Income Tax Appellate Tribunal - Mumbai
Sonata Information Technology Ltd, ... vs Assessee on 5 July, 2012
ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench
IN THE INCOME TAX APPELLATE TRIBUNAL
"E" Bench, Mumbai
Before Shri D.K. Agarwal, Judicial Member and
Shri B. Ramakotaiah, Accountant Member
ITA No.1507/Mum/2012
(Assessment year: 2008-09)
Sonata Information Technology Vs. D.C.I.T. - LTU
Ltd., 208 TV Industrial Estate, Mumbai
S.K. Ahire Marg, Worli,
Mumbai 400025
PAN: AAECS 8734 J
(Appellant) (Respondent)
Assessee by: Shri Arvind V. Sonde
Department by: Shri B.Jaya Kumar, DR
Date of Hearing: 05/07/2012
Date of Pronouncement: 07/09/2012
ORDER
Per B. Ramakotaiah, A.M.
This is an assessee appeal against the orders of CIT (A)-24 Mumbai, dated 27/01/2012. Assessee has raised various grounds and at the outset the learned Counsel submitted that the issues are covered by the earlier year's orders. However, the learned DR did not agree and stated that on facts there is a difference as considered by the CIT (A) in the order. Therefore, the case was heard elaborately on all the grounds. Keeping in mind the orders in earlier years, the issues were decided as under:
2. Ground No.1 raised by the assessee reads as follows:
"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 `14,98,56,338/- being service charges incurred for the services rendered by SSL for the purposes of the business of the appellant. The appellant submits that the amount incurred was for the purpose of carrying on the appellant's business and the same is admissible and may pleas be allowed"Page 1 of 37
ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench
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, 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 turnover as basis with reference to 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.Page 2 of 37
ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench
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 to furnish the supporting evidence for the out of pocket expenses on travel, conveyance, etc. In response, the assessee furnished its explanation on 25.11.2009, that SSL was its parent company. SSL was in the business the profits of which were not taxable u/s. 10A of the Income Tax Act, 1961 (the Act) as well as other business. The assessee company was formed and started operating from 01.07.2000 and took over the business activities of SSL the profits of which were not exempt u/s. 10A of the Act. The assessee entered into an agreement dt.28.9.2000 referred to in the earlier paragraph of this order with SSL for availing common services in the areas of Finance, Accounts, Taxation, Legal Administration, HRD etc. for the consideration on terms and conditions contained in the said agreement. The Assessee pointed out that SSL has raised debit note on the Assessee for rendering services, which are duly authenticated by agreement dated 28.09.2000 which has been duly revised on 01.07.2002 and 01.07.2004 and 01.07.2006. The Assessee pointed out that for services rendering during the previous year, the Assessee raised debit notes amounting to Rs. `14,98,56,338/-
5. The Assessee submitted before the AO that the agreement was a commercial agreement executed in the best interests of business between two independent corporate entities and there is no room, whatsoever, for doubting the genuineness of the said agreement. As per the terms of the agreement, Sonata Software Ltd. did render services as 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 Page 3 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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). The decision of the Hon'ble Supreme Court in the case of CIT vs. Walchand & Co. (1967) 65 ITR 381 (SC) 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 (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 admissible loss under any of the provisions of section 10(2) (corresponding to section 29 of the 1961 Act) and yet such an expenditure or loss would have to be allowed in order to determine what were the true profits of a business, and it is the duty of every one who has anything to do with taxing business- people to understand what are the principles of commercial expediency. Unless one understands these Page 4 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench principles it is difficult to make a proper assessment on a business or on a businessman."
