Software License Fees Without Enduring Benefits is Revenue Expenditure

CIT Vs Danfos Industries Pvt Ltd (Madras High Court)

In a significant ruling for businesses, the Madras High Court has dismissed appeals filed by the Revenue against Danfoss Industries Pvt. Ltd., affirming that software expenses, including license fees, incurred by the company are to be treated as revenue expenditure rather than capital expenditure. The decision, delivered in the case of CIT vs. Danfoss Industries Pvt. Ltd., upholds the findings of the Income Tax Appellate Tribunal (ITAT) and the Commissioner of Income Tax (Appeals).

Software Expenses: Revenue or Capital?

The core of the dispute for the assessment years 2007-08 and 2008-09 centered on the classification of software expenses and, for 2008-09, additional license fees paid by Danfoss Industries Pvt. Ltd. The company, engaged in the marketing and service of automatic control systems, had debited these costs to its profit and loss account, claiming them as exempt revenue expenses.

Arguments Presented:

• Assessee’s Stance: Danfoss Industries contended that these expenditures were for accessing and maintaining the information technology infrastructure of its parent company, Danfoss Denmark. This included support for Enterprise Resource Planning (ERP) systems, routine operations, user support, and generating standardized templates. The company argued that these costs facilitated routine business functions, did not create an enduring benefit, and were contingent upon annual renewal or upgrades.
• Revenue’s Stance: The Assessing Officer, relying on the “functional test” and precedents such as Tata Consultancy Services Ltd. -vs- State of Madhya Pradesh [271 ITR 401 (SC)] and Amway India Ltd. -vs- Deputy Commissioner of Income-tax, Circle 1(1), New Delhi [2009 27 SOT 344 (Delhi)], classified these expenses as capital in nature. The Revenue argued that the software provided an enduring benefit, making it a capital asset.

Judicial Precedents and Court’s Analysis:

The Madras High Court, in its judgment, meticulously reviewed the arguments and referenced several judicial precedents that supported the assessee’s position:

• Functional Test Application: Both the CIT(A) and the Tribunal applied the “functional test,” concluding that the software expenses did not form part of the “profit-making apparatus” of the assessee. Instead, they merely facilitated the company’s trading operations, enabling it to conduct business more efficiently or profitably. This distinction is crucial in determining whether an expenditure is capital or revenue.
• CIT v. Raychem RPG Ltd. [2012] 21 Taxmann.com 507 (Bombay): This Bombay High Court decision, cited by the Tribunal, held that ERP package software, which facilitated trading operations without being part of the profit-making apparatus, was allowable as revenue expenditure.
• CIT Vs. Toyota Kirloskar Motors (P.) Ltd. [2013] 30 Taxmann.com 294 (Karnataka): The Karnataka High Court in this case ruled that a software license with a shelf life of less than two years was allowable as revenue expenditure.
• CIT, Bangalore Vs. Robert Bosh India Ltd. [2014] 50 Taxmann.com 275 (Karnataka): This judgment from the Karnataka High Court affirmed that the amount paid for software purchase was revenue expenditure, even if used in subsequent years, as long as it was in the course of business.
• Oriental Bank of Commerce Vs. Additional CIT [2018] 93 Taxmann.com 432 (Delhi): The Delhi High Court, following Alembic Chemicals Works Co. Ltd Vs. CIT [177 ITR 377 (SC)], allowed expenditure incurred on acquiring a software license as a deduction under Section 37(1) of the Act, specifically when it did not confer any enduring benefit.
• CIT, Trichy Vs. Lakshmi Vilas Bank Ltd. [2018] 97 Taxmann.com 105 (Madras): This Madras High Court decision held that software expenses were revenue expenditure, even if the advantage endured for an indefinite period, as long as it merely facilitated trading operations and enabled more efficient business conduct. The court noted that the software was pre-designed and not customized, a factual finding that resonated with the present case where the software operated on a Windows platform, indicating it was not customized for a particular requirement.
• KGISL Technologies and Infrastructures Private Limited Vs. Assistant/Deputy Commissioner of Income Tax, Company Circle-V, Chennai [decided on 27.11.2018 in TCA Nos.73 to 74 of 2011]: This recent Madras High Court decision also treated expenses incurred in developing/upgrading software as revenue expenditure, citing Alembic Chemicals Works Co. Ltd Vs. CIT and CIT Vs. Southern Roadways Ltd.

