2006 (10) TMI 128 - HC - Income Tax

Challenged the Order passed by Tribunal - Royalty payment - technical know-how - capital expenditure for acquiring an asset or advantage of enduring nature, or expenditure properly attributable to revenue - HELD THAT - When one is dealing with tangible assets, it is generally not very difficult to reach a decision. Things, which the trader uses in his business to produce what he has to sell are part of his fixed capital and their cost is a capital outlay although their useful life may be short. Things, which a trader turns over in the course of his trade, are circulating capital and their cost is a revenue expense. However, when one comes to intangible assets there is much more difficulty. To help the conduct of his business a trader may obtain a right to do something on someone else's property or an obligation by someone to do or refrain from doing something or makes a contract which affects the way in which he conducts his business; and the right or obligation or the effect of the contract may endure for a short or a long period of years. The question then arises whether the sum, which he has paid for that advantage, is a capital or revenue expense. If the asset, which is acquired, is in its intrinsic nature a capital asset, then any sum paid to acquire it must surely be capital outlay; and we do not see how it could matter that the payment was made by sums paid annually or periodically. It appears to us, however, that an asset, which is nothing more than a right to enjoy a certain advantage over a period, is intrinsically of a different character from a thing, which a person buys and can immediately use or consume in any way he chooses. We are dealing with payments made to MMC to secure technical know-how and to sell LCVs under their brand name during the currency of the agreement subject to periodic payment of royalty for using the licence. The Supreme Court in CIT v. Ciba of India Ltd. 1968 69 ITR 692; AIR 1968 SC 1131 has enunciated the principles applicable to such cases. In that case, the assessee a subsidiary of the Swiss company paid certain payment to Ciba Ltd., Basle (the Swiss company) pursuant to the agreement dated December 17, 1947, whereby the latter agreed for technical and research contribution in so far as they relate to pharmaceutical products which were manufactured, processed and sold by the assessee in India. It was held that the agreement merely give the right to the assessee, without any thing more, to draw upon the technical knowledge of the foreign collaborator for the purpose of carrying on its business and did not acquire an asset or advantage of enduring nature for the benefit of its business. Considering the effect of payment, it was held to be a revenue expenditure. We think, it is more reasonable to regard the periodic royalty payment to MMC as an outlay for earning profits in the normal course of business than as expenditure with the object of acquiring an advantage or asset of enduring and/or lasting nature for the benefit of the trade. Thus, we have no hesitation to hold that the Tribunal rightly decided the issue relating to question No. 1 in favour of the assessee and against the Revenue. Hence, we dismiss these appeals by holding that the affirmative answer to all the three questions must go in favour of the assessee and against the Revenue.

Summary

Issues Involved:
1. Whether the amount paid to Mitsubishi Motors Corporation by the assessee as royalty was allowable as revenue expenditure.
2. Whether the Tribunal was justified in permitting the assessee to raise additional ground relating to funded interest.
3. Whether the Tribunal was justified in confirming the order of the Commissioner of Income-tax (Appeals) in allowing the depreciation on notional foreign exchange fluctuation.

Detailed Analysis:

Issue 1: Allowability of Royalty as Revenue Expenditure
The assessee, an automobile manufacturer, entered into a technical assistance agreement with Mitsubishi Motors Corporation (MMC) Japan, paying royalties for technical know-how and assistance. The Department initially accepted the royalty payments as revenue expenditure for the assessment years 1988-89 and 1989-90 but disallowed them in subsequent years, treating them as capital expenditure. The Income-tax Appellate Tribunal, however, treated these payments as revenue expenditure. The court analyzed the nature of the expenditure under Section 37 of the Income-tax Act, which allows deductions of expenses wholly and exclusively for business purposes, provided they are not capital expenditures. The court referenced various precedents, including CIT v. Ciba of India Ltd. and Alembic Chemical Works Co. Ltd. v. CIT, to conclude that the royalty payments were made for the purpose of earning profits in the normal course of business rather than acquiring an enduring advantage. Thus, the Tribunal's decision to treat the royalty payments as revenue expenditure was upheld.

Issue 2: Permitting Additional Grounds in Appeal
The Tribunal allowed the assessee to raise an additional ground regarding funded interest, which was not initially claimed before the Assessing Officer or Commissioner of Income-tax (Appeals). The court cited CIT v. S. Nelliappan and National Thermal Power Co. Ltd. v. CIT, establishing that the Tribunal has the jurisdiction to allow new grounds if they bear on the tax liability and relevant facts are on record. The Revenue did not argue that they were denied the opportunity to address this new ground. Therefore, the Tribunal's decision to permit the additional ground was found to be justified.

Issue 3: Depreciation on Notional Foreign Exchange Fluctuation
The Commissioner of Income-tax (Appeals) allowed the assessee's claim for depreciation on notional foreign exchange fluctuation, following the Supreme Court's decision in CIT v. Arvind Mills Ltd. The court noted that this issue did not present a substantial question of law, as defined in Santosh Hazari v. Purushottam Tiwari, since it was not debatable or previously unsettled. Consequently, the Tribunal's confirmation of the Commissioner's order was upheld.

Conclusion
All three questions were answered in favor of the assessee and against the Revenue. The appeals were dismissed, affirming the Tribunal's decisions on all counts.