$~
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ INCOME TAX APPEAL NOS. 25/2012, 287/2008,
417/2009, 447/2009, 461/2009, 683/2009
Reserved on: 2nd September, 2013
Date of decision: 25th November, 2013
ORACLE INDIA PRIVATE LIMITED
..... Appellant
Through Mr. M.S. Syali, Sr. Advocate with
Ms. Husnal Syali Nagi, Mr. Mayank Nagi
and Mr. Harkunal Anand, Advocates.
versus
COMMISSIONER OF INCOME TAX
..... Respondent
Through Mr. Sanjeev Sabharwal, Sr.
Standing Counsel & Mr. Puneet Gupta,
Advocate.
INCOME TAX APPEAL NOS. 797/2006, 951/2006,
961/2006, 390/2007
ORACLE SOFTWARE INDIA LIMITED
..... Appellant
Through Mr. M.S. Syali, Sr. Advocate with
Ms. Husnal Syali Nagi, Mr. Mayank Nagi
and Mr. Harkunal Anand, Advocates.
versus
COMMISSIONER OF INCOME TAX
..... Respondent
Through Mr. Sanjeev Sabharwal, Sr.
Standing Counsel & Mr. Puneet Gupta,
ITA No. 25/2012- connected appeals Page 1 of 32
Advocate.
CORAM:
HON'BLE MR. JUSTICE SANJIV KHANNA
HON'BLE MR. JUSTICE SANJEEV SACHDEVA
SANJIV KHANNA, J.:
These 10 appeals by the assessees-Oracle India Private Limited
and Oracle Software India Limited relating to Assessment Years 1994-
95 to 2004-2005 raise a common substantial question of law and are,
therefore, being disposed of by this decision. The substantial question
of law as admitted for hearing reads:-
"Whether on the facts and in the
circumstances of the case, the Income Tax
Appellate Tribunal was justified in holding
that media cost paid for the import of a master
copy of Oracle Software used for duplication
and licensing is an expenditure of a capital
nature and as such is not an allowable
deduction?"
2. For the purpose of clarity and to notice facts, ITA No. 797/2006,
which relates to Assessment Year 1995-96, was treated as a lead case
but as noticed below, wherever necessary and required we have
referred to facts of assessment year 1994-95.
3. The appellant-assessee incorporated on 18th January, 1993, is a
subsidiary of Oracle Corporation, USA. The appellant entered into
licence agreement dated 28th May, 1993 with its parent/holding
company under which the appellant was granted non-exclusive non-
ITA No. 25/2012- connected appeals Page 2 of 32
assignable right and authority to duplicate on appropriate carrier media
software products mentioned in schedule ,,A thereto or other products
which may be added to the said list, and sub-licence the same to third
parties in India. The appellant could enter into enforceable sub-
licensing and services agreement in the prescribed form with third
parties users. The holding company retained ownership of the
copyright in the software and all associated and applicable intellectual
property rights in the products mentioned in schedule ,,A or to be
added to the said schedule. It was specifically stipulated that nothing
contained in the agreement shall confer or deem to confer on the
appellant any of the aforesaid rights. The holding company also
retained rights to continue to manufacture or distribution activities in
the field of software and software products, including the products
mentioned in schedule ,,A or to be added to the said schedule with full
rights to produce, reproduce, duplicate and distribute the said products
in India or into India. The agreement stipulated that the appellant shall
duplicate and reproduce the software in India and sub-licence the same
as per the terms of the sub-licence deed stipulated and with the holding
company retaining entire data/intellectual property rights in the
software. The appellant was entitled to use the trademark and trade
name of the holding company with approval as to the manner of use
from the holding company and no royalty or remuneration was to be
ITA No. 25/2012- connected appeals Page 3 of 32
paid for the said use.
4. The appellant was to pay royalty to the holding company @
30% of the list price of the licenced products as prescribed in the
Indian Published Price, fixed in consultation with the licensor at the
time of the sub- licence or such lesser amount agreed to. Royalty was
to be also paid on software products put to internal use. The royalty
was payable on quarterly fiscal basis and was subject to deduction of
tax at source. The licence agreement was for a period of five years but
it appears it was extended for further period relevant to the assessment
years in question.
