Income Tax Appellate Tribunal - Madras
Income-Tax Officer vs E.I.D. Parry (India) Ltd. on 13 September, 1991
Equivalent citations: [1991]39ITD506(MAD)
ORDER
T.V. Rajagopala Rao, Judicial Member
1. This is a Departmental appeal for the assessment year 1986-87 and it is directed against the order of the CIT (Appeals)-II, Madras, dated 21st April, 1987. The main question involved is whether the payments of £ 40,000 in respect of Shuttle Kiln and £ 65,000 in respect of Tunnel Kiln to British Ceramics Service Co. Ltd. should be taxed at 20 per cent since it should be considered as royalty payment. The facts leading to this appeal, briefly stated, are as follows: British Ceramics Services Co. Ltd. is a British company which specialised in erection and construction of kilns for the manufacture of vitreous china sanitary-ware. It has developed its own patented design of kilns. E.I.D. Parry (India) Ltd. is an Indian company having its manufacturing unit at Ranipet, Tamil Nadu. The Indian company wanted to establish a Tunnel Kiln and a Shuttle Kiln and for that purpose it wanted to borrow the special designs of those kilns evolved by the British company. As it is the policy of the Indian Government not to permit the wholesale import of the constructed kilns from foreign countries and it would give permission only for constructing the kilns after using the locally available material, the Indian company had to approach the British company to establish one Tunnel Kiln and one Shuttle Kiln at their industrial site at Ranipet, the models of which were designed by them. The Indian company entered into a contract bearing No. K 921-1 dated 1-7-1985 with regard to Bricesco Twin Track Shuttle Kiln for the refiring of vitreous china sanitary ware, and another contract bearing No. K922-1 dated 1-7-1985 with reference to Bricesco Tunnel Kiln for the first firing of vitreous china sanitaryware. Copies of these two agreements are furnished to this Tribunal at the time of hearing. Under the terms of each of these agreements, the foreign company undertook to construct, commission and operate a Bricesco Twin Track Shuttle Kiln and a Bricesco Tunnel Kiln. The British company agreed to construct these kilns with the indigenous materials procured by the Indian company. The British company also agreed to furnish drawings, information, essential components as well as specialist supervision/commissioning engineers for constructing, commissioning and operating the Bricesco Twin Track Shuttle Kiln as well as the Bricesco Tunnel Kiln. Under each of these agreements, the British Company agreed to supply the necessary materials and also agreed to depute their specialists (Construction Engineers as well as Commissioning Engineers) and also agreed to furnish one complete set of drawings and specifications. For furnishing one complete set of drawings and specifications with reference to construction of Bricesco Twin Track Shuttle Kiln, an amount of £ 40,000 was stipulated. For supply of materials for the Shuttle Kiln, a sum of £ 36,350 was stipulated. For providing the specialists a sum of £ 10,000 was stipulated. Thus the total contractual value for constructing, commissioning and operating the Bricesco Twin Track Shuttle Kiln was agreed at £ 86,250. So also for construction, commissioning and operation of Bricesco Tunnel Kiln, the British Company agreed to supply the following:
(a) One complete set of drawings and specifications.
(b) The materials to be supplied, and
(c) Specialists' help to be provided.
Separate charges were stipulated for each category of the supplies to be made. For the first category, the stipulated amount was £ 65,000. For the second category, the stipulated amount was £ 1,60,620 and for the third category the stipulated amount was £ 30,000. Thus the total contractual value for construction, commissioning as well as operation of the Bricesco Tunnel Kiln was agreed to be £ 2,55,620. In this appeal, we are concerned with the nature of payment made towards furnishing one complete set of drawings and specifications for each of these Kilns. The particular items agreed to be furnished or the items which comprised is the set of drawings and specifications are important to be noted under each of these contracts. Under Contract No. K921-1, under the terms of which Bricesco Twin Track Shuttle Kiln is to be constructed, commissioned and operated, the following items are agreed to be furnished under the head "Drawings and Specifications" :
Bills of Material.
Detailed Specifications.
Maintenance and Operation Instructions for the following:
(a) Refractory/Insulation lining.
