2025 (5) TMI 1572 - AT - Income Tax

Disallowance u/s 14A computed as per Rule 8D - HELD THAT - We note that the issue raised by the Assessee is no longer res integra; and in this regard it is noted that the disallowance u/s. 14A of the Act should be restricted only on the investments which give rise to exempt income i.e. dividend income is covered by Hon ble Madras High Court judgements and this Tribunal is also consistently taking view that disallowance u/s. 14A of the Act should be restricted only on exempt income earned. Thus we are of the view that the action of the ld.CIT(A) cannot be countenanced and hence we direct the AO to restrict the disallowance u/s. 14A of the Act to the exempt income earned for A.Y.2010-11 Enhancement of the exemption u/s. 10A 10AA - Assessee submitted that the AO provided the relief u/s 10A /10AA on the enhanced profits arising due to disallowance u/s 14A of the Act - Given that the disallowance u/s. 14A of the Act is restricted to exempt income earned for AY 2010-11 we direct the AO to recompute the consequential relief u/s.10A/ 10AA of the Act on the enhanced profits arising due to disallowance under Section 14A of the Act. Accordingly the Grounds of appeal are partly allowed for AY 2010-11. TDS u/s 195 - Disallowance u/s 40(a)(ia) - payment towards Software Annual Maintenance Charges ( Software AMC ) and payments towards license to use software ( Software License ) without deducting TDS - HELD THAT - Software AMC payments made in relation to vendors from countries which does not have any make available clause in the DTAA shall be taxable as per Sec. 9(1)(vii) of the Act and also the DTAA. Therefore the disallowance made by the AO in relation to vendors from Germany and Austria are upheld by dismissing the grounds raised by the assessee. Assessee submitted that the said disallowance results in enhanced business income eligible for deduction u/s 10A/10AA - We direct the AO to compute the relief u/s 10A/10AA of the Act on the enhanced profits arising due to disallowance of payments towards Software AMC. Payments towards Software License - We find that this issue is squarely covered by the decision of this Tribunal in assessee s own case for A.Y.2009-10 also upheld in case of Engineering Analysis Centre of Excellence (P.) Ltd. 2021 (3) TMI 138 - SUPREME COURT in favour of assessee. Disallowance of set-off of losses incurred by units eligible for deduction under section 10A and 10AA against other taxable income - Since this issue is squarely covered by the decision of Hon ble Madras High Court in assessee s own case 2021 (1) TMI 168 - MADRAS HIGH COURT in allowing losses incurred by the units u/s. 10AA of the Act the profits and set-off of losses against other taxable profits of the business made by the assessee we respectfully following the decision of Hon ble Madras High Court and the decision of Yokogawa India Ltd. 2016 (12) TMI 881 - SUPREME COURT direct the AO to allow the losses incurred by the units u/s.10AA of the Act to set off with the profits taxable profits of the business made by the assessee by upholding the order of the ld.CIT(A) in this matter. Treatment of computer software as Intangible asset and restriction of depreciation thereon to 25 percent - HELD THAT - As decided in own case 2023 (12) TMI 1442 - ITAT CHENNAI delete the disallowance made to the depreciation of computer software and grant depreciation at the rate of 60 percent on the computer software. Unrealized gains on mutual fund units remaining unsold at the end of the year added as income of current year - AO has treated the un-realized gain on mutual fund units remaining unsold in the hands of the assessee recognized in the financial statements as having accrued to the assessee during assessment year under consideration on the presumption that the units have been sold by the assessee during the financial year - HELD THAT - AO has added unrealized gains on mutual fund units remaining unsold at the end of the year as income of current year but on perusal of the CIT(A) order these units were unsold during the year end and the capital gain on sale of these mutual funds were offered to tax as income from Capital Gains in the year in which they were sold. The revenue did not bring anything on record to controvert this fact relevant for A.Y.2011-12 A.Y.2012-13. Hence CIT(A) has rightly deleted the addition and held that un-realized gain on mutual fund units remaining unsold in the hands of the assessee cannot be added back as income of the current year and the capital gain on sale of mutual funds were offered to tax as income from Capital Gains in the year in which they were sold. Disallowance u/s 14A r/w rule 8D in computing book profits under section 115JB - HELD THAT - CIT(A) has rightly deleted the disallowance made by the AO invoking the provisions of Section 14A r.w.r. 8D while computing the book profits u/s. 115JB.

Summary

The primary legal issues considered in this judgment pertain to the disallowance of expenditure under section 14A of the Income-tax Act, 1961 (the Act) read with Rule 8D of the Income-tax Rules, 1962 (the Rules); disallowance under section 40(a)(i) of the Act relating to payments for software annual maintenance charges (AMC) and software licenses; set-off of losses incurred by units eligible for deduction under sections 10A/10AA against other taxable income; treatment of computer software as intangible assets and the applicable depreciation rate; taxation of unrealized gains on mutual fund units; addition of disallowance under section 14A in computing book profits under section 115JB; and consequential penalty proceedings under sections 271(1)(c) and 274 of the Act.

