Company formed by reconstruction cannot be qualified for claiming deduction under sec 10A

IN THE INCOME TAX APPELLATE TRIBUNAL

“C” BENCH: MUMBAI

BEFORE SHRI R.S. SYAL, ACCOUNTANT MEMBER

AND SHRI R.S. PADVEKAR, JUDICIAL MEMBER

ITA.2832/Mum/2009

(Assessment Year: 2005-06)

ITA.957/Mum/2010

(Assessment Year: 2006-07)

ITA.4306/Mum/2010

(Assessment Year: 2007-08)

Income-tax Officer Wd.10 (3) (4),

Room No.452, Aayakar Bhavan,

4th Floor, M.K. Marg,

Mumbai -400 710.....…. Appellant

Vs

Caliber Point Business Solutions Ltd.,

Bldg. No.3, MBP, TTC Indl. Area,

Sector-2, Mahape,

Navi Mumbai -400 710.....… Respondent

PAN: AACCC 3705 H

Appellant by: Shri A.C. Tejpal

Respondent by: Shri Beharilal

Date of Hearing: 18.01.2012

Date of Pronouncement: 14.03.2012

O R D E R

PER R.S. PADVEKAR, JM:

This batch of three appeals of the same assessee are filed by the revenue challenging the respective impugned orders of the Ld. CIT (A), Mumbai for the A.Ys. 2005-06, 2006-07 & 2007-08 respectively. The issues as well as facts are identical and hence, these appeals are disposed of by this common order.

2. We first take appeal for the A.Y. 2005-06 being ITA No.2832/M/2010.

3. The first issue is whether Ld. CIT (A) is justified in allowing the deduction u/s.10A to the assessee when the same was denied by the A.O. on the reason that the assessee undertaking was formed by ‘splitting and reconstruction’ of existing undertaking.

4. The facts which revealed from the records are as under. The assessee company is engaged in the business of providing business process management, transitioning services, BPO services to its clients. The assessee is carrying out the said activity from its unit at Navi Mumbai as Software technology Parks (STP). The assessee is wholly owned subsidy of M/S. Hexaware Technologies Ltd. (in short referred to as HTL). The HTL appellant company is engaged also in software development and related services and it has been operating through registered STP and also eligible for deduction u/s.10A of the Act. The assessee’s case for the A.Y. 2005-06 was selected for scrutiny and assessment was completed u/s.143(3). The A.O. has noted that the assessee was incorporated on 14th May, 2004 and A.Y. 2005-06 is first year of its operation. The assessee had claimed deduction of Rs.1,22,23,849/- u/s.10A of the Act. The A.O. has a serious reservation for allowing the claim of deduction to the assessee u/s.10A of the Act. The A.O. sought the explanation of the assessee to justify the claim of deduction u/s.10A. The A.O. has noted that the

assessee company is 100% subsidiary of M/s. Hexaware Technologies Ltd., India. M/s. Hexaware Technologies Inc., USA is another subsidiary of the parent company. The assessee has

transactions with the holding company as well as fellow subsidiary. As noted by the A.O Mr. Ashok S. Bildikar is a President and Executive Director and is a Key Management Personnel. The A.O. has given the chart on page no.5 of the assessment order showing the transactions between the assessee holding company and fellow subsidiaries which is as under:

5. The A.O. has also noted that there are transactions with M/s. Hexaware Technologies Ltd. Inc., USA for data entry jobs to the extent of Rs.2,80,49,630/- and the assessee had also business transaction with M/s. Hexaware Technologies Ltd., parent company, data entry for Pay roll Project to the extent of Rs.14,62,440/-. The A.O. has noted that the parent M/s. Hexaware Technologies Ltd. is also in the business of the software development and the said company is claiming deduction u/s.10A of the Act. We may like to put on record that as per the data given by the A.O. in the assessment order apart from transactions with parent company and associated subsidy, the assessee has business transactions with the other companies also. As noted by the A.O. the parent company, M/s. Hexaware Technologies Ltd. supports processing and development of software on behalf of the assessee company. The A.O. disbelieved the explanation of the assessee that since business of BPO services is a new and upcoming field viz. M/s. Hexaware Technologies Ltd. parent company decided to form a new company i.e. the assessee company. The A.O. has noted that as per the data entry service agreement between the assessee and East Division India Corporation the assessee is BPO arm of M/s. Hexaware Technologies Ltd. It appears that in some of the agreements between the assessee and its other clients there is a Solutions Ltd. reference of the parent company that is M/s. Hexaware Technologies Ltd. The A.O., therefore, came to the conclusion that due to the capacity of the M/s. Hexaware Technologies Ltd. for providing BPO services, the assessee had undertaken projects of BPO. The A.O. also rejected the contention of the assessee that software development and BPO are two different IT activities. In the opinion of the A.O., BPO services are part and parcel of software business and both activities cannot work in isolation. The A.O. examined the balance sheet of the assessee company and has noted that the assessee issued 84 lakhs equity shares of Rs.10/- each fully paid up and raised the capital of Rs.8,40,00,000/- and entire capital is funded by holding company M/s. Hexaware Technologies Ltd. and which is a nominee. The A.O. has also took the cognisance of the fact that holding company has stood as a guarantor for the amount of Rs.6 lakhs (nature not mentioned in the assessment order). In sum and substance in view of the A.O. the assessee company has been formed by splitting or reconstruction of existing company or company’s business already in existence. For coming to the said conclusion the A.O. given the following reasons:

6) Splitting, reconstruction and business already in existence:

In the light of the above facts, the words i) splitting ii) reconstruction & iii) business already in existence i.e. whether the same business was split and the new undertaking formed is discussed as under

6.1) The concept of business already in existence, invariably revolves around the following matters for consideration.

(i) unity of control and management: in the instant case, the share capital has been introduced by the holding company i.e. M/s. Hexaware Technologies Ltd., and stood as guarantors to the loans sanctioned to the assessee company. Staff from the parent company have been deployed for execution of projects and salaries re-imbursed.

(ii) conduct of the business through the same agency: this is established through subcontracting and re-imbursement of expenses by the parent company to the assessee company. The role played by the parent company in getting the project for the assessee company cannot also be undermined.

(iii) the inter-relation of the business: the assessee company owes its existence to the holding company being a 100% subsidiary. Also, the inter-related transactions prove beyond doubt that there is inter-relation, inter-linking and interdependence by the assessee company over its subsidiaries.

(iv) the employment of same capital: The financial control, resources supplied and infrastructure support of the parent company has been corroborated by the facts as discussed above.

(v) the employment of same staff to run the business: expenses towards payment of salary to the employees of the assessees’ parent company have been re-imbursed by the assessee. Related clauses covering this aspect is also seen in contracts entered with respect of its client. For e.g., in the case of one client, “Imagemax Inc” and also, “Cardinal Health”, the facilities of infrastructure and other resources have been provided by M/s. Hexaware Technologies Ltd. This clearly points to the fact of employment of the parent company’s staff and other resources for carrying out activities of the assessee.

(vi) the nature of the different transactions: it has already been found that the assessee company is in the same business as the parent company, viz.Mis. Hexaware Technologies Ltd i.e. development of software for export; and

(vii) the possibility of one business being closed without affecting the texture of the other business: there is interdependence and interconnection between the assessee and its parent company. Based on the facts and circumstances, as discussed above, it is clear that both the companies are in the same business, and there is a strong possibility of the business of the assessee getting affected severely, if the same stands withdrawn.”

6. In the opinion of the A.O. if the business of the undertaking is formed by splitting up or reconstruction then the undertaking cannot be qualified for claiming the deduction. To support the conclusion the A.O. has observed that the assessee has transferred its plant and machinery from its fellow subsidiary i.e. M/s. Hexaware Technologies Ltd. Inc., USA & M/s. Hexaware Technologies Ltd. The A.O. has noted that the assessee company is using previously used assets and by using the said asset the assessee’s undertaking has been formed. The A.O., therefore, denied the deduction of Rs.1,22,23,849/- claimed by the assessee u/s.10A of the Act. The A.O. has given alternate reasons for restricting the deduction u/s.10A. The assessee challenged the assessment order on this issue before the first appellate authority. On the issue of formation by splitting or reconstruction, Ld. CIT (A) did not agree with the A.O. The operative part of the findings of the Ld. CIT (A) are as under:

“3.2 The first is the fact that both the parent company, M/s. Hexaware Technologies Limited (HTL) and the appellant are entitled to deduction u/s.1OA till A.Y.2010-11. Thus even if the HTL would have done the new business in its existing undertaking still it would have been entitled to deduction u/s.1OA of the Act till A.Y.2010-11 i.e. the same year till which the appellant is also entitled. Thus there appears to be no gain on their part to resort to such arduous tax planning by splitting or reconstruction. The intention to avoid tax in this manner is absent.

