Whether when initial expenses incurred on development of software is capitalised, any expenditure on further improvement of the same is to be necessarily treated as capital in nature - NO: HC

THE issues before the Bench are - Whether when the initial expenses incurred on development of software is capitalised, any expenditure on further improvement of the same is to be necessarily treated as capital in nature and Whether expenditure on scientific research, even if it is capital in nature, but incurred in relation to the business of the assessee u/s 35(1)(iv) of the Act, is a deductible expenditure. And the verdict goes in favour of the assessee.

Facts of the case

The assessee is in the business of software development and software product sales and services. The assessee has acquired an intellectual property for Rs.10.82 crores, which was capitalized in the books. The assessee spent a sum of Rs.9,27,34,277/- in further developing and improving the same product. The development expenditure mainly included salary cost of the employees and other general administrative expenses incurred in connection with development of the product called “Talisma”. The product development cost was claimed deduction as revenue expenditure. The AO rejected the case of the assessee that it constituted revenue expenditure and levied taxes on the ground that it is a capital asset, disallowing the expenses incurred, but he allowed the depreciation. On appeal before the CIT(A), the assessee reiterated its submissions, and also contended that even if it is held as a capital asset, it was in the nature of a scientific research and therefore, the entire amount spent was deductable u/s 35(1)(iv). The CIT(A) accepted the contentions of the assessee, which was also confirmed by the Tribunal.

Aggrieved, the Revenue has filed this appeal before the High Court.

The main issue was when the AO had treated the same as improvement of capital assets i.e., capital expenditure, whether the same can be allowed as deductable expenditure u/s 35(1)(iv) of the Act. The Departmental Representative contended that although the expenditure incurred was of capital nature on scientific research but it was not related to the business, and therefore, not deductible u/s 35(1)(iv) of the Act. The DR submitted that the expenditure and purchase of Talisma software had been capitalized by the assessee. Therefore, any expenditure incurred on further development of the software has to be treated as capital in nature.

Having heard the parties, the High Court held that,

++ it is the specific case of the Revenue that, the amount of Rs.10.82 crores spent by the assessee in acquiring an intellectual property is capitalized in the books. Now further amount of Rs.9,27,34,277/- is spent in developing and improving the said product. Therefore, the expenditure on further development of software, which is treated as a capital in nature, is also capital in nature. This development is on account of scientific research. The evidence on record shows most of the money is spent towards cost of the employees, who had developed the product “Talisma Enterprise 2.5”, multi channel customer relationship management solution, which provides sales, marketing, services, human resources and finance through the medium of e-mail, chat, wireless, fax, phone, etc. to the end users. Therefore, the expenditure in respect of the scientific research, even if it is capital in nature as it was incurred in relation to the business carried on by the assessee under Section 35(1)(iv) of the Act, the said expenditure is to be deducted. That is what the Appellate Authority as well as the Tribunal have held. Accordingly, we answer the substantial questions of law in favour of the assessee and against the Revenue.