2025 (5) TMI 1417 - HC - Income Tax

Foreign exchange expenses for technical services cannot be included in export turnover under Sections 10A, 80HHE, 80M

The HC ruled on multiple substantial questions of law regarding deductions under Sections 10A, 80HHE, and 80M of the Income Tax Act. The court held that ... Computation of deduction u/s 10A and 80HHE and Section 80M - HELD THAT:- The benefit under Section 10A and Section 80HHE of the Act are two independent reliefs which the Appellant/Assessee availed independently. Section 10A of the Act was inserted in 1981. Section 10A of the Act contains a special dispensation for deduction of profit and gains from export sale of “articles” or “things” or “computer software” from the total income of a unit located in Free Trade Zone. Thus, not only freight, telecommunication charges or insurance attributable to the delivery of “articles” or “things” or “computer software” in Section 10A of the Act and “computer software” in Section 80HHE of the Act but also any expenses incurred in foreign exchange for providing technical services outside India cannot form part of “export turnover”. It is the amount received in foreign exchange for the above purpose alone and not expenses incurred in foreign exchange can be considered for determining the “export turnover” under the respective provisions. Under Section 80M of the Act, dividend income could be allowed as deduction while computing the total income which is equivalent to so much of the amount of income by way of dividends from another domestic company which does not exceed the amount of dividend distributed by the domestic company to an Assessee company. The dividend income in the hands of the Appellant/Assessee from the other domestic company could be allowed in as much the dividend income incurred by the Assessee is equivalent to the dividend distributed by such domestic company on or before the due date. The benefit u/s 10A of the Act was initially available for ten consecutive Assessment Years beginning with the Assessment Year relevant to the Previous Year in which such an undertaking began to manufacture or produce such “articles” or “things” or “computer software”. With effect from 01.04.2003 vide amendment to Section 10A of the Act by the Finance Act, 2002, the deduction under Section 10A of the Act was restricted to 90% of the profits and gains derived by an undertaking located in Free Trade Zone from export of such “articles” or “things” or “computer software”. Thus, during the period in dispute i.e., during the AY 2003-2004, the deduction was restricted to 90% of the profits and gains for the export of “computer software” from the units located in Free Trade Zone. Deduction u/s 80HHE of the Act is much wider. Section 80HHE of the Act was inserted in the year 1991 vide Finance Act, 1991 with effect from 01.04.1991. As per sub-section (1B) of Section 80HHE of the Act, an Indian Company or such person other than a company resident in India was entitled for deduction in respect of profit derived from, (i) export out of India of computer software or its transmission from India to a place outside India by any means; (ii) providing technical services outside India in connection with the development or production of computer software. During the period in dispute which pertains to the AY 2003-2004, the benefit under Section 80HHE of the Act was confined to 50% of the profit derived from export of computer software or its transmission from India to a place outside India or for providing technical services outside India in connection with the development or production of computer software. To claim deduction both u/s 10A and/or Section 80HHE of the Act, an Assessee is also required to furnish in the prescribed form along with the Return of Income filed by the Assessee, the report, as defined in the Explanation below sub-section (2) of Section 288 of the Act certifying that the deduction has been correctly claimed in accordance with the provisions of Section 10A of the Act. The expression “computer software” and “export turnover” have been defined similarly in Explanations to Section 10A and Section 80HHE of the Act. Since there is difference between manufacturing of 'computer software' and providing 'technical services', the Substantial Question of Law has to be answered in favour of the Appellant/Assessee in view of express language in Section 80HHE of the Act. Therefore, Substantial Questions of Law (ii) and (iii) are answered in favour of the Appellant/Assessee If the Appellant/Assessee was not exporting “computer software” from its unit located in Free Trade Zone, the benefit of Section 10A of the Act cannot be allowed. Therefore, deduction on balance 10% of “export turnover” which was outside the purview of Section 10A of the Act cannot be claimed separately under Section 80HHE(1)(ii) of the Act. That apart, the benefit is to be restricted to 50% of profit and gains for service provided by a Company. There is no scope for nixing the income and expenses incurred for computation of deduction under Section 10A of the Act and Section 80HHE of the Act. Therefore, Substantial Questions of Law (v) has to be answered against the Appellant/Assessee. As far as Substantial Question regarding benefits under Section 80M of the Act is concerned, based on the decision of Commissioner of Income Tax Vs State Bank of India [2003 (3) TMI 88 - BOMBAY HIGH COURT] makes clear that deduction under Section 80M of the Act during the period in dispute deduction was confined to dividend received by a domestic company from another domestic company. This has been remitted back. If the amount was not realized, benefit cannot be claimed. Therefore, Substantial Question of Law No. (i) is answered against the Appellant/Assessee. With regard to Substantial Question of Law (iv), since the issue has been remitted back as far as Substantial Question of Law (iv) is concerned, we are refraining to answer the same. In the light of the decisions of this Court in the Appellant's/Assessee’s own case (cited supra) the computation have to be made by the AO after ascertaining whether indeed the