TMI Blog2010 (7) TMI 843X X X X Extracts X X X X X X X X Extracts X X X X ..... ote No. 1 to the computation of total income and note No. 11 in the tax audit report. The certificate in Form No. 10CCAF was given by the auditors but they certified the income eligible for deduction u/s 80HHE as Nil because the computation of total income as per return of income was loss. That does not preclude the AO from allowing the deduction u/s 80HHE, if otherwise the claim can be allowed. Even according to the AO, the assessee is otherwise entitled to claim deduction u/s 80HHE. In respect of export turnover brought into India in convertible foreign exchange - HELD THAT:- the assessee should be allowed deduction u/s 80HHE. Such deduction has been computed by the assessee at Rs. 8,22,68,736 in the submissions filed before CIT(A). The AO is directed to verify the claim of the assessee and allow relief u/s 80HHE. In respect of export turnover of Rs. 5,50,91,092 - HELD THAT:- the AO shall verify nexus between the expenditure incurred abroad and the business of export of computer software which yielded the income on which deduction is claimed u/s 80HHE as also the nexus between the outstanding payable by the assessee to ICICI Infotech Inc., USA and the export of computer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nature of research and development expenditure and, therefore, allowable as a revenue expenditure. (3)Learned CIT(A) erred in observing that the above alter- native claim was not made before the Assessing Officer without appreciating the fact that the appellant had made the above alternative claim before the Assessing Officer in its submissions made vide letter dated 7th February, 2005. (4)Learned CIT(A) erred in confirming the action of the Assessing Officer in not allowing deduction under section 80HHE of the Income-tax Act. (5)Learned CIT(A) erred in observing that the foreign exchange has not brought to India by the appellant and, therefore, condition of section 80HHE(2) of the Income-tax Act is not satisfied. (6)Without prejudice to the above, learned CIT(A) erred in not appreciating the alternative claim of the appellant to allow deduction under section 80HHE of the Income-tax Act on net amount of foreign exchange realized. 3. The assessee is in the business of, inter alia, development of computer software, which includes production of computer software and all processes thereon, assembling and recording of programmes on any tapes, disc, perforated medi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ucts. The assessee, thus, submitted that the expenses on software development/up-gradation are allowable deduction under section 37(1) of the Act. The assessee placed reliance on the decision of Supreme Court in the case of Alembic Chemical Works Co. Ltd. v. CIT [1989] 177 ITR 377 1, wherein Hon ble Supreme Court has observed at one has to keep in mind rapid progress in science and technology while applying the enduring benefit test to decide whether an expenditure is capital or revenue. Besides the above, reliance was also placed on several decisions as to when an expenditure can be regarded as revenue expenditure. 4. Alternatively, it was contended that as per the provisions of section 35(1)(iv) of the Act, deduction in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee is allowed in the year in which such expenditure is incurred. The whole of the capital expenditure incurred in a previous year is allowable as a deduction against income, if any, for that previous year. The relevant extract from the definition of the term scientific research as per section 43(4) of the Act is as under : (i)"scientific ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k-in-progress in the earlier assessment year. This year the said expenditure was capitalized on reaching commercialization. The Assessing Officer wanted to have a working of the profits of the assessee, if the expenditure treated as work-in-progress this year, viz., Rs. 12,59,33,429 is disallowed as revenue expenditure and 60 per cent depreciation is allowed on the value of expenses of Rs. 3,92,90,000 capitalized in the books of account in the present year. The assessee gave a calculation of such profits, without prejudice to its claim that the entire expenditure of Rs. 12,59,33,429 is to be allowed as revenue expenditure. The same is at pages-61 of the assessee s paper book. This aspect is relevant in the context of the claim of the assessee made for deduction under section 80HHE of the Act. 6. The facts with regard to the claim of the assessee for deduction under section 80HHE are as follows:- The assessee had filed its return of income declaring a loss of Rs. 46,96,990. Though the assessee was entitled to deduction under section 80HHE of the Income-tax Act, however, in view of the loss declared in the return of income, no deduction was claimed under section 80HHE. However ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not allow the claim of the assessee for deduction under section 80HHE of the Act also. The following were the conclusion of the Assessing Officer in this regard : "Notwithstanding the fact that the Auditor has certified