M/S NANOBI DATA AND ANALYTICS PVT LTD ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-5(1)(1), BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL ‘B’ BENCH : BANGALORE BEFORE SHRI. CHANDRA POOJARI, ACCOUNTANT MEMBER AND SMT. BEENA PILLAI, JUDICIAL MEMBER ITA No. 472/Bang/2017 Assessment Year : 2013-14 M/s. Nanobi Data and Analytics Pvt. Ltd., The Deputy No. 1289/1090/E, Commissioner of 18th Cross, 3rd Sector, Income Tax, Vs. HSR Layout, Circle – 5(1)(1), Bangalore – 560 102. Bangalore. PAN: AADCN8822F APPELLANT RESPONDENT : Shri S.V. Ravishankar, Assessee by Advocate : Capt. Pradeep Shoury Arya, Revenue by Addl. CIT (DR) Date of Hearing : 21-12-2021 Date of Pronouncement : 07-03-2022 ORDER PER BEENA PILLAI, JUDICIAL MEMBER Present appeal is filed by assessee against order dated 11/11/2016 by the Ld.CIT(A)-5, Bangalore for assessment year 2013-14 on following grounds of appeal: “1. The Order of the learned Commissioner of Income Tax (Appeals) in so far it is against the Appellant, is opposed to law, equity, weight of evidence, probabilities, facts of and the circumstances in the Appellant's case. 2. The learned Commissioner of Income Tax (Appeals) is not justified in not giving the Appellant a reasonable opportunity of being heard in the impugned matter. 3. That notice under section 143(2) having been served after the expiry of time limit stipulated under section 143(2) is time barred and hence bad in law and the order

Page 2 of 14 ITA No. 472/Bang/2017 of assessment passed pursuant thereto is invalid and is liable to be quashed. 4. The learned Commissioner of Income Tax (Appeals) is not justified in confirming the assessment order wherein the assessing officer completed the assessment u/s. 143(3), determining the total loss at Rs.1,47,76,347/- as against the returned loss of Rs. 1,82,01,098/-. 5. Without prejudice, the learned Commissioner of Income Tax Appeals has erred in confirming the disallowance of Rs.1,71,379/- being payment of salary and erroneously held to be capital expenditure incurred towards purchase of securities, which is contrary to the facts of and in the circumstances of the Appellants case. 6. The learned Commissioner of Income Tax Appeals has erred in confirming the disallowance of Rs. 2,51,429/ - being expenditure incurred towards registration of Trade Mark which was erroneously held to be a capital expenditure, contrary to the facts of and in the circumstances of the Appellants case. 7. The learned Commissioner of Income Tax Appeals has erred in confirming the disallowance of Rs. 39,09,451/- being salary paid to employees working in R&D holding the same to be a capital expenditure incurred in the process of creating a copy right, contrary to the facts of and in the circumstances of the Appellants case. 8. The learned Commissioner of Income Tax Appeals has erred in confirming the addition of Rs. 69,854/-, being Share Premium received, under section 56(1)(vii) of the Income Tax Act contrary to the facts of and in the circumstances of the Appellant's case. 9. The Appellant craves leave to add, alter, delete, substitute or remove any or all the grounds urged above during the hearing of the Appeal. 10. For the above and the other grounds to be urged during the hearing of the Appeal, the Appellant prays that the appeals be allowed in full in the interest of equity and justice.” 2. Brief facts of the case are as under: The assessee is a private limited company registered under the companies Act 1956, it is 'engaged in the business of a) Designing developing, implementing licensing and marketing of computer software, computer systems and program products b) Rendering consultancy services in related areas

