FUNDTECH INDIA P.LTD,MUMBAI vs. DCIT (OSD) 8(1), MUMBAI

ORDER

PER N.K. PRADHAN, AM

2.1. Briefly stated, the facts are that assessee-company filed its return of income for the A.Y. 2008-09 on 30.09.2008 declaring loss of Rs. 1,42,78,056/-. The nature of business is software development and related activities. The AO on examination of the details of bills submitted by the assessee-company along with copy of agreement for services, noticed that it had incurred an expenditure of Rs. 3,98,41,574/- for product development and customized software development and later on it marketed the same to its clients. The AO has narrated the details at page 3-5 of the assessment order dated 10.12.2010 passed by him. The AO held the said expenditure as intangible asset u/s 32(1)(ii) and allowed depreciation @25% on the above and made addition of Rs. 2,98,81,181/- (Rs. 3,98,41,574/- minus Rs. 99,60,393/-)

2.2 The assessee-company preferred an appeal against the order of the AO before the learned CIT(A). In respect of treatment of consultancy expenditure of Rs. 3,98,41,574/- as capital expenditure and considering the same as an intangible assets, the learned CIT(A) sent a copy of written submission and additional evidence filed by the of the assessee- company before her to the AO for examination and called for a remand report. After considering the assessment order, the remand report of the AO, the contentions of the assessee and materials on record, the learned CIT(A) noted that the assessee- company claimed that it had contracted with Fundtech Corporation, US, for providing software development services for fees, and the assessee-company in turn outsourced some of these activities for which it had paid consultancy charges, as such the amount paid should be treated as revenue expenses for earning fees from Fundtech Corporation. The assessee-company provided software products not only to Fundtech Corporation, but also to its Indian customers. There is nothing brought on record to show that the assessee-company had transferred all the rights in the product software including intellectual property in such software to its customers. The learned CIT(A) thus came to a finding that the assessee-company had developed software and provided services to its clients, hence in principle she agreed with the AO’s action in treating expenses on software development of the assessee’s products as capital expenditure. Thus coming to specific invoices listed at serial No. 1 to 39, she held the related expenses as capital expenditure.

Regarding invoices at serial No. 40 & 45, the learned CIT(A) arrived at a finding that the same related to product implementation for security checks of the software after sale of the product for security assessment and hence cannot be held to be for software development and thus allowable as revenue expenses. As regards invoice at serial No. 46 for Rs. 8,42,700/-, the payment being to Deloitte Haskins and Sells for tax consultation and tax related issues, the same cannot be held as for software development and therefore, she allowed it as revenue expenditure. The learned CIT(A) held in

respect invoices at serial No. 41 to 49 and 51 that these were for marketing services and the same cannot be held as for software development and held the AO’s action treating the same as capital expenditure as incorrect. She also held the invoice at serial No. 50 of Rs. 2,33,836/- for online support services to be for providing annual maintenance services and for implementation of the product after sales and hence held the same as revenue expenditure. The learned CIT(A) also directed the AO to take note of the assessee’s explanation regarding cancellation of invoice/s by M/s. I- Flex Solutions Ltd. and raising of fresh invoice and for amounts adjusted against provisions made and re-compute disallowance accordingly after due verification. 2.3 Before us, the learned counsels of the assessee-company filed a summary of the details of consultancy charges. Broadly stated it is as under: Sl No. Name of the Narration as per assessment Nature of services entity order

2.4. The learned DR supported the order passed by the learned CIT(A).

2.5. We have heard the rival submissions and perused the relevant material on record. The AO in the assessment order dated 10.12.2010 for the impugned assessment year has mentioned the nature of business of the assessee-company as software development and related activities. As per Form No. 3 CD, the nature of business of the assessee-company has been mentioned as (a) software development and related activities and (b) trading in computer software.

