2024 (12) TMI 1561 - AT - Income Tax

Deduction u/s 80JJAA - qualification as an industrial undertaking engaged in the manufacture or production of an article or thing - requirement of employing new regular workmen for 300 days or more - assessee argued that the condition precedent is that new workmen should be employed for 300 days or more not that the workmen should complete 300 days of work within the relevant previous year - CIT(A) held that the appellant assessee engaged in software development and IT enabled services did not meet this requirement. Whether the assessee qualifies as an industrial undertaking and whether the development of computer software and IT-enabled services amounts to the manufacture or production of an article or thing u/s 80JJAA? - HELD THAT - The term industrial undertaking has not been defined for the purposes of section 80JJAA of the Act. However the same has been defined for the purpose of provision of section 10(15) includes the manufacture of computer software as an industrial undertaking. Since the term industrial undertaking is not specifically defined for the purposes of Section 80JJAA of the Act or any other relevant provisions of the Act we are inclined to rely on the definition provided u/s 10(15) of the Act. The appellant assessee is engaged in the development of computer software IT-enabled services and the development of embedded software for automobile components and accessories which in our considered opinion falls within the definition of an industrial undertaking. Whether the activity of the assessee can be described as manufacture or production of article or thing ? - It is important to note that the provisions of Section 80JJAA of the Act use the term manufacture or production. This distinction implies that production is broader than manufacture and an industrial undertaking may qualify for the deduction if it engages in either manufacturing or production activities. The term production refers to the process of creating goods and services by combining various resources such as labor capital raw materials and technology. It encompasses a wide range of activities. The Oxford English Dictionary defines production as that which is produced; a thing that results from any action process or effort; a product of human activity or effort. The development of computer software involves intellectual and technical efforts to create a product or service with economic value thereby fulfilling the criteria for production. Inputs such as human expertise technology and tools (e.g. coding platforms) are combined to produce software aligning with the general definition of production. The output typically intangible (a software application or code) is a hallmark of production in knowledge-based or service-oriented industries. Therefore in our considered opinion the activity of the assessee amounts to the production of an article or thing. Thus the finding of the CIT(A) that the assessee company is not an industrial undertaking engaged in manufacture or production does not hold merit. Accordingly we set aside the finding of the learned CIT(A) on this matter. Hence the first question is answered in favor of the assessee. Whether the appellant assessee is claiming double benefits by first availing exemptions u/s 10A and 10AA of the Act and subsequently u/s 80JJAA? - We note that the learned AR for the assessee submitted before us that no deduction under Section 80JJAA was claimed in respect of wages paid to the employee of Coimbatore CHIL unit and the Coimbatore TIDEL Park unit. However we find that this claim has not been verified by the lower authorities. For the sake of justice and fair play we are inclined to set aside this issue to the file of the AO for verification. AO is directed to examine the claim of the AR and decide the issue accordingly. The assessee is also directed to provide all necessary details to substantiate that no deduction was claimed u/s 80JJAA of the Act for wages paid to employees of the two units eligible for exemptions u/s 10A and 10AA of the Act. Whether the condition that an employee should be employed for 300 days or more during the previous year must be met in the particular assessment year or cumulatively over two assessment years? - The order of the Tribunal in the assessee s own case for A.Y. 2011-12 was passed without considering the judgment of the Hon ble High Court in the case of Aquarelle India Ltd 2023 (9) TMI 258 - KARNATAKA HIGH COURT as the same was not available on record at that time. Therefore in light of the recent judgment of the Hon ble High Court we are inclined to depart from the earlier stand taken by the Tribunal in the assessee s own case and hold that the requirement of 300 days of