Madras High Court
Commissioner Of Income-Tax Tamil ... vs Madras Rubber Factory Ltd. on 17 September, 1982
JUDGMENT
Balasubrahmabyan J.
1. These tax cases are concerned with a point arising out of a technical collaboration agreement between the assessee, an indian company, and an Amercial company called "Mansfield Rubber and Tyer Company Inc. " the agreement dealt with two distinct matter : (i) the planning and setting up of a tyre factory in Madras, for the assessee-company; and (ii) a continuous supply of information and technical consultancy services for a period of years running the assessee's factory after its installation. On both the assessee sought the collaboration of Mansfield. On both Mansfield gave the requires collaboration. The consideration payable by the assessee to Mansfield wa set out in the agreement. But it was distinct and separate fro each aspect of collaboration. For supply of blue print for setting up the factory there was a separate consideration. the assessee has to pay the Amercial collaborator in this regard a lump sum consideration of 100,000 dollars. fro supply o plant and machinery of foreign make for the factory to be set up in INdia, there wa another distinct provision. The Indian company was to allot to Mansfield fully paid equity shares of the value of 500,000 dollars inserted of cash payment.
2. There is no dispute that these tow payments namely 100,000 dollars paid for impost of the factory equipment and 500,000 dollars worth of equity shares allotted to Mansfield in consideration for supply of blue print and factory installation were in the nature of capital expenditure in the has of the assessee-company. The assessee accordingly did not claim and deduction for this capital outlay either in drawing up its profit and loss accounts or in formulating its income-tax returns.
3. The other part of the consideration payable by the assessee to Mansfield related to payment for consultancy services supplied by Mansfield from time to time for running the factory and for maintaining in production. The collaboration agreement laid down that this part of the consideration was to be paid for by the assessee to Mansfield at the rate of so much on the gross value of the products turned out from the factory after commencement of production. The ITO took the view that by an large the payment made by the assessee for consultancy services supplied by the foreign collaborator for running the factory would be revenue account. Nevertheless the officer though that there must be some capital element even in this consideration paid to the foreign firm of technical advice on the day-to-day running of the factory. The officer, however, has no means of precisely indentifying the capital element in this payment. He accordingly resorted to a rough and ready estimate, and disallowed 25, per cent. of the fees paid by the assessee s relating to capita element, and allowed the balance of 75 per cent. alone as revenue outgoing.
4. the AAC, as well as the Appellate Tribunal, differed from the ITO. they held that there wa no warrant for the disallowance of any portion of the royalty fees paid by the assessee to Mansified in consideration of their supply of technical information and consultancy services for running the factory.
5. In this reference the Tribunal decision is challenged by the Department on the following question of law :
"Whether, on the facts and in the circumstance of the case, the Appellate Tribunal was right in law in holding that the entire payment of royalties made by the assessee-company to its collaborator, M/s. Mansfield Tyre and Rubber Company, U. S. A. was revenue expenditure and, therefore, liable to be allowed as a deduction from the income of the assessee?"
6. The question impliedly reiterates the Departments stand that 25 per cent. of the fees paid by the assessee to Mansfield has to be disallowed as partaking of the nature of capital expenditure, having regard to the nature, m object and effect of the payment.
7. Collaboration agreements and know-how payments are the economic consequences of the peace. When they first emerged after World WAr5 II, the tendency of people around was to regard them with peculiar respect, if not veneration. Even tax courts, in the beginning approached collaboration and know-how as out of the ordinary., The novelty of the jargon has since worn off. So too the inhibitions on our understanding. WE are now capable of deciding, m with confidence and ease, questions of the kind which were once thought difficult to answer, such for instance, as to whether a given known-how payment is capital or revenue. We are assets in this task by the fact that collaboration agreements are invariably reduced to writing often set, down in rigid legal prose, leaving very little to be inferred from outside. Whenever, therefore, a question is raised about the nature of the commitment of one or the other of the parties to a collaboration agreement we have only to go into the relevant clauses to be able to arrive a a satisfactory solution. A different approach is not indicated merely because the question which call for our answers relate to taxation. they too depend, first and foremost, on the terms of the documents. Once their meaning is grasped, m the rest is merely the application of the usual tests were employ to every other commercial contract. The tools of our understudying are the same; the materials are the same; customer alone is different, namely, the REvenue.
