Whether Expenditure Incurred under a Technical Collaboration Agreement for Setting up of New Plant is Revenue Expenditure?- Held No
Admittedly, there was no existing business and, thus, question of improvising the existing technical know-how by borrowing the technical know-how of the HMCL, Japan did not arise. The assessee was not in existence at all and it was the result of joint venture of HMCL, Japan and M/s. HSCIL, India. The very 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.
As a result of this agreement, assessee company was incorporated which entered into TCA in question for technical collaboration. This technical collaboration included not only transfer of technical information, but, complete assistance, actual, factual and on the spot, for establishment of plant, machinery etc. so as to bring in existence manufacturing unit for the products. Thus, a new business was set up with the technical know-how provided by HMCL, Japan and lumpsum royalty, though in five instalments, was paid therefor.
1. M/s. Honda Motors Company Limited, Japan (hereinafter referred to as “HMCL, Japan”) had entered into a joint venture dated September 12, 1995 with M/s. SEIL Ltd., a company incorporated under the Indian Companies Act.
2. After getting necessary approval from the Government of India, a joint venture company in the name of the assessee was incorporated
3. After incorporation of the assessee as a joint venture, An agreement dated May 21, 1996 between HMCL, Japan and the assessee was entered into, known as ‘Technical Collaboration Agreement’ (for short, ‘TCA’)
4. As per the TCA, HMCL, Japan which is engaged in the business of development, manufacture and sale of automobiles and their parts agreed to give ‘license’ and ‘technical assistance’ to the assessee
5. The TCA also stipulated different kinds of technical know-how and technical information which were to be provided by HMCL, Japan (as a licensor) to the assessee (as a licensee)
6. For providing the aforesaid facilities, it was agreed that a consideration/lump sum fee of 30.5 million US Dollar would be paid by the assessee to the HMCL, Japan in five continuous equal installments and payment thereof was to commence from third year after commencement of commercial production. Besides, assessee was also liable to pay royalty of 4%, both on internal and exports, subject to taxes
7. The dispute which has arisen is as to whether the said technical fee of 30.5 million US Dollar payable in five equal installments on yearly basis is to be treated as revenue expenditure or capital expenditure
8. The assessee had filed its first return for the Assessment Year 1999-2000 (in which year, first installment was paid) showing the said expenditure as revenue expenditure. Though, in the normal assessment, the expenditure was allowed as such, thereafter a notice was issued under Section 148 of the Income Tax Act (hereinafter referred to as the ‘Act’) stating that said expenditure was capital in nature and, therefore, instalment towards royalty paid in the sum of Rs. 79602000/-, by the assessee to HMCL, Japan in that year had escaped assessment. Ultimately, orders were passed treating the same as capital expenditure. In the subsequent years, the Assessing Officer again treated the royalty paid as capital expenditure
9. The assessee filed appeals before the CIT(A) which were dismissed. However, further appeals before the Income Tax Appellate Tribunal (ITAT) were allowed and the ITAT held that the expenditure is to be treated as the revenue expenditure. Against the order of the ITAT, the Department went in appeal before the High Court of Allahabad which has allowed these appeals thereby reversing the order of the ITAT and agreeing with the view taken by the Assessing Officer the payments of royalty expenditure in-question are to be treated as capital expenditure. In the present appeals challenging the impugned judgment dated December 21, 2016 passed by the High Court is challenged
Arguments by Assessee
Mr. Tripathi, learned senior counsel appearing for the assessee submitted at the outset that on identical issue pertaining to this very assessee, Delhi High Court has taken a contrary view in the case of CIT vs. Hero Honda Motors [(2015) 327 ITR 481(Delhi)] holding that payment of technical know-how fee and royalty was in the nature of revenue expenditure. His further submission was that the very premise on which Allahabad High Court had given the impugned judgment, was contrary to record. In this behalf his submission was that the High Court had proceeded on the premise that the technical know-how fee and royalty was paid for setting up the plant for manufacture of automobiles which are contrary to the factual finding recorded by the Tribunal in this case. According to him, the know-how was provided to the assessee for the purpose of manufacturing of products in India.
He also argued that the High Court was influenced by irrelevant factors like extent of share holding of HMCL, Japan in the assessee which was of no relevance. The learned counsel laid much emphasis that in terms of TCA, the appellant had only acquired the right to use the technical know-how provided by HMCL for manufacture of products, during the currency of the TCA, which was for an initial period of ten years from the date of agreement or seven years from the date of commercial production. The ownership rights in the know-how continued to remain with HMCL, Japan and the appellant was not authorized to transfer the know-how license to any other person or assign or convey the same to any third party. Thus, what the appellant acquired was only a limited right to use and exploit the know-how for manufacture of products and parts.
