9911796707
TMI Blog2012 (9) TMI 335X X X X Extracts X X X X X X X X Extracts X X X X ..... AO to allow the expenditure - in favour of assessee. Disallowance of deputation charges - common services in the areas of Finance, Accounts, Taxation, Legal, Administration, HRD, education, Training, Research etc. - Held that:- the expenses on account of deputation charges as well as other expenses are not covered under the aforesaid agreement. The other reasons given by the AO for making the impugned disallowance cannot also be sustained - in favour of assessee. Non deduction of TDS while making payment towards purchase of software - Disallowance u/s 40(a)(ia) - the payment in question is in the nature of Royalty as per AO - Held that:- Following the view expressed by the Hon'ble Dellhi High Court in the case of DIT v. Ericsson AB (2011 (12) TMI 91 - DELHI HIGH COURT) that consideration paid merely for right to use cannot be held to be royalty which is favourable to the Assessee to hold that the consideration received by the Assessee for software was not royalty. Admittedly the Assessee who is 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 - as the assessee wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of carrying on the appellant's business and the same is admissible and may pleas be allowed" 3. The assessee is a company engaged in the business of purchase and sale of software. The assessee while computing its income from business had claimed expenditure of ₹ 14,98,56,338/- on account of service charges paid to M/s. Sonata Software Ltd. (SSL), holding company. The expenditure was claimed to be in accordance with the agreement dated 28.09.2000 entered into by the assessee with M/s. Sonata Software Ltd., which has been revised on 01.07.2002 and 01.07.2004 and 01.07.2006. As per the said agreement, the assessee was to pay service charges to M/s. Sonata Software Ltd. for rendering the following services: (a) Advise and assistance to SITL relating to compliance of various laws, Orders, Regulations and legal requirements of the Central, State and other governmental and local authorities concerning the conduct of the business and affairs of SITL. (b) Training employees of SITL in the above areas. (c) Assist and liaise with various government departments as and when required by SITL. (d) Overseeing the compliance requirements in regard to Companies Act, incl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stated above and in consideration of the services actually rendered, the assessee incurred an amount of ₹ 14,98,56,338/-. The Assessee pointed out that expenditure incurred for obtaining services/assistance for the running of the business is an allowable commercial expenditure. The Assessee submitted that the expenditure of ₹ 14,98,56,338/- was incurred out of commercial expediency. Assessee relied judicial decisions to highlight that commercial expediency means anything that serves to promote and includes every means suitable to that end and expenditure which a prudent man may incur for the purpose of business. The decisions rendered in the following cases were referred to for the above proposition viz., Indian Steel & Wire Products Ltd. v. CIT [1968] 69 ITR 379 & Calcutta Landing & Shipping Co. Ltd. v. CIT [1967] 65 ITR 1, Calcutta. It was argued that it was the prerogative of the businessman how to run the business and it is not upon the Revenue to prescribe what expenditure an assessee should incur and in what circumstances it should incur. It was reiterated that every businessman knows his interest best - CIT v. Dhanrajgirji Raja Narasinghirji [1973] 91 ITR 544 (SC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was also brought to the notice of the AO that the issue of allowability of service charges was also decided in assessee's favour in its own case by the Hon'ble ITAT in A.Y. 2002-03, A.Y. 2003-04, A.Y. 2004-05 and A.Y. 2005-06 has also deleted the disallowance in respect of service charges paid by the assessee to SSL. In view of the above the Assessee submitted that the entire amount of ₹ 14,98,56,338/- should be allowed as business expenditure. 7. The AO however was of the view that (i) Payment of service charges by the Assessee to SSL is mere diversion of income without services rendered by SSL. Mens rea for this claim is to reduce taxable profit and claim more 10-A profit in SSL. (ii) The receipts on account of Service Charges in the hands of SSL have not been credited separately as the income of its non-10A activity. However, these receipts have been reduced from the expenditure claimed of 10A activity of SSL. The net implication of this is that the profits of the 10A activity of SSL have increased and on which no tax has been paid. Whereas in fact, these receipts are clearly pertaining to the non 10A activity of SSL and therefore such receipts should have been o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has been filed before the high court in all the concerned years, the final decision of which is still awaited. Accordingly, the assessee's claim of payment of services charges of ₹ 14,98,56,338/- to M/s. Sonata Software Ltd. was disallowed and added back to the total income of the assessee. 9. On appeal by the assessee the CIT(A) confirmed the addition made by the AO differing from his predecessors and the Tribunal orders in the earlier assessment years. 