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Income Tax Appellate Tribunal, “I” BENCH, MUMBAI
Before: SHRI AMIT SHUKLA, JM & SHRI S. RIFAUR RAHMAN, AM
आदेश / O R D E R Per Amit Shukla, Judicial Member: The aforesaid cross appeals have been filed by the assessee and revenue against separate impugned order of even date 09.06.2017, passed by Ld. CIT (Appeals)-24, Mumbai for the quantum of assessment passed u/s 143(3) for the AY 2006-07, 2009-10 & 2010-11.
Since the issue involved in all the cross appeals filed by the assessee as well as revenue are identical arising out of similar set of facts and same reasoning have been given in the orders of the AO and Ld. CIT (A), therefore the same were heard together and are being disposed of by the way of this consolidated order.
In the assessee’s appeal on merits, the only one issue which has been raised is, taxability of the unearned revenue disclosed in
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the balance sheet as income of the current year without appreciating that the assessee has been following consistent method of percentage completion as per the AS-9-Revenue Recognition whereby income is recognized over a period of time following the matching concept of accounting. Besides this, assessee has also challenged levy of interest u/s 234A, 234B, 234C and 234D, which at the time of hearing Ld. Counsel submitted that are consequential in nature.
Apart from that, additional ground has also been filed by the assessee regarding the liability of education cess which again at the time of hearing has not been pressed. In AY 2006-07, assessee has also challenged the validity of reopening u/s 147 of the Act which too has not been pressed at the time of hearing; therefore, the same are dismissed as not pressed.
The effective issue in all the appeals pertains to taxability of the unearned revenue during the year; whereas in revenue’s appeals, the sole issue raised is that Ld. CIT (A) has erred in allowing the assessee by holding that payment made by assessee to
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its AE for purchase of subscription services for reselling is not „royalty‟ within the meaning of section 9(1)(vi).
As a lead case, we are taking up cross appeals for AY 2006-07 and our findings given therein will apply mutatis mutandis in all the other cross appeals i.e. AY 2009-10 and 2010-11.
In so far as assessee’s appeals, Ld. Counsel for the assessee submitted that this precise issue regarding taxability of unearned revenue had been decided in favour of the assessee by the Tribunal in assessee’s own case for AY 2016-17 in ITA No. 1379/Mum/2021 vide order dated 25.02.2022. On the other hand, Ld. DR admitted that this issue is covered in favour of the assessee.
The brief facts qua the issue involved are that, assessee is engaged in the business of marketing, promotion and distribution of „Red Hat Subscriptions‟ to customers in the Indian sub-continent. The ‘Red Hat Subscriptions’ enable the subscribers to avail support services for Red Hat ‘open source’ software such as Linux which grants every user ‘free’ access to the source code and enables the
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user to modify and customize the same to suit its requirement. The assessee provides support services to the customers under the ‘Red Hat Subscriptions’ so purchased include ongoing support for the open source software used by the customers during the subscription period, troubleshooting support for the open source software by responding to queries pertaining to the open source software through web based systems and telephone calls.
In so far as the taxability of unearned revenue, it has been stated that during this year under consideration, the ‘Red Hat Subscription’ are purchased by the assessee from Red Hat Asia Pacific Pte. Ltd., a Singapore based entity and these subscriptions enable the customers of the assessee to avail maintenance support services for Red hat 'open source' software. The assessee basically acts as distributor of Red Hat Subscription which enables the customers in India to avail the support services for open source software systems for a period ranging from one to seven years, which is established through specific subscription agreement or contract. The assessee has accounted the revenues for which the services would also be performed in the future years in its books as
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‘unearned revenues’. It was further stated that the above practice adopted by the assessee in respect of accounting for the sale of subscriptions, is in line with the principles laid down in Accounting Standard-AS-9 issued by the Institute of Chartered Accountants of India (ICAI).
In respect of rendering of services, AS-9 provides that revenue should either be recognized on a straight line basis over the period in which the services are proposed to be rendered or in the event where the services yet to be performed are so significant in relation to the transaction taken as a whole that performance cannot be deemed to have been completed until the execution of those acts, revenue should be recognized when the sole or final act takes place and the service becomes chargeable.
