Income-tax Officer, Ward-9(2), New Delhi v. Spice Communications Ltd.

C.L. Sethi, Judicial Member. - These three appeals, filed by the revenue, are directed against three separate orders dated 3-3-2008, 24-3-2008 and 20-6-2008 passed by the CIT(A) pertaining to assessment years 2003-04, 2004-05 and 2005-06 respectively.

2. The grounds taken in these appeals being common, identical and identically worded, are being disposed of together.

3. Ground number one in all the years is as under :—

"On the facts and in the circumstances of the case, the ld. CIT(A) has erred on facts in law by allowing advertising and sales promotion expenditure as revenue expenditure and failed to appreciate that such expenditure also resulted partly in brand building and, hence, an acquisition of an intangible asset which may be transferred to/shared by the assessee for commercial benefits or consideration."

4. Following amount of Advertisement & Sales Promotion Expenses were disallowed by the Assessing Officer in these three assessment years :—

5. During all these assessment years under consideration, it was noticed by the Assessing Officer that assessee had claimed advertisement and sales promotion expenses and debited the same in the profit & loss account as under :—

6. The Assessing Officer asked the assessee to justify why part of the expenses should not be allowed being of capital in nature, viz., expenditure incurred towards brand building. The assessee explained before the Assessing Officer that the expenses on account of advertisement and sales promotion comprises the expenses incurred on press advertisements, neon sign, hoardings, etc., and are of revenue nature having incurred for the purpose of carrying on business of the assessee. It was submitted by the assessee that the company is in the business of providing mobile telephonic services since 1997 and since then name "Spice" is being used as its own brand, and has not used brand name of any other company. The assessee also clarified that expenditure incurred on advertisements and sales promotion are commensurate to the total revenue earned by the assessee during the years under consideration.

7. After considering the assessee’s explanation, the Assessing Officer allocated 10 per cent of the total expenditure on advertisements and sales promotion towards capital expenditure and disallowed the sum of Rs. 3,50,50,300 and Rs. 3,48,88,000 and Rs. 3,12,60,500 in the assessment year 2003-04 and assessment year 2004-05, and assessment year 2005-06 respectively, and added the same to the assessee’s total income. In the assessment year 2005-06, the Assessing Officer disallowed 10 per cent only of the advertisement expenses total amounting to Rs. 31,26,05,000, and, thus, disallowed the sum of Rs. 3,12,60,500. The reason given by the assessee Assessing Officer in all the years under consideration in disallowing aforesaid expenses are identical, and his observations made in assessment year 2003-04 is extracted below for ready reference—

"The above reply of the assessee has been considered. The assessee has itself admitted that since 1977, the name ‘Spice’ has been used as its own brand. This points to the fact the assessee has consciously incurred advertisement expenses in order to play up the brand. ‘Spice’ not only in its designated sectors, Punjab and Karnataka but also in the neighbouring regions. Besides, such aggressive advertisement and sales promotion in the nature of blitzkrieg also create an enduring advantage to the company as the image gets imprinted in the minds of the customers which is not very easy to dislodge. Since an exact appointment of the profits accruing to the company as the component of enduring benefit on account of advertisement and sales promotion is not feasible to work out. 10 per cent of the expenses is treated as relatable to brand image and is treated as capital expenditure. Therefore, an amount of Rs. 3,50,50,300 is added to the income of the assessee on account of disallowance of advertisement and business promotion expenses which is of capital nature as being relatable to brand building."

7.1 On an appeal, CIT(A) deleted the addition by observing and holding as under :

"I have considered the observation of the Assessing Officer in the order of assessment as well as the submissions of the appellant before me. I agree with the submissions of the appellant to the effect that the normal advertisement and sales promotion expenditure incurred by it are allowable to it as a revenue expenditure. These expenses do not lead to creation of any capital asset or the benefit of an enduring nature. The case law cited by the appellant is on the identical facts and circumstances. The reliance of the learned AR on the Accounting Standard 26 issued by the Institute of Chartered Accountants also support the view that the expenditure incurred on advertisement and sales promotion including the expenditure incurred even for launching of a new product is allowable as a revenue expenditure in the year in which the expenditure is incurred. In view of the above, this ground of appeal is decided in favour of the appellant and the disallowance of Rs. 3,50,000 made by the Assessing Officer is directed to be deleted."

7.2 While deleting the addition CIT(A) made reference to the following decisions :—

(i) Empire Jute Co. v. CIT [1980] 124 ITR 1 ¹ (SC).

(ii) Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC).

(iii) CIT v. Berger Paints (India) Ltd. (No. 2) [2002] 254 ITR 503 ² (Cal.).

(iv) Commissioner Of Income-Tax v. Brilliant Tutorials P. Ltd. [2007] 292 ITR 399 (Mad.).

(v) Amar Raja Batteries Ltd. v. Asstt. CIT [2004] 91 ITD 280 (Hyd.).

8. Being aggrieved with the CIT(A)’s order, the revenue is in appeal before us.

9. We heard both the parties and have carefully gone through the orders of the authorities below. We have also perused the material on record.

