Commissioner of Income Tax vs Carburettors Ltd.

At the instance of the Department, the Tribunal referred the following question of law said to arise out of the order of the Tribunal for the

assessment year 1976-77 for our opinion u/s 256(1) of the Income Tax Act, 1961 :

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 56,567 paid to Zenith

Carburettors Limited for obtaining the drawings and the sum of Rs. 15,000 being travelling expenses for procuring the said drawing should be

allowed as a revenue expenditure and the Income Tax Officer was not correct in treating as capital expenditure ?

The assessee is a company which manufactures carburettors. While completing the assessment for the assessment year 1976-77, the Income

Tax Officer made an addition of Rs. 71,657 consisting of two items as relating to capital expenditure. The first item is with regard to the technical

charges of Rs. 56,657 paid to Zenith Carburettors Limited, U. K., for obtaining drawings for manufacturing carburettors required by the Defence

Ministry of the Government of India. The second item is with reference to a sum of Rs. 15,000 being the travelling expenses for procuring the

drawings. The assessee claimed these two items of expenditure as revenue expenditure in this assessment year. But, the Income Tax Officer

disallowed the same.

On appeal, the Commissioner of Income Tax (Appeals) pointed out that the assessee had acquired the drawings from the foreign collaborator

for the manufacturing of a special type of automobile component on the specific orders of the Defence Department. According to the

Commissioner of Income Tax (Appeals), as there was no possibility of such orders being repeated in future and as in the modern days of day-to-

day technological improvements, the designs that are in use at a particular time may not be of use after some years. Therefore, according to the

Commissioner of Income Tax (Appeals), the acquisition of the information in the form of drawings would not be of a permanent value to the

assessee so as to treat such expenditure as capital expenditure. Accordingly, the Commissioner of Income Tax deleted the addition of Rs. 71,657.

Aggrieved, the Department field the second appeal before the Tribunal. The Tribunal, on considering the facts arising in this case, confirmed the

order passed by the Commissioner of Income Tax (Appeals).

Learned standings counsel appearing for the Department submitted that the drawings were purchased by the assessee by an outright purchase.

The drawings were not purchased for a particular time or with a condition to return it back. The aim and object of purchasing the drawings is for

the benefit of enduring nature. It is not a licence to manufacture carburettors or the right to use the drawings that was purchased by the assessee.

There was no obligation on the part of the assessee to return the drawings after exploiting the drawings. It was, therefore, pleaded that the Tribunal

was not correct in holding that the expenditure incurred for the purpose of the purchase of the drawings and the travelling expenditure incurred for

procuring the drawings are revenue in nature. Learned standing counsel further submitted that whether the particular expenditure is revenue in

nature or capital in nature depends upon the facts of each case. According to standing counsel, in the present case, the facts would warrant to

show that the expenditure incurred for purchase of the drawings and the travelling expenditure incurred for procuring the drawings are capital in

nature. Therefore, according to learned standing counsel, the Tribunal was not correct in holding that the abovesaid expenditure of Rs. 71,657 is

revenue expenditure. In order to support his contention, learned counsel relied upon the decisions reported in the cases of Fenner Woodroffe and

Co. Ltd. Vs. Commissioner of Income Tax, ; Additional Commissioner of Income Tax and Another Vs. Southern Structurals Ltd., ; CIT v.

Southern Switchgear Ltd. [1984] 148 ITR 272 ; Kirloskar Oil Engines Ltd. Vs. Commissioner of Income Tax, and Scientific Engineering House

(P) Ltd. Vs. Commissioner of Income Tax, Andhra Pradesh, .

On the other hand, learned counsel appearing for the assessee submitted that what was purchased by the assessee is only a drawing in order to

improve the manufacture of carburettors. It is not a secret formula consisting of technical know-how, supply of technical personnel and for getting

training in foreign countries with a collaboration agreement, etc., to meet the exigencies of the business, the assessee purchased the drawings. It is a

one time contract for supply of a special variety of carburettors to the Defence Department. The assessee was compelled to purchase the

drawings. Thus, in order to meet the one time order given by the Government of India, the assessee required the drawings which were purchased

outright. The fact that the documents were purchased outright would not in any way conclude that the expenditure incurred for purchasing the

drawings is capital in nature. Learned counsel further pointed out that in order to understand whether a particular expenditure is revenue or capital,

the aim and object of purchase should be ascertained. Therefore, according to learned counsel for the assessee, the facts on record would reveal

that the expenditure incurred for purchasing the drawings outright would go to show that the expenditure was incurred for the purpose of meeting

the requirement of the assessee so as to satisfy the one time purchaser. Learned counsel appearing for the assessee submitted that the decisions

cited by learned standing counsel would not be applicable to the facts arising in the present case. Learned counsel for the assessee heavily relied

upon the decision of the Supreme Court in the case of Alembic Chemical Works Co. Ltd. v. CIT : [1989]177ITR377(SC) .

