Income Tax Appellate Tribunal - Bangalore
M/S Crane Software International ... vs Assessee
ITA.741,742, 774 & 775/B/2010 Page - 1
IN THE INCOME TAX APPELLATE TRIBUNAL
BANGALORE BENCH 'A', BANGALORE
BEFORE DR. O. K. NARAYANAN, VICE PRESIDENT
AND
SMT. P. MADHAVI DEVI, JUDICIAL MEMBER
1-2. I.T.A Nos.741 & 742/Bang/2010
(Assessment Years : 2005-06 & 2006-07)
M/s. Crane Software International Ltd.,
Block-1, 4th floor, Shankaranarayana Building,
Bangalore 560 001 .. Appellant
v.
Deputy Commissioner of Income-tax,
Circle -11(2), Bangalore .. Respondent
3-4. I.T.A Nos.774 & 775/Bang/2010
(Assessment Years : 2005-06 & 2006-07)
(By the Revenue)
Assessee by : Shri. V. Srinivasan, CA
Revenue by : Shri. G. V. Gopala Rao, Commissioner of Income-tax-I
ORDER
PER DR. O. K. NARAYANAN, VICE PRESIDENT :
This is a bunch of four appeals consisting of two appeals by the assessee and two appeals by Revenue. These appeals relate to the assessment years 2005- 06 and 2006-07.
ITA.741,742, 774 & 775/B/2010 Page - 2
02. These cross appeals are directed against the orders of the Commissioner of Income-tax(A)-I at Bangalore, dated. 01/03/2010 and arise out of the assessments completed u/s.143(3) of the Income-tax Act, 1961.
03. The assessee-company provides software products and solutions on statistical analytics and engineering simulations to enterprises in different countries. Assessee's business interests include productised software solutions, services and Research and Development. Assessee offers different proprietary products such as SYSTAT, SIGMA PLOT, SIGMA STAT, PEAKFIT, iCAPELLA and other packages of IBM, Texas Instruments, Mathworks, etc.,
04. The assessee company filed its returns for the assessment years 2005-06 and 2006-07 on a total income of ` 22,97,28,090/- and ` 15,99,42,940/-
respectively.
05. In the relevant previous year period, the assessee company had purchased softwares mainly from foreign companies. The purchase was for ` 77,70,44,460/- and for ` 57,70,15,039/- respectively for the assessment years 2005-06 and 2006-07. The assessee treated these new acquisitions as additions to the existing Block of Assets and claimed depreciation allowance @ 60%. The assessee stated that the softwares were purchased for its own use, analogous to plant and machineries of manufacturing units. The assessee stated that the ITA.741,742, 774 & 775/B/2010 Page - 3 purchases were not meant for re-sale but to develop products and packages so as to provide the same to customers, out of which the assessee generated its income.
06. The assessing authority could not accept the claim of depreciation allowance as deductible. He examined the purchase agreements entered into between the assessee-company and the different suppliers and purchase invoices and other features of the transactions and came to the following findings :
i) The assessee has acquired the right to distribute the software with licence to use the source code, documentation and technical information associated with the software.
ii) The assessee has obtained exclusive and non-transferrable rights to market and sub-licence the software and user documentations and to use the software source to modify, enhance, change or convert the software packages as and when necessary in the light of marketing requirements.
iii) The assessee-company is basically a trader and distributor of software products. The assessee purchases licences, source codes and makes sales and distribution of updated products to end customers.
iv) What the assessee has purchased is comprehensive software packages and the right to sell to multiple customers and not any article or asset as explained by the assessee.
v) Therefore, the payments made by the assessee were in the nature of Royalty as explained in Explanation 2 to Section 9(1)(vi) of the Act and ITA.741,742, 774 & 775/B/2010 Page - 4 accordingly liable to tax as the income arising to the foreign suppliers are to be treated as income accruing or arising in India.
07. On the basis of the above findings, the assessing authority held that tax should have been deducted at source u/s.194J when payments were made to foreign suppliers against the purchase of software. No TDS was made which attracted the provisions of law stated in sections 40(a)(i) and 40(a)(ia). The assessing authority invoked sections 40(a)(i) and 40(a)(ia) and disallowed the claims of depreciation made by the assessee.
