1. The appellant is a public limited company, which manufactures road-making machinery and other construction machinery. This appeal arises out of its income-tax assessment for the year 1982-83, for which the previous year ended on 31-12-1981. The Income-tax Officer made an original assessment in this case on 28-3-1985 Under Section 143(3) of the Income-tax Act and determined the total income at Rs. 8,94,213, as against a net loss of Rs. 2,37,890 claimed by the appellant. The assessee took up the matter on appeal, and by his order dated 2nd August, 1985, the CIT (Appeals) directed the Income-tax Officer to apply his mind to three vital aspects regarding a sum of Rs. 8,12,095, which was claimed by the appellant as a deduction and which represented the total technical know-how fee paid by it. He, therefore, directed the Income-tax Officer to study the two technical know-how agreements and to ascertain the amount of deduction to be granted on account of technical know-how fee for the assessment year 1982-83.
2. Thereafter, the Income-tax Officer passed a fresh order giving effect to the appellate order of the CIT (Appeals), on 25-11-1985. In this order, the Income-tax Officer determined the total income of the assessee at Rs. 7,03,090. While passing this order, the Income-tax Officer held that the assessee was not entitled to any deduction on account of technical know-how fees payable to the two West German Collaborators DEMAG and Weyhausen in the present accounting year and that further, the payments made by the assessee were capital expenditure.
3. Aggrieved by this order, the assessee again filed an appeal objecting to the disallowance of Rs. 8,12,095 by the Income-tax Officer. The assessee contended that this amount paid by it for acquisition of technical know-how from two German Companies was admissible as a revenue expenditure. The expenditure so claimed by the assessee consisted of the following two amounts : Republic of Germany (Demag, equivalent to Rs. 1,85,724 for short).
usen, Federal Republic of Ger- equivalent to Rs. 6,25,371 many (Weyhausen, for short) -------- Rs. 8,12,095 4. After examining the appellant's contentions, the CIT (Appeals) accepted the assessee's claim for deduction of the sum of Rs. 1,85,724 paid to Demag, as admissible revenue expenditure in the year under appeal. However, in respect of the other amount of Rs. 6,26,371 payable to Weyhausen, the CIT (Appeals) held that on the facts of the case it was quite clear that it could not be allowed either on cash basis or on mercantile basis in the hands of the assessee in the present assessment year 1982-83. This point is dealt with by the CIT (Appeals) in paragraphs 10 to 18 of his appellate order. In para 12, the CIT (Appeals) states that he requested the assessee to specifically let him know the basis for making the claim of DM 1,50,000 in the accounting year ended on 31-12-1981 and that the assessee replied that the production of wheel loaders started in the calendar year 1981 and that was why it made the claim in the present accounting year ended 31-12-1981. He further stated that when he asked for the exact month in which the production of wheel loaders was started, the appellant replied that production was started in November 1981. It was also stated that though production was started in November 1981, the remittance was postponed to March, 1982 since the Income-tax Department and the Reserve Bank of India took time to give 'no objection certificate' and that in accordance with its usual practice of mercantile system of accounting, it made the entire claim of DM 1,50,000 in this accounting year, since it was the year of actual manufacture of wheel loaders.
5. After examining the printed balance-sheet of the company pertaining to the calendar year 1981, the CIT(A) held that according to note 10 of the 'notes on accounts', the assessee did not produce even a single item of 'Hydraulic self propelled loaders' in this accounting year.
According to him, it was quite clear that the company did not start manufacture of wheel loaders in accordance with the agreement even till 26th April, 1982, on which day the Directors submitted the company's accounts to the shareholders. After referring to the Directors' report, the CIT(A) held that it was quite clear that as on 31-12-1981 and even as on 26-4-1982 the assessee only received the drawings and designs from Weyhausen, but that the assessee did not start even trial production, not to speak of commercial production of the wheel loaders, which are also known as Front End Loaders, or as Hydraulic Self Propelled Loaders. The CIT (Appeals) next pointed out that according to the cash system of accounting, the payment of DM 50,000 made to Weyhausen pertained to the assessment year 1981-82 and the payment of DM 1,00,000 pertained to the assessment year 1983-84 and that neither of these payments pertained to the present assessment year 1982-83. He further held that even according to the appellants own mercantile system of accounting, the claim of either DM 50,000 or DM 1,00,000 did not pertain to the assessment year 1982-83, but it pertained to a future assessment year depending on the actual date of production. The CIT(A) was of the view that perhaps the appellant was anxious to make a provision in its accounts prematurely in the present assessment year 1982-83 itself for the sum of DM 1,50,000, because the assessee changed its 'previous year' from the calendar year to the year ending 30th June and therefore there would be no assessment for the assessment year 1983-84 at all. He also referred to the fact that the appellant-company got amalgamated with its holding company, called Marshall Sons & Co.
