Venkataramiah, J.:— The question of law referred in I.T.R.C No. 116 of 1974 under Section 256(1) of the Income-Tax Act (hereinafter referred to as ‘the Act’) by the Income-Tax Appellate Tribunal, Bangalore Bench (hereinafter referred to as ‘the Tribunal’). reads as follows:—
“Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the payment of a sum of Rs. 5,95,000 represented capital expenditure and therefore not deductible in arriving at the income of the assessee?”
In I.T.R.C 117 of 1974, the question of law referred is the same but the expenditure in respect of which the relief claimed is Rs. 5,96,000 instead of Rs. 5,95,000.
2. The assessee in these two cases is the Indian Telephone Industries Limited, Bangalore, which is a Government Company. I.T.R.C 116 of 1974 arises out of the assessment proceedings under the Act in respect of the assessment year 1966-1967 and I.T.R.C 117 of 1974 arises out of the assessment proceedings in respect of the assessment year 1967-1968. The facts leading to these references are as follows;—
3. The assessee is engaged in the manufacture of telephone and allied equipment. Till the year 1964, the assessee was manufacturing telephone exchange equipment known as ‘strowger’ type equipment which functioned on the ‘step by step’ system. In the year 1964, the Government of India wanted to introduce direct dialing system throughout India and for this purpose, it was considered necessary to convert the telephone exchanges into the ‘cross bar’ type which could later be incorporated and adopted into electronic telephone exchanges. Pursuant to the above decision, the Government of India entered into three agreements on 21st May, 1964. The parties to these three agreements were:—
I Agreement:
(i) The Government of India;
(ii) The assessee;
(iii) International Standard Electric Corporation of USA (hereinafter referred to as ‘Standard’);
II Agreement:
(i) The Government of India;
(ii) The assessee;
(iii) Bell Telephone Manufacturing Company, S.A of Antwerp, Belgium (hereinafter referred to as BTM).
III Agreement:
(i) The Government of India;
(ii) The assessee;
BTM was a subsidiary of Standard. Standard and BTM were manufacturing cross-bar telephone exchanges under the trade mark ‘pentaconta’. By the I agreement, Standard agreed to finance the setting up of a factory for the manufacture of Pentaconta switching equipment and to cause BTM to provide the required technical information and know-how and to sell certain machinery to the assessee, which was designated by the Government of India, to establish such a factory. Standard agreed to invest US$ 1,250,000 of which the sum of $ 750,000 was in cash and the balance in know-how valued at $ 500,000 in the share capital of the assessee and also to lend to the assesses $ 1,000,000 and loan. Standard was, among other things, entitled to receive royalty.
4. During the accounting year relating to assessment year 1966-1967, the assessee paid Rs. 5,95,000 and during, the accounting year relating to assessment year 1967-1968, the assessee paid Rs. 5,96,000 towards the amount of $500,000 which it had to pay under the agreement and which the Standard had undertaken to invest with the assessee as share capital. During the said assessment years, the assessee claimed the two sums, viz., Rs. 5,95,000 and Rs. 5,96,000 as business expenditure allowable under Section 37 of the Act. Before the Income-tax Officer the case of the assessee was that the sums in question which had been paid for acquiring the necessary technical know-how pursuant to the agreements referred to above, constituted revenue expenditure as the said sums had been wholly laid out on the business of the assessee with a view to earning higher profits. The Income-tax Officer, however, rejected the claim of the assessee and disallowed the claim holding that the said sums represented capital expenditure. The Appellate Assistant Commissioner reversed the finding of the Income-tax Officer in the appeals preferred by the assessee. In the further appeal filed by the Department against the orders of the Appellate Assistant Commissioner, the Tribunal reversed the orders appealed against and restored the orders of the Income-Tax Officer. Thereafter, these references were made by the Tribunal at the instance of the assessee.
5. In order to reach the conclusion that the sums in question represented capital expenditure, the Tribunal principally relied upon the decision of this Court in Mysore Kirloskar Ltd. v. Commissioner of Income-Tax, Mysore(1) (hereinafter referred to as the first Kirloskar's case) in which this Court had declined to follow the judgment of the High Court of Bombay in Commissioner of Income-Tax v. Ciba Pharma Private Ltd.(2). The said decision of the Bombay High Court was later on affirmed by the Supreme Court in Commissioenr Of Income Tax, Bombay v. Ciba Of India Ltd.(3). When a question similar to the one which arose for consideration in MYSORE KIRLOSKAR's case (supra), arose for consideration again before a Full Bench of this Court in Mysore Kirloskar Ltd. v. Commissioner of Income-Tax, Bangalore(4) (hereinafter referred to as the second Kirloskar's case) the decision in the first MYSORE KIRLOSKAR's case was over-ruled in view of the pronouncement of the Supreme Court in CIBA's case. Thus the decision in the first MYSORE KIRLOSKAR's case relied on by the Tribunal is no longer good law.
6. In the instant cases, the undisputed facts are:
(i) the assessee was carrying on the business of manufacturing telephone exchange equipments though of a different type before the aforesaid agreements were entered into.
(ii) Under the agreement, the assessee acquired the right to make use of the technical know-how made available by BTM at the instance of Standard regarding ‘Pentaconta’ cross-bar exchanges;
(iii) Under the agreements the assessee acquired the right to use that know-how in manufacturing such equipment in India and to sell such equipment in India.
(iv) The assessee also acquired under the agreements an unlimited right to sell such equipment in some specified countries and a limited right in respect of some other countries.
