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Income Tax Appellate Tribunal, “C”, BENCH KOLKATA
Before: SHRI J. SUDHAKAR REDDY, AM & SHRI S. S. GODARA, JM
BEFORE SHRI J. SUDHAKAR REDDY, AM & SHRI S. S. GODARA, JM आयकर अपीलसं./I.T.A No.67/Kol/2015 (�नधा�रण वष� / Assessment Year: 2008-09) DCIT, Circle-2(1), Kolkata Vs. M/s. ITC Infotech India Ltd. 37, J.L Nehru Road, Kolkata – 700071. �थायीलेखासं./जीआइआरसं./PAN/GIR No.: AAACI7376Q (Appellant/Revenue) .. (Assessee ) & आयकर अपीलसं./I.T.A No.485/Kol/2019 (�नधा�रण वष� / Assessment Year: 2008-09) M/s. ITC Infotech India Ltd. Vs. DCIT, Circle-2(1), Kolkata 37, J.L Nehru Road, Kolkata – 700071. �थायीलेखासं./जीआइआरसं./PAN/GIR No.: AAACI7376Q (Assessee ) .. (Revenue) Appellant/Revenue by : Dr. P. K. Srihari, CIT(DR) Assessee by : Shri J. P Khaitan, Sr. Adv. & Bikash Chanda, FCA सुनवाईक�तार�ख/ Date of Hearing : 06/08/2019 घोषणाक�तार�ख/Date of Pronouncement : 23/10/2019 आदेश / O R D E R Per Shri S. S. Godara: These Revenue’s and assessee’s cross appeal for assessment year 2008-09 arise against the Commissioner of Income Tax (A) - VI, Kolkata dated 24.10.2014 passed in Case No.TP-07/CIT(A)-VI/R-2/2012-13/Kol involving proceedings u/s 143(3) of the Income Tax Act, 1961; in short ‘the Act’. Heard both the parties. Case file perused.
We come to the Revenue’s appeal ITA No.67/Kol/2015. Its first substantive ground pleads that the CIT(A) has erred in law and on facts in reversing the & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 Transfer Pricing Officer’s action making arm’s length price adjustment in respect of assessee’s payments of account management charges of Rs.5,54,88,960/- made to overseas associated enterprises. It transpires at the outset that the very issue arises in A.Y 2007-08 as well involving ITA No.550/Kol/2014 dated 05.12.2018. which stood adjudicated in assessee’s favour as under:
“3. Coming to ground no.1. At the outset itself the Ld. Sr. Counsel for the assessee submitted that the issue raised in ground no.1 of the revenue is no longer res integra. According to him, this issue has already cropped up in AYs 2005-06 and 2006-07 and the Tribunal in assessee’s own case for these Assessment Years in & 2223/Kol/2010 was pleased to uphold similar action of the ld CIT (A) and against the same the revenue preferred an appeal before the Hon’ble High Court which has been dismissed by the Hon’ble High Court in GA No. 2314 of 2015 by order dated 08.01.2016 and thus Hon’ble High Court confirmed the order of the Tribunal. We note that the Tribunal in assessee’s own case wherein the Ld. CIT(A) had deleted the addition made by the AO/TPO as per the transfer pricing adjustment made by them, was challenged by the revenue before this Tribunal for AYs. 2005-06 and 2006-07 wherein the Tribunal upheld the action of Ld. CIT(A) by holding as under: “13. We noted from factual aspects of the case that the TPO perceived that functional and risk profile of the assessee and its AEs are different in both the business models wherein the assessee assumes larger share of risks when contracts are entered by it with customers (Business Model-I) as compared to arrangements wherein the AEs executes the contract with customer (Business Model-II). The two business models are optically different (in terms of contractual party), but the functional and risk profile of both the assessee and its AEs remain ITA No. 2222 & 2223/Kol/10 ITC Infotech India .Ltd 15 the same in both the models, which is evident not only from the terms of the MSA but also from the conduct of the parties. The assessee has explained the business model followed by it along with its functional and risk profile. The assessee explained the “global Delivery Model” as adopted and forming the very basis of two alternative inter-company invoicing models. The business model followed by the assessee and 12A/12B is summarized below:- Model I – Where the customer directly enters into the contract with the respondent; and Model II – Where the customer directly enters into the contract with 12A/12B The assessee explained the economic substance underlying the two arrangements, the roles and responsibilities and the functional profile of the assessee as well as that of its AEs 12A/12B. Further, it explained that inter-company invoicing agreements and contractual terms entered with the AEs. Under both the business model, the basic functions of the subsidiaries, with regard to the administrative functions i.e. account management, are same. On the other hand, assessee is performing non- administrative functions under both the business models and thus entire risks with regard to non- administrative services are being borne by the assessee irrespective of the business model. Furthermore, it was also explained that customers enter into contract with either assessee or 12A/12B with the basic understanding that the activities/services in connection with development of the assignment/project would be essentially driven by assessee in adherence with various commercial and technical qualification parameters/norms specified by the customer namely share capital, average revenue over a period of time, brand value, reputation in the market, track record of successful project, vast and experienced resource pool with expertise in various areas of work, etc. Hence, the essential factor for awarding a service contract would always be technical and commercial expertise and experience of the assessee in handling such similar projects. The local presence of the AEs or it stand- alone financial or technical capabilities hardly influence the decision of the customer to sign the agreement with the AEs. The assessee stated that the possibility of a customer raising any claim for deficiency in administrative services are very remote, as they are rendered to the assessee as an internal arrangement and the customers are not affected by it. Only possibility of any customer raising a claim would be in respect of non-administrative services which are exclusively provided by ITA No. 2222 & 2223/Kol/10 ITC Infotech India .Ltd 16 the assessee irrespective of the business model. It was also emphasised that it is the assessee, which has adequate capital and technical expertise to bear the risks arising from deficiency in services, which neither 12A nor 12B possess. Thus even if a customer raises any claim on 12A/12B, such risk would be eventually passed on to the assessee.
