Income Tax Appellate Tribunal - Chennai
Laser Soft Infosystems Limited, ... vs Assessee on 9 January, 2013
IN THE INCOME TAX APPELLATE TRIBUNAL
'A' BENCH, CHENNAI
BEFORE N.S. SAINI, ACCOUNTANT MEMBER AND
SHRI VIKAS AWASTHY, JUDICIAL MEMBER
ITA No.107/Mds/2012
(Assessment Year: 2007-08)
Laser Soft Infosystems Ltd., Vs. The Income Tax Officer,
Prince Info Park, A Block, Company Ward-II(1)
81B, II Main Road, Chennai-600 034.
Ambattur Industrial Estate,
Ambattur,
Chennai-600 058.
PAN: AAACL5896N
(Appellant) (Respondent)
Appellant by : Mr. Vikram Vijayaraghavan, Advocate
Respondent by : Mr. Shaji P.Jacob, Addl. CIT
Date of Hearing : 9th January, 2013
Date of Pronouncement : 31st January, 2013
ORDER
Per Vikas Awasthy, JM:
This appeal has been preferred by the assessee impugning the order of the CIT(A)-IV, Chennai dated 1.11.2011 relevant to the assessment year 2007-08. The only issue involved in the appeal is whether the product development cost is revenue or capital in nature?
2. The brief facts of the case are that the assessee is a company engaged in the business of development and export 2 ITA No.107/Mds/2012 of computer software mainly for the Banking and Financial service sector. For the assessment year 2007-08, the assessee filed its return of income on 31.10.2007 admitting income of ` 3,38,58,500/-. The case of the assessee was selected for scrutiny. The Assessing Officer vide order dated 24.12.2009 disallowed certain expenses and made additions in the income returned by the assessee. The Assessing Officer inter-alia made additions on account of expenditure incurred by the assessee on product development.
The assessee claimed the expenditure to be Revenue in nature. The stand of the assessee before the Assessing Officer was that since the expenditure relates to salary, travel, rentals, consumables, electricity charges etc. which primarily relates to day to day functioning of the organization, therefore, the same are to be allowed as revenue expenditure. As per the assessee, similar revenue expenditure is incurred by the company whenever it develops a new product or enhances an existing product to meet the emerging market demand. Since the expenditure is done in anticipation of future orders, these are classified as product development expenditure. In 3 ITA No.107/Mds/2012 tune with the company's accounting policies, such product development expenses are treated as deferred expenditure in the books and written off equally over a period of three years commencing from the subsequent year.
3. The Assessing Officer was of the view that the alleged expenditure on product development results in creating of prototype which will be used to develop software again and again for different systems. The Assessing Officer further observed that the assessee has not furnished the details of income generated by incurring this expenditure. Since, it relates to new product from which the assessee will be generating income in future, all these expenses have to be capitalized. The Assessing Officer rejected the contention of the assessee and treated the entire expenditure of `4,56,96,957/- as capital in nature.
4. Aggrieved against the assessment order, the assessee preferred an appeal before the CIT(A). The assessee contended before the CIT(A) that the Assessing Officer has failed to appreciate the fact that expenditure incurred towards project development is purely revenue in nature and is 4 ITA No.107/Mds/2012 related to business activities of the assessee company and the treatment given in books would not affect the claim of deduction under the provisions of the Income Tax Act. The assessee claimed that the expenditure is allowable under section 37 of the Act. The assessee made an alternate prayer that in case the expenditure is to be treated as capital in nature, the assessee is entitled to claim depreciation @ 60% as applicable to computer software based on clause III(5) of New Appendix I read with Rule 5 of the Income Tax Rules, 1962.
The CIT(A) dismissed both the pleas of the assessee and upheld the findings of the Assessing Officer. The CIT(A) held that the expenditure incurred on software development is capital expenditure and the assessee is entitled to claim depreciation @ 25% as in the case of intangible asset or copy right.
Aggrieved against the order of the CIT(A), the assessee has come in second appeal before the Tribunal.
5. Mr. Vikram Vijayaraghavan appearing on behalf of the assessee reiterated his stand taken before the authorities 5 ITA No.107/Mds/2012 below. The learned counsel submitted that both the Assessing Officer and CIT(A) have failed to appreciate the fact that expenditure incurred on the development of new product is revenue in nature. The expenditure is allowable under section 37 of the Income Tax Act, as the same was incurred wholly and exclusively for the purpose of business of the assessee company. The expenditure in relation to product development has neither generated any capital asset nor has resulted in enduring benefit to the assessee and as such the expenditure cannot be treated as capital expenditure. In order to support his contentions, the counsel for the assessee relied on the order of the Pune Bench of the Tribunal in ITA No. 1179, 1205 & 1206/PN/2009 and 466/PN/2011 in Opus Software Solutions P. Ltd. Vs. ACIT., wherein the Tribunal has held that the expenditure incurred on development of various software packages for being sold in the assessee's business of software development and selling is to be regarded as in the nature of revenue expenditure.