The assessee enters into contracts with the customers to sell Red Hat Subscriptions. These subscriptions enable the customers to avail the services over a period of time as may be specifically agreed with its customers in the agreement. The primary responsibility to ensure that the end users receive the services under the Red Hat subscriptions dwells on the assessee. While the
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assessee may engage and compensate another party to perform the services, the assessee records the revenue from the subscription. In the event of any deficiency of services /non provision of services, the assessee would be liable to pay pro rata refund for unexpired period of subscription /re-performance of the services to its customers. In view of the above, the assessee recognizes revenue earned from the sale of subscriptions over the period during which the services are performed. Further, the said accounting policy has been consistently followed by the assessee and has been considered appropriate by the auditors.
It was further stated that in the event where a customer is not satisfied with the services, he may seek a proportionate refund for the unexpired period and in such an event the assessee would be obliged to refund the same to the customer. There have been instances in the past where if the customer is not satisfied with the services, the assessee has refunded the appropriate amount for the unexpired period of the subscription bought by the customer.
The AO rejected the contention of the assessee and noted that assessee is merely a distributor of support services and not the
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provider of the subscription of support services to be provided by its AE. The assessee has charged all the expenses including the full cost of access to the subscription services, commission and training expenses, etc. without taking into account the corresponding revenue. Thus, assessee has violated the matching concept of accounting by acknowledging the entire expenses without accruing the corresponding revenue.
Ld. AO further observed that assessee is merely a re- distributor of the subscription rights to be performed by the AE and not by the assessee. The performance of the assessee is complete immediately after the sale of subscription right. He also referred ‘Reseller Agreement’ entered into as on 1st October 2006 between the assessee and its Singapore AE. After a detail discussion, he held that AS-9 pertaining to Revenue Recognition does not apply as AE of the assessee is providing support services and assessee is mainly selling the access code for the subscription. Thus, the revenue is aggrieved by the sale of access code is to be considered as income for that year only. AO has also referred to various judgments in his order in support of his reasoning and finding and accordingly, he
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held that unearned amounting to Rs. 19,80,033/- is income of the assessee. His relevant findings reads as under:- RHIPL has not submitted any documentary evidence to substantiate that significant performance obligation remain pending on the reseller after the subscription services are resold. The accounting standard requires that even in the case of guaranteed sale the revenue be recognized at the time of sale. AS-9 on Retail Sale- In the case of retail sales offering a guarantee of "money back if not completely satisfied" it may be appropriate to recognize the sale but to make a suitable provision for returns based on previous experience Even if, some expenditure are required to be done by RHIPL to perform its obligation as reseller, the same can be easily estimated. Further, there is no definite liability on the assessee as a reseller of the Subscription services. 6.19 In view of the above discussions, it is established that the assesses's method of accounting is not correct. Income is accrued to the assessee at the time of sale of access code. He is required to recognize the full revenue, immediately after his performance to the sale transaction is over i.e after the training of user and activation of access code.
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6.20 By deferring the revenue recognition over many years and by charging the entire expenses corresponding to this revenue in the year of sale, the assessee has evaded its tax liability by reducing its Revenue and Profit. Accordingly, RHIPL's income is recomputed by recognizing the "Unearned Revenue" of Rs. 35,75,75,020/- shown in the current liability as accrued revenue not yet offered for tax. In absence of the details on record, it is not possible to allocate this unearned revenue to the earlier financial years and since this unearned Revenue has not been offered to tax in any of the earlier years the same is taxed as revenue in the A.Y under consideration. In view of the above discussion the total unearned amounting to Rs. 19,80,033/- is added to the total income of the assessee. Penalty proceedings are separately initiated u/s 271(1)(c) r.w.s.274 of the Act for concealment of income and for furnishing inaccurate particulars of income. 15. Ld. CIT (A) too has confirmed the reasoning of the AO and independently referred to the ‘Reseller Agreement’ between assessee and Singapore entity. After referring to AS-9 observation, he held that assessee is selling the access code only, therefore it does not hold merit. Accordingly, the entire revenue recognized by the assessee in the year of sale and not deferred over the period of contract.