There is contractual relationship among the assessee, its subsidiaries and third parties. The subsidiaries, based on agreement entered into with the assessee, engage in marketing of the IT service I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 capabilities of the assessee in their respective countries and try to win contract for providing IT services. Once a customer is identified, the subsidiaries in coordination with the assessee try to win the customer contract. As it has been explained through the sample customer proposals, the customer is made aware of the assessee’s technical expertise, experience, resource pool etc. from initial stages of the proposal/bidding stage. Once the customer is won, the subsidiaries download the non- administrative services to the assessee. There may be some customers who may not be at all willing to enter into a contract with the subsidiaries as the subsidiaries on a stand-alone basis may not be fulfilling the conditions set by the customers for awarding the contract for provision of IT services. However, these customers may be willing to enter into a contract with the assessee as it has the requisite man power for providing IT services, vast and experienced resources pool with expertise in various areas of work, adequate share capital for bearing the risk arising out of the contract, average revenue over a period of time, brand value, reputation in the market, track record of successful projects, etc. In such cases, the contract is entered into between the customer and the assessee but the functions and risks undertaken by both the assessee and its subsidiaries remain the same as they are when the customers enter into the contract with the subsidiaries. Ld. counsel explained the concept of ‘conduct of the parties’ and risks associated with it. He referred to para 5.3.2.22 and 5.3.2.23 of the United Nations Practical Pricing Manual on Transfer Pricing for Developing Countries (‘Practice Manual’) wherein, allocation of risk and conduct of parties is explained that:- ‘It is not only necessary to identify the risks but also to identify who bears such risks. The allocation of risks is usually based on the contractual terms between the parties. However, contacts between associated enterprises may not specify the allocation of all the risks. Even where a written contract is in place, an analysis of the conduct of the parties is critical in order to determine whether the actual allocation of risk conforms to the contractual risk allocation’ ‘When analysing the economic substance of a transaction, it is necessary to examine whether the conduct of the associated enterprises over time has been consistent with the purported allocation of risk and whether changes in the pattern of behaviour have been matched by changes in the contractual arrangements (emphasis added) Furthermore, in relation to contractual relationship and conduct of the contracting parties, para 5.3.2.30 states that: The conduct of the contracting parties is generally a result of the terms of the contract between them. The contractual relationship thus warrants careful analysis when computing the transfer price. Other than a written contract, the terms of the transactions may be found in correspondence and communications between the parties involved. In cases where the terms of the arrangement between the two parties are not explicitly defined, the contractual terms have to be deduced from their economic relationship and conduct. (emphasis added) It is also pertinent to mention at this juncture that the concept of business risk in transfer pricing context has been discussed at length in the recent amendments to the OECD Transfer Pricing Guidelines 2010 (hereinafter referred to as “OECD Guidelines”) under the new Chapter IX (Transfer Pricing Aspects of Business Restructuring). As per this new guidance, para 9.10 provides that: “Risks are of critical importance in the context of business restructurings. An examination of the allocation of risks between associated enterprises is an essential part of the functional analysis. Usually, in the open market, the assumption of increased risk would also be compensated by an increase in the expected return, although the actual return may or may not increase depending on the degree to which the risks are actually realized.” Under para 9.11 and 9.12: “... .. the examination of risks in an Article 9 context starts from an examination of the contractual terms between the parties, as those generally define how risks are to be divided between the parties. Contractual arrangements are the starting point for determining which party to a transaction bears the risk associated with it ... ..” ... a tax administration is entitled to challenge the purported contractual allocation of risk between associated enterprises if it is not consistence with the economic substance of the transaction . Therefore, in examining the risk allocation between associated enterprises and its transfer pricing consequences, it is important to review not only the contractual terms but also the following additional questions:
I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 · Whether the conduct of the associated enterprises conforms to the contractual allocation of risks, ·Whether the allocation of risks in the controlled transaction is arm’s length, and What the consequences of the risk allocation are.” Specific attention was drawn to the concept of ‘risk allocation’ and ‘control’, on which para 9.22 and 9.23 of the OECD Guidelines state that: “In the absence of comparables evidencing the consistency with the arm’s length principle of the risk allocation in a controlled transaction, the examination of which party has greater control over the risk can be a relevant factor to assist in the determination of whether a similar risk allocation would have been agreed between independent parties in comparable circumstances. In such situations, if risks are allocated to the party to the controlled transaction that has relatively less control over them, the tax administration may decide to challenge the arm’s length nature of such risk allocation. ... ”control” should be understood as the capacity to make decisions to take on the risk (decision to put the capital at 5risk)) and decisions on whether and how to manage the risk, internally or using an external provider. This would require the company to have people – employees or directors – who have the authority to, and