2003 (3) TMI 277 - AT - Income Tax

Tribunal upholds software development expenditure as deductible under IT Act

The Tribunal dismissed the Revenue's appeals for multiple assessment years and upheld the CIT(A)'s decision to allow the expenditure on software ... Deduction under section 35 for scientific research expenditure - scientific research related to business - treatment of software development expenditure as capital or revenue - entries in books of account not conclusive for tax computation - recognition of manufacture/production of computer software as scientific researchDeduction under section 35 for scientific research expenditure - scientific research related to business - recognition of manufacture/production of computer software as scientific research - entries in books of account not conclusive for tax computation - Expenditure on development of computer software is allowable as deduction under section 35 as scientific research related to the assessee's business for the assessment years in question. - HELD THAT: - The Tribunal accepted the factual characterisation of the software-development process as involving planned investigation (systems analysis and specification), derivation of logical systems, design, programming, testing and quality assurance, with possibilities of backtracking-processes which constitute scientific research and development related to the assessee's business (paras. 13-14). Applying the statutory scheme, including the definition and scope of scientific research and the mechanism of deduction under section 35(1)(iv) and section 35(2), the Tribunal held that capital expenditure on scientific research incurred after the relevant date is deductible (paras. 14-15). The Tribunal also noted the CBDT notification treating manufacture/production of computer software as an article or thing for purposes of section 35, and accepted the Expert Advisory Committee's view that software development expenditure is eligible under section 35; Accounting Standards were held not determinative of the statutory question (paras. 16, 20). Reliance on precedent and the settled principle that book entries are not conclusive for tax computation further supported the allowance (paras. 21-22). On these bases the Tribunal concluded that the claimed software-development expenditure for the listed assessment years is allowable under section 35 as scientific research expenditure (paras. 18, 23). [Paras 18, 20, 21, 22, 23]Deduction under section 35 allowed for the software-development expenditure for the assessment years 1990-91, 1991-92, 1992-93, 1993-94 and 1995-96.Treatment of software development expenditure as capital or revenue - Whether the software-development expenditure is capital or revenue was not decided on merits for the purposes of this order. - HELD THAT: - Although the CIT(A) and parties debated whether the expenditure resulted in a valuable asset and therefore was capital in nature, the Tribunal expressly refrained from expressing a final view on the capital-versus-revenue character. The Tribunal held that allowance under section 35 as scientific research was determinative and allowed the deduction irrespective of whether the expenditure might for some purposes be regarded as capital or revenue (para. 18). [Paras 6, 18, 23]No adjudication on capital versus revenue character; allowance under section 35 granted irrespective of that classification.Final Conclusion: Revenue's appeals are dismissed and the assessee is entitled to deduction under section 35 for the software-development expenditure for AYs 1990-91, 1991-92, 1992-93, 1993-94 and 1995-96; the assessee's cross-objections have become infructuous. Issues Involved:1. Allowance of expenditure incurred on the development of software package u/s 35 and 37 of the IT Act, 1961.2. Nature of the expenditure (capital or revenue).3. Applicability of scientific research provisions u/s 35.4. Treatment of software development expenses in books of accounts vs. tax treatment.Summary:1. Allowance of Expenditure u/s 35 and 37:The primary issue in these appeals is whether the expenditure incurred on the development of software packages by the assessee can be allowed as a deduction u/s 35 or 37 of the IT Act, 1961. The AO rejected the claim under both sections, stating that the business of the assessee is development and sale of software, not research and development. The CIT(A) agreed with the AO that the expenditure created a valuable asset and should be capitalized, but allowed the deduction u/s 35 as scientific research expenditure.2. Nature of the Expenditure (Capital or Revenue):The AO and CIT(A) both concluded that the expenditure on software development resulted in a valuable asset and thus was capital in nature. The CIT(A) observed that the software development process was complex and involved highly skilled technical personnel, which justified the expenditure as scientific research under s. 35, despite being capital in nature.3. Applicability of Scientific Research Provisions u/s 35:The Tribunal agreed with the CIT(A) that the software development process involved significant research and development activities, making the expenditure eligible for deduction u/s 35. The Tribunal noted that the CBDT notification No. S.O. 452, dt. 8th Feb., 2000, supports the view that the manufacture or production of computer software is considered a scientific research activity.4. Treatment of Software Development Expenses in Books of Accounts vs. Tax Treatment:The AO objected to the different treatments of the expenditure in the books of accounts and the tax return. The Tribunal, however, held that entries in the books of accounts are not decisive for computing taxable income, citing several case laws to support this view.Conclusion:The Tribunal dismissed the Revenue's appeals for all the assessment years (1990-91, 1991-92, 1992-93, 1993-94, and 1995-96) and upheld the CIT(A)'s decision to allow the expenditure as a deduction u/s 35. The cross-objections filed by the assessee for the assessment years 1992-93, 1993-94, and 1995-96 were also dismissed as infructuous.