Madras High Court
Commissioner Of Income-Tax vs W.S. Insulators Of India Ltd. on 29 July, 1998
Equivalent citations: [2000]243ITR348(MAD)
Author: R. Jayasimha Babu
Bench: R. Jayasimha Babu
JUDGMENT R. Jayasimha Babu, J.
1. The assessee entered into an agreement with a Swiss company for the manufacture of insulators, lightning arresters, coupling capacitors, capacitive voltage transformers and line traps. Under the agreement, know-how was acquired for the manufacture and which has to be provided by the Swiss company, which also granted licence to the assessee to manufacture the products then based on its drawings and market the same in India and in consultation with the Swiss firm also export the products so manufactured. The products were entirely new products. The licensor was to check the equipment which was ordered by the assessee from Switzerland and in other countries in Europe. The licensor also undertook to give advice regarding the suitability of the equipment made in India required for installation in the newly established industry. Advice regarding the lay out and the manufacturing operation was also to be given. The products manufactured by the assessee in the newly established factory were to be tested by the licensor in its testing room in Basle in Switzerland. All drawings and documents were not to be used by the licensee for purposes other than the purpose of the agreement without the specific approval of the licensor. The licensor undertook under the head "Technical assistance" to provide all data concerning the device and methods including the know-how of manufacturing secrets, so that normally qualified technicians can use them, after a reasonable period of training. The drawings required for the manufacture of the device along with a complete technical file were also to be placed at the disposal of the licensee. The licence was not assignable and the licensee was the sole and exclusive licensee for the Union of India.
2. The payment for the services rendered was split in the agreement itself between the payment for transfer of information in Clause 9 and payment by way of royalty in Clause 10. Clause 9 of the agreement requires the licensee to pay a sum of Rs. 1,27,500 equivalent to SFr. 71500 free of tax before receiving the drawings and information. Royalty was payable in respect of the device manufactured at the rate of 3 per cent. of the price invoiced, which may be subject to tax. Under Clause 13 of the agreement, the licensee was required to maintain a special register regarding the exact number of devices manufactured under the agreement and any other information relevant for determining the amount of royalties payable. Clause 16 of the agreement provided for secrecy of the documents and information provided under the agreement. The duration of the agreement is specified as five years with a further declaration that the parties to the agreement intended to extend the period of agreement by another five years. The licensee was only required to refrain from disclosing any document, after the expiry of the term of the licence, but was not required to stop the manufacture of the products.
3. It is evident from the several clauses in the agreement that it provides for the transfer of the know-how possessed by the licensor who was engaged in the manufacture of the products licensed to be manufactured p> by the assessee under this agreement, including the drawings required for the manufacture of the devices in India, without which drawings manufacture could not possibly commence as also various other services to be provided under the agreement. The compensation payable to the licensor was split up in the agreement itself between payment for the drawings and royalty for products manufactured. Payment for drawings was to be made initially even before any service under the agreement would commence and, thereafter royalty was payable as a percentage of the value of the products manufactured. A separate special register was required to be maintained for the manufacture. As noticed earlier, the agreement was for setting up a completely new plant for the manufacture of a completely new product with the aid of machinery imported from European countries and set up in the assessee's new factory.
4. For the assessment year 1977-78, the assessee claimed as a deduction the payment made by it to the foreign company in a sum of Rs. 1,92,145 (the discrepancy in the amount is said to be due to the depreciation of the rupee value vis-a-vis the Swiss Franc as between the date of agreement and the date of payment), as revenue expenditure. The Assessing Officer disallowed 80 per cent. of the claim treating it as capital expenditure. Though that order was reversed by the Commissioner (Appeals), the same was restored by the Tribunal. The assessee as also the Revenue have brought up the questions arising out of the said disallowance. The assessee contends that no part of the amount claimed should have been disallowed, as according to the assessee, the entire amount paid towards the drawings and information is revenue expenditure. The Revenue contends that the depreciation ought not to have been allowed by the Tribunal on the amount of 80 per cent. of the technical fee paid, as according to the Revenue, drawings do not constitute plant on which depreciation can be allowed. One other question raised by the Revenue is the deletion of the sum of Rs. 70,251 by the Tribunal, that amount having been claimed by the assessee as entertainment expenditure.
5. Counsel for the assessee submitted that the amounts paid by the assessee as technical know-how fee for drawings and information supplied by the Swiss licensor was not in the nature of capital expenditure as the assessee did not derive any enduring benefit and the assessee was only a licensee and the information provided was to be treated as confidential, and the same was not to be disclosed to any third party. Counsel referred to us the decision of the Supreme Court in Alembic Chemical Works Co. Ltd. v. CTT [1989] 177 ITR 377. In that case the expenditure that had been incurred by the assessee for acquiring the know-how was in respect of a product in the manufacture of which, the assessee was already engaged and the payment made by the assessee therein to acquire know-how for upgrading and modernising technology was not regarded as capital expenditure. The assessee therein was the manufacturer of penicillin and had entered into an agreement with the Japanese company and made a once-for-all payment. The assessee obtained Meiji's most suitable penicillin producing strains, the technical information, know-how and written description of Meiji's process for fermentation of penicillin along with a flow sheet of the process on a pilot plant. The court held that it was not a case of a completely new plant with a completely new process and a completely new technical know-how having been obtained by the assessee, as the assessee had been engaged in the manufacture of penicillin from 1961 and even after the agreement, the product continued to be penicillin. The court further observed that it would be unrealistic to ignore the rapid advances in research in antibiotic material microbiology and to attribute a degree of endurability and performance to the technical know how at any particular stage in this fast changing era of medical science.