Arguments by Revenue
The learned counsel for the Revenue refuted the aforesaid submissions of Mr. Tripathi. His contention was that finding of fact was arrived at by the Assessing Officer, which was confirmed by the CIT(A) as well that a new asset in the form of setting up of a new company had come into existence with the aid of technical know-how and, therefore, the expenditure in-question was capital expenditure. He further submitted that the view which was taken by ITAT was un-sustainable and, therefore, rejected by the High Court. Referring to the reasoning given by the High Court in the impugned judgment which is already taken note of above, his submission was that the same should be accepted.
Observation of Honb Supreme Court
1. We have considered the respective submissions of counsel for the parties on either side. First thing which is discernible in the impugned judgment of the High Court is that the High Court has proceeded entirely on the basis that technical know-how was used for setting up of a plant for manufacture of automobiles. Judgment of the ITAT, on the other hand, reveals that it had arrived at a contrary conclusion.
2. Record reveals that simultaneously with the signing of TCA, certain other agreements were also entered into between HMCL, Japan and the assessee on May 21, 1996
3. Nomenclature of these three agreements is already taken note of above. These are ‘Memorandum on Exchange of Technicians’, ‘Memorandum on Supply of Parts’ and ‘Memorandum on Supply of Manufacturing Facilities’. The Tribunal went into the nature of these agreements. Engineers and technicians were sent by HMCL, Japan to India for providing necessary guidance for setting up of plant. Likewise, Memorandum on Supply of Parts related to the supply by HMCL, Japan of parts required for the manufacture of Honda cars. This Agreement basically provided each sale and purchase of pats shall be effected in accordance with the terms and conditions of an individual purchased contract for the parts, which means that the supply of parts is governed by separate contracts. Third Agreement known as ‘Memorandum on Supply of Manufacturing Facilities’ stipulated the specification of the manufacturing facilities to be sold by Japanese company to the assessee, their sale prices and the time of delivery which was to be separately decided by the parties from time to time. It contained detailed provisions in respect of the specifications and changes thereto, terms of payment, inspection before delivery, functional testing of materials, packing, insurance, on-sight inspection, warranty title risk, patents, trademarks etc. Undoubtedly, payments made in respect of facilities given under the aforesaid Memoranda are capitalised by the assessee, showing the same to be the capital expenditure. Contrasting these three Memoranda with the TCA, ITAT returned a finding to the effect that for setting up the manufacturing facilities and for the tax, separate agreements had been entered into by the parties and separate payments were made by the assessee as consideration therefor. This makes it clear that the payment of technical know-how and royalty are not part of payments for setting up the plant which manufactures the Honda cars in India but, were made to enable the assessee to manufacture the Honda cars in India which are its stock and trade. The Tribunal was conscious of the fact that this TCA was also entered into at the time of setting up of the fact and since the know-how was being obtained for the first time and was crucial to the setting up of the business of the assessee. It posed a question as to whether this could make the difference and the expenditure was to be treated as capital expenditure. However, after noticing that no such distinction was drawn by Delhi High Court in Shriram Refrigeration Industries Vs. Commissioner of Income Tax2 and Triveni Engineering Works Ltd. Vs. CIT3 and the test applied was as to whether the expenditure, whether incurred at the time of setting up of the business or later, acquisition of technical know-how or was only for the use of the know-how for a particular period. Applying the aforesaid test, the Tribunal found that TCA in-question gave a limited right to the assessee to use the technology with no ownership or proprietary rights therein
4. The aforesaid conclusion recorded by the ITAT has been upset by the High Court in the impugned judgment. It would be pertinent to point out that even the High Court has not interpreted the clauses of the TAC to conclude that proprietary rights in the technical know-how stood acquired by the assessee. It has proceeded on the basis that it was only right to use the technical know-how which was given. Its conclusion rests entirely on the basis that the technical know-how was given for setting up of the new plant. It is this difference of opinion which is to be settled here
5. Distinction between capital and revenue expenditure with reference to acquisition of technical information and know-how has been spelled out by this Court as well as High Courts in series of cases. Primary test which is adopted to differentiate between capital and revenue expenditure remains the same, namely, the enduring nature test. It means where the expenditure is incurred which gives enduring benefit, it will be treated as capital expenditure. In contradistinction to the cases where expenditure of concurrent and reoccurring nature is incurred and the later would belong to revenue field. Technical information and know-how are intangible. They have different and distinct character from tangible assets. When the expenditure is incurred to acquire a tangible asset, determination as to whether the said acquisition of tangible asset is of capital nature or the expenditure is of revenue nature, may not pose a problem. However, in case of technical information and know-how, having regard to their unique characteristic, the questions that need to be posed for determining the nature of such an expenditure are also of different nature. In case where there is a transfer of ownership in the intellectual property rights or in the licences, it would clearly be a capital expenditure
