Sriram Seshadri

Treatment of expenditure on such areas as ERP need to be in line with the changing times.

`Business @ the Speed of Thought' advocates businesses to demand more from technology to respond faster to consumers, to adapt to changing facets of business and to prosper in the digital economy. In racing down this high-speed, lane-changing business-world, organisations need to trim their structures, processes, costs, improve productivity, evaluate HR, etc., with real time, three-dimensional knowledge of its business using critical and timely flow of data. Enterprise Resource Planning (ERP) enables this.

Enterprise Resource Planning

ERP is an industry term for the broad set of activities supported by multi-module application software that helps in managing important parts of business, including product planning, parts purchasing, maintaining inventories, interacting with suppliers, providing customer service, tracking orders, book keeping and more.

It typifies seamless integration of various aspects of a business with the flexibility to customise the process. Large organisations have implemented ERP at considerable costs for software licences and consultancy for customisation. While these costs are claimed as revenue expenditure by the industry, the Income-Tax Department has been disallowing them as capital expenditure.

The contention of the industry (hereinafter referred as `assessee') is that it is evident from the software licensing agreement that the assessee does not enjoy any enduring benefit on the capital side for the expense to be labelled capital expenditure. A typical agreement grants a non-exclusive licence to use the programmes, with prohibitions on sub-licensing, assignment, reverse engineering, disassembly or de-compilation. The licensor retains the title in the programme, the copyright and other proprietary rights and the licensee gets no right except use of the software. The licensor reserves the rights to audit the manner of utilisation of the software, collect penalties for unauthorised use and to terminate the agreement for any breach of licence terms. On termination, the licensee has to return the software or destroy it. The licensee is bound by non-disclosure/confidentiality agreement.

The assessee contends that the fruits of the expenditure vest only a limited right of use, which is so ephemeral as to provide any enduring benefit on the capital field. There is enough merit in this claim. The decisions of the Supreme Court in CIBA of India Ltd (69 ITR 692), the Calcutta High Court in Agarwal Hardware Work (121 ITR 510) and National Engineering Industries (190 ITR 525), and the Madras High Court in IAEC Pumps in (110 ITR 353), though not specifically rendered for ERP, support the assessee with a similar backdrop of licensing of patents with restrictive covenants.

The assessee's contention also draw strength from the thumbs up for technology outlays given by the Supreme Court in Alembic Chemical Works (177 ITR 377), where the outlay provided the assessee certain technology with limitations on its rights with conditions on its non-portability, confidentiality and secrecy.

The Court held that rapid strides in science and technology should make us a little slow and circumspect in too readily pigeon-holing an outlay such as this as capital, taking into account that the expenditure was designed to bring about improvisation in the process of existing business. It held that the `once-for-all' payment test is also inconclusive and what is relevant is the purpose of the outlay vis-à-vis the business realities.

But the Department does not accept these decisions as conclusive authorities for allowing the ERP expenses as revenue.

However, in a recent decision, the Delhi Bench of the Income Tax Appellate Tribunal in the Asahi India Safety Glass case (6 SOT 656) held that the ERP expenses have resulted in the improvement of the working systems, the accounting and MIS framework, which all go to improve the day-to-day functioning and, therefore, it should be held as revenue expenditure. It also examined the terms of the software agreement and held that the assessee does not get any ownership rights and what is passed on is only a limited user right, while concluding that the expenditure is revenue in nature.

This decision is a shot-in-the-arm for the assessee, as it also recognises that the overall ERP expenses include consulting charges payable for implementation and training, apart from licence of software and held that these charges are allowable as revenue expenditure.

No depreciation on intangibles

But it must be noted that this decision was rendered for the Assessment Year 1997-98, wherein the Income-Tax Act did not provide for depreciation on intangible assets. One of the contentions of the Department is that the term `copyright' in Section 32 covers software and in the alternate, the term `licence' should at least be applicable. Both these arguments are fallacious.

As far as the copyright argument goes, Section 32 punctuates the expenditure for intangibles with the word `acquired'. The Delhi Bench of the Tribunal interpreted this term in the Hero Honda case (95 TTJ 782), though on a different context of Section 35AB, to cover full ownership rights. But ERP licensing agreement does not confer such ownership rights.

As for the licence argument, one cannot interpret that any item covered in Section 32 should be capital expenditure. In fact, Section 32 is the subsidiary test for allowance of depreciation. Only when an item is capital expenditure, is Section 32 perused to determine whether it is eligible for depreciation. One cannot put the cart before the horse.

In fact, even the Supreme Court, in a unique factual configuration, held that `building' should be allowed as revenue expenditure, though it is a listed item in the Section .

Also, a licence that is inherently an income-earning apparatus could be looked at as a capital expenditure, such as a telecom licence, and be allowed depreciation.

This cannot be extended to a licence, which facilitates improvement in day to day working.

It is clear that the industry has to fight this issue out. Law has to be interpreted keeping in mind the changing times.

Doctrine of updating construction presumes that Parliament intends the court to apply to an ongoing Act a construction that continuously updates its wordings, as an allowance for changing times.

The decision of the Apex Court has captured the spirit of updating with changing times.

But will this be applied while allowability of ERP expenses is put to the litmus test?

(The author is a Chennai-based Chartered Accountant.)

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