as a deduction and the quantum of expenditure incurred cannot be questioned. The Karnataka High Court in the case of CIT Vs Motor Industries Co Ltd (223 ITR 535) has held as under:
"The commercial expediency of a businessman's decision to incur an expenditure cannot be tested on the touchstone of strict legal liability to incur such an expenditure. Such decisions in the very nature of things have to be taken from a business point of view and have to be respected by the authorities no matter that it may ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 42 of 51 appear to the latter that the expenditure incurred was unnecessary or avoidable." (Emphasis supplied)
55. In respect of provision of free meals to employees, it cannot be denied that such expenses are essential for the purpose of employee welfare, and hence are clearly allowable as business expenditure. In fact it is an industry-wide practice followed in India by IT companies. Such facilities are extended in the industry to ensure low employee attrition which will progress the growth of the Assessee. With effect from AY 2005-06, value of free food and non-alcoholic beverages provided by the employer to an employee is not even treated as "perquisites" in the hands of employees [as per clause (iii) under sub-rule 7 to Rule 3 of the Income-tax Rules, 1962]. In fact, even under the Fringe Benefit Taxes ("FBT") regime, though inapplicable for AY 2005-06, it may be pertinent to note that a specific exemption has been provided in respect of expenditure incurred on food or beverages procured by the employer for providing to his employees in an office or factory. Thus even the legislature thought such benefits not to be expenditure which would provide any benefit of a personal nature for the employees. We do not find any basis for disallowance of the remaining expenses out of staff welfare expenses also. We therefore hold that the disallowance sustained by the CIT(A) be deleted. Gr.No.3 is allowed. Sales promotion expenses; (Gr.No.4)
56. The AO disallowed Rs 2,00,000,00 out of sales promotion expenses, on the basis that these expenses (specifically, expenses incurred towards ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 43 of 51 sponsorship of events, hosting of conferences, promotional gifts, public relations), cannot be said to be incurred exclusively for business purposes. The CIT(A) reduced the disallowance made by the AO from Rs 20,000,000 to approximately Rs 11,307,150 (i.e., 10% of the total claim).
57. The submission of the learned counsel for the Assessee in this regard was that the Assessee is a software product company and sub- licenses the SAP software to customers in the Indian sub-continent including Sri Lanka and Bangladesh. Hence, it incurs sales promotion expenses while promoting the SAP software product in the region. Such sales promotion expenses are necessary to create awareness of the different SAP products and its utility for the buyer in the Indian sub- continent. It was submitted that the expenses claimed by the Assessee are not uncommon expenses and is incurred by any software product company. A comparison of expenses incurred by various other companies in the same line of business in India was also provided: -
Infosys Wipro SAP India
Particulars
(Rs in '000) (Rs in '000) (Rs in '000)
Income/
68,596,600 72,331,610 4,467,831
Revenue
Sales &
Promotion 3,921,200 5,105,430 113,072
Expenses
% 5.72% 7.06% 2.53%
ITA Nos.1492-1495(B)12 &
ITA No.265(B)/13
Page 44 of 51
It was submitted that the expenses incurred by the Assessee on Sales promotion are not abnormally high and were incurred wholly and exclusively for its business purposes and would satisfy the test of commercial expediency. The learned DR relied on the order of the CIT(A).
58. We have considered the rival submissions. The principles applicable for allowing such expenses are the same as was discussed while deciding Gr.No.3 and are not being repeated. It is not the case of the Revenue that sales promotion expenses incurred by the Assessee are not directly linked to the promotion of its business and growth objectives. The CIT(A) after having agreed with the submissions of the Assessee in this regard has however without any basis restricted the disallowance made by the AO to 10% of the expenses. In this regard it is seen that the Assessee claims that it is responsible for advertising and promotion of SAP products in the Indian sub-continent and undertakes advertising for SAP products including designing product brochures, deciding the medium of advertising and developing advertising content for the products. These facts have not been disputed by the Revenue. In these circumstances we are of the view that sales promotion expenses, being incurred wholly and exclusively for the purpose of the Assessee's business, are fully allowable as deduction under Section 37(1) of the Act. Gr.No.4 is accordingly allowed.
