Karnataka H.C : Conversion of the assessee-firm to a company and conversion of the same into an STP unit would not amount to transfer of ownership or beneficial interest or reconstruction or splitting of business and would be entitled to section 10A deduction as a ‘newly established undertaking’ despite the assessee commencing manufacturing and production in the previous year 1993-94 is perverse and arbitrary

Karnataka High Court

CIT vs. Foresee Information Systems (P.) Ltd.

Section 10A

Assessment Years 2002-03 To 2004-05

Dilip B. Bhosale And B. Manohar, JJ.

IT Appeal Nos. 592, 616 & 617 Of 2007

February 12, 2014

JUDGMENT

B. Manohar, J. – The Revenue has preferred these appeals under section 260A of the Income-tax Act, 1961 (for short “the Act”), being aggrieved by the common order dated March 16, 2007, made in I.T.A. Nos. 3014/2004, 1363 and 1364/Bang/2005 passed by the Income-tax Appellate Tribunal, Bangalore Bench “A” (for short “the Tribunal”) confirming the order dated July 23, 2004, passed by the Commissioner of Income-tax (Appeals-I) (for short “the CIT(A)”) declaring that the assessee is entitled for the benefit under section 10A of the Act for the assessment years 2002-03 to 2004-05.

2. The assessee-company is engaged in the business of exporting software having its unit at software technology park. The assessee-company had filed return of income claiming 100 per cent. exemption under section 10A of the Act. The Assessing Officer verified the records of the assessee-company and found that the assessee-company was original a partnership firm formed on November 29, 1993. Subsequently, it was reconstituted in the year 1995 as well as in the year 1997. The name of the firm was changed from M/s. Foresee Software Consultant to M/s. Foresee Information Systems on August 22, 1995. From the year 1995-96, the firm is exporting software to the US based company, M/s. Effone Software Inc., and it has claimed deduction under section 80HHE from the assessment year 2000-01 and continued up to 2002-03. On July 24, 2001, the partnership firm was converted into a company and the same business was continued after conversion of the firm into company. The assessee-company made an application before the Software Technology Park of India (hereinafter referred to as “STPI” for short) for approval of setting up software technology park unit (hereinafter referred to as “STP” for short). The STPI by its letter dated January 3, 2002, accorded approval for the same. The assessee-company communicated its acceptance to the terms and conditions, vide letter dated January 7, 2002. Thereafter, a legal agreement was executed on January 8, 2002, between the STPI and the assessee. On the basis of the said agreement, an application was made before the customs authorities for issue of licence. Accordingly, the customs authorities issued licence on January 22, 2002, and a bond was executed on February 4, 2002. The assessee-company commenced its commercial production on February 4, 2002. The Assessing Officer found that exemption under section 10A can be extended only to the new undertakings whereas the assessee-company is an existing unit and it has continued its business which, it was doing from 1993. Accordingly, refused to extend the benefit of 100 per cent. exemption under section 10A of the Act for the following reasons:

1.No new undertaking came into being after approval of the STPI.

2.There was only one unit of the firm which continued to be single unit of the company.

3.No new plant and machinery had been put to use between the period January 15, 2002, i.e., date of receipt of approval from the STPI to March 31, 2002.

4. The date of commencement of commercial production intimated to the STPI is incorrect in the absence of undertaking having come into being.

5.In the absence of any other unit, the question of maintenance of separate accounts did not arise.

3. The assessee-company being aggrieved by the order passed by the Assessing Officer preferred an appeal before the Commissioner of Income-tax (Appeals) contending that the assessment order passed by the Assessing Officer declining the benefit of 100 per cent. exemption under section 10A of the Act is contrary to law. The Assessing Officer has misunderstood and misread section 10A, Board Circular No. 1 of 2005 and Import and Export Policy of the Government of India and contended that the assessee is entitled for the benefit under the Act. The appellate authority after examining the matter in detail, taking into consideration the extract of Import and Export Policy of the Government of India and Board Circular No. 1 of 2005 (see [2005] 272 ITR (St.) 6) held that the assessee is entitled for the benefit of 100 per cent. exemption under section 10A of the Act. The appellate authority held that the understanding of the Assessing Officer with regard to the benefit under section 10A is erroneous in law. The assessee has not violated any of the conditions under section 10A(2)(ii) and section 10A(2)(iii) of the Act. It was also held that there is no transfer of ownership or the beneficial interest in the undertaking consequent upon the conversion of the firm into a company and it is only a transformation of the erstwhile firm into company. Relying upon the judgment in CIT v. Texspin Engg. and Mfg. Works [2003] 263 ITR 345/129 Taxman 1 (Bom) the appellate authority held that the assessee is entitled for the benefit of exemption under section 10A of the Act and partly allowed the appeal by its order dated July 23, 2004. Being aggrieved by the order passed by the appellate authority, the Revenue preferred appeals in I. T. A. Nos. 3014/Bang/04, 1363 and 1364/Bang/2005 before the Appellate Tribunal on various grounds. The Appellate Tribunal after re-examining the matter afresh and taking into consideration the extract of Import and Export Policy, Board Circular No. 1 of 2005 and also taking into consideration sections 10A and 10B of the Act held that the assessee-company is entitled for exemption for a period of 10 years from the date of approval from the STPI and dismissed the appeals filed by the Revenue. Being aggrieved by the same, the assessee has preferred these appeals.

