LARSEN & TOUBRO INFOTECH LTD,MUMBAI vs. ADDL CIT RG 2(2), MUMBAI

Per contra, the Ld. Departmental Representative supported the 17. Transfer Pricing Adjustment by placing reliance on the Transfer Pricing Order, dated 26.12.2012 and submitted that the TPO has made the detailed analysis while rejecting the internal CUP adopted by the Appellant and had rightly made adjustments to the base rate of 6.05% on which loan in USD was taken by the Appellant to make the same comparable with the loan taken by the AE. He submitted that the order passed by the TPO deserves to be upheld.

We find that the Appellant has adopted the rate of interest on which 19. funds were borrowed by the Appellant as internal CUP to benchmark interest rate on which funds were given to the subsidiary. In our view, TPO was correct in concluding that the rate at which loan is taken by the Appellant cannot be taken as internal CUP to benchmark the loan given by the Appellant to its AE. In the facts of the present case, it cannot be disputed that there is a difference in credit rating of the Appellant and its AE. In our view, the same would impact the rate at lending to the Appellant/AE. In this regard, it would be pertinent to refer to the following observations made by the Hon‟ble Delhi High Court in the case of Cotton Naturals (I) Pvt. Ltd (supra): “43. Normally there would be a difference between the lending rate and borrowing rate in each country. Some authors and writers suggest that the average or mid-point between the two should be taken. However, others like Klaus Vogel, have suggested that economic purpose and substance of the debt-claim or debt for which granting of credit calls for the lending rate would be determinative. Thus, in case of a capital investment, the borrowing rate will apply, whereas in case of credit allowed to a customer on sale of goods, the lending rate would apply. We do not deem it necessary to enter into this controversy and express our view as regards the same.

Accordingly, in view of the above, we confirm the rejection of 21. internal CUP as adopted by the Appellant for benchmarking the international transaction under consideration. However, we remand the issue back to the file of Assessing Officer/TPO for adjudication afresh. During the course of hearing the Ld. Senior Counsel appearing for the Appellant had, relying upon „Statement showing cost of borrowing during the FY 2008-09’ placed at page 17 of the paper-book, submitted that the cost of borrowing was computed incorrectly at 6.05% by taking „Interest as per Annual Accounts‟ (i.e. INR 8,26,06,178/-) as the total interest cost whereas the actual cost of borrowing comes to around 3.18%. We direct the Assessing Officer to verify the claim of the Appellant and determine the cost of borrowing accordingly for the purpose of adjudication as aforesaid. In terms of the aforesaid, the issue remanded to the file of the Assessing Officer/TPO, and Ground No. 1 raised by the Appellant is partly allowed.

