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Acc-vickers Babcock Ltd. Vs. Commissioner of Income-tax, Bombay City Ii - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberIncome-tax Reference No. 59 of 1972
Judge
Reported in[1976]103ITR321(Bom)
ActsIncome Tax Act, 1961 - Sections 30, 31, 32, 33, 34, 35, 36, 37(1) and 37(2)
AppellantAcc-vickers Babcock Ltd.
RespondentCommissioner of Income-tax, Bombay City Ii
Appellant AdvocateR.J. Kolah, Adv.
Respondent AdvocateR.J. Joshi, Adv.
Excerpt:
(i) direct taxation - deduction - sections 30, 31, 32, 33, 34, 35, 36, 37 (1) and 37 (2) of income tax act, 1961 - whether assessee-company entitled to deduction of rs. 47602 being expenditure of revenue nature - amount represented payment of first installment for purpose of securing licence and technical know-how including designs, drawings and other technical information to enable assessee to manufacture and sell equipments - payment made for benefit of entire technical know how agreed to be made available to assessee to enable it to manufacture and sell listed equipment so that assessee could earn profits - expenditure related to carrying on of business will be regarded as integral part of profit making process - held, expenditure revenue in nature. (ii) entertainment allowance -.....tulzapurkar, j. 1. three questions of law arising out of the tribunal's order dated 28th october, 1970, have been referred to this court for our determination and out of these three questions the third questions is covered by the decision of the supreme court in challapalli sugars ltd. v. commissioner of income-tax : [1975]98itr167(sc) and has to be answered in the affirmative, in favour of the assessee. the question is : 'whether, on the facts and in the circumstances of the case, the assessee was entitled to treat the sum of rs. 2,64,167, being the amount of interest paid on moneys borrowed, as part of the actual cost for the purpose of depreciation and development rebate ?' in view of the supreme court decision mentioned above, we answer that question in the affirmative, in favour of.....
Judgment:

Tulzapurkar, J.

1. Three questions of law arising out of the Tribunal's order dated 28th October, 1970, have been referred to this court for our determination and out of these three questions the third questions is covered by the decision of the Supreme Court in Challapalli Sugars Ltd. v. Commissioner of Income-tax : [1975]98ITR167(SC) and has to be answered in the affirmative, in favour of the assessee. The question is : 'whether, on the facts and in the circumstances of the case, the assessee was entitled to treat the sum of Rs. 2,64,167, being the amount of interest paid on moneys borrowed, as part of the actual cost for the purpose of depreciation and development rebate ?' In view of the Supreme Court decision mentioned above, we answer that question in the affirmative, in favour of the assessee.

2. The remaining two question which were hotly debated at the Bar run as follows :

'(1) Whether, on the facts and in the circumstances of the case, and on a proper construction of the agreement dated 24th July, 1961, between the assessee-company and M/s. Fuller & Co., U.S.A., the assessee-company is entitled to a deduction of the sum of Rs. 47,602, as being expenses of a revenue nature

(2) Whether, on the facts and in the circumstances of the case, and on a proper construction of the applicable provisions of the INcome-tax Act, 1961, the assessee-company is entitled to an allowance of Rs. 36,446, being the aggregate of Rs. 9,128, for hotel bills for lodging and boarding for guests in hotel and Rs. 27,318, for catering of guests ?'

