TMI Blog2012 (9) TMI 48X X X X Extracts X X X X X X X X Extracts X X X X ..... ave no right to exploit or in any way to use the know-how and shall forthwith discontinue all use of the know-how and shall not thereafter use the know-how, thus the revenue’s arguments that the royalty amount to be in the nature of capital expenditure, is meritless - in favour of assessee. Disallowance of publicity expenses - Held that:- The reasoning for disallowance of 50% of expenses as the advertising expenses were to be borne by the sister concern dealer, and that the proportion was in respect of its territory, was not upheld as brand promotion enhances the visibility of given products or services, and are often perceived as conferring a competitive advantage on those who adopt those strategies or schemes. Expenditure towards that end is based on pure commercial expediency, which the revenue in this case, ought to have recognized, and allowed - in favour of assessee. Disallowance of consultancy charges u/s 40A (2) - Held that:- In order to determine whether the payment is not sustainable, the AO has to first return a finding that the payment made is excessive, under Section 40-A (2) and only if it is found to be so, then the AO has to determine what constitutes the fair ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paid royalty of Rs.. 4,73,06,822 to RML in pursuance of the grant of right to use the technical know-how. The assessing officer disallowed this royalty expenditure stating that the amount paid to the licensor was not expenditure wholly and exclusively incurred for the business of the assessee and that it was incurred partly for the business of the sister concerns of the assessee, i.e., its contract manufacturer M/s. Kamakhya Cosmetics and Pharmaceuticals Pvt. Ltd., and its distributor M/s. Win Medicare Ltd. It was held that deduction of royalty could be allowed in the hands of the assessee on the basis of the proportion of its sales to the total sales on which royalty is calculated and payable to the licensor. The assessing officer treated part of royalty payment as capital in nature, and disallowed 25%, of such royalty payment. The AO s objection while capitalizing 25 per cent, of the royalty paid was on account of his opinion that the know-how agreement was open ended in terms of duration and that the assessee had exclusive right to use the know-how and patents and the new products developed by the licensor. The Appellate Commissioner, on appeal by the assessee held that capital ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6. The revenue argues that the fact that the know-how agreement between the assessee and Revlon Mauritius was a continuing one, and the time agreed to originally had long since passed. This, coupled with the fact that the Revlon brand was given over exclusively to the assessee by its owner, is a clear pointer to its conferring an enduring capital advantage to the former. Thus, the conclusion drawn by the AO that disallowance to the extent of 25% of royalty payment was warranted. Counsel for the revenue relied on the judgment of the Madras High Court in Commissioner of Income Tax v Madras Rubber Factory (1983) 144 ITR 678 to say that the royalty resulted in the foreign brand owner imparting to the assessee an advantage that on operational matters might tend to outlast, and endure beyond, the contract period clearly amounting to a capital advantage of an enduring nature. Reliance was also placed on the judgment in CIT v. Kirloskar Cummins Ltd. [1993] 202 ITR 36 (SC) and the judgments reported as Commissioner Of Income Tax, vs. I.A.E.C. (Pumps) Ltd., 1998 (232) ITR 316 (SC). 7. On the question of consultancy charges it was argued that the AO given cogent and sound reasons for not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sset of enduring nature, vested in the assessee s favor, justifying the AO to hold that 25% of the expenditure in that regard had to be treated as capital. It was further submitted that merely because two sister concerns were engaged in the distribution and production of Revlon products did not mean that the Assessee was not the licensee. The Assessee does business affairs in the most efficient manner possible which meant in turn that it gave the job of production to one sister concern and distribution of the product to another. Further, the evidence showed that royalty liability was not passed on to the product manufacturer. The benefit of know-how, for manufacturing of the products was given for this purpose without any obligation to pay royalty to the licensor. Consequently, the payment of royalty was revenue in nature and could not be classified as capital expenditure. Learned counsel relied upon the judgment of this Court in CIT v. Sharda Motor Industrial Limited 319 ITR 109 and that of the Supreme Court in Commissioner of Income Tax v. CIBA of India Limited 69 ITR 692 (SC) and submitted that as long as the licensee or the beneficiary did not become entitled exclusively to use ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llowed as much as 50%. However, the reasoning of the AO and the CIT (Appeals) in disallowing the sum of Rs..14.87 lakhs was tenuous and unsustainable. It was submitted that having accepted the fact that the Assessee could spend amounts for brand promotion activities, the tax authorities could not dictate as to what proportion of such expenses were justified. Learned counsel submitted that such expenses is not supported by legal authority and the partial disallowance was correctly set-aside by the Tribunal in its impugned order. 