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TMI Blog2013 (9) TMI 519X X X X Extracts X X X X X X X X Extracts X X X X ..... -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 whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct 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, including matters related to Board of Directors and shareholders, contractual matters, advice and assistance in maintenance of statutory records, filing required return and form etc. Further, all out of pocket expenses including travel, conveyance etc. were to be billed separately by Sonata Software Ltd. and was to be reimbursed by the assessee. The quantum of service charges was determined by adopting the following basis. The expenditure incurred by SSL on account of insurance, salaries, allowances, directors' remuneration's electricity & charges, printing & stationery, Professional charges, repairs & maintenance, rent for offices, etc. and also depreciation has been apportioned to the assessee on the basis of turnover as service charges. 4. The AO called upon the Assessee to furnish the necessary documentary evidence to show that services stated at (a) to (d) above were rendered by SSL to the assessee. The assessee was also asked ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as 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 Narasingirji [1973] 91 ITR 544 (SC). The decision of the Hon'ble Supreme Court in the case of CIT v. Walchand & Co. (P.) Ltd. [1967] 65 ITR 381 was referred to and it was submitted that in applying the test of commercial expediency whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the business man and not of the revenue. The Hon'ble Bombay High Court's decision in the case of Aruna Mills Ltd. v. CIT [1957] 31 ITR 153 was also referred to wherein it was held as follows: "Now, we have had occasion to point out in several decisions that what the Income-tax purports to tax is business profits, and business profits are the true profits of a business as ascertained according to commercial principles. There may be an expenditure or there may be a loss which may not be an admiss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of its non-section 10A activity. However, these receipts have been reduced from the expenditure claimed of section 10A activity of SSL. The net implication of this is that the profits of the section 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 section 10A activity of SSL and therefore such receipts should have been offered to tax. (iii) The assessee has contended that the said agreements have been executed in the best interest of the business between two independent corporate entities. It has also been contended that the same has been incurred out of commercial expediency. It has further been submitted that it is prerogative of the businessman as to how to run its business and the department should be prescribed the quantum of expenditure etc. : These contentions of the assessee would have been acceptable if this agreement was entered into between two independent entities not under the common management and control. In the instant case, the assessee is a 100% subsidiary of SSL. The implication of this agreement is that the taxable profits of the assessee have been reduced and at the same tim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 eligible for exemption u/s. 10A and (ii) the activity not eligible for exemption u/s. 10A. Separate accounts were maintained by SSL for these activities. Direct expenses relating to these activities were accounted for in the separate accounts respectively. However, service charges were common and later on allocated to these activities on the basis of turnover. The assessee, after its incorporation, took over the activity of SSL, which was not eligible for exemption u/s. 10A on 1.7.2000. However, an agreement was entered into between assessee and SSL to the effect that SSL would continue to incur expenses in the nature of service charges on behalf of assessee as before and the same would be reimbursed by the assessee. The assessee paid the sum of Rs. 6,55,80,590/- as service charges for the year under consi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 pf service charges from SITL 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. (iii) 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 recetts 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 offered for tax. (iv) The assessee has contended that the said agreement has been in the best interest of the business between two independent corporate entities. It has also been contended that the same has been incurred out of commercial expediency. It has further been submitted that it is t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng 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 activity of assessee. Hence, in his opinion, the expenditure on support services to the assessee in the ratio of turnover was patently wrong. After going through the agreement, it was also held that SSL was required to advise the assessee in the matters of finance, accounts, taxation, legal, administration, HRD etc. and proper maintenance of record, compliance under various laws and training of employees. He also noted that assessee itself had incurred operational expenses of Rs. 835.76 lacs which shows that assessee itself maintaining a large force of its employees. Such expenses amounted to 8.31% of total turnover which itself was ver,1 high. Proceeding further, he examined the nature of expenses of SSL, which had been allocated on the basis of turnover. He found that such expenses were incurred on account of various heads totaling 44. According to him, such services had nothing to do with services mentioned in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n 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 section 10A and non-section 10A activity has been directly