Hylam Ltd Vs Commissioner of Income Tax - Citation 431892 - Court Judgment

Judgment:

Sriramulu, J.

1. At the instance of the assessee a consolidated reference under Section 256(1) of the Income-tax Act, 1961, for the four assessment years 1963-64 to 1966-67 has been made to this court by the Income-tax Appellate Tribunal, Hyderabad, on the following questions of law :

'(1) Whether, on the facts and in the circumstances of the case, the sums claimed by the assessee in terms of the agreement with the English company dated December 7, 1959, are allowable expenditure ?

(2) Whether, on the facts and in the circumstances of the case, the sums paid to the English company in each of the years in pursuance of the agreement dated September 29, 1959, as consultation fee, are a proper deduction ?

(3) Whether, on the facts and in the circumstances of the case, the assessee was entitled to have its chargeable profits determined under the Sur-tax Act with reference to its total income for income-tax purposes after allowance of the sums in question paid by the assessee to the English company respectively under the agreements dated December 7, 1959, and September 29, 1959?'

2. The material facts are: The assessee is a public limited company, carrying on business of manufacture of laminated materials, resins and moulding powders. Bakelite Company, London, was the proprietor of Indian Letter Patent Nos. 57094, 57095 and 57459 for the production of copper-clad laminates. For the purposes of manufacture of copper-clad laminates, patents of which were owned by the Bakelite Company Ltd., London, the assessee-company entered into an agreement on December 7, 1959, with Bakelite Company Ltd., London (hereinafter called the ' English company'). By that agreement, the English company granted to the assessee an exclusive non-assignable licence to make use, exercise and vend laminates in accordance with processes covered by the Letter Patent Nos. 57094, 57095 and 57459. The licence granted to the assessee-company was to continue for the unexpired term of those Indian Letter Patent and any extension or regrant thereof. As a consideration for the grant, the assessee agreed to pay 5% royalty on the net selling price of all laminated products made and sold by it in accordance with those patented processes. When the total of the royalty payments reached 5,000 the assessee was no more liable to pay the royalty. This agreement was entered into by the assessee with the English company pursuant to Clause (5) of the agreement dated February 1, 1949, which was already entered into by and between them. Under Clause 5(a) of the agreement dated February 1, 1949, the assessee-company agreed to pay a sum equal to 1/3 of the costs and expenses incurred by the English company in developing new laminated products, if at any time, at the request of the assessee, the English company supplied to it information regarding production of the new laminated products. In pursuance of the agreement dated December 7, 1959, the assessee-company paid the following amounts of royalty to the English company and claimed deduction of those amounts in the computation of its total income for the respective assessment years:

Rs.1963-644,6001964-658,1291965-6612.0051966-6714,731

3. In order to acquire technical information on the manufacture andtesting of the synthetic resins and compositions containing synthetic resins,possessed by the English company, the assessee entered into another agreement dated September 29, 1959, with the English company. The technicalinformation which the assessee-company wanted to acquire from theEnglish company has been defined to mean ' information relating to themanufacture and testing of the products and design, construction andoperation of the plant used in making and testing the production and moreparticularly discribed in Schedule II attached hereto.' The meaning ofthe word 'of products' has also been stated in the agreement. TheEnglish company agreed to furnish exclusively to the assessee in India,during the term of the agreement, such technical information in the possession of the English company which is necessary for the manufacture andtesting of the products, which the English company will have a right totransmit without infringing the right of any third party. As a consideration therefor the assessee-company agreed to pay to the English companyconsultancy fee at 2% of net sales on all Class I products, and at 5% of thenet sales on Class II products, sold by the assessee during every year,during which the agreement remained in force. It was also agreed thatthe consultancy fees paid to the English company was subject to Indiantaxes. The agreement was to be in force for 10 years from the date thereof. Any extension thereafter was to be by mutual consent and with the approval of the Government of India. , Clause (5) of the said agreement cast an obligation on the assessee not to divulge to any person at any time during the tenure of the agreement, or thereafter, the information that it may acquire under this agreement from the English company. In pursuance of the second agreement, the assessee paid to the English company the following sums :

Rs.1963-642,1501964-6518,6261965-6659,5471966-6780,286

4. The assessee claimed deduction of those payments in the computation of its income for the respective assessment years as expenditure of a revenue nature.

5. The Income-tax Officer disallowed the claim of the assessee for the deduction of the aforesaid amounts paid as royalty and as consultancy fees, on the ground that they were of the nature of capital expenditure. The Income-tax Officer observed in the assessment order for 1963-64, that;

'Though the payment is stated to be royalty based on the annual sales, it is seen that in fact it is a payment for the technical know-how in respect of copper-clad laminates and the total amount is fixed as 5,000. Instead of the amount being paid in lump sum it has been made payable over a period of years and for the sake of convenience, the annual payment is linked on the sales but the sales as such have nothing to do with the total amount payable which is fixed at 5,000. The entire amount of Rs. 6,750 is therefore disallowed as capital expenditure....'

