JUDGMENT
Amareswari, J.
1. The following question is referred for our opinion under s. 256(1) of the I.T. Act, 1961 :
“Whether, on the facts and in the circumstances of the case, the expenditure incurred by the assessee-company, viz., Rs. 5,04,799, for the assessment year 1970-71 is revenue in nature either in whole or ] part ?”
2. The facts :
The assessee, M/s. Hyderabad Asbestos Cement Products Ltd. Hyderabad is a limited company carrying on business of manufacturing asbestos cement products since several years. They were manufacturing ordinary pipes under what is known as Magnani process. They wanted to manufacture better type of pipes known as pressure pipes. For that purpose, they entered into a collaboration agreement dated December 30, 1964, with Johns-Manville Corporation, New York hereinafter called J-M. The object recited in the agreement is for the purpose of supplying technical knowhow for the manufacture of machine of the Mazza type as are in the commercial operation at J-M’s plant at Denison, Texas, United States of America. It is also mentioned in one of the clauses that J-M would give technical training to a reasonable extent in the manufacture of products, i.e., pipes and pipe couplings. The consideration for the agreement was also stipulated. The assessee paid the amount to J-M and this was the subject-matter of a claim by the assessee for the assessment year 1966-67. The matter ultimately went before the Tribunal before whom it was agreed that the amount need not be allowed as a revenue expenditure if depreciation is allowed on the plant and machinery including the amount involved as per the agreement with J-M. This plea was accepted by the Tribunal with the result that amount paid by the assessee to J-M was treated as cost of plant and machinery on which the assessee was allowed depreciation and development rebate. The machinery was set up ultimately with technical know-how from J-M and the assessee started production of pressure pipes from October, 1965. While so, the assessee entered into another agreement with J-M on April 8, 1966. The object of this agreement is to obtain technical know-how and assistance from J-M with regard to the manufacturing to the products as stated in the preamble which is as follows :
“Whereas, HACP desires to obtain the benefits of J-M’s experience in manufacturing the said products.”
“Clause 1.11 provides that J-M shall furnish to HACP such technical advice and assistance to enable HACP to manufacture products of the same quality which are manufactured and sold by J-M.”
Clauses 1.121, 1.122, 1.123, 1.124 and 1.125 read as follows :
“the certain formulae; specifications for machinery and equipment; production line layout; raw material specification; technical information necessary to the processing and manufacture of such products; technical advice to a reasonable extent in connection with the purchase, installation and erection of building, machinery and/or equipment; and assistance to a reasonable extent in the preparation of drawings, plans and specifications for the buildings, machinery and equipment other than architectural design of buildings and detailed mechanical design of machinery and equipment not personnel by HACP; technical training in accordance with J-M’s current customs in such circumstances for employees of HACP so as to qualify them to matters relating to the manufacture of such products; access for the officers and key employees of HACP to those portions of the factories of J-M and or its wholly-owned subsidiaries in the United States of America where products are commercially manufactured; and assistance in the selection and purchase of ingredients required in the manufacture of such products;
Making available to HACP the services of the Johns-Manville Research Laboratories at manville, New Jersey, to a reasonable extent such as is now rendered in connection with similar products manufactured by J-M’s wholly-owned subsidiaries in the United States of America, for the purpose of testing and analyzing products manufactured or sold by its competitors, if any, in India;
Making available to HACP a reasonable number of copies from time to time of technical sales literature made available by J-M or by any of its wholly-owned subsidiaries to its or their customers in the United States of America for use by HACP as guides in preparing its own such sales literature, provided, however, that HACP shall not distribute, reproduce for distribution, or copy the same in whole or in part for distribution, to others without the prior written consent of J-M; and
Granting permission for HACP in its advertising and sales literature regarding products, and upon products and packages and samples thereof, to use any of the following expressions :
