Expenditure incurred for software development are capital expenditure

Calcutta High Court in a recent judgment has held that expenditure incurred for software development was  capital expenditure

Case Details:
ITA No. 278 OF 2007
Indian Aluminium Co. Ltd Versus Commissioner of Income Tax-III Kolkata
Date of Judgment: 18/03/2016

Question of Law:
Whether on the facts and in the circumstances of the case the Tribunal erred in law in confirming the disallowance of expenditure incurred for software development as capital expenditure?

Brief Facts of the Case:
The assessee was engaged in the manufacture and production of aluminium and related products. During the relevant previous year the assessee incurred an expenditure of Rs.41,08,556/- on software development. The assessee treated this expenditure as a deferred revenue expenditure in its books of accounts and amortized Rs.2,40,000/- by debiting the same to the Profit and Loss Account of the relevant previous year. By the order dated 13th March, 2000, the Assessing Officer completed the scrutiny assessment under Section 143(3) for the assessment year 1997-98. By the aforesaid order the assessing officer inter alia disallowed the expenditure on account of software development by holding that it was a capital expenditure.  The CIT(A) held in favour of the assessee and deleted the disallowance of the expenditure incurred on software development. CIT(A) placed reliance on the judgment(s) of the Apex Court and ITAT Jaipur where it was observed that software used by the assessee was not or any enduring benefit it has to be changed within a short span of timebecause of change of system and change of technology. The ITAT however reversed the order of the CIT(A) holding that the expenditure on software development was capital in nature and should be disallowed.

Excerpts from High Court Judgments:
The software used by the assessee has the following characteristics:-
1. It is an application package developed on Windows NT.
2. It helps the assessee in planning the production and bauxite grade control in mines.
3. It covers geological data processing, mine field surveying, mine excavation planning, and grade control.
4. It is a planning tool in the hands of the production department of mines.
5. It helps in gauging proper control for effective mining since it gives statistics of Bauxite deposits by way of lithography, surface plane and graphic representation.
From the points noted above, it is clear that the software developed by the assessee is an application software and not an operational one.

The distinction between system software and application software was also considered by the Karnataka High Court in CIT v. IBM India Ltd (supra). The issue that arose for consideration was whether the Tribunal was correct in holding that the purchase of software amounting to Rs.33,14,298 should be allowed as a revenue expenditure.

In the instant case the revenue has relied on the principle of enduring nature to contend that the expenditure incurred by the assessee was of Capital nature. However there are a plethora of judicial pronouncements which go to show that the test of enduring nature is not to be applied mechanically without taking into account the facts and circumstances of each case.

The Apex Court in Empire Jute Co. (supra) has cautioned the courts against the application of the test of enduring nature without considering the surrounding circumstances.

The Apex Court in Alembic Chemicals has recognised the fact that in a field where advancements are taking place rapidly and where technology which was once the state of the art becomes obsolete in a short time, the test of enduring nature cannot always reliably be applied. Software industry is one such field where advancements and changes happen at a lightning pace and it is difficult to attribute any degree of endurability even to system software let alone application software.

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