CA INDIA TECHNOLOGIES PVT. LTD.,MUMBAI vs. A.C.I.T. RG. 6(2), MUMBAI

Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा लेखा सद�य लेखा लेखा सद�य सद�य राजे�� सद�य राजे�� राजे�� केकेकेके अनु राजे�� अनु अनुसार अनु सार सार PER RAJENDRA, AM- सार Challenging the order dated of the CIT(A)- , Mumbai,the Assessing Officer(AO) and the assessee have filed cross appeals for the AY.2004-05,whereas for the AY.2006-07,only the assessee has filed appeal. The assessee raised following Grounds of Appeal: I.Disallowance of Bad Debts of Rs. 69,45,581: 1.1 On the facts and circumstances of the case and in law, the Hon'ble Commission r of Income-tax (Appeals) ('CIT(A)') erred in confirming the action of the Assessing Officer in not allowing the claim of bad debts made during the assessment amounting to Rs. 69,45,581 while computing the income under the head 'Profits and gains of business or profession'. 1.2 The Appellant prays that the bad debts amounting to Rs. 69,45,581 be allowed as deduction for the year under consideration. II. Addition of Rs. 19,96,50,209 on account of change in the method of accounting: 2.1 On the facts and circumstances of the case and in law, the Hon'ble CIT(A) erred in confirming the addition amounting to Rs. 19,96,50,209 made by the Assessing Officer on account of change in the method of accounting adopted by the Appellant. 2.2 Without prejudice to ground no. 2.1 above, the Hon'ble CIT(A) erred in facts and circumstances of the case and in law in concluding that the revenue loss due to change in the method of accounting is Rs. 19,96,50,209 and not Rs. 13,97,55,146. 2.3The Appellant prays that the change in the method of accounting adopted by the Appellant be accepted and the addition of Rs. 19,96,50,209 be deleted. III. Initiation of penalty proceedings: 3.1 On the facts and circumstances of the case and in law, the Hon'ble CIT(A) erred in concluding that mere initiation of penalty does not cause any prejudice against the Appellant.

8218/10;8376/11 & 8106/11CA(India)

2. The appellant prays that the order of CIT (A) on the ground be set aside and that of the assessing officer be restored.

3. The appellant craves leave to amend or alter any ground or add a new ground that may be necessary. ITA No.8218/Mum/2010- AY.2005-06: Following are the grounds of appeal for the AY. under appeal: 1.On the facts and in the circumstances of the case and in law, the Assistant Commissioner of Income Tax -10(1),Mumbai (hereinafter referred to as "the Learned AO") has erred in assessing the income of the appellant at Rs.1 ,46,00,560. Addition on account of Transfer Pricing adjustment of Rs.17,61,155

2. On the facts and in the circumstances of the case, and in law, the Additional Commissioner of Income Tax Transfer Pricing -1 (2), Mumbai (hereinafter referred to as "the Learned TPO"), the Learned AO and the DRP authorities have erred in confirming the addition made by the AO of Rs 17,61,155 by disallowing the royalty payment to Associated Enterprise on the amount written off as bad debts in the books of accounts for determining the arm's length price.

3. On the facts and in the circumstances of the case, and in law, the Learned AO has erred in making addition towards transfer pricing adjustment on the reasoning that the assessee has not raised any objection before the DRP without appreciating that the same was objected by the assessee before the DRP, which is evident from the DRP application filed in form 36A. Addition on account of Advance Billings of Rs.8,64,26,828 4.On the facts and in the circumstances of the case and in law, the Learned AO and the DRP authorities have erred in making addition of Rs.8,64,26,828 on account of advance billing. 5 Without prejudice to the above, the Learned AO and the DRP authorities have erred in not restricting the amount to Rs.7,38,59,019 being the advance billings relating to financial year 2005-06 relevant to assessment year 2006-07.

6. Without prejudice to the above, the Learned AO and the DRP authorities have erred in not concluding that while computing the income of the assessee for the subsequent assessment years, the relief to the extent of advance billings considered as taxable income for the current financial year 2005-06 should not be included in those years.

7. Without prejudice to the above, the Learned AO and the DRP authorities have erred in not allowing the deduction for royalty at 30% of advance billings (payable in accordance with the relevant distribution agreement) considered as income for the year. That Appellant craves leave to add, to amend, to substitute, to withdraw, to modify, to alter and/or re- instate the foregoing grounds of the appeal at or before the time of hearing.” Assessee-company,CA(India)Technologies Private Limited(CATPL),a company incorporated in India,is a wholly-owned subsidiary of Computer Associates International Inc.(CAII)of USA.It is primarily engaged in licensing mainframe midrange and system infrastructure software products of CAII(US),developing software that can generally be deployed “öut of box” or with customer/industry-specific adaptations and developing of software that allows technologists and programmers to write custom applications and create new categories of packaged applications.It has also established a technical support-centre at Tidel Park, a software technology park (STP) unit in Chennai and the profits made by the STP unit are 2

