1997 (2) TMI 4 - SC - Income Tax

Collaboration agreement between the assessee & foreign company - Royalty - it is difficult to hold that the entire payment made is revenue expenditure merely because the payment is required to be made at a certain percentage of the rates of the gross turnover of the products of the assessee as royalty - Tribunal was right in holding that 25 per cent. of the amount paid by the assessee as royalty, was capital expenditure and, therefore, not allowable as a revenue expenditure

Issues Involved:

1. Whether the payment made by the assessee to the foreign company as royalty constitutes capital expenditure or revenue expenditure under the Income-tax Act, 1961.
2. Interpretation of various clauses of the agreement between the assessee and the foreign company.
3. Analysis of judicial precedents on capital vs. revenue expenditure.

Detailed Analysis:

1. Whether the payment made by the assessee to the foreign company as royalty constitutes capital expenditure or revenue expenditure under the Income-tax Act, 1961:

The primary issue revolves around whether the royalty payments made by the assessee to the foreign company for technical know-how and assistance should be classified as capital expenditure or revenue expenditure. The Income-tax Officer disallowed one-fourth of the payments, considering them as capital expenditure due to the enduring nature of the services provided by the foreign company. The High Court upheld this view, concluding that the assessee acquired a benefit of enduring nature, which constituted the acquisition of an asset, thereby making the payment capital expenditure.

2. Interpretation of various clauses of the agreement between the assessee and the foreign company:

The agreement stipulated that the foreign company would provide technical information, know-how, drawings, estimates, specifications, manufacturing methods, blueprints, and other necessary data for setting up a plant and manufacturing the products. The payment for these services was to be made as royalty based on the turnover of the licensed products. The High Court interpreted these clauses to mean that the assessee acquired a benefit of enduring nature, which was not merely for the use of rights but a composite payment for all services and information provided by the foreign company. This interpretation led to the conclusion that the payments were capital in nature.

3. Analysis of judicial precedents on capital vs. revenue expenditure:

Several judicial precedents were analyzed to determine the nature of the expenditure:

- Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 (SC): The court held that expenditure incurred for obtaining an advantage of enduring benefit might still be revenue expenditure if it facilitates trading operations or improves the efficiency of the business without affecting fixed capital.

- CIT v. CIBA of India Ltd. [1968] 69 ITR 692 (SC): The court concluded that payments for technical knowledge and experience, which do not confer exclusive rights or enduring benefits, are revenue expenditures.

- Alembic Chemical Works Co. Ltd. v. CIT [1989] 177 ITR 377 (SC): The court emphasized the need to consider the purpose and effect of the expenditure in a commercial sense, acknowledging that the test of enduring benefit is not conclusive.

- CIT v. Lucas-T.V.S. Limited (No. 1) [1977] 110 ITR 338 (Mad): The court found that payments for technical know-how, which do not grant rights beyond the agreement period, are revenue expenditures.

- CIT v. Sarada Binding Works [1976] 102 ITR 187 (Mad): The court distinguished between fixed capital payments and indefinite, profit-based payments, treating the latter as revenue expenditures.

- Agarwal Hardware Works (P.) Ltd. v. CIT [1980] 121 ITR 510 (Cal): Payments for patents usable only during the agreement period were deemed revenue expenditures.

- CIT v. Tata Engineering and Locomotive Co. Pvt. Ltd. [1980] 123 ITR 538 (Bom): Payments for technical know-how, without enduring benefits, were classified as revenue expenditures.

The Supreme Court, considering these precedents and the specific facts of the case, concluded that the High Court was justified in classifying the payments as capital expenditure. The cumulative effect of the agreement's terms indicated that the assessee acquired a new business setup with enduring benefits from the foreign company's services, justifying the capital expenditure classification.

Conclusion:

The Supreme Court upheld the High Court's decision that the payments made by the assessee to the foreign company constituted capital expenditure. The appeals were dismissed, affirming the classification of the expenditure as capital in nature, based on the enduring benefits derived from the technical know-how and services provided by the foreign company.

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