Case Law on Section 10 A - New Unit

THE Chennai Tribunal has held that where new undertaking has been formed by making substantial investments in new plant & machinery, sizeable addition to the workforce, revenue, client and nature of service offered, it cannot be regarded as a split up of the existing unit even if it has used some of the existing infrastructure. In the relevant case the tribunal considered, the assessee company was engaged in the business of development of software. During the financial year, it setup a new STPI unit and claimed deduction under Section 10A on the same. AO denied the claim for deduction of assessee on the ground that new unit is formed by the splitting of existing unit as technology, most of the workers and clients were transferred from the existing business. The tribunal found that the new unit was clearly established by substantial investments in plant and machinery. Though the new unit took some of the old employees, there was almost a three-fold increase in thenumber of employees. There was substantial addition to nature and type of services rendered to the clients and also in the volume of business. There was good increase in the number of clients also. Therefore, the tribunal held that there was no splitting up of the existing unit and allowed deduction under Section 10A to the new unit.

IN THE INCOME TAX APPELLATE TRIBUNALBENCH 'A' CHENNAI
I.T.A.No. 2345/Mds/05Assessment Year 2001-02
INCOME TAX OFFICER (OSD),COMPANY RANGE I,CHENNAI-600 034
Vs
M/s DSM SOFT (P) LTD,(OLD-9),15 CROSS STREET,SHASTRI NAGAR, ADYAR, CHENNAI-600 020
Shri N. Vijayakumaran, JM and Shri Shamim Yahya, AM

Appellant Rep by : Shri B. Ramakrishanan Respondent Rep by : Shri Shaji, P. Jacob
Income Tax - Assessee Co., engaged in development of software for export and local market, sets up a new unit in the financial year under consideration on which a rebate u/s 10A is claimed - A.O. denies on the ground that the new unit is formed by splitting of existing business as most of the workers and clients were transferred from the existing unit - Rebate u/s Sec.10A is a special provision which provides for exemption to a new undertaking set up in free trade zones on fulfilling certain conditions one of which under clause 2(ii) of the said section is that the new unit should not be formed by splitting or reconstruction of an existing undertaking and in order to hold that the new unit is formed by splitting the existing one, there should be sufficient material to hold that new unit was formed by diverting of assets of existing one or it is an integral part of the existing business - In the instant case setting up of a new unit is established as there was substantial amount spent on new plant & machinery instead of diversion of assets and moreover sizeable addition was made to the workforce, revenue, clients and nature of services offered in the relevant financial year - Revenue's appeal dismissed - (Para 6,7,14,17).
ORDER
Per : Shri Shamim Yahya:
This appeal by the Revenue is directed against the order of Commissioner of Income Tax (Appeals)-VIII, Chennai-34 dated 29.07.2005 and pertains to assessment year 2001-02.
2. The issue raised in the appeal is that the learned Commissioner of Income Tax (Appeals) erred in directing the Assessing Officer to allow relief u/s 10A in respect of STPI Unit-I at Trichy.
3. The brief facts of the case are brought out as under:-
The assessee company, with a unit in Chennai, was incorporated on 8.6.1991 and since then has been engaged in development of software both for export and local market. The assessee had claimed deduction u/s 80HHE till assessment year 2000-01. During the present financial year, assessee had started a new STPI Unit at Trichy and has claimed that the entire export has been affected by its export unit situated at Trichy. During the course of scrutiny assessment, the Assessing Officer noted that the STPI Unit continued to have the same export clients like that of last year. The majority of the employees of the Chennai Unit were taken into the STPI Unit. The Assessing Officer further noted that there were huge losses in the domestic unit. The domestic unit in earlier years has been showing handsome profits from its business but substantially in this year has shown huge losses. The telephone, fax, internet and e-mail expenses of STPI Unit at Trichy were actually much less then those of the Chennai Unit. From these facts, the Assessing Officer came to the conclusion that export of software which is accomplished by the assessee through internet has been handled from Chennai and not from Trichy. Consequently, the Assessing Officer held that the unit at Trichy was established by splitting the earlier business and hence was not eligible for Section 10A rebate.
