Liquidated Damages as Business Expenditure: TATA Claim Allowed, BSNL Claim Remanded.

I. Liquidated Damages as Business Expenditure: TATA Claim Allowed, BSNL Claim Remanded.

Issue:

Whether liquidated damages payable by an assessee for failing to meet contract delivery deadlines with BSNL and TATA become a real liability and are deductible under Section 37(1) of the Income-tax Act, 1961, in the year the delay occurs, even if actual payment is later.
Whether an issue already decided in the assessee’s favor in a previous assessment year by a Coordinate Bench should be followed for the current assessment years.

Facts:

For Assessment Years 2005-06 and 2006-07, the assessee had contracts with BSNL and TATA, making it liable to pay liquidated damages (LD) if delivery deadlines were not met. The assessee claimed these LDs. The Assessing Officer (AO) disallowed the claim, arguing that the liability did not become “real” during the year and should be claimed in later years when it materialized.

It was noted that a Coordinate Bench, in the assessee’s own case for Assessment Year 2007-08, had allowed the claim for similar LDs, observing that the contract terms established liability the moment delay occurred. In the present assessment years, the issue related to the TATA contract was decided in favor of the assessee by lower authorities based on the agreement. However, the BSNL issue was not verified by the lower authorities.

Decision:

In favor of the assessee (partially), Matter remanded (partially):

The liquidated damages claimed by the assessee with respect to the agreement with TATA were allowed.
With regard to the BSNL liquidated damages, the issue was remanded back to the file of the Assessing Officer to verify the claim of the assessee in line with the directions of the Coordinate Bench in Assessment Year 2007-08.

Key Takeaways:

Accrual of Liability (Mercantile System): In a mercantile system of accounting (generally followed for business income), a liability accrues when it is incurred, irrespective of actual payment, if it is definite and quantifiable. Liquidated damages, if fixed by contract upon a specific event (delay), can become a real liability in the year the event occurs.
Binding Nature of Coordinate Bench Decisions: Decisions of a Coordinate Bench (e.g., of the ITAT) in the assessee’s own case for a different assessment year on the same issue are generally binding on lower authorities unless there’s a material change in facts or law.
Need for Verification: Even with a favorable precedent, if the facts related to a specific claim (like BSNL’s LD) have not been properly verified by lower authorities, the matter may be remanded for such verification.

II. Business Disallowance – Provision for Leave Salary Under Section 43B(f).

Issue:

Whether a provision for leave salary made by an assessee is to be disallowed under Section 43B(f) of the Income-tax Act, 1961, if it is not paid on or before the due date for filing the return of income for the relevant year.

Facts:

For Assessment Years 2005-06 and 2006-07, the assessee had made a provision for leave salary. This amount was not actually paid on or before the due date prescribed under the Income-tax Act for filing the return of income.

Decision:

In favor of the revenue: The court held that where an assessee had made a provision of leave salary which was not paid on or before the due date prescribed under the Income-tax Act for filing of the return of income, such provision made by the assessee was to be disallowed under Section 43B(f).

Key Takeaways:

Section 43B – Payment-Based Disallowances: Section 43B overrides general accounting principles (like mercantile system) and specifies certain expenses that are allowed as deductions only in the previous year in which they are actually paid, irrespective of when they are incurred.
Section 43B(f) – Leave Salary: Section 43B(f) specifically covers “any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee.” This means that provision for leave salary, if not actually paid by the due date of filing the return, is not deductible.
Strict Application of Section 43B: The provisions of Section 43B are applied strictly to ensure that certain liabilities are allowed only upon actual outflow of cash or its equivalent.

III. Business Expenditure – Allowability of Software License Expenditure (Annual Maintenance Charges).

Issue:

Whether expenditure incurred by an assessee towards software annual maintenance charges should be allowed as revenue expenditure under Section 37(1) of the Income-tax Act, 1961, or be treated as capital expenditure.

Facts:

For Assessment Years 2005-06 and 2006-07, the assessee incurred expenditure towards software annual maintenance charges.

Decision:

Matter remanded: The court held that it could not be said that the software had given any benefit of an enduring nature to the assessee or was capital expenditure in nature. Since this software expenditure incurred by the assessee was day-to-day routine expenditure and annual renewal charges only, the same was to be allowed as revenue in nature. However, the exact reason for the remand (as indicated by “Matter remanded”) is not fully detailed in the provided text, but it implies a need for verification by the AO based on these principles.

