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Income Tax Appellate Tribunal, “J” BENCH, MUMBAI
Before: SHRI SAKTIJIT DEY & SHRI N.K. PRADHAN
PER SAKTIJIT DEY, J.M.
The captioned cross appeals arise out of the order dated 28th June 2016, passed by the learned Commissioner of Income Tax (Appeals)–58, Mumbai, for the assessment year 2009–10.
ITA no.5713/Mum./2016 Assessee’s Appeal
In ground no.1, the assessee has challenged disallowance of State taxes paid overseas.
Brief facts are, the assessee, an Indian company, is engaged in the business of export of computer software, providing e– Solutions, Business Process Outsourcing (BPO) activities and other management consultancy activities. The assessee has several overseas branches across the globe which are its Associated Enterprises (AE). For the assessment year under consideration, the assessee filed its return of income declaring total income of ` 77,25,47,829, under the normal provisions of the Income Tax Act, 1961 (for short "the Act") after claiming deduction under section 10A / 10AA of the Act. Further, the assessee also declared book profit of ` 40,32,25,37,283, under section 115JB of the Act.
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Subsequently, on 30th March 2011, the assessee filed a revised return of income enhancing the claim of TDS from ` 139,10,63,978, to ` 160,10,63,978. During the assessment proceedings, the Assessing Officer while verifying the return of income filed by the assessee along with the financial statements noticed that the assessee had claimed deduction of State taxes paid in overseas countries. It was submitted that these taxes were paid in USA and Canada. It was submitted by the assessee that the State taxes paid in USA and Canada do not come within the purview of section 40(a)(ii) of the Act. According to the assessee, the term “tax” as defined under section 2(43) of the Act, would mean the tax chargeable under the Income Tax Act, 1961. Further, it was submitted, in respect of State taxes paid, the assessee is not eligible for any relief either under sections 90 or 91 of the Act r/w the applicable Double Taxation Avoidance Agreements (DTAAs). Further, referring to the applicable DTAAs, it was submitted, the State and local taxes levied by local authorities like State, Cities or Counties are not covered under the tax treaties / conventions with USA and Canada. Thus, it was submitted, the deduction claimed by the assessee is not disallowable under section 40(a)(ii) of the Act. The Assessing Officer, however, did not find merit in the submissions of the assessee. He observed, the expression “tax”
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under section 40(a)(ii) of the Act would encompass all taxes levied on the profit or gains of the business or profession and is not limited to tax levied on total income computed under the provisions of Indian Income Tax Act. Referring to various judicial precedents in this context, the Assessing Officer ultimately disallowed the deduction claimed on account of State taxes paid overseas. Though, the assessee challenged the aforesaid disallowance before learned Commissioner (Appeals), however, he also sustained the disallowance noticing that while deciding identical issue in assessee’s own case in assessment year 2005–06, the Tribunal has upheld such disallowance.
Shri Porus Kaka, the leaned Sr. Counsel for the assessee submitted, the State taxes in respect of which the assessee claimed the deduction were paid in USA and Canada to the State authorities. He submitted, these taxes were levied on the income of the assessee by various Provincial and State Governments and not by Federal / Central Government. He submitted, section 40(a)(ii) of the Act does not allow deduction of taxes levied on profit or gains of any business. He submitted, as per section 2(43) of the Act, tax would mean taxes which are chargeable under the Indian Income Tax Act. He submitted, as per Explanation–1 to section 40(a)(ii) of the Act, only taxes which are eligible for relief under section 90 or
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91 of the Act are not eligible for deduction. He submitted, as per technical explanation of Indo–US and Indo–Canada Tax Treaties, taxes on income levied by various Provincial or Sate Governments are not eligible for relief. Thus, he submitted, the taxes paid being outside the purview of section 40(a)(ii) of the Act, would be eligible for deduction under section 37 of the Act. He submitted, though, in the assessment year 2005–06, the Tribunal in ITA no.7513/Mum./ 2010, dated 4th September 2015, has decided the issue against the assessee, however, by virtue of the recent decision of the Hon'ble Jurisdictional High Court in Reliance Infrastructure Ltd. v/s CIT, [2017] 390 ITR 271 (Bom.), the issue stands covered in favour of the assessee.
The learned Departmental Representative strongly relying upon the observations of the Assessing Officer and learned Commissioner (Appeals) submitted, the decision in Reliance Infrastructure Ltd. (supra) would not apply to the facts of the present case as the taxes levied by Saudi Arabia was both on Indian income as well as income earned in that country. He submitted, the facts in assessee’s case are different as the State taxes were levied on USA income only. He submitted, since the assessee is governed by the applicable tax treaties it is covered by
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the provisions of section 90 of the Act. Hence, the State taxes paid by the assessee are covered under section 40(a)(ii) of the Act.
We have considered the rival submissions and perused the material on record. From the stage of the assessment proceeding itself, it is the claim of the assessee that the term “tax”, as defined under section 2(43) of the Act would only include taxes chargeable under the Indian Income Tax Act. It is the further case of the assessee that since in respect of the State taxes paid overseas, the assessee is not eligible to claim relief under section 90 or 91 of the Act, it will not be covered under section 40(a)(ii) of the Act. On a perusal of provisions of sub–section (43) of section 2 of the Act, it becomes clear that the term “tax” has been defined to mean any tax paid under the provisions of the Act. Section 40(a)(ii) of the Act says that any rate or taxes levied on the profits or gain in any business or profession would not be allowable as deduction. Explanation–1 to section 40(a)(ii) of the Act inserted by the Finance Act, 2006, w.e.f. 1st April 2006, further clarifies that any sum eligible for relief of tax either under section 90 or 91 of the Act would not be allowable as deduction under section 40(a)(ii) of the Act. It is the say of the assessee that the tax eligible for relief under section 90 of the Act are only those taxes which are levied by Federal / Central Government and not by any local authority of
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State, City or County. Thus, it is ineligible for any relief under section 90 of the Act. The aforesaid submissions of leaned Sr. Counsel for the assessee, prima facie, is acceptable if one has to strictly go by the meaning of “tax”, defined under section 2(43) of the Act, as it only refers to tax paid under the provisions of the Act. It is also worth mentioning, the State taxes paid by the assessee in DTAA countries are not eligible for relief under section 90 of the Act. Therefore, the issue which arises is, whether it can be allowed as deduction under section 37 of the Act. No doubt, in assessee’s own case in assessment year 2005–06, the Tribunal in the order referred to above following its own decision in DCIT v/s Tata Sons Ltd., [2011] 43 SOT 27 (Mum.), has held that the State taxes paid overseas cannot be allowed as deduction in view of the provisions of section 40(a)(ii) of the Act. However, the aforesaid legal position has substantially changed after the decision of the Hon'ble Jurisdictional High Court in Reliance Infrastructure Ltd. (supra). While interpreting the provisions of section 2(43) of the Act, vis–a– vis section 40(a)(ii) of the Act, the Hon’ble Court held that the tax which has been paid abroad would not be covered within the meaning of section 40(a)(ii) of the Act, since, the meaning of the word “tax” as defined under section 2(43) of the Act would mean only the tax chargeable under the Act. Thus, as per the aforesaid
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decision of the Hon'ble Jurisdictional High Court, taxes levied overseas which are not eligible for relief either under section 90 or 91 of the Act, would not come within the purview of section 40(a)(ii) of the Act. It is the specific plea of the assessee that the State tax is not covered either under Indo–US or Indo–Canada tax treaty, hence, not eligible for any relief under section 90 of the Act. Pertinently, unlike section 91 read with Explanation–(iv), section 90 does not provide for inclusion of tax levied by any State/ local authority of that country within the expression ‘income tax’. In view of the aforesaid, we direct the Assessing Officer to verify whether the State taxes paid by the assessee overseas are eligible for any relief under section 90 of the Act and if it is not found to be so, assessee’s claim of deduction should be allowed. In view of our decision above, no separate adjudication of grounds no.1.2 is required.
In ground no.2, the assessee has challenged disallowance of expenditure incurred for purchase of software by invoking the provisions of section 40(a)(i) of the Act.
Brief facts are, during the assessment proceedings, the Assessing Officer noticing that the assessee has claimed expenditure incurred in respect of purchase of software called upon
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the assessee to furnish the necessary details. On verifying the details furnished by the assessee, he found that the assessee had purchased software for its internal use amounting to ` 47,36,54,498, and for trading purpose amounting to ` 31,03,03,823. After perusing the details, the Assessing Officer was of the view that the amount paid towards acquiring software brought along with support service is in the nature of royalty as per section 9(i)(vi) of the Act. In this context, he referred to Explanation–3 to section 9(1)(vi) of the Act as well as CBDT Circular no.621 dated 9th December 2019. Having held so, the Assessing Officer observed that since the assessee had not deducted tax at source while making payment for purchases of software both for internal use as well as for trading purpose, the amount paid is liable for disallowance under section 40(a)(i) of the Act. Accordingly, he disallowed the entire amount of ` 78,39,58,321. The assessee challenged the aforesaid disallowance before the first appellate authority.
