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TMI Blog2011 (9) TMI 1249X X X X Extracts X X X X X X X X Extracts X X X X ..... nd in law in enhancing the disallowance on account of royalty by a sum of Rs. 4.90 lakhs in respect of applicable TDS paid on such amount of know-how fees as per the terms of agreement and treating the same as capital expenditure primarily on the ground that it is a capital expenditure. 2. The facts in brief as emerged from the corresponding assessment order passed under section 143(3) of the Income-tax Act, 1961 dated March 30, 2004 were that the assessee-company is in the business of manufacturing of ball-bearings. It was stated by the Assessing Officer that the assessee was in the said business since 1996. It was noted by the Assessing Officer that an agreement was entered into between the assessee and FAG Auto-mobile-tech-nik AG dated March 30, 2000. That agreement was in respect of a know-how to be provided by the said collaborator to the assessee, called as Indian company. That know-how was in respect of manufacturing of certain kinds of ball-bearings listed therein. As per clause 2 the character of the know-how was as follows: 2. The know-how shall: (a) be in line with the process of manufacture of the products being followed by the Indian company; and (b) incl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sections 30 to 38 as well as section 40, then the provisions of section 40 shall prevail. As per the Assessing Officer, For the purpose of section 40(a)(1) according to clause (A) of the Explanation to that section the expression royalty shall have the same meaning as in Explanation 2 to section 9(1)(vi); clause (B) of the Explanation to section 40(a)(i) coins a definition of the expression fees for technical services shall have the same meaning as in Explanation 2 to section 9(1)(vii). Technical know-how for industrial information and technical services are covered under the provisions of section 32(1)(ii) of the Income-tax Act . In the result, the assessees claim that the said expenditure was revenue in nature was disallowed. However, it was held that the assessee was eligible for claim of depreciation. The issue was carried before the first appellate authority. 5. The learned Commissioner of Income-tax (Appeals) has discussed the clauses of the impugned agreement and related facts in detail. The learned Commissioner of Income-tax(Appeals) has also discussed certain case law. The learned Commissioner of Income-tax (Appeals) has also called for a remand report and in that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aler in foreign exchange; (ii) second one-third on delivery of know-how documentation; and (iii) third and final one-third on commencement of commercial production, or four years after the proposal is approved by the Reserve Bank of India and agreement is filed with the authorised dealer in foreign exchange, whichever is earlier; (2) a sum equal to 5 per cent, net of Indian taxes of the net ex-factory sale price of the products; (3) the sums payable to the collaborator is payable also in respect of the products that may be in stock with the Indian company at the time of expiration or sooner termination of the agreement. 6. The observation of the learned Commissioner of Income-tax (Appeals) was that as per the terms and conditions of the agreement there were two kinds of payment; one was a lump sum consideration and, the other was recurring in nature depending upon the net ex-factory sale price. As regards to the lump sum consideration, as per the learned Commissioner of Income-tax (Appeals), it was stated to be Rs. 43.10 lakhs. At that juncture, the learned Commissioner of Income-tax (Appeals) has quoted CIT v. Sarada Binding Works [1976] 102 ITR 187 (Mad) f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and who shall have, prior to such communication, undertaken in wrong to treat it as confidential. (d) Clause 10 The obligations undertaken by the Indian company under the provisions of clauses 8 and 9 aforegoing shall continue to remain in force even after expiry or sooner termination of this agreement. (e) Clause 12 Neither of the parties shall assign this agreement or any part hereof nor any right hereunder without the previous consent in writing of the other party. (f) Clause 13 The Indian company shall not during the currency of this agreement, except with the previous consent in writing of the collaborator, directly or indirectly, receive or seek to receive from any third party and know-how relative to the products. (g) Clause 14 The Indian company may export the products manufactured by it with prior approval in writing of the collaborators. (h) In terms of the clause 24(a) of the agreement, upon termination of the agreement, the Indian company has to return to the collaborators the know-how as has been provided to it by the collaborators. 