Key Takeaways:

Revenue vs. Capital Expenditure: The distinction between revenue and capital expenditure is crucial for deductibility. Capital expenditure creates an enduring asset or brings into existence an advantage of an enduring nature, while revenue expenditure is incurred for running the business or maintaining existing assets.
Software Annual Maintenance Charges: Annual maintenance charges (AMCs) for software are typically considered revenue expenditure because they are incurred to maintain the existing functionality of the software, ensure its smooth operation, receive updates, and avoid disruptions. They do not typically create a new asset or a new enduring advantage.
No Enduring Benefit Argument: The court’s finding that the software did not provide an “enduring benefit” and that the expenditure was “day-to-day routine expenditure and annual renewal charges only” is key to classifying it as revenue in nature.
Remand for Factual Verification: Even if the legal principle is established (revenue nature), a remand might be necessary for the Assessing Officer to verify the exact nature of the expenditure and confirm that it indeed falls into the category of annual maintenance/renewal charges and not for the acquisition of new software or significant upgrades that could be capitalized.

IN THE ITAT DELHI BENCH ‘I’

Motorola Solutions India (P.) Ltd.

ACIT

Vimal Kumar, Judicial member
and S. Rifaur Rahman, Accountant member

IT Appeal No.4789 (DEL) of 2014
IT Appeal Nos.3641 and 3646 (DEL) of 2015
[Assessment Years 2005-06 and 2006-07]

MAY 16, 2025

G.C. Srivastava, Adv. and Mayank Patawari, AR for the Appellant. Dharam Veer Singh, CIT DR for the Respondent.

ORDER

S. Rifaur Rahman, Accountant Member.- The assessee has filed appeal against the order of the Learned Commissioner of Income Tax (Appeals) – 2, Faridabad [“Ld. CIT(A)”, for short] dated 16.06.2014 for the Assessment Year 2005-06 and the assessee and Revenue has also filed cross appeals against the order of ld. CIT (A)-1, Gurgaon dated 26.03.2015 for the Assessment Year 2006-07.

2. First we take up assessee’s appeal being ITA No.4789/Del/2014 for Assessment Year 2005-06 raising following grounds of appeal :-

“The following grounds of appeal are independent of and without preju.uce to one another:

1. That on the facts and circumstances of the case and in law, the Ld. AO as well the Hon’ble CIT(A) erred in disallowing the provision for leave encashment of Rs.1,53,71,919/- by erroneously invoking the provisions of section 43B(f) of the Act.

1.1 That the Ld. AO as well as the Hon’ble CIT(A) erred on facts and in law in not appreciating that the provisions of section 43B(f) of the Act were not applicable in facts of the instant case.

1.2 That the Ld. AO erred in disallowing the provision for leave encashment by invoking provisions of see 43B(f) without appreciating that this amount does not represent sum payable by the company.

2. That the Ld. AO as well as the Hon’ble CIT(A) erred in not allowing the deduction for provision for warranty amounting to Rs.5,73,56,176/-without appreciating that the provision was created on scientific basis and the same represents liability in praesenti allowable under section 37(1) of the Act.

2.1 The Hon’ble CIT(A) erred in not appreciating the basis adopted by the company for calculating the provision for warranty expenses thereby holding that there is hardly any co-relation between actual warranty expenses and provision made in the books of account for the subsequent year of the company.

2.2 The Hon’ble CIT(A) erred in holding that the appellant decisively fails the test of “estimation with reasonable accuracy” without appreciating the complete details furnished to substantiate its claim in this regard.

2.3 The Hon’ble CIT(A) erred in not granting relief to the appellant despite the fact that the Company’s case is squarely covered by the decision of Hon’ble Supreme Court in the case of Rotork Controls India (P) Ltd. v. CIT (314 ITR 62 ) and that the provision for warranty expenses was allowed by his predecessor in company’s own case for Assessment Year 2003-04 and 200405.

2.4 Without prejudice to the above, the Hon’ble CIT(A) erred in not allowing the provision for warranty expenses being reversed/utilized during the year.

3. The Ld. AO as well as the Hon’ble CIT(A) erred on facts and in law in disallowing Rs.1,65,65,066/- incurred on acquiring the computer software and treating the same as capital expenditure.

3.1 The Hon’ble CIT(A) erred in disallowing these expenses by not appreciating the various judicial precedents (High Court) relied upon by the Appellant, wherein the software expense has been allowed as revenue expenditure.

3.2 The Hon’ble CIT(A) erred in not appreciating the fact that relief was granted by the Hon’ble ITAT as well as the CIT(A) on these expenses to the erstwhile group company.