Learned Commissioner (Appeals) following the order passed by the Tribunal in assessee’s own case for the assessment year 2005–06, held that the expenditure incurred on software products acquired for internal use is a capital expenditure, hence, the assessee is entitled to depreciation thereon. However, in respect of
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payment made towards software products acquired for re–sale / trading purpose, learned Commissioner (Appeals) agreed with the Assessing Officer that it is in the nature of royalty, hence, the assessee was required to deduct tax at source.
The leaned Sr. Counsel for the assessee submitted, the issue is squarely covered in favour of the assessee by the decision of the Tribunal in its own case in assessment year 2005–06. He submitted, while deciding identical issue in assessment year 2005– 06, the Tribunal accepted the decision of learned Commissioner (Appeals) that expenditure incurred for acquiring software for internal use is capital expenditure and eligible for depreciation. He submitted, since, the Tribunal did not decide the issue correctly and left a part of the issue undecided, assessee filed an application under section 254 of the Act and the appeal order on the issue was recalled. He submitted, that while deciding the issue afresh in ITA no. 7513/Mum./2010, dated 23rd March 2017, the Tribunal has held that the expenditure incurred for acquiring software for trading purpose is not in the nature of royalty. Hence, there is no requirement for deduction of tax at source. He submitted, the reasoning on the basis of which the Tribunal came to such conclusion was, the payment made for purchase of software is for acquiring a copyrighted article and not for transfer of any right in a
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copyright, hence, cannot be treated as royalty. The leaned Sr. Counsel submitted, by incorporation of Explanation–4 to section 9(1)(vi) of the Act by Finance Act, 2012, with retrospective effect, Revenue cannot fasten the liability of TDS on the assessee as the assessee cannot be expected to deduct tax at source in respect of a transaction effected long time back anticipating such amendment. In this context, he relied upon the following decisions:–
i) NGC Networks India Pvt. Ltd. v/s CIT, ITA no.397/2015 (Bom.); and ii) Channel Guide India Ltd., ITA no.1221/Mum./2006, dated 29.08.2012.
Further, he submitted, Explanation–4 to section 9(1)(vi) of the Act, does not apply to section 40(a)(i) of the Act which specifically refers to Explanation–2 to section 9(1)(vi) of the Act for the definition of royalty. For such submission, he relied upon the following decisions:–
i) NGC Networks India Pvt. Ltd. v/s CIT, ITA no.397/2015 (Bom.); and ii) Sonata Information Technology Ltd. v/s DCIT, 7 SOT 465 (Mum.).
The leaned Sr. Counsel for the assessee submitted, even the payment made towards purchase of software cannot be treated as
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royalty under the tax treaties as the definition of royalty therein is narrower than the definition in the Act. Referring to Article–12 of Indo–US Tax Treaty, he submitted, the payment made for a copyrighted article is not covered within the meaning of royalty. He submitted, the technical explanation issued by US IRS for explaining the background and the rationale behind the drafting of the Indo–US Tax Treaty clearly indicate that the license granted to the company to use software not being contingent on its use, productivity or further alienation, the license fee paid cannot take the colour of royalty. He submitted, the same rationale can be extended to the Tax Treaties with other countries as the definition of royalty same in all treaties. He submitted, the OECD commentary on Article–12 also clarifies that payment for partial or complete rights in a copy of the program does not amount to royalty. In this context, he relied upon the decision of the Tribunal in its own case in ITA no.7513/Mum./2010, dated 23rd March 2017, and following other decisions:–
i) Intrasoft Ltd., 220 Taxman 273 (Del.); and ii) Ericson A.B., 246 CTR 422 (Del.);
He submitted, once the payment made is not in the nature of royalty, it can be a business profit of the payee and in the absence
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of a Permanent Establishment (PE) in India, it is not chargeable to tax. Hence, there was no obligation to deduct tax at source.
The learned Departmental Representative relying upon the observations of the Assessing Officer and learned Commissioner (Appeals) submitted, since the assessee has used the software as a module and on the basis of such software is developing its own products, the payment made for acquiring such software is in the nature of royalty, therefore, subject to deduction of tax at source.
We have considered rival submissions and perused the material on record. We have also applied our mind to the decisions relied upon. Undisputedly, in the year under consideration, the assessee has claimed deduction on account of expenditure incurred towards purchase of software products acquired for internal use. The expenditure relating to that has been treated as capital in nature and depreciation has been allowed by the Departmental Authorities. Insofar as software products acquired for re–sale / trading purpose, the assessee’s claim of deduction in respect of expenditure incurred thereon as revenue in nature has been disallowed on the ground that the payment made being in the nature of royalty, the assessee was required to deduct tax at source under section 195 of the Act. Insofar as the expenditure
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incurred on the software products acquired in internal use, we, on a perusal of the facts on record are of the view that by incurring such expenditure, the assessee has acquired assets of enduring benefit. Therefore, the expenditure incurred is capital in nature and the assessee would be entitled for depreciation on the cost of such assets. The Tribunal while deciding identical issue in assessee’s own case for the assessment year 2005–06 in ITA no.7513/Mum./2010, dated 4th November 2015, the Tribunal has expressed similar view. Thus, following the aforesaid view of the Tribunal in assessee’s own case, we uphold the decision of learned Commissioner (Appeals) on the issue. Insofar as the disallowance of expenditure incurred on acquiring software products for re–sale / trading purpose, it is noted that the Assessing Officer has not at all deliberated on the factual aspect of the issue. Simply relying upon certain judicial precedents and the statutory provisions, he has concluded that the payment made by the assessee for acquiring these software is in the nature of royalty as per section 9(1)(vi) of the Act, hence, assessee is liable to deduct tax at source under section 195(2) of the Act. Whereas, learned Commissioner (Appeals) has improved upon the reasoning of the Assessing Officer by observing that the software acquired by the assessee for trading purpose were not sold as it is by the assessee but have been utilized in programs
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developed by it for its clients. He has observed that the products developed by the assessee using software acquired were then sold to clients with rights and license. Thus, according to the learned Commissioner (Appeals), it is not a case of mere purchase and subsequent sale of software as a re–seller / trader. He observed, assessee’s software package will not be complete without the software acquired for trading purpose. In other words, the software acquired by the assessee is a necessary ingredient of the package being developed and supplied to the client and the assessee is prohibited by agreement to sell the software independently and they can only be supplied as a part of the package. As per section 9(1)(vi) of the Act, income in the nature of royalty shall be deemed to accrue or arise in India even in respect of a non–resident where the royalty is payable in respect of any right, property or information used or services utilized for the purpose of a business or profession carried on by a person in India or for the purpose of making or earning any income from any source in India. Pertinently, the expression “royalty” as per section 9(1)(vi) of the Act in its initial form did not specifically define computer software. By virtue of Explanation–3 to section 9(1)(vi) of the Act inserted by Finance Act w.e.f. 1st April 2010, computer software was defined to mean any computer program recorded on any disc, tape,
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perforated media or other information storage device and includes any such program or any customized electronic data. The scope of the term “royalty” was further explained by Explanation–4 to section 9(1)(vi) of the Act inserted by Finance Act, 2012, with retrospective effect from 1st June 1976, wherein, it was clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software including granting of a license irrespective of the medium through which such right is transferred. It is the contention of the assessee that the software acquired by the assessee for the purpose of trading is a copyrighted article and the assessee has sold it to the customers as it is. It has been submitted that while re–selling / trading the software products, there is neither any transfer of right in copyright in favour of the assessee nor the assessee has transferred any right in the copyright. However, the learned Commissioner (Appeals) has recorded a categorical finding that the software products acquired by the assessee cannot be sold independently and can be sold by utilising in the package developed by it. In the aforesaid factual context, it requires examination whether the software products acquired by the assessee for trading purpose was sold as a chattel qua chattel or
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the assessee has made some value addition to it or has transferred the copyright relating to the software product along with the software product. No doubt, in assessee’s own case for assessment year 2005–06, the Tribunal in ITA no.7513/Mum./2010, dated 23rd March 2017 (after recall of the original appeal order) while dealing with similar issue has held that the payment made by the assessee towards acquiring the software products is not royalty as the assessee has sold a copyrighted article and has not transferred any license or copyright. However, in the facts of the present case, in our considered opinion, further enquiry is required to be made by the Assessing Officer to factually verify the nature of transaction relating to acquisition of software product for trading purpose to find out whether it is sale of copyrighted article simpliciter or sale of copyright. In case, the payment made by the assessee is found to be royalty in view of Explanation–4 to section 9(1)(vi) of the Act, the contention of the assessee that it could not have withheld tax anticipating the change in law brought with retrospective effect, has to be considered keeping in view the decision of the Hon'ble Jurisdictional High Court in NGC Network India Pvt. Ltd. (supra). Further, assessee’s contention that Explanatino–4 to section 9(1)(vi) of the Act cannot be brought into play while applying section 40(a)(i) of the Act as it only refers to Explanation–2 to
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section 9(1)(vi) of the Act for the definition of royalty also has to be examined keeping in view the ratio laid down in NGC Networks India Pvt. Ltd. (supra). In case, the payment made by the assessee does not fit into the definition of royalty as provided under the relevant tax treaty, the assessee certainly would get the benefit of the tax treaty and in that event the liability under section 195 of the Act cannot be fastened on the assessee. Since, all these issues have not been properly examined and deliberated upon by the Departmental Authorities, we are inclined to restore the issue to the Assessing Officer for fresh adjudication in terms with our observations hereinabove. The Assessing Officer must decide the issue after providing reasonable opportunity of being heard to the assessee.
