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M/s. Subex Limited Versus The Deputy Commissioner of Income Tax Circle 6 (1) (2) Bangalore and Vica-Versa

Determination of arm’s length interest rate - Held that:- This issue is similar to the issue raised in earlier year, wherein the DRP has directed the AO to adopt the interest rates of the loanee country and to search in the ‘Loan connector’ data base which was not done by the AO/TPO. Thus we direct the TPO to follow accordingly in this year also and examine the ALP on similar lines. - Deduction claimed u/s. 35D - Held that:- We direct the AO to examine the above and allow relief as in earlie .....

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tatement of FCCBs. When the DRP directed the AO to treat the foreign exchange fluctuation as an operational cost revenue/cost vide para 8.3, we are unable to understand how the AO can take a decision now treating it as a speculative loss, contrary to the direction of the DRP - Un-realized foreign exchange gain on FCCBs - whether treated as ‘income’ or not? - Held that:- We direct the AO to treat the above amount as on capital account, to be adjusted in capital accounts. However, if any benef .....

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has to be reexamined. This issue can be considered by the TPO afresh and if necessary, necessary proceedings can be initiated under the TP provisions as a direction by the Bench. With these directions, these grounds are allowed. - Realised foreign exchange fluctuation pertaining to assets as ‘business income’ - Held that:- AO is directed to allow the claim from the computation of income to adjust the same from the cost of assets in accordance with the provisions of Section 43A. These ground .....

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llowance of depreciation u/s. 40(a)(ia) on an asset which was capitalised in the Books of Account and depreciation was claimed. The action of the AO cannot be upheld. Accordingly, he is directed to allow depreciation as claimed by assessee in its computation. The alternate contention of excess disallowance becomes academic. The disallowance so made by the AO is deleted. - Adjustments made to the export turnover for the purpose of computing deduction u/s. 10AA - Held that:- We direct the TPO .....

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s disallowances, AO was informed about the details of FTC but AO did not consider the same. It was the submission that AO should examine the FTC entitlement in case, there is any taxable income while giving effect to the order of the ITAT. After considering the rival contentions, we agree with assessee’s contentions. In case, assessee’s claim of total income being NIL was not accepted by the AO and any disallowances or adjustments are made, then, assessee’s claim for FTC also should be examined, .....

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attracts TDS. Since the direction of the DRP is not in accordance with the provisions of the Act, we have no hesitation in reversing the said decision. The AO’s action is upheld. However, AO is directed to examine whether the amounts so disallowed are pertaining to the unit in which assessee has claimed 10AA deduction and if so, the disallowance would increase the profits of such unit. Accordingly, deduction u/s. 10AA may have to be increased. This aspect requires examination by the AO. Subject .....

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port turnover has to be reduced from the total turnover and this principle was accepted by the jurisdictional Karnataka High Court in the case of CIT Vs. Tata Elxsi Ltd.[2014 (9)1013 - KARNATAKA HIGH COURT], which the DRP has followed. We do not see any reason to interfere with the above principle, however, we have already directed in assessee’s appeal to exclude certain expenditure which was disallowed by the AO from the export turnover. Consequently, there will be adjustments to be made to the .....

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ion Panel [DRP]. 2. Briefly stated assessee is a public limited company primarily engaged in software development services with its primary focus and telecommunication industry. For the AY. 2010-11, assessee filed a revised return of income on 29-03-2012 declaring NIL income after claiming deduction of ₹ 29.5 Crores u/s. 10AA of the Act. As assessee has international transactions with its Associated Enterprise (AE), the AO referred the matter to Transfer Pricing Officer (TPO) and the TPO d .....

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TP adjustments. AO in addition has also raised various issues pertaining to Section 35D, foreign exchange fluctuations, depreciation on computer software and working out deduction u/s. 10AA as against assessee s claims. Another issue on non-granting of foreign tax credit is also involved. Aggrieved on the DRP s orders, assessee is in appeal and raised as many as 32 grounds. Likewise, Revenue is also aggrieved on the DRP s directions allowing some of the contentions of assessee and accordingly, R .....

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es. It was submitted that interest so received was at Arm s Length Price (ALP), however, TPO adopted the rate of 14.74% in respect of loans advanced by assessee to its AE. Assessee contended before the DRP that the determination of bench mark rate of interest is without any basis. The DRP did not follow the order passed in earlier year wherein the DRP directed that interest rates of that country should be adopted and effective interest rate should be verified from the Loan connector data base. 6 .....

