KOTAK MAHINDRA BANK LIMITED (AS SUCCESSOR IN BUSINESS OF ERSTWHILE ING VYSYA BANK LIMITED),BANGALORE vs. COMMISSIONER OF INCOME TAX (APPEALS)-I, BANGALORE

The assessee is a company engaged in the business of banking. An Order of Assessment under section 143(3) of the Income Tax Act, 1961 (hereinafter called ‘the Act’), was passed in the case of the assessee for Assessment Year 2001-02 dated 26.03.2002 determining the total income of the assessee under section 115JB of the Act. It is an admitted position that the total income of the assessee as per the normal computation provisions under the Act was less than the computation of total income on the basis of books profits under section 115JB of the Act and therefore the total income of the assessee was determined in terms of section 115JB of the Act. While computing the total income of the assessee as per the normal provisions of the Act, the AO made several additions to the total income declared by the assessee. Against those additions, the assessee preferred an appeal before the CIT(A) and by order dated 19.05.2011, the CIT(A) deleted certain additions made by the AO and confirmed certain additions made by the AO. Against the additions that were confirmed by the CIT(A), the assessee filed appeal before the Tribunal and against the relief allowed by the CIT(A), the Revenue preferred appeal before the CIT(A). The appeal of the Revenue was and the appeal of the assessee was . The Tribunal passed common order dated 28.08.2014 deciding the appeals of the assessee and of the Revenue. The Tribunal allowed assessee’s appeal and dismissed the Revenue’s appeal.

The Revenue filed appeal before the Hon’ble High Court against the order of the Tribunal and in so far as the order of the ITAT allowing relief to the assessee’s appeal is concerned, the appeal of the Revenue was numbered as and against the order of the Tribunal dismissing the Revenue’s appeal, the appeal was numbered as ITA No.5/2015. Both the appeals were heard by the Hon’ble High Court and common issues were framed in both the appeals. The Hon’ble High Court dismissed all the grounds raised by the Revenue by its order dated 02.03.2021 except the ground in ITA No.4/2015 in so far as it relates to the order of the Tribunal in holding that the assessee is eligible to claim deduction of a sum of Rs.23,05,49,466/- as revenue expenditure incurred on purchase of application software. The substantial question of law framed by the Hon’ble High Court in this regard was as follows:

The Hon’ble High Court on the above issue held as follows:

It can be thus seen from the order of the Hon’ble High Court that the Hon’ble High Court remanded only the question with regard to eligibility of the claim of the assessee for deduction of a sum of Rs.23,05,49,466/- as revenue expenditure and all other grounds have been dismissed. Consequently the only issue that survives for consideration before the Tribunal is the issue remanded by the High Court which is ground Nos.7 to 10 of the grounds of appeal of the assessee in . The Registry has however erroneously restored also which does not survive for consideration as it has already been decided by the Tribunal and confirmed by the Hon’ble High Court. Consequently, ITA No.733/Bang/2011 is dismissed as not required for adjudication.

In so far as the only ground that requires adjudication in Assessee purchased an application software being core banking solution (CBS) for networking 125 branches of the bank with centralized processing solution. This banking software is called 'Profile' & 'M data base. This project was called by the Assessee bank as Vysyamulya' Project. This software was purchased from Sanchez Computer Associates Inc. As per the agreement entered into Sanchez, the Assessee bank was granted license to use the 'Profile' and other software solely for processing the bank's data. The Bank was granted a 'non- exclusive, non-transferable license' to use the integrated 'PROFILE' Software system for processing a specified number of loan accounts, deposit accounts of the bank's customers. A single processing location was to be located at Bangalore to support 8 lakh accounts.

The details of the expenditure incurred, and the breakup thereof are as follows:

Apart from the above, the assessee also incurred a sum of Rs. 3,35,16,164/-towards purchase of computer systems from IBM in connection with the above project. This amount was capitalized by the assessee and there is no dispute in this regard. The assessee claimed the expenditure of Rs. 23,05,49,466/- as detailed above, towards purchase of software as Revenue Expenditure. The contention of the assessee was that the bank has only purchased software license and not the ownership. Further, it was the case of the assessee that the software enables smooth running of the business of the assessee. Since the software is an application software, the same is an allowable expenditure u/s 37 of the Act.

