2011 (7) TMI 303 - AT - Income Tax

Addition - Expenditure incurred on purchase of softwares - No data whatsoever has been furnished in respect of useful life of the softwares and the purpose for which they are used - In assessment year 2005-06, the assessee had capitalized the expenditure in respect of card scanner software - This has been claimed as revenue expenditure in this year - In absence of the details above the nature, use and useful life of the softwares, it is held that the lower authorities were right in capitalizing the expenditure, as the burden cast on assessee u/s 37 has not been discharged Royalty payment- the terms of agreement are quite comprehensive and the whole technical know-how to set up the business has been provided by the Gates Corporation, USA. The assessee has been given indivisible non-transferable and exclusive license to assemble and manufacture products and parts in the territory of India and to sell the products so assembled or manufactured. Comprehensive technical know-how has been provided because of which the assessee is a market leader - the agreement is valid for a period of 10 years and is further extendable, which shows that the benefit is not restricted only to 10 years - The assessee does not retain any residual right under the agreement - Therefore, exclusive right to manufacture goods in India for 10 years does not lead to inference of benefit of enduring nature in the capital field - At the same time it is seen that the license fee is paid on the basis of net turn over and it has a direct relationship with an item in the revenue field - Therefore, the expenditure is of revenue in nature.

Issues Involved:
1. Capitalization of software expenses for the assessment years 2005-06 and 2006-07.
2. Capitalization of royalty payment for the assessment year 2006-07.

Issue-wise Detailed Analysis:

1. Capitalization of Software Expenses for Assessment Year 2005-06:
The assessee claimed a deduction of software expenses amounting to Rs.5,74,674/-, arguing that these expenses were revenue in nature due to the high obsolescence of the software. The Assessing Officer (AO) treated the software as intangible assets, included them in fixed assets, and capitalized the expenditure, allowing depreciation at 60%. This resulted in an addition of Rs.2,29,870/- to the total income after deducting the depreciation.

Upon appeal, the CIT(A) upheld the AO's decision, referencing the Special Bench decision in Amway India Enterprises, which stated that software with a life of less than two years could be considered revenue expenditure. However, as no evidence was provided that the software had a short lifespan, the expenditure was treated as capital.

Before the tribunal, the assessee argued that they had capitalized significant software expenses themselves, indicating a thoughtful application of mind regarding the useful life of the software. The tribunal found that the lower authorities had not considered the functional test and upheld the addition because the assessee did not provide evidence of the software's useful life being less than two years. The tribunal decided that only Rs.3,50,000/- out of Rs.5,74,674/- should be capitalized as no detailed explanation was provided for the backup software. The AO was directed to revise the order accordingly.

2. Capitalization of Software Expenses for Assessment Year 2006-07:
Similar to the previous year, the AO capitalized software expenses amounting to Rs.37,130/- and allowed depreciation at 60%, leading to a net addition of Rs.14,855/-. The CIT(A) upheld the AO's decision, as the assessee did not provide any data regarding the useful life of the software. The tribunal found no reason to differ from the lower authorities and dismissed this ground.

3. Capitalization of Royalty Payment for Assessment Year 2006-07:
The assessee paid royalty and training fees to Gates Corporation, USA, under a technical collaboration agreement and claimed these as revenue expenses. The AO capitalized the royalty payment of Rs.29,77,118/-, citing that the agreement provided comprehensive technical know-how and a non-transferable, exclusive license to manufacture and sell products in India. The CIT(A) upheld the AO's decision, noting the agreement's 10-year validity and the enduring benefit derived by the assessee.

The tribunal examined the agreement and noted that the assessee had been in the business of manufacturing industrial hoses before the agreement, indicating that no new business was set up. The agreement was a continuation of a pre-existing one, and the technical knowledge provided was necessary for business survival amidst rapid technological innovations. The tribunal concluded that the agreement did not grant any fixed asset or benefit of enduring nature in the capital field to the assessee. The royalty payment was tied to the net turnover, indicating a direct relationship with revenue. Hence, the tribunal held the expenditure as revenue in nature and allowed the appeal on this ground.

Conclusion:
Both appeals were partly allowed, with the tribunal directing the AO to revise the orders based on the findings. The software expenses were partly capitalized for the assessment year 2005-06, while the royalty payment for the assessment year 2006-07 was considered revenue expenditure.

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