6. Attention of the AO was to drawn to the fact that in the assessment order u/s. 143(3) for A.Y. 2001-2002, the A.O. disallowed the service charges incurred by the assessee, which was payable to SSL., on the ground that such expenses have been incurred to reduce the tax liability of the assessee and increase the non-taxable profits of Sonata Software Ltd. by relying on Supreme Court Judgment in the case of 154 ITR 148. It was highlighted that the learned CIT(A) however only allowed partial relief to the assessee by allowing expenses to the extent of Rs. 50.00 lacs and upheld the order of A.O. for the balance amount. On second appeal, the Hon'ble Tribunal deleted the addition made and allowed total relief to the assessee, Further attention was drawn to the fact that the learned CIT(A) in the preceding years for A. Y. 2002- 03, A.Y. 2003- 04 A.Y. 2004-05 & A.Y. 2005- 06, has also allowed relief to the assessee by placing reliance on the Hon'ble Tribunal's order in assessee's own case for A.Y. 200 1-02. Further it 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-1OA activity. However, these receipts have been reduced from the expenditure claimed of Page 5 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 1OA activity of SSL. The net implication of this is that the profits of the 1OA activity of SSL have increased and on which no tax has been paid. Whereas in fact, these receipts are clearly pertaining to the non 1OA 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 time increasing the non-taxable profits of its holding company - SSL.
8. For the above reasons, the 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. The AO relied on the decision of the Hon'ble Supreme Court in the case of McDowell (154 ITR 148) wherein it was held that colourable devices cannot be part of tax planning and it is wrong to encourage avoidance of tax by dubious methods and that it is for the Courts to take stock and determine the nature of legal devices to avoid taxes and to expose these devices for what they really are. The AO also held that the Assessee did not prove that services were in fact rendered by SSL with supporting evidence. He also held that the assessee has only submitted debit notes raised by SSL which in no way substantiates as to whether SSL has really provided any Page 6 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench services to the assessee company and has incurred any expenses for providing the same. He held that the onus to prove that a particular expenditure has been incurred for the purposes of business is on the assessee and as the assessee has failed to discharge this onus, the expenditure claimed is not allowable. Accordingly, the amount of `14,98,56,338/- paid to SSL was held to not an expenditure incurred by the assessee for the purposes of its business and thus was not allowable expenditure. The AO also held that the decision of the ITAT in the earlier Assessment years has not been accepted by the department and appeal 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 Rs.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 eligible for exemption u/s. 1OA 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 Page 7 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 consideration and claimed the same as business expenditure.
8. The Assessing Officer disallowed the entire expenditure by observing as under:
"(i) The following tabulation gives details of the sales, expenditures claimed of the nature "Legal & Professional expenses" and of the nature "Recruitment & Training" in the separate Profit & Loss Accounts prepared for the non-
10A activity of SSL in the A. Yrs. 1998-99, 1999-00 and 2000-01 and in the case of the assessee company for the A. Yrs. 200 1-02 and 2002-03.
Sonata
Information
Sonata Software Ltd. Technology Ltd.
2000-
Asst. Yr. 1998-99 1999-00 01 2001-02 2002-03
Non-10 activity New Company
(Rs. In lakhs)
Trading sale
of software 4980.00 6305.60 9184.80 9694.00 12378.80
Legal & 655.88 91
Professional 18.25 23.68 39.50 0.27
Recruitment (Service (Service
& Training .............. 9.59 Charges) charges)
From the above, it is observed that the expenditure in SSL under the heads "Legal and Professional" and "Recruitment and Training" for the A. Yrs. 1998-99 to 2000-0 1 increased in proportion to the turnover from Rs. 18.25 lakhs to Rs.49.09 lakhs (Rs39.5 lakhs + Rs.9.5 lakhs). However, in comparison to this, the expenditure on account of "Service charges" (which encompasses the expenditures claimed under the said two heads) in the assessee company for A. Yrs. 200 1-02 and 2002- 03 has been claimed at an abnormally high amount of Rs.655.88 lakhs and Rs.9 10.27 lakhs respectively, disproportionate to the turnover of the assessee.
Page 8 of 37ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench
(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 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-1 0A 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 the prerogative of the businessman as to how to run its business and the Department should not prescribe 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 Page 9 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench that the taxable profits of the assessee have been reduced and at the same time increasing the non-taxable profits of its holding company-SSL.
v) 0n perusal of the Balance Sheet of the assessee company, it is observed that out of the total service charges of Rs. 655 88 lakhs payable to SSL for the relevant year, an amount of Rs.522.57 lakhs is outstanding as on 31.03.2001. This further indicates that the basic purpose of this agreement is to reduce the tax liability in the hands of the assessee and increase the non-taxable profits of SSL"
In Para 4.4 of his order, the Assessing Officer also observed that entire exercise was a colourable device to reduce its tax liability and to increase non-taxable profits of SL".