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 45 of 51
59. Ground no.5 was not pressed and the same is dismissed as not pressed. Ground no.6 is with regard to charging of interest u/s 234B of the IT Act, 1961 is consequential in nature and the AO is directed to give consequential relief. Ground no.7 is with regard to interest levied u/s 234C of the IT Act, 1961. While deciding the similar ground of appeal for the assessment year 2004-05, we have already held that interest u/s 234C of the IT Act, 1961 are to be levied by taking income declared in the return of income, as criteria. For the reasons stated therein, we direct the AO to calculate interest u/s 234C of the IT Act, 1961 by considering the returned income and not the assessed income.
60. In the result, the appeal is partly allowed. ITA No.1494(B)/12 (AY: 2006-07)
61. Ground no.1 is general in nature and calls for no adjudication. Ground no.2 raised by the assessee is identical to ground no.2 raised by the assessee in the appeal relating to assessment year 2004-05. For the reasons stated while deciding the similar grounds in AY: 2004-05, this ground of appeal of the assessee is treated as allowed for statistical purpose.
62. Ground No.3 raised by the assessee reads as follows;
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 46 of 51 "3. The learned CIT(A) is erred in law and in facts in not adjudicating grounds No.4 to 9 raised by the assessee in its appeal u/s 246A(1) (a) of the Act, which are as follows; a. The ld.AO has erred in law and in facts by holding that the assessee in foreign currency towards support charges incurred by relatable to the STP unit of the assessee during the FY: 2005-06 (aggregating Rs.93,335,000) have been incurred in connection with rendering of technical services outside India, without appreciating the fact that the assessee's STP unit is engaged in the business of software development and related services.
b. The ld.AO has erred in law and in facts by holding that the expenses in foreign currency towards cost of purchased services incurred by/relatable to the STP unit of the assessee during FY:2005-06 (aggregating to Rs.81,643,654) have been incurred in connection with rendering of technical services outside India, without appreciating the fact that the assessee's STP unit is engaged in the business of software development and related services.
c) The learned AO has erred in law and in facts, by holding that all expenses in foreign currency towards travel & conveyance, communication and other expenses incurred by relatable to the STP unit of the assessee during FY: 2005-06 (aggregating Rs.43,156,449) have been incurred in connection with rendering of technical services outside India, without appreciating the fact that the assesses STP unit is engaged in the business of software development and related services.
d) The learned AO has erred in law and in facts by holding that the entire foreign currency expenses are incurred towards providing technical services outside India and should be reduced from export turnover while computing the deduction u/s 10A of the Act.
e) The learned AO has erred in law and in facts by not considering the alternative plea of the assessee that if the expenses mentioned in Ground no.3.1 to 3.3 above are reduced from export turnover, an equal amount ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 47 of 51 should also be reduced from total turnover for computing the deduction under section 10A of the Act.
f) The learned AO has erred in la and in facts by reducing an amount of Rs.30.198,542 (representing export sales proceeds realised beyond six months from the end of relevant FY) from the export turnover while re-computing the deduction u/s 10A of the IT Act, though the entire proceeds were received before completion of assessment u/s143(3) of the Act.
63. The CIT(A) in his order, did not adjudicate these grounds for the following reasons;
" 7. These grounds involve expenses incurred in foreign currency towards support charges, cost of purchased services, travel and conveyance, expenses incurred in providing technical services outside India and foreign expenses attributable to the delivery of computer software outside India. Since they all concern nuances of the exemption u/s 10A, once I have already determined above that the assessee is not entitle to the basic exemption u/s 10A, the question of adjudicating upon the different aspects of the exemption as covered by the grounds under consideration does not arise. Accordingly, these grounds are dismissed".
64. Since we have remanded to the AO the question of eligibility of the assessee to deduction u/s 10A of the IT Act, 1961, the AO is directed to adjudicate the aforesaid claim of the assessee in the order giving effect to the decision of the Tribunal.
65. Ground no.4 with regard to credit for foreign taxes paid was not pressed, as the assessee has obtained necessary relief by filing an application u/s 154 of the IT Act, 1961. Hence Gr.No.4 is dismissed.
