1. This is an appeal filed by Klayman Porcelains Ltd. of Hyderabad as statutory agents for Karamische Industries of Berlin, West Germany, for the assessment year 1980-81.
2. The assessee, Karamische Industries, is a West German company engaged in the business of building of tunnel-kilns for the ceramic industries. It entered into an agreement with Klayman Porcelains Ltd., henceforth described as Indian company, for construction of a tunnel-kiln at Nandigaon, Shafnagar Taluk, Mahaboobnagar District, in Andhra Pradesh for its modern ceramic tableware plant with 4-5 tonnes/day capacity. The Indian company is run in joint venture with Andhra Pradesh Industrial Development Corporation, a State undertaking.
The Memorandum of Understanding, dated 20-12-1979, (copy filed) signed in Berlin between the assessee-foreign company and the Indian company envisages construction of the kiln as the object of the Memorandum of Understanding. There are three parts to this Understanding having the following three components:1. Kerabedarf's Supply of materials and spare CIF Madras Portorder No. 32910 parts for the kiln D.M. 84,8052. Kerbedarf 's Drawings, technical documents, C1F Madras Air Portorder No. 32911 such as assembly drawings, D.M. 1,62,450 specifications regardingGuarantee for 10 per cent extra for guaranteeorder Nos. 32910 for a period of 12 months fromand 32911 the date of commissioning or 21 months from the date of last despatch3. Deputation of expert for supervision, engineering DM. 300 per day and commissioning of the plant.
plus overtime and other This understanding also provided that the tax to be borne by the assessee-foreign company will not exceed to 40 per cent of the amount payable for erection (3rd item). In other words, the understanding did not contemplate taxation in respect of the first two items, a point regarding which there was much dispute though nothing may turn on the same. There is no dispute that there is no profit arising out of that part of the contract relating to supply of materials and spare parts as they were despatched by the foreign company from abroad. There is also similarly no dispute that the last part may well become liable to tax though no part of such payment arises for consideration for this year.
The dispute relates to the amount payable for what is described by the assessee as payment for technical drawings, etc., towards engineering for the kiln. The ITO took the view that this is also in the nature of royalty within the definition of Explanation to Section 9(1)(vi) of the Income-tax Act, 1961 ('the Act'). He was, therefore, of the view that read with Section 44D of the Act, the entire amount is taxable. He, therefore, construed that it was a tax-free remuneration for the assessee in view of the stipulation regarding the maximum 40 per cent tax on the last part of the transaction. He, therefore, grossed it up and brought the entire amount in Indian currency at Rs. 8,56,920 to tax at 20 per cent. The first appellate authority concurred with the ITO and upheld the assessment subject to partial relief on the ground that there was no case for assuming that the income was tax-free in the hands of the assessee-foreign company. He, therefore, held that there was no case for grossing up of the income. The assessee, not being satisfied with the relief, has come up in second appeal. The learned representative for the assessee contended that it was a single agreement with a non-resident company for construction of a tunnel-kiln in India. The non-resident company supplied materials and technical data by post from abroad. It also deputed a person to supervise the construction of the kiln and that this was the only service rendered in India. He contended that if the agreement is read as a whole, it will be clear that there was no intent to have any property in India for exploitation by the Indian company so as to constitute royalty. He further claimed that the agreement is a single one and had the approval of the Government of India, vide communication from Ministry of Industry, Department of Industrial Development F.C. II 95 (79)/270/(79), dated 25-7-1979. The approval in the second part clearly says that it is 'for import of designs and drawings from Karamische Industries, West Germany, for fabrication of tunnel-kiln for the manufacture of ceramic tableware (crockery)'. The body of the communication also mentions the same. No doubt, the approval further says that it is subject to Indian taxes 'if any'. He claimed that both the Memorandum of Understanding and the Government approval clearly indicate that there was import of engineering materials by the Indian company and that the foreign company exported the same. The document refers to the amount received by the assessee-foreign company as 'price' for such supplies of technical requirements. The word 'royalty' has not been used because it was not royalty in any sense of the word.
There were no patent rights, copy rights, or any such asset which was allowed by the assessee-foreign company to be used by the Indian company. If it were royalty described as some other amount to escape Indian taxes, the Government would not have approved the agreement which describes the payment as the 'price' for import of 'designs and drawings'. Under the circumstances, he claimed that it was too far-fetched to say that this constituted royalty. He also claimed that even the most careful reading of the Explanation would indicate that there was no transfer of any right to the Indian company. There was also no imparting of information to Indian company inasmuch as they were neither interested nor had the capability by way of expertise to use these materials for construction of other kilns for themselves or for others. The Indian company was not in business of construction of kilns for others. Its only purpose in having a kiln constructed was for manufacture of ceramic tableware for sale by it. It was, therefore, neither interested nor did it acquire the designs and drawings for the exploitation of the same by the use of the self-same designs and drawings for construction of other kilns. He contended that the document must be read as a whole and if it is done, the question of considering any element of royalty in the payment would not arise at all. Shri P. Radhakrishnamurthy, the ITO who sought to defend his assessment with the assistance of the learned departmental representative, claimed that it is not necessary that the word 'royalty' should have been used in the agreement. According to him, the Explanation 2 to Section 9(1)(vi) clearly justified the treatment accorded by him to the amount. He claimed that the designs and drawings were given to the assessee for its use and that it contained information concerning technical and scientific knowledge. He claimed that it would come under any of the clauses in the said Explanation.
According to him, the payment for knowledge which could be utilised by the assessee should ordinarily be construed as royalty in the hands of the assessee-foreign company as it was in business of construction of kilns for others. He did not seriously dispute that the entire contract should be read as a whole. Even if it is so done, he claimed that the profit arising in India should not be limited only to the third item but also to the second part inasmuch as the drawings and designs were used in India. He claimed that the assessment could be justified even from this angle.
3. We have carefully considered the records as well as the arguments.
We have summarised the provisions of the contract in paragraph 2 supra.
The contract is one by which the assessee-foreign company undertook to construct a kiln for the Indian company in India. Though the contract is one and indivisible, it contemplated three components of the same (ii) for supply of drawings and designs and technical data to enable the collection of the relevant materials in India and to assist the foreign expert to complete the construction according to the specifications including guarantee for the sound working of the kiln for the period specified; and (iii) payment towards the services to the foreign expert for the services rendered in India. Though the contract should be read as a whole, there is nothing wrong in considering that the contract contains three components and fixation of a price for each component separately. There is no dispute as regards the first component relating to the supply of materials. The second component relates to the supply of engineering data, the details of which have already been mentioned in paragraph 2 supra. The payment for the same is described as the 'price' for it and the price for the same is also CIF. It is now well-settled that the technical drawings constituting know-how would also be plant. The Gujarat High Court in CIT v. Elecon Engg. Co. Ltd.  96 ITR 672, CIT v. Emco Electro (P.) Ltd.  118 ITR 864, (Bom.), the Madras High Court in CIT v. Festo Elgi (P.) Ltd.  129 ITR 499, the Karnataka High Court in Nippon Electronics (P.) Ltd .v. CIT  116 ITR 231 and the Andhra Pradesh High Court itself in an unreported decision in the case of Scientific Engg. House (P.) Ltd. v. CIT [RC No. 118 of 1977, judgment dated 7-12-1981] [since reported in  15 Taxman 468 (AP.)] have held in different contexts that technical know-how contained in such blue prints, drawings and other technical data may constitute plant eligible for depreciation. If this could be treated as a plant, the supply of the same from abroad in the same manner as the supply of materials would have the same consequences. If there is no taxable profit element in the supply of materials because they were sent from abroad, there could not similarly be any taxable element in the supply of such engineering data. From this angle alone, the assessee is entitled to succeed. However, it is necessary to consider the ITO's interpretation that the definition of the word 'royalty' would comprehend the transaction of the type encountered here and that we have no option except to hold that the receipt is in the nature of royalty and, therefore, assessable in its entirety under Section 44D.4. Explanation 2 to Clause (vi) of Sub-section (1) of Section 9 reads as under: For the purposes of this clause, 'royalty' means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head 'Capital gains') for (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property; (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property; (iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill; (v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or (vi) the rendering of any services in connection with the activities referred to in Sub-clauses (i) to (v); Sub-section (1) of Section 9 deems royalty as defined in Explanation 2 as one of the categories of income which 'shall be deemed to accrue or arise in India'. Section 44D denies the recipient of such royalty any other deduction under the statute. Explanation to Section 44D specifically mentions that the word 'royalty' should have the same meaning as assigned to it by Explanation 2 to Clause (vi) of Sub-section (1) of Section 9. When these provisions are read together, they do not leave us in any doubt as to the meaning sought to be assigned to the word 'royalty'. 