10. It is not in dispute that the assessee is in the business of providing cellular mobile services under its own self-generated brand "Spice" since 1997. The assessee’s business of providing cellular mobile services is undoubtedly a highly competitive business, and assessee has to provide services in a competent environment. This is also not in dispute that the assessee has incurred expenditure towards advertisement and sales promotion in course of carrying on its business activities. The Assessing Officer has allowed 90 per cent of the expenses as revenue expenditure and allocated 10 per cent towards capital by observing that 10 per cent of expenses have been incurred towards brand building. The Assessing Officer has not been able to justify as to how the 10 per cent of the total advertisement and sales promotion expenses can be allocated towards capital expenditure when the assessee has not acquired any brand from any outside party. The expenditure on advertisement and sales promotion constituted expenditure incurred on press advertisement, hoardings,neon signs, brochures, etc. The press advertisements could not be considered as capital asset acquired by the assessee. Similarly, putting hoardings and neon signs could not also be considered on capital field. These expenditures do not lead to create any capital asset to the assessee. Even there is no benefit of enduring nature so to treat the expenses as capital expenditure. Since by incurring expenditure on advertisement and sales promotion, the assessee has not acquired any fixed capital asset, but these expenditures were incurred for earning better profits, and for facilitating assessee’s operation of providing cellular mobile services, there exist direct nexus between the advertisement and sales promotion expenses and the carrying out of the business activity of the assessee. We, therefore, do not find any justification in interfering with the order of the CIT(A) in deleting the disallowance of 10 per cent of expenses towards advertisements and sales promotion incurred by the assessee for smooth functioning and carrying on assessee’s business effectively, proficiently and profitability. The order of the CIT(A) is, thus, upheld on this issue.

11. Ground No. 2 in assessment year 2003-04, and ground No. 3 in assessment year 2004-05 and assessment year 2005-06, are identical as under :

12. In assessment year 2003-04, the total expenditure of Rs. 95,15,191 incurred by the assessee has been disallowed by the Assessing Officer by considering the same to be of capital in nature. However, the Assessing Officer allowed depreciation at the rate of 60 per cent on Rs. 95,15,191 which comes to Rs. 56,49,115 and the balance amount of Rs. 38,66,076 was disallowed.

13. In the assessment year 2004-05, total expenditure incurred by the assessee was Rs. 22,038, which has been considered to be of capital in nature by the Assessing Officer. The Assessing Officer allowed depreciation at the rate of 60 per cent on Rs. 22,038, which comes to Rs. 13,222, and the balance of Rs. 8,815 has been disallowed by the Assessing Officer.

14. In the assessment year 2005-06, the assessee claimed software expenses of Rs. 3,13,296, which has been considered to be of capital in nature by the Assessing Officer. The Assessing Officer then allowed depreciation at the rate of 60 per cent of Rs. 3,13,296 which comes to Rs. 1,87,978, the balance Rs. 1,25,318 has been disallowed by the Assessing Officer.

15. From the details filed by the assessee in the assessment year 2003-04, it was noticed by the Assessing Officer that assessee had claimed software expenses amounting to Rs. 95,15,191 as revenue expenditure, which has been considered to be of capital in nature by the Assessing Officer. The assessee vide reply dated 24-3-2006, stated before the Assessing Officer that the expenditure were related to purchase and rental charges of certain application software, for use by the assessee at different location, and, thus, it had claimed the same as revenue expenditure allowable under section 371(1) of the Act, inasmuch as purchase made of application software and rental charges paid to use application software does not result in creation of any capital asset or providing enduring benefit to the company. However, the Assessing Officer treated the expenditure to be of capital in nature by observing as under :

"The assessee’s reply has been considered. However, this claim is not acceptable, especially in view of the case of "Commissioner Of Income-Tax v. Arawali Constructions Co. (P.) Ltd. vide 259 ITR 30, wherein expenditure on acquisition of computer software has been held by the Hon’ble Rajasthan High Court, to be expenditure of capital nature. Moreover, the prescribed rate for claim of depreciation on computer software in the block assets for the relevant year is 60 per cent as per Income-tax (24th Amendment) Rules, 2002, with effect from 1-4-2003. Therefore, the assessee is allowed depreciation at the rate of 60 per cent on Rs. 94,15,191 which amounts to Rs. 56,49,115. The balance excess claim of depreciation of Rs. 38,66,076 is added back to the income of the assessee."

16. On an appeal, the CIT(A) allowed the assessee’s claim after relying upon the decision of Hon’ble Delhi High Court in the case of CIT v. GE Capital Services Ltd. [2007] 164 Taxman 46 and the decision of the Tribunal, Delhi Benches in the case of Addl. CIT v. Asahi India Safety Glass [2006] 6 SOT 656. The CIT(A) also observed that since Hon’ble jurisdiction High Court has held that expenditure incurred on application software is allowable as deduction, which was binding on him, the decision of Hon’ble Rajasthan High Court referred to by the Assessing Officer in the order of assessment will not applicable to the present case. An identical view has been taken by the CIT(A) in all the three years. The expenditure incurred by the assessee on software development were, thus, allowed as deduction under section 37 of the Act by the CIT(A) and consequently, the depreciation allowed by the Assessing Officer by treating the expenses to be of capital in nature was withdrawn by the CIT(A).

17. Being aggrieved with the order of CIT(A) on this issue, the department is in appeal before us.

18. The ld. DR reiterated the reasons given by the Assessing Officer in treating the software development expenses to be capital in nature.

19. However, on the other hand, the ld. counsel for the assessee supported the order of the CIT(A) in holding that expenditure incurred by the assessee on software developments are allowable as a revenue expenditure under section 37 of the Act.

20. We have heard both the parties and have carefully gone through the orders of the authorities below. We have carefully perused the materials available on record.

21. In the assessment year 2003-04, the assessee has claimed software expenses of Rs. 95,15,191 as revenue expenditure. The assessee furnished its reply before the Assessing Officer vide letter dated 24-3-2006. From the details of software expenses incurred in the assessment year 2003-04, it is seen that the assessee has incurred software expenses towards following items :—

(i)In the books of Punjab Unit, the sum of Rs. 24,42,332 has been incurred towards following items :—

(ii)In its corporate office Rs. 4,07,264 has been incurred on account of Windows 98 Office, Norton Antivirus, Notes, etc.

(iii)In its Karnataka Unit Rs. 65,65,595 has been incurred on account of Norton Antivirus, Trend interscan virus wall for linux, etc., amounting to Rs. 2,74,560 and, on account of rental for use of software SIMGO platform for the prepaid customers amounting to Rs. 62,91,135.