Issue 1: Disallowance under Section 14A read with Rule 8D

The core legal question was whether disallowance under section 14A of the Act, which pertains to expenditure incurred in relation to exempt income, can be computed as per Rule 8D in the absence of exempt income or when the exempt income is less than the disallowance computed.

Legal Framework and Precedents: Section 14A disallows deduction of expenditure incurred to earn exempt income. Rule 8D provides a method for computing such disallowance. The Tribunal noted judicial precedents, including the decision of the Madras High Court in Envestor Ventures Ltd., which clarified that disallowance under section 14A cannot exceed the exempt income earned during the assessment year. The Supreme Court's decision in Maxopp Investment Ltd. was also referenced to emphasize that the Assessing Officer (AO) must record satisfaction before invoking Rule 8D for disallowance.

Court's Interpretation and Reasoning: For AY 2010-11, the assessee earned exempt income from mutual funds, and the AO applied Rule 8D to compute disallowance. The Tribunal held that the disallowance must be restricted to the amount of exempt income actually earned and that the AO must record satisfaction regarding the apportionment of expenditure before applying Rule 8D. For AYs 2011-12 to 2014-15, where no exempt income was earned, the Tribunal held that no disallowance under section 14A is warranted.

Application of Law to Facts: The AO's disallowance beyond the exempt income was disapproved. The Tribunal directed the AO to recompute disallowance for AY 2010-11 restricting it to exempt income and to recompute consequential relief under sections 10A/10AA for enhanced profits. For subsequent years without exempt income, disallowance was disallowed.

Conclusion: The Tribunal held that disallowance under section 14A read with Rule 8D cannot exceed exempt income earned and cannot be invoked without AO's recorded satisfaction. This principle was applied across assessment years, partly allowing the assessee's appeal.

Issue 2: Disallowance under Section 40(a)(i) on Payments for Software AMC and Software License

The legal questions involved whether payments made to non-resident vendors for software AMC and software licenses attract tax deduction at source (TDS) under section 195 and whether such payments are taxable as fees for technical services (FTS) or royalty under the Act and relevant Double Taxation Avoidance Agreements (DTAAs).

Legal Framework and Precedents: Section 40(a)(i) disallows expenditure where TDS is not deducted as required. Section 9(1)(vii) defines FTS. The Tribunal relied on various judicial decisions, including the Supreme Court's ruling in Engineering Analysis Centre of Excellence (P.) Ltd. vs. CIT, which held that payments for the use of copyrighted articles (such as software licenses) do not constitute royalty under DTAA and thus are not taxable as such. The Tribunal also referred to its own earlier decisions in the assessee's case and other authorities holding that routine software maintenance and support services do not constitute technical services taxable in India.

Court's Interpretation and Reasoning: For software AMC payments made to vendors resident in countries with a 'make available' clause in the DTAA (e.g., USA, Singapore, UK), the Tribunal held these payments do not make available technical knowledge or skill and hence are not taxable as FTS, negating the obligation to deduct TDS. For payments to vendors in countries without such a clause (e.g., Germany, Austria), the Tribunal upheld the disallowance, as these payments are taxable under section 9(1)(vii) and the DTAA.

Regarding software license payments, the Tribunal held that such payments constitute acquisition of a copyrighted article and not royalty under the DTAA, referencing the Supreme Court decision in Engineering Analysis Centre of Excellence (P.) Ltd. The Tribunal directed deletion of disallowance for these payments for AYs 2010-11 to 2012-13.

Application of Law to Facts: The Tribunal examined the country of residence of vendors, the nature of services, and applicable DTAA provisions. It accepted the assessee's submissions and prior favorable decisions, rejecting the Revenue's contentions where applicable.

Conclusion: The Tribunal partly allowed the assessee's appeal by deleting disallowance on software AMC payments made to vendors in countries with 'make available' clauses and on software license payments, while upholding disallowance for payments to vendors in countries without such clauses.

Issue 3: Set-off of Losses Incurred by Units Eligible for Deduction under Sections 10A/10AA

The legal question was whether losses incurred by units eligible for tax holiday under sections 10A/10AA can be set off against profits of other units not eligible for such deduction.

Legal Framework and Precedents: The Tribunal relied on the Supreme Court's decision in CIT vs. Yokogawa India Ltd. and the Madras High Court's rulings, which clarified that deductions under section 10A are to be made at the gross total income stage of the eligible undertaking and that set-off of losses is permissible against other taxable income.

Court's Interpretation and Reasoning: The Tribunal agreed with the CIT(A)'s order allowing set-off of losses incurred by eligible units against taxable profits of other units. It noted that the stage of deduction under section 10A is prior to the computation of total income under Chapter VI, supporting the allowance of set-off.

Application of Law to Facts: The Tribunal examined the assessee's business structure and applied the judicial principles to hold that the losses of eligible units are to be allowed against other profits.

Conclusion: The Tribunal dismissed the Revenue's appeals on this issue and upheld the CIT(A)'s order allowing set-off of losses for AYs 2010-11 to 2014-15.

