Tambe, J.:— This is a reference under sub-s. (1) of s. 66 of the Indian Income-tax Act and is in respect of the five reference applications made to the Tribunal relating to the assessment years 1949–1950, 1950–1951, 1951–1952, 1952–1953 and 1953–1954: the accounting years being the respective previous calendar years. After consolidation of these five reference applications relating to the aforesaid assessment years, two questions of law have been referred to this Court. The first question is common for all the five years and the second question is common only for three assessment years, viz. 1950–1951, 1951–1952 and 1952–1953. Pacts giving rise to this reference in brief are:

The assessee company Messrs Ciba Pharma Private Limited, Bombay, hereinafter referred to as the “Ciba Pharma” is a cent per cent Indian subsidiary of Ciba Limited, Basle (Switzerland), hereinafter referred to as “the Ciba Basle”. Ciba Basle deals in drugs, medicines, chemicals, pharmaceuticals and biological products. Ciba Pharma has been incorporated in India on December 13, 1947. Prior to incorporation of Ciba Pharma and for some little time after its incorporation, Ciba Basle was carrying on its business in India through a company called Ciba (India) Limited, which was also a cent per cent subsidiary company of Ciba Basle. The activities of the Ciba Basle carried on in India through Ciba (India) Ltd. consisted of dealings both in pharmaceuticals as well as dealings in dyes and chemicals. In the year 1948 the activities of Ciba (Basle) in India till then carried on through Ciba (India) Ltd. were bifurcated. The pharmaceutical section was carved out and given over to Ciba Pharma and rest of the activities in dyes and chemicals were being continued by Ciba (India) Ltd. under a changed name Ciba Dyes Ltd.

2. Now, with regard to the business in pharmaceuticals, which was handed over to Ciba Pharma, an agreement has been entered into between the Ciba Basle and Ciba Pharma. The agreement is of date December 17, 1947 and is annexure A to the Statement of the Case. The answer to the first question turns on the construction of this agreement. The preamble of this agreement consists of two paras. The first para, describes the various activities of Ciba Basle and the second para, sets out the business, which Ciba Pharma had installed for carrying on its business and the consideration it had agreed to pay to Ciba Basle for obtaining the necessary information for the conduct of its, business. After the preamble, the operative part of the agreement consists of six articles. Articles 1 and 2 set out the obligations, which Ciba Basle had undertaken to perform or fulfil. Article 1 relates to the technical consultancy which Ciba Basle had agreed to give to Ciba Pharma and article 2 relates to the licence under Ciba Basle's Patent and Trade Mark rights, the use of which Ciba Basle had agreed to grant to Ciba Pharma. Article 3 describes the consideration, which Ciba Pharma had agreed to pay to Ciba Basle. Article 4 prohibits Ciba Pharma from assigning the benefit and the obligation of this agreement without the written consent of Ciba Basle. It similarly prohibits Ciba Pharma from granting any sub-licence under the Patents and/or Trademarks of Ciba Basle without its previous written consent. Article 5 relates to the duration of the agreement and its termination. It provides that the agreement would come into force from January 1, 1948, and its duration was five years, but terminable on three months' notice in the event of default in the performance of its obligations by any party. Article 6 relates to the arbitration in the event of any dispute arising between the parties to the agreement. We are here concerned principally with the preamble and Articles 1 to 3. The first para, of the preamble shows that Ciba Basle, at the material time, was engaged in the development, manufacture and sale of medical, pharmaceutical, biological and bacteriological preparations. These products have been referred to in this agreement as “the said products”. For the purpose of the production or of the trade with the said products, Ciba Basle had established and was maintaining and continuously developing chemical, medieval, biological, bacteriological and pharmaceutical research laboratories, factory laboratories, standardization departments, engineering departments and propaganda and patent departments. Ciba Basle, therefore, had acquired valuable scientific knowledge, research methods, data and material concerning its activities in the aforesaid sphere of development, manufacture and sale of medical, pharmaceutical, biological and bacteriological preparations. The preamble further states that the work, which had been allocated to these various departments essentially consisted of discovery of new pharmaceutical products, the introduction thereof into the clinical, medical and general use, as the case of each particular product may be, the elaboration of processes of production on factory scale and the improvement of already used processes, the drawing up and filing and supervising of patent applications as well as the continuous watch on patents, the standardization of processes and of new products; the design and construction of suitable engines for the production on laboratory and factory scale, the continuous entertainment of relations with the scientific and medical professions in order to secure their help as well as the results of their medical, clinical and scientific work. Paragraph 1 of the preamble further states that for these purposes Ciba Basle had employed and was employing in its various departments, chemists, physicians, druggists, lawyers, engineers and other scientific and technical experts. It had also secured the help of considerable number of famous University professors and other well-known scientific authorities. Ciba Basle was also engaged in training certain staff members in various departments with a view to sending them out to its affiliated and associated companies in order to give the benefit of the special knowledge acquired by these members of the staff in the various departments conducted by Ciba Basle. The concluding part of the first para, of the preamble is:

“The yearly amount of current costs, salaries and expenses incurred by Ciba Basle in the maintenance and the development of these departments as well as in new equipments forms part of Ciba Basle's general costs.”

3. Paragraph 2 of the preamble provides:

“Ciba Pharma has installed its own tabletting, ampoule filling and finishing work and has an organisation suited for the distribution and promotion of the said products. Ciba Pharma wishes to acquire the extensive knowledge and practical experience in the pharmaceutical field that Ciba Basle commands by reason of its long and extensive research work and scientific and practical experience. Therefore, the parties have agreed that Ciba Pharma shall pay to Ciba Basle a technical and research contribution for the use of its Indian patents and/or Trade Marks referring to the said products. The technical and research contribution is at the same time a consideration for the scientific and technical assistance and will refund partly Ciba Basle's costs and expenses for the maintenance and development of the research work described in this Preamble.”