6. For the same reason, other amounts were disallowed for the later years.

7. The assessee preferred appeals to the Appellate Assistant Commissioner against disallowance of the payment of royalty and consultancy fee. The Appellate Assistant Commissioner allowed the claim for deduction of payments made by the assessee in all these years. In his opinion, the expenses could not be regarded as bringing into existence an asset of an enduring advantage. In coming to that conclusion, the Appellate Assistant Commissioner relied upon the following decisions : Gotan Lime Syndicates v. Commissioner of Income-tax, : [1966]59ITR718(SC) . Travancore Sugars & Chemicals Ltd. v. Commissioner of Income-tax, : [1966]62ITR566(SC) India Cements Ltd. v. Commissioner of Income-tax, : [1966]60ITR52(SC) and Commissioner of Income-tax v. Ciba Pharma (P.) Ltd., [1965] 57 I.T.R. 428 (Bom.).

8. The reasons given by the Appellate Assistant Commissioner for allowing the expenditure are :

' It is not correct in law, therefore, to hold that the payments made as and when sales are made are really instalment payments of lump sum capital amount and on this ground the payment cannot be treated as capital, and

(2) The payment was related to the actual sales made which in turn depended on the costs of production and the raw material made use of and that the payment had a direct relation to each item manufactured and also sold.'

9. Aggrieved by the orders of the Appellate Assistant Commissioner allowing the claims of the assessee for deduction of those amounts paid under both the agreements, the Income-tax Officer filed appeals to the Income-tax Appellate Tribunal. With regard to the royalty payment, the Tribunal held that, in essence, what the assessee was paying for was the cost of development of the new laminated products and in that sense not allowable as revenue expenditure. Regarding the consultancy fee, the Tribunal did not agree with the department that all the items enumerated in Schedule II to the agreement dated September 29, 1959, related to the permanent structure or framework of the assessee's business. Items 6 to 8 of the technical information clearly related to the routine operations of the business, and in so far as those items were concerned, due allowances had, necessarily, to be made of the consultancy fee relating to them. With regard to items 1 to 5, the Tribunal found that the Income-tax Officer had not disputed the assessee's claim that those items of information were not taken advantage of by the assessee and the Appellate Assistant Commissioner had given a positive finding that the services of the foreign company were not at all pressed into service for the purpose of erection of the machinery, or other capital items. The Tribunal did not express the nature of the information in item No. 9, as the department proceeded on the footing that it was of the same nature as items 6 to 8. Having found so, the Tribunal observed that the admissibility. of the consultancy fee as a deduction in determining the profits of the assessment year in question did not depend upon only the benefit derived by the assessee in the relevant years of account, but on the answer to the question whether the consultancy fee was agreed to be paid wholly for information useful for the carrying on of the day-to-day business of the company, or it was agreed to be paid wholly for material alteration in the permanent structure or apparatus of the company, or it related partly to the first category and partly to the second category, and the answer depended on considerations which influenced the fixation of the consultancy fee at the time the agreement was made. The mere fact that these items of information on items 1 to 5 were not utilized by the assessee-company did not mean that they did not influence the determination of the consultancy fee, at least in part. The Tribunal further observed that items of information of capital nature, moreover, were relevant to the first three years of the period of the agreement. Their importance would be reduced after the plant had reached the ' take-off ' stage, and even in the initial stages the function of the item was, clearly, ancillary. Taking those facts into consideration, the Tribunal considered it fair and appropriate to apportion the consultancy fee between capital and revenue items in the ratio of 1 : 2 and only 1/3rd of the consultancy fee claimed by the assessee should be disallowed as being of capital nature. The Tribunal, accordingly, allowed 2/3rd of the consultancy fee as revenue expenditure. Hence this reference.

10. The learned counsel, Sri Y.V. Anjaneyulu, appearing for the assessee-applicant, contended that the assessee-company was already manufacturing laminates and the copper-clad laminate was only one kind of laminate. The assessee, by agreement dated December 7, 1959, acquired a licence to make use of process covered by patents owned by the English company. The licence was only for the unexpired period of the patents, and not permanent. The payment of the royalty was linked with the net sales of copper-clad laminates manufactured by the assessee-company under the processes of these patents. Since no new asset or advantage of an enduring nature was acquired by the payment of royalty to the English company, the payments made by the assessee-company to the English company under agreement dated December 7, 1959, were expenditure of a revenue nature and not of capital nature. The question whether any expenditure is on capital or revenue account must be viewed in the larger context of business expediency and whether it is wholly incurred for business purposes, so as to form an integral part of profit earning process. Not only the agreement, but also the surrounding circumstances must be taken into consideration for purposes of finding out the nature of the expenditure. Considered from that point of view, the payments made to the English company under the agreement dated December 7, 1959, are payments on revenue account; and the authorities below erred in disallowing those payments.

11. Clause (5) of the agreement dated February 1, 1949, did not alter the nature of the payments made under the agreement dated December 7, 1959. No lump sum could be said to have been fixed. If the assessee-company did not manufactures copper-clad laminate, then no amount of royalty was payable to the English company.

