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2017 (2) TMI 126 - ALLAHABAD HIGH COURT

2017 (2) TMI 126 - ALLAHABAD HIGH COURT - TMI - Payment towards Royalty - whether would be 'Revenue expenditure' or 'Capital expenditure' - Held that:- In the present case, a concurrent finding has been recorded by CIT(A) and Tribunal both that on termination of Agreement, which was for a period of five years, Assessee would return all relevant material relating to know-how acquired through Agreement. This is one of the relevant consideration observed in Alembic Chemical works Ltd. Vs. CIT(A) (1 .....

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of agreement shall constitute full compensation for use of patent right till expiry of life of patent and Indian Company shall be free to manufacture that item even after expiry of the collaboration agreement without making any additional payments. Assessee claimed that royalty payment is part of percentage of selling price of product and not for acquiring technical know-how of manufactured licensed product having enduring benefit. These facts available on record have not been disputed and we h .....

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ct, 1961") arising from judgment and order dated 28.02.2005 passed by Income Tax Appellate Tribunal, Lucknow Bench, Lucknow (hereinafter referred to as "Tribunal") in Income Tax Appeal No. 596/Alld/95 and Income Tax Appeal No. 450/Alld/95 Tribunal was admitted on following two substantial questions of law: I. Whether on the facts and in the circumstances of the case, Tribunal was justified in holding an amount of ₹ 18,20,277.00 being royalty paid to its collaborators, M/s CE .....

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ring House reported in 157 ITR 86. 3. In the present case, from the facts, as emerged from record, it is clear that "technical know-how" remained property of Foreign Company and Assessee has only right to use the same on payment of royalty to the said Company. 4. The dispute relates to Assessment Year 1988-89. The facts in brief, necessary for determination of aforesaid questions may be narrated as under. 5. The respondent-Assessee entered into an agreement with M/S CEAT, CAVI Italy (h .....

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commenced its production on 23.03.1987 and account for the first time were closed on 31.12.1987. The disputed assessment therefore is for the period from 23.03.1987 to 31.12.1987 (Assessment Year 1988-89). 7. Assessee filed return before Assessing Authority i.e. Income Tax Officer, Company Circle, Lucknow (hereinafter referred to as A.A.') on 30.06.1998 declaring loss of ₹ 4,58,24,694/-. The return was filed as per Section 115J of Act, 1961 declaring book profit of ₹ 1,48,880/-. .....

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ee preferred appeal before Commissioner of Income Tax (Appeals)-II, Lucknow (hereinafter referred to as "CIT(A)") who reversed the view taken by A.A. in respect to aforesaid amount of ''Royalty' and. accepted claim set up by Assessee that it is ''capital expenditure'. Against this part of order of CIT(A), and some other aspects, Revenue as well as Assessee both preferred Income Tax Appeal No. 596/ Alld/1995 and Income Tax Appeal No. 450/Alld/1995, respectively, .....

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venue has said in para 15 of impugned judgment that Assessee was granted license subject to terms and conditions to utilize the patent and know-how in manufacture of licensed product within India and to sell, use or otherwise dispose off licensed product within the territory. Foreign Company had granted to Assessee non-exclusive right to manufacture, use and sell products in India under the rights of patent, owned or controlled by Licensor i.e. Foreign Company. 11. Licensor, however, agreed to g .....

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ll the licensed products, manufactured and sold by Assessee-Comapny, commencing with commercial production's starting date and would continue for a period of five years. Article 6 provides for imparting further information to Assessee in respect of new inventions, methods, processes, materials etc. in the said technology. Article 7 provides secrecy clause and Article 9 provides that on termination of agreement, Assessee shall return to Licensor all written technical information, design, draw .....

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hat case, Delhi High Court observed that Assessee had obtained a license to manufacture valves, right to sell the same and assistance in carrying it out. The recurring payment of ''Royalty' was for the use of know-how/assistance and not for its acquisition. It was recurring charge on the net selling value and no advantage of enduring benefit was obtained. Payment of ''Royalty' has a direct nexus with the carrying on or conduct of business of Assessee, and, commercially co .....

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discussed in the judgment of Tribunal are not disputed before us. Learned counsel appearing for Revenue submitted that in view of Supreme Court's judgment in Jonas Woodhead and Sons (India) Ltd. Vs. Commissioner of Income Tax 1997 (224) ITR 342 and Southern Switch Gear Ltd. Vs. Commissioner of Income Tax and another 1998 (232) ITR 359; and, Kerala High Court's judgment in Commissioner of Income Tax Vs. Polyformalin (P.) Ltd. 1986 (161) ITR 36 (Kerala) payment of ''Royalty' an .....

