TaxTMI 
TaxTMI 
TaxTMI 
2014 (2) TMI 602
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....ant objects to the order of the Commissioner of Income-tax (Appeals) -15, Mumbai ('CIT(A)') dated 11 January 2010 for the aforesaid assessment year on the following among other grounds: Software development expenses 1. The learned CIT(A) erred in confirming the disallowance of expenses of Rs. 16,74,93,240 incurred on development/up-gradation of various software products. 2.The learned CIT(A) erred in rejecting the alternative claim of appellant that the software development expenses incurred by the appellant was in the nature of research and development expenditure and therefore allowable as a revenue expenditure. 3. The learned CIT(A) erred observing that "it is not clear from material on record as to whether all the conditions given in section 35(1) (iv) is satisfied in this case or not" Transfer of employees to foreign subsidiaries 4. The learned CIT (A) erred in confirming the action of the assessing officer in adding an amount of Rs. 13,34,0 18 to the total income of the appellant, as consideration for transferring certain ....
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....f research and development expenditure and therefore allowable as a revenue expenditure. Transfer of employees to foreign subsidiaries 3. The learned CIT (A) erred in confirming the action of the assessing officer in adding an amount of Rs. 11,60,692 to the total income of the appellant, as consideration for transferring certain employees to its associated enterprises (ICICI Infotech Inc., 3i Infotech (UK) Ltd., ICICI Infotech Pte Ltd., Semantic Solutions GmbH) without appreciating the fact that these employees were neither highly qualified nor significant cost was incurred for training them." Grounds of ITA No.9131/Mum/2010,A.Y.2005-06- Assessee's Appeal: "The appellant objects to the order of the Commissioner of Income-tax (Appeals) -15, Mumbai ('CIT(A)') dated 26 October 2010 for the aforesaid assessment year on the following among other grounds: Software development expenses 1. The learned CIT(A) erred in confirming the disallowance of expenses of Rs.15,61,07,344 incurred on development/up-gradation of various software produ....
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....nses for research and development of computer software are nothing but capital in nature as the appellant has been deriving the enduring benefit. 3.4 The learned ACIT erred in not allowing the depreciation on software expenses capitalized in the books of account under the head "Software Products". The learned ACIT erred in not appreciating the fact that if the software expenses are treated as capital in nature, the depreciation ought to be allowed on the expenses which are capitalized in the year of commercialization. 3.5 The learned ACIT erred in observing that the appellant has not furnished the appropriate details called for nor has it submitted details and evidences of putting the said capital-work-in-progress of software to use. 3.6 He erred in not appreciating the fact that the without prejudice claim of the appellant for allowing depreciation is not made on the amount which is lying in capital-work-in- progress but is made on the amount which is capitalized in the books of account in the year of commercialization. 3.7 The learned ACIT erred in not allowing the depreciation....
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....espect of international transaction of transfer of employees 5.1 The learned ACIT / Transfer Pricing Officer ("TPO") erred in making the adjustment of Rs. 24,26,618 to the total income of the appellant, as consideration for transferring certain employees to its associated enterprises without appreciating the fact that these employees were neither highly qualified nor significant cost was incurred for training them. 6. Short credit of TDS The learned ACIT erred in granting credit for TDS of Rs.4,22,4788 as against Rs. 6,64,07,564 claimed by the appellant in the return of income. 7. Levy of interest under section 234D The learned ACIT erred in incorrectly levying interest under section 234D 8. Initiation of penalty under section 271(1)(c) The learned ACIT erred in initiating penalty under section 271(1)(c)" 2. All these appeals were argued together by the parties as some of the issues are common. On common issue reference to facts was made mainly in respect of assessment year 2003-04. It was the common c....
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....for development of software and by their nature they were revenue expenditure. He drew our attention to para 1.3 (b) of the Significant Accounting Policies and Notes to Accounts. The same relates to method of depreciation/amortization. In so far as business and commercial rights and software products are concerned the accounting policy adopted by the Assessee was as follows: "Business and Commercial Rights and Software Products are amortized over a period of five years, as considered appropriate by the management" His submission was that treatment of a particular item of expenditure in the books of accounts is not conclusive as to whether an item of expenditure is in the nature of capital or revenue. 11. The learned D.R. submitted that the Assessee did not give enough material to show as to whether the software in question is for own use or for sale. If it is for own use then the allowability of the expenses in question has to be adjudicated afresh by the AO in the light of the principles laid down by the special bench decision in the case of Amway India Ltd. (supra). His further submission was that if the....