In ground no.3, the assessee has challenged the decision of learned Commissioner (Appeals) in partly sustaining the disallowance made out of advertisement expenditure by treating it as capital in nature.
At this stage, we must observe, against the partial relief granted by learned Commissioner (Appeals) on this issue, Revenue has also came in appeal and the corresponding ground being
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ground no.1. Accordingly, we propose to dispose of both the grounds together.
Brief facts are, in the course of assessment proceedings, the Assessing Officer noticed that the assessee has debited substantial expenditure of ` 39,69,25,798, towards advertisement. After calling for necessary details, he found that the expenditure incurred are for advertising in newspapers/magazines, holding events/seminars, conferences, exhibitions, etc., advertising at airports, global campaign etc.. Thus, mostly, the expenditure incurred was for promotional/publicity activities of the assessee. After considering the submissions of the assessee in the context of facts and material on record, the Assessing Officer was of the view that out of the expenditure incurred of ` 1,88,28,573, towards advertisement in newspapers / magazines, expenditure to the extent of 50% can be treated as revenue and non–brand building expenditure. Accordingly, out of the total expenditure, the Assessing Officer treated an amount of ` 38,75,11,510, as expenditure incurred towards brand building, hence, capital in nature. Having held so, the Assessing Officer observed that 1/5th of the expenditure amounting to ` 7.75 crore would be allowed in the current year and the balance 80% amount to ` 31,00,09,210, would be amortized over the period of next three years in equal proportion. The
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assessee challenged the aforesaid disallowance before the first appellate authority.
The learned Commissioner (Appeals), after considering the submissions of the assessee in the context of facts and material on record, held that except the amount of ` 5.28 crore, the balance amount has to be treated as revenue expenditure. Insofar as the amount of ` 5.28 crore is concerned, learned Commissioner (Appeals) held it to be capital in nature by observing that the assessee itself has admitted it to be so.
The leaned Sr. Counsel for the assessee submitted, assessee had incurred the expenditure for advertisement in newspaper/magazines for marketing of its products of ongoing business. He submitted, such expenditure is routinely incurred every year. He submitted, the expenditure incurred is not in the nature of brand building, hence, not capital. He submitted, even if it is held to be expenditure incurred for building the brand, still, it has to be treated as revenue. In this context, he relied upon the following decisions:–
i) CIT v/s Asian Paints India Ltd., 243 Taxman 348 (Bom.); ii) CIT v/s Geogree Manners & Co. Ltd., 35 SOT 78; iii) ITO v/s Spice Communications Ltd., 35 SOT 77; iv) Asian Paints Ltd. v/s ACIT, [2014] 41 taxmann.com 71 (Mum.);
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v) Sony India Pvt. Ltd., 141 TTJ 438 (Del.); and vi) Monto Motors Ltd., 203 Taxman 43 (Del.).
The leaned Sr. Counsel for the assessee submitted, by incurring such expenditure, the assessee does not derive any enduring benefit. Therefore, the expenditure has to be allowed as revenue expenditure. Insofar as the disallowance of ` 5.28 crore is concerned, the leaned Sr. Counsel submitted, the said expenditure was incurred towards experience certainty campaign. He submitted, learned Commissioner (Appeals) completely misconceived the submissions made by the assessee while observing that the assessee has itself admitted it to be a capital expenditure. The leaned Sr. Counsel submitted, the expenditure incurred by the assessee towards experience certainty campaign is no less different from the other advertisement expenditure, hence, should be allowed. He submitted, had learned Commissioner (Appeals) called upon the assessee to clarify his doubt, the assessee would certainly have produced the documentary evidences to demonstrate that the experience certainty campaign is nothing but advertisement expenditure incurred by the assessee. To support his contention, the learned Senior Counsel sought the permission of the Bench to furnish certain documents as additional evidence under rule 29 of the Income Tax (Appellate Tribunal)
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Rules, 1963. The leaned Sr. Counsel submitted, the additional evidences submitted by the assessee may be admitted and the issue may be restored back to the Assessing Officer for fresh consideration.
The learned Departmental Representative while relying upon the observations of the Assessing Officer with regard to the ground raised by the Revenue submitted that the issue relating to assessee’s claim of deduction in respect of expenditure incurred towards experience certainty may be restored to the Assessing Officer for fresh adjudication in view of the additional evidence filed by the assessee.
We have considered rival submissions and perused the material on record. We have also carefully examined the case laws cited before us. On a detailed analysis of facts on record, we have noted that the reasoning of the Assessing Officer that the expenditure was incurred for brand building is without any basis. It is to be noted, before the Departmental Authorities the assessee had demonstrated that in no way it is connected with development of Tata brand. The details of expenditure incurred clearly demonstrate that they were basically for the purpose of advertising assessee’s products in print media or through seminar,
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conferences, etc. As rightly observed by learned Commissioner (Appeals), the Assessing Officer has brought no material on record to establish that the expenditure is for brand building. As observed earlier, the expenditure relates to advertisement in newspaper, magazine, events, seminars, conferences, exhibitions, etc. Thus, the nature of expenditure incurred by the assessee clearly indicates that it was for promoting its own business. Further, considering the turnover of the assessee, the expenditure incurred on advertisement does not appear to be unusually high. That being the case, the expenditure incurred on advertisement cannot be treated to be in the nature of capital expenditure and amortized over a period of five years. To that extent, we agree with the decision of learned Commissioner (Appeals) on the issue. However, as regards experience certainty expenditure amounting to ` 5.28 crore, it appears that learned Commissioner (Appeals) has held it to be of capital nature on the basis that the assessee itself admitted so. However, before us, leaned Sr. Counsel for the assessee has vehemently argued that no such admission was made by the assessee before learned Commissioner (Appeals) and under a misconception, learned Commissioner (Appeals) has come to such conclusion. The leaned Sr. Counsel submitted, the experience certainty campaign was also for the purpose of advertisement only
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and in this context, he has furnished before us the details of such expenditure through additional evidences. Since, the additional evidences furnished by the assessee will have a crucial bearing in determining the nature of expenditure, we are inclined to admit the additional evidences. However, considering the fact that these evidences were not furnished before the Departmental Authorities, to afford a fair opportunity to the Department to verify the authenticity of assessee’s claim vis–a–vis the additional evidences furnished before us, we restore the issue to the Assessing Officer for de novo adjudication after providing reasonable opportunity of being heard to the assessee. We make it clear, our aforesaid direction is only with regard to the experience certainty expenditure of ` 5.28 crore. The decision of learned Commissioner (Appeals) on this issue is modified to this extent only.
As regards ground no.4, the leaned Sr. Counsel submitted that the assessee has already got the desired relief in the order passed by the Assessing Officer while giving effect to the first appeal order. Thus, he submitted, the ground has become academic. In view of the above, ground no.4, is dismissed.
Ground no.5, is not pressed, hence dismissed.
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In ground no.6, corresponding to ground no.7 of Revenue’s appeal, the assessee has claimed foreign tax credit in respect of income pertaining to section 10A/10AA of the Act eligible units in India.