effectively do, perform these control functions. Thus, when one party bears a risk, the fact that it hires another party to administer and monitor the risk on a day-to-day basis is not sufficient to transfer the risk to that other party.” Further, the OECD Guidelines have also discussed on the issue of “risk allocation” and “financial capacity” in para 9.29 9.30 as follows: “Another relevant, although not determinative factor that can assist in the determination of whether a risk allocation in a controlled transaction is one which would have been agreed between independent parties in comparable circumstances is whether the riskbarer has, at the time when risk is allocated to it, the financial capacity to assume (i.e to take on) the risk. Where risk is contractually assigned to a party (hereafter ’the transferee) that does not have, at the time when the contract is entered into, the financial capacity to assume it, e.g. because it is anticipated that it will not have the capacity to bear the consequences of the risk should it materialise and that it also does not put in place a mechanism to cover it, doubts may arise as to whether the risk would be assigned to this party at arm’s length. In effect, in such a situation, the risk may have to be effectively borne by the transferor, the parent company, creditors, or another party, depending on the facts and circumstances of the case, irrespective of the contractual terms that purportedly assigned it to the transferee.” Based on the above OECD Guidelines and Practice Manuals, we are of the view that the conduct of the assessee and its AEs should be given due cognizance which in the assessee’s case is same in both the business models. The assessee has also explained from the table, that the functions performed and the risks assumed by the assessee and its AEs under both the business models are the same i.e. the assessee undertakes the core delivery functions and assumes the service liability risks while the AEs are only engaged in marketing and administrative functions. Further, the sample proposal documents submitted by the assessee also vindicates that the prospective customers are fully aware of assessee’s technical capabilities and expertise while awarding a contract and even if the actual contract is executed by the AEs, the customer would presumably not tend to believe that the offshore IT/software development services under Global Delivery Model is being rendered by the AEs and not the assessee. Hence, the execution of the agreement directly by the assessee or by the AE would not create any substantial difference in the sharing of functions or risks between the parties or in turn, would not change the functional characteristic of the parties.
Now before us Ld. counsel explained possible claim by customer for provision of services by the assessee and 12A/12B that · Claim for any deficiency in administrative service – That the possibility of a customer raising any claim for any deficiency in administrative services seems to be very remote as the customer is not impacted by the services which are in the nature of travel arrangements and liasing between the customer and the respondent. It is the respondent who would be impacted for any deficiency in the services provided by the subsidiaries. The only area of any probable I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 dispute and consequential claims is with regard to non-administrative services which are being provided by the respondent u9nde both the business models. · Claim for any deficiency in non-administrative services – The Ld. TPO, vide his order, has acknowledged the fact that the MSA very clearly envisage that the subsidiaries would sub-contract to the respondent the nonadministrative services and the provider of these non-administrative services, i.e., the respondent would be fully liable to the user, i.e., customer for the same. He further submitted that it has the adequate capital and the technical expertise to bear the risk that may arise for any deficiency in the services provided to the customers. The subsidiaries do not have adequate capital or technical expertise to bear such a risk. Thus, in our view, under the Business Model 2, as per terms of the MSA, in case a Customer raises any claim for non-performance of the non- administrative services, the subsidiaries would eventually pass on such risk to the assessee and the assessee has to bear such risk. The customers enter into contract with either the assessee or the subsidiaries for providing software development services. The contracts entered with customers also mention the expected standard of services to be provided for software development work. It is the internal arrangement between the assessee and the subsidiaries where the marketing and the administrative functions are performed by the subsidiaries under both the business model. The subsidiaries provide the marketing and the administrative services to the assessee and not to the clients. Thus, in both the business model the risk profiles of the subsidiaries remain the same. Further, in course of the contract negotiation and mapping of the scope of work, the customer is fully aware of the underlying delivery mechanism, since technical capabilities of the assessee are always showcased and presented before the customer. Therefore the customer based on their individual preferences and driven by the considerations, which are exclusively their own, chooses to enter into contract with 12A / 12B or the assessee, which does not make any essential variation in the business model as a global organisation. Invoicing is the derivative of the methodology proposed to be pursued by the respective client who awards the assignment. The prospective customer is also fully aware of the financial standing of 12A / 12B vis-a-vis the ITC Infotech Group even while entering into service contract with 12A / 12B in view of the fact that every service proposal specifically highlight the technical strength and the financial strength of the assessee which plays its pivotal role before the clients while entering into a contract with 12A / 12B. Hence, the presumption of the TPO that the overseas customers’ decision to enter into contracts directly with 12A or 12B are essentially governed by the standalone financial or technical strengths of these entities devoid of the backup of the assessee’s financial / technical strengths, is inappropriate and without any basis.
