Commissioner Of Income-Tax v. Avery India Ltd.

Ajit K. Sengupta, J.:— In this reference, the following question has been referred to us by the Tribunal under section 256(1) of the Income-tax Act, 1961:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee is entitled to claim the amount of Rs. 13,28,450 as revenue expenditure?”

2. The matter relates to the assessment of the assessee for the assessment year 1982–83 for which the previous year ended on December 31, 1981. Shortly stated the facts are that the assessee-company derives income from manufacture and sale of weighing and testing machines, weights, etc. The Assessing Officer held that the payment of Rs. 13,28,450 was of capital nature since as per the terms of the agreement relating to the use of trademarks and patents and copyrights of the Revere Corporation, the assessee-company had full right to use them in India not only until the existence of the said agreement but also after the expiry or termination of the agreement. The disallowance made by the Assessing Officer was upheld by the Commissioner of Income-tax (Appeals). On the assessee's appeal, the Tribunal held that the payment under the agreement with the said foreign company of the amount of Rs. 13,28,500 was revenue expenditure and deductible as such. The Tribunal set forth its reasons for the conclusion as under:

“We have considered the matter. As per section 2 of article VI, the assessee-company is entitled to continue to use the information transferred and imparted by the collaborator even after the expiry of the agreement. But at the same time, under article VII of the said agreement, the assessee-company was prohibited from disclosing to others any information derived from technical or other data to be received from the collaborator under the said agreement. The argument of the income-tax department that the expenditure could be on capital account where the Indian company continues to get the benefit of technical know-how in the sense that it did not return it after the expiry of the agreement and that it continues to manufacture the same product thereafter, was rejected by the Andhra Pradesh High Court in the case of Praga Tools Ltd. v. Commissioner Of Income-Tax, Hyderabad., [1980] 123 ITR 773 [FB]. According to the Andhra Pradesh High Court, once the assessee had the advantage of utilising special knowledge and technical know-how along with the specific drawings, designs and other information during the period under the agreement it did not alter the true state of affairs by agreeing that the assessee would be free to make use of the technical know-how and the knowledge even after the period of the agreement. It also held that there was no property right in the know-how which was transferable. Further, according to the court, the imparting of special knowledge and technical know-how by the foreign collaborator would be like a teacher selling his skill or knowledge to his pupil. Same is the view of the Bombay High Court in the case of CIT v. Tata Engineering and Locomotive Co. Pvt. Ltd., [1980] 123 ITR 538. In that case, the Bombay High Court held as under (headnote):

‘Technical know-how cannot be called a tangible asset. Technical know-how and technical advice for the time being cannot, in these days of technological and scientific development and consequent change in production techniques, be treated as a capital asset. The length of the period of the agreement is not of much consequence, if the nature of the advice made available is such that it cannot be called a capital asset. Merely because an assessee who has entered into a contract with regard to know-how is entitled to use the know-how even after the agreement has expired it does not mean that he has acquired a benefit of an enduring nature. Agreement of foreign collaboration where foreign know-how is availed of in lieu of payment, is in substance a transaction of acquiring the necessary technical information with regard to the technique of production. Instead of employing persons having knowledge of techniques and utilising their knowledge, technical know-how is acquired. Technical know-how made available by a party to such an agreement does not stand on the same footing as protected rights under a registered patent’.”

3. Useful reference can also be made to the following observations of Viscount Radcliffe in the case of Musker v. English Electric Co. Ltd., [1964] 41 TC 556 (HL) (at page 585):

“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.”

4. The exclusivity is contained in section 1 of article IV, which reads as under:

“Revere shall not transfer or permit to be transferred or imparted the information constituting the subject-matter of this agreement to any other person or company in India or knowingly to any person or company acquiring the same for use in India and shall not enter into any other agreement with any other party in India in connection with the agreement products.”

5. One of the objections of the lower authorities in refusing the assessee's claim is this exclusivity. But the High Courts have held otherwise. The Andhra Pradesh High Court in the case of Praga Tools Ltd., [1980] 123 ITR 773 [FB], held as under (at page 788):

“The mere fact that the foreign collaborators have agreed to grant to the assessee-company the right to manufacture under exclusive licence in India, under the trademark ‘C.V.A Praga’ Drill Chucks of all sizes and descriptions as listed in C.V.A price lists in the first agreement and the right to manufacture under exclusive licence in India under the Jones and Shipman trademark ‘Jones Shipman’ tool and cutter grinding machine with all the technical know-how and assistance, would not in any way alter the very nature and character of the payments in question. By clause 2 of article II, the Swiss company in Ciba's case, [1968] 69 ITR 692 (SC) granted to the assessee ‘full and sole right and licence’ in the territory of India under the patent listed in Schedule I, to make use, exercise and vend the inventions referred to therein and to use the trademarks set out in Schedule II in the territory of India. Hence, this would not in any way alter the position in the present case.”

