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2016 (1) TMI 114 - ITAT BANGALORE

2016 (1) TMI 114 - ITAT BANGALORE - TMI - Entitlement to deduction u/s 10B - Held that:- The agreement entered by the assessee with its customers clearly show that the parties expected definite results , be it in the nature of new or improved compounds or in the nature of research documentation and each step that assessee had to take for achieving this result was also set out. Such results were to be given to its customers. The activities done by the assessee used sophisticated equipment and met .....

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done by the assessee on man hour basis would at the best demonstrate the difficulty in fixing the value of the ultimate production, considering the inherent complexities of the processes involved and the value of the outcome as such. It will not be a reason to say that assessee was being compensated only for the research, irrespective of the final outcome. Thus not only was there exports but the exports were of articles or things produced by the assessee. We are alive to the fact that assessee .....

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ssessee was eligible for claiming the benefit of Section 10B of the Act. Ld CIT was justified in directing so - Decided in favour of assessee. - 1-2. I.T.A Nos.1106 & 1107/Bang/2012, 3-4. Cross Objection Nos.40 & 41/Bang/2013 - Dated:- 16-9-2015 - ABRAHAM P. GEORGE, ACCOUNTANT MEMBER For The Assessee : Shri. Padamchand Khincha, CA For The Revenue : Shri. Sunil Kumar Agarwal, JCIT ORDER PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER : These are appeals and cross objections filed by Revenue and assessee .....

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. 2005-06 was ₹ 21,31,59,892/- and for A. Y. 2006-07, it was ₹ 37,44,17,834/-. 03. Facts apropos are that assessee engaged in contract research related activities, had filed its return declaring income of ₹ 8,07,40,434/- and ₹ 9,16,05,470/- for the A. Ys. 2005-06 and 2006-07 respectively. During the course of assessment proceedings, it was noted by the AO that tax audit report filed by assessee mentioned it to be engaged in the business of providing contract research serv .....

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t-I in earlier years, but the period for which it was entitled for such deduction stood expired. In F. Y. 2003-04 it started a second unit at a different place and from F. Y. 2004-05 was claiming deduction u/s.10B of the Act on such second unit. AO was of the opinion that deduction u/s.10B of the Act can be given only for export earnings arising out of export of articles or things which were manufactured or produced by the assessee. As per the AO assessee was doing research work on contract basi .....

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not be eligible for claiming deduction u/s.10B of the Act, and the only exception was with regard to computer software. 04. When the line of approach mentioned above was put to the assessee, its reply was that unit-II was a separate facility established in a different location, namely, Bommasanda Industrial area, Bangalore. Assessee pointed out that the second unit had got approval from Special Economic Zone (SEZ) and fulfilled all conditions u/s.10B(2) of the Act. An alternate claim was also m .....

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computer software ; (ii) Not being formed by the splitting up, or the reconstruction, of a business already in existence : (iii) Not being formed by the transfer to a new business of machinery or plant previously used for any purpose. As per the AO, assessee did not fulfil the conditions (i) and (ii) above. AO verified the agreements entered by the assessee with its customers which were titled Contract Research Agreements . As per the AO, the agreements were similarly worded and assessee was me .....

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was based on man-hours utilised for the research work nomenclatured as FACs or in other words fully allocated chemists. After extracting the relevant parts of the agreement assessee had entered with one M/s. AB Science S. A. France, AO came to a conclusion that the manufacturing activity, if at all any carried on by the assessee from its clients were only incidental to the research work and the payments received by the assessee were predominantly for research and not for the compounds. 06. AO w .....

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nit were working in the new unit as well. As per the AO, assessee itself had admitted that unit-II was created only for obtaining deduction u/s.10B of the Act, consequent to the expiry of the period of eligibility with regard to the first unit. 07. Vis-a-vis alternate claim put forward by the assessee that it would be eligible for deduction u/s.80IB(8A) of the Act, AO was of the opinion that assessee was not able to demonstrate as to how it fulfilled the conditions set out in the said section fo .....

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l High Court in the case of T. Satish U Pai v. CIT [(1979) 119 ITR 877], assessee argued that for a split up to take place some assets of an existing business had to be divided and transferred to the new unit. Or in other words, as per the assessee it should be breaking up of the very same business. Assessee also pointed out that it had substantial turnover in its old unit even after establishment of the new unit. Unitwise turnover reported by the assessee read as under : Turnover - year wise Un .....

