Maintenance of software is not capital expenditure

Maintenance of software is not capital expenditure


SHV ENERGY INDIA PVT LTD HYDERABAD

Vs

ASSISTANT COMMISSIONER OF INCOME TAX CIRCLE 3(1) HYDERABAD


The assessee is in appeal before us against the order of the learned CIT(A) dated 17-11-2004 for assessment year 2001-02. First four grounds in the appeal relate to the disallowance of 60% the unshared expenses.

2. The assessee company is engaged in the business of trading in raw materials, distribution of liquid petroleum gas (LPG), establishment of LPG terminals, blending and bottling plants, manufacturing of cylinders and developing LPG network. It has wholly owned subsidiaries as well as joint ventures for the aforesaid purpose. For the year under consideration it declared a business loss of Rs.2,11,35,329 and long-term capital loss of Rs.17,57,95,625. The assessee has entered into agreement with each of its subsidiaries known as ‘Shared Service Agreement', as per which the services rendered by the assessee company to the subsidiaries are to be charged to the respective subsidiaries. In this connection, the assessee showed a recovery of Rs.3,00,34,000 from the subsidiaries. The details revealed that the total cost of shared services is Rs.5,93,42,541. Thus, it was seen that the subsidiaries had shared about 51% of the total cost. The Assessing Officer scrutinised in detail the structure of the conglomerate and their activities. He found that the control of the companies was in the hands of the assessee company with common management, common public relations, common purchases, common sharing of services and data processing. Therefore, the question the Assessing Officer posed to himself was as to what was the basis of allocation of costs incurred by the assessee amongst the subsidiaries. The details on record revealed that the assessee had recovered the aforesaid sum of Rs.3,00,34,000 only from four of its subsidiaries and that too at a fixed rate of 20 or 30%. It was further noted that there was no correlation between capital employed in each of these four subsidiaries and the capital expenditure recovered from them. According to the Assessing Officer, allocating the expenditure on the basis of turnover would have been more scientific but that too was not done by the assessee. The next question the Assessing Officer posed to himself was as to why the total expenditure was not allocated to all the subsidiaries. He noted that whereas six subsidiaries did not have any activity, three were in the business of maintenance of storage terminals which involved lot of expenditure. The Assessing Officer compared the total capital employed in the four subsidiaries from whom recoveries were made with the capital employed in the three companies maintaining storage terminals and was of the view that on proportionate basis a sum of Rs.86,13,278 should have been recovered from these three companies. However, it was submitted by the assessee that the three companies were not its subsidiaries but were joint ventures and had little control over them. The Assessing Officer having noted the absence of a proper method of allocation of expenditure, fell back upon assessment year 1997-98 in which year 60% of the expenditure was disallowed and which was also confirmed by the CIT(A) by his order dated 20-3-2002 . Accordingly, for the year under consideration, the Assessing Officer followed the same pattern and disallowed Rs.1,75,85,124 out of the total expenditure.

3. The CIT(A), by and large agreed with the action of the Assessing Officer except to the extent that he directed to disallow 60% of the total expenditure after reducing the salary paid to the Managing Director and the expenditure incurred on software as these expenses were considered separately for disallowance.

4. At the outset, the learned counsel drew our attention to the basic fact and the quantum of disallowance. The assessee incurred total staff costs of Rs.2,98,70,096 and establishment costs of Rs.2,94,72,445 aggregating to Rs.5,93,42,541. The above two amounts appear debited in the profit and loss account. Out of the aggregate, the assessee distributed Rs.3,00,34,000 to the subsidiaries and the credit for which is found in the profit & loss account. Thus, the balance amount of Rs.2,93,08,541 (5,93,42,541-3,00,34,000) was claimed by the assessee as its own expenditure. However, the Assessing Officer disallowed 60% of Rs.2,93,08,541 on the ground of not having recovered any expenditure from the three storage companies and against which the assessee is aggrieved. Since the Assessing Officer made the disallowance in the light of the finding in assessment year 1997-98, the learned counsel drew our attention to the order of the Tribunal for that year in ITA No.670/Hyd/2002 dated 28-2-2007. In this connection, it was pointed out that according to the finding of the Tribunal, except Government of India's letter dated 12-10-1995 , there was no other material to suggest that the assessee provided any service to the other companies where investments were said to have been made. In a miscellaneous application filed by the assessee against the said order of the Tribunal, the amended approval of the Government of India in the form of its letter dated 19-2-1996 was placed on record to show that the formation of the new company was to implement the project. However, since this evidence was filed for the first time, the Tribunal vide its order dated 25-5-2007 in M.A.No.27/Hyd/2007 held that there was no mistake apparent on record. Thus, for the present appeal the emphasis of the learned counsel was on the letter dated 19-2-1996 to which our attention was drawn to impress that the assessee company was established to implement the project. In view of this, it was submitted that the order of the Tribunal in assessment year 1997-98 should not be followed and that the matter requires a fresh look. It was also argued that there was absolutely no basis to make a disallowance of 60%. It could well have been 6% or even 80%. It was also submitted that no disallowance could be made unless the expenditure was of a personal nature or capital nature and it was not the case of the revenue claiming to be either of this. It was also not unconnected with the business, it was submitted. The learned counsel relied on the following judgments:
(a) CIT v. Walchand And Co. Pvt. Ltd. – 65 ITR 381 (SC)
(b) J.K. Woollen Manufacturers v. CIT – 72 ITR 613 (SC)
(c) Aluminium Corporation of India Ltd. v. CIT – 86 ITR (SC)