3. The facts relevant for the purpose of the first question may be stated thus : The assessee-company (M/s. ACC-Vickers Babcock Ltd., Bombay) was incorporated on 16th January, 1959, with the object, inter alia, to carry on business as manufacturers of and dealers in Cement Making Machinery, Coal Mining Machinery, Earth Moving Machinery, Gears and Ancillaries and equipment of all kinds, etc. The question relates to the assessment year 1962-63, the relevant financial year being 1961-62. On July 24, 1961, the assessee-company entered into an agreement with M/s. Fuller Company, U.S.A. (hereinafter referred to as 'Fuller'), with a view to secure a licence and all the necessary know-how, designs, drawings, specifications and other technical information to enable it to manufacture or have manufactured 'Fuller' equipment and processes. Clauses 2,3,4,10,12, and 13 of this agreement are material. Under clause 2 Fuller granted to the assessee the exclusive right and licence to manufacture in India and to sell and use in India the machinery and equipment more particularly set out in that clause; (about 11 items have been set out). Under clause 3 Fuller granted to the assessee-company the non-exclusive right and licence to sell the machinery and equipment (items specified in clause 2) manufactured in India, in the countries of Afghanistan, Iran, Iraq, Nepal, Pakistan and Saudi Arabia. Under clause 4 Fuller agreed 'to furnish to AVB (assessee-company) detailed information, designs, technical and engineering know-how and drawings, necessary to permit AVB to manufacture, or to have manufactured by ACC, and sell the equipment contemplated herein efficiently; and to keep AVB currently informed of improvements of the equipment during the term of this agreement'. Under clause 8 Fuller also agreed to supply to the assessee-company in future from time to time any and all information in its possession on the equipment contemplated under the agreement including prints of drawings of equipment manufactured and sold by it together with engineering data and information as to its experience and performances and operation of said equipment, all of which were to be regarded as part of the agreement. Under clause 13 the agreement was to be effective for a period of 10 (ten) years from 1st April, 1962, and was agreed to be extended by periods of five years unless written notice of 6 months for termination was given by either party. Under clause 12 it was provided that the assessee-company shall keep confidential all information, designs and engineering information supplied by Fuller relating to the equipment covered by the agreement and shall not release details thereof to any third parties except to A.C.C. as its sub-manufacturers who were obliged to produce such equipment for the assessee-company only; the assessee further agreed to return the said information to Fuller at the termination of the agreement and to cease the manufacture and sale of such equipment of the Fuller design for a period of 3 years after the termination date. It was further agreed that the equipment covered by the agreement shall bear the name of Fuller and legally proper patent notices but may also carry the name of the assessee-company as manufacturer and /or licensee of Fuller in the countries mentioned in the agreement. Clause 10 made a provision for payments which were to be made by the assessee-company to Fuller in consideration for the technical and manufacturing information given by Fuller to the assessee-company and the right and licence for manufacture and sell the Fuller equipment; that clause, so far as is material, runs as follows :

'10. In consideration for the technical and manufacturing information given by FULLER to AVB and the right and licence for manufacture and sell the FULLER : equipment listed herein, the following payments shall be made to FULLER :- a)A lump sum payment of 1,00,000 (one hundred thousand) U.S. dollars, free of Indian taxes for the supply of detailed manufacturing and constructional drawings, technical information and specifications and designs, manufacture, sales and servicing know-how in respect of the standard range and sizes of all the Fuller Products listed in the Agreement to be paid at the rate of 10,000 U.S. dollars per year for 10 years, the first payment being made on 1st October 1961........ '.

4. In view of this agreement the assessee-company paid the sum of Rs. 47,602 on account of the 1st instalment of 10,000 dollars as per sub-clause (a) of clause 10 of the agreement to Fuller during the year of account and it claimed this amount as allowable deduction under section 37(1) of the Income-tax Act, 1961. The Income-tax Officer disallowed the claim on the ground that the payment of Rs. 47,602 was of a capital nature. The Appellate Assistant Commissioner confirmed the order of the Income-tax Officer and the matter was carried in second appeal to the Appellate Tribunal by the assessee and it was contended that the aforesaid payment was for the use of technical know-how supplied by Fuller and as such was of revenue nature. Reliance was placed on the Supreme Court judgment in Commissioner of Income-tax v. Ciba of India Ltd. : [1968]69ITR692(SC) . On behalf of the department it was contended that the present case was distinguishable from Ciba's case : [1968]69ITR692(SC) which was decided by the Supreme Court and it was urged that the facts in the present case were more akin to the facts which obtained in the case of Mysore Kirloskar Ltd. v. Commissioner of Income-tax : [1968]67ITR23(KAR) , where the payment of Rs. 26,713, for acquiring know-how for the manufacture of either Herbert No. 4 Capstan lathes or Herbert No. 7B Combination Turret lathes was held to be of a capital nature. The Tribunal after considering the rival submissions that were put before it sustained the disallowance on the ground that the fact in the instant case were distinguishable from the facts that obtained in Ciba's case which was decided by the Supreme Court in : [1968]69ITR692(SC) . The Tribunal took the view that the object of the agreement in question was to obtain the exclusive right and licence to manufacture in India certain machinery and equipment as per the agreement and that this right was different from the object of technical assistance in Ciba's case. It also took the view that in the instant case there was a transfer of the fruits of the research, inasmuch as the necessary know-how, designs, drawing, specification and technical information which were in the possession of fuller were passed on to the assessee-company. At the instance of the assessee, therefore, the first question mentioned above has been referred to this court by the Tribunal for determination.

