2016 (9) TMI 1546 - AT - Income Tax

Disallowance u/s 14A - HELD THAT - We find that the Hon ble High Court of Delhi in case of Chem Investment Ltd. Vs CIT 2015 (9) TMI 238 - DELHI HIGH COURT has held that section 14A will not apply if no exempt income is received or receivable during the relevant previous year. - Decided against revenue Allowance of a depreciation adjustment - HELD THAT - Following the ratio of the above said decision in the case of Market Tools Research Pvt. Ltd. 2013 (12) TMI 414 - ITAT HYDERABAD we hold that DRP erred in directing to exclude depreciation from the cost of the Tax Payer as well as comparables. Hence we direct the AO to rework depreciation. TP Adjustment - comparable selection - HELD THAT - Companies functionally dissimilar with that of assessee need to be deselected from final list. Since the Assessee s margin of 26.12% is higher than the arithmetical mean of the margins of the comparables that is 14.01% the international transaction of provision of software development services by the Assessee to its AE in FY 2009-10 can be concluded as being at arm s length. Section 40(a)(ia) application to depreciation allowance under Section 32 - assessee had capitalized software expenses and appropriate income tax depreciation was claimed u/s 32 - HELD THAT - We are of the opinion that the issue is squarely covered by the decision in the case of Kawasaki Microelectronics Inc. Vs DICT (International Taxation) 2015 (9) TMI 9 - ITAT BANGALORE where it has been held that once the assessee has capitalized payment in question though the assessee has not deducted tax at source on such payment section 40 (a) (1) cannot be invoked for disallowance of depreciation.

Issues Involved:
1. Disallowance under Section 14A.
2. Adjustment for depreciation in computing the arm's length price.
3. Inclusion and exclusion of certain companies as comparables.
4. Disallowance under Section 40(a)(ia) related to software expenses.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A:

The Department contested the deletion of the disallowance under Section 14A by the DRP, arguing that expenses related to earning exempt income should be disallowed regardless of whether exempt income was earned during the financial year. The Tribunal referenced the Delhi High Court decision in Chem Investment Ltd. Vs CIT, which held that Section 14A does not apply if no exempt income is received or receivable during the relevant previous year. Consequently, the Tribunal dismissed the Department's ground, affirming that Section 14A disallowance is not applicable in the absence of exempt income.

2. Adjustment for Depreciation in Computing Arm's Length Price:

The Department appealed against the DRP's direction to exclude depreciation from the cost of the taxpayer and comparables. The assessee argued that Rule 10B of the Income-tax Rules necessitates adjustments for differences in depreciation policies between the assessee and comparables. The Tribunal cited previous decisions, including the Bangalore Bench in the assessee's own case for AY 2005-06 and the Hyderabad Bench in Market Tools Research Pvt. Ltd., which supported the need for depreciation adjustments to ensure comparability. The Tribunal directed the AO to rework depreciation following the decision in Market Tools Research Pvt. Ltd., thereby rejecting the Department's ground.

3. Inclusion and Exclusion of Certain Companies as Comparables:

The assessee challenged the inclusion of certain companies (Infosys Ltd., Kals Information Systems Ltd., Larsen & Toubro Infotech Ltd., Mindtree Ltd., Persistent System Ltd., Sasken Communication Technologies, and Tata Elxsi Ltd.) as comparables, citing functional dissimilarities. The Tribunal referenced the decision in M/s Electronics for Imaging India Pvt. Ltd., where these companies were rejected as comparables due to functional dissimilarities. The Tribunal directed the exclusion of these companies from the list of comparables.

Additionally, the assessee sought the inclusion of Akshay Software Technologies Ltd. and Evoke Technologies Pvt. Ltd. as comparables. The Tribunal noted that Akshay Software Technologies Ltd. had been accepted as a comparable in the assessee's own case for the preceding assessment year and in other similar cases. Similarly, Evoke Technologies Pvt. Ltd. was accepted by the TPO but was omitted from the final list due to an oversight. The Tribunal directed the inclusion of both companies in the final list of comparables.

4. Disallowance under Section 40(a)(ia) Related to Software Expenses:

The AO disallowed Rs. 6,88,872 under Section 40(a)(ia) for non-deduction of tax at source on software purchases, treating the payment as 'royalty'. The assessee argued that Section 40(a)(ia) does not apply to depreciation allowance, which is a statutory deduction under Section 32 and not an expenditure outgo. The Tribunal cited several decisions, including Crane Software International Ltd. v. ACIT and Kawasaki Microelectronics Inc. v. DDIT, which held that Section 40(a)(ia) cannot be invoked for disallowance of depreciation on capitalized payments. The Tribunal allowed the assessee's cross-objection, confirming that the disallowance under Section 40(a)(ia) was not applicable.

Conclusion:

The Tribunal dismissed the Department's appeal and allowed the assessee's cross-objections, directing the AO to rework the depreciation adjustment and include Akshay Software Technologies Ltd. and Evoke Technologies Pvt. Ltd. in the list of comparables. The disallowance under Section 40(a)(ia) was also overturned, affirming that it does not apply to depreciation allowances. The judgment was pronounced on 30th September 2016.

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