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Judgment
Ramanujam, J.—The first batch of five references is at the instance of the Revenue while the second batch of five cases is at the instance of
the assessee against the same orders of the Tribunal.
The assessee-company entered into a collaboration agreement with a foreign company by names Messrs. Brush Electrical Engineering Co. Ltd.,
U.K., December 12, 1963. Under the said agreement, the foreign company agreed to provide the assessee-company technical add and
information in the manufacture of low tension switchgear, high mention switchgear, etc., 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 trains the necessary personnel at the U.K. factory, etc., Under the said agreement, the assessee-company agreed to pay as
consideration for the services rendered by the foreign company a lump sum of 20,000 sterling payable in five equal instalments of 4,000 sterling
each, the first installment to be paid three months after the date of the agreement and subsequent payments at intervals of 12 months from the first
payment. For the year 1966-67, the assessee-company claimed the payment made to the foreign companies a revenue expenditure.
The ITO, however, held that as the consideration paid in the form of royalty was an enduring benefit to the assessee, a part of it will have to be
disallowed. He, therefore, deducted from the loss claimed by the assessee for the assessment year 1966-67, the technical collaboration fees and
1/4th of the royalty paid and similarly for the assessment years 1967-68, 1968-69, 1969-70 and 1971-72. The details of the disallowance for
each of the years are given below.
------------------------------------------------------------------------
Asst. year Disallowed Disallowed
technical collaboration 1/4th royalty
fees
------------------------------------------------------------------------
Rs. Rs.
1966-67 3,340 1,311
1967-68 10,494 23,523
1968-69 11,702 32,685
1969-70 9,028 32,082
1970-71 12,788 54,349
------------------------------------------------------------------------
On appeal, the AAC referred to the various clauses of the collaboration agreement, in particular, to clauses 3,6,15, 21 and 23, and came to the
conclusion that the acquisition of the technical know-how and other services for which the technical aid fees was paid was of a permanent nature
and would always be availed of by the assessee-company for its own business and industrial requirements, and therefor, there was definitely an
element of capital expenditure in the technical and aid fees paid. He, however, did not agree with the ITO that the entire payment of technical aid
fees could be treated as capital expenditure. He restricted the disallowance to 1/4th of the gross payment of the technical aid fees, since according
to him that alone could be termed to represent capital expenditure. He further held that his finding with reference to technical aid fees would apply
with equal force to the claim of payment of royalty, and, therefore, he confirmed the disallowance of 1/4th in respect of royalty. Against the orders
of the AAC, both the assessee-company and the Revenue filed appeals and cross-objections before the Tribunal. The Revenue contended that the
AAC erred in holding that 1/4th of the expenditure towards technical aid fees alone had to be considered as capital. The Tribunal after considering
the various clauses in the collaboration agreement dated December 12, 1963, in extenso, came to the conclusion that as per the said clauses of the
agreement, the technical knowledge that the assessee obtained through this agreement was an enduring advantage and benefit in so far as the same
was available to the assessee for its manufacturing and industrial process even after the termination of the agreement, and that in view of the
decision of this court in Transformer and Switchgear Ltd. Vs. Commissioner of Income Tax, , 1/4th of the technical aid fees has rightly been
disallowed as relating to capital expenditure. In this view, the Tribunal upheld the order of the AAC relating to both the disallowance of 1/4th of the
technical aid fees and 1/4th of the royalty amount. Aggrieved by the order of the Tribunal, both the Revenue and the assessee filed reference
applications before the Tribunal and the Tribunal has referred the following common questions for the opinion of this court.
Whether, on the facts and in the circumstances of the case, the entire claim of payment of technical aid fees and 1/4th of the royalty to the
foreign collaborator under the collaboration agreement dated December 12, 1963, is liable to be disallowed ?
If the first question is answered in the negative, whether the disallowance of 1/4th of the above claim is justified ?
