Delhi High Court
Commissioner Of Income Tax vs J K Synthetics Limited on 17 December, 2008
Author: Rajiv Shakdher
Bench: Badar Durrez Ahmed, Rajiv Shakdher
+* THE HIGH COURT OF DELHI AT NEW DELHI
Judgment reserved on : 28.08.2008
% Judgment delivered on : 17.12.2008
+ ITR 139/1988 AND ITR NO. 202/1989
COMMISSIONER OF INCOME TAX ..... APPELLANT
versus
J K SYNTHETICS LIMITED .......RESPONDENT
Advocates who appeared in this case:
For the Appellant : Ms Prem Lata Bansal, Advocate
For the Respondent : Mr P N Monga and Mr Manu Monga,
Advocates
CORAM :-
HON'BLE MR JUSTICE BADAR DURREZ AHMED
HON'BLE MR JUSTICE RAJIV SHAKDHER
1. Whether the Reporters of local papers may
be allowed to see the judgment ? Yes
2. To be referred to Reporters or not ? Yes
3. Whether the judgment should be reported
in the Digest ? Yes
RAJIV SHAKDHER, J
1. These references have been made at the instance of the Revenue
under Section 256(1) of the Income Tax Act, 1961 (hereinafter referred
to as the „Act‟). A Division Bench of this court, by an order dated
7.1.2008 passed in ITR No. 139/1988 and an order dated 19.5.2008
passed in ITR No. 202/1989, framed the following questions of law,
respectively:-
ITR No. 139/1988
"Whether the ITAT was correct in law and on facts in
holding that the third Instalment of know how fee as also
ITR 139-88 & 202/89 Page 1 of 65
interest paid thereon for belated payment was allowable
as revenue expenditure?"
ITR No. 202/1989
"Whether on the facts and in the circumstances of the
case and having regard to the agreements that the
Assessee company entered into with the Italian and West
German companies, the payments made of Rs
30,57,499 to M/s Technimont and Rs 3,48,033 to M/s
IWKA, West Germany was allowable as revenue
expenditure and not as capital expenditure?"
2. The issues involved in the two references are inter-related as they
pertain to the same Licence and Technical Assistance Agreement (in short
„the agreement‟) which would be evident shortly, from the facts detailed
out hereinafter. The questions of law on which our opinion is sought, are
ubiquitous and perennial in nature, in as much as, whether an expenditure
undertaken by an assessee would be in the nature of capital or revenue
expenditure, having regard to the provisions of Section 37 of the Act.
There is, undoubtedly a plethora of judgments, both of the Supreme Court
and of various High Courts on this aspect of the matter. The difficulty
which is encountered often, is to slot the facts of a particular case to the
law and the principles enunciated by Courts in the country. Fortunately, in
this particular case, there has been no submission made by the learned
counsel for the parties as to any perversity in the findings recorded by the
authorities below. The counsel who appeared before us i.e, Ms Prem Lata
Bansal for the Revenue and Mr P N Monga for the assessee, laid stress on
what, according to them, ought to have followed logically upon
ITR 139-88 & 202/89 Page 2 of 65
appreciation of the facts on record, as also from, reading of various clauses
of the agreement to which, reference is made.
3. In this context it would, therefore, be necessary to first record the
facts as found by the authorities below:-
4. On 29.04.1974, the assessee entered into an agreement with one,
M/s Technimont, Italy for manufacture of Acrylic Fibre. The assessee
also entered into another agreement with one, M/s IWKA, a West German
entity. The date of agreement with M/s IWKA is not set out either in the
statement of case or in the orders of the authorities below. It is important
to note that the agreement with M/s Technimont referred to another
company by the name of Montefibre which, in turn, was a successor of
one, M/s Chatillon. M/s Montefibre as per the agreement, was the owner
of knowhow and patent rights for the design, erection, operation and
production of Acrylic fibre. Importantly, M/s Technimont which had a
licence for use of know-how of patent rights owned by Montefibre had the
right to sub-license the same to other parties. It is in this contextual
background that an agreement was entered into between M/s Technimont
and the assessee.
5. Under the agreement, the assessee was required to pay a total
sum of 623 million Italian Liras which, at the relevant time,
amounted to Rs 54,54,794/- in consideration for the use of know-how,
basic design engineering and technical assistance. The point to be noted is
that, the total amount of 623 million Italian Liras or the equivalent i.e,
ITR 139-88 & 202/89 Page 3 of 65
Rs 54,54,794/- was paid by the assessee for three different aspects of the
same transaction. This basic fact emerges, as noted by the authorities
below, from a reading of Article 9 of the agreement.
"9.1 The fees to be paid by JK to TEC for the use of
the KNOW HOW in India, basic design engineering and
technical assistance provided for herein is 623 (six
hundred and twenty three) million Italian Liras
consisting of:
a) 186,500,000 : one hundred eighty six million five
hundred thousand) Italian Lira for the grant of the
process and know-how licence under Article 2;
b) 250,000,000 (two hundred and fifty million) Italian lira
for the supply of the know-how and basic design
engineering as referred to in Article 3;
c) 186,500,000 (one hundred eighty six million five
hundred thousand Italian lira for the supply of technical
assistance and continuous know-how in Italy, including
training of JK‟s personnel in Italy, as referred to in
Article 5.
The amounts indicated under (a)/(b) and (c) are firm and
not subject to escalation."
6. Out of a total consideration of 623 million liras, the assessee on its
own treated a sum of 250 million liras expended towards supply of basic
design engineering of the plant as capital expenditure, while the remaining
373 million liras which, at the relevant point of time was equivalent to
Rs 30,57,499, spent on grant of process and know-how licence, and for
supply of technical assistance and, continuous know-how including
training of company‟s personnel, in Italy, as revenue expenditure. In
short, two identical sums of money amounting to 186.5 million liras each,
amounting in all to 373 million liras, towards grant of process and know-
how licence, as well as, technical assistance and continuous know-how, in
Italy, including training of company‟s personnel, in Italy was, claimed by
ITR 139-88 & 202/89 Page 4 of 65
the assessee, as revenue expenditure, in its return for, assessment year
1976-77.
7. The Assessing Officer disallowed the claim made by the assessee
and treated the sum of Rs 30,57,499/- to be paid to M/s Technimont and
Rs 3,48,003 to IWKA, as capital expenditure, broadly, on the following
grounds:-
(i) even though the erection of the Acrylic plant, in respect of which an
agreement had been entered into with M/s Technimont had
commenced in 1975, it had not been completed, therefore, the
business of Acrylic division had not come into existence;
(ii) in view of the above, no distinction could have been drawn by the
assessee in respect of liability incurred under the agreement with
M/s Technimont, towards basic engineering design, which was
capitalized, and that which was incurred towards acquisition of grant
of process and know-how licence, and for supply of technical
assistance and continuous know-how, as well as, towards training of
assessee‟s personnel, in Italy;
(iii) the entire expenditure had been incurred for setting up of the plant
which had not commenced production and hence, had to be treated
as capital expenditure;
(iv) the expenditure in issue also fulfilled the test of enduring benefit, in
as much as, the expenditure incurred for acquisition of „process
know-how‟ and „technical expertise‟ of personnel who would look
ITR 139-88 & 202/89 Page 5 of 65
after the Acrylic fibre division once it commenced manufacture will
result in enduring benefit to the assessee and hence, result in an
acquisition of an asset;
(v) the process/know-how involved certain secret formula which came
into the possession of the assessee; thus the expenditure in issue
being an integral part of setting up of the Acrylic fibre division will
result in an acquisition of a benefit of a permanent nature to the
assessee; and
(vi) technical assistance and training at this stage of setting up of the
Acrylic fibre division was distinct from an exchange, training or
refresher course which is normally attended by the employees for
updating their knowledge. It is a case of permanently acquiring a
technique, which will, result in setting up the plant and using it in
future.
8. On the same basis, the Assessing Officer also disallowed the
treatment by the assessee as revenue expenditure, the sum of Rs 3,48,033/-
incurred for manufacture of machines under the agreement entered into
with M/s IWKA.
9. Pertinently, the Assessing Officer also disallowed depreciation and
rebate on the sum of Rs 30,57,499/- incurred in connection with the grant
of process, know-how and technical assistance with respect to the
Agreement entered into with M/s Technimont. However, depreciation
ITR 139-88 & 202/89 Page 6 of 65
was allowed on Rs 3,48,033/- incurred in connection with the Agreement
entered into with M/s IWKA.
10. The assessee being aggrieved, filed an appeal with the
Commissioner of Income Tax (Appeals) [hereinafter referred to as the
„CIT(A)‟]. The CIT(A) based on the material placed on record, and upon
perusal of the judgments cited before him, examined the nature of the
expenditure in the background of the following question posed by him,
which according to him arose for determination. According to the
CIT(A), in our opinion rightly, the basic issue which arose for
determination was whether the payments made by the assessee were for
acquisition of an asset or, for a use of technical knowledge and
information for running the business during the period of the Agreement
and for a mere user of patents and trademark. If, what had been acquired
under the Agreement by the assessee, was merely a licence for use of
technical knowledge of the foreign collaborator, the payment would not
bring into existence an asset of an enduring nature and, therefore, ought to
be regarded as an expenditure incurred by the assessee for the purposes of
running the business during the period of the Agreement.
10.1 In the background of the aforesaid poser, the CIT(A) found the
following facts:-
(i) the ownership of the technical know-how vested with
M/s Montefibre. M/s Technimont with whom the assessee
ITR 139-88 & 202/89 Page 7 of 65
had entered into an agreement, had only a right to licence the
said know-how and patent rights;
(ii) the assessee had not acquired any exclusive rights. It had on
the contrary acquired a „non exclusive‟ and a „non-
transferable‟ licence to use the process.
(iii) under Article 8 of the Agreement, the assessee could not use
the process or know-how supplied by M/s Technimont for
construction of any new plant either in India or in any other
country. The assessee was, as a matter of fact prohibited from
using the process for setting up or expansion of a new plant
without the say of M/s Technimont. As a matter of fact, under
Article 15, the assessee could not use the process and know-
how for any other purpose except to the extent permitted by
M/s Technimont under Article 8 of the Agreement;
(iv) the assessee was required to keep the „process and know-how‟
secret and confidential. The assessee was prohibited from
revealing the process to a third party without the prior consent
of M/s Technimont;
(v) the assessee was bound under Article 15.4 in respect of
obligations undertaken, for a period of 12 years;
(vi) M/s Technimont was required to provide technical assistance
for a period of 7 years; and
ITR 139-88 & 202/89 Page 8 of 65
(vi) technical assistance which was provided by M/s Technimont
for the purposes of construction and setting up of the plant
was not only paid separately as per Articles 5.1, 5.2, 5.3, 5.5,
5.5.1(a) and 5.5.2(2) but was also capitalized alongwith the
payments for basic design engineering. The only item which
the assessee claimed as revenue, related to technical
assistance for training of its personnel and, in connection
with the day to day running of the plant for the period
provided under the agreement i.e 7 years.
10.2 Based on the aforesaid findings, the CIT (A) reversed the view taken
by the Assessing Officer and allowed the liability incurred as a deductible
expenditure, both, with respect to, M/s Technimont and M/s IWKA by
treating them as revenue expenditure.
