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Income Tax Appellate Tribunal, “B” BENCH, MUMBAI
Multi Commodity Exchange of Dy. Commissioner of Income Tax, (I) Ld. Central Circle-46 Exchange Square, CTS No. 255 Mumbai Vs. Suren Rd, Chakala, Mumbai-400 093 PAN No. AADCM9239K Appellant .. Respondent .. S/Shri Chetan Karia & Assessee by Rajesh Shah, AR Revenue by .. Shri Suman Kumar, DR Date of hearing .. 02-02-2017 Date of pronouncement .. 07-04-2017 O R D E R PER MAHAVIR SINGH, JM:
These five appeals by the assessee are arising out of the common order of CIT(A)-38, Mumbai, in appeal Nos. CIT(A)-38/IT-356,357,358 & 359/2011-12, CIT(A)-38/IT-185/2012-13 dated 29-08-2013. The Assessments were framed by DCIT Circle-46, Mumbai for the A.Y. 2005-06, 2007-08, 2006-07,2008-09 & 2009-10 vide order dated 30-11-2011, 30-11-2011, 31-01-2013, 13-12-2011 u/s 143(3) read with section 153A read with section 148 read with section 254 of the Income Tax Act, 1961 (hereinafter ‘the Act’).
The first common issue in all these five appeals of assessee is as regards to the order of CIT(A) confirming the action of the AO in disallowing the to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 expenses relatable to exempted income by invoking the provisions of section 14A of the Act reads with Rule 8D of the Rules. For this assessee has raised identical worded ground in all these years.
Briefly stated facts are that the AO estimated the disallowance for AY 2005-06, 2006-07 & 2007-08 at 3% of exempt income by invoking the provisions of Section 14A of the Act. The assessee before CIT(A) as well as before AO contended that 1% disallowance should be made of the exempt income. The CIT(A) after discussing the facts upheld the disallowance made by AO at 3% by observing in Para 9.1 to 9.4 as under: - “9.1 For the A.Yrs.2005-06, 2006-07 & 2007-08, the appellant computed the disallowances based on the indirect expenses such as rent, salary, staff welfare, telephone & fax charges for each assessment year as under:
9.2 The disallowance made by the appellant is meager compared to the total expenditure incurred under the heads of expenses such as salaries, bonus, staff welfare, rent & services charges, travelling and conveyance, communication expenses etc. and the relevant details are reproduced as under: - to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10
9.3 It can also be seen that the quantum of disallowance made by the assessing officer small as compared to the dividend income earned on the investments made. The dividend income and total investments earned by the assessee and the total receipts as per P & L a/c. are given as under:
9.4 The investment decision requires substantial market research, day today analysis of market trends, reporting and accounting, making telephone calls, fax, c-mails etc. To carry out such work, staff support is necessary, though the appellant claims that the service of distributer of mutual fund was utilized for such services and the assessee had not carried out any activity. This claim of the appellant is not acceptable. No person would blindly invest without taking its own investment decisions. The appellant's role will always be there in investment decisions. This requires maintenance and monitoring of such activities by its own staff concerned. Therefore, the disallowance under the administrative expenditure such as salary, staff welfare, rent, travelling and conveyance, communication expenses have to be at reasonable basis. Page 3 of 13 to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10
Considering the quantum of investment, dividend income and the sums incurred under relevant administrative head of expenses, the disallowance on the exempted income appears reasonable. Therefore, appellant's request to adopt the disallowance @1% is not acceded to. In view of the above. 3% disallowance made by the Assessing Officer on exempt income is considered reasonable and accordingly the disallowances of Rs.81.186/-, Rs.25.56.1 121- and Rs.73,63,698/- in respect of AYrs.2005-06, 2006-07 & 2007-08 respectively are hereby upheld..”