6. However, when no such rights are transferred but the arrangement facilitates grant of licence to use those rights for a limited purpose or limited period, the Courts have held that in such a situation, the royalty paid for use of such technical information or know-how would be in the nature of revenue expenditure as no enduring benefits is acquired thereby. This was so held in a classic case, entitled Commissioner of Income Tax, Bombay City I v. Ciba India Limited4 . In the said case, the assessee company had procured know-how in the form of processes, formulae, scientific data, working, prescription and other intellectual property rights developed by a Swiss Company, to produce licensed preparations and to promote their sale in India. Inspite of the fact that the Swiss Company had granted to the Indian assessee “full and sole right and licence” in the territory of India under the patents listed in Schedule-I, to make use, exercise and vend the inventions referred to therein and to use the trade marks set out in Schedule-II in the territory of India, this Court held that what was conferred was a mere right to use. The Indian assessee, it was observed, was not entitled to exclusive rights to patents, trademarks etc. As per the agreement, proprietary information was not to be divulged to third parties without consent
7. The rights granted enabled access to the technical knowledge and experience with right to use patents and trademarks for a limited period. The Swiss Company did not part with any asset of its business, nor did the Indian assessee acquire any asset or advantage of enduring nature. The right empowered the Indian assessee to draw for the purpose of carrying on its business as a manufacturer and rely upon the technical knowledge of the Swiss Company. There was no attempt to part with technical knowledge absolutely in favour of the Indian assessee. It was not a case of transfer of intellectual rights once for all. Thus, the expenditure incurred was revenue in nature
It is important to note that in case of termination of the Agreement, joint venture itself would come to an end and there may not be any further continuation of manufacture of product with technical know-how of foreign collaborator. The High Court has, thus, rightly observed that virtually life of manufacture of product in the plant and machinery, establishes with assistance of foreign company, is co-extensive with the agreement. The Agreement is framed in a manner so as to given a colour of licence for a limited period having no enduring nature but when a close scrutiny into the said Agreement is undertaken, it shows otherwise. It is significant to note in this behalf that the Agreement provides that in the event of expiration or otherwise termination, whatsoever, licensee, i.e., joint venture company/ Assessee shall discontinue manufacture, sale and other disposition of products, parts and residuary products. All these things then shall be at the option of licensor.
In other words, licensee in such contingency would hand over unsold product and parts to licensor for sale by him. In case licensor does not exercise such an option and the product is allowed to be sold by licensee, it would continue to pay royalty as per rates agreed under the agreement. Clauses 19 and 21, in our view, make the Agreement in question, i.e., establishment of plant, machinery and manufacture of product with the help of technical know-how, co-extensive, in continuance of Agreement. The Agreement also has a clause of renewal which, in our view, in totality of terms and conditions, will make the unit continue so long as manufacture of product in plant and machinery, established with aid and assistance of foreign company, will continue. Since, it is found that 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. The Tribunal is conclusion that it is only the other three memoranda which were necessary for setting up the manufacturing facilities and payment thereunder would qualify as capital expenditure, and not the payment of technical fees/royalty on the ground that this Agreement was not in connection with the setting up of a plant or manufacturing facilities, is not correct. It would be interesting to note that even the Tribunal had nurtured doubt on the nature of this expenditure as TCA was signed simultaneously with the other memoranda to facilitate setting up of a new factory and not improvising the earlier set up
However, discussion that follows thereafter suggests that the ITAT was satisfied with the explanation of the assessee that the High Courts have always applied the test as to whether the expenditure, whether incurred at the time of setting up of business or later, was for acquisition of the technical know-how or was only for the use of know-how for a particular period. ITAT felt satisfied with the said explanation and held that the expenditure was revenue in nature. It is at this stage that the Tribunal erred in not approaching the issue in right perspective.
Coming to the judgment of the Delhi High Court in the case of this very assessee, it would be noticed that in that case, technical know-how was obtained for improvising scooter segment, which unit was already in existence. On the contrary, in present case, the TCA was for setting up of new plant for the first time to manufacture cars. The Delhi High Court specifically noted this fact in para 14 of the judgment. While analysing the agreement in that case which was for providing technical know-how in relation to the product i.e. two wheelers and three wheelers and the purpose was to introduce ‘new models’ of the said product developed by the Japanese Company, the High Court noted that the agreement specifically recorded that the respondent assessee was already engaged in the business of manufacturing, assembling, selling and otherwise dealing with two/three wheelers and their parts as a joint venture. It referred to the earlier collaboration agreement dated January 24, 1984 and the subsequent amendment thereto which conferred and had granted to the respondent assessee a right and licence to manufacture, assemble, sell, distribute, repair and service two/three wheelers.
The aforesaid distinction between the two Agreements has made all the difference in the results. As a consequence, we find no merit in these appeals which are dismissed with cost.
Cases Referred to
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