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Facts
The assessee, Knowlarity Communications India Private Ltd., appealed against the order of the CIT(A) upholding additions made by the AO. The AO had made ad hoc disallowances for foreign exchange difference and server hosting charges. Additionally, the AO added Rs. 51 crores received as share premium from a foreign holding company under Section 68 r.w.s. 115BBE.
Held
The Tribunal held that the disallowance of foreign exchange difference and server hosting charges were made on an ad hoc basis and required further examination. Regarding the share premium, the Tribunal noted that investment in shares is a capital transaction and not income. Relying on High Court decisions, it was held that the source of the source was not required to be established for investments from a foreign parent company, especially when sourced from a venture capital.
Key Issues
Whether ad hoc disallowances for foreign exchange difference and server hosting charges were justified. Whether the addition of share premium received from a foreign holding company under Section 68 was sustainable, particularly concerning the requirement to establish the source of the source.
Sections Cited
143(3), 37, 145, 68, 115BBE, 234A, 234B, 234C, 270A, 271AAC, 133, 56(2)(viib)
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Income Tax Appellate Tribunal, DELHI BENCHES: E : NEW DELHI
Before: SHRI M. BALAGANESH & SHRI ANUBHAV SHARMA
IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCHES: E : NEW DELHI BEFORE SHRI M. BALAGANESH, ACCOUNTANT MEMBER AND SHRI ANUBHAV SHARMA, JUDICIAL MEMBER Assessment Year: 2017-18 Knowlarity Communications India Vs ACIT, Private Ltd., Circle 14(2), Awfis, 7th Floor, Delhi. Ambience Mall, NH-8, Gurgaon, Haryana – 122 002. PAN : AAFCK1875R (Appellant) (Respondent) Assessee by : Shri Salil Kapoor, Shri Shivam Yadav, Shri Sumit Lalchandani & Ms Ananya Kapoor, Advocates Revenue by : Ms Rajinder Kaur, CIT-DR Date of Hearing : 18.03.2025 Date of Pronouncement : 06.06.2025 ORDER PER ANUBHAV SHARMA, JM:
This appeal is preferred by the assessee against the order dated 31.01.2024 of the Ld. Commissioner of Income-tax (Appeals), NFAC, Delhi (hereinafter referred to as the Ld. First Appellate Authority or ‘the Ld. FAA’, for short) in Appeals No.CIT(A), Delhi-5/10229/2019-20 arising out of the appeal before it against the order dated 21.12.2019 passed u/s 143(3) of the Income Tax Act, 1961 (hereinafter referred as ‘the Act’) by the ACIT, Circle 14(2), Delhi (hereinafter referred to as the Ld. AO).
The appellant is engaged in providing super receptionist cloud-based telephony services. During the relevant year, the return was filed at a total loss of Rs.4,10,65,410/- and claiming a refund of Rs.14,09,690/-. The return was revised and the current year loss to be carried forward was reduced to Rs.2,88,15,783/- and the refund of Rs.14,09,690/- was claimed. In the assessment proceedings, the AO had made the following ad hoc disallowances:- S. No. Expense Disallowed Expenses Expense Claimed disallowed 1 90% of Foreign exchange difference 1,39,35,348 1,39,35,348 (Net) 2 80% of Server hosting charges 2,85,58,037 2,28,46,430 3 10% of Rates and taxes 38,59,304 3,85,930 Total Adhoc disallowances made 4,63,52,689 3,71,67,708
Further, the appellant company during the year issued 57 lakh equity shares to its holding company Knowlarity Communications Holding Pte Ltd. on different dates having face value of Rs.1 per share with a premium of Rs.59 and Rs.99 and received Rs.51 crores through banking channel directly from Singapore. The AO had made addition of this amount u/s 68 r.w.s. 115BBE of the Act. The CIT(A) had given the relief partly for which the assessee is in appeal raising the following grounds:- “
1. That the Learned Commissioner of Income Tax (Appeals) [Ld. CIT(A)] erred both in law and in respect of facts of the case on certain issues on which disallowance has been done against the appeal filed by the Appellant. The Ld. CIT(A) erred in not fully allowing the appeal filed by the Appellant vide its order dated 31.01.2024 bearing order no.
2. ITBA/NFAC/S/250/2023-24/1060348370(l) under section 250 of the Income Tax Act, 1961 (‘the Act’) for assessment year 2017-18 and upholding the order passed by the Learned Assessing Officer (‘Ld. AO’).
