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Income Tax Appellate Tribunal, DELHI BENCH “B” BENCH NEW DELHI
Before: SHRI AMIT SHUKLA & SHRI PRASHANT MAHARISHI
ORDER
PER AMIT SHUKLA, JUDICIAL MEMBER:
The aforesaid appeal has been filed by the assessee against impugned order dated 22.08.2012, passed by Ld. CIT (Appeals) for the quantum of assessment u/s 143(3) for the A.Y. 2009-10. The assessee has raised following grounds of appeal which reads as under:-
“1. That the Ld. CIT(A) has erred both in facts and in law while sustaining the addition of Rs. 24,65,578/- made by the assessing officer relating to expenditure incurred on development of software.
2.b. That the Ld. CIT(A) failed to appreciate that Rs. 24,65,578/- incurred on development of software even otherwise was allow able under section 37(1) of the Income Tax Act. 1.c. That the Ld. CIT(A) has gone wrong by confirming that the expenditure on development of software is covered under section 35D of the income Tax Act and thereby sustaining the disallowance of Rs. 24,65,578/- made by the assessing officer. 1.d. That without prejudice to the above, the Ld. CIT(A) while treating the expenditure incurred on development of software as capital in nature erred in not allowing , alternatively (depreciation on the same.
On the Facts and the circumstances of the case the order passed by the C1T (Appeal)- XIII is bad in law and against the facts of the case.”
Apart from that the assessee has also raised additional grounds which read as under:- “That in the fact and circumstances of the case and in law the Ld. CIT (A) has failed to appreciate that the expenses of Rs. 24,65,578/- incurred on the development of the software project “SIMS” resulted in creation of trading asset/ stock in trade in case of the appellant, who is in the business of software development and was thus even otherwise an allowable business loss / expenditure written off during A.Y. 2009-10 under Sections 28/29 of the Income Tax Act, 1961, on account of the same having become obsolete through passage of time.”
Since the aforesaid additional grounds raises an alternative contention and is purely a legal plea arising out of material already on record and arising out of same issue as raised in main grounds of appeal in respect of allowability of expenses of Rs. 24,65,578/-, therefore, we are admitting the same for adjudication.
2. The brief facts apropos the matter is that, the assessee company is engaged in the business of software development, I.T. enabled services and HR outsourcing. The ld. Assessing Officer noted that the assessee has claimed the deduction of Rs. 24,65,578/- under the head ‘software development expenses’. In response to the show cause notice the assessee before the AO had submitted as under:- “Cost incurred on in-house development of technically feasible software/process and/or product capable of commercial marketability/exploitation and in respect of which enduring income or benefit is expected to accrue in future are accumulated and deferred until the completion of development, due testing and validation of such software/process or products. The said cost, upon cessation/ completion of such development are amortized on a systematic basis over a reasonable time period considering the expected sale or economic use of the product/process with reference to various factor such as technological and economic obsolescence, uncertainties etc. The company during the year under scrutiny had amortized carried forward from 4/5 years back expenditure in relation to project of SMIS amounting to Rs. 24,65,578/-, the said amortization has been considering expected sale or economic use of the product process with reference to various factors such as technological and economic obsolescence, uncertainties etc. The notes on amortization of software development expenditure is in continuance of our earlier submission in this regard. Further to our submission, we have to state as under:- • The expenditure incurred on the software development in the form of developer salary, expenses attributable to the project etc. were capitalized. • These expenses are amortized considering various factors as stated in our earlier submission. • You had quoted us some case law 259 ITR 30 (Aravali construction) and 92 ITR 119 (Maruti Udyog) where these expenses were disallowed. Page 3 of 12
• In this regard we have to state that facts of the above cases were completely different from ours. Whereas in first case payments were made for outright purchase of software in second case disallowed refers to section 43B. • Our claim of expenses is allowable u/s 371(1).”
However, the ld. Assessing Officer held that the said expenditure cannot be allowed u/s 37(1) because, this expenditure has been accumulated over the period of 4 to 5 years back and the benefit is expected to be spread over a number of years and as such the same are capital in nature. Since, the assessee has in-house software development for the purpose of business, therefore, the claim of the assessee will be allowed u/s 35D and accordingly, he held that the assessee would be entitled for deduction of Rs. 99,131/- being 1/5thof total software development and the excess claim of Rs. 23,66,447/- has been disallowed and added to the income of the assessee.