We have heard the rival submissions. The fact remains that the assessee is a company which manufactures carburettors. The assessee received

an order from the Defence Department for supply of certain special types of carburettors. In order to fulfil this contract, the assessee purchased

drawings from Zenith Carburettors Limited, U.K. The point for consideration is whether the expenditure incurred by the assessee for the purpose

of purchasing the drawings outright and the expenditure incurred by way of travelling expenditure for procuring the said drawings would amount to

capital in nature as contended by learned standing counsel appearing for the Department. It is significant to note that a particular expenditure is

revenue or capital depends upon various facts arising a particular case. It does not depend upon any one of the decision enumerated for the

purpose of ascertaining the nature of the expenditure. The cumulative effect of all the decisions enumerated for this purpose has got to be applied

before deciding whether a particular expenditure is capital in nature or revenue in nature.

A similar question came up for consideration before the Supreme Court in the case of Scientific Engineering House (P) Ltd. Vs. Commissioner

of Income Tax, Andhra Pradesh, . According to the facts arising in that case, under clause 6(a) of an agreement, the assessee was to make a lump

sum payment of Rs. 80,000 for giving the documentation service. There were also provisions in the agreement enjoining the foreign collaborator to

render training and imparting of knowledge of the know-how techniques of manufacturing these instruments. The agreement was to remain in force

for five years. Pursuant to the agreement, the assessee mad full payment of Rs. 1,60,000 which includes Rs. 80,000 debiting the amount in its

account book under the head ""Library"", and the foreign collaborator rendered ""documentation service"" by supplying complete sets of all the

documents including designs, drawings, charts, plans and other literature in accordance with clause 3. According to the assessee, the expenditure

incurred for the outright purchase of documentation would be revenue in nature. While deciding this question, the Supreme Court held under :

(ii) that the various documents such as drawings, designs, charts, plan, processing and other literature included in documentation service, the

supply whereof was undertaken by the foreign collaborator, more or less formed the tools by using which the business of manufacturing the

instruments was to be done by the appellate and for acquiring such technical know-how through these documents, a lump sum payment was made.

This expenditure was incurred by ten appellate as and by way of purchase price of the drawings, designs, charts, plans, processing data and other

literature, etc., comprised in ''documentation service'' and was of a capital nature as a result whereof a capital asset of technical know-how in the

shape of drawings, designs, charts, plans, processing data and other literature was acquired by the appellate.

Thus, the facts arising in the abovesaid decision would go to show that apart from purchasing the documentation outright the assessee also

received training and imparting knowledge of technical know-how under a collaboration agreement.

Thus, under a package deal, the assessee obtained the benefit of documentation and imparting knowledge on technical know-how from the

foreign collaborator. This agreement was for a period of five years. It is under these circumstances, the Supreme Court held in the abovesaid case

that the assessee derived enduring benefit of entering into the abovesaid contract. Thus, this conclusion was arrived at by the Supreme Court on an

appraisal of the facts arising in that case.

Reliance was placed upon a decision in the case of Fenner Woodroffe and Co. Ltd. Vs. Commissioner of Income Tax, . According to the

facts rising in that case, the assessee-company entered into an agreement for a period of ten years with a foreign company incorporated in England

under which the foreign company agreed to make available the technical data relating to the manufacture of leather belting and also to permit the

use of such technical data for purpose of manufacture of the product. The agreement also provided that the foreign company would provide foreign

technicians to attend at the assessee-company''s factory in India and also provide training facilities at the foreign company''s works in England to

technicians of the assessee-company. The assessee-company had, under the agreement, to pay to the foreign company a remuneration at the rate

of one-half of one per cent. of the amount of the ex-factory invoice price of the Indian company in respect of the quantities of the product sold by

the assessee-company. In pursuance of the agreement, the assessee-company paid varying amounts during the accounting years relevant to the

assessment years 1962-63, 1963-64 and 1964-65 to the foreign company and claimed these payments as allowable deductions in its Income Tax

assessments for the respective years. While considering these aspects, the Madras High Court held :

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 and consequence. The fact that the agreement did not fix any lump sum consideration but

referred to a periodical payment limited to the production or sale of the articles will not take it out of the category of capital expenditure. As, in this

case, there was no limitation in the agreement as to its endurability and the assessee could use the technical data and knowledge acquired even

after the period of ten years and could deal with it as if it were their own asset, and amounts paid are not admissible as business expenditure under

the Income Tax Act.

Thus, according to the facts in the abovesaid decision also, the assessee incurred expenditure under a collaboration agreement as a package

deal the technical know-how and imparting the technical training from the foreigners in the foreign country. The expenditure was incurred which

was linked with the ex-factory invoice price of the Indian company. The aim and object of the assessee-company in incurring the abovesaid

expenditure was said to be for obtaining enduring benefit. It is on the basis of these facts this court held that the expenditure incurred by the

assessee-company is capital in nature.