5. In addition to the aforesaid royalty, the appellant had also paid
the following amounts to the parent company reflected as expenditure
on import of software master copy:-
S No. ITA Assessment Year Expenditure on import of
software master copy
1 951/06 1994- 95 94,49,041
2 797/ 06 1995-96 1,02,34,099
3 961/06 1996-97 82,39,876
4 390/07 1997-98 49,87,045
5 287/08 1998-99 72,49,066
6 461/09 1999-2000 45,52,944
7 417/09 2000- 01 20,05,860
8 447/09 2001- 02 17,37,557
9 683/09 2002- 03 4,11,177
10. 25/ 12 2004- 05 14,40,342
6. The aforesaid payments were not made in lumpsum, but on
distinct and separate dates in each assessment year on import of the
ITA No. 25/2012- connected appeals Page 4 of 32
master media from the holding company. To avoid prolixity, we are
not reproducing details of import in each assessment year but for the
purpose of clarity, we are reproducing details of the said import in the
Assessment Year 1994-95:-
"
Invoice Invoice Invoice Bill of Bill of No. of
No. Date Value (in Entry No. Entry Copies
IEP) Date
13896 20/10/93 158.88 264270 18/11/93 2
13962 26/10/93 599.60 264271 18/11/93 25
13910 21/10/93 807.10 264860 19/11/93 24
13307 16/9/93 411.00 264800 11-10-93 20
14619 12-1-93 113.26 274179 27/12/93 2
14942 17/12/93 716.83 274191 27/12/93 10
14698 12-6-93 168.84 274540 28/12/93 15
14745 12-8-93 150.47 275522 31/12/93 3
15045 23/12/93 194.93 275525 31/12/93 4
15044 23/12/93 209.25 275518 31/12/93 2
14821 13/12/93 143.84 275733 31/12/93 4
15287 14/1/94 7381.85 204690 24/1/94 351
15165 1-7-94 2028.38 204703 24/1/94 150
15228 1-11-94 274.59 204705 24/1/94 5
15156 1-7-94 6702.20 205951 29/1/94 700
15191 1-10-94 808.91 204701 24/1/94 110
15336 17/1/94 241.29 206483 31/1/94 10
15385 19/1/94 1282.47 207246 2-2-94 129
15425 21/1/94 740.73 207259 2-3-94 15
15541 26/1/94 324.17 209405 2-11-94 15
15578 27/1/94 234.83 209403 2-11-94 5
15501 25/1/94 327.70 209429 2-11-94 15
15604 28/1/94 401.69 209399 2-11-94 20
15656 31/1/94 192.19 209401 2-11-94 3
15569 27/1/94 344.46 209397 2-11-94 5
16395 3-11-94 326.87 220380 28/3/94 5
14206 11-11-93 208.70 266143 24/11/93 5
14186 11-10-93 535.55 266135 24/11/93 10
Total IEP 26,030.58 Total 1664
ITA No. 25/2012- connected appeals Page 5 of 32
"
7. The Assessing Officer held that the aforesaid payments of
Rs.94,49,041/- for the Assessment Year 1994-95 and similar payments
for the other years described as software master copy and
documentation was capital expenditure and not revenue in nature. He
referred to the agreement dated 28th May, 1993, which was for a term
of five years and observed on interpreting the terms that the appellant
had acquired copyright and all other associated and applicable
Intellectual Property Rights. He invoked Section 35A and held that on
this amount, the appellant was entitled to deduction equal to 1/14 th of
the expenditure as it was incurred on acquisition of copyright. He held
that there was transfer of copyright, in addition to other associated and
applicable Intellectual Property Rights by Oracle Corporation, USA to
the appellant company and the appellant had acquired the said rights
for the purpose of business.
8. For the Assessment Years 1994-95 to 2004-2005, Commissioner
of Income Tax (Appeals) reversed the finding of the Assessing Officer
to this extent. For the Assessment Year 1994-95, Commissioner
(Appeals) observed that the obsolescence rate in software industry was
extremely high and updated version of softwares were developed
frequently. Some softwares had a commercial life of only 1 - 2 months
and had to be substituted by an upgraded version thereby making the
ITA No. 25/2012- connected appeals Page 6 of 32
earlier version redundant or useless. Referring to the agreement, he
observed that the intellectual property rights in the software were not
transferred to the appellant by Oracle Corporation, USA. Royalty was
payable to Oracle Corporation, USA based upon the number of copies
duplicated from each original master copy sold or sub-licensed to third
parties. Large number of master copies were imported every 2-3
weeks. As far as royalty payment was concerned, there was no dispute
that it was revenue in nature. Similarly, the cost of procuring the
master copy was of recurring nature, which was established and proved
beyond doubt from shipment of numerous master copies and the fact
that there was no single lumpsum payment. He observed that firstly,
master copy updated software had to be procured, which was a
recurring expenditure. Secondly, there was no enduring benefit as
there were corrections; strides and frequent upgradation of software.
Thirdly, the expenditure incurred in question was for conduct of
business as an integral part of profit earning process and not for
acquisition of assets or right of permanent character. Fourthly, the
expenditure in question was in nature of procurement of raw material
for the purpose of business and not to procure capital and, therefore,
was a part of working capital of the company.
9. After noticing these facts, the Commissioner (Appeals) deemed
it appropriate to ask for remand report. The Assessing Officer
ITA No. 25/2012- connected appeals Page 7 of 32
submitted a report and also appeared in person. Before the first
appellate authority, the assessing officer somewhat changed his stance
and submitted that the expenditure was in the nature of technical
services and know-how but, tax at source had not been deducted. It
was accordingly pleaded that if the expenditure was to be allowed as
revenue, it cannot be allowed as a deduction as per Section 40(a)(i) of
the Income Tax Act, 1961 (herein after referred to as the "Act").