6. Reliance placed by the Department on the exclusive use given to the assessee by Daimler Benz to Tata Engineering and Locomotive Company for treating the technical know-how fee as capital expenditure was also rejected by the Bombay High Court in CIT v. Tata Engineering and Locomotive Co. Pvt. Ltd., [1980] 123 ITR 538. The exclusiveness of the assessee during the currency of the agreement was also considered by the Delhi High Court in the case of Triveni Engineering Works Ltd.…Applicant v. Commissioner Of Income-Tax, New Delhi…, [1982] 136 ITR 340. In spite of this the High Court held that the expenditure had to be treated as revenue expenditure. In these circumstances, respectfully following the above decisions we hold that the assessee is entitled to claim the amount of Rs. 13,28,460 as revenue expenditure.

7. Before us, the parties reiterated the contentions canvassed before the Tribunal. Learned counsel for the assessee emphasised that the assessee engaged in the business of manufacturing weighing machines and weigh bridges in India entered into a collaboration agreement with the American company. The purpose was to update the assessee's technology. Under the agreement the assessee acquired the right to use the technical know-how. The right so acquired does not go to alter the nature of the transaction being in the revenue field. Reliance was placed on the decision of the Andhra Pradesh High Court in Praga Tools Ltd. v. Commissioner Of Income-Tax, Hyderabad., [1980] 123 ITR 773 [FB]. The facts in the said case were that the assessee carrying on the business of manufacturing precision tools and machine tools entered into a licence agreement with a U.K company which was to supply the accessories, designs, technical know-how with latest modifications and to provide assistance. U.K company agreed to assist the assessee in its existing business of manufacture of weigh bridge machines and all the fixtures, jigs, gauges, raw materials and special parts. In consideration of grant of manufacturing know-how and for providing assistance, the assessee agreed to pay an initial amount. The agreement was for ten years and renewal for five years by mutual consent. During the subsistence of the agreement, the assessee had to pay royalty at five per cent. on the Indian selling price on the production of the machine, subject to Indian taxes. The rights of the assessee to use all the information, techniques and know-how, patents, copyrights and drawings received from the foreign company were not to be affected by the termination of the agreement. The only restriction was that the assessee in that case could not use the trademark of the foreign collaborator. The assessee claimed the royalty payment to the foreign collaborator as revenue expenditure deductible from the profits. But the Andhra Pradesh High Court held that the expenditure incurred had a direct nexus or relation to the carrying on or the conduct of the business of the assessee and, therefore, it had to be treated as an integral part of the profit-making process. The payment made in order to obtain the manufacturing licence and technical know-how including drawings, specifications and other technical information enabled the assessee to manufacture and sell the products. Merely because the agreement conferred on the assessee the right to retain technical know-how, designs, drawings even after expiry of the agreement it did not change the nature of the transaction. There was no property right transferable in the technical know-how. The prohibition against the use of the trademark of the foreign collaborator clinched the issue in favour of the assessee. The totality and cumulative effect of the material facts and surrounding circumstances were taken into consideration by the High Court to arrive at the decision as to what the nature of the transaction was. Viewed in the larger context of the business, each factor or circumstance by itself may not be decisive. The decision of the Andhra Pradesh High Court has support of the ratio of the Supreme Court in CIT v. Ciba of India Ltd., [1968] 69 ITR 692. This court also in Commissioner Of Income-Tax v. B.N Elias & Co. (P.) Ltd. and Co. Pvt. Ltd., [1987] 168 ITR 190 has held that even where a lump sum payment is made under an agreement for acquisition of know-how for user of such know-how for the period of the agreement the payment has to be allowed as business expenditure since the payment does not bring into existence any assel or benefit of enduring nature. In that case, the assessee was engaged in manufacturing carpet-backing looms, cloth-rolling machines and other machines under the collaboration agreement with the U.K company. The assessee obtained assistance from the U.K company in manufacturing power press machines. In that case also, the agreement was renewable after the expiry of the initial period of ten years. The agreement could also be terminated before that time. The assessee was entitled to use the know how for manufacture of the machines up to the termination of the agreement. The assessee paid by way of a lump sum to the British company fixed fee and also royalty on the sale of the machines at a stipulated rate. This court held that the assessee had obtained user of the know-how only during the continuance of the agreement. It had been found as a fact by the Tribunal that under the agreement, the assessee had not acquired or started a new line of business. The assessee was already a manufacturer of machines, and the agreement only enabled the assessee to utilise its existing business unit. For the purpose of manufacturing new items, there was no outright transfer of know-how to the assessee and the know-how supplied remained the property of the foreign company. The assessee had only the user of the know-how during the currency of the agreement. The fact that the assessee had to pay a lump sum in addition to royalty was not of consequence. The lump sum amount paid was directed to be allowed as a revenue deduction.

