Income Tax Appellate Tribunal - Ahmedabad
Sandeep Enterprises (P.) Ltd. vs Income-Tax Officer on 13 July, 1989
Equivalent citations: [1989]31ITD101(AHD)
ORDER
K.R. Dixit, Judicial Member
1. Both the above appeals are inter-connected and therefore, they are disposed of by this common order. For the asst. year 1981 -82 there is only one ground. It is as follows:-
The CIT erred in disallowing depreciation and investment allowance on the capitalised expenditure of Rs. 1,03,678 being technical fees paid to M/s. Liquid Nitrojen Processing Corporation, USA.
2. The assessee had entered into a collaboration agreement with a foreign corporation for the manufacture of certain products and the licence to sell the same. The material parts of that agreement are-
1. Under clause 2(a) the Corporation agreed to grant the assessee exclusive licence to use know-how and improvement to be disclosed by the corporation and practise the same for the manufacture, use and sale of licenced products.
2. Under clause 3(a) the corporation agreed to supply to the assessee all its present know-how to the extent practicable.
3. Under clause 4 of the agreement the assessee was to pay the corporation $ 18,000 as "technical fee" during the term of the agreement. The payment was to be made as follows:-
(i) Within 30 days of the effective date of the agreement the assessee was to pay the corporation an initial instalment of $ 6,000.
(ii) Within 30 days of the time of transfer of technical documentation the assessee was to pay the corporation the second instalment of $ 6,000.
(iii) Within 30 days after the end of the month in which commercial production was achieved the assessee was to pay the corporation a third instalment of $6,000.
The assessee also agreed to pay the corporation a royalty of 3% of the net ex-factory sale price of the product for a period of 5 years starting at the end of the month in which the first commercial production was achieved. The Income-tax Officer disallowed the assessee's claim of depreciation and investment allowance on the capitalised expenditure of the rupee equivalent of the first two instalments of the aforesaid payment of $ 18,000, i.e., $ 12,000 following the directions of the IAC Under Section 144B. The Commissioner has reproduced the directions Under Section 144B and agreed with the reasoning therein. We have, therefore, to consider those directions. Briefly stated the substance of the reasoning therein is that under the agreement the assessee got (a) the licence to produce and sell the licenced products, and (b) the know-how of the manufacture thereof. Since under the terms of payment there was no bifurcation specifying the payments for the licence and payment for the know-how a rule of logic had to be applied for the purpose. Beginning serially the first part of the agreement was regarding the grant of licence. Unless the assessee received that licence, know-how could not be purchased and therefore, the first part of the payment related to the licence and the second part, viz., royalty related to the know-how. There could not be "technical fee" for sale of technical know-how. The words used in the agreement 'technical fee' could not change the character of the payment. That fee is a lump sum amount related to the grant of licence while technical know-how being direct source of production and income was its price in terms of royalty. Thus, according to him, the lump sum payment of $ 18,000 was relatable to the licence and royalty was relatable to know-how. The second step is that the licence was not a part of machinery while technical know-how got translated into machinery and designs, production, process, materials, etc., and into something tangible. The third step is that the two instalments of $ 6,000 each were to be paid at the time of transfer of technical documentation. Therefore, at the point of time of payment of these two instalments no technical know-how passed to the assessee. Therefore, the payment of $ 12,000 equivalent to Rs. 1,06,678 was for the purchase of licence and not related to plant and machinery. Consequently, the claim of depreciation and investment allowance in respect of this amount could not be allowed.
3. On behalf of the assessee it was submitted that the IAC's method of interpreting the agreement was incorrect. The terms of payment could not be bifurcated according to some logical process. On the other hand, the learned Departmental Representative pointed out that under the terms of payment the lump sum payments were all to be paid within 90 days of the agreement.' The royalty payments were measured in terms of the value of the production and were for the know-how. He, therefore, submitted that if there was no specific allocation it had to be done on the basis of logic particularly because the licence was saleable and it was paid for separately.
4. In our view, the last submission of the learned Departmental Representative is the very question which we have to consider viz. whether the licence is paid for separately. Now, this agreement is to be viewed as a whole. It cannot be divided in terms of licence and know-how. The licence to sell the goods produced as a result of know-how serves the purpose of obtaining the know-how. When a party obtains the know-how to produce certain goods, ultimately it is interested in selling those goods so as to earn a profit. The licence is given to the party by the very corporation which supplies the know-how and it is in respect of the goods for which the know-how is given that the licence to sell those goods is also given. Therefore, the licence cannot be separated from the know-how. Moreover, it is not correct to say that the licence is assignable as the learned Departmental Representative suggested. Clause 2(a) of this agreement clearly provides that the licence is personal to the assessee and can be transferred or assigned only with a prior written permission of the corporation. Clause 11 of the agreement also permits the assignment of the agreement as a whole and not the licence and the know-how separately. Looking to the terms of the payment the purpose of providing for the lump sum payment is that the corporation wishes to start collecting the payment from the assessee as soon as the agreement is entered into by stages before the production commenced. Part of the payment is in lump sum and the remaining is on the basis of percentage (called royalty). These are merely various stages in obtaining payment. Further, the second instalment of $ 6,000 is to be paid within 30 days of the transfer of the technical documentation. This means that it is paid after the know-how is given by the corporation to the assessee and not before that as wrongly stated by the IAC. So even on the basis of his own reasoning the second instalment has to be taken into account for depreciation and investment allowance. However, in view of our above reasons the entire sum of $ 12,000 equivalent to Rs. 1,03,678 has to be taken into consideration for this purpose.