5. The principles on the basis of which the question whether a particular expenditure is capital expenditure or revenue expenditure could be decided have been discussed by the Supreme Court in Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax : [1955]27ITR34(SC) , where Justice Bhagwati approved the principles laid down by a Full Bench of the Lahore High Court in In re Benarsidas Jagannath as the true and correct principles for the purpose of deciding that question. At page 45 of the report this is what the Supreme Court has observed :

'This synthesis attempted by the Full Bench of the Lahore High Court truly enunciates the principles which emerge from the authorities. In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement o f 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 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. 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 the 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.'

6. The aforesaid principle enunciated by the Supreme Court was again reiterated by the Calcutta High Court in the case of Commissioner of Income-tax v. Aluminium Corporation of India Ltd. : [1973]92ITR563(Cal) . The relevant head-note where the principle has been summarised runs as follows :

'Whether a particular expenditure is a capital expenditure or revenue expenditure should be judged by applying the correct legal principles from a commercial point of view. One of the primary rules for determining whether an expenditure is of a revenue or capital nature is to ascertain the purpose for which it is incurred. If the expenditure is so related to the carrying on or the conduct of the business that it might be regarded as an integral part of the profit making process it should be held to be revenue expenditure. If the purpose is the acquisition of an asset or a right of a permanent character, the possession whereof is a condition precedent to the commencement or continuance of the business, the expenditure would be of a capital nature.'