4. Article 1 consists of two paras, and para. 1, which is the material paragraph, reads:

“Ciba Basle will communicate currently and/or at request of Ciba Pharma all the results of its research work, insofar as they relate to the said products, which are already manufactured or processed or sold by Ciba Pharma or which shall hereafter with the prior approval of Ciba Basle be manufactured or processed or sold by Ciba Pharma. Whenever manufacture or processing of a preparation is taken up by Ciba Pharma with the prior approval of Ciba Basle, the pertaining patent rights and Trade Marks will be licensed to Ciba Pharma according to the terms of Articles II and III. In this case Ciba Basle undertakes to deliver to Ciba Pharma all processes, formulae, scientific data, working rules and prescription pertaining to the manufacture or processing of the said products, which have been discovered and developed in Ciba Basle's laboratories and will forward to Ciba Pharma as far as possible all scientific and bibliographic information, pamphlets or drafts, which might be useful to introduce licensed preparations and to promote their sale in India. All physical material shall be invoiced by Ciba Basle to Ciba Pharma at cost price.”

5. Paragraph 2 of article 1 prohibits Ciba Pharma from divulging to third parties confidential information received by Ciba Pharma from Ciba Basle and requires Ciba Pharma to keep all data connected with the manufacturing processes under lock and key. Paragraph 1 of article 2, which relates to the licence under Ciba Basle's patent and trade-mark rights, states:

“Ciba Basle is registered or has applied for the registration as the case may be as the proprietor of several Letters Patent in India relating to the pharmaceutical products and listed in Schedule I of this Agreement. Furthermore, Ciba Basle is registered proprietor or has applied for the registration as the case may be of several trade marks relating to pharmaceutical products and giving protection in India, these Trade Marks being set out in Schedule II of this Agreement.”

6. Under para. 2 of the said article II Ciba Basle granted to Ciba Pharma the full and sole right and licence under the Patents listed in Schedule I to make use of, exercise and vend the inventions referred to therein in India. It similarly granted Ciba Pharma the full and exclusive licence to use the Trade Marks set out in Schedule II. The other paragraphs of this article are not material for the purpose of this case. Paragraph 1 of article III is in following terms:

Technical Research Contributions.

“As consideration for Ciba Basle's obligations stipulated in Article I and II, Ciba Pharma agrees to pay to Ciba Basle half-yearly the following percentage contributions of the total of the net selling prices of all pharmaceutical products manufactured or processed and/or sold by Ciba Pharma:

(a) Contribution towards Technical Consultancy and technical service rendered and research work done. .. .. 5% (b) Contribution towards cost of raw material used for experimental work. 3% (c) Royalties on Trade Marks used by Ciba Pharma. .. .. 2% Total .. .. 10%

7. The said technical research-contribution of 10 per cent was reduced to 6 per cent with effect from January 1, 1949. It has been stated at the Bar by counsel for the parties that the reduction was from 5 per cent to 1 per cent in the aforesaid item (a). The other paragraphs of Article III are not material for the purposes of this case. Schedule I sets out the Indian Patents of which Ciba Basle had been registered as a proprietor or which had been applied for. It may be mentioned that it held a patent for a preparation known as “Cibazol” Schedule II gives a list of these trade marks of which Ciba Basle was the proprietor or which had been applied for by Ciba Basle. It may be mentioned that it was also the proprietor of the Indian Trade Mark “Cibazol”.

8. The first question relates to the payment made by Ciba Pharma to Ciba Basle under the aforesaid para. 1 of Article III of the said Agreement. Paragraph 6 of the Statement of the Case shows that under the certificate dated June 6, 1950, given by the Swiss Company, it is found that out of the total expenditure of 8,409,364 Swiss frs. incurred in 1948, on research, recoveries from several entities like the Ciba Pharma and others came only to 4,613,701 Swiss frs. It is not necessary for us to give the figures of all the five years of the contributions made by Ciba Pharma to Ciba Basle. Barring the difference in the figures and the amount paid, the facts are identical. We may, therefore, take the assessment figure of 1949–1950.

9. Now, in the assessment year 1949–1950 Ciba Pharma claimed deduction under s. 10 in respect of the payment of 10 per cent of its net sale price made by it to Ciba Basle under para. 1 of article III of the Agreement. Two per cent out of the said amount had been allowed by the Income-tax Officer being a payment towards royalties on Trade Marks used by Ciba Pharma. But the remaining 8 per cent which amounted to Rs. 6,32,948 had been disallowed by the Income-tax Officer on the ground that the expenditure was incurred by the Swiss Company for its own business and that the assessee was not a manufacturing company so as to be eligible to get the benefit of research expenditure.

