Transfer Pricing: Re-characterization of Software Developer as ‘Contract R&D Provider’ Rejected; BAPA and Past TPO Orders Confirm ‘Software Development’ Status
ISSUE
Whether the Transfer Pricing Officer (TPO) was justified in re-characterizing the assessee as a “Software Research/R&D Service Provider” (instead of a “Software Development Service Provider”) based on US tax documents, despite a signed Bilateral Advance Pricing Agreement (BAPA) and consistent past TPO orders accepting the latter profile.
FACTS
Assessee’s Profile: Engaged in software development services. Benchmarked transactions using comparables in software development.
TPO’s Action: Relying on documents obtained from US tax authorities (Global TP documentation), the TPO re-characterized the assessee as a “Software Research Company” (implying higher risk/margin expectations) and made an upward adjustment.
The Defense:
BAPA: The assessee had signed a BAPA with the CBDT for AYs 2019-20 to 2023-24. Post-site visit, the APA authorities characterized the assessee as a “Software Development Service Provider.”
Consistency: In AYs 2013-14, 2017-18, 2018-19, and 2020-21, the TPO himself had accepted the characterization as a software developer.
Clarification: A letter from the Group’s Chief Tax Officer clarified the FAR (Functions, Assets, Risks) profile.
DECISION
BAPA as Evidence: Although the BAPA was for future years, the FAR profile had not changed. The APA authorities’ rigorous verification (site visit) serves as strong evidence of the actual nature of business.
Rule of Consistency: The TPO cannot flip-flop on characterization when he has accepted the “Software Developer” status in immediate prior and subsequent years.
Rejection of Re-characterization: The Tribunal held that re-characterizing the assessee as a “Contract R&D” provider was baseless given the BAPA and consistent history.
Verdict: The adjustment was deleted. [In Favour of Assessee]
Finance Lease Rentals Fully Allowable as Revenue Expenditure; Disallowance of Principal Portion Deleted
ISSUE
Whether the principal portion of lease rentals paid under a Finance Lease is a capital expenditure (disallowable) or revenue expenditure (allowable), and who is entitled to depreciation—the lessor or the lessee?
FACTS
The Expense: The assessee took vehicles on a finance lease and claimed the entire lease rental (Interest + Principal) as revenue expenditure.
AO’s Action: Treated the lease as a capital transaction (purchase of asset). Disallowed the principal repayment portion and allowed depreciation instead (treating the lessee as the owner).
DRP’s View: Sustained the AO’s view.
DECISION
Legal Precedent: The Tribunal relied on the decision in Minda Corporation Ltd. v. Dy. CIT [2016], which affirmed the principle laid down by the Supreme Court in I.C.D.S. Ltd.: In a finance lease, the Lessor remains the legal owner and is entitled to depreciation.
Lessee’s Deduction: Since the lessee is not the owner, they cannot claim depreciation. Consequently, the entire lease rental payment is a charge for using the asset and constitutes Revenue Expenditure.
Relief: The AO was directed to allow the deduction of the full lease rental (including principal) and reverse the depreciation granted erroneously.
Verdict: [In Favour of Assessee]
KEY TAKEAWAYS
BAPA’s Persuasive Value: Even if an Advance Pricing Agreement (APA) covers future years, its findings on “Characterization” and “FAR Analysis” are highly persuasive for past years if the business model hasn’t changed. Use your APA success to defend open past assessments.
Finance Lease Tax Arbitrage: This is a classic tax dispute.
Accounting (AS-19/IndAS 116): Lessee capitalizes the asset and claims Dep + Interest.
Tax (I.C.D.S. SC Ruling): Lessor claims Depreciation; Lessee claims full Rental as expense.
Tip: Ensure your tax computation adjusts the accounting profit (add back Book Dep/Interest) and claims the actual “Lease Rental” as a deduction to maximize benefits.
IN THE ITAT CHENNAI BENCH ‘D’
Scientific Games India (P.) Ltd.
v.
Deputy Commissioner of Income-tax*
Manu Kumar Giri, Judicial Member
and S. R. RAGHUNATHA, Accountant Member
and S. R. RAGHUNATHA, Accountant Member
IT (TP) Appeal No. 60 (Chny) OF 2019
[Assessment year 2014-15]
[Assessment year 2014-15]
NOVEMBER 21, 2025
S. P. Chidambaram, Adv. for the Appellant. AR. V. Sreenivasan, C.I.T. for the Respondent.
ORDER
S.R. Raghunatha, Accountant Member.- This appeal by the Assessee directed against the Final Assessment order u/s.143(3) r.w.s. 144C(1) and section 92CA of Income Tax Act, 1961 (in short “the Act”) passed by the Deputy Commissioner of Income-tax, Corporate Circle 1(2), Chennai dated 04.07.2019 for the Assessment year (A.Y.) 2014-15.
2. The brief facts of the case are that the Assessee is a Company was incorporated in the year 2005, as a wholly owned subsidiary of Bally Technologies Inc., USA. (currently known as LNW Gaming Inc.) The registered office of the company is situated at Chennai and the company operates through its centres in Chennai and Bangalore. The Assessee is a 100% Export Oriented Undertaking (EOU) registered under the Software Technology Park of India (‘STPI’) scheme at Chennai & Bangalore. The Assessee had entered into a software development agreement with its associated enterprise and performs coding/decoding, debugging and quality test and assurance functions for its Group companies. The Assessee filed its return of income for the A.Y.2014-15 on 29.11.2024 declaring its income as 40,39,02,110/-. The case was selected for scrutiny under CASS and issued statutory notices accordingly.
3. Later the case was referred to the Transfer Pricing Officer (“TPO”) by the AO and during the course of Transfer Pricing proceeding, the TPO Vide communication dated 31.10.2017.
4. Based on the functional, asset, and risk (“FAR”) analysis coupled with the availability of data, the Transactional Net Margin Method (“TNMM”) was selected as the most appropriate method. For the purpose of applying this method, operating profit to total operating costs (“OP/OC”) was considered to be the most appropriate Profit Level Indicator (“PLI”). The Assessee had performed a detailed search for independent comparable companies engaged in provision of software development services in public databases and identified 6 comparable companies. The arithmetic mean OP/OC margins of the 6 comparable companies was 10.02% while the margins of the assessee was 13.72%. Given the same, since the margin of the assessee was more than the arithmetic mean margins of the comparable companies, the international transactions were concluded to satisfy the arm’s length criteria from an Indian transfer pricing standpoint for the Assessment year (‘AY’) 2015-16.
5. The TPO seem to have invoked the provisions of Exchange of Information under Double Tax Avoidance Agreement (‘DTAA’) and sought for details from the US IRS. Hence the time limit for completion of TP assessment by the virtue of Explanation 1(x) to section 153(9) was extended as a reference was made for exchange of information by the Competent Authority in the case of the Assessee. Through the exchange of information, the TPO collated the Global Transfer Pricing documentation and basis the same, the TPO recharacterized the business of the Assessee as a Contract R&D service provider and proceeded to make a fresh search of companies engaged in Software research and development activities thereby rejecting the software development search undertaken by the Assessee. The TPO finally selected 9 comparable companies with the arithmetic mean OP/OC margins of 26.87% and increased the margins of the assessee from 13.72% to 15.11% after treating the foreign exchange gain as operating in nature. The TPO accordingly proceed to make an upward TP adjustment of Rs.25,26,64,677/- on account of the difference in the margins earned by the Assessee. The Assessing officer (AO) passed the draft assessment order dated 24.09.2018 after incorporating the upward Transfer Pricing addition of Rs.25,26,64,677/- made by the TPO and disallowing the finance lease rent payment made to the tune of Rs.62,55,408/
6. The Dispute Resolution Panel (“DRP”) rejected the Transfer Pricing grounds raised by the Assessee. On the Corporate Tax issue, though the ld.DRP disallowed the grounds raised by the Assessee on treating the finance lease payment made as a revenue expenditure, it allowed the alternate ground raised by the Assessee and allowed depreciation on the same by considering it as a capital expenditure. The AO passed the final assessment order dated 04.07.2019 incorporating the above, which is now impugned before us.
7. Being aggrieved, the Assessee raised several Transfer Pricing and Corporate Tax grounds before us which are reproduced hereunder:
“1. The Final Assessment Order dated 04.07.2019, received on 11.07.2019 passed under section 143(3) r.w.s. 144C (1) r.w.s 92CA of the Incometax Act, 1961 (‘the Act’) by the Deputy Commissioner of Income-tax Corporate Circle – 1(2), Chennai (‘the Assessing Officer’/’AO’) in pursuance of the DRP directions dated 28.06.2019 is erroneous and contrary to law, facts and circumstances of the case.
2. Pricing grounds – Upward adjustment to arm’s length price
General Ground:
2.1.The AO/TPO/DRP erred in facts and in law by making an upward adjustment of INR 25,26,64,677/- to the value of international transaction.
Re-characterization of the business of the assessee as contract R&D service provider instead of risk mitigated software service provider
2.2 The Learned AO/DRP failed to take cognizance of the fact that even as per the terms of the inter-company agreement between the assessee and its AE, the assessee was only responsible to provide its AE with assistance in the software development function which the AE may require and that there was no obligation to undertake any R&D activities.
2.3 The Ld. AO/DRP failed to appreciate the fact that only in the event the assessee funds the R&D or undertakes the functions of taking critical R&D decisions or bears the risks relating to IP, it can be considered as undertaking R&D functions / risks.
2.4 The Ld. AO/DRP erred in concluding that since employee cost was 86.5% of total operating cost, the employees were engaged for high end job without appreciating the basic fact that in any service industry (including low end service providers), employee cost would be substantially high.
2.5 The Ld. AO/DRP have erred in classifying the assessee as a risk bearing entity which undertakes all risks related to the gaming software product development, thereby completely ignoring the fact that the assessee receives full operating costs plus mark-up from AEs irrespective of the success or failure of the gaming products supported by it.
2.6 The Ld. AO/DRP have grossly erred in concluding risk mitigated assessee entity to be substantial risk bearing entity especially when the assessee is remunerated on full operating cost plus mark-up basis.
2.7 The Ld. AO/DRP erred in concluding the assessee as risk bearing entity by providing high importance to non-critical risk factors like single customer risk, political risk, manpower risk, legal and statutory risk instead of giving importance to critical risks like Market risk, Price risk, Credit risk, Technology risk, Quality risk etc.
2.8 The Ld. AO/DRP have grossly erred in adopting approach different from its predecessors in concluding the assessee to be a risk bearing contract R&D service provider instead of risk mitigated software development service provider, without any change in facts and circumstances of the case from earlier years.
2.9 The Ld. AO/DRP have erred on the facts and circumstances of the case in classifying software development services rendered by the assessee as contract R&D Services merely based on the terminology used in the Global Transfer Pricing documentation and annual report in Form 10K filed by Bally US before the United States Securities and Exchange commission.
2.10 The Ld. AO/DRP erred in completely ignoring the clarification provided by the Chief Tax Officer of the Scientific Games Corp in relation to terminology used in Global Transfer Pricing documentation and US SEC filings.
Rejection of FAR analysis undertaken by the assessee
2.11 The Ld. AO/DRP erred in facts by not appreciating the detailed FAR analysis undertaken by the assessee in the Transfer Pricing documentation in good faith substantiating its functional profile.
