CIT vs. SPICE COMMUNICATIONS LTD

{. !l ?i. { $-5 to 7 *IN THE HIGH COURT OF DELHI AT NEW DELHI t- ITA Nos. 64312010,64912010 and 680i2010 CIT ..... Appellant fhrough : Ms. Suruchi Aggarwal, Advocate. versus SPICE COMMI.]NICATIONS LTD ..... Respondent Through: Mr. M.S.Syali, Sr. Advocate with Ms.Husnal Syali, Advocatc. COITAM: TION'I3LE MR. JUSTICE SANJIV KIIANNA }ION'BLE MR. JUSTICE R.V.EASWAR ORDER t6.05.2012 1. 'l'hese appeals filed by the Revenue under Section 260A of the Incomc Tax Act, 1961 (hereinafter referred to as 'the Act') in the case of M/s Spice Communications Limited relate to the assessment years 2003-04, 2004-05 and 2005-06. The Revenue is aggrieved of a corlulron orcler dated 9tl' Octob er, 2009 passed by the Income 'fax Appellatc 'I'ribunal (hereinafter referred to as 'I'[AT') on three grounds. (i) 'l'he I1AT has ered in holding that the entire adveftisernent and sales promotion expenses incurred should be treated as rcvenue expenditure. Part thereof, namely, 10% r.vas rightly treated as capital cxpenditure by the Assessing Officer. (ii) The software (r --_1 ITA Nos. 643/2010, 649/2010 and 680/2010 Page 1 of 16 2012:DHC:9842-DB

cxpenses of Rs.22,038/- and Rs.3,13,2961- telating to assessment year 2004-05 and 2005-06, respectively have been wrongly treated as rcvenue expenditure and should have been treated as capital cxpenditure. (iii) Payrnents made to Modicorn Network and Distacom Communication India Ltd. under the 'management service agreement' and 'tcchnical service and operating agreements' respectively, were cntircly capital expenses and the ITAT has erred in holding that only 25Yo was capital expense and the balance 75Yo should be treated as rcvenue expense. 2. On the first issue, the findings recorded by the Tribunal are that the respondenVassessee is in the business of promoting mobile telephonic services since 1997 and that the market was highly competitive and required aggressive marketing. Expenses were incurred to invite customers and promote the cellular rnobile service of thc asscssec. 'I'he advertisement and sales promotion expenses were incunccl for the purpose of carrying on the business and not for creating a capital asset. Accordingly, it has been held that the C[I(A) was justified in holding that the entire expenditure should be treated as revenlle expenditure and the Assessing Officer was not right in treating rc% of the expense as capital expenses incurred towards brand --a ll'A Nos. 643/20tO,649/2Ot0 and 680/2010 Page 2 of 16 2012:DHC:9842-DB

"(- building. A Division Bench of this Court had an occasion to examine the issue of advertisement expenditure in the case of CIT v. Adidas Inclicr Morketing, (2010) 195 Taxman 256, wherein it was held as under:- "4. We find from the order of the ITAT that the Tribunal has discussed in detail the terrns of Technical Assistant Agreement dated l4-2-I997, as per which the assessee was provided the technical know-how and was also allowed to use the brand name 'Adidas' on the products manufactured by the assessee, which are to be sold in India, Nepal and Bhutan. The Tribunal observed that merely because the assessee was paying royalty at the rate of 5 per cent to IWs. AIPL would not mean that the assessee could not incur the expenditure on advertisement to popularize the products dealt rvith by it in Indian market. No doubt, brand name of 'Adidas' is already a well-known brand which belongs to the parent company of the assessee. However, to popularize the said product in India and to promote its sale in the Indian territories, it becamc essential for the assessee to incur expenditure on advertising to propagate the aforesaid brand narne. The bcnefit thereof had to necessarily accrue to the assessee as well as the main purpose of the advertisemcnt is to augment the sales. The contention of the assessee that it was a commercial practice and commercial expediency has rightly been accepted by the Tribunal. The relevant portion of the judgment of the Tribunal dealing with this aspect is reproduced below : " 17. xxx 19. In the present case, the ery2enditure has been incurred by the assessee in the carryi.ng on of its business activities of ntanufacturing and selling the product under ITA Nos. 643/2010,649/2010 and 680/2010 -, Page 3 of 16 2012:DHC:9842-DB