The AO in the Order of Assessment has made the following observations for denying the claim of the assessee for deduction viz., (a) the computerization project will secure an enduring advantage to the assessee and that the assessee has acquired capital infrastructure i.e., core banking solution in the form of integrated licenced software. According to the AO, the assessee acquired a capital asset which would deliver to the assessee tangible benefits of an enduring nature. The AO referred to the licence agreement dated 10.07.2000 whereby the Assessee purchased licence wherein it was provided that the licence will be perpetual. The AO therefore came to the conclusion that the expenditure in question was capital expenditure. He also found that the assessee has capitalized these expenses in the books of accounts. The AO therefore rejected the claim of the assessee for deduction of the aforesaid sum as revenue expenditure. He however allowed depreciation on the expenditure incurred by the assessee.

The CIT(A) confirmed the order of the AO. Aggrieved by the order of the CIT(A), the assessee has raised the aforesaid grounds before the Tribunal.

The learned counsel for the assessee submitted that it is an undisputed fact that the expenditure incurred by the assessee is towards purchase of Core Banking Solutions (CBS) software which is an application software. There is a clear finding in this regard in the order of the lower authorities. The CBS software acquired is a specific customized software, which is specific to the assessee's banking activities. But for the use of such software, the nature of expenditure otherwise incurred for streamlining its functions i.e. towards fee payable to the consultants for systems and employment of special professionals to carry on the tasks that the software in fact performs, would have fallen undoubtedly in the revenue stream. The CBS software purchased by the assessee is an application software. According to Webster — dictionary, System software & application software is defined as under:

It has been contended by the learned counsel for the assessee before us that the difference between the system software and application software is as follows:

Based on the above, it was submitted that it can be said that the CBS software purchased by the assessee is an application software. Further, FIS Payments Solutions & Services India Pvt Ltd., a technical consultants, has certified that the PROFILE software is an application software. It is settled principle of law that any expenditure incurred on purchase of application software is a revenue expenditure allowable u/s 37 of the Income Tax Act, 1961. In this regard, reliance was placed on the following decisions: Name of the Case law CIT v. IBM India Ltd [2013] 357 ITR 88 (Kar) CIT v. Asahi India Safety Glass Ltd. (2012) 346 ITR 329 (Del) Oriental Bank of Commerce v. Addl CIT - 2018 (4) TMI 1534 - DELHI HIGH COURT CIT v. The Lakshmi Vilas Bank Ltd [2018] 12 ITR-OL 594 (Mad) (SLP dismissed vide order dated 12-04-2019 Reported in 2019 (4) TMI 839 - SC ORDER) The Karur Vysya Bank Ltd v. CIT [2021] 438 ITR 467 (MAD)

Apart from the above, it was pointed that the Tribunal in the Assessee’s own case has held that the expenditure incurred on application software is an allowable expenditure. The reference of these decisions are as follows: Relevant Page ITA No 288/B/2013 decision dt 9 — 28 — 6/2/2015 13 30 ITA No 289/B/2013 decision dt 7 — 9 34 — 12/6/2015 35

With regard to the argument of the lower authorities that the assessee obtained an enduring benefit, it was submitted that 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 profitmaking 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 would thus collapse in such like cases. It would 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.

The learned DR while relying on the order of the CIT(A), pointed out that the assessee by incurring expenses on the project “Vysyamulya” linked 125 branches with a Centralized Processing Solution. The expenses would provide an enduring benefit to the assessee. He submitted that computerization through utilization of modern know-how would give a permanent benefit to the assessee. He submitted that the assessee was allowed depreciation at 25% of the expenses incurred and would get the benefit of deduction of the entire expenses over a period of 4 years. According to him the legislature in its wisdom has allowed higher depreciation on computers/computer software keeping in mind the fact that obsolescence of computer/computer software is faster than other assets.

We have considered the rival submissions. The issue before us is as to whether expenditure incurred on “Vysyamulya Project” which is a project by which the assessee wanted to link its 125 branches networked with a Centralized Processing Solution. In doing so, the assessee incurred a sum of Rs.23,05,49,466/-, the break up of which is as follows:

Sanchez Computer Associates Inc., (Sanchez) is a company incorporated as a corporation as per the laws of Pennsylvania State, United States of America.

