Madras High Court
Commissioner Of Income Tax vs Aquapump Industries on 14 July, 1995
JUDGMENT Abdul Hadi, J.
1. These tax cases by the Revenue under s. 256 of the IT Act, 1961 (hereinafter referred to as "the Act"), respectively, relate to the asst. yrs. 1978-79 to 1980-81 and the common questions referred to this Court are as follows :
(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that no capital asset of enduring nature had been acquired by the assessee by payment of the royalty and, hence, no portion of it should be disallowed as capital in nature ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding and had valid materials to hold that nothing was conveyed by Texmo Industries to the assessee by way of an asset in accordance with the agreement except the use of the trade mark and access to the technical information?"
2. Though the said questions have been set out as two questions, they actually relate to the question whether the expenditures of Rs. 21,60,682, Rs. 2,83,655 and Rs. 4,23,291 in the above said three assessment years, respectively, incurred by the assessee as royalty payments to Texmo Industries, Coimbatore, under the agreement dt. 1st Jan., 1977, between them, are revenue expenditures deductible under s. 37(1) of the Act or capital expenditures not deductible thereunder. (The above said agreement was literally between Texmo Industries and one, C. K. Industries, but the said C. K. Industries changed its name subsequently to Aquapump Industries, who is the assessee. So, the agreement is really only between Texmo Industries and the assessee).
3. As per the abovesaid s. 37(1), inter alia, only if the expenditure in question is not capital expenditure, but is revenue expenditure, it is allowable as deduction in computing the total income under the head "Profits and gains of business or profession". In that context only, the Tribunal below held that the above referred to expenditures incurred by the assessee are revenue expenditures on the footing that no capital asset of enduring nature had been acquired by the assessee by incurring those expenditures in paying the abovesaid sums in question as royalty to Texmo Industries and on the footing that nothing was conveyed by Texmo Industries and on the footing that nothing was conveyed by Texmo Industries to the assessee by way of an asset in accordance with the relevant agreement entered into between them except the use of the trade mark and access to technical information.
The ITO, in his separate orders of the abovesaid three different assessment years, treated one-fifth of the said respective payments alone as capital expenditure and gave the deduction for the balance four-fifths. But, on appeal, the CIT(A) treated the entire payments in each of the said years as revenue expenditure and gave full deduction. Likewise, in the second appeal, the Tribunal also accorded full deduction. Hence. at the instance of the Revenue, the abovesaid questions have been referred to this Court.
4. In order to answer the above question (capital or revenue expenditure), we have to, first of all, see the relevant portions of the abovesaid agreement, which are as follows :
"Whereas Texmo, manufacturers of all types of electric motors, pumpsets, monoblocks and submersible pumpsets has agreed to allow CKI the use of its brand name for the production, manufacture and sale of the products mentioned hereunder, namely, (1) Single phase motors, (2) Side channel pumps, (3) Single phase monoblocks, (4) Jet pumps, and (5) Piston pumps.
1. In consideration of the royalties hereinafter reserved Texmo has agreed to allow C. K. Industries to manufacture the article referred above for a period of five years from 1st April, 1977, and this period of licence can be extended thereafter for such periods as may be mutually agreed upon.
2. Texmo has agreed to allow CKI the use of the trade mark 'Texmo' for the production and marketing the licensed products according to the design specifications and standards of Texmo.
3. Texmo has agreed to furnish technical information pertaining to the manufacture of its licensed products.
4. Texmo has agreed to offer guidance to CKI in the procurement of the following drawings/description/specification :...
5. Texmo shall make available the services of their personnel for :
(a) Discussion with the engineers of CKI and advice on the projection and pre-planning for the new CKI factory including determination of the sequence of tasks to be taken up, specification and selection of equipment and materials; and
(b) Transfer of specialised skills and knowledge, regarding all aspects of the production of the licensed products....
