Software development charges must be excluded from both export and total turnover for Section 10A deduction calculations

Commissioner of Income Tax, Central-III Versus HCL Technologies Ltd.

Commissioner of Income Tax, Central-III Versus HCL Technologies Ltd. - [2018] 404 ITR 719 (SC), 2018 (16) SCC 709 Issues Involved:
1. Whether software development charges should be excluded while calculating the deduction under Section 10A of the Income Tax Act, 1961, as expenses incurred for technical services provided outside India.

Detailed Analysis:

Issue 1: Exclusion of Software Development Charges for Technical Services Outside India

Facts:
The Respondent, a company engaged in the development and export of computer software, claimed deductions under Section 10A of the Income Tax Act, 1961 (IT Act). The Assessing Officer (AO) held that software development charges were expenses for technical services provided outside India and estimated that 60% of these charges were for such services. The Commissioner of Income Tax (Appeals) [CIT (Appeals)] reduced this to 10%. The Income Tax Appellate Tribunal (ITAT) allowed the Respondent's appeal, and the High Court upheld this decision.

Arguments:
- Revenue's Argument: The Revenue argued that the term 'total turnover' is not defined under Section 10A, and hence, its ordinary meaning should be adopted. The Revenue contended that expenses like freight, telecommunication, and insurance should not be excluded from the total turnover for calculating deductions under Section 10A.
- Respondent's Argument: The Respondent argued that export turnover, as defined in Section 10A, does not include expenses like freight, telecommunication, and insurance attributable to the delivery of goods outside India. Therefore, these expenses should also be excluded from the total turnover to maintain consistency in the formula for computing deductions.

Discussion:
The Supreme Court noted that the term 'total turnover' is not defined in Section 10A, but it is defined in Section 80HHC and 80HHE of the IT Act. The Court emphasized that the definition of 'total turnover' in these sections should not be imported into Section 10A. The Court highlighted that the purpose of Section 10A is to encourage new business undertakings in free trade zones by providing suitable deductions.

The Court observed that the Respondent was engaged in software development, which sometimes required activities to be carried out at the client's site outside India. The AO failed to provide evidence that the Respondent was providing technical services independent of software development. The CIT (Appeals) also did not find conclusive evidence but still estimated 10% of software development charges as expenses for technical services outside India.

Judgment:
The Supreme Court held that the definition of 'total turnover' under Sections 80HHC and 80HHE should not be applied to Section 10A. The Court stated that if expenses are excluded from the export turnover, they should also be excluded from the total turnover to avoid an illogical and unjust result. The Court cited the principle of harmonious construction and previous judgments, including CIT vs. Tata Elxsi Ltd., to support this view.

The Court concluded that expenses for freight, telecommunication, and insurance attributable to the delivery of software outside India should be excluded from the total turnover. Similarly, expenses incurred in foreign exchange for providing technical services outside India should also be excluded from the total turnover.

Conclusion:
The Supreme Court dismissed the appeals, holding that the exclusion of software development charges for technical services outside India is justified under Section 10A. The Court emphasized that the formula for calculating deductions should be logical and consistent, ensuring that expenses excluded from export turnover are also excluded from total turnover.