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2016 (3) TMI 691 - CALCUTTA HIGH COURT

2016 (3) TMI 691 - CALCUTTA HIGH COURT - [2016] 384 ITR 386 - Disallowance of agency commission paid for arrangement of loan, holding it to be capital expenditure - Whether on a true and proper interpretation of Explanation-8 to Section 43(1) of the Act interest paid on borrowed funds used for acquisition of capital assets by a running concern can be disallowed as deduction under Section 36(1)(iii) of the Act? - Held that:- The proviso to Section 36(1)(iii) was introduced with effect from 1st Ap .....

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ments are taking place rapidly and where technology which was once the state of the art becomes obsolete in a short time, the test of enduring nature cannot always reliably be applied. Software industry is one such field where advancements and changes happen at a lightning pace and it is difficult to attribute any degree of endurability even to system software let alone application software. - In view of the aforesaid discussion, question is answered in the negative and in favour of the asse .....

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e assessment year 1997-98. By the order dated 1st August, 2007 a Division Bench of this Court admitted this appeal on the following substantial questions of law:- (I) Whether on the facts and in the circumstances of the case the Tribunal erred in law in upholding the disallowance of agency commission paid for arrangement of loan, holding it to be capital expenditure? (II) Whether on a true and proper interpretation of Explanation-8 to Section 43(1) of the Act interest paid on borrowed funds used .....

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f CIT -Vs.- Associated Fiber and Rubber Industries reported in (1999) 226 ITR 471. He added that the proviso to Section 36(1)(iii) was introduced with effect from 1st April, 2004 whereas we are concerned in this case with the assessment year 1997-98. He submitted that this proviso can have no application. In any case, he added that the Supreme Court in the case of Deputy Commissioner of Income Tax -Vs- Core Health Care Ltd. reported in (2008) 298 ITR 194, has held that the proviso has only prosp .....

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no longer res integra and are covered in favor of the assessee. Therefore question number (I) is answered in the affirmative and question number (II) is answered in the negative. Before coming to question no (III) we would like to briefly discuss the facts and circumstances of the case which are relevant for deciding this issue. The assessee M/s. Indian Aluminium Co. Ltd. is engaged in the manufacture and production of aluminium and related products. During the relevant previous year the assess .....

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d the expenditure on account of software development by holding that it was a capital expenditure. To be precise the assessing officer held as follows:- In respect of (d) above, the assessee has also incurred expenditure on Rs..41,08,556/- on account of software development etc. In connection with mining practices and study on Viniculture on biodegradable Wastes on experimental basis. It was submitted on behalf of the assessee that the said package helps them in planning the production and bauxi .....

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opment expenditure for this software is purely revenue. After having considered the submision made on behalf of the assessee, it is found that the amount spent on software development was not for the purpose of facilitating the assessee s existing trading or manufacturing operations or enabling management and conduct of the assessee s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched. As can be seen from the submission made on behalf of the a .....

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the amount amortised is deleted. Aggrieved by the order of the assessing officer the assessee appealed before the Commissioner of Income Tax (Appeals) (hereinafter referred to as the CIT(A) ). The CIT(A) by an order dated 30th October, 2002 held in favour of the assessee and deleted the disallowance of the expenditure incurred on software development. To be precise the CIT(A) held as follows:- The ratio decidendi laid down in the aforesaid judgement has been reiterated by the Supreme Court In C .....

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ring benefit as assessee has to change these software within a short span of time i.e. 4 months or 6 months and that at times it is of no use at all because it become outdated because of change of system and change of technology. The Tribunal further observed that the time is fast changing day by day, and the new systems are being developed and software is needed like raw material in manufacturing. The Tribunal, therefore held that the software expenses are of purely revenue nature and are allow .....

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the assessee states that the software development expenditure was on experimental basis. Actually this package helps in planning the production and bauxite grade control in mines. This software covers geological data processing, mine field surveying, mine excavation planning and grade control. Therefore, it is a planning tool in the hands of production department of mines. It helps the assessee in gauging proper control for effective mining since it gives statistics of bauxite deposits by way o .....

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wing the claim towards software development expenditure. In view of this addition made by the Assessing Officer of an amount .of ₹ 41,08,556/- is deleted. The Assessing Officer is also directed to withdraw depreciation allowed on this item. Further, the amortized amount of ₹ 2,40,000/- is to be added to the income. The revenue appealed against the order of the CIT(A) before the Tribunal. The Tribunal by an order dated 15th December, 2002 reversing the order of the CIT(A) held that th .....