7. CKI shall every year before the end of September, pay to Texmo a royalty at the rate specified hereunder for the manufacture and sale of licensed products during the previous financial year.
Royalty rates :
Financial year 1977-78 - 10% of the net sale proceeds -do- 1978-79 - 5% - do- -do- 1979-80 - 5% - do- -do- 1980-81 - 5% - do- -do- 1981-82 - 5% - do-
5. Learned counsel for the Revenue, after adverting to the above features of the agreement very much relied on the decisions in Addl. CIT vs. Southern Structurals Ltd. , CIT vs. Maschmeijer Aromatics (India) (P) Ltd. and Fenner Woodroffe & Co. Ltd. vs. CIT to contend that the abovesaid expenditures are only capital expenditures. On the other hand, learned counsel for the respondent-assessee relies on Alembic Chemical Works Co. Ltd. vs. CIT , Empire Jute Co. Ltd. vs. CIT , Praga Tools Ltd. vs. CIT (FB) and CIT vs. Madras Rubber Factory Ltd. (1983) 14 ITR 678 (Mad) to contend that the abovesaid expenditures are only revenue expenditures.
5. We have considered the rival submissions. In the light of the decisions cited and in the light of the nature and terms of the abovesaid agreement, it is clear to us that the abovesaid expenditures are in toto only revenue expenditures incurred by the assessee and for the purpose of its business and they are deductible under s. 37(1) of the Act and that the abovesaid questions have to be answered in the affirmative and against the Revenue. We now give our reasons :
We may, at the outset refer to the legal position by referring to two or three of the Supreme Court decisions. In Alembic Chemical Works Co. Ltd. vs. CIT (supra), the assessee, engaged in the manufacture of antibiotics, with a view to increase the quantum of manufacture, entered into an agreement with a Japanese firm, whereunder the said Japanese firm, in consideration of "once for all payment" U. S. $50,000 agreed to supply to the said assessee, the sub-cultures of the Japanese firm, most suitable penicillin producing strains in a pilot plant, the technical information, know-how and written description of the said firm's process for fermentation of penicillin, etc. Under the said agreement, the assessee therein was also to keep the technical know-how confidential and secret and was not to seek any patent for the process. In the above circumstances, the Supreme Court held, reversing the decision of the High Court that the abovesaid payment was only a revenue expenditure on the ground that there was no material to come to definite conclusion that the assessee therein had obtained under the abovesaid agreement a "completely new plant" with a completely new process and a completely new technical know-how. The following observations of the Supreme Court are significant :
"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.... It would, in our opinion, 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 medical science. The state-of-the-art in some of these areas of high priority research is constantly updated so that the know-how cannot be said to be 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.... It appears to us that the answer to the questions referred should be on the basis that the financial outlay under the agreement was for the better conduct and improvement of the existing business and should, therefore, be held to be revenue expenditure. Reference may also be made to the observations of this Court in CIT vs. Ciba of India Ltd. (1968) 69 ITR 692 (Mad) : TC 16R. 1185.
There is also no single definitive criterion which, by itself, is determinative as to 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 commonsense way having regard to the business realities. In a given case, the test of 'enduring benefit' might break down. In CIT vs. Associated Cement Companies Ltd. (1988) 172 ITR 257 (SC) at page 31 of CTR and 262 of ITR, this Court said :
'As observed by the Supreme Court in the decision in Empire Jute Co. Ltd. vs. CIT that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principles laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test.....'."
