WORLDWIDE SOFTWARE (EXPORTS),MUMBAI vs. ITO 18(2)(3), MUMBAI

O R D E R Per ASHWANI TANEJA, AM: These appeals pertain to same assessee involving identical issues, therefore these appeals were heard together and are disposed of by this common order.

2. First we shall take up appeal for A.Y. 2004-05 in This appeal has been filed against the common 2 I.T.A. Nos.1933 to 1938/Mum/2016 order passed by the Commissioner of Income-tax (Appeals)-33, Mumbai [hereinafter called CIT(A)] dated 24-01-2012 for A.Ys 2004-05 to 2009-10 passed against the assessment orders u/s 143(3) r.w.s. 254 of the Act dated 22-12-2011 . The grounds raised in this appeal are as follows:- “Based on the facts, and in the circumstances of the case and in law, the Appellant respectfully submits that the learned Commissioner of Income Tax (Appeals) ['CIT(A)'] has: General ground 1. erred in confirming the action of the AO in assessing the total income of the Appellant at Rs.5,54,700/- as against NIL offered by the Appellant in the return of income; Disallowance of claim of exemption under section 10B of the Act of Rs.5,54,694/- 2. erred in confirming the action of the AO in not granting deduction under section 10B of the Act of Rs. 5,54,694, in the 5th year of claim (out of block period of 10 year) on the ground that conditions with regard to formation etc. is not being satisfied by the appellant. 3. erred in confirming the action of the AO in denying deduction under section 10B of the Act, in the s" year of claim (out of block period of 10 year), on the profits earned by Appellant on export of software to Arroweye Solutions Inc, without appreciating that firm was formed in the AY 2000-01 and deduction was allowed by AO in earlier year after verification of facts and hence not justified for denial of deduction claimed in the s" year by the appellant on account of non fulfilment of conditions; 4. erred in confirming the action of the AO in holding that Appellant is formed by splitting up or the reconstruction of the existing business i.e. Worldwide Software Pvt. Ltd.(which is already in existence), even though appellant was formed in AY 2000-01 and therefore not justified for denial of deduction claimed in the 5th year by the appellant; S. erred in confirming the action of the AO in holding that Appellant firm is formed by using plant and machinery as well as employees previously used by some other entity i.e. Worldwide Software Pvt. Ltd., even though appellant was formed in AY 2000-01 and therefore not justified for denial of deduction 3 to 1938/Mum/2016 claimed in the s" year by the appellant; Invoking provisions of section 10B(7) rws 80IA(10) of the Act 6. erred in upholding order of the AO in invoking provisions of section 10B(7) r.w.s. 80IA(10) of the Act by holding that Appellant has 'arranged' its business, where more than ordinary profit is shown to-claim higher deduction under section 10B of the Act; 7. erred in confirming the action of the AO, wherein the AO on without prejudice basis held that the net profit rate of 2.88% earned in AY 2010-11 (i.e first year after expiry of 10B deduction period) is reasonable profit and thereby held that deduction if any to be allowed under section 10B of the Act, the same should be restricted to 2.88% of the turnover as against 14% claimed by the appellant; Applicability of provision of section 92E and initiation of penalty under section 271 BA of the Act 8. erred in confirming the action of the AO, in holding that (even though software exported by the appellant to non AE as defined in section 92A of the Act), provisions of section 92E will apply in the present case (i.e for obtaining report from accountant), by treating the impugned transaction as international transaction and thereby initiating penalty proceeding under section 271 BA of the Act; Levy of interest under section 2348 of the Act

9. erred in confirming the action of AO in levy of interest under section 234B of the Act; Initiation of penalty proceeding u/s 271(1)(c) of the Act 10. erred in confirming the action of AO, for initiation of penalty proceeding under section 271 (1 )(c) of the Act; The Appellant craves leave to add, alter, modify or delete such other objections before or during the course of hearing before the Hon'ble Income Tax Appellate Tribunal ('ITAT), so as to enable the panel to decide on the objections raised by the Appellant, as per law.” 3. The first ground deals with the grievance of the assessee for denying benefit of exemption claimed by the assessee u/s 10B amounting to Rs.5,54,694/-.

