Income Tax Appellate Tribunal - Mumbai
3I Infotech Ltd, Navi Mumbai vs Assessee on 14 August, 2013
आयकर अपील य अ धकरण, धकरण मंुबई IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCHES 'K' MUMBAI सव ी आय.पी. बंसल, या यक सद य /एवं एवं नरे कमार ु ब लै या, लेखा सद य के सम ।
BEFORE SHRI I.P. BANSAL, JUDICIAL MEMBER /AND
SHRI N.K.BILLAIYA, ACCOUNTANT MEMBER
आयकर अपील सं. / ITA No. 3354 & 3355/Mum/2010
नधारण वष /Assessment Years 2003-04& 2004-05
आयकर अपील सं. / ITA No. 9131 & 9011/Mum/2010
नधारण वष /Assessment Years 2005-06 & 2006-07
3i Infotech Limited, Vs. The Additional
Tower No.5, 3 r d Floor to 6 t h Commissioner of Income
floor, International Tax 10(3)/ ITO, Range -
Infotech Park, Vashi, 10(3)(1),
Navi Mumbai 400 703. Mumbai.
PAN :AAACI 5205Q
Appellant Respondent
आयकर अपील सं. / ITA No. 2616/Mum/2010 & 128/Mum/2011 नधारण नधारण वष /Assessment Years 2003-04 & 2005-06 The Asstt. Commissioner of 3i Infotech Limited, Income Tax 10(3)/ ITO, Vs. Tower No.5, 3 r d Floor to Range - 10(3)(1), 6 t h floor, International Mumbai. Infotech Park, Vashi, Navi Mumbai 400 703.
PAN.AAACI 5205Q
Appellant Respondent
Assessee by: Shri P.J.Pardiwala
Revenue by : Shri Ajit Kuamr Jain
सनवाई
ु क तार ख / Date of Hearing : 14/08/2013
घोषणा क तार ख /Date of Pronouncement : 21/08/2013
2 ITA NOS.3354/MUM/2010 & Others
3i Infotech Limited.
आदे श / O R D E R
PER BENCH:
Appeals for assessment year 2003-04 are cross appeals and are directed against the order passed by Ld. CIT(A)-15, Mumbai dated 11/1/2010. Appeal for assessment year 2004-05 is assessee's appeal, which is directed against order passed by Ld. CIT(A)-15, Mumbai dated 11/1/2010. Appeals for A.Y 2005-06 are cross appeals and they are directed against order passed by Ld. CIT(A)-15, Mumbai dated 26/10/2010. Appeal for assessment year 2006-07 is appeal filed by the assessee which is directed against assessment order dated 25/10/2010 passed under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (the Act). The grounds of appeal in all these appeals read as under:
Grounds of ITA No.3354/Mum/2010,A.Y.2003-04-Assessee's Appeal:
"The appellant objects to the order of the Commissioner of Income-tax (Appeals) - 15, Mumbai ('CIT(A)') dated 11 January 2010 for the aforesaid assessment year on the following among other grounds:
Software development expenses
1. The learned CIT(A) erred in confirming the disallowance of expenses of Rs. 16,74,93,240 incurred on development/up-gradation of various software products.
2.The learned CIT(A) erred in rejecting the alternative claim of appellant that the software development expenses incurred by the appellant was in the nature of research and development expenditure and therefore allowable as a revenue expenditure.
3.The learned CIT(A) erred observing that "it is not clear from material on record as to whether all the conditions given in section 35(1) (iv) is satisfied in this case or not"
Transfer of employees to foreign subsidiaries
4. The learned CIT (A) erred in confirming the action of the assessing officer in adding an amount of Rs.13,34,0 18 to the total income of the appellant, as consideration for transferring certain employees to associate enterprises (ICICI Infotech Inc., ICICI Infotech Pte Ltd and Semantic Solutions GmbH), without appreciating the fact of the case that the appellant is not engaged in the business of that of a placement agency. These employees were mainly marketing personnel and their transfer is a prudent business decision considering the 3 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
overall benefit of the business and no significant cost was incurred for training them.
5. The learned CIT (A) erred in not allowing relief to the appellant with regard to transfer of a managing director to USA without appreciating the fact that the managing director continued to be the employee of the appellant company and has been sent to the USA for development of appellant's own business."
Grounds of ITA No.2616/Mum/2010,A.Y.2003-04-Revenue's Appeal:
1. That on the facts and in the circumstances of the case, and in law, the Ld. CIT(A) was not correct in holding that both on fact and in law the compensation received by the assessee company of Rs.15.00 Crores is a capital receipt and directed to delete such addition.
2. at on the facts and in the circumstances of the case, and in law, the Ld. CIT(A) could not appreciate the fact that the agreement dated 10.10.2002 between the assessee company and ICICI bank entails compensation to be paid to the assessee for the loss of business/futures earnings and such compensation received by the assessee company of Rs.15.00 Crores is a revenue receipt as held by the A.O. and in that view of the matter erred in directing the A.O. to delete the same.
Grounds of ITA No.3355/Mum/2010,A.Y.2004-05-Assessee's Appeal:
"The appellant objects to the order of the Commissioner of Income-tax (Appeals) - 15, Mumbai ('CIT(A)') dated 11 January 2010 for the aforesaid assessment year on the following among other grounds:
Software development expenses
1. The learned CIT(A) erred in confirming the disallowance of expenses of Rs.
12,76,66,915 incurred on developmental up-gradation of various software products.
2. The learned CIT(A) erred in rejecting the alternative claim of appellant that the software development expenses incurred by the appellant was in the nature of research and development expenditure and therefore allowable as a revenue expenditure.
Transfer of employees to foreign subsidiaries
3. The learned CIT (A) erred in confirming the action of the assessing officer in adding an amount of Rs. 11,60,692 to the total income of the appellant, as consideration for transferring certain employees to its associated enterprises (ICICI Infotech Inc., 3i Infotech (UK) Ltd., ICICI Infotech Pte Ltd., Semantic Solutions GmbH) without appreciating the fact that these employees were neither highly qualified nor significant cost was incurred for training them."
4 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
Grounds of ITA No.9131/Mum/2010,A.Y.2005-06- Assessee's Appeal:
"The appellant objects to the order of the Commissioner of Income-tax (Appeals) - 15, Mumbai ('CIT(A)') dated 26 October 2010 for the aforesaid assessment year on the following among other grounds:
Software development expenses
1. The learned CIT(A) erred in confirming the disallowance of expenses of Rs.15,61,07,344 incurred on development/up-gradation of various software products.
2. The learned CIT(A) erred in rejecting the alternative claim of appellant that the software development expenses incurred by the appellant was in the nature of research and development expenditure and therefore allowable as a revenue expenditure."
Grounds of ITA No.128/Mum/2011,A.Y.2005-06- Revenue's Appeal:
"1.On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in holding that if the assessee had charged ICICI Infotech, USA (Associated Enterprise) , the cost of deputation of employees, the cost of ICICI Infotech, USA will automatically go up and on such increased cost, the appellant will have to remunerate them the fixed percentage and in that event, there will be erosion of the tax base in India.
(i) The appellant craves leave to add, amend, vary omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of appeal."
Grounds of ITA No.9011/Mum/2010,A.Y.2006-07- Assessee's Appeal:
"The appellant objects to the order under section 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961, dated 25th October 2010 (received on 1st November 2010 ) passed by the Assistant Commissioner of Income-tax, Range -- 10(3), Mumbai ('ACIT') for the aforesaid assessment year on the following among other grounds:
1. The learned ACIT erred in assessing the total income of the appellant at Rs.
12,46,11,66/-.
2. The order of the learned ACIT is bad in law, contrary to the provisions of law and facts of the case and without following the directions of the Dispute Resolution Panel ('DRP') in the right perspective.
3. Disallowance of Software Expenses 3.1 The learned ACIT erred in disallowing a sum of Rs.22,24,13,341 incurred on software development.
5 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
3.2 The learned ACIT erred in not appreciating the fact that the said expenditure was incurred by the appellant mainly on account of salary, electricity, printing and stationary, rent, etc. which was primarily revenue expenditure incurred on a particular software product and hence allowable as a deduction.
3.3 The learned ACIT erred in observing that the expenses for research and development of computer software are nothing but capital in nature as the appellant has been deriving the enduring benefit.
3.4 The learned ACIT erred in not allowing the depreciation on software expenses capitalized in the books of account under the head "Software Products". The learned ACIT erred in not appreciating the fact that if the software expenses are treated as capital in nature, the depreciation ought to be allowed on the expenses which are capitalized in the year of commercialization.
