1. The assessee is a public limited company incorporated on November 28, 1956. They manufacture transformers at its factory at Adyar, Madras. This reference relates to the assessment year 1961-62 and the accounting year being the calendar year 1960. The assessee received technical assistance from a West German company (hereinafter called Dominit). The subject-matter of the assistance and the terms and conditions thereof are contained in an agreement dated December 28, 1956, executed by the assessee and the Dominit. The relevant portions of the agteement are as follows :
'1. Whereas Transformer & Switchgear intends to establish at Madras, a factory for the manufacture of transformers, whereas Dominit disposes of procedures, designs, experience and technical know-how used in the field of manufacture of the transformers.
Whereas Transformer and Switchgear desires that Dominit should render technical aid and assistance for the establishment, the starting of work and operating of the factory that is to be established at Madras and that Dominit for this purpose should make available to Transformer & Switchgear its procedures, designs, experiences and technical know-how and whereas Dominit is prepared to do so, if compensated by the assignment of Transformet & Switchgear shares in accordance with the following provisions of the agreement:
The contract matter is the manufacture of transformers of all kinds and types..... Article 3:
Dominit agrees to grant Transformer & Switchgear technical aid and assistance in the field hereinbefore defined as to the contract matter for the establishment, the starting of work and the operation of the factory which is to be established at Madras by Transformer and Switchgear in accordance with Article 2 hereof. The grant of the technical aid and assistance includes:
(a) the complete communication to Transformer & Switchgear of all inventions, procedures, designs, methods of manufacture, experience and technical know-how (hereinafter referred to as 'inventions', etc.), which Dominit disposes of in the field of the contract matter;
(b) the yielding up of the plans, drawings, construction designs and calculation appertaining to the inventions etc., defined in sub-paragraph (a), the particulars are to be based on the BSS-P or I.S.I. (Indian Standards Institution) regulations; the plans must include the testing of the materials for manufacture and the establishment of a testing station for transformers :
(c) the assistance given by the experts which will be sent according to paragraph 6;
(d) the granting by Dominit to Transformer & Switchgear of an exclusive licence covering the inventions, etc., defined in sub-paragraph (a), whether they be protected or not, and including the industrial protection rights appertaining to them (patents, rights from patent applications and registered designs). The duration of the licence is equal to the duration of this agreement. The territory for which the licence is granted is India.
Transformer & Switchgear is not entitled to assign the licences and/or to grant sub-licences. Dominit shall determine the kind and the extent of any and all rights of industrial protection (i.e., patent rights, rights under patent applications and registered designs) in the field of the contract matter. The industrial protection rights in the field of the contract matter are, remain or shall become the property of Dominit who shall be responsible for obtaining, maintaining and defending those industrial protections. The costs involved in matters of industrial protection in the field of the contract matter in India, including the costs for maintaining and defending such protection shall be debited by Dominit to Transformer & Switchgear and shall be credited by Transformer & Switchgear to Dominit after the debit has been entered. Transformer & Switchgear undertake to do nothing and to refrain from doing anything which might in any way impair the obtaining in the field of the contract matter of the most extensive industrial protection possible.
All communications which Dominit and which Transformer & Switchgear give to one another in pursuance of this agreement are to be kept strictly secret from all third parties in so far as they have not been disclosed by patents. This particularly concerns inventions, etc., made by the parties in the field of the contract matter, improvements, etc., thereto. All communications between the parties which are marked 'confidential' and which are in respect of turnover, calculations, drawings, construction designs and business connections are also to be kept strictly secret. Dominit undertakes not in India to manufacture, nor there to have manufactured by third persons or firms in the manufacture of the products of the contract matter in so far and inasmuch as Transformer & Switchgear manufactures these products in the course of this agreement. Dominit also undertakes not to offer or to deliver the products mentioned in the first sentence of this paragraph to any third party in India unless such offer or delivery were made upon request by or with the express consent of Transformer & Switchgear. Transformer & Switchgear undertakes not outside India to manufacture nor there to have manufactured by third persons or firms, nor to assist such persons or firms either technically or financially in the manufacture of the products in the field of the contract matter manufactured by Transformer & Switchgear. Transformer & Switchgear also undertakes not to offer or to deliver the products of the contract matter manufactured by it to third parties outside India unless such offer or delivery were made upon request by or with the express consent of Dominit. Dominit undertakes to put at the disposal of Transformer & Switchgear one (if necessary two) trustworthy engineers who has (have) experience in the field of the contract matter and whose task is responsibly to direct the establishment of and the smooth procedure of work in the factory. Therefore, Dominit shall send to Transformer & Switchgear at Madras an experienced Engineer who is familiar with the general management of a factory of the kind to be established by Transformer & Switchgear. Transformer & Switchgear will put this engineer in charge of the general management of the whole factory which is to be established according to art. 2 hereof and shall vest him with the necessary authority for the management.