Commissioner (Appeals) did not agree with the Assessing Officer and
observed that the expenditure incurred was neither for extension of
business nor for substantial replacement of equipment, which related to
carrying on or conduct of business and an integral part of profit making
process. It was nothing but for procurement of raw material. He
overturned the finding of the Assessing Officer that the appellant had
acquired right of enduring nature by importing master copies and also
rejected the finding that Section 35A was applicable. The price paid
for the master copy or royalty payment did not involve transfer of
intellectual property rights and no such rights were acquired by the
appellant. The price at which the product was sold did not include the
cost of intellectual property right. He noticed that the Assessing
Officer in the appellate proceedings for the first time had relied upon
Section 40(a)(i) and observed that the cost of the master copy does not
constitute technical know-how or royalty under Section 9 of the Act.
ITA No. 25/2012- connected appeals Page 8 of 32
The transaction in question, i.e., import of master copy was separate
and could not be inter-linked with payment of royalty. It was held that
the payments made for acquisition of the master copy should be
allowed as business expenditure under Section 37 of the Act.
Commissioner (Appeals) for the Assessment Year 1994-95 gave a
categorical finding that there was no transfer of intellectual property
rights and the copyright continued to vest and remain with Oracle
Corporation, USA. The master copies were not of enduring
nature/benefit as they had to be updated frequently in view of high
degree of obsolescence. Price paid for the master copy did not include
cost involved in transfer of rights in the software. Royalty was paid
towards intellectual property rights of the Oracle Corporation, USA
and the cost of the master copy did not include the said price.
10. Tribunal by their order dated 28th October, 2005, which was a
common order, relating to Assessment Years 1994-95, 1995-96, 1996-
97 reversed the order of the Commissioner (Appeals) and restored the
view taken by the Assessing Officer. We would like to reproduce two
paragraphs from the said impugned order as the same reflect the core
of the findings recorded by the tribunal:-
"3.4 We have perused the records and
considered the rival contentions carefully. The
assessee is a 100% subsidiary of Oracle
Corporation, USA and is authorised as per the
agreement signed to sub-lease the software
ITA No. 25/2012- connected appeals Page 9 of 32
products developed by the foreign company.
For this purpose, the assessee has imported the
Master Copy of the softwares as goods under
the open general licence scheme of the Export
Import Trade Policy. The assesse is making
duplicate copies from the Master Copy and
selling it to local clients. For importing the
Master copy it has paid a lumpsum
consideration and is also paying royalty @ 30%
of the listed price of duplicate softwares sold
locally. The Assessing Officer treated the
lumpsum consideration paid for import of the
Master Copy as capital expenditure holding that
it was an asset of enduring benefits to the
assessee.
3.5 The import of Master Copy with the
righty of duplication is definitely an asset of
enduring benefit. But whether the expenditure
on the acquisition of the same can be
considered as capital expenditure or a revenue
expenditure has to be examined in the light of
judicial pronouncements on the subject. The
payment of lumpsum consideration or enduring
benefits are not conclusive tests in deciding
whether an expenditure is a revenue
expenditure or capital expenditure as held by
the Supreme court in the case of M/s Empire
Jute company (124 ITR 1) and subsequently
reiterated in the case of M/s Alembic Chemical
Works (177 ITR 377). It would be pertinent to
elaborate these cases which will be useful in
understanding the true nature of the expenditure
in the instant case."
11. Thereafter, reference was made to the facts and the ratio in the
case of Empire Jute Company (1980) 124 ITR 1 (SC) and Alembic
Chemical Works (1989) 177 ITR 377 (SC) and it was observed that
imported master copy was used for duplicating copies of software and,
ITA No. 25/2012- connected appeals Page 10 of 32
therefore, a part of the profit earning apparatus. It was not a case
where the appellant had imported some know-how device or device by
which copying of software was done more efficiently. Once master
copies were held to be a part of profit earning apparatus or source of
income, it was immaterial whether the appellant had ownership rights
or only right to duplication. Decisions of the tribunal in the cases of
sound tracks of film songs and the film music were distinguished as
they related to payment of yearly royalty, based on sales of cassettes
obtained from master plates. In the said cases, the expenditure was
relating to trading operation and no lumpsum payment was made. In
the present case also, on royalty there was no dispute but the dispute
related to lumpsum payments. Another case was distinguished on the
ground that lumpsum payment made for procurement of master plates
for producing audio cassette could be treated as revenue expenditure as
the sound tracks got duplicated in the process and were used as raw
material. The master copies of softwares, it was observed had
unlimited life and capable of giving unlimited number of copies. The
master copies were not raw material but only a tool to get duplicate
copies of software. Further, the mater copies were not procured from
third parties but from in-house establishment.
