High Court Of Bombay
CIT, City-VII, Mumbai vs. Sonata Software Ltd.
Section : 10A
Dr. D.Y. Chandrachud And M.S. Sanklecha, JJ.
IT Appeal No. 311 Of 2004
March 6, 2012
DR. D.Y. Chandrachud, J. – This appeal by the Revenue under Section 260A of the Income Tax Act, 1961 arises from a decision of the Income Tax Appellate Tribunal dated 17 March 2003; the Assessment Year to which the appeal relates being 1998-1999. The Revenue has raised six questions of law. During the course of hearing we have granted leave to the learned counsel to amend the first question so as to correctly reflect the nature of the controversy raised in the appeal. The amendment may be carried out forthwith. Verification is dispensed with. The questions of law are as follows:
(A) Whether on the facts and in the circumstances of the case the Tribunal was justified in holding that the assessee was entitled to an exemption in respect of the profits derived from the STP undertaking on the basis that the conditions of Section 10A(2) are fulfilled;
(B) Whether the assessee’s claim for depreciation, repairs and maintenance on the plant and machinery and interest on borrowings which does not have nexus to the trading activity is not allowable as deduction on trading activity;
(C) Whether excess provisions in the total turnover made by the assessee are liable to be added back in the total turnover for the purpose of determining the deduction under Section 80HHE of the Act;
(D) Whether the miscellaneous income is to be excluded in computation of deduction under Section 80HHE of the Act;
(E) Whether the assessee is not entitled for claim under Section 80HHE if the claim has not been made within the stipulated time limit prescribed under Section 139(5) of the Act and required audit report had not been filed during the assessment proceedings;
(F) Whether the expenditure incurred for indigenisation of software is a Capital Expenditure as against the Revenue Expenditure as claimed by the assessee?
2. The appeal is admitted on the first question. The appeal is taken up for hearing and final disposal at this stage by consent.
3. The facts as they are necessary for considering the first question are as follows:
Indian Organic Chemicals Ltd. set up a division called Sonata Software Division in the 1980s. IOCL made an application for setting up an undertaking in a Software Technology Park (STP) for which an approval was obtained on 30 October 1993. The plant and machinery was imported in July 1994; the first export purchase order was obtained on 2 August 1994 and the first export was effected on 12 October 1994. The manufacturing activities, therefore, commenced in the STP undertaking after 1 April 1994. The entire software division was transferred as a going concern on a slump sale basis under an agreement dated 19 October 1994 to the assessee for a total consideration of Rs.8.13 crores. Sonata Software Division which was transferred to the assessee consisted of two parts (i) A non STP undertaking; and (ii) An STP undertaking. In respect of the Assessment year 1998-999 the assessee made a claim for deduction under Section 10A as it then stood. The Assessing Officer rejected the claim under Section 10A on the ground that (i) If an STP undertaking was already engaged in a manufacture of software programs before 1 April 1994, the Section 10A benefits could not be extended to the unit; (ii) In order to fulfill the conditions prescribed by Section 10A, an undertaking must commence production on or after the stipulated date; (iii) It should not be formed by splitting up or reconstruction of a business already in existence and it should not be formed by the transfer to a new business of plant and machinery previously used for any purpose. The Assessing Officer held that the undertaking was carrying on the same business before Assessment Year 1995-96; it was formed by splitting up or reconstruction of a business already in existence since the same business was being carried on by the software division of IOCL before the assessee came into existence and all the assets and liabilities including plant and machinery previously used were transferred to the Section 10A undertaking. This finding was confirmed in appeal by the Commissioner (Appeals). The Commissioner (Appeals) held that (i) The business of the appellant was in existence prior to 1 April 1994 in the form of a division of IOCL; (ii) The assessee took over the assets and liabilities of the software division of IOCL and hence the new business was formed by splitting up of the business already in existence ; and (iii) the assessee had taken over all the assets and liabilities of the software division including the plant and machinery.
