V.S. Desai, J.
1. This is a reference under section 66(1) of the Indian Income-tax Act made by the Income-tax Appellate Tribunal at the instance of the Commissioner of Income-tax referring to this court a question of law arising out of its order relating to the assessment of the assessee for the assessment year 1959-60, for which the relevant previous year is the calendar year 1958, which is as follows :
'Whether, on the facts and circumstances of this case, the assessee was entitled to have the sum of Rs. 63,478 received by it under the agreements dated 6th October, 1950, 1st March, 1954, and 23rd April, 1957, for the year 1959-60, set off under section 24(2) against its losses of the past year and carried forwards ?'
2. Although three agreements are mentioned in the question as framed by the Tribunal, the first of them, namely, the agreement dated 6th October, 1950, was superseded by the second agreement dated 1st March, 1954, and was not, therefore, subsisting at the material time. The sum of Rs. 63,478 was received by the assessee in accordance with the terms of the third agreement dated 23rd April, 1957, which was entered into in pursuance of the second agreement. We are, therefore, concerned only with the latter two agreements and more particularly with the last agreement dated 23rd April, 1957. It is not disputed that the assessee has unabsorbed business losses of the past years carried forward to the present assessment year. Its claim to set off the sum of Rs. 63,478 against the said losses was based on the ground that the said sum was its income from business. The claim was disallowed by the Income-tax Officer and the Appellate Assistant Commissioner because both of them took the view that the sum of Rs. 63,478 was not income from business falling under section 10 but it was income from other sources falling under section 12 and consequently was not capable of being allowed to be set off against the unabsorbed business losses of the past years under section 24(2) of the Act. The Tribunal, however, has accepted the claim of the assessee that the sum of Rs. 63,478 represents income from business and has accordingly allowed it to be set off against the carried forward losses. It is not denied that the assessee would be entitled to the set off if the income is from business. The short question to be considered, therefore, is whether the sum of Rs. 63,478 was the assessee's income from business as held by the Tribunal.
3. The assessee, M/s. Cilag Limited, is a foreign company incorporated in Switzerland and carries in the business of amongst other things, development, manufacture and sale of chemical, medical, pharmaceutical, biological, bacteriological and related products and specialities. It has a world trade and also trade in India and in respect of its income subject to the Indian Income-tax Act, it has been assessed in the status of a non-resident. There is an Indian company named 'Cilag Hind Limited', which is a 60% subsidiary of the assessee, incorporated in India with the object of conditioning, manufacturing, treating, refining, importing, exporting, buying and selling, drug, medicines, pharmaceuticals, etc. The three agreements mentioned in the question framed by the Tribunal are the agreements entered into between the assessee and Cilag Hind Ltd. on the respective dates. The first agreement of the 6th October, 1950, and the agreement dated the 1st of March, 1954, which was in suppression of the said agreement, were substantially on the same lines and were entered into with the same objects and purposes in view. Since the first agreement, as we have already pointed out, was superseded by the second agreement, we will refer to the terms of the second agreement only. The said agreement, which was executed on the 1st of March, 1954, stated in its preamble that since Cilag Limited was engaged in the development, manufacture and sale of chemical, medical, pharmaceutical, biological, bacteriological and related products and specialities and since for the purpose of such manufacture Cilag Limited had established, maintained and was continuously developing laboratories for chemical, medical, biological, bacteriological and related research work factory and standardization laboratories and also patent, engineering and propaganda departments and thus had acquired valuable scientific and practical experience enabling it not only to improve already existing products and manufacturing processes, but also to discover new products, etc., and was spending considerable amounts for the maintenance and development of such departments and as Cilag Hind Ltd. was desirous of acquiring the