11. Aggrieved by the order of the CIT(A), the matter was carried in
appeal to the Income Tax Appellate Tribunal (hereinafter referred to as the
„Tribunal). The Tribunal sustained the view taken by the CIT(A) with
regard to payments made to M/s Technimont, as well as, M/s IWKA. In
arriving at the said conclusion, the Tribunal based its decision on the
findings and reasons recorded hereinbelow:-
(i) M/s Technimont was not the owner of the technical know-
how. The technical know-how belonged to another company,
namely, M/s Montefibre. M/s Montefibre owned both the know-
how, as well as, patent rights. M/s Technimont had only a right to
ITR 139-88 & 202/89 Page 9 of 65
licence the said know-how. In other words, M/s Technimont was
only the licensee of the know-how of patent rights owned by
Montefibre;
(ii) the grant of licence by Montefibre to M/s Technimont was
„non-exclusive‟, and irrevocable, as well as, permanent which, in
other words, gave M/s Technimont the right to sub-lease or sub-
licence the right under its licence to any third party and, in order to,
enable it to do so, M/s Montefibre had to grant to M/s Technimont a
licence which was permanent and irrevocable. The assessee had
acquired the technical know-how for a limited period of 7 years.
The department's submission that the assessee had acquired
know-how for unlimited period was factually incorrect;
(iii) the assessee under the Agreement had acquired only an access
to information. The assessee had, in fact, acquired know-how which
was related to process of manufacture and no trade name or
trademark had been acquired by the assessee; and
(iv) the payments under the Agreement were made by the assessee
for the purposes of acquiring technical knowledge to erect a factory
and thereafter to operate and train the personnel of the assessee; and
hence, are payments, which cannot be categorized as those resulting
in an enduring advantage.
11.1 Importantly, on the aspect whether payments related to a new
business or an existing business; it noted that the CIT(A) had pointed out
ITR 139-88 & 202/89 Page 10 of 65
that the payments are to be regarded as payment for extension of existing
business, and that the departmental representative had fairly conceded this
point, resultantly, no arguments were addressed on the said issue.
Pertinently, it returned a finding of fact that the records demonstrated, that
the products, were already being manufactured by the assessee, and hence,
the payments made by the assessee to increase its profitability by applying
a new method of manufacture or process of manufacture could not be said
to be on capital account.
12. Aggrieved by the aforesaid judgment of the Tribunal, the
Commissioner of Income Tax filed an application before the Tribunal
under Section 256(2) of the Act for referring questions of law to this
Court. This application was allowed and the above-mentioned questions
were referred to us.
13. In support of the case of the Revenue, Ms Prem Lata Bansal,
Advocate has submitted that a holistic reading of the Agreement would
show that the entire transaction which, even though divided into three
segments, is a composite whole and is inseparable. It is submitted by the
learned counsel for the Revenue, that it is inexplicable in the facts of this
case that if, expenditure incurred by the assessee towards basic design
engineering for setting up of the plant is treated by the assessee as capital
in nature then, how is that, the remaining part of the expenditure towards
acquisition of process know-how and training of personnel is treated as
revenue. The learned counsel for the Revenue has buttressed her
ITR 139-88 & 202/89 Page 11 of 65
submissions by laying stress on the fact that what has been acquired by the
assessee is know-how which is unlimited in span of time and, is
„permanent‟ and irrevocable in nature. She submits, in that sense, the
impugned expenditure both, in respect of, M/s Technimont and M/s
IWKA has resulted in a benefit of an enduring nature and hence, was
required to be treated as capital expenditure and not as revenue
expenditure as claimed by the assessee.
13.1 She also submitted that what the assessee was manufacturing was an
entirely new product. In support of her submissions Ms Prem Lata Bansal,
the learned counsel for the Revenue cited the following authorities:-
(i) Assam Bengal Cement Co Ltd vs CIT: (1955) 27 ITR 34
(SC)
(ii). Scientific Engineering House (P) Ltd vs CIT: (1986) 157
ITR 86 (SC)
(iii). CIT vs Warner Hindustan Limited: (1986) 160 ITR 217
(AP)
(iv). Jonas Woodhead & Sons (India) Ltd vs CIT: (1997) 224
ITR 342 (SC)
(v). CIT vs Southern Structurals Ltd: (1977) 110 ITR 890 (Mad)
(vi). Ram Kumar Pharmaceutical Works vs CIT: (1979) 119 ITR
33 (All)
(vii). CIT vs. Toshniwal Electrodes Manufacturing Co Ltd:
(1991) 192 ITR 209 (Bom)
(viii). CIT vs Polyformalin (P) Ltd (1986) 161 ITR 36 (Ker)
14. As against this, the learned counsel for the assessee has basically
relied upon the findings returned by the CIT(A) and the Tribunal. It is the
contention of Mr P N Monga, Advocate that, what the assessee had
ITR 139-88 & 202/89 Page 12 of 65
acquired, in the instant case, was only a licence for use of process and
know-how. The payments made by the assessee did not result in an
acquisition of either an asset or a benefit of an enduring nature. It was
contended by the learned counsel for the assessee that the liability towards
the said expenditure was incurred for the expansion of the assessee‟s
business. He contended that the assessee was already in the same line of
business as it had been manufacturing synthetic fiber since 1962.
According to the learned counsel for the assessee, no new business had
been set up by him as found by the authorities below. The liability
towards the impugned expenditure was incurred by the assessee to run its
business in a more efficient manner, so as to, enhance its profitability. Mr
P N Monga, also contended, that this was also true of the expenditure
incurred towards training of employees by M/s Technimont. In support of
his submission, Mr P N Monga, Advocate relied upon the following
judgments:-
(i). CIT vs Ciba of India Ltd.: (1968) 69 ITR 692 (SC)
(ii). Mysore Kirloskar Ltd vs CIT : (1978) 114 ITR 443 (Kar)
(iii). CIT vs Tata Engineering & Locomotive Co Pvt Ltd : (1980)
123 ITR 538 (AP)
(iv). Praga Tools Ltd vs. CIT: (1980) 123 ITR 773 (AP)
(v). Hylam Ltd vs CIT: (1973) 87 ITR 310 (AP)
(vi). CIT vs SLM Maneklal: (1977) 101 ITR 133
(vii). CIT vs IAEC Pumps Ltd: (1998) 232 ITR 316 (SC)
(viii). CIT vs Eicher Motors Ltd: (2007) 293 ITR 464 (MP)
ITR 139-88 & 202/89 Page 13 of 65
(ix). Sriram Refrigeration Industries Ltd vs. CIT: (1981) 127 ITR
746 (Del)
(x). CIT vs Mihir Textiles: (2006) 287 ITR 232 (Guj.)
(xi). Sriram Pistons & Rings Ltd vs CIT: (2008) 177 Texmann
81
(xii). Bajaj Tempo Ltd vs CIT: (1994) 207 ITR 1017 (Bom)
(xiii). CIT vs MRF: (1983) 144 ITR 678 (Mad)
(xiv). CIT vs Aquapump Industries: (1996) 218 ITR 427 (Mad)
15. Having heard the learned counsel for both, the Revenue, as well as,
the assessee and perused the records, we are of the view that the references
deserve to be answered in favour of the assessee, for the reasons given
hereinafter:-
DISCUSSION OF SUPREME COURT CASES CITED BEFORE US
16. Assam Bengal Cement Co Ltd v. Commissioner of Income Tax,
West Bengal, (1955) 27 ITR 34: In this case, the assessee acquired
from the Government of Assam, for the purpose of carrying on the
manufacture of cement, a lease of lime stone quarries for a period of 20
years in consideration of payment of yearly rents and royalties. The
assessee, in addition to rents and royalties, agreed to pay two further
sums under the covenants contained in clauses 4 & 5 of the lease in
issue as „protection fee‟. The „protection fee‟ was paid in lieu of lessor
giving an undertaking not to grant lease, permit or a prospecting licence
with regard to lime stone to any other party without a condition that no
ITR 139-88 & 202/89 Page 14 of 65
limestone could be used for the manufacture of cement. In this context,
the Supreme Court, after considering a bevy of authorities, affirmed the
principles enunciated by the full Bench of the Lahore High Court in
Benarsidas Jagannath in Re: (1947) 15 ITR 185. The Supreme Court
encapsulated the essence of the judgement of the Full Bench of the
Lahore High Court in its observations made at page 45 to 47. These
being apposite are extracted hereinbelow:-
".....This synthesis attempted by the Full Bench of
the Lahore High Court truly enunciates the
principles which emerge from the authorities. In
cases where the expenditure is made for the initial
outlay or for extension of a business or a substantial
replacement of the equipment, there is no doubt that
it is capital expenditure. A capital asset of the
business is either acquired or extended or
substantially replaced and that outlay whatever be its
source whether it is drawn from the capital or the
income of the concern is certainly in the nature of
capital expenditure. The question however arises for
consideration where expenditure is incurred while
the business is going on and is not incurred either for
extension of the business of for the substantial
replacement of its equipment. Such expenditure can
be looked at either from the point of view of what is
acquired or from the point of view of what is the
source from which the expenditure is incurred. If the
expenditure is made for acquiring or bringing into
existence an asset or advantage for the enduring
benefit of the business it is properly attributable to
capital and is of the nature of capital expenditure. If
on the other hand it is made not for the purpose of
bringing into existence any such asset of advantage
but for running the business or working it with a view
to produce the profits it is a revenue expenditure. If
any such asset or advantage for the enduring benefit
of the business is thus acquired or brought into
existence it would be immaterial whether the source
of the payment was the capital or the income of the
ITR 139-88 & 202/89 Page 15 of 65
concern or whether the payment was made once and
for all or was made periodically. The aim and object
of the expenditure would determine the character of
the expenditure whether it is a capital expenditure or
revenue expenditure. The source or the manner of
the payment would then be of no consequence. It is
only in those cases where this test is of no avail that
one may go to the test of fixed or circulating capital
and consider whether the expenditure incurred was
part of the fixed capital of the business or part of its
circulating capital. It is was part of the fixed capital
of the business it would be of the nature of capital
expenditure and if it was part of its circulating capital
it would be of the nature of revenue expenditure.
These tests are thus mutually exclusive and have to
be applied to the facts of each particular case in the
manner above indicated. It has been rightly observed
that in the great diversity of human affairs and the
complicated nature of business operations it is
difficult to lay down a test which would apply to all
situations. One has therefore got to apply these
criteria, one after the other from the business point of
view and come to the conclusion whether on a fair
appreciation of the whole situation the expenditure
incurred in a particular case is of the nature of
capital expenditure or revenue expenditure in which
latter event only it would be a deductable allowance
under section 10(2)(xv) of the Income-tax Act. The
question has all along been considered to be a
question of fact to be determined by the Income-tax
authorities on an application of the broad principles
laid down above and the courts of law would not
ordinarily interfere with such findings of fact if they
have been arrived at on a proper application of those
principles......
The expression "once and for all" used by Lord
Dunedin has created some difficulty and it has been
contended that where the payment is not in a lump
sum but in instalments it cannot satisfy the test.