(India) Ltd., whose head office is at Calcutta, and that the said amalgamation was effective from 1-1-1982. The CIT (Appeals) held that it would be significant to note that by the time the appellant made the remittance of DM 1,00,000 to Weyhausen in May 1982 (which the learned counsel says, should be March 1982), the assessee already got amalgamated with its holding company and that it was the holding company (the amalgamated company) which really started the manufacture of wheel loaders. The CIT (Appeals) further held that it appeared to him that the assessee was quite anxious to get the deduction of DM 1,50,000 in its own assessment to avoid any uncertainty, but that whatever might be the motive of the assessee, on facts it was quite clear to him that this claim of DM 1,50,000 could not be allowed either on cash basis or on mercantile basis in the hands of the assessee in the present assessment year 1982-83. In this view of the matter, he did not go into the question whether this payment represented capital expenditure or revenue expenditure, as he was of the view that this issue would have to be decided for a future assessment year in the hands of the holding company, perhaps by the Income-tax Officer at Calcutta. The appellant feels aggrieved by this order of the CIT (Appeals) and has come up on further appeal to the Tribunal.
6. Shri P. Balasubramaniam, the learned counsel for the appellant relied on Clause 7 of the know-how licence agreement dated 27th July, 1978 as amended by the further agreement dated 16-3-1979 entered into between the appellant and Weyhausen and submitted that the amount of DM 1,50,000 had become due from the appellant to Weyhausen during the accounting year ended 31-12-1981 when the appellant-company commenced production of this AR 61 Loaders and that it had become its liability under the scheme of payment specified in Article 7 of the said agreement. Shri Bala-subrarnaniam submitted that the first amount of DM 50,000 paid by the appellant in September 1980 could not have been claimed by the appellant in the earlier years since the said amount was an advance liable to forfeiture if the agreement was prematurely terminated. He further submitted that the second and third instalments of DM 50,000 each would go together by virtue of the agreement and the conditions imposed for these two payments were fulfilled in the accounting year. According to Shri Balasubramaniam, the documents containing the complete set of manufacturing drawings were handed over to the appellant in February 1981 and that the appellant had commenced production of this product in October 1981 as could be seen from the issue of materials to the shop floor. He pointed out that the copies of the vouchers for the materials issued from the stores on 22-10-1981 and 29-11-1981 at page 23 of the assessee's paper book clearly established that the appellant had commenced production of this product as per the agreement during the accounting year. He next referred us to the copy of the purchase order dated 10th November, 1981 placed by the appellant-company on Weyhausen at pages 24 to 27 of the paper book and pointed out that this further established that the appellant had placed the order for import of the raw materials and components for the manufacture of AR-61 Front End Loaders during the accounting year. He also relied on the two certificates one dated 17th June, 1986 issued by the Dy. General Manager (Works), and the other dated 18th June, 1986 issued by the Financial Controller of the appellant-company to show that the production of Hydraulic Front End Loaders had commenced in October, 1981 and that the value of Rs. 51,169 being the work-in-progress in respect of the same formed part of the total work-in-progress of Rs. 61,17,226 as per the balance-sheet as at 31st December, 1981. He also relied on the order received by the appellant from the Hindustan Construction Co. Ltd., Bombay dated 28th December, 1981 for the supply of one Marshall AR-81 Front End Loader, by the end of February 1982. The learned counsel, however, fairly stated that the appellant-company supplied this Front End Loader only in August 1982, as the necessary components ordered from Weyhausen in November 1981 were received only in April 1982.
