2018 (12) TMI 988 - HC - Income Tax

Nature of expenditure - expenditure incurred in developing/upgrading the software - revenue or capital - Held that - The case of the assessee, not disputed by the Revenue is that the assessee incurred these expenditure for developing a existing software. This was with the reason to compete in the market and for the improvement of the existing product. Therefore, the Tribunal erred in applying the said decision and consequently, erred in allowing the appeal filed by the Revenue. The CIT-A after taking into consideration the facts of the case, in our opinion rightly held that the products are not similar to development of specific new products and it is in respect of the expenditure incurred in improving of the existing product and the work was initiated for securing the market over others in the field of business and the assessee s business is developing of software and expenditure incurred on a project which was perceived to be of great potential cannot be disallowed because such potential has not been realised. As pointed out that it is not necessary that every expenditure results in taxable income and it cannot be held that unless income is generated, expenditure cannot be allowed. - Decided in favour of the assessee.

Summary

Issues Involved:
1. Whether the expenditure incurred in developing/upgrading the software is capital or revenue expenditure.
2. Whether the Tribunal erred in applying the decision of Hasimara Industries Ltd. to the present case.
3. Whether the Tribunal should have considered the nature of the expenses for determining its allowability irrespective of its treatment in the assessee's accounts.

Issue-wise Detailed Analysis:

1. Expenditure Classification:
The primary issue was whether the expenditure incurred by the assessee for developing/upgrading software should be treated as capital or revenue expenditure. The assessee claimed the expenditure as revenue expenditure under Section 37(1) of the Income Tax Act, 1961, arguing that the software development was intended to enhance existing products to compete in the market. The Tribunal, however, classified the expenditure as capital, drawing on the decision in Hasimara Industries Ltd., which involved a deposit for securing a license to operate a cotton mill, deemed a capital expenditure.

2. Applicability of Hasimara Industries Ltd. Decision:
The Tribunal's reliance on the Hasimara Industries Ltd. case was contested. The High Court noted that the facts of Hasimara Industries Ltd. involved a deposit to acquire a profit-making asset, which was a capital expenditure. In contrast, the present case involved expenditure for improving existing software products, not creating a new asset or acquiring a profit-making asset. The High Court concluded that the decision in Hasimara Industries Ltd. was not applicable to the present case.

3. Nature of Expenses Determination:
The High Court emphasized that the Tribunal should have considered the nature of the expenses independently of how they were treated in the assessee's accounts. The Commissioner of Income Tax (Appeals) (CITA) had correctly identified the expenses as revenue expenditure, noting that the software development was for improving existing products to maintain market competitiveness. The High Court supported this view, citing precedents where similar expenditures on software upgrades were treated as revenue expenditures.

The High Court referenced the decision in CIT vs. Southern Roadways Limited, which held that expenses for software upgrades are revenue expenditures, as they enhance efficiency without creating a new asset. The Court also cited Alembic Chemical Works Co. Ltd. vs. CIT, emphasizing that the concept of "enduring benefit" should be flexible and responsive to economic realities, and that not all enduring benefits result in capital expenditures.

Conclusion:
The High Court concluded that the Tribunal erred in its judgment and restored the CITA's order, treating the software development expenditure as revenue expenditure. The substantial questions of law were answered in favor of the assessee, and the appeals were allowed.