TMI Blog2008 (5) TMI 607X X X X Extracts X X X X X X X X Extracts X X X X ..... ufacturing facilities and for the parts, separate agreements have been entered into by the parties and separate payments have been made by the assessee as consideration therefor. This makes the position clear that the impugned payment of lump-sum know-how fees and royalty are not part of the payment for setting up the plant which manufactures the Honda cars in India. This aspect of the matter needs to be disposed of first. It is well-settled that initial expenditure incurred by a businessman to set up his business or expenditure incurred to install the frame-work of the business must be treated as capital. Reference in this connection may be made to the classic ruling of Lord Sands in IRC v. Granite City Steamship Co. Ltd. where it was observed: Broadly speaking, outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment . The English case noted was applied in India with approval by the Supreme Court in Assam Bengal Cement Co. Ltd. v. CIT [ 1954 (11) TMI 2 - SUPREME COURT] but the final judgment, as observed by Kanga and Palkhivala, rested on another ground, viz., that the expen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed by the provisions of the Income-tax Act noticed above. The Transfer Pricing Officer is not concerned, nor is he competent to decide as to whether the payment under the collaboration agreement is capital or revenue. It is first necessary to determine the nature of the payment and decide whether it is capital or revenue. If it is held to be capital, it is not allowable as deduction and the question of determining the arm's length price may not be necessary to be decided by the Transfer Pricing Officer. However, as we have held the payment to be revenue in nature and hence allowable, accepting the submission of Mr. Vohra, we direct that while giving effect to our order the Assessing Officer may, if so advised, refer the question of the arm's length price to the Transfer Pricing Officer for determination in accordance with law. The decision of the Tribunal regarding the nature of the payment cannot be deferred, as requested by the learned Commissioner of Income-tax- Departmental representative, to a stage after the Transfer Pricing Officer determines the arm's length price. Such a course is not contemplated by law. We, therefore, reject the preliminary objection raise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenditure being allowable in the hands of the assessee. So long as the expenditure benefits the assessee it should be allowed as a deduction. The CIT (A) has stated that there was no increase in the sales. This is not a relevant criterion. The association of the assessee-company with the advertisement scheme launched by Nerolac Paints and the assurance of giving away a Honda car at its own cost to the winner may be beneficial to the assessee in the long run. It cannot be denied that it had advertisement value. Expenditure incurred on advertisement is undisputedly business expenditure. Thus, we direct the AO to allow the assessee's claim. The ground is allowed. In the result, the assessee's appeal is partly allowed. Disallowance on research and development expenses - It is well settled that every expenditure that confers some enduring advantage cannot be regarded as capital expenditure and reference in this connection may be made to the judgment of the Supreme Court in Gotan Lime Syndicate v. CIT [ 1965 (11) TMI 35 - SUPREME COURT] . If the expenditure has relation to the stock-in-trade, the sale of which is the business of the assessee, the mere fact that some ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee's appeal is directed against the disallowance of Rs. 29,40,64,000 being lump-sum fee for technical know-how Rs. 18,55,24,000 being royalty paid to Honda Motor Company Ltd., Japan (hereinafter referred to as HMCL), under the technical collaboration agreement. While completing the assessment the assessee was asked to explain the payment of Rs. 29,40,64,000. The assessee submitted that the amount represented the third instalment of the lump-sum fees paid to HMCL under the technical collaboration agreement dated May 21, 1996, that HMCL had granted an indivisible, non-transferable and exclusive right and licence to use the know-how and technical information for the manufacture of automobiles, the models and types of which were listed in the agreement, that in consideration of the right and licence granted to the assessee and for furnishing the technical information it was required to pay a sum of US dollar 30.5 million in five equal instalments beginning from the third year after the commencement of commercial production, that in addition the assessee was required to pay a royalty of 4 per cent. of the sales effected in each year, that under the technical collaboration agre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss. He considered that the agreement was for the purpose of setting up the plant and manufacturing facility and not towards running of an existing business. As regards the restrictions placed on the assessee under the technical collaboration agreement, such as, confidentiality, prohibition on