2020 (8) TMI 669 - AT - Income Tax

Nature of expenditure - expenditure incurred on salaries for software product development and its marketing - assessee has also taken support from Accounting Standards-26 issued by the ICAI for accounting of expenditure on research and development to argue that in the research phase of a project, an enterprise cannot demonstrate that an intangible asset existed from which future economic benefits are probable - HELD THAT - On perusal of facts available on record, it is very clear from facts brought out by the A.O. that actually the assessee is developing a new software platform but such new platform was abandoned during the subsequent financial year due to rapid change in technology and shifting of technology from desktop to mobile platform. The product has never been put to use and no depreciation has been claimed. Expenditure incurred towards development of new software platform was treated as part of revenue expenditure and has never been debited to capital work in progress in the books of account. When the product was in development stage during the year under consideration and the same has never been put to use even in subsequent financial year and finally abandoned, then it cannot be termed that an independent product was came into existence, which gives enduring benefit to the assessee to treat expenditure incurred on development of said product to be in capital in nature. At best, the expenditure incurred by the assessee towards development of new software platform is in the nature of expenditure incurred for preparation of feasibility of the new project in respect of same business, which is already carried out by the assessee, even if it is for expansion of business and definitely cannot be treated as capital expenditure incurred for development of a new product, which gives enduring benefit to the assessee. This view taken by us is fortified by the decision of Karnataka State Industrial Development Corporation 1986 (2) TMI 16 - KARNATAKA HIGH COURT where the court clearly held that expenditure incurred on investigation, research and feasibility studies laid out by assessee was revenue expenditure in nature and thus was an allowable deduction. As per Accounting Standard-26 prescribed by the ICAI for treatment of expenditure of research and development expenses, the standard clearly laid down the procedure for accounting of research expenditure, as per which expenditure on research should be recognised as an expenditure when it is incurred. The Accounting standard further states that in the research phase of the project, an enterprise cannot demonstrate that an intangible asset exists from which future economic benefits are probable. A.O. as well as the Ld. CIT(A) were erred in coming to the conclusion that expenditure incurred on developing new software platform is expected to give enduring benefit and one can recognise the intellectual property in the same to come to conclusion that expenditure incurred for development of new software platform is capital in nature. Hence, we direct the A.O. to delete additions made towards disallowance of salary expenses incurred for development of new software platform. Marketing expenses Allowability - marketing expenses incurred by the assessee has no nexus with new product being developed by the assessee. Further, marketing expenses were incurred in order to show-cause the capabilities of Adadyn to the potential customers and from this it has a clear indication that expenses were incurred primarily towards attracting potential customers and further development of the business in general for the company. When the marketing expenditure incurred towards the overall promotion of the business of the company and there is no direct nexus between the marketing expenses and the new software platform being developed by the assessee, the A.O. as well as Ld. CIT(A) were clearly erred in coming to the conclusion that marketing expenditure is in the nature of capital expenditure. Further, assuming that said marketing expenses were associated with the new platform developmental project, even then said expenditure is revenue in nature, because the product under development was never put to use and also the same has been abandoned in subsequent financial year. Therefore,marketing expenses incurred by the assessee in USA to gauge the effect of new software platform cannot be treated as capital in nature. Accordingly, we direct the A.O. to delete additions made towards marketing expenses as capital in nature.

Summary

Issues Involved:
1. Classification of salary expenses for software development as capital or revenue expenditure.
2. Classification of marketing expenses as capital or revenue expenditure.

Issue-wise Detailed Analysis:

1. Classification of Salary Expenses for Software Development:
The primary issue was whether the salary costs incurred for the development of a new software platform should be treated as capital expenditure, providing enduring benefits, or as revenue expenditure. The assessee argued that the software was never put to use and was eventually abandoned due to rapid technological changes, thus the expenses should be considered as revenue in nature. The A.O. and CIT(A) held that the expenses were capital in nature, assuming the software would provide enduring benefits.

Upon review, it was noted that the software developed was never operational and was abandoned due to technological shifts. The tribunal referenced the decision of the Karnataka High Court in Karnataka State Industrial and Development Corporation, which held that expenses on research and feasibility studies are revenue expenditures. The tribunal also cited Accounting Standard-26, which states that research expenses should be recognized as incurred. Therefore, the tribunal concluded that since the software was never put to use and no new asset came into existence, the salary expenses should be treated as revenue expenditure. The tribunal directed the A.O. to delete the additions made for salary expenses.

2. Classification of Marketing Expenses:
The second issue involved whether marketing expenses incurred in the USA to gauge the effect of the new software platform should be treated as capital expenditure. The assessee contended that these expenses were for promoting the company's overall business and attracting potential customers, not specifically tied to the new software platform.

The tribunal found that the marketing expenses had no direct nexus with the new software platform and were primarily for overall business promotion. Even if associated with the new platform, the expenses would still be revenue in nature as the software was never utilized and was abandoned. Therefore, the tribunal directed the A.O. to delete the additions made for marketing expenses as capital expenditure.

Conclusion:
The tribunal allowed the appeals for both assessment years, directing the deletion of additions made towards salary and marketing expenses, treating them as revenue expenditures. The judgment emphasized that expenses related to research and feasibility studies, which do not result in a usable asset, should be considered revenue in nature.