1. These two appeals, one each by the assessee and the ITO, relate to the assessee's assessment for the assessment year 1967-68. The assessee is a non-resident company. It filed its returns of income for the first time for the assessment year 1971-72, inter alia, disclosing a loss of Rs. 7,272. The assessment was completed on 1-7-1975 determining the total income at Rs. 33,120. Return for the assessment year 1972-73 was filed on 10-2-1976 disclosing dividend income on 21,000 equity shares held by it in an Indian company by the name Albright Morarji & Pandit Ltd. During the course of proceedings for the assessment year 1972-73, the ITO came to learn that the assessee-company has sold its technical know-how relating to its designs, drawings, specifications, etc., and also certain patents to the Indian company under an agreement dated 10-2-1966 and that in consideration thereof the Indian company had allotted 21,000 equity shares of Rs. 50 each out of its initial issue of shares to the assessee free of cost during the financial year ending on 31-3-1967.
2. The ITO felt that the aforesaid amount of Rs. 10,50,000 being the face value of the shares representing the sale price of the assessee's know-how, etc., was taxable and that income had escaped assessment on account of the assessee's not filing its return of income for the assessment year 1967-68. Accordingly, he initiated proceedings under Section 147(a) of the Income-tax Act, 1961 ('the Act'), and with the approval of the Commissioner issued a notice under Section 148 of the Act on 24-3-1976. In response thereto the assessee filed a return showing nil income. Thereafter there were hearings, notices were issued by the ITO and explanations were given by the assessee. Eventually, the ITO completed the assessment on 11-8-1980 computing the total income liable to tax under the head 'Capital gains' at Rs. 4,19,495. It is pertinent that the ITO found that the shares of the face value of Rs. 10,50,000 were received by the assessee in consideration of a number of items which included two Indian patents exclusively and irrevocrably on which no royalty was payable and that the consideration therefor was specifically given as Rs. 4,20,000 in the agreement. It is this amount which the ITO has considered as taxable under the head 'Capital gains'.
As regards the cost of the aforesaid two Indian patents, the case of the assessee was that the cost was not determinable. Alternatively, however, the assessee claimed that the cost might be estimated at 1,000, i.e., Rs. 21,000. However, the ITO has taken the cost of the patents at Rs. 505 only, being the registration charges of the patents in India.
3. The Commissioner (Appeals) has observed that even though the first ground of appeal was against the ITO's action in initiating proceedings under Section 147(a), Mr. Pawari had fairly not made any submissions as it was manifest that if there was any income liable to charge and there being no return filed by the assessee, the ITO's action would be eminently proper.
On merits, it was contended that what was transferred by the assessee was nothing but a self-generated asset and, therefore, as held by the Bombay High Court in CIT v. Home Industries & Co. [1977] 107 ITR 609 the surplus, if any, would not be taxable. Reliance was also placed in this behalf on the Madras High Court's decision in the case of CIT v.K. Rathnam Nadar [1969] 71 ITR 433 and the Kerala High Court's decision in the case of CIT v. B.C. Jacob [1973] 89 ITR 88 (FB). However, for reasons given in paras 6 to 8 of his order, the Commissioner (Appeals) held that the consideration received for the patents was rightly taxed by the ITO to capital gains, As regards the cost, however, for reasons given in para 9 of his order, the Commissioner (Appeals) felt that the cost of the two patents could be reasonably taken at Rs. 21,000.
Accordingly, he directed the ITO to modify the assessment.
4. Being aggrieved by the aforesaid order of the Commissioner (Appeals), both the assessee and the ITO had come up in appeal before the Tribunal. There are two effective grounds in the assessee's appeal.
They are against the initiation of the proceedings under Section 147(a) and against the taxability of the sum of Rs. 4,20,000 to capital gains being the sale price of the two Indian patents. On the other hand, the only ground in the departmental appeal is that the Commissioner (Appeals) was not justified in holding that a sum of Rs. 21,000 might reasonably be considered as the cost of the two Indian patents.
5. For the sake of convenience, we will take up the assessee's appeal first. We have already referred to the Commissioner (Appeals)'s observations that though there was a ground against the initiation of proceedings under Section 147(a) before him, the said ground was not really pressed on behalf of the department, However, Shri Dastur, the learned counsel for the assessee, submitted that this ground goes to the very root of the assessment and that even though not specifically pressed, it would be open to the assessee to urge the ground before us.
On merits, Shri Dastur invited our attention to the reasons recorded by the ITO which do not indicate that the ITO was aware of the transfer of two Indian patents. Referring then to the Board's Circular No. 21 [F.No. 7A/40/68-IT(A-II)], dated 9-7-1969 [see Taxmann's Direct Taxes Circulars, Vol. 1, 1980 edn., p. 231], Shri Dastur submitted that the mere fact that the assessee was allotted 21,000 equity shares of Rs. 50 each of the Indian company in consideration of its know-how, etc., would not provide a reason to believe that income had escaped assessment. He contended that it was immaterial that subsequently during the course of the assessment proceedings the ITO came to leant about the transfer of the patents and that what was really material in this case was what were the facts when the ITO initiated the proceedings under Section 147(a). The departmental representative has, on the other hand, invited our attention to the sale agreement dated 12-10-1966 which, according to him, referred to the transfer of patents also. He also invited our attention to the correspondence exchanged between the assessee and the ITO during the course of the assessment proceedings for the assessment year 1972-73 which clearly indicated that a sum of Rs. 4,20,000 was specifically receivable out of the aforesaid sum of Rs. 10,50,000 as the sale price of the two Indian patents exclusively and irrecoverably. When the attention of the assessee's counsel was invited to the correspondence exchanged between the assessee and the ITO on the basis of which the ITO had initiated the proceedings under Section 147(a), Shri Dastur, it must be stated in fairness to him, almost conceded that in that cases he had nothing more to say. There is, of course, no dispute that once there is material justifying the ITO's reason to believe that income had escaped assessment, the sufficiency of the material is not justiciable. In the circumstances we have no difficulty in holding that the Supreme Court's decision in the case of Ganga Saran & Sons (P.) Ltd. v. ITO [1981] 130 ITR 1 is distinguishable, Accordingly, we uphold the ITO's action in initiating the proceedings under Section 147(a).
