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Commissioner of Income-tax (Central) Vs. Hindusthan General Electrical Corporation Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Case NumberIncome-tax Reference No. 94 of 1965
Judge
Reported in[1971]81ITR243(Cal)
ActsIncome Tax Act, 1922 - Section 10(2)
AppellantCommissioner of Income-tax (Central)
RespondentHindusthan General Electrical Corporation Ltd.
Appellant AdvocateDebiprosad Pal, Adv.
Respondent AdvocateDipak Sen, Adv.
Cases ReferredAlianza Co. v. Bell
Excerpt:
- sankar prasad mitra, j. 1. the assessment year is 1959-60 for which the previous year ended on the 31st july, 1958. the assessee is a public limited company. it carries on the business of manufacture and sale of certain electrical goods. on the 21st may, 1956, the assessee entered into an agreement with messrs. simplex electric company ltd. of england (hereinafter sometimes called the ' foreign company '}. by this agreement the assessee acquired certain rights to manufacture and sell in india products of ' simplex ' design and to use the trade name ' simplex ' on the terms and conditions therein mentioned. some of the clauses of this agreement which the tribunal has quoted in the statement of the case are as follows :' clause 3(a).--hgec shall be liable to pay ' simplex ' the cost.....
Judgment:

Sankar Prasad Mitra, J.

1. The assessment year is 1959-60 for which the previous year ended on the 31st July, 1958. The assessee is a public limited company. It carries on the business of manufacture and sale of certain electrical goods. On the 21st May, 1956, the assessee entered into an agreement with Messrs. Simplex Electric Company Ltd. of England (hereinafter sometimes called the ' foreign company '}. By this agreement the assessee acquired certain rights to manufacture and sell in India products of ' Simplex ' design and to use the trade name ' Simplex ' on the terms and conditions therein mentioned. Some of the clauses of this agreement which the Tribunal has quoted in the statement of the case are as follows :

' Clause 3(a).--HGEC shall be liable to pay ' Simplex ' the cost (including freight, transport and insurance costs) of preparing and providing prints, designs, drawings, specifications, instructions and other information as aforesaid and of supplying patterns and tools upon invoices in respect thereof being submitted by ' simplex ' to HGEC. HGEC shall also pay to ' Simplex ' a fee at the rate of 500 per annum (payable annually in advance, the first payment to be made within one month from the date hereof and thereafter on the first day of each year of this agreement), towards the salary of the members of the staff of 'Simplex' appointed for the purposes of paragraph (d) of Clause 2 and sums equivalent to the salaries or other remunerations of any persons sent as production engineers or technical advisers for the purpose of paragraph (e) of Clause 2 during their absence from England and all travelling and living expenses incurred by them during such absence, payments of such sums to be made promptly upon the same being invoiced by ' Simplex ' to HGEC. '

' Clause 5(a).--Simplex will file and prosecute with due diligence an application for registration of HGEC as the registered user of the trade mark in respect of 'Simplex' products and HGEC shall do all such acts and execute all documents necessary for enabling 'Simplex' to obtain registration but in order that the validity of the registration by ' Simplex ' of the trade mark or any other trade mark bearing or using the word 'Simplex' shall not be prejudiced by appearing in the market within India of ' Simplex ' products manufactured by HGEC no use shall be made of the said mark by HGEC until registration of HGEC as the registered user thereof shall have been completed. '

' Clause 5(g).--Nothing herein contained shall affect, prejudice or derogate from the full right of ' Simplex ' either, (i) to use the trade mark in India upon or in relation to any goods for which it is the registered proprietor of such trade mark or upon or in relation to any goods on which it has heretofore used this trade mark in India, or (ii) to authorise another manufacturer thereof in so far as provided for in this agreement to make use of the trade mark as registered user thereof. '

' Clause 5(h).--HGEC shall not manufacture or assemble ' Simplex ' products upon or in relation to which the trade mark is used save in accordance with such standards of quality and specifications as are acceptable to ' Simplex' in so far as those specifications are not at variance with specifications of the Indian Standard Institute and ' Simplex * is hereby empowered to withdraw the use of the trade mark from any products which it reasonably considers to be below standard and HGEC fails to manufacture in accordance with the standard of equality and specifications of ' Simplex ' in spite of being called upon to do so. '

