2008 (5) TMI 607 - AT - Income Tax

Amount paid towards Technical know-how and 'Royalty' - Revenue Expenditure or capital expenditure - Disallowances of - customs duty - provision for warranty - the showroom price of Honda City car - prize under a sales promotion scheme - research and development expenses - provision under the head Sales promotion expenses - roof alteration/renovation expenses. Amount paid towards Technical know-how and 'Royalty' - Revenue Expenditure or capital expenditure - whether the expenditure could not be considered as part of the initial expenditure or for setting up the business (as opposed to the setting up of the manufacturing facilities or plant)? - Technical collaboration agreement between the assessee and HMCL - treated as capital or revenue without obtaining the arm's length price from the Transfer Pricing Officer - HELD THAT - It may be seen that for setting up the manufacturing facilities and for the parts, separate agreements have been entered into by the parties and separate payments have been made by the assessee as consideration therefor. This makes the position clear that the impugned payment of lump-sum know-how fees and royalty are not part of the payment for setting up the plant which manufactures the Honda cars in India. This aspect of the matter needs to be disposed of first. It is well-settled that initial expenditure incurred by a businessman to set up his business or expenditure incurred to install the frame-work of the business must be treated as capital. Reference in this connection may be made to the classic ruling of Lord Sands in IRC v. Granite City Steamship Co. Ltd. where it was observed Broadly speaking, outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment . The English case noted was applied in India with approval by the Supreme Court in Assam Bengal Cement Co. Ltd. v. CIT 1954 (11) TMI 2 - SUPREME COURT but the final judgment, as observed by Kanga and Palkhivala, rested on another ground, viz., that the expenditure was incurred to acquire an asset or advantage of enduring benefit to the trade and was therefore of a capital nature. It would thus appear that the test that is to be applied in such cases is only whether the assessee obtained any proprietary rights in the technical know-how or he merely obtained the right to use the same for the purpose of his business for a limited period of time, irrespective of whether the expenditure was incurred at the time of initiation of the business or at any point of time subsequent thereto. In our humble opinion, the question has to be decided on the basis of the facts of the particular case with which we are dealing. We have referred to the common basic principle which runs through all the cases cited by both the sides and there is no need to repeat it. If that principle is applied to the facts of the present case and to the terms and conditions of technical collaboration agreement, it would be seen that the assessee obtained only the right to use, during the currency of the agreement, the technical know-how and information and the intellectual property rights relating to the manufacture of the Honda cars and did not secure any ownership rights over them. We, therefore, hold that the payment of the lump-sum fees for technical know-how and the royalty is allowable as revenue expenditure. We have held, on a perusal of the terms and conditions of the collaboration agreement that the assessee was not the owner of the technical know-how or information and was merely licensed to use the same for its business during the currency of the agreement. It follows that the assessee cannot claim depreciation on the know- how. The provisions of section 35AB, which were also referred to by the learned CIT (DR), are applicable only where the assessee pays lump-sum consideration for acquiring any know-how for use for the purposes of his business and since the assessee-company has been found by us to have been permitted only to use the know-how for a limited period for the purpose of its business and that it has not acquired any proprietary or ownership rights over the same these provisions are also not applicable. Thus, we allow the first ground. Treatment of Technical collaboration agreement between the assessee and HMCL - It seems to us that the submissions of Mr. Vohra should prevail, as they are logical and supported by the provisions of the Income-tax Act noticed above. The Transfer Pricing Officer is not concerned, nor is he competent to decide as to whether the payment under the collaboration agreement is capital or revenue. It is first necessary to determine the nature of the payment and decide whether it is capital or revenue. If it is held to be capital, it is not allowable as deduction and the question of determining the arm's length price may not be necessary to be decided by the Transfer Pricing Officer. However, as we have held the payment to be revenue in nature and hence allowable, accepting the submission of Mr. Vohra, we direct that while giving effect to our order the Assessing Officer may, if so advised, refer the question of the arm's length price to the Transfer Pricing Officer for determination in accordance with law. The decision of the Tribunal regarding the nature of the payment cannot be deferred, as requested by the learned Commissioner of Income-tax- Departmental representative, to a