Ground No 2 & 3 Ground No. 2 & 3 pertain to the disallowance of INR 22. 172,94,09,811/- out of deduction of INR 263,04,15,538/- claimed by the Appellant under Section 10A of the Act. In this regard, the Ld. Senior Counsel appearing for the Appellant vehemently contended that the Assessing Officer has failed to appreciate the business of the Appellant and by incorrectly appreciating the terms and conditions of one of the contracts entered into by the Appellant with its clients, the Assessing Officer has incorrectly concluded that the Appellant is engaged in the business of „Body Shopping‟. In this regard, he relied upon Note placed at Page 244 & 245 of the paper- book which reads as under: “Larsen & Toubro Infotech Limited (LTIL) India is engaged in providing software development services to global clients in the areas of Financial Services, Manufacturing and Product Engineering Services (Telecom). LTIL India has software development centres at Mumbai (Powai and Navi Mumbai), Pune, Chennai, Bangalore and Mysore. LTIL uses a mixed/hybrid model for providing Software Development Services, wherein, services are rendered both from offshore development centres in India and at onsite locations of the customers in various countries. Nearly 98% of customer contracts in terms of revenue are of this type containing both offshore and onsite software development projects. Very small proportion of contracts (i.e. only 2% of revenue), are in the nature of pure onsite contracts and these are in the nature of Software Development Projects for SAP/ERP Development & Implementation which are required to be executed at client site. Employees working onsite are under the supervision and control of the Project/Delivery Manager from LTIL India. E.g. contract with Mushrif Trading & Contracting Company is enclosed herewith for your reference. Providing software services to overseas customers requires a combination of onsite services and offshore services. This is required for the following reasons: when a customer is transitioning the work from his IT team to outsourced vendor like us, detailed knowledge transfer is planned followed by scoping of work that needs to be done onsite as it requires proximity to customer and the work that can be offshored. Second, there is a need of certain technical staff to be onsite for better understanding of customer's ongoing requirements and translating the same to the offshore team for cost effective and timely delivery of services to the customer. Third, in cases where certain software development services are required to be integrated with other systems at customer's end, it requires interaction at customer site. Thus, onsite and offshore services are an integral part of software services delivery and are managed in a manner which ensures cost effective and timely execution. From customer's viewpoint, the customer is interested in keeping the onsite requirement to the minimum considering the higher cost involved for onsite services. The onsite as well as offshore employees work under the supervision and control of LTIL'S Engagement Manager/ Delivery Manager Project Manager. There are service level agreements on key parameters of service delivery such system up-time, response time, level of compliance to customer's standards etc. and these are jointly delivered by the onsite and offshore teams. LTIL has branch offices in various countries, through which ting is done to customers in both cases of Offshore and Onsite services provided to the customers. This is done basically to comply with the local laws of the respective countries and ease of collection of service fees charged from customers in those specific countries in many countries, there are VAT/ GST regulations requiring un to charge the same to the clients which necessitate billing to be done in respective countries. We have been trying to get the customers to agree to enter into contract with India address and we have been able to achieve this for certain clients such as Chevron Texaco Inc, USA, Freescale Semiconductor Inc., USA, Motorola Inc., USA, Samsung Electronics, South Korea, etc. E.g. contract with Chevron is enclosed for your reference. As regards contracts entered into with customers through overseas 15 branches, these branches are part of LTIL India organization only and operate as front-end offices of the company in various countries where customers are located. These front end offices are basically working as marketing arm of LTIL India. E.g. contract with Hitachi Ltd is enclosed herewith for your reference. In certain cases, customer wants control of the data shared during software development projects, due to the confidentiality requirements. In some other cases, customers observe our capabilities and in the Initial phase, they require our professionals to be onsite and once we gain their trust, we are able to get work orders involving onsite and offshore work or some work orders which can be largely executed from offshore. E.g. contract with the Thales is enclosed for your reference. From the above explanation of LTIL's business model, it can be observed that in LTIL'S business model of providing software development services through a combination of onsite and offshore services, the onsite services are effectively connected with offshore services. Hence, the onsite services are not in the nature of "Manpower Supply" which is referred to as "Body Shopping". Even in case of the small proportion of 2% business which is done through onsite project development, the onsite activities are under the control and supervision of LTIL-India. E.g. contract with Mushrif Trading & Contracting Company as also enclosed above for your reference. Hence we submit that LTIL India is eligible for exemption on its 100% export profits as it has complied with all the conditions required for claiming benefit of Sec 10A.”

In order to support the above submission, the Ld. Sr. Counsel for the Appellant took us through the relevant clauses of various contracts placed at Page 63 to 222 of the paper-book.

Further, the Ld. Sr. Counsel appearing for the Appellant also relied 23. upon submissions, dated 12.02.2013, to contend that the Assessing Officer had erred in excluding communication expenses of INR 9,54,60,091/- and other expenditure incurred in foreign currency aggregating to INR 8,82,15,41,969/- from the export turnover on the ground that provisions of Explanation 2(iv) to Section 10A of the Act are not attracted. In this regard, reliance was placed on the decision of the Tribunal in the case of M/s Patni Telecom P. Ltd. vs. ITO [2009] 308 ITR (AT) 414 (Hyderabad). Without prejudice to the aforesaid, the Ld. Senior Counsel appearing for the Appellant submitted that, in any case, as per the decision of the Special Bench of the Tribunal in the case of Income-tax Officer, Company Ward- VI(1), Chennai vs. Sak Soft Limited :[2009] 121 TTJ 865 (Chennai) (SB)[06-03-2009] if the „export turnover‟ is arrived at after excluding certain expenses, the same should also be excluded in computing the „total turnover‟.

