Oracle India Private Limited v. Commissionerof Income Tax

$~ *IN THE HIGH COURT OF DELHI AT NEW DELHI +INCOME TAX APPEAL NOS. 287/2008, 417/2009,447/2009, 461/2009, 683/2009 Reservedon: 2"^September,2013Date of decision:25^'' November, 2013 ORACLE INDIA PRIVATE LIMITED Appellant Through Mr. M.S. Syali, Sr. Advocate withMs. Husnal Syali Nagi, Mr. Mayanlc Nagiand Mr. Harkunal Anand, Advocates. versus COMMISSIONEROF INCOME TAX RespondentThroughMr.SanjeevSabharwal,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 withMs. Husnal Syali Nagi, Mr. MayanlcNagiand Mr. Harkunal Anand, Advocates. versus COMMISSIONEROF INCOME TAX Respondent Through Mr. Sanjeev Sabharwal, Sr.Standing Counsel & Mr. Puneet Gupta, CORAM:HON'BLE MR. JUSTICE SANJIV KHANNAHON'BLE MR. JUSTICE SANJEEV SACHDEVA SANJIV KHANNA, J.: Fordetailedordersee ITA25/2012,OracleIndiaPrivateLimited Vs. Commissioner ofIncome Tax pronounced today. ^- 7/^(SANJIV KHANNA)JUDGE NOVEMBER 25'^ 2013 (SANJEEV SACHDEVA)JUDGE *IN THE HIGHCOURTOF DELHIAT NEW DELHI -I- INCOME TAX APPEAL NOS. 25/2012, 287/2008,417/2009, 447/2009, 461/2009, 683/2009 Reservedon: 2"''^eptember,2013Date of decision: ^ November,2013 ORACLE INDIA PRIVATE LIMITED Appellant Through Mr. M.S. Syali,-Sr. Advocate withMs. Husnal Syali Nagi, Mr. Mayank Nagiand Mr. Harkunal Anand, Advocates. versus COMMISSIONEROF INCOME TAX RespondentThroughMr.SanjeevSabharwal,Sr.Standing Counsel & Mr. Puneet Gupta,Advocate. INCOME TAX APPEAL NOS. 797/2006, 951/2006,961/2006, 390/2007 ORACLE SOFTWARE INDIA LIMITED Appellant ThroughMr. M.S. Syali,Sr. AdvocatewithMs. Husnal Syali Nagi, Mr. MayankNagiand Mr. Harkunal Anand, Advocates. versus COMMISSIONER OF INCOME TAX Respondent ThroughMr. SanjeevSabharwal,Sr.StandingCounsel& Mr. PuneetGupta, ITANo. 23/2012- connected appeals CORAM: HON'BLE MR. JUSTICE SANJIV KHANNAHON'BLE MR. JUSTICE SANJEEV SACHDEVA SANJIV KHANNA, J.: These 10 appeals by the assessees-Oracle India Private Limitedand 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 questionof law as admitted for hearing reads :- "Whetheronthefactsandinthecircumstancesof the case,the IncomeTaxAppellate Tribunal was justified in holding, that media cost paid for the import of a mastercopy of Oracle Software used for duplicationand licensing is an expenditure of a capital .natureandassuchisnotanallowablededuction?" 2.For the purpose of clarityand to notice facts, ITA No. 797/2006,which relates to AssessmentYear 1995-96, was treated as a lead casebut as noticedbelow, wherever necessaryand required we havereferred to facts of assessment year 1994-95. 3.The appellant-assesseeincorporatedon 18"' January, 1993, is asubsidiary of Oracle Corporation,USA. The appellant entered intolicence agreement dated 28^' May, 1993 with its parent/holdingcompany under which the appellantwas granted non-exclusivenon- "Whetheronthefactsandinthecircumstancesof the case,the IncomeTaxAppellate Tribunal was justified in holding, that media cost paid for the import of a mastercopy of Oracle Software used for duplicationand licensing is an expenditure of a capital .natureandassuchisnotanallowablededuction?" 2.For the purpose of clarityand to notice facts, ITA No. 797/2006,which relates to AssessmentYear 1995-96, was treated as a lead casebut as noticedbelow, wherever necessaryand required we havereferred to facts of assessment year 1994-95. 3.The appellant-assesseeincorporatedon 18"' January, 1993, is asubsidiary of Oracle Corporation,USA. The appellant entered intolicence agreement dated 28^' May, 1993 with its parent/holdingcompany under which the appellantwas granted non-exclusivenon- assignable right and authority to duplicate on appropriate carrier mediasoftware products mentioned in schedule 'A' thereto or other productswhich may be added to the said list, and sub-licencethe same to thirdpartiesin India.The appellantcould enter into enforceablesub-licensingand services agreement in the prescribedform with thirdpartiesusers.Theholdingcompanyretainedownershipof thecopyright in the software and all associated and applicable intellectualpropertyrights in the products mentionedin schedule'A' or to beadded to the said schedule,ft was specifically stipulated that nothingcontainedin the agreementshall conferor deem to conferon theappellantany of the aforesaidrights.The holding companyalsoretained rights to continue to manufactureor distributionactivities inthe field of softwareand software products,includingthe productsmentionedin schedule 'A' or to be added to the said schedule with fullrights to produce, reproduce, duplicate and distribute the said productsin India or into India.The agreement stipulated that the appellant shallduplicate and reproduce the software in India and sub-licence the sameas per the terms of the sub-licencedeed stipulated and with the holding entire data/intellectual in thecompany retaining property rightssoftware. The appellant was entitled to use the trademark and tradename of the holding company with approval as to the manner of usefrom and no or remunerationwas to be the holding company royaltyITA No. 25/2012-connectedappeals3 of32 paid for the said use. 4.Tlie appellant was to pay royalty to the holding company30% of the list price of the licenced products as prescribed in theIndian PublishedPrice, fixed in consultationwith the licensorat thetime of the sub- licence or such lesser amount agreed to. Royalty wasto be also paid on software products put to internal use. The royaltywas payable on quarterly fiscal basis and was subject to deduction oftax at source.The licence agreement was for a period of five years butit appears it was extended for further period relevant to the assessmentyears in question. 