2017 (3) TMI 476 - AT - Income Tax

Tribunal upholds disallowance under Section 14A for investments, ERP software expenses

The Tribunal dismissed the appeals by the assessee, upholding the disallowance under Section 14A of the Income Tax Act for investments in subsidiary ... Addition u/s 14A - Held that:- In the present case, the shares are admittedly not held as stock-in-trade and, accordingly, yield dividend income or, in case of their transfer, capital gains, so that there is no scope for scaling down the disallowance u/s. 14A.In fact, the said reduction is only with reference to interest expenditure, direct or indirect, and not indirect, administrative expenditure, for which only disallowance stands made in the instant case, so that it would hold in any case (refer: Damani Estates & Finance (P.) Ltd. (2013 (8) TMI 457 - ITAT MUMBAI). The disallowance of impugned indirect, admissible expenditure under section 14A read with rule 8D (2) (iii) is, in view of the foregoing, apposite and upheld. We may, before parting, though clarify that we have based our decision on, apart from the clear language of the provision of sec. 14A read with rule 8D, the decisions in Godrej & Boyce Mfg. Co. Ltd. (2010 (8) TMI 77 - BOMBAY HIGH COURT ), which itself draws on several by the Apex Court. In fact, we observe an inconsistency insofar as the tribunal directs non-invocation of s. 14A r/w r. 8D (2)(iii) in case of strategic investments - which would though need to be proved, while at the same time approving the application of r. 8D(2) (i)/(ii) in case of borrowed capital used for such investments. Either s. 14A applies or not so in respect of such investments. If the investment being strategic is a relevant consideration - which would require defining it as well as a finding in the matter, it would exclude application of s. 14A in whole, and not in part. Disallowance u/s. 14A, it needs to be appreciated, is only qua expenditure actually incurred and claimed in relation to such investments bearing tax exempt income, and there could be no disallowance in the absence of expenditure. Therefore, to say that one limb of the said rule shall not apply for the reason that the investment is strategic, as (say) for acquiring controlling interest, while upholding the other limb, may not be proper. Besides being incongruent with the law in the matter as explained by the higher courts of law as well as the larger benches of this tribunal, the premise is internally inconsistent. Admissibility of expenditure of Enterprise Resource Planning (ERP) software - revenue or capital expenditure - Held that:- Clearly, therefore, ERP is, functionally speaking, a tool, a part of the profitmaking apparatus, of the business, for enabling it’s management and operations in a manner not possible or feasible otherwise, improving productivity in short. The assessee has not placed any material on record at any stage to exhibit or substantiate its case, nor has in any manner rebutted the findings by the Revenue or impugned the reliance/s made by it. Its’ case thus rests on and is therefore no more than a bald statement of the expenditure yielding no enduring benefit, which being allied to the functional test, is precisely question that is to be determined. Rather, broadly speaking, we do not think there is much difference, i.e., conceptually or in principle, between the hardware (computer) and the software, which are two integral components of one composite computerized environment/system, working in unison for the purpose of the assessee’s business, so that regarding one as capital, merely because it is tangible, and the other as revenue, because it is not, may not be proper. Thus Enterprise Resource Planning (ERP) software installed by the assessee denied on the ground of it representing capital expenditure, inadmissible u/s. 37(1) of the Act Issues Involved:1. Disallowance under Section 14A of the Income Tax Act, 1961.2. Admissibility of expenditure on Enterprise Resource Planning (ERP) software as revenue expenditure.3. Non-allowance of proper opportunity of hearing before the Commissioner of Income Tax (Appeals).Detailed Analysis:1. Disallowance under Section 14A of the Income Tax Act, 1961:The primary issue was whether the investments made by the assessee in subsidiary/associate companies for business purposes should attract disallowance under Section 14A. The assessee argued that these investments were for strategic reasons and should not be subject to disallowance. However, the Tribunal observed that there was no record to exhibit the purpose of the investment and proceeded on the footing that the investments were within the company's powers and interests.The Tribunal emphasized that Section 14A mandates the disallowance of any expenditure in relation to income not forming part of the total income, regardless of whether the investments were held as stock-in-trade or for business purposes. Citing precedents such as ITO v. Daga Capital Management (P.) Ltd. and Dy. CIT v. Damani Estates & Finance (P.) Ltd., the Tribunal clarified that the disallowance is independent of the head or nature of the income arising from the investments and is solely based on whether the income is tax-exempt.The Tribunal further highlighted that the assessee's claim of no expenditure incurred for these investments was untenable, as decisions related to investments involve costs, including those incurred by the Board of Directors and Management. The Tribunal referenced decisions like HSBC Invest Direct (India) Ltd. and Wella India Hair Cosmetics (P.) Ltd., which found that investments in subsidiary companies for strategic reasons do not preclude the application of Section 14A.The Tribunal upheld the disallowance of indirect expenditure under Section 14A read with Rule 8D(2)(iii), stating that the nature of the investment (strategic or otherwise) is irrelevant for the purpose of Section 14A.2. Admissibility of Expenditure on Enterprise Resource Planning (ERP) Software as Revenue Expenditure:The second issue was whether the expenditure on ERP software should be treated as revenue or capital expenditure. The Tribunal noted that the law is well-settled that if the expenditure forms part of the profit-making apparatus or adds to it, it would be considered a capital asset. The Tribunal referenced the decision in Empire Jute Company Ltd. v. CIT, which emphasized the functional test to determine whether an expenditure is capital or revenue.The Tribunal considered the detailed examination of ERP software in Sudarshan Chemical Industries Ltd., which described ERP as a complex system that significantly improves business efficiency and productivity, thus forming part of the profit-making apparatus. The Tribunal found that the assessee had not provided any material to substantiate its claim that the ERP expenditure did not yield an enduring benefit.The Tribunal also referenced the decision in Amway India Enterprises v. Dy. CIT, which emphasized the functional test and the advantage to the business in determining the nature of the expenditure. The Tribunal concluded that the expenditure on ERP software was capital in nature, yielding an enduring benefit, and upheld the decision of the authorities below.3. Non-Allowance of Proper Opportunity of Hearing Before the Commissioner of Income Tax (Appeals):The assessee had also raised a ground regarding the non-allowance of a proper opportunity of hearing before the Commissioner of Income Tax (Appeals). However, no arguments were raised before the Tribunal regarding this issue, and it was dismissed as not pressed.Conclusion:The appeals by the assessee were dismissed, with the Tribunal upholding the disallowance under Section 14A and the treatment of ERP software expenditure as capital expenditure. The issue regarding the opportunity of hearing was dismissed as not pressed. The order was pronounced on 20th February 2017 at Chennai.