M/s. A. T.Kearney (India Branch), New Delhi, a company incorporated in India, who possess the requisite expertise, fully qualified and experienced person to design, develop and implement the assessee’s CBS project, was engaged by the assessee under an Agreement dated 21.2.2000 (copy at page 67 to 124 of assessee’s paper book). This agreement gives a picture of what problem the assessee faces in its business and the objective behind undertaking the CBS project. The problem statement says that the assessee wants to gain and exploit technology advantage to be able to provide anytime anywhere, any channel banking services to its clients and compete with international banks and new private sector banks operating in India. The technology solution was desired to have (i) customer centric approach to provide full range of customer, deposit and loan applications and providing on-line batch services to meet the assessee’s transaction processing and financial management requirements. (ii) to meet mandatory functional needs of the bank and regulators, (iii) support overall IT strategy of the Bank and (iv) make it reasonably future-proof meaning that it is based on open systems, standards confirms to usage of contemporary technologies and supports the bank’s evolving functional needs. The technology solutions were to support retail banking, corporate banking, commercial banking, retailing of financial products and services, loan origination and collection processes, inter-branch transactions and reconciliation till all branches operate from the core solution, capital assets accounting, consolidation of GL of all branches, offices, treasuries etc., clearing activities for the present and future, IBD operations, CRM, generation of all MIS reports, costing, budgeting and profitability analysis at client, product, branch levels, lagging foundation for a robust CIF and interfaces to external systems and other current applications. The overall program objective is to position assessee competitive as a leading domestic retail bank, to ensure that the program confirms and is in line with the business strategy and objectives of the assessee, to advise and guide CBS project as per specifications, budget, time and quality, to advise and guide the assessee as to how to operate effectively in a new IT enabled business environment etc.

For implementing the CBS project, the assessee needs to have a data centre for which the assessee entered into an Agreement with IBM Global Services India Pvt. Ltd., dated 5.6.2000 (copy at page 125 to 146 of assessee’s paper book) whereby IBM agreed to create Data Centre (design, planning etc.).

The assessee also entered into an Agreement dated 26.4.2000 with Banalore Labs Private Ltd., to provide networking requirements for the CBS project.

The revenue authorities treated the expenditure so incurred as above as giving an enduring advantage to the assessee and therefore capital expenditure. According to the revenue authorities, the assessee acquired capital infrastructure viz., Core Banking Solution in the form of integrated licensed software from M/s.Sanchez, associated network and hardware, data centre and consultant to implement the CBS project. Therefore the assessee obtained an advantage of an enduring nature and therefore the expenditure is capital expenditure. The revenue authorities also held that the assessee has itself treated the expenditure as capital expenditure in its books of accounts and therefore the expenditure was to be regarded as capital expenditure. Accordingly, depreciation was allowed to the assessee as per the Act and rules on the expenditure incurred on computer software. Alternatively, the AO held that since the benefit of the expenditure would be available to the assessee for atleast 10 years, the assessee can deduction of the entire expenses in equal amount over a period of 10 Assessment years.

Before we specifically deal with the issue in this appeal whether expenditure incurred in implementation of CBS project is to be regarded as Capital Expenditure or Revenue expenditure, it would be relevant to dwell upon the general guidelines and principles laid down by the various higher Courts including the Hon'ble Apex Court for deciding the nature of any expenditure whether capital or revenue. Lord Denning in Heather v. P.E. Consulting Group Ltd. (1972) 48 TC 293 made the following still very pertinent observations at page 321 A:

To the same effect are the ratio laid down by the Hon'ble Supreme Court in the case of Alembic Chemical Works Co. Ltd. v. CIT 177 ITR 377, wherein it was observed that some broad and general tests have been suggested from time to time in the various judicial pronouncements to ascertain on which side of the line the outlay in a particular case might reasonably be held to fall. It was held that these tests are generally efficacious and serve as usual servants and as masters, they tend to be over exacting. There is also no single definitive criterion which by itself is determinative as to whether a particular outlay is capital or revenue and what is relevant is the purpose of the outlay said its intended object and effect considered in a common sense way having regard to the business realities. The Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT 124 ITR 1, there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may nonetheless be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principles laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. In the case of CIT v. Ciba of India. Ltd. 69 ITR 692, the assessee had acquired under the agreement merely the right to draw for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products, upon the technical knowledge of the Swiss company for a limited period and since the Swiss company did not part with any asset of its business nor did the assessee acquire any asset or advantage of enduring nature for the benefits of its business, the payment made by the assessee to Swiss company under the agreement was held by the Hon'ble Supreme Court to be towards revenue expenditure observing that the nature of receipt as capital or revenue is not always determinative of the nature of this outgoing in the hands of the person who receives it. Explaining further, it was observed by the Hon'ble Apex Court that the license was for a period of five years liable to be terminated in certain events and since the object of the agreement was to obtain the benefit of the technical assistance for running the business of the assessee the expenditure in question was of revenue nature.