A. ‘Manufactured by the Johns-Manville Process’ or B. ‘Manufactured in accordance with specifications of Johns-Manville’ or C. ‘Manufactured in accordance with Johns-Manville Technique’ or D. ‘Any other phrase of similar import, upon obtaining prior approval of J-M’;
On condition that HACP will not use either the initials’J-M’ or the name ‘Johns-Manville’ in a trade mark sense indicating that J-M is the source of the products produced by HACP; provided that J-M shall have the right at any time in its sole discretion to cancel the rights granted to HACP by this Paragraph 1.125 if the products manufactured by HACP shall, in the sole judgment of J-M, not in fact be manufactured in accordance with specifications and techniques of J-M, or be of a quality inferior to products of the same or similar kind manufactured by J-M or by its wholly-owned subsidiaries in the United States of America; and provided further that HACP shall have no right under this agreement or otherwise to use or to register any trade marks, trade names, or other commercial marks or indicate of J-M, or any translation, transliterations, variations or portions thereof, or any marks or indicia similar thereto or to use the name of J-M or of its subsidiaries in any manner whatsoever except as herein above expressly provided. No failure or delay on the part of J-M in exercising its right of termination hereunder for any one or more causes shall prejudice or be construed to prejudice its right to termination for such or for any other or subsequent cause. J-M shall grant to HACP non-exclusive licences for the life of this agreement under any Letter Patent of India owned by K-M prior to the Seventh anniversary of the effective date of this agreement to enable HACP to manufacture, use and sell said products in India.”
Clause 2.1 deals with payment of lump sum of 1,00,000 dollars.
Clause 2.2 stipulates that royalty of 3% of the net sales of products for use or consumption in India and 5% of the net sales sent aboard for export should be paid.
3. As per the terms of clause 2.2, the assessee paid royalty and claimed the same as revenue expenditure on the ground that it is an expenditure incurred in connection with the carrying on of business of the assessee which is manufacturing pipes with the assistance of J-M. The claim was allowed by the ITO.
4. But the Commissioner revised the said order under s. 263 of the I.T. Act by his proceedings dated January 28, 1974, holding that the order of the ITO was prejudicial to the interests of the Revenue. The Commissioner was of the view that the agreement dated December 30, 1964, and the agreement dated April 8, 1966, are of the same nature, that the second agreement is a continuation of the first agreement and that there was no material variation between the two agreements. He mainly referred to clause 1.121 to 1.125 whereby J-M agreed to supply the assessee, formula specifications for machinery and equipment, production line layout and technical information necessary to the processing and manufacturing of such products. He held that the second agreement also contemplated supply of capital assets of enduring nature and there is no difference between the earlier agreement and subsequent agreement. On this finding, he held that the sum of Rs. 5,04,799 should be disallowed and directed the ITO to pass necessary and consequential orders. The matter was carried in appeal to the Income-tax Appellate Tribunal. The Tribunal after comparing the two agreement clause by clause held that the second agreement was altogether different and it was only entered into for the purpose of improving and maintaining the quality of the products already manufactured by the assessee and has nothing to do with the installation of plant and machinery or for manufacture of any capital assets. Accordingly, the assessee’s claim was allowed and the order of the Commissioner was set aside. On these facts, the above question was referred for our opinion at the instance of the Revenue.
5. The main contention of Mr. M. Suryanarayana Murthy, the learned counsel for the Revenue, is that the two agreements are of the same nature and if the expenditure incurred under the terms of the earlier agreement was treated as capital expenditure, there is no reason why a departure should be made in the case of the latter agreement.
6. On the other hands, it is contended by Mr. R. N. Bajoria, the learned counsel for the assessee, that it is fallacious to think that the two agreements are the same. He urged that the earlier agreement is for the manufacture and installation of machinery and plant which is used in the manufacturing of pressure pipes according to the specifications of J-M and the dominant object of the second agreement is in connection with the manufacturing of pressure pipes, i.e., carrying on the business of the assessee, and, therefore, the position is different in the case of the latter agreement.
