By Sherry Samuel Oommen & Ajith R
Background: The question as to the classification of an item of expense as revenue or capital in nature for income-tax purpose has long been a contentious issue before the courts. The same has been settled by the courts on a case-to-case basis, also setting-forth the general principles relevant for determining the deductibility of an expense as revenue expenditure under section 37(1) of the Income-tax Act, 1961 (‘the Act’). The said issue attains greater significance in the case of tax deductibility of payments made towards purchase of software for the purpose of business, considering the fact that said payments would constitute a major item of expenditure not only for major business houses but also for small and medium enterprises (SMEs).
In response to the relentless advance of technology, many business owners regularly acquire new computer software. Although the learning curve associated with using the new software may be painful for owners, the related pain gets partially relieved when they hear that the related cost of acquiring the new software could be fully tax deductible in the year of acquisition itself rather than being eligible for amortization as depreciation. Recently, the Delhi High Court in the case of Asahi India Safety Glass Limited (ITA No 1110/2006 & 1111/2006, dated 4 October 2011) held that the expenditure incurred on application software is allowed as revenue expenditure for income tax purposes and that the test of enduring benefit is not certain or conclusive in determining the expenditure as capital or revenue. The said principles were reiterated also by the Delhi High Court in the case of Amway India v DCIT (2011-TIOL-710-HC-DEL-IT), following its own ruling in the case of Asahi India Safety Glass Ltd. (supra).
In the wake of the above-mentioned recent rulings in connection with the issue of deductibility of software payments for income-tax purpose, we have provided below our brief analysis and comments on the said issue. For the benefit of the readers, the article lays down the generic principles and the judicial precedents endorsing the deductibility of expenses incurred on computer software and the related circumstances under which such expense can be treated as revenue in nature.
Deductibility of Software Payments
Overview: Software is a general term used to describe different computer programmes and supplementary material. The term also includes the following: computer programmes, databases, programme language, guides, information stored on computerised outputs such as sound, data, printouts, software development media and the initial designs for the development of programmes. Due to the wide definition of software costs, these costs can be of a capital or revenue nature. It will be more advantageous for the taxpayer to deduct software costs over the shortest possible period and therefore obtain a cash flow advantage.
Recent Judicial Views
Recently the Delhi High Court in the case of CIT v Asahi India Safety Glass Limited (supra) while discussing the question of deductibility of software expenses under section 37 (1) held as follows:
* The expenditure incurred on application software is allowable as revenue expenditure.
* The test of enduring benefit is not certain or conclusive in determining the expenditure as capital or revenue in nature. The real intent of the expenditure and whether the expenditure results in creation of fixed capital for the taxpayer are to be examined.
* The claim of the taxpayer could not be denied which was otherwise allowable under the Act on the ground that the taxpayer had treated it differently in the books of accounts. The treatment of a particular expenditure or a provision in the books of accounts can never be conclusively determinative of the nature of the expenditure.