employment should be considered cumulatively across both the previous year and the succeeding year. Hence the third question is hereby decided in favour of the assessee. Based on the detailed examination of the facts and the relevant legal provisions we set aside the findings of the CIT(A) and direct the AO to consider the matter in line with the above observations. Hence the ground of appeal of the assessee is hereby partly allowed for statistical purposes. Additional depreciation u/s 32(1)(iia) on computers used for the production of software - assessee explained that it was in the business of software development which amounts to the production of an article or thing and that the computers used for software production qualify as plant and machinery thus making them eligible for additional depreciation - HELD THAT - The assessee s business activities fall under the broader definition of production under the Act and thus the development of software constitutes a form of production in a knowledge-based industry. The argument that computers used in the development of software are part of plant and machinery is substantiated by the fact that the Income Tax Rules categorize computers and computer software within the block of plant and machinery eligible for depreciation at a higher rate. This indicates that computers software despite being intangible in terms of output play a crucial role as plant and machinery in the production process. Given that the assessee is engaged in the production of an article or thing (software) the computers used in the production of such software can be treated as plant and machinery under the provisions of Section 32(1)(iia) of the Act. Therefore the claim for additional depreciation on the computers used in the production of software is in line with the provisions of the Act. We hereby reverse the findings of the CIT(A) and allow the assessee s claim for additional depreciation under Section 32(1)(iia) of the Act. Disallowances of maintenance charges by treating prior period item - HELD THAT - Prior period expenses are those expenses that relate to an earlier accounting period but are recognized or incurred in the current financial year. These expenses could be related to the previous year s business and are often found when errors are discovered or when payments are made after the relevant accounting period. The provisions of Section 37(1) of the Income Tax Act allow the deductions for any expenditure (not being capital expenditure or personal expenditure) that is incurred wholly and exclusively for the purposes of business or profession. When a prior period expense is allowed as a deduction under Section 37(1) it directly reduces the taxable income for the current period. The expense is typically deducted in the year in which it is crystalized even though it pertains to a previous period. In holding so we draw support and guidance from the judgment of Balmer Lawrie and Company Ltd 2023 (4) TMI 581 - CALCUTTA HIGH COURT Now turning to the facts of the present case we note that the debit note was raised by the party dated 12 September 2011 for the impugned expenses pertaining to the period from 1st April 2010 to 31 March 2011 which is placed on page 587 of the paper book. Thus it is transpired that the liability to expenses in dispute were crystalised in the year under consideration and therefore the same was claimed as deduction in the current year. Whether such expenses were incurred for the purpose of the business and the same were not capital in nature ? - We note that the maintenance charges were paid for the maintenance of the property. There is no information available on record whether such property was purchased by the assessee as investment or for the purpose of the business. In the absence of such information we are inclined to remit the issue to the file of the AO for fresh adjudication as per the provisions of law after considering the discussion stated above. Hence the ground of appeal of the assessee is hereby partly allowed for statistical purposes. Disallowance made u/s 14A - HELD THAT - We note that that issue of disallowance u/s 14A of the Act is covered in favour of the assessee by the order of this Tribunal in own case of the assessee for A.Y. 2010-11 2022 (2) TMI 1503 - ITAT BANGALORE as observing the fact that the Ld.AO has not expressly mentioned any dissatisfaction in the suomoto disallowance computed by assessee we hold that the disallowance computed by the assessee is appropriate. TP Adjustment - comparables selection while calculating the ALP of the international transaction carried out by the assessee with its associated enterprise - whether companies with a turnover exceeding Rs. 200 crores should be excluded