4. Upon assessee's appeal, the learned Commissioner of Income Tax (Appeals) asked for remand report from the Assessing Officer and concluded as under:-
"i) Substantial fresh investment in Plant & Machinery exceeding Rs. 50 lakhs was made in STPI Unit at Trichy.
ii) A net addition of 153 employees by STPI Unit at Trichy was made during the year under consideration.
iii) Four new foreign clients were added to the existing six clients during the year under consideration. More than two crore worth of export has been made in rendering new services of Geographical Information Systems (GIS), Photogrammatary, Software exports in addition to CAD services which have been rendered in earlier years as well."
5. On the basis of above, the learned Commissioner of Income Tax (Appeals) concluded that there was substantial force in the contention of the assessee that STPI Unit at Trichy was not formed by splitting up or reconstruction of its earlier business. Aggrieved by this order of the Commissioner of Income Tax (Appeals), the Revenue is in appeal before us.
6. We have heard the rival contentions and perused the relevant records. We find that section 10A which provides for special provision in respect of newly established undertakings in free trade zones provides vide clause (2) the conditions which are to be satisfied by the undertakings in order to claim exemption granted by the Section as under:-
"(2) This section applies to any undertaking which fulfils all the following conditions, namely :—
(1) it has begun or begins to manufacture or produce articles or things or computer software during the previous year relevant to the assessment year-
(a) commencing on or after the 1st day of April, 1981, in any free trade zone; or
(b) commencing on or after the 1st day of April, 1994, in any electronic hardware technology park, or, as the case may be, software technology park;
(c) commencing on or after the 1st day of April, 2001 in any special economic zone;
(ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence :
Provided that this condition shall not apply in respect of any undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such undertakings as is referred to in section 33B, in the circumstances and within the period specified in that section;
(iii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose.
Explanation.- provisions of Explanation 1 and Explanation 2 to sub-section (2) of section 80-I shall apply for the purposes of clause (iii) of this sub-section as they apply for the purposes of clause (ii) of that subsection."
7. Admittedly, it is Revenue's case that assessee has not complied with clause 2 (ii). In other words, the Assessing Officer has made up a case that the STPI Unit at Trichy was formed by splitting up or by reconstruction of the business already set up at Chennai.
8. The first objection of the Assessing Officer is with regard to the employees. It is the contention of the Assessing Officer that employees of the new unit basically came from the old unit. On this issue the learned Commissioner of Income Tax (Appeals) had obtained remand report from the Assessing Officer and following facts have emerged:-
"The STPI Unit had 86 employees in April, 2000 which were taken over from the existing unit at Trichy. However, 214 more employees were added during the financial year 2000-2001 in the STPI Unit. The assessee has also furnished a month-wise chart from April, 2000 to March, 2001 giving details of the number of employees at the beginning of the month, number of employees added during the month and number of employees resigned / deleted during the month. From this chart, it is seen that to the opening number of 86 employees in the month of April, 2000, 214 new employees were added by recruitment during the entire year. The number of employees resigned / deleted during the year is shown at 61 with the result, at the end of the year there were 239 employees in the STPI Unit at Trichy. Thus, there was net addition of 153 employees during the previous year relevant to assessment year, 2001-02."
9. Another objection of the Assessing Officer in this regard was that less skilled and inexperienced new employees of the STPI Unit at Trichy would not be competent to develop highly complicated software as required by foreign clients of the assessee. In this regard, assessee submitted before the learned Commissioner of Income Tax (Appeals) that all the newly recruited employees were technically competent holding ITT certificates and were duly trained by the company.
10. The next objection of the Assessing Officer is regarding the transfer of old clients to the new unit. In this regard, it is the submission of the assessee that out of total ten export clients, six were old clients and four new clients were added during the assessment year. While in the previous unit assessee provided only Computer Aided Design (CAD) services for the current assessment year, the STPI Unit has rendered new technological services even to the old clients, namely, Geological Information Systems (GIS), Photogrammatary & Software Services. Out of the total turn over of Rs.2,69,57,499/-, only Rs.65,57,765/-were from CAD services.
