– Section 40(a)(i) and (ia) provides for disallowance only in respect of expenditure, which is revenue in nature and therefore, provision does not apply to a case of assessee whose claim is for depreciation, which is not in nature of expenditure but an allowance. Depreciation is not an outgoing expenditure and, therefore, provisions of section 40(a)(i) and (ia) are not applicable – Vide Decision of High court of Karnataka in Principal Commissioner of Income Tax Vs. Tally Solutions (P.) Ltd.

Facts of the case:

  1. The Assessee is engaged in business of software development and sale of software product licence, software maintenance and training in software.
  2. The assessee filed the return of income for the Assessment Year 2009-10 after claiming brought forward losses and declared its income as XNIL’. The return of income was processed on 30-10-2010 and the case was selected for scrutiny and notices under section 143(2) and Section 142(1) of the Act were issued.
  3. The Assessing Officer by an order dated 27-3-2013 concluded the assessment by making certain additions and disallowed a sum of Rs. 6,70,94,074/- in respect of depreciation on Intellectual Property Rights.
  4. Thereupon the assessee filed an appeal before the Commissioner of Income-tax (Appeals) who by an order dated 20-8-2014 allowed the claim of the assessee and held that there being an irrevocable and unconditional sale of Intellectual Property and transfer being absolute, it was an outright purchase of capital asset and therefore, Section 40(a)(ia) of the Act could not be invoked in case of a claim for depreciation.
  5. The IT Department thereupon filed an appeal before the Income-tax Appellate Tribunal (hereinafter referred to as ‘the tribunal’ for short). The tribunal by an order dated 29-11-2016 held that since, the amount was capitalized and the same was not claimed as revenue expenditure, the claim of depreciation cannot be disallowed by invoking the provisions of Section 40(a)(ia) of the Act. In the aforesaid factual background, the revenue has filed these appeals.
  6. Learned counsel for the revenue submitted that the assessee had purchased the software from non-resident and had claimed depreciation under section 32 of the Act. It is also submitted that aforesaid payment was made towards purchase of software was in the nature of royalty in terms of Explanation 2 to Section 9(l)(vi) of the Act and since, no TDS was deduction under section 195 of the Act on the aforesaid payment, therefore, disallowance under section 40(a)(ia) of the Act has rightly been made.
  7. It is also argued that Section 40 of the Act begins with a non obstante clause and has an overriding effect on Sections 3 to 38 of the Act and therefore, in case, any deduction is claimed under section 32 of the Act while computing the income under the head of ‘profits and gains of business and profession’ can be disallowed if the assessee has not deducted the tax at source.
  8. On the other hand, learned counsel for the assessee submitted that Section 40(a)(1) and (ia) of the Act provides for disallowance in respect of amounts claimed as deduction on which tax has not been deducted or paid after deduction under Chapter XVII-B of the Act and the provision does not apply to a claim for depreciation, which is not in the nature of expenditure but is a disallowance.
  9. It is also urged that depreciation is not an outgoing expenditure and therefore, provisions of Section 40(a)(1) or (ia) of the Act are not attracted. It is also urged that depreciation is a statutory deduction available to the assessee on the asset, which is wholly or partly owned by the assessee and used for the purpose of business or profession.
  10. Thus, from close scrutiny of Section 40(a)(i) of the Act, it is understood that an amount payable towards interest, royalty, fee for technical services or other sums chargeable under this Act shall not be deducted while computing the income under the head profit and gain of business or profession on which tax is deductible at source; but such tax has not been deducted.
  11. The expression ‘amount payable’ which is otherwise an allowable deduction refers to the expenditure incurred for the purpose of business of the assessee and therefore, the said expenditure is a deductible claim. Thus, Section 40 refers to the outgoing amount chargeable under this At and subject to TDS under Chapter XVII-B. The deduction under section 32 is not in respect of the amount paid or payable which is subjected to TDS; but is a statutory deduction on an asset which is otherwise eligible for deduction of depreciation.
  12. The depreciation is not an outgoing expenditure and therefore, provisions of Section 40(a)(1) and (ia) of the Act are not applicable. In the absence of any requirement of law for making deduction of tax out of expenditure, which has been capitalized and no amount was claimed as revenue expenditure, no disallowance under section 40(a)(1) and (ia) of the Act would be made.
  13. The depreciation is an allowance and not an expenditure, loss or trading liability. The Commissioner of Income-tax (Appeals) has held that the payment has been made by the assessee for an outright purchase of Intellectual Property Rights and not towards royalty and therefore, the provision of Section 40(a)(ia) of the Act is not attracted in respect of a claim for depreciation. The aforesaid finding has rightly been affirmed by the tribunal. The findings recorded by the Commissioner of Income-tax (Appeals) as well as the tribunal cannot be termed as perverse.
  14. In view of preceding analysis, the substantial question of law framed by a bench of this court is answered against the revenue and in favour of the assessee.

Judgement:

The Honorable High Court of Karnataka held the case as follows:

  1. Section 40(a)(i) and (ia) provides for disallowance only in respect of expenditure, which is revenue in nature and therefore, provision does not apply to a case of assessee whose claim is for depreciation, which is not in nature of expenditure but an allowance.
  2. Depreciation is not an outgoing expenditure and, therefore, provisions of section 40(a)(i) and (ia) are not applicable

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