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Commissioner of Income-tax Vs. Associated Electrical Industries (India) Private Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Case NumberIncome-tax Reference No. 233 of 1967
Judge
Reported in[1975]101ITR844(Cal)
ActsIncome Tax Act, 1961 - Section 37
AppellantCommissioner of Income-tax
RespondentAssociated Electrical Industries (India) Private Ltd.
Appellant AdvocateSuhas Sen and ;Ajoy Mitra, Advs.
Respondent AdvocateDebi Pal and ;Manisha Seal, Advs.
Cases ReferredWolf Electric Tools Ltd. v. Wilson
Excerpt:
- .....income-tax act, 1922. it was further argued in the alternative that if the amount represented capital expenditure then the amount should be allowed under section 35(1)(iv) of the 1961 act corresponding to section 10(2)(xiv) of the indian income-tax act, 1922.5. the tribunal came to the conclusion that the expenditure incurred in connection with obtaining the design and the technical information could not be said to be of capital nature in a case of this kind. therefore, the tribunal was unable to uphold the view taken by the revenue. the tribunal was further of the opinion that the expenditure in question did not have the capital character, and was only of a revenue nature. in view of that the tribunal ruled out section 35(1)(iv) of the income-tax act, 1961, and held further that.....
Judgment:

Sabyasachi Mukharji, J.

1. In this reference under Section 256(1) of the Income-tax Act, 1961, we are concerned with the assessment for the assessment year 1962-63, for which the relevant previous year ended on the 31st October, 1961. The assessee, Messrs. Associated Electrical Industries ., is a company incorporated in India and is a 100 per cent. subsidiary of another company known as Associated Electrical Industries (India) Ltd. There was an amalgamation of the two companies approved by an order of the High Court on the 7th September, 1965. We are, however, dealing with a period when the two companies were in existence separately and, therefore, these two companies have been treated as separate entities. The Associated Electrical Industries (India) Ltd., the holding company, was itself a subsidiary of a well-known foreign company known as Associated Electrical Industries, London. By virtue of an agreement between the Associated Electrical Industries (India) Private Ltd., hereinafter referred to as 'the agent-company', and the Associated Electrical Industries Ltd., London, hereinafter referred to as 'the English company', the agent-company had the right to technical and manufacturing information, designs and data emanating from the English company. The assessee at the relevant time was carrying on business in the manufacture of various electrical equipments and components like electric motors, etc. The manufactured items were sold entirely to the agent-company by the assessee and the agent-company in its turn effected sales in accordance with an agreement dated the 21st December, 1960, between the assessee and the agent-company. The recital of the said agreement states that the company and the agent were desirous of entering into certain arrangements relating to the manufacture and sale of goods coming within the scope of the agreement. The agreement provided, inter alia, as follows :

'(1) The scope of this agreement shall be such that electrical and allied goods as may from time to time be manufactured by the company by arrangement between the company and the agents (hereinafter referred to as 'the goods').

(2) The company undertake to manufacture the goods as agreed on between the parties from time to time and supply such goods only to the agents.

3. (a) So far as they are in a position to do so the agents agree to supply to the company all manufacturing information, designs and data which they may obtain from the said Associated Electrical Industries Ltd.and which may be necessary to enable the company successfully to manufacture the goods.

(b) All manufacturing information, etc., supplied by the agents to the company shall be confidential to the company and shall not in any circumstances be communicated to any other party and on the termination of this agreement, the company shall return to the agents all manufacturing information, design and data.

(c) The company shall reimburse the agents any costs incurred bythe agents in supplying to the company manufacturing information,drawings and assistance and undertaking tests or work of similar nature...

(4). (a) The agents will place manufacturing orders on the companyfrom time to time for their requirements of the goods......

(10) This agreement shall remain in force for a period of ten years certain from the First day of November One thousand nine hundred and sixty and thereafter either of the parties may at any time give to the other not less than twenty-four calendar months notice in writing of its intention to determine the agreement, and at the expiry, of such notice the agreement shall accordingly terminate without prejudice to any outstanding claim by either party.'

