Technical know-how: Entire law explained on whether expenditure incurred under a Technical Collaboration Agreement for setting up of new plant for the first time to manufacture cars constitutes capital or revenue expenditure
(a) 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. After getting necessary approval from the Government of India, a joint venture company in the name of the assessee was incorporated. 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’). 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. 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). 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.
(b) The dispute arose 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.
(c) 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. 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. On appeal by the assessee to the Supreme Court HELD dismissing the appeal:
(i) When we apply the aforesaid parameters to the facts of the present case, the conclusion drawn by the High Court that expenditure incurred was of capital nature, appears to be unblemished. 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.
(ii) No doubt, this technical know-how is for the limited period i.e. for the tenure of the agreement. However, 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.
(iii) 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.
(iv) 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.