Court’s decision
The Madras High Court partly allowed the appeals and answered several substantial questions of law in favour of the assessee. The Court held that losses incurred by Software Technology Park units eligible for deduction under Section 10A of the Income Tax Act are capable of being adjusted while computing total income and cannot be ring-fenced merely because the unit enjoys a tax holiday. Relying extensively on the Supreme Court’s interpretation of Section 10A, the Court held that deduction under Section 10A operates at the stage of computing profits of the eligible undertaking and prior to aggregation under Chapter VI.
On the issue of payments made towards International Private Leased Circuits, the Court held that the Tribunal erred in mechanically treating such payments as royalty without undertaking an independent factual and legal analysis. The High Court found that mere reliance on earlier decisions without examining the nature of services rendered was legally unsustainable. Consequently, disallowance under Section 40(a)(i) was interfered with.
The Court further held that the Tribunal committed a jurisdictional error by failing to adjudicate the assessee’s ground relating to tax holiday deduction on miscellaneous income, thereby warranting remand on that limited issue. Interest under Section 234D was upheld in favour of the Revenue.
Facts
The assessee was engaged in software development and export activities through multiple units, some of which were registered Software Technology Park units claiming deduction under Sections 10A and 10B of the Income Tax Act. For the relevant assessment years, certain STPI units incurred losses, while other units earned taxable profits.
During assessment, the Assessing Officer denied set-off of losses of the STPI units against profits of non-eligible units on the ground that such losses had to be carried forward until the expiry of the tax holiday period. The Assessing Officer also disallowed payments made to a foreign entity for International Private Leased Circuits on the ground that tax was not deducted at source, treating such payments as royalty.
Further, the assessee’s claim for tax holiday deduction under Section 10A on certain items of miscellaneous income was rejected without proper examination. Interest under Sections 234B and 234D was also levied. These findings were largely upheld by the appellate authorities and the Tribunal, leading to the present appeals before the High Court.
Issues
Whether losses of units eligible for deduction under Section 10A can be set off against income of other units while computing total income.
Whether payments made for International Private Leased Circuits constitute royalty under Section 9 read with the applicable tax treaty.
Whether disallowance under Section 40(a)(i) was sustainable without examining the nature of services rendered.
Whether the Tribunal erred in not adjudicating the assessee’s claim for tax holiday deduction on miscellaneous income.
Whether levy of interest under Section 234D was justified.
Petitioner’s Arguments
The assessee contended that Section 10A, post amendment, provides for deduction and not exemption, and therefore losses of eligible units are part of the computation mechanism under Chapter IV. It was argued that the Supreme Court has conclusively held that deduction under Section 10A must be applied at the stage of computing profits of the undertaking and prior to aggregation of income, making set-off legally permissible.
On IPLC payments, the assessee argued that the payments were made for standard telecommunication services and did not involve any transfer of rights in equipment or technology. It was contended that the Tribunal mechanically applied earlier rulings without examining contractual terms or the factual matrix.
The assessee further submitted that the Tribunal failed to adjudicate a specific ground relating to deduction under Section 10A on miscellaneous income, which vitiated the appellate order. cognizant-technology-solutions-…
Respondent’s Arguments
The Revenue argued that losses of Section 10A units could not be adjusted against profits of non-eligible units during the tax holiday period and had to be carried forward as per Section 10A(6). It was contended that the Supreme Court decision relied upon by the assessee was distinguishable and did not deal with loss-making eligible units.
With respect to IPLC payments, the Revenue contended that such payments constituted royalty for use of sophisticated telecommunication infrastructure and were taxable in India, thereby attracting disallowance under Section 40(a)(i).
The Revenue supported the levy of interest under Section 234D and contended that no interference was warranted on that aspect.
Analysis of the law
The High Court undertook an extensive analysis of Section 10A as amended and examined the scheme of computation of income under the Act. It emphasised that the Supreme Court has clarified that Section 10A, though placed in Chapter III, operates as a deduction provision and not as an exemption.
The Court held that deduction under Section 10A is to be granted immediately after determination of profits of the eligible undertaking and before application of set-off provisions under Sections 70 and 71. Consequently, losses of eligible units are not to be artificially isolated and can be adjusted while computing total income.
On IPLC payments, the Court held that characterisation of payments as royalty requires careful examination of the nature of services and contractual rights. Mechanical reliance on precedents without factual analysis was held to be legally impermissible.
The Court also reiterated that appellate authorities are statutorily bound to adjudicate every ground raised before them. Failure to do so amounts to a jurisdictional error.
Precedent Analysis
The Court relied heavily on the Supreme Court’s decision interpreting Section 10A, where it was held that deduction under Section 10A must be applied at the stage of computing profits of the eligible undertaking and before aggregation of income.
Decisions relating to the nature of royalty under tax treaties were referred to, emphasising that use of standard telecommunication services does not automatically amount to royalty.
Judgments stressing the obligation of appellate authorities to decide all grounds raised were also applied to hold that non-adjudication vitiates the appellate order.
Court’s Reasoning
The Court found that the Tribunal’s reasoning on set-off of losses was directly contrary to binding Supreme Court precedent. It rejected the Revenue’s attempt to distinguish the Supreme Court decision and held that the legal position squarely applied to loss-making eligible units as well.
On IPLC payments, the Court held that the Tribunal abdicated its adjudicatory function by simply following an earlier ruling without independent examination. Such an approach was held to be legally flawed.
The Court further held that failure to adjudicate the claim relating to miscellaneous income deprived the assessee of appellate consideration, warranting remand on that limited issue.
Conclusion
The High Court answered the substantial questions relating to set-off of losses and IPLC payments substantially in favour of the assessee. The Tribunal’s findings on these issues were set aside. The issue relating to tax holiday deduction on miscellaneous income was remanded for fresh consideration. Levy of interest under Section 234D was upheld.
Implications
This judgment reinforces the binding nature of the Supreme Court’s interpretation of Section 10A and provides clarity on treatment of losses of eligible units. It also cautions tribunals against mechanical application of precedents without factual analysis, particularly in cross-border taxation issues involving royalty.
