The interest rate at which the Appellant’s loan cannot be used as a baseline for the AE’s loan

Fact and issue of the case

The present appeal is directed against the Assessment Order dated, 15/01/2014, passed under Section 143(3) read with Section 144C(13) of the Income Tax Act, 1961 [hereinafter referred to as „the Act’], as per directions, dated 31/12/2013, issued by the Dispute Resolution Panel-III, Mumbai (hereinafter referred to as „the DRP’) under Section 144C(5) of the Act while disposing Objection Number 161 pertaining to Assessment Year 2009-10.

The Grounds of Appeal raised by the Assessee are as under:

On the fats and in the circumstances of the case and in law, the learned Assessing Officer, relying on the direction of Dispute Resolution Panel – III, Mumbai [“DRP”], erred in making addition of Rs. 2,72,430/- by way of adjustment to the transfer price of the international transaction entered in to by the appellant with its associated enterprise by invoking the provisions of Section 92CA(3) of the Act.

On the facts and in the circumstances of the case and in law, the learned Assessing Officer, relying on the direction of DRP, erred in treating the onsite software development services as “supply of manpower” and “body shopping” and not as “export of software” so as to reduce the claim of the appellant under Section 10A of the Act by Rs. 172,94,09,811/-.

Without prejudice to Ground no.2, on the facts and in the circumstances of the case and in law, the learned Assessing Officer, relying on the direction of DRP, erred in adopting the proportion of software development costs incurred outside India to quantify and disallow the claim attributable to “supply of manpower” / “body shopping” as aforesaid.

Without prejudice to Ground no. 2 and 3, on the facts and the circumstances of the case and in law, the learned Assessing Officer, relying on the direction of DRP, erred in holding that the onsite software development services rendered by the appellant to its customers do not form part of exports of the Undertaking comprised in the Software Technology Park Units (“STPI Units”) and on that basis holding that in any case the deduction under Section 10A needed to be recomputed and reduced to Rs. 151,70,24,446/-.

Without prejudice to Ground no. 2, 3 and 4, of the facts and in the circumstances of the case and in law, the learned Assessing Officer, relying on the direction of DRP, erred in holding that communication charges of Rs. 9,27,34,738/-incurred in Indian Rupees and expenditure in foreign currency of Rs. 8,82,15,41,969/- are liable to be excluded from the export turnover for the purpose of computing the deduction under Section 10A of the Act.

The appellant company craves leave to add, to, to amend, to alter or modify any or all the aforesaid grounds of appeal.”

The Appellant has also raised the following additional ground of appeal vide letter, dated 23/06/2017:

“Without prejudice to grounds 2 and 3, on the facts and in the circumstances of the case and in law, the Assessing Officer be directed to adopt actual profitability of onsite work instead of determining the profit by adopting the proportion of software development cost incurred outside India for calculation of disallowance u/s 10A attributable to “supply of manpower”/”body shopping” and also grant DIT relief of Rs. 11,52,25,628/- in respect of the same.”

The relevant facts in brief are that the assessee filed return of income for the Assessment Year 2009-10 on 26.09.2010 declaring total income of INR 30,25,87,218/- under normal provisions of the Act which was revised on 29.03.2011. In the revised return of income, the Appellant declared total income of INR 32,29,45,823/-under normal provision of the Act. The case of the Appellant was selected for scrutiny and noticed under Section 143(2) of the Act was issued.

During the assessment proceedings, the Assessing Officer noted that the Appellant has entered into the international transactions with its Associated Enterprises (AEs) and therefore, reference was made to the Transfer Pricing Officer (“in short TPO”) under Section 92CA(1) of the Act on 21.09.2010. The TPO, vide order, dated 26.12.2012 passed under Section 92CA(3) of the Act, proposed transfer pricing adjustment to INR 2,72,430/- in respect of interest received by the Appellant on loan advanced by the Appellant to its AE. The above transfer pricing adjustments were incorporated in the Draft Assessment Order, dated 28.03.2013.

