2019 (7) TMI 1312 - AT - Income Tax

Consideration received on assignment of know-how - assignment of know how relating to scientific medical and technical documents relating to development and manufacture of non-pegylated liposomal doxorubicin an oncology product under development - characterization of income - the assessee claimed as exempt as capital receipt - AO taxed u/s 41(1) - in appeal CIT(A) taxed as capital gain as self generated assets - HELD THAT - CIT(A) has held that the cost of acquisition is to be determined in the present case by relying on the fiction contained in section 55(2)(a). According to him the capital asset which was transferred in the present case was a right to manufacture produce or process any article or thing and hence the cost of acquisition must be deemed to be Nil. In the present case first of all the know-how was under development and therefore as a consequence of its transfer the transferee did not acquire any right to manufacture produce or process any article or thing at this stage. Further the simplicitier transfer of knowhow cannot be equated to a right to manufacture as contemplated by section 55(2)(a). The know-how when fully developed would nable manufacture or production or processing of an article or thing. However it would not give any right in respect thereof. It is well settled position in law that know-how with respect to a product would give knowledge about how the product is to be manufactured. The said know-how is not registered. Therefore it does not confer any rights on its owner. The said knowledge only enables the manufacture of the product but does not confer any manufacturing rights. In view thereof transfer of know-how cannot be regarded as transfer of right to manufacture or produce or process an article or thing for the purposes of Section 55(2)(a) of the Act. What the section contemplates is the grant of a right to manufacture say by grant of a license to use a patent. Moreover section 55(2)(a) of the Act makes no reference to know-how which is the asset under consideration. Hence the CIT(A) was not justified in holding that the capital gains should be computed with the cost of acquisition in respect of the said asset being taken as Nil. He ought to have held that the cost of acquisition of know-how under development being a self-generated asset is not ascertainable and hence no chargeable capital gains would arise

Summary

Issues Involved:

1. Taxability of the sum received on the assignment of know-how.
2. Classification of the receipt as either capital gain or business income.
3. Applicability of Section 55(2) versus Section 41(3) of the Income Tax Act.

Issue-wise Detailed Analysis:

Issue 1: Taxability of the Sum Received on Assignment of Know-How

The primary issue revolves around whether the sum of ?5,25,00,000 received by the assessee for the assignment of know-how should be taxed. The assessee claimed this amount as exempt, treating it as a capital receipt. The Assessing Officer (AO) taxed the amount under Section 41(3) of the Income Tax Act, while the Commissioner of Income Tax (Appeals) [CIT(A)] held it taxable under Section 55(2) as a capital gain.

Issue 2: Classification of the Receipt as Either Capital Gain or Business Income

The Revenue argued that the receipt should be classified as business income since the know-how was developed through the assessee's regular R&D activities, for which expenses were already claimed in the Profit & Loss Account. The CIT(A) disagreed, stating that the know-how was a self-generated capital asset and not an asset acquired from outside sources. Therefore, it could not be treated as revenue income under Section 41(3). Instead, the CIT(A) classified it as a capital gain under Section 55(2), with the cost of acquisition deemed as Nil.

Issue 3: Applicability of Section 55(2) Versus Section 41(3) of the Income Tax Act

The CIT(A) and the Tribunal reviewed the terms of the agreement dated 26.10.2005 between the assessee and BSV Research and Development Pvt. Ltd. The CIT(A) concluded that the transaction was for commercial exploitation, thus falling under the purview of Section 55(2). However, the Tribunal noted that the know-how was under development and did not confer any manufacturing rights. Therefore, it could not be equated with a right to manufacture as contemplated by Section 55(2)(a). The Tribunal cited the Supreme Court's rulings in CIT Vs. B.C. Srinivasa Setty and CIT Vs. D.P. Sandu Bros. (Chembur) Pvt. Ltd., emphasizing that where the cost of acquisition of an asset is not ascertainable, the computation mechanism for capital gains fails, and thus, the receipt cannot be taxed as capital gains.

Conclusion:

The Tribunal concluded that the know-how under development was a self-generated asset with no ascertainable cost of acquisition. Consequently, the ?5,25,00,000 received could not be brought to tax under the head 'capital gains.' The appeal filed by the Revenue was dismissed, and the appeal of the assessee was allowed, holding that the receipt was a capital receipt not chargeable to tax.

Order Pronounced:

The order was pronounced in the open court on 24/05/2019.