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and it will be useful for a long period, thus it would be of enduring benefit to the assessee. Therefore, the A.O. rightly treated the same to be capital expenditure. In support of this contention, the ld. D.R. relied upon the following decisions a) 259 ITR 30 (Raj) - CIT -Vs.- Arawali Constructions Co. P. Ltd. b) ITAT order in assessee s own case for A.Y. 2002-03. The learned counsel for the assessee, on the other hand, stated, that the software normally has a very short life and they have to b .....

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ACIT [(2005) 1 507' 91 (Del)] d) Business Information Processing Services -vs.- ACIT 73 ITD 304 (JP) e) ITC Classic Finance Ltd. -vs. DCIT 112 Taxman 155 (Cal) We have carefully considered the rival submissions and perused the material placed before us. During the year under consideration, the assessee has incurred expenditure of ₹ 41,08,556/- on account of software development in connection with mining practices and study on verniculture on bio-degradable wastes on experimental basis. .....

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the assessee, viz. Arawali Constructions Co. Pvt. Ltd. had acquired computer software which is used as technique for mining operation. The expenditure on acquisition of the software was claimed as a revenue expenditure by the assessee. The A.O. treated the same as capital expenditure. The CIT (A) and ITAT held the expenditure to be revenue expenditure. On reference Their Lordships of Hon ble Rajasthan High Court answered the reference in favour of the revenue and against the assessee with the fo .....

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ed as a capital asset and expenditure on that is capital expenditure. Considering. these facts and the decision of their Lordships and a later decision of the Bombay High Court, in our view, the acquisition technical know-how-how is capital expenditure, therefore, the Assessing Officer has rightly treated the expenditure on acquiring the computer software as expenditure of capital nature and rightly allowed depreciation as per rules. In the result, we answer the reference in negative, i.e. in fa .....

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incurred the expenditure on maintenance of computers and their upgradation including software. Thus the facts in that case were altogether different because the expenditure was on upgradation of computers including software. Moreover, in the above case, Their Lordships of Delhi High Court did not admit the revenue s appeal holding that no substantial question of law arises. Thus there is no decision on merit by Their Lordships of Delhi High Court. Therefore, the above decision would be of no hel .....

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hether an expenditure on acquisition of software is a capital expenditure or a revenue expenditure would depend on the facts of each case. Considering the facts of the assessee s case we are of the opinion that the facts in the assessee s case are identical to the facts of Arawali Constructions Co. P. Ltd. (supra) before the Hon ble Rajasthan High Court and therefore the said decision of Hon ble Rajasthan High Court would be squarely applicable. Therefore, respectfully following the same we reve .....

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e this was an application software as was contended before the assessing officer at page 51, this should have been allowed as a revenue expenditure. Mr. Bhowmik submitted that this is an addition to the capital asset of the assessee and, therefore, is a capital expenditure. He relied on a judgment of the Rajasthan High Court in the case of CIT Vs. Arawali Constructions Co. (P.) Ltd. reported in (2003) 259 ITR 30 following a judgment of the Bombay High Court in the case of CIT Vs. Premier Automob .....

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oftware provides benefit of an enduring nature. He contended that in that view of the matter there is no scope to contend that the expenditure is revenue in nature. Mr. Khaitan submitted that benefit of an enduring character should be viewed realistically, regard being had to the rapid changes in the area of computers. In support of his submission, he relied on the judgment in the case of Alembic Chemical Works Co. Ltd. V. CIT reported in (1989) 177 ITR 377 at page 390. He also relied on a judgm .....

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ich pure aluminum is manufactured by various industrial processes. Therefore bauxite is a basic raw material for manufacturing aluminum. The software used by the assessee has the following characteristics:- 1. It is an application package developed on Windows NT. 2. It helps the assessee in planning the production and bauxite grade control in mines. 3. It covers geological data processing, mine field surveying, mine excavation planning, and grade control. 4. It is a planning tool in the hands of .....

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pose of facilitating the assessee s existing trading and manufacturing operations or enabling management and conduct of the assessee s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched. 2. Expenditure on software development was incurred with a view to obtain an asset or advantage of a permanent nature. Before proceeding further we would like to clarify an important aspect which appears to have eluded the attention of all the authorities belo .....

