2025 (3) TMI 1115 - AT - Income Tax

Nature of expenditure - professional fees paid for drafting application for patents - revenue or capital expenditure - HELD THAT - Considering that the genuineness of the expenditure is not in dispute are of the view that since the expenditure in question before us has been incurred in the regular course of business and no specific intangible asset has been created therefore the assessee deserves the deduction of the alleged expenses u/s 37(1) and it has been rightly claimed as revenue expenditure . Thus ground no.2 raised by the assessee is allowed. Translation expenses for software development - This claim of the assessee has been denied by AO treating it to be a capital expenditure - HELD THAT - We observe that the assessee in the business of providing solutions for enterprise application language localization across all industry verticals for which the assessee requires experts who can translate various words into the customers specified language. The translation expenses is specific to each sale as the dictionary prepared for one customer once is hardly of any use in any other sale. We also observe that no new asset came into existence and the expenditure is customer specific and has no enduring benefit. Further the intention of the expenditure is to facilitate sales and not develop software. Therefore since the alleged expenditure towards translation expenses for software development has been incurred in the regular course of business for the year under consideration the same is hereby treated as revenue expenditure and the claim made by the assessee deserves to be allowed. Disallowance u/s 14A - assessee has claimed that AO has not made proper satisfaction - HELD THAT - Considering the fact that the assessee had earned dividend income from mutual funds investments only at Rs. 1210/- therefore as decided in Joint Investment (P.) Ltd. 2015 (3) TMI 155 - DELHI HIGH COURT wherein it has been held that disallowance u/s 14A of the Act cannot exceed exempt income earned by it we affirm the disallowance u/s 14A of the Act at Rs. 1210/- and delete the remaining amount of disallowance at Rs. 1 02 574/-. Thus ground no.4 raised by the assessee is partly allowed.

Summary

ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal were:

• Whether the professional fees paid for patent drafting should be treated as capital expenditure or revenue expenditure.
• Whether the translation expenses for software development should be treated as capital expenditure or revenue expenditure.
• Whether the disallowance under Section 14A of the Income Tax Act, 1961, should be limited to the exempt income earned during the year.

ISSUE-WISE DETAILED ANALYSIS

Disallowance of Professional Fees for Patent Drafting

• Relevant Legal Framework and Precedents: The dispute revolves around the classification of expenditure as either capital or revenue. Section 37(1) of the Income Tax Act allows for the deduction of revenue expenditure incurred wholly and exclusively for the purposes of business.
• Court's Interpretation and Reasoning: The Tribunal noted that the expenditure on patent drafting did not result in the creation of a new asset, as the patent had not been registered. The assessee followed Accounting Standard 26, which supports the claim that the expenditure should not be capitalized.
• Key Evidence and Findings: The ledger account and invoices for patent drafting were examined, confirming that the expenditure was incurred in the regular course of business.
• Application of Law to Facts: Since the expenditure did not result in an asset and was part of regular business operations, it was classified as revenue expenditure under Section 37(1).
• Treatment of Competing Arguments: The Tribunal considered the genuineness of the expenditure and the lack of asset creation, rejecting the Revenue's argument for capital treatment.
• Conclusions: The Tribunal allowed the deduction of Rs. 15,69,849 as revenue expenditure.

Disallowance of Translation Expenses for Software Development

• Relevant Legal Framework and Precedents: Similar to the patent drafting issue, the classification of expenditure as capital or revenue is central. Section 37(1) applies here as well.
• Court's Interpretation and Reasoning: The Tribunal observed that the translation expenses were specific to each customer and did not create an enduring benefit or asset.
• Key Evidence and Findings: The expenses were incurred for customer-specific language localization, which is essential for sales rather than software development.
• Application of Law to Facts: The Tribunal determined that these expenses were part of the regular business operations and did not result in asset creation, thus qualifying as revenue expenditure.
• Treatment of Competing Arguments: The Tribunal rejected the Revenue's classification of the expenses as capital, emphasizing the lack of enduring benefit.
• Conclusions: The Tribunal allowed the deduction of translation expenses as revenue expenditure.

Disallowance under Section 14A

• Relevant Legal Framework and Precedents: Section 14A deals with disallowance of expenditure incurred in relation to income not includible in total income. The Tribunal referenced the decision in Joint Investment (P.) Ltd. vs. CIT, which limits disallowance to the amount of exempt income.
• Court's Interpretation and Reasoning: The Tribunal noted that the assessee earned only Rs. 1210 as exempt income, and thus, disallowance should not exceed this amount.
• Key Evidence and Findings: The Tribunal found that the Assessing Officer did not record proper satisfaction before making the disallowance.
• Application of Law to Facts: The Tribunal applied the precedent to limit disallowance to the exempt income earned.
• Treatment of Competing Arguments: The Tribunal acknowledged the assessee's argument regarding the lack of satisfaction recorded by the Assessing Officer.
• Conclusions: The Tribunal affirmed the disallowance at Rs. 1210 and deleted the remaining amount.

SIGNIFICANT HOLDINGS

• The Tribunal established that expenditures not resulting in asset creation and incurred in regular business operations should be treated as revenue expenditure under Section 37(1).
• It reiterated the principle that disallowance under Section 14A cannot exceed the exempt income earned, as per the decision in Joint Investment (P.) Ltd. vs. CIT.
• Final Determinations:
  • The professional fees for patent drafting were allowed as revenue expenditure.
  • The translation expenses for software development were allowed as revenue expenditure.
  • The disallowance under Section 14A was limited to Rs. 1210, the amount of exempt income earned.