1989 (2) TMI 56 - HC - Income Tax

Royalty payment for know-how deemed revenue, not capital expense

The court held that the royalty payment for continuing know-how was a revenue expenditure, not a capital expenditure. The payment was deemed necessary for ... Capital Gains, Deductions From Total Income Issues Involved:1. Whether the entire royalty paid by the assessee to its foreign collaborator for providing continuing know-how is deductible as revenue expenditure.Issue-wise Detailed Analysis:1. Nature of Royalty Payment:The primary issue revolves around the nature of the royalty payment made by the assessee to B. F. Goodrich Chemical Company under a collaboration agreement dated October 1, 1962. The assessee, a company manufacturing PVC resins and compounds, entered into a 'Technical Service Agreement' with B. F. Goodrich Chemical Company. The agreement stipulated payments for 'accumulated know-how' and 'continuing know-how.' The royalty payment for accumulated know-how was capitalized, and the dispute pertains to the royalty for continuing know-how.2. Treatment by Income-tax Authorities:During the assessment years 1968-69 to 1972-73, the Income-tax Officer disallowed 25% of the royalty payment, considering it as capital expenditure, arguing that the continuing know-how provided an enduring benefit to the assessee. This view was upheld by the Appellate Assistant Commissioner (AAC), who emphasized that the payment represented part of the general technical assistance pattern, resulting in a permanent benefit.3. Tribunal's Findings:On further appeal, the Tribunal concluded that the royalty payment for continuing know-how was intimately linked to the assessee's manufacturing activities. The Tribunal noted that the payment enabled the assessee to stay updated with the latest technical developments, which was essential for its manufacturing operations. It held that the bifurcation of royalty into capital and revenue was not justified and that the entire royalty payment should be treated as revenue expenditure.4. Revenue's Argument:The Revenue contended that the payment was a consolidated one, part of which was attributable to capital. It argued that the continuing know-how resulted in an enduring advantage to the assessee, making the royalty payment a capital expenditure. The Revenue relied on precedents such as M. R. Electronic Components Ltd. v. CIT and CIT v. Southern Switchgear Ltd. to support its position.5. Assessee's Argument:The assessee argued that the royalty payment was for acquiring knowledge and skills related to the latest technical advances, which facilitated its manufacturing business. It contended that the expenditure was revenue in nature, as it was incurred for the efficient running of the business. The assessee cited decisions like Empire Jute Co. Ltd. v. CIT, CIT v. Sundaram Clayton Ltd., and CIT v. Madras Rubber Factory Ltd. to bolster its argument.6. Court's Analysis of Agreement Clauses:The court examined the relevant clauses of the collaboration agreement. Clause 1-B provided for the supply of accumulated and continuing know-how. The court found that the continuing know-how was meant to keep the assessee updated with the latest manufacturing methods, which would enhance its production efficiency and product quality. The court rejected the Revenue's contention that the agreement was a consolidated one and that part of the payment was attributable to capital.7. Precedent Analysis:The court distinguished the present case from CIT v. Southern Switchgear Ltd. and M. R. Electronic Components Ltd. based on the specific terms of the agreement. It noted that the agreement in the present case clearly delineated between capital and revenue components. The court found the decision in Empire Jute Co. Ltd. v. CIT particularly relevant, emphasizing that the nature of the advantage in a commercial sense is crucial. The court observed that the knowledge acquired enabled the assessee to carry on its business more efficiently and profitably, without affecting its fixed capital.8. Conclusion:The court concluded that the royalty payment for continuing know-how was a revenue expenditure. It held that the expenditure was incurred for acquiring knowledge and skills necessary for the efficient running of the business, which did not result in an enduring capital advantage. The court answered the reference in the affirmative, in favor of the assessee, and against the Revenue. The assessee was entitled to costs of the reference, with counsel's fee set at Rs. 500 (one set).