Issue 4: Treatment of Computer Software as Intangible Asset and Depreciation Rate

The question was whether computer software licenses should be treated as intangible assets attracting depreciation at 25% or as computer software eligible for depreciation at 60% under the Income-tax Rules.

Legal Framework and Precedents: The Tribunal relied on the Madras High Court decision in CIT vs. Computer Age Management Services, which held that computer software licenses are to be treated as computer software (not general intangible assets) and are eligible for depreciation at 60% under Entry 5 of Part A of New Appendix I of the Rules.

Court's Interpretation and Reasoning: The Tribunal upheld the CIT(A)'s order allowing depreciation at 60%, noting that this issue was decided favorably in the assessee's own case for AY 2015-16.

Application of Law to Facts: The Tribunal examined the nature of software licenses used by the assessee and applied the judicial precedent to allow depreciation at the higher rate.

Conclusion: The Tribunal dismissed the Revenue's appeals on this issue for AYs 2011-12 to 2014-15.

Issue 5: Addition of Unrealized Gains on Mutual Fund Units

The legal question was whether unrealized gains on mutual fund units remaining unsold at the end of the year can be added to income for the assessment year.

Court's Interpretation and Reasoning: The Tribunal upheld the CIT(A)'s order deleting such additions, noting that capital gains are taxable only upon transfer of the units. Unrealized gains recognized on a mercantile basis in the books cannot be taxed until actual sale.

Application of Law to Facts: The Tribunal found that the AO erred in treating unrealized gains as accrued income and that the assessee had correctly offered capital gains for taxation in the year of sale.

Conclusion: The Tribunal dismissed the Revenue's appeals for AYs 2011-12 and 2012-13 on this issue.

Issue 6: Addition of Disallowance under Section 14A in Computing Book Profits under Section 115JB

The legal question was whether disallowance under section 14A read with Rule 8D can be added back in computing book profits under section 115JB.

Legal Framework and Precedents: The Tribunal referred to the Special Bench decision in ACIT vs. Vireet Investments (P.) Ltd. and other High Court decisions holding that disallowance under section 14A cannot be added back while computing book profits under section 115JB.

Court's Interpretation and Reasoning: The Tribunal agreed with the CIT(A)'s order deleting such addition, noting no contrary decision was brought on record by the Revenue.

Application of Law to Facts: The Tribunal applied the above precedents to the facts of the case.

Conclusion: The Tribunal dismissed the Revenue's appeals on this issue for AYs 2010-11 to 2014-15.

Issue 7: Consequential Penalty Proceedings under Sections 271(1)(c) and 274

The legal question was the validity of penalty proceedings initiated by the AO without appreciating the contentions raised by the assessee in the appeals.

Court's Interpretation and Reasoning: The CIT(A) held that no order under section 271(1)(c) had been passed by the AO, rendering the grievance premature. The Tribunal found no infirmity in this view and dismissed the assessee's grounds.

Conclusion: The Tribunal dismissed the appeals relating to penalty proceedings but kept the issue open for challenge upon passing of any order under section 271(1)(c).

Significant Holdings:

"The disallowance under rule 8D of the IT Rules read with Section 14A of the Act can never exceed the exempted income earned by the Assessee during the particular assessment year and further, without recording the satisfaction by the Assessing Authority that the apportionment of such disallowable expenditure made by the Assessee with respect to the exempted income is not acceptable for reasons to be assigned the Assessing Authority, he cannot resort to the computation method under Rule 8D of the Income-tax Rules, 1962."

"Payments made for software license constitute acquisition of a copyrighted article and do not amount to 'royalty' under the relevant DTAA, and hence, are not taxable as royalty or fees for technical services."

"Routine repair/maintenance services and remote IT support services do not constitute 'technical services' taxable under section 9(1)(vii) and thus, payments for software AMC to non-resident vendors from countries with 'make available' clause are not subject to withholding tax."

"Losses incurred by units eligible for deduction under sections 10A/10AA can be set off against profits of other units not eligible for such deduction, as the stage of deduction under these sections is at the gross total income of the eligible undertaking."

"Computer software licenses are to be treated as computer software eligible for depreciation at 60% under the Income-tax Rules, not as general intangible assets attracting 25% depreciation."

"Unrealized gains on mutual fund units remaining unsold at the end of the year cannot be added as income for the current year; capital gains are taxable only upon actual transfer."

"Disallowance under section 14A read with Rule 8D cannot be added back in computing book profits under section 115JB of the Act."

"Penalty proceedings under section 271(1)(c) cannot be initiated without proper appreciation of contentions and without passing an order; premature grievances in this regard are not maintainable."

The Tribunal accordingly partly allowed the assessee's appeals on issues of section 14A disallowance, software AMC and license payments, set-off of losses, depreciation on software, and unrealized gains, while dismissing the Revenue's appeals on these points and penalty proceedings. The Revenue's appeals on set-off of losses and depreciation were dismissed, affirming the CIT(A)'s orders. The Tribunal directed recomputation of relief under sections 10A/10AA where applicable due to adjustments in disallowance.