a the brand nanrc Adidas. The expenses are thus have the direct nexus with the sales or lhe business promotion of the assessee. At this stage, it is also pertinent to mention that nterely because the assessee-company has been paying royalty to IUI/s. Adidas A.G. for the use of the brand nanre Adidas, that by itself cannot be a ground to disallow the assessee's claim on account of advertisentent expenses which nxere made to prornote the assessee's busittess in India and to increase its business and the sales of the products under the brand nanxe Adidas. The assessee was paying royalty for using brand nanrc Adidas to the custonters in various parts of India to nwke them muare about the nature of the products being sold by the assessee at dffirent outlets as per assessee's business strategy. To promote business and conlnxerce by any businessman would certainly come within the expression of ' con'mzercial expediency and no label of any oblique ntotive with a view to reduce tax incidence can be fastened. The activity to promote ones sales by advertising the product which were being sold by him arc certainly to come within the expression "wholly and exclusively incurced for the pnrpose of business", which ,s to be considered and looked into having regard to the realities of business front the point of view of a prudent businessman and not from the point of view of a tax collector. 20. In the light of the discussions nmde above and having found that since the assessee had incurred the advertisentent and publicity expense with a view to promote its sale of products under the brand nanxe Adidas which were sold bv the assessee, the ITA Nos. 64312010,649/2010 and 580/2010 -_J Page 4 of 16 2012:DHC:9842-DB

{ advertisement expenses incurred by the assessee are to be held as incurred to facilitate the assessee's business, and would thus be eligible fo, deduction while contputing the assessee's profit from busi.ness. At this stage, it is also pertinent to note that the expression '\vholly and exclusively" used in section 37 of the Act v,ould not ntean "necessqrily". h is for the assessee to decide whether any expenditure should be incurred to facilitate its bttsiness activities. It is also well-settled that even such expenditure incurred voluntarily and not for any necessity by are incurred for prornoting the business and to earn profit, the assessee can claim deduction under section 37(1) of the Act. This was so obsertted by the Hon'ble Suprente Cottrt in the case of Sasson J. David & Co. (P.) Ltd (supra) We, therefore, reverse the order of the CIT(A) and direct the Assesstng Officer lo allow the assessee's claim of deduction on account of advertisentent and publicity expenses in all the three assessment years." 3. fhe aforesaid reasoning and ratio was approved in case of CIT v. Solora Internationol Limited, (2009) 308 ITR 199, wherein a Division Bench of this Court opined: "3. 'l'he first issue that is sought to be raised in this appeal pertains to advertising expenditure of approximately Rs 3.08 crores. According to the Asscssing Officer, the expenditure were incurred for launching of its products. The Assessing Officer was of the view that such expenditure was of an enduring nature and, therefore, treated one-third as "capital expenditure" and only allowed the two-thirds of the said amount as "expenditure, to the assessee". fhe t '-a ITA Nos. 643/2010,649/2010 and 680/2010 Page 5 of 15 2012:DHC:9842-DB

-e Commissioner of Income-tax (Appeals) allowed the entire amount after treating the expenditure as "revcnue expenditure". The findings of the Comrnissioner of Income-tax (Appeals) were confirmed by the Income-tax Appellate Tribunal by virtue of the impugned order. Particularly, the Tribunal held that there was a direct nexus between the advertising expenditure and the business of the assessee and that the assessee had to incur such cxpenditure to meet the competition in the Indian market for selling its products in India. A finding was retutned that unless the assessee made its products known to the market, its business would suffer. Consequently, the Tribunal held the entire cxpenditure on advertising to be of a revenue nature and allowed the same. The Tribunal also noted the decision of the Supreme Court in the case of Empire fate Co. Ltd. v. CIT [1980] l24ITR 1 wherein thc Supreme Court held that there could be cases where the expenditure cven if it was incurred for obtaining of a benefit of an enduring nature may, nevertheless, be on the revenue account and, in such cases, the test of "enduring benefit" may break down. 4. We are of the view that the decision of the Tribunal on this aspect of the matter does not call for any interference and, therefore, no substantial question of law arises on this aspect." 4. Subsequently, another Divison Bench of this Court, in ITA No. 96612009 titled as CIT v. Agra Beverages Irttlustries Private Limitecl, decided on25.1.2011. held as under: "6. Learned counsels appearing for the appellant have submitted that the agreement entered into between the assessee and the Pepsi clearly shows that it was Pepsi who was to remain owner of the trademark and arr I r-J ITA Nos. 643/2010, 649/20IO and 680/2010 Page 6 of 16 2012:DHC:9842-DB