10. The assessee took an appeal to the Appellate Assistant Commissioner, who took the view that the said payment, which has been made under the agreement of December 17, 1947, was clearly in the nature of a purchase price paid for the permanent rights of acquisition conferred upon the appellant company under the agreement of the knowledge and the technical ‘know-how’ of the-parent company for the enduring benefit of the undertaking of the appellant's business in pharmaceuticals, which is in the offing to be set up. The payment is clearly in the nature of a payment by annual instalment of a capital sum. In this view of the matter, the Appellate Assistant Commissioner held that the payment is in the nature of a capital expenditure. He, therefore, disallowed the claim of the Ciba Pharma that the said payment was an expenditure incurred on scientific research relating to its business. In this view of the matter the Appellate Assistant Commissioner dismissed the appeal. The assessee-company took a further appeal to the Tribunal. Before the Tribunal, the aforesaid amount was claimed as an allowable expenditure under s. 10(2)(xii) as well as under s. 10(2)(xv). The Tribunal accepted the contentions of the assessee and allowed the assessee's claim on the ground that the expenditure was incurred in connection with the research in the line of the assessee's business. It, therefore, came within the provisions of s. 10(2)(xii). There was nothing to show in s. 10(2)(xii) that the expenditure must be incurred by the assessee. The Tribunal also, in the alternative, held that the expenditure was laid out wholly and exclusively for the assessee's business and there was no capital element involved in the expenditure. The Tribunal, therefore, in the alternative held that the expenditure would be an allowable deduction under s. 10(2)(xv) of the Income-tax Act. At the instance of the Department, the following questions have been referred to us:

“Whether on the facts and in the circumstances of the case, the payment made by the assessee to Ciba Basle Ltd. in pursuance of the Agreement dated 17-12-1947 is an admissible deduction under the provisions of sec. 10(2)(xii) of the Income-tax Act and if not, under sec. 10(2)(xv) of the Act, either in part or whole?”

11. It would be convenient to deal with this question first before we proceed to deal with the second question. The first aspect of the question, therefore, that arises is whether the said payment, which admittedly is made in pursuance of the agreement dated December 17, 1947, is an expenditure laid out and expended on scientific research relating to the business within the meaning of s. 10(2)(xii) of the Indian Income-tax Act.

12. It is the contention of Mr. Joshi, learned counsel for the Revenue, that the payment is not an expenditure within the meaning of s. 10(2)(xii) of the Act. It is his argument that on a true construction of the said agreement of December 17, 1947, it is not an expenditure laid out or expended by Ciba Pharma on scientific research. On the other hand, it is a contribution made towards the expenditure incurred by Ciba Basle. The organisation or the research carried on by Ciba Basle is maintained by Ciba Basle for its own purpose and for the purpose of extending its own business. The research, which is carried on by Ciba Basle is not dependent on whether the contribution is made by Ciba Pharma or not. There is also no obligation on the Ciba Basle to carry on any research in a particular manner as such at the instance of Ciba Pharma. Ciba Pharma, therefore, has neither incurred any expenditure on scientific research nor has it incurred any expenditure on scientific research carried on its behalf. On the other hand, it is the argument of Mr. Kaka, learned counsel for the assessee, that the expenditure falls under s. 10(2)(xii) of the Act. To attract the provisions of s. 10(2)(xii) it is sufficient to establish that it is an expenditure, not being in the nature of a capital expenditure, laid out and expended on scientific research relating to the business. It has not been held that the expenditure is in the nature of a capital expenditure. For an expenditure to be laid out or expended on scientific research, it is not necessary that an assessee himself must expend it on the research. If two or more persons agree to conduct for their mutual benefit research work and share the expenses, the contributions made by each would be an expenditure incurred, laid out or expended on such research. It will thus be an allowable deduction as an expenditure laid out or expended on scientific research relating to the business. Mr. Kaka also drew our attention to the following observation of the Tribunal in its order:

“There is no dispute that this expenditure relates to the appellant's business….”

and contended that one of the conditions that the expenditure must relate to the business has been established. There is also no dispute that Ciba Basle was carrying on research and the research carried on by Ciba Basle was also in respect of the products in which Ciba Pharma was dealing. There could, therefore, be no doubt that the expenditure incurred by Ciba Pharma was an expenditure relating to its business. Mr. Kaka also further drew our attention to the first sentence in para. 10 of the Tribunal's order, which reads:

“The amount paid per Article III of the Agreement appears to us to be in the nature of a share of expenses incurred by the foreign company for conducting research for itself and also on behalf of the Indian company.”

13. Relying on the aforesaid observation Mr. Kaka argued that the Tribunal has found as a fact that the research, which was carried on by Ciba Basle was on behalf of the assessee company. That being the position, it can hardly be said that the contribution made by Ciba Pharma towards the expenditure incurred by Ciba Basle was not an amount laid out or expended on scientific research.

14. We are unable to accept Mr. Kaka's contention that in the aforesaid observation on which reliance has been placed by Mr. Kaka, there is any finding of fact as such that the research carried on by Ciba Basle was a research carried on by itself and on behalf of Ciba Pharma. On the other hand, reading the judgment as a whole, it is clear that the said view taken by the Tribunal is on the construction of the Agreement. The Tribunal does not say that they so hold on consideration of the evidence, but, on the other hand, what is said by the Tribunal is “it appears to them” that the amount paid under article III of the Agreement to be “in the nature of a share of expenses incurred by the foreign company” for conducting research for itself and also on behalf of the Indian company. After setting out the facts upto para. 4, the Tribunal has set out article III of the agreement. In para. 5 the reduction in the percentage contributions is referred to Paragraph 6 refers to the calculation of 8 per cent and paras. 6A and 7 of the judgment the arguments advanced on behalf of Ciba Pharma as well as the Department are summarised. The arguments advanced by Ciba Pharma as summarised in para. 6A show that the contentions raised before it were two-fold: in the first instance it was contended that the contribution made as per agreement represented a part of, or an addition to, the invoice cost of the goods and as such allowable under s. 10(1) on the principles of commercial accountancy. In the alternative, it was argued that it was allowable under s. 10(2)(xii), 10(2)(xiv) or 10(2)(xv). The arguments advanced related to the construction of the agreement. Paragraphs 8 and 9 deal with the first part of the argument as to whether it was a part of the sale price, and the sentence on which reliance is placed is the first sentence of para. 10 of the judgment. In our opinion, therefore, the observations on which reliance is placed are made on a construction of the agreement and the question to be considered is whether such a position emerges on the construction of the Agreement. section 10(2)(xii) is in the following terms:

(1) “The tax shall be payable by an assessee under the head profits and gains of business, profession or vocation in respect of the profits or gains of any business, profession or vocation carried on by him.