2. For the purpose of manufacturing RW-105 and 120 H.P. squirrel cage motors the assessee obtained certain designs from the agent-company as contemplated by the aforesaid agreement. The cost of these designs and drawings and technical information came to Rs. 22,039. In the account of the assessee this amount was appropriated over a period of five years with the result a sum of Rs. 4,408, being 20 per cent. or 1/5th of Rs. 22,039, was debited this year. The assessee claimed deduction of Rs. 4,408. The Income-tax Officer held that since the information and knowledge received by the assessee in respect of these designs were of an enduring nature, the expenses were, therefore, capital, expenditure and he accordingly disallowed the expenditure.

3. The assessee appealed to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner held that these expenses did not stand in the same footing as expenses for raw materials or even expenses of an expert for the purpose of production. These expenses had been incurred prior to production. In the circumstances, he upheld the order of the Income-tax Officer.

4. The assessee, thereafter, appealed to the Tribunal. It was submitted before the Tribunal that the whole of Rs. 22,039 should be allowed as deduction under Section 37 of the Income-tax Act, 1961, corresponding to Section 10(2)(xv) of the Indian Income-tax Act, 1922. It was further argued in the alternative that if the amount represented capital expenditure then the amount should be allowed under Section 35(1)(iv) of the 1961 Act corresponding to Section 10(2)(xiv) of the Indian Income-tax Act, 1922.

5. The Tribunal came to the conclusion that the expenditure incurred in connection with obtaining the design and the technical information could not be said to be of capital nature in a case of this kind. Therefore, the Tribunal was unable to uphold the view taken by the revenue. The Tribunal was further of the opinion that the expenditure in question did not have the capital character, and was only of a revenue nature. In view of that the Tribunal ruled out Section 35(1)(iv) of the Income-tax Act, 1961, and held further that the assessee was Entitled to deduction under Section 37 of the said Act. In the circumstances, the Tribunal has referred the following question to this court:

'Whether, on the facts and in the circumstances of the case, the sum of Rs. 25,039 could be allowed as deduction under Section 37 of the Income-tax Act, 1961, or in the alternative 1/5th thereof under Section 35(1)(iv) of the 1961 Act?'

6. In order to determine the question it would be necessary to refer to certain facts as found by the Tribunal, The Tribunal found that no new machinery was installed to commence manufacture of the items for which the designs were obtained. The manufacture was done with the help of the existing machinery. It also found that the assessee had been manufacturing similar items of motors and the present manufacture was only a change of the design. The manufacture, however, resulted in a new item because the assessee had not manufactured this identical item earlier. It was also found that the assessee had been carrying on manufacture of items of motors and the present design was only a type of motor which was of the same nature as the kind of goods manufactured by the assessee. It was also found that without the designs the manufacture was not possible. In this case, the question is whether the expenditure is capital expenditure or of revenue nature. , The principles that are applicable in a case of this nature have been discussed in several cases depending upon the facts of each case. The Supreme. Court, however, in the case of Commissioner of Income-tax v. Ciba of India Ltd., : [1968]69ITR692(SC) had occasion to deal with a situation more or less of similar nature. There the assessee originally named Ciba Pharma Ltd. was an Indian subsidiary of Ciba Ltd. of Basle, a Swiss company engaged in development, manufacture and sale of medical and pharmaceutical preparations. The pharmaceutical section of the Swiss company in India was taken over by the assessee on 1st January, 1948. Under an agreement dated 17th December, 1949, the Swiss company undertook to deliver to the assessee in that case all 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. It 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 the 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%, 3% and 2%, 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 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 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 materials received by it to any person.

7. The agreement was to be in force for a period of five years from 1st January, 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 months' notice. By a subsequent agreement the contribution payable was reduced from 10% to 6% 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 allowance either under Clause (xii) or under Clause (xv) of Section 10(2) of the Indian Income-tax Act, 1922.