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nit did not mean that there was a split up of the business already in existence. There was no reconstruction or split up, as per the assessee. Assessee also contended that there was no transfer of any plant and machinery from unit-I to unit-II. 09. Vis-a-vis, finding of the AO that it was not engaged in the manufacture, assessee submitted that compounds were exported and the intellectual property used for developing such compounds was the technical back-up. Courier slips evidencing the exports w .....

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by itself. In any case, as per the assessee what was sold clearly came within the terms of articles or things. As per the assessee, article had a much more wider meaning than goods . Term article was wide enough to cover both tangible and intangible items. Even if technical expertise was put into a physical media like drawings, maps and CDs, it constituted goods. In any case as per the assessee it had admittedly manufactured complex chemical compounds and sold it to its customers. End result of .....

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ment of the assessee was that the ultimate compounds transferred to the parties were technologically different and superior to the raw materials used, whether the raw materials were sourced by the assessee or received from the customers. Further as per the assessee, assuming its supplies to its customers as not falling within the meaning of article , it did fall within the meaning of thing . Relying on the judgment of Hon ble Rajasthan High Court in the case of CIT v. Trinity Hospital [(1997) 22 .....

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being deemed as a manufacturer of article or thing . There was application of various process on the raw materials. Process involved imparting treatments and manufacturing of new materials. The raw materials were transferred into a new article and the new article had a different name, character and used commercially. 11. Another submission of the assessee before CIT (A) was that even if it was considered as doing only scientific research, still it would constitute manufacture or production. Comp .....

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neficially interpreted so as to advance the object of earning foreign exchange. 12. CIT (A) was impressed by the above arguments of the assessee. According to him assessee was entitled for deduction u/s.10B of the Act. The reasons mentioned by the CIT (A) in his order for coming to this conclusion reads as under : i. Though the A.O stated that Unit-II of the appellant company was established by splitting up of the existing Unit- I, the A.O was unable to counter the claims of the appellant that U .....

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espect of Unit-I, initially the appellant claimed deduction U/S-80HHC of the IT Act 1961 and subsequently claimed deduction U/S-10B of the Act and those claims were allowed by the Department. Only in respect of Unit-II the claim of the appellant U/S-10B of the Act was denied though the activities carried on at Unit-I and Unit-II are identical. iii. I am in agreement with the stand taken by the A.R of the appellant that the output generated by the appellant in the form of research out put and che .....

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broad economic development policy of the Government of India. Therefore, I am of the opinion that while examining the allowability of the deduction in the hands of the appellant one has to see whether the country is benefited by the investment made by the appellant in the said unit. On careful examination of the facts of the case I am of the considered opinion that the appellant is eligible for deduction U/S-10B of the Act. He thus allowed the claim u/s.10B of the Act. Since he allowed the clai .....

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assessee by itself billed its customers on man hours spent by its chemists. Assessee had bifurcated its revenue into two, one as contract fee for research receipts and receipts from sale of compounds. After having itself divided its receipt under two distinct heads, as per the Ld. DR, assessee could not turn around and say that the whole of the receipts were from sale of compounds. Even such bifurcation was perfunctory as per the Ld. DR, and only an attempt to camouflage research as manufacture .....

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mself had admitted the assessee to be engaged in manufacture. Relying on para 5 of the Remand Report dt.13.05.2009 placed at paper book at pages 555 to 568, Ld. AR submitted that there was a clear admission with regard to production and transport of chemical compounds by the assessee. Again at para 7 of the Remand Report, AO had mentioned that there was manufacture of compounds. Thus as per the Ld. AR there was a clear admission by the AO that assessee was engaged in manufacturing goods, article .....

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and provide compounds to the customers. Stressing his contention that assessee was into manufacture, Ld. AR referred to the project technical plan contained in one of the agreements placed at paper book pages 509 and 540. As per the Ld. AR the operations that were to be done on various raw materials, formed the building blocks for various drugs. Structures of the compounds which were proposed were set out therein and assessee was to do the necessary processes so that the proposed structures wer .....

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As per the Ld. AR, definition under Foreign Trade Policy gave a very wide ambit to the term manufacture . 15. At this juncture, the bench requested the Ld. AR to produce copies of the invoices raised by it, but he stated that the such invoices were not readily available. 16. Articulating his arguments further, Ld. AR submitted that there was no splitting up of the existing business. There was no break up of unit-I to form Unit-II. Unit-II was independently established with new machinery. There .....

