NEW DELHI, FEB 21, 2008 : AFTER the Supreme Court held that computer
software is goods in the context of the AP Sales Tax Act, its ripples spread
to Service Tax, Central Excise and now the Income Tax Appellate Special
Bench is concerned with the issue. The Special Bench laid down the general
guidelines and held that the issue has to be decided for each software based
on the tests enunciated by it.
The Special Bench has been constituted to dispose of the appeals filed in
the case of M/s. Amway India Enterprises and M/s. SQL Star International
Ltd., as well as to dispose of the following important questions: -
(i) Whether, in the facts and circumstances of the case, the expenditure
incurred by the assessee on account of computer software is of revenue
nature or capital nature?
(ii) If the expenditure incurred on computer software is held to be of
capital nature, what would be the rate of depreciation applicable thereon?"
In the case of M/s Amway India Enterprises, a deduction on account of
software expenditure incurred amounting to Rs. 20,04,105/- was claimed by
the assessee company in its return of income filed for A.Y. 2001-2002. The
said expenditure was claimed to be incurred by the assessee company for
acquiring the following software for use in its business : -
1. MS Project 2000 Full Packaged Product (FPP) : Rs. 19,700/- - used by
project managers who need a desktop tool to manage their projects
2. MS project 2000 Central Open License Program : Rs. 78,600/- - basically
platform software - helps in operating MS Project 2000 Full Packaged Program
3. Macromedia Dream weaver and Flash : Rs. 35,800/- - web development tool.
4. Turbo Gold Software : Rs. 17,61,034.68 - helps in compression of size of
e-mails sent through the Lotus Notes.
5. Wim tap call billing software Rs. 40,000/- - used for recording telephone
calls and its cost.
6. Bright Star Are Server Advance Edition : Rs. 2,50,000/- - is to keep back
up of data
7. Windows 2000 : Rs. 279,543/- Back Office Server 2000 and Windows 2000
Server Microsoft Open License Program (MOLP).
8. Win XP Software : Rs. 14,456/- you know what it is.
The Assessing Officer held that the said software were part of the plant and
machinery of the assessee and gave enduring benefit to it. The Assessing
officer also noted that all the application software purchased by the
assessee had long-lasting use of more than three-four years and the same,
according to him, thus resulted into enduring benefit to it. He, therefore,
treated the expenditure incurred by the assessee on acquisition of software
as capital in nature and treating the same as part of the plant and
machinery, depreciation thereon at the normal rate of 25% was allowed by him
in the absence of any specific rate prescribed in the Schedule for the
The action of the Assessing Officer in treating the software expenditure as
that of capital nature was upheld by the CIT(A) since he found on
verification of the relevant details that the assessee has not upgraded or
replaced the software frequently. He however, directed the AO to allow
depreciation at the rate of 60% on the software considering that the rate of
depreciation provided on computers for AY 1999-2000 to 2002-03 was 60% and
from AY 2003-04 onward, even the computer software was included in the
computers to be eligible to claim the depreciation at this higher rate.
Against the order of CIT(A), an appeal was filed by the assessee before the
Tribunal. The Division Bench noted that there were divergent orders of
different benches on the issue. Since the issue was expected to occur
regularly in many cases, it was felt by the Division Bench that the same may
be referred to the Special Bench for decision after taking into
consideration all the aspects as well as other contentions that might be put
forth by the parties. Accordingly, this Special Bench has been constituted.
Before the Special Bench could sit and hear the appeals filed in the case of
Amway, a similar issue relating to allowability of software expenditure
arose for consideration before the Division Bench of Tribunal i.e. Delhi 'G'
Bench, in the case of M/s. SQL Star International Ltd. Having noted that a
similar issue relating to allowability of software expenditure has already
been referred to the Special Bench in the case of Amway, this case was also
referred to the Special bench which was duly acceded to.
The Special Bench exhaustively considered the issue referring to several
landmark judgements from the Indian Supreme Court and other foreign courts.
