TEKLA INDIA P.LTD,NAVI MUMBAI vs. ITO 10(3)(4), MUMBAI

The captioned appeals by the assessee are directed against separate orders of CIT(A)-22, Mumbai dated 28.02.2013 and 07.08.2014 pertaining to Assessment Years 2009-10 and 2010-11 respectively, which in turn have arisen from the orders passed by the Assessing Officer, Mumbai dated 26.12.2011 and 13.03.2013 respectively u/s 143(3) of the Income Tax Act, 1961 (in short ‘the Act’).

Since both the appeals involve certain common issues, therefore, they have been clubbed and heard together and a consolidated order is being passed for the sake of convenience and brevity.

We may take-up for consideration the appeal for Assessment Year 2009-10 wherein the assessee has raised the following Grounds of appeal :- Grounds of appeal for Assessment Year 2009-10 :-

The first substantive dispute is with regard to the addition of Rs.7,03,09,000/- made to the returned income by disallowing expenditure representing remittance to a foreign concern by invoking Sec. 40(a)(i) of the Act on the ground that the requisite tax has not been deducted at source. In this context, the relevant facts are that the appellant is a company incorporated under the provisions of the Companies Act, 1956 and is, inter- alia, engaged in the business of distribution of specialised off-the-shelf software products developed by its holding company, Tekla OYJ, Finland (hereinafter referred to as ‘Tekla Finland’). Pertinently, during the previous year relevant to the assessment year under consideration, assessee paid Rs.4,76,09,000/- and Rs.2,27,00,000/- to Tekla Finland towards purchase of software and upgrades/services respectively. The aforesaid expenditure has been considered by the Assessing Officer to be in the nature of ‘Royalty’, which required deduction of tax at source and since the assessee had failed to do so, he disallowed such expenditure u/s 40(a)(i) of the Act. The stand of the Assessing Officer has also been upheld by the CIT(A), and in this manner assessee is in appeal before us.

In this background, it is to be appreciated that the crux of the controversy is as to whether the payments made by the assessee to Tekla Finland would constitute ‘Royalty’ as per the provisions of Sec. 9(1)(vi) of the Act and/or under the provisions of India-Finland Double Taxation Avoidance Agreement which governs the recipient of income. In order to address the said controversy, we may briefly refer to the manner in which the Assessing Officer as well as the CIT(A) have considered such payments to be in the nature of ‘Royalty’. Pertinently, the recipient, i.e. Tekla Finland, is a tax resident of Finland, and is a 100% holding company of the assessee- company. In terms of an agreement for Resale of software dated 01.02.2008, Tekla Finland appointed the assessee for distribution and marketing of the software in India. In terms of the arrangement, Tekla Finland entered into an agreement with the assessee to distribute and sub- licence shrink-wrap software products developed by it. The stand of the assessee is that once a transaction is initiated with the customer who intends to purchase the software product, assessee enters into an agreement with the customer. Thereafter, Assessee, in turn, prepares a repurchase order on Tekla Finland and on acceptance of the order by Tekla Finland, the software product alongwith a temporary password is sent to the assessee. It was explained at the time of hearing that at this stage an invoice is raised on the assessee and assessee thereafter delivers the software alongwith the temporary password to the customer for which purpose, assessee raises a sales invoice. At the time of hearing, the aforesaid has also been sought to be explained by means of a diagram alongwith sample copies of customer order and software licence agreement, repurchase order, purchase invoice from Tekla Finland as also the sales invoice raised on the the customer by the assessee.

At the time of hearing, it has also been emphasised that assessee is neither granted the source code of the software product and is nor permitted to modify, translate, recompile or alter the software in any manner. It has been explained on the basis of the terms of the agreement, that assessee is merely granted non-exclusive right to market, re-sell and sub-licence the software product developed by Tekla Finland. It was also pointed out that all the trademarks and trade names involved in connection with the products distributed by the assessee remain the exclusive property of Tekla Finland. It is sought to be pointed out that there is no transaction which could enable it to be considered as a ‘Royalty’ as explained in Explanation-2 to Sec. 9(1)(vi) of the Act.

A perusal of the order of the Assessing Officer reveals that much emphasis has been given to clause 4.13 of the agreement, which reads as under :- “4.13 The RESELLER has a right to develop customer specific additional localized features (the “Additional Features”), such as macros, and links to third party software products using SOFTWARE tools provided by TEKLA. Such Additional Features, which may be used by more than one customer on a commercial basis, may only be developed with the prior written consent of TEKLA. Such consent is subject to the RESELLER entering into a separate development agreement with TEKLA. Said agreement shall cover the development, sale and other related matters in respect of Additional Features as well as the payment of royalties in case TEKLA sells Additional Features developed by RESELLER to TEKLA’s other resellers or customers. Any such development shall not entitle the RESELLER to any rights in the SOFTWARE.”

As per the Assessing Officer, the terms and conditions of the Re-seller agreement clearly suggest that the payments have been made for the use or right to use the software and, therefore, it would be in the nature of ‘Royalty’. The Assessing Officer also referred to the agreement to point out that it envisages assessee receiving the software from Tekla Finland and sub- licensing it to customers in the Indian territory and no way does it justify the assertions of the assessee that it was required to purchase the software from Tekla Finland for onward sale to the customers in India. The payments made are for use of intellectual property and not for purchase of goods and, therefore, it being in the nature of ‘Royalty’, tax was required to be deducted at source. The CIT(A) has also more or less concurred with the reasoning taken by the Assessing Officer based on the meaning of expression “Royalty” ascribed in Explanation-2 to Sec. 9(1)(vi) of the Act. Further, the CIT(A) also referred to Explanation-4 to Sec. 9(1)(vi) of the Act, inserted by the Finance Act, 2012 w.r.e.f. 01.06.1976, to say that the payments were for right to use of software, which would amount to ‘Royalty’.

In the above context, the learned representative, in particular, with respect to the reliance placed by the Assessing Officer on clause 4.13 of the agreement, pointed out that the ‘Additional features’ referred therein were never developed by the assessee during the period under consideration and that the impugned payments were merely towards the purchase of software for ultimate sale to the customers in India. The learned representative emphasised that though the agreement refers to obtaining software product by getting a licence, but in effect, it was a case where assessee had purchased the software and resold it to the customers in India. For this purpose, the purchase invoice raised by Tekla Finland on assessee and thereafter the sales invoice raised by the assessee on the customers in India have been referred to on a sample basis to say that it is a case of a purchase of product for onward sale. Reference has also been made to the financial statements showing that the transactions have been depicted as Purchase and Sale of software products. The learned representative pointed out that the aforesaid detailed position was not specifically raised before the lower authorities, but referred to an Affidavit which seeks to point out that the assessee has not developed any additional features in the software product of Tekla Finland before onward sale to the customers. At the time of hearing, the learned representative referred to an application dated 24.01.2018 requesting for admission of additional evidence in terms of Rule 29 of the Income Tax (Appellate Tribunal) Rules, 1963. The additional evidence which have been sought to be admitted are as follows :-

Apart therefrom, the financial statements for the year under consideration have been referred to, in order to demonstrate the manner in which the transactions have been entered in the books of account.

Another aspect raised in support of the plea that no additional features in the software have been developed by the assessee is based on the department-wise bifurcation of employees and their salary costs. These details have been referred, to say that employees of the assessee are predominantly engaged in the activities of sales, marketing and distribution of software products and assessee does not have any employee competent to undertake software development activities. The aforesaid material have been referred by the assessee before us to show that it is a case where assessee has bought the software and in the process of facilitating its distribution and sale in India, rendered sales and marketing services and it is not a case where assessee has indulged in an activity which would render the payments as ‘Royalty’ in nature.

On the other hand, the ld. DR supported the stand of the lower authorities, which we have already noted in the earlier paras and is not being repeated for the sake of brevity.

Having considered the rival stands, it is abundantly clear that the dispute hinges around the mechanics of Re-seller agreement of the assessee with Tekla Finland in terms of which assessee is appointed to distribute and market the software of Tekla Finland in the Indian territory. The case sought to be made out by the assessee is that it has merely purchased and sold a copyrighted article while, on the contrary, what the Assessing Officer has concluded is that assessee acquired a right in the copyright of the article and it is not a case where assessee has merely dealt with a copyrighted article. The stand of the Assessing Officer is primarily based on clause 4.13 of the agreement, which says that assessee would have a right to develop customer specific features in the software product and only thereafter sell it to the Indian customers. Without going into the question as to whether the aforesaid clause enables the characterisation of the payment to Tekla Finland as ‘Royalty’, it is vehemently claimed by the appellant before us that, on facts, no such activity has been undertaken by the assessee during the period under consideration. It is sought to be emphasised that no such localised features were developed; and, on the basis of sample copies of documents, the entire sequence starting from initiation of transaction with the customer who intends to purchase the software, obtaining the same from Tekla Finland and finally selling it to the customer, it has been explained that assessee has merely acted as a ‘distributor’ of the product. We find that this aspect was not specifically raised by the assessee before the lower authorities and in this background, assessee has prayed for admission of such evidence as additional evidence in terms of Rule 29 of the Income Tax (Appellate Tribunal) Rules, 1963. At the time of hearing, both sides were asked to give their say on the importance of the aforesaid evidence in order to determine the correctness of the tax liability of the assessee. Of course, the assessee sought to justify the consideration of such Additional evidence on the on the ground that it will enable the assessee to prove its point that the impugned payments could not be treated as royalties. The Ld. Departmental Representative on the other hand, opposed the plea primarily on the ground that such evidence was always available with the assessee but was not produced before the lower authorities.

The last Ground in this appeal is with regard to the disallowance of Rs.6,936,000/- towards foreign exchange loss on account of restatement of trade receivables/ payables on the end of the year. In this context, it is noted that assessee is following the mercantile system of accounting and as on 31/03/2009 the value of trade receivables and payables was restated in the financial statements in accordance with the Accounting Standard which resulted in marked to market loss of Rs.69,36,000/-. The said loss was claimed as revenue loss by way of debit in the P&L Account. The Assessing Officer as well as the CIT(A) disallowed the claim on the ground that it was a contingent liability. In this context, the Ld.Representative for the assessee relied upon the judgment of the Hon’ble Supreme Court in the case of CIT vs. Woodward Governor India Private Limited, 312 ITR 254 (SC) to contend that loss was allowable as an expenditure in computing the total income. Our attention has also been drawn to the judgment of the Hon;ble Bombay High Court in the case of Vassantram Mehta & Co. Vs. JCIT, 63 Taxmann.com, 102(Bom), wherein it has been held that the loss incurred on account of fluctuation in foreign exchange rate was allowable on the date of making of balance sheet and its allowability could not be postponed to a future date. In view of the aforesaid precedents, we find that the claim of the assessee is justified and it is ordered to be allowed. Thus, on this aspect assessee succeeds.

In the result, appeal of the assessee for assessment year 2009-10 is allowed as above.