22. From the aforesaid details, it is clear that the software charges were incurred towards application software, and rental charges were paid for use of software, which cannot be considered to be of capital in nature. In this connection, we may rely upon the decision of Hon’ble jurisdictional Delhi High Court in the case of GE Capital Services Ltd.’s case (supra), where the Hon’ble jurisdictional Delhi High Court has held and observed as under :—

"The Revenue is aggrieved by an order dated August 25, 2006, passed by the Income-tax Appellate Tribunal Delhi Bench "C" in IT Appeal Nos. 2038, 2525 and 2529/Delhi/2002 relevant to the assessment years 1995-96 to 1997-98.

The only question that has arisen in this case pertaining to the assessment year 1997-98 is that the expenditure incurred by the assessee on software was treated by the Assessing Officer as capital expenditure. The Tribunal was of the view that due to technological changes and the need to upgrade the software on a regular basis it cannot be said that the software was of an enduring nature.

We are informed that the software for which the expenditure was incurred was MS Office, which is not a custom built software for the assessee and it is common knowledge that this software requires regular upgradation.

We can understand that where customized software is prepared, then it could be of an enduring nature, but in this case MS Office is not customized software and it cannot be said that the software does not require frequent upgradation.

We are of the view that there is no error committed by the Tribunal in taking the view that it did.

No substantial question of law arises. Dismissed."

23. In the present case also, the software for which expenditure was incurred was Acrobat reading PDF files and M.S. Office and Windows 98 and 2000 and it is admitted position that these software need regular up-gradation. Further, in the assessment year 2003-04, the assessee has paid rental charges amounting to Rs. 62,92,035 towards rent for use of software Simgo Platform for the prepaid customers. These facts have not been disputed by the Assessing Officer while making a reference to the assessee’s reply dated 24-3-2006 wherein it was stated that the expenditure were related to the purchase/rental charges, certain application software for use by the assessee at different location. In the light of the nature of the expenses incurred by the assessee, we, therefore, do not find any reason to take any view other than the view taken by the CIT(A) in treating the software expenses as of revenue in nature. In the assessment years 2004-05 and 2005-06, the amount of expenses involved is very nominal as compared to the assessment year 2003-04, and the amount were spent towards application software and not for the acquisition of any asset of capital in nature or asset giving any enduring benefit to the assessee. Thus, this ground raised by the revenue in all the years is rejected.

24. Ground No. 3 in the assessment year 2003-04 and ground No. 2 in the assessment years 2004-05 and 2005-06 is of identical nature, which reads as under :—

"On the facts and in the circumstances of the case, the ld. CIT(A) has erred on facts and in law by allowing management services charges as revenue expenditure and failed to appreciate that the payments made for transfer/sharing of technical know-how and Intellectual Properly Rights resulted in acquisition of intangible assets and, hence, were capital expenditure."

25. The relevant facts as emerging from the assessment order and other material available on record relating to this issue are stated in brief as under :—

25.1 In the assessment year 2003-04, the assessee claimed expenses under the head "Management service charges to shareholders" of Rs. 6,82,06,000 as per details given in Schedule - 12 of the profit & loss account, pertaining to "Administration cost". The assessee submitted before the Assessing Officer that these expenses were on account of management servicing charges paid to Distacom and M/s. Modicorp to the tune of Rs. 6,82,06,433 for providing assistance and advices as per Agreement with the above concerns. A copy of Agreement styled as "technical services and operating Agreements" entered into with Distacom Communication (India) Ltd. has been furnished to the Assessing Officer. During the year, a payment of Rs. 3,47,69,118 was made to Distacom. The assessee further submitted before the Assessing Officer that it had entered into a management-services Agreement with Modicorp for providing assistance as per the Agreement executed in October, 1999, a copy of which was also furnished to the Assessing Officer. In this regard, the company paid Rs. 3,42,56,250 to Modicorp for the services rendered during the year.

26. The terms of the Agreement were considered and analysed by the Assessing Officer, and after considering the same, the Assessing Officer was of the view that the assessee’s Agreement with M/s. Distacom and M/s. Modicorp was with regard to the transfer of technical know-how and license to use Intellectual Property Rights. The relevant extract of the Agreements with above concerns were reproduced by the Assessing Officer in his assessment order.

27. In the light of the terms and conditions of the management services Agreement titled "know-how and Intellectual Property Rights", the Assessing Officer has taken a view that the payment made by the assessee on account of management service charges is of capital in nature. He, therefore, treated the expenditure to be of capital in nature, and allowed depreciation at the rate of 25 per cent being the asset a part of intangible asset. The Assessing Officer’s conclusions reads as under :—

"From the above-mentioned provisions of Income-tax Act, it is seen that the definition of "Intangible assets" includes know-how, patents, copyrights, trade marks, licenses, franchises or any other business or commercial rights of similar nature. The Clause 2 of Management Services Agreement, titled ‘know-how and Intellectual Properly Rights’, which has been reproduced above, states that Modicorp hereby grants to Modicom, a non-exclusive, non-transferable license of rights in Modicorp know-how and Modicorp Intellectual Property Rights during the terms of this Agreement. Thus, a license of rights in know-how has been granted to the assessee-company. As per the definition of intangible assets in sub-section (1) of section 32, "licenses" are squarely covered in the definition. Further the definition of "Modicorp Intellectual Property Rights" in the Agreement stated that the same means any and all of the following in which Modicorp has any rights whatsoever, patents, service marks, trade names, registered designs, and copyright. These kind of business and commercial rights are also covered in the definition of "intangible assets" in sub-section (1) of section 32 of the Income-tax Act. The assessee submitted in this regard that from the terms and conditions of the Agreements, no such know-how and licence to use Intellectual Property Rights are transferred by either of the party to the assessee on ownership basis either wholly or partly. However, the assessee’s contention is not correct as the Clause 1 (definitions) of the said Agreement clearly states that "Management Services" means the transfer of Modicorp know-how and the grant of non-exclusive, non-transferable license to use the Modicorp Intellectual Property Rights in India and advice and assistance more fully described in Schedule 1. As fees has been paid for the management services only have the assessee-company it is clear that know-how and license to use the Modicorp Intellectual Property Rights in India have been transferred to the assessee-company. The provisions of section 32 also state that depreciation is allowable on intangible assets owned, wholly or partly, by the assessee. Thus, even part ownership of the assets is enough for claiming depreciation. In the instant case, even if it is accepted that the license of rights in Modicorp know-how and the Modicorp Intellectual Property Rights has not been fully transferred, there is no doubt that the assessee at least has part ownership of these licenses and know-how.

