2024 (5) TMI 644 - AT - Income Tax

AO's failure to follow DRP directions on software licence fees renders assessment order invalid under section 144C(13)

Home Credit International a.S. Czech Republic Versus Assistant Deputy Commissioner of Income Tax, International Taxation, Gurgaon

The ITAT Delhi held that the final assessment order was invalid due to the AO's failure to implement DRP directions regarding royalty/FTS receipts ... Validity of the final assessment order due to non-implementation of the directions of learned DRP - Royalty/FTS receipts - amount received towards licence fee - whether the AO, while passing the final assessment order, was justified in holding the receipts in dispute as equipment royalty under section 9(1)(vi) of the Act read with Article 12 of India – Czech DTAA? - HELD THAT:- Materials on record reveal that in course of assessment proceedings, AO issued a show-cause notice to the assessee to explain, as to why the receipts in dispute should not be treated as royalty/FTS, as, such receipts are ancillary to enjoyment of such services, for which, royalty income has been received. In response to the show-cause notice, assessee had furnished a detailed reply submitting that the amount received towards licence fee cannot be treated as royalty, as, it was for a non-exclusive right given to the Indian entity to use copyrighted software. As regards reimbursement of software licence fee and maintenance fee, the assessee had submitted that it had procured certain licences centrally for its group companies and has cross-charged the Indian affiliates the licence and maintenance fees in respect of the same on a cost-to-cost basis. While framing the draft assessment order, the Assessing Officer observed that the assessee maintains a global IT infrastructure, which consists of owned, leased, supported and hosted IT systems etc. According to him, IT infrastructure made of various hardware devices and software/applications is a scientific equipment and also in the nature of commercial equipment. He has further observed that the agreement between the assessee and Indian group entities provide for use or right to use of equipment. Thus, in these premises, he treated the receipts as royalty. However, before learned DRP, to counter the aforesaid finding of the Assessing Officer, the assessee made detailed submissions categorically denying the allegation that it had provided use or right to use of any IT infrastructure etc. to the Indian group entities. Though, learned DRP had specifically directed the Assessing Officer to demonstrate, how the IT infrastructure is maintained; how it is beneficial to AEs in terms of acquiring the right to use; what are the various hardware devices and matching software applications, which can constitute scientific or commercial equipment etc., the Assessing Officer has failed to demonstrate such fact in the assessment order. On a specific query from the Bench, as to what constitutes IT infrastructure and what are the hardware devices etc., which can be construed as scientific or commercial equipment, learned Departmental Representative fairly submitted that such facts are not forthcoming from the assessment order. The contention of the learned Departmental Representative that the Indian entity has been given right to use the server while accessing the software, is too specious an argument to be accepted. It would be preposterous to even assume that right of ownership over the server has been transferred by the assessee while selling software licences. More so, when the Revenue has failed to bring any material on record to even remotely establish such fact. Thus, in our view, it is a clear case of non-implementation of directions of learned DRP by the AO. In the facts of the present appeal, undisputedly, the Assessing Officer has failed to implement the directions of learned DRP, hence, has not acted as per the mandate of section 144C(13). We hold that the impugned assessment order is wholly without jurisdiction, hence, invalid. Accordingly, we quash it Issues Involved:1. Validity of the final assessment order due to non-implementation of DRP directions.2. Taxability of receipts as equipment royalty u/s 9(1)(vi) of the Income-tax Act read with Article 12 of India-Czech DTAA.Summary:1. Validity of the Final Assessment Order Due to Non-Implementation of DRP Directions:The assessee, a non-resident corporate entity incorporated in Czech Republic, challenged the validity of the final assessment order dated 30.05.2023, passed u/s 143(3) read with section 144C(13) of the Income-tax Act, 1961, on the grounds of non-implementation of the directions of the Dispute Resolution Panel (DRP). The DRP had directed the Assessing Officer (AO) to consider the assessee's arguments and complete the assessment through a speaking and reasoned order without conducting any fresh inquiry.However, the AO failed to implement these directions and passed the final assessment order in line with the draft assessment order, holding the receipts as equipment royalty. This non-compliance was highlighted by the assessee, who argued that the AO did not specify how the IT infrastructure was maintained or beneficial to the Indian group entities, nor did he clarify the hardware devices and software applications involved.The Tribunal observed that the AO did not follow the statutory provisions u/s 144C, which mandates that the AO must implement the DRP's directions in the final assessment order. The Tribunal, referencing the case of Bechtel Ltd. Vs. ACIT, held that non-implementation of DRP directions renders the final assessment order wholly without jurisdiction and void-ab-initio. Consequently, the Tribunal quashed the assessment order, declaring it invalid.2. Taxability of Receipts as Equipment Royalty u/s 9(1)(vi) of the Income-tax Act Read with Article 12 of India-Czech DTAA:The AO had treated the receipts from software licenses and reimbursements as equipment royalty, arguing that the Indian entity had acquired the right to use the IT infrastructure maintained by the assessee. The assessee contended that the receipts were from the sale of off-the-shelf software and cost reimbursements without any markup, and thus not taxable in India. The assessee relied on the Supreme Court decision in Engineering Analysis Centre of Excellence Pvt. Ltd. Vs. CIT, which held that such receipts cannot be taxed as royalty.The DRP found the AO's draft order ambiguous and lacking in clarity, directing the AO to provide a detailed and reasoned order. Despite this, the AO repeated the observations from the draft order without addressing the DRP's concerns. The Tribunal noted that the AO failed to demonstrate how the IT infrastructure was maintained and beneficial to the Indian entities, and what constituted the hardware devices and software applications. The Tribunal concluded that the AO's argument that the Indian entity had the right to use the server was speculative and unsupported by evidence.As the AO did not comply with the DRP's directions, the Tribunal quashed the final assessment order, holding it invalid. The issues on merits were kept open for future consideration.Conclusion:The Tribunal quashed the final assessment order due to the AO's failure to implement the DRP's directions, declaring it invalid and without jurisdiction. The issues on the taxability of receipts as equipment royalty were left open for future adjudication.