4. That the Ld. AO as well as the Hon’ble CIT(A) erred in not allowing the deduction for provision for liquidated damages amounting to Rs.10,05,19,000/- without appreciating that the provision was created on scientific basis and the same represents liability in praesenti allowable under section 37(1) of the Act.

4.1 The Hon’ble CIT(A) erred in not appreciating the basis adopted by the company for calculating the provision for liquidated damages thereby holding that there is hardly any co-relation between actual expenses and provision for the same made in the books of account.

4.2 The Hon’ble CIT(A) erred in stating that the appellant decisively fails the test of “estimation with reasonable accuracy” without appreciating the complete details furnished before the CIT(A) in this regard.

5. That the Hon’ble CIT (Appeals) erred in following the order passed by the Ld. AO u/s 143(3) in respect of AY 2005-06, the same being arbitrary, contrary to law, facts and circumstances of the case.

5.1 That the Hon’ble CIT(Appeals) erred in following the order of the Ld. AO, since the Ld. AO did not exercise his judgment in referring the appellant’s case to the Transfer Pricing Officer (TPO).

5.2 That the Ld. CIT(Appeals) erred in law in relying on the order u/s 92CA(3) of the Act passed by the Ld. TPO and Ld. AO’s action of confirming the Ld. TPO’s order, which in itself is bad in law and liable to be quashed.

5.3 That the Ld. CIT (Appeals) grossly erred both in facts and law by upholding the decision of the Ld. AO/ TPO of disregarding the transfer pricing study (TP Study) and the fresh search conducted by the appellant in determining the arm’s length price with respect to the international transactions undertaken by the appellant to provide software development services, to its overseas group companies.

5.4 That the Ld. CIT (Appeals) erred in supporting the use of current year data for comparable companies, i.e., data for IT 2004-05, despite the fact that the same was not available to the appellant at the time of preparing its TP documentation report.

5.5 That the Ld. CIT (Appeals) erred in accepting the search strategy of the Ld, TPO and thereby deviating from the fundamental quantitative search strategy and filtering process accepted by the Department in the audit proceedings for AY 2004-05.

5.6 That the Ld. CIT(Appeals) erred in upholding the Ld. TPO’s decision to use subjectivity in identification of comparables via use of various quantitative and qualitative filters without disclosing the information/analysis to arrive at arm’s length price and in also disregarding the comparability analysis undertaken by the appellant without giving any cogent reasons.

5.7 That the Ld. CIT (Appeals) erred in rejecting all the loss making comparables in the search process adopted by the Ld. TPO for comparison with the appellant, which amounts to “cherry picking” of the comparables and is in complete violation of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations by Organization for Economic Cooperation and Development (‘OECD guidelines’).

5.8 That the Ld. CIT (Appeals) has erred on the facts and in law by confirming the decision of the Ld. TPO of not allowing working capital adjustment to the margin of the comparable to bring them in line with the working capital requirements of the appellant.

5.9 That the LO. CIT (Appeals) has erred in ignoring the business/commercial reality that since the appellant is remunerated on an arm’s length cost plus basis, i.e., it is compensated for all its costs plus a preagreed mark-up based on a benchmarking analysis, the appellant undertakes minimal business risks as against comparable companies that are full risk taking entrepreneurs, and by not allowing a risk adjustment to the appellant on account of this fact.

6. That on the facts and circumstances of the case, the Ld. AO has erred in law initiating penalty proceedings u/s 271(1)(c) of the Act for concealment of particulars of income and for furnishing inaccurate particulars thereof.

7. The Hon’ble CIT(A) erred in not adjudicating on the additional ground of the Appellant raised in respect of non- allowance of the credit of Tax deducted at source (TDS) allowable to the Appellant.

That the above grounds of appeal are without prejudice to each other.”

3. With regard to ground no.1 to 1.2, at the time of hearing, ld. AR of the assessee brought to our notice that the issue raised by the assessee in these grounds are covered against the assessee in assessee’s own case in AYs 2003-04 & 2004-05 vide order dated 24.08.2018 passed by ITAT and filed a copy of order at the Bar. The decision of coordinate Bench is also reported in and in this regard, he also brought to our notice para 10 of the aforesaid order.

4. On the other hand, ld. DR of the Revenue also submitted that the issue is covered against the assessee vide aforesaid order of ITAT in assessee’s own case.

