TMI Blog2019 (10) TMI 1243X X X X Extracts X X X X X X X X Extracts X X X X ..... emerges that the assessee has succeeded from the very issue of inclusion of loss making entities in preceding as well as succeeding assessment years. We find that this Revenue has failed to justify exclusion of the loss making entities in question in the light of the functions, assets and risk FAR analysis and therefore, the mere fact of assessee's PLI determined at a lesser rate after inclusion of the loss making entities forms no reason to exclude the same from the array of comparables. We therefore affirm the CIT(A)'s action deleting the impugned arm's length price adjustment in respect of assessee's management fee in issue. Software purchases Expenses - revenue or capital expenditure - HELD THAT:- CIT(A) has examined the assessee's application software purchase expenditure claim is the light of the tribunal's Special Bench's [ 2008 (2) TMI 454 - ITAT DELHI-C] that as no enduring benefit has accrued from the same. He further recorded the finding of fact that the assessee's impugned revenue expenditure of ₹ 1,41,36,670/- mainly relates to day to day functions in the field of application software for office as well as technology tools ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al for assessment year 2008-09 arise against the Commissioner of Income Tax (A) - VI, Kolkata dated 24.10.2014 passed in Case No. TP-07/CIT(A)-VI/R-2/2012-13/Kol involving proceedings u/s. 143(3) of the Income Tax Act, 1961; in short 'the Act'. Heard both the parties. Case file perused. 2. We come to the Revenue's appeal ITA No. 67/Kol/2015. Its first substantive ground pleads that the CIT(A) has erred in law and on facts in reversing the Transfer Pricing Officer's action making arm's length price adjustment in respect of assessee's payments of account management charges of ₹ 5,54,88,960/- made to overseas associated enterprises. It transpires at the outset that the very issue arises in A.Y. 2007-08 as well involving ITA No. 550/Kol/2014 dated 05.12.2018, which stood adjudicated in assessee's favour as under: 3. Coming to ground No. 1. At the outset itself the Ld. Sr. Counsel for the assessee submitted that the issue raised in ground No. 1 of the revenue is no longer res Integra. According to him, this issue has already cropped up in AYs 2005-06 and 2006-07 and the Tribunal in assessee's own case for these Assessmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , assessee is performing non-administrative functions under both the business models and thus entire risks with regard to non-administrative services are being borne by the assessee irrespective of the business model. Furthermore, it was also explained that customers enter into contract with either assessee or 12A/12B with the basic understanding that the activities/services in connection with development of the assignment/project would be essentially driven by assessee in adherence with various commercial and technical qualification parameters/norms specified by the customer namely share capital, average revenue over a period of time, brand value, reputation in the market, track record of successful project, vast and experienced resource pool with expertise in various areas of work, etc. Hence, the essential factor for awarding a service contract would always be technical and commercial expertise and experience of the assessee in handling such similar projects. The local presence of the AEs or it standalone financial or technical capabilities hardly influence the decision of the customer to sign the agreement with the AEs. The assessee stated that the possibility of a customer rai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es. Ld. counsel explained the concept of 'conduct of the parties' and risks associated with it. He referred to para 5.3.2.22 and 5.3.2.23 of the United Nations Practical Pricing Manual on Transfer Pricing for Developing Countries (Practice Manual') wherein, allocation of risk and conduct of parties is explained that- It is not only necessary to identify the risks but also to identify who bears such risks. The allocation of risks is usually based on the contractual terms between the parties. However, contacts between associated enterprises may not specify the allocation of all the risks. Even where a written contract is in place, an analysis of the conduct of the parties is critical in order to determine whether the actual allocation of risk conforms to the contractual risk allocation' 'When analysing the economic substance of a transaction, it is necessary to examine whether the conduct of the associated enterprises over time has been consistent with the purported allocation of risk and whether changes in the pattern of behavior have been matched by changes in the contractual arrangements (emphasis added) Fu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rises conforms to the contractual allocation of risks, - Whether the allocation of risks in the controlled transaction is arm's length, and What the consequences of the risk allocation are. Specific attention was drawn to the concept of 'risk allocation' and 'control', on which para 9.22 and 9.23 of the OECD Guidelines state that: In the absence of comparables evidencing the consistency with the arm's length principle of the risk allocation in a controlled transaction, the examination of which party has greater control over the risk can be a relevant factor to assist in the determination of whether a similar risk allocation would have been agreed between independent parties in comparable circumstances. In such situations, if risks are allocated to the party to the controlled transaction that has relatively less control over them, the tax administration may decide to challenge the arm's length nature of such risk allocation.... control should be understood as the capacity to make decisions to take on the risk (decision to put the capital at 5risk)) and decisions on whether and how to manage the risk, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee's technical capabilities and expertise while awarding a contract and even if the actual contract is executed by the AEs, the customer would presumably not tend to believe that the offshore IT/software development services under Global Delivery Model is being rendered by the AEs and not the assessee. Hence, the execution of the agreement directly by the assessee or by the AE would not create any substantial difference in the sharing of functions or risks between the parties or in turn, would not change the functional characteristic of the parties. 15. Now before us Ld. counsel explained possible claim by customer for provision of services by the assessee and 12A/12B that -Claim for any deficiency in administrative service- That the possibility of a customer raising any claim for any deficiency in administrative services seems to be very remote as the customer is not impacted by the services which are in the nature of travel arrangements and liaising between the customer and the respondent. It is the respondent who would be impacted for any deficiency in the services provided by the subsidiaries. The only area of any probable dispute and conseq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tomer is also fully aware of the financial standing of12A/12B vis- -vis. the ITC Infotech Group even while entering into service contract with 12A/12B in view of the fact that every service proposal specifically highlight the technical strength and the financial strength of the assessee which plays its pivotal role before the clients while entering into a contract with 12A/12B. Hence, the presumption of the TPO that the overseas customers' decision to enter into contracts directly with 12A or 12B are essentially governed by the standalone financial or technical strengths of these entities devoid of the backup of the assessee's financial/technical strengths, is inappropriate and without any basis. 16. Further, in relation to quantification of Risk adjustment, we are of the view that the exercise of risk adjustment is not a simple exercise. A lot of research has been carried out in this field of economics over the years, as a result of which various theories have evolved, that have been applied across businesses to quantify the inherent business risks. However, the subject of risk evaluation and quantification has continued to be an area of extensive study and rese ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of the proceedings for both the AYs 2005-06 2006-07, that the TPO totally erred in making transfer pricing adjustments in the case of assessee in both the AYs. In view of facts and circumstances, we are of the view that the TPO just on the basis of conjunctures and surmises made this transfer pricing adjustments. Hence, we dismiss this common issue of revenue's appeals in both the AYs. 4. We take note that the Tribunal's order (supra) confirming the Ld. CIT(A) 's action has been upheld at the level of the Hon'ble High Court wherein the Hon'ble High Court by order dated 08.01.2016 for both the assessment years in GA No. 2314 of 2015 and 2318 of 2015 was pleased to uphold the action of the Tribunal by holding as under: The submission of the appellant that the adjustment of TPO towards Account of Management charges is arbitrary has been dealt by the First as well as the Second Appellate Authority and a concurrent finding of fact has been recorded that the TPO in principle accepted the remuneration model of 25% revenue sharing and the same has been substantiated and justified by the documents so submitted before the authorities below. Fu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have also been excluded. Once this is done, mean PLI of the comparables would be within (+/-) 5% of the appellant and no adjustment would be called for. 4.3. I am not in agreement with the contention of the appellant that multiple year data should have been considered by the TPO. The statutory requirement under section 92CA is of using contemporaneous documents and data. The importance of contemporaneous economic and market conditions on price-setting mechanism is also reflected in provisions of Rule 10B (4) of I.T. Rules. Hon'ble tribunal has also held in the decisions in the cases of M/s. ST Microelectronics Private Ltd. vs. CIT(A)-XX, New Delhi 145 TTJ 553 (Del) and DCIT, Circle 1(2), Hyderabad vs. Deloitte Consulting India P. Ltd., Hyderabad 145 TTJ 549 (Hyd), that for purpose of section 92CA(3), the contemporaneous data relevant to the year under consideration, i.e. the current year data is to be used first and not multiple year data. 4.4. However, I find force in the appellant's objection against exclusion of loss making companies. As mentioned earlier, the single year comparables identified by the appellant were having both profit and loss makin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng entities in question in the light of the functions, assets and risk FAR analysis and therefore, the mere fact of assessee's PLI determined at a lesser rate after inclusion of the loss making entities forms no reason to exclude the same from the array of comparables. We therefore affirm the CIT(A)'s action deleting the impugned arm's length price adjustment of ₹ 22,20,039/- in respect of assessee's management fee in issue. 6. Lastly comes the Revenue's third substantive ground that the CIT(A) has erred in deleting software purchases disallowance of ₹ 1,41,36,670/- (₹ 1,63,71,912/- - ₹ 22,35,242/-) thereby treating the same as Revenue's expenditure in nature. The CIT(A)'s detailed discussion to this effect reads as under: 5. The second ground of appeal relates to disallowance of expenses of ₹ 1,63,71,912/- in respect of purchase of software. The appellant had claimed expenditure of ₹ 1,63,71,912/- towards purchase of software as revenue expenditure. Following his order for the A.Y. 2007-08, the assessing officer treated the same to be capital in nature. 5.1. The appellant has given follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aim of treating the same as revenue expenditure was disallowed. Further the AO did not grant the consequential depreciation arising out of the treatment of these expenses as capital expenditure. While disallowing the expenditure incurred on purchase of application softwares the Assessing Officer similar to the erstwhile AOs ignored the fact that Application softwares are used by the appellant for the efficient conduct of its business and do not extend any enduring benefit to the appellant company. A. Appellant's contention The appellant submits the following establishing that the disallowance made by the Assessing Officer was arbitrary and without appreciating the facts and the nature of business of the appellant: During the captioned Assessment Year the appellant has capitalized software of ₹ 3,63,49,672/-, which were systems software and thus enduring in nature. Consequently these expenditures incurred were treated as Capital expenditure and depreciation at the prescribed rate was charged on these softwares for the purpose of Income Tax. Expenditure incurred on the purchase of the application softwares used exclusiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be on revenue account. These criteria are required to be applied to determine exact nature of expenditure incurred by an assessee for acquiring different computer softwares. This decision of ITAT has also been upheld by the hon'ble Delhi high Court (2011-TIOL-710-HC-DEL-IT). The appellant company has duly adhered to the aforesaid tests/principles laid down by the Special Bench of the Tribunal and also accepted by Hon'ble Delhi High Court with regard to treatment of software expenses as either capital or revenue and accordingly claimed these expenditure as revenue for the purpose of income tax. We also rely on the decision of the Hon'ble Punjab Haryana High Court in CIT Vs. Varinder Agro Chemicals Limited [2009] 309 ITR 272 (P H) (Refer Exhibit B Pages from 125 to 127 of the Paper Book-II), the extract of which is given below: The Court held that there was nothing to show that the software used by the assessee was of enduring nature and would not become outdated. Since technology is fast changing and day-by-day systems are being developed in a new way, software may be needed like raw material. Computer software expenses were re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .' The position in respect of allowability of expenditure on purchases of application software is summarised below: (i) Acquisition of application softwares used in the business of providing software services for client servicing and consequently used for earning revenue, have been appropriately treated and claimed as revenue expenses. It may further be highlighted that these software have limited useful life. (ii) The above principles adopted for treating expenditures for purchase of software either as Capital or as Revenue are in accordance with the generally accepted accounting principles and treatment of the same for the purpose of income tax also is in consonance with the judicial principles laid down by the various Courts of Low as follows: 1. ITAT Bangalore in IMB India Ltd. vs. Commissioner of Income Tax (Appeals) [290 ITR (AT) 183 (Bangalore)] 2. Hon'ble Punjab Haryana High Court in CIT vs. Varinda Agro Chemicals Limited [2009] 309 ITR 272 (P H) 3. Hon'ble Special Bench of The Delhi Tribunal in Amwag India Enterprises vs. DCIT (2008-TIOL-97-ITAT-DEL-SB) 5.2 Though the appellant ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot have effectively carried out otherwise. They are meant to be used for executing a number of customer contracts giving enduring benefit to the appellant and in that respect, they are akin to machinery or equipment acquired by a manufacturing unit. On this functional test, they fall in the category of capital assets and expenditure on the same, in my opinion, is to be treated as capital expenditure. Considering this, the same were, in my opinion, required to be capitalized. The disallowance is therefore, confirmed in respect of them. The assessing officer shall however, allow depreciation on the same. 5.3. However, the remaining items of software are found to be useful for day to day functioning of the appellant and they are either application of software for office park or tools like anti-virus, fire-walls etc. Therefore, cost of these items is to be considered as revenue expenditure and be allowed as deduction. 5.4. The assessing officer is directed to reduce the disallowance accordingly. 7. It is clear from a perusal of the foregoing lower appellate discussion that the CIT(A) has examined the assessee's application software purchase expendit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be condoned. We order accordingly. The assessee's cross-appeal ITA No. 485/Kol/2019 is taken for adjudication. 9. Adverting to the assessee's sole substantive grievance seeking to delete its educational cess disallowance made in both the lower proceedings u/s. 40(a)(ii) of the Act, hon'ble Rajasthan high court and as well this tribunal (supra) have already held the same to be not sustainable. Learned CIT-DR took pains to refer to the tribunal's latter decision in ACIT vs. Srei Infrastructure Finance Ltd. ITA No. 1302-1318/Del/2012 decided on 27.02.2019 that the issue stands adjudicated in the Revenue's favour. We are informed that the hon'ble jurisdictional high court has restored the very issue back to the tribunal for fresh adjudication. We therefore follow hon'ble Rajasthan high court's decision (supra) to conclude that the both lower authorities have erred in disallowing educational cess amounting to ₹ 8,60,379/- u/s. 40(a)(ii) of the Act. The assessee's sole substantive grievance as well main appeal ITA No. 485/Kol/2019 are accepted therefore. 10. This Revenue's appeal ITA No. 67/Kol/2015 is dismissed and asse ..... X X X X Extracts X X X X X X X X Extracts X X X X
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