TRIVENI ENGINEERING & INDUSTRIES LTD.,NOIDA vs. ADDL. CIT, NEW DELHI

Being aggrieved by the assessment order, the assessee filed appeal before the CIT(A). The CIT(A) partly allowed the appeal of the assessee.

As regards to Ground No. 1 relating to ERP and software related expenses amounting to Rs. 1,16,60,400/-, the Ld. AR submitted that the assessee is a public limited company engaged in the business of manufacture and sale of Turbine, Gear and Gear Boxes, sugar plants, water treatment plants, mini hydel power projects, etc. The assessee had, during the relevant previous year, inter alia, incurred the following expenditure aggregating to Rs. 1,16,60,400 on implementation of new ERP package which was treated as deferred revenue expenditure in the books of accounts: i) Rs.66,29,773/- on Enterprise Resource Planning (“ERP”) package; ii) Rs.50,30,627/- on design, development, consultancy and other software related expenses. The Ld. AR submitted that though in the books of account, the aforesaid expenses were treated as deferred revenue expenditure, the aforesaid expenses, being revenue in nature, were claimed as deduction in the return of income. The Assessing Officer however, disallowed the aforesaid expenses holding the same to be capital expenditure on the ground that the same resulted in enduring benefit to the assessee, and allowed depreciation @ 60% on the same. Accordingly, the Assessing Officer made disallowance of Rs.81,62,280 (Rs. 1,16,60,440 - Rs.34,98,120), after allowing depreciation of Rs.34,98,120 [@ 30% since installed after 30th September, 2000]. On further appeal, the CIT(A), despite agreeing that expenditure was incurred to improve the efficiency and productivity of the assessee, confirmed the action of the Assessing Officer, holding that such efficiency and productivity is a long-term enduring benefit, going beyond the year under consideration. The Ld. AR submitted that the aforesaid action of the Assessing Officer/CIT(A) is without judicious appreciation of the facts of the case and the position in law. During the relevant Assessment year 2001-02, the assessee entered into a License Agreement dated 20.9.2000 with SAP India Systems Ltd. for introduction of ERP package at the Bengaluru Unit. The Ld. AR submitted that ERP is a general purpose software which is used to link the work of each department within the organization so that resources of an organization can be pooled to share information as well as generate reports and to check status of each activity. ERP/SAP software is one of the most robust and highly acclaimed software throughout the world and has its application in processing and documenting business data. The SAP software is divided into sub-modules like work-flow management, human resources, finance and accounting, logistics, production, etc. The software provides capability to surpass the boundaries between departments in an organization and the integrated modules work together and support the individual departments. The Ld. AR submitted that the Assessing Officer failed to appreciate that aforesaid expenses incurred merely facilitated the day-to-day business operations and did not result in any enduring benefit in the capital field, ignoring the following facts: i) ERP is a standardized software and not a customized software. Further, ERP is an application software and not an operating software; ii) The software does not involve transfer of any technology for the production of any particular product nor it is an integral part of any particular machinery used in manufacture of finished products by the assessee; iii) The assessee only had the limited right to use the software for the purpose of business; the assessee cannot copy, translate, disassemble, etc., the software; iv) The assessee has a non-exclusive license to use the software and proprietary information; v) The ownership and title in all the intellectual property rights, including patent, trademarks, service mark, copyright and trade secrets in the SAP proprietary information shall continue to vest with the licensor of the software; vi) There was no outright sale of the aforesaid software by SAP to the assessee and the aforesaid expenditure did not result in acquisition/creation of an asset in the capital field as the assessee did not acquire any ownership rights in the said software; vii) The assessee was prohibited from making copies of the aforesaid software for commercial exploitation. Further, the use was limited in time and the right to use the software were to lapse after expiry of the license.

The Ld. DR submitted that the expenditure on ERP as pointed out by Assessing Officer clearly is linked to acquiring SAP Software and its implementation. The benefit derived by acquiring such software is not limited to the current year but brings to the Assessee an advantage of enduring nature. The benefits associated with the software would accrue over a protracted period of time. The benefits derived through other expenses on software & design development, similarly confer long term benefits to assessee. Hence such expenditure is in the capital field and rightly disallowed by the Assessing Officer. In Assessment Year 2000-01 the Assessing Officer disallowed and held that the expenses are capital in nature and allowed depreciation benefits. Thus the Assessing Officer as well as CIT(A) was right in holding that these expenses are capital in natures. The Ld. DR relied upon the assessment order and order of the CIT(A).

