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Judgment
The present appeal has been filed against the order of Income Tax Appellate Tribunal, Chandigarh (hereinafter referred to as 'the Tribunal'), passed in I.T.A. No. 103/Chandi/2002. The Tribunal reversed the order of Commissioner of Income Tax (Appeals) {hereinafter referred to as 'the C.I.T.(A)'}, whereby the royalty paid for technical know-how amounting to ` 1,64,157/- was held to be capital in nature. The assessment year involved is 1996-97.
According to the appellant, following substantial question of law arises for consideration :-
"Whether the payment of royalty on account of obtaining technical know-how would constitute a revenue expenditure permissible for deduction ?"
The bare necessary facts of the case are that the appellant-company was incorporated on 27.09.1994. Prior to its incorporation, Memorandum of Understanding (for short 'MoU') was signed on 07.07.1994, between M/s Berlac Limited of Switzerland (for short 'foreign company') and appellant. The MoU was signed for setting up of a joint venture in India for manufacturing of lacquers, varnishes, paints etc. The foreign company was to transfer technical information for manufacture of planned products including composition/specification of material, equipment required, technique of production and tests & procedures for quality control. The appellant-company was to pay royalty @ 5% net of taxes on sales of respective products for a period of seven years. The foreign company deputed Mrs. Heinz Kohler, one of its employee for supervising new products and development to be undertaken by the appellant-company.
The assessment year involved was the first year of commercial production. The appellant filed Income Tax Return and claimed ` 1,64,157/- royalty paid, as revenue expenditure.
Vide order dated 24.08.1998, the Assessing Officer finalized the assessment under section 143(3) of the Income Tax Act, 1961 (in short 'the Act'). The claim of royalty was disallowed holding it to be capital expenditure.
Aggrieved of the assessment order, appellant filed an appeal before C.I.T.(A). Vide order dated 12.11.2001, the appeal was allowed. It was held that payment of royalty was revenue in nature and addition made by the Assessing Officer was deleted.
Aggrieved of the order of C.I.T.(A), revenue filed an appeal before the Tribunal. The appeal was partly allowed, vide order dated 22.09.2005. On issue of payment of royalty, the order of C.I.T.(A) was set aside and addition made by the Assessing Officer was upheld.
Aggrieved of the order, the appellant is in appeal, claiming that amount of royalty paid was revenue expenditure.
We answer the question of law claimed by the assessee against the assessee-appellant.
The contention raised by the learned counsel for the appellant is that the payment of royalty to the foreign company was to be paid on percentage of sales for a period of seven years and no lump sum payment was made. It was next argued that while paying royalty no enduring benefit was derived by the appellant. Support was gathered from the decision of the Supreme Court in Alembic Chemical Works Co. Ltd. Vs. Commissioner of Income-Tax, Gujarat, (1989) 177 ITR 377 and Delhi High Court in M/s Abhipra Capital Ltd. Vs. Deputy Commissioner of Income Tax (Investigation) (2018) 402 ITR 1.
On the other hand, the learned counsel for the revenue defended the order passed by the Tribunal. It was argued that the foreign company has passed-on technical know-how for the establishment of a joint venture and the Tribunal considered various clauses of MoU while deciding the matter in favor of the Revenue. In other words, it was urged that merely because payment was made on the basis of percentage of sales, would not make the payment of royalty a revenue expenditure. She relied upon the decision of Calcutta High Court in Commissioner of Income Tax Vs. Shriram Bearings Ltd. (2001) 251 ITR 155.
Before delving into the legal position, it would be appropriate to extract various relevant clauses of MoU, relied upon by the Tribunal :-
"Memorandum of Understanding signed on this 7th day of July, 1994 at Sissach, Switzerland, between BERLAC LTD. Situated at Allemndweg 39, CH-4450., Sissach, Switzerland, hereinafter referred to as "BERLAC" and Mr. Y. Saboo (including his nominees and nominated/associated firms and companies), residing at H. No.1, Sector 5, Chandigarh 160008 (INDIA), hereinafter referred to as "SABOO", for the purpose of setting up a joint venture in India for the manufacture of specialty lacquers, varnishes, paints and other similar products.
