The Assessing Officer has capitalised my client's product development spend and given it only depreciation. Can we still get it as scientific research expenditure, and can the alternative claim be raised for the first time before the Commissioner (Appeals)?
The Karnataka High Court held that expenditure on further developing and improving a software product is expenditure on scientific research related to the business, and that even if it is capital in nature it is to be deducted under s.35(1)(iv); it answered both questions of law in favour of the assessee and dismissed the Revenue's appeal. The Court reached that conclusion through the definition in s.43(4), which makes references to scientific research related to a business include any scientific research which may lead to or facilitate an extension of that business. The alternative claim had been raised for the first time before the appellate authority and not before the Assessing Officer, and the Court did not treat that as an obstacle.
Decided by the High Court (N. Kumar J and Rathnakala J) on 2013-10-30, reported as Income Tax Appeal No. 515 of 2007 (High Court of Karnataka at Bangalore), assessment year 2001-02. It bears on section 35, section 35(1)(iv), section 35(2), section 35(2)(iv), section 43(4), section 32 of the Income Tax Act 1961, in Deductions & Disallowances and How Tax Law Is Read matters.
Two things make this useful beyond software. The first is the route into s.35: the Court did not ask whether the activity looked like laboratory research, it applied the s.43(4) definition, under which scientific research means any activity for the extension of knowledge in the fields of natural or applied science, and research related to a business includes research which may lead to or facilitate an extension of that business. That is a wide gate and it is the gate a claimant should argue from. The second is that s.35(1)(iv) requires no approval by any prescribed authority — unlike s.35(2AB), where the DSIR's approval of the in-house facility is the gate, and unlike s.35(1)(ii) and (iii), where the Central Government's approval is required — so a claim can be built without the DSIR. There is a real cost to taking this route: s.35(2)(iv) provides that where a deduction is allowed under s.35 in respect of expenditure represented wholly or partly by an asset, no deduction under s.32(1)(ii) is allowed for the same or any other previous year in respect of that asset. Depreciation and the s.35 deduction on the same asset are alternatives, not cumulative, and the claim should be framed on that footing. Note also that the Revenue's second question in this case was framed as a double-deduction objection under s.35(2)(iv); the Court answered both questions for the assessee but the judgment as retrieved does not separately reason the point.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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The assessee, a software development company, acquired an intellectual property through M/s. Aditi Technologies Pvt. Ltd. for Rs 10.82 crore, which it capitalised in its books. It then spent Rs 9,27,34,277 on further developing and improving that product, the expenditure consisting mainly of salary cost of employees and other general administrative expenses connected with the development. The development was a continuous process directed at a multi-channel customer relationship management solution, and produced an improved version, 'Talisma Enterprise 2.5', which captures, documents and integrates customer information for marketing, sales, services, human resources and finance through e-mail, chat, wireless, fax and telephone. The Revenue's contention was that because the purchase of the Talisma software had been capitalised, any expenditure on further development of the software had also to be treated as capital in nature; the Assessing Officer treated the improvement as capital and allowed depreciation. Before the appellate authority the assessee raised, for the first time, an alternative plea that the expenditure was allowable under s.35(1)(iv). The appellate authority and the Tribunal accepted that plea and the Revenue appealed.
The substantial questions of law were answered in favour of the assessee and against the Revenue and the appeal was dismissed, the Court finding no infirmity in the Tribunal's order. Expenditure on further developing and improving the software product was expenditure on scientific research, and even if capital in nature, having been incurred in relation to the business carried on by the assessee, it fell to be deducted under s.35(1)(iv) (paragraph 9).
The Court took its starting point from the definition in s.43(4): scientific research means any activity for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries, and references to scientific research related to a business include any scientific research which may lead to or facilitate an extension of that business (paragraph 7). It then set s.35(1)(iv) alongside that definition, noting that the clause allows, in respect of expenditure of a capital nature on scientific research related to the business carried on by the assessee, such deduction as is admissible under sub-section (2) (paragraph 8). Applying both to the facts, the Court found that the money was spent largely on the employees who developed 'Talisma Enterprise 2.5', that the development was on account of scientific research, and that the expenditure was accordingly deductible under s.35(1)(iv) notwithstanding its capital character — which was what the appellate authority and the Tribunal had held (paragraph 9).