8. We are of the view that the advantage of continued utilisation of the special knowledge and technical know-how along with the specific drawings, business and other information does not obliterate the fact that the payment in question was merely for the more technically competent manufacture of the machines which has been the existing line of the assessee's business. The assessee's right to make use of the technical know-how and the knowledge even after the period of the agreement is of no consequence. It is also correct that there was no property right in the know-how which could be transferred. This view also accords with the view taken by the Bombay High Court in CIT v. Tata Engineering and Locomotive Co. Pvt. Ltd., [1980] 123 ITR 538. Support has also rightly been drawn by the Tribunal from the decision of the Delhi High Court in Triveni Engineering Works Ltd.…Applicant v. Commissioner Of Income-Tax, New Delhi…, [1982] 136 ITR 340.

9. It is by now well-settled that there is no capital element in the payment for acquiring technical collaboration from foreign manufacturers. Such collaborations are entered into merely for the purpose of running the factory as a more technically viable efficient and profitable unit to yield larger profit. The contention of the Department that the agreement not compelling the Indian party to return to the foreign collaborator all the drawings, specifications and other technical information creates an asset or advantage of an enduring nature is unsound as it is based on the fallacious presumption that any expenditure by a taxpayer resulting in an enduring benefit must in all cases be regarded as capital in character. The accrual of a benefit, however enduring or lasting, is not the sole test of the capital character of the payment. The Supreme Court in Empire Jute Co. Ltd.'s case, [1980] 124 ITR 1 has decided that a benefit that might endure long in the assessee's business may none the less be in the revenue field, if the benefit is in respect of an asset which is part of the circulating capital. In that case, the assessee bought loom hours so as to obviate constraints on its option to increase the output by running its plant and machinery for a longer period than it could otherwise do. The Supreme Court held that where the manufacturer employs additional variable factors, i.e, circulating factors keeping the fixed factors constant, it cannot be an activity in the capital field so that the expenditure incurred therefor should be treated as capital expenditure: The purchase of loom hours was considered as good as employing a larger labour force for a larger output, the capital outfit remaining constant. Even though, in a sense, the procurement of loom hours brings to the factory an advantage that lasts for long, still the expenditure for such procurement has a direct bearing on the working, running of the existing fixed capital not creating any advantage in the capital field.

10. There is one more aspect that has been emphasised by the different High Courts in similar situation. By acquiring technical know-how the advantage that comes into being is too short-lived by reason of the fast-moving technology. The new technology acquired becomes obsolete too soon for the advantage in such acquisition to be treated as enduring. This view has been taken in Coromandel Fertilizers Ltd. v. CIT, [1984] 148 ITR 546 (AP). There the Andhra Pradesh High Court held that the know-how acquired cannot be said to be enduring for the reason that further development in technology within a short span of time renders the know-how obsolete. Therefore, having regard to the rapid pace of scientific and technical development in the global economic scene it is unrealistic to say that the technical know-how is an advantage of enduring nature.

11. The corner-stone of all these decisions is CIT v. Ciba of India Ltd., [1968] 69 ITR 692 (SC). In that case, the assessee in order to obtain the benefit of technical assistance for running its business entered into an agreement with a foreign company whereby the foreign company was to deliver for a specified period to the assessee all processes, formulae, scientific data and working rules pertaining to the manufacture or processing of products discovered and developed in the foreign company's laboratories. The foreign company also allowed the assessee to use its patents and trademarks. The assessee was expressly prohibited from divulging confidential information to third parties without the consent of the foreign company. Upon termination of the agreement the assessee had to stop making use of the patents and trademarks and it was to return all data and drawings supplied to it and the royalty was to be paid upon the sales and the same is payable only for the period of the agreement. The Supreme Court held that the assessee did not under the agreement become entitled exclusively even for the period of agreement to the patents and trademarks of the company. It had merely access to the technical knowledge and experience at the command of the foreign company. The assessee was on that account a mere licensee for a limited period of the technical knowledge of the foreign company with the right to use the patents and trademarks of that company. In fact, the assessee acquired merely the right to draw, for the purpose of carrying on its business as a manufacturer and dealer, upon the technical know-how of the foreign company for a limited period. By making the technical knowledge available the foreign company did not part with any asset of its own nor did the assessee acquire any asset or advantage of an enduring nature for the benefit of its business. Accordingly, the payments to the foreign company were held allowable as revenue deduction. The facts of the case before us present a close approximation to those on which the Supreme Court made its pronouncements. The fact that the payment is in a lump sum or a percentage of the profit on sale proceeds makes no difference in so far as the expenditure is for a more efficient running of the business on a better technology.

