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Summary of Opinion

Factual and Procedural Background

The Revenue filed an appeal raising two questions of law concerning (a) whether the Income-tax Appellate Tribunal (ITAT) was justified in deleting additions by treating certain software expenditure of Rs. 23,62,368 as revenue (the contention being that software used for the first time should be capital in nature), and (b) whether ITAT was correct in deleting additions relating to scrap sales for the purpose of computing the deduction under section 80HHC (specifically whether receipts credited to the profit & loss account should be included in total turnover or whether 90% of such receipts should be reduced while computing profit of the business).

The ITAT, relying on its own earlier order in the assessee's case for assessment year 2001–02, had held that the software expenditure was revenue in nature. The appeal filed by the Revenue for AY 2001–02 was dismissed for want of removal of office objections, and that ITAT order has attained finality. The present appellate court reviewed those questions and disposed of the appeal.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case and in law, the ITAT was justified in deleting additions in respect of disallowance of software expenditure of Rs. 23,62,368 by treating the software expenditure as capital rather than revenue (i.e., whether software used for the first time must be considered capital in nature).
  2. Whether, on the facts and in the circumstances of the case and in law, the ITAT was right in deleting additions made in respect of scrap sales when computing the eligible deduction under section 80HHC of the Income-tax Act—specifically whether receipts credited to the profit and loss account should be included in total turnover or whether 90% of such receipts should be reduced while computing profit of the business.

Arguments of the Parties

The opinion does not contain a detailed account of the parties' legal arguments.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
CIT v. Dresser Rand India P. Ltd., [2010] 323 ITR 429 (Bom) The opinion cites this judgment as the governing authority for reconsideration of the issue relating to scrap sales and deduction under section 80HHC. On the parties' agreement in view of this judgment, the court restored the second question to the file of the ITAT for fresh consideration in the light of this decision.
Order of the Income-tax Appellate Tribunal in the assessee's own case for assessment year 2001–02 (no formal citation provided) Used as a precedent within the same matter to treat the software expenditure as revenue expenditure; the earlier appeal by Revenue for AY 2001–02 was dismissed for want of removal of office objections and thus attained finality. The court accepted that the ITAT had relied on that earlier final order and found no fault with the ITAT's deletion of the addition treating the expenditure as revenue in nature.
Judgment of the Special Bench of the Tribunal (specific citation not provided) Referred to for the "functional test" to decide whether software forms part of the profit-making apparatus. The ITAT applied the functional test suggested by the Special Bench, concluded the ERP software did not form part of the profit-making apparatus and therefore allowed the expenditure as revenue expenditure; the appellate court found no fault with this application.

Court's Reasoning and Analysis

The court examined each question separately:

  1. Software expenditure (first question):
    • The ITAT had relied on its own earlier order in the assessee's case for AY 2001–02, which had become final because the Revenue's appeal for that year was dismissed for want of removal of office objections.
    • The earlier ITAT order applied the "functional test" (as suggested by a Special Bench of the Tribunal) to determine whether the software was part of the profit-making apparatus. Under that test the ERP software was found to facilitate trading operations and enable management to conduct business more efficiently or profitably, but it did not constitute a profit-making apparatus.
    • Based on that analysis, the ITAT treated the expenditure (noted in the earlier order as Rs. 20.60 lakhs) as revenue expenditure. The appellate court found no fault in the ITAT's application of the functional test and its conclusion that the software expenditure was allowable as revenue expenditure.
  2. Scrap sales and section 80HHC (second question):
    • The parties and the court agreed that the question should be reconsidered in light of the decision in CIT v. Dresser Rand India P. Ltd., [2010] 323 ITR 429 (Bom).
    • Accordingly, the court restored this question to the file of the ITAT for fresh consideration applying the law as expounded in the Dresser Rand judgment.

Holding and Implications

Holding:

  • The appeal is disposed of.
  • With respect to the first question, the court upheld the ITAT's conclusion that the software expenditure was revenue in nature and that no fault was found in the ITAT's order (which relied upon the ITAT's earlier, final order for AY 2001–02 applying the functional test).
  • With respect to the second question, the matter is restored to the ITAT for fresh consideration in the light of CIT v. Dresser Rand India P. Ltd., [2010] 323 ITR 429 (Bom).

Implications: The immediate effect is that the ITAT's treatment of the software expenditure as revenue expenditure stands in favour of the assessee for the year under appeal, and the issue concerning scrap sales and computation under section 80HHC will be reconsidered by the ITAT following the cited Bombay High Court decision. The opinion does not state that it establishes any broader precedent beyond these outcomes.

    Commissioner Of Income-Tax v. Raychem Rpg Ltd.

    1. Two questions of law raised by the Revenue in this appeal, which read thus:

    “(a) Whether, on the facts and in the circumstance of the case and in law, the hon'ble Income-tax Appellate Tribunal was justified in deleting the additions in respect of disallowance of software expenditure to the extent of Rs. 23,62,368 as capital expenditure as software used for the first time will have to be considered as capital in nature?

    (b) Whether, on the facts and in the circumstances of the case and in law, the hon'ble Income-tax Appellate Tribunal was right in deleting the additions made in respect of the scrap sales as while computing the eligible deduction under section 80HHC of the Act, any receipt credited to the profit and loss account should either be included in the total turnover or 90 per cent, of the same should be reduced while computing profit of the business?”

    2. As regards the first question, the Income-tax Appellate Tribunal relying upon on its order in the assessee's own case relating to the assessment year 2001–02 held that the software expenditure was a revenue expenditure.

    3. The appeal filed by the Revenue for the assessment year 2001–02 has been dismissed for want of removal of office objections and thus the order passed by the Income-tax Appellate Tribunal for the assessment year 2001–02 has attained finality. Moreover, the Tribunal in its order relating the assessment year 2001–02 has allowed the expenditure as revenue expenditure by recording thus:

    “7. When we apply this functional test suggested by the Special Bench of the Tribunal, we find that the impugned software does not form part of the profit-making apparatus of the assessee and, hence, the same is to be allowed as revenue expenditure. We hold so because we find that the business of the assessee-company is that of manufacturing of telecommunication and power cable accessories and trading in oil retracing system and other products and the impugned software is an enterprises resources planning (ERP) package and, hence, it facilitated the assessee's trading operations or enabling the management to conduct the assessee's business more efficiently or more profitably but it is not in the nature of profit-making apparatus. We, therefore, decide this issue also in favour of the assessee and we hold that this expenditure of Rs. 20.60 lakhs is of revenue expenditure. We hold so by following the judgment of the Special Bench of the Tribunal relied upon by the learned authorised representative of the assessee.”

    4. In our view, no fault can be found in the aforesaid order of the Income-tax Appellate Tribunal holding that software expenditure was allowable as revenue expenditure.

    5. As regards the second question is concerned, the learned counsel for the parties agree that in view of the judgment in CIT v. Dresser Rand India P. Ltd., [2010] 323 ITR 429 (Bom), the question be restored to the file of the Income-tax Appellate Tribunal for fresh consideration in the light of the aforesaid judgment. Accordingly, the second question is restored to the file of the Income-tax Appellate Tribunal for fresh consideration in the light of the judgment in Dresser Rand India P. Ltd., [2010] 323 ITR 429 (Bom).

    6. The appeal is disposed of accordingly.

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    Comments

    Commissioner Of Income-Tax v. Raychem Rpg Ltd.
    (Jul 4, 2011)