' Clause 5(j).--HGEC shall not at any time hereafter do any act or thing which may in any way prejudice or harm the registered proprietorship of ' Simplex ' in India of the trade mark and it will at the request and cost of 'Simplex' do all such things and take all such steps as 'Simplex' may reasonably require to protect or assist in the protection of the registration of ' Simplex ' as proprietor of the said trade mark in India including the carrying out of all requirements governing the manner of use of the trade mark or the indications to be given of the position of HGEC and/or ' Simplex ' with respect to the trade mark on the ' Simplex ' products that ' Simplex ' may from time to time direct. '

'Clause (5(6).--If HGEC has not started to manufacture or fails or is unable or unwilling to meet or fulfil the demand in India for the ' Simplex ' products or any of them in spite of ' Simplex ' making available to HGEC all information, drawings, specifications and technical advice in terms of Clause 2 above, ' Simplex ' may either, (i) itself sell or supply such products to any person, firm or company in India, or (ii) be free to make arrangements (including the provision of services and information similar to those herein provided) for the manufacture and sale of such products in India by persons, firms and companies other than by HGEC PROVIDED that in the latter eveat 'Simplex' shall first give notice in writing to HGEC of its intention to make such arrangements for the manufacture of such products in India and if after receipt of such notice as aforesaid HGEC shall satisfy ' Simplex ' that it will within a reasonable time manufacture sufficient quantities of such products to meet the demand therefor ' Simplex ' shALL not proceed with such arrangements. Subject as aforesaid ' Simplex ' shall not at any time during the continuance of this agreement sell or supply to any person, firm or company in India the ' Simplex ' products '.

' Clause 9(a).--In consideration of the rights, services and facilities agreed to be granted by ' Simplex ' to HGEC under this agreement, HGEC agrees to remunerate ' Simplex' in addition to the payments provided by Clause 3(a) by paying to ' Simplex' a royalty on ' Simplex ' products manufactured by HGEC during the continuance of this agreement, as follows :

(i) 250 volt domestic type switch and distribution gear (existing design): 21/2 per cent.(ii) 250 volt switch and distribution gear (future designs) : 5 per cent.(iii) All domestic wiring accessories of Miniac range and their industrialironclad equivalents : 2 1/2 per cent.(iv) Regent switch and distribution gear, Monarch rsnge of switches and switch fuses, Regent busbar chambers and sealing chamber,connection boxes : 5 per cent.(v) Lighting fittings of Simplex manufacture, as at present listed : 31/2 per cent.(vi) Lighting fittings of specialised design by way of future additions : 5 per cent.(vii) Flame proof equipments: 5 per cent.(viii) Special type of Simplex accessories (formerly Lundberg accessories), e.g., Marvel switch, series and paralled switches, door switches, Runlex and motor starter switches, etc : 5 per cent.(ix) Conduit fittings and accessories : 21/2 per cent. (b) The royalty will be calculated on the net ex-factory prices as invoiced by HGEC to customers on sales of ' Simplex ' products effected by HGEC from day to day.

(c) Payments of royalty shall become due every half year ending on 31st January and 31st July and shall be credited by HGEC to the account of ' Simplex ' not later than 60 days from the end of each such half year and HGEC shall notify ' Simplex ' in writing when each such credit is made and the amount so credited. The amounts so credited shall carry interest at 4 per cent. per annum from that date. Payments of amounts credited to the account of 'Simplex ' and/or interest thereon shall be effected by HGEC to ' Simplex ' in England in U. K. Sterling, in accordance with instructions given from time to time by notice in writing, from ' Simplex' to HGEC. The rate of exchange for Indian currency to U. K. Sterling will be the official rate of the Reserve Bank of India on the date remittances are due to be made in accordance with such instructions.

(d) During the currency of this agreement HGEC shall maintain full and accurate records of production and sales of ' Simplex ' products and billing of the same to ' Simplex ' quarterly within thirty days after the last day of January, April, July and October of each year detailed reports of manufacture and sales of ' Simplex ' products covered by this agreement, and to permit' Simplex's ' duly authorised representative to inspect such records from time to time.

