2005 (12) TMI 454 - AT - Income Tax

Business expenditure - software development expenses - Income from manufacturer of automotive safety glass of two types viz. tempered and laminated - agreement of licensing the software and for providing services - HELD THAT - We have to be clear on the fact that manufacturing activity of the assessee is the main source of its income. Purchase and sales activities go to fulfil this basic objective of the company whereas accounting and management information systems only helps the assessee to know its own state of affairs on which rest the decisions to be taken. To further clarify the matter, at the cost of repetition we may state that sophisticated accounting and management systems do not actually generate income for the assessee but it only aids the management in taking important decisions. The consideration for getting the right to use the software is in the form of licence fees and not in the form of any purchase price. Over and above the licence fees, since the agreement is also for providing maintenance services, the assessee is liable to pay fees for support and maintenance to Oracle. The licence given under the agreement is liable to be terminated under the provisions of the agreement. Thus, from the various clauses of the agreement, we find that the assessee has not acquired the software in its own right but has acquired only the right to use the software. In other words, what we are trying to emphasize is the fact that by paying the impugned amount, the assessee has not acquired any tangible asset, much less any asset which provides any new source of income or which augments the present source of income. Therefore, the expenses incurred by the assessee cannot be said to be of capital nature. If we look at the break-up of the expenditure for the two years, we find that the major heads under which the payment is made are license fees, annual technical support fees, professional charges, data entry operator charges, training charges and travelling expenses. This goes to show that by incurring these expenses, no new asset has come into existence nor any new source of income has arisen to the assessee. All the expenses are of recurring nature required either to upgrade the systems or to run the systems. Therefore, there is no substance in the argument of the revenue that these expenses have brought in benefit of enduring nature to the assessee. The above observations of the Supreme Court in the case of Alembic Chemical Works Co. Ltd. 1989 (3) TMI 5 - SUPREME COURT hold equally true for the rapid strides made in the information technology sector. In fact, the pace of advancement is so rapid that whatever technology we install today becomes obsolete within a wink of the eye. In other words, the test of enduring benefit is more prone to failure in the present days than it was when the above observations were made. Therefore, upgradation of technology is the order of the day and to treat the outlay on such up-gradation in the realm of capital would not be proper. It would be like taking a step backward on a conveyor belt which is moving ahead. The observations of the Supreme Court with regard to non-partibility, confidentiality and secrecy and also with regard to the mere right to use are equally applicable to the facts of the present case. Thus, we allow the claim of the assessee on software development expenses as revenue expenditure. We need not re-emphasize that the turnover of the company which hovered around Rs. 150 crores during those years would have reached at that level even without this outlay. It has only benefited the company to run its business more efficiently.

Issues Involved: Deletion of additions made on account of software development expenses for assessment years 1997-98 and 1998-99.

Issue-wise Detailed Analysis:

1. Nature of Software Development Expenses:
The primary issue revolves around whether the software development expenses incurred by the assessee should be treated as capital expenditure or revenue expenditure. The assessee amortized expenditures of Rs. 1,36,77,664 and Rs. 1,70,68,811 on software and professional expenses as deferred revenue expenditure but claimed the entire amount as revenue expenditure while computing total income. The Assessing Officer (AO) treated these expenses as capital in nature, arguing that the software had an enduring benefit, and thus disallowed the expenses. The AO also denied depreciation on the grounds that it was unclear whether the software was put to use during the relevant year.

2. Assessee's Argument:
The assessee argued that the software technology was rapidly changing and thus had no enduring benefit. The software was installed to enhance business efficiency and did not create any asset generating income. The expenditures were primarily for license fees, technical support, documentation, and professional charges, not for acquiring the software itself. The assessee contended that these expenditures were for upgrading existing systems and should be treated as revenue expenditure.

3. CIT(Appeals) Decision:
The learned CIT(Appeals) considered various judicial decisions and concluded that the expenditures were revenue in nature. The CIT(Appeals) relied on decisions from the Kerala High Court, the Supreme Court, and the Jaipur Bench of the Tribunal, which supported the assessee's claim. The CIT(Appeals) allowed the assessee's claim, noting that no case law favoring the department was presented.

4. Department's Argument:
The department, represented by the learned DR, argued that the expenditures were capital in nature, drawing support from the decision of the Delhi Bench of the Tribunal in the case of Maruti Udyog Ltd. The department contended that even expenses on upgradation should be treated as capital expenditures.

5. Tribunal's Analysis:
The Tribunal examined the facts and the nature of the expenditures. It noted that the software was not attached to any machinery used in production nor was it part of the production process. The software facilitated better management decisions but did not generate income directly. The Tribunal emphasized that the assessee had acquired only the right to use the software and not ownership, which did not create a new asset or source of income.

6. Enduring Benefit Test:
The Tribunal discussed the test of enduring benefit, citing the Calcutta High Court's decision that this test is not conclusive and should not be applied mechanically. It referenced the Madras High Court's decision that expenditures facilitating business operations without affecting fixed capital are revenue in nature. The Tribunal found that the software expenditures facilitated business management and were thus revenue expenditures.

7. Rapid Technological Advances:
The Tribunal acknowledged the Supreme Court's observations on rapid technological advances, noting that the enduring benefit test is less applicable in fast-changing fields like information technology. The Tribunal concluded that the expenditures for upgrading technology should be treated as revenue expenditures.

8. Alternative Plea for Depreciation:
The assessee's cross-objections included an alternative plea for depreciation if the expenditures were treated as capital in nature. Since the Tribunal allowed the expenditures as revenue, this plea was dismissed as infructuous.

Conclusion:
The Tribunal dismissed the department's appeals and the assessee's cross-objections, upholding the CIT(Appeals) decision to treat the software development expenses as revenue expenditures. The expenditures were deemed necessary for business efficiency and did not create any new asset or income source, aligning with judicial precedents and the nature of the expenditures.

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