Section 80IC deduction allowed for service charges based on direct nexus between service rendered & product

Xalted Information Systems Pvt. Ltd. Vs ITO (ITAT Banglore)

Section 80IC deduction allowed for service charges based on direct nexus between service rendered & product

The issue under consideration is that whether deduction u/s 80-IC will be allowed against service charges since services rendered were part of business and also involved manufacturing activity?

The assessee is a company engaged in telecommunication software development and trading in telecommunication hardware required mainly to run their software that are being supplied to the prospective consumers. Assessee has claimed deduction u/s 80-IC in its return. The income received from service charges is also included in the Total Eligible Turnover for calculation of deduction u/s 80-IC which is disallowed by A.O.

The assessee in this regard pointed out the nature of service fees is such that the assessee needs to render the services even after the sale of product, to meet the complete scope of work which includes services like Integration testing, Validation/System testing and Acceptance testing, changes requirements, etc. Hence it becomes part and parcel of the software being developed and supplied by the assessee. Hence, the same should be considered while calculation deduction u/s 80-IC of the Act. In other words it was submitted that service fee received like installation, training, support services etc form integral part of the products supplied by the assessee, therefore have nexus between the products supplied and services provided by the assessee in connection with the said products.

In our opinion, this will not be conclusive to hold that there were two segments or verticals and is contrary to the Agreements under which the Assessee had to perform certain obligations in the form of supply of software, hardware, installation and maintenance thereof. As we have already seen, the agreement it is very clear that the supply of software and hardware necessary to support the software supply, installation & commissioning as well as rendering support services were to be done on a turnkey basis. Though the services agreement is separately entered into by the assessee, it has a direct nexus and connection with the agreement for supply of software. In these circumstances, the decisions cited by the Id. counsel for assessee, clearly supports the case of the assessee. ITAT therefore is of the view that the claim made by the assessee for deduction u/s. 80IC of the Act ought to have been allowed by the AO/CIT(A). ITAT therefore hold that the assessee is entitled to claim deduction u/s. 80IC of the Act on service charges. Hence this ground is allowed accordingly.

FULL TEXT OF THE ITAT JUDGEMENT

This appeal by the assessee is against the order dated 22.02.2019 of the CIT(Appeals)-7, Bengaluru relating to AY 2014-15.

2. Grounds 2 to 6 raised by the assessee in the appeal read as follows:-

2. The learned Commissioner of Income-tax (A) ought to have considered the explanation offered by the appellant with respect to the deduction computed under section 80-IC of the Act.

3. The learned Commissioner (A) failed to appreciate the fact that the appellant had claimed deduction under section 80-IC of the Act only out of profits and gains derived by the business of the undertaking that was set up in the State of Himachal Pradesh wherein a detailed working of such deductions claimed were submitted by the appellant.

4. The learned Commissioner (A) erred in upholding the order of the Assessing Officer by wrongly concluding that the income from service are not eligible for deduction under section 80-IC of the Act. Further the learned Commissioner (A) failed to consider the fact that the scheme of deduction under sec 80-IC provides that the benefit of deduction is available to the profits and gains derived by the undertaking from the business carried and to the extent of percentage provided under sub-section (3) to Sec.80-IC of the Act. The deduction shall be 100% of such profits and gains derived from such undertaking.

5. The learned CIT(A) failed to appreciate the profits and gains derived from business included the service charges since the services rendered were part of business and also involved manufacturing activity.

6. The learned Commissioner (A) grossly erred in upholding the observations made by the AO and as such erred in interpreting the provisions by restricting the deductions only to the profits and gains from manufacturing activities and not considering the profits and gains derived from the business of the undertaking.

3. The grievance of the assessee by the aforesaid grounds is against the action of the revenue authorities in denying the benefit of deduction u/s. 80IC of the Income-tax Act, 1961 [the Act]. The assessee is a company engaged in telecommunication software development and trading in telecommunication hardware required mainly to run their software that are being supplied to the prospective consumers. For the AY 2014-15, the assessee filed return of income claiming deduction u/s. 80IC of the Act of a sum of Rs.4,93,84,285. The computation of deduction u/s. 80IC as filed by the assessee is as follows:-

XALTED INFORMATION SYSTEMS PVT. LTD.

