Wednesday, January 26, 2011

Allocation of Expenses – Allowable (Sec-10A)--Sonata

2011-TIOL-61-ITAT-MUM



ASSTT COMMISSIONER OF INCOME TAX


Vs


M/s SONATA INFORMATION TECHNOLOGY LTD




Income tax – Sec 10A - Allocation of Expenses – Whether expenses incurred for service charges on the basis of the agreement and allocated on the basis of various factors, are allowable though the assessee company and the other company are under the same management.






The assessee company is engaged in the business of software and is a fully owned subsidiary of Sonata Software Limited (SSL). The assessee claimed expenditure of Rs.13,02,42,275/- on account of service charges to SSL in accordance with an agreement dated 28.9.2000 entered into for rendering various services such as advice and assistance relating to compliance of various laws, Orders, Regulations, training employees of SITL and liason with various government departments compliance requirements of Companies Act, contractual matters etc. Actual expenses were to be billed separately. The working of the service charges was based on the expenditure incurred by SSL on account of insurance, salaries, allowances, directors’ remuneration’s, electricity & charges, printing and stationery, professional charges, repairs & maintenance, rent for offices, etc. and apportioned to the assessee on the basis of turnover. AO disallowed the expenses observing that service charges are mere diversion of income without rendering any services and to claim more profit in SSL which is eligible for deduction u/s 10A. Further, the commercial expediency could have been considered if the agreement was entered into between two independent entities and not under the common management and control and disallowed the expenses following the judgment of the Supreme Court in the case of McDowell And Co. Ltd. vs. CTO. CIT(A) allowed the appeal of the assessing following the orders of the earlier years.






In appeal, the ITAT held following its own decision in the case of the assessee itself -






++ that the revenue did not find that the agreement was sham or there is no agreement or the payments were not made as per the agreement and it is already held by the Tribunal in the case of the assessee that the assessee has placed each and every head of expenditure and this expenditure has been bifurcated under the three heads – STP unit entitled to deduction u/s.10A, non STP not entitled to deduction u/s.10A and support services and the basis of allocation amongst the three heads is actual expenses, number of employees and ratio of fixed assets, floor area and turnover ratio. Thus, on the basis of above five criteria, expenditure has been allocated to the three heads and the expenditure claimed as service charges is correct.






This appeal preferred by the revenue is directed against the order dated 29.10.2009 passed by the ld. CIT(A) for the Assessment Year 2006-07.


2. Briefly stated facts of the case are that the assessee company Sonata Information Technology Ltd. (SITL) is engaged in the business of software . It is a fully owned subsidy of Sonata Software Ltd. It filed return declaring total income of Rs.3,13,88,932/- .During the course of assessment proceeding it was observed by the Assessing Officer that the assessee has claimed expenditure of Rs.13,02,42,275/- on account of service charges to M/s. Sonata Software Ltd. (SSL). This expenditure was claimed in accordance with an agreement dated 28.9.2000 entered into by the assessee with SSL which has been revised on 9.7.2002 and 16.8.2004. As per the said agreement the assessee was to pay service charges to SSL for rendering the following services( extracted from para 4.1 of the assessment order):


“(a) Advice and assistance to SITL relating to compliance of various laws, Orders, Regulations and legal requirements of the Central, State, other governmental and local authorities concerning the conduct of the business and affairs of SITL.


(b) Training employees of SITL in the above areas;


(c) Assist and liaise with various government departments as and when required by SITL.


(d) Overseeing the compliance requirements in regard to Companies Act, including matters related to Board of Directors and shareholders, contractual matters, advice and assistance in maintenance of statutory records, filing required returns and form etc.


Further, all out of pocket expenses including travel, conveyance etc. were to be billed separately by Sonata Software Ltd. and was to be reimbursed by the assessee.


However, it has been observed that the quantum of service charges was determined by adopting the following basis:


The expenditure incurred by SSL on account of insurance, salaries, allowances, directors’ remuneration’s, electricity & charges, printing and stationery, professional charges, repairs & maintenance, rent for offices, etc. and also depreciation has been apportioned to the assessee on the basis of turnover as service charges”.


The assessee was asked to explain the allowability of its claim with documentary evidence. In response, it was interalia explained by the assessee vide letter dated 31.12.2008 that as per agreement SSL has raised debit note of Rs.13,02,42,275/- to the assessee for rendering services. The assessee also filed month wise summary of debit note showing the amount of service charges and TDS. It was further submitted by the assessee that the said expenditure was incurred out of commercial expediency. It was further submitted by the assessee that the agreement was necessitated because the assessee did not have the necessary infrastructure of the services it required. The expenditure incurred out of commercial expediency is genuine and it has been acknowledged by the payee also. The assessee while relying on certain decisions in support of his claim submitted that the similar expenses have been allowed in the assessee's own case by the ld. CIT(A) for the Assessment Year 2001-02 and the order of the ld. CIT(A) was confirmed by the Tribunal , therefore, the same may be allowed as business expenditure. However, the Assessing Officer was of the view that the expenditure of Rs.13,02,42,275/- on account of service charges is not acceptable because of the following reasons(extracted from para 4.3.3 of the assessment order):-


“(i) Payment of service charges from SITL to SSL is mere diversion of income without services rendered by SSL. Mens rea for this claim is to reduce taxable profit and claim more 10- A profit in SSL.


(ii) The receipts on account of Service Charges in the hands of SSL have not been credited separately as the income of its non- 10A activity. However, these receipts have been reduced from the expenditure claimed of 10A activity of SSL. The net implication of this is that the profits of the 10A activity of SSL have increased and on which no tax has been paid. Whereas in fact, these receipts are clearly pertaining to the non 10A activity of SSL and therefore such receipts should have been offered for tax.


(iii) The assessee has contended that the said agreement has been executed in the best interest of the business between two independent corporate entities. It has also been contended that the same has been incurred out of commercial expediency. It has further been submitted that it is prerogative of the businessman as to how to run its business and the Department should not be prescribed the quantum of expenditure etc. These contentions of the assessee would have been acceptable if this agreement was entered into between two independent entities not under the common management and control. In the instant case, the assessee is a 100% subsidiary of SSL. The implication of this agreement is that the taxable profits of the assessee have been reduced and at the same time increasing the nontaxable profits of its holding company –SSL”.


The Assessing Officer for the reasons as mentioned above and keeping in view the ratio of the decision of the Hon'ble Supreme Court in McDowell And Co. Ltd. vs. CTO (1985) 154 ITR 148(SC) disallowed the payment of service charges of Rs.13,02,42,275/- and added to the income of the assessee and accordingly completed the assessment at an income of Rs.16,16,31,210/- vide order dated 31.12.2008 passed u/s.143(3) of the Income tax Act, 1961, (the Act).


3. On appeal, the ld. CIT(A) following the Tribunal order for the Assessment Year 2001-02 and the consistent view of the Tribunal in the subsequent years deleted the disallowance of Rs.13,02,42,275/- and allowed the appeal.


4. Being aggrieved by the order of the ld. CIT(A) the revenue is in appeal before us taking following grounds of appeal :-


“1. On the facts and in the circumstances of the case and in law and without prejudice, the ld. CIT(A) erred in ignoring the fact that the ‘service charges’ reimbursed / paid to the holding company M/s. Sonata Software Ltd. has not been substantiated by proof of the service rendered by the holding company.


2. On the facts and in the circumstances of the case and without prejudice to Ground No.1, the ld. CIT(A) erred in ignoring the fact that the agreement by way of which ‘service charges’ were reimbursed/paid by the assessee company to M/s. Sonata Software Ltd. was only a collusive arrangement to reduce the profits of the assessee company which is not entitled for exemption and increase the profits of Sonata Software Ltd. which is a company enjoying under section10A.


3. On the facts and in the circumstances of the case and in law the ld. CIT(A) erred in deciding the issue on the basis of the orders of the CIT(A) and ITAT for earlier years in the assessee's own case without considering the case on merits even though these decisions have not been accepted by the revenue and appeals have been filed under section 260A to the High court in all the years.


4. The appellant prays that the order of the CIT(A) on the above grounds be set aside and that of the Assessing Officer restored. The appellant craves leave to amend or alter any ground or add a new ground that may be necessary.”


5. At the time of hearing the ld. DR while relying on the order of the Assessing Officer further submits that since the assessee has failed to furnish necessary documentary evidence in respect of services rendered by SSL to the assessee, therefore, the ld. CIT(A) was not justified in deleting the disallowance made by the Assessing Officer. He further submits that in the interest of justice the issue may be set aside to the file of the Assessing Officer.


6. On the other hand the ld. Counsel for the assessee submits that the disallowance was made by the Assessing Officer for the reasons recorded in para 4.3.3 of the assessment order wherein there is no such finding that the assessee has failed to furnish necessary documentary evidence in respect of services rendered by SSL to the assessee, therefore, the new plea taken by the ld. DR is not maintainable. He further submits that the issue is directly covered in favour of the assessee by the orders of the Tribunal in assessee's own case for the assessment years 2001-02 to 2004-05 and also by the order of the Tribunal in the case of SSL for the Assessment Years 2002-03 and 2003-04. He also placed on record the copy of the said orders of the Tribunal alongwith chart showing the Assessment Year wise reference of the impugned issue, appearing at page 1 to 42 of the assessee's paper book. He, therefore, submits that the order passed by the ld. CIT(A) in deleting the disallowance be upheld.


7. We have carefully considered the submissions of the rival parties and perused the material available on record. We find that there is no dispute that the payment of Rs.13,02,42,275/- was made by the assessee on account of service charges to M/s. SSL as per agreement dated 28.9.2000 which was revised subsequently on 9.7.2002 and 16.8.2004. It is not the case of the revenue that the agreement was found to be sham or there is no such agreement or the payment of service charges has not been made in accordance with such agreement. We further find that in all the preceding Assessment Years i.e. in Assessment Years 2001-02 to 2005-06 the similar disallowance was made by the Assessing Officer which was allowed by the ld. CIT(A) and the order of the ld. CIT(A) was upheld by the Tribunal. We further find that the Tribunal in assessee's own case in Sonata Information Technology Ltd. vs. DCIT and vice- versa in ITA N.3702 & 4789/Mum/2004 for Assessment Year 2001-02 dated 11.11.2005 after considering the Tribunal’s order in the case of SSL and the plea of the revenue that allocation of expense requires verification and therefore, the matter may be referred to the Assessing Officer for necessary verification has held vide para-11 of its order as under :-


“11. We have heard both the parties in the light of the material placed before us. We find that the issue regarding allocation of expenses in respect of service charges arose in the case of SSL. In that case, the Assessing Officer was of the view that allocation of expenses for Non-10A unit (not eligible for exemption) was excessive as exempted unit was much more expenditure oriented. The matter ultimately reached the Tribunal which accepted the case of assessee that allocation of support service expenses on the basis of turnover was justified. The Tribunal vide para 34 of its order dated 17.03.2003 in ITA No.495/496/M/02 held as under:-


“We have considered the submissions and we have perused the various records placed in the paper book. In the paper book at page 27 to 34 the assessee has placed each and every head of expenditure and this expenditure has been bifurcated under the three heads – STP unit entitled to deduction u/s.10A, non STP not entitled to deduction u/s.10A and support services. Further it is found that the basis of allocation amongst the three heads is actual expenses, number of employees and ratio of fixed assets, floor area and turnover ratio. Thus, on the basis of above five criteria, expenditure has been allocated to the three heads. Further, it is noticed that the total expenditure allocated under third head i.e. support services, has been again allocated under two heads – 1) STP units entitled to deduction u/s.10A and non STP which is not entitled for deduction u/s.10A on the basis of turnover ratio. In our considered opinion, the allocation of expenditure contained in the paper book at page 27 to 31 appears to be appropriate . As per details contained in pages 27 to 31, it can be seen that the appellant company has only allocated expenses of Support Service Division between 10A and non 10A activities in the ratio of turnover has been called for by the Assessing Officer by his letter dated 20.01.2000 appearing at page 35 of the paper book. Further, direct expenses relating to 10A and non 10A activity has been directly charged against the profits of these activities and do not call for any interference.”


The above observations of the Tribunal resolve the controversy before us. Admittedly, prior to incorporation of assessee company, SSL was carrying on two units independently i.e. unit exempted u/s.10A and the unit not exempted. Direct expenses incurred were separately booked to respective units. Only the support services expenses were allocated on the basis of turnover. Such allocation has been found to be proper and reasonable by the Tribunal. There is no dispute that nonexempted unit was taken over by the assessee company and support services were continued to be rendered by SSL. From the inception, the stand of the assessee has been that such expenses were allocated on the basis of turnover as is apparent from para 4.3.3(ii) of the assessment order, wherein it has been mentioned that expenses were allocated in debit notes as the basis of turnover. Even the CIT(A) has also admitted this factual position at page 23 of his order where he mentioned ‘the details of the expenditure which has been allocated on the basis of respective turnover is given along with debit notes, copies of which were filed before me, as also before the Assessing Officer”. Faced with the same, the learned D.R. had nothing to add except to rely on the order of Assessing Officer. The learned D.R. submitted that allocation of expenses requires verification and therefore the matter may be referred to Assessing Officer for necessary verification. We are unable to accept this request since there is no dispute to the factual position that allocation of service expenses was made on the basis of turnover. No useful purpose would be served in restoring the issue. Accordingly following the finding of the Tribunal in the case of SSL, we set aside the order of CIT(A) on this issue and delete the disallowance sustained by him.”


The above order of the Tribunal has been consistently followed by the Tribunal in the assessee's own cases for the Assessment Years 2002- 03, 2003-04, 2004-05 and 2005-06.


8. In the absence of any distinguishing feature brought on record by the revenue we respectfully following the consistent view of the Tribunal and keeping in view that in the case of SSL the Tribunal has accepted the receipt of corresponding service charges as genuine for the Assessment Years 2001-02, 2002-03 and 2003-04, we are of the view that the ld. CIT(A) was fully justified in deleting the disallowance made by the Assessing Officer and accordingly the grounds taken by the revenue are rejected.


9. In the result, revenue’s appeal stands dismissed.








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