5.In addition to the aforesaid royalty, the appellant had also paidthe following amounts to the parent company reflected as expenditureon import of software master copy:- 6.The aforesaid were not made in but on payments lumpsum,distinct and separate dates in each assessmentyear on import of the master media from tlie holding company.To avoid prolixity, we arenot reproducing details of import in each assessment year but for thepurpose of clarity, we are reproducing details of the said import in theAssessmentYear 1994-95:- ITANo. 25/2012- connected appeals 5.In addition to the aforesaid royalty, the appellant had also paidthe following amounts to the parent company reflected as expenditureon import of software master copy:- 6.The aforesaid were not made in but on payments lumpsum,distinct and separate dates in each assessmentyear on import of the master media from tlie holding company.To avoid prolixity, we arenot reproducing details of import in each assessment year but for thepurpose of clarity, we are reproducing details of the said import in theAssessmentYear 1994-95:- ITANo. 25/2012- connected appeals 7.The AssessingOfficer held that the aforesaidpaymentsofRs.94,49,041/- for the Assessment Year 1994-95 and similar paymentsfortheotheryearsdescribedassoftwaremastercopyanddocumentationwas capital expenditure and not revenue in nature.Hereferredto the agreementdated 28^'' May, 1993, which was for a termof five years and observed on inteipreting the terms that the appellanthadacquiredcopyrightandallotherassociatedandapplicableIntellectual Property Rights. He invoked Section 35A and held that onthis amount, the appellantwas entitledto deductionequal to 1/14^'^ ofthe expenditure as it was incurred on acquisition of copyright. He heldthat there was transfer of copyright, in addition to other associated andapplicable Intellectual Property Rights by Oracle Corporation, USA tothe appellant company and the appellant had acquired the said rightsfor the purpose of business. 8.For the Assessment Years 1994-95 to 2004-2005,Commissionerof Income Tax (Appeals) reversed the finding of the Assessing Officertothisextent.FortheAssessmentYear1994-95,Commissionerobservedthat the obsolescencerate in softwarewas(Appeals)industry version of softwares wereextremely high and updated developedfrequently. Some softwareshad a commerciallife of only 1- 2 monthsand had to be substituted by an upgraded version thereby making the,ITANo. 25/2012-connectedappealsPage6 of32of Income Tax (Appeals) reversed the finding of the Assessing Officertothisextent.FortheAssessmentYear1994-95,Commissionerobservedthat the obsolescencerate in softwarewas(Appeals)industry version of softwares wereextremely high and updated developedfrequently. Some softwareshad a commerciallife of only 1- 2 monthsand had to be substituted by an upgraded version thereby making the,ITANo. 25/2012-connectedappealsPage6 of32 earlier version redundantor useless.Referringto the agreement,heobsei-ved that the intellectual property rights in the software were nottransferred to the appellant by Oracle Corporation, USA. Royalty waspayable to Oracle Corporation, USA based upon the number of copiesduplicated from each original master copy sold or sub-licensedto thirdparties.Large number of master copies were imported every 2-3weeks. As far as royalty payment was concerned, there was no disputethat it was revenue in nature.Similarly, the cost of procuring themastercopywas ofrecurringnature,whichwas establishedand provedbeyond doubt from shipmentof numerousmaster copies and the factthat there was no single lumpsumpayment. He observed that firstly,master software had to be which was a copy updated procured, there was no benefit asrecurring expenditure. Secondly, enduringthere were coiTections; strides and frequent upgradation of software. the incurred in was for conduct ofThirdly, expenditure questionbusiness as an integral part of profit earning process and not foracquisitionof assets or right of permanentcharactei. Fourthly, theinwas in nature ofof raw.mateiialexpenditure question procurementfor the purpose of businessand not to procure capital and, therefore,was a partofworkingcapitalofthe company.9.After noticingthese facts, the Commissioner(Appeals)deemedit appropriate to ask for remand report.The Assessing Officer,Page 7 of 32ITANo. 25/2012- connected appeals submitted a report and also appeared in person.Before the firstappellateauthority,the assessingofficersomewhatchangedhis stanceand submitted that the expenditure was in the nature of technicalservices and know-how but, tax at source had not been deducted. Itwas accordinglypleadedthat if the expenditurewas to be allowed asrevenue,it cannotbe allowedas a deductionas per Section40(a)(i)ofthe Income Tax Act, 1961 (herein after referred to as the "Act").Commissioner(Appeals)did not agree with the AssessingOfficerandobsei-vedthat theincurred was neither for extension of expenditurebusinessnor for substantialreplacementof equipment,whichrelatedtocarryingon or conductofbusinessand an integralpartofprofitmakingprocess. It was nothing but for procurementof raw material. Heoverturnedthe finding of the AssessingOfficerthat the appellanthadacquiredright of enduringnatureby importingmastercopies and alsothethat Section35A was Therejected finding applicable. price paidfor the master or did not involve transfer of copy royalty paymentintellectual and no such were thepropertyrights rights acquired by Theat whichthewas sold did not includetheappellant. price productcost of intellectualproperty right.He noticed that the AssessingOfficerin the appellateproceedingsfor the first time had relieduponSection40(a)(i)and observedthatthe cost ofthe mastercopy does notconstitutetechnicalloiow-howor royaltyunder Section9 of the Act.,Page 8 of 32ITANo. 