In view of the above, the revenue expenditure claimed for computing Business Income on account of "Management Service Charges" of Rs. 6,82,06,000 is disallowed, being capital expenditure, on which depreciation at the rate of 25 per cent, i.e., Rs. 1,70,51,500 is allowable, as the same is part of "Intangible assets" as per the provisions of sub-section (1) of section 32. Net addition of Rs. 5,11,54,500."

28. On an appeal, the CIT(A) after considering the nature and character of the services obtained by the assessee, the CIT(A) has taken a view that management service charges paid by the assessee to Distacom and Modicorp does not resulted in creation of any intangible asset in favour of the assessee whether wholly or in part. The concluding part of order of the CIT(A) runs as under :—

"I have considered the observations of the Assessing Officer in the order of assessment as well as the submissions of the appellant. I agree with the view of the appellant that the management service charges paid by it to Distacom and Modicorp does not result in creation of any intangible assets in favour of the appellant, whether wholly or in part. From the description of the services provided, it is evident that the management services provided by Distacom and Modicorp to the appellant basically pertain to day-to-day operational activities of the appellant but for the services provided by these two promoter companies of the appellant, the appellant would have incurred expenditure on its own for these services. In such a situation, the expenditure so incurred would have been allowed to the appellant as deduction under section 37 of the Income-tax Act, 1961. The mere fact that instead of arranging services of its own, the appellant is availing expertise of its promoter companies does not lead to the conclusion that the expenses so incurred partakes the character of a capital expenditure. The various judicial pronouncement referred to by the appellant including those of the Hon’ble Supreme Court fully support the claim of the appellant that in case of grant of non-exclusive, non-transferable right, the payment made is allowable as a revenue expenditure. The payment partakes the character of a capital expenditure only when the same pertains to an absolute transfer of know-how either wholly or partly. Section 32 of the Act also covers such cases. When the payment is made only for use of the expertise of a party, there is no benefit of enduring nature or transfer of an intangible asset. The payment in the case of appellant is not a one time lump sum payment for acquisition of technical know-how. The appellant has made payment on quarterly basis for use of the expertise of its promoter companies. The decision of Income-tax Appellate Tribunal, Delhi in the case of Glaxo Smithkline Asia (P.) Ltd. v. ACIT, Range 12 [2006] 6 SOT 113 (Delhi) is on identical facts wherein the appellant instead of employing its own staff has made use of the infrastructure of another company and made payment to it."

29. Hence, the department is in appeal. The ld. DR reiterated the reasons given by the Assessing Officer in treating the payment of management service charged of capital in nature.

30. The ld. counsel for the assessee, on the other hand, supported the order of the CIT(A) and drew our attention to the submissions made in details before the CIT(A) as reproduced in the order of the CIT(A).

31. Rival contention of both the parties has been considered and order of the authorities have been carefully gone through. We have also perused the papers and documents filed before us, which includes (i) the Agreement entered into between Distacom Communication (India) Ltd. and Distacom Communication Ltd. and Modicom Network Ltd., and (ii) Agreement entered into between Modicorp Pvt. Ltd. and Modicom Network Ltd.

32. The assessee-company is a joint venture company set-up by Dr. B.K. Modi Group of Companies in India along with Distacom Communications (India) Ltd., Hongkong, for providing cellular mobile services in the States of Punjab and Karnataka pursuance to the licenses granted to it by the Department of Telecommunications, Government of India. For its day-to-day operations and to made use of the expertise of the promoters, the assessee-company entered into Agreements with Modicorp and Distacom in 1999. A copy of each of the Agreement has been placed on record.

33. The first Agreement styled as "Technical Services and Operating Agreement" is made in the month of October, 1999 between following parties :—

I.Distacom Communication India Limited, a corporation duly authorized and existing under the laws of Mauritius (hereinafter referred to as "DCIL" which expression shall, unless the context otherwise requires, include its successors and permitted assigns);

II.Distacom Communication Limited, a corporation duly authorized and existing under the laws of Hongkong (hereinafter referred to as "Distacom" which expression shall, unless the context otherwise requires, include its successors and permitted assigns);

III.Modicom Network Ltd., a company incorporated under the Companies Act, 1956, having its registered office at Modicorp Tower, 13th Floor, 98, Nehru Place, New Delhi 110 019, India (hereinafter referred to as "Modicom" which expression shall, unless the context otherwise requires, include its successors and permitted assigns);

IV.Richard Siemens of Hillsborough Court, Mid Levels, Hong Kong;

V.Asian Infrastructure (Mauritius) Inc. whose registered office is at 608, St. James Court, St. Denis Street, Port Louis, Mauritius (hereinafter referred to as "AIM" which expression shall, unless the context otherwise requires, include its successors and permitted assigns); and

VI.PAII (Mauritius) Company Limited of Sixth Floor, Cern’e House, Chaussee, Port Louis, Mauritius (hereinafter referred to as "PAII" which expression shall, unless the context otherwise requires, include its successors and permitted assigns).

33.1 In these Agreements, the assessee has been described by its erstwhile name styled as "Modicom Network Pvt. Ltd.". The assessee-company was formerly known as Modicom Network Pvt. Ltd. incorporated on 28-3-1995 as private limited company under the Companies Act, 1956, having its registered office at 60-D, Sainik Farms, New Delhi - 110 062 and its circle office at Mohali for Punjab circle and Karhati for Bangalore circle.