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he facts it reveals that nowhere the assessee states that the software development expenditure was on experimental basis. In Asahi Safety Glass (supra) the assessee was engaged in the business of manufacturing safety glass used in automobiles. The assessee entered into an agreement with Arthur Anderson & Associates for installation of a software application for assistance in areas related to financial accounting, inventory and purchase. According to the said agreement the assessee was also r .....

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s stand took recourse to the test of enduring benefit. The Delhi High Court rejected the Revenue s contention and held as follows:- The revenue in support of its stand has taken recourse to the test of enduring benefit. It is in our view now somewhat trite to say that the test of enduring benefit is not a certain or a conclusive test which the Courts can apply almost by rote. What is required to be seen is the real intent and purpose of the expenditure and whether the expenditure results in crea .....

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tructure 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 may last for an indefinite period. Test of enduring benefit or advantage would thus collapse in such like cases. It would in our view be only truer in cases which deal wi .....

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hereinabove, that the assessing officer as a matter of fact has returned a finding that the expenditure undertaken was for overhauling the accountancy of the assessee and to efficiently train the accounting staff of the assessee. The Tribunal, which is decidedly the final fact finding authority has after noticing the material on record observed that the expenditure was incurred under various sub-heads, which included licence fee, annual technical support fee, professional charges, data entry ope .....

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aid that the expenses brought about in an enduring benefit to the assessee. The assessing officer was perhaps swayed by the fact that in the succeeding financial year, i.e., 1997-98 (assessment year 1998-99), the amount spent was large. First of all, the extent of the expenditure cannot be a decisive factor in determining its nature… 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., th .....

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quired to write programmes. (See Microsoft Computer Dictionary, 5th Edition Software at page 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. The fact that the application software would have to be updated from time-to-time based on the requirements of the assessee in the context of the advancement of its business .....

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ture 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. The Tribunal in the instant case has held against the assesse .....

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expenditure incurred was debited to Profit and Loss Account. The assessee also made the following submission:- This is not an asset, as stated by you during the course of discussion, as the life of this is restricted to shorter period, for a particular time only this thing is required and again they have to get the programme when get another nature of work…. whereas software is just a programme and it cannot be called a capital expenditure. The assessing officer rejected the assessee s co .....

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and nothing but a consultancy fee being paid to Hindustan Computers Ltd. The Assessing Officer noticed that in the agreement, nowhere is it stated that the amount has been paid for consultancy fee and in fact it is an out-right purchase of a computer programme which relates to technical know-how. It is an asset of capital nature, therefore, treating it as an asset, he allowed depreciation admissible in the rules. In appeal before the Commissioner of Income-tax (Appeals), the Commissioner of Inco .....

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61, have no application. In Shriram Refrigeration Industries Ltd. v. CIT, [1981] 127 ITR 746 (Delhi), there was a collaboration agreement, a licence was given to the assessee to manufacture and sell particular items, there was no transfer or parting with secret process and technical knowledge to the assessee, a lump sum payment was made in addition to royalty based on the sale price of the manufactured articles, it was treated as revenue expenditure. When the technical know-how has not been tran .....

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n on this issue whether technical know-how is a capital expenditure or a revenue expenditure. In the case of CIT v.Premier Automobiles Ltd., [1994] 206 ITR 1, wherein the Bombay High Court has taken the view that the technical know-how is a capital expenditure and expenses incurred on technical know-how are entitled for depreciation under section 32 of the Income-tax Act, 1961. In CIT v. Elecon Engineering Co. Ltd., [1987] 166 ITR 66 (SC), their Lordships have considered the issue that in an agr .....

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de for outright sale of computer software which is used as technique in mining operations. The finding of the Commissioner of Income-tax (Appeals) is that the acquisition of software cannot be treated to be an asset of endurable nature. If the programme is used in one mining to another mining operation why it should not be treated as a capital asset and expenditure on that is capital expenditure. Considering these facts and the decision of their Lordships and a later decision of the Bombay High .....

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company is entitled to depreciation on the price paid for acquisition of drawings, blue prints, specifications, process sheets and technical data from Henry Meadows Ltd. of England being plant within the meaning of section 32 of the Income-tax Act, 1961, for each of the assessment years 1970-71, 1971-72 and 1972-73? 3. Whether, on the facts and in the circumstances of the case, the assessee-company is entitled to depreciation on the expenditure of £2,000 incurred by the assessee for the pu .....