The first question comprises of two issues, on relating to the technical aid fees and other relating to the royalty. So far as the issue relating to the
disallowance of the technical aid fees paid to the foreign collaborator is concerned, as already seen, the Tribunal has purported to follow the
decision of this court in Transformer and Switchgear Ltd. Vs. Commissioner of Income Tax, , which was rendered with reference to an agreement
containing similar closes wherein this court has observed as under (at p. 357) :
As seen from the relevant portions of the agreement extracted above, the agreement covered the technical aid and assistance for the
establishments, starting of work and the operating of the factory for manufacture of transformer of all kinds and types. Dominate shall also make
available to the assessee its procedures, designs, experience and technical know-how in respect of the same. In consideration, the assessee agreed
to pay 3% of their annual turnover. The duration of the agreement was for 10 years and at the end of that period it would automatically be
extended for another period of five years unless the renewal was terminated. The assessee even after the expiry of the period of the agreement
could use the methods of production, procedure, experiments, improvements, which had been made available to them in pursuance of the
agreement, but only subject to the condition that its obligation to keep them secret still continues even after termination. It was also subject to
another condition that the transformers and switchgears manufactured by the assessee shall not be exported to certain countries. Thus, the assessee
had acquired knowledge or advantage of an enduring nature. Therefore, the amount paid was not an admissible deduction."" In that case, the
portion of the fee relatable to the supply of technical know-how, patents and designs was taken as an expense anchored to acquire an asset of a
permanent nature and as such held to be capital in nature, but the fee referable to the user of the patents and designs was held to be revenue
expenditure. Since the sum paid was a composite payment, 50% of the claim was disallowed as relating to capital expenditure. This was upheld by
this court. The same view has been taken by this court in Fenner Woodroffe and Co. Ltd. Vs. Commissioner of Income Tax, . In that case, this
court held that it is the aim and object of the expenditure that would determine the character of the sum whether it is capital or revenue and that
neither the source nor the manner of payment may be of any consequence. This court further held that, on the facts of that case, the amounts paid
were not admissible as business expenditure under the I.T. Act, since the question of apportionment of the expenditure which was a composite one
was not referred to the High Court. This court has again considered a similar collaboration agreement between an Indian company and a foreign
company containing similar terms as in the instant case in M.R. Electronic Components Ltd. Vs. Commissioner of Income Tax, Madras, . It was
held, in that case, that as the foreign company had under taken to advise the assessee on the construction and equipment of its works and also on
the processes and manufactures, and as the object of the expenditure was with reference to the erection of the factory, to that extent the payment
would be disallowed as not relating to the carrying on of the business, and that if a portion of the consideration was attributable to the manufacture
of fresh items, there will be an element of acquisition of a right exploitable in future and, hence, it would not relate to the running of the business,
and that, therefore, the Tribunal was justified in its conclusion that 25% of the payment under the collaboration agreement has to be disallowed as
being capital in nature.
Keeping in view the principles laid down by this court in the above three cases, let us analyse the various clauses of the collaboration agreement
dated December 12, 1963. The relevant and important clauses of the agreement are set out below : or under letters patent under which it may be
entitled to grant licences; (i) An exclusive licence to manufacture, use and sell during the continuance of this agreement the scheduled products
within India; and
(ii) A non-exclusive licence to sell the scheduled products in the export territories subject always however to the provisions of this agreement and
to any restrictions or obligations from time to time upon BRUSH in respect of such letters patent. Such licence or licences shall be in such
reasonable form as S. S. may require so as to enable it to have the full benefit of such letters patent in accordance with the provisions of this clause
and during the continuance of this agreement.
(b) Subject to the provisions of this agreement, BRUSH shall furnish S. S. which one complete set of the working drawings, specifications and
other written manufacturing information and data relating to the manufacture of each type of the scheduled products according to the latest
developments and currently in standard use by BRUSH so as to enable S. S. to establish the manufacture in India on a commercial basis of each
type of the scheduled products to the specifications and standards used by BRUSH at the respective dates of commencement of manufacture of
each type of the scheduled products together with a list of all jigs, tools, etc., and drawings and data for jig, tools, fixtures and patterns as are made
in India and the schedule of the machine tools necessary for the production of the scheduled products. All drawings, specifications and other date
aforesaid furnished to S. S. shall be in the English language with measurements shown in the system currently used by BRUSH but shall be the
property of S. S. on the condition that S. S. hereby agrees to hold such property subject always to the continued fulfillment by S. S. of all the
obligations contained in clause a : 1 16(c), 6(d), 23 & 25 of this Agreement and the period of ten years thereafter. The parties hereto shall from
time to time draw up by mutual consolation a time-table regarding the supply of BRUSH to S. S. of all drawings and specifications and other date
hereinbefore offered to in respect of each type of the scheduled products.
BRUSH hereby agrees and undertakes that it will not during the continuance of this agreement manufacture in India any scheduled products or
grant or furnish or make available to any other person, firm or company any manufacturing information, licence, rights and date for scheduled
products in India.
S. S. hereby agrees with BRUSH at all times during the continuance of this Agreement :
(a) To use its best endeavours to manufacture the scheduled products so as to meet the demands within India for the scheduled products to an
adequate commercial extent and on reasonable terms and shall cause scheduled products so manufactured to be of such quality and in all respects
in their respective kinds and shall give such service in respect thereof as will maintain the reputation of products associated with the name of
BRUSH and as will not cause injury to the reputation of BRUSH.
(b) To affix or attach to or stamp, emboss or impress in a conspicuous place and in a permanent manner on all scheduled products manufactured
or sold by S. S. the words following :
Manufactured under Licence from Brush Electrical Engineering Company Limited of England"".
