Commissioner Of Income Tax-Viii v. Ms. Kiran Kapoor

$~ IN THE HIGH COURT OF DELHI AT NEW DELHI +ITA NO.13/2015 Decided on : 19.01.2015 +ITA NO.14/2015 +ITA NO.15/2015, C.M. APPL.157/2015 COMMISSIONER OF INCOME TAX-VIII..... Appellant versus MS. KIRAN KAPOOR..... RespondentThrough : : Sh. Balbir Singh, Sr. Standing Counselwith Sh. Angad Sandhu and Ms. Rubal Maini,Advocates for CIT. Sh. Mayank Nagi, Advocate, for respondent. CORAM:HON'BLE MR. JUSTICE S. RAVINDRA BHATHON'BLE MR. JUSTICE R.K. GAUBA MR. JUSTICE S. RAVINDRA BHAT (OPEN COURT) % 1.The questions of law which the revenue urges in support of theseappeals, directed against three orders of the ITAT for AY 2003-04, 2004-05,2005-06 and 2006-07 are: (1)Whether the assessee is engaged in activity which can be termed“manufacture” so as to claim benefit of Section 10B of the Income Tax Act,1961 (hereafter “the Act”) and (2)Whether the activity (of collection, collation, formatting of data andinformation and its export) fulfils the conditions stipulated in Section10B(2)(i) of the Act. 2.The brief facts of the case that the assesse, an individual, in her returnclaimed exemption under Section 10B of the Act to the tune of ` 39,32,654.She claimed to be a software exporter to Netherlands. The importer was oneMr. Rolli Janssen B.V. The claim was disallowed by the Assessing Officer(AO) who added back ` 39,32,654/- and finalized the assessment.Dissatisfied by the view of the AO, the assessee appealed to the CIT(A),who confirmed those findings. Aggrieved by the order of the CIT(A) theassessee successfully appealed to the ITAT. The revenue is, therefore, inappeal under Section 260-A of the Act. 3.Mr. Balbir Singh, learned counsel for the revenue argued that theITAT fell into error on both the questions. Stating that the process deployedby the assessee was neither “manufacture” nor did it amount to creation ofsoftware, he supported the orders of the AO and CIT(A). He urged that theasseessee was unable to establish that computer software is manufactured orproduced by it. He contended that the conditions specified in Section 10B,Explanation 2 (1) viz, "any customized electronic data or any product orservice of similar nature, as may be notified by the CBDT, which istransmitted or exported from India to any place outside India by anymeans” had a precondition for a successful claim under the Act. He arguedthat the ITAT fell into error in disturbing the concurrent finding of theauthorities below. 4.Learned counsel relied upon the terms of the Notification S.O.890(E)dated 26-9-2000, to say that the ITAT failed to uphold the findings of theCIT (A) that the assessee’s activities did not fit the description of any of theprocesses mentioned. It was argued that the mere compilation of datawithout anything more, could not be said to have resulted in a customized or“legal database”. The database had to be such as was capable of use by thecustomer or client, as software. Else, activity of any description even if itcould not be characterised as “manufacture” or “production” wouldsuccessfully claim benefit under Section 10B. 5.Learned counsel relied on the judgment of the Supreme Courtreported as Commissioner of Income Tax v Gem India Manufacturing CoLtd 2001 (249) ITR 307 (SC). It was inter alia, held in that judgment that: “There can be little difficulty in holding that the raw and uncutdiamond is subjected to a process of cutting and polishing whichyields the polished diamond, but that is not to say that thepolished diamond is a new article or thing which is the result ofmanufacture or production. There is no material on the recordupon which such a conclusion can be reached.” Counsel also relied upon the terms of the CBDT circular, which reads as follows: 5.Learned counsel relied on the judgment of the Supreme Courtreported as Commissioner of Income Tax v Gem India Manufacturing CoLtd 2001 (249) ITR 307 (SC). It was inter alia, held in that judgment that: “There can be little difficulty in holding that the raw and uncutdiamond is subjected to a process of cutting and polishing whichyields the polished diamond, but that is not to say that thepolished diamond is a new article or thing which is the result ofmanufacture or production. There is no material on the recordupon which such a conclusion can be reached.” Counsel also relied upon the terms of the CBDT circular, which reads as follows: "S.O.890(E) - In exercise of the powers conferred by clause (b)of item (i) of Explanation 2 of section 10A, clause (b) of item (l)of Explanation 2 to section 10B and clause (b) to Explanation tosection 80HHC of the Income-tax Act, 1961 (43 of 1961), theCentral Board of Direct Taxes hereby specifies the followingInformation Technology enabled products or services as the casemay be for the purpose of said clauses namely :- (l) Back-Office Operations (ii) Call Centres (iii) Content Development or animation (iv) Data Processing (v) Engineering and Design (vi) Geographic Information System Services (vii) Human Resources Services (viii) Insurance claim processing (ix) Legal Databases (x) Medical Transcription (xi) Payroll (xii) Remote Maintenance (xiii) Revenue Accounting (xiv) Support Centres and (xv) Web-site Services.” It was submitted that preparation of data for its ready printing use could notamount to manufacture of software, entitling the assessee to claim benefit ofSection 10B. 6.The ITAT noticed that in this case, there are four stages for thecompletion of the assessee’s product. The first stage is where the assesseecollects the raw material that goes into making of the final files. Thiscomprises mainly of text and photographs. The providers of these materials-depending on the subject of the book- are various authors, photographers,photo agencies. The data is sourced from different places including internet.The ITAT cited a specific work of the assessee, a book titled “100 Wondersof India” and noticed that a freelancer, Mr Nirad Grover was engaged forcollection of photographs necessary for production of the book. The assesseealso relied on an agreement with Mr Nirad Grover and stated that thematerials were in an edited state. The next stage in the process is design and layout. Here the designers use the said material to prepare the layout of thebook within the given parameter and specifications of clients. This involvesdesigning and lay out of materials in a manner which fits the size andnumber of pages given for the particular book. This stage is specialized andthe assessee’s book designers are experts in the field of making uniquelyuser friendly layouts. The third stage is the scanning and color correction.For that the images used in the book have to be of a good print quality; andhave to go through the “scanning and colour correction” stage. Everyphotograph (provided to the designers in a hard format) is scanned anddigitally colour-corrected; it involves user of software such as AcrobatReader and QuarkX Press, manipulation of the date, photographs andcolours to remove blemishes so as to make the final product, i.e. the book,appealing to the eyes of the client and customers. A hard copy of the book,“100 Wonders of India" was shown to the ITAT to establish the entiretransformation process, and present the best results in the final product. Thelast stage is the embedding of high resolution colour corrected images intothe lay out and preparation of the ready to be exported final files (software),on a CD or electronically, onto the servers of their client. 7.Addressing the question whether the assessee could be said to haveinvolved herself in "manufacture" or "produced" any goods or articles, theITAT relied on the Supreme Court rulings inGraphic Company India Ltd.v. Collector of Customs[2001] 1 SCC 549; CIT v. Tara Agencies [2007] 292ITR 444;Union of India v. Delhi Cloth and General Mills Company LimitedAIR1963 SC 791 and CIT vs. Lovesh Jain 204 Taxman 134(Del) and heldas follows: "17. In the instant case we find that the appellant after collectingraw data and pictures has utilized its expert designing skills inproducing a ready to print e-book. Shri Syali in his submissionshas neatly narrated the entire sequence of activities carried onby the appellant. The samples produced before us were alsoshown to the AO, however he has conveniently chosen to remainquite on this aspect. The final product is intended for use of aparticular customer and therefore the case under considerationdoes fit in the category of production of "any customizedelectronic data" as per the definition of computer softwaredefined in Explanation 2 to section 10B of the Act. The aboveThird Member decision is germane to the issue before us andtherefore it clearly supports the case of appellant. In ourconsidered opinion even if it is said that the appellant has merelycustomized the data, which was already available and has notcreated altogether new software then too the appellant cannot bedeprived of the benefit of deduction. It is pertinent to note thatthe definition of "produce" is wider than the term manufacture asheld by the Hon'ble Supreme Court in a number of decisions(referred to in Lovesh Jain’s case above) and does not require toproduce or manufacture altogether a new product; but if theoutcome of the process is a different product than the input, itwould fall under the definition of 'produce'. In our consideredview, whatever form the input data is, so long as the end productis in the form of electronic data which is customised by theappellant for the end use of a particular customer, then benefit ofdeduction u/s 10B of the Act cannot be denied." The ITAT also held that the assessee's activity involved data processing andexport: "18. We find that the ld CIT(A) has erred in considering thedefinitionof"ComputerSoftware"asperclause(i)ofExplanation 2 to section 10B in a conjunctive manner and notdisjunctive manner without considering that word used inbetween sub-clauses (a) and (b) is "or". The ld CIT(A) has erredin comparing the work done by the assessee with "ComputerProgramme". Here it is to noted that it is not assessee’s case that its case falls under sub-clause (a) of clause (i) to Explanation 2to section 10B. It is the consistent stand assessee that its casefalls under sub clause (b) of clause (i) to Explanation 2 to section10B. Here it is to be seen that whether the assessee is engaged inany customization of electronic data. We find that ld CIT(A) hasnot recorded any finding in this respect in his order. We find alsothat ld CIT(A) has tested assessee’s case u/s 10BB. However wefind that counsel for the assessee had submitted that scope ofsection 10BB is limited in scope as compared to the newdefinition in new section 10B. In this regard it is to be taken notethat post amendment old section 10B requires "processing ormanagement of electronic data" whereas new section 10B islarger in scope and only requires "any customized electronicdata". The difference is that old section 10B requires that inputdata must necessarily be in electronic form where as in newsection10Bthisrequirementisdoneawaywith.Thisinterpretation has found favour by ITAT in Accurum’s case(Supra) were in at para 9 (of Third Member order) it has beenheld that "The data which a customer may require, may begathered either by manual effort or by electronic means, as forexample, through internet. By whatever means the data iscollected, once it is stored in an electronic form, it becomes acustomized electronic data which can be exported to qualify fordeduction u/s 10A". 19. The requirement of the provision (Section 10B) is that thereshould be a customized electronic data and such data should beexported outside India. The data which a customer may requiremay be gathered either by manual effort or by electronic means,as for example, through internet. By whatever means the data iscollected, once it is stored in an electronic form, it becomes acustomized electronic data which can be exported to qualify fordeduction u/s 10A. The process of actually collecting the dataneed not be IT enabled. What all is required is that the datacollected should be in an electronic form. The exact language ofsub-clause(b) of clause (1) of Explanation 2 is "any customizedelectronic data. 20. Thus we find that Assessee‟s business involved export of ready to print books which in the instant case is the "customizedelectronic data". The nature of activity done by the assessee inthe EOU was that of producing designs, drawings, layouts andscanning for the projects of foreign clients on the basis of theirparameters and specifications. This activity is done by takinginto consideration the data collected by the assessee itself orfrom clients. Though the steps/stages involved in completion of aparticular assignment for the foreign client has been reproducedby the AO at page 2 of the assessment order, still neither theAssessing Officer nor ld CIT(A) have appreciated these aspectsin the right perspective." 8.In the decision of this court, reported as Commissioner of Income Taxvs. Lovesh Jain 204 Taxman 134(Del), it was held that: "10. The word "manufacture" can be given, both a wider as wellas a narrower connotation. In wider sense, it simply means tomake, fabricate or bring into existence an article or producteither by physical labour or by mechanical power. Given anarrower connotation it means transforming of the raw materialinto a commercial product/commodity or finished product whichhas a new, separate entity but this does not necessarily mean thatthe material by which the commodity is manufactured must loseits identity. The latter connotation has been accepted and appliedwith some moderation/clarification in several decisions, keepingin view the context in which the word "manufacture" has beenused. The Supreme Court inGraphic Company India Ltd. v.Collector of Customs[2001] 1 SCC 549 andUnion of India v.Delhi Cloth and General Mills Company Limited AIR1963 SC791 has held that manufacture has to be understood to meantransformation of goods into a new commodity commerciallydistinct and separate, and having its own character, use andname whether it be the result of one or several processes.However, every change does not result in "manufacture" thoughevery change in an article may be a result of treatment ormanipulation by labour or/and machines. If an operation orprocess that renders a commodity or article fit for use, which it is otherwise not fit, the change/process falls within the meaning ofthe word "manufacture". 9.Besides referring to and following the above decision, the ITAT alsocited Commissioner of Income Tax v. Tara Agencies [2007] 292 ITR 444(SC) where the Supreme Court, after noticing that the Act did not define“manufacture”turned to the definition of that expression in the CentralExcise Act, 1944 The relevant extracts of that decision are as follows: "11. The term manufacture has not been defined in the Income-tax Act, 1961. 12. The term manufacture has been defined in section 2(f) of theCentral Excise Act, 1944. Parts (i) and (ii) of section 2(f) read asunder:- 2(f). 'Manufacture' includes any process- (i) incidental or ancillary to the completion of a manufacturedproduct; and (ii) which is specified in relation to any goods in the Section orChapter notes of the Schedule to the Central Excise Tariff Act,1985 as amounting to manufacture". Referring to Anheuser-Busch Brewing Assn. v. United States (1907) 52 LEd. 336 it was held by the ITAT that the concept of “manufacture” wasfollowed in subsequent American, English and Indian cases. The SupremeCourt then held that: "11. The term manufacture has not been defined in the Income-tax Act, 1961. 12. The term manufacture has been defined in section 2(f) of theCentral Excise Act, 1944. Parts (i) and (ii) of section 2(f) read asunder:- 2(f). 'Manufacture' includes any process- (i) incidental or ancillary to the completion of a manufacturedproduct; and (ii) which is specified in relation to any goods in the Section orChapter notes of the Schedule to the Central Excise Tariff Act,1985 as amounting to manufacture". Referring to Anheuser-Busch Brewing Assn. v. United States (1907) 52 LEd. 336 it was held by the ITAT that the concept of “manufacture” wasfollowed in subsequent American, English and Indian cases. The SupremeCourt then held that: “The definition reads as under: Manufacture implies a change,but every change is not manufacture, and yet every change in anarticle is the result of treatment, labour and manipulation. Butsomething more is necessary.” 10.The ITAT also relied upon a Gujarat High Court decision, in CITv. Ajay Printers Pvt. Ltd: (1965) 58 ITR 811 (Guj) where it was held that"manufacture" has a wider and a narrower connotation: “In the wider sense it simply means to make, or fabricate orbring into existence an article or a product either by physicallabour or by power. The word "manufacture" in ordinaryparlance would mean a person who makes, fabricates or bringsinto existence a product or an article by physical labour orpower. The other shade of meaning which is the narrowermeaning implies transforming raw materials into a commercialcommodity or a finished product which has an entity by itself, butthis does not necessarily mean that the materials with which thecommodity is so manufactured must lose their identity. Thus boththe words "manufacture" and "produce" apply as well to thebringing into existence of something which is different from itscomponents. One manufactures or produces an article which isnecessarily different from its components." 11.Section 10B of the Act provides as follows: "10B. (1) Subject to the provisions of this section, a deduction ofsuch profits and gains as are derived by a hundred per centexport-oriented undertaking from the export of articles or thingsor computer software for a period of ten consecutive assessmentyears beginning with the assessment year relevant to the previousyear in which the undertaking begins to manufacture or producearticles or things or computer software, as the case may be, shallbe allowed from the total income of the assessee. ... ..... (2) This section applies to any undertaking which fulfills all thefollowing conditions, namely :-- (i) it manufactures or produces any articles or things orcomputer software; (ii) it is not formed by the splitting up, or the reconstruction, of abusiness already in existence : ... ..... Explanation 2.--For the purposes of this section,-- (i) "computer software" means-- (a) any computer programme recorded on any disc, tape,perforated media or other information storage device; or (b) any customized electronic data or any product or service ofsimilar nature as may be notified by the Board, which istransmitted or exported from India to any place outside India byany means" 12.In the two decisions of the Supreme Court, the construction placed onthe term “manufacture” was a liberal one. The extracts of those decisions areDeputy Commissioner of Sales Tax v. M/s. Pio Food Packers,1980 Supp. SCC 174: (i) it manufactures or produces any articles or things orcomputer software; (ii) it is not formed by the splitting up, or the reconstruction, of abusiness already in existence : ... ..... Explanation 2.--For the purposes of this section,-- (i) "computer software" means-- (a) any computer programme recorded on any disc, tape,perforated media or other information storage device; or (b) any customized electronic data or any product or service ofsimilar nature as may be notified by the Board, which istransmitted or exported from India to any place outside India byany means" 12.In the two decisions of the Supreme Court, the construction placed onthe term “manufacture” was a liberal one. The extracts of those decisions areDeputy Commissioner of Sales Tax v. M/s. Pio Food Packers,1980 Supp. SCC 174: "…commonly manufacture is the end result of one or moreprocesses through which the original commodity is made to pass.The nature and extent of processing may vary from one case toanother, and indeed there may be several stages of processingand perhaps a different kind of processing at each stage. Witheach process suffered, the original commodity experiences achange. But it is only when the change, or a series of changes,take the commodity to the point where commercially it can nolonger be regarded as the original commodity but instead isrecognized as a new and distinct article that a manufacture canbe said to take place." Again, in Aspinwall & Co. Ltd v Commissioner of Income Tax (2001) 251ITR 323 it was held as follows: "the word manufacture has not been defined in the Act. In theabsence of a definition of the word manufacture it has to be givena meaning as is understood in common parlance. It is to beunderstood as meaning the production of articles for use fromraw or prepared materials by giving such materials new forms, qualities or combinations whether by hand labour or machines.If the change made in the article results in a new and differentarticle then it would amount to a manufacturing activity." 13.The term “manufacture” is of wide import and in numerous occasionswas held by the Supreme Court to include a variety of activities. Thus,refining crude oil (M/s. B.P. Oil Mills Ltd. vs. Sales Tax Tribunal andothers- AIR 1998 SC 3055); extracting oil from oil-seeds (the ConstitutionBench in Devi Das Gopal Krishnan etc. vs. State of Punjab & others, AIR1967 SC 1895,); cutting and shearing of metal scrap for use by rolling mills(Ashirwad Ispat Udyog & Ors vs State Level Committee & Ors (1998 (8)SCC 85,); conversion of coconut husk into fibres (in Deputy Commissionerof Sales Tax (Law), Board of Revenue (Taxes), Ernakulam vs. M/s. CocoFibres, AIR1991 SC 378); lamination of paper ( Laminated Packings (P)Ltd. vs. Collector of Central Excise(1990) 4 SCC 51), were all held to beactivities that qualify as “manufacture”. In M/S. Sonebhadra Fuels vsCommissioner,Trade Tax (2006) 7 SCC 322 the Supreme Court clarifiedthat the term manufacture is of wide import and that: “the expression 'manufacture' covers within its sweep not onlysuch activities which bring into existence a new commercialcommodity different from the articles on which that activity wascarried on, but also such activities which do not necessarilyresult in bringing into existence an article different from thearticles on which such activity was carried on. For example, theactivity of ornamenting of goods does not result in manufacturingany goods which are commercially different from the goodswhich had been subjected to ornamentation, but yet it willamount to manufacture..” 14.In the present case Section 10B uses the expression “manufactures orproduces… things or computer software”. The four stage process of compiling material, collating the text, designing the layout, scanning, digitalimage editing (to remove distortion) and final arrangement of the data,ultimately transmitted according to the customer’s specification – and readyto be used for printing, (or even e-Book publication) is undoubtedlymanufacture or production. 14.In the present case Section 10B uses the expression “manufactures orproduces… things or computer software”. The four stage process of compiling material, collating the text, designing the layout, scanning, digitalimage editing (to remove distortion) and final arrangement of the data,ultimately transmitted according to the customer’s specification – and readyto be used for printing, (or even e-Book publication) is undoubtedlymanufacture or production. 15.The second question is whether assessee’s manufacturing activitydescribed earlier results in “computer software”. The main thrust of therevenue’s contention here was that final product or “thing” does not answerthat description because it is not software per se, but mere compilation ofdata. This court is of opinion that this contention is unpersuasive. Theexpression “computer software” is wide enough to embrace diverseactivities. To eliminate any doubt, the reference to “customized electronicdata” in the second Explanation to Section 10B (2), Parliament enabled theBoard (CBDT) to include (by notification) diverse activities – which involveexport of software, etc. The Notification relied on in the present case usesthe expressions “(iii) Content Development or animation (iv) DataProcessing…(vii)HumanResourcesServices”and“(ix)LegalDatabases”. Here, the very first head “content development or animation”describes the process and is wide enough to cover compilation of material ordata and its transformation into a ready to print/ ready to publish book. It isalso a “legal database”. The expression “legal” here cannot be confined todatabases that cater to law students or legal practitioners or academics; it isagain of wide import to include databases that are legal – as databases. Thiscourt also notices that the term “computer software” is defined by theCopyright Act, 1957 by Section 2 (ffc) as follows: “(ffc)"computerprogramme"meansasetofinstructionsexpressed in words, codes, schemes or in any other form,including a machine readable medium, capable of causing acomputer to perform a particular task or achieve a particularresult..”In the present case, the work which ultimately results as the culmination ofthe assessee’s efforts of compiling, editing, digital designing, etc. “istransmitted or exported from India to any place outside India by anymeans".Itis,therefore,computersoftwarethatareproducedormanufactured, to qualify for benefit under Section 10B. 16.For the above reasons, the questions of law framed in this case areanswered against the revenue and in favour of the assessee. The appeals areconsequently dismissed. S. RAVINDRA BHAT(JUDGE) JANUARY 19, 2015 R.K. GAUBA(JUDGE)