8. The learned authorised representative has also quoted a clarification ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The appellant is entitled to the know-how till the period of the agreement and not beyond it. 10. In support of the above arguments, case law cited were as under: Sl.No(s) Decision in the case of Reported in 1. Sayaji Industries Ltd. vs. Dy.CIT 68 TTJ 851 (ITAT Delhi) 2. Goodyear India Ltd. vs. ITO 73 ITD 189 (ITAT Delhi) 3. Wellman Incandescent India Ltd. vs. Dy.CIT 55 ITD 338 (ITAT, Calcutta) 4. Dy.CIT vs. Metalman Auto (P) Ltd. 78 ITD 327 (ITAT Chandigarh) 5. K.B. Mehta vs. Dy.CIT 86 ITD 256 (ITAT Pune) 6. Eicher Motors Ltd. vs. Dy.CIT 82 TTJ 61 (ITAT Indore) 7. CIT vs. CIBA of India Ltd. [1968] 69 ITR 692 (SC) 8. CIT vs. Lucas T.V.S. Limited (No.1) [1977] 110 ITR 338 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d through the said collaborator. Therefore the agreement was a production sharing agreement . Since it was a production sharing agreement , therefore the payment of know-how was in instalments. The learned Departmental representative has also mentioned that in the subsequent assessment year for the assessment year 2006-07 the impugned know-how payment has again been disallowed by the Assessing Officer. He has also supported the view of the learned Commissioner of Income-tax (Appeals) that merely by deduction of the TDS did not mean that the know-how payment was revenue in nature. He has concluded that the tone and tenor of the agreement was for the production of an altogether new product and therefore for the acquisition of a new technology through which the assessee has been benefited for a long period hence the expenditure was nothing but capital in nature. 12. We have heard the parties at some length. We have carefully perused the orders of the authorities below in the light of a voluminous compilation filed before us containing almost 400 pages and the case law cited. Before us, an agreement dated March 30, 2000 was referred to which was executed between FAG Auto-Mobil-tec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ithout the right to use the patents and trade marks then if any payment made would not bring into existence an asset of enduring advantage to the Indian participants. This circular therefore states that the payment should be regarded if expenditure incurred for the purpose of running the business during the period of agreement. An another argument has also been extended that there were series of agreements, however, the know-how initially was acquired out of an agreement dated August 30, 1996. The changes in the provisions of section 32 were made subsequently from the 1st day of April, 1998, therefore not applicable in the case of the assessee. It has been clarified that the agreements executed later on, had in fact, arose out of the original agreements which were in operation since inception of the company. In the light of the factual background, we have scrutinised the case law cited before us. We have noted that in one of the case it was held that if the payment is made for exclusive acquisition of technical know-how, then the expenditure is capital in nature, but if the payment is for securing the use of know-how, then allowable as revenue expenditure. 16. In these decisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncome-tax (Appeals) has looked into the reasonableness of the expenditure. It was noticed by him that in terms of an agreement with FAG OEM Und Handel AG, the assessee was paying royalty/fees at 1.5 per cent. However, during the year under consideration, on account of various agreements the said fees were paid at 3 per cent, on scheduled products and 5 to 8 per cent, on non-scheduled products. As per the Commissioner of Income-tax (Appeals), there was no change in the know-how provided and also there was no change in the products manufactured, therefore there was no reason to enhance the payment of fees. He has quoted that having regard to the fair market value the said payment was excessively made to a specified person. In defence, assessee has submitted as follows: At the time of hearing we were required to give submissions with respect to applicability of the provisions of section 40A(2)(b) of the Act for payments made to group companies on account of royalty. With respect to the same we submit as under. In paper book 2 at pages 45 to 47 we have given the summary of royalty paid under different agreements. We have also attached the summary of royalty payments made for v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red by the Government of India is 5 per cent, for domestic and 8 per cent, for exports sales. In the paper book we have also attached the copy of liberalised industrial policy for foreign technology agreements of the Government of India (see page 295 of paper book 4). On the perusal of the same your kind office would notice that the payments made by the appellant are lower than the rates considered by the Government of India. We, therefore, submit that all payments made on account of royalty are required to be allowed as business deduction. 