12. In Ciba of India Ltd.'s case, [1968] 69 ITR 692 (SC), the assessee was to return all technical data and drawings to the foreign company. In our view, the same ratio shall apply even where the assessee has no obligation to return such drawings and data to the collaborator.

13. In CIT v. Hindusthan General Electrical Corporation Ltd., [1971] 81 ITR 243 (Cal), royalty paid for similar collaboration was held to be a revenue deduction.

14. In CIT v. Ciba of India Ltd., [1968] 69 ITR 692, the Supreme Court held that the contribution made by the Indian company to the foreign company was allowable as expenditure under section 10(2)(xv) because, (1) the agreement was for a definite term, liable to be terminated before the end of the term in certain eventualities, (2) the object was to enable the assessee to commence and continue the manufacture in India of all types of simplex products, (3) the licence was granted subject to the rights actually granted or which may be granted after the date of the agreement to other persons, (4) the assessee shall treat as secret and confidential, and not disclose or permit the disclosure of any matter provided or made available by simplex, (5) there was no transfer of the fruits of research but simplex should make available to the assessee the “know-how” and give advice and assistance in the manufacture of the products, and (6) the stipulated payment of royalty was recurrent and entirely dependent on simplex products actually manufactured by the assessee.

15. It is not the law that, in every case, if any enduring advantage is obtained, the expenditure for securing it must be treated as a capital expenditure. In CIT v. Hindusthan General Electrical Corporation Ltd., [1971] 81 ITR 243 (Cal), the assessee had to pay the cost of preparing and providing prints, designs,. drawings, etc., and for that a sum of £500 per annum was advanced towards salaries and remuneration of engineers or technical advisers. The assessee had also to pay certain percentage of royalties, but these payments were current expenditure (and not capital expenditure) for the purpose of carrying on the trade which the assessee had agreed to carry on in India in accordance with the terms of the agreement.

16. This principle was applied in CIT v. Aluminium Corporation of India Ltd., [1973] 92 ITR 563 (Cal). Again in CIT v. Associated Electrical Industries (India) Pvt. Ltd., [1975] 101 ITR 844 (Cal), the same principle has been followed. The assessee-company was a 100 per cent. subsidiary of another company AEI (India) Ltd. (the agent-company), which itself was a subsidiary of a foreign company AEI Ltd., London (the English company). The agent company had the right to technical and manufacturing information, designs and data emanating from the English company. The assessee-company manufactured electrical components which were sold solely to the agent-company. Under an agreement dated December 21, 1960, the assessee-company agreed to manufacture and supply goods to the agent-company, the agent-company agreed to supply to the assessee-company all manufacturing information, designs and data which they might obtain from the English company which might be necessary to enable the assessee-company to manufacture the goods; the manufacturing information supplied should be kept confidential; the assessee-company should reimburse the agent-company any costs incurred in supplying manufacturing information, etc. For the purpose of manufacturing certain types of motors, the assessee obtained certain designs from the agent-company at a cost of Rs. 22,039. In the books of the assessee, this amount was appropriated equally over a period of five years, with the result that a sum of Rs. 4,408 was debited in the previous year relevant to the assessment year 1962–63. The assessee claimed deduction of this amount. The Income-tax Officer held that since the information and knowledge received by the assessee were of an enduring nature, the expenses were capital expenditure and he, accordingly, disallowed the expenditure. In second appeal, the Appellate Tribunal, held that the expenditure was only of a revenue nature and that the assessee was entitled to deduction under section 37 of the Income-tax Act, 1961.

17. There, it was held that the agreement between the assessee and the agent-company fixed a period of ten years during which the assessee was to have the licence. Under the agreement, all the information under the licence given were to be treated as confidential to the assessee and on the termination of the agreement, had to be returned to the English company. Therefore, the assessee had merely the use of this licence for a limited period of time and for certain limited purpose, that is to use it for the manufacture of its motors for the purpose of mainly selling it to the agent-company. It should be borne in mind that for this purpose no new machinery was acquired or installed. The new type of things manufactured were improvements over the existing machinery. Further, as found by the Tribunal, the assessee was manufacturing similar items of motors and the present design covered only one type of manufacture of goods by the assessee. In these circumstances, the assessee did not have any right or advantage of an enduring nature. On the other hand, what the assessee was getting was something which was necessary in the profit-earning process of the assessee.

18. Having regard to the principles laid down by this court in CIT v. Associated Electrical Industries (India) Pvt. Ltd., [1975] 101 ITR 844, it must be held that the Tribunal had come to the correct conclusion and the sum of Rs. 13,28,450 should be allowed as a revenue expenditure under section 37 of the Act.

19. We, therefore, answer the question in this reference in the affirmative and in favour of the assessee. There will be no order as to costs.

Shyamal Kumar Sen, J.:— I agree.