The High Court emphasized that the software expenses, including the license fees, were for running existing systems, maintenance, support, and routine operations, not for acquiring new systems or facilities of an enduring nature. The fact that the license was valid for only one year further supported the assessee’s claim of it being a revenue expense.

Conclusion

The Madras High Court’s ruling in favor of Danfoss Industries Pvt. Ltd. provides clarity on the tax treatment of software-related expenditures. By applying the functional test and relying on a consistent line of judicial precedents, the court has reinforced the principle that expenses incurred to facilitate business operations and enhance efficiency, without creating a new profit-making apparatus or acquiring an enduring asset, should be classified as revenue expenditure. This judgment is expected to have implications for various businesses that frequently incur costs related to software licenses, maintenance, and upgrades.

FULL TEXT OF THE JUDGMENT/ORDER OF MADRAS HIGH COURT

These appeals filed by the Revenue under Section 260-A of the Income Tax Act, 1961 (‘the Act’ for short) is directed against the order dated 28.06.2013 by the Income Tax Appellate Tribunal, Madras “B” Bench, Chennai in ITA Nos.369 & 370/Mds/2013 for the assessment years 2007-08 and 2008-09.

2. The above appeals were admitted on 14.07.2015 on the following substantial questions of law :-

1. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the software expenses incurred by the assessee were revenue expenditure?

2. Is not the finding of the Tribunal bad by holding that the claim of license fee on software expenses paid to its parent company was for the utilization of the software which gave a enduring benefit and therefore capital in nature?

3. Heard Mrs. R.Hemalatha, Learned Senior Standing Counsel appearing for the appellant-Revenue and Mr. R.Sivaraman, Learned Counsel for the respondent-assessee.

4. The assessee is engagedin the business of marketing and service of automatic control and filed the income tax return for the assessment years under consideration (AY 2007-08 and 2008-09). The return was processed and some details were called for, after issuance of notice under Section 143(2) of the The assessee debited in the profit and loss account the software expenses and classified the same as exempt expenses under the head ‘IT Software Bills and License’. For the assessment year 2007-08 the expenses only towards the software expenses and for the assessment year 2008-09, in addition to software expenses, expenses towards license fee, which was also claimed as exempt expense. The assessee claimed the expenditure to be revenued, as the cost was incurred to access information technology, infrastructure of Danfoss Denmark, primarily comprising maintenance and support software supplement, routine operation, user, support charges for the Enterprises Resources Planning [‘ERP’ for short] systems and cost incurred for the purpose of generating standardized templates, which integrated business function and claimed this expenditure as it facilitates routine business function, which had no enduring benefits.

5. Further, the assessee contended that the software license were valid only for one year or they are contingent upon upgradation of the same. The Assessing Officer while completing the assessments by orders dated 31.12.2010 and12.2011 respectively held to be capital in nature by applying the functional tests by relying upon the decision of the Hon’ble Supreme Court in Tata Consultancy Services Ltd -vs- State of Madhya Pradesh reported in 271 ITR 401 (SC). Accordingly, the Assessing Officer relies on the decision of the ITAT, Delhi in the case of Amway India Ltd. -vs- Deputy Commissioner of Income-tax, Circle1(1), New Delhi reported in 2009 27 SOT 344 (Delhi).

6. Aggrieved by the same, the assessee preferred appeals before the Commissioner of Income Tax (Appeals)-IX, Chennai (CIT), who by orders dated 27.12.2012 allowed the assessee’s appeals, after noting the decision of the Tribunal in the assessee’s own case for the assessment year 2005-06 in I.T.A.No.612/Mds/2011, dated 09.05.2012.