33.2 In the Agreement styled as "Technical Services and Operating Agreement" entered into with DCIT/Distacom and others, it has been stipulated that by this Agreement, DCIL and Distacom shall provide Modicom with the full transfer of Distacom know-how, and non-exclusive, non-transferable license to use the Dislacom Intellectual Property Rights in India and is obliged to provide certain advice assistance for the designs, construction, installation, management operations, marketing, and accounting and finance of the Systems under and in accordance with the license Agreement dated 18-12-1995 between Modicom and Department of Telecommunications, Ministry of Communications, Government of India relating to the Punjab and Karnataka telecom circles. The expression "Distacom Intellectual Property Rights" has been defined as under :—

""Distacom Intellectual Property Rights" means any and all of the following in which the Distacom Group has any rights whatsoever, namely, patents, service marks, trade names, registered designs, copyrights, all forms of intellectual or industrial property (including in each case applications thereof and renewals and extensions thereof) in any part of the work and whether or not registered or registerable but excluding the trademarks and trade names "Sunday"."

33.3 The expression "Distacom know-how" has been defined as under:—

""Distacom know-how" means all of the knowledge, skill and experience of the Distacom Group in the design, construction, installation, management, operations, marketing, accounting and finance required for the provision of cellular telecommunications."

33.4 Clause 2 of the Agreement provides as under :

"2. Know-how and Intellectual Property Rights—

2.1 Subject to Clause 9, each of DCIL and Distacom hereby grants to Modicom, a non-exclusive, non-transferable license to use the Distacom know-how and Distacom Intellectual Property Rights other than Distacorn Intellectual Property Rights owned by Sunday during the term of this Agreement and thereafter to manage and operate the Systems.

Distcom shall use its best efforts to obtain all necessary consents to enable it to extend the license granted by it hereunder to the Disiacom Intellectual Property Rights owned by Sunday, and upon all such consents being obtained this license shall be automatically extended accordingly (and references to "Distacom Intellectual Property Rights" shall thereupon be deemed to include "Distactom Intellectual Property Rights owned by Sunday".

2.2 Modicom shall use it reasonable efforts to protect Distacom Know-how and Distacom Intellectual Property Rights. Without prejudice to the generally of the foregoing, Modicom shall :

2.2-1 Not grant or purport to grant any sub-license or other rights in the Distacom know-how or Distacom Intellectual Property Rights; and

2.2-2 Inform DCIL and Distacom of any real or anticipated claim by any third party in respect of use of the Distacom know-how or Disiacom Intellectual Property Rights, give DCIL and Distacom as much information as possible regarding such claim, and fully and promptly assist DCIL and/or Distacom in any proceedings in connection with the same.

2.3 Subject to Clause 9, Modicom shall :

2.3-1 treat all Distacom know-how and Disiacom Intellectual Property Rights as confidential and use all reasonable care not to divulge such information to any third party; and

2.3-2 ensure that the Distacom know-how and Distacom Intellectual Property Rights shall only be used and disclosed on a need to know basis to Modicom’s employee."

33.5 In Clause 3 of the Agreement, it is stipulated that Modicom has appointed DCIL and Distacom to provide, and DCIL and Distacom each agrees to provide to Modicom, on the terms of the Agreement, the advice and assistance as set out in Schedule 1 during the term of the Agreement.

33.6 Services to be provided by Distacom to Modicom has been specified in Schedule 1 of the Agreement. Schedule 1 runs as under :—

"Schedule 1

Services to be provided by Distacom to Modicom

"Transferring Distacom Know-how and licensing Distacom Intellectual Property Rights to Modicom and training Modicom staff to be capable of operating efficiently and independently in the following areas :—

1.1 Construction and erection of the cellular telecommunications network;

1.2 Selection of appropriate computer hardware systems, platforms and associated technology;

1.3 Selection and training of computer software personnel to continuously upgrade software and software tools;

1.4 Quality assurance of hardware and software chosen so that data security and integrity is maintained;

1.5 Specification of switch equipment, network design and layout ("Systems");

1.6 Holding technical discussions with potential vendors and contractors for installation and upgrade of the systems;

1.7 Engineering layout for microwave sites;

1.8 Erection of microwave stations;

1.9 Identification of suitable locations for installation of microwave towers and base stations and interfacing with them with the electronic equipment of the main switch center;

1.10 Identifications of suitable locations for installation of generators and interfacing with them with the electronic equipment of the main switch center and base stations;

1.11 Erection and commissioning of generators/Uninterrupted Power Supply systems;

1.12 Training personnel in operation and maintenance of power supply systems;

1.13 Design and layout of the facilities to achieve the objectives of optimum efficiency, maximum utilization of space, meet international norms on service quality;

1.14 Creating an awareness within industry on the superiority of Modicom’s services and consequently develop a customer, utilizing contracts developed worldwide in the industry to source inputs at low rates;

1.15 Implementing systems following by Distacom worldwide in various activity areas be production planning, commercial, finance and customers service; and

1.16 Establishing a corporate culture with Distacom’s worldwide policies both terms of quality and service.

1.17 Hiring all levels of employees.

1.18 Controlling and improving the operating and transmission costs and service reliability.

1.19 Ensuring high network quality and performance, sufficient functional capabilities, efficient utilization rate and have sufficient capacity to handle the subscriber demand in an optimum efficient manager.

1.20 Providing high customer value and quality service.

1.21 Developing and growing the subscriber base.

1.22 Providing a wide range of value added services.

1.23 Developing brand name awareness and marketing strategy including advertising and promotions.

1.24 Developing and expanding distribution channels including opening of its own retail stores.

1.25 Training the sales personnel to educate customers about cellular technology, Modicom’s network and service features.