(b) Pipework.
(c) Ductwork.
(d) Steel construction and rails.
(e) Kiln cars and transfer cars.
(f) Foundation drawings for the kiln and tracks.
(g) Safety and control equipment.
(h) Setting of kiln cars.
(i) Advice on choice of indigenous materials.
(j) Fans and combustion equipment.
(k) Instrumentation and controls.
(1) Electrical wiring diagrams.
Total...£40,000 The following items are agreed to be furnished under the head "Drawings and Specifications" under contract No. K-922-1 with reference to the constructions, commissioning and operation of Bricesco Tunnel Kiln :
Bills of Material.
Detailed Specifications.
Maintenance and Operation Instructions for the following :
(a) Refractory/Insulation lining.
(b) Pipework.
(c) Ductwork.
(d) Steet construction and rails.
(e) Kiln cars and transfer cars.
(f) Foundation drawings for the kiln and tracks.
(g) Safety and control equipment.
(h) Setting of kiln cars.
(i) Advice on choice of indigenous materials.
(j) Fans and combustion equipment.
(k) Instrumentation and controls.
(1) Electrical wiring diagrams.
(m) Hydraulic pusher unit.
(n) Mechanical handling equipment.
Total...£ 6.5,000
2. The payments towards designs and drawings were approved by the Government of India. Under the letter dated 11 -3 -1985 from the Secretariat for Industrial Approvals, Foreign Collaboration-I Section, 460-B, Udyog Bhavan, the assessee was given approval of the Government of India for the import of designs and drawings. With regard to the Shuttle Kiln, the letter of approval contained the following:
With reference to your letter dated 21-11-1984 on the above subject I am directed to convey the approval of the Government of India to the import of designs and drawings by you from M/s. British Ceramic Service Co. Ltd., England, for shuttle kiln on a lump sum payment of 40,000 (Pounds Forty thousand only) net of taxes. Taxes, if any, will be borne by you.
This approval is valid for a period of six months from the date of issue of this letter.
The approval for the manufacture of Tunnel Kiln was also by means of a similar letter dated 11-3-1985. The body of the letter of approval is the same as the one extracted above except the fact that the Government of India approved the payment of £ 65,000 to the English Company net of taxes.
3. Under separate letters dated 2-9-1985, the Government of India extended the validity period of the approval for a further period up to 10-12-1985 to enable the Indian company to complete the formalities. Extracts of the approval letters are furnished before us. It would appear that the Indian company sought a' No Objection Certificate' from the ITO for the remittance of £ 40,000 towards Shuttle Kiln and £ 65,000 towards Tunnel Kiln to the foreign company. The assessee filed its letter requesting the ITO to issue 'No Objection Certificate' under Section 195(2) on 2-12-1985. The ITO sent his reply letter dated 24-12-1985 to the assessee-the Indian company. He directed the Indian company to deduct 20 per cent from out of the amounts to be remitted to the foreign company towards tax deducted at source. No reasons were assigned as to why such deductions were to be made. Aggrieved against this direction of the ITO in his letter dated 24-12-1985, asking the Indian company to deduct 20 per cent of the remittances to the foreign company, the Indian company filed an appeal before the CIT (Appeals). The learned CIT (Appeals) had dealt with the merits involved in the appeal before him at para 2.3 of his order. It is as follows:
2.3. The purpose of the contracts which the appellant entered into with the UK Company, was to get erected in its factory a tunnel kiln and a shuttle kiln. The lump sum payments for drawings and specifications were a part of the contracts for acquiring the equipment concerned. The appellant is certainly not in the business of manufacturing kilns. It cannot, therefore, be inferred that these drawings and specifications contain a specialised knowledge which the appellant will be able to exploit for making income through manufacture and erection of similar kilns. These drawings and specifications are relevant only for the kilns erected in its factory. In such a situation, the payments for the,-drawings and specifications cannot be described as royalty. This is precisely the rationale behind the decision of the Tribunal referred to above-Klayman Porcelains Ltd. v ITO [1984] 8 ITD 265 (Hyd.). The Tribunal also took into account the settled position in law that technical drawings, constituting know-how, would also be 'plant' as held by several High Courts including the Madras High Court in CIT v. Festo Elgi (P) Ltd. [1981] 129 ITR 499. They have also gone into the scope of Explanation 2 to Clause (vi) of Sub-section (1) of Section 9 where the term 'royalty' has been defined for the purpose of that clause and have come to the conclusion that the payments for drawings and specifications for an equipment imported and erected in India would not have the character of royalty. From the facts of the case, I am of the view that the payments for drawings and specifications are part and parcel of the cost of machinery imported and that they do not constitute incomes liable to tax in the hands of the non-resident company. If they are not so liable to tax, the question of tax being deducted at source as per provisions of Section 195/section 200 does not arise.