3.3 The second issue is whether the business of software development and BPO are one and the same thing as held by the AO. The parent company is in the business of Software development while the appellant is in business of BPO, software development involves 1aunchg of new software products under contract with customers. It also involves implementation / customization of services rendered to services received for development of software. M/s.Hexaware Technology Limited is a global provider of It listed on the Bombay Stock Exchange and National Stock Exchange. The company has extensive experience in managing large IT applications in real time as well as providing high value services around packaged enterprise application such as SAP and Peoplesoft. Its global operations are located in North America, Europe and Asia Pacific and its offshore development are assessed at SEI-CMMI Level5, and are also ISO 9001:2000 and Tick IT certified whereas BPO’s also popularly known as Call Centers are part of Information Technology Enabled Services (ITES).

3.4 The software development and customization are high end services Research and Intellectual Capital whereas the ITES-BPO are low end services involving routine, repetitive work with little or no intellectual capital. The name Hexaware Technology with emphasis on ‘Technology’ and Caliber Point Business Solutions’ with emphasis on ‘Business Solution’ is relevant.

3.5 The revenue from Software Development Services are, therefore, naturally higher as they are on value added services whereas BPO is at the lower end of the value chain fetching less price.

Thus, it is an erroneous assumption on the part of the AO that both the Software Development in which the parent company HTL is involved and the BPO sector to which the appellant is engaged is one and the same business / services.

3.6 Reverting back to the factual issue as to whether there is splitting or reconstruction of the parent company and transfer of assets, it is observed that the phrases ‘splitting up’ or ‘reconstruction’ which are used in the 10A have been used in Chapter –IVA of the Income-tax Act, 1961 right from the days of Section 15C to 8OE, Section 80J, Section 80J, Section 84, Section 80I and all its successive sections. However, these phrases have not been defined in any of these sections including Section 10A. A splitting up refers to a situation where a business carried on is segmented and thereafter carried out in two or more undertakings. Splitting up of a business would also involve something similar. It means that two businesses were an integral part earlier. In a splitting up, the integrity, of the existing business is impaired. Applied to the facts of this case, the parent company is in the business of software development and at no point was doing BPO business. It started its subsidiary (appellant) to do the BPO business. The two businesses are not integral similar and by starting its BPO business are not integral, similar and by starting its BPO business under the name and style of Caliber Point Business Solutions Limited the integrity of its existing business of software development was not imparted.

3.7 The term ‘Reconstruction’ implies that the existing business emerges in an altered form and the identity of the existing business is lost to that extent. The establishment of the new unit has its moorings in the destabilization of the existing business. Applied to the facts of this case, the identity of the parent company continues and there no de-stabilization of that existing business of software development. Both the appellant and the AO have relied on the landmark judgment of the Supreme Court in Textile Machinery Corporation Ltd. vs. CIT (1977) 107 ITR 195 and I quote the operative portion:

“It is not every alteration in mode, method or scope of business activities and not every transfer of assets from one unit to another that will involve reconstruction. The answer, in every particular case, depends upon the peculiar facts and conditions of the new industrial undertaking on account of which the assessee claims exemption. Trade and industry do not run in earmarked channels, particularly so in view of manifold scientific and technological developments. There is a great scope for expansion of trade and industry. Every new creation in business is an expansion and advance of some kind. The true test is not whether new industrial undertaking connotes expansion of existing business but whether it is all the same a new and identifiable undertaking separate and distinct from existing business. In order that a new ‘undertaking is not formed out of an already existing business, there must be a new emergency of a physically separate industrial unit. This unit may exist on its own as a viable unit. ‘Reconstruction’ of a business or of an industrial undertaking necessarily involves the concept that the original business or undertaking does not cease to function. Art undertaking of some definite kinds is carried on and it is not desirable to kill that undertaking. Instead it is desirable that the undertaking is preserved in some form; and to do so, the form is altered so that the persons now carrying it on will substantially continue to carry it on in the same manner.”