Whether a payment be in a lump sum or by
instalments, what has got to be looked to is the
character of the payment. A lump sum payment can
as well be made for liquidating certain recurring
claims which are clearly of a revenue nature, and on
the other hand payment for purchasing a concern
ITR 139-88 & 202/89 Page 16 of 65
which is prima facie an expenditure of a capital
nature may as well be spread over a number of years
and yet retain its character as a capital expenditure.
(Per Mukherjea, J., in Commissioner of Income-tax
v. Piggot Chapman & Co. ([1949] 17 I.T.R. 317,
329)). The character of the payment can be
determined by looking at what is the true nature of
the asset which has been acquired and not by the fact
whether it is a payment in a lump sum or by
instalments. As was otherwise put by Lord Greene,
M.R., in Henriksen (Inspector of Taxes) v. Grafton
Hotel Ltd. ([1942] 2 K.B. 184) :
"The thing that is paid for is for a permanent quality
although its permanence, being conditioned by the
length of the term, is shortlived. A payment of this
character appears to me to fall into the same class as
the payment of a premium on the grant of a lease,
which is admittedly not deductible".
The case of Tata Hydro-Electric Agencies Ltd.,
Bombay v. Commissioner of Income-tax, Bombay
Presidency and Aden ((1937) L.R. 64 I.A. 215) affords
another illustration of this principle. It was observed
there :-
"If the purchaser of a business undertakes to the
vendor as one of the terms of the purchase that he will
pay a sum annually to a third party, irrespective of
whether the business yields any profits or not, it would
be difficult to say that the annual payments were made
solely for the purpose of earning the profits of the
business."
The expression "once and for all" is used to denote an
expenditure which is made once and for all for
procuring an enduring benefit to the business as
distinguished from a recurring expenditure in the
nature of operational expenses.
The expression "enduring benefit" also has been
judicially interpreted. Romer, L.J., in Anglo-Persian
Oil Company, Limited v. Dale ([1932] 1 K.B. 124,
146) agreed with Rowlatt, J. that by enduring benefit is
meant enduring in the way that fixed capital endures :
ITR 139-88 & 202/89 Page 17 of 65
"An expenditure on acquiring floating capital is not
made with a view to acquiring an enduring asset. It is
made with a view to acquiring an asset that may be
turned over in the course of trade at a comparatively
early date."
Latham, C.J., observed in Sun Newspapers Ltd. &
Associated Newspapers Ltd. v. Federal Commissioner
of Taxation ((1938) 61 C.L.R. 337, 355) :
"When the words 'permanent' or 'enduring' are used in
this connection it is not meant that the advantage
which will be obtained will last for ever. The
distinction which is drawn is that between more or less
recurrent expenses involved in running a business and
an expenditure for the benefit of the business as a
whole"...... e.g. ...... - "enlargement of the goodwill of a
company." - "permanent improvement in the material
or immaterial assets of the concern."
To the same effect are the observations of Lord
Greene, M. R. in Henriksen (H. M. Inspector of Taxes)
v. Grafton Hotel Ltd. ((1942) 24 T. C. 453) above
referred to.
These are the principles which have to be applied in
order to determine whether in the present case the
expenditure incurred by the company was capital
expenditure or revenue expenditure. Under clause 4 of
the deed the lessors undertook not to grant any lease,
permit or prospecting licence regarding limestone to
any other party in respect of the group of quarries
called the Durgasil area without a condition therein
that no limestone shall be used for the manufacture
of cement. The consideration of Rs. 5,000 per annum
was to be paid by the company to the lessor during
the whole period of the lease and this advantage or
benefit was to endure for the whole period of the
lease. It was an enduring benefit for the benefit of the
whole of the business of the company and came well
within the test laid down by Viscount Cave. It was not
a lump sum payment but was spread over the whole
period of the lease and it could be urged that it was
recurring payment. The fact however that it was a
recurring payment was immaterial, because one had
got to look to the nature of the payment which in its
ITR 139-88 & 202/89 Page 18 of 65
turn was determined by the nature of the asset which
the company had acquire. The asset which the
company had acquired in consideration of this
recurring payment was in the nature of a capital
asset, the right to carry on its business unfettered by
any competition from outsiders within the area. It
was a protection acquired by the company for its
business as a whole. It was not a part of the working
of the business but went to appreciate the whole of
the capital asset and make it more profit yielding. The
expenditure made by the company in acquiring this
advantage which was certainly an enduring advantage
was thus of the nature of capital expenditure and was
not an allowable deduction under section 10(2)(xv) of
the Income-tax Act."
16.1 While applying the aforesaid principle to the facts of the case
being considered by us, one will have to keep in mind the nature of the
asset acquired and the resultant benefit acquired by virtue of the
payment. A close scrutiny would show it is distinguishable from the
facts of the present case. In Assam Bengal Cement Co Ltd (supra),
payments were made as „protection fee‟ in terms of clauses 4 and 5 of
the lease agreement, whereby the lessor had undertaken not to grant any
lease, permit or prospecting licence regarding lime stone to any other
party in respect of certain quarries without the condition, that the
limestone would not be used for manufacture of the cement within the
assessee‟s area. The „protection fee‟ even though paid annually enured
to the benefit of the assessee for whole period of the lease. It is in this
context the Court came to the conclusion that it was an enduring benefit,
for the benefit of the whole business of the company, and came, well
within the test laid down by Viscount Cave. The fact that „protection
ITR 139-88 & 202/89 Page 19 of 65
fee‟ was not a lump sum payment but a recurring payment was
immaterial because one had to look at the nature of the payment which,
in turn, was determined by the nature of the asset which the assessee
had acquired. The assets which the assessee had acquired in
consideration of this recurring payment was in the nature of a capital
asset i.e. a right to carry on its business unfettered by any competition
from outsiders within the area. It was a protection acquired by the
company for its business as a whole. It was not a part of the working of
the business but went on to appreciate the whole of the capital asset and
make it more profit yielding. The Court thus concluded that the
expenditure incurred by the assessee in acquiring this advantage was
certainly an enduring advantage and hence, in the nature of capital
expenditure.
17. Commissioner of Income-Tax, Bombay City I v. CIBA of India
Ltd (1968) 69 ITR 692. In this case, the assessee was an Indian
subsidiary of a Swiss Company. The assessee was engaged in the
development, manufacture and sale of medical and pharmaceuticals
preparations. The parent Swiss company entered into an agreement
with the assessee which, inter alia provided, that in consideration of
payment in the form of technical and research contribution for the use of
its Indian patent and trade marks, it would obtain, scientific and
technical assistance. Under the agreement, the assessee was prohibited
from divulging to a third party without the Swiss company‟s consent,
ITR 139-88 & 202/89 Page 20 of 65
any confidential information received under the agreement, in particular,
data connected with the manufacturing process. The Swiss company,
under the agreement, granted to the assessee full and sole right and a
licence in the territory of India, in respect of, the patents listed in the
Schedule accompanying the agreement, so as to enable the assessee to
make use of, exercise rights, and vend the inventions referred to therein,
as also, the use of trade mark set out in the second schedule
accompanying the agreement, in the territory of India. By virtue of
clause 3, the sole right of the assessee under the Swiss company‟s
Indian patent was limited to existing licences granted by the Swiss
company to third parties. Furthermore, a right was also reserved in
favour of the Swiss company to conclude other licence agreements with
third parties. In consideration of this, the assessee was to pay half
yearly, a certain percentage of the contributions of the total of the net
sale price of all the pharmaceutical products manufactured and/or sold
by the assessee. In the background of these broad facts, Mr Justice J.C.
Shah (as he then was) speaking for the court made the following crucial
observations on page 701:-
"....In the case in hand it cannot be said that the
Swiss Company had wholly parted with its Indian
business. There was also no attempt to part with the
technical knowledge absolutely in favour of the
assessee.
The following facts which emerge from the
agreement clearly show that the secret processes
were not sold by the Swiss Company to the assessee:
(a) the licence was for a period of five years, liable to
ITR 139-88 & 202/89 Page 21 of 65
be terminated in certain eventualities even before the
expiry of the period; (b) the object of the agreement
was to obtain the benefit of the technical assistance
for running the business; (c) the licence was granted
to the assessee subject to rights actually granted or
which may be granted after the date of the
agreement to other persons; (d) the assessee was
expressly prohibited from divulging confidential
information to third parties without the consent of
the Swiss Company; (e) there was no transfer of the
fruits of research once for all: the Swiss Company
which was continuously carrying on research and
had agreed to make it available to the assessee; and
(f) the stipulated payment was recurrent dependent
upon the sales, and only for the period of the
agreement. We agree with the High Court that the
first question was rightly answered in favour of the
assessee."
18. In Empire Jute Co Ltd v. Commissioner of Income Tax; (1980)
124 ITR 1, the facts briefly were that the assessee was engaged in the
business of manufacture of jute. The assessee was the member of the
Jute Mills Association which was formed with the object of, inter alia,
protecting the trade of its members, by regulating the production of the
mills, run by its members. In pursuance thereto, the members had
entered into a working time agreement, whereby the number of working
hours per week for which the mills were entitled to work their „looms‟
was restricted. In this background, the assessee had purchased „looms
hours‟ from four other mills. The issue which arose for consideration of
the court was whether the money expended by the assessee for purchase
of "loom hours" was revenue or capital expenditure. The observations
of the Supreme Court being apposite are extracted hereinafter:-
ITR 139-88 & 202/89 Page 22 of 65
".....The Revenue, however, contended that by purchase of
loom hours the assessee acquired a right to produce more
than what it otherwise would have been entitled to do and
this right to produce additional quantity of goods constituted
addition to or augmentation of its profit making structure.
The assessee acquired the right to produce a larger quantity
of goods and to earn more income and this, according to the
Revenue, amounted to acquisition of a source of profit or
income which though intangible was never-the-less a source
or "spinner" of income and the amount spent on purchase of
this source of profit or income, therefore, represented
expenditure of capital nature. Now it is true that if
disbursement is made for acquisition of a source of profit
or income, it would ordinarily, in the absence of any other
countervailing circumstances, be in the nature of capital
expenditure. But we fail to see how it can at all be said in
the present case that the assessee acquired a source of profit
or income when it purchased loom hours. The source of
profit or income was the profit making apparatus and this
remained untouched and unaltered. There was no
enlargement of the permanent structure of which the income
would be the produce or fruit. What the assessee acquired
was merely an advantage in the nature of relaxation of
restriction on working hours imposed by the working time
agreement, so that the assessee could operate its profit-
earning structure for a longer number of hours.
Undoubtedly, the profit earning structure of the assessee
was enabled to produce more goods, but that was not
because of any addition or augmentation in the profit
making structure, but because the profit making structure
could be operated for longer working hours. The
expenditure incurred for this purpose was primarily and
essentially related to the operation or working of the looms
which constituted the profit earning apparatus of the
assessee. It was an expenditure for operating or working the
looms for longer working hours with a view to producing a
larger quantity of goods and earning more income and was,
therefore, in the nature of revenue expenditure."