4 to 1938/Mum/2016 4. The brief facts as culled out from the orders of the lower authorities are that the assessee firm i.e. M/s Worldwide Software Exports (hereafter referred to as (WWSE or the "assessee firm") was formed in the F.Y.1999- 2000 relevant to AY.2000- 01 by claiming itself 100% export oriented unit (EOU) engaged in the business of exporting computer software. It claimed that it was eligible for exemption u/s 10B of the Income Tax Act for 10 years i.e. from A.Y. 2000-01 to A.Y. 2009-10. The assessee firm is stated to be registered with Software Technology Parks of India vide STPI approval dated 25/03/2000 as 100% EOU. It filed its original return of income for the A.Y. 2004-05 showing total income at Rs. 55,569/- after claiming exemption u/s 10A amounting to Rs. 5,00,125/-. During the assessment proceedings, a revised return of income was filed on 08.12.2004 declaring total income at Rs. Nil after claiming exemption u/s 10B at Rs. 5,55,694/-. The assessment was completed u/s 144 vide order dated 26.12.2006 assessing total income of Rs. 5,66,4001/-. During the first appellate proceedings the CIT(A) vide order dated 05.08.2008 dismissed the appeal of the assessee. Thereafter, an appeal was filed before the Tribunal. The Tribunal vide order dated 30.04.2010 remitted back the order to the file of the AO for framing assessment afresh after allowing a reasonable opportunity of being heard to the assessee. During the assessment proceedings in the second round, the AO found that the assessment records indicated that the assessee firm had not developed any software on its own and utilized the assets, manpower and business clients of its sister concern namely World Wide Software Pvt. Ltd. ( in short ‘WWSPL’). Further, it was noted by the AO that the assessee had shown very low GP as compared to other years when it was not eligible for exemption in compared to the profit declared for eligible years. Accordingly, to verify 5 to 1938/Mum/2016 the genuineness of the claim of exemption u/s 10B of the Act, a survey action u/s 133A was carried out by the AO at the business premises of the assessee on 27.01.2011. Thus, during the course of assessment proceedings, after placing reliance on the statements recorded of the key employees, Mr. Abhay Waghimare & Mr. Vijay Kumar and Dr. Padam Raj Singhvi (partner of the firm) as well as based on the some evidences found during tile course of survey operation and analysis of the submissions made during assessment proceedings, the AO arrived at the conclusion that the partners of the firm owned another company WWSPL, whose business, fixed assets as well as employees were shifted to the assessee firm and thus the conditions prescribed u/s 10B of the Income Tax Act were not fulfilled. Further, to examine the possibility of arrangement of business transactions between the assessee and M/s Arroweye Solutions Inc (in short ‘ASI’) and also to examine production of more than ordinary profits, the AO analysed financial details i.e. total turnover and profit of the business in absolute terms and also worked out its ratio for the periods from A.Y.2002-03 to AY.2010-11 and arrived at the conclusion that during the 10 years period for which the assessee was eligible for exemption u/s.10B of the Income Tax Act, the profits were exorbitant and in the very next year, after the expiry of the said 10 year's i.e. AY. 2010-11, the profit ratio was reduced to 2.88%. Thus, the AO concluded that if at all exemption u/s 10B of the Income Tax Act is to be allowed, the same should be restricted to 2.88% of the turnover for the aforesaid assessment year, which arrives at RS.1,03, 118/- (2.88% of T.O.) for A. Y.2004-0S. The AO determined the total income of the assessee at Rs.5,60,794/- for the year under consideration.

6 to 1938/Mum/2016 5. Being aggrieved, assessee filed appeal before the Ld. CIT(A) and made exhaustive submissions to demonstrate that the assessee firm was freshly constituted and it was not formed as a result of split up or reconstruction of the earlier business and that there was no transfer of asset nor the transfer of employees in violation of provisions of law. It was also demonstrated that the business of the assessee firm was different from the earlier business of its sister concern, namely WWSPL. Various documentary evidences were submitted to show that the nature of business was different, copies of agreement were submitted, copies of affidavits from the partners and employees were also submitted, copies of ledger accounts, financial statements, etc. were submitted, various additional evidences were submitted in support of the facts claimed to be correct by the assessee. The Ld. CIT(A) sent these submissions and additional evidences to the AO for their examination during the remand proceedings and for sending remand report. The AO sent the remand report which was provided to the assessee. The assessee submitted its reply. Ld.CIT(A) considered all the material held on record i.e. order of the AO, copy of remand report, written submission of the assessee, reply to the remand report and documentary evidences placed on record by both the sides and thereafter upheld the action of the AO and denied the benefit of deduction u/s 10B. It was inter-alia held by him that the assessee firm was formed as a result of reconstruction or splitting up of the existing business carried out by the sister concern, viz. WWSPL. Ld. CIT(A) analysed the statements recorded during the course of survey operations of employees and also financial statements of the two parties and concluded that assets, manpower and business were shifted from WWSPL to the assessee (WWSE) from A.Y. 2000-01, i.e. the year since the 7 to 1938/Mum/2016 assessee firm came into existence. Thus, Ld. CIT(A) disregarded the contention of the assessee that the assessee company was doing separate business in view of the fact that the foreign party, viz. Yoursoul.com, USA had made separate agreement with WWSPL and WWSE for developing software in India. After analysing the facts of the case, the Ld. CIT(A) concluded as under:- “25. From the detailed analysis of the issues in hand in the instant case, the following conclusions are drawn vis-a-vis guidelines laid down by the Hon'ble Apex Court in the above case.

