1. This is reference under s. 256(1) of the I.T. Act, 1961, made at the instance of the assessee. The question referred to us for our determination in this reference is as follow :
'Whether, on the facts and in the circumstances of the case, it was rightly held that the payment of Rs. 77,756 made by the assessee to M/s. Grasso of Netherlands was not of a revenue nature and hence not allowable as a deduction ?'
2. Facts giving rise to this references are as follow :
3. The assessee-company was formed to manufacture various types of machinery including air compressors, pneumatic tools and was, at the relevant time, in its fourth year of production. The assessment year in questions is 1962-63, the relevant accounting year being the year ended on March 31, 1962. On January 2, 1962, the assessee entered into an agreement with M/s. Grosso's Koninklijke Machinefabrieken N. V. of Hertogenboach, the Netherlands (hereinafter referred to as 'the said Grasso'). The recitals to the said agreement show that the assessee, which was engaged in the manufacturing of air compressors, desired to extend its business or the manufacture and sale of certain types of industrial refrigerating compressors. As the said Grasso had for over 50 years been engaged in the manufacture of refrigerating compressors, the assessee had requested the said Grasso to provide and make available to the assessee the scientific and technical knowledge and information, know-how, engineering date, calculations, drawings, designs, material specification, experience and continuous development with the benefit of all patents held by the said Grasso in connection with products described in cl. 1 of the said agreement. The objection of the said agreement which has been described in cl. 1 thereof was to enable the assessee to obtain scientific and technical knowledge and so on set out earlier, all of which items have been collectively referred to as 'know-how' in the said clause. This clause makes it clear that the agreement covered the existing know-how relating to the products mentioned in cl. 1 as well as to the accessories and also the continuous benefit of the research and development work carried on in the works of the said Grasso on the know-how of the compressors. The said clause further records, that the said Grasso would generally keep the assessee informed and advised about the progress in the development work from time to time and would convey to the assessee by means of drawings or otherwise alterations and improvement therein from time to time. By cl. 2, the said Grasso granted to the assessee for the territory of India the sole and exclusive rights, licence and privilege to assemble and manufacture the products and to sell in the territory, i.e., in India, the products made by the assessee. Under cl. 3 the said Grasso purported to grant to the assessee the non-exclusive right to export the products made by the assessee to five countries and provided that the export by the assessee to countries other than those specified in the said clause would have to be agreed upon by both the parties. Under cl. 4 the said Grasso undertook to put at the disposal of the assessee with dye observation of cl. 17 of the agreement the know-how of all manufacturing processes of the products specified in cl. 1. Under the said clause, the said Grasso further undertook to make available to the assessee the results of the research and development work and generally all information required to build the said compressors in India on the same manufacturing basis as was done in the works of the said Grasso. Under cl. 5, it was provided that the said agreement was of a limited duration. Clauses 6 provided that neither the assessee nor the said Grasso would be entitled to assign or transfer the said agreement or the benefits thereof or any interest therein to any other person, firm or company without the previous written consent of the other party. By cl. 8 both the parties agreed to give each other a free licence of existing and future patents in the filed of the products mentioned in cl. 1 of the said agreement. By cl. 9, the assessee undertook to start the manufacture of the said products within 15 months after the receipts of the drawings against the payment specified in cl. 17. By cl. 10 the assessee agreed to manufacture the said products generally in accordance with the know-how furnished by the said Grasso. Under cl, 11, the assessee agreed to keep all the know-how relating to the products and the designs and manufacture thereof as strictly confidential and to use them for the purposes for which they were given and not to disclose the same to any person except its own employees or contractors or sub-contractors without the previous written consent of the said Grasso. By cl. 13, the said Grasso undertook to train certain authorised personnel from the assessee and to make available to the assessee competent technical personnel from the works of the said Grasso for the training of the employees of the assessee if necessary. Clause 15 provides that the assessee would use the words or inscription.'LICENSE-GRASSO' on all the products destined for India. The relevant portion of cl, 17, which is directly material for the purpose of this reference, runs as follows :
'(a) The assessee-company will pay to the said Grasso against receipt of drawings covering the products a sum of Hfl. 59,000 (fifty-nine thousand Dutch Guilders), a further sum of Hfl. 28,000 (twenty-eight thousand Dutch Guilders) twelve months after the initial payment of Hfl. 59,000 referred to above has been made and a further sum of Hfl 28,000 (twenty-eight thousand Dutch Guilders) twenty-four months after the initial payment referred to above has been made. These payments will be in full and final payment of the cost of the drawings covering the products and parts thereof which drawings the assessee-company will not have to return 'in the event of termination of the agreement by either side and also in full payment of compensation to the said Grasso for the right to export of the assessee-company to territories as stated in clause 3 thereof'.