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The Tribunal in AY 2016-17 following the assessee’s own case for AY 2012-13 order dated 10.04.2019 has accepted the assessee’s contention. The relevant observation of the Tribunal read as under:-
We have perused the order passed by the co-ordinate Bench of the Tribunal in assessee’s own case wherein the issue in question has been decided in favour of the assessee. 73. Undisputedly, the assessee has entered into Red Hat Enterprise Agreement (subscription agreement) with third party Indian customers which enable such customers to avail support services (subscription services) such as ongoing maintenance support services, updates, promotion and sale of 'Red Hat subscriptions' to customers in Indian sub-continent to avail support services that are for the open source software system during the subscription period which generally spreads from 1 to 7 years. 74. The Ld. A.R. for the assessee contended that the assessee has recognized revenue from subscription service in its books of account as per the Percentage Completion Method (PCM) prescribed under Accounting Standard-9 (AS-9). Revenue recognition and subscriptions are provided over a period of 1 to 7 years, the amount received from customer in relation to subscription services are offered to tax on straight line basis under “Long term basis” and “other current liabilities” and is offered as income in the profit & loss account in subsequent years and accordingly offered to tax.
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For this subscription services the assessee also claimed to have entered into agreement with Red Hat US under which it is required to pay royalty and services fee to Read Hat US, computed as specific percentage of revenue recorded in profit & loss account of the assessee for the respective years, available at page B239, B252 of the paper book of volume-2. At the same time due taxes have been deducted and paid with Income Tax Authority while making such payment to Read Hat US. 76. However, the AO treated such advances received (unearned revenue) as income of the year under assessment by rejecting the revenue recognition policy followed by the assessee. 77. We have perused the order passed by the co-ordinate Bench of the Tribunal in assessee’s own case available at page B22 to B57 wherein this issue has been decided in favour of the assessee by returning the following findings: “61. Upon careful consideration we find that assessee has been following consistent system of revenue recognition. The assessee is inter alia engaged in the business of marketing, promotion and sale of 'Red Hat subscriptions' to customers in Indian sub- continent to avail support services that are for the open source software system during the subscription period ranging from one to seven year, which is established by the special services agreement or contract. As per the consistent policy of revenue recognition, the assessee accounts for the revenue for service which would be performed in future year in its books as
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unearned revenue. Assessee's claim is that this practice by the assessee in respect of accounting for the sale of subscription is in accordance with Accounting Standard9 issued by ICA1. In support of this it is submitted that for rendering of service AS-9 provides that revenue should either be recognized on straight line basis over a period in which services are proposed to be rendered. The Assessing Officer has tinkered with this regularly adopted system on the plea that no further services is required to be performed by the assessee, that there is no significant uncertainty existing regarding amount of consideration that will be derived. The Assessing Officer has also find fault with compelated contract method claimed to have been followed by the assessee. 62. Assessee's contention in this regard is that the assessee never claimed that it is recognizing revenue from subscription under completed service contract method rather it is following the percentage compelation method for recognition of revenue. Assessee has further reiterated that the assessee has been regularly recognizing revenue over a period to which such subscription relates. It has been claimed that the said practice of recognizing revenue is in accordance with paragraph-? of percentage complete method of AS-9. The assessee has further placed reliance upon the Income Computation and Disclosure Standard (ICDS) issued by the CBDT pursuant to section 145(2) vide Notification No. 21/2016 dated 29.9.2016 for the proposition that when services are provided by indeterminate number of acts over a period of specified time, Revenue may be