Brief facts are, in the course of assessment proceedings the assessee furnished countrywise statement of tax paid in support of its claim of tax credit under section 90 and 91 of the Act amounting to ` 93,48,94,709. It was contended by the assessee that the tax paid on income charged to tax outside India and in India would be eligible for deduction in terms of the applicable tax treaties as well as under section 91 of the Act. The Assessing Officer after examining the claim of the assessee and verifying the details allowed tax credit in respect of tax paid overseas on the income which was not only offered to tax abroad but was also subjected to tax in India to the extent not exceeding the rate of tax payable in India. However, in respect of income subjected to tax abroad but exempt from payment of tax in India, he did not grant relief either under section 90 or 91 of the Act. The assessee challenged the aforesaid decision of the Assessing Officer before the first appellate authority.
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Learned Commissioner (Appeals), after considering the submissions of the assessee and taking note of the decision of the Hon’ble Karnataka High Court in Wipro Ltd. v/s DCIT, [2015] 62 taxmann.com 26 (Kar.) bifurcated the foreign tax credit into three parts i.e., tax paid in USA, tax paid in other DTAA countries and tax paid in non–DTAA countries. Thereafter, he directed the Assessing Officer to allow tax credit in respect of tax paid in USA even on the income which is exempt from tax in India under section 10A / 10AA of the Act. However, in respect of tax paid in other DTAA and non– DTAA countries, learned Commissioner (Appeals) held that no tax credit will be available in respect of income which is exempt from tax in India under section 10A / 10AA of the Act. While the assessee has challenged the decision of learned Commissioner (Appeals) on non–grant of tax credit in respect of taxes paid in other DTAA countries and non–DTAA countries, the Department is aggrieved with the decision of learned Commissioner (Appeals) in granting tax credit in respect of taxes paid in USA. Since, the grounds raised by the assessee and Revenue, as noted above, are on a common issue, we dispose of both the grounds together.
The leaned Sr. Counsel for the assessee submitted, as per section 90(1)(a)(ii) of the Act, the Central Government may enter into an agreement with any country outside India for granting relief
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in respect of Income Tax chargeable under the Act and under the corresponding law in force in that country, as the case may be, to promote mutual economic relationship, trade and investment. Thus, he submitted, section 90 of the Act empowers the Central Government to enter into DTAA with the Government of any other country for granting relief in respect of cases where income tax is chargeable. He submitted, section 10A/10AA grants deduction from eligible income from the total profit. However, such income is chargeable to tax in India as per the provisions of section 4 and 5 of the Act. He submitted, the exemption under section 10A / 10AA of the Act is for a specified period and after expiry of that period such income would otherwise be chargeable to tax. Referring to article 25 of Indo–U.S. DTAA, the leaned Sr. Counsel submitted, the condition mandated in the treaty is that if any income derived and tax paid in USA on such income then tax relief / credit shall be granted in India of such tax paid in USA. He submitted, the aforesaid article does not speak of any income tax being paid by the resident assessee under the Indian Income Tax Act as a condition precedent for claiming the benefit of tax credit under DTAA. He submitted, like article 25(2)(a) of India-USA DTAA, similar clause also appear in various other tax treaties concluded by the Government of India with foreign countries from which the
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assessee has received income under section 10A / 10AA of the Act till assessment year 2009–10, such as, Denmark, Finland, Hungary, Norway, Oman, South Africa, Saudi Arabia, Taiwan. In this context, he drew our attention to the relevant clauses of the DTAAs with the above noted countries. Thus, he submitted, tax credit has to be provided for taxes paid in overseas jurisdiction in respect of section 10A/10AA eligible income in India as per the provisions of respective DTAAs. He submitted, even under MAT computation, the assessee should be allowed full credit for taxes paid overseas in respect of section 10A/10AA eligible income. In support of his contention, the learned Sr. Counsel put strong reliance upon the decision of the Hon’ble Karnataka High Court in Wipro Ltd. (supra).The learned Sr. Counsel submitted, when no decision of the Hon'ble Jurisdictional High Court is available on the issue and the only decision of a High Court which is available is that of the Hon’ble Karnataka High Court, even though, the decision is of a non–jurisdictional High Court, however, this being the only decision available on the issue, it will be binding when there is no contrary decision of another High Court is available. For such proposition, he relied upon the following decisions:–
i) CIT v/s Smt. Nirmalabai K. Davekar, [1990] 186 ITR 242 (Bom.)
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ii) CIT v/s Highway Construction Co. Pvt. Ltd., [1996] 217 ITR 234 (Gauhati); and iii) CIT v/s Maganlal Mohanlal Panchan (HUF), [1994] 210 ITR 580 (Guj.).
The learned Departmental Representative strongly relying upon the observations of the Assessing Officer submitted, since all income of section 10A/10AA eligible units are exempt and not subjected to tax in India, the assessee would not get tax credit for taxes paid on such income in overseas countries, except, USA.
We have considered rival submissions and perused the material on record. We have also applied our mind to the decisions relied upon. As could be seen, while the Assessing Officer has disallowed assessee’s claim of foreign tax credit in respect of income exempt under section 10A/10AA of the Act on the reasoning that only such income which is subjected to tax in both the countries would qualify for tax credit, learned Commissioner (Appeals) has restricted the relief of foreign tax credit only in respect of tax paid in USA even in respect of income which is exempt under section 10A/10AA of the Act. The learned Commissioner (Appeals) has come to such conclusion by following the decision of the Hon’ble Karnataka High Court in Wipro Ltd. (supra). The reasoning of the learned Commissioner (Appeals) on the issue is, as per the decision of Hon’ble Karnataka High Court in
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Wipro Ltd. (supra), the foreign tax credit benefit under section 90(1)(a)(ii) of the Act would only be applicable under Indo–US DTAA and would not be applicable to other DTAA countries and non–DTAA countries. On a careful reading of the decision of the Hon’ble Karnataka High Court in Wipro Ltd. (supra), it is noted, while dealing with identical issue the Hon’ble Court held that in the cases covered under section 90(1)(a)(ii) of the Act, it is not the case of income being subjected to tax or the assessee has paid tax on the income. The provision applies to a case where the income of the assessee is eligible to tax under the Act as well as in the corresponding law in force in the other country. The Court observed, though, income tax is chargeable under the Act, it is open to the Parliament to grant exemption under the Act from payment of tax for any specified period, normally, to incentivize the assessee the to carry on manufacturing activities or providing services. The Court thereafter referring to the treaty provisions with USA held that it is not the requirement of law that the assessee before he claims credit under the Indo–US convention or under the provision of the Act must pay tax in India on such income. The Court observed, as per the embargo placed in the DTAA, the assessee is entitled to such tax credit only in respect of that income which is taxed in USA. In similar context, the Court
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also referred to the tax treaty with Canada where the provisions does not allow credit for tax paid in Canada if the income is not subjected to tax in India. With regard to country’s with which India does not have any agreement for avoidance of double taxation, the Court observed that as per section 91 of the Act, the assessee would be eligible to avail tax credit. Thus, on a careful reading of the aforesaid judgment of the Hon’ble Karnataka High Court, it becomes clear that where the respective tax treaty provides for benefit for foreign tax paid even in respect of income on which the assessee has not paid tax in India, still, it would be eligible for tax credit under section 90 of the Act. Like Article 25 of the Indo–USA treaty, treaties with various other countries such as Indo–Denmark, Indo–Hungary, Indo–Norway, Indo–Oman, Indo–US, Indo–Saudi Arabia, Indo–Taiwan also have similar provision providing for benefit of foreign tax credit even in respect of income not subjected to tax in India. However, Indo–Canada and Indo–Finland treaties do not provide for such benefit unless the income is subjected to tax in both the countries. Therefore, the foreign tax credit would be available to the assessee in all cases except the foreign tax paid in Finland and Canada. The Assessing Officer is directed to grant credit accordingly.
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In grounds no.7 and 8, the assessee has challenged the addition made on account of transfer pricing adjustment in respect of provisions of software consultancy services. The Revenue has also raised grounds no.8, 9 and 10, in its appeal on identical issue. Therefore, these grounds, if necessary, would be dealt with at a later stage while dealing with grounds no.8, 9 and 10 of Revenue’s appeal.
In ground no.9, the assessee has challenged the addition made on account of provision of interest free loans provided to the AEs.
