Delhi HC upheld employee head count method for allocating cost towards STP unit for the purpose of computing benefit under Section 10A of the Income-tax Act,1961

CIT v. EHPT India P. Ltd.  (Delhi High Court)- Section 10A provides for deduction for profits derived from the export of software for a period of ten years. During the period of tax-holiday, it is desirable that the same method of computing the profits of the STP unit is adopted so that any distortion is avoided. We must however clarify that we are not to be understood as laying down as a proposition that in all cases arising under Section 10A, where the question of apportionment of common/indirect expenses between the taxable and the exempt units arises, the head-count method is the most appropriate method.

The question will have to depend, in the very nature of things, on the nature of the business and the facts of the particular case. Our decision is confined to the facts of the present case. In the present case, there is no finding by the revenue authorities that by adopting the head-count method which was hitherto being accepted by them there was a distortion of the profits nor have they said that the head-count method of accounting is not the correct method of accounting. All that they have said is that in their opinion the turnover basis of apportionment of the expenses is more logical and needs to be applied. In the present case, the Assessing Officer has accepted the head-count method adopted by the assessee in the past but has rejected it only for the years under appeal. This would disturb or distort the profits. The question whether the head-count method is the most appropriate method has been raised by the Assessing Officer in the course of the assessment proceedings and it has been stated by the assessee that though the turnover basis preferred by the Assessing Officer may be more suited to manufacturing businesses, in the case of service industry such as the assessee’s case the head-count method would be more appropriate to be followed for the purpose of apportioning the indirect expenses. It appears to be a plausible view, though it can possibly also be a debatable view. But merely because there can be more than one method of apportioning the common expenses between the STP and domestic units it cannot be said that the method of head-count followed by the assessee should be discarded, that too mid-way, even though it was not questioned at any time in the past.

The provisions of sub-section (4) of section 10A, relied upon by the Assessing Officer, apply for the purpose of segregating the profits of the business into export profits and domestic profits. It is a statutory formula for ascertaining what are profits derived from the export of the eligible items. It has to be read with sub-section (1). It says that the export profits have to be apportioned on the basis of the ratio which the export turnover bears to the total turnover of all the businesses of the eligible undertaking. We are not in the present case concerned with sub-section (4). That sub-section will apply when the combined profits  of the exempt unit and those of the nonexempt unit ± have been ascertained; the next step will be to apportion them on the basis of the ratio which the export turnover bears to the total turnover. What we are concerned herein is the stage before that. We are concerned herein with the method by which the indirect or common expenses  which are incurred for both the exempt and taxable units are to be apportioned between the two units. To apply the formula prescribed in sub-section (4) may be appropriate in a given case considering its peculiar facts. But applying the same formula to all cases of apportionment without having regard to the history of assessments and other relevant factors may not be justified.

In a case where alternative methods of apportionment of the expenses are recognised and there is no statutory or fixed formula, the endeavour can only be towards approximation without any great precision or exactness. If such is the endeavour, it can hardly be said that there is an attempt to distort the profits. On the contrary, as we have already pointed out, distortion of profits may arise if the consistently adopted and accepted method of apportionment is sought to be disturbed in a few years, especially in a case such as the present one where the deduction under Section 10A is available over a period of ten years and only in some years the method of apportionment of income is disturbed. In other words, there is no “just cause” made out for abandoning the past method.

HIGH COURT OF NEW DELHI

Date of Decision : 14^th December, 2011.

ITA 1172/2008, ITA 1194/2008

Commissioner of Income Tax

Versus

EHPT India P. Ltd.

R.V. EAS WAR, J.:

These are two appeals filed by the revenue under Section 260 A of the Income-tax Act (“Act”, for short) against the common order passed by the Income Tax Appellate Tribunal (“Tribunal”, for short) on 31-1-2008 in ITA Nos. 2395/DEL/2005 & 93/DEL/2006 for the assessment years 2001-02 and 2002-03 respectively. On 23-7-2010 the appeals were admitted and the following substantial questions of law were framed:

“(a) Whether Income Tax Appellate Tribunal was correct in law in accepti7LX^JEl d-FIfl7t” XmE1 PHXo1 X distribution of expenses adopted by the assessee for allocation of indirect expenses between STP unit and non-STP unit?

b) Whether Income Tax Appellate Tribunal was correct in law in applying Rule of consistency when the method of allocation adopted by the assessee was not the correct method of accounting?

c) Whether Income Tax Appellate Tribunal was correct in law in discarding the method of distribution adopted by Assessing Officer which was in accordance with the provisions contained in Section 10 A (iv) of the Act itself?

d) Whether order passed by Income Tax Appellate Tribunal is perverse in law and on facts?”

2. The respondent-assessee is a private limited company resident in India. During the relevant previous years, it operated two units: a Software Technological Park unit (“STP unit”, for short) which was engaged in the development of software which was primarily exported to the parent company in Sweden and another domestic unit (non-STP unit) which was primarily engaged in the implementation of the telecom software for vendors/customers in India. In respect of the profits from the STP unit the assessee was undisputedly entitled to the deduction provided in Section 10 A of the Act. In the returns filed for the years under appeal the assessee computed the profits from the STP unit by apportioning the indirect or common expenses on the basis of the head-count of the employees working in the said unit and the domestic unit and claimed the deduction u/s. 10 A in respect of the former unit accordingly. For instance, we may take up the computation of the profits from the STP unit for the assessment year 2001-02 which according to the assessee was as under: