Saktijit Dey, Judicial Member

1. These two appeals by assessee are directed against assessment orders passed u/s 143(3) read with section 92CA(3) and 144C(13) of the Act for the Ays 2008-09 and 2009-10.

ITA No. 1780/Hyd/2012 for Ay 2008-09

2. In this appeal assessee has raised seven grounds. Ground Nos. 1 & 7 being general in nature, do not require any specific adjudication. Ground No. 2 has three sub-grounds. Sub-ground No. (i) is in relation to disallowance of Rs. 14,98,07,749 being payment towards consultancy charges by determining Arms Length Price (ALP) at Nil. Sub-ground No. (ii) is in relation to selection of two comparables, i.e., M/s Infosys Technologies Ltd. and Wipro Ltd. In sub-ground No. (iii) though, assessee raised the issue of disallowance made u/s 40(a)(i) for an amount of Rs. 14,98,07,749, but, subsequently, in course of hearing, ld. AR admitted that the said ground has been mistakenly raised as there is no disallowance made u/as 40(a)(i) of the Act. In addition to the issues in ground No.2, assessee also raised two additional grounds as under:

"(1) The TPO and the Honble DRP and the AO erred in determining the arms length price of the so called consultancy charges paid by the appellant company to its non resident subsidiaries at NIL as against the claim by the appellant of Rs. 14,98,07,749.

(1.1) The said authorities ought to have realized that the so called consultancy charges were actually payments made by the appellant to its foreign subsidiaries for the software services rendered by them."

Additional ground which corresponds to sub-ground No. (i) will be dealt with at a later stage while considering the issue of determination of ALP for consultancy charges paid of Rs. 14,98,07,749 at Nil.

3. Briefly the facts relating to the issue raised in sub-ground Nos. (i) & (ii) are, assessee an Indian company incorporated as private limited company in August, 1991 was subsequently converted to a public ltd. company in the year 1997. Assessee has various subsidiaries located in USA and Europe to provide software development services to its clients. Assessee basically is a global technology services and solutions company specialized in geospatial, engineering design and IT solutions. Assessee operates under two vertical business segments i.e. UTG (utilities, transportation, government) and EMI (Engineering, manufacturing and industrial products). Assessees range of services include digitization of drawings and maps, photogrammetry, computer aided design/engineering reverse engineering (CAD/CAE), design and modeling, repair development engineering, software products development consulting and implementation. For the AY under consideration, assessee filed its return of income on 24/09/2008 declaring total income of Rs. 24,44,28,898 after claiming deduction u/s 10A of the Act. In course of assessment proceeding, AO while examining the financials of the company noticed that assessee has earned revenue from international transactions entered with its AEs as under:

RevenueRs. 438,22,27,819

CostRs. 379,58,49,475

PBITRs. 58,63,78,344

PBIT as % of Cost15.45%





3.1 AO, therefore, referred the matter to the Transfer Pricing Officer (TPO for determining ALP of the international transactions. During the proceeding before him, TPO called for various informations and submissions from assessee. On examining the TP study done by assessee through external consultant, he noticed that assessee has selected itself as the tested party and adopted Transaction Net Margin Method (TNMM) as most appropriate method with operating profit to operating cost as the profit level indicator (PLI). Assessee selected 16 comparable companies from the databases with weighted average margin of 12%. As margin of assessee was shown at 15.45%, the price charged by assessee was found to be within the arms length as per TP report. TPO, though, accepted TNMM as the most appropriate method, for bench marking the transactions pertaining to sales of services and payment towards consultancy services, but, he nevertheless found the approach adopted by assessee in selecting comparables unacceptable. TPO termed the TP study report of assessee as unreliable and rejected the same. After rejecting the TP study report of assessee, TPO embarked upon a selection process himself by applying certain additional filters and the search process yielded 19 comparable companies (including three selected by assessee) with arithmetic mean of 26.20%. After allowing working capital adjustment of 0.11%, the adjusted arithmetic PLI was worked out at 26.09%. By applying the adjusted arithmetic mean PLI to the operating cost, ALP was determined at Rs. 483,32,88,400 after excluding the sales to non-AEs of Rs. 221,49,20,530, ALP of sales to AEs was determined at Rs. 261,83,67,870 as against the price shown by assessee of Rs. 216,73,07,289. Thus, the shortfall of Rs. 45,10,60,581 was treated as adjustment to be made u/s 92CA of the Act.

3.2 As far as the payment of Rs. 14,98,07,749 towards consultancy services (intra group services) is concerned, TPO observed that assessee is the parent company and the companies from whom services were claimed to have been received are as subsidiary. He observed that on the one hand assessee claimed to have rendered software development services to the same subsidiaries and on the other hand it claims of receiving consultancy services from them. TPO observed that assessee could not substantiate whether there was any need for consultancy services and if required whether such services were actually rendered and if rendered whether there are any benefits to assessee in terms of higher profits. Further, he observed that if at all there was any benefit from availing such services, whether the payment made is commensurate with benefits derived. Expressing his view as above, TPO proceeded to determine ALP of the payment made towards consultancy services at Rs. Nil. However, since adjustment on account of the said transaction has already got merged in the adjustment proposed by him u/s 92CA, no separate adjustment was made by him. In terms with the order passed by TPO, AO passed draft assessment order incorporating the addition proposed by TPO towards TP adjustment. That besides, AO also made various other additions, adjustments on non TP issues. Being aggrieved of the draft assessment order, assessee filed objections before ld. Dispute Resolution Panel (DRP).