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....d expenditure was capitalized on reaching commercialization. The AO allowed depreciation at 60% on such capitalized value of expenditure and the Assessee has accepted the same. However in respect of the expenditure treated as work- in-progress in the present assessment year, the Assessee wants a different treatment. It is true that entries in the books of accounts are not conclusive when it comes to computing income under the Income Tax Act, 1961 but it cannot be said that they are totally irrelevant. The method of accounting adopted by the Assessee goes well with the matching concept of accounting which mandates that incomes shall, as far as possible, be matched with the corresponding expenses to earn them. In the present case, the dispute is as to whether the Assessee will get the benefit of deduction of the entire expenditure in one year or a deduction of proportionate expenditure spread over several years. As we have already observed the method of accounting followed by the Assessee and the method of computation of total income in the case of the Assessee as accepted by the Assessee is to treat expenditure on development of computer software as part of work-in-progress during t....
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....(2), where such capital expenditure [referred to in section 35(1)(iv)] is incurred after March 31, 1967, the whole of such capital expenditure incurred in any previous year is deductible for that previous year, with exception being expenditure incurred on acquisition of land. It is the plea of the Assessee that even if the expenditure is considered as of capital nature the same would be eligible for deduction under section 35, provided such expenditure is incurred on scientific research. The submission of the Assessee is based on the decision of the Income Tax Appellate Tribunal (Delhi), in the case of DCIT v. TCIL Bellsouth Ltd. 89 TTJ 851, wherein it has been recognized that the expenses incurred on software product development would qualify as being in the nature of scientific research and thus, be admissible deduction under the provisions of section 35. It is the plea of the Assessee the expenditure is nothing but in the nature of research and development expenditure and therefore allowable as a revenue expenditure. 16. This argument in our view deserves to be rejected. In the submissions made by the Assessee before CIT(A), the Assessee had explained t....
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....ground No.1to 3 raised by the Assessee. ' 5. It may be further mentioned that against the aforementioned order of the Tribunal an appeal was filed by the assessee before the Hon'ble Bombay High Court which has been admitted vide order dated 18/1/2012 in Income Tax Appeal No.1013 of 2011 and following substantial questions of law have been admitted with the following observations: "1. Heard. Admit on the following substantial questions of law. "(i) Whether on the facts and in the circumstances of the case and in law, the Tribunal erred in holding that expenditure of Rs.12,59,33,429/-incurred by the appellant on development / upgradation of software is capital in nature? (ii) Whether on the facts and in the circumstances of the case and in law the Tribunal erred in denying the appellant's alternative claim for deduction of Rs.12,59,33,429/-as scientific research expenditure under Section 35 of the Act ?" 6. During the course of hearing though it was not disputed by Ld. AR that facts and circumstances are the same but it was his contention that th....
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....cial Bench decision was considered by the High Court in the case of CIT vs. Amway India Enterprises and it was held that entire expenditure was liable to be allowed as revenue expenditure. 7. We have carefully considered such submission of Ld. AR in the light of aforementioned two decisions of Hon'ble High Court. However, we are of the opinion that none of the aforementioned two decisions are applicable to the facts of the case of the assessee as the expenditure incurred by the assessee on development of software relates to assessee's own business activity of development of computer software and all processes thereon, assembling and recording of programmes on any tapes, disc, perforated media etc. Assessee's range of offerings includes software products and solutions for the Banking, Financial Services and Insurance (BFSI) industries. The assessee company has also range of enterprise software solutions and it develops and keep ready best version of software products and customizes it based on customers specific requirements. Though such expenditure is incurred mainly on account of salary, communication, electricity, printing and stationary, rent etc. but till the product is in the....
