2023 INSC 917 1

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO(S). 11128 OF 2016

C.I.T., DELHI ....APPELLANT(S)

VS.

BHARTI HEXACOM LTD. ...RESPONDENT(S)

WITH

CIVIL APPEAL NO(S). 4902/2022

CIVIL APPEAL NO(S). 162/2018

CIVIL APPEAL NO(S). 159/2021

CIVIL APPEAL NO(S). 4839/2017

CIVIL APPEAL NO(S). 153/2021

CIVIL APPEAL NO(S). 6897/2018

CIVIL APPEAL NO(S)._ _______of 2023

(@ SLP (C)_________OF 2023

(@DIARY NO(S). 4178/2019)

CIVIL APPEAL NO(S). ________of 2023

(@ SLP(C) NO. 24740/2019)

CIVIL APPEAL NO(S). ________of 2023

(@ SLP(C) NO. 20863/2019)

CIVIL APPEAL NO(S). 158/2021

CIVIL APPEAL NO(S). 302/2021

CIVIL APPEAL NO(S). 303/2021

2

CIVIL APPEAL NO(S). 11149/2016

CIVIL APPEAL NO(S). 11148/2016

CIVIL APPEAL NO(S). 11130/2016

CIVIL APPEAL NO(S). 11131/2016

CIVIL APPEAL NO(S). 11134/2016

CIVIL APPEAL NO(S). 11132/2016

CIVIL APPEAL NO(S). 11136/2016

CIVIL APPEAL NO(S). 11133/2016

CIVIL APPEAL NO(S). 11135/2016

CIVIL APPEAL NO(S). 11137/2016

CIVIL APPEAL NO(S). 11140/2016

CIVIL APPEAL NO(S). 11141/2016

CIVIL APPEAL NO(S). 11139/2016

CIVIL APPEAL NO(S). 11142/2016

CIVIL APPEAL NO(S). 11143/2016

CIVIL APPEAL NO(S). 11145/2016

CIVIL APPEAL NO(S). 11146/2016

CIVIL APPEAL NO(S). 11147/2016

CIVIL APPEAL NO(S). 163/2018

CIVIL APPEAL NO(S). 11129/2016

CIVIL APPEAL NO(S). ________OF 2023

(@ SLP (C)__________OF 2023

DIARY NO(S). 24728/2023)

3

J U D G M E N T

NAGARATHNA, J.

Delay condoned.

2. Leave granted.

3. The judgment of the Division Bench of the High Court of Delhi,

dated 19 December, 2013 in ITA No. 1336 of 2010 and connected

matters, whereby the High Court of Delhi, confirming the decision of the

Income Tax Appellate Tribunal, New Delhi (hereinafter, “Tribunal” for

short) has held that the variable licence fee paid by the respondents-

assessees under the New Telecom Policy, 1999 ((hereinafter referred to

as “Policy of 1999” for the sake of convenience), is revenue expenditure

in nature and is to be deducted under Section 37 of the Income Tax Act,

1961 (hereinafter referred to as “the Act” for the sake of brevity) is

assailed in these appeals. Some of these appeals also arise from

judgments passed by the High Courts of Bombay and Karnataka,

following the judgment of the Division Bench of the High Court of Delhi,

dated 19 December, 2013.

4. Since common questions of law and facts arise in these appeals,

they have been clubbed together and heard and disposed of by this

common judgment.

4

Bird’s eye view of the controversy:

5. The controversy in these cases revolves around the question, as

to, whether, the variable licence fee paid by the respondent-assessees

to the Department of Telecommunications (hereinafter referred to as

“DoT”, for short) under the New Telecom Policy of 1999 (Policy of 1999)

is revenue expenditure in nature and is to be allowed deduction under

Section 37 of the Act, or, whether the same is capital in nature, Section

35ABB of the Act.

Brief facts of the case:

6. The National Telecom Policy of 1994 was substituted by the New

Telecom Policy of 1999 dated 22

July, 1999. The said Policy of 1999

stipulated that the licencee would be required to pay a one-time entry

fee and additionally, a licence fee on a percentage share of gross

revenue. The entry fee chargeable would be the fee payable by the

existing operator upto 31 July, 1999, calculated upto the said date and

adjusted upon notional extension of the effective date. Subsequently,

w.e.f. 01

August, 1999, licence fee was payable on a percentage of

Annual Gross Revenue (“AGR” , for short) earned. The quantum of

revenue share to be charged as licence fee was to be finally decided after

obtaining recommendation of the Telecom Regulatory Authority of India

(“TRAI”) but in the meanwhile, the Government of India fixed 15% of the

gross revenue of the licencee as provisional licence fee. On receipt of

5

TRAI’s recommendation by the Government, adjustment of the dues

was to be made.

6.1. Clause 7 of the Policy of 1999 stipulated that upon migration

thereto, the licencees would forego the right of operating in a regime of

limited number of operators as per the existing licensing agreement and

would operate in a multiple licence regime, that is, additional licences

without any limit could be issued in a given service area. The period of

licence was stated to be twenty years from the effective date of the

existing licence agreement, that is, the 1994 Agreement. Migration to

the Policy of 1999 was on the condition and premise that the conditions

should be accepted as a package in entirety and simultaneously and all

legal proceedings shall be withdrawn and no dispute relating to the

period upto 31 July, 1999 shall be raised at any future date. If all the

terms were accepted, amendments to the existing licence agreement

would be signed. The respondents herein migrated to the Policy of 1999.