18.1 The other important observation which the Supreme Court made
in this, was, that there may be cases where the test of enduring benefit
may breakdown even though expenditure incurred may result in
advantage of enduring benefit, the money spent, may still be, on
ITR 139-88 & 202/89 Page 23 of 65
revenue account. The Supreme Court observed that the nature of
advantage had to be viewed in a commercial sense and it was only when
the advantage was in the capital field that the expenditure would be
disallowable on application of the said test. It further went on to say
that if the advantage consists merely in facilitating assessee‟s trading
operation or enabling the management to carry on business more
efficiently and profitably while leaving the fixed asset untouched the
expenditure would be on revenue account even though the advantage
may endure for an indefinite period. The Supreme Court observed that
the test of enduring benefit is, therefore, not a conclusive test and it
cannot be applied blindly and mechanically without regard to the
particular facts and circumstances of a given case. At page 13 of the
said report, the Supreme Court enunciated an important principle by
approving the dictum laid down by Dixon J., Hallstorm's Property Ltd
v. Federal Commissioner of Taxation ( 72 CLR 634), which reads as
follows:-
"When dealing with cases of this kind where the
question is whether expenditure incurred by an
assessee is capital or revenue expenditure, it is
necessary to bear in mind what Dixon, J. said in
Hallstorm's Property Limited v. Federal
Commissioner of Taxation 72 C.L.R. 634 : "What is
an outgoing of capital and what is an outgoing on
account of revenue depends on what the expenditure
is calculated to effect from a practical and business
point of view rather than upon the juristic
classification of the legal rights, if any, secured,
employed or exhausted in the process." The question
must be viewed in the larger context of business
ITR 139-88 & 202/89 Page 24 of 65
necessity or expediency. If the outgoing expenditure
is so related to the carrying on or the conduct of the
business that it may be regarded as an integral part of
the profit-earning process and not for acquisition of
an asset or a right of a permanent character, the
possession of which is a condition of the carrying on
of the business, the expenditure may be regarded as
revenue expenditure...."
19. Scientific Engineering House Pvt Ltd v. CIT, Andhra Pradesh;
(1985) 157 ITR 86. In this case, the assessee, who was, in the business
of manufacture of scientific instruments and apparatus entered into two
separate collaboration agreements with a Hungarian Company, one for
the manufacture of theodolites and other for the manufacture of
microscopes. The terms of both agreements were identical. Under the
terms of the said agreement, the foreign collaborator agreed that in
consideration of Rs 80,000/-, in each case, it would supply to the
assessee technical know-how required for the manufacture of the said
instruments. In order to enable the assessee to manufacture the
instruments in India, the foreign collaborator in terms of clause 3 of the
said agreement, agreed to render "documentation service" by supplying
to the assessee an updated, correct and complete set of each of the
documents which included manufacturing drawings and full processing
documents, as also, complete set of specifications of raw-material, lay-
out of manufacturing process and know-how, sample drawings and
casting drawings. The assessee had claimed before the Income Tax
Authorities that the payment made under the said agreement to the
ITR 139-88 & 202/89 Page 25 of 65
foreign collaborator resulted in acquisition of depreciable assets. The
question which came up for consideration was whether monies spent by
the assessee for acquiring, from the foreign collaborator,
„documentation service‟, whereby the assessee acquired technical know-
how requisite for the purpose of manufacturing the instruments, in
question, were payments on capital account and hence, brought into
existence a depreciable asset. The Supreme Court observed that the
answer to the question was dependent on a proper interpretation of the
terms and conditions of the two agreements. After examining the terms
of the agreement it disagreed with the view expressed by the Tribunal
and the High Court by observing as follows:-
".....Having regard to the rival contentions that were
urged before us, it is clear that two questions really
arise for determination in the case. The first is
whether the 'documentation service' (supply of 5
complete sets of documents) agreed to be and actually
rendered by the foreign collaborator to the assessee
under the two agreements was incidental to the other
services contemplated therein or whether it was the
principal service for which mainly the payment of Rs
1,60,000 was made by the assessee as a result
whereof the assessee acquired all the technical know-
how requisite for the purpose of manufacturing the
instruments in question? And secondly whether the
said expenditure, which was entirely of a capital
nature, brought into existence a depreciable asset?
The answer to the former question depends upon the
proper interpretation of the terms and conditions of
the two agreements while the answer to the latter
depends upon whether a capital asset like the
technical know-how acquired in the shape of
drawings, designs, charts, plans, processing data and
other literature which formed the basis for the
business of manufacturing the instruments in question
ITR 139-88 & 202/89 Page 26 of 65
would fall within the wide and inclusive definition of
'plant' given in Section 43(3) of the Income Tax Act,
1961.
Turning to the first question, having regard to the
relevant terms of the two agreements we find it very
difficult to accept the view concurrently expressed by
the Tribunal and the High Court that the
'documentation service' undertaken to be rendered by
the foreign collaborator to the assessee was incidental
or that the payment of Rs. 1,60,000 could not be
regarded as being mainly for and by way of purchase
price of the drawings, designs, charts, plans and all
the documents comprised in 'documentation service'
specified in Clause 3 of the agreements. Such a view
as will be shown presently runs counter to the express
language contained in Clauses 3 and 6 of the
agreements......
The tenor of the agreements clearly shows that the
various documents such as drawings, designs, charts,
plans, processing data and other literature included in
documentation service, the supply whereof was
undertaken by the foreign collaborator, more or less
formed the tools by using which the business of
manufacturing the instruments was to be done by the
assessee and for acquiring such technical know-how
through these documents lump sum payment was
made. In other words, the payment of Rs. 80,000
under each of the agreements was principally for
rendition of 'documentation service'."
19.1 It is obvious that the result of the case pivoted on the finding that
the payments made by the assessee to the foreign collaborator was not
for services which were incidental to the principal service, which was,
for the purchase of drawings, designs, charts and plans required for the
purpose of manufacture of instruments, in question i.e. theodolites and
microscopes. The Supreme Court rejected the contrary view of both the
Tribunal and the High Court, whereby they held that the payments were
made for incidental services. The other question which the Supreme
ITR 139-88 & 202/89 Page 27 of 65
Court was called upon to decide was whether the documentation
provided to the assessee by the foreign collaborator would come within
the definition of a „plant‟ within the meaning of Section 43(3) of the
Act. As is obvious, the fact situation of this case is different to the issue
under consideration in the present appeal and hence, would not be
applicable.
20. Commissioner of Income Tax v. I.A.E.C. (Pumps) Ltd; (1998)
232 ITR 316. The question which the court was called upon to consider
was "whether amount paid by the respondent-assessee to the foreign
collaborator for the technical know-how is capital or revenue". The
Supreme Court sustaining the view of the Madras High Court and cited
with approval the following observations contained in the judgment of
the Madras High Court.
"......Having regard to the said Clauses, we are clearly
of the opinion that the Tribunal was right in its
conclusion that the whole of the amount paid by the
assessee constitutes revenue expenditure and has to be
allowed as a deduction. From the terms of the
agreement referred to above, the following facts are
clear;
(1) The agreement itself provides that what was
granted by Aturia to the assessee is merely a license
to use its patents and designs exclusively in India;
(2) The agreement is for a duration of 10 years with
the parties having the option to extend the agreement
or renew the same, subject to the approval of the
Government of India;
(3) During the currency of the agreement, Aturia had
undertaken not to surrender its patents without the
ITR 139-88 & 202/89 Page 28 of 65
consent of the assessee and to make available to the
assessee any improvements, modifications and
additions to designs;
(4) Aturia has also undertaken to enable the assessee
to defend any counterfeit by others and also had
undertaken to share the expenses with reference
thereto;
(5) The assessee shall not disclose to third parties any
of the documents made available by Aturia to the
assessee without having received a written
authorisation from Aturia.
We are of the opinion that the above features clearly
establish that what was obtained by the assessee is
only a license and what was paid by the assessee to
Aturia is only a license fee and not the price for
acquisition of any capital asset....."
20.1 The Supreme Court, crucially observed that, the High Court‟s
conclusions were correct, in as much as, it had appreciated that the
amounts which were paid by the assessee to the collaborator were only
on account of licence fee and not a price for acquisition of capital assets
and hence, the entire payment be treated as revenue expenditure.
21. Alembic Chemical Works Co Ltd v. Commissioner of Income
Tax, Gujarat; (1989) 177 ITR 377. In this case, the assessee since
1961 had been engaged in the business of manufacture of antibiotics and
pharmaceuticals. The assessee was granted a licence for manufacture, at
its plant, a well-known antibiotic "penicillin". In 1963, in order to
increase the yield of penicillin the assessee negotiated with a Japanese
Company for supply of requisite technical know-how, so as to, achieve
substantially higher level of performance and/or production. In
ITR 139-88 & 202/89 Page 29 of 65
consideration thereof, the assessee made a "once for all payment",
against which, the assessee was supplied by the Japanese company the
sub-cultures of the most suitable penicillin producing strain, as also,
technical information, know-how and written description of the process
for fermentation of penicillin, along with, a flow-sheet of the process for
a pilot plant, design and specification of main equipment, for such a
pilot plant. Furthermore, the Japanese company was also obliged to
arrange for the training of the representatives of the assessee at the
Japanese company‟s plant, in Japan at the assessee‟s expense as also
advice, which the assessee would receive, in order to engage in large
scale manufacture of penicillin for the period of two years from the
effective date of agreement. Importantly, the assessee was required to
keep technical know-how supplied to it confidential and secret, with a
further prohibition, on the assessee in parting with the technical know-
how in favour of others or to seek patent for the process. In these
circumstances, the lump sum payment made by the assessee to the
Japanese company was claimed by the assessee as a revenue
expenditure. In the context of these facts, Mr Justice M.N.
Venkatachaliah (as he then was) made the following observations:-
"......In computing the income chargeable under the
head "Profits and gains of business or profession",
section 37 of the Act, enables the deduction of any
expenditure laid out or expended wholly and
exclusively for the purpose of the business or
profession, as the case may be. The fact that an item
of expenditure is wholly and exclusively laid out for
ITR 139-88 & 202/89 Page 30 of 65
the purposes of the business, by itself, is not sufficient
to entitle its allowance in computing the income
chargeable to tax. In addition, the expenditure should
not be in the nature of a capital expenditure. 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 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 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 over-exacting....
On a consideration of the matter, we are persuaded to
hold that there was no material for the Tribunal to
record the finding that the assessee had obtained
under the agreement a "completely new plant" with a
completely new process and a completely new
technical know-how from Meiji. Indeed, the High
Court recognized the fallacy in this assumption of the
Tribunal that a completely new plant was obtained by
the assessee, though, however, the High Court
attributed the inaccuracy to what it considered to be
some inadvertence or misapprehension on the part of
the Tribunal in that regard. But the High Court was
inclined to the view that a completely new process and
technical know-how was obtained from Meiji under
the agreement. Certain assumptions fundamental to,
and underlying, the approach of the High Court are
that the agreement dated October 9, 1963, envisaged
a new process and a new technology so alien to the
extant infrastructure, equipment, plant and machinery
in the assessee‟s enterprises as to amount to an
entirely new venture unconnected with the different
from the line of the assessee‟s extant business. It is in
that sense that the expense was held not to have been
incurred for the purposes of the day-do-day business
of the assessee but for acquiring a new capital
asset.....