extensive knowledge and practical experience in the pharmaceutical filed that Cilag had acquired by reason of its long and extensive research work and scientific and practical experience which it had acquired in connection with the importation, introduction and distribution of the said products in India and also in other territories to be mutually agreed to between the parties and also for conditioning and manufacture of the same in India, the agreement was being entered into between the parties. Under clause (1) of the agreement, Cilag Hind Ltd. were appointed the authorised importers, distributors, processors and manufacturers of the said products of Cilag Ltd. for the duration of the agreement. Clauses (2), (3) and (4) related to the supply of the products of Cilag Ltd. to Cilag Hind and the price to be paid for by the latter in respect of the same. Under clause (5) Cilag Ltd. agreed to put at the disposal of Cilag Hind Ltd. all their professional knowledge and experience useful in introducing the said products and promoting their sale in India and also to supply to Cilag Hind with the necessary prospectuses and clinical literature, etc. Under clause (6) Cilag Ltd. agreed to supply to Cilag Hind the necessary active substances and furnish adequate conditioning processes, that is, manufacture tables, pills, etc., and also to furnish adequate conditioning processes and formulas and sustain their applicant with all their relevant scientific and technical data, information and experience. The price to be paid by Cilag Hind for the active substances to be supplied was to be as agreed to between the parties. The further clauses of the agreement are more important for the purpose of consideration of the question before us. Under clause (7) it was provided that in order to enable Cilag Hind to manufacture or have manufactured for it the active substances of the said products or any of the said products for it the active substances of the said products or any of the said products in India, Cilag shall grant to Cilag Hind exclusive and non-transferable licences for all Cilag's relevant patents whether protected or not, secret industrial and laboratory procedures for their respective use in India. Cilag shall also grant to Cilag Hind exclusive and non-transferable licences in so far as is permissible in law, to use the relevant trade marks or trade names of Cilag in India. Under clause (8) Cilag agreed to furnish all the necessary construction plans and technical and chemical instructions for the setting up of the required factories, laboratories, industrial apparatuses and installations. By clause (9) Cilag agreed to delegate temporarily their technical and other experts for the supervision of the construction work as well as the setting up of the apparatuses and installations and for the launching of the actual chemical production and to give adequate theoretical and practical training to the Indian personnel of Cilag Hind until they were able to handle the production independently. Cilag also agreed to permit Cilag Hind to delegate its Indian personnel to the manufacturing plant of Cilag for training at the cost of Cilag Hind. Under clause (11) Cilag agreed to make available to Cilag Hind and allow Cilag Hind to participate in all Cilag's future scientific and technical activities and achievements. Cilag Hind on the other hand agreed not to divulge at any time to third parties without the consent of Cilag any of the chemical and technical information supplied to it or made available to it by Cilag and in particular all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture of the said products and to keep the same under lock and key. Cilag Hind also under took that the said products manufactured and conditioned by it in India shall also in all respects conform in quality, presentation and outer appearance to Cilag's regulations and prescriptions. It was also agreed that Cilag should be entitled at any time to request samples of there said products to be sent to it by Cilag Hind for approval of Cilag. It was further agreed that Cilag Hind was to be guided in all respects by Cilag's directions and advices as to the conditions of such samples and the improvements, if any, to be made thereto. Cilag Hind also agreed to permit Cilag's representatives to inspect the plants, installations and laboratories of Cilag Hind and to supervise the manufacturing and conditioning processes, whenever required by Cilag. Under clause (14) Cilag Hind agreed that the imported, manufactured and/or conditioned products in India will be sold, marketed and distributed only under the respective registered trade marks of