1. At the instance of the assessee, the Income-tax Appellate Tribunal, Madras Bench 'B', Madras, has referred the following question for the opinion of this Court:--
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that 25% of the amount paid by the assessee as royalty to Messrs. Jonas Woodhead & Sons, was capital expenditure and therefore not allowable as a revenue expenditure under the provisions of the Income-tax Act, 1961, for the assessment years 1967-68 and 1968-69".
2. The assessee is a limited company incorporated on 8-3-1963 to carry on the business of manufacturing automobile springs. The accounting year of the assessee company is the calendar year. On 8-4-1964, it entered into an agreement with Jonas Woodhead and Sons Ltd., having its registered Office in the United Kingdom, hereinafter referred to as the "English Company" for the manufacture of all types of springs and suspensions for road and rail vehicles as were being manufactured by the English Company, with the help of the technical knowledge and experience possessed by the English company in connection therewith. In the preamble portion of the said agreement, it is stated that the new company, namely, the assessee-company is desirous of obtaining from the English Company the right to manufacture and sell such of the products manufactured and sold by the English Company as are mentioned in the agreement subject to and upon the terms and conditions therein mentioned. It is also stated in the preamble portion that it was agreed between the assessee-company and the English Company that the assessee-company will have an issued equity share capital of Rs. 13,98,00/- and that the English Company will subscribe for equity shares equivalent to 33 1/3 percent of the issued equity share capital. The important clauses in the agreement are as follows:
3. Clause 1(a) of the agreement defined 'licensed products' as meaning as on the date of the agreement, 'all types or descriptions of springs and all types of suspension for road and rail vehicles.'
4. Clause 2 stated that the English Company granted to the assessee-company, subject to the terms of the agreement, the right to manufacture in accordance with the processes and techniques of the English Company, the licensed products in India and that the assessee agreed to provide buildings having a factory area of 35,000 square feet having all services necessary in connection therewith, in accordance with the instructions to be given by the English Company for the manufacture of the licensed products.
5. Clause 3 dealt with grant of sales rights.
6. Clause 4(a) of the agreement read as follows:
"During the continuance of this agreement JWS (English Company) will supply to the new Company (assessee company) all technical information and know how in the possession of JWS relating to the setting up of plants suitable for the manufacture of the licensed products and relating to the actual manufacture thereof including plant drawing estimates, specifications, manufacturing methods, blue prints of production and testing equipment and other data and information necessary or desirable to enable the new Company to manufacture the licensed products on the scale required and to set up proper and efficient plants therefor provided that JWS shall not be under any obligation to supply to the new Company any information which JWS shall itself have received from some third party and which JWS shall not be at liberty to divulge to the new Company" (Italics are ours).
Sub-clause (b) of this clause provided for the English Company supplying to the assessee-company from time to time, as and when available all such further technical information, know-how and research development relating to the licensed products, the materials therefor or the manufacture thereof which may come to the knowledge of the English Company.
7. Clause 5 dealt with manufacturing standards and tests. Sub-clause (e) of this clause provided that the assessee-Company will not purchase from any source not previously approved in writing by the English Company and the English Company are appointed purchasing agents for all raw material and other materials and plant to be purchased outside India during the term of this agreement.
8. Clause 6 dealt with the marking of the licensed goods.
9. Clause 7 dealt with advertisements and clause 8 dealt with competing product.
10. Clause 9 dealt with visits by the employees of the English Company to the works of the assessee-company. Sub-clause (a) of this clause provided:
"At the request of the new Company (assessee-Company) JWS (the English Company) will during the period of this agreement and any extension thereof arrange for engineers and/or technical specialists employed by JWS to visit the premises of the new Company in India for the purpose of assisting and advising and co-operation with the new Company in connection with the manufacture of the licensed products and the setting up of a proper and efficient plant suitable for the manufacture thereof on the scale required by the new Company."
11. Clause 10 provided for visits by the employees of the assessee-company to the English Company's Factories.
12. Clause 11 dealt with confidential information, Sub-clause (b) of this clause provided that after the termination of this agreement from any cause the assessee-company will promptly return to the English Company at the expense of the assessee-company all specifications, designs, formulas, plans and other technical data furnished by the English Company under the agreement and remaining in the possession of the assessee-company relating to the licensed products.
13. Clause 12 dealt with the payment of royalty, which is important and sub-clause (a) of it read as follows.
"In consideration of the information to be furnished and services to be rendered to the new Company (assessee-company) by JWS (the English Company) the new company shall pay to JWS during the continuance of this agreement a royalty at the following rates of the licensed products turnover of the new Company which shall be calculated and payable in accordance with the provisions of this clause:--
(i) During the first period of twelve months commencing on the date on which actual production on a commercial scale of the licensed products is started by the new company the rate per cent shall be 3.
(ii) During the second period of twelve months from such date the rate per cent shall be 2.
(iii) Thereafter the rate per cent shall be 11/2".
It is unnecessary to reproduce the other portions of this clause.
14. Clause 13 dealt with accounts and clause 14 dealt with trade marks and trade names. Clause 15 dealt with patents and clause 16 dealt with assignment and sub-licenses.
15. Clause 17 imposed a restriction on the assessee-company not to export the licensed products or sell the licensed products for export from India without previous written approval of the English Company.
16. Clause 18 death with the life of the agreement an provided for a period of ten years from the date of production by the assessee-company and also provided for a further period of ten years, subject to obtaining a license from the Indian Government.
17. Clause 19 deal with the termination of the agreement other than under clause 18.
18. Clause 20 dealt with notices to be served.
19. The agreement contained a schedule which was intended to be a form of Registered User Agreement to be entered into between the parties. Clause 4 of the said Registered User Agreement read as follows:--
"There is no royalty or other remuneration payable by the new company (the assessee-company) to JWS (the English Company) for the rights granted to the new Company under this agreement."