25/2012-connectedappeals The transaction in question, i.e., import of master copy was separateand could not be inter-linked with payment of royalty. It was held thatthe payments made for acquisition of the master copy should beallowed as business expenditure under Section 37 of the Act.Commissioner (Appeals) for the Assessment Year 1994-95 gave a that there was no transfer of intellectualcategoricalfindingpropertyrights and the copyright continued to vest and remain with Oracle USA.The master were not ofCorporation, copies enduringnature/benefitas they had to be updated frequently in view of highdegreeofobsolescence.Pricepaid for the mastercopy did not includecost involvedin transferof in the software. was rights Royalty paidtowards intellectualproperty rights of the Oracle Corporation,USAandthe costofthe mastercopy did not includethe saidprice.10.Tribunal by their order dated 28"^ October, 2005, which was acommonorder,relatingto AssessmentYears 1994-95,1995-96,1996-97 reversedthe orderofthe Commissioner(Appeals)and restoredthe•viewtakenby the AssessingOfficer. We wouldliketo reproducetwofrom the saidorder as the same reflectthe coreparagraphs impugnedofthe findingsrecordedby the tribunal:- "3 4 Wehave perused the records andconsideredthe rival contentionscarefully.-Theassessee is a 100% subsidiary of OracleCorporation,USA and is authorisedas pei theagreement signed to sub-lease the softwaie Page 9 of 32 ITANo.25/2012-connecledappeals productsdevelopedby the foreigncompany.For this purpose, the assessee has imported tlieMaster Copy of the softwaresas goods underthe open general licencescheme of the ExportImport Trade Policy.The assesse is makingduplicatecopies from the MasterCopy andselling it to local clients.For importingtheMastercopyithaspaidalumpsumconsideration and is also paying royalty @ 30%of the listed price of duplicate softwares soldlocally.The AssessingOfficertreatedthelumpsum consideration paid for import of theMaster Copy as capital expenditure holding that •it wasan asset of enduringbenefitsto theassessee. Page 9 of 32 ITANo.25/2012-connecledappeals productsdevelopedby the foreigncompany.For this purpose, the assessee has imported tlieMaster Copy of the softwaresas goods underthe open general licencescheme of the ExportImport Trade Policy.The assesse is makingduplicatecopies from the MasterCopy andselling it to local clients.For importingtheMastercopyithaspaidalumpsumconsideration and is also paying royalty @ 30%of the listed price of duplicate softwares soldlocally.The AssessingOfficertreatedthelumpsum consideration paid for import of theMaster Copy as capital expenditure holding that •it wasan asset of enduringbenefitsto theassessee. 3.5Theimportof MasterCopywiththerighty of duplicationis definitelyan asset ofenduring benefit.But whether the expenditureontheacquisitionofthesamecanbeconsidered as capital expenditure or a revenueexpenditure has to be examined in the light ofjudicial pronouncements on the subject.Thepayment of lumpsum consideration or enduringbenefitsare not conclusivetestsin decidingwhetheranexpenditureisarevenueexpenditure or capital expenditure as held bythe Supreme court in the case of M/s EmpireJute company (124 ITR 1) and subsequentlyreiteratedin the case of M/s Alembic ChemicalWorks (177 ITP. 377). It would be pertinent toelaboratethesecases which will be usefulinunderstanding the true nature of the expenditurein the instant case." 11.Thereafter, reference was made to the facts and the ratio in thecase of Empire Jute Company (1980) 124 ITR 1 (SC) and AlembicChemical Works (1989) 177 ITR 377 (SC) and it was observedthatimportedmastercopy was used for duplicatingcopiesofsoftwareand, therefore,a part of the profit earning apparatus.It was not a casewhere the appellant had imported some laiow-how device or device bywhich copying of software was done more efficiently. Once mastercopies were held to be a part of profit earning apparatus or source ofincome, it was immaterial whether the appellant had ownership rightsor only right to duplication. Decisions of the tribunal in the cases ofsound tracks of film songs and the film music were distinguished asthey related to payment of yearly royalty, based on sales of cassettesobtained from master plates. In the said cases, the expenditure wasrelating to trading operation and no lumpsum payment was made. Inthe present case also, on royaltythere was no dispute but the disputerelatedto Anothercase was lumpsumpayments. distinguishedon thegroundthat lumpsumpaymentmade for procurementof masterplatesforaudio cassettecouldbe treatedas revenueas producingexpenditurethe sound tracks got duplicatedin the process and were used as lawmaterial.The master copies of softwares, it was observed hadunlimitedlife and capableofgivingunlimitednumberofcopies. Themaster were not raw materialbut a tool to copies only get duplicatecopies of software. Further,the mater copies were not procuredfromthirdpartiesbut from in-houseestablishment.12.Before we dwell upon the questions raised, we would like topoint out certain undisputedfacts. The Assessing Officer had alsoITA No. 25/2012-connectedappealsHof32 denied benefit to tlie appellant under Section 80-IA on the ground thatduplicationof software did not amount to manufacture.Section40(a)(i) was also invoked in respect of royalty payments.The tribunaldecided the two issues against the revenue.Revenue preferred appealsbefore the High Court, but the appeals were dismissed on the twoissues vide judgment CIT v. Oracle