12. Regarding payments under the second agreement dated September 29, 1959, the learned counsel submitted that the Tribunal has given a finding of fact that items 1-5 of the Second Schedule to the agreement dated September 29, 1959, related to the structure or frame-work of the business, and the payments made in respect of information under those items constituted capital expenditure and payments in respect of items 6 to 8, being related to the day-to-day routine operation of business, are of revenue nature. The income or profit of a business in any assessment year has to be determined on the facts and circumstances existing in the relevant accounting year. In the relevant accounting year, the finding of the Tribunal is that the assessee-company did not utilize the services of the English company in respect of information on items 1 to 5. That finding was sufficient to allow the entire expenditure as revenue expenditure and the Tribunal erred in apportioning the expenditure and disallowing 1/3 in each of the assessment years.

13. In view of its own finding that the items of information of capital nature were relevant only to the first three years of the period of agreement, the Tribunal erred in not allowing the entire expenditure for the assessment year 1966-67.

14. The learned standing counsel for the income-tax department, on the other hand, contended that copper-clad laminate is a new item which was not hitherto manufactured by the assessee-company. Acquisition of the patented processes in respect of a new item constitutes acquisition of a new asset or advantage. It endured for the benefit of the company not only for the unexpired period of the patents, but also for the periods of renewals of that agreement. The amount of royalty was fixed at 5,000. That is the amount which the assessee-company had agreed to pay to the English company in respect of its liability to pay its 1/3 portion of the costs and expenses incurred by the English company in developing such new laminated product. At the expiry of the period fixed in the agreement, the information that the assessee-company had acquired in respect of the patented processes under the terms of the agreement, was not returnable to the English company. Whether the payment is made once for all, or periodically, or whether payments are linked with the capital or the net sales, are not conclusive or decisive to hold that the payments in question are of one category, or the other. The payments made under the first agreement are, therefore, of capital nature and have been rightly disallowed by the department and the Tribunal.

15. Regarding payments under the second agreement dated September 29, 1959, the learned counsel submitted that technical know-how is 'property' and the passing of it to another is passing of property. If it is for consideration, then the consideration is for acquisition of an asset. The period fixed under the agreement is 10 years. The assessee-company acquired an advantage for a period extending over 10 years. The acquisition of that asset or advantage was of an enduring nature. Not only with regard to the plant and machinery that has been erected, but the English company was bound to supply the necessary information regarding the new acquisitions of the type of machinery that was contemplated therein. That information is related to the capital structure of the assessee's business. The entire information regarding items 1 to 5 and 9 in the Second Schedule to the agreement that was acquired by the assessee-company has not been placed before the Tribunal to warrant a conclusion that those items related to the day-to-day routine operation of the business. The assessee is bound to pay to the English company under the terms of the said agreement, whether or not in any accounting year it acquired information on any of the items under Schedule II to the agreement. The agreement is a composite one. All the items in the Second schedule to the agreement cumulatively influenced the minds of the parties when the quantum of the consultancy fee was fixed. Hence in a year, if no information regarding items 1 to 5 is obtained but only information regarding items 6 to 8 is obtained, the entire payment cannot be allowed. The Tribunal was not, therefore, justified in apportioning the expenditure, allowing a part of it. In any case, since the department has not filed a reference, it is not open to it to question the correctness of that portion of the Tribunal's order.

16. The income, profits and gains of a business, chargeable to tax under Section 28 of the Act, are computed after allowing deductions of those items of expenditure which are specified in Sections 30 to 43A of the Act. The royalty payments and consultancy fee paid by the assessee-company in this case are claimed by the assessee as deductions in the computation of its business. The expenditure in question does not fall under any of the items stated in Sections 30 to 36 of the Act. To qualify for deduction under Section 37, two conditions are required to the fulfilled. The first is that the expenses in question must not be of a personal nature, but should wholly and exclusively be laid out for business purposes. The second condition is that the expenditure incurred should not be in the nature of capital expenditure. There is no doubt that the expenditure in question has been wholly and exclusively laid out for business purposes. The question of allowance or disallowance of the expenditure in question has to be decided by resolving the question as to whether it is of a revenue nature or of a capital nature.

17. The assessee-company carries on the business of manufacture and sale of laminated materials, resins and moulding powders. By an agreement dated February 1, 1949, the assessee-company agreed to pay to the English company a sum equal to 1/3 of the costs and expenses incurred by the English company in developing new laminated products, if at the assessee's request the English company provided such information which would enable the assessee-company to produce such laminated products. Pursuant to Clause (5) of the agreement dated February 1, 1949, the assessee-company entered into a further agreement dated December 7, 1959, with the English company. The purpose for which the agreement dated December 7, 1959, was executed was that the assessee-company required a licence under the Indian Letter Patent Nos. 57094, 57095 and 57459, of which the English company was the proprietor, in order to produce copper-clad laminates, and pursuant to Clause (5) of the agreement dated February 1, 1949, the English company had agreed to supply information to the assessee in order to enable it to produce copper-clad laminates.

18. Under Clause (1) of the agreement dated December 7, 1959, the English company granted to the assessee-company an exclusive non-assignable licence to make use, exercise and vend laminates in accordance with the processes covered by the Letter Patent Nos. 57094 and 57095. Clause (2) of the agreement says that the licence shall be in force for the unexpired terms of those patents and any extensions and regrants thereof. Under Clause (3) the assessee-company agreed to pay to the English company royalty at the rate of 5% on the net selling price of laminated products made and sold in accordance with those patented processes and if the royalty payments reached 5,000, then the assessee-company would no more be liable to pay further royalties. Under Clause (5), the assessee-company was put under an obligation to use on the products and the invoices relating thereto the words ' manufactured under Indian Patent Nos. 57094, 57095 and 57459 '. Under Clause (6) of the agreement, the assessee-company agreed to pay recurrent fees that may be necessary to maintain and keep on foot the aforesaid Indian Letter Patents.