Therefore, the expenditure in respect of the scientific research, even if it is capital in nature as it was incurred in relation to the business carried on by the assessee under Section 35(1)(iv) of the Act, the said expenditure is to be deducted.
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Handle my notice → Ask a CA on WhatsAppThe Karnataka High Court held that expenditure on further developing and improving a software product is expenditure on scientific research related to the business, and that even if it is capital in nature it is to be deducted under s.35(1)(iv); it answered both questions of law in favour of the assessee and dismissed the Revenue's appeal. The Court reached that conclusion through the definition in s.43(4), which makes references to scientific research related to a business include any scientific research which may lead to or facilitate an extension of that business. The alternative claim had been raised for the first time before the appellate authority and not before the Assessing Officer, and the Court did not treat that as an obstacle. This was decided by the High Court (N. Kumar J and Rathnakala J) and bears on section 35, section 35(1)(iv), section 35(2), section 35(2)(iv), section 43(4), section 32 of the Income Tax Act 1961. It is reported as Income Tax Appeal No. 515 of 2007 (High Court of Karnataka at Bangalore), assessment year 2001-02. Two things make this useful beyond software. The first is the route into s.35: the Court did not ask whether the activity looked like laboratory research, it applied the s.43(4) definition, under which scientific research means any activity for the extension of knowledge in the fields of natural or applied science, and research related to a business includes research which may lead to or facilitate an extension of that business. That is a wide gate and it is the gate a claimant should argue from. The second is that s.35(1)(iv) requires no approval by any prescribed authority — unlike s.35(2AB), where the DSIR's approval of the in-house facility is the gate, and unlike s.35(1)(ii) and (iii), where the Central Government's approval is required — so a claim can be built without the DSIR. There is a real cost to taking this route: s.35(2)(iv) provides that where a deduction is allowed under s.35 in respect of expenditure represented wholly or partly by an asset, no deduction under s.32(1)(ii) is allowed for the same or any other previous year in respect of that asset. Depreciation and the s.35 deduction on the same asset are alternatives, not cumulative, and the claim should be framed on that footing. Note also that the Revenue's second question in this case was framed as a double-deduction objection under s.35(2)(iv); the Court answered both questions for the assessee but the judgment as retrieved does not separately reason the point. If it applies to you, the first step is this: Frame the claim from the s.43(4) definition, not from a general notion of research: show the activity extends knowledge in a field of natural or applied science and that the research may lead to or facilitate an extension of the business.
The assessee, a software development company, acquired an intellectual property through M/s. Aditi Technologies Pvt. Ltd. for Rs 10.82 crore, which it capitalised in its books. It then spent Rs 9,27,34,277 on further developing and improving that product, the expenditure consisting mainly of salary cost of employees and other general administrative expenses connected with the development. The development was a continuous process directed at a multi-channel customer relationship management solution, and produced an improved version, 'Talisma Enterprise 2.5', which captures, documents and integrates customer information for marketing, sales, services, human resources and finance through e-mail, chat, wireless, fax and telephone. The Revenue's contention was that because the purchase of the Talisma software had been capitalised, any expenditure on further development of the software had also to be treated as capital in nature; the Assessing Officer treated the improvement as capital and allowed depreciation. Before the appellate authority the assessee raised, for the first time, an alternative plea that the expenditure was allowable under s.35(1)(iv). The appellate authority and the Tribunal accepted that plea and the Revenue appealed. The matter was decided on 2013-10-30 by the High Court (N. Kumar J and Rathnakala J). On those facts the High Court held as follows. The substantial questions of law were answered in favour of the assessee and against the Revenue and the appeal was dismissed, the Court finding no infirmity in the Tribunal's order. Expenditure on further developing and improving the software product was expenditure on scientific research, and even if capital in nature, having been incurred in relation to the business carried on by the assessee, it fell to be deducted under s.35(1)(iv) (paragraph 9).