(e) ' Simplex ' shall have the option by notice in writing to HGEC at any time and from time to time to apply for ordinary shares in the capital of HGEC for cash at par and to apply the whole or part of the amount for the time being standing to the credit of ' Simplex ' in the said account in meeting snath subscription money provided-that 'Simplex' may not apply and subscribe for ordinary shares of a nominal amount in excess of the total amount for the time being credited to it as aforesaid and that the total number of ordinary shares of HGEC held by ' Simplex ' at any time shall not exceed 49% of the issued ordinary shares of HGEC for the time being. Upon ' Simplex ' exercising its option to apply for and subscribe any ordinary share pursuant to this provision HGEC shall forthwith allot and issue the same and deliver to ' Simplex ' a share certificate in respect thereof and shall debit the said account of ' Simplex ' with the amount of such subscription moneys. During the continuance of this agreement HGEC shall accordingly not issue any ordinary shares or other shares ranking pad passu as to voting or otherwise with ordinary shares of HGEC without the prior consent of ' Simplex ' and without first offering to ' Simplex' on the same terms a part of such additional share capital proportionate to the number of shares for the time being held by ' Simplex.' '

' Clause 12.--This agreement may be determined at any time by ' Simplex ' upon giving notice in writing to HGEC to that effect :

(i) If HGEC shall fail to effect any payment of royalties or other moneys within 28 days of the date upon which the same shall be due to be paid to ' Simplex ' in accordance with the provisions of this agreement;

(ii) If HGEC shall commit any other breach of its obligation under this agreement and shall not remedy such breach within 30 days after receipt of a notice in writing from ' Simplex' requiring the same to be remedied;

(iii) If HGEC shall be placed in liquidation whether voluntary or compulsory (other than voluntary liquidation for the purpose of construction or amalgamation) or shall suffer the appointment of a receiver of its assets or undertaking or any part thereof or shall make any assignment or composition for the benefit of its creditors or be placed under judicial management or cease to carry on the business of manufacturing ' Simplex ' products ;

(iv) If the registration of HGEC as registered user of the trade mark shall be cancelled for any reason ;

(v) If the said approval of the Government of India shall be withdrawn, revoked, cancelled or modified in any way. '

2. During the previous year the assessee paid to the foreign company Rs. 5,360 for the cost of preparing and providing prints, designs, drawings, specifications, instructions and other information in terms of Clause 3(a) of the agreement. The assessee also paid a sum of Rs. 13,938 under Clause 9(a) of the agreement being royalty based on specified percentages. The Income-tax Officer allowed a deduction of Rs. 5,360 but disallowed the claim for deduction of Rs. 13,938 on the ground that it represented expenditure of a capital nature.

3. The Appellate Assistant Commissioner held that the expenditure of Rs. 13,938 depended upon production and did not bring into existence any assets of an enduring nature. He allowed the sum of Rs. 13,938 as deduction in computing the assessee's business profit.

4. The Tribunal held that what the assessee acquired was not the right of the trade name as such but the right to use the foreign company's trade mark on ' payment of royalty to be paid periodically depending on manufacture and sale of the products of ' Simplex ' design. The Tribunal concurred with the Appellate Assistant Commissioner's View that the sum of Rs. 13,938 was an expenditure of revenue nature ana dismissed the appeal.

5. The following question of law has been referred to this court under Section 66(1) of the Indian Income-tax Act, 1922 :

' Whether, on the facts and in the circumstances of tnis case, and on a proper construction of the terms of the agreement dated May 21, 1956, entered into by the assessee with Messrs. Simplex Electric Go. Ltd. of England, the sum of Rs. 13,938 was an expenditure of a revenue nature and was accordingly allowable as a deduction in computing the business profits of the assessee '