12. It was lastly urged by learned counsel that as regards the consultancy charges payable to MMPL, the AO did not reject this head of expenditure outright; but instead allowed only Rs..30 lakhs, rejecting the balance of Rs..58.98 lakhs. The reasoning for the AO holding the amount in excess of Rs..30 lakhs to be disproportionate was unsustainable. Learned counsel submitted that the finding of the AO and as endorsed by the CIT(Appeal) that the maximum amount payable in terms of the Companies Act was Rs.. 30 lakhs per month, was based upon a reading of the provision which pertained to public limited companies. The Assessee in this case was not a public limit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xxxxxxxxxx xxxxxxxxxxx 7. CONSIDERATION AND TAXES. 7.01 Royalty. In consideration of the grant of license rights to it hereunder, Licensee shall pay to Licensor during the subsistence of this Agreement a royalty of 5% net of taxes, of its Net Sales per annum (the Royalty ). 7.02 Quarterly Installments. The Royalty shall be paid in quarterly installments by the Licensee within 45 days following the close of each fiscal quarter with respect to Net Sales achieved during such fiscal quarter. 7.03 Sales Beyond Termination. In the event of termination of this Agreement, the Royalty shall be payable within 30 days after such termination for the portion of the calendar quarter up to the date of such termination. xxxxxxxxxx xxxxxxxxxxx 10. TERM OF AGREEMENT. Unless earlier terminated in accordance with the terms hereof, this Agreement shall remain in full force and effect from the Effective Date for the period contained in the Foreign Collaboration Approval letter issued by the Indian Government. The Parties shall made prompt application for such letter and shall make application in due time for renewal or replacement of this Agreement . 14. The question of whether royalty ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or all: the Swiss Company which was continuously carrying on research and had agreed to make it available to the assessee; and (f) the stipulated payment was recurrent dependent upon the sales, and only for the period of the agreement. We agree with the High Court that the first question was rightly answered in favour of the assessee." 16. In Empire Jute Co (supra), the assessee manufactured jute. It was a member of the Jute Mills Association (formed to protect the trade of its members, by regulating the production of the mills, of its members). The members had entered into a working time agreement, whereby the number of working hours per week for which the mills were entitled to work their looms was restricted. The assessee had purchased looms hours from four other mills. The issue was whether the money spent for purchase of "loom hours" was revenue or capital expenditure. The Supreme Court s observations are instructive in this context: ".....The Revenue, however, contended that by purchase of loom hours the assessee acquired a right to produce more than what it otherwise would have been entitled to do and this right to produce additional quantity of goods constituted addit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e advantage merely facilitates the assessee s trading operations or helps it to carry on business with greater efficiency, or profit, at the same time leaving the fixed assets intact, the expenditure would be classifiable as revenue expenditure regardless of its conferring enduring benefit. The test of enduring benefit is not therefore a formula universally applicable. As observed by the Supreme Court in Alembic Chemical Works (supra) the test of enduring benefit to determine whether expenditure is to the capital or revenue account, is a broad one but should not be applied inflexibly: some broad and general tests have been suggested from time to time to ascertain on which side of the line the out-lay in any particular case might reasonably be held to fall. These tests are generally efficacious and serve as useful servants; but as masters they tend to be over-exact- ing. 17. The decision in Jonas Woodhead and Sons (India) Ltd. v. CIT [1997] 224 ITR 342 (SC) is relevant, especially the following observations: "It would thus appear that the courts have applied different tests like starting of a new business on the basis of technical know-how received from the foreign firm, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inue from 1-10-2003 until such time as both parties mutually decide to terminate the agreement. In terms of Clause 3 of the agreement, it was treated as part of the original assessment except as modified. Consequently all the terms and conditions remained unchanged. The original know-how licence agreement was dated 14-1-1994 and royalty payments in terms of that agreement were made till August 2002, i.e., for a period of seven years. The payment of royalty in the year under assessment was made in terms of supplement agreement dated 16-9-2003. The Tribunal therefore concluded that there was no question of any fresh input of know-how/technology and the payments were only in respect of continued use of brand name and patents owned by the foreign company. Hence no benefit of enduring nature was derived by the assessee against these payments of royalty. 