8218/10;8376/11 & 8106/11CA(India) eligible for tax holiday under section 10A of the Act.Details of filing of returns,returned incomes,assessed incomes,dates of the orders of CIT(A)can be summarised as under: Dt. of orders of ROI filed Returned Assessment Assessed CIT(A)/DRP on Income dt. Income 2004-05 31.10.2004 (-)21.16Crore 27.12.2006 (-)3.98Crore 02.09.2011 2005-06 29.11.2006 (-)12.65Crores 30.09.2010 1.46Crores 05.08.2010 2.First ground of appeal is about disallowance of bad debts of Rs.69,45,581/-.During the assessment proceedings,the AO found that the assessee had written off bad debts of Rs.16.93 lakhs. He directed it to file details in that regard.In response to the directions the assessee filed details of aging analysis of bad debts of Rs.86.38 lakhs as against the amount debited to P & L account of Rs.16.93lakhs.The AO held that the assessee was not entitled to write off said bad debts.He also rejected the claim made by it about the bad debts of Rs.86,38,802/-. 2.1.During the appellate proceedings,the assessee,before the First Appellate Authority(FAA) contended that during the AY.under appeal the assessee had written off bad debts of Rs.86.38 lakhs, that out of the said sum it had debited Rs.16.93 crores under schedule 15 as bad debts written off,that same was wrongly disallowed by the AO,that it had also written off debts of 69.45 lakhs by debiting the same to the Provision for bad and doubtful debts for the year under consideration,that the provisions of Rs.68,88,882/-made in earlier years was reversed,that net amount of Rs.56,699/- was reflected as provisions for bad and doubtful debts in the P & L account,that the amount of bad debts written off of Rs.69,45,581/- was inadvertently not claimed as a deduction by the assessee either in original or the revised return of the income,that it realized the mistake during assessment proceedings,that vide its letter dated 22.11.2006 it made the above claim. After considering the submissions of the assessee and the assessment order,the FAA held that that the assessee had written of bad debts to the extent of Rs.16,93,221/- in its books of accounts and had claimed the same in its P&L account,that such debts which have been written off were offered to tax and are of revenue in nature,that the action of the AO in disallowing such claim of the assessee on the ground that it had not been able to demonstrate that such debts had become really bad was not sustainable.Following the decision of the Hon'ble ApexCourt in the case of TRFLimited (2010-TIOL-15-SC-IT),he directed the AO to allow the claim.With regard to the balance bad debts,he observed,that such debit to the provision for doubtful debt had not been debited to the P&L account of the assessee.He referred to the decision of the Vijaya Bank (231CTR2)and held that the assessee(s)were now required not only to debit the profit and Loss account but simultaneously also reduce loans and advances or the debtors from the asset side of the Balance sheet to the extent of the corresponding amount so that at the end of the year the amount of loans and advances/ debitors was shown as net of provisions for impugned bad debt,that debit at both places was essential to make claim and allowance of the same under Section 36(1) (vii) of 1961 Act.He further discussed the matter of Goetze India Ltd.(157 Taxman 1) and held that such claim of debit to the provisions for Doubtful Debt account by the assessee could have been made in the return filed or the revised return filed by it,that the assessee had not made claim for such deduction in either its return or in the revised return filed,that for any fresh claim of deduction the decision of the Hon'ble Apex Court in the case of Goetze India Ltd. was 8218/10;8376/11 & 8106/11CA(India) squarely applicable to the facts of the assessee.Accordingly,the action of the AO was upheld to the extent of Rs.69.45 lakhs. 2.2.Before us,the Authorised Representative(AR)contended that the assessee had by mistake did not made a claim of the entire amount written off during the AY.under appeal,that vide letter no. 22.11.2006 the assessee had made the claim,that the amount was actually written off,that the said amount was shown as provision in the earlier year,that AO and the FAA had not appraised the facts properly,that the FAA should have accepted the claim made by the assessee even though same was made during the assessment proceedings for the first time.He referred to the page no.69 of the paper book and relied upon the cases of Pruthvi Brokers and Sharesholders(349 ITR336)and Jai Parabolic Spring Ltd.(172Taxman258).Departmental Representative (DR) supported the order of the FAA. 2.3.We have heard the rival submissions and perused the material before us.We find that in the case of Pruthvi Brokers and Sharesholders Pvt.Ltd.(supra). “An assessee is entitled to raise not merely additional legal submissions before the appellate authorities but is also entitled to raise additional claims before them. The appellate authorities have the discretion to permit such additional claims to be raised. The appellate authorities have jurisdiction to deal not merely with additional grounds, which became available on account of change of circumstances or law, but with additional grounds which were available when the return was filed. The words “could not have been raised” must be construed liberally and not strictly. There may be several factors justifying the raising of a new plea in an appeal and each case must be considered on its own facts.” While deciding the matter the Hon’ble High Court had considered the judgment of Goetz India Ltd.(supra).It was claimed that the assessee had reversed the entry with regard to the amount written off during the year i.e.it had brought the amount in question under the head bad debts from the head provision for bad debts.The FAA without considering the above argument had decided the issue.Therefore,in the interest of justice we are remitting back the matter to the file of the FAA for verification purposes.He would allow the claim of the assessee with regard to the bad debts written off during the year under appeal amounting to Rs.69.45 lakhs,if same have been transferred from the provisions of bad debts to bad debts.Ground no.1 is decided in favour of the assessee,in part.