3.5 The learned ACIT erred in observing that the appellant has not furnished the appropriate details called for nor has it submitted details and evidences of putting the said capital-work-in-progress of software to use.
3.6 He erred in not appreciating the fact that the without prejudice claim of the appellant for allowing depreciation is not made on the amount which is lying in capital-work-in- progress but is made on the amount which is capitalized in the books of account in the year of commercialization.
3.7 The learned ACIT erred in not allowing the depreciation on opening WDV of software expenses disallowed and treated as capital expenditure in earlier assessment years.
3.8 He erred in observing that the depreciation on software expenses is claimed in respect of certain opening balances without appreciating the fact in its proper perspective.
3.9 Without prejudice to the above, the learned ACIT erred in not correctly computing the deduction under section 10A. He erred in not appreciating the A fact that due to disallowance of software expenses, the deduction under section 1OA would be revised to Rs. 22,98,46,640 as against Rs.7,84,12,263 computed in the return of income.
3.10 Alternatively and without prejudice to the above, the learned ACIT erred in not appreciating that the above expenditure incurred by the appellant was in the nature of research and development expenditure and therefore allowable as deduction under section 35(1)(iv) in view of the fact that in order to be in tune with the fast changing technology, the appellant was constantly in the process of developing and upgrading its software products.
4. Disallowance of expenses under section 14A 4.1 The learned ACIT erred in disallowing a sum of Rs. 544,750 under section 14A as expenses incurred in respect of tax free income.
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4.2 The learned ACIT erred in not appreciating that Rule 8D has been inserted with effect from 24 March 2008 and hence it should only apply prospectively i.e. from assessment year 2008-09 and not retrospectively and therefore it would not be applicable to assessment year under consideration.
4.3 The learned ACIT erred in not appreciating the fact that the assessee has not obtained any loan for making investments and therefore no interest can be attributable to tax free income.
4.4 The learned ACIT erred in not appreciating the fact that the investment made in SDG Software Technologies Pvt. Ltd. was for the purpose of amalgamation effective from 1 April 2006. Therefore, investment in SDG Software Technologies Pvt. Ltd. shall not generate any exempt income and hence it should not be considered for working out average investment for computing disallowance under section 14A r. w. rule 8D.
5. Adjustment in respect o4nternational transaction of transfer of employees 5.1 The learned ACIT / Transfer Pricing Officer ("TPO") erred in making the adjustment of Rs. 24,26,618 to the total income of the appellant, as consideration for transferring certain employees to its associated enterprises without appreciating the fact that these employees were neither highly qualified nor significant cost was incurred for training them.
6. Short credit of TDS The learned ACIT erred in granting credit for TDS of Rs.4,22,4788 as against Rs. 6,64,07,564 claimed by the appellant in the return of income.
7. Levy of interest under section 234D The learned ACIT erred in incorrectly levying interest under section 234D
8. Initiation of penalty under section 271(1)(c) The learned ACIT erred in initiating penalty under section 271(1)(c)"
2. All these appeals were argued together by the parties as some of the issues are common. On common issue reference to facts was made mainly in respect of assessment year 2003-04. It was the common contention of the parties that facts and circumstances of other years in respect of common issues are similar. Therefore, while deciding common issues reference will be made to the facts for the assessment year 2003-04 and the decision taken therein will be applicable to those issues on other years also.
7 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
3. The first common issue found in these appeals is regarding allowability or otherwise of software expenses. Alternatively, it is claimed that such expenditure are allowable being in the nature of research and development expenditure should be allowed as revenue expenditure under the provisions of section 35(1)(iv) of the Act.
4. At the outset it may be pointed out that similar issue was examined by the Tribunal at length in assessee's own case in respect of assessment year 2002-03. Copy of this order is placed at pages 1 to 35 of the paper book. In the said case it was the claim of the assessee that amount of Rs.12,59,33,429/- incurred on development and up-gradation of various software products should be allowed as revenue. Alternatively, it was claimed that these expenditure being in the nature of research and development should be allowed under section 35(1)(iv) of the Act . As the facts and circumstances are same and it is the case of both the parties that there is no change in the facts and circumstances of the present case, therefore, this issue is covered by ITAT order for A.Y 2002-03. For the sake of completion of facts, the relevant portion of the aforementioned order of Tribunal dated 30/07/2010 in ITA No.2831/Mum/2007 for assessment year 2002-03 are reproduced below: "10. We have heard the rival submissions. The learned counsel for the Assessee reiterated the submissions as were made before the AO. It was submitted by him that one has to see the nature of business of the Assessee. In the hands of the Assessee who is a software developer the expenditure cannot be said to be capital expenditure. He referred to be decision of the Special Bench of ITAT Delhi in the case of Amway India Ltd. 111 ITD 112 (SB)(Del), wherein at page-168 the Special Bench has explained that the expenditure on software, whether capital or revenue will depend on the nature of business of an Assessee. He referred to the details of the expenses which were claimed by the Assessee as deduction and submitted that those expenses were salary, rent etc., for development of software and by their nature they were revenue expenditure. He drew our attention to para 1.3 (b) of the Significant Accounting Policies and Notes to Accounts. The same relates to method of depreciation/amortization. In so far as business and commercial rights and software products are concerned the accounting policy adopted by the Assessee was as follows:
"Business and Commercial Rights and Software Products are amortized over a period of five years, as considered appropriate by the management"
8 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
His submission was that treatment of a particular item of expenditure in the books of accounts is not conclusive as to whether an item of expenditure is in the nature of capital or revenue.
11. The learned D.R. submitted that the Assessee did not give enough material to show as to whether the software in question is for own use or for sale. If it is for own use then the allowability of the expenses in question has to be adjudicated afresh by the AO in the light of the principles laid down by the special bench decision in the case of Amway India Ltd. (supra). His further submission was that if the software is for sale even then the claim of the Assessee is contrary to its own treatment in the books of accounts and the accounting policy adopted by the Assessee. It was also submitted by him that the alternative claim made by the Assessee that the expenditure on computer software was in the nature of research and development expenditure is contrary to its claim that the expenditure was revenue expenditure.
13. We have considered the rival submissions. In the business of development of computer software, there is some uncertainty till such time technological feasibility is established for a product. Technological feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. Assessees' who are in the business of development of computer software, therefore adopt different method of accounting for software development expenses during the period of its development till technological feasibility and sale of the software. The method of accounting adopted by the Assessee in respect of computer software development expenses is to accumulate expenses as work-in-progress. This is done till such time the Assessee thinks that the technological feasibility is achieved and the product is ready for sale. Thereafter the entire expenditure incurred on development of computer software is amortized over a period of five years or as considered appropriate by the management. Capitalization occurs once technological feasibility has been reached and costs are determined to be recoverable. Capitalization ends and amortization begins when the product is available for general release to customers.
14. Instead of claiming expenditure on computer software by amortization of expenditure incurred upto the stage of development over a period of time, depreciation can also be allowed on the capitalised cost of the computer software. In such cases an Assessee instead of ammortization gets the benefit of depreciation, which is one way allows deduction of expenses/costs, just as one would get deduction by ammortization of cost. We have already seen that in respect of some expenditure incurred on development/up-gradation of software in the earlier assessment year a sum of Rs.3,92,90,000/- had been treated as capital work-in-progress in the earlier assessment year. This year the said expenditure was capitalized on reaching commercialization. The AO allowed depreciation at 60% on such capitalized value of expenditure and the Assessee has accepted the same. However in respect of the expenditure treated as work- in-progress in the present assessment year, the Assessee wants a different treatment. It is true that entries in the books of accounts are not conclusive when 9 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
it comes to computing income under the Income Tax Act, 1961 but it cannot be said that they are totally irrelevant. The method of accounting adopted by the Assessee goes well with the matching concept of accounting which mandates that incomes shall, as far as possible, be matched with the corresponding expenses to earn them. In the present case, the dispute is as to whether the Assessee will get the benefit of deduction of the entire expenditure in one year or a deduction of proportionate expenditure spread over several years. As we have already observed the method of accounting followed by the Assessee and the method of computation of total income in the case of the Assessee as accepted by the Assessee is to treat expenditure on development of computer software as part of work-in-progress during the period of development of software and on attaining technical feasibility and on the software being ready for sale, the expenditure is capitalized and depreciation is claimed and allowed on such capitilzed cost. This way of allowing expenditure is also an accepted method both for accounting purposes as well as for computing income under the Act. On the facts of this case, we see no reason to take a different view. We therefore uphold the order of the CIT(A) treating the expenditure in question as capital expenditure. We have not considered the applicability of the decision of the special bench in the case of Amway India Ltd. (Supra) in view of our decision as above. We however make it clear that the AO will allow depreciation in the year of capitalization as was done in respect of the expenditure of Rs.3,92,90,000/- which was the expenditure on development of computer software incurred in the earlier year and which was capitalized in the previous year. This decision will off course be subject to the decision on the alternate ground of the Assessee before us that the entire expenditure is to be allowed as deduction as Research and Development expenditure u/s. 35(1)(iv) of the Act.