As regards to the AY 2008-09 and 2009-10 are concerned, the AO as well as CIT(A) invoke the provision of section 14A of the Act read with Rule 8D (2) and made disallowance of Rs. 1,4,37,783/- and Rs. 1,47,6,408/- for AY 2008-09 and 2009-10 respectively. For this the CIT(A) observed in Para 9.5 is as under: -
“9.5 As far as the A.Yrs.2008-09 & 2009-10 are concerned, the Assessing Officer invoked the provisions of sub-section 2 of section 14, of the Act read with Rule 8D(2) correctly and accordingly computed the disallowance. For the assessment year 2008-09, the appellant requested for reasonable disallowance 1% and this plea of the appellant is misplaced in view of the Hon'ble Bombay High Court's decision in the case of Godrej Boyce Manufacturing Company Ltd. (supra). wherein it is categorically held that once sub-section (2) of section 14A is invoked, thereafter the disallowance will be as per the Rule 80(2) of 1.1. Rules, 1962 and the application of Rule 80 is w.e.f. A.Y.2008-09 and the disallowance on the basis of reasonable estimate can be adopted only in respect of assessment years prior to A.Y.2008-09. Therefore, the appellant's request to adopt the disallowance @ 1% is not possible since sub-section (2) of section 14A read with Rule 8D(2) of I.T. Rules, to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10
1962 has been invoked for the A.V.2008-09. The appellant does not disagree with the computation but its primary case is that the invocation of Rule 8D(2) is not necessary. The facts and circumstances of the case as narrated by the Assessing Officer in the assessment order and also as discussed in pan 9.2. 9.3 & 9.4 above requires computation of disallowance under Rule 80(2) of 1.1. Rules. 1962. Since the administrative expenses in the nature of salary, staff welfare. rent, travelling & conveyance, communication expenses are incurred for earning both exempt income as well as taxable income, computation of disallowance as per section 14A of the Act read with Rule 80(2) is necessary. Accordingly, the disallowance of Rs.1.04.37.783- and Rs.1.47,06,408/- for A.Yrs.2008-09 & 2009-10 respectively are hereby upheld.”
The assessee, aggrieved by the orders of CIT(A) for all these five years, came in second appeal before Tribunal.
We have heard the rival contentions and gone through the facts of the case. We have gone through the assessment order and the order of CIT(A) and noted that both the authorities below have rejected the assessee’s contention for disallowance under section 14A of the Act for the AY 2005-06, 2006-07 and 2007-08 simply for the reason that Rule 8D of the Rules applies to the assessee and accordingly, the AO estimated the disallowance at 3% of the exempted income. The assessee before lower authorities offered the disallowance at 1% of the exempted income to be estimated at the best, but both the authorities below estimated disallowance at 3%. We find that this issue is covered in favour of assessee’s and against Revenue and Tribunal is taking consistent view in all the case that 1% disallowance prior to applicability of Rule 8D will not meet the end of justice. Accordingly, we direct the AO to re-compute the disallowance at 1% to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 of the exempted income in all these three AYs. i.e. AY 2005-06, 2006-07 and 2007-08. In these three years this issue of the assessee’s appeal is partly allowed.
Now, coming to the AYs 2008-09 and 2009-10, we find from the assessment order that no satisfaction is recorded by the AO for rejecting the claim of the assessee regarding expenses and correctness of the same. We find that the assessee in AY 2008-09 has claimed expenses relatable to exempted income at Rs. 6,03,821/- and in AY 2009-10 at Rs. 6,53,594/-. Now, we find that these issues stand cover in favour of assessee against Revenue by the Tribunal’s decision of Calcutta Bench in the case of REI Agro Ltd. Vs. DCIT (2013) 35 taxman.com 404(Cal Trib), wherein it is held that no disallowance under section 14A of the Act read with rule 8D of the Rules can be made if satisfaction is not recorded with reference to correctness of the claim of the assessee. We are also find that this decision of the Tribunal was confirmed by Hon’ble Calcutta High Court in the case of CIT vs. REI Agro Ltd. in GA No. 3022 of 2013 in of 2013 dated 23-03-2013. In view of the above facts and circumstances, we restrict the disallowance as claim by assessee at Rs. 6,03,821 in AY 2008-09 and sum of Rs. 6,53,594/- in AY 2009-10. Accordingly, this issue of the assessee’s appeal is allowed for these two AYs.
The only issue remains for adjudication in for AY 2006-07 is as regards to the disallowance of software support charges claimed by assessee and disallowed by AO and restricted by CIT(A). For this assessee has raised following ground No. 3 and 4: - “3) On the facts and in the circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) erred in confirming disallowance of Rs. 1,96,80,000/- in relation to software support charges.
4) On the facts and in the circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) erred in stating that, "Any change or modification in the nature of alteration referred in the Page 6 of 13 to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 agreement will make changes in the original architecture of the software. Any change in the architecture of original software will not be called as maintenance of software. The substantial change made to software is in the nature of bringing in a modified capital asset for enduring benefit", especially when the alterations/modifications in the software were frequently required to comply with the changing regulatory environment and were in the nature of current not repairs allowable u/s 31(i) or allowable u/s 37(1) of the Act and were not of enduring nature.”