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again placed on the very many decisions cited by the assessee before the Ld. CIT (A). 17. We have perused the orders and heard the rival submissions. The question before us is whether assessee was eligible for claim of deduction u/s.10B of the Act in the nature of business carried on by it. It is necessary to have a careful look at Section 10B of the Act, which read as under : SPECIAL PROVISIONS IN RESPECT OF NEWLY ESTABLISHED HUNDRED PER CENT.EXPORTORIENTED UNDERTAKINGS (1) Subject to the prov .....

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computing the total income of the undertaking for any assessment year, its profits and gains had not been included by application of the provisions of this section as it stood immediately before its substitution by the Finance Act, 2000, the undertaking shall be entitled to the deduction referred to in this sub-section only for the unexpired period of aforesaid ten consecutive assessment years : Provided also that for the assessment year beginning on the 1st day of April, 2003, the deduction und .....

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software ; (ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence : Provided that this condition shall not apply in respect of any undertaking which is formed as a result of the reestablishment, reconstruction or revival by the assessee of the business of any such undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section ; (iii) it is not formed by the transfer to a new business of machinery or .....

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undertaking begins to manufacture or produce articles or things or computer software. As per the assessee, it was manufacturing the molecules and the research that went into manufacturing of such molecules were an embedded part of the price which it received from the clients. 18. To see how far this claim is correct, we may have to look at the agreements entered by the assessee with its clients. One such agreement which has been placed before us at paper book page 127 entered with M/s. Dow Chemi .....

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n ; and, WHEREAS, SYNGENE is engaged in the business of providing synthetic chemical research and analysis, chemistry-consulting, chemical synthesis, manufacturing of specialty chemical products, analytical method development, and related services, and undertakes such as an independent company, understanding that neither SYNGENE nor its employees nor agents shall be considered an employee of DOW: nor a participant in any programs, insurance or other benefits extended to DOW 's employees and, .....

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t forth in appendices, commencing with Appendix 1. DOW will define the parameter of the Projects and define the time frame in which the services are to be provided as requested. B. Specific Duties of SYNGENE: In assuming responsibility for undertaking this Agreement, SYNGENE will: (a) Perform chemistry consulting, synthetic chemical research, hit/lead evolution and optimization chemistry, process development and process optimization studies, and manufacturing of specialty chemicals for any Proje .....

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um, and an MS spectrum on any compounds provided. (f) Provide to DOW from time to time, but no less frequently than once each month, a statement setting forth the services performed and the time expended during the period covered. SYNGENE shall also submit a final report of all services performed and time expended during the entire term of this Agreement (the Final Report ). SYNGENE shall maintain records for three years from performance of all time and work under this Agreement. (g) On request .....

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ds and information which SYNGENE obtains or develops under this Agreement. C. DOW's Obligations: DOW will: (a) Provide appropriate technical assistance such as is deemed appropriate in the conduct of a fully integrated research project team effort. (b) Provide written commentary on research reports. (c) Agree to pay SYNGENE for the services to be performed by SYNGENE as set forth in the schedule of payments in Section F. D. CONFIDENTIALITY: With respect to any and all information indicated a .....

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non-employees used by SYNGENE to perform the work or any part of it) to, use said information other than for the purposes of this Agreement, it will not, and will not permit any of its employees, consultants or representatives to, disclose any of said information to a third party except as is required pursuant to the purposes of this Agreement, and it will not and will not permit any of its employees, consultants or representatives to, publish or submit for publication said information without .....

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as a result of SYNGENE's services for DOW without the prior written consent of DOW which may be withheld in DOW's sole discretion. SYNGENE's obligation with regard to confidential information shall continue for a period of ten (10) years from the date such confidential Information is disclosed or available to SYNGENE and will survive, without limitation, the expiration or earlier termination of this Agreement. The foregoing obligation shall not apply to information which is or lawfu .....

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31, 2004, unless earlier terminated by DOW hereto. Extension of this Agreement shall be subject to future written agreement. (b) This Agreement may be terminated by DOW prior to the expiration of the term under the following conditions: (c) If SYNGENE materially breaches any of the covenants and agreements under this Agreement, upon thirty (30) days written notice to SYNGENE. (d) If DOW determines that SYNGENE is substantially unable to perform assigned duties hereunder whether due to sickness, .....