3.Next ground i.e. ground no.2 is on account of addition of Rs.19,96,50,209/- on account of change in the method of accounting.In order to determine Arm’s Length Price(ALP)in relation to the international transactions reported in Form 3CEB,the AO referred the case to the Transfer Pricing Officer(TPO) u/s. 92CA(1) of the Act,who passed an order on 05.12. 2006,u/s.92CA(3) of the Act, making an adjustment in respect of the Royalty payable to its Associated Enterprise ('AE').On completion of the scrutiny assessment, an order u/s.143(3) of the Act was passed,assessing the total loss of the assessee at Rs.3,98,69,991/-as against 24,40,44,974/-,as stated earlier.The disallowances/adjustments included transfer pricing adjustment of Rs.18,57,454/-on account of royalty payable to CAII and addition of Rs.19,96,50,209/-on account of change in method of accounting for sale of software license. During the assessment proceedings,the AO found that in the notes to financial statement the auditors had made qualifying remark regarding the change in method,that prior to AY.under appeal the assessee recognised its revenue depending on the year in which the products were sold,that earlier the entire billing was shown assessee in the first year of the sale/ license,that during the year under consideration it changed its accounting policy.With regard to the change of policy,it was argued that the assessee provided to its customers not only the upgrades and enhancements of software purchased/licensed but also the maintenance of the software and unspecified future software products i.e.new release of a 4

8218/10;8376/11 & 8106/11CA(India) product,that under terms of the agreement it was required to provide services over a period falling in different financial years,that it had to provide a new release of the software product to the customer free of cost,that same could not be anticipated by it at the commencement of the contract,that the revenue to be earned by the assessee from the agreement with the customer was deferred on a straight line basis over the tenure of the contract, that in that background it was decided to change its accounting method.The AO,while passing the assessment order held that the change in accounting method had prejudicial impact on reveue,that the assesseehad deferred the sale of software licence and had recognised only Rs.5.33 Crores as revenue on account of licence fee out of total amount of invoices of Rs.25.29 Crores,that it resulted in revenue loss of Rs.19.96 Crores,that the change had diluted the income of the assessee for the year under appeal.He made an addition of Rs.19,96,50,209/-to the total income of the assessee.He relied on the decision of the Honble Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilisers Ltd.(227 ITR 172)and held that AS did not supersede the taxing provisions. 3.1.Before the FAA,it was argued that that the AO had failed to appreciate the entire facts of the case,that until the previous year,it recognised revenue on stand-alone maintenance contracts and license fees as per contract terms,that in the current year,it had started recognising revenue on stand-alone maintenance contracts on a straight line basis over the period of the contract,that the method was adopted in accordance with Accounting Standard 9 on Revenue Recognition issued by the Institute of Chartered Accountants of India (ICAI),that for the sale of licenses it started recognising revenue on such license fees on a straight line basis by deferring the revenue rateably over the period of such contract, that at the end of a reporting period,an amounts billed in excess of the revenue accrued on a straight line basis over the contract period were recognised as advance billings, that the change in accounting policy had been made to ensure a more appropriate presentation of the financial statements in accordance with generally accepted revenue recognition principles and is also in line with the policy for revenue recognition in respect of maintenance contracts and license sales followed by the parent company, which prepares its financial statements in accordance with the requirements of US Generally Accepted Accounting Principles,that the basis of the change in the accounting policy conformeed to the requirements of Accounting Standard 5 Net Profit or loss prior period items and changes in accounting policies issued by the ICAI,that due to the above change,the loss for the year is higher by Rs.13,97,55,146/- and reserves and surplus were lower by Rs.13,97,55,146/-,that the decision relied upon by the AO was distinguishable to the present facts of the case,that in the assessee case under consideration,as per terms of the contract,the income was accruing to it over the period of the contract and therefore it had decided to defer it in its book of accounts and offer the same in the subsequent years based on its accrual,that as per section 211 of the Companies Act,1956,the assessee,being a private limited company,had to mandatorily comply with the AS recommended by the ICAI,that if any change in the method of accounting wass to be made so as to comply with the statutory requirements it could not be considered to be a malafide change and a loss in revenue. The assessee referred to the matter of Taparia Tools Ltd(260 ITR 102)in its support.It also relied upon other cases and argued that it was open to an assessee to make a clean change of the regular method adopted by it irrespective of the resultant loss to the revenue,that change in the method of accounting was made to reflect true and correct picture of the profits,that had this change not been made by the assessee the statutory auditors of the assessee might also have qualified the audit report,that the method of accounting had been followed regularly and consistently by the assessee from AY.2004-05 onwards,that with the change 5