12. Before we dwell upon the questions raised, we would like to
point out certain undisputed facts. The Assessing Officer had also
ITA No. 25/2012- connected appeals Page 11 of 32
denied benefit to the appellant under Section 80-IA on the ground that
duplication of software did not amount to manufacture. Section
40(a)(i) was also invoked in respect of royalty payments. The tribunal
decided the two issues against the revenue. Revenue preferred appeals
before the High Court, but the appeals were dismissed on the two
issues vide judgment CIT v. Oracle Software India Ltd. (2007) 293
ITR 353 (Delhi) observing that no substantial question of law arose for
consideration and Section 40(a)(i) was not applicable.
13. Not satisfied, Revenue preferred further appeals on issue of
deduction under Section 80-IA but did not succeed vide detailed
decision in CIT v. Oracle Software India Ltd. reported as (2010) 320
ITR 546 (SC). The Supreme Court in the said decision has noted that
the appellant had imported master media of software from Oracle
Corporation, USA for duplicating on blank disc, which were packed
and sold in the market along with the relevant brochure. The appellant
had paid lumpsum amount to Oracle software for import of master
media. The Supreme Court has further observed that the software in
question was application software and not operating software or
system software. The software could be categorised as product line
application, application solutions and interim applications. The master
media was subjected to validation and checking process by software
engineers by installing and rechecking the integrity of the master
ITA No. 25/2012- connected appeals Page 12 of 32
media with the help of the software installed in the fully operational
computer. Thereafter the same was inserted in a machine CD blaster
and virtual image of the software was created on the internal storage
device. This virtual image was replicated to produce or duplicate the
software. The virtual image was too large to be shown on screen. The
Supreme Court has further observed that softwares were goods as held
in Tata Consultancy Services versus State of Andhra Pradesh, (2004)
271 ITR 401 (SC). The software copyright might remain with the
originator of the programme but the moment copies were made and
sold, they would be termed as goods. There was no difference between
sale of software programme on CD and sale of music on cassettes/CDs.
The intellectual copyrights had got incorporated on the media for the
purpose of transfer and, therefore, media cannot be split up. Reference
was made to the decision in Gramophone Company of India Limited
versus Collector of Customs, (1999) 114 ELT 770 (SC) and it was
observed that duplication or recording of audio cassettes amounts to
manufacture as goods were produced.
14. Before proceeding further, we would like to reproduce the exact
reply given by the appellant as recorded in the assessment order for
Assessment Year 1994-95 on the issue in question. The same reads as
under:-
"1. Imports master copy of Oracle products
ITA No. 25/2012- connected appeals Page 13 of 32
under the OGL Classification 85.24 after the full
payment of custom duty. These are further
replicated in India using the appropriate carrier
media by virtue of an agreement OSIPL has with
Oracle Corporation.
2. The master copies are versions of
Oracles new product offerings which have a
very accelerated obsolence. At any point of
time it is not capable of determining whether the
version will be current for one day or one
month. In the life cycle of product if a version is
released and improvement is developed the next
day the earlier version is obsolete. The master
copy/documentation write off policy which
Oracle has adopted recognizes the accelerated
obsolence and the non-enduring use of master
copy/documentation."
(Emphasis supplied)
15. After recording/ reproducing the said reply, the Assessing
Officer in the assessment order has not disputed or factually
controverted the contents or the assertion made by the appellant. The
Assessing Officer accepted and did not contradict the said factual
assertion as incorrect, but addition was made by the Assessing Officer
on the grounds, namely, (i) in spite of the factual position the
expenditure was capital (ii) Section 35A of the Act was applicable and,
therefore, the cost paid on master copy was to be amortised/allowed in
14 instalments for the Assessment Year 1994-95. Even if the
expenditure was revenue in nature, the same has to be disallowed.
16. We have quoted the finding recorded by the tribunal in
ITA No. 25/2012- connected appeals Page 14 of 32
paragraphs 3.4 and 3.5 of the order for the Assessment Years 1994-95,
1995-96 and 1996-97. It has been observed that lumpsum payment
was made for the master copy and as the appellant also had right of
duplication it lead to creation or acquisition of an asset of enduring
benefit. It became part of the profit making apparatus and source of
income. The Tribunal without disturbing or contradicting the stand of
the appellant, on legal principles has held that the expenditure was
capital in nature.
17. We have given thoughtful consideration to the said findings, but
find that the final conclusion cannot be sustained and should be
reversed. Tribunal in the impugned order and the reasoning given
therein has not disturbed the finding of the Commissioner (Appeals) or
the assertion of the appellant before the Assessing Officer that the
master copies were versions of software developed by Oracle
Corporation, USA, a new product offerings, which had high
accelerated obsolescence and even at the point of time of import it was
difficult whether the version would be replaced by a new or updated
version after one day or a month. The life cycle of the version released
was limited and improvements and further developments were constant
and intermittent. The earlier version had a high degree of obsolescence
and the master copy, documentation and policy adopted by the
appellant recognised that the master copy did not have enduring or
ITA No. 25/2012- connected appeals Page 15 of 32
long- term benefit.
