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TMI Blog1986 (4) TMI 11X X X X Extracts X X X X X X X X Extracts X X X X ..... g ? (2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in bifurcating the expenditure of royalty into 2/3rds revenue expenditure and 1/3rd capital expenditure ? (3) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the assessee could withdraw the claim of extra shift allowance before the Income-tax Officer ? " The question referred at the instance of the assessee and question No. 2 at the instance of the Revenue cover common ground in the sense that the core question to be decided is whether the sum of Rs. 3,09,991 or any part thereof paid by the assessee in terms of the agreement with the foreign collaborators contained any element of capital nature/revenue nature. The Tribunal had directed that one-third of the payment should be disallowed as representing capital expenditure in the hands of the Indian company and the balance should be allowed as revenue expenditure. By this verdict of the Tribunal both the parties are aggrieved. That has led to two references challenging the correctness of the part decided against them. It will be convenient at this stage to dispose of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it the sums in the Government treasury. In the relevant year in question, therefore, it must be held to be income. It will, of course, be entitled to allowance as expenses when it pays into the Government treasury. The liability to pay would arise when the assessment has been made. The nature of such realisations is related to the question whether the assessee follows the cash system of accounting or the mercantile system of accounting. Since the assessee was following the mercantile system of accounting, the liability to pay had accrued during the assessment year in question and the assessee did not pay it, it must be deemed to be the income of the assessee. The view that I have taken is supported by the decision of the Supreme Court in Sinclair Murray and Co. P. Ltd. v. CIT [1974] 97 ITR 615 and our own decision in CIT v. Motipur Sugar Factory (P.) Ltd. [1985] 154 ITR 259 (Pat). That brings us to the vexed question, question No. (2), hotly contested by the parties in regard to the nature of the payments made by the assessee to its foreign collaborators. According to the assessee, the entire sum of Rs. 3,09,991 paid as royalty was revenue expenditure and allowable as such. Accor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th for vibrating screens. Speed reducers. Industrial Chain." These agreements show that the TRF was to establish a factory/plant and TRF would set up materials handling and processing machines for its own constituents. It is not in controversy that the payments made under these agreements were capital expenses and development allowance and rebate were allowable accordingly, but the said sums were not allowable as business expenditure in terms of section 37 of the Act. Apart from the above set of agreements, there was another set of agreements between the very same parties which may be referred hereto as agreement II. In terms of these agreements, H. R. Int. and the GEC were to render technical services and technical assistance to TRF for which the latter was to pay to H. R. Int. royalty at the following rates : "(a) One half per cent. of the total value of engineered contract sales of TRF less the value of the components and services imported from foreign sources, but including the value of the manufactured product. (b) One per cent. of the ex-works value of all products sold as merchandise by TRF less the value of imported components thereof purchased by TRF. " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns of revenue. The latter can be considered, estimated and determined only in relation to a period or interval of time, the former as at a point of time. For the one concerns the instrument for earning profits and the other the continuous Process of its use or employment for that purpose." A rough and ready test has, however, been followed in this country by trying to ascertain whether a particular expenditure brings about enduring benefit". In that situation, it would be a capital expenditure. This test leaves many gaps, but has generally been adopted as the answer to the question. This subject cannot be complete without referring to the decision in Benarsidas Jagannath, In re [1947] 15 ITR 185, 199 (Lah) [FB], where Mahajan J., as he then was, laid down the following tests: " (i) Outlay is deemed to be capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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. It is only in those cases where this test is of no avail that one may go to the test of fixed or circulating capital and consider whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital." And even after laying down the laws so succinctly, Bhagwati J. observed as follows (at pages 45 and 46): " It has been rightly observed that in the great diversity of human affairs and the complicated nature of business operations, it is difficult to lay down a test which would apply to all situations. One has, therefore, got to apply these criteria one after the other from the business point of view and come to the conclusion whether on a fair appreciation of the whole situation the expenditure incurred in a particular case is of the nature of capital expenditure or revenue expenditure in which latter event only it would be a deduc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amshedpur incorporating up-to-date improvements and designs to meet performance guarantee to be mutually agreed to by the parties hereto. (ii) The necessary drawings and specifications of machinery and plant and the drawings and plants for the arrangement and installation of the machinery and plant in the factory to be established by TRF. (iii) Advice on tenders and placing of orders for the purchase of machinery and equipment and for the construction of the Plant and factory at Jamshedpur." Other several clauses need not be referred to. It is not in controversy that the expenditure for carrying out exhibit I was capital expenditure. have, however, quoted from the agreement only to highlight the distinction between agreement No. I and agreement No. II. We must now look at the contents of agreement No. II. In the preamble to this agreement, it is stated that TRF is an Indian company specially formed for the purpose of manufacturing and selling certain materials handling and Processing equipment and components and Providing certain engineering services, as described in exhibit " A " (appendix I) to the agreement. It is also recited in the preamble that TRF shall manufactu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... licence under all patents owned or controlled by H.R. Int. or its affiliates or under which H.R. Int. or its affiliates have power to grant sub-licences without payment of additional royalty to their respective licensors) to make, use, sell and provide the Specified Equipment and Services in India in accordance with the, designs, technical data, processes formulae and procedures used by H. R. Int. or its affiliates for the commercial production of the Specified Equipment and Services. It is understood that drawings, data, technical services and other technical information which H.R. Int. is required to provide under this clause 2 shall be that which is available to H.R. Int. or its affiliates at any given time during the period of this agreement including the benefit of all research and development and H.R. Int. shall not be required to perform or provide any new or special design or engineering work for TRF. From the above, it will be seen that whereas the