Delhi High Court

Commissioner Of Income Tax vs M/S. Control & Switchgear ... on 6 November, 2009

Author: A.K.Sikri

*            IN THE HIGH COURT OF DELHI AT NEW DELHI
                          ITA No. 677 of 2009
                                         Reserved on: 06th October, 2009.
%                                  Pronounced on : 06th, November, 2009.

      Commissioner of Income Tax                             . . . Appellant
                       through :          Ms. Suruchi Aggarwal with Mr.
                                          Anish Kumar, Advocates.

                             VERSUS

      M/s. Control & Switchgear Contactors Ltd.            . . . Respondent
                       through:           Mr. Ajay Vohra with Ms. Kavita Jha
                                          and Ms. Akansha Aggarwal,
                                          Advocates.

CORAM :-
   THE HON'BLE MR. JUSTICE A.K. SIKRI
   THE HON'BLE MR. JUSTICE SIDDHARTH MRIDUL

      1.     Whether Reporters of Local newspapers may be allowed
             to see the Judgment?
      2.     To be referred to the Reporter or not?
      3.     Whether the Judgment should be reported in the Digest?

A.K. SIKRI, J.

1. The assessee company is engaged in the business of

manufacturing of the Electrical products, control panel,

switchgear, Air circuit breakers etc. In its return filed for the

Assessment Year 2003-04, the assessee company declared loss of

Rs.3,12,57,184/-. This return was processed under Section

143(1) of the Income Tax Act (hereinafter referred to as „the

Act‟), as the MAT income of Rs.3,22,23,192 under Section 115JB

of the Act. Subsequently, notice under Section 143(2) was issued

pursuant to which assessment order was passed on 30.03.2006.

The Assessing Officer (AO) found that during the said

assessment year, the assessee had paid Rs.2,06,00,010/- to M/s.

Simelectro France and treated it as royalty. The AO after

examining the relevant clauses of agreement relating to

payments of royalty/technical know-how fee held that the

assessee was deriving enduring benefit from the

technology/information received. Accordingly, the AO

capitalized the same and made addition under this head after

allowing 25% depreciation to the assessee. The AO relied on the

judgment in the cases of Commissioner of Income Tax Vs.

Jacobs (P) Ltd., (1979) 120 ITR 197, Division Bench of Kerala

High Court, Commissioner of Income Tax Vs. Polyformation

(P) Ltd. (1986) 161 ITR 36 (Ker.), Commissioner of Income

Tax Vs. Coal Shipments P. Ltd., (1971) 82 ITR 902 (SC) and

held that the expenses incurred by way of royalty/technical fee

were capital in nature and assessee was not entitled to deduction

of the same as an item of revenue expenditure. Hence,

capitalizing this expenditure, he allowed deduction of 25% of the

amount, treating the same as technical know-how fee as defined

in Section 32 of the Act.

2. The assessee preferred appeal against this order of the AO. In

the appeal, the CIT(A) noted that the royalty/technical know-

how fee was paid two parties, which required to be decided in

different ways, i.e.,

(i) In respect of royalty paid to M/s. Simelectro

France as technical know-how fee for

Rs.20,60,010/-, the CIT(A) found that the assessee

was deriving enduring benefits from such party.

Hence, in the light of case laws as relied upon by

the AO, the CIT(A) upheld the AO‟s action trading

treating this expenditure as capital in nature.

Thus, the AO was held to be justified in allowing

the depreciation @ 25%.

(ii) In respect of payment of Rs.17,45,198/- in favour

of M/s. SPG Holding GMPH, the CIT(A) found

that neither the technical know-how was provided

by the said party nor the amount was refunded.

Thus, the payment made to this party was still in

dispute. Hence the payment of Rs.17,45,198/- in

favour of M/s. AVK SPG Holding was receivable

amount and the same was a matter of balance

sheet. It was neither a capital expenditure nor the

revenue expenditure nor the capital loss. In this

situation, the disallowance of Rs.17,45,198/- was

upheld, and the deprecation already allowed @

25% against such capitalization of Rs.17,45,198/-,

was held to be not justified. Accordingly, the AO

was directed to withdraw the deprecation allowed

against the capitalized amount of Rs.17,45,198/-.

Aggrieved by the order of the CIT(A), the assessee filed an

appeal before the Income Tax Appellate Tribunal (hereinafter

referred to as „the Tribunal‟) being ITA No.5007/DEL/2007.

The Tribunal vide its impugned order dated 12.12.2008 has

partly allowed the appeal of the assessee and directed the AO to

capitalize 25% of royalty payment of Rs.20,60,010/- to M/s.