when calculating the ALP for the assessee given the fact that the assessee s turnover under the ITES Segment is only Rs. 132.28 crores? - HELD THAT - We are inclined to exclude companies with a turnover exceeding Rs. 200 crores as comparables while calculating the ALP for the international transactions carried out by the assessee with its Associated Enterprise (AE). According to the assessee the list of companies with a turnover exceeding Rs. 200 crores is as Infosys BPO Limited and TCS E-Services Ltd Hence we direct the TPO/AO to exclude the companies listed above from the set of comparables while calculating the ALP for the international transactions carried out by the assessee provided they have a turnover exceeding Rs. 200 crores. This exclusion shall be made after conducting the necessary verification. Excel Infoways Ltd. - AO/TPO is directed to re-examine the compliance of Excel Infoways Ltd. with the filters applied and if the company is found to fail the thresholds it shall be excluded from the list of comparables for the purpose of determining the ALP. Cameo Corporate Services Ltd. - We find merit in the argument of the learned AR that exclusion on account of non-availability of data is no longer valid if the requisite data is now accessible. However since the functional similarity and other comparability criteria require verification we remand the matter to the AO/TPO for necessary verification. If upon examination the functions of Cameo Corporate Services Ltd. are found to be similar to those of the assessee and the company satisfies the required filters it shall be included in the list of comparables for determining the ALP. E4e Healthcare Services Ltd. - We find merit in the argument of the learned AR as bank charges are generally considered an operating expense in the context of transfer pricing analysis. However this issue requires factual verification to determine whether the treatment of bank charges as non-operating cost was indeed an error.Accordingly we remand this issue to the file of the AO/TPO for necessary verification. Exclusion of comparable companies namely Universal Print System Ltd and BNR Udhyog Limited - We note that the ld. CIT-A has given categorical finding that these 2 companies do not meet the criteria adopted by the AO /TPO for selecting the comparables. As such these 2 companies do not meet the criteria of 75% for revenue from the operations of ITeS services. This finding of the ld. CIT-A has not been disputed by the learned DR appearing on behalf of the revenue. Accordingly we do not find any reason to interfere in the finding of the learned CIT-A. Hence the ground of appeal of the revenue is hereby dismissed. Corporate dividend tax at a rate higher than the rate specified under DTAA - AR submitted that in this regard a direction can be issued to the AO for necessary adjudication as per the provisions of law. DR did not raise any serious objection if the issue is set aside to the file of the AO for necessary verification and fresh adjudication as per the provisions of law - HELD THAT - After hearing both the parties in the interest of justice and fair play we direct the AO to charge the tax on the dividend declared by the assessee in pursuance to the provisions of the Act. Accordingly we set aside the issue to the file of the AO for fresh adjudication as per the provisions of law. Hence the additional ground raised by the assessee is allowed for statistical purposes. Deduction for the education cess and higher and secondary education cess while computing the income under normal computation - As we note that there is an amendment under the provisions of section 40(a)(ii) of the Act by the Finance Act 2022 wherein an explanation has been inserted with retrospective effect i.e. assessment year 2005-06. As per the amendment there remains no ambiguity to the fact that the assessee cannot claim the deduction of the cess by treating the same as revenue expenditure. Thus we do not find any merit in the additional ground of appeal raised by the assessee. Hence the ground of appeal raised by the assessee is hereby dismissed. Claim for the provision of doubtful debts - HELD THAT - CIT(A) has categorically held that the issue under consideration is identical to the decisions of Vijaya Bank 2010 (4) TMI 46 - SUPREME COURT and Sadvik Asia 2013 (2) TMI 900 - KARNATAKA HIGH COURT DR for the Revenue has not brought any contrary facts or judicial precedents on record to dispute the applicability of these decisions to the facts of the case. We find no reason to interfere with the findings of the learned CIT(A). Hence the ground of appeal of the revenue is hereby dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in the judgment include:

