M/s Crane Software International Ltd.,, Bangalore v. DCIT, Bangalore

ITA.741 742 774 & 775/B/2010 PAGE - 1 IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCH 'A' BANGALORE BEFORE DR. O. K. NARAYANAN VICE PRESIDENT AND SMT. P. MADHAVI DEVI JUDICIAL MEMBER 1-2. I.T.A NOS.741 & 742/BANG/2010 (ASSESSMENT YEARS : 2005-06 & 2006-07) M/S. CRANE SOFTWARE INTERNATIONAL LTD. BLOCK-1 4TH FLOOR SHANKARANARAYANA BUILDING BANGALORE 560 001 .. APPELLANT V. DEPUTY COMMISSIONER OF INCOME-TAX CIRCLE -11(2) BANGALORE .. RESPONDENT 3-4. I.T.A NOS.774 & 775/BANG/2010 (ASSESSMENT YEARS : 2005-06 & 2006-07) (BY THE REVENUE) ASSESSEE BY : SHRI. V. SRINIVASAN CA REVENUE BY : SHRI. G. V. GOPALA RAO COMMISSIONER OF INCOME-TAX-I O R D E R PER DR. O. K. NARAYANAN VICE PRESIDENT : THIS IS A BUNCH OF FOUR APPEALS CONSISTING OF TWO APPEALS BY THE ASSESSEE AND TWO APPEALS BY REVENUE. THESE APPEALS RELATE T O THE ASSESSMENT YEARS 2005- 06 AND 2006-07. ITA.741 742 774 & 775/B/2010 PAGE - 2 02. THESE CROSS APPEALS ARE DIRECTED AGAINST THE OR DERS OF THE COMMISSIONER OF INCOME-TAX(A)-I AT BANGALORE DATED. 01/03/2010 AND ARISE OUT OF THE ASSESSMENTS COMPLETED U/S.143(3) OF THE INCOME-TAX ACT 1961. 03. THE ASSESSEE-COMPANY PROVIDES SOFTWARE PRODUCTS AND SOLUTIONS ON STATISTICAL ANALYTICS AND ENGINEERING SIMULATIONS T O ENTERPRISES IN DIFFERENT COUNTRIES. ASSESSEE'S BUSINESS INTERESTS INCLUDE P RODUCTISED SOFTWARE SOLUTIONS SERVICES AND RESEARCH AND DEVELOPMENT. ASSESSEE OF FERS DIFFERENT PROPRIETARY PRODUCTS SUCH AS SYSTAT SIGMA PLOT SIGMA STAT PE AKFIT ICAPELLA AND OTHER PACKAGES OF IBM TEXAS INSTRUMEN TS MATHWORKS ETC. 04. THE ASSESSEE COMPANY FILED ITS RETURNS FOR THE ASSESSMENT YEARS 2005-06 AND 2006-07 ON A TOTAL INCOME OF ` 22 97 28 090/- AND ` 15 99 42 940/- RESPECTIVELY. 05. IN THE RELEVANT PREVIOUS YEAR PERIOD THE ASSES SEE COMPANY HAD PURCHASED SOFTWARES MAINLY FROM FOREIGN COMPANIES. THE PURCH ASE WAS FOR ` 77 70 44 460/- AND FOR ` 57 70 15 039/- RESPECTIVELY FOR THE ASSESSMENT YEAR S 2005-06 AND 2006-07. THE ASSESSEE TREATED THESE NE W ACQUISITIONS AS ADDITIONS TO THE EXISTING BLOCK OF ASSETS AND CLAIMED DEPRECI ATION ALLOWANCE @ 60%. THE ASSESSEE STATED THAT THE SOFTWARES WERE PURCHASED F OR ITS OWN USE ANALOGOUS TO PLANT AND MACHINERIES OF MANUFACTURING UNITS. THE ASSESSEE STATED THAT THE ITA.741 742 774 & 775/B/2010 PAGE - 3 PURCHASES WERE NOT MEANT FOR RE-SALE BUT TO DEVELOP PRODUCTS AND PACKAGES SO AS TO PROVIDE THE SAME TO CUSTOMERS OUT OF WHICH THE ASSESSEE GENERATED ITS INCOME. 06. THE ASSESSING AUTHORITY COULD NOT ACCEPT THE CL AIM OF DEPRECIATION ALLOWANCE AS DEDUCTIBLE. HE EXAMINED THE PURCHASE AGREEMENTS ENTERED INTO BETWEEN THE ASSESSEE-COMPANY AND THE DIFFERENT SUPP LIERS AND PURCHASE INVOICES AND OTHER FEATURES OF THE TRANSACTIONS AND CAME TO THE FOLLOWING FINDINGS : I) THE ASSESSEE HAS ACQUIRED THE RIGHT TO DISTRIBUT E THE SOFTWARE WITH LICENCE TO USE THE SOURCE CODE DOCUMENTATION AND T ECHNICAL INFORMATION ASSOCIATED WITH THE SOFTWARE. II) THE ASSESSEE HAS OBTAINED EXCLUSIVE AND NON-TRA NSFERRABLE RIGHTS TO MARKET AND SUB-LICENCE THE SOFTWARE AND USER DOC UMENTATIONS AND TO