Tax Street – July 2025

Introduction

We are pleased to present the latest edition of Tax Street – our newsletter that covers all the key developments and updates in the realm of taxation in India and across the globe for the month of July 2025.

• The 'Focus Point' elaborates upon the impact of the Split Verdict in Shelf Drilling Ron Tappmeyer on Assessment Timelines.
• Under the 'From the Judiciary' section, we provide in brief, the key rulings on important cases, and our take on the same.
• Our 'Tax Talk' provides key updates on the important tax-related news from India and across the globe.
• Under 'Compliance Calendar', we list down the important due dates with regard to direct tax, transfer pricing and indirect tax in the month.

We hope you find our newsletter useful and we look forward to your feedback.

You can write to us at taxstreet@nexdigm.com. We would be happy to hear your thoughts on what more can we include in our newsletter and incorporate your feedback in our future editions.

Warm regards,
The Nexdigm Team

Focus Point

Constitution of Larger Bench Sought Following Split Verdict in Shelf Drilling Ron Tappmeyer on Assessment Timelines

The time barring of the transfer pricing assessment cases has stirred significant debate in the Indian Transfer Pricing landscape (popularly known as the Roca Bathroom or Shelf Drilling case). Though more than sixty years old, the law has gone through numerous litigations, but the periodical changes in the law and the complexity of it have put the tax department and taxpayers at loggerheads. This underscores the Honorable Prime Minister of India's clarion call to make laws simple, reminding us of his words: "While making laws, our focus should be that even the poorest of the poor can understand the new legislation well." Yet the present reality is quite the opposite. When two Supreme Court (SC) judges deliver diametrically opposed interpretations of the same provision, it exposes not clarity but confusion. Such judicial divergence may be celebrated as a hallmark of democratic debate, but it simultaneously undermines the ease of doing business and weakens confidence in India's dispute resolution framework. If the law cannot speak with one voice at the highest court, how can businesses and taxpayers be expected to navigate it with certainty?

To put the issue in simple terms, the dispute arises in transfer pricing cases, when the taxpayer chooses to file objections against the draft order before the Dispute Resolution Panel (DRP), the clock for completing the assessment gets extended. The complexity stems from the interplay of two provisions:

• Section 153 of the Act¹ , which governs the outer timelines within which assessment, reassessment, or re-computation must be completed (passing the final assessment order)
• Section 144C of the Act, which governs the procedure and timeline for raising objections before the DRP

To address these anomalies, the majority of High Courts (HCs) across the country refused to accept the revenue's argument for an extended timeline. Both the Madras High Court (in Roca Bathroom²) and the Bombay High Court (in Shelf Drilling³) categorically ruled in favor of taxpayers, holding that final assessment orders passed beyond the statutory deadline were time-barred and therefore liable to be quashed.

The ripple effect of these rulings was significant. A large number of similar cases would inevitably have been struck down on the same ground, leading to a substantial setback for the income-tax department. Recognizing the gravity of the issue, particularly given that the disputed additions collectively amounted to nearly INR 1300 Billion, the department escalated the matter to the Supreme Court. The apex court admitted the appeal, framing it as a pure question of law of great consequence, and directed that all related proceedings before lower courts be stayed until its final decision.

After a prolonged wait, when it was widely expected that the controversy would finally be settled, the Supreme Court delivered a split verdict. The two judges on the Bench could not agree on a common interpretation of the law, leaving the issue unresolved and necessitating reference to a larger Bench. Diving into the technical aspects of the ruling, the key takeaways can be summarized as follows:

Technical aspect – non-obstante clause

At the heart of the controversy lies a non-obstante clause in Section 144C(4) which provides:

'The Assessing Officer shall, notwithstanding anything contained in section 153 or section 153B, pass the assessment order under sub-section (3) within one month ...'

