Customisation of software amounts to production of computer program and entitled for benefit under Section 10B of the Income-tax Act

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1 KPMG FLASH NEWS KPMG IN INDIA Customisation of software amounts to production of computer program and entitled for benefit under Section 10B of the Income-tax Act 29 March 2012 Background Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of Cybertech Systems & Software Ltd 1 (the taxpayer) held that customisation of software amounts to production of computer program and entitled for benefit under Section 10B of the Income-tax Act, 1961 (the Act). Further, the Tribunal held that the interest income did not have direct nexus to the income derived by the taxpayer from the undertaking and therefore not liable for benefit available to Export Oriented Unit (EOU) under Section 10B of the Act. Facts of the case The taxpayer was a company registered with the Ministry of Industry as 100 percent EOU. The taxpayer was involved in the activities of advance learning center to train SAP consultants, to undertake & provide worldwide customer support on behalf of Unisys from India providing onsite technical service and development of software, Onsite services, Offshore projects, Software development. The activities of the taxpayer were approved and sanctioned by the Secretariat for industrial approvals and the same were recognised as an integral part of the EOU. For the Assessment Year (AY) to AY , the taxpayer filed its return of income declaring the total income at nil by claiming the exemption under Section 10B of the Act which deals with the benefit of exemption from tax for 100 percent EOU. 1 Cybertech Systems & Software Ltd v. CIT (ITA No. 2781/Mum/2003) Taxsutra.com

2 The Assessing Officer (AO) had not allowed the benefit available to the EOU under Section 10B of the Act. The Commissioner of Income-tax (Appeals) [CIT(A)] had set aside the assessment order with a direction to examine the taxpayer s claim under Section 80HHE of benefit of exemption for export of software and 80-O besides Section 10B of the Act. Accordingly, the AO after examining the various agreements entered into by the taxpayer with Cybertech International Corporation (CIC) and Unisys Corporation (Unisys) held that the taxpayer was not engaged in the activities relating to manufacture and exports of computer software and programmes. Therefore, the AO denied the benefit under Section 10B and 80HHE as well as 80-O of the Act. The CIT(A) confirmed the denial of benefit of exemption available to EOU in respect of the entire receipts collected by the taxpayer. However, the CIT(A) allowed the claim of benefit of exemption for export of software towards the services rendered by the taxpayer to Unisys by holding that it amounts to providing technical services out of India in connection with development or production of computer software. Further the CIT(A) directed the AO to exclude 90 percent of gross receipts of the interest while computing benefit of exemption for export of software. Issues before the Tribunal Whether the taxpayer was liable for benefit under Section 10B or 80HHE of the Act? Whether the interest income earned by the taxpayer was also entitled for benefit under Section 10B of the Act? Taxpayer s contentions The training was part and parcel of the whole process of job of customisation of software i.e. SAP which was carried out by the taxpayer. The certificate issued by Ministry of Industry showed that the taxpayer was engaged in the manufacture of computer software and in providing technical services outside India in connection with the development or production of computer software. The taxpayer referred Section 10BB of the Act and contended that the meaning of computer programme had been expanded by Section 10BB of the Act for the purpose of Section 10B which includes computer programmes or processing or management of electronic data. Relying on the decision in the case of SGS Consultants Pvt. Ltd. 2, the taxpayer contended that when the main object was to act as a technical and management consultant in relation to all aspects of computer software, then merely because the invoices were raised on candidate basis would not show that the taxpayer was not producing any software. The taxpayer had made huge investment in building, plant and software. Therefore, the taxpayer contended that if the taxpayer was only a recruitment agency, then there was no need of making such a huge investment. The taxpayer relied on the decision in the case of is3c Consultancy Services Ltd. 3 and contended that the activity of customisation of software amounts to manufacture and production of computer software and thus entitled for benefit available to EOU. The definition of manufacture provided in the Explanation to Section 10B of the Act includes any process, assembling, recording or storing of information as well as produce in relation to any article or thing including computer programmes. The taxpayer was doing the work of development programme, running various transactions and working on the local system of CIC, maintenance, testing the results, final work and documents the programme/transactions and the result was then sent to CIC through . All these activities showed that the taxpayer was involved in the work of development of computer programme as per the requirement of the clients of CIC. The taxpayer relying on the decision of Amadeus India p Ltd 4 contended that the computer programme should be understood as defined in 2 ACIT v. SGS Consultants Pvt. Ltd. (ITA No. 6508/Mum/97) 3 is3c Consultancy Services Ltd. v. DCIT (ITA No.319/Mum/2002) 4 ACIT v. Amadeus India (P.) Ltd. [2001] 79 ITD 407 (Del)