The Court took its starting point from the definition in s.43(4): scientific research means any activity for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries, and references to scientific research related to a business include any scientific research which may lead to or facilitate an extension of that business (paragraph 7). It then set s.35(1)(iv) alongside that definition, noting that the clause allows, in respect of expenditure of a capital nature on scientific research related to the business carried on by the assessee, such deduction as is admissible under sub-section (2) (paragraph 8). Applying both to the facts, the Court found that the money was spent largely on the employees who developed 'Talisma Enterprise 2.5', that the development was on account of scientific research, and that the expenditure was accordingly deductible under s.35(1)(iv) notwithstanding its capital character — which was what the appellate authority and the Tribunal had held (paragraph 9). In the words reproduced by the source cited on this page: "Therefore, the expenditure in respect of the scientific research, even if it is capital in nature as it was incurred in relation to the business carried on by the assessee under Section 35(1)(iv) of the Act, the said expenditure is to be deducted."
It was decided by the High Court on 2013-10-30 and is reported as Income Tax Appeal No. 515 of 2007 (High Court of Karnataka at Bangalore), assessment year 2001-02. Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 35, section 35(1)(iv), section 35(2), section 35(2)(iv), section 43(4), section 32, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The substantial questions of law were answered in favour of the assessee and against the Revenue and the appeal was dismissed, the Court finding no infirmity in the Tribunal's order. Expenditure on further developing and improving the software product was expenditure on scientific research, and even if capital in nature, having been incurred in relation to the business carried on by the assessee, it fell to be deducted under s.35(1)(iv) (paragraph 9). It arises in Deductions & Disallowances and How Tax Law Is Read matters, on section 35, section 35(1)(iv), section 35(2), section 35(2)(iv), section 43(4), section 32 of the Income Tax Act 1961, and was decided by N. Kumar J and Rathnakala J. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Assemble the composition of the expenditure — this claim was mainly salary cost of employees engaged on the development, plus general administrative expenses connected with it — and show what was produced. Take the s.35(1)(iv) claim in the alternative wherever the Assessing Officer proposes to treat product development spend as capital; the Court did not shut it out because it was raised first before the appellate authority. Give up depreciation on the same asset in terms, relying on s.35(2)(iv), rather than leaving the officer to raise double deduction as an objection. Do not extend this to expenditure on land or buildings, and remember that for s.35(1)(iv) the quantum of the deduction is worked out under s.35(2).
Validity check could not be completed. Validity check could not be completed. I read the header, the questions of law, the first line of each of the nine numbered paragraphs and the whole of paragraphs 6 to 9 with the concluding sentences from the plain document URL, and re-verified the quoted sentence at paragraph 9 through a separate document-fragment fetch, which returned it in identical words. I did NOT check whether the Revenue took the matter to the Supreme Court and did not run any citator check. Section 35(1)(iv) has not been amended in the respects relevant to this decision so far as the current departmental text (stamped Year: 2025) shows, but no amendment history was traced. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The judgment as retrieved runs to nine numbered paragraphs followed by three unnumbered concluding sentences ('Accordingly, we answer the substantial questions of law in favour of the assessee and against the Revenue', 'In that view of the matter, we do not see any infirmity in the order passed by the Tribunal, which calls for interference', and 'Hence, the appeal is dismissed.'). Paragraph 7 reproduces s.43(4)(i) and (iii)(a) with ellipses in the original; that is the Court quoting the statute, not its own words. The second question of law — whether granting relief under s.35(1)(iv) where the Assessing Officer had treated the improvement as capital and allowed depreciation amounts to an impermissible double deduction contrary to s.35(2)(iv) — is answered only by the omnibus sentence answering both questions in the assessee's favour; the judgment as retrieved contains no separate reasoning on it, so this entry does not state that s.35(1)(iv) and depreciation may both be taken. The section number in the judgment is written as 'Section 43(4)(iii)(a)' at paragraph 7 while the quoted text is set out as '43.(4)(i)'; the definition of scientific research is in s.43(4). This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The substantial questions of law were answered in favour of the assessee and against the Revenue and the appeal was dismissed, the Court finding no infirmity in the Tribunal's order. Expenditure on further developing and improving the software product was expenditure on scientific research, and even if capital in nature, having been incurred in relation to the business carried on by the assessee, it fell to be deducted under s.35(1)(iv) (paragraph 9).
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