charged against the profits of these activities and do not call for any interference." . The above observations of the Tribunal resolve the controversy before us. Admittedly, prior to incorporation of assessee company, SSL was carrying on two units independently i.e. unit exempted u/s. 10A and the unit not exempted. Direct expenses incurred were separately booked to respective units. Only the support services expenses were allocated on the basis of turnover. Such allocation has been found to be proper and reasonable by the Tribunal. There is no dispute that non-exempted unit was taken over by the assessee company and support services were continued to be rendered by SSL. From the inception, the stand of the assessee has been that such expenses were allocated on the basis of turnover as is apparent from para 4.3.3(ii) of the 'assessment order, wherein it has been mentioned that expenses were allocated in debit notes as the basis of turnover. Even the CIT(A) has also admitted this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the AO no supporting evidence was filed and therefore the Assessee failed to establish that the payment was made to SSL in respect of services performed for and on behalf of the Assessee. The AO also held that the Assessee failed to establish that expenses in question were incurred for the purpose of business of the Assessee. The AO also held that there was already an agreement between the Assessee and SSL whereby SSL was rendering common services in the areas of Finance, Accounts, Taxation, Legal Administration, HRD etc. for which the Assessee was making payment to SSL. The AO held that the Assessee failed to establish that the reimbursement of expenses in question were different from the services for which payment was made by the Assessee to SSL under the agreement for rendering common services. Finally the AO held that the Assessee and SSL were subsidiary and Holding companies and the transaction in question was entered into with a clear intention of reducing the tax liability of the Assessee and increasing the non-taxable profits of SSL as SSL was claiming deduction u/s.10A of the Act. For all the above reasons the AO disallowed the aforesaid expenditures and added the sums r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submissions of the learned DR on Gr.No. 2 and 3 who relied on the order of the AO. The learned counsel for the Assessee reiterated submissions made before CIT(A) and the order of the CIT(A). 18. We have considered the rival submissions. While deciding Gr.No.1 of the Assessee, we have already seen 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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llowed as a deduction in computing the income of the previous year in which such tax has been paid." ; According to the AO, the payment in question is in the nature of Royalty because it was for a right to use software and therefore the Assessee ought to have deducted tax at source and since the Assessee had not so deducted tax at source, the sum in question was allowed as deduction in computing income under the head business income and an addition was made accordingly to the business income of the Assessee. The AO also relied on the decision of the Hon'ble Karnataka High Court in the case of CIT (International Taxation) v. Samsung Electronics Co. Ltd. wherein the issue was decided in favour of the Revenue. The stand of the Assessee was that it was in the business 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 u/s.40(a)(ia) of the Act. The AO however made disallowance under the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted computer and to take back up copy of the software, it is clear that what is transferred is right to use the software, an exclusive right which the owner of the copyright i.e., the respondent -- supplier owns and what is transferred is only right to use copy of the software for the Internal business as per the terms and conditions of the agreement. The decision of the Delhi High Court In Commissioner of Income-tax Delhi - V v. M/s. Dynamic Veritcal Software India Pvt. Ltd. in ITA No. 1692/2010 Dated 22.02.2011 relied upon by Sri Aravind Dattar, learned senior counsel appearing for the respondent in some of the cases in support of his contention that by no stretch of imagination, payment made by the respondents to the non-resident suppliers can be treated as royalty is not helpful to the respondents in the present cases as in the said case, Delhi High Court was considering the provisions of Sections 40(a)(1) of the Act and the order of the High Court reads as follows: - "What is found, as a matter of fact, is that the assessee has been purchasing the software from Microsoft and sold it further in Indian market. By no stretch of imagination, it would be termed as royalty." There ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... take a copy of the software and to store it in the hard disk of the designated computer if licence is granted in that. behalf and in the absence of licence the same would amount to infringement of copyright, which is exclusively owned by non-resident suppliers, who would continue to be the proprietor of copyright. Therefore, there is no similarity between the transaction of purchase of the book or prercorded music C.D. or the C.D. containing software and in view of the same the Legislature in its wisdom, has treated the literary work like books and other articles separately from computer software within the meaning of the 'Copyright' as referred to above under Section 14 of the Copyright Act. 25. It Is also clear from the above said analysis of the DTAA income Tax Act, Copyright Act that the payment would constitute royalty within the meaning of Article 12(3) of the DTAA and even as per the provisions of 9(l)(vi) of the Act as the definition of royalty under clause 9(1)(vi) of the Act is broader than the definition