We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that no ownership of any software is acquired by the assessee as a consequence of the ERP expenditure. This fact was not disputed by the Assessing Officer. The assessee has only limited right to use the concerned software product which the assessee acquired without acquiring the right of transferring the said software. Thus, from the perusal of the material on record it can be seen that no benefit of an enduring nature has been derived by the assessee as result of said expenditure. The said expenditure has been incurred only for smooth working and for improving the functioning of the organization. The Assessing Officer ignored the fact that in today’s fast changing technology where software becomes obsolete for smooth functioning of the business, the software needs to be replaced / upgraded by an assessee from time to time, the software, in any, case cannot also be said to result in any enduring benefit to the assessee to be considered and thus, it cannot be held as capital expenditure. The case laws referred by the Ld. AR supports the contentions of the assessee as expenditure incurred on computer software does not constitute enduring benefit to term the same as capital in nature. Thus, the Assessing Officer as well as the CIT(A) failed to take cognizance of the decisions of the various High Court and the Apex Court as well as the nature of the expenditure incurred by the assessee. Hence, Ground No. 1 of Assessee’s appeal is allowed.

As regards to Ground No. 2 relating to disallowance under Section 14A of the Act to the extent of Rs. 86,398/-, the Ld. AR submitted that during the year under consideration, the assessee earned dividend income aggregating to Rs. 17,27,950 from investment in various equity shares, which was claimed as exempt under Section 10(33) of the Act. The investment in the shares which yielded above exempt dividend income, had been made out of surplus funds available in earlier years. Since no expenditure was incurred by the assessee in relation to exempt dividend income, no disallowance under Section 14A of the Act was suo moto offered by the assessee. In the assessment order, the Assessing Officer made ad-hoc disallowance of expenses of Rs.3,00,000 on the ground that some manpower/man hours alongwith the expenses on other clerical staff / managerial staff and expenses for portfolio management must have been incurred towards earning of aforesaid exempt dividend income. The CIT(A) however, restricted the disallowance to 5% of the dividend income earned by the assessee during the relevant assessment year. Assessee has challenged the action of the CIT(A) in restricting the disallowance made under Section 14A to 5% of dividend income received. The Ld. AR submitted that the aforesaid action of the Assessing Officer is, not based on correct appreciation of facts and law. In terms of the provisions of Section 14A of the Act, only expenditure incurred, having relation with earning of exempt income, is not an allowable deduction under the provisions of the Act. The phrase “expenditure incurred” used in the aforesaid section refers to actual expenditure, which has proximate nexus with exempt income, and not some imaginary or notional expenses, for the purposes of disallowance under that section. The provisions of Section 14A are applicable if and only if the assessing officer, at the first place, finds that the assessee has actually incurred expenses, which have proximate nexus with earning of exempt dividend income and not otherwise. In other words, the onus is on the Assessing Officer to find proximate nexus of expenses with earning of exempt income, before computing any disallowance under section 14A of the Act. The Ld. AR submitted that in the absence of such nexus being established, it is not open to the Assessing Officer to disallow any part of the expenditure on proportionate basis. Thus, the pre- requisite condition for applying the provisions of Section 14A of the Act is that some expenditure must be incurred “in relation to” the earning of exempt income. The said expression “in relation to” has been judiciously explained in various decisions to mean some real, dominant and immediate relationship. In this regard, the Ld. AR pointed out the decision of Hon’ble Supreme Court in the case of CIT vs. Walfort Share & Stock Brokers: 233 CTR 42, wherein it has been held that there must be a proximate relationship of expenditure with exempt income, for the purposes of making disallowance of same under Section 14A of the Act. In the case of Godrej & Boyce Mfg. Co. Ltd. v. DCIT 328 ITR 81, the Hon’ble Bombay High Court, while deciding the issue of disallowance under Section 14A of the Act, following the aforesaid the Hon’ble Supreme Court decision in Walfort Shares & Stock Brokers (supra), observed that disallowance under Section 14A can be effected only when a proximate cause for disallowance is established, stating the relationship of the expenditure with income which does not form part of the total income. The Ld. AR also relied upon the decision of the Hon’ble Delhi High Court in case of Maxopp Investment Ltd. 203 Taxman 364 wherein the Hon’ble High Court, while approving the contention raised by the assessee held that the term “expenditure incurred’’ appearing in Section 14A(1) of the Act would mean “actual” expenditure incurred, held that no disallowance could be made under the said section where no expenditure has 'actually' been incurred by the assessee in relation to earning of the exempt income. Pertinently, the Hon’ble Supreme Court while affirming the aforesaid decisions of the Hon’ble Bombay and the Delhi High Court have repeatedly emphasized on the requirement of recording satisfaction. The Hon’ble Supreme Court in the case of Godrej & Boyce Manufacturing Co. Ltd vs DCIT, 394 ITR 449 (SC), while affirming the aforesaid decision, held that recording of satisfaction under Section 14A(2) is of paramount importance, failing which the provisions of Rule 8D, applicable from Assessment Year 2008-09 or a best judgment determination, as earlier prevailing till assessment year 2007-08, cannot be applied. It was held, likewise, by the Hon’ble Supreme Court in the case of Maxopp Investment Ltd vs CIT: 402 ITR. Thus the Ld. AR submitted that on perusal of the aforesaid decisions, it can be seen that the disallowance under Section 14A of the Act cannot be made unless there is direct or indirect connection between the exempt income and the actual expenditure incurred. In order to justify disallowance of any part of the expenditure under the said section, the onus is on the Revenue to bring on record nexus between the expenditure and the exempt income. The decision of the Hon’ble Kerala High Court in the case of CIT(A) Vs. Catholic Syrian Bank Ltd and Ors 330 ITR 556/237 CTR 164. The Ld. AR relied upon the decision of the Hon’ble Kerala High Court in case of Catholic Syrian Bank (Supra), the decision of Ahmedabad Bench of Tribunal in case of ACIT Vs. Torrent Pharmaceuticals Ltd 137 ITD 301 as well as the decision of the Delhi Bench of the Tribunal in case of SIL Investment Ltd. vs. ACIT: 148 TTJ 213 (Del.), wherein the Tribunal held that no disallowance could be made under Section 14A of the Act out of audit fees, normal travelling expenses, etc. The Ld. AR also referred the decision of Amritsar Bench of the Tribunal in case of DCIT v. Jammu and Kashmir Bank Ltd. 152 TTJ 522. In the light of the aforesaid, the Ld. AR submitted that there is no rationale/justification as to how Rs.3 lac of administrative expenditure could be assumed to be incurred for earning exempt income, which is received automatically by direct transfer to the bank account of the assessee. In this regard, the Ld. AR pointed out that in the subsequent Assessment Year, i.e., 2002-03, even though the assessee earned dividend income amounting to Rs.7,52,875, no disallowance under Section 14A of the Act was made by the Assessing Officer. Thus, the Ld. AR submitted that the Assessing Officer accepted the contention of the assessee that no expenditure has been incurred for earning the dividend income and therefore no disallowance under Section 14A was called for. Accordingly, the Assessing Officer erred in disallowing, on an ad-hoc basis Rs.3 lacs under section 14A of the Act, without appreciating that no expenditure was actually incurred for earning dividend income and without bringing any evidence on record to establish nexus between the expenditure and earning of dividend income.