8. In this case, too, the arguments from the bar were addressed, under standably enough on terms of the collaborations agreement between Mansfield and the assessee-company. Two clauses in particular figure much in the discussion. clause 1(g) of the agreement lays down that Mansfield has undertaken to do, m once the assessee's factory was set up and got going. Clause 2(f) deal with the consideration payable to Mansfield on this aspect of collaboration. Both clauses, it seems to us, are singularly free from ambiguity of any kind. Under the former provision, Mansfield wa to maintain at the assessee's plant a full-time engineer qualified as a production and quality control expert. This resident engineer was to keep the assessee informed of the specifications, chemical formula and other technical development at Mansfilds's plant at Ohio in Amercial and also make the relevant information available to the assessee technical personnel. The resident engineer was also to be available for advice to the assessee's technicians on all working days excepting days when he wa on leave f absence. the general aim expressly avowed in this clause was that development and improvements in Mansfilds's Ohio plant must be "simultaneously made available" to the assessee Company.
9. In consideration of the services undertaken by mansfiled under clause 1(g) to be performed directly as well as through their resident engineer, Mansfiled was to get a remuneration called "fees". Clause 2(f) lays down that fees have got to be calculated on the gross sale piece of the products turned out by the assessee's factory. this calculation varied from product to product. Tyre and tubes were calcified under one has, miscellaneous products other than types and tubes were grouped under another head. The fees payable to Mansfiled were calculated at a flat rate of 2 per cent. on the gross sale value of the miscellaneous products. Fro tyre and tubes, however, graduated rates were fixed. For instance, a rate of 2 1/2 per cent/. was to be calculated on the value of the first 120,000 tyers produced; for production in excess of 120,000 tyers but up to 180,000 the rate was 2 per cent. and so on.
10. On a plain reading of these two privation in the agreement it is clear to us that no part of the fees payable by the assessee to Mansfiled can partake of h character of capital payment. the whole of the fees was avowedly intended by the parties as a consideration for technical consultancy services which are requisites for keeping the factory going. the agreement itself, as we pointed out before, keep's the two aspect of Mansfield's collaboration meticulously distinct nd separate. One connected with the initial setting up of the factory and the other connected with the running of the factor. the object and end-result of the fees paid by the assessee to expenditure. capital as period contract the of duration for Mansfiled to payable fees consultancy portion any disallowing scope afford not do implied or express whether case. this in agreement terms that satisfied are We contract. commercial ordinary other under payments way same just viewed be but special, something collaboration foreign a observed, earlier we As expenses. running factory?s competent another only while, all constitutes, it when collaborator nature considering enunciated can principal different how see rest. revenue and character, composite mixed expenditure regarded yet must expenses, operational assessee?s part from they although outgoing, these suggest is character. exclusively wholly overheads incurring material, raw price purchase payment staff, workmen won its assessee by suggested outgoing. represent latter expenditure, presents former even whatever doubt no There profit. into turn stocks trading produce unit, industrial an run factory instillation after
11. Mr. Jayaraman, learned counsel foe the Revenue, directed his argument to one aspect of the agreement which he considered significant. He stressed, not what the agreement expressed, but what it left unexpressed. There wa no provision in the agreement, he said which obliged the assessee to return to Mansfiled all the formulae, specification, and other technical information it has received from the Ohio plant during the subsistence of the contract. Learned counsel pointed out that where the assessee wa not under any obligation to pay Mansfiled any royalty or consultancy fee after the end of the contract period, there was noting to prevent the assessee from putting to use, till the end of time, all the technical know0-now it has learnt from the literature sent by Mansfiled from Amercial during the term of the contract. Herein lies, according to Mrs. Jayaraman, the element of enduring benefit to the assessee, and with it the element of capital expenditure in the fees and royalties payable by the assessee to Mansfiled under the agreement.
