Section 143(2) Scrutiny Notice - SaaS Startup, Angel-Funded

The Problem

A Hyderabad-based SaaS startup received a Section 143(2) scrutiny notice for AY 2021-22. The Assessing Officer raised queries on two issues:

1. High deduction-to-revenue ratio — The startup had claimed deductions of ₹68L against revenue of ₹1.1 Cr (63% ratio), which the AO flagged as unusually high for a software company.
2. Foreign software subscriptions without TDS — ₹22L paid to AWS, Stripe, Zoom, and other US SaaS vendors had not been subjected to TDS under Section 195, raising a potential disallowance under Section 40(a)(i).

The total potential addition exceeded ₹90 lakhs, which would have wiped out the startup's entire revenue for the year.

What We Did

Documentation for Deductions We prepared a detailed schedule mapping every deduction to its supporting invoice and purpose. Key items explained:

• Salaries (₹34L): Full employment records, PF returns, and payslips
• Cloud infrastructure (₹18L): AWS invoices classified as operational expenses under a revenue model, not capital expenditure
• Marketing and SaaS subscriptions (₹16L): Business necessity demonstrated through customer acquisition data

Foreign Payment TDS Analysis For the foreign vendor payments, we prepared a memorandum analysing each vendor:

• AWS, Google Cloud: Payment for infrastructure services; under DTAA with USA, royalty vs. FTS classification was analysed. We relied on the Supreme Court ruling in Engineering Analysis (2021) holding that software payments are not royalties, and hence not taxable in India, making TDS under 195 inapplicable.
• Stripe: Payment processing fees — characterised as business income of the payee, not taxable in India without a PE.

We also cited CBDT Circular No. 17/2020 and presented documentation showing that Stripe does not have a permanent establishment in India, eliminating any TDS obligation.

AO Hearing We appeared before the AO on two occasions, presenting the full documentation set and responding to each query in writing within stipulated timelines.

The Result

The AO accepted all submissions without making any additions to income. The scrutiny assessment was completed under Section 143(3) with the returned income confirmed. The startup avoided a tax demand of approximately ₹27L (at applicable rates) plus interest.

Key Takeaway: SaaS startups with foreign vendor payments should keep a running analysis of TDS applicability under DTAA before each payment — not just when a notice arrives. The Engineering Analysis ruling provides strong protection, but the documentation must be in place.