An understanding has been reached between the two parties as to the following :-
Subject to the techno-economic - viability being established, parties agree to set up a joint venture to manufacture in India at first lacquers, followed by varnishes, enamels, printing inks and related auxiliary products in mutually agreed phases. Necessary steps for the planning and implementation of this project shall be started on both sides.
BERLAC agrees to transfer to SABOO all technical information for the manufacture of the planned products including the composition specifications of materials and equipment required, the techniques of production, tests and procedures for the quality control. For the knowhow transfer as above, BERLAC is to be paid royalty @5%, net of taxes on sales of respective products in India for a period of 7 years.
Sales
It is agreed that SABOO shall have the exclusive right to manufacture and sell the products in India. SABOO will be entitled to use BERLAC marks and names for the purpose of its sales, and BERLAC agrees to transfer the same to SABOO. It is, however, specifically provided that BERLAC names and marks, if and when used on Indian fabrication, must include a suitable suffix or prefix to allow clearly an identification of Indian fabrication as distinct from Swiss manufacture. SABOO would also be free to create new trademarks and to get them registered in India. SABOO will also have the right to sell to other countries, provided they are specifically clarified and listed with mutual agreement and sanction of BERLAC.
Development and Adaptation
As per the guidelines of the Government of India, BERLAC, foreign collaborators will assist in setting up of an appropriate R&D facility for development of new lacquers and other products to suit the Indian Market and conditions. It is also the intent of both the parties that the future improvements, modifications and developments made by BERLAC, within the defined product range, shall also be made available to SABOO at agreed terms and conditions.
Secrecy It is agreed that all appropriate steps to protect the confidentiality and secrecy of the technical information passed on by BERLAC shall be taken. Both the parties will agree to specific procedure for the same.
It is the intention that a company would be formed for the purpose of the project, of which SABOO will hold about 60% of the equity shares and BERLAC about 40%. The day-to-day management will be responsibility of SABOO. However, the Board of Directors would also have an active appropriate representation from BERLAC.
Sub-Licence SABOO shall have the right to sub-licence the manufacture of planned products to any other Indian company, provided however, this shall require the specific prior agreement of BERLAC.
The terms of this Understanding are subject to the approval of the Government of India."
It is well established principle that there cannot be any straight-jacket formula for determining whether a particular expenditure is revenue or capital expenditure in nature. It depends upon cumulative effect of various factors taken together.
The Supreme Court in case of Honda Siel Cars (India) Ltd. Vs. CIT (2017) 8 SCC 170, while considering royalty paid for acquisition of technical information and know-how, held as under :-
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"19. If the aforesaid factors are taken in isolation, probably the claim of the assessee may be justified. Distinction between capital and revenue expenditure with reference to acquisition of technical information and know-how has been spelled out by this Court as well as the High Courts in series of cases. Primary test which is adopted to differentiate between capital and revenue expenditure remains the same, namely, the enduring benefit, it will be treated as capital expenditure. In contradistinction to the cases where expenditure of concurrent and reoccuring nature is incurred and latter would belong to revenue field. Technical information and know-how are intangible. They have different and distinct character from tangible assets. When the expenditure is incurred to acquire a tangible asset, determination as to whether the said acquisition of tangible asset is of capital nature or the expenditure is of revenue nature, may not post a problem. However, in case of technical information and know-how, having regard to their unique characteristic, the questions that need to be posed for determining the nature of such an expenditure are also of different nature. In case when there is a transfer of ownership in the intellectual property rights or in the licenses, it would clearly be a capital expenditure. However, where no such rights are transferred but the arrangement facilitates grant of licence to use those rights for a limited purpose or limited period, the Courts have held that in such a situation, the royalty paid for use of such technical information or know-how would be in nature of revenue expenditure as no enduring benefits is acquired thereby. This was so held in a classic case, entitled CIT Vs. Ciba of India Ltd.