7. The question which we will have to consider is whether the particular expenditure of Rs. 47,602 which was incurred by the assessee for making payment of the first instalment to Fuller in terms of sub-clause (a) of clause 10 of the agreement was for the purpose of acquisition of an asset or a right of permanent character, the possession whereof was a condition precedent to the continuance of its business or the same was so related to the carrying on of the business so that it might be regarded as an integral part of the profit making process In other words, the aim and object or the purpose of the expenditure would be determinative of the question. Therefore, it will be necessary to consider the relevant clauses of the agreement dated 24th July, 1961, and the surrounding circumstances. In the first place, it must be pointed out that the assessee-company was incorporated as early as on January 16, 1959, that the main object with which it was incorporated was to carry on business as manufactures of and dealers in cement making machinery, coal mining machinery, earth moving machinery, gear and ancillaries and equipment of all kinds, etc., and that long before the agreement in question the assessee-company had gone into production and while it was carrying on its business of manufacturing different types of machineries it entered into the agreement with M/s. Fuller & Company. The aim or object of the agreement has been clearly indicated by the preamble to the agreement which shows that Fuller owned various designs, specifications and maintained a staff of engineers with expert knowledge and know-how, all having to do with the design, manufacture, installation, operation and sale of a variety of industrial and processing equipment and involving inventions comprising the subject-matter of patent rights and pending or proposed patent application owned or controlled by it and the assessee was desirous of securing from Fuller a licence and all the necessary know-how, designs, drawings, specifications and other technical information to enable it to manufacture or have manufactured and sell such equipment and processes. The operative part of the agreement carried into effect the aforesaid object indicated in the preamble, for, under the operative part, Fuller granted to the assessee the exclusive right and licence to manufacture and sell and use in India certain types of machinery and equipment (being 11 items specified in clause 2) and Fuller further granted to the assessee non-exclusive right and licence to sell the aforesaid items of machinery and equipment manufactured in India in the countries of Afghanistan, Iran, Iraq, Nepal, Pakistan and Saudi Arabia (clauses 2 and 3 of the agreement). To enable the assessee to effectively use the licence and the right so granted, Fuller agreed to furnish to the assessee detailed information, designs, technical and engineering know-how and drawings, necessary to permit the assessee to manufacture or to have manufactured by it and sell the equipment contemplated under the agreement and to sell the same efficiently (clause 4 of the agreement). Under clause 8 Fuller further agreed to supply in future to the assessee from time to time any and all information in its possession on the equipment contemplated under the agreement, including prints of drawings equipment manufactured and sold by it, together with engineering data and information as to its experience and performances and operation of the said equipment, all of which were declared to be part of the agreement; reciprocal obligation was also cast upon the assessee to furnish to Fuller the same information which the assessee may develop or acquire, all of which was also regarded as part of the agreement. In other words, both the parties agreed to disclose promptly to one another all inventions or improvements in design made by them or their employees or which they may acquire respecting such equipment. The purpose of the expenditure agreed to be incurred under the agreement by the assessee, particularly the one under sub-clause (a) of clause 10, has been clearly indicated in clause 10. It has been expressly stated in the opening words of clause 10 that all the payments referred to in sub-clauses (a) to (d) thereof have been agreed to be made 'in consideration for the technical and manufacturing information given by Fuller to AVB (the assessee) and the right and licence for manufacture and sell the Fuller equipment listed herein'; under sub-clause (a) the payment of 1,00,000 U.S. dollars per year-for 10 years-is expressly stated to be 'for the supply of detailed manufacturing and constructional drawings, technical information and specifications and designs, manufacture, sales and servicing know-how in respect of the standard range and sizes of all the Fuller products listed in the agreement'. The other salient features of the agreement are : (a) the agreement was to remain in operation for a period of 10 years which could be extended by periods of five years unless 6 months' written notice terminating the same was given by either party to the other; (b) the assessee was required to keep confidential all information, designs and engineering information supplied by Fuller relating to the equipment covered by the agreement and the assessee was not to release details thereof to any third parties expect to A.C.C. who were its sub-manufacturers and were obligated to produce such equipment for the assessee only,(c) there was further obligation cast upon the assessee to return the said information to Fuller at the termination of the agreement and to cease the manufacture and sale of such equipment of the Fuller design for a period of three years after the termination date, and (d) the equipment covered by the agreement was to bear the name of the Fuller and legally proper patent notices but could also carry the name of the assessee as manufacturer and/or licensee of Fuller in the said countries.

8. Having regard to various clauses of the agreement in question and the salient features thereof as indicated above, it seems to us quite clear that the expenditure of 1,00,000 U.S. dollars payable in yearly instalments of 10,000 U.S. dollars for ten years was clearly for the purpose of securing from Fuller a licence and all necessary technical know-how including designs, drawings, specifications and other technical information to enable the assessee to manufacture and sell the equipments listed in the agreement. In other words, the payment was for the benefit of the entire technical know-how agreed to be made available to the assessee to enable it to manufacture and sell the listed equipment so that the assessee could earn profits. The expenditure was thus so related to the carrying on of the business that it will have to be regarded as an integral part of the profit making process and there does not appear to be any indication that the payments undertaken to be made by the assessee under the agreement, particularly under sub-clause (a) of clause 10, was for the purpose of acquisition of an asset or a right of a permanent character, the possession whereof was a condition precedent to the continuance of its business.

