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TMI Blog2017 (1) TMI 729X X X X Extracts X X X X X X X X Extracts X X X X ..... g various clauses of agreement in entirety and thus has erred in law. A.O and CIT(A) were justified in recording their finding and reasons to treat payment of "Technical Know-how" fee and 'Royalty' as "Capital Expenditure" and not "Revenue Expenditure". Reasonings given by the said two authorities similar to what we have also noticed in addition to our discussion have our affirmance. The view taken by Tribunal otherwise is unsustainable and cannot be accepted. No hesitation to hold that both the payments to foreign company are in respect of a benefit which is not only of enduring nature but for the purpose of acquiring of an asset and hence a 'Capital Expenditure' and not 'Revenue Expenditure'. - Decided against Assessee - Income Tax Appeal No. 503, of 2008, Income Tax Appeal No. 187, 277, 34, 28 of 2010 - - - Dated:- 21-12-2016 - Hon'ble Sudhir Agarwal And Hon'ble Dr.Kaushal Jayendra Thaker, JJ. For the Appellant : Dhananjay Awasthi, Manish Goel For the Respondent : R.S. Agarwal, Roopesh Nath ORDER ( Delivered by Hon. Dr.Justice K. J. Thaker ) 1. All these appeals have raised common substantial questions of law, therefore, have been heard ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elates to the question, whether amount paid towards Technical know-how and 'Royalty' should be treated as Revenue Expenditure or capital expenditure . 5. M/s Honda Motor Company Ltd. Japan (hereinafter referred to as HMCL, Japan ) entered into a joint venture agreement dated 12.9.1995 with M/s Seil Ltd, (a company duly registered under the Companies Act, 1956 (hereinafter referred to as Act,1956 ) having its registered office at Surya Kiran Building, 19, Kasturba Gandhi Marg, New Delhi) (hereinafter referred to as Seil India .) 6. Ministry of Industry, Government of India, vide letter dated 13.11.1995 approved application of HMCL, Japan and Seil India to enter into a foreign collaboration and constitute a joint venture. Terms and conditions of approval letter were amended by subsequent letters of Government of India dated 27.12.1995 and 19.01.1996. 7. A joint venture Company was incorporated with the name of M/s Honda Seil Cars India Private Ltd. (hereinafter referred to as 'HSCIL/Assessee'). 8. Total share capital of HSCIL/Assessee was 36 crores shares out of which 356399995 shares were held by HMCL, Japan while remaining 3600005 shares held ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is) and (ii) the parts which may be procured by licnesee from suppliers (excluding such subcontractors) other than LICENSOR (such Parts (b) (I) and (ii) being hereinafter collectively referred to as the Domestic Parts ). Such classification shall be deemed to be so effected from the date of issue Notice to this effect by the LICENSOR to the licnesee. In this regard, the parts which may be locally manufactured by licnesee hereunder as referred to in (b) (I) above shall particularly be hereinafter referred to as the licenced Parts ; 3. The terms Manufacturing Facilities shall mean jigs, tools, dies, machinery and equipment which licnesee uses for the manufacture, assembly, testing of inspection of the Products; 5. The term Intellectual Property Rights shall mean those patents, utility models design patents and other intellectual property rights directly relating to the Products or the licenced Parts themselves, or relating to the manufacture of the Products or the licenceD parts (including may pending application thereof, but excluding trademarks, and excluding patents utility models design patents and other intellectual property rights relating to the Manufacturing F ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... subject to taxes. Article 14 of agreement which talks of lump sum fee and royalty reads as under: 14.1 In consideration of the right and licence granted to licensee under Article 2 hereof and of the furnishing of the Technical Information under Article 4.2 hereof, licensee shall pay to LICENSOR the following fees: 1. Lumpsum fee: The amount of lumpsum fee payable by the licensee to the LICENSOR shall be USS 30.5 million. This fee shall be payable in 5 continuous equal annual installments, the amount of each of which installments shall be six million one hundred thousand US dollars (USS6,100,000), beginning from the 3rd year after the commencement of Commercial Production. The lump sum fees shall be payable by licensee in currency of US dollars by bank transfer remittance to the bank account designated by LICENSOR, based on final government approval. 2. Royalty: The rate of royalty payable by the licensee to the LICENSOR shall be Four (4) percent; both on internal sales and exports, subject to taxes. The royalty shall calculated on the basis of the ex-factory sale price of the product exclusive of excise duties, minus the cost of standard bought out com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t a factory or factories of LICENSOR or any of its designers, including but not limited to technical guidance fees, per dien allowances, traveling expenses, staying or living expenses and other incidental expanses, shall be payable by licensee to LICENSOR in accordance with such Memorandum on Exchange of Technicians , separate from and in addition to the payments under this Article 14, and that no amount of any such fees, costs, expenses or other consideration is included in the payments under this Article 14. (emphasis added) 15. Article 19 provides term/tenure of agreement and reads as under: Article 19. TERMS OF AGREEMENT This Agreement shall become effective on the Effective Date, and shall continues in full force and effect for period of ten(10) years from the date of agreement or seven (7) years from the date of commencement of commercial production, and shall thereafter be renewed