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TMI Blog1965 (1) TMI 78X X X X Extracts X X X X X X X X Extracts X X X X ..... ;Ciba Pharma", is a cent. per cent. Indian subsidiary of Ciba Limited, Basle (Switzerland), hereinafter referred to as "the Ciba Basle." Ciba Basle deals in drugs, medicines, chemicals, pharmaceuticals and biological products. Ciba Pharma has been incorporated in India on 13th December, 1947. Prior to incorporation of Ciba Pharma and for some little-time after its incorporation, Ciba Basle was carrying on its business in India through a company called Ciba (India) Limited, which was also a cent. per cent. subsidiary company of Ciba Basle. The activities of the Ciba Basle carried on in India through Ciba (India) Ltd. consisted of dealings both in pharmaceuticals as well as dealings in dyes and chemicals. In the year 1948, the activities of Ciba Basle in India till then carried on through Ciba (India) Ltd. were bifurcated. The pharmaceutical section was carved out and given over to Ciba Pharma and the rest of the activities in dyes and chemicals were being continued by Ciba (India) Ltd. under a changed name, Ciba Dyes Ltd. Now, with regard to the business in pharmaceuticals, which was handed over to Ciba Pharma, an agreement has been entered into between the Ciba Basl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oratories, standardization departments, engineering departments and propaganda and patent departments. Ciba Basle, therefore, had acquired valuable scientific knowledge, research methods, data and material concerning its activities in the aforesaid sphere of development, manufacture and sale of medical, pharmaceutical, biological and bacteriological preparations. The preamble further states that the work, which had been allocated to these various departments essentially consisted of discovery of new pharmaceutical products, the introduction thereof into the clinical, medical and general use, as the case of each particular product may be, the elaboration of processes of production on factory scale and the improvement of already used processes, the drawing up and filing and supervising of patent applications as well as the continuous watch on patents, the standardization of processes and of new products; the design and construction of suitable engines for the production on laboratory and factory scale, the continuous entertainment of relations with the scientific and medical professions in order to secure their help as well as the results of their medical, clinical and scientific wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... prior approval of Ciba Basle, the pertaining patent rights and trade marks will be licensed to Ciba Pharma according to the terms of articles I and III. In this case Ciba Basle undertakes to deliver to Ciba Pharma all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of the said products, which have been discovered and developed in Ciba Basle's laboratories and will forward to Ciba Pharma as far as possible all scientific and bibliographic information, pamphlets or drafts, which might be useful to introduce licensed preparations and to promote their sale in India. All physical material shall be invoiced by Ciba Basle to Ciba Pharma at cost price." Paragraph 2 of article I prohibits Ciba Pharma from divulging to third parties confidential information received by Ciba Pharma from Ciba Basle and requires Ciba Pharma to keep all data connected with the manufacturing processes under lock and key. Paragraph 1 of article 2, which relates to the licence under Ciba Basle's patent and trade mark rights, states: "Ciba Basle is registered or has applied for the registration as the case may be as the proprieto ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase shows that under the certificate dated June 6, 1950, given by the Swiss company, it is found that out of the total expenditure of 8,409,364 Swiss francs incurred in 1948 on research, recoveries from several entities like the Ciba Pharma and others came only to 4,613,701 Swiss francs. It is not necessary for us to give the figures of all the 5 years of the contributions made by Ciba Pharma to Ciba Basle. Barring the difference in the figures and the amount paid, the facts are identical. We may, therefore, take the assessment figures of 1949-50. Now, in the assessment year 1949-50 Ciba Pharma claimed deduction under section 10 in respect of the payment of 10% of its net sale price made by it to Ciba Basle under paragraph 1 of article III of the agreement. 2% out of the said amount had been allowed by the Income-tax Officer being a payment towards royalties on trade marks used by Ciba Pharma. But the remaining 8% which amounted to ₹ 6,32,948 had been disallowed by the Income-tax Officer on the ground that the expenditure was incurred by the Swiss company for its own business and that the assessee was not a manufacturing company so as to be eligible to get the benefit of res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eal with this question first before we proceed to deal with the second question. The first aspect of the question, therefore, that arises is whether the said payment, which admittedly is made in pursuance of the agreement dated December 17, 1947, is an expenditure laid out and expended on scientific research relating to the business within the meaning of section 10(2)(xii) of the Indian Income-tax Act. It is the contention of Mr. Joshi, learned counsel for the revenue, that the payment is not an expenditure within the meaning of section 10(2)(xii) of the Act. It is his argument that on a true construction of the said agreement of December 17, 1947, it is not an expenditure laid out or expended by Ciba Pharma on scientific research. On the other hand, it is a contribution made towards the expenditure incurred by Ciba Basle. The organisation or the research carried on by Ciba Basle is maintained by Ciba Basle for its own purpose and for the purpose of extending its own business. The research, which is