2022 (1) TMI 282 - AT - Income Tax

Nature of expenditure - Allowable revenue expenditure u/s 37 - expenditure towards purchase of software - assessee submitted that the expenditure incurred by the assessee is towards purchase of Core Banking Solutions (CBS) software which is an application software - whether expenditure incurred on Vysyamulya Project which is a project by which the assessee wanted to link its 125 branches networked with a Centralized Processing Solution? - HELD THAT - With passage of time, a perpetual license purchased 10 years ago may not be compatible on that brand new computer that a person may buy. So, every few years, one has to purchase new software to ensure that one remains up-to-date, compatible with new hardware and with other people s operating systems. In fact, there was a time in which perpetual license agreements were the only ones that existed regarding software. That has since changed, and now many software companies provide subscription services or annual licenses. Therefore the business model adopted by the licensor to grant licenses only on the basis of perpetual license cannot be the basis to hold that the expenditure incurred by the assessee is capital expenditure. Notwithstanding the use of the term perpetual, the license agreement between the assessee and Sanchez provides for annual maintenance and upgrade fee also. Therefore it is not possible to look into the clause in the license agreement in isolation to come to a conclusion that because the license is in perpetuity, the expenditure incurred is capital expenditure. We hold that advantage of an enduring benefit, need not be on capital account. If the advantage consists merely in facilitating the assessee's trading operations or enabling him to manage and conduct his business more efficiently or more profitably while leaving the fixed capital untouched, the same cannot be regarded as on capital account. In order to treat any expenditure as capital expenditure, the same should result in accrual of advantage of enduring benefit and such benefit should accrue to the assesses in the capital field. Such accrual of benefit in the capital field would mean that the said benefit should form part of the profit-making apparatus of the assessee s business. The expenditure in question only facilitates carrying on the business of the assessee more profitably without touching the profit making apparatus of the bank which is receiving deposits and lending/investing them for profit. Therefore the expenditure in question has to be regarded as revenue expenditure. Thus the relevant grounds of appeal are allowed.

Summary

Issues Involved:
1. Whether the expenditure incurred on the Vysyamulya Project (computerization of branches) amounting to ?23,05,49,466/- is capital or revenue in nature.

Detailed Analysis:

1. Nature of Expenditure on Vysyamulya Project:
- The primary issue revolves around the classification of expenditure incurred by the assessee on the Vysyamulya Project, which involved networking 125 branches with a centralized processing solution, as either capital or revenue expenditure.
- The assessee argued that the expenditure on application software, which facilitated the smooth running of its banking operations, should be considered revenue expenditure under Section 37 of the Income Tax Act, 1961.
- The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] treated the expenditure as capital, citing that it secured an enduring advantage and involved the acquisition of a capital asset, granting tangible benefits of an enduring nature. The AO allowed depreciation on the expenditure but denied it as a revenue expenditure.
- The Tribunal had previously allowed the assessee's appeal, treating the expenditure as revenue, but the High Court remanded the matter back to the Tribunal for fresh consideration, particularly focusing on whether the expenditure should be capitalized due to its long-term benefits.

2. Tribunal’s Observations and Decision:
- The Tribunal noted that the assessee purchased an application software called 'Profile' from Sanchez Computer Associates Inc., which was used for processing the bank's data. The license granted was non-exclusive and non-transferable.
- The Tribunal emphasized that the software was application software, which typically supports specific tasks like managing loan and deposit accounts, rather than system software that operates the hardware.
- It was highlighted that the expenditure incurred facilitated the business operations without altering the profit-making apparatus of the bank, thus qualifying as revenue expenditure.

3. Legal Precedents and Principles:
- The Tribunal referred to several judicial precedents, including decisions in CIT v. IBM India Ltd., CIT v. Asahi India Safety Glass Ltd., and Oriental Bank of Commerce v. Addl CIT, which supported the view that expenditure on application software is revenue in nature.
- The Tribunal also discussed the principles laid down by the Supreme Court in cases like Alembic Chemical Works Co. Ltd. v. CIT and Empire Jute Co. Ltd. v. CIT, which emphasized that not all enduring benefits result in capital expenditure and that the nature of the advantage in a commercial sense is crucial.

4. Functional Utility and Economic Role:
- The Tribunal applied the functional test, considering the economic and functional role of the software in the assessee's business. It concluded that the software facilitated the bank's operations, enabling it to manage its business more efficiently and profitably without altering its fixed capital structure.
- The Tribunal also addressed the revenue's argument regarding the perpetual nature of the license, clarifying that the mode of licensing (perpetual or otherwise) does not necessarily determine the nature of the expenditure.

Conclusion:
- The Tribunal held that the expenditure incurred on the Vysyamulya Project, being an application software, facilitated the assessee's business operations and was thus revenue in nature. Consequently, the relevant grounds of appeal were allowed.
- The appeal of the revenue was dismissed, and the grounds of appeal of the assessee remanded by the High Court for fresh consideration were allowed.

Final Pronouncement:
- The Tribunal pronounced its decision in the open court, affirming that the expenditure on the Vysyamulya Project is to be treated as revenue expenditure.