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Commissioner of Income-tax, Delhi-ii Vs. Bhai Sunder Dass and Sons P. Ltd. - Court Judgment

LegalCrystal Citation
Subject Direct Taxation
CourtDelhi High Court
Decided On
Case NumberI.T.R. No. 202 of 1976
Judge
Reported in[1986]158ITR195(Delhi)
ActsIncome Tax Act, 1961 - Sections 37(1)
AppellantCommissioner of Income-tax, Delhi-ii
RespondentBhai Sunder Dass and Sons P. Ltd.
Cases ReferredMusker v. English Electric Co. Ltd.
Excerpt:
.....expenditure - technical information includes plans and drawings of making article - utilization of information for limited period for manufacture of goods - information and know-how not to be passed - benefit not of enduring nature - held, amount paid by assessed was revenue expenditure. - - the assessed gets the advantage of the drawings as well as the know-how regarding the high frequency concrete vibrators in the sense that the swiss party does not lose that knowledge and does not deprive itself of the right to make the machines. ahuja states that the information regarding the method of manufacture was given as well as the sole manufacturing right in india. 20. the principles on which such agreements have to be examined are really well settled. the agreement could very..........by the assessed in india. a lump sum price of 50,000 swiss francs was to be paid to the swiss party for the 'know-how' and drawings which would facilitate the manufacture in india. a royalty of 3% was to be paid on the net sale price of the manufacture. the contract was for a period of five years ; the assessed was not to give the information to anybody else. there was, however, no agreement for the return of any drawings, etc., to the swiss party at the conclusion of the contract. 6. so, the information parted with in favor of the assessed company would exclusively belong to the assessed. the real problem is whether this does not amount to an enduring benefit in favor of the assessed. 7. it is now necessary to turn to a previous decision of this court in shriram refrigeration.....
Judgment:

D.K. Kapur, J.

1. The following question has been referred to us at the instance of the Commissioner of Income-tax in relation to the assessment year 1969-70 :

'Whether, on the facts and in the circumstances of the case, the payment of Rs. 87,200 made by the assessed company to M/s. K. Laier A. G. Switzerland in terms of the collaboration agreement constitutes revenue expenditure or capital expenditure ?'

2. The facts of the case show that the assessed which is a private limited company paid a sum of Rs. 87,200 to its collaborator, a Swiss firm. The agreement between the parties was in the form of a license contract. According to the Income-tax Officer, the payment was of capital nature. The assessed appealed to the Appellate Assistant Commissioner who was of the view that the decision in Ciba's case [1968] 69 ITR 692, was distinguishable. On a further appeal to the Tribunal, it was held that no sale of an asset was involved. Some technical information and knowledge available to the Swiss firm was permitted to be utilised by the assessed. Thus, the amount was treated as a revenue expenditure and allowed as a deduction.

3. It is contended by the learned counsel for the Department that the payment was for the know-how and was in a lump sum form. thereforee, it was a capital expenditure. Reference was made to a decision of the Allahabad High Court in Ram Kumar Pharmaceutical Works v. CIT : [1979]119ITR33(All) , where it was held that the know-how had been acquired without any limit of time. It was not limited to the period of payment of royalty.

4. In the case of CIT v. Ciba of India Ltd. : [1968]69ITR692(SC) , the Supreme Court held that no exclusive use of the patents and trade marks of the Swiss company had been passed on to the assessed. It was held that the assessed was a licensee for a limited period with a right to use the patents and trade marks. It was also held that no asset was parted with by the Swiss company and hence no assets or any advantage of enduring nature was obtained by the assessed company. A most important part of the agreement was that on its termination, the assessed would stop using the patents and trade marks except in respect of the stocks-in-hand and would return to Ciba of Basle or such other person as may be appointed, all the scientific data and material sent to it. The court held that the rights emerging from the agreement were that the license was for a period of five years liable to be terminated on certain eventualities even before the expiry of that period. The object was to obtain technical assistance, but the information was not to be parted with to any third party and, hence, it was nothing more than a license.