4. There is no employment of any person during F.Y. 1999- 2000, as the only person shown to be employed was paid its meagre salary of Rs. 6670/- only, that too, paid in the month of May, 2000 i.e. in the next F.Y.

5. When there exists no computer hardware or software and there is no evidence of any computer trained person employed by the appellate firm there is no question of manufacture or production of any software by the newly established undertaking during the first year of its formation.

7. In view of the above, one can only conclude that there is no separate and distinct identity of the WWSE, set up as new undertaking other than WWSPL.

6. In support of his justification, the Ld. CIT((A) relied upon various judgements.

7. The Ld. CIT(A) also rejected the submission of the assessee that since assessee firm was formed in assessment year. 2000-01 and exemption has been granted upto assessment year. 2003-04, therefore, no different stand could have been taken and thus exemption u/s 10B could not have been denied in A.Y. 2004-05 without disturbing the status of exemption for AY 2000-01. It was, in nutshell, contended by Ld. CIT(A) that it was for 9 to 1938/Mum/2016 the first time in AY 2000-01 when the claim of the assessee has been examined on its merits. Further various facts were revealed during the course of survey due to which it came to light that assessee firm was constituted as a result of splitting up and reconstruction of the existing business. Thus, after the survey, AY 2004-05 was the first year wherein the exemption has been rightly denied. It was also held by the Ld.CIT(A) that in the light of evidences brought on record during the course of survey, the AO had rightly come to the conclusion that provisions of section 10B r.w.s. 80IA(10) were fully applicable. It was also concluded by him that the AO had rightly analysed the facts and thereafter the AO correctly took profit of AY 2010-11 as benchmark year for estimating profits of the years during which 100% exemption u/s 10B was claimed. It was also held that AO had rightly invoked the provisions of section 92E and rightly initiated penalty proceedings u/s 271BA for non compliance of provisions of section 92E by the assessee. 8. Being aggrieved, assessee filed appeal before the Tribunal. During the course of hearing, exhaustive submissions have been made by the Ld. Counsel of the assessee to meet adverse observations of the lower authorities and to demonstrate that there was no violation of condition in section 10B and all the conditions were duly complied with and exemption u/s 10B has been rightly claimed by the assessee. Ld. Counsel was requested to summarise all his arguments and accordingly, he filed a brief note wherein all his pleadings in support of his claim u/s 10B have been summarised, which reads as under:- “3. The Assessing Officer ('AO') and the Commissioner of Income Tax (Appeals) ('CIT(A)') had held that the appellant firm Worldwide Software (Exports) was formed with a view to take the benefit of section 10B of the Act by transferring the assets 10 to 1938/Mum/2016 and employees from Worldwide Software Private Limited ('WWSPL'), which was owned by the partners of appellant firm. The contention of the AO was that the appellant firm was formed by splitting and reconstruction of a business already in existence and hence was not eligible to claim the exemption under section 10B of the Act. The CIT(A) upheld the order of the AO .

