Subscription fee of golf club paid by Company for director and his family was not allowable expense

By | October 9, 2015
(Last Updated On: October 9, 2015)

During year, assessee company paid subscription fee for membership of director and his family members to a golf club and claimed deduction of same as revenue expenditure . Assessing Officer treated expenditure as personal expenditure of director and disallowed same

Held :-

subscription fee paid on behalf of director could not be allowed as expenditure at hands of assessee-company .

IN THE ITAT HYDERABAD BENCH ‘A’

K.L. Hitech Secure Print Ltd.

v.

Joint Commissioner of Income-tax

P.M. JAGTAP, ACCOUNTANT MEMBER
AND SAKTIJIT DEY, JUDICIAL MEMBER

IT APPEAL NO. 47 (HYD.) OF 2014
[ASSESSMENT YEAR 2009-10]

MAY  15, 2015

A.V. Raghuram, Authorised Representative for the Appellant. Rama Krishna Bandi for the Respondent.

ORDER

Saktijit Dey, Judicial Member – This is an appeal by the assessee against the order dated November 13, 2013 passed by the learned Commissioner of Income-tax (Appeals)-III, Hyderabad, for the assessment year (AY) 2009-10.

2. The assessee has raised in total 8 grounds. Grounds Nos. 1 and 8 being general in nature, do not require any specific adjudication. In ground No. 2, the assessee has challenged disallowance of expenditure amounting to Rs. 89,47,827 towards purchase of software.

3. Briefly the facts relating to this issue are, the assessee a company is engaged in the business of printing of all high security documents and business forms. For the assessment year under consideration, the assessee filed its return of income on February 5, 2010, declaring total income of Rs. 1,15,60,760. During the assessment proceedings, the Assessing Officer while examining the profit and loss account noticed that the assessee has debited an amount of Rs. 89,47,827 towards “software expenses”. He issued a notice to the assessee calling upon the assessee to show cause why the expenses incurred should not be treated as “capital expenditure”. In reply to the said show-cause notice, as noted by the Assessing Officer, the assessee submitted that software purchased being application software and not system software it has to be allowed as “revenue expenditure”. The Assessing Officer (AO) after considering the submissions of the assessee and on examining the details furnished, found that the assessee had purchased two types of software, viz., KMPC 4 data preparation software and MPS data preparation software from Kodak Versamark. The Assessing Officer accessing information from the internet found that KMPC 4 data preparation software is a vector-based processing and onchip memory service to super charge the performance of ad hoc reports and query response times by up to 70 times faster with no new equipment. The software helps in analysing more data and getting rapid results to critical data queries. It also automatically reduces the cost of processing and empowers the end users to easily answer ad hoc questions faster. The Assessing Officer observed, the features of the software enable the users to access the data assets and increases the speed of data processing and analysis. He noted that the software is useful for printing VDP jobs like recharge cards, OMR forms, courier way bills, marks statements and certificates. The Assessing Officer opined that as the business activity of the assessee is printing of highly secured documents, phone billing statements, recharge voucher coupons, digital variable data with variable data, scanning, processing, etc., the software acquired by the assessee makes a definite value addition to this particular activity, hence it has got enduring value. As far as MPS data preparation software is concerned, the Assessing Officer observed, it is useful for printing the complex VDP jobs like account statements, telephone/mobile bills, certificates with photographs, etc. The Assessing Officer observed that since the benefit of the software is derived by the assessee not for a single year but for ensuing years, the expenditure incurred is not to be treated as “revenue” but as “capital expenditure”. The Assessing Officer noted that the software will not only enhance the technical capacity of the computers where data merging and customised lay out will be used but a permanent feature in printing software will be installed to the system. Thus, being of the opinion that the softwares purchased by the assessee are of enduring nature, the Assessing Officer treated the expenditure as “capital” and disallowed the deduction claimed by the assessee. Being aggrieved of such disallowance, the assessee preferred an appeal before the learned Commissioner of Income-tax (Appeals). The learned Commissioner of Income-tax (Appeals) after considering the submissions of the assessee observed that whether a particular expenditure is “capital” or “revenue” has to be decided on the basis of the facts involved in that case. Thereafter, the learned Commissioner of Income-tax (Appeals) examining the functionality and the nature of software purchased by the assessee and applying the tests laid down in various judicial precedents upheld the disallowance by observing as under:

“6.12 It is clear from the above that the software purchased is not just an enhancement over the existing systems meant only to improve efficiency. Rather, it is entirely new set of tools and described as a complete language which bring about a total paradigm shift in the existing operations. It gives knowledge and technology to the appellant which was hitherto unavailable.

6.13 From the point of view of functional tests, it is seen that these new software systems change the very core operations of the appellant with a significant change in technology. They also enable the appellant to conduct operations which were hitherto not possible.

