Software development charges allowed after authorities wrongly treated legitimate vendor transactions as sham arrangements

ITAT Chennai allowed the appeal regarding software charges disallowance. The assessee selected a vendor after evaluating quotations from reputed companies and paid charges for software development and maintenance. Lower authorities treated transactions as sham based solely on agreements. ITAT deleted the disallowance following identical ruling in associate trust's case. Regarding personal gifts of Rs. 20,500 received by an individual recorded in gift management system, ITAT held these should be taxed in recipient's hands, not the trust's. Since gifts were below Rs. 50,000 threshold under section 56(2)(x)(a), no tax liability arose and addition was deleted.

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The primary legal issue considered in these appeals concerns the legitimacy and allowability of software-related expenses claimed by the assessee, a Religious and Charitable Trust, for assessment years 2019-20 to 2021-22. The Assessing Officer (AO) disallowed these expenses, alleging that the payments for software development and maintenance were sham transactions lacking actual service, based solely on agreements. The Commissioner of Income Tax (Appeals) (CIT(A)) upheld the AO's disallowance by relying on a prior decision involving an associate trust, applying identical reasoning and findings. Additional issues raised include the taxability of personal gifts recorded in the 'Gift Management System' and the applicability of exemption provisions under the Income-tax Act, 1961.

The detailed analysis of the core issues is as follows:

1. Legitimacy of Software Charges Claimed as Expenses

Legal Framework and Precedents: The assessment was conducted under section 143(3) read with section 153A of the Income-tax Act, 1961, following a search under section 132. The key legal principle invoked by the AO and CIT(A) was the disallowance of expenses under section 13(1)(c) for amounts not applied to the objects of the trust. The CIT(A) relied heavily on findings from an earlier appeal involving the associate trust Karunya Educational and Research Trust (KERT), where software charges paid to entities linked to the managing trustee were held to be non-genuine and for personal benefit, thus disallowable.

Court's Interpretation and Reasoning: The Tribunal examined the facts and circumstances independently, noting that the facts in the present case were identical to those in the KERT case. However, after a detailed inquiry in the KERT appeals, the Tribunal had concluded that the disallowance of software charges was not justified and deleted the additions made by the AO. Applying the same reasoning mutatis mutandis, the Tribunal held that the software charges claimed by the assessee were genuine expenses incurred for software development, maintenance, and support, and thus allowable. The Tribunal recognized that the assessee had initially used software developed by a third party, which malfunctioned, followed by software developed internally by an associate educational institute, which also faced operational issues. Consequently, the assessee outsourced software development and maintenance to an external company, TFMSS, backed by PW Data Solutions, UK, after evaluating multiple quotations. The Tribunal found no incriminating material or evidence to support the AO's assertion that these payments were sham transactions.

Key Evidence and Findings: The Tribunal noted the absence of any direct evidence or incriminating material to substantiate the AO's allegation of sham transactions. The AO's reliance on statements from former employees hostile to TFMSS and a report from FDI Labs was scrutinized. The Tribunal found that the report was not furnished to the assessee, contained presumptions and inaccuracies, and was not relied upon by the AO in the assessment order. Furthermore, the Tribunal emphasized the lack of opportunity for cross-examination of hostile witnesses, which diminished the evidentiary value of their statements. The Tribunal also observed that the software charges were paid to reputed entities after due evaluation and that the software was actively used by the assessee in its operations.

Application of Law to Facts and Treatment of Competing Arguments: The Tribunal applied the principles that additions in search assessments require incriminating material and that mere suspicion or reliance on uncorroborated statements is insufficient. The AO's and CIT(A)'s reliance on the KERT decision without considering the specific facts of the present case was found misplaced. The Tribunal distinguished the present case by noting the genuineness of the software services and payments. The contention that software charges were not incurred or were for personal benefit was rejected due to lack of evidence. The Tribunal also held that the CIT(A)'s disallowance under section 13(1)(c) was incorrect as the expenses were applied for the objects of the trust.

Conclusions: The Tribunal deleted the disallowance of software charges in all three assessment years, allowing the grounds raised by the assessee.

2. Taxability of Personal Gifts Recorded in the Gift Management System

Legal Framework: Section 56(2)(x)(a) of the Income-tax Act provides that cash gifts exceeding Rs. 50,000 received without consideration are taxable as income. The issue was whether the gifts recorded in the system and received by individuals associated with the trust should be taxed in the hands of the trust or the individual donees.