2.6 A perusal of the “Independent Contractor Agreement” entered into on 24.03.2006 between Cashtech Solution India Ltd. (the former name of the present assessee) and Quexst Solutions Pvt. Ltd., indicate that the former engages the latter, as an independent contractor, to perform services, for product development and customized software development. We may refer to clause 10 of the said agreement which says:

‘’All intellectual property rights including, rights and inventions, designs and improvements, which the contractor may make either alone or with Cashtech pursuant to or in relation to this agreement, shall automatically belong to Cashtech. The contractor shall have no claims and shall not make any claims in respect thereto. For this purpose the contractor shall promptly disclose and deliver to Cashtech all the information and data in its possession necessary to impart a full understanding of the said improvement, invention, processes, systems or designs and shall assist Cashtech or its nominees in every proper way, without any person-month charges, in obtaining protection of said improvements, inventions, processes, systems or designs in any and all countries.

The Contractor hereby agree that the Cashtech is an shall be the sole and exclusive owner of all present and future intellectual property rights in and to all material written or devised by the contractor pertaining to the product, the operation or business of Cashtech or resulting from any work which the contractor shall have carried out pursuant to this Agreement and all rights of action for damages for infringement of such intellectual property rights for the entire period of the subsistence of the intellectual property rights and any renewals and extensions thereof and irrevocably undertake and confirm to execute, upon receipt of a request from Cashtech. All necessary and adequate documents to confirm the same.’’ 2.7 Similar is the agreement between the assessee and the other entities. The assessee has engaged them to perform software services, for product development and customized software development.

2.8 A similar issue arose before ITAT, Pune Bench in the case of Opus Software Solutions (P) Ltd. vs. ACIT (2012) 139 ITD 427. In this case the assessee was engaged in the business of development of software products. The claim of the assessee was that it was engaged in the development of various software packages, like Trade Now, Electra ATM, Electra Card and Electra Payment Gateway (EPG), etc. The assessee explained to the AO that the expenditure incurred on development of such products was to the tune of Rs. 2,77,07,736/- and the same was claimed as revenue expenditure. The AO and thereafter the learned CIT(A) held that such development expenditure was capital in nature. In further appeal, the Tribunal held that:

‘’ In our considered opinion, the aforesaid proposition of the Revenue is quite alien to the business realities under which the assessee is operating. Quite clearly, the assessee is in the business of software development which entails fast technological changes and in that view, there is no permanence attached to any product developed. In fact, it is quite understandable that the business of the assessee is exposed to volatility of new and upcoming technological advances and the products developed by it may not be sustainable over a period of time to compete in the market place. Therefore, in this background one has to examine as to whether the expenditure incurred on development and launching of new products in the same line of business results in an advantage in the revenue field or in the capital field. The Hon’ble Supreme Court in the case of Empire Jute Co Ltd (supra) has held that the true test to ascertain the nature and import of the expenditure is to examine the same from a commercial perspective. Even if, it has to be accepted that the expenditure results in an enduring benefit to the assessee, yet following discussion by the Hon’ble Supreme Court would show that each and every incidence of enduring benefit would not result in classification of expenditure as a capital expenditure: “There may be cases where expenditure even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may breakdown. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is nature of the principle laid down in this test. What is material to consider is nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be of revenue account, even though the advantage may endure for an indefinite future.” In the present case, in our view, the expenditure on development of new product in the line of business being carried out by the assessee is an expenditure related to such business and benefit to the assessee is in the revenue field, inasmuch as it seeks to improve the profitability of the assessee and the enduring benefit cannot be regarded to be in the capital field. The parity of reasoning laid down by the Hon’ble Apex Court in the case of Empire Jute Co Ltd (supra), as extracted above, clearly supports the stand of the assessee, inasmuch as the expenditure in question merely results in development of new products by the assessee in its existing line of business. Even otherwise, it is noteworthy that none of the expenditures in question are of capital nature and in fact, the expenditure which has been referred to by us in the earlier paragraph clearly are such expenditure, which are incurred in the course of carrying on of business.’’ 2.9 In view of the foregoing reasons, the 1st ground of appeal of the assessee is allowed.

4. The 2nd ground raised by the assessee in this appeal is that the learned CIT(A) has erred in upholding the disallowance of one-third of directors’ foreign travel and conveyance expenses amounting to Rs. 11,72,587/- on an adhoc basis even though it was wholly and exclusively incurred for the purpose of business of the appellant.