The Ld. DR relied upon the Assessment Order.

We have heard both the parties and perused all the relevant material available on record. From the perusal of records, it can be seen that the Assessing Officer accepted the contention of the assessee that no expenditure has been incurred for earning the dividend income and therefore no disallowance under Section 14A was called for. Without appreciating this aspect, the Assessing Officer disallowed Rs.3 lacs under section 14A of the Act on an ad-hoc basis, and while doing so the Assessing Officer has not established any nexus between the expenditure and earning of dividend income. The CIT(A) also failed to look into this aspect. Thus, Ground No. 2 is allowed.

In result, the appeal being Assessee for A.Y. 2001-02 is allowed.

As regards Assessment Year 2002-03 & 2003-04, both these appeals are identical to Ground No. 1 of Assessment Year 2001-02. Thus, and ITA No. 1957/Del/2016 for A.Y. 2002-03 and 2003-04 respectively are allowed.

In result, the appeal being and ITA No. 1957/Del/2016 filed by the Assessee for A.Y. 2002-03 and 2003-04 respectively are allowed.

As regards Assessment Year 2004-05, Ground No. 1 is related to prior period expenses, the Ld. AR submitted that the CIT(A) has not taken cognizance of all the contentions of the assessee, therefore, the same should be remanded back to the file of the CIT(A). Thus, we are remanding back this issue to the file of CIT(A) for proper adjudication after taking cognizance of all the relevant evidences produced by the assessee. Needless to say, the assessee be given proper opportunity of hearing by following principles of natural justice. Ground No. 1 is partly allowed for statistical purpose. As regards to Ground No. 2 & 3, the Ld. AR submitted that the same are requires to be verified and the same may be set aside to the file of the CIT(A). Thus, we are remanding back this issue to the file of CIT(A) for proper adjudication after taking cognizance of all the relevant evidences produced by the assessee. Needless to say, the assessee be given proper opportunity of hearing by following principles of natural justice. Ground No. 2 and 3 are partly allowed for statistical purpose.

In result, filed by the Assessee for A.Y. 2004-05 is partly allowed for statistical purpose.

As regards Assessment Year 2005-06, the same is identical to Ground No. 2 to Assessment Year 2004-05 and same needs to be set aside to the file of the CIT(A). Thus, we are remanding back this issue to the file of CIT(A) for proper adjudication after taking cognizance of all the relevant evidences produced by the assessee. Needless to say, the assessee be given proper opportunity of hearing by following principles of natural justice. Ground No. 1 is partly allowed for statistical purpose. As regards Ground No. 2, since the amount is less, the Ld. AR is not pressing the same at this juncture but reserves its right to contest the said issue at the proper time in subsequent years. Therefore, Ground No. 2 is dismissed.

In result, filed by the assessee for A.Y. 2005-06 is partly allowed for statistical purpose.

In result, and ITA No. 1957/Del/2016 filed by the Assessee for A.Y. 2001-02, A.Y. 2002-03 and 2003- 04 respectively are allowed and ITA No. 1958/Del/2016 & ITA No. 1959/Del/2016 filed by the Assessee for A.Y. 2004-05 and A.Y. 2005-06 are partly allowed for statistical purpose.