Brief facts are, in the course of proceedings before him, the Transfer Pricing Officer noticed that the assessee has provided loan facilities to its AEs without charging any interest. He found that as on 1st April 2008, there was an outstanding loan of U.S. $ 92,50,000 against TCS, Singapore, part of which was re–paid by the AE on 12th December 2008, and on 25th November 2008. When the Transfer Pricing Officer called upon the assessee to show cause why the adjustment in respect of interest chargeable on the interest free loan should not be made at appropriate market rate, it was submitted by the assessee that since the loan provided are in the nature of equity infusion, no interest has been charged. Further
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explaining, it was submitted that the objective of advancing the loan was mainly to acquire downstream companies and further infusion of capital by the AE to other companies as well as entering into joint venture with overseas parties. It was submitted, the assessee is not in the business of lending and borrowing money and the loans advanced by it are quasi equity in nature. Therefore, no interest has been charged and the loans have been provided to further the interest of the assessee and not to assist the AEs in any way. The Transfer Pricing Officer, however, did not find merit in the submissions of the assessee. He observed, unduly the assessee has extended loan to its AEs without charging any interest. Further, the loan advanced is unsecured. He observed, in similar uncontrolled transaction between non–related parties, interest would have been charged taking into account creditworthiness of the AEs, margin, security or any other consideration relevant for deciding the financial solvency of the borrower. He observed, if the assessee would have given similar loan to unrelated party under similar circumstances, it certainly would have earned interest. Accordingly, he proceeded to determine the arm’s length price of the interest on free loans advanced to the AEs by charging interest @ 9% per annum in respect of loans advanced to TCS Ibero America, TCS FNS Pty. Ltd., TCS Asia Pacific Pty. Ltd., TCS Morocco Ltd. and
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suggested an adjustment of ` 43,97,31,046. Though, the assessee challenged the aforesaid adjustment before learned Commissioner (Appeals),however, it was unsuccessful. Learned Commissioner (Appeals), however, granted partial relief to the assessee by reducing the rate of interest from 9% to 5.86%.
The learned Sr. Counsel for the assessee submitted, the purpose of loans to various AEs was either for acquisition of downstream subsidiary or for working capital. Thus, the loans are quasi equity. The learned Sr. Counsel submitted, majority of the loans were providing for acquiring downstream subsidiary and only TCS Morocco was provided loan for working capital purpose only. He submitted, majority of the loans were either converted into equity or re–paid as on 31st March 2013. Referring to the written submissions filed before learned Commissioner (Appeals), learned Sr. Counsel submitted, as per OECD transfer pricing guidelines 2010, the provision of loan for acquisition of downstream subsidiary is a shareholder activity, hence, not part of internal transaction. In this context, he also referred to UK and Australian Regulations. Referring to the commercial position of the AEs, learned Sr. Counsel submitted, in case of TCS Ibero America, loan was provided as continuous loss made in the downstream subsidiary restricted the ability to service a loan. Hence, the loan was
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subsequently converted to equity. He submitted, in case of TCS FNS Australia, debt equity ratio did not permit it to obtain third party funding. He submitted, TCS Morocco has been dormant ever since its incorporation and did not have any operation revenue or significant assets. He submitted, TCS Singapore was also in similar position and the loan was for acquisition of downstream subsidiary. He submitted, in all these cases, the assessee has taken strategic decision for acquisition of entities and had decided it to route it through its AEs and accordingly advanced loans to the AEs for further acquisition. Thus, he submitted, the advancement of loan to the AEs being a shareholder’s activity, the adjustment made has to be deleted. In support of his contention, the learned Sr. Counsel placed strong reliance upon the decision of the Tribunal, Delhi Bench, in DLF Holdings Ltd. v/s DCIT, ITA no.6336/Del./2012, dated 30th June 2016.
The learned Departmental Representative submitted, the entire loan cannot be treated as quasi equity as they were also for working capital purpose. He submitted, in similar uncontrolled transaction, certainly interest would have been charged. Therefore, the Transfer Pricing Officer was justified in determining the arm’s length price of interest on interest free loans. Thus, he submitted,
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the decision of the learned Commissioner (Appeals) on the issue should be sustained.
We have considered rival submissions and perused the material on record. We have also carefully gone through the case law cited before us. Notably, right from the stage of transfer pricing proceeding itself the assessee has taken a stand that loans and advances to the AEs are in the nature of quasi equity, hence, cannot be treated as loan simpliciter. It is relevant to observe, the transfer pricing adjustment made on account of interest is in respect of loans advanced to four overseas AEs. From the details available on record, it is noticed that major portion of loans advanced to TCS Ibero America, is for acquisition of downstream subsidiary and about 20% of the advance was for working capital. Money advanced to TCS FNS Pty. Ltd., Australia, was purely for acquisition of downstream subsidiary. Similarly, advance to TCS Asia Pacific Pty. Ltd., is for acquisition of downstream subsidiary. Only the advance made to TCS Morocco is for working capital requirement. It is further noted, major part of advances made to TCS Ibero America, TCS FNS Pty. Ltd. and TCS Morocco have been converted to equity subsequently. It is also a fact on record that before learned Commissioner (Appeals), the assessee has filed a detailed written submission on 27th March 2014, elaborately
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discussing the nature of advance made to the AEs and the purpose for which such advances were made. It was submitted by the assessee that the advances made to the AEs were as a part of business strategy and not simply to help the AEs with capital infusion. The assessee has advanced detailed argument stating that advances made to the AEs is a shareholder activity and not advancement of loan. In this context, the assessee has referred to OECD Transfer Pricing Guidelines as well as UK and Australian Regulations. It is evident from the impugned order of the learned Commissioner (Appeals), though, he sketchily referred to some of the submissions made by the assessee, however, he has not at all dealt with them in an effective manner. The learned Commissioner (Appeals), though, has observed that the loans advanced were not merely for downstream acquisition but for a variety of purpose including working capital requirement and other business uses, however, he has not elaborated as to for what other purpose loans were advanced. Without properly dealing with the factual aspect of the issue, learned Commissioner (Appeals) has jumped to the legal aspect and has held that the amount advanced by the assessee is in the nature of loan and has to be benchmarked as such. After considering the submissions of the parties and examining the material on record, we are convinced that various submissions
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made by the assessee before learned Commissioner (Appeals) have not at all been dealt with. The primary contention of the assessee that the advance made to the AEs is in the nature of quasi equity and falls within shareholder’s activity has not been properly addressed by the Departmental Authorities keeping in view the ratio laid down in the relevant case laws. It also requires deliberation whether it can be considered as an international transaction under section 92B r/w Explanation–1(c). Since, the aforesaid legal and factual aspects have not been considered properly, we are inclined to restore the issue to the file of the Assessing Officer for de novo adjudication after due opportunity of being heard to the assessee. The Assessing Officer must examine all relevant facts to find out the exact nature of the advances made to the AEs. He should also examine the applicability of the ratio laid down in the case of DLF Hotel Holdings Ltd. (supra) and any other case laws which may be cited before him. The assessee must be afforded reasonable opportunity of being heard. Ground is allowed for statistical purposes.
In ground no.10, the assessee has challenged the addition made on account of provision for various guarantees.
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Brief facts are, during the transfer pricing proceedings, the Transfer Pricing Officer noticed that the assessee has provided various guarantees such as performance, financial and other guarantees to the AEs during the year without charging any commission. The Transfer Pricing Officer was of the view that in an arm's length scenario, an independent enterprise would have paid commission to the enterprise for a similar guarantee to its bank for credit facility. According to the Transfer Pricing Officer, the guarantee provided by the assessee on behalf of its AEs is a service rendered and would squarely fall within the meaning of international transaction as defined under section 92B of the Act. Hs observed, once the AEs are categorized as risk bearing distributors, they are liable to bear all risk including performance risk with reference to the functions carried out by them. He observed, if the assessee takes guarantee for rendering all services by its AEs, who are not merely service providers but risk bearing entities, the assessee cannot claim that the guarantees benefit itself and not the AEs. Thus, he proceeded to benchmark the guarantee commission for various guarantees provided to the AEs. In respect of performance and lease guarantee, the Transfer Pricing Officer on the basis of information obtained from Allahabad Bank charged guarantee commission @ 2.4% per annum. Whereas, in
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respect of financial guarantee, he fixed guarantee commission @ 3% per annum.
While deciding assessee’s appeal on the issue, the learned Commissioner (Appeals) reduced the guarantee commission on performance and lease guarantee to 1.23% per annum i.e., the rate of fee paid by the assessee to the insurance company. Insofar as financial guarantee is concerned, learned Commissioner (Appeals) reduced the guarantee commission to 0.77% per annum relying upon the decision of the Tribunal in Asian Paints India Ltd. (supra).
Contesting the charging of guarantee commission, learned Sr. Counsel for the assessee submitted, the provision of corporate guarantee to the AEs does not come within the purview of international transaction as per section 92B of the Act as the guarantee transaction does not constitute purchase, sale or lease of either tangible or intangible property. It also does not have any bearing on the profits, income, losses or assets and does not include any cost apportionment. He submitted, guarantee also does not tantamount to lending or borrowing of money. It also does not constitute provision of intra group chargeable services. He submitted, it is only a shareholder service which is enjoyed by the
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AEs just being a part of the group. In support of such contention, he relied upon a number of judicial precedents. Without prejudice, the learned Sr. Counsel for the assessee submitted, if at all, guarantee commission should be charged @ 0.5%. In this context, he relied upon the decision of the Hon'ble Jurisdictional High Court in CIT v/s Everest Canto Cylinders Ltd., [2015] 378 ITR 57 (Bom.). Further, he relied upon the decision of the Tribunal in WNS Global Services Pvt. Ltd. v/s ITO, ITA no.7378/Mum./ 2012, dated 16th January 2019.