9. The matter was carried in appeal before the CITAO before whom it was submitted that:
"Before me in the appeal proceedings, it was explained on behalf of the assessee that Assessing Officer has misled himself in presuming that the agreement for services covers only the legal and professional charges and recruitment and training expenses. 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 activity of assessee. Hence, in his opinion, the expenditure on support services to the Page 10 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 very, 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 the agreement. In his view, only a portion of salaries and other allowances of employees working in finance, accounts, taxation, legal, administration, HRD, education and research and training deptt. could be allocated. He then estimated the sum of Rs.50 lacs towards the services of SSL rendered from assessee and held the same to be allowable. Rest of the expenditure was held to be disallowable. Aggrieved by the same, the assessee is in appeal before the Tribunal.
11. We have heard both the parties in the light of the materials placed before us. We find that 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-1 OA unit (not eligible for exemption) was excessive as exempted unit was much more expenditure oriented. The matter ultimately reached the Tribunal which accepted the case of assessee that allocation of support services expenses on the basis of turnover was justified. The Tribunal, vide Para 34 of its order dated 17.03.2003 in ITA No. 495/496/M/02, held as under:
"We have considered the submissions and we have perused the various records placed in the Paper book. In the Paper book at page 27 to 34, the assessee has 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. Further, it is found that the basis of allocation amongst the three heads is actual expenses, number of Page 11 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 1 0A 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."
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. 1OA 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 factual position at page 23 of his order where he mentioned "The details of the expenditure which has been allocated on the basis of respective turnover is given along with debit notes, copies of which were filed before me, as also before the Assessing Officer". Faced with the same, the id. Departmental Representative had nothing to add except to rely on the order of Assessing Officer. The Id. Departmental Representative submitted that allocation of expenses requires verification and therefore the matter may be referred to Assessing Officer for necessary Page 12 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench verification. We are unable to accept this request since there is no dispute to the factual position that allocation of service expenses was made on the basis of turnover. No useful purpose would be served in restoring the issue. Accordingly, following the finding of the Tribunal in the case SSL, we set aside the order of CIT(A) on this issue and delete the disallowance sustained by him."
11. The above order of the Tribunal has been followed in assessee's own case for AY 2002-03 in ITA No.3027/M/06, AY 2003-04 in ITA No.3758/M/06, AY 2004-05 & AY 2005-06 in ITA Nos. 3158 & 3161/M/08.
12. The learned CIT (A) made out a case that the issue is one of facts and assessee has not furnished the complete details of services provided. Therefore, he differed from the orders of his predecessors in earlier years and also mentioned arguments which he has raised as DR before the ITAT in earlier years to justify 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 Page 13 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench recovered/ paid from/to each other, we do not see any reason to doubt that assessee has not incurred the expenditure and the other company has not provided any services. Further there is levy of service tax also in each month's bill at 12.5%. If only tax avoidance is main issue in allocation of expenditure to assessee, there is no need for allocating the expenditure to assessee paying service tax at 12.5% directly on the gross amount. Assessee also in schedule 14 of the accounts showed operating and other expenditure at `43,14,39,860/- out of which only `14,98,56,338/- were service charges paid to the holding company. This is about 1/3rd of the expenditure claim. AO has not even inquired or examined or whispered about the 2/3rd of the expenditure. It is to be kept in mind that assessee is a 100% subsidiary of the principle company SSL and there is exchange of personnel depending on the field of operation and the agreement clearly provided for distribution of service charges on the basis of turnover. We do not see any reason to doubt either about the services being provided or about the amounts paid by the assessee company since service charges recovered from the assessee company were shown as income in the other company (by adjusting in the operating expenditure). The Revenue contention that expenditure was passed on to assessee company is also not a valid argument as the recovery amount is also shown as income in the other company and this exercise is going on from 2001 onwards. It is also one of the arguments of the Revenue that even the training expenses being passed on inspite its existence for so many years. Extent of expenditure in the main company and the service charges provided being only 1/3rd of the operative expenditure of the assessee company and the training expenses claimed is still less than the above, we do not see any reason to doubt the allocation of training expenses. The requirement of training is an on-going exercise in the changed scenario of technological up-gradation in the software industry. AO Page 14 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench cannot dictate terms to assessee how to run the business. He can only examine the genuineness of expenditure for the purpose of business. He can only examine whether the expenditure is laid out wholly and exclusively for the purpose of business. This elaborate discussion was made because the learned CIT (A) differed from his predecessors' orders 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. Sonata Software Ltd. (SSL) on behalf of the Assessee, which the Assessee had reimbursed to SSL. The AO called upon the Assessee to establish that SSL had really incurred these expenses on behalf of the Assessee. The Assessee filed debit notes raised by SSL regarding the above expenses. According to 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 Page 15 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 referred to above to the total income of the Assessee.