Cilag and will not be substituted, altered or changed, and Cilag Hind also agreed not to claim any right to the said rights or trade names or the get-up of the said products. Under clause (15) Cilag Hind undertook not to export or re-export any of the products imported by it into India nor export or sell outside its territory any of the products manufactured by or for it and/or conditioned by or for it in India except with the express consent in writing of Cilag. Under clause (16) the duration of the agreement was fixed for an initial period of ten years and if it was not terminated at the end of the said period, it was to continue further and be in force for such period as would be agreed to between the parties. On a termination of the agreement, however, Cilag Hind was to cease to use the trade marks, patents, information, data, formulae, processes, etc., covered by the agreements and shall return to Cilag or such persons as Cilag may appoint in that behalf all the copies of such information, scientific data or material sent to it by Cilag under the agreement or any separate licence agreements and then in its possession, power and control. Clause (12) of the agreement provided for the compensation, fee, royalty or payments which were to be made by Cilag Hind to Cilag for the matters mentioned in clauses 7, 8, 9 and 11. Clause (12) provided that the compensation, fee, royalty or payments to be made by Cilag Hind to Cilag for the grant of licences, and for the giving of such information, processes, formulae, scientific and other technical data as provided for in clauses 7, 8, 9 and 11 shall be mutually agreed to between Cilag and Cilag Hind and the same may be by way of current contribution to the scientific and technical research expenses incurred by Cilag or otherwise. It was further provided that the terms and provisions of such agreements and, in particular, the granting of licences by Cilag to Cilag Hind, their validity and continuity were, wherever possible, to be recorded in separate agreements. The compensation, fee, royalty or payments due to Cilag, it was agreed, was not to exceed 5 per cent. of the net proceeds from sales of the said products manufactured by or for Cilag Hind in India under the licences granted by Cilag, during the first ten years and not to exceed half thereof for the remaining five years of such a licence's validity. It was in pursuance of this clause (12) of the agreement that the agreement of 23rd April, 1957, was entered into between the parties, viz., Cilag Limited and Cilag Hind. This agreement having stated in its preamble that it was being entered into in pursuance of the agreement dated 1st March, 1954, and after having referred to the relevant provisions of the said agreement, stated that whereas Cilag in terms of the said agreement granted to Cilag Hind exclusive and non-transferable licences for all of Cilag's relevant patents, whether protected or not, secret industrial and laboratory processes, formulae, scientific and technical data and assistance in connection with the manufacturein India by Cilag Hind of several active substances and whereas Cilag Hind has with the assistance of such information, processes, formulae, scientific and technical data and assistance commenced manufacture, in India of some active substances and will in due course manufacture other active substances, but no formal agreement has been entered into between the parties as to the compensation, fee, royalty or payments to be made by Cilag Hind to Cilag as aforesaid, the agreement was being entered into for fixing the said compensation, fee, royalty or payments to be made by Cilag Hind to Cilag as aforesaid, the agreement was being entered into for fixing the said compensation, fee, fee, royalty or payments. Under clause (1) of this agreement, Cilag Hind was to pay to Cilag, compensation, fee, royalty or payment in respect of any off the active substances hitherto or now manufactured or that may be manufactured thereafter by Cilag Hind in India with the assistance of such information, processes, formulae, scientific data and assistance equivalent to a net figure of five per cent. of the cost thereof, such cost to be computed on the basis of the cost of the raw materials at the site of the manufacture and the costs of production including manufacturing charges. Clause (2) provided for the method of payment of the said compensation, fee, royalty or payments and clause (3) added that the payment of the royalty fixed shall be made by remittance from India subject to the permission of exchange control authorities in India. The duration of the agreement was fixed at ten years.