21. However, the learned Commissioner of Income-tax (Appeals) was not convinced. In his opinion, no cogent reason was given as to why the royalty was enhanced from 1.5 per cent, up to 5 per cent. Rather, he has alleged that the assessee has failed to produce any correspondence between the appellant-company and the said foreign collaborator. According to him, the onus was on the assessee to prove that the price paid was reasonable. The assessee had furnished certain approvals for the payment of the know-how fees but that argument was dismissed by the learned Commissioner of Income-tax (Appeals) on the ground that those approvals were the requ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st 30, 1996. 11. Letter of the RBI for agreement with FAG Rugelfischer Georg Schaefer AG, Germany, dated August 30, 1996. 12. Renewal agreement with FAG Rugelfischer Georg Schaefer AG, Germany, dated August 30, 1996. 13. Approval of SIA for agreement with FAG Rugelfischer Georg AG, Germany, dated June 24, 2002. 14. Letter of the RBI for agreement with FAG Rugelfischer Georg AG, Germany, dated June 24, 2002. 23. For this legal proposition, the learned authorised representative has cited EWAC Alloys Ltd. v. Deputy CIT [1992] 42 ITD 218 (Bom), Anand Dyes Industries P. Ltd.: [1986] 17 ITD 1041 (And); [1986] 25 TTJ (Ahd) 482, Kinetic Honda Motor Ltd. v. Joint CIT [2001] 11 ITD 393 (Pune), Honda Siel Cars India Ltd. v. Asst. CIT [2007] 109 ITD 1 (Del), Addl. CIT v. Nestle India Ltd. [2005] 94 TTJ (Del) 53 and CTT v. Shriram Pistons and Rings Ltd. [1990] 181 ITR 230 (Del). 24. From the side of the Revenue the learned Departmental representative Mr. Rabindra Kumar has placed reliance on the reasoning assigned by the first appellate authority for invocation of the provisions of section 40A(2)(b). His first vehement objection was that a new plea has been raised by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... their respective arguments suggested in a way that since the Assessing Officer had disallowed the claim on different footing therefore he had no occasion to proceed on the lines of the requirement of section 40A(2) (b). On account of these facts, we are of the view that the applicability of the provisions of section 40A(2)(b) in the present set of facts and circumstances can be decided if the Assessing Officer forms an opinion that such expenditure is excessive having regard to the fair market value of the facility enjoyed by the assessee. As far as the onus to demonstrate the reasonableness of the payment, the assessee has already cited few clauses of the agreement explaining the legitimate need of the business and now the onus has shifted on the revenue to place on record the reason with evidence as to how the impugned payment was excessive or unreasonable. Merely comparing the agreements of the assessee is not enough in our opinion because that plea may not stand in the eye of law having regard to the fact that the agreements were revised and that were stated to be revised because of legitimate business need. We have made these observations simply to throw certain suggestions, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sue. The assessee has furnished particulars in respect of an expenditure of Rs. 46,58,516 only. Those expenditure were stated to be in respect of following items: (a) Track grinding machine : The assessee explained that Rs. 17,49,762 was incurred for rebuilding of this machine because the machine was very old. (b) Upgradation of C. N. S. machines : It was submitted by the assessee that rebuilding cost of Rs. 18,25,018 was incurred for upgradation of this machine. (c) Super finishing machine : It was submitted by the assessee that rebuilding cost of Rs. 5,51,736 was incurred for upgradation of this machine in order to achieve desired quality and quantity of product. (d) Jotes surface grinder : It was submitted by the assessee that rebuilding cost of Rs. 5,32,000 was incurred for upgradation of this machine in order to achieve desired quality and quantity of product. 29. The main allegation of the Assessing Officer was that in fact the assessee had not furnished particulars of repairing work carried out. A one sentence clarification was given that the expenditure was towards repairs. The Assessing Officer has also discussed the basic princ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pages 211 to 289, the assessee has furnished certain details of the bills of repairs and details of replacement of furnace. The assessee was under strict obligation to furnish the proof and evidence in support of the repairs and replacement of furnace. A passing remark was made before us that the assessment order under consideration was passed on March 30, 2004 and might be because of the time barring assessment procedure those details were not scrutinised by the Assessing Officer or the assessee might have prevented by inadequate opportunity to place those details. Therefore, we are of the view that the natural justice demands to provide an opportunity to this assessee to furnish full details along with bills and vouchers to demonstrate the nature of expenditure incurred; before the Assessing Officer, so that after proper investigation about the nature of expenditure can be determined. With these observations, these two grounds of the assessee being restored back for de novo adjudication, hence may be treated as allowed but for statistical purposes. 