19. It is under the terms of the above agreement that the assessee-company made various payments to the English company in the assessment years concerned and claimed those payments as deductions in the computation of its assessable profits for those assessment years.

20. The line of demarcation between capital expenditure and revenueexpenditure is very thin and the learned judges deciding cases arisingbefore them have often pointed out the difficulties beset in that task. Inconsidering whether an expenditure is of revenue nature, the court has toconsider the nature and the ordinary course of business and the objects forwhich the expenditure has been incurred. Whether an expenditure isincurred for the purpose of business, must be viewed in the larger context ofbusiness necessity or expediency. For that purpose the court has to looknot only to the documents, but also to the surrounding circumstances so asto arrive at a decision as to what was 'the real nature of the transactionfrom the commercial point of view.

21. In the great diversity of human affairs and the complicated nature of business operation, it is very often difficult to lay down a test which would be of universal application. Different tests have to be applied from a business point of view, and the courts should come to the conclusion on the question whether on a fair appreciation of the whole situation, the expenditure incurred in a particular case is of the nature of revenue expenditure or capital expenditure. In deciding that question, the name that the parties may give to it or its characterization are of little consequence.

22. In Assam Bengal Cement Company Ltd. v. Commissioner of Income-tax, : [1955]27ITR34(SC) Bhagwati J. approved the principles laid down by a Full Bench of the Lahore High Court in Benarsidas Jagannath, In re, [1947] 15 I.T.R. 185 (Lah.) [F.B.]as the true and correct principles for the purpose of deciding the question whether an expenditure is of a revenue nature or of a capital nature. At page 45 of the report, the learned judge observed that:

' In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits, it is a revenue expenditure. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be immaterial whether the source of the payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence.'

23. If the 'know-how' is utilized for the purposes of manufacturing a product different from the one which an assessee is already manufacturing and the 'know-how' was to become the property of the assessee at the end of the period of the agreement, the expenditure incurred on it would be a capital expenditure. In Mysore Kirloskar Ltd. v. Commissioner of Income-tax, [1968] 67 I.T.R. 23 (Mys.) Hegde J. (as he then was), speaking for a Division Bench of the Mysore High Court, observed that:

'......as the ' know-how' in question was to be utilised nor 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 property of the assessee at the end of the period of agreement, the sum of Rs. 26,713 was properly disallowed as a capital expenditure.'

24. In Commissioner of Income-tax v. Ciba of India Ltd., : [1968]69ITR692(SC) under an agreement dated December 17, 1949, the Swiss company undertook to deliver to the assessee 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 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 produce 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 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 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.

25. The agreement was to be in force for a period of 5 years from 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 3 months' notice. By a subsequent agreement, the contribution payable was reduced from 10% to 6% of the net selling price of the phar-maceuticals. 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. Allowing the expenditure claimed as admissible deduction in the computation of its profits for the relevant assessment years, the Supreme Court held that:

' 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 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 knowlege 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 its business.'

26. In Commissioner of Income-tax v. Hindustan General Electrical Corporation Ltd., : [1971]81ITR243(Cal) a Division Bench of the Calcutta High Court held that:

' Special knowledge or skill can indeed ripen into a form of property in the fields of commerce and industry, as in copyright, trade marks and designs and patents, where such property is parted with for money, what is received can be, but will not necessarily be, a receipt on capital account.'

27. The court allowed the expenditure as an admissible deduction in computing its business profits, observing that there were certain striking similarities between certain clauses in the agreement in the case before them and that in the case of Commissioner of Income-tax v. Ciba of India Ltd. The reasons given by them for allowing the claim of the assessee in that case are:

' 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 the instant case the various types gf payments that the assessee had to make were closely related to the assessee's manufacturing processes of Simplex products. In other words, the payments were intimately linked up with the manufacturing activities of the assessee and not with the capital values of the assets that the assesee would acquire. They could not, strictly speaking, be said to be the purchase price of the assets. Though the assessee's foreign principals would be imparting their 'know-how' to the assessee for a reward, 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 Pingle Industries Ltd. v. Commissioner of Income-tax, : [1960]40ITR67(SC) the assessee carrying on business of selling Shahabad flag stones, obtained from a jagirdar, under a contract, the right to extract stones from quarries for a period of 12 years, on an annual payment of Rs. 28,000. The assessee also acquired a similar lease from the Government for a period of five years, under which it agreed to pay Rs. 9,000 per year in monthly instalments of Rs. 750 each. The question arose whether the amounts paid by the assessee to the jagirdar and the Government each year were revenue expenditure allowable under Section 10(2)(xv) of the Indian Income-tax Act, 1922. The Supreme Court disallowed the expenditure as capital expenditure, holding that:

'The stones in situ were not his stock-in-trade in a business sense but a capital asset from which after extraction he converted the stones into his stock-in-trade. The payment, though periodic in fact, was neither rent nor royalty but a lump payment in instalments for acquiring a capital asset of enduring benefit to his trade. The amounts were outgoings on capital account and were not allowable deductions.'