Software India Lid. (2007) 293ITR 353 (Delhi) observing that no substantial question of law arose forconsideration and Section 40(a)(i) was not applicable.13.Not satisfied, Revenue preferred further appeals on issue ofdeductionunderSection80-IAbut did not succeedvidedetaileddecision in CIT v. Oracle Software India Ltd. reported as (2010) 320ITR 546 (SC). The SupremeCourt in the said decisionhas noted thatthe appellant had imported master media of software from OracleCoi-poration,USA for duplicatingon blank disc, which were packedand sold in the market along with the relevant brochure. The appellanthad paid lumpsum amount to Oracle software for import of mastermedia. The Supreme Court has ftirtherobservedthat the software inquestion was application software and not operating software orsystem software. The software could be categorisedas product lineapplication,applicationsolutionsand interimapplications.The mastermedia wasto validationand software subjected checkingprocess byengineers by installing and rechecking the integrity of the masterrrANo. 25/2012-connectedappeals12 of32 media with the help of the software installed in the fully operationalcomputer.Thereafter the same was inserted in a machine CD blasterand virtual image of the software was created on the internal storagedevice.This virtual image was replicated to produce or duplicate thesoftware.The virtual image was too large to be shown on screen. TheSupremeCourthas ftirtherobservedthat softwareswere goods as heldin Tata Consultancy Services versus State ofAndhra Pradesh, (2004)271 ITR 401 (SC).The software copyright might remain with thebut the moment were made andoriginator of the programme copiessold,they would be termed as goods. There was no differencebetweensale of softwareprogrammeon CD and saleof music on cassettes/CDs.The intellectual copyrights had got incorporated on the media for thepurposeoftransferand, therefore,mediacamiotbe splitup. Referencewas made to the decision in Gramophone Company of India Limitedversus Collector of Customs, (1999) 114 ELT 770 (SC) and it wasobsei-vedthat duplication or recording of audio cassettes amounts tomanufacture as goods were produced.14.Beforeproceedingfiarther,we would like to reproducethe exactreply given by the appellantas recorded in the assessmentorder forAssessmentYear 1994-95on the issue in question. The same leads asunder "1.Imports master copy of Oracle products ITAlMo.25/2012-connectedappeals13 ol 32 under the OGL Classification85.24 after the fiillpaymentof custom duty.These are furtherreplicated in India using the appropriate carriermedia by virtue of an agreement OSIPL has withOracle Corporation. 2.ThemastercopiesareversionsofOracle'snew productofferingswhichhaveavery acceleratedobsolence.At anv point oftime it is not capable of determiningwhether theversionwillbecurrentforonedayoronemonth.In the life cycle of product if a version isreleased and improvementis developed the nextday the earlier version is obsolete.The mastercopy/documentation writeoff policywhichOraclehas adoptedrecognizesthe acceleratedobsolenceand the non-enduringuse of mastercopy/documentation."(Emphasis supplied)Oracle'snew productofferingswhichhaveavery acceleratedobsolence.At anv point oftime it is not capable of determiningwhether theversionwillbecurrentforonedayoronemonth.In the life cycle of product if a version isreleased and improvementis developed the nextday the earlier version is obsolete.The mastercopy/documentation writeoff policywhichOraclehas adoptedrecognizesthe acceleratedobsolenceand the non-enduringuse of mastercopy/documentation."(Emphasis supplied) 15.After recording/ reproducing the said reply, the AssessingOfficerintheassessmentorderhasnotdisputedorfactuallycontroverted the contents or the assertion made by the appellant. TheAssessing Officer accepted and did not contradict the said factualassertion as incorrect, but addition was made by the Assessing Officeron the grounds, namely, (i) in spite of the factual position theexpenditurewas capital(ii) Section35A ofthe Actwas applicableand,therefore,the cost paid on master copy was to be amortised/allowedin14 instalmentsfor theAssessmentYear1994-95.Evenif theexpenditurewas revenueinnature,the same has to be disallowed.16.We have quoted the finding recorded by the tribunal in ITANo,25/2012-connectedappealsPa&e 14 of32 paragraphs 3.4 and 3.5 of the order, for the Assessment Years 1994-95,1995-96 and 1996-97.It has been observedthat lumpsum payment.was made for the master copy and as the appellant also had right ofduplication it lead to creation or acquisition of an asset of enduringbenefit.It became part of the profit making apparatus and source ofincome. The Tribunal without disturbing or contradicting the stand ofthe appellant, on legal principles has held that the expenditure wascapital in nature. 17.We have given thoughtful consideration to the said findings, butfindthatthefinalconclusioncannotbe sustainedandshouldbereversed.Tribunal in the impugned order and the reasoning giventherein has not disturbed the finding of the Commissioner (Appeals) orthe assertion of the appellant before the Assessing Officer that themaster copies were versions of software developed by OracleCoi-poration, USA, a new product offerings, which had highaccelerated obsolescence and even at the point of time of import it wasdifficult whether the version would be replaced by a new or updatedversionafterone day or a month. The life cycle of the versionreleasedwas limited and improvementsand further developmentswere constantand intermittent. The earlier version had a high degree of obsolescenceand the master copy, documentation and policy adopted by theappellantrecognisedthat the master copy did not have enduring orITA No. 25/2012-connectedappeals15 ol 32 long- term benefit. 