TMI Blog1976 (2) TMI 21X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the case, the Tribunal was correct in law in holding that the one-fifth of the expenditure incurred by the assessee for purchase of drawings, designs and patterns from the foreign concern under the agreements for manufacture of certain machinery was allowable as revenue expenditure ? " In this reference, at the instance of the assessee, the following second question has been referred to us by the Appellate Tribunal : " Whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing the expenditure of Rs. 2,125 incurred by way of presents to the sales manager and other officials of its collaborators by holding that the same did not satisfy the test laid down for allowance of the claim under section 37 of the Income-tax Act, 1961 ? " In Income-tax Reference No. 181 of 1974, at the instance of the revenue, question No. 1, which is on the same lines as question No. 1 in Income-tax Reference No. 125 of 1974, has been referred to us : " Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the one-fifth of the expenditure incurred by the assessee in respect of drawings, designs and pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... between the contracting parties that the balance period of the agreement of August 14, 1957, should be transferred to the new company, the assessee-company before us. As a result of this agreement, all the three agreements stood transferred in the name of the assessee-company. Under the three agreements, the main clause in respect of each of the products covered by the agreement was the same except that there was some variation regarding the export of the product covered by the agreement relating to rotary blowers and water-ring pumps. Clause 13 of that particular agreement dated 7th March, 1961, was slightly different regarding the export of these particular articles. But barring this distinction, the rest of the provisions of the three agreements are on the same lines. At the time when the assessment was under consideration before the Income-tax Officer for the assessment year 1965-66, the assessee contended that it was the usual practice of this assessee in their accountancy system that the expenditure incurred by it for paying the price for the supply of workshop drawings, manufacturing instructions, etc., as stated in accordance with clause (18) of each of these three agree ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , therefore, held that there was no need to disturb the basis adopted in the past and, consequently, one-fifth of the expenditure as claimed by the assessee should be allowed as a revenue expenditure in the year under reference. It is under these circumstances that the Tribunal declined to go into the alternative contention with regard to the allowance of the claim in full as a revenue deduction or claim for depreciation. It was on these same facts that in each of these two references, the first question has been referred to us at the instance of the revenue. So far as question No. 2 in Income-tax Reference No. 125 of 1974 is concerned, it arises under the following circumstances : An amount of Rs. 2,125 was spent by the assessee-company in the previous year relevant to the assessment year 1965-66 for presentation articles given to the sales manager as well as other officials of S.L.M. of the foreign company with which the assessee-company had entered into collaboration. So far as this item was concerned, the Income-tax Officer and the Appellate Assistant Commissioner held that this expenditure was not allowable as it could not be said to be incurred wholly and exclusively fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... running of the assessee's business. The assessee also did not acquire any asset for the business. It appeared to the Tribunal that the assessee made an attempt to explore if it could get into a new line, but after spending this much amount, came to the conclusion that the report was not of much use, and, under these circumstances, the Tribunal did not see any reason to interfere with the order of the Appellate Assistant Commissioner on this point. Thereafter, at the instance of the assessee, the second question in Income-tax Reference No. 181 of 1974 came to be referred to us by the Tribunal. Before coming to the discussion of the common question which arises for our discussion in each of these cases, we will dispose of question No. 2 referred to in each of these two references, because they are comparatively short and can be disposed of briefly. As regards the presents to the sales manager and other officials of the S.L.M. the question is whether this expenditure of Rs. 2,125 is covered by the second question in income-tax references. It must be observed in this connection that, as will be later on seen in the course of this judgment, the S.L.M. and the assessee-company had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... connection with the report of new foundry for S.L.M. Maneklal Industries Ltd. as to its lay-out, size and lay-out of necessary buildings and crane capacity, and working method of every department of foundry, etc. " The Appellate