29. If what was extracted was directly stock-in-trade, the payments made for that purpose would be revenue expenditure, as held in Gotan Lime Syndicate v. Commissioner of Income-tax, : [1966]59ITR718(SC) . Their Lordships of the Supreme Court held that:

'Although the appellant did derive an advantage--assuming that that advantage was to last at least for a period of five years--there was no payment once for all. No lump sum payment was ever settled or paid; there was only an annual payment of royalty or dead rent. The royalty was not a direct payment for securing an enduring advantage; it had relation to the raw material to be obtained.'

30. Sikri J. (as he then was), speaking for the Supreme Court, further observed at page 725 that:

' In our opinion, the test does not apply fully to this case because there is no payment once for all; it is a yearly payment of dead-rent and royalty. It is true that if a capital sum is arrived at and payment is made every year by chalking out the capital amount in various instalments, the payment does not lose its character as a capital payment if the sum determined was capital in nature. But, it is an important fact in this case that it is a case of an annual payment of royalty or dead rent. No lump sum payment was ever settled or paid.'

31. In Nethersole v. Withers (H. M. Inspector of Taxes), [1946] 28 T.C. 501, 510 (C.A.) Lord Greene M.R. observed that:

' One might perhaps have expected that where a piece of property, be it copyright or anything else, is turned to account in a way which leaves in the owner what we may call the reversion in the property, so that upon the expiration of the rights conferred, whether they are to endure for a short or a long period, the property comes back to the owner intact, the sum paid as consideration for the grant of the rights, whether consisting of a lump sum or of periodical or royalty payments, should be regarded as of a revenue nature. We emphasise the word 'intact'--salva rei substantia, to use the expression adopted by Lord Fleming in Trustees of Earl Haig v. Commissioners of Inland Revenue, [1939] 22 T.C. 725, 735 (C. Sess.) since (save in the special cases of wasting property) if the property is permanently diminished or injuriously affected, it means that the owner has to that extent realised part of the capital of his property as distinct from merely exploiting its income-producing character.'

32. In Bombay Steam Navigation Co. v. Commissioner of Income-tax, [1965] 56 I.T.R. 52; [1965] 1 S.C.R. 770 (S.C.) the assessee, an amalgamated company, took over certain passenger and ferry services from out of its component company, part of the purchase price was paid by shares and the balance was treated as a loan repayable with interest. Interest was paid on the said amount of loan and claimed as a revenue expenditure. The claim was allowed by the Supreme Court under Section 10(2)(xv) of the Indian Income-tax Act, 1922. This is what their Lordships observed:

' The transaction of acquisition of assets was closely related to the commencement and carrying on of the assessee's business and interest paid on the unpaid balance of the consideration for the assets acquired had, in the normal course, to be regarded as expended for the purpose of the business which was carried on in the accounting periods.' Their Lordships further observed that: ' If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition to the carrying on of the business, the expenditure may be regarded as revenue expenditure.'

33. In Commissioner of Income-tax v. Devidas Vithaldas & Company, [1968] 68 I.T.R. 388 (Bom.) P, chartered accountant, carrying on his profession under the memo ' Devidas Vithaldas & Co.', admitted a partner, A. P retained the goodwill for himself. Later P retired from the partnership and sold the goodwill to A, who had become the sole owner, under an agreement that 8 annas of the profits were to be paid to P for life and to his wife and son after his death. The Bombay High Court held that the amounts were paid as the purchase price of the goodwill which was capital asset of P until the date of the agreement, and which A had purchased from P in consideration of the payments to be made under the agreement. The payments were, therefore, in the nature of expenditure to acquire a capital asset. Disallowing the expenditure as capital expenditure, the learned judges held that the fact that consideration for the sale of the goodwill was not a lump sum or a sum payable in instalments, but was a share in the profits, did not make any difference, whether the consideration is paid in a lump sum or in instalments, or whether it is paid out of the profits, and what was being paid to P and his heirs was the purchase price of a capital asset, namely, the goodwill. The intention of the parties was to sell the goodwill outright, and that was the aim and object of the expenditure which A made under the agreement.

34. In India Cements Ltd. v. Commissioner of Income-tax expenditure incurred by the assessee for obtaining a loan for its business was held to be a revenue expenditure. The Supreme Court held that:

' Where there is no express prohibition, an outgoing, by means of which an assessee procures the use of a thing by which he makes a profit, is deductible from the receipts of the business to ascertain the taxable income......A loan obtained cannot be treated as an asset or advantage for the enduring benefit of the business of the assessee.'

35. In Regent Oil Co. Ltd. v. Strick (H. M. Inspector of Taxes), [1966] A.C. 295, 317, 333 ; [1965] 3 All E.R. 174; [1969] 73 I.T.R. 301, 321 335 (H.L.). Lord Reid observed that:

' If the asset which is acquired is in its intrinsic nature a capital asset, then any sum paid to acquire it must surely be capital outlay. And I do not see how it could matter that the payment was made by sums paid annually. But, it appears to me that an asset which is nothing more than a right to enjoy a certain advantage over a period is intrinsically of a different character from a thing which a person buys and can immediately use or consume in any way he chooses.'

