K.C. SINGHAL, J.M. These are cross-appeals filed by assessee and Revenue pertaining to asst. yr. 2001-02. same were heard together and, therefore, are being disposed of by common order for sake of convenience. 2 . common issue arising from cross-appeals relates to disallowance of Rs. 59,50,64,0 7 6 under s. 40(a)(ii) of IT Act, 1961 ( Act ). Briefly stated, facts are these : assessee is distributor of software products. During year under consideration, assessee purchased software from various non-resident parties and paid total consideration of Rs. 59,50,64,0 7 6, which was claimed as revenue expenditure. AO, for reasons given in assessment order, treated such sum as payment on account of royalty under s. 9(1)(vi) of Act. Since no tax was deducted at source by assessee at time of making payments, AO disallowed same as revenue expenditure under s. 40(a)(i) of Act. CIT(A), for reasons given in his order, confirmed finding of AO that such payments fell within ambit of s. 9(1)(vi) of Act and consequently, assessee was under obligation to deduct tax at source under s. 195. Hence, provisions of s. 40(a)(i) of Act were attracted. However, he accepted alternative plea of assessee that since biggest supplier of software namely, Microsoft Regional Sales Corpn., Singapore had paid tax on amount received by assessee, no disallowance is justified to that extent. This plea was accepted after following various judgments of various High Courts. Accordingly, he deleted disallowance to extent of Rs. 5,460.80 lakhs after verifying fact that tax due was paid by Singapore party on 22nd March, 2004. Aggrieved by same, assessee as well as Revenue are in appeal before Tribunal. 3. assessee is aggrieved by finding of CIT(A) that payment on account of purchase of software amounted to royalty within meaning of s. 9(1)(vi) of Act while Revenue is in appeal against finding of CIT(A) that no disallowance under s. 40(a)(i) could be made if it is found that due tax has been paid by non-resident supplier. learned counsel for assessee has submitted that issue is now covered by decision of Tribunal in assessee s own case wherein it has been held that such payment could not be considered as payment on account of royalty within ambit of s. 9(1)(vi) of Act and consequently, assessee was not legally required to deduct tax at source under s. 195. On other hand, learned Departmental Representative has relied on reasonings given by CIT(A) as well as AO in their orders. 4 . We have considered submissions of rival parties. issue before us has already been concluded by decision of Tribunal dt. 28th April, 2005 in assessee s own case wherein Tribunal, following its decision in case ofSamsung Electronics Co. Ltd. vs. ITO (2005) 93 TTJ (Bang) 658has held that payment made by assessee for purchase of software did not amount to royalty within ambit of s. 9(1)(vi) of Act and, therefore, assessee was not liable to deduct tax at source under s. 195. Following said decision, it is further held that, as necessary corollary, provisions of s. 40(a)(i) could not be applied to case of assessee. finding of CIT(A) that payment towards purchase of software amounted to royalty within meaning of s. 9(1)(vi) of Act is hereby vacated. 5 . We are also unable to uphold other finding of CIT(A) that disallowance under s. 40(a)(i) could not be made and since non-resident company paid tax on amount received by them from assessee. reason is obvious as deduction under s. 40(a)(i) is allowable only in year i n which tax has been paid. main provision disentitles assessee from claiming deduction if tax deducted has not been paid. Further, proviso in clear terms provides that where tax has been paid in any subsequent year then deduction shall be allowed in year in which such tax has been paid. In present case, it has been noted by CIT(A) that non-resident had paid tax on 22nd March, 2004, consequently, deduction could be claimed only in asst. yr. 2004-05 and not in year under consideration. CIT(A), therefore, was incorrect in holding that no disallowance could have been made under s. 40(a)(i) of Act as tax was ultimately paid by non-resident. Accordingly, we also vacate this finding of CIT(A). 6 . In view of above discussion, we set aside order of CIT(A) and delete entire disallowance under s. 40(a)(i) made by AO and sustained by CIT(A). 7 . next issue arising from appeal of assessee relates to disallowance of Rs. 6,55,88,590 on account of service charges paid to Sonata Software Ltd. (SSL). Brief facts giving rise to this appeal are these : assessee is 100 per cent subsidiary of SSL. It came into existence in year under consideration with object to carry out one of activities of SSL which was not eligible for exemption under s. 10A. Prior to year under consideration, SSL was carrying out two independent activities i.e.,(i) activity eligible for exemption under s. 10A, and (ii) activity not eligible for exemption under s. 10A. Separate accounts were maintained by SSL for these activities. Direct expenses relating to these activities were accounted for in separate accounts respectively. However, service charges were common and later on allocated to these activities on basis of turnover. assessee, after its incorporation, took over activity of SSL, which was not eligible for exemption under s. 10A on 1st July, 2000. However, agreement was entered into between assessee and SSL to effect that SSL would continue to incur expenses in nature of service charges on behalf of assessee as before and same would be reimbursed by assessee. assessee paid sum of Rs. 6,55,80,590 as service charges for year under consideration and claimed same as business expenditure. 