The Bench took guidance from Lord Denning in Heather v. P.E. Consulting
"The question revenue expenditure or capital expenditure is a question
which is being repeatedly asked by men of business, by accountants and by
lawyers. In many cases the answer is easy; but in others it is difficult.
The difficulty arises because of the nature of the question. It assumes that
all expenditure can be put correctly into one category or the other: but
this is simply not possible. Some cases lie on the border between the two:
and this border is not a line clearly marked out; it is a blurred and
undefined area in which anyone can get lost. Different minds may come to
different conclusions with equal propriety. It is like the border between
day and night, or between red and orange. Everyone can tell the difference
except in marginal cases; and then everyone is in doubt. Each can come down
either way. When these marginal cases arise, then the practitioners be they
accountants or lawyers must of necessity put them in one category or
another. And then, by custom or by law, by practice or by precept, the
border is staked out with more certainty. In this at least, where no
decision can be said to be right or wrong, the only safe rule is to go by
precedent. So the thing to do is to search through the cases and see whether
the instant problem has come up before. If so, go by it. If not, go by the
nearest you can find."
The Bench did exactly that. And observed,
While dealing with this complex issue, three tests generally applied to
decide the nature of expenditure as to whether it is capital or revenue, are
the test of
1. enduring benefit,
2. ownership test and
3. functional test.
Applying the said tests, expenditure is treated as capital expenditure
either when it results in acquisition of capital asset by the assessee as
owner thereof or when it results in accrual of advantage of enduring nature
to the assessee in the capital field. In the first situation, the ownership
test assumes greater significance because the acquisition of capital asset
by the assesses as a result of incurring expenditure is a condition. If the
expenditure is resulting merely in acquisition or creation of asset without
the assessee becoming owner thereof, it cannot be said that the said
expenditure is a capital expenditure. The coming into existence of an asset
as a result of incurring expenditure alone thus is not sufficient to treat
the said expenditure as of capital nature unless the asset coming into
existence is also owned by the assesses.
In other situation, the expenditure can be treated as capital expenditure
only when it results in accrual of advantage of enduring nature to the
assesses in the capital field. The relevant tests applied to determine the
nature of expenditure in such a situation are the functional tests and the
test of enduring benefit. An advantage is to be considered as of enduring
benefit if the benefit accruing is not of a transient nature but is of such
durability as to justify it being treated as a capital asset.
The Tribunal considered in detail the landmark decision of the Sc in the
famous TCS case on software and observed,
(i) it is no doubt true that a transaction of sale of computer software
package off the shelf was held to be a sale of "goods" by the Supreme Court
in the case of TCS relying, inter alia, on the extended definition given in
Section 2(n) of the Andhra Pradesh General Sales Tax Act. 1957. But it was
not the only basis on which the decision of the Hon'ble Apex Court was
exclusively based. First and foremost, there was a reference made to the
decisions of American Courts rendered in several cases including especially
the cases of Commerce Union Bank v. Tidwell.
(ii) On the other hand, the view of American Court on the issue as well as
its own decision rendered in the case of Associated Cement Co. (supra) in
the context of Customs Act wherein the definition of the term "goods'" given
was not as wide or exhaustive as the definition of term "goods" in the A.P.
Sales Tax Act was taken into account and relied upon by the Hon'ble Supreme
Court to hold that a software, whether customised or non-customised,
satisfies all the attributes of being a "goods' and as such, the same is
capable of being bought and sold add becomes an object of trade and
(iii) the ratio laid down by the Supreme Court in the case of TCS holding
that computer software put in a medium of disk would be goods can only lead
to the conclusion that purchase of such disk is acquiring a tangible asset.
(iv) If the disk, tape or floppy or other electronic medium in which the
software is stored is by itself goods, then the assessee, who acquires the
same, acquires a tangible asset.