3.8 Applied to the facts of this case, the appellant business of BPO is a new and identifiable undertaking separate and distinct from existing business. The appellant had provided a number of documents before the AO as well as at the appellate stage to highlight this fact, which was ignored. These documents, evidences find mention in the appellate order while incorporating the appellant’s submissions and do not require repetition here.

3.9 As regards the related issue of transfer of assets, it is observed only 3 laptops / PC, one printer and two motor cars being used by the five employees of the parent company was transferred. This is negligible when compared with the fact that the appellant employed more than 250 employees in the year. A new undertaking cannot be formed by transfer of such minor and inconsequential amount of assets. The AO is wide off the mark in holding that the transfer of assets is of such a magnitude to negate the clause u/s 1OA.

3.10 It is observed that despite devoting Sixteen pages on this issue of 1OA denial, the AO at page 9 page 17 states “ without prejudice to the above, if the claim of deduction u/s 1OA is allowed to the assessee, then the said deduction will be determined as under... .

“It is obvious that he has serious doubts about his stand and this sentence betrays his lack of confidence on this issue.

3.11 Thus taking into account the totality of facts, circumstances, evidences and position of law, it is stated that the action of the AO in holding that the new unit does not fulfills the basic conditions of eligibility u/s 1OA is not based on correct appreciation of facts and law. The appellant succeeds on this ground of appeal and it is allowed.”

7. Now, the revenue is in appeal before us. We have heard the rival submission of the parties and perused the records. The Ld. D.R. vehemently argues that there is no justification on the part of the Ld. CIT (A) to brush out the findings of the A.O. Per contra, the Ld. Counsel took us through the order of the Ld. CIT (A) and submits that only three laptops, one PC, one printer and two motor-cars used by the five employees of the parent company were transferred. He submits that the assessee has employed 250 employees in the year. Merely because some minor assets are transferred which are otherwise negligible cannot be the base for arriving at the conclusion that there is a splitting and reconstruction of the business of the parent company.

8. We find force in the arguments of the Ld. Counsel. As per the details given by the assessee in respect of the assets transfer from the parent company, page no. 37 of the paper book, we find that total assets valuing at Rs.23,03,411/- are transferred from the parent company to the assessee as under:

1. Del lap-top 1,05,252

2. Laptop 62,255

3. Toy car and Lgo 18,11,013

4. Buying systems 18,350

5. Daily server 2,01,541

-----------------

Total Rs. 23,03,411

===========

9. We further find that few managerial employees are transferred from the parent company to the assessee company. In our opinion, merely because two laptops and cars are transferred having value of Rs.23 lakhs it cannot be construed that the assessee company has been formed by splitting-up of the parent company. In facts as copy of the balance sheet (Sch.-4) to the fixed asset (page no.43 of the paper book) we find that total value of the assets of the company is Rs.15,60,74,586/- as on 31.03.2005. So we concur with the finding of the Ld. CIT (A) that the assessee company is not formed by splitting of the parent company. Now, so far as allegation of reconstruction is concerned, we have to confirm the order of the Ld. CIT (A). It is not the case of reconstruction at all. There is no dispute that the assessee company is formed a subsidiary of the parent company on 11th May, 2004. Moreover, the assessee company is in the BPO business and

the parent company is in the software development and so to some extent also in BPO business. We further find that the parent company is also entitled for deduction u/s.10A. The A.O. has given more emphasis on the investment made by the parent company in funding the equity capital of the assessee company. In our opinion, when it is admitted position that the assessee is a subsidy of the parent company then how to manage funds for the business and investment, is their outlook of the parent company to decide and tax authorities cannot question their decision. In our opinion, the basic purpose of denying the deduction to any undertaking which is formed by reconstruction and splitting is that the dishonest persons/assessee should not take undue advantage of the exemption/deduction granted by the Legislature.

10. Considering the totality of the facts we are of the opinion that the Ld. CIT (A) is right in holding that the assessee company has not been formed by splitting of the parent company nor it is case of reconstruction. We find no reason to interfere with the order of the Ld. CIT (A). Accordingly, the same is confirmed and ground no.1 is dismissed.