5. Turning now to the facts of the present case, before looking at any other reported case, it is necessary to examine the terms of the agreement. The contract related to certain types of motor concrete vibrators manufactured by Laier, which were permitted to be manufactured by the assessed in India. A lump sum price of 50,000 Swiss francs was to be paid to the Swiss party for the 'know-how' and drawings which would facilitate the manufacture in India. A royalty of 3% was to be paid on the net sale price of the manufacture. The contract was for a period of five years ; the assessed was not to give the information to anybody else. There was, however, no agreement for the return of any drawings, etc., to the Swiss party at the conclusion of the contract.

6. So, the information parted with in favor of the assessed company would exclusively belong to the assessed. The real problem is whether this does not amount to an enduring benefit in favor of the assessed.

7. It is now necessary to turn to a previous decision of this court in Shriram Refrigeration Industries Ltd. v. CIT : [1981]127ITR746(Delhi) , in which the technical assistance agreement was with Westinghouse of U.S.A. Under that agreement, an exclusive license was granted in India which was not to be transferred or assigned. There was also a term that all technical and scientific information would continue to remain the legal property of Westinghouse.

8. In that case, the Tribunal had held that a sum of Rs. 2,39,084 spent by the assessed was a capital expense, but the High Court held that it was a revenue expense. The reason given by this court for this judgment was as follows :

'The principle laid down by the Supreme Court in the above decision is that if the agreement results in the absolute transfer of technical knowledge to the assessed, the assessed could be said to have acquired an asset of enduring advantage but where the payment is made only for obtaining access to information which does not become its own, the payments can not be elevated to the status of payment of a capital nature.'

9. The court on further examination held :

'The information remained that of Westinghouse and there was no sale involved.'

10. A similar point came before the Madras High Court in M.R. Electronic Components Ltd. v. ClT : [1982]136ITR305(Mad) . In that case, it was held that the payments under the agreement could be divided into two parts, one part being capital in nature and the other revenue. The right to manufacture some fresh items was considered as the acquisition of a right exploitable in future which was capital.

11. As already pointed our earlier in this judgment, the exact term which is involved in the present case is the payment of the lump sum price. The term relating to this is clause (6) which reads as follows :

'LAIER will make available to BHAI all necessary drawings and the documentation for the manufacture of vibrators, convertors, generators, furthermore for the corresponding jigs and fixtures. For the know-how and the fore-mentioned drawings BHAI shall pay to LAIER a lump sum price of Swiss francs 50,000 subject to Indian taxes payable immediately on receipt of the necessary permit.'

12. What we have to see is whether the know-how or the drawings represent a capital expenditure or a revenue expenditure. The other terms in the agreement need not be set out here because they deal with various steps that the Swiss party had to take for bringing about the manufacture of the goods such as export of components at various times. The agreement also provides for the training of specialists for bringing about the production. The only restriction as far as the assessed is concerned is that the information regarding the making of the high frequency vibrators is not to be passed on to others. The real point is that there is nothing about the return of the know-how to the Swiss party.

13. Assume for instance that the contract is terminated immediately after these drawings have been received. Then there is nothing said as regards the utilisation of the information and the drawings, limiting the user by the assessed for any length of time. The only restriction which would continue to apply is the restriction on parting with the information to others. This makes the present case a kind of borderline case regarding the expenditure. The assessed gets the advantage of the drawings as well as the know-how regarding the high frequency concrete vibrators in the sense that the Swiss party does not lose that knowledge and does not deprive itself of the right to make the machines. Can it be said that there was no sale On the other hand, as far as the assessed is concerned, it is of an enduring nature because there is no term to the effect that the information cannot be used even after the agreement ends.

14. In another judgment of the Madras High Court, Fenner Woodroffe & Co. Ltd. v. CIT : [1976]102ITR665(Mad) , it was held that the agreement was a sale of the know-how. References were made to Lord Radcliffe's speech in Jeffrey v. Rolls-Royce Ltd. [1962] 40 TC 433 ; [1965] 56 ITR 580 (HL) decided by the House of Lords and to other English cases. It was held that 'know-how' is an intangible asset. Quoting from Lord Denning's speech in Musker v. English Electric Co. Ltd. [1964] 41 TC 556, it was observed that 'know-how' had two qualities. The 'know-how' could be sold to others and could also be used to produce an enduring result by utilisation in manufacture.