10. As stated above this issue has come up in consideration in assessee's own case in assessment year 2001-02 in ITA No. 3702/Mum/2004 and this Tribunal on identical issue held as follows: "7. The next issue arising from the appeal of assessee relates to the disallowance of ₹ 6,55,88,590/- on account of service charges paid to Sonata Software Ltd. (SSL). Brief facts giving rise to this appeal are these: The assessee is 100% subsidiary of SSL. It came into existence in the year under consideration with the object to carry out one of the activities of SSL which was not eligible for exemption u/s. 10A. Prior to the year under consideration, SSL was carrying out two independent activities i.e. (i) activity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oportionate to the turnover of the assessee. (ii) It has been stated in the said agreement of SSL with the assessee company that all out of pocket expenses including travel, conveyance etc. are to be billed separately by SSL and shall be reimbursed bit the assessee. However, rather than separately billing for these out of pocket expenses, SSL is raising periodic lump sum credit notes by apportioning the expenditure incurred by SSL on account of insurance, salaries and allowances, directors remuneration, electricity and water charges, printing and stationery, professional charges, repairs and maintenance, rent for offices and also depreciation. The assessee was categorically asked to furnish supporting evidences to show that the said services stated at (a) to (d), above were rendered by SSL. However, the assessee has not furnished the same till the finalization of the assessment. The only evidences submitted are the debit/credit notes raised on the assessee by SSL according to which the expenses incurred in SSL have been apportioned to the assessee on the basis of turnover of the assessee and SSL. Payment of service charges from SITL to SSL is mere diversion of income without servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . ft was explained that the area of services covered under the agreement is very broad and that the expenditure has been claimed on the basis of actual expenditure incurred on the basis of debit notes received from SSL and that f the expenditure in question was not incurred the assessee would not have been able to carry on its business. ft was further submitted that the debit notes issued by SSL and the details given to the Assessing Officer in support of the expenditure included in the debit notes show that not only legal and other specified services were the subject in the agreement but also other services which are not specifically stated in the agreement were also included." 10. The CIT(A) examined the details of the expenditure which had been allocated on the basis of respective turnover which was given along with debit notes. It has been made clear that such details were also furnished before Assessing Officer. (See page 23-24 of the order). It was noted by CIT(A) that entire expenditure was incurred commonly for SSL and assessee and was allocated on the basis of turnover. According to him, business activities of SSL was much more expenditure oriented than business acti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uction u/s. 10A and support services. Further, it is found that 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. Further, it is noticed that the total expenditure allocated under third head i.e. support services; has been again allocated under two heads - (1) STP units entitled to deduction u/s. 10A and non-STP which is not entitled for deduction u/s. 10A on the basis of turnover ratio. In our considered opinion the allocation of expenditure contained in the Paper book at page 27 to 31 appears to be appropriate. As per details contained in pages 27 to 31, it can be seen that the appellant company has only allocated expenses of Support Service Division between 10A and non-10A activities in the ratio of turnover has been called for by the Assessing Officer by this letter dated 20.01.2000 appearing at page 35 of the Paper book. Further, direct expenses relating to 10A and non-10A activity has been directly charged against the profits of these activities and do not call for any interference." ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ify differing from the findings from the earlier years. In order to examine the issue, we have called for the annual reports of M/s. Sonata Software Ltd, the holding company and assessee's accounts in the consolidated annual report for assessment year 2007-08. The learned CIT (A) identified some of the expenditure on electricity, rent advertisements etc., so as to state that most of the expenditure was allocated to increase the profits in the case of SSL which was claiming deduction under section 10A. In our view the examination by the CIT(A) on few items is selective and not appropriate according to the facts. Assessee has given detailed statement of various expenditures and how these are allocated. As seen from the schedule 13 of accounts of Sonata Software Ltd., the total expenditure incurred by the SSL was ₹ 165,37,53,627/- under the operating and other expenditure. Out of this an amount of ₹ 14,98,56,338/- i.e. less than 10% was allocated and recovered from a subsidiary i.e. assessee company SSIL. Considering the extent of expenditure in both the cases and the fact that in both the companies are reporting the above amount as service charges recovered/paid from/ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ers allowing the said expenditure, which was upheld by the ITAT. This issue is similar on facts to earlier years and there is no need to differ from the orders in earlier years. Respectfully following the precedent on the issue, we direct AO to allow the expenditure. 