2008 (7) TMI 447 - AT - Income Tax

Summary

Issues Involved:
1. Classification of royalty payment as capital expenditure or revenue expenditure.
2. Validity of the contract agreement with M/s Hongo Company Ltd., Japan.
3. Allowability of the royalty payment as business expenditure.

Detailed Analysis:

1. Classification of Royalty Payment as Capital Expenditure or Revenue Expenditure:
The assessee company, engaged in the manufacture of sheet metal components, claimed Rs. 79,66,532 as royalty payment to M/s Hongo Company Ltd., Japan (HCL, Japan) as revenue expenditure. The Assessing Officer (AO) classified this payment as capital expenditure based on several factors:
- The technical collaboration agreement was entered at the inception of the company.
- The agreement provided an exclusive, non-transferable license to manufacture and sell products using HCL, Japan's know-how.
- The agreement ensured that HCL, Japan would not provide the same license to any other company.
- The AO argued that the agreement provided an enduring benefit, thus classifying it as capital expenditure.

The CIT(A) upheld the AO's decision, adding that the royalty payment should be treated as a diversion of profit since no income tax was paid on it. The Tribunal, however, disagreed, stating that the nature of the payment should be judged from a practical business perspective rather than a strict legal classification. The Tribunal cited the Supreme Court's decision in Alembic Chemical Works Co. Ltd. vs. CIT, emphasizing that the "once for all" payment test and the "enduring benefit" test are not conclusive. The Tribunal concluded that the royalty payment was an integral part of the profit-making process and not for acquiring an asset of permanent character, thus classifying it as revenue expenditure.

2. Validity of the Contract Agreement with M/s Hongo Company Ltd., Japan:
The CIT(A) questioned the validity of the contract, suggesting it could be voidable and treated as a diversion of profit. The Tribunal found no basis for this assertion, noting that the necessary tax was deducted at source and paid to the government. The Tribunal criticized the CIT(A) for making assumptions without examining the relevant details submitted by the assessee.

3. Allowability of the Royalty Payment as Business Expenditure:
The Tribunal examined the terms of the agreement, noting that the assessee was granted a non-transferable license to use HCL, Japan's know-how for manufacturing specified automobile components. The agreement stipulated that upon termination, the assessee would cease to use the know-how and return all related materials. The Tribunal compared this case to the Supreme Court's decision in Jonas Woodhead & Sons Ltd. vs. CIT, where the enduring benefit test was applied. The Tribunal found that since the assessee could not use the know-how post-termination, the royalty payment did not result in an enduring benefit and was, therefore, a revenue expenditure.

The Tribunal also referenced the Supreme Court's decision in CIT vs. Ciba of India Ltd., where payments for technical know-how were treated as revenue expenditure since the assessee did not acquire any asset of enduring nature. Similarly, the Tribunal concluded that the royalty payment to HCL, Japan was an allowable business expenditure.

Conclusion:
The Tribunal allowed the appeal filed by the assessee, classifying the royalty payment as revenue expenditure and rejecting the CIT(A)'s assertion of it being a diversion of profit. The Tribunal emphasized the practical business perspective and the specific terms of the agreement in reaching its decision.