the deduction under section 80HHE to be at Nil, the arguments of the assessee were looked into. In the Notes 1 and 2 to Form No. 10CCAF, it has been clearly stated as follows :- Note 1 : Realization of Export turnover has been considered as realized on the basis of dues payable to the parties to whom exports have been made. Note 2 : Export proceeds retained by the foreign branch for its expenses has been considered as realized export proceeds. From the above, it is abundantly clear that the assessee-company has not complied the provisions of sub-section (2) of section 80HHE, which stipulates that the realization of export turnover should be brought into the country in convertible foreign exchange with the prescribed time-limit. This provision reads as follows :- The deduction specified in sub-section (1) shall be allowed only if the consideration in respect of the computer software referred to in that sub-section is received in, or brought into, In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... venue expenditure. In ground Nos. 2 and 3, the assessee has projected its grievance regarding the non-consideration of the alternative claim of treating the expenditure of Rs. 12,59,33,429 as allowable as deduction as Research and Development expenditure under section 35(1)(iv) of the Act. In ground Nos. 4 to 6, the assessee has projected its grievance regarding the refusal of deduction under section 80HHE of the Act. 10. We have heard the rival submissions. The learned counsel for the assessee reiterated the submissions as were made before the Assessing Officer. It was submitted by him that one has to see the nature of business of the assessee. In the hands of the assessee who is a software developer the expenditure cannot be said to be capital expenditure. He referred to the decision of the Special Bench of ITAT Delhi in the case of Amway India Enterprises v. Dy. CIT [2008] 111 ITD 112 SB)(Del), wherein at page-168, the Special Bench has explained that the expenditure on software, whether capital or revenue will depend on the nature of business of an assessee. He referred to the details of the expenses which were claimed by the assessee as deduction and submitted that those exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asibility is achieved and the product is ready for sale. Thereafter the entire expenditure incurred on development of computer software is amortized over a period of five years or as considered appropriate by the management. Capitalization occurs once technological feasibility has been reached and costs are determined to be recoverable. Capitalization ends and amortization begins when the product is available for general release to customers. 14. Instead of claiming expenditure on computer software by amortization of expenditure incurred up to the stage of development over a period of time, depreciation can also be allowed on the capitalised cost of the computer software. In such case, an assessee instead of amortization gets the benefit of depreciation, which is one way allows deduction of expenses/costs, just as one would get deduction by amortization of cost. We have already seen that in respect of some expenditure incurred on development/up-gradation of software in the earlier assessment year a sum of Rs. 3,92,90,000 had been treated as capital work-in-progress in the earlier assessment year. This year the said expenditure was capitalized on reaching commercialization. The As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e learned counsel for the assessee pointed out that as per the provisions of section 35(1)(iv) of the Act, deduction in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee is allowed in the year in which such expenditure is incurred. The whole of the capital expenditure incurred in a previous year is allowable as a deduction against income, if any, for that previous year. The definition of the term scientific research as per section 43(4) of the Act is as under :- (i)"scientific research" means any activities for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries; (iii)references to scientific research related to a business or class of business include (a)any scientific research which may lead to or facilitate an extension of that business or, as the case may be, all businesses of that class; As per section 35(2), where such capital expenditure [referred to in section 35(1)(iv)] is incurred after 31-3-1967, the whole of such capital expenditure incurred in any previous year is deductible for that previous year, with except ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the customers. Moreover the business of the assessee is development of software for its clients. Under section 35(1)(iv), deduction is allowed in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee. The business carried on by the assessee cannot itself be considered as research and development. It is not the purpose of section 35(1)(iv) to allow such deduction. In the present case, the business of the assessee was development of software for its clients. Any expenditure incurred in doing so cannot by itself fall within the parameters of section 35(1)(iv) of the Act. The allowability of such expenses will be governed by the provisions of section 37(1) of the Act because there is no other provision under Chapter-IV sections 28 to 44 of the Act under which the allowability of the aforesaid expenditure can be considered. 