13. Ground Nos. 2 & 3 raised by the revenue read as follows: "2. On the facts and circumstances of the case and in law, the learned CIT(A) erred in confirming the order of the learned AO in disallowing an amount of ₹ 10,02,95,870/- being deputation charges in respect of personnel deputed by SSL for the purposes of the business of the appellant. 3. On the facts and circumstances of the case and in law, the learned CIT(A) erred in confirming the order of the learned AO in disallowing an amount of ₹ 25,63,434/- being reimbursement of various expenses incurred by SSL for and on behalf of the appellant." 14. In the course of assessment proceedings, the AO noticed that the Assessee had claimed expenses under the head "Deputation Expenses" of ₹ 10,02,95,870/- and ₹ 25,63,434/- under the head "Other Expenses". These expenses were claimed as having been incurred by M/s. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xpenses are not covered under the aforesaid agreement. The other reasons given by the AO for making the impugned disallowance cannot also be sustained. The order of the Tribunal referred while deciding Gr. No. 1 will equally apply to Gr. No. 2 and 3 also as the other reasons given for making the impugned disallowance are similar to the one given while making the disallowance of expenses which is subject matter of Gr. No. 1. We are therefore of the view that there is merit in Gr. No. 2 and 3 raised by assessee. Consequently Gr. No. 2 and 3 are allowed. 17. Ground No. 4 raised by the revenue reads as follows: "Ground No. 4. On the facts and circumstances of the case and in law, the learned CIT(A) erred in confirming the order of the learned AO in disallowing an amount of ₹ 199,79,11,595/- under section 40(a)(ia) of the Act". 18. As far as Gr. No. 4 is concerned, the facts are that the Assessee made a payment of ₹ 199,79,11,595/- for purchase of software from persons who are resident in India. The Assessee did not deduct tax at source while making payment towards such purchases. According to the AO, the Assessee as a purchaser of the software had a right to us ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of purchase and sale of software and that it did not have a right to use the software and that it was akin to purchase and sale of goods and therefore the payment in question was not in the nature of royalty and there was no obligation to deduct at source on the part of the Assessee for such payment and therefore no disallowance of expenses can be made under section 40(a)(ia) of the Act. The AO however made disallowance under the provisions of Section 40(a)(ia) of the Act. 19. On appeal the CIT(A) confirmed the addition made by AO following the decision of the Hon'ble Karnataka High Court wherein it was held that payment made in respect of purchases in question would constitute royalty. Accordingly since assessee has not deducted the tax at source on the expenditure of ₹ 199,79,11,595/-, he confirmed the disallowances made invoking the provisions of section 40(a)(ia). Hence assessee is aggrieved. 20. The learned Counsel referred to the order of the ITAT in assessment year 2007-08 wherein following the decision of the Karnataka High Court dealing with the case where the question was as to whether the amounts paid to foreign software suppliers were royalty and the decisio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 23. The next submission is that since this payment is made to the Indian Residents and not to Non-Residents and those recipients paid taxes relying on the principles laid down by the Hon'ble Supreme Court in the case of Hindustan Coca Cola Beverage (P) Ltd. v. CIT [2007] 293 ITR 226 (SC). It was a submission that no deduction is required under section 194J and therefore, no disallowance is called for under section 40(a)(ia). He also placed on record the decision of the ITAT in the case of Solid Works Corporation in ITA No.3219/Mum/2010 dated 8/02/12 wherein following the decision of the Hon'ble Delhi High Court, the Tribunal held that the view favorable to assessee should be followed and deleted the addition made under section 40(a)(ia) of the Act in respect of payment made for purchase of software (Pro-quip corporation v. CIT 255 ITR 354). 