TOYO ENGGINEERING INDIA LTD,MUMBAI vs. ADDL CIT RG 10(3), MUMBAI

grounds.Therefore,we are restoring back both the issues(Gs.AO 3 and 4 raised before us)to the file of the FAA for fresh adjudication.He is directed to afford a reasonable opportunity hearing to the assessee.Third and fourth ground,raised by the assessee,for the year under consideration are decided in its favour,in part. 3.Second ground of appeal is about disallowance of provision of anticipated loss of Rs. 6.49 crores.During the assessment proceedings,the AO found that assessee got a contract from IOC,in Panipat Naptha Cracker Unit, that it had claimed anticipated loss at Rs.6,49,42,668/-, that it had referred to the provisions of Accounting Standard(AS)7,the AO held that assessee was following the Mercantile system of accounting as per section 145 of the Act,that the anticipated losses had not accrued to it, that as per the matching principles income accrued during the previous year only could be taxed, that future losses could not be set off with the present income, that losses accrued during the year only were allowable and not the future losses. He further observed that the cases relied upon by the assessee, namely, Woodward Governer(312 ITR 354) and Triveni Engineering Industries Ltd.were of no help to decide the issue,that the facts of the case under consideration were different from the facts of the above referred two cases,that in the case under consideration contract was yet to be executed, that the losses were uncertain.He disallowed the claim made by the assessee. 3.1.Aggrieved by the order of the year, the assessee preferred an appeal before the FAA and made elaborate submissions. It also relied upon certain case laws. After considering the order of the AO and the submissions of the assessee, he held that the annual report of the assessee for the year ended on 31/03/2009 showed that it was into securing turnkey and project mana - gement consultancy contracts related to oil and gas refining, petrochemical sectors, that during the year under consideration it had secured new contracts from IOC and Hindustan Petroleum Corporation Ltd,that losses admitted pertained to contract related to Naphtha Cracker Unit of IOC,Panipat, that the assessee had claimed that as per AS-7 anticipated loss could be claimed,that revised standard were applicable for the contracts commencing on or after 01/04/2003,that it only recognised percentage completion method in contrast to previous AS-7 that was applicable to both completed contract method as well as percentage completi- on method.He referred to clases 31-35, 38, 39 and 41 of the AS-7 and held that the assessee could recognise expenses immediately when the recovery of contract cost was not probable, that the assessee did not bring any material to show that any of the situation mentioned in the clause existed to recognise the expenses immediately, that the assessee failed to satisfy the condition of clause 34,that clause 38 dealt with disclosure the amount of revenue recognised 6219/M/14&6916/M/14 -M/s. Toyo Engineering India Ltd. from the contract and the method used for such recognition,that it did not disclose the specific requirement of methods used to determine the stays of completion of contract, that it failed to meet many of the mandatory requirements as per the AS,that once a particular AS was followed then it had to be followed in full, that the assessee had complied some of the clauses,that it did not comply with some other requirements,that AS-7 did not talk about provisions of anticipated losses,that it allowed/recognised the loss in the year itself even though the contract was not completed in the relevant year,that the contract work was completed in the subsequent year without any problem,that the claim of provision for anticip -ated loss could not be allowed,that the cases relied upon by it were distinguishable on facts. Finally,he dismissed the appeal filed by the assessee. 3.2.Before us,the AR argued that the assessee was following AS-7 for its construction activities,that being a company it was mandatory for the assessee to follow the accounting standards. He referred to the provisions of section 211 of the Companies Act and stated that the FAA had allowed the disputed amount in the succeeding year. He relied upon the cases of Woodward Governor (312 ITR 254),Jacobs Engineering India Private Ltd.(14 taxmann.com 186), Dredging International NV (48 SOT 430) and ITD Cementation India Ltd.(146 ITD 59).The Departmental Representative(DR)supported the order of the FAA. 3.3.We have heard the rival submissions and perused the material before us.We find that vide its letter is dated 11/10/2012,01/11/201 and 29/01/2013,the assessee had made detailed submissions about applicability of AS-7,that it had argued that the main reason for the anticipated loss was a highly budgeted cost in excess of the budgeted revenue on the project, that it had submitted budgeted revenue, budgeted expenses, revenue recognised till the end of the year along with the total expenses recognised till 31/03/2009, that the AO and the F AA rejected the claim made by it and held that under the percentage of completion of contract method revenue and expenses could be provided to the extent of percentage of project compl -eted,that the also held that future profit for balance contract/Project could not be charged to tax,that future losses also could not be sort of for the particular year,that the FAA further held that claim made by the assessee was not as per the various clauses of the AS-7,that it had secured a few contacts from IOC and HPCL, that it had claimed anticipated loss with regard to the Panipat Naptha contract.