subject to the prevailing laws in India; provided, however, that this Agreement may be terminated by either party at the end of the initial period as mentioned above or at the end of any subsequent renewed period by written notice to that effect given to the other party at least thre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Parts which licensee then has on hand and which remain unso2ld and unused at the time of the expiration or termination of this Agreement; 6. LICENSOR may at its option sell, directly or indirectly, the Products and the Parts repurchased by it under paragraph (5) above in the Territory or any other country, without any liability on the part of LICENSOR, to account to licensee for any part of the proceeds of such sale or any other sums whatsoever; 7. If LICENSOR does not exercise its option referred to in Paragraph (6) above within a reasonable period of time after the expiration or termination of this Agreement, then licensee may, notwithstanding the provision set forth in Paragraph (1) above, sell on a non-exclusive basis, the Products and the Parts which licensee has on hand at the time of the expiration or termination of this Agreement within such a reasonable period of time as may be agreed upon by the parties hereto; provided, however, that such sale shall be made in accordance with this Agreement and without impairing LICENSOR's reputation, provided further that the said sale shall be so executed without using the Trade mark of the LICENSOR in full or in part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 24.8.2006, making an addition of ₹ 7,96,02,000/-, treating it a 'Capital Expenditure' and not 'Revenue Expenditure'. 21. For AY 2001-2002 assessee filed return on 30.10.2001, declaring a net loss of ₹ 68,14,22,302/-. This case was taken in scrutiny and notice under section 143(2) was issued on 25.10.2002. ACIT passed ultimate assessment order dated 26.3.2004, treating following amount as 'Capital Expenditure' (which was claimed by assessee as 'Revenue Expenditure'), and made addition thereof accordingly. Sl.No Nature of expenditure Amount 1. Expenditure of capital nature ₹ 60,07,099/- 2. Technical Guidance Fee ₹ 28,67,00,000/- 3. Royalty payment ₹ 12,38,37,000/- 4. Capital expenditure on R D ₹ 57,44,102/- Total ₹ 25,91,34,101/- 22. For AY 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appeals, as noticed above, relates to the nature of payments made towards technical know-how and 'royalty' whether can be treated to be a revenue expenditure or capital expenditure . 26. Basic contention raised on behalf of Revenue, i.e. appellant before us is that 'Technical know-how' and 'Royalty' payments are of enduring nature and therefore, same would qualify and liable to be treated as 'Capital Expenditure' and not 'Revenue Expenditure'. Shri Manish Goel, learned counsel appearing for appellant in support of his submissions placed reliance on judgments in Scientific Engineering House (Pvt.) Ltd. versus Commissioner of Income-Tax, Andhra Pradesh (1986) 157 ITR 86 (SC); Alembic Chemical Works Co.Ltd. Versus Commissioner of Income Tax, Gujarat (1989) 177 ITR 377 (SC); Jonas Woodhead and Sons (India) Ltd. versus Commissioner of Income Tax and (1997) 224 ITR 342 (SC). 27. Per contra, Sri Roopesh Nath, assisted by Sri R.S. Agarwal, Advocates, appearing for Assessee respondent, contended that certain payments being of enduring nature, by itself would not be determinative of the fact whether the same is 'Revenue Expenditure' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to run business, so as to make payment smoothly. Even earlier activities of company of Assessee, i.e incorporation of joint venture, approval from Government of India and foreign collaboration is for manufacture of motor car on proposed location. All these would show that firstly plant and manufacturing faculties were to be set up, and technical collaboration was foundation for this purpose. Apparently it was not towards improvement or running of existing business more efficiently. Restrictions to which Assessee relied so as to bring aforesaid payments within the ambit of 'Revenue Expenditure' are only by way of precaution and to wriggle out of real nature of payment, i.e 'Capital Expenditure'. In fact, Assessee company is nothing but a predominant entity. Foreign company, namely HMCL, Japan held almost the entire shares, i.e 99%. Shares held by Indian Company is negligible i.e 1%. Hence, it is only a tactical foreign collaboration but for all practical purposes, it is an establishment by a foreign company itself in India and there is virtually no difference in two entities. Hence, it cannot be said that there is payment by one entity to another but, in fact, enti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure of payments made towards fee for 'Technical know-how' and 'Royalty' would qualify to be treated as 'Revenue Expenditure' or 'Capital Expenditure', as it is well known, if it is 'Revenue Expenditure', Assessee would be entitled for deduction from income and if 'Capital Expenditure', it would be taxable. 32. The term 'Revenue Expenditure' as such is not defined in the Act, 1961. Thus term 'Revenue Expenditure' was explained in Assam Bengal Cement Co. Ltd. Versus Commissioner of Income Tax , AIR 1955 SC 89 (at page 96) as under: If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure. (Emphasis added) 33. In Commissioner of Income Tax vs. Ciba of India Limited (Supra), a question arose, whether payment made by Assessee to Ciba Limited, Basl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent merely right to access to technical knowledge and experience for the purpose of carrying its business and was merely a licensee for a limited period of technical knowledge of Swiss company with right to use patents and trade works of that company by making that technical knowledge available. Swiss company did not part with any asset of its business nor did the Assessee acquire any assets or part in the nature of benefits or advantage. 