A technical engineer (if necessary) who is familiar with the calculation, the construction and the supervision of the production, in the field of the contract matter. Transformer & Switchgear Limited will put this engineer in charge of the manufacture of the factory to be established, according to Article 2 hereof, this engineer will be the production-director and Transformer & Switchgear will vest him with the appropriate authority for management.
Dominit undertakes to give Indian engineers a practical training in its plant at Hoppecke at the expense of Transformer & Switchgear. The height of the costs must be decided in each case. Transformer & Switch-gear pays as return for the assistance of Dominit a licence fee of 3% of the annual turnover. The sum of the net amount of the invoices is understood as turnover for the articles of the relevant contract. The net invoice value is equal to the gross invoice value less costs for packing, freight and taxes, etc. Transformer & Switchgear grants Dominit the acquisition of dividends and/or shares up to 25% of these new shares which are issued at the time of increasing capital. The contract price, which Dominit will have to pay, is the nominal value (at par). The duration of this agreement is 10 years counting from the date when it has been signed in due form of law by both parties.
After the end of this period the duration of the agreement is automatically extended for another period of five years at any given time unless one of the parties terminate it by one year's written notice to be served upon the other party.
In the event of any Dominit's patents, rights from applications or regis- tered designs still existing in India at the time of termination of this agreement the right of Transformer & Switchgear in future to use the still existing industrial protection rights shall end. Provided always that the notice has been served by Transformer & Switchgear or that the termination of this agreement is due to faulty acts of Transformer & Switchgear. In case notice of termination is served by Dominit or in case the termination of the agreement is due to faulty acts of Dominit, Transformer & Switchgear shall be entitled to use those Dominit patents, rights from patent applications or registered designs in India in the field of the contract matter until such time when they run out. Patentable secret procedures shall be treated alike to patents in the meaning of the provisions. After termination of this agreement Dominit shall again be free to manufacture and sell products of the contract matter in India. However, the manufacture and export restrictions imposed upon Transformer & Switchgear for the countries outside India shall remain in force even after termination of this agreement in so far as Transformer & Switchgear manufactured products of the contract matter using methods of production, procedures, experiences of improvements which have been made available to it in pursuance of this agreement. The parties' obligation to keep strictly secret and communications mentioned in Article 4 paragraph (7) hereof continues in full after termination of the agreement.'
2. In the assessments of the assessee for the assessment years 1957-58, 1958-59, 1959-60 and 1960-61 the fee paid to Dominit under this agreement was allowed as a revenue expenditure by the Income-tax Officer. In the assessment year 1961-62 the assessee had paid to Dominit a sum of Rs. 56,865 as fee payable under the agreement, on the basis of 3% of its turnover of Rs. 18,95,503. But the Income-tax Officer allowed only 50% of the fee paid, namely, Rs. 28,433, as revenue expenditure and disallowed the balance of 50 per cent. as capital expenditure. This was in the view that the fee paid was partly for the supply of technical know-how, patents and designs and partly for the use of patents and designs by the assessee. The Income-tax Officer was of opinion that the portion of the fee relatable to the supply of technical know-how, patents and designs was a payment for obtaining an asset of a permanent nature and hence it is capital in nature; but the fee referable to the user of the patents and designs of Dominit was revenue expenditure. On the ground that the sum of Rs. 56,865 paid to Dominit was a composite payment he apportioned the payment at 50% each.