15. The CIT(A) confirmed the additions made by the AO, differing from his predecessor's orders on same issue on the reason that assessee has not justified the expenditure.
16. We have considered the rival submissions. While deciding Ground 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 Page 16 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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.
20. 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".
21. As far as Gr.No.4 is concerned, the facts are that the Assessee made a payment of Rs.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 use the software and the payment was for such right to use software, which was in the nature of a royalty. Under the provisions of Sec.40(a)(ia) of the Act, any payment to a resident which is claimed as deduction while computing income and on which tax is deductible in accordance with the provisions of the Act and where tax is not so deducted, the Assessee will not be entitled to deduction while computing income. The payments have to be in the nature set out in those provisions. The provisions of Sec.40(a)(ia) as amended by the finance Act, 2008 with retrospective effect from 1st April, 2005 read as under:-
"(ia) any interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been paid,-Page 17 of 37
ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench (A) in a case where the tax was deductible and was so deducted during the last month of the previous year, on or before the due date specified in sub-section (1) of section 139 ; or (B) in any other case, on or before the last day of the previous year.
Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted (A) during the last month of the previous year but paid after the said due date; or (B) during any other month of the previous year but paid after the end of the said previous year, such sum shall be allowed 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 not 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 (Intl.Taxation) Vs. Samsung Electronics Co. Ltd. ITA No.2808 of 2005 dated 24.9.2009 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 under section 40(a)(ia) of the Act. The AO however made disallowance under the provisions of Section 40(a)(ia) of the Act.
Page 18 of 37ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench
22. 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.
23. 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 decision of the Delhi High Court in the case of Director of Income Tax vs. Ericsson A.B. New Delhi dealing with the similar issue held in Para 26 that these decisions are the decisions of the High Court available as of now on the issue. He further referred to the decision of the Hon'ble Delhi High Court in the case of CIT vs. Dynamic Vertical Software India Pvt. Ltd(332 ITR 222 Del.) wherein the Hon'ble Delhi High Court held that assessee had purchased software from Microsoft and sold in Indian market. Assessee acted as a dealer and this could not be termed as a royalty. Therefore, section 40(a)(ia) of the I.T. Act 1961 had no application. He also referred to various other cases including decision of the AAR in support of the contentions that payments for shrink wrap software cannot be considered as royalty.
24. The next submission of the learned Counsel was that under section 40(a)(ia) any payment on account of royalty on which tax is deductible under section 194J of the act alone can be subject matter of disallowance. In this regard it was submitted that section 194J of the Act cast an obligation to deduct tax at source. The Board has given a circular in notification No.21/2012 dated 13/06/2012 notifying that no deduction of tax shall be made on the Page 19 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench following specified payment under section 194J. Even though this notification has come into force w.e.f. 1.7.2012, it is his submission that this notification is retroactive in operation and benefit should be given to assessee.