6. On merits, Shri Dastur stated that there was no material difference between the sale of know-how as such and the know-how patented.
According to him, 'patent' is not a positive right ; it is a negative right, viz., once the know-how is patented others would perhaps be not able to exploit it in a given territory. That is how what holds good of the know-how should hold good for the patents. On the other hand, Shri Krishnan, the departmental representative, submitted that even though theoretically Shri Dastur might be right, technically once a know-how is patented, it becomes tangible commodity and does not remain intangible like the mere know-how. The effect of the registration of the know-how in India as patent, according to Shri Krishnan, is that thereafter the particular know-how could not be used by any person other than the assessee in India. It is this right which the assessee sold to the Indian company exclusively and irrevocably. We find that the two patents were registered in India in 1964 and 1966 and that, as contended by Shri Krishnan, the patents are capital assets, the transfer of which would ordinarily attract liability to capital gains.
7. The alternative contention of Shri Dastur has been that the patent is the shell and the know-how is the real thing within it. Assuming it is held that the sale of the patent would attract liability to capital gains, the liability would be confined only to the sale of the patent and not to the know-how. On the other hand, Shri Krishnan submitted that once a know-how is patented, the patented know-how becomes one indivisible tangible item and it is neither possible nor desirable to bifurcate the consideration attributable to the know-how and the patent. Here again, in our view, the submissions made on behalf of the assessee have no merit. Once a know-how is patented, it is the patent which is the capital asset and it is the consideration for the transfer of the patent that becomes material. The illustration that comes to our mind in this connection is that of gold ornament. No doubt an ornament means nothing but gold plus workmanship but once the gold is converted into an ornament what is sold is the ornament and not the gold and workmanship separately.
8. Next contention raised on behalf of the assessee has been that it is almost impossible to determine the cost of the patent. However, the learned counsel fairly admitted that the non-resident assessee-company was maintaining a huge research and development department and that the know-how including patented ones are the results of the research conducted in that department. He contended that it was almost impossible to determine the cost of any know-how patented or not patented in the nature of things. In support, Shri Dastur placed reliance on the Supreme Court's decision in the case of CIT v. B.C.Srinivasa Setty [1981] 128 ITR 294 wherein the Bombay High Court's decision in Home Industries & Co.'s case (supra), the Madras High Court's decision in K. Rathnam Nadar's case (supra) and other cases have been approved. The departmental representative, on the other hand, pointed out that the Supreme Court's decision was not applicable inasmuch as in the Supreme Court's case the transferred capital asset did not cost at all as distinct from this case in which the cost as such is not disputed and the only dispute has been that it is not possible to determine the cost. He stated that whatever may be the difficulty in estimating the cost, there being no dispute that there is a cost, the sale of patents would attract liability to capital gains.
In reply, Shri Dastur referred to the unreported decision of the Bombay High Court in the case of Evans Fraser & Co. Ltd. v. CIT [IT Reference Nos. 146 of 1970 and 66 of 1979, dated 13-8-1981] since reported in [1982] 137 ITR 493 (Bom.) which according to him, indicated that unless the cost of an asset could be determined with an amount of certainty, the transfer of such an asset did not attract capital gains.
9. Having heard the parties and after going through the decisions relied upon as well as the Bombay High Court's decision in the case of ITO v. S.P. Sharma dated 12-1-1981 and the Board's circular referred to by the Commissioner (Appeals) in para 9 of his order carefully, we are of the view that there is a clear and material distinction between a capital asset which cost nothing to the assessee and a capital asset which has admittedly cost something but it is difficult to ascertain its cost with some definiteness. While the transfer of the capital asset, the cost of which is nil, will not attract liability to capital gains as held by a number of High Courts decisions and the Supreme Court's decision in the case of B.C. Srinivasa Setty (supra), we do not think that it would be so in the case of transfer of a capital asset falling in the latter category. Since the two Indian patents transferred by the assessee in this case fall in the latter category, we hold that the transfer thereof attracts liability to capital gains.
10. Now we come to the departmental appeal. The departmental representative invited our attention to the submissions made on behalf of the assessee that in the case of know-how developed in a big research and development department, it would almost be impossible to determine the cost of a particular know-how with reasonable certainty.
He stated that in this view of the matter, it is not necessary for him to advance any arguments and that the ITO was fully justified in treating the cost of the patents at Rs. 505, being registration charges only. On the other hand, Shri Dastur strongly relied on the order of the Commissioner (Appeals). We have already held that it is a case of a capital asset which has admittedly cost something to the assessee but it is not possible to ascertain the cost with definiteness. In the circumstances, we are inclined to accept the assessee's estimate of cost of 1,000, i.e., Rs. 21,000.
11. In the result, both the assessee's and the departmental appeals are dismissed.