24. It was also the alternate contention that the Hon'ble Special Bench of the ITAT considered the issue of section 40(a)(ia) in the case of Merilyn Shipping & Transports v. ADCIT (16 ITR Trib. (1) Viz)in ITA No.477/Viz/2008 for AY 2005-06 dated 29.3.2012 and held that the word "payable" used in the section refers to only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... High Court in the case of Samsung (supra) and the Hon'ble Delhi High Court in the case of Ericsson (supra) held as follows: "9. On the other submission of the learned D.R. that the decision rendered by the Hon'ble Delhi High Court was in respect of use of software embedded in an equipment supplied and therefore the same should not be applied to the case of shrink wrap software, we are of the view that the Hon'ble Delhi High Court after referring to the decision of the Hon'ble Supreme Court in the case of Tata Consultancy Services (supra) went on to observe at para-56 of its judgment that when software is incorporated in a CD it becomes a tangible property and the payment made for acquiring the same is not a payment by way of royalty. In para-60 of its judgment, the Hon'ble Delhi High Court has approved the ruling of the Authority for Advance Ruling (AAR) in the case of Dassault Systems KK 322 ITR 125 (AAR). The facts giving rise to the ruling of the AAR were that the applicant, a Japanese company, engaged in the business of providing "Products lifecycle management" software solutions, applications and services, marketed licensed software product ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... were retained by the applicant. (ii) That passing of a right to use and facilitating the use of a product for which the owner had a copyright was not the same thing as transferring or assigning rights in relation to the copyright. Where the purpose of the license or the transaction was only to establish access to the copyrighted product for internal business purpose, it was not legally correct to say that the copyright itself had been transferred to any extent. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently did not amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. (iii) That the VAR had not been given an independent right to sell or offer for sale the software products of the applicant to the end-users. What the VAR did, in the course of carrying out its marketing function, was to canvass for orders, collect the purchase order from the interested customer and forward that offer to the applicant; and it was the applicant that accepted or rejected that offer. In the absence of an independent right to conclude the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the protection afforded in relation to computer programmes under copyright law may differ from country to country. In some countries the act of copying the programme onto the hard drive or random access memory of a computer would, without a license, constitute a breach of copyright. However, the copy right laws of many countries automatically grant this right to the owner of software which incorporates a computer programme. Regardless of whether this right is granted under law or under a license agreement with the copyright holder, copying the programme onto the computer's hard drive or random access memory or making an archival copy is an essential step in utilizing the programme. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the programme by the user, should be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as commercial income in accordance with article 7. The method of transferring the computer programme to the transferee is not relevant. For example, it does not matter whether the transferee acquires a computer di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d on to the customer. Such an inference leads to unintended and irrational results. We may in this context refer to section 52(aa) of the Copyright Act (extracted supra) which makes it clear that "the making of copies or adaptation" of a computer programme by the lawful possessor of a copy of such programme, from such copy (i) in order to utilize the computer program, for the purpose for which it was supplied or (ii) to make back up copies purely as a temporary protection against loss, destruction, or damage in order to utilize the computer programme for the purpose of which it was supplied" will not constitute infringement of copyright. Consequently, customization or adaptation, irrespective of the degree, will not constitute "infringement" as long as it is to ensure the utilization of the computer programme for the purpose for which it was supplied. Once there is no infringement, it is not possible to hold that there is transfer or licensing of "copyright" as defined in the Copyright Act and as understood in common law. This is because, as pointed out earlier, copyright is a negative right in the sense that it is a right prohibiting someone else ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the order of CIT(A) and dismiss the appeal of the Revenue." 31. The above ruling of the Tribunal though rendered in the context of Non-residents involving definition of Royalty under Double Taxation Avoidance Agreements (DTAA), the ratio laid down therein will equally applicable to definition of Royalty under the Act and both the Hon'ble Karnataka High Court as well as the Hon'ble Delhi High Court have considered the issue in the light of the definition of royalty under the Act also. We are therefore of the view that the order of the CIT(A) deleting the addition made by the AO is justified and calls for no interference. 32. Since we have confirmed the order of the CIT(A) on the ground that the payment in question is not royalty, the other arguments of the learned counsel for the Assessee on applicability of Sec.40(a)(ia) based on decision of Special Bench ITAT, Vishakhapatnam in the case of Merilyn Shipping (supra) and Hon'ble Bombay High Court in the case of Kotak Securities (supra) are not taken up for consideration". 