1. The Appellate Tribunal has referred the following question under Section 256(1) of the I.T. Act, 1961 :
'Whether, on the facts and in the circumstances of the case, the technical aid fee paid by the asscssce to Josepli Lucas (Industries) Ltd. of the U.K. under the collaboration agreement dated May 4, 1966, is allowable as business expenditure or whether the whole or any part of it (not exceeding 50% thereof) is liable to disallowance as capital expenditure ?'
2. The relevant assessment years are 1967-68, 1968-69 and 1969-70. The assessee carries on business in the manufacture and sale of brake equipments for automobiles including commercial vehicles. It commenced its business some time in 1963. For these assessment years, the question that arose for the consideration of the ITO was, whether the technical aid fee paid to M/s. Joseph Lucas under the agreement dated May 4, 1966, could be allowed in full. This agreement had the approval of the Govt. of India and was effective from January 1, 1966. But, under the direction of the Govt. of India, a supplemental agreement on June 2, 1969, conferred retrospective effect to the agreement with effect from April 1, 1964. The U.K. company was engaged in the manufacture of complete brake systems for the automobile and non-automobile units comprising foundation brakes, master cylinders, wheel cylinders, brake seals, brake hoses and component parts and service tools for all such equipment. The U.K. company was in possession of technical information relating to the above types of equipment. It also obtained patents in India in respect of several items of equipment. The assessee started to manufacture brakes and other items and, therefore, entered into an agreement of collaboration with the U.K. company.
3. By Clause 3 of the agreement, the U.K. company granted to the assessee the exclusive right and licence to make use, exercise and vend the licensed devices and parts thereof within the licensed territory, i.e., India. There was also a non-exclusive right to export or sell for export outside India any of the licensed devices fitted as original equipment on vehicles made in India or in replacement of such original equipment. There was also the non-exclusive right to export or sell for export the licensed devices where such exports did not conflict with the U.K. company's obligations in the particular country. The agreement was to be in force for a period of 10 years. The licensee, i.e., the Indian company, covenanted with the U.K. company that the Indian company during the continuance of the agreement would observe and perform the covenants and provisions of the agreement. The consideration due under the agreement was provided as follows:
'7. (a) That the licensee will pay to the grantor-
(i) In consideration of the technical services rendered by the grantor hereunder a fee amounting to one and a half per cent. of the factory cost of all licensed devices and spare parts for such devices manufactured and sold by the licensee, and...
(iii) In consideration of the licence and other rights granted hereunder in respect of the schedule 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 and where the licensee pays further royalties and/or technical aid fees to a third party or parties the licensee may deduct from the total fees and royalties payable thereunder to the grantor an amount equal to the-said royalties and/or technical aid fees.'
4. The Indian company was to pay the salary together with the travelling and its subsistence expenses of any representative of the U.K. company who visited the Indian company's premises or elsewhere for the purpose of instructing the Indian company's personnel or for otherwise rendering technical assistance. Under Sub-clause (s) of Clause 7, it was provided that if at any time during the continuance of the licence, the Indian company made or discovered any improvement or addition to the licensed devices or the working of the same or became the owner of such improvement or addition, the Indian company would communicate and explain the same to the U.K. company which would enjoy a royalty-free licence under any patent that the Indian company may obtain covering such improvement or addition for the term of such patent. Sub-clause (i) of Clause 7 stated that the licensee (Indian company) would not, without the prior written consent of the grantor (U.K. company), 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 (Indian company) except such information as was made available to the general public by or with the consent of the U.K. company. The U.K. company had also certain obligations to discharge and they are described in Clause 8. In Clause 8(a) it was provided that in consideration of the payments mentioned in Clause 7, the U.K. company would, at the request of the Indian company, deliver to the Indian company copies of such working drawings as it had, related to the licensed devices, and would render to the Indian company its servants or workmen such instruction, information and assistance as was available with the U.K. company and which was necessary or proper for enabling the Indian company to manufacture such devices to the best advantage. Similarly, the U.K. company had also to communicate and explain any improvements or addition to the licensed devices whether patented or not by the U.K. company and if the improvements were patented, the U.K. company would apply for patents in India, which patents, according to the grant, would be added to the patents set out in the first schedule to the agreement. Even unpatented improvements effected by the U.K. company could be utilised by the Indian company for purposes of manufacture. The U.K. company undertook to acquaint the Indian company's employees with information relating to the U.K. company's methods of manufacture and test of the licensed devices. The agreement was not liable to be assigned by the Indian company and the Indian company could not also grant sub-licence or create any charge or mortgage or deal with the rights granted under the agreement without the previous consent in writing of the U.K. company. There was a provision for termination of the agreement in case of nonpayment of royalties or fees or bankruptcy, etc., or other breach of covenant. The Indian company was under an obligation under Clause 14(c) to keep the information confidential indefinitely, i.e., even beyond the period of agreement. Except as provided in the agreement, all the rights and obligations of the parties would cease upon the termination thereof by any of the methods provided therein. (See Clause 14(e)). These are material clauses.