Before the Learned CIT(Appeals), the assessee submitted that as per its regular accounting policy, it has been amortizing carried forward expenditure in relation to the software products, here in this case a software product named as SIMS (sales information management system) was developed on which expenditure amounting to Rs. 24,65,578/-, was incurred in the F.Y.2003-04 (relevant to AY 2004-05). The said software was developed for selling it in the future date to the prospective customers. It was never meant for captive consumption. Since there was no sale of the said software in the year of incurrence and sale was to be undertaken in the future years, therefore, such an expense was not claimed in the A.Y. 2004- 05. The company intended to write off the said expenditure matching Page 4 of 12 with the revenue realized from the sale of such software product so that no extra expenses is claimed in the profit and loss account. The amortization of such brought forward expenditure was written off in the year under consideration due to number of factors like it had become obsolete etc. The amortization of the expenses was done as per the accounting policy and duly disclosed in the financial statement of the assessee company. The assessee has been following the same accounting policy consistently since inception and same has been accepted by the department during the scrutiny proceedings in the earlier years. The accounting policy mentioned in the financial statement was as under:- “(h) Software/process Development Cost Costs incurred on in-house development of technically feasible/process and or/product capable of commercial marketability/exploitation and in respect of which enduring income or benefit is expected to accrue in future are accumulated and deferred until the completion of development, due testing and validation of such software/process or products. The said costs, upon cessation/completion of such development, are amortized on a systematic basis over a reasonable time period considering the expected sale or economic use of the product/process with reference to various factor such as technological and economic obsolescence, uncertainties etc.”
The assessee had further submissions in this has regard which has been duly noted by the Learned CIT(Appeals) from pages 5 to 8 of the appellate order.
The Learned CIT(Appeals), upheld the disallowance made by the Assessing Officer on the ground that it is a capital expenditure having enduring benefit and Assessing Officer was fully justified by partly allowing such expenditure in accordance with the section 35D.
Before us the ld. counsel after explaining the entire facts and background of the case, submitted that the assessee is into development of software and whenever a software is developed for future sales, expenditure incurred on such development of software is amortized during the year and is to be claimed whenever the said product comes up for sale. This has been done so under the matching principle of the cost associated with the revenue. The said expenditure has been written off in this year for reason that the assessee company realized that the said software product was not commercially and technically viable due to fast change in the technology and the software programme and assessee’s software SIMS had become obsolete during the year. Thus, as a prudent businessman the assessee has written off in this. He also submitted that similar write off for other software was made in the A.Ys. 2006- 07 and 2007-08 which has been accepted by the department in the scrutiny proceedings u/s 143(3) and in the A.Y. 2008-09 also similar written off of various software products has been done for which no disallowance has been made. Thus, the following principle of consistency and fact that the assessee has been following similar accounting policy for earlier years the assessee’s claim should not be disallowed. The main plank of his argument was that the write off of software products in this year was on the ground that it has become obsolete which is to be allowed as business loss in this year.
On the other hand the ld. DR strongly relied upon the order of the Assessing Officer and the Learned CIT (Appeals) submitted that Page 6 of 12 firstly, the assessee’s expenditure cannot be allowed u/s 37(1), because the said expenditure has not been incurred during the relevant previous year; and secondly, the product has been developed which has been amortized therefore, same is to be allowed under provision of section 35D. Thus, order of the Learned CIT (Appeals) should be confirmed.