In CIT vs. British India Corpn. Ltd. , the assessee, while carrying on the business of tanning hides and manufacture of leather products, entered into an agreement with a London collaborator who agreed to permit the said assessee to use a number of registered trade marks and also agreed to disclose the technique, practices and application of specialised tanning processes. There too, the agreement was for seven years and the assessee therein agreed to pay the collaborator's technical fee, calculated at a percentage of the selling price of its products produced by the process disclosed in one clause in the said agreement and also provided that the assessee therein was to appoint a particular company as its distributor for the sale of industrial leather manufactured by the assessee and, inter alia, pay a sum of Rs. 50,000 to the said company for meeting the initial expenses for establishing the distributorship. In computing the total income for the relevant year, the assessee therein claimed deduction of the said sum of Rs. 50,000 paid to the said company as revenue expenditure. The Supreme Court, while affirming the decision of the High Court held that the organisation set up under the distributorship under the abovesaid agreement was to endure only for seven years and upon the expiry of the said period, the assessee therein had no relationship with he said collaborator and that the period of agreement with the abovesaid distributor company was co-terminous with the agreement with the collaborator and so, the Supreme Court held that he abovesaid sum of Rs. 50,000 was part of the consideration for the receipt of the benefits under the agreement with the collaborator and the said sum pad was only a revenue expenditure.
In CIT vs. Madras Rubber Factory Ltd. (supra), this Court had to deal with a collaboration agreement between the assessee therein and an American company and the said agreement dealt with, (i) the planning and setting up of a tyre factory, and (ii) a continuous supply of information and technical consultancy services for a period of years for running the factory after its installation. There was no dispute with reference to the first one which was held to be capital expenditure. But, with reference to the second of the above, this Court held that it was only a revenue expenditure. In that connection, the following observation of this Court is significant :
"The Supreme Court's enunciation of the test of enduring benefit is particularly apposite in the present case. It may be conceded that what Mansfield (the abovesaid American company) or its resident engineer in India were imparting to the assessee on operational matters might tend to outlast, and endure beyond, the contract period. This, however, is a common characteristic of all knowledge which a person acquires... Expenditure to acquire it cannot be disallowed merely because knowledge dies hard. It is only where the expenditure bears on the fixed capital or other capital structure of the assessee that it can be regarded as capital in nature. Where the expenditure, although enduring in character has its impact on the running of the business, there can be no doubt that it is out and out revenue expenditure".
Thus, we find that in the light of the earlier Supreme Court decisions, this Court has made the above referred to significant observation, which will clearly negative the main contention of learned counsel for the Revenue. The said main contention is that in the present case also, the technical know-how acquired during the five year contractual period under the present agreement entered into by the assessee, would enure to it subsequently also, in running its business.
Further, in the present case also, since the expenditure incurred, although might be enduring in character, would have impact only on the running of the assessee's business and there is nothing to show that the said expenditures bear on the fixed capital or the other capital structure of the assessee. This aspect also has been emphasised in Empire Jute Co. Ltd. vs. CIT (supra), which has also been referred to in Alembic Chemical Works Co. Ltd. vs. CIT (supra), as already referred to.
The same point was also emphasised in Praga Tools Ltd. vs. CIT (supra). There, the assessee, a manufacturer of precision and machinery tools, entered into a licence agreement with a foreign company in the U. K. for the manufacture of certain tool and cutter grinding machine for which the said company was to supply the accessories, designs, technical know-how, etc. The agreement therein was also for a period of ten years and renewable thereafter for five years by mutual consent. During the subsistence of the agreement, the assessee therein had to pay royalty at five per cent on the Indian selling price on the production of the machine. In that context, the Full Bench of the Andhra Pradesh High Court held that the expenditure incurred in paying the abovesaid royalties had a direct nexus to the carrying on of the business of the assessee and, therefore, it had to be treated as part of the profit-making process. So, the Court held that it was a revenue expenditure.
We may also point out that the said Full Bench has also held that merely because the collaboration agreement provided that the assessee shall be entitled to retain technical know-how, designs, drawings, etc. even after the expiry of the contract period under the agreement, it did not alter the nature of the transaction and that the fact that the assessee was not entitled to use the relevant trade mark for the products after the expiry of the agreement period, clinched the issue. Here also the assessee is not so entitled, after the expiry of the abovesaid agreement period, unless the agreement is mutually agreed to be renewed.