6 ITA No.107/Mds/2012
6. Shri Shaji P.Jacob appearing on behalf of the Revenue submitted that the order of CIT(A) is a well reasoned and the CIT(A) is absolutely correct in holding that nature of expenditure is capital in nature and that the assessee is entitled to claim depreciation on the same @ 25%, as in the case of copyrights or intangible assets. The DR submitted that the assessee is not entitled to claim depreciation @ 60% for the reasons recorded by the CIT(A) in his order. In order to support his contention that expenditure incurred by the assessee is capital in nature he relied on the order of the Chennai Bench of the Tribunal in the case of ITO Vs. M/s. Millennium Infocom Ltd. reported as 2008-TIOL-481-ITAT- MAD. The Tribunal in the said order has categorically held that expenditure incurred by the assessee for acquiring software is capital expenditure. The DR in order to further fortify his contentions referred to the judgement of the Hon'ble Supreme Court of India in the case of Dalmia Jain & Co.Ltd. Vs. CIT reported as 81 ITR 754 and the judgement of the jurisdictional High Court in the case of M/s EID Parry (India) Ltd. vs. CIT reported as 257 ITR 253 ( Mad). 7 ITA No.107/Mds/2012
7. We have heard the submissions made by both the parties. We have perused the orders of the authorities below and the judgements/orders relied on by both the sides. In order to determine whether expenditure incurred is revenue or capital in nature, it has to be judged on various factors. The Hon'ble Supreme Court in the landmark case of Empire Jute Co. Ltd. Vs.CIT reported as 124 ITR 001 has laid down various test to determine the nature of expenditure. The said judgement has been followed year after year by the Hon'ble Supreme Court and the various High Courts as well as the Tribunal in deciding such issue. In the said judgement, the Hon'ble Apex Court while considering various earlier judgements observed as under:-
"The decided cases have, from time to time, evolved various tests for distinguishing between capital and revenue expenditure but no test is paramount or conclusive. There is no all embracing formula which can provide a ready solution to the problem; no touchstone has been devised. Every case has to be decided on its own facts, keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. But a few tests formulated by the courts may be referred to as they might help to arrive at a correct decision of the controversy between the parties. One celebrated test is that laid down by Lord Cave L.C. in Atherton v. British Insulated and Helsby 8 ITA No.107/Mds/2012 Cables Ltd. [1925] 10 TC 155, 192(HL), where the learned Law Lord stated:
"........ when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital."
This test, as the parenthetical clause shows, must yield where there are special circumstances leading to a contrary conclusion and, as pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC), it would be misleading to suppose that in all cases, securing a benefit for the business would be, prima facie, capital expenditure so long as the benefit is not so transitory as to have no endurance at all. There may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, there-fore, not a certain or conclusive test and it cannot be 9 ITA No.107/Mds/2012 applied blindly and mechanically without regard to the particular facts and circumstances of a given case."
xxxx "Another test which is often applied is the one based on the distinction between fixed and circulating capital. This test was applied by Lord Haldane in the leading case of John Smith and Son v. Moore [1921] 12TC 266, 282 (HL) where the learned law Lord drew the distinction between fixed capital and circulating capital in words which have almost acquired the status of a definition. He said:
"Fixed capital as what the owner turns to profit by keeping it in his own possession; circulating capital as what he makes profit of by parting with it and letting it change masters."
Now so long as the expenditure in question can be clearly referred to the acquisition of an asset which falls within one or the other of these two categories, such a test would be a critical one. But this test also sometimes breaks down because there are many forms of expenditure which do not fall easily within these two categories and not infrequently, as pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC), the line of demarcation is difficult to draw and leads to subtle distinctions between profit that is made " out of "assets and profit that is made " upon " assets or " with " assets. Moreover, there may be cases where expenditure, though referable to or in connection with fixed capital, is nevertheless allowable as revenue expenditure. An illustrative example would be of expenditure incurred in preserving or maintaining capital assets. This test is, therefore, clearly not one of universal application. But even if we were to apply this test, it would not be possible to characterise the amount paid for purchase of loom hours as capital expenditure, because acquisition of additional loom hours does not add at all to the fixed capital of the assessee. The permanent 10 ITA No.107/Mds/2012 structure of which the income is to be the produce or fruit remain, the same; it is not enlarged."
