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Facts
The assessee, an IT service provider, incurred expenditure on acquiring software, including upgrades, which it claimed as revenue expenditure. The Assessing Officer treated this as capital expenditure, allowing depreciation. The CIT(A) upheld the capital nature but increased depreciation.
Held
The Tribunal held that software expenses, particularly for application software that enhances efficiency and does not create a new asset, should be treated as revenue expenditure. The disallowance and depreciation on these expenses were deleted.
Key Issues
Whether expenses incurred for acquiring software, including upgrades, are revenue or capital in nature, and whether they qualify for depreciation if treated as capital.
Sections Cited
143(3)
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Income Tax Appellate Tribunal, “C” BENCH MUMBAI
Before: SMT. BEENA PILLAI & SHRI GIRISH AGRAWAL
O R D E R PER GIRISH AGRAWAL, ACCOUNTANT MEMBER: These two appeals filed by the assessee are against the orders of Ld. CIT(A)-49, Mumbai, vide order nos. ITBA/APL/S/250/2024- 25/1070768266(1) and ITBA/APL/S/250/2024-25/1070769231(1), dated 29.11.2024 passed against the assessment orders by Dy. Commissioner of Income-Tax, Central Circle-7(3), u/s.143(3) of the Income-tax Act, 1961 (hereinafter referred to as the “Act”), dated 30.03.2016 and 30.11.2016 for Assessment Years 2013-14 and 2014- 15 respectively.
Grounds taken by the assessee are reproduced as under:
1. On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) ['CIT(A)'] erred in disallowing expenses of Rs. 3,29,78,462 incurred for acquiring software and capitalizing the same towards fixed assets by upholding that the software would grant enduring benefit to the appellant.
1. On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) ['CIT(A)'] erred in disallowing expenses of Rs. 1,19,35,391 incurred for acquiring software and capitalizing the same towards fixed assets by upholding that the software would grant enduring benefit to the appellant.
2.1. It is stated before us that issue involved in both the appeals is common relating to disallowance of expenses incurred for acquiring software and capitalizing the same toward fixed assets. Accordingly, we take up both the appeals together by passing this consolidated order. For drawing facts of the case, we refer to the appeal for Assessment Year 2013-14. Our observations and findings shall accordingly apply mutatis mutandis to the appeal for Assessment Year 2014-15.
Brief facts of the case are that assessee is engaged in the business as Information Technology Service Provider. During the year under consideration, assessee has provided professional and technical services. It follows mercantile system of accounting. During the year, assessee had incurred expenditure of Rs.3,29,78,642/- towards various software. The expenditure so incurred includes purchase of antivirus, Microsoft email, database, upgradation and purchase of MS office etc. According to the assessee, since these expenses were towards upgradation of existing software, which contributed towards the smooth running of its business, the same were claimed as revenue expenditure. Assessee had demonstrated the nature of the software, their usage and also stated that the software had short life span which needs constant upgradation for smooth and efficient functioning of the business of the assessee. Contrary to this, ld. Assessing Officer took the view that the expenditure incurred by the assessee is capital in nature and therefore not allowable. However, he by treating the same as capital expenditure, allowed depreciation on the same, at the rate of 25%. Thus, negating the submissions made by the assessee, addition was made for which assessee went in appeal before the Ld. CIT(A), who after considering the submissions made, allowed the depreciation at the rate of 60% instead of 25% but continued to treat the expenditure as capital in nature.
3.1. Assessee had contested the addition broadly on the following points- i) that the software becomes obsolete in short life span, ii) expenses were incurred for upgradation of the software to carry out day to day business effectively and efficiently, iii) software are in the nature of application software and do not result in creation of new asset, iv) certain software are on yearly subscription and therefore cannot be treated as capital expenditure.