08. In the previous year relevant to the assessment year 2005-06, the assessee had incurred an expenditure of `.3,53,20,000/- towards market support activities undertaken, mainly in European markets. The expenses were incurred to position the software products of the assessee with its brand image. The activities included sourcing of market data-base, market survey for its products like Pcats, Witel and bwd asset. The assessee company treated the expenditure as Deferred Revenue Expenditure in its financial accounts with a one-fifth annual write-off, but claimed the entire expenditure as deduction in its income- tax computation. The assessing authority treated the expenditure as incurred for technical services under Explanation 2 to section 9(1)(vii) and held the payments are accountable for TDS u/s.194J. As no TDS was made by the assessee company, sections 40(a)(i)/40(a)(ia) were invoked and the claim of ` 3,53,20,000/- was disallowed.
ITA.741,742, 774 & 775/B/2010 Page - 5
09. In the previous year relevant to the assessment year 2006-07 also, the assessee company had incurred such expenditure to the extent of ` 45,93,52,988/- which was claimed as deduction in its income-tax computation. The details of the expenditure are as follows:
Payments made to :
(1) Systat Software GmBH-Germany .. ` 21,23,600
(2) Aamer Pacific P. Ltd., .. ` 39,08,79,350
` 39,30,02,950
FCCB Issue Expenses .. ` 6,63,50,038
` 45,93,52,988
10. The payments to the foreign companies were made towards market exploration expenditure as already stated for the assessment year 2005-06. On the same grounds considered for asst.year 2005-06, the assessing authority treated the payment made to Aamar Pacific P. Ltd as payments made for technical services liable for TDS u/s.194J. As no TDS was made, sections 40(a)(i) and 40(a)(ia) were invoked and that amount was disallowed.
11. The FCCB issue expenses were incurred in connection with issue of Foreign Currency Convertible Bonds. As the Bonds were convertible, the assessing authority treated the bond proceeds as increase to capital.
Accordingly, he treated the expenditure of ` 6,63,50,038/- as capital in nature as ITA.741,742, 774 & 775/B/2010 Page - 6 it was incurred for raising the capital of the assessee company. The said expenditure was also disallowed.
12. As in the earlier year 2005-06, the assessee had purchased software and claimed 60% depreciation amounting to `38,20,11,156/-. As already stated, the assessing authority treated the payments as having made towards Royalty liable for TDS. As there was no TDS made, sections 40(a)(i)/40(a)(ia) were invoked and the claim of depreciation was disallowed.
13. In the assessment year, the assessee-company had claimed the benefit of section 10A. While computing the said benefit the assessing authority excluded the telecommunication charges from the export turnover without a corresponding deduction from total turnover, thereby reduced the quantum of benefit, marginally.
14. To summarise, the disallowances made by the assessing authority were as follows :
Sl. Assessment years
No
Item particulars 2005-06 2006-07
1. Depreciation allowance ` 46,23,33840 ` 16,68,78,386
Para 07 & 12 above
2. Market Promotion Expenses ` 3,53,20,000 ` 39,08,79,350
Para 08 & 10 above
3. FCCB Issue Expenses -- ` 6,63,50,038
Para 11 above
4. 10A Computation Adjustment -- ` 39,03,051
Para 13 above
ITA.741,742, 774 & 775/B/2010 Page - 7
15. The above mentioned disallowances and adjustment were taken in first appeals.
16. On the question of depreciation allowance, the Commissioner of Income- tax(A) found that the assessing authority has come to his finding that the assessee had purchased only the rights in software and not the property; and he made the finding not on the basis of full appreciation of the clauses of the agreements. He found that it is discernible from the same agreements that the assessee was given the option to purchase the software and in fact the assessee had exercised the option and purchased the software and capitalized the payments as cost of the software purchased.
17. He further held that section 40(a)(i) does not affect the depreciation allowance as it is not in the nature of any revenue expenditure. He held that the expenses covered by section 40(a)(i) are expenses in the nature of interest, royalty, fee for technical services and similar items and not depreciation allowance. Accordingly, the Commissioner of Income-tax(A) deleted the disallowance of depreciation for both the assessment years.
18. In the case of market promotion expenditure (Deferred Revenue Expenditure), the Commissioner of Income-tax(A) agreed with the view of the ITA.741,742, 774 & 775/B/2010 Page - 8 assessing authority. He found that the services obtained by the assessee related to marketing support, product branding, marketing survey, road shows etc in Europe. He held that the above mentioned services could not have been provided with out expert support based on technical knowledge and managerial capacity. Accordingly, he held that such payments were made for technical services covered u/s.9 of the Income-tax Act.
19. Having held that the payments were made for technical services, on the facts of the case, he accepted the alternate contention of the assessee made on the basis of exception provided u/s.9(1)(b) of the Act.