7. Relying on the above materials, the learned counsel argued that in order to give effect to Article 7 of the agreement, the date on which the liability arose would be the date of commencement of production and not any other date. The learned counsel challenged the findings of the GIT (Appeals) and submitted that as a matter of fact the appellant-company had remitted the entire amount of DM 1,50,000 in March 1982 after obtaining clearance from the ITO and the Reserve Bank of India, but before the import of the components and assembling of the final products. He further contended that the Directors' report relied on by the CIT(A) to draw an adverse inference against the appellant was actually in favour of the appellant's contentions. He further argued that the reference to the change in the accounting year and the amalgamation of the appellant-company with its holding company were neither relevant nor material for the admissibility of the appellant's claim. He therefore argued that on the terms of the agreement entered into by the appellant with Weyhausen, the appellant was entitled to claim this deduction in this year, as the liability to pay this amount had arisen under Clause 7 of the agreement and that the CIT(A) ought to have accepted the appellant's claim in this year for deduction in this yea.r. He contended that the findings of the CIT(A) to the contrary and to the effect that it would come up for consideration in a future assessment year in the hands of the amalgamated company, was erroneous and that the same should be reversed.
8. The learned counsel further submitted that so far as the present item of end-product to be manufactured, there was no trial production involved and that it was regular commercial production, where the cost of the Front End Loader manufactured was nearly Rs. 5 lakhs. Shri Balasubramaniam submitted that such a trial production was not possible or feasible in the present case. He submitted that the decided cases related to cases of setting up of a new business or commencement of a new business and therefore would be of no help in deciding the issue in the present case. He submitted that the release of the drawings and designs and the raw materials to the shop floor in October and December 1981 would be the first step in the production of this item and that, therefore, the appellant would be entitled to make this claim in the year under appeal. He therefore argued that the CIT (Appeals) ought to have allowed the assessee's claim in this year.
9. Shri S.V. Jagannathan, the learned departmental representative, who argued the appeal on the first occasion relied on the findings of the OIT(A) and submitted that the appellant's claim for deduction in the year of appeal had been rightly negatived, as nothing had happened, much less the production of the article covered by this agreement had been completed during the year under appeal to entitle the appellant to claim this amount in this year. He pointed out that when the appellant paid the first instalment of DM 50,000 in September 1980, it was paid only as an advance and that the said payment was not in the year of account, but in the earlier year. He next submitted that the second instalment was due according to the agreement in February 1981 on the handing over of the complete set of manufacturing drawings, but on the facts found by the CIT (Appeals), the second and third instalments were paid together only in March 1982, which fell outside the accounting year under appeal. He further pointed out that the Director's report extracted by the CIT (Appeals) in paragraph 13 of his order only showed that some drawings had been released to the shop floor and that some orders were placed for the import of the components from materials from Weyhausen. The learned Senior Departmental Representative submitted that these acts would not amount to commencement of production as contemplated either in the agreement or in law. He submitted that unless the end-product to be manufactured under this Know-how Licence Agreement, namely Front End Wheel Loaders AR-61, were fully manufactured, it could not be held that the appellant had commenced production of this product in its factory. Shri Jagannathan pointed out that on the appellant's own admission, the first AR-61 Wheel Loader was manufactured only in August 1982 and supplied to a Bombay party and that therefore the production was only in the next accounting year and not in the year under appeal. He therefore submitted that the findings and conclusion of the CIT (Appeals) in this regard were correct and that the same should be upheld. The learned departmental representative further pointed out that the facts referred to by the CIT (Appeals), namely the change in the accounting year of the appellant, as well as its amalgamation with its holding company as on 1-1-1982 were all very relevant and material facts in the context of the present claim of the appellant and that the CIT (Appeals) had rightly referred to the same.
He further submitted that in the view he had taken on the facts about the allowability of the appellant's claim in the year under appeal, the CIT (Appeals) had not examined the appellant's claim for deduction as a revenue expenditure on its merits, as this amount has been disallowed by the ITO on merits by treating it as capital expenditure. In case the Tribunal came to the conclusion that the appellant is entitled to make this claim for deduction in the year under appeal, the learned departmental representative submitted, then the matter may have to be sent back to the CIT (Appeals) for further examination of the appellant's claim for deduction on its merits as to whether it is revenue expenditure or capital expenditure.
