Tax holiday not available to a foreign branch carrying on-site software development and full-fledged marketing operation

Tax holiday not available to a foreign branch carrying on-site software development and full-fledged marketing operations – Delhi HC

Facts

•           Interra Software India Private Limited (ISIPL) had a software development unit in NOIDA Export Processing Zone (NEPZ). It was a 100% export oriented unit engaged in the business of development of software and therefore eligible for deduction under section 10A of the Indian Income tax Act ( “the Act”) .

•           ISIPL had, with the approval of RBI, opened a non-trading branch in Tokyo, Japan to facilitate communication between the NEPZ unit and the Japanese customers, to provide onsite development service, assist in marketing efforts, help procure orders, render assistance to professionals deputed there on off-shore assignments, attend to validation and testing of the products, if required and providing other requisite comforts to customers.

•           ISIPL claimed deduction under section 10A in respect of the income of the Japan branch relying on Explanation 3 to section 10A of the Act as per which profits and gains derived from on site development of computer software shall be deemed to be profits and gains derived from the export of computer software outside India.

•           The Assessing Officer (AO) denied the exemption under Section 10A of the Act, with respect to the profits of the Japan Branch on the ground that the said branch is not eligible under Section 10A(2) of the Act.

•           The Commissioner of Income tax (Appeals) and the Tribunal however allowed the claim for deduction. The Department preferred an appeal before the Delhi High Court against the Tribunal order.

Issues before the High Court :- Whether tax holiday is available to a foreign branch carrying on-site software development and full-fledged marketing operations?

Observation and Ruling of the High Court

•           The High Court held that a foreign office carrying “on site software development” could only be a “Liaison Office” acting as an intermediary between the developer enterprise and the customers and vice-versa to be eligible for tax holiday under section 1 0A of the Act read with Explanation 3 thereto.

•           Wherever such foreign office is working as a separate branch carrying on full-fledged marketing operations, its activities would not be treated as “on site development” and tax holiday under section 10A would not be available in respect of the revenue earned by the branch.

•           The High Court set aside the orders of the lower authorities and remitted the matter to the AO for examination of specific factual aspects in light of the above principles laid down by it.

Comments :-The above ruling provides that tax holiday under section 10A would be available to a foreign office, i.e. a branch carrying on-site software development only if it is a liaison office. An independent branch carrying out full -fledged marketing operations would not be eligible for claiming the income from its operations as eligible for deduction under section 1 0A of the Act.

Source: CIT V/s Interra Software India P. Ltd. – Tax case (Appeal Nos) ITA Nos. 507/2008 and 260/2008 dated 24th December, 2010.