2025 (7) TMI 521 - AT - Income Tax

Trust wins appeal on software development and business consultancy charges after authorities ignored crucial evidence

ITAT Chennai allowed the assessee trust's appeal regarding disallowance of software development and business consultancy charges paid to TFMSS. The ... Assessment trust - Disallowance of charges paid for software development and maintenance - as alleged transaction was sham and done to economically benefit Trustee’s individual or family interest - definition of ‘related party’ or ‘relative’ - whether the entity True Friend Management Support Services Ltd (TFMSS) had provided substantive services for software development and maintenance to the assessee, payments made were for genuine services received, payments were made at FMV and the transaction was done at arm’s length? - whether any of the payments made towards software charges by the assessee and Jesus Calls to TFMSS had flown to the accounts of the Managing Trustee of the assessee and Jesus Calls Mr. Paul Dhinakaran, his family members or his entities through PWDS, UK. AO has observed that the assessee created a mechanism to intentionally divert Trust funds to a related foreign entity in the guise of software development charges without actual services - HELD THAT:- After considering all the facts and circumstances, we find that software services received were genuine and the consideration paid for such services was as per FMV. As such, we do not allow interference with the claim made by the assessee in this regard. After carefully considering all the facts available on record and the circumstances, we find that the lower authorities completely ignored and kept aside the relevant and crucial evidence in support of the claim made by the assessee. Such evidence included the sworn statement of Smt.Yamini Prabha, Sr.Software Developer, huge data of emails exchanged between Smt.Grace and Mr. Timothy Jackson regarding software development, taking cognisance of huge difference in the data on software of MyKarunya vis-à-vis Eduserve and the software development work done to make the same to match with the requirement of Microsoft Azure to upload it in the Cloud. On the contrary, they relied upon statements of unreliable witnesses without providing cross-examination, strongly relied upon unreliable and purported DFR, misinterpreted uncorroborated whatsapp chats, misrepresented entries in bank statements etc., to enable them somehow to disallow the claim. Having considered the relevant facts available on record in totality, we find that the lower authorities failed to lead appropriate evidence to sustain the disallowance. Disallowance of business consultancy charges - HELD THAT:- As seen that the AO had no occasion to apply his mind regarding the claim as the same got clubbed with the software charges. He disallowed it mechanically along with software charges without even realising that the claim of business consultancy charges was included in it. As noticed that ld. CIT(A) confirmed the disallowance in a mechanical manner without due application of find. It is admitted in the order that in support of the claim, the assessee submitted the agreement and details of students who got benefited consequent to the agreement. If he was not satisfied with the details, he should have required the assessee to furnish details in the manner he intended. If the assessee failed to do so, it is open for him to decide the issue. The assessee discharged the onus cast on his part whereas ld. CIT (A) simply brushed it aside giving vague reasons. Details of foreign universities with which the assessee entered into MOUs and collaboration agreements regarding student exchange programs and opening research facilities to students. It also contained details of students who got placements in foreign companies. Even though the results achieved are modest, it appears a new beginning was made. Regarding the objection of CIT(A) of no direct correlation with the results, we are inclined to agree with the submission of the ld. AR that there cannot be direct correlation between the expenditure incurred and the results achieved in arithmetical proportions in the same year in this kind of activities unlike in trading or manufacturing business. Another reason mentioned by ld. CIT (A) that TFMSS was created to divert funds outside the country for the benefit of Mr. Paul Dhinakaran and his family is nothing but his hypothesis and surmise. As discussed in the detailed order for A.Y. 2017-18, we did not find even one instance of such diversion of Trust funds as alleged. CIT (A) expressed his opinion that business consultancy charges paid to TFMSS was also similar to software charges is without any basis as no contrary evidence were brought in by the revenue. The disallowance of a claim merely on personal hypothesis does not have a place in law and every decision has to be backed up by appropriate evidence that too when a liability is fastened to the assessee. We have considered the argument of ld. AR that similar claim was made in A.Y. 2021-22 