Further, in relation to quantification of Risk adjustment, we are of the view that the exercise of risk adjustment is not a simple exercise. A lot of research has been carried out in this field of economics over the years, as a result of which various theories have evolved, that have been applied across businesses to quantify the inherent business risks. However, the subject of risk evaluation and quantification has continued to be an area of extensive study and research. The assessee vide submission dated 11th October, 2009 briefly discussed one such concept in the area of risk management i.e., towards risk evaluation and quantification. In case of the assessee, there is an inherent transfer of risk by 12A / 12B to the assessee vide the MSA in relation to cases where the customer contacts directly with these. AEs and there are financial claims relating to the quality of deliverables. Such a transfer of risk through contractual arrangement is a common risk management practice in commercial world and should be duly recognized. The TPO made adjustment by determining a different revenue split [15% or 13% as the case may be] from the one followed by the respondent and 12A / 12B. Such an adjustment made by the TPO was without any basis or analysis. In relation to difference in clauses in the MSA between the assessee and 12A as referred to by the TPO for making an ad-hoc adjustment, the assessee further drew our attention towards Clauses 4A (iii) and clause 4B (ii) of the MSA which provides for the same effect in relation to exclusion of certain administrative services to be performed, Clause 4B (ii) provides that: “if INFOTECH US subcontracts its obligation in accordance with this clause 4(B), the parties agree that the provisions of clause 5(iii) to (v) inclusive shall not apply and that a fee equal to 75% of the revenue derived under the applicable customer contract from non-administrative services provided by the respondent’s employees shall be paid by INFOTECH US i.e ‘12A’ to the respondent.” Further, the assessee also calculated the effect of adjustment on profitability of ITC Infotech Group taking into consideration the risk adjustment envisaged by TPO for the AY 2006-07 and submitted that both 12A and 12B would make losses at net level if the risk adjusted pricing model, as proposed by the TPO were put in actual practice. Thus the risk adjusted business model as proposed by the TPO would I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 result in an absurd situation from 12A / 12B’s perspectives defeating the concept of stable positive return for a low risk tested party. In the light of the above, we are of the view taking into cognizance the business model of the assessee along with the functions undertaken and risks assumed by the assessee and its subsidiaries, the facts and written submission made during the course of the proceedings for both the AYs 2005-06 & 2006- 07, that the TPO totally erred in making transfer pricing adjustments in the case of assessee in both the AYs. In view of facts and circumstances, we are of the view that the TPO just on the basis of conjunctures and surmises made this transfer pricing adjustments. Hence, we dismiss this common issue of revenue’s appeals in both the AYs.”
We take note that the Tribunal’s order (supra) confirming the Ld. CIT(A)’s action has been upheld at the level of the Hon’ble High Court wherein the Hon’ble High Court by order dated 08.01.2016 for both the assessment years in GA No. 2314 of 2015 and 2318 of 2015 was pleased to uphold the action of the Tribunal by holding as under: “The submission of the appellant that the adjustment of TPO towards Account of Management charges is arbitrary has been dealt by the First as well as the Second Appellate Authority and a concurrent finding of fact has been recorded that the TPO in principle accepted the remuneration model of 25% revenue sharing and the same has been substantiated and justified by the documents so submitted before the authorities below. Further, the genuineness of the documents which were relied on by the authorities have not been doubted by the Department. Thus, in view of the above, we do not find any illegality and infirmity in the orders and further we are of the opinion that a concurrent finding of fact on the basis of the documents on records was recorded by the First Appellate Authority as well as the Second Appellate Authority. Accordingly, no question of law arises out of the judgment rendered by the authorities below. The appeals are devoid of merits and the same are dismissed accordingly along with the applications being GA No. 2314 of 2015 and GA No. 2318 of 2015 respectively.”
Therefore, respectfully following the order of the Hon’ble High Court in AYs 2005- 06 and 2006-07 and taking note of the Hon’ble jurisdictional High Court decision in assessee’s own case, supra, we confirm the order of the Ld. CIT(A) and dismiss this ground of appeal of the revenue.”