(2) Such profits or gains shall be computed after making the following allowances, namely;…

(xii) any expenditure not being in the nature of capital expenditure laid out or expended on scientific research related to the business.”

15. Clauses (i) and (ii) of the Explanation relating to cls. (xii) and (xiii) provide:

(i) “‘Scientific research’ means any activities in the fields of natural or applied science for the extension of knowledge.

(ii) references to expenditure incurred on scientific research do not include any expenditure incurred in the acquisition of rights in, or arising out of, scientific research, but, save as aforesaid, include all expenditure incurred for the prosecution of, or the provision of facilities for the prosecution of, scientific research.”

16. Mr. Joshi, laying emphasis on the concluding words of sub-s. (1) “carried on by him” argued that the profits and gains on which tax is leviable are the profits and gains of the business, profession or vocation carried on by the assessee. It is from this amount that certain deductions in respect of certain expenditure under sub-s. (2) are allowed. It would necessarily follow that the allowable deduction is in respect of the expenditure incurred by the assessee on a research carried on by him in the conduct of his business. It is not in dispute that the Ciba Pharma itself had not carried on any activity in the field of natural or applied science for the extension of knowledge. It, therefore, cannot be said, and indeed it has not been said, that it is the Ciba Pharma who had carried on scientific research. Scientific research has been carried on by Ciba Basle. The payments made to Ciba Basle under article III of the Agreement, therefore, cannot be said to be an expenditure incurred by Ciba Pharma on any activity in the field of natural or applied science carried on by itself.

17. On the language used, it does not appear that to be an allowable deduction, the expenditure incurred must necessarily be on an activity in the field of natural or applied science, for extension of knowledge carried on by the assessee himself. All that is required to be established is that the expenditure incurred by the assessee was laid out or expended on scientific research related to the business. In other words, all that is required to be established is (1) that the expenditure was on scientific research and (2) the scientific research was one which related to the business of the lassessee. It would necessarily follow that for an expenditure to be one laid out and expended on such scientific research, there must be some direct or at any rate proximate nexus or connection between the expenditure and the scientific research and the research and business of the assessee. The instance which Mr. Kaka gave is one where there is such a connection established. Two or more persons conducting business of a similar nature may not individually be in a position to carry on research for the purpose of their business. They may join together, agreeing to share expenses and conduct scientific research for the purpose of their business. Here, though it cannot be said that each one of them is carrying on research himself, yet, there is a direct connection between expenditure incurred by each one of them and the scientific research which relates to their business. If we may give another instance, a business man may ask a research institution to conduct on his behalf a research on a particular subject or problem relating to his business, agreeing to pay its charges. Here again, there is a proximate connection between the expenditure incurred by the businessman and the research which relates to his business. In our opinion, therefore, in order to bring the case within the exemption cl. 10(2)(xii), it is incumbent on the assessee on whom the burden lies, to establish that the expenditure incurred by him was on a research carried on either by himself or on his behalf or at his instance, for the purposes of his own business. The sum paid by an assessee to another merely to obtain the knowledge gained by him by carrying on research for himself cannot be said to be an expenditure incurred by the assessee on scientific research, because it is neither carried on by him, nor on his behalf, nor at his instance. When cls. 10(2)(xii) and 10(2)(xiii) are read together, it becomes apparent that the Legislature has distinguished between the two situations—one where the expenditure is laid out or expended by the assessee on scientific research, and the other where a sum is paid by the assessee to another who is carrying on scientific research relating to the class of business carried on by the assessee. No doubt, the expenditure relating to which exemption has been claimed has been described in the agreement as “Technical and Research Contribution”. But the description given by a party to the expenditure is not determinative of the issue. It is not in dispute that the scientific research is not carried on by the assessee itself, but by Ciba Basle. Of course, if on the construction of the agreement it emerges that the scientific research carried on by Ciba Basle was on its behalf or was at the instance of the assessee, the assessee would, none the less, be entitled to claim exemption under the said cl. 10(2)(xii).

18. We have already referred in detail to the preamble of the agreement, and when the preamble is read as a whole, there is no doubt that the research carried on by Ciba Basle is for the advancement of its own business, and not on behalf of the assessee or at the instance of the assessee. Paragraph 1 of the preamble discloses that Ciba Basle is engaged in the development, manufacture and sale of medical, pharmaceutical, biological and bacteriological preparations. These preparations have been referred in the agreement as “the said products”. It is for the purpose of the production or the trade with the “said products” that the Ciba Basle had established various laboratories, such as, Chemical, Medical, Biological, Bacteriological and Pharmaceutical laboratories in which research is carried on continuously for the purpose of its business. It has continuously maintained various departments for the purpose of the said business, such as Standardization department, Engineering department, Propaganda and Patent departments. For the purpose of carrying on activities in these laboratories and departments, Ciba Basle had employed chemists, physicians, druggists, lawyers, engineers and technical experts. The activities in these various laboratories and departments have been carried on continuously for a long time, and the work allocated to them consists essentially of “discovery of new pharmaceutical products, the introduction thereof into the clinical, medical and general use, as the case may be”. At the end of para. 1 of the preamble, it has been clearly stated that the expenditure incurred by it on the research “consisting of current costs, salaries and other expenses incurred in the maintenance and development of the various departments mentioned in para. 1 as well as in new equipments, form part of Ciba Basle's general costs”. There is no ambiguity in the matter. It has not been said that the costs incurred by Ciba Basle are incurred for itself as well as on behalf of some other person or on behalf of Ciba Pharma or at its instance. There can hardly be any doubt that as a result of these activities carried on a large-scale, Ciba Basle had acquired “valuable scientific knowledge, research method, data and material concerning the aforesaid sphere of activities.”