Court's Interpretation and Reasoning: The Tribunal observed that the gifts were personal gifts received by named individuals, such as Ms. Sharon Angel Dhinakaran, and not by the trust itself. The Tribunal noted that except for Rs. 19,900, all other gifts had been offered to tax by the recipients in their individual tax returns. The gifts received by Ms. Sharon Angel Dhinakaran were below the threshold of Rs. 50,000, and thus not taxable under section 56(2)(x)(a).

Application of Law to Facts: Since the gifts were personal and recorded with the names of the donees, the Tribunal held that the gifts should be assessed in the hands of the individual recipients and not the trust. The addition of Rs. 19,900 to the income of the trust was therefore unwarranted.

Conclusions: The Tribunal deleted the addition of Rs. 19,900 and allowed the ground raised by the assessee.

3. Applicability of Exemption under Section 11 of the Income-tax Act

The assessee contended that the trust was eligible for exemption under section 11, which deals with income derived from property held for charitable or religious purposes. The Tribunal found that since the disallowances were deleted on merits, the question of exemption under section 11 became infructuous and did not require separate adjudication.

4. Reliance on Reports and Statements in the Absence of Cross-Examination

The assessee challenged the reliance placed by the AO and CIT(A) on statements of former employees hostile to TFMSS and a report by FDI Labs, which was neither furnished to the assessee nor subjected to scrutiny. The Tribunal emphasized that such evidence, especially in search assessments, must be corroborated and that denial of opportunity for cross-examination undermines the validity of such statements. The Tribunal found that the CIT(A) erred in upholding additions based on such unreliable evidence.

5. Application of Section 13(1)(c) of the Income-tax Act

The CIT(A) disallowed part of the software usage charges under section 13(1)(c), which restricts application of income for purposes other than charitable objects. The Tribunal held that the CIT(A) erred in this approach because the expenses were genuinely incurred for software used in the trust's activities and thus applied for the objects of the trust.

6. Applicability of Prior Decisions and Mutatis Mutandis Application

The CIT(A) had applied the findings from the KERT case to the present case. The Tribunal clarified that while facts were similar, the detailed inquiry in the KERT appeals led to deletion of disallowances, and hence the same principle must apply here. The Tribunal also noted that the report relied upon in KERT was not relevant to the present case as it did not examine the software applications used by the assessee.

Significant Holdings:

"Considering all the facts and circumstances are identical regarding the issue in both the cases, we hold that the decision taken in the case of M/s.Karunya Educational and Research Trust in appeals ITA Nos.799/CHNY/2025 to 803/CHNY/2025 for assessment years (A.Y) 2017-18 to 2021-22, are applicable mutatis mutandis in the present case of the assessee under consideration for all 3 assessment years 2019-20 to 2021-22."

"As discussed in our orders in the case of M/s.Karunya Educational and Research Trust(supra) the disallowance of software charges made by the lower authorities is deleted and the grounds raised by the assessee are allowed."

"Since the name of donee is specifically mentioned in the system, personal gifts received are to be considered in the individual hands of the donee in her assessment and not in the hands of the Trust. No addition could have been made in the case of the assessee and the ground raised by the assessee is hereby allowed."

"The provisions of section 56(2)(x)(a) stipulates that cash gifts received in excess of Rs. 50,000/- are to be treated as income u/s. 56(1) of the Act. As the entire cash gifts received by Ms.Sharon Angel Dhinakaran are less than Rs. 50,000/- the same are not taxable in her hands. Hence, the addition is deleted and the ground is allowed."

"The addition made by the AO is deleted and appeal of the assessee for AY 2019-20 is allowed. Considering all the facts and circumstances and grounds raised by the assessee in these two appeals are identical to the facts and circumstances and the grounds in ITA Nos.796/CHNY/2025 for the A.Y.2019-20, it is held that the present order passed for A.Y.2019-20 is applicable mutatis mutandis to A.Y 2020-21 and 2021-22. Hence, the appeals for A.Y.2020-21 and 2021-22 are stand allowed."

The Tribunal's final determination was to allow the appeals for all three assessment years, deleting the disallowances of software expenses and personal gifts additions, and rejecting the reliance on uncorroborated evidence and reports not furnished to the assessee. The Tribunal underscored the necessity of substantiated evidence for additions in search assessments and adherence to procedural fairness, including the opportunity for cross-examination.

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