6.14 On the other hand, the software systems are not just upgrade, rather they are complete and new solutions in themselves. They are designed to last much more than two years being technology altering in scope.

6.15 Thus, both from the point of view of functionality as well as from the economic time span the new software systems pass the tests of capital expenditure. I have therefore no hesitation in holding that the expenditure in question is capital in nature and it has brought about a distinct capital asset into existence. The addition on this account is ordered to be sustained and the Assessing Officer is directed to allow depreciation as per law.”

4. Being aggrieved, the assessee is before us.

5. The learned authorised representative more or less reiterating what was stated before the Departmental authorities submitted that the software purchased being in nature of application software is allowable as “revenue expenditure”. The learned authorised representative submitted even though it was explained before the Assessing Officer that the software purchased merely enhanced the performance of the work which the Assessing Officer also has accepted but we still treated it as capital in nature and disallowed the expenditure. The learned authorised representative submitted, any software which merely enhances the working or performance cannot be treated as of enduring benefit as the duration of the software is of very short span and has to be allowed as “revenue expenditure”. The learned authorised representative submitted that the Commissioner of Income-tax (Appeals) also without properly examining the functionality and working of the software has upheld the disallowance. The learned Departmental representative on the other hand strongly supporting the reasoning of the Assessing Officer and the learned Commissioner of Income-tax (Appeals) submitted before us that the software purchased by the assessee is part of profit making apparatus as without the software, the assessee could not have carried out its activity. The learned Departmental representative submitted that the software is not the replacement of earlier software but it completely overhauls the system. Hence, in fact it is a new system acquired by the assessee. Thus, the software purchased being of enduring nature, the expenditure incurred on acquiring such software has to be treated as “capital expenditure”.

6. We have considered the submissions of the parties and perused the orders of the Revenue authorities as well as the other material on record. As rightly observed by the learned Commissioner of Income-tax (Appeals), whether a particular expenditure is “capital” or “revenue” will depend upon the fact of each individual case and no straitjacket formula can be adopted for deciding the issue. The same also applies to the expenditure incurred on software. Whether expenditure incurred on a particular software is revenue or capital will not only depend upon its ownership and enduring nature but also the functionality. The Income-tax Appellate Tribunal, Delhi Special Bench in case of Amway India Enterprises v. Dy. CIT[2008] 111 ITD 112/21 SOT 1 observed, for determining whether expenditure in acquiring software is revenue or capital, the advantage which an assessee derives has to be seen in a commercial sense. If the advantage is in the capital field, then the same would be capital expenditure. If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently and more profitably, while leaving the fixed capital untouched, the expenditure would be on revenue account. The Special Bench however, observed, if assets/advantage is part of profit earning apparatus, it is capital. Observing as above, the Special Bench laid down certain broad parameters for determining the nature of expenditure which are as under :

i.If the software forms part of profit making apparatus of the assessee’s business, it is to be treated as capital.
ii.If the software is more expensive and if there are associated capital expenditure like purchase of new computer for manning the software, it is more likely to be a central tool of the business and it will be more enduring in nature adding to the profit earning apparatus.
iii.If the acquisition of software radically changes the way operations hitherto was carried on, the expenditure will be capital.
iv.If the life span of the software is more than two years, the expenditure will be capital.

7. Reverting back to the facts of the present case, as could be seen the Assessing Officer at least in the case of one of the software, viz., MPC 4 data preparation software has observed that it enhances the technical capacity of the computers. If that is the case, then it cannot be said that it brings in a radical change to the operations of the assessee or part of the profit making apparatus. Further, though, the Assessing Officer has observed that software packages are going to give benefit to the assessee in the ensuing years, hence are of enduring nature, but he has not examined the exact life span of the software packages. The learned Commissioner of Income-tax (Appeals) has also not examined these aspects. In our view, without examining the nature of software purchased by applying the tests laid down by the Special Bench of the Income-tax Appellate Tribunal, Delhi in the case of Amway India Enterprises (supra), it cannot be condusively said that expenditure incurred on software is capital in nature. As the Departmental authorities have not done the aforesaid exercise, we are inclined to remit the matter back to the file of the Assessing Officer for deciding afresh keeping in view the decision of the Special Bench of the Income-tax Appellate Tribunal, Delhi referred to above. Needless to say the Assessing Officer must afford a reasonable opportunity of being heard to the assessee in the matter. This ground is allowed for statistical purposes.