25. The next submission of the learned counsel for the Assessee was that in the past the Assessee has not been deducting tax at source as it has favourable decisions by ITAT and other High Courts. Based on the decision of the Hon'ble Bombay High Court in the case of CIT Vs. Kotak Securities Ltd. 340 ITR 333 (Bom) wherein the Hon'ble Court took the view that if due to bonafide belief a person does not deduct tax at source while making payment, then there can be no disallowance under section 40(a)(ia) of the Act. In this regard it was also submitted that the recipient had duly paid taxes on the income embedded in such receipts and therefore there is no loss to the revenue. It was further submitted that the provisions of Section 40(a)(ia) of the Act are meant to ensure that taxes are duly paid and the revenue is not put to loss and this purpose is fulfilled in the present case.
26. 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 Page 20 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench respect of payment made for purchase of software (Pro-quip corporation v. CIT 255 ITR 354).
27. 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 vs. 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 the amount outstanding as on 31st March and not the entire amount. The learned Counsel placed on record the details of the outstanding amount as on that date.
28. The learned DR in reply however, relied on the order of the Karnataka High Court more so in assessee's own case given in the contest of section 201. The learned DR placed on record the decision of the Hon'ble Karnataka High Court in assessee's own case with reference to payment to non resident wherein on similar payments made to foreign suppliers the amounts were held as royalty as defined under Sec.9. In addition he also placed on record the decision of the AAR in the case of Citrix Systems Asia Pacific Pty. Ltd In re 205 Taxman 320 to submit that payments made by assessee even as distributor for sale of software products has to be considered in nature of royalty within the meaning of section 9(1)(vi). He also placed on record the decision of the Hon'ble High Court of Karnataka in the case of CIT vs. Sunray Computers (P) Ltd wherein assessee having purchased software and hardware from two different NRIs integrated them for manufacture of telecommunication equipments it is held that the payment made was royalty. He also referred to the latest amendment brought to section 9(1)(vi) by way of Explanation-4 which is as under:
Section 9 - Explanation-4 Explanation 4.--For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of Page 21 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred".
It was his submission that this explanation was inserted by the Finance Act, 2012 w.e.f. 01.06.1976. Therefore, the payments made for computer software is to be considered as royalty.
29. We have considered the issue, rival contentions and examined various cases relied upon before us. First of all it has to be admitted that this issue is considered by the Coordinate Bench in AY 2007- 08 in assessee's own case as under:
30. We have considered the rival submissions. On the question whether the payment in question would constitute Royalty, we find that the ITAT Mumbai in the case of Solid Works Corporation (supra) after considering the decision of the Hon'ble Karnataka 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 products mostly through a distribution channel comprising value 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 Page 22 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 license 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 license key via e-mail so that the customer would directly download the product through the web link. On these facts, the applicant sought the advance ruling of the Authority on the question "Whether on the facts and circumstances of the case and in law the payment received by Dassault Systems K. K. (hereinafter referred to as 'the applicant') from sale of software products to independent third party resellers will be taxable as business profits under article 7 of the India-Japan Double Taxation Avoidance Agreement ('India Japan DTAA' or 'Treaty') and will not constitute 'royalties and fee for technical services' as defined in article 12 of India-Japan DTAA ?" On the facts stated, the Authority ruled on the question whether the payment would amount to royalty as follows:
(i) That the computer programme forming part of the software fell within the description of literary or scientific work. A copyright in or over the computer software produced by the applicant was in the nature of an intangible, incorporeal right belonging to the category of intellectual property rights. All intellectual property rights in the licensed programs exclusively belonged to the applicant or its licensor and they 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 Page 23 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 sale or offer for sale, section 14(b)(ii) of the Copyright Act, 1957, could not be invoked to bring 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 granting of rights to use the programme in a manner that would, without such license, constitute an infringement of copyright. Examples of such arrangements include licenses to reproduce and distribute to the public software incorporating the copyrighted programme, or to modify and publicly display Page 24 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench the programme. In these circumstances, the payments are for the right to use the copyright in the programme (i.e., to exploit the rights that would otherwise be the sole prerogative of the copyright holder).