8218/10;8376/11 & 8106/11CA(India) in the method of accounting the revenues had been deferred on rateable basis,that the change in the method of accounting was bonafide and legitimate and without any malafide intention, that the income had accrued to the assessee over the period of contract since it had agreed with the customers to provide not only the licenses but also the upgrades and other new products/new variations in the products at no additional consideration,that applying the accounting standards for revenue recognition,accrual concept and revenue v.cost concept the income accrued to the assessee over the tenure of the contract,that the assessee was under an obligation to provide to its customer free of cost, any New Product or New variations in the product or additional or new functionality in the product, which it would develop in thefuture,during the term of the contract,that it was not just up -gradation or maintenance of the software that it is providing for, but it was developing altogether new software for its clients,that in order to be competitive in the software industry it was required to introduce new and innovative products at regular intervals,that going by the matching concept, the assessee had recognised its revenue spread over the term of the contract in order to match the revenue with the cost incurred for developing new software. The assessee relied upon the decision of the Chennai Tribunai dated May 26, 2010 in the cases of Mahindra Holidays and Resorts(2010-TIOL-262-ITAT-MAD-SB), Sify E- Learning Ltd(124 TTJ 331),GFA Anlagenbau Gmbh(57 ITD 81)and argued that the assessee had agreed to provide its customers with a new release / upgrades to the software product,without charging any additional fees for such release/upgrades over the term of the contract,that the amount of services that would be rendered by the assessee in providing such new release/upgrades could not be estimated at the commencement of the contract,that till such time the assessee fulfils its obligation the entire contractual income could not be considered to have accrued to the assessee and the same had been deferred over the term of contract,that in case the assessee were to credit the entire receipts from the sale of software license to the profit & loss account in the first year of contract itself then it would tantamount to taking credit for income over which the right to receive had not vested in the assessee,that the P & La/c.would reflect illusory profits and hence would fail to reflect a true & fair view of the financial position of the assessee,that the primary consideration in selection of accounting policies are that the financial statement presented should represent true and fair view of the state of affairs of the enterprises,that in earlier years when the assessee was recognising entire sale revenue in the first year of contract itself,its claim for bad debts were substantially high.The assessee emphasized that the change in method of accounting was regularly followed in the subsequent years,that change in method of accounting based on the accounting standards issued by the ICAI for tax purposes was bonafide,that the income accrued to the assessee was taxable over the entire tenure of the contract. 3.1.a.After considering the submissions of the assessee and the order of the AO,the FAA held that prior to AY.under appeal the assessee was recognising its income depending upon the year in which product was sold and the entire income was reflected in revenue by it in the first year of sale of licnece,that the assessee had claimed that it had to upgrade/enhance the software during the contract period without charging anything from the customers,that it had claimed that it was following market practice.The FAA observed that it was not the market practice or trend to defer revenue on the straight line method based on such future services / upgrades,that during the assessment proceedings the assessee was asked to give details and evidences in respect of general practice followed in accounting and recognising revenue by other players in the field,that the submission made by the assessee in that regard proved that the assessee had not been able to give anything in specific about the practice of 6

8218/10;8376/11 & 8106/11CA(India) revenue recognition by the other dealers of the same field,that the assessee had cited example of IBM India Pvt.Ltd.,that in the case of IBM the contract was for a long period, that it was not about sale of licence of the software which had some term of licence,that matching principle recognised the fact that revenue and cost should be accounted for on the basis when the revenue is recognised the relevant cost was recognised as well,the assessee was following straight line method of accounting, that it was deferring the proportionate revenue based on the number of years for the licence was valid,that method adopted by it was not in accordance with matching principles, that when the software licence was sold or when the software contract was completed the assessee would receive full revenue,that at that point of time there would not be significant expenses, that would be required to be incurred by it either for the services of such licence software or for providing upgrades.He directed the assessee,vide order sheet entry 19.07.2011,to give cost incurred by it for subsequent update of the licences which were sold during the year and for the compliance of same. The FAA, referring to the provisions of section 145 of the Act held that where the AO was not satisfied about the correctness of the accounts of the assessee he could complete the assessment in the manner provided u/s.144,that in the case under consideration the AO was not satisfied about the correctness of the accounts of the assessee, that the revenue received by the assessee during the year under consideration-for which there was no matching cost ascertained to be incurred-was brought to tax during the year under appeal, that the assessee had deferred the revenue following the straight line method for the future years, that since AY.1999 it was following one particular method of accounting,that the adopted by it was accepted by the department,that during the year under appeal it changed the method by which a sizeable portion of revenue,amounting to Rs.19.96 crores,was deferred for the future years, that by following the change method of accounting it deferred the revenue upto 79% to the future years,that the fact deferring of revenue was indicator that the method of accounting was incorrect,that no detail was available about expenditure incurred by the assessee in the subsequent years for the so called services towards maintenance and upgrading the softwares,that the updates were developed by the parent company,that each accounting/assessment year was a separate year and income of that particular year had to be taxed in the same year, that the tax payer could not be given liberty to follow the method of accounting which suits its requirement to postpone sizeable portion of revenue to the future years, that it was following mercantile or accrual system of accounting,that under the accrual method accounting transactions were recognised as the underlying economic events occur regardless of the time related cash receipts and payments,that revenue would be recognised when income is earned and expenses are recognised when liabilities arose/when resources were consumed,that in the accrual system of accounting recognition of revenue receivable could be postponed when the consideration was not determinable within a reasonable period of time, that advances received would the only exception in such a system,that the amount received by the assessee had not been offered to tax inspite of the fact that the underlying economic event of delivery of license of software/product had taken place and that money had been received by it as per the terms of the agreement,that the future event were such for no liability had accured,that the liability was not even ascertainable at the close of the accounting period. With regard to change of method based on the AS issued by the ICAI, the FAA held that assessee was following particular AS since inception,that the AS had not changed in the year under appeal warranting change in the method of accounting, that there was no justification to follow and change the method of accounting in such a fashion that would postpone major portion of the revenue to the future years,that it was not following proportionate completion method of accounting where 7