8. It was held by the Supreme Court that 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). However, the contribution was allowable as business expenditure under Section 10(2)(xv). 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 the experience in the. pharmaceutical field which the Swiss company commanded. The assessee on that account was 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 Swiss company. The assessee acquired under the agreement merely the right to draw, for the purpose of carrying on the 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 the business. The Supreme Court referred to the relevant English authorities on this point and came to the aforesaid conclusion. These principles, though in slightly different circumstances, have been applied by this court in the case of Commissioner of Income-tax v. Hindusthan General Electrical Corporation Ltd., : [1971]81ITR243(Cal) . It had occasion to consider this question in relation to know-how. The court was of the opinion that one of the primary rules for determining whether a particular expenditure was revenue or capital expenditure was, from the terms of the agreement between the parties and from the surrounding circumstances, to find out what was the purpose for which it was being incurred. It was held that if the expenditure was so related to the carrying on or conduct of the business that it might be regarded as an integral part of the profit earning process, it should be held to be revenue expenditure. Should, however, the purpose of acquisition be an asset or a right of a permanent character, the possession whereof was a condition precedent or the pre-requisite to the commencement or continuance of the business, the expenditure should be regarded as capital expenditure.

9. The Andhra Pradesh High Court in the case of Hylam Ltd. v. Commissioner of Income-tax, : [1973]87ITR310(AP) had occasion to consider this question. There theassessee, a public limited company, was carrying on business of laminatedmaterials and entered into an agreement with an English company inrespect of the patents owned by the English company for production ofcopper-clad laminates. By that agreement, the company granted to theassessee an exclusive non-assignable licence to manufacture laminates inaccordance with the process covered by the assessee. The licence grantedto the assessee-company was to continue for unexpired terms of the Indian Letters Patent and the extension or re-grant thereof. As a consideration for the grant the assessee was to pay 5% royalty on the net selling price of all laminated products made or sold by it in accordance with those patented processes. The total royalty payment reached 5,000 and the assessee was no more liable to pay royalty. The assessee-company also entered into an agreement with the English company under which the English company agreed to furnish exclusively to the assessee-company technical information relating to the manufacture and testing of the products as described in the schedule II attached to the said agreement. As consideration thereof, the assessee-company agreed to pay consultancy fee at 2% of net sale proceeds on certain class of products and at 5% of the net sale proceeds of the other products sold by the assessee during every year during which the agreement remained in force. The assessee claimed deduction of the amount paid as royalty and consultancy fees under the above agreement in computation of its income for the respective assessment years on the ground of expenditure of a revenue nature. It was held by the Andhra Pradesh High Court that payment made by the assessee towards royalty was capital in nature and inadmissible as deduction in computation of the assessee's business income for the relevant years. Acquisition of knowledge in respect of the new product, although allied in nature to the products already manufactured by the assessee, would amount to acquisition of an advantage or an asset for the extension of the assessee's business.

10. In the case of Commissioner of Income-tax v. Aluminium Corporation of India Ltd., : [1973]92ITR563(Cal) this court had occasion to consider this question and was of the opinion that whether a particular expenditure was capital expenditure or revenue expenditure should be judged by applying correct legal principles from a commercial point of view. It was held that one of the primary rules for determining whether an expenditure was revenue or capital in nature was related to the carrying on or conduct of the business that it might be regarded as an integral part of the profit making process, it might be held to be revenue expenditure. If the purpose was acquisition of an asset or right of a permanent nature the possession whereof was condition precedent to the commencement or continuance of the business, the expenditure would be capital in nature.

11. It appears to us that in order to determine the question which arises often and presents difficulties in answering whether an expenditure incurred by the assessee is of capital or revenue in nature, the following principles may have to be borne in mind. Whether a particular expenditure is revenue expenditure or capital expenditure must be judged, (a) by applying correct legal principles from commercial point of view, (b) the decision in each case must depend on the particular facts and circumstances of the case, and (c) one of the main factors for determining the nature of the expenditure is to find out the purpose and object of incurring the expenditure and the results following the incurring of the expenditure. If by incurring the expenditure an asset or advantage of a permanent character was acquired, then the expenditure would be capital in nature. But if the expenditure was one which was related to the carrying on or the conduct of the business and formed an integral part of the profit making process, then it should be considered to be revenue expenditure. What is permanent or enduring cannot be laid down by any fixed standard. Permanency, however, is not synonymous with perennial. What is meant is relative durability having regard to the transaction between the parties and having regard to things or advantages obtained. If it is intrinsically a capital asset, then the nature of payment, though a relevant factor, is not decisive or conclusive for determination whether it was incurred for revenue or capital purposes. The asset or advantage may be tangible or of intangible right. It has to be borne in mind, as it was pointed out by the Andhra Pradesh High Court, that these principles are not exhaustive and these could not be laid down for all cases to be applied. These merely provided for certain guidelines for determining the facts of each case.

