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TMI Blog1971 (11) TMI 25X X X X Extracts X X X X X X X X Extracts X X X X ..... sultation fee, are a proper deduction ? (3) Whether, on the facts and in the circumstances of the case, the assessee was entitled to have its chargeable profits determined under the Sur-tax Act with reference to its total income for income-tax purposes after allowance of the sums in question paid by the assessee to the English company respectively under the agreements dated December 7, 1959, and September 29, 1959 ? " The material facts are : The assessee is a public limited company, carrying on business of manufacture of laminated materials, resins and moulding powders. Bakelite Company, London, was the proprietor of Indian Letter Patent Nos. 57094, 57095 and 57459 for the production of copper-clad laminates. For the purposes of manufacture of copper-clad laminates, patents of which were owned by the Bakelite Company Ltd., London, the assessee-company entered into an agreement on December 7, 1959, with Bakelite Company Ltd., London (hereinafter called the " English company "). By that agreement, the English company granted to the assessee an exclusive non-assignable licence to make use, exercise and vend laminates in accordance with processes covered by the Letter Patent Nos. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... As a consideration therefor the assessee-company agreed to pay to the English company consultancy fee at 2% of net sales on all Class I products, and at 5% of the net sales on Class II products, sold by the assessee during every year, during which the agreement remained in force. It was also agreed that the consultancy fees paid to the English company was subject to Indian taxes. The agreement was to be in force for 10 years from the date thereof. Any extension thereafter was to be by mutual consent and with the approval of the Government of India. Clause (5) of the said agreement cast an obligation on the assessee not to divulge to any person at any time during the tenure of the agreement, or thereafter, the information that it may acquire under this agreement from the English company. In pursuance of the second agreement, the assessee paid to the English company the following sums : Rs. 1963-64 2,150 1964-65 18,626 1965-66 59,547 1966-67 80,286 The assessee claimed deduction of those payments in the computation of its income for the respective assessment years as expenditure of a revenue nature. The Income-tax Officer disallowed the claim of the assessee for the ded ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l held that, in essence, what the assessee was paying for was the cost of development of the new laminated products and in that sense not allowable as revenue expenditure. Regarding the consultancy fee, the Tribunal did not agree with the department that all the items enumerated in Schedule II to the agreement dated September 29, 1959, related to the permanent structure or framework of the assessee's business. Items 6 to 8 of the technical information clearly related to the routine operations of the business, and in so far as those items were concerned, due allowances had, necessarily, to be made of the consultancy fee relating to them. With regard to items 1 to 5, the Tribunal found that the Income-tax Officer had not disputed the assessee's claim that those items of information were not taken advantage of by the assessee and the Appellate Assistant Commissioner had given a positive finding that the services of the foreign company were not at all pressed into service for the purpose of erection of the machinery, or other capital items. The Tribunal did not express the nature of the information in item No. 9, as the department proceeded on the footing that it was of the same nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ish company, the payments made by the assessee-company to the English company under agreement dated December 7, 1959, were expenditure of a revenue nature and not of capital nature. The question whether any expenditure is on capital or revenue account must be viewed in the larger context of business expediency and whether it is wholly incurred for business purposes, so as to form an integral part of profit earning process. Not only the agreement, but also the surrounding circumstances must be taken into consideration for purposes of finding out the nature of the expenditure. Considered from that point of view, the payments made to the English company under the agreement dated December 7, 1959, are payments on revenue account, and the authorities below erred in disallowing those payments. Clause (5) of the agreement dated February 1, 1949, did not alter the nature of the payments made under the agreement dated December 7, 1959. No lump sum could be said to have been fixed. If the assessee-company did not manufactures copper-clad laminate, then no amount of royalty was payable to the English company. Regarding payments under the second agreement dated September 29, 1959, the lear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts made under the first agreement are, therefore, of capital nature and have been rightly disallowed by the department and the Tribunal. Regarding payments under the second agreement dated September 29, 1959, the learned counsel submitted that technical know-how is " property " and the passing of it to another is passing of property. If it is for consideration, then the consideration is for acquisition of an asset. The period fixed under the agreement is 10 years. The assessee-company acquired an advantage for a period extending over 10 years. The acquisition of that asset or advantage was of an enduring nature. Not only with regard to the plant and machinery that has been erected, but the English company was bound to supply the necessary information regarding the new acquisitions of the type of machinery that was contemplated therein. That information is related to the capital structure of the assessee's business. The entire information regarding items 1 to 5 and 9 in the Second Schedule to the agreement that was acquired by the assessee-company has not been placed before the Tribunal to warrant a conclusion that those items related to the day-to-day routine operation of the bus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such