8218/10;8376/11 & 8106/11CA(India) recognition of revenue could be postponed due to uncertainties, that on being asked details of cost incurred by it in subsequent years pertaining to the product sold during the year under appeal it had not filed any details,that it had admitted that such licensed based costing/product based costing was not maintained by it, that postponement of revenue on a hypothetical basis could not be considered a valid reason for change of method. Considering the above,the FAA held that when any specific cost for the updates and improvement towards the licence sold during the year was not ascertainable then the concept of matching the revenue with cost would not arise,that the assessee had submitted such an explanation of matching revenue v/s.cost without having following such principle in its method of accounting,that it had simply followed the straight line method to recognize the revenue over the period of licence/contract without having to do with anything with matching cost,that when the licence of software/product was sold the major portion of expenses of marketing and distribution including payment of royalty were incurred,that it would receive the revenue in respect of those deliverable,that had there been any situation of such kind that either a high committed cost/further deliverable the customers would have withheld certain portion of such sale consideration payable,that the assessee was not justified in postponing such revenues to the further years following the hypothetical straight line method,that bad debts were common in business,that same were allowable as per the provisions of law,that assessee should follow a method that would produce a realistic position of profit/loss,that a method of accounting should not be based on such principles that would not have any correlation between revenue and cost,that for the AY.s 2003-04 and 2004-05 the bad debts were to the extent 16-20% of the revenue,that the by effecting the change the assessee had attempted to defer 79% of its revenue. With regard to alternate ground of allowing the consequential relief for the subsequent years the FAA held that those years were not before him,that such directions could not be given. The assessee had also mentioned that the revenue loss due to change in method was 13.97 crores and not 19.96 crores because of prepaid royalty of Rs.5.98 crores,that the assessee had claimed the expense for the future years,that it had not withdrawn its claim on account of royalty for subsequent years,that the claim made by it was not based on facts.Finally,the FAA dismissed the various grounds raised by the assessee with regard to change of method of accounting.The FAA distinguished the facts of the case under appeal with the facts of the matters of Mahindra Holidays Resorts(supra),Sify E-Learning Ltd(supra),GFA Anlagenbau Gmbh(supra)and K K Khullar. 3.2.Before us,the AR contended that that the change in the method of accounting was made considering the change in the terms of the contract wherein the assessee had to provide new release of the software products to the customers over the period of contract without consideration,that the assesseechanged its method of accounting to reflect the revenues on rateable basis,that same was in accordance with AS 9 -Revenue Recognition,that the change in the method of accounting made in the year under consideration had been regularly followed by the assessee in the subsequent years,that in the instant case the assessee had changed its terms of contracts with the customers and hence, it was imperative for it to change the method of accounting, that the assessee was justified in changing its accounting method to correctly reflect its financial position,that the change in accounting policy had been made to ensure a more appropriate presentation of the financial statements of the assessee in accordance with the·generally accepted principles of revenue recognition, that it was also in line with the revenue recognition policy in respect of maintenance contracts and license sales followed by the parent company,that the statutory auditors have also certified assessee reflects true and fair view and principles generally accepted in India,that while 8

8218/10;8376/11 & 8106/11CA(India) passing the assessment order, the AO disregarded the above bonafide reasons for change in method of accounting.He relied upon the cases of Snow White food Products Co. Ltd.(141 ITR 847),H. P. State Civil Supplies Corporation Ltd. (309ITR 102),The Bank of Rajasthan (20 DTR-Trib,260),Venus Wire Industries Ltd.(1 SOT836),Marg Marketing & Research Group (91TTJ813),George Oakes Ltd.(303 ITR357),Uniflex Industries (P) Ltd.(15 SOT246),Eastern Bengal Jute(112 ITR 575),Andhra Pradesh IRF(236 ITR 648),Haryana Minerals(242 ITR 704),Travancore Cochin Chemicals Ltd.(243 ITR 284).DR supported the orders of the lower authorities.

