Software Payments Not 'Royalty': ITAT Deletes Disallowances, Supports Consistent Allocation of Service Charges.

The ITAT ruled in favor of the assessee, overturning the CIT(A)'s disallowances under section 40(a)(i) of the Income-tax Act, 1961, and for service charges paid to SSL. The Tribunal found that payments for software did not constitute 'Royalty' and that the allocation of service charges based on turnover was consistent and previously accepted. Consequently, the Tribunal deleted the disallowances, allowing the assessee's appeal and dismissing the revenue's appeal.

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Issues Involved:
1. Disallowance under section 40(a)(i) of the Income-tax Act, 1961.
2. Disallowance of service charges paid to Sonata Software Ltd. (SSL).

Detailed Analysis:

1. Disallowance under section 40(a)(i) of the Income-tax Act, 1961:
The primary issue in the cross appeals relates to the disallowance of Rs. 59,50,64,076 under section 40(a)(i) of the Income-tax Act, 1961. The assessee, a distributor of software products, purchased software from various non-resident parties and claimed the total consideration as revenue expenditure. The Assessing Officer treated this sum as 'Royalty' under section 9(1)(vi) and disallowed the expenditure since no tax was deducted at source. The CIT(A) confirmed the disallowance but allowed relief for payments to Microsoft Regional Sales Corp., Singapore, as the tax was paid by the supplier.

The Tribunal considered the submissions and noted that the issue had been concluded in the assessee's favor in a previous decision, where it was held that payments for software did not amount to 'Royalty' under section 9(1)(vi), and thus, no tax deduction at source under section 195 was required. Consequently, the provisions of section 40(a)(i) could not be applied. The Tribunal vacated the CIT(A)'s finding that the payment amounted to 'Royalty' and also disagreed with the CIT(A)'s view that disallowance under section 40(a)(i) could not be made if the non-resident supplier paid the tax. The Tribunal clarified that deduction under section 40(a)(i) is allowable only in the year in which tax has been paid, and since the tax was paid in a subsequent year, the deduction could be claimed only in that year. Therefore, the Tribunal set aside the CIT(A)'s order and deleted the entire disallowance under section 40(a)(i).

2. Disallowance of service charges paid to Sonata Software Ltd. (SSL):
The next issue pertains to the disallowance of Rs. 6,55,88,590 on account of service charges paid to SSL. The assessee, a 100% subsidiary of SSL, reimbursed SSL for expenses incurred on its behalf. The Assessing Officer disallowed the expenditure, observing that the service charges were disproportionately high compared to the turnover and that the agreement between the assessee and SSL was a colorable device to reduce taxable profits.

The CIT(A) examined the details and noted that the expenses were allocated on the basis of turnover. However, he found the allocation method to be incorrect, as the business activity of SSL was more expenditure-oriented. The CIT(A) estimated Rs. 50 lakhs as allowable expenses for services rendered by SSL and disallowed the rest.

The Tribunal reviewed the matter and found that the allocation of expenses on the basis of turnover had been accepted in SSL's case by the Tribunal in a previous decision. The Tribunal noted that the allocation method was consistent and had been verified. Since there was no dispute regarding the factual position that the allocation was based on turnover, the Tribunal saw no reason to restore the issue for further verification. Following the previous Tribunal decision, the Tribunal set aside the CIT(A)'s order and deleted the disallowance sustained by him.

Conclusion:
The Tribunal allowed the appeal of the assessee and dismissed the appeal of the revenue, thereby deleting the disallowances under section 40(a)(i) and the disallowance of service charges paid to SSL.

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