Enduring benefit test cannot be applied mechanically on software expenses

Brief of the case:

• The Hon’ble Kolkata High court in the case of Indian Aluminum Company Ltd. held that application software is an aid in the business operations rather than the tool itself. Therefore, the payment for such application software, though there is an enduring benefit, does not result in acquisition of any capital asset and it merely enhances the productivity or efficiency and hence, has to be treated as revenue expenditure.
• Therefore, the test of enduring benefit cannot be applied mechanically in case of software expenditure
  

Facts of the case:

• The assessee M/s. Indian Aluminum Co. Ltd. is engaged in the manufacture and production of aluminum and related products. During the relevant previous year the assessee incurred an expenditure of Rs. 41,08,556/- on software development. The assessee treated this expenditure as a deferred revenue expenditure in its books of accounts and amortized Rs. 2,40,000/- by debiting the same to the Profit and Loss Account of the relevant previous year.
• The AO in the assessment order disallowed the expenditure on account of software development by holding that it was a capital expenditure. Aggrieved by the order of the assessing officer the assessee appealed before the Commissioner of Income Tax (Appeals). CIT(A) decided the case in favour of the assessee and deleted the dis allowance of the expenditure incurred on software development.
• CIT(A) held that software used by the assessee is not or any enduring benefit as assessee has to change these software within a short span of time i.e. 4 months or 6 months and that at times it is of no use at all because it become outdated because of change of system and change of technology. Therefore, it cannot be treated as capital expenditure giving enduring benefit.
• On appeal to ITAT by revenue, ITAT reversing the order of CIT(A) held that the expenditure on software development was capital in nature and should be disallowed because the software was developed for the purpose of assessee’s business and it will be useful for a long period, thus it would be of enduring benefit to the assessee. Therefore, the AO rightly treated the same to be capital expenditure.
• Aggrieved assessee is in appeal before the High Court.
  

Contention of the Assessee:

• The learned counsel for the assessee contended that test of enduring benefit need to be applied realistically having regard to the rapid changes in the area of software &. technology. Reliance was placed on the decision of Madras HC in the case of CIT Vs. Southern Roadways Ltd. reported in (2008) 304 ITR 84 (Mad), wherein such expenditure was treated as a revenue expenditure.
• It was also submitted that software developed by the assessee is an application software. Reference was also made to decision of Delhi High court in the case of CIT Vs. Asahi Safety Glass Ltd. (Delhi) reported in (2012) 346 ITR 329, wherein a distinction was made between a software meant for use as an operating system and a software meant for an use as a software for application.
• Since in the instant case ,the expenditure was incurred on development of application software , the deduction of expenditure incurred should be allowed as a revenue expenditure.
  

Contention of the Revenue:

• The learned counsel for the revenue submitted that this is an addition to the capital asset of the assessee and, therefore, is a capital expenditure. Reliance was placed on the decision of Rajasthan High court in the case of CIT Vs. Arawali Constructions Co. (P.) Ltd. reported in (2003) 259 ITR 30.
• Further, in the case of CIT Vs. Southern Roadways Ltd., Madras High Court has accepted the proposition that the expenditure on account of software provides benefit of an enduring nature.
• Further, expenditure on software development was incurred with a view to obtain an asset or advantage of a permanent nature. Thus, that would result in benefit of enduring nature and allowable as capital expenditure and not revenue.
  

Held by Hon’ble High Court:

• HC observed that the revenue has relied on the principle of enduring nature to contend that the expenditure incurred by the assessee was of capital nature. But there are a no. of judgements which show that the test of enduring nature is not to be applied mechanically without taking into account the facts and circumstances of each case.
• The Hon’ble Supreme court in the case of Alembic Chemicals recognized the fact that in a field where advancements are taking place rapidly and where technology which was once the state of the art becomes obsolete in a short time , the test of enduring nature cannot always reliably be applied.
• It is why because software industry is one such field where advancements and changes happen at a lightning pace and it is difficult to attribute any degree of en durability even to system software then what to say of  application software.
• In the instant case the software developed by the assessee is application software which allows it to efficiently carry out mining activity for the extraction of Bauxite. Application software is distinct from system software as it has to be constantly updated due to rapid advancements in technology and increasing complexity of the features.
• High court placed reliance on the decision of Hon’ble Madras HC in the case of CIT v. Southern Roadways wherein the court held that the concept of enduring benefit must respond to the changing economic realities of the business. The expenses incurred by installation of software packages in the present computer world, which revolves on the modern communication technology, enables the assessee to carry on its business operations effectively, efficiently, smoothly and profitably.
• However, such software itself does not work on a standalone basis. It has to be fitted to a computer system to work. Such software enhances the efficiency of the operation. It is an aid in the manufacturing process rather than the tool itself. Therefore, the payment for such application software, though there is an enduring benefit, does not result in acquisition of any capital asset and it merely enhances the productivity or efficiency and hence, has to be treated as revenue expenditure.
• In result the assessee is entitled to claim deduction of software development expenses as revenue expenditure. Accordingly, assessee’s appeal was allowed.