3. The Revenue is fair enough in not pinpointing any distinction on facts or law the two corresponding assessment years. The CIT(A)’s detailed discussions has already relied upon his findings in the said earlier assessment year whilst deleting the impugned adjustment. We therefore decline the Revenue’s instant first substantive ground by adopting judicial consistency.
4. Next comes this Revenue’s second substantive ground seeking to revive the Transfer Pricing Officer’s action making arm’s length price adjustment of Rs.22,20,039/- in respect of assessee’s management fee. The CIT(A)’s detailed discussion deleting the adjustment reads as under:
I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 I.T.A No.67/Kol/2015 & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 “4.2. I have considered the facts of the case. The appellant has objected to above adjustment mainly on the ground, that the TPO had arbitrarily rejected certain companies, merely because they were loss making companies. Accordingly to the appellant, all the comparables should have been considered for arriving at a I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 representative bench mark. The appellant also stated that multiple year data should have been considered and this was in accordance with well accepted OECD principles. Without prejudice, it was stated, that if the loss making companies were being excluded, then by the same logic even the companies showing super- normal profit should have also been excluded. Once this is done, mean PLI of the comparables would be within (+/-) 5% of the appellant and no adjustment would be called for. 4.3. I am not in agreement with the contention of the appellant that multiple year data should have been considered by the TPO. The statutory requirement under section 92CA is of using contemporaneous documents and data. The importance of contemporaneous economic and market conditions on price- setting mechanism is also reflected in provisions of Rule 10B (4) of I.T. Rules. Hon'ble tribunal has also held in the decisions in the cases of M/s ST Microelectronics Private Ltd. vs. CIT(A)-XX, New Delhi 145 TTJ 553 (Del) and DCIT, Circle 1(2), Hyderabad vs. Deloitte Consulting India P. Ltd., Hyderabad 145 TTJ 549 (Hyd.) , that for purpose of section 92CA(3), the contemporaneous data relevant to the year under consideration, i.e. the current year data is to be used first and not multiple year data. 4.4. However, I find force in the appellant's objection against exclusion of loss making companies. As mentioned earlier, the single year comparables identified by the appellant were having both profit and loss making companies. The TPO has eliminated only the loss making companies. No justification has been given for the same. It appears that he might have excluded loss making companies because their profitability was not considered as normal. However, no case has been made out to show that such companies were affected by any abnormal factors and loss making comparables have been summarily eliminated. lt has been held in several decisions, including that by Special bench of tribunal in the case of Quark Systems P. Ltd. vs. DCIT 38 SOT 307 that a comparable cannot be rejected merely because of showing loss. Some other such decisions are in the cases of Exxon Mobil Company India P. Ltd. vs. DCIT, 15 ITR(Trib) 353(Mum), Willis Processing Services (I) P. Ltd. vs. DCIT 30 ITR (Trib) 39 (Mum.) and Yum Restaurants (India) P. Ltd. vs. ACIT 14 ITR (Trib.) 420 (Del.). lt has been also informed, that the TPO himself has accepted loss-making comparables in the appellant's case in A.Y.2007-08 and A.Y. 2009-10. lf one considers contemporaneous data of all the comparables without excluding loss making companies from the set of comparables, mean PLI works out to be lower than PLI of the appellant. It is also informed by the appellant that in the order u/s 92CA(3) of AY.2009-10 the TPO has not rejected loss making companies and has not made any adjustment on account of management fee, though the order for the that year was passed subsequent to the year under present appeal. Considering all these facts, I am of the view that in the facts and circumstances of the case no adjustment in respect of management fee is warranted. The adjustment of Rs.22,20,039/- is deleted.”
5. Learned CIT-DR vehemently contends during the course of hearing that the CIT(A) has erred in law and on facts in deleting the impugned arm’s length price adjustment after including loss making comparables. He invited our attention to Para 4.4 in the CIT(A)’s discussion extracted hereinabove that the Transfer Pricing Officer had rightly excluded the loss making comparable entities. We see no reason to express our concurrence with the Revenue’s instant grievance. It emerges that the assessee has succeeded from the very issue of inclusion of loss making entities in preceding as well as succeeding assessment years. We find that this Revenue has failed to justify exclusion of the loss making entities in question in the light of the functions, assets and risk “FAR” analysis and therefore, the mere fact of assessee’s PLI determined at a lesser rate after inclusion of the loss making entities forms no reason to exclude the same from the array of comparables. We & I.T.A No.485/Kol/2019 M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 therefore affirm the CIT(A)’s action deleting the impugned arm’s length price adjustment of Rs.22,20,039/- in respect of assessee’s management fee in issue.