In order to support the contention that the expenditure incurred by the assessee in the present case is capital in nature, reliance was placed on

a decision of this court rendered in the case of CIT v. Southern Switchgear Ltd. [1984] 148 ITR 272. According to the facts arising in this case,

the assessee-company entered into a collaboration agreement with a foreign company under the terms of which the foreign company agreed to

provide the assessee-company technical aid and information in the manufacture of switchgears and the right to sell such products. The foreign

company also agreed to keep the Indian company posted with the latest and modern developments in the field of manufacture of switchgears and

transformers and to train the necessary personnel at its U.K. factory. Under the terms of the agreement, the assessee-company agreed to pay to

the foreign company as consideration for the services rendered by it a lump sum payable in five equal instalments, the payment to be spread over a

period of time. For the assessment year 1966-67, the assessee claimed over a period of time. For the assessment year 1966-67, the assessee

claimed deduction of the payment made to the foreign company as a revenue expenditure. While considering these facts, this court held that a

perusal of the various clauses of the agreement clearly indicated that the technical knowledge that the assessee obtained through the agreement with

the foreign company secured to the assessee an enduring advantage and benefit in that the same was available to the assessee for its manufacturing

and industrial process even after the termination of the agreement. The foreign company had also agreed not to manufacture in India any of the

products in question or grant or make available to any other person any information relating to manufacture, licence or rights, for any of the

products in question in India thereby conferring on the assessee exclusive right of manufacture and the sale of the products. Thus on an appraisal of

the facts arising in this case this court held that 25 per cent. of the expenditure incurred by the assessee would be capital in nature since the

assessee derived enduring benefit by the acquisition of the right under the agreement.

Learned standing counsel appearing for the Department also relied upon the decision reported in the case of Additional Commissioner of

Income Tax and Another Vs. Southern Structurals Ltd., . On an appraisal of the facts arising in this case following the decision reported in Fenner

Woodroffe and Co. Ltd. Vs. Commissioner of Income Tax, , this court held ""that the assessee had acquired an enduring benefit under the

agreement and to that extent the amount paid was clearly capital in nature. Though under clause 2 of the agreement there was a certain amount of

limitation on the assessee not being in a position to assign the benefits it obtained under the agreement, that would not take the case out of the ratio

of the decision in Fenner Woodroffe and Co. Ltd. Vs. Commissioner of Income Tax, "". This conclusion was arrived at by his court in view of the

fact that under clause 4 of the agreement after the expiration of the agreement, the assessee would be free from any further obligation to pay any

amount to the foreign company while the assessee-company would have the continued use, free of charge, of all information made available by the

foreign company during the period of the validity of the agreement.

Lastly, learned standing counsel relied upon a decision of the Bombay High Court rendered in the case of Kirloskar Oil Engines Ltd. Vs.

Commissioner of Income Tax, . According to the facts arising in that case, the assessee entered into an agreement with a foreign company, for the

exclusive right of manufacture in India of particular type of diesel engine. The designs, drawings and specifications were to be given by the foreign

company to the assessee-company and under the agreement, the assessee-company was entitled to manufacture the abovesaid engines in India

and to sell the same in India. The drawings and other information received by the assessee-company, under the terms and conditions of the

agreement, because entirely the property of the assessee. Under the agreement, the assessee was required to pay a sum of DM 70,000 for

purchase of manufacturing rights and drawings, designs and specifications. In addition the assessee was also required to pay a sum of DM

2,20,000 for the purchase of export rights. The amount was payable in five-yearly instalments. During the accounting year relevant to the

assessment year under consideration, the assessee paid the first instalment which the assessee claimed as revenue expenditure. On considering

these facts, the Bombay High Court held that from a careful reading of the agreement, more particularly clause 4 thereof it was clear that what the

assessee had purchased was the manufacturing right, drawings, designs, specifications and export rights. For all other items except the export

rights, the payment was made in one instalment. The payment in respect of the export right was allowed to be made in five instalments spread over

a period of five years. The payment of instalments by the assessee was held to be capital in nature. While deciding whether an expenditure is on

account of revenue or capital has always to be decided by looking to the facts and circumstances of each case. While doing so, the authorities

should always examine the controversy from the point of view of a practical and prudent businessman rather than from the view point of a tax-

gatherer upon strict juristic classification of the legal right, if any, secured in process. Thus in the present decision also there was a package deal of

purchasing the documentation and right sell the goods in India. The benefit obtained by the assessee was allowed to be used as entirely as its own

property. Therefore, on the facts the Bombay High Court came to the conclusion that the expenditure incurred by the assessee was of enduring

nature and, therefore, it is capital expenditure.

