Export Of Software Embedded Into Hardware; Sale Proceeds From Export Of Hardware Eligible For Deduction : Karnataka High Court

Taking a judicial note of the fact that the software and the hardware components were inseparable from each other, the division bench of Justices P.S. Dinesh Kumar and M.G. Uma held that issue of separate invoices by the assessee for sale of hardware and software components is inconsequential. The Court ruled that what is relevant is the intention of the parties and the product that is actually sold.

The assessee- M/s. Subex Limited, is in the business of software development. The assessee installs the developed software into the hardware devices purchased by it, and exports the product. The assessee filed its income tax return and claimed a deduction under Section 10A of the Income Tax Act.

Section 10A provides that the profits and gains derived by a newly established undertaking from the export of articles, things, or computer software, as manufactured by it, shall be eligible for deduction for a period of ten consecutive assessment years from the total income of the assessee.

During the assessment proceedings, the Assessing Officer (AO) opined that sale of the hardware component, which is not manufactured by the assessee, could not be considered as a part of the export. The AO held that since the assessee did not manufacture or produce any hardware components, it was not eligible for deduction under Section 10A. Against this, the assessee filed an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)). The CIT(A) ruled that the assessee did not manufacture or produce any hardware products and that it was only engaged in the trade of such products. Thus, the CIT(A) dismissed the appeal, holding that the assessee was not eligible for deduction under Section 10A.

The assessee filed an appeal before the ITAT against the order of the CIT(A), challenging the disallowance of the amount received by the assessee from the sale of hardware components, from the export turnover under Section 10A of the Income Tax Act.

While observing that the software and hardware components were sold by the assessee separately since they were separately invoiced, the ITAT held that the assessee had failed to establish that the software could not be used without the hardware. Holding that the assessee was not a manufacturer of hardware products, the ITAT upheld the order of the CIT(A).

The assessee filed an appeal before the Karnataka High Court against the order passed by the ITAT.

The assessee M/s. Subex Limited submitted before the High Court that the assessee develops software and installs it into specified hardware devices. The assessee added that what is eventually sold by it is an indivisible product consisting of a software embedded into a hardware device, which qualifies as a 'computer software' under Section 10A of the Income Tax Act.

To this, the revenue department contended that the benefit under Section 10A is only available to an undertaking which is located in a free trade zone, an export processing zone, or a software technology park. The department averred that since the assessee had not manufactured the hardware in the prescribed zones, as mentioned in Section 10A, and since it had purchased the hardware, therefore, it was not entitled to the benefit under Section 10A.

The revenue department argued that the assessee's contention that the hardware components formed an integral part of the software cannot be accepted, since the two components were separately invoiced.

While referring to the decision of the Apex Court in Sultan Brothers Pvt. Ltd. versus CIT (1963), the Court ruled that the issue whether the hardware and the software components are inseparable depends upon the intention of the parties. The Court added that since the intention of the purchaser was to buy the software and the intention of the assessee was to export the software, hence the software and the hardware were inextricably connected.

Further, the bench noted that the software could not be exported without loading it onto the hardware and hence, they were inseparable.

The Court accepted the contention of the assessee that what is relevant is the intention of the parties and the product that is actually sold, and that the invoices raised by the assessee do not represent the transaction. Hence, the Court ruled that issue of separate invoices by the assessee for sale of hardware and software components is inconsequential.

"In this case, 'manufacture' has to be understood in common parlance as developing software and loading onto the hardware. Software will be written in binary code and it is intangible. It can be used only when loaded onto a compatible hardware. Therefore, in our view, hardware becomes an integral part of the exported commodity.", the Court said.

Taking a judicial note of the fact that the software could not be used unless it was loaded onto a hardware and that it could not be used independently, the Court allowed the appeal and ruled that the assessee was eligible to claim the benefit under Section 10A.

Case Title: M/s. Subex Limited versus The Deputy Commissioner of Income Tax

Citation: 2022 LiveLaw (Kar) 373

Dated: 26.08.2022 

Counsel for the Appellant/Assessee: Mr. Chythanya K.K., Senior Advocate A/W Mr. Sharath S, Advocate

Counsel for the Respondent/Revenue Department: Mr. K.V. Aravind, Advocate

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