8. AO disallowed entire expenditure by observing as under : "(i) following tabulation gives details of sales, expenditures claimed of nature Legal and professional expenses and of nature Recruitment and training in separate P&L a/cs prepared for non-s. 10A activity of SSL in asst. yrs. 1998-99, 1999-2000 and 2000-01 and in case of assessee-company for asst. yrs. 2001-02 and 2002-03. Sonata Sonata Information Software Ltd. Technology Ltd. 1998- 1999- 2001- 2002- Asst. yr. 2000-01 99 2000 02 03 New Non-s. company 10 activity (Rs. in lakhs) Trading 12,3 7 4,980 6,305.60 9,184.80 9,694 sales of software 8.80 Legal & 18.25 23.68 39.50 655.88 910.2 7 professional Recruitment (service (service 9.59 & training charges) charges) From above, it is observed that expenditure in SSL under heads Legal and professional and Recruitment and training for asst. yrs. 1998- 99 to 2000-01 increased in proportion to turnover from Rs. 18.25 lakhs to Rs. 49.09 lakhs (Rs. 39.5 lakhs + Rs. 9.5 lakhs). However, in comparison to this, expenditure on account of service charges (which encompasses expenditures claimed under said two heads) in assessee-company for asst. yrs. 2001-02 and 2002-03 has been claimed at abnormally high amount of Rs. 655.88 lakhs and Rs. 910.2 7 lakhs, respectively, disproportionate to turnover of assessee. (ii) It has been stated in said agreement of SSL with assessee- company that all out of pocket expenses including travel, conveyance, etc. are to be billed separately by SSL and shall be reimbursed by assessee. However rather than separately billing for these out of pocket expenses, SSL is raising periodic lump sum credit notes by apportioning expenditure incurred by SSL on account of insurance, salaries and allowances, director s remuneration, electricity and water charges, printing and stationery, professional charges, repairs and maintenance, rent for offices and also depreciation. assessee was categorically asked to furnish supporting evidences to show that said services stated at (a) to (d), above were rendered by SSL. However, assessee has not furnished same till finalisation of assessment. only evidences submitted are debit/credit notes raised on assessee by SSL according to which expenses incurred in SSL have been apportioned to assessee on basis of turnover of assessee and SSL. Payment of service charges from SITL to SSL is mere diversion of income without services rendered by SSL.Mens reafor this claim is to reduce taxable profit and claim more s. 10A profit in SSL. (iii) receipts on account of service charges in hands of SSL have not been credited separately as income of its non-s. 10A activity. However, these receipts have been reduced from expenditure claimed of s. 10A activity of SSL. net implication of this is that profits of s. 10A activity of SSL have increased and on which no tax has been paid. Whereas in fact, these receipts are clearly pertaining to non-s. 10A activity of SSL and, therefore, such receipts should have been offered for tax. (iv) assessee has contended that said agreement has been executed in best interest of business between two independent corporate entities. It has also been contended that same has been incurred out of commercial expediency. It has further been submitted that it is prerogative of businessman as to how to run its business and Department should not prescribe quantum of expenditure, etc. These contentions of assessee would have been acceptable if this agreement was entered into between two independent entities not under common management and control. In instant case, assessee is 100 per cent subsidiary of SSL. implication of this agreement is that taxable profits of assessee have been reduced and at same time increasing non-taxable profits of its holding company- SSL. (v) On perusal of balance sheet of assessee-company, it is observed that out of total service charges of Rs. 655.88 lakhs payable to SSL for relevant year, amount of Rs. 522.5 7 lakhs is outstanding as on 31st March, 2001. This further indicates that basic purpose of this agreement is to reduce tax liability in hands of assessee and increase non- taxable profits of SSL." In para 4.4 of his order, AO also observed that entire exercise was colourable device to reduce its tax liability and to increase non-taxable profits of SSL. 9. matter was carried in appeal before CIT(A) before whom it was submitted that : "Before me in appeal proceedings, it was explained on behalf of assessee that AO has misled himself in presuming that agreement for services covers only legal and professional charges and recruitment and training expenses. It was explained that area of services covered under agreement is very broad and that expenditure has been claimed on basis of actual expenditure incurred on basis of debit notes received from SSL and that if expenditure in question was not incurred assessee would not have been able to carry on its business. It was further submitted that debit notes issued by SSL and details given to AO in support of expenditure included in debit notes show that not only legal and other specified services were subject in agreement but also other services which are not specifically stated in agreement were also included." 