6. Counsel's reliance on this decision in our opinion is wholly inapposite, as what was done by the assessee in this case was to acquire information and drawings required for setting up a completely new plant with a completely new process for the manufacture of a completely new product. The question is not whether as the assessee purchased drawings and know-how all purchases of drawings and know-how are required to be treated as revenue expenditure. As observed by the Supreme Court in Alembic Chemical Works Co. Ltd. v. CIT [1989] 177 ITR 377 (headnote) :
"The question in each case would necessarily be whether the tests relevant and significant in one set of circumstances are relevant and significant in the case on hand also. Judicial metaphors are narrowly to be watched, for, starting as devices to liberate thought, they end often by enslaving it."
7. Counsel for the Revenue next relied upon the case of Jonas Woodhead and Sons (India) Ltd. v. CIT . This decision also is not of any assistance to the assessee. The court held therein that the question whether a particular payment made by an assessee under the terms of an agreement forms a part of capital expenditure or revenue expenditure, would depend upon several factors, viz., whether the assessee obtained a completely new technology for manufacture of the product, or the payment was made for the technical know-how which was for the betterment of the product in question which was already being produced. In that case, the assessee therein had entered into an agreement for setting up a manufacturing unit of all types of springs and suspension for road and rail vehicles. The agreement provided that in consideration of the information to be furnished and services to be rendered to the assessee by the foreign company, the assessee shall pay a royalty at the specified rates on the licensed products turnover of the business. The payment had not been split up into fee for the know-how and royalty for the use of the information, in respect of each item manufactured. The view of the High Court that the entire payment made could not be held to be revenue expenditure, merely because the payment made was at certain percentage rate of the gross turnover of the product, was affirmed by the apex court. The disallowance of 25 per cent. of that sum as not being revenue expenditure was also affirmed by the Supreme Court.
8. In the instant case, the payments made in the agreement towards revenue and capital expenditure have been categorised by the parties themselves. The revenue part being characterised as royalty and the capital part being provided for as payment in lumpsum for the know-how and information. Such know-how and information having been provided only after receipt of that payment.
9. Counsel then relied upon the decision of the Supreme Court in CIT v. I.A.E.C. (Pumps) Ltd. [19981 232 ITR 316. It was held therein that the salient features of the agreement examined by the court would go to show that the assessee therein obtained a licence and what was paid by the assessee to the foreign company was only a licence fee and not the price for acquisition of any capital asset. As to whether the industry for which the know-how was obtained was entirely a new plant and the process was also new and the product as well was new have not been set out in that judgment. We are unable to see this judgment as departing from the law laid down in the earlier decision's of the court more particularly the cases to which we have already adverted. It has been emphasised in those decisions that where the plant is new, the product is new and the process also is new, the expenditure incurred thereon for obtaining technical know-how would be treated as capital expenditure.
10. Having regard to the terms of the agreement between the assessee and the Swiss licensor, the scope of the agreement, the payment provided for therein for obtaining know-how, drawings and information is primarily a capital expenditure. The Assessing Officer has allowed twenty per cent. of that amount as being attributable to technical advice regarding day-to-day operation, layout, manufacturing operation, suitability of equipment in India and in Switzerland and that estimate at the rate of twenty per cent. would constitute revenue expenditure. That view has been upheld by the Tribunal and that has not been questioned by the Revenue. The question referred to us, viz., whether out of the technical know-how fee of Rs. 1,92,145 paid by the assessee to Emile Hafely Company Ltd., under the agreement dated January 18, 1973, during the assessment years 1977-78 and 1978-79, twenty per cent. of that amount is allowable as revenue expenditure and the balance of 80 per cent. of that amount should be disallowed as capital expenditure is therefore to be answered against the assessee and in favour of the Revenue.
11. As regards the question referred to us at the instance of the Revenue relating to the allowance of depreciation on the capital expenditure incurred for acquiring technical know-how in the form of drawing's and whether the assessee is entitled to depreciation thereon that question is required to be answered against the Revenue and in favour of the assessee. The Supreme Court in the case of Scientific Engineering House P. Ltd. v. CIT [1986] 157 ITR 86, has held that the documentation services, comprising drawings, designs, charts, plans, processing data, etc., can be treated as book and would constitute "plant" for the purpose of determining the eligibility of the investment on such drawings, designs, etc., for depreciation. The court further held that the plant was not necessarily confined to an apparatus which was used for mechanical operations or process or was employed in mechanical or industrial activity. What was required was that the particular article had to have some degree of durability. The purpose of rendering documentation service by supplying these documents was to enable the-assessee to undertake its trading activity of manufacturing the articles.
12. We therefore answer the question as to whether the Tribunal was justified in holding that depreciation should be allowed on that portion of the technical know-how fee as is directed to be capitalised, against the Revenue and in favour of the assessee. The remaining question referred to us at the instance of the Revenue regarding the addition of the sum of Rs. 70,251 by the Assessing Officer against the amount, which the assessee had incurred towards the entertainment expenses, which according to the Assessing Officer was not allowable and the deletion of that amount by the Tribunal is answered in favour of the Revenue and against the assessee. The view taken by the Revenue on this aspect must be upheld. After the date of the amendment, viz., from April 1, 1976, by the insertion of the Explanation to Section 37(2B) of the Act, such expenditure cannot be claimed as a deduction.
13. Parties are directed to bear their respective costs.