11. Ground no.2 reads as under:

“2. On the facts and in the circumstances of the case as well as in law, the Ld. CIT (A) has erred in holding that the assessee is eligible for inclusion of expenses in foreign currency from export turnover amounting to Rs.1,37,72,409/- without following the definition of Export turnover as mentioned in Clause (iv) Explanation 2 to Sec.10A.”

12. The fats pertaining to the issue revealed from the record are as under. Though the A.O. denied the claim of deduction u/s.10A to the assessee but at the same time he was of the opinion that the export turnover is inflated by the assessee by an amount of Rs.1,37,72,409/. The A.O. called for the details of the assessee and in his opinion the assessee has included the foreign travel expenses, commission expenses, communication expenses, miscellaneous expenses including networking charges in the export turnover. The A.O., therefore, reduced the export turnover by Rs.1,37,72,409/-. We may mention here that there is no clarity of facts in respect of this issue in the assessment order. The assessee carried the issue before the Ld. CIT (A). It was pleaded that the assessee has already considered exclusion of said expenses aggregating to Rs.1,37,72,409/- in calculating the deduction u/s.10A. The Ld. CIT (A) was of the opinion that the action of the A.O. is not correct. He, therefore, reversed finding of the A.O. In sum and substance, in his opinion if at all the amount is to be reduced from the ‘export turnover’ then the same is to be reduced from the ‘total turnover’. The operative part of the findings is as under:

 “4.8 Applied to the facts of the case, only those foreign exchange expenses, which can be excluded, are those, which are incurred in providing technical services outside India. Since the appellant is providing services in respect of BPO based at Mumbai, the same is rendered inside India. This fact cannot be ignored. The communication expenses to the extent of Rs.13,70,423/- are included in Foreign Currency expenses as well as communication expenses, which have been excluded leading to double exclusion of the said amount, The AO has also mis-understood software charges of Rs.4,86,837/- to be networking charges and they are neither fright, tele-communication expenses or insurance attributable to delivery of software nor are they incurred in foreign exchange and so not liable for exclusion from export turnover. The insurance charges, which have been taken to be insurance claimed, are also incurred as premium for various policies to the outside India. In respect of communication expenses, the break-up of which has been submitted shows that out of total expenditure of Rs.60,82,294/-, a sum of Rs.50,43,500/- relate to internet lease line through which the delivery of the work is done. The balance expenses of Rs.10,38,764/- is in respect of mobile and courier and by very nature do not relate to computer software outside India.

4.9 The AO has failed to appreciate the definition of export turnover in proper prospective. The export turnover as defined in Section 1OA ‘does include’ freight etc. attributable to delivery of computer software or article or things outside India. It is necessary to note that the words used are ‘does not include” and not ‘to be reduced by’. The underlined phrases have different connotations. The phrase ‘does not include’ deals with items which by trade practice or contractual terms or accounting treatment are considered as components of export turnover but by the aforesaid fiction are not to be so considered as components of export turnover but by the aforesaid fiction are not to be so considered. The phrase ‘to be reduced by’ may mean statutory deduction irrespective of the composition of the sale price. We may take an example of an export sale at FOB of INR 100 as against at CIF of INR 120. In the first case, as freight and insurance any way do not form part of sale price, there is no question of exclusion of the same. Accordingly, in this case, the aforesaid condition of ‘does not include’ stands satisfied without any adjustment. However, in the second case, as freight and insurance form part of sale price, in order to satisfy the aforesaid condition, the same are required to be excluded. In relation to telecommunication charges also, the same principle should apply. Therefore, if the telecommunication charges have not formed part of sale price, the aforesaid condition remains satisfied without calling for any adjustment by way of exclusion of telecommunication charges debited to profit and loss account from the sale price.

4.10 The exclusion contemplated is only in respect of freight, etc, attributable to the delivery of the articles or things or computer software outside India. In other words, freight inward and inward telecommunication charges which cannot be said to be attributable to the delivery outside India cannot be reduced.