18.The Right to duplication and import of master copy thoughconnected, cannot and does not show that the expenditure in questionwas capital in nature. The import of master copy was for the purpose ofcreating virtual image for the purpose of duplication.The right toduplicationwas given to the appellantunder the agreementdated 28"''May, 1993 and was subject to payment of royalty. The payments inquestionwere not for acquiringthe right to duplication.This is not thecase of the Revenue or the finding of the Assessing Officer or theTribunal.We have also quoted above the sample data for AssessmentYear 1994-95, which shows that there were as many as 28 imports ondifferentdates after October,1993 indicatingthe number of mastercopies imported. The averageprice per copy was minimal. We havealso noted the findings recorded by the Supreme Court as to the natureand character of the software of which virtual image was created fromthemastercopies. This is not a case wherethemastercopiescontainedoperatingor system software,which normallydo not requirefrequent or for considerationor Neither are weupgradation changes price.dealing with a case of an assesseewho is the end user of software.We arewith thewho wasto dealing appellant required repeatedlypayfor the master media in view of newer or copy frequent updatedversionsof thesoftwarefrom time to time. Once neweror applicationITA No. 25/2012-connectedappeals,16 ot 32 better version of application softwares was available, the earlier /application softwares were not saleable and did not have any marketvalue for the seller i.e. the appellant.The earlier versionsbecameobsolete and had limited shelf life, as long as the newer version wasnot available.No one would like to pay or obtain an older version ofthe same software, when the new or updated version was available.19.Courts have grappled with the problem of classification ofincome and expenditure as capital and revenue.The distinctionbetween capital and revenue nature though basic and fundamental topreparation of accounts and income tax, appears to be a never endingconcoctandresultantcauseof litigation.Eventheprinciplesapplicable,oscillate and the difficultyalso arises on selectingthe right facts case.principle applicable to of the givenThere is divergenceand conflict as to the principle which should be applied. Thus, it is nota case of applicationof principlesto facts alone, which is a cause ofdebate and confusion. The terms "capital" or "revenue expenditure"have not been specifically defined in the Act.They are closelyconnected with accounting practices,though elucidated and expoundedin judicialpronouncements. Most income tax enactments,includingthe presentAct, require and mandate determinationof income earnedby the appellant during two particular points of time i.e., theassessmentyear. The income is determinedon the basis of principlesITA Mo. 25/2012-connectedappealsPagel7of32 of accountancyor accountingpracticesas moderatedand subject tomandate/amendmentsby the Act.Theexpression"income"hashistorically received somewhat derisory and derisive interpretation butas a theoreticalas wellas practicalconceptmeansthe incomegenerated during two particular points of time by a person withoutimpoverisliment of oneself (see J.R. Hicks "Value and Capital- Aninquiry into some fundamental principles of economic theory, OxfordUniversity Press, London, Second Edition 1946). Alexander makingreference to the term income in corporate context has stated: income is"the amount which [a] company can distribute to the shareholders andbe as well off at the end of the year as it was at the beginning".It wasobserved:- "The net income of an entity for any period is themaximumamount that can be distributedto itsowners during the period and still allow theentity to have the same net worth at the end ofthe period as at the beginning,after adjustingfortheowner'scontributions.Inotherwords,capital must be maintained before an entity canearn income." 20.Theaforesaiddefinitionsareimprovementsontheconceptualizationof the term "income" as assigned by the Germaneconomist Georg Von Schanz in 1896, who held that income meansthe economicpower accruedto a given person over a period of time,i.e., the disposing power of a given person during the period in question, witliout impairing his capital or incurring personal debts.The aforesaid definitions have become subject matter of new thought/thinldng to categorise revenue and capital expenditure based uponmarket place criteria [see Working Paper "The Classification of capitaland revenue in accounting and the definition of income in the marketplace (Centre for Accounting, Governance and Taxation Research,Schoolof AccountingandCommercialLaw,Wellington,NewZealand" at the works referred to therein.)The aforesaid article refersto the notion of capital maintenance or net accretion. The said note alsorefers to the report on Wheat Committee, 1972 (a special committee ofthe AmericanInstituteof CertifiedPublicAccountschargedwithstudying how accounting principles should be determined) wherein ithas been observed that financial accounting standards and reporting arenot grounded in natural laws as are the physical sciences, but must reston a set of conventionsor standardsdesignedto achieve what areperceived to be the desired objectives of financial accounting andreporting.] 