- Whether the assessee qualifies as an industrial undertaking engaged in the manufacture or production of an article or thing under Section 80JJAA of the Income Tax Act (the Act), particularly in the context of software development and IT-enabled services.

- Whether the deduction under Section 80JJAA can be claimed when exemptions under Sections 10A and 10AA have also been availed, raising the question of double benefit.

- The interpretation of the requirement that new regular workmen must be employed for at least 300 days during the previous year for claiming deduction under Section 80JJAA, specifically whether this period must be fulfilled in a single year or cumulatively over two years.

- The eligibility of additional depreciation claimed under Section 32(1)(iia) of the Act on computers used for software development, and whether such activity qualifies as manufacture or production of an article or thing.

- The allowability of prior period maintenance expenses claimed by the assessee, including whether such expenses relate to the current year and are wholly and exclusively for business purposes.

- The correctness of disallowance under Section 14A of the Act regarding expenses related to exempt income, including the applicability of Rule 8D of the Income Tax Rules.

- The selection and comparability of companies used for benchmarking in transfer pricing (TP) analysis, including the application of turnover and other filters for comparables in the ITES segment.

- The entitlement to relief on excess Dividend Distribution Tax (DDT) paid beyond the rate specified under the Double Taxation Avoidance Agreement (DTAA) between India and Germany.

- The deductibility of education cess and higher and secondary education cess paid on income tax under normal computation.

- The allowability of provision for doubtful debts claimed by the assessee.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Qualification as Industrial Undertaking and Manufacture/Production of Article or Thing under Section 80JJAA

The legal framework involves Section 80JJAA, which provides deduction for wages paid to new regular workmen employed by an industrial undertaking engaged in manufacture or production of articles or things. The term "industrial undertaking" is not defined under Section 80JJAA, but the Court relied on the definition under Section 10(15) of the Act, which explicitly includes the manufacture of computer software as an industrial undertaking.

The Court examined the definition of "manufacture" under Section 2(29BA), which requires a change in a non-living physical object resulting in a new and distinct object. Since software development does not involve a physical object, the Court found that software development does not strictly qualify as "manufacture."

However, the statute also uses the term "production," which is broader. The Court referred to authoritative definitions and Supreme Court precedents to conclude that software development constitutes "production" of an article or thing, as it involves intellectual and technical efforts to create a product with economic value.

The Court noted that the revenue authorities had not disputed the industrial undertaking status in the preceding assessment year. Hence, the finding by the CIT(A) that the assessee is not an industrial undertaking was set aside, and the issue was decided in favor of the assessee.

Issue 2: Double Benefit under Sections 10A/10AA and Section 80JJAA

Section 80A(4) prohibits double benefits under different provisions for the same income. The CIT(A) disallowed the deduction under Section 80JJAA for units whose profits were exempt under Sections 10A and 10AA.

The assessee claimed no deduction under Section 80JJAA for wages paid to employees of these exempt units. However, this claim was not verified by the authorities. The Court directed the Assessing Officer (AO) to verify the claim and decide accordingly, remanding the issue for fresh adjudication.

Issue 3: 300 Days Employment Requirement under Section 80JJAA

The AO disallowed the deduction on the ground that new regular workmen employed did not complete 300 days in the relevant previous year. The CIT(A) upheld this view relying on Tribunal precedents.

The Tribunal in the assessee's own case for the preceding year clarified that if an employee does not complete 300 days in the first year, deduction is not allowable for that year, but if the employee completes 300 days in subsequent years, deduction should be allowed for those years. This interpretation aligns with the legislative intent of allowing deduction for three consecutive assessment years.

Further, the Karnataka High Court held that the 300 days requirement can be considered cumulatively over the previous and succeeding years, not mandatorily within a single year.

Applying this, the Court departed from the earlier Tribunal view and held the 300 days condition should be considered cumulatively, deciding this issue in favor of the assessee and remanding the matter to the AO for verification.

Issue 4: Additional Depreciation under Section 32(1)(iia) on Computers Used for Software Development

The AO disallowed additional depreciation claiming the assessee was not engaged in manufacture or production of articles or things, and computers are not plant and machinery.

The assessee argued that software development constitutes production, and computers used in this process qualify as plant and machinery. The assessee relied on judicial precedents and the classification of computers under the Income Tax Rules as plant and machinery.

The CIT(A) rejected the claim, holding that software services are not manufacture or production, and the revenue is from services, not products.

The Court reconsidered the issue, reiterating that software development is production of an article or thing and that computers are plant and machinery under the Rules. The Court reversed the CIT(A)'s findings and allowed the claim for additional depreciation.

Issue 5: Disallowance of Prior Period Maintenance Expenses

The AO disallowed Rs. 27.71 lakhs as prior period expenses relating to earlier years but claimed in the current year. The CIT(A) upheld the disallowance.

The Court analyzed the principles under Section 37(1) for prior period expenses, requiring that the expense must be wholly and exclusively for business, relate to the business, and be appropriately disclosed.

The Court found the debit note dated 12 September 2011 crystallized the liability in the current year, supporting the claim. However, the Court noted absence of evidence whether the property maintained was for business or investment purposes.

The Court remanded the issue to the AO for fresh adjudication after considering the nature of the property and the business purpose of the expense, partly allowing the ground for statistical purposes.