The learned Departmental Representative relying upon the observations of the Transfer Pricing Officer submitted, the guarantee fee charged by the Transfer Pricing Officer should be restored.
We have considered rival submissions and perused the material on record. We have also applied our mind to the decisions relied upon. Insofar as the contention of learned Sr. Counsel for the assessee that provision of guarantee is not an international transaction as per section 92B of the Act, we are unable to accept such contention. In our considered opinion, after introduction of Explanation–(i)(c) to section 92B of the Act, with retrospective effect from 1st April 2002, provision of guarantee to AEs has to be
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considered as an international transaction. Different Benches of the Tribunal have also expressed similar view on the issue. Therefore, we hold that the provision of guarantee to the AEs is an international transaction. In fact, the aforesaid view has been expressed by the Co–ordinate Bench in WNS Global Services Pvt. Ltd. (supra). Therefore, following the aforesaid decision of the Co– ordinate Bench and the decision of the Hon'ble Jurisdictional High Court in Everest Canto Cylinders Ltd. (supra), we direct the Assessing Officer to charge guarantee commission @ 0.5% per annum both on performance / lease guarantee as well as financial guarantee.
In the result, assessee’s appeal is partly allowed.
ITA no.5823/Mum./2016 Revenue’s Appeal
In ground no.1, the Revenue has challenged part relief granted by the learned Commissioner (Appeals) in respect of advertisement expenditure.
While deciding ground no.3, in assessee’s appeal being ITA no. 5713/Mum./2016 in the earlier part of this order, we have upheld the decision of learned Commissioner (Appeals) on the issue
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on the basis of our detailed reasoning therein. In view of the aforesaid, this ground is dismissed.
In ground no.2, the Revenue has challenged the decision of learned Commissioner (Appeals) in allowing assessee’s claim of exemption under section 10A of the Act in respect of units for which deduction under section 80HHE of the Act was earlier claimed.
Brief facts are, during the assessment proceedings, the Assessing Officer noticed that the assessee has claimed deduction under section 10A of the Act in respect of a unit for which deduction under section 80HHC of the Act was claimed in the past.
The Assessing Officer observed, at the time when the unit was commenced, section 10A of the Act was not available and the assessee was claiming deduction under section 80HHE of the Act. He observed that after opting out of section 80HHE of the Act for the assessment year 2001–02, the assessee started claiming benefit under section 10A of the Act. Thus, holding that the assessee is not eligible to claim benefit under section 10A of the Act, the Assessing Officer disallowed the same. The assessee challenged the disallowance before the first appellate authority.
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Learned Commissioner (Appeals) noticed that similar claim made by the assessee in assessment year 2005–06, though, disallowed by the Assessing Officer, but was subsequently allowed by the first appellate authority and such decision of the first appellate authority was also upheld by the Tribunal. Accordingly, learned Commissioner (Appeals) allowed assessee’s claim.
The learned Departmental Representative though relied upon the observations of the Assessing Officer, however, he fairly submitted that the issue has been decided in favour of the assessee in assessment year 2005–06.
The learned Sr. Counsel for the assessee submitted, the decision of the Tribunal in assessment year 2005–06 has also been upheld by the Hon'ble Jurisdictional High Court while dismissing the appeal filed by the Revenue.
We have considered rival submissions and perused the material on record. As noted, identical issue arising in assessee’s own case for the assessment year 2005–06 came up for consideration before the Tribunal in ITA no.6820/Mum./2010 dated 4th November 2015. While deciding the issue, the Tribunal held that since both, section 80HHE and section 10A of the Act entitle the assessee for benefit, the assessee would legitimately be entitled to
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the benefit of that provision of law which enables a larger benefit being earned by him. It is also noticed that the aforesaid decision of the Tribunal has been upheld by the Hon'ble Jurisdictional High Court while deciding Revenue’s appeal in ITA no. 1778/2016, vide judgment dated 18th March 2019. The observations of the Hon'ble Jurisdictional High Court on the issue is as under:–
"6] Section 80HHE of the Act pertains to deduction in respect of profits from export of computer software etc. Sub-section (5) of section 80 HHE provides that where deduction under said section is claimed and allowed in respect of the profits of the business referred in sub- section (1) for any assessment year, no deduction shall be allowed in relation to such profits under any other provision of the Act for the same or any other assessment year. What subsection (5) of section 80 HHE thus prohibits is the claim of deduction allowed under section 80HHE under any other provision, be it in the same assessment year or in other assessment year. In the present case, it is not even the ground of the revenue that the deduction under section 10A of the Act claimed by the assessee in the present year is in relation to profit for which the assessee was granted deduction under section 80HHE. Sub-section 5 of section 80 HHE of the Act, therefore, in the present case would have no applicability. We are fortified in our view by a division bench judge ent of Delhi High Court in the case of Commissioner Income Tax Vs. Damco Solutions Pvt. Ltd., reported in 200 Taxman page 26 in which it was observed as under:- "2. This stand of the Assessing Officer was repelled by the CIT (A) holding that the purpose of subsection (5) of section 80HHE was to avoid double benefit and that would not mean that if the assessee for a particular assessment year wanted relief only under section 10A of the Act that would be denied to the assessee. The only embargo was not to give relief under both the provisions."
7] Coming to the revenue’s second objection to the assessee’s claim of deduction under section 10A of the Act, we may recall, that the assessee had admittedly started manufacturing computer software for export prior to 1st April 2001, when section 10A was substituted by the Finance Act of 2000. It was under this amendment that the profit and gains derived by an undertaking from export of computer software came to be covered for deduction under section bA. The revenue contends that this benefit would not be available to an industry which was already existing and engaged in such activity. However, the interpretation of the revenue would render the first proviso to subsection (1) of section 10A wholly redundant. This proviso reads as under:- "10A(1)Provided that where in computing the total income of the undertaking for any assessment year, its profits and gains had not been included by application of the provisions of this section as it stood immediately before its substitution by the Finance Act, 2000, the undertaking shall be entitled to deduction referred to in this subsection only for the unexpired period of the aforesaid ten consecutive assessment years. As per this proviso, therefore, while computing total income of the undertaking for any assessment year, the profit and gain which had not been included prior to the introduction of Finance Act, 2000, such an undertaking would be entitled to deduction as per sub-section (1) only for the unexpired period of 10 consecutive assessment years. In plain terms, therefore, this proviso would apply to an industry which was already in existence, engaged in manufacturing and export of computer software when the said amendment was made in section 10A. However, such an industry would be eligible to claim that deduction in relation to profit and gain arising out of such activity only for remainder of the period of 10 assessment years, which could be claimed for consequent assessment years alone. 9] If the revenue's interpretation of sub-section (1) of section 10 were to be accepted, then, this proviso would be rendered redundant. "10] Coming to the revenue's contention in relation to the computation of benefit of section 10A of the Act, this issue is squarely covered by the judgment of Supreme Court in the case of Commissioner of Income Tax Vs. HCL Technologies, reported in 404 ITR 719, in which the Court held that the total turnover for the purpose of section 10 of the Act cannot be understood as defined for the purpose of section 80 HHE. It was further held that thus the expenses which are to be excluded from the export turnover, would also have to be excluded for the purpose of computing total turnover.
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Thus, respectfully following the decision of the Co–ordinate Bench and the decision of the Hon'ble Jurisdictional High Court in assessee’s own case as referred to above, we uphold the decision of learned Commissioner (Appeals) on the issue. This ground is dismissed.
In grounds no.3 and 4, the Revenue has challenged deletion of disallowance of commission paid to non–residents under section 40(a)(i) of the Act.