carried on by Ciba Basle is not dependent on whether the contribution is made by Ciba Pharma or not. There is also no obligation on Ciba Basle to carry on any research in a particular ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenditure incurred by Ciba Basle was not an amount laid out or expended on scientific research. We are unable to accept Mr. Kaka's contention that in the aforesaid observation on which reliance has been placed by Mr. Kaka, there is any finding of fact as such that the research carried on by Ciba Basle was a research carried on by itself and on behalf of Ciba Pharma. On the other hand, reading the judgment as a whole, it is clear that the said view taken by the Tribunal is on the construction of the agreement. The Tribunal does not say that they so hold on consideration of the evidence, but on the other hand, what is said by the Tribunal is "it appears to them" that the amount paid under article III of the agreement to be "in the nature of a share of expenses incurred by the foreign company" for conducting research for itself and also on behalf of the Indian company. After setting out the facts up to paragraph 4, the Tribunal has set out article III of the agreement. In paragraph 5 the reduction in the percentage contributions is referred to. Paragraph 6 refers to the calculation of 8 per cent. and in paragraphs 6A and 7 of the judgment the arguments advan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat certain deductions in respect of certain expenditure under sub-section (2) are allowed. It would necessarily follow that the allowable deduction is in respect of the expenditure incurred by the assessee on a research carried on by him in the conduct of his business. It is not in dispute that the Ciba Pharma itself had not carried on any activity in the field of natural or applied science for the extension of knowledge. It, therefore, cannot be said, and indeed it has not been said, that it is the Ciba Pharma who had carried on scientific research. Scientific research has been carried on by Ciba Basle. The payments made to Ciba Basle under article III of the agreement, therefore, cannot be said to be an expenditure incurred by Ciba Pharma on any activity in the field of natural or applied science carried on by itself. On the language used, it does not appear that to be an allowable deduction, the expenditure incurred must necessarily be an activity in the field of natural or applied science, for extension of knowledge carried on by the assessee himself. All that is required to be established is that the expenditure incurred by the assessee was laid out or expended on scientifi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h relating to the class of business carried on by the assessee. No doubt, the expenditure relating to which exemption has been claimed has been described in the agreement as "Technical and Research Contribution." But the description given by a party to the expenditure is not determinative of the issue. It is not in dispute that the scientific research is not carried on by the assessee itself, but by Ciba Basle. Of course, if on the construction of the agreement it emerges that the scientific research carried on by Ciba Basle was on its behalf or was at the instance of the assessee, the assessee would, none the less, be entitled to claim exemption under the said clause 10(2)(xii). We have already referred in detail to the preamble of the agreement, and when the preamble is read as a whole, there is no doubt that the research carried on by Ciba Basle is for the advancement of its own business, and not on behalf of the assessee or at the instance of the assessee. Paragraph 1 of the preamble discloses that Ciba Basle is engaged in the development, manufacture and sale of medical, pharmaceutical, biological and bacteriological preparations. These preparations have been refer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 and it is, therefore, that Ciba Pharma had agreed to pay to Ciba Basle 'a technical and research contribution'." This technical and research contribution has been divided under different heads in paragraph 1 of article III of the agreement. Paragraph 2 further provides that the technical and research contribution, which it had agreed to pay was by way of consideration: "(i) for the use of Indian patents and/or trade marks referring to the 'said products.' (ii) for the scientific and technical assistance." Concluding part of paragraph 2 provides that Ciba Pharma had also agreed to refund part of Ciba Basle's costs and expenses for the maintenance and development of the research work described in this preamble. Reading the preamble as a whole, it becomes patently clear that for the purpose of its own business, Ciba Basle has maintained laboratories and departments in which activity on a large scale is continuously going on. The costs incurred by Ciba Basl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic research. It is true that the contribution as described in respect of these items and referable to clauses (a) and (b) gives an impression that it is an amount laid out or expended by Ciba Pharma on scientific research. But then it is a well settled principle that in construing an agreement, it is to be read as a whole and when so read, in our opinion, for reasons which we have already stated, it appears to us that the scientific and research work done by Ciba Basle was on its own behalf and not on behalf of itself and somebody else, much less on behalf of Ciba Pharma or at its instance. Reason, which Ciba Pharma has given in paragraph 2 of the preamble for making the research contribution, is also not that Ciba Basle had agreed to carry on any scientific and research work at the instance of Ciba Pharma. On the contrary, what has been said in paragraph 2 is that Ciba Pharma had agreed to make these payments, apart from the reason that use of the trade marks and patents were given to it, but wished to acquire 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 