7. Aggrieved by the same, the Revenue preferred an appeal before the Tribunal, which has been dismissed by the impugned order. As could be seen from the orders passed by the CIT(A) as well as the Tribunal, the functional test was applied to the assessee’s case and it was found that the software does not found part of the profit-making apparatus of the assessee and it only facilitates the assessee’s trading operations or to conduct the assessee’s business more efficiently or more profitably, but, it is not in the nature of the profit-making

8. Further, with regard to the license, the Tribunal found that it is valid for only one year and it may be useful for the assessee for various functions, like sales, finance and logistics operations and use of ERP system and may confer certain benefits to the assessee but it cannot be said that there is enduring benefit to the assessee.

9. The CIT(A), while allowing the assessee’s appeal, took note of the decision of the Tribunal in the assessee’s own case for the assessment year 2005-06, wherein the functionality test was analysed by the Tribunal and it has noted that the components of software expenses are for running its software system and not foracquiring any new system and consumables and others were purchases for servicing the existing net Another item is internet charges and small expenditure expended on training and the major amount is spent for IT help desk and none of the expenses were incurred for acquiring any new system of facility of enduring nature.

10. In such circumstances, we find that the Tribunal was right in confirming the order passed by the CIT(A). We note the decision, which was referred to by the Tribunal in the case of CIT Raychem RPG Ltd. reported in [2012] 21 Taxmann.com 507 (Bombay). Wherein the ERP package software, which facilitated the assessee’s trading operation to conduct its business more efficiently or more profitably but was held to be not in the nature of ‘profit-making apparatus’ and the software expenditure was allowable as revenue expenditure.

11. With regard to the license fee, which was for acquiring a software license of shelf life of less than two years was held to be as allowable as revenue expenditure in CIT Vs. Toyota Kirloskar Motors (P.) Ltd. reported in [2013] 30 Taxmann.com294 (Karnataka).In CIT, Bangalore Vs. Robert Bosh India Ltd. reported in [2014] 50 Taxmann.com 275 (Karnataka), the amount paid by the assessee for purchase of software was held to be revenue expenditure even when the same was used in course of business of assessee not only during the assessment year under consideration, but also during the subsequent year. In Oriental Bank of Commerce Vs. Additional CIT reported in [2018] 93 Taxmann.com 432 (Delhi), the expenditure incurred by the assessee on acquiring license to use software which did not confer any enduring benefit on assessee was allowed as a deduction under Section 37(1) of the Act, wherein the decision of the Hon’ble Supreme Court in Alembic Chemicals Works Co. Ltd Vs. CIT reported in 177 ITR 377 (SC) was followed. In CIT, Trichy Vs. Lakshmi Vilas Bank Ltd. reported in [2018] 97 Taxmann.com 105 (Madras), expenditure incurred by the assessee towards software expenses was treated as revenue expenditure as advantage, though endured for an indefinite period, it merely facilitated assessee’s trading operation, enabling it to carry on business more efficiently. In the said case, the contentions of the assessee that the software was a pre-designed software and not customized to suit the assessee’s particular requirement was taken note of. We pointed out this fact, because the Tribunal has rendered a factual finding that the software was to operate the Windows platform, which will go to show that it has not been customised for a particular requirement. Similar decision taken in KGISL Technologies and Infrastructures Private Limited Vs. Assistant/Deputy Commissioner of Income Tax, Company Circle-V, Chennai [decided on 27.11.2018 in TCA Nos.73 to 74 of 2011], wherein the Court, apart from taking note of decision in Alembic Chemicals Works Co. Ltd Vs. CIT, noted the decision in CIT Vs. Southern Roadways Ltd decided on 07.10.2006 in T.C.(A). No. 2454 of 2006 and decided the substantial questions of law in favour of the assessee by treating the expenses incurred in developing/upgrading the software to be revenue expenditure.

12. In the light of the above discussions, we hold that the Tribunal was right in dismissing these appeals filed by the revenue. In the result, the Tax Case Appeals are dismissed and the substantial questions of law are answered against the Revenue. No costs. Consequently, connected Miscellaneous Petitions are closed.