PROFIT & LOSS STATEMENT FOR THE YEAR ENDED ON 31ST MARCH 2014

4. The AO did not allow the claim of assessee as he computed the gross total income at a negative figure and denied the benefit of deduction u/s. 80IC observing as follows:-

Deduction U/s 80-IC

1. The assessee has claimed deduction u/s 80IC at Rs. 4,93,84,285/- in the return of Income and as per Form No. 10CCB of the Chartered Accountant. It is seen that the assessee has considered other income amounting to Rs. 6,38,13,310/- in total eligible turnover. The same should have been considered as income from other sources, since it is not related to manufacturing activities. The assessee has not given any reasons for not excluding the same from the Total turnover. Further, it is seen that, income received from service charges is also included in the Total Eligible Turnover. Therefore, considering these discrepancies in claim of deduction u/s 80IC, the total eligible deduction under section of 80IC of the IT Act is reworked as under:

i) Profit as per P&L Account: Rs. 7,34,14,261

ii) Less

Income which not eligible for deduction u/s 80IC

A. Other income

a. Interest on FD’s 14,07,962

b. income 6,19,55.068

c. Foreign Exchange profit: 1,95,296

d. Profit on sale fixed assets: 2,54,984

Rs. 6,38,13,310

B. Net income from services

Gross receipts from services : 3,89,36,355

Less:- Direct cost related

to purchase of services          14,13,654

Rs.3,75,22,701

Rs.10,13,36,011

Rs. 2,79,21,750

5. Aggrieved by the aforesaid order of the AO, the assessee preferred appeal before the CIT(Appeals). The first aspect which the assessee pointed out was that it had not claimed deduction u/s. 80IC of the Act on a sum of Rs.6,38,13,310, which is ‘other income’ as given by the AO in the computation referred to in the earlier para. The second aspect that was pointed out by the assessee was that the net income from services of Rs.3,75,22,701 was also entitled to the benefit of deduction u/s. 80IA of the Act. The assessee in this regard pointed out the nature of service fees is such that the assessee needs to render the services even after the sale of product, to meet the complete scope of work which includes services like Integration testing, Validation/System testing and Acceptance testing, changes requirements, etc. Hence it becomes part and parcel of the software being developed and supplied by the assessee. Hence, the same should be considered while calculation deduction u/s 80-IC of the Act. In other words it was submitted that service fee received like installation, training, support services etc form integral part of the products supplied by the assessee, therefore have nexus between the products supplied and services provided by the assessee in connection with the said products. The Assessee gave details of the Breakup of services provided by the undertaking along with the Ledger extracts & copy of the contract with the parties. The Assessee placed reliance on certain judicial pronouncements for the proposition that where the services rendered are incidental or had nexus with the manufacture of article or thing for which deduction u/s.80IC of the Act is claimed, the income from rendering services should also be regarded as eligible for deduction u/s.80IC of the Act. We shall refer to these decisions in the subsequent paragraphs of this order.

6. The CIT(Appeals), however, held that income derived from rendering services was not eligible for deduction u/s. 80IC of the Act because they are not profits derived from manufacture or production of any article or thing. In this regard the CIT(A) made reference to the nature of services performed by the Assessee as appearing in their virtual domain and first concluded that the Assessee was a Service Provider of a wide range of services which include Proactive Intelligence Analysis Solution, IT Consulting Services, Management Services, Delivery Services, Oss & Bss Solution and Proactive Intelligence Analysis Services. Thereafter he referred to the financial statements of the Assessee and found that the description of income in the profit and loss account contained two types of income viz.,

From the above, he concluded that the Assessee had two streams of revenue viz., software development and sale of software license and products. Therefore revenue from service fees cannot be considered as integral to manufacturing and sale of products and hence the same cannot be included in the revenue for the purpose of deduction u/s 80IC.