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's own case which is reported in Premier Automobiles Ltd. v. CIT, [1984] 150 ITR 28. The entire amount paid by the assessee for acquisition of drawings, blue prints, specifications, process sheets and technical data, etc., in respect of which depreciation has been allowed by the Tribunal in this case to the assessee, has been held in the above case to be revenue expenditure and allowed as a deduction in the computation of the income of the assessee for the year in which the payment had been .....

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from Henry Meadows Ltd. of England for the assessment years 1970-71, 1971-72 and 1972-73. This question is, therefore, answered in the negative and in favour of the Revenue and against the assessee… As regards question No. 3, which is referred to at the instance of the Revenue, it is agreed by counsel for the parties that in view of the decisions of the Supreme Court in Scientific Engineering House P. Ltd. v. CIT, [1986] 157 ITR 86 and CIT v. Elecon Engineering Co. Ltd., [1987] 166 ITR 66 .....

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t mining activity for the extraction of Bauxite. Application software is distinct from system software as it has to be constantly updated due to rapid advancements in technology and increasing complexity of the features. The distinction between system software and application software was also considered by the Karnataka High Court in CIT v. IBM India Ltd (supra). The issue that arose for consideration was whether the Tribunal was correct in holding that the purchase of software amounting to  .....

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nduring benefit but is not with a view to bringing into existence any asset, the same cannot be always classified as capital expenditure. The test to be applied is, is it a part of the company's working expenses or is it expenditure laid out as a part of the process of profit earning. Is it on the capital layout or is it an expenditure necessary for acquisition of property or of rights of a permanent character, possession of which is condition on carrying on trade at all. The assessee in the .....

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yment of such application software, though there is an enduring benefit, it does not result into acquisition of any capital asset. The same merely enhances the productivity or efficiency and, hence, to be treated as revenue expenditure. In fact, this court had an occasion to consider whether the software expenses is allowable as revenue expenses or not and held, when the life of a computer or software is less than two years and as such, the right to use it for a limited period, the fee paid for .....

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t. It merely enhances the productivity or efficiency and, therefore, it has to be treated as revenue expenditure. In that view of the matter, the finding recorded by the Tribunal is in accordance with law and does not call for any interference. Accordingly, the second substantial question of law is answered in favour of the assessee and against the Revenue. In the instant case the revenue has relied on the principle of enduring nature to contend that the expenditure incurred by the assessee was .....

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e claimed the expenditure incurred on software packages as revenue expenditure, but the same was disallowed by the Revenue. The concept of enduring benefit must respond to the changing economic realities of the business. The expenses incurred by installation of software packages in the present computer world, which revolves on the modern communication technology, enables the assessee to carry on its business operations effectively, efficiently, smoothly and profitably. However, such software its .....

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o. (supra) has cautioned the courts against the application of the test of enduring nature without considering the surrounding circumstances. The Apex Court held as follows:- The decided cases have, from time to time, evolved various tests for distinguishing between capital and revenue expenditure but no test is paramount or conclusive. There is no all embracing formula which can provide a ready solution to the problem; no touchstone has been devised. Every case has to be decided on its own fact .....

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only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital. This test, as the parenthetical clause shows, must yield where there are special circumstances leading to a contrary conclusion and, as pointed out by Lord Radcliffe in Commissione .....

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ry advantage of enduring nature, acquired by an assessee that brings the case within the principle 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. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to b .....

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including penicillin. With a view to increasing the yield of penicillin, the assessee negotiated with M/s Meiji a reputed enterprise engaged in the manufacture of antibiotics in Japan, which agreed to supply to the assessee the requisite technical know-how so as to achieve substantially higher levels of production. The negotiations culminated in an agreement dated 9-10-1963, whereunder Meiji, in consideration of the once for all payment of 50,000 US dollars (then equivalent to ₹ 2,39,625) .....

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nd to advise the assessee in the large scale manufacture of penicillin for a period limited to 2 years from the effective date of the agreement. The assessee claimed that ₹ 2,39,625 paid under the agreement to Meiji was one laid out wholly and exclusively for the purpose of the business and claimed its deduction as a revenue expenditure. The Income Tax Officer, on the view that the expenditure was for the acquisition of an asset or advantage of an enduring benefit, held it to be a capital .....

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ate of the art in some of these areas of high priority research is constantly updated so that the know-how cannot be said to be the element of the requisite degree of durability and non-ephemerality to share the requirements and qualifications of an enduring capital asset. The rapid strides in science and technology in the field should make us a little slow and circumspect in too readily pigeonholing an outlay, such as this as capital. The circumstance that the agreement insofar as it placed lim .....

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