11. Another objection by the Assessing Officer was that despite very successful track record in earlier years, all of a sudden during the relevant assessment year, the new STPI Unit at Chennai has suffered huge losses. In this regard, following submission of the assessee was accepted by the learned Commissioner of Income Tax (Appeals) :-
"a. During the financial year 1999-2000, the major customer for the local unit was Reliance Petroleum Ltd., Jam Nagar, Gujarat.
b. During 2000-2001, Reliance Petroleum Ltd. at Jam Nagar completed their project constructions and commenced their commercial production. The assessee had Reliance Petroleum Ltd. projects only upto June, 2000.
c. The billing rate on Reliance Petroleum Ltd. was very high during 1999-2000 and the bills were to the order of Rs.2,60,48,518/- for the 1999-2000 financial year as against Rs.39,88,695/- for the financial year 2000-2001, which resulted in a fall in the turnover to the extent of Rs.2,20,59,823/- which accounted for the serious fall in income resulting in a loss ultimately for the financial year 2000-2001. The net income from Reliance Petroleum Ltd. projects was nearly 50% of the gross receipts as the expenditure was to the order of Rs. 1,39,67,539/-.
d. After July 2000, the assessee got Reliance Engineering Associates (P) Ltd. projects at Jam Nagar, Hyderabad, Bangalore, Chennai, Lucknow, Cochin and Calcutta and the receipts from the above projects amounted to Rs.1,01,95,480/- and but for these receipts the loss for the financial year 2000-2001 would have been still higher.
e. The net income would be 7% to 10% from Reliance Engineering Associates P. Ltd. projects done during the financial year 2000-2001, whereas the net income percentage was around 50% during the financial year 1999-2000 from the projects of Reliance Petroleum Ltd."
12. The fifth objection raised by the Assessing Officer states that the expenditure on telephone, fax, internet and e-mail charges were more for Chennai Unit and less for STPI Unit at Trichy which clearly establishes that the software exported by the assessee company were uploaded mostly from Chennai. In this regard, the learned Commissioner of Income Tax (Appeals) noted that the assessee had furnished a detailed explanation wherein it has been clarified that the Assessing Officer has not considered an amount of Rs.4,74,530/- which related to STPI Unit at Trichy but were incurred at Chennai. The assessee has furnished the details of such expenses. Thus, after considering this, the actual expenses relating to STPI Unit at Trichy worked out to Rs.7,57,563/- whereas the domestic unit at Chennai had incurred an amount of Rs.3,12,991/- on telephone, fax, internet and e-mail charges during the year under consideration.
13. The learned Commissioner of Income Tax (Appeals) further noted that assessee's claim is further strengthened by the fact that new Plant & Machinery at Trichy was procured at a cost of more than Rs.50 lakhs.
It was in the background of aforesaid analysis and fact finding whereby all the objections of Assessing Officer were cogently rebutted that Commissioner of Income Tax (Appeals) decided the issue in favour of assessee.
14. It is well settled that in order to hold that a business was formed by splitting up of a business already in existence, there must be some material to hold that either some assets of the existing business is diverted and another business is set up from such splitting up of assets or that the two businesses are same and the one formed was an integral part of the earlier one. Admittedly, in this case, it is not the case of the revenue that the new business involved diversion of assets from the old unit. The new unit was established by procuring machinery worth more than Rs.50 lakhs. In our opinion, whether there is reconstruction of a business in terms of this section depend on facts of the case. If the alterations or changes are substantial, there would be little scope of describing what emerges as a reconstruction of business. Hence, in these matters one has to look at the substance of a transaction and not at the form.
15. In this context, it will be worthwhile to refer to Hon'ble Apex Court decision in the case of Textile Machinery Corporation Ltd. Vs. Commissioner of Income Tax, West Bengal (1977) 107 ITR 195 wherein it was held that,
"A new activity launched by the assessee by establishing new plants and machinery by investing substantial funds may produce the same commodities of the old business or it may produce some other distinct marketable products, even commodities which may feed the old business. These products may be consumed by the assessee in his old business or may be sold in the open market. One thing is certain that the new undertaking must be an integrated unit by itself wherein articles are produced and at least a minimum of ten persons with the aid of power and a minimum of twenty persons without the aid of power have been employed. Such a new industrially recognizable unit of an assessee cannot be said to be reconstruction of his old business since there is no transfer of any assets of the old business to the new undertaking which takes place when there is reconstruction of the old business. For the purpose of Section 15C the industrial units set up must be new in the sense that new plants and machinery are erected for producing either the same commodities or some distinct commodities. In order to deny the benefit of Section 15C the new undertaking must be formed by reconstruction of the old business.
