1.At the instance of the Commissioner of Income-tax, Madras, the Income-tax Appellate Tribunal, Madras Bench, under Section 256(1) of the Income-tax Act, 1961, has referred the following questions of law, arising out of the order of the Tribunal dated December 31, 1971, relating to the four assessment years 1964-65 to 1967-68 for the opinion of this court:
' (1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the disputed 50% of the technical aid fees to Messrs. Joseph Lucas (Industries) Ltd., England, was revenue expenditure and, therefore, liable to be allowed as deduction from the income of the assessee ?
(2) Whether, on the facts and in the circumstances, the Appellate Tribunal was right in law in holding that the initial depreciation should not be deducted in determining the written down value of assets for computation of capital employed in the newly established industrial undertaking under rule 19 of the Income-tax Rules, 1962 ?'
2. The assessee is a limited company engaged in the manufacture of electrical equipments like generators, starters, regulators, etc., and distributors for commercial vehicles, tractors, cars and motor cycles. It entered into a technical collaboration agreement dated June 6, 1962, with a foreign company, Messrs. Joseph Lucas (Industries) Ltd., England, hereinafter referred to as the foreign company. The foreign company granted to the assessee the exclusive right and licence to make, use, exercise and vend items of the electrical equipment for vehicles and engines and service tools. The agreement which has been annexed to the statement of the case marked annexure ' A ' contains several clauses which will give a clue as tothe nature of the arrangement arrived at between the parties. In the agreement the foreign company is termed as ' the grantor' and the assessee is termed as ' the licensee '. It also refers to the fact that the grantor is registered as proprietor of or has rights (including the right to sub-licence) in the patents effective in the licensed territory, meaning the geographical area of India. Such registered patents have been referred to in the first part of the first schedule to the agreement and the second part of the first schedule refers to the patents for which the grantor had then made application. Clause (e) of the preamble states that the grantor had agreed to grant to the licensee such licence in connection with inventions comprised in the said patents and licensed devices as mentioned in the agreement. Clause 2(d) defines ' non-exclusive right ' as meaning right enjoyed by the licensee in common with the grantor, its successors and assigns and all other persons to whom the grantor had granted or the grantor, its successors and assigns shall thereafter grant the like right.
3. Clause 3(a) refers to the nature of the right granted to the licensee and the same is as follows :
'The exclusive right and licence to make use, exercise and vend the Licensed Devices and parts thereof within the Licensed Territory, ALWAYS PROVIDED that the Grantor shall have the right to import into the Licensed Territory any of the Licensed Devices made by or for or under licence from the Grantor and which are fitted as original equipment on vehicles or engines made outside the Licensed Territory and also have the right to import spare parts and/or replacements which shall be sold either through licensee or through Lucas's wholly owned subsidiary company Lucas Indian Service Private Limited AND PROVIDED FURTHER that the exclusive licence herein granted shall be subject to any licence which the Grantor may at the date hereof have granted in respect of the licensed devices in the Licensed Territory.'
Clause 6 provides that the licence and agreement shall become effective on the first day of October, 1962, and shall continue in force for a period of ten years from such date and thereafter may with the consent of the parties be extended for further five-year periods.
4. There is a provision for termination of this licence even before the expiry: of the period of the said ten years for stated reasons mentioned in clause 10. Clause 10(a) stated that if any of the fees or royalties or other payments payable under the agreement shall be in arrear and remain unpaid for a period of thirty days after the same became payable as therein referred to, whether or not a formal demand therefor shall have been made by the grantor, the grantor can terminate the licence. Clause 10(b) provided for termination in the event of bankruptcy, etc., of the licensee. Clause 10(c) also enabled the grantor to terminate the licence if the licenseegranted a sub-licence or assigned the agreement or the licence, contrary to the terms of the agreement in favour of a third party.
5. Clause 7(a) deals with payments to be made under the agreement. Under Clause 7(a)(i), in consideration of the technical services rendered by the grantor, a fee amounting to one per cent. of the factory cost of all licensed devices and spare parts for such devices manufactured and sold by the licensee shall be paid by the licensee to the grantor. Under Clause 7(a)(ii), in consideration of the licences and other rights granted under, the agreement in respect of the scheduled patents and the grantor's designs, a royalty amounting to two per cent., of the factory cost of all licensed devices and spare parts for such devices manufactured and sold by the licensee shall be paid by the licensee to the grantor. Clause 7(a)(iii) states that in respect of licensed devices which are exported outside the licensed territory, a royalty of one per cent. in addition to the fees and royalties referred to in Clauses 7(a)(i) and (ii) above, shall be paid.
