Delhi HC allows software license fees as revenue expenditure under section 37, rejects KPO comparables for IT services

The Delhi HC upheld the exclusion of Knowledge Process Outsourcing comparables for an assessee providing IT-enabled services to banks and financial institutions, noting functional dissimilarity in back-end credit card operations. Regarding license fees paid to GECC(USA) for software usage rights, the court held these constituted revenue expenditure deductible under section 37, not capital expenditure. The assessee acquired no ownership rights in the software, with all rights reverting to GECC(USA) upon license termination. The payment provided no enduring benefit, making it revenue in nature rather than acquisition of a capital asset.

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Issues Involved:

1. Delay in refiling the appeal.
2. Functional comparability of certain companies for transfer pricing analysis.
3. Disallowance of license fee as capital or revenue expenditure.

Detailed Analysis:

1. Delay in Refilling the Appeal:

The court addressed the issue of a significant delay of 815 days in refiling the appeal. The delay was condoned by the court, indicating that the reasons provided were sufficient to justify the delay. Consequently, the application concerning the delay was disposed of, allowing the appeal to proceed.

2. Functional Comparability for Transfer Pricing:

The primary issue involved the functional comparability of certain companies used in the transfer pricing analysis by the Income Tax Appellate Tribunal (ITAT). The appellant challenged the exclusion of several companies on the grounds of functional non-comparability:

- Eclerx Services Limited: The ITAT considered it functionally non-comparable as it is a Knowledge Process Outsourcing (KPO) service company, whereas the respondent was involved in IT-enabled services (ITES). The appellant argued that KPO services are part of ITES and that marketing expenses and intangible assets should not disqualify it as a comparable.

- TCS E Serve: The ITAT excluded it due to functional differences, despite the Transfer Pricing Officer (TPO) noting similarities in brand value with the respondent. The appellant questioned whether brand value should influence comparability.

- BPO Infosys Pvt. Ltd.: The ITAT excluded it without considering the TPO's findings that it passed all applied filters and was involved in ITES. The appellant argued that acquisitions and investments should not be deemed extraordinary events affecting comparability.

- Acropetal Technologies Ltd. and E4e Healthcare Services Pvt. Ltd.: Both were excluded by the ITAT on the basis of functional non-comparability, despite their involvement in ITES according to their annual reports. The appellant questioned these exclusions.

- Overall Exclusion Criteria: The appellant contended that the ITAT excluded comparables without performing a FAR (functions performed, assets deployed, and risk assumed) analysis, as required by Rule 10B(2) of the Income Tax Act, 1962.

The court found that the ITAT's exclusion of these companies was justified based on the functional differences and the nature of services provided by the respondent. The ITAT's decision to exclude comparables engaged in KPO activities was deemed appropriate given the respondent's specific business operations in ITES.

3. Disallowance of License Fee:

The issue revolved around whether the disallowance of a license fee by the Assessing Officer should be categorized as capital or revenue expenditure. The Tribunal had previously ruled in favor of treating the license fee as revenue expenditure, deductible under Section 37(1) of the Income Tax Act. This decision was based on:

- Nature of the License Agreement: The agreement granted only limited rights to use software for business purposes, without transferring ownership or providing enduring benefits. The license was subject to termination, and the software had to be returned to the licensor upon termination.

- Consistency in Tribunal's Rulings: The Tribunal had consistently ruled in favor of the assessee in previous assessment years, and the High Court had affirmed this view for one of the years, although the specific issue was not contested by the Revenue.

The court upheld the Tribunal's decision, emphasizing the principle of consistency and noting that the Revenue had not previously contested this issue in higher courts. Consequently, the appeal was dismissed, and the Tribunal's ruling on the license fee as revenue expenditure was affirmed.

Conclusion:

The court dismissed the appeal, finding no substantial question of law. It upheld the ITAT's decisions on both the functional comparability of companies for transfer pricing purposes and the treatment of the license fee as revenue expenditure. The judgment reinforced the importance of consistent application of legal principles and the need for a thorough functional analysis in transfer pricing cases.

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