1.26 Advising on the pricing strategy on the handsets and tariffs for its cellular services if tariff control removes.

1.27 Providing a full range of customer support services from the point of sale onwards including customer inquiry helplines and service centres, and on line assistance to customers with inquiries with respect to bill and technical difficulties.

1.28 Improving billing accuracy, payment convenience and timelines or resolving network difficulties, in order to promote customers loyalty.

1.29 Developing wide range of value added services including voicemail, short messaging and advanced date transfer capabilities if applicable.

1.30 Pricing strategy.

1.31 Provide the necessary technical support for the value added services.

1.32 Negotiation of all types of equipment and services supply contracts, interconnect and maintenance Agreements subject to approval of the terms thereof by the Board of Modicom.

2. Providing Advice and Assistance

2.1 Reporting on developments in the field of information technology and bringing in state of the art produce and tools for increased productivity and cost reduction in the following ways;

2.2 Providing radio paging network engineering services;

2.3 Evaluating appropriate types of networks equipment and technical services;

2.4 Information technology requirements for billing and customer care systems, network management systems and integration requirements;

2.5 Network design services and support services;

2.6 Project management and implementation services, including turnkey supervision; and

2.7 Network performance evaluation and adjustment;

2.8 Advice and assistance on customer care processes, including billing credit control, fraud control systems and processing and management processing adapted by Modicom;

2.9 Assistance in the development and grooming of local talent to assume responsibility to independently implement network development and management;

2.10 Supporting Modicom in the development of new opportunities in the telecommunications industry in India (except in Calcutta and Bombay), including cellular data transfers and Internet businesses."

33.7 Clause 4 of the Agreement provides that in full consideration for the performance of the Technical and Operational Services by Distacom and DCIL, the assessee shall pay Base Fee calculated and payable in accordance with the clause 4.2 plus or minus by amount of the bonus payable to DCIL or the liquidated payable by DCIL calculated and payable in accordance with Schedule 2 of the Agreement. The Base fee is the lump sum fee and shall cover all costs and expenses incurred by DCIL and Distacom in the performance of the Technical and Operational Services, and shall not be adjusted for any reason whatsoever, save as provided in clauses 4.4 and 4.5. Subject to clause 4.3, the Base fee shall be payable in the instalments on dates spreading over a period of time as specified in para 4.2 of the Agreement.

33.8 Under clause 5 of the Agreement it was provided that subject to the termination made in accordance with clause 6, the Agreement shall terminate on 31-12-2003. The Clause 7 provides payment of liquidated by the DCIL and/or Distacom in the case of the assessee fails to achieve the Performance Target as setout in Schedule 2 of the Agreement. However, it has been provided that Modicom shall pay DCIL a bonus fee if Modicom exceeds the performance target. Clause 9 of the Agreement speaks up about confidentiality wherein it has been provided that Modicom shall not publish or otherwise disclose any proprietary information to any third party save as provided in sub-clauses 9.1-1 to 9.1-7.

33.9 Clause 9.2 of the Agreement provides that notwithstanding any disclosure of proprietary information, the Modicom acknowledges that proprietary information shall remain the proprietary information of the Distacom, and Modicom shall not use such proprietary information in any manner or disclose such information to third parties, except as expressly permitted under the Agreement.

33.10 Clause 9.3 provides that performance of this Clause 9 shall survive the termination to this Agreement subject to a maximum of three years from the date of the Agreement.

33.11 Clause 11 of the Agreement for performance guarantee given by Mr. Richard Siemens acting on joint instructions of AIM and PAII.

34. Another Agreement on similar lines was entered into with Modicorp Pvt. Ltd. along with Dr. B.K. Modi and Asian Infrastructure (Mauritius) Inc. and PAII (Mauritius) Co. Ltd. This Agreement was entered into October 1999, styled as "Management Services Agreement" as per this Agreement, Modicorp shall provide assessee with the full transfer of Modicom know-how and the non-exclusive and non-transferable license to use Modicorp Intellectual Property Rights in India and shall be obliged to provide certain advice and assistance with respect to organization, structure and management process, Government relations, public relations and advertising, finance and human resources and other functions of its businesses in accordance with the license granted to the assessee by the Department of Telecommunications. The expression "Management Services" has been defined as transfer of Modicom know-how and grant of non-exclusive and non-transferable license to use the Modicom Intellectual Property Rights in India and advice assistance morefully described in Schedule 1 to the Agreement. The expression "Modicom Intellectual Property Rights" means and all of the following in which Modicorp has any right whatsoever, patents, service marks, trade names, registered designs, and copyrights (including in each case applications, therefore, and renewals and extensions thereof) in any part of the world and whether or not registered or registerable. The term "Modicorp know-how" means all of the knowledge, skill, expertise and experience of the Modicorp Group in organization and management, public relations, Government relations and other functions required for the success of Modicom’s businesses in Karnataka and Punjab and for the fulfilment of its obligations under the license granted by the Department of Telecommunications.

34.1 The advice and assistance to be provided by Modicorp to the assessee has been set out in Schedule 1 of the Agreement. In full consideration for the performance of the management services, the assessee shall pay Modicom the Base fee calculated and payable in accordance with clause 4.2 plus or minus by the amount specified in the Agreement. The base fee shall be payable in the instalments on the dates as fully described and specified in clause 4.2 of the Agreement. All other terms and conditions are identical to that of the Agreement entered into with Distacom/DCIL. Schedule 1 provides about services to be provided by Modicorp to Modicom (the assessee), which are describable as under :—

"Schedule 1

Services to be provided by Modicorp to Modicom

"1. Transferring Modicorp Know-how and licensing Modicorp Intellectual Property Rights to Modicom and training Modicom staff to be capable of operating efficiently and independently in the following areas :—

1.1 Handling Ministry of Finance and Telecom Commission for Policy issues on Cellular Industry towards financing of telecom projects, reduction of project costs in terms of import duty and interfacing with Telecom Commission on cellular policies.