2. That in view of the facts and circumstance of the case, the ad-hoc disallowance of Rs. 1,39,35,348/- towards exchange difference is illegal, bad in law and deserves to be deleted. The Ld. AO / CIT(A) erred in not appreciating the fact that creation of foreign exchange difference is the statutory requirement imposed by Accounting Standard - 11 ‘The effects of changes in foreign exchange rates’ and no disallowance can be made.
3. That in view of the facts and circumstance of the case, the disallowance of Rs. 1,95,24,984/- towards server hosting charges is illegal, bad in law and deserves to be deleted. The Ld. AO / CIT(A) erred in not appreciating the details submitted by the Appellant which suffice its claim towards expenditure for payments made on account of server hosting charges.
4. That in view of the facts and circumstance of the case, the disallowance u/s 37 of the Act for charges paid towards server hosting has been done while commenting on the authenticity of the books of accounts, thus far exceeding its jurisdiction and without invoking the provisions of Section 145 of the Act. Thus, this disallowance is arbitrary and bad in law.
5. That in view of the facts and circumstance of the case, the Ld. C1T(A) has invoked the provisions of Section 68 of the Act on amounts received by the Appellant towards share capital from non-residents, thus has committed a fundamental error in the application of aforementioned provisions.
6. That in view of the facts and circumstance of the case, the Appellant had discharged its onus to prove the identity and genuineness of the transaction by furnishing the details of share capital money received. Hence, all necessary details and evidence have been duly filed and furnished.
7. That in view of the facts and circumstances of the case and in law, the Ld. AO / CIT(A) has erred in making the addition under Section 68 of the Act and has failed to appreciate that the mandatory preconditions for invoking Section 68 of the Act have not been fulfilled in the present case and thus the invocation of the Section and the addition made therein is illegal, bad in law and liable to be deleted.
8. That in view of the facts and circumstances of the case and in law, the Ld. CIT(A) has far exceeded his authority by challenging the valuation report and the basis of preparation. 3
9. That in view of the facts and circumstances of the case and in law, the Ld. C1T(A) erred in not appreciating the provision of law which allows the Appellant to obtain the valuation report from an accountant for the purposes of satisfying the provisions of Rule 11UA.
10. That in view of the facts and circumstances of the case and in law, the Ld. AO / CIT(A) has erred in not appreciating that Section 115BBE is not applicable which is in consequence to wrong invocation of Section 68 of the Act.
That in view of the facts and circumstance of the case, the explanations given, evidence produced and material placed and made available on record have not been properly considered and judicially interpreted. The observation/addition made is unjust, illegal, arbitrary, highly excessive and based on surmises and conjectures. 12. That interest under Section 234A, 234B and 234C of the Act has been wrongly and illegally charged and has been wrongly worked out. 13. That, the Ld. AO has erred in initiation of penalty proceedings under Section 270A and 271AAC of the Act. 14. That Appellant reserves its right to add, amend or withdraw any grounds of appeal, before the appeal is finally heard.”
4. Heard and perused the record. In regard to grounds No.1 and 11, we find that the same are general in nature and grounds No.12, 13 and 14 are consequential, thus, require no separate adjudication.
5. Ground No.2: In regard to this ground, we find that the AO has made a disallowance of Rs.1,39,35,348/- which pertains to the restatement of balances pursuant to Accounting Standard-11 which require to give effects on changes in foreign exchange rates as notified u/s 133 of the Companies Act, 2013. The AO has found the same to be on higher side. The case of the assessee is that the AO has ignored the fact that it is the legal requirement to adjust the foreign receivables and payables in the balance sheet on the closing date according to the exchange rate in force. The ld. AR has pointed out that in fact, after observing the 90% of Rs.1,39,35,348/- is disallowed and added back to the income of the assessee which comes to Rs.1,25,41,813/- in the final calculation the complete amount of Rs.1,39,35,348/- is disallowed. The case of the assessee is that in response to notice issued by the AO, the assessee had submitted ledger details of expenses along with the copy of invoices on sample basis and without raising any further questions, the disallowance was made on ad hoc basis. In this context, we find that the CIT(A) had called for a remand report from the AO wherein again the AO had asserted that the assessee has not provided any information as to why there is such huge increase in this head of expense, i.e., exchange difference. At page 119 of the paper book, the assessee has provided the ledger of unrealized foreign exchange gain which has been debited to Knowlarity Communications Holdings Pte Ltd. by way of a general voucher. Thus, we consider it an appropriate issue to be set aside to AO with a direction to the assessee to file complete details. AO shall give an opportunity for same. Accordingly, this ground is sustained for statistical purposes.