2.12The Ld. AO/DRP erred in concluding that the assessee had changed its functional profile without appreciating the fact that the functions performed by the assessee and the AE were only elaborated in detail / provided clarifications and hence there was no change in functional profile from that of as mentioned in TP documentation.
Analysis of the assessee’s employee profiles by the TPO
2.13 The Ld. AO/DRP erred in facts by not appreciating the detailed submissions made by the assessee with respect to the list of employees, their respective designations and experience.
2.14 The Ld. AO/DRP erred in their understanding that the number of years experience mentioned against each employee as their experience in Assessee Company.
2.15 The Ld. AO/DRP failed to appreciate the fact that most of the employees of the assessee were only analysts which is evident from the table reproduced by the TPO himself in the TP Order.
2.16 The Ld. AO/DRP failed to appreciate the fact that none of the employees were either IIT engineers or PhDs.
Rejection of Transfer Pricing documentation
2.17 The Ld. AO/DRP erred in law by rejecting the Transfer Pricing study undertaken by the assessee without considering facts of the case and analyzing the detailed comparable search process undertaken by the assessee.
2.18 The Ld. AO/DRP erred in law by ignoring the detailed FAR analysis undertaken by the assessee and the methodical process adopted in its economic analysis in accordance with the factors of comparability as laid out in Rule 10B(2) of the Rules and wrongly misinterpreted the disclosure in the Global Transfer Pricing documentation maintained by the AE.
2.19 The Ld. AO/DRP erred in facts of the case by not taking into consideration the detailed reply provided by the AE justifying the disclosure made in its Transfer Pricing documentation.
2.20 The Ld. AO/DRP failed in law by ignoring both the contract (agreement between the assessee and AE) and the actual conduct of the business undertaken by the assessee and proceeded to benchmark the ALP of the transactions of the assessee by treating the services as “Captive contract R&D services” instead of “Captive software development service provider”.
Ownership of the Intellectual Property rights
2.21 The Ld. AO/DRP failed to appreciate the fact that only in the event the assessee bears the risks of developing IP or shares the cost of developing IP/ funds the R&D activities or performs the key decision making functions with respect to development of IP/ new product, it can claim the ownership or rights in the IP.
2.22 The Ld. AO/DRP also failed to appreciate the detailed submission made by the assessee explaining the US patents registration process requiring disclosure of the names of personnel who helped in creating the underlying IP.
2.23 The Ld. AO/DRP failed to appreciate the fact that inventor and the legal ownership of the patent are two different concepts and that assessee would only appear a part of the inventor (being part of the team) and not the owner of the Intellectual Property.
2.24 The Ld. AO/DRP failed to take cognizance of the fact that as per the intercompany agreement, all the IP rights would vest with Bally US (AE) as assessee is compensated on cost plus basis and hence doesn’t bear any risks related to R&D.
2.25 The Ld. AO/DRP failed to take cognizance of the fact that the AE is the actual owner of all the rights and title, including all the rights in copyright or other Intellectual Property Rights as the assessee neither creates nor owns the end software developed as it provides services as per terms of the inter-company agreement legally enforceable.
Comparable search undertaken and relevant economic adjustments
2.26 The Ld.AO/TPO erred in conducting a comparable search for entrepreneurial companies engaged in undertaking R&D functions without appreciating the fact that the assessee is a Captive software development service provider.
2.27 The Ld. AO/DRP failed to appreciate the fact that the entrepreneurial companies engaged in undertaking R&D functions can at the best be comparables to the AE who undertakes all the significant functions and risks and not to the assessee who is only a risk mitigated captive software development service provider.
2.28 The Ld. AO/DRP erred in law by comparing entrepreneurial companies having high turnover with that of assessee, which is a captive software development service provider.
2.29 Without prejudice to the fact that the assessee is a risk mitigated captive software development service provider, the TPO ought to have appreciated that the search if any should have been undertaken for contact R&D service provider and not entrepreneurial companies engaged in providing full-fledged R&D functions.
2.30 The Ld.TPO and AO have failed to make appropriate adjustments to account for differences in working capital employed by the assessee vis-a-vis the comparable companies.
2.31 The Ld. AO/DRP have erred in law and facts by not making appropriate adjustments to account for differences in the risk profile of the assessee vis-a-vis the comparables.
2.32 The Ld. AO/DRP erred in not rejecting the companies as comparable as per Rule 10C(3)(ii) in respect of which accurate risk adjustment could not be made due to want of information.
2.33 The Ld. TPO erred in not appreciating the detailed rebuttals made by the assessee with respect to final set of comparable companies selected by him.
2.34 The Ld. TPO failed to appreciate the fact that the final set of comparable companies selected by him were not comparable companies to the assessee for the reasons stated below:
Functional dissimilarity:
1. Infosys Limited
2. Wipro Limited,
3. Mindtree Limited
4. Nihilent Technologies Limited and
5. Persistent Systems Limited
Presence of Brand name / Intangibles:
1. Infosys Limited
2. Wipro Limited and
3. Persistent Systems Limited
High Turnover:
1. Infosys Limited (approximately 188 times the assessee’s turnover)
2. Wipro Limited, (approximately 158 times the assessee’s turnover)
3. Mindtree Limited (approximately 12 times the assessee’s turnover)
Extraordinary events/ acquisitions:
1. Infosys Limited
2. Nihilent Technologies Limited and
3. Persistent Systems Limited
Varied business segments / undertaking research and development activities:
1. Infosys Limited
Advertisement, marketing and promotion expenses:
1. Infosys Limited
Product innovation:
1. Mindtree Limited
3. Corporate Tax grounds
General Ground:
3.1 The Ld. AO erred in disallowing the amount of INR 62,55,408 in respect of Finance lease payment by stating that it is capital in nature.
3.2 The Ld. AO erred in not appreciating the fact that the assessee is not the owner of the vehicles and hence the finance lease payment is allowable as business expenditure under section 37 of the Act.
The Assessee craves leave to add, alter, amend, substitute, rescind, modify and/or withdraw in any manner whatsoever all or any of the foregoing grounds of appeal at or before the hearing of the appeal.”
8. Ground Nos. 1 and 2.1 : These grounds are general in nature and hence not adjudicated separately.
9. Ground Nos. 2.2 to 2.10 and 2.11 to 2.12: Re-characterization of the business of the assessee as contract R&D service provider instead of risk mitigated software service provider and Rejection of FAR analysis undertaken by the assessee:-
10. The Ld.AR submitted before us that the Assessee was incorporated in 2005 and is a wholly owned subsidiary of Bally Technologies Inc., USA/SG Gaming Inc. (currently known as LNW Gaming Inc.) Since 2005, company is undertaking captive software development services for its group companies. The Assessee performs coding/ decoding, debugging, quality test and assurance functions for its group companies and is not involved in any R&D activities. To substantiate the claim, the Ld. AR took us through the software development agreement and highlighted from the agreement (Article II -provision of services) dated 01.04.2007 (Page No. 72 of the Paper book -Volume I) that the Assessee only undertakes software development services for its group companies. Further, the Ld. AR also took us through the Global Transfer Pricing report of Bally Technologies Inc. US relied on by the TPO to conclude that the Assessee provides contact R&D services (Page Nos. 85 to 87 of the Paper book – Volume I) to its group companies. In this regard, the Ld. AR drew our attention to Paras 4 and 5 of the Global Transfer Pricing report (Page No. 85 of the Paper book – Volume I) which specifically mentions that the Assessee’s efforts are focused on software development and that it tests the systems using gaming devices, debugs the system and identify the areas of improvement. Therefore, it the contention of the Ld.AR that the Assessee is only a software development service provider which does testing and debugging. The Ld. AR also highlighted from para 2(e) (Page No. 87 of the Paper book – Volume I) of the said report that it is very clearly mentioned that Assessee does not bear any R&D risk which the TPO has conveniently ignored.