also. After due consideration, the AO allowed the same and the ld. CIT (A) also accepted it having not disturbed it even though the appeal for A.Y. 2021-22 was decided by him. Hence, we do not find consistency in the approach of ld. CIT (A) in respect of the same issue in two successive years. Assessee appeal allowed. The core legal questions considered by the Tribunal in these appeals primarily revolve around the genuineness and allowability of software development and maintenance expenses claimed by a charitable trust under the Income-tax Act, 1961. Specifically, the issues include:1. Whether the payments made by the trust to True Friend Management Support Services Ltd (TFMSS) for software development and maintenance were for genuine services actually rendered.2. Whether the payments were made at fair market value (FMV) and on an arm's length basis, given allegations that TFMSS and PW Data Solutions (PWDS), UK, were related parties controlled by the Managing Trustee.3. Whether the software charges were a sham transaction intended to divert trust funds for the personal benefit of the Managing Trustee and his family.4. The validity and evidentiary value of statements recorded from former employees of TFMSS, especially in the absence of cross-examination.5. The admissibility and reliability of a Digital Forensic Report (DFR) relied upon by the revenue authorities, which was not furnished to the assessee during proceedings.6. The probative value of WhatsApp chats and bank account statements relied upon by the revenue to establish diversion of funds.7. The applicability of section 13(1)(c) of the Income-tax Act in disallowing part of the software expenses.8. Whether the assessee is entitled to exemption under section 11 of the Act despite the disallowances.9. The allowability of business consultancy charges incurred in AY 2020-21, which were initially clubbed with software charges and disallowed.Issue-wise Detailed Analysis1. Genuineness of Software Development and Maintenance ServicesThe legal framework requires that expenses claimed must be genuine and incurred wholly and exclusively for the purposes of the trust. The AO alleged that TFMSS was incorporated solely to divert trust funds without rendering any actual service. The Tribunal noted that TFMSS had multiple business activities, with software development constituting a minor portion of its receipts, negating the AO's assertion of sham incorporation.The assessee relied on sworn statements, emails, and a Digital Forensic Analysis Report (DFAR) to establish that TFMSS and PWDS were actively involved in software development and maintenance. The Tribunal found the statements of the former Project Manager and her subordinate unreliable due to hostility and evasiveness, and the absence of cross-examination. Conversely, the statement of a senior programmer, Smt. Yamini Prabha, was accepted as credible evidence confirming PWDS's active role in supervising and guiding software development.Emails exchanged between Smt. Grace and Mr. Timothy Jackson of PWDS, which were ignored by the AO and CIT(A), demonstrated ongoing training, supervision, and technical support. The Tribunal held that such evidence was crucial and should have been considered, concluding that genuine services were rendered.2. Fair Market Value and Arm's Length Nature of TransactionsThe AO and CIT(A) suggested that payments were excessive and not at arm's length, yet neither conducted a market comparison nor invoked section 40A(2) to restrict expenses to FMV. The assessee demonstrated that TFMSS was selected after obtaining competitive quotations from reputed firms including TCS and Serosoft, establishing that the transaction was at arm's length and at FMV.The Tribunal emphasized that the Act does not empower authorities to arbitrarily disallow expenses without proper valuation or evidence. It rejected the revenue's casual remarks on relatedness and the absence of FMV analysis.3. Alleged Diversion of Funds to Managing Trustee and FamilyThe AO alleged that funds were routed through TFMSS and PWDS to the Managing Trustee and family members. The Tribunal examined WhatsApp chats and bank statements relied upon by the revenue and found them to be misinterpreted or factually incorrect. For example, credits to the daughter's bank account were from Pears World LLC (USA), not PWDS (UK), and payments labeled as 'online payments to Capital One' were credit card payments, not fund transfers to family members.No direct evidence was found to substantiate diversion of funds. The Tribunal held that mere suspicion or surmise without corroborative evidence cannot sustain such allegations.4. Reliance on Statements Without Cross-examinationThe statements of Smt. Grace and Mr. Jebamalai were relied upon by the revenue despite the assessee's request for cross-examination being denied. The Tribunal held that partial reliance on such statements is impermissible and that both statements should be disregarded as evidence. This approach aligns with settled legal principles that statements recorded during search proceedings cannot