Pune Tribunal disallows expense on which no TDS was deducted as the taxpayer claimed it as reimbursement of expense

Tax Update

Pune Tribunal disallows expense on which no TDS was deducted as the taxpayer claimed it as reimbursement of expense. The Tribunal opines that a shall be called as a reimbursement only when undiluted benefit, flowing from the incurring of expenditure is passed on, as such, to the other.

Facts of the case

1. The Assessee is a Switzerland based non-resident and had received certain amounts from it’s Indian affiliate Rieter India Private Limited (‘RIPL')

2. During the assessment, the AO observed that the Assessee had included a sum of Rs.20,04,14,231/- in its total income, being, IT service charges received through RIPL and offered it for tax at 10% in terms of the Double Taxation Avoidance Agreement between India and Switzerland (DTAA). However, another receipt of Rs.4,05,96,997/- from RIPL was not offered for taxation.

3. The assessee submitted that a sum of Rs.17,02,173/- was in the nature of reimbursement of expenses received from RIPL, representing supply of clothes required for Rieter India employees, Promotional gifts for exhibitions and expenses incurred by employees towards their accommodation etc. which was charged back without any mark-up. The AO accepted the transaction as not chargeable to tax.

4. The remaining amount of Rs.3,88,94,824/-, was claimed as reimbursement of IT license costs incurred towards centrally purchasing software licenses and use by RIPL

5. The AO analysed the MSA under which the IT services to RIPL was offered and deduced the precise nature of the services rendered wherein it was observed that the Assessee could not explain as to how the receipt of Rs.3.88 crore claimed as reimbursement, was different from the receipt of Rs.20.04 crore from the IT services rendered under the MSA, which was offered to tax

6. Therefore, the same was chargeable to tax in India as Fees for technical services/ Royalty under ITA and Article 12 of DTAA.

7. Considering the above, ITAT adjudicated on the following questions:

• Whether receipt was in the nature of reimbursement?
• Whether receipt was in the nature of royalty?
• If none of the above, what is the true nature of the receipt?

8. Is the receipt a reimbursement? The ITAT acknowledged that in principle, chargeability is attracted on the income element embedded in a revenue receipt. A receipt de hors profit element, which is only a Reimbursement, is not taxable. However, to categorize a particular amount as reimbursement, it is sine-qua-non that the expenditure should be incurred for and on behalf of the other.

9. It envisages two cumulative conditions:

• Undiluted benefit flowing from the incurring of expenditure is passed on, as such, to the other; and
• The amount incurred is recovered as it is from the other without any plus or minus to that

10. The ITAT observed that if the costs incurred go in a common pool which are then shared by several persons on certain allocation keys, even if the amount so allocated and recovered may be without any mark up, but it may not necessarily constitute reimbursement in the strict sense qua each participant independently

11. In light of the above, the ITAT went on to analyse the actual nature of the services wherein it noted that the services rendered were mainly of two types, namely, Client Based Services and Business Application.

12. The ITAT highlighted that the Assessee in its submission had stated that the reimbursement of IT license cost amounting to Rs.3.88 crores had no relationship with the services provided under the MSA. It was purely recovery of software license cost which were transferred to RIPL and recharged without any mark-up.

13. However, on verification of the submissions made before the AO, the ITAT noted that the third-party software were centrally purchased by Assessee and IT support services were provided to all its group entities by allowing access to highly developed and efficient IT infrastructure.

14. Is the receipt a reimbursement?ITAT also verified the complete detail of IT costs reimbursement worth Rs.3.88 crore and the manner of its allocation wherein it noted that the nature of the services in case of amount stated as reimbursement were identical to the services as laid down in the MSA towards which a taxable revenue was received of Rs. 20.04 crores (the only difference being what was already offered to tax was w.r.t IT services rendered from its own developed software and the latter being expenses w.r.t purchase of third party software)

15. Thus, it was stated that the transaction sheds the character of the Assessee purchasing certain software licenses from third party vendors and then sub-licensing the same to its group entities including RIPL, for which it received reimbursement of the costs incurred on purchasing them (this was also corroborated based on the Assessee’s submission before DRP wherein it was stated that the company does not have the authority to sub-license).

16. Thus it was held that the first condition of Reimbursement being, the passing of the unfiltered benefit of the expenditure to the other, fails in this case as the assessee purchased software from the third party vendors and did not pass on the same to RIPL, but offered services with the help of such software

17. Further, w.r.t to allocation of the costs, the ITAT observed that the allocations keys were not supported by enough evidence. Also reference was made to the MSA, which firstly talks of incurring software and license fee in rendering the services and then, of loading software and license fee cost with mark-up of 5%. In absence of any evidence to support the allocation and considering the terms of the MSA, the ITAT held that even the second condition fails in the present case.

18. Therefore, it was concluded that the receipt is not in the nature of reimbursement.

19. Is the receipt software royalty?The Assessee placed reliance on the judgement of the Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. Vs. CIT (2021) 432 ITR 472 (SC) to state that the payment was not in the nature of royalty.

20. In this regard, the ITAT observed that the present case is not a situation in which the assessee purchased software from third party vendors and then licensed the same to RIPL for use. Rather all the software purchased by it were integrated by the assessee into its own centralized IT infrastructure for facilitating the provision of the IT services enlisted above to its group entities and RIPL is one of such beneficiary of the services.

21. ITAT observed that the ratio of Engineering Analysis (supra) can apply where the vendors demonstrate that what they transferred to the assessee was copyrighted article and not copyright. On the contrary, the present case is concerned with the second stage in which the software licenses, being in the nature of copyrighted article, were purchased by the assessee and then used in the providing various services

22. Accordingly, the ITAT analysed the details shared by the Assesseew.r.t. nature of services and cost allocations wherein it was evidenced that apart from purchasing the software for the centralized IT infrastructure Centre, the assessee also incurred certain IT infrastructure costs for integrating them into its centralized system so as to render services to the worldwide entities, which was charged to RIPL at 17.09%.

23. Considering the above, it was held that the amount recovered by the assessee from RIPL is not towards transfer of any software transaction (copyrighted article) not chargeable to tax

24. What is the nature of the receipt? The assessee offered revenue to tax in so far the consideration for the I.T. services rendered from its own developed software is concerned, but claimed the corresponding revenue to the extent of cost incurred in purchasing software from third party vendors and the cost incurred in setting up the matching infrastructure, as reimbursement

25. The ITAT noted that the nature of services w.r.t. amounts of Rs. 20.04 crores and Rs. 3.84 crores is no different and hence cannot be treated differently

26. The Assessee had offered the aforesaid amount of Rs. 20.04 crores as royalty or FTS @10% (as the same did not make any difference in the taxability considering the consistent tax rate) and hence, the ITAT concluded that Rs. 3.84 crores be offered to tax @10% in line with the same

Our Comments

The taxpayers need to re-consider the existing positions that have been adopted with respect to payments to be made to group entities. A lot of such payments may not fall within the meaning of the term ‘reimbursement’in light of the above ruling.

Non-deduction or deposition of withholding tax under the above situation may lead to the following consequences under the Income Tax Act, 1961:

In light of the above, it is important especially for taxpayers making payment to their group entities outside India for common cost allocation, to have a deeper understanding of the nature of payment in light of the suggested parameters.