Unexpired AMC charges not income but advance. Due to refund obligation, the whole income did not accrue at the time of entering into contract – ITAT

Unexpired AMC charges not income but advance. Due to refund obligation, the whole income did not accrue at the time of entering into contract – ITAT

Unexpired AMC charges

ABCAUS Case Law Citation:
ABCAUS 1209 (2017) (04) ITAT

The Grievance:
The appellant assessee company was aggrieved by the order of the Commissioner of Income Tax (Appeals) in confirming inter alia the additions on account of Annual Maintenance Charges billed for unexpired period.

Assessment Year : 2007-08
Date/Month of Pronouncement: April, 2017

Important Case Laws Cited/relied upon:
DCIT Vs. TVS Electronics Limited
M/s. Career Launcher (India) Ltd. Vs ACIT

Brief Facts of the Case:
The assessee was a private limited company engaged in development of software products and providing emailing solutions. The assessee was  also providing messaging services, support/ maintenance services etc. The assessee had entered into Annual Maintenance Contract (AMC) with its clients for providing maintenance services for its software products.

For the relevant assessment year, the assessee filed its return of income declaring total income as Nil after claiming set off of brought forward losses of earlier years. The case of the assessee was selected for scrutiny under CASS and accordingly statutory notice u/s 143(2) of the Income Tax Act, 1961 (“the Act”) was issued. During scrutiny assessment proceedings, the Assessing Officer (“AO”) made certain additions / disallowances which inter alia included receipts from AMC not offered to tax.

Aggrieved by the assessment order passed by the AO, the assessee filed an appeal before the CIT(A). However, CIT(A) upheld the additions in respect of AMC receipts for unexpired period.

Aggrieved by the additions confirmed by the Commissioner of Income Tax (Appeals), the assessee was in second appeal before the Tribunal (“ITAT”).

Contentions of the appellant assessee:
It was submitted that although the assessee receives entire AMC charges from its customers at the time of executing AMC agreements, but the AMC charges are treated as income only after the elapse of period mentioned in the agreement. Where annual maintenance services accrue in more than one accounting year, the AMC charges for unexpired period are credited to unexpired services account and are shown as Current Liabilities in the Balance Sheet. The amount credited to unexpired services in current year are transferred to revenue account in the next year.

It was submitted that as per the terms of the AMC Agreement, the assessee is under obligation to refund the AMC charges for unexpired period if the customer cancel the agreement midway and seek refund of the AMC charges paid.

It was contended that since by paying AMC charges the customers are entitled for support and upgrade of software during the currency of AMC,  the assessee recognizes income from AMC only for the period which has elapsed. Thus, the AMC charges for unexpired period are not considered as income of the assessee.

Contention of the Respondent Revenue:
It was submitted that the assessee has adopted straight line method of accounting for recognizing income from AMC charges only with the intention of postponing tax liability as there has been no single instance where the assessee had refunded any part of Annual Maintenance Charges for cancellation of agreement.

It was further submitted that the method adopted by the assessee in treating the annual maintenance charges by spreading it over the total period of annual maintenance contract is against the concept of matching cost and revenue and Accounting Standard-9 (AS-9). It was pointed out that the matching principle of cost and revenue is not satisfied as the receipts are postponed on the basis of number of months remaining in the unexpired period of AMC but the software expenses which are part of AMC are not postponed or spread over the period of AMC but the entire expenditure and other expenses required for software upgradation are claimed in the year in which they are incurred.

Counter Contentions of the Appellant Assessee:
Controverting the submission forwarded on behalf of the Department, the assessee contended that the customers had so far not cancelled any of the AMC agreements, as the assessee was promptly and efficiently resolving the problems faced by its customers. The assessee should not be penalized for its efficient services. However, if the eventuality arises the assessee had to refund the pro-rata amount for unexpired period of AMC as per the terms of the contarct.

Observations made by the Tribunal:
The Tribunal observed that in the case of TVS Electronics Limited, under similar circumstances the ITAT had allowed the claim of assessee. In the said case, the assessee was engaged in manufacturing and sale of computer peripherals and had entered into AMC with various customers. The assessee had shown income only with respect to that part of revenue from AMCs which fall within the relevant previous year i.e. the pro-rata revenue for the period falling outside the previous year was not offered as income. The Assessing Officer rejected the method of accounting adopted by the assessee and made addition of the entire amount received on annual maintenance charges. In first appeal, the Commissioner of Income Tax (Appeals) upheld the findings of Assessing Officer. However the Tribunal had allowed the appeal of the assessee observing as under:

“The clients of the assessee could at any point cancel the contract and get a refund for the unexpired period. This itself meant that the amount received by the assessee at the point of time it entered into an AMC was nothing but an advance, which on the progress of each day got converted into revenue. The income was accruing on a day-to-day basis based on the progress of time and it did not accrue on the day of entering into the contract. An obligation was there on the assessee to refund the unexpired value of AMC, if the AMC was cancelled by its customers. So, we cannot say that whole of the income had accrued to the assessee at the point of time it entered into the AMC. The obligation arising out of the contract as well as earning of the income ran side by side and progressed simultaneously. Therefore, contention of the assessee that it could not recognize revenue for the unexpired period of AMC is on strong footing. Principle of matching concept of income and expenses, comes to the aid of the assessee in such a situation. Assessee, in our opinion, was justified in its claim that income relatable to the unexpired period of AMC could be considered only in the subsequent year and not in the relevant previous year. CIT(Appeals), in our opinion, had taken a correct decision which does not require any interference.”

The Tribunal further observed that in the case of M/s. Career Launcher (India) Ltd. the dispute was with regard to assessment year in which income generated from receipts of tuition fee for that the entire course of two years had to be recognized. The Tribunal held in favour of the assessee observing as under:

“The facts are that the assessee received non-refundable fees in this year. The coaching was to be given in this year as well as in the subsequent year. This means that the attendant obligation was to be discharged in two accounting years. The assessee booked a part of the fees in this year and a part thereof in the subsequent year. As held in the case of K.K. Khullar (supra), a distinction has to be made between the terms “receipt” and “income”. What is liable to be taxed is income and not the receipt. Therefore, only that amount which is received as income can be brought to tax.”

The Tribunal accepted the contention of the assessee and directed the Assessing Officer to delete the addition in respect of Annual Maintenance Charges billed for unexpired period.

Unexpired AMC charges

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