5. At the outset, the learned Departmental Representative did not dispute about the new fact being brought on record in the form of Government's letter dated 19-2-1996 . However, according to her this did not make any material difference. Referring to paragraph 4 in the letter dated 12-10-1995 , it was contended that the legal mandate to the parent foreign company was to set up a company for the main object to carry on the business of trade in LPG, setting up and operation of LPG terminals and so on. Setting up of subsidiaries was not the business of the assessee and hence all activities other than the business in LPG were incidental only. The learned Departmental Representative likened the case of the assessee with that of a kirana dealer whose business is to trade in kirana but setting up of shops cannot be said to be his business. The submission was that the expenditure incurred by the assessee for the subsidiaries had no nexus with its own business and that the business of the subsidiaries was independent of the assessee. It was not the business of the assessee to run the business of the subsidiaries and she also raised a question as to why the recovery was from four companies only and not from all fourteen subsidiaries. The learned Departmental Representative also questioned the basis of allocation adopted by the assessee and submitted that though the allocation was stated to have been made on the basis of a careful study, no details of such study were placed on record. She further questioned the responsibility of the assessee's own assessment of time spent and resources utilised on behalf of the subsidiaries for allocating the expenditure in different propositions. Referring to the Shared Services Agreement (SSA), it was submitted that there was no payment of fees as stipulated in clause 2 of the agreement and hence it could not be said that the SSA was sacrosanct. Further, if some companies had not begun operations, it means they did not have employees and it further means that their activities were undertaken by the assessee. If that were so, the assessee should have been reimbursed for the same. According to the learned Departmental Representative, the subsidiaries were the fiefdom of the assessee and hence recoveries were effected only from them leaving out the Joint Ventures (JVs). It was submitted that the assessee did have some stake in the JVs and it was irrelevant that because they were JVs, no recoveries could be made from them. Finally, the learned Departmental Representative summed up her arguments by reiterating that the only difference from assessment year 1997-98 was the amended approval of FIPB, but the basic mandate to carry on the business of LPG did not undergo any change and hence the disallowance made this year on the basis of assessment year 1997-98 was justified and should be upheld.

6. We have duly considered the rival contentions and the material on record. First let us ascertain the raison d'etre of the assessee company. It is supposed to have been set up as a wholly owned subsidiary of SHV energy NV, Netherlands for operation of LPG terminals, blending and bottling plants, and manufacture of gas cylinders, regulators, valves and ancillary equipment and development of a LPG dealer network throughout the country. This is as per the approval letter dated 12-10-1995 . Clause 4 of this letter is also relevant. It reads as follows:
“It is noted that the proposed holding company would route the investments in downstream joint ventures, would coordinate them and provide managerial and technical assistance wherever required.”
The question is as to which is the holding company which is to route its investments in downstream joint ventures and also provide managerial and technical assistance. Well, we need not venture to interpret the clause as the Tribunal has already done so in its order for assessment year 1997-98 cited supra. As per paragraph 6 of the said order, the assessee appears to be a wholly owned subsidiary company of SHV Energy Mauritius Pvt. Ltd. which in turn is a subsidiary of SHV Energy NV, Netherlands . The Tribunal, therefore, held that the holding company was SHV Energy NV, Netherlands , and not the assessee company. The Tribunal further observed that the assessee company has nothing to do with the approval granted by the Government of India for setting up of another wholly owned subsidiary company by SHV Energy NV, Netherlands . Therefore, it may not be correct to say that the assessee company was providing any managerial and technical assistance. In the light of these findings, the Tribunal held that unless and until it is shown that the assessee is making investment in an organized and systematic manner, it cannot be said that the assessee was in the business of investment. Admittedly, it was also not in the business of money lending. In the light of these findings, the Tribunal held that the interest income is not the business income of the assessee but income from other sources. Further, in the light of these findings the Tribunal also upheld the disallowance of expenses by observing that there was no material available on record to suggest that the assessee had provided managerial or technical services to the subsidiaries. This is the factual position so far as assessment year 1997-98 is concerned. Now let us come to the present year.