of royalty under the DTAA as the right that is transferred in the present case is the transfer of copyright including the right to make copy of software for Internal bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts with ten cellular operators in India for supply of hardware and software. The Assessing Officer was of the view that the income of the assessee was taxable in India, both, under the Income-tax Act, 1961 as well as under the treaty between India and Sweden. He held that it was business income and Assessee had a PE in India. The CIT(A) held that the receipts in respect of license to use software which is part of the hardware alone could be taxed in India as royalty. The Assessee argued before Tribunal that the payment made by the assessee for the use of software in the equipment does not amount to royalty. The Tribunal in the aforesaid context examined the issue as to whether the payment is for a copyright or for a copyrighted article. If it is for copyright, it should be classified as royalty both under the Income-tax Act and under the DTAA and it would be taxable in the hands of the assessee on that basis. If the payment is really for a copyrighted article, then it only represents the purchase price of the article and, therefore, cannot be considered as royalty either under the Act or under the DTAA. The Tribunal after referring to definition of Royalty under the Act and the def ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Copyright Act, 1957 and, therefore what is transferred is not a copyright but actually a copyrighted article (iii) The cellular operator cannot commercially exploit the software and therefore a copyright is not transferred. (iv) Further, the parties to the agreement have not agreed upon a separate price for the software and therefore it is not open for the income tax authorities to split the same and consider part of the payment for software to be royalty (v) The bill of entry for importing of goods shows that the price has been separately mentioned for software and that this was only for the purposes of customs. There is no evidence to show that the assessee was a party to the fixation of value for the customs duty purposes (vi) The software provided under the contract is goods and therefore no royalty can be said to be paid for it. 53. Mr. Prasaran, countered the aforesaid reasoning arguing that Clause 20 of the Supply Contract uses the term "licence" and the same term is used in the context of software throughout the three Agreements, indicating that it is not an outright sale of goods, or a full transfer of rights from the assessee to the Indian company. He also submitted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee to the Indian customers was a GSM which consisted both of the hardware as well as the software, therefore, the Tribunal is right in holding that it was not permissible for the Revenue to assess the same under two different articles. The software that was loaded on the hardware did not have any independent existence. The software supply is an integral part of the GSM mobile telephone system and is used by the cellular operator for providing the cellular services to its customers. There could not be any independent use of such software. The software is embodied in the system and the revenue accepts that it could not be used independently. This software merely facilitates the functioning of the equipment and is an integral part thereof. On these facts, it would be useful to refer to the judgment of the Supreme Court in TATA Consultancy Services v. State of Andhra Pradesh, 271 ITR 401, wherein the Apex Court held that software which is incorporated on a media would be goods and, therefore, liable to sales tax. Following discussion in this behalf is required to be noted:- "In our view, the term "goods" as used in Article 366(12) of the Constitution of India and as defined under the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cians and in itself is not a "good," but when transferred to a laser-readable disc becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good. That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that some programs may be tailored for specific purposes need not alter their status as "goods" because the Code definition includes "specially manufactured goods." 56. A fortiori when the assessee supplies the software which is incorporated on a CD, it has supplied tangible property and the payment made by the cellular operator for acquiring such property cannot be regarded as a payment by way of royalty. 57. It is also to be borne in mind that the supply contract cannot be separated into two viz. hardware and software. We would like to refer the judgment of Supreme Court in CIT v. Sundwiger EMFG Co., 266 ITR 110 wherein it was held: "A plain and cumulative reading of the terms and conditions of the contract entered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts of such literary work. In the presence case, this has not been established. It is not even the case of the Revenue that any right contemplated under Section 14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the Supply Contract. Distinction has to be made between the acquisition of a "copyright right" and a "copyrighted article". 