The Hindu Business Line : From Arawali mines to Juhu supermarket

Radhakrishna Foodland Ltd runs a supermarket in Juhu, Mumbai. Sometime ago, it incurred an expenditure of Rs 41 lakh `towards development and implementation of software'. The company had treated the spend as a deferred revenue expenditure in its books of account, meaning that it wanted to write off the amount in not just one year but many years. However, when filing the income-tax (I-T) return, Radhakrishna Foodland claimed the expenditure as deduction in full, like any other revenue expenditure.

For starters, revenue expenditure is what is deducted from the income of the period when computing profit, as in the case of advertising. Deferred revenue expenditure may be a major outlay, such as a massive ad campaign, which may be anticipated to yield fruits over a few years; this, therefore, is written off in instalments, over 3-5 years, say. Capital expenditure refers to what is spent for acquiring assets with value that lasts several years, as in the case of plant and machinery; in these cases, only depreciation at a specific percentage gets accounted for each year when calculating the profits.

Coming back to the Juhu supermarket, the taxman noticed the difference in the treatment of the item between the accounts and the I-T return. The company explained that Rs 41 lakh included a sum of Rs 27.5 lakh, `being the licence fees paid to Ramco Systems, in terms of Systems Licence Agreement dated September 18, 1997." And that Ramco, the owners of Marshal ERP (enterprise resource planning) software, had granted Radhakrishna the licence to use `certain specific modules'.

Radhakrishna explained to the Assessing Officer (AO) the following salient features of the Agreement:

i) Ownership of the ERP software and all intellectual property rights therein remained the sole and exclusive property of Ramco Systems.

ii) The licensee, that is, Radhakrishna, was bound to observe various restrictions laid down in the Agreement while using the software.

iii) The software system was to be used by the assessee without any modifications.

iv) Radhakrishna had undertaken that the software and related documentation including any extensions of modifications provided by Ramco would be treated as a proprietary trade secret of Ramco

v) Also, Radhakrishna would not make public any information regarding the programs constituting the software without the express written consent of Ramco, which consent could be granted or withheld at the discretion of the licensor, that is, Ramco.

vi) Radhakrishna acquired only the right to use the software systems and not any ownership rights or title for the same. So, it was prevented from distributing either the software system or any part thereof to any other person or entity in any manner. Also, Radhakrishna was required to use the software system to process its own data.

"Relying on the aforesaid clauses of the agreement," Radhakrishna submitted before the AO that what it had obtained was mere licence to use the software, and not any capital asset or a benefit of enduring nature. Therefore, the amount in question should be allowed as deduction when computing income, said Radhakrishna.

The AO was not convinced enough by the company's line of reasoning. He cited the notes to accounts in which it had been stated that the expenditure of Rs 41 lakh was expected to benefit the company over a period of five years. He said that, accordingly, only Rs 8,87,500 was allowable, as depreciation relevant to the year.

Radhakrishna went on appeal against the AO's decision, before the Commissioner of Income-Tax (CIT), who ruled that the expenditure was in the nature of revenue expenditure. The company was happy, but not the taxman.

So, the Department appealed against the CIT's order, before the Mumbai Income Tax Appellate Tribunal (ITAT). There, Durgesh Sumrott spoke for the Department, and K. D. Shah represented the company, as one learns from the text of the December 20, 2005 ruling on Taxindiaonline.com.

Sumrott contended that the licence from Ramco was for 30 years, `to use the software for the sole and exclusive purpose of operating and managing its own business'. Therefore, the sum of Rs 27,50,000 was a capital expenditure that gave Radhakrishna a benefit of an enduring nature, he said. To support his view, Sumrott cited, among others, the Abdul Gafar A. Nadiawala case, where it had been held that the right to exploit the films given by way of lease would be regarded as sale. Likewise, "the acquisition of right by the assessee to use software by way of license would be regarded as sale of software by the licensor to the licensee," said Sumrott. Other cases he had relied upon were: Scientific Engg. House P Ltd, Arawali Construction Co (P) Ltd, and Maruti Udyog Ltd. In response, Shah drew support from cases such as Alembic Chemicals Works Co Ltd, Karanpura Development Co Ltd, Media Video Ltd, and Bank of Punjab Ltd.

The Maruti Udyog case was about an expenditure of Rs 1.4 crore on acquisition on computer software. There, it was held that software is intangible capital asset in the form of know-how and so the expenditure was capital in nature.

Those who like to mine judicial precedents for insights may like to know that the Arawali case was about Rs 1.4 lakh paid for `outright sale of computer software which was used in mining operations; in this, too, the decision was that the expenditure was of capital nature.

Fine. What was the decision in Radhakrishna? "In the case before us, the assessee has paid a sum of Rs 27,50,000 to acquire the licence for use of computer software for its own business for 30 years," observed K.C. Singhal and D.K. Srivastava, of the Mumbai ITAT. "We feel that the judgment in Arawali Construction Co Pvt Ltd is squarely applicable on the facts of the case." Accordingly, the decision went in favour of the Department.

Interesting case of how judicial reasoning travelled from Arawali mines to a Juhu supermarket.

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