We are inclined to agree with Sri Ramachandran that
there was no material for the Tribunal to hold that the
area of improvisation was not a part of the existing
ITR 139-88 & 202/89 Page 31 of 65
business or that the entire gamut of the existing
manufacturing operations for the commercial
production of penicillin in the assessee‟s existing
plant had become obsolete or inappropriate in
relation to the exploitation of the new sub-culture of
the high yielding strains of penicillin supplied by
Meiji and that the mere introduction of the new bio-
synthetic source required the erection and
commissioning of a totally new and different type of
plant and machinery. Shri Ramachandran is again
right in the submission that the mere improvement in
or updating of the fermentation process would not
necessarily be inconsistent with the relevance and
continuing utility of the existing infrastructure,
machinery and plant of the assessee......
The improvisation in the process and technology in
some areas of the enterprise was supplemental to the
existing business and there was no material to hold
that it amounted to a new or fresh venture. The
further circumstance that the agreement pertained to
a product already in the line of the assessee‟s
established business and not to a new product
indicates that what was stipulated was an
improvement in the operation of the existing business
and its efficiency and profitability not removed from
the area of the day-to-day business of the assessee‟s
established enterprise.
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......"
22. Jonas Woodhead and Sons (India) Ltd v. Commissioner of
Income Tax; (1997) 224 ITR 342:- In this case, the question which
came for consideration before the Supreme Court was as follows:-
"Whether on the facts and in the circumstances of the
case, the Tribunal was right in holding that 25% of the
amount paid by the assessee as royalty to Jonas
Woodhead and Sons, was capital expenditure and,
therefore, not allowable as revenue expenditure under
ITR 139-88 & 202/89 Page 32 of 65
the provisions of the Income Tax Ac t, 1961, for the
assessment years 1967-68 and 1968-69."
22.1 This question arose in the background of the following facts. The
assessee was engaged in the business of manufacture of automobiles
springs. The assessee entered into an agreement with Jonas Woodhead
and Sons (India) Ltd, a company of United Kingdom, for manufacture
of all types of springs and suspension for road and rail vehicles. Under
the agreement, the assessee was to receive technical information and
know-how relating to the setting up of a plant suitable for manufacture
of products, as well as, technical know-how relating to setting up of the
plant itself i.e., the drawings, estimates, specifications, manufacturing
methods, blue prints of production and testing equipment and other data
and information necessary to manufacture the product and to set up
proper and efficient plants. In consideration thereof, the assessee was to
pay royalty on fixed rate based on the turnover of the licensed product.
On commencement of the production, assessee made certain payments
as royalty. In the assessment proceeding the Income Tax Officer
disallowed 25% of the aforesaid payments on the ground that such
payment represented a consideration for service provided by the foreign
company of an „enduring nature‟ and was therefore, in the nature capital
expenditure. While sustaining the view of the High Court that 25% of
the payment made by the assessee was in the nature of capital
expenditure and hence, not allowable as a deduction, the Supreme Court
made following observations at page 347 of the judgment.
ITR 139-88 & 202/89 Page 33 of 65
".....The question whether a particular payment made
by an assessee under the terms of the agreement forms
a part of capital expenditure or revenue expenditure
would depend upon several factors, namely, whether
the assessee obtained a completely new plan with a
completely new process and completely new
technology for manufacture of the product or the
payments was made for the technical know-how which
was for the betterment of the product in question
which was already being produced; whether the
improvisation made, is part and parcel of the existing
business or a new business was set up with the so-
called technical know-how for which payments were
made; whether on expiry of the period of agreement
the assessee is required to give back the plans and
designs which were obtained, but the assessee could
manufacture the product in the factory that has been
set up with the collaboration of the foreign firm; the
cumulative effect on a construction of the various
terms and conditions of the agreement; whether the
assessee derived benefits coming to its capital for
which the payment was made. This Court in the case
of Alembic Chemical Works Co. Ltd. v. Commissioner
of Income Tax [1989] 177 ITR 377 has indicated that
"in the infinite variety of situational diversities in
which the concept of what is capital expenditure and
what is revenue arises, it is not possible to form any
general rule even in the generality of cases,
sufficiently accurate and reasonably comprehensive,
to draw any clear line of demarcation". This Court
further held that there is no single definitive criterion
which, by itself, is demarcative, whether a particular
outlay is capital or revenue. And therefore, "once for
all" test as well as the test of "enduring benefit" may
not be conclusive. Consequently, the various terms
and conditions of the, agreement, the advantages
derived by an assessee under the agreement, the
payment made by the assessee under the agreement,
are all to be taken into account and then it has to be
decided whether the whole or a part of the payment
thus made is a capital expenditure or a revenue
expenditure......."
In the case of Commissioner of Income-Tax, Bombay
City I v. CIBA of India Ltd. (1968) 69 ITR 692 (SC)
this Court held on consideration of the agreement
ITR 139-88 & 202/89 Page 34 of 65
between the parties that the assessee did not become
entitled exclusively even for the period of the
agreement, to the patents and trademark of the Swiss
company; it had merely access to technical knowledge
and experience in the pharmaceutical field which the
Swiss company commanded. The assessee on that
account have a mere licensee for a limited period of a
technical knowledge of the Swiss company with the
right to use the patent and trademark of that company.
The assessee acquired under the agreement merely
the right to draw for the purpose of carrying on its
business as a manufacturer or dealer upon the
technical knowledge of Swiss company for limited
period. By making a technical knowledge available
the Swiss company did not part with any asset of its
business, nor did the assessee acquire any asset or
advantage of an enduring nature for the benefits of its
business and, therefore, the said contribution was
merely a revenue expenditure or a business
expenditure."
The reason why the Supreme Court sustained the view
of the Tribunal in this case that part of the royalty
paid in the said case had to be held as paid towards
capital account is evident from the following
observations in the said case. But in the case in hand
the Tribunal having considered the different clauses
of the agreement and having come to the conclusion
that under the agreement with the foreign firm what
was set up by the assessee was a new business and
the foreign firm had not-only furnished information
and the technical know-how but rendered valuable
services in setting up of the factory itself and even
after the expiry of the agreement there is no embargo
on the assessee to continue to manufacture the
product in question, it is difficult to hold that the
entire payment made is a revenue expenditure merely
because the payment is required to be made on a
certain percentage of the rates of the gross turnover
of the products of the income as royalty. In our
considered opinion, in the facts and circumstances of
the case the High Court was fully justified in
answering the reference in favour of the revenue and
against the assessee......."
ITR 139-88 & 202/89 Page 35 of 65
22.2 It is clear in this case, the Supreme Court in concluding that a part
of the payment was made on capital account, took note of the fact that
the Tribunal had returned a finding, that the foreign firm under the
agreement was obliged to assist the assessee in setting up a new
business. The finding in the present case is to the contrary. In any
event impugned expenditure relates to licence fee the purpose of which
is different as explained in the latter part of our judgement.
DISCUSSION OF HIGH COURT CASES:
23. Mysore Kirloskar Ltd. v. Commissioner of Income Tax,
Banglore (1978) 114 ITR 443. In this case a full bench of the
Karnataka High Court was called upon to consider whether monies paid
to the foreign company for acquisition of technical knowledge for a
limited period could be construed as revenue expenditure. The main
thrust of the judgment is contained paragraphs 17-18 of the judgment of
the Court. The observations of the Division Bench being apposite are
extracted hereinbelow:-
".........Read as a whole, it is seen that under the
agreement the assessee acquired merely the right to
draw for the purpose of carrying on its business as a
manufacturer of certain articles upon the technical
knowledge of the foreign company for a limited period.
The foreign company did not part with any of its assets
absolutely for ever or for any limited period of time. It
continued to have a right of user of its knowledge, even
after the agreement had run its course: its right in this
behalf was not lost. The assessee did not acquire any
right to the user of the name 'HERBERT' in regard to
the products even if the agreement had run its course.
ITR 139-88 & 202/89 Page 36 of 65
Actually it could not use that name and had to
discontinue such user or associating that name with
the products to be manufactured thereafter. In the
words of the Supreme Court in Ciba's case:-
".......by making that technical knowledge available
the foreign company did not part with any asset of its
business, nor did the assessee acquire any asset or
advantage of an enduring nature for the benefit of its
business....."
From the terms of the agreement it is clear that (1) No
secret process or technical knowledge was sold by the
foreign company to the assessee, (2) the period of user
was for 15 years; (3) the object of the agreement was
to obtain the benefit of the technical assistance for
running the business; (4) the permission was granted
to the assessee subject to rights actually granted or
which may be granted after the date of the agreement
to other persons though outside India; (5) the assessee
was expressly prohibited from divulging the
confidential information to third parties; (6) there was
no transfer of fruits of research once for all; and (7)
the foreign company which was continuously carry-ing
on research had agreed to make it available to the
assessee. These are the very factors which were taken
into consideration by the Supreme Court in coming to
the conclusion that the expenditure was of revenue
nature and allowable under Section 10 (1) (xv) of the
Indian Income-tax Act 1922, which is pari materia
with Sec. 37 of the Income-tax Act 1961. Therefore, it
is clear that the facts and circumstances in the instant
case are indistinguishable from those in Ciba's case,
The Supreme Court in the course of its judgment
referred to the decision of the House of Lords in
Jeffrey v. Rolls Royce Ltd. ((1965) 56 ITR 580) (HL)
and Mus-ker v. English Electric Co. ((1964) 41 Tax
Cas 556) and distinguished the decision in Evans
Medical Supplies Ltd. v. Mori-arty ((1959) 35 ITR
707) (HL). The principles enunciated by the Supreme
Court in Ciba's case were applied by the High Court of
Calcutta in Commr. of Income-tax (Central) Calcutta
v. Hindustan General Electrical Corporation Ltd. The
learned Judges referred to the speech of Viscount Rad-
cliffe in Musker v. English Electric Co. Ltd. and
extracted the following observations:
ITR 139-88 & 202/89 Page 37 of 65
"In my opinion, there are two considerations which
govern cases of this kind and which go a long way
towards destroying the force of the analogies by which
the appellant's argument seeks to prove that the
transactions under review were sales of fixed assets,
and that receipts arising from them ought to be treated
as receipts on capital account, One is that in reality no
sale takes place. The appellant had after the
transaction what it had before it. There is no property
right in "know-how" that can be transferred, even in
the limited sense that there is a legally protected
property interest in a secret process. Special
knowledge or skill can indeed ripen into a form of
property in the fields of commerce and industry, as in
copyright, trademarks and designs and patents, and
where such property is parted with for money what is
received can be, but will not necessarily be. a receipt
on capital account, But imparting "know-how" for
reward is not like this, any more than a teacher sells
his knowledge or skill to his pupil,"
23.1 It is also important to note that in this case the Full Bench of the
Karnataka High Court over-ruled the judgement of its own court in
Mysore Kirloskar Ltd. v. Commissioner of Income Tax (supra).
24. Ramkumar Pharmaceutical Works v. CIT; (1979) 119 ITR 33
(All.). This was a case where the assessee, which was, in the business
of manufacture and sale of saccharine entered into an agreement with a
West German Company. Under the agreement, the assessee was to
receive from the foreign collaborator know-how and data for the
construction and operation of the plant for manufacture of saccharine.