7. Before we go to decided cases on the point which have laid down broad principles in determining whether an expenditure is capital or revenue in nature, we will deal with the relevant clauses in the agreement as, ultimately, the question depends upon the facts of each case. We have already quoted the preamble to the second agreement. In the first agreement, the experience of J-M was to be obtained in the manufacture of machines, where as in the second agreement, the experience was to be obtained in respect of manufacturing of products. Clause 1.11 in the first agreement relates to furnishing of engineering information, drawings, specifications and designs to enable the assessee to manufacture the machines, while in the second agreement, it is only to enable the assessee to manufacture products. Clauses 1.121 to 1.125 in the second agreement which were relied upon by the Commissioner no doubt relate to obtaining technical know-how in connection with the machinery and equipment, but they relate to specifications for machinery and equipment and not for supplying technical know-how for the manufacture of machinery and equipment. The one important factor to be noticed is that the installation of machinery was completed with the technical know-how supplied by J-M under the first agreement and production had started in October, 1965, before the second agreement was entered into. The counsel for the Revenue challenged the correctness of this finding that the company started production from October, 1965. But we are afraid we cannot go into this question in a reference under s. 256. Even in the order of the Commissioner, we find there is a reference to this fact, namely, that the company went into production in October, 1965. No doubt, there is a mention of technical advice in connection with the installation and construction of the building and machinery in the second agreement. But that was only to see that the machinery already installed is properly laid out and what was contemplated was only advice to a reasonable extent to give the benefits of maximum production. In our view, the dominant intention of the second agreement is to get technical assistance and experience in the manufacture of products and not for erecting any machinery and plant as was done in the first agreement. Clause 1.122 quoted above refers only to matters in connection with the manufacture of products. Clause 1.123 mrequires J-M to provide the result of research which again relates to the manufacture of the product. Clause 1.124 relates to sales and sales literature regarding products. Though some rights are given by J-M for using their names on the products, it was stipulated under clause 1.125 that the name should not be used as a trade mark so as to indicate that J-M is the source of the product predicated by the assessee. No trade mark or patent right was assigned. No doubt there is a similar clause in the first agreement. But it must be understood in the context of the dominant purpose of that agreement. Clause 1.2 of the agreement dated April 8, 1966, clearly stipulated that the assessee is granted non-exclusive licence for the life of the agreement which is seven years, so that the assessee is enabled to manufacture, use and sell products in India. In the earlier agreement, the emphasis was more on the machines. The payment clause also is indicative though not determinative. Royalty is to be paid as per clause 2.2 at 3% of the net sales in India and at 5% in respect of the sales made outside India. On a close scrutiny of the several clauses in the two agreements, we are of the view that the second agreement was only for the purpose of improving the quality of the products already manufactured by the assessee. It is also for the purpose of getting latest improvements in technology relating to the manufacture of such products that the agreement was entered into. The agreement is to last only for seven years. The right to use the licence is non-exclusive in nature. J-M can issue the licence to any other person in India. No right of trade mark or patent was granted by J-M to the assessee. The technical assistance imparted by J-M to the assessee is only in respect of manufacture of products and has nothing to do with the installation of plant and machinery or for manufacture of any capital assets.
8. In Fenner Woodroffe & Co. Ltd. v. CIT , the assessee-company entered into an agreement with the foreign company under which the foreign company agreed to make available the technical data relating to the manufacture of leather belting. The agreement also provided that the foreign company would provide foreign technicians to attend at the assessee-company’s factory in India and also to provide training facilities at the foreign company’s works in England to technicians of the assessee-company. The assessee-company had to pay a remuneration at the rate of one-half of one per cent. of the amount of the ex-factory invoice prices of the Indian company for the quantity sold. The Income-tax Tribunal held that it was a new venture undertaken for the first time by the assessee-company and, hence, the assessee had acquired benefit of enduring nature and, therefore, it is capital expenditure. On a reference, the High court said that the deciding factor whether it is a capital or revenue expenditure is neither the source nor the manner of payment. But since there was no limitation in the agreements as to its endurability and the assessee could use the technical data even after the period of ten years and deal with it as if it was their own asset, the amounts paid constituted capital expenditure.
