2022 (5) TMI 1645 - AT - Income Tax

Software license costs and IT support services treated as revenue expenditure, not capital assets

The ITAT Bangalore upheld the CIT(A)'s decision treating Data Automation Software expenses as revenue expenditure, finding no asset creation or ownership ... Revenue v. capital expenditure - revenue treatment of Electronic Design Automation (EDA) and Information Technology Support Service (ITSS) costs - Transfer pricing comparability - exclusion of functionally dissimilar companies as non-comparables - Application of Bilateral APA / MAP outcome to non-party related international transactions - Deductibility of business loss - under recovery of insurance proceeds / advances written off as revenue loss - Verification remand - directed factual verification of TDS shortfall claim Revenue v. capital expenditure - revenue treatment of Electronic Design Automation (EDA) costs - right to use licence payments - no enduring asset created - Expenditure on EDA software treated as revenue expenditure and allowed as deduction. - HELD THAT: - The Tribunal examined the group cost allocation agreement and the factual matrix showing that the parent company (TI Inc.) purchased and owned the EDA licences and charged the assessee on actual usage; the assessee acquired only a right to use the software and no asset of enduring nature was brought into existence. The Tribunal followed its earlier decision in the assessee's own case for AY 2008 09 where similar facts led to treating the amount as revenue expenditure. On that basis the Tribunal upheld the CIT(A)'s deletion of the AO's addition and dismissed the Revenue's ground. [Paras 7, 11] Claim for Data Automation Software (EDA) expenses allowed as revenue expenditure; Revenue's appeal dismissed in respect of this issue. Revenue v. capital expenditure - revenue treatment of Information Technology Support Services (ITSS) costs - allocation based on usage - ownership of software/voucher retained by parent - Expenditure on information technology support services held to be revenue expenditure and allowed as deduction. - HELD THAT: - The Tribunal accepted the CIT(A)'s finding that the parent company owned the relevant licences and that the assessee was charged by allocation (per person/per usage) for IT support; there was no separate purchase of software by the assessee nor any acquisition of ownership. The Tribunal noted identical facts in other assessment years and followed those decisions to uphold the CIT(A)'s deletion of the AO's capitalisation and depreciation treatment. [Paras 15, 16] ITSS expenditure treated as revenue expenditure; additions by AO deleted and assessee's appeal allowed on this point. Transfer pricing comparability - exclusion of functionally dissimilar companies as non-comparables - TNMM comparability criteria - functions, assets and risks - Certain comparable entities (including Asian Business Exhibition & Conference Ltd., HCCA Business Services Pvt Ltd., Killick Agencies & Marketing Ltd., Just Dial Ltd., I Media Corp Ltd., Irunway India Pvt Ltd.) were functionally not comparable and rightly excluded from the comparable set. - HELD THAT: - Applying the comparability criteria (functions performed, assets employed, risks assumed and other Rule 10B considerations), the Tribunal agreed with the CIT(A) and earlier Bench precedents that the named companies were engaged in materially different activities (event management, payroll services, agency/distribution, local search/IPR services etc.), possessed different revenue profiles and intangibles, or failed export/revenue filters. On that factual and functional analysis the CIT(A)'s exclusions were sustained and the Revenue's grounds challenging those exclusions were dismissed. [Paras 21, 34, 61] Exclusions of the named comparables upheld; TP adjustments based on inclusion of those comparables were disallowed. Application of Bilateral APA / MAP outcome to non-party related international transactions - consistency in treatment where no functional distinction made - Margin determined under a Bilateral APA / MAP for transactions with the US AE was applied to similar transactions with the non US AE (Natsem Malaysia) where no distinction in functions was made. - HELD THAT: - The Tribunal followed prior decisions wherein, when neither the assessee nor the TPO made a functional distinction between US and non US AE transactions, the arm's length margin agreed through MAP/BAPA for the US AE was applied to the non US AE transactions. Given that the services to TI Inc., US and Natsem Malaysia were not distinguished and the US transactions formed the overwhelming bulk of activity, the Tribunal directed adoption of the APA/MAP margin for the non US AE as well and rejected the Revenue's contention that the BAPA is binding only on the parties to it for the purpose of transaction with a different AE. [Paras 29, 30] APA/MAP margin applied to non US AE transactions where functional profile is same; Revenue's SWD segment grounds dismissed. Deductibility of business loss - under recovery of insurance proceeds / advances written off - loss incidental to business allowable under business income provisions - Under recovery of insurance claim (advances written off) arising from receipt of a damaged capital item in transit is an allowable revenue loss incidental to business