We have heard the rival submissions and perused the relevant finding as well as material referred to before us. The assessee is in business of software development and sale of software products. For developing the software, it has being carrying out in-house development for which it has been incurring expenditure which otherwise is a business expenditure. Since the year in which expenditure has been incurred the software was not ready for sale in the market, therefore, the assessee as a matter of its regular accounting policy, it has been amortizing the same over a reasonable period of time considering the future sale of the product. The reasons given for following such policy was that, the cost should be associated with the revenue and since there was no matching revenue in the year of development of the software and incurring of the expenses, therefore, instead of claiming in that year, the assessee has been amortizing the said claim for making the claim in the future when the product is sold. Here in this case, it has been submitted that the assessee has developed a software product named as SMIS for which it has incurred expenditure of Rs. 24,65,578/- during the A.Y. 2004-05. As the product could not be sold either in the A.Y. 2004-05 or up till AY 2008-09, the assessee company took a decision that the same should be write off in the impugned assessment year 2009-10, for the reason the said software Page 7 of 12 had been rendered obsolete. Before us, the assessee in its paper book has given the following details of amortizing of various software developed from the A.Y. 2001-02 to AY 2009-10, which for the sake of ready reference are given herein below:- Assessment SOFTWRAES Total Assess year ment E- HMS Medarch Smart HQMS SMIS made Consultant Search U/S 2001-02 5108072 143(1) Additions 5,108,072 - during the year Less: amortized 5,108,072 5108072 during the year balance 2002-03 6065997 7886367 143(1) Additions 1,820,370 (2022000) (2022000) during the year 4043997 10972439 Less: amortized 6,928442 during the year balance 2003-04 144152 555381 523433 3481512 143(1) Additions 6,928,442 (2022000) 961546 523433 (2022000) during the year 3463149 961456 555381 12431951 Less: amortized during the year balance 2004-05 (2,022,000) 346149 555381 523433 2465578 - 143(1) Additions 4,906,442 961546 246578 - during the year 2465578 Less: amortized (2022000) during the year 12875529 balance 2005-06 (1,635,480) 346149 555381 523433 2465578 - 143(1) Additions 3270962 (320515) - during the year 641031 (1955995) Less: amortized 10919534 during the year balance 2006-07 1635480 629954 641031 555381 523433 2465578 629954 143(3) Additions 1635482 4093103 (1635480) during the year 9914008 Less: amortized during the year balance 2007-08 (1635482) 4093103 641031 555381 523433 2465578 - 143(3) Additions - during the year - Less: amortized (1635482) during the year 8278526 balance Page 8 of 12 2008-09 (4093103) (641031) (555381) (523433) 2465578 - 143(1) Additions - during the year - Less: amortized (5812948) during the year 2465578 balance 2009-10 (2465578) - 143(1) Additions - during the year - Less: amortized (2465578) during the year balance From the above it can be seen that similar write-off of various software products have been done in the A.Y. 2005-06, 2006-07, 2007-08, 2008-09. Such a write-off of expenses has been also allowed by the department either under the scrutiny proceedings u/s 143(3) or the return income has not been disturbed. In this year the assessee has written off all the expenses of Rs. 24,65,578/- which was amortized during the A.Y. 2004-05, on the ground that this product has become obsolete.
However, the manner in which the assessee has been amortizing the expenses and later on writing it off the expenses which has been amortized earlier is not appreciable, because if an expenditure has been incurred for development of software product which is to be sold, then same should go to enhance the value of stock-in-trade and in the year in which its written off on the ground that the said product is not saleable and is rendered obsolete, the same can be claimed as business loss. The other manner would be to take it as part of work-in-progress of saleable product and claim the expense against the revenue realised. The expenses incurred in the development of software is for sale then definitely it is of revenue in nature and the same is allowable only while computing the income Page 9 of 12 chargeable as business income. However, without going into the accounting entries and accounting policies followed by assessee and looking to the manner in which the assessee has been amortizing the expenses to be claimed in future against matching revenue, we find that it is an undisputed fact that the assessee did incurred expenditure for development of software of Rs. 24,65,578/- way back in the A.Y. 2004-05 and such development of software was meant to be sold in the market as a part of core its business activity. If over the period of time the said product could not be sold and has become obsolete due to fast changing technologies and software programme, then it has to be left to the prudence of the businessman to write it off in the year in which it considers that the said product cannot be sold at all or it has become scrap. In the year under consideration, the assessee has written off the said amount of expenses, which has been amortized since 2004-05, therefore, the same needs to be allowed as business loss in this year. We also look at the issue form another angle, assessee is a software developer and is developing software for sale, therefore software developed are inventories held for sale by it. Further, the moment assessee feels that the inventory of software held by it for sale cannot be sold in the market because of its technological obsolescence; naturally, this inventory is required to be written off to its realizable value, which has been determined by the assessee at Nil, therefore, the whole amount is written off during the year and claimed as loss. The revenue has not disputed the fact that software is not saleable or has ‘nil’ realizable value. It is also the fact stated before us that this software is not sold as it has lost its utility. Thus, on this ground we are of opinion that the said amount of Rs. 24,65,578/- is to be allowed as business loss as technical obsolescence of the inventory while computing the income Page 10 of 12 under section 28/29 of the act in this year. Hence, the appeal of the assessee is allowed on the reasoning given above.
In the result, the appeal of the assessee is allowed.
Order pronounced in the open court on 23.05.2017.