2013 (2) TMI 108 - HC - Income Tax

Licence fee for the use of software - Revenue expenditure Versus Capital expenditure Assessee debited the licence fee to the Profit and Loss Account Held that - When the software are licensed for a particular period, for utilizing the same for the subsequent years fresh licence fee is to be paid, without renewing the licence or without paying the fee on such renewal, it is not possible to use those software When the life of a computer or software is less than two years, fee paid for the acquisition of the right to use the same is allowable as revenue expenditure Decided against the revenue. Whether provision for warranty is a contingent liability Assessee claimed deduction Held that - As decided in Rotark Controls India P. Ltd. v. CIT reported in 2009 (5) TMI 16 - SUPREME COURT OF INDIA makes it clear the historical trend is the question whether in the past there was any defect in the manufactured goods and not the actual expenditure incurred in rectifying the defect or in substituting the defective product with a defectless product Assuming that the amount of warranty claiming deduction is actual and not incurred by the assessee, the difference in the amount is taxed in the subsequent year warranty is not a contingent liability and the assessee is entitled to claim deduction Decided against the revenue.

Summary

Issues:
1. Treatment of provision for warranty as contingent liability and deduction eligibility.
2. Classification of software licence fee as revenue or capital expenditure.

Issue 1: Treatment of provision for warranty as contingent liability and deduction eligibility:

The case involved an appeal by the Revenue against the Appellate Tribunal's decision regarding the provision for warranty. The Tribunal held that the provision for warranty is not a contingent liability but an allowable deduction. The Commissioner of Income-tax (Appeals) allowed the deduction, considering the software's short lifespan due to technological advancements. The Revenue challenged this decision. The Tribunal affirmed the deduction but remanded the matter to ensure no double deduction. The High Court upheld the Tribunal's decision, citing the Supreme Court's ruling that historical trends of defects in goods justify warranty provisions for deduction. The Court emphasized that the absence of past cash outflows does not preclude claiming warranty deductions.

Issue 2: Classification of software licence fee as revenue or capital expenditure:

The second aspect of the case revolved around the classification of a software licence fee as revenue or capital expenditure. The assessee debited a significant amount as software expenses, including a licence fee for "Lotus Notes." The assessing authority disallowed this amount as capital expenditure, but the Commissioner of Income-tax (Appeals) reversed this decision, considering the short lifespan of software. The Tribunal upheld this decision, treating the licence fee as revenue expenditure based on the limited period of software use. The High Court concurred with the Tribunal's finding, stating that fees for software acquisition and renewal are revenue expenditures, especially when the right to use the software is time-limited. The Court dismissed the Revenue's appeal, finding no substantial question of law for consideration.

In conclusion, the High Court upheld the Tribunal's decisions regarding the treatment of provision for warranty and software licence fee. The judgments were based on the principles of deduction eligibility for warranty provisions and the classification of software expenses as revenue expenditure due to the limited lifespan of the software. The Court emphasized the importance of historical trends in justifying warranty provisions and reiterated that software licence fees for time-limited usage are considered revenue expenditures.