It may be mentioned here that the assessee produced a receipt dated December 1985, evidencing that a complete set of drawings and specifications, designs etc. as detailed under Item A of the documents for Contract No. K922-1 for Bricesco Tunnel Kiln were received in England from the foreign company. One Shri A.V.A. Kumar, for and on behalf of E.I.D. Parry (India) Ltd., the Indian party, received the drawings, specifications, designs etc. noted in the receipt. The case of the Revenue before us is that the payments made towards drawings and specifications were nothing but royalty payments and wholly covered by the provisions of Section 9(1)(vi), Explanation 2 of the I.T. Act. The learned Departmental Representative contended that firstly we must bear in mind that these contracts are entered into subsequent to 1 -4-1976. In Klayman Porcelains Ltd. v. ITO [1984] 8 ITD 265 (Hyd.), the ordinary sense of "royalty" is taken to be rent or revenue attributable to the use of an asset belonging to one person by another. Even assuming that the ordinary meaning of the word "royalty" is to be applied, from the facts of the case it would appear that the Shuttle Kiln and Tunnel Kiln constructed with the help of the foreign company are patented or developed models and they bear specific names given by the foreign company like Bricesco Twin Track Shuttle Kiln. The foreign company helped the Indian company in setting up one Bricesco Twin Track Shuttle Kiln and one Bricesco Tunnel Kiln which are the exact models which they have evolved in Ranipet for the sake of the Indian company. The foreign company is an expert in setting up as well as commissioning of their own designed kiln. How to design them, what are the materials to be used in their construction, what are the dimensions of the kilns, what sort of foundation they require, what sort of material is to be used for constructing the kiln, what are the special electrical fittings which a kiln should be having, what type of pipe work, duct work it requires, were all known to the British company. In short, the foreign company is helping the Indian company in erecting a replica of their design or model of the shuttle kiln and tunnel kiln respectively, at Ranipet which is the factory site of the Indian company. The foreign company is charging separately for the material which it is supplying and also for the experts it agreed to depute to supervise the commissioning as well as erection of the kilns. How to work their own evolved model of the kiln is known only to the foreign company and it is in fact the expert knowledge which they alone had possessed and which they were parting to the Indian company on payment of £ 40,000 and £ 65,000 respectively under the two contracts in question. The drawings and specifications included the maintenance and operating instructions of the two kilns. A reading of these two contracts completely would not disclose how much the foreign company is charging the Indian company for making available their specially designed kiln models to the Indian company. The payment of £ 40,000 and £ 65,000 would include the charge of rent or revenue attributable to the use of the special model developed by the foreign company for the Indian company. Therefore, the payment of £ 40,000 is not simply a payment made towards price for obtaining the maintenance and operating instructions for the Shuttle Kiln and Tunnel Kiln. These maintenance and operating instructions by themselves will be of no use unless they were used with reference to the Shuttle Kiln and Tunnel Kiln. The payment towards these instructions, therefore, can be said to be a royalty since this can be considered to be a rent or revenue attributable to the use of an asset belonging to one person (the special model belonging to the foreign company) by another (by the Indian Company). Thus the payments of £ 40,000 and £ 65,000 should be considered as royalty payments by the Indian company to the foreign company. In this connection the learned Departmental Representative invited our attention to the definition given to the word 'royalty' obtaining in the Explanation 2, Clause (vi) of Sub-section (1) of Section 9 which reads as under:-
Explanation 2: For the purposes of this clause, "royalty" means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for -
(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property;
(ii) the imparting of any information concerning the working of, or the use of, a patent invention, model, design, secret formula or process or trade mark or similar property;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes, for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or
(vi) the rendering of any services in connection with the activities referred to in Sub-clauses (i) to (v).
