1. to 38. [These paras are not reproduced here, as they involve minor issues.] 39. Ground Nos. 10 to 29 challenge the disallowance of royalty paid to Honda Motor Company Ltd. for technical know-how and other support.
40. The assessee company was established in 1984 as a joint venture Company between Kinetic Engineering Limited and Honda Motor Company of Japan (hereinafter referred to as Honda). Initially, both Kinetic Engineering Ltd. and Honda Motor Co. Ltd. held 28.56% equity each.
Balance 42.88% was held by public including financial institutions.
41. A technical know-how agreement was entered into between the assessee and Honda on 21-4-1984 in respect of one Scooter model NH-100.
The agreement provided for technical assistance in setting up of the plant and manufacture and sale of scooters together with use of Honda name for a period of 10 years. Royalty was to be paid for a period of seven years from the commencement of commercial production, which was on and from 10-4-1986. The royalty was payable at the rate of 4% of sales. The agreement also provided for assistance in marketing, supply of critical components and use of extensive marketing network of Honda for exports.
42. The agreement was duly approved by the Government of India as required by law and the entire royalty paid was allowed as permissible business expenditure in earlier years.
43. During the course of assessment proceedings, the Assessing Officer noted that Royalty was payable by the assessee to Honda at the rate of 3% on domestic sales and at the rate of 4% on export sales made by the Indian company as per terms of collaboration agreement and the same was payable upto 9-4-1998. The assessee informed the Assessing Officer in this connection that it had originally entered into collaboration with Honda on 21-4-1984 according to which Royalty was payable for a period of seven years which had expired on 9-4-1993. Though there was no Clause in the original agreement providing for extension of the agreement, the original agreement was renewed by the assessee for a.
further period of five years after obtaining the approval of the Government of India. It was on the basis of the renewed agreement that Royalty of Rs. 3,54,71,304 had been paid and claimed in the Profit and Loss account. However, on perusal of the various documents and the assessee's explanation in this regard, the Assessing Officer noted as under: (i) The original agreement dated 21-4-1984 was effective for a period of 10 years.
(ii) As per the original agreement, royalty was payable for a period of 7 years, which expired on 9-4-1993.
(iii) There was no provision for extension of the royalty period beyond 7 years in the original agreement.
(iv) As per Article 32.1 of the original agreement, the assessee was entitled to not only use the know-how, the industrial property rights and other knowledge for a period of 10 years, but also thereafter.
(v) There was no resolution of the Board of Directors of the assessee company, authorizing the extension of royalty period beyond 7 years.
(vi) The Honda Motors Company Ltd. holds 51% shares of the assessee company and thereby is in a position to exercise its control or influence on the decisions of the assessee Company.
(vii) Since the agreement had not been terminated (as per Clause 31 of the agreement), the assessee was not prohibited from using the technical know-how, industrial property rights and other knowledge as provided in the agreement.
(viii) The assessee company was allowed and had right to use not only the know-how, knowledge etc. which were owned by Honda Motors Co. Ltd. at the time of signing the agreement, but also know-how, knowledge, rights, drawings etc. which would have been developed during the subsequent period of 10 years.
Since as per (iv) above, the assessee was entitled to use the know-how, industrial property rights etc. not only for a period of 10 years of the initial agreement, but even after that, the Assessing Officer was of the opinion that it was not necessary for the assessee company to have renewed the original agreement. Considering the fact that Honda had an influence on the decisions of the assessee company as mentioned at (vi) above, the Assessing Officer came to the conclusion that the payment of Royalty paid during the year was for considerations other than business. The Assessing Officer, therefore, intimated the assessee of his intention to disallow the claim of deduction on account of Royalty. In response thereto, the assessee, inter alia, argued that it had made the second Agreement after obtaining the approval of the Government of India. The assessee's further argument was that tax had been deducted at source from the payments of Royalty made to Honda.
However, according to the Assessing Officer, mere deduction of tax at source from the payments of Royalty was not sufficient to make the said payment an allowable expenditure. With regard to the approval of the Government of India, the Assessing Officer has mentioned in the assessment order that the same had been obtained on a specific request/application made by the assessee in this regard. The Assessing Officer further remarks in this context that the Government of India approves thousands of such applications and the approval of the Government of India cannot be a criterion for allowing deduction under the Income-tax Act. The assessee had raised following other contentions before the Assessing Officer in support of its claim of allowance of Royalty: (i) The assessee could not have functioned smoothly without further technical know-how from the collaborators.
