2008 (5) TMI 361 - AT - Income Tax

Allowability of deduction u/s 10B - Object clause - No new undertaking - Violation of STPI norms - Not engaged in production of computer software - business of software development - 100 per cent export oriented software technology park - conversion of an existing software export unit to STP unit - Whether or not company can be termed as manufacture or production of software - Main contention of the AO is that the employees of the taxpayer, including its CMD have admitted during the survey that the taxpayer company was not undertaking any manufacturing activities - HELD THAT - Manufacture or production of software has to be decided in the light of relevant provisions of law and the activities actually undertaken by the taxpayer and not on the basis of statement of employees. The words 'manufacture or production' have been subject-matter of judicial interpretation under various enactments. What their meaning is in common parlance may not necessarily be so on interpretation of relevant provisions of an enactment. In any case interpretation of these words for the purpose of deduction under s. 10B of the Act, cannot solely be decided on the statement of employees alone. Sec. 10B was inserted by the Finance Act, 1988 w.e.f. 1st April, 1989 and later on it was amended from time to time. According to this provision, any profits and gains derived by an assessee from a hundred per cent EOU shall not be included in the total income of the assessee. As provided in cl. (2) of s. 10B, the exemption is available to undertakings. Sec. 10BB The profits a gains derived by an undertaking from the production of computer programs u/s 10B, as it stood prior of its substitution by s. 7 of the Finance Act, 2000 00 of 2000), shall be construed as if for the words 'computer programs', the words 'computer programs or processing or management of electronic data' had been substituted in that section . When the provisions of s. 10BB of the Act, stipulate the profits and gains derived by an undertaking from the production of computer programs or processing or management of electronic data, to be eligible for deduction u/s 10B of the Act, we are inclined to accept the findings of learned CIT(A), who after analyzing the details of activities of the taxpayer concluded that taxpayer is entitled to deduction under s. 10B of the Act. As explained before the learned CIT(A), unit is involved in developing test programs that would automate the function of verifying the functioning of complete designs involving millions of transistors on a single chip. That chip verification as a process is not a manual job as may be viewed by an outsider. It requires development of highly sophisticated test programs in very special high level languages. Further unit is also involved in software development and manufacturing of such programs from a scratch. Apparently, these are very complex programs. Similarly, the complete system, that incorporates microprocessor hardware and software; but does not look like a computer is stated to be an 'embedded system'. Telephone exchanges as well as phone instruments are examples of such products. Unit also designs, develops, prototypes and markets such complete products. Besides, unit designs, develops and manufactures such application software for its clients and tests it. From time to time, it is also involved in testing of such software to ensure that there are no defects in such programs. Apparently, in the light of relevant provisions of ss. 10B and 80HHE of the Act, unit is involved in software development activity in writing 'programs' to carry out the services as per the agreements with various customers. Moreover, the AO in his order admits that activities of human resource, engineering and design as also data processing falling within the notification issued by the CBDT, are entitled to deduction under s. 80HHE of the Act but not under s. 10B of the Act. Apparently, this stand of the AO is self-contradictory, as pointed out by the learned CIT(A), especially when the aforesaid notification has been issued, having recourse to same definition of computer software in both the sections and is thus, equally applicable for benefits under both these sections. Manufacture or production of computer programs, In the case of Sovika Infotek Ltd. vs. ITO 2007 (7) TMI 441 - ITAT MUMBAI training activity of the assessee intrinsically connected with software development, sale, maintenance, etc. was held to be entitled to deduction under s. 10B of the Act. The argument of the Revenue that the ld CIT(A) has completely overlooked that 'computer software' as defined under the section means any computer program recorded on any disc, tape, perforated media or other information storage device and does not include any services of qualified personnel given by the assessee, is not in accordance with the intent expressed in the circular and Expln. 3 to s. 10B applicable for the year under consideration. The next plea of the Revenue that even tools for manufacturing are not available with the company, is also baseless since for development of software, what is necessary is skilled manpower, computer and internet apart from certain reference books. Even otherwise, assuming this plea is accepted, then on what basis the AO allowed deduction u/s. 80HHE of the Act, has not been explained. Another argument of the Revenue is that learned CIT(A) erred in applying the definition of computer software under the Copyright Act and not under the IT Act. We find from the order of learned CIT(A) that while referring to decision of the Tribunal in the case of Asstt. CIT vs. Amadeus India (P) Ltd. 2001 (1) TMI 918 - ITAT DELHI , it was observed that computer program (not computer software) is not defined in the Act. We are in agreement with the findings of learned CIT(A) that activities undertaken by the taxpayer were in respect of production and export of computer software within the meaning of provisions of s. 10B of the Act, especially when the AO himself concluded so for the purpose of s. 80HHE of the Act. We are also in agreement with the uncontroverted submission of the ld AR on behalf of the taxpayer that the taxpayer did not claim any deduction in AY 1996-97 and for the first time claimed deduction u/s 10B in AY 1997-98 and this being the 5th year, claim has to allowed. Violation of STPI norms and Establishment of new undertaking - On the aspects of violation of STPI norms and establishment of new undertaking, we do not find any infirmity in the findings of learned CIT(A) - In the light of this circular and the findings of learned CIT(A), with which we agree, there is no ground for denial of claim for deduction under s. 10B of the Act, the taxpayer having registered as 100 per cent EOU in the period relevant to AY 1996-97. Violation of norms of STPI, we are of the view that unless violation of conditions of approval, impinge on conditions for grant of deduction under the relevant provisions of the Act, there is no ground for denial of deduction. In this case the status of taxpayer as 100 per cent EOU and under STPI scheme continues. For the default, already penalty has been imposed by the concerned authorities. Domestic sales - second proviso to the extant s. 10B(1) itself permits that that the profits and gains derived from such domestic sales of articles or things or computer software as do not exceed twenty-five per cent, of total sales shall be deemed to be the profits and gains derived from the export of articles or things or computer software. Therefore, we do not find any infirmity in the findings of learned CIT(A) and consequently uphold his order and reject the grounds raised by the Revenue - Appeal is dismissed.