As can be clearly seen that under Clause (ii) of the Explanation, imparting of any information concerning the working of the model or design should be clearly understood as "royalty". Here the Shuttle Kiln and the Tunnel Kiln are two special designs evolved by the British company. How to operate them is the exclusive preserve of the foreign company and under the stipulations of these agreements it is parting with that knowledge by way of giving maintenance and operating instructions to the Indian company. Thus the payment made towards imparting of information concerning the working of the model or design is nothing but royalty. The learned Departmental Representative drew our attention to Section 44D and Section 115A of the I.T. Act. He argued that under Section 44D(b), since these are intended payments to be made under the stipulations entered in the contracts executed subsequent to 31-3-1976, no deduction in respect of any expenditure or allowance shall be allowed under the provisions of Sections 28 to 44c while computing the income by way of royalty from the Indian concern. He also brought to our notice Sub-clause (c) of the Explanation under the said section according to which it is stated that royalty should bear the same meaning as in Explanation 2 to Clause (vi) of Sub-section (1) of Section 9. He also invited our attention to the provisions of Section 115 A of the I.T. Act, which as far as relevant to our purpose, read as follows:
115A. (1) Subject to the provisions of Sub-sections (1A) and (2), where the total income of an assessee, being a foreign company, includes any income by way of -
(b) royalty or fees for technical services received from an Indian concern in pursuance of an agreement made by the foreign company after the 31st day of March, 1976, and where such agreement is with an Indian concern, such agreement is approved by the Central Government:
the income-tax payable shall be aggregate of -
(ii) the amount of income-tax calculated on the income by way of royalty, if any, included in the total income - (1) on so much of the amount of such income as consists of lump sum consideration for the transfer outside India of, or imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property, at the rate of twenty per cent; (2) on the balance of such income, if any, at the rate of forty per cent.
Under the Explanation given under Sub-section (1) of Section 115A also, royalty should bear the same meaning as in Explanation 2 to Clause (vi) of Sub-section (1) of Section 9. Therefore, by virtue of the provisions of Section 115 A, the foreign company is liable to pay 20 per cent of the royalty payment as tax and it is to be deducted while remitting the amount and, therefore, it is correctly ordered to be deducted under the orders of the ITO which was conveyed through his letter to the Indian company.
4. It is also argued that the decision of the Hyderabad Bench of the Tribunal in Klayman Porcelains Ltd.' s case (supra) does not apply to the facts of the case because the kiln constructed in that case is not stated to be a special design or model evolved by the foreign company. Therefore, there was no scope to hold that the kiln constructed in India with the assistance of the West German company in that case cannot be said to be the property of the West German company, whereas in this case the two types of kilns constructed were no other than the replicas of the special models designed by the foreign company and, therefore, the foreign company has got property in the specialised design and models wherever such models are reproduced. Under the agreements, such models were reproduced. maintenance and operating instructions were intended to give the clues as to how those kilns are to be worked. Therefore, the payments towards imparting of information concerning the working or use of the patented model or design is nothing but royalty. The learned Departmental Representative argued that what we have to see is the nature of the receipt in the hands of the foreign company but not in the hands of the Indian company. The payments made towards these instructions is to be considered as part of the payment made towards purchase of plant and machinery and the payments go to enhance the cost of machinery to the assessee, the book of instructions being considered to be plant by itself, and the payment should be considered to be towards capital asset, are all arguments which lead us nowhere and cannot be of any use to the assessee because what we have to consider is the nature of the payments in the hands of the foreign company. So long as the nature of the payment remains as royalty payment, how that payment is treated by the Indian company is neither here nor there. Therefore, the order of the ITO should be restored and the order of the CIT (Appeals) should be set aside.