8. The next issue as raised in ground No. 3 relates to disallowance of an amount of Rs. 23,10,434 claimed as expenditure incurred on repairs and maintenance. Briefly, the facts relating to the issue are during the assessment proceedings, the Assessing Officer noticed that the assessee has claimed an amount of Rs. 1,05,07,020 as expenditure towards repairs and maintenance. On verifying the details/informations submitted by the assessee, the Assessing Officer observed that out of the total expenditure incurred, an amount of Rs. 23,10,434 is capital in nature. The details of such expenditure is as under :

Rs.
False ceiling1,80,000
Flooring (replacement)4,07,936
Flooring (replacement)11,58,530
Flooring (replacement)1,91,973
Flooring (replacement)14580
Partition charges1,88,560
Self-made voucher16100

9. The Assessing Officer commenting that the expenditures incurred are of enduring nature treated the same as “capital expenditure” and disallowed the claim of the assessee. Being aggrieved, the assessee challenged the same in the appeal preferred before the learned Commissioner of Income-tax (Appeals). The learned Commissioner of Income-tax (Appeals) however, sustained the addition. The learned authorised representative drawing our attention to the details of expenditure incurred submitted before us that replacement of flooring cannot be considered to be a “capital expenditure” as no new asset of enduring benefit has come into existence. As far as false ceiling and partition charges is concerned, the learned authorised representative submitted that they are also of the same nature and cannot be considered to be of any enduring benefit to the assessee. He therefore submitted that the assessee’s claim should be allowed. The learned Departmental representative on the other hand submitted that as far as replacement of flooring is concerned, the same has to be treated as “capital expenditure” as replacement of a capital item will always be a “capital expenditure”. As far as false ceiling and partition charges are concerned, the learned Departmental representative submitted that as they are completely new items, they have to be treated as “capital expenditures”.

10. We have considered the submissions of the parties and perused the materials on record. On examining the details of expenditure, we are of the view that expenditure incurred towards replacement of flooring cannot be considered to be a “capital expenditure” as no new asset comes into existence as a result of such expenditure, rather, the expenditures incurred is more in the nature of maintenance of a capital asset. However, as far as false ceiling and partition charges are concerned, admitted fact is these were not existing earlier. Thus, the expenditure incurred by the assessee has brought into existence certain new assets. Therefore, the expenditure incurred being of enduring nature, it has to be treated as “capital expenditure”. Similarly, the expenditure of Rs. 16,100 has not been explained by the assessee with proper evidence. Therefore, on overall consideration of facts and materials on record, we direct the Assessing Officer to allow the expenditure incurred towards replacement of flooring. The ground raised is considered to be partly allowed.

11. The next issue as raised in grounds Nos. 4 and 5 relates to disallowance of depreciation on plant and machinery due to foreign exchange fluctuation. Briefly, the facts relating to this issue are on verifying the material on record, the Assessing Officer noticed that during the year, the assessee has imported plant and machinery worth of Rs. 7,35,66,480 from M/s. Muller Martini (Singapore) P. Ltd. He observed that the assessee has capitalised foreign exchange fluctuation of Rs. 49,07,886 to the respective machinery as dues payable and claimed depreciation on the said amount. When the Assessing Officer called upon the assessee to submit the proof of payment made to the foreign companies, the assessee submitted a ledger extract of the machinery wherein the amount of Rs. 49,07,886 was credited to the asset account. On verifying the details, the Assessing Officer observed that the foreign exchange fluctuation is only a notional loss which the assessee has added to the value of the machinery. He observed that the assessee did not produce any supporting evidence to establish the foreign exchange loss due to fluctuation. The Assessing Officer therefore disallowed the proportionate depreciation amounting to Rs. 7,36,183 claimed on the capitalised foreign exchange fluctuation loss of Rs. 49,07,886. Similarly, the Assessing Officer observed that the assessee has imported computers during the relevant previous year from another foreign company namely M/s. Atlantic Zeiser P. Ltd., for Rs. 33,57,500. In respect of this asset also the assessee has capitalised an amount of Rs. 87,985 towards foreign exchange fluctuation loss and claimed depreciation on the said amount. However, since the assessee could not produce any evidence to substantiate its claim, the Assessing Officer observed that loss on account of foreign exchange fluctuation being notional depreciation on that account cannot be allowed. Accordingly, he disallowed depreciation on foreign exchange fluctuation loss capitalised to the value of computer and added back the amount of Rs. 52,791. When the assessee challenged the disallowances before the first appellate authority, the learned Commissioner of Income-tax (Appeals) after considering the submissions of the assessee in the light of Accounting Standard 11 as well as the provisions of section 43A held that, as per the statutory provision, the change in the value of the asset can be recognised only at the time of payment and not before that. Thus, he approved the view of the Assessing Officer that no adjustment to the cost of asset can be made on notional losses or gains. In this context, he relied upon a decision of the hon’ble Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254 .