15. The learned counsel for the Assessee pointed out that as per the provisions of section 35(1)(iv) of the Act, deduction in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee is allowed in the year in which such expenditure is incurred. The whole of the capital expenditure incurred in a previous year is allowable as a deduction against income, if any, for that previous year. The definition of the term 'scientific research' as per section 43(4) of the Act is as under :-
(i) "scientific research" means any activities for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries;
(iii) references to scientific research related to a business or class of business include--
(a) any scientific research which may lead to or facilitate an extension of that business or, as the case may be, all businesses of that class;
As per section 35(2), where such capital expenditure [referred to in section 35(1)(iv)] is incurred after March 31, 1967, the whole of such capital expenditure incurred in any previous year is deductible for that previous year, with exception being expenditure incurred on acquisition of land. It is the plea of the Assessee that even if the expenditure is considered as of capital nature the same would be eligible for deduction under section 35, provided such expenditure is incurred on scientific research. The submission of the Assessee is based on the decision of 10 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
the Income Tax Appellate Tribunal (Delhi), in the case of DCIT Vs. TCIL Bellsouth Ltd., 89 TTJ 851, wherein it has been recognized that the expenses incurred on software product development would qualify as being in the nature of scientific research and thus, be admissible deduction under the provisions of section 35. It is the plea of the Assessee the expenditure is nothing but in the nature of research and development expenditure and therefore allowable as a revenue expenditure.
16. This argument in our view deserves to be rejected. In the submissions made by the Assessee before CIT(A), the Assessee had explained the nature of software developed by it in respect of which the expenditure of Rs.12,55,81,222 was incurred and claimed as deduction as revenue expenditure. The Assessee had clearly mentioned therein (copy at pages 69 to 80 of paper book) that the expenditure in question was incurred for development of software product for a client. The Assessee gave description of the software products as Hercules, E- Kastle PhaseII, M-Kastle, Tangible, Pinnacle, Risk Free, Triton, Knowledge management portal, quality portal and IISS. The Assessee now wants to say that it did research and development and wants to claim the expenditure as deduction. In our view there is no factual basis for the Assessee's claim for deduction u/s.35(1)(iv) of the Act and on this ground the plea of the Assessee deserves to be rejected. The decision in the case of DCIT Vs. TCIL Bellsouth Ltd. (Supra) is therefore not applicable to the facts of the Assessee's case as in that case the software expenses were incurred for use in telecommunication industry in general and not to any specific order by any client. This would be clear from para-9 of the said order wherein the Assessee has explained the nature of its business as not one of sale of the software package developed through scientific research. The Assessee gives copies of software so developed after customizing them as per requirements of the customers and only license to use such customized software is given to the customers. Moreover the business of the Assessee is development of software for its clients. Under sec.35(1)(iv) deduction is allowed in respect of any expenditure of a capital nature on scientific research related to the business carried on by the Assessee. The business carried on by the Assessee cannot itself be considered as research and development. It is not the purpose of Sec.35(1)(iv) to allow such deduction. In the present case the business of the Assessee was development of software for its clients. Any expenditure incurred in doing so cannot by itself fall within the parameters of Sec. 35(1)(iv) of the Act. The allowability of such expenses will be governed by the provisions of Sec.37(1) of the Act because there is no other provision under Chapter-IV section 28 to 44 of the Act under which the allowability of the aforesaid expenditure can be considered.
17. For the reasons given above, we dismiss ground No.1to 3 raised by the Assessee. "
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5. It may be further mentioned that against the aforementioned order of the Tribunal an appeal was filed by the assessee before the Hon'ble Bombay High Court which has been admitted vide order dated 18/1/2012 in Income Tax Appeal No.1013 of 2011 and following substantial questions of law have been admitted with the following observations:
" 1. Heard. Admit on the following substantial questions of law.
"(i) Whether on the facts and in the circumstances of the case and in law, the Tribunal erred in holding that expenditure of Rs.12,59,33,429/-
incurred by the appellant on development / upgradation of software is capital in nature?
(ii) Whether on the facts and in the circumstances of the case and in law the Tribunal erred in denying the appellant's alternative claim for deduction of Rs.12,59,33,429/-as scientific research expenditure under Section 35 of the Act ?"
6. During the course of hearing though it was not disputed by Ld. AR that facts and circumstances are the same but it was his contention that the aforementioned decision of Tribunal should not be followed in view of the two subsequent decisions of Hon'ble Bombay High Court, in which it has been held that software expenses are allowable as revenue expenditure. For this purpose Sr.A.R of the assesee has relied upon the following decisions:
(1) CIT vs. Raychem RPG Ltd., 346 ITR 138(Bom) - In this case the Tribunal was held to be right in deleting the addition in respect of disallowance of software expenditure of Rs.23,62,368/-, which was treated by the revenue as capital expenditure. It was found by Hon'ble Bombay High Court that in respect of assessment year 2001-02 revenue's appeal on this issue was dismissed for want of removal of office objections and therefore, order of Tribunal granting similar relief to assessee in respect of assessment year 2001-02 has attained finality and thereafter relying upon the finding recorded by the Tribunal the claim has been allowed as Tribunal had found that the impugned software did not form part of profit making apparatus of the assessee and hence the same is 12 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
to be allowed as revenue expenditure. It was found that business of the assessee was that of manufacturing of telecommunication and power cable accessories and trading in oil retracing System and other products and software was an Enterprise Resources Planning (ERP) package which facilitate the assessee's trading operations or enabling management to conduct its business more efficiently or more profitably. It is in this manner Tribunal had allowed the claim regarding acquisition of software expenses, which has been upheld by their Lordships.
(2) CIT vs. Kotak Securities Ltd (2012) 340 ITR 333(Bom) : In this case the relevant question which was raised by the revenue was that whether Tribunal was right in setting aside the order of Ld. CIT(A) on the issue of claim of assessee for software expenses and the matter was remitted back to the file of AO to decide the issue afresh in the light of decision of Special Bench in the case of DCIT vs. Amway India Enterprises, 111 ITD 112 (Del) (SB), after giving reasonable opportunity to the assessee. The said decision of Tribunal was not accepted by the revenue. On appeal it was observed by their Lordships that no question of law arose out of the appeal decided by the Tribunal. Their Lordships have also observed that Special Bench decision was considered by the High Court in the case of CIT vs. Amway India Enterprises and it was held that entire expenditure was liable to be allowed as revenue expenditure.
7. We have carefully considered such submission of Ld. AR in the light of aforementioned two decisions of Hon'ble High Court. However, we are of the opinion that none of the aforementioned two decisions are applicable to the facts of the case of the assessee as the expenditure incurred by the assessee on development of software relates to assessee's own business activity of development of computer software and all processes thereon, assembling and recording of programmes on any tapes, disc, perforated media etc. Assessee's range of offerings includes software products and solutions for the Banking, 13 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
Financial Services and Insurance (BFSI) industries. The assessee company has also range of enterprise software solutions and it develops and keep ready best version of software products and customizes it based on customers specific requirements. Though such expenditure is incurred mainly on account of salary, communication, electricity, printing and stationary, rent etc. but till the product is in the state of development, the amounts spent on development of software product is debited to capital work in progress in the books of accounts maintained by the company. Only in the year of commercialization, such expenditure is capitalized in the books of accounts under the head "software products". It is in these circumstances it was held by the Tribunal that Ld. CIT(A) was right in treating the expenditure as capital expenditure. The cases relied upon by Ld. AR relate to outright purchases of software to facilitate the business of the respective assessees. Therefore, keeping in view the facts and circumstances of the case it was held by the Tribunal in the case of present assessee vide aforementioned order that assessee will be entitled to depreciation in the year of capitalization. Therefore, according to the aforementioned order of the Tribunal the expenditure incurred by the assessee during the years under consideration which has been treated as work-in-progress is held to be capital expenditure and depreciation is held to be allowable to the assessee only in the year of capitalization of such expenditure. We hold so.