Page 3 of 14 ITA No. 472/Bang/2017 c) Establishing maintaining and /or running data processing centers and offer related services For the impugned assessment year assessee filed the return of income on 03/09/2014 declaring loss of Rs. 1,82,01,098/-. The case was selected for scrutiny and notice u/s. 143(2) and notices u/s. 142(1) of the Act was issued calling for various information. Assessee filed the requested information vide letter dated 18/09/2015 and 25/01/2016. The authorized representative of assessee also produced documents and provided clarifications during the course of assessment proceeding. After going through the details filed by assessee, the Ld.AO observed that the assessee debited Rs.1,71,379/- as securities transferred to Business promotion. The Ld.AO was of the opinion that purchase of securities cannot be allowed as revenue expenditure and the same was added back in the hands of assessee. 3. The Ld.AO observed that assessee debited Rs.2,51,429/- towards, registration, license and renewal charges. The assessee submitted that these expenses were incurred towards trade mark registration. The Ld.AO however did not allow it as revenue expenditure. 4. The Ld.AO then observed that assessee reported to have spent Rs.39,09,451/- towards research and development in the nature of salary expenses. The Ld.AO was of the view that these were expenses incurred for development of products. The Ld.AO also held that the expenditure incurred are very high as compared to income recognized during the relevant year. He thus disallowed the expenditure in the hands of assessee.

Page 4 of 14 ITA No. 472/Bang/2017 The Ld.AO also added Rs.68,854/- under section56(1)(viia) by holding it to be share premium received. Aggrieved by the order of the Ld.AO, assessee filed appeal before the Ld.CIT(A). 5. The Ld.CIT(A) held as under: “6. I have considered the written submissions filed by the appellant and also gone through the order passed by the Assessing Officer. The appellant has raised as many as eight arounds of appeal and the main objection raised against the disallowance of Rs.1.71.379/- made by the Assessing Officer on the ground that purchase of the securities transferred to business promotion which is not allowable. The appellant submitted that it was the securities received from the employees in the A Y.2012-13 and was refunded during the year. As the explanation given by the appellant is not supported by any proof, I do not find any infirmity in the impugned order passed by the Assessing officer in disallowance the same and therefore the grounds of appeal is hereby dismissed. 7. In the next ground the appellant raised the objection against the disallowance of Rs.2,51,429/- on the ground that it is capital in nature incurred for registration of trade mark. The appellant submitted that though it was incurred for making an application for trademark, since the trademark did not granted, professional fee paid for making application cannot be capital expenditure. as there was no enduring benefit. It further submitted that the company it is a software related and trademark is one of the essential requirement and the expenditure incurred in relation to the same are allowable to the business expenditure. It relied on the Hon'ble Mumbai Tribunal's decision in the case of CIT Vs. Finaly Mills Ltd. 20 ITR 475. I have gone through the above decision and found that the facts are not similar to that of appellants case. All the expenses incurred for the purpose of acquiring trademark are capital in nature therefore, I do not find any infirmity in the impugned order passed by the Assessing officer in disallowance the same, the grounds of appeal is dismissed. 8. The next ground is related to disallowance of Rs.39,09,541/-. The Assessing Officer disallowed for the reason that salary paid to employees in respect of research & development is work in progress and not a revenue expenditure. The appellant has incurred a sum of Rs.39,09.541/- towards research & development related

Page 5 of 14 ITA No. 472/Bang/2017 to the development of a product having enduring benefit. The Assessing Officer has observed that total expenditure debited towards salary was 471 times more than the revenue earned which is disproportionate and therefore treated the research & development charges as capital. Whereas the appellant submitted that it is related to the payment made to the employees who are on the rolls for the development/upgrading of the cloud as per the market requirement. As such expenditure incurred on research and development cannot be treated as revenue and since they have been incurred for the purpose of creating an intangible asset which has got enduring benefit and the case laws relied by the appellant such as Praga Tools Ltd. Vs. CIT 23 ITR 773 and CIT Vs. Westren India State Motors 203 ITR 363 365 will not be in any help to the appellant. The other case laws relied on by the appellant are distinguishable and the facts are different from that of the appellant. As regards the alternate plea that depreciation has to be allowed, the Assessing Officer is hereby directed to allow the depreciation as per law. 9. The next ground is related to the disallowance made of Rs.69,854/- u/s.56(1)(vii). The appellant explained that it was only issue price rounded off to nearest rupees for convenience of transfer of money to shareholders and accounting and therefore cannot be considered as income u/s.56(1)(vii). The Assessing Officer has rightly pointed out that the appellant had issued 776160 shares to its domestic shareholder during the year with a premium of Rs.22/- per share as against share value of Rs.21.91/- per share as per share valuation report, therefore the excess of Rs.69,854/- has been taxed u/s.56(1)(vii). I do not find any infirmity in the impugned order passed by the Assessing officer in disallowance of the same and therefore the grounds of appeal is hereby dismissed.” Aggrieved by the order of the LdCIT(A), assessee has filed the present appeal before this Tribunal. 6. The Ld.AR submitted that Grounds 1-2 & 4 are general in nature and therefore do not require any adjudication. 7. In respect of the legal issue raised by assesse in Ground no.3, it is submitted that the same me be kept open as assessee do not wish to contest the issue at this stage.