9. Turning to the decided cases, we shall first refer to the Supreme Court decision in Ciba's case : [1968]69ITR692(SC) and we may observe at the outset, as has been rightly pointed out by Mr. Kolah, that some of the clauses and features of the agreement in that case are very much similar or akin to those obtaining in the agreement before us. In Ciba's case : [1968]69ITR692(SC) , the assessee, an Indian company (a subsidiary of a Swiss company, Ciba Ltd. of Basle), entered into an agreement dated December 17, 1949, with Ciba Basle under which the Swiss company undertook to deliver to the assessee all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of products discovered and developed in the Swiss company's laboratories and to forward to the assessee as far as possible all scientific and bibliographic information, pamphlets or drafts which might be useful to introduce licensed preparations and to promote their sale in India. It granted to the assessee full and sole right and licence under the patent listed in the agreement to make, use, exercise and vend the inventions specified 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 products 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 sublicenses 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 Swiss company all copies of information, scientific data or material sent to it and to refrain from communicating any such information, scientific data or material sent to it and to refrain from communicating any such information, scientific data or material received by it to any person. The court further noticed that the agreement was to be in force for a period of 5 years from 1st January, 1948, and was liable to cancellation by either party if the other party failed to perform or observe the provisions of the agreement by giving it 3 months' notice. By a subsequent agreement the contribution payable was reduced from 10% to 6% of the net selling price of the pharmaceuticals. On the question whether the contribution other than that part paid as royalties (royalties having been allowed as a deduction) was admissible as an allowance either under section 10(2)(xii) or under section 10(2)(xv) of the Indian Income-tax Act, 1922, the court held that the contribution was not allowable under section 10(2)(xii) as expenditure laid out or expended on scientific research but the contribution was allowable as business expenditure under section 10(2) (xv). It may be stated that the court took the view that secret process had not been sold by the Swiss company to the assessee, that the assessee did not become entitled, even during the period of the agreement, to the patents and trade marks of the Swiss company but it had merely access to the technical knowledge and experience in the pharmaceutical field which the Swiss company commanded, and the assessee was on that account a mere licensee for a limited period of the technical knowledge of the Swiss company with the right to use the patents and trade marks of that company. What the assessee acquired under the agreement was 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. For this view the court principally relied upon certain features of the agreement, namely that it was for a period of 5 years liable to be terminated earlier in certain events, that the assessee had agreed not to divulge to third parties any confidential information received under the agreement without the consent of the Swiss company as well as not to assign the benefit of the agreement or grant sublicenses of the patents and trade marks without the written consent of the Swiss company and it further agreed to cease to use the patents and trade marks and to return to the Swiss company all copies of information, scientific data or material sent to it under the agreement and to refrain from publishing any such information. It is not possible to accept the Tribunal's view that the object of the agreement in Ciba's case : [1968]69ITR692(SC) . It must be pointed that as in Ciba's case : [1968]69ITR692(SC) , the object of the agreement in the instant case also was to secure from Fuller a licence and all the necessary know-how, designs, drawings, specifications and other technical information to enable the assessee to manufacture and sell engineering goods of Fuller design-equipments listed in the agreement. The detailed manufacturing and structural drawings, technical information, specifications and drawing, manufacturing and servicing know-how in respect of engineering goods undertaken to be supplied by Fuller to the assessee in this case could be easily compared to the processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of pharmaceutical products that were undertaken to be delivered by the Swiss company to the assessee in Ciba's case : [1968]69ITR692(SC) . It is true that in this case Fuller had agreed to make available to the assessee the fruits of the research inasmuch as the necessary know-how, designs, drawings, specifications and technical information in their possession was to be passed on to the assessee but that was so in Ciba's case : [1968]69ITR692(SC) also where in fact the Swiss company had agreed to communicate the results of its research work in consideration of the payment of a 'technical and research contribution'. Further, as under the agreement in Ciba's case : [1968]69ITR692(SC) , in the instant case also the assessee agreed to keep confidential all information, designs and engineering information supplied by Fuller relating to the equipment covered by the agreement and not to release details thereof to any third parties except to A.C.C. who were its sub-manufacturers and who were obligated to produce such equipment for the assessee only. Moreover, as was the case in Ciba, the assessee in the case agreed to return the information to Fuller upon termination of the agreement and to cease to manufacture and sell such equipment of Fuller design for a particular period. Two distinguishing features were pointed out Mr. Joshi appearing for the revenue. He first pointed out that the agreement in Ciba's case : [1968]69ITR692(SC) was for a period of 5 years only and was liable to be terminated earlier in certain events whereas the agreement in the instant case is for a period of 10 years and is liable to be extended for further periods of 5 years until the same is terminated by 6 months' written notice given by one party to the other. In our view, the duration of the agreement cannot be decisive of the matter. Secondly, it was pointed out by Mr. Joshi that under clause 12 of the agreement in question an obligation has been cast upon the assessee after the termination of the agreement to cease to manufacture and sell equipments of Fuller design for a period of 3 years after the termination date, which means that it may be open to the assessee to indulge in the manufacture and sale of such equipments after the expiry of the said period of 3 years. It is true that the position which obtained in Ciba's case : [1968]69ITR692(SC) in this respect was different. But even then it cannot be forgotten that along with this particular obligation which is cast upon the assessee under clause 12 of the agreement, that clause further casts an obligation upon the assessee to return all the information and technical know-how to Fuller at the termination of the agreement. In other words, it is quite clear that the parties thought that by imposing an obligation upon the assessee to return all the information, which the assessee had received from Fuller and which the assessee was called upon to keep confidential throughout the period of the agreement, the period of 3 years after the termination date was regarded as sufficient during which the assessee should cease to manufacture and sell equipments of Fuller design. In any case, such a term, in our view, is no indication of Fuller having transferred any asset or a right of a permanent character to the assessee. The two points of distinction, which were sought to be pressed by Mr. Joshi, are not, in our view, sufficient to take the present case out of the ratio of the Supreme Court's decision in Ciba's case : [1968]69ITR692(SC) . As stated earlier, the object of the agreement and the purpose of the expenditure incurred thereunder by the assessee would be determinative of the question and we have already pointed out above that the object of the agreement was to secure form Fuller a licence and all the necessary know-how, designs, drawings, specifications and other technical information to enable the assessee to man