It is not in dispute that the assessee is executing fixed price contract which means that the contractor has agreed to a fixed contract price or rate in some cases subject to cost escalation prices. As per AS-7, the assessee is entitled to make provision for foreseeable losses.

A perusal of the accounting statement of the assessee for the year under consideration shows that at para-1.6 to the notes to the financial statement, the auditors have provided as under: "Revenue recognition on contracts Contract prices are either fixed or subject to price escalation clauses. Revenue from contracts is recognized on the basis of percentage completion method, and the level of completion depends on the nature and type of each contract including : Unbilled work-in-progress valued at lower of cost and net realizable value upto the stage of completion. Cost includes direct material, labour cost and appropriate overheads; and Amounts due in respect of the price and other escalation, bonus claims and/or variation in contract work approved by the customer/third parties etc. where the contract allows for such claims or variations and there is evidence that the customer/third party has accepted it. In addition, if it is expected that the contract will make a loss, the estimated loss is provided for in the books of account. Contractual liquidated damages, payable for delays in completion of contract work or for other causes, are accounted for as costs when such delays and causes are attributable to the company or when deducted by the client."

A similar issue has been considered by the Tribunal in the case of Mazagoan Dock (supra) wherein the Tribunal has held as under: "The question that came up for consideration was as to whether the anticipated loss on the valuation of fixed price contract in view of the mandatory requirements of the AS-7, was to be allowed in the year in which the contract had been entered into or it was to be spread over a period of contract, as was done by the assessee in earlier years. As far as the change in the method of valuation of work-in-progress was concerned, it could not be disputed that in view of mandatory requirements of the AS-7, it was a bona fide change in the method of valuation of work-in-progress, particularly in view of the qualification made in this regard by statutory auditors as well as by the Comptroller & Auditor General of India. Therefore, the observation of the Commissioner (Appeals) that the assessee had booked bogus loss was not correct. As far as the basis of estimation was concerned, the same was done on technical estimation basis and, therefore, merely because there were some variations in the figures furnished by the assessee at different stages, it could not be said that the estimated loss was not allowable. It was not disputed that the department in earlier years had allowed the loss on estimated basis having regard to the expenditure actually incurred in various years. Therefore, in principle, it was not disputed that the estimated loss under the present circumstances was an allowable deduction. However, merely because the change in method of accounting was bona fide, it could not lead to the inference that the income was also deducible property under the Act. This aspect is very evident from the first proviso to section 145 as it stood prior to the amendment by the Finance Act, 1995 with effect from 1/4/1997. It could not be disputed that from the method adopted by the assessee, the assessee's income could not be deducted property in the year in which the loss had been anticipated. As a matter of fact this aspect was not disputed by the Assessing Officer also. He had swayed more by the revenue loss than by the correct principle to be applied. The matching principle of accounting was not of much significance in the present context because if the loss had been properly estimated in the year in which the contract had been entered into, then it had to be allowed in that very year and could not be spread over the period of contract. The matching principle is of relevance where income and expenditure, both are to be considered together. However, in the instant case, the effect of valuation of WIP would automatically affect the profits of subsequent years accordingly. Therefore, there was no reason for not accepting in principle the assessee's claim as being allowable. However, in view of discrepancies pointed out by the Commissioner (Appeals) for correct estimation of loss, the matter was to be restored to the file of the AO to examine the correctness of amount claimed." 18. A similar view has been taken by the Tribunal in the case of Jacobs Engg. India P. Ltd. (supra) wherein the assessee's claims of foreseeable losses were allowed irrespective of method of accounting in terms of AS-7. In the case of Dredging International (supra), the issue before the Tribunal was whether u/s. 37(1) of the Act provision for foreseeable loss made in accordance with guidelines of AS-7 and duly debited in audited accounts of company is an allowable expenditure. 5 6219/M/14&6916/M/14 -M/s. Toyo Engineering India Ltd.