In other types of transactions, the rights acquired in relation to the copyright are limited to those necessary to enable the user to operate the programme, for example, where the transferee has limited rights to reproduce the programme. This would be the common situation in transactions for the acquisition of a programme copy. The rights transferred in these cases are specific to the nature of computer programmes. They allow the user to copy the programme, for example onto the user's computer hard drive or for archival purposes. In this context, it is important to note that 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 disk containing a copy of the programme or directly receives a copy on the hard disc of her computer via a modem connection. 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) Page 25 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench
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 storing it in the computer for his own use. The copying/ reproduction or storage is only incidental to the facility extended to the customer to make use of the copyrighted product for his internal business purpose. As admitted by the Revenue's representative, that process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it is only integral to the use of copyrighted product. Apart from such incidental facility, the customer has no right to deal with the product just as the owner would be in a position to do. In so far as the licensed material reproduced or stored is confined to the four corners of its business establishment, that too on a non-exclusive basis, the right referred to in sub-clause (i) of section 14(a) would be wholly out of place. Otherwise, in respect of even off-the-shelf software available in the market, it can be very well said that the right of reproduction which is a facet of copyright vested with the owner is passed 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 Page 26 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 to do an act, without authorization of the same, by the owner.
It seems to us that reproduction and adaptation envisaged by section 14(a)(i) and (vi) can contextually mean only 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 license for mere reproduction or adaptation of work for one's own use. Even without such license, 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 exploitation.
13. The ruling of the AAR in the case of Dassault (supra) was approved by the Hon'ble Delhi High Court in the case of DIT Vs. Ericsson AB,New Delhi (supra). It can therefore be said that the Hon'ble Delhi High Court has Page 27 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench held that consideration paid merely for right to use cannot be held to be royalty. This ratio laid down by the Hon'ble Delhi High Court would also apply when shrink wrap software is sold.
14. Following the view expressed by the Hon'ble Dellhi High Court in the case of DIT Vs. Ericsson AB, New Delhi (Supra), which is favourable to the Assessee, we hold that 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 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.
15. For the reasons given above, we confirm 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".
29. Since the Coordinate Bench decision is to be followed on similar facts, we have no option than to follow the same. However, in assessee's very own case the Hon'ble Karnataka High Court in Page 28 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench appeal on orders under section 201 and payments made to non- residents has held that the amounts are royalty in nature. Therefore, since the High Court order is available in assessee's own case, the judicial propriety require us to follow the Hon'ble High Court order. We have asked the learned Counsel to explain whether the facts involved in the above case (payments to non residents) are similar to the payments made to the Indian Companies. He however, expressed inability to furnish the details immediately and has no objection if the matter is examined by AO. Therefore, in the interest of justice without adjudicating whether the amounts paid were royalty or not, we direct AO to examine the issue afresh in the light of facts before the Hon'ble High Court of Karnataka and the facts involved in payments made to Indian Companies and decide the issue fresh after giving due opportunity to assessee.
30. However, there are two more issues which require further examination. One is that the Hon'ble Special Bench of the ITAT considered the issue of section 40(a)(ia) in the case of Merilyn Shipping & Transports vs. ADCIT (16 ITR Trib. (1) Viz)in ITA No.477/Viz/2008 for assessment year 2005-06 dated 29.3.2012 and held that the word "payable" used in the section refers to only the amount outstanding as on 31st March and not the amount paid by the date. The learned Counsel placed on record the details of the outstanding amount as under:
Details of amount paid and payable as on 31/03/2008 for purchase of software in respect of the amounts disallowed under section 40(a)(ia) of the I.T. Act 1961:
S.No Name of the Total amount Paid before Payable as party disallowed 31.03.2008 on (excl. of local (excl. local 31.03.2008 taxes taxes) (excl. local taxes) 1 Oracle India 1,114,471,630 768,167,218 346,304,412 Pvt. Ltd 2 BEA systems 108,922,200 93,631,520 15,290,680 India Private Page 29 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 3 IBM India 436,492,087 428,949,124 7,542,963 Private Limited 4 Ingram Micro 176,188,548 149,500,880 26,687,668 India Pvt Ltd 5 Redington 60,107,319 60,103,840 3,479 India Ltd 6 Hewelett 38,406,545 22,986,317 15,420,228 Packard India 7 Others 63,323,265 47,018,483 16,304,782 Total 1,997,911,595 1,570,357,383 427,554,212 As can be seen from the above the total amount paid 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.