Per contra, the Ld. Departmental Representative vehemently 24. contended that the Appellant would not engaged in the business of Software Development and therefore, not entitled to claim depreciation for the revenue stated to have been received by the Appellant from on-site development of software. He submitted that the Appellant was engaged in Body Shopping and in this regard relied upon clauses contained in various contracts placed on record by the Appellant pertaining to „supplier staff‟ or „staffing‟. He submitted that the clients exercise full control over the personnel provided by the Appellant on full time basis to the clients. He submitted that the overseas branches generated revenues from the aforesaid employees which could not have been considered as export of services from India derived from eligible units located in India. Without prejudice to the foresaid, the Ld. Departmental Representative submitted that the Assessing Officer was correct in excluding communication expenses and other expenses incurred in foreign currency as mandated by the provisions of Explanation 2(iv) to Section 10A of the Act.

We have considered the rival submissions and perused the material 25. on record including the judicial precedents cited during the course of hearing. Before dealing with the issue raised in the present appeal, we deem it appropriate to refer to the legal background as succinctly noted by the Tribunal in its decision in the case of DCIT Circle 11(4), Bangalore, Vs. M/s. iGate Global Solutions Ltd. [IT(TP)A No.286/BANG/2013, Assessment Year 2007-08, dated 05/08/2019] which read as under: “19. Section 10A is a special provision in respect of newly established undertakings in free trade zones etc. Sub-section (1) of this section provides for a deduction of profits and gains as are derived by an undertaking from the export, inter alia, of computer software for a specified period. It is not disputed that the assessee satisfied all the requisite conditions for becoming eligible to deduction under this section, which is apparent from the action of the AO in himself allowing deduction to some extent. The dispute is only to restricting the amount of deduction in respect of the alleged profits derived by the assessee from DTM and onsite charges, which in the opinion of the AO, were not derived from export of computer software.

In the appeal before us also, it is not disputed that the Appellant 26. had units eligible for deduction under Section 10A of the Act. The Assessing Officer has allowed part deduction claimed by the Appellant under Section 10A of the Act and the dispute before us is limited to the Revenue derived from on-site software development services. The contention of the revenue is that the Appellant is engaged in providing personnel and is, therefore, engaged in body shopping. On the other hand, the contention of the Appellant is providing software development services to the customers in discharge of its contractual obligations. Thus, the first issue is arises for consideration is whether the Appellant is engaged in providing software development services as claimed by the Appellant. The answer to a query regarding the nature of services provided by an assessee would depend upon the facts and circumstances of each case requiring examination of the business model and contractual obligations of such assessee. It is admitted position that 98% of the Revenue is earned by the Appellant under mixed/hybrid model requiring, both, services in India and onsite services outside India. Only 2% of the Revenue earned by the Appellant comes from the pure onsite services rendered outside India. The Appellant has placed before us the extracts of the following contracts (at page 63 to 222 of the paper-book) (a) Contract for Information Technology Services with Mushrif Trading & Contracting Co. [for short „Mushrif Contract‟] (b) Information Technology Services Agreement with Chevron U.S.A. Inc. [for short „Chevron Agreement‟] (c) Master Services Agreement on Software Development with Hitachi Limited, Japan [for short „Hitachi Agreement‟] and (d) Fixed Price Agreement with Thales, France (DAG/S&HT/2007/A262) [for short „Thales Agreement‟]. The Ld. Senior Counsel for the Appellant appearing before us relied upon the recitals and various clauses of the aforesaid agreement dealing with the scope/provision/location of services, obligations of the Appellant in relation to staff/personnel working on the project, price/consideration for services and its payment, to support the contention that the Appellant was engaged in providing software development services as per the contracts entered into by the Appellant with its clients. Countering the aforesaid submissions, the Ld. Departmental Representative placed reliance upon Clause 12 „Supplier Staff‟ of Chevron Agreement and Clause 14 „Staffing‟ of Hitachi Agreement to drive home the point that the Appellant was engaged in body shopping. He vehemently contended that Appellant was essentially supplying personnel who were under complete control and management of the clients and, therefore, Assessing Officer has rightly denied deduction claimed by the Appellant under Section 10A of the Act. However, on perusal of the agreements including the specific clauses highlighted by the Ld. Departmental Representative, we are of the view that the Appellant is not engaged in body shopping in view of the following:

26.1 Perusal of Mushrif Contract we find that according to the recital the Appellant has been engaged to implement, develop, create, test and deliver ERP/Software services. Clause 4 of the Mushrif Agreement dealing with „Notice of Delay‟, inter alia, provides that the Appellant could hire sub-contractors to provide some or all of the services set out in the relevant work order with prior written consent of the client. Further, the compensation structure provided in Clause 5 included fixed price compensation payable on completion of the services/milestone. Clause 10 dealing with „Ownership and Rights‟ provided, inter alia, that the intellectual property rights developed pursuant to work orders shall be owned by the client. As per Clause 11 dealing with „Representation and Warranties‟, the Appellant represented that it shall perform services in accordance with the degree of scale and care exercised by a service provider providing substantially similar services. The aforesaid agreement did not have any clauses pertaining to staff/personnel.

26.2. Next we take up the Chevron Agreement. The Ld. Departmental Representative had relied upon Clause 12 „Supplier Staff‟ of the Chevron Agreement and therefore, we proceed to first examine the same. The Ld. Departmental Representative had highlighted the facts Clause 12.1 provides that subject to approval by the client „Supplier Account Executive‟ appointed by the Appellant would serve on a full time basis as the primary representative and shall have overall responsibilities for managing/coordinating the performance of obligations by the Appellant and shall also be authorized to act on behalf of the Appellant. Similarly, Clause 12.2 provides that all „Key Supplier Personnel‟ working on the project shall work on full time basis. Before assigning any individual to key supplier position, the Appellant is required to notify the client, provide resume/ regarding such individual and obtain written approval of the client for such assignment. Further, Clause 12.2 (c) provides that the Appellant shall not replace „Supplier Account Executive‟/‟Key Supplier Personnel‟ for a period of two years. In our view, the terms and conditions highlighted by the Ld. Departmental Representative must be read in understood in the context of the rights and obligations of the parties under the agreement. On perusal of various provisions contained in Clause 12 we find that the provisions are intended to ensure continuous supply of quality services as represented by the Appellant. The limited control exercised by the client over assignment for specified duration and removal of the staff for the project cannot be treated at par with the right to appoint and terminate the employment of staff. As per Clause 12.1, the „Supplier Account Executive‟ bares the responsibilities of managing/coordinating the Appellant‟s obligations and also has the authority to act on behalf of the Appellant. Clause 12.2(c)/(d) do not bar replacement/re-assignment of personnel and also recognizes the right to the Appellant to terminate services of the employee/staff. Clause 12.3 clearly castes obligation on the Appellant to recruit/hire „Project Staff‟ required for providing the services under the agreement. Clause 12.4 and 12.5 requires to application maintain „Buffer Staff‟ and „Relief Staff‟ of 15 to 20% of the Project Staff and 3 to 5% of Project Staff, respectively. The aforesaid clauses when read with the Clause 3 „Services‟ read with Exhibit 2 „Statement of Work‟ giving details of possible services which could be availed by the client, clearly shows that the subject matter of the agreement under consideration is software development services and not supply of personnel as contended by the Revenue.

26.3 Under Hitachi Agreement also the Appellant has been engaged for providing program support and services as specified in Article 3 of the said agreement for a firm/fixed price to be settled between the parties for each work/supplement project. In our view, merely because the Hitachi Agreement requires that the personnel deployed for the contract would serve on a full time basis with the client (and not for any other client of the Appellant) cannot lead to a conclusion that the Appellant is supplying personnel and not providing services to its clients. 26.4. Perusal of Thales Agreement shows that it is a fixed price contract for work including software development, associated technical documentation, etc. The aforesaid agreement does not contain a clause akin to Clause 12 of the Chevron Agreement, however, according to the Ld. Departmental Representative as per the terms of the agreement the Appellant can change assigned employee only after approval from Thales. In our view, the limited right/control exercised by the client cannot be viewed de-hors the other terms and conditions contained in contract to arrive at a conclusion that the Appellant is engaged in body shopping.

