Supreme Court clarifies total turnover under Section 10A of IT Act: Commissioner of Income Tax vs. HCL Technologies Ltd. (24 April 2018)

Date of the Judgment: 24 April 2018
Citation: 2018 INSC 342
Judges: R.K. Agrawal, J. and R. Banumathi, J.
Can expenses related to software development, freight, and telecommunication be excluded from the ‘total turnover’ when calculating income tax deductions under Section 10A of the Income Tax Act, 1961? The Supreme Court addressed this question in a batch of appeals, clarifying how to compute deductions for businesses engaged in software exports. The core issue was whether the term “total turnover” under Section 10A should be interpreted to include or exclude expenses related to software development and delivery, similar to how “export turnover” is calculated. The bench comprised Justices R.K. Agrawal and R. Banumathi, with the judgment authored by Justice R.K. Agrawal.

Case Background

HCL Technologies Ltd., the respondent, is a company involved in developing and exporting computer software and providing technical services. For the assessment year 2004-05, the company declared a gross income of Rs. 267,01,76,529 and claimed deductions of Rs. 273,45,39,379 under Section 10A of the Income Tax Act, 1961, resulting in a net loss. The company also declared an undisclosed income of Rs. 91,25,68,114, later revised to Rs. 91,16,99,060. The Assessing Officer (AO) scrutinized the return and determined that the software development charges claimed by HCL were essentially expenses for technical services provided outside India. The AO estimated 40% of these charges as software development expenses and 60% as technical service expenses, reassessing the taxable income at Rs. 137,20,34,576 and imposing a penalty of Rs. 21,81,90,239.

Aggrieved by the AO’s order, HCL appealed to the Commissioner of Income Tax (Appeals) [CIT(A)], who partly allowed the appeal, estimating 10% of the charges as software development expenses. Both HCL and the Revenue appealed to the Income Tax Appellate Tribunal (ITAT). The ITAT dismissed the Revenue’s appeal and allowed HCL’s appeal. The Revenue then appealed to the High Court of Delhi, which also dismissed the Revenue’s appeal, upholding the ITAT’s decision. Consequently, the Revenue filed the present appeals before the Supreme Court of India.

Timeline

Course of Proceedings

The Assessing Officer (AO) determined that the software development charges were actually expenses for technical services provided outside India. The AO estimated that 60% of these charges were for technical services and the remaining 40% for software development. The Commissioner of Income Tax (Appeals) [CIT(A)] partly allowed HCL’s appeal, reducing the technical services expense estimate to 10%. The Income Tax Appellate Tribunal (ITAT) dismissed the Revenue’s appeal and allowed HCL’s appeal. The High Court of Delhi also dismissed the Revenue’s appeal, upholding the ITAT’s decision. The Revenue then approached the Supreme Court.

Legal Framework

The core of the dispute revolves around Section 10A of the Income Tax Act, 1961, which provides deductions for profits from export-oriented undertakings. The section does not define the term “total turnover.” The court also considered the definition of “total turnover” in the Explanation to Section 80HHC of the IT Act, which excludes freight and insurance attributable to the transport of goods beyond customs stations.

Section 10A of the Income Tax Act, 1961 states:
“Special provision in respect of newly established undertakings in free trade zone, etc.—(1) Subject to the provisions of this section, a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software shall be allowed from the total income of the assessee.”

Explanation to Section 80HHC of the IT Act defines “total turnover” as:

“(ba) ‘total turnover’ shall not include freight or insurance attributable to the transport of the goods or merchandise beyond the customs stations as defined in the Customs Act, 1962 (52 of 1962).
Provided that in relation to any assessment year commencing on or after the 1st day of April, 1991, the expression “total turnover” shall have effect as if it also included any sum referred to in clauses (iiia), (iiib), (iiic), (iiid) and (iiie) of section 28;”

Arguments

Revenue’s Arguments:

• The Revenue argued that since “total turnover” is not defined under Section 10A of the IT Act, its ordinary meaning should be adopted, which does not allow for the reduction of any expenses.
• The Revenue contended that the technical meaning of “total turnover” should be applied, which does not permit the deduction of any expenses.
• The Revenue submitted that expenses such as freight, telecommunication, and insurance, which are attributable to the delivery of software outside India, should not be excluded from the total turnover while calculating deductions under Section 10A of the IT Act.

Respondent’s Arguments:

• The Respondent argued that “export turnover,” as defined in Section 10A of the IT Act, excludes freight, telecommunication charges, and insurance attributable to the delivery of goods outside India, as well as expenses for technical services provided outside India.
• The Respondent contended that if these expenses are excluded from the numerator (export turnover), they should also be excluded from the denominator (total turnover) to avoid undesirable results in the formula for computing profit from exports.
• The Respondent submitted that it is legally entitled to exclude these expenses from the total turnover.

