Depreciation Dispute: Court Upholds Assessee’s Claim Over Revenue’s Objection

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Case Name:

Principal Commissioner of Income Tax and Anr. vs M/s. Tally Solutions Pvt. Ltd. (High Court of Karnataka)

ITA No. 199 of 2017 C/w ITA No. 951 & 952 of 2017

Date: 16th December 2020

Key Takeaways:

• The court decided that Section 40(a)(ia) (of Income Tax Act, 1961), which disallows certain deductions if tax is not deducted at source, does not apply to depreciation claims.
• Depreciation is considered a statutory allowance, not an expenditure, and thus not subject to disallowance under Section 40(a)(ia) (of Income Tax Act, 1961).
• The decision reinforces the distinction between capital and revenue expenditure in tax law.

Issue

Does Section 40(a)(ia) (of Income Tax Act, 1961) apply to disallow depreciation claims on intellectual property rights when tax is not deducted at source?

Facts

• Tally Solutions Pvt. Ltd., engaged in software development, claimed depreciation on intellectual property rights.
• The revenue disallowed this claim, arguing it was akin to royalty payments requiring tax deduction at source under Section 195 (of Income Tax Act, 1961).
• The case was brought to the High Court after the Income Tax Appellate Tribunal ruled in favor of Tally Solutions.

Arguments

• Revenue’s Argument: The payment for software was a royalty, requiring TDS under Section 195 (of Income Tax Act, 1961). Non-deduction should lead to disallowance under Section 40(a)(ia) (of Income Tax Act, 1961).
• Assessee’s Argument: Depreciation is not an expenditure but a statutory allowance, thus not subject to disallowance under Section 40(a)(ia) (of Income Tax Act, 1961).

Key Legal Precedents

• Munjal Sales Corporation vs. Commissioner of Income Tax and Anr.: Highlighted the need for compliance with Sections 30 to 38 of the Act.
• Nectar Beverage (P.) Ltd. vs. Deputy Commissioner of Income Tax: Supported the view that depreciation is a statutory deduction.
• Commissioner of Income Tax vs. Mark Auto Industries Ltd.: Reinforced the distinction between capital and revenue expenditure.

Judgement

The court ruled in favor of Tally Solutions, affirming that Section 40(a)(ia) (of Income Tax Act, 1961) does not apply to depreciation claims. The court found that depreciation is a statutory allowance, not an expenditure, and thus not subject to disallowance for non-deduction of tax at source.

FAQs

Q1: Why was the depreciation claim initially disallowed?

A1: The revenue argued it was akin to a royalty payment, requiring tax deduction at source, which was not done.

Q2: What does this decision mean for businesses?

A2: It clarifies that depreciation claims are not subject to disallowance under Section 40(a)(ia) (of Income Tax Act, 1961) for non-deduction of tax at source.

Q3: How does this affect the interpretation of Section 40(a)(ia) (of Income Tax Act, 1961)?

A3: It reinforces that this section applies to revenue expenditures, not statutory allowances like depreciation.

1. These appeals under Section 260-A (of Income Tax Act, 1961), 1961 (hereinafter referred to as ‘the Act’, for short) have been preferred by the revenue. The subject matter of I.T.A.No.199/2017 pertains to the Assessment

Year 2009-10, whereas, subject matter of I.T.A.No.951/2017 pertains to Assessment Year 2010-11 and 2011-12. The subject matter of I.T.A.No.952/2017

pertains to Assessment Year 2010-11 and 2011-12. Since, in all the appeals, the same substantial question of law arises for consideration, therefore, they were heard together and are being decided by this common judgment. I.T.A.No.199/2017 was admitted by a Bench of this Court vide order dated 07.11.2017 on the following substantial question of law:

"Whether, on the facts and in the circumstances of the case, the Tribunal

was right in deleting the disallowance made under section 40(a)(ia) (of Income Tax Act, 1961) in respect of depreciation on intellectual property rights by relying upon the decisions which has not reached finality and without appreciating that the assessing officer rightly invoked provisions of section 40(a)(ia) (of Income Tax Act, 1961) as the assessee had failed to deduct tax on payments made in respect of purchase of software as required under section 195 (of Income Tax Act, 1961)?

2. I.T.A.No.951/2017 was admitted by a Bench

of this Court vide order dated 05.11.2018 on the

following substantial question of law:

"Whether, on the facts and in the

circumstances of the case, the Tribunal is

justified in setting aside the disallowance

of claim of depreciation on purchase of, Intellectual Property Rights made by assessing authority under section 40(a)(ia) (of Income Tax Act, 1961)

of the Act as they had failed to deduct TDS

on payments made in respect of purchase

of intellectual property rights by following

its earlier order which has not reached

finality and even when the ingredients of

section 40(a)(ia) (of Income Tax Act, 1961) are satisfied in

case of assessee?

3. I.T.A.No.952/2017 was admitted by a Bench

of this Court vide order dated 25.02.2019 on the

following substantial question of law:

"Whether, on the facts and in the

circumstances of the case, the Tribunal is

justified in setting aside the disallowance

of claim of depreciation on purchase of

Intellectual Property Rights made by

assessing authority under section 40(a)(ia) (of Income Tax Act, 1961)

of the Act as they had failed to deduct TDS

on payments made in respect of purchase

of intellectual property rights by following

its earlier order which has not reached

finality and even when the ingredients of

section 40(a)(ia) (of Income Tax Act, 1961) are satisfied in

case of assessee?

4. Facts leading to filing of these appeals briefly

stated are that assessee is engaged in business of

software development and sale of software product

licence, software maintenance and training in software.

For the sake of brevity, facts from I.T.A.No.199/2017

are being referred to. The assessee filed the return of

income for the Assessment Year 2009-10 after claiming

brought forward losses and declared its income as ‘NIL’.