18. The Right to duplication and import of master copy though
connected, cannot and does not show that the expenditure in question
was capital in nature. The import of master copy was for the purpose of
creating virtual image for the purpose of duplication. The right to
duplication was given to the appellant under the agreement dated 28 th
May, 1993 and was subject to payment of royalty. The payments in
question were not for acquiring the right to duplication. This is not the
case of the Revenue or the finding of the Assessing Officer or the
Tribunal. We have also quoted above the sample data for Assessment
Year 1994-95, which shows that there were as many as 28 imports on
different dates after October, 1993 indicating the number of master
copies imported. The average price per copy was minimal. We have
also noted the findings recorded by the Supreme Court as to the nature
and character of the software of which virtual image was created from
the master copies. This is not a case where the master copies contained
operating or system software, which normally do not require frequent
upgradation or changes for consideration or price. Neither are we
dealing with a case of an assessee who is the end user of software.
We are dealing with the appellant who was required to repeatedly pay
for the master copy media in view of frequent newer or updated
versions of the application software from time to time. Once newer or
ITA No. 25/2012- connected appeals Page 16 of 32
better version of application softwares was available, the earlier
application softwares were not saleable and did not have any market
value for the seller i.e. the appellant. The earlier versions became
obsolete and had limited shelf life, as long as the newer version was
not available. No one would like to pay or obtain an older version of
the same software, when the new or updated version was available.
19. Courts have grappled with the problem of classification of
income and expenditure as capital and revenue. The distinction
between capital and revenue nature though basic and fundamental to
preparation of accounts and income tax, appears to be a never ending
concoct and resultant cause of litigation. Even the principles
applicable, oscillate and the difficulty also arises on selecting the right
principle applicable to facts of the given case. There is divergence
and conflict as to the principle which should be applied. Thus, it is not
a case of application of principles to facts alone, which is a cause of
debate and confusion. The terms "capital" or "revenue expenditure"
have not been specifically defined in the Act. They are closely
connected with accounting practices, though elucidated and expounded
in judicial pronouncements. Most income tax enactments, including
the present Act, require and mandate determination of income earned
by the appellant during two particular points of time i.e., the
assessment year. The income is determined on the basis of principles
ITA No. 25/2012- connected appeals Page 17 of 32
of accountancy or accounting practices as moderated and subject to
mandate/ amendments by the Act. The expression "income" has
historically received somewhat derisory and derisive interpretation but
as a theoretical as well as practical concept means the income
generated during two particular points of time by a person without
impoverishment of oneself. (see J.R. Hicks "Value and Capital- An
inquiry into some fundamental principles of economic theory, Oxford
University Press, London, Second Edition 1946). Alexander making
reference to the term income in corporate context has stated: income is
"the amount which [a] company can distribute to the shareholders and
be as well off at the end of the year as it was at the beginning". It was
observed:-
"The net income of an entity for any period is the
maximum amount that can be distributed to its
owners during the period and still allow the
entity to have the same net worth at the end of
the period as at the beginning, after adjusting for
the owners contributions. In other words,
capital must be maintained before an entity can
earn income."
20. The aforesaid definitions are improvements on the
conceptualization of the term "income" as assigned by the German
economist Georg Von Schanz in 1896, who held that income means
the economic power accrued to a given person over a period of time,
i.e., the disposing power of a given person during the period in
ITA No. 25/2012- connected appeals Page 18 of 32
question, without impairing his capital or incurring personal debts.
The aforesaid definitions have become subject matter of new thought/
thinking to categorise revenue and capital expenditure based upon
market place criteria [see Working Paper "The Classification of capital
and revenue in accounting and the definition of income in the market
place (Centre for Accounting, Governance and Taxation Research,
School of Accounting and Commercial Law, Wellington, New
Zealand" at the works referred to therein.) The aforesaid article refers
to the notion of capital maintenance or net accretion. The said note also
refers to the report on Wheat Committee, 1972 (a special committee of
the American Institute of Certified Public Accounts charged with
studying how accounting principles should be determined) wherein it
has been observed that financial accounting standards and reporting are
not grounded in natural laws as are the physical sciences, but must rest
on a set of conventions or standards designed to achieve what are
perceived to be the desired objectives of financial accounting and
reporting.]
21. While interpreting the meaning of "accounting income", the
Financial Accounting Standards Board, United States of America
formally embodied capital maintenance, or net accretion, notion in its
statements of Financial Accounting Concepts (Financial Accounting
Standards Board). It has been elucidated as:-
ITA No. 25/2012- connected appeals Page 19 of 32
" An enterprise receives a return only after its
capital has been maintained or recovered. The
concept of capital maintenance, therefore, is
critical in distinguishing an enterprises return
on investment from return of its investment.
Both investors and the enterprises in which they
acquire an interest invest financial resources
with the expectation that the investment will
generate more financial resources than they
invested."