Lastly comes the Revenue’s third substantive ground that the CIT(A) has erred in deleting software purchases disallowance of Rs.1,41,36,670/- (Rs.1,63,71,912/- - Rs.22,35,242/-) thereby treating the same as Revenue’s expenditure in nature. The CIT(A)’s detailed discussion to this effect reads as under:
“5. The second ground of appeal relates to disallowance of expenses of Rs.1,63,71,912/- in respect of purchase of software. The appellant had claimed expenditure of Rs.1,63,71,912/- towards purchase of software as revenue expenditure. Following his order for the A.Y. 2007-08, the assessing officer treated the same to be capital in nature. 5.1. The appellant has given following submission in the matter:- "The appellant, M/s ITC Infotech India Ltd, during Financial Year zooT-o8 relevant to AY 2008-09 has incurred the following software related expenses: Sl. Particulars Amount (in Rs.) Remarks
1. Purchase of System Software's 3,63,49,672/- Capitalised by the Appellant Company enduring in nature Capitalised as under "Capitalised Software" of Schedule
4. Fixed Assets by the appellant company of the Audited Annual Accounts - Refer Exhibit A Page 45 of the Paper Book-II Total amount of Systems 3,63,49,672/- Software's capitalised by The Appellant Company
2. Software related expenditure towards 3,54,03,415/- Revenue expenditure incurred on consumables, maintenance, yearly maintenance of softwares and other related renewal charges, Annual Maintenance expenditure incurred in the normal course contracts etc. of business – duly allowed by the Assessing Officer
3. Expenditure towards purchase of 1,63,71,912/- Application Sofware's Application Software - not extending facilitating appellants and enduring benefit and having conduct of business and limited useful life having limited useful life Total "Software Related Expenditure" 5,17,75,327/- debited in the Profit and loss Account by the Appellant Company under Schedule 16 of the Audited Annual Accounts - Refer Exhibit A Page 49 of the Paper Book - II The appellant was subjected to Scrutiny Assessment under section 143(2) of the Act conducted by the AO. The AO on 7th July 2011 and 28th July 2011 issued a notice under section 143(2) of the Act and after the assessment proceedings the AO issued the order under section 143(3) of the Act dated 1st February 2012 wherein the expenditure incurred on the purchase of application software amounting to Rs.1,63,71,912/- was treated as capital expenditure and the appellant claim of treating the same as revenue expenditure was disallowed. Further the AO did not grant the consequential depreciation arising out of the treatment of these expenses as capital expenditure. While disallowing the expenditure incurred on purchase of application softwares the Assessing Officer similar to the erstwhile AOs ignored the fact that Application softwares are used by the appellant for the efficient conduct of its business and do not extend any enduring benefit to the appellant company. A. Appellant's contention The appellant submits the following establishing that the disallowance made by the Assessing Officer was arbitrary and without appreciating the facts and the nature of business of the appellant:
I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 During the captioned Assessment Year the appellant has capitalized software of Rs.3,63,49,672/-, which were systems software and thus enduring in nature. Consequently these expenditures incurred were treated as Capital expenditure and depreciation at the prescribed rate was charged on these softwares for the purpose of Income Tax. Expenditure incurred on the purchase of the application softwares used exclusively for the purpose of the business of the appellant company amounting to Rs.1,63,71,912/- (Refer Exhibit B Page 67 of the Paper Book- II) has been charged as revenue expenditure and debited to the Profit and Loss Account. These application softwares have not resulted in any enduring benefit to the Company. Hence the expenditure is not classifiable as Capital Expenditure. These were appropriately treated as revenue expenditures and were claimed accordingly for the purpose of income tax too. These application software, have had limited useful life and are used as tools of business like any other component or consumable item used for the purpose of earning revenue. The appellant company has incurred these application software expenses to fine tune its business operations thereby, enabling the running of its business more effectively, efficiently and profitably. Legal position in respect of allowability of expenses on purchase of application softwares: Appellant refer to the decision of the Hon’ble Special Bench of the Delhi Tribunal in Amway India Enterprises vs. DCIT (2008-TIOL-97-ITAT-DEL-SB) (Refer Exhibit B Pages from 90 to 124 of the Paper Book-II), laying down the tests/principles with regard to the treatment of expenditure incurred for acquisition of software either as revenue or as capital. Extract of the said decision is given below:- “Since computer software becomes obsolete with technological innovation and advancement within a short span of time, if can be said that that where the life of the computer software is shorter (say less than 2 years), it may be treated as revenue expenditure; any software having utility to assessee for a period beyond two years can be considered as accrual of benefit of enduring nature, however, that by itself will not make expenditure incurred on software as capital in nature and functional test also needs to be satisfied. For applicability of functional test, advantage which a assessee derives from use of computer software has to be seen in a commercial sense; if advantage is in a capital field then same would be capital expenditure and, if advantage consist merely in facilitating assessee’s trading operations or enabling management and conduct of assessee's business to be carried on more efficiently or more profitably while leaving fixed capital untouched, expenditure would be on revenue account. These criteria are required to be applied to determine exact nature of expenditure incurred by an assessee for acquiring different computer softwares." This decision of ITAT has also been upheld by the hon'ble Delhi high Court (2011-TIOL-710-HC-DEL-IT).The appellant company has duly adhered to the aforesaid tests/principles laid down by the Special Bench of the Tribunal and also accepted by Hon'ble Delhi High Court with regard to treatment of software expenses as either capital or revenue and accordingly claimed these