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d in earlier year, wherein the DRP has directed the AO to adopt the interest rates of the loanee country and to search in the Loan connector data base which was not done by the AO/TPO. The issue is dealt with as under in AY. 2009-10: 13. The third issue for consideration in the TP issues is with reference to determination of ALP of interest received. During the impugned year, assessee had received interest on loans to an extent of ₹ 4,94,11,033. It was submitted to the TPO that the loan wa .....

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assessee s objections, the DRP while accepting the credit rating at BB, directed the TPO to adopt average credit risk spread from the Loan Connector database. The TPO, as stated earlier, did not do such exercise and adopted the same rate of interest and made addition. 13.2. It was submitted by the ld. counsel that assessee s rate of interest is on par with LIBOR rates which is generally being accepted by the ITAT in a number of cases. Further, it was submitted that Thomson Reuters s Loan Connect .....

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LIBOR rate is an average of 2.854%. Accordingly, assessee s interest received being at 6% should be considered at arm s length. 13.4 We have considered the contentions and perused the orders of authorities. As noted above, the AO did not implement the DRP direction, therefore to that extent, assessee s grievance is valid. It was submitted that if the DRP directions are implemented, the effective interest rate on the Loan Connector database would come to 3.53% and on the basis of decision of the .....

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ould be examined and if they are found to be less than 6%, we direct that no adjustment need be made on the interest received by the assessee. With this, grounds No.1.5 and 7 is considered as allowed for statistical purposes . Respectfully following the same, we direct the TPO to follow accordingly in this year also and examine the ALP on similar lines. With this, Ground Nos. 9 to 11 are considered allowed for statistical purposes. Corporate Tax Issues: 8. Ground Nos. 12 and 13 pertain to deduct .....

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of such expenditure as deduction u/s. 35D. Subsequently, assessee received a refund of ₹ 3,83,74,819 with respect to the aforesaid expenses and accordingly assessee reduced the claim u/s. 35D from AY 2008-09 onwards. As in earlier years, the AO restricted the claim to an amount of ₹ 11,72,873 and disallowed the balance claim of ₹ 11,24,86,458 mainly on interpreting the term capital employed in the business of the company . 15.1 It was submitted that this issue had been examine .....

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regard as under:- Sl. No. Particulars Amount (in INR) 1. GDR Face Value (as already allowed by AO) 117,287,280 2. FCCBs (As per Tribunal s order at para 35 and 36) 7,807,500,000 3. Capital Employed 7,924,787,280 4. 5% of capital employed 396,239,365 5. 1/5th of 5% of capital employed (claim allowable consequent to Tribunal s order) 79,247,872* * As against the claim of INR 1,172,873 computed by the ld. AO. We direct the AO to examine the above and allow relief as in earlier years, since claim is .....

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so, he also did not allow the foreign exchange gain on restatement of FCCB as well as exchange gain adjusted with cost of assets while computing the income. Assessee is contesting the issues under these grounds. 10. The brake-up of exchange fluctuation loss ultimately disallowed by the AO and debited to P&L A/c as under: Sr. No. Description Gain / (Loss) in Rs. 1. Mark-to-market ( MTM ) gain on outstanding option contracts 9,28,75,309 2. Gain on restatement of forward contracts 12,76,10,419 .....

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loss as speculative in nature without examining the nature of the contract/item on which gain or loss has come. It was submitted that assessee has consistently offered the incomes or losses of the business incomes and these were taxed in earlier years. The arguments are similar to the arguments raised in earlier year wherein these were examined and concluded as under: MTM Losses (ground No.8) 16. Since the assessee is engaged in the business of software development and related services, its ear .....

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f assessee to sell the designated amount of foreign currency to the contracting bank at a date and rate specified in the agreement. Since the period of contract is spread over some times into the next accounting year, following the Accounting Standards AS-11, mark-to-market (MTM) losses or gains are determined and accounted for under the head foreign exchange gains/losses . 16.1 It was submitted that during the financial year relevant to AY 2009-10, assessee has entered into hedging contracts wi .....

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g with regard to MTM gains/losses on option contracts. For the years where there is MTM gain, assessee had dully offered the gain to tax and in years where there has been MTM losses, assessee claimed the same as deduction. The details submitted by the assessee are as under:- Sl. No. A.Y. MTM Gain/(Loss) on option Appellant s treatment of MTM gain/MTM loss on option contracts Department s treatment of MTM gain/MTM loss on option contracts 1. 2008-09 (5,500,000) Claimed as a deduction No adjustmen .....