32. Ground No. 5 reads as under: 5. The learned Commissioner of Income-tax (Appeals) erred in fact and in law in confirming t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Expenditure on replacing and fixing tiles 2,95,330/- (b) Construction of shed 2,46,739/- (c) Expenditure on expansion of Tool room 12,55,771/- (d) Oil quaker coolant plant 9,63,000/- TOTAL 27,60,840/- 36. Before the learned Commissioner of Income-tax (Appeals) it was contested to allow the claim, however, in respect of expenditure on tiles and an expenditure on coolant plant was held as revenue expenditure, however, in respect of construction of sheds an expenditure on tool room was held as capital expenditure. It is informed that both sides are in appeals against the said part relief. 37. We have heard both sides. As far as the assessees appeal is concerned the amount contested before us is Rs. 2,46,739 towards construction of shed and Rs. 12,55,771 towards expenditure on tool room, totalling to Rs. 15,02,510. We have also examined the nature of repairs incurred by the assessee. Some of the expenditure was for replacement o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... debts. The learned Commissioner of Income-tax (Appeals) erred in fact and in law in not allowing the deduction of sundry balances written off on the ground that the same is allowable as trading loss under section 28(iv) or business expenditure under section 37(1) of the Act. 44. The assessee has claimed a deduction of Rs. 7,13,677 as writing off debit balances of creditors. As per the Assessing Officer, mere writing off the outstanding debtors in the books of account did not mean that the claim is allowable as deduction. As per the Assessing Officer, in terms of section 36(1)(vii) a debt must become bad for eligible allowance. Against the said addition, the assessee has challenged before the learned Commissioner of Income-tax (Appeals) who has affirmed the action of the Assessing Officer. 45. Having heard the submissions of both sides, we are of the view that the issue now stood covered by T. R. F. Ltd. v. CIT [2010] 323 ITR 397 (SC). Respectfully following the decision this ground is hereby allowed. 46 Ground No. 9 reads as under: 9. The learned Commissioner of Income-tax (Appeals) erred in fact and in law in confirming the action of the Assessing Officer in cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt case, royalties etc., (payable to FAG Rugelfischer AG under agreement dated May 21, 1998) arising out of the agreement dated August 30, 1996 would automatically exclude themselves. In respect of the agreement dated December 21, 2000 with FAG Industrial Bearings AG, the royalty therefrom essentially arose out of the original agreement of July 25, 1994, but were merely assigned, on account of organisational restructuring at the collaborators end. In other words, the acquisition if any of the know-how came along with the 1994 agreement and not those of 2000. 53. In respect of other agreement with FAG OEM Und Handel AG, the details were as follows: (i) Agreement with FAG OEM Und Handel AG, Germany dated December 21, 2000 The original agreement with FAG Rugelfischer Georg Schaefer AG, Germany was executed in August, 1979, which was renewed on February 3, 1989 and July 25, 1994. Due to the group reorganisation, the next agreement was entered into with FAG OEM Und Handel AG Germany on February 24, 2000 (which was renewal of agreement dated July 25, 1994) and again on December 21, 2000 with FAG Industrial Bearings AG (renewal of agreement dated February 24, 2000). It was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and in law, the learned Commissioner of Income-tax (Appeals), Baroda has erred in-- IV. deleting the disallowance of Rs. 83,14,354 on account of operating and licence fee for use of SAP R3 software. 58. While allowing this ground, the learned Commissioner of Income-tax (Appeals) has observed as follows: 12.3 I have carefully considered the facts of the case and the appellants submission. During the year, the assessee has not paid any sum for acquiring the software or for further upgradation. The entire expenses of Rs. 83,14,354 consists of monthly payments for DM 32,282.50. This expenditure is towards monthly charges of 74 IDs used by the assessee. By making monthly payments, the assessee got advantage of using the facility for one month only and therefore, these payments cannot be said to have given advantage of enduring nature to the assessee. The assessee has also not acquired any capital asset. The expenditure is in the feature of user charges only and therefore, cannot be treated as capital expenditure. The licence fee paid by the assessee is not a one-time fee giving the assessee licence to use the software for prescribed number of years. The fee, which the asse ..... 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