Alladi Kuppuswami, J.
1. By an agreement dated July 28, 1965, a firm known as M/s. Switch Gear Manufacturing Company, Hyderabad, entered into an agreement with the National Research Development Corporation of India (referred to in this judgment as 'N.R.D.C.') for the purpose of using a process developed by the Indian Institute of Science under licence from N.R.D.C. for the manufacture of non-linear resistor compound. This compound is useful for the purpose of manufacture of lightning arresters. Under clause 1 of the agreement, the licence was granted for a term of 14 years from the day of October 1, 1964, and comprised the right to use the invention for non-linear resistor compound from conducting and semi-conducting materials such as graphite and silicon carbide covered by Indian Patent No. 55282 at the grantee's own factory, and to sell the product manufactured in accordance with the said invention. This was in consideration of a payment of Rs. 5,000 by way of premium and payment of royalty as specified in the agreement. Under clause 3(i) it was provided that a royalty of 2% on the net ex-factory sales of lightning arresters and other products arising from the exploitation of the patent by the grantee in accordance with the said invention and marketed by them should be paid by the grantee to N.R.D.C. during the period of the agreement, viz., 14 years. Such royalties had to be paid on the first of April and on the first October every year in respect of the articles manufactured and marketed or used by the grantee during the preceding held year and shall be paid by the first day of May and first day of November of that year. In default of payment of such royalties on the due dates the grantee had to pay interest on the amount in default at the rate of six per cent. per annum. It was further provided that the grantee will not, at any time assign, mortgage, charge or grant sub-licences in respect of or otherwise deal with or part with the possession or control of the licence hereby granted. Clause 4(1) of the agreement stated that the licence was granted on a non-exclusive basis and N.R.D.C. reserved the right to grant similar licences to any other parties at its discretion.
2. On the December 23, 1966, there was a tripartite agreement between N.R.D.C., M/s. Switch Gear ., which is the assessee. N.R.D.C. accepted the transfer of the licence of the assessee-company along with all the assets and liabilities. The assessee paid a sum of Rs. 72,055 towards royalty to N.R.D.C. in terms of the original agreement. It claimed a deduction of this amount, but the ITO negatived it on the ground that there was no privity of contract between the assessee and N.R.D.C. and the expenditure was capital in nature. On appeal, the AAC held that there was a privity of contract, but he took the view that th claim for deduction should be made under s. 35A relating to the expenditure on acquisition of patent right or copyrights. In accordance with this provision, he allowed the claim pro rata 14 years. As against the said order the assessee preferred an appeal claiming that the entire expenditure should be allowed for each of the years and that s. 35A has no applicantion and the department also preferred an appeal claiming that the expenditure has to be treated only as capital expenditure. Both the appeals were heard together by the Income-tax Appellate Tribunal. By its order dated December 9, 1975, after consideration of all the circumstances of the case it held that the expenditure was of a revenue nature. In this view they held that the question of applicability of s. 35A would not arise and there was no necessity to pronounce any opinion on such applicability. They, therefore, held that the royalty payment was allowable as revenue expenditure and as a consequence the interest payable on the amount due was also revenue expenditure. In the result they allowed the appeal of the assessee and dismissed the appeal preferred by the department. As the Tribunal felt that a question of law arose out of the order they referred the following question to this court for its opinion :
'Whether, on the facts and in the circumstances of the case, the royalty payment is admissible as revenue expenditure ?'
3. The question whether any expenditure incurred is of capital or revenue nature has been the subject of consideration in innumerable decisions. The lines of demarcation between capital expenditure and revenue expenditure is very often difficult to draw. The court has, in coming to a conclusion, to consider the various circumstances including the nature of business, the object for which the expenditure has been incurred and has to look into not only the record but to the surrounding circumstances to find out what is the real nature of the transaction from the commercial point of view. For this purpose different tests have been applied from time to time. It is sufficient if we refer to a recent decision of the Full Bench of this court in R.C. No. 115/76 dated November 19, 1979 (Praga Tools Ltd. v. CIT : 123ITR773(AP) ), in which there is an exhaustive discussion on this subject. In that case also, the assessee entered into a licence agreement with a foreign collaborator for the manufacture of a particular type of tool and cutter grinding machine for which the collaborator was to supply the necessary designs, drawings, technical know-how and assistance. In consideration of the grant of the manufacturing rights and for providing assistance the assessee-company agreed, inter alia, to pay 5% of the Indian selling price on the production of the machine. The agreement was for a period of ten years and it was to be renewed thereafter for a period of five years by mutual consent. It was also provided that the rights and liabilities of either party to the agreement shall not be assigned to a third party without the written consent of the other party. There was a similar agreement entered into by the assessee with another foreign company for the manufacture of 'drill chucks'. By virtue of the aforesaid agreements the assessee paid royalty to the two foreign collaborators. The question before the Full Bench was whether these amounts were allowable deductions as revenue expenditure. The Full Bench, after consideration of a number of decisions, held that the expenditure was revenue in character. In coming to the conclusion, the Full Bench observed that these payments related to the profit-making process. It is the totality or the cumulative effect of all the circumstances that should be the guiding factor in deciding the nature of an expenditure. Where the expenditure has a direct nexus, connection or relation to the carrying on or conducting of the business of the assessee which must be regarded as an integral part of the profit-making process, it must be held to be a revenue expenditure. Where, however, the purpose and object of the expenditure is to acquire an asset or a right of an enduring nature or of a permanent character it is a capital expenditure. The Full Bench referred to the leading decision of the Supreme Court in Ciba's case : 69ITR692(SC) wherein the Swiss company had granted to the assessee the full and sole right of licence under the patent to make use, exercise and vend the inventions specified in the agreement in India and also a licence to use some specified trade marks and deliver to the assessee all processes, formulae, scientific data, working rules, etc. and supply all scientific and technical know-how and assistance. The assessee in consideration of the aforesaid right to receive scientific and technical know-how and assistance agreed to make contributions of 5%, 3% and 2% of the net sale price of the products sold by the assessee for a period of 5 years. The Supreme Court held that the payments made to the assessee-company were allowable as revenue expenditure. The Supreme Court observed that the assessee did not acquire any asset or advantage of an enduring nature for the benefit of its business except acquiring the right to draw for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products, upon the technical knowledge and know-how of the Swiss company for a limited period. The Supreme Court noted the following facts that emerged from the agreement, viz., (1) the licence was for a period of five years, liable to be terminated in certain eventualities even before the expiry of the period; (2) the object of the agreement was to obtain the benefit of the technical assistance for running the business; (3) the licence was granted to the assessee subject to the rights actually granted or which may be granted after the date of the agreement to other persons; (4) the assessee was expressly prohibited from divulging confidential information to third parties without the consent of the Swiss company; (5) there was no transfer of the fruits of research once for all; and (6) the stipulated payment was recurrent dependent upon the sales, and only for the period of the agreement.
4. In the present case before us, the agreement provides for the use of know-how only for a period of 14 years. After the end of that period the assessee cannot use the patent which is owned by N.R.D.C. The grantee cannot assign, mortgage, charge or grant sub-licence without the permission of N.R.D.C. even during the period of agreement. It is further provided that the grant is on a non-exclusive basis. The payment of royalty under clause 3 of the agreement is only for a period of 14 years. The grantee has to pay 2% on the net ex-factory sales of lightning arresters and other products arising from the exploitation of the patent. Thus, as pointed out by the Tribunal, the payment of royalty is linked up with the sales.
5. Having regard to all these circumstances and applying the principles laid down by the decision of the Full Bench of this court in Praga Tools Ltd. v. CIT : 123ITR773(AP) and the Supreme Court in Ciba's case : 69ITR692(SC) we have no hesitation in coming to the conclusion arrived at by the Tribunal that the expenditure incurred by the way of payment of royalty is of a revenue nature. We, accordingly, answer the question referred to us in favour of the assessee. Advocate's fee Rs. 250.