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onsistency. Reliance was placed on the judgment of Hon ble Supreme Court in the case of CIT v. Woodward Governor (P) Ltd., 179 Taxman 326 (SC). It was further submitted that the AO passed his order on CBDT Instruction No.3/2010 which is not applicable to the assessee s facts of the case. It was submitted that the CBDT instructions are internal to the Officers and are not binding on the assessee. For this proposition, the ld. counsel relied on the decision of the Hon ble Supreme Court in the case .....

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s and the balance amount was on the basis of last year s turnover. Therefore, assessee has entered into hedging transactions only to the extent of foreign exchange received in the earlier year and even though there cannot be any one to one match to the sale invoices, but anticipated recoverables over a period of time, assessee hedged foreign exchange risk by entering into above contracts. It was submitted that judicial precedents as laid down by the Hon ble Supreme Court in the case of CIT v. Wo .....

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he rival contentions. As stated by the Auditors, assessee has entered into option contracts/forward contracts for the purpose of hedging the risk associated with foreign exchange exposure only to the extent of receipts in the earlier years, which is less by ₹ 60 crores of total foreign currency received during the year. This indicates that assessee has entered into contracts on the anticipated receivables in order to protect the variations in fluctuation market. The Hon ble Supreme Court i .....

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of the loans became repayable in the year under consideration, but date of payment of some loans fell after the end of the relevant accounting year. The Assessing Officer disallowed the assessee s claim on both the counts on the ground that such a loss could be allowed to the assessee on discharge of liability at the time of actual repayment of those loans. On appeal, the CIT(A) affirmed the view taken by the AO on the ground that it was a notional liability and the same had not crystallized or .....

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otton, and therefore losses represented a business loss to the assessee. Following the principles laid down by the Hon ble Supreme Court in the case of ONGC (supra) and by the Hon ble Bombay High court in the case of Badridas Gauridu (P.) Ltd. (supra), we hold that the claim of assessee on foreign exchange loss is not contingent in nature and also not speculative in nature. AO is directed to allow losses as business losses. If any deduction u/s. 10A / 10AA was computed by disallowing any part of .....

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directed the AO to treat the foreign exchange fluctuation as an operational cost revenue/cost vide para 8.3, we are unable to understand how the AO can take a decision now treating it as a speculative loss, contrary to the direction of the DRP. In view of this, Ground Nos. 14 & 15 is allowed. 10.1. Coming to the issue in Ground Nos. 16 & 17, the facts are that assessee has issued FCCBs amounting to ₹ 780.75 Crores for the purpose of acquisition of Subex America INC, a overseas sub .....

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lowed the said income to be operational income while considering the TP adjustments. Assessee has not questioned the above order of the DRP in TP matter. However, as far as the issue whether un-realized foreign exchange gain on FCCBs should be treated as income or not has been concluded in favour of assessee by the orders of Co-ordinate Bench in ITA No. 689/Bang/2014 dt. 19-06-2015, wherein it was held as under: 37. The last issue that arises for consideration is as to whether unrealised foreign .....

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herefore been consistent and not inconsistent as has been observed by the CIT in the impugned order u/s.263 of the Act. The learned counsel for the Assessee has before us placed reliance on the decision of the Hon ble Supreme Court in the case of Woodward Governors 312 ITR 254 and the decision of the decision of the Hon ble Madras High Court in the case of CIT Vs. PVP Ventures Ltd. (2012) 23 Taxmann.com 286 (Mad.). 39. The factual position that the exchange fluctuation is owing to restatement of .....

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we are concerned with exchange differences arising in foreign currency transaction on revenue items. In such category, we are concerned with the assessee(s) incurring loss on revenue account. In that category, we are concerned with the provisions of ss. 28, 29, 37(1) and 145 of the IT Act, 1961 ("1961 Act"). In the second category of cases, we are concerned with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets. In other words, .....

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issue which arises for determination in this batch of civil appeals is : whether the assessee was entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance sheet date pending actual payment of the varied liability. In this batch of civil appeals, we are concerned with increase in the existing liability on account of foreign exchange fluctuations on "capital account". 40. After considering the pr .....

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of exchange takes effect. Increase or decrease in liability for repayment of foreign loan should be taken into account to modify the figure of actual cost in the year in which the increase or decrease in liability arises on account of fluctuation in the rate of exchange, irrespective of the date of actual payment in foreign currency. 41. In the case of PVP Ventures Ltd. (supra), the facts were that the Assessee gained from exchange fluctuation. The fluctuation was on foreign exchange received pu .....

