Tribunal rules Microsoft license fee not royalty, allows expenses as deductible business profits

The Tribunal allowed the assessee's appeal regarding the disallowance under Section 40(a)(i) for non-deduction of tax on Microsoft license fee, holding that the payment was not royalty but for the use of a copyrighted article, assessable as business profits. The disallowance was deleted based on legal precedents and DTAA interpretations. Additionally, the Tribunal upheld the deletion of expenses claimed as capital in nature, considering them as a loss incidental to business, deductible under Section 28. The revenue's appeal was dismissed, affirming that the expenses were allowable deductions.

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Issues Involved:
1. Disallowance under Section 40(a)(i) of the Income-tax Act, 1961 for non-deduction of tax under Section 195 on Microsoft license fee.
2. Deletion of expenses amounting to Rs. 75,29,700/- claimed as capital in nature by the AO.

Issue-wise Detailed Analysis:

1. Disallowance under Section 40(a)(i) of the Income-tax Act, 1961 for non-deduction of tax under Section 195 on Microsoft license fee:

At the outset, the assessee challenged the disallowance of Rs. 15,66,910/- made by the AO under Section 40(a)(i) for non-deduction of tax under Section 195 on Microsoft license fee payable to Organon NV (AE). The Tribunal noted that a similar issue arose in AY 2003-04 and AY 2004-05, where the Tribunal allowed the assessee’s appeal. The Tribunal extensively analyzed the question and concluded that the payment in question was not royalty but for the use of a copyrighted article, not the copyright itself. It was held that the payment was for purchases, assessable as business profits in the hands of the AE, which did not have a permanent establishment in India. Therefore, no tax was deductible under Section 195, and the disallowance under Section 40(a)(i) was deleted.

The Tribunal relied on various judgments, including the Hon'ble Delhi High Court in the case of Director of Income Tax vs. Nokia Networks OY, which held that the consideration for supply of software was not taxable as 'royalty' under Section 9(1)(vi) or the relevant provision of the DTAA. The Tribunal also referred to the Hon'ble Supreme Court in the case of GE India Technology Centre P Ltd. vs. CIT, which held that tax is deductible only if the sum paid is chargeable to tax in India.

The Tribunal further noted that even if the payment was considered under the Non-Discrimination Clause of Article 24 of the India-Netherlands DTAA, the same conditions for deductibility would apply as if the payment was made to a resident. The Tribunal cited the Hon'ble Delhi High Court in the case of Herbalife International (P) Ltd., which held that the requirement of deduction of TDS should be under the same conditions for residents and non-residents.

2. Deletion of expenses amounting to Rs. 75,29,700/- claimed as capital in nature by the AO:

The revenue appealed against the deletion of Rs. 75,29,700/- by the CIT(A), which the AO treated as capital expenditure. The assessee incurred expenses for setting up a pharmaceutical factory, which was later abandoned due to non-viability. The AO disallowed the expenses, treating them as capital in nature, not allowable as revenue expenditure.

The CIT(A) found that the expenses were incidental to the business and allowed the claim under Section 28 as a loss incidental to business. The Tribunal upheld the CIT(A)'s decision, noting that the expenses were for the expansion of the existing business and no asset of enduring nature was created. The Tribunal cited the Hon'ble Supreme Court in Ramchandran Shivnarayaan vs. CIT, which held that losses incurred in the ordinary course of business are deductible as trading losses.

The Tribunal dismissed the revenue's appeal, affirming that the expenses were incidental to the business and allowable as a deduction under Section 28.

Conclusion:

The Tribunal allowed the assessee's appeal regarding the disallowance under Section 40(a)(i) and dismissed the revenue's appeal concerning the deletion of capital expenses. The Tribunal's decision was based on extensive legal precedents and interpretations of relevant provisions of the Income-tax Act and DTAA. The order emphasized that the payments for Microsoft license fees were not royalty and the expenses incurred for the abandoned project were incidental to the business, thus deductible.

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