5. Considered the rival submissions and perused the material on record. We find that this issue is covered against the assessee vide coordinate Bench order dated 24.08.2019 (supra) and the relevant finding given in para 10 is reproduced below for the sake of clarity :-

“10. We have carefully considered the rival contentions and found that the assessee has made a provision for leave encashment of Rs.41633651/-. This sum was not paid during the year and therefore, is outstanding as provision for leave encashment payable. The only issue is whether the provision of section 43B(f) applies to that or not. As per provisions of section 43B (f) of the act any deduction otherwise allowable under the act in respect of any sum payable by assessee as an employer in lieu of any leave at the credit of his employees shall be allowed irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him only in computing the income referred to in section 28 of the previous year in which some such sum is actually paid by him. Therefore irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him any such provision for leave encashment for accrued leave shall be allowable only in the year in which such sum is paid. According to the assessee the above sum is payable to the employees who leaves the job by resigning. It is not payable to any employees who are working with the company. The assessee claimed that the liability created would keep getting accumulated and not payable until the employee leaves the company. The ld AR heavily relied upon the decision of the Bharat Earth Movers v. CIT. We have carefully considered the decision of the Hon’ble Supreme Court however, the issue before the Hon’ble Supreme Court was that whether the provision for meeting the liability on earned leave by an employee is an admissible deduction. The Hon’ble Supreme Court has held that the above liability is a provision made by the assessee for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by the employees of the company would be allowable as deduction the year in which the provision was made for that liability. It was further held that liability was not contingent liability but accrued liability. The above decision was referred for Assessment Year 1978-79. However, disallowance has been made by the Ld AO and confirmed by the Ld CIT (A) u/s 43B(f) of the Act. There cannot be any doubt that leave encashment liability is an eligible deduction available to the assessee. But, in view of the clear-cut provisions of the law that from 1 April 2002 leave salary payable by the assessee as an employer to his employees is brought within the purview of section 43B of the act However, the relaxation contained in the 1st proviso is available. On further it is clarified that once deduction of the provision made in an earlier year’s is allowed, no deduction is permissible in respect of the same amount once again on payment basis. Therefore, if the assessee has made the provision of leave salary which has not been paid on or before the due date prescribed under the income tax act for filing of the return of income then such provision cannot be allowed as deduction in the year in which the provision is made but the payment has not been made before the due date of filing of the return of income. In view of this, we do not find any infirmity in the order of the lower authorities. Hence ground number 1 of the appeal of the assessee against the disallowance of provision of leave encashment by invoking the provisions of section 43B (F) of the act of Rs.4163365/- is dismissed.”

6. Respectfully following the decision of the coordinate Bench (supra), we dismiss ground nos.1 to 1.2 raised by the assessee. 7. With regard to grounds no.2 to 2.4, it is brought to our notice that the coordinate Bench in the decision (supra) considered the issue raised by the assessee in ground no.2 and remitted the issue back to the file of AO/CIT (A). He brought to our notice para 13 of the aforesaid order wherein coordinate Bench has observed that the issue under consideration was remanded back to Assessing Officer for verification, therefore, there is no grievance to the assessee. Ld. AR brought to our notice Order Giving Effect (OGE) to the above order which is placed in the paper book as Annexure ‘A’ & ‘B’. He prayed that similar direction may be given in this assessment year also.

8. On the other hand, ld. DR of the Revenue also submitted that the OGE passed by the Assessing Officer may be relied upon.

9. Considered the rival submissions and material placed on record. We observed that the issue under consideration is squarely covered by the decision of coordinate Bench in AYs 2003-04 & 2004-05 (supra), therefore, we are inclined to direct the Assessing Officer to follow the directions and the relevant findings in OGE in AYs 2003-04 and 2004-05 may be followed. Accordingly, this issue is allowed in favour of the assessee as indicated above. Grounds No. 2 to 2.4 are allowed as above.

10. With regard to Grounds No.3 to 3.2, ld. AR submitted that this issue is also covered in favour of the assessee and in this regard, he brought to our notice para 23 of the coordinate Bench order (supra) and submitted that the issue was considered by the coordinate Bench and expenditure involved is software expenditure which is not in the capital nature, therefore, similar expenditure was incurred in this year also may be allowed.

11. On the other hand, ld. DR of the Revenue objected to the above submissions and submitted that assessee has incurred major expenditure in the software upgradation and he prayed that the addition made by the Assessing Officer may be sustained. He further brought to our notice page 26 of the appellate order and submitted that he relied on the findings of the lower authorities.