9. In Addl. CIT v. Southern structurals Ltd. , the agreement was for giving technical assistance of inventions and designs relating to railway wagons owned by the British company. One of the clauses provided that after the expiry of the agreement, the assessee would be free from any obligation to pay any amount on the foreign company while the assessee-company would have the continued views free of charge of all information made available by the foreign company during the period of the validity of the agreement. On these facts, it was held that the expenditure was capital in nature.
10. In Jonas Woodhead & Sons (India) Ltd. v. CIT [FB], the agreement with the English company was for the supply of all technical information and know-how relating to the setting up of plants suitable for the manufacture of all types of springs and suspensions for road and rail including plays, drawings, estimates and specifications. It also provided for payment of royalty by the assessee-company to the English company at rates depending upon the turnover relating to the licensed products. The ITO treated one-fourth of the amount as representing consideration for services provided by the English company of an enduring nature and disallowed the same as being capital in nature. On a reference, it was confirmed by the High Court.
11. In all the aforementioned cases, the agreement was for manufacture of a new product altogether and having regard to the terms in that agreement , it was held that the expenditure was capital expenditure.
12. In praga Tools Ltd. v. CIT [FB], the assessee which was carrying on business in the manufacture of precision and machine tools, machinery and forgings entered into a licence agreement with J. & S. Ltd., a foreign company of U.K., for other manufacture of certain tool and cutter grinding machine for which J. & S. Ltd. should supply the accessories, designs, technical know-how with latest modifications and assistance. J. & S. Ltd. also agreed to assist the assessee in the manufacture of main castings of the machine and sell to the assessee all the fixtures, jigs, tools, gauges, raw material and special parts at their commercial retail value. The agreement was for a period of ten years and renewable thereafter for five years by mutual consent. During the subsistence of the agreement, the assessee had to pay royalty at 5 per cent. on the India selling price on the production of the machine, subject to Indian taxes. The termination of the agreement was not to affect the rights of the assessee of use, for the purpose of their business, all the information, techniques, technical know-how, patents, copyrights and drawings transferred by J. & S. to the assessee or which might have come into the possession of the assessee during the subsistence of the agreement. Similarly, the assessee entered into another agreement with another foreign company, K.T. of U.K., for the manufacture of “drill chucks”. The assessee claimed that the payments made towards royalty constituted revenue expenditure and was, therefore, to be deducted. Though the ITO reject plea, the AAC upheld the claim. But the Appellate Tribunal held that the two types of the machinery manufactured by the assessee under the agreements were entirely new agreements which were patented by collaborators and the same was not in production line of the assessee before entering into such agreements, that the payments were made to secure an enduring advantage and, therefore, the expenditure incurred in connection therewith was capital expenditure. On a reference, a Full Bench of our High Court to which one of us (Amareswari J.) was a party, held that the expenditure incurred had a direct nexus or relation to the carrying on or conduct of the business of the assessee and, therefore, it had to be treated as an integral part of the profit-making process. The very object of payment of royalty based upon the production and sale of the products manufactured by the assessee was to obtain manufacturing licence and technical know-how including drawings, designs, specifications and other technical information, to enable the assessee to make and sell the products indicated in the agreements. Merely because the agreements provided that the assessee shall be entitled to retain technical know-how, designs, drawings, etc., even after the expiry of the agreements, it did not alter the nature of the transaction. There was no property right transferable in the technical know-how. The fact that the assessee was not entitled to use the trade mark of J. & S. for the products, after expiry of the agreement period, clinched the issue. The expenditure incurred by the assessee for the purpose of payment of royalty to the collaborators is revenue in nature and, hence, deductible. The Full Bench further held that it is the totality or cumulative effect of all the material facts evidenced by the documents and the surrounding circumstances that are to be taken into consideration to arrive at a decision as to whether the expenditure is capital or revenue. The ratio of this Full Bench case is directly applicable to the case on hand. The assessee, M/s. Hyderabad Asbestos Cement Products Ltd., Hyderabad, is not entitled to use the trade mark of J-M for the products after the expiry of the agreement and this, according to the Full Bench, was one of the important circumstances in deciding the question. It is to be further noticed that this Full Bench case reversed the decision in Hylam Ltd. v. CIT [1973] 87 ITR 310, on which reliance was placed by the Commissioner in holding that the expenditure was capital in nature.