5. The assessee paid during the relevant previous years royalties and technical aid fees and the respective amounts are set out in para. 5 of the Tribunal's order. It is unnecessary to reproduce those details. The asses-see claimed both the royalties as well as the technical aid fees paid to the U.K. company as a deduction allowable in its assessment for these years. The ITO allowed the royalty payments as deductions, but disallowed 50% of the technical aid fees treating it as capital expenditure. In doing so, he followed an order made by him for the assessment year 1965-66. The assessee appealed to the AAC contesting the disallowance of 50% of technical aid fees as stated above. The AAC held that the expenditure in the shape of technical aid fees was revenue in nature and not capital and pointed out that the payment was not made for the acquisition of any asset, but only for the user of the knowledge, that the period of 10 years mentioned in the agreement was not a long period and that the assessee paid the technical aid fee in order to earn more income. The ITO appealed to the Tribunal. The Tribunal after considering the facts and also some other orders in which it had discussed a similar question, came to the conclusion that the technical aid fee paid under the agreement constituted revenue and not capital expenditure. In the course of its order it referred to a decision of it in I.T.A. Nos. 514 to 517 (Madras) of 1969-70 dated December 31, 1971, in the case of Lucas-TVS Ltd. That order was the subject of a reference to this court and the judgment of this court was reported as CIT v. Lucas-TVS Ltd. (No. 1) : 110ITR338(Mad) . However, at the time when the Tribunal disposed of the appeal, it did not have the benefit of the judgment of this court and, therefore, it followed its own earlier order.
6. The only question is whether the expenditure incurred as and by way of what is called technical aid fee is liable to be disallowed to the extent of 50% on the ground that it was capital in nature. The decision in CIT v. Lucas-TVS Ltd. (No. 1) : 110ITR338(Mad) was rendered in construing an agreement with identical terms. In that case also, on a consideration of the various clauses in the agreement, the AAC and the Tribunal had held that the entire technical aid fees was allowable as a revenue expenditure. One of the questions that came up before this court for consideration was whether the disallowance as made by the ITO to the extent of 50% of the technical aid fee was proper. This court pointed out after referring to the terms of the agreement and also other decisions that the case was on all fours with Ciba's case decided by the Supreme Court and reported in : 69ITR692(SC) , and the entire payments made by the assessee to the foreign company would be in the nature of licence fee and, therefore, would constitute an item of expenditure in the computation of its profits and gains. As the decision in that case was rendered in construing the identical terms of similar agreement, the question referred to us would have to be answered in the same way. However, the learned counsel for the revenue places before us two aspects as not having been considered in the earlier decision or not having had to be considered in the earlier decision.
7. The first aspect is with regard to what is set oat in Clause 8, Sub-clause (b). We have already referred to the fact that Clause 8 dealt with the U. K. company having to provide the drawings, assistance, etc., and also to keep the assessee-company informed about the improvements in the licenced devices. That clause may be reproduced here in order to appreciate the contentions of the learned counsel for the revenue. It runs as follows :
'The grantor (U. K. company) hereby covenants with the licensee (Indian company) that the grantor will during the continuance of this agreement observe and perform the covenants and provisions following (that is to say): (a)...
(b) That if at any time during the continuance of this licence the grantor shall make or discover any improvement of 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 to and in such case and whether the improvement or addition shall have been patented or not the grantor will (without payment, by the licensee of any further expenses occasioned thereby to the grantor) communicate and explain the same to the licensee and if it shall be patentable the grantor will (at the request and cost of the licensee) apply for patents in the licensed territory...the licensee shall have the right to use the same during the continuance of this licence without payment of any increased rate in respect of any device incorporating the same...' (Underlined by us).
8. The words underlined above were emphasised by the learned counsel for the revenue as showing that the assessee had obtained an enduring benefit by paying the fees contemplated under Clause 7 of the agreement. This identical term appeared also in the agreement construed in CIT v. Lucas-TVS Ltd. (No. 1) : 110ITR338(Mad) . Specific reference was made to these terms at p. 341. It was noticed that the provisions of cls. 7(3) and 8(b) were in the nature of reciprocal provision with regard to the improvements that may be made by either party which had to be communicated to each other. In spite of this, this court held that there was no capital element in the payment.
9. Even after considering the submission of the learned counsel for the revenue we are not satisfied that the obligation to make available the improvements has anything to do with the consideration set out in Clause 7. As pointed out in the earlier judgment these are only reciprocal provisions for sharing the knowledge about the improvements and no consideration is to be paid therefor by either party. The consideration, if any, in the respective clauses cancels each other. The consideration set in Clause 7 is only for the drawing, assistance, etc., as shown by Clause 8(a) and not for any other purpose.