12. We have heard the parties and perused the orders of the Revenue authorities as well as the other materials on record. It is manifest from record that deduction claimed by the assessee is on the basis of notional loss due to foreign exchange fluctuation. In our view, no addition or deduction can be made to the cost of the asset on account of such notional loss/ gain on account of foreign exchange fluctuations as the assessee has not made any payment during the year. Only when the assessee makes payment any loss or gain on account of foreign exchange fluctuations can be adjusted towards cost of the asset. In that view of the matter, we do not see any reason to disturb the finding of the learned Commissioner of Income-tax (Appeals).

13. In ground No. 6, the assessee has challenged the disallowance of expenditure for an amount of Rs. 93,928. Briefly, the facts are, the Assessing Officer in the course of the assessment proceedings, while verifying the profit and loss account noticed that the assessee has debited an amount of Rs. 93,928 towards subscriptions. On verifying the details of expenditure, the Assessing Officer noticed that the expenditure is towards subscription fee paid for the membership of the director and his family members to Hyderabad Golf Association, All India Federation of Lottery Trade and Allied Industries, The Indian Hotels Co. Ltd., and German Chamber of Commerce. The assessee further explained that these subscriptions were made to promote the activities of business. The Assessing Officer however, was not convinced with the explanation of the assessee. The Assessing Officer treating the expenditure incurred as the “personal expenditure” of the directors, disallowed the same and added back to the income of the assessee. The learned Commissioner of Income-tax (Appeals) also confirmed the addition. The learned authorised representative submitted before us that out of the aforesaid amount claimed as expenditure an amount of Rs. 50,000 relates to payment of insurance for the earlier years and transferred in the impugned assessment year. As far as other expenditures are concerned, the learned authorised representative reiterated that since the subscriptions were made for the purpose of business, they are allowable as “revenue expenditure”. The learned Departmental representative on the other hand submitted before us that expenditure incurred being personal expenditures of the directors cannot be allowed as expenditures of the company. As far as the amount of Rs. 50,000 claimed to be towards insurance payment of earlier years is concerned, the learned Departmental representative submitted that the assessee never brought this fact to the notice of the Departmental authorities.

14. We have heard the parties and perused the materials on record. On verifying the details of expenditure incurred, we are of the view that the subscription fees paid on behalf of the directors cannot be allowed as expenditure at the hands of the assessee-company. However, as far as the amount of Rs. 50,000 claimed to be towards insurance payment relating to earlier years is concerned, we are of the view that the same requires examination by the Assessing Officer. Therefore, to the limited extent of verifying the payment of Rs. 50,000, we remit the issue back to the file of the Assessing Officer to verify and allow the expenditure if the assessee’s claim is found to be correct. This ground is partly allowed for statistical purposes.

15. In ground No. 7, the assessee has challenged the disallowance of expenditure amounting to Rs. 2,82,600 under the head “Miscellaneous expenditure”. Briefly, the facts are during the assessment proceedings, the Assessing Officer found that the assessee has claimed an amount of Rs. 20,14,022 towards miscellaneous expenses. When the Assessing Officer called upon the assessee to explain the nature of expenditure with supporting evidences, the assessee submitted the details of expenditure with supporting vouchers. However, on verification of the information submitted, the Assessing Officer noticed that expenditure booked under the heads “Business promotion” amounting to Rs. 5,20,815 and miscellaneous expenses of Rs. 6,09,491 are through self-made vouchers and are not supported by any authentic bills. When the Assessing Officer proposed to disallow these expenditures, the assessee submitted that when employees were deployed on outside duties, the company reimburses the expenditure incurred by them. The Assessing Officer however, not being fully convinced with the submission of the assessee, disallowed 25 per cent. amounting to Rs. 2,82,600 out of the aforesaid two items of expenditure. Being aggrieved, the assessee challenged the same in appeal. The learned Commissioner of Income-tax (Appeals) also confirmed the disallowance.

16. We have heard the parties and perused the materials on record. As can be seen, out of the total amount claimed towards “miscellaneous expenses”, the Assessing Officer has restricted the disallowance that too at 25 per cent. to two items of expenditure, viz. “business promotion expenses” of Rs. 5,20,815 and miscellaneous expenses Rs. 6,09,491 for the reason that they are supported by self-made vouchers only. As can be seen from the explanation of the assessee before the Departmental authorities, the assessee has claimed that such expenditures were incurred on employees when they were sent outstation. However, considering the fact that the expenditures incurred were not supported by any authentic bills/vouchers, some amount of inflation by the assessee while claiming this expenditure cannot be ruled out. In these circumstances, disallowance of 25 per cent. of the expenditure claimed in our view is reasonable and need not be interfered with. Accordingly this ground is dismissed.

17. In the result, the assessee’s appeal is partly allowed for statistical purposes.

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