Tribunal upholds disallowance under IT Act for tax non-deduction, directs deduction on enhanced profits

The tribunal partly allowed the appeal, upholding the disallowance under Section 40(a)(ia) of the IT Act for non-deduction of tax on software purchase but directing the AO to allow deduction under Section 10A on enhanced profits. The disallowance under Section 10A for bank interest was dismissed as not pressed. The decision was pronounced on 13/11/2017.

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Issues Involved:
1. Disallowance under Section 40(a)(ia) of the IT Act for non-deduction of tax at source on purchase of software.
2. Disallowance under Section 10A of the IT Act for bank interest from deposits out of business surplus.

Issue-Wise Detailed Analysis:

1. Disallowance under Section 40(a)(ia) of the IT Act:

The primary issue pertains to the disallowance of Rs. 1,14,68,383/- under Section 40(a)(ia) due to the assessee's failure to deduct tax at source on the purchase of software from two US-based sellers. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] treated the payment for software as royalty, making it taxable in India under Section 195 of the IT Act and the Indo-US Double Taxation Avoidance Agreement (DTAA).

The assessee contended that the software purchase was akin to buying goods, which is subject to sales tax in the USA, and should not be considered royalty or a taxable service in India. The assessee also argued that the retrospective amendment to Section 9(1)(vi) by the Finance Act 2012 should not apply to their case, and the DTAA provisions, being more beneficial, should prevail. The assessee relied on several judicial precedents, including Tata Consultancy Services Vs. State of Andhra Pradesh and Pr. CIT Vs. M. Tech India P. Ltd., to support their claim that the payment for software should not be treated as royalty.

Conversely, the Department Representative (DR) argued that the software purchase included rights to modify and resell, which qualifies as royalty under Section 9(1)(vi) and the Indo-US DTAA. The tribunal examined the agreement between the assessee and the US seller, noting that the assessee acquired not just the software but also rights to modify and resell it, thus constituting royalty. The tribunal referenced the Delhi High Court's decision in Pr. CIT Vs. M. Tech India P. Ltd., emphasizing the distinction between acquiring a copyrighted product and acquiring rights to use a copyright. Ultimately, the tribunal upheld the disallowance, concluding that the payment fell under the definition of royalty.

2. Alternative Plea Regarding Enhanced Profits and Deduction under Section 10A:

The assessee alternatively argued that the disallowance under Section 40(a)(ia) would enhance their business income, which is eligible for a deduction under Section 10A, thus negating any additional tax liability. The tribunal acknowledged this argument, referencing multiple decisions from Coordinate Benches and the Bombay High Court's ruling in Gem Plus Jewellery India Ltd. The tribunal noted that disallowances under various sections, including Section 40(a)(ia), result in enhanced profits of the eligible business, thereby increasing the deduction under Section 10A. The tribunal directed the AO to allow the deduction on the enhanced profit, following the CBDT's Circular No. 37 of 2016, which supports this view.

3. Disallowance under Section 10A for Bank Interest from Deposits:

The second issue involved a disallowance of Rs. 3,06,563/- under Section 10A for bank interest from deposits out of business surplus. During the hearing, the assessee chose not to press this ground due to the smallness of the amount. Consequently, the tribunal dismissed this ground as not pressed, with no objection from the DR.

Conclusion:

The appeal was partly allowed. The tribunal upheld the disallowance under Section 40(a)(ia) but directed the AO to allow the deduction under Section 10A on the enhanced profit. The disallowance under Section 10A for bank interest was dismissed as not pressed. The order was pronounced in the open court on 13/11/2017.

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