10. We have carefully examined the contentions of parties in the light of the materials placed before us. In our view, the answer to the problem posed in the present case is directly given by the decision of the Madras High Court in Addl. CIT v. Southern Struc-turals Ltd. [1977] 110 ITR 164. In the said case, the assessee-com-pany had entered into a contract with the Government of India, Ministry of Railways for manufacture and delivery of 250 railway wagons according to specifications provided by the Ministry. This contract was entered into on 13th January, 1957. The asses-see manufactured a proto-type wagon for the approval of the representative of the Government. On the approval of the wagon on 14th January, 1959 with certain rectifications, the assessee was authorised to go in for production.
The assessee thereafter manufactured the wagons and the first batch of six wagons was delivered on 14th August, 1959. The assessee's claim for relief Under Section 84 of the Income-tax Act, 1961, for 1964-65 was rejected by the departmental authorities in the view that the assessee had commenced manufacture in the calendar year 1958 relevant for the assessment year 1959-60, and that the relief would be available only up to the assessment year 1963-64, and hence no relief was admissible for 1964-65. The Appellate Tribunal, however, held that the assessee could not be said to have begun manufacturing or producing wagons in any commercial sense in the calendar year 1958, relevant for the assessment year 1959-60, and hence the assessee was entitled to the relief for the assessment year 1964-65 as well. On a reference to the High Court at the instance of the department, their Lordships of the Madras High Court upheld the order of the Appellate Tribunal. At page 167 of the reports, their Lordships held as follows : There can be no dispute about the fact that the article that is relevant in the context of the present case is the wagon as such.
Production of a proto-type is not production of an article as such, because if the Ministry of Railways had rejected the proto-type or had suggested substantial modifications thereto, then it would not have been possible for the assessee to go into production of the wagons in accordance with the proto-type already produced and the process of manufacture in accordance with the rectified type of wagon would take some further time. Therefore, the mere manufacture of proto-type would not be enough to show that the assessee had begun to manufacture or produce articles. The manufacture or production of articles must be in some commercial sense.
After referring to the decision of the Bombay High Court in CIT v.Hindustan Antibiotics Ltd. [1974] 93 ITR 548, their Lordships held as follows at page 168 : The test as propounded above shows that it is not necessary to find out as to when the assessee commenced manufacturing operations as such, but to find out as to when the assessee began to manufacture or produce the articles as such. The mere manufacture of proto-type may have resulted in commencement of operations, but that would not be enough, as the actual commencement of manufacture or production of the articles is the test. The passage quoted above makes it clear that the articles contemplated are articles of finished products for whose manufacture and sale the undertaking has come into existence.
We are in complete agreement with this view.
11. When we examine the facts of the present case in the light of the aforesaid ratio of the decision of the Madras High Court, we have no hesitation in coming to the conclusion that the CIT (Appeals) has rightly rejected the appellant's claim for deduction in the year under appeal, namely assessment year 1982-83, relevant for the accounting year ended 31-12-1981. There is no dispute that the know-how licence agreement with Weyhausen was entered into for the manufacture, use and sale of "Wheel Loaders AR-61" which are described as "contractual products" in the said agreement entered into by the appellant with Weyhausen on 27-7-1978. Article 7 of the original agreement dated 27-7-1978 relating to the payment reads as follows : Down Payment. For the supply of the drawings and other documents by Weyhausen on the basis of the present agreement and for the conveyance of the technical know-how in connection with the contractual products, Marshall shall pay a lump sum of DM 1,50,000 in total which will be effected as follows : 1/3 DM 50,000 - to be transferred immediately after signature of this contract by both parties. Marshall shall not be entitled to the return of the sum if for any reason this agreement should be prematurely terminated.
1/3 DM 50,000 - to be transferred at handing over of a complete set of manufacturing drawings. Marshall shall not be entitled to the return of the sum if for any reason this agreement should be prematurely terminated.