19. Paragraph 2 of the preamble indicates the purposes for which Ciba Pharma had agreed to make the payment termed as “Technical and Research contribution”. The first part of para. 2 of the preamble shows that Ciba Pharma had by then installed its own tabletting, ampoule filling and finishing work and it had also built up its own organization suited for the distribution and promotion of the said products. It is for the conduct of this business of Ciba Pharma, it has been stated in para. 2:—

“Ciba Pharma wishes to acquire the extensive knowledge and practical experience in the pharmaceutical field that Ciba Basle commands by reason of its long and extensive research work and scientific and practical experience and it is, therefore, that Ciba Pharma had agreed to pay to Ciba Basle ‘a technical and research contribution’.”

20. This technical and research contribution has been divided under different heads in para. 1 of article III of the agreement. Paragraph 2 further provides that the technical and research contribution, which it had agreed to pay was by way of consideration:—

(i) for the use of Indian patents and/or Trade Marks referring to the “said products.”

(ii) for the scientific and technical assistance;.

21. Concluding part of para. 2 provides that Ciba Pharma had also agreed to refund part of Ciba Basle's costs and expenses for the maintenance and development of the research work described in this preamble. Reading the preamble as a whole, it becomes patently clear that for the purpose of its own business, Ciba Basle has maintained laboratories and departments in which activity on a large scale is continuously going on. The costs incurred by Ciba Basle are its own costs. As a result of these activities, very valuable knowledge is in possession of Ciba Basle. The assessee company which is a 100 per cent subsidiary company of Ciba Basle, had by then installed its own tabletting, ampoule filling and finishing work, and had also built its own organization suited for the distribution and promotion of certain products relating to which Ciba Basle had patents and had registered trade marks. Use of Indian patents and/or trade marks relating to these products was allowed by Ciba Basle to the assessee. The assessee wanted to obtain from Ciba Basle scientific and technical knowledge. Ciba Basle had agreed to give that knowledge to Ciba Pharma. In consideration thereof, Ciba Pharma had agreed to make certain payments which are referred to in the agreement as “technical and research contribution” as well as to “refund partly of Ciba Basle's costs and expenses for the maintenance and development of research work” described in the preamble.

22. For the reasons stated above, it is not possible to hold that the consideration paid for the use of patents and trade marks or for obtaining scientific and technical ‘know-how’ or an amount paid by way of refund of costs of research carried on by Ciba Basle on its own behalf is an amount expended by the assessee on technical research. The view taken by the Tribunal that the payment of Rs. 6,32,948 representing the 8 per cent of the net sale price is primarily an allowable deduction under s. 10(2)(xii) does not appear to be in consonance with the terms of the agreement.

23. Mr. Kaka in the course of his argument later admitted this position. He conceded that the contributions paid by Ciba Pharma towards technical consultancy and technical service rendered by Ciba Basle and the consideration paid for by Ciba Pharma to Ciba Basle for the use of patents and trade marks is not an expenditure allowable under s. 10(2)(xii). He, however, contended that part of the technical and research contribution, which is referable to “research work done” as mentioned in cl. (a) of para. 1 of article III and “contribution towards costs of raw material used for experimental work” as mentioned in cl. (b) of para. 1 of article III, is allowable as a deduction under s. 10(2)(xii) being an amount laid out or expended on scientific research.

24. It is true that the contribution as described in respect of these items and referable to cls. (a) and (b) gives an impression that it is an amount laid out or expended by Ciba Pharma on scientific research. But then it is a well settled principle that in construing an agreement, it is to be read as a whole and when so read, in our opinion, for reasons which we have already stated, it appears to us that the scientific and research work done by Ciba Basle was on its own behalf and not on behalf of itself and somebody else, much less on behalf of Ciba Pharma or at its instance. Reason, which Ciba Pharma has given in para. 2 of the preamble for making the research contribution, is also not that Ciba Basle had agreed to carry on any scientific and research work at the instance of Ciba Pharma. On the contrary, what has been said in para. 2 is that Ciba Pharma had agreed to make these payments, apart from the reason that use of the trade marks and patents were given to it, but wished to acquire the extensive knowledge and practical experience in the pharmaceutical field that Ciba Basle commands by reason of its long and extensive research work and scientific and practical experience. In other words, the object with which Ciba Pharma had agreed to make technical and research contribution was for the use of patents and trade marks and to obtain the know-how of the business it was then conducting. The consideration paid or the amount expended for the said purpose cannot be called an expenditure laid down or expended on scientific research. The view taken by us that one of the reasons why Ciba Pharma had agreed to pay these technical and research contribution was to obtain the technical ‘know-how’ of the business from Ciba Basle, which Ciba Basle had acquired, receives support from certain other parts of the agreement itself.

