Judgment:
1. This appeal by the assessee is directed against the order of CIT(A) dt. 19th Sept., 2003 for asst. yr. 2000-01.
1. The learned CIT(A) erred in not accepting the bona fide change in the system of valuation of closing stock made and which has support of accounting standards consistently adhered to subsequently which did not inflict any loss to the Revenue should have been unreservedly accepted by the AO and therefore, addition of Rs. 26,63,104 resulting into net addition of Rs. 4,20,596 considering the adjustment is unjustified and it be deleted.
2. He failed to appreciate that on the basis of telescopic study it transpires that this addition of Rs. 26,63,104 has in fact a double effect and it be considered accordingly.
3. He failed to appreciate that the valuation of closing stock cannot be a source of income and, therefore, the addition on this count is required to be deleted and it be deleted accordingly.
2. The AO has noted in para 3 of his order that the assessee was valuing its stock of raw materials on the basis of the lowest price of the raw material in the last quarter of the year, that this method was not accepted by the Department in the past and the raw material was valued at the highest rate of purchases during the last quarter of the year, that in asst. yr. 2000-01 the assessee changed its method of valuation to average inventory method, that in asst. yr. 1999-00 the value of inventory was increased by Rs. 22,42,508, that the difference in inventory was worked out at Rs. 26,63,104, and that after accepting the alternative plea of the assessee net addition of Rs. 4,20,597 was made. The AO's action was upheld by the CIT(A).
3. It was pointed out by Shri S.N. Inamdar, the learned Authorised Representative, that this issue was covered by the decision of Tribunal, Pune, in the assessee's own case in ITA No. 1125/Pune/1994 for asst. yr. 1990-91, dt. 13th July, 2004. The observations made by the Tribunal in paras 2 and 5 of its order are as under: 2. Briefly stated, the facts of the case are these : In the course of assessment proceedings, the assessee was required to furnish complete inventory of closing stock of the raw materials and the basis of valuation of the same. As per the learned Counsel for the assessee, the assessee used to value the closing stock of the raw materials on the basis of the lowest rate of purchase of the raw materials in the last quarter of the year i.e. commencing from 1st January to 31st March. It was also stated that all the inward expenses were loaded while computing the cost of the raw materials for the purpose of value of the stock. It was also stated that this method was being adopted for the last 40 years and therefore, should not have been disturbed. However, the AO was not satisfied with the method of the valuation adopted by the assessee. The AO made the addition of Rs. 5,75,099 by adopting the highest rate of purchase of the raw materials in the last quarter of the year. The AO also referred to the Supreme Court judgment in the case of CFT v. British Paints India Ltd. (1991) 91 CTR (SC) 108 : (1991) 188 HR 44 (SC) for the proposition that the principles of res judicata would not have been applied, if the correct method of valuation is adopted by the assessee for computation of correct profit. This addition has been confirmed by the CIT(A). Aggrieved by the same, the assessee is in appeal before the Tribunal.
5. In view of the above discussions, the order of the CIT(A) is set aside and the matter is restored to the file of the AO for fresh adjudication in the light of the above discussions. He is directed to value the closing stock as well as the opening stock by applying average cost method including all inward expenses and then determine the true profit of the business.
4. We respectfully follow the precedent and restore the matter back to the file of the AO for fresh adjudication in the light of the directions given by the Tribunal in its order dt. 15th July, 2004 (supra). The ground Nos. 1, 2 and 3 are decided accordingly.
4. The learned CIT(A) erred in treating the license fees paid on account of user of computer software programme as capital expenditure as laid down in Section 32(1)(ii) and considering the terms of the agreement with SAP India Systems, Applications & Products in Data Processing (P) Ltd., the provisions of Section 32(1)(ii) are to be read on the principles of 'ejusdem generis' by which such 'license fees' for user of a computer programme paid are not covered by that provision and it be held accordingly.
5. The learned CIT(A) ought to have held that the essence of terms of agreement shows that such license fees were paid for use of the 'Software System' sans ownership, control and are different and distinguishable from the phraseology used as "Licenses acquire" and, therefore, was a revenue expenditure which was correctly claimed and it be held accordingly.
6. The learned CIT(A) ought to have held that alternatively, the assessee company is entitled to depreciation at 60 per cent and not at 25 per cent as allowed by the AO and it be allowed accordingly.Madras Industrial Investment Corponation Ltd. v. CIT ; (vii) Asst. CIT v. Bauckau Wolf New India Engineering Works Ltd ;CIT v. Tata Engineering & Locomotive Co. (P) Ltd. .