Briefly stated facts are that the assessee has debited a sum of Rs. 6.15 crores on account of the software support charges under the head of operating and other expenses which were paid to Financial Technologies India Ltd. The facts are that the assessee is a regulator and carrying on the activity of commodity exchange on an electrical platform and infrastructure has been provided by the assessee to its members to carry out the activity. The major income of the assessee is membership, annual recording fee, and transaction processing charges carried out on the electrical field provided by the assessee and assessee incurred expenses on software to keep its electrical platform operational for the purpose of its business. To carry out these expenses the assessee debited a sum of Rs. 6.15 crores towards software support charges. The AO during the year under proceeding noted on verification of ledger account that the narration of expenses are general in connection with provision of software fee comprehensive risk management system for derivatives markets, towards modification/alteration of commodity exchange software, exchange software etc. According to AO these expenses are in the nature of capital expenses and not allowable under section 37 of the Act. Accordingly, the AO disallowed the same. However, the AO allowed depreciation at the rate of 60% at Rs. 3.69 crore. Aggrieved assessee preferred the appeal before CIT(A). the CIT(A) restricted the disallowance at 1.56 crore by observe in Para 12.4 to 12.6 as under: - to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10
“12.4 A careful analysis of the above clauses / paragraphs of the agreement dated 01.10.2005 clearly specify that the agreement was entered for two different purposes, one of the purposes being alteration/modification of the existing software which means that the existing architecture of the software under use is primarily changed suggesting that there is substantial replacement of the original software and the other part of the contract is maintenance and supervision. The appellant paid higher payment @ Rs.60 lacs per month for replacement and only Rs. 15 lacs per month for maintenance.
12.5 In the agreement dated 31.5.2004, the distinction of job profile dividing it into providing of alteration or modification and technical supervision are together worded. It is submitted by the appellant that the original software is capital asset and maintenance of such software is revenue expenditure. This contention of the appellant is correct but the dispute is on account of alteration, changes or modification made to the original software. Though the appellant claims the function of such as alternation or replacement of original software is also in the nature of maintenance, I am not able to hold a similar view. Any change or modification such as in the nature of alteration referred in the agreement will make changes in the original architecture of the software. Any change in the architecture of original software will not be called as maintenance of software. The substantial change made to software is in the nature of bringing in a modified capital asset for enduring benefit. Therefore, it is hereby held that alteration/maintenance of Rs. 60 lacs p.m. is to be capitalized and Rs. 15 lacs p.m. is to he to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 allowed. However, the assessee would be entitled for depreciation on the capitalized assets.
12.6 As mentioned in the above paragraph No.12.1 the appellant had submitted the total expenses incurred in the entire year alongwith bifurcation based on both agreements. As per agreement dated 31 .5.2004 a sum of Rs. 1,27,50,000/- was paid for the period from April to September 2005 and a sum of Rs. 4,87,50,000/- was paid for the period from October 2005 to March 2006 totaling to Rs. 6,15,00,000/-. A sum of Rs 4,87,50,000/- includes Rs.97,50,000/- towards maintenance and Rs.3,90,00,000/- is towards alteration/modification. A sum of Rs.3,90,00,000/- is towards alteration/ modification, therefore, the same is required to be capitalized and depreciation should be allowed 60% which works out to Rs.2,34,00,000/-. Therefore, the disallowance as per agreement dated 1.1.2005 is Rs.4,87,50,000/- Rs.3,31,50,000/-(Rs.2,34,00,000 + Rs.97,50,000) = Rs. 1,56,00,000/-.”
Aggrieved assessee came in second appeal before Tribunal. Now, the short controversy for adjudication is whether the amount of Rs.97.50 lakhs towards maintains and Rs.3.90 crores towards alteration / modification of software is capital expenditure or Revenue expenditure.
In order to ascertain as to whether such expense was towards revenue or capital, one shall have to fall back upon the agreement under which such services were availed of by the assessee. We have gone through relevant clauses in the agreement for providing upgradation in software, the relevant clause of the agreement dated 01. 10.2005, which read as under:-
"The operation of the exchange is such that the new commodities are added, new members are recruited, the credit worthiness of the members is required to Page 9 of 13 to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 he continuously reviewed, and new criteria are to be fired. Thus, the requirements of the changes in the exchange are frequent. Such arise from changes in statutory requirement, changes arises as per the requirement of regulator of the exchange i. e. Forward Market Commission (FMC), requirement of the exchange with whom it is affiliated etc.