3.3.We have heard the rival submissions and perused the material before us.We find that during the year under consideration out of the total invoices amounting to Rs.25,29,99,544/- towards license fees issued,the assessee recognised Rs.5, 33,49,335/-as Revenue-License fees in the Profit and loss account and the balance amount of Rs.19,96, 50,209/-was reflected as Advance Billings under the head Current in the Balance Sheet,that the corresponding royalty(related to such advance billings)of Rs.5,98,95,063/-was considered as Prepaid royalty under the head Loans and Advances in the Balance Sheet,that deferred revenue was offered to tax in subsequent year/s depending upon the tenure of the contracts.The assessee claimed that it had changed method of accounting for recognising revenue from license fees and maintenance contracts as per and in accordance with the AS-9,that as a result the revenue was deferred rateably over the period of contract, that the changed method of accounting was regularly followed by the assessee on and from AY.2004-05 onwards,that as a result of this new method of accounting, the amounts billed to the customers that were in excess of the revenue accrued on a straight line basis over the period of contract were recognised as Advance Billings in the financial statements of the assessee under the head Current Liabilities,that it also recognised the royalty paid to CAII in respect of the revenues considered for the year only and the balance royalty was considered as Prepaid Royalty under the head Loans and Advances,that method of accounting was changed to converge with the AS prescribed by the ICAI.The FAA held that the change in method of accounting was not genuine and the assessee had in the garb of change had postponed 79%of its revenue. We are of the opinion that the primary issue to be decided is whether the change in method of accounting can be allowed considering the facts of the case.Undisputed facts are that the assessee is selling the software of the parent company it paid royalty to the CIIA,that it was following a particular method of accounting from inception and was recognsing the income on sale of software for that particular year,that during the year under appeal it started recongnising its income on straight line method.There is no doubt that the change in method of accounting for bona fide purpose has been accepted and allowed by the courts from very beginning.The AO has been given power,u/s.145(3)of the Act to reject the change if he is of the opinion that the method of accounting adopted is such that true profit cannot be deduced therefrom.It is said that the duty of the AO is to administer the provisions of the Act in the interest of public revenue and to prevent evasion or escapement of tax legitimately due to the State.In the case under consideration we find that AO had disallowed the change of method of accounting as he was not convinced about the bona fide of the change.Before the FAA,it was contended that change was made in accordance with the market practice.He directed the assessee to furnish details in respect of general practice followed in accounting and recognising revenue by the other players in the field. In response to the same the assessee submitted as under : “You would appreciate that the accounting for software licenses and maintenance support depends upon various factors.Further, in the published accounts of the companies it was very difficult to ascertain whether the factors on the basis of which accounting for revenue from software are determined are similar to the case of appellant. However considering the competitive business of 9

8218/10;8376/11 & 8106/11CA(India) software the assessee had enclosed the accounts of IBM India Pvt. Ltd.(One of the competitors of the appellant) attached as Annexure-I.You would observe in the notes to the Financials of IBM India Pvt. Ltd. that revenue from the term contract is recognized over the contract term base of percentage of services that are provided during the period compared with total estimate of services provided over the entire contract.” From the above reply,it is clear that the assessee was not able to prove that it was following some market practice.The nature of work done by the assessee and IBM was totally different. It is dealing in software prepared by the parent company and supplies updates to the customers during the period of linence.In the fast changing world of software there cannot be any long term contract.Even if there was any it was not produced by the assessee before the FAA or us.We have gone through the contracts entered in to by the assessee and we do not find that same is of the nature which could be held to a contract where revenue depends upon compulsory supply of some ingredients in subsequent years of the sale of the product.Definitely the assessee is bound for future service/upgrade of the software.But.it is not preparing the software,so,it was duty of the assessee to prove that it had actually incurred some expenses on account of such service/ upgrade.If any expenditure has been incurred,it has been incurred by the parent company who develops the software as well as upgrades it.We find that during the appellate proceedings,the FAA had made a specific query with regard to the expenditure incurred under the head service/ upgrade of software in the subsequent years and the hearing was fixed on 02.08.2011.As per the FAA the assessee did not furnish required details.He again directed it to file necessary details and adjourned the matter to 16.08.20 11.But,the details were not made available to him.He again directed the assessee to comply the directions and on 27.08.2011,the assessee submitted as under: “As you are aware that during the year under consideration, the appellant had changed its method of accounting for recognizing revenue from license fee and maintenance contract to Straight Line basis such that revenue was recognized rateably over the period of contract. As per the contract of sale of software with the customers the appellant was required to provide active maintenance charges consisting of operational support and assistance for updated versions, improvisation and enhancement to the product at no extra cost to the customers,as regards the specific costs incurred by the appellant for the subsequent upgrades of the license sold during the year, it is submitted that the appellant does not maintain project/contract wise accounting records. Therefore, any costs specific to the update of the contract and an improvement was not ascertainable. (emphasis supplied) From the above reply,it is clear that the specific cost for the upgrade and improvisation of the license sold during the year was not ascertainable.In these circumstances it can safely be held that the concept of matching revenue with the cost did not arise and that the assessee had followed straight line method to recognise the revenue over a period of time without having to do anything with the matching cost.For applying the concept of matching cost, it is imperative that incurring of expenditure with regard to the income earned or accrued to an assessee should be proved.For existence of matching concept two constituents must exit i.e. what is to be matched with what should be clearly proved.In the name of applying AS, revenue earned or accrued in a particular year should not be deferred/postponed.So,we hold that the method adopted by the assessee was not in accordance with matching principles because when the software licence was sold or when the software contract was completed it used to receive full revenue.It wants to defer the income of the year to subsequent years. But, in our opinion,to talk about matching principle without furnishing the details about the expenditure actually incurred does not serve any useful purpose. Straight line method, matching-principle and principles governing AS cannot be applied in air-their application needs hard facts.In the case before us,the assessee has raised several theoretical issues,but has not proved as to how the theory,relied upon by it,was applicable to facts. Paying of taxes in 8218/10;8376/11 & 8106/11CA(India) subsequent years or showing corresponding royalty payment made to the parent company cannot be the basis for deferring the revenue from the year under appeal to subsequent years.

