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Commissioner of Income-tax, Gujarat-i Vs. Ahmedabad Manufacturing and Calico Printing Co. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-tax Reference No. 162 of 1975
Reported in[1983]139ITR806(Guj)
AppellantCommissioner of Income-tax, Gujarat-i
RespondentAhmedabad Manufacturing and Calico Printing Co.
Cases ReferredRolls Royce Ltd. v. Jeffery
Excerpt:
.....to be free to manufacture, sell and exploit their production of vinyl acetate in india and other parts of the world subject to patents and instructions outside the companys control which may affect such sales outside india and the company agreed to use its best endeavours to obtain such agreements with other parties as may be proved necessary to remove any such restrictions to the benefit of calico. 4, the company represented and warranted that it had enjoyed and continued to enjoy the sole proprietary rights of manufacture, sale and distribution and exploitation of the products and that it had not entered into any commitments or agreements with any person, firm and company in india and else where for the manufacture of the said products in india. calico was to designate a..........in the finance (no. 2) act of 1971 ?'the facts leading to this reference are as follows :the assessee-company, the respondent herein, entered into an agreement on august 28,1961, with messrs vinyl products ltd., a company located in the united kingdom, and under that agreement, the foreign company agreed to supply to the assessee-company the technical know-how and the assessee-company ag reed to pay one per cent. of the net sale proceeds of the products mentioned in the agreement which the assessee-company could manufacture under the permission granted under the said agreement. this amount calculated at one per cent. of the net sale proceeds was to be paid as 'research contribution' under cl.17 of the agreement. the payment agreed to be made to the foreign company was tax-free,.....
Judgment:

DIVAN C.J. - In this case, at the instance of the Revenue, the following question has been referred to us for our opinion :

'Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the payments made by the assessee to the foreign company were Royalty Payments and as such liable to deduction of tax at lower rate of 50% as prescribed in the Finance (No. 2) Act of 1971 ?'

The facts leading to this reference are as follows :

The assessee-company, the respondent herein, entered into an agreement on August 28,1961, with Messrs Vinyl Products Ltd., a company located in the United Kingdom, and under that agreement, the foreign company agreed to supply to the assessee-company the technical know-how and the assessee-company ag reed to pay one per cent. of the net sale proceeds of the products mentioned in the agreement which the assessee-company could manufacture under the permission granted under the said agreement. This amount calculated at one per cent. of the net sale proceeds was to be paid as 'research contribution' under cl.17 of the agreement. The payment agreed to be made to the foreign company was tax-free, that is, the tax chargeable on these payments was to be borne by the assessee and the foreign company was to receive only the net amount. The ITO worked out the gross contribution at Rs. 1,62,330 and determined tax at 70 per cent. the reof at Rs. 1,13,632. According to the assessee, the rate at which tax was deductible on the remittances made in accordance with the provisions of s.195 of the Act read with the Finance (No. 2) Act of 1971 was 50 per cent. The claim of the assessee was that the impugned payments made were 'royalties' and as such, the tax to be deducted at source was 50 per cent. while the ITO was of the view that the impugned payment was research contribution and as such was covered by the residuary clause in pa ra. 2 (ii) Part II of Schedule I of the Finance (No. 2) Act, 1971. This decision of the ITO was upheld in appeal by the AAC. The assessee carried the matter in further appeal to the Income-tax Appellate Tribunal and the main question of controversy before the Tribunal was whether the impugned payments were covered by the expression 'royalties' used in the relevant provisions of the Finance (No. 2) Act, 1971, so as to be liable to a deduction of tax at the lower rate of 50 per cent. Since the expression 'royalty' has not been defined in the I.T. Act. The Tribunal relied upon two decisions, one of the Calcutta High Court in CIT v. Hindustan General Electrical Corporation Ltd. : [1971]81ITR243(Cal) , a nd the other in Rolls Royce Ltd. v. Jeffery (Inspector of Taxes) [1965] 56 ITR 580 , which is a decision of the House of Lords, and in the light of those decisions, it came to the conclusion that having regard to cl. 17 of the agreement. The impugned payments were royalty payments and as such liable to a deduction of tax at source at the lower rate of 50 per cent. as prescribed in the relevant provisions of the Finance (No. 2) Act, 1971. Thereafter, at the instance of the Revenue, the question

A F nB set out has been referred to us for our opinion.