4. In appeal, the Tribunal has held that the entire software division was transferred as a going concern by an agreement dated 19 October 1994 to the assessee. The software division had two sources of income viz. from the non STP activity and the STP activity. The claim by the assessee was only in respect of the STP activity, under the provisions of Section 10A. The STP activity was set up on 24 May 1994, the first purchase was on 3 July 1994 and the first export was on 12 October 1994. Hence the manufacturing or production activities in the STP activities commenced only after 24 May 1994 which was after the stipulated date of 1 April 1994 provided for in Section 10A. While the non STP undertaking had commenced business in the early 1980s the STP was found to have commenced business after 1 April 1994 and as noted earlier the deduction was confined under Section 10A in respect of the STP unit. The Tribunal observed that it was an admitted fact that the undertaking of the software division which was hitherto owned by IOCL was transferred on a going concern basis together with its assets and liabilities to the assessee. The Tribunal relied upon a decision of this Court in CIT v. Gaekwar Foam & Rubber Co. Ltd.  35 ITR 662 in which a distinction was drawn between reconstruction of a business and sale of the business and it was held that in the case of a sale there can be no question of reconstruction. This decision was approved by the Supreme Court in Textile Machinery Corpn. Ltd. v. CIT  107 ITR 195 Reliance was also placed on a Circular issued by the Board under the provisions of Section 84 stating that the benefit under the provision attaches not to the ownership of the undertaking but to the undertaking itself. The appeal was accordingly allowed.
5. Counsel for the Revenue has submitted that in the present case the facts which were found by the Assessing Officer would indicate that (i) The business of the assessee was formed by splitting up and reconstruction of the business which was already in existence; (ii) The business of the assessee was in existence prior to 1-4-1994 and was carried on by IOCL; (iii) All assets and liabilities including plant and machinery were transferred to the assessee. On this submission it was urged that the requirements of Section 10A have not been fulfilled.
6. Sub-sections (1) and (2) of Section 10A as they stood at the material time, inter alia, provided as follows:
“10A. (1) Subject to the provisions of this section, any profits and gains derived by an assessee from an industrial undertaking to which this section applies shall not be included in the total income of the assessee.
(2) This section applies to any industrial undertaking which fulfils all the following conditions, namely:-
(i) it has begun or begins to manufacture or produce articles or things during the previous year relevant to the assessment year-
(a) commencing on or after the 1st day of April, 1981, in any free trade zone; or
commencing on or after 1st day of April, 1994, in any electronic hardware technology park or, as the case may be, software technology park;
(ia) in relation to an undertaking which begins to manufacture or produce any article or thing on or after the 1st day of April, 1995, its exports of such articles or things are not less than seventy-five per cent of the total sales thereof during the previous year;
(ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence:
Provided that this condition shall not apply in respect of any industrial undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such industrial undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section;
(iii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose.”
Explanation (v) to the provision defined a “software technology park” to mean any park set up in accordance with the Software Technology Park Scheme notified by the Government of India in the Ministry of Commerce.
7. Sub-section (1) of Section 10A provides that the gains derived by an assessee from an industrial undertaking to which the Section applies are not to be included in the total income of the assessee. The conditions on the fulfillment of which the provision would apply are spelt out in sub-section (2) of Section 10A. In relation to a software technology park, the condition required that the undertaking must begin to manufacture or produce articles or things during the previous year relevant to the Assessment Year commencing on or after 1 April 1994. Moreover there were two conditions cast in negative terms; these being that (i) the industrial undertaking is not formed by splitting up or reconstruction of the business already in existence; and (ii) the industrial undertaking is not formed by transfer to a new business of machinery or plant previously used for any purpose. The admitted facts before the Court are that IOCL had a software division. On 24 May 1994 IOCL obtained registration of a software technology park under the STP scheme. The plant and machinery was imported in July 1994. The unit became operational in October 1994 and the exports were made on 12 October 1994. IOCL had both a non STP undertaking and an STP undertaking comprising in its software division. By an agreement dated 19 October 1994 the assessee acquired the software division for a consideration of Rs.8.13 crores on a going concern basis. Consequently, the first requirement that the unit must commence production or manufacturing of articles or things in the previous year relevant to the Assessment Year commencing on or after 1 April 1994 was fulfilled.