60. Mr. Dastur is right in this submission which is based on the commentary on the OECD Model Convention. Such a distinction has been accepted in a recent ruling of the Authority for Advance Ruling (AAR) in Dassault Systems KK 229 CTR 125. We also find force in the submission of Mr. Dastur that even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below Section 9 (1) (vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid decision by a majority expressed the view that the provisions of section 40(a)(ia) of the Act are applicable only to the amounts of expenditure which are payable as on the date 31st March of every year and it cannot be invoked to disallow expenditure which had been actually paid during the previous year, without deductions of TDS. The ld. Counsel for the assessee submitted that the factum of actual payment can be verified by the AO and subject to that disallowance under section 40(a)(ia) of the Income Tax Act, 1961 (the Act) can be deleted, if the AO find that the payment have already been made on or before the last date of the previous year. 28. The next submission of the learned counsel for the Assessee was that u/s.40(a)(ia) of the Act, any payment on account of royalty on which tax is deductible u/s.194-J of the Act alone can be subject matter of disallowance. In this regard it was submitted that Sec.194-J of the Act cast an obligation to deduct tax at source on payment on account of royalty by the Taxation Laws (Amend.) Act, 2006, w.e.f. 13-7-2006. Therefore any payments made prior to 13-7-2006 cannot be subject matter of disallowance u/s.40(a)(ia) of the Act only on or a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... added resellers (VAR) who were independent third party resellers. To authorize a VAR to act as a reseller the applicant entered into a general VAR agreement. The terms of the agreement explicitly provided for the appointment of reseller/distributor of product on a non-exclusive basis for making the product available to the end-user within the territory for his internal use. The product was sold to the VAR for a consideration based on the standard list price less discount ; and the VAR in turn would sell the product to the end-users at a price independently determined by the VAR. The end-user would enter into the end-user licence agreement with the applicant and the VAR for the product supplied. The reseller did not hold any inventory of the software in India. The VAR was free to negotiate the price with the customer but the VAR paid to the applicant the standard price in force less agreed discount. The reseller (VAR) would get the order from the end-user and place a back-to-back order on the applicant. On acceptance of the order by the applicant, the applicant would provide a licence key via e-mail so that the customer would directly download the product through the web link. On th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the case within the fold of article 12(3) of the DTAA or section 9(1)(vi) of the Income-tax Act, 1961. 10. In Para 60 of its judgment the Hon'ble Delhi High Court has accepted the commentary on OECD Model Convention referred to in Dassault Systems KK (Supra), which is as follows: "Transfers of rights in relation to software occur in many different ways ranging from the alienation of the entire rights in the copyright in a programme to the sale of a product which is subject to restrictions on the use to which it is put. The consideration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. The difficulty of determination is compounded by the ease of reproduction of computer software, and by the fact that acquisition of software frequently entails the making of a copy by the acquirer in order to make possible the operation of the software. Payments made for the acquisition of partial rights in the copyright (without the transferor fully alienating the copyright rights) will represent a royalty where the consideration is for g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection. It is also of no relevance that there may be restrictions on the use to which the transferee can put the software." (Underlining by us for emphasis) 11. After referring to the aforesaid OECD Commentary, the AAR in its decision rendered in the case of Dassault Systems KK (supra) observed as follows: "It has been contended on behalf of the Revenue that the right to reproduce the work in any material form including the storing of it in any medium by electronic means (vide section 14(a)(i) of the Copyright Act) must be deemed to have been conveyed to the end-user. It is pointed out that a CD without right of reproduction on the hard disc is of no value to the end-user and such a right should necessarily be transferred to make it workable. It appears to us that the contention is based on a misunderstanding of the scope of right in sub-clause (i) of section 14(a). As stated in Copinger's treatise on Copyright, "the exclusive right to prevent copying or reproduction of a work is the most fundamental and historically oldest right of a copyright owner". We do not think that such a right has been passed on to the end-user by permitting him to download the computer programme and st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reproduction and adaptation for the purpose of commercial exploitation. Copyright being a negative right (in the sense explained in paragraph 9 supra), it would only be appropriate and proper to test it in terms of infringement. What has been excluded under section 52(aa) is not commercial exploitation, but only utilizing the copyrighted product for one's own use. The exclusion should be given due meaning and effect; otherwise, section 52(aa) will be practically redundant. In fact, as the law now stands, the owner need not necessarily grant licence for mere reproduction or adaptation of work for one's own use. Even without such licence, the buyer of product cannot be said to have infringed the owner's copyright. When the infringement is ruled out, it would be difficult to reach the conclusion that the buyer/licensee of product has acquired a copyright therein." (underlining by us for emphasis) 12. The above decision of the AAR in the case of Dassault (supra) was a case of sale of shrink wrap software and the AAR has held that reproduction and adaptation envisaged by section 14(a)(i) and (vi) can contextually mean only reproduction and adaptation for the purpose of commercial expl ..... X X X X Extracts X X X X X X X X Extracts X X X X
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