It may be pointed out that the matter did not arise in the assessment proceedings, but, the assessee appears to have addressed a letter on November 16, 1971, to the ITO, Special Investigation Circle IV. Ahmedabad, in connection with the amount of Rs. 48,698 which was paid under cl.17 of the agreement by the assessee-company to M/s. Vinyl Products Ltd., the U.K. company. The letter was written by the assessee-company in regard to the technical research contribution to M/s. Vinyl Products Ltd., Surrey, England, for the period from October 1, 1970 to October 31, 1971. According to the ITOs reply dated November 23, 1971, which is annex. A to statement of the case, the tax payable on the gross remittances was worked out as pointed out in the letter. The assessee was requested to confirm the said amount and pay tax at the earliest. The computation, according to the ITO, was in accordance with the letter dated February 18, 1971, in connection with the earlier payment of research contribution. And a challan was enclosed for the necessary payment. According to that calculation, in respect of the amount of Rs. 48,698 which was remitted during the period from October 1, 1970 to March 31, 1971, the gross contribution payable came to Rs. 1,62,330 and 70 per cent. that is Rs. 1,13,632 was the tax payable thereon. As pointed out above. The U.K. company was entitled to receive Rs. 48,698 being one per cent. of the net sale proceeds of the products, which were manufactured and sold in India and other territories, covered by the agreement in accordance with the terms of the agreement dated August 28, 1961.

The relevant provisions of law are as follows :

Under s. 195 of the I.T. Act, provision is made for tax deduction at source in respect of some of the sums mentioned in that section, sub-s.(1) of s. 195 provides :

'Any person responsible for paying to a non-resident, not being a company, or to a company which is neither an Indian company nor a company which has made the prescribed arrangements for the declaration and payment of dividends within India, any interest, not being interest on securities, or any other sum, not being dividends, chargeable under the provisions of this Act, shall, at the time of payment, unless he is himself liable to pay any income-tax thereon as an agent, deduct income-tax thereon at the rates in force.'

The proviso to sub-s. (1) is not material for the purpose of this judgment. Under sub-s. (2) of s. 195 :

'Where the person responsible for paying any such sum chargeable under this Act (other than interest including interest on securities, dividends and salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Income-tax Officer to determine, by general or special order, the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable.'

Under the Finance (No. 2) Act, 1971, by s. 2(4) it has been provided :

'In cases in which tax has to be deducted under sections 193, 194, 194A and 195 of the Income-tax Act at the rates in force, the deduction shall be made at the rates specified in Part II of the First Schedule.'

The First Schedule, Pt. II of the Finance (No. 2) Act, 1971, is in these terms :

'Rates for deduction of tax at source in certain cases :

In every case in which under the provisions of sections 193, 194, 194A and 195 of the Income-tax Act, tax is to be deducted at the rates in force, deduction shall be made from the income subject to deduction, at the following rates :....'

Now, below this heading, a Table has been set out and in item (2) it has been provided :

'In the case of a company...

(b) where the company is not a domestic company...

(ii) on the income by way of royalties payable by an Indian concern in pursuance of an agreement made by it with the Indian concern after the 31st day of March, 1961, and which has been approved by the Central Government.'

the rate of income-tax is 50 per cent. and the rate of surcharge is nil.

'(v) on any other income'

the rate of income-tax is 70 per cent. and the rate of surcharge is nil.

Therefore, it is clear, in view of the provisions of the Finance (No. 2) Act, 1961, that, so far as the assessee-companys payments to M/s. Vinyl Products Ltd., were concerned, if they amounted to payments of royalty and was thus an income by way of royalty, so far as M/s. Vinyl Products Ltd., was concerned, income-tax was payable at 50 per cent. of the income, where if they amounted to any other income, and thus fell under the residuary clause, then income-tax was payable at 70 per cent. of the gross income. It is common ground that the case would fall either under cl.(ii) which provides for taxation at 50 per cent. in the case of payment of income by way of royalties, or under cl.(v) which provides for income-tax at the rate of 70 per cent. on any other income.

Mr. Desai, appearing for the Revenue, has urged that, in fact, the appeals to the AAC and thereafter to the Tribunal were both incompetent as the AAC had no jurisdiction under the I.T. Act to entertain the appeal. In this connection, he relied on the provisions of s.246 of the I.T. Act, 1961, and contended that since this was not an appealable order as set out in s. 246, no appeal lay to the AAC against the decision of the ITO as set out in the letter dated November 21, 1971, to the assessee. Now we find that this very contention was urged before the Income-tax Appellate Tribunal, and in para. 7 of its order the Tribunal dealt with this contention in these words :

'Before we close, we would like to deal with another contention raised on behalf of Revenue in regard to admissibility of this appeal. Since we have taken the view in the earlier years that an appeal on this point was competent, this contention also fails.'

Thus the Tribunal rejected the contention urged on behalf of the Revenue that the appeal was not maintainable. However, against this decision of the Tribunal rejecting the contention regarding the maintainability of the appeal, no question was sought for by the Revenue when the application under s. 256(1) was made an the only question on which reference was sought to this High Court was regarding the question of royalties, and, that question actually has been referred to us for our opinion.

Mr.Desai, on behalf of the Revenue, when faced with this circumstance, contended that the question that is referred to us speaks of 'Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding' etc., and he says that since on the question of law, the Tribunals decision being right in law is being agitated, the question of maintainability of the appeal by the Tribunal would be another aspect of the matter and would be covered by the wide language of the words 'right in law' as set out in the question referred to us.

In this connection, Mr. Desai relied on the decision of a Division Bench of this High Court in Shankerlal H. Dave v. CIT, Income-tax References Nos. 57 and 82 of 1975 decided by a Division Bench of this court on 11/12th July, 1977 -since reported in : [1980]124ITR733(Guj) ). In that case, on behalf of the assessee, certain questions of fact were sought to be agitated before the High Court because, the decision of the Tribunal was a mixed question of law and fact and in order to arrive at the correct conclusion, the High Court was asked to consider certain aspects of the questions of fact. Thereupon on behalf of the Revenue an objection was raised that in view of some decisions of the Supreme Court it was not open to the High Court to do so. This contention urged on behalf of the Revenue in Shankerlal H. Daves case : [1980]124ITR733(Guj) was dealt with in this manner by the Division Bench (at p. 749) :

'... the learned Standing Counsel has raised various technical contentions to support the conclusions of the Tribunal. His first contention was that this was a case of pure finding of fact and unless that finding of fact is expressly challenged as being perverse or unreasonable and not supportable on the materials on record by a specific question raised in the reference, this court was bound by that finding of fact. The decision in CIT v. Madan Gopal Radhey Lal : [1969]73ITR652(SC) , where the earlier decision in India Cements Ltd. v. CIT : [1966]60ITR52(SC) , had been relied upon had been marshalled in aid. In these decisions, the Supreme Court had laid down that in a reference under the I.T. Act the High Court must accept the findings of fact made by the Appellate Tribunal and it is for the person who has applied for a reference to challenge those findings first by an application under s. 66(1). If he has failed to file an application under s. 66(1) expressly raising the question about the validity of the findings of fact, he is not entitled to urge before the High Court that the findings are vitiated for one reason or another. Where that principle applies it is not open to the assessee to contend on the question raised that the finding of the Tribunal was not supported by the evidence. These decisions are in the context of pure findings of fact which have to be specifically challenged by raising expressly the question that the finding is perverse or unreasonable and not supported by the evidence on record. This line of decisions has no application whatever where the finding of the Tribunal raises either a pure question of law or a mixed question of law. In the two latter categories of cases no such bar can be invoked that the High Court must accept even such an erroneous finding on mixed question of law and facts or on a pure question of law. The whole distinction is so well settled that it hardly needs any elaboration but as the learned Standing Counsel had vehemently relied on this question in a number of cases, we would point out the settled legal position in the matter.'

After referring to the decision in Shree Meenakshi Mills v. CIT : [1957]31ITR28(SC) and G. V. Naidu & Co. v. CIT [1959] 35 ITR 94 , the Division Bench culled out the ratio in Meenakshi Mills case as reiterated in G. V. Naidus. Case as follows (at p.602 of 35 ITR) :

'on principles established by authorities only such questions as relate to one or the other of the following matters can be questions of law under section 66(1) : (1) the construction of a statute or a document of title; (2) the legal effect of the facts found where the point for determination is a mixed question of law and facts; and (3) a finding of fact unsupported by evidence or unreasonable and perverse in nature.'

On the facts of that particular case in Shankerlal H. Daves case : [1980]124ITR733(Guj) , it was held that the question before the High Court was a mixed question of law and fact, the question before the High Court in that case being in the following terms : 'Whether, on the facts and circumstances of the case, the Tribunal was right in law in disallowing the remuneration paid by the HUF to its karta, Shri Shankerlal H. Dave, for all the three years under reference ?' This was a mixed question of fact and law and the conclusion of the Tribunal formed part of the mixed question of law and fact; hence the same could be considered by the High Court, and the High Court came to its conclusion on this mixed question of law and fact.

In the case before us the question, Mr. Desai wants to urge, is in regard to the jurisdiction of the AAC and the Tribunal regarding the entertainment of the appeal and since this question of law has not in terms been raised by an application under s. 256(1) and has not been referred to us, it cannot be said to be covered by the words 'right in law' occurring in the question referred to us. If the Revenue wanted to agitate this question, which is a pure question of law, it should have asked the Tribunal to refer the question to us by a specific prayer in that behalf in the application under s. 256(1) and since that was not done, we are not going into the question and we will only deal with the question which is referred to us. Therefore, the first submission made on behalf of the Revenue must fail.

As regards the question as to what is meant by the word 'royalty' the Tribunal is right when it says that the word

' is nowhere defined and it is in the light of the general legal principles relating to royalty that the question has to be decided, looking to the terms of the agreement entered into between the parties, namely, between the assessee company and Vinyl Products Ltd., of the U.K. The agreement, dated August 25, 1961, is annex. E to the statement of the case and it points out in the second part of the preamble that the company, that is M/s. Vinyl Products Ltd., is a manufacturer of certain vinyl polymers and complymers, in the form of emulsion, solutions and solid resins based on the vinyl monomers such a vinyl acetate, Styrene and esters and salts of acrylic and methacrylic acids and others and derivatives of these and similar resins and certain monomers produced by a process of ester interchange such as vinyl caprate and vinyl aterate and others according to certain secret or patent formulations owned or controlled by the company. In this agreement, Vinyl Products Ltd., is referred to as the company whereas the assessee-company is referred to as Calico. The further recital in the preamble is that Calico was desirous of obtaining the benefit of the results of future research and development by the company relating to the products upon the terms and conditions set out in the agreement and was also desirous of acquiring and enjoying the exclusive manufacturing and distribution rights of the products mentioned in Sch. A to the agreement and those products which were being developed by the company, namely, by Vinyl Products Ltd. Under cl. 1, the company granted and conveyed to Calico the sole and exclusive right and licence to manufacture, distribute, sell and exploit the products and improvements, modifications thereof in India and use of any Indian patents owned or to be owned by the company in respect of the said products. Under cl. 2, the company agreed from time to time and at all times to make available to Calico or its fully authorised agents such know-how within the companys knowledge and capability necessary for the use by Calico of vinyl acetate and products to be manufactured in India to the companys standards. Under cl. 3, Calico was to be free to manufacture, sell and exploit their production of vinyl acetate in India and other parts of the world subject to patents and instructions outside the companys control which may affect such sales outside India and the company agreed to use its best endeavours to obtain such agreements with other parties as may be proved necessary to remove any such restrictions to the benefit of Calico. By cl. 4, the company represented and warranted that it had enjoyed and continued to enjoy the sole proprietary rights of manufacture, sale and distribution and exploitation of the products and that it had not entered into any commitments or agreements with any person, firm and company in India and else where for the manufacture of the said products in India. Under cl. 5, the company undertook to make available to Calico the benefits of the results of future research and development by the company relating to the products and furnish Calico simultaneously with the execution of the agreement with all and any secret or patent formulations used by or known to the company for the manufacture of the products and as occasion might arise with all and any improvements, modifications and verifications thereof and any new products based on synthetic resins discovered or developed during the course of the agreement and to instruct Calico in the use of such products, their formulations and method of manufacture. Clause 7 stated that where the company was the proprietor of a trade mark registered in India which was used in relation to the said products, the company was bound to produce, if so desired by Calico, a registration of Calico as exclusive registered user of such trade mark in respect of the said products. Under cl. 12 of the agreement, Calico undertook to maintain and preserve the secrecy of the formulations and methods and processing the products and all improvements, modifications and variations thereof. Calico was to designate a representative to receive such information from the company who would be responsible for its safe custody. Calico was to instruct such nominee not to disclose to outside parties any secret information received from the company and to disclose such information to employees of Calico only to the extent necessary for proper conduct of the business and any and all information given by the company was to be strictly limited to Calico. Clause 13 provided that during the subsistence of the agreement, the company agreed that it was not to give or disclose to any other person, firm or company in India the benefit of such researches, discoveries or inventions or patents relating to the said know-how and was not itself to use such discovery, inventions or patents in India so as to compete with the Indian company anywhere in the whole of India in any manner whatever. Under cl. 14, the company was to provide facilities in their factory from time to time as might be mutually convenient to training and instruct suitable technicians from Calico in the manufacture. Processing and methods or applications of the products, the travelling and living expenses and salaries to be paid by Calico. Under cl. 17, it was provided as follows :