A similar statement shall appear with reasonable prominence in all literature, advertisements and others sales media of S. S. relating to the
scheduled products. (c) To use all drawings, specifications, technical information and date supplied by BRUSH here under only in connection with
the manufacture and sale of the scheduled products.
BRUSH shall have the right :
(a) to nominate such of its own staff as it considers necessary to supervise the erection of the S. S. factory premises, the layout of the machine
tools and the organization of all workshops therein.
(b) Subsequent to the commencement of manufacture of S. S. to have undisputed control for a minimum period of three years or less at its
discretion of all manufacturing processes and activities;
(c) to recommend appointment or dismissal of any employees directly concerned with the manufacturing process of the scheduled products.
(d) Subsequent to the initial period of three years or less after commencement of manufacture as referred to in clause (b) of this clause BRUSH
shall at its discretion be entitled to maintain at S. S.''s factory for such period as it shall decide such technical staff as it considers necessary for the
efficient production of the scheduled products and S. S. undertakes to carry out without delay whatever recommendations are made by such staff
always, provided that in the event of any dispute, the Board of Directors of Brush shall have the right to make the final decision.
As consideration for the licences hereby granted and for the information and goods to be supplied and services to be rendered by BRUSH
under this Agreement S. S. shall pay to BRUSH.
(a) Such sin as after deductions required under India law shall equal 20,000 sterling which sum shall be paid in equal installments of 4,000 sterling
each, the first payment to be made three months after the date hereof and successful payments at intervals of twelve months after the due date of
the first payment.
(b)(i) A royalty on all switchgear products and parts thereof sold by or on behalf of S. S within India and at the rate of 2 1/2% on the nest
invoiced price of all low and at the rate of 5% on the net invoiced sales price of all high tension switchgear products and parts thereof.
(ii) A royalty on all switchgear products and parts thereof sold by or on behalf of S. S within the export territories at the rate of 7% on the net
invoiced sales prices thereof.
(iii) In the event of any assemblies, components for parts of such products as aforesaid being purchased by S. S from BRUSH, then the total
BRUSH invoiced price (excluding freight, carriage and insurance charges) of all such items shall be deducted from the total net invoiced sales price
before calculating the royalty payable to BRUSH.
This agreement shall commence at and from the date of signature and subject to termination as provided in clause 22 shall remain in force for ten
years and thereafter shall remain in force subject to either party giving the other notice in writing to terminate at any time.
Upon the termination of the agreement : (a) any licences, permissions, authorities granted by BRUSH in favour of S. S. in respect of any patent
or similar rights shall determine and S. S. shall forthwith return to BRUSH all copies of drawings specifications, information and other data in the
possession or under the control of S. S. and relating in whole or in part to the designs or intentions which are the subject of patent or similar rights
owned or controlled by BRUSH in India.
(b) S. S. hereby agrees to continue to observe the obligations contained in clauses 6(e) and 6(d) and 25 of this agreement throughout the period of
ten years commencing upon the termination of this agreement but in all other respect, S. S. shall have the right to use and to continue to use all
information, methods, processes and formulae acquired in pursuance of this agreement so far as the same shall not relate to patents or similar rights
owned or controlled by BRUSH in India. Provided always that this right shall not apply in the event of this Agreement being terminated by
BRUSH pursuant to either clause 22 or clause 24 hereof. 25. All licences, rights and benefits granted or to be granted to S. S. under this
agreement are personal to S. S. and shall not be transferable or divisible and S. S. shall not at any time assign or attempt to assign all or any part of
this agreement to any third party or grant any sub-licence to or otherwise assist any person, firm or company regarding the manufacture of the
scheduled products save that in the event an order is made or an effective resolution is passed for the winding up of S. S. for the purpose of
amalgamation or reconstruction, S. S. may assign its rights and obligations hereunder to any company which at the time the order is made or the
resolution is passed is a subsidiary as defined in the Indian Companies Act of S. S."" A perusal of the above clauses clearly indicates that the
technical knowledge the assessee-company obtained through this agreement from 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 processes even after the termination of the
agreement. The technical assistance contemplated in the agreement covers the establishment of the factory and the operation thereof for the
manufacture of transformers of all kinds and types.
The foreign company also makes available to the assessee its procedures, designs, experience and technical know-how in respect of the same.
