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 (software) providing enduring benefits and generating revenue. Consequently, the expenditure was treated as capital expenditure. Regarding the rate of depreciation, the Tribunal allowed a 60% depreciation rate on the capitalized expenditure, considering computer software as a tangible asset. The appeal was partly allowed in favor of the assessee on these grounds.

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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.

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