Taxpayers interpret this provision to mean that while the Assessing Officer (AO) must pass the final order within one month of receiving the DRP's directions. This does not extend the outer limitation period laid down under Section 153. In other words, the one-month requirement is a procedural timeline operating within the broader cap of Section 153, and cannot override or extend the statutory deadlines fixed therein. However, the other school of thought (department) says that while the AO is bound to act within one month from the DRP's directions, the nonobstante clause ensures that the outer limitation in Section 153 automatically stands extended to accommodate this process. Hence, Section 144C timelines prevail over the general cap in Section 153. The SC bench including Justice Nagarathna has sided with taxpayers, and in contrast, Justice Satish Chandra Sharma has sided with the department. Their views are as follows:

Justice Nagarathna (Taxpayer view)

• Sections 153 and 144C are distinct and not contradictory.
• Section 144C, introduced in 2009 to attract foreign investment, must be interpreted strictly to ensure speedy dispute resolution.
• Legislative intent must prevail; specific provisions cannot be diluted or overridden by general timelines.
• The DRP route is a beneficial option, and taxpayers should not be penalized with an extended limitation merely for exercising it.

Justice Satish Chandra Sharma (Revenue view)

• The Bombay and Madras HC interpretations are incorrect and unworkable.
• Section 144C prescribes a self-contained procedure with its own timelines, which must override Section 153.
• Courts must avoid interpretations that render the law ineffective; adequate time for DRP is necessary to protect natural justice.
• Since DRP proceedings are initiated at the taxpayer's option, they cannot claim prejudice from the resulting extension in timelines.

Conclusion

While it is apparent that Judge Nagarathna ruled in favor of taxpayers, quashed the orders, and Justice Satish allowed the appeal of the department. Considering this, the warring parties will again have to put forth the matters before the larger bench, consisting of three SC judges, including the Honorable Chief Justice of India.

Our Comment

• The case underscores the critical importance of procedural timelines in tax assessments.
• Tax officers must initiate proceedings promptly rather than waiting until the deadline. If transfer pricing references are made early in the departmental audit, a two-year window remains available, giving the TPO over 14 months to adjudicate, which is sufficient under current practices. Taxpayers, in turn, should prepare for earlier closure of audits.
• Although conceived as a fast-track remedy, the DRP has in practice become a procedural step before appeal to the Tribunal. Involving a neutral third party could enhance its credibility and effectiveness.
• The department should prioritize quality over quantity in assessments, focusing on substantive issues rather than volume, to reduce litigation and improve certainty.
• The upcoming Income-tax Bill offers an opportunity to resolve these anomalies. However, since the matter is sub judice before the Supreme Court, the government has not materially amended Sections 144C and 153 in the current draft.
• The view of the larger bench is now eagerly awaited, as it will provide much-needed clarity on the interplay between Sections 153 and 144C and set the course for future transfer pricing assessments in India. The larger bench's ruling will be decisive in restoring certainty to India's transfer pricing regime and will directly shape the balance between procedural safeguards and the ease of doing business.

From the Judiciary

Direct Tax

Is income from the sale of software licenses, software embedded in hardware, and related hardware support services taxable as royalty or fees for technical services in India?

Arista Networks Limited [TS-845-ITAT-2025(Bang)]

Facts

The assessee is a company engaged in providing cloud networking solutions and related products/services. Its return of income was scrutinized for receipts from India, including software sales, hardware, support services, and training.

The dispute concerned the taxability of three income streams:

• Sale of standardized software license
• Software embedded in hardware, and
• Hardware replacement and support services involving embedded software.

The assessee claimed these income streams were not taxable in India due to the absence of a Permanent Establishment (PE).

However, the AO held that the income from these sources was taxable as royalty in India. The AO stated that distributors had potential access to confidential proprietary information, including source code, which distinguishes it from mere shrink-wrapped software.

The AO also treated maintenance services as Fees for Technical Services (FTS) due to human intervention and applied a 10% tax. Despite the assessee's reliance on the Supreme Court rulings.

The assessee filed an appeal before the ITAT Bangalore challenging the order passed by the AO and DRP.

Held

The ITAT stated that the grounds raised by the assessee in the appeals concerning these income streams are allowed based on the following facts.