11 to 1938/Mum/2016 A. Meaning of the term splitting and reconstruction as per section 10B of the Act 6. The terms 'splitting up' and 'reconstruction' have not been defined in the Act. Hence, these terms have to be interpreted in the light of judicial precedents existing in this connection. In this regard, reliance is placed on the following case laws wherein the interpretation of the term 'splitting up' and 'reconstruction' in referred: • Textile Machinery Corporation Ltd. (107 ITR 195) (SC) The Supreme Court held that to constitute reconstruction, there must be formation of new unit by transfer of assets of the existing business to the new industrial undertaking. In the instant case industrial undertaking is formed by splitting up of the existing business undertaking since that can take place only when the substantial assets of the old business are transferred to the new undertaking. There is no such transfer of assets in the two cases with which this case is concerned. Reconstruction of business involves the idea of substantially the same persons carrying, on substantially the same business .

• Hindustan General Industries Limited reported in (137 ITR 851) (Del HC) The High Court held that where the assessee sets up a new factory and only an insignificant portion of plant and machinery from previous business is utilized and the integrity of earlier unit is not affected, the new unit cannot be said to be reconstruction, splitting up or transfer of assets of existing business, hence entitled to deduction under s.

13 to 1938/Mum/2016 (Copy of agreement between the Appellant and ASI is enclosed at Page no. 286 to 299 of Paper Book). The software application had been architected by WWSPL. (Copy of agreement between WWSPL and ASI is enclosed at Page no. 286 to 299 of Paper Book). Therefore, the Appellant submits that there were two different contracts entered by the Appellant and WWSPL with ASI respectively and the business started and carried on by the firm was not carried on by the WWSPL, hence there is no question of transfer of business by WWSPL to Appellant firm.

9. Further there was no transfer of assets and employees (within permissible limit) leading to splitting and reconstruction of existing business. It is therefore submitted that it is not a case of reconstruction of existing business or splitting up of existing business for formation or setting up of new firm. Transfer of employees from WWSPL to the Appellant 10. In the present case, the first condition is satisfied as the appellant is involved in the business of software development. Further, as submitted above there was no splitting or reconstruction of business already in existence as there was transfer of employees (within permissible limit) and no transfer of assets from WWSPL to WWSE resulting into close down of WWSPL. Further, in first year of operations (which was for 15 to 20 days) were started by partners with the help of 1 technical person and was subsequently expanded.

14. Therefore, the appellant submits that the appellant firm was not formed by splitting or reconstruction of the existing company and hence satisfies the second condition for eligibility of deduction under section 10B of the Act. B. Whether expansion in existing business (where there was no deduction available under section 10B of the Act) would be eligible for deduction in section 10B of the Act 15. The appellant wishes to place reliance on the press release of CBDT dated 17 January 2013 wherein it has been clarified whether setting up of new unit/undertaking in a location (covered by sections 10A, 10AA or 10B), where an eligible unit is already existing, would amount to expansion of such already existing unit and would be eligible subject to satisfying the condition of section 10B of the Act.

17. In view of the above it is submitted that even if new business of the appellant firm i.e. WWSE would have been carried by the old company i.e. WWSPL, it would still have been eligible for benefit under section 10B of the Act, since it was expansion.

15 to 1938/Mum/2016 Hence there is no loss to the department, as in both the situations, profit on export of software would not be chargeable to tax and it is not that the case where exemption in new undertaking is claimed on expiry of exemption in old undertaking. 18. In view of the above, the appellant wishes to submit that it was eligible for claiming exemption under section 10B of the Act and the disallowance made by AO/CIT(A) should be deleted.”

10. In response, the Ld. Counsel of the assessee submitted that the lower authorities erred in not appreciating the facts correctly. It was submitted that during the course of remand proceedings it was shown to the AO that the nature of business mentioned in the respective agreement by WWSPL and WWSE with the US company show that the nature of business was totally different. This fine distinction has been ignored by the lower authorities although it was explained to the AO and the AO was satisfied and mentioned it so in the remand report, but Ld. CIT(A) as well as the CIT-DR overlooked this crucial fact. It was also submitted that facts sheet available in the record would show that employees transferred from WWSPL were less than 50% and thus within the permissible limit as prescribed by the CBDT in its circular. It was also submitted that in the course of remand proceedings it was explained to AO that different parts of computers were purchased and with that computers were assembled and this crucial fact has been accepted by the AO in the remand proceedings. It was finally submitted that WWSPL provided the services of software architecting whereas the assessee firm rendered services of development of software. Though the final product was same, but two different processes of the development of the product were followed by the two different entities. Under these circumstances, Ld. CIT(A) grossly 17 to 1938/Mum/2016 erred in observing that WWSE had carried out same business which was earlier done by WWSPL. In support of his argument, he drew our attention upon the chart showing turnover of both the entities in different years. He summed up his argument by saying that the lower authorities wrongly concluded that the business of the assessee was carried out as a result of reconstruction of the existing business and requested for granting benefit of exemption.