34. In L.B. Sugar Factory and Oil Mills (P) Ltd, Pilibhit Vs. Commissioner of Income Tax, U.P Lucknow (1980) 125 ITR 293(SC), the question was considered in a different but interesting context. Assessee was a sugar factory engaged in manufacture and sale of crystal sugar at Pilibhit, State of U.P. In 1952-53, a dam was to be constructed by State of U.P at a place called Deoni. A road, Deoni Dam-Majhala was constructed connecting Deoni Dam with Majhala. Collector requested Assessee to make some contribution towards construction of Deoni Dam and Deoni Dam-Majhala Road pursuant whereto Assessee contributed certain amount. Assessee also contributed some amount towards meeting the cost of construction of roads in the area around its factory under a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e that in all cases securing a benefit for the business, would be prima facie capital expenditure so long as the benefit is not so transitory as to have no endurance at all. Court relied on its earlier decision in Empire Jute Company Ltd. Versus Commissioner of Income Tax (1980) 124 ITR 1 (SC) that there may be cases where expenditure even if incurred for obtaining advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. Court further said as under: It is not every advantage of enduring nature acquired by an Assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only whether the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the Assessee's business operations or enabling management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though advantage may endu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the business or working it with a view to produce the profits, it is a revenue expenditure. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be immaterial whether the source of payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence. 37. It also referred to the decision of Supreme Court in Gotan Lime Syndicate versus Commissioner of Income Tax (1966) 59 ITR 718, wherein it was held that expenditure incurred to secure an enduring advantage must not invariably be treated as capital expenditure and royalty payment including dead-rent, which has no direct nexus for securing an enduring benefit but has relation to the raw material viz. lime deposits, was held to be a Revenue Expenditure . Court found that under the agreement, amount paid by Assessee at the time of signing was not claimed to be 'Revenue Expenditure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owable. In further appeal, Tribunal observed that some of the services of Foreign Collaborator do qualify for 'Revenue' account and therefore, to the extent, services qualified for 'Revenue' account, may be allowed to be deducted and rest may be added. In appeal Supreme Court considered the question, whether 'Technical know-how' in the shape of drawings, designs, charts, plans, processing data and other literature falls within the definition of Plant . It replied aforesaid question by referring to judgments and reasonings in Yarmouth v.France (1987)19 QBD 647, a case in which it was decided that a cart horse was plant within the meaning of section 1(1) of the Employers' Liability Act, 1880. It was held: There is no definition of plant in the Act: but, in its ordinary sense, it includes whatever apparatus is used by a business man for carrying on his business not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or movable, live or dead, which he keeps for permanent employment in his business. 39. Court also referred and approved decision in Commissioner of Income tax Vs. Elecon Engineering Company Ltd., (197 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to High Court who answered the question against Assessee. Hence matter went in appeal to Supreme Court. Referring to some earlier judgments, Court culled out certain principles laid down therein to determine, whether expenditure of Assessee was 'Capital Expenditure' or 'Revenue Expenditure' and said : (i) When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital ( referred to British Insulated Helsby Cables Ltd. v. Atherton, [1926] AC 205). (ii) If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits, it is a revenue ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asting. The time over which the thing 'endures' is a matter of degree and one element only to be considered. Thereafter Court looked into the process of making antibiotics and penicillin and observed that Indian company was already engaged in the preparation of antibiotics since long. In the background facts, Court held, it cannot be said that the area of improvisation by obtaining know how from foreign collaboration was not a part of improvisation of existing business or that the entire gamut of existing manufacturing operations for the commercial production of penicillin in the Assessee's existing plant had become obsolete or inappropriate in relation to exploitation of the new sub-cultures of the high yielding strains of penicillin. It cannot be said that mere introduction of new bio-synthetic source required erection and commissioning of a totally new and different type of plant and machinery. Adding the fact that agreement placed limitations on the right of assessee in dealing with the know-how and the conditions as to non-partibility, confidentiality and secrecy of the know-how inclined towards the inference that the right pertained more to the use of the know-how ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and conditions of the agreement and (v) whether Assessee derived benefits coming to its capital for which the payment was made. 45. Relying on tests laid down in the earlier authorities including Alembic Chemical Works Co. Ltd, vs Commissioner Of Income Tax (supra), Court decided the issue against Assessee observing that under the agreement with foreign firm Assessee had to set up a new business and foreign firm had not only furnished information and technical know-how but also rendered valuable services in setting-up of the factory itself and even after expiry of agreement, there is no embargo on Assessee to continue to manufacture the product in question. Court held that merely because payment is required to be made at a certain percentage of the rates of gross turnover of the products of Assessee as 'Royalty', it cannot be said that the entire payment is a 'Revenue Expenditure'. 