2011 (7) TMI 65 - HC - Income Tax

Royalty for trademark and technical knowhow held revenue expenditure deductible under Section 37(1); no enduring asset created

HC held that royalty paid by Assessee to foreign collaborator for use of trademark and technical knowhow was revenue expenditure allowable under Section ... Addition - Royalty - Whether learned ITAT/CIT(A) erred in deleting the addition on account of Royalty, ignoring that payment made as royalty has element of Capital Expenditure? - HELD THAT:- From the terms of the agreement it is noticed that this arrangement was for a period of 5 years, which may be extended by another period of 5 years unless either party gives 6 months notice to the other party prior to the end of such 5 years period. The payment of commission @ 1% was based on the net sales and not lumpsum. On the termination of expiration of the sub license agreement, the assessee was to return all G4F knowhow obtained pursuant to the said agreement. Not only that, the assessee was not even entitled to make use of the trade mark name or G4F knowhow and was forthwith to change its’ corporate and/or trade names. All rights and knowhow, therefore, continued to vest in G4F and it was only the right to use the knowhow that was made available to the assessee and that too based on its net sales. That means all the royalty paid in the shape of 1 % of net sales for the use of trade mark and right to use knowhow could not be considered to be of enduring nature and thus capital expenditure. The expenditure was to be of revenue nature. We are of the considered view that under the terms of the agreement as noted, the ownership rights of the trade mark and knowhow throughout vested with G4F and on the expiration or termination of the agreement the assessee was to return all G4F knowhow obtained by it under the agreement. The payment of royalty was also to be on year to year basis on the net sales of the assessee and at no point of time the assessee was entitled to become the exclusive owner of the technical knowhow and the trade mark. Hence, the expenditure incurred by the assessee as royalty is revenue expenditure and is therefore, relatable under Section 37(1) of the Act. We thus, answer the question in favour of the Assessee and against the Revenue and consequently dismiss all the three appeals. Issues:1. Common question of law regarding the addition of royalty as capital expenditure.2. Appeals against ITAT's order for different assessment years.3. Interpretation of agreements for royalty payments.4. Determination of royalty payments as revenue or capital expenditure.Issue 1: Common question of law regarding the addition of royalty as capital expenditureThe appeals in question dealt with a common question of law regarding the addition of royalty as capital expenditure. The primary issue was whether the ITAT and CIT(A) erred in deleting the addition of a specific amount on account of royalty, considering the payment made as royalty had an element of capital expenditure. The appeals pertained to the same Assessee but different Assessment Years.Issue 2: Appeals against ITAT's order for different assessment yearsThe appeals, namely ITA 1943/2010, ITA 763/2011, and ITA 765/2011, were directed against the common order dated 10.07.2009 of the ITAT. These appeals were related to assessment years 2003-04, 2005-06, and 2002-03, respectively. The ITAT had dismissed the appeals of the Revenue for the assessment year 2005-06, which was challenged in ITA 763/2011. Subsequently, the appeals for the assessment year 2002-03 and 2003-04 were also dismissed by the ITAT, leading to challenges in ITA 765/2011 and 1943/2010, respectively.Issue 3: Interpretation of agreements for royalty paymentsThe agreements between the Assessee and foreign companies were crucial in determining the nature of royalty payments. The agreements specified the terms and conditions for the use of trade marks, technical knowhow, and other intellectual property. It was noted that the Assessee had entered into sub-license agreements based on the original agreement between the foreign companies. These agreements outlined the operational period, rights and obligations of the parties, and the consequences upon termination or expiration of the agreements.Issue 4: Determination of royalty payments as revenue or capital expenditureThe Court analyzed the agreements and relevant legal precedents to determine the nature of royalty payments. It was observed that the Assessee did not acquire ownership rights of the technical knowhow or trade marks but had the right to use them based on its net sales. The Court referred to various cases where payments based on turnover or profits were considered revenue expenditure. Considering the terms of the agreements and the continuous vesting of rights with the foreign companies, the Court concluded that the royalty payments were revenue expenditure under Section 37(1) of the Income Tax Act. Therefore, the Court ruled in favor of the Assessee and dismissed all three appeals filed by the Revenue.This detailed analysis of the judgment highlights the key issues, legal interpretations, and conclusions drawn by the Court in the case.