20. According to various clauses of the know-how licence agreement read along with the supplement agreement royalty payable as net sales of taxes the know-how was provided by the contract manufacturer in terms of Clause 4.01 of the agreement. This was for the limited purpose of manufacture of Revlon products only. The responsibilities ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngs on this point are therefore, upheld. 22. As far as the second aspect, i.e. expenditure for promotion of the brand is concerned, there is no doubt that the dealer s functions extend to advertising the products of the assessee, manufactured by the sister concern. On this aspect, Section 37 of the Income Tax Act would be relevant. The said provision reads as follows: SECTION 37 GENERAL: (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". Explanation : For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. (2B) Notwithstanding anything contained in sub-section (1), no allowance shall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... approach or reasoning, on this aspect. One is not unmindful of the concerns of a business which engages in sale of consumer items, and faces continuous competition. Brand promotion enhances the visibility of given products or services, and are often perceived as conferring a competitive advantage on those who adopt those strategies or schemes. Expenditure towards that end is based on pure commercial expediency, which the revenue in this case, ought to have recognised, and allowed. The revenue s arguments on this point too are insubstantial. 24. The last aspect pertains to the payment of consultancy charges On this aspect, the Tribunal s findings are as follows: 11. We have considered the rival contentions and found from the record that the consultancy charges have been paid in lieu of MMPL for providing various advices as discussed in the above paragraph. Mr. U.K. Modi has represented one of the joint venture parties, MMPL, as director, in the business of collaboration with RML. We found him as an instrument in negotiating the collaboration as representative of MMPL for which he himself gave his personal undertaking. We also found that Mr. U.K. Modi did not render any service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... remuneration payable to MM hereunder shall not exceed the sum of US$ 300,000 per annum. (b) The compensation payable to MM stated in paragraph 4(a) and the determination of the U.S. dollar equivalent of the Net Sales of Modi-Revlon shall be paid and determined, as applicable, in Indian Rupees at the exchange rate in effect for purchasing U.S. Dollars with Indian Rupees as of the last day of each calendar year, as published in the Wall Street Journal. 5. Term. This Agreement shall continue until December 31, 1997 at which time or anytime thereafter it shall be terminable by either party upon three months notice to the other party. This agreement shall terminate in the event of the termination of the Shareholders Agreement. In Dhanrajgiriji Raja Narsinghji (supra), the Supreme Court considered the question of such payments and ruled as follows: we find no support for this contention from the language of Section 10(2)(xv). That provision does not make any distinction between civil litigation and criminal litigation. In fact, expenses incurred in connection with litigation with are not separated dealt with under that provision. In our opinion, it makes no difference whethe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld take the character of a gratuitous payment or payment received in spite of not rendering any services. Such finding can only be made in the case of MMPL and that too after examining the various documents in relation to services rendered by him for MMPL. In any case, rendering of services by MMPL is amply proved from the records and therefore, in my opinion, no disallowance appears warranted when considered with further discussion in the ensuing Paras. 25. This Court notices that in order to determine whether the payment is not sustainable, the AO has to first return a finding that the payment made is excessive, under Section 40-A (2) of the Income Tax Act. If it is found to be so, then the AO has to determine what constitutes the fair market value of the services rendered and disallow the difference between what is claimed and what is such value determined (as fair market value). Apart from the fact that no such exercise was undertaken by the AO, the Court sees that the assessment order went off into a tangent, in following a method that was clearly inapplicable. The annual cap of Rs.. 30 lakh payable to managerial personnel applied to public limited companies, and not those ..... X X X X Extracts X X X X X X X X Extracts X X X X
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