Though the duration of the agreement is five years, the assessee even after the expiry of the period, could use the methods of production,
procedure, experiments, improvements which had been made available to them in pursuance of the agreement. Thus, the assessee had acquired a
knowledge of enduring nature. Further, apart from the technical know-how supplied by the foreign company and the grant of patent rights, the
foreign company has agreed not to manufacture in India any of the scheduled products or to grant or make available to any other person, firm or
company any manufacturing information, licences, rights for any one of the scheduled products in India, thus conferring an exclusive benefit on the
assessee-company to manufacture and sell the scheduled products. The conferment of an exclusive benefit to manufacture and sell the articles
which are the subject-matter of the agreement cannot be said to be a part of a mere know-how agreement. The right to make or manufacture
certain goods exclusively in India should be taken to be an independent right secured by the assessee from the foreign company which is of an
enduring nature. Therefore, the principle laid down by this court in Transformer and Switchgear Ltd. Vs. Commissioner of Income Tax, , Fenner
Woodroffe and Co. Ltd. Vs. Commissioner of Income Tax, and M.R. Electronic Components Ltd. Vs. Commissioner of Income Tax, Madras, ,
straightway applies, and, therefore, the entire technical fees cannot be allowed as a revenue expenditure. The learned counsel for the assessee
relies on the decision of the Supreme Court in Commissioner of Income Tax, Bombay Vs. Ciba of India Ltd., , Mysore Kirloskar Ltd. Vs. The
Commissioner of Income Tax, Bangalore, and Praga Tools Ltd. Vs. Commissioner of Income Tax, . But these decisions do not assist the
petitioner. In Mysore Kirloskar Ltd. Vs. The Commissioner of Income Tax, Bangalore, , the Full Bench of the Karnataka High Court, after
considering the terms of the know-how agreement in that case, held that under the agreements, the assessee acquired merely the right to draw
upon the technical knowledge of the foreign companies for a limited period, for the purpose of carrying on its business, that the foreign companies
did not part with any of their assets absolutely for ever or for a limited period of time, that they continued to have the right to use their knowledge
and, even after the agreements had run their course, their rights in this behalf was not lost, that the assessee had not, therefore, acquired any asset
or advantage of an enduring nature for the benefit of its business and that the payments were, therefore, revenue in nature and were deductible. The
Full Bench followed the decision of the Supreme Court in Commissioner of Income Tax, Bombay Vs. Ciba of India Ltd., . In the said case, the
Supreme Court has held that in making the technical knowledge available to the Indian company, the foreign company did not part with any assets
of its business or advantage of an enduring nature for the purpose of business. The decision in Praga Tools Ltd. Vs. Commissioner of Income Tax,
, is also to the same effect. All the above three cases dealt with a mere know-how agreement under which the Indian company acquired only
technical knowledge from the foreign company and did not acquire any other right or advantage of an enduring nature for the purpose of its
business, unlike the facts in this case. Here, in addition to the acquisition of technical knowledge, the assessee-company got an exclusive right to
manufacture and sell its articles without any objection from anyone including the foreign company and this is clearly an advantage of enduring
nature. It is well-established that even without acquisition of an asset, a right of a permanent advantage could be acquired and the cost of
acquisition of such a right could be taken to be capital expenditure. In Regent Oil Co. Ltd., v. Strick (Inspector of Taxes) [1966] AC 295; [1969]
73 ITR 301, the House of Lords had expressed the view that payment made by an assessee to secure exclusive sales stations are payments for
permanent assets and for an enduring benefit, and, therefore, the expenditure is capital in nature. Lord Reid in that case observed thus (at page
312-313) :
Whether a particular outlay by a trader can be set against income or must be regarded as a capital outlay has proved tone a difficult question......
So it is not surprising that no one test or principle or rule of thumb is paramount.
The question is ultimately a question of law for the court, but it is a question which must be answered in the light of all the circumstances which it is
reasonable to take into account, and the weight which must be given to a particular circumstance in a particular case must depend rather on
common sense than on strict application of any single legal principle.
We have, therefore, to hold, following the above said decisions of this court that in this case, the Tribunal its right in holding that 25% of the
technical fee has to be taken as a capital expenditure and as such cannot be allowed as a revenue expenditure.
Coming to the second issue as to whether the Tribunal is right in upholding the disallowance of 25% of the royalty paid, the ITO, the appellate
authority as well as the Tribunal have all concurrently held that the disallowance of 25% of the royalty is justified. Under the terms of the know-
how agreement, the royalty is payable on all switchgear products and the parts thereof sold on behalf of the Indian company at the rate of 2 1/2%
of the invoice value of all low tension switchgear products at 5% in all the high tension switchgear parts and a royalty of 7% in all switchgear
products exported. Thus, it is seen that the assessee paid a royalty for the acquisition of an exclusive privilege of manufacturing and selling the
products. The acquisition of such a right has rightly been treated partly towards capital and party towards the revenue. The Tribunal has chosen to
estimate the value of that portion of the royalty which is relatable to acquisition of right of an enduring nature. In this view, the Tribunal is right in
holding that 25% of the royalty is to be disallowed.
The result is, the first question his answered partly in favour of the Revenue and partly in favour of the assessee and the second question is
answered in the negatives and against the assessee. The assessee will pay the costs of the Revenue. Counsel''s fee Rs. 500 one set.