laminated products. Pursuant to clause (5) of the agreement dated February 1, 1949, the assessee-company entered into a further agreement dated December 7, 1959, with the English company. The purpose for which the agreement dated December 7, 1959, was executed was that the assessee-company required a licence under the Indian Letter Patent Nos. 57094, 57095 and 57459, of which the English company was the proprietor, in order to produce copper-clad laminates, and pursuant to clause (5) of the agreement dated February 1, 1949, the English company had agreed to supply information to the assessee in order to enable it to produce copper-clad laminates. Under clause (1) of the agreement dated December 7, 1959, the English company granted to the assessee-company an exclusive non-assignable licence to make use, exercise and vend laminates in accordance with the processes covered by the Letter Patent Nos. 57094 and 57095. Clause (2) of the agreement says that the licence shall be in force for the unexpired terms of those patents and any extensions and regrants thereof. Under clause (3) the assessee-company agreed to pay to the English company royalty at the rate of 5% on the net sell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e true and correct principles for the purpose of deciding the question whether an expenditure is of a revenue nature or of a capital nature. At page 45 of the report, the learned judge observed that : " In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fied therein in India and also a licence to use certain specified trade marks in the territory subject to any existing licence which third parties held at the date of agreement, or which the Swiss company might grant to third parties thereafter. In consideration of the right to receive scientific and technical assistance the assessee agreed to make contributions of 5%, 3% and 2% respectively, of the net sale price of the produce sold by the assessee towards: (i) technical consultancy and technical service rendered and research work done ; (ii) cost of raw material used for experimental work ; and (iii) royalties on trade marks used by the assessee. The assessee further agreed : (a) not to divulge to third parties without the consent of the Swiss company any confidential information received under the agreement ; (b) without the written consent of the Swiss company, not to assign the benefit of the agreement or grant sub-licences of the patents and trade marks ; and (c) upon termination of the agreement for any cause to cease to use the patents and trade marks and to return to the company all copies of information, scientific data or material sent to it and to refrain fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etween certain clauses in the agreement in the case before them and that in the case of Commissioner of Income-tax v. Ciba of India Ltd. The reasons given by them for allowing the claim of the assessee in that case are : " Royalties, usually, are periodical payments for continuous enjoyment of certain benefits under a contract. In every case payment of royalty is not a capital expenditure. In the instant case the various types of payments that the assessee had to make were closely related to the assessee's manufacturing processes of Simplex products. In other words, the payments were intimately linked up with the manufacturing activities of the assessee and not with the capital values of the assets that the assessee would acquire. They could not, strictly speaking, be said to be the purchase price of the assets. Though the assessee's foreign principals would be imparting their 'know-how' to the assessee for a reward, that is nothing more than a teacher selling his knowledge or skill to his pupil. The assessee's foreign principals were merely supplying technical information to enable the assessee to carry on business in terms of the agreement. " In Pingle Industries Ltd. v. Comm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ole v. Withers (H. M. Inspector of Taxes) Lord Greene M.R. observed that: " One might perhaps have expected that where a piece of property, be it copyright or anything else, is turned to account in a way which leaves in the owner what we may call the reversion in the property, so that upon the expiration of the rights conferred, whether they are to endure for a short or a long period, the property comes back to the owner intact, the sum paid as consideration for the grant of the rights, whether consisting of a lump sum or of periodical or royalty payments, should be regarded as of a revenue nature. We emphasise the word 'intact'-salva rei substantia, to use the expression adopted by Lord Fleming in Trustees of Earl Haig v. Commissioners of Inland Revenue since (save in the special cases of wasting property) if the property is permanently diminished or injuriously affected, it means that the owner has to that extent realised part of the capital of his property as distinct from merely exploiting its income-producing character. " In Bombay Steam Navigation Co. v. Commissioner of Income-tax the assessee, an amalgamated company, took over certain passenger and ferry services from ou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sell the goodwill outright, and that was the aim and object of the expenditure which A made under the agreement. In India Cements Ltd. v. Commissioner of Income-tax expenditure incurred by the assessee for obtaining a loan for its business was held to be a revenue expenditure. The Supreme Court held that: "Where there is no express prohibition, an outgoing, by means of which an assessee procures the use of a thing by which he makes a profit, is deductible from the receipts of the business to ascertain the taxable income ...... A loan obtained cannot be treated as an asset or advantage for the enduring benefit of the business of the assessee. " In Regent Oil Co. Ltd. v. Strick (H. M. Inspector of Taxes) Lord Reid observed that: " If the asset which is acquired is in its intrinsic nature a capital asset, then any sum paid to acquire it must surely be capital outlay. And I do not see how it could matter that the payment was made by sums paid annually. But, it appears to me that an asset which is nothing more than a right to enjoy a certain advantage over a period is intrinsically of a different character from a thing which a person