|Claim Income Tax deduction on Computer Software expenditure|
|Facts of the case|
By Sherry Samuel Oommen & Ajith R
Background: The question as to the classification of an item of expense as revenue or capital in nature for income-tax purpose has long been a contentious issue before the courts. The same has been settled by the courts on a case-to-case basis, also setting-forth the general principles relevant for determining the deductibility of an expense as revenue expenditure under section 37(1) of the Income-tax Act, 1961 (‘the Act’). The said issue attains greater significance in the case of tax deductibility of payments made towards purchase of software for the purpose of business, considering the fact that said payments would constitute a major item of expenditure not only for major business houses but also for small and medium enterprises (SMEs).
In response to the relentless advance of technology, many business owners regularly acquire new computer software. Although the learning curve associated with using the new software may be painful for owners, the related pain gets partially relieved when they hear that the related cost of acquiring the new software could be fully tax deductible in the year of acquisition itself rather than being eligible for amortization as depreciation. Recently, the Delhi High Court in the case of Asahi India Safety Glass Limited (ITA No 1110/2006 & 1111/2006, dated 4 October 2011) held that the expenditure incurred on application software is allowed as revenue expenditure for income tax purposes and that the test of enduring benefit is not certain or conclusive in determining the expenditure as capital or revenue. The said principles were reiterated also by the Delhi High Court in the case of Amway India v DCIT (2011-TIOL-710-HC-DEL-IT), following its own ruling in the case of Asahi India Safety Glass Ltd. (supra).
In the wake of the above-mentioned recent rulings in connection with the issue of deductibility of software payments for income-tax purpose, we have provided below our brief analysis and comments on the said issue. For the benefit of the readers, the article lays down the generic principles and the judicial precedents endorsing the deductibility of expenses incurred on computer software and the related circumstances under which such expense can be treated as revenue in nature.
Deductibility of Software Payments
Overview: Software is a general term used to describe different computer programmes and supplementary material. The term also includes the following: computer programmes, databases, programme language, guides, information stored on computerised outputs such as sound, data, printouts, software development media and the initial designs for the development of programmes. Due to the wide definition of software costs, these costs can be of a capital or revenue nature. It will be more advantageous for the taxpayer to deduct software costs over the shortest possible period and therefore obtain a cash flow advantage.
Recent Judicial Views
Recently the Delhi High Court in the case of CIT v Asahi India Safety Glass Limited (supra) while discussing the question of deductibility of software expenses under section 37 (1) held as follows:
* The expenditure incurred on application software is allowable as revenue expenditure.
* The test of enduring benefit is not certain or conclusive in determining the expenditure as capital or revenue in nature. The real intent of the expenditure and whether the expenditure results in creation of fixed capital for the taxpayer are to be examined.
* The claim of the taxpayer could not be denied which was otherwise allowable under the Act on the ground that the taxpayer had treated it differently in the books of accounts. The treatment of a particular expenditure or a provision in the books of accounts can never be conclusively determinative of the nature of the expenditure.
The facts of the case are as follows:
* The taxpayer is engaged in the business of manufacturing of automobile safety glass. During the assessment year 1997-98 the taxpayer entered into an agreement with Arthur Anderson & Associates for installation of software application for assistance in areas related to financial accounting, inventory and purchase. The taxpayer was required to pay professional fees to Arthur Anderson & Associates.
* The software application supplied by the Arthur Andersen & Associates worked on Oracle application. Therefore, the taxpayer was required to enter into a licence agreement with Oracle. Accordingly, the taxpayer was required to pay licence fee to Oracle and also an additional fee for support and maintenance services.
* The taxpayer had amortised expenditure amounted to INR 13.67 million in AY 1997-08 and 17.06 million in AY 19998-99 towards application software and professional expenditure in the books of accounts although it had not written off any expenditure in its books of accounts. However, while computing taxable income the taxpayer claimed the entire amount as revenue expenditure.
In appeal before the High Court, the issue was ruled in favour of the tax payer, wherein the expenditure incurred on application software was held as revenue in nature and eligible for deduction under section 37(1) of the Act. The High Court in the instant case, made the following important observations:
# It is in our view now somewhat trite to say that the test of enduring benefit is not a certain or a conclusive test which the courts can apply almost by rote. What is required to be seen is the real intent and purpose of the expenditure and whether the expenditure results in creation of fixed capital for the assessee.
# It is important to bear in mind that what is required to be seen is not whether the advantage obtained lasts forever but whether the expense incurred does away with a recurring expense(s) defrayed towards running a business as against an expense undertaken for the benefit of the business as a whole.
# In other words, the expenditure which is incurred, which enables the profit making structure to work more efficiently leaving the source of the profit making structure untouched, would in our view be an expense in the nature of revenue expenditure.
# Fine tuning business operations to enable the management to run its business effectively, efficiently and profitably leaving the fixed assets untouched would be an expenditure in the nature of revenue expenditure even though the advantage may last for an indefinite period. Test of enduring benefit or advantage would thus collapse in such like cases.
# It would in our view be only truer in cases which deal with technology and software application, which do not in any manner supplant the source of income or added to the fixed capital of the assessee.
# Given the fact that there are myriad factors which may call for expenses to be incurred in the field of software applications, it cannot be said that either the extent of the expense or the expense being incurred in close proximity, in the subsequent years, would be conclusively determinative of its nature
It would be pertinent to note that the Delhi High Court reiterated the above principle by following the above ruling while adjudicating on the issue of deductibility of software payments in the recent case of CIT v Amway India Pvt. Ltd. (2011-TIOL-710-HC-DEL-IT).
Conclusion: Costs associated with acquiring or using computer software comprise an ever increasing portion of an entity’s net asset value or its total expenditure every year. The onus is on each taxpayer to look at the nature of the software costs and to determine whether the costs can be of capital or revenue nature. What is required to be seen is the real intent and purpose of the expenditure and whether the expenditure results in creation of fixed capital for the assessee. Once such expenditure is determined to be of revenue in nature, the same ought to be allowed under section 37(1) of the Act, in its entirety during the year in which it is incurred, provided the same fulfils the other conditions prescribed under section 37 (1) of the Act. Needless to state, in the event, the related expenditure does not satisfy the conditions under section 37 of the Act, depreciation can be claimed under section 32 of the Act.
About the Authors: Sherry Samuel Oommen & Ajith R are tax professionals working with KPMG in Kochi, Kerala. The views expressed in this article are purely personal and does not necessarily reflect the views of the organization. They can be contacted at sherryoommen @ kpmg.com & ajithr @ kpmg.com, respectively.
Kerala IT News
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