1/3 DM 50,000 - to be transferred at commencement of production and assembly of the product latest 12 months after handing over of the set of manufacturing drawings. Marshall shall not be entitled to the return of the sum if for any reason this agreement should be prematurely terminated. Marshall is obliged to secure payment of this DM 50,000 by a corresponding bank guarantee issued by a bank of the Federal Republic of Germany at the date of second payment which is due at handing over a complete set of manufacturing drawings.
Remittance shall be made to one of Weyhausen's accounts in the Federal Republic of Germany.
This Article 7 was amended on 16-3-1979 in the following manner by the parties, as could be seen from the Annexures at pages 19 and 20 of the papers filed by the assessee : 4. In the original agreement under Article 7 the third instalment of DM 50,000 was to be made latest 12 months after the handing over the set of manufacturing drawings. This shall now read : 1/3 DM 90,000 - to be transferred at the commencement of commercial production and assembly of the product, immediately after receipt of necessary components imported from Weyhausen. Marshall shall not be entitled to the return of the sum if for any reason this agreement should be prematurely terminated. Marshall is obliged to secure payment of this DM 50,000 by a corresponding bank guarantee issued by a bank of the Federal Republic of Germany at date of second payment which is due at handing over a complete set of manufacturing drawings. Remittance shall be made to one of Weyhausen's accounts in the Federal Republic of Germany.
Considerable stress is laid by the learned counsel for the appellant on the words "the commencement of commercial production and assembly of the product" in this Article 7, which we have quoted above, to contend that since the assessee had commenced the production of this product by the issue of drawings and some materials to the shop floor in October/December 1981, the assessee is entitled to make this claim for deduction in this year. The assessee further relies on the placing of the order with the German company in December 1981 for the import of the component parts. But all these facts admittedly do not establish the complete production of the final product, namely AR-61 Wheel Loader by the a.ppellant-company. Even if we go by the materials placed by the appellant's learned counsel in the form of certificates from Dy.
General Manager (Works) and Financial Controller, the Hydraulic Front End Loader was still in the form and stage of work-in-progress and was not in the form of the final end-product namely AR-61 Hydraulic Front End Loader, as contemplated in the agreement. Their Lordships of the Madras High Court have pointed out that the articles contemplated are articles of finished products for whose manufacture and sale the new industrial undertaking has come into existence in the case of Southern Structurals Ltd. The same principle, in our view, would apply to the interpretation of this agreement entered into between the appellant-company and Weyhausen on 27-7-1978 as amended in 1979. Any other interpretation would lead to an absurd result and would be opposed to facts. In fact, the first AR-61 Front End Loader was manufactured by the appellant-company and supplied to its customer, Hindustan Construction Co. Ltd. only in August 1982, which falls in the next accounting year relevant for the assessment year 1S83-84 and not in the year under appeal. The certificate of the Dy. General Manager (Works) shows that there was inspection of the Front End Loader manufactured by the assessee, by the technical representative of the foreign collaborators, i.e., Weyhausen and that the same was cleared for despatch only in August 1982. We have already referred to the fact that the components for the manufacture of this product were imported by the a.ppellant from West Germany and that they were received in India by the appellant only in April 1982. The Directors' report for the calendar year 1981, which has been extracted by the CIT(A) in para 13 of his order, clearly establishes that the Front End Loaders were not manufactured during the accounting year 1981, but that the drawings for the same received from Weyhausen were still at the stage of scrutiny by the Design Department of the assessee-company before release to the shop floor. At another place, the Directors state that the drawings bad also been released to the shop floor and necessary arrangements for import of the raw material components for assembly of these Front End Loaders were made. This report is dated 26th April, 1982. Therefore, on the above facts, it is futile for the appellant to contend that it had manufactured the Front End Loader during the calendar year 1981 only, to be eligible for the deduction of this amount in the assessment year 1982-83. We, therefore, respectfully follow the decision of the Madras High Court referred to above, and applying the ratio of the said decision to the facts of the present case hold that the assessee is not entitled to the deduction of this amount of DM 1,50,000, equivalent to Rs. 6,26,371 in the computation of its income for the assessment year 1982-83 and that the CIT (Appeals) rightly rejected its claim for this deduction in this year.
Accordingly, the appeal is dismissed.