Whether when assessee provides software services, expenses incurred on development of software are revenue ?

IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI BENCHES “H”, MUMBAI

Before Shri R.S.Syal, AM and Shri V.Durga Rao, JM

ITA No. 6533/Mum/2007 : Asst. Year 2004- 2005

ITA No. 3584/Mum/2008 : Asst. Year 2005- 2006

ITA No. 5058/Mum/2008 : Asst. Year 2006- 2007

The Asstt.Commissioner of Income-tax Circle 6(1) Mumbai.	Vs.	M/s.Aftek Infosys Limited 265 V.S.Road, Shivaji Park Dadar (West), Mumbai – 400 028. PA No.AAACA4711B.
		(Respondent)
(Appellant)

 

Appellant by : Shri Goli Srinivas Rao
Respondent by : Shri Reepal Tralshawala

O R D E R

Per R.S.Syal, AM :

These three appeals by the Revenue relate to the assessment years 2004- 2005, 2005-2006 and 2006-2007. Since some of the issues raised in these appeals are common, we are, therefore, proceeding to dispose them off by this consolidated order for the sake of convenience.

Assessment Year- 2004- 2005

2. First ground is against the direction of the learned CIT(A) not to exclude expenses amounting to Rs.41,50,84,960 towards installation, testing etc. of computer software exported from export turnover. Briefly stated the facts of this ground are that the assessee was engaged in the business of export of computer software. The Assessing Officer noted that a sum of Rs. 41.50 crores was debited under the head “Foreign Expenses (Installation, Services Testing etc.)”. Considering the definition of “export turnover” given under Explanation 2 to section 10B(7), the Assessing Officer opined that this amount could not be included in the export turnover while computing u/s.10B. On being called upon to explain the reasons in this regard the assessee stated that these expenses were incurred on installation and services etc. for the software exported by the assessee. Not convinced with the assessee’s submission the Assessing Officer excluded this amount from the export turnover. The assessee furnished copies of certain purchase contracts entered into by the assessee with the foreign parties, which were not called for by the Assessing Officer during the course of assessment proceedings, in support of its claim. The learned CIT(A) called for the comments of the Assessing Officer. After considering the remand report and the reply of the assessee, he, held that no technical services were provided by the assessee outside India in foreign currency and the obligation of the assessee continued till the stage when the customer was able to effectively use the software supplied. It was, therefore, held the expenses incurred in foreign currency were part of the software development cost. As such it was directed that this amount be not excluded from the export turnover against which the Revenue has come up in appeal before us.

3. After hearing the rival submissions and perusing the relevant material on record it is noted that when the assessee exported software, it was under obligation to ensure that the software so supplied was effectively used. In order to ensure the proper use, the customer had to get it properly installed and get it tested. The learned A.R. has explained that if the export invoice is raised for Rs. 100 for supply of software, and the customer has incurred testing and installation expenses of Rs. 10, which have been reimbursed by the assessee this cost of Rs. 10 should be considered as installation etc. and should not be excluded from the export turnover. In our considered opinion when the cost towards installation and testing etc. of Rs. 10 is borne by the assessee, the net effective export turnover is sliced to Rs. 90 instead of Rs. 100. In such a situation the proper course is to have the figure of export turnover at Rs. 90 and not Rs. 100. Coming to the formula u/s. 10B, by which benefit is calculated by multiplying profit of the business of the undertaking with the export turnover and divided by the total turnover of the business carried on by the undertaking, it is seen that there is difference in export turnover and total turnover. The amount of export turnover in numerator actually constitutes part of the total turnover in denominator if there is some other local turnover also. If a particular amount is reduced from the amount of export turnover, such amount also needs to be excluded from the figure of total turnover which comprises of the amount of export turnover. The Hon’ble jurisdictional High Court in the case of CIT Vs. Gem Plast Jewellery India Ltd. [(2011) 330 ITR 175 (Bom.)] has held so in computing the relief u/s. 10A by laying down that once the amount of freight and insurance is excluded from the figure of export turnover, it has naturally to be excluded from the figure of total turnover. In that view of the matter it becomes clear that the figure of export turnover in our above example at Rs.90 shall form part of the total turnover and it shall not be taken at Rs. 100 for the purposes of inclusion in the total turnover. The finding given by the learned CIT(A) is accordingly modified by which he had held that expenses for installation etc. are not to be excluded from the export turnover. In our opinion the proper course is to exclude such amount both from the export turnover as well as export turnover. We, therefore, set aside the impugned order on this issue and direct the Assessing Officer to re-compute the deduction in accordance with our above observations.