buys and can immediately use or consume in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is intrinsically a capital asset, it is immaterial whether the price for it is paid once and for all, or periodically, or whether it is paid out of capital or income, or linked up with the net sales. The outgoing, in such a case, would be of the nature of capital expenditure. (6) If the amount paid for the acquisition of an asset of an enduring nature is settled, the mere fact that the amount so settled is chalked out into various small amounts or periodic instalments, the capital nature of expenditure would not cease to be so or alter into the nature of a revenue expenditure. (7) A lump sum amount for liquidating recurring claims would not cease to be revenue expenditure or get converted into capital expenditure merely because its payment is spread over a number of years. It is the intention and object with which the asset is acquired, that determines the nature of the expenditure incurred over it, and not the method or the manner in which the payment is made, or the source of such payment. (8) If the expenditure is recurring and is incurred during the course of business or manufacture, it would be revenue expenditure. (9) An asset or advantage of an enduring nature does ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y not only gets the advantage of the use of those patents for the unexpired period of those patents, but also for the periods of extension or regrants. The acquisition in this case, therefore, is an asset or advantage of an enduring nature to the assessee's business. It is immaterial whether the agreed price for it is paid in a lump sum once and for all, or in periodic instalments, or whether it is paid out of capital or income of the assessee, or linked up with the net sales of such products manufactured by the assessee. As far as the English company is concerned, there was a complete breaking up or cessation of its business in India, so far as those patents were concerned and it was an acquisition of a new business for the assessee-company. If the royalties that are paid reach pound 5,000, the assessee would no more be liable for the payment of royalties. If in the first few years the net sales of the produce manufactured by the assessee-company under those patented processes are sufficiently large, and if the royalty paid thereon at the agreed percentages would reach pound 5,000, then for the rest of the unexpired period of those patents the assessee would use that knowledge and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... over it is of a revenue nature. Moreover, in Ciba's case, the period of agreement was five years. The agreement was liable to be cancelled earlier also. But, in the assessee's case, the advantage or the benefit of the user of those patented processes is not only for the entire life of those patents, but also for the extensions and regrants thereof. Another distinguishing feature in this case is that after the payments reach pound 5,000 the assessee would not be liable to pay any royalty in respect of those patents for the subsequent unexpired period of those patents ; that is to say, the price for the entire user which has already been fixed at pound 5,000 has been paid whereas in Ciba's case, no price as such had been fixed for the user of the special knowledge for the entire period of licence or use. For all these reasons, we have no hesitation to agree with the finding of the Tribunal that the payments made by the assessee-company under the agreement dated December 7, 1959, are of capital nature and inadmissible as deductions in the computation of the assessee's business income for the relevant assessment years. We, therefore, answer the first question referred to us in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce in the purchase of such plant ; (3) supervision of the construction of the plant purchased ; (4) a design summary and flow diagram necessary for the assembly of the plant ; and (5) construction of the plant which was intended to be fabricated in India, together with guidance as to its operation, undoubtedly, relate to the profit-making apparatus, that is, structure and framework of business of the assessee-company. The payments made in respect thereof would, undoubtedly, be of the nature of capital expenditure. On the other hand, information relating to (6), the guidance on selection and purchase of raw materials, manufacture and testing of the finished products together with the formulae and specifications of such raw material and finished products, and (7), information on new developments or improvements in manufacturing process and testing methods, and (8), technical bulletins and literature normally used by the English company to assist sales relate, undoubtedly, to the business operations carried on by the assessee-company and sales of the finished products manufactured by it. On a perusal of those items regarding which special information is sought for by the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icular assessment year. In the accounting years relevant to the assessment years concerned, the finding of the income-tax authorities is that the assessee did not get any information regarding items 1 to 5 and, therefore, no part of the expenditure incurred by the assessee in those years, which it claims as admissible deductions, was capital expenditure. The Tribunal, therefore, erred in not allowing the entire expenditure as admissible deduction. Allocation, in these circumstances, was not called for and the whole expenditure must be allowed as a deduction. We are unable to agree with this submission. Although no information regarding items 1 to 5 has been received in the accounting years relevant to the assessment years under consideration, still these items also include information regarding plant that may be acquired by the assessee in future. The assessee-company had a right, under the terms of the agreement dated September 29, 1959, to call upon the English company to furnish to it information relating to the plant that it may acquire in future. It is, therefore, evident that when the consultancy fee at the rate of 2% under class I products and 5% under class II products wa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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