Considering the facts of the case in the light of the accounting standards and the decisions of the Tribunal (supra),and as no distinguishing cases have been brought on records by the revenue, reversing the findings of the Ld. CIT(A), we direct the AO to recompute the business profits by allowing the losses provided by the assessee in its books. The appeal filed by the assessee is allowed.

In the result, the appeal filed by the Revenue is dismissed and the appeal filed by the assessee is allowed.” In light of the above discussion,ground no.2 is decided in favour of the assessee. 4.Next effective ground of appeal

The appeal filed by the Revenue against the Judgment of the Special Bench of the ITAT was dismissed by the High Court of Delhi in the case of DIT V. Nokia Networks OY (2012) 253 CTR (Del) 417: (2012) 78 DTR (Del) 41. The bench approved of the findings of the Special Bench of the Tribunal in the Motorola case supra that Copyright is distinct from the material object, copyrighted. It is an intangible incorporeal right in the nature of a privilege, quite independent of any material substance, such as a manuscript. He has an individual right of exclusive enjoyment. The transfer of the manuscript does not, of itself, serve to transfer the copyright therein. The transfer of the ownership of a physical thing in which copyright exists gives to the purchaser the right to do with it (the physical thing) whatever he pleases, except the right to make copies and issue them to the public. Just because one has the copyrighted article, it does not follow that one has also the copyright in it.

In the case of DIT v. Ericsson A.B. (2012) 66 DTR (Del) 1: (2012) 246 CTR (Del) 422: (2012) 343 ITR 470(Del), one issue that the Delhi High Court was considering was whether the consideration for supply of software was payment by way of royalty and hence assessable both under s. 9(1)(vi) and the Double Taxation Avoidance Agreement between the government of India and Sweden? The High Court relying on the Judgment of the Supreme Court of India in Tata Consultancy Services vs. State of Andhra Pradesh, (supra), held that software incorporated on a media would be goods and liable to sales tax. The High Court has held as under: "56. A fortiorari when the assessee supplies the software which is incorporated on a CD, it has supplied tangible property and the payment made by the cellular operator for acquiring such property cannot be regarded as a payment by way of royalty.

Be that as it may, in order to qualify as royalty payment, within the meaning of s. 9(1)(vi) and particularly clause (v) of Expln. 2 thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any licence) in respect of copyright of a literary, artistic or scientific work. Sec. 2(o) of the Copyright Act makes it clear that a computer programme is to be regarded as a "literary work". Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the present case, this has not been established. It is not even the case of the Revenue that any right contemplated under s. 14 of the Copyright Act, 1957, stood vested in this cellular operator as a consequence of art. 20 of the supply contract. Distinction has to be made between the acquisition of a "copyright right" and a "copyrighted article".

Mr. Dastur is right in this submission which is based on the commentary on the OECD Model Convention. Such a distinction has been accepted in a recent ruling of the Authority for Advance Ruling (AAR) in Dassault Systems K.K., In re 229 CTR (AAR) 105: (2010) 34 DTR (AAR) 218. We also find force in the submission of Mr. Dastur that even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Expln. 2 below s. 9 (1) (vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in art. 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. art. 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what is contemplated is a payment that is dependent upon user of the copyright and not a lump sum payment as is the position in the present case. We thus hold that payment received by the assessee was towards the title and GSM system of which software was an inseparable parts incapable of independent use and it was a contract for 7 6219/M/14&6916/M/14 -M/s. Toyo Engineering India Ltd.

The Delhi High Court further in Ericsson Case (supra) further held that once it is held that payment in question is not royalty which would come within the mischief of clause (vi), the Explanation will have no application and that the question of applicability of the Explanation would arise only when payment is to be treated as "royalty" within the meaning of clause (vi) or "fee for technical services" as provided in clause (vii) of the Act.