(b) For the further development work and technical assistance on the relevant products by the said Grasso, the benefit of which the assessee-company is to receive continuously during the period of the agreement the assessee-company will pay to the said Grasso a technical services fee of 3 per cent, on the 'net proceeds' of the products made and sold by the assessee-company, the fee being subject to Indian taxes, if any.
(c) for the right to use the patents and the inscription 'LICENSE-GRASSO' as described in clause 15, the assessee-company will pay to the said Grasso a royalty of 2% on the 'net proceeds' of sale of the products described in clause 1 hereof made and sold by the assessee-company, the royalty being subject to Indian taxes.'
4. Clauses 19 provides that from the date the assessee commenced the manufacture of any products mentioned in the said agreement, the said Grasso would not directly or indirectly manufacture or sell such products in India with the exception that such produce could be sold and delivered by the said Grasso to India when they were incorporated in compete refrigerating plants or ice factories. Clauses 21 provided that the agreement could be terminated summarily with immediate effect by either of the parties by giving to the other a notice in writing in the circumstances set out in the said clause. The ITO found that the assessee had paid Rs. 82,853 to the said Grasso during the relevant assessment year in pursuance of the said agreement. The assessee claimed the said amount as a deduction in the computation of its chargeable income. The ITO disallowed the said deduction on the ground that the said payment was the initial payment made for acquiring technical know-how, and, therefore, of a capital nature. On an appeal by the assessee to the AAC the AAC held that out of the said sum, a sum of Rs. 4,588 related to the travelling expenses and could be allowed as a deductions. The AAC, however, declined to grant any deduction in respect of the balance amount of Rs. 77,756 on the ground that the said amount was in the nature of payment to the said Grasso in respect of drawings and was in the nature of a capital payment. The assessee then appealed to the Income-tax Appellate Tribunal (referred to hereinafter as 'the Tribunal'). The Tribunal held that the said sum of Rs. 77,756 represented a part of the initial payment to be made under cl. 17(a) of the said agreement. The Tribunal followed the decision of a Divisions Bench of the Karnataka (then Mysore) High Court in the case of Mysore Kirloskar Ltd. v. CIT : 67ITR23(KAR) an held that the said amount did not represent a payment of a revenue nature. On this basis, it disallowed the deduction claimed by the assessee. It is from this decision of the Tribunal that the aforesaid question has been referred to us.
5. The submission of Mr. Inamdar, the learned counsel for the assessee, in that under the said agreement there was no sale of drawings as such and that the entire agreement was a composite agreement regarding the supply of know-how by the said Grasso to the assessee. It was submitted by him that it could not be said that, under the said agreement, the assessee acquired any asset of an during nature and hence no part of the amount paid by the assessee under the said agreement, and, in particulars, the said sum of Rs. 77,756, could be said to be a payment of a capital nature.
6. On the other hand, it was submitted by Mr. Kotwal, the learned counsel for the department, that in the present case, there was a distinct agreement by the assessee for the purchases of the said drawings from the said Grasso, that by such purchase, the assessee acquired an asset of an enduring nature and hence the consideration paid for the same must be regarded as in the nature of a capital expenditure.