Simelectro France instead of 100% capitalization by the AO.

The Tribunal held that the facts correspond to the facts of the

case of Southern Switch Gear Ltd. (supra), a decision which

was later on approved by the Hon‟ble Supreme Court.

Following this decision, it was held that 25% of the expenditure

was of capital nature and balance 75% was revenue in nature and

the AO was directed to allow the expenditure and depreciation

accordingly.

3. The Revenue is in appeal against the aforesaid order. The

grievance is that the Tribunal wrongly equated the present case

with that of Southern Switch Gear Ltd. (supra) and gave the

benefit of capitalizing the amount paid to M/s. Simelectro

France. It is the submission that entire amount paid to the said

company should have been capitalized and not only 25%. It is

the submission of the learned counsel for the Revenue that the

Tribunal passed the order despite the fact that agreement

between the assessee and M/s. Simelectro France was to remain

in force for a long period of ten years. The agreement further

provided that the assessee could file, with prior consent of the

said company, an application with the Indian Patent Agency

with respect to any new invention, patent and design without

any financial obligation on the part of the assessee. Even after

the expiry of the agreement, after the lapse of ten years, the

assessee was still permitted to use technical information,

improvements and patents, etc. free of charge for a period of ten

years. It was clear that residuary benefit was available to the

assessee for use of the technical know-how, patents, etc. free of

charge and therefore, the entire royalty paid was in the nature of

capital expenditure and the Tribunal could not have held that

only 25% of this amount is to be capitalized and 75% is to be

treated as revenue expenditure.

4. The learned counsel for the respondent, on the other hand,

supported the reasoning given in the order of the Tribunal and

referred to plethora of case law, on the basis of which he went to

the extent of submitting that even entire expenditure could have

been treated as revenue expenditure. Therefore, the order of the

Tribunal should not be interfered with and no question of law

arises.

5. We may point out that the Tribunal has referred to the various

clauses of Agreement and extracted the relevant portion

therefrom as well. On the basis of this agreement, the Tribunal

came to the conclusion that the assessee had obtained assistance

in pre-order phase as well as post-order phase from M/s.

Simelectro France. The consideration was fixed on the basis of

the contract value of the order received. The Tribunal also

specifically noted the features of the agreement as pointed out by

the learned counsel for the Revenue as well. After considering

the same, it opined that the facts of the case are same as in

Southern Swith Gear Ltd. (supra) and therefore, accorded the

same treatment as was done in the said case by Madras High

Court and approved by the Supreme Court.

6. Commissioner of Income Tax Vs. Southern Switch Gear

Ltd., 148 ITR 272 (Mad.), that is also a case where an exclusive

license to manufacture, use and sell during the continuance of

this agreement was granted to the assessee for all drawings,

specifications and other data were also furnished to the assessee,

which was to be the property of the assessee on the condition

that it agreed to hold such property of the assessee on the

continued fulfillment of all obligations contained in certain

clauses of the said agreement. Agreement was for a period of ten

years and right to use the technical know-how was provided for

another ten years after the expiry of the agreement period.

Clause 23 of the Agreement provided the arrangement after

termination of the agreement in the following words:

"23. Upon the termination of the agreement:

(a) any licences, permissions, authorities granted by BRUSH in favour of S S. in respect of any patent or similar rights shall determine and S.S. shall forthwith return to BRUSH all copies of drawings specifications, information and other data in the possession or under the control of S.S. and relating in whole or in part to the designs or inventions which are the subject of patent or similar rights owned or controlled by BRUSH in India.

(b) S.S. hereby agrees to continue to observe the obligations contained in clauses 6(e) and 6(d) and 25 of this agreement throughout the period of ten years commencing upon the termination of this agreement but in all other respect, S.S. shall have the right to use and to continue to use all information, methods, process and formulae acquired in pursuance of this agreement so far as the same shall not relate to patents or similar rights owned or controlled by BRUSH in India. Provided always that this right shall not apply in the event of this Agreement being terminated by BRUSH pursuant to either clause 22 or clause 24 hereof."

7. The clauses of agreement were thus almost similar. After taking

note of the aforesaid agreement, the Madras High Court found

that the benefit secured by the assessee was of an enduring

nature and therefore, the entire technical fee could not be

allowed as a revenue expenditure. Discussion on this aspect is in

the following terms:

"A perusal of the above clauses clearly indicates that the technical knowledge the assessee-company obtained through this agreement from the foreign company secured to the assessee an enduring advantage and benefit in that the same was available to the assessee for its manufacturing and industrial processes even after the termination of the agreement. The technical assistance contemplated in the agreement covers the establishment of the factory and the operation thereof for the

manufacture of transformers of all kinds and types. The foreign company also makes available to the assessee its procedures, designs, experience and technical know-how in respect of the same. Though the duration of the agreement is five years, the assessee even after the expiry of the period, could use the methods of production, procedure, experiments, improvements which had been made available to them in pursuance of the agreement. Thus, the assessee had acquired a knowledge of enduring nature. Further, apart from the technical know-how supplied by the foreign company and the grant of any of the scheduled products or to grant or make available to any other person, firm or company any manufacturing information, licences, rights for any one of the scheduled products in India, thus conferring an exclusive benefit on the assessee-company to manufacture and sell the scheduled products. The conferment of an exclusive benefit to manufacture and sell the articles which are the subject-matter of the agreement cannot be said to be a part of a mere know-how agreement. The right to make or manufacture certain goods exclusively in India should be taken to be an independent right secured by the assessee from the foreign company which is of an enduring nature. Therefore, the principle laid down by this Court in Transformer & Switchgear Ltd. v. CIT [1976] 103 ITR 352, Fenner Woodroffe & Co. Ltd. v. CIT [1976] 102 ITR 665 and M.R. Electronic Components Ltd. v. CIT [1982] 136 ITR 305, straightaway applies, and, therefore, the entire technical fees cannot be allowed as a revenue expenditure."

8. The Madras High Court thus held that the payment of royalty

against the said technical know-how received by the assessee had

the element of capital expenditure. Thereafter, it held that 25%

of the said royalty paid should be capitalized and 75% should be

treated as revenue expenditure, in the following manner:

"We have, therefore, to hold, following the above said decisions of this court that in this case, the Tribunal is right in holding that 25% of the technical fee has to be taken as a capital expenditure and as such cannot be allowed as a revenue expenditure.

Coming to the second issue as to whether the Tribunal is right in upholding the disallowance of 25% of the royalty

paid, the ITO, the appellate authority as well as the Tribunal have all concurrently held that the disallowance of 25% of the royalty is justified. Under the terms of the know-how agreement, the royalty is payable on all switchgear products and the parts thereof sold on behalf of the Indian company at the rate of 2 ½% of the invoice value of all low tension switchgear products at 5% in all the high tension switchgear parts and a royalty of 7% in all switchgear products exported. Thus, it is seen that the assessee paid a royalty for the acquisition of an exclusive privilege of manufacturing and selling the products. The acquisition of such a right has rightly been treated partly towards capital and partly towards the revenue. The Tribunal has chosen to estimate the value of that portion of the royalty which is relatable to acquisition of right of an enduring nature. In this view, the Tribunal is right in holding that 25% of the royalty is to be disallowed."

9. The Supreme Court in Southern Switch Gear Ltd. Vs.

Commissioner of Income Tax, 232 ITR 359 upheld the

aforesaid order. It is a short order dismissing the appeal, which

reads as under:

"We have perused the order of the High Court. We have also seen the agreement. We are not perused to hold that the view taken by the High Court is erroneous; the appeals are dismissed. There will be no order as to costs."

10. Significantly, the assessee had filed the appeal and not the

Department. Thus, the assessee wanted that entire 100%

expenditure be treated as revenue expenditure. Appeal was,

however dismissed and thus, it is clear that this plea of the

assessee was not accepted thereby implying that expenditure was

treated as capital expenditure. However, the revenue had not

gone into the appeal and therefore, whether 75% expenditure

was rightly treated by the High Court as revenue expenditure or

not, was not the matter, which arose for consideration before the

Supreme Court. From the judgment of the Madras High Court,

two things become apparent:

a) The benefit accrued in favour of the assessee was treated as

that of enduring nature and therefore, in the first instance

it was held that it is capital expenditure.

b) At the same time, this expenditure was apportioned

between capital and revenue expenditure. However, it is

not discernible from the judgment as what was the basis of

holding that 25% of the technical fee only is to be treated as

capital expenditure and 75% thereof was to be allowed as

the revenue expenditure. The High Court has stated that

the Tribunal was right in apportioning the expenditure in

the aforesaid manner, but what was the basis on which the

Tribunal has upheld is not spelt out in the judgment of the

Madras High Court. Significantly, the ITO, CIT (A) as

well as the Tribunal had taken this view that 25% of the

royalty be disallowed as revenue expenditure and this

concurrent finding of fact was accepted by the High Court.