6. Mr. Dipak Sen, learned counsel for the revenue, contends that the agreement between the assessee and the foreign company is for a period of 10 years. In other words, the benefits conferred by this agreement are to last for a fixed number of years and the period is fairly long. Secondly, during the subsistence of the agreement, the assessee would enjoy these benefits exclusively. Thirdly, apart from the benefit of the use of the foreign company's trade mark and inventions over a period of ten years, the assessee was also to derive a permanent benefit, namely, the ' know-how ' of the equipments produced by the foreign company. Mr. Sen submits further that under Clauses 3(a) and 9(a) the assessee has to pay the costs of preparation of prints, designs, etc., annually and royalty on certain percentages dependent on the assesseeV pioduction from year to year ; but it would appear from Clauses 1(a) and 5 that the assessee's benefits under the contract are not to accrue from year to year but are to be derived continuously for a period of 10 years. Moreover, under Clauses 6(c) and 13 of the agreement, the assessee is prohibited from divulging the secrets that the assessee learns from the foreign company except to its own engineers and using the trade mark on the expiry of the agreement; but the user of the 'know-how' is a permanent user. From all these points of view, counsel for the department urges, the expenditure of Rs. 13,938 was an expenditure of a capital nature.

7. Mr. Sen first drew our attention to the Judicial Committee's observations on ' capital expenditure ' in Mohanlal Hargovind v. Commissioner of Income-tax, [1949] 17 I.T.R. 473, 477 (P.C.). Lord Greene, delivering the judgment of the Privy Council, has said :

' There is no definition of that expression ('capital expenditure') which must .... be construed in a business sense save in so far as there may be rules of construction applicable to it . ...'

8. There can be no doubt that whether or not an assessee has incurred ' capital expenditure', has to be determined in a business sense depending on the facts of each case.

9. A problem of this nature came before this court in Commissioner of Income-tax v. J. K. Industries (Private] Ltd. : [1969]71ITR594(Cal) . The assessee was a private limited company. It acted as the managing agent of several public limited companies including Hoyle's Paints Ltd. and J. K. Steel Ltd. During the relevant period, one of the assessee's directors was sent to Europe to explore the possibility of technical and financial collaboration with foreign concerns in the matter of manufacture of paints (the business of Hoyle's Paints Ltd.) and hoist-cranes & conveying-equipments (later on manufactured by J. K. Steel Ltd ) and also to acquire generally available technical knowledge about manufacture of paints, wire ropes, hoops and box-strappings. The total expenses of the foreign tour came to Rs. 33,009. The assessee claimed it as business expense. This court has held that, though by reason of expenses incurred by the managing agent, certain assets of enduring benefit might have accrued to one or more of the managed companies, the purpose for which the managing agent incurred these expenses was to increase its own earnings or augmenting the commission it derived from its managed companies, and it was with the object of creating possibilities for enlargement of its income that the assessee spent the amount in question. The foreign tour expenses of the director in these premises were, therefore, allowable as the assessee's business expenditure under Section 10(2)(xv). It is clear that the purpose that induced the managing agents to incur its director's foreign tour expenses was the guiding factor in determining whether the expenses were of a capital nature or could be treated as legitimate business expenditure.

10. In a case before the Mysore High Court in Mysore Kirloskar Ltd. v. Commissioner of Income-tax : [1968]67ITR23(KAR) , the assessee entered into an agreement with H, on August 1, 1958, for manufacturing Capstan and Turret lathes of particular designs. The agreement was to last for 15 years. H was to provide the assessee with manufacturing technique, drawing specifications, etc., from time to time and also supplies of special tools at agreed prices. The articles that the assessee manufactured were to be sold under the trade mark HK. The assessee, on the execution of the agreement, was to pay for the 'know-how' to H, 1,000 in respect of Capstan lathes and 1,000 in respect of combination Turret lathes. On the assessee's invoice of all products manufactured, the assessee was to pay to H 71/2 per cent. subject to deduction of tax. During the relevant year the assessee paid to H two several suras of 1,000 each, that is, Rs. 26,713. The Mysore High Court has held that as the ' know-how' in question was to be utilised not for the purpose of manufacturing any machine that the assessee was already manufacturing but for the purpose of bringing into production new types of machines solely on the basis of ' know-how ' supplied by H, and the ' know-how ' was to become the assessee's property at the end of the period of agreement, the sum of Rs. 26,713 was properly disallowed as a capital expenditure.

11. We do not think that this case would assist us in settling the controversies in the'instant reference. For our purposes it would be appropriateto rely on certain observations of the House of Lords. We shall revert tothis argument of the department's counsel as well as the views of theHouse of Lords, a little later.