3.a.Here we would like to discuss some of the principles,culled out from various judgments, regarding accrual of income and method of accounting: i.It is universally accepted that income-tax is a levy on income. Though the Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt,yet the substance of the matter is the income. ii.Profits do not accrue from day to day or even from month to month and have to be ascertained by a comparison of assets at two stated points. Unless the right to profits comes into existence, there is no accrual of profits and the destination of profits must be determined by the title thereto on the day on which they arise. iii. Where an assessee regularly employs the mercantile method of accounting, his income, profits and gains have to be computed in accordance with that method of accounting, i.e., on the basis of accrual, and not on the basis of receipt.Under this system, credit entries are made in respect of amounts due immediately they become legally due and before they are actually received. Similarly, the expenditure items for which legal liability has been incurred are immediately debited even before the amounts in question are actually disbursed. Where accounts are kept on the mercantile basis, the profits or gains are credited though they are not actually realised, and the entries thus made really show nothing more than an accrual or arising of the said profits at the material time. In other words, the basic conception of the accrual of income is that the assessee must have acquired a right to receive it. It would not matter that the valuation of the income is postponed or that the materialisation of the income depends on some other contingency. iv.The question of accrual or non- accrual of income and the subsidiary question of the time of accrual of income have got to be decided on fiscal principles and not on the basis of any given accounting method which is in vogue or which might be practiced by the assessee. The concept of accrual of income for purposes of income-tax is a concrete concept. The Act does not deal with abstractions.It deals with income. Therefore, when for the purpose of income-tax accrual of income is spoken of, it is not accrual in the abstract or of income in the abstract.The talk of accrual and of income would make sense only where accrual in a given period of time or of income of a given amount is dealt with. v.The accrual of income must be real. What has really accrued to the assessee has to be found out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in a realistic manner In the matter of S. K.G.Sugar Ltd.(96ITR194),the Hon'ble Patna High Court has laid down following general principles with regard to accrual of liability are: (1) In a mercantile system of accounting actual cash receipt of income is not necessary for the purpose of taxing a particular item as income; it is sufficient if the income has accrued during the period in question. Similarly, if the liability for a particular sum has been incurred during the accounting year and if otherwise the sum is allowable as a revenue expense then whether the sum has been actually paid or not is immaterial and the liability so incurred has got to be allowed as a revenue expense. (2) If, after the accrual of the income or incurring of the liability, any party forgoes the sum by way of gift, charity or the like and voluntarily, which cannot be characterised as a remission on grounds of commercial expediency, then such forgoing cannot affect the accrual of the income for the purpose of carrying on the business and the liability so incurred cannot be obliterated by such forgoing.