25. Now, if really the research had been carried on by Ciba Basle on behalf of itself and at the instance of and/or on behalf of Ciba Pharma, Ciba Pharma would have equal rights in the results of the research as Ciba Basle would therein have. Such, however, is not the position. Clause (2) of article 1 provides:—

“Ciba Pharma agrees not at any time to divulge to third parties without Ciba Basle's consent any confidential information received under this Agreement from Ciba Basle and in particular to keep all data connected with the manufacturing processes under lock and key.”

26. Similarly, para. 3 of article V provides:—

“Upon the termination of this Agreement for any cause Ciba Pharma shall cease to use the Patents and Trade Marks to which this Agreement refers except as to stocks then on hand and shall return to Ciba Basle or to such persons as they may appoint for that purpose all copies of information, scientific data or material sent to it by Ciba Basle under this agreement and then in its possession and shall expressly refrain from communicating any such information, scientific data or material received by it hereunder to any person, firm or company whomsoever other than Ciba Basle.”

27. These two clauses leave no doubt that the result of scientific research was exclusively the property of Ciba Basle and its use only for the purpose of its business during the course of its business was allowed to Ciba Pharma, and the contribution made was for that purpose. In other words, the contribution made by Ciba Pharma or the payment made by Ciba Pharma was for the purpose of acquiring the extensive technical knowledge and practical experience in the pharmaceutical field, which Ciba Basle commanded by reason of its long and extensive research work and scientific and practical experience. The payment is nothing but a payment for acquiring the technical ‘know-how’.

28. Mr. Kaka in the course of his arguments laid some stress on the words “at the request of Ciba Pharma” appearing in the first sentence of para. 1 of article I. The sentence reads:—

“Ciba Basle will communicate currently and/or at request of Ciba Pharma all the results of its research work, insofar as they relate to the said products which are already manufactured or processed or sold by Ciba Pharma.”

29. Laying emphasis on the words “at the request of Ciba Pharma” Mr. Kaka argued that the obligation incurred by Ciba Basle was not only to communicate currently results of its research work but there was also an obligation to communicate to Ciba Pharma the result of its research work at the request of Ciba Pharma. This clause, according to Mr. Kaka, shows that the research work, which was carried on by Ciba Basle, was carried on at the instance and on behalf of Ciba Pharma.

30. We find it difficult to accept this argument of Mr. Kaka. The sentence, when read as a whole, itself shows that the research work carried on by Ciba Basle was not on behalf of Ciba Basle and Ciba Pharma. On the other hand, the sentence itself shows that the research work of Ciba Basle was its own. What Ciba Basle had promised was to communicate to Ciba Pharma, at the request of Ciba Pharma, results of its research work. In our judgment, therefore, no part of the payment of 8 per cent can be said to be an expenditure laid out or expended by Ciba Pharma on scientific research. The said payment, therefore, is not an allowable deduction under s. 10(2)(xii) of the Act.

31. The question next to be considered is whether the said payment of 8 per cent of the sale price is an allowable deduction under s. 10(2)(xv). That clause reads:—

(xv). “any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation.”

32. It has not been contended on behalf of the Department that it is an expenditure falling under any of the clauses (i) to (xiv), nor has it been contended that it is in the nature of personal expenses of the assessee. The question to be considered is whether the said payment or any part thereof is laid out or expended wholly and exclusively for the purposes of the business of Ciba Pharma or whether the expenditure incurred is in the nature of a capital expenditure.

33. It is the contention of Mr. Joshi that save and except the payment attributable to “technical services” rendered by Ciba Basle referred to in cl. (a) of para. 1 of article III of the agreement, the rest of the payment must be disallowed because it is of capital nature. Mr. Joshi, in the course of his argument, drew our attention to the observations made by the Tribunal for holding that the expenditure was not of capital nature. The reasons given in para. 12 of the judgment are in the following terms:—

“The Departmental Representative's next contention was that even assuming that any portion of the expenditure was of a revenue nature, the whole of it cannot be treated as such and that he would require the expenditure being apportioned suitably between capital and revenue. As we have already stated the certificate given by the foreign company has been accepted as such. That clearly states that no capital expenditure has been incurred by the foreign company. Nor has the appellant acquired any asset of enduring benefit.”

34. It is the argument of Mr. Joshi that whether the foreign company has incurred any capital expenditure or not is not relevant for the purpose of deciding whether the expenditure incurred by Ciba Pharma was of capital nature or not. This part of the argument undoubtedly is well-made. But the decision of the Tribunal is not based solely on that observation. The other reason given by the Tribunal is that in its opinion by incurring this expenditure, Ciba Pharnm had not acquired any asset of enduring benefit and the expenditure incurred by Ciba Pharma, therefore, is not of a capital nature.

35. We have recently in S.F Engineer v. Commr. of Inc. Tax . 1965 67 Bom. L.R 394. elaborately discussed what is a capital expenditure and what is a revenue expenditure. Therein we have also referred to three decisions of their Lordships of the Supreme Court. The first decision of their Lordships is in Assam Bengal Cement Co. Ltd. v. Commr. of Inc-tax . 1954 27 I.T.R 34.. Bhagawati, J., who spoke for the Court, after discussing the various decisions and after referring to the Full Bench decision of the Lahore High Court and enumerating the three tests laid down in the Full Bench of the Lahore High Court, observed as follows (p. 45):

“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 or 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 or 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 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 a 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. If it 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…. 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 deductible allowance under section 10(2)(xv) of the Income-tax Act.”

