TMI Blog1975 (3) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... n company is proposing to undertake the manufacture of the product in India and has requested Cockill to make available to it Cockill's secret processes and technical knowledge in relation to the product which Cockill has agreed to do upon and subject to the terms of this agreement. NOW THIS AGREEMENT WITNESSETH AND IT IS HEREBY AGREED AND DECLARED AS FOLLOWS : 1. In this agreement where the context so permits the following expressions shall have the meanings set opposite thereto respectively, that is to say : (a) "the product" means leather belting and such other products as may from time to time be agreed on by Cockill and the Indian company. (b) "the territory" means the Republic of India as now constituted. (c) "technical data" means (subject as hereinafter provided) all processes, formulae, engineering drawings, tool designs, bills of material specifications and any other technical information in the possession of Cockill necessary to enable a competent manufacturer to undertake the manufacture on a commercial scale of the product to which the technical data relates PROVIDED that any such supplied to Cockill by a third party under licence or under a pledge of se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r as any such new developments are applicable to the product. 6. (a) The Indian company shall use upon or in connection with the product such trade marks as Cockill may from time to time designate by notice in writing addressed to the Indian company provided that nothing herein contained shall authorise the Indian company to use any trade marks owned by Cockill except as a registered user thereof in conformity with laws of the territory. (b) Cockill shall grant or procure the grant to the Indian company and the Indian company shall enter into such registered user agreements as may be necessary for the purpose aforesaid and each party shall do all things necessary to procure the registration of any such registered user agreement. 7. The Indian company may not except with the prior written consent of Cockill assign, mortgage, charge or otherwise alienate its rights under this agreement and may not grant any sub-licence or sub-rights hereunder. 8. The Indian company shall use and maintain and procure its officers and employees to use and maintain the utmost secrecy in connection with any technical data supplied by Cockill to the Indian company hereunder. 9. The Indian c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Revenue preferred appeals to the Tribunal. The Tribunal on an interpretation of the terms of the agreement held that till the date of the agreement the assessee was not manufacturing leather belts or any other leather products and it was for the first time entering into a new venture to manufacture those products with foreign collaboration and the foreign company had undertaken to supply the secret process and technical data required for the production. The Tribunal further held that the technical information or know-how supplied by the foreign collaborators to the assessee-company was a capital asset and that the payments made for the purchase of that was a capital expenditure. In any case, the assessee-company had acquired an asset or benefit of an enduring nature and, therefore, the amount spent or laid out for acquiring such enduring benefit would be a capital expenditure. In coming to this conclusion the Tribunal relied on the fact that there was no provision in the agreement that the technical data obtained by the assessee can be used by it for the duration of the agreement and there was also no provision for returning the drafts of formulae, engineering drawings, tool desi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t to be considered. They are--Evans Medical Supplies Ltd. v. Moriarty, Jeffrey v. Rolls-Royce Ltd. and Musker v. English Electric Co. Ltd. In Evans Medical Supplies case the facts as summarised in the headnote were as follows : "The appellant-company, which manufactured pharmaceutical products and had a world-wide trade, carried on business in Burma through an agency. In 1953 the Burmese Government wished itself to establish an industry there for the production of pharmaceutical and other products, and the company secured a contract, dated 20th October, 1953, from the Burmese Government to assist in setting up this industry. The company undertook to disclose secret processes to the Burmese Government and to provide other information in consideration of the payment of a 'capital sum of pound 100,000'. The company also undertook to provide certain services and to manage the proposed factory in return for an annual fee, which was admitted to be subject to tax. No similar agreement had been entered into by the company with any other foreign Government or any other party." It was held that the sum of pound 100,000 received by the company represented consideration for the sale of a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the articles they sell or alternatively or in addition they can be imparted to others for reward. The nature of the consideration for imparting the know-how, whether capital or revenue, would depend on the circumstances of each cage and the nature of the contract. If the knowledge imparted is some secret of permanent value given by the owner while transferring or terminating the business the consideration received would amount to a sale of a fixed asset and the consideration also a capital receipt. The House of Lords also took the view that know-how is an intangible asset of sui generis. Lord Radcliffe, as he then was, as to the nature of know-how, said : "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 manufactu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The respondent-company, in the course of carrying on its trade of engineering manufacturers, acquired a fund of specialised information and technique in engineering processes. It had not been its practice to turn this information and technique to account by imparting it to others. In 1949, however, at