INCOME TAX ACT, 1961

Section 145

Accounting method - Revenue recognition - Unearned revenue qua subscription services -

Assessee was engaged in the business of marketing, promotion and distribution of 'Red Hat Subscriptions' to customers in the Indian sub-continent. The 'Red Hat Subscriptions' enabled the subscribers to avail support services for Red Hat 'open source' software such as Linux which grants every user 'free' access to the source code and enables the user to modify and customize the same to suit its requirement. Assessee provided support services to the customers under the 'Red Hat Subscriptions' so purchased including ongoing support for the open source software used by the customers during the subscription period, troubleshooting support for the open source software by responding to queries pertaining to the open source software through web-based systems and telephone calls. During the year under consideration, the 'Red Hat Subscription' were purchased by assessee from Red Hat Asia Pacific Pte. Ltd., a Singapore based entity and these subscriptions enabled customers of assessee to avail of maintenance support services for Red Hat 'open source' software. Assessee basically acted as distributor of Red Hat Subscription which enables the customers in India to avail the support services for open source software systems for a period ranging from one to seven years, which was established through specific subscription agreement or contract. Assessee accounted the revenues for which services would also be performed in the future years in its books as 'unearned revenues'. AO alleged that assessee was merely a distributor of support services and not provider of the subscription of support services to be provided by its AE. Assessee charged all the expenses including full cost of access to the subscription services, commission and training expenses, etc., without taking into account the corresponding revenue. Thus, assessee violated matching concept of accounting by acknowledging entire expenses without accruing corresponding revenue. Further assessee was merely a re-distributor of the subscription rights to be performed by the AE and not by the assessee. The performance of assessee was complete immediately after the sale of subscription right. Thus, AO held that AS-9 pertaining to Revenue Recognition did not apply as AE of assessee was providing support services and assessee was mainly selling the access code for subscription. Thus, AO held the unearned amounting of Rs. 19,80,033 as income of assessee. Held: In terms of AS-9, there must be the right to receive income on a particular date, so as to bring about a creditor and debtor relationship on the relevant date. A right receive a particular sum under the agreement would not be sufficient unless the right accrued by rendering of services and not by promising for services and where the right to receive is interior to rendering of service, the income, therefore, would accrue on rendering of services. Accordingly, when due taxes were deducted and paid to the IT Authorities while making such payment to Red Hat US in terms of the agreement entered into between assessee and the Red Hat US in accordance with consistent revenue recognition policy adopted by assessee, addition made by AO on account of unearned revenue qua subscription services was not sustainable in the eyes of law.

SUBSCRIBE FOR FULL CONTENT