11. The Ld. AR also took us through the letter dated 11.07.2018 provided by Chief T ax officer of the group (Page Nos.89 and 90 of the Paper book – Volume I) clarifying that there is no conflict between the documentation maintained by the Assessee and the group as each report need to be read from the perspective of the respective entity and that the Assessee is only providing support services to its group companies on a cost plus markup basis and does not undertake any R&D functions.
12. Further, it also the contention of Ld.AR that the Assessee was subject to Transfer pricing assessments for Assessment year 2013-14 (the year pervious to the subject Assessment year) and Assessment years 2017-18, 2018-19 and 2020-21 (years post the subject Assessment year) wherein the TPO has accepted the characterisation of the Assessee to be a Software Service Provider and not questioned the same. Hence, the TPO erred in recharacterizing the business of the Assessee to be contract R&D service provider for only the subject assessment year i.e. AY 2014-15 while accepting the characterisation of the Assessee for the pervious and subsequent years.
13. The Ld. AR also highlighted that while for AY 2017-18 and AY 2018-19 the TPO had made TP adjustment on account of outstanding receivables and for AY 2020-21, the TPO had made TP adjustment on account of the difference in the margins and outstanding receivables. The Ld.AR further submitted in all the above-mentioned Assessment years, the characterisation of Assessee to be a software development service provider was accepted by the TPO who had not questioned the same which was evident from the Transfer Pricing orders passed by the TPO (Page Nos. 27 -60 of the additional paper book).
14. It is also the submission of the Ld. AR before us that Bilateral Advance Pricing Agreement (‘BAPA’) has been entered into by the Assessee with the Central Board of Direct Taxes (‘CBDT’) for 5 year period commencing from previous year 2019-20 to pervious year 2023-24 on 19.03.2025 from which it is amply clear that the Assessee is engaged in the provision of Software Development services to its Associated Enterprises (‘AEs’) (Page Nos. 4 and 7 of additional Paper book). The Ld. AR also highlighted that BAPA agreement specifically contains the detailed FAR analysis which confirms the same (Page Nos. 14 to 20 of additional Paper book). The Ld. AR argued that unlike the TP proceedings which only happens basis the documents submitted, BAPA in the case of the Assessee was signed only after the APA authorities conducted physical site visit at the premises of the Assessee, interviewed people from various departments of the Assessee and satisfied themselves on functions actually undertaken by the Assessee vis-a-vis the group companies. Accordingly, only after satisfying itself that the Assessee is actually performing only software Development function for its group companies, the BAPA was signed with Transactional Net Margin Method (‘TNMM’) as the most appropriate transfer pricing method (‘MAM’).
15. Accordingly, the Ld.AR contended before us that Assessee should be characterised as Software development service provider for AY 2014-15 as accepted by the APA authorities and not as contract R&D service provider. Hence, the R&D search undertaken by the TPO is unwarranted and the corresponding transfer pricing adjustment undertaken by the TPO based on such R&D search is completely erroneous and hence bound to be stuck down as the same is bad in law.
16. The Ld.DR raised a preliminary objection that the additional evidence (i.e. Global Transfer Pricing Documentation) filed by the Assessee before this Tribunal should not be admitted and in case if it is admitted, the matter should be remanded back to the TPO for fresh consideration in light of the additional evidence.
17. The Ld. DR further submitted that from the Global TP documentation relied on by the TPO/ DRP, it was evident that the Assessee indeed was a contact R&D service provider and not just a Software development service provider and hence the upward adjustment made by the TPO should be upheld.
