THE PR COMMISSIONER OF INCOME TAX vs. M/S MPHASIS LTD

IN THE HIGH COURT OF KARNATAKA AT BENGALURU

DATED THIS THE 24TH DAY OF FEBRUARY, 2021

PRESENT

THE HON'BLE MR. JUSTICE SATISH CHANDRA SHARMA

AND

THE HON'BLE MR. JUSTICE V.SRISHANANDA

I.T.A. NO.62/2018

BETWEEN:

INCOME TAX-4,

BMTC COMPLEX,

KORAMANGALA, BENGALURU.

OF INCOME TAX, RANGE 12,

BANGALORE.

…APPELLANTS

(BY SRI.E.I.SANMATHI, ADV.,)

AND:

M/S. MPHASIS LTD., BAGMANE WORLD TECHNOLOGY CENTRE, 1ST FLOOR, WING-A, WTC-3, K.R.PURAM, MARATHHALLI, OUTER RING ROAD, MAHADEVAPURA, BENGALURU 560 048. PAN AAACB 6820C. … RESPONDENT

(BY SRI.SURYANARAYANA T, ADV.,)

THIS APPEAL IS FILED UNDER SECTION 260-A OF INCOME TAX ACT, 1961, ARISING OUT OF ORDER DATED 09.08.2017 PASSED IN IT (TP)A NO.242/BANG/2014, FOR THE ASSESSMENT YEAR 2009-2010, PRAYING TO DECIDE THE FOREGOING QUESTION OF LAW AND/OR SUCH OTHER QUESTIONS OF LAW AS MAY BE FORMULATED BY THE HON’BLE COURT AS DEEMED FIT ETC.,

THIS APPEAL HAVING BEEN HEARD AND RESERVED ON 22.01.2021, COMING ON FOR ‘PRONOUNCEMENT’ OF JUDGMENT THIS DAY, SATISH CHANDRA SHARMA J., DELIVERED THE FOLLOWING:

JUDGMENT

The present appeal has been filed by the Income tax department under Section 260-A of the Income tax Act, 1961 against the order dated 9.8.2017 passed by the Income tax Appellate Tribunal, ‘A’ Bench, Bengaluru, in IT(TP)A. No.242/Bang/2014 for the assessment year 2009-10.

Section 10B of the Income tax Act, 1961 (‘the Act’ for short) in respect of two units claimed by the assessee for income from onsite-subcontract work given to its associated enterprises in its order passed under Section 143(3) r/w Section 144(C)(13) by holding that the above profit was not eligible for deduction and hence, disallowed the claim of deduction under Section 10B of the Act.

(i) The assesse is not entitled to claim deduction in respect of turnover relatable to onsite development of software sub-contracted by it to its Associate Enterprises (‘the AEs’ for short); (ii) The expenses incurred by the assessee in foreign currency having been incurred for providing technical services should be excluded from export turnover.

(b) disallowance of depreciation claimed by the assessee at 60% on switches and routers on the ground that they are not parts and accessories of computers; and

(c) disallowance of foreign exchange loss claimed by the assessee as a deduction on account of fluctuation in foreign exchange in respect forward contracts.”

“5. It is submitted that the Tribunal failed to appreciate the fact that in the case of on-site sub- contracting of work, complete work of software development, testing and installation is done by the associated enterprises and the assessee only acts as middleman/ intermediary between client and its associated enterprises. Deduction u/s.10B is site specific

and the provisions of the Act are very clear in providing various specific requirements for eligibility if deduction u/s 10B of the Act. The Tribunal while relying on the decision in the case of M/s.Mphasis Software and Services India Pvt Ltd., has quoted various judgments of different Tribunals which are not applicable to the facts of this case. The Tribunal after going through the agreements as well as the work orders has found that the work of software development was undertaken by the assessee and risk and reward under the agreement belong to the assessee and not to the associated enterprises of the assessee, mere signing of an agreement does not change the actual nature of work performed. In the instant case the arrangement of work contract has been made by the assessee and its associated enterprises solely to avoid taxes. The Revenue was in appeal before the Tribunal on the only issue is whether the assessee is eligible for deduction u/s 10B with regard to income earned by the assessee from the on site development of software through its associated enterprises under sub contract. The Tribunal dismissed the Revenue’s appeal relying on the identical issue in the case of Mphasis Software Services India P.Ltd., which has not reached finality.

