2009 (10) TMI 116 - HC - Income Tax

Expenditure capital or revenue - applicant-company (hereinafter referred to as the assessee ), engaged in the manufacturing and sale of heat exchangers, (radiators) entered into technical collaboration agreement with a US company to manufacture radiators with the technology owned by USA Company - the appellant was obliged to pay royalty at 3 per cent. of domestic sales and at 5 per cent, of export sales, to Ford Motor Company, USA for a period of 7 years for using the technology and for availing of technical services - depends on the domestic as well as export sales. Quantum of the said sales would determine the extent of royalty to be paid and it will decrease or increase every year depending upon the decrease or increase in the sales. Significantly, this payment is not because of transfer of technology, but for providing technical services . In such circumstance, we are of the opinion that this payment of royalty, which is a continuous process, should have been treated as revenue expenditure

Summary

Issues:
Interpretation of technical collaboration agreement for royalty expenditure treatment as capital or revenue

Detailed Analysis:

Issue 1: Interpretation of technical collaboration agreement
The judgment pertains to an appeal regarding the treatment of royalty expenditure in the annual income-tax return for the assessment year 2002-03. The applicant, engaged in manufacturing and sale of heat exchangers, entered into a technical collaboration agreement with a foreign collaborator, Ford Motor Company, USA, for manufacturing controlled atmosphere brazed aluminum heat exchangers with technology owned by Ford. The dispute arose when the Assessing Officer disallowed the claimed royalty payment as revenue expenditure, deeming it capital in nature. The Tribunal upheld this decision, leading to the present appeal.

Issue 2: Capital or Revenue Expenditure
The Tribunal considered various aspects to conclude that the payment represented capital expenditure. It highlighted that the agreement allowed the assessee to continue using technical information even after termination, indicating an enduring benefit. Additionally, it noted that the technical services were not provided on a continuous basis but as a one-time affair, resembling an outright transfer of technical know-how. The Tribunal also cited precedents to support its decision, emphasizing the capital nature of the expenditure.

Issue 3: Arguments and Counter-arguments
The appellant argued that the agreement had distinct parts for technology transfer and technical services, each with separate consideration. It contended that the agreement granted non-exclusive rights and licenses, not involving acquisition of technical information. The appellant stressed that the continuous services provided opportunities for improvement in products, constituting routine business activity without a capital element. Reference was made to a Supreme Court decision where a lump sum payment for know-how was treated as revenue expenditure.

Issue 4: Judicial Interpretation
The High Court analyzed the agreement clauses related to technology transfer and royalty payments. It noted that while the lump sum payment for technology transfer was capital expenditure, the royalty payment for technical services was a continuous process based on sales, thus qualifying as revenue expenditure. Citing a similar case precedent, the court emphasized that annual expenditure linked to production volume typically indicates revenue expenditure. It referred to principles distinguishing capital and revenue expenditure based on access to technical knowledge and transfer of research fruits, ultimately ruling in favor of the assessee.

In conclusion, the High Court ruled in favor of the assessee, setting aside the orders of the authorities below and determining the royalty payment as revenue expenditure. The judgment underscored the distinction between capital and revenue expenditure based on the nature of benefits derived and the continuous nature of the payment, aligning with previous legal principles and precedents.