2008 (11) TMI 432 - AT - Income Tax

Nature of expenses - software expenses incurred by the assessee - capital or revenue expenditure - Disallowance of expenditure incurred on lease hold improvements - Addition charged to VP-1 stock, to the P L account. Nature of expenses - software expenses incurred by the assessee - capital or revenue expenditure - functionality test - Whether the expenditure on license is capital or revenue in nature - HELD THAT - The issue was considered by the Special Bench in the assessee s own case which was reported in Amway India Enterprises v. Dy. CIT 2008 (2) TMI 454 - ITAT DELHI-C and it was held that computer software in a disc is tangible asset, tests of enduring benefit, ownership test and the functional test are to be applied to decide the nature of expenditure. AO will examine the question whether expenditure on computer software is capital or revenue expenditure in the light of the principles laid down by the Special Bench. After hearing the assessee, AO will decide the question whether the expenditure is capital or revenue expenditure. If on such examination, AO comes to the conclusion that the expenditure is capital expenditure, then the question regarding allowing depreciation will be decided in accordance with the principles laid down - Therefore, matter is restored back to the file of the AO. Disallowance of expenditure incurred on lease hold improvements - HELD THAT - The expenditure was claimed u/s 37(1) which provide that any expenditure, not in the nature described under sections 30 to 36 and not being in the nature of capital expenditure or personal expenditure and which is laid out wholly and exclusively for the purpose of business, shall be allowed in computing the income chargeable under the head Profit and gains of business and profession . The nature of expenditure which was on account of refurbishment, wooden partition/panelling, flooring, plumbing work, electric work, laying down of cables etc., are essentially revenue in nature. As the expenditure were incurred on lease hold premises, assessee did not get any enduring benefit on account of such expenditure. The expenditure so incurred could not be removed or reused at the time of vacating the leased premises. In case of Modi Spg. Wvg. Mills Co. Ltd. 1992 (10) TMI 76 - DELHI HIGH COURT , observed that where assessee had taken two flats of the building for a period of 11 months, but renewable for 10 periods of 11 months each, the expenditure incurred by the assessee on items like fixing false ceiling, painting, making some structural changes, fixing of doors in the common walls between the flats etc. it was held to be incurred for the purpose of facilitating carrying out of its business, accordingly revenue in nature - Therefore, there are no merit in the action of lower authorities for disallowing assessee s claim for expenditure incurred on improvement of the lease hold premises, except the expenditure incurred on air-conditioning unit and furniture - This ground taken by the revenue is also restored back to decided afresh after taking into account the principles laid down by the Special Bench in assessee s own case, as discussed hereinabove. Addition charged to VP-1 stock, to the P L account - contention of the assessee was that VP-1 was an application docket, which was purchased by distributors to enroll their prospects as new distributors with the company - HELD THAT - We have found that VP-1 form was nothing but a set of papers and is essentially part of printing and stationery. As the stock of printing and stationery was consumed during the year itself, there was no reason to disallow the same. The CIT(A) also recorded the detailed finding at his appellate order which has not been controverted by the Ld. D.R. We, therefore, do not find any reason to interfere in the order of CIT(A) for deleting the addition. In the result, both the appeals of the assessee and the revenue are allowed in part.

Issues Involved:
1. Disallowance of expenditure on leasehold improvements.
2. Disallowance of software expenses.
3. Treatment of expenditure on leasehold improvement as revenue or capital.
4. Addition on account of VP-1 stock.
5. Allowance of depreciation on computer software.

Issue-wise Detailed Analysis:

1. Disallowance of Expenditure on Leasehold Improvements:
The assessee contested the disallowance of Rs. 2,46,57,910 incurred on leasehold improvements, arguing it should be treated as revenue expenditure. The Assessing Officer (AO) considered the expenditure as capital in nature, citing enduring benefits from improvements like flooring, partition, wiring, plumbing, false ceiling, and air-conditioning ducts. The CIT(A) upheld the AO's decision. The assessee argued that these expenses did not bring into existence an asset of enduring nature and were necessary for commercial use and international standards. The Tribunal found that except for air-conditioning ducts and furniture, the expenses did not result in new assets and were incurred for commercial expediency, thus allowable as revenue expenditure under section 37(1).

2. Disallowance of Software Expenses:
The assessee incurred Rs. 24,79,134 on software licenses, which the AO treated as capital expenditure. The CIT(A) confirmed this disallowance. The Tribunal referred to the Special Bench decision in Amway India Enterprises v. Dy. CIT, which established criteria for determining whether software expenses are capital or revenue. The Tribunal restored the matter to the AO to re-examine the nature of the expenditure based on the Special Bench's guidelines, which include the nature of the business, the cost and centrality of the software, associated organizational changes, and the fast-changing nature of the software industry.

3. Treatment of Expenditure on Leasehold Improvement as Revenue or Capital:
The revenue challenged the CIT(A)'s decision to treat Rs. 11,98,062 of leasehold improvement expenditure as revenue. The Tribunal upheld the CIT(A)'s decision, reiterating that the nature of the expenditure did not result in new assets and was necessary for commercial use. The Tribunal referenced several cases, including Empire Jute Co. Ltd. v. CIT and Modi Spg. & Wvg. Mills Co. Ltd. v. CIT, to support the view that such expenditures, even if providing benefits over several years, could be considered revenue if they facilitate business operations without creating new assets.

4. Addition on Account of VP-1 Stock:
The AO added Rs. 14,82,000 to the income, considering it as closing stock of VP-1 forms. The assessee explained that VP-1 forms were stationery items consumed during the year, and the cost was reclassified from cost of sales to printing and stationery. The CIT(A) deleted the addition, agreeing with the assessee's explanation. The Tribunal upheld the CIT(A)'s decision, noting that the stock was consumed during the year and there was no reason to disallow it.

5. Allowance of Depreciation on Computer Software:
The assessee argued that if software expenses were treated as capital expenditure, depreciation should be allowed at 60% as per Income-tax Rules. The Tribunal restored this matter to the AO to decide afresh, considering the principles laid down by the Special Bench in the assessee's own case, which recognized software in a disc as a tangible asset eligible for depreciation.

Conclusion:
The Tribunal allowed the appeals in part, restoring certain matters to the AO for fresh consideration and upholding the CIT(A)'s decisions on other issues. The key determinations included treating most leasehold improvement expenses as revenue, re-examining the nature of software expenses, and confirming the deletion of the addition related to VP-1 stock.

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