Brief facts are, during the year under consideration the assessee paid commission to some non–residents located in Denmark, Saudi Arabia, UAE and South Africa without withholding tax under section 195 of the Act. When the Assessing Officer called upon the assessee to explain why the commission paid should not be disallowed under section 40(a)(i) of the Act, the assessee submitted that these commissions were paid outside India to non–resident agents operating outside India. It was submitted, these commissions were paid in respect of services performed / delivery by the non–resident agents outside the territory of India in respect of assessee’s export business. The Assessing Officer, however, did not find merit in the submissions of the assessee and disallowed the commission paid of ` 20,23,55,367 under section 40(a)(i) of the Act due to non–deduction of tax at
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source. While deciding assessee’s appeal on the issue, learned Commissioner (Appeals) observed that the payment made towards commission is in the nature of pure contract / project related payment without any further business connection between the parties to the transactions. The payment has been made to the non–residents for getting contracts in their country of residence. On factually verifying the issue, learned Commissioner (Appeals) found that non–resident agents did not have any business connection in India. Since, the remittances were not in the nature of interest, royalty and fees for technical services, learned Commissioner (Appeals) held that at best the commission paid can be treated as business income of the non– residents and which can only be brought to tax in India if the non– residents have business connection in India or have permanent establishment (PE) in India. Thus, learned Commissioner (Appeals) finally concluded that neither the non residents have any business connection in India nor they have PE in India. Therefore, he held that there is no requirement for deduction of tax at source on the commission paid to non–residents.
We have considered rival submissions and perused the material on record. The facts on record clearly reveal that commission has been paid to non–resident agents located in their respective countries towards services rendered by them in those countries in relation to
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obtaining export contracts for the assessee. No material has been brought on record by the Assessing Officer to demonstrate that the non–resident agents either have any business connection in India or have PE in India so as to bring the commission payment within the tax net. The factual finding recorded by learned Commissioner (Appeals) that the non–resident agents have rendered the services in their respective countries and do not have either any business connection in India or any PE in India has not been controverted by the Revenue. Further, the nature of payment viz. commission has also not been disputed by the Revenue. That being the case, since the commission paid to the non–resident agents is not chargeable to tax in India at their hands, there is no necessity for the assessee to withhold tax under section 195(1) of the Act on such payment. Accordingly, we uphold the decision of learned Commissioner (Appeals) on this issue.
In grounds no.5 and 6, the Revenue has challenged the decision of learned Commissioner (Appeals) in directing the Assessing Officer to reduce the expenditure incurred in foreign currency both from export turnover as well as total turnover while computing deduction under section 10A / 10AA of the Act.
Brief facts are, while computing deduction under section 10A of the Act, the Assessing Officer held that the expenditure incurred in
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foreign currency while providing technical services outside India, which is basically salary paid to TCS employees stationed abroad should be reduced from the export turnover. Though, it was argued by the assessee that it is not in the business of providing technical services, but is providing software development services, however, the Assessing Officer was not convinced with the submissions of the assessee and concluded that a part of the foreign currency expenditure can be linked to provision of technical services. So, estimating such expenditure in respect of provision of technical services @ 30%, he reduced it from the export turnover while computing deduction under section 10A of the Act. While deciding assessee’s appeal on the issue, learned Commissioner (Appeals) following the decision of the Tribunal in assessee’s own case rendered in assessment year 2005–06, directed the Assessing Officer to reduce the foreign currency expenditure both from export turnover as well as the total turnover.
We have considered rival submissions and perused the material on record. Notably, identical issue came up for consideration before the Tribunal in assessee’s own case in assessment year 2005–06 (supra). The Tribunal while deciding the issue has held that foreign currency expenditure has to be reduced both from the export turnover as well as total turnover. The aforesaid decision of the Tribunal has been upheld by the Hon'ble Jurisdictional High Court while deciding
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Revenue’s appeal for the assessment year 2005–06 in ITA no.1778/ 2016, dated 18th March 2019. Respectfully following the decision of the Co–ordinate Bench and the decision of the Hon'ble Jurisdictional High Court as referred to above, we uphold the decision of learned Commissioner (Appeals) on this issue. Ground raised is dismissed.
The issue raised in ground no.7, has already been decided by us in ground no.6 of assessee’s appeal being ITA no.5713/Mum./2016. Hence, no separate adjudication is required.
In grounds no.8, 9 and 10, the Revenue has challenged certain decisions of learned Commissioner (Appeals) with regard to the transfer pricing adjustment relating to provision of software consultancy services to the AEs.
As discussed elsewhere in this order, on the very same issue, the assessee has also raised certain grounds being ground no.8, with its sub–grounds.
At the outset, we must observe, in the course of hearing of the present appeal, learned Counsels appearing for the parties have brought to our notice that certain issues relating to transfer pricing adjustment including selection of tested parties insofar as it relates to provision of software consultancy services have in the meanwhile
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being resolved through Mutual Agreement Procedure (MAP) as per Article 27 of the Indo–US and Article–25 of the Indo–Netherland tax treaties. It was also submitted that both the parties have accepted the MAP resolution. However, as submitted by the learned Counsels appearing for the parties, the aforesaid MAP resolution would only apply in respect of international transactions with the AEs in USA and Netherland and would not apply to the international transactions with AEs located in other countries. Keeping the aforesaid factual position in perspective, we will proceed to resolve the issue at hand.
Brief facts are, the assessee provides consultancy services, develops and implements products for customers on all the matters covering implementation of computer software and hardware system, management and data processing and information system and data communication system. It has several subsidiaries in India and abroad. As stated by the assessee, its foreign subsidiaries (AEs) carry out significant marketing and distribution functions, perform onsite services and play key role in securing contracts with clients and maintaining customer relationship. The assessee carries out software development services in India. It is stated that the assessee has rendered software development, technical and consultancy services to its AEs on the basis of specific request received from them. While benchmarking the international transaction in the transfer pricing
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study report, the assessee considered itself as the tested party claiming itself to be a limited risk bearing service provider whereas the activities performed / undertaken by the AEs are more complex in nature. To determine the arm’s length price of the transaction with AEs, the assessee selected Transactional Net Margin Method (TNMM) as the most appropriate method with operating profit / operating cost (OP/OC) as the profit level indicator (PLI). The assessee selected thirteen comparables with weighted average PLI of 9.80% as against the PLI of the assessee shown at 33.35%. Thus, the price charged for the transaction with AEs were claimed to be at arm's length. Additionally, the assessee also computed the margin earned from the AEs @ 27.15% to net margin earned from both, AEs and non–AEs. Since, the margin earned from AEs was higher, the transactions were taken to be at arm's length. After examining the transfer pricing study report in detail, the Transfer Pricing Officer, however, did not accept the assessee as a tested party. He was of the view that the activities of the assessee is more complex compared to the AEs. The Transfer Pricing Officer observed, the assessee is engaged in the core activities for providing service in the nature of designing, development and maintenance of software service and products to overseas clients through the AEs. Thus, ultimately he held that the AEs should be considered as tested parties. Further,, he did not agree with the PLI
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adopted by the assessee and held that the cost incurred by the AEs on payment of price to TCS are in the nature of pass through cost, hence, cannot be considered for computing the margin of the AEs. Thus, he held that the PLI to compute the margin would be operating profit/value added expenditure (OP/VAE). Without discussing anything about the search process followed by him, the Transfer Pricing Officer selected some comparables and proceeded to compute the margin. By adopting the aforesaid PLI, the Transfer Pricing Officer computed the net cost plus margin of 6.42% and suggested an adjustment of ` 811.81 crore. It is relevant to observe, in course of transfer pricing proceeding, the assessee had furnished alternative benchmarking by considering the AEs as tested parties in their respective geographical locations with independent comparables. However, such benchmarking furnished by the assessee was completely ignored by the Transfer Pricing Officer. The adjustment made to the arm’s length price was challenged before the first appellate authority.
Learned Commissioner (Appeals), after considering the submissions of the assessee, though, agreed with the Transfer Pricing Officer that the task performed by the AEs is less complex, hence, they have to be treated as tested parties, however, accepting assessee’s contention on functional analysis he held that the appropriate PLI would be gross margin / sales (gross profit / sales). Further, learned
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Commissioner (Appeals) also held that the Transfer Pricing Officer was not justified in not considering the costs incurred by the AEs by treating it as pass through cost while not doing the same exercise while computing the margin of the comparables. Further, learned Commissioner (Appeals) also proceeded to examine the alternative benchmarking provided by the assessee by considering the respective AEs as a tested parties and after a detailed analysis he accepted such benchmarking and directed the Assessing Officer to make adjustment accordingly on the basis of comparables finally selected by the first appellate authority. Being aggrieved with the aforesaid observations of learned Commissioner (Appeals), both, the assessee as well as the Revenue are in appeal before the Tribunal.
Revenue’s grounds basically are against the decision of learned Commissioner (Appeals) on the appropriate PLI to be applied, consideration of costs incurred by the AEs, alternative benchmarking submitted by the assessee considering the AEs in different geographical locations as tested parties along with comparables situated in those geographical locations. Whereas, the grounds raised by the assessee are on selection of the tested party and some other ancillary issues.