Page 6 of 14 ITA No. 472/Bang/2017 Accordingly Ground no. 3 is dismissed with liberty to raise in an appropriate circumstances. We therefore confine this order to issue raised in Grounds 5-8. 8. Ground No.5: This ground is raised by assessee challenging the disallowance of Rs.1,71,379/- as capital expenditure. The Ld.AR submitted that during the financial year 2012-13 the assessee made provision for salary to its employees of Rs.1,46,90,517/-. Out of this, a sum of Rs. 1,71,379/- was deducted by way of employees share towards the P.F. liabilities. However, upon becoming aware that the P.F. provisions were yet to become applicable to its establishment, the assessee credited the sum of Rs. 1,71,379/- to its salary account thus closing the P.F. payable account, by debiting the same, and the balance salary was duly paid off. But however the sum of Rs. 1,71,379/- being payable to the employees having been deducted from their salary was credited to the security deposit received from the employees and was eventually paid off to the respective employees and the business development expenditure account was debited instead of salary account by inadvertence. It is submitted that these facts were brought to the notice of the Ld.AO during the assessment proceedings, and that the Ld.AO did not agree with the assessee's submissions and went ahead making the impugned additions of Rs.1,71,379/-holding the same to be a capital expenditure incurred towards the purchase of securities erroneously. The Ld.CIT(A) also concurred with the view taken by the Ld.AO. Both sides submitted that the issue may be remanded to the Ld.AO for verification.

Page 7 of 14 ITA No. 472/Bang/2017 We note that the Ld.AO made addition in the hands of assessee on appreciation of incorrect facts. In our opinion, in the interest of both sides, it is would be just and proper to remand this issue back to Ld.AO for verification. We direct the Ld.AO to consider the claim of assessee under correct facts in accordance with law. Needless to say that proper opportunity of being heard may be granted to assessee. Accordingly this ground raised by assessee stands allowed for statistical purposes. 9. Ground No.6: This ground raised by assessee is challenging disallowance of Rs.2,51,429/- incurred towards registration of trade mark as capital in nature. The Ld.AR submitted that these expenses were incurred by assessee towards, registration, license and renewal charges incurred towards trade mark registration. It is submitted that assesssee is a software development company and trademark is one of the essential requirement to protect the product developed from being duplicated. He thus submitted that expenditure incurred in this behalf cannot be treated as capital in nature. He placed reliance on the decision of Hon’ble Mumbai Tribunal in case of CIT vs. Finlay Mill Ltd. reported in (1951) 20 ITR 475. On the contrary, the Ld.DR relied on the orders passed by the authorities below. We have perused the submissions advanced by both sides in light of records placed before us. 10. Being a software development company, assessee in the process would develop intangibles that needs to be protected to establish the ownership. In our view, these expenses are incurred

Page 8 of 14 ITA No. 472/Bang/2017 by assessee in the regular course of business to safeguard its interest. The decision of Hon’ble Supreme Court in case of CIT vs. Finlay Mill Ltd.(supra) on this aspect is very clear. The relevant observation are as under: “In our opinion, the contention urged on behalf of the appellant must fail. It is not contended that by the Trade Marks Act a new asset has come into existence. It was con- tended that an advantage of an enduring nature had come into existence. It was argued that just as machinery may attain a higher value by an implementation causing greater productive capacity, in the present case the trade mark which existed before the Trade Marks Act acquired an advantage of an enduring nature by reason of the Trade Marks Act and the fees paid for registration there under were in the nature of capital expenditure. In our opinion, this analogy is fallacious. The machinery which acquires a greater productive capacity by reason of its improvement by the inclusion of some new invention naturally becomes a new and altered asset by that process. So long as the machinery lasts, the improvement continues to the advantage of the owner of the machinery. The replacement of a dilapidated roof. by a more substantial roof stands on the same footing. The result however of the Trade Marks Act is only two-fold. By registration, the owner is absolved from the obligation to prove his ownership of the trade mark. It is treated as prima facie proved on production of the registration certificate. It thus merely saves him the trouble of leading evidence, in the event of a suit, in a court of law, to prove his title to the trade mark. It has been said that registration is in the nature of collateral security furnishing the trader with a cheaper and more direct remedy against infringers, Cancel the registration and he has still his right enforceable at common law to restrain the piracy of his trade mark. In our opinion, 'this is neither such an asset nor an advantage as to make payment for its registration a capital expenditure. In this connection it may be useful to notice that expenditure incurred by a company in defending title to property is not considered expense of a capital nature. In Southern (H. M. Inspector of Taxes) v. Borax Consolidated Limited(1). it is there stated that where a sum of money is laid out for the acquisition or the improvement of a fixed capital asset it is attributable to capital, but if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to

