2022 (8) TMI 1568 - AT - Income Tax

Disallowance of software development expenses - AO noticed that the assessee had incurred expenditure on purchase development of software and other upgradation charges included under the head EDP expenses - AO was of the opinion that such expenses confer enduring benefit to the assessee and therefore disallowed the same as capital expenditure - HELD THAT - In so far as expenses incurred on purchase of MS Office software server upgradation charges and software development charges are concerned we are of the considered view that the same were incurred to keep update with change in technology and therefore the assessee had to incur such expenditure to upgrade his software. Element of upgradation does not automatically make the expenditure capital. However the same cannot be said for purchase of Modem UPS and billing software development charges. In our considered opinion expenses incurred on these items give advantage in capital field and therefore the same cannot be Revenue expenditure. Billing software development charges are part of the profit earning apparatus of the assessee and therefore would be regarded as capital in nature. We restrict the disallowance to the extent of Modem UPS purchases of Rs. 1, 09, 200/- and billing software development charges of Rs. 11, 30, 400/- and direct the Assessing Officer to delete the other disallowances. Ground No. 2 is partly allowed. LTCG computation - increasing the amount of long term capital gains computed by the assessee by denying benefit of indexation - invocation of Explanation to section 73 - HELD THAT -Explanation to Section 73 of the Act is not at all applicable on the facts of the case in hand. Firstly because the assessee is engaged in marketing and distribution of entertainment software and production of TV serials and is also engaged in distributing pay channels and secondly admittedly there is no loss in the transaction of sale of shares. In fact there is long term capital gain returned by the assessee. We do not find any merit in the application of Explanation to Section 73 - AO is directed to delete addition. Ground No. 3 is accordingly allowed. Denial of set off of brought forward losses as claimed by the assessee - HELD THAT - As it is incumbent upon the Assessing Officer and also on the ld. CIT(A) to explain why the claim of set off of brought forward losses are not allowed to the assessee. Therefore in the interest of justice we restore this issue to the file of the AO. AO is directed to allow the claim of set off of brought forward losses as per the relevant provisions of the Act and after affording reasonable opportunity of being heard to the assessee. Ground No. 4 is allowed for statistical purposes.

Summary

ISSUES PRESENTED and CONSIDERED

The Tribunal considered the following core legal issues:

1. Whether the disallowance of software development expenses amounting to Rs. 19,93,650/- as capital expenditure was justified.

2. Whether the denial of the benefit of indexation in computing long-term capital gains, leading to an increase of Rs. 4,92,611/-, was appropriate.

3. Whether the denial of set-off for brought forward losses as claimed by the assessee was correct.

ISSUE-WISE DETAILED ANALYSIS

Issue 1: Disallowance of Software Development Expenses

- Relevant legal framework and precedents: The core question was whether the expenses incurred on software development and related purchases should be classified as capital or revenue expenditure. The Tribunal considered precedents such as the decisions in Amway India Enterprises and Asahi India Safety Glass Ltd, which provided guidance on distinguishing between capital and revenue expenses.

- Court's interpretation and reasoning: The Tribunal acknowledged that while certain expenses like MS Office software and server upgrades were necessary to keep up with technological changes, they did not automatically qualify as capital expenditure. However, expenses on items like Modem & UPS and billing software development were deemed to confer an enduring benefit, thus qualifying as capital expenditure.

- Key evidence and findings: The Tribunal analyzed the nature of each expense, distinguishing between those that merely upgraded existing systems and those that contributed to the profit-earning apparatus of the business.

- Application of law to facts: The Tribunal concluded that the expenses for MS Office software and server upgrades were revenue in nature, while expenses for Modem & UPS and billing software development were capital in nature.

- Treatment of competing arguments: The Tribunal balanced the arguments of the assessee, who claimed all expenses as revenue, against the Department's position that certain expenses were capital. The Tribunal partially agreed with both sides, allowing some expenses as revenue and others as capital.

- Conclusions: The Tribunal directed the Assessing Officer to delete disallowances for MS Office software and server upgrades while upholding disallowances for Modem & UPS and billing software development.

Issue 2: Denial of Indexation Benefit for Long-Term Capital Gains

- Relevant legal framework and precedents: The issue revolved around the applicability of Explanation to Section 73, which concerns the treatment of certain share transactions as speculative.

- Court's interpretation and reasoning: The Tribunal found that Explanation to Section 73 was inapplicable as the assessee was not engaged in the business of trading shares and had reported gains, not losses.

- Key evidence and findings: The Tribunal noted the nature of the assessee's business, which included marketing and distribution of entertainment software, and the absence of any speculative loss.

- Application of law to facts: The Tribunal concluded that the denial of indexation was erroneous as the Explanation to Section 73 did not apply.

- Treatment of competing arguments: The Tribunal considered the Department's reliance on Explanation to Section 73 and the assessee's argument regarding the nature of its business and the gains reported.

- Conclusions: The Tribunal directed the Assessing Officer to delete the addition of Rs. 4,92,611/- and allow the benefit of indexation.

Issue 3: Denial of Set-Off for Brought Forward Losses

- Relevant legal framework and precedents: The issue concerned the proper application of provisions related to the set-off of brought forward losses.

- Court's interpretation and reasoning: The Tribunal emphasized the requirement for the Assessing Officer to provide a rationale when denying set-off claims.

- Key evidence and findings: The Tribunal noted the lack of discussion in the assessment order regarding the partial allowance of brought forward losses.

- Application of law to facts: The Tribunal found that the Assessing Officer had not adequately justified the partial allowance of losses.

- Treatment of competing arguments: The Tribunal considered the assessee's claim for full set-off and the lack of explanation from the Department.

- Conclusions: The Tribunal restored the issue to the Assessing Officer for reconsideration, directing a proper examination and allowing the claim as per relevant provisions.

SIGNIFICANT HOLDINGS

- Preserve verbatim quotes of crucial legal reasoning: The Tribunal noted, "In our humble opinion, element of upgradation does not automatically make the expenditure capital."

- Core principles established: The distinction between capital and revenue expenditure depends on the nature and purpose of the expenses, and the applicability of Explanation to Section 73 requires careful consideration of the nature of the business and the presence of speculative losses.

- Final determinations on each issue: The Tribunal allowed partial relief on software expenses, directed the allowance of indexation benefits, and remanded the issue of set-off for brought forward losses for further consideration.