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.....1,2 & 3 of assessee's appeal for A.Y 2003-04, ground No.1&2 of assessee's appeal for A.Y 2004-05 and ground Nos.1 & 2 of assessee's appeal for A.Y 2005-06 and these grounds are treated to be partly allowed. 11. So far as it relates to assessee's similar claim in respect of A.Y 2006-07, it may be mentioned here that certain additional aspects on this issue have been raised which are as under: (1) Depreciation has not been allowed by the AO on capitalized software expenses. (2) The assessee is entitled for additional deduction under section 10A on the disallowed portion of software expenses. 12. So far as it relates to allowability of depreciation on capital work in progress which has been capitalized in the books of account in the year of commercialization, the aforementioned order of the Tribunal is clear that the depreciation is allowable to the assessee. Therefore, we direct the AO to grant such depreciation to the assessee. 13. So far as it relates to claim of exemption under section 10A of the Act, it is the case of the assessee that disallowance of software expenses will enhance the income of the assessee which is eligibl....
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.... by ICICI Bank, 63% by ICICI Ventures, a subsidiary of ICICI Bank and the balance is held by the Dubai based group. The Assessee is a software developing company. The four key business lines are software Development & consultancy services, software product, IT Infrastructure, Networking & Facilities Management services ltd. and business process outsourcing. The Assessee entered into some international transactions with associated enterprises. The following are the details of associate enterprises. (i) ICICI Infotech Inc. (hereinafter Infotech, USA), incorporated in Delaware, USA is a wholly owned subsidiary of the Assessee. (ii) ICICI Infotech Pte. Ltd., Singapore is also a wholly owned subsidiary of the Assessee and is engaged in the business of Information Technology related products and services. (iii) Tricolor Infotech International Inc, Mauritius is a joint venture company of the Assessee (50% equity) and Emirates Bank Group (50% equity). The company is engaged in the sales, marketing and business development ....
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.... enterprises, details of costs incurred by Infotech USA with regard to marketing services and as a contract service provider were also submitted. 29. The AO by his letter dated 29/9/03 had referred for computation of arm's length price to the TPO the transactions referred to Form No.3CEB filed by the Assessee pursuant to provisions of Sec.92E of the Act. The TPO considering the facts of the international transactions for the year and economic analysis carried out by him was of the view that no adjustment requires to be made to the value of the international transactions entered into by the assessee. 30. The TPO after having held that the value at which the international transactions reported by the Assessee in its Form No.3CEB u/s.92-E read with Rule 10-E of the Rules, carried out by the Assessee does not require any adjustment, however proceeded to make an adjustment in respect of an issue which was not reported by the Assessee as an international transaction in Form No.3CEB filed pursuant to Sec.92-E of the Act. The following were the relevant observations of the TPO in his report in this regard: &....
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....l income of the assessee and this amount is not eligible for any deduction u/s. 10A or section 10B or under Chapter-VIA in view of proviso to section 92C(4) of the I.T. Act, 1961.' 31. Following the above report of the TPO, the AO made an addition of Rs.2,71,773 to the total income of the Assessee. 32. Before CIT(A), the Assessee submitted that the first step, when applying the CPU method, is to find a comparable transaction. This could be done in two different ways. The easiest and most preferable way is to compare the controlled transactions (i.e. transaction between two related parties) with another transaction made by the same MNE but with an unrelated party. This is an "internal comparable". The reason why it is preferable is that the quality of the data is more accurate since the MNE is part of the transaction and thus has access to all the facts of the transactions. It was submitted that to test the arm's length pricing in the case of transfer/seconding of the employee's, it may be possible to use the CUP method where the same entity has undertaken similar transaction under comparable circumstances to independent enterprise....
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....as also argued that the Assessee is not in the business of transferring employees. It was pointed out that the employees transferred were mainly handling market development responsibilities and that their transfer to the wholly owned subsidiary US company was to help marketing of the Assessee's product by the wholly owned subsidiary US company and that the Assessee would generate income in the form of improved business and this factor has been completed lost sight by the TPO. 34. The CIT(A) however confirmed the order of the AO for the following reasons:- "I have carefully considered the findings of the Assessing Officer and submissions of the appellant. The argument of the appellant that no substantial amount was incurred for training and development of employees is not acceptable. The employees transferred were recruited and trained by the appellant company before they were actually interest the work of software development. Generally most qualified employees are transferred to foreign location. By aforesaid transfer the transferee entity was benefited because they have not incurred any expenses on ....