Page 9 of 14 ITA No. 472/Bang/2017 revenue, being in substance a matter of maintenance, the maintenance of the capital structure or the capital asset of the company. In our opinion, the advantage derived by the owner of the trade mark by registration falls within this class of expenditure. The fact that a trade mark after registration could be separately assigned, and not as a part of the goodwill of the business only, does not also make the expenditure for registration a capital expenditure. That is only an additional and incidental facility given to the owner of the trade mark. It adds nothing to the trade mark itself. In the judgment of the High Court some emphasis is laid on the fact that by reason of registration the duration of the trade mark is only for seven years, and it does not thus possess that permanency which is ordinarily required of an expenditure to make it a capital expenditure and in order to prove the existence of a benefit of an enduring character. The learned Attorney-General contended that the view that as the benefit of registration lasted for seven years, i.e., for a limited period, it prevented the expenses of registration being treated as capital expenditure, is unsound and for that contention he relied on Henriksen (Inspector of Taxes) v. Grafton Hotel Ltd.(1). In that case, tenants of licensing premises by agreement with the landlord paid by installment the monopoly value fixed by the licensing justices when granting the licence under section 14 of the Licensing (Consolidation) Act, 1910. These were sought to be deducted as revenue expenditure but were disallowed by the Court. Lord Greene M.R. first considered that the payment fell into the same class as the payment of a premium on the grant of a lease or the expenditure on improvements to the property which justices may require to be made as a condition of granting a licence. Having reached that conclusion he rejected the argument that the payment not being made in one lump sum but by installments made a difference in the character of the payment. He observed as follows :- "Whenever a licence is granted for a term, the payment is made as on a purchase of a monopoly for that term. When a licence is granted for a subsequent term, the monopoly value must be paid in respect of that term and so on. The payments are recurrent if the licence is renewed, they are not periodical so as to give them the quality of payments which ought to be debited to revenue account. The thing that is paid for is of a permanent quality although its permanence, being conditioned by the length of the term, is short lived. A payment of this character appears to me to

Page 10 of 14 ITA No. 472/Bang/2017 fall into the same class as the payment of a premium on the grant of a lease, which is admittedly not deductible." The Attorney- General relied on these observations to point out that the permanence of the advantage was thus not dependent on the number of years for which it was to endure for the benefit of the proprietor of the trade mark. In our opinion, these observations have to be read in the context in which they have been made. The learned Master of the Rolls was discussing only the question of payment being made by installments as not making any difference in the nature of the expenditure. It was first held by him that the payment in question was of a capital nature and of the same character as premium paid on the grant of a lease and was therefore necessarily of a capital nature. Having come to that conclusion, he only rejected the contention that because the premium was paid in more installments than one it lost its character a capital expenditure. In our opinion, this is an entirely different thing from stating that the fact of the advantage being for a limited time altered the character of the payment in any way. As observed by Viscount Cave L.C. the question is always one of fact depending on the circumstances of each case individually. In our opinion, the decision of the High Court reported in Commissioner of Income-tax, Bombay v. The Century Spinning and Weaving and Manufacturing Co. Ltd.(1) is correct and in the present case also the contention of the appellant must fail.” In the present facts there is nothing on record to establish that the expenditure incurred by assessee towards registration of Trade mark, results in enduring benefit. Further it is an admitted fact that, assessee obtains registration only for a limited period, which needs to be renewed in regular intervals. Therefore expenses incurred towards statutory registration cannot be treated as capital in nature. Therefore respectfully following the view by Hon’ble Supreme Court in case of CIT vs. Finlay Mill Ltd.(supra), we direct the Ld.AO to delete the addition made. Accordingly this ground raised by assessee stands allowed.