7. The Assessee had filed copies of invoices and agreement with ZTE Telecom India Pvt Ltd. He referred to invoices dated 01-07-2013, 18-06­-2013, 31-10-2012, 09-10-2012 and held that the said invoices were raised for services for software and hardware. According to him Service Tax was also charged in all those invoices indicating that the invoice is only for providing service and no sale of product is involved. He also referred to agreement with ZTE Telecom India Pvt Ltd dated 19-09-2012 and was of the view that the nomenclature of the Agreement was itself ‘Service Agreement’ and not agreement for supply of product. The appellant company is the sub-contractor to the main contractor ZIE Telecom India Nigam Ltd who has taken the contract from BSNL. He referred to the scope of work as contained in the said agreement and concluded that the scope of the agreement was entirely for supply of service by the assessee as subcontractor of ZTE to the customer BSNL. The CIT(A) therefore held that the service segment of the Assessee was distinct and separate different from its product segment and that the revenue from service fees/charges is not dependent or connected on the revenue from sales of products. Therefore, the revenue from service fees /charges cannot be considered as revenue from sale of products and accordingly cannot be included in the income for the purpose of claiming deduction u/s. 80-IC of the Act. Consequently, the decision of the AO to exclude the service charges for the purpose of allowing deduction u/s. 80IC of the Act was upheld by the CIT(A).

8. Aggrieved by the order of CIT(Appeals), the assessee is in appeal before the Tribunal. The Id. counsel for assessee submitted that BSNL vide their tender dated 14.7.2011 invited tenders for providing various types of telecom services/equipments for their Fraud Management Control Centre (FMCC) and Revenue Assurance systems (RA). ZTE Telecom (India) P. ltd. and their associates ZTE Corporation were the successful bidders of the aforesaid tender. They in turn sub-contracted FMCC and RA to the assessee under agreements dated 7.8.2012. These agreements provide for supply of software and the hardware necessary to support the use of the hardware for the purpose for which the software is supplied. The tender was a turnkey solution and both software for FMCC and RA along with hardware and services required to make the software being supplied ready to use had to be given/performed by the assessee. Our attention was drawn to the fact that the assessee was bound to install and commission the required software and hardware, besides providing services. Our attention was drawn to the Services Agreement dated 19.9.2012 at page 294 of the assessee’s PB, which is captioned ‘Services Agreement’. This agreement very clearly specifies that the same is related to the earlier agreement dated 7.8.2012 for supply of software and hardware. The preamble of the agreement reads as follows:-

“WHEREAS:

XALTED is inter alia engaged in the business of providing end to end Telecom and Home and Security solution worldwide.

ZTE has offered Customer. FMCC and RA Solution and therefore ZTE would like to subcontract FMCC and RA Services by procuring the Services from Subcontractor.

The Subcontractor acknowledges that its performance under this Agreement is intended to support the Contractor and satisfy the obligations and liabilities of the Contractor towards the Customer with reference to the Tender, No.CA/CM/GSM-Ph VIUT-404A/2011-12 dated 14¹¹‘ Jul^y 2011 and the clarifications/amendments thereto issued by BSNL

The Contractor desires to engage the Subcontractor and the Subcontractor has agreed to execute the Works (defined below) subject to and in accordance with the provisions of this agreement.”

9. According to him, the above aspects clearly show that the performing of services was also linked and had nexus with the supply of software and the hardware required to run the software and therefore the entire receipts both for supply of software, hardware and services rendered, all being interlinked should be regarded as profits derived by industrial undertaking from manufacture of goods. The Id. counsel for assessee in this regard drew our attention to the various decisions which were cited by him before the CIT(A). Our attention was also drawn to the service fees ledger, the description in which demonstrates that all the services fees received were in connection with BSNL project.

10. The Id. DR placed reliance on the observations of the CIT(Appeals) in the impugned order that the service fees received was distinct and not linked to the supply of software.

11. We have given a careful consideration to the rival submissions. The relevant part of the provisions of Sec.80IC of the Act under which the Assessee claimed deduction reads thus:

Special provisions in respect of certain undertakings or enterprises in certain special category States.

80-IC. (1) Where the gross total income of an assessee includes any profits and gains derived by an undertaking or an enterprise from any business referred to in sub-section (2), there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such profits and gains, as specified in sub-section (3).