12. Considered the rival submissions and material placed on record. We observed that the issue under considered is the expenditure of software annual maintenance charges and we observed that the coordinate Bench in the decision (supra) has considered the similar issue and allowed the same in favour of the assessee vide para 23 of its order. For the sake of repetition, findings of the coordinate Bench in para 23 is reproduced below :-

“23. We have carefully considered the rival contention and perused the orders of the lower authorities. We have noted the details of the software expenditure produced before us by the learned authorized representative, which was also provided to the learned departmental representative. Out of the total expenditure of Rs.6714164/-, most of the expenditure has been incurred by the assessee towards the software annual maintenance charges. The assessee’s major expenditure of Rs.836030/- was also because of the annual renewal of the software licenses. Assessee has also made the software development expenditure for bringing up the relevant software used for the day-to-day business needs of the assessee. In view of this, it cannot be said that the software has given any benefit of enduring nature to the assessee or are capital expenditure in nature. In view of this is the expenditure incurred by the assessee on software expenditure is day-to-day routine expenditure and annual renewal charges only, we are of the opinion that it is revenue in nature. In view of this, we direct the learned assessing officer to delete the disallowance of Rs.6714164/- made by the learned AO because of software expenditure holding the same to be capital expenditure. He is also further directed to withdraw the allowance of the depreciation at the rate of 60% thereon. Accordingly, ground number 6 of the appeal of the assessee is allowed.”

13. Respectfully following the same, we are inclined to allow grounds no.3 to 3.2 raised by the assessee.

14. With regard to Grounds No.4 to 4.2, ld. AR of the assessee brought to our notice the submissions made in the written submissions which are reproduced below :

“B. Liquidated Damages B.1. The AO, in his order, makes the disallowances on the ground that the liquidated damages become actual when the client is not able to meet the delivery deadline. The liability does not become real till then. Hence, the deduction should have been claimed in the later years, when it assumes the character of real liability. (Page 29 of the AO’s order for AY 2005-06 and Page 4 of AY 2006-07)

B.2. The CIT(A) confirms the disallowance by comparing the provision for the damages made in the accounts and the actual utilization of funds for the same and thereby holding that the test of estimation with reasonable certainty fails in this case. (Page 35 of CIT(A) order for AY 2005-06 and Page 13 of A Y 2006-07 Order)

B.3. It may be submitted that the Assessee claimed the liquidated damages for only BSNL in A Y 2005-06, for Tata and BSNL in A Y 2006-07 and BSNL and Reliance in AY 2007-08. (Refer to page 430 of the Corporate tax PB for A Y 2006-07)

B.4. The matter relating to AY 2007-08 has been decided by the Hon’ble Coordinate Bench giving full relief to the Assessee by observing as under:

“169.1 We have considered the rival submission and have perused the record of the case. Admittedly the contract entered into by the Assessee with its customer contained a specific clause on liquidated damages which define terms and conditions of liquidated damages including the method of calculation as noted earlier. It is not disputed that assessee has created the provision only in those cases where the delay had actually occurred and on the basis of terms and conditions of contract. The terms of contract contemplated that the moment delay occurs in the execution of contract then assessee will become liable for payment of liquidated damages. The liability, thus, crystallized with the occurrence of event of delay in the execution of contract. The assessee might, after entering into negotiation with the party, get a waiver or partial deduction in its liability but that does not absolve the assessee from being liable for liquidated damages on occurrence of the event of delay in execution of the contract. ”

(page 556 of the Corporate tax PB for AY 2006-07)

B.5. The ITAT has not restored the matter back to the AO for any further verification and therefore the observation that the ground is allowed for statistical purposes in Para 175 is a typographical error on the face of it.

B.6. This is also evident from the order giving effect to the order of Hon’ble Tribunal for AY 2007-08 which is enclosed as Annexure ‘C’. In fact, the Hon’ble Members wanted to see the OGE for AY 2007-08 which was not readily available and thus a direction was given to submit the same, B.7. It may kindly be appreciated that the AO passed a fresh order of assessment as the matters relating to TP and Software Expenses were restored to the AO. The AO issued SCN and gave opportunity to the assessee only for TP addition and disallowance of Software expenses. The relief given in respect of liquidated damages was not an item which was either set aside or even considered again by the AO in the fresh assessment. The relief given by the Hon’ble Bench was taken such. It is apparent that the matter was taken as concluded by the Tribunal.

B.8. The entire correspondence with BSNL running from pages 194 to 200 of corporate tax PB for AY 2005-06 pertains to BSNL. Hence, CIT(DR) is not justified in stating that the details in respect of BSNL were not filed.