8. Ld. AR has further relied upon the decision of Pune Bench of Tribunal in the case of Opus Software Sales Pvt. Ltd., vs. ACIT (2012) 26 Taxamann.com 47 (Pune), order dated 27/7/2012, copy placed on record and was also given to Ld. DR. According to Ld. AR Tribunal in the said case, under similar circumstances has allowed these expenditure of the assessee.
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9. We have carefully considered such submission of Ld. AR. We found that in assessee's own case Tribunal has already taken a view against which substantial question of law has already been admitted by Hon'ble Jurisdictional High Court. Therefore, as per the principle of consistency, we are bound by earlier decision. Respectfully following the same we hold that the expenditure incurred by the assessee during the year under consideration treated as capital work-in-progress are capital expenditure. However, the assessee will be eligible for depreciation on these expenditure in the year when these have been capitalized.
10. On the alternative claim of the assessee regarding allowability of these expenditure as per section 35(1)(iv), respectfully following the aforementioned decision of Tribunal in assessee's own case we reject such claim. 10.1 The above adjudication will cover Ground No.1,2 & 3 of assessee's appeal for A.Y 2003-04, ground No.1&2 of assessee's appeal for A.Y 2004-05 and ground Nos.1 & 2 of assessee's appeal for A.Y 2005-06 and these grounds are treated to be partly allowed.
11. So far as it relates to assessee's similar claim in respect of A.Y 2006-07, it may be mentioned here that certain additional aspects on this issue have been raised which are as under:
(1) Depreciation has not been allowed by the AO on capitalized software expenses. (2) The assessee is entitled for additional deduction under section 10A on the disallowed portion of software expenses.
12. So far as it relates to allowability of depreciation on capital work in progress which has been capitalized in the books of account in the year of commercialization, the aforementioned order of the Tribunal is clear that the depreciation is allowable to the assessee. Therefore, we direct the AO to grant such depreciation to the assessee.
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13. So far as it relates to claim of exemption under section 10A of the Act, it is the case of the assessee that disallowance of software expenses will enhance the income of the assessee which is eligible for additional exemption under section 10A. According to assessee such claim is supported by the decision of Hon'ble Bombay High Court in the case of CIT vs.Gem Plus Jewellery India Ltd., 330 ITR 175 (Bom).
14. We have heard both the parties on this issue. Hon'ble Jurisdictional High Court in the aforementioned decision of CIT vs. Gemplus Jewellery India Ltd. (supra) has held that assessee is entitled to exemption under section 10A with reference with reference to addition of disallowance of PF/ESIC payments as the plain consequence of the disallowance and add back made by the AO has increased the business profits of the assessee. Therefore, respectfully following the said decision of Hon'ble Bombay High Court we hold that the exemption under section 10A is to be calculated accordingly. The AO is directed to do so.
15. In this manner Ground No.3 touching to all the aspects of disallowance of software expenses is disposed off is considered to be partly allowed.
16. Ground No. 4 & 5 of assessee's appeal for A.Y 2003-04, Ground No.3 of assessee's appeal for A.Y 2004-05, Ground No.5 of assessee's appeal for assessment year 2006-07 and Ground No. 1 of revenue's appeal for A.Y 2005- 06 raise a common issue i.e. with regard to TP adjustment in respect of transfer of certain employees by the assessee to its AEs. This issue was stated to be covered by the aforementioned decision of the Tribunal rendered in respect of A.Y 2002-03. Admittedly, the facts and circumstances of all the years are similar to the facts and circumstances for A.Y 2002-03. Therefore, it 16 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
will be relevant to reproduce the entire relevant portion of the aforementioned order of the Tribunal for the sake of completeness and clarity:
"25. Ground No. 7 raised by the Assessee reads as follows:
Learned CIT(A) erred in confirming the action of the Assessing Officer in adding an amount of Rs. 2,71,773/- to the total income of the appellant, as consideration for transferring certain employees to its subsidiary (ICICI Infotech Inc.) not appreciating that these employees were neither highly qualified nor significant investments were made for training them.
26. We have already seen that the assessee is an information technology company. It was originally promoted by ICICI Group. 29.5% of the equity is held by ICICI Bank, 63% by ICICI Ventures, a subsidiary of ICICI Bank and the balance is held by the Dubai based group. The Assessee is a software developing company. The four key business lines are software Development & consultancy services, software product, IT Infrastructure, Networking & Facilities Management services ltd. and business process outsourcing. The Assessee entered into some international transactions with associated enterprises. The following are the details of associate enterprises.
(i) ICICI Infotech Inc. (hereinafter Infotech, USA), incorporated in Delaware, USA is a wholly owned subsidiary of the Assessee.
(ii) ICICI Infotech Pte. Ltd., Singapore is also a wholly owned subsidiary of the Assessee and is engaged in the business of Information Technology related products and services.
(iii) Tricolor Infotech International Inc, Mauritius is a joint venture company of the Assessee (50% equity) and Emirates Bank Group (50% equity). The company is engaged in the sales, marketing and business development activities for software development in UAE & West Asia
27. The Assessee had entered into the following international transactions with the aforesaid associated enterprises:-
Sl. Name & Countr Nature Description of Amount
No Address of y of tax of transaction with received/r
. Associated residen relation AEs eceivable,
Enterprises ce of ship paid/paya
(AEs) AEs ble as per
books of
accounts
1 ICICI Infotech USA AE as i) Provision of 62,684,77
Inc., 450, per technical (software) 7
Raritan Centre Sec. services.
Parkway, 92A(1)( (Receipt by the
Edison a) Assessee) 218,548,6
New Jersey, ii) Marketing 95
08837 services provided
by Infotech Inc. to
17 ITA NOS.3354/MUM/2010 & Others
3i Infotech Limited.
Infotech India.
(Payment by the 31,737,25
Assessee) 9
iii) Contract service
provider expenses
incurred by Infotech
India. 844,346
(Payment by the
Assessee)
iv) Interest received
on loan granted
(Receipt by the
Assessee)
2 ICICI Infotech Singap AE as Provision of 3,002,811
Pte. Ltd. ore per technical services.
8th Cross sec. (Receipt by the
Street 92A(1)( Assessee)
#11-00 PWC a)
Building
Singapore
048424.
3 Tricolour Mauriti AE as Provision of 16,135,99
Infotech us per technical services. 8
International Sec. (Receipt by the
Inc., 92A(1)( Assessee)
3rd Floor, Les a)
Cascades
Edith Cavell
Street
Port Louis
Mauritius
28. As per audit report, the arm's length price of the international transactions computed by the assessee is same, as recorded in the books of accounts. The assessee has used comparable uncontrolled price method for determining the arm's length price in respect of international transactions with Singapore & Mauritius entity. Costplus method was used in case of transactions referred at (ii) and (iii) and Transactional Net Margin Method was used for transactions referred in (i), in case of Infotech USA. The Assessee had submitted copy of three Transfer Pricing Memorandums (hereinafter: T.P. Report), in respect of international transactions with three Associated Enterprise. The TP Report dealt with description of inter-company transactions, functional analysis and economic analysis. The details of bench marking the international transactions with independent enterprises were also submitted. The agreements with all the three associated enterprises, details of costs incurred by Infotech USA with regard to marketing services and as a contract service provider were also submitted.
29. The AO by his letter dated 29/9/03 had referred for computation of arm's length price to the TPO the transactions referred to Form No.3CEB filed by the 18 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
Assessee pursuant to provisions of Sec.92E of the Act. The TPO considering the facts of the international transactions for the year and economic analysis carried out by him was of the view that no adjustment requires to be made to the value of the international transactions entered into by the assessee.
30. The TPO after having held that the value at which the international transactions reported by the Assessee in its Form No.3CEB u/s.92-E read with Rule 10-E of the Rules, carried out by the Assessee does not require any adjustment, however proceeded to make an adjustment in respect of an issue which was not reported by the Assessee as an international transaction in Form No.3CEB filed pursuant to Sec.92-E of the Act. The following were the relevant observations of the TPO in his report in this regard:
'The assessee has also transferred three employees of the company to Infotech US vide this office letter dated 23.10.2004, the assessee was issued a show cause letter, the relevant portion read as :
"Infotech India has deputed three employees to Infotech US, during financial year 2001-02 who have become employees of Infotech Inc. In the matter please submit whether in respect of such transferred employees, Infotech India has levied any charge. If not, why and also state why such charge @ 12.5% of the total annual compensation last paid to employees in India, be calculated as the Arm's Length Price. This Arm's Length rate is adopted as per the agreement infotech India had with Tricolor Infotech Inc. for the similar services. The total cost to the company incurred on the employees during the month prior to their transfer be submitted."