36. Lord Morris of Borth-y-Gest, at page 44 of the report, observed that:

' In considering the nature of a payment it may well be relevant to know whether similar payments will recur and whether the payment is but one of a number of periodic payments. Here again it becomes important to consider what it is that the items of payment will produce. Some capital assets may last but a short time. They do not for that reason lose their character as capital assets. If they are much needed so that a succession of them must be obtained there will be periodic or constantly recurring payments of money. Yet each of these payments will be of a capital nature. If the nature of what is acquired makes it a capital asset the payment for it will be a capital payment.'

37. The aforesaid discussion of the decided cases on the question whether an expenditure incurred by an assessee in any assessment year is, or is not an expenditure of revenue nature, leads us to the following conclusion:

(1) If the expenditure is for the initial outlay or for acquiring or bringing into existence an asset or advantage of an enduring benefit to the business that is being carried on, or for extension of the business that is going on, or for a substantial replacement of an existing business asset, it would be capital expenditure.

(2) If, on the other hand, the expenditure, although for the purpose of acquiring an asset or advantage, is for running of the business or for working out that asset with a view to produce profit, it would be revenue expenditure.

(3) If the outgoing 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 or operations, and not for the acquisition of an asset of a permanent character, the possession of which is a condition precedent for the running of the business, then it would be expenditure of a revenue nature.

(4) Special knowledge, or technical knowledge, or a patent, or a trade mark, is an asset and if it is acquired for payment for use and exploitation for a limited period, and what is acquired is not an asset or advantage of an enduring nature and at the end of the agreed period that advantage or asset reverts back intact to the giver of that special knowledge or the owner of the patents or trade marks, it would be expenditure of a revenue nature.

(5) If it is intrinsically a capital asset, it is immaterial whether theprice for it is paid once and for all, or periodically, or whether it is paidout of capital or income, or linked up with the net sales. The outgoing, insuch a case, would be of the nature of capital expenditure.

(6) If the amount paid for the acquisition of an asset of an enduring nature is settled, the mere fact that the amount so settled is chalked out into various small amounts or periodic instalments, the capital nature of expenditure would not cease to be so or alter into the nature of a revenue expenditure.

(7) A lump sum amount for liquidating recurring claims would not cease to be revenue expenditure or get converted into capital expenditure merely because its payment is spread over a number of years. It is the intention and object with which the asset is acquired, that determines the nature of the expenditure incurred over it, and not the method or the manner in which the payment is made, or the source of such payment.

(8) If the expenditure is recurring and is incurred during the course of business or manufacture, it would be revenue expenditure.

(9) An asset or advantage of an enduring nature does not mean that it should last for ever. If the capital asset is, in its nature, a short-lived one, the expenditure incurred over it does not, for that reason, cease to be a capital expenditure.

(10) It is not the law that if an enduring advantage is obtained, the expenditure for securing it must always be treated as capital expenditure. If the advantage acquired is to get the stock-in-trade of the business, then it would be revenue expenditure. But if what is acquired is not the advantage of getting the stock-in-trade directly, but of something which has to be dressed up or processed before it is converted into stock-in-trade, the expenditure incurred over it would be capital expenditure.

38. These principles are neither exhaustive, nor intended to be. They only serve as guidelines to solve the problems that is before the court.

39. Bearing in mind the above principles, we will examine the nature of the payments made by the assessee-company to the English company in the relevant assessment years, under the terms of the agreement dated December 7, 1959, which have been set out supra.

40. By virtue of the payments, which it calls ' royalties ', the assessee-company acquired a licence for the use of the processes covered by certain patents owned by the English company. The special knowledge of those patented processes is not in respect of any product that was already being manufactured by the assessee-company, but it related to a new product, i.e., copper-clad laminate. We are unable to agree with the argument of the learned counsel for the assessee that merely because the assessee-company was already manufacturing laminated products, the acquisition of special knowledge regarding a new laminated product, although of an allied nature, did not amount to extension of the assessee's business. In our opinion, the acquisition of knowledge in respect of a new product, although allied in nature, of the products that were being manufactured by the assessee, would amount to the acquisition of an advantage or an asset for the extension of the assessee's business. The English company parted with their patents, which are their assets, in favour of the assessee for the whole of the unexpired period of those patents, or extensions or regrants thereof. The normal life of a patent is 16 years. But the life of a patent can be extended or a fresh period regranted. The assessee-company not only gets the advantage of the use of those patents for the unexpired period of those patents, but also for the periods of extension or regrants. The acquisition in this case, therefore, is an asset or advantage of an enduring nature to the assessee's business. It is immaterial whether the agreed price for it is paid in a lump sum once and for all, or in periodic instalments, or whether it is paid out of capital or income of the assessee, or linked up with the net sales of such products manufactured by the assessee. As far as the English company is concerned, there was a complete breaking up or cessation of its business in India, so far as those patents were concerned and it was an acquisition of a new business for the assessee-company. If the royalties that are paid reach 5,000, the assesee would no more be liable for the payment of royalties. If in the first few years the net sales of the produce manufactured by the assessee-company under those patented processes are sufficiently large, and if the royalty paid thereon at the agreed percentages would reach 5,000, then for the rest of the unexpired period of those patents the assessee would use that knowledge and patents, for the manufacture of copper-clad laminates, without any obligation for payment of royalty. That is to say, the payment of the so-called royalty has no direct relation to the user of those patents. On the other hand, it leads to an inevitable conclusion that the amount of 5,000 was the settled price of the asset acquired by the assessee for the period of the licence. In this connection, it may be noted that the agreement dated December 7, 1959, is entered into by the assessee-company with the English company pursuant to Clause (5) of the agreement dated February 1, 1949. The amount of 5,000 represented 1/3 of the costs and expenses incurred by the English company in developing such laminated products. Since the English company is not exclusively carrying on that scientific research for and on behalf of the assessee-company, the payment made by the assessee-company under Clause (5) of the agreement dated February 1, 1949, may not be allowable under Section 35 of the Income-tax Act, 1961, as an admissible deduction in the computation of the assessee's business income. The assessee, in order to get over that difficulty, has in our opinion attempted to bring that expenditure under Section 37 of the Act.

41. Strong reliance has been placed by the learned counsel for the assessee on the decision of the Supreme Court in Ciba's case. The learned counsel, Sri Y. V. Anjaneyulu, submitted that the facts in this case are almost similar to the facts in Ciba's case and, therefore, the decision in Ciba's case would hold good in this case also. We are unable to agree with this submission of the learned counsel. There are marked and significant facts in this case which distinguish it from Ciba's case. In Ciba's case, the technical ' know-how ' was with regard to the same products which the Ciba company was already manufacturing. In the case before us, the special knowledge relates to a new product which the assessee-company was not hitherto manufacturing. In Ciba's case, after the expiry of the agreed period, the special knowledge, scientific data and the material relating to it had to be returned to the Swiss company. In the case before us, there is no such clause; if the special knowledge is parted by the English company, which is their asset, does not revert back to the giver of that special knowledge, it cannot be said that the expenditure incurred over it is of a revenue nature. Moreover, in Ciba's case, the period of agreement was five years. The agreement was liable to be cancelled earlier also. But, in the assessee's case, the advantage or the benefit of the user of those patented processes is not only for the entire life of those patents, but also for the extensions and regrants thereof. Another distinguishing feature in this case is that after the payments reach 5,000 the assessee would not be liable to pay any royalty in respect of those patents for the subsequent unexpired period of those patents; that is to say, the price for the entire user which has already been fixed at 5,000 has been paid whereas in Ciba's case, no price as such had been fixed for the user of the special knowledge for the entire period of licence or use.

42. For all these reasons, we have no hesitation to agree with the finding of the Tribunal that the payments made by the assessee-company under the agreement dated December 7, 1959, are of capital nature and inadmissible as deductions in the computation of the assessee's business income for the relevant assessment years.

43. We, therefore, answer the first question referred to us in the negative and against the assessee.

44. We will then consider the nature of the consultancy fee paid by the assessee to the English company in each of the assessment years in question, under the terms of the agreement dated September 29, 1959.

45. Under the agreement dated September 29, 1959, the English company agreed to furnish, exclusively in India to the assessee-company, technical information as defined in the agreement. regarding the manufacture and testing of products mentioned in the first schedule attached to the agreement. In consideration thereof, the assessee-company agreed to pay consultancy fee @ 2% of the net sales of class I products and 5% on net sales of class II products, for a period of 10 years, for which period the agreement was to remain in force. The assessee was under an obligation, under Clause (5) of the agreement, not to divulge such information to any one except to its directors, officers, etc., for its business purposes, and to punish the offenders who contravene that clause. The English company also agreed to grant non-assignable exclusive licences to the assessee-company so far as they related to the manufacture and testing of the products mentioned in the schedule.

46. The technical information that the English company agreed to furnish to the assessee-company relates to the following items which are mentioned in Schedule II to the agreement:

' (1) Specification for the plant;

(2) Assistance in the purchase of such plant;

(3) Supervision of the construction of plant which is purchased in England (including a certificate that the plant would be insurable in England);

(4) A design summary and flow of diagram necessary for the assembly of the plant.

(5) Information in the construction of plant which it is intended to be fabricated in India together with guidance as to its operation;

(6) Continuous guidance on selection and purchase of raw materials, manufacture and testing of the finished products together with the formulae and specifications of such raw materials and finished products';

(7) Information on new developments or improvements in plant, manufacturing process and testing methods.

(8) Technical bulletins and literature normally used by Bakelite to assist sales;

(9) Full details of Bakelite's testing equipment and schedule of tests...'

47. Information regarding, (1) the specification for the plant; (2) assistance in the purchase of such plant; (3) supervision of the construction of the plant purchased; (4) a design summary and flow diagram necessary for the assembly of the plant; and (5) construction of the plant which was intended to be fabricated in India, together with guidance as to its operation, undoubtedly, relate to the profit-making apparatus, that is, structure and framework of business of the assessee-company. The payments made in respect thereof would, undoubtedly, be of the nature of capital expenditure.

