Depreciation on capitalised software asset cannot be denied under withholding disallowance rules for non-deduction of tax at source.

Section 40(a)(ia) disallows otherwise deductible business expenditure where tax deductible at source is not deducted or paid, but that mechanism does not extend to depreciation on a capitalised software asset. Depreciation is a statutory allowance under Section 32, not a revenue expense claimed in the profit and loss account, so non-deduction of tax at source may trigger withholding consequences but not denial of depreciation. The disallowance of depreciation under Section 40(a)(ia) was therefore held impermissible and relief was allowed to the assessee.

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Issues: Whether disallowance of depreciation on software purchase could be made under Section 40(a)(ia) of the Income-tax Act, 1961, where the expenditure had been capitalised and tax was not deducted at source at the time of payment.

Analysis: Section 40(a)(ia) operates to disallow otherwise deductible business expenditure where tax deductible at source has not been deducted or paid. Capitalised expenditure is not claimed as a revenue outgoing in the profit and loss account, whereas depreciation is a statutory allowance under Section 32 of the Income-tax Act, 1961 on an eligible asset. The non-deduction of tax at source may attract consequences under the withholding provisions, but the disallowance mechanism under Section 40(a)(ia) does not extend to denial of depreciation on a capitalised asset.

Conclusion: Disallowance of depreciation under Section 40(a)(ia) was not permissible and the issue was decided in favour of the assessee.

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