Whether software expenditure is capital or revenue in nature is to be seen independently in respect of each software

IN THE ITAT BANGALORE BENCH ‘B’

Timken Engineering & Research India (P.) Ltd.

Versus

Deputy Commissioner of Income-tax, Circle 12(4), Bangalore

IT Appeal No. 656 (Bang.) of 2011

[Assessment year 2005-06]

October 31, 2012

ORDER

Jason P. Boaz, Accountant Member – This appeal by the assessee is directed against the order of the Commissioner of Income Tax (Appeals)-IV, Bangalore dt.8.3.2011 for Assessment Year 2005-06.

2. The facts of the case, in brief, are as under :

2.1 The assessee-company (hereinafter referred to as ‘the assessee’), engaged in the business of engineering and research services, filed its return for Assessment Year 2005-06 on 29.10.2005 declaring loss of Rs.82,28,850. The assessee’s case was taken up for scrutiny by issue of notice under section 143(2) of the Income Tax Act, 1961 (herein after referred to as ‘the Act’) on 11.8.2006. The assessment was completed by an order under section 143(3) of the Act on 24.12.2008 determining the income of the assessee at Rs.9,08,48,203 which included the following additions/disallowance :

2.2 Aggrieved by the order of assessment for Assessment Year 2005-06 dt.24.12.2008, the assessee went in appeal before the CIT(Appeals). The learned CIT(Appeals) disposed the appeal allowing the assessee partial relief.

3. Aggrieved by the order of the learned CIT(Appeals) dt.8.3.2011, the assessee is now before the Tribunal. In the grounds of appeal raised, it has been contended as under :

“1.  The order passed by the CIT (Appeals)-IV, Bangalore (hereinafter referred to as the ‘Learned CIT (A)’) to the extent against the appellant is contrary to the law and is liable to be quashed.

 2.  That the learned CIT (Appeals) erred in confirming the action of the Assessing Officer in disallowing the donation of Rs.5,61,578.

 3.  That the learned CIT (Appeals) erred in confirming the action of the Assessing Officer in treating software expenses of Rs.52,49,862 as capital in nature.

 4.  That the learned CIT (Appeals) erred in confirming the action of the Assessing Officer in adding back Rs.3,94,061 incurred under the head ‘Legal & Professional charges.’

 5.  That the learned CIT (Appeals) erred in upholding interest under sections 234B and 234D of the Act.

 6.  That the appellant craves leave to add to and/or alter, amend, rescind or modify the grounds herein above before or at the time of hearing the appeal.”

4. The grounds raised at S.Nos.1 and 6 are general in nature and therefore no adjudication is called for thereon.

5. At the outset, the learned counsel for the assessee submitted that the grounds of appeal at S.No.2 and 4 in respect of the disallowances of (i) donation amounting to Rs.5,61,578 and (ii) legal and professional charges amounting to Rs.3,94,061 are not being pressed in this appeal. In this view of the matter, these grounds are accordingly dismissed as not pressed.

6.1 Only ground raised at S.No.3 survives for consideration. In this ground, the assessee challenges the order of the learned CIT(Appeals) confirming the action of the Assessing Officer in treating software expenses of Rs.52,49,862 as capital in nature. The learned counsel for the assessee supporting the grounds raised submitted that the break up of software expenses were at Annexure 1 to the assessee’s written submissions dt.4.7.2012 and clearly were in the nature of application software. It was submitted that the software expenses included only application software when the ownership is either in the form of ‘copyright under assignment’ or ‘a license’ as a right to be a copy right for the purpose of own business. It is submitted that the said software expenditure was incurred for obtaining licenses for the use of the aforesaid software and since all this software are essentially in the nature of application software, the expenditure incurred is revenue in nature as the same only facilitates the day to day operations of the assessee. It is contended that since the software expenditure does not result in enduring benefit as the life of the application software is invariably short and the same is bound to become technically obsolete very fast, it should be allowed under section 37 of the Act as a revenue expenditure and not treated as capital expenditure as held by the Assessing Officer. In support of the assessee’s proposition the learned counsel for the assessee relied on a number of judicial decisions of the Tribunal across India including the following decision of the co-ordinate bench of this Tribunal in the following cases :

 (i)  IBM India Ltd. v. CIT [2007] 105 ITD 1 (Bang.).