12. Bearing the aforesaid principles in mind we have to examine the facts of this case. We have seen the agreement entered into between the parties. Under the agreement the assessee was to have the licence for a limited period, though in this case the period was fairly long in the sense that it was for 10 years certain and for two years more, that is to say, for 12 years, unlike the case of Ciba & Co., where it was for 5 years. What is of importance, however, is that the period was fixed by the agreement. It has, secondly, to be borne in mind that under the agreement all the information under the licence given were to be treated as confidential to the assessee and should not be communicated to any other party and, on the termination of the agreement, these should be returned to the company viz., Associated Electrical Industries Ltd., London. Therefore, the assessee had merely the use of this licence for a limited period of time and for certain limited purpose, i.e., to use it for the manufacture of its motors for the purpose of mainly selling it to the Associated Electrical Industries (India) Private Ltd. It should be borne in mind that for this purpose no new machinery was acquired or no new machinery was installed. The new types of things manufactured were improvements over the existing machinery. It has further to be borne in mind as found by the Tribunal that the assessee was manufacturing similar items of motors and the present design covered only one type of manufacture of goods by the assessee. In these circumstances, it appears to us that the assessee did not have any asset or advantage or right of enduring nature. On the other hand, what the assessee was getting was something which was necessary in the profit earning process of the assessee. In the aforesaid view of the matter, we are of the opinion that the Tribunal was right in coming to the conclusion that it did.

13. We will, however, shortly refer to those cases to which attention was drawn by counsel for the revenue. Reliance was placed on the decision in the case of Handley Page v. Butterworth (H. M. Inspector of Taxes), [1933] 19 TC 328. There the assessee was the manager of an aircraft construction company which worked out the designs, for certain types of bombing aeroplanes. - These designs were not capable of being registered, or of being the subject of letters patent, although certain minor features had been patented including some by the appellant which was used by the company under a verbal licence. During the war the company was required to impart to other constructors in the United Kingdom and to the United States Government the information necessary to enable them to build machines from the designs. For this the assessee received certain amount of money, the details of which it is not necessary for us to refer. It was held that the assesseee was not liable to income-tax in respect of any part of the awards which were wholly received by the company in its own right and not as the appellant's agent. Counsel drew our attention to the observations of Romer L.J. at page 359 of the report. There, the Lord Justice was dealing with a person who was parting with his knowledge of patent. We are concerned really with a reverse case of the recipient of an advantage. Parting with an advantage or knowledge may in certain circumstances amount to parting with capital asset. But whether or not the advantage received by the recipient has to be treated as advantage of capital in nature or revenue in character has to be judged by the nature and the quality of the advantage received by the recipient of the advantage or right. In the aforesaid view of the matter we do not think' much assistance can be had in this case from the aforesaid observations upon which counsel for the revenue relied.

14. Reliance was also placed on the decisions in the case of Murray (H. M. Inspector of Taxes) v. Imperial Chemical Industries Ltd., [1967] 44 TC 175 in the case of Rose & Co. (Wallpaper & Paints Ltd.) v. Campbell (H. M. Inspector of Taxes), [1967] 44 TC 500 and in the case of McVeigk (H. M. Inspector of Taxes) v. Arthur Sanderson & Sons Ltd., [1968] 45 TC 273 and reliance was also placed on the observations at page 283 of the report and on the decision in the case of Wolf Electric Tools Ltd. v. Wilson (H. M. Inspector of Taxes), [1968] 45 TC 326 . In the view we have taken of the facts and circumstances of the case and in view of the agreement referred to hereinbefore, we do not think that the principles laid down in these decisions can be applied to the instant case.

15. In the aforesaid view of the matter we are of the opinion that the Tribunal came to the correct conclusion and the sum of Rs. 22,039 should be allowed under Section 37 of the Income-tax Act, 1961. The question is answered accordingly. Each party will pay and bear its own costs.

Janah, J.

16. I agree.


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