2015 (10) TMI 2062 - HC - Income Tax

Software development income qualifies for deduction under Section 10A

Commissioner of Income-tax-III, Bangalore Versus Mphasis Software & Service India (P.) Ltd.

The court held that income earned by the assessee through 'on-site' development of software by its Associated Enterprise (AE) is eligible for deduction ... Eligibility for deduction under Section 10A - income earned by the assessee through the development of the software by the Associated Enterprise - sole ground for denying the benefit of section 10A is that 'on-site' development of computer software has not been executed by the assessee itself through its own personnel - Held that:- The entire 'on-site' work has been sub-contracted to the AE. The MSA provides for the AE to work under total supervision and control of the assessee. The software to be produced by the assessee during its 'on-site' development has to be as per the specifications given by the assessee. The AE has no concern or direct dealing with the end customer. The assessee provides all relevant information and inputs to the AE on behalf of the end customer. The AE is admittedly answerable to the assessee and not the end customer. In such nature of the work which is carried on by the AE on behalf of the assessee, it cannot be said that there is no nexus between 'off-shore' development and 'on-site' development. In view of the above we are of the opinion that in the facts of the present case, the income earned by the assessee through 'on- site' development of software by the AE on behalf of the assessee, would be eligible for deduction under Section 10A of the Act - Decided in favour of the assessee. Issues Involved:1. Eligibility of deduction under Section 10A of the Income Tax Act, 1961 for income earned from sub-contracted software development work.2. Interpretation of Section 10A and its applicability to 'on-site' work performed by Associated Enterprises (AEs).3. Compliance with conditions laid out in sub-section (2) of Section 10A.4. Consideration of Circulars issued by the Central Board of Direct Taxes (CBDT) in the context of Section 10A.Issue-Wise Detailed Analysis:1. Eligibility of Deduction under Section 10A for Sub-contracted Work:The primary question was whether an assessee could claim deduction under Section 10A for income derived from software development work sub-contracted to an agency outside India. The court examined the nature of the work carried out by the assessee and its AE. It was found that the assessee performed 'off-shore' activities in India and sub-contracted 'on-site' activities to its AE. The Tribunal had ruled that the income earned from such 'on-site' work was eligible for deduction under Section 10A, which the High Court upheld, stating that the supervision and control of the work remained with the assessee.2. Interpretation of Section 10A and Applicability to 'On-site' Work:The court analyzed Section 10A, including Explanation-3, which clarifies that profits from 'on-site' development of computer software outside India shall be deemed as profits from export of software. The court noted that the main section does not specify that 'on-site' work must be performed by the assessee's personnel. Therefore, it concluded that denying the benefit of Section 10A merely because the 'on-site' work was done by AE's personnel would be incorrect. The court emphasized that the beneficial nature of Section 10A should be interpreted liberally once the conditions are fulfilled.3. Compliance with Conditions in Sub-section (2) of Section 10A:The Revenue argued that the conditions in sub-section (2) were not met, particularly that the production or manufacture should occur in a free trade zone. The court, however, read the entire section in conjunction with Explanation-3 and concluded that 'on-site' development outside India, supervised and controlled by the assessee, also qualifies for the deduction. The court rejected the argument that the benefit is site-specific and not project-specific.4. Consideration of CBDT Circulars:The court reviewed Circular No. 694 dated 23.11.1994, which clarified that software developed at the client's site abroad by a unit in an EPZ/EOU/STP should not be denied tax holiday under Section 10A. The court found this Circular to be in favor of the assessee, as it supported the view that the software product remains the assessee's product even if developed on-site by AE under the assessee's supervision and control. The court also noted that Circulars cannot override the provisions of the Act.Conclusion:The court held that the income earned by the assessee through 'on-site' development of software by its AE is eligible for deduction under Section 10A. The substantial question of law was answered in favor of the assessee, and the appeals were dismissed.