2013 (11) TMI 1267 - AT - Income Tax

Tribunal rules software development cost as capital expenditure, allows 60% depreciation rate

The Tribunal determined that the product development expenditure incurred by the assessee is of a capital nature, resulting in the creation of an asset ... Nature of Cost - Product development cost - Revenue or Capital - Held that:- The expenditure incurred by the assessee in the development of software is capital in nature - Following Millennium Infocom Technologies Limited. Versus Assistant Commissioner Of Income-tax, Circle - 6(1), New Delhi. [2008 (1) TMI 437 - ITAT DELHI-E] and Empire Jute Co. Ltd. Vs.CIT [1980 (5) TMI 1 - SUPREME Court] - The assessee was enjoying benefits from the sale of software to different customers - The prototype of the software remains with the assessee - The assessee is only giving copy of the software without disclosing the intricate method of developing the same to its prospective customers. Depreciation on expenditure incurred in the development of computer software – Held that:- Depreciation @ 60% has been provided on computer software and hardware - The CIT(A) on the one hand has given its findings that the assessee has not shown any asset in its balance sheet, therefore, the assessee is not entitled for depreciation @ 60%, on the other hand, the CIT(A) has allowed depreciation @ 25% to the assessee treating it as copy right or intangible asset - Once it is held that the expenditure incurred by the assessee for the development of the software is capital in nature, the software developed by the assessee is an asset of the assessee. Relying upon Tata Consultancy Services Vs. State of Andhra Pradesh [2004 (11) TMI 11 - Supreme Court ] - computer software is a tangible asset - As per clause III (5) of New Appendix I read with Rule 5 of the Income Tax Rules, 1962, rate of depreciation as applicable to computer software is 60% - thus the assessee is entitled to claim depreciation @ 60% on expenditure incurred in the development of computer software being capital in nature – Decided partly in favour of Assessee. Issues Involved:1. Whether the product development cost is revenue or capital in nature.2. Determination of the appropriate rate of depreciation if the expenditure is treated as capital in nature.Detailed Analysis:1. Nature of Product Development Cost:The primary issue in this appeal is whether the product development cost incurred by the assessee is revenue or capital in nature. The assessee, engaged in the development and export of computer software, claimed that the expenditure related to salary, travel, rentals, consumables, and electricity charges should be treated as revenue expenditure. The assessee argued that these costs are part of the day-to-day functioning and are incurred in anticipation of future orders, classifying them as product development expenditure.The Assessing Officer (AO) disagreed, stating that the expenditure resulted in creating a prototype used to develop software for different systems, thus generating future income. Consequently, the AO treated the entire expenditure of Rs. 4,56,96,957/- as capital in nature.The CIT(A) upheld the AO's decision, stating that the expenditure incurred on software development is capital expenditure. The CIT(A) noted that the product development expenditure was treated as a capital asset by the assessee in its books, amortized over three years, and thus should be capitalized.Upon appeal to the Tribunal, the assessee reiterated its stance, emphasizing that the expenditure did not generate any capital asset nor resulted in enduring benefit, and should be allowable under Section 37 of the Income Tax Act. The Tribunal referred to the Supreme Court's judgment in Empire Jute Co. Ltd. Vs. CIT, which laid down tests for distinguishing between capital and revenue expenditure. It was noted that the nature of the advantage in a commercial sense is crucial, and if the advantage facilitates trading operations without affecting fixed capital, the expenditure is on revenue account.However, the Tribunal concluded that the expenditure incurred by the assessee resulted in the creation of an asset (software) that provided enduring benefits and generated revenue, thus classifying it as capital expenditure.2. Appropriate Rate of Depreciation:The second issue concerned the rate of depreciation applicable if the expenditure is capitalized. The assessee argued for a 60% depreciation rate applicable to computer software, while the CIT(A) allowed only 25%, treating it as an intangible asset or copyright.The Tribunal observed that once the expenditure is treated as capital in nature, the software developed becomes an asset of the assessee. Citing the Supreme Court's judgment in Tata Consultancy Services Vs. State of Andhra Pradesh, which held that computer software is a tangible asset, the Tribunal concluded that the appropriate rate of depreciation is 60% as per clause III (5) of New Appendix I read with Rule 5 of the Income Tax Rules, 1962.Conclusion:The Tribunal held that the product development expenditure incurred by the assessee is capital in nature. However, the assessee is entitled to claim depreciation at the rate of 60% on the capitalized expenditure. The appeal was thus partly allowed in these terms.