(ii)  Software & Silicon Systems India (P.) Ltd. v. ITO [IT Appeal No.44/Bang./2006].

The learned counsel for the assessee also relied on the decision of the Special Bench of the Delhi Tribunal in the case of Amway India Enterprises v. Dy. CIT [2008] 111 ITD 112.

6.2 Per contra, the learned Departmental Representative supported the orders of the authorities below.

6.3 We have heard both parties and carefully perused the material on record. On perusal of the orders of the authorities below, we find that no proper examination of the issue has been carried out to establish whether the software expenses claimed were revenue in nature as claimed by the assessee or capital expenditure as held by the Assessing Officer and confirmed by the learned CIT(Appeals). At para 7.3 of the order of assessment the Assessing Officer noted that “the assessee company could not substantiate its claim for the same being revenue expenditure in nature by producing supporting documents or evidence” and then proceeds to treat the same as capital expenditure. This is a clear indication that the issue has not been examined and addressed at the assessment stage itself. The learned CIT(Appeals) has dealt with this issue in para 6 at page 4 of his order and we find that other than mechanically confirming the Assessing Officer’s action of holding software expenses to be capital in nature, he has also not called for supporting documents or evidences which the Assessing Officer noted were not filed during assessment proceedings. We are, therefore, of the view that the issue of software expenditure of Rs.52,49,862 incurred by the assessee in the relevant period requires re-examination.

6.4 In this regard for the method/test to be applied for ascertaining whether the said expenditure is capital or revenue in nature, we draw support from the principles laid down in the decision of the Hon’ble Special Bench of the ITAT, Delhi in the case of Amway India Enterprises (supra), the author of which order, is part of this Bench. In this order, the Tribunal has observed that there cannot be any specific or precise test which can be applied conclusively or universally for distinguishing between capital and revenue expenditure and that different minds come to different conclusions with equal propriety. The cardinal rule is that the question whether a certain expenditure is on capital or revenue account should be decided from the practical and business view point and in accordance with sound accountancy principles. The Tribunal further observed that while dealing with this complex issue, these tests generally applied to decide the nature of expenditure as to whether it is capital or revenue, are the fact of enduring benefit, ownership test and functional test. These tests when applied would decide whether the expenditure incurred on software is of capital or revenue in nature. These observations on the tests to be applied have been dealt with in detail at paras 43 to 58 thereof. The conclusions in the Tribunal order at paras 59 and 60 are summarized as under :

(i)  When the assessee acquires a computer software or for that matter the license to use such software, he acquires a tangible asset and becomes owner thereof.

(ii)  Having regard to the fact that software becomes obsolete with technological innovation and advancement within a short span of time, it can be said that where the life of the computer software is shorter (say less than two years), it may be treated as Revenue expenditure. Any software having its utility to the assessee for a period beyond two years can be considered as accrual of benefit of enduring nature. However, that by itself will not make the expenditure incurred on software as capital in nature and the functional test as discussed above also needs to be satisfied.

(iii) Once the test of ownership and enduring benefit are satisfied, the question whether expenditure incurred on computer software is capital or Revenue has to be seen from the point of view of its utility to a businessman and how important an economic or functional role it plays in his business. In other words, the functional test becomes more important and relevant because of the peculiar nature of the computer software and its possible use indifferent areas of business touching either capital or Revenue held or its utility to a businessman which may touch either capital or Revenue field.

6.5 The fact situation in respect of the necessity for having the issue of software expenditure examined to ascertain whether it is capital or revenue in nature in the case of Amway India Enterprises (supra) is similar to that of the present case of the assessee. We, therefore, respectfully following the decision in the case of Amway India Enterprises (supra), hold that since the examination of whether software expenditure incurred is capital or revenue in nature would require to be done in respect of each and every software independently having regard to the criteria/principles laid down in the cited case, the matter requires to be restored back to the file of the Assessing Officer for carrying out the same. The Assessing Officer is directed to examine the question of whether expenditure on computer software is capital or revenue in the light of the criteria/facts laid down in the case of Amway India Enterprises (supra) at paras 43 to 60 thereof after giving the assessee adequate opportunity of being heard in the matter. It is ordered accordingly.

7. In the result, the assessee’s appeal is allowed for statistical purposes.