2017 (4) TMI 819 - AT - Income Tax

Disallowance of depreciation invoking of section 40(a)(ia) in respect of ERP system software purchased by the assessee and capitalized the same - Held that - Once the assessee has capitalized the payment in question, then even the assessee has not deducted tax at source on such payment, the provisions of section 40(ia) cannot be invoked for disallowance of the claim of depreciation. Accordingly, we set aside the orders of the authorities below and allow the claim of the assessee.

Issues Involved:
1. Disallowance of depreciation on computer software.
2. Classification of payment for software as royalty.
3. Obligation to deduct tax at source on software payments.
4. Capitalization of professional fees and other expenses related to software implementation.

Detailed Analysis:

1. Disallowance of Depreciation on Computer Software:
The primary issue in the appeal was the disallowance of depreciation by the AO on ERP system software purchased by the assessee, capitalized, and claimed under section 32 of the Income Tax Act. The AO disallowed the depreciation by invoking section 40(a)(i) since the assessee did not deduct tax at source on the payment for the software, which was classified as royalty. The Tribunal noted that an identical issue was previously decided in favor of the assessee in the case of M/s. Kavasaki Microelectronics Inc., where it was held that section 40(a)(i) cannot be invoked for disallowance of depreciation if the expenditure has been capitalized and not claimed as an expenditure against business profits. The Tribunal reiterated that depreciation is a statutory deduction and not an outgoing expenditure, thus section 40(a)(i) is not applicable.

2. Classification of Payment for Software as Royalty:
The CIT(A) sustained the AO's disallowance on the grounds that the payment for the software was considered royalty as per the jurisdictional High Court's decision. The assessee argued that the payment for packaged software should not be treated as royalty, citing decisions from other High Courts and the jurisdictional High Court in the case of Wipro Ltd. The Tribunal emphasized that the provision of section 40(a)(i) is an additional measure to enforce compliance with Chapter XVII-B of the Act and is applicable only when an expenditure is claimed without TDS. Since the payment was capitalized, the disallowance under section 40(a)(i) was not justified.

3. Obligation to Deduct Tax at Source on Software Payments:
The CIT(A) held that the assessee was obliged to deduct tax at source on payments made for software licenses, considering them as royalty. The Tribunal, however, observed that the remedy for non-compliance with section 195 lies under sections 201 and 201A of the Act, not under section 40(a)(i). The Tribunal concluded that since the assessee capitalized the payment and did not claim it as an expenditure, the disallowance of depreciation under section 40(a)(i) was not warranted.

4. Capitalization of Professional Fees and Other Expenses Related to Software Implementation:
The CIT(A) included professional fees for implementation, interest paid to the bank, and other related expenses in the disallowed amount, treating them as part of the royalty. The Tribunal, following its earlier decisions, held that once the payment is capitalized, the provisions of section 40(a)(i) cannot be invoked for disallowance of depreciation. The Tribunal set aside the orders of the authorities below and allowed the claim of the assessee, emphasizing that depreciation is a statutory deduction and not subject to disallowance under section 40(a)(i).

Conclusion:
The Tribunal allowed the appeal of the assessee, setting aside the orders of the lower authorities. It held that the provisions of section 40(a)(i) cannot be invoked to disallow depreciation on capitalized payments, even if tax was not deducted at source on such payments. The decision reinforced that depreciation is a statutory deduction and not an outgoing expenditure subject to TDS provisions.

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