(2013) 40 taxmann.com 108 (Delhi),

3.2 The Income tax Appellate Tribunal, Delhi “F” Bench in the case of Expeditors International (India) (P) Ltd. Vs. CIT reported in (2008) 118 TTJ 652 (Delhi) has held that peripherals such as printer, scanners, NT Server, etc. form integral part of the computer and the same, therefore, are eligible for depreciation at the rate of 60% as applicable to a computer.

entitled to depreciation at 60%. The revenue has not been able to controvert the said finding of the Tribunal and therefore, in light of the judgment delivered by the Delhi High Court, the first substantial question of law is answered in favour of the assessee and against the revenue.

“6. Mr. Malhotra, learned Counsel appearing for the Revenue submits that this appeal had to be admitted as the impugned order has ignored its order in the case of S. Vinodkumar Diamonds Pvt. Ltd. v. Addl. CIT, (2013) 59 SOT 124/35 taxmann.com 337 (Mum.-Trib.) rendered on 3 May 2013 which on similar facts is in favour of the Revenue. He further submits that the impugned order of the Tribunal is suspect because it accepts the Respondent assessee's claim without calling upon it to prove that the

same was not speculative. Lastly, he sought to place reliance upon Accounting Standard-11 to claim that such a loss is not allowable thereunder.

on the ground that it was notional. Lastly, the reliance placed on the decision in S. Vinodkumar Diamonds Pvt.Ltd., (supra) in the Revenue's favour would not by itself govern the issues arising herein. This is so as every decision is rendered in the context of the facts which arise before the authority for adjudication. Mere conclusion in favour of the Revenue in another case by itself would not entitle a party to have an identical relief in this case. In fact, if the Revenue was of the view that the facts in S. Vinodkumar (supra) are identical/similar to the present facts, then reliance would have been placed by the Revenue upon it at the hearing before the Tribunal. The impugned order does not indicate any such reliance. It appears that in S. Vinodkumar Diamonds Pvt.Ltd., (supra), the Tribunal held the forward contract on facts before it to be speculative in nature in view of Section 43(5) of the Act. However, it appears that the decision of this court in CIT v. Badridas Gauridu (P) Ltd., 2004 (134) Taxman Pg. 376 (Mum) was not brought to the notice of the Tribunal when it rendered its decision in S. Vinodkumar Diamonds Pvt.Ltd., (supra). In the above case, this court has held that forward contract in foreign exchange when incidental to carrying on business of cotton exporter and done to cover up losses on account of differences in foreign exchange valuations, would not be speculative activity but a business activity.”

In light of aforesaid judgment, this Court is of the opinion that the Tribunal was justified in setting aside the disallowance of foreign exchange loss on forward contract.

assessee is in the ordinary course of its business and therefore, would fall within the exceptions provided in the proviso to Section 43(5) of the Act. Therefore, the judgment delivered in the case of D.Chethan and Co., (supra) squarely covers the present case.

LTD., reported in (2009) 179 Taxman 326(SC) in paragraphs 13 to 15 has held as under: “13. As stated above, one of the main arguments advanced by the learned Additional Solicitor General on behalf of the Department before us was that the word "expenditure" in Section 37(1) connotes "what is paid out" and that which has gone irretrievably. In this connection, heavy reliance was placed on the judgment of this Court in the case of Indian Molasses Company (supra). Relying on the said judgment, it was sought to be argued that the increase in liability at any point of time prior to the date of payment cannot be said to have gone irretrievably as it can always come back. According to the learned counsel, in the case of increase in liability due to foreign exchange fluctuations, if there is a revaluation of the rupee vis-a-vis foreign exchange at or prior to the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of "expenditure" is not met. Consequently, the additional liability arising on account of fluctuation in the rate of foreign exchange was merely a contingent/notional liability which does not crystallize till payment. In that case, the Supreme Court was considering the meaning of the expression "expenditure incurred" while dealing with the question as to whether there was a distinction between the actual liability in presenti and a liability de futuro. The word "expenditure" is not defined in the 1961 Act. The word "expenditure" is, therefore, required to be understood in the context in which it is used. Section 37 enjoins that any expenditure not being expenditure of the nature described in Sections 30 to 36 laid out or expended wholly and exclusively for the