t obligation was cast upon the assessee not to take any action which would prejudice or harm the trademark or Pepsi's ownership thereof in any way. It is also stated in the said agreement that the use of the trademark by the assessee enures to the benefit of Pepsi. It is also pointed out by the leamed counsels that as per Clause 19 of the agreement, the assessee was to seek prior approval in respect of any advertising and sales promotion which is incured in the trademark and trade name of Pepsi. The learned counsels also argued that the advertisement and publicity which was done by the assessee, nowhere mentions the name of thc assessee and exclusively name of Pepsi appeared therein, i.e. its trademark and trade address etc. were exhibited. From this, it is sought to be argued that by specific agreement in writing the assessee agreed to give advantage to the Pepsi in respect of publicity and advertisement carried out by the assessee for Pepsi"s product. In these circumstances, argued the leamed counsels, the CIT (A) was justified in apportioning the expenditure and the principles laid down by the Supreme Court in the case of Sassoon (supra) would not be applicable. We are unable to accept the aforesaid submission of the learned counsel for thc appellant. In Ssssoon case (supra), the Supreme Court categorically held that when the expenditure incurred for promoting the business to earn profits merely because from the said expenditure some third pafty has benefited cannot be a reason to disallow the expenditure. Instead of analyzing that judgment in detail, our purpose would be served by referring to a Division Bench judgment of this court in CIT Ys. Dalmia Cement (8.) Ltd.120021254ITR 377, wherein the judgment of Supreme Court in Sassoon ':a ITA Nos. 643/2010,649/2010 and 680/2010 Page 7 of 15 2012:DHC:9842-DB

-a case (supra) and some other judgrnents are taken note of, analysed and the principles laid <lown therein are succinctly culled out. Examining and interpreting the provisions of Section 37 ofthe Act, the Court expressed that the true import of the expression "wholly or cxclusively" appearing in Section 37 of the Act would not rnean "necessarily". Ordinarily, it was for the assessec to decide whether any cxpenditurc was incurred in the course of its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction under relevant provision even if there was no compelling necessity to incur such cxpenditure. The fact that somebody, other than the assessee is benefitted by the expenditure should not come in the way of an expenditure-being allowed by way of deduction under Section 37 of the Act, if it otherwise satisfies the tests laid down by law. 7. The Court went into the legislative history of Section 37 of the Act and pointed out that though in the Income-Tax Bill, 196I, in the original Section 37, as per the draft, the word "necessity" appeared was ultimately omitted and instead replaced by the word "ordinarily". Thus, for allowing the expenditure incurred nnder Section 37 (I) of the Act, the conditions which are to be satisfied are:- (a) there must be expenditure, (b) such expenditure must not be the nature described in Section 30.to 36 of the Act, (c) the expenditure must not be in the nature of capital expenditure or personal expenses of the assessee, (d) The expenditure must have been laid out ITA Nos. 643lz}t}, 649/2010 and 580/2010 Page 8 of 16 2012:DHC:9842-DB

( --J \ or exclusively for the purposes or profession. 8. It was clarified by the Division Bench that the word "wholly" refers to quantum of expenditure while the word "exclusively" refers to the motive, objective and purpose of thc expenditure. The Court also explained that the term "colrlmercial expediency" is not a term of art and it means anything that serves to promote commercial expediency and includes evcry rneans suitable to that end. While cxamining the issue of deductibility of such expenditure, the Court also laid down the role of the Assessing Officer therein. In no uncertain term, the Court explained that the jurisdiction of the Assessing Officer was confined to "deciding the reality of the expenditure" namely, whether the amount claimed as deduction was factually expanded or laid down or whether it was wholly or exclusively for the purpose of the business. Thc reasonableness of the expenditure could be gonc into only for the purpose of determining whether, in fact, the amount was spent. When we apply the aforesaid test to the facts of this case, it becomes manifest that all the ingredients laid down in Section 37 (l) of thc Act are satisfied. It is not in dispute that the expcnditure is in fact incurred. The Assessing Officer or the CIT (A) did not question the amount incurred by the assessee on the advertisement. It is also not the case of the I{evenue that the expenditure is of the nature described in Section 30 to 36 of the Act. Ihe expenditure is not capital 'expenditure or personal expenditure of the ass'essee either. It is also clear that the entire quantum of expenditure was for the pulpose of business and, therefore, it is wholly for the purpose of business. We are also of the opinion that the ITA Nos. 643/2010,649/2010 and 680/2010 Page 9 of 15 2012:DHC:9842-DB