4. It will be thus seen that under the agreement dated 1st March, 1954, Cilag Hind was to be the sole importer and distributor of the products of Cilag Limited in India. It was also to be provided by Cilag Ltd., with active substances necessary for the conditioning of the products of Cilag Limited in India. Apart from these two things, Cilag Limited was also to put at the disposal of Cilag Hind its know-how for the manufacture of the active substances and also of its products. The technical know-how and the secret processes which Cilag Limited had acquired because of its extensive knowledge and practical experience and research in the particular field and the patents which it had developed and acquired clearly constituted the commercial assets of Cilag Limited, which it was using in the course of its business of development, manufacture and sale of chemicals, medical, pharmaceutical, biological, bacteriological and related products. Under this agreement of 1st March, 1954, Cilag Limited was granting to Cilag Hind an exclusive and non-transferable licence to use in India Cilag's patents and secret processes for manufacturing the same kind of products. Which Cilag Limited itself was manufacturing. Clauses (3), (9) and (11) provided for the necessary and ancillary held required by Cilag Hind for the purpose of employing the licences granted by Cilag Ltd. in the manufacture and development of Cilag's products in India. The obligations undertaken by Cilag Hind under this agreement show that by the grant of the licences to use the secret processes and patents of Cilag, Cilag was not parting with its commercial trade of manufacture and development of the said products. The secret processes and the technical information supplied by Cilag to Cilag Hind could not be divulged by Cilag Hind to any one else and had to be employed only for the purpose of producing the products of Cilag. On the termination of the agreement, Cilag Hind was to cease to use the patents, trade marks, names, information, data, formulae, processes, etc., covered by the agreement and was to return to Cilag all copies of such information, scientific data or material, etc. Provision was made under the agreement that the manufactured products by Cilag Hind under the licence granted to it had to conform in all respects to the manufactured products of Cilag Limited. And Cilag in that connection was entitled to ascertain and insist upon the same. The goods manufactured had to be sold, marketed and distributed under the registered trade marks of Cilag only and there was no change to be made either in the trade mark or in the trade name, or even in the get-up of the finished products. The goods manufactured by the use of the licences granted were not to be exported outside India except with the permission of Cilag Limited. What has got to be considered is whether having regard to these terms, Cilag Limited was exploiting its commercial assets in carrying on its business or was engaging in an activity, which was other than the activity of its business. The income-tax officer has taken the view that the activity of the assessee was the supply of a technical know-how, which cannot be regarded as an activity of carrying on business. The compensation or the royalty which the assessee received was for the technical advice given by the assessee to the Indian company, which did not constitute its business activity. The income, therefore, which was received by the assessee could not be regarded as business income, but was income received from other sources. The view taken by the Appellate Assistant Commissioner was that the royalty received by the assessee was for the use of its patents and secret information by others and the income received therefrom was not the income from business since it could not be said to be the business of the assessee to supply technical know-how to others.
5. In our opinion, it cannot be said that the supply of know-how by a person, which is using the know-how in his business, to others on a licence basis, cannot be regarded as a method of carrying on his business. As has been pointed out by Romer L. J. in Handley Page v. Butterworth, the patent of a patentee or the secret knowledge possessed by the assessee of a process are both capital assets and both these assets possessed by the possessors thereof are capable of being employed in business in either of two ways, viz., that he can himself exploit the patent or the secret knowledge or process in business for profit or can grant a licence to others to do so on payment of royalty. The profit, which he would derive by exercising the invention or process or the profit the derives from the royalty are profits and gains within the meaning of Schedule D, that is, profits from business. It is no doubt true that parting of the patent or process in favour of a third party may, in certain circumstances, amount to a disposal of a capital asset and not its employment in trade. If, for instance, the secret process is sold away or is surrendered by making it public to the world, the payment which he may receive on the sale of the process or for its disclosure to the world may be a payment received on a disposal of a capital asset and not income from business. What is required to be considered is whether, on the facts and the circumstances of a given case, the licence granted to make use of the patents or the secret information to another was in the nature of parting of an asset or only in the nature of employing it in trade. In the present case, in our opinion, the latter is the true position.