36. These tests have again been referred to as principles formulated in determining the question as to whether a given item of expenditure is a capital or a revenue expenditure in State of Madras v. G.J Coelho . 1964 53 I.T.R 186. and in a still more recent decision of their Lordships of the Supreme Court given in the case of Bombay Steam Navigation Co. Ltd. v. Commissioner of Income-tax, Bombay . 1964 54 I.T.R 21 [Short Notes]. decided on October 21, 1964 (not yet fully reported), it has been observed:—

“The question whether a particular expenditure is revenue expenditure incurred for the purpose of the business must be viewed in the larger context of business necessity or expediency. If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit-making process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition to the carrying on of the business, the expenditure may be regarded as revenue expenditure.”

37. In the light of these tests and the observations of their Lordships of the Supreme Court, the facts of the present case will have to be considered in the larger context of the business necessity or expediency of Ciba Pharma.

38. The contention of the Department, as raised before the Tribunal, was that part of the said expenditure was of capital nature, because it brought in asset of an enduring benefit. The same argument also has been advanced before us. We have already discussed the various clauses of the agreement and, in our opinion, the payment of 8 per cent of its net sales, which, has been made by Ciba Pharma is by way of consideration:

(1) for the use of the rights under the Patents of Ciba Basle, and

(2) for acquiring the extensive knowledge and practical experience in the pharmaceutical field that Ciba Basle commands by reason of its long and extensive research work and scientific and practical experience in so far as it relates to the products which were manufactured or processed or sold by Ciba Pharma.

(3) for obtaining Scientific and technical assistance.

39. It is indeed true that the payment of 8 per cent of the net sale price, though referred to under various heads in cls. (a) and (b) of para. 1 of article III as contributions, is on an analysis of the agreement, a consideration paid for the aforesaid objects. It is not in dispute that consideration paid or payment made for the use of rights in patents of Ciba Basle is a revenue expenditure. The question to be considered is whether the consideration paid for acquiring the extensive knowledge and practical experience of Ciba Basle constitutes acquisition of an asset of an enduring nature. In other words, whether by the expenditure incurred for acquiring the technical know-how of the business, Ciba Pharma had acquired an asset of an enduring benefit. Having regard to para. 2 of article I and para. 5 of article V of the agreement, there can hardly be any doubt that Ciba Pharma had acquired no asset in obtaining the ‘know-how’ of the business. No right in the results of the scientific research has been acquired by Ciba Pharma. These two paragraphs make it clear that the confidential information received by Ciba Pharma from Ciba Basle about the conduct of the business and all data connected with the manufacturing processes was not to be divulged by Ciba Pharma during the currency of the agreement. On the termination of the agreement, Ciba Pharma is required to return to Ciba Basle or to such other persons as Ciba Basle may appoint, all copies of information, scientific data or material sent to it by Ciba Basle under this agreement. Further, Ciba Pharma is expressly refrained from communicating such information, scientific data or material received by it hereunder to any person, firm or company whomsoever, other than Ciba Basle. The use of the knowledge or the practical experience, which Ciba Pharma gets by knowing the technical ‘know-how’ is thus limited only for the purpose of the conduct of the business during the period of the agreement, which is of a duration of five years. Payments made for acquiring the said knowledge cannot, in our opinion, be said to have brought into existence an asset of an enduring nature. On the other hand, payment has been made to get the technical ‘know-how’ only for the purpose of running the business during the period of the agreement with a view to earn profits. In the payment, therefore, in our opinion, no expenditure of a capital nature is involved.

40. It is next argued by Mr. Joshi that on a true construction of para. 1 of article I, the expenditure incurred or the payment made cannot be said to be an expenditure wholly and exclusively laid out or expended for the purposes of Ciba Pharma's business in the year of account. According to Mr. Joshi, the consideration paid is for all the obligations of Ciba Basle, which it had stipulated in articles 1 and 2. The obligation stipulated by Ciba Basle in para. 1 of article I is not confined to convey to Ciba Pharma the ‘know-how’ in respect of the products in which Ciba Basle was then dealing. The obligation stipulated by Ciba Basle in these clauses was also to convey to Ciba Pharma the technical ‘know-how’ in respect of certain other products also as and when Ciba Pharma would undertake the manufacture or processing of these products. It is the argument of Mr. Joshi that the payment made or the expenditure incurred also relates to both the things: for obtaining the ‘knowhow’ in respect of the products in which Ciba Pharma was already dealing as well as in respect of the right to acquire the technical ‘know-how’ in respect of the other products as and when Ciba Pharma would undertake the manufacture or processing of those products.