first agreement was for setting up a plant at Jamshedpur, the second agreement was for enabling TRF to manufacture, sell and provide Specified Equipment and Services. The second agreement provided for activity which may be r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, the expenditure must be deemed to be capital expenditure. The submission is fallacious. The number of years for which an agreement is to remain operative or for which the expenses have to be incurred are not a conclusive index for determining whether the assessee can be said to have obtained enduring benefit. A similar argument was advanced before the Bombay High Court in ACC-Vickers Babcock Ltd. v. CIT [1976] 103 ITR 321 (Bom). This submission was rejected with the observation that the duration of the agreement cannot be decisive of the matter. The same view was taken by a Full Bench of the Mysore High Court in Mysore Kirloskar Ltd. v. CIT [1978] 114 ITR 443 (Kar) where the user was for fifteen years. The submission urged on behalf of the Revenue was rejected by their Lordships with the observation that the period of agreement by itself is not determinative of the nature of the payments made under it. I am in respectful agreement with the views of the Bombay and Mysore High Courts in this behalf. The length of the period of expenditure does not indicate that the expenditure is capital in nature. Learned senior standing counsel drew our attention to some of the clauses of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecuting material handling projects. Surely, having set up a factory for providing material handling projects on turnkey basis, the factory would not be closed down on the termination of the agreement. But what did H.R. Int. part with ? Not its rights in the patents or the drawings in regard to setting up of the plant of the constituents of TRF. It only gave TRF the right to use the patent and the technical knowledge acquired by H.R. Int. It is true that this agreement does not provide for return of documents. Even so, H.R. Int. did not part with any of its assets absolutely for ever. This would be so for two reasons. Firstly, that knowledge cannot be returned back, once it has been acquired by TRF, it could not be returned to H.R. Int. The conclusion would be the same for still another reason, namely, the knowledge or know-how provided by H.R. Int. would pale into obsolescence. After a number of years, the knowledge imparted to TRF by H.R. Int. by the drawings and layouts would become outmoded and of no use to either party. In that view of the matter, the drawings, the ideas and the inventions were not transferred to TRF for all times. The absence of the clause relating to the retu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urt held that the royalty payments were revenue expenditure. In this connection, I cannot refrain from quoting the observations of Shah J. (at p. 700) : " The assessee acquired under the agreement merely the right to draw, for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products, upon the technical knowledge of the Swiss company for a limited period: by making that technical knowledge available the Swiss company did not part with any asset of its business nor did the assessee acquire any asset or advantage of an enduring nature for the benefit of its business." It is thus obvious that Ciba of India Ltd.'s case [1968] 69 ITR 692 (SC) was decided in favour of the assessee not on the consideration that the Indian company had to return the documents to the Swiss company, but upon the footing of the six circumstances enumerated above. It is not necessary for me to refer to the English cases, as Ciba's case [1968] 69 ITR 692 (SC) has already taken note of them. The assessee in this case, as in Ciba's case [1968] 69 ITR 692 (SC), did not under the agreement become entitled exclusively even for the period of the agreement to the patents and tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n terms of the agreement. Learned senior standing counsel for the Revenue heavily placed reliance on the case of Scientific Engineering House (P.) Ltd v. CIT [1986] 157 ITR 86 (SC). The decision apparently appears to support the Revenue. It will, therefore, need consideration in some greater detail. The assessee in that case manufactured scientific instruments and apparatus like dumpy Levellers, staves, prismatic compass, etc. It entered into two separate collaboration agreements with a Hungarian Trading Company for undertaking the manufacture of microscopes and theodolites, which, in consideration of payment of Rs. 1,60,000 under the two agreements, agreed to supply to the assessee all the technical know-how required for the manufacture of these instruments. The object of both the agreements was to enable the assessee to manufacture the said instruments of certain specifications and the assessee under the agreements acquired the right to manufacture in India under its own trade mark and name the said instruments and the right to sell the same in India. To enable the assessee to manufacture these instruments in India, the foreign collaborator agreed to render "documentation servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llows (at page 92) : " Having regard to the rival contentions that were urged before us, it is clear that two questions really arise for determination in the case. The first is whether the 'documentation service' (supply of 5 complete sets of documents) agreed to be and actually rendered by the foreign collaborator to the assessee under the two agreements was incidental to the other services contemplated therein or whether it was the principal service for which mainly the payment of Rs. 1,60,000 was made by the assessee as result whereof the assessee acquired all the technical know-how requisite for the purpose of manufacturing the instruments in question ? And, secondly, whether the said expenditure which was entirely of a capital nature, brought into existence a depreciable asset ? The answer to the former question depends upon the proper interpretation of the terms and conditions of the two agreements while the answer to the latter depends upon whether a capital asset like the technical know-how acquired in the shape of drawings, designs, charts, plans, processing data and other literature which formed the basis for the business of manufacturing the instruments in question wou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. In terms of clause 5, TRF was granted non-exclusive right to sell in, or for use in, neighbouring countries the Specified Equipment and Services manufactured by it in India. In terms of clause 6, H.R. Int. covenanted with TRF not to sell or supply by itself or through any of its subsidiaries to any other party in India, the technical information and services which it had agreed to supply to TRF. These are not strictly monopoly rights. Further, the agreement was terminable on six months' notice by either party. That would bring about an end to the monopoly, if any, which existed. In this connection, the terms of clause 20 are rather significant which read as under: " 20. This agreement is subject to the obtaining of all approvals and consent required by law in India and if the last of such approvals and consents has not been obtained by December 1, 1963, H. R. Int. may terminate the same at its option by giving 30 days' notice in writing to that effect to TRF. In the event of termination as aforesaid, TRF will return to H. R. Int. all materials and documents whatsoever furnished to TRF by it prior to the date of such termination and TRF shall not divulge to any other person, fi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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