4. Ground no.2 is against holding software development expenses amounting to Rs. 16,60,65,953 as revenue expenses. The facts of this ground are that the assessee debited the same under the head software development charges and claimed deduction for the same. On being called upon to justify this deduction, the assessee stated that its software development activities involved series of trials and errors and the software tools and materials used did not have even a scrap value. The materials used for developing a product were always as per clients’ requirements and specifications and could not be used for manufacturing any other product or services. It was, therefore, claimed that such expenses were to be considered as revenue expenditure as was done in earlier years. Not convinced with the assessee’ s submission the Assessing Officer treated this amount as capital and by allowing depreciation at the rate of 60%, made dis-allowance of Rs. 6.64 crores. The learned CIT(A) overturned the assessment order on this point and ordered for the deletion of addition.

5. After considering the rival submissions and perusing the relevant material on record it is noted that the assessee’ s business is that of computer software services and products development. In order to supply software to its customers as per their requirements, the assessee has necessarily to incur certain expenses which go in making the product customised. When the sale proceeds are considered as revenue receipt, there is no reason for taking such expenses as not revenue because of the fact that there is no enduring benefit to the assessee by incurring such expenses. As and when this amount is spent in developing software for a particular customer, the tools and materials become useless. In other words this expenditure is input cost for the development of software which is in the nature of stock in trade of the assessee. In our considered opinion the learned CIT(A) was right in holding that software development expenses of Rs. 16.60 crores were allowable as revenue expenses.

6. Last ground of this appeal is against the direction of the learned CIT(A) to reduce unrealised export proceeds of Rs. 8,1 1,8 8,085 for the purpose of calculating total turnover. The assessee had total turnover of the undertaking at Rs. 123.57 crores. The Assessing Officer while calculating relief u/s 10B adopted the figure of total turnover at Rs.1 15.45 crores, which resulted by reducing a sum of Rs. 8.1 1 crores towards export realisation beyond the period of six months from the end of the previous year, from the above referred figure of total turnover of the undertaking. The learned CIT(A) observed that the amount of foreign exchange not brought into India within stipulated time was to be excluded from the computation of relief u/s. 10B. In his opinion the said amount of Rs. 8.11 crores was to be reduced both from the total turnover and export turnover and as such it would be neutral to the benefit of deduction u/s.10B.

7. We have heard both sides and perused the relevant material on record. The view point of the learned CIT(A) that the amount of export turnover not brought into India within the stipulated period of six months should be excluded both from export turnover and total turnover, is incorrect. It is for the reason that “export turnover” has been defined in clause (iii) of Explanation 2 below section 10B(9) as per which the “export turnover” means the consideration in respect of export of article or things received in or brought into India by the assessee in convertible foreign exchange in accordance with sub-section (3). When we go to sub-section (3) of section 10B, it becomes apparent that this section applies to an undertaking if the sale proceeds of articles or things or computer software exported out of India are received in or brought into India by the assessee in convertible foreign exchange within the period of six months from the end of the previous year or within such further period as the competent authority may allow in this behalf. On a conjoint reading of the definition of `export turnover’ and sub-section (3) of section 10B, it becomes abundantly clear that in order to constitute part of export turnover it is sine qua non that the sale proceeds must be received in or brought into India in convertible foreign exchange within the time prescribed period of six months from the end of the previous year or such further period as the competent authority may allow in this behalf. It, therefore, becomes clear that if the amount is not brought into India in convertible foreign exchange as per sub-section (3) of section 10B, then it will stand reduced from the figure of export turnover, but will find its place in the figure of total turnover for the purpose of calculating relief u/s. 10B. This finding given by the learned CIT(A) is, therefore, set aside.