1.2 Keeping current on various policies and guidelines of the Government.

1.3 Getting timely approvable from respective Central/State Government departments, including Reserve Bank of India.

1.4 Initiating, developing and maintaining contacts with external agencies (e.g., bureaucrats, Government officials, foreign missions).

1.5 Dealing with the Indian and international banking communities.

1.6 Establishing, sound and effective credit control.

1.7 Establishing effective financial control systems.

1.8 Establishing effective risk management systems.

1.9 Developing human resources strategies linked to business plans.

1.10 Benchmarking and implementing best human resources processes/practices in the business and facilitating development of organizational culture and systems.

1.11 Management development and training.

1.12 Brand positioning.

1.13 Corporate communications with third parties.

1.14 Support in development in implementation of effective organization structure.

1.15 Support in development in implementation of management processes.

1.16 Handling Media - PR and public affairs.

2. Providing advice and assistance

2.1 Advertising and marketing communications.

2.2 Support in representing Modicom in Cellular Industry Association (COAI) and Telecom Industry Associates (TISA).

2.3 Support in forging marketing alliances to introduce Value Added Services (VAS).

2.4 Procure candidates suitable executives to fill the position of the Modicom Chief Executive Officer and Chief Technical Officer and other executives suitable to fill senior management positions in Modicom other than the Chief Financial Officer, negotiation of terms of employment of such executives, incentives and remuneration packages in each case subject to the approval of the board of Modicom and as may be required from time to time by Modicom.

2.5 Supporting Modicom in the development of new opportunities in the telecommunications industry in India (except Calcutta and Bombay), including cellular data transfers and Internet business."

35. In the light of the nature of the services provided by the Modicorp and DCIL/Distacom as per Agreements, we have to determine the nature of the payment made by the assessee to aforesaid two concerns. The question that arises for consideration as to whether these payments are revenue expenditure or expenditure of capital nature. Law is well-settled that the question whether an expenditure is on account of revenue or capital is to be decided by looking at the facts and circumstance of the case. In order to arrive at just and proper conclusion, one must look at the nature and character of the advantage in a commercial sense in the light of the surrounding circumstances. The legal position has been summed up by Hon’ble Supreme Court in Jonus Woodhead & Sons Ltd. v. CIT [1997] 224 ITR 342¹ as follows :—

"It would, thus, appear that the Courts have applied different tests like starting of a new business on the basis of technical know-how received from the foreign firm, the exclusive right of the company to use the patent or trademark which it receives from the foreign firm, the payment made by the company to foreign firm whether a definite one or dependant upon certain contingencies, the right to use the technical know-how of production or the activity even after the completion of the agreement obtaining enduring benefit for a considerable part on account of the technical information received from a foreign firm, payment whether made "once for all" or in different instalments co-relatable to the percentage of gross turnover of the product ultimately find out whether the expenditure or payment, thus, made makes an accretion to the capital asset and after the Court come to the conclusion that it does so, then it has to be held to be a capital expenditure. As has been held by this Court and already indicated in Alembic Chemical Works’ case [1989] 177 ITR 377 no single definitive criterion by itself could be determinative and, therefore, bearing in mind the changing economic realities of business and the varieties of situational diversities the various clauses of the agreement are to be examined. But, in the case in hand, the High Court having considered the different clauses of the agreement and having come the conclusion that under the agreement with the foreign firm what was set up by the assessee was a new business and the foreign firm had not only furnished information and the technical know-how but rendered valuable services in setting up of the factory itself and even after the expiry of the agreement, there is no embargo on the assessee to continue to manufacture the product in question, it is difficult to hold that the entire payment made is revenue expenditure merely because the payment is required to be made at a certain percentage of the rates of the gross turnover of the products of the assessee as royalty. In our considered opinion, in the facts and circumstances of the case, the High Court was fully justified in answering the reference in favour of the revenue and against the assessee. These appeals are, accordingly, dismissed but in the circumstances without any order as to costs."

36. In the above case, 25 per cent of the payment was held to be capital expenditure in view of the finding of the High Court that in the Agreement with the foreign firm what was set-up by the assessee was a new business and the foreign firm had not only furnished information and the technical know-how but rendered valuable services in setting up of the factory itself, and even after the expiry of the Agreement the assessee shall free to continue to manufacture the product in question.

37. In the case before us, the Agreement between the assessee and DCIL/Distacom and Modicorp is to assist the assessee by providing services in the manner set out in Schedule-1 to the Agreement. In the Agreement, it has been clearly provided that DCIL and Distacom have technical and operational know-how and capability which are necessary to the success of assessee’s business in providing cellular communications services in the States of Karnataka and Punjab (India) and the fulfilment of its obligations under the Agreement between assessee and the Department of Telecommunications, Ministry of Communication, Government of India, relating to Karnataka and Punjab telecom circle. In the Agreement with the Modicorp, it has been maintained that Modicorp has management know-how and capabilities which are necessary to the success of Modicom businesses in providing aforesaid cellular communication services, and the fulfilment of its obligation under the aforesaid license granted by the Department of Telecommunications. It is also mentioned in the agreement that the assessee needs to obtain the full transfer of Distacom know-how or Modicorp know-how and the right to use the Distacom Intellectual Property Rights, India or Modicorp Intellectual Property Rights, in India and was desires of certain advice and assistance in order to enable the assessee to successfully provide cellular commercial services in the States of Punjab and Karnataka as per the license granted to it by the Department of Telecommunications. The nature of services provided by DCIL and Distacom and Modicorp, are to provide know-how for establishing or constructing and erecting of cellular telecommunications networks as per the obligations under the license granted to the assessee by the Department of Telecommunications. It is also equally true that these agreements provides for providing know-how and other information for carrying on the business of providing cellular telecommunication services. It is, thus, clear that the agreements of providing technical know-how, and rights to use Intellectual Property Rights is a composite agreements for providing technical know-how, and right to use Intellectual Property Rights and providing services for setting up of cellular telecommunication networks, and as well for carrying on successfully the business of providing cellular communication services to the assessee’s customers in the States of Punjab and Karnataka as per the license granted to the assessee by the Department of Telecommunications. It is well-settled that know-how for establishing/setting-up the business is prima facie capital character.