In consideration, the assessee was to pay a lump sum down payment
followed by royalty @ 2.5% of the sale value of the manufactured
product, subject to, a maximum of DM 35,000/-, for the next five years.
In this case, the Division Bench was impressed by the fact that know-
ITR 139-88 & 202/89 Page 38 of 65
how and data was parted with, by the foreign collaborator, for setting up
and operating of a plant for production of saccharine, and that, know-
how and data was transferred to the assessee for being used by it in
future without any time limit. The Court observed that the only
restriction which was placed on the assessee was that it could not
transfer the know-how to anyone else and that, it had to be kept a secret.
The Court observed that this was a case of acquisition and not merely a
user for all limited time. The assessee according to the Court obtained
an advantage of enduring nature and thus the payment for acquisition of
such know-how was clearly capital in nature.
24.1 This case as is evident turned on its own facts.
25. Commissioner of Income Tax v. Tata Engineering &
Locomotive Co Pvt Ltd (1980) 123 ITR 538. This was a case where the
Bombay High Court was considering payments made by the assessee to
the German collaborator with respect to provision of drawings, designs
and technical information required for manufacturing of automotive
products. Under the agreement the assessee could also use the name
and the trade mark of the German collaborator. The point to be noted in
this case was that after the agreement came to an end, the assessee was
entitled to continue its manufacture, but without the use of the trade
name Tata-Mercedez-Benz. The Division Bench, while holding that the
payments in the agreement were in the nature of revenue expenditure,
observed that where in substance the transaction for acquiring necessary
ITR 139-88 & 202/89 Page 39 of 65
technical information is really in the nature of having access to
techniques of production, it cannot be said that the payments made in
lieu thereof were on capital account. The rationale provided by the
Division Bench was that, instead of employing persons having
knowledge of the techniques and utilizing their knowledge, what was
being done, is that the technical know-how was being acquired under a
collaboration agreement. The Division Bench went on to hold, that the
fact that, the same information was being continuously used whether in
the same form or in an improved form will, therefore, not be relevant in
deciding whether technical know-how obtained under such an
agreement is a capital asset. The Court observed that technical know-
how made available to a party under such an agreement does not stand
on the same footing as protected rights in a registered patent. According
to the Division Bench, there was no property right in a know-how which
can be transferred just as, it is, in a limited sense, in a patent. The
Division Bench of the Bombay High Court rejected the contention that
the expenditure was capital in nature since, once the know-how was
made available, the assessee could continue to use it for its production
even after the expiry of the agreement; on the ground that this aspect
was wholly immaterial for the purposes of ascertaining whether such an
expenditure could be treated on capital account. The Division Bench
categorically disagreed with the view of the Madras High Court taken in
Addl. Commissioner of Income Tax v Southern Structural Ltd (supra)
ITR 139-88 & 202/89 Page 40 of 65
which, in turn, was based on the view held in Fenner Woodroffe & Co
Ltd v. Commissioner of Income-Tax (1976) 102 ITR 665.
26. Praga Tools Ltd v. Commissioner of Income-Tax, Hyderabad;
(1980) 123 ITR 773(AP). In this case, the Full bench of the Andhra
Pradesh High Court was called upon to examine the nature of payments
made by the assessee under a licence agreement with a foreign company
for manufacture of certain tools and cutter grinding machine, for which,
the foreign company was to supply the accessories, designs, technical
know-how with the latest modification and assistance. The agreement
was for a period of 10 years and thereafter, renewable for a further
period of five years with mutual consent. The assessee was required to
pay royalty at the rate of 5% on the Indian selling price, on the
production of the machine, subject to Indian taxes. The Full Bench like
in the case of Tata Engineering & Locomotive Co Pvt Ltd (supra)
came to the conclusion that merely because the agreement provided that
the assessee was entitled to retain technical know-how, designs and
drawings even after the expiry of agreement did not alter the nature of
the transaction. There was, according to the court, no property right
transferrable in technical know-how. The fact that the assessee was not
entitled to use the trade mark of the foreign company for the products
manufactured by it after the expiry of the agreement clinched the issue.
The Court also observed that in determining the nature of the
expenditure the totality or cumulative effect of the material facts
ITR 139-88 & 202/89 Page 41 of 65
evidenced by the documents and the surrounding circumstances had to
be taken into consideration in arriving at the decision. The Court
observed that the circumstances had to be viewed in the larger context
of business, each factor or circumstance by itself may not be decisive.
Importantly, in this case the Full bench over-ruled the judgment of its
own court in Hylam Ltd v. CIT (A.P.) (1973) 87 ITR 310. In these
circumstances we do not consider it necessary to discuss the said case
i.e., Hylam Ltd. (supra)
27. Commissioner of Income Tax v. Polyformalin (P.) Ltd; (1986)
161 ITR 36 (Ker). This is a case, in which, the Division Bench of the
Kerala High Court was called upon to consider the correctness of the
view taken by the Tribunal in respect of, the nature of royalty payment
made under a collaboration agreement. The Tribunal had taken the view
that, the payments made contained an element of capital; this would be
clear from the questions referred by the Tribunal to the High Court for
its opinion under Section 256(1) of the Act. Upon a reading of the facts
in this case, it seems that at various points of time, the assessee entered
into three collaboration agreements with the same collaborator.
Broadly, the assessee, which was in the business of manufacture and
sale of organic and synthetic chemicals under various agreements,
sought technical know-how and right to use trade mark of the
collaborator for production of urea formaldehyde resin. Under the
agreements, the collaborator was also required to supply information
ITR 139-88 & 202/89 Page 42 of 65
with regard to any further improvements in the technical know-how
which it may obtain. The assessee was required to keep the technical
know-how which it received confidential. In the background of these
broad facts, the matter travelled up to the Tribunal. The Tribunal in the
proceedings before it, returned a finding of fact that a part of the
payment of royalty under the agreement was attributable to „initial
manufacture‟ and hence, would have to be treated as capital in nature,
while the remaining payment would be on revenue account. It seems
that the Division Bench of the High Court, while sustaining the view of
the Tribunal that there was an element of capital in the royalty payments
was persuaded by this finding of fact returned by the Tribunal.
28. Commissioner of Income Tax v. Warner Hindusthan Ltd (1986)
160 ITR 217 . This was a case where the assessee has entered into a
collaboration agreement with an American company. The agreement
was entered into at the inception and before setting up of the plant. The
foreign collaborator i.e., the American company held a 40% shares in
the assessee company. The foreign collaborator i.e., the American
company had a right to terminate the agreement if the American
company‟s shareholding in the assessee company fell below 40%. The
American company was required to provide expertise in the
construction of the factory, lay-out, as also, the know-how which, the
American company was required to keep updated. The American
Company was also required to provide technical personnel in
ITR 139-88 & 202/89 Page 43 of 65
connection with setting up of the plant and manufacture of the products
and facilities at the assessee‟s plant and also, at the plant of the
assessee‟s associates and, for the training of associates‟ personnel.
Under the agreement, the assessee had no right to use any trade name,
however, it could continue to use the know-how even after termination
of the agreement. In this case, in consideration thereof, the assessee
paid certain sums of money to the American Company during the
assessment years, under consideration. The assessee had claimed these
payments as technical fee and hence, as revenue expenditure. The
Tribunal held the payment, in issue, to be in the nature of revenue
expenditure. The High Court, considering the facts of said case,
reversed the view of the Tribunal on the grounds that: First of all, the
collaboration agreement was not on record; Secondly, the agreement
related to assistance at the very inception i.e., formation of a company;
Thirdly, the agreement provided for not only transfer of know-how, but
also for consultancy assistance and help, in several other areas; And
lastly, the American Company had a 40% shareholding in the assessee
company and, under the provisions of the agreement the American
Company could terminate the agreement if its equity holdings fell below
40%. The High Court concluded that, therefore, it could not be said that
the payments made were only for the acquisition of know-how. The
High Court most crucially observed that there was neither a running or
an existing business nor, was the know-how acquired in connection with
ITR 139-88 & 202/89 Page 44 of 65
the manufacture of a new item, in relation, to a running business. The
sum and substance of the court discussion was that there was no way of
apportioning that part of the payment which was made towards
acquisition of the know-how under the agreement. This is a critical
distinction which will have to be borne in mind while considering the
impact of this case.
29. CIT v. Toshniwal Electrodes Manufacturing Co Ltd (1991) 192
ITR 209 (Bom). In this case we find that there is no discernable ratio
and hence, it does not call for any discussion. The court decided the
case based on a decision in an earlier reference, relating to the same
assessee, which had travelled to the Court.
30. Addl. Commissioner of Income Tax v. Southern Structural
(1997) 110 ITR 890 (Mad). In this case, the assessee was engaged in
the manufacture of goods wagon for supply to Indian Railways. The
assessee entered into an agreement with a British Company. Under the
agreement, the British Company was required to acquire a 40%
shareholding in the assessee company on certain basis. The British
company, under the agreement, was also required to give to the assessee
Company technical assistance in the form of inventions, designs relating
to railway wagons, whether obtained or not, which were owned by the
British Company. The British Company under the agreement had also
undertaken to supply to the assessee at their request full technical advice
and manufacturing data and details which the British Company may
ITR 139-88 & 202/89 Page 45 of 65
have acquired in relation to design and manufacture of existing type of
railway wagons and which could be of assistance to the assessee in
tendering for any other order for such a wagon or, in manufacturing the
same at Madras. In consideration thereof, the assessee was to pay a
certain percentage of the works price, in respect of, certain kinds of
wagons. Importantly, the agreement was required to subsist for a
minimum of 10 years, which was terminable by either party on giving
12 months prior notice. Upon the expiration of the agreement both
parties were to be relieved of their obligations, in particular, the assessee
was free to use without a charge, all such information made available by
the British Company, during the tenure of the agreement. In coming to
the conclusion that the monies paid by the assessee to the British
Company were in the nature of capital expenditure, the Division Bench
of the High Court, was impressed by the fact that the assessee could use
the information acquired for an indefinite period, and that too, free of
charge. In other words, whatever information was acquired by the
assessee during the period of the agreement would enure to the benefit
of the assessee without any limitation of time. In coming to this
conclusion the Division Bench applied the principle laid down by its
own court in the case of Fenner Woodroffe & Co Ltd v. Commissioner
of Income-Tax (supra).
30.1 As discussed above the Full Bench of the Andhra Pradesh High
Court in the case Praga Tools Ltd (supra) has disagreed with views of
ITR 139-88 & 202/89 Page 46 of 65
the Madras High Court in the aforesaid case. We respectfully agree
with the view taken in Praga Tools Ltd (supra).
31. Commissioner of Income Tax, Gujarat - I v. S.L.M. Maneklal
Industries Ltd (1977) 101 ITR 133. This was also a case where the
assessee had entered into three agreements with certain foreign
collaborators. The first agreement was for manufacture of rotary air-
compressors. The second agreement was for the manufacture of rotary
blowers and water-ring pumps, and the third agreement, was for the
manufacture of vertical diesel engines. The agreements were entered
into between the Swiss collaborator and one T. Maneklal. Pursuant to
discussions between the two contracting parties, a new company S.L.M.