8. The issue before the Court is whether the two requirements, cast in negative terms, have been fulfilled. Clause (ii) of Sub-section (1) of Section 10A stipulates that the industrial undertaking must not be formed by splitting up or reconstruction of a business already in existence. In other words, the test in law is as to whether the undertaking is formed by splitting up or reconstruction of a business already in existence. In Gaekwar Foam & Rubber Co. Ltd.’s case (supra) a Division Bench of this Court construed the provisions of Section 15C of the Income Tax Act, 1922, Section 15C(2)(i) contained a similar provision that the section would apply to an industrial undertaking which is not formed by the splitting up or the reconstruction of a business already in existence or by the transfer to a new business of building, machinery or plant used in a business which was being carried on before 1 April 1948. In that case, there was a partnership firm and its assets and goodwill were taken over by the assessee for a stated consideration and against the allotment of shares to the three partners in the assessee company. The Assessing Officer had rejected the claim of exemption under Section 15C on the ground that the assessee was formed by the reconstruction of the business already in existence. The Appellate Commissioner took a different view which was affirmed by the Tribunal. The Division Bench of this Court held that the reconstruction of a business connotes that the original business is not to cease functioning and the undertaking must continue to carry on the same business in an altered form. On the other hand if the ownership of a business or an undertaking is transferred that would not constitute a reconstruction. The Division Bench held as follows:
“…The reconstruction of a business or an industrial undertaking must necessarily involve the concept that the original business or undertaking is not to cease functioning, and its identity is not to be lost or abandoned. The concept essentially rests on changes but the changes must be constructive and not destructive. There must be something positive about the whole matter as opposed to negative. The underlying idea of a reconstruction evidently must be – and this is brought out by the section itself – of a “business already in existence”. There must be a continuation of the activities and business of the same industrial undertaking. The undertaking must continue to carry on the same business though in some altered or varied form. If the alterations and changes are substantial, there would be little scope for describing what emerges as a reconstruction of the business. Thus for instance if the ownership of a business or an undertaking changes hands not ostensibly but in reality and effectively, that would not be reconstruction or if the very nature of the business is changed, that again would not be reconstruction. On the other hand, reorganization of the business on sounder lines or alterations in the mode or method or scope of the activities of the business or in its personnel or infusion of new blood in the management or control of the business which may even be by some changes in the constitution of persons interested in the undertaking would certainly be no more than reconstruction of the business if it is substantially the same business carried on by substantially the same persons.”
Reconstruction, the Division Bench held, means that substantially the same business is carried on and substantially the same persons carry it on:
“…The emphasis, it will be noticed, is on two things -when substantially the same business was carried on and substantially the same persons were carrying it on. It is also to be noticed that the learned Judge draws a clear distinction between a reconstruction and a sale of an undertaking. In the case of a sale, there can be no question of reconstruction. Now, in these matters, we have to look at the substance of the transaction and not the form. If looking at the substance of the transaction, it is a sale, then the concept of reconstruction must be ruled out for in such a case there is no scope for speaking about any reconstruction of an existing business….”
9. The judgment of the Division Bench of this Court in Gaekwar Foam & Rubber Co. Ltd.’s case (supra) was approved by the Supreme Court in a judgment in Textile Machinery Corpn. Ltd.’s case (supra). The Supreme Court in that case dealt with the issue as to whether within the meaning of Section 15C(2)(i) of the Income Tax Act, 1922, the industrial undertakings which consisted of a steel foundry division and jute mill division were not formed by the reconstruction of a business already in existence. The Supreme Court observed that in order to be entitled to the benefit of Section 15C the following facts would have to be established by the assessee:
“(1) investment of substantial fresh capital in the industrial undertaking set up;
(2) employment of requisite labour therein;
(3) manufacture or production of articles in the said undertaking;
(4) earning of profits clearly attributable to the said new undertaking and
(5) above all, a separate and distinct identity of the industrial unit set up.”