• In view of the Honorable Supreme Court's decisions, including the Engineering Analysis Centre of Excellence Pvt. Ltd. ruling, it is held that computer software is a literary work under the Copyright Act, with copyright conferring exclusive rights such as reproduction and distribution.
• The Supreme Court has clarified that software embedded in hardware constitutes a sale, not royalty, and without a PE in India, such income is not taxable.
• Upon reviewing the agreements of the assessee, it is observed that the confidentiality clause protects the assessee's copyright by limiting disclosure without granting rights to distributors. As an Original Equipment Manufacturer, the assessee sells hardware with embedded software and licenses standard software under strict, non-exclusive, non-transferable terms that prohibit copying or modification, granting only resale rights consistent with Supreme Court rulings.
• The distributor receives a limited license to resell software in object code form only, with no access to source code or reverse engineering; there is no evidence of source code provision, making the AO's claim baseless.
• Hardware replacement and support services involving embedded software are treated as the sale of hardware, not fees for technical services.

Our Comments

The case clarifies that income from the sale of software licenses, software embedded in hardware, and related hardware support services without a PE in India is not taxable as royalty or fees for technical services under the Double Taxation Avoidance Agreement (DTAA).

Whether ITAT can allow a deduction claim for ESOP expenses under Section 37(1) that was not originally filed or revised before the AO?

HDFC Bank Limited [TS-961-ITAT-2025(Mum)]

Facts

The assessee, Housing Development Finance Corporation Ltd. (HDFC), a housing finance company regulated by the National Housing Bank, filed its return of income under Section 139(1) of the Income-tax Act. The return was processed under Section 143(1) by the CPC, wherein certain additions and disallowances were made.

Aggrieved, the assessee filed an appeal before the CIT(A) challenging the disallowances. Additionally, it raised a fresh ground seeking a deduction of INR 2,167.8 million 37(1) for expenses incurred under the Employee Stock Option Scheme (ESOP). This amount represented the difference between the perquisite value and the fair value of the ESOPs computed under the Black-Scholes Model. However, the claim was not made in the original return, nor was a revised return filed.

The CIT(A) rejected the claim, relying on the Supreme Court decision in Goetze (India) Ltd. v. CIT, stating that a new claim cannot be entertained unless made through a revised return. Since the claim was made for the first time before the CIT(A) and not before the AO, it was held to be inadmissible.

Before the ITAT, the assessee argued that similar ESOPrelated claims had been admitted and allowed in earlier years by the Tribunal in its own case. The assessee also relied on the Bombay High Court's ruling in Prithvi Brokers & Share Pvt. Ltd., which clarified that appellate authorities could consider new claims if the relevant facts are already on record.

The Departmental Representative (DR) supported the lower authority's decision, stating that the claim was rightly rejected as it was not part of the original return or assessment proceedings.

Held

The ITAT allowed the appeal by the assessee, HDFC Ltd., regarding the claim for deduction of ESOP expenses under Section 37(1) of the Income-tax Act. Although the claim was not made in the original or revised return, and was first raised before the CIT(A).

Relying on the jurisdictional High Court's decision in Prithvi Brokers and Shareholders Pvt. Ltd., the ITAT held that appellate authorities, including itself, can entertain legal claims not previously raised before the AO if the facts are on record and the issue is purely legal. The Tribunal also noted earlier favorable orders in the assessee's case for AYs 2013-14 to 2020-21 and relevant judicial precedents supporting the ESOP deduction as revenue expenditure.

However, since the claim was not verified in the present proceedings, the ITAT remanded the matter to the AO for fresh adjudication, directing the assessee to submit necessary details and the AO to examine the claim in accordance with law after giving the assessee a reasonable opportunity to be heard.

Accordingly, the appeal (ITA No. 1828/Mum/2025) was allowed and the matter remanded for reconsideration.

Our Comments

This case underscores the importance of permitting taxpayers to raise valid legal claims at the appellate stage if facts are on record. It reinforces that procedural barriers should not override substantive justice, especially for ESOP expense deductions under Section 37(1). The ruling affirms ITAT's power to admit additional grounds and ensure fair tax adjudication.

To view the full article click here

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.