expenditure as revenue for the purpose of income tax. We also rely on the decision of the Hon'ble Punjab & Haryana High Court in CIT Vs.Varinder Agro Chemicals Limited [2009] 309 ITR 272 (P & H) (Refer Exhibit B Pages from 125 to 127 of the Paper Book- II), the extract of which is given below: The Court held that "there was nothing to show that the software used by the assessee was of enduring nature and would not become outdated. Since technology is fast changing and day-by-day systems are being developed in a new way, software may be needed like raw material. Computer software expenses were revenue expenditure and deductible as such." We further refer to the decision of the Hon'ble ITAT Bangalore in IBM India Ltd, Vs. Commissioner of Income Tax (Appeals) [2007] [290 ITR (AT) 183 (Bangalore) (Refer Exhibit B Pages from 128 to 155 of the Paper Book- II) which is squarely applicable in this context. The relevant portion of the judgement is extracted below for your ready reference and kind consideration please: "The test to be applied is, is it a part of company's working expenses or is it expenditure laid out as a part of process of profit earning. Is it on the capital layout or is it expenditure necessary for acquisition of property or of rights of a permanent character, possession of which is condition on carrying on a trade at all. The Hon'ble Supreme Court in the case of Alembic Chemical co. [1989] 177 ITR 377 held that the concept of payment made 'once and for all' and of 'enduring benefit' must respond the changing economic realities of the business. It is also observed that 'once for all' payment test is also inconclusive. In a given case the test of 'enduring benefit' might break down. In the light of above principle, let us examine the facts of the present case." The ITAT further observed in the above mentioned judgment of IBM that "the assessee in the course of its business acquired certain application software. It is made clear that the amount is paid for application software and not system software. The application software enables the assessee to carry out its business operation efficiently and smoothly. However, such software itself does not work on stand-alone basis. The I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 same has to be fitted to the computer system to work. Such software enhances the efficiency of the operation. It is an aid in manufacturing process rather than the toll itself." Therefore, the expense for purchase of software packages were incurredfor acquisition of application software, which were used by the company in the business of providing software related services to the customers. These are essentially revenue in nature and can be lawfully claimed as such. Without prejudice to above, the appellant seeks a relief in respect of depreciation @ 6% on the treatment of expenditure incurred on purchase of application software as capital expenditure. Conclusion.' The position in respect of allowability of expenditure on purchases of application software is summarised below: (i) Acquisition of application softwares used in the business of providing software services for client servicing and consequently used for earning revenue, have been appropriately treated and claimed as revenue expenses. It may further be highlighted that these software have limited useful life. (iii) The above principles adopted for treating "expenditures for purchase of software" either as Capital or as Revenue are in accordance with the generally accepted accounting principles and treatment of the same for the purpose of income tax also is in consonance with the judicial principles laid down by the various Courts of Low as follows: 1. ITAT Bangalore in IMB India Ltd. vs. Commissioner of Income Tax (Appeals) [290 ITR (AT) 183 (Bangalore)] 2. Hon’ble Punjab & Haryana High Court in CIT vs. Varinda Agro Chemicals Limited [2009] 309 ITR 272 (P&H) 3. Hon'ble Special Bench of The Delhi Tribunal in Amwag India Enterprises vs. DCIT ( 2008-TIOL - 97- ITAT - DEL - SB ) " 5.2 Though the appellant has relied upon a number of decisions, including appellate order for earlier year, treatment of expenditure on software as capital / revenue is essentially a question of facts, which naturally varies from case to case and even from year to year. Expenditure towards purchase of software can be capital as well as revenue in nature. There is no hard and fast rule in this regard. Rather, functional test has to be applied on nature of the software purchased on case to case basis to decide as to whether the purchase of software is in nature of capital expenditure or revenue expenditure. This is also the ratio of various decisions, including those cited by the appellant such as the decision of Special Bench of ITAT, Delhi in the case of Amway India Enterprises vs. DCIT 111 ITD 112, on this issue. With that perspective, the details of software purchased were called for from the appellant and were examined. lt is seen that the software purchases included following items:- Sl. No. Vendor Particular Amount (Rs.) 1 Microgenesis Cardsoft P. Ltd. Autodesk Inventor Professional 2008 for 11,13,840/- engineering design 2 Credence Innovations (lndia) P. Power designer data architect for data 2,96,400/- Ltd. modelling 3 Dell lndia P. Ltd. Project 2007 for project management 5,14,734/- 4 Sonata lnformation IBM Rational Software Architect Floating for 3,10,268/- Technology Ltd. application design data modelling The aforesaid software tools are useful for carrying out projects on a continuous basis. They function as tool for creation of application, data modelling, software designing, project management and engineering design. Considering nature of business of the appellant, these software items are tools of trade for the appellant to be utilized for executing contracts for clients over a long term. They enhance technical capability of the appellant to enable it to undertake work which it could not have effectively carried out otherwise. They are meant to be used for executing a number of customer contracts giving enduring benefit to the appellant and in that respect, they are akin to machinery or equipment acquired by a manufacturing unit. On this functional test, they fall in the category of capital assets and expenditure on the same, in my opinion, is to be treated as capital expenditure. Considering this, the same were, in my opinion, required to be capitalized. The disallowance is therefore, confirmed in respect of them. The assessing officer shall however, allow depreciation on the same.
