Issue: Whether expenditure on acquisition of software was revenue or capital expenditure?
Sections Involved: Section 37 (1) of the Income Tax Act (Capital expenditure is not allowed as per this section)
Appeal by Assessee before ITAT: (Relevant Extract)*
“1. That the Order dated March 23, 2007 passed by the learned Commissioner of Income Tax (Appeals)-XV [“CIT(A)”] is erroneous and bad in law in so far as it has confirmed the additions/disallowances made in the assessment order
2. That on the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in confirming the disallowance of expenses incurred on purchase of software for updating the existing data processing system of the appellant company amounting to Rs. 23,28,270/- considering the same as capital expenditure.
2.1 That the Ld. CIT(A) erred on facts and in law in not appreciating the fact that claim for similar expenditure as revenue expenditure in the past has been upheld by the Hon’ble Tribunal and that the same has been accepted by the department.
Observations of CIT and (A) (Who erred in holding that the expenditure is a Capital Expenditure, thereby disallowed the claim of assessee):
2.3 I have considered the appellant submissions with reference to the facts and record and also the binding Judicial decisions on the given issue. Although a decision has been rendered In favour of the appellant in its own case in the first appeals for A Y. 96-97 to Assessment Year 1999-2000, with the decision of the ITAT in the case of Maruti Udyog (92 ITD 119 f(Delh), the earlier decision in first appeal in the appellant’s own case or earlier years might not hold good. In the case of Maruti Udyog, the ITAT held as under:
“The issue, as to whether expenditure on acquisition of software was revenue or capital expenditure is no more res integra as it is well settled the expenditure incurred on acquisition of an asset (other than trading asset) is always capital expenditure.
Software is a capital asset and is an intangible asset. Hardware, commonly called as computer, is a tangible asset which by itself cannot function. The computer can function only with the help of software. Software is akin to know how. Admittedly, the assessee was not in the business of software. Hence, software was a capital asset as far as the assessee-was concerned. The Income-tax Rules, as amended with effect from 1.4.2003 rather helped the revenue and not the assessee inasmuch as it provides for depreciation on software at the rate of 60 per cent. By, providing higher depreciation, it could not be said that prior to 1-4-2003, it was revenue expenditure, It was always a capital asset Prior to 1-4-2003, the assessee was entitled to normal rate of depreciation which was enhanced to 60 percent by the amendment considering the rapid wear and tear.Therefore, the expenditure was incurred on acquisition of capital assets and, thus, it was a capital expenditure. Resultantly, the same could not be allowed as’ revenue expenditure.
Observations of ITAT and Judgement:
6. Now, coming to the grounds of appeal raised in the appeal, Ld. A.R. had f iled synopsis containing the issues involved in the appeal
The 1st ground relates to disallowance of expenditure, incurred for purchase of application software, which the A.O. had disallowed holding the same to be of capital in nature. Ld. A.R. submitted that similar allowance was allowed to assessee in 1996-97 to 1999-2000 and even for Assessment Year 1997-98, Hon’ble Delhi High Court in the case of assessee itself had dismissed the appeal of revenue and in this respect, our attention was invited to paper book pages 12-14 of compilation of judgements. Ld. A.R. submitted that reliance placed by Ld. CIT(A) on the case law of Maruti Udyog Ltd. 2 ITD 119 was misplaced as software in that case was ERP software which was not a routine application software and was of an enduring nature whereas the assessee’s software gets obsolete / redundant in a short span of time and required regular updation.
Ld. A.R. placed his reliance on the following case laws:
D.R. however strongly placed his reliance on the orders of authorities below and submitted that specific rate of depreciation is allowed on software and, therefore, it is a capital asset eligible for depreciation at specified rate as provided in the Act.
We have heard rival parties and have gone through the material placed on record. We find that Ld. CIT(A) himself supported a finding that in earlier year, the assessee was allowed deduction on account of software by ITAT and we further find that during the year 1995-96 to 1997-98, Hon’ble Delhi High Court had also confirmed the order of ITAT and had dismissed the appeal of Revenue. We further observe that Hon’ble Delhi High Court had recorded a finding of fact that expenditure was incurred on M S Office and not on customized software and had therefore, confirmed the ITAT order. In the present case, the A.O. had noted in the assessment order that expenditure was incurred on application software and, therefore, assessee cannot be said to have incurred expenditure on customized software. In the case law of CIT (A) Vs Asahi India Safety Glass Ltd. 203 Taxman 277 relied upon by Ld. A.R. the Hon’ble Court has held that expenditure incurred on application software is a revenue expenditure. In the present case as noted by A.O. the expenditure was incurred on application software. Therefore, respectfully following the Hon’ble Delhi High Court, we hold the expenditure incurred on application software to be revenue in nature and therefore, we allow Ground No.2.
It is a general presumption that, expenditure in acquisition of assets is a capital expenditure there by not eligible for deduction u/s 37 (1) of the IT Act (However depreciation is allowed as per IT Rules) The honorable CIT (A) failed to note the difference in the nature of the soft-wares as dealt in Maruti Udyog Ltd. vs Deputy Commissioner Of Income Tax (2005 92 ITD 119 Delhi, (2005) 92 TTJ Delhi 987) case and in the present case. The software type treated as capital in Maruti Udyog case was ERP software which was not a routine application software and was of an enduring nature whereas the assessee’s software gets obsolete / redundant in a short span of time and required regular updation.
As in the present era of rapid and advance technology many of the softwares become obsolete in short period of time and need constant upgradations, hence the logically application software are rightly held as revenue expenditure by Honorable ITAT and there by allowed the claim of Assessee.