Further, taking into account the above referred to significant observation of the Supreme Court in Alembic Chemical Works Co. Ltd. vs. CIT (supra) that "the rapid strides in science and technology in the filed should make us a little slow and circumspect in too readily pigeon-holding an outlay such as this as capital", we have to hold in the present case also, that the above referred to payments made by the assessee to Texmo Industries under the above referred to agreement are only revenue expenditure. No doubt, learned counsel for the Revenue argues that in the present case, the technical know-how given in relation to the manufacture of the abovesaid specified products may not become outdated as in the case spoken to in Alembic Chemical Works Co. Ltd. vs. CIT (supra). We are unable to agree with this contention. It cannot be said that the technical know-how given in the present case by the abovesaid Indian company at Coimbatore, Texmo Industries cannot become outdated.
Regarding Addl. CIT vs. Southern Structurals Ltd. (supra), very much relied on by learned counsel for the Revenue, we must state that the said decision will have no application to the present facts and that too, in the light of the above referred to observations of the Supreme Court. There, under the collaboration agreement entered into between a foreign company and the assessee therein, the assessee was granted, for the duration of the said agreement, viz., ten years, the right to use "all inventions and designs relating to railway wagons, whether patented or not, owned by the Metro (the abovesaid foreign company)". Further, the agreement therein provided that the said foreign company has to supply "full technical information, advice, manufacturing data and details which Metro may have acquired in relation to the design and manufacture of any existing type of railway wagon" and "such information and advice shall include the benefit of all the knowledge gained by Metro as a result of their long experience in the design and manufacturing of railway wagons with particular reference to welded wagons".
It cannot be said that the collaboration agreement in Addl. CIT vs. Southern Structurals Ltd. (supra) is similar to the collaboration agreement in the present case. In this context, the following observation of the Supreme Court in the abovesaid Alembic Chemical Works Co. Ltd. vs. CIT (supra) is also significant :
"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."
In the light of the abovesaid observation, we have only to observe that Fenner Woodroffe & Co. Ltd. vs. CIT (supra) turned on its own facts in holding that the relevant expenditure was capital expenditure.
No doubt, one other decision relied on by the Revenue, viz., CIT vs. Maschmeijer Aromatics (India) (P) Ltd. (supra) makes the following observation :
"It was also submitted that what the assessee has obtained from its foreign collaborator is the licence to use the design, etc., and not the ownership thereof and, therefore, the amount paid was only to be treated as revenue expenditure and not capital. There is again no substance in the submission."
But, we do not hold in the present case that, simply because the term "licence" is used in the collaboration agreement herein, or, simply because there is no transfer of ownership of any asset under the said agreement, the relevant expenditure is revenue expenditure.
Further, it is also pointed out that there is conflict between Fenner Woodroffe & Co. Ltd. vs. CIT (supra) and CIT vs. Sarada Binding Works as pointed out by Kanga and Palkhivala in The Law & Practice of Income-tax, Eighth edition, Volume I, pages 671 and 672. But, we feel, there is no necessity to go into that question in view of the above referred to observations of the Supreme Court.
6. To conclude, in the light of the abovesaid discussion by us, based on the above referred to observations of the Supreme Court and the High Courts, particularly in Alembic Chemical Works Co. Ltd. vs. CIT (supra) and in CIT vs. Madras Rubber Factory Ltd. (supra), we feel it appropriate to reframe the above referred to two questions into a single question as follows :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the expenditures of Rs. 2,60,682, Rs. 2,83,655 and Rs. 4,23,291 in the asst. yrs. 1978-79, 1979-80 and 1980-81, respectively, incurred by the assessee as royalty payments to Texmo Industries, Coimbatore, under the agreement dt. 1st Jan., 1977, between them are revenue expenditures [deductible under s. 37(1) of the IT Act, 1961] ?"
and we answer the said question in the affirmative and against the Revenue. No. costs.