transferring the know-how, etc. the Assessing Officer held that these are only clauses inserted by way of abundant caution. He concluded that the assessee had obtained an advantage of enduring nature by payment of the lump-sum fee, citing the judgment of the Supreme Court in CIT v. Ciba of India Ltd. [1968] 69 ITR 692. He also referred to the judgment of the hon'ble Allahabad High Court, which is the jurisdictional High Court, in Ram Kumar Pharmaceutical Works v. CIT [1979] 119 ITR 33 and that of the Supreme Court in CIT v. Warner Hindustan Ltd. [1998] 9 SCC 533 ; [1999] 239 ITR 566. On the basis of the above, he concluded that the payment of the lump-sum fees was directly related to the installation of the factory for production of cars and accessories thereof and the same should be treated as capital expenditure. As regards royalty, he concluded that the assessee is not already in the bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oducts or the licenced parts. The products shall mean the automobiles, the specific models and types which are listed in exhibit I attached to the agreement. All the exhibits attached to the agreement have been stated in the preamble to form an integral part of the agreement. A look at exhibit I shows that the products referred to therein are two. The first is an 1000 cc, 16 valve, 4 cylinder, 4 door sedan and the second is a 1500 cc, 16 valve, 4 cylinder, 4 door sedan. It is thus clear that the know-how relates to the manufacture of the products, namely, the cars and not the setting up of the plant or factory. The parts are defined in article 1.2 to mean the component parts of the products and shall include the parts for repair or replacement of the products. Technical information has also been defined in article 1.7 to mean know-how or other technical information which is necessary for the manufacture of the cars or the parts thereof. This article reiterates the assessee's contention that the agreement relates to know-how for the manufacture of cars and not for the setting up of the plant. 7. Article 2 refers to the grant of licence. The licence given to the assessee is an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the technical information and provides for a lump-sum fee of US dollar 30.5 million payable by the assessee. It further provides that the same shall be paid in five continuous equal annual instalments of US dollar 6,100,000 commencing from the third year after the commencement of commercial production. It also provides for the royalty payment on both internal sales and exports of cars made by the assessee. The royalty shall be calculated at 4 per cent. on the sales and was payable for a period of seven years from the date of commencement of commercial production. 14. Article 16 provides for the trademarks. It says that the assessee was granted by HMCL an indivisible, non-transferable and exclusive right and licence to use the trademarks within the territory in connection with the sale and marketing of the cars and the parts thereof as also for repair or replacement of the same. With regard to such trademarks, the assessee was required to obtain the prior written consent of HMCL with regard to the design and manner of use of trademark. The assessee was also under an obligation to ensure that they were not used by any third party and to notify any infringement or illegal use of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amounted to US dollar 525 per day as technical assistance or guidance fee for each technical expert originating from HMCL's manufacturing facility in Japan or at US dollar 250 per day in case the expert originates from the affiliated companies of HMCL in other Asian countries. Article 7 of this memorandum provided for separate lodging and living conditions for the technical experts, means of transport from the lodging to the work place, boarding expenses, etc. Detailed provisions were made for the working condition of the technical experts, their medical care and insurance, etc. On the other hand, the cost and expenses for sending the engineers of the assessee- company to HMCL was to be borne by the assessee-company. Their working conditions were subject to the rules and regulations adopted by HMCL for its own employees. The medical treatment of these engineers was to be provided by HMCL but their insurance against death or injury or illness was to be the responsibility of the assessee. 19. The other agreement entered into simultaneously with the technical collaboration agreement is the memorandum on supply of parts . It relates to the supply by HMCL of parts required for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ital account, incurred for setting up the plant/manufacturing facility for the manufacture of the cars. 22. It follows from the above that the impugned payments are not in connection with the setting up of the plant or the manufacturing facilities, but have been made to enable the assessee to manufacture the Honda cars in India which are its stock-in-trade. 