3. On appeal, the Appellate Assistant Commissioner took the view that the technical know-how received by the assessee was neither a capital asset nor by the payment of the fee to the Dominit the assessee acquired any asset of a permanent nature. This was in the view that the technical assistance was limited to the period of the agreement and the quantum of payment was also dependent on the turnover and that the payment was only in the nature of royalty. Accordingly, the Appellate Assistant Commissioner allowed the entirety of the fee as a revenue expenditure. The department preferred appeal to the Tribunal. The Tribunal divided the services to be rendered by the Dominit under the agreement into three categories--firstly, assistance for establishment, starting of work and operation of the work; secondly, giving technical know-how for the manufacture; and thirdly, grant of right to use the licences, patents, etc. In the view of the Tribunal the fee paid for the first category of assistance was capital in nature. Since the assessee was never manufacturing transformer at any earlier stage and they were starting manufacturing them for the first time, the grant of technical know-how resulted in bringing into existence a new business and a new source of income and amounted to acquisition of an asset or an advantage of an enduring nature for the benefit of the assessee and that, therefore, the fee paid for the second category of assistance was also capital. The fee paid for the third category was revenue in nature. Since the fee paid to Dominit under the agreement covered all these three types of assistance it was a composite payment and that the Income-tax Officer was, therefore, justified in disallowing 50% as capital expenditure. At the instance of the assessee the following question has been referred :
'Whether, on the facts and in the circumstances of the case, and the terms of the agreement, the treatment of 50% of the licence fees paid by the assessee as capital expenditure is right in law ?'
4. Even at the outset, we want to make it clear that the learned counsel for the revenue did not agree that the payment was a composite payment or that the allocation of the expenditure between capital and revenue at 50% each was justified. The question referred to us did not call for any consideration as to whether payment was composite or the allocation was proper. Therefore, we have to consider only as to whether payment of Rs. 28,433 representing 50% of the total payment was a capital expenditure.
5. We have considered in our judgment in T.C. No. 299 of 1968 (Fenner Woodroffe & Co. Ltd. v. Commissioner of Income-tax : 102ITR665(Mad) the nature of the know-how and the various decisions which dealt with the know-how agreements. We, therefore, have to only note the facts in respect of this case and apply the principles laid down in that judgment.
6. As seen from the relevant portions of the agreement extracted above, the agreement covered the technical aid and assistance for the establishment, starting of work and the operating of the factory for manufacture of transformers of all kinds and types. Dominit shall also make available to the assessee its procedures, designs, experience and technical know-how in respect of the same. In consideration, the assessee agreed to pay 3% of their annual turnover. The duration of the agreement was for 10 years and at the end of that period it would automatically be extended for another period of five years unless the renewal was terminated. The assessee even after the expiry of the period of the agreement could use the methods of production, procedure, experiments, improvements, which had been made available to them in pursuance of the agreement, but only subject to the condition that its obligation to keep them secret still continues even after termination. It was also subject to another condition that the transformers and switchgears manufactured by the assessee shall not be exported to certain countries. Thus, the assessee had acquired knowledge or advantage of an enduring nature. Therefore, the amount paid was not an admissible deduction.
7. The learned counsel for the assessee argued that the consideration payable under the agreement was not a lump sum payment and it is a periodical payment which was linked and made dependent on the turnover and that, therefore, the payment cannot be treated as capital expenditure. This point also we have discussed in detail in our judgment in T.C. No. 299 of 1968 (Fenner Woodroffe & Co. Ltd. v. Commissioner of Income-tax). We have there held that it is the aim and object of the expenditure that would determine the character of the sum, whether it is capital or revenue expenditure and neither the source nor the manner of payment are the sole test. The fact that the agreement did not fix any lump sum consideration but referred to a periodical payment linked to the production or turnover, does not in any way take it out of the category of a capital expenditure.
8. For the foregoing reasons, we answer the reference in the affirmative and against the assessee with costs. Counsel fee Rs. 250.