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When we apply the aforesaid parameters to the facts of the present case, the conclusion drawn by the High Court that expenditure incurred was of capital nature, appears to be unblemished. Admittedly, there was no existing business and, thus, question of improvising the existing technical know-how by borrowing the technical know-how of HMCL, Japan did not arise. The assessee was not in existence at all and it was the result of joint venture of HMCL, Japan and M/s. HSCIL, India. The very purpose of agreement between the two companies was to set up a joint venture company with the aim and objective to establish a unit for manufacture of automobiles and part thereof. As a result of this agreement, the assessee company was incorporated which entered into TCA in question for technical collaboration. This technical collaboration included not only transfer of technical information, but, complete assistance, actual, factual and on the spot, for establishment of plant, machinery, etc. so as to bring in existence manufacturing unit for the products. Thus, a new business was set up with the technical know-how provided by HMCL, Japan and lump sum royalty, though in five installments, was paid therefor.
(emphasis supplied)
The Supreme Court in this case considered the aspect that there was no existing business of the assessee, hence question of improvising technical know-how never arose. The assessee came into existence because of joint venture with H.M.C.L. It was further noted that technical collaboration not only included technical information but complete assistance to set up a new business. Inspite of the fact that the technical know-how was for a limited period, but considering the agreement, it was held that agreement was framed in a manner to give it a colour of licence for a limited period, whereas it was not so.
In M/s Jonas Woodhead and Sons Ltd., Madras Vs. Commissioner of Income Tax, Madras (1997) 224 ITR 342, the apex Court laid down test to determine whether a particular payment is revenue expenditure or capital expenditure as follows:-
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"4. The question whether a particular payment made by the assessee under the terms of the agreement forms a part of capital expenditure or revenue expenditure would depend upon several factors, namely, whether the assessee obtained a completely new plan with a complete new process and completely new technology for manufacture of the product or the payment was made for the technical know-how which was for the betterment of the product in question which was already being produced; whether the improvisation made, is the part and parcel of the existing business or a new business was set up with the so called technical know-how for which payments were made; whether on expiry of the period of agreement the assessee is required to give back the plans and designs which were obtained, but the assessee could manufacture the product in the factory that has been set up with the collaboration of the foreign term; the cumulative effect on a construction of the various terms and conditions of the agreement; whether the assessee derived benefits coming to its capital for which the payment was made. This Court in the case of Alembic Chemical Works Co. Ltd. v. Commissioner of Income-Tax, Gujarat, (1989) 177 ITR 377 has indicated that "in the infinite variety of situational diversities in which the concept of what is capital expenditure and what is the revenue arises, it is not possible to form any general rule even in the generality of cases, sufficiently accurate and reasonable comprehensive, to draw any clear line of demarcation". This Court further held that there is no single definitive criterion which by itself is demarcative, whether a particular outlay is capital or revenue. And therefore "once for all" test as well as the test of "enduring benefit" may not be conclusive. Consequently, the various terms and conditions of the agreement, the advantages derived by an assessee under the agreement, the payment made by the assessee under the agreement, are all to be taken in account and then it has to be decided whether the whole or a part of the payment thus made is a capital expenditure or a revenue expenditure.
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It would thus appear that the courts have applied different tests like starting of a new business on the basis of technical know-how received from the foreign-firm, exclusive right of the company to use the patent or trademark which it receives from the foreign firm, the payments made by the company to the foreign-firm whether a definite one or dependant upon certain contingencies, right to use the technical know-how of production or the activity even after the completion of the agreement, obtaining enduring benefit for a considerable part on account of the technical informations received from a foreign-firm, payment whether made "once for all" or in different instalments co-relatable to the percentage of gross turnover of the product to ultimately find out whether the expenditure or payment thus made makes an accretion to the capital asset and after the court comes to the conclusion that it does so then it has to be held to be a capital expenditure. As has been held by this Court and already indicated in Alembic Chemical Work's case (1989) 177 ITR 377 no single definitive criterion by itself could be determinative and, therefore, bearing in mind the changing economic realities of business and the varieties of situational diversities the various clauses of the agreement are to be examined. But in the case in hand the Tribunal having considered the different clauses of the agreement and having come to the conclusion that under the agreement with the foreign firm what was set up by the assessee was a new business and the foreign firm had not only furnished information and the technical know-how but rendered valuable services in setting up of the factory itself and even after the expiry of the agreement there is no embargo on the assessee to continue to manufacture the product in question, it is difficult to hold that the entire payment made is a revenue expenditure merely because the payment is required to be made on a certain percentage of the rates of the gross turnover of the products of the income as royalty. In our considered opinion, in the facts and circumstances of the case the High Court was fully justified in answering the reference in favour of the revenue and against the assessee. These appeals are accordingly dismissed but in the circumstances without any order as to costs.
(emphasis supplied)
Herein, the Supreme Court was after considering its decision in the case of Alembic Chemical Works Co. Ltd. (supra), held that the assessee set up a new business under the agreement with the foreign firm. The foreign firm not only furnished information regarding technical know-how but helped in setting up of factory. Merely because payment was required to be made in percentage of rates, the payments were held to be capital in nature.
It would be appropriate to notice the citation of Calcutta High Court in Shriram Bearings Ltd.'s case (supra) relied upon by learned counsel for the revenue. The Calcutta High Court, therein, following the decision of Supreme Court in M/s Jonas Woodhead and Sons Ltd., Madras (supra), held that royalty paid before commencement of production to use the technical know-how was capital expenditure.
Adverting to the factual matrix in the present case, from the clauses of MoU quoted earlier in the order, it is evident that the appellant established a joint venture with the foreign company for manufacture of lacquers, varnishers, paints etc. It has not been disputed that the appellant-company was incorporated after signing the MoU. The foreign company transferred all technical information for manufacture of planned products which included composition/specification of the material, equipment required, techniques of production and tests & procedures of quality control. Apart from this, the authorities noted the fact that Mrs. Heinz Kohler was deputed for supervising the new products and development to be undertaken by the appellant. As per the MoU, the appellant got exclusive right to sell the products in India. The appellant could use brand name 'BERLAC' for the purpose of sales. The appellant had a right to sell the manufactured products in other countries in mutual agreement with foreign company. The foreign company was assisting the appellant-company for setting up R&D facility for development of new lacquers in India. The appellant had a right to sub-licence the manufacture of planned products.
It is established that MoU with foreign company resulted in setting up of new business in shape of joint venture. It was not merely transfer of technical know-how, but it extended to the level of rendering valuable services including setting up of factory. Though, the royalty was to be paid over a period of seven years, there was no restriction on the appellant to continue with the manufacture and sale of products thereafter also. In the present case, the expenditure was incurred at the pre-production stage and hence is being held as capital expenditure. In view of the decisions of the Supreme Court in M/s Jonas Woodhead and Sons Ltd., Madras (supra) and Honda Seil Cars India Limited (supra), no blemish can be cast upon by the findings arrived by Tribunal holding that the payment of royalty was capital in nature.
In all fairness, we refer to the contention of the learned counsel for the appellant that since the payment of royalty was being made on percentage basis of sales, therefore, payment was revenue in nature, is not well founded. Though, the CIT(A) had allowed the appeal merely on that basis but had erred as the mode of payment either being made in lump sum or in installments or on percentage of sales, is a decision taken by the parties, as per their commercial expediency. It would not be the sole deciding factor regarding nature of expenditure.
The reliance of the learned counsel for the appellant on the decision of Supreme Court in Alembic Chemical Works Co. Ltd. (supra) is of no help. The said decision has been considered by Supreme Court in the case of M/s Jonas Woodhead and Sons Ltd., Madras (supra) and Honda Seil Cars India Limited (supra) and thereafter, it was held that the payment made was capital in nature. Reliance of the learned counsel for the appellant on Delhi High Court Judgment in M/s Abhipra Capital Ltd. (supra) also does not advance his case. In the said decision the Delhi High Court was considering the question whether the payment made for acquiring membership by the assessee in National Stock Exchange would amount to capital or revenue expenditure. It was concluded, applying the enduring benefit test, that expenditure incurred was capital in nature.
The appeal is dismissed accordingly and question of law is answered against the assessee.