15. The problem of the present case is whether or not the information supplied to the assessed is of an enduring nature enabling the manufacture of high frequency motor concrete vibrators covered by the agreement.

16. Mr. Ahuja, for the respondent has urged us to accept the fact that the present case does not lead to obtaining of any enduring benefit to the assessed. For this purpose, he has urged us to construe the agreement only as a license agreement similar to the one in Ciba's case and the case of Shriram Refrigeration. He says that the payments to be made to the Swiss company were divided into two parts, one a lump sum amount and the other a payment of royalty. What did the assessed get under the agreement For this purpose, Mr. Ahuja states that the information regarding the method of manufacture was given as well as the sole manufacturing right in India. This is provided in term No. 2 of the license agreement. At the same time, the assessed was debarred from giving the mechanical and other principles for manufacture of the high frequency vibrators to any other person. So, it was only a personal right. The term of the agreement is limited by clause 9 to five years from the date of commencement of production.

17. We have to consider what is the effect of the contract after the period of five years. Does the assessed company have the benefit of an enduring nature after five years or does the right elapse. There are no terms in the contract regarding this matter and that is why there is a difficulty in the construction of the agreement.

18. In ClT v. S.L.M. Maneklal Industries Ltd. : [1977]107ITR133(Guj) , the Gujarat High Court considered the effect of some collaboration agreements. Part of the agreement was that workshop, drawings, manufacturing instructions and other instructions for erecting factories for manufacturing machinery came to the Indian company. The Income-tax Officer held that expenses attributable to the obtaining of information was a capital expense. This was examined by the High Court. The High Court held that when some information or know-how was obtained as part of a larger contract, i.e., a collaboration agreement, it became very necessary to critically examine the entire transaction. One of the points that prevailed with the court was that after the termination of the agreement, the assessed could not utilise the drawings and, thereforee, the expenditure was revenue in nature. The court actually followed the judgment in Ciba's case, but referred to a large number of other cases relating to the same point.

19. A very large number of cases have been cited before us. The agreements in each case have been critically examined by the courts. It is difficult to apply the facts of one case to the facts of another case. Every one of the collaboration agreements and other agreements are full of complex questions peculiar to the agreements in question. If we are to examine the ratio of other cases and apply the same to the facts of the present case, we feel that the result is not likely to be fruitful.

20. The principles on which such agreements have to be examined are really well settled. There can be an agreement by which the utilisation of know-how is transferred ; there can be an agreement by which know-how is allowed to be utilised in a restricted manner ; there can be an agreement in which know-how has to be transmitted as part of a larger agreement of collaboration. There may conceivably be other types of agreements in which a question can arise as to whether the know-how has been acquired as a capital asset by the assessed.

21. As pointed out earlier, this is a borderline case. The agreement, most definitely, divides the payment to be received under the agreement into two parts. One is a lump sum price to be paid when the drawings and information regarding the mode of manufacture of the vibrators is obtained by the assessed. The other payment is a royalty to be paid to the Swiss party on the (sale of the) manufactured articles. At the same time, the assessed got the sole right to manufacture the articles in India to the exclusion of other parties. Also, the information was not to be transmitted to any third party, nor was the method of manufacturing to be communicated to others. It, thereforee, appears to be a case where the assessed has the information and know-how but he can only use it himself. He cannot give it to anybody else. Nevertheless, the advantage of the know-how is received by the assessed and can lead to a benefit of enduring nature to the assessed.

22. How then does this case differ from the case of Shriram Refrigeration : [1981]127ITR746(Delhi) . There also the information was obtained from Westinghouse by the assessed. It had to be returned to the American company at the end of the agreement. There is no such term in the present case. So, it can be argued, and has been argued, by the learned counsel for the Revenue, that this is a benefit of an enduring nature.