13. In ACC-Vickers Babcock Ltd. v. CIT [1976] 103 ITR 321, a Division Bench of the Bombay High Court held that where an expenditure is incurred while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment, the aim and object of the expenditure would determine whether it is a capital expenditure or a revenue expenditure. If the expenditure is so related to the carrying on, or the conduct of, the business that it might be regarded as an integral part of the profit-making process, it should be held to be revenue expenditure. If the purpose is for an acquisition of an asset or right of a permanent character, the possession whereof is a condition precedent to the commencement or continuance of the business, the expenditure would be of a capital nature. Having regard to the various clauses of the agreement, it was held that the payment was for the benefit of the entire technical know-how agreed to be made available to the assessee to enable it to manufacture and sell the listed equipment so that the assessee could earn profits. The expenditure was thus so related to the carrying on of the business that it would have to be regarded as an integral part of the profit making process and, hence, the expenditure was held to be revenue in nature. The Full Bench of our High Court in Praga Tools Ltd.’s case [1980] 123 ITR 773, relied upon this case in arriving at the conclusion that the expenditure was revenue in nature.
14. A Full Bench of the Karnataka High Court in Mysore Kirloskar Ltd. v. CIT [1978] 114 ITR 443, held that the acquisition of the right to draw upon the technical knowledge of the foreign companies for a limited period of 15 years for the purpose of carrying on its business does not amount to acquiring any asset or advantages of an enduring nature for the benefits of its business and the payments made by the assessee under the agreements to the foreign collaborator were revenue in nature. The object of the agreements therein which was for a period of 15 years was to obtain the benefit of technical assistance for running the business and the permission therein was granted to the assessee subject to rights actually granted or which may be granted after the date of the agreements to other persons though outside India and the foreign companies had agreed to make their research and advantage available to the assessee. The earlier decision of the Division Bench of the Mysore High Court in Mysore Kirloskar Ltd. v. CIT [1968] 67 ITR 23 (Mys), on which much reliance was placed by our High Court in Hylam’s case [1973] 87 ITR 310 was overruled.
15. In Moriarty v. Evans Medical Supplies Ltd. [1959] 35 ITR 707 (HL), it was held by Lord Denning that there could be no distinction between the money paid for disclosing information of secret processes and money paid for other information and that the amount paid for “know-how” in the course of the assessee’s trade was income and not capital.
16. In Jeffrey v. Rolls-Royce Ltd. [1965] 56 ITR 580 (HL), it was held that payment received for licensing a foreign Government to manufacture aeroengines with the accumulated technical knowledge of the tax payer and for supplying the necessary information, drawings, designs, advice and assistance in the manufacture of engines by the licensee was a revenue receipt. The amounts received by the taxpayer for imparting this manufacturing technique to the licensee to design and develop a turbine and to license the manufacture were held to be income in English Electric Company’s case (Musker v. English Electric Co. Ltd. (1964) 41 TC 556 (HL). The decision of the Bombay High Court in CIT v. Devidas Vithaldas and Co. (1968) 68 ITR 388, relied upon by the learned judges in Hylam’s case , was reversed by the Supreme Court.