In the case of Dassault Systems K. K., In re (2010) 229 CTR (AAR) 105: (2010) 34 DTR (AAR) 218: (2010) 322 ITR 125 (AAR) the Authority on Advance Ruling has held as under: "Passing on a right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to trigger the royalty definition. Viewed from this angle, a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in a copyright. Where the purpose of the licence or the transaction is only to establish access to the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself has been transferred to any extent. It does not make any difference even if the computer programme passed on to the user is a highly specialized one. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the definition clause in the Act as well as the Treaty. As observed earlier, those rights are incorporated in s.

Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, in our view, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. However, where, for example, the owner of copyright over a literary work grants an exclusive licence to make out copies and distribute them within a specified territory, the grantee will practically step into the shoes of the owner/grantor and he enjoys the copyright to the extent of its grant to the exclusion of others. As the right attached to copyright is conveyed to such licencee, he has the authority to commercially deal with it. In case of infringement of copyright, he can maintain a suit to prevent it. Different considerations will arise if the grant is non-exclusive that too confined to the user purely for in-house or internal purpose. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/transferor who divests himself of the rights he possesses protanto. That is what, in our view, follows from the language employed in the definition of "royalty" read with the provisions of the Copyright Act, viz., s. 14 and other complementary provisions. We may refer to one more aspect here. In the definition of royalty under the Act, the phrase "including the granting of a licence" is found. That does not mean that even a non exclusive licence permitting user for inhouse purpose would be covered by that expression. Any and every licence is not what is contemplated. It should take colour from the preceding expression "transfer of rights in respect of copyright". Apparently, grant of "licence" has been referred to in the definition to dispel the possible controversy a licence whatever be its nature, can be characterized as transfer.

In order to qualify as royalty payment, it is necessary to establish that there is transfer of all or any rights (including the granting of any licence) in respect of copyright of a literary, artistic or scientific work. In order to treat the consideration paid by the Licensee as royalty, it is to be established that the licensee, by making such payment, obtains all or any of the copyright rights of such literary work. Distinction has to be made between the acquisition of a "copyright right" and a "copyrighted article". Copyright is distinct from the material object, copyrighted. Copyright is an intangible incorporeal right in the nature of a privilege, quite independent of any material substance, such as a manuscript. Just because one has the copyrighted article, it does not follow that one has also the copyright in it. It does not amount to transfer of all or any right including licence in respect of copyright. Copyright or even right to use copyright is distinguishable from sale consideration paid for "copyrighted" article. This sale consideration is for purchase of goods and is not royalty. 8 6219/M/14&6916/M/14 -M/s. Toyo Engineering India Ltd.

The license granted by the Assessee is limited to those necessary to enable the licensee to operate the program. The rights transferred are specific to the nature of computer programs. Copying the program onto the computer's hard drive or random access memory or making an archival copy is an essential step in utilizing the program. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the program by the user, should be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as business income in accordance with art. 7.

There is a clear distinction between royalty paid on transfer of copyright rights and consideration for transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his copyright, is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to invoke the royalty definition. Viewed from this angle, a non exclusive and non- transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in art. 12 of DTAA. Where the purpose of the licence or the transaction is only to restrict use of the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself or right to use copyright has been transferred to any extent. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the Treaty. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/ transferor who divests himself of the rights he possesses pro tanto. 90. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said para because it is only integral to the use of copyrighted product. Apart from such incidental facility, the licensee has no right to deal with the product just as the owner would be in a position to do. 91. There is no transfer of any right in respect of copyright by the Assessee and it is a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article and cannot be considered as royalty either under the IT Act or under the DTAA. 92. The licensees are not allowed to exploit the computer software commercially, they have acquired under licence agreement, only the copy righted software which by itself is an article and they have not acquired any copyright in the software. In the case of the Assessee company, the licensee to whom the Assessee company has sold/licensed the software were allowed to make only one copy of the software and associated support information for backup purposes with a condition that such copyright shall include Infrasoft copyright and all copies of the software shall be exclusive properties of Infrasoft. Licensee was allowed to use the software only for its own business as specifically identified and was not permitted to loan/rent/sale/sub licence or transfer the copy of software to any third party without the consent of Infrasoft. 93. The licensee has been prohibited from copying, decompiling, deassembling, or reverse engineering the software without the written consent of Infrasoft. The licence agreement between the Assessee company and its customers stipulates that all copyrights and intellectual property rights in the software and copies made by the licensee were owned by Infrasoft and only Infrasoft has the power to grant licence rights for use of the software. The licence agreement stipulates that upon termination of the agreement for any reason, the licencee shall return the software including supporting information and licence authorization device to Infrasoft. 94. The incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee. The right to use a copyright in a programme is totally different from the right to use a programme embedded in a cass ette or a CD which may be a software and 9 6219/M/14&6916/M/14 -M/s. Toyo Engineering India Ltd.