During the use of the application, the exchange may find the need to alter / modify the application to meet their need in a more efficient way or the exchange may need additional features, validations, reports and process check which benefits the exchange for its operations, the same shall be communicated to the FTIL If the FTIL finds the need technically feasible and functional/v within the scope of the application, they would incorporate the same."
Para E reads as under;
MCX is also desirous of availing the services for maintenance and supervision on continuous basis of the above system to ensure that the system remains in functioning condition without interruption...
From the copy of agreement dated 01.10.2005, we observed that such payment is made for making various changes which were required to be made on the basis to incorporate various changes such as statutory changes, regulatory change etc. such changes necessitated need for dynamic changes in the application of software on continuous basis which included the expense relating to maintenance and supervision and also of the software to the extent of Rs. 1500000/- per month. The clause of the agreement referred to in clause 'D' above explain the position. Such changes in some of the applications and expenses on Page 10 of 13 to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 incorporating such changes were carried out for the purposes of the business and were in the nature of recurring expenses. Such expenditure was in the nature of current repairs expenses. The expenses incurred were incurred wholly and exclusively for the purposes of carrying on the business as a commodity exchange regulator. Such expenses were carried out to change the software or the reports processed by the software as per the needs of the regulator FMC. With more and frequent changes, such reports shall require further upgradation. Such expenses were incidental to the business for the purpose of keeping the business going. Unlike in a regular trading or manufacturing concern, where there may not be any need for change in and upgradation of the software, in the case of the assessee such up gradation was necessary for the purposes of the business as the assessee acted as a regulator working under FMC and to meet with various requirements of RBI, central Government, income Tax Act, 1961, FMC etc. it was essential to dynamically change and upgrade software. It was necessary for the assessee to upgrade its Software from time to time. Such expenses were not in the nature of capital expenses. Such expenses were incurred out of commercial expediency. Had the assessee not incurred such expenditure, it would not have been possible for the assessee to continue and carry on the business to act as a regulator and supervise and surveillance the transactions entered into by its members effectively. Such expenses were directly and intimately connected with the business of the assessee as a regulator and such expense were not incurred as owner of the asset. No new assets were created by upgrading such software. The clause of the agreement referred herein above also refers to the reasons for need for the up gradation of software. Such expenses were incurred which were and integral part of profit earning process of the company. The title of the agreement entered into by the assessee with FTIL itself suggests that it is an agreement of technical service related to the software and for providing services. In other words, it is not a supply agreement whereby the assessee has purchased the software from FTIL.
By paying the impugned amount, the assessee has not acquired any tangible asset, or any other assets which provides any new source of income or Page 11 of 13 to 6691/Mum/2013 Multi Commodity Exchange of (I) Ld.; AYs: 05-06, 06-07,07-08,08-09,09-10 which augments the present source of income. By receiving above services the assessee could run its operational activities more efficiently. Moreover the base software was purchased separately and capitalized separately in the books of the MGX and what paid now are expenses towards upgradation of software. The assessee had already purchased software for risks, supervision and surveillance. However, when more risks are unearthed / required to be managed, it had required upgradation in the software. Very clearly the description refers to provisioning for modification / alteration of commodity exchange software. It referred to upgradation of software and not change of software. Such software already capitalised in the books of accounts as on 31.03.2006 was for Rs. 26,52,53,452/- as it stood at Gross level in the books of assets in Schedule of Fixed assets. During the year, the assessee had purchased software worth Rs.10,55,16,872/- and alongwith the earlier amount of Rs. 15,97,36,580/-, Cost of total software purchased was Rs, 26,52,53,452/-. Hence, according to us, the clauses of the agreement, actual services rendered, nature of services, non- receiving of any enduring benefit, non-creation of any asset shall lead to certain view that expenses incurred were revenue in nature. Therefore, we allow the claim of the assessee in entirety and this issue of assessee’s appeal is allowed.
In the result, the appeals in 6688 & 6689/Mum/2013 are partly allowed and in ITA Nos. 6690 & 6691/Mum/2013 are allowed. Order pronounced in the open court on 07-04-2017.