USE THE SOFTWARE SOURCE TO MODIFY ENHANCE CHANGE OR C ONVERT THE SOFTWARE PACKAGES AS AND WHEN NECESSARY IN THE LIGHT OF MARK ETING REQUIREMENTS. III) THE ASSESSEE-COMPANY IS BASICALLY A TRADER AND DISTRIBUTOR OF SOFTWARE PRODUCTS. THE ASSESSEE PURCHASES LICENCES SOURCE CODES AND MAKES SALES AND DISTRIBUTION OF UPDATED PRODUCTS TO END CUSTOMERS. IV) WHAT THE ASSESSEE HAS PURCHASED IS COMPREHENSIV E SOFTWARE PACKAGES AND THE RIGHT TO SELL TO MULTIPLE CUSTOMER S AND NOT ANY ARTICLE OR ASSET AS EXPLAINED BY THE ASSESSEE. V) THEREFORE THE PAYMENTS MADE BY THE ASSESSEE WER E IN THE NATURE OF ROYALTY AS EXPLAINED IN EXPLANATION 2 TO SECTION 9( 1)(VI) OF THE ACT AND ITA.741 742 774 & 775/B/2010 PAGE - 4 ACCORDINGLY LIABLE TO TAX AS THE INCOME ARISING TO THE FOREIGN SUPPLIERS ARE TO BE TREATED AS INCOME ACCRUING OR ARISING IN INDI A. 07. ON THE BASIS OF THE ABOVE FINDINGS THE ASSESSI NG AUTHORITY HELD THAT TAX SHOULD HAVE BEEN DEDUCTED AT SOURCE U/S.194J WHEN P AYMENTS WERE MADE TO FOREIGN SUPPLIERS AGAINST THE PURCHASE OF SOFTWARE. NO TDS WAS MADE WHICH ATTRACTED THE PROVISIONS OF LAW STATED IN SECTIONS 40(A)(I) AND 40(A)(IA). THE ASSESSING AUTHORITY INVOKED SECTIONS 40(A)(I) AND 4 0(A)(IA) AND DISALLOWED THE CLAIMS OF DEPRECIATION MADE BY THE ASSESSEE. 08. IN THE PREVIOUS YEAR RELEVANT TO THE ASSESSMENT YEAR 2005-06 THE ASSESSEE HAD INCURRED AN EXPENDITURE OF ` .3 53 20 000/- TOWARDS MARKET SUPPORT ACTIVITIES UNDERTAKEN MAINLY IN EUROPEAN MARKETS. THE EXPENS ES WERE INCURRED TO POSITION THE SOFTWARE PRODUCTS OF THE ASSESSEE WITH ITS BRAND IMAGE. THE ACTIVITIES INCLUDED SOURCING OF MARKET DATA-BASE M ARKET SURVEY FOR ITS PRODUCTS LIKE PCATS WITEL AND BWD ASSET. THE ASSESSEE COMP ANY TREATED THE EXPENDITURE AS DEFERRED REVENUE EXPENDITURE IN ITS FINANCIAL AC COUNTS WITH A ONE-FIFTH ANNUAL WRITE-OFF BUT CLAIMED THE ENTIRE EXPENDITUR E AS DEDUCTION IN ITS INCOME- TAX COMPUTATION. THE ASSESSING AUTHORITY TREATED T HE EXPENDITURE AS INCURRED FOR TECHNICAL SERVICES UNDER EXPLANATION 2 TO SECTION 9 (1)(VII) AND HELD THE PAYMENTS ARE ACCOUNTABLE FOR TDS U/S.194J. AS NO TDS WAS MA DE BY THE ASSESSEE COMPANY SECTIONS 40(A)(I) / 40(A)(IA) WERE INVOKED AND THE CLAIM OF ` 3 53 20 000/- WAS DISALLOWED. ITA.741 742 774 & 775/B/2010 PAGE - 5 09. IN THE PREVIOUS YEAR RELEVANT TO THE ASSESSMENT YEAR 2006-07 ALSO THE ASSESSEE COMPANY HAD INCURRED SUCH EXPENDITURE TO THE EXTENT OF ` 45 93 52 988/- WHICH WAS CLAIMED AS DEDUCTION IN IT S INCOME-TAX COMPUTATION. THE DETAILS OF THE EXPENDITURE ARE AS FOLLOWS: PAYMENTS MADE TO : (1) SYSTAT SOFTWARE GMBH-GERMANY .. ` 21 23 600 (2) AAMER PACIFIC P. LTD. .. ` 39 08 79 350 ` 39 30 02 950 FCCB ISSUE EXPENSES .. ` 6 63 50 038 ` 45 93 52 988 10. THE PAYMENTS TO THE FOREIGN COMPANIES WERE MADE TOWARDS MARKET EXPLORATION EXPENDITURE AS ALREADY STATED FOR THE A SSESSMENT YEAR 2005-06. ON THE SAME GROUNDS CONSIDERED FOR ASST.YEAR 2005-06 THE ASSESSING AUTHORITY TREATED THE PAYMENT MADE TO AAMAR PACIFIC P. LTD AS PAYMENTS MADE FOR TECHNICAL SERVICES LIABLE FOR TDS U/S.194J. AS NO TDS WAS MADE SECTIONS 40(A)(I) AND 40(A)(IA) WERE INVOKED AND THAT AMOUNT WAS DISALLOWED. 