Appellant/Assessee had indeed exported computer software as is contemplated in Section 10A/ 80HHE(1)(i) of the Act or had indeed provided technical services outside India under Section 80HHE(1)(ii) of the Act. ORDER “Question No. (i):- Whether on the facts and in the circumstances of the case, the Tribunal was right in law in rejecting the contention of the appellant concerning the computation of deduction under Section 10A and 80HHE? Answer:- Answered against the Appellant/Assessee Question No. (ii):- Whether on the facts and in the circumstances of the case, the Tribunal was right in law in upholding the exclusion of expenditure incurred in foreign currency in relation to on-site software development from the purview of export turnover for the purpose of computation of deduction under Section 10A and 80HHE of the Income Tax Act? Answer:- Answered in favour of the Appellant/Assessee Question No. (iii):- Whether on the facts and in the circumstances of the case, the Tribunal was right in law in not noting the distinction between 'manufacture of computer software' and the provision of 'technical services'? Answer:- Answered in favour of the Appellant/Assessee Question No. (iv):- Whether on the facts and in the circumstances of the case, the Tribunal was right in law in remitting back to the Assessing Officer without giving its finding on the issue relating to the exclusion of the component of unrealized sale proceeds both from export turnover and total turnover? Answer:- Answered against the Appellant/Assessee Question No.(v):- Whether on the facts and in the circumstances of the case, the Tribunal was right in law in setting aside the order of the Assessing Officer without giving its finding on the issue relating to deduction under Section 80HHE towards the balance 10% of the profits not available as deduction under Section 10A? And Answer:- Answered against the Appellant/Assessee Question No.(vi):- Whether on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the dividend income from other mutual funds are not akin to dividend income from Unit Trust of India and do not qualify as income received from domestic company for deduction under Section 80M?” Answer:- Answered against the Appellant/Assessee 1. ISSUES PRESENTED and CONSIDEREDThe Court considered the following core legal questions arising from the tax appeals:(i) Whether the Tribunal was correct in law in rejecting the appellant's contention regarding the computation of deduction under Sections 10A and 80HHE of the Income Tax Act;(ii) Whether the Tribunal was correct in law in upholding the exclusion of expenditure incurred in foreign currency related to on-site software development from the export turnover for deduction computation under Sections 10A and 80HHE;(iii) Whether the Tribunal erred in law by failing to recognize the distinction between the 'manufacture of computer software' and the provision of 'technical services';(iv) Whether the Tribunal was correct in remitting the matter back to the Assessing Officer without deciding on the exclusion of unrealized sale proceeds from export and total turnover;(v) Whether the Tribunal was correct in setting aside the Assessing Officer's order without deciding on the issue of deduction under Section 80HHE for the balance 10% profits not deductible under Section 10A;(vi) Whether the Tribunal was correct in holding that dividend income from mutual funds is not equivalent to dividend income from Unit Trust of India and thus does not qualify as income from a domestic company for deduction under Section 80M.2. ISSUE-WISE DETAILED ANALYSISIssue (i): Computation of Deduction under Sections 10A and 80HHEThe legal framework involves Sections 10A and 80HHE of the Income Tax Act, which provide deductions for profits and gains from export of computer software and related services. Section 10A applies to units in Free Trade Zones (FTZ) and allows deduction of profits from export of 'articles' or 'computer software,' restricted to 90% of profits post-2003 amendment. Section 80HHE allows deduction of 50% of profits from export of software or technical services.Precedents include decisions by this Court and the Supreme Court, notably the ruling in CIT vs. HCL Technologies (2018) which clarified the formula for computing deduction under Section 10A, emphasizing that expenses excluded from export turnover must also be excluded from total turnover to avoid illogical results.The Court observed that the appellant claimed large expenses incurred in foreign currency and deductions under both Sections 10A and 80HHE. The Assessing Officer disallowed certain expenses, particularly those related to foreign currency expenditure for on-site software development, treating them as technical services excluded from export turnover.The Tribunal partly upheld these disallowances but remitted some issues back to the Assessing Officer. The Court noted duplication and inconsistency in the Assessing Officer's computations and emphasized the need for clear proof that the appellant indeed exported 'computer software' as defined.The Court applied the law to facts by requiring the Assessing Officer to reassess whether the appellant's activities constituted export of software or provision of technical services, as the distinction affects eligibility for deductions. The Court found the Tribunal's refusal to fully decide on the computation issues premature and remitted the matter for fresh determination.Competing arguments included the appellant's reliance on earlier favorable decisions and the Department's challenge based on the nature of expenses and compliance conditions. The Court favored a fact-based inquiry rather than blanket exclusion or inclusion.Conclusion: The Tribunal's rejection of the appellant's contention on deduction computation was not entirely correct; the matter requires reassessment with proper factual determination.Issue (ii): Exclusion of Foreign Currency Expenditure from Export TurnoverThe statutory definitions in Sections 10A and 80HHE exclude freight, telecommunication, insurance, and expenses incurred in foreign exchange for providing technical services outside