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.... be considered non est. In this regard he also brought to our notice Instruction No.3 of 2003 dated 20-5-2003 issued by the CBDT regarding computation of income from international transaction having regard to arm's length price wherein the CBDT explaining the role of TPO has instructed that in terms of Sec.92CA of the Act, the TPO's role is limited to the determination of arm's length price in relation to the international transactions referred to him by the AO and if during the course of proceedings before him it is found that there are certain other transactions which have not been referred to him by the AO, he will have to take up the matter with the AO so that a fresh reference is received with regard to such transaction. The Board has further opined that reference to the TPO is transaction and not enterprise specific. His further submission was that since the AO made the impugned addition by relying on the order of the TPO the same cannot be sustained. 37. The learned D.R. submitted that the definition of international transaction is wide enough to include the act of deputation of three employees by the Assessee to Infotech US. According to him, the A....
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....bsp; Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer." Section 92CA(1) to (3) empowers the AO to make a reference to the Transfer Pricing Officer and it reads as follows: "Reference to Transfer Pricing Officer. 92CA (1) Where any person, being the assessee, has entered into an international transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm's length price in relation to the said international transaction under section 92C to the Transfer Pricing Officer. (2) Where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to b....
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....ons which have not been referred to him by the AO, he will have to take up the matter with the AO so that a fresh reference is received with regard to such transaction. The Board has further opined that reference to the TPO is transaction and not enterprise specific. In the present case, the determination of ALP in respect of the transaction by which the Assessee deputed three of its employees to ICICI infotech, USA, by the TPO is therefore non est to that extent and cannot form the basis for making an addition to the total income. The AO therefore could not have made the impugned addition on the basis of the order of the TPO. Since the impugned addition has been made by the AO only by placing reliance on the report of the TPO, the addition cannot be sustained. 39. The next question is whether the report of the TPO can be considered as material, information or document based on which the addition made by the AO could be sustained. U/S.92C(3) the AO has power to determine ALP on the basis of material or information or document in his possession. But exercise of such power is conditional on the AO being satisfied that : (a) the pric....
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....e TPO is no doubt binding on the AO in terms of the above provisions but only if the same is in conformity with the other provisions of Sec. 92CA viz., there being a valid reference made to the TPO by the AO. 40. On merits of the addition sustained by the CIT(A) the learned counsel for the Assessee reiterated submissions made before CIT(A) and further submitted as follows: (a) That the TPO determined the ALP on assumptions that the employees transferred were recruited by the Assessee and that the Assessee gave proper training, before they were actually entrusted the work of software development. The next assumption of the TPO was that employees transferred to foreign locations are generally better qualified and the best performers. The third assumption was that the transfer of such employees, results into benefit to the transferee entity, as they are not to incur any expenses on the recruitment and training and the salary packages to such employees are also less in comparison to foreign employees, resulting into savings to the transferee company. It was his submission that there is no basis for these ....
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....erprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. The above definition is wide enough and includes any arrangement between two associated enterprises for allocation of cost in connection with a benefit, service or facility provided. Therefore the act of deputation of three employees by the Assessee to Infotech US will be covered within the aforesaid definition. The fact that there is no consideration paid for the transfer of employees will not take the transaction out of the purview of the provisions of Sec.92 of the Act. The deciding factor as to whether ALP has to be determined in such cases will be to see if the Indian tax base is eroded. If there is likely to be erosion of Indian tax base then the AO will be well within his powers to determine income arising out of an international transaction. Therefore the AO was well within his powers to examine the transaction with a vie....
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....year 2004-05. Ld. CIT(A) has relied upon the order passed by TPO for assessment year 2002-03 and 2003-04 and as already mentioned that it is not the case of revenue that the facts of the present years are different in any manner, therefore respectfully following the aforementioned order of the Tribunal we decide all these grounds in favour of assessee and these grounds are allowed. REVENUE'S APPEAL FOR A.Y. 2003-04: 18. On the basis of mutual agreement, the assessee has been providing back office support services to ICICI Bank in respect of retail lending business of ICICI Bank (the Bank) comprising of housing loans, auto loans, credit cards etc., ever since the Bank has started its retail lending business in the year 1999. For the sake of convenience these activities of the assessee are referred to as RFCO activities. 18.1 For providing such services the assessee had put in place adequate resources in the terms of (a) office space; (b) soft ware; (c) IT Infrastructure; (d) manpower sources with technical skill; (e) managerial and other skills required to handle such activity. However, in the year 2002, with a view to exercise direct control over these activities and to reduce c....
