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TMI Blog2018 (12) TMI 518X X X X Extracts X X X X X X X X Extracts X X X X ..... as well as the Second Appellate Authority. Accordingly, no question of law arises out of the judgment rendered by the authorities below. Disallowance of software expenses - non business expenses - Held that:- Respectfully following the order of the Tribunal in AY 2005-06 [2015 (1) TMI 870 - ITAT KOLKATA] as well as taking note of the Hon’ble jurisdictional High Court decision in Indian Aluminium Co. ltd. Vs. CIT [2016 (3) TMI 691 - CALCUTTA HIGH COURT] wherein has held that software development expenditure which was application software was revenue in nature, and also the fact that the revenue has accepted the view of the Ld. CIT(A)/Tribunal on this issue, we confirm the action of the Ld. CIT(A) and dismiss this ground of appeal of revenue. - I.T.A. No. 550/Kol/2014 - - - Dated:- 5-12-2018 - Shri A. T. Varkey, JM And Shri M. Balaganesh, AM For The Appellant : Shri Sanjoy Paul, Addl. CIT, Sr. DR For The Respondent : Shri J. P. Khaitan, Sr. Counsel ORDER Per Shri A.T.Varkey, JM This appeal preferred by the revenue is against the order of the Ld. CIT(A)-VI, Kolkata dated 27.12.2013 for AY 2007-08. 2. The following effective ground nos. 1 an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unctional and risk profile. The assessee explained the global Delivery Model as adopted and forming the very basis of two alternative inter-company invoicing models. The business model followed by the assessee and 12A/12B is summarised below:- Model I Where the customer directly enters into the contract with the respondent; and Model II Where the customer directly enters into the contract with 12A/12B The assessee explained the economic substance underlying the two arrangements, the roles and responsibilities and the functional profile of the assessee as well as that of its AEs 12A/12B. Further, it explained that inter-company invoicing agreements and contractual terms entered with the AEs. Under both the business model, the basic functions of the subsidiaries, with regard to the administrative functions i.e. account management, are same. On the other hand, assessee is performing non-administrative functions under both the business models and thus entire risks with regard to non-administrative services are being borne by the assessee irrespective of the business model. Furthermore, it was also explained that customers enter into contract with either assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... all willing to enter into a contract with the subsidiaries as the subsidiaries on a stand-alone basis may not be fulfilling the conditions set by the customers for awarding the contract for provision of IT services. However, these customers may be willing to enter into a contract with the assessee as it has the requisite man power for providing IT services, vast and experienced resources pool with expertise in various areas of work, adequate share capital for bearing the risk arising out of the contract, average revenue over a period of time, brand value, reputation in the market, track record of successful projects, etc. In such cases, the contract is entered into between the customer and the assessee but the functions and risks undertaken by both the assessee and its subsidiaries remain the same as they are when the customers enter into the contract with the subsidiaries. Ld. counsel explained the concept of conduct of the parties and risks associated with it. He referred to para 5.3.2.22 and 5.3.2.23 of the United Nations Practical Pricing Manual on Transfer Pricing for Developing Countries ( Practice Manual ) wherein, allocation of risk and conduct of parties is explained th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e examination of risks in an Article 9 context starts from an examination of the contractual terms between the parties, as those generally define how risks are to be divided between the parties. Contractual arrangements are the starting point for determining which party to a transaction bears the risk associated with it ... .. ... a tax administration is entitled to challenge the purported contractual allocation of risk between associated enterprises if it is not consistence with the economic substance of the transaction . Therefore, in examining the risk allocation between associated enterprises and its transfer pricing consequences, it is important to review not only the contractual terms but also the following additional questions: Whether the conduct of the associated enterprises conforms to the contractual allocation of risks, Whether the allocation of risks in the controlled transaction is arm s length, and What the consequences of the risk allocation are. Specific attention was drawn to the concept of risk allocation and control , on which para 9.22 and 9.23 of the OECD Guidelines state that: In the absence of comparables evidenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ransferee. Based