2005 (3) TMI 61 - HC - Income Tax

Expenditure section 37 - payment of royalty by the assessee-company to M/s. GTC Industries Ltd. - Tribunal has recorded a finding that the right acquired by the assessee was not exclusive and that too was for a limited period and which too could be terminated earlier within the period of the agreement and payment was dependant on the quantum of the items manufactured. In view of these findings the Tribunal has rightly concluded that the payments towards royalty was nothing but a revenue expenditure and was allowable deduction.

Summary

Issues:
1. Characterization of royalty payment as revenue or capital expenditure.

Analysis:
The case involved the assessment of a company manufacturing cigarettes under a franchise agreement with another company. The primary issue was whether the royalty charges paid by the assessee to the other company should be considered as revenue expenditure or capital expenditure for the assessment year 1986-87. The agreement between the parties required the assessee to pay royalty charges for acquiring technical know-how, assistance, and the use of the other company's trademark. The Assessing Officer initially treated the royalty payment as capital expenditure, disallowing it from being claimed as a revenue expenditure. However, the Tribunal overturned this decision, stating that the payment of royalty was a revenue expenditure to maintain the factory operations without acquiring any enduring asset.

The Tribunal's decision was based on the distinction between revenue and capital expenditure, emphasizing that expenditure of an enduring nature typically constitutes capital expenditure. Citing previous judgments, including the Supreme Court's rulings in Alembic Chemical Works Co. Ltd. v. CIT and Jonas Woodhead and Sons (India) Ltd. v. CIT, the Tribunal highlighted factors such as the nature of the payment, the benefits derived, and the terms of the agreement to determine the expenditure's classification. Additionally, the Tribunal referred to the case of CIT v. I. A. E. C. (Pumps) Ltd., where the Supreme Court clarified that payments for licensing agreements did not constitute capital expenditure if the rights acquired were not exclusive and for a limited period.

Ultimately, the High Court upheld the Tribunal's decision, affirming that the royalty payment in question was a revenue expenditure and hence deductible under section 37 of the Income-tax Act. The Court concurred with the Tribunal's findings that the payment was for a limited period, dependent on the quantity of items manufactured, and did not result in the acquisition of any capital assets. Therefore, the Court ruled in favor of the assessee, concluding that the royalty payment should be treated as a revenue expenditure, allowing it as a deduction for the assessment year in question.

In conclusion, the judgment resolved the issue by affirming that the royalty payment made by the assessee was a revenue expenditure, eligible for deduction under section 37 of the Income-tax Act, based on the nature of the payment, the terms of the agreement, and the absence of enduring asset acquisition.