4. These appeals were admitted for considering the following substantial question of law :

“Whether the finding of the appellate authorities that conversion of the assessee-firm to a company and conversion of the same into an STP unit would not amount to transfer of ownership or beneficial interest or reconstruction or splitting of business and would be entitled to section 10A deduction as a ‘newly established undertaking’ despite the assessee commencing manufacturing and production in the previous year 1993-94 is perverse and arbitrary ?”

5. Sri K.V. Aravind, learned counsel appearing for the Revenue, contended that deduction under section 10A of the Act is a special provision, which is applicable in respect of newly established industrial undertakings in a free trade zone. In the instant case, the assessee-company was admittedly established in the year 1993 and it was converted from the firm into a company in the year 1996. An application was filed before the STPI authorities and obtained approval for setting up of a new unit. But the assessee has not set up a new unit. Hence, they are not entitled for any exemption under section 10A of the Act. The assessee is already enjoying the exemption under section 80HHE of the Act. However, the assessee has not fulfilled the provisions of section 10A(2)(i)(b) of the Act and they have violated section 10A(2)(ii) and of the Act. The assessing authority taking into consideration the relevant records, import and export policy and conditions of the STPI authorities for approval passed the assessment order.
The first appellate authority as well as the Appellate Tribunal without examining the matter in detail set aside the order passed by the assessing authority and granted deduction under section 10A of the Act, which is contrary to law.

6. On the other hand, Sri K.K. Chaithanya, learned counsel appearing for the assessee-company, argued in support of the order passed by the Appellate Tribunal as well as the first appellate authority and contended that initially the respondent-assessee was a partnership firm and by virtue of the order passed by the company court, they had converted the firm into a company. They are in the business of exporting software and enjoying the benefit under section 80HHE of the Act. Subsequently, on an application filed before the STPI authorities and with the permission of the customs authorities, the firm was converted into STP unit. Hence, the assessee is entitled for deduction under section 10A of the Act. There is no transfer of ownership or the beneficial interest in the undertaking consequent upon the conversion of firm into company. All the partners of the firm have become the shareholders of the company and all the assets and liabilities were transferred to the company. None of the outsiders were inducted as shareholders of the company and they have not violated the conditions of section 10A(2)(ii) and section 10A(2)(iii) of the Act. He also relied upon a judgment reported in CIT v. Expert Outsource (P.) Ltd. [2013] 358 ITR 518/[2012] 20 taxmann.com 481 (Kar.)CIT v. Maxim India Integrated Circuit Design (P.) Ltd. [2011] 202 Taxman 365/14 taxmann.com 68 (Kar.) and CIT v. Texspin Engg. and Mfg. Works [2003] 263 ITR 345/129 Taxman 1 (Bom) and sought for dismissal of the appeal.

7. We have carefully considered the arguments addressed by the learned counsel for the parties and perused the orders impugned in the appeals.

8. The records clearly disclose that the respondent-assessee is a partnership firm engaged in the business of exporting software. It was subsequently converted into a company and got changed its name as M/s. Foresee Information Systems. All the partners in the firm became the shareholders of the company and all the assets and liabilities of the firm were transferred to the company. The assessee-company made an application before the STPI authorities for approval to set up a STP unit. The STPI authorities accorded approval for setting up a STP unit. The licence was granted by the customs authorities in January, 2002. Prior to the setting up of STP unit, the assessee was claiming deduction under section 80HHE. The assessee is dealing with the US based company, M/s. Effone Software Inc., and all exports have been made to the said company only. He filed returns of income claiming deduction under section 10A of the Act. The assessing authority, after scrutinising the returns filed by the assessee held that the assessee is not entitled for deduction under section 10A and rejected the same for the reasons referred to in the earlier part of the order. On an appeal filed by the assessee, the first appellate authority considered the matter afresh and held that the assessee is entitled for the benefit under section 10A. The said order was confirmed by the Tribunal.