6. There is a provision dealing with improvements to the patented material that may be made by the licensee. Clause 7(e) states : ' If at any time during the continuance of this licence, the licensee shall make or discover any improvement or addition to the licensed devices or the working of the same or is now or shall hereafter become the owner of or has now or shall hereafter obtain the control of any such improvement or addition then and in any such case the licensee will communicate and explain the same to the grantor which shall enjoy a royalty-free licence under any patent that the licensee may obtain covering such improvement or addition for the term of such patent.'
7. There is a reciprocal provision with regard to the improvements that may be made by the grantor which is contained in clause 8(b) and that clause is more or less similar to Clause 7(e) except for the fact that in respect of such improvements or additions, the patentable right shall remain with the grantor.
8. Clause 7(h) imposes an obligation on the licensee to recognise and acknowledge the validity of every patent at any time licensed under the agreement and prohibits the licensee, during the continuance of the licence or after termination thereof, from contesting the validity of any such patent either directly or indirectly or in any way assisting counsel or procuring others so to do.
9. Clause 7(i) is important and it states that the licensee will not without the written consent of the grantor during the continuance of the licence or at any time after its termination disclose to any third party any manufacturing information supplied to or acquired by the licensee under the agreement except such information as is made available to the general public by or with the consent of the grantor.
10. Clause 9 expressly provided that the licensee shall have no power at any time to assign the licence or to grant any sub-licence or in any way to charge, mortgage or deal with the rights granted under the agreement without the previous consent in writing of the grantor first had been obtained.
11. Under Clause 14(c), the obligation to keep information confidential set out in the agreement in sub-clause 7(i) shall continue indefinitely. Clause 14(d) provided that if the licensee had stock in hand of the licensed devices at the date of termination, it might within one year after the date of termination dispose of such stock and its obligations regarding payment of royalties, keeping of records and submission of reports shall be deemed to continue in respect of such stock in hand, so disposed of.
12. It is with reference to this agreement the assessee claimed amounts which it paid by way of fees and royalties provided for in Clause 7(a) of the agreement, as deductible expenditure in the computation of the profits or gains. The Income-tax Officer held that 50% of such expenditure was capital in nature as it brought into existence an enduring asset, namely, necessary information for the manufacture of the patented articles, and therefore only 50% of the amounts paid by the assessee could be allowed as deduction. However, on appeal preferred by the assessee, the Appellate Assistant Commissioner held that the assessee had not acquired any capital asset or derived any enduring benefit under the technical collaboration agreement and that the assessee's case was on all fours with the decision of the Supreme Court in Ciba's case : 69ITR692(SC) and accordingly allowed the entire technical fees as revenue expenditure. Aggrieved by the order of the Appellate Assistant Commissioner in respect of the assessments for all the four years, the department preferred appeals and all these appeals were disposed of by a common order of the Tribunal. The Tribunal held that the principles laid down by the Supreme Court in Cuba's ease : 69ITR692(SC) applied to the facts of the present case and that consequently the Appellate Assistant Commissioner was fully justified in reversing the order of the Income-tax Officer. It also held that the initial depreciation was not to be deducted for computation of capital for the purpose of Section 84 of the Income-tax Act, 1961. It is the correctness of these conclusions that are challenged in the form of questions extracted already referred to this court.
13. As far as the first question is concerned, we are clearly of the opinion that the principles laid down by the Supreme Court in Commissioner of Income-tax v. Ciba of India Ltd. : 69ITR692(SC) directly apply to the facts of the present case. The terms of the agreement which have been extracted in the judgment of the Supreme Court would appear to be more or less similar to the ones which the assessee entered into with the foreign company in the present case, to which we have already drawnattention. The Supreme Court in the judgment in question pointed out at page 699 :
' 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 access to the technical knowledge and experience in the pharmaceutical field which the Swiss company commanded. The assessee was on that account a mere licensee for a limited period of the technical knowledge of the Swiss company with the right to use the patents and trade marks of that company.'
14. After referring to the terms of the agreement, the Supreme Court further pointed out at page 701 :
' The following facts which emerge from the agreement clearly show that the secret processes were not sold by the Swiss company to the assessee : (a) the licence was for a period of five years, liable to be terminated in certain eventualities even before the expiry of the period; (b) the object of the agreement was to obtain the benefit of the technical assistance for running the business ; (c) the licence was granted to the assessee subject to rights actually granted or which may be granted after the date of the agreement to other persons; (d) the assessee was expressly prohibited from divulging confidential information to third parties without the consent of the Swiss company; (e) there was no transfer of the fruits of research once and for all; the Swiss company which was continuously carrying on research had agreed to make it available to the assessee ; and (f) the stipulated payment was recurrent dependent upon the sales, and only for the period of the agreement.'
15. The Supreme Court also pointed out at page 700 :
' The assessee acquired under the agreement merely the right to draw, for the purpose 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 : by making that technical knowledge available the Swiss company did not part with any asset of its business nor did the assessee acquire any asset or advantage of an enduring nature for the benefit of its business.'