31. 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 vs. 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.
32. In the course of argument the learned DR referred to the provisions of 9(1)(vi) Exp.4 which was introduced w.e.f. 01.06.1976 by the Finance Act 2012. Even though the explanation was given by way of clarification in which the scope of royalty under section Page 30 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 9(1)(vi) was explained, we are of the opinion that this amendment will not apply to the disallowance under section 40(a)(ia). The provisions of section 40(a)(ia)- explanation with reference to royalty is as under:
Section 40(a)(ia):
.....
.....
Explanation : for the purposes of this sub-clause:-
i) 'Commission or brokerage' shall have the same meaning as in clause (i) of the Explanation to section 194H
ii) 'fees for technical services' shall have the same meaning as in clause(a) of the Explanation to section 194J;
iii) 'professional services' shall have the same meaning as in clause (a) of the Explanation to section 194J;
iv) 'work' shall have the same meaning as in
Explanation III to section 194C;
v) 'rent' shall have the same meaning as in clause (i)
to the Explanation to section 194-I;
vi) 'royalty' shall have the same meaning as in
Explanation 2 to clause (vi) of sub-section (1) of section 9;"
As can be seen from the above for the purpose of section 40(a)(ia), royalty shall have the same meaning as in Explanation-2 of clause vi of sub- section 1 of section 9. Explanation-4 which was introduced w.e.f. 1.6.1976 by the Finance Act, 2012 has no effect as that explanation was not referred to in section 40(a)(ia). Since the definition of royalty was specifically mentioned in section 40(a)(ia), the examination of the issue can only be made with reference to Explanation 2 alone. This is by the concept of legislation by incorporation. Argument of the learned DR that Explanation-4 increases the scope of royalty in section 9(1)(vi) may have validity for examining the issue of royalty under section 9(1)(vi) in its entirety, but not for the purpose of disallowance under Page 31 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench section 40(a)(ia) wherein the scope of royalty was limited to Explanation -2 to clause vi of section 9(1). The explanation-4 can not be considered as the same was not incorporated in definition of Royalty in sec 40(a)(ia). Argument of the DR to consider the Explanation-4 also has no validity and accordingly the same was to be rejected.
33. AO is directed to consider whether the amounts paid to Indian suppliers can be considered as royalty keeping in mind 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.
34. 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.
34.1 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 acceptable. He found that the aggregate investment as on 31/03/2008 was `.18,02,46,449/- while the total assets were `.1,53,40,53,692/-. Thus investments in mutual fund were about 11.75% of total assets. Assessee has debited interest of `.58,99,405/-. Assessee Page 32 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench has not been able to produce any evidence that surplus funds were used to decrease such liability of interest instead of keeping the same in mutual funds. Further, once it is held that disallowance has to be made under section 14A, even if assessee has not received the dividend income in F.Y 2007-08 does not mean that all mutual fund investments, income from which falls in category of exempt income, cannot be taken for computing the disallowance. This view has been upheld by Hon'ble ITAT in Cheminvest Ltd (2009) 121 ITD 318 (Del.) 9SB). AO therefore, worked out the disallowance by the method prescribed in Rule 8D. The total disallowance under section 14A was worked out at `.13,09,588/-. Since assessee had itself disallowed `.2,43,360/- under section 14A in the computation of income, the balance amount of `.10,66,228/- was added back to the total income of assessee both under the normal provisions of the Act as well as under section 115JB.