Assistant Commissioner, in para. 17 of his order, has observed that the foundry was actually erected in 1969. The production of castings of iron was started in the month of March, 1969. But the foundry was not erected as per the opinion expressed by the Zurich company or as per the diagrams, statistics, etc., furnished by Hayeka Engineering A.G. Zurich. This particular foreign company, Hayeka Engineering, had prepared a report containing their expert opinion running into 29 pages. That company had also furnished lots of statistics giving various details in 32 pages with maps, diagrams, models of the foundations, engines, buildings, etc., etc. The assessee-company had not made any use of the opinion expressed and the maps and diagrams, etc., furnished by the foreign company. The assessee-company had not erected the foundry with the collaboration of the Zurich company, and it was stated before the Appellate Assistant Commissioner that the plans furnished b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the conclusion that the plans, specifications, etc., set out by the expert in his opinion and the documents which accompanied the opinion were not useful for the foundry which the assessee-company did actually establish. But, at the same time, it cannot be gain-said that the amount paid for the expert opinion was with the object of acquiring an asset of a capital nature. The question of preliminary expenditure incurred in connection with a capital asset was considered by this High Court in Ambica Mills Ltd. v. Commissioner of Income-tax [1964] 54 ITR 167 (Guj). In that case, the assessee-company which carried on textile manufacture authorised the tour by the director and superintendent of the company's mills for two purposes, viz., (i) to make an on-the-spot study of the latest developments in the manufacture, designing and processing of cloth in the United Kingdom and other countries ; and (ii) to make a report on their return on the work done by them as to the latest developments in the manufacturing, designing and processing of textiles seen by the representatives, and recommend as to whether the latest developments should be adopted and for that purpose, to purchase new ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o consider the deductibility of this expenditure of Rs. 10,965 is from the point of view of considering whether the expenditure was of a capital nature or not. Since it must be held that this preliminary expenditure of Rs. 10,965 was incurred for the purpose of bringing into existence a capital asset, the preliminary expenditure itself must be held to be an expenditure of a capital nature within the meaning of section 37 of the Act of 1961 and hence, deduction cannot be allowed under section 37 of the Act of 1961. In view of this conclusion, question No. 2 regarding disallowance of the expenditure of Rs. 10,965 paid to Hayeka Engineering Co. must be answered in favour of the revenue and against the assessee. However, we must make it clear that the process of reasoning which has appealed to us is different from the process of reasoning which appealed to the Tribunal. Coming now to question No. 1 in each of these two income-tax references, in order to answer the question referred to us, it is necessary to refer in detail to the different clauses of each of these three agreements. As pointed out above, the three agreements were as follows : (1) rotary compressors, (2) rotary blo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, but in the event of such negotiations failing or Maneklal not being interested, S.L.M. were to be free to grant such manufacturing rights to other parties in India. By clause (2) of the agreement, S.L.M. agreed to prepare and put at the disposal of Maneklal one completed set of copiable workshop drawings in millimeter scale and clearance tables, manufacturing instructions, part lists, specification of materials to be used, instructions for assembling, testing and operation, all in English or with regard to manufacturing drawings with English translation annexed and also to advise Maneklal with regard to machine tools and other workshop equipments required for an economic manufacture and reliable testing of the compressors covered by the agreement, it being understood that S.L.M. were to give all such information, instructions and advice according to their best knowledge and experience, but without thereby assuming any responsibility for possible errors or omissions. Under clause (3), at the request of Maneklal, S.L.M. were to supply at lowest current prices one complete set of proto-type manufacturing devices, jigs, special tools, control gauges, and callipers required for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arts and accessories thereto shall be communicated to Maneklal who will have the right to make use thereof in their own manufacture ; likewise, S.L.M. shall have the right of free use of any improvements Maneklal may, according to their own experience, propose to be incorporated in the design of the compressors." " (9) The drawings and all other technical information supplied by S.L.M. shall be treated strictly confidential and shall