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recognized on straight line basis over specified period. The assessee has further relied upon the analogy from recently introduced section 43CB. In the light of the above assessee's contention is that subscription package agreed may involve various support services which cannot be predeterminate. Recipient of service can raise queries numerous times during the tenure of agreement. Similarly, any correction bug fixes etc. can be required by the customers any time during the duration of the agreement. In the light of the above submissions in our considered opinion the Assessing Officer has clearly erred in changing consistently followed method of revenue recognition adopted by the assessee. In the facts and circumstances elaborately dealt with above, we find due merits of the revenue recognition adopted by the assessee which is duly supported by mandate of AS-9 and other parameters referred above. 63. We also note that it is also a settled law that unless there is change in the facts and circumstances or that it can be said that earlier adopted system was wrong, revenue recognition method cannot be disturbed. We note that no such case exists here. In these circumstances, we set aside the order of the Assessing Officer and delete the addition in this regard.” 78. Moreover, revenue recognition policy has been consistently being followed by the assessee over the years. This identical issue has also been dealt with by the Hon’ble Delhi High Court in the case of CIT vs. Dinesh Kumar Goel (197 Taxman 375) by relying
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upon the decision rendered by the Hon’ble Supreme Court in the case of E.D. Sassoon & Co. Ltd. vs. CIT (1954) 26 ITR 27, wherein the issue “whether the customer had paid entire fee in advance on which services remained due to be rendered in succeeding years, such receipts could not be considered as income accrued in the year of receipts”, has been decided by the Hon’ble High Court by returning the following findings: “Reading of the accounting standard makes it clear that the revenue is recognized only when the services are actually rendered. If the services are rendered partially, revenue is to be shown proportionate to the degree of completion of the services. This really clinches the issue in favour of the assessee.” “…What is the relevant yardstick is the time of accrual or arisal for the purpose of its taxation, viz., in order to be chargeable, the income should accrue or arise to the assessee during the previous year. If income has accrued or arisen, even if actual receipt of the amount is not there, it would be chargeable to tax in the said year. Though the amount may be received later in the succeeding year, the income would be said to accrue or arise if there is a debt owed to the assessee by somebody at that moment. From this, it follows that there must be the "right to receive the income on a particular date, so as to bring about a creditor and debtor relationship on the relevant date". The Court further explained that a right to receive a particular sum under the agreement would not be sufficient unless the right accrued by
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rendering of services and not by promising for services and where the right to receive is interior to rendering of service, the income, therefore, would accrue on rendering of services...” 79. So in view of the matter and by following the order passed by co-ordinate Bench of the Tribunal in assessee’s own case for A.Y. 2012-13 & 2013-14 (supra), we are of the considered view that when due taxes have been deducted and paid to the Income Tax Authorities while making such payment to Red Hat US in terms of the agreement entered into between the assessee and the Red Hat US in accordance with the consistent revenue recognition policy adopted by the assessee, upheld by the Tribunal in assessee’s own case for earlier years, addition made by the Ld. AO/DRP on account of unearned revenue qua subscription services is not sustainable in the eyes of law. 17. Accordingly, following the aforesaid decision of Tribunal, we hold that addition made by the AO and confirmed by Ld. CIT (A) on account of unearned revenue like subscription services is not sustainable. Hence, Ground no. 2, 3, & 4 is allowed.
The other grounds of revenue on account of levy of interest u/s 234A, 234B, 234C and 234D are consequential in nature, therefore the same are dismissed.
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In other appeals of assessee for AY 2009-10 and 2010-11 also are exactly similar grounds, therefore, our decision as above are also applicable to these appeals as well. Therefore, these appeals are also allowed.
In so far as revenue appeal is concerned, the facts in brief are that AO noted that assessee has made remittance of Rs. 3,62,03,442/- to Red Hat Singapore for the import of software and according to him, the said payment is in the nature of „Royalty‟ not only under the provisions of section 9(1)(vi) and also ‘Fees for Technical Services‟ u/s 9(1)(vii); but as well as under Article 12 of India-Singapore DTAA. Since the assessee has failed to deduct TDS, as required u/s 195 while making payment of foreign bank, therefore, the same is disallowable u/s 40(a)(i). He has also referred to amend the provision of Finance Act 2012 in section 9(1)(vi). Though there is not much of discussion by the AO on this issue.