Maneklal Industries Ltd (which was the assessee in the case) was
floated and by subsequent agreement, it was agreed between one S.L.M.
on the one hand and one, Maneklal on the other, that in the three
agreements, referred to above, wherever the name "T. Maneklal"
appeared the name of new company S.L.M. Maneklal Industries should
be substituted. Under the agreements the assessee company made
payments for the price of supply of workshop drawing, manufacturing
instruments etc.; which were spread over a period of five years and
accordingly, the assessee claimed deduction of 1/5th of the expenditure
for drawings and designs in respect of each of the three agreements.
The Income Tax Officer treated the said payments as capital in nature
as, according to him, they were for acquisition of a capital asset in the
ITR 139-88 & 202/89 Page 47 of 65
shape of designs and drawings. The matter travelled right up to the
Tribunal. The Tribunal held that it was a clear case of licence and not of
sale so far as, designs and drawings and patterns were concerned and
that, by parting with them, the right of the foreign collaborator had not
diminished, in any, manner. The Tribunal also held that payments made
for the use of drawings, designs and patterns did not bring into existence
an asset of an enduring nature. The Division Bench of the High Court
sustained the view of the Tribunal. The Division Bench held that the
workshop drawings, manufacturing instruments etc. were obtained by
the assessee company from the foreign company for the purpose of
enabling it to exploit the licence agreement and to manufacture rotary
air-compressor under the licensing agreement. It further held that the
supply of workshop drawings was for the purpose of main licence itself,
and in the course of, working the terms and conditions of the license to
manufacture rotary air-compressor. It also observed that other
expenditure incurred in connection with capital asset is not expenditure
of a capital nature. The nature of the expenditure depends essentially
upon the totality of the attendant circumstances obtaining in respect of a
transaction and the context in which it is made. Where a payment is
made for the ownership of a capital asset, which is the tool of the
assessee‟s trade, it may not be difficult to come to the conclusion that
the expenditure is in the nature of capital expenditure. Where, however
the benefit of a capital asset is secured as one element of a
ITR 139-88 & 202/89 Page 48 of 65
comprehensive arrangement, by virtue of which a trader seeks to obtain
advantage, with the end in view to expand his business and earn greater
profits, the whole transaction will have to be critically analyzed in order
to find out whether the expenditure incurred is a part of that transaction
for acquiring the benefit for the use of the capital asset and hence, is in
the nature of capital expenditure. The court came to the conclusion that
no property for the workshop drawings passed to the assessee. There
was no independent sale of the workshop drawings, and furthermore,
the workshop drawings, by themselves, were of no use to the assessee
unless they were meant for the purpose of manufacturing of different
types of machinery. The Division Bench was impressed by the fact that
the assessee was required to keep the information obtained as
confidential and to use the same, only for the purpose of working the
license agreement, and that too only during the continuance of the
licensing agreement.
32. Commissioner of Income Tax v. Eicher Motors Ltd; (2007) 293
ITR 464 (MP). It was again a case dealing with expenditure incurred on
acquisition of technical know-how. The Division Bench of the Madhya
Pradesh High Court, Indore Bench observed that the matter should be
decided by taking into account all circumstances and the weight, which
may have to be given to a particular circumstance, must depend on
common sense and business point of view rather than juristic
ITR 139-88 & 202/89 Page 49 of 65
classification of the juristic rights, if any, secured employed or
exhausted in the process.
33. Sriram Refrigeration Industries Ltd v. Commissioner of Income
Tax, Delhi - I; (1981) 127 ITR 746 (Del). This is a judgment of a
Division Bench of this court. In this case, the assessee, who was in the
business of manufacture of sealed compressors for air-conditioners and
refrigerators, entered into a technical assistance agreement with
Westhinghouse Electric, an international company. The said foreign
collaborator provided information in the form of basic designs, data,
drawings, process specifications, material specifications etc. The
Division Bench after examining the facts, as well as, the case law on the
subject held that the whole object of the agreement was to obtain benefit
of technical assistance for running the business, on a restricted licence
and to accord limited use of patent rights of the foreign company, the
use of which, was restricted to the assessee alone and that too for the
duration of the agreement. It concluded that on examining the basic
features of the agreement the foreign company had not parted with the
"technical knowledge" absolutely in favour of the assessee as the
foreign company had not sold their secret process to the assessee. It
was of the view that it could not be said that assessee had absolutely
acquired any knowledge or asset. The payments, according to the
Division Bench were made to have an „access‟ to the knowledge and
information that was necessary to carry on and run the business from
ITR 139-88 & 202/89 Page 50 of 65
day-to-day, and that, it was not of much significance as to whether the
agreement was entered into at the time of commencement of business or
in the course of business which is already being carried out.
34. Sriram Pistons & Rings Ltd. v. Commissioner of Income Tax,
New Delhi; (2008) 177 Taxmann 81. This is again a judgment of
Division Bench of this Court, wherein this court, after examining a
plethora of case law including the judgment of this court in the case of
Sriram Refrigeration Industries Ltd (supra) has followed the view held
in another judgment of a Division Bench of this Court in Triveni Engg.
Works ltd. v. CIT (1982) 136 ITR 340. The observations made in para
17, 28 & 29 being apposite are set out below:-
" ........The Supreme Court interpreted this to mean that the
right pertained more to the use of the know-how than to its
exclusive acquisition by the assessee. The Supreme Court
also noted that there is no single definitive criterion which
by itself is determinative of the question whether a
particular outlay was revenue in nature. What is relevant is
to see the intended object and effect of the agreement
between the parties, considered in a common sense manner
having regard to business realities. The Supreme Court
noted that in a given case, the test of „enduring benefit‟
might break down as laid down by the Supreme Court in
CIT v. Associated Cement Companies Ltd (1988) 172 ITR
257.
Applying the various principles that have been laid down,
we find that there was in fact no absolute transfer of any
right in the documentation given by Riken to the assessee.
The assessee was entitled to use the technical know-how for
a period of five years or for a lesser period, in case the
agreement was terminated before that. The assessee did not
have a free hand to sub-license the technical know-how and
that was possible only with the prior written permission
from Riken. For all other matters, the assessee was liable
ITR 139-88 & 202/89 Page 51 of 65
to treat as confidential in inventions, drawings, documents,
specification etc. furnished by Riken to the assessee. Even
though the assessee was entitled to use the name of Riken in
the marketing of its products but that right would cease
upon the expiry or terminated of the agreement.
As already noted, the Agreement was valid only for a period
of five years but could be terminated earlier. There is no
magic in the word "sold" used in clause 5.0 of the
agreement because on a reading of the agreement as a
whole, it appears to us that what was transferred to the
assessee was only a right to use the technical know-how of
Riken and there was no sale of the technical know-how
which the assessee could exploit. The assessee‟s right were
hedged in with all sorts of conditions, clearly making it a
case of right to use the technology and not sale of the
technical know-how......"
34.1 From the above, it is clear that despite the use of the word „sold‟
in one of the clauses of the agreement, in relation to, technical know-
how and the process which the assessee acquired, this Court held that, if
on a holistic reading of the agreement it appears that what was
transferred to the assessee was only a right to use technical know-
how and not sale of technical know-how then the expenditure would
have to be treated as one on revenue account.
35. Bajaj Tempo Ltd v. Commissioner of Income Tax; (1994) 207
ITR 1017 (Bom). Mr. Justice B.N. Srikrishna (as he then was) speaking
for the Division Bench cited with approval the observations of the
judgement of its own court in Tata Engineering & Locomotive Co (P)
Ltd (supra) that there was no property right in know-how which can be
transferred just as, it is, in a limited sense in a patent. The court
approved the observation of its own Division Bench in the case of Tata
ITR 139-88 & 202/89 Page 52 of 65
Engineering & Locomotive Co (P) Ltd (supra) that technical know-
how made available by a party to an agreement does not stand on same
footing as protected rights under a registered patent. The Division
Bench distinguished the judgment of the Supreme Court in the case of
Scientific Engineering House P. Ltd (supra) by observing that the
Supreme Court in that case was considering whether the „documentation
service‟ was the main service rendered by the foreign collaborator and
also, that the documentation service supplied to the assessee in the said
case constituted „book‟ or „plant‟ so as to entitle the assessee to claim
depreciation thereon. The Division Bench observed that "the argument
before the Supreme Court did not appear to have turned on the issue
whether the payments made for procuring such documents really
amounted to capital expenditure or revenue expenditure."
36. Commissioner of Income Tax, Tamil Nadu- III v. Madras
Rubber Factory (1983) 144 ITR 678. This was a case where the
assessee entered into an agreement with an American Company which
dealt with two distinct matters, namely (i) planning and setting up of a
tyre factory (ii) continuous supply of information and technical
consultancy services for a period of years for running the factory after
its installation. The Court noted that there was no dispute that the
payment which related to the first item i.e., for setting up of the factory
were capital in nature in the hands of the assessee, and consequently, the
assessee had claimed no deduction in respect of the said amounts.
ITR 139-88 & 202/89 Page 53 of 65
However, under the agreement, the assessee was also required to pay to
the foreign company for the consultancy services supplied by the
foreign company from time to time for running the factory and for
maintaining production. The Income Tax Officer took the view that
though payments made for consultancy service for running the factory
were on revenue account there would be an element of capital and
hence, disallowed 25% of the fee payable by the assessee attributable to
capital element, while allowing the balance 75% as revenue
expenditure. The view of the assessee was over-turned by the first
Appellate Authority and the Tribunal. The Department carried the
matter to the High Court. The High Court held that the agreement by
itself kept two aspects of the collaboration agreement distinct and
separate, one was connected with the initial setting up of the factory and
the other was connected with running of the factory. The fee paid by
the parties for obtaining technical consultancy services required for
keeping the factory running was in the nature of revenue expenditure.
The Court rejected the argument of the Revenue that, since the assessee
was not bound to return the know-how acquired during the contract
period the expenses incurred for obtaining the same had to be treated as
capital expenditure as it had acquired the use of knowledge beyond the
contractual period and hence, was in the nature of an enduring
advantage. In this connection the following observations of the court
are of significance:-
ITR 139-88 & 202/89 Page 54 of 65
".....We must reject the argument of Mr. Jayaraman
as unsound. It is based on the supposition that any
expenditure or outlay by a taxpayer which results in
enduring benefit to his 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 celebrated author,
Viscount Cave, while laying down this testin Atherion
v. British Insulated and Helsby Cables 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 had
occasion to clarify this position. They explained
Viscount Cave‟s dictum this way: enduring benefit or
advantage might enure to an assessee‟s business
either in a capital field of its activity or in a non-
capital field; 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.
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 or its
resident engineer in India were imparting to the
assessee on operational matters might tend to outlast,
and endure beyond, the contract period. There is,
however is a saying in Tamil that knowledge once
acquired is everlasting, and it cannot be destroyed
either by flood or by fire, nor can it be obliterated or
even 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 revenue expenditure.
If 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
ITR 139-88 & 202/89 Page 55 of 65
benefit or advantage tends to pay in the business.
This, however, is not the law."