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2016 in Income Tax Appeal No. 503 of 2008 (Commissioner of Income Tax, Ghaziabad Vs. M/S Honda Siel Cars India Ltd.) and other connected matters. 15. The term 'Revenue Expenditure' as such is not defined in the Act, 1961. Thus term 'Revenue Expenditure' was explained in Assam Bengal Cement Co. Ltd. Versus Commissioner of Income Tax, AIR 1955 SC 89 (at page 96) as under: "If the expenditure is made for acquiring or bringing into existence an asset or advantage for the endurin .....

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asle, pursuant to agreement dated 17.12.1947 is an admissible deduction under Section 10(2)(xii) of Income Tax Act 1922. Ciba of India Limited was originally floated in the name of 'Ciba Pharma Limited' and subsequently became "Ciba of India Limited", an Indian subsidiary of "Ciba Limited, Basle", (the Swiss Company), and is engaged in the development, manufacture and sale of medical and pharmaceutical preparation. Swiss company originally carried on business in India .....

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Swiss company and Assessee in consideration of payment of "technical and research contribution for the use of Indian patents and or trade marks" to communicate the results of its research work, in so far as they relate to the products which were already manufactured or processed or sold by Assessee. Court held that 'Royalty' payment made by Assessee were revenue expenditure and, for this purpose, it held that secret processes were not sold by Swiss company to Assessee. Further .....

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e was expressly prohibited from divulging confidential information to third parties without consent of Swiss company; (e) there was no transfer of fruits of research once and for all; the Swiss company which was continuously carrying on research had agreed to make it available to Assessee and (f) stipulated payment was recurrent dependent upon the sales, and only for the period of agreement. Court stressed upon the fact that Assessee acquired under the agreement merely right to access to technic .....

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Lucknow (1980) 125 ITR 293(SC), the question was considered in a different but interesting context. Assessee was a sugar factory engaged in manufacture and sale of crystal sugar at Pilibhit, State of U.P. In 1952-53, a dam was to be constructed by State of U.P at a place called Deoni. A road, Deoni Dam-Majhala was constructed connecting Deoni Dam with Majhala. Collector requested Assessee to make some contribution towards construction of Deoni Dam and Deoni Dam-Majhala Road pursuant whereto Asse .....

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e. Appeal before CIT also failed. In Tribunal, two Members of the Bench differed in their view, one held "Revenue Expenditure" another "Capital Expenditure". The matter was referred to a third Member who instead of going into the question whether expenditure could be treated as "Capital Expenditure" or "Revenue Expenditure" took a third view that contribution was made by Assessee as a good citizen and cannot be said to be in relation to business of Assesse .....

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d citizen and not connected with the business of Assessee, hence disallowable under section 10(2)(xv). With respect to another item, which Assessee paid under Sugarcane Development Scheme, Court followed the test laid down in British Insulated and Helsby Cables Ltd. Vs. Atherton 10 TC 155 where learned Law Lord Cave L.C. stated "When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, the .....

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solidated Copper Mines Ltd. (1965) 58 I.T.R 241 where it was highlighted that it would be misleading to suppose that in all cases securing a benefit for the business, would be prima facie capital expenditure so long as the benefit is not so transitory as to have no endurance at all. Court relied on its earlier decision in Empire Jute Company Ltd. Versus Commissioner of Income Tax (1980) 124 ITR 1 (SC) that there may be cases where expenditure even if incurred for obtaining advantage of enduring .....

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ge consists merely in facilitating the Assessee's business operations or enabling management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though advantage may endure for an indefinite future." 18. It was therefore, held that the expenditure incurred in the scheme was on revenue account and not capital. Hence, it was allowable as deduction under .....

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-Shipman Tool and Cutter Grinding Machine with all items of standard equipment. The foreign collaborator was to supply necessary designs, drawings, Technical know-how and assistance. It also agreed to assist Assessee in the production of main castings of machine and also to sell all relative jigs, fixtures, tools, gauges, raw materials and special parts as ordered at their normal commercial retail value. The agreement also required foreign collaborator to furnish all technical information with t .....