8. Now coming to the facts of the case, it is fairly admitted by the learned A.R. that the amount in question was brought into India beyond a period of six months from the end of the previous year. He relied on the order passed by the Mumbai Bench of the Tribunal in M/s.Shangold India Ltd. Vs. ITO – ITA No.6041/Mum/2002 dated 6^th May, 2009 in which the Tribunal noted that for the assessment year 2004-2005 the Reserve Bank of India, being the competent authority as per sub-section (3), has extended the period. Though this order was passed in the context of section 10A, the learned A.R. contended that the same would be applicable for calculating relief u/s. 10B also. On a specific query, the learned A.R. could not place on record the full text of Circular of Reserve Bank of India on which he has placed reliance. The ld. AR candidly accepted that the matter be restored to the file of Assessing Officer with the direction to decide this aspect in the light of the RBI Circular as well as the mandate of sub-section (3) of section 10B in the light of the definition of export turnover in Explanation 2(iii) of section 10B. No serious objection was taken by the learned Departmental Representative. Under such circumstances, we, set aside the impugned order on this issue and direct the Assessing Officer to re-compute the relief u/s.10B by initially not including the sum of Rs.8.1 1 crores in the export turnover, which was realised beyond the period of six months from the close of the previous year. If however as per RBI Circular there is some scope for the extension of the above said period of six months and the assessee has realised the sale proceeds in foreign exchange within such extended period, then the resultant amount should be included in the amount of `export turnover’ . However the figure of total turnover, in any case, shall continue to include the amount of Rs.81 1 crores as discussed above.

9. In the result, the appeal is partly allowed for statistical purposes.

10. Ground no.1 of this year is admittedly similar to ground no.1 of assessment year 2004- 2005. We, therefore, hold that the sum of Rs. 60.87 crores and odd, being expenses towards installation etc. of computer software be excluded from the export turnover and simultaneously from the total turnover and the benefit u/s 10B be computed accordingly.

11. Ground no.2 is against the capitalisation of software development expenses. Here again both the sides are in agreement that the facts and circumstances of this year are mutatis mutandis similar to those of assessment year 2004-2005. Following the view taken herein above, we uphold the impugned order and direct that a sum of Rs. 17.21 crores be taken as revenue expenditure.

12. The only other ground is against the direction of the learned CIT(A) for adopting total turnover of the business carried on by the undertaking at Rs.169.08 crores in place of Rs. 174.33 crores thus excluding other sales of Rs.3.88 crores. The facts apropos this ground are that while computing the deduction u/s.10B, the Assessing Officer adopted the figure of profits of the business of the undertaking at Rs .71.03 crores. It was multiplied with Rs. 107.17 crores and divided by the figure of total turnover at Rs. 174.33 crores. The difference between the amount of export turnover and total turnover was that of expenses which were of Rs.60.87 crores, being the subject matter of ground no.1 towards installation and testing etc. of computer software. The assessee argued before the learned CIT(A) that the figure of export turnover should have been taken at gross of expenses and further the amount of total turnover should have been taken that of section 10B unit and not local turnover. The learned CIT(A) concurred with the submissions advanced on behalf of the assessee and directed accordingly.

13. After considering the rival submissions and perusing the relevant material on record we find that sub-section (4) of section 10B provides that for the purpose of sub-section (1), the profits derived from export of articles or things or computer software shall be the amount which bears to the `profits of the business of the undertaking’, the same proportion as the export turnover in respect of such articles or things or computer software bears to the “total turnover of the business carried on by the undertaking”. Thus it can be seen that the profits of the business as well as total turnover of the business have to be considered that of the undertaking alone and not the entire business of the assessee. The Assessing Officer has rightly taken the profits of the business of the undertaking at Rs. 71.03 crores but the amount of total turnover adopted by him at Rs. 174.33 crores includes that of local turnover of Rs.3.88 crores which is not part of section 10B undertaking, as is apparent from the chart drawn by the A.O. on page 2 of the assessment order. As we have held, while deciding ground no.1, that the amount of Rs.60.87 crores is to be reduced both from the export turnover as well as total turnover, it therefore, becomes clear that the amount of deduction u/s. 10B shall be calculated by multiplying the profit of the business of the undertaking at Rs.71.03 crores multiplied with the export turnover and as reduced by the total turnover discussed accordingly. In other words, the local turnover, which does not relate to the eligible undertaking u/s 10B, should be excluded. The Assessing Officer is directed to compute relief u/s. 10B in accordance with our above observations.

14. In the result, appeal is partly allowed for statistical purposes.

15. Both the sides are in agreement that all the grounds of this year are mutatis mutandis similar to assessment year 2005-2006. We, therefore, follow the view taken herein above for assessment year 2005-2006 and hold that the expenses amounting to Rs. 89.77 crores towards installation etc. of computer software should be reduced both from export turnover as well as total turnover, which is subject matter of ground no.1. Software development expenses of Rs. 38.45 crores are held to be revenue expenses, being the subject matter of ground no.2 and relief u/s. 10B is directed to be computed by taking profits of the business of the undertaking vis-à-vis export turnover and total turnover of the business carried on by the undertaking as per sub-section (4) of section 10B in accordance with our above directions given in assessment year 2005- 2006.