17. In CIT v. Oblum Electrical Industries (P.) Ltd. , the same principle was enunciated as in the Full Bench decision in Praga Tools Ltd. v. CIT . It was held that since the agreement provided for the use of know-how for a period of 14 years only and the grant of licence was on a non-exclusive basis and the grantee had to pay royalty on the net sales effected by it by exploitation of the patent, the expenditure was revenue in nature.
18. In CIT v. Madras Rubber Factory Ltd. , a Division Bench of the Madras High Court held that the expenditure is of a revenue nature on the ground that the whole of the fee payable to the foreign company was intended by the parties as consideration for technical consultancy services required for keeping the factory going. The agreement itself kept the two aspects of the collaboration meticulously distinct and separate, one connected with the initial setting up of the factory and the other connected with the running of the factory. The fact that the assessee was not bound to return the knowledge acquired during the contract period and that it was in a position to keep for itself the said knowledge only served the assessee to run its business as efficiently after the contract period as it did during the period. Consequently, no part of the fees paid could be disallowed as having any capital element in it.
19. On the principles laid down in Praga Tools Ltd. v. CIT (FB), CIT v. Oblum Electrical Industries (P.) Ltd. and CIT v. Madras Rubber Factory Ltd. , we have no hesitation in holding that the Tribunal was justified in treating the expenditure as a revenue expenditure. In fact, the Madras High Court had taken a slightly different view from its earlier decisions in Fenner Woodroffe & Co. Ltd. v. CIT , Addl. CIT v. Southern Structurals Ltd. and Jonas Woodhead & Sons (India) Ltd. v. CIT [FB].
20. Then we have the unreported decision of our High Court in R.C. No. 15 of 1978, dated June 10, 1983 Coromandel Fertilizers Ltd. v. CIT – since reported in [1984] 148 ITR 546). Chief Justice Madhava Reddy, who spoke for the Division Bench, held as follows (p. 559) :
“Whether an expenditure incurred by an assessee is capital expenditure of revenue expenditure has to be determined on a consideration of the facts of each case. On the facts what one has to ask is : Has the expenditure incurred resulted in creation of an asset of enduring benefit ? ‘Technical know-how with regard to agronomical research, soil conditions, manufacture and distribution of complex fertilisers suitable for various types of soil in a particular area for a certain period to the exclusion of others without any transfer of the right in the technical know-how and leaving the transferor free to sell that technical know-how outside the area and restrict the transferee from disclosing it to third parties does not result in acquisition of any asset of enduring benefit so as to make the expenditure incurred for acquiring the same capital expenditure. Acquisition of sales and marketing know-how or acquiring the exclusive right to market the goods and eliminating a competitor from the market whether constitutes acquiring an asset of enduring benefit, depends upon the nature of the business which the assessee carried on. With the fast pace of development of scientific and technical knowledge and the quick spread of advanced technology all over the world, the technical know-how of the sort acquired by the assessee from E.I.D. Parry under the agreement is, in our view, liable to become obsolete within a short span of time. An asset which may become obsolete within a short time cannot be regarded as an asset of enduring nature and hence expenditure incurred thereon cannot be treated as capital expenditure; it would be revenue expenditure.”
21. Though these observations are made in the context of technical know-how with regard to manufacture of fertilisers, they apply with equal force in the case of supply of technical know-how with regard to other products also. As found supra, the purpose of the second agreement is only to improve and maintain the quality of the products already manufactured by the assessee. The agreement is to last only for seven years and the licence to manufacture is a non-exclusive licence. There is no right to trade mark or patent right granted either permanently or for an indefinite period.
22. The assistance and knowledge is only with regard to manufacture of products with a view to earn more profits and has nothing to do with the manufacture of machinery. In the circumstances, the view of the Income-tax Appellate Tribunal that the expenditure is revenue in character is fully justified.
23. We answer the reference in the affirmative and in favour of the assessee.