37. Commissioner of Income Tax v. Aquapump Industries; (1996)
218 ITR 427. The Division Bench of the High Court was called upon to
determine as to whether expenses incurred by the assessed to acquire
technical know-how were in the nature of revenue expenditure. In this
case, there was an agreement between the assessee and a collaborator,
under which the collaborator allowed the assessee to use its brand name
for the production, manufacture and sale of specified products. In
consideration, the assessee paid royalties to the collaborator who agreed
to allow manufacture of articles for five years. The collaborator under
the agreement was required to furnish technical information pertaining
to manufacture of the said articles. The issue which came before the
Madras High Court was whether royalty payments made by the assessee
could be treated as revenue expenditure. The court observed that
expenditure to acquire knowledge 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 revenue expenditure.
BROAD PRINCIPLES WHICH EMERGE ON READING OF
VARIOUS AUTHORITIES
ITR 139-88 & 202/89 Page 56 of 65
38. An overall view of the judgments of the Supreme Court, as well
as, of the High Courts would show that the following broad principles
have been forged over the years, which require, to be applied to the facts
of each case:-
(i) the expenditure incurred towards initial outlay of business would be
in the nature of capital expenditure, however, if the expenditure is
incurred while the business is on going, it would have to be ascertained
if the expenditure is made for acquiring or bringing into existence an
asset or an advantage of an enduring benefit for the business, if that be
so, it will be in the nature of capital expenditure. If the expenditure, on
the other hand, is for running the business or working it, with a view to
produce profits, it would be in the nature of revenue expenditure;
(ii) it is the aim and object of expenditure, which would, determine
its character and not the source and manner of its payment;
(iii) the test of "once and for all" payment i.e., a lump sum payment
made, in respect of, a transaction is an inconclusive test. The character
of payment can be determined by looking at what is the true nature of
the asset which is acquired and not by the fact whether it is a payment in
„lump sum‟ or in an instalment. In applying the test of an advantage of
an enduring nature, it would not be proper, to look at the advantage
obtained, as lasting forever. The distinction which is required to be
drawn is, whether the expense has been incurred to do away with, what
ITR 139-88 & 202/89 Page 57 of 65
is a recurring expense for running a business, as against, an expense
undertaken for the benefit of the business as a whole;
(iv) an expense incurred for acquisition of a source of profit or income
would in the absence of any contrary circumstance, be in the nature of
capital expenditure. As against this, an expenditure which enables the
profit making structure to work more efficiently leaving the source or
the profit making structure untouched, would be in the nature of
revenue expenditure. In other words, expenditure incurred to fine tune
trading operations to enable the management to run the business
effectively, efficiently and profitably leaving the fixed assets untouched
would be an expenditure of a revenue nature even though the advantage
obtained may last for an indefinite period. To that extent, the test of
enduring benefit or advantage could be considered as having broken
down;
(v) expenditure incurred for grant of License which accords „access‟ to
technical knowledge, as against, „absolute‟ transfer of technical
knowledge and information would ordinarily be treated as revenue
expenditure. In order to sift, in a manner of speaking, the grain from the
chaff, one would have to closely look at the attendant circumstances,
such as:-
(a) the tenure of the Licence.
(b) the right, if any, in the licensee to create further
rights in favour of third parties,
ITR 139-88 & 202/89 Page 58 of 65
(c) the prohibition, if any, in parting with a confidential
information received under the License to third parties
without the consent of the licensor,
(d) whether the Licence transfers the „fruits of research‟
of the licensor, „once for all‟,
(e) whether on expiry of the Licence the licensee is
required to return back the plans and designs obtained
under the Licence to the licensor even though the licensee
may continue to manufacture the product, in respect of,
which „access‟ to knowledge was obtained during the
subsistence of the Licence.
(f) whether any secret or process of manufacture was
sold by the licensor to the licensee. Expenditure on
obtaining access to such secret process would ordinarily be
construed as capital in nature;
(vi) the fact that assessee could use the technical knowledge obtained
during the tenure of the License for the purposes of its business after the
Agreement has expired, and in that sense, resulting in an enduring
advantage, has been categorically rejected by the courts. The Courts
have held that this, by itself, cannot be decisive because knowledge by
itself may last for a long period even though due to rapid change of
technology and huge strides made in the field of science, the knowledge
may with passage of time become obsolete;
(vii) while determining the nature of expenditure, given the diversity of
human affairs and complicated nature of business; the test enunciated by
courts have to be applied from a business point of view and on a fair
appreciation of the whole fact situation before concluding whether the
expenditure is in the nature of capital or revenue.
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39. In the context of the present case what has emerged is as follows:-
a. The agreement was in three parts. One part related to
purchase of basic design, engineering and for provision of
technical assistance by the collaborator to the assessee. For
this purpose a sum of 250 Million Liras were paid by the
assessee to the collaborator. This expenditure was
capitalized by the assessee, on his own.
b. The balance amount expended by the assessee being; 3.73
million Liras, for grant of process and know-how Licence
and for supply of technical assistance and continuous know-
how, which included, training to its employees, in Italy; was
treated as revenue expenditure by the assessee.
39.1 The important finding returned by the authorities below, on
consideration of the facts obtaining in the case and on interpretation of
the terms of the agreement, was that; First of all, what the assessee
acquired was „access‟ to the technical information; Secondly, there was
no transfer of ownership with respect to the process and the know-how
under the agreement, in favour of the assessee; Lastly, the „access‟ to
technical know-how did not relate to any secret process or patent rights
or use of trade mark or trade name. As recorded by the authorities below
the technical know-how was owned by one M/s Montefibre, the
successor to another concern known as, M/s Chatillon. M/s Monte
Fibre granted to M/s Tecnimont a non-exclusive, and an irrevocable and
ITR 139-88 & 202/89 Page 60 of 65
permanent License in favour of M/s Tecnimont. This was, as found by
the authorities below, done to enable M/s Technimont to exercise its
rights under the License by granting a sub-License to third parties, in
this case the assessee. The submission of the learned counsel for the
Revenue, based on Article 2.12 of the Agreement, to the effect that,
what the assessee had obtained was a permanent right by virtue of the
Agreement is incorrect; in view of the fact that, M/s Tecnimont could
not have granted that, which it did not itself possess. In any event, grant
of Licence by itself does not result in transfer of property, in a limited
sense as, in the case of, patent rights. It is not the case of the Revenue
that any patent rights were transferred in favour of the assessee.
39.2 In our opinion, in view of the aforementioned findings, in
particular, that under the Agreement the assessee had only acquired
„access‟ to technical information, that is, know-how which related to the
process of manufacture, which was not; related to any secret process or
patent rights or even the right to use a trademark or trade name under
the Agreement, the payments in issue, made for such a purpose, can
only be categorized as one made on revenue account.
39.3 The Revenue, in order to buttress their submission with respect to
the permanent character and so called enduring nature of the advantage
obtained under the Licence, had submitted that the Agreement had no
time limit prescribed for working the Licence. This submission of the
revenue is factually incorrect as found by the authority below. As
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noted, hereinabove, under Article 15.4 the obligation for certain
purposes was limited to 12 years, and likewise, under Article 5.5.1 and
5.5.2 M/s Tecnimont was obliged to give advice for a period of 7 years.
39.4 In respect of payments made by the assessee towards training of
personnel and supply of technical assistance and continuous know-how
as referred to in Article 5 of the Agreement, it is clear on an application
of the tests enunciated by Courts, that it would not result in an
advantage of enduring nature, especially as noted above, that by virtue
of Article 5.5.1 and 5.5.2 M/s Tecnimont was obliged to give advice
limited to a period of 7 years.
39.5 It is important, at this juncture, to refer to the finding returned by
CIT(A), which has been, sustained by the Tribunal, to the effect that, all
payments which related to setting up of the plant as per Article 9.1(b) of
the agreement, as well as, expenses towards technical assistance
provided by M/s Tecnimont for the purpose of construction and setting
up of the plant were not only to be paid separately, as per Article 5.1,
5.2, 5.3, 5.5.1(a) and 5.5.2(2) but, had also been capitalized and not
claimed by the assessee as a revenue expenditure. The only item which
the assessee had claimed as revenue expenditure related to technical
assistance granted for a period of 7 years for training of its personnel
and in connection with running of the plant day-to-day. In view of these
findings, which when, analysed in the light of the test evolved by the
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Courts, it cannot, but be held, that the expenditure in issue would have
to be treated as one, on revenue account.
39.6 The submission of the learned counsel for the Revenue that the
expenditure was incurred by the assessee for manufacturing a new
product, is not only factually incorrect, but completely contrary to the
stand taken by the Revenue both before the CIT(A), as well as, the
Tribunal. The Tribunal has, as indicated above, hereinabove
categorically noted that the Revenue had fairly conceded that the
expense incurred was for extension of an existing business. The
Tribunal, in no uncertain words, recorded a finding that, the record
demonstrated, that the products, in issue, were already being
manufactured by the assessee and hence, payments made by the
assessee towards this end, would only go to increase the profitability; as
what it had obtained, by virtue of the Agreement was a new method of
manufacture or process of manufacture.
39.7 Similarly, in respect of payments made to M/s IWKA, the CIT(A)
found that, the know-how for which the assessee had made payments
was for manufacture of machines. The CIT(A), examined the
Agreement of the assessee with M/s IWKA, and found that, the assessee
had been granted an exclusive manufacturing licence for India. He,
however noted, that the assessee was not permitted to use any
knowledge or experience gained for any other purpose. The CIT(A)
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also returned the finding that under the Agreement, M/s IWKA was to
provide the following services to the assessee.
a) assistance in Germany in planning, construction and
installation of JK‟s Engineering Workshops;
b) delivery of Germany of drawings and technical data;
c) transfer in Germany of the use of IWKA manufacturing
know-how;
d) transfer of IWKA sales know-how;
e) training of specialists for JK in Germany and India;
f) delegation of IWKA staff member for technical
assistance to India;
g) exchange of experiences including continued technical
assistance and development.
39.8 In the background of these facts, the CIT(A) came to the
conclusion that the expenditure incurred by the assessee on know-how
during the year, under consideration, was in respect of, a business which
was already in existence and hence, the payments were made for user of
licence and were akin to the payments made to M/s Tecnimont. The
CIT(A) agreed with the assessee that money paid to M/s IKWA was
required to be treated as expenditure on revenue account. This finding
of the CIT(A) has been sustained by the Tribunal.
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40. Given the findings returned by both the CIT(A), as well as, the
Tribunal and given the discussion held above by us, we have no
hesitation in coming to the conclusion that Rs 30,57,499/- paid to M/s
Technimont and Rs 3,48,033/- paid to M/s IKWA had to be treated as
revenue expenditure.
41. In view of the fact that we have already held that the third
instalment of know-how fee which related to grant of technical
assistance and continuous know-how, in Italy, including training of
personnel, in Italy is revenue in nature, any interest paid in relation to
delayed payments will also, have to be treated, as one, which is, on
revenue account.
42. In view of the above discussion, both questions referred to us are
answered in favour of the assessee and against the Revenue. These
references are accordingly disposed of. However, in the circumstances
the parties shall bear their own costs.
RAJIV SHAKDHER, J.
December 17, 2008 BADAR DURREZ AHMED, J. mb/kk ITR 139-88 & 202/89 Page 65 of 65