The assessee, in the letter dated 5.11.2004, has only submitted that as per month cost to the company of the three employees transferred and this is Rs. 181,182/- and did not contest the issue raised by this office regarding compensation.
The employees transferred are recruited by the company and such persons are given proper training, before they are actually entrusted the work of software development. Employees transferred to foreign locations are generally better qualified and the best performers. The transfer of such employees, results into benefit to the transferee entity, as they are not to incur any expenses on the recruitment and training and the salary packages to such employees are also less in comparison to foreign employees, resulting into savings to the transferee company. Considering this, either the company to whom the persons are transferred, should share the profit earned or atleast compensate the transferor entity for losing the valuable resources. Infotech India, in its agreement with Tricolour Mauritius has provision for receipt of such transfer fees and the same is in the form of a one time charge of 12.5% of the annual compensation paid to the employees transferred/seconded. Considering the same rate, the Arm's Length Compensation to ICICI Infotech is computed at Rs. 2,71,773/-. The Assessing Officer is required to add this amount to the total income of the assessee and this amount is not eligible 19 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
for any deduction u/s. 10A or section 10B or under Chapter-VIA in view of proviso to section 92C(4) of the I.T. Act, 1961.'
31. Following the above report of the TPO, the AO made an addition of Rs.2,71,773 to the total income of the Assessee.
32. Before CIT(A), the Assessee submitted that the first step, when applying the CPU method, is to find a comparable transaction. This could be done in two different ways. The easiest and most preferable way is to compare the controlled transactions (i.e. transaction between two related parties) with another transaction made by the same MNE but with an unrelated party. This is an "internal comparable". The reason why it is preferable is that the quality of the data is more accurate since the MNE is part of the transaction and thus has access to all the facts of the transactions. It was submitted that to test the arm's length pricing in the case of transfer/seconding of the employee's, it may be possible to use the CUP method where the same entity has undertaken similar transaction under comparable circumstances to independent enterprises (para 6.23 of OECD Guidelines on Transfer Pricing). CUP method could not be applied under the facts of the case as the Assessee Company has not transferred/seconded employees to any other independent enterprises. The Assessee referred to Para 6.25 of the OECD guidelines, the relevant extract of which is as under :-
"6.25 For example, it may be the case that a branded athletic shoe transferred in a controlled transaction is comparable to an athletic shoe transferred under a different brand name in an uncontrolled transaction both in terms of the quality and specification of the shoe itself and also in terms of the consumer acceptability and other characteristics of the brand name in that market. Where such a comparison is not possible, some help also may be found, if adequate evidences is available, by comparing the volume of sales and the prices chargeable and profits realized for trademarked goods with those for similar goods that do not carry the trademark."
However, in case internal comparable is not available the transaction must be tested with transactions made by other independent parties, called 'external comparables'. Since, the MNE is not part of the comparable transactions it is increasingly difficult to find accurate data. In the case of the Assessee, the data of whether other companies are receiving for such types of services was not available. Hence, external comparable was also not possible. The assessee therefore submitted that the Transfer Pricing Regulations obliges to test the compliance with arm's length principle by testing the controlled transactions with that of comparable uncontrolled transactions (internal/external comparable). In other words, it was submitted that the transactions entered into inter se between associated enterprises-controlled transactions cannot be applied to test the compliance with arm's length principle. Hence, it was submitted that CUP method cannot be selected as there are no comparable transactions to benchmark such transactions. Therefore CUP method cannot be applied.
20 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
33. It was further contended that such transfer/seconded employees was general industry practice and that there was no cost incurred on training and development of employees transferred. Hence, there was no need to recover any cost. It was also argued that the Assessee is not in the business of transferring employees. It was pointed out that the employees transferred were mainly handling market development responsibilities and that their transfer to the wholly owned subsidiary US company was to help marketing of the Assessee's product by the wholly owned subsidiary US company and that the Assessee would generate income in the form of improved business and this factor has been completed lost sight by the TPO.
34. The CIT(A) however confirmed the order of the AO for the following reasons:-
"I have carefully considered the findings of the Assessing Officer and submissions of the appellant. The argument of the appellant that no substantial amount was incurred for training and development of employees is not acceptable. The employees transferred were recruited and trained by the appellant company before they were actually interest the work of software development. Generally most qualified employees are transferred to foreign location. By aforesaid transfer the transferee entity was benefited because they have not incurred any expenses on such employees. I agree with the observations of the Assessing Officer that the transferee company should compensate the transferor for using the valuable resources. Therefore TPO/Assessing Officer was fully justified in making adjustment of Rs. 2,71,773/-in view of the proviso of section 92C(4) of I.T. Act, 1961. In view of the above facts, no interference is called for in the order of the Assessing Officer. Thus, ground No. 8 is dismissed."
35. Aggrieved by the order of CIT(A), the Assessee has raised ground No.7 before the Tribunal.
36. The learned counsel for the Assessee submitted that under the provisions of Sec.92CA(1) of the Act, where any person, being the assessee, has entered into an international transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm's length price in relation to the said international transaction under Section 92C, to the Transfer Pricing Officer. U/S.92CA(2) where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to be specified therein, any evidence on which the assessee may rely in support of the computation made by him of the arm's length price in relation to the international transaction referred to in sub- section (1). He pointed out that the AO by his letter dated 29/9/03 had referred for computation of arm's length price to the TPO in respect of transactions referred to Form No.3CEB filed by the Assessee pursuant to provisions of Sec.92E of the Act. He pointed out that the international transactions referred to in Form No.3CEB did not include the international transaction of the Assessee deputing three of its employees to infotech US during the previous year. According to him the TPO's jurisdiction to determine arm's length price of an international transaction is restricted to the international transactions set out in the order of 21 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
reference of the AO. It was his argument that the TPO exceeded his jurisdiction in determining the arm's length price (ALP) of the international transaction of the Assessee deputing three of its employees to infotech US during the previous year and to this extent the order of the TPO should be considered non est. In this regard he also brought to our notice Instruction No.3 of 2003 dated 20-5-2003 issued by the CBDT regarding computation of income from international transaction having regard to arm's length price wherein the CBDT explaining the role of TPO has instructed that in terms of Sec.92CA of the Act, the TPO's role is limited to the determination of arm's length price in relation to the international transactions referred to him by the AO and if during the course of proceedings before him it is found that there are certain other transactions which have not been referred to him by the AO, he will have to take up the matter with the AO so that a fresh reference is received with regard to such transaction. The Board has further opined that reference to the TPO is transaction and not enterprise specific. His further submission was that since the AO made the impugned addition by relying on the order of the TPO the same cannot be sustained.
37. The learned D.R. submitted that the definition of international transaction is wide enough to include the act of deputation of three employees by the Assessee to Infotech US. According to him, the Assessee ought to have disclosed this transaction in the report in Form No.3CEB. Having failed to do so, the Assessee cannot take advantage of its own wrong. Another submission made by him was that two of the transactions reported in Form 3CEB between the Assessee and Infotech US related to (a) marketing services provided by Infotech Inc to Infotech India (Assessee) and (b) Contract service provider expenses incurred by Infotech India (Assessee). Since the transactions referred to in Form 3CEB were referred to TPO for determining ALP by implication even the act of deputation of the three employees by Assessee to Infotech US should be considered as having been referred to TPO for determining ALP.
38. We have considered the rival submissions. Under the provisions of Sec.92-E, an Assessee who has entered into an international transaction during a previous year has to obtain a report from an Accountant and furnish such report in the prescribed form, i.e., Form No.3CEB. Sec.92C(3) provides as follows:
"(3)Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that--
(a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or
(b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or
(c) the information or data used in computation of the arm's length price is not reliable or correct; or 22 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
(d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-
section (3) of section 92D, the Assessing Officer may proceed to determine the arm's length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him:
Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer."
Section 92CA(1) to (3) empowers the AO to make a reference to the Transfer Pricing Officer and it reads as follows:
"Reference to Transfer Pricing Officer.
92CA. (1) Where any person, being the assessee, has entered into an international transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm's length price in relation to the said international transaction under section 92C to the Transfer Pricing Officer.
(2) Where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to be specified therein, any evidence on which the assessee may rely in support of the computation made by him of the arm's length price in relation to the international transaction referred to in sub-section (1). (3) On the date specified in the notice under sub-section (2), or as soon thereafter as may be, after hearing such evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require on any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm's length price in relation to the international transaction in accordance with sub-section (3) of section 92C and send a copy of his order to the Assessing Officer and to the assessee."