In the Draft Assessment Order, the Assessing Officer also proposed disallowance of INR 172,94,09,811/- out of aggregate deduction of INR 263,04,15,538/- claimed by the Appellant under Section 10A of the Act on the ground that the Appellant was engaged in providing services which were in the nature „Body Shopping‟ as opposed to export of software as contended by the Appellant. The Assessing Officer, without prejudice to the aforesaid disallowance of deduction under Section 10A of the Act, observed even if the Appellant is considered to be engaged in the business of export of software, the revenue earned from onsite services provided by the Appellant cannot be considered as export of software from India derived from STPI Units located in India. Therefore, proposed disallowance of 53.40% of the deduction claimed by the Appellant under Section 10A of the Act in proportion of Software Development Expenses plus Administration & Another Expenses incurred by the Appellant outside India aggregating to INR 871,75,78,841/- and the total Software Development Expenses plus Administration & Another Expenses incurred by the Appellant aggregating to INR 1632,29,65,745/- and computed the amount of disallowance as under:

S.No.	Particulars	Amount of Disallowance (INR)
1	Profit derived from overseas branches not considered as export services from India I.e. 53.40% of [Business Income of eligible units as per return Rs. 281,96,61,057- Interest Income of Rs. 2,51,16,781 as below ]	149,22,86,643
2	Interest Income excluded from export profits	2,51,16,781
3	Depreciation allowed on software expenses treated as capital expenditure in earlier years	(3,78,978)
Total disallowance out of exemption claimed u/s 10A		151,70,24,446

Observation of the court

We have considered the rival submission and perused the material on record. The Learned Senior Counsel appearing for the Appellant had submitted that the Appellant was no engaged in export of software and was providing software development services. The telecommunication charges were not related to the delivery of software outside India and therefore, not be excluded from the „Export Turnover‟ as defined in Explanation 2(iv) to Section 10A of the Act for the purpose of determining the quantum of deduction under Section 10A of the Act. As regards, the expenses incurred in foreign currency outside India, the stand of the Appellant before the Assessing Officer and CIT(A) was that the same are not to be excluded that the Appellant has not provided independent technical services. Per Contra, the Learned Departmental Representative relied upon the definition of „Export Turnover‟ as contained in Explanation 2(iv) of Section 10A of the Act and the order passed by the Assessing Officer and the CIT(A).

While adjudicating Ground No.1 and 2 above, we have accepted the contention of the Appellant that the Appellant was engaged in providing onsite software development services after examining the scope services of the agreements placed before us. Therefore, we accept the contention advanced on behalf of the Appellant that the Appellant is not engaged in export of computer software and has provided software development services to its clients outside India. Section 10A provides for deduction in respect of profit and gains derived by an undertaking, inter alia, from export of computer software. The Appellant is eligible to claim deduction under Section 10A of the Act since Explanation 3 to Section 10A clarifies that profits and gains derived from the services of development of computer software shall be deemed to be the profits and gains derived from the export of computer software outside India. Explanation 2(iv) to Section 10A provides for exclusion of, inter alia, telecommunication charges attributable to delivery of computer software outside India, and since the telecommunication expenses of INR 9,27,34,738/- are related to provision of software development services and not to delivery of computer software outside India, the same are, in our view, not required to be excluded from the „Export Turnover‟. However, as regards the foreign currency expenses aggregating to INR 8,82,15,41,969/- are concerned, we are of the view the same have to be excluded from the „Export Turnover‟ in case the same are connected with the provision of technical services outside India. The Appellant has provided the following break-up of the aforesaid foreign currency expenses of INR 8,82,15,41,969/-:

(a) Overseas Staff Costs – INR 5,41,21,70,046/-,

(b) Foreign Travel – INR 15,26,63,738/-,

(d) Others (includes overseas office expenses) – INR 3,25,31,33,585/-.

The Appellant has admittedly provided software development services to clients outside India which are in the nature of technical services as is clear on perusal of scope of services contained in the agreements on which reliance was placed by the Appellant to establish that the Appellant is engaged in providing onsite services for development of computer software for its clients outside India. However, neithern Assessing Officer nor the CIT(A) has returned a finding regarding nexus between the foreign currency expenses of INR 8,82,15,41,969/-, and rendering of technical services outside India. Though the Appellant has contended that the same have not been incurred in relation to provision of technical services outside India, there is nothing on record to determine the nature of expenses. The head under which the expenses have been aggregated is also not determinative. Accordingly, in the aforesaid facts and circumstances we deem it appropriate to remand this issue to the file of the Assessing Officer to identify and exclude from „Export Turnover‟ the expenses incurred in foreign exchange which are connected to providing services of software development outside India for the purpose of computing deduction under Section 10A of the Act. It is clarified that while computing the quantum of deduction under Section 10A of the Act the amount excluded from „Export Turnover‟ by the Assessing Officer shall also be excluded from „Total Turnover‟ as per the judgment of the Hon‟ble Supreme Court in the case of CIT, Central – III Vs. HCL Technologies Limited: 404 ITR 719 SC. In terms of the aforesaid, Ground No. 5 raised by the Appellant is partly allowed.

33. In result, the present appeal preferred by the Assessee is partly allowed.

Order pronounced on 30.05.2023.