21.While intei-pretingthe meaning-of "accounting income", theFinancial Accounting Standards Board, United States of Americaformallyembodiedcapitalmaintenance,or net accretion,notion in itsstatements of Financial Accounting Concepts (Financial AccountingStandards Board). It has been elucidated as:-ITA No. 25/2012-connectedappealsPage 19 o( 32 " An enterprisereceivesa returnonly afteritscapital has been maintainedor recovered.Theconceptof capitalmaintenance,therefore,iscritical in distinguishing an enteiprise'sreturnon investmentfromreturnof itsinvestment.Both investors and the enterprises in which theyacquirean interestinvestfinancialresourceswith the expectation that the investmentwillgeneratemorefinancialresourcesthantheyinvested."capital has been maintainedor recovered.Theconceptof capitalmaintenance,therefore,iscritical in distinguishing an enteiprise'sreturnon investmentfromreturnof itsinvestment.Both investors and the enterprises in which theyacquirean interestinvestfinancialresourceswith the expectation that the investmentwillgeneratemorefinancialresourcesthantheyinvested." 22.In theFrameworkforthePresentationandPreparationofFinancial Statements published by International Accounting StandardsBoard, an asset has been defined as "a resource controlled by the entityas a result of past events and fi"om which future economic benefits areexpected to flow to the entity" in subsequent accounting periods. Theassets are recognised in the balance sheet, when "it is probable thatfuture economic benefits will flow to the entity and the asset had a costor value that can be measured reliably."The words "income"and"expenditure"have been definedin the said frameworkas under:- "Increasesineconomicbenefitsduringtheaccounting period in the form of inflows orenliancementsof assets or decreases of liabilitiesthat result in increases in equity, other than thoserelatingtocontributionsfromequityparticipants"accounting period in the form of inflows orenliancementsof assets or decreases of liabilitiesthat result in increases in equity, other than thoserelatingtocontributionsfromequityparticipants" 23.The word "expense" in the said Framework has been defined asdecreases in economic benefits during the accounting period in theform of outflows or depletions of assets or incurrence of liabilitiesITA"No. 25/2012-connectedappealsPage20of32 other than those relatingto distributionto equity participants.TheFrameworkrecognisedthe principleof matchingof costs with therevenues in preparation of financial statements and has stipulated:- "Expensesarerecognisedin theincomestatementon the basis of a direct associationbetween the costs incurred and the earning ofspecific items of income.This process iscommonly refeiTed to as the matching of costswith revenues........ Wlien economic benefits are expected to ariseoverseveralaccountingperiodsandtheassociationwith income can be only broadlyorindirectlydetermined,expensesarerecognised in the income statement on thebasis of systematic and rational allocationproceduresThese allocation proceduresare intendedto recogniseexpensesin theaccounting periods in which the economicbenefitsassociatedwiththeseitemsareconsumed or expire. An expense is recognised immediately in theincomestatementwhenanexpenditureproduces no future economic benefits orwhen, and to the extent that, future economicbenefits do not qualify, or cease to qualify, forrecognition in the balance sheet as an asset." 24.Compendiumof AccountingStandardsby Instituteof CharteredAccountants of India defines "income" as encompassing both revenueand gains including um-ealized gains.The term "expenses"encompassesthe expendituresthat arise in the ordinary course of anenterpriseas well as.losses. Expenseswill includedepreciationas it isin the form of outflow caused due to depletion of assets. The term1ITANo.25/2012-connectedappealsPage 21 of32 An expense is recognised immediately in theincomestatementwhenanexpenditureproduces no future economic benefits orwhen, and to the extent that, future economicbenefits do not qualify, or cease to qualify, forrecognition in the balance sheet as an asset." 24.Compendiumof AccountingStandardsby Instituteof CharteredAccountants of India defines "income" as encompassing both revenueand gains including um-ealized gains.The term "expenses"encompassesthe expendituresthat arise in the ordinary course of anenterpriseas well as.losses. Expenseswill includedepreciationas it isin the form of outflow caused due to depletion of assets. The term1ITANo.25/2012-connectedappealsPage 21 of32 "depreciation" and its significance in accounting as elucidated in theCompendium of Accounting Standards are set out below. Adjustmenttowards capital accounts is when the expenditure includes a futureeconomic benefit associated with the article/ goods which will flow toor from the enteiprise.This may be, inspite of the degree ofuncertainty regarding future economic, benefits and this degree ofuncertainty is ascertained on the basis of evidence avaikble when thefinancial statements are prepared. But, an asset is not recognised in thebalance sheet, when expenditure has been incurred in respect of anitem, on which it is improbable that economic benefit will flow beyondthe current accounting period. Such transactions merit recognition asan loss.Thus the term expense in the statement of profit and'expenses' as recognizedin the profit and loss account will take intoaccountdecreasein futureeconomicbenefitsrelatingto an asset.Concept of expenses includes decrease in the value of asset.An isin the statementof and lossexpense recognizedimmediately profitaccount, if expenditure produces no future economic benefit (seeparagraphs 73 to 97 of the Compendium of Accounting Standardsissuedby the Instituteof CharteredAccountantsof India).25. of cost with revenues takes into considerationdirectMatchingassociation between cost incun-ed and earning of specific items ofincome and also includesvarious componentsof expensesmaking upITANo. 