Issue 6: Disallowance under Section 14A of the Act

The AO disallowed expenses related to exempt income under Section 14A, applying Rule 8D, despite the assessee's suo moto disallowance.

The CIT(A) confirmed the AO's disallowance. The Tribunal in the assessee's own case for an earlier year held that the assessee's self-determined disallowance was appropriate and that Rule 8D cannot be mechanically applied without cogent reasons.

The Court found no material to distinguish the current year from earlier years and set aside the disallowance, allowing the ground in favor of the assessee.

Issue 7: Transfer Pricing - Selection of Comparable Companies

The assessee's TP study for the ITES segment was rejected by the TPO, who selected a new set of comparables applying various filters including turnover, export turnover, related party transactions, and employee cost.

The CIT(A) excluded two companies that failed the service revenue filter but confirmed the rest.

The Court considered whether companies with turnover exceeding Rs. 200 crores should be excluded, noting precedents that turnover is a relevant criterion for comparability and that companies with substantially higher turnover than the assessee should be excluded.

The Court directed exclusion of such companies after verification. The Court also remanded the issue of whether Excel Infoways Ltd. met the employee cost and service revenue filters, and whether Cameo Corporate Services Ltd. should be included based on availability of current year data and functional similarity.

The Court found merit in the assessee's contention that bank charges were incorrectly treated as non-operating expenses for E4e Healthcare Services Ltd. and remanded for verification.

The Court sustained the inclusion of certain comparable companies not objected to by the assessee and dismissed the revenue's appeal against exclusion of two companies.

Issue 8: Excess Dividend Distribution Tax Paid Beyond DTAA Rate

The assessee claimed refund of excess DDT paid beyond the 10% rate prescribed in the India-Germany DTAA, instead of the 16.2225% charged under the Act.

The Court admitted this additional ground and directed the AO to adjudicate the issue afresh as per law, allowing the ground for statistical purposes.

Issue 9: Deductibility of Education Cess and Higher and Secondary Education Cess

The assessee claimed deduction of cess paid on income tax as revenue expenditure.

The Court noted the retrospective amendment by the Finance Act 2022 inserting Explanation 3 to Section 40(a)(ii), clarifying that tax includes cess and surcharge, and such cess is not deductible.

The Court dismissed the ground of appeal, holding that the assessee cannot claim deduction for cess paid on income tax.

Issue 10: Provision for Doubtful Debts

The AO disallowed provision for doubtful debts treating it as contingent liability. The CIT(A) allowed the claim relying on binding Supreme Court and High Court precedents.

The Court found no contrary material and upheld the CIT(A)'s order, dismissing the revenue's appeal.

3. SIGNIFICANT HOLDINGS

- "The appellant assessee is engaged in the development of computer software, IT-enabled services, and the development of embedded software for automobile components and accessories, which, in our considered opinion, falls within the definition of an industrial undertaking."

- "The activity of the assessee amounts to the production of an article or thing."

- "The requirement of 300 days of employment should be considered cumulatively across both the previous year and the succeeding year."

- "Computers used in the production of software can be treated as plant and machinery under the provisions of Section 32(1)(iia) of the Act."

- "Prior period expenses are allowable if the liability crystallized in the current year and the expenses are wholly and exclusively for business purposes."

- "The disallowance under Section 14A of the Act cannot be mechanically applied through Rule 8D where the assessee has made suo moto disallowance."

- "Turnover is a relevant criterion for selection of comparable companies in transfer pricing analysis, and companies with turnover substantially exceeding that of the assessee should be excluded."

- "Bank charges are generally operating expenses and should be treated accordingly in transfer pricing computations."

- "The assessee is entitled to refund of excess Dividend Distribution Tax paid beyond the DTAA rate."

- "Education cess and higher and secondary education cess paid on income tax are not deductible under the Act."

- "Provision for doubtful debts is allowable if not a contingent liability, as per binding Supreme Court and High Court precedents."

- The appeals of the assessee were partly allowed for statistical purposes, while the appeals of the revenue were dismissed.