5. On the other hand, Shri R. Vijayaraghavan, the learned Advocate for the assessee, contended that all these drawings and specifications were admittedly received outside India. As for furnishing information about the Shuttle kiln and its construction, the learned Advocate submitted that the imported components of the kiln cost only Rs. 11 lakhs whereas the indigenous components which went into the construction of the shuttle kiln were valued at Rs. 43 lakhs whereas the technical know-how fee paid was only Rs. 6 lakhs. He submitted that most of the components with which the Indian company built these kilns were indigenous components and were not imported. The Tunnel Kiln was fabricated in India and the technical experts deputed by the foreign company showed only the working of the kiln. He argued that the drawings relating to the construction of the kiln formed part of the purchase price of the machinery which is to be capitalized. It is part of sale price in the hands of the foreign supplier. It is not imparting any knowledge independent of supply of machinery. Under the contractual terms the foreign company cannot say that it would supply machinery without revealing how to work it. The knowledge as to how to work it does not become royalty within the meaning of Section 9(1)(vi), Explanation 2. He submitted that the facts of this case were almost identical with the facts dealt with by the Hyderabad Bench in its decision in Klayman Porcelains Ltd.'s case (supra). In that case also, a West German company entered into an agreement with an Indian company for the construction of a tunnel kiln. There also the question was whether the payment made for drawings and technical documents constituted royalty and whether 20 per cent of the payment to be made to the foreign company could be deducted. In that case, it was held that technical documents constituted know-how and will also be plant and it would be eligible for depreciation. If the drawings and technical documents are to be treated as plant, the supply of the same from abroad in the same manner as supply of material would have the same consequences. If there is no taxable profit element in the supply of material because they were sent from abroad, there could not similarly be any taxable element in the supply of engineering data. The learned Bench held that from this angle alone the assessee is entitled to succeed. Next, dealing with the question of 'royalty' it was held that 'royalty' in the ordinary sense is rent or revenue attributable to the use of an asset belonging to one person by another. The bench found that there was no such 'royalty' in the arrangement between the assessee-foreign company and the Indian company. It was specifically found in that case that the foreign company undertook to supply, erect and commission a kiln in India, the only services rendered in India being that of supervision by an expert deputed by the assessee-foreign company. It was found that there has been no hire of any patent right or technical know-how on the part of the taxpayer in India. In that case, it was also held that there was no imparting of information to the Indian company inasmuch as they were neither interested nor had the capability by way of expertise to use these materials for construction of other kilns for themselves or for others. The Indian company was not in the business of construction of kiln for others. Its only purpose of having a kiln constructed was for manufacture of ceramic tableware for sale by it. It was, therefore, neither interested nor did it acquire the designs and drawings for the exploitation of the same by the use of the self-same design and drawings for construction of other kilns. Ultimately the Tribunal held that it was not liable to tax. Therefore, the learned Advocate for the assessee contended that imparting of knowledge as to the maintenance forms part of the machinery. Shri Vijayaraghavan also brought to our notice the C.B.D.T. Circular No. 23 of 1969, dated 23rd July, 1969 which is printed at pages 779 to 783 of Sampath Iyengar's Law of Income Tax, (Eighth Edition). He also seeks to rely upon the Supreme Court decision in Carborandum Co. v. CIT [1977] 108 ITR 335 at page 344.
6. The learned Departmental Representative while replying contended that though the drawings were handed over outside India, they were implemented in India and so part of the income arose to the foreign company in India. Therefore, the income arose under Section 5 which is not concerned with the deeming provisions of Section 9. The Departmental Representative also relied upon the Andhra Pradesh High Court decision in Skoda Export v. Addl. CIT [1983] 143 ITR 452 at page 456 in which Carborandum Co.'s case (supra) relied on by the assessee was distinguished.
