Assessing Officer did not follow the directions of Dispute Resolution Panel (DRP); Interest Rate of 6% not accepted by the AO (which was LIBOR + and higher than the interest rates of the loanee country; instead adopted interest rate of 17.22% for loans advanced to the subsidiary (bond rating of BB)
March 18, 2016
IN THE INCOME TAX APPELLATE TRIBUNAL “B” BENCH : BANGALORE BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER AND SHRI NARENDRA KUMAR CHOUDHURY, JUDICIAL MEMBER IT(TP)A No. 373/Bang/2015 Assessment year : 2010-11 M/s. Subex Limited, Vs. The Deputy Commissioner of RMZ Ecoworld, Income Tax, Outer Ring Road, Circle 6(1)(2), Devarabisanahalli, Bangalore. Bangalore. PAN: AABCS 9255R APPELLANT RESPONDENT IT(TP)A No. 374/Bang/2015 Assessment year : 2010-11 The Deputy Commissioner of Vs. M/s. Subex Limited, Income Tax, Bangalore. Circle 6(1)(2), PAN: AABCS 9255R Bangalore. APPELLANT RESPONDENT Assessee by : Shri Raghunathan S., Advocate Revenue by : Ms. Neera Malhotra, CIT-II(DR) Date of hearing : 08.03.2016 Date of Pronouncement : 18.03.2016 ORDER
Per B. Ramakotaiah, Accountant Member These cross appeals are by assessee and Revenue against the orders of Assessing Officer (AO) u/s. 143(3) r.w.s. 144C, consequent to the directions of the Dispute Resolution Panel [DRP].
IT(TP)A Nos.373 & 374/Bang/2015 Page 2 of 27
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 Rs. 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 determined the TP adjustment of Rs. 3,18,09,842/-. This adjustment has been proposed on advances given to its subsidiary and according to the TPO, since the loans are advanced from India Bond rate of ‘BB rating’ should be considered as against the 6% PA received by assessee. He adopted a rate of 14.74% in respect of the loans advanced and proposed an addition. On assessee’s objections, the DRP deferred from its findings in earlier year and accepted the TPO’s adjustment, hence the grounds under 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 3 of 27of the contentions of assessee and accordingly, Revenue has raised four material grounds in its appeal.
3. We have heard the Ld. Counsel for assessee and the Ld. DR and perused the Paper Books placed on record.
Assessee’s Appeal in IT(TP)A No. 373/Bang/2015:
4. Ground Nos. 1 to 8 are general in nature and does not require any adjudication.
5. TP issue: Ground Nos. 9 to 11 pertains to determination of arm’s length interest rate by the TPO. During the FY. 2009-10, assessee received interest on loans given to its AE amounting to Rs. 2.18 Crores. 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.
IT(TP)A Nos.373 & 374/Bang/2015 Page 4 of 27
6. It was the contention that DRP should have followed its findings in previous assessment year i.e., AY. 2009-10 and if those are adopted, assessee’s interest rate is within the ALP verified either on the basis of LIBOR+ or any other method. It was fairly admitted that this issue was similar to the issue in last year wherein, even after DRP directions, AO did not implement the directions.
7. We have considered the rival contentions and perused the record. 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. 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 Rs.4,94,11,033. It was submitted to the TPO that the loan was advanced in foreign currency USD @ 6% p.a. by using CUP method as an appropriate method to bench mark interest rate on LIBOR basis. It was also submitted that interest received was within the regulatory framework laid down by RBI. However, the AO did not agree and considered that assessee having advanced funds from India should analyse comparability on the interest rates prevailing in India. He has adopted Bond rating of BB at 17.22% in respect loans advanced and proposed an addition.
13.1 On 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 5 of 27of cases. Further, it was submitted that Thomson Reuters’s Loan Connector database was mentioning 2.53% being paid by companies rated as BB in comparable transactions and if 1% LIBOR rate is increased, the effective interest rate would be 3.53% which is still lesser than 6% rate received by the assessee. 13.3 It was further submitted that the Hon’ble Bombay High Court in the case of Tata Autocomp Systems Ltd., 56 taxman.com 206 (Bom) has upheld the interest rate being charged in the country where the loan is received/consumed. Accordingly, it was submitted that USD 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 Hon’ble Bombay High Court, if average rate prevailing in USD is considered, that would come to 2.85%. Since the above interest rates are less than the rate of interest received by the assessee at 6%, there is no need to make any adjustment in the given facts of the case. However, since the AO did not undertake the exercise of giving effect to DRP order, we are of the opinion that the details furnished by the assessee with reference to the above average rates based on Loan Connnector database should 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 deduction claimed u/s. 35D of the Act. This issue is also covered by the order of ITAT in ITA No. 223/Bang/2014, wherein it was held as under:
IT(TP)A Nos.373 & 374/Bang/2015 Page 6 of 27 “15. As far as claim u/s. 35D is concerned, this issue was raised by the assessee in ground No.10. This is not the first year of claim and original claim was made during AY 2007-08, in which assessee acquired two companies and has raised capital to through GDR and FCCBs. Assessee has incurred expenditure of Rs.61,62,65,172 during that year and claimed 1/5th of such expenditure as deduction u/s. 35D. Subsequently, assessee received a refund of Rs.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 Rs.11,72,873 and disallowed the balance claim of Rs.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 examined in assessee’s own case in ITA No.689/Bang/2014 for AY 2008-09 and the Tribunal directed that FCCBs are in the nature of debentures and hence are eligible to be calculated as part of ‘capital employed in the business of the company’ for allowing deduction 35D of the Act. Even though ITAT did not agree on the other issue of excluding securities premium and assessee is in appeal before the Hon’ble Karnataka High Court, the assessee submitted that the eligible amount based on the ITAT order in this regard as under:-
Sl. Particulars Amount No. (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 79,247,872* consequent to Tribunal’s order) * 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 arising in earlier years. With this, this ground is considered as allowed.
Respectfully following the same, we direct the AO to examine and allow as in earlier years and these grounds are considered as allowed.
IT(TP)A Nos.373 & 374/Bang/2015 Page 7 of 27
9. Ground Nos. 14 to 19 pertains to adjustment made by the AO under the head ‘Foreign Exchange Loss’ as in earlier years. AO referred to the Board Circular and treated the mark to market gains/losses and some of the option contracts, forward contracts etc., as speculative loss. While doing 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 9,28,75,309 outstanding option contracts 2. Gain on restatement of forward contracts 12,76,10,419 3. Realised foreign exchange gain on 3,25,62,589 settlement of revenue items (debtors and creditors) 4. Unrealised foreign exchange loss on (28,93,95,416) revenue items (debtors/creditors) 5. Total foreign exchange fluctuation loss (3,63,47,099)
As can be seen from the above, assessee has gain under three heads and loss on Revenue items of debtors and creditors which was netted off and claimed the net foreign exchange fluctuation loss. AO following the orders in earlier years, treats the entire 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 8 of 27incomes 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 earnings are primarily in foreign exchange. In order to secure a study flow of Rupee to meet its operating expenses, assessee entered into various hedging contracts with the banks in the nature of option/forward contracts. These contracts are both short term and long term. Assessee agrees to sell a specified amount of foreign currency which it anticipates to receive over a period to the bank. The rate was determined at the inception of the contract itself and it becomes the obligation on the part of 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 with various banks. Some of these above contracts did not mature till 31.3.2009. Accordingly, the MTM losses to an extent of Rs.9,72,32,040 was booked in the books of account on the basis of exchange rates prevailing on 31.3.2009 in accordance with AS-11. 16.2 The AO treated the losses as speculative in nature and contingent in nature and disallowed the same. The DRP also accepted the opinion of the AO. 16.3 It was submitted that assessee has consistently followed the same method of accounting 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. A.Y. MTM Gain/ Appellant's Department's treatment of MTM No. (Loss) on treatment of MTM gain/MTM loss on option contracts option gain/MTM loss on option contracts 1. 2008-09 (5,500,000) Claimed as a No adjustment made deduction 2. 2009-10 (97,231,040) Claimed as a Disallowed deduction 3. 2010-11 92,875,309 Offered to tax No adjustment for the said gain has been made. However, forex losses pertaining to debtors/ creditors were alleged to be MTM losses and IT(TP)A Nos.373 & 374/Bang/2015 Page 9 of 27 accordingly disallowed. 4. 2011-12 954,666 Offered to tax. No adjustment made.
16.4 It was submitted that Department has accepted the gains in the years assessee had positive income and now the Department ought not to have changed the treatment on the basis of consistency. 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 of Minwool Rock Fibres Ltd., (2012) 3 SCC 518 SC and CIT v. Hero Cycles, 228 ITR 463 (SC). 16.5 It was further submitted that Accounting Standards issued by Institute of Chartered Accountants of India (ICAI) are mandatory and there is no deviation from the same. The ld. counsel referred to Notes to the accounts and statements made by the Auditors to submit that assessee has not hedged foreign currency exposure to an extent of Rs.60 crores as that was incremental foreign exchange receivables 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. Woodward Governor (P) Ltd. (supra) and ONGC v. DCIT, 322 ITR 180 in fact support the assessee’s contentions that these transactions are not contingent in nature. It was further submitted that these are also not speculative in nature.
16.6 The ld. DR, however, relied on the order of AO and read out the Instruction as issued by the Board and analysed that transactions entered into by the assessee are both speculative in nature and the losses booked are contingent in nature.
16.7 We have considered the 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 Rs.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 in the case of ONGC v. DCIT, 322 ITR 180, has considered similar claims. In fact, in that case, assessee was engaged in capital intensive exploration and production of petroleum products for which it had to heavily depend on foreign loans to cover up its expenses, both capital and revenue. It had taken three types of foreign exchange borrowings: – (i) in revenue account; (ii) in capital account; and (iii) for general purposes. As per terms & conditions of the foreign exchange borrowings, some 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 10 of 27the 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 accrued in the relevant assessment year. The Hon’ble Supreme Court, placed reliance in the case of CIT v. Woodward Governor (P) Ltd. (supra) and held that loss claimed by the assessee on account of fluctuation in rate of foreign exchange as on date of balance-sheet was allowable as an expenditure under section 37(1). In the case of Badridas Gauridu (P.) Ltd. v. CIT, 261 ITR 256 (Bom), the Hon’ble Bombay High Court held that hedging contracts were incidental to assessee’s business of export of cotton, 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 the above loss, then the AO is directed to make necessary modification in the claims u/s. 10A / 10AA. Ground No.8 is accordingly allowed”.
Respectfully following the decision taken in earlier year, we direct the AO to allow the loss as claimed. Moreover, as seen from the order of the DRP, the DRP also directed the AO to include the foreign exchange loss or gain as part of operating cost vide para 4 & 5 with reference to foreign exchange fluctuation gain on restatement 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. 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 Rs. 780.75 Crores for the purpose IT(TP)A Nos.373 & 374/Bang/2015 Page 11 of 27of acquisition of Subex America INC, a overseas subsidiary. The investment in Subex America’s INC amounting toRs. 774.95 Crores appears in schedule ‘G’ to the financial statements. Assessee has recognized un- realised foreign exchange fluctuation gain amounting to Rs. 91.88 Crores on restatement of FCCBs and credited the same to its P&L A/c. However, restatement gain being related to investment in Subex America was not offered to tax in the return of income. AO has not allowed the exclusion from the computation of income. The DRP it seems allowed 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 exchange gain should be treated as “Income” or not?
38. The stand of the Assessee in this regard was that the gain is on capital account and cannot be regarded as income. The Assessee also pointed out that in the subsequent year, there was a loss on account of restatement of the Assessee’s liability on account of adverse fluctuation of foreign exchange and consequent liability on account of FCCBs and in that year the Assessee did not claim the loss as it was on capital account. The Assessee has therefore 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 FCCBs is not disputed. The admitted position is that FCCBs were issued for purpose IT(TP)A Nos.373 & 374/Bang/2015 Page 12 of 27of acquisition of a new industrial undertaking and was therefore on capital account. The Hon’ble supreme Court in the case of Woodward Governor (supra) laid down the principles in this regard. The Hon’ble Court in Para-4 of its judgment observed as follows:-
“At the outset, for the sake of convenience, we may state that in this batch of civil appeals broadly we have before us two categories. In the first category, 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, in the second category of cases, we are concerned with the assessee(s) incurring liabilities on capital account. In such cases, we are required to consider the provisions of s. 43(1), 43A (both, before and after amendment vide Finance Act, 2002).”
Thereafter in para 22 of its judgment it dealt with cases where the fluctuation is on account of capital items as follows:-
“Facts in M/s Honda Siel Power Products Ltd.
(Civil Appeal arising out of SLP(C) No. 7632/08) Capital account case :
22. The main 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 provisions of Sec.43A of the Act, the Hon’ble Supreme Court held that Sec. 43A(1) applies where as a result of change in rate of exchange there is an increase or reduction in the liability of the assessee in terms of Indian rupees to pay the price of any asset payable in foreign exchange or to repay moneys borrowed in foreign currency specifically for the purpose of acquiring the asset. 43A(1) has no application unless the asset is acquired and the liability existed, before the change in the rate 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 pursuant to issue of shares in the form of GDS. The assessee kept a part of the money abroad. When the money was brought to India, due to strong dollar position, the assessee gained on the repatriated amount. This was claimed as a capital receipt. The amount had direct nexus with the capital raised and consequently the assessee IT(TP)A Nos.373 & 374/Bang/2015 Page 13 of 27contended the same was a capital receipt. The Commissioner of Income Tax pointed out that there was no dispute with regard to the fact that the exchange fluctuation income 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, the amount received on account of exchange fluctuation to the tune of Rs.16,35,77,977/- was to be treated as revenue receipt and the Assessing Officer erred in reducing it in the income of the assessee while computing the deduction under Section 80HHE. The Hon’ble Madras High Court held that the claim of the revenue was unsustainable. The Hon’ble Court held that since the amount had direct nexus with the capital raised, the assessee’s claim that the same was capital receipt and hence not taxable 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 the Assessee and such liability would be on capital account. Therefore the gain or loss would be on capital account and not taxable. We accordingly hold in favour of the Assessee on this issue”. Respectfully following the same, we direct the AO to treat the above amount as on capital accout, to be adjusted in capital accounts. However, if any benefit was obtained by assessee in the TP provisions by treating this amount as operational income, we direct the AO/TPO to examine the working again, so 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 14 of 27necessary, necessary proceedings can be initiated under the TP provisions as a direction by the Bench. With these directions, these grounds are allowed. 10.2. The last of the issue is with reference to realised foreign exchange fluctuation of Rs. 3,36,176/- pertaining to assets as ‘business income’. This gain also is directly pertain to loans on Capital assets and assessee has adjusted the cost of assets in accordance with the provisions of Section 43A and accordingly states that depreciation was claimed on reduced cost. The AO however, without giving any cogent reasons 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. 20 to 22 pertain to disallowance of depreciation on computer software amounting to Rs. 36,35,280/- on account of non- deduction of tax at source. The AO noticed that assessee has purchased software amounting to Rs. 60,58,801/- (including Rs. 16,55,390/- paid to non-residents which was capitalized for tax purposes and depreciation @ IT(TP)A Nos.373 & 374/Bang/2015 Page 15 of 2760% and thereon). The AO disallowed the depreciation claimed to an extent of Rs. 36,35,280/- on the reason that entire amount of software purchase was 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 Rs. 35,86,893/-. The details of which were provided on record. It was submitted that disallowance claimed u/s. 32 cannot be disallowed invoking the provisions of Section 40(a)(ia). Assessee relied on the following case law:
a. ITO (International Taxation), Ward 1(2), Bangalore V. M/s.
Kawasaki Micro Electronics Inc. [Cross objection No. 18/Bang/2015 in I.T. (IT) A. No. 1221/Bang/2014 (Bangalore Tribunal)];
b. SMS Demag (P) Ltd. V. DCIT [(2010) 132 TTJ 498 (Delhi Tribunal)];
c. CIT V. Mark Auto Industries Limited [ITA No. 57 of 2009 –
unreported (Punjab and Haryana High Court]; and IT(TP)A Nos.373 & 374/Bang/2015 Page 16 of 27 d. SKOL Breweries Ltd. 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 Rs. 1,23,240/- was pertaining to purchases of less than 180 days on which, thee was excess disallowance of Rs. 36,972/-.
14. We have considered the rival contentions and examined the provisions of Section 40(a)(ia). As per the provisions of Section 40(a)(ia), what the AO can disallow invoking the said provision is only with reference to interest, commission/brokerage, rent, royalty, fees for professional services or fees for technical services or amounts payable to a contractor or sub-contractor. It is not known how the AO can treat the software purchases as part of the above amounts. In fact the definition of ‘royalty’ as provided in Explanation-vi to the above sub-section also does not cover the software purchases as held by the Co-ordinate 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 17 of 27extended to the disallowance of depreciation which is allowable u/s. 32. In case any default is there for non-deduction of tax, AO could have invoked the provisions of Section 201/201(1A), but cannot resort to disallowance 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.
15. Ground 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 Rs. 1,46,71,497/-; b. Insurance expense incurred amounting to Rs. 1,16,30,388/-; c. Travelling expenses incurred in foreign currency amounting to Rs. 5,04,12,543/- and d. Product marketing expenses incurred in foreign currency amounting to Rs. 1,91,54,500/-;
IT(TP)A Nos.373 & 374/Bang/2015 Page 18 of 2715.1. It was submitted that :
a. Of the total communication cost of Rs. 1,46,71,497/- only Rs.
15,76,290/- was incurred towards internet charges which is used for inward and outward transmission of data, as well as for transmission of data within the territories of India;
b. The aforesaid communication costs were not attributable to delivery of computer software outside India and hence no adjustment was 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 of the AO that, the aforesaid expenses relate to both the SEZ units and not SEZ Unit 2 alone and also for reasons stated above, none of the aforesaid expenses were required to be reduced from the ‘export turnover’. AO, however, proceeded to reduce all the IT(TP)A Nos.373 & 374/Bang/2015 Page 19 of 27aforesaid expenses from the ‘export turnover’ of SEZ Unit 2 for the purpose of computing deduction under section 10AA of the Act.
16. We have considered this issue also in the appeal for AY. 2009-10 in IT(TP)A No. 223/Bang/2014 and decided as under:
“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 1 : For the purposes of this section,–
(i) “export turnover” means the consideration in respect of export by the undertaking, being the Unit of articles or things or services received in, or brought into, India by the assessee but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things outside India or expenses, if any, incurred in foreign exchange in rendering of services (including computer software) outside India;
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 (including computer software) outside India”. Thus, there is no need for rendering technical services, but ‘rendering of any services including computer software outside India’ is covered as part of definition of export turnover. Thus, any expenditure on freight, telecommunication charges or insurance attributable to delivery of articles or things outside India or expenses, if any, incurred in rendering of services outside India, are to be excluded. The above provisions postulates that ‘freight, telecommunication 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:-
IT(TP)A Nos.373 & 374/Bang/2015 Page 20 of 27 “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, telecommunication charges or insurance attributable to the delivery of articles or things or computer software outside India or expenses incurred in foreign exchange in providing technical services outside India. Thus from the definition it is clear that telecommunication charges and insurance are not to be directly incurred for the purpose of delivery of articles or things or computer software outside India but it is sufficient if the same is attributable to the said purpose. The assessee’s business being 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 the second part of the said definition with regard to the expenditure incurred in foreign exchange in providing technical services outside India. In view of the same, we are of the opinion that the telecommunication charges and insurance charges are indirectly included in the export turnover of the assessee and therefore it has to be necessarily reduced from the export turnover for the purpose of computation of deduction u/s 10A of the Act. “
18.6 Therefore, the expenses which are attributable to delivery 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 foreign exchange in rendering of services outside India. These expenditures are not in the nature of attributable to delivery of articles. The words expenses if any, incurred in contrast to attributable used earlier do indicate that the expenditure must be direct expenditure for rendering services. Further use of if any qualify the incurred used in the provision. The intention of legislature is very clear that these are to be direct expenses in rendering of services. The expenditures considered by AO 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 delivery of articles or things, as they are not in the nature of freight, telecommunication charges or insurance. Since the AO has not given any finding that these are direct expenditure for rendering services outside India, we are not in a position to uphold such exclusion IT(TP)A Nos.373 & 374/Bang/2015 Page 21 of 27from the export turnover. More over, as far as traveling expenditure is concerned, the ITAT in ITA No.1430/Bang/2010 vide order dated 13.11.203 for AY 2006-07 has held that foreign traveling expenses cannot be reduced from export 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 100% deduction u/s. 10AA profit as quantified by the AO. We find that the above discussion is purely of academic nature, as practically there is no grievance of the assessee, since deduction was allowed at 100% on the alternative ground accepted by the DRP. Since the assessee has contested the issue in the grounds and since we find that these expenditures are not related to the expenditure of the nature as specified in Explanation 1, we adjudicated this contention on merits. The grounds are considered 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 out- side 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 Rs. 1,18,35,826/-. It was claimed that assessee paid taxes in foreign jurisdictions by way of taxes withheld by the customers in overseas jurisdictions and is therefore eligible to claim FTC amounting to Rs. 1,18,35,826/-. Since the taxable income as per the return of income was NIL, assessee did not claim the FTC in its return of income. While making the various disallowances, AO was informed about the details of FTC but IT(TP)A Nos.373 & 374/Bang/2015 Page 22 of 27AO 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, 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 appeal is allowed for statistical purposes. Revenue’s Appeal in IT(TP)A No. 374/Bang/2015:
18. Aggrieved on the directions of the DRP, AO has come in appeal on four issues.
18.1. The first issue contested in Ground No. 2 is with reference to disallowance of year end professional charges amounting to Rs. 43,52,820/- on account of non-deduction of tax at source. AO noticed that assessee has credited the amount as a provision towards professional charges and since TDS was not deducted on these amounts, 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 23 of 27account 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 disallowance by stating as under:
“9.1 The ground of objection along with all the material placed on record has been pursued. The AO disallowed the year end professional charges accrued in the books on account of non-deduction of tax at source. In this regard it is stated that when an income is credited to any account in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee, but the fact that the credit to any account 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 professional charges accrued but not due is made. Accordingly, no tax was required to be deducted at source in respect of the provision for professional charges payable made by the assessee which reflected provision for ‘professional charges accrued but not due’ in a situation where the ultimate recipient of such ‘professional charges accrued but not due’ could not have been ascertained at the point of time when the provisions was made. Therefore, the assessee did not have any liability to deduct tax 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 specifies that credit in the Books of IT(TP)A Nos.373 & 374/Bang/2015 Page 24 of 27Account also 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 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 Rs. 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, the DRP has allowed the contentions of assessee by stating as under:
10.1 The ground of objection along with all the material placed on record has been perused. The word ‘Computer’ has not been defined in the Income-tax Act or Income-tax Rules. In order to determine whether a particular machine can be classified as a computer or not common parlance understanding would have to be taken into account. A computer, in common sense and as popularly understood, refers to any electronic or other high speed 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 IT(TP)A Nos.373 & 374/Bang/2015 Page 25 of 27computer equipment and cannot work in isolation and accordingly fall under the purview of the term ‘Computer & Software’ and are eligible for depreciation at the rate of 60%; Therefore depreciation on servers will be allowed at the rate applicable to computers i.e. 60%”.
19.1. After considering the rival contentions, we do not see any reason to interfere with the order of the DRP. The servers are the part of computer equipment and cannot work in isolation. Accordingly, the directions are upheld. Revenue’s ground on this issue is rejected.
20. Next issue for consideration in Ground Nos. 4 & 5 is with reference to adjustments made to export turnover for the purpose of deduction of Section 10AA. AO has disallowed certain expenditure pertaining to delivery of goods outside India and re-worked out the export turnover while calculating deduction u/s. 10AA. However, he has not reduced the same from the total turnover. DRP while upholding the exclusion of certain expenditure (which was considered in assessee’s appeal above), directed the AO to treat the same for the purpose of total turnover also and to exclude them, following the decision of ITAT in M/s. Sak Soft Ltd., and also Co- ordinate Bench decision in the case of Tata Elxsi. Revenue is aggrieved on that. It is admitted that on a parity of comparison, whatever is reduced from the export 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., which the DRP has followed. We do not IT(TP)A Nos.373 & 374/Bang/2015 Page 26 of 27see 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 total turnover also. Subject to those adjustments, the DRP’s direction that whatever is excluded from the export turnover should also be excluded from the total turnover is upheld. Revenue’s grounds on this issue are accordingly dismissed. 20.1. In the result, Revenue’s appeal is partly allowed.
21. To sum-up, assessee’s appeal in IT(TP)A No. 373/Bang/2015 is allowed for statistical purposes and Revenue’s appeal in IT(TP)A No. 374/Bang/2015 is partly allowed.
Pronounced in the open court on this 18th day of March, 2016 Sd/- Sd/-
(NARENDRA KUMAR CHOUDHURY) (B. RAMAKOTAIAH) Judicial Member Accountant Member Bangalore, Dated, the 18th March, 2016. /D S/ TNMM IT(TP)A Nos.373 & 374/Bang/2015 Page 27 of 27 Copy to: 1. Appellant 2. Respondents 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file By order Assistant Registrar, ITAT, Bangalore.