On the other hand, learned counsel for the assessee relied upon a decision of the Supreme Court in Alembic Chemical Works Co. Ltd. v. CIT

: [1989]177ITR377(SC) in order to support his contention that on the facts available on record, the expenditure incurred by the assessee should

be determined as revenue in nature. According to the facts arising in the abovesaid decision, the assessee-company engaged in manufacturing of

antibiotics and pharmaceuticals, was granted a licence for the manufacture of penicillin. By the year 1963, it had already made an outlay of more

than Rs. 66 lakhs for setting up a plant for the production of penicillin. In the initial years, the assessee was able to achieve only moderate yields of

penicillin. With a view to increasing the yield, the assessee started negotiations in 1963, with Meiji, a reputed Japanese enterprise engaged in the

manufacture of antibiotics, which culminated in an agreement dated October 9, 1963, whereunder Meiji, in consideration of a ""once for all

payment"" of U.S. $ 50,000 agreed to supply to the assessee the ""sub-cultures of Meiji''s most suitable penicillin producing strains"", in a pilot plant,

the technical information, know-how and written description of Meiji''s process for fermentation of penicillin along with a flow-sheet of the process

in the pilot plant, and the design and specifications of the main equipment in such pilot plant, and to arrange for the training of the assessee''s

representatives in Meiji''s plant in Japan at the assessee''s expense and advise the assessee in large-scale manufacture of penicillin for a period of

two years. For the assessment year 1964-65, the assessee claimed deduction of the sum of Rs. 2,39,625 as a revenue expenditure. While

deciding the issue arising in this case, the Supreme Court held as under :

The idea of ''once for all'' payment and ''enduring benefit'' are not to be treated as something akin to statutory conditions; nor are the notions of

''capital'' or ''revenue'' a judicial fetish. What is capital expenditure and what is revenue are not eternal verities but must needs 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 emphasise the

element of a sufficient degree of durability appropriate to the context.

There is also no single definitive criterion which, by itself, is determination whether a particular outlay is capital or revenue. The ''once for all''

payment test is also inconclusive. What is relevant is the purpose of the outlay and its intended object and effect, considered in a common-sense

way having regard to the business realities. In a given case, the test of ''enduring benefit'' might break down.

Further, in the abovesaid the Supreme Court on an appraisal of the facts arising in that case also came to the following conclusions :

BY THE COURT : (i) ''It would be unrealistic to ignore the rapid advances in research in antibiotic medical microbiology and to attribute a degree

of endurability and permanence to the technical know-how at any particular stage in this fast changing area of any particular stage in this fast

changing area of medical science. The state of the art in some of these areas of high priority research is constantly updated so that the know-how

could not be said to bear the element of the requisite degree of durability and nonephemerality to share the requirements and qualifications of an

enduring capital asset. The rapid strides in science and technology in the field should make us a little slow and circumspect in too readily pigeon-

holding an outlay, such as this, as capital.''

(ii) ''In the infinite variety of situational diversities in which the concept of what is capital expenditure and what is revenue arises, it is well nigh

impossible to formulate any general rule, even in the generality of cases, sufficiently accurate and reasonably comprehensive, to draw any clear line

of demarcation. However, some broad and general tests have been suggested from time to time to ascertain on which side of the line the outlay in

any particular case might reasonably be held to fall. These tests are generally efficacious and serve as useful servants; but as masters they tend to

be overexacting.

(iii) ''The question in each case would necessarily be whether the tests relevant and significant in one set of circumstances are relevant and

significant in the case on hand also. Judicial metaphors are narrowly to be watched for, starting as devices to liberate though, they end often by

enslaving it.

According to the facts arising in the present case, the assessee purchased drawings from the foreign company for the purpose of manufacture

of a special type of carburettors in order to meet the order placed by the Defence Department. The order was only for a particular period. It is not

under a package deal the expenditure was incurred in the present case. Though it is outright purchase, the plan would be useful only up to the

period of fulfilling the order placed by the Defence Department. In order to meet the exigencies of the business, the assessee purchased the

drawings. On facts both the first appellate authority and the Tribunal came to the conclusion that the expenditure incurred by the assessee for the

purchase of the drawings would not be for the purpose of obtaining any enduring benefit. All the decisions on this aspect unanimously say that the

decision whether a particular type of expenditure is revenue in nature depends upon the facts arising in that particular case. Thus applying the ratio

of the decision rendered by the Supreme Court in the case of Alembic Chemical Works Co. Ltd. v. CIT : [1989]177ITR377(SC) to the facts

arising in this case we hold that there is no infirmity in the order passed by the Tribunal in holding that the expenditure incurred by the assessee for

the purpose of purchasing the drawings is revenue in nature. Accordingly, we answer the questions referred to us in the affirmative and against the

Department. No costs.