In the present case, the AO referred to the TPO for determination of ALP the transactions set out in FormNo.3CEB by his letter dated 29-9-2003. The details of these transactions have already been set out above in the earlier paras. The transaction by which the Assessee deputed three of its employees to ICICI Infortech, USA, was not considered as an international transaction to be set out in Form NO.3CEB by the Assessee. The AO therefore never referred the computation of ALP to the TPO the transaction of deputation of three of its employees by the Assessee to ICICI infotech, USA. The jurisdiction of the TPO is therefore restricted to the transactions referred to him by the AO u/s.92CA(1). The TPO therefore could not under Section 92CA(3) determine the ALP in relation to an international transaction not referred to him by the AO u/s.92CA(1). In this regard Instruction No.3 of 2003 dated 20-5-2003 issued by the CBDT regarding computation of income from international transaction having regard to arm's 23 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
length price, is very clear. In the said instructions, the CBDT explaining the role of TPO has instructed that in terms of Sec.92CA of the Act, the TPO's role is limited to the determination of arm's length price in relation to the international transactions referred to him by the AO and if during the course of proceedings before him it is found that there are certain other transactions which have not been referred to him by the AO, he will have to take up the matter with the AO so that a fresh reference is received with regard to such transaction. The Board has further opined that reference to the TPO is transaction and not enterprise specific. In the present case, the determination of ALP in respect of the transaction by which the Assessee deputed three of its employees to ICICI infotech, USA, by the TPO is therefore non est to that extent and cannot form the basis for making an addition to the total income. The AO therefore could not have made the impugned addition on the basis of the order of the TPO. Since the impugned addition has been made by the AO only by placing reliance on the report of the TPO, the addition cannot be sustained.
39. The next question is whether the report of the TPO can be considered as material, information or document based on which the addition made by the AO could be sustained. U/S.92C(3) the AO has power to determine ALP on the basis of material or information or document in his possession. But exercise of such power is conditional on the AO being satisfied that :
(a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or
(b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or
(c) the information or data used in computation of the arm's length price is not reliable or correct; or
(d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-
section (3) of section 92D, The provisions of clause(a) (b) and (d) above would not apply because no price had been charged by the Assessee in this case, in respect of the international transaction in question, neither was the Assessee called upon to furnish any details in respect of the said transaction nor was there any failure to furnish any details. It is neither the complaint of the AO or the TPO that there was any failure within the meaning of clause(b) above. Further the AO did not comply with the mandate of the proviso to Sec.92C(3) which lays down as follows:
"Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer."
24 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
Since the conditions laid down in Sec.92C(3) were not satisfied the impugned addition cannot also be sustained on the premise that the AO has determined the ALP on the basis of material or information or document in his possession.
39. Sec.92CA(4) reads as follows:
(4) On receipt of the order under sub-section (3), the Assessing Officer shall proceed to compute the total income of the assessee under sub-section (4) of section 92C in conformity with the arm's length price as so determined by the Transfer Pricing Officer.
The report of the TPO is no doubt binding on the AO in terms of the above provisions but only if the same is in conformity with the other provisions of Sec. 92CA viz., there being a valid reference made to the TPO by the AO.
40. On merits of the addition sustained by the CIT(A) the learned counsel for the Assessee reiterated submissions made before CIT(A) and further submitted as follows:
a) That the TPO determined the ALP on assumptions that the employees transferred were recruited by the Assessee and that the Assessee gave proper training, before they were actually entrusted the work of software development. The next assumption of the TPO was that employees transferred to foreign locations are generally better qualified and the best performers. The third assumption was that the transfer of such employees, results into benefit to the transferee entity, as they are not to incur any expenses on the recruitment and training and the salary packages to such employees are also less in comparison to foreign employees, resulting into savings to the transferee company. It was his submission that there is no basis for these assumptions. The three personnel transferred by the Assessee on deputation to Infotech Inc. USA had the following experience:
Name Experience with the Per month cost to the
Assessee Assessee
1. K.N.Madhava 2 years Rs. 1,36,141
2. Vivek Pillai 1 and ½ years Rs.24,821
3. Mr.Alex -do- Rs.20,220
According to him the personnel transferred to Infotech Inc. USA cannot be said to possess any of the skills as assumed by the AO.
b) He drew attention to page-33 of the Assessee's paper book which contains note 2.18 being notes to the Accounts of the Assessee for the previous year relevant to AY 02-03. It has been mentioned therein that the Assessee has engaged ICICI Infotech Inc. USA the wholly owned subsidiary for providing market development and sales support in the US for project software and implementation services for onsite projects. That the Assessee remunerates Infotech Inc. on a cost plus basis for the aforesaid services and all the project revenues accures to the Assessee. The learned counsel submitted that, if the Assessee charges Infotech USA the cost of deputation of employees, the cost 25 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
of Infotech USA will go up and on such increased cost the Assessee will have to remunerate them the fixed percentage. In that event there will be erosion of tax base of India.
41. The learned D.R. relied on the order of the CIT(A) and submitted that the TPO was right in his conclusions and relying on the Agreement between the Assessee and Tricolour Mauritius, an Associate Enterprise where there was provision for receipt of such transfer fees in the form of a one time charge of 12.5% of the annual compensation paid to the employees transferred/seconded was right in determining the impugned ALP.
42. We have considered the rival submissions. The definition of international transaction as given in Sec.92-B(1) of the Act is:
"international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.
The above definition is wide enough and includes any arrangement between two associated enterprises for allocation of cost in connection with a benefit, service or facility provided. Therefore the act of deputation of three employees by the Assessee to Infotech US will be covered within the aforesaid definition. The fact that there is no consideration paid for the transfer of employees will not take the transaction out of the purview of the provisions of Sec.92 of the Act. The deciding factor as to whether ALP has to be determined in such cases will be to see if the Indian tax base is eroded. If there is likely to be erosion of Indian tax base then the AO will be well within his powers to determine income arising out of an international transaction. Therefore the AO was well within his powers to examine the transaction with a view to determine the ALP of this transaction and determine income which the Assessee ought to have earned on the transaction.
43. In the present case, we find that the arrangement between the Assessee and Infotech USA was that the Assessee remunerates Infotech Inc. on a cost plus basis for the aforesaid services and all the project revenues accures to the Assessee. If the Assessee charges Infotech USA the cost of deputation of employees, the cost of Infotech USA will go up and on such increased cost the Assessee will have to remunerate them the fixed percentage. In that event there will be erosion of tax base of India. In such cases, we feel that the AO ought not to resort to the provisions of Sec.92 to determine income of international transactions. There may be cases where apparently there is no erosion of Indian tax base but the AO may find the value of the benefit is part of some other international transaction and determination of ALP of the other transaction will depend determination of ALP of the benefit, in such cases he may resort to the 26 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
provisions of Sec.92. We therefore agree with the submission of the learned counsel for the Assessee that on the facts and circumstances of the present case, there was no necessity to have determined ALP of the transaction in question. We also agree with the learned counsel for the Assessee that the TPO has proceeded to determine ALP of the transaction on the basis of assumptions not supported by any evidence. We also agree with his submission that CUP method could not be applied under the facts of the case as the Assessee has not transferred/seconded employees to any other independent enterprises. To test the arm's length pricing in the case of transfer/seconding of the employee's, it may be possible to use the CUP method where the same entity has undertaken similar transaction under comparable circumstances to independent enterprises. In the present case, the similar transaction on the basis of which the TPO determined ALP was not with an independent enterprise and the said transaction was also with an Associated enterprise. In such circumstances, even the determination of ALP by the TPO was not proper. We therefore delete the addition made by the AO. Ground No.7 of the appeal of the Assessee is also allowed."
17. We have seen that while upholding the action of AO in respect of assessment year 2004-05. Ld. CIT(A) has relied upon the order passed by TPO for assessment year 2002-03 and 2003-04 and as already mentioned that it is not the case of revenue that the facts of the present years are different in any manner, therefore respectfully following the aforementioned order of the Tribunal we decide all these grounds in favour of assessee and these grounds are allowed.
REVENUE'S APPEAL FOR A.Y. 2003-04:
18. On the basis of mutual agreement, the assessee has been providing back office support services to ICICI Bank in respect of retail lending business of ICICI Bank (the Bank) comprising of housing loans, auto loans, credit cards etc., ever since the Bank has started its retail lending business in the year 1999. For the sake of convenience these activities of the assessee are referred to as RFCO activities.