p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sle commanded by reason of its long and extensive research work and scientific and practical experience. The payment is nothing but a payment for acquiring the technical "know-how". Mr. Kaka in the course of his arguments laid some stress on the words "at the request of Ciba Pharma" appearing in the first sentence of paragraph 1 of article I. The sentence reads: "Ciba Basle will communicate currently and/or at the request of Ciba Pharma all the results of its research work, in so far as they relate to the said products which are already manufactured or processed or sold by Ciba Pharma." Laying emphasis on the words "at the request of Ciba Pharma" Mr. Kaka argued that the obligation incurred by Ciba Basle was not only to communicate currently results of its research work but there was also an obligation to communicate to Ciba Pharma the result of its research work at the request of Ciba Pharma. This clause, according to Mr. Kaka, shows that the research work, which was carried on by Ciba Basle, was carried on at the instance and on behalf of Ciba Pharma. We find it difficult to accept this argument of Mr. Kaka. The sentence, when read as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtificate given by the foreign company has been accepted as such. That clearly states that no capital expenditure has been incurred by the foreign company. Nor has the appellant acquired any asset of enduring benefit." It is the argument of Mr. Joshi that whether the foreign company has incurred any capital expenditure or not is not relevant for the purpose of deciding whether the expenditure incurred by Ciba Pharma was of a capital nature or not. This part of the argument undoubtedly is well made. But the decision of the Tribunal is not based solely on that observation. The other reason given by the Tribunal is that in its opinion, by incurring this expenditure, Ciba Pharma had not acquired any asset of enduring benefit and the expenditure incurred by Ciba Pharma, therefore, is not of a capital nature. We have recently in I.T. Ref. No. 63 of 1961 Reported infra, p. 455 decided on 11th January, 1965, elaborately discussed what is a capital expenditure and what is a revenue expenditure. Therein, we have also referred to three decisions of their Lordships of the Supreme Court. The first decision of their Lordships is in Assam Bengal Cement Co. Ltd. v. Commissioner of Income-ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the fixed capital of the business or part of its circulating capital. If it was part of the fixed capital of the business it would be of the nature of capital expenditure and if it was part of its circulating capital, it would be of the nature of revenue expenditure. These tests are thus mutually exclusive and have to be applied to the facts of each particular case in the manner above indicated...One has, therefore, got to apply these criteria one after the other from the business point of view and come to the conclusion whether on a fair appreciation of the whole situation the expenditure incurred in a particular case is of the nature of capital expenditure or revenue expenditure in which latter event only it would be deductible allowance under section 10(2)(xv) of the Indian Income-tax Act." These tests have again been referred to as principles formulated in determining the question as to whether a given item of expenditure is a capital or a revenue expenditure in State of Madras v. G.J. Coelho [1964] 53 I.T.R. 186 (S.C.) and in a still more recent decision of their Lordships of the Supreme Court given in the case of Bombay Steam Navigation Co. Ltd. v. Commissioner of Inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enduring nature. In other words, whether the expenditure incurred for acquiring the technical know-how of the business, Ciba Pharma had acquired an asset of an enduring benefit. Having regard to paragraph 2 of article I and paragraph 5 of article V of the agreement, there can hardly be any doubt that Ciba Pharma had acquired no asset in obtaining the know-how of the business. No right in the results of the scientific research has been acquired by Ciba Pharma. These two paragraphs make it clear that the confidential information received by Ciba Pharma from Ciba Basle about the conduct of the business and all data connected with the manufacturing processes was not to be divulged by Ciba Pharma during the currency of the agreement. On the termination of the agreement, Ciba Pharma is required to return to Ciba Basle or to such other persons Ciba Basle may appoint, all copies of information, scientific data 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this agreement, as and when the occasion would arise, viz., "whenever manufacture or processing of a preparation is taken up by Ciba Pharma with the prior approval of Ciba Basle." It is only when such an occasion would arise Ciba Basle had promised that it would license the pertaining patent rights and trade marks to Ciba Pharma according to the terms of articles II and III. Ciba Basle further promised that it would in that event deliver to Ciba Pharma all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of those products, which have been discovered and developed in Ciba Basle's laboratories. The further promise is that in that event Ciba Basle would forward to Ciba Pharma as far as possible all scientific and bibliographic information, pamphlets or drafts, which might be useful to introduce licensed preparations and to promote their sale in India. These being the terms of the latter part of paragraph 1 of article I, in our opinion, there was no present obligation incurred thereunder by Ciba Basle. On the other hand, as we have already said, the latter part contains only an agreement to enter into anot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enditure related to Ciba Pharma's business. The expenditure thus would be an expenditure wholly and exclusively laid out or expended for the purpose of business. In our