11. THE FCCB ISSUE EXPENSES WERE INCURRED IN CONNEC TION WITH ISSUE OF FOREIGN CURRENCY CONVERTIBLE BONDS. AS THE BONDS W ERE CONVERTIBLE THE ASSESSING AUTHORITY TREATED THE BOND PROCEEDS AS IN CREASE TO CAPITAL. ACCORDINGLY HE TREATED THE EXPENDITURE OF ` 6 63 50 038/- AS CAPITAL IN NATURE AS ITA.741 742 774 & 775/B/2010 PAGE - 6 IT WAS INCURRED FOR RAISING THE CAPITAL OF THE ASSE SSEE COMPANY. THE SAID EXPENDITURE WAS ALSO DISALLOWED. 12. AS IN THE EARLIER YEAR 2005-06 THE ASSESSEE HA D PURCHASED SOFTWARE AND CLAIMED 60% DEPRECIATION AMOUNTING TO ` 38 20 11 156/-. AS ALREADY STATED THE ASSESSING AUTHORITY TREATED THE PAYMENTS AS HAVING MADE TOWARDS ROYALTY LIABLE FOR TDS. AS THERE WAS NO TDS MADE SECTIONS 40(A)( I)/40(A)(IA) WERE INVOKED AND THE CLAIM OF DEPRECIATION WAS DISALLOWED. 13. IN THE ASSESSMENT YEAR THE ASSESSEE-COMPANY HA D CLAIMED THE BENEFIT OF SECTION 10A. WHILE COMPUTING THE SAID BENEFIT THE ASSESSING AUTHORITY EXCLUDED THE TELECOMMUNICATION CHARGES FROM THE EXPORT TURNO VER WITHOUT A CORRESPONDING DEDUCTION FROM TOTAL TURNOVER THEREBY REDUCED THE QUANTUM OF BENEFIT MARGINALLY. 14. TO SUMMARISE THE DISALLOWANCES MADE BY THE ASS ESSING AUTHORITY WERE AS FOLLOWS : SL. NO ASSESSMENT YEARS ITEM PARTICULARS 2005-06 2006-07 1. DEPRECIATION ALLOWANCE PARA 07 & 12 ABOVE ` 46 23 33840 ` 16 68 78 386 2. MARKET PROMOTION EXPENSES PARA 08 & 10 ABOVE ` 3 53 20 000 ` 39 08 79 350 3. FCCB ISSUE EXPENSES PARA 11 ABOVE -- ` 6 63 50 038 4. 10A COMPUTATION ADJUSTMENT PARA 13 ABOVE -- ` 39 03 051 ITA.741 742 774 & 775/B/2010 PAGE - 7 15. THE ABOVE MENTIONED DISALLOWANCES AND ADJUSTMEN T WERE TAKEN IN FIRST APPEALS. 16. ON THE QUESTION OF DEPRECIATION ALLOWANCE THE COMMISSIONER OF INCOME- TAX(A) FOUND THAT THE ASSESSING AUTHORITY HAS COME TO HIS FINDING THAT THE ASSESSEE HAD PURCHASED ONLY THE RIGHTS IN SOFTWARE AND NOT THE PROPERTY; AND HE MADE THE FINDING NOT ON THE BASIS OF FULL APPRECIAT ION OF THE CLAUSES OF THE AGREEMENTS. HE FOUND THAT IT IS DISCERNIBLE FROM T HE SAME AGREEMENTS THAT THE ASSESSEE WAS GIVEN THE OPTION TO PURCHASE THE SOFTW ARE AND IN FACT THE ASSESSEE HAD EXERCISED THE OPTION AND PURCHASED THE SOFTWARE AND CAPITALIZED THE PAYMENTS AS COST OF THE SOFTWARE PURCHASED. 17. HE FURTHER HELD THAT SECTION 40(A)(I) DOES NOT AFFECT THE DEPRECIATION ALLOWANCE AS IT IS NOT IN THE NATURE OF ANY REVENUE EXPENDITURE. HE HELD THAT THE EXPENSES COVERED BY SECTION 40(A)(I) ARE EXPENSES I N THE NATURE OF INTEREST ROYALTY FEE FOR TECHNICAL SERVICES AND SIMILAR ITE MS AND NOT DEPRECIATION ALLOWANCE. ACCORDINGLY THE COMMISSIONER OF INCOME -TAX(A) DELETED THE DISALLOWANCE OF DEPRECIATION FOR BOTH THE ASSESSMEN T YEARS. 18. IN THE CASE OF MARKET PROMOTION EXPENDITURE (DE FERRED REVENUE EXPENDITURE) THE COMMISSIONER OF INCOME-TAX(A) AGR EED WITH THE VIEW OF THE ITA.741 742 774 & 775/B/2010 PAGE - 8 ASSESSING AUTHORITY. HE FOUND THAT THE SERVICES OB TAINED BY THE ASSESSEE RELATED TO MARKETING SUPPORT PRODUCT BRANDING MARKETING S URVEY ROAD SHOWS ETC IN EUROPE. HE HELD THAT THE ABOVE MENTIONED SERVICES COULD NOT HAVE BEEN PROVIDED WITH OUT EXPERT SUPPORT BASED ON TECHNICAL KNOWLEDGE AND MANAGERIAL CAPACITY. ACCORDINGLY HE HELD THAT SUCH PAYMENTS WERE MADE FOR TECHNICAL SERVICES COVERED U/S.9 OF THE INCOME-TAX ACT. 19. HAVING HELD THAT THE PAYMENTS WERE MADE FOR TEC HNICAL SERVICES ON THE FACTS OF THE CASE HE ACCEPTED THE ALTERNATE CONTEN TION OF THE ASSESSEE MADE ON THE BASIS OF EXCEPTION PROVIDED U/S.9(1)(B) OF THE ACT. 20. IN THE ASSESSMENT YEAR 2005-06 THE TOTAL PAYME NTS OF ` 3 53 20 000/- WERE MADE TO THE FOLLOWING PARTIES : M/S. SYSTAT SOFTWARE GMBH GERMANY .. ` 1 36 44 000 M/S. S2 SOFTTECH PVT. LTD. - INDIA .. ` 2 16 76 000 21. IN THE ASSESSMENT YEAR 2006-07 THE ENTIRE PAYM ENT OF ` 39 08 79 350/- WAS MADE TO M/S. AAMER PACIFIC A SINGAPORE COMPANY. 22. IN THE CASE OF THE PAYMENTS MADE TO THE TWO FOR EIGN COMPANIES NOTED ABOVE THE COMMISSIONER OF INCOME-TAX(A) FOUND THAT THOSE COMPANIES DO NOT HAVE ANY PERMANENT ESTABLISHMENT IN INDIA (PE). TH E SERVICES WERE RENDERED BY ITA.741 742 774 & 775/B/2010 PAGE - 9 THOSE COMPANIES OUTSIDE INDIA. THE PAYMENTS WERE M ADE OUTSIDE INDIA. THE INCOME WAS EARNED OUTSIDE INDIA. THE INCOME DID NO T ACCRUE OR ARISE IN INDIA. HE HELD THAT THEREFORE THE PAYMENTS MADE TO THE ABO VE STATED TWO FOREIGN COMPANIES WERE COVERED BY THE EXCEPTION PROVIDED IN SECTION 9(1)(B) AND NO TAX WAS DEDUCTIBLE AND SECTION 194J WAS NOT ATTRACTED A ND SO ALSO SECTIONS 40(A)(I)/ 40(A)(IA). HE FURTHER RELIED ON THE FOLLOWING DECI SIONS AS WELL : ISHIKAWAJIMA-HARIMA HEAVY INDUSTRIES V. DIT (288 IT R 408) (SC) ; JINDAL THERMAL POWER COMPANY LTD. V. DCIT (26 DTR 172) (KAR). 23. ACCORDINGLY THE COMMISSIONER OF INCOME-TAX(A) DELETED THE DISALLOWANCE OF ` 1 36 44 000/- FOR THE ASSESSMENT YEAR 2005-06 AND THE DISALLOWANCE OF ` 39 08 19 350/- FOR THE ASSESSMENT YEAR 2006-07. HO WEVER HE CONFIRMED THE DISALLOWANCE OF INDIAN PAYMENT OF ` 2 16 76 000/- FOR THE ASSESSMENT YEAR 2005- 06. 24. ON THE QUESTION OF DISALLOWANCE OF FCCB ISSUE E XPENSES THE COMMISSIONER OF INCOME-TAX(A) HELD THAT FCCB IS NOT HING BUT AN INTEREST BEARING LIABILITY. THE MERE FACT THAT LOANS CAN BE CONVERTED TO EQUITY AT THE OPTION OF THE LENDER AT A LATER DATE DOES NOT ALTER THE BASIC CHARACTER OF THE AMOUNT BORROWED AS LOAN. SO ALSO THE ASSESSEE-COMP ANY HAS CATEGORIZED THE FCCB UNDER UNSECURED LOANS IN THE BALANCE-SHEET. HE DELETED THE SAID DISALLOWANCE. ITA.741 742 774 & 775/B/2010 PAGE - 10 25. IN RESPECT OF EXCLUDING THE TELECOMMUNICATION C HARGES FROM EXPORT TURNOVER WITHOUT DEDUCTING FROM TOTAL TURNOVER THE COMMISSIONER OF INCOME- TAX(A) DISMISSED THE GROUNDS RAISED BY THE ASSESSEE COMPANY ON THE BASIS OF HIS OWN EARLIER DECISION. 26. IN SHORT THE COMMISSIONER OF INCOME-TAX(A) ALL OWED THE GROUNDS OF THE ASSESSEE COMPANY ON DEPRECIATION ALLOWANCE FOR BOTH THE ASSESSMENT YEARS. HE FULLY ALLOWED THE CLAIM OF MARKET PROMOTION EXPENSE S FOR THE ASSESSMENT YEAR 2006-07 AND PARTLY ALLOWED FOR ASSESSMENT YEAR 2005 -06. FCCB ISSUE EXPENSES HAVE BEEN ALLOWED; BUT CONFIRMED THE ADJUSTMENT OF TELECOMMUNICATION EXPENSES MADE U/S.10A. 27. THE REVENUE IS AGGRIEVED ON QUESTIONS OF DEPREC IATION ALLOWANCE ON SOFTWARE ; PAYMENTS MADE TO FOREIGN COMPANIES FOR M ARKET PROMOTION ; AND FCCB ISSUE EXPENSES. THE ASSESSEE IS AGGRIEVED BY THE CONFIRMATION OF DISALLOWANCE OF PAYMENTS MADE TO INDIAN COMPANY FOR MARKET PROMOTION AND ON THE ADJUSTMENT OF TELECOMMUNICATION EXPENSES U/S.10 A. THE ASSESSEE HAS ALSO RAISED GROUNDS AGAINST LEVY OF INTEREST U/S.234B AN D 234C. 28. ON THE BASIS OF THE COMMON GROUNDS RAISED IN TH IS CROSS APPEALS THE FOLLOWING ISSUES ARISE FOR OUR CONSIDERATION : ITA.741 742 774 & 775/B/2010 PAGE - 11 I) WHETHER THE ASSESSEE IS ENTITLED FOR DEPRECIATIO N ON THE PURCHASE COST OF SOFTWARE AND FOR THAT MATTER WHETH ER THE ASSESSEE HAS PURCHASED ASSETS ITSELF OR ONLY A RIGHT TO USE AND IF SO WHETHER THE PAYMENTS AMOUNT TO ROYALTY ? II) WHETHER THE EXPENSES INCURRED FOR MARKET PROSPE CTING COULD BE HELD AS INCURRED FOR OBTAINING TECHNICAL SERVICES A ND LIABLE FOR TAX ? IF SO WHETHER THE PAYMENTS MADE TO FOREIGN COMPANIES WERE LIABLE FOR TDS OR NOT ? III) WHETHER FCCB ISSUE EXPENSES ARE IN THE NATURE OF CAPITAL OR REVENUE ? IV) WHETHER THE ADJUSTMENT OF TELECOMMUNICATION CHA RGES MADE U/S.10A IS JUSTIFIED OR NOT ? 29. WE HEARD SHRI. G. V. GOPALA RAO THE LEARNED CO MMISSIONER OF INCOME-TAX FOR THE REVENUE AND SHRI. V. SRINIVASAN THE CHARTE RED ACCOUNTANT APPEARING FOR THE ASSESSEE. 30.1. THE ISSUE OF DEPRECIATION HAS BEEN DISCUSSED IN DETAIL IN PAGES 02 TO 10 OF THE ASSESSMENT ORDER FOR THE ASSESSMENT YEAR 2005-0 6. THE COMMISSIONER OF INCOME-TAX(A) ALSO HAS EXAMINED THE ISSUE IN DETAIL AS DISCUSSED IN PAGES 03 TO 07 OF HIS ORDER. THE ASSESSING AUTHORITY HAS HELD THAT THE ASSESSEE HAS ACQUIRED ONLY THE RIGHT TO USE THE SOFTWARE PRODUCTS AND TH EREFORE THE PAYMENTS MADE ITA.741 742 774 & 775/B/2010 PAGE - 12 WOULD AMOUNT TO PAYMENT OF ROYALTY WHERE SECTION 9 APPLIES AND CONSEQUENTLY SECTIONS 194J AND 40(A)((I)/40(A)(IA). 30.2. THE COMMISSIONER OF INCOME-TAX(A) HAS HELD TH AT THE ABOVE FINDING WAS BASED ONLY ON CERTAIN CLAUSES OF THE AGREEMENTS AND HE HAS NOT CONSIDERED THE CLAUSES WHICH ENABLED THE ASSESSEE TO EXERCISE THE OPTION TO PURCHASE THE PRODUCTS AND WHERE IN FACT THE ASSESSEE HAD EXERCI SED THE OPTION AND PURCHASED THE PRODUCTS. 30.3. THE NATURE OF THE BUSINESS CARRIED ON BY THE ASSESSEE HAS BEEN DISCUSSED BY THE ASSESSING OFFICER FOR ASSESSMENT Y EAR 2005-06 IN PARA 03 OF HIS ORDER WHICH IS EXTRACTED BELOW : '3. THE ASSESSEE-COMPANY (HEREINAFTER CSIL) WAS EST ABLISHED IN THE YEAR 1991. THE COMPANY STARTED AS A DISTRIBUTO R OF ANTI-VIRUS SOFTWARE IN BANGALORE AND LATER MOVED ON TO BECOME SOLO AUTHORIZED DISTRIBUTOR OF MATLAB IN SOUTH ASIA IN 1993. THE A SSESSEE-COMPANY PROVIDES ENTERPRISE STATISTICAL ANALYTICS AND ENGIN EERING SIMULATION SOFTWARE PRODUCTS AND SOLUTIONS ACROSS THE GLOBE. THE COMPANY'S BUSINESS INTEREST SPAN PRODUCTS PRODUCTIZED SOLUT IONS SERVICES AND R & D IN FUTURE TECHNOLOGIES. CSIL OFFERS A RANGE OF PROPRIETARY PRODUCTS VIZ. SYSTAT SIGMA PLOT SIGMA STAT PEAK FIT ICAPELLA AND OTHER PRODUCTS FROM IBM TEXAS INSTRU MENTS MATHWORKS ETC. ' ITA.741 742 774 & 775/B/2010 PAGE - 13 30.4. THE AGREEMENTS ENTERED IN TO BY THE ASSESSEE HAVE TO BE EXAMINED IN THE BACKGROUND OF THE ABOVE MENTIONED ACTIVITIES OF THE ASSESSEE WHICH PREDOMINANTLY INCLUDE SALE OF PROPRIETARY PRODUCTS OF THE ASSESSEE. THE AGREEMENTS ARE TITLED AS 'SOFTWARE' DISTRIBUTION AN D ASSET PURCHASE AGREEMENT . THE AGREEMENTS THEREAFTER PROVIDES FOR PROCUREMENT OF PRODUCTS ON OUTRIGHT PURCHASE BASIS EVEN THOUGH OPTION IS AVAILABLE FOR LICENCE-ARRANGEMENT AS WELL. THERE IS NO DOUBT THAT THE ASSESSEE HAS EXERCISED I TS OPTION FOR PURCHASES AND THE PRODUCTS WERE ACQUIRED AS PURCHASE OF ASSETS. THE ASSESSEE IS USING THOSE PRODUCTS TO DEVELOP ITS OWN BRANDED PROPRIETARY SOF TWARE PACKAGES. WHILE DISCUSSING THE ISSUE OF MARKETING EXPENDITURE INCUR RED IN EUROPE THE ASSESSING OFFICER HIMSELF HAS ACKNOWLEDGED THE PROMOTION OF A SSESSEE'S PATENTED PRODUCTS LIKE PCATS WITEL AND BWD ASSET (PARA 21 OF TE ASSE SSMENT ORDER). IN PARA 3 OF THE ORDER THE ASSESSING OFFICER HAS REFERRED TO THE PRO PRIETARY PRODUCTS LIKE SYSTAT SIGMA PLOT SIGMA STAT PEAKFIT ICAPELLA ETC 30.5. AS RIGHTLY OBSERVED BY THE COMMISSIONER OF IN COME-TAX(A) THE ASSESSEE HAS EXERCISED ITS OPTION TO PURCHASE THE PRODUCTS. THE PAYMENTS WERE MADE AGAINST PURCHASES. THE PRICING HAS BEEN MADE ON PU RCHASE BASIS. THE ASSESSING AUTHORITY IS SEEN TO HAVE EXAMINED CERTAIN CLAUSES OF THE AGREEMENTS ON SELECTIVE BASIS BY REPRODUCING THE CLAUSES RELATING TO SECURI NG OF A LICENCE TO MODIFY AND MARKET THE SOFTWARE. THE ASSESSING AUTHORITY HAS N OT DISCUSSED THE CLAUSES ITA.741 742 774 & 775/B/2010 PAGE - 14 RELATING TO PURCHASE BY EXERCISING OPTION AND HE HA S ALSO NOT ACKNOWLEDGED THE FACT THAT THE ASSESSEE HAD EXERCISED THE OPTION AND PURCHASED THE PRODUCTS. 30.6. IN THE LIGHT OF THE ABOVE FACTS WE FIND THAT THE COMMISSIONER OF INCOME- TAX(A) IS JUSTIFIED IN HOLDING THAT THE ASSESSEE HA D PURCHASED THE SOFTWARE AND CAPITALIZED THE COST IN ASSET ACCOUNT. THEREFORE HE IS JUSTIFIED IN HOLDING THAT THE PAYMENTS MADE BY THE ASSESSEE AGAINST PURCHASE OF S OFTWARE CANNOT BE HELD AS 'ROYALTY'. THE COMMISSIONER OF INCOME-TAX(A) IS JU STIFIED IN DELETING THE DISALLOWANCE OF DEPRECIATION FOR BOTH THE ASSESSMEN T YEARS UNDER APPEAL. 30.7. THE FIRST ISSUE OF DEPRECIATION ALLOWANCE ON SOFTWARE IS DECIDED IN FAVOUR OF THE ASSESSEE-COMPANY. 31. THE COMMISSIONER OF INCOME-TAX(A) HAS FURTHER H ELD THAT SECTIONS 40(A)(I)/40(A)(IA) DO NOT APPLY TO DEPRECIATION AS DEPRECIATION IS NOT AN EXPENDITURE IN THE NATURE OF INTEREST RENT ROYALT Y FEES MENTIONED IN THOSE SECTIONS AND DEPRECIATION CANNOT BE DISALLOWED FOR VIOLATION OF SECTION 194J. AS THE ISSUE HAS ALREADY BEEN DECIDED ON THE FACTS OF THE CASE THAT SOFTWARE WERE PROCURED AS PURCHASES WE NEED NOT PROCEED TO CONSI DER THE ABOVE LEGAL CONTROVERSY. ITA.741 742 774 & 775/B/2010 PAGE - 15 32. THE COMMISSIONER OF INCOME-TAX(A) HAS FURTHER H ELD THAT FOR THE ASSESSMENT YEAR 2005-06 THE DISALLOWANCE WOULD NOT BE JUSTIFIED AS THE LAW DID NOT INCLUDE ROYALTY WHICH WAS INSERTED ONLY FROM AS SESSMENT YEAR 2006-07. THIS FINDING HOLDS GOOD. 33.1. THE SECOND COMMON ISSUE IS THAT OF PAYMENTS M ADE FOR EXPENSES INCURRED IN MARKET MOBILIZATION. THE PAYMENT OF ` 1 36 44 000/- WAS MADE TO GERMAN COMPANY IN THE ASST.YEAR 2005-06. A SUM OF ` 2 16 76 000/- WAS PAID TO AN INDIAN COMPANY M/S. S2 SOFTTECH PVT. LTD. IN THE ASST. YEAR 2006-07 ` 39 08 79 350/- WAS PAID TO A SINGAPORE COMPANY M/S . AAMER PACIFIC. 33.2. THE PAYMENT WAS MADE TO THE GERMAN COMPANY FO R RENDERING MARKET SUPPORT FOR POSITIONING THE SOFTWARE PRODUCTS AND B RANDING THOSE PRODUCTS FOR THE ASSESSEE IN EUROPEAN MARKET. THE PAYMENT WAS MADE TO THE INDIAN COMPANY TOWARDS MARKET SURVEY AND RESEARCH ACTIVITIES BY CO MPILING CUSTOMER DATA BASE FOR PROMOTING ASSESSEE'S PROPRIETARY PRODUCTS. THE SINGAPORE COMPANY WAS PAID FOR MARKETING AND PROMOTION OF ASSESSEE'S PRODUCTS ABROAD. 33.3. ALL THE SERVICES RENDERED TO THE ASSESSEE TH US ARE PROFESSIONAL AND TECHNICAL IN NATURE. THE PRODUCTS OF THE ASSESSEE-COMPANY AR E SOFTWARE PRODUCTS. THE PROMOTION OF THOSE PRODUCTS IN COMPETITIVE MARKETS REQUIRE TECHNICAL EXPERTISE. ITA.741 742 774 & 775/B/2010 PAGE - 16 MARKET LANDING OF THOSE PRODUCTS CALL FOR ELABORATE MARKETING MANAGEMENT NETWORK AND EXTREME PROFESSIONAL STRATEGY. 33.4. THEREFORE THE PAYMENTS MADE BY THE ASSESSEE COMPANY HAVE BEEN RIGHTLY TREATED AS FEE FOR TECHNICAL SERVICES. 33.5. THIS ISSUE IS DECIDED IN FAVOUR OF THE REVENU E. 33.6. BUT THE GERMAN COMPANY AND SINGAPORE COMPANY DID NOT HAVE ANY PE IN INDIA. PAYMENTS WERE MADE OUTSIDE INDIA. SERVICES WERE RENDERED OUTSIDE INDIA. PROFITS WERE GENERATED IN THE HANDS OF THOSE COMPAN IES OUTSIDE INDIA. 33.7. THE HON'BLE SUPREME COURT IN ISHIKAWAJIMA-HAR IMA HEAVY INDUSTRIES V. DIT (288 ITR 408) (SC) HAS HELD THAT THE SERVICES WHICH ARE SOURCES OF INCOME SOUGHT TO BE TAXED IN INDIA MUST (I) BE UTILIZED IN INDIA AND (II) RENDERED IN INDIA. IN THE PRESENT CASE OF PAYMENTS TO FOREIGN COUNTRIE S BOTH THE CONDITIONS HAVE NOT BEEN SATISFIED SIMULTANEOUSLY. THEREFORE IN THE L IGHT OF ABOVE JUDGEMENT THE EXCEPTION AVAILABLE U/S.9(1)(B) APPLIES TO THE PAYM ENTS MADE TO THE TWO FOREIGN COMPANIES. 33.8. THE HON'BLE JURISDICTIONAL HIGH COURT IN THE CASE OF JINDAL THERMAL POWER COMPANY LTD. V. DCIT (26 DTR 172) (KAR) HAS HELD T HAT THE CRITERIA OF ITA.741 742 774 & 775/B/2010 PAGE - 17 RENDERING SERVICE IN INDIA AND THE UTILIZATION OF S ERVICE IN INDIA LAID DOWN BY HON'BLE SUPREME COURT IN ISHIKAWAJMA'S CASE REMAINS THE SAME IN SPITE OF EXPLANATION INSERTED TO SECTION 9(2). 33.9. THEREFORE THE COMMISSIONER OF INCOME-TAX(A) IS JUSTIFIED IN DELETING THE DISALLOWANCE OF ` 1 36 44 000/- FOR THE ASST. YEAR 2005-06 AND ` 39 08 79 350/- FOR THE ASST. YEAR 2006-07 BEING THE PAYMENTS MADE TO GERMAN COMPANY AND SINGAPORE COMPANY RESPECTIVELY. 33.10.SO ALSO THE COMMISSIONER OF INCOME-TAX(A) IS JUSTIFIED IN CONFIRMING THE DISALLOWANCE OF ` 2 16 76 000/- FOR THE ASST. YEAR 2005-06 BEING THE PAYMENT MADE TO INDIAN COMPANY M/S. S2 SOFTTECH PVT. LTD. 34.1. NEXT IS WHETHER FCCB ISSUE EXPENSES ARE CAPIT AL OR REVENUE IN NATURE. THE ASSESSEE COMPANY HAD INCURRED EXPENSES IN CONNECTIO N WITH THE ISSUE OF FOREIGN CURRENCY CONVERTIBLE BONDS. ASSESSEE CLAIMED THE E XPENSES AS DEDUCTIBLE AS THE EXPENSES WERE INCURRED TO RAISE LOAN FINANCE. THE ASSESSING AUTHORITY HELD THAT THE BOND HOLDERS HAD THE OPTION TO CONVERT THE BOND S TO EQUITY SHARES AND THEREFORE THE COLLECTION OF FUNDS THROUGH THE ISSU E OF BONDS NEEDS TO BE TREATED AS TO INCREASE THE CAPITAL AND THEREFORE THE CONNEC TED EXPENSES WOULD BE CAPITAL IN NATURE AND HENCE DISALLOWED. ITA.741 742 774 & 775/B/2010 PAGE - 18 34.2. WE AGREE WITH THE VIEW OF THE COMMISSIONER OF INCOME-TAX(A) THAT THE EXPENSES ARE NOT CAPITAL IN NATURE. AS ON 31.03.20 06 THE PREVIOUS YEAR ENDING FOR THE ASST. YEAR 2006-07 THE FUNDS COLLECTED BY THE ASSESSEE COMPANY THROUGH THE ISSUE OF FCCB WERE IN THE NATURE OF LIABILITY. THE ASSESSEE COMPANY WAS BOUND TO DISCHARGE THE BONDS ON DUE DATES. THE ASS ESSEE WAS PAYING INTEREST TO BOND-HOLDERS. IT IS CLEAR THAT THE BOND FINANCE WA S IN THE NATURE OF LOAN FINANCE. 34.3. IT BECOMES THE CAPITAL OF THE COMPANY ONLY WH EN THE BOND HOLDERS EXERCISE THEIR OPTION AT THE APPROPRIATE TIME IN FUTURE. TH AT CONVERSION IS ONLY A FUTURE EVENT THAT MAY OR MAY NOT HAPPEN DEPENDING ON THE OPTION EXERCISED BY THE BOND-HOLDERS. THEREFORE THE POSSIBLE EQUITY CHARA CTER OF THE FUNDS WAS CONTINGENT ON THE FACT WHETHER BONDS WOULD BE CONVE RTED OR NOT IN A FUTURE DATE. THE NATURE OF A PRESENT DAY LOAN FUND CANNOT BE HEL D AS EQUITY FUND ON THE BASIS OF SUCH CONTINGENCY. 34.4. AS FAR AS THE NATURE OF THE FUNDS FOR THE ASS T. YEAR 2006-07 IS CONCERNED IT WAS A LIABILITY IN THE NATURE OF LOAN THAT TOO INT EREST BEARING LOAN. IF THE FUNDS ARE TREATED AS EQUITY CAPITAL FOR ASST. YEAR 2006-0 7 HOW THE PAYMENT OF BOND INTEREST WOULD BE JUSTIFIED IN LAW AS LAW DOES NOT PERMIT PAYMENT OF INTEREST ON A COMPANY'S EQUITY CAPITAL. ITA.741 742 774 & 775/B/2010 PAGE - 19 34.5. IN THE FACTS AND CIRCUMSTANCES OF THE CASE T HE ISSUE IS DECIDED IN FAVOUR OF THE ASSESSEE. 35.1. THE NEXT ISSUE IS THAT OF SECTION 10A COMPUT ATION WITH REFERENCE TO TELECOMMUNICATION CHARGES. THE ASSESSING OFFICER H AS EXCLUDED THE CHARGES FROM EXPORT TURNOVER ALONE; NO CORRESPONDING EXCLUS ION IS MADE FROM TOTAL TURNOVER; THEREBY THE ASSESSEE IS LOOSING A MARGINA L AMOUNT IN THE QUANTUM OF SECTION 10A BENEFIT. 35.2 ITAT CHENNAI IN A SPECIAL BENCH DECISION IN T HE CASE OF SAK SOFT LTD. REPORTED IN 313 ITR (AT) 353 HAS HELD THAT THE EXC LUSION MUST BE MADE FROM TOTAL TURNOVER AS WELL. 35.3. IN THE LIGHT OF THE ABOVE SPECIAL BENCH DECIS ION THAT THE ADJUSTMENT MUST BE FACTORED BOTH IN EXPORT AND TOTAL TURNOVER WE DIRE CT THE ASSESSING AUTHORITY TO EXCLUDE THE TELECOMMUNICATION CHARGES FROM TOTAL TU RNOVER AS WELL AND REVISE THE COMPUTATION OF THE QUANTUM OF BENEFIT AVAILABLE U / S.10A. 35.4. THIS ISSUE IS DECIDED IN FAVOUR OF THE ASSESS EE. ITA.741 742 774 & 775/B/2010 PAGE - 20 36. THE GROUNDS RELATING TO THE LEVY OF INTEREST U/ S.234B AND 234C ARE CONSEQUENTIAL WHICH DO NOT CALL FOR ANY FORMAL ADJU DICATION. THEY SHALL BE CONSIDERED BY THE ASSESSING AUTHORITY IN ACCORDANCE WITH LAW. 37. IN RESULT : APPEAL OF THE ASSESSEE FOR A. Y. 2005-06 IS DISMISS ED. APPEAL OF THE ASSESSEE FOR A. Y.2006-07 IS ALLOWED. APPEALS OF REVENUE FOR A.YS. 2005-06 & 2006-07 ARE DISMISSED. ORDER PRONOUNCED ON TUESDAY THE 08TH DAY OF FEBRUA RY 2011 AT BANGALORE. SD/- SD/- (P. MADHAVI DEVI) (DR. O. K. NARAYANAN) JUDICIAL MEMBER VICE PRESIDENT