7. Before considering the merits of these contentions, it would not be out of place to refer to some of the decision cited by the respective counsel. In Mysore Kirloskar Ltd. v. CIT : 67ITR23(KAR) , relied upon by the Tribunal, it was observed that for manufacturing Capstan and Turret lathes of particular designs, the assessee, Mysore Kirloskar Limited, entered into an agreement with M/s. Alfred Herbert Ltd. (referred to herein as 'Alfred Herbert'). The said agreement was to last for 15 years and Alfrad Herbert was to provide Mysore Kirloskar Ltd. with manufacturing techniques, drawings, specifications, etc., from time to time and also to supply special tools at agreed prices. An employee of Alfred Herbert was to superintend the assessee's factory and manufacture. The articles manufacture by the assessee were to be sold under the trade mark 'Herbert Kirloskar'. On the execution of the agreement, the assessee had to pay to Alfred Herbert, in respect of the know-how supplied, Pound 1,000 in respect of the Herbert No. 4, Capstan lathes and Pound 1,000 in respect of the Herbert No. 7B, Combination Turret lathes. On all the products manufactured, Mysore Kirloskar Ltd., had to pay 7 1/2 per cent. To Alfred Herbert, subject to any deduction of tax payable. Pursuant to the said agreement, the assessee paid to Alfred Herbert during the relevant year two sums of 1,000 each, i.e., Rs. 26,713. The assessee agreed to observe secrecy regarding the information and 'know-how' in supplied to it by Alfred Herbert. It was held 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 in to new types of the machines solely on the basis of 'know-how' supplied by Alfred Herbert and the said 'know-how' was to become the property of the assessee at the end of the period of the agreement the sum of Rs. 26,713 was properly disallowed as a capital expenditure. It is interesting to bear in mind that under cl. 21 of the agreement between the assessee and Alfred Herbert, which has been annexed as annex. E to the statement of the case herein, it is, inter alia, provided that, even on the expiry of the said agreement between the assessee and Alfred Herbert by efflux of time, the assessee would be entitled to manufacture and sell the products comprised in the agreement between the assessee and Alfred Herbert.
8. The aforesaid decision of the Division Bench of the Karnataka (Mysore) High Court had been expressly overruled by the decision of a Full Bench of the same High Court in Mysore kirloskar Ltd. v. CIT : 114ITR443(KAR) . It is pointed out by the Full Bench of the Karnataka (Mysore) High Court that under the agreement in question, no secret process or technical knowledge was sold by the foreign company to the assessee; the period of user was of fifteen years; the object of the agreement was to obtain the benefit of the technical assistance for running the business, he permission was granted to the assessee subject to right actually granted after the date of the agreement by M/s. Alfrad Herbert Ltd., U.K., to other person, though outside India; the assessee was expressly prohibited from divulging the confidential information to third parties; there was no transfer of fruits of research once for all, and the foreign company which are continuously carrying on research had agreed to make it available to the assessee. It was held by the Full Bench that, under the agreement, the assessee acquired merely the right to draw upon the technical knowledge of the foreign company for a limited period, for the purposes of carrying on its business. The foreign company did not part with any of its asserts absolutely for ever or for a limited period of time. It continued to have the right to use its knowledge and, even after the agreement had run their course, its rights in this behalf were not lost. The assessee had not, therefore, acquired any basset or advantage of an enduring nature of the benefit of its business and hence the payments in question were of revenue in nature and were deductible. It was pointed out by the Full Bench that the period of the agreement by itself was not determinative of the nature of the payment made under it. It was observed that, in view of the continuous research in machinery tool industry, the developments were clearly susceptible to obsolescence and this had to be taken into account.
9. In CIT v. Ciba of India Ltd. : 69ITR692(SC) a somewhat similar question arose before the Supreme Court. The assessee was an Indian subsidiary of Ciba Ltd., of Base, a Swiss company engaged in the development, manufacture, and sale of medical and pharmaceutical preparations. The pharmaceutical section of the Swiss company in India was taken over by the assessee in January 1, 1948. Under an agreement dated December 17, 1949, 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 sole right and licence under the partners 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 dated the 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 : cost of raw material used for experimental work; and (iii) royalties on trace 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 benefits of the agreement or grant sub-licenses 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 date or material sent to it and to refrain from communicating any such information, scientific date or material received by it to any person. It was held, inter alia, that the contribution made by the assessee as aforestated to the Swiss company was allowable as business expenditure under s. 10(2)(xv) of the India I.T. Act, 1922. The assessee did not under the agreement become entitled exclusively even for the period of the agreement, to the patents and trade marks of the Swiss company, it had merely filed which the Swiss company commenced. The assessee was on that account a mere licence for a limited period of the technical knowledge of the Swiss company with the right to use to patents and trade marks of that company. The assessee acquired under the agreement merely the right to draw, for the purposes 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, and by making that technical knowledge available the Swiss company did not part with any asset of its business, nor did the assessee acquired any asset or advantage of an enduring nature for the benefit of its business. This decision has been relied upon by a Division Bench of this court in Acc-Vickers Babcock Ltd. v. CIT : 103ITR321(Bom) . It is not necessary to discuss this case been pointed out (at page 33 of the aforesaid report) that in connection with the question, such as the one before us, the duration of the agreement cannot be decisive of the matter. In that case, the decision of the Divisions Bench of the Mysore High Court in Mysore Kirloskar Ltd. v. CIT : 67ITR23(KAR) has been distinguished and the Division Bench of this court has gone on to point out that some of the grounds on which the Division Bench of the Mysore High Court distinguished the case before it from the Ciba's case : 69ITR692(SC) , discussed by us earlier, did not bear scrutiny.
10. In CIT v. Tata Engineering & Locomotive Co. Ltd. : 123ITR538(Bom) , this court. The assessee, Tata Engineering & Locomotive Co. Pvt. Ltd. (referred to herein aftrer as 'TELCO') had entered into two agreements, one with Daimler Benz and another with Henricot. Under the first agreement, Daimler Benz were to provide drawings and designs and full technical information required for the manufacture of automotive products. They were to provide training facilities for Indian personnel in their German plants. Telco could use the name and trade mark of Daimler Benz. The period of the agreement was fifteen years but either one of the parties could terminate the agreement by six months notice in case of a service breach of its terms and condition. After the agreement came to an end, Telco was entitled to continue its manufacture but they could not use the trade name of Tata-Mercedez-Benz. It was held in that case that the agreement was one of the foreign collaboration, where foreign know-how was availed of in lieu of payment and was in substance a transaction of acquiring the necessary technical information with regard to technique of production. Instead of employing persons having knowledge of those techniques and utilising their knowledge, what is done is that technical know-how is acquired under a collaboration agreement. Technical know-how made available by a party to such an agreement does not stand on the same footing as protected rights under a registered patent. There is no property right in a know-how which can be transferred just as it is, in a limited sense, in a patent. In any case, a party making the know-how available can hardly make any attempt to retrieve all the information supplied after the other party to the agreement has fully equipped itself and made itself familiar with the technical information and know-how supplied. It has been observed in the case that from the mere fact that the assessee was entitled to use the know-how even after the expiry of the period of the agreement, it cannot be held that the assessee had acquired a benefit of an enduring character because the know-how does not remain stagnant. This judgment clearly show that the Division bench came to the conclusion that the acquisition of technical know-how and technical advice for the time being cannot be in these days of technological and scientific development and consequent change in production techniques be treated as acquisition of a capital asset.
11. We may have also to refer to a decision of a Division Bench of the Gujarat High Court in CIT v. S. L. M. Maneklal Industries Ltd. : 107ITR133(Guj) , where the Divisions bench came to the conclusion that even though the workshop drawings, manufacturing instructions, etc., for which 'selling prices' were paid by the assessee-company were capita assets, yet the expenditure incorrect by the assessee in connection with the acquisition of those capital assets was not an expenditure of a capital nature. It was observed that, as held in CIT v. Elecon Engineering Co. Ltd. : 96ITR672(Guj) , know-how is a peculiar kind of asset. It is the accumulated fund of knowledge acquired, by year of observation, research, experimentation and experience. The whole of it is not in an intangible form even while it is in the process of being acquired and very often it takes a physical form in the shape of formulae, drawings, pattern's, blue prints, specification and so on. It was observed by the Division Bench that in view of the restrictions placed on the rights of the assessee-company regarding the said workshop drawings and manufacturing instructions, it was not possible to say that the property in the said drawings and instruction for which the consideration was paid, had passed to the assessee-company. We may make it clear, however, that in the present case, it has not bee contended by Mr. Kotwal at all that the drawings, etc., for which the amount in questions has been paid by the assessee, constituted a capital asset and hence it is not necessary for us to go into that question in this reference.