{ expenditure was exclusively incurred for the purpose of the business and promote the sales by the assessee. Therefore, it was incurred wholly or exclusively for the purposes of business. 9. l'hc agreement entered into between the asscssee and the Pepsi shows that the assessee was given a particular territory in Haryana, boundaries whereof are specifically defined in the agreement for the purposes of bottling, selling and distributing of the beverages. This entire territory within which the assessee was to operate, the assessee was not only supposed to bottle the beverages he was also given rights to sell and distribute the project of the Pepsi in the defined territory during the currency of the said agreement. Naturally, therefore, in order to augment its profits in the said teritory, it was the business decision of the assessee to advertise and publicize the product for rnaximizing its sale. The expenditure was thus incurred by the assessee for its own benefit. Clause 18 of the agreement authorized the assessee to undertake appropriate adverlising and sales promotion activity for the beverage. If in the process, Pepsi or its trademark also benefitcd, that would not militate against the assessee as far as claiming the deduction under Section 37 of the Act is concerned, once all the characteristics of the said provision stood satisfied." In ITA No. 978/2011 titled CIT v. Mono Motors Ltd., decided 12.12.2011, this Bench held as under:' "4. ...Advertisement expenses when incurred to increase sales of products are usually treated as a revenue expenditure, since the memory of *-rl \ 5. ITA Nos. 643/2010,649/2010 and 680/2010 Page 10 of L6 2012:DHC:9842-DB

purchasers or customers is short. Advertisements are issued from time to tirne and the expenditure is incurred periodically, so that the customers remain attracted and do not forget the product and its qualities. The advertisements published/displayed may not be of relevance or significance after lapse of time in a highly competitive rnarket, wherein the products of different companies compete and are available in abundance. Advertisements and sales promotion are conducted to increase sale and their impact is limited and felt for a short duration. No permanent character or advantage is achieved and is palpable, unless special or specific factors are brought on record. Expenses for advertising consumer products generally are a part of the i- process of profit earning arid not in the nature of capital outlay. The expenses in the present case were not incurred once and for all, but were a . periodical expenses which had to be incurred continuously in view of the nature of the business. It was an on-going expense. Given the factual rnatrix, it is diffrcult to hold that the expenses were incurrcd for setting the profit earning machinery in motion or not for eaming Profits." { -.31 6. Keeping in view the findings recorded by the Tribunal and the nature and character of business of the respondenVassessee, we do not think that any substantial question of law arises on the first aspect. 7. On the second ground, it is noticeable that the amounts involved are small. The Assessing Officer had allowed depreciation @ 600/o on the said amounts. The assessee had claimed that the entire amount should be allowed as revenue expenditure. 'Ihe decision of the Delhi ITA Nos. 643/20t0,649/2010 and 680/2010 Page 11 of 15 I 2012:DHC:9842-DB

'@ \-- I-Iigh Court in the case of CIT v. GE Capitol Services Ltd., (2008) 300 ITR 420 (Dethi) has been followed by the ITAT. 'fhe tribunal has also noticed the nature and type of software acquired, and has recorded that the software in question required frequent up-gradation and purchases' This issuc was also examined by this Court in ITA Nos. 1110/2006 and 4112006 titlcd as cIT v. Asahi Intlin saf'ety Glass Limited decided on 4.IL.2011. In this case it has been held as under:- "11. Software is nothing but another word for computer programmes, i.e., instructions that make the hardware work. Software is broadly of two types, i.e., the systems software, which is also known as the operating system which controls the working of the computer; while the other being applications such as word processing programs, spread sheets and data base which perform the tasks for which people use computers. Besides these there are two other categories of software, these being network software and language software. I'he network software enables groups of computers to communicate with each other, while language software provides with tools required to write programmes. (See Microsoft Computer Dictionary, 5t" Edition "software" atpage 489). 12. The aforesaid would show that what the assessee acquired through Arthur Anderson and Associates was an application software which, enabled it to execute tasks in the field of accounting, purchases and inventory maintenance. 'I'he fact that the application software would have to be updated from tirne to time based on the requirements of the assessee in the context of the advancement of its business and/or its ITA Nos. 643/zOtO, 649/2010 and 580/2010 Page 12 of 1.5 2012:DHC:9842-DB