12. The Supreme Court in the case of Commissioner of Income-tax v. Ciba of India Ltd., : [1968]69ITR692(SC) . has dealt with a case similar to the one we have before us. The assessee (originally named Ciba Pharma Ltd.) was an Indian subsidiary of a Swiss company called ' Ciba Ltd. of Basle '. The Swiss company was engaged in the development, manufacture and sale of medical and pharmaceutical preparations. The assessee took over the pharmaceutical section of the Swiss company in India from January 1, 1948. Under an agreement dated December 17, 1949, the Swisscompany undertook to deliver to the assessee ail processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of products discovered and developed in the Swiss company's laboratories and to forward to the assessee as far as possible all scientific and bibliographic information, pamphlets or drafts, which might be useful to introduce licensed preparations and to promote their sale in India. The Swiss company granted to the assessee full and sole right and licence under the patent listed in the agreement to make, use, exercise and vend the inventions specified therein in India and also a licence to use certain specified trade marks in the territory subject to any existing licence which third parties held at the date of agreement, or which the Swiss company might grant to third parties thereafter. In consideration of the right to receive scientific and technical assistance the assessee agreed to make contributions of 5 per cent., 3 per cent. and 2 per cent. respectively, of the net sale price of the products sold by the assessee towards, (i) technical consultancy and technical service rendered and research work done; (ii) cost of raw material used for experimental work ; and (iii) royalties on trade marks used by the assessee. The assessee further agreed : (a) not to divulge to third parties without the consent of the Swiss company any confidential information received under the agreement, (b) without the written consent of the Swiss company, not to assign the benefit of the agreement or grant sub-licences of the patents and the trade marks, and (c) upon termination of the agreement for any cause to cease to use the patents and trade marks and to return to the Swiss company all copies of information, scientific data or material sent to it and to refrain from communicating any such information, scientific data or material received by it to any person. The agreement was to be in force for a period of 5 years from January 1, 1948, and was liable to cancellation by either party if the other party failed to perform or observe the provisions of the agreement, by giving it three month's notice. By a subsequent agreement the contribution payable was reduced from 10 per cent. to 6 per cent. of the net selling price of the pharmaceuticals. The question was whether the contribution other than that part paid as royalties (royalties having been allowed as a deduction) was admissible as an allowance either under Clause (xii) or under Clause (xv) of Section 10(2) of the Income-tax Act, 1922. The Supreme Court has held as follows :

' (i) The contribution was not allowable under Section 10(2)(xii) as expenditure laid out or expended on scientific research. Payment made to recoup another person for expenditure on scientific research incurred by that other person, even if it might ultimately benefit the assessee, was, unless it was carried on for or on behalf of the assessee, not expenditure laid out or expended on scientific research related to the business of the assessee under Section 10(2)(xii).

(ii) The contribution, however, was allowable as business expenditure under Section 10(2)(xv). The assessee did not under the agreement become exclusively entitled, 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. 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; and 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. '

13. There are a few other aspects of this case which are not necessary for our purposes. At pages 701 and 702, their Lordships of the Supreme Court have referred to the salient features of the agreement between the parties which show that the Swiss company did not sell its secret processes to the assessee. If we compare these salient features with the relevant clauses in the agreement in the instant reference, we would discover striking similarities between these two cases. Let us, therefore, deal with these salient features one by one and compare them with the relevant clauses in our agreement.

14. Firstly, in the Supreme Court case, the licence was for a period of 5 years, liable to be terminated in certain eventualities even before the period of expiry. In our case the agreement is for 10 years, but may be determined at any time by Simplex upon giving notice in writing to HGEC in the event of certain contingencies occurring; two of these contingencies are, (a) if HGEC shall fail to effect any payment of royalties or other moneys within 28 days of the date upon which the same shall be due to be paid to 'Simplex' in accordance with the provisions of this agreement, and (b) if HGEC shall commit any other breach of its obligations under this agreement and shall not remedy such breach within 30 days after receipt of a notice in writing from 'Simplex' requiring the same to be remedied : tide Clause 12.

