2005 (11) TMI 384 - AT - Income Tax

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 ... Disallowance u/s 40(a)(i) - Purchased software from various non-resident - Revenue expenditure or Royalty u/s 9(1)(vi) - Disallowance u/s 40(a)(ii) on account of service charges - Allocation of expenses in respect of service charges - HELD THAT:- The issue before us has already been concluded by the decision of the Tribunal in assessee’s own case wherein the Tribunal, following its decision in the case of Samsung Electronics Ltd. [2005 (2) TMI 438 - ITAT BANGALORE-A] has held that payment made by assessee for purchase of software did not amount of ‘Royalty’ within the ambit of section 9(1)(vi) of the Act and therefore, assessee was not liable to deduct tax at source u/s 195. Following the said decision, it is further held that, as a necessary corollary, the provisions of section 40(a)(i) could not be applied to the case of assessee. The finding of CIT(A) that payment towards purchase of software amounted to ‘Royalty’ within the meaning of section 9(1)(vi) of the Act is hereby vacated. In the present case, it has been noted by the CIT(A) that the non-resident had paid the tax on 22-3-2004, consequently, deduction could be claimed only in the assessment year 2004-05 and not in the year under consideration. The CIT(A), therefore, was incorrect in holding that no disallowance could have been made u/s 40(a)(i ) of the Act as the tax was ultimately paid by non-resident. Accordingly, we also vacate this finding of the CIT(A). Thus, we set aside the order of CIT(A) and deleted the entire disallowance u/s 40(a)(i) made by Assessing Officer and sustained by CIT(A). We find that the issue regarding the allocation of expenses in respect of service charges arose in the case of SSL. In that case, the Assessing Officer was of the view that allocation of expenses of Non-10A unit (not eligible for exemption) was excessive as exempted unit was much more expenditure oriented. The matter ultimately reached the Tribunal which accepted the case of assessee that allocation of support services expenses on the basis of turnover was justified. Admittedly, prior to incorporation of assessee company, SSL was carrying on two units independently i.e., unit exempted u/s 10A and the unit not exempted. Direct expenses incurred were separately booked to respective units. Only the support services expenses were allocated on the basis of turnover. Faced with the same, the ld. DR had nothing to add except to rely on the order of Assessing Officer. The ld. DR submitted that allocation of expenses requires verification and therefore, the matter may be referred to Assessing Officer for necessary verification. We are unable to accept this request since there is no dispute to the factual position that allocation of service expenses was made on the basis of turnover. No useful purpose would be served in restoring the issue. Accordingly, following the finding of the Tribunal in the case SSL, we set aside the order of CIT(A) on this issue and delete the disallowance sustained by him. In the result, the appeal of the assessee is allowed while the appeal of revenue is dismissed. 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.