34.4 In the appellate proceedings, assessee had made the following submissions:
"At the outset we wish to submit that as per the policy consistently followed by the appellant, it had already added back in computation of income an amount equivalent to 5% of the dividend income. Accordingly an amount of `.2,43,360/- was added back to the computation of income. Thus, no further disallowance is warranted under section 14A of the Act. Further, the appellant has made investments out of own funds and has not used any borrowed funds for the purpose of investing in Mutual funds"
In this regard the appellant has relied on the decision of the Hon'ble Punjab & Haryana High Court in the case of CIT vs. Hero Cycles Ltd (323 ITR 518). The relevant Para of the case is reproduced as under:
"The contention of the Revenue that directly or indirectly some expenditure is always incurred which must be disallowed under section 14A and the impact of expenditure so incurred cannot be allowed to be set off against the business income which may nullify the mandate of section 14A cannot be accepted. Disallowance under section 14A requires finding of Page 33 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 vs. 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 form part of the total income.
Assessee has not incurred any expenditure directly related to income which does not form part of the total income. Therefore, no disallowance ought to be made on this account.
2) In a case where assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:-
A x B C A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year;
B = Average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of assessee on the first day and the last day of the previous year.Page 34 of 37
ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench C = the average of total assets as appearing in the balance sheet of assessee on the first day and the last day of the previous year;
Not applicable. As assessee has not incurred any expenditure by way of interest directly related to the earning of dividend income.
An amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of assessee, on the first day and the last day of the previous year:
The working for the same is as follows:
S.No Particulars Opening Closing Average (`.)
balance Balance
1 Standard 100,130,743 80,108,891 90,119,817
Chartered Mutual
Fund
2 Birla Sun Life - 100,137,558 50,068,779
Liquid Fund
Total Average value of investments (`.) 140,188,596
½% of total average value of investments = 700,943/-
Total Disallowance As per Rule 8D(1+2+3)= `.700,943 In this regard without prejudice to the disallowance of `.243,360/- already done by assessee, we wish to submit that the disallowance under section 14A of the Act cannot exceed the amount of `.700,943/- as computed above. Thus, addition, if any, only of the differential amount of `.4,57,583/- (i.e. `.700,943-243,360) can be made to the total income of assessee.
35. The CIT (A) held in Para 7.3 as under:
"7.3 I have considered the facts of the case and the submissions made by assessee. In the assessment proceedings, assessee had contended that the investments were made out of own funds and hence no disallowance could be made under section 14A. AO has however, not found the contentions of assessee acceptable. Once AO has made the disallowance on Page 35 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 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 exempt income had been earned during the year. The contention of assessee to the effect that the disallowance cannot exceed the amount of exempt income cannot be accepted This is for the reason that it is the amount computed as per the mandatory method prescribed in Rule 8D which is required to be taken for disallowance. If this amount exceeds the exempt income earned during the year, the same cannot be restricted to the amount of the exempt income.
In view of the aforesaid reasons, the action of AO of disallowing `.10,66,228/- under section 14A of the I.T. Act 1961 is upheld. The action of AO of disallowing `.10,66,228/- while computing book profit under section 115JB of the I.T. Act, 1961 is also upheld. Ground Nos. 5 & 6 filed by assessee are dismissed".
36. We have heard the learned DR and the Authorized Representative on the issue. After considering the rival submissions, we do not see any reason to interfere with the orders of the authorities since AO and the CIT (A) has considered the issue on facts and disallowed proportionate expenditure which in our view is according to the facts and law on the issue. We uphold the disallowance so made under section 14A. Consequent to the above disallowance, the same is also to be disallowed under section Page 36 of 37 ITA No.1507 of 2012 Sonata Information Technology Ltd Mumbai E Bench 115JB working as well. Accordingly we reject assessee's ground on the above issue.
37. In the result appeal filed by assessee is considered partly allowed.
Order pronounced in the open court on 7th September, 2012.
Sd/- Sd/-
(D.K. Agarwal) (B. Ramakotaiah)
Judicial Member Accountant Member
Mumbai, dated 7th September, 2012.
Vnodan/sps
Copy to:
1. The Appellant
2. The Respondent
3. The concerned CIT(A)
4. The concerned CIT
5. The DR, "E " Bench, ITAT, Mumbai
By Order
Assistant Registrar
Income Tax Appellate Tribunal,
Mumbai Benches, MUMBAI
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