7. We have completely heard the arguments advanced on both sides and we have perused the records of the case. We are of the view that the appeal should succeed. From the facts it is clear that the foreign company had some special designs of Shuttle Kiln and Tunnel Kiln. They are their patented designs and models in U.K. By use of their patented models and designs, they have been producing the sanitaryware products and because their products gained fame and name in the world market and because they were recognised specialists in the world the Indian company approached them with a request that the foreign company should furnish drawings and specifications etc. of their model designs of Shuttle Kiln and Tunnel Kiln (specifically named as Bricesco Twin Track Shuttle Kiln and Bricesco Tunnel Kiln). The foreign company for the purpose of construction of the kilns offer advice as to the materials to be used for construction, the availability of such material in India, supply of certain machinery from abroad and they should depute their engineers both at the time of construction as well as at the time of commissioning of the kilns. So with the help and assistance of the foreign company, the Indian company was able to produce a replica of the patent or design or model of one Shuttle Kiln and one Tunnel Kiln invented by the foreign company at the factory site of the Indian company at Ranipet. It is easy to be seen that the foreign company had its property in the special design or model evolved by them in the construction of the same type of Shuttle Kiln and Tunnel Kiln. Thus the model or design which was copied in India is the property of the foreign company. How to work the Shuttle Kiln and the Tunnel Kiln which are of the special make of the foreign company is the exclusive preserve of the foreign company. When once that information as to the working of the Kilns as well as the maintenance of the Kilns is imparted to the Indian party, in our opinion, it would amount to imparting of information concerning the working or the use of the invention, model or design belonging to the foreign company. If the purpose of the documents containing maintenance and operating instructions was only to impart the information concerning the working of the invention, model or design of the foreign company within the meaning of Section 9(1)(vi), Explanation 2, of the I.T. Act, then the payment for obtaining such maintenance and operating instructions should be held to be 'royalty'. In this connection, we are of the opinion that the facts in the case of Klayman Porcelains Ltd. (supra) are different from the facts of this case. In the case dealt with by the Hyderabad Bench of the Tribunal, nowhere it was found that the Tunnel Kiln constructed with the help of the German company was a patented design of the German company. This makes ocean of difference and non-availability of this material fact would also distinguish this case. In our opinion, the patented design or model evolved by the British company (Bricesco Twin Track Shuttle Kiln and Bricesco Tunnel Kiln) are to be considered as property of the foreign company and allowing the Indian company to exploit the said model as against some payment is nothing but realising the rent from out of such property even though the meaning of the term 'royalty' should be taken as rent or revenue attributable to the use of an asset belonging to one person by another is to be applied. According to us, the ratio of the decision in Klayman Porcelains Ltd's case (supra) cannot be applied to the facts of this case since that facts are not identical and they differ very much in one material particular, namely, that the Kilns erected in India are a replica of the patented model or design evolved by the foreign company. The argument of Shri Vijayaraghavan that the assessee has only constructed the kiln and the foreign company only supplied some part of the kiln cannot be accepted as correct. A reading of the stipulations in the agreement would falsify the said argument. The foreign company had to supply even the foundation drawings for the kiln and the preamble of each of the contracts is as follows:-
We, British Ceramic Service Co. Limited, undertake to supply to E.I.D. Parry Limited the following drawings, information, essential components and specialist supervision/commissioning engineers to enable E.I.D. Parry to procure the necessary indigenous materials and construct, commission and operate Bricesco Twin Track Shuttle Kiln for the retiring of vitreous china sanitaryware.
A similar preamble also occurs in the other contract concerning the Tunnel Kiln. It is very clear that the kilns constructed at Ranipet were only replicas of Bricesco Twin Track Shuttle Kiln and Bricesco Tunnel Kiln which are the specialised version of the foreign company. It is very clear that for construction, the foreign company is obliged to supply even from the stage of drawings the essential components as well as information. Therefore, from the very beginning till the end, the construction must be done as per the advice of the foreign company. Schedule 7 speaks of guarantee and performance and schedule 7.1 speaks of structure and equipment and it is stated in that paragraph:
We guarantee the kiln structure and lining for 300 firings or 12 months from the date of light-up (whichever is the sooner) and all mechanical and electrical equipment supplied by us or specified and approved by us for a period of 12 months from light-up and will supply free of charge within that period replacement parts (ex works, packed for shipment) for any parts which may prove defective, either from faulty materials or improper workmanship, fair wear and tear excepted. Unless and until the structure of the kiln was the sole responsibility of the foreign company and it was constructed at the responsibility of the foreign company completely, how does the foreign company come forward to guarantee the performance of the kilns. Therefore, these kilns were constructed not by the Indian company with the mere assistance of the foreign company. These kilns, on the other hand, were built up on the sole responsibility of the foreign company for which guarantee of performance was also given. Further, Schedule 8 speaks of "Functional Tests" in which it is stated as follows: On general completion of the kiln Bricesco will carry out the following Functional Tests within 48 hours notice of the Engineer :