Summary

Issues Involved:
1. Object Clause
2. No New Undertaking
3. Violation of STPI Norms
4. Not Engaged in Production of Computer Software

Issue-wise Detailed Analysis:

1. Object Clause:
The AO contended that the object clause of the taxpayer's memorandum of association did not include software development, thus disqualifying the taxpayer from claiming deductions under Section 10B of the IT Act. However, the CIT(A) held that the object clause is not conclusive in determining the nature of the business. The CIT(A) referenced decisions from the Supreme Court, indicating that the activities of the company, rather than the object clause, determine the nature of the business. The CIT(A) concluded that the taxpayer's activities, including chip design, embedded systems, and application software development, fall within the definition of software development.

2. No New Undertaking:
The AO argued that the taxpayer was not a new undertaking as it was incorporated in 1988, and Section 10B benefits were not applicable since the provisions came into force from the assessment year 1991. The CIT(A) disagreed, stating that the taxpayer commenced software development in 1994 and was registered as a 100% EOU in 1995. The CIT(A) clarified that Section 10B applies to undertakings that manufacture or produce software and are registered as EOUs, regardless of whether they were initially set up as new undertakings.

3. Violation of STPI Norms:
The AO highlighted violations of STPI norms and central excise regulations, including local sales without prior approval and improper warehousing of imported goods. The CIT(A) considered these as procedural lapses and not substantial violations that would disqualify the taxpayer from claiming deductions under Section 10B. The CIT(A) noted that the taxpayer continued to be registered with STPI and fulfilled export obligations, thus maintaining its status as a 100% EOU.

4. Not Engaged in Production of Computer Software:
The AO found that the taxpayer was not engaged in manufacturing computer software but was providing consultancy services and qualified personnel to clients. The CIT(A) rejected this view, stating that the taxpayer's activities involved developing complex software programs, chip design, and embedded systems, which qualify as software development. The CIT(A) referenced the definition of computer software under Section 10B and judicial interpretations, concluding that the taxpayer's activities fall within the scope of software development.

Conclusion:
The CIT(A) upheld the taxpayer's claim for deductions under Section 10B, rejecting the AO's contentions on all grounds. The CIT(A) found that the taxpayer was engaged in software development, met the conditions of Section 10B, and any procedural lapses did not disqualify the taxpayer from claiming the deductions. The appeal by the Revenue was dismissed, and the order of the CIT(A) was upheld.