The Hon'ble Apex Court further held that:
"When dealing with cases of this kind where the question is whether expenditure incurred by an assessee is capital or revenue expenditure, it is necessary to bear in mind what Dixon J. said in Hallstorm's Property Ltd. v. Federal Commissioner of Taxation (72 CLR 634): " What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. "
The question must be viewed in the larger context of business necessity or expediency. If the outgoing expenditure is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure.........."
At times there is a thin line of distinction between the expenditure to be treated as revenue or capital in nature. These tests have to be applied in the facts and circumstances of each case to come to the final conclusion. In the present case, an expenditure has been incurred by the assessee to bring into existence an asset from which it would earn revenue. The life of the asset and the nature of expenditure 11 ITA No.107/Mds/2012 viz. salary, staff welfare expenses etc. in bringing such assets into existence cannot determine the nature of investment made for developing such asset i.e. "a computer software". The assessee is in the business of developing software. Once the software is developed it becomes the asset of the assessee. The assessee earns income/revenue from the sale of such software to various consumers or class of consumers. The software so made gives an enduring benefit to an assessee. The life span of the asset may not be so long but it does not change the nature of expenditure outlay.
8. A perusal of the order of the Commissioner of Income Tax (Appeals) shows that the A.R. for the assessee has furnished information relating to the income that is being received out of the product developed. The relevant extract of the finding of the Commissioner of Income Tax (Appeals) are reproduced herein below:-
" During the appeal proceedings, the ld. A.R. was asked to furnish information relating to income that is being received out of this and in pursuance of the same, the ld. AR has filed written submission 12 ITA No.107/Mds/2012 dated 13.10.2011 and in the Annexure enclosed to it clearly shows that income arose to the assessee company in the subsequent years because of this product development expenses and hence these expenditure are to be treated as capital asset which gives rise to income."
The information furnished by the assessee shows that it is generating revenue from the sale of the product developed by it, this gives imputes to our view that the product developed is asset of the assessee and the expenditure incurred on its development has to be capitalized.
9. The CIT(A) has further observed that "the product development expenditure was treated as capital asset by the assessee company itself in the books of account and they have valued the same as if the expenditure will yield for three years and amortize the entire expenditure." It is a well settled law that the entries in the books of account may not be conclusive in nature. However, some inference can be drawn from them with regard to the nature and objective of the expenditure.
If functional test is applied in the instant case, it is clear that the advantage is in capital field and as such the 13 ITA No.107/Mds/2012 expenditure is capital in nature. The creation of software in the case of the assessee does not merely facilitate in trading operation. The software developed is a source of generating revenue to the assessee.
10. From the facts of the case and documents on record, we are of the considered opinion that the expenditure incurred by the assessee in the development of software is capital in nature. Our view is further fortified by the order of the Chennai bench of the Tribunal in the case of M/s. Millennium Infocom Ltd. (supra). The assessee is enjoying benefits from the sale of software to different customers. The prototype of the software remains with the assessee. The assessee is only giving copy of the software without disclosing the intricate method of developing the same to its prospective customers.
11. It is an undisputed fact that software industry is highly volatile and there are frequent changes or upgradation in the existing softwares. On account of technological advancement and changing market conditions, the existing software becomes obsolete very fast. Keeping this fact in mind to keep pace with the ever changing software technology and to 14 ITA No.107/Mds/2012 meet the changing market requirements, depreciation @ 60% has been provided on computer software and hardware. The CIT(A) on the one hand has given its findings that the assessee has not shown any asset in its balance sheet, therefore, the assessee is not entitled for depreciation @ 60%, on the other hand, the CIT(A) has allowed depreciation @ 25% to the assessee treating it as copy right or intangible asset. The findings of the CIT(A) are not tenable. Once it is held that the expenditure incurred by the assessee for the development of the software is capital in nature, the software developed by the assessee is an asset of the assessee. The Hon'ble Supreme Court of India in the case of Tata Consultancy Services Vs. State of Andhra Pradesh reported as 271 ITR 401 (SC) has held that computer software is a tangible asset. As per clause III (5) of New Appendix I read with Rule 5 of the Income Tax Rules, 1962, rate of depreciation as applicable to computer software is 60%. Therefore, we hold that the assessee is entitled to claim depreciation @ 60% on expenditure incurred in the development of computer software being capital in nature. 15 ITA No.107/Mds/2012
12. In view of our above findings, the appeal of the assessee is partly allowed in the aforesaid terms. Order pronounced in the open court on Thursday the 31st day of January, 2013 at Chennai.
Sd/- Sd/-
( N.S. Saini ) (Vikas Awasthy)
Accountant Member Judicial Member
Chennai,
Dated the 31st January, 2013.
somu
Copy to: (1) Appellant (4) CIT(A)
(2) Respondent (5) D.R.
(3) CIT (6) G.F.