5. The facts of the case in brief are that the assessee company entered into a license agreement dt. 4th March, 1999 with SAP India, Systems, Applications & Products in Data Processing (P) Ltd. (SAP India for short) for installation of R/3 software, which is an ERP package. The assessee paid Rs. 1 crore as per Clause 4.1 of the said agreement and claimed it as revenue expenditure. The AO while rejecting the assessee's claim held in para 7.6 of his order that the ERP package was a capital asset under the category of 'intangible asset in the form of license' and he allowed depreciation at 25 per cent. The CIT(A) upheld the AO's action and his order has been challenged by the assessee in the present appeal.
6. Shri S.N. Inamdar, the learned Authorised Representative, reiterated the arguments put forward on behalf of the assessee before the AO and the CIT(A). The submissions made by him are summarised below: that the expenditure was incurred for ERP implementation which enhanced productivity and efficiency, that the benefit acquired by the assessee was in the day-to-day operations of the company, that acquiring of enduring benefit could not be a ground for holding that the expenditure was of capital nature, that the license fee paid for the user of a computer program could not be covered by the provisions of Section 32(l)(ii) of the Act on the application of the principle of ejusdem generis, that the decision of the Bombay High Court in the case of Premier Automobiles Ltd (supra) did not apply to this case.
7. Shri Atul Pranay the learned Departmental Representative, relied on the orders of the AO and the CIT(A). He drew our attention to Section 32(l)(ii) of the Act and submitted that in the case of CFT v. Aiawali Constructions Co. (P) Ltd. (2002) 177 CTR (Raj) 79 : (2003) 259 OR 30 (Raj), the Rajasthan High Court had held that purchase of software was acquisition of know-how. He vehemently argued saying that the order of the CIT(A) needed to be upheld.8. We have considered the rival submissions in the light of material on record and the precedents cited. The assessee company acquired a license from SAP India vide agreement dt. 4th March, 1999, for a period of 25 years for use of its proprietary R/3 software, an ERP package, for the purposes of its business and paid Rs. 1 crore for the same. In the aforesaid agreement dt. 4th March, 1999, the opening part of the recital reads as under: Whereas, SAP desires to grant to licensee and licensee desires to accept from SAP, a license to use (as defined herein) SAP's proprietary R/3 software (as defined herein) upon the terms and conditions hereinafter set forth; 9. The assessee has filed a detailed 'note' explaining the nature and the scope of the software used for the ERP implementation. ERP is an acronym for Enterprise Resource Planning which is a complex computer based system used by corporations across the world to automate key back-office business processes leading to remarkable advantages in terms of productivity and profits for any organisation small, medium or large.
9.1 The ERP implementation takes place in a phased manner in the following modules of SAP/R3: Considerable reduction in operating cycle time of the business by pruning lead time in all the business functions.
Improved vendor performance in terms of timing, consistence, quality and innovation.
Greater flexibility of operations, thereby ensuring moderate and fantastic return on investments.
Reliance on timely and updated critical management information, improved system and procedures, and, hence, faster decision making.
Effective cost control and benchmarking against predetermined budgets would then become part of a routine.
Becoming more customer driven and being consistently goal oriented through best business practice.
9.3 The ERP implementation involves networking the entire organisation, reorganisation of data flow and decision making centres, training of manpower and considerable expenditure on hardware. It brings about tremendous improvement in the day-to-day efficiency by reducing operating cycle time of the business, pruning lead time in all business functions, reducing inventory carrying cost, improving vendor performance in terms of timing and quality, improving return on investments, making available updated critical management information, improving system and procedures resulting in faster decision making, bringing about effective cost control and benchmarking, resulting in improved productivity and profits. In other words, ERP implementation makes a business organisation a better profit-making apparatus for all time to come.
9.4 One of the methods of achieving ERP implementation in an organisation is through installation of the SAP/R/3 software. This is what the assessee company has done in this case and has claimed the expenditure of Rs. 1 crore as revenue expenditure.
10. Before proceeding further, it may be useful to describe a computer software, in brief and in a layman's language. A software is an integral part of a computer system. A typical/basic personal computer (PC) has a central processing unit (CPU), a monitor and a key board.