23. Having cleared the above factual aspect, we shall now proceed to examine the question whether the payment of the lump-sum know-how fees and royalty is on capital account or revenue account. Before doing so, we must note that a question arose in the initial stage of the arguments as to whether the expenditure could not be considered as part of the initial expenditure or for setting up the business (as opposed to the setting up of the manufacturing facilities or plant) and considered to be not allowable as revenue expenditure on that score. Our doubt was why the payment, at least of the lump-sum technical know-how fees, cannot be considered as being connected to the initial starting up of the business and hence not allowable since the know-how was being obtained for the first time and was crucial to the setting up of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arning machinery in motion . The English case noted above was applied in India with approval by the Supreme Court in Assam Bengal Cement Co. Ltd. v. CIT [1955] 27 ITR 34 but the final judgment, as observed by Kanga and Palkhivala (supra, page 666), rested on another ground, viz., that the expenditure was incurred to acquire an asset or advantage of enduring benefit to the trade and was therefore of a capital nature. 25. It would thus appear that the test that is to be applied in such cases is only whether the assessee obtained any proprietary rights in the technical know-how or he merely obtained the right to use the same for the purpose of his business for a limited period of time, irrespective of whether the expenditure was incurred at the time of initiation of the business or at any point of time subsequent thereto. This aspect of the matter, if we may say so with utmost respect, has been adverted to pointedly by the Delhi High Court in Shriram Refrigeration Industries Ltd. v. CIT [1982] 127 ITR 746. In this case, the question was whether the lump-sum payment in addition to the royalty based on the sale price of the manufactured articles was allowable as revenue expenditure u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ical know-how the plant and machinery would have been of no use, that the technical know-how was as much a part of the company's permanent apparatus of profit making as the plant and machinery and drawings, that the know-how was necessary for the starting of the manufacturing organisation and not merely for running the business and that the initial payment was, therefore, clearly of a capital nature. It needs to be noticed that the Assessing Officer in the present case has also adopted a similar line of reasoning. On a reference at the instance of the assessee, the Delhi High Court held that the know-how obtained by the assessee had nothing to do with the installation or setting up of the plant or design organisation but was concerned only with the techniques of using the plant and machinery for the manufacture of the end products. It was, therefore, held that the technical know-how was not part and parcel of the plant and machinery or design organisation. In this case, the earlier judgment in Shriram Refrigeration Industries Ltd. v. CIT [1982] 127 ITR 746 (Delhi) was noticed, as also the fact that the manufacture of steam turbines was a new business for the assessee. These two ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sugar plant which was the business in which the assessee was engaged. 29. It is now necessary for us to examine the impact of the terms and conditions of the technical know-how agreement. The relevant terms and conditions have already been noticed by us. A conjoint reading of all the clauses of the agreement shows that the assessee did not become the owner of the technical know-how which enured in HMCL. HMCL continued to retain the proprietary rights in the technical know-how. The know-how related to the manufacture of the Honda cars the purpose for which the assessee-company was incorporated. The manufacture of the cars was the business for which the company was established. The cars manufactured with the help of the technical collaboration agreement would constitute the stock-in-trade of the assessee. Thus, by the use of the technical know-how, the assessee was only producing stock-in-trade the sale proceeds of which would be revenue receipts. The assessee was merely granted a licence to use the technical know-how for the manufacture of the cars. The licence was indivisible and non-transferable. There was the usual secrecy and confidentiality clause in which it was reiterated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eature in all the cases was that there is no divergence of judicial opinion so far as the principles to be applied are concerned ; cases were decided on the application of such principles to the facts of a particular case. We have already referred to the common basic principle which runs through all the cases cited by both the sides and there is no need to repeat it. If that principle is applied to the facts of the present case and to the terms and conditions of technical collaboration agreement, it would be seen that the assessee obtained only the right to use, during the currency of the agreement, the technical know-how and information and the intellectual property rights relating to the manufacture of the Honda cars and did not secure any ownership rights over them. We, therefore, hold