4.1 The details of the foreign travel by the directors are mentioned by the AO at page 6 of the assessment order. The assessee-company submitted before the AO that the entire amount incurred on hire charges – local, hotel stay – overseas was incurred wholly and exclusively for the business purpose and therefore allowable. The assessee-company filed a written submission before the AO which is available at page 7 – 9 of the assessment order. The AO was not convinced with the said explanation of the assessee-company because of the reasons that “in now-a-day’s, business scenario nobody requires to go door to door for effecting sales particularly in software trade. The sales made to various foreign clients are not the new one.’’ In view of the above, the AO disallowed Rs.1,50,00,000/- (out of travel expenses of Rs. 4,49,96,230/-) as not related to business expenditure and added to the total income of the assessee- company. 4.2 In respect of disallowance of Rs.1,50,00,000/- made by the AO out of foreign travelling and overhead hotel charges incurred for the directors, the learned CIT(A) having gone through the assessment order, remand report of the AO, the contentions of the assessee and materials on record observed that there had been no rebuttal of the AO’s observations that the sales were not made to new foreign clients, consequently there was no requirement for prolonged visits of a week or so. Further there was no record of proceedings of the discussion, what was discussed and the outcome of the same. The learned CIT(A) thus confirmed the disallowance of Rs.1,50,00,000/- made by the AO. 4.3 The learned counsels submitted that on perusal of the details filed before the AO, it would be apparent that the entire expenditure towards travel and conveyance by the directors were incurred wholly and exclusively for the purpose of business. Commercial expediency was explained by stating that as most of the clients are located outside India, the assessee is required to frequently visit the clients for rendering of services and maintaining and developing the existing business relationship and for new business opportunities. It was submitted by them that the names of clients visited and the purpose of the said meeting were furnished to the AO. There is a direct nexus between the expenditure incurred on directors’ travel and expenses carried out by the assessee. The learned counsels also submitted that the assessment made on the basis of ad-hoc disallowance is liable to be deleted. 4.4 The learned DR supported the order passed by the learned CIT(A). 4.5 We have heard the rival submissions and perused the relevant material on record. We find that the conclusion arrived at by the AO that the sales were not made to new foreign clients, hence there is no requirement of prolonged visit of a week or so is not based on reasons. We find that the AO has disallowed an ad-hoc amount of Rs. 1,50,00,000/- out of travel expenses of Rs. 4,49,96,230/-. The assessee filed a rectification petition before the AO on 27.01.2011 and the rectification order dated 17.02.2011 was passed by the AO restricting the disallowance to Rs. 11,72,587/- (out of Director’s expenses of Rs. 35,23,293/-). We find that the details were furnished by the assessee company before the AO. The same has been extracted at page 9 – 11 of the assessment order by the A.O. In Seshasayee Brothers Ltd. vs. CIT (1961) 42 ITR 568 (Mad) and Cooper Engineering Ltd. vs. CIT (1982) 135 ITR 597 (Bom), it has been held that where the details are not furnished by the assessee, the claim can be disallowed on the ground that the assessee had not established that the amount in question was expenditure laid out wholly and exclusively for the purposes of the business. If the object of the undertaken tour is commercial in nature, the expenditure would qualify for deduction. We find that the disallowance made by the AO of the directors’ expenses is bereft of sound reasoning. Therefore, the disallowance made by the AO of Rs. 11,72,587/- is deleted. The 2nd ground of appeal filed by the assessee is therefore, allowed.

(a) Invoices for security assessment (at Sr. No. 40 &45) are revenue in nature as the same were incurred for product implementation for security checks of the software after sale of the product. (b) Invoices at Sr. No. 41 to 49 and 51 were for marketing services”

9.1. The learned DR supported the order passed by the AO whereas the learned counsels of the assessee supported the order of the learned CIT(A).

9.2 We have heard the rival submissions and perused the relevant material on record. We find that the learned CIT(A) has given specific reasons for invoices at serial no. 40 & 45, 41 to 49 and 51 for allowing the same as revenue expenditure. Serial No. 40 & 45 of the invoice are for product implementation for security checks of the software after sale of the product. Serial No. 46 of the invoice is for tax consultation and tax related issues. Invoices at Serial No. 41 to 49 and 51 are for marketing services. Therefore, the learned CIT(A) has rightly arrived at a finding that the said expenditures are revenue in nature.

9.3 In view of the above, the above ground of appeal filed by the revenue is dismissed.

Order pronounced in the open court on 16/ 01/2017