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 48 of 51
66. Ground no.5 is with regard to levy of interest u/s 234B of the IT Act, 1961 is purely consequential. The AO is directed to give consequential relief.
ITA No.1495(B)/12 ( AY: 2007-08)
67. Ground no.1 is general in nature and calls for no adjudication. Gr.No.2 raised by the assessee is identical to ground no.2 raised by the assessee for the assessment year 2004-05. For the reasons stated while deciding the similar grounds in AY: 2004-05. This ground of appeal of the assessee is treated as allowed for statistical purpose.
68. Ground no.3 raised by the assessee reads as follows;
"3. The learned CIT(A) has erred in law and in facts in not allowing credit in respect of foreign taxes paid by the assessee on income earned in foreign jurisdictions"
69. Ground no.3 with regard to credit for foreign taxes paid is not pressed as the assessee has obtained necessary relief by filing an application u/s 154 of the IT Act, 1961. Hence, Gr.No.3 is dismissed.
70. Ground no.4 raised by the assessee reads as under;
"4. The learned CIT(A) has erred in law and in facts in confirming the order of the learned AO by upholding the levy of interest u/s 234D of the Act amounting to Rs.39,524,814 for AY: 2007-08".
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 49 of 51
71. Ground no.4 is with regard to levy of interest u/s 234D of the IT Act, 1961 is purely consequential. The AO is directed to give consequential relief.
ITA No.265(B)/2013 (AY: 2008-09)
72. ITA No. 265(B)/13 is an appeal by the assessee against the order dated 15-11-2012 of CIT(A)-III Bangalore relating to assessment year 2008-09. In this appeal, the assessee has raised as many as four grounds which are as under;' "1. The learned CIT(A) has erred in law and in facts, in confirming the order issued by the joint Commissioner of Income-tax (OSD) Circle-12(3), Bangalore (The learned AO) u/s 143(3) of the Act. The assessee craves that the order of the learned CIT(A) inasmuch as it confirms the order of the learned AO being unsustainable and bad in law, be set aside.
2.The learned CIT(A) has erred in law and in facts in confirming the order of the learned AO by upholding the disallowance of the deduction claimed by the assessee u/s 10A of the Act, amounting to Rs.1,652,643,181 for AY: 2008-09.
3. The learned CIT(A) has erred in law and in facts in not allowing credit in respect of foreign taxes paid by the assessee on income earned in foreign jurisdictions.
4.The learned CIT(A) has erred in law and in facts in confirming the order of the learned AO by upholding the levy of interest u/s 234D of the Act, amounting to Rs.120,511,853 for AY: 2008-09".
ITA Nos.1492-1495(B)12 & ITA No.265(B)/13 Page 50 of 51
73. Ground no.1 is general in nature and calls for no adjudication. Gr.No.2 raised by the assessee is identical to ground no.2 raised by the assessee for the assessment year 2004-05. For the reasons stated while deciding similar ground of appeal in AY: 2004-05, this ground of appeal of the assessee is treated as allowed for statistical purpose. Ground no.3 raised by the assessee with regard to credit for foreign taxes paid is not pressed as the assessee has obtained necessary relief by filing an application u/s 154 of the IT Act, 1961. Hence, Gr.No.3 is dismissed. Ground no.4 raised by the assessee with regard to levy of interest u/s 234D of the IT Act, 1961 is purely consequential. The AO is directed to give consequential relief.
74. In the result, all the appeals filed by the assessee are partly allowed.
Order pronounced in open Court on the 13th day of Nov. 2013.
Sd/- Sd/-
(N.BARATHVAJA SANKAR) (N.V.VASUDEVAN)
VICE-PRESIDENT JUDICIAL MEMBER
Place: Bangalore
Dated : 13.11.2013.
am* / DS /
ITA Nos.1492-1495(B)12 &
ITA No.265(B)/13
Page 51 of 51
Copy to :
1. The Assessee
2. The Revenue
3. CIT(A)
4. CIT
5. DR
6. GF(B'lore)
By Order
Senior Private Secretary
ITAT, BANGALORE