on the above OECD Guidelines and Practice Manuals, we are of the view that the conduct of the assessee and its AEs should be given due cognizance which in the assessee s case is same in both the business models. The assessee has also explained from the table, that the functions performed and the risks assumed by the assessee and its AEs under both the business models are the same i.e. the assessee undertakes the core delivery functions and assumes the service liability risks while the AEs are only engaged in marketing and administrative functions. Further, the sample proposal documents submitted by the assessee also vindicates that the prospective customers are fully aware of assessee s technical capabilities and expertise while awarding a contract and even if the actual contract is executed by the AEs, the customer would presumably not tend to believe that the offshore IT/software development services under Global Delivery Model is being rendered by the AEs and not the assessee. Hence, the execution of the agreement directly by the assessee or by the AE would not create any substantial difference in the sharing of functions or risks between the partie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... remain the same. Further, in course of the contract negotiation and mapping of the scope of work, the customer is fully aware of the underlying delivery mechanism, since technical capabilities of the assessee are always showcased and presented before the customer. Therefore the customer based on their individual preferences and driven by the considerations, which are exclusively their own, chooses to enter into contract with 12A / 12B or the assessee, which does not make any essential variation in the business model as a global organisation. Invoicing is the derivative of the methodology proposed to be pursued by the respective client who awards the assignment. The prospective customer is also fully aware of the financial standing of 12A / 12B vis-a-vis the ITC Infotech Group even while entering into service contract with 12A / 12B in view of the fact that every service proposal specifically highlight the technical strength and the financial strength of the assessee which plays its pivotal role before the clients while entering into a contract with 12A / 12B. Hence, the presumption of the TPO that the overseas customers decision to enter into contracts directly with 12A or 12B are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adjustment envisaged by TPO for the AY 2006-07 and submitted that both 12A and 12B would make losses at net level if the risk adjusted pricing model, as proposed by the TPO were put in actual practice. Thus the risk adjusted business model as proposed by the TPO would result in an absurd situation from 12A / 12B s perspectives defeating the concept of stable positive return for a low risk tested party. In the light of the above, we are of the view taking into cognizance the business model of the assessee along with the functions undertaken and risks assumed by the assessee and its subsidiaries, the facts and written submission made during the course of the proceedings for both the AYs 2005-06 2006-07, that the TPO totally erred in making transfer pricing adjustments in the case of assessee in both the AYs. In view of facts and circumstances, we are of the view that the TPO just on the basis of conjunctures and surmises made this transfer pricing adjustments. Hence, we dismiss this common issue of revenue s appeals in both the AYs. 4. We take note that the Tribunal s order (supra) confirming the Ld. CIT(A) s action has been upheld at the level of the Hon ble High Court ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ground no. 4 is raised in AY 2005-06 reads as under:- 4. That on the facts circumstances of the case the Ld. CIT(A) erred in deleting the addition of ₹ 6897876/- made on purchase of software in the head operating manufacturing expenses wrongly interpreting it as an expense revenue in nature whereas the expenditure is of capital nature. 18. We have heard rival contentions and gone through facts and circumstances of the case. We find that the AO made disallowance of Software expenses in AYs 2005-06 2006-07 amounting to ₹ 68,97,876/- 9,67,408/- respectively. But CIT(A) deleted by holding the software expenses to have been incurred for the purposes of business not resulting in any enduring benefit. Aggrieved, now revenue is in second appeal before tribunal for both AYs. 19. We find that during the AYs 2005-06 2006-07, the assessee incurred expenditure in connection with the purchase of software. The assessee is engaged in the business of software development and this software was acquired by it in connection with client projects. The software acquired was application software. During assessment proceedings also the assessee asked as to why ..... X X X X Extracts X X X X X X X X Extracts X X X X
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