(ii) The critical components for manufacture were being supplied by the collaborators and without these components, the product could not be manufactured.
(iii) The assessee was able to export scooters in such a large quantity, only because it was associated with Honda Motors Co. Ltd. 44. Even the above contentions of the assessee in support of the claim of deduction of Royalty were not acceptable to the Assessing Officer.
The A.O. accordingly disallowed the claim of the assessee.
45. On appeal, the learned CIT(A) agreed with the Assessing Officer's conclusion that the expenditure on Royalty could not be considered to be incurred wholly and exclusively for the purpose of business.
According to the CIT(A), perusal of the record reveals that as per the earlier Agreement dated 21-4-1984 itself, the assessee had become entitled to the know-how, designs, specifications etc. supplied by Honda not only for the period of the said agreement, but even after that and it was obvious that only because of this reason, there was no provision for extension of the Royalty period in the original Agreement. The CIT(A) accordingly held that "in these circumstances, it appears that there was no business purposes for the appellant to ask for renewal of the Agreement". According to the CIT(A), "after all, what could be the business purpose, when all the technical knowledge was available with the appellant not only for the present, but for the future also. It, therefore, appears that some extraneous considerations might have played a part in the appellant's asking for the renewal of the Agreement". As regards the approval of the Agreement by the Government, the CIT(A) remarks, "However, in my opinion, a mere approval of the Agreement by the Government of India has no relevance for the allowability or otherwise of the expenditure under the Income-tax Act. The amounts may be allowed to be remitted outside India by the Government of India for various other considerations, but it cannot be allowed as an expenditure under the Income-tax Act, unless it is proved that the expenditure was wholly and exclusively for the purpose of business. The Government of India, while approving such Agreements, examines them from a broad angle taking into consideration the various policies of the Government. Allowability of the expenditure under the Income-tax Act is not a criterion for grant of such approval". The CIT(A) further remarks that, "The appellant's Agreement was approved by the Department of Industries Development, which cannot be considered to be an expert in Income-tax matters. What is more is that the question before the said department was definitely not the allowability of the expenditure under the Income-tax Act. In these circumstances, the approval of the appellant's Agreement by the Government would automatically not mean that the expenditure was allowable under the Income-tax Act". Accordingly, the CIT(A) confirmed the finding of the Assessing Officer.
46. Shri S.N. Inamdar, the learned counsel for the assessee, submitted that there was no justification for the impugned addition. He submitted that the first Agreement entered into between the assessee and Honda for payment of Royalty expired on 9-4-1993. At this stage, the assessee had just come out of its teething troubles having incurred losses consistently earlier and started making a dent in the scooter market competing against giants like Bajaj Auto and LML Vespa. Further at that time, new pollution norms were in the offing and also the use of unleaded petrol. The assessee was struggling hard to make changes suitable to Indian customers, conditions and roads and constant efforts were on the redesign the product. Under the circumstances, according to the learned counsel, there was a compelling need to avail of Honda's technical and marketing support for a further period. Accordingly, an application was made to the Government of India for renewal of the technical assistance Agreement for a further period of seven years on payment of Royalty at 4% of sales. Full details were furnished to the Government of India including the fact that Honda was holding 50.92% of equity. He drew our attention to this application placed at pages 88 to 98 of the paper book No. 2. He also drew our attention to a Note giving justification for renewal of the Agreement furnished to the Government (pages 86 to 87 of paper book No. 2). He submitted that it was emphasized that Honda had already undertaken R & D work to improve fuel consumption. The application for renewal was thoroughly examined by the Government and though renewal was prayed for seven years and royalty of 4%, the Government was pleased to grant approval only for a period of five years and at 3% royalty, after studying the facts of the case. He submitted that under the liberalised policy, automatic permission is granted for foreign technology agreements upto 5% Royalty on domestic sales and 8% on exports. But even under the liberalised policy, there is no automatic approval for renewal of technology agreements and specific approval had to be obtained. Thus, the approval granted by the Government was after proper application of mind by an Authority which is more concerned with industrial needs and outflow of foreign exchange and export competitiveness of Indian products than the Tax department.