20. In the assessment year 2005-06, the total payments of ` 3,53,20,000/- were made to the following parties :
M/s. SYSTAT Software GmBH - Germany.. ` 1,36,44,000 M/s. S2 Softtech Pvt. Ltd., - India .. ` 2,16,76,000
21. In the assessment year 2006-07, the entire payment of ` 39,08,79,350/- was made to M/s. Aamer Pacific, a Singapore company.
22. In the case of the payments made to the two foreign companies noted above, the Commissioner of Income-tax(A) found that those companies do not have any Permanent Establishment in India (PE). The services were rendered by ITA.741,742, 774 & 775/B/2010 Page - 9 those companies outside India. The payments were made outside India. The income was earned outside India. The income did not accrue or arise in India. He held that therefore the payments made to the above stated two foreign companies were covered by the exception provided in section 9(1)(b) and no tax was deductible and section 194J was not attracted and so also sections 40(a)(i)/ 40(a)(ia). He further relied on the following decisions, as well :
Ishikawajima-Harima Heavy Industries v. DIT (288 ITR 408) (SC) ; Jindal Thermal Power Company Ltd., v. DCIT (26 DTR 172) (Kar).
23. Accordingly, the Commissioner of Income-tax(A) deleted the disallowance of ` 1,36,44,000/- for the assessment year 2005-06 and the disallowance of ` 39,08,19,350/- for the assessment year 2006-07. However, he confirmed the disallowance of Indian payment of ` 2,16,76,000/- for the assessment year 2005-
06.
24. On the question of disallowance of FCCB issue expenses, the Commissioner of Income-tax(A) held that FCCB is nothing but an interest bearing liability. The mere fact that loans can be converted to equity at the option of the lender at a later date does not alter the basic character of the amount borrowed as loan. So also the assessee-company has categorized the FCCB under unsecured loans in the Balance-Sheet. He deleted the said disallowance.
ITA.741,742, 774 & 775/B/2010 Page - 10
25. In respect of excluding the telecommunication charges from export turnover without deducting from total turnover, the Commissioner of Income- tax(A) dismissed the grounds raised by the assessee company on the basis of his own earlier decision.
26. In short, the Commissioner of Income-tax(A) allowed the grounds of the assessee company on depreciation allowance for both the assessment years. He fully allowed the claim of Market promotion expenses for the assessment year 2006-07 and partly allowed for assessment year 2005-06. FCCB issue expenses have been allowed; but confirmed the adjustment of telecommunication expenses made u/s.10A.
27. The Revenue is aggrieved on questions of depreciation allowance on software ; payments made to foreign companies for market promotion ; and FCCB issue expenses. The assessee is aggrieved by the confirmation of disallowance of payments made to Indian company for market promotion and on the adjustment of telecommunication expenses u/s.10A. The assessee has also raised grounds against levy of interest u/s.234B and 234C.
28. On the basis of the common grounds raised in this cross appeals, the following issues arise for our consideration :
ITA.741,742, 774 & 775/B/2010 Page - 11
i) Whether the assessee is entitled for depreciation on the
purchase cost of software and for that matter whether the assessee has purchased Assets itself or only a right to use and if so, whether the payments amount to Royalty ?
ii) Whether the expenses incurred for market prospecting could be held as incurred for obtaining technical services and liable for tax ? If so, whether the payments made to foreign companies were liable for TDS or not ?
iii) Whether FCCB issue expenses are in the nature of Capital or Revenue ?
iv) Whether the adjustment of telecommunication charges made u/s.10A is justified or not ?
29. We heard Shri. G. V. Gopala Rao, the learned Commissioner of Income-tax for the Revenue and Shri. V. Srinivasan, the Chartered Accountant appearing for the assessee.
30.1. The issue of depreciation has been discussed in detail in pages 02 to 10 of the assessment order for the assessment year 2005-06. The Commissioner of Income-tax(A) also has examined the issue in detail as discussed in pages 03 to 07 of his order. The assessing authority has held that the assessee has acquired only the right to use the software products and therefore the payments made ITA.741,742, 774 & 775/B/2010 Page - 12 would amount to payment of royalty where section 9 applies and consequently sections 194J and 40(a)((i)/40(a)(ia).
30.2. The Commissioner of Income-tax(A) has held that the above finding was based only on certain clauses of the agreements and he has not considered the clauses which enabled the assessee to exercise the option to purchase the products and where in fact, the assessee had exercised the option and purchased the products.
