2017 (6) TMI 66 - AT - Income Tax

Addition of expenditure incurred on development of software - CIT(A) confirming that the expenditure on development of software is covered under section 35D and thereby sustaining the disallowance of expenditure incurred on development of software - assessee is in business of software development and sale of software products - Held that - It is an undisputed fact that the assessee did incurred expenditure for development of software way back in the A.Y. 2004-05 and such development of software was meant to be sold in the market as a part of core its business activity. If over the period of time the said product could not be sold and has become obsolete due to fast changing technologies and software programme, then it has to be left to the prudence of the businessman to write it off in the year in which it considers that the said product cannot be sold at all or it has become scrap. In the year under consideration, the assessee has written off the said amount of expenses, which has been amortized since 2004-05, therefore, the same needs to be allowed as business loss in this year. The revenue has not disputed the fact that software is not saleable or has nil realizable value. It is also the fact stated before us that this software is not sold as it has lost its utility. Thus, on this ground we are of opinion that the said amount of ₹ 24,65,578/- is to be allowed as business loss as technical obsolescence of the inventory while computing the income under section 28/29 of the act in this year. Hence, the appeal of the assessee is allowed on the reasoning given above.

Issues Involved:
1. Whether the expenditure incurred on the development of software amounting to ?24,65,578/- is allowable under Section 37(1) of the Income Tax Act.
2. Whether the expenditure should be treated as capital in nature under Section 35D of the Income Tax Act.
3. Whether the expenditure should be allowed as depreciation if treated as capital in nature.
4. Whether the expenditure incurred on the development of the software project "SIMS" should be considered as a trading asset/stock in trade and thus allowable as a business loss under Sections 28/29 of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Allowability under Section 37(1):
The assessee argued that the expenditure on software development should be allowed under Section 37(1) of the Income Tax Act. The Assessing Officer (AO) disallowed this claim, stating that the expenditure was accumulated over 4-5 years and had enduring benefits, thus classifying it as capital in nature. The AO allowed only 1/5th of the total expenditure under Section 35D, disallowing the balance amount of ?23,66,447/-. The CIT(A) upheld this view, agreeing that the expenditure had enduring benefits and should be treated as capital.

2. Treatment as Capital Expenditure under Section 35D:
The AO and CIT(A) both held that the expenditure on software development should be treated as capital in nature under Section 35D. The CIT(A) justified this by stating that the expenditure resulted in enduring benefits for the business. Consequently, only 1/5th of the expenditure was allowed, and the remaining amount was disallowed.

3. Allowability as Depreciation:
The assessee contended that if the expenditure is treated as capital in nature, then depreciation should be allowed on the same. However, this issue was not specifically addressed in the judgment as the primary contention was regarding the nature of the expenditure (revenue vs. capital).

4. Treatment as Trading Asset/Stock in Trade under Sections 28/29:
The assessee raised an additional ground, arguing that the expenditure on the software project "SIMS" should be considered as a trading asset/stock in trade. They claimed that the software became obsolete over time and thus should be allowed as a business loss under Sections 28/29. The Tribunal admitted this additional ground for adjudication.

The Tribunal noted that the assessee had consistently followed an accounting policy of amortizing software development costs over a reasonable period, matching the revenue realization. The software "SIMS" was developed in AY 2004-05 but was not sold due to technological obsolescence. The Tribunal observed that similar write-offs in previous years were accepted by the department. It concluded that the expenditure should be allowed as a business loss in the year it was written off, considering the software had become obsolete.

The Tribunal further reasoned that the software developed was part of the inventory held for sale. Since the software became obsolete and unsellable, the write-off should be allowed as a business loss. The Tribunal allowed the appeal, permitting the assessee to claim the expenditure as a business loss under Sections 28/29.

Conclusion:
The Tribunal allowed the appeal, permitting the assessee to claim the expenditure of ?24,65,578/- as a business loss due to technological obsolescence, under Sections 28/29 of the Income Tax Act. The Tribunal emphasized the principle of consistency and the fact that the assessee had followed a similar accounting policy in previous years, which was accepted by the department. The appeal was allowed, and the order was pronounced in the open court on 23.05.2017.

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