23. It was held in the case of Shriram Refrigeration : [1981]127ITR746(Delhi) , that the utilisation of the information must be contrasted with the purchase of the information. We would, thereforee, prefer to follow that line of reasoning and hold that notwithstanding the fact that there is no term for the return of the drawings, this information can only be utilised by the assessed for the manufacture of the vibrators in India under the license agreement.

24. It is a case in which an implied term must be supplied that when the license comes to an end, then the assessed loses the right to manufacture the vibrators. This inevitable result is achieved by reading clauses (2), (6) and (9) of the agreement together. Under clause (2), Bhai, which is the name given to the assessed, obtained the sole manufacturing rights from the Swiss party ; under clause (9), the contract was for a period of five years. We have been told during the arguments that the contract did not subsist for very long in this case. In any event, it is an agreement limited to five years. Under clause (6), the drawings and know-how are to be given to Bhai by Laier (the Swiss party) against payment of 50,000 Swiss francs. We take it that this know-how and drawings can only be used for the manufacture of Laier high frequency motor concrete vibrators. If the right to manufacture comes to an end, these plans cannot be used. At the same time, the plans are not to be communicated to any other person and nor anybody was to be assisted in making the vibrators. It is provided by clause (13).

25. The sum and substance of the agreement is that it is a kind of collaboration agreement. The sole manufacturing right was passed to the assessed for five years. Obviously, you cannot manufacture a thing unless you know how to make it. As a necessary part of the arrangement, the information as to how to make the vibrators had to come to the assessed. We cannot imagine a situation in which Bhai could make the machines without the information. It would follow that the lump sum payment did not result in an advantage of an enduring nature to the assessed but must be considered as part of the expense for manufacturing the machines in India. The agreement could very well have been that the Swiss party has agreed to help in the manufacture of vibrators in India on payment of a particular amount. This expense cannot, thereforee, be treated as a capital expense, though it appears very much like a capital expense.

26. The distinction between the capital and revenue expense is sometimes difficult to ascertain although the two things are distinct and yet they tend to overlap at particular points. If an entrepreneur has to manufacture anything, he must first get the necessary machinery and plant for making the article. He must also get the information as to how that machinery is to be utilised in the making of the goods that he wants to market. The expense on the manufacturing machinery and plant is most definitely a capital expenditure. The question as to whether the information obtained for running that machinery is a capital expense or a revenue expense becomes a problematic question. For instance, the manufacturer may buy the know-how from another party or he may engage the services of an expert who knows how to do the manufacture. If he gets expert managerial staff, the expense could be of revenue in nature except to the extent utilised for setting up the machinery. In the present case, the information is given by way of plans and drawings for making the article. It could be considered to be capital, but as the utilisation is limited to manufacturing the goods of the Swiss party for a limited period, it has to be treated as a revenue expenditure in the light of the judgment of the Supreme Court in Ciba's case : [1968]69ITR692(SC) . After a careful examination of the question, which is indeed a difficult one, we think that we should hold that the amount is a revenue expenditure.

27. There is another way of looking at this problem. The Swiss party who is manufacturing vibrators in Switzerland had to be induced to enter into the agreement permitting the Indian party to make the goods normally manufactured in Switzerland by the Swiss party. For such an agreement, the Swiss party might prefer to get a lump sum to start with and a small payment periodically or, it might prefer to get no 'down' payment, but a larger share in the profits. Normally, not knowing what the consequence might be later, a party will prefer a larger 'down' payment. That is the way in which most of these agreements are worded. A substantial sum paid initially is followed by some royalty. The point which requires emphasis is the fact that the foreign party did not permit the information and know-how to be used by anyone else. It is, thereforee, a kind of license agreement and not a sale of the now-how. Viewed from this angle, which is a different line of reasoning, it must be held that the sum of 50,000. Swiss francs paid initially was really a method by which the Swiss party got its consideration for giving the manufacturing right for five years to the assessed. It was the payment for the license and not a payment for the know-how. The know-how was communicated to the assessed-company company as a part and parcel of the collaboration agreement. Without the know-how, the agreement could not work. So, by this line of line of reasoning also, it must be held that the amount is a revenue expenditure and not a capital expenditure. The question referred to us is answered accordingly. Due to the complexity of the case, the parties are left to bear their own costs.


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