18.1 For providing such services the assessee had put in place adequate resources in the terms of (a) office space; (b) soft ware; (c) IT Infrastructure; (d) manpower sources with technical skill; (e) managerial and other skills required 27 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
to handle such activity. However, in the year 2002, with a view to exercise direct control over these activities and to reduce cost, the Bank decided to carry on these activities independently. Therefore, the Bank proposed to appoint senior personnel of the assessee, who was handling these activities on their rolls. It is in these circumstances it was mutually agreed between the assessee and the Bank that the Bank shall discontinue the arrangement of RFCO activities being handled by the assessee w.e.f. 1/9/2002. As mentioned earlier that the assessee had already put in place adequate resources mentioned above to handle these activities, the Bank agreed to pay a sum of Rs.15.00 crores to the assessee as compensation for the loss of business/future earning/ transfer of knowledge, which is subject to confirmation through valuation of RFCO business activities by the two independent agencies. Copy of the agreement dated 9/10/2002 was filed which was entered into between the assessee and bank alongwith a copy of valuation report in respect of retail asset business of the assessee.
18.2 The aforementioned amount of Rs.15.00 crores was treated as capital receipt by the assessee on the ground that after having pre-determined the contract with the Bank, the assessee has given up one source of income completely for which the compensation has been received. Such compensation is towards loss of business order towards loss of one source of income which has affected the profit making structure of the assessee and the same is accordingly a capital receipt. The AO did not accept such claim of the assessee and considered the said amount as revenue receipt. The main basis on which AO has held this issue against the assessee is that there is no transfer of any asset or business expertise or IPR or such item which normally be transferred when such type of business is transferred by one entity to another. In this regard reply of the assessee was that the assessee's is a service oriented business and accordingly its major asset is manpower. As per terms of the agreement, the assessee has transferred complete senior staff and many of its 28 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
junior staff to the bank. Reference in this regard was made to the list of 105 employees, who were transferred to the bank, therefore, it was contended that there was a transfer of asset.
18.3 The second ground on which the AO has rejected the claim of the assessee was that there is no clause in the agreement which restrain or restrict the assessee from continuing RFCO activity and assessee is free to carry on such activity, if it so desired. In this regard it was submitted that assessee company is not providing such services to any other company and after termination of contract with the Bank the assessee did not entered into any other similar agreement with any other company. In view of the fact that there was a proposed change in the business model and reduction in the future revenue and also considering the fact that all key personnel were transferred to bank, it was not felt feasible for the assessee to continue such activity. Therefore, it was pleaded that after termination of contract of the assessee with the Bank, the assessee has given up one source of income completely.
18.4 Further, AO has relied upon the decision of Hon'ble Supreme Court in the case of Obroi Hotels Pt. Ltd., vs. CIT, 236 ITR 903(SC). According to AO where payment is made to assessee for compensation of cancellation of a contract which does not affect the trading structure of business and does not deprive him of what in substance is his source of income then termination of the contract is a normal incident of business. If such cancellation leaves him free to carry on his trade then receipt will be of revenue in nature. In this regard it was the submission of the assessee that in the case of the assessee, as a result of cancellation of agreement the assessee has incurred a loss of a source of income and therefore, the compensation received is capital in nature. All these issues have been discussed in the order of Ld. CIT(A) in para No.3. Apart from aforementioned arguments assessee has also relied upon other decisions also and after considering all of them Ld. CIT(A) has arrived at a 29 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
conclusion that the compensation received by the assessee is capital receipt. Ld. CIT(A) has mentioned that the business of the assessee can be broadly segregated into two main activities viz. (a) software development; (b) providing back office support services in respect of retail lending business of the Bank. Admittedly, assessee does not provide such support services to any other company other than ICICI Bank. The assessee also did not enter into other similar agreement with any other company. Due to termination of contract with the Bank, the assessee had to close its retail asset business division which essentially managed retail asset portfolio of the Bank. Therefore, it has to be accepted that the termination of contract resulted in closure of retail asset business. In effect the assessee had given up one source of income completely for which the assessee had received compensation. For all purposes the compensation is towards loss of business or towards one source of income which was generated 10 to 13% of the total turnover of the assessee and, therefore, has definitely affected the profit making structure of the assessee and is capital receipt. Reliance placed by the AO on the decision of Hon'ble Supreme Court in the case of Oberoi Hotels Pvt. Ltd. vs. CIT(supra) is misplaced. In fact the said judgment support the case of the assessee. On the basis of following decisions the issue was to be decided in favour of assessee. (1) Oberoi Hotels Pt. Ltd., vs. CIT, 236 ITR 903(SC).
(2) Karamchand Tappar & Brothers Pvt. Ltd.80 ITR 167 (3) CIT vs. Ambadi Enterprises Ltd., 267 ITR 702.
(4) CIT vs. Vazir Sultan , 36 ITR 175 (SC) (5) Kettlewell Bullen and Co. v. CIT, 53 ITR 261 (SC) (6) CIT v. TI & M Sales Ltd., 259 ITR 116 (Mad) (7) JCIT vs. Khanna & Andhanam, 305 ITR 336 (Del) (8) CIT v. Bombay Burmah Trading Corporation, 161 ITR 386(SC) In this manner Ld. CIT(A) has deleted the addition of Rs.15.00 crores. Aggrieved, the revenue has filed aforementioned ground.
30 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
19. After narrating the facts it was submitted by Ld. DR that Ld. CIT(A) has erred in concluding that the compensation received by the assessee was in respect of loss of business or towards one source of income. He submitted that RFCO activities of the assessee were continued in respect of subsequent period also and there was no loss of business or one source of income. In this regard Ld. DR has produced before us financial reports of the assessee, wherein revenue from such activity has not altogether stopped in financial year2004. Thus he submitted that there was no absolute erosion of such source. He referred to the following table from the above financial report.
Revenue Mix. FY % of FY % of FY % of FY % of
2004 sale 2003 Sales 2002 slaes 2001 sales
Software 559.62 31% 580.70 32% 539.43 37% 423.24 39%
Development
Services
Software Products 499.48 28% 334.85 19% 36.76 3% - -
IT Infra Networking 493.43 27% 274.00 15% 229.09 16% 158.93 15%
and Facilities
Management
Business Processing 244.64 14% 454.12 25% 661.97 45% 496.35 46%
Outsourcing
Services
Compensation - - 150 8% - - - -
pertaining to BPO
Division
Total 1797.17 100% 1793.67 100% 1467.23 100% 1078.52 100%
19.1 Ld. DR further submitted that there was no transfer of asset as assets of the assessee has never decreased. For this he relied upon the figures of fixed assets given in financial report, copy of which was placed on our record and was also given to Ld. A.R. 19.2 Ld. DR further submitted that the decision of Hon'ble Supreme Court in the case of Oberoi Hotels Pvt. Ltd. (supra) mainly referred to the earlier decision of Hon'ble Supreme Court in the case of Kettlewell Bullen and Co. Ltd. vs. CIT, 53 ITR 261(SC). He referred to the following observations of Hon'ble 31 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
Supreme Court to contend that simple termination of the contract is normal incidents of the business and if cancellation leaves the assessee free to carry on his trade then the receipt will be of revenue in nature.
"21. On an analysis of these cases which fall on two sides of the dividing line, satisfactory measure of consistency in principle is disclosed. Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue : Where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.
In the present case, on a review of all the circumstances, we have no doubt that what the assessee was paid was to compensate him for loss of a capital asset. It matters little whether the assessee did continue after the determination of its agency with the Fort William Jute Co. Ltd. to conduct the remaining agencies. The transaction was not in the nature of a trading transaction, but was one in which the assessee parted with an asset of an enduring value. We are, therefore, unable to agree with the High Court that the amount received by the appellant was in the nature of a revenue receipt."
Thus Ld. DR pleaded that the claim has wrongly been allowed by Ld.CIT(A) and his order on this issue should be set aside and that of AO be restored.
20. On the other hand, in addition to relying upon the order passed by Ld. CIT(A), countering the arguments of Ld. DR it was submitted by Ld.Sr. Counsel that the decision of Hon'ble Supreme Court in the case of Kettlewell Bullen and Co. Ltd. vs. CIT(supra) was rendered in respect of compensation received by the assessee in respect of one of the agencies. He submitted that in that very decision it has been clarified by Hon'ble Supreme Court that where out of several agencies the activity of the assessee in respect of agency of Fort William Jute Company Ltd. was stopped and on the basis of the fact that assessee continued similar activity with other remaining agencies was not considered relevant. Ld. AR drew our attention towards observation of their Lordships in 32 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
para-21 which have already been reproduced in the above part of this order where their Lordships of Hon'ble Supreme Court has observed that "It matters little whether the assessee did continue after the determination of its agency with the Fort William Jute Co. Ltd. to conduct the remaining agencies. The transaction was not in the nature of a trading transaction, but was one in which the assessee parted with an asset of an enduring value."