17. For the reasons given above, we dismiss ground Nos. 1 to 3 raised by the assessee. 18. Ground Nos. 4 to 6 are with regard to the claim of the assessee for deduction under section 80HHE of the Act. We have already seen that the assessee had filed its return of income declaring a loss of Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of total income and note No. 11 in the tax audit report. The certificate in Form No. 10CCAF was given by the auditors but they certified the income eligible for deduction under section 80HHE as Nil because the computation of total income as per return of income was loss. That does not preclude the Assessing Officer from allowing the deduction under section 80HHE of the Act, if otherwise the claim can be allowed. 19. The second ground on which the deduction was not allowed was because of violation of the provisions of section 80HHE(2) of the Act. Under section 80HHE of the Act, where an assessee being an Indian company engaged in the business of export out of India of computer software he is entitled to deduction in computing the total income of 70 per cent of the profits derived from such business as per the law applicable to assessment year 2002-03. The profits derived from business is the amount which bears to the profits of the business, the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee. The assessee s computation of deduction under section 80HHE as filed during the course of assessment proceedings (copy at p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ree with the submission of the learned counsel for the assessee that in respect of the remaining export turnover brought into India in convertible foreign exchange, the assessee ought to have been allowed deduction under section 80HHE. Such deduction has been computed by the assessee at Rs. 8,22,68,736 in the submissions filed before CIT(A). This requires verification by the Assessing Officer. The Assessing Officer is directed to verify the claim of the assessee and allow relief under section 80HHE of the Act. 21. With regard to the sums not brought into India, the learned counsel for the assessee submitted netting off of amount due to the customer against the amount due from the same customer is to be treated as amount realized from export turnover. It was his submission that instead of getting the gross remittance, the assessee brought in the net remittance after reducing the sum payable to the same party. According to him, it makes no difference whether one gets into India the gross receipts and then makes payment to the same party or when one gets the net payment after reducing the sum payable to the same party. The adjustment is merely an administrative convenience and, henc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the set off pleaded by the assessee should not be accepted. With prejudice, he further submitted that the claim of the assessee that the monies payable by it abroad arose out of the transactions in respect of which the assessee received remittance in convertible foreign exchange for export of computer software was not substantiated with any evidence and it was, therefore, not possible for the Assessing Officer to have made any verification. In the event of the Tribunal agreeing with the submissions of the assessee, the matter should be remanded to the Assessing Officer to examine this aspect and it should be made clear that the set off, if any, should be only between the same transactions in relation to the assessee was to receive remittances in convertible foreign exchange. Secondly, the learned D.R. submitted that the condition for allowing deduction under section 80HHE(2) was that the remittances should reach India within six months from the end of the previous year. The assessee can get set off only in relation to expenses which crystallized within the aforesaid period and past liabilities outstanding cannot be set off. Even this aspect, according to the learned D.R., needs ve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... HE in the note No. 1 to the computation of total income and note No. 11 in the tax audit report. The certificate in Form No. 10CCAF was given by the auditors but they certified the income eligible for deduction under section 80HHE as Nil because the computation of total income as per return of income was loss. That does not preclude the Assessing Officer from allowing the deduction under section 80HHE of the Act, if otherwise the claim can be allowed. Even according to the Assessing Officer, the assessee is otherwise entitled to claim deduction under section 80HHE of the Act. (b)In respect of export turnover brought into India in convertible foreign exchange, viz., Export Turnover of Rs. 19,86,76,868 less Rs. 5,50,91,092 (Dues payable by assessee to parties to whom exports were made) + Rs. 6,18,44,229 (Amount retained by the foreign branch as expenses out of export proceeds realized), the