(2) This section applies to any undertaking or enterprise,

(a) which has begun or begins to manufacture or produce any article or thing, not being an^y article or thing specified in the Thirteenth Schedule, or which manufactures or produces any article or thing, not being any article or thing specified in the Thirteenth Schedule and undertakes substantial expansion during the period beginning

…………………

(3) The deduction referred to in sub-section (1) shall be‑

(i) in the case of any undertaking or enterprise referred to in sub-clauses (i) and (iii) of clause (a) or sub-clauses (i) and (iii) of clause (b), of sub-section (2), one hundred per cent of such profits and gains for ten assessment years commencing with the initial assessment year;

(ii) in the case of any undertaking or enterprise referred to in sub-clause (ii) of clause (a) or sub-clause (ii) of clause (b), of sub-section (2), one hundred per cent of such profits and gains for five  assessment years commencing with the initial assessment year  and thereafter, twenty-five per cent (or thirty per cent where the  assessee is a com^pan^y) of the profits and gains.

12. Under Section 80IC of the Act, a deduction is allowed on the profits and gains derived from an industrial undertaking from business referred to Sec.80IC(2) of the Act, viz., from manufacture of article or thing other than the article or thing mentioned in Schedule-13 of the Act. It is not in dispute that the Assessee was engaged in the manufacture of an article or thing viz., computer software and was eligible to claim deduction u/s.80IC of the Act on the profits derived therefrom. The dispute is as to whether the service income received by the Assessee can also be regarded as profits derived from manufacture of article or thing.

13. BSNL vide their tender dated 14.7.2011 invited tenders for providing various types of telecom services/equipments for their Fraud Management Control Centre (FMCC) and Revenue Assurance systems (RA). ZTE Telecom (India) P. ltd. and their associates ZTE Corporation were the successful bidders of the aforesaid tender. They in turn sub-contracted FMCC and RA to the assessee under agreements dated 7.8.2012. These agreements provide for supply of software and the hardware necessary to support the use of the hardware for the purpose for which the software is The tender was a turnkey solution and both software for FMCC and RA along with hardware and services required to make the software being supplied ready to use had to be given/performed by the assessee. As per the agreement, the assessee was bound to install and commission the required software and hardware, besides providing services. The Services Agreement dated 19.9.2012 clearly specifies that the same is related to the earlier agreement dated 7.8.2012 for supply of software and hardware. We have already extracted the preamble portion of the Agreement and it is clear from the reading of the Agreement that performing of services was also linked and had nexus with the supply of software and the hardware required to run the software and therefore the entire receipts both for supply of software, hardware and services rendered, all being interlinked should be regarded as profits derived by industrial undertaking from manufacture of goods.

14. The break-up of service fee received by the Assessee which is the subject matter of dispute in this appeal is as follows:-

15. It is clear from the break-up of service fee received that they were all related to the FMCC & RA project of BSNL which the Assessee had to perform as sub-contractor. In the case of CIT v. Meghalaya Steels Ltd. & Pride Coke Pvt. Ltd. (2013) 356 ITR 235 (Gau) it was held that assessee was entitled to deduction u/s 80-IB or 80-IC on transport subsidy, interest subsidy, power subsidy and insurance subsidy as it was held that there is a nexus between the subsidies, on one hand, and the profits and gains derived by, or derived from, the industrial undertakings concerned. The Hon’ble Gauhati High Court in the case of Torsa Machines Ltd. v. CIT (2017) 154 TR (A) 79 (Gau-HC), was concerned with a case wherein the assessee was engaged in business of manufacturing of stone crushing plant and accessories. It claimed deduction under section 80-IC. AO disallowed deduction of claim towards service and erection charges. AO opined that earnings from service and erection charges were not derived from manufacturing business and not eligible for deduction. CIT(A) as well as Tribunal affirmed disallowance. It was held that when the assessee, installed/erected the self-manufactured stone crushing plants and serviced them at the customers site, the amount received from such service was nothing but earnings from the business of manufacturing activity. The Hon’ble Himachal Pradesh High Court in the case of [Spray Engineering Devices Ltd. v. Asstt. CIT & Anr.] IT Appeal No. 39 of 2006 judgment dated 7.11.2009 took the view that when a manufacturer is required by the customer to erect and commission the machinery, the amount received by the manufacturer on this count, is the income derived from the business itself and therefore, the same is eligible for deduction under section 80-IB of the Income Tax Act. The Hon’ble Bombay High Court in the case of CIT v. International Data Management Ltd. (2003) 261 ITR 177 (Born) had to deal with a case regarding entitlement of deduction under section 80-IC for income, received on account of service and maintenance charge. In the context, the Bombay High Court held that the income received by the assessee which rendered service and maintenance facilities for the clients, has a direct nexus with the main business activity of the assessee.