purposes of the business should be allowed in computing the income chargeable under the head "profits and gains of business". In Sections 30 to 36, the expressions "expenses incurred" as well as "allowances and depreciation" has also been used. For example, depreciation and allowances are dealt with in Section 32. Therefore, Parliament has used the expression "any expenditure" in Section 37 to cover both. Therefore, the expression "expenditure" as used in Section 37 may, in the circumstances of a particular case, cover an amount which is really a "loss" even though the said amount has not gone out from the pocket of the assessee. 14. In the case of M.P. Financial Corporation v. CIT reported in (1987) 165 ITR 765 the Madhya Pradesh High Court has held that the expression "expenditure" as used in Section 37 may, in the circumstances of a particular case, cover an amount which is a "loss" even though the said amount has not gone out from the pocket of the assessee. This view of the Madhya Pradesh High Court has been approved by this Court in the case of Madras Industrial Investment Corporation Ltd. v. CIT reported in (1977) 225 ITR 802. According to the Law and Practice of Income Tax by Kanga and Palkhivala, Section 37(1) is a residuary section extending the allowance to items of business expenditure not covered by Sections 30 to 36. This Section, according to the learned Author, covers cases of business expenditure only, and not of business losses which are, however, deductible on ordinary principles of commercial accounting. (see page 617 of the eighth edition). It is this principle which attracts the provisions of Section 145. That section recognizes the rights of a trader to adopt either the

cash system or the mercantile system of accounting. The quantum of allowances permitted to be deducted under diverse heads under Sections 30 to 43C from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining the word "paid" in Section 43(2), which is used in several Sections 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under Section 28/29. That is why in deciding the question as to whether the word "expenditure" in Section 37(1) includes the word "loss" one has to read Section 37(1) with Section 28, Section 29 and Section 145(1). One more principle needs to be kept in mind. Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. One more aspect needs to be highlighted. Under Section 28(i), one needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The 1961 Act makes no provision with regard to valuation of stock. But the ordinary principle of commercial accounting requires that in the P&L account the value of the stock-in- trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading Section 37(1) with Section 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into

account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. This is the theory underlying the Rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following years account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually. At this stage, we need to emphasise once again that the above system of commercial accounting can be superseded or modified by legislative enactment. This is where Section 145(2) comes into play. Under that section, the Central Government is empowered to notify from time to time the Accounting Standards to be followed by any class of assessees or in respect of any class of income. Accordingly, under Section 209 of the Companies Act, mercantile system of accounting is made mandatory for companies. In other words, accounting standard which is continuously adopted by an assessee can be superseded or modified by Legislative intervention. However, but for such intervention or in cases falling under Section 145(3), the method of accounting undertaken by the assessee continuously is supreme. In the present batch of cases, there is no finding given by the AO on the correctness or completeness of the accounts of the

assessee. Equally, there is no finding given by the AO stating that the assessee has not complied with the accounting standards. 15. For the reasons given hereinabove, we hold that, in the present case, the "loss" suffered by the assessee on account of the exchange difference as on the date of the balance sheet is an item of expenditure under Section 37(1) of the 1961 Act.” The Hon’ble Supreme Court has held that the loss on account of foreign exchange fluctuation is allowable as a deduction under Section 37(1) of the Act.

The appeal is dismissed accordingly. No orders as to costs.

Sd/- JUDGE

Sd/- JUDGE nd