2018 (7) TMI 2035 - HC - Income Tax

Court rules royalty payment for technical know-how as capital expenditure, not deductible, resulting in enduring benefits.

The court held that the royalty payment for obtaining technical know-how was capital expenditure, not permissible for deduction as revenue expenditure. ... Payment of royalty on account of obtaining technical know-how - nature of expenses - revenue or capital expenditure - deciding factor regarding nature of expenditure - HELD THAT:- From the clauses of MoU quoted earlier in the order, it is evident that the appellant established a joint venture with the foreign company for manufacture of lacquers, varnishers, paints etc. It has not been disputed that the appellant-company was incorporated after signing the MoU. The foreign company transferred all technical information for manufacture of planned products which included composition/specification of the material, equipment required, techniques of production and tests & procedures of quality control. Apart from this, the authorities noted the fact that Mrs. Heinz Kohler was deputed for supervising the new products and development to be undertaken by the appellant. As per the MoU, the appellant got exclusive right to sell the products in India. The appellant could use brand name 'BERLAC' for the purpose of sales. The appellant had a right to sell the manufactured products in other countries in mutual agreement with foreign company. The foreign company was assisting the appellant-company for setting up R&D facility for development of new lacquers in India. The appellant had a right to sub-licence the manufacture of planned products. MoU with foreign company resulted in setting up of new business in shape of joint venture. It was not merely transfer of technical know-how, but it extended to the level of rendering valuable services including setting up of factory. Though, the royalty was to be paid over a period of seven years, there was no restriction on the appellant to continue with the manufacture and sale of products thereafter also. In the present case, the expenditure was incurred at the pre-production stage and hence is being held as capital expenditure. In view of the decisions of the Supreme Court in M/s Jonas Woodhead and Sons Ltd., Madras [1997 (2) TMI 4 - SUPREME COURT] and Honda Seil Cars India Limited [2017 (6) TMI 524 - SUPREME COURT] no blemish can be cast upon by the findings arrived by Tribunal holding that the payment of royalty was capital in nature. Since the payment of royalty was being made on percentage basis of sales, therefore, payment was revenue in nature, is not well founded. Though, the CIT(A) had allowed the appeal merely on that basis but had erred as the mode of payment either being made in lump sum or in installments or on percentage of sales, is a decision taken by the parties, as per their commercial expediency. It would not be the sole deciding factor regarding nature of expenditure. - Decided against assessee. Issues Involved:- Whether the payment of royalty on account of obtaining technical know-how constitutes a revenue expenditure permissible for deduction.Detailed Analysis:Background and Facts:The appellant-company was incorporated on 27.09.1994. Prior to its incorporation, a Memorandum of Understanding (MoU) was signed on 07.07.1994 with a foreign company for setting up a joint venture in India for manufacturing lacquers, varnishes, paints, etc. The foreign company was to transfer technical information for the manufacture of planned products, and the appellant was to pay a royalty of 5% net of taxes on sales for seven years. The assessment year involved was 1996-97, the first year of commercial production. The appellant claimed Rs. 1,64,157/- royalty paid as revenue expenditure in its Income Tax Return, which was disallowed by the Assessing Officer as capital expenditure.Issue 1: Nature of Royalty Payment - Capital or Revenue ExpenditureThe primary issue was whether the royalty payment for obtaining technical know-how was a revenue expenditure permissible for deduction.Appellant's Argument:The appellant contended that the royalty payment was based on a percentage of sales over seven years, not a lump sum, and did not result in an enduring benefit. They cited the Supreme Court decision in Alembic Chemical Works Co. Ltd. Vs. Commissioner of Income-Tax, Gujarat, and the Delhi High Court decision in M/s Abhipra Capital Ltd. Vs. Deputy Commissioner of Income Tax (Investigation).Revenue's Argument:The revenue argued that the royalty payment was capital expenditure as it was for the establishment of a joint venture and included transfer of technical know-how essential for setting up the business. They relied on the decision of the Calcutta High Court in Commissioner of Income Tax Vs. Shriram Bearings Ltd.Tribunal's Finding:The Tribunal upheld the Assessing Officer's decision, reversing the CIT(A)'s order, and held that the royalty payment was capital expenditure.Legal Principles and Precedents:The court referred to several precedents to determine the nature of the expenditure:1. Honda Siel Cars (India) Ltd. Vs. CIT (2017): The Supreme Court held that the primary test to differentiate between capital and revenue expenditure is the enduring benefit. If the expenditure facilitates the acquisition of a tangible or intangible asset with enduring benefits, it is capital in nature.2. M/s Jonas Woodhead and Sons Ltd., Madras Vs. Commissioner of Income Tax, Madras (1997): The Supreme Court laid down several factors to determine the nature of expenditure, including whether the payment was for a completely new process and technology, whether it was for betterment of an existing product, and whether it resulted in setting up a new business.3. Alembic Chemical Works Co. Ltd. (1989): The Supreme Court held that there is no single definitive criterion, and various factors must be considered to determine the nature of expenditure.4. Commissioner of Income Tax Vs. Shriram Bearings Ltd. (2001): The Calcutta High Court held that royalty paid before the commencement of production for technical know-how was capital expenditure.Court's Analysis and Conclusion:The court analyzed the MoU and found that the appellant established a new business through a joint venture with the foreign company. The foreign company provided not only technical know-how but also assistance in setting up the factory, R&D facilities, and exclusive rights to sell the products in India and abroad. The royalty payment, although spread over seven years, was for setting up a new business and provided enduring benefits.The court concluded that the expenditure was incurred at the pre-production stage and was capital in nature. The mode of payment (percentage of sales) was not the sole deciding factor. The court dismissed the appellant's reliance on Alembic Chemical Works Co. Ltd. and M/s Abhipra Capital Ltd., as those cases did not support the appellant's contention in the context of the present facts.Final Judgment:The appeal was dismissed, and the question of law was answered against the assessee, affirming that the royalty payment was capital expenditure.