5. For the asst. year 1982-83 the first ground is that the Commissioner erred in confirming the Income-tax Officer's order adopting the WDV of the assets which was taken after reducing the element of know-how fees capitalised in the earlier year. The Income-tax Officer had not allowed the amount of Rs. 1,03,678 to be capitalised in the earlier year and so arrived at a lower figure for the WDV. This ground is merely consequential upon the earlier year's decision. Since we have held that the said amount is to be capitalised this ground is allowed for this year.
6. The next ground is that the Commissioner erred in confirming the Income-tax Officer's decision disallowing a sum of Rs. 15,353 being the royalty paid to the said Corporation treating it as capital expenditure. The details of payment regarding royalty has already been stated above. We have to consider whether this expenditure is of capital or revenue nature. For this purpose it is necessary to ascertain what this royalty amount was paid for and what advantage the assessee got from this payment. The expression "know-how" has been defined in clause \(d) of the agreement as follows:--
(d) 'know-how means drawings, plans, design, quality controls, machine and mechanical specifications, engineering data, production techniques, tooling information, installation data, application data, inventions, processes, sources of supply, marketing data, and sales techniques all relating to the Field of this Agreement, and shall include, by way of illustration, but not limitation :
(i) Product formulations - specific basic resing, colorants, glass, asbestos fibres or other ingredients (including fibre length, sizing agents) plus coupling agents and/or lubricants, as appropriate,
(ii) Product characterizations - physical property data on commercial and development products.
(iii) Product processing recommendations - plastic processing equipment settings and conditions, mold design recommendations, and, to a limited degree, the effect of varying settings on finished piece properties.
(iv) Product application data - recommended design features peculiar to fortified thermoplastics, application descriptions and case histories.
(v) Manufacturing equipment design - including resin-fortified blending and feed systems, extruders, screws, drives, venting systems, extrusion dies, water baths, cooling belts and blowers, pelletizers, pellet classifiers, pellet blenders, scrap/off grade refeeding systems, packaging systems.
(vi) Manufacturing processing recommendations - settings and operation of above equipment.
(vii) Quality Control - recommended tests and procedures, expected test results and limits used for production specifications.
(viii) Competitive products - evaluation of such materials, as to physical properties and processability.
(ix) Marketing information - market forecasts and historical data showing volume of products sold by resin category and application area; pricing; samples of promotional literature and advertising.
Under clause 3(c) of the agreement of the know-how including all writings was to remain the sole property of the corporation and in case the agreement is terminated it has to be returned to the corporation at its request. Further, the assessee was not to disclose or communicate to any third party the know-how except with the permission of the corporation. The term of the contract under clause 8 is a period of 8 years from the effective date of the agreement or 5 years from the date of commencement of the production whichever was the shortest. Under clause 9 the corporation has power to terminate the agreement for certain special reasons. Under Sub-clause (c) of clause 9 on termination of the agreement for any of those reasons all writings, drawings, photographs dealing with the information referred to above were to be returned to the corporation. On behalf of the assessee it was submitted that royalty is a revenue expenditure relying upon certain observations in the book of Chaturvedi and Pithisaria at pages 525 to 527 and on the decision in Mysore Kirloskar Ltd. v. CIT [1968] 67 ITR 23 (Mys.).
7. On the other hand, the learned Departmental Representative submitted that we have to ascertain whether the assessee has derived any benefit of enduring nature. He relied upon Tribunal's decision (Ahmedabad Bench - C) dated 25th October, 1988 in ITA Nos. 2428 to 2432/Ahd/1986 where it has been held that the royalty payments for know-how were of a capital nature.
8. Now, first of all as indicated above by a reference to the specific clauses of the agreement the know-how material was to be returned to the corporation at the end of the agreement and even, during the agreement it was to remain the property of that corporation. Secondly, the agreement is for a period of only 5 years from the date of the commencement of the production. Moreover, clause 8(b) also provides that within that period the assessee is to develop its own design and research so that it does not remain dependent upon the corporation beyond that period. Therefore, both these features of the agreement show that the assessee did not get an advantage for a long period. As stated above, the learned Departmental Representative has relied upon a Tribunal decision and in that connection pointed out the definition of know-how in the agreement which has been reproduced above. The Commissioner in that case had held the royalty payment to be of a revenue nature relying upon the following services the collaborators were to render:--
(i) Inspection of out-existing machinery and instruction regarding general plant lay-out and scope drawing.
(ii) Detailed specification of the equipments.
(iii) Periodic inspection of equipments during their several visits.
(iv) Witnessing tests for equipments where necessary.
(v) Drawings for structural supports for equipments, piping, electricals, along with equipments.
(vi) Supervision of erection.
(vii) Supervision of commissioning.
(viii) Training of technical personnel.
(ix) Operation and maintenance instructions.
(x) Conducting test runs to show guaranteed production.
According to him most of these services were such that expenditure in relation to them would be of a revenue nature. The Tribunal however, pointed out that the collaborators in that case had not only sold the drawings of the plant and machinery to the assessee but also taken upon themselves the obligation of rendering advice for purchase of machinery, its erection, commission, test running and working with guaranteed production. The Tribunal called this the main services which according to it had been overlooked by the CIT who had relied only upon the 10 services (above) listed by him. Now, in the present agreement there is no such clause as the one which the Tribunal has relied on. On the contrary, under clause 3(b) of the agreement it is stated that the sole obligation of the corporation was to furnish the know-how and that it makes no warranty in respect thereof whether for any result of the use thereof or the sufficiency thereof to accomplish a desired result or the quality or quantity of the licenced product which could be made thereunder, etc. Therefore, the above decision of the Tribunal is not applicable to the present case. On the other hand, some of the items in the definition of know-how are such that they would be of current use during the process of production for short period. They are quality control, marketing data, sale techniques. Therefore, the royalty payment in this case has to be regarded as of revenue nature. 9. In the result, both the appeals are allowed.