Before Ld. CIT(A), it was contended that the payment made to Red Hat Singapore for purchase of Red Hat Subscriptions for resale in India do not fall within the scope and definition of royalty as defined in Article 12(3) of India-Singapore DTAA or even as a matter
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of fact u/s 9(1)(vi) of the Act. It was further submitted that assessee is engaged is engaged in the business of marketing, promotion and distribution of ‘Red Hat Subscriptions’. The Red Hat Subscriptions enable the subscribers to avail support services for 'open source' software which is freely shared. Its source code can be downloaded free of cost from a variety of websites. Further, open source software is freely shared and there are no licensing fees for the use of, or the right to use, such software. The open source software (alongwith related documentation) is available freely in the public domain with universal access and hence, no consideration is paid for the software or for the use of the software. Further, the payments made by users of the Red Hat subscriptions are for the purposes of availing convenient installation, ongoing maintenance and support services provided by Red Hat engineers to the users of Red Hat Subscriptions and not towards Red Hat software. Thus, the payments received by Red Hat Singapore from the assessee are not towards sale of software as the same is open source software and is freely available in the public domain. Such payments are actually towards sale of subscriptions which enable the subscribers (i.e. the
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customers of the assessee) to avail support services for such open source software.
Ld. CIT (A) after considering the entire facts of the case, observed as under:-
6.5.1 I have carefully examined the arguments taken by the assessee and the submissions filed. I have also perused the assessment order in detail. On a careful analysis of all the facts considered together, the assessee has made payments to Red Hat Singapore for the Red Hat Subscription for Indian subcontinent customers. The source code of the software has not been shared by the assessee with the Indian customers. The assessee has contended that this is a freely shared software and hence, the assessee has not charged any license fees for the use of or right to use such a software. The assessee has primarily charged for availing convenient installation, ongoing maintenance and support services. 6.5.2 It is important to note here that as the software under question is freely shared, the said software does not provide a right in the copyright to the users. The Red Hat subscriptions purchased by the assessee from Red Hat Singapore are facilitated with the subscription keys which facilitate in the recognition/identification of an eligible subscriber/end user to avail the support services.
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Any modification, customization, correction or updates are also provided by the assessee to the customers. 6.5.3 As per section 9(1)(vi) of the Act and Article 12 of the DTAA, "payments of any kind in consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work" is deemed to be "royalty". Under the Copyright Act, 1957, a software programme constitutes a "copyright". A right to make a copy of the software and use it for internal business by making copy of the same and storing it on the hard disk amounts to a use of the copyright u/s 14(1) of that Act because in the absence of such a licence, there would have been an infringement of the copyright. 6.5.4 Accordingly, it is evident that the transaction involves only a free sale. The amount paid to Red Hat Singapore supply of the Red Hat Subscription is the price of the maintenance and support services and does not include the price of licence granted. In substance, the licencee was not granted any right permitting the end user to download the software, or to modify or customize the same. 6.5.5 This makes it clear that the end users have purchased subscription and no licence to use such subscription, which would allow the customer to modify/customize the software programme to its own use. 6.5.6 Further, section 9(1)(vi) and Article 12 define the term "royalty" to include any payment for the use of, or the right to use, a "copyright" of scientific work. Software programmes are a
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"copyright" and are protected under the Copyright Act, 1957. As the software programme is not a "copyright", any payment received for transferring the right to use it is not "royalty" as defined in the Act. The argument that there is a distinction between a "copyright" and a "copyrighted article" is acceptable because there is a distinction made between use of copyright and use of copyrighted article, with the assessee's case qualifying under the latter. Accordingly, the fee for the use of a "copyrighted article" is not assessable as "royalty". 6.5.7 Since no specific query has been raised by this office to the assessee asking the assessee to detail the reasons as to why the aforesaid payment should not be treated as fees for technical services under Act or DTAA, I have not discussed the same at this point of time. 6.5.8 The assessee has also submitted that the Hon'ble Mumbai ITAT in the assessee's own case has passed an order quashing the orders u/s. 201(1) and 201 (1 A) of the Act for AY 2007-08 and AY 2008-09. 6.5.9 On a perusal of the order, the Hon'ble Mumbai ITAT, following the Special bench ruling in the case of Mahindra & Mahindra Ltd. v. DCIT (28CCH 0220) has concluded by upholding the principle that where no action has been taken in the hands of the payee (i.e. Red Hat Singapore), there cannot be any liability for withholding taxes on the payer (i.e. the assessee). This ground of appeal is allowed