22. In the Framework for the Presentation and Preparation of
Financial Statements published by International Accounting Standards
Board, an asset has been defined as "a resource controlled by the entity
as a result of past events and from which future economic benefits are
expected to flow to the entity" in subsequent accounting period s. The
assets are recognised in the balance sheet, when "it is probable that
future economic benefits will flow to the entity and the asset had a cost
or value that can be measured reliably." The words "income" and
"expenditure" have been defined in the said framework as under: -
"Increases in economic benefits during the
accounting period in the form of inflows or
enhancements of assets or decreases of liabilities
that result in increases in equity, other than those
relating to contributions from equity
participants"
23. The word "expense" in the said Framework has been defined as
decreases in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrence of liabilities
ITA No. 25/2012- connected appeals Page 20 of 32
other than those relating to distribution to equity participants. The
Framework recognised the principle of matching of costs with the
revenues in preparation of financial statements and has stipulated:-
"Expenses are recognised in the income
statement on the basis of a direct association
between the costs incurred and the earning of
specific items of income. This process is
commonly referred to as the matching of costs
with revenues........
When economic benefits are expected to arise
over several accounting periods and the
association with income can be only broadly
or indirectly determined, expenses are
recognised in the income statement on the
basis of systematic and rational allocation
procedures.........These allocation procedures
are intended to recognise expenses in the
accounting periods in which the economic
benefits associated with these items are
consumed or expire.
An expense is recognised immediately in the
income statement when an expenditure
produces no future economic benefits or
when, and to the extent that, future economic
benefits do not qualify, or cease to qualify, for
recognition in the balance sheet as an asset."
24. Compendium of Accounting Standards by Institute of Chartered
Accountants of India defines "income" as encompassing both revenue
and gains including unrealized gains. The term "expenses"
encompasses the expenditures that arise in the ordinary course of an
enterprise as well as losses. Expenses will include depreciation as it is
in the form of outflow caused due to depletion of assets. The term
ITA No. 25/2012- connected appeals Page 21 of 32
"depreciation" and its significance in accounting as elucidated in the
Compendium of Accounting Standards are set out below. Adjustment
towards capital accounts is when the expenditure includes a future
economic benefit associated with the article/ goods which will flow to
or from the enterprise. This may be, inspite of the degree of
uncertainty regarding future economic benefits and this degree of
uncertainty is ascertained on the basis of evidence available when the
financial statements are prepared. But, an asset is not recognised in the
balance sheet, when expenditure has been incurred in respect of an
item, on which it is improbable that economic benefit will flow beyond
the current accounting period. Such transactions merit recognition as
an expense in the statement of profit and loss. Thus the term
,,expenses as recognized in the profit and loss account will take into
account decrease in future economic benefits relating to an asset.
Concept of expenses includes decrease in the value of asset. An
expense is recognized immediately in the statement of profit and loss
account, if expenditure produces no future economic benefit (see
paragraphs 73 to 97 of the Compendium of Accounting Standards
issued by the Institute of Chartered Accountants of India).
25. Matching of cost with revenues takes into consideration direct
association between cost incurred and earning of specific items of
income and also includes various components of expenses making up
ITA No. 25/2012- connected appeals Page 22 of 32
the cost of goods. The term ,,depreciation has been defined in the
Accounting Standard VI, as a measure of wearing out, consumption or
loss of value arising from use of any type, efflux of time, of
obsolescence through technology and market changes. But depreciable
items are those which are used for more than accounting period and its
useful life is over a period during which a depreciable item is expected
to be used by the enterprise or number of production of similar units
expected to be obtained from use of the asset by the enterprise.
Assessment of depreciation is done based upon the three criterions: (1)
historical cost or other amounts substituted when the asset has been
revalued; (2) expected useful life of the depreciable asset; and (3)
estimated residual value. Useful life of depreciable asset may be
shorter than its physical life and is determined by several factors
including obsolescence due to technological changes, improvements,
change in market demand or service output etc. Useful life of
depreciable asset is a matter of estimation and is mainly based upon
experience with similar type of assets. Determination of residual
value, it is stated, is a difficult matter but when insignificant, it should
be taken as nil. One of the basis for determining residual value would
be realizable value of similar assets.
26. The Act does not define the term ,,asset in generality though the
term ,,block of assets is defined but the said definition is not relevant.
ITA No. 25/2012- connected appeals Page 23 of 32
Explanation 3 to section 32 states the term asset for the said provision
means tangible and intangible assets being know-how, copyrights etc.
The Act, however, more appropriately and pertinently defines the term
,,capital asset in Section 2(14) as property of any kind, but does not
include stock in trade, consumable stores or raw materials held for the
purposes of his business or profession. Personal effects and
agricultural land etc. are also excluded. The term/expression
,,expenditure finds elucidation in Section 37 of the Act and it excludes
any expenditure of capital nature or personal expenses. There is
substantial authority for the proposition that determination of whether
an expenditure is capital or revenue in nature must and should be
decided keeping in view the nature of the business, commercial reasons
for incurring the said expenses in business and the object for which the
expense is incurred. Emphasis being placed on business and
commercial considerations, rather than pure legal and technical
aspects. Thus, primacy is given to practical and business point of view
and not on juristic classification. The expression ,,capital or revenue
expenditure must be construed in business sense and by applying
sound accountancy principles unless there is statutory mandate to the
contrary. (see Section 145 of the Act and observations of the Delhi
High Court in CIT v. Virtual Soft Systems Ltd. (2012) 341 ITR 593).