10. Manufacture and sell engineering equipments of Fuller design-equipments listed in the agreement and the purpose of the expenditure incurred under clause 10 (a) was to have the benefit of the entire technical know-how so that the assessee could effectively use the licence granted to manufacture and sell the said equipments exclusively in India and non-exclusively in other specified countries and earn profits in the usual course of carrying on its business. The expenditure is so related to the carrying on of the business that it will have to be regarded as an integral part of the assessee's profit making process and hence revenue in nature.

11. Mr. Joshi then relied upon two decisions, one of the Mysore High Court in Mysore Kirloskar Ltd. v. Commissioner of Income-tax : [1968]67ITR23(KAR) and the other of Andhra Pradesh High Court in Hylam Ltd. v. Commissioner of Income-tax : [1973]87ITR310(AP) . In our view, both these cases are clearly distinguishable and the instant case cannot be compared with either of the two decisions. In the first mentioned case, for manufacturing Capstan and Turret lathes of particular designs, the assessee, Mysore Kirloskar Ltd., had entered into an agreement with H on August 1, 1958, which was to last for 15 years and under the agreement H was to provide the assessee with manufacturing technique, drawings specifications, etc., from time to time and also supply special tools at agreed prices. The articles manufactured by the assessee were to be sold under the trade mark HK. On the execution of the agreement the assessee was to pay to H in respect of 'know-how' to be supplied Pounds 1,000 in respect of the Herbert No. 4 Capstan lathes and Pounds 1,000 in respect of the Herbert No. 7B Combination Turret lathes. In pursuance of this agreement the assessee paid to H during the relevant year two sums of Pounds 1,000 each, i.e., Rs. 26,713, and the question was whether the expenditure that was incurred in making these two payments was a capital expenditure or a revenue expenditure. The Mysore High Court took the view that as the 'know-how' in question was to be utilised not for the purpose of manufacturing any machine that the assessee was already manufacturing but for the purpose of bringing into production new types of machines solely on the basis of 'know-how' supplied by H and the 'know-how' was to become the property of the assessee at the end of the period of agreement, the sum of Rs. 26,713 was properly disallowed as a capital expenditure. It is true that the decision has been rested on two grounds : (1) that the 'know-how' was to be utilised for the purpose of bringing into production new types of machines and was not to be utilised for the purpose of manufacturing any machine that the assessee was already manufacturing, and (2) that the 'know-how' was to become the property of the assessee at the end of the period of agreement. In our view, the second ground on which the decision has been rested is clearly distinguishable from the facts in the instant case. In other words, it is quite clear that in that case the technical know-how was not merely made available by a foreign company to the assessee during the period of the agreement but was actually sold by the foreign company to the assessee-company as the same was to become the property of the assessee at the end of the period of agreement. In the instant case there is no such thing as the technical know-how having been sold by Fuller to the assessee-company. In the other case decided by the Andhra Pradesh High Court (Hylam Ltd. v. Commissioner of Income-tax : [1973]87ITR310(AP) there were two types of payments made by the assessee to the foreign company; one payment was in the nature of royalty and the other was by way of consultation fees and as regards payments made by the assessee towards royalty, the Andhra Pradesh High Court took the view that the payments were of a capital nature and inadmissible as deductions in the computation of the assessee's business income for the relevant years. We are not concerned with the other type of payments made, namely, payments made as and by way of consultation fees. The decision about royalties was rested on the ground that the acquisition of knowledge in respect of a new product, although allied in nature to the products that were already being manufactured by the assessee, would amount to the acquisition of an advantage or an asset for the extension of the assessee's business. It is true that the court took the view that the payments made by the assessee towards royalty were of capital nature principally because by making those payments knowledge in respect of a new product has been acquired and, therefore, the expenditure was by way of acquiring an advantage or an asset for the extension of the assessee's business and the decision of the Supreme Court in Ciba's case : [1968]69ITR692(SC) , was distinguished in these terms :