30.3. The nature of the business carried on by the assessee has been discussed by the Assessing Officer for assessment y ear 2005-06 in para 03 of his order, which is extracted below :
"3. The assessee-company (hereinafter CSIL) was established in the year 1991. The company started as a distributor of anti-virus software in Bangalore and later moved on to become solo authorized distributor of MATLAB in South Asia in 1993. The assessee-company provides enterprise statistical analytics and engineering simulation software products and solutions across the globe. The company's business interest span, products, productized solutions, services and R & D in future technologies. CSIL offers a range of proprietary products viz., SYSTAT, SIGMA PLOT, SIGMA STAT, PEAKFIT, iCAPELLA, and other products from IBM, Texas Instruments, Mathworks, etc.,"
ITA.741,742, 774 & 775/B/2010 Page - 13 30.4. The agreements entered in to by the assessee have to be examined in the background of the above mentioned activities of the assessee which predominantly include sale of proprietary products of the assessee. The agreements are titled as "software" distribution and asset purchase agreement. The agreements thereafter provides for procurement of products on outright purchase basis even though option is available for licence-arrangement as well. There is no doubt that the assessee has exercised its option for purchases and the products were acquired as purchase of assets. The assessee is using those products to develop its own branded proprietary software packages. While discussing the issue of marketing expenditure incurred in Europe, the Assessing Officer himself has acknowledged the promotion of assessee's patented products like Pcats, Witel and bwd asset (Para 21 of te assessment order). In para 3 of the order the Assessing Officer has referred to the proprietary products like SYSTAT, SIGMA PLOT, SIGMA STAT, PEAKFIT, iCAPELLA, etc 30.5. As rightly observed by the Commissioner of Income-tax(A), the assessee has exercised its option to purchase the products. The payments were made against purchases. The pricing has been made on purchase basis. The assessing authority is seen to have examined certain clauses of the agreements on selective basis by reproducing the clauses relating to securing of a licence to modify and market the software. The assessing authority has not discussed the clauses ITA.741,742, 774 & 775/B/2010 Page - 14 relating to purchase by exercising option and he has also not acknowledged the fact that the assessee had exercised the option and purchased the products. 30.6. In the light of the above facts, we find that the Commissioner of Income- tax(A) is justified in holding that the assessee had purchased the software and capitalized the cost in asset account. Therefore, he is justified in holding that the payments made by the assessee against purchase of software cannot be held as "Royalty". The Commissioner of Income-tax(A) is justified in deleting the disallowance of depreciation for both the assessment years under appeal. 30.7. The first issue of depreciation allowance on software is decided in favour of the assessee-company.
31. The Commissioner of Income-tax(A) has further held that sections 40(a)(i)/40(a)(ia) do not apply to depreciation as depreciation is not an expenditure in the nature of interest, rent, royalty, fees mentioned in those sections and depreciation cannot be disallowed for violation of section 194J. As the issue has already been decided on the facts of the case that software were procured as purchases, we need not proceed to consider the above legal controversy.
ITA.741,742, 774 & 775/B/2010 Page - 15
32. The Commissioner of Income-tax(A) has further held that for the assessment year 2005-06, the disallowance would not be justified as the law did not include royalty which was inserted only from assessment year 2006-07. This finding holds good.
33.1. The second common issue is that of payments made for expenses incurred in market mobilization. The payment of ` 1,36,44,000/- was made to German Company in the asst.year 2005-06. A sum of ` 2,16,76,000/- was paid to an Indian company, M/s. S2 Softtech Pvt. Ltd. In the asst. year 2006-07, ` 39,08,79,350/- was paid to a Singapore company, M/s. Aamer Pacific. 33.2. The payment was made to the German company for rendering market support for positioning the software products and branding those products for the assessee in European market. The payment was made to the Indian company towards market survey and research activities by compiling customer data base for promoting assessee's proprietary products. The Singapore company was paid for marketing and promotion of assessee's products abroad. 33.3. All the services rendered to the assessee, thus are professional and technical in nature. The products of the assessee-company are software products. The promotion of those products in competitive markets require technical expertise.
ITA.741,742, 774 & 775/B/2010 Page - 16 Market landing of those products call for elaborate marketing management network and extreme professional strategy.