and deductible. - HELD THAT: - The Tribunal found that the damaged EMC storage hardware was procured for business, never reached usable condition and the consequent shortfall in insurance settlement represented a loss incidental to the business and not a capital expenditure. Relying on precedents (including Graphite India Ltd. and related authorities), the Tribunal held that the loss should be allowed under business income provisions rather than being treated as a capital loss or disallowed as a mere advance written off; thus the CIT(A) and AO were directed to allow the claim. [Paras 49, 50, 51] Assessee's claim for advances written off on under recovery of insurance proceeds allowed as deductible business loss; appeal allowed on this point. Verification remand - directed factual verification of TDS shortfall claim - The claim of short grant of TDS was not finally adjudicated and was directed to be verified afresh by the AO with opportunity to the assessee. - HELD THAT: - The Tribunal noted the assessee's plea regarding short grant of TDS and directed the Assessing Officer to verify the claim and consider it afresh after affording the assessee an opportunity of being heard, thereby remitting the factual verification to the assessing authority. [Paras 63] TDS shortfall claim remitted to AO for verification and fresh adjudication after hearing the assessee. Final Conclusion: The Tribunal allowed the assessee's claims that EDA and IT support service expenditures are revenue in nature (upholding CIT(A) orders), sustained the exclusion of multiple functionally dissimilar comparables in transfer pricing analyses, directed application of the APA/MAP margin to non US AE transactions where no functional distinction was made, allowed the loss on under recovered insurance/advances written off as deductible business loss, and remitted the limited issue of alleged short grant of TDS to the Assessing Officer for verification. Issues Involved:1. Condonation of delay in filing the appeal.2. Nature of data automation expenses and information technology support service expenses.3. Transfer Pricing (TP) issues related to the selection of comparable companies and determination of Arm's Length Price (ALP).Detailed Analysis:Condonation of Delay:The Revenue's appeal was filed with a delay of 26 days, explained due to administrative reasons. The tribunal found the delay not inordinate and condoned it.Nature of Data Automation Expenses:The assessee, involved in the design and manufacture of computer software, claimed a deduction for 'Data Automation Software Expenses' (EDA). The Assessing Officer (AO) treated these expenses as capital expenditure, allowing 60% depreciation. The CIT(A) reversed this decision, treating the expenses as revenue in nature, citing that the payment was for the usage of software tools provided by the parent company, Texas Instruments Inc. (TI Inc.), and did not result in the acquisition of any new asset. The tribunal upheld the CIT(A)’s decision, noting that the nature of the expenses was identical to those considered in previous years where they were treated as revenue expenditure.Nature of Information Technology Support Service Expenses:Similar to the EDA expenses, the Information Technology Support Service (ITSS) expenses were initially treated as capital expenditure by the AO. However, the CIT(A) treated these expenses as revenue in nature, noting that the assessee was charged for using licenses owned by the parent company, without acquiring any ownership rights. The tribunal upheld this decision, referencing a similar conclusion in the assessee’s case for a different assessment year.Transfer Pricing (TP) Issues:The Revenue challenged the CIT(A)’s decision to exclude certain companies as comparables for determining the ALP for Marketing Support Services (MSS). The CIT(A) excluded companies like M/s Asian Business Exhibition & Conference Ltd., M/s HCCA Business Services Pvt Ltd., and M/s Killick Agencies & Marketing Ltd., citing functional dissimilarity. The tribunal upheld the CIT(A)’s decision, referencing previous tribunal decisions where these companies were excluded for similar reasons.Determination of ALP in Software Development Services (SWD) Segment:The assessee argued that the profit margin agreed in a Bilateral Advance Price Agreement (BAPA) with the US should apply to transactions with Natsem Malaysia, given the similarity in services provided. The CIT(A) accepted this argument, and the tribunal upheld this decision, noting that neither the assessee nor the TPO had distinguished between US and non-US transactions in their comparability analysis.Disallowance of Loans and Advances Written Off:The assessee claimed a deduction for under-recovery of insurance claims on damaged shipments, which was treated as a capital loss by the AO. The tribunal held that the loss was incidental to the business and allowable under section 28 r.w.s 29 of the Act, directing the Revenue to allow the claim.Conclusion:The appeals by the Revenue were dismissed, and the appeals by the assessee were allowed, with the tribunal upholding the CIT(A)’s decisions on the nature of expenses and TP adjustments, and directing the Revenue to allow the deduction for loans and advances written off. The tribunal also directed the AO to verify and consider the assessee’s claim for short grant of TDS.