TMI Blog1992 (10) TMI 19X X X X Extracts X X X X X X X X Extracts X X X X ..... a company which carries on business in the manufacture and sale of three-wheeler tempos. For the relevant assessment year 1966-67, the previous year ended on September 30, 1965. In the concerned assessment year, the assessee claimed, by way of revenue expenditure, an amount of Rs. 48,312 paid to Messrs. Zahnradifabrik Friedrichshafen Aktiengesellschaft of Germany (hereinafter referred to as the "German company"). The Income-tax Officer disallowed this claim on the ground that this payment had been made to the German company for obtaining a complete set of master-drawings and other technical documentation necessary for the purpose of starting manufacture of automatic gear boxes and, therefore, this was an item of capital expenditure. The view of the Income-tax Officer was confirmed by the Appellate Assistant Commissioner in appeal. In further appeal, the Income-tax Appellate Tribunal referred to the various clauses of the agreement between the assessee and the German company and took the view that the payment in question was capital, as it was laid out for a new line of manufacture, a new type of gear box, by utilising the information which was made available by the German company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts ; furnish to the assessee all drawings, information of production, operations and processing instructions required for the said purpose ; place at the disposal of the assessee their technical personnel for studying all specific problems concerning the manufacturing of the product and, finally, that the German company would provide technical training to specified number of technical people for a certain period. For these services, the assessee was required to pay a tax-free service charge of 2 per cent. based upon the difference in value of the gear box manufactured and/ or distributed by the assessee and of such parts or components which would be supplied completely finished or semi-finished by the German company to the assessee from time to time for assembling and manufacturing the gear boxes in India. Article 4 of the agreement provides for payment of royalties. The German company granted a non-exclusive, non-transferrable licence for manufacturing the concerned gear boxes in the assessee's own works or for manufacture of the said gear boxes by other suppliers according to the design specifications and information supplied by the German company. The licence granted was extende ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... irection to be followed. Though a number of authorities were cited at the Bar on general principles as to when an expenditure laid out for the business can be treated as capital or revenue, it is sufficient to focus our attention only on those cases which deal with expenditure for purchase of technical know-how, as that is the issue in the present case. The earliest judgment cited on this point is the judgment of the Supreme Court in CIT v. Ciba of India Ltd. [1968] 69 ITR 692. In this case, the assessee-company had entered into an agreement with a foreign principal company for transfer of the latest technology in the field of pharmaceuticals. In consideration of the right to receive scientific and technical assistance, it had agreed to make contributions at certain stipulated rates of its net sale price of the products sold by it. The consideration was towards technical consultancy and technical service rendered and research work done, cost of raw material used for experimental work and royalties on trade marks used by the assessee. The agreement was restrictive agreement under which the assessee could not divulge to others, any secret process under the agreement without writt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnel in their works and for releasing members of their own staff to assist in the manufacture of engines by the licensee was held to be received on revenue account of the taxpayer's trade. In English Electric Company's case [1964] 41 TC 556 (HL), the assessee had contracted with the Admiralty to design and develop a turbine and to license its manufacture by a limited number of companies in the United Kingdom, Australia and Canada and also contracted with the Government of Australia and an American aircraft manufacturing corporation to license the manufacture of a bomber which the taxpayer had designed and developed, and received fixed lump sum payments as a consideration for imparting "manufacturing technique" to the licensee. The receipts under this agreement were also held by the House of Lords to be income. The line of reasoning adopted by the Supreme Court in Ciba's case [1968] 69 ITR 692 has been followed by a number of judgments in this court. In CIT v. Tata Engineering and Locomotive Co. Pvt. Ltd. [1980] 123 ITR 538, this court had to consider a somewhat similar case. Under two agreements between the assessee and the foreign company, technical know-how and technical advice ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e available by a party to such an agreement does not stand on the same footing as protected rights under a registered patent. There is no property right in know-how which can be transferred just as it is, in a limited sense, in a patent. In any case, a party making the know-how available can hardly make any attempt to retrieve all the information supplied after the other party to the agreement has fully equipped itself and made itself familiar with the technical information and know-how supplied. The fact that the production can still be continued after the expiry of the agreement was, therefore, held to be wholly immaterial for deciding whether such know-how can be treated as a capital asset. In ACC-Vichers Babcock Ltd. v. CIT [1976] 103 ITR 321, the same view had been expressed in this court. Kirloskar Pneumatic Co. Ltd. v. CIT [1982] 136 ITR 746 (Bom) which is heavily relied upon by the assessee is a much later judgment which reiterates the same view. In fact, this case bears a very close resemblance to the facts of the assessee's case. The assessee therein which was formed to manufacture various types of machinery, including air-compressors, entered into an agreement with a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to a new strain of penicillin which had been developed by the Japanese company. Though the facts before the Supreme Court were slightly different, some of the observations made by the Supreme Court in its judgment are significant and of help. With regard to the transient nature of the technical know-how, the Supreme Court observed (at page 390) : ".It would, in our opinion, be unrealistic to ignore the rapid advances in research in antibiotic medical microbiology and to attribute a degree of endurability and permanence to the technical know-how at any particular stage in this fast-changing area of medical science. The state of the art in some of these areas of high priority research is constantly updated so that the know-how cannot be said to be the element of the C requisite degree of durability and non-ephemerality to share the requirement and qualifications of an enduring capital asset. The rapid strides in science and technology in the field should make us a little slow and circumspect in too readily pigeon-holing an outlay such as this as capital. The Supreme Court further observed (at page 384) : "In the infinite variety of situational diversities, in which the concept ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts out that in this case the Supreme Court has in indubitable terms held that payments made for acquiring technical documents, data sheets and such others are payments of capital nature. Relying upon this judgment, he submits that whatever may have been the nature of the payments under the other articles of the assessee's agreement, payments made under article 1, for acquisition of technical documentation, must fall within the ratio of the Supreme Court judgment in Scientific Engineering's case [1986] 157 ITR 86 and we must hold that such payment is on account of capital. The argument, though prima facie attractive, does not convince us. In Scientific Engineering's case [1986] 157 ITR 86 (SC), the appellant-assessee was a manufacturer of several scientific instruments and apparatuses. It had entered into two collaboration agreements, one for manufacture of theodolites, and the other for the manufacture of microscopes. Under the agreements, in consideration of payment of certain amounts, the foreign collaborator agreed to supply to the assessee all up-to-date technical documents, drawing material, layouts, etc. In respect of such documentation service, the assessee was required to m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... whether the payments made for procuring such documents really amounted to capital expenditure or revenue expenditure. As we read it, the proposition that emerges from this judgment is that, if under an agreement an assessee is given mainly documentation service, then the expenditure towards that would amount to capital expenditure. We are unable to accept that this proposition applies the assessee's case. This is so, because we are unable to read the assessee's agreement with the German company as an agreement the predominant purpose of which was to render mere documentation service. As pointed in Kirloskar Pneumatic's case [1982] 136 ITR 746 (Bom), it is not possible to scan a contract in bits and pieces to determine its nature, nor by referring to a particular clause. As we read the agreement of the assessee with the German company, the predominant object of the agreement was to render technical know-how to the assessee. In relation to the main purpose, one of the incidental objects was to transfer the designs, data sheets and such other technical documents. We are unable to accept the argument of Mr. Jetley that the agreement in question, when read in its entirety, should be he ..... X X X X Extracts X X X X X X X X Extracts X X X X
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