We have not examined the effect of the subsequent amendment to s. 9(1)(vi) of the Act and also whether the amount received for use of software would be royalty in terms thereof f or the reason that the Assessee is covered by the DTAA, the provisions of which are more beneficial.

The amount received by the Assessee under the licence agreement for allowing the use of the software is not royalty under the DTAA.

What is transferred is neither the copyright in the software nor the use of the copyright in the software, but what is transferred is the right to use the copyrighted material or article which is clearly distinct from the rights in a copyright. The right that is transferred is not a right to use the copyright but is only limited to the right to use the copyrighted material and the same does not give rise to any royalty income and would be business income.

We are not in agreement with the decision of the Andhra Pradesh (sic-Karnataka) High Court in the case of Samsung Electronics Co. Ltd (supra) that right to make a copy of the software and storing the same in the hard disk of the designated computer and taking backup copy would amount to copyright work under s. 14(1) of the Copyright Act and the payment made for the grant of the licence for the said purpose would constitute royalty. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use was only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process was necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it is only integral to the use of copyrighted product. The right to make a backup copy purely as a temporary protection against loss, destruction or damage has been held by the Delhi High Court in DIT v. Nokia Networks OY (Supra) as not amounting to acquiring a copyright in the software.

In view of the above we accordingly hold that what has been transferred is not copyright or the right to use copyright but a limited right to use the copyrighted material and does not give rise to any royalty income. As far as retrospective applicability of the provisions of section 40(a)(ia)is concerned we would like to refer to the order of the Tribunal in the matter of Channel Guide India Ltd.(supra)and it reads as under: “25. In our opinion, the issue involved in the present case however, is relating to disallowance made u/s.40(a)(i) for non-deduction of tax-at-source from the payment made by the assessee to SSA and as held by Ahmedabad Bench of this Tribunal in the case of Sterling Abrasives Ltd. v. ITO [I.T. Appeals 2243 & 2244 (Ahd.) of 2008] by its order dated 23.12.2010 cited by the Ld. Counsel for the assessee, the assessee cannot be held to be liable to deduct tax at source relying on the subsequent amendments made in the Act with retrospective effect. In the said case, Explanation to sec.9(2) was inserted by the Finance Act, 2007 with retrospective effect from 1.6.1976 and it was held by the Tribunal that it was impossible for the assessee to deduct tax in the financial year 2003-04 when as per the relevant legal position prevalent in the financial year 2003-04, the obligation to deduct tax was not on the assessee. The Tribunal based its decision on a legal Maxim lex non cogit ad impossiblia meaning thereby that the law cannot possibly compel a person to do something which is impossible to perform and relied on the decision of Hon'ble Supreme Court in the case of Krishnaswamy S. Pd v. Union of India [2006] 281 ITR 305 / 151 Taxman 286 wherein the said legal Maxim was accepted by the Hon'ble apex court.

In view of the above discussion, we are of the view that the amount in question paid by the assessee to SSA was not taxable in India in the hands of SSA either u/s.9(1)(vi) or 9(1)(vii) as per the legal position prevalent at the relevant time and the assessee therefore was not liable to deduct tax at source from the said amount paid to M/s. SSA and there was no question of 10 6219/M/14&6916/M/14 -M/s. Toyo Engineering India Ltd. disallowing the said amount by invoking the provisions of sec.40(a)(i). In that view of the matter, we delete the disallowance made by the AO u/s.40(a)(i) and confirmed by Ld. CIT (A) and allow ground no.1 of the assessee's appeal.” Considering the above,we decide ground no in favour of the assessee. ITA/6916/Mum/2014,AY.2010-11: The solitary ground of appeal is about anticipated loss of Rs.2.89 crores.Following our order for the earlier AY.we decide effective ground of appeal in favour of the assessee.