1. Pressure test the gas/liquid Naptha system.
2. Light all burners individually.
3. Test all safety circuit.
4. Demonstrate function ability of all electrical and mechanical equipment.
On satisfactory completion of these tests the Contractor issues a Functional Certificate and hands over the Operational Manual. As from the date of the Functional Certificate the Purchaser is responsible for the labour and materials to operate the plant and the insurance of the plant.
Schedule 9 gives out what would be contained in Operational Manual. It is stated that it contain the following:
1. Operating instructions.
2. Maintenance Instructions.
3. Electrical wiring diagrams.
4. Spare Parts List.
Now in this case we have to apply the law which came into force subsequent to 1-4-1976. Section 44D came into the statute book only from 1-6-1976. Similarly, the provisions of Section 115A also were brought into effect from 1-6-1976 under the Finance Act, 1976. Under these provisions, we are not concerned as to how the payment is considered by the Indian company but we are very concerned with the nature of the payment in the hands of the foreign company. To determine whether the payment constitutes royalty or not we will have to understand the meaning of the word "royalty" as it is given under Section 9(1)(vi), Explanation 2. Only for that limited purpose, the provisions of Section 9 are relevant. We are not concerned with the rest of the section. No doubt, Section 9 deals with income deemed to accrue or arise in India. We are not concerned with the deemed income arising in India. It is not necessary that before royalty is to be taxed in the hands of the foreign company, it should be the income deemed to accrue or arise in India. We have to only see whether the provisions of Section 115A are complied with or not. Now in this case the provisions of Section 115A(1)(b) are fully complied with since we hold that the amount receivable by the foreign company was in the nature of "royalty" from an Indian concern and the said sum was payable in pursuance of an agreement made by the foreign company with the Indian concern after 31st March, 1976 and the said agreement was also approved by the Central Government. Therefore, according to us, the amounts of £ 40,000 and £ 65,000 before they being paid to the foreign company, 20 per cent should be deducted towards tax deducted at source.
8. The Supreme Court case in Carborandum Co. (supra) is distinguishable on facts and the ratio laid down therein cannot be applied to the facts on hand for the following reasons:
(i) The Supreme Court case is a case decided under the Indian Income-tax Act, 1922 but not under the Income-tax Act, 1961. In that case the question of 'royalty' does not figure at all. Neither the definition of 'royalty' nor the payment of 'royalty' figured for decision by the Hon'ble Supreme Court. In that case, what was paid was technical fee but it was considered as 'royalty' by the Commissioner while passing his order on revision. The question which was referred to the Madras High Court by the Tribunal in that case was whether the technical fee over and above 5 per cent received by the American company from the Indian company during the accounting year relevant to the assessment year 1957-58 had accrued or arisen in India? The Hon'ble Supreme Court had occasion to interpret Section 42 of the Indian Income-tax Act which is equivalent to Section 9 of the Income-tax Act, 1961 which speaks about deemed income. In this case we are not concerned with the whole body of Section 9 of the I.T. Act except the definition of "royalty" given under Section 9(1)(vi) Explanation 2. In this case we are concerned with Sections 115A and 44D both of which do not deal with deemed income but only deal with royalty income actually received by the foreign company. In the facts before the Hon'ble Supreme Court in Carborandum Co.' s case (supra), it was specifically found that no part of the activity was carried on in India by the foreign company. Even the technical personnel required to assist the Indian company were provided only outside India. Their Lordships of the Supreme Court had reiterated the principle which was already set out in the earlier decision of the Supreme Court in CIT v. R.D. Aggarwal & Co. [1965] 56 ITR 20. The principle thus reiterated was inter alia the following :-
Income not taxable under Section 4 of the Act of a non-resident becomes taxable under Section 42(1) if there subsists a connection between the activity in the taxable territories and the business of the non-resident, and if through or from that connection income directly or indirectly arises. Since we are not considering any deemed income in the hands of the foreign company under Section 9 of the I.T. Act, the ratio of the decision of the Hon'ble Supreme Court in Carborundum Co.'s case (supra) is not at all relevant to be considered in this case and hence Carborandum Co.'s case (supra) cannot be of any help to the assessee.