B.9. The chart on Page 246 of the Corporate tax PB for AY 2005- 06 shows the movement of provisions. This chart shows that the Assessee even booked a reversal of the provision to the extent of Rs. 3.97 crores, pertaining to BSNL. This amount of Rs. 3.97 crores is offered to tax in the year of reversal. This is exactly the point that has been taken into consideration by the ITAT in AY 2007-08 (para 167.4).

B.10. It is prayed that the principles set out by the coordinate bench in the order for AY 2007-08 for the allowability of liquidated damages may kindly be followed and the relief allowed to the appellants.

B.11. It is emphasized that provision for BSNL was also a subject matter of consideration before the coordinate bench in AY 2007-08.”

15. On the other hand, ld. DR of the Revenue submitted that the issue under consideration in this assessment year is different compared to the submissions made by the assessee by referring to the AYs 2003-04 and 2004-05. He submitted that in this assessment year, the assessee has entered into two separate contracts with BSNL and TATA and as far as, BSNL is concerned, he submitted that there is no contract entered by the assessee with BSNL and was not filed by the assessee. He submitted that assessee is referring on the final recommendation of the BSNL Committee and moreover assessee has only credited provisions and there is no specific/scientific calculation submitted before the Assessing Officer to claim the expenditure. He brought to our notice page 430 of the paper book wherein assessee has relied on the chart submitted before the Assessing Officer. He submitted that from the above, it is clear that it is only a provision, therefore, provision of expenses cannot be allowed. He brought to our notice page 195 of the paper book wherein the details are based on milestones i.e. attaining the milestone of 30%, 60% & 100%. It clearly indicates that it is a provision and not actual damages claimed by the BSNL. With regard to damages claimed by the TATA AIG, he submitted that the issue under consideration is covered by the decision of earlier assessment year and submitted that the same may be remitted back to the Assessing Officer for verification and prayed that the issue of BSNL may also be remitted back to Assessing Officer for proper verification.

16. Considered the rival submissions and material placed on record. We observed that assessee has claimed liquidated damages claimed by the BSNL and TATA in respective assessment years under consideration. It is brought to our notice that in AY 2007-08, the coordinate Bench in assessee’s own case allowed the claim of the assessee by observing as under :-

17. We further observed that at the time of hearing, ld. AR submitted the OGE passed for AY 2007-08 and in the abovesaid order, Assessing Officer has allowed the claim of the assessee after due verification based on the directions of the coordinate Bench. It is also brought to our notice by the ld. DR of the Revenue that in present assessment year, the issue of two agreements involved is BSNL and TATA. We observed that the issue under consideration is decided in favour of the assessee based on the agreement entered by the assessee with TATA AIG. However, BSNL issue is not verified by the lower authorities and, therefore, we are inclined to allow the liquidated damages claimed by the assessee with respect to the agreement with TATA AIG. With regard to BSNL, we are inclined to remit the issue back to the file of Assessing Officer to verify the claim of the assessee in line of the directions of the coordinate Bench in AY 2007-08. Accordingly, the issue raised by the assessee relating to BSNL is remitted back to the Assessing Officer for verification after giving opportunity of being heard to the assessee. Accordingly, grounds no.4 to 4.2 raised by the assessee are partly allowed for statistical purposes.

18. With regard to grounds no.5 to 5.9, the issue raised by the assessee is relating to transfer pricing issue. At the time of hearing, ld.AR of the assessee brought to our notice that assessee has filed a copy of the MAP with the USA for AYs 2005-06, 2006-07, 2009-10, 2010-11 and 2011-12 in accordance with Rule 44G (8) of the Income-tax Rules, 1962. Copy of the same is placed on record. Based on the above MAP, the assessee seeks to withdraw the grounds raised by the assessee with regard to provision of software development expenses.

19. After considering the same, we are inclined to allow the withdrawal of ground nos.5 to 5.9 raised by the assessee with regard to transfer pricing issue, since the current assessment year under consideration is covered by the MAP provisions.

20. Ground no.6 is against the initiation of penalty proceedings u/s 271(1)(c) which is premature at this stage and accordingly, the same is dismissed as such.

21. Ground No.7 is general in nature, hence the same is dismissed as such.

22. In the result, the appeal filed by the assessee being ITA No.4789/Del/2014 for AY 2005-06 is partly allowed.

23. The assessee has filed appeal being ITA No.3641/Del/2015 for AY 2006-07 raising following grounds of appeal :-

“The following grounds of appeal are independent of, and without prejudice to one another:

1. That on the facts and in the circumstances of the case and in law, the order passed by the Ld. AO and the Hon’ble CIT(A) is bad in law.