16. We also find that the AO is not right in observing that in the claim for deduction u/s. 80IC of the Act, the assessee has included other income of Rs.6,38,13,310. This is a wrong observation in the order of assessment and we have already extracted the computation of deduction u/s. 80IC of the Act in the earlier part of this order. The CIT(Appeals), in our view, has drawn inference by looking into the profile of assessee as contained in the virtual domain (web site), which in our view, may not always be a correct indicator. The facts on record brought out before the AO should be the basis on which the claim of assessee should be examined. There is no basis for the AO to conclude that there were two streams of revenue to the assessee viz, software products and licence & software services. In this regard, it is relevant to notice that in the P&L account of the assessee for the year ending 31.3.2014, the revenue from operations is shown at Rs.23,09,20,703 and Note 16 gives the following break-up:-

16. Revenue from Operations

17. In our opinion, this will not be conclusive to hold that there were two segments or verticals and is contrary to the Agreements under which the Assessee had to perform certain obligations to BSNL in the form of supply of software, hardware, installation and maintenance thereof. As we have already seen, the agreement with ZTE is very clear that the supply of software and hardware necessary to support the software supply, installation & commissioning as well as rendering support services were to be done on a turnkey basis. Though the services agreement is separately entered into by the assessee, it has a direct nexus and connection with the agreement for supply of software. In these circumstances, the decisions cited by the Id. counsel for assessee, clearly supports the case of the assessee. We are therefore of the view that the claim made by the assessee for deduction u/s. 80IC of the Act ought to have been allowed by the AO/CIT(A) and they fell into an error in not allowing the said claim. We therefore hold that the assessee is entitled to claim deduction u/s. 80IC of the Act on service charges of Rs.3,75,22,701. Ground Nos. 2 to 6 are accordingly allowed.

18. Ground Nos.7 to 10 reads as follows:-

“7. The learned Commissioner (A) erred in disallowing the bad debts written off by the appellant, concluding that the appellant had claimed deduction under section 80-IC on such debts without appreciating the fact that the appellant had made a provision for bad and doubtful debts during FY: 2012-13 which was already offered for tax during that financial year itself.

8. The learned Commissioner(A) ought to have appreciated that the deduction u/s. 80-IC claimed in relevant year is only out of profits of this year whereas the bad debts claimed was in respect of the debts written off, related to the amount due in the preceding years and accordingly there was no double claim as surmised by the Assessing Authority.

9. The learned Commissioner (A) failed to consider the Apex Court judgment in the case of T.R.F Ltd (2010) 190 Taxman 391 (SC) and CBDT circular No.12/2016 dated 30th May 2016 and proceeded to confirm the disallowance made by the AO.

10. The learned Commissioner (A) erred in confirming the order of the AO in making the additions to the bad debts written off when it had already suffered tax in the earlier year and hence taxing the same amount twice is not called for.”

