Software development cost as capital expenditure, with depreciation allowed at the applicable higher rate on the resulting asset.

Product development cost incurred to create software that generated future revenue was treated as capital expenditure because it brought into existence an asset with enduring advantage in the capital field. The fact that the outlay consisted of salaries, travel, rentals, consumables and electricity did not alter its character, and book treatment was not conclusive. Once capitalised, the resulting computer software qualified as an asset, and depreciation was allowable at 60% under the applicable software depreciation rate rather than 25%.

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Issues: (i) Whether product development cost incurred for software development was revenue expenditure or capital expenditure. (ii) If the expenditure was capital in nature, whether depreciation was allowable at 60% on computer software.

Issue (i): Whether product development cost incurred for software development was revenue expenditure or capital expenditure.

Analysis: The expenditure was incurred to bring into existence software that generated revenue for the assessee in future. The software developed constituted an asset of the assessee and gave an enduring advantage in the capital field. The nature of the outlay was not changed by the fact that it comprised salary, travel, rentals, consumables, electricity and similar items, and the treatment in the books was not conclusive. Applying the functional and enduring benefit tests, the expenditure was held to be capital in nature.

Conclusion: The product development cost was held to be capital expenditure and not allowable as revenue expenditure under section 37.

Issue (ii): If the expenditure was capital in nature, whether depreciation was allowable at 60% on computer software.

Analysis: Once the software development outlay was treated as capital expenditure, the resulting software was an asset of the assessee. The applicable depreciation rate for computer software was taken from the relevant Appendix and rule governing depreciation on such asset, and the view taken by the lower authority allowing 25% was found unsustainable.

Conclusion: The assessee was held entitled to depreciation at 60% on the capitalised software development expenditure.

Final Conclusion: The appeal succeeded only in part, with the software development expenditure characterised as capital while the assessee received the higher depreciation benefit on the resulting asset.

Ratio Decidendi: Expenditure incurred to create a software asset that generates enduring commercial advantage is capital in nature, and once so classified, the resulting computer software is eligible for depreciation at the rate applicable to that asset class.

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