47. The learned counsel submitted that the first year after the renewal was assessment year 1994-95 for which the Assessing Officer allowed the Royalty paid as business expenditure in an assessment made under Section 143(3). However, surprisingly he purported to re-examine the issue again for the assessment year 1995-96 (which is the year under appeal) and came to the conclusion that not even a rupee was justified as Royalty and the payment was made for extra commercial considerations. Though he has not spelt out the so-called extra commercial considerations, he has obliquely referred to the fact that Honda was holding 51% equity in the assessee company and thus was in a position to impose a decision. He submitted that this fact was fully disclosed to the Government of India at more than one place in the renewal application and inspite of this fact, the Assessing Officer brushed aside the Government approval on the ground that it was granted routinely just for asking as it renews thousands of such Agreements. He submitted that the Assessing Officer has not examined either the Government official who approved the renewal nor anyone from Honda to understand the reasons behind renewal and approval. He also did not carry out any factual investigation. According to the learned counsel, the Assessing Officer's views are solely based on his own interpretation of various classes of the 1984 Agreement and not on any findings of fact as is clear from para 13 of his order. The learned counsel further submitted that the Assessing Officer adopted a negative approach and went on rejecting every reason given by the assessee, solely relying either on his own opinion or interpretation. To the observation of the Assessing Officer that the assessee was entitled to supply of know-how not only for 10 years, but also even after expiry of the contract period, the learned counsel submitted that this is factually incorrect. The assessee was entitled to know-how developed during 10 year period in Japan and relating only to one model NH-100.
The assessee was not entitled to and could not have asked for continuous supply of know-how after expiry of 10 year period for know-how developed solely for Indian conditions or to meet new emission norms without any payment. The learned counsel further submitted that the Assessing Officer has no right to substitute his subjective opinion in place of that of a businessman and for this proposition, he relied upon the judgment of the Supreme Court in the case of CIT v.Dhanrajgirji Raja Narasingirji [1973] 91 ITR 544. He concluded that the CIT(A) is not justified in endorsing the reasonings of the Assessing Officer and confirming the impugned addition.
48. Shri Naresh Kumar, thejearned senior D.R. strongly supported the orders of the authorities below. He drew our attention in particular to page 30 of the assessment order where the Assessing Officer has summarized the reasons for disallowing the said payment. He placed reliance on the decision of the Supreme Court in the case of Bengal Enamel Works Ltd. v. CIT [1970] 77 ITR 119 and also the decision of the Supreme Court in the case of Lachminarayan Madan Lal v. CIT [1972] 86 ITR 439 which have also been relied upon by the Assessing Officer. He drew our attention to page 87 of the assessee's paper book No. 2 where the assessee has given justification for extension of the technical collaboration Agreement as follows: (1) On our request M/s. Honda Motor Co. have already asked their R&D to immediately study the possibility to improve the fuel consumption of the present scooter. The matter is receiving their urgent attention and we hope to receive the results very soon.
(2) M/s. Honda Motor Co. are also giving us the technical support to make our scooter to comply to the pollution requirement that are to be sent by the Government of India.
(3) It will also be possible for M/s. Honda Motor Co. to give us the technology for further emission control when unleaded petrol is available in India.
According to the learned senior D.R., a plain reading of the above points would show that what Honda Motors Co. Ltd. had agreed to transfer was the technology, if any, to be developed as a result of research being undertaken by the Honda Motors Co. Ltd. and there was no existing technology. Therefore, there was only a promise to transfer the technology. However, as per page 91 of the assessee's paper book No. 2, the assessee was required to pay Royalty on all the sales, i.e., domestic as well as exports. Accordingly, according to the learned senior D.R., the payment of Royalty has nothing to do with the transfer of the technology. During the course of hearing before us, the learned senior D.R. sought permission to introduce a new evidence in the form of notice for enhancement of capital by Honda. The counsel of the assessee did not object to the admission of this document. Accordingly, the D.R. was allowed to introduce this document. Pointing to page 4 of the said document, the learned senior D.R. argued that Honda had promised to make available the latest technology and extensive Research and Development facilities of Honda in view of the enhanced capital. He submitted that this resolution had twofold implications as follows: (i) The Honda company has promised to make the available latest technology and extensive R & D in view of the enhancement of capital. Hence, no further royalty was required to be paid to Honda company for acquiring latest technology and extensive R&D. Inspite of this, the assessee company has again agreed to pay royalty. This amounts to double payment for the same item.
