TMI Blog1966 (10) TMI 17X X X X Extracts X X X X X X X X Extracts X X X X ..... ert was to provide the assessee with manufacturing technique from time to time and also furnish two complete sets of detailed and general arrangements, drawings, material specifications and parts lists relating to the appropriate machines. Herberts had also to supply patterns, jigs, fixtures and special tools at certain agreed prices. One of the employees of Herbert was to superintend the assessee's factory and manufacture. The assessee could send its employees for training to the Herbert Company at England. Under clause 8 of the agreement, it is provided that the machines manufactured by the assessee should be sold under the trade mark "HERBERT KIRLOSKAR". On the machines the assessee had also to make it clear that the machines were made for and to the designs of Alfred Herbert Limited. All information about improvements in the design, manufacture or using of the products, were to be the subject-matter of mutual communication between the assessee and Herbert. Clause 12 of the agreement is the most important clause for our present purpose. It reads thus : "In consideration of the facilities information and manufacturing technique provided by HERBERT hereunder M. K. (Mysore Kirl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee, the same became a part of its own "know-how". There was no objection for utilising that "know-how" by the assessee even after the period of agreement came to an end in the event the assessee complied with the terms of the agreement during its currency. In pursuance of the agreement, the assessee paid during the relevant accounting year a sum of Rs. 26,713 as provided in clause 12 of the agreement. The question for consideration is whether that item of expenditure should be considered as a capital expenditure or as a revenue expenditure. The Income-tax Officer, the Appellate Assistant Commissioner as well as the Income-tax Appellate Tribunal have all come to the conclusion that the expenditure in question is a capital expenditure. The Income-tax Appellate Tribunal dealt with that question in paragraph 3 of its order. This is what it says : "It was submitted on behalf of the assessee in the appeal before us that the sum of Rs. 26,713 was only revenue expenditure as the amount was paid in respect of drawings and designs relating to articles whose manufacture was likely to change from time to time. We are unable to consider that the amount represents revenue expenditur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lathes are taken up. This does not detract from the position that in respect of the lathes for which the blue prints have now been obtained, there is capital expenditure. When there is manufacture and sale, the running royalty becomes payable and that will be the consideration for patents, etc., being put to use. But this is for a different object. Some stress was laid about the payment being small. The size or quantum of payment does not determine its character, at least in this case. We have to see the nature and object of the payment which in this case disclose a capital element." The distinction between capital expenditure and the revenue expenditure has been well brought out, if we may say so with respect, in the decision of the Supreme Court in Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax. Therein their Lordships observed thus : "In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is dr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t were new types of machines. Therefore, it is clear that the "know-how" in question was to be utilised not for the purpose of manufacturing the machine that the assessee was already manufacturing, but for the purpose of bringing into production new types of machines solely on the basis of the "know-how" supplied by Herbert. In A. Y. S. Parisutha Nadar v. Commissioner of Income-tax, the Madras High Court laid down that section 10(2)(xv) of the Act relating to expenditure laid out or expended wholly and exclusively for the purpose of the assessee's business, clearly indicates that the expenditure should relate to a business which is already in existence and not one that is to come into existence in the future. If the "know-how" supplied by Herbert can be considered as a capital asset, then there is no doubt that the expenditure incurred by the assessee for acquiring that "know-how" is a capital expenditure. We have already noticed that the "know-how" acquired by the assessee was to become its property at the end of the period of agreement. It is not some knowledge acquired merely for the purpose of carrying on the day to day business of the assessee. That knowledge was acquired ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... regard. We shall quote the relevant portion of his Lordship's speech. It reads : "My Lords, I think that the issue of this appeal depends upon a right appreciation of just two matters. One is the nature of this asset of the appellants which is conveniently comprehended in the word 'know-how' : the other is the nature of the considerations given by them in exchange for the payment of the sums of money which are the subject of this dispute. First, as to 'know-how'. I see no objection to describing this as an asset. It is intangible : but then so is goodwill. It would be difficult to identify with any precision the sources of the expenditure which has gradually created it and, patents apart, I would not have thought of it as a natural balance-sheet item. But it is a reality when associated with production and development such as that of Rolls-Royce, and a large part, though not the whole of it, finds its material record in all those lists, drawings and manufacturing and engineering data that are specified in the various licence agreements. It is fundamental to the appellants' case that we should categorise this asset as being part of their fixed capital. Indeed, their argument p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecomes evident that "know-how" supplied by Herbert in the hands of the assessee is a capital asset, but the price realised for the sale of that "know-how" by Herbert is a revenue income. From that conclusion, it follows that the "know-how" acquired by the assessee during the assessment year is an acquisition of a capital asset and, consequently, the price paid for that acquisition is a capital expenditure. In support of his contention that the expenditure in question is a revenue expenditure, Mr. Venkatesa Iyer, the learned counsel for the assessee, relied on the decision of the Bombay High Court in Commissioner of Income-tax v. Ciba Pharma Private Ltd. Therein the assessee-company under an agreement dated June 18, 1948, was to pay to the Swiss company 8 per cent. of its net sales by way of consideration : (1) for the use of the rights under the patents of Ciba Basle, (2) for acquiring the extensive knowledge and practical experience in the pharmaceutical field that Ciba Basle commands by reason of its long and extensive research work and scientific and practical experience in so far as it relates to the products which were manufactured or processed or sold by Ciba Pharma, and (3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ta or material sent to it by Ciba Basle under this agreement. Further, Ciba Pharma is expressly refrained from communicating such information, scientific data or material received by it hereunder to any person, firm or company whomsoever, other than Ciba Basle. The use of the knowledge or the practical experience, which Ciba Pharma gets by knowing the technical 'know-how', is thus limited only for the purpose of the conduct of the business during the period of the agreement, which is of a duration of five years. Payments made for acquiring the said knowledge cannot, in our opinion, be said to have brought into existence an asset of an enduring nature. On the other hand, payment has been made to get the technical 'know-how' only for the purpose of running the business during the period of the agreement with a view to earn profits. In the payment, therefore, in our opinion, no expenditure of a capital nature is involved." From the above observations, it is clear in that case the High Court came to the conclusion that the "know-how" in question is not a capital asset because of the fact that its use is limited for a short period of 5 years and further that the technical knowledge su ..... X X X X Extracts X X X X X X X X Extracts X X X X
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