41. In our opinion, the argument is not well-founded. The consideration, which Ciba Pharma had agreed to pay to Ciba Basle, is not for a fixed sum. On the other hand, the consideration it had agreed to pay was a certain percentage of the net sale price of all pharmaceutical products manufactured, processed and/or sold by Ciba Pharma. The later part of para. 1 of article I is merely an agreement to enter into another agreement on the same terms and conditions as are mentioned in articles II and III of this agreement, as and when the occasion would arise, viz. “Whenever manufacture or processing of a preparation is taken up by Ciba Pharma with the prior approval of Ciba Basle”. It is only when such an occasion would arise Ciba Basle had promised that it would licence the pertaining patent rights and trade marks to Ciba Pharma according to the terms of articles II and III. Ciba Basle further promised that it would in that event deliver to Ciba Pharma all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of those products, which have been discovered and developed in Ciba Basle's laboratories. The further promise is that in that event Ciba Basle would forward to Ciba Pharma as far as possible all scientific and bibliographic information, pamphlets or drafts, which might be useful to introduce licenced preparations and to promote their sale in India. These being the terms of the later part of para. 1 of article I, in our opinion, there was no present obligation incurred thereunder by Ciba Basle. On the other hand, as we have already said, the later part contains only an agreement to enter into another agreement for a fresh consideration. The consideration stipulated in article III relates only to the obligations that had already been incurred by Ciba Basle under the agreement. Reading the agreement as a whole, it would be noticed that the consideration, which Ciba Pharma had agreed to pay, was not a fixed sum but was proportionate to the advantage received by it from Ciba Basle. The agreement in short is that Ciba Pharma agreed to pay to Ciba Basle 10 per cent of the net selling price of the products manufactured, processed and/or sold by Ciba Pharma in consideration of the user of the technical and scientific knowledge of research conducted by Ciba Basle, technical assistance and for the user of trade marks and patents pertaining to those products. The later part of article I further provides that as and when Ciba. Pharma would undertake manufacture or processing of some other products, which would by then have been discovered by Ciba Basle, Ciba Pharma would also be required to pay 10 per cent of the net sale price of those products in lieu of the user of the knowledge of the research conducted by Ciba Basle pertaining to those products as well as for the user of the Trade Marks and Patents pertaining to those products. In our opinion, therefore, there was no payment made by Ciba Pharma to Ciba Basle in respect of any obligation stipulated by Ciba Basle, which had no concern with the relevant assessment years. The entire expenditure, therefore, was an expenditure incurred in respect of matters pertaining to the year of account. We have already said that the expenditure incurred, viz. the payment of 8 per cent or 4 per cent as the case may be, of the net selling price, was for acquiring the technical knowledge of the research conducted by Ciba Basle and for the user of patents pertaining to the products manufactured, processed or sold by Ciba Pharma in the years of account. It is not in dispute that the expenditure incurred pertaining to the user of the patents is a revenue expenditure. We have also said that the expenditure incurred for the use of the knowledge of the research conducted by Ciba Basle also is a revenue expenditure and that therein no element of capital nature is involved inasmuch as by incurring the expenditure, Ciba Pharma had not acquired any asset of an enduring nature. Before the Tribunal it was not in dispute that the expenditure related to Ciba Pharma's business. The expenditure thus would be an expenditure wholly and exclusively laid out or expended for the purpose of business. In our judgment, therefore, the expenditure would be an allowable deduction under s. 10(2)(xv) of the Act. The view taken by us finds support in a decision of King's Bench Division in British Sugar Manufacturers, Ltd. v. Harris (H.M Inspector of Taxes) . 1937 21 T.C 528.. Facts in that case were that the assessee company, which was the appellant, had agreed to pay to two other companies a certain percentage of its net annual profits “in consideration of their giving to the company (assessee-company) the full benefit of their technical and financial knowledge and experience”. The question to be considered was whether the payment made under this agreement by the assessee company to the other companies was an allowable deduction. The contention of the assessee-company was that payment under the agreement was a payment for the services rendered; that it was a sum expended in earning its profits and not expended for capital purposes; that it was not a distribution of its profits and, therefore, the expenditure should be allowed as a deduction in computing the assessee-company's profits. The contentions of the assessee-company were upheld by the Appeal Court and it held that the payments made under the aforesaid agreement were admissible deductions in computing the appellent-company's profits.

42. Our attention has been also drawn, to another case reported in Musker v. English Electric Co., Ltd. . 1964 41 T.C 556. Though the case is distinguishable on facts and the question considered there related to the income of the assessee-company and not to its expenditure, it throws considerable light on the point to be considered. Facts in this case were: the assessee-company in the course of carrying on its trade of engineering manufacturers, had acquired a fund of specialised information and technique in engineering processes. It has not been the practice of the assessee-company to turn this information and technique to account by imparting it to others. However, at the request of the Admiralty, the assessee-company had entered into an agreement to design and develop a marine turbine and to license its manufacture by a limited number of companies in the United Kingdom, Australia and Canada. The agreement, which the assessee-company had entered into with these companies, provided for imparting of manufacturing technique to the licensee-companies and in consideration of this, the assessee-company received specified lump sum payments. The claim made by the assessee-company was that the amount received by it under the agreement was not the income of its business, but capital receipt and, therefore, was not taxable. The claim of the assessee-company was negatived by the House of Lords. Viscount Radcliffe in his speech observed (p. 585):

“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, trade-marks 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.”

43. The position here is more or less the same. As a result of its extensive and valuable research Ciba Basle is in possession of very valuable technical knowledge and practical experience. They had also obtained certain patent rights in respect of certain products and have also registered their trade marks.

44. Under the agreement Ciba Basle have parted with their rights and trade marks. All what has been agreed to under the agreement is to grant the user of the patents and trade marks to Ciba Pharma and to give Ciba Pharma the technical ‘know-how’ and assistance. In the transaction, there is no transfer of any property or asset nor any capital element is therein involved. The transaction, therefore, is not “capital in nature”.

[His Lordship after dealing with the second question, concluded.]

45. For reasons stated above, our answer to the first question is that the payment made by the assessee to Ciba Basle in pursuance of the agreement of December 17, 1947, is not an admissible deduction under the provisions of s. 10(2)(xii) of the Income-tax Act, but the whole of the amount is an admissible deduction under s. 10(2)(xv).

46. Our answer to the second question is in the negative. In the circumstances of the case we make no order as to costs.

47. Answer accordingly.