20.1 Coming to the decision of Hon'ble Supreme Court in the case of Oberoi Hotels Pvt. Ltd. vs. CIT (supra), Sr. Counsel submitted that in that case also assessee was operating activities with various hotels and compensation was received by it in respect of operation of only one hotel namely Hotel Oberoi Imperial, Singapore and similar activity with other hotels were continued. It was held that the compensation received by the assessee was a capital receipt. He submitted that amount in the present case was received by the assessee because assessee has to give up its right to render services in respect of its agreement with the bank. It was loss of source of income to the assessee and for such loss of source of income consideration was paid to the assessee which is capital in nature. Ld. Sr. Counsel of the assessee also relied upon the decisions which have been mentioned in the order of Ld. CIT(A) and which have been described in the above part of this order.
21. We have heard both the parties and their contentions have carefully been considered. In the present case assessee was providing back office support services to ICICI Bank in respect of retail lending business of ICICI Bank and was receiving payment as per agreement entered into by the assessee with the said Bank. This was one of the activity of the assessee. In respect of termination of the said agreement the sum of Rs.15.00 crores had been given to the assessee by the bank. As pointed by Ld. Sr. Counsel of the assessee that assessee company has also departed with the personnel who were handling this activity of the assessee company to give them on the role of the Bank. Thus it was a case where the compensation has been received by the assessee on losing its right 33 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
to receive income in respect of services being rendered by the assessee to the Bank. In the facts and circumstances of the case it is a loss of source of income to the assessee and compensation has been determined on the basis of the said loss. According to arguments of Ld. DR, the assessee company has not given up its entire activity of rendering back office services as the assessee has been earning income from such activity even after termination of such agreement. Therefore, it is the case of Ld. DR that the amount received by the assessee should be considered as income in the nature of revenue. However, such arguments of the Ld. DR does not find support from the aforementioned two decisions of Hon'ble Supreme Court namely Kettlewell Bullen and Co. Ltd. vs. CIT(supra) and Oberoi Hotel Pvt. Ltd. vs. CIT (Supra). It has been clearly observed by Hon'ble Supreme Court in the case of Kettlewell Bullen and Co. Ltd. vs. CIT(supra) that it is irrelevant that the assessee continued similar activity with the remaining agencies. So relevant criteria to decide such issue is that whether or not the assessee has lost one of its source of income. In the present case the assessee has lost its source of income with respect to its agreement entered into by it with the bank. It is also the case of the assessee that it has never rendered such services to any other person right from the inception and there is no material on record to contradict such argument of the assessee. Therefore, if he facts of the present case are seen in the light of aforementioned two decisions of Hon'ble Supreme Court namely Kettlewell Bullen and Co. Ltd. vs. CIT(supra) and Oberoi Hotel Pvt. Ltd. vs. CIT (supra), then we find no infirmity in the order passed by Ld. CIT(A) on this issue, whereby it has been held that the compensation received by the assessee was in the nature of capital. We decline to interfere and this ground of the revenue is dismissed.
22. Now we are left with the remaining grounds of assessee's appeal for A.Y 2006-07.
34 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
23. Ground No.4 is with respect to disallowance made under section 14A of the Act. The AO applied Rule 8D and disallowed a sum of Rs.1,14,52,987/- in the draft order and Ld. DRP after referring to the decision of Hon'ble Bombay High Court in the case of Godrej & Boyce Mfg. Company Ltd vs. DCIT, 328 ITR 81(Bom) has given the following directions to the A.O. "3.1 The Bombay High Court has held that the provisions of Rule 8D are prospective and can be applied from A.Y 2007-08 onwards, however, disallowance 14A is to be made in the earlier years based on reasonable basis for computation of expenses relating to earning of exempt income. The Assessing Officer shall disallow all the direct expenses incurred in connection with the earning of exempt income as well as disallow interest in the ratio of value of assets used in earning exempt tax free income to the total assets. The Assessing Officer is directed to make the disallowance u/s.14A accordingly."
24. Before AO it was the contention of the assessee that the only investment made by the assessee in the shares from which dividend income has been received in India is an amount of Rs.9.90 crores invested in SDG Software Technologies Pvt. Ltd. Finding this contention of the assessee as true, Ld. AO has observed that amount of Rs.9.90 crores invested by the assessee in SDG Software Technologies Pvt. Ltd. will be covered under section14A of the Act. Accordingly, AO has computed disallowance of Rs.5,44,750/-. It is the case of the assessee that such disallowance has been calculated by the AO without appreciating the fact that assessee did not invest any interest bearing borrowed funds for the purpose of investment in SDG Software Technologies Pvt. Ltd. It was submitted by Ld. AR that this matter may be sent back to the file of AO with a direction to give proper opportunity to the assessee to explain its case that disallowance of Rs.5,44,750/- under section 14A was not called for.
25. However, on the other hand, Ld. DR relied upon the order passed by the AO.
35 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
26. After considering the submissions of both the parties we consider it just and proper to restore this issue to the file of AO with a direction to readjudicate this issue as per law in accordance with the decision of Hon'ble Jurisdictional High Court in the case of Godrej & Boyce Mfg. Company vs. DCIT (supra) after giving the assessee opportunity of hearing. We direct accordingly. This ground is considered as allowed for statistical purposes in the manner aforesaid.
27. For ground No.6 of assessee's appeal for assessment year 2006-07, it was submitted by Ld. A.R that AO may be directed to give the credit of TDS to the assessee in respect of tax deducted from the payments received by the assessee.
28. On this issue after hearing both the parties we direct the AO to give credit to the assessee in respect of tax deducted on the payments made to the assessee which are accounted for as income during the year under consideration after verification of such TDS. We direct accordingly. This ground is also considered as allowed for statistical purposes in the manner aforesaid.
29. Ground No.7 of assessee's appeal for A.Y 2006-07 is regarding levy of interest under section 234D. It was submitted by Ld. AR that the levy of interest under section 234D is consequential and AO may be directed to re- compute interest leviable under section 234D as per income determined after giving effect to the present appeal. Therefore, after hearing both the parties we direct the AO to recompute interest under section 234D as per income computed after giving effect to this order. We direct accordingly. This ground is allowed in the manner aforesaid.
36 ITA NOS.3354/MUM/2010 & Others 3i Infotech Limited.
30. Ground No.8 of assessee's appeal for assessment year 2006-07 is regarding initiation of penalty proceedings under section 271(1)(c) of the Act. Such ground of the assessee is premature, therefore, the same is dismissed.
31. No other grounds were argued before us.
32. In the result, appeals filed by the assessee are partly allowed in the manner aforesaid and revenue's appeals are dismissed.
Order pronounced in the open court on 21/08/2013 आदे श क घोषणा खले ु यायालय म दनांकः 21 /08/2013 को क गई ।
Sd/- Sd/-
(नरे कमार
ु ब लै या / N.K.BILLAIYA) (आय.पी. बंसल / I.P. BANSAL)
लेखा सद य / ACCOUNTANT MEMBER या यक सद य / JUDICIAL MEMBER
मंुबई Mumbai; दनांक Dated 21/08/2013
आदे श क त ल प अ े षत/Copy
षत of the Order forwarded to :
1. अपीलाथ / The Appellant
2. यथ / The Respondent.
3. आयकर आयु (अपील) / The CIT(A)-
4. आयकर आयु / CIT
5. वभागीय त न ध, आयकर अपील य अ धकरण, मंब
ु ई / DR, ITAT,
Mumbai
6. गाड फाईल / Guard file.
आदे शानसार
ु / BY ORDER,
स या पत त //True Copy//
उप/सहायक
उप सहायक पंजीकार (Dy./Asstt. Registrar)
आयकर अपील य अ धकरण,
धकरण मंब
ु ई / ITAT, Mumbai
व. न.स./Vm, Sr. PS
37 ITA NOS.3354/MUM/2010 & Others
3i Infotech Limited.
Details Date Initials Designation
1 Draft dictated on 14 & 16/08/13 Sr.PS/PS
2 Draft Placed before author 19/08/2013 Sr.PS/PS
3 Draft proposed & placed JM/AM
before the Second Member
4 Draft discussed/approved JM/AM
by Second Member
5. Approved Draft comes to the Sr.PS/PS
Sr.PS/PS
6. Kept for pronouncement on Sr.PS/PS
7. File sent to the Bench Clerk Sr.PS/PS
8 Date on which the file goes
to the Head clerk
9 Date of Dispatch of order