Royalty and fee for technical assistance held revenue expenditure not capital as on termination of agreement all rights of the assessee stood extinguished.

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Royalty and fee for technical assistance held revenue expenditure not capital as on termination of agreement all rights of the assessee stood extinguished. The judgment was delivered by the Hon’ble Allahabad High Court in a batch of similar cases.

Royalty and fee for technical assistance held revenue expenditure

ABCAUS Case Law Citation:
ABCAUS 1160 (2017) (03) HC

Question for determination:
The leading Income Tax Appeal in the bunch was admitted on the following question of law: 

“Whether on the facts and circumstances of the case, the ITAT was legally justified in holding that the payment of royalty paid was an allowable business expenditure in the hands of the assessee company and cannot be held to be capital in nature.” 

Assessment Year : 2009-10

Important Case Laws Cited/relied upon:
CIT versus Kanpur Cigarettes (P) Ltd.
Jonas Woodhead & Sons India Ltd. vs CIT

Brief Facts of the Case:
The respondent assessee was a private limited company which had been granted a licence by its parent company for manufacture of automobile components and component parts as per specifications of the parent company.

As per Article 18 of the agreement between the assessee and the parent company, in the event of and upon expiration of the agreement in favour of the assessee, the later was obliged to discontinue the manufacture, sale and other disposition of the licenced products and it could not have thereafter made use of the know-how furnished by the parent company under the agreement. Further the assessee could not sell on its own any books, notings, drawings etc. 

However during the pendency of agreement licence, the assessee was obliged to pay certain amount to the parent company by way of royalty and fee for technical assistance.  The Assessing Officer was of the view that the said payments were in the nature of capital expenditure and he therefore disallowed the revenue expenditure claimed by the assessee. 

The CIT upheld the order of assessment. However, the tribunal in the appeal arising from the assessment year 2001-02 examined the issue elaborately and considered several provisions of the agreement between the parties and thereafter reached to the conclusion that the payment of royalty and fee for technical know-how were not capital in nature but only revenue expenditure, and therefore allowed the assessee’s appeal. 

Observations made by the High Court:
From a perusal of the order of the tribunal for assessment year 2001-02, the High Court observed that the tribunal had examined the nature of the agreement and the payments made by the assessee to the parent company and in paragraph 15 thereof, it has observed as under: 

“15. Having noticed so, we proceed to consider the different clauses of the agreement entered into by the assessee with M/s. Hongo Japan to resolve the controversy as to whether the expenses in question claimed by the assessee as deduction are on account of revenue or capital. In the case before us, the agreement between the assessee and Hongo Japan was to provide a licence and technical collaboration in the manner set out in the agreement with M/s.Hongo Japan so as to enable the assessee to manufacture and sell specified automobile components in the Republic of India. The licence products in the agreement defined to mean those components and parts for the use of the automobiles details of which were specified as agreed to in writing by the parties to the agreement for each model of automobiles which were specified in the exhibit-1 attested to the agreement. Component parts would mean any and all component parts of the licence products. Know-how for the purpose of the agreement would mean any and all those informations, inventions, design, expertise, experience and technical know-how regarding the manufacture of the licensed products which are owned or controlled by Hongo Japan and which include the specifications, blue prints details, photo copies, drawings and other drawings of such information, inventions, design, expertise, experience and technical know-how and also include sample prototype models and pattern of licensed products. In addition the assessee was also granted an exclusive and non-transferable licence to manufacture and sell the licensed products through the Republic of India by using the know-how and in strict compliance with such conditions and for such duration as set forth in the agreement. It was also provided therein that the assessee shall have no right to assign, transfer or sub-licence, in whole or in part, the licence or the know-how, nor engage anyone other than the assessee itself to undertake the production or manufacture of the licenced products, except with the prior written consent of Hongo Japan. However it was also provided that Hongo shall have no right to make use of and sell the licensed products, component parts and manufacturing equipment in the territory and to otherwise utilize the know-how in any manner in the Republic of India other than for the assessee, except in the cases where Hongo grants to any third party in the Republic of India the right to manufacture and sell the manufacturing equipment pursuant to sub-section (2) of Article 4 of the agreement. As per Article 13 of the agreement, this agreement was made effective for an initial period of 10 years and shall thereafter be automatically renewed for succeeding one year period subject to the prevailing laws in the Republic of India. However it was further provided that the agreement may be terminated by either party at the end of the initial period of 10 years or at the end of any subsequent renewed period by written notice to that effect given to the other party at least 3 months prior to the expiration of the initial period of 10 years or in subsequent renewed period. Nothwithstanding the period provided in the agreement, the agreement shall be terminated forthwith in the event of termination of the joint venture agreement entered into between Hongo and Pawha Builders Pvt. Ltd. Article 14 of the agreement gives either party a right to terminate the agreement at any time by a written notice to the other party in the case of happening of certain events mentioned in the Article 14 of the agreement. Article 18 provides for the effect of termination. In the event of the expiration of the agreement or any other termination of the agreement for any reason whatsoever, the assessee shall promptly discontinue (i) the manufacture, sell and other disposition of the licensed product and (ii) the use of the know how furnished by Hongo Japan under the said agreement. It has also been provided that the assessee company shall in its own return to Hongo Japan such books, notings, drawings, and writings and other documents, samples, models and other materials relating to the know-how as provided by Honga Japan to assessee company and all improvements and inventions made by the assessee company regarding the licensed products and Hongo Japan shall not be liable to the assessee company for, and the assessee company shall not be entitled to, any damages, reimbursements, or other payments for the reason of the expiration or other termination of the agreement or failure to renew or extend it, except in case where the agreement is terminated for any reason imputable to Hongo.” 

It was further noted that the tribunal applying  the ratio laid down by the Hon’ble Apex Court held that the benefit accruing to the assesee was under the licence agreement, not of enduring nature and that it was purely revenue in nature. In the present appeal, the tribunal has followed its earlier order passed in the case of the assessee for the assessment year 2001-02. 

The Hon’ble High Court opined that the expenditure incurred by the assessee towards royalty and fee for technical assistance in pursuance of the licence agreement entered between the assessee and the parent company were revenue expenditure and not capital in nature in view of the fact, upon termination of the licence agreement, all rights created in favour of the assessee under the licence agreement stood extinguished and no benefit was passed on to or retained with the assessee. 

The Hon’ble High Court referred to its earlier judgments in respect of a similar clause in the licence agreement wherein it held that nature of expenditure was revenue and not capital. It was noted that the facts of the existing case in material part was similar to the earlier case.

The Hon’ble High Court observed that nothing was on record suggesting that the finding recorded by the tribunal with respect to the nature of the payment under the licence agreement suffered from any mistake and error.

Held:
Held that expenditure incurred towards royalty and fee for technical assistance were revenue expenditure. The order of the ITAT was affirmed. 

Royalty and fee for technical assistance held revenue expenditure

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