stage after the Transfer Pricing Officer determines the arm's length price. Such a course is not contemplated by law. We, therefore, reject the preliminary objection raised by the learned Commissioner of Income-tax-Departmental representative. Disallowance of the customs duty - drawings imported under the technical collaboration agreement - The assessee has adduced evidence before us to show that the payment was made during the year under appeal. We are of the view that merely for the purpose of verification of the evidence for the payment, the matter should be restored to the Assessing Officer without any further directions. If the Assessing Officer is satisfied with the evidence, the payment should be allowed as a deduction. With this remark, we restore the issue to the Assessing Officer. Disallowance on the provision for warranty - This issue is covered in favour of the assessee by the order of the Tribuna in Honda SIEL Cars India Ltd. v/s Asst. CIT, 2006 (7) TMI 258 - ITAT DELHI . respectfully following the order of the Tribunal, we direct the Assessing Officer to allow the provision for the warranty as an ascertained liability. The ground is allowed. Disallowance of commission - paid to HMCL in relation to the exports made to M/s. Honda Automobiles, Thailand - This issue is covered in favour of the assessee by the order of the Tribuna in Honda SIEL Cars India Ltd. v/s Asst. CIT, 2006 (7) TMI 258 - ITAT DELHI . There is no dispute that the facts for the year under consideration are similar. Therefore, respectfully following the earlier order of the Tribunal, we direct the Assessing Officer to allow the commission as a deduction. Disallowance on the showroom price of Honda City car - prize under a sales promotion scheme - In the perception of the assessee as a businessman, which is very important and should be the governing consideration in such cases, it would stand to benefit even though the main scheme was launched by Nerolac Paints. Expenditure incurred wholly and exclusively for the purposes of the business does not cease to be so merely because it also benefits some other persons. For instance in CIT v. Birla Jute Manufacturing Co. Ltd. 1989 (5) TMI 27 - CALCUTTA HIGH COURT , where the assessee agreed to pay a certain amount to the electricity board to facilitate the laying of service-lines, it was held by the Calcutta High Court that the mere fact that the service-lines would be the property of the electricity board and can be used by other persons also would not come in the way of the expenditure being allowable in the hands of the assessee. So long as the expenditure benefits the assessee it should be allowed as a deduction. The CIT (A) has stated that there was no increase in the sales. This is not a relevant criterion. The association of the assessee-company with the advertisement scheme launched by Nerolac Paints and the assurance of giving away a Honda car at its own cost to the winner may be beneficial to the assessee in the long run. It cannot be denied that it had advertisement value. Expenditure incurred on advertisement is undisputedly business expenditure. Thus, we direct the AO to allow the assessee's claim. The ground is allowed. In the result, the assessee's appeal is partly allowed. Disallowance on research and development expenses - It is well settled that every expenditure that confers some enduring advantage cannot be regarded as capital expenditure and reference in this connection may be made to the judgment of the Supreme Court in Gotan Lime Syndicate v. CIT 1965 (11) TMI 35 - SUPREME COURT . If the expenditure has relation to the stock-in-trade, the sale of which is the business of the assessee, the mere fact that some enduring advantage results by the incurring of the expenditure does not mean that the expenditure must be treated as capital expenditure. In the case before the Supreme Court, the royalty payment under a mining lease to obtain raw material was held to be revenue in nature because it had relation to the raw material to be obtained. Applying these principles to the present case, we are of the view that the CIT (A) has rightly held the expenditure to be revenue in nature. His decision is upheld and the ground is dismissed. Disallowance of provision under the head Sales promotion expenses - If the provision has been made for a known liability that has already arisen during the relevant previous year, the same cannot be regarded as a provision for a contingent liability. We accordingly confirm the decision of the CIT (A) and dismiss the ground. Disallowance on roof alteration/renovation expenses - Here, the object was to repair and restore the five year old roof to its original leak-proof condition. Thereby no capital asset was created. The ultimate object was to protect and preserve the plant and machinery on the shop floor. The mere fact that the life of the repaired roof was guaranteed to be for ten years does not mean that any asset of enduring nature was received by the assessee. The expenditure merely restored the roof to its original condition. In these circumstances, it is difficult to regard the expenditure as capital in nature. CIT (A) has rightly held it is revenue. We agree with his decision and dismiss the ground. In the result, the appeal by the Department is dismissed. To sum up Assessee's appeal is partly allowed and Department is dismissed.