10. The Supreme Court was of the view that the new undertaking must not be substantially the same old existing business. Even if a new business is carried on but by piercing the veil of the new business it is found that there is employment of the assets of the old business, the benefit will not be available. From this perspective the Court held that a substantial investment of new capital is imperative.
11. The Tribunal in the present case has come to the conclusion that where a running business is transferred lock, stock and barrel by one assessee to another assessee the principle of reconstruction, splitting up and transfer of plant and machinery cannot be applied. According to the Tribunal the benefit of Section 10A attaches to the undertaking and not to the assessee which owns the undertaking. The benefit of Section 10A was held to have attached itself to the STP unit of the software division which was owned by IOCL till 19 October 1994 and it was owned by the assessee subsequent to that date. What is material, according to the Tribunal, is not who owns the undertaking but whether the undertaking is entitled to the benefit available under Section 10A. As regards the issue of transfer by IOCL to the assessee, the Tribunal noted that Section 10A(9) was substituted by the Finance Act 2000 with effect from 1 April 2002. Section 10A(9) provided that where during any previous year the ownership or beneficial interest in an undertaking of the business is transferred by any means, the deduction under sub-section (1) shall not be allowed to the assessee for the Assessment Year relevant to such previous year and the subsequent years. The Tribunal noted that if a transfer between IOCL and the assessee were to be effected after 1 April 2001, that would result in the undertaking being disentitled to the benefit under Section 10A. This was a pointer to the fact that prior to the substitution a transfer of ownership or beneficial interest in the undertaking would not disentitle an assessee to the benefit of Section 10A. (As a matter of fact it may also be noted that the provisions of Section 10A(9) were omitted by the Finance Act 2003 with effect from 1 April 2004).
12. The judgment of the Division Bench of this Court in Gaekwar Foam & Rubber Co. Ltd.’s case (supra) explains that the concept of a reconstruction of a business implies that the original business is not to cease functioning and its identity is not lost. Reconstruction is of a business already in existence and there must be a continuation of the activities and business of the same industrial undertaking. Where the ownership of a business or undertaking changes hands that would not be regarded as reconstruction. This judgment has specifically been approved by the Supreme Court in Textile Machinery Corpn. Ltd.’s case (supra). As regards the splitting up of a business, the relevant test is whether an undertaking is formed by splitting up of a business already in existence. Unless the formation of the undertaking takes place by the splitting up of a business already in existence, the negative prohibition would not be attracted. In the present case, the entire business of the software undertaking was transferred to the Assessee. The undertaking of the Assessee was not formed by the splitting up of the business.
13. For the aforesaid reasons, the first question of law would have to be answered in the affirmative in favour of the assessee and against the Revenue.
14. As regards the second question, the Tribunal has noted that the assessee had bifurcated its expenditure under three heads: (i) STP unit entitled to a deduction under Section 10A; (ii) non STP unit which was not entitled to deduction under Section 10A; and (iii) support services. The Tribunal has noted that the expenses of the support services were allocated between Section 10A and the non-Section10A activities in the ratio of turn over. This issue was restored to the file of the Assessing Officer with a direction to allocate interest and depreciation of the support services division in the ratio of turn over between the Section 10A and non Section 10A activities. There is no cogent challenge to this finding at all. No substantial question of law would arise on the second question.
15. The third, fourth and fifth questions really do not arise from the decision of the Tribunal. The Tribunal has observed in paragraph 37 of its order that these grounds were alternative grounds which were urged by the assessee which would be rendered infructuous if the first question was decided in his favour. Since the first question was held in favour of the assessee, the three consequential questions were rendered infructuous.
16. In so far as the sixth question is concerned, the Tribunal has noted that the assessee had undertaken expenditure for indigenisation of software. The Tribunal noted that software is a product subject to high obsolescence. Having regard to the aforesaid position the expenditure incurred on indigenisation has correctly been held to be allowable as revenue expenditure. Hence no substantial question of law will arise on this finding.
17. The appeal shall accordingly stand disposed of in the aforesaid terms. There shall be no order as to costs.
[Citation : 343 ITR 397]