(v) Computer Software has not been defined in the Act, but in Note-7 to
Appendix-I to the I.T. Rules, it has been explained to include computer
programme recorded on any disc, tape, perforated media or other information
storage device. Therefore computer software (whether in canned form or
uncanned form) is goods and a tangible asset by itself.
(vi) The question whether an assessee by purchase of a disk containing
software has purchased a capital asset or not should not, therefore, be
viewed from the angle of acquisition of any copyright or any of the bundle
of rights comprised in such copy right.
(vii) An assessee purchasing such a software becomes owner thereof. But the
test of ownership in the computer software in the light of the question
whether the same is capital or revenue cannot be decided on the basis of
ownership test alone but has to be seen from the point of its utility to
businessman and to see how important an economic or functional role it plays
in his business.
(viii) In other words, the functional test becomes more important and
relevant because of the peculiar nature of a computer software and its
possible use in different areas of business reaching either capital or
revenue field or its utility to a businessmen which may touch either capital
or revenue Held.
(ix) The manner in which the computer software is used is again peculiar,
General mode is to acquire computer software on a license. That by itself
will not be sufficient to conclude that the said expenditure is revenue
expenditure, if on application of the functional test, it is fond that the
expenditure operates to confer a benefit in the capital field.
(x) On the other hand, some computer software may have a very limited
economic life so as to be treated as capital expenditure, though owned by an
Whether expenditure on computer software gives an enduring benefit to an
For ascertaining as to whether expenditure on computer software gives an
enduring benefit to an assessee, the duration of time for which the assessee
acquires right to use the software becomes relevant. Having regard to the
fact that software becomes obsolete with technological innovation and
advancement within a short span of time, if can be said that that where the
life of the computer software is shorter (say less than 2 years), it may be
treated as revenue expenditure. It is also evident from the amendment to the
law w.e.f. 1.4.2003 granting 60% depreciation on computer software that even
the legislature considers the life of computer software as about two years
by providing the higher rate of depreciation @ 60% thereon so as to enable
assessee to write off the same to the extent of 84% even when treated as
capital asset within a period of two years. An assessee may own a software
outright or be a licensee but the same ratty operate to confer benefit only
in the revenue field and therefore is may have to be regarded as Revenue
So the Tribunal concluded:-
(i) When the assessee acquires a computer software or for that matter the
license to use such software, he acquires a tangible asset and becomes owner
thereof as held above relying on the decision of Supreme Court in the case
(ii) Having regard to the fact that software becomes obsolete with
technological innovation and advancement within a short span of time. It can
be said that where the life of the computer software is shorter (say less
than 2 years), it may be treated as revenue expenditure. Any software having
its utility to the assessee for a period beyond two years can be considered
as accrual of benefit of enduring nature. However, that by itself will not
make the expenditure incurred on software as capital in nature and the
functional test also needs to be satisfied.
(iii) Once the tests of ownership and enduring benefit are satisfied, the
question whether expenditure incurred on computer software is capital or
revenue has to be seen from the point of view of its utility to a
businessman and how important an economic or functional role it plays in his
business. In other words, the functional test becomes more important and
relevant because of the peculiar nature of the computer software and its
possible use in different areas of business touching either capital, or
revenue field or its utility to a businessman which may touch either capital
or revenue field.
Having laid down the criteria for determining the nature of expenditure
incurred on acquisition of software, whether capital or revenue, the Special
Bench was of the view that these criteria need to be applied to determine
the exact nature of expenditure incurred by the assessees in the present
cases for acquiring different softwares. Since this exercise is required to
be done in respect of each and every software independently having regard to
the criteria laid down above, the matter needs to be restored back to the
file of the Assessing Officer for doing such exercise. The AO shall examine
the question whether expenditure on computer software is capital or revenue
in the light of the criteria laid down above after giving an opportunity of
being heard to the assessees. If on such examination, the AO comes to the
conclusion that the expenditure is capital expenditure, then the question
regarding allowing depreciation will be decided in accordance with the
principles laid down.