Depreciation on capitalised software cannot be denied under tax-deduction rules; server and network equipment qualify for higher computer depreciation.

Section 40(a)(i)/(ia) does not disallow depreciation on software that has been capitalised, because the provision applies to amounts otherwise deductible as business expenditure and not to a statutory depreciation allowance on a capital asset; the assessee's claim on software depreciation was therefore allowed. The software transaction analysis also noted that mere use of a copyrighted article does not, by itself, constitute royalty where no right to commercially exploit the copyright is transferred, and the treaty override under section 90(2) was relevant where applicable. Server and network equipment were treated as integral to the computer system, so higher depreciation as computer assets was upheld.

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Issues: (i) Whether depreciation claimed on software capitalised in the books could be disallowed under section 40(a)(i)/(ia) of the Income-tax Act, 1961 for alleged non-deduction of tax at source on payment for software. (ii) Whether the assessee was entitled to higher depreciation on server/network equipment as part of computer assets.

Issue (i): Whether depreciation claimed on software capitalised in the books could be disallowed under section 40(a)(i)/(ia) of the Income-tax Act, 1961 for alleged non-deduction of tax at source on payment for software.

Analysis: The software purchases were capitalised and no revenue deduction was claimed for the purchase price. Section 40(a)(i)/(ia) operates on amounts otherwise deductible as expenditure and is directed to outgoing sums chargeable under the Act; it does not govern a statutory depreciation allowance on a capital asset. The decision on royalty treatment was also tested against the later law laid down on software transactions, including the principle that mere use of a copyrighted article does not by itself amount to royalty when no right to commercially exploit the copyright is transferred. The treaty override under section 90(2) further supported the assessee where applicable.

Conclusion: The disallowance of depreciation on software was not sustainable; the issue was decided in favour of the assessee.

Issue (ii): Whether the assessee was entitled to higher depreciation on server/network equipment as part of computer assets.

Analysis: The claim was covered by the assessee's earlier year decision, and the equipment was treated as integral to the computer system for depreciation purposes. No contrary material was shown to depart from the earlier view.

Conclusion: The assessee was entitled to higher depreciation on server/network equipment; the issue was decided in favour of the assessee.

Final Conclusion: The transfer pricing grounds having become infructuous, the remaining substantive disputes were resolved by allowing the assessee's claim on software depreciation and sustaining the higher depreciation on server/network equipment.

Ratio Decidendi: Section 40(a)(i)/(ia) does not disallow depreciation on a capitalised asset, because depreciation is a statutory allowance and not an expenditure payable for business operations.

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