'Calico shall pay to the company 1% (one per cent.) on its net sales of the said products (excluding sales of vinyl) as research contribution only provided that the research contribution shall not be payable on the net sales made by Calico during the period of 12(twelve) months commencing from the date of production, the term net sales as used in this agreement shall mean the actual invoice value of all sales of the said products (excluding vinyl acetate) made by Calico less return allowances and credits, less all discounts, freight, transport, insurance, handling, delivery and all other charges relating to or arising from delivery of goods as are included in the invoice or which are added to the invoice, less and royalties and commissions allowed to agents or distributors. Less all taxes imposed or other charges directly made or levied upon the manufacture or sale (excluding other taxes based upon income). Calico undertake to keep true and accurate accounts showing the net value of sales of the products in India and shall render the company every six months within 45 (forty-five) days of the expiry of each six months period a full and accurate statement of the quantity and value of the products sold by them during the preceding six months and within one month f the acceptance of the statement by the company, Calico shall pay contributions due to the company.

No other fee or remuneration shall be payable to the company under this agreement.'

Under cl. 19 of the agreement, the term and duration of the agreement was to extend from the date of signing of the agreement for a period of 10 (ten) years and thereafter as mutually agreed or unless determined by one years notice but such notice could not be served before the end of the ninth year of the agreement. This agreement was subject to the approval of the Govt. of India, and it is on record that, in fact, the agreement was approved by the Govt. of India. The question, in the light of the provisions which we have set out hereinabove, is whether the payment of what is referred in cl.17 as a research contribution, amounted to 'royalty' as known to law.

In Corpus Juris Secundum, Vol. 77, at p. 542, it has been mentioned :

'Defined generally, the word royalty means a share of the product or profit reserved by the owner for permitting another to use the property; the share of the production or profit paid to the owner; a share of the product or proceeds therefrom reserved to the owner for permitting another to use the property; the share of the produce reserved to the owner for permitting another to exploit and use the property; a share of the profit, reserved by the owner for permitting another to use the property; the amount reserved or the rental to be paid the original owner of the whole estate.'

And it has been pointed out in foot-notes that 'royalty proper' is a share of product or profits reserved by the owner for permitting another to use or develop his property, and a case of one of the American Courts is referred to in support of this proposition in Corpus Juris Secundum.

In 'Words and Phrases Legally Defined', Volume 4, at p. 354, it has been pointed out :

'Royalty (except in the expression tonnage royalty includes a dead rent and any periodical or other payment for minerals got under a mining lease, and tonnage royalty means a royalty calculated by reference to the amount of minerals so got from time to time, or of manufactured articles produced from such minerals, or by any similar method.'


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