In a recent judgment, Mumbai ITAT has upheld that expenditure on an upgradation or buying of software is revenue expenditure only.

Case Law Details:
ITA No.3325/M/2012 Assessment Year: 2005-06
DCIT (Appellant) vs. M/s. Integrated Technology Solutions P. Ltd (Respondent)
Date of Order: 12-02-2016

Facts of the case:
The assessee was in the business of online lottery. The already existing software in the lottery terminal of the assessee was not supporting the software used by the Martin Lotteries in relation to which the assessee has been running the above business. The assessee upgraded the software for smooth running of lottery business. During the year under consideration, the assessee had incurred various expenses for software development and maintenance amounting to Rs.44,34,703/-. The Assessing Officer (AO) disallowed the said expenditure treating the same as capital in nature; however, he allowed the deprecation on the same. Being aggrieved, the assessee filed appeal before the  CIT (A). The CIT(A) after considering the details submitted by the assessee, held that except the expenses relating to software adaptation charges for terminals activated on 22.07.04, the other software expenses incurred by the assessee for maintenance and back up etc. were of revenue in nature. In respect of the expenses of Rs.17 lakhs incurred on account of software adaptation charges for terminals, he has held that the same were in the nature of operating software and thus capital in nature. He, however, has allowed depreciation on the same as per the rules.

Grounds of appeals:
The assessee was aggrieved by the action of the Ld. CIT(A) in confirming the disallowance of a sum of Rs.17 lakhs holding the same as a capital expenditure as against the claim of the assessee that the same being of revenue in nature.

1. The Commissioner of Income Tax (Appeals) - 14 Mumbai ("CIT(A)"), erred in confirming the action of the A.O. in disallowing a sum of Rs.17,00,000/- (after considering depreciation) incurred for software development and maintenance on the alleged ground that the same is capital expenditure,.

2. The appellant prays that the said Software Development Expenditure be treated as revenue expenditure and be allowed as a business expenditure.

Contentions of the assessee:
The assessee submitted that the said expenses were incurred by the assessee for up-gradation of the already installed software. All the earlier expenses incurred on operating software had already been capitalized by the assessee, itself, in the earlier year. The expenditure of Rs. 17 lakhs was incurred by the assessee for up-gradation of existing software which in fact contributed towards the smooth running of the business of the assessee. He, therefore submitted that such software expenses having life of short duration which require continuous up-gradation due to new technology introduced from time to time and not having long term enduring benefit were required to be treated as revenue in nature.

The assessee placed reliance upon the decision of the coordinate bench of this Tribunal in the case of “ACIT vs. Sanghvi Savla Stock Brokers Ltd.” (2014) 43 Taxmann.com 323 (Mum-Trib.).

Important Excerpts from ITAT Judgment:
The Tribunal in the said decision has very elaborately discussed about the nature of the software expenses and has observed that software keep on changing at a very past pace with the growing requirement in the day to day business. Most of the software become obsolete in short span and new and upgraded versions are required for better functioning and that any expenditure on such an up-gradation or buying of software for facilitation and efficient working of operations through computers in day to day business management is to be treated as revenue in nature until and unless it is established that the software installed has a very long lasting life and enduring benefit on a capital asset. The relevant observations made by the Tribunal in para 12 of the said decision, for the sake of convenience, are reproduced as under:

“…………. Whether any particular expense falls in the capital field or revenue field has to be judged, looking to the nature of expenses and various tests laid down by the courts from time immemorial. In this age of computerization, various softwares are developed for smooth functioning of various business needs that helps business to run effectively, efficiently and profitably. The softwares keep on changing at a very fast pace with the growing requirement in the day-today business. Most of the softwares become obsolete in short span and new and upgraded version are required for better functioning. Unless, it has been brought on record that the software installed has a very long lasting life and enduring benefit on a capital asset, then, probably it can be said that it may not be of revenue in nature. However, the software application, per-se, do not, in any manner, supplants the source of income or make any addition to the capital side of the assessee. Thus, in our opinion, software application expenses are nothing, but up-gradation of efficient working of operations through computers in the day-today business management, which keeps on changing periodically and thus any expenditure on such an upgradation or buying of software is revenue expenditure only. The decisions as relied upon by the learned Counsel also supports our view. Even though the Rules have provided rate of depreciation on computer software, but that does not lead to any kind of drawing legal inference that all the softwares have to be characterised as capital asset. Thus, the grounds raised by the assessee in the cross objection are treated as allowed.”

The above observations of the co-ordinate bench of the Tribunal can be safely applied to the case of the assessee wherein the assessee had demonstrated that the above expenditure of Rs.17 lakhs was incurred by the assessee for up gradation of existing software for smooth running of online lottery business of the assessee. We, therefore, hold that the said expenditure was rightly claimed by the assessee as revenue expenditure. We, accordingly, hereby, set aside the finding of the Ld. CIT(A) on this issue and delete the disallowance so made by the lower authorities on this issue and direct the AO to treat the said software expenses of Rs. 17 lakhs as revenue in nature.

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