26.5. Thus, on perusal of the extract of various contracts placed before us and the clauses of contracts relied upon by the Assessing Officer in the assessment order and referred to by the Ld. Departmental Representative during the course of arguments, we are of the view that the Appellant is not engaged in body shopping qua the contracts/agreements placed before us. There is nothing on record to suggest that the Appellant is engaged in body shopping. Accordingly, we hold that for the Assessment Year 2009-10 deduction claimed by the Appellant cannot be denied on the ground that the Appellant is engaged in body shopping. Accordingly, Ground No. 2 raised in the present appeal is allowed and therefore, Ground No. 3, raised by the Appellant on without prejudice basis, as well as Additional Ground raised by the Appellant is disposed off as being infructuous.

Ground No. 4 According to the Assessing Officer the onsite services provided by 27. the Appellant were not connected to the units in India and therefore, could not be considered as export of software from India derived from STPI Units located in India. Therefore, the Assessing Officer had concluded that 53.40% of the deduction claimed by the Appellant under Section 10A of the Act should be disallowed on proportionate basis. The case set up by the Assessing Officer was that the services are provided outside India by staff controlled by the foreign branches and are billed by the foreign branches (incorrectly stated to be subsidiaries by the DRP) and therefore, not linked to the eligible units located in India.

We note that during the authorities below the Appellant had 28. explained that the invoicing was done in the name of branches for the convenience of complying with the requirements of the jurisdictional VAT/GST regulations. Further, as per the decision of the Co-ordinate Bench of the Tribunal in the case of M/s. iGate Global Solutions Ltd. (supra) the test to be applied is whether the onsite services form integral part of the overall computer software project. The Revenue has not contended that the onsite services do not form part of the computer project. Further, the Revenue has also accepted that 98% of the revenues earned by the Appellant are from hybrid model requiring, both, off-shore services from India and onsite services outside India. The foreign branches are part of the Appellant, though the same may be assessed in the status of Permanent Establishment outside India and treated separate/distinct from the Appellant as per tax regulations. In our view, while the finding by the Assessing Officer that the onsite services rendered by the Assessing Officer are not connected to the eligible units is without any basis, the finding returned by the DRP that the billing is done by foreign subsidiaries is contrary to the material on record. The CBDT had, vide Circular No.1/2013 dated 17.1.2013, as well as vide Instruction No. 17/2013 dated 19.11.2013, clarified that the benefit of Section 10A would be available in respect of the profits earned as a result of deployment of technical manpower at the client‟s place abroad for software development work provided all the prescribed conditions are fulfilled. The Assessing Officer has allowed part deduction under Section 10A of the Act in respect of eligible units and therefore, it can be inferred that the other conditions stand fulfilled in the case of the Appellant. Thus, we hold that for the Assessment Year 2009-10 deduction claimed by the Appellant under Section 10A of the Act in respect of revenue from onsite services cannot be denied on the ground that the onsite services are not connected to the eligible units located in India. Accordingly, Ground No. 4 raised in the appeal is allowed.

Ground No. 5 This takes us to the issue of computation of deduction under Section 29. 10A of the Act. The Assessing Officer was of the view that while computing deduction under Section 10A of the Act following should be excluded from export turnover (a) communication charges, (b) expenditure in foreign currency, (c) interest income, and (d) additional depreciation. Therefore, on a without prejudice basis, the Assessing Officer computed deduction under Section 10A of the Act at INR 251,47,86,799/- and computed the disallowance of INR 11,73,66,598/- (INR 263,21,53,385/- minus INR 251,47,86,799/-). The CIT(A) confirmed the order passed by the Assessing Officer and therefore, the Appellant is before us in appeal on this issue.

In Ground No. 5 the Appellant has challenged the exclusion of 30. communication charges of INR 9,27,34,738/- and foreign currency expenses of INR 8,82,15,41,969/- from the „Export Turnover‟ for the purpose of computing deduction under Section 10A of the Act.

We have considered the rival submission and perused the material 31. 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).

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/-, (c) Agency Commission – INR 35,74,600/-, and (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, neither 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.

Order pronounced on 30.05.2023.