The CPU is an electronic device and it requires a set of instructions to do computing. These set of instructions are collectively known as 'programme' and several languages have been developed to write these programmes. These programmes have, collectively, come to be known as 'software' in order to contra distinguish them from the other part of the computer system, the hardware. In other words, a computer system is comprised of two parts-a software and a hardware. The hardware is the tangible part and the software is the intangible part.
10.1 The software enables the hardware i.e. the CPU, to perform the designated functions. A very simple example of a software that is widely used in a PC is 'MS Office' which enables the user to use the hardware, inter alia, for writing letters, preparing spreadsheets, preparing power point presentations, etc. This is a very simplistic picture, whereas a software like the 'R/3 software' is very complex software which, when installed in an organisation, goes to cover every nook and corner of its functioning as described in paras 9 to 9.4.
11. It is seen that for and from asst. yr. 1999-2000 Section 32(1) of the Act allows depreciation also on 'intangible assets', such as, know-how, patents copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, owned wholly or partly by an assessee, acquired on or after 1st April, 1998, and used by him during the relevant year for the purposes of his business or profession. The Clause (ii) to Sub-section (1) of Section 32 as introduced by the Finance (No. 2) Act, 1998 reads as under: (ii) know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April 1998, owned, wholly or partly, by the assessee and used for the purposes of the business or profession, the following deductions shall be allowed- 11.1 And, the Income-tax (Twelfth Amendment) Rules, 1998 inserted Part B in respect of such 'intangible assets', in the table of rates at which depreciation was admissible, in Appendix-I, under Rule 5 of IT Rules 1962, providing for depreciation at 25 per cent, as under:Intangible assets, know-how, patents, - 25 per centcopyrights, trademarks, licences, franchises 12. It was argued by the learned Authorised Representative that the license fee paid for the user of a computer program could not be covered by the provisions of Section 32(l)(ii) of the Act on the application of the principle of ejusdem generis. He tried to argue that the 'R/3 software' was neither a know-how nor a patent nor copyright nor a trademark, and therefore on the application of the principle of ejusdem generis, a license acquired to use such a software was not covered by the provisions of Section 32(l)(ii) of the Act.
13. Now, the question that we have to examine is whether R/3 software was an 'intangible asset' within the meaning of Clause (ii) of Section 32(1) the Act.
14. Shri Atul Pranay, the learned Departmental Representative, relying on the decision of the Rajasthan High Court in the case of Arawali Constructions Co. (P) Ltd. (supra), submitted that a software was a know-how within the meaning of Section 32(l)(ii) of the Act. He pointed out that the Rajsthan High Court had, in turn, placed reliance on the decision of the Bombay High Court in the case of Premier Automobiles Ltd. (supra). Shri Inamdar, the learned Authorised Representative, submitted that the decision of the Bombay High Court was not appreciated by the Rajasthan High Court in right perspective.
14.1 The Rajasthan High Court, in the case of Arawali Constructions Co.
(P) Ltd. (supra), after taking into consideration the decision of Bombay High Court in Premier Automobiles Ltd. (supra), held that the outright purchase of computer software was acquisition of know-how and the relevant expenditure of Rs. 1,38,360 incurred during the asst. yr.
1984-85 was capital expenditure. The decision of the Rajasthan High Court had two parts-one, the purchase of computer software amounted to acquisition of technical know-how and two, that the expenditure incurred on acquiring technical know-how was capital expenditure.
14.2 It is seen that the decision of the Bombay High Court in the case of Premier Automobiles Ltd. (supra) was taken into consideration by the Rajasthan High Court with regard to the second part of its decision, namely, that the expenditure incurred for acquiring technical know-how was capital expenditure and was eligible for depreciation under Section 32 of the Act. The decision of the Bombay High Court was silent, insofar as the first part of the decision of the Rajasthan High Court, namely, that the purchase of computer software amounted to acquisition of technical know-how. It is this part of the decision of the Rajasthan High Court which is relevant for deciding the issue in this case.
15. It needs to be mentioned that the matter before the Bombay High Court related to asst. yrs. 1970-71, 1971-72, and 1972-73 and that before the Rajasthan High Court related to asst. yr. 1984-85. The expression 'know-how' was introduced in Clause (ii) of Section 32(1) for and from asst. yr. 1999-2000. And, for and from asst. yr. 2003-04, a new entry was introduced as S. No. III (5) in Part-A of the table of rates for depreciation in Appendix-I in respect of 'computers including computer softwares'.