7. The dispute in the present year is, by and large the same. Facts also, by and large are the same except the new evidence placed on record in the form of Government of India's letter dated 19-2-1996 . In the light of the new evidence on record, we shall try to approach the problem by posing to ourselves the following questions:
(a) are the expenses of Rs.5,93,42,541 incurred by the assessee for the purpose of its business ? if the answer to this question is in the affirmative, then obviously, the expenses would be allowable. However, if the expenses are held to be not for the purpose of the business, then the next question that arises is,
(b) whether the said expenses are incurred on behalf of the subsidiaries/JVs, and if so, was the assessee under an obligation to recover the same from them?
Let us consider the first question in the light of the new evidence placed on record. The crucial content of the letter after referring to the earlier approval is that “a new company in the name and style of M/s. SHV Energy India Private Limited has been formed to implement the project.” The implication of this letter is that the Netherland company is not to set up other subsidiaries or joint ventures but it is the assessee company which will set up subsidiaries and joint ventures in future. This is strengthened by two aspects in the original approval dated 12-10-1995 . Clause 4 uses the expression “proposed holding company”. The word ‘proposed' itself is indicative of the fact that it refers to the company which is to be established and not to the one which is already in existence. However, in absence of proper clarification in the form of the letter dated 19-2-1996, the tribunal was constrained to hold in assessment year 1997-98 that the assessee is not the holding company but only a subsidiary company. Second aspect which strengthens our view is clause 5 of the letter. It says that “for setting up further joint ventures/subsidiaries in India for downstream activities, you shall require prior approval of the Govt. of India.” Now it is common sense that if the proposed company is going to be the holding company as mentioned above, and if it has to implement the project as envisaged in the letter dated 19-2-1996 , obviously that company only will have to obtain the approval of the Government before setting up joint ventures/subsidiaries. Therefore, we are of the firm view that with the clarification coming in, in the form of the letter dated 19-2-1996, it is the assessee company which is to be the holding company which would route the investments in downstream joint ventures, would coordinate them and provide managerial and technical assistance wherever required. This fact is tacitly accepted by the Tribunal in its order in the Miscellaneous Application also when it is observed that the learned counsel very fairly conceded that the letter dated 19-2-1996 was not on record at the time of hearing the appeal, and the Tribunal could not take cognizance of the said letter in the proceedings u/s 254(2) of the Act.

8. What transpires from the foregoing discussion is that one vital additional fact has changed the status of the assessee company and hence, the complexion of the matter. It was in the case of Padmasundara Rao (decd.) v. State of Tamil Nadu (255 ITR 147) at page 153 of the report, the Supreme Court observed that circumstantial flexibility, one additional or different fact may make a world of difference between conclusions in two cases. The same is the case here. Thus, to fulfill its objects, mandated both by the memorandum of association as well as the FIPB, the assessee company set up certain wholly owned subsidiaries and invested in some joint ventures. It entered into agreements with these companies for sharing of services and charges therefor. It was also to provide managerial and technical assistance to these companies. Therefore, the assessee incurred business development costs, stewardship costs and service related costs. The first two types were not charged to the subsidiaries but were born by the assessee company itself. So far as service related costs re concerned, the assessee incurred staff costs and establishment costs. As regards staff costs, the assessee has given details of the employees and the description of the services rendered by them. Referring to these details, it was pointed out by the learned Departmental Representative that some employees were shown to have worked for all the companies. The question raised by her was as to why there were no recoveries from the JVs and according to her there was hardly any difference between the JVs and the subsidiaries. Well, undoubtedly these are insignificant trivialities which have no bearing on the actual matter of fact. De hors that, firstly, it cannot be disputed that all the companies, whether JVs or subsidiaries are distinct legal entities. The assessee has stake in both. However, the difference is that in JVs there is another party who maybe equally interested but in subsidiaries no one except the assessee company is interested. In that sence, if the subsidiaries are the fiefdom of the assessee as the learned Departmental Representative has described it, it may not be wrong but the assessee company certainly has control over it and it has an agreement for sharing services amongst themselves. The objects of subsidiaries and JVs would obviously be different. Generally speaking, in the context of the assessee's business, subsidiaries would act in furtherance of the object of the holding company whereas the JV would be undertaking a distinct business by itself. As it appears from the overall business spectrum of the assessee, the JVs are to be kept independent and the subsidiaries are to be subservient to the holding company. In short, how the assessee has to run its business, how it has to be structured and how it has to be organized, it is all assessee's own lookout and the revenue officers need not take upon themselves the role of a business consultant. Even if there is a deviation from the SSA, it makes no difference and does not prejudice the interests of the revenue unless it is specifically shown to be so. There is no allegation or even a doubt that the expenses are fictitious or that they are of capital nature or having personal element. All the expenses incurred by the assessee are for the purpose of business and shared by some of the subsidiaries which are nothing but special purpose vehicles to smoothen the business operations of the assessee. We may also clarify that there cannot be a business of floating and winding up of subsidiaries as the learned Departmental Representative had argued. Even if the kirana dealer opens several shops, it cannot be said that he is in the business of opening shops. His business remains that of kirana only. Therefore, we do not find the comparison with the kirana dealer to be apt. In the ultimate analysis, we hold that all the expenses incurred by the assessee are wholly and exclusively for the purpose of business and no disallowance is called for. Therefore, the disallowance of 60% of Rs.2,93,08,451 is deleted.

