Whether expenditure incurred by an entity for developing application software for facilitating itself in manufacturing operations is capital in nature merely because it is for obtaining benefit of enduring nature – NO: HC

THE issue is – Whether expenditure incurred by an entity for developing application software for facilitating itself in manufacturing operations is capital in nature merely because it is for obtaining benefit of enduring nature. NO is the verdict.

Facts of the case
The assessee is engaged in the manufacture and production of aluminium and related products. During relevant year, the assessee incurred an expenditure of Rs.41,08,556/- on software development and treated this expenditure as deferred revenue expenditure in its books of accounts and amortized Rs.2,40,000/- by debiting the same to the P&L A/c of the relevant previous year. The AO however completed the scrutiny assessment u/s 143(3) disallowing the expenditure on account of software development by holding it as a capital expenditure.
Having heard the parties, the High Court held that,
++ it is seen that the assessee in the instant case is engaged in the manufacture and production of aluminum and related products. Bauxite is an aluminum ore, which is obtained by the process of mining, from which pure aluminum is manufactured by various industrial processes. Therefore bauxite is a basic raw material for manufacturing aluminum. Further, the software developed by the assessee is an application software and not an operational one. The AO had disallowed the claim of the assessee on the ground that the amount spent on software development was not for the purpose of facilitating the assessee’s existing trading and manufacturing operations or enabling management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched. Further, expenditure on software development was incurred with a view to obtain an asset or advantage of a permanent nature. The AO in the assessment order u/s 143(3) erroneously came to the conclusion that software development was in connection with mining practices and study on verinculture on bio-degradable wastes on experimental basis. This was rightly pointed out by the CIT(A) in his order, wherein he held that nowhere the assessee states that the software development expenditure was on experimental basis. In the instant case, the software developed by the assessee is application software which allows it to efficiently carry out mining activity for the extraction of Bauxite. Application software is distinct from system software as it has to be constantly updated due to rapid advancements in technology and increasing complexity of the features;
++ the distinction between system software and application software was considered by the Karnataka High Court in CIT v. IBM India Ltd (supra), wherein the issue that arose for consideration was whether the Tribunal was correct in holding that the purchase of software should be allowed as a revenue expenditure. The Karnataka High Court therein has held that the application software enables the assessee to carry out his business operation efficiently and smoothly. However, such software itself does not work on stand alone basis. The same has to be fitted to a computer system to work. Such software enhances the efficiency of the operation. It is an aid in manufacturing process rather than the tool itself. Thus, for payment of such application software, though there is an enduring benefit, it does not result into acquisition of any capital asset. The same merely enhances the productivity or efficiency and, hence, to be treated as revenue expenditure. In the instant case the revenue has relied on the principle of enduring nature to contend that the expenditure incurred by the assessee was of capital nature. However there are a plethora of judicial pronouncements which go to show that the test of enduring nature is not to be applied mechanically without taking into account the facts and circumstances of each case. The question regarding the allowability of expenditure on acquisition of software package arose for consideration before the Madras High Court in CIT v. Southern Roadways, wherein the Court held the payment for such application software, though there is an enduring benefit, does not result in acquisition of any capital asset and it merely enhances the productivity or efficiency and hence, has to be treated as revenue expenditure. In view of the aforesaid discussion, the question is answered in favour of assessee.