9. The assessee is a 100 per cent. export oriented unit, enjoying deduction under section 80HHE of the Act. In the Central Board of Direct Taxes Circular No. 1 of 2005, dated January 6, 2005, it has been stated that the existing domestic tariff area (for short “DTA”) units which were approved as 100 per cent. EOU units by the Board shall be eligible for deduction under section 10B of the Act. Further, the scheme of biotechnology park framed by the Ministry of Government of India, clause 6.36.1 provides for conversion. Clauses 6.36.1 and 6.36.2 read thus :

“6.36.1 : Existing DTA units, may also apply for conversion into EOU/EHTP/STP/BTP unit, but no concession in duties and taxes would be available under scheme for the plant, machinery and equipment already installed. On conversion, they would get Income-tax concessions but limited to period of 10 years from original commencement of manufacture or that prescribed under section 10 of Income-tax Act whichever is earlier. For this purpose, DTA unit may apply to the DC/Designated Officer concerned in same manner as applicable to new units. In case there is an outstanding export commitment under EPCG scheme/advance authorization scheme, it will follow the procedure laid down in the appendix.

6.36.2 : Existing EHTP/STP/BTP units may also apply for conversion/merger to EOU unit and vice versa, In such cases, units will continue to avail permissible exemption in duties and taxes as applicable under relevant scheme. EHTP/STP/BTP units desiring conversion as an EOU may apply to DC concerned through Officer designated by DoIT/DoBT in same manner as applicable to new units. Likewise, EOU desiring conversion into EHTP/STP/BTP may apply to officer designated by DoIT / DoBT through DC concerned.”

10. Reading of the above clauses makes it very clear that the benefit under section 10A can be extended even to the existing units, if they have fulfilled the condition under section 10A(2)(a)(ii) and section 10A(2)(a)(iii) of the Act and as contended by the assessee, the requirement of setting up of a new STP unit does not arise. The Bombay High Court in Texspin Engg. and Mfg. Works (supra) has clearly held that the conversion of a firm into a company is not a case of distribution of assets or dissolution of the Firm. In the present case also, there is no transfer of business as contemplated under section 45(1) of the Act and only the partnership firm was converted into a company and all the partners of the firm have become the shareholders of the company. Further, all the assets and liabilities were transferred to the company. None of the outsiders were inducted as shareholders. In view of the STPI scheme framed by the Government of India, the existing DTA units can also be converted into STP units and enjoy the deduction under section 10A of the Act. The records further disclose that the assessee has not violated any of the conditions prescribed under section 10A of the Act. Further, a Division Bench of this court also had an occasion to examine the Circular No. 1 of 2005 issued by the Central Board of Direct Taxes in Expert Outsource (P.) Ltd. (supra), wherein the Division Bench of this court has held that though the circular is in the context of section 10B, the ratio of the circular equally applies to section 10A also. The benefit under section 10A would also be available even when an existing unit gets converted into STP unit. Hence, it is not open to the Assessing Officer to contend that no new undertaking came into being after approval of STPI. In a judgment reported in CIT v. Maxim India (supra) in paragraph 5, the Division Bench of this court has held under :

“The material set out amply proves that it is not a case of reconstruction as mistook by the assessing authority. The facts disclosed that the assessee commenced production from May 1, 2002, and the assessee was entitled to the benefit under section 80HHE. However after approval was granted by the Director of STPI on December 31, 2002, the assessee was entitled to the benefit of section 10A of the Act. This is supported by the Circular No. 1 of 2005, dated October 6, 2005, issued by the Central Board of Direct Taxes.”

11. Further, a similar view has been taken in Expert Outsource (supra). Hence, the law declared by the Division Bench of this court referred to above is binding on the Assessing Officer. The first appellate authority as well as the Tribunal after considering the matter in detail and taking into consideration the Board Circular No. 1 of 2005 issued by the Central Board of Direct Taxes and the import and export policy clearly held that the assessee is entitled for deduction under section 10 of the Act. The respondent-company fulfils all the conditions enumerated under section 10A of the Act and it is not formed by splitting up, or reconstruction of the business already in existence. It is also not formed by transformation of new business of plant or machinery previously used for any purpose. Both the assessing authority as well as the Tribunal have concurrently held that the respondent-assessee is entitled for deduction under section 10A of the Act. We find there is no infirmity or irregularity in the said finding. Hence, the substantial question of law framed in these appeals is answered against the Revenue and in favour of the assessee. Accordingly, we pass the following :

ORDER

The appeals are dismissed.

[Citation : 365 ITR 335]