be used only for the scope and during the continuance of the present licence agreement. They shall not be handed-over, made accessible for inspection or otherwise during the period of this agreement or after its termination. " Under clause (10) of the agreement, Maneklal got a right to sell single-stage compressors manufactured under the licence agreement for use as vacuum pumps, providing the necessary adjustment and alterations in layout as per advice to be obtained from S.L.M. from time to time. Under clause (11), Maneklal were to develop the manufacture of compressors according to the programme proposed to the Government and sanctioned by the manufacturing licence issued by the Government of India. Clause (12) is also material for the purpo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provided in this clause (17). This payment was to be subject to the Indian Income-tax Act. Clause (18) provides that for the supply of copiable workshop drawings, manufacturing instructions, etc., as per clause (2) of the agreement, S.L.M. were to charge Maneklal the selling prices as set out in clause (18). An advance of Swiss francs 37,500 representing the cost of manufacturing documents for three single and two stage compressors, small and medium types, were to be paid to S.L.M. within 30 days of the agreement becoming effective, and the principal question that we have to consider is the payment made by the assessee-company to S.L.M. in Switzerland under clause (18) of the agreement. It is common ground between the parties that the royalty payment made by the assessee-company to S.L.M. under clause (17) of the agreement has been allowed as a deductible expenditure. Amounts exceeding the advance payments were to be paid on commencement of the work of preparing workshop drawings, manufacturing instructions, etc., by S.L.M. All payments due to S.L.M. under clause (18) were to be made in Swiss francs. Import duty, income-tax and other taxes and fees, if any, payable in India, wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in licence itself and in the course of working out the terms and conditions of the licence to manufacture the rotary air-compressors. In Commissioner of Income-tax v. Elecon Engineering Co. Ltd. [1974] 96 ITR 672 (Guj) we had an occasion to consider the exact nature of drawings and patterns acquired from a foreign company and also regarding the nature of the know-how forming the basis of business. The question was, whether these drawings and patterns and know-how forming the basis of business of the assessee could be considered to be "plant" within the meaning of the word "plant" in a compendious phrase "buildings, machinery, plant or furniture"occurring in section 32 of the Income-tax Act, 1961. Section 32 provides for depreciation of buildings, machinery, plant or furniture owned by the assessee and used for the purposes of business or profession and deductions for depreciation have to be allowed in accordance with the other provisions of section 32 subject to the provisions of section 34. We examined the entire legal position and held that know-how is a peculiar kind of asset. It is the accumulated fund of knowledge acquired by years of observation, research, experimentation a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of Jeffrey v. Rolls-Royce Ltd. [1965] 56 ITR 580 (HL) and Musker v. English Electric Co. Ltd. [1964] 41 TC 556 (HL) were considered and the nature of know-how was considered. It was pointed out that the nature of receipts from the know-how depends essentially upon the transaction out of which they arise and the context in which they are received. Where know-how is imparted under certain circumstances, it may be a revenue expenditure as was held in Rolls-Royce's case [1965] 56 ITR 580 (HL) and in Musker v. English Electric Co. Ltd. [1964] 41 TC 556 (HL). However, we have pointed out in Elecon Engineering Company's case [1974] 96 ITR 672 (Guj) that the question that is to be considered in a case where the assessee before the court is a recipient of the know-how is, whether in the case of the assessee who is a recipient of the know-how the know-how itself and the physical embodiments of these know-how in the shape of plans, designs, workshop drawings, etc., are a capital asset or not in the sense of being "plant" and it was held by us that the know-how and physical embodiments of the know-how were clearly included within the meaning of the word "plant" and, therefore, was a capital ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... posits to the assessee on October 4, 1954, on terms and conditions prescribed under the Jodhpur Division Vidhyan Limestone Mining Leases Rules, 1954. For the period July, 1952, up to the date the new lease was to be given effect to, a fixed royalty of Rs. 96,000 per annum had to be paid on the basis of dead rent. Under those Mining Rules, a mining lease could be granted only to a holder of a certificate of approval from the mining department, and the lease was to be for a period of five years with an option for renewal for another period of five years. Dead rent was to be charged at Rs. 10 per acre while royalty was to be charged