2013 (9) TMI 519 - AT - Income Tax

Allowability of Service Charges - AO held that the services agreement between the assessee and its holding company has been entered into with the clear intention of reducing the tax liability of the assessee and increasing the non-taxable profits of SSL. - Held that - The assessee had placed each and every head of expenditure and this Expenditure has been bifurcated under the three heads- STP unit entitled to deduction under section 10A, non STP not entitled to deduction u/s.10A and support services - the basis of allocation amongst the three heads is actual expenses, number of employees and ratio of fixed assets, floor area and turnover ratio - Thus, on the basis of above five criteria, expenditure has been allocated to the three heads - The issue regarding the allocation of expenses in respect of service charges arose in the case of SSL - In that case, the Assessing Officer was of the view that allocation of expenses for Non-section 10A unit (not eligible for exemption) was excessive as exempted unit was much more expenditure oriented - allocation of support services expenses on the basis of turnover was justified. - Decided in favor of assessee. Allowability of Deputation Charges - Reimbursement of Various Expenses Held that - The terms of the Agreement between the Assessee and SSL by which SSL agreed to render some common services in the areas of Finance, Accounts, Taxation, Legal, Administration, HRD, education, Training, Research etc. Clause-3 of the said agreement which have been referred to in the earlier part of this order clearly shows that the expenses covered by that agreement cannot and do not relate to expenditure incurred on deputing employees to work on specific projects of the Assessee - Therefore the expenses on account of deputation charges as well as other expenses were not covered under the aforesaid agreement - The other reasons given by the AO for making the impugned disallowance cannot also be sustained. Royalty u/s. 91 (1)(vi) OR Not - Purchase of Software from Various Resident Entities - Held that - Payment received by the assessee was towards the title and GSM system of which software was an inseparable parts incapable of independent use and it was a contract for supply of goods - Therefore, no part of the payment therefore can be classified as payment towards royalty - The consideration received by the Assessee for software was not royalty - The receipts would constitute business receipts in the hands of the Assessee - Admittedly the Assessee who was a non-resident does not have a permanent establishment and therefore business income of the Assessee cannot be taxed in India in the absence of a permanent establishment. Following Director of Income-tax Versus Ericsson A.B. & Ericsson Radio System A. B. & Metapath Software International Ltd. 2011 (12) TMI 91 - Delhi High Court - The consideration received by the Assessee for software was not royalty - The receipts would constitute business receipts in the hands of the Assessee - Admittedly the Assessee who was a non-resident does not have a permanent establishment and therefore business income of the Assessee cannot be taxed in India in the absence of a permanent establishment.

Issues Involved:
1. Allowability of service charges paid to holding company.
2. Allowability of deputation charges and reimbursement of various expenses.
3. Treatment of purchase of software as royalty under Section 91(1)(vi) of the Income Tax Act.

Detailed Analysis:

1. Allowability of Service Charges Paid to Holding Company:
The primary issue revolves around whether the service charges paid by the assessee to its holding company, Sonata Software Ltd. (SSL), are allowable as business expenditure. The assessee claimed an expenditure of Rs. 117,611,029/- for services rendered by SSL under an agreement. The Assessing Officer (AO) disallowed the expenditure, arguing that the agreement was a colorable device to reduce taxable profits and increase non-taxable profits of SSL. The AO contended that the services were not substantiated with adequate evidence and that the agreement was not between independent entities but between a parent and its wholly-owned subsidiary, which indicated a tax avoidance motive.

The CIT(A) allowed the expenditure following the Tribunal's order for earlier assessment years. The Tribunal upheld the CIT(A)'s decision, emphasizing that the issue had been consistently decided in favor of the assessee in previous years. The Tribunal noted that the expenditure was allocated based on turnover, which was found to be appropriate in earlier cases. Therefore, the Tribunal dismissed the revenue's ground on this issue, affirming that the service charges were indeed allowable as business expenditure.

2. Allowability of Deputation Charges and Reimbursement of Various Expenses:
The second issue pertains to the allowability of deputation charges and reimbursement of various expenses to SSL. The AO disallowed these expenses, arguing that the assessee failed to establish that SSL incurred these expenses on its behalf and that they were for the purpose of the assessee's business. The AO also contended that these expenses might overlap with the services covered under the existing agreement for common services.

The CIT(A) admitted additional evidence submitted by the assessee, which detailed the employees deputed by SSL and the specific projects they worked on. The CIT(A) was satisfied that the expenses were genuine and incurred wholly and exclusively for the assessee's business. The Tribunal upheld the CIT(A)'s decision, noting that the expenses on deputation charges and other reimbursements were not covered under the common services agreement and were legitimate business expenditures.

3. Treatment of Purchase of Software as Royalty:
The third issue involves whether payments for the purchase of software from resident entities should be treated as royalty under Section 91(1)(vi) of the Income Tax Act, thereby necessitating tax deduction at source. The AO treated these payments as royalty, relying on the Karnataka High Court's decision in the case of Samsung Electronics Co. Ltd., which held that payments for the right to use software constitute royalty.

The CIT(A) disagreed, following the ITAT Mumbai's decision in Kansai Nerolac Paints Ltd., which held that payments for software embedded in a medium are akin to goods and not royalty. The Tribunal upheld the CIT(A)'s decision, citing the Delhi High Court's ruling in DIT v. Ericsson A.B., which distinguished between payments for copyrighted articles and payments for the use of copyright. The Tribunal concluded that the payments in question were for copyrighted articles (software) and not for the use of copyright, thus not constituting royalty.

The Tribunal also considered the alternative argument that Section 40(a)(ia) applies only to amounts payable as of the end of the previous year and not to amounts already paid, following the Special Bench decision in Merilyn Shipping & Transports. However, since the primary issue was resolved in favor of the assessee, this argument was not further addressed.

Conclusion:
The Tribunal dismissed the revenue's appeal on all grounds, affirming the CIT(A)'s decisions. The service charges paid to the holding company, deputation charges, and reimbursement of expenses were all deemed allowable as business expenditures. Payments for software purchases were not treated as royalty, aligning with the Delhi High Court's interpretation and thus not subject to tax deduction at source under Section 40(a)(ia).

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