The return of income was processed on 30.10.2010 and

the case was selected for scrutiny and notices under

Section 143(2) (of Income Tax Act, 1961) and Section 142(1) (of Income Tax Act, 1961) were

issued. The Assessing Officer by an order dated

27.03.2013 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.

5. Thereupon the assessee filed an appeal

before the Commissioner of Income Tax (Appeals) who

by an order dated 20.08.2014 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 Income Tax Act, 1961) could

not be invoked in case of a claim for depreciation. The

revenue 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 Income Tax Act, 1961).

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 Income Tax Act, 1961)

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(1)(vi) of the Act and since, no TDS was deduction

under Section 195 (of Income Tax Act, 1961) on the aforesaid payment,

therefore, disallowance under Section 40(a)(ia) (of Income Tax Act, 1961) of the

Act has rightly been made. 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 Income Tax Act, 1961) 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.

7. It is also submitted that the intention of the

legislature in providing disallowance under Section

40(a)(i) of the Act is to ensure prevention of revenue

leakage on foreign payments as recovery of tax from

non resident payees is difficult. It is also submitted that

the substantial question of law involved in these appeals

has already been answered by Supreme Court in

'MUNJAL SALES CORPORATION VS.

COMMISSIONER OF INCOME TAX AND ANR.', 298

ITR 288 and it has been held that assessee has to

satisfy the conditions set out in Section 30 (of Income Tax Act, 1961) to Section 38 (of Income Tax Act, 1961)

of the Act and it has to establish that the assessee is not

hit by Section 40 (of Income Tax Act, 1961). It is urged that in the

present case, assessee is not entitled for claiming

deduction under Section 32 (of Income Tax Act, 1961) since, the

assessee is hit by Section 40 (of Income Tax Act, 1961) due to non

deduction of tax at source and substantial question of

law deserves to be answered in favour of the revenue.

8. On the other hand, learned counsel for the

assessee submitted that Section 40(a)(i) (of Income Tax Act, 1961) 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. It is also urged that depreciation is

not an outgoing expenditure and therefore, provisions of

Section 40(a)(i) (of Income Tax Act, 1961) 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. It is also pointed out

that the Commissioner of Income Tax (Appeals) as well

as the tribunal have recorded concurrent findings on the

aforesaid issue in favour of the assessee, which do not

suffer from any perversity and therefore, the substantial

question of law is required to be answered in the

negative. In support of aforesaid submissions, reliance

has been placed on decision of the Supreme Court in

'NECTAR BEVERAGE (P.) LTD. VS. DEPUTY

COMMISSIONER OF INCOME TAX', (2009) 182

TAXMAN 319 and decision of High Court of Punjab and

Haryana in 'COMMISSIONER OF INCOME TAX VS.

MARK AUTO INDUSTRIES LTD.', (2013) 40

TAXMANN.COM 482.

9. We have considered the submissions made

by learned counsel for the parties and have perused the

record. Before proceeding further, it is apposite to take

note of relevant extract of Section 40 (of Income Tax Act, 1961), which

is reproduced below for the facility of reference:

Notwithstanding anything to the contrary

in sections 30 to 38, the following amounts

shall not be deducted in computing the income

chargeable under the head" Profits and gains

of business or profession",-

(a) in the case of any assessee-

(ia) thirty per cent of any sum payable to

a resident], on which tax is deductible at

source under Chapter XVII-B and such tax has

not been deducted or, after deduction, has not

been paid on or before the due date specified

in sub-section (1) of section 139 (of Income Tax Act, 1961) :

Provided that where in respect of any

such sum, tax has been deducted in any

subsequent year, or has been deducted during

the previous year but paid after the due date

specified in sub-section (1) of section 139 (of Income Tax Act, 1961),

thirty per cent of such sum shall be allowed as

a deduction in computing the income of the

previous year in which such tax has been

paid :

Provided further that where an assessee

fails to deduct the whole or any part of the tax

in accordance with the provisions of Chapter

XVII-B on any such sum but is not deemed to

be an assessee in default under the first

proviso to sub-section (1) of section 201 (of Income Tax Act, 1961), then,

for the purpose of this sub-clause, it shall be

deemed that the assessee has deducted and

paid the tax on such sum on the date of

furnishing of return of income by the resident

payee referred to in the said proviso.

Explanation.-For the purposes of this

sub-clause,-

(vi) "royalty" shall have the same

meaning as in Explanation 2 to clause (vi) of

sub-section (1) of section 9 (of Income Tax Act, 1961);

10. Thus, from close scrutiny of Section 40(a)(i) (of Income Tax Act, 1961)

of the Act, it is axiomatic 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. 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 (of Income Tax Act, 1961) refers to the outgoing

amount chargeable under this At and subject to TDS

under Chapter XVII-B. The deduction under Section 32 (of Income Tax Act, 1961) 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. Section 40(a)(i) (of Income Tax Act, 1961) and (ia) of the Act

provides for disallowance only in respect of expenditure,

which is revenue in nature, therefore, the provision does

not apply to a case of the assessee whose claim is for

depreciation, which is not in the nature of expenditure

but an allowance. The depreciation is not an outgoing

expenditure and therefore, provisions of Section 40(a)(i) (of Income Tax Act, 1961)

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)(i) (of Income Tax Act, 1961) and (ia) of the Act

would be made. It is also pertinent to note that

depreciation is a statutory deduction available to the

assessee on a asset, which is wholly or partly owned by

the assessee and used for business or profession. 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 Income Tax Act, 1961) 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.

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.

In the result, the appeals fail and are hereby

dismissed.

Sd/-

JUDGE

Sd/-

JUDGE