assessee should be allowed deduction under section 80HHE. Such deduction has been computed by the assessee at Rs. 8,22,68,736 in the submissions filed before CIT(A). This requires verification by the Assessing Officer. The Assessing Officer is directed to verify the claim of the assessee and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uritius is a joint venture company of the assessee (50 per cent equity) and Emirates Bank Group (50 per cent equity). The company is engaged in the sales, marketing and business development activities for software development in UAE and West Asia. 27. The assessee had entered into the following international transactions with the aforesaid associated enterprises:- Sl. No. Name Address of Associated Enterprises (AEs) Country of tax residence of AEs Nature of relationship Description of transaction with AEs Amount received/receivable, paid/payable as per books of accounts 1. ICICI Infotech Inc., 450, Raritan Centre Parkway, Edison New Jersey, 08837 USA AE as per Sec. 92A(1)(a) i) Provision of technical (software) services. (Receipt by the Assessee) ii) Marketing services provided by Infotech Inc. to Infotech India. (Payment by the Assessee) iii) Contract service provider expenses incurred by Infotech India. (Payment by the Assessee) iv) Interest received on loan granted (Receipt by the Assessee) 62,684,777 218,548,695 31,737,259 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ustment in respect of an issue which was not reported by the assessee as an international transaction in Form No. 3CEB filed pursuant to section 92E of the Act. The following were the relevant observations of the TPO in his report in this regard: "The assessee has also transferred three employees of the company to Infotech US vide this office letter dated 23-10-2004, the assessee was issued a show cause letter, the relevant portion reads as : Infotech India has deputed three employees to Infotech US, during financial year 2001-02 who have become employees of Infotech Inc. In the matter please submit whether in respect of such transferred employees, Infotech India has levied any charge. If not, why and also state why such charge at the rate of 12.5 per cent of the total annual compensation last paid to employees in India, be calculated as the Arm s Length Price. This Arm s Length rate is adopted as per the agreement, Infotech India had with Tricolor Infotech Inc. for the similar services. The total cost to the company incurred on the employees during the month prior to their transfer be submitted. The assessee, in the letter dated 5-11-2004, has only submitted that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here the same entity has undertaken similar transaction under comparable circumstances to independent enterprises (para 6.23 of OECD Guidelines on Transfer Pricing). CUP method could not be applied under the facts of the case as the assessee-company has not transferred/seconded employees to any other independent enterprises. The assessee referred to Para 6.25 of the OECD Guidelines, the relevant extract of which is as under :- "6.25 For example, it may be the case that a branded athletic shoe transferred in a controlled transaction is comparable to an athletic shoe transferred under a different brand name in an uncontrolled transaction both in terms of the quality and specification of the shoe itself and also in terms of the consumer acceptability and other characteristics of the brand name in that market. Where such a comparison is not possible, some help also may be found, if adequate evidences is available, by comparing the volume of sales and the prices chargeable and profits realized for trademarked goods with those for similar goods that do not carry the trademark." However, in case internal comparable is not available the transaction must be tested with transactions m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ations of the Assessing Officer that the transferee-company should compensate the transferor for using the valuable resources. Therefore, TPO/Assessing Officer was fully justified in making adjustment of Rs. 2,71,773 in view of the proviso of section 92C(4) of Income-tax Act, 1961. In view of the above facts, no interference is called for in the order of the Assessing Officer. Thus, ground No. 8 is dismissed." 35. Aggrieved by the order of CIT(A), the assessee has raised ground No. 7 before the Tribunal. 