16. We are of the opinion that the above reasoning of the Supreme Court will clearly apply to the facts of the present case. We have already referred to the fact that the arrangement itself is termed as 'licence 'and 'agreement' and that the foreign company is called the ' grantor ' and the assessee is called the ' licensee '. Even assuming that this nomenclature is not decisive of the character of the arrangement, the other terms to which we have drawn attention will clearly show that the assessee had not acquired any capital asset nor the foreign company had parted with any capital asset in favour of the assessee. Mr. Jayaraman, learned standingcounsel for the department, repeatedly contended before us that there is nothing in the agreement prohibiting the assessee from manufacturing identical articles with the know-how which it had already obtained, even after the termination of the agreement. We are unable to find any support whatever for this contention from the terms of the agreement. We have already referred to the clause wherein it is provided that even the stock which remained at the hands of the assessee after the expiry of the period of the licence should have to be sold within a period of one year and the royalties payable in respect thereof should be paid. If that be the case with regard to the products already manufactured and remaining unsold on the date of the termination of the agreement, it will automatically follow that the assessee had no right to manufacture fresh articles on the basis of the know-how which it obtained from the foreign company.
17. The learned counsel also drew our attention to the use of the word ' exercise ' occurring in Clause 3(a) of the agreement, namely, ' The exclusive right and licence to make, use, exercise and vend the licensed devices and parts thereof within the licensed territory ' and contended that the word ' exercise ' contemplated a continuous right to use on the part of the licensee, even after the agreement came to an end. We are unable to agree with this contention, because the word ' exercise ' would appear to be a common word used in such agreements and, as a matter of fact, identical collocation of words finds a place in the agreement in the case of Ciba Co. : 69ITR692(SC) , considered by the Supreme Court itself.
18. Having regard to all these circumstances, we are clearly of the opinion that the present case is on all fours with Ciba's case : 69ITR692(SC) , decided by the Supreme Court, referred to already. Consequently, we hold that the entire payments made by the assessee to the foreign company will be in the nature of licence fee and, therefore, will constitute an item of expenditure in the computation of its profits and gains. The result is, as far as the first question is concerned, we answer the same in the affirmative and in favour of the assessee.
19. As far as the second question is concerned, it turns upon the construction of rule 19 of the Income-tax Rules, 1962. Rule 19(1) states that for the purpose of Section 84, the capital employed in an undertaking or a hotel to 'which the said section applies shall be taken to be--in the case of assets acquired by purchase and entitled to depreciation--if they have been acquired before the computation period, their written down value on the commencing date of the said period. Rule 19(6) defines the expression, 'written down value.' in Clause (iv) thereof, as meaning ' written down value computed under Sub-section (6) of Section 43 as if for the words 'previous year' the words 'computation period' were substituted. 'Section 43(6) of the Income-tax Act, 1961, defines 'written down value' as meaning:
'(a) in the case of assets acquired in the previous year, the actual cost to the assessee;
(b) in the case of assets acquired before the previous year, the actual cost to the assessee less all depreciation actually allowed to him under this Act, or under the Indian Income-tax Act, 1922 (XI of 1922), or any Act repealed by that Act, or under any executive orders issued when the Indian Income-tax Act, 1886 (II of 1886), was in force : Provided that in determining the written down value in respect of buildings, machinery or plant for the purposes of Clause (ii) of Sub-section (1) of Section 32, 'depreciation actually allowed' shall not include depreciation allowed under Sub-clauses (a), (b) and (c) of Clause (vi) of Sub-section (2) of Section 10 of the Indian Income-tax Act, 1922 (XI of 1922), where such depreciation was not deductible in determining the written down value for the purposes of the said Clause (vi).'
Thus, a combined reading of Rule 19(1) and (6) read with Section 43(6) of the Income-tax Act, 1961, will clearly show that the initial depreciation shall not be deducted in computing the written down value for the purpose of calculating the capital. However, it would appear that a curious argument was advanced before the Tribunal on behalf of the department, which is found in paragraph 10 of the order of the Tribunal, namely, 'The contention of the revenue is that initial depreciation should not be deducted only for purposes of Section 32(1)(ii) and for purposes of Rule 19, the deduction is permissible'. We are unable to appreciate this argument. As a matter of fact, Rule 19(6) dealing with the written down value throws one back to Section 43(6) and Section 43(6) will necessarily include the proviso thereto and the proviso expressly states that initial depreciation will not be included in the expression ' depreciation actually allowed.'
20. Consequently, the Tribunal was right in holding that the initial depreciation should not be deducted for arriving at the written down value for the computation of the capital for the purposes of Section 84 of the Income-tax Act, 1961. Hence, we answer the second question also in the affirmative and in favour of the assessee.
21. The assessee will be entitled to its costs. Counsel's fee is fixed at Rs. 500 (Rs. Five hundred only).