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(3) Mere book entries are not decisive of the matter. What has to be seen and found out is the effect of the forgoing in law on the accrual of the income or the incurring of the liability or expenditure. 3.b.In the case under appeal,the receipt of income as well as accrual took place as soon as the sale proceeds of software were received and not when the life span of software would come to an end.Therefore,spreading the income over the licence-period of the software,in our opinion,was not justified.The agreement was for up-gradation and improvisation of software - it was not warranty. Even in the matter of warranty,after the case of Rotork Controls India P.Ltd.(314ITR62)things have become very clear-it talks of historical trend.During the course of hearing before us.the assessee had not given any indication about the expenditure incurred by it for improving and upgrading the software during the remaining period of licence.ln short,the argument of matching the revenue v/s.cost is missing.lt our opinion,the method adopted by it would fall in the category which 'tends to distort the picture for the purpose of taxable income of the assessee'. 3.c.Now,we would like to discuss the cases relied upon by the assessee. We find that in the case of Mahindra Holding and Resorts(supra)it was held that the assessee had to contribute to its acquiring or arising by rendering services or otherwise the debt was created in favour of the assessee,that it could not be said that the assessee had fully contributed to its accruing by rendering services,that it had a continuing obligation to provide accommodation to the member for one week every year till the currency of membership. We find that in the case under appeal there was tenure of license/product but there was no certainty that in every subsequent year some determinate service had to be provided by it,that there was no determined/committed expenditure which the assessee was required to incur in the future years towards the corresponding share of revenue,that the indeterminate event of providing of updates and services as and when the they were developed which had been in keeping with the industrial norm.The assessee had no right to postpone the revenue.Inspite of adequate opportunitie,the assessee had not filed any facts before the FAA or us,as stated earlier,in that regard.ln the case of Sify E-Learning Ltd.(supra),it was found that the assessee was following project completion method,whereas in the case under appeal the assessee had changed method of accounting deferring more than 75% of its revenue to future period perpetually. Such a change, in our opinion, is not a bona fide change. With regard to other cases relied upon we find that the FAA has thoroughly distinguished them and has given a finding that facts of the case under consideration are different from those cases.We agree with him.Therefore,we hold that the order of the F AA does not suffer from any legal or factual infirmity.Confirming,his order,we decide ground no.2.1.against the assessee. 4.However,with regard to the ground no.2.2.we would like to state that while determining the income of an assessee for a particular income all the necessary facts have to considered. Income offered by an assessee cannot be taxed twice i.e.same income cannot be taxed in two A Y.s.Seocndly,if the assessee has offered portion of its income for taxation then while determining the total income for that year such income it has to be taken in to consideration. The claim made by the assessee has to be verified in light of the above observations. Ground no.2.2. is allowed in favour of the assessee,in part. 5.Ground no.3,pertaining to initiation of penalty u/s.271 (1)( c ),is considered to be infructous.

- A Y.2004-05: 6.Grounds field by the AO is about deleting the adjustments done by the TPO and consequent addition made by him. During the assessment proceedings,the AO held that the royalty should not be allowed to be written off to the extent of the unpaid invoices during the year itself. At the time of hearing before us,representatives of both the sides agreed that the issue stands covered by the order of the Tribunal (IT A5420-21 /Mum/2006/ A Y.2002-03&03-04- dtd. 28.01.2010) and that the Hon'ble Bombay High Court had confirmed the order on 03.07.2012 (ITA NO.20 of2011-).We find that the Court has dealt the matter as under: 2. The appeal is admitted and with the consent of the parties heard finally on the following substantial question of law :- 12

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Whether on the facts and circumstance of the case and. in law, the ITAT was justified in deleting the disallowance made of royalty paid by the assessee to CA. Management Inc. USA for distribution of software products in India without appreciating that the royalty had been paid on the amount of bad debts even where the software had not worked at all ?

8218/10;8376/11 & 8106/11CA(India) and the fact to which the Revenue is terming to be production was mere receipt of a sum of about Rs. 1 lakh on account of job charges which were recovered during the process of testing of some machines installed. This cannot in any manner be termed to be setting up of the plant and start of manufacturing therefrom. It is further submitted that to enable the assessee to start production, industrial licence was required which itself was received by the assessee on March 23, 1985, relevant to the assessment year 1986-87. To sum up, he submitted that once setting up of the plant itself was completed in the assessment year 1986- 87 and licence to manufacture was also granted during that year, there is no reason to deny the benefit of section 80-I of the Act to the assessee for 7 years starting therefrom.

10. We find the contention raised by counsel for the assessee, supported by the facts as narrated above, to be persuasive. Section 80-I of the Act applies to any industrial undertaking which fulfils four conditions as laid down in sub-section (2) thereof and one of them being the Act to manufacture or produce articles. It is not in dispute that the industrial undertaking could start manufacturing only after industrial licence is granted and in fact started manufacturing thereafter. It is also not in dispute that the assessee claimed deduction under section 80-I of the Act only during the year 1985-86 for the first time and not before that and calculating therefrom, the present assessment year will be the seventh year. This being the admitted position, we do not find any reason to differ with the view taken by the Tribunal. Accordingly, we dismiss the appeal of the Revenue on this issue.”

had not paid for the same, it would make no difference to the determination of the Arm's Length Price of the transaction. 8.Section 92C of the Act reads as under:- XXXXXXXXXXX 9.Section 92C provides the basis for determining the ALP in relation to international transactions. It does not either expressly or impliedly consider failure of the respondent's customers to pay for the products sold to them by the respondent to be a relevant factor in determining the ALP. Indeed in the absence of any statutory provision or the transactions being colourable bad debts on account of purchasers refusing to pay for the goods purchased by them from the assessee can never be a relevant factor while determining the ALP of the transaction between the assessee and its principal. Once it is accepted that the ALP of the royalty is justified, there can be no reduction in the value thereof on account of the assessee's customers failing to pay the assessee for the product purchased by them from the assessee. Absent a contract to the contrary, the vendor or licensor is not concerned with whether its purchaser / licensee recovers its price from its clients to which it has in turn sold / licensed such products. The two are distinct, unconnected transactions. The purchaser's / licensee's obligation to pay the consideration under its transaction with its vendor / licensor is not dependent upon its recovering the price of the products from its clients.

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