judgment, therefore, the expenditure would be an allowable deduction under section 10(2)(xv) of the Act. The view taken by us finds support in a decision of the King's Bench Division in British Sugar Manufacturers Ltd. v. Harris [1937] 21 Tax Cas. 528; [1937] 7 I.T.R. 101. Facts in that case were that the assessee-company, which was the appellant, had agreed to pay to two other companies a certain percentage of its net annual profits "in consideration of their giving to the company (assessee-company) the full benefit of their technical and financial knowledge and experience". The question to be considered was whether the payment made under this agreement by the assessee-company to the other companies was an allowable deduction. The contention of the assessee- company was that payment under the agreement was a payment for the services rendered; that it was a sum expended in earning its profits and not expended for capital purposes; that it was not a distribution of its profits and, therefore, the ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... skill can indeed ripen into a form of property in the fields of commerce and industry, as in copyright, trade-marks and designs and patents, and where such property is parted with for money what is received can be, but will not necessarily be, a receipt on capital account. But imparting 'know-how' for reward is not like this, any more than a teacher sells his knowledge or skill to his pupil." The position here is more or less the same. As a result of its extensive and valuable research Ciba Basle is in possession of very valuable technical knowledge and practical experience. They had also obtained certain patent rights in respect of certain products and have also registered their trade marks. Under the agreement Ciba Basle have parted with their rights and trade marks. All that has been agreed to under the agreement is to grant the user of the patents and trade marks to Ciba Pharma and to give Ciba Pharma the technical "know-how" and assistance. In the transaction, there is no transfer of any property or asset nor any capital element is therein involved. The transaction, therefore, is not "capital in nature". And this brings us to the second ques ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ement, May & Baker had obtained patents in India, bearing Nos. 26513 and 26350. These were licensed to Ciba Basle under the said agreement of November 15, 1944. In clause 5 of the agreement it was stipulated that each party shall take all necessary steps to defend patents granted to or applied for by it in respect of sulphathiazole products against infringement, but before any infringement or other similar proceedings are taken or defended, each company had to consult the other and if a litigation was launched or defended by the consent of the parties in respect of the infringement of the patents, then the expenditure incurred was to be shared equally by Ciba Basle and May & Baker. If, on the other hand, any of the companies launched a litigation or defended a suit without the consent of the other, that company had to bear its expenses exclusively. Alleging that Messrs. Boots Pure Drug Co. (India) Ltd. had infringed the aforesaid Indian patents, Messrs. May & Baker instituted in the Calcutta High Court a suit against Boots Pure Drug Co. Ltd. The suit was instituted after due consultation with Ciba Basle as stipulated in the aforesaid clause 5 of the agreement of November 15, 1944. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iness of Ciba (India) Ltd., who were responsible for this payment. We do not agree with these reasons given by the Income-tax Officer. Messrs. May & Baker instituted the claim in the Calcutta High Court and the fact that as per the agreement a half share has to be borne by Ciba Ltd., Basle, is not in dispute. The appellant has taken over the business relating to the pharmaceutical section and this is part of the liability that arose to the appellant in the course of the carrying on of its business. There is no capital element in the expenditure. We consider that this claim should succeed under the provisions of section 10(2)(xv)." At the instance of the department, the Tribunal has referred to us the following question: "Whether, on the facts and in the circumstances of the case, the payment made in accordance with the terms of the agreements dated November 15, 1944, and June 18, 1948, for meeting the expenses of Suit No. 890 of 1946 is an allowable expense under section 10(2)(xv) of the Income-tax Act?" Mr. Joshi contends that the Tribunal was in error in holding that the expenditure was an allowable deduction under section 10(2)(xv). It is the argument of Mr. J ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any time become the liability of Ciba (India) Ltd. prior to the transfer of the business in pharmaceuticals by Ciba (India) Ltd. to Ciba Pharma, in our opinion, is well founded. Clause 3 of the agreement of June 18, 1948, between Ciba (India) Ltd. and Ciba Pharma is in the following terms : " As the residue of the consideration for the said sale the purchaser shall undertake to pay, satisfy, discharge, perform and fulfil all the debts, liabilities, contracts, engagements and obligations of the vendor whatsoever in relation to the said business as from and after the said 1st day of January, 1948, and shall indemnify the vendor against all actions, proceedings claims and demands in respect thereof. " Under this clause the liability, which has been undertaken by Ciba Pharma, was to satisfy, discharge and pay all debts and liabilities of Ciba (India) Ltd. and of none else. We have already said that there is no finding that the said liability has become the liability of Ciba (India) Ltd. The clause, therefore, cannot be of any assistance to Ciba Pharma. Clause (5) of article III of the agreement of December 17, 1948, is in the following terms : "Ciba Basle will pay a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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