They had paid licence fee upto 31 July, 1999. The respondents treated

the licence fee paid upto to 31 July, 1999 that is, the one-time licence

fee as stipulated in the letter/communications dated 22 July, 1999, as

capital expenditure.

6.2. The respondent companies which are engaged in the business of

telecommunication services have procured licences in different telecom

circles. Initially, the said licences were given under a licence agreement

executed in the year 1994 for a period of ten years subject to expansion

6

of one year or more at the discretion of the authorities. The said licence

was non-transferable and non-assignable. In case, there was a breach

of any term of the licence or default in payment, the licence could be

revoked after providing sixty days’ notice. The licence gave the right to

operate the services within a geographical area on a non-exclusive basis

and the authorities would have the right to modify the conditions of the

licence as explained in Schedule A and Schedule B of the licence

agreement, in the interest of general public or for security

considerations. The schedules pertained to the area of service, tariff

ceiling etc.

6.3. In the above backdrop, for the sake of convenience, the specific

facts of the lead matter, Civil Appeal No. 11128 of 2016 shall be narrated

hereinunder:

Pursuant to the request of the respondent-assessee, a licence was

granted to it, inter-alia on certain terms and conditions to establish,

maintain and operate cellular mobile services. Accordingly, having

accepted the Policy of 1999 and migrated thereto, after paying the

licence fee upto 31 July, 1999, i.e., the one-time licence fee as stipulated

in the Communication dated 22 July, 1999, the respondent-assesee

continued in the business of cellular telecommunication and associated

value added services, under the regime governed by the Policy of 1999.

6.4. The respondent-assessee filed its return of income on 01

November, 2004 for the assessment year 2003 -2004 declaring nil

7

income. The same was processed under Section 143(1) of the Act on 30

March, 2006. The case was selected for scrutiny and a notice was issued

to the respondent-assessee under Section 143(2) of the Act, on 20

October, 2005.

6.5. It was noted that an amount of Rs. 11,88,81,000/-, which was the

licence fee paid by the assessee on revenue sharing basis, was claimed

by the respondent-assessee as revenue expenditure. In that regard, vide

questionnaire dated 15 November, 2006, the assessee was required to

explain as to why the said amount may, instead, be treated as capital

expenditure and amortised over the remaining licence period of twelve

years. The respondent-assessee furnished its response to the

questionnaire, on 04 December, 2006. On consideration of the

assessee’s response, an Assessment Order was passed on 27 December,

2006 observing that the amount of Rs. 11,88,81,000/-, i.e. the licence

fee paid by the assessee on revenue sharing basis, which was claimed

as a revenue expense, ought to have instead been amortised over the

remainder of the licence period, i.e., twelve years. Accordingly, an

amount of Rs. 99,06,750/- was allowed as a deduction under Section

35ABB of the Act and the remaining amount of Rs. 10,89,74,250/- was

disallowed and added back to the income of the respondent-assessee.

6.6. Being aggrieved, the respondent-assessee filed an appeal before

the Commissioner of Income Tax (Appeal), New Delhi. In view of the

decision of the Commissioner of Income Tax (Appeal) in the assessee’s

8

own case for the assessment year 2003-2004, it was reaffirmed vide

order dated 27 September, 2007 that the annual licence fee calculated

on the basis of annual gross revenue of the assessee would be revenue

expenditure deductible under Section 37 of the Act.

6.7. Aggrieved by the said order, the appellant-Revenue preferred an

appeal before the Tribunal, New Delhi. By order dated 24 July, 2009,

the Tribunal dismissed the Revenue’s appeal following its earlier order

dated 29 May, 2009 in ITA No. 5335 (Del)/2003 in the case of Bharti

Cellular Ltd., for the assessment year 2000-2001, the facts of which

case were held to be identical to the facts of the case at hand. Being

aggrieved, the Revenue filed an appeal before the High Court of Delhi.

6.8. Before the High Court, the Revenue made the following

submissions:

That the respondents were granted a licence under the agreement

executed under the Indian Telegraph Act, 1885 (hereinafter referred to

as the “Telegraph Act” for the sake of brevity). This agreement stated

that the licence was granted on certain terms and conditions to

establish, maintain and operate cellular mobile services. That the

significance of the words "establish, maintain and operate" in the

original licence cannot be lost sight of under the Telecom Policy of 1999.

The nature and character of the licence fee was not changed. What was

changed was only the method of computation. That the assessees had

accepted the licence fee payable under the 1994 Agreement as a capital

9

expenditure. They cannot now dispute the same under the Policy of

1999. That under the Policy of 1994, from the fourth year onwards, the

assessee had to pay a fixed sum per hundred subscribers. The only

change that was made was in the measure, namely, that under the

Policy of 1999, the amount was modified to 15% of the gross revenue,

but the nature and character of the payment was the same. That mere

payment of an amount in instalments did not convert or change the

capital payment to a revenue payment. That in order to acquