Delhi High Court
Commissioner Of Income Tax vs M/S. Oracle India Pvt. Ltd. on 30 March, 2011
Author: A.K.Sikri
REPORTABLE
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA No.383 of 2009
with
ITA No.987 of 2010
ITA No.1242 of 2010
ITA No.1247 of 2010
RESERVED ON: JANUARY 24, 2010
% PRONOUNCED On: MARCH 30, 2011
1) ITA No.383 of 2009
COMMISSIONER OF INCOME TAX . . . Appellant
through : Ms. Prem Lata Bansal, Sr.
Standing Counsel.
VERSUS
M/s. ORACLE INDIA PVT. LTD. . . .Respondent
through: Mr. M.S. Syali, Sr. Advocate
with Ms. Mahua Kalra,
Advocate.
2) ITA No.1242 of 2010
COMMISSIONER OF INCOME TAX . . . Appellant
through : Ms. Prem Lata Bansal, Sr.
Standing Counsel.
VERSUS
M/s. ORACLE INDIA PVT. LTD. . . .Respondent
through: Mr. M.S. Syali, Sr. Advocate
with Ms. Mahua Kalra,
Advocate.
3) ITA No.1247 of 2010
COMMISSIONER OF INCOME TAX . . . Appellant
through : Ms. Prem Lata Bansal, Sr.
Standing Counsel.
ITA No.383 of 2009 Page 1 of 19
VERSUS
M/s. ORACLE INDIA PVT. LTD. . . .Respondent
through: Mr. M.S. Syali, Sr. Advocate
with Ms. Mahua Kalra,
Advocate.
4) ITA No.987 of 2010
COMMISSIONER OF INCOME TAX . . . Appellant
through : Ms. Prem Lata Bansal, Sr.
Standing Counsel.
VERSUS
ORACLE INDIA PVT. LTD. . . .Respondent
through: Mr. M.S. Syali, Sr. Advocate
with Ms. Mahua Kalra,
Advocate.
CORAM :-
HON'BLE MR. JUSTICE A.K. SIKRI
HON'BLE MR. JUSTICE M.L. MEHTA
1. Whether Reporters of Local newspapers may be allowed
to see the Judgment?
2. To be referred to the Reporter or not?
3. Whether the Judgment should be reported in the Digest?
A.K. SIKRI, J.
1. In all these appeals, filed under Section 260A of the Income Tax
Act (hereinafter referred to as „the Act‟) by the Revenue,
parties are common. Whereas the Revenue is the appellant,
same assessee is the respondents in all these appeals. Further
though different assessment years are involved, there is
singular question of law which has arisen for consideration.
2. ITA No.383 of 2009 which relates to the Assessment Year
1999-2000 was admitted on the following question of law:
"Whether on the facts of the present case, Tribunal was
justified in law in allowing deduction of `17,10,24,600
disallowed by the AO under Section 92 read with Section
37(1) of the Act being royalty paid by the assessee to its
holding company beyond 30% of the sub-licensing fees
earned by the assessee?"
Question of law in all other appeals is identical and there is only
difference of amount which is involved. Before we delve into
the niceties, a brief narration of facts stating the background
under which this question has arisen for consideration would be
apt. For the sake of convenience, we may record facts from ITA
No.383 of 2009, which would cover other cases as well. Brief
facts entailing the present appeal are stated as under:
3. The assessee is a 100% subsidiary of Oracle Corporation, USA
and was incorporated with the object of developing, designing,
improving, producing, marketing, distributing, buying, selling
and importing of computer software. The assessee is entitled
to sub-licence the software developed by Oracle Corporation,
USA to its local clients. The assessee imports master copies of
the software from Oracle Corporation, USA. These are then
duplicated on blank discs, packed and sold in the market along
with the relevant brochures and information by way of a sub-
license. The assessee pays a lump sum amount to Oracle
Corporation, USA for the import of the master copy and in
addition thereto it also pays royalty at 30% of the list price of
the licensed products. For the year under consideration, the
assessee filed its return on 31.12.1999 declaring income at
`12,27,40,360/-. The said return was processed under Section
143(1) of the Act on 14.09.2000. The case was selected for
scrutiny and notice under Section 143 (2) of the Act was issued.
4. While framing the assessment order, the Assessing Officer (AO)
disallowed certain expenditure and made certain additions. It
is not necessary to deal with other items except the one on
which the question of law has arisen. It was further noticed by
the AO that during the year, the assessee had claimed to have
paid an amount of `35,00,88,000/- to M/s. Oracle Corporation
on account of royalty for duplicating and sub-licensing of
software to its customers. It may be mentioned here that the
assessee company is 100% subsidiary of M/s Oracle
Corporation, USA. It was explained by the assessee that
royalty was being paid at maximum of 30% of the Indian
published price of the Oracle Software for sub-licensing.
However, the AO noted that the total revenue earned by the
assessee at Delhi unit involved in sub-licensing of software was
to the extent of `98,16,72,000/-. Out of which the assessee
had earned the following receipts:
(a) Software Licensing Fee `59,68,78,000/-
(b) Software Technical Support `26,00,08,000/-
Service Receipts
(c) Consultancy Charges `4,01,20,000/-
(d) Trading receipts `7,93,81,000/-
(e) Sale of Software Documentation `52,85,000/-
Considering that the receipts disclosed on account of software
sub-licensing on which the assessee is paying royalty for sub-
licensing is only at `59,68,78,000/-, the assessee was required
to explain as to why provision of Section 92 should not be
invoked since even if the royalty is paid at 30% of the sale
consideration the amount payable was only to the extent of
`17.90 Crores. Being dissatisfied by the explanation furnished
by the assessee in this regard and for the reasons recorded in
the order of assessment the disallowance of `17,10,24,600/-
was made by the AO under Section 92 read with Section 37(1)
of the Act on account of payment of royalty beyond 30% of the
sub-licensing fee earned by the assessee. The assessment
was, however, framed by determining total taxable income at
`38,36,55,851/-.
5. Feeling aggrieved by the assessment order, the assessee
preferred the appeal before the CIT (A), which was allowed
partly by the CIT (A). Insofar as the issue of royalty is
concerned, the CIT (A), however, upheld the disallowance made
by the AO on the ground that a significant amount of profit had
been siphoned off to M/s. Oracle Corporation, USA by paying
royalty by ignoring the saleable price of the product. As
regards the applicability of provisions of Section 92 of the Act,
the CIT (A) after examining the facts of the case and also the
relevant rules in this regard held that the provisions of Section
92 of the Act coupled with Rule 10 and 11 were squarely
applicable to the case of the assessee. Consequentially, the
disallowances of royalty of `17,10,24,600/- was sustained for
the specific reasons recorded in the order. Further, the
assessee had also contended before the First Appellate
Authority that the AO ought to have allowed provisions of leave
encashment amounting to `30,67,728/- created by the
assessee during the year. However, the aforesaid ground was
rejected by the CIT (A) by inter alia observing that no such
provision was claimed by the assessee for the Assessment Year
1998-99 for denying the benefit of the aforesaid claim made by
the assessee.
6. The order of the CIT (A) was not accepted by the assessee on
this issue and by the Revenue on other issues which led to
filing appeals by both the parties before the Income Tax
Appellate Tribunal (hereinafter referred to as 'the Tribunal').
The appeals filed by the assessee have been allowed on the
aforesaid issue and the appeals of Revenue have been
dismissed in terms of impugned consolidated order dated
29.08.2008.
7. On the issue at hand, the Tribunal had held that the assessee
would be entitled to get the deduction in respect of entire
amount paid by it to parent company by way of royalty. The
order of the Tribunal further reveals that according to it, pre-
condition for invoking the provisions of Section 92 of the Act,
viz., there is no profit or less than ordinary profit accruing to
the resident assessee on account of business connection
between the resident and non-resident has not been
established. Therefore, Section 92 of the Act would have no
application to the facts of this case. The Tribunal has
concluded that since the assessee itself had declared profits of
amount of `1227.40 lacs in the return for the income for this
year, it was not the case of no profit. The Tribunal has also
answered another facet of Section 92 of the Act, viz., as to
whether it can be said that the profits earned by the assessee
are less than the ordinary by holding that the AO did not bring
on record any comparable case as to what is the ordinary
profit in this type of business. Thus, the Revenue has not
discharged its onus by proving that the profit being earned by
the assessee is ordinary profit in this type of business and
hence, Section 92 of the Act could not be invoked.
8. Ms. P.L. Bansal, learned Sr. Standing Counsel appearing for
Income Tax Department, made a fervent attack on the
aforesaid conclusion of the Tribunal holding that Section 92 of
the Act would not be applicable. She was vehement in her
submission that the order of the AO as well as CIT (A) were
replete with adequate justification invoking the provisions of
Section 92 of the Act which were glossed over by the Tribunal.
She highlighted the fact that in the income tax return, the
assessee had shown its total receipts from software sub-
licensing to the tune of `59,68,78,000/- and sale of software
documentation was `52,85,000/- only on which the assessee
was profiting royalty to its parent company for sub-licensing
sale of software duplicating in India. The affairs were managed
in such a manner that the Indian Published Prize (IPP) was
taken into consideration while calculating royalty at 30%.
However, the software was sold at a lesser rate and income
received on this account was `59.68 Crores. 30% thereof
amounted to `17.9 Crores only whereas actual royalty paid was
`35.01 Crores, as it was calculated on higher amount, viz., IPP.
Thus, stressed the learned Senior Standing Counsel, the affairs
were arranged in such a manner that though the assessee was
earning lesser revenue, it was paying more royalty, even at its
own loss. In this backdrop, according to the learned Senior
Counsel, the AO had rightly disallowed `17,10,24,600/-
(`35,00,88,000 - `17,90,63,400/-).
9. Predicated on these facts, the learned counsel proceeded to
make following submissions with legal arguments:
1) The expenses were to be allowed under Section 37 of
the Act. However, when IPP was not the genuine
basis, as it was not the price at which the commodity
was sold by the assessee in India and no effort was
made by the assessee with the parent company to get
it changed to payment of royalty on actual sales, this
was clearly superfluous and therefore, not permissible
under Section 37(1) of the Act.
2) Section 92 of the Act was the second step after finding
justification of the expenses under Section 37 of the
Act. The Tribunal had not done any exercise or looked
the matter from the point of view of Section 37 of the
Act and straightaway jumped to second step. Ms.
Bansal's submission was that first provisions of
Section 37 were to be applied as per which burden
was on the assessee to demonstrate as to how IPP was
arrived at.
3) She also submitted that the Tribunal erred in not
giving any weightage to the submission that ordinary
revenue and royalty was paid at actual price and
agreement was arrived at by the assessee with its
parent company should not have been accepted on its
face value.
10. Mr. M.S. Syali, learned Senior Counsel, appeared for the
assessee countered the aforesaid submissions of Ms. Bansal.
He stressed that the conclusion of the Tribunal was based on
correct understanding of the law. Rather the approach of the
AO was impermissible, who had mixed up the provisions of
Section 37 and Section 92 of the Act. His submission, in this
behalf, was that Section 37 is expenses oriented in nature and
the focus of this provision was to see whether expenses
incurred were wholly or exclusively for the purpose of business
to entitle the same for deduction. On the other hand, Section
92 of the Act was pricing oriented. On this aspect, the learned
Senior counsel pointed out that the price fixed as per the
agreement was Arm‟s Length Price which was accepted even
by the Transfer Pricing Officer (TPO) after holding appropriate
inquiry. He referred to the orders dated 10.03.2005 (sic.)
passed by the Joint Commissioner of Income Tax in his capacity
as TPO-II under Section 92CA(3) accepting the price as ALP for
the Assessment Year 2002-03 in the following words:
"After examination of the documentation and economic
analyses contained therein the Arm‟s Length Price (ALP)
of the international transactions, as declared by the
assessee in Form 3CEB, annexed to the return of income
is accepted."
Orders to similar effect accepting this price by the TPO for
other Assessment Years were also produced before us. The
learned Senior counsel pointed out that the AO was conscious
of these facts as is evident from the reading of the assessment
order passed for the Assessment Year 2003-04 wherein it was
inter alia recorded as under:
"Although the Transfer Pricing Officer after examination
of the company‟s transfer pricing documentation
accepted the international transaction as per the
Transfer Pricing adopted by the company vide order
dated 27.01.2006. Payment of royalty was decided by
the TPO with respect to the provisions of Section 92CA of
the I.T. Act, whereas the disallowance made on the issue
here is in view of the fact that the payment made has
been found not to be wholly and exclusively for business
purpose of the assessee and hence is being made U/s
37(1) of the I.T. Act."
11. He, thus, argued that it is clear that the AO was wrong in
mixing up the provisions of Section 92CA and Section 37 of the
Act thereby falling into legal error. It was also the argument of
the learned Senior counsel that the assessee was making
payments of royalty to its parent company under the same
agreement on the same basis right from the Assessment Year
1994-95. However, in respect of Assessment Years 1994-95 to
1998-99, this expenditure was not even questioned and royalty
paid in those years was allowed as expenditure in toto. The
decision by Income Tax Appellate Tribunal, Mumbai Bench in
the case of Reuters India Pvt. Ltd. Vs. Deputy
Commissioner of Income Tax (in ITA Nos.1089 &
4744/Del/04) was referred to in addition to the orders passed
by the Income Tax Appellate Tribunal, Delhi Bench in the case
of Assistant Commissioner of Income Tax Vs. Nestle
India Ltd. [94 TTJ (Del.) 53].
12. Insofar as first decision in Reuters India Pvt. Ltd. (supra) is
concerned, the purpose was to show that in order to determine
the applicability of Section 92 of the Act to see as to whether
the profits could be termed as no profit or lesser ordinary profit,
it was for the AO to bring on record comparable case to find out
as to what is the ordinary profit in the type of business. If that
exercise is not done, the profits by the assessee could not be
treated as the case of „no profit or lesser ordinary profit‟.
13. Insofar as decision in Nestle India Ltd. (supra) is concerned,
the same was pressed into service for limited purpose, viz.,
burden was upon the AO to prove that the circumstances
stipulated in special provision (like Section 92 of the Act in the
instant case) and not upon the assessee. Though at the same
time, under provisions of Section 37(1) of the Act, the primary
burden to substantiate the claim of deduction of expenditure
lay on the assessee.
14. We have given our thoughtful consideration to the respective
submissions. From the aforesaid narration, the salient features
which have emerged on record in the present case may first be
recapitulated. The same are as under:
(i) There is an agreement between the assessee and
its parent company which provides for payment of
royalty @ 30% of IPP of the Oracle Software
appliances.
(ii) This agreement is approved by the Reserve Bank of
India. The copy of the RBI Notification was filed
before the AO who has mentioned about it in the
assessment order. This Notification categorically
permits the remission of foreign currency upto 30%
of IPP. However, we may hasten to add that for the
purpose of Section 92, this may not be a relevant
factor and therefore we are not influenced by the
same.
(iii) The price fixed is accepted as Arm‟s Length Price
by the TPO under Section 92 of the Act.
(iv) From the Assessment Years 1994-95 to 1998-99,
royalty paid as per the aforesaid agreement by the
assessee to its parent company was allowed.
15. Section 92 of the Act, which is held to be applicable by the AO
reads as under:
"Section 92.Computation of income from
international transaction having regard to arm's
length price.
(1) Any income arising from an international transaction
shall be computed having regard to the arm‟s length
price.
Explanation.-For the removal of doubts, it is hereby
clarified that the allowance for any expense or interest
arising from an international transaction shall also be
determined having regard to the arm‟s length price.
(2) Where in an international transaction, two or more
associated enterprises enter into a mutual agreement or
arrangement for the allocation or apportionment of, or
any contribution to, any cost or expense incurred or to
be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more of
such enterprises, the cost or expense allocated or
apportioned to, or, as the case may be, contributed by,
any such enterprise shall be determined having regard
to the arm‟s length price of such benefit, service or
facility, as the case may be.
(3) The provisions of this section shall not apply in a
case where the computation of income under sub-
section (1) or the determination of the allowance for any
expense or interest under that sub-section, or the
determination of any cost or expense allocated or
apportioned, or, as the case may be, contributed under
sub-section (2), has the effect of reducing the income
chargeable to tax or increasing the loss, as the case
may be, computed on the basis of entries made in the
books of account in respect of the previous year in
which the international transaction was entered into."
16. If the conditions mentioned in this provision are satisfied, this
Section empowers the AO to determine the amount of profits
which is reasonably deemed to have been derived from there.
In the process, the AO is authorized to include such amount in
the total income of the respondent (assessee herein). For the
purpose of assumption of jurisdiction under this provision, it is
necessary to establish:
(a) Business is carried between a resident and a
non-resident;
(b) Close connection between resident and a non-
resident ;
(c) The course of business between the resident and
a non-resident is so arranged that the business
transacted between them provides to the
resident either (i) no profits, or (ii) less than the
ordinary profits, which might be expected to
arise in the business.
17. The first two conditions are undoubtedly satisfied. It is, thus, to
be examined as to whether it is a case where the transaction
between the assessee and its parent company, viz., payment of
royalty @ 30% on IPP instead actual sale price has resulted in
no profit or less than the ordinary profits which might be
expected to arise in the business. The assessee has declared
an income of `1227.40 lacs. Thus, it is not a case of 'no
profits'. The neat question is as to how one is to determine as
to whether the profits are less than the ordinary profits which
might be expected to arise in the business? Obviously, this can
be found only when exercise is undertaken comparing the
income of the assessee with other comparable business
enterprises in India. However, the AO did not do this exercise
at all. He did not bring on record any comparable case to find
out what is ordinary profit in this type of business. Definitely,
onus in this behalf under the provisions of Section 92 of the Act
lay on the AO. This pertinent aspect coupled with the fact that
price fixed is acceptable as Arm‟s Length Price by the TPO
under Section 92 of the Act itself is sufficient to clinch the issue
in favour of the assessee.
18. In this backdrop, we have to examine whether such an
expenditure could still be disallowed and the opinion of the AO
was correct that in the aforesaid scenario, the payment made
cannot be treated to be wholly and exclusively for business
purpose of the assessee to enable it to cover the same under
Section 37(1) of the Act. As noted above, Ms. Bansal, learned
counsel for the Revenue had argued that since the payment of
royalty on TPO was not the genuine basis as the goods had not
been sold at IPP, but at much lesser price, payment of royalty
on IPP rather than on actual sales is superfluous and not
permissible under Section 37(1) of the Act. It is difficult to
accept such an argument. Once it is held that the payment of
royalty by the assessee to its parent company is not hit by the
provisions of Section 92 of the Act and the price fixed is ALP as
determined by the TPO himself, there is no reason to hold that
the expenses would not be allowed under Section 37(1) of the
Act. This provision reads as under:
"Section 37: General
(1) Any expenditure (not being expenditure of the
nature described in sections 30 to 36 and not being in
the nature of capital expenditure or personal expenses
of the assessee), laid out or expended wholly and
exclusively for the purposes of the business or
profession shall be allowed in computing the income
chargeable under the head "Profits and gains of business
or profession".
19. It is, thus, clear that what is to be seen is that the expenditure
was incurred by the assessee in the course of business and had
nexus with the business of the assessee. It could not be
disputed that the payment of royalty is a business expenditure,
which was expended wholly and exclusively for the purpose of
business of the assessee. The nature of the expenses is also
not such which would fall in any of the exceptions carved out
under Section 30 and 36 of the Act. Once these conditions are
satisfied, the expense is to be allowed in toto as business
expenditure, and the Revenue cannot sit in the arm‟s chair of
the assessee and decide as to how affairs of the business are to
be run and wasteful or excessive expenditure is to be curtailed.
The question of commercial expediency is to be judged by the
assessee and not by the AO. Following test was laid down in the
case of Atherton Vs. British Insulated & Helsby Cables
Ltd. reported as 10 TC 155, 191 (HL) in the following terms:
"A sum of money expended, not of necessity and with a
view to a direct and immediate benefit to the trade, but
voluntarily and on the grounds of commercial
expediency and in order indirectly to facilitate the
carrying on the business, may yet be expended wholly
and exclusively for the purposes of the trade."
The above test was quoted with approval and applied by the
Supreme Court in the case of Eastern Investments Ltd. Vs.
Commissioner of Income Tax, 20 ITR 1.
20. It is well-settled that it is not open to the Department to adopt
a subjective standard of reasonableness and disallow a part of
business expenditure as being unreasonably large, or decide
what type of expenditure the assessee should incur and in what
circumstances. This was so held by the Supreme Court in the
case of Commissioner of Income Tax Vs. Walchand, 65
ITR 381 which principle has thereafter been often repeated
and remains the bedrock of Section 37 of the Act till date.
Thus, the jurisdiction of the AO is only confined to deicide
"Profits and gains of business or profession", i.e., whether the
expenditure claimed was actually and factually expended or
not and whether it was wholly and exclusive for the purposes of
business. Reasonableness of the expenditure can be
considered only from this limited angle for the purpose of
determining whether in fact amount was spent or not.
21. Mr. Syali, learned Senior Counsel was right in his submission
that Section 37 was expenses oriented in nature and the focus
of this provision was to see whether expenses incurred were
wholly or exclusively for the purpose of business to entitle the
same for deduction. The AO committed serious error in mixing
the provisions of Section 92 and Section 37 of the Act.
22. The upshot of the aforesaid discussion leads us to conclude
that the Tribunal was justified in law in allowing the deduction
disallowed by the AO being royalty paid by the assessee to its
holding company. Resultantly, these appeals warrant to be
dismissed, but there shall be no orders as to cost.
(A.K. SIKRI)
JUDGE
(M.L. MEHTA)
JUDGE
MARCH 30, 2011
pmc