20. The certificate of commencement of business was issued to the assessee-company on 9-3-1964 and the production of spring for automobiles commenced on 1-1-1966. In terms of the agreement referred to above, the assessee-company made payments of Rs. 24,000/- and Rs. 47,000/- for the assessment years 1967-68 and 1968-69 respectively to the English Company as royalty. The Income-tax Officer disallowed one-fourth of the payments, namely Rs. 6000/- for the assessment year 1967-68 and Rs. 11,750/- for the assessment year 1968-69 on the ground that such part of the payments represented consideration for services provided by the English Company of an enduring nature and was therefore capital in content. The assessee-company's appeals to the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal failed and hence the question extracted above was referred to this Court for its opinion.
21. Before the Tribunal, the assessee relied on the ratio of the decision of the Supreme court in Ciba (India) Ltd's case and contended that the entire payment made by the assessee-company to the foreign company was revenue in nature and should have been allowed in the computation of profits. As against this, the Department relied on a decision of the Karnataka High court in Mysore Kirloskar Ltd's case ((1968) 67 ITR 23) and contended that the authorities below were right in disallowing the portion as capital expenditure.
22. In our opinion, it is not necessary to refer to any of these decisions for the reasons we will indicate presently. There is no dispute in the present case that under the agreement with the English company, what was set up by the assessee was a new business. Equally there is no dispute that under the there is no dispute that under the agreement, the English company had furnished information and rendered services in setting up the factory itself. Under these circumstances, the question for consideration is, whether the amounts paid by the assessee-company to the English Company can be said to be wholly revenue in nature so as to entitle the assessee-company to claim deduction of the whole of the amounts in the computation of its profits.
23. We have just now mentioned that it is unnecessary to refer to any of the cases for the simple reason that ultimately the question has to be decided on the basis of the terms of the particular agreement and the only general principle that can be derived from the decisions is that under the terms of an agreement, if the assessee acquired a benefit of enduring nature that will constitute "acquisition of an asset" and any amount paid for the same would constitute "capital expenditure" and on the other had if the assessee had acquired merely technical knowledge or knowledge for the manufacture of any particular item for a specified duration, then he had acquired only a licence to use the other party's patent and knowledge and the amount would constitute "revenue expenditure". In the present case, as we have pointed out already, there is no dispute and the terms of the agreement also provided for the same, that the English company rendered assistance and furnished information for the purpose of setting up a factory to produce the licensed products. Under the terms of agreement, even after the agreement comes to an end, there is no provision for dismantling the factory and the factory will continue to exist as an asset of the assessee-company and therefore there cannot be any controversy that under the agreement the assessee-company acquired an enduring asset.
24. The only question for consideration is whether the assessee made any payment for the acquisition of this enduring asset or not. Mr. S. Padmanabhan, learned counsel for the assessee-company repeatedly contended before us that even though under the agreement the assessee-company had acquired a capital asset, the assessee-company had not made any payment to the English Company for the services rendered in setting up the factory and the payment which the assessee-company made was only for the production of the licensed products and not for anything else. We are unable to accept this argument for more than one reason. We have already referred to the terms of the agreement and clause 4 of the agreement expressly contemplates the English Company supplying all technical information and know-how to the assessee-company for setting up a plant for the manufacture of the licensed products. We have also extracted sub-clause (a) of clause 12 which uses the expression. "In consideration of the information to be furnished and services to be rendered" to the new company (assessee-company) by JWS (the English Company in general terms, without restricting it towards manufacture of licensed products. Therefore a combined reading of clause 4 and clause 12 will lead to the result that the royalty whose payment is, provided for, in clause 12 was in consideration of the information furnished and the services rendered by the English Company to the assessee-company, which information and services were not confined only to the production of the licensed products, but extended also to the setting up of the factory itself. In view of this, the conclusion is inescapable that the payment made by the assessee company as royalty to the English Company had in it an element of capital expenditure embedded, and the only question was what should be the percentage of that element. The Tribunal has found as a fact 25% arrived at by the Department was a reasonable percentage, and there was no argument relating to this percentage before us.
25. For coming to the conclusion which we have come to we are not relying exclusively on the absence of any provision in the agreement that the services rendered and information furnished for the setting up of the factory were free as contended by the learned counsel for the assessee, but we are drawing the inference form the combined effect of the clauses contained in the agreement, to the most important of which we have already drawn attention. It is worthwhile to refer to one other feature. We have already referred to the form of the User agreement annexed to the agreement in question. Clause 4 of the said User Agreement annexed to the agreement in question stated that there was no royalty or other remuneration payable by the new company, that is, the assessee-company to the English Company for the rights granted to the assessee-company under that agreement. This will make it clear that what was provided for in clause 12 rights was not the remuneration for user of the rights granted by the English Company but a composite payment for all the services rendered and information furnished by the English Company to the assessee-company in the setting up of the factory as well as the manufacture of the licensed products in that factory.
26. In view of these features present in the case, we are clearly of the opinion that the answer to the question referred to this Court must be in the affirmative and in favour of the Revenue. We accordingly answer the question in the affirmative and in favour of the Revenue.
27.We have not referred to any decided cases, because in reply to the specific question put to the learned counsel for the assessee-company, the learned counsel stated that there is no direct decision of any court on an agreement similar to the one in the present case and dealing with the claim to apportion the payment partly as capital and partly as revenue.
28. The Department will be entitled to its costs of this reference. Counsel's fee Rs. 500/- (Rupees five hundred only).
29. Answer in the affirmative.