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....tivity and assessee is free to carry on such activity, if it so desired. In this regard it was submitted that assessee company is not providing such services to any other company and after termination of contract with the Bank the assessee did not entered into any other similar agreement with any other company. In view of the fact that there was a proposed change in the business model and reduction in the future revenue and also considering the fact that all key personnel were transferred to bank, it was not felt feasible for the assessee to continue such activity. Therefore, it was pleaded that after termination of contract of the assessee with the Bank, the assessee has given up one source of income completely. 18.4 Further, AO has relied upon the decision of Hon'ble Supreme Court in the case of Obroi Hotels Pt. Ltd., vs. CIT, 236 ITR 903(SC). According to AO where payment is made to assessee for compensation of cancellation of a contract which does not affect the trading structure of business and does not deprive him of what in substance is his source of income then termination of the contract is a normal incident of business. If such cancellation leaves him free to carry on hi....
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....sp; (6) CIT v. TI & M Sales Ltd., 259 ITR 116 (Mad) (7) Jt. CIT v. Khanna & Annadhanam [2005] 305 ITR (AT) 336 (Delhi) (8) CIT v. Bombay Burmah Trading Corporation, 161 ITR 386(SC) In this manner Ld. CIT(A) has deleted the addition of Rs.15.00 crores. Aggrieved, the revenue has filed aforementioned ground. 19. After narrating the facts it was submitted by Ld. DR that Ld. CIT(A) has erred in concluding that the compensation received by the assessee was in respect of loss of business or towards one source of income. He submitted that RFCO activities of the assessee were continued in respect of subsequent period also and there was no loss of business or one source of income. In this regard Ld. DR has produced before us financial reports of the assessee, wherein revenue from such activity has not altogether stopped in financial year2004. Thus he submitted that there was no absolute erosion of such source. He referred to the following table from the above financial report. Revenue Mix. FY 2004 % of sale FY 2003 % of Sales FY 2002 % of sales FY 2001 % of sales Software Development Services 559.62 31% 580.70 32% 539.43 ....
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....maining agencies. The transaction was not in the nature of a trading transaction, but was one in which the assessee parted with an asset of an enduring value. We are, therefore, unable to agree with the High Court that the amount received by the appellant was in the nature of a revenue receipt." Thus Ld. DR pleaded that the claim has wrongly been allowed by Ld.CIT(A) and his order on this issue should be set aside and that of AO be restored. 20. On the other hand, in addition to relying upon the order passed by Ld. CIT(A), countering the arguments of Ld. DR it was submitted by Ld. Sr. Counsel that the decision of Hon'ble Supreme Court in the case of Kettlewell Bullen & Co. Ltd. (supra) was rendered in respect of compensation received by the assessee in respect of one of the agencies. He submitted that in that very decision it has been clarified by Hon'ble Supreme Court that where out of several agencies the activity of the assessee in respect of agency of Fort William Jute Company Ltd. was stopped and on the basis of the fact that assessee continued similar activity with other remaining agencies was not considered relevant. Ld. AR drew our attention towards observation of their L....
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....been determined on the basis of the said loss. According to arguments of Ld. DR, the assessee company has not given up its entire activity of rendering back office services as the assessee has been earning income from such activity even after termination of such agreement. Therefore, it is the case of Ld. DR that the amount received by the assessee should be considered as income in the nature of revenue. However, such arguments of the Ld. DR does not find support from the aforementioned two decisions of Hon'ble Supreme Court namely Kettlewell Bullen & Co. Ltd. (supra) and Oberoi Hotel (P.) Ltd. (supra). It has been clearly observed by Hon'ble Supreme Court in the case of Kettlewell Bullen & Co. Ltd. (supra) that it is irrelevant that the assessee continued similar activity with the remaining agencies. So relevant criteria to decide such issue is that whether or not the assessee has lost one of its source of income. In the present case the assessee has lost its source of income with respect to its agreement entered into by it with the bank. It is also the case of the assessee that it has never rendered such services to any other person right from the inception and there is no materi....