18. We have heard the submissions of both the parties perused material available on record and gone through the orders of the authorities along with the paper book filed by the assessee. We find that the additional evidence document is the base document originally called for and obtained by the TPO during the course of TP assessment by invoking the exchange of information section 153(9) of the Act. The Assessee has refiled the same as additional evidence on 17.02.2020. Under normal circumstances, as pointed out by the Ld. DR, if any additional evidence was produced before Tribunal for the first time and which was not available before the lower tax authorities, there may be consideration for remanding back to the lower authorities for deciding the matter in light of the additional evidence. In response, the Ld.AR submitted that the Assessee need not have filed a petition for admission of additional evidence as this is only a resubmission of the document which was already available with the TPO himself. Upon verification of the TP order page no.7, we find that the TPO has mentioned that he had called for Global Transfer Pricing documentation from the US tax authorities and has relied on certain portion of the said document while framing the assessment. Since, this document is already available with lower authorities the Global Transfer Pricing document is not a fresh/additional evidence adduced at the appellate stage. Hence, the preliminary objection of the Ld.DR is rejected and we are inclined to adjudicate the case by admitting the said document.
19. The main plank of the Ld.AR’s contention is that the Assessee is engaged in the business of software development and it has accordingly benchmarked the international transaction by considering comparable companies engaged in software development. However, the TPO has obtained certain documents including the Global Transfer Pricing documentation from the US tax authorities and recharacterized the Assessee as software research company. We have perused the copy of BAPA dated 19.03.2025 entered into by the Assessee with the Central Board of Direct Taxes (‘CBDT’) (Page 7 of Additional Paper book) wherein under the heading Covered transactions, which reads as follows:
“3. Covered Transactions
3.1 The international transactions between the Applicant and its AEs covered by this APA (the “Covered Transactions”) are as follows:
a. Provision of Software Development Services and support services (“SWD Transaction”)
b. Reimbursement of expense received”
20. Similarly, all through the said agreement it is categorically mentioned that the Assessee is engaged in the business of software development for its AE in the US. Further, the letter dated 11.07.2018 provided by Chief Tax officer of the group clarifying the nature of services actually provided by the Assessee to its group companies. We find that the BAPA has been entered into by the Assessee with the CBDT in relation to its international transactions with entities in United States of America (‘USA’) (Page No. 14 of additional Paper book). We find that the BAPA is for the futuristic 5-year period commencing from previous year 2019-20 to pervious year 2023-24. It is pertinent to note that post the site visit conducted by the APA authorities, the BAPA was signed and concluded by characterizing the Assessee as engaged in provision of Software Development Services and Support Services (‘SWD’).
21. Similarly, it is noted that even the TPO has conducted assessments for the Assessment years 2013-14, AY 2017-18, AY 2018-19 and AY 2020-21 by accepting the characterisation of the Assessee to be a Software Development service provider. While the TPO has passed a clear order for AY 2013-14, adjustments were made on account of outstanding receivables for AY 2017-18, AY 2018-19 and AY 2020-21. We find that while additionally there was an adjustment on account of the margin difference on account of fresh search conducted by the TPO for AY 2020-21, wherein also the TPO has undertaken search to identify comparable companies engaged in the business of software development and did not search for comparables engaged in software research & development. Therefore, when the characterisation and FAR profile of the Assessee is abundantly clear from the BAPA signed, clarification letter issued by the Chief Tax officer of the group and the Transfer Pricing orders passed by the TPO for the years pervious and subsequent assessment years, we are not inclined in upholding the upward adjustment made by the TPO by recharacterizing the business of the Assessee as a Contract R&D service provider. Further, the TPO has rejected the search undertaken by the Assessee only by recharacterizing the profile of the Assessee and since we have held that the recharacterization is not warranted, the benchmarking analysis undertaken will have to be accepted. Hence, we direct the AO/TPO to delete the upward transfer pricing adjustment.