15. Secondly, in the Supreme Court case, the object of the agreement was to obtain the benefit of the technical assistance for running the business. In our case, the object is to enable HGEC to commence and continue the manufacture in India of all types and sales of ' Simplex' products: vide Clause 2.

16. Thirdly, in the Supreme Court case, 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. In our case, almost the same rights have been conferred on ' Simplex ' under Clauses 5(g) and 6(b) of the agreement which we have quoted above.

17. Fourthly, in the Supreme Court case the assessee was expressly prohibited from divulging confidential information to third parties without the consent of the Swiss company. In our agreement, HGEC shall not at any time directly or indirectly give to any person any information relating to or assistance in the manufacture of ' Simplex' products except to its engineers and shall treat as secret and confidential and not disclose or permit the disclosure of any master provided or made available by ' Simplex' : HGEC shall not also assign, lease, deal with or otherwise transfer or seek to transfer the benefit conferred on them to use the ' Simplex trade mark : vide Clauses 6(c) and 5(e).

18. Fifthly, there was no transfer in the Supreme Court case of the fruits of research once for all; the Swiss company which was continuously carrying on research had agreed to make it available to the assessee. In our case, there are similar terms in Clauses 2(a) and (b) of the agreement: ' Simplex ' shall make available to HGEC at their request complete prints of all designs, working drawings, manufacturing material specifications, detailed manufacturing and assembling instructions and all other information (that is 'know-how') for efficient and modern manufacture and testing of such products respectively : and ' Simplex' shall also in a consultative capacity give advice for and assistance in such manufacture at the request of HGEC and as the)' may reasonably require from time to time so as to enable HGEC to manufacture ' Simplex ' products in the best and most up to date manner known to ' Simplex '.

19. And, sixthly, the stipulated payment was recurrent, in the case before the Supreme Court, dependent upon the sales, and only for the period of the agreement. In our case also, as we have seen from Clause 9 quoted above, the stipulated payments of royalty on percentage basis (in addition to payments provided by Clause 3(a) also quoted above) were entirely dependent on 'Simplex' products actually manufactured by HGEC during the continuance of the agreement.

20. We intend to refer to a few other decisions before we summarise our views on this reference.

21. Mr. Dipak Sen, learned counsel for the department, strongly urged, as we have observed, that the assessee in the instant case had derived a permanent benefit under the agreement in question, namely, the 'know-how ' of ' Simplex ' products. In Musker v. English Electric Co. Ltd., [1964] 41 T.C. 556 (H.L.), the respondent-company, in the course of carrying on its trade of engineering manufacturers, acquired a fund of specialised information and technique in engineering processes. It had not been its practice to turn this information and technique to account by imparting it to others. In 1949, however, at the request of the Admiralty, the company entered into an agreement to design and develop a marine turbine and to license its manufacture by a limited number of companies in the United Kingdom, Australia and Canada. Later, in 1950 and 1952, the company, at the request of the Ministry of Supply, entered into agreements with the Government of Australia and an American Aircraft Manufacturing Corporation, respectively, under which it licensed them to manufacture the Canberra bomber which it had designed and developed. All three agreements provided, inter alia, for the imparting of ' manufacturing technique ' to the licensees and in consideration of this the company received specified lump sum payments. The profits .of the company's trade were assessed to income tax for the years 1951-52 and 1952-53 and to profits tax for the chargeable accounting period, viz., 1st January, 1950, to 31st December, 1950, on the footing that these payments should be included as trading receipts. On appeal to the Special Commissioners, the company contended that the sums were of a capital nature. The House of Lords held that the sums in question were of an income nature. At page 585, discussing the point relating to ' know-how ', Viscount Radcliffe has said :

' In my opinion, there are two considerations which govern cases of this kind and which go a long way towards destroying the force of the analogies by which the appellant's argument seeks to prove that the transactions under review were sales of fixed assets, and that receipts arising from them ought to be treated as receipts on capital account. One is that in reality no sale takes place. The appellant had after the transaction what it had before it. There is no property right in ' know-how ' that can be transferred, even in the limited sense that there is a legally protected property interest in a secret process. Special knowledge or skill can indeed ripen into a form of property in the fields of commerce and industry, as in copyright, trademarks and 'designs and patents, and where such property is parted with for money what is received can be, but will not necessarily be, a receipt oh capital account. But imparting 'know-how' for reward is not like this, any more than a teacher sells his knowledge or skill to his pupil. '

22. With great respect we agree with this view. We do not think, on the facts of this case, that ' Simplex ' by communicating its ' know-how ' to HGEC was parting with any capital assets. We are, therefore, unable to uphold this contention of the department's counsel.