Summary

Issues Involved:

1. Disallowance of technical know-how fee and royalty as capital expenditure.
2. Disallowance of customs duty paid on drawings.
3. Disallowance of provision for warranty.
4. Disallowance of commission paid to HMCL.
5. Disallowance of showroom price of a Honda City car given as a prize.
6. Disallowance of research and development expenses.
7. Disallowance of provision for sales promotion expenses.
8. Disallowance of roof alteration/renovation expenses.

Detailed Analysis:

1. Disallowance of Technical Know-How Fee and Royalty as Capital Expenditure:

The assessee, a manufacturer of Honda cars, claimed a lump-sum fee for technical know-how and royalty paid to Honda Motor Company Ltd., Japan (HMCL) as business expenditure. The Assessing Officer (AO) disallowed these payments, treating them as capital expenditure necessary for setting up the business. The Tribunal, after examining the technical collaboration agreement, concluded that the payments were for the use of technical know-how and information for manufacturing cars, not for setting up the plant. The Tribunal found that the assessee did not acquire any proprietary rights in the know-how, which remained with HMCL. The payments were thus held to be revenue in nature, allowing the assessee's claim.

2. Disallowance of Customs Duty Paid on Drawings:

The AO disallowed the customs duty paid on imported drawings, asserting it was not related to the year under consideration and was provisional. The Tribunal found that the payment was made within the relevant year and directed the AO to verify the evidence and allow the deduction if satisfied.

3. Disallowance of Provision for Warranty:

The Tribunal noted that the issue of provision for warranty was covered in favor of the assessee by a previous order, where it was treated as an ascertained liability. The Tribunal directed the AO to allow the provision for warranty.

4. Disallowance of Commission Paid to HMCL:

The commission paid to HMCL for exports to Honda Automobiles, Thailand, was disallowed by the AO. The Tribunal, following a previous order, directed the AO to allow the commission as a deduction, as the facts were similar to the earlier year.

5. Disallowance of Showroom Price of a Honda City Car Given as a Prize:

The AO disallowed the showroom price of a Honda City car given as a prize under a sales promotion scheme, arguing that the scheme was launched by Nerolac Paints, not the assessee. The Tribunal held that the expenditure was incurred for advertisement purposes, benefiting the assessee, and directed the AO to allow the claim.

6. Disallowance of Research and Development Expenses:

The AO capitalized part of the research and development expenses, considering them as capital expenditure. The Tribunal noted that the expenses were for day-to-day research activities relevant to Indian conditions and held that they did not confer any enduring benefit. The Tribunal upheld the Commissioner of Income-tax (Appeals) (CIT(A))'s decision to allow the expenses as revenue expenditure.

7. Disallowance of Provision for Sales Promotion Expenses:

The AO disallowed the provision for sales promotion expenses, treating it as contingent. The Tribunal found that the provision was made for a known liability incurred during the relevant year and directed the AO to allow the provision as a deduction.

8. Disallowance of Roof Alteration/Renovation Expenses:

The AO disallowed the expenses for roof alteration/renovation, treating them as capital expenditure. The Tribunal held that the expenditure was for repairing and restoring the roof to its original condition, which was necessary to protect the machinery and maintain production quality. The Tribunal upheld the CIT(A)'s decision to treat the expenditure as revenue in nature.

Conclusion:

The Tribunal allowed the assessee's appeal in part, directing the AO to allow the disallowed expenses as revenue expenditure, and dismissed the Department's appeal, upholding the CIT(A)'s decisions on the disallowed provisions and expenses. The order was pronounced in open court on May 16, 2008.