11. We have gone through the facts and circumstances of the case. It is noted by us that much emphasis has been made by the Ld. Counsel that since the claim of exemption u/s 10B has been made from AY. 2000-01, which has been allowed till AY 2003-04, it cannot be disturbed for the first time in AY. 2004-05. Though, we principally agree with the Ld. Counsel on this aspect since this issue is well settled now in view of various judgments relied upon before Ld. CIT(A) as well as before us by the Ld. Counsel during the course of hearing, but the benefit of these judgements would be available in the normal circumstances where the facts remain same. But in case, where the revenue detects some facts which may have direct bearing on the eligibility of the claim made by the assessee, then it would not be justified to disregard those evidences at the very outset. The claim may ultimately be held to be allowable or not, but whatever evidences or crucial facts are discovered by the Revenue, these must be examined independently and if it is found that the exemption has been granted wrongly because true facts were concealed by the assessee, and these facts were within the knowledge of the assessee and these facts were so material or crucial having bearing on allowability of claim of deduction, then it would not be justified to perpetuate the wrong claim of deduction, merely for the reason that the deduction has been allowed in the first year 18 to 1938/Mum/2016 in absence of disclosure of proper facts by the assessee. Under these circumstances, we find it appropriate to examine the averments and allegations made by the AO as well as by Ld. CIT(A), independently on merits, to examine their effect on the claim made u/s 10B by the assessee.

19 to 1938/Mum/2016 contained detailed description of the project as well as basic logarithm for the application was also outlined therein. It appears that both the lower authorities got influenced by this fact that most of the terms used in both the agreements looked identical. It was quite apparent when the ultimate product was same and the customer, 4Yoursoul.com (US) LLC (US firm) was also same, then the pattern and writing of the agreement may also be identical. But even on the basis of common sense, a man of ordinary prudence can make distinction between the two jobs. The development of software and architecting the software are altogether two different aspects. An example of total process required for construction of a Building was quoted before us during the course of hearing to explain the distinction. For construction of a building, first of all a ‘lay out’ plan is drafted, which is done by a building architect. Thereafter, based upon the lay out plan, construction of building is done by a civil contractor. In this example, though ultimate product i.e. ‘Building’ remains the same, but drafting of a lay-out plan and construction of building are two separate activities, and different set of professionals/technicians possessing skill and specialisation in their respective fields are required for carrying out these activities. In the case of assessee before us also, similar distinction exists. This distinction should not have been blurred by lower authorities merely for the sake of reaching on to the conclusion that same business has been carried out by both the entities. The line of business may appear to be identical but the work to be carried out in both the agreements is different from each other. In our considered opinion, perusal of the agreement suggests that different activities have been carried out and lower authorities have not properly understood the facts in this regard. Thus, this allegation is not sustainable.

20 to 1938/Mum/2016 13. Further, with regard to the allegation of the AO that no fresh computers were purchased by the assessee, it is noted that the assessee presented before the AO during the course of remand proceedings the bills of the computers showing that since assessee was in this line of business it was economical and commercially expedient for the assessee to buy parts of computer and then assemble them for their usage. Therefore, the bills produced by the assessee were for purchase of parts of computers. Our attention was also drawn on the remand report where following observations have been made by the AO: “Page 96 gives ledger accounts of computers for A.Y. 2000-01 in the books of M/s WWSPL, The assessee has submitted a few bills from Arihant Computers that shows that the assessee firm has purchased computers in subsequent years as the assessee firm grew.

Thus, from the perusal of the above, it is seen that all these evidences were shown to the AO and these were found acceptable by the AO. Under these circumstances, it was not appropriate on the part of the CIT(A) to disregard these evidences. In addition to that our attention was also drawn on page 433 and 435 of the paper book, which are invoice and ledger account of the computers showing purchase of computers on 16th March, 2000. Thus, this allegation is also not sustainable.

16. Since we have allowed ground 2 to 5, the other grounds become infructuous and do not find it necessary to adjudicate them.

17. It was jointly stated by both the parties that the issue involved is identical in all the years. Therefore, the AO is directed to follow our order for AY. 2004-05 and allow the benefit of deduction u/s 10B in all other years under appeal.