12. It appears to use that in order to determine the question refereed to us, we must consider the agreement dated January 2, 1962, as a whole rather than to put too much emphasis on the various clauses in isolation. In our view, the object of the agreement which is set out in cl. (1) thereof was mainly to acquire the technical know-how for the manufacturing and sale of the products referred to in the said clauses. The said clause also shows that the agreement was not confined to the said Grasso supplying such know-how but it was also intended that the said Grasso would keep the assessee informed about the research and development work carried on in the works of the said Grasso on the know-how of the compressors. Clause 2 shows that the intention of the assessee in entering into the agreement was to manufacture and sell in India the products in question with the help of the know-how supplied by the said Grasso. The duration of the agreement was for a limited period, although that period was of six years, with a provision for extension for another period of six years. However, it is significant that either the parties to the agreement was giving the right to terminate the said agreement by a notice as provided in cl. 5. This would show that the benefits acquired under the agreement were not intended to be permanent in nature. It is significant that cl. 10 imposed on the assessee a restriction generally to manufacturing the products in question in accordance with the know-how furnished by the said Grasso and not to deviate from the said know-how except with the approval of the said Grasso. The said Grasso undertook to train certain personnel of the assessee regarding the manufacture, use and maintenance of the said products. The opening part of cl. 17, which we have set out earlier, show that what was dealt with in that clause was compensation payable for the know-how and services rendered and the rights granted by the said Grasso to the assessee under the said agreement. It is true that certain sums have been specifically mentioned as being payable in full and final payment of the cost of drawings to be supplied by the said Grasso to the assessee which the assessee was not obliged to return even on the termination of the agreement. But, reading the agreement as a whole, it is clear that the intention of the parties was not to enter into a separate contract for the purchase of the drawings; the intention of the assessee clearly was to acquire technical knowledge or know-how from the said Grasso and the drawings were acquired as a part of this technical knowledge. In this view, it appears to use that the principles laid down by the Supreme Court in Ciba's case : 69ITR692(SC) and the principles laid down by the Divisions Bench of this court in ACC-Vickers Babcock Ltd. v. CIT : 103ITR321(Bom) and in CIT v. Telco : 123ITR538(Bom) , are clearly applicable to the case. As pointed out in Telco's case, the fact that the assessee was entitled to retain the drawings after the period of the agreement cannot be decisive of the matter.
13. Mr. Kotwal, the learned counsel for the department, submitted that there were essential difference between the agreement in this case and the agreement before the Supreme Court in Ciba's case : 69ITR692(SC) , which would take this case out to the ratio of the decision in Ciba's case. It was submitted by him that in Ciba's case, there was no sale of materials containing know-how, whereas in the present case there was in effect a sale of the know-how contained in the form of the drawings. In out view, this contention is totally unsustainable. As we have pointed out, it is clear that there is not spare the agreement for the sale of the drawings as such and all that the agreement provinces is that the drawings should be supplied by the said Grasso to the assessee as a part of the supply of the technical know-how which was not entirely comprised in the said drawings. It was next urged by Mr. Kotwal that, in the present case, there was a right given under the agreement to the assessee to export the products manufactured with the help of the know-how supplied by the said Grasso to certain foreign countries. We may point out that this circumstances has no relevance. In fact, if there had been no mention in the agreement regarding export at all, the assessee would have been entitled to export such products to any country that the assessee chose. It was next pointed out by Mr. Kotwal that in Ciba's : 69ITR692(SC) , there was no right conferred on the assessee to manufacture the products after the termination of the agreement, whereas under this agreement, there was no restriction put on the right of the assessee to manufacture the products after the termination of the agreement. In the first place, it seems to use that construction put by Mrs. Kotwal on the agreement is not quite accurate and in any even this circumstances cannot be regarding as decisive. It was next urged by him that in Ciba's case, all the payments were made dependent upon sales whereas, in the present case, the payment in question was against the supply of drawings. In our view, this circumstances cannot make any difference at all, as it merely relates to a different mode of payment. It was pointed out by Mr. Kotwal that, in the present case, there was a clause imposing a restriction on the said Grasso from manufacturing or selling products similar to those covered under the said agreement in India, where as there was no such clause in the agreement in question in Ciba's case : 69ITR692(SC) and that the parties had dealt differently in the matter in the two cases. In our view, this and the other dissimilarities in the two agreements pointed out by Mr. Kotwal also cannot lead to the conclusion that the payment in question in the percentage case was of a capital nature or that what the assessee acquired under the agreement was an enduring benefit. We may point out that it is hardly useful to embark upon a detailed comparison of the clauses in the different agreements with a view to find out minor differences therein as Mr. Kotwal would have us do. What we have to consider is the agreement generally and broadly. As we have already pointed out, the agreement in question is to be looked at from the point of view that it is for the acquisition of the technical know-how for a limited period. This know-how is bound to become obsolete with the technological development and changes in techniques. The assessee was under the agreement bound not to disclose the know-how acquired by the assessee to a third party. In view of this, in our view, it cannot be said that under the said agreement, the assessee acquired any asset or benefit of an enduring nature and hence the payment made by the assessee, which is referred to in the question submitted to us, cannot be regarded as of a capital nature.
14. In the result, we answer the question referred to us in the negative. The department must pay to the assessee their costs of the reference.