'There are marked and significant facts in this case which distinguish it from the Ciba's case : [1968]69ITR692(SC) . In Ciba's case : [1968]69ITR692(SC) , the technical 'know-how' was with regard to the same products which the Ciba company was already manufacturing. In the case before us, the special knowledge relates to a new product which the assessee-company was not hitherto manufacturing. In Ciba's case : [1968]69ITR692(SC) , after the expiry of the agreed period, the special knowledge, scientific data and the material relating to it had to be returned to the Swiss company. In the case before us, there is no such clause; if the special knowledge imparted by the English company, which is their asset, does not revert back to the giver of that special knowledge, it cannot be said that the expenditure incurred over it is of a revenue nature. Moreover, in Ciba's case : [1968]69ITR692(SC) , 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 re-grants thereof. Another distinguishing feature in this case is that after the payments reach Pounds 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 Pounds 5,000 has been paid whereas in Ciba's case : [1968]69ITR692(SC) , no price as such had been fixed for the user of the special knowledge for the entire period of licence or use.'

12. It will appear clear that the Andhra Pradesh High Court distinguished the case before it from Ciba's case : [1968]69ITR692(SC) on three or four grounds and though the first ground of distinction may not bear scrutiny, the last two points of distinction indicated by the court were really material and significant on the basis of which Ciba's decision could be validly distinguished. With respect, we may point out that in Ciba's case : [1968]69ITR692(SC) , the technical 'know-how' was not merely with regard to the same products which Ciba India was already manufacturing but the technical 'know-how' was also to extend to new products which Ciba India were to manufacture after the agreement had come into operation. As such, in our view, the aspect that the technical 'know-how' is supplied for manufacturing a new product, though relevant, would not be decisive of the matter. That apart, it seems to us clear that under the agreement which obtained in the case before the Andhra Pradesh High Court the advantage or the benefit of the user of those patented processed was not only for the unexpired life of those patents but also for the extensions and re-grants thereof. In other words, there was so to say complete transfer of their patents by the English company in favour of the assessee for the whole of the unexpired period of those patents as also extensions and re-grants thereof. What is more, the agreement also provided that after the payment had reached Pounds 5,000 the assessee was not liable to pay any further royalty in respect of those patents for the subsequent unexpired period of those patents. In other words, the parties by implication had settled upon the price of Pounds 5,000 as being the price for the patents which were made available to the assessee-company. In other words, there was a clear indication that the patented processed were actually parted with once and for all by the English company in favour of the assessee. It was in those circumstances that the Andhra Pradesh High Court took the view that the payments as and by way of royalty made by the assessee-company to the English company were in the nature of capital expenditure. In our view, both the decisions on which reliance was placed by Mr. Joshi are clearly distinguishable and the ratio of none of those decisions is applicable to the facts of the present case. In the result, we answer the first question in the affirmative and in favour of the assessee.