India from 'export turnover.' The Court relied on the Supreme Court's decision in CIT vs. HCL Technologies, which held that such expenses must be excluded from both export turnover and total turnover for a logical and workable formula.The appellant contended that on-site software development expenses do not amount to technical services and thus should not be excluded. The Tribunal upheld the exclusion, but this Court observed that the distinction between software development and technical services must be examined on the facts of the contract and nature of services rendered.The Court noted that the Tribunal failed to consider whether the technical services were rendered on a standalone basis or as an integral part of software development, an essential factual inquiry.Conclusion: The Tribunal's upholding of exclusion of foreign currency expenditure was affirmed in principle but subject to factual verification. The Court answered this question in favor of the appellant, emphasizing the need to distinguish between software export and technical services.Issue (iii): Distinction Between Manufacture of Computer Software and Provision of Technical ServicesThe Court examined the statutory definitions and prior rulings, including this Court's earlier decisions, which recognized that software development and technical services are distinct activities. The appellant argued that the Tribunal erred in treating them as identical.The Court emphasized that the nature of the contract and scope of work must be scrutinized to determine whether technical services were rendered independently or as part of software development.The Tribunal's failure to make this distinction was found to be legally incorrect. The Court held that the appellant's claim for deduction under Section 10A and 80HHE depends on this distinction.Conclusion: The Court answered this issue in favor of the appellant, holding that the Tribunal erred in not recognizing the distinction between manufacture of software and provision of technical services.Issue (iv): Remittance to Assessing Officer Without Deciding on Unrealized Sale ProceedsThe Tribunal remitted the issue of exclusion of unrealized sale proceeds from export and total turnover back to the Assessing Officer without giving a finding. The Court noted that this issue is factual and requires detailed inquiry.Conclusion: The Court refrained from deciding this issue, leaving it to the Assessing Officer's fresh determination. The question was answered against the appellant in terms of the Tribunal's remand.Issue (v): Deduction Under Section 80HHE for Balance 10% Profits Not Deductible Under Section 10AThe appellant sought deduction under Section 80HHE for the 10% of profits not eligible under Section 10A (which allows only 90% deduction post-2003). The Court examined precedents, including the Division Bench decision in Commissioner of Income-tax vs. Ambattur Clothing Ltd., which held that such deductions cannot be claimed separately.The Court held that the balance 10% of profits not deductible under Section 10A cannot be claimed under Section 80HHE, which is limited to 50% of profits from eligible exports or technical services.Conclusion: The Tribunal was correct in setting aside the Assessing Officer's order without allowing such deduction. This issue was answered against the appellant.Issue (vi): Deduction Under Section 80M for Dividend Income from Mutual FundsSection 80M allows deduction for dividend income received from another domestic company, provided it does not exceed the dividend distributed by the domestic company. The appellant claimed deduction for dividends received from mutual funds.The Court relied on the Bombay High Court decision in Commissioner of Income Tax vs. State Bank of India, which held that dividends from Unit Trust of India qualify, but dividends from other mutual funds do not qualify as income from a domestic company under Section 80M.The Tribunal remitted this issue for fresh consideration, and the Court upheld this approach, noting that mutual fund dividends are not akin to dividends from domestic companies for Section 80M purposes.Conclusion: The issue was answered against the appellant, with remand for reassessment.3. SIGNIFICANT HOLDINGSThe Court made the following crucial legal determinations:'The formula for computation of the deduction under Section 10A of the Act would be as follows: Export Profit = total profit of the Business x Export turnover as defined in Explanation 2(IV) of Section 10A of the IT Act + domestic sale proceeds.''If the deductions on freight, telecommunication and insurance attributable to the delivery of computer software under Section 10A of the IT Act are allowed only in Export Turnover but not from the Total Turnover, then, it would give rise to inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the respondent which could have never been the intention of the legislature.''Expenses incurred in foreign exchange for providing the technical services outside shall be allowed to exclude from the total turnover.''The Tribunal erred in not noting the distinction between manufacture of computer software and provision of technical services, which are two distinct activities under the Income Tax Act.''The balance 10% of profits not deductible under Section 10A cannot be claimed separately under Section 80HHE.''Dividend income from mutual funds other than Unit Trust of India does not qualify as income from a domestic company for deduction under Section 80M.'The Court's final determinations on each issue were:Issue (i): Against the appellant; remand for reassessment on deduction computation.Issue (ii): In favor of the appellant; exclusion of foreign currency expenditure upheld subject to factual inquiry.Issue (iii): In favor of the appellant; distinction between software manufacture and technical services recognized.Issue (iv): Against the appellant; remand for fresh decision on unrealized sale proceeds.Issue (v): Against the appellant; no separate deduction under Section 80HHE for balance 10% profits.Issue (vi): Against the appellant; dividends from mutual funds not qualifying under Section 80M.