3 Copyright Act, 1957 (Copyright Act) and should be interpreted broadly, liberally and consistently with other relevant legislation of Government to include export of data processing software. Further the taxpayer contended that the tax department ignored the technological developments and the principle of updating construction as applied by the Supreme Court in the case of Podar Cement Pvt. Ltd 5. The taxpayer relying on the Supreme Court s decision in the case of Bajaj Tempo Ltd. 6 contended that Section 10B of the Act is an incentive provision and designed to encourage an industry identity like the software industry and therefore, the said provision has to be liberally construed. There was no difference as far as the activity of the taxpayer, qua Unisys or CIC and when export to Unisys has been accepted as eligible for benefit available to EOU by the Tribunal in different assessment proceeding then, the export of the CIC was also eligible for benefit available to EOU. Alternatively, the taxpayer contended that the taxpayer had customised the electronic data with respect to SAP programme and transmitted the same through to outside India. Therefore, the profit and gain from such export of other software was eligible for benefit available for export of software. The taxpayer relied on the decisions in the case of Nagpur Engineering Co. 7 and Paramount Premises (P.) Ltd. 8 and contended that the interest income is eligible for benefit available to EOU in view of the fact that the taxpayer was a 100 percent EOU. Tax department s contentions The taxpayer s primary activity was imparting training and employment for the principle company. The source of the income was not manufacture or produce of article or software computer programme but from placement of trained personnel. The AO had specifically asked the details about the remuneration received by the CIC from its clients for which the taxpayer had claimed to have customised the SAP programme. However, the taxpayer failed to produce such information. 5 CIT v Podar Cement (P.) Ltd. [1997] 226 ITR 625 (SC) 6 Bajaj Tempo Ltd. v. CIT [1992] 196 ITR 188 (SC) 7 CIT v. Nagpur Engineering Co. Ltd. [2000] 245 ITR 806 (Bom) 8 CIT v.paramount Premises (P.) Ltd. [1991] 190 ITR 259 (Bom) The certificate of the Ministry of Industry as 100 percent EOU, had limited purpose of authorising the taxpayer to do a business but did not itself an evidence of actual business done by the taxpayer. The taxpayer did not file any audit report for claim of benefit available for export of softwares. Therefore, in the absence of audit report, the claim of the taxpayer was not maintainable. The tax department relied on the Supreme Court s decision in the case of Liberty India Ltd. and contended that when the interest income has no nexus with the income derived from the undertaking then it was not liable to the benefit available to EOU. Tribunal s ruling The term computer programme had not been defined under Section 10B of the Act, however, it had been defined under Section 10BB of the Act as computer programme or process or management of electronic data. After the amendment with effect from 1 April 2001, the definition of computer software had been given in the Explanation 2 to Section 10B of the Act which includes any customised electronic data or any product or services of similar nature as notified by the Central Board of Direct Taxes (CBDT) which is transmitted or exported from India to any place outside by any means. Therefore, the human resource service in the field of development of software programme as notified falls under the definition of computer programme as stipulated in the Explanation as well as the definition under Section 10BB of the Act. Further, Section 10BB of the Act enlarges the ambit of term computer programme by including the process or management of electronic data. Therefore, the engagement of analyst/programmer and imparting training to them in the process of development and customisation of SAP programme was part of process of the customisation of SAP and customisation of data and cannot be treated as a separate activity of the taxpayer.

4 Since the taxpayer was carrying out work as per the specific requirement of the CIC clients, method of invoice cannot be the basis of rejection of the claim of the taxpayer. Relying on the decision of is3c consultancy Services Ltd. the Tribunal held that when the process of customisation involves addition, modification and creation of new programmes as per the requirement of the individual clients by utilising the foundation of standard programme and such exercise involves human expertise and intellectual process to bring the end result a different product or thing, such process fit into the definition of term produce. The taxpayer had made huge investment in building, plant and software and if the taxpayer was only a recruitment agency, then there was no need of making such a huge investment. Accordingly, in view of above and relying on the Tribunal s order for earlier AY the Tribunal held that the taxpayer is entitled for benefit available to EOU. Since the decision relied upon by the taxpayer was prior to the decision of the Supreme Court in the case of Liberty India, the Tribunal following the decision of the Liberty India held that the interest income did not have direct nexus to the income derived by the taxpayer from the undertaking and therefore not liable for benefit available to EOU of the Act. Our comments The Tribunal held that human resource service in the field of development of software programme falls under the definition of computer programme. Addition, modification and creation of new programmes as per the requirement of the individual clients by utilising the foundation of standard programme involves human expertise and intellectual process to bring the end result a different product or thing, therefore such process fit into the definition of term produce and liable for benefit under Section 10B of the Act. Further, the Tribunal relied on the Supreme Court s decision in the case of Liberty India and held that the interest income had no nexus with the income derived from the undertaking therefore the benefit under Section 10B of the Act is not allowable.

5 Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad Tel: Fax: Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore Tel: Fax: Chandigarh SCO (Ist Floor) Sector 8C, Madhya Marg Chandigarh Tel: /781 Fax: Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai Tel: Fax: Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana Tel: Fax: Hyderabad /2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad Tel: Fax: Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi Tel: Fax: Kolkata Infinity Benchmark, Plot No. G-1 10th Floor, Block EP & GP, Sector V Salt Lake City, Kolkata Tel: Fax: Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai Tel: Fax: Pune 703, Godrej Castlemaine Bund Garden Pune Tel: Fax: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. The KPMG name, logo and cutting through complexity are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

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