10. The next submission of the learned counsel for the revenue is based on what was set out in the assessment order for 1965-66. As mentioned already in making the assessment for these years, the ITO followed the earlier order of, assessment for 1965-66. In that order, it is stated :
'In addition to the collaboration agreement there is another agreement for the formation of the company for manufacturing the licensed devices. Article 13(b)(ii) of this agreement read as under : 'After termination contained in the first part of the schedule hereto for any cause the company shall have the right to continue in the field of manufacture and sale of the products mentioned in the objects of the company with the benefit of all technical information and experience acquired by it under the terms of the said licence agreement shall not be entitled to use any trade marks licensed to it under this agreement...'
11. The learned counsel for the revenue contended that this clause clearly showed that what was obtained by reason of the payment of technical aid fee was an enduring benefit which would endure beyond the period of the agreement under consideration. His further point, was that the assessee had not to cease manufacture these items and that the only obligation was not to use the trade mark or trade name. So long as the assessee obtained the knowledge imparted during the currency of the agreement, the assessee, it was submitted, would be entitled to carry on the manufacture of brakes, etc., and this would, in the submission of the counsel, be an enduring benefit.
12. We do not have before us the agreement of which Article 13(b)(ii) forms part. Even the quotation as found in the assessment order is not full, but only a part of the said clause. We do not know whether the 'licence' contemplated by the said clause is the licence agreement with which wo are now concerned. This doubt arises because even the ITO refers to the present agreement as a 'collaboration agreement' and in the extract the agreement is referred to as 'the licence agreement'. In the extract, there is a reference to trade marks and trade name. The trade marks or trade name is not to be found referred to in the agreement with which we are now concerned. It is, therefore, possible that there was another agreement with reference to those items and the prohibition relating to the non-user of the trade name and the permission to continue the business by the newly formed company related to some other agreement.
13. Even assuming that the agreement contemplated by the said clause is the agreement with which we are now concerned, still we do not consider that there is any capital element in the payment with which we are now concerned. The payment in the present case is for specific purposes and not for acquisition of any knowledge of a permanent nature with which the assessees could carry on its business ; and any person who enters into a collaboration agreement would necessarily acquire some knowledge during the process of manufacture carried on with the help of the collaboration agreement. Knowledge acquired cannot be disgorged and ordinarily forms part of the equipment of the person concerned. It is not for the acquisition of the knowledge, but for application thereof, that the consideration is paid. The real test that has to be applied to cases like this to find out whether the consideration was statedly for any such enduring purposes or merely for the help rendered during the period of the agreement. In the present case, the consideration related only to the period of the agreement and to the services rendered or benefits obtained during that period.
14. In the case of CIT v. Lucas-TVS Ltd.(No. 1) : 110ITR338(Mad) , there is a reference to this aspect also. At p, 344, it was pointed out :
'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.'
15. The construction of the relevant clauses placed on an identical agreement, would also apply to the present case. Even assuming that the assessee could carry on the business subsequently, of manufacturing brakes and other items used in automobiles, still if the manufactured items offend any of the patents, then the assessee would have to pay damages and could also be prevented from carrying on the manufacture. Therefore, the assessee would not be in a position to carry on the manufacture of those items in the manner in which it was carrying it on, up to the date of the termination of the agreement.
16. The learned counsel for the revenue laid great emphasis on a decision of this court reported in Addl. CIT v. Southern Structurals Ltd. : 110ITR890(Mad) .
17. In that case, the whole question turned on the particular terms of the agreement. In fact, most of these cases would turn on the particular terms employed in the agreements themselves. If, in the present case, we were applying the decision in CIT v. Lucas-TVS Ltd. (No. 1) : 110ITR338(Mad) , it is only because the terms of the agreements are identical. In the case of Addl. CIT v. Southern Structurals Ltd. : 110ITR890(Mad) , there was a provision which stated that the agreement would remain in force for a minimum period of 10 years and that it could thereafter be terminated after giving 12 months' notice in writing. Upon the expiration of the agreement, it was provided that both the parties would be free from further obligations and the Indian company could have the continued use free of charge of all information made available by the foreign company during the period of the validity of the agreement. Particularly, in the light of this provision and the possible indefinite period of the agreement, it was held that there was a capital element in the payment. There was no other clause in the agreement which could throw light on the relationship between the parties as to how the manufacture would be carried on after the expiry of the agreement.
18. The decision of the Supreme Court in CIT v. Ciba of India Ltd. : 69ITR692(SC) has been followed in CIT v. Lucas-TVS Ltd. (No. 7) : 110ITR338(Mad) , and the present qase also does fall within the scope of the decision of the Supreme Court. In our opinion, in the present case, the assessee had only a licence for a limited period for making use of the technical knowledge of the foreign company with the right to use the patent, etc., and by reason of this agreement, the Indian company did not acquire any kind of assets or an advantage of an enduring nature which would introduce a capital element into the consideration. The result is that the question referred to us is answered as follows :
The whole of the technical aid fee is liable to be allowed as a revenue expenditure. The assessee will be entitled to its costs. Counsels' fee Rs. 500 one set.