9. Again our attention was drawn to be C.B.D.T. Circular No. 23 dated 23-7-1969 found quoted at page 779 of Sampath Iyengar's Law of Income-tax, Eighth Edition. Our particular attention was drawn to paras 7(i) and (ii) of the Circular No. 23 of 1969 dated 23-7-1969. The text of the circular is as follows:-
7(i) Where the technical know-how obtained, relates to the design and engineering of the plant in India or the erection and commissioning of the plant, the payment should be treated as forming part of the cost of the machinery and plant and depreciation and development rebate should be allowed thereon. Where, however, the technical know-how is not directly relatable to the depreciable assets and cannot be regarded as forming part of their cost, the expenditure though treated as capital, would not be eligible for the allowance of depreciation and development rebate.
(ii) As regards technical know-how obtained in the form of drawings and designs and technical information and knowledge concerning the product to be manufactured and the process of manufacture, it will be sometimes difficult to decide whether the payment made therefor is capital or revenue expenditure. A pertinent question to be answered in this connection will be : Have the technique and knowledge obtained through the designs, drawings, etc. become the property of the Indian participant for all time to come or only for the duration of the agreement? If it is only for the duration of the agreement, the next question is whether the agreement is for such a long period that the Indian participant might still be said to have acquired an enduring benefit for the purpose of his trade? Further, after the conclusion of the period of the collaboration, what are the rights and benefits, if any, which would permanently accrue to the Indian participant's business? These and other related questions have to be looked into in order to decide whether the expenditure is capital or revenue in nature. If as a result of this examination, it is found that no asset or advantage of a permanent or enduring character is acquired by the Indian participant, the expenditure should be treated as revenue expenditure and allowed as a deduction. It may, however, be noted, in this connection, that if the said expenditure on product and process designs and drawings is treated as capital expenditure, the Indian participant will not be entitled to any depreciation or development rebate on the outlay. The amount cannot also be amortised and allowed Over a period of years (unless the payment is for the acquisition of patent rights which are discussed separately) as there is at present no provision to this effect, in the Income-tax Act.
As can be seen from the above, what was clarified was the treatment of the payment made by the Indian company to the foreign company. It was stated that where technical know-how obtained relates to design and engineering of the plant in India or the erection and commissioning of the plant, the payment should be treated as forming part of the cost of the machinery and plant. As regards payment made towards technical know-how obtained in the form of drawings and designs and technical information and knowledge concerning the product to be manufactured and the process of manufacture, the payment may be capital in certain circumstances and revenue in certain other circumstances enumerated therein. However, the C.B.D.T. Circular was not a clarification given as to how the payment is to be treated in the hands of the foreign supplier. It deals with the nature of the payment in the hands of the recipient Indian party only. Further, the C.B.D.T. Circular is given under Section 9 of the I.T. Act, 1961, with which we are not concerned in this appeal. We have already clarified that we are mainly concerned with the interpretation of Section 115A and 44D of the I.T. Act, 1961. Thus the C.B.D.T. Circular cannot be of any avail to the assessee.
10. The learned Departmental Representative relied upon the Andhra Pradesh High Court decision in Skoda Export's case (supra). There, the question was whether any income accrued or arose to the non-resident company in respect of fee for consulting activity as a result of operations carried out by it within the taxable territories and whether there was any business connection. Again, we are not on the question of business connection at all since we are not dealing with this case under Section 9(1)0) of the I.T. Act. In our opinion, the ratio of the Andhra Pradesh High Court decision is not relevant for the purpose of this case.
11. In the view we have taken, we set aside the order of the CIT (Appeals) and restore the order of the ITO.
12. In the result, the appeal is allowed.