6. Cilag Limited was engaged in the manufacture and development of chemicals, medical, pharmaceutical, biological, bacteriological and related products and specialities. It had carried on extensive research work and was maintaining laboratories for a continuous research and further advancement and improvement. It had its trade all over the world including India. The vast experience, the extensive knowledge and the practical experience in the pharmaceutical field, which Cilag Ltd. had acquired, it was using in its trade. By the present agreement, which it has entered into with Cilag Hind, it was employing its technical knowledge and vast experience for production of its products through the machinery of Cilag Hind in India. Having found that it would be more desirable and practicable in the circumstances which were existing, to set up a machinery in India for the purpose of manufacturing its own products than to trade in India with good brought in from Switzerland. it has entered into the present agreement with Cilag Hind which is a 60% subsidiary of Cilag Ltd. The effect of the terms of the agreement, with which we are concerned, is, in our opinion, that whereas formerly Cilag was trading in India with goods which it had manufactured in Switzerland, it now found it a more convenient and practical way of carrying on its trade to facilitate the production of its own persecutes in India through an Indian subsidiary. It appears from the order of the Tribunal that this is not an isolated instance and agreements like the present one have been entered into by Cilag Ltd., in several other countries. This case, in our opinion, is very similar to the English case of Jeffrey v. Roll-Royce Ltd. The respondent company, which was a manufacturer of aero engines, had acquired a fund of technical knowledge commonly called 'know-how'. During the period 1946 to 1953, it entered into a number of agreements with foreign Governments and companies under which it agreed to supply information necessary to construct certain engines which it had developed and to license the other parties to manufacture these engines in consideration of the payment of a capital sum plus royalties. The question arose as to whether sums received under the agreements should be included as trade receipts. The House of Lords held that the sums in question were receipts on revenue account of the company's trade and fell to be included in the computation of its profits or gains. Viscount Simonds was of the view that the effect of the agreement was that in territories where the company could not how to sell its engines, it was pursuing a wise policy of allowing local manufacture from which it would receive the benefits of advertisement, lump sums and royalties. It was not a case of the company parting with its asset, but of using or trading in them in the only or at least the most advantageous way that was open to it. Lord Radcliffe observed :
'It seems to me that, so long as it kept its 'know-how' to itself, it used it for the manufacture of its own engines, and its value was expressed in the successful sales which it achieved of those products. I dare say that the company would have preferred, ideally, to reserve its 'know-how' solely for the purposes of its own manufacture. I am not sure of that, when I read some of the chairman's speeches at the annual meetings. However that may be, it is clear that it saw that, having the 'know-how', it could derive profit from the manufacture of its engines even by others, in parts of the world where it either could not or would not sell or manufacture them itself, provided only that it equipped those others with the requisite expertise. So it turned the 'know-how' to account by undertaking, for regard, to impart it to the others in order to bring about this alternative form of manufacture.'
7. In our opinion, in the case before us also, Cilag Limited, by the terms agreed to under the contract, has turned its 'know-how' to account by undertaking to allow its use to be made by the Indian company to bring about an alternative form of manufacture of its own products.
8. Mr. Joshi, the learned counsel for the revenue, has argued that the payment, which is made under clauses 2 and 3 of the agreement of 1957, is royalty for the explicit use of the know-how and the technical processes comprised in the licence, patents and trade marks by the Indian company which is carrying on its own business. Such a payment by way of royalty cannot be regarded as income from business, once the business which is carried on is not by the assessee, but by someone else. Moreover, Mr. Joshi says that in the present case before us the quantum of royalty is fixed at 5 per cent. of the cost of production of the articles produced by the use of the process and is not related to the profits made in the business. The assessee, therefore, could not be said to be sharing in the profits of the business of Cilag Hind., Mr. Joshi, therefore, says that the income of royalty received by the assessee could not be considered as business income falling under section 10. In support of his submission that income from royalty cannot be considered as income from business, he has invited our attention to the Privy Council case in Raha Bahadur Kamakshya Narain Singh of Ramgarh v. Commissioner of Income-tax. In our opinion, however, it is not possible to say that because a payment is received as royalty, it could not be an income from business, and we do not think that the case cited by him supports any such proposition. There the case was, that the owner of mines had leased out on royalty basis various mining leases. The leases purported to grant and demise unto the lessees for 999 years the underground coal mining rights specified in the schedule to the leases and all the estate, right, title and interest of the lessor into and upon the same and every part thereof with full liberty and power to the lessees to search for, work, make merchantable and carry away the coal there found and with power to dig and sink pits, to erect engines, machinery, buildings, workshops, cottages and to make such railways, tramways, and roads as are required. In return for these rights the lessees were to pay a sum by way of salami or premium and an annual sum as royalty computed at a certain rate per ton on the amount of coal raised and coke manufactured, subject always to a minimum annual sum. The lessor had the right to render in case of failure to pay the rent or royalties. It was contended on behalf of the assessee that the sums received as salami and royalty did not constitute income but were capital receipts representing the price of the minerals removed. It was held that the royalty amount was income from other sources within the meaning of section 12 of the Act. It may be pointed out that the owner, who granted the leases was not carrying on any business of mining coal. Nor was it anybody's case that the income was income from business. The dispute was whether the receipt was a receipt of a capital nature or of income, and what the Privy Council had to consider was whether it was an item of income or capital. In the context of the facts of the case, Lord Wright observed :
'Royalties cannot be regarded as 'profits or gains' of a business. The sources of the royalties may properly be deemed to be the lessees' covenants to pay them, and hence royalties fall under 'other sources'.'