I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 5.3. However, the remaining items of soft ware are found to be useful for day to day functioning of the appellant and they are either application of soft ware for office park or tools like anti-virus, fire-walls etc. Therefore, cost of these items is to be considered as revenue expenditure and be allowed as deduction. 5.4. The assessing officer is directed to reduce the disallowance accordingly.”
It is clear from a perusal of the foregoing lower appellate discussion that the CIT(A) has examined the assessee’s application software purchase expenditure claim is the light of the tribunal’s Special Bench’s decision (supra) that as no enduring benefit has accrued from the same. He further recorded the finding of fact that the assessee’s impugned revenue expenditure of Rs.1,41,36,670/- mainly relates to day to day functions in the field of application software for office as well as technology tools like antivirus, firewalls etc requiring periodic updation. Learned CIT-DR fails to indicate any illegality or irregularity in the CIT(A)’s findings based on correct appreciation of the detailed factual evidence on the foregoing issue. We therefore decline the Revenue’s instant last substantive ground as well the main appeal ITA No.67/Kol/2015.
Next comes assessee’s cross-appeal ITA No.485/Kol/2019. It emerges at the outset the same suffers 1535 days’ delay in filing. The assessee’s detailed condonation petition reads that it has sought to delete section 40(a)(ii) education cess disallowance of Rs.8,60,379/- as a business expenditure allowable u/s 37(1) of the Act since incurred only and exclusively for the purpose of the business. Learned CIT-DR vehemently contended that the impugned 1535 days’ delay in filing of the instant appeal has not been properly explained as attributable to circumstances beyond assessee’s control. The taxpayer’s case on the other hand is that hon’ble Rajasthan high court’s judgment in Chambal Fertilizers and Chemicals Ltd. case dated 31.07.2018 considered in the tribunal’s order in M/s ITC Limited vs. ACIT ITA No.685-1267/Kol/2014 decided on 27.11.2018 held that the impugned disallowance of educational cess u/s 40(a)(ii) is not sustainable. Hon’ble apex court’s landmark decision in Collector, Land Acquisition vs. Mst. Katiji & Others (1987) 167 ITR 471,472-473 (SC) settled the law long back that the cause of substantial justice prevails over all technical aspects. Their lordships’ latter decision in National Thermal Power Co.
I.T.A No.67/Kol/2015 & M/s. ITC Infotech India Ltd. Assessment Year: 2008-09 Ltd. vs. CIT (1998) 229 ITR 383 (SC) also held that the tribunal can very well entertain an additional ground/issue in order to determine correct tax liability of an assessee provided all the relevant facts are already on record. We hold in view of the foregoing pleadings and settled legal proposition that the impugned delay of 1535 days in filing deserves to be condoned. We order accordingly. The assessee’s cross-appeal ITA No.485/Kol/2019 is taken for adjudication.
Adverting to the assessee’s sole substantive grievance seeking to delete its educational cess disallowance made in both the lower proceedings u/s 40(a)(ii) of the Act, hon’ble Rajasthan high court and as well this tribunal (supra) have already held the same to be not sustainable. Learned CIT-DR took pains to refer to the tribunal’s latter decision in ACIT vs. Srei Infrastructure Finance Ltd. decided on 27.02.2019 that the issue stands adjudicated in the Revenue’s favour. We are informed that the hon’ble jurisdictional high court has restored the very issue back to the tribunal for fresh adjudication. We therefore follow hon’ble Rajasthan high court’s decision (supra) to conclude that the both lower authorities have erred in disallowing educational cess amounting to Rs.8,60,379/- u/s 40(a)(ii) of the Act. The assessee’s sole substantive grievance as well main appeal ITA No.485/Kol/2019 are accepted therefore.
This Revenue’s appeal is dismissed and assessee’s cross-appeal ITA No.485/Kol/2019 of the assessee is allowed. Ordered accordingly. A copy of this order be place in the respective case files.
Order is pronounced in the open court on 23.10.2019.