27. This aforesaid principle of matching, as we shall elucidate
ITA No. 25/2012- connected appeals Page 24 of 32
below, is of immense importance and significance. When we
determine whether an expenditure is capital or revenue in nature, it
exposes and brings to forefront the practice and commercial approach
from the true and correct perspective and objective; "income" earned
should be taxed. This has to be kept in mind as the guiding principle,
subject to the statutory mandate which will override. A statement of
accounts prepared on the basis of the aforesaid matching principle will
generally reflect the true and correct income earned during the
specified period. The said determination would be fair, just and
equitable both to the appellant and the revenue. An asset is not
normally created when a liability is incurred and it does not give
benefit or advantage in future accounting periods or beyond a short/
small length of time, in view of the past practice and practical/
commercial reality. The expenses will be revenue in nature if its
usefulness will come to an end within the financial year itself or is for
limited time and would not have any residual value thereafter.
Therefore, while determining whether expenditure is capital or
revenue in nature, we must also dwell into the question whether the
expenditure, would create an asset which is of value in further
assessment periods and should be amortised ( i.e. depreciated) as
long as it has value. (The last portion is obviously subject to the
statutory mandate of an enactment, which may prescribe amortisation
ITA No. 25/2012- connected appeals Page 25 of 32
or depreciation rates. These being fixed by law will override the
accounting principles). Thus, when an expenditure incurred does lead
to creation of an asset but of a limited or short life, it has to be treated
as a liability and not as a fixed asset. The said expenditure cannot be
valued for price for future financial years.
28. A word of caution and a caveat for the aforesaid test, is one of
importance as was elucidated by the Supreme Court in Empire Jute
Company Limited versus Commissioner of Income Tax, (1980) 124
ITR 1 (SC). The said decision highlights advantage of enduring benefit
test but nonetheless it was cautioned that the said test may break down
and what is material to be considered is the nature of advantage in
commercial sense. If the advantage consists of merely facilitating
assets in trading operation or enabling the management and conduct of
business more efficiently, it would be expenditure on revenue account
even though the advantage may be of indefinite future. Thus, in
Alembic Chemical Works Company Limited versus Commissioner of
Income Tax, (1989) 177 ITR 377 (SC) and Jonas Woodhead and
Sons (India) Limited versus CIT, (1997) 224 ITR 342 (SC), the
Supreme Court observed that though the technology had been received
but it related to a product already under production and to ensure
betterment or of the improvement, it was part and parcel of the existing
business and, therefore, the benefits were composite partly revenue and
ITA No. 25/2012- connected appeals Page 26 of 32
partly capital. However, in the present case we need not apply the
caveat. The caveats and caution elucidated would apply as exceptions
of the enduring benefit tests. When the enduring benefit test itself
justifies the conclusion that the expense is revenue, it would not be
proper and appropriate to apply the caveats or exceptions. These
secondary tests apply when in spite of the primary test of enduring
benefit being in negative, i.e. against the assessee a different
conclusion against the revenue is justified. Thus the dictum and in the
words of Viscount Cave LC in Atherton v. British Insulated & Helsby
Cables Ltd. 10 TC 155:-
"When an expenditure is made, not only once
and for all, but with a view to bringing into
existence an asset or an advantage for the
enduring benefit of a trade, there is very good
reason (in the absence of special circumstances
leading to an opposite conclusion) for treating
such an expenditure as properly attributable not
to revenue but to capital."
The said enunciation has been approved by the Supreme Court in CIT
vs. Finlay Mills Ltd. 20 ITR 475 (SC) and Empire Jute (Supra) and
other cases. The term enduring we clarify does not mean permanent,
perpetual or everlasting but it refers and indicates that the right
acquired must have enough durability to justify it being treated as a
capital asset.
ITA No. 25/2012- connected appeals Page 27 of 32
29. The view we have taken find support and is in consonance with
the view taken by the Delhi High Court in Commissioner of Income
Tax versus Ashahi India Safety Glass Limited, (2012) 346 ITR 329
(Del) wherein appellant had procured software which was amortised in
the books as deferred revenue expenditure but was claimed as a
deduction in the income tax income statement. It was observed that
the said expenditure along with other expenditures neither created a
new asset nor brought forth a new source of income. The expenditure
incurred was to upgrade or to run the existing set up. It was to remove
deficiencies in the software installed in the earlier years, to modify,
customise or upgrade the software. Similarly, in Commissioner of
Income Tax versus G.E. Capital Services Limited, (2008) 300 ITR
420 (Del) it was observed that the software procured by the assessee in
question was not customised software and the software in question
required regular upgradation and, therefore, was not of enduring
benefit.
