2010 (7) TMI 843 - AT - Income Tax

Assessee's Appeal Partly Allowed: Software Expenses Capitalized, Deductions Allowed

3i Infotech Ltd. Versus Deputy Commissioner of Income-tax, Circle 10 (3) Mumbai

The Tribunal partly allowed the assessee's appeal by upholding the treatment of software development expenses as capital expenditure, rejecting the ... Method of accounting - Expenses on software development/up-gradation - deduction u/s 37(1) - disallowed as revenue expenditure - HELD THAT:- In the present case, the business of the assessee was development of software for its clients. The business carried on by the assessee cannot itself be considered as research and development. It is not the purpose of section 35(1)(iv) to allow such deduction. The allowability of such expenses will be governed by the provisions of section 37(1) because there is no other provision under Chapter-IV sections 28 to 44 under which the allowability of the aforesaid expenditure can be considered. we dismiss ground raised by the assessee. claim of the assessee for deduction u/s 80HHE - computation of total income - the assessee had filed its return of income declaring a loss of Rs. 46,96,990. HELD THAT:- The assessee specifically made the claim for deduction u/s 80HHE in the note No. 1 to the computation of total income and note No. 11 in the tax audit report. The certificate in Form No. 10CCAF was given by the auditors but they certified the income eligible for deduction u/s 80HHE as Nil because the computation of total income as per return of income was loss. That does not preclude the AO from allowing the deduction u/s 80HHE, if otherwise the claim can be allowed. Even according to the AO, the assessee is otherwise entitled to claim deduction u/s 80HHE. In respect of export turnover brought into India in convertible foreign exchange - HELD THAT:- the assessee should be allowed deduction u/s 80HHE. Such deduction has been computed by the assessee at Rs. 8,22,68,736 in the submissions filed before CIT(A). The AO is directed to verify the claim of the assessee and allow relief u/s 80HHE. In respect of export turnover of Rs. 5,50,91,092 - HELD THAT:- the AO shall verify nexus between the expenditure incurred abroad and the business of export of computer software which yielded the income on which deduction is claimed u/s 80HHE as also the nexus between the outstanding payable by the assessee to ICICI Infotech Inc., USA and the export of computer software business which yielded income on which deduction u/s 80HHE is claimed by the assessee. If such nexus is found to exist then the deduction u/s 80HHE as claimed by the assessee is directed to be allowed to the extent such nexus exists. computation of arm’s length price - TPO transactions - In the present case, the determination of ALP in respect of the transaction by which the assessee deputed three of its employees to ICICI Infotech, USA, by the TPO is, therefore, non est to that extent and cannot form the basis for making an addition to the total income. HELD THAT:- on the facts and circumstances of the present case, there was no necessity to have determined ALP of the transaction in question. We also agree with the learned counsel for the assessee that the TPO has proceeded to determine ALP of the transaction on the basis of assumptions not supported by any evidence. We also agree with his submission that CUP method could not be applied under the facts of the case as the assessee has not transferred/seconded employees to any other independent enterprises. To test the arm’s length pricing in the case of transfer/seconding of the employees, it may be possible to use the CUP method where the same entity has undertaken similar transaction under comparable circumstances to independent enterprises. In the present case, the similar transaction on the basis of which the TPO determined ALP was not with an independent enterprise and the said transaction was also with an Associated enterprise. In such circumstances, even the determination of ALP by the TPO was not proper. We, therefore, delete the addition made by the AO. Ground of the appeal of the assessee is also allowed. Issues Involved:1. Disallowance of expenses incurred on software development/up-gradation.2. Alternative claim of software development expenses as research and development expenditure.3. Non-allowance of deduction under section 80HHE of the Income-tax Act.4. Addition of Rs. 2,71,773 as consideration for transferring employees to a subsidiary.Detailed Analysis:1. Disallowance of Expenses Incurred on Software Development/Up-gradation:The assessee claimed Rs. 12,59,33,429 as revenue expenditure for software development/up-gradation. The Assessing Officer (AO) and CIT(A) treated this as capital expenditure, citing that the expenses were debited to the capital work-in-progress account and not claimed as a deduction in the profit and loss account. The Tribunal upheld this view, emphasizing that the method of accounting adopted by the assessee, which involves treating these expenses as work-in-progress and capitalizing them upon commercialization, aligns with the matching concept of accounting. The Tribunal concluded that there was no reason to deviate from this accepted method.2. Alternative Claim of Software Development Expenses as Research and Development Expenditure:The assessee argued that the software development expenses should be considered as research and development expenditure under section 35(1)(iv) of the Act, which allows deduction for capital expenditure on scientific research. The CIT(A) rejected this claim, stating that it was not made before the AO and lacked supporting evidence. The Tribunal agreed, noting that the expenses were incurred for developing software products for clients, not for scientific research. The Tribunal found no factual basis for the claim under section 35(1)(iv) and upheld the CIT(A)'s decision.3. Non-allowance of Deduction under Section 80HHE of the Income-tax Act:The assessee claimed that if a positive income was determined during assessment, a deduction under section 80HHE should be allowed. The AO and CIT(A) rejected this claim, citing non-compliance with section 80HHE(2), which requires foreign exchange realization within a prescribed time. The Tribunal directed the AO to verify the assessee's claim regarding the export turnover brought into India in convertible foreign exchange and allow the deduction if the conditions were met. For amounts not brought into India, the Tribunal instructed the AO to verify the nexus between the expenses incurred abroad and the export income.4. Addition of Rs. 2,71,773 as Consideration for Transferring Employees to a Subsidiary:The AO, based on the Transfer Pricing Officer's (TPO) report, added Rs. 2,71,773 as consideration for transferring employees to a subsidiary, Infotech US. The CIT(A) upheld this addition. The Tribunal, however, found that the TPO exceeded his jurisdiction as the transaction was not referred to him by the AO. The Tribunal also noted that the TPO's assumptions about the employees' qualifications and benefits to the transferee entity were unsupported. The Tribunal concluded that there was no necessity to determine the Arm's Length Price (ALP) for this transaction, as it would not erode the Indian tax base. The addition was deleted.Conclusion:The Tribunal partly allowed the assessee's appeal, upholding the treatment of software development expenses as capital expenditure, rejecting the alternative claim under section 35(1)(iv), and directing the AO to verify and allow the deduction under section 80HHE if conditions were met. The addition of Rs. 2,71,773 for transferring employees was deleted.