19. The material facts regarding these grounds are that the assessee had claimed deduction on account of bad debts written off of a sum of Rs.7,47,94,151. The AO was of the view that u/s. 36(1)(vii) of the Act, debts which are written off as bad and doubtful can be allowed as a deduction, but the assessee has to satisfy the condition laid down in section 36(2) of the Act which lays down that such debt or part thereof which is written off as bad and doubtful should have been taken into account in computing income of the assessee of the previous year in which the amount of such debt or part thereof is written off or an earlier previous year. According to the AO, the amount written off as bad debt was shown in the books of account of assessee, but on such income the assessee availed the benefit of deduction u/s. 80IC of the Act and therefore it cannot be said that the income was taken into account in computing income of the Assessee. In this regard, the AO observed as follows:-

“2.4 The assessee company has claimed bad debts of Rs.7,47,94,151/- from the following parties:

As per the ledger a/c copies of those parties, the receipt was first recorded in Financial Year 2011-12. For F.Y. 2011-12 assessee has claimed total deduction u/s 80IC of the IT Act of 100% of Total Income. It means, this amount was part of deduction claim. Therefore, it can’t be said that, such bad debt or part thereof has been taken into account in computing the income of the assessee of the previous year. If such income was not subject to tax in the year in which it was received, the assessee can’t take further deduction in the form of bad debt from ‘Income which is not eligible income for deduction u/s 80IC of the IT Act.”

20. The AO accordingly denied the benefit of deduction to the assessee. On appeal by the assessee, the CIT(Appeals) confirmed by order of AO for the following 3 reasons assigned by the AO that :-

(i) the income offered to tax u/s. 36(2) did not suffer tax because of deduction claimed by the assessee u/s. 801C;

(ii) the assessee failed to prove that debt which was written off as bad debt was included as income in the previous years; and

(iii) there was nothing to show that the debt written off as bad debt has in fact become bad.

21. Aggrieved by the order of CIT(Appeals), the assessee has filed the present appeal before the Tribunal.

22. The Id. counsel for assessee drew our attention to the following chart and submitted that out of debts written off as bad and doubtful debts, only a sum of Rs.67,97,554 enjoyed the benefit of deduction u/s. 80IC of the Act as per the chart, which is enclosed as Annexure-I to this order. With regard to the year in which the bad debts was offered as income, the counsel for assessee drew our attention to page 216 of the PB, which gives the required details. The same is given as Annexure-II to this order. Another chart providing the details at Page 218 of the PB is enclosed as Annexure-Ill to this order.

23. It was submitted that the AO did not doubt the fact that the debt which was written off as bad and doubtful had in fact been offered to tax in the earlier previous year. It was submitted that there was no condition u/s. 36(1)(vii) that the debt which was written off as bad and doubtful should have suffered tax and that what is required is that the debt should have been shown as income in the earlier previous year. With regard to the condition that the assessee has not shown the debt to have become bad, the Id. counsel for assessee placed reliance on the decision of the Hon’ble Supreme Court in the case of TRF Ltd. Vs CIT 323 ITR 397 (SC) wherein the Hon’ble Supreme Court held that it is not necessary for the assessee to prove that the debt has become bad to claim deduction on account of bad debts written off. A mere writing off of the debt as bad in the books of account was sufficient to claim deduction u/s 36(1)(viii) of the Act. The CBDT Circular No.12 of 2016 dated 30.05.2016 also expresses the same view on the issue of deduction account of bad debts. The Id. DR relied on the order of CIT(Appeals).

24. We have given a careful consideration to the rival submissions and are of the view that the claim of assessee for deduction ought to have been allowed by the revenue authorities. It is clear from the order of AO that AO never doubted that the sum written off as bad debts was already included as income of assessee in the earlier previous years. There is no condition laid down in section 36(1)(vii) that the sum which is written off as bad debts should have suffered tax and if that income is claimed as exempt or deduction is claimed, then deduction on account of bad debts written off should not be allowed. We are also satisfied that the assessee has established that the sum written off as bad debts was in fact offered to tax in the earlier previous years as income and included while computing total The requirement of establishing that the debt has become bad and irrecoverable is no longer necessary after the decision of the Hon’ble Supreme Court in the case of TRF Ltd. (supra). We are therefore of the view that none of the reasons assigned by the revenue authorities to deny the benefit of deduction on account of bad debts written off are sustainable. The claim is directed to be allowed.

25. In the result, the appeal by the assessee is allowed.

Pronounced in the open court on this 26^th day of February, 2020.