If an undertaking is not formed by the reconstruction of the old business that undertaking will not be denied the benefit of section 15C merely because it goes to expand the general business of the assessee in some directions.
Use by the assessee of the articles produced in its existing business or the concept of expansion are not decisive tests in construing section 15C."
16. Some other important case laws in this regard are discussed as under:-
i) Hon'ble jurisdictional High Court in the case of CIT Vs. Metropolitan Springs (P) Ltd. 191 ITR 288 has held in the context of provisions of Section 80J that, even if some members of the staff were common to the old and new unit, it will not be a bar on the eligibility or deduction u/s 80J.
ii) Hon'ble Apex Court decision in the case of CIT Vs. Indian Aluminium Company Ltd. 108 ITR 367 has held that, even if the new undertaking was involved in manufacturing the same commodity as manufactured by the old unit, it will still be treated eligible undertaking for Section 80J.
iii) Hon'ble jurisdictional High Court decision in the case of CIT Vs. Premier Cotton Mills Ltd. 240 ITR 434 has held that, it was not required for deciding the question of splitting up or reconstruction of the existing business that the new undertaking should produce different article to that produced by the old unit.
17. On the anvil of aforesaid discussion and case laws, we find that in this case there is a clear establishment of new unit by substantial investment in Plant & Machinery. The new unit though, took some of the old unit's employees but during the financial year itself the substantial expansion led to almost three-fold increase in the number of employees. There was substantial addition to the nature and type of services rendered to the clients and also in the volume of business. Furthermore, there was good increase in the number of customers also. The old unit's incurring losses has been duly explained as mainly due to completion of Reliance Petroleum Ltd., Jam Nagar Project which led to substantial reduction in assessee's business.
18. Another objection raised by the Revenue is that the learned Commissioner of Income Tax (Appeals) failed to note that in the earlier year the assessee had claimed relief u/s 80HHE which profits / receipts from Trichy Unit also and hence as per 80HHE(5), the assessee is not permitted to claim relief u/s 10A.
19. In this regard the learned counsel of the assessee submitted that this is factually wrong. He referred to Assessing Officer's finding in page number 3 of the assessment order where it is clearly mentioned that the STPI Unit commenced its commercial operation from April, 2001. The learned Departmental Representative did not dispute this finding.
In this regard, we further find that Hon'ble jurisdictional High Court in the case of L.G. Balakrishnan and Brothers Ltd. Vs. CIT 151 ITR 270 has held that a new undertaking can be said to have been formed only when it is ready to commence the production of article for which the undertaking was established and the formation of company will not include the initial steps taken for its establishment.
Considering the aforesaid, we find that this objection by the Revenue is unfounded.
20. In the background of above discussion and case laws cited above, it is clear that it cannot be said that the STPI Unit at Trichy was established as a result of splitting up or reconstruction of the Unit at Chennai. Hence, we uphold the order of the learned Commissioner of Income Tax (Appeals) in this regard and decide the issue in favour of the assessee.
21. It will not be out of place here to mention that it is a settled proposition often reiterated by the Hon'ble Apex Court that in cases where two views are possible, the one favourable to the assessee should be adopted. CIT v. Podar Cements Ltd. and another 226 ITR 625 (SC) and Mysore Minerals Ltd. Vs. Commissioner of Income Tax 239 ITR 775 (SC). Further more, the Hon'ble Apex Court in the case of Bajaj Tempo Ltd. Vs. Commissioner of Income Tax 196 ITR 188 with respect to relief for new industrial undertaking u/s 15C of the Income Tax Act, 1922 has held that such provisions should be construed liberally. Very literal construction which defeats the very purpose of enacting the provision should be avoided.
22. In the result, this appeal by the Revenue is dismissed.