(ii) By virtue of this resolution, the Honda Motor Company acquired the controlling stake in the assessee company. Hence Honda Motors Co. Ltd. was in a position to influence decision. This royalty payment was a result of such influence.
He, therefore, submitted that the Assessing Officer was right in invoking the provisions of Section 40A(2) of the Act.
49. We have considered the rival submissions and perused the facts on record. At the first instance, it is noted that the Royalty paid as per the renewed Agreement with Honda was duly allowed by the Assessing Officer for the immediate preceding year, i.e. assessment year 1994-95.
Even in earlier years, Royalty claimed by the assessee was duly allowed in assessment orders passed under Section 143(3). Only in the assessment year 1995-96, which is the year under appeal, the Assessing Officer has purported to examine the issue again and came to the conclusion that not even a rupee was justified as Royalty and the payment was made for extra commercial considerations. Though principle of res judicata does not apply to the decisions of the Income-tax authorities, yet, on the same facts, the assessee cannot be denied a benefit given in the preceding year. In H.A. Shah & Co. v. CIT/CEPT [1956] 30 ITR 618, the Hon'ble Bombay High Court has held as under: As a general rule the principle of res judicatais not applicable to decisions of Income-tax authorities. An assessment for a particular year is final and conclusive between the parties only in relation to the assessment for that year and the decisions given in an assessment for an earlier year are not binding either on the assessee or the department in a subsequent year. But this rule is subject to limitations, for there should be finality and certainty in all litigations including litigation arising out of the Income-tax Act and an earlier decision on the same question cannot be reopened if that decision is not arbitrary or perverse, if it had been arrived at after due inquiry, if no fresh facts are placed before the Tribunal giving the later decision and if the Tribunal giving the earlier decision has taken into consideration all material evidence. A Tribunal like the Appellate Tribunal, should be extremely slow to depart from a finding given by an earlier Tribunal.
There is also a further limitation, namely, that the effect of revising a decision in a subsequent year should not lead to injustice and the court must always be anxious to avoid injustice to the assessee. For instance, if the court is satisfied that by depriving the assessee of his rights under the later decision, in an earlier year, the assessee lost an important advantage or lost some benefit which he could have got under the Income-tax Act, then the Court may take the view that departing from the earlier decision leads to injustice or denial of justice and the Court may prevent an Income-tax Authority from doing something which would be unjust and inequitable.
It is noted that the Assessing Officer's views are merely based on his own interpretation of various clauses of the 1984 Agreement and not on any findings of fact as is clear from para 13 of his order; he is placing only his interpretation on various clauses to conclude that the assessee need not have paid any Royalty and was entitled to receive the know-how for all times to come on the basis of the first Agreement only [Emphasis supplied]. It is significant to note that he did not deny that the assessee actually received valuable know-how under the renewed Agreement. On page 12 of his order, he observes that the fact that "continuous technical support is received from HMCL is in my opinion, not sufficient reason for paying "royalty". Thus, he merely sits in judgment over the opinion of the Ministry of Industry without any concrete evidence to the contrary, which is neither fair nor in accordance with Government propriety. He also overlooked the fact that obligation on Honda under the first Agreement was restricted to the "term of the contract" and that too to the technical developments in that particular model of the scooter. Constant changes and redesigning required by Indian conditions and meeting pollution norms which were not even in contemplation in 1984 could not have been covered by that Agreement.