9. We have no doubt whatsoever that when it was said that royalties cannot be regarded as profits or gains of business, it was not intended to lay down a general proposition that royalties can never be regarded as income from business. It was on the facts of the case that the Privy Council held that it was not possible to regard royalties as income from business. Mr. Joshi has also invited our attention to another English case in Evans Medical Supplies Ltd., v. Moriarty (Inspector of Taxes). In that case Evans Medical Supplies Ltd., which carried on the business of manufacturing chemists and wholesale druggists, entered into an agreement with the Government of Burma by which the company agreed to assist the Government in the establishment of a pharmaceutical industry. under the terms of the agreement the company was to supply technical data and designs for the erection of the factory and the installation of machinery required for the manufacture of the pharmaceutical products. They were also to disclose to the government the secret processes used by them in the preparation, storage and packaging of the various pharmaceutical products, which were of great value to the company, the products themselves being of known composition. These processes had never been disclosed before to anyone else, and during the seven years' currency of the agreement, the company agreed not to disclose them to any one else in Burma. The company was permitted to continue its agency in Burma, but that agency would become of less value as the Burmese Government established their own industry. The consideration for the agreement included a lump sum payment of Pounds 1,00,000. The question was whether this was a capital amount received by the company or an income item. Justice Upjohn held that the amount could not be regarded as a part of the profits or gains of the company in their trade as wholesale druggists. Under the agreement, according to him, the company was not exploiting its business but in and by the agreement it entered into the entirely new activity of acting as advisor of the Burmese Government by assisting to set up a completely new industry there, which involved the disclosure to the Government of secrets never disclosed to anyone before, and also involved the gradual cessation of its wholesale trading activities. In our opinion, the facts of the case are clearly distinguishable. The agreement entered into in that case could in no may be considered as exploitation of the commercial assets of the company in the course of its trade. As a matter of fact, the parting of the know-how in that case had, far from advancing the trade of the assessee, was affecting it adversely. Referring to that case in the case of Jeffrey v. Rolls-Royce Ltd., already referred to, Viscount Simonds observe as follows :
'In the circumstances of that case, regard in particular being had to the fact that the transaction was an isolated one of its kind, the conclusion was inevitable that the so-called capital sum was a receipt of a capital nature.'
10. Lord Reid observed :
'In that case it was held that the company parted with a capital asset and received for it a capital sum. For one thing, it lost its Burmese market. And, further, it was said to be obvious that the capital value of the secret processes must have been greatly diminished by their disclosure to the Burmese Government. Every case of this kind must be decided on its own facts; and, at least in these two respects, that case was very different from the present case. There is also the difference that in that case there was a single transaction, whereas in the present case there was a series of similar transactions.'
11. According to Lord Radcliffe in Evans Medical Supplies' case, the company had sold to the Burmese Government a secret process upon which the success of its business in Burma had to depend and it had, in effect, disposed altogether of its Burmese trade. To do that was to dispose finally of part of its fixed capital, and moneys received in return were not trading receipts.
12. In the present case before us, as we have already pointed out, the assessee, by granting licences to its Indian subsidiary, was neither disposing of its commercial asset nor was it employing it in any way to the detriment of its trade or business. Far from it, on the other hand, it was employing it for the purpose of popularising and furthering the sale of its products in countries where it was not possible or practicable for it to export its products manufactured in Switzerland. In our opinion, therefore, the view taken by the Tribunal is the correct view and the question, therefore, must be answered in favour of the assessee. We accordingly answer it in the affirmative. Commissioner will pay the costs of the assessee.
13. Question answered in the affirmative.