3.2. Reliance was placed on the decision of Coordinate Bench of ITAT, Mumbai in the case of Palava Dwellers Pvt. Ltd., in which is an associate concern of the group to which assessee also belongs. On this identical issue, the Coordinate Bench held in favour of the assessee. While taking the favourable view, Coordinate Bench placed reliance on the decision of Hon'ble jurisdiction High Court of Bombay in the case of CIT vs. Raychem, RPG Limited, [2012] 346 ITR 318 (Bom), wherein it was held that software expenses be allowed as revenue expenditure. The observation of Hon'ble Court on this issue is extracted below. "When we apply this functional test suggested by the Special Bench of the Tribunal, we find that impugned software does not form part of the profit-making apparatus of the assessee and hence the same is to be disallowed as revenue expenditure. We hold so because we find that the business of the assessee company is that of manufacturing of telecommunication and power cable accessories and trading in oil retracing system and other products and impugned software is an enterprises resources planning (ERP) package and hence it facilitates the assessee's trading operations or enabling the management to conduct the assessee's business more efficiently or more profitably but it is not in the nature of profit-making apparatus. We, therefore, decide this issue also in favour of the assessee and we hold that this expenditure of Rs. 20.60 lakhs is revenue expenditure."
Ld. CIT(A), despite all these submissions, held that software acquired by the assessee is purchase of a new asset, resulting into enduring benefits and thus treated it as capital expenditure. Aggrieved, assessee is in appeal before the tribunal.
Before us, ld. Counsel reiterated the above stated facts. He also referred to the list of various softwares and licenses which were purchased or subscribed during the year for which the expense was incurred and claimed as the revenue expenditure. The same is extracted below.
5.1. Additionally, ld. Counsel also placed a strong reliance on the decision of Hon'ble High Court of Karnataka in the case of CIT vs. IBM India Limited. [2013] 357 ITR 88 (Kar) wherein it was held that – “Application software enables assessee to carry out his business operation efficiently and smoothly - However, such software itself does not work on standalone basis - Same has to be fitted to a computer system to work -Such software enhances efficiency of operation It is an aid in manufacturing process rather than tool itself-Thus, for payment of such application software, though there is an enduring benefit, it does not result into acquisition of any capital asset Same merely enhance productivity or efficiency and hence to be treated as revenue expenditure”
5.2. It was thus asserted by the ld. Counsel that the expenditure incurred by the assessee are towards application software, which enables it to carry out its business operations effectively and efficiently. These expenses do not result into acquisition of any capital asset, and therefore, claim of the assessee is ought to be allowed.
Per Contra, ld. Sr. DR placed reliance on the orders of the authorities below and justified the depreciation allowance rightly made by ld. CIT(A) at the rate of 60% which is suffice to meet the requirements of the assessee.
We have heard both the parties and perused the material on record. The factual position as emerges from the details given by the assessee is that expenditure incurred by the assessee is towards application software, enabling the assessee to conduct its business operations efficiently and effectively. These purchases and subscriptions do not result into acquisition of any capital asset. On identical set of facts, a favourable view has been taken by the Coordinate Bench in the case of Palava Dwellers Pvt. Ltd. (supra), fortified by the decision of Hon'ble Jurisdictional High Court of Bombay. Further, Hon'ble High Court of Karnataka in the case of IBM India Ltd. (supra) wherein also assessee is engaged in the business of software services has held in favour of the assessee on such expenditure. Therefore, respectfully following the above referred judicial precedents and taking into consideration the factual matrix of the present case, disallowance made by ld. Assessing Officer, by treating the expenditure as capital in nature is deleted. Claim of the assessee is allowed in toto. Depreciation allowed by the ld. Assessing Officer and ld. CIT(A) stands withdrawn. Accordingly, ground raised by the assessee is allowed.
Our above stated observations and findings apply mutatis mutandis to the appeal for Assessment Year 2014-15, factual matrix being same.
In the result, both the appeals of the assessee are allowed.
Order is pronounced in the open court on 27th May, 2025