at 1 a. 6 p. per maund of lump lime and 1 a. per maund of limestone. Rule 19 of the rules laid down that the lessee shall not encroach upon cultivable land or bapi holdings within the leased area without obtaining the permission of the Director of Mines and payment of compensation to the holder of such land. The lessee could not carry away any other minerals which might be found in the area and he was further obliged to allow other lessees of those minerals to go on the land and win them. The assessee never executed the contemplated lease deed but continue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 32 of the Act. It is clear that depreciation allowance can only be claimed by an assessee in respect of property which he owns and in Elecon Engineering Co.'s case [1974] 96 ITR 672 (Guj) the question about the ownership of designs, etc., was never in dispute. Both the sides in Elecon Engineering Co.'s case [1974] 96 ITR 672 (Guj) proceeded upon the footing that by incurring that particular expenditure, the assessee in that case had acquired certain know-how and the question was whether depreciation allowance could be allowed in respect of that particular know-how which was taken to be a capital asset. The question, therefore, which this court had to decide in Elecon Engineering Co.'s case [1974] 96 ITR 672 (Guj) was whether the plans, designs, machinery, etc., became a capital asset or was a " plant " within the meaning of section 32 of the Income-tax Act. The question, however, which is in issue before us in this case and which was never in issue in Elecon Engineering Co.'s case [1974] 96 ITR 672 (Guj) is whether the assessee in the instant case acquired ownership of the workshop drawings, manufacturing instructions, etc., as contemplated by law and, therefore, whether p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e us, that in the instant case, in clause (18) of each of the three agreements reference is to the selling prices and the amount mentioned in clause (18) is to be paid by the assessee-company to S.L.M. for the supply of workshop drawings, manufacturing instructions, etc., mentioned in clause (2) of the agreement. It can, therefore, be said that there was an agreement to sell, if there were no other provisions in this connection in each of the three licensing agreements. Secondly, it can be said that consideration in terms of money was to be paid, but the main question that remains is whether the property in these workshop drawings, manufacturing instructions, etc., passed or was in contemplation of the parties to pass from S.L.M. to the assessee-company. Normally, when a person purchases any property and there is a completed sale, he gets full title over the property and he can deal with the purchased articles in such manner as he likes. It is true that at the time of sale, certain conditions may be imposed, which, under certain circumstances, can even be enforced against the purchaser. But the question that we ask ourselves is whether in the context in which these workshop drawing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ements, they have first to be approved by S.L.M. and S.L.M. itself will have a right to the free use of such improvements, in the designs, etc. Thus, even the improvements in the designs, etc., which improvements are suggested by experience, have to get the prior approval of S.L.M. and, secondly, S.L.M. gets a free right to use such improvements in the designs, etc. Clause (9) requires that the drawings and all other technical information supplied by S.L.M. have to be treated as strictly confidential and have to be used only for the scope and during the continuance of the licence. They are not to be handed over, made accessible for inspection or otherwise communicated to other parties, either during the period of continuance of the licence or after its termination. Therefore, so far as the assessee-company was concerned, apart from treating the drawings and all other technical information as strictly confidential, it was incumbent upon the assessee-company to use the drawings and other technical information supplied by S.L.M. only for the scope of the licensing agreement concerned and it was to be used only during the continuance of the licensing agreement and after the termination ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing instructions, it is not possible for us to say that the property in these workshop drawings, manufacturing instructions, etc., for which the consideration is set out in clause (18) passed to the assessee-company. Since the property in the goods in question, viz., workshop drawings, manufacturing instructions and all technical information supplied by S.L.M. did not pass from S.L.M. to the assessee-company there can be no sale of these goods. The word "goods" in this context covers the workshop drawings, manufacturing instructions, technical information, know-how, etc., and there being no sale, it cannot be said that the assessee-company purchased these workshop drawings, manufacturing instructions, etc. The amount referred to in clause (18) was, therefore, not for the purpose of acquisition of ownership of any "plant" as