2020 (11) TMI 951 - HC - Income Tax

Nature of expenditure - Revenue expenditure u/s 37(1) or capital expenditure - royalty payment for user of technical know-how and intellectual property rights along with the right to manufacture for a temporary period - HELD THAT - Distinction between capital and revenue expenditure with reference to acquisition of technical information and know-how has been spelled out in various cases and the primary test to ascertain whether a expenditure is a capital expenditure or revenue expenditure is the same viz., enduring nature test, which means where the expenditure is incurred which gives enduring benefit, it will be treated as capital expenditure.See HONDA SIEL CARS INDIA LTD. 2017 (6) TMI 524 - SUPREME COURT . In the present case from perusal of the relevant clauses of the agreement, it is clear that the assessee is a joint venture company and under the agreement has been granted non transferable licence to manufacture / assemble the Hitachi licence products within the territory using technical know-how furnished by Hitachi and to sell otherwise dispose of the Hitachi licence products. The products shall be sold only under the trade / brand name of Tata Hitachi - even expiry of the 11 years from the date of commercial production, the assessee is entitled to continue the manufacture and sale of Hitachi licence products for the aforesaid term of the agreement. Under the agreement, the assessee has incurred an expenditure which gives him enduring benefit, therefore, the same has to be treated as capital expenditure. AO as well as the tribunal rightly held that payment of royalty made by the assessee is a capital expenditure and is not a permissible deduction under Section 37(1) - Decided against the assessee.

Summary

Issues:
1. Whether royalty payment for the use of technical know-how and intellectual property rights should be considered as revenue or capital expenditure under Section 37(1) of the Income Tax Act, 1961.
2. Whether the expenditure towards royalty should be treated as capital expenditure due to the enduring benefit received by the appellant.

Analysis:

Issue 1:
The appellant, a manufacturing company, claimed a deduction for royalty payment made to a Japanese company for using technical know-how and intellectual property. The Assessing Officer concluded that the payment was for acquiring enduring benefits, thus a capital expenditure. The Commissioner of Income Tax (Appeals) allowed the deduction, but the Income Tax Appellate Tribunal reversed the decision. The appellant argued that since no new unit was set up and the payment was based on sales, it should be treated as revenue expenditure. However, the tribunal considered the enduring benefit received and ruled in favor of the revenue. The court analyzed the relevant clauses of the agreement and upheld the tribunal's decision, stating that the expenditure provided an enduring benefit, making it a capital expenditure not deductible under Section 37(1) of the Act.

Issue 2:
The court referred to the definition of 'capital asset' under Section 2(14) of the Act and the distinction between capital and revenue expenditure based on the enduring nature test. It cited previous cases to support the principle that enduring benefits indicate capital expenditure. By examining the clauses of the Technical Licence Agreement, the court found that the appellant had obtained a non-transferable license to manufacture and sell products under certain conditions, entitling them to continue production even after the royalty period. As the expenditure provided enduring benefits, it was deemed a capital expenditure. The court dismissed the appeal, ruling in favor of the revenue based on a thorough analysis of the agreement and the enduring benefits received by the appellant.

In conclusion, the court upheld the tribunal's decision, considering the enduring benefits received by the appellant from the royalty payment, and ruled that it constituted capital expenditure, not eligible for deduction under Section 37(1) of the Act. The detailed analysis of the agreement's clauses and the principles of capital versus revenue expenditure supported the court's decision in favor of the revenue.