25/2012-connectedappealsPage 22 of 32 the cost of goods. The term 'depreciation'has been defined in theAccounting Standard VI, as a measure of wearing out, consumption orloss of valuearisingfrom use of any type,efflux of time, ofobsolescence tlirough technology and market changes. But depreciableitems are those which are used for more than accounting period and itsusefrillife is over a period during which a depreciable item is expectedto be used by the enteiprise or number of production of similar unitsexpected to be obtained from use of the asset by the enterprise.Assessmentof depreciationis done based upon the three criterions:(1)historicalcost or other amounts substitutedwhen the asset has beenrevalued; (2) expected useful life of the depreciable asset; and (3)estimated residual value.Useful life of depreciable asset may beshorter than its physical life and is determined by several factorsincludingobsolescencedue to teclmologicalchanges, improvements,change in market demand or service output etc.Useful life ofdepreciableasset is a matter of estimationand is mainly based uponexperience with similar type of assets.Determinationof residualvalue, it is stated,is a difficultmatterbut when insignificant,it shouldbe taken as nil.One of the basis for determiningresidual value wouldbe realizable value of similar assets. 26.The Act does not definethe term 'asset' in generalitythoughtheterm 'block of assets' is definedbutthe said definitionis not relevant.ITANo.25/2012-connertedappeals^^8® 23 of 32 26.The Act does not definethe term 'asset' in generalitythoughtheterm 'block of assets' is definedbutthe said definitionis not relevant.ITANo.25/2012-connertedappeals^^8® 23 of 32 Explanation 3 to section 32 states the term asset for the said provisionmeans tangible and intangible assets being loiow-how, copyrights etc.The Act, however, more appropriatelyand pertinently defines the term'capital asset' in Section 2(14) as propeityof any kind, but does notinclude stock in trade, consumable stores or raw materials held for thepui-poses of his business or profession.Personal effects andagricultural land etc. are also excluded.The term/expression'expenditure' finds elucidationin Section37 of the Act and it excludesany expenditure of capital nature or personal expenses. There issubstantial authority for the proposition that determination of whether revenue in nature must and should bean expenditure is capital orreasonsdecidedkeeping in view the natureof the business, commercial whichthefor incurringthe said expensesin businessand the objectforexpense is incurred.Emphasis being placed on., business andcommercialconsiderations,ratherthanpurelegaland technicalaspects. Thus, primacyis givento practicaland businesspointofview revenueand not on juristic classification. The expression 'capital orexpenditure' must be construed in business sense and by applyingsound accountancyprinciplesunless there is statutoiy mandateto thecontrary, (see Section 145 of the Act and observationsof the DelhiHigh CourtinCIT v. VirtualSoftSystemsLtd. (2012)341 ITR 593).27.This aforesaid of as we shall elucidate principle matching,ITANo.25/2012-connectedappealsPage24 of32 below, is of immense importance and significance.When wedetermine whether an expenditure is capital or revenue in nature, itand to forefronttheand commercialexposes brings practiceapproachfrom the true and correct perspectiveand objective;"income" earnedshould be taxed. This has to be kept in mind as the guidingprinciple,subjectto the statutorymandatewhich will override. A statementofaccountspreparedon the basis ofthe aforesaidmatchingprinciplewillgenerally reflect the true and coiTect income earned during the 'specified period.The said determinationwould be fair, just and both to the and the revenue.An asset is notequitable appellantnormally created when a liability is incuiTed and it does not givebenefit or advantagein future accountingperiods 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 itsusefulnesswill come to an end withinthe financialyear itself or is forlimited time and would not have residual value thereafter. anyTherefore, while determining whetherexpenditure is capital orrevenue in nature, we must also dwell into the questionwhether theexpenditure, would create an asset which is of value in furtherassessment periods and should be amortised ( i.e. depieciated)aslong as it has value. (The last portion is obviously subject to thestatutorymandate of an enactment,which may prescribeamortisation'ITA No. 25/2012-connectedappeals25 ot 32 or depreciationrates. Tliese being fixed by law will override theaccounting principles).Thus, when an expenditure incurred does leadto creation of an asset but of a limited or short life, it has to be treatedas a liability and not as a fixed asset.The said expenditure cannot bevalued for price for future financial years. or depreciationrates. Tliese being fixed by law will override theaccounting principles).Thus, when an expenditure incurred does leadto creation of an asset but of a limited or short life, it has to be treatedas a liability and not as a fixed asset.The said expenditure cannot bevalued for price for future financial years. 