'Royalty' in ordinary senses is rent or revenue attributable to the use of an asset belonging to one person by another. There is no such royalty in the arrangement between the assessee-foreign company and the Indian company. Here was a case of a foreign company undertaking to supply, erect and commissioning a kiln in India, the only services rendered in India being that of supervision by an expert deputed by the assessee-foreign company. The remuneration for such supervision is separately paid for and the tax liability in respect of such services is not the matter before us. There has been supply of materials and know-how which have both been despatched from abroad. There has been no hire of any patent rights or technical know-how on the part of the taxpayer in India. Obviously the entire payment has been considered as the cost of the kiln by the Indian taxpayer and rightly so. What is a capital cost to the Indian taxpayer can, no doubt, be a revenue receipt in the hands of the recipient. But the question is not whether it is capital or revenue in foreign assessee-company's hands, but whether the income accrued or arose in India. Obviously it does not accrue or arise in India as no part of the activities relating to supply of materials or engineering data were undertaken in India. It is for this reason that the ITO himself has attempted to tax the same under Section 9 which deals with income deemed to accrue or arise in India. Since it is a deeming provision, it stands to reason that it is the ITO's duty to bring it squarely under the deeming provisions. In an agreement which had the approval of the Government, we should have imagined that if it were royalty, it would have been described as such. Even disregarding the nomenclature given by the parties in the agreement which had the approval of the Government, we are not in a position to any that it would constitute royalty because there have been no transfer of any rights for this data. The understanding nowhere transfers any such right. It is clear that all the documents related to the kiln specifically designed for the Indian company's use. It should also be remembered that the Indian company was not interested in the designs, etc., and had to pay for it as part of its cost of construction of the kiln. It had no intention to exploit the technical data even for construction of another kiln for itself, leave alone for others. It cannot, therefore, come under Clause (i) relating to transfer of assets or imparting of information under Clause (ii) or for use of any patent, etc., in Clause (iii). A serious attempt was made to show that it might be imparting of any information concerning technical, industrial, commercial or scientific knowledge, expertise, or skill under Clause (iv) or rendering of service in connection with other items under Clause (vi). Even this argument should fail for the same reason because the Indian company was not interested in this information and had not paid for any information as such. There was also no service done in connection with this supply in relation to the payment. The payment was for a component of an indivisible contract for construction of a kiln. Merely because the price for the construction was fixed separately with reference to the materials, engineering data and expertise made available, such an indivisible contract does not become three different contracts. Even if they were read as three different contracts, we are not in a position to say that the price for the supply of engineering data would constitute asset even under the extended meaning assigned by Explanation 2, referred to earlier. It does not come strictly under any of the clauses. It must also be mentioned that in the context of the taxation of the entire amount as arising in India as per Section 44D, it cannot possibly be considered that the payment for certain designs and drawings sent from abroad was intended to be roped in unless it constituted a sort of rent or hire for patent or copyright or an invention. Though we have considered that it does not fall under the Explanation, even disregarding the nomenclature given by the parties themselves to the agreement and by the Government in its approval, we do not see why such nomenclature should be disregarded. It is because the agreement is between a reputed Indian company in which a state undertaking is interested and a foreign company. It had also the approval of the Government of India and such approval also adopted the nomenclature given by the parties describing the amount received by the assessee-foreign company as one 'for import of designs and drawings ...
for fabrication of kiln for manufacture of ceramic tableware (crockery)'. What was received was the price for export of designs and drawings from abroad in pursuance of an agreement signed abroad. Again, the receipt was for fabrication of a tunnel-kiln and not for any right to use the designs and drawings. In this context the assessee's consistent and repeated argument that the designs were not capable of being understood by its engineers and much less used by them for exploitation of the drawings as such cannot altogether be ignored.
Hence, from any view of the matter, we do not find any substance in the orders of the authorities below to justify the inference that the receipt by the foreign company of a lump sum amount for import of drawings and technical documents for the construction of a kiln as a part of such construction contract could be treated as royalty either in the ordinary sense or the special statutory sense under Section 9(1)(vi). The appeal will have to be allowed.