explained in Elecon Engineering Co.'s case [1974] 96 ITR 672 (Guj). All that the assessee-company was doing was paying consideration, though separately designated in clause (18) and though separately set out from royalty, was in effect "payment", for the use of workshop drawings, manufacturing instructions, technical information and know-how. All these were bein ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that so far as the aspect of workshop drawings, manufacturing instructions, etc., is concerned, this case falls directly within the four corners of the principles laid down by the Supreme Court in Commissioner of Income-tax v. Ciba of India Ltd. [1968] 69 ITR 692 (SC). In Ciba's case [1968] 69 ITR 692 (SC) the assessee, originally named Ciba Pharma Ltd., was an Indian subsidiary of Ciba Ltd. of Basle, a Swiss company engaged in the development, manufacture and sale of medical and pharmaceutical preparations. The pharmaceutical section of the Swiss company in India was taken over by the assessee from January 1, 1948. Under an agreement dated December 17, 1949, the Swiss company undertook to deliver to the assessee all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of products discovered and developed in the Swiss company's laboratories and to forward to the assessee 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. It granted to the assessee full and sole right and licence under the patent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xpenditure laid out or expended on scientific research related to the business of the assessee under section 10(2)(xii). It was further held that the contribution was allowable as business expenditure under section 10(2)(xv). The assessee did not under the agreement become entitled exclusively, even for the period of the agreement, to the patents and trade marks of the Swiss company ; it had merely access to the technical knowledge and experience in the pharmaceutical field which the Swiss company commanded. The assessee was on that account a mere licensee for a limited period of the technical knowledge of the Swiss company with the right to use the patents and trade marks of that company. The assessee acquired under the agreement merely the right to draw, for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products, upon the technical knowledge of the Swiss company for a limited period ; by making that technical knowledge available the Swiss company did not part with any asset of its business, nor did the assessee acquire any asset or advantage of an enduring nature for the benefit of its business. Shah J. (as he then was), delivering the jud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee. It may also be further pointed out that, in the instant case, S.L.M. agreed to grant exclusive right to manufacture all these pieces of machinery and sale thereof to the assessee-company. There is no material before us to show whether prior to the entering into these licensing agreements, S.L.M. had any extensive or limited business in these commodities in India. But it is definite that by each of these three licensing agreements, S.L.M. was shutting itself out of and lending to the assessee-company the markets in the entire territory of the Union of India. In the absence of any material, it is not possible for us to say what exactly the S.L.M. were ceding to the assessee-company and, therefore, this aspect of the case makes no difference so far as the facts of Ciba's case [1968] 69 ITR 692 (SC) and the facts of the present case are concerned. The fact that the stipulated payment was recovered in Ciba's case [1968] 69 ITR 692 (SC) dependent upon the sale and under the terms of clause (18) of the agreements before us, it was paid in one lump sum, makes no difference whatsoever to the essential nature of the transaction of the parties, so far as the facts of the present case ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er of Income-tax [1973] 89 ITR 138 (All) the question before the Allahabad High Court was whether the amount of Rs. 50,000 spent by the assessee-company for developing distributorship of the assessee-company could be considered as a capital expenditure or revenue expenditure and it was held that it was not a capital expenditure and it could be allowed as a deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922. In Commissioner of Income-tax v. Hindusthan General Electrical Corporation Ltd. [1971] 81 ITR 243 (Cal), the question before the Calcutta High Court was regarding expenditure incurred by the assessee-company for paying to Simplex the cost (including freight, transport and insurance costs) of preparing and providing prints, designs, drawings, specifications, instructions and other information and of supplying patterns and tools upon invoices in respect thereof being submitted by Simplex to the assessee-company and the assessee-company had also to pay to Simplex a fee at the rate of pound 500 per annum towards salary of the members of the staff of Simplex appointed for the purpose. In that case, the Income-tax Officer allowed a deduction of Rs. 5,360 incurred b ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