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related to the deposit of money raised by the assessee from the GDS issue. Pointing out the printed prospectus to the issue of GDS, the Commissioner viewed that the aggregate net proceeds received were used principally to fund the establishment of offshore software development and the balance was used for working capital and for other general corporate purposes. The Commissioner viewed that the assessee had kept FDs of the GDS proceeds on its own and not because of any compulsion. Consequently, .....

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xable was correct. 42. In our view the facts of the case in the decision of the Madras High Court in the case of PVP Ventures Ltd. (supra), is identical to the facts of the case of the Assessee in this appeal. FCCBs are instruments issued to investors for raising funds which is repayable after certain period. It is a debt instrument. The increase or decrease in liability on account of fluctuation in foreign exchange as on the date of the Balance sheet would increase or decrease the liability of .....

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as to exclude the amount from the computation and if any adjustment is required. Assessee cannot take advantage of its own stand to the detriment of Revenue in TP provisions. There should be a constant approach. Treatment of this gain as operational income does not arise as the same was not treated as income, therefore any computation based on that has to be reexamined. This issue can be considered by the TPO afresh and if necessary, necessary proceedings can be initiated under the TP provisions .....

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easons has denied the reduction from the computation of income. 11. These issues are covered in favour of assessee by various principles established on the issue and also similar to the issue considered in Ground Nos. 16 and 17 above. AO is directed to allow the claim from the computation of income to adjust the same from the cost of assets in accordance with the provisions of Section 43A. These grounds are also treated as allowed. In the result, Ground Nos. 14 to 19 are allowed. 12. Ground Nos. .....

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to be disallowed u/s. 40(a)(ia) on account of non-deduction of tax at source on the said software purchases. DRP however, approved the stand of the AO. 13. While submitting that purchases of software purchases which are capitalised does not come within the purview of Section 40(a)(ia), it was further submitted that assessee has not deducted tax only on software purchases amounting to ₹ 35,86,893/-. The details of which were provided on record. It was submitted that disallowance claimed u/s .....

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. V. ACIT [(2013) 29 taxmann.com 111 (Mumbai Tribunal)], etc. 13.1. Another contention raised is that the AO wrongly calculated the depreciation @ 60% considering the assets to be used for more than 180 days. It was submitted that an amount of ₹ 1,23,240/- was pertaining to purchases of less than 180 days on which, thee was excess disallowance of ₹ 36,972/-. 14. We have considered the rival contentions and examined the provisions of Section 40(a)(ia). As per the provisions of Section .....

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te Bench in the case of Sonata Information Technology Ltd., Vs. DCIT [25 Taxmann.com 125 (Mumbai)]. Not only that, if assessee claims depreciation on a particular item, the claim of depreciation is allowable u/s. 32. There is no adjustment to be made u/s. 43(6) towards the cost of assets which are capitalised, in case of failure to deduct tax. The provisions of Section 40(a)(ia), therefore cannot be extended to the disallowance of depreciation which is allowable u/s. 32. In case any default is t .....

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No. 23 to 26 pertain to issue of adjustments made to the export turnover for the purpose of computing deduction u/s. 10AA of the Act. The AO has reduced the following items from the export turnover for the purpose of computation of deduction u/s. 10AA of the Act. a. Communication costs incurred amounting to ₹ 1,46,71,497/-; b. Insurance expense incurred amounting to ₹ 1,16,30,388/-; c. Travelling expenses incurred in foreign currency amounting to ₹ 5,04,12,543/- and d. Product .....

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warranted to the export turnover ; c. No expenditure was incurred in foreign currency for rendering any technical services outside India and hence no reduction of foreign currency expenditure was warranted from the export turnover ; and d. The export invoices of the Appellant do not include any expense towards communication costs, insurance or expenses incurred in foreign currency and hence, the said expenses ought not to be reduced from the export turnover . 15.2. It was brought to the notice o .....

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: 18.4 We have considered the rival contentions and perused the arguments placed on record. As far as definition of export turnover as provided in Explanation 1 to section 10AA is concerned, the same is slightly different from Explanation 2 to section 10A which was already considered in various cases earlier. In fact, decision of Patni Telecom (P.) Ltd. (supra) and Willis Processing Services (supra) are given in the context of section 10A. Explanation 1 to section 10AA is as under:- Explanation .....

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……………. 18.5 Even though the major part of the definition is similar to Explanation 2 to section 10A, the difference is with reference to usage of words expenses, if any, incurred in foreign exchange in providing technical services outside India . This sentence is not exactly provided in Explanation 1 to section 10AA. Therefore, there is a variation in the sense that section provides expenses, if any, incurred in foreign exchange in rendering of services (includ .....

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nication charges or insurance attributable which has wider meaning than incurred in rendering services. The word attributable was analysed in assessee s own case in ITA Nos.673, 674, 676 and 677/Bang/2010 for the AYs 2002-03 and 2005-06 as under:- 11. Having heard both the parties and having considered the rival contentions, we find that clause (iv) of Explanation 2 to section 10A has defined export turnover and has clearly been provided that export turnover does not include freight, telecommuni .....

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development and export of computer software, all the expenditure incurred by it is attributable to the delivery of articles or things or computer software outside India. If the Legislature has intended that the said charges should be directly incurred for the purpose of delivery of articles or things or computer software outside India, then the Legislature would not have used the word attributable but would have used the word incurred for the delivery of articles or things as has been done in t .....

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elivery of articles or things outside India are to be excluded from the export turnover. However, the AO has excluded traveling, product marketing expenses and marketing & allied services, without giving any finding whether these expenses can be categorized under freight, telecommunication or insurance. As seen from the nature of expenditure, they are not attributable to the above three items. 18.7 That leaves us with the second part of the expenses, i.e., expenses, if any, incurred in forei .....

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may be relatable to assessee s business, but what the provision specifies is to exclude expenses, if any, incurred in foreign exchange in rendering of services. Even though services need not be technical services, but there should be a direct nexus with reference to rendering of services outside India. There is no such finding by the AO while disallowing these expenditure from the export turn over. As already stated, the three heads under which expenditure was incurred are not attributable to d .....

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ort turnover. In view of this, we are of the opinion that the expenditures of the above nature disallowed by the AO cannot be excluded as per definition of export turnover provided in Explanation 1 to section 10AA of the Act. 18.8 Even though the DRP has considered the alternate contention that this expenditure has to be reduced from total turnover and in the consequential order passed AO these were excluded from export turnover and total turnover, the assessee had in fact became eligible for 10 .....

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ered as allowed . Respectfully following the above, we direct the TPO to exclude the amounts which are considered for disallowance, other than those expenses pertaining to freight, telecommunication charges or insurance attributable to the delivery of articles or things outside India or directly relatable to service outside India. Grounds are considered allowed accordingly. 17. Ground No. 27 pertains to the issue of non-grant of Foreign Tax Credit to the extent of ₹ 1,18,35,826/-. It was c .....

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case, there is any taxable income while giving effect to the order of the ITAT. After considering the rival contentions, we agree with assessee s contentions. In case, assessee s claim of total income being NIL was not accepted by the AO and any disallowances or adjustments are made, then, assessee s claim for FTC also should be examined, before raising any tax demand on assessee. 17.1. With these directions, the ground is considered allowed for statistical purposes. In the result, assessee s a .....

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mounts, he disallowed the amount invoking the provisions of Section 40(a)(ia). Before the DRP, it was contended that year end professional charges have not been credited to any particular account and therefore, TDS need not be made. Further, it was submitted that without prejudice to the generality of the above, the same amount if disallowed would be eligible for deduction of Section 10AA of the Act. The DRP however, accepted assessee s contentions and directed the AO not to make the disallowanc .....

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ount is to be deemed to be credit to the account also presupposes that identity of the payee can be ascertained. Therefore, this deeming fiction can only be activated when the identity of the payee can be ascertained. Therefore, this deeming fiction can only be activated when the identity of the payee can be ascertained. Therefore, TDS provisions cannot be invoked in a case where the person who is to receive the professional charges cannot be identified at the stage at which the provisions for p .....

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at source in respect of provision for professional fees accrued but not due. 9.2 In view of the above the objection relating to disallowance of professional charge u/s. 40(a)(ia) on account of non deduction of TDS is hereby accepted . 18.2. After considering the rival submissions, the order of the DRP cannot be accepted. First of all, DRP should have seen whether the amounts are credited to individual accounts or general provision was made. Not only that explanation © to the section 194J s .....

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is aspect requires examination by the AO. Subject to that, Revenue s ground is treated as allowed. 19. The next issue for consideration in Ground No. 3 is regarding the disallowance of depreciation on servers amounting to ₹ 25,91,516/- by treating them as Plant & Machinery and not computer software. The AO treated the servers as not part of the computers but treated it as Plant & Machinery. Depreciation therefore accordingly modified and restricted. On the submissions of assessee, .....

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d data processing device which performs logical, arithmetic and memory functions on data and includes only those input and output devices without which the computer cannot function. Devices such as servers are devices without which the computer cannot function and such devices are integral part of computers. Moreover the servers are part of computer equipment and cannot work in isolation and accordingly fall under the purview of the term Computer & Software and are eligible for depreciation .....

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