38. In the present case, the assessee-company is a joint venture company set up by Dr. B.K. Modi Group of Companies in India along with Distacom Communications (India) Ltd., Hongkong, for providing cellular mobile services in the States of Punjab and Karnataka pursuance to the licenses granted to it by the Department of Telecommunications, Government of India, and has intended to start a business of providing cellular communication services as per the license agreement granted by the Department of Telecommunications, and for that purpose Technical Services and Operating Agreement, and Management Services Agreement has been entered into with a foreign concern for providing know-how, and use of Intellectual Property Rights. This agreement was entered in the month of October 1999. The nature of services set out in the Schedule 1 to the agreement are also related to initial set-up of the cellular telecommunication networks, such as, construction and erection of the cellular telecommunication networks, selection of appropriate computer hardware systems, platforms and associated technology, quality assurance of hardware and software chosen so that data security and integrity is maintained, identification of suitable locations for installation of microwave towers and base stations and interfacing with them with the electronic equipment of the main switch center, erection of microwave stations, engineering layout for microwave sites, and commissioning of generators and uninterrupted power supply systems/ATS, and various other initial activities on capital field necessary to set-up the business of providing cellular telecommunication services. The payment for technical know-how obtained to establish or set-up the business of providing teleco-mmunication services or to erect or install network, microwave sites, micro-wave stations, microwave towers and base stations, etc., has to be held as capital expenditure. The other services provided by DCIL/Distacom and Modicorp are undoubtedly connected to the carrying on and operating efficiently, the business of providing cellular telecommunication services, and notwithstanding the fact that assessee might have derived some benefit of enduring nature, the payment on that account would be certainly on revenue account. It is, thus, a case where the payment made by the assessee is composite payment for supply of technical know-how services, and use of Intellectual Property Rights for setting up cellular telecommunication networks or business, and also for operating and carrying on efficiently and profitably the assessee’s business of providing cellular telecommunication services. In the present case, there exist no embargo on the assessee in carrying on business of providing telecommunication services even after expiry of agreement entered into with DCIL/Distacom and Modicorp. Thus, the payment of lump sum Base fee specified in the agreement payable in instalments is to be allocated partly towards capital expenditure and partly towards revenue expenditure. The Assessing Officer has treated whole of the payment to be of capital in nature as against which the CIT(A) has treated the whole of the payment as revenue expenditure. The present case is a case whether entire payment made by the assessee could not either be held to be of revenue expenditure or, on the other hand as capital expenditure. The entire payment made by the assessee is to be considered as paid towards set-up of the business as well as for efficiently carrying on the business after the same was being set-up, and, thus, the payment is to be allocated towards capital as well as revenue expenditure.

39. The Hon’ble Supreme Court in the case of Jonus Woodhead & Sons Ltd. (supra) has treated 25 per cent of the total payment on capital side. The said criterion of allocating 25 per cent of payment towards capital has also been applied by the Hon’ble Madras High Court in the case of Commissioner Of Income-Tax, Tamil Nadu-Ii v. Southern Switchgear Ltd. [1984] 148 ITR 272 ¹ which had been affirmed by the Hon’ble Supreme Court in Southern Switechgear Ltd. v. CIT [1998] 232 ITR 359. In the case of Southern Switchgear Ltd. (supra), the 25 per cent of the lump sum amount payable in five equal instalments to be spread over a period of time was held to be of capital in nature as on perusal of the various clauses of the agreements, it was found by the Hon’ble High Court that assessee derived the benefit or right of enduring nature, and in that situation, the entire technical fee paid could not be allowed as a revenue expenditure. Applying the same criterion, we, therefore, hold that 25 per cent of the payment by way of instalments spread over a period of time and paid in the years under consideration shall be allocated towards capital expenditure and the balance 75 per cent of the payment is to be allowed as a revenue expenditure. Needless to say that the assessee shall be entitled to depreciation on the amount allocated towards capital field. The Assessing Officer shall modify the assessment order accordingly.

40. Before parting with the issue, we would like to say that the decision of Hon’ble Bombay High Court in the case of CIT v. Kiloskar Tractors Ltd. [1998] 231 ITR 849¹ , treating the whole of the payment as revenue in nature is of no help to the assessee as in that case, the payment was made towards right to use know-how for efficiently running of business and better profitability, and no part of the payment was at all related to the initial set-up of that assessee’s business. The Hon’ble Bombay High Court has noted the proposition or the legal position laid down by the Hon’ble Supreme Court in the case of Jonus Woodhead & Sons Ltd. (supra), and has noted the fact that 25 per cent of the payment was held by the Hon’ble Supreme Court to be of capital expenditure in view of the finding of the Hon’ble High Court in that case. There is no quarrel as to the legal position discussed by the Hon’ble Bombay High Court in the case of Kiloskar Tractors Ltd. (supra), but, each case is to be decided in the light of its own facts, and the nature of the payment, as so noted by the Hon’ble Bombay High Court in the aforesaid case. Therefore, on the facts, the decision of the Hon’ble Bombay High Court in the case of Kiloskar Tractors Ltd. (supra) is not squarely applicable to the assessee’s case, and it renders help to the assessee only with regard to the portion of the payment made by the assessee for efficient running and operating of the assessee’s business of providing cellular telecommunication services, and that is the reason that 75 per cent of the payment has been held by us to be revenue in character.

41. In the result, all these appeals filed by the revenue are partly allowed in the manner as indicated above.