16. There is another way of looking at the above issue. The expressions "a know-how, a patent, a copyright and a trademark," are examples of 'intellectual property' and are included in Clause (ii) of Section 32(1) as 'intangible assets'. The aforesaid 'intellectual properties', or a license acquired in respect of such a property, are all 'intangible assets' under Clause (ii) of Section 32(1).
17. In view of the discussion in the above paras, explaining the nature and scope of the ERP implementation and the software used for this purpose, we have no doubt in our mind that the R/3 software and a license to use this software were both 'intangible assets' within the meaning of Clause (ii) of Section 32(1). The principle of 'ejusdem generis' does not render ahy help on the facts of the present case to the assessee.
18. Therefore, taking guidance from the decision of the Rajasthan High Court (supra), we are of the view that the impugned R/3 software has to be treated as an 'intangible asset' within the meaning of Clause (ii) of Section 32(1) of the Act. And, consequently, a license acquired by the assessee to use the same will also come within the ambit of Clause (ii) of Section 32(1). Therefore, we hold that, on the facts of the present case, the expenditure of Rs. 1 crore incurred for acquiring the impugned license, was rightly treated by the AO and the CIT(A) as capital expenditure, eligible for depreciation under Section 32(1).
19. The AO treated the aforesaid license acquired vide agreement dt.
4th March, 1999 as an 'intangible asset' qualifying for depreciation under the provisions of Clause (ii) of Section 32(1) of the Act. He allowed depreciation at 25 per cent which is the rate mentioned in Part B of the table of rates in Appendix-I applicable to intangible assets.
The rate of 60 per cent applicable in respect of 'computers including computer software' was introduced for and from asst. yr. 2003-04.
Therefore, the alternative plea claiming depreciation @ 60 per cent has no merit and is rejected. The ground Nos. 4, 5, and 6 are accordingly rejected.
The EMD gross receipts of Rs. 40,75,145 is income from business and which is outside the purview of Expln. (baa) to Section 80HHC of the Act.
20. It was pointed out by Shri S.N. Inamdar, the learned Authorised Representative, that this issue was covered by the decision of Tribunal, Pune, in the assessee's own case in ITA No. 103/Pune/2000 for asst. yr. 1996-97, dt. 10th Feb., 2006. In para 15(d) of its order, the Tribunal observed as under: (d) The fourth issue is regarding reduction of 90 per cent of the profits of Environment Management Division (hereinafter called the EMD) from the profits and its inclusion in total turnover. In this connection, the assessee referred to p. 23 of the paper book which deals with the activities of the EMD. The division provides services in the fields of waste water management, anaerobic treatment, gaseous emission control, safety and microbial cultures. The total receipts by way of consultancy fees, turnkey contracts and laboratory testing fees were Rs, 58,41,705. The profit after deducting expenditure was Rs. 40,80,823. Having considered the facts of the case and submissions made before us, we are of the view that provision of Sub-clause (1) of Clause (baa) of the Explanation are not applicable to the profit even in terms of the statutory language. Therefore, the whole of the profits is includible in the term 'profit of the business'. It is also equally true that the receipts form part of the total turnover of the assessee as Clause (baa) of the Explanation excludes only freight, insurance and export incentives. Thus, it is held that the receipts shall be included in the 'total turnover' also.
The interest on overdue account which was charged to customers for belated payments which is outside the purview of Expln. (baa) to the Section 80HHC(4B) of the Act.
22. Shri S.N. Inamdar, the learned Authorised Representative, submitted that this issue was covered by the decision of Gujarat High Court in the case of Nirma Industries Ltd. v. Dy. CIT . The Court observed as under: When the assessee enters into a contract for sale of its product it could either stipulate (a) that interest at the specified rate would be charged on the unpaid sale price and added to the outstanding till the point of time of realisation, or (b) that in case of delay the payment for sale of products worth Rs. 100 to carry the sale price of Rs. 102 for the first month's delay, Rs. 104 for the second month's delay, Rs. 106 for the third month's delay and so on. In sum and substance, these are only two modes of realising sale consideration, the object being to realise the sale proceeds at the earliest and without delay. The purchaser pays a higher sale price if it delays payment of the sale proceeds. In other words, this is a converse situation to offering a cash discount. Thus, in principle, in reality, the transaction remains the same and there is no distinction as to the source. While computing the special deduction under Section 80-1, interest received from trade debtors towards late payment of sale consideration is to be included in the profits of the industrial undertakings.
23. A similar view was taken by the Madras High Court in the case of CIT v. Indo Matsushita Carbon Co. Ltd. . We