The innovativeness of the argument by the respondent was that they argued that if certain expenses are excluded from the numerator (export turnover), they should also be excluded from the denominator (total turnover) to maintain the integrity of the formula. This argument was crucial in establishing that the interpretation of “total turnover” should be consistent with the interpretation of “export turnover” to achieve a fair and logical outcome.

Issues Framed by the Supreme Court

The main issue before the Supreme Court was:

1. Whether, in the facts and circumstances of the case, the software development charges are to be excluded while working out the deduction admissible under Section 10A of the IT Act on the ground that such charges are relatable towards expenses incurred on providing technical services outside India?

Treatment of the Issue by the Court

Authorities

Cases Relied Upon by the Court:

• Commissioner of Income Tax vs. J.H. Gotla, (1985) 23 Taxman 14J (SC): The Supreme Court emphasized that if a literal interpretation of a statutory provision leads to an unjust result, the court may modify the language to achieve the legislature’s intent and produce a rational construction.
• CIT vs. Tata Elxsi Ltd. (2012) 204 Taxman 321/17 (Karnataka High Court): The Karnataka High Court held that when a term is not defined by the legislature, its ordinary meaning should be consistent with the context. What is excluded from ‘export turnover’ must also be excluded from ‘total turnover.’

Legal Provisions Considered by the Court:

• Section 10A of the Income Tax Act, 1961: This section provides deductions for profits from export-oriented undertakings.
• Explanation to Section 80HHC of the Income Tax Act, 1961: This defines “total turnover” for the purposes of that section, excluding freight and insurance attributable to the transport of goods beyond customs stations.

Judgment

How each authority was viewed by the Court?

• Commissioner of Income Tax vs. J.H. Gotla, (1985) 23 Taxman 14J (SC): The Court used this case to justify modifying the interpretation of “total turnover” to prevent a manifestly unjust result.
• CIT vs. Tata Elxsi Ltd. (2012) 204 Taxman 321/17 (Karnataka High Court): The Court followed the principle that the meaning of a term should be consistent with its context, and what is excluded from ‘export turnover’ should also be excluded from ‘total turnover’.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need for a harmonious and logical interpretation of Section 10A of the IT Act. The Court aimed to ensure that the calculation of deductions for export-oriented undertakings was fair and consistent. The key factors that weighed in the mind of the Court were:

• Consistency in Calculation: The Court emphasized that if certain expenses are excluded from “export turnover” (the numerator), they should also be excluded from “total turnover” (the denominator) to maintain the integrity of the formula.
• Legislative Intent: The Court sought to uphold the legislative intent behind Section 10A, which is to encourage and boost new business undertakings in free trade zones by providing suitable deductions.
• Avoidance of Injustice: The Court aimed to avoid a situation where a strict, literal interpretation of “total turnover” would lead to unjust and illogical results, which would not have been the intention of the legislature.
• Harmonious Construction: The Court applied the principle of harmonious construction, ensuring that the various provisions of the IT Act are interpreted in a consistent and coherent manner.

The Court’s reasoning was based on the principle of harmonious construction and the need to avoid an interpretation that would render the formula for calculating deductions under Section 10A illogical. The Court emphasized that the intention of the legislature was to provide a benefit to export-oriented undertakings, and this intention would be defeated if expenses excluded from the numerator were not also excluded from the denominator.

The Court considered alternative interpretations but rejected them because they would lead to an illogical and unjust outcome. The Court emphasized that the formula for calculating deductions should be workable and consistent with the legislative intent.

The Court’s decision was that expenses related to software development, freight, telecommunication, and insurance, which are excluded from “export turnover,” should also be excluded from “total turnover” when calculating deductions under Section 10A of the IT Act. This interpretation ensures that the formula for computing export profits is fair and consistent.

The Court stated:
“In the instant case, if the deductions on freight, telecommunication and insurance attributable to the delivery of computer software under Section10A of the IT Act are allowed only in Export Turnover but not from the Total Turnover then, it would give rise to inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the Respondent which could have never been the intention of the legislature.”

The Court further stated:
“Even in common parlance, when the object of the formula is to arrive at the profit from export business, expenses excluded from export turnover have to be excluded from total turnover also. Otherwise, any other interpretation makes the formula unworkable and absurd. Hence, we are satisfied that such deduction shall be allowed from the total turnover in same proportion as well.”

The Court also stated:
“On the issue of expenses on technical services provided outside, we have to follow the same principle of interpretation as followed in the case of expenses of freight, telecommunication etc., otherwise the formula of calculation would be futile. Hence, in the same way, expenses incurred in foreign exchange for providing the technical services outside shall be allowed to exclude from the total turnover.”

There were no dissenting opinions. The judgment was delivered by a two-judge bench.

The Court’s reasoning was based on the principle of harmonious construction and the need to avoid an interpretation that would render the formula for calculating deductions under Section 10A illogical. The Court emphasized that the intention of the legislature was to provide a benefit to export-oriented undertakings, and this intention would be defeated if expenses excluded from the numerator were not also excluded from the denominator.

The potential implications of this decision are that it provides clarity on how to calculate deductions under Section 10A of the IT Act, ensuring that businesses engaged in software exports receive the intended benefits. It also sets a precedent for interpreting similar provisions in the IT Act, emphasizing the need for a consistent and logical approach.

The Court did not introduce any new doctrines or legal principles but reinforced the existing principles of harmonious construction and the importance of legislative intent in statutory interpretation.

Key Takeaways

• Expenses related to software development, freight, telecommunication, and insurance that are excluded from “export turnover” must also be excluded from “total turnover” when calculating deductions under Section 10A of the Income Tax Act, 1961.
• The interpretation of “total turnover” should be consistent with the interpretation of “export turnover” to ensure a fair and logical outcome in the formula for computing export profits.
• The Supreme Court emphasized the principle of harmonious construction and the importance of legislative intent in statutory interpretation.
• This judgment provides clarity for businesses engaged in software exports, ensuring they receive the intended benefits under Section 10A of the IT Act.

Directions

The Supreme Court dismissed the appeals filed by the Revenue, upholding the decision of the High Court. No specific directions were issued.

Development of Law

The ratio decidendi of this case is that when calculating deductions under Section 10A of the Income Tax Act, 1961, expenses excluded from “export turnover” must also be excluded from “total turnover.” This interpretation ensures consistency and fairness in the formula for computing export profits. The Supreme Court clarified that the meaning of “total turnover” in Section 10A should be interpreted harmoniously with the definition of “export turnover” to avoid illogical results, thereby reinforcing the principle that the intention of the legislature must be followed. This case does not change the previous position of law but rather clarifies the application of existing provisions to a specific context.

Conclusion

The Supreme Court’s judgment in Commissioner of Income Tax vs. HCL Technologies Ltd. clarifies the interpretation of “total turnover” under Section 10A of the Income Tax Act, 1961. The Court held that expenses excluded from “export turnover,” such as freight, telecommunication, insurance, and software development charges, must also be excluded from “total turnover” to ensure a consistent and logical calculation of deductions. This decision provides clarity for businesses engaged in software exports and reinforces the principles of harmonious construction and legislative intent in statutory interpretation.

Category

Parent Category: Income Tax Act, 1961
Child Categories:

• Section 10A, Income Tax Act, 1961
• Export Turnover, Income Tax Act, 1961
• Total Turnover, Income Tax Act, 1961
• Deductions, Income Tax Act, 1961
• Software Exports, Income Tax Act, 1961

FAQ

Q: What is Section 10A of the Income Tax Act, 1961?

A: Section 10A of the Income Tax Act, 1961 provides deductions for profits derived from the export of articles, things, or computer software by newly established undertakings in free trade zones.

Q: What is “export turnover” under Section 10A?

A: “Export turnover” refers to the consideration received for the export of articles, things, or computer software. It specifically excludes expenses such as freight, telecommunication charges, insurance, and expenses for technical services provided outside India.

Q: What is “total turnover” under Section 10A?

A: While “total turnover” is not defined in Section 10A, the Supreme Court clarified that it should be interpreted consistently with “export turnover.” This means that expenses excluded from “export turnover” should also be excluded from “total turnover” when calculating deductions under Section 10A.

Q: Why did the Supreme Court rule that certain expenses should be excluded from “total turnover”?

A: The Supreme Court ruled that expenses excluded from “export turnover” should also be excluded from “total turnover” to maintain consistency in the formula for computing export profits. This ensures a fair and logical outcome and upholds the legislative intent behind Section 10A.

Q: What types of expenses are excluded from both “export turnover” and “total turnover”?

A: The expenses excluded include freight, telecommunication charges, insurance attributable to the delivery of software outside India, and expenses for technical services provided outside India.

Q: How does this ruling affect software companies?

A: This ruling provides clarity for software companies engaged in exports, ensuring that they can accurately calculate deductions under Section 10A. By excluding specific expenses from both “export turnover” and “total turnover,” the calculation becomes more consistent and fair.

Q: What is the practical implication of this judgment?

A: The practical implication is that software export companies can now exclude the expenses related to freight, telecommunication, insurance, and technical services provided outside India from their total turnover while calculating deduction under Section 10A of the Income Tax Act. This will result in a higher deduction and thus lower tax liability for eligible companies.