46. In Commissioner of Income Tax, Hyderabad versus Warner Hindustan Ltd. 1998 (9) SCC 533, Court did not examine this aspect in detail since the amount involved in dispute was small. Hence, it is not an authority on the question whether technical fee paid to a foreign company wou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on received was for imparting know-how not in association with the disposal of a capital asset. It was a for a limited period, not permanently, and not for establishment of any plant or machinery but for manufacture of equipment and machinery for Cane Sugar Plant. Hence, it was not of enduring nature and a ''Revenue Expenditure' and not ''Capital Expenditure'. This decision evidently makes it clear that therein agreement and parting of Technical know-how was not for establishment of plant and machinery but for manufacture of equipment and machinery of Cane Sugar Plant which was a distinguishing feature. 49. The other judgments relied on behalf of Assessee, of different High Courts, basically have examined the issues in the light of Supreme Court's judgments in Commissioner of Income Tax Vs. Ciba of India Ltd. (Supra) and others which we have already discussed. Therefore, we directly come to the facts of this case to examine whether in the present case, payments made as 'Technical know-how' fee and 'Royalty' should be held to be a Revenue Expenditure or Capital Expenditure . 50. Looking into the exposition of law laid down in vari ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... limited period having no enduring nature but a close scrutiny of agreement shows otherwise. Various tests laid down in judicial precedents as discussed above, have been attempted to cover up by giving colour to agreement that it is not of enduring nature. The fact however is otherwise, when we read the entire agreement in consonance, harmony and together. 52. Agreement provided that in the event of expiration or otherwise termination, whatsoever, licensee, i.e., joint venture company/Assessee shall discontinue manufacture, sale and other disposition of products, parts and residuary products. All these things then shall be at the option of licensor. In other words, licensee in such contingency would hand over unsold product and parts to licensor for sale by him. In case licensor does not exercise such option and product is allowed to be sold by licensee, thereupon licensee would continue to pay royalty as per rates agreed under the agreement. Clauses 19 and 21, in our view, make the agreement in question, i.e., establishment of plant, machinery and manufacture of product with the help of technical know-how, co-extensive, in continuance of agreement. 53. The agreement also has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of A.O. with regard to Technical Know-how fee so as to be treated as 'Capital Expenditure' holding as under: Beyond doubt, it is established that but for the technical know how provided, the plant would have neither come into existence nor could have started manufacture of vehicles. The technical know how provided enabled the setting up of the manufacturing activity/plant. The A.O. has rightly observed that the technical collaboration agreement was made for setting up of the plant and not towards improvement or running of an existing business and as such the payment has been made (as established by the documents and not denied by the appellant) for technical guidance provided from time to time during the course of the same. The A.O. has rightly held that the lum sum fee and royalty are relatable to the installation of the appellant's plant and hence capital in nature. It is pertinent to note that as per provisions of the TCA, the technical know how provided are for setting up of the plant and manufacture of vehicles. As such the repeated pleas of the appellant that the appellant acquired only limited rights on the technical know how and is not free to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y in existence. The technical information provided is not for day-to-day running of the company and as such cannot be treated as a revenue expenditure. 57. We also find from record that at the time of entering into Technical Know-how agreement, HMCL had only 60% of share holding in HSCIL/Assessee but only in AY 2004-2005, it increased its share holding to 99% and above and thus got virtually entire control and ownership over the alleged joint venture. A.O. has found this exercise as diversion of profit. Assessee explained it to be in accordance with Government policy. Even if the same aspect is ignored, as a relevant consideration for deciding the questions up for consideration before us, yet we find that reasons given in the light of various clauses of the agreement so as to treat Technical Know-how fee as Capital Expenditure is well founded but unfortunately Tribunal while taking otherwise view has impressed itself with superficial approach treating ownership of Technical Know-how fee by parent company and limited tenure etc. without appreciating various clauses of agreement in entirety and thus has erred in law. We are therefore, of the view that A.O and CIT(A) were ..... X X X X Extracts X X X X X X X X Extracts X X X X
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