50. The Assessing Officer has held that the payment of Royalty was made for extra commercial considerations, but he has not pointed out what were the extra commercial considerations. It is not his case that the payment was made for some forthcoming events, i.e. Honda moved out of the Company after a few years. It is well-settled that under Section 37, the Assessing Officer has no right to substitute his subjective opinion in place of that of a businessman. The Supreme Court in the case of Dhanrajairji Raja Narasingirji (supra) has observed, "It was for the assessee to decide how best to protect his own interest...it was not open to the Department to prescribe what expenditure an assessee should incur and in what circumstances he should incur that expenditure". To the same effect are the decisions in the cases of CIT v. Walchand & Co. (P.) Ltd. [1967] 65 ITR 381 (SC), CIT v. S. Krishna Rao [1970] 76 ITR 664 (AP) and Aluminium Corpn. of India Ltd. v.CVT[1972] 86 ITR 11 (SC). We find that the Assessing Officer instead of finding facts adopted a negative approach and went on rejecting every reason given by the assessee, solely relying either on his own opinion or interpretation as can be seen from: (a) The Assessing Officer rejects the contention that Honda's continuous supply of critical components was essential to continue to manufacture a scooter of international standard, on the ground that such components are in any case imported for a price. Here, we must say that the Assessing Officer has overlooked that considering Honda's global operations, it was not bound to manufacture or supply such components and they could not have been imported from any other manufacturers.
(b) Regarding assured supply of components, the Assessing Officer rejects the contention on the ground that the assessee has subcontracted the manufacture of components to Kinetic Engineering Ltd. a sister concern. Firstly, critical components were not subcontracted and even what was sub-contracted was only under Honda's know-how, drawings and designs and secondly, the assessee had not established any testing facility and quality control had to be approved by Honda to make the product internationally competitive and acceptable.
(c) The Assessing Officer brushes aside the fact that due to Honda's technical support, there was an increase in exports of 191% in five years, by saying that exports can be increased by paying-commission.
In our opinion, it is oversimplification of the matter. Exports can be increased only if the product is competitive and of high quality and not by simply paying commission which is paid mainly to take care of establishment expenses of the agent.
(d) The Assessing Officer's contention that since Honda holds 51 % share in equity which constitutes the reason, motivation, control and influence exercised by Honda is untenable. It is noted that in 1998 when Honda did not hold any equity in the assessee company a further technology Agreement has been entered into and that too has been approved by the Government of India. Hence, it will be naive to suggest that by virtue of its 51% holding Honda was able to exercise influence not only on the assessee, but also on the Ministry of Industry/Government of India.
51. Both the Assessing Officer and the CIT(A) are not justified in rejecting the Government approval in a light hearted manner. According to them, the Government of India's approval has no weight as persons granting approval are not expert in Income-tax. This is mere simplification of the matter. We have gone through the contents of the application and find that specific reasons were given for the payment of Royalty and after taking into consideration all such reasons/facts, the Ministry of Industry, Government of India approved the same. The Central Board of Direct Taxes in Circular No. 6. P dated 6-7-1968 (Explanatory Notes) has stated in the context of Section 40A(2)(b) that when payments are approved by one wing of the Government, there is no question of such payment being treated as excessive or unreasonable having regard to the legitimate business needs [Emphasis supplied]. In our opinion, the principle behind this view is applicable with equal force to Section 37(1) also. The lightly brushing aside the Government approval in the manner done by the lower authorities will set a dangerous precedent and accordingly, we do not approve of it.
52. Coming to the argument of the learned senior D.R. that the renewed Agreement contains only a promise to render technical services, but payment is already made, we note that it is not factually correct.
There is no down payment. It is only based on sales. Secondly, promises have been translated into performance as can be seen from the subsequent results.
53. The reliance placed by the learned senior D.R. on the Notice for holding EGM while allotting additional shares to Honda and reliance on the statement therein to the effect that Honda's greater involvement will benefit the Company from their technical expertise is also of no assistance to the Revenue. Firstly, the Issue was subscribed by Honda at a premium as approved by Reserve Bank of India with total infusion of funds to the extent of Rs. 14.41 crores by Honda on this account.
Secondly, it is nowhere stated that Honda in consideration of issue of shares will provide technical know-how free of charge. There are scores of know-how agreements where foreign partner holds 51% or more equity and still Royalty is paid for know-how supplied by them.
54. In the light of the above discussion, we see no justification for the impugned addition. The same is accordingly deleted.
The appellant craves leave to add to, withdraw or modify any of the grounds of appeal at the time of hearing.