A resume of the aforesaid judicial pronouncements shows that there cannot be any specific or precise test, which can be applied conclusively or universally for distinguishing between capital and revenue expenditure. It is a blurred and undefined area in which anyone can get lost. Different minds may come to different conclusions with equal propriety. The cardinal rule is that the question whether a certain expenditure is on capital or revenue account should be decided from the practical and business view point and in accordance with sound accountancy principles and this rule is of special significance in dealing with expenditure on expansion and development of business.

An advantage is to be considered as of enduring benefit if the benefit accruing is not of a transient nature but is of such durability as to justify it being treated as a capital asset. The expression "enduring benefit" has been explained by the Hon'ble Supreme Court in the ease of Assam Bengal Cement Co. Ltd. v. CIT 27 ITR 34 to mean enduring in the way that fixed capital endures. As held by Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT -124 ITR 1, there may be cases where expenses, even, if resulting in the advantage of an enduring benefit, may be properly chargeable to revenue account if the advantage consists merely in facilitating the assessee's trading operations or enabling him to manage and conduct his business more efficiently or more profitably while leaving the fixed capital untouched. It is thus necessary that in order to treat any expenditure as capital expenditure, the same should result in accrual of advantage of enduring benefit and such benefit should accrue to the assesses in the capital field. What exactly is meant by accrual of benefit in the capital field is that the said benefit should form part of the profit-making apparatus of the assessee’s business. The question whether expenditure incurred on computer software is capital or revenue has to be seen from the point of view of its utility to a businessman and how important an economic or functional role it plays in his business. In other words, the functional test becomes more important and relevant because of the peculiar nature of the computer software and its possible use in different areas of business touching either capital, or revenue field or its utility to a businessman which may touch either capital or revenue field.

Tested on the touchstone of the principles laid down as above, we find that the objective of CBS project was to gain and exploit technology advantage to be able to provide anytime anywhere, any channel banking services to its clients and compete with international banks and new private sector banks operating in India. Towards this end the assessee acquired license to use software “profile” which was to maintain loan and deposit account of customers from Sanchez. It engaged the services of a consultant to design, develop and implement CBS project and the purpose or objectives are already given in paragraph-20 of this order and are not repeated. IBM was engaged to develop a Data Centre and Bangalore Labs Private Limited carried out networking of all the branches of the assessee with Head office through Data Centre. The objective of CBS project is that the assessee wants to gain and exploit technology advantage to be able to provide anytime anywhere, any channel banking services to its clients and compete with international banks and new private sector banks operating in India. The technology solutions were to support retail banking, corporate banking, commercial banking, retailing of financial products and services, loan origination and collection processes, inter- branch transactions and reconciliation till all branches operate from the core solution, capital assets accounting, consolidation of GL of all branches, offices, treasuries etc., clearing activities for the present and future, IBD operations, CRM, generation of all MIS reports, costing, budgeting and profitability analysis at client, product, branch levels, lagging foundation for a robust CIF and interfaces to external systems and other current applications. The overall program objective is to position assessee competitive as a leading domestic retail bank, to ensure that the program confirms and is in line with the business strategy and objectives of the assessee, to advise and guide CBS project as per specifications, budget, time and quality, to advise and guide the assessee as to how to operate effectively in a new IT enabled business environment etc.

Every advantage of an enduring benefit, need not be on capital account, if the advantage consists merely in facilitating the assessee's trading operations or enabling him to manage and conduct his business more efficiently or more profitably while leaving the fixed capital untouched. It is thus necessary that in order to treat any expenditure as capital expenditure, the same should result in accrual of advantage of enduring benefit and such benefit should accrue to the assesses in the capital field. What exactly is meant by accrual of benefit in the capital field is that the said benefit should form part of the profit-making apparatus of the assessee’s business. The expenditure in question only facilitates carrying on the business of the assessee more profitably without touching the profit making apparatus of the bank which is receiving deposits and lending/investing them for profit. Therefore the expenditure in question has to be regarded as revenue expenditure.