23. The Supreme Court has explained the legal principles applicable to this type of cases in Travancore Sugars and Chemicals Ltd. v. Commissioner of Income-tax, : [1966]62ITR566(SC) , in these words :

' It is often difficult, in any particular case, to decide and determine whether a particular expenditure is in the nature of capital expenditure or in the nature of revenue expenditure. It is not easy to distinguish whether an agreement is for the payment of price stipulated in instalments or for making annual payments in the nature of income. The court has to look not only into the documents but also at the surrounding circumstances so as to arrive at a decision as to what was the real nature of the transaction from the commercial point of view. No single test of universal application can be discovered for a solution of the question. The name which the parties may give to the transaction which is the source of the receipt and the characterisation of the receipt by them are of little consequence. The court has to ascertain the true nature and charater of the transaction from the covenants of the agreement tested in the light of surrounding circumstances. '

24. We have seen the result of the application of the principles to the facts of the instant case in the light of the Supreme Court's judgment in the case of Ciba of India Ltd.

25. The Supreme Court in Gotan Lime Syndicate v. Commissioner of Income-tax, : [1966]59ITR718(SC) quotes with approval the observation of Channell J. in Alianza Co. v. Bell, [1904] 2 K.B. 666, 673 (K.B.). Channell J. said :

' In the ordinary case, the cost of the material worked up in a manufactory is not a capital expenditure ; it is a current expenditure, and does not become a capital expenditure merely because the material is provided by something like a forward contract, under which a person for the payment of a lump sum down secures a supply of the raw material for a period extending over several years. '

26. Before quoting these observations the Supreme Court has said that it is not the law that, in every case, if any enduring advantage is obtained, the expenditure for securing it must be treated as a capital expenditure. In our case the assessee, under Clause 3(a) of the agreement, has to pay the costs (including freight, transport, insurance costs) of preparing and providing prints, designs, drawings, etc., and for that a sum of 500 per annum is advanced towards salaries and remuneration of engineers or technical advisers. The assessee has also to pay in terms of Clause 9(a) certain percentages of royalties ; but these payments appear to us to be current expenditure (and not capital expenditure) for the purpose of carrying on the trade which the assessee had agreed to carry on in India in accordance with the terms of this agreement.

27. Broadly speaking, therefore, it may be observed that one of the primary rules for determining whether a particular expenditure is a revenue or a capital expenditure is that the court from the terms of the agreement between the parties and from the surrounding circumstances has to ascertain the purpose for which it is being incurred. If the expenditure is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit earning process it should be held to be a revenue expenditure. Should, however, the purpose be the acquisition of an asset or a right of a permanent character the possession whereof is the condition precedent or the pre-requisite to the commencement or continuance of the business, the expenditure would be a capital expenditure. Royalties; usually, are periodical payments for continuous enjoyment of certain benefits under a contract. In every case payment of royalty is not a capital expenditure. In our case the various types of payments that the assessee has to make seem to be closely related to the assessee's manufacturing processes of ' Simplex ' products. In other words, these payments are intimately linked up with the manufacturing activities of the assessee and not with the capital values of the assets that the assessee would acquire. They cannot, strictly speaking, be said to be the purchase price of these assets. It is true that the assessee's foreign principals would be imparting their ' know-how ' to the assessee for a reward ; but that is nothing more than a teacher selling his knowledge or skill to his pupil. The assessee's foreign principals were merely supplying technical information to enable the assessee to carry on business in terms of the agreement.

28. In these premises, the answer to the question in this reference is that the sum of Rs. 13,938 was art expenditure of a revenue nature and was accordingly allowable as a deduction in computing the assessee's business profits. The Commissioner would pay to the assessee its costs of this reference.

Saeyasachi Mukharji, J.

29. I agree.


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