36. The learned counsel for the assessee submitted that under the provisions of section 92CA(1) of the Act, where any person, being the assessee, has entered into an international transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm s length price in relation to the said international transaction under section 92C, to the Transfer Pricing Officer. Under section 92CA(2) where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding to him, the assessee ought to have disclosed this transaction in the report in Form No. 3CEB. Having failed to do so, the assessee cannot take advantage of its own wrong. Another submission made by him was that two of the transactions reported in Form No. 3CEB between the assessee and Infotech US related to (a) marketing services provided by Infotech Inc. to Infotech India (assessee) and (b) Contract service provider expenses incurred by Infotech India (assessee). Since the transactions referred to in Form No. 3CEB were referred to TPO for determining ALP by implication even the act of deputation of the three employees by assessee to Infotech US should be considered as having been referred to TPO for determining ALP. 38. We have considered the rival submissions. Under the provisions of section 92E, an assessee who has entered into an international transaction during a previous year has to obtain a report from an Accountant and furnish such report in the prescribed form, i.e., Form No. 3CEB. Section 92C(3) provides as follows : "(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require on any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm s length price in relation to the international transaction in accordance with sub-section (3) of section 92C and send a copy of his order to the Assessing Officer and to the assessee." In the present case, the Assessing Officer referred to the TPO for determination of ALP the transactions set out in Form No. 3CEB by his letter dated 29-9-2003. The details of these transactions have already been set out above in the earlier paras. The transaction by which the assessee deputed three of its employees to ICICI Infortech, USA, was not considered as an international transaction to be set out in Form No. 3CEB by the assessee. The Assessing Officer, therefore, never referred the computation of ALP to the TPO the transaction of deputation of three of its employees by the assessee to ICICI Infotech, USA. The jurisdict ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c)the information or data used in computation of the arm s length price is not reliable or correct; or (d)the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D. The provisions of clauses (a), (b) and (d ) above would not apply because no price had been charged by the assessee in this case, in respect of the international transaction in question, neither was the assessee called upon to furnish any details in respect of the said transaction nor was there any failure to furnish any details. It is neither the complaint of the Assessing Officer nor the TPO that there was any failure within the meaning of clause (b) above. Further, the Assessing Officer did not comply with the mandate of the proviso to section 92C(3) which lays down as follows: "Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show-cause, on a date and time to be specified in the notice, why the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to possess any of the skills as assumed by the Assessing Officer. (b)He drew attention to page-33 of the assessee s paper book which contains note 2.18 being Notes to the Accounts of the assessee for the previous year relevant to assessment year 2002-03. It has been mentioned therein that the assessee has engaged ICICI Infotech Inc., USA the wholly-owned subsidiary for providing market development and sales support in the US for project software and implementation services for onsite projects. That the assessee remunerates Infotech Inc. on a cost plus basis for the aforesaid services and all the project revenues accures to the assessee. The learned counsel submitted that, if the assessee charges Infotech USA the cost of deputation of employees, the cost of Infotech, USA will go up and on such increased cost the assessee will have to remunerate them the fixed percentage. In that event there will be erosion of tax base of India. 41. The learned D.R. relied on the order of the CIT(A) and submitted that the TPO was right in his conclusions and relying on the Agreement between the assessee and Tricolour Mauritius, an Associate Enterprise where there was provision for receipt of su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the assessee will have to remunerate them the fixed percentage. In that event there will be erosion of tax base of India. In such cases, we feel that the Assessing Officer ought not to resort to the provisions of section 92 to determine income of international transactions. There may be cases where apparently there is no erosion of Indian tax base but the Assessing Officer may find the value of the benefit is part of some other international transaction and determination of ALP of the other transaction will depend determination of ALP of the benefit, in such cases he may resort to the provisions of section 92. We, therefore, agree with the submission of the learned counsel for the assessee that on the facts and circumstances of the present case, there was no necessity to have determined ALP of the transaction in question. We also agree with the learned counsel for the assessee that the TPO has proceeded to determine ALP of the transaction on the basis of assumptions not supported by any evidence. We also agree with his submission that CUP method could not be applied under the facts of the case as the assessee has not transferred/seconded employees to any other independent enterpr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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