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However, at the outset, learned Sr. Counsel for the assessee, submitted, if the grounds raised by the Department are decided against it, there would be no need to adjudicate assessee’s grounds. In view of the aforesaid, to begin with, we propose to deal with the grounds raised by the Department.
The learned Departmental Representative submitted, the order passed by the Transfer Pricing Officer is a well-reasoned one, wherein, he has dealt with all the aspects of the issue. He submitted, adoption of OP/VAE as PLI is most appropriate considering the FAR analysis of the assessee as well as the AEs. He submitted, the observation of the Transfer Pricing Officer that the cost incurred by the AEs is in the nature of pass through cost is well thought out and well–reasoned. He submitted, though, the Transfer Pricing Officer may not have mentioned in so many words about the search process undertaken to find out comparables, however, he had undertaken a search process. Thus, he submitted, learned Commissioner (Appeals) was not justified in modifying the order of the Transfer Pricing Officer with regard to application of appropriate PLI, pass through cost and foreign comparables.
Learned Sr. Counsel for the assessee strongly supporting the decision of learned Commissioner (Appeals) on the issues contested by
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the Department submitted, the functional analysis depicts that the AEs are undertaking significant and risk bearing distribution functions, hence, have to be remunerated based on sales. He submitted, for determination of arm's length remuneration of AEs, it is not incentive compatible for AEs to generate business in most strategic markets under a cost plus contract. To put further emphasis on such contention, learned Sr. Counsel drew our attention to the extract from UK and U.S. transfer pricing guidelines wherein it is made clear that in such circumstances, remuneration should be based on sales verses costs. In this context, he also referred to para–2.27 and Para–2.35 of OECD guidelines. He also relied upon the following case laws:–
i) Mastek Ltd., [2012] 53 SOT 111 (Ahd.);
ii) Development Consultants Pvt. Ltd. v/s DCIT, [2008] 115 TTJ 577 (Kol.); and iii) ITO v/s Loreal India Pvt. Ltd., ITA no.5423/Mum./2009, dated 25.04.2012.
In addition, he also relied upon various other decisions as referred to in the written notes.
The learned Sr. Counsel for the assessee submitted, the AEs undertake all marketing activities overseas and obtain contracts on behalf of the assessee. In fact, he submitted, the AEs are the
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signatory to the contracts and outsource/sub–contract part of the work to the assessee. Therefore, ignoring the major cost of the work done in the execution of the contract would be contrary to the FAR analysis as a risk bearing distributor. He submitted, the AEs are risk bearing entities including credit risk. Therefore, the cost of TCS in sub– contracting is not pass through cost that can be ignored unlike a commission agent. He submitted, the comparables selected by the Transfer Pricing Officer also have similar costs. However, while computing their margin such costs have not been ignored. In view of the aforesaid, the role of AEs cannot be viewed as a routine marketing service provider as has been held by the Transfer Pricing Officer. He submitted, that in information technology industry, the value / profit driven organization which can bring any business is as important and significant as the delivery function. Accordingly, the AEs do perform significant function and assume distribution and marketing risk. Therefore, the cost of sub–contracting cannot be ignored while determining the PLI as is the case with all the comparables. The learned Sr. Counsel submitted, there is no dispute on the geographical region comparables relating to the North America, Asia Pacific and European Region. He submitted, after further analysis of the comparables by learned Commissioner (Appeals), it was remanded for further verification to the Transfer Pricing Officer and the same has
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been accepted by the Revenue as there is no appeal on the issue. Thus, he submitted, the companies approved / selected by learned Commissioner (Appeals) should be considered as comparables with gross profit / sales as the PLI.
We have considered rival submissions and perused the material on record. We have also applied our mind to the decisions relied upon. From the grounds raised by the Revenue, the following three issues arise for consideration – (i) what should be the appropriate PLI; (ii) whether cost of outsourcing / sub–contracting to the TCS should be considered for computing the margin; and (iii) whether the alternative benchmarking furnished by the assessee by treating the AEs as tested party with comparables in the same geographical locations is acceptable. On a careful perusal of the facts on record as well as submissions of the learned Counsel for the parties in the course of hearing as well as in the written note, we are of the view that the decision of learned Commissioner (Appeals) on the aforesaid issues are unassailable. As regards the issue of appropriate PLI, we are of the view that considering the nature of activity performed by the assessee as well as the AEs, it cannot be said that the A.Es are not bearing any risk. Rather the facts on record reveal that the AEs performed the role of risk bearing distributors. It is well brought out by learned Commissioner (Appeals) in his order that the AEs are bearing credit
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risk and risk of default by client. In fact, the assessee through proper evidences has demonstrated instances where the credit risk with reference to part cancellation of contract has been borne by the AEs without compensation from the assessee. The documentary evidences in this regard furnished by the assessee were thoroughly examined not only by learned Commissioner (Appeals) but they were also produced before us. Thus, from the aforesaid facts, it becomes clear that significant marketing functions are being performed and distribution and marketing risk are being taken by the AEs. On examination of the financials of the subsidiaries it is revealed that some subsidiaries are still making loss at net level which signifies that some risk is being borne by the AEs. It has further been brought on record that the manpower base of AEs performed various functions relating to marketing as well as client co–ordination. The AEs have developed sufficient competency to handle the marketing work independently. The entire contract related work is performed by the AEs, though, in cooperation with the assessee. Thus, it is quite natural that for being a sufficiently motivated work force, the AEs are compensated at return on sales and not merely on value added costs. Therefore, learned Commissioner (Appeals) was justified in directing the Transfer Pricing Officer to adopt the PLI of gross margin on sales. As regards consideration by the Transfer Pricing Officer, the outsourcing / sub–
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contracting cost to assessee as a pass through cost, learned Commissioner (Appeals) was absolutely correct in observing that the decision of the Transfer Pricing Officer to exclude such costs while computing the margin of the AEs is incorrect. When similar cost incurred by the comparables were not excluded while computing their margin, a different treatment cannot be given to such costs in case of the AEs. Certainly, the aforesaid approach of the Transfer Pricing Officer has resulted in distorting the correct PLI of the AEs. In the aforesaid context, the observations of learned Commissioner (Appeals) are appreciable, wherein, he has observed that the PLI of the AEs and PLI of comparables have not been computed on similar lines by the Transfer Pricing Officer, hence, comparability condition fails. It is further relevant to observe, the alternative benchmarking furnished by the assessee before the Transfer Pricing Officer by considering the AEs in different geographic locations as tested parties with the comparables selected on the basis of the respective geographic locations furnished before the Transfer Pricing Officer were not properly considered. However, in course of appeal proceedings, the learned Commissioner (Appeals) examined them in detail and after a detailed analysis approved some comparables selected by the assessee and also added some new comparables. Whereas, the comparable selected by the Transfer Pricing Officer were not on the
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basis of any detailed search process. At least, no such analysis is either forthcoming from the order of the Transfer Pricing Officer or could be brought to our notice by learned Departmental Representative. On the contrary, on a thorough and careful reading of the impugned order of learned Commissioner (Appeals), we are of the view that learned Commissioner (Appeals) has taken pains to examine in detail the alternative benchmarking done by the assessee with foreign comparables and after detailed analysis has shortlisted the final comparables to be considered for comparability analysis. No convincing argument or evidence has been brought on record by the learned Departmental Representative to persuade us to disturb the finding of learned Commissioner (Appeals) on these issues. In view of the aforesaid, we do not find any merit in the grounds raised by the Revenue on the issues. Accordingly, grounds are dismissed.
In view of our decision on the grounds raised by the Revenue, grounds no.7 and 8, in assessee’s appeal have become academic, hence, do not require adjudication.
At this juncture, we must make it clear that our decision hereinabove on the aforesaid grounds would not apply to transfer pricing adjustment made in respect of AEs situated in USA and
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Netherland, as such issues are covered under the MAP resolution, as discussed earlier.
In view of our decision in ground no.10 in assessee’s appeal, no separate adjudication of grounds no.11, 12 and 13, in Revenue’s appeal is required. Hence, they are dismissed.
In the result, Revenue’s appeal is dismissed and assessee’s appeal is partly allowed. Order pronounced in the open Court on 30.10.2019 Sd/- Sd/- N.K. PRADHAN SAKTIJIT DEY ACCOUNTANT MEMBER JUDICIAL MEMBER
MUMBAI, DATED: 30.10.2019 Copy of the order forwarded to: (1) The Assessee; (2) The Revenue; (3) The CIT(A); (4) The CIT, Mumbai City concerned; (5) The DR, ITAT, Mumbai; (6) Guard file. True Copy By Order Pradeep J. Chowdhury Sr. Private Secretary
Assistant Registrar ITAT, Mumbai