22. Thus, the above grounds of appeal are allowed in favour of the Assessee.
23. Ground Nos. 2.13 to 2.34 :- Analysis of the assessee’s employee profiles by the TPO, Rejection of Transfer Pricing documentation, Ownership of the Intellectual Property rights, Comparable search undertaken and relevant economic adjustments
24. Given that the entire TP adjustment now stands deleted based on the Assessee’s characterisation as a Software Development Service Provider and the FAR profile accepted by CBDT (in the BAPA signed with the Assessee post conducting the site visit at the Assessee ‘s office) and the TPO in all the previous and subsequent year assessment orders, the adjudication of these grounds raised by the Assessee becomes academic in nature and hence not adjudicated.
25. Ground Nos. 3.1 and 3.2:- Disallowance in respect of Finance Lease payment
26. The Ld.AR submitted before us the assessee has taken certain vehicles on finance lease for which the assessee pays lease rentals to the lessor which comprises of both principal and interest portion. The Ld. AR also pointed out that as per Accounting Standard -19 ‘Leases’, while accounting for finance leases, lease rental paid cannot be fully charged to profit and loss account and should be apportioned between principal portion (reduced from the outstanding liability n Balance Sheet) and interest portion (finance charges debited to the profit and loss account).
27. The Ld.AR further submitted the since only the interest portion was claimed as finance charges in the profit and loss account, principal portion of lease rentals actually paid during the years is separately claimed in the tax computation under section 37 of the Income-tax Act. The Ld. AR also submitted that the ownership the assets is with the lessor and hence the lessor claims the tax depreciation on leased assets. Since, the assessee is not the owner, these leased assets are not included in the income-tax depreciation block and it has not claimed tax depreciation on lease assets, in accordance with CBDT Circular NO. 2 of 2001 dated 09.02.2001.
28. With regard to the claim on principal portion of lease rentals (finance lease) as deduction in the tax computation, the Ld.AR has placed reliance on the below decisions:
| 1. | NIIT Ltd. v. Deputy Commissioner of Income-tax (Delhi – Trib.)/[2020] 180 ITD 141 (Delhi – Trib.) |
| 2. | Minda Corporation Ltd. v. Dy. CIT (Delhi – Trib.) |
| 3. | Banashankari Medical & Oncology Research Centre Ltd. [2009] 316 ITR 407 (Karnataka) |
| 4. | Rajshree Roadways v. Union of India (Rajasthan) |
29. On the other hand, the Ld. DR relied upon the orders of lower authorities in this regard.
30. We have heard the submissions of both the parties and perused the submissions made by the Assessee. We find strength in the arguments advanced by the Ld.AR. We gainfully refer to the Delhi Tribunal in the Minda Corporation Ltd (supra) wherein it is held as under:
5.4 Thus, the CBDT’s view on the treatment of finance lease is not aligned to the accountant’s perspective of a finance lease. For accounting purposes, although the lessee shows the asset in his balance sheet, charges depreciation in accounts and even makes impairment provision, yet the assessee is not eligible to claim depreciation under the Act, which is allowed to the legal owner of the asset. Furthermore, not only the interest/ finance/ other charges component in the lease payments, but the entire lease payments are treated as a deductible expense and no deduction is allowed for the impairment provision. In the hands of the lessor, the entire ‘lease rentals’ and not merely the finance charges component thereof is taxed as income. The lessor, who is the legal owner of the asset, is entitled to claim depreciation under the provisions of the Act.
5.5 The aforesaid legal position finds support from the decision of the Hon’ble Supreme Court in the case of ICDS Ltd. v. CIT , wherein the Hon’ble Court held that the lessor is the owner of the leased property in case of finance lease, entitled to depreciation of the same.
31. The issue has been analysed and treated the entire lease payments as revenue expenditure in the above said decision and hence respectfully following the same, we delete the disallowance made by the AO and allow the deduction of Principal portion of lease rentals of Rs.62,55,408/- u/s.37 of the Act. Accordingly, we direct the AO to reverse the depreciation, if any, allowed pursuant to the DRP directions by allowing the ground of appeal raised by the assessee.
32. In the result, appeal of the Assessee is partly allowed.