be used against the assessee without opportunity for cross-examination.5. Digital Forensic Report (DFR) by RevenueThe DFR was prepared by FDI Labs but was never furnished to the assessee despite repeated requests. The Tribunal found the report to be self-serving, lacking details of data examined, methodology, and basis for conclusions. It contained irrelevant, baseless, and imaginary inferences, such as alleging immigration of professors for setting up PWDS years later and disintegration of entities for tax evasion, which was factually incorrect.The Tribunal rejected the DFR as inadmissible and unreliable evidence.6. Digital Forensic Analysis Report (DFAR) by AssesseeThe assessee submitted a DFAR as additional evidence, prepared by a qualified expert based on seized data. The report was detailed, fact-based, and demonstrated substantial differences between the old and new software, including source codes, platform, and features, thereby disproving the revenue's claim of mere renaming without development.The Tribunal admitted the DFAR as additional evidence but declined to remit the matter back to the AO for verification, holding that the DFR was invalid and the DFAR's acceptance or rejection would not materially affect the outcome.7. Interpretation of WhatsApp Chats and Bank StatementsThe Tribunal carefully scrutinized the WhatsApp chats and found the revenue's conclusions to be factually incorrect and based on misinterpretations. The chats were academic discussions or unrelated to the alleged diversion. Similarly, the bank statements were misread by the revenue, leading to erroneous conclusions.8. Application of Section 13(1)(c) of the ActThe CIT(A) disallowed part of the software expenses under section 13(1)(c), alleging that some payments were not for charitable purposes. The Tribunal found this disallowance unjustified as the payments were for genuine software services essential for the trust's functioning. The Tribunal held that the disallowance was unsupported by evidence.9. Exemption under Section 11 of the ActEven if disallowances were sustained, the assessee claimed exemption under section 11 on the ground that adjusted expenditure exceeded 85% of receipts. The Tribunal held this ground as infructuous since the disallowance itself was deleted on merits.10. Business Consultancy Charges for AY 2020-21Additional grounds were raised for AY 2020-21 concerning disallowance of business consultancy charges of Rs. 2.36 crores, which were mistakenly clubbed with software charges and disallowed. The assessee furnished evidence of international collaborations, student placements, and research opportunities facilitated by TFMSS under the consultancy agreement.The CIT(A) disallowed the claim citing lack of direct correlation and alleging diversion of funds similar to software charges. The Tribunal noted that the AO had not applied his mind to this claim and the CIT(A)'s disallowance was mechanical and unsupported by evidence.The Tribunal accepted the assessee's explanation that results from such consultancy cannot be measured arithmetically in the same year and that the activities were a new beginning. It also noted inconsistency in allowing similar claims in AY 2021-22. The disallowance was deleted accordingly.Significant Holdings'Merely having an acquaintance with a person who had worked with the organisation nearly 2 decades ago do not make the persons 'related' within the meaning of the Act.''No software of any organisation can run normally without regular maintenance. It is an undisputed fact that the software team of TFMSS has been providing maintenance services on regular basis besides uploading the software in Microsoft Azure Cloud. Therefore, all this would not be possible without any services being received.''Statements recorded during search proceedings cannot be relied upon against the assessee without opportunity of cross-examination; partial reliance on such statements is impermissible.''A Digital Forensic Report which is self-serving, lacking in particulars of data examined, methodology and basis for conclusions, and containing baseless and irrelevant inferences, cannot be considered as valid evidence.''The Income-tax Act does not empower authorities to arbitrarily disallow expenses without proper valuation or evidence; if payments are made at fair market value and at arm's length, they are allowable.''Disallowance of expenditure on mere hypothesis or surmise without supporting evidence is not sustainable.''Where the assessee discharges the onus of proving genuineness of expenditure and the revenue fails to produce cogent evidence to the contrary, disallowance cannot be sustained.''There cannot be a direct arithmetic correlation between expenditure incurred on business consultancy for international promotion and the results achieved in the same year; sustained promotion over years is necessary.'Accordingly, the Tribunal allowed all five appeals for assessment years 2017-18 to 2021-22, deleting the disallowances of software charges and business consultancy charges made by the revenue authorities.