2017 (1) TMI 729 - HC - Income Tax

Amount paid towards Technical know-how and Royalty - whether should be treated as Revenue Expenditure or capital expenditure ? - Held that - As find from record that at the time of entering into Technical Know-how agreement, HMCL had only 60% of share holding in HSCIL/Assessee but only in AY 2004-2005, it increased its share holding to 99% and above and thus got virtually entire control and ownership over the alleged joint venture. A.O. has found this exercise as diversion of profit. Assessee explained it to be in accordance with Government policy. Even if the same aspect is ignored, as a relevant consideration for deciding the questions up for consideration before us, yet we find that reasons given in the light of various clauses of the agreement so as to treat Technical Know-how fee as Capital Expenditure is well founded but unfortunately Tribunal while taking otherwise view has impressed itself with superficial approach treating ownership of Technical Know-how fee by parent company and limited tenure etc. without appreciating various clauses of agreement in entirety and thus has erred in law. A.O and CIT(A) were justified in recording their finding and reasons to treat payment of Technical Know-how fee and Royalty as Capital Expenditure and not Revenue Expenditure . Reasonings given by the said two authorities similar to what we have also noticed in addition to our discussion have our affirmance. The view taken by Tribunal otherwise is unsustainable and cannot be accepted. No hesitation to hold that both the payments to foreign company are in respect of a benefit which is not only of enduring nature but for the purpose of acquiring of an asset and hence a Capital Expenditure and not Revenue Expenditure . - Decided against Assessee

Summary

Issues Involved:
1. Whether the fee for technical services and royalty payments should be treated as revenue expenditure or capital expenditure.

Issue-wise Detailed Analysis:

1. Nature of Expenditure: Revenue or Capital
- Basic Facts and Dispute: The central issue is whether the payments made towards "Technical know-how" and "Royalty" should be classified as "Revenue Expenditure" or "Capital Expenditure". The appeals relate to different assessment years and orders of the Tribunal.
- Arguments by Revenue: The Revenue argued that the payments for technical know-how and royalty are of enduring nature, thus qualifying as capital expenditure. They relied on judgments such as Scientific Engineering House (Pvt.) Ltd. vs. Commissioner of Income-Tax, Alembic Chemical Works Co. Ltd. vs. Commissioner of Income Tax, and Jonas Woodhead and Sons (India) Ltd. vs. Commissioner of Income Tax.
- Arguments by Assessee: The Assessee contended that the payments were for enhancing business efficiency and not for acquiring an asset of enduring benefit. They cited cases like Commissioner of Income Tax vs. Ciba of India Limited, Commissioner of Income Tax vs. I.A.E.C (Pumps) Ltd., and others to support their claim that these payments should be treated as revenue expenditure.
- Court's Analysis: The court examined various precedents and the specific terms of the technical collaboration agreement. It noted that the agreement was crucial for setting up the business and not merely for improving an existing one. The technical know-how and royalty payments were fundamental to the establishment and running of the business, indicating an enduring benefit.
- Conclusion: The court concluded that the payments made for technical know-how and royalty were capital in nature. The agreement's terms showed that these payments were for acquiring an enduring benefit and were integral to the business's foundation and operation. Therefore, they should be treated as capital expenditure.

2. Relevant Precedents and Legal Principles
- Assam Bengal Cement Co. Ltd. vs. Commissioner of Income Tax: The court referred to this case to distinguish between capital and revenue expenditure, emphasizing the enduring benefit aspect.
- Commissioner of Income Tax vs. Ciba of India Limited: This case was crucial in determining that payments for technical assistance and know-how, which do not transfer ownership of the know-how, can be treated as revenue expenditure. However, the court found the facts of the current case different as the technical know-how was for setting up a new business.
- Scientific Engineering House (Pvt.) Ltd. vs. Commissioner of Income-Tax: The court noted that payments for acquiring technical know-how that results in a depreciable asset should be treated as capital expenditure.
- Alembic Chemical Works Co. Ltd vs. Commissioner of Income Tax: The court discussed the principles laid down in this case, emphasizing the need to look at the nature of the advantage and its lasting qualities.

3. Specific Clauses in the Agreement
- Technical Collaboration Agreement: The court scrutinized the agreement's clauses, which indicated that the technical know-how and royalty payments were for setting up the plant and machinery, essential for the business's existence and operation.
- Enduring Benefit and Asset Creation: The agreement provided for continuous assistance and was co-extensive with the business's life, indicating that the payments were for acquiring an enduring benefit.

4. Tribunal's Error
- Superficial Approach: The court found that the Tribunal erred by focusing on the ownership and limited tenure aspects without appreciating the agreement's entirety. The Tribunal's view that the payments were revenue expenditure was unsustainable.

5. Doctrine of Lifting the Veil
- Shareholding and Control: The court acknowledged the argument that the foreign company held 99% of the shares, suggesting no real distinction between the foreign and joint venture companies. However, this issue was not raised before the lower authorities, so the court did not address it in detail.

Conclusion:
The court held that the payments for technical know-how and royalty were capital expenditures and not revenue expenditures. The Tribunal's judgment was set aside, and the appeals were allowed in favor of the Revenue. The court emphasized that the payments were for acquiring an enduring benefit essential for the business's establishment and operation.