2. That the Ld. AO as well as the Hon’ble CIT(A) erred in not allowing the deduction for provision for liquidated damages amounting to Rs.32,17,57,928/- without appreciating that the provision was created on scientific basis and the same represents liability in praesenti allowable under section 37(1) of the Act.

2.1 On the facts and in the circumstances of the case and in law, the Hon’ble CIT(A) erred in mechanically following the order passed by him for the immediately preceding year i.e. AY 2005-06 and thereby ignoring the decision of the Hon’ble ITAT in Appellant’s own case for the AY 2007-08, wherein the ITAT has allowed the claim of provision for liquidated damages to the Appellant.

2.2 The Hon’ble CIT(A) erred in not appreciating the basis adopted by the company for calculating the provision for liquidated damages thereby holding that there is hardly any co-relation between actual expenses and provision for the same made in the books of account.

2.3 The Hon’ble CIT(A) erred in stating that the appellant decisively fails the test of “estimation with reasonable accuracy” without appreciating the complete details furnished before the CIT(A) in this regard.

3. The Ld. AO as well as the Hon’ble CIT(A) erred on facts and in law in disallowing Rs.2,12,74,929/- incurred on expenses relating to computer software and treating the same as capital expenditure.

3.1 On the facts and in the circumstances of the case and in law, the Hon’ble CIT(A) has erred in mechanically following the order passed by him in the immediately preceding year i.e. AY 2005-06 and thereby ignoring the decision of the Hon’ble ITAT in Appellant’s own case for the AY 2007-08, wherein the ITAT has directed the AO to decide the issue in the light of guidelines laid down by Special Bench of ITAT in the case of Amway India Enterprises v. DCIT(Punjab & Haryana)).

3.2 The Hon’ble CIT(A) erred in disallowing these expenses by not appreciating the various judicial precedents (High Court) relied upon by the Appellant, wherein the software expense has been allowed as revenue expenditure.

3.3 The Hon’ble CIT(A) erred in not appreciating the fact that relief was granted by the Hon’ble ITAT as well as the CIT(A) on these expenses to the erstwhile group company i.e. Motorola India Electronics Pvt. Ltd., for the AY 2003-04.

4. Without prejudice to the above grounds of appeal, the appellant is entitled to the deduction available under section 10A / 10B of the Income-tax Act, 1961 (the Act) on the increased profits of the business of the eligible undertakings on account of various disallowances made. Accordingly, a direction may kindly be given in this regard.

5. That on the facts and in the circumstances of the case, the reference made by the Ld. Assessing Officer (Ld. AO’) suffers from jurisdictional error as the Ld. AO has not recorded any reasons in the assessment order based on which he reached the conclusion that it was ‘expedient and necessary’ to refer the matter to the Ld. Transfer Pricing Officer (‘Ld. TPO’) for computation of the arm’s length price, as is required under section 92CA(1) of the Act.

6. That the Ld. CIT erred in upholding the adjustment to the income of the appellant of Rs.27,52,24,842 by holding that the appellant’s international transaction of provision of software development services to the Associated Enterprises (‘AEs’) does not satisfy the arm’s length principle as envisaged under the Act and in doing so have grossly erred in.-

5.1 disregarding the Arm’s Length Price (,ALP’), as determined by the appellant in the TP documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 (‘Rules’);

5.2 using current year data i.e., data for FY 2005-06 for comparable companies, despite the fact that the same was not available to the appellant at the time of preparing its TP documentation report;

5.3 arbitrarily disregarding the comparable companies identified by the appellant in respect of its provision of software development services, and thereby failing to appreciate that the appellant had undertaken a detailed and appropriate Function-Asset-Risk (‘FAR’) analysis followed by a methodical benchmarking process for the said purpose;

5.4 resorting to an arbitrary rejection of law profit companies included in the set of comparable companies selected by the appellant based on erroneous and inconsistent filtration criteria/reasons, and selecting high-profit making companies having similar functions and circumstances, and thus deriving an incorrect/unrepresentative industry set for benchmarking the operating profit margins earned’ by the appellant in respect of its software development services, thus demonstrating an intention to arrive at a pre-formulated opinion without complete and adequate application of mind, with the single minded intention of making an addition to the returned income of the appellant;

5.5 arbitrarily applying a Wages/ Total Cost (‘wages/ TC’) filter of 30 to 70 percent in order to reject certain functionally comparable companies;

5.6 arbitrarily ignoring comparable segments of companies selected by the appellant in respect of its software development services, on the ground of non-availability of data for application of wages/ TC filter;

5.7 retaining in comparable engaged in related party transactions during the year.