33.4. Therefore, the payments made by the assessee company have been rightly treated as fee for technical services.
33.5. This issue is decided in favour of the Revenue.
33.6. But, the German company and Singapore company did not have any PE in India. Payments were made outside India. Services were rendered outside India. Profits were generated in the hands of those companies outside India. 33.7. The Hon'ble Supreme Court in Ishikawajima-Harima Heavy Industries v. DIT (288 ITR 408) (SC), has held that the services which are sources of income sought to be taxed in India must (i) be utilized in India and (ii) rendered in India. In the present case of payments to foreign countries, both the conditions have not been satisfied simultaneously. Therefore, in the light of above judgement, the exception available u/s.9(1)(b) applies to the payments made to the two foreign companies.
33.8. The Hon'ble jurisdictional High Court in the case of Jindal Thermal Power Company Ltd., v. DCIT (26 DTR 172) (Kar) has held that the criteria of ITA.741,742, 774 & 775/B/2010 Page - 17 rendering service in India and the utilization of service in India laid down by Hon'ble Supreme Court in Ishikawajma's case remains the same in spite of Explanation inserted to Section 9(2).
33.9. Therefore, the Commissioner of Income-tax(A) is justified in deleting the disallowance of ` 1,36,44,000/- for the asst. year 2005-06 and ` 39,08,79,350/- for the asst. year 2006-07, being the payments made to German company and Singapore company respectively.
33.10.So also the Commissioner of Income-tax(A) is justified in confirming the disallowance of ` 2,16,76,000/- for the asst. year 2005-06 being the payment made to Indian company, M/s. S2 Softtech Pvt. Ltd., 34.1. Next is whether FCCB issue expenses are capital or revenue in nature. The assessee company had incurred expenses in connection with the issue of foreign currency convertible bonds. Assessee claimed the expenses as deductible as the expenses were incurred to raise loan finance. The assessing authority held that the bond holders had the option to convert the bonds to equity shares and therefore, the collection of funds through the issue of bonds needs to be treated as to increase the capital and therefore the connected expenses would be capital in nature and hence disallowed.
ITA.741,742, 774 & 775/B/2010 Page - 18 34.2. We agree with the view of the Commissioner of Income-tax(A) that the expenses are not capital in nature. As on 31.03.2006, the previous year ending for the asst. year 2006-07, the funds collected by the assessee company through the issue of FCCB, were in the nature of liability. The assessee company was bound to discharge the bonds on due dates. The assessee was paying interest to bond-holders. It is clear that the bond finance was in the nature of loan finance. 34.3. It becomes the capital of the company only when the bond holders exercise their option at the appropriate time in future. That conversion is only a future event, that may or may not happen, depending on the option exercised by the bond-holders. Therefore, the possible equity character of the funds was contingent on the fact whether bonds would be converted or not in a future date. The nature of a present day loan fund cannot be held as equity fund on the basis of such contingency.
34.4. As far as the nature of the funds for the asst. year 2006-07 is concerned, it was a liability in the nature of loan, that too interest bearing loan. If the funds are treated as equity capital for asst. year 2006-07, how the payment of bond interest would be justified in law, as law does not permit payment of interest on a company's equity capital.
ITA.741,742, 774 & 775/B/2010 Page - 19 34.5. In the facts and circumstances of the case, the issue is decided in favour of the assessee.
35.1. The next issue is that of section 10A -computation with reference to telecommunication charges. The Assessing Officer has excluded the charges from export turnover alone; no corresponding exclusion is made from total turnover; thereby the assessee is loosing a marginal amount in the quantum of section 10A benefit.
35.2 ITAT, Chennai in a Special Bench decision in the case of SAK Soft Ltd., reported in 313 ITR (at) 353, has held that the exclusion must be made from total turnover as well.
35.3. In the light of the above Special Bench decision that the adjustment must be factored both in export and total turnover, we direct the assessing authority to exclude the telecommunication charges from total turnover as well and revise the computation of the quantum of benefit available u /s.10A. 35.4. This issue is decided in favour of the assessee.
ITA.741,742, 774 & 775/B/2010 Page - 20
36. The grounds relating to the levy of interest u/s.234B and 234C are consequential which do not call for any formal adjudication. They shall be considered by the assessing authority in accordance with law.
37. In result :
Appeal of the assessee for A. Y. 2005-06 is dismissed. Appeal of the assessee for A. Y.2006-07 is allowed. Appeals of Revenue for A.Ys. 2005-06 & 2006-07 are dismissed. Order pronounced on Tuesday, the 08th day of February, 2011, at Bangalore.
Sd/- Sd/-
(P. MADHAVI DEVI) (DR. O. K. NARAYANAN)
JUDICIAL MEMBER VICE PRESIDENT