30. The Punjab and Haryana High Court in Chief Commissioner of
Income Tax versus O.K. Play India Private Limited, (2012) 346 ITR
57 has again observed that computer software does not enjoy a degree
of permanence and it could be unrealistic to ignore the stand and
repeated upgradation and newer versions which have to be adopted and
applied on the payment. In Alembic Chemicals Works Company
ITA No. 25/2012- connected appeals Page 28 of 32
Limited (supra), lumpsum consideration paid for technical know-how
to achieve higher level of production by better technology was held to
be of revenue account. This was in spite of the fact that there was
enduring benefit, but the Supreme court deemed it appropriate to apply
a more liberal test on the consideration that in this age of rapidly
advancing technology the contention of the Revenue that the
expenditure brought into existing capital asset, should be rejected. The
need of the age, the environment and the business consideration
mattered and were given due recognition and acceptance. The said
view has been followed by the Courts in India. As noticed above, in
the present case the appellant is duplicating software and sells the same
to generate income. It requires master copies, which have to be
updated and upgraded to be able to sell the said software. In case the
appellant had imported the said software and sold the same, it would be
stock in trade and deductible. However, when the master copies were
used for duplication and the software replicated and transferred on the
media as a result of the said activities was then sold, the master copy
itself might not be stock in trade as such in strict sense, but it did not
have a long life and its value and life span was small since it perished
and diminished when the upgraded version or a better software in form
of the next master copy was imported, for the purpose of duplication.
When we accept the said position, the requirement of enduring benefit
ITA No. 25/2012- connected appeals Page 29 of 32
fails and it cannot be said that any capital asset was acquired or
purchased. In these circumstances, we need not apply and go into the
other test or caveats. The flaw and the error committed by the tribunal
is that they applied other tests or caveats without first ascertaining and
determining whether enduring benefit test is satisfied or not. The
enduring test may not be the sole, exclusive or universal test but is
considered to be the primary test.
31. The Supreme Court in CIT versus IAEC Pumps limited (1998)
232 ITR 316 upheld the decision of the tribunal that payment towards
royalty was revenue expenditure and was allowable after observing
that the licence for use of patents and designs was for a duration of 10
years with the parties having option to renew or extend the licence.
The assessee had been only allowed use and there was no transfer of
rights. The rights acquired by the assessee were not exclusive and
were for a limited period which could be determined earlier also.
Payment was dependent upon quantum of items manufactured.
32. Decision in the case of Commissioner of Income Tax versus
Denso India Limited, (2009) 318 ITR 140 (Del) and submission
relying upon Section 35A of the Act is misconceived. The said
provision comes into play only when the expenditure incurred is of
capital nature and is on the acquisition of patent rights and copyrights.
ITA No. 25/2012- connected appeals Page 30 of 32
Merely because expenditure has been incurred for material for
duplication without acquisition of proprietary and when the
expenditure is not of capital nature, the said Section would not be
applicable. In any case, the said provision is not applicable with effect
from the 1st day of April, 1998. The view we have taken finds
affirmation and support from the decision of the Delhi High Court in
Denso India Limited (supra). It supports the case of the appellant as it
has been held that depreciation claim in respect of intangible assets
would arise only when it is first determined that the expenditure was
capital in nature. Reference was made to CIT v. J.K. Synthetics Ltd.
(2009) 309 ITR 371 (Del) where broad principles have been culled out
and some of the principles have been set out in seritum. Decision in
CIT v. Sharda Motors Industrial Ltd. (2009) 319 ITR 109 (Del) was
also referred too.
33. The question of law mentioned above is accordingly answered in
favour of the appellant-assessee and against the Revenue.
34. In the assessment year 1997- 98, in ITA No. 390/2007 titled
Orcale India Softwares Ltd vs. CIT Delhi, two additional questions
have been raised, which read as under:-
"(2) Whether the Assessing Officer could have charged interest
on the taxable income of the Assessee under the provisions of
Section 234B of the Income Tax Act, 1961 without any specific
order to this effect and in spite of the existence of ITNS 50?
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(3) If the answer to the question No. (1) is in the affirmative,
whether the interest under Section 234B of the Income Tax Act,
1961 has to be charged on the assessed income or the returned
income of the Assessee?"
35. Interest under Section 234B is mandatory in nature and has to be
paid when the statutory conditions are satisfied. Further, the interest
has to be paid on the assessed income [see decision of the Supreme
Court in Commissioner of Income Tax, Mumbai versus Anjum M.H.
Ghaswala and Others, (2001) 252 ITR 1 (SC)]. Tribunal in the
impugned order has already directed that interest under section 234B
of the Act shall be determined only after ascertaining the taxability.
The question Nos. 2 and 3 are accordingly answered in favour of the
Revenue and against the appellant.
36. The appeals are accordingly disposed of with no orders as to
costs.
(SANJIV KHANNA)
JUDGE
(SANJEEV SACHDEVA)
JUDGE
NOVEMBER 25th, 2013
VKR
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