2015 (6) TMI 999 - AT - Income Tax

Appellate Tribunal rules royalty payment as revenue expenditure, linked to sales revenue.

The Appellate Tribunal allowed the assessee's appeal, directing the Assessing Officer to treat the entire royalty payment of Rs. 30,41,829/- as revenue ... Running royalty - capital or revenue expenditure - enduring benefit doctrine - exclusive right of manufacture and sale - apportionment of royalty between capital and revenue - precedential application of Southern SwitchgearRunning royalty - capital or revenue expenditure - apportionment of royalty between capital and revenue - enduring benefit doctrine - exclusive right of manufacture and sale - precedential application of Southern Switchgear - Treatment of the running royalty payments of Rs. 30,41,829 paid under the technical collaboration agreement as revenue or capital expenditure and the correctness of treating 25% thereof as capital expenditure with depreciation. - HELD THAT: - The Agreement provided for running royalty at fixed percentages (5% domestic, 8% export) computed periodically and payable for a defined term of seven years (extendable up to ten years), with royalty linked directly to sales. While the Revenue relied on the decision in Southern Switchgear to treat 25% of the royalty as capital in nature on the ground that the agreement conferred enduring benefits and exclusive manufacturing rights, the Tribunal examined the terms of the present agreement and found material differences. In the present case the royalty is a periodic payment directly tied to revenue and payable only for a definite term; there is no lump-sum technical fee payable as in Southern Switchgear nor an enduring right of the same character that would render part of the royalty capital in nature. On these facts the Tribunal held that the payments do not secure an enduring advantage of the type contemplated in Southern Switchgear and therefore the entire running royalty is revenue expenditure and deductible. [Paras 6, 7]The entire running royalty of Rs. 30,41,829 is revenue expenditure and deductible; the treatment of 25% as capital expenditure is disallowed.Final Conclusion: The appeal is allowed: the Appellate Tribunal directed the Assessing Officer to treat the entire running royalty payment as revenue expenditure and allow deduction accordingly, reversing the disallowance that capitalised 25% of the royalty. Issues Involved:1. Disallowance of the entire amount of Rs. 30,41,829/- incurred towards running royalty.2. Treatment of 25% of the running royalty as capital expenditure amounting to Rs. 5,70,344/- and allowing depreciation thereon.Detailed Analysis:1. Disallowance of the Entire Amount of Rs. 30,41,829/- Towards Running Royalty:The assessee, a company engaged in manufacturing electrical fuel pumps, filed a return of income admitting an income of Rs. 2,77,85,819/-. During scrutiny, the Assessing Officer (A.O.) disallowed the royalty payments to Hyundai Industries Co. Ltd., Korea. The A.O. reasoned that the technical knowledge gained by the assessee provided an enduring benefit for manufacturing and industrial processes, initially for seven years, extendable indefinitely. The agreement included provisions for technical assistance, exclusive manufacturing and selling rights, and royalty payments based on sales percentages. The A.O. concluded that the royalty payments constituted both capital and revenue expenses, disallowing Rs. 5,70,344/- as capital expenditure.2. Treatment of 25% of Running Royalty as Capital Expenditure:On appeal, the Commissioner of Income Tax (Appeals) [CIT (A)] upheld the A.O.'s decision, categorizing the royalty as an annual payment calculated at a fixed percentage of sales. The CIT (A) referenced the Supreme Court decision in the case of M/s. Southern Switch Gear Ltd Vs. CIT, which established a 3:1 ratio for treating royalty expenses as revenue and capital expenditures. The CIT (A) noted that the facts of the assessee's case were identical to the Southern Switch Gear case, where the High Court and Supreme Court held that payments providing enduring benefits should be treated as capital expenses.Appellate Tribunal's Decision:The assessee appealed to the ITAT, arguing that the royalty payments should be treated entirely as revenue expenditure. The Tribunal reviewed the agreement and noted that the royalty was linked directly to revenue, paid at 5% on domestic sales and 8% on export sales, for a definite period of seven years, extendable to ten years. The Tribunal distinguished the assessee's case from the Southern Switch Gear case, where the payment was a lump sum for technical aid, noting that the royalty in the current case was based on sales and for a limited period.The Tribunal concluded that the entire royalty payment should be treated as revenue expenditure, directing the A.O. to allow the deduction of Rs. 30,41,829/-. Thus, both grounds raised by the assessee were decided in its favor.Conclusion:The appeal of the assessee was allowed, and the entire royalty payment of Rs. 30,41,829/- was directed to be treated as revenue expenditure. The order was pronounced on 2nd June 2015 at Chennai.