2017 (6) TMI 524 - SC - Income Tax

Technical fees paid in installments for establishing new manufacturing plant constitute capital expenditure, not revenue

The SC held that technical fees paid in five equal annual installments constituted capital expenditure, not revenue expenditure. The court found no ... Technical fee/ royalty payable in five equal installments on yearly basis - Nature of Technical Fees - revenue expenditure or capital expenditure - Held that:- There was no existing business which needed to be improvised with the aid of technical know-how - Royalty was not only for running the business but for bringing the business into existenc - whenever a complete new plant with a complete new process, with new technology is brought into existence, payment for such technical know-how is to be treated as capital expenditure - purpose of Agreement between the two companies was to set up a joint venture company with aim and objective to establish a unit for manufacture of automobiles and part thereof - this technical collaboration included not only transfer of technical information, but, complete assistance for establishment of plant, machinery etc. so as to bring in existence manufacturing unit for the products - the Agreement in question was crucial for setting up of the plant project in question for manufacturing of the goods, the expenditure in the form of royalty paid would be in the nature of capital expenditure and not revenue expenditure - Decided against the assessee Issues Involved:1. Whether the technical fee of 30.5 million US Dollar payable in five equal installments is to be treated as revenue expenditure or capital expenditure.Issue-Wise Detailed Analysis:1. Nature of Technical Fee: Revenue or Capital ExpenditureThe core issue in the appeals was whether the technical fee of 30.5 million US Dollar, payable in five equal installments, should be classified as revenue expenditure or capital expenditure. The Assessee, Honda SIEL Cars Ltd., had entered into a Technical Collaboration Agreement (TCA) with Honda Motors Company Limited, Japan (HMCL, Japan). Under this agreement, HMCL, Japan provided the Assessee with a license and technical assistance for the development, manufacture, and sale of automobiles and their parts. The consideration for this was a lump sum fee of 30.5 million US Dollar, payable in five continuous equal installments, and a royalty of 4% on internal and export sales.The Assessee initially treated this expenditure as revenue expenditure in its returns. However, the Assessing Officer reclassified it as capital expenditure, a stance upheld by the CIT(A) but reversed by the Income Tax Appellate Tribunal (ITAT). The High Court of Allahabad later overturned the ITAT's decision, siding with the Assessing Officer, leading to the present appeal.2. High Court's RationaleThe High Court concluded that the royalty and technical fee payments were for the enduring benefit of the business, not merely for running it. The TCA was aimed at establishing a new unit for automobile manufacturing, thus creating a new asset. The High Court applied the test from the Full Bench of the Madras High Court in M/s. Jonas Woodhead and Sons (India) vs. Commissioner of Income Tax, which states that payments for technical know-how to set up a new plant with new technology should be treated as capital expenditure.3. Assessee's ArgumentThe Assessee argued that the technical fee and royalty payments were for the right to use technical information provided by HMCL, Japan, without acquiring any enduring asset. The Assessee cited a contrary decision by the Delhi High Court in CIT vs. Hero Honda Motors, which classified similar payments as revenue expenditure. The Assessee emphasized that the ownership rights in the know-how remained with HMCL, Japan, and the Assessee only had a limited right to use this know-how.4. Revenue's ArgumentThe Revenue contended that the payments were capital expenditure, as they facilitated the creation of a new asset—the manufacturing plant. The Revenue upheld the High Court's view that the TCA was crucial for setting up the plant and not merely for running an existing business.5. Supreme Court's AnalysisThe Supreme Court analyzed the TCA and related agreements, noting that the technical fee and royalty payments were for the right to use the technical know-how, not for acquiring ownership. However, the Court acknowledged that the TCA was essential for setting up the new plant. The Court referred to established principles distinguishing capital and revenue expenditure, emphasizing the enduring nature test.The Court cited the case of Commissioner of Income Tax, Bombay City I v. Ciba India Limited, where payments for the right to use technical know-how were treated as revenue expenditure. However, the Court noted that in the present case, the Assessee was a new entity, and the TCA was for setting up a new business, not for improving an existing one.6. ConclusionThe Supreme Court upheld the High Court's decision, concluding that the technical fee and royalty payments were capital expenditure. The Court emphasized that the TCA was integral to setting up the new plant, and the payments provided an enduring benefit to the Assessee.Final JudgmentThe appeals were dismissed with costs, affirming the High Court's classification of the technical fee and royalty payments as capital expenditure.