10. CIT(A) examined details of expenditure which had been allocated on basis of respective turnover which was given along with debit notes. It has been made clear that such details were also furnished before AO. (See pp. 23-24 of order). It was noted by CIT(A) that entire expenditure was incurred commonly for SSL and assessee and was allocated on basis of turnover. According to him, business activity of SSL was much more expenditure oriented than business activity of assessee. Hence, in his opinion, expenditure on support services to assessee in ratio of turnover was patently wrong. After going through agreement, it was also held that SSL w s required to advise assessee in matters of finance, accounts, taxation, legal, administration, HRD, etc., and proper maintenance of record, compliance under various laws and training of employees. He also noted that assessee itself had incurred operational expenses of Rs. 835. 7 6 lakhs which shows that assessee itself maintaining large force of its employees. Such expenses amounted to 8.31 per cent of total turnover which itself was very high. Proceeding further, he examined nature of expenses of SSL, which had been allocated on basis of turnover. He found that such expenses were incurred o n account of various heads totalling 44. According to him, such services had nothing to do with services mentioned in agreement. In his view, only portion of salaries and other allowances of employees working in finance, accounts, taxation, legal administration, HRD, education and research and training Department could be allocated. He then estimated sum of Rs. 50 lakhs towards services of SSL rendered from assessee and held same to be allowable. Rest of expenditure was held to be disallowable. Aggrieved by same, assessee is in appeal before Tribunal. 11. We have heard both parties in light of materials placed before us. We find that issue regarding allocation of expenses in respect of service charges arose in case of SSL. In that case, AO was of view that allocation of expenses of non-s. 10A unit (not eligible for exemption) was excessive as exempted unit was much more expenditure oriented. matter ultimately reached Tribunal which accepted case of assessee that allocation of support services expenses on basis of turnover was justified. Tribunal, vide para 34 of its order dt. 1 7 th March, 2003 in ITA Nos. 495 and 496/M/2002, held as under : "We have considered submissions and we have perused various records placed in paper book. In paper book at pp. 2 7 to 34, assessee has placed each and every head of expenditure and this expenditure has been bifurcated under three heads STP unit entitled to deduction under s. 10A non-STP not entitled to deduction under s. 10A and support services. Further, it is found that basis of allocation amongst three heads is actual expenses, number of employees and ratio of fixed assets, floor area and turnover ratio. Thus, on basis of above five criteria, expenditure has been allocated to three heads. Further, it is noticed that total expenditure allocated under third head, i.e., support services, has been again allocated under two heads (1) STP units entitled to deduction under s. 10A and non-STP which i s not entitled for deduction under s. 10A on basis of turnover ratio. In our considered opinion allocation of expenditure contained in paper book at pp. 2 7 to 31 appears to be appropriate. As per details contained in pp. 2 7 to 31, it can be seen that appellant-company has only allocated expenses of support service division between s. 10A and non-s. 10A activities in ratio of turnover has been called for by AO by this letter dt. 20th Jan., 2000 appearing at p. 35 of paper book. Further, direct expenses relating to 10A and non-s. 10A activity has been directly charged against profits of these activities and do not call for any interference." above observations of Tribunal resolve controversy before us. Admittedly, prior to incorporation of assessee-company, SSL was carrying on t w o units independently, i.e., unit exempted under s. 10A and unit not exempted. Direct expenses incurred were separately booked to respective units. Only support services expenses were allocated on basis of turnover. Such allocation has been found to be proper and reasonable by Tribunal. There is no dispute that non-exempted unit was taken over by assessee- company and support services were continued to be rendered by SSL. From inception, stand of assessee has been that such expenses were allocated on basis of turnover as is apparent from para 4.3.3(ii) of assessment order, wherein it has been mentioned that expenses were allocated in debit notes as basis of turnover. Even CIT(A) has also admitted this factual position at p. 23 of his order where he mentioned "The details of expenditure which has been allocated on basis of respective turnover are given along with debit notes, copies of which were filed before me, as also before AO". Faced with same, learned Departmental Representative had nothing to add except to rely on order of AO. learned Departmental Representative submitted that allocation of expenses requires verification and therefore, matter may be referred to AO for necessary verification. We are unable to accept this request since there is no dispute to factual position that allocation of service expenses was made on basis of turnover. No useful purpose would be served in restoring issue. Accordingly, following finding of Tribunal in case of SSL, we set aside order of CIT(A) on this issue and delete disallowance sustained by him. 12. In result, appeal of assessee is allowed while appeal of Revenue is dismissed. *** SONATA INFORMATION TECHNOLOGY LTD. v. DEPUTY COMMISSIONER OF INCOME TAX