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enditure has been incurred and it is not an individual test but totality or cumulative effect of all the relevant facts and circumstances which would help in arriving at a particular inference. It referred to an extract from a Full Bench judgment of Lahore High Court in Benarsidas Jagannath, In re (1947) 15 ITR 185, which was approved in Assam Bengal Cement Co.Ltd. Vs. CIT (supra) which reads as under: "If the expenditure is made for acquiring or bringing into existence an asset or advantag .....

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of payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence." 20. It also referred to the decision of Supreme Court in Gotan Lime Syndicate versus Commissioner of Income Tax (1966) 59 ITR 718, wherein it .....

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'royalty' was for the benefit of business and, therefore, should be treated to be a "Revenue Expenditure'. It held: "Where the expenditure has a direct nexus, connection or relation to the carrying on of or conducting the business of the assessee, it must be regarded as an integral part of the profit-making process. In such a case, it must be held to be a revenue expenditure. Where the purpose and object of the expenditure is to acquire an asset or right of an enduring natu .....

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f collaboration agreement. Indian company, M/s Scientific Engineering House (Pvt.) Ltd., was engaged in manufacture of Scientific Instruments and Apparatus like dumpy levellers, levelling staves, prismatic compass, etc. It entered into two separate collaboration agreements dated 15.3.1961 and 31.3.1961 with M/s Metrimpex Hungarian Trading Company, Budapest for manufacture of microscopes and theodolites. Foreign Company agreed to supply Indian company all 'Technical know-how' required for .....

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ible or depreciable asset was brought into existence, hence no depreciation can be claimed. Appellate Authority, in appeal, preferred by Assessee took the view that what Assessee had done was to make an outright purchase of certain specimen drawings, charts, plans, etc, on special papers and these documents collected together, constituted a book on which depreciation would be allowable. In further appeal, Tribunal observed that some of the services of Foreign Collaborator do qualify for 'Rev .....

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it was decided that a cart horse was plant within the meaning of section 1(1) of the Employers' Liability Act, 1880. It was held: "There is no definition of plant in the Act: but, in its ordinary sense, it includes whatever apparatus is used by a business man for carrying on his business not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or movable, live or dead, which he keeps for permanent employment in his business." 22. Court also referred .....

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7 (SC), a company engaged in the manufacture of antibiotics and pharmaceuticals, was granted licence for manufacture in its plant, well-known antibiotic, penicillin. It negotiated with M/s. Meiji Seika Kaishna Limited ("Meiji" for short), a reputed enterprise engaged in the manufacture of antibiotics in Japan, which agreed to supply to Assessee, requisite 'Technical-know-how' so as to achieve substantially higher levels of performance or production of more than 10,000 units of .....

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information, know-how and written description of Meiji's process for fermentation of penicillin along with a flow-sheet of the process on a pilot plant, the design and specifications of the main equipment in such pilot plant, arrange for the visits to and training at Assessee's expense, of technical representatives of the Assessee, Meiji's plant at Japan and to advise Assessee in the large scale manufacture of penicillin for a period, limited to 2 years from the effective date of the .....

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l. At the instance of Assessee, reference was made to High Court who answered the question against Assessee. Hence matter went in appeal to Supreme Court. Referring to some earlier judgments, Court culled out certain principles laid down therein to determine, whether expenditure of Assessee was 'Capital Expenditure' or 'Revenue Expenditure' and said : "(i) When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advant .....

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is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits, it is a revenue expenditure. (iii) The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure." 24. Court in Alembic Chemical Works Co.Ltd. (Supra) held that three aspects should .....

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es which are reasonable to take into account, and the weight which must be given to a particular circumstance in a particular case, must depend on common sense rather than on strict application of any single legal principle. 26. Referring to B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, (1966) AC 224 (PC), Court in Alembic Chemical Works Co.Ltd. (supra) observed that solution to the problem is not to be found by any rigid test or description. It has to be deri .....

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ons of "Capital" or "Revenue" a judicial fetish. What is 'Capital Expenditure' and what is 'Revenue' are not eternal varieties but must need be flexible so as to respond to the changing economic realities of business. The expression "asset or advantage of an enduring nature" was evolved to emphasize the element of a sufficient degree of durability, appropriate to the context. It was clarified that the phrase 'enduring benefit' in British Insu .....