the request of the Admiralty, the company entered into an agreement to design and develop a marine turbine and to license its manufacture by a limited number of compaines in the United Kingdom, Australia and Canada. Later, in 1950 and 1952, the company, at the request of the Ministry of Supply, entered into agreements with the Government of Australia and an American aircraft manufacturing corporation, respectively, under which it licensed them to manufacture the Canberra bomber which it had designed and developed. All three agreements provided, inter alia, for the imparting of 'manufacturing technique' to the licensees and in consideration of this the company received specified lump sum payments. " Justice Pennycuick held that the case was governed by the decision in Rolls-Royce case. As for the difference between Evans Medical Supplies case and Rolls-Royce case, the learned judge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lar area, and the said monies paid for the know-how, whether or not independently quantified, may properly rank as capital receipts. But the Rolls-Royce case provides a different context in which the imparting is no more than a service, of however special a kind, attendant upon an activity that arises out of the appellant's trading. Updating the references, we find two cases applying these principles. In Wolf Electric Tools Ltd. v. Wilson, the facts were these : The company which carried on business as mechanical and electrical engineers, manufactured electric power tools among others in which it had an extensive export trade. About 1950 its sole agency in India was taken over by Rallis Ltd., which bought from the company on a principal to principal basis. On a representation from the Indian company about the Indian Government's policy of encouraging the setting up of local factories for making tools and the possibility of losing the entire market in India, the company agreed with Rallis India to the formation of a new company in the name of Ralliwolf Private Ltd. for the manufacture of electric power tools. In consideration of the issue to the company by Ralliwolf of 3,625 ordi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore, it was a revenue receipt. All the above cases related to the nature of the receipt in the hands of the company which disclosed the know-how. but they do help us to understand the nature of know-how itself, and it is because of this we have dealt with these cases in extenso. It is seen from these judgments that it is difficult to give a comprehensive definition for the word "know-how", but it may be safely taken as comprehending within it the fund of knowledge or experience gained by a manufacturer during the long number of years in which they had been manufacturing on how to make each component accurately, quickly and efficiently, how to adapt standard machine tools for particular purposes, how to stretch or bend materials to particular shapes, how to assemble the components accurately, quickly and efficiently into a complete article, the formulae, the engineering drawings and specifications, mechanical details or processes and general knowledge that is associated with the production and development which is in the exclusive knowledge of the trader. Know-how is also referred to as a manufacturing technique. The disclosure of this know-how is generally made by handing o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to in India and had also granted a licence to use the trade marks in the territory of India. In consideration of this right to receive scientific and technical assistance, Ciba Pharma agreed to pay the following percentage of contributions of the net selling prices of all pharmaceutical products manufactured or processed and are sold by Ciba Pharma. (a) Contribution towards technical consultancy and technical service rendered and research work done ... 5% (b) Contribution towards cost of raw material used for experimental work ... 3% (c) Royalties on trade marks used by Ciba Pharma ... 2% ------ 10% ------- Ciba Pharma was prohibited from divulging or assigning the benefit of the agreement or sub-licensing of the patents and trade marks to third parties without the consent of the Swiss company any confidential information received under the agreement. The agreement further provided that it shall be in force for a period of five years from January 1, 1948, and that upon termination of the agreement for any cause Ciba Pharma shall cease to use the patents and trade marks and to return to the Swiss company all copies of information, scientific data, or material ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s under the agreement and shall not grant any sub-licence or sub-right thereunder. The assessee was also under an agreement to maintain utmost secrecy in connection with the technical data supplied. Though the agreement is stated to be in force for a period of ten years there was no prohibition of the use of the technical data by the assessee after the period of ten years nor is there any clause requiring the assessee to return the technical data as in Ciba's case implying that the benefit under the agreement is to be enjoyed only during the period of the agreement. Even the prohibition against assignment, mortgage or charge or otherwise alienating the rights under the agreement was not made to enure beyond the period of ten years provided under the agreement. Nor even the assessee was required to keep the knowledge secret after the period of ten years. Under these circumstances, we have no doubt that the assessee has acquired an asset or an advantage of enduring benefit to his trade. The decision in Commissioner of Income-tax v. Hindustan General Electrical Corporation Ltd. is to the effect that the facts in that case were very similar to the facts in Ciba's case and, therefore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set. Therefore, either way there can be no doubt that the expenditure incurred by the assessee for acquiring that know-how is a capital expenditure. In support of the finding that know-how is a capital