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We have heard both the parties at length and also perused the relevant material placed on record. We have already noted the facts as above. It is evident that the ‘Red Hat Subscriptions’ is purely for support services and it is open source software which is freely available after downloading from variety of website and no licence fees for the use of right to such software is charged. In fact no where it is discernable from records whether there was any kind of licence agreement for open source use of software. It is also not the case of AO that there is some kind of license which subscriber has to agree. In fact the software is available for free. There is no subscription for the use of software by the subscribers either to the assessee or Red Hat Singapore. The payments in question is made by the user of the Red Hat Subscriptions for the purpose of availing convenient installation, ongoing maintenance and support services provided by Red Hat engineers to the users of Red Hat Subscriptions and not towards Red Hat software. Thus, the payment does not towards sale of software which is freely available in the public domain. Therefore, in terms of Article 12(3) of India-
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Singapore DTAA it is not recognized royalty. The relevant extract of the said article reads as under:-
Article 12(3) of the Tax Treaty:- 3. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use: (a) any copyright of a literary, artistic or scientific work, including cinematograph film or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning Industrial, commercial or scientific experience, including gains derived from the alienation of any such right, property or information; (b) any industrial commercial or scientific equipment, other than payments derived by an enterprise from activities described in paragraph 4(b) or 4(c) of Article 8. 24. Thus, the payments made by the assessee to Red Hat Singapore for purchase of Red Hat Subscriptions for resale cannot be held to be use of copy right and also under the Copy Right Act, 1957, to fall within the scope and definition of royalty under Article 12(3). Further it cannot be treated as FTS as payments are not of any kind made to any person in consideration for services of a
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managerial, technical or consultancy nature, because Red Hat Singapore does not provide services to the assessee. Assessee is mainly purchasing subscription from the Red Hat Singapore and reselling to the customers while distributing in India and sub- continent. Here in this case, on purchase of the Red Hat Subscriptions, the customers in India is only eligible to obtain support services, i.e., trouble shooting, error solving, etc. in respect of the freely downloadable open source of software. The Red Hat Singapore does not make available any technical skills, knowledge, experience, process or knowhow to the assessee or the assessee’s customers through the sale of the subscriptions. Thus, the payment cannot be brought under the purview of Article 12(4). Thus, we agree with the reasoning and findings of Ld. CIT(A) that the transaction involved is free sale and the amount paid to Red Hat Singapore for supply of Red Hat Subscriptions is the price of maintaining and support services and not the price of any kind of licence granted. Nowhere the Red Hat Singapore has granted the right or permiting to download the software and there is no licence
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is payable to use as subscription. Thus, the order of Ld. CIT (A) is confirmed and the ground raised by the revenue is dismissed.
The ground raised in other appeals of revenue are exactly similar, therefore the aforesaid findings will apply mutatis mutandis to these appeals i.e. AY 2009-10 and 2010-11.
In the result, all the appeals filed by the assessee are partly allowed and all the appeals filed by the revenue are dismissed.
Orders pronounced in the open court on 28th July, 2022. Sd/- Sd/- (S. Rifaur Rahman) (Amit Shukla) Accountant Member Judicial Member मुंबई Mumbai;नदनधंक Dated : 28/07/2022 Sr.PS. Dhananjay
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आदेशकीप्रतितितिअग्रेतिि/Copy of the Order forwarded to : 1. अपीलधथी/ The Appellant 2. प्रत्यथी/ The Respondent आयकरआयुक्त(अपील) / The CIT(A) 3. 4. आयकरआयुक्त/ CIT- concerned 5. नवभधगीयप्रनतनननध, आयकरअपीलीयअनधकरण, मुंबई/ DR, ITAT, Mumbai गधर्ाफधईल / Guard File 6. आदेशानुसार/ BY ORDER,
.उि/सहायकिंजीकार (Dy./Asstt.Registrar) आयकरअिीिीयअतिकरण, मुंबई/ ITAT, Mumbai