48. On the other hand, information relattng to (6), the guidance on selection and purchase of raw materials, manufacture and testing of the finished products together with the formulae and specifications of such raw material and finished products, and (7), information on new developments or improvements in manufacturing process and testing methods, and (8), technical bulletins and literature normally used by the English company to assist sales relate, undoubtedly, to the business operations carried on by the assessee-company and sales of the finished products manufactured by it.

49. On a perusal of those items regarding which special information is sought for by the assessee-company from the English company against payment of consultancy fee, it appears to us that some of these items relate to the profit making apparatus of the assessee-company and some to the profit making or routine business operations of the assessee-company. The payment made for the former would be a capital expenditure and for the latter would be revenue expenditure. To that effect is the finding of the Tribunal, and that finding of fact given by the Tribunal has not been seriously disputed by the parties in this case.

50. Information under item (9) relates to testing of equipment and the schedule of tests. Unless the actual information is known, it may not be possible to say with definiteness whether the expenditure incurred for getting such information is or is not of a capital nature.

51. We need not specifically decide the nature of the expenditure incurred for getting the information relating to item No. (9). The Tribunal has, however, proceeded on the footing that the expenditure over it would be revenue expenditure.

52. Suffice to say that some of the items in Schedule II relate to the profit making apparatus, structure or framework of the assessee's business and some to the routine business operations carried on by the assessee for earning profit, for both of which a composite fee is paid to the English company as ' consultancy fee '. A part of it would be capital expenditure and a part revenue expenditure. In such a case, the only method of arriving at the true business income assessable to income-tax is to split up that expenditure or allocate it between capital and revenue expenditure and allow only that portion of the expenditure which is of revenue nature as a deduction. That the Tribunal has done in this case. The question of allocation of the total expenditure between capital and revenue is dependent upon facts, and the Tribunal is the final fact-finding authority. If allocation was called for between capital and revenue expenditure and the Tribunal has actually allocated it, it is not for this court to alter or modify that allocation. This position is fairly conceded.

53. In this connection, the learned counsel appearing for the assessee advanced two arguments. The first argument was that each assessment year is distinct and separate from any other assessment year. The profit of a business of an assessment year has to be brought to tax in that particular assessment year. In the accounting years relevant to the assessment years concerned, the finding of the income-tax authorities is that the assessee did not get any information regarding items 1 to 5 and, therefore, no part of the expenditure incurred by the assessee in those years, which it claims as admissible deductions, was capital expenditure. The Tribunal, therefore, erred in not allowing the entire expenditure as admissible deduction. Allocation, in these circumstances, was not called for and the whole expenditure must be allowed as a deduction.

54. We are unable to agree with this submission. Although no information regarding items 1 to 5 has been received in the accounting years relevant to the assessment years under consideration, still these items also include information regarding plant that may be acquired by the assessee in future. The assessee-company had a right, under the terms of the agreement dated September 29, 1959, to call upon the English company to furnish to it information relating to the plant that it may acquire in future. It is, therefore, evident that when the consultancy fee at the rate of 2% under class I products and 5% under class II products was fixed, both the parties had in their minds that it included some capital expenditure and some revenue expenditure. In such a case, it would be proper to make an allocation of the expenditure between capital and revenue, irrespective of the fact whether information of the one kind or the other was sought for or utilized in the relevant assessment years.

55. The next argument that the construction and setting up of the plant was completed in the first three years and in view of its own finding, the Tribunal should have allowed the entire expenditure in the last assessment year concerned, does not, in our opinion, arise in view of the conclusion reached by us on the first argument addressed by the assessee in this behalf.

56. Allocation of the expenditure between capital and revenue is on a rough and ready basis and the Tribunal has allocated the consultancy fee between capital and revenue in the ratio of 1 : 2, that is to say, the Tribunal has allowed 2/3 of the consultancy fee as admissible deduction and disallowed 1/3 of it on the ground that it was capital expenditure. This allocation appears to us to be eminently fair in the circumstances of the case. The allocation, in any event, cannot, therefore, be disturbed. We, therefore, answer question No. 2 referred to us in the following manner :

The consultancy fee paid by the assessee-company to the English company is not admissible as deduction in its entirety but only 2/3 of it is admissible as deduction as held by the Tribunal.

Question No. 3 is merely a question which is consequential on the findings given by this court on questions Nos. 1 and 2. Chargeable profits under the surtax have to be determined with reference to the total income for income-tax purposes, computed on the basis of the answers given by us on questions Nos. 1 and 2.

57. The assessee shall pay the costs of this reference. Advocate's fee Rs. 250.

Subject	Direct Taxation
Court	Andhra Pradesh High Court
Decided On	Nov-29-1971
Case Number	Case Referred No. 48 of 1969
Judge	Vaidya and ;Sriramulu, JJ.
Reported in	[1973]87ITR310(AP)
Appellant	Hylam Ltd.
Respondent	Commissioner of Income-tax
Appellant Advocate	Y. Anjaneyulu, Adv.
Respondent Advocate	P. Rama Rao, Adv.

Hylam Ltd. Vs. Commissioner of Income-tax - Court Judgment