4. As far as the determination of ALP of consultancy charges of Rs. 14,98,07,749 at Nil, ld. DRP dealt with the issue as under:

"43.3 The TPO dealt with the payment of Rs. 14,98,09,749 towards consultancy charges from para 30 to 37.7 of his order. The assessee did not raise any ground in respect of this issue and also did not make any submissions about the findings of the TPO. The TPO gave a finding that the taxpayer did not substantiate the consultancy services rendered by the AE. And also observed that the payment made towards consultancy services merged with the adjustment made in respect of transactions pertaining to sale of development services for a sum of Rs. 45,10,60,581. Thus, a separate adjustment was not made by TPO and the benefit of telescope was given to the taxpayer. Therefore, the AO is directed while reworking the adjustment u/s 92CA, the total adjustment on application of arithmetic mean PLI should not go down below a sum of Rs. 14,98,07,749. However, the adjustment u/s 92CA can be higher than this sum."

5. As far as the objections of assessee with regard to selection of certain comparables is concerned, ld. DRP after considering the same, accepted assessees objections with regard to one of the comparable companies M/s Celestial Bio Labs Ltd. and directed TPO to exclude the same. In respect of two other companies, namely, Kals Information Systems Ltd. and Softsol India Ltd., though ld. DRP upheld the selection of these companies as comparables, but, directed TPO to take the margin of these two companies at 30.92% and 25.78% respectively.

6. Addressing on the issue of determination of ALP of consultancy charges at Nil, ld. AR submitted before us, the finding of TPO and ld. DRP on the issue has no basis of law. It was submitted, though the amount of Rs. 14,98,07,749 is described in the account as consultancy charges paid by assessee to non-resident subsidiaries, but, actually the payment was made for the software development services rendered by them. Ld. AR referring to the master services agreement entered with M/s Pratt and Whitney, USA and the agreement entered into between assessee and its subsidiary in USA, submitted before us, assessee has obtained some orders from M/s Pratt and Whitney, USA for development of certain software. A portion of the software development work obtained from M/s Pratt & Whitney was parceled out to its subsidiary in USA and the payments made were towards services rendered by subsidiary towards software development services. Thus, in reality, there was no consultancy charged paid by assessee to the subsidiaries. Thus, it was submitted, determination of ALP of the payment made towards software development services at Nil by treating the same as consultancy charges is not only illegal but unreasonable. Ld. AR submitted, in the preceding AYs 2006-07 and 2007-08 also payments were made by assessee to foreign subsidiaries towards similar software development services rendered by them. However, TPO though verified the international transaction did not make any adjustment as far as such payments are concerned, whereas, AO in the draft assessment order disallowed the payments made by applying provisions of sec. 40(a)(i) of the Act. When the disallowance made ultimately came up for consideration before the ITAT in those AYs, ITAT vide its order passed in ITA Nos. 115 & 2184/Hyd/2011 dated 16/01/2014 Infotech Enterprises Ltd. v. Addl. CIT [2014] 63 SOT 23/41 taxmann.com 364 (Hyd.), after examining the nature of payment, as well as analyzing the master service agreement and intra group company agreement and also keeping in view the provisions of section 195 read with section 9 of the IT Act and Indo-USA DTAA held that the payments made being towards software development services rendered by companies outside India are not taxable in India. Thus, it was submitted by ld. AR, since the payments made was towards software development services rendered by foreign subsidiaries and not towards any consultancy charges, ALP cannot be determined at Nil. Ld. AR submitted, same view was again expressed by ITAT while deciding the issue in assessees own case for AYs 2002-03, 2004-05 and 2005-06 in ITA Nos. 1450, 1452 & 1453/H/13 dated 25/03/15.

7. Ld. DR contesting the submissions made by assessees counsel submitted before us, assessee cannot raise the ground at this stage as assessee never objected to the determination of ALP of the consultancy charges at nil by raising any ground before ld. DRP. In this context, she specifically referred to the observations of ld. DRP in para 43.3. Thus, it was submitted by ld. Dr, since assessee did not raise any specific ground before ld. DRP on the issue, he cannot raise the same for the first time before ITAT.

8. In the rejoinder as well as in the petition filed seeking to raise additional ground, though, ld. AR accepted the fact that no direct ground assailing the determination of ALP of consultancy charges at Nil was raised before ld. DRP, inadvertently, however, he submitted as the issue relating to disallowance of consultancy charges of Rs. 14,98,07,749 was merged into the addition of Rs. 45,10,65,081 on account of TP adjustment, the issue relating to determination of ALP at nil cannot be looked into in an isolated manner. Thus, he requested for consideration of the additional ground raised on the issue.

9. We have considered the submissions of the parties and perused the orders of revenue authorities as well as other material on record. At the outset, the issue relating to admission of additional ground needs to be resolved. It is a fact on record that assessee has specifically not raised any objection before ld. DRP with reference to determination of ALP of so called consultancy charges of Rs. 14,98,0-7,749 at Nil. Though, in course of hearing, ld. AR submitted before us, in the written submissions filed before ld. DRP assessee has raised the issue, but, on careful perusal of the said written submission we do not find any reference to the issue. Thus, it can be held that assessee has not specifically raised the issue of disallowance of consultancy charges at Nil before ld. DRP. Having held so, it is to be decided whether assessee can raise such issue by way of additional ground. As can be seen, TPO has determined the ALP of consultancy charges at Nil by applying the benefit test. However, it is the specific claim of assessee before us that the amount of Rs. 14,98,07,749 paid to foreign subsidiaries were not consultancy charges, but, towards rendering software development services for a portion of work sub-contracted to them. On perusal of the master service agreement between assessee and M/s Pratt & Whitney, a copy of which is at page 354 of paper book and the agreement between assessee and its foreign subsidiaries in USA, a copy of which is at page 372, the contention of assessee to certain extent appears to be correct. Further, sample invoices enclosed in the paper book also bear testimony to this fact. It is further evident from record that in the preceding AYs i.e. AY 2006-07 and 2007-08 though the international transactions of assessee were examined by TPO, but, similar payments made to foreign subsidiaries were accepted by him without making any adjustment. Of course, AO in the draft assessment order disallowed the payments made by applying the provisions of section 40(a)(i) by treating them as royalty. When the matter came up for consideration before the coordinate bench in appeals preferred by assessee, the coordinate bench after considering the nature of payment as found from the relevant agreements and considered in the context of statutory provisions as well as Indo-USA DTAA, held as under:

35. We have heard both the parties. We find that the A.O. disallowed the amount of Rs.19,48,02,907/- on the ground that there is a business connection in terms of Explanation 2 to Section 9(1)(i) of the I.T. Act, between the assessee and its concerned foreign subsidiaries to whom the said amount has been paid. He held that the assessee has been "habitually/ securing orders in India for the benefit of non-resident in terms of clause (c) of the said Explanation.

36. With respect to IEAI USA, we find that factually the assessee has secured the orders from PRATT (PWC) for its own benefit and it only parcelled out a portion of the work entrusted to it by PRATT & WHITNEY to IEAI USA. The said Explanation to Section 9(1)(i) can be invoked only when the Indian company secures orders for the benefit of non-resident. In the present case, the assessee has not canvassed / secured any orders for its non resident subsidiaries. Hence, section 9(1)(i) cannot be invoked.

37. We have gone through the copy of the "Master Terms Agreement" (in short "MTA") entered into by the assessee with United Technology Corporation (PWC) which is filed at pages 179 to 196 of the paper book. Similarly, we have perused intercompany agreement entered into by the assessee with its subsidiaries placed in the paper book at page 197 to 222. This proves that the assessee obtained orders on its own behalf and it has only parcelled out a portion of its work to its foreign subsidiaries. As per the terms of the agreement, the assessee "shall release the work order" before the commencement of the work by IEAI USA and each work order shall be supported by end customers order copy. Clause 3 of the agreement reads as under :

"Commencing on the date(s) specified in each Work Order, IEAI will allocate qualified personnel through Software Services requirements statements and regular project meetings, which may be modified from time to time by IEL. IEAI shall inform IEL at the time of the request, or as soon thereafter as that the information becomes available, should it be unable to deliver the qualified personnel specified in the Work Order. Parties shall within 30 days negotiate in good faith a revised Work Order mutually agreeable to both parties, however if no such agreement can be reached either party may terminate that work order according to provisions of section 1. Obligations of IEL and IEAI under this agreement are detailed in the Annexure."

38. Further, we find that the TPO has found that the operation transaction were effected at arms length price. We also observe that the foreign subsidiaries do not work exclusively for the assessee and they obtain orders on their own from other foreign parties and also sub contract the work to the assessee depending on exigencies.

39. We also find that no operations have been undertaken by foreign subsidiaries in India and no engineers have been deputed by them to India and even they do not have permanent establishment in India. In terms of the respective DTAA, no income of the foreign subsidiary is taxable in India in terms of either section 9(1)(i) of the I.T. Act or the concerned Articles relating to business profits (Article 7 r.w. Article 5) in the respective DTAAs. As submitted by the assessee, the Board Circular No. 29 dated 27.3.1969 is inapplicable to the present case as the example given by the Board, the non-resident is the parent company whereas, in the present case, the Indian Company is the parent company and the assessee has not sold the products of its US subsidiaries or any other foreign subsidiaries. The contention of the assessee that the rate of tax in India is lesser than the rates in USA is also well taken. Hence there is no income taxable in India u/s 9(1)(i) and hence no requirement for TDS and there can be no application of S.40(a)(i).

40. The AO seems to have invoked S.9(1)(vii) only on the communication expenses incurred and in such a case the assessee is right in as much as said amount of communication expenses should be excluded while assessing the purview of taxability of income u/S.9(1)(i). However, we point out that the DRP in its order seem to have held that the entire amount paid by assessee to its foreign companies may be regarded as Fees for Technical Services u/S.9(1)(vii). So while we have held already that S.9(1)(i) is inapplicable in the instant case, we now have to deal with the alternate of the entire amount being disallowed u/S.9(1)(vii) (or Article 12) as Fees for Technical Services.

41. Firstly, under the Act, the payments made to the subsidiaries may indeed be construed as Fees for Technical Services. However this is only due to the fact of the retrospective amendment by Finance Act 2010. Prior to that, the Honble Supreme Court in Ishikawajima-Harima Heavy Industries Ltd., v. DIT [2007] [288 ITR 408 ] had held that Section 9(1)(vii) as it stood then envisaged two conditions which need to be met simultaneously namely that services have to be rendered in India and said services have to be utilized in India. The Apex Court held that merely the "source" of income being located in India would not render sufficient nexus to tax the income from that source. The Apex Court held that there must be a direct live link between the services rendered and India. The Government subsequently introduced a retrospective amendment in Finance Act 2007 which read

"for the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clause (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non resident has a residence or place of business or business connection in India"

-to overcome the effect of the Ishikawajima-Harima decision (supra) but in the decisions of Clifford Chance v. DCIT (176 Taxmann 458) as well as Jindal Thermal Power Company v. DCIT (182 Taxmann 252 Karnataka HC) it was held that the Finance Act 2007 amendment did not changeIshikawajimas (supra) application. In response, the Government subsequently introduced a modified Explanation to S.9(1) via Finance Act 2010 and it stands till date reading as under:

"Explanation. - For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India."

42. Thus, it is seen clearly that at the time of the payment in the instant case Ishikawajima-Harima (supra) was the law of the land and the twin condition laid down of rendering and utilizing the technical service in India was clearly not satisfied in the assessees case as the foreign subsidiaries rendered the service which was utilized by the clients (such as PWC). Thus the assessee could have been of the bonafide belief that TDS was not necessary on payments to the foreign subsidiaries. Furthermore, the assessee could not have been expected to know that TDS should have been deducted in accordance with a law that was to be brought in subsequently. Hence any disallowance u/s 40(a)(i) based on the application of a retrospective amendment which the assessee could not have foreseen is wholly erroneous. This rationale is upheld by various decisions of the Tribunals which we rely on such as Channel Guide (139 ITD 49) & Sterling Abrasives (IT No.2243, 2244/Ahd/ 2008 dated 23-12-2010) and Metro & Metro v.. ACIT (ITA No.393/Agra/2012 dated 1-11-2013). Hence under the Act the disallowance u/s 40(a)(i) for FTS payments cannot be upheld.

43. We also point that even under the India-USA and India-UK treaties (not the India-Germany treaty though) due to the presence of the "make available" clause in these two Treaties the payments made by the assessee will not fall under FTS. This is because no technical knowledge has been made available by the non-resident to the assessee. Further, no technical plan or technical design placement has been transferred by US subsidiary to the assessee. What IEAI did was only in fulfilment of contractual requirement with PRATT & WHITNEY and not for the benefit of the assessee. The non resident has simply executed the portion of work parcelled out to it by the assessee. The Karnataka High Court in CIT v. De Beers India Minerals Pvt. Ltd. (ITA No.549 of 2007 dated 15th May 2012) lucidly explained the concept of "make available" as follows:

"What is the meaning of make available. The technical or consultancy service rendered should be of such a nature that it "makes available" to the recipient technical knowledge, know-how and the like. The service should be aimed at and result in transmitting technical knowledge, etc., so that the payer of the service could derive an enduring benefit and utilize the knowledge or know-how on his own in future without the aid of the service provider. In other words, to fit into the terminology "making available", the technical knowledge, skills, etc., must remain with the person receiving the services even after the particular contract comes to an end. It is not enough that the services offered are the product of intense technological effort and a lot of technical knowledge and experience of the service provider have gone into it. The technical knowledge or skills of the provider should be imparted to and absorbed by the receiver so that the receiver can deploy similar technology or techniques in the future without depending upon the provider. Technology will be considered "made available" when the person acquiring the service is enabled to apply the technology. The fact that the provision of the service that may require technical knowledge, skills, etc., does not mean that technology is made available to the person purchasing the service, within the meaning of paragraph (4)(b). Similarly, the use of a product which embodies technology shall not per se be considered to make the technology available. In other words, payment of consideration would be regarded as "fee for technical included services" only if the twin test of rendering services and making technical knowledge available at the same time is satisfied."

44. In the instant case, the UK and USA subsidiaries did only contractual work parcelled out to it whose results were given to clients directly and no technical knowledge was made available to assessee. Hence, even under the respective DTAA, the payments made to UK and US subsidiaries/companies would not fall under the ambit of FTS.

From the finding of the coordinate bench as aforesaid, it is clearly evident that the payments made by assessee to its foreign subsidiaries were towards software development services rendered by them on the portion of work sub-contracted by assessee to them. Thus, if the so called consultancy charges of Rs. 14,98,07,749 paid in the impugned AY are of identical nature, then, it cannot be treated as consultancy charges simpliciter Further, it is relevant to note that though similar payments were made even in the subsequent AY 2009-10, TPO has not determined the ALP of such payments at nil. In view of the aforesaid factual position, since the issue raised by assessee goes to the root of the matter as it is inextricably linked with the ultimate determination of TP adjustment made by TPO and since the primary/basic facts relating to such issue are already available on record, in our view, the additional grounds raised by assessee required to be admitted in consonance with the principle decided by the Honble Supreme Court in case of NTPC Ltd. v. CIT [1998] 229 ITR 383 (SC) . However, since this issue was not raised by assessee before ld. DRP and was raised for the first time before us, in the interest of fair play and justice, we remit the issue back to the file of TPO to decide afresh after examining the agreements between assessee and M/s Pratt & Whitney as well as assessee and its subsidiaries and other evidences brought on record by assessee. Further while deciding the issue, TPO must keep in view the findings of the coordinate bench in assessees own case for AYs 2006-07, 2007-08 in ITA Nos. 115 & 2184/Hyd/2011 Infotech Enterprises Ltd. (supra) and for AYs 2002-03, 2004-05 and 2005-06 in ITA Nos 1450, 1452, 1451 & 1453/Hyd/2013. The assessee must be given an opportunity of being heard. Thus, the additional grounds raised along with sub-ground No. (i) of Ground No. 2 are considered to be allowed for statistical purposes.

10. As far as sub-ground no. (ii) of Ground No. 2 is concerned, assessee has objected to selection of Infosys Technologies Ltd and Wipro Ltd. Ld. AR submitted before us, these two companies cannot be treated as comparables to assessee as the turnover of these companies are huge and these companies are in a different league. Ld. AR submitted, while the turnover of Infosys Technologies Ltd. during the year was Rs. 15,677 crores that of Wipro Ltd. was Rs. 11,258, whereas, assessees turnover is only Rs. 435 crores. Thus, the turnover of these two companies being in excess of 10 times of assessees turnover, these two companies cannot be treated as comparable to assessee. For such proposition, ld. AR relied upon the decision of Honble Delhi High Court in case of CIT v. Agnity India Technologies (P.) Ltd,[2013] 219 Taxman 26 /36 taxmann.com 289 and a number of decisions of ITAT as referred to in the revised written submissions.

11. Ld. DR, on the other hand, submitted before us, two companies objected to by assessee cannot be treated as uncomparable only on the basis of turnover. Referring to the reasoning of the TPO/DRP, ld. DR submitted, turnover has no significant effect as far as margins are concerned.

12. We have considered the submissions of the parties and perused the materials on record as well as the orders of revenue authorities. We agree with the submission of ld. DR that only on the basis of turnover a company cannot be treated as uncomparable. More so, when assessees turnover is also equally high. Even otherwise also, as can be seen, TPO has selected some comparables with very less turnover compared to assessee. A reference of few such companies are as under:

1.Avani TechnologiesRs. 2.93 crore

2.E-Zest SolutionsRs. 7.66 crores

3.Kals Information SystemsRs. 2.05 crores

4.Bodhtree Solutions Ltd.Rs. 10.43 crores

5.Soft Solutions Ltd.Rs. 23.47 crores





As can be seen, the difference in turnover between assessee in comparison to Infosys Technologies Ltd and Wipro Ltd. is more or less in the same range as the difference between the turnover of assessee and companies referred to hereinabove. Thus, on the basis of turnover alone, these two companies cannot be treated as uncomparable considering the fact that assessee has no problem with selection of companies with very low turnover. However, it is worth mentioning, Infosys Technologies Ltd and Wipro Ltd are uncomparable to assessee for various other factors such as brand name, economy of scales, goodwill, diversified activities, owning of intangibles. It is accepted fact that these two companies are leading software companies and have carved out a separate place for themselves. They are in their own league and cannot be compared to any other software development company. The Honble Delhi High Court in case of Agnity India Ltd. (supra) has also observed that big companies like Infosys cannot be considered as comparable to other software development companies. Different benches of ITAT have also expressed similar view while examining the comparability of Infosys Technologies Ltd and Wipro Ltd. In view of the aforesaid, we direct TPO to exclude these two companies from the list of comparables. In view of the above TPO is directed to compute, ALP afresh interms with the observations made by us hereinabove.

13. In Ground No. 3, assessee has challenged the disallowance of an amount of Rs. 2,29,78,128 u/s 40(a)(i) of the Act.

14. Briefly the facts are, during the assessment proceeding, AO noticed that assessee has debited an amount of Rs. 5,02,70,792 towards purchase of computer software. On verification of the details submitted by assessee in response to query raised by AO, it was found that out of such sum debited to P&L A/c, an amount of Rs. 2,29,78,128 represents payments made to non-resident companies towards software licenses. AO being of the view that aforesaid payment made by assessee being in the nature of royalty as explained in section 9(1)(vi), assessee was required to deduct tax u/s 195 of the Act. As assessee has not withheld tax on such payments, AO proposed to disallow the amount claimed as expenditure by applying section 40(a)(i) of the Act. Though, assessee objecting to the proposed disallowance advanced elaborate arguments explaining that the payments cannot be treated as royalty, AO rejecting all contentions of assessee disallowed the amount of Rs. 2,29,78,128 u/s 40(a)(i) by holding that since payment made is in the nature of royalty, assessee was required to deduct tax u/s 195 of the Act. Being aggrieved of such disallowance assessee raised objections before ld. DRP. However, ld. DRP following its decision in AY 2006-07 and 2007-08 sustained the disallowance.

15. Ld. AR more or less reiterating the submissions made before departmental authorities submitted, assessee had purchased a software called small world software from M/s G.E. Network Solutions, Netherland and bundled it with its own software and thus customized it and sold it to its own customers both in India and abroad. It was submitted, M/s G.E. Network Solutions, Netherland neither has any permanent establishment in India nor has any business activity giving rise to taxable income in India. Thus, it was submitted, the provisions of section 195 are not applicable to the payments made to M/s G.E. Network Solutions, Netherland. Ld. AR further submitted, the issue is squarely covered in favour of assessee by the order of ITAT, Hyderabad Benches in assessees own case for AY 2006-07 and 2007-08 wherein the Tribunal after analyisng the facts and also the nature of payments as well as keeping in view the Double Taxation Avoidance Agreement (DTTA) between India and Netherlands held that no tax is required to be deducted at source u/s 195 of the Act, hence deleted the addition. He submitted, the view expressed by the Tribunal also was upheld by the Jurisdictional High Court while dismissing departments appeal in order dated 25/07/14 passed in ITTA No. 485 of 2014. Ld. AR further submitted, the same view was reiterated by ITAT while deciding assessees appeal on identical issue in AYs 2004-05 and 2005-06 in ITA Nos. 1451 to 1453/Hyd/2013.

16. Ld. DR, on the other hand, while accepting the fact that the issue is covered by the decisions of ITAT nevertheless relied upon the reasoning of the AO as well as ld. DRP.

17. We have considered the submissions of the parties and perused the material on record. There is no dispute to the factual aspect that an amount of Rs. 2,29,78,128 was paid to M/s G.E. Network Solutions, Netherlands towards purchase of a software called small world software. The department has also not controverted the fact that M/s G.E. Network Solutions, Netherlands neither has permanent establishment in India nor has any business activity in India giving rise to income taxable under the Indian Income-tax Act. It is further evident from the record that ld. DRP while confirming the disallowance has relied upon its finding in AY 2006-07 and 2007-08. It will be pertinent to mention here, when similar issue relating to disallowance of amounts paid to M/s G.E. Network Solutions, Netherlands towards purchase of small world software came up for consideration before the ITAT in assessees own case for AYs 2006-07 and 2007-08, the Tribunal after considering the nature of payment and going through the Indo-Netherlands DTAA in the context of provisions contained u/s 195 read with section 9(1)(vi) of the Act, held that the payments made by assessee to M/s G.E. Network Solutions, Netherlands is not in the nature of royalty. Further, the Tribunal held that when the payment made to non residents is not assessable to tax under the Indian Income-tax Act, there cannot be any withholding of tax u/s 195 and consequentially no disallowance can be made u/s 40(a)(i). The findings of the coordinate bench are extracted hereunder for the sake of convenience:

"24. We have heard the parties and perused the material available on record. We find that the decision in the case of GE India Technology Centre Pvt. Ltd. v. CIT 327 ITR 456 has clearly stated that the obligation to deduct tax at source is however limited to appropriate proportion of income chargeable under the Act forming part of the gross sum of money payable to the non-resident. In other words, if the tax is not so assessable, there is no question of tax at source being deducted. Hence, the short point is that one has to see whether the amount of Rs.52,55,881/- represents amount chargeable to tax in the hands of the non-resident both in terms of sec.9(1)(i) and 9(1)(vi) of the I.T. Act and also DTAA between India and Netherlands.

25. We find that the amount in question is not taxable u/s 9(1)(i) because even assuming for a moment there is a business connection between the assessee and the foreign software supplier there are no operations in India of the foreign company to which income may be reasonably attributed to as required under Explanation 1(a) to section 9(1)(i). Hence we find there is no applicability of S.9(1)(i) in the instant case.

26. Now we address the issue of characterization of these payments as Royalty so as to fall under Section 9(1)(vi) or Article 12 of India-Netherlands DTAA. We find that the assessee has purchased the Small World Software from Netherlands and bundled it with its own software and thus customised it and sold it to its own customers both in India and abroad. The assessee cannot meddle with the copies of the software in the process of its customization. We also observe that the assessee has to purchase the said software each time it wanted to sell the bundled software to its customers and if it had got any right to the copyright to the said software it would not have bought it every time when it wanted to sell. Further, perusing the books of the assessee at pages 170 to 175 of the paper book, we find that there are multiple purchases of software during the year and each purchase of single item on software is merely one thousand rupees and not huge amount. Hence, we are of the opinion that they are simply purchase cost of trading goods especially when the licence in respect of software is not obtained by the assessee and the perpetual licence is given directly to the end customer by the vendor company. Copies of the invoice raised by Net Work Solutions on the assessee and at paper book 176 to 178 support the view of the assessee where the invoice mentioning name of the end customer supports our view. Hence, in our opinion, when there is no transfer of even the license to the assessee even though it is the purchaser, it cannot be said that there is any royalty payment by the assessee to the vendor company. The amount of Rs.52,55,81/- is simply the cost of imported trading goods and not royalty payment.

27. It is therefore clear that the payments made by assessee to the Netherlands company will not fall under the ambit of Royalty as per Article 12 of the India-Netherlands DTAA. Hence there is no question of tax withholding required by the assessee and hence S.40(a)(i) disallowance is erroneous. Accordingly, ground No.5 is allowed."

It is worth mentioning, department challenged the aforesaid decision of the coordinate bench by filing an appeal before the jurisdictional high court. The Honble High Court, however, dismissed the appeal of the department on this issue by upholding the view expressed by the coordinate bench. Further, the coordinate bench deleted similar disallowances made in AYs 2004-05 and 2005-06 in ITA Nos. 1450 to 1453/Hyd/2013 dated 25/03/2015 expressing similar view. As the ld. DR has not brought to our notice any material difference in the facts in the impugned AY, respectfully following the decisions of the coordinate bench and the jurisdictional high court, we delete the addition made of Rs. 2,29,78,128. Thus, this ground raised by assessee is allowed.

18. In Ground No. 4, assessee has challenged the decision of TPO/ld.DRP in excluding the communication expenses from the export turnover while granting deduction u/s 10A.

19. We have considered the submissions of the parties and perused the materials on record. This issue is squarely covered by the decision of the Honble Bombay High Court in case of CIT v. Gemplus Jewellery[2011] 330 ITR 175 /[2010] 194 Taxman 192 and ITO v. Saksoft Ltd. [2009] 30 SOT 55 (Chennai)(SB). Following the ratio laid down in the aforesaid judgments, we direct the AO to exclude the communication expenses from export turnover as well as total turnover while computing deduction u/s 10A of the Act.

20. Ground No. 5 is in respect of disallowance of guest house maintenance expenditure of Rs. 18,28,883.

21. As can be seen, in course of the assessment proceeding, AO noticed that assessee has debited an amount of Rs. 18,23,883 to the P&L a/c towards guest house maintenance . As observed by AO, though, assessee was asked to prove the details of expenditure with documentary evidence, assessee failed to produce the same. In absence of any evidence to substantiate the claim of expenditure, AO disallowed the same and added back to the total income of assessee. Ld. DRP also sustained the addition.

22. We have considered the submissions of the parties and perused the materials on record. Undisputedly, though, assessee has claimed the expenditure towards maintenance of guest house, but, he has failed to furnish any documentary evidence towards claim of such expenditure. Therefore, assessees claim of expenditure cannot be allowed in full. However, considering the fact that assessee maintains guest house and some expenditure must have been incurred towards maintenance of the same. It will be reasonable to allow 50% of the expenditure claimed. Accordingly, we direct AO to sustain the addition to the extent of 50% of the expenditure claimed by assessee. This ground is partly allowed.

23. In Ground No. 6, assessee has challenged the disallowance of picnic expenditure of Rs. 11,27,340. This issue is similar to ground No. 5. Following the decision therein, we direct AO to sustain the addition to the extent of 50% of the expenditure claimed by assessee.

ITA No. 395/Hyd/2014 for AY 2009-10

24. Ground No. 1 & 7 being general, do not require any specific adjudication, hence, they are dismissed.

25. In Ground No. 2, assessee has challenged the disallowance of an amount of Rs. 49,81,113 u/s 40(a)(i) of the Act.

26. We have heard the parties and perused the materials on record. This issue is identical to the issue raised by assessee in Ground No. 3 of ITA No. 1780/Hyd/14, following our decision therein as expressed in para No. 17 Of the order we delete the addition made by AO.

27. In Ground No. 3, assessee has challenged the disallowance of consultancy fees of Rs. 17,11,39,243 paid to its foreign subsidiaries by invoking the provisions of section 40(a)(i).

28. Briefly the facts are, during the assessment proceeding, while examining the financial statement of assessee, AO noticed that assessee has claimed professional service charges paid to the tune of Rs. 38,40,02,762, out of which an amount of Rs. 17,11,39,243 represented technical consultancy charges paid in foreign exchange to outside India. On further verification of the information submitted by assessee, it was noticed by AO that assessee has paid such consultancy fees to its foreign subsidiaries without deducting tax at source as per section 195. He, therefore, proposed to disallow the same by invoking section 40(a)(i) of the Act. Though, assessee strongly objected to the proposed disallowance, but, AO rejecting the contentions of assessee, disallowed the amount of Rs. 17,11,39,243 u/s 40(a)(i) by alleging violation of section 195 of the Act. Though, assessee objected to such disallowance before ld. DRP, but, ld. DRP without any detailed reasoning upheld the disallowance made by AO.

29. Ld. AR submitted before us, though the amount disallowed is described as consultancy charges, but, they are actually software development charges paid by assessee to its non-resident subsidiaries for the work done by them. Referring to the details of work done and payments made, ld. AR submitted, assessee had a contractual agreement with United Technologies ( Pratt and Whitney), USA to render some software development services. It was submitted, in the process of fulfilling the contractual obligations, assessee parceled out a portion of work to its non-resident subsidiaries for rendering onsite services and the payments made were towards services rendered by subsidiaries for software development work sub-contracted to them. In this context, ld. AR drew our attention to the Master Service Agreement between assessee and United Technologies (Pratt and Whitney), sales agreement entered by assessee with its subsidiaries. Ld. AR submitted, assessee has not obtained orders for the non-resident subsidiaries. In fact the orders were obtained by assessee itself and only a portion of the work was sub-contracted to non-resident subsidiaries for convenience and to meet delivery schedules. Ld. AR submitted, the issue is more or less covered by the decision of the ITAT, Hyderabad Benches in assessees own case for AY 2006-07 and 2007-08 in ITA Nos. 115 & 2184/Hyd/2011 dated 16/01/14 Infotech Enterprise Ltd. (supra) as the Tribunal while considering similar disallowance made in these assessment years deleted the additions while holding that payments made were towards software development charges and not consultancy charges. Ld. AR submitted, the order passed by the Tribunal on this issue was accepted by the department as no appeal was preferred before the Honble High Court on this issue. He further submitted, same view was expressed by the Tribunal while disposing assessees appeals for AYs 2002-03, 2004-05 and 2005-06 in order dated 25/03/2015 in ITA Nos. 1450, 1452 and 1453/Hyd/2013. Thus, he submitted, addition made has to be deleted.

30. Ld. DR, though, agreed that the issue is covered by the decisions of ITAT in assessees own case, but, she supported the reasoning of AO and ld. DRP.

31. We have considered the submissions of the parties and perused the relevant material on record. On perusing the master service agreement between assessee and Pratt & Whitney as well as inter company agreement, we find merit in assessees contention that the amounts paid were actually towards software development charges towards a portion of work sub-contracted to the non-resident subsidiaries, though in the accounts, it has been termed as consultancy charges. In fact similar payments made to foreign subsidiaries arising out of the same agreement were subject matter of addition in AY 2006-07 and 2007-08. However, when the matter came up for considering before the ITAT, the coordinate bench of this Tribunal after examining in detail the agreements between the parties, the nature of payment vis--vis DTAA and also keeping in view the relevant statutory provisions came to a categorical finding that the payments made do not attract the provisions of section 195 of the Act and deleted the addition made u/s 40(a)(i). The relevant extract from the order of the Tribunal has already been reproduced in the earlier part of this order. (vide paragraph no. 9). It is also a fact on record that the department has accepted the aforesaid finding of the coordinate bench since no appeal was preferred on this issue before the Honble High Court. As the facts involved in the impugned AY is materially same, and no contrary fact has been brought to our notice by ld. DR, respectfully following the decision of the coordinate bench in AYs 2006-07 ad 2007-08 (supra), we hold that the payments made to the foreign subsidiaries are outside the purview of section 195 of the Act, hence, disallowance made u/s 40(a)(i) cannot be sustained. Accordingly, we delete the same.

32. In Ground No. 4, assessee has challenged the disallowance of an amount of Rs. 1,23,19,993 claimed as deduction towards stores and spares written off.

33. Briefly the facts are, while examining the final accounts of assessee, AO noticed that assessee has claimed an amount of Rs. 1,23,19,993 as stores and spares being written off. On verifying the details submitted by assessee, he noticed that the spares written off were hard disk, R&D material, soft mouse and DAT drives, modems, Dell hardware, MB Ram etc. AO observed that all these items are fixed assets relating to computers, hence, are in the nature of capital asset. He opined that replacement of the spares of a capital asset is an expenditure, which is capital in nature, hence, cannot be allowed as a revenue expenditure. However, he held that assessee is entitled for depreciation on such amount of expenditure. Accordingly, after allowing depreciation for an amount of Rs. 30,79,998, AO disallowed the balance amount of Rs. 92,39,994. Being aggrieved of such disallowance made by AO, assessee objected before ld. DRP. Ld. DRP, however, rejecting objections of assessee upheld the disallowance.

34. Ld. AR submitted before us, the expenditure claimed is allowable either u/s 31 of the Act as current repairs or u/s 37 as revenue expenditure. He submitted, similar expenditure claimed by assessee in AY 2008-09 was allowed by ld. DRP following the decision of the jurisdictional High Court, hence, there is no reason why it was disallowed in the impugned AY.

35. Ld. DR, however, relied upon the assessment order.

36. We have considered the submissions of the parties and perused the material on record. There is no dispute with regard to the fact that the expenditure claimed by assessee relates to replacement of certain spares to the computer which was claimed as revenue expenditure. As evident from record, similar expenditure claimed by assessee in AY 2008-09 was allowed by ld. DRP following its own order passed in AY 2006-07 and 2007-08. However, in the impugned AY, AO has again treated the expenditure as capital in nature. Considering the aforesaid factual aspect, we remit the matter back to the file of AO to verify the nature of expenditure vis--vis- the expenditure claimed in AY 2006-07, 2007-08 and 2008-09. If, on verification, the nature of expenditure is found to be same, then, the expenditure claimed has to be allowed as ld. DRP in AYs 2006-07, 2007-08 and 2008-09 has allowed such expenditure as revenue expenditure. This ground is allowed for statistical purposes.

37. In Ground No. 5, assessee has challenged the decision of TPO/ld.DRP in excluding the communication expenses from the export turnover while granting deduction u/s 10A.

38. We have considered the submissions of the parties and perused the materials on record. This issue is squarely covered by the decision of the Honble Bombay High Court in case of Gemplus Jewellery(supra), and Saksoft Ltd. (supra). Following the ratio laid down in the aforesaid judgments, we direct the AO to exclude the communication expenses from export turnover as well as total turnover while computing deduction u/s 10A of the Act.

39. Ground No. 6 is with regard to guest house expenditure, picnic expenditure and miscellaneous expenditure.

40. This issue is similar to ground No. 5 & 6 raised in ITA No. 1780/Hyd/2012. Following the decision therein, we direct AO to sustain the addition to the extent of 50% of the expenditure claimed by assessee.

41. In the result, both the appeals of assessee are partly allowed for statistical purposes.