2003 (3) TMI 277 - AT - Income Tax

Summary

Issues Involved:
1. Allowance of expenditure incurred on the development of software package u/s 35 and 37 of the IT Act, 1961.
2. Nature of the expenditure (capital or revenue).
3. Applicability of scientific research provisions u/s 35.
4. Treatment of software development expenses in books of accounts vs. tax treatment.

Summary:

1. Allowance of Expenditure u/s 35 and 37:
The primary issue in these appeals is whether the expenditure incurred on the development of software packages by the assessee can be allowed as a deduction u/s 35 or 37 of the IT Act, 1961. The AO rejected the claim under both sections, stating that the business of the assessee is development and sale of software, not research and development. The CIT(A) agreed with the AO that the expenditure created a valuable asset and should be capitalized, but allowed the deduction u/s 35 as scientific research expenditure.

2. Nature of the Expenditure (Capital or Revenue):
The AO and CIT(A) both concluded that the expenditure on software development resulted in a valuable asset and thus was capital in nature. The CIT(A) observed that the software development process was complex and involved highly skilled technical personnel, which justified the expenditure as scientific research under s. 35, despite being capital in nature.

3. Applicability of Scientific Research Provisions u/s 35:
The Tribunal agreed with the CIT(A) that the software development process involved significant research and development activities, making the expenditure eligible for deduction u/s 35. The Tribunal noted that the CBDT notification No. S.O. 452, dt. 8th Feb., 2000, supports the view that the manufacture or production of computer software is considered a scientific research activity.

4. Treatment of Software Development Expenses in Books of Accounts vs. Tax Treatment:
The AO objected to the different treatments of the expenditure in the books of accounts and the tax return. The Tribunal, however, held that entries in the books of accounts are not decisive for computing taxable income, citing several case laws to support this view.

Conclusion:
The Tribunal dismissed the Revenue's appeals for all the assessment years (1990-91, 1991-92, 1992-93, 1993-94, and 1995-96) and upheld the CIT(A)'s decision to allow the expenditure as a deduction u/s 35. The cross-objections filed by the assessee for the assessment years 1992-93, 1993-94, and 1995-96 were also dismissed as infructuous.