Besides the above, the software in question is application software. Every computer or machine has hardware, but that hardware is not enough to run applications like Microsoft Word. One needs system software to run the hardware and operate applications on it. In other words, computer’s hardware (the actual physical parts) is useless without system software – the Windows OS (Operating System). Application software, on the other hand, is a type of software or program that is designed to complete a specific task. For example, Microsoft Word is application software, and it allows you to write documents. An internet browser like Google Chrome is also an application software because it allows you to complete a specific task – like conduct Google searches. The software in respect of which the assessee acquired license from Sanchez is an application software. The Hon’ble Karnataka High Court in the case of IBM Ltd. (supra) taken the view that payment of application software though there is an enduring benefit, it does not result into acquisition of any capital asset and merely enhances the productivity or efficiency and hence has to be treated as revenue expenditure.

Another important aspect that needs to be addressed is the stand of the revenue that under clause 5.1 of the license agreement between assessee and Sanchez, the license to use the software is in perpetuity and therefore the assessee has acquired a capital asset which also provides enduring benefit to the assessee. As we have already observed the tests for deciding the question whether an expenditure is capital or revenue in nature cannot be decided on the basis of ownership test or enduring benefit test alone. The question whether expenditure incurred on computer software is capital or revenue has to be seen from the point of view of its utility to a businessman and how important an economic or functional role it plays in his business. This is because of the peculiar nature of the computer software and its possible use in different areas of business touching either capital, or revenue field or its utility to a businessman which may touch either capital or revenue field. Therefore the fact that the license is in perpetuity is not very relevant. Apart from the above, perpetual license granted in an agreement between the licensor and licensee is only a mode by which licensee can use the software. A perpetual license agreement, much as the word, “perpetual” implies, provides the licensee rights to the product, for life, provided that they do not violate the terms of the agreement. Perpetual License Agreements are often used in software purchases; So long as the licensee does not use the software outside the scope of the agreement (allowing a third party to use it, using it for commercial purposes, making copies of it, etc.), a perpetual license agreement often means that the licensee has to pay maintenance fee or additional fees to install any software updates provided by the manufacturer. Many people prefer perpetual license agreements, as they just have to pay once for the software, then as needed, pay for technical support and any software updates. However, with this structure, you run the risk of your software becoming obsolete as technology changes. With passage of time, a perpetual license purchased 10 years ago may not be compatible on that brand new computer that a person may buy. So, every few years, one has to purchase new software to ensure that one remains up-to-date, compatible with new hardware and with other people’s operating systems. In fact, there was a time in which perpetual license agreements were the only ones that existed regarding software. That has since changed, and now many software companies provide subscription services or annual licenses. Therefore the business model adopted by the licensor to grant licenses only on the basis of perpetual license cannot be the basis to hold that the expenditure incurred by the assessee is capital expenditure. Notwithstanding the use of the term perpetual, the license agreement between the assessee and Sanchez provides for annual maintenance and upgrade fee also. Therefore it is not possible to look into the clause in the license agreement in isolation to come to a conclusion that because the license is in perpetuity, the expenditure incurred is capital expenditure.

In the light of the above discussion, we hold that advantage of an enduring benefit, need not be on capital account. If the advantage consists merely in facilitating the assessee's trading operations or enabling him to manage and conduct his business more efficiently or more profitably while leaving the fixed capital untouched, the same cannot be regarded as on capital account. In order to treat any expenditure as capital expenditure, the same should result in accrual of advantage of enduring benefit and such benefit should accrue to the assesses in the capital field. Such accrual of benefit in the capital field would mean that the said benefit should form part of the profit-making apparatus of the assessee’s business. The expenditure in question only facilitates carrying on the business of the assessee more profitably without touching the profit making apparatus of the bank which is receiving deposits and lending/investing them for profit. Therefore the expenditure in question has to be regarded as revenue expenditure. Thus the relevant grounds of appeal are allowed.

In the result, the appeal of the revenue is dismissed and the grounds of appeal of the assessee remanded by the High Court for fresh consideration are allowed.