2011 (1) TMI 161 - AT - Income Tax

Reimbursement of Incentive paid to employees - Arm s length price Addition of income of - Assessee in this case is engaged in the business of designing packaged software and also provides software consultancy services - While making adjustment the TPO has observed that the assessee has received payment towards technical services rendered to its AE - Held that the sum of 10, 66, 08, 194 received from the associated enterprise/parent company was merely in the nature of reimbursement towards incentive paid to the employees and does not have any element of income. The matter has been duly disclosed in the financial statement of accounts. Moreover the amount received from the associated enterprises was in fact reimbursement of such payment of incentive and was inextricably linked with corresponding expenses. If the working is re-worked taking the amount received as assessee s receipt and payment as assessee s expenses still the PLI would be favourable as comparable to the average comparables. - Decided in favor of assesee Deduction u/s 10B - As per AO the deduction u/s 10B is not allowable once the deduction is claimed u/s 80HHE of the IT Act in view of provisions of sub-section 5 of section 80HHE. - Issue remitted back to AO - If assessee satisfies the pre-requisites stipulated for the purpose of getting benefit under s. 10A is a matter left to be determined by the AO. So also the entitlement of the assessee to seek deduction under s. 80HHE having been left to be determined by the AO subject to assessee s satisfying the pre-requisites stipulated for the grant of such a benefit under the said provision. Project expenses - assessee has claimed expenditure of 1, 93, 12, 834 on account of project expenses. Assessing Officer asked the Assessee to explain as to why the same should not be capitalized. Assessee submitted that company has incurred the expenses in respect of various software development projects. Such expenses were routine business expenses incurred in the course of software business. Such expenses were not incurred for acquisition of any capital asset nor resulted in enduring benefit of capital field to be recorded as capital expenditure - Held that - It is undisputed that the aforesaid amount was spent for training of the personnel. By any stretch of imagination these expenses cannot be said to have resulted in enduring benefit to be classified as capital expenditure. - Decision of apex court in Empire Jute Mills 1980 (5) TMI 1 - SUPREME Court followed.

Summary

Issues Involved:
1. Adjustment to the arm's length price of the international transaction of payment of incentive to employees.
2. Disallowance of deduction under section 10B of the Income-tax Act.
3. Disallowance of project expenses claimed as revenue expenditure.

Issue-wise Detailed Analysis:

1. Adjustment to the Arm's Length Price of the International Transaction of Payment of Incentive to Employees:

The Assessing Officer (AO) proposed an adjustment of Rs. 2,97,96,990 to the arm's length price of the international transaction of payment of incentive to employees, based on the order passed under section 92CA(3) of the Income-tax Act by the Transfer Pricing Officer (TPO). The TPO observed that the payment received by the assessee from its associated enterprise (AE) was for technical services rendered, not merely an incentive to employees, and thus required a mark-up. The TPO used the Operating Profit/Total Cost (OP/TC) margin of 27.95% to apply a mark-up on the payment, resulting in the proposed adjustment.

The assessee argued that the payment was an incentive to retain employees following the takeover by Flextronics International Singapore Pte Ltd., and not for services rendered. The assessee provided detailed documentation, including letters to employees, payment schedules, and financial disclosures, to support their claim. The Dispute Resolution Panel (DRP) upheld the TPO's adjustment, but the tribunal found merit in the assessee's argument, noting that the payment was indeed an incentive and not for services rendered. The tribunal also observed that similar payments in previous and subsequent years were not adjusted, and thus, set aside the AO's order, deciding in favor of the assessee.

2. Disallowance of Deduction under Section 10B:

The AO disallowed the deduction of Rs. 1,35,11,53,643 claimed under section 10B of the Act, following an earlier disallowance for the assessment year 2003-04. The AO questioned the justification for the exemption claimed and referenced an order passed under section 143(3) read with section 263.

The assessee contended that the issue was covered by the jurisdictional High Court's decision in CIT v. Legato Systems India Pvt. Limited, which allowed the exemption under section 10A if the assessee satisfied the prerequisites. The tribunal, respecting the precedent, set aside the AO's order and remitted the issue back to the AO for reconsideration in light of the High Court's decision, ensuring the assessee was given adequate opportunity for a hearing.

3. Disallowance of Project Expenses:

The AO disallowed Rs. 1,93,12,834 claimed as project expenses, treating them as capital expenditure. The assessee argued that these were routine business expenses incurred for training personnel in the course of their software business and did not result in any enduring benefit.

The tribunal reviewed the submissions and found that the expenses were indeed for training and did not constitute capital expenditure. Citing the Supreme Court decision in Empire Jute Mills and other case laws, the tribunal concluded that the expenses were revenue in nature and set aside the AO's order, deciding in favor of the assessee.

Conclusion:

The tribunal allowed the appeal filed by the assessee, setting aside the orders of the AO on all three issues. The tribunal found that the adjustment to the arm's length price was unwarranted, the disallowance of the section 10B deduction needed reconsideration in light of the High Court's decision, and the project expenses were correctly claimed as revenue expenditure.