asset, the learned judges also relied on the decision of the House of Lords in Rolls-Royce case. This decision is, therefore, directly in point and is in favour of the revenue. In Hylam Ltd. v. Commissioner of Income-tax the facts were these : Under one agreement the assessee-company who was carrying on the business of manufacture of laminated materials obtained an exclusive non-assignable licence to manufacture laminates in accordance with the process covered by the patents owned by an English company in India. The licence granted was to continue for an unexpired term of Indian Letters Patent and any extension or regrant thereof. As a consideration for the grant the assessee was to pay 5% royalty on the net selling price of all laminated products made and sold by it in accordance with the patented processes. When the total of the royalty payment reached pound 5,000, the assessee was no more liable to pay royalty. Under another agreement the English company agreed to furnish exclu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... but for the purpose of bringing into production new types of machines solely on the basis of the know-how supplied by the foreign company. In this connection, the learned judges also referred to Parisutha Nadar v. Commissioner of Income-tax, where it was held that section 10(2)(xv) indicates that the expenditure should relate to a business which is already in existence and not one that is to come into existence in future. But that was not the point on which the case was decided. Relying on Rolls-Royce case, they first held that know-how is a capital asset or an advantage of enduring nature. They referred to the decision in Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax and observed that if the know-how supplied by the foreign company 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. Therefore, the ratio of the judgment is that know-how is a capital asset and that, therefore, the expenditure was a capital expenditure. On facts, they also found that the knowledge acquired was an enduring benefit to the assessee and on that ground also the expenditure is capital. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal 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 drawn from the capital or the income of the concern, is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and 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. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital. Conservatively managed companies every day pay for capital assets out of revenue if they are fortunate enough to have the revenue available. It is, therefore, no sufficient test to say that an asset has been paid for out of revenue, because the consequence does not by any means necessarily follow that it is an asset of a revenue nature as distinct from a capital nature. Similarly, there is nothing to prevent a company or a trader who has acquired a capital asset from refraining from placing any value on that asset in his balance-sheet. I put to Mr. King an example which I think is worth repeating. If a trader buys up somebodyelse's business and pays pound 10,000 for the goodwill, that being the price on which the vendor insists, there is nothing in the world to prevent the purchaser paying the pound 10,000 out of revenue and debiting it to revenue account, and then writing down the goodwill in his own balance-sheet to nothing. The fact that he has written it down in his own balance-sheet does not mean that he has not got an asset. He has ; he has the goodwill, but for his own domestic purposes he chooses not to put a value upon it just in the same way as many companies, wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ings run by the Travancore company. The consideration for the sale was a fixed cash consideration, agreed to be paid for the sale. In addition to the fixed cash consideration the agreement provided a payment of 20% of the net profits earned by the assessee in every year subject to a maximum of Rs. 40,000 per annum. The question for consideration was whether this 20% share in the net profits payable to the company was a capital expenditure or a revenue expenditure. On the ground that the amount was payable for an indefinite period and was related to annual profits and the "payment has no relation to the capital value of the asset" it was held that it was a revenue expenditure. If we take the ratio of the judgment it was more on the ground that the payment has no relation to the capital value of the asset that the decision was rendered. We, therefore, think that these two decisions in no way help the assessee. We may also now notice a note of caution made by Lord Reid in Regent Oil Co. Ltd. v. Strick, which reads as follows : "Whether a particular outlay by a trader can be set against income or must be regarded as a capital outlay has proved to be a difficult question. It may b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process." It may be seen from the foregoing discussions that it is the aim and object of the expenditure that would determine the character of the sum whether it is a capital or revenue expenditure and neither the source nor the manner of payment may be of any consequence. The fact, therefore, that the agreement did not fix any lump sum consideration but referred to a periodical payment linked to the production or sale of the articles does not in any way take it out of the category of a capital expenditure. The foregoing discussions would show that if the facts and circumstances of the case and the nature of the contract are such as to warrant a finding that there was a sale of the know-how it could safely be inferred that even in the transferee's hand it is capital asset unless the same is considered as a trading asset of the transferee. If, on the other hand, it is considered to be an exploitation of its know-how by a trader without any diminution or destruction in the value to him there may not be a sale but still the knowledge acquire ..... X X X X Extracts X X X X X X X X Extracts X X X X
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