9. Second ground in the appeal is against the disallowance of royalty of Rs.4,71,317. The impugned amount was paid to the parent company towards maintenance of Kernel Software. Since TDS was not deducted from the said payment, the Assessing Officer disallowed the same u/s 40(a)(i) of the Act. The CIT(A) confirmed the same.

10. The contention of the learned counsel is that the said amount represents credit and not actual payment. It is pointed out that as per rule 30(1)(b)(i)(1) of the Income tax Rules, if the amount is credited on 31 st March, then the tax in respect of the said amount should be deducted and paid before 31 st May. It is also submitted that the payment of tax was in fact made on 31-5-2001 . In view of the said rule, we delete the disallowance subject to the verification of the payment by the Assessing Officer.

11. Third ground in the appeal is against restricting the remuneration allowable to Rs.51 lacs paid to the managing director. The assessee paid a salary of Rs.75,50,264 to its managing director. The Assessing Officer observed that though the remuneration paid to the managing director was approved by the shareholders, the same was subject to the approval of the Central Government, which was awaited. Therefore, he disallowed the entire salary paid to him. In the course of appellate proceedings, the assessee produced the approval of the Central Government, as per which salary of Rs.4,25,000 per month was approved. Therefore, the Assessing Officer was directed to allow deduction to the extent of Rs.51 lacs and the disallowance of the balance amount of Rs.24,50,264 was confirmed.

12. The contention of the learned counsel is that the expenditure is for the purpose of business and hence is allowable. The learned Departmental Representative relied on the orders of the lower authorities.

13. On due consideration of the matter, we allow the claim of the assessee. It is not disputed that the expenditure is incurred wholly and exclusively for the purpose of business. It is also not a capital expenditure nor an expenditure of a personal nature. Therefore, all the conditions required under the Income tax Act for the allowance of the expenditure are fulfilled. The Act does not lay down any condition that remuneration to the managing director will be allowed only to the extent approved by the Central Government. Thus, the disallowance sustained by the CIT (A) is not in accordance with law and hence we delete the same.

14. Last ground in the appeal is against treating the expenses of acquiring computer software as capital expenditure. The assessee incurred expenditure of Rs.14,21,002 for purchase of software, MS Technet and Norton licences. According to the Assessing Officer it was an enduring benefit acquired by the assessee and hence proposed to treat it as capital expenditure. It was explained by the assessee that major portion of the expenses i.e. Rs.14,06,402 was towards maintenance charges/licence fees of the MS Office Enterprise and anti-virus software. However, the Assessing Officer was not convinced with the explanation and hence disallowed Rs.14,06,402. The CIT(A) confirmed the action of the Assessing Officer and also directed him to grant depreciation thereon. We do not detain ourselves for long on this issue as in several cases the Tribunal has taken the stand to hold that in the rapidly changing technological environment, nothing is of enduring nature and more so in the field of software. Moreover, in the present case, the expenses are mainly for the maintenance of the software and hence it is of revenue nature. Accordingly we delete the disallowance.

15. In the result, the appeal of the assessee is allowed.
The order was pronounced in the court on 4-12-2008 .