28. Since the Coordinate Bench decision is to be followed on similar facts, we have no option than to follow the same. However, in assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to various software developers is ₹ 1,99,79,11,595/- out of which ₹ 1,57,03,57,383/- was paid before 31-03-2008. The outstanding amount was only ₹ 42,75,54,212/-. Subject to verification of the amounts, in case the payments are considered as royalty covered by section 9(1)(vi), then the disallowance under section 40(a)(ia) can only be restricted to the amount outstanding as payable as on 31/03/2008 as per the principles laid down by Special Bench in the case supra. 30. The next issue for examination is that all the above companies are residents in India and they are also assessed to income tax. It was the submission that the recipients paid the tax and following the principles laid down by the Hon'ble Supreme Court in the case of Hindustan Coca Cola Beverage Pvt Ltd. v. CIT 293 ITR 226 (SC), the taxes cannot be recovered from assessee. Even though the issue before the Hon'ble Supreme Court was with reference to the recovery of taxes and not the disallowances under section 40(a)(ia). AO is also directed to examine whether there is any non-payment of taxes by those companies. 31. In the course of argument the learned DR referred to the provisions of 9(1)( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the latest pronouncements of various higher judicial authorities on the issue and the nature of purchase and the rights involved therein, in order to examine whether the payments can be considered as royalty as per Explanation 2 of clause vi of sub- section 1 of section 9. Assessee should be given due opportunity and issue should be considered in the light of the facts and the law on the issue. Ground is accordingly considered allowed for statistical purposes. 33. Ground No.5 pertains to the issue of disallowance of an amount of ₹ 10,66,228/- under section 14A of the Act and also Ground No.6 for disallowance of same while computing the book profits under section 115JB. 33.1 The facts of the case relating to this ground of appeal are that during the course of the assessment proceedings it was seen that assessee had investment in mutual fund from which assessee had earned exempt dividend income of ₹ 48,67,136/-. Assessee explained that the investments were made out of own funds and hence no disallowance could be made. Assessee placed reliance on the decision in the case of Hero Cycles Ltd reported in 323 ITR 518 (P&H). AO did not find the contentions of assessee accepta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... res finding of incurring of expenditure where it is found that for earning exempted income no expenditure has been incurred, disallowance under section 14A cannot stand. In the present case finding on this aspect, against the revenue is not shown to be perverse. Consequently, disallowance is not permissible". Further, the Hon'ble ITAT Delhi in the case of M/s Minda Investments v. DCIT (ITA No.4046/Del/2009) relied on the decision of Hon'ble Punjab & Haryana High Court in the case of Hero Cycles Limited (supra) has held that disallowance under section 14A of the Act cannot be made where it is found that for earning exempted income no expenditure has been incurred. Further, Hon'ble Bombay High Court in the case of M/s Godrej & Boyce Mfg. Co, Ltd (ITA No.626 of 2010 and Writ P.No.758 of 2010) has held that for disallowing expenditure under section 14A of the Act there should be proximity (i.e. relationship) between the expenditure incurred and exempt income. Without prejudice to the above, the detailed working of disallowance as per rule 8D of the Rules is as under: Disallowance as per rule 8D: (1) Amount of expenditure directly related to income which does not f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wance could be made under section 14A. AO has however, not found the contentions of assessee acceptable. Once AO has made the disallowance on account of interest expenditure, it was for assessee to produce evidence in the appellate proceedings that the investments were in fact made out of the free surplus funds available with assessee and that no part of the interest bearing funds were used for making investments which have given tax free income or which may give tax free income to assessee. The appellant, other than placing reliance on certain decisions, has not produced any evidence before me that the investments were made out of free surplus funds of assessee and that no part of the interest bearing funds had been used for the purposes of making the investments. Hence, the disallowance of the proportionate interest expenditure has to be necessarily made by the mandatory method prescribed in Rule 8D. Therefore, the action of AO cannot be faulted with. Similarly, the disallowance made as per Rule 8D(2)(iii) has also been made as per the prescribed method and the average value of all investments are required to be taken and not only the average value of the investments from which e ..... X X X X Extracts X X X X X X X X Extracts X X X X
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