12. We must reject the argument of Mr. Jayaraman as unsound. it is based on the supposition that any expenditure our outlay by a taxpayer which results in enduring benefit to this trade must, without more, be regarded as capital in character. The truth, however, is that enduring benefit is not the acid test of capital expenditure in all cases. Even its elaborate author, Viscound Cave while laying done this test in Atherton v. British Insulated and Helsby Cablkes Ltd. [1925] 10 TC 155 (HL), did not mean to propound a doctrine in unqualified terms. In the recent Empire Jute Co.; s case [1980] 124 ITR 1, our Supreme Court has has occasion to clearly this position. They explained Viscount Cave's dictum this way : enduring benefit to advantage might ensure to an assessees business either in a capital filed to its activity might ensure to an assessees business either in a capital filed to its activity or in a non-capital filed' in every case, therefore, the inquiry must be directed as much to the character of the expenditure as to the nature of the advantage derived therefrom.
13. The supreme Court's enunciation of the test of enduring benefit is particularly apposite in the present case. It may be concealed that what Mansfiled or its resident engines in India were imparting to the assessee on operational matter might tend to outlast, and endure beyond, the contract period. this however, is a common characteristic of all knowledge which a person acquires. there is a saying in Tamil that knowledge once acquire is everlasting and it cannot be destroyed either by flood or by fire, nor can it be obliterated or eve diminished by being imparted to others. Technical or commercial knowledge acquired by a trader or industrialist is of this kind, enduring, if not everlasting. 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 reven expenditre. it the position were otherwise, practically any item of revenue outgoing in the day-to-day running of a business can be broken up and dissected in an effort to discover in it some fractional element or other of a capital nature, merely on the score that the resulting benefit or advantage tends to pay in the business. This, however, is not the law.
14. In our view, there is no principle or authority to support the partial disallowance which the ITO made in this case out of the total amount of fees and roulettes paid buy the assessee to Mafuled. it cannot be said that the object of this payment or even its end-result has enlarged the assessee's fixed capital equipment or the capital structure. the assessee is no about in a position to keep for itself all that it has learnt from Mansfield during the contract period. But this only serves the assessee to run its business as efficiently after the contract period s it did during that period. We did not, therefore, accept the these is that any part of the fees can be regarded as having any capital element deserving of disallowance under the I. T. ACt.
15. In support this construction of the agreements in this case, Mr. Jayaraman particularly relied on two reported decision, CIT v. Ciba of India Ltd. [1968] 69 ITR 692 rendered by the Supreme court and the Fenner Woodroffe case [1976] 102 ITR 665, rendered by this court. Both were cases dealing with foreign collaboration agreements in which the tax treatment of royalty paid for acquiring foreign known-how was in question. In the Supreme Court case, the agreements in question contained. internal laid, an express provision requiring the assessee to return to the foreign collaborator all the formulae and specifications at the end of the contract period. In the Madras case, a clause of this kind was not to be found in the agreement in question. According to learned counsel; s comparative study of these two decisions, the presence or absence of a provision for a return of the specifications at the end of the agreement made all the difference for the determination of the real nature of the expenditure in each case. In the one case, it was said the provision was regarded by the court as decisive and on that basis the royalty paid to the foreign collaborator was delay with as an item of revenue expenditure4e. In the other case, according to learned counsel, the absence of a like provisions led the court to arriving at the opposite conclusion that the expenditure was capital in nature.
16. We do not have to consider whether and to what extent the Supreme Court wa swayed by the presence of the clause in question. Nor do we have to examine the validity of the assumption that a return of the specifications to the foreign collaborator at the end of a collaboration agreement would automatically obliterate the experience, gained by the assessee in working these specifications for the duration, for, our task in this case is curt out for us. What we have is an agreement in writing between two commercial concerns which cries around for being construed on its own terms. Earlier decision of courts even though rendered on agreements in this genre can only come in our way nd clutter up our decisions. They are neither precedents to be followed, nor aids to construction to be adopted. The Ciba case and the Fenner Woodroffe case [1876] 102 ITR 665 (Mad), whether considered separately or in juxtaposition, m do not lay down any rule of construction which regards the presence or case of a provision for return of the know-how literature to the foreign collaborate as a crucial factor in the construction of collaboration agreements. We, therefore, desist from further consideration not only of these two decisions, but of other reported cases cited before us during argument.
17. In the result, our answer to the question of a is in th affirmative and in the assessee's favour. The Department will pay the cost of this reference to the assessee. Counsel's fee Rs. 500 (one set).