13. Turning to the second question, it may be stated that the sum of Rs. 36,446, which was claimed by the assessee as a deductible item under section 37(1) and which was disallowed by the Tribunal, formed part of a larger sum of Rs. 2,78,619 which had been spent by the assessee-company on the inaugural function of the company's heavy engineering works at Durgapur at the hands of the Chief Minister of West Bengal. The Income-tax Officer rejected the entire claim on the ground that the company got an enduring benefit by incurring this expenditure. The Income-tax Officer also observed that the sum of Rs. 36,446 (comprised of Rs. 9,128 and Rs. 27,318) would in any case fall under the category of entertainment expenditure for which the maximum limit admissible was Rs. 5,000 and this ceiling had been exhausted by the amount of Rs. 2,34,678 (separate expenditure on travelling and entertainment debited to installation charges). Before the Appellate Assistant Commissioner a contention was raised that the project launched involved an outlay of more than Rs. 5 crores and the expenditure was incurred to obtain publicity for the project. It was also pointed out that the business was commenced much earlier than the date of the function fixed on 6th February, 1962, and the work-in-progress before that date amounted of Rs. 20,36,310. It was also pointed out that orders received from the different parties amounted to more than Rs. 3 crores. The Appellate Assistant Commissioner accepted the contention of the assessee and held that the expenditure was incidental to the carrying on of the assessee's business and no asset of any enduring benefit came into existence by incurring the same. The matter was carried further by the department in appeal to the Appellate Tribunal and the Tribunal took the view that the expenditure was incurred wholly and exclusively for the purpose of the expenditure was incurred wholly and exclusively for the purpose of the assessee's business, but even so, out of the total expenses of Rs. 2,78,619 two items of Rs. 9,128 (being hotel bills for lodging and boarding of guests in hotels) and Rs. 27,318 (being catering charges of guests) totalling to Rs. 36,446 were obviously incurred by way of entertainment expenditure and as such the same could not be allowed as a deduction under section 37(2) of the Act. The Tribunal took the view that in view of a separate expenditure of Rs. 2,34,678 on travelling and entertainment having been incurred, no further deduction was possible. Mr. Kolah appearing for the assessee contended before us that after all even these two items of Rs. 9,128 and Rs. 27,318 had been incurred in connection with the inaugural function, the expenditure in respect of whole of which has been regarded by the Tribunal as business expenses falling within sub-section (1) of section 37 of the Act. He urged that these two items, though incurred by way of meeting hotel bills for lodging and boarding of guests, should be regarded as publicity expenditure incurred by the assessee in connection with the inaugural function and as such should have been allowed. It is not possible to accept this contention of Mr. Kolah for the simple reason that the provisions of section 37(2) override the provisions contained in sub-section (1), for sub-section (2) commences with a non-obstante clause. Under sub-section (1) of section 37 any expenditure not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession is allowed in computing the income chargeable under the head 'Profits and gains of business or profession'. But under sub-section (2) it has been provided that, notwithstanding anything contained in sub-section (1), no expenditure in the nature of entertainment expenditure shall be allowed beyond certain specified limits. In other words, notwithstanding the fact that the expenditure might have been laid out or expended wholly or exclusively for the purpose of business, if such expenditure is in the nature of 'entertainment expenditure' the same is not to be allowed beyond the specified limit. On the face of it the two items of Rs. 9,128 and Rs. 27,318 were incurred by way of meeting hotel bills for lodging and boarding of guests in hotels and by way of meeting catering charges of guests which are clearly in the nature of entertainment expenditure and obviously under sub-section (2) of section 37 beyond the specified limit of Rs. 5,000 no further deduction can be allowed to the assessee. In our view, therefore, the tribunal was right in taking the view that the expenses of Rs. 36,446 were not allowable as a deduction in computing the profits of the business of the assessee-company. The second question is, therefore, answered in the negative and against the assessee.

14. In view of the fact that on one question the assessee has succeeded and on the other question the department has succeeded, there will be no order as to costs of this reference.


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