6. Grounds No.3 and 4: The AO has made an ad hoc disallowance of 18% of business expenditure for server hosting charges amounting to Rs.2,85,58,037/- paid to various independent vendor not related to the assessee company. The AO has considered the same to be on higher side. Ld. AR has submitted that the AO has incorrectly recorded that evidences were not filed. The ld.CIT(A) has given a partial relief to the assessee on the basis of limited evidences in the form of sample invoices filed. He has observed that some of the entries of payment pertained to AY 2017-18. Thus, this issue is also requires to be restored to the files of the AO with a direction to give an opportunity to the assessee to file complete details and not just a sample invoice. Due opportunity shall be given by the AO for the same. The grounds are sustained for statistical purposes.
7. Ground No.5 to 10; The AO had examined the receipt of Rs.51 crores from share premium during the year and found that the assessee has failed to substantiate the source of the source of these funds. Allegedly, the assessee failed to submit copy of ITR, balance sheet, any confirmations, balance confirmation during the course of assessment proceedings and, thus, the genuineness and credit worthiness of these transactions were allegedly not established. The claim of the assessee is that the amount was received from holding company and, after necessary and statutory compliances and approval from the Reserve Bank of India and other regulators of remittances of foreign exchanges. The ld. AR has also submitted that addition u/s 68 had been made without an opportunity of hearing.
8. In this context, we find that at page 345 of the paper book, the assessee has provided copy of notice u/s 142(1) of the Act and in annexure attached to it 6 by way of query No.8, the AO had called for providing details of the parties from whom share application money was received and with query No.9, valuation report for share application received was sought. The assessee, vide the reply, copy of which is available at page 349 of the paper book, had provided the necessary details including Form PAS-3, copy of foreign inward remittance certificate and copy of valuation reports. At page 596 of the paper book Vol.II, copy of show cause notice is provided by the assessee which shows that the assessee was questioned specifically with regard to examining the receipt for the purpose of section 56(2)(viib) of the Act and the assessee was directed to provide complete valuation report of the shares, source of such funds along with confirmations, source of source along with confirmations and balance sheets for AYs 2016-17, 2017-18 and 2018-19. At page No.601, copy of assessee’s reply is provided wherein all the relevant details were provided including mentioning that the fair value have been derived on DCF method.
As regards the source of the source of such funds, it was submitted that the holding company has received money from approved venture capital fund ‘Sequoia Capital’ for the purpose of operations and expansion. A copy of bank statement clearly mapping out funds received from Sequoia and invested by holding company was also provided to AO vide submissions dated 10.12.2019. It was also specifically stated that provisions of section 56(2)(viib) of the Act are not applicable as the consideration is received from a non-resident.
Thus, very apparently, at the first instance, after issuing show cause notice for examining the receipt of share premium u/s 56(2)(viib) of the Act, the AO has made an addition u/s 68 of the Act alleging the source of source is unexplained. Though the CIT(A) has done some exercise to examine the valuation of the fair market value of the shares but then sustained addition only u/s 68 of the Act for the reason being failure of the assessee to establish the source to be genuine. However, completely overlooking the fact of investments coming from the parent company. The Hon’ble Delhi High Court in M/s Angelantoni Test Technologies SRL vs. ACIT, W.P.(C) 15928/2023 & CM APPL 64160-64161/2023 has relied its decision in Nestle SA Versus Assistant Commissioner of Income Tax [W.P.(C) No.12643/2018] to hold that it is settled law that investment in shares in an Indian subsidiary cannot be treated as income and that such investment in shares are ‘capital account transaction’ not giving rise to any income. Reliance in this regard is also placed on the decision of the Hon’ble Bombay High Court in the case of Vodafone India Services Pvt. Ltd. vs. Union of India (2014) 368 ITR 1 (Bom). Further, the coordinate Bench in ACIT vs. M/s Experion Hospitality Pvt. Ltd., order dated 20.09.2023 in which one of us, i.e., the Judicial Member was in quorum, has found substance in the contention of the assessee that the investing company being foreign company, the source of the source was not required to be established even after amendment brought in section 68 of the Act qua obligation to establish the source of the source. The decision has been sustained 8 by the Hon’ble Delhi High Court in order dated 19.07.2024 observing that the findings given do not give rise to any substantial question of law. Even otherwise in the case before us the assessee had brought on record that remittances received as share premium were sourced by the parent company from a venture capital. Thus, there was no justification to make any addition u/s 68 of the Act on facts or in law. The grounds deserves to be sustained.