2015 (9) TMI 9 - AT - Income Tax

Disallowance of depreciation by invoking the provisions of section 40(a)(i) in respect of the payments made for purchase of software and capitalized by the assessee - Held that - Once the assessee has capitalized the payment in question though the assessee has not deducted the tax at source on such payment, Section 40(a)(i) cannot be invoked for disallowance of depreciation. Accordingly, we set aside the orders of the authorities below and the addition made by the Assessing Officer is deleted. See SMS Demang (P.) Ltd. V DCIT 2010 (1) TMI 624 - ITAT, DELHI - Decided in favour of assessee.

Issues Involved:
1. Incorrect interpretation of law by the AO and DRP.
2. Assessment of total income against the returned loss.
3. Classification of payment for software purchase as royalty.
4. Disallowance of tax depreciation due to non-deduction of TDS.
5. Eligibility for deduction under Section 10A of the Act.
6. Levy of interest under Section 234B of the Act.

Detailed Analysis:

1. Incorrect Interpretation of Law by the AO and DRP:
The assessee contended that the assessment order and DRP directions were based on incorrect interpretation of law, rendering them legally flawed. This foundational issue questions the legal basis upon which the AO and DRP made their decisions.

2. Assessment of Total Income Against Returned Loss:
The AO assessed the total income at Rs. 1,029,574 against the returned loss of Rs. 718,133 computed by the appellant. This discrepancy forms the basis of the appeal, as the assessee argues that the correct interpretation of the law should reflect the returned loss rather than the assessed income.

3. Classification of Payment for Software Purchase as Royalty:
The AO classified the payment made to Cadence Systems Ireland Ltd. for software purchase as royalty under the Act and the India-Ireland Tax Treaty. This classification required the assessee to deduct tax at source. The assessee argued that the payment, capitalized in their accounts, should not be treated as royalty, thus not necessitating TDS.

4. Disallowance of Tax Depreciation Due to Non-Deduction of TDS:
The AO disallowed the tax depreciation claimed on computer software amounting to Rs. 1,747,680 under Section 40(a)(i) due to non-deduction of TDS. The assessee argued that since the expenditure was capitalized, Section 40(a)(i) should not apply. They cited ITAT decisions in SKOL Breweries Ltd. and SMS Demang (P.) Ltd., asserting that depreciation, being a statutory deduction under Section 32, is not an outgoing expenditure subject to TDS provisions.

5. Eligibility for Deduction Under Section 10A of the Act:
The assessee claimed that even if the tax depreciation is disallowed, resulting in income, they are eligible for deduction under Section 10A, being a unit registered under the Software Technology Parks of India (STPI) Scheme. This argument was not directly addressed in the judgment but forms part of the broader contention of the assessee.

6. Levy of Interest Under Section 234B of the Act:
The AO levied interest of Rs. 115,197 under Section 234B. This issue is ancillary to the primary contention regarding the classification of software payments and the applicability of TDS provisions.

Tribunal's Findings:

- Depreciation Disallowance: The Tribunal focused on the disallowance of depreciation by invoking Section 40(a)(i). It noted that the payment for software was capitalized and not claimed as an expenditure, thus Section 40(a)(i) should not apply. The Tribunal referenced ITAT decisions in SKOL Breweries Ltd. and SMS Demang (P.) Ltd., which supported the view that depreciation is a statutory deduction and not an outgoing expenditure subject to TDS provisions.

- Section 195 Compliance: The Tribunal acknowledged the AO's argument that non-compliance with Section 195 (TDS on payments to non-residents) could invoke Section 40(a)(i). However, it emphasized that the remedy for non-compliance lies under Sections 201 and 201A, not Section 40(a)(i).

- Conclusion: The Tribunal concluded that the AO's disallowance of depreciation under Section 40(a)(i) was incorrect. It set aside the orders of the authorities below and deleted the addition made by the AO, allowing the appeal in favor of the assessee.

Judgment:
The appeal was allowed, and the Tribunal pronounced the order in the open court on 26th June 2015. The Tribunal's decision emphasized the proper application of Section 40(a)(i) and the statutory nature of depreciation under Section 32, providing clarity on the treatment of capitalized software payments.

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