that the payment of the lump-sum fees for technical know-how and the royalty is allowable as revenue expenditure. We may add that we have avoided the temptation to burden this order with any detailed discussion of the entire case law cited before us because, as we have already noticed, the decision in such cases should be based on the facts and the basic principles applicable are well- settled and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Supreme Court on which heavy reliance was placed by the Commissioner of Income-tax- Departmental representative to contend that any expenditure incurred under an agreement which facilitates the setting up of a new business is capital in nature. A close reading of the judgment does not show that any such principle was laid down. In that case the Supreme Court itself observed (pages 347-8) that the question whether a payment under a collaboration agreement would be capital or revenue would depend upon several facts such as whether the assessee obtained a completely new plan or process or technology, whether the technical know-how obtained was for the betterment of the product, whether the improvisation made is part of the existing business or a new business was set up with the help of the know-how, whether on expiry of the term of the agreement the assessee would be required to return the plans and designs etc. It was further held that the various terms and conditions of the agreement, the advantage derived by the assessee under the agreement, the payment made there- under etc. are all to be taken into account. On facts, it was noticed that the assessee set up a new business under t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch less revenue expenditure. The Supreme Court observed that what in effect was done by the assessee in allotting equity shares to the foreign company was to reimburse the contribution made by the foreign company by way of technical know-how which could never be treated as expenditure. It may be noted that this case turned on its own peculiar facts and the amount spent by the assessee-company could not even qualify as expenditure. A further proposition laid down in this case was that the claim would be put only under section 37(1) of the Income-tax Act and it was not covered under sections 30 to 36 of the Act. This fortifies our view that the decisions of the Supreme Court in CIT v. Saravana Spinning Mills P. Ltd. [2007] 293 ITR 201 and Ballimal Naval Kishore v. CIT [1997] 224 ITR 414 are not applicable to the present case as they were concerned with the allowance of expenditure claimed as current repairs under section 10(2)(v) of the Indian Income-tax Act, 1922 and section 31(i) of the Income-tax Act, 1961. 32. We may also refer to the argument of the learned Commissioner of Income-tax-Departmental representative based on section 32 of the Income-tax Act as it stands with effe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Act as also to the order of the Special Bench of the Tribunal in the case of Aztec Software and Technology Services Ltd. v. Assistant CIT [2007] 294 ITR (AT) 32 (Bang). This plea was opposed by Mr. Vohra, learned counsel for the assessee. He submitted that the only function of the Transfer Pricing Officer under the provisions of sections 92 to 92C of the Act is to see if the price paid is an arm's length price and that he is not concerned with the question whether the payment was capital or revenue, nor was he competent in law to decide the question. He further submitted that the order of the Special Bench cited above does not touch upon the controversy sought to be raised by the Department. He contended that the nature of the payment whether it is capital or revenue has to be decided first, and the question of determining the quantum of the allowance would logically come in for consideration only later. Mr. Vohra however had no objection to the arm's length price being referred to the Transfer Pricing Officer for determination after the Tribunal's order determining the nature of the payment. On a consideration of the matter, it seems to us that the submissions o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, a copy of which has been placed at page 188 of the assessee's paper-book. This shows that the amount was paid on April 27, 2002, by demand draft dated April 19, 2002, drawn on Bank of America, Barakhamba Road under the major head 0037-customs duty . The amount has been paid into the State Bank of India, Mumbai main branch. Thus, the payment falls within this year. Learned counsel for the assessee has fairly drawn our attention to the order of the Tribunal for the assessment years 2001-02 and 2002-03 in I. T. A. Nos. 3688 and 3689/Del/2005 dated July 21, 2006 (Honda Siel Cars India Ltd. v. Assistant CIT [2007] 109 ITD 1 (Delhi)). In paragraph 19.4, the Tribunal dealt with the disallowance of customs duty of Rs. 32,63,032 out of a payment of Rs. 3 crores made on March 31, 1999, as advance customs duty. The amount was not allowed in the assessment year 1999-2000 on the ground that it was only an advance and was not a final payment. The appeal of the assessee before the Tribunal was pending. Noticing this fact, the Tribunal in its order dated July 21, 2006, set aside the orders of the Departmental authorities and directed the Assessing Officer to allow the claim if it was not a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eration are similar. Therefore, respectfully following the earlier order of the Tribunal, we direct the Assessing Officer to allow the commission as a deduction. 