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t cannot be said that the area of improvisation by obtaining know how from foreign collaboration was not a part of improvisation of existing business or that the entire gamut of existing manufacturing operations for the commercial production of penicillin in the Assessee's existing plant had become obsolete or inappropriate in relation to exploitation of the new sub-cultures of the high yielding strains of penicillin. It cannot be said that mere introduction of new bio-synthetic source requi .....

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amp; Sons Ltd. Vs. The Commissioner Of Income-Tax (supra), Assessee Company was incorporated in March 1963 to carry on the business of manufacture of automobiles springs, entered into an agreement with M/s. Jonas Woodhead and Sons Ltd. of United Kingdom for manufacture of all types of springs and suspension for road and rail vehicles. The foreign company was to provide Assessee, technical information and know-how, relating to and suitable for manufacture of the products as well as the technical .....

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agreement. Assessing Officer held payment to foreign company of an enduring nature and treated it to be a "capital receipt". Assessee lost before Commissioner as well as Tribunal in appeal and also in High Court and therefore, in last, matter came to Supreme Court. The questions considered by Court, were (i) whether a particular payment made by an Assessee under the terms of the agreement forms a part of capital expenditure or revenue expenditure would depend upon several factors, nam .....

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f agreement, Assessee is required to give back the plans and designs which were obtained, but the Assessee could manufacture the product in the factory that has been set up with the collaboration of the foreign firm; (iv) what is the cumulative effect on a construction of the various terms and conditions of the agreement and (v) whether Assessee derived benefits coming to its capital for which the payment was made. 28. Relying on tests laid down in the earlier authorities including Alembic Chemi .....

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equired to be made at a certain percentage of the rates of gross turnover of the products of Assessee as 'Royalty', it cannot be said that the entire payment is a 'Revenue Expenditure'. 29. In Commissioner of Income Tax, Hyderabad versus Warner Hindustan Ltd. 1998 (9) SCC 533, Court did not examine this aspect in detail since the amount involved in dispute was small. Hence, it is not an authority on the question whether technical fee paid to a foreign company would be a '' .....

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erms and agreement only a licence to use other party's patent and knowledge and not a benefit of enduring nature which will constitute acquisition of an asset. 31. This Court in Commissioner of Income Tax Vs. Prem Heavy Engineering Works Pvt. Ltd. (2006) 282 ITR 11 (All) also had an occasion to consider a similar question. Assesee entered into an agreement on 11.04.1984 with the West German Company who was specialized in manufacture of machinery and equipment for Cane Sugar Industry. Assesse .....

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, not manufactured by foreign company itself, data on necessary special tools and special manufacturing techniques, assembly instructions, arrangement drawing of the mill, foundation and loading plan, operation and maintenance instructions, information on the storage of spare parts etc. The agreement allowed to make use of the 'Technical know-how' to manufacture the mill at its workshops in India, to sell the mill within India without any limitation and also to export the mill to Countri .....

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capital asset. It was a for a limited period, not permanently, and not for establishment of any plant or machinery but for manufacture of equipment and machinery for Cane Sugar Plant. Hence, it was not of enduring nature and a ''Revenue Expenditure' and not ''Capital Expenditure'. This decision evidently makes it clear that therein agreement and parting of Technical know-how was not for establishment of plant and machinery but for manufacture of equipment and machinery o .....

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ssed. There will be no order as to costs." 33. From the aforesaid judgment, it is difficult to cull out any exposition of law laid down therein as such. However, in the Law Report, brief facts from judgment of Madras High Court judgment have been given which show that High Court held that various clauses of agreement show that the technical knowledge which Assessee obtained through agreement with Foreign Company secured to Assessee an enduring advantage and benefit in that the same was avai .....

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ws that one fourth of total amount paid towards technical know-how fee was held capital and rest as revenue expenditure. 34. Kerala High Court in Commissioner of Income Tax Vs. Polyformalin (P.) Ltd. (supra) has looked into this aspect from a different angle. Relying on Supreme Court's judgment in Scientific Engineering House P. Ltd. Vs. CIT (supra), it has observed that expenditure incurred for acquisition of technical know-how by way of designs, drawings, charts, plans and other literature .....

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plant. That being so, it held that expenditure is of capital nature. 35. The question as to whether a particular payment made towards technical know-how fee or royalty to a Foreign Company in lieu of an Agreement will be a "capital expenditure" or "revenue expenditure" would depend upon facts of individual case, and, in particular, various terms of Agreement involved therein. 36. In the present case, a concurrent finding has been recorded by CIT(A) and Tribunal both that on t .....

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