5.8 denying the appellant, the benefit of a working capital adjustment.

5.9 denying the appellant, the benefit of a risk adjustment and holding that the appellant is a risk bearing entity while ignoring the business/ commercial reality that since the appellant is remunerated on an arm’s length cost plus basis, i.e., it is compensated for all its costs plus a preagreed mark-up, the appellant undertakes minimal business risks as against comparable companies that are full- fledged risk taking entrepreneurs; and

5.10 disregarding judicial pronouncements in India in undertaking the TP adjustment

5.11 disregarding the fact that the appellant was entitled to tax holiday on its part of its profits from provision of software development services to the AEs and therefore would not have any untoward motive of deriving any tax advantage by manipulating transfer prices of its international related party transactions

5.12 disregarding the factual realities of the functional profile of the appellant in respect of its software development activities and wrongly holding that the appellant is involved in research and development activities and product development and consequently including companies involved in the trading of products in the comparable set

5.13 Without prejudice to ground 5.2, the action of Ld. CIT in confirming the action of the TPO in selecting comparable whose data does not correspond to the financial year of the Appellant as thus in conflict with Rule 10B(4) of the Income tax Act, being the data not contemporaneous.

7. That the Ld. CIT grossly erred on facts and in law in denying the benefit of (+/-) %% range mentioned in the proviso to section 92C of the Act to the appellant.

That on the facts and circumstances of the case, the Ld. AO has erred in law in initiating penalty proceedings u/s 271(1)(C) of the Act for concealment of particulars of income and for furnishing inaccurate particulars thereof.

That the above grounds of appeal are without prejudice to each other.”

24. Ground No.1 is general in nature, hence not adjudicated. 25. Ground Nos.2 to 2.3 is covered in favour of the assessee by our above decision in ITA No.4789/Del/2014 for AY 2005-06 in Para Nos.14 to 17. Respectfully following the same, these grounds are partly allowed for statistical purposes. 26. With regard to Ground Nos.3 to 3.3, the same are covered vide Paras 10 to 13 of our above order and accordingly, these grounds raised by the assessee are allowed.

27. With regard to Ground No.4, the assessee has not submitted any submission, hence the same is dismissed as such.

28. Ground Nos.5 to 7 are also covered vide Para 18 & 19 of our above order and the same is decided as indicated above.

29. Ground No.8 is premature, hence the same is dismissed.

30. In the result, the appeal being ITA No.3641/Del/2015 for AY 2006-07 filed by the assessee is partly allowed.

31. The Revenue has filed appeal being ITA No.3646/Del/2015 for AY 2006-07 raising following grounds of appeal :-

“1. That while working out Arm’s Length Margin on remuneration for chip design service, Ld. CIT(A) has failed to appreciate that the TPO has established that;

(i)

Assessee is engaged in high end activity of chip design that cannot be equated with a typical run of the mill software development activity.

(ii)

The choice of comparable if made strictly according to the norms, will not yield a set that can be squarely used for comparison.

(iii)

The companies that are functionally closed to the company do have elements of controlled party transactions, owing to the typical nature of the industry/organization.

(iv)

Best international practices support the view that even within the contract R&D sector, the mark up varies with industry and type of research.

2. That on the facts and in the circumstances of the case, Ld. CIT(A) is not justified in directing to exclude M/s Sat yam Computers Systems Ltd. from comparables although it is functionally similar and has been selected after applying primary and secondary screening.

3. That on the facts and in the circumstances of the case, Ld. CIT(A) is not justified in directing to exclude M/s Aztech Software Technologies Ltd. from comparables although it is functionally similar and has been selected after applying primary and secondary screening.

4. That on the facts and in the circumstances of the case, Ld. CIT(A) is not justified in directing to include M/s VJIL Consulting Ltd. in comparables although it is functionally different.”

32. Since the assessee has completed the ‘MAP’ formalities and the transfer pricing issues are covered by the MAP provisions, therefore, the appeal preferred by the Revenue has become infructuous, hence dismissed as such.

33. In the result, the appeal being ITA No.3646/Del/2015 for AY 2006-07 filed by the Revenue is dismissed.

34. To sum up : both the appeals filed by the assessee are partly allowed and the appeal filed by the Revenue is dismissed.