(v) The assessee acquired under the agreements the right to obtain and use further technical knowledge which might be developed by Standard and its associates and the right to use the patents of Standard and its associates both during and after the period of agreements.
(vi) The agreements were to be in force for a period of 7 years.
(vii) The assessee had no right to part with the know-how in favour of a third party and receive consideration therefor.
(viii) Such technical know-how was itself subject to speedy obsolescence having regard to the extensive and rapid research and development going on the field of tele-communication.
7. The true tests that have to be applied in determining whether an item of expenditure is of capital or of revenue nature have been laid down by the Supreme Court in Assam-Bengal Cement Co., Ltd. v. Commissioner of Income-Tax, West Bengali(5) on which the learned Standing Counsel for Revenue strongly relied. Those tests read:
“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 mutally exclusive and have to be applied to the facts of each particular case in the manner about indicated.”
8. In the instant cases, the asset which, according to the Department, was acquired by the assessee was technical know-how. The nature of expenditure incurred by an assessee in the course of his business for acquiring technical know-how has been explained by the Supreme Court in Commissioenr Of Income Tax, Bombay v. Ciba Of India Ltd.,. There, the assessee-Company was incorporated on the 13th December, 1947 and a collaboration agreement was entered into with a foreign Company for acquiring technical know-how on the 17th December, 1947. Under the relevant terms of that agreement, the assessee got merely access to the technical knowledge and experience in the pharmaceutical field which was acquired by the foreign company (the collaborator). The assessee was on that account held to be a mere licencee for a limited period, of technical knowledge of the foreign company with a right to use the patents and trade marks of that Company. In other words, the assessee was held to have acquired under the agreements, merely the right to draw for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products upon the technical knowledge of the foreign company for a limited period and 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. The payment made by the assessee in that case for the purpose of acquiring the technical know-how in those circumstances was held to be revenue expenditure allowable under Section 10(2)(xv) of the Indian Income-tax Act, 1922, correspondmg to Section 37 of the Act. In support of its conclusion, the Supreme Court relied on the decision of the House of Lords in Rolls Roice Ltd. v. Jeferey(6) wherein the assessee, a manufacturer of motor cars and air-craft engines, had been engaged also in matallurgical research and discovery and development of engineering techniques and secret processes. The technical knowledge which it had acquired at enormous cost could not be used by the assessee for its own purposes. It, therefore, under agreements entered into with the foreign Governments, made available for a consideration, the technical knowledge and secret processes acquired by it to be used by the foreign Governments in the course of their own business. The question before the House of Lords was whether the consideration realised by the assessee under the agreement with the foreign Governments could be treated as a revenue receipt or capital receipt. Lord Radcliffe in the course of his speech in that case observed:
“I cannot accept the contention that by each of these agreements the appellants sold a part of that capital asset and received a price for it. There is nothing in the case to indicate that capital asset was in any way diminished by carrying out these agreements. The whole of their knowledge and experience remained available to the appellants for manufacturing and further research and development, and there is nothing to show that its value was in anyway diminished. They had not even given up a market which had been open to them. They could not sell their engines in these countries whether they made these agreements or not. If they had not made these agreements they would have got nothing from these countries; by making them they were able to exploit their capital asset by receiving large sums for its use there. In essence what they did was to teach the “licensees” how to make use of the “licences” which they granted.”
The learned Lord was of the opinion that the receipts in question were in the nature of revenue receipts since the assessee had not parted in entirety its title to the technical know-how in favour of the “Licensees”. It may be, that in the case before the House of Lords, the question that arose for consideration was whether the money received by the licenser was a revenue receipt or capital receipt and not whether the payments made to the assessee constituted revenue or capital expenditure. But as the Supreme Court has pointed out in the course of its decision in C.I.T Bombay City-I v. Ciba of India Ltd., the observation made by the House of Lords would equally apply in a case of this nature, where the question is whether the payment made by the licensee is of capital nature or of revenue nature. The Supreme Court rested its decision in CIBA's case on the following circumstances; (a) the licence was for a period of five years, liable to 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 agreement to other persons; (d) the assessee was expressly prohibited from divulging confidential information to third parties without the consent of the foreign company; (e) there was no transfer of the fruits of research once for all; the foreign company which was continuously carrying on research 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.
9. As observed by the Supreme Court in Assam Bengal Cement Company's case, the last circumstance, namely, whether the payment to be made is a recurrent one or a lump sum payment may not be decisive of the question. The other circumstances on which the Supreme Court relied, more or less, are present in the case before us.
10. In the ultimate analysis, the assessee instead of spending its own money on research and development which would have been an admissible deduction under Section 35 of the Act and also time in carrying on research, was only ‘buying’ time by entering into the agreements in question to acquire the technical know-how to improve the prospects of its own business and to meet the requirements of the transitional stage before taking to the manufacture of electronic equipment. It cannot be said that the expenditure in question was incurred for acquiring an asset of an enduring nature.
11. For the foregoing reasons, we are of the view that the Tribunal was in error in holding that the expenditure in question was of capital nature and was therefore not allowable under Section 37 of the Act.
12. Following the decision of the Full Bench in the second Mysore Kirloskar Ltd's Case (114 ITR 443), we hold that the assessee was entitled to claim by way of deduction the two sums paid in these two cases. We, therefore, answer the question referred to us in the negative and in favour of the assessee.
13. In the circumstances, the parties shall bear their own costs.