4.11 The AO also failed to appreciate the fact that what can be excluded for export turnover should at the first place form part of it. Since the above expenses does not form part of the company’s export turnover as it has not been bui1t as separate reimbursement from its clients there is no question of reducing it as done by the AO.”

13. Now, the revenue is in appeal before us. We have heard the parties and perused the records. We find that above expenses were not at all included in the export turnover. Moreover, if the expenses are to be excluded from the ‘export turnover’ then the same are also to be excluded from the total turnover. We find that as per the break-up of the total expenses, Rs.60,82,264/- and Rs.50,43,500/- are relating to internet, lease line and balance expenditure of Rs.10,38,764/- is in respect of mobile, land line, courier charges etc, same are not part of export turnover. Now, nothing has been placed before us to show that how the order of the Ld. CIT (A) is wrong. Moreover, we find that in A.Y. 2007-08 the identical addition was deleted by the Ld. CIT (A) and revenue is not in appeal. We find no reason to interfere with the order of the Ld. CIT (A) accordingly, the same is confirmed. Accordingly, ground no.2 is dismissed.

14. Next ground is with regards to rate of depreciation, which reads as under:

“3. On the facts and in the circumstances of the case as well as in law, the learned CIT (A) has erred in holding that the assessee is eligible for allowance of depreciation @ 60% on computer accessories amounting to Rs.7,44,515/- without distinguishing the fact that depreciation at higher rate of 60% is allowable on ‘computer’ and not ‘computer accessories’”.

15. We have heard the parties. The assessee has claimed the depreciation @ 60% on the computer and its accessories. The A.O., therefore, restricted depreciation on the following items to 25% in place of 60%.

The assessee carried the issue before the Ld. CIT (A) and Ld. CIT (A) directed the A.O. to allow the depreciation at 60%. Now, the revenue is in appeal before us.

16. The Ld. Counsel submits that in view of the decision of the Special Bench of the Tribunal in the case of DCIT vs. Datacraft India Ltd. 113 TTJ 377, Mumbai in which it is specifically mentioned that computer accessories are to be allowed depreciation @ 60% as accessories are part of the computer hardware system. We find that in the case of Datacraft India Ltd. (supra) the Hon’ble Special Bench has examined this issue and held that when the functions of accessories are integral part of the computer, then the same are part and parcel of the computer and depreciation applicable to the computer is to be allowed. From the details given above, we find that except Item no.8 i.e. telephone cable Rs.25,000/- and item no. (9) Giga Cable Rs.3,17,472/-, all other items has direct proximately functional integrity with the computer. We, therefore, following the principles laid down in the case of Datacraft India Ltd. (supra) partly reverse the order of the Ld. CIT (A) and direct the A.O. that on the above two items depreciation @ 60% should not be allowed but should be allowed @ 25%. Accordingly, ground no.3 is partly allowed.

17. Ground no.4 & 5 are general in nature.

18. Now, we take-up the appeals for the A.Y. 2006-07 and 2007-08. The only common issue in both the appeals is in respect of deduction u/s.10A which was denied by the A.O. on the reason that the assessee company is formed by splitting and reconstruction of the existing business/undertaking.

19. We have already decided the identical issue in the appeal for the A.Y. 2005-06. As facts as well as reasoning for denial of deduction are identical in both these assessment years, we, therefore, following our findings and reasons for A.Y. 2005-06 dismiss grounds taken by the revenue in A.Ys. 2006-07 and 2007-08. There is no other issue save allow ability of deduction u/s.10A in the A.Y. 2006-07 and 2007-08.

20. In the result, revenue’s appeal for the A.Y. 2005-06 is partly allowed and appeals for the A.Ys. 2006-07 & 2007-08 are dismissed.

Order pronounced in the open court on this day of 14th March, 2012.

                                           Sd/-                                        Sd/-

                                   (R.S. SYAL)                    (R.S. PADVEKAR)

                          ACCOUTANT MEMBER     JUDICIAL MEMBER

Mumbai, Date: 14th March, 2012

Copy to:-

1) The Appellant.

2) The Respondent.

3) The CIT (A)-XIX, Mumbai.

4) The CIT-10, Mumbai.

5) The D.R. “C” Bench, Mumbai.

/ / True Copy / /

By Order

Asstt. Registrar

I.T.A.T., Mumbai

*Chavan