28.A word of caution and a caveat for the aforesaidtest, is one ofimportance as was elucidated by the Supreme Court in Empire JuteCompany Limited versus Commissioner of Income Tax, (1980) 124ITR 1 (SC). The said decision highlights advantage of enduring benefittest but nonethelessit was cautioned that the said test may break downand what is materialto be consideredis the nature of advantageincommercialsense.If the advantageconsistsof merelyfacilitatingassets in trading operation or enabling the management and conduct ofbusiness more efficiently, it would be expenditure on revenue accounteven though the advantage may be of indefinite future.Thus, inAlembic Chemical Works Company Limited versus Commissioner ofIncome Tax, (1989) 111 ITR 377 (SC) and JonasWoodhead andSons (India) Limited versus CIT, (1997) 224 ITR 342 (SC), theSupremeCourtobsei-vedthat thoughthe teclmologyhad been receivedbut it related to a product already under production and to ensurebetterment or of the improvement,it was part and parcel of the existingbusiness and, therefore, the benefitswere compositepartly revenue andITA No. 25/2012-connectedappealsPage26of32 partly capital.However, in the present case we need not apply thecaveat.The cayeats and caution elucidated would apply as exceptionsof the enduring benefit tests.When the enduring benefit test itselfjustifies the conclusion that the expense is revenue, it would not beproper and appropriate to apply the caveats or exceptions. Thesesecondary tests apply when in spite of the primary test of enduringbenefit being in negative, i.e. against the assessee a differentconclusion against the revenue is justified. Thus the dictum and in thewords of Viscount Cave LC in Atherton v. British Insulated & HelsbyCables Ltd. \QTC\55-.- "When an expenditure is made, not only onceand for all, but witha view to bringingintoexistenceanassetoranadvantagefortheenduring benefit of a trade, there is very goodreason (in the absence of special circumstancesleading to an opposite conclusion) for treatingsuch an expenditure as' properly attributable notto revenue but to capital." The said enunciation has been approved by the Supreme Court in CITvs. Finlay Mills Ltd. 20 ITR 475 (SC) and Empire Jute (Supra) andother cases.The temi enduring we clarify does not mean peraianent,pei-petual or everlasting but it refers and indicates that the rightacquiredmust have enough durabilityto justify it being treated as acapital asset. ITA No. 25/2012-connectedappeals "When an expenditure is made, not only onceand for all, but witha view to bringingintoexistenceanassetoranadvantagefortheenduring benefit of a trade, there is very goodreason (in the absence of special circumstancesleading to an opposite conclusion) for treatingsuch an expenditure as' properly attributable notto revenue but to capital." The said enunciation has been approved by the Supreme Court in CITvs. Finlay Mills Ltd. 20 ITR 475 (SC) and Empire Jute (Supra) andother cases.The temi enduring we clarify does not mean peraianent,pei-petual or everlasting but it refers and indicates that the rightacquiredmust have enough durabilityto justify it being treated as acapital asset. ITA No. 25/2012-connectedappeals 29.The view we have taken find support and is in consonance withthe view taicen by the Delhi High Court in Commissioner of IncomeTax versus Ashahi India Safety Glass Limited, (2012) 346 ITR 329(Del) whereinappellanthad procuredsoftwarewhichwas amortisedinthe books as deferred revenue expenditure but was claimed as adeduction in the income tax income statement.It was observed thatthe said expenditurealong with other expendituresneither created anew asset nor brought forth a new source of income. The expenditureincurredwas to upgrade or to run the existingset up. It was to removedeficiencies in the software installed in the earlier years, to modify,'icustomise or upgrade the software. Similarly, in CommissionerofIncome Tax versus G.E, Capital ServicesLimited, (2008) 300 ITR420 (Del) itwas observedthatthe softwareprocuredby the assesseeinquestion was not customisedsoftware and the software in questionrequired regular upgradation and, therefore, was not of enduringbenefit.30.The Punjab and HaryanaHigh Court in ChiefCommissionerofIncome Tax versus O.K. Play IndiaPrivateLimited,(2012) 346 ITR57 has again observedthat computersoftwaredoes not enjoy adegreeof and it could be unrealisticto the stand and permanence ignorerepeatedupgradationand newerversionswhichhaveto be adoptedandapplied on the payment. In Alembic Chemicals Works Company.Page 28 of 32ITA No. 25/2012-connected appeals Limited(supra),lumpsumconsiderationpaid for technicalImow-how (H'xto achieve higher level of production by better technology was held tobe of revenue account.This was in spite of the fact that there was'Venduringbenefit,but the Supremecourtdeemedit appropriateto applyfa more liberal test on the considerationthat in this age of rapidlyadvancing technology the contention of the Revenue that theexpenditurebroughtinto existingcapitalasset,shouldbe rejected. Theneed of the age, the environment and the business, considerationmattered and were given due recognition and acceptance. The saidview has been followed by the Courts in India. As noticed above, inthe presentcasethe appellantis duplicatingsoftwareand sells,the sameto generate income. It requires master copies, which have to beupdatedand upgradedto be able to sell the said software. In case theappellanthad importedthe saidsoftwareand soldthe same,itwould bestock in trade and deductible. However, when the master copies wereused for duplicationand the softwarereplicatedand transferredon themedia as a result of the said activitieswas then sold, the master copyitselfmight not be stock in trade as such in strictsense, but it did nothave a long life and its value and life span was small since it perishedand diminishedwhenthe upgradedversionor a bettersoftwaremformofthe next master wasfor theof copy imported, purpose duplication.When we acceptthe said positio