1971 (11) TMI 25 - HC - Income Tax

Agreement with the English company to use patented process of manufacture - payment towards royalty is of capital nature not of revenue - acquisition of knowledge in respect of the new product, amount to acquisition of an advantage of an asset for extension of assessee s business

Issues Involved:
1. Allowability of sums claimed by the assessee under the agreement with the English company dated December 7, 1959, as expenditure.
2. Deductibility of sums paid to the English company as consultation fee under the agreement dated September 29, 1959.
3. Determination of chargeable profits under the Sur-tax Act with reference to the total income after allowance of sums paid to the English company.

Issue-wise Detailed Analysis:

1. Allowability of Sums Claimed by the Assessee as Expenditure:

The assessee, a public limited company, entered into an agreement with Bakelite Company Ltd., London (the "English company") on December 7, 1959, to acquire an exclusive non-assignable license to use patented processes for manufacturing copper-clad laminates. The agreement stipulated a royalty payment of 5% on the net selling price of the laminated products, capped at lb5,000. The Income-tax Officer disallowed the royalty payments, considering them as capital expenditure. The Appellate Assistant Commissioner, however, allowed the deduction, arguing that the payments did not bring into existence an asset of enduring advantage. The Tribunal reversed this, holding that the payments were for the cost of developing new laminated products, thus capital in nature. The court agreed with the Tribunal, noting that the acquisition of knowledge for a new product constituted an asset or advantage of enduring nature, and the payment was not directly related to the user of the patents but was a settled price for the asset acquired. The court distinguished this case from the Ciba case, emphasizing that the special knowledge related to a new product and did not revert to the English company after the agreement period.

2. Deductibility of Sums Paid as Consultation Fee:

The assessee also entered into another agreement on September 29, 1959, with the English company to acquire technical information for manufacturing synthetic resins and compositions. The consultancy fee was set at 2% of net sales for Class I products and 5% for Class II products. The Income-tax Officer disallowed these payments as capital expenditure. The Tribunal partially allowed the deduction, distinguishing between items related to the profit-making apparatus (capital expenditure) and routine business operations (revenue expenditure). The court upheld the Tribunal's allocation of the consultancy fee between capital and revenue expenditure in the ratio of 1:2, allowing 2/3 of the consultancy fee as revenue expenditure. The court emphasized that the allocation was fair and appropriate, considering that the agreement included both capital and revenue elements.

3. Determination of Chargeable Profits under the Sur-tax Act:

The determination of chargeable profits under the Sur-tax Act was contingent upon the findings on the first two issues. The court concluded that the chargeable profits should be computed based on the total income for income-tax purposes, as determined by the court's answers to the first two questions.

Conclusion:

The court concluded that the payments made under the agreement dated December 7, 1959, were capital in nature and not allowable as revenue expenditure. For the consultancy fee under the agreement dated September 29, 1959, only 2/3 of the fee was admissible as revenue expenditure. The chargeable profits under the Sur-tax Act should be determined based on the total income computed in accordance with these findings. The assessee was ordered to pay the costs of the reference, with an advocate's fee of Rs. 250.

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