-.i divcrsification, if any; the changes brought about due to statutory amendments by law or by professional bodics like the Institute of Chartered Accountants of India, which are given thc responsibilify of conceiving and forrnulating the accounting standards from time to time, and perhaps also, by reason of the fact that expenses may have to be incurred on account of comrption of the software due to unintended or intended ingress into the system - ought not give a colour to the expenditure incurred as one expended on capital account. 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. The assessing officer has, in our view, erred precisely for these very reasons." 8. In view of the findings recorded by the tribunal we do not think that any substantial question of law arises on the second aspect' 9. At this stage, learned counsel for the Revenue has subrnitted that that in tlre appeal for the assessment year 2003-04 no substantial question of law has been specifically raised but in one of the grounds of the appeal, namely, (g) it is mentioned as under:- "(g) BECAUSE the Tribunal and the CIT have erred in holding that there is no mention in the above said I.T. Rules that the application software are outside the ambit of computer software for the purpose of depreciation as prescribed therein. The definition of Computer Software given in the IT rules reads as under: l'IA Nos. 643/2O1O,649/20t0 and 680/2010 Page 13 of 16 2012:DHC:9842-DB

@ rL "The term 'Computer Software' nxeans any compttter progranxrne recorded in any disc, tape, perforated media or other infornration device-" As per the above definition, the application softwares are also included in its purview" It is urged that the assessee had incurred substantial expenditure of Rs. 95,15,191/- in the assessement year 2003- 04. 10. 'I'he I'tAI'has observed that the said expenditure was incurred on purchase and towards rental charges of application softwares which were used by the assessee at different locations. The details/break ups of thc said soflwares have been mentioned in para 19 of the order of the I'IAT. 'fhe assessee had paid rental charg_es of Rs.62,9I;1351- for use of software SIMGO platform for prepaid customers. Rental charges should be normally treated as revenue expenditure. There is no justification or ground to hold/ contend to the contrary. With regard to the balance cxpenses it is noticeable that it relates to antivirus soflware and other of the self software which requires frequent upgradation. The ground itself observes that the software was application software. The findings of the tribunal do not require interference. 1 1. On the third aspect, the ITAT has examined the issue in great depth and detail. The Assessing Officer had treated the entire expenditure as capital expenditure. The CIT(A) treated the entire Page 14 of 15 -J ITA Nos. 643/2010, 649/2010 and 680/2010 2012:DHC:9842-DB

cxpenditurc under the fwo agreements as revenue expenditure. ITAT cxamined the relevant clauses of the two agreements and the services, which were required to be undertaken by the Distacom Communication and Modicom Network. After referring to relevant clauses, it was noticed that the payments made werc partly towards services, which were capital in nature and partly towards services, which were revenue in nature. We have also examined the clauses of the agreements, which havc becn cluoted in the order passed by the IIAT. This finding of the I'IAT is correct. During the course of hearing, learned counsel for the Itevenue also accepted part payments made by the respondent assessee under the agreements were revenue in nature. Leamed counsel for the appcllant however submits that the tribunal has erred in holding that only 25% should be treated as capital expenditure. The figure/ percentags should be much higher. We have already noticed that the business of the respondent/assessee was set up in the year 1997. The assesslnent years in question are seven years after the business was set up and had commenced. In the assessment order nor in the grounds of appeal, there is reference or discussion with reference to any specific or preclominant services which were rendered in the assessment year in question. Initial years normally would require substantial capital outlay ITA Nos. 643/2010,649/zOtO and 680/2010 Page 15 of 16 2012:DHC:9842-DB

and expenditure. However, once services have colnmenced, expenses are frequently incured to keep the business/Services in operation. Kecping in view the discussions made by the tribunal and the ratio I applied thercin, we do not find any ground to interfere with the order of the I IAT. 12. Ihe present appeal is accordingly dismissed. No costs. r- 4tra .L( SANJIV KHANNA, J. l,l tl I t ll tz<-+l ' R.V.EASWAR, J. *' MAY t6,20L2 l{K ITA Nos. 64312010,649/2010 and 680/2010 Page 16 of 15 2012:DHC:9842-DB