Page 11 of 14 ITA No. 472/Bang/2017 11. Ground No. 7: This ground is raised by assessee challenging the disallowance of Rs. 39,09,451/- by holding that salary to the extent is paid to the employees of the assessee involved in Research & development are capital in nature. The Ld.AR submitted that during the F.Y. 2012-13 the assessee incurred total salary expenditure of Rs.1,45,19,138/-. However, the Ld.AO disallowed sum of Rs.39,09,451/- being a capital expenditure incurred in the process of developing a new product by the employees of the assessee in it's Research and Development section. Further, the Ld.AO observed that, the total salary expenditure incurred by the assessee is Rs. 1,45,19,138/- as against its revenue for the F.Y. 2012-13 of Rs. 6,84,498/-, which is grossly disproportionate. It is the submission of Ld.AR that the payment is made to the employees of assessee which is salary. 12. On the contrary, the Ld.DR submitted that the research and development team of assessee developed certain products, for which expenditure was incurred and that trade mark registration has been incurred in respect of the product developed. The Ld.DR thus argued that the Ld.AO rightly held such expenditure to be capital in nature. We have perused the submissions advanced by both sides in light of records placed before us. Admittedly, the assessee is engaged in developing various software products. The expenditure disallowed by the revenue is out of the salary paid to the employees involved in R& D. It is the plea of the Revenue that the expenditure has resulted in development of software products, which in turn resulted in an

Page 12 of 14 ITA No. 472/Bang/2017 enduring benefit, and accordingly, such expenditure was to be held as capital expenditure. In our view, the aforesaid proposition of the Revenue cannot be appreciated in the line of business under which the assessee is operating. The Revenue is also objecting to the allowance of expenditure on the ground that registration under trade-mark is done of the products developed by assessee. This in our view, is irrelevant to decide the nature of the expenditure incurred on development of products. The reason being that software industry is highly competitive field and change is an inevitable factor. No software developed can be permanent due to rapid change in the needs and technology. Every software developed will get redundant over a period of time. The Ld.AR relied on the decision of Hon’ble Pune Tribunal in case of M/s.Opus Software Solutions Pvt.Ltd vs. ACIT reported in 139 ITD 427 in support of assessee’s claim. Thus in our view, the salary paid to the employees linked to R& D are directly connected to the business of the assessee. Respectfully following the view of Hon’ble Pune Tribunal in case of M/s.Opus Software Solutions Pvt.Ltd vs. ACIT(supra), we do not find and justification in disallowing the salary paid to the employees linked to R& D. Accordingly this ground filed by assessee stands allowed. 13. Ground No.8: This ground is raised by assessee challenging the disallowance made under section 56(1)(viia) of the Act. The Ld.AR submitted that it was an issue wherein the price was rounded off to the nearest rupee for convenience of transfer of money to the share holders. It is submitted that this amount will not not fall within the perview of section 56(1)(viia) of the Act. The

Page 13 of 14 ITA No. 472/Bang/2017 Ld.AR relied on the Share valuation report submitted before the authorities below. On the contrary, the Ld.DR relied on the orders passed by authorities below. We have perused the submissions advanced by both sides in light of records placed before us. 14. We are of the opinion that this issue needs to be considered in the light of valuation report. The Ld.AO is directed to verify the same and consider the claim of assessee in accordance with law. Needless to say that proper opportunity of being heard may be granted to assessee in accordance with law. Accordingly this ground raised by assessee stands allowed for statistical purposes. In the result the appeal filed by assessee stands partly allowed. Order pronounced in the open court on 07th March, 2022.

Sd/- Sd/- (CHANDRA POOJARI) (BEENA PILLAI) Accountant Member Judicial Member Bangalore, Dated, the 07th March, 2022. /MS /

Page 14 of 14 ITA No. 472/Bang/2017 Copy to: 1. Appellant 4. CIT(A) 2. Respondent 5. DR, ITAT, Bangalore 3. CIT 6. Guard file

By order

Assistant Registrar, ITAT, Bangalore