39. The fifth ground is directed against the disallowance of Rs. 6,91,000 being the showroom price of Honda City car given as a prize under a sales promotion scheme. It is seen from the assessment order that the aforesaid car was given to M/s. Sundaram Iyengar and Sons Ltd., a dealer of the assessee. It appears that M/s. Nerolac Paints had launched a sales promotion scheme called Har Din Diwali where the winner of the prize would get a Honda City car. The assessee-company undertook to bear the cost of the prize being a Honda City car. The assessee agreed to the proposal of Nerolac Paints because it thought that there was an opportunity for it to get some advertisement value for the car manufactured by it. It was on these considerations that the winner of the Nerolac Prize Scheme was given a Honda car by the assessee. The objection of the income-tax authorities appears to be that the promoter of the scheme was Nerolac Paints which stands to benefit from the advertisement campaign and the assessee did not stand benefit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns also would not come in the way of the expenditure being allowable in the hands of the assessee. So long as the expenditure benefits the assessee it should be allowed as a deduction. The Commissioner of Income-tax (Appeals) has stated that there was no increase in the sales. This is not a relevant criterion. The association of the assessee-company with the advertisement scheme launched by Nerolac Paints and the assurance of giving away a Honda car at its own cost to the winner may be beneficial to the assessee in the long run. It cannot be denied that it had advertisement value. Expenditure incurred on advertisement is undisputedly business expenditure. For these reasons, we direct the Assessing Officer to allow the assessee's claim. The ground is allowed. 41. In the result, the assessee's appeal is partly allowed. DEPARTMENT'S APPEAL : 42. The first ground is that the Commissioner of Income-tax (Appeals) erred in deleting the disallowance of Rs. 3,09,48,408 made by the Assessing Officer on account of research and development expenses. The total expenditure on research and development was Rs. 3,98,97,000 and the break-up is as under : (i) Capital expen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -trade of the assessee. They are not part of the plant. The stock-in-trade must be made more attractive and safe from the point of view of the customers and any expenditure towards this end can only be regarded as revenue expenditure. Thus, the enduring benefit, if any, is not in the capital field. It is well settled that every expenditure that confers some enduring advantage cannot be regarded as capital expenditure and reference in this connection may be made to the judgment of the Supreme Court in Gotan Lime Syndicate v. CIT [1966] 59 ITR 718. If the expenditure has relation to the stock-in-trade, the sale of which is the business of the assessee, the mere fact that some enduring advantage results by the incurring of the expenditure does not mean that the expenditure must be treated as capital expenditure. Reference in this connection may be made to the observations of the Supreme Court at page 727 of the Report where there is a reference to Alianza Co. v. Bell [1904] 2 KB 666, an English case where the assessee incurred expenditure for securing raw material for a considerable period of time by paying a lump-sum which was treated as capital by the Revenue authorities. The King&# ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... revious year, the same cannot be regarded as a provision for a contingent liability. We accordingly confirm the decision of the Commissioner of Income-tax (Appeals) and dismiss the ground. 46. The third ground is that the Commissioner of Income-tax (Appeals) erred in deleting the disallowance of Rs. 1,06,11,728 made by the Assessing Officer on account of roof alteration/renovation expenses. It is contended that the person who carried out the repairs had guaranteed that the life of the roof would be around ten years and this showed that the assessee derived an enduring benefit. The payment has been made to Lloyd Insulation. It was explained that the assessee carried out repairs/alteration to the roof of the building in which the plant was functioning. It was explained that the roof was originally erected in 1997 and was made of low degree of slope and the joints in the sheets and vertical openings in the roof were giving problems of water leakage and thus there was a threat of water dripping on the shop floor and damaging the costly equipment which may affect production. It was, therefore, contended that the repairs to the roof was in the nature of current repairs incurred merely ..... X X X X Extracts X X X X X X X X Extracts X X X X
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