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W. Boone The Dow Chemical Company 2301 Brazosport Blvd, B-3827 Freeport, TX 77541 U.S.A. The above named persons are acting on behalf of their respective organizations and may be changed on and as needed basis. (b) Payments: Unless modified by the written agreement in consideration of the services to be performed by SYNGENE under this Agreement DOW will provide the following: (i) Fee. The FTE cost to DOW shall be per year. FTE means a fully allocated chemist employed by SYNGENE and working on t .....

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signment: DOW may assign this Agreement in whole or in part without SYNGENE's consent; provided that no such assignment will expand the scope of SYNGENE's services hereunder without the prior written consent of SYNGENE. This Agreement may not be assigned or otherwise transferred by SYNGENE without the prior written consent of DOW. Any permitted assignee shall assume all obligations of its assignor under this Agreement. H. Entire Agreement: (a) This Agreement represents the entire agreeme .....

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All materials, documents, information, programs, syntheses and suggestions of any kind and description supplied to SYNGENE. from DOW, or generated by SYNGENE as a result of the services performed hereunder, shall be the sole and exclusive property of DOW. Any ideas, inventions, discoveries, techniques, methods, processes, Trade Secrets or other know-how, whether patentable or not that may evolve from the materials, documents, information, programs, syntheses and suggestions above described, or .....

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s either solely or jointly with others in the course of or as a result of SYNGENE's services for DOW (the "Service Information") shall be and remain the exclusive royalty-free property of DOW, shall be considered trade secrets of DOW (subject to the confidential information requirement herein), and shall remain free of any claim of SYNGENE or any person deriving any rights or interest from SYNGENE and/or the work performed by SYNGENE under this Agreement. (b) At the request of DOW, .....

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deration for performance of the obligations under this Section I. (c) Upon DOW's request, SYNGENE shall transfer any technology and/or know-how used in the performance of services under this Agreement to DOW in such form as will best allow its use by DOW. (d) DOW may at its own discretion prepare, file and prosecute, in its own name and at its own expense, applications for any letters patent and/or copyrights on this property. Upon request of DOW and at its expense, SYNGENE shall assist DOW .....

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ment, SYNGENE shall maintain all written materials and all other data obtained or generated by SYNGENE in the course of providing the services performed under this Agreement in a secure area reasonably protected from fire, theft and destruction. At the expiration or termination of this Agreement, all written materials and all other data and information obtained or generated by SYNGENE in the course of providing the services will, at DOW's option, be (a) delivered to DOW or its designee in su .....

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ment without first giving DOW sixty (60) days prior written notice of SYNGENE's intent to do so. J. Conflicts of Interest: SYNGENE represents and warrants that it has the full power and right to enter into this Agreement. To avoid potential conflicts of interest, SYNGENE agrees to strictly honor its obligation of confidentiality under Section D, particularly as concerns SYNGENE's agreements with other parties relating to the same or similar work as that to be done by SYNGENE under the Ag .....

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e agreement does show that there was substantial research work intended by both the parties. But the question is what would evolve out of the research. Is assessee s client paying only for doing the research or for the end results? If the payments are indeed for the end results can such results be classified as manufacture or production of article or thing? There is no dispute that the billings done by the assessee on its clients were based on the manhours spent by its chemists on the job, at ag .....

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ii) No compound but only certain research documentation in the nature of experimental records and laboratory notebooks, showing the results of the research which in turn show what has been empirically achieved. In respect of the first two scenarios, doubtlessly there is a production or manufacture in the nature of compounds. The compounds may be useful or useless but it is an end result of the process of research undertaken by the assessee. Such compounds, irrespective of its ultimate utility, w .....

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. However the third scenario requires a deeper analysis. To decide whether the research documentation can be said to be the result of production and whether they can fall within the meaning of an article or thing calls for a good understanding of those terms as it has come out of the judicial wisdom of higher courts . The first and foremost of these is the judgment of the Hon Apex court itself in the case of CIT vs N C Budhiraja and Co (1993) 204 ITR 412. The question before their Lordship was w .....

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s is whether the compounds or research documentation were produced . 21. Though the term manufacture is defined in Section 2(29BA) of the Act, production is not. According to Oxford English Dictionary, production means amongst other things, that which is produced, a thing that results from any action process or effort, a product of human activity or effort. In the case of the assessee here, there are processes of research, efforts put in by assessees scientists, and products which are in the nat .....

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xtapostition with the term manufacture. This is elucidated by the judgment of Hon Calcutta High Court in the case of CIT vs Air Survey Co. of India Ltd 232 ITR707. The question before Hon Calcutta High Court was whether business of surveying, mapping and aerial photography which resulted in photographs was production of article or thing. Revenue had rejected assessee s claim for investment allowance on the ground that the activity of the assessee could not be called as manufacture or production .....

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essions "article" or "thing". This view was upheld by Hon Calcutta High Court. 23. Research conclusions can be considered as documentations of the analysis and steps done during the research process. Or in other words the end result is the analysis and presentation of data in a desired format. Hon Madras High court had an occasion to consider the issue as to whether data processing done with the help of computer resulting in end product which was analysis and presentation of .....

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can be said in broad terms that there is production. It was pointed out by the Supreme Court in the case of CIT vs. N.C. Budharaja & Co. & Anr. (1993) 114 CTR (SC) 420 : (1994) 204 ITR 412 (SC) : TC 25R.185 that the word "production" has a wider connotation than the word "manufacture". While every manufacture can be regarded as production, every production need not amount to manufacture. It was further observed by the Court that the word "production" or &quo .....

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never employed to denote construction activity of the nature involved in construction of a dam or a building. 5. The word "production" in s. 32A(ii) therefore, comprehends processing activity and the word "article" in that provision includes movables. The data processing computers involves processing and therefore, capable of being regarded as part of process of production. The balance sheet, sales analysis, statements, etc. obtained as a result of processing are movables an .....

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that purpose. The employee and employer relationship in running a data processing company inevitably exists as between those who operate the system and the company which runs the business. The term "industry" is not defined in s. 32A of the Act, and is therefore, required to be understood in the sense in which the word is ordinarily understood. The term "industry" is a term of wide amplitude. "Industry" as used in s. 32A refers to the industries which are engaged i .....

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puter is and what is does, for the purpose of deciding as to whether it is merely an office machine or some thing more. The Court held that in view of the varied functions which the computer "system" is capable of performing data processing machines, cannot be classified as "office appliances" and are eligible for development rebate under s. 33(1) of the IT Act. 8. In the case of CIT vs. Datacons (P) Ltd. (1985) 47 CTR (Kar) 162 : (1985) 155 ITR 66 (Kar) : TC 24R.231 the Karn .....

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nufacture of goods. 9. In the case of CIT vs. Peerless Consultancy Services (P) Ltd. (1990) 90 CTR (Cal) 73 : (1990) 186 ITR 609 (Cal) : TC 24R.235, the Calcutta High Court also held that a data processing company is an industrial company for the purpose of Finance Act, 1981. 24. Hon Delhi High Court also had had also considered the issue whether processed data can be termed as something manufactured or produced in the case of CIT vs HLS India Ltd (2011) 335 ITR 292. The question there was wheth .....

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and the material available for our perusal and the cited case law, we find force in the submissions of Mr. Vohra, learned counsel for the assessee. No doubt, the raw material i.e. the primary input in the impugned activity is the "information" but can we equate this "information" with something which is being copied from there in toto. Whether the characteristics regarding which the information is being sent back to computers on surface from logging tools working inside the d .....

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ntiality and other technical and commercial characteristics of the oil well. Can we say, when a latent physical property of the rocks, which was otherwise unreadable and thus unusable, has been changed by way of sophisticated scientific tests and calculations into scientific data which subsequently has been further changed into logs printed on the papers or recorded on the magnetic tapes, that the character and identity of end product and final product is not distinct. We are unable to uphold su .....

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lities of the business and sometimes over simplified tests create confusion, particularly, in modern times when technology grows each day. 25. The assessee here had done research using sophisticated machinery and the end product was either research documents in the nature of experimental records or compound. Just because these were intermediary things which would find use only in later stages of development of industrially useful chemicals and formulations would not disentitle the assessee from .....

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ounds and documentations. The payments effected by the clients, though based on manhour spent were for such results. Hon Madras High court had again in the case of CIT vs N Venkatraman (2000) 245ITR73 clearly held that the nature of the state of the what is produced, ie whether an intermediary or final product, could not be criteria for deciding whether an assessee was manufacturing or producing an article or thing. 26. Billing done by the assessee on man hour basis would at the best demonstrate .....

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