Indian income-tax law disallows claim of expenses ‘payable’ where taxes are not appropriately deducted at source. Courts have in the past expressed conflicting views on whether this disallowance extends to expenses which do not remain ‘payable’ at yearend. After a plethora of conflicting rulings, the Central Board of Direct Taxes (CBDT) recently issued a circular clarifying that the provisions are clear and the disallowance would also apply to expenses already paid.

It, however, states that if any High Court takes a contrary view, the court decision would be binding on the tax authority in its jurisdiction. Chief Commissioners of Income-tax have been instructed to bring such rulings to the attention of the Central Technical Committee formed by CBDT, which will then decide whether a Special Leave Petition before the Supreme Court would be an adequate response or whether a legislative amendment is called for.

Masterstroke from High Court

In a recent case before the Delhi High Court, the taxpayer (Oracle India Pvt Ltd) had entered into an agreement with a US company for a non-exclusive right to duplicate and sub-license software products owned by the US company.

In addition to royalty payments for the rights, the taxpayer was required to pay for each import of a ‘master copy’, which was then duplicated and sub-licensed to customers. While deduction was allowed for the royalty payments, the cost of the master copy was treated as capital expenditure by the tax authority and only an amortised deduction was allowed over 14 years.

Ruling in favour of the taxpayer, the court held that the cost of the master copy was allowable as revenue expenditure in the year of incurrence as it was subject to high obsolescence, constant improvement, and hence had no enduring benefit. The ‘enduring benefit test’ has been widely used by courts in similar contexts. The ruling reiterates the principle that in this age of rapidly advancing technology, the enduring benefit test is not easily satisfied.

Software development is ‘research’

Indian income-tax law grants 100 per cent deduction for the capital expenditure incurred on “scientific research” for business. Whether a taxpayer engaged in developing and exploiting software products is eligible for this deduction is a contentious issue.

In a recent case before the Karnataka High Court, software development company Talisma Corporation Pvt Ltd had acquired intellectual property rights in a software product and also incurred expenditure on developing it further. Treated as capital expenditure, it was disallowed by the tax authority.

The court held that the software development expenditure qualified for “scientific research” and was deductible for tax. While the ruling provides useful guidance to companies engaged in software development, a careful evaluation of facts is called for when applying its principle.

Good deals for EOUs

The Government of India has issued a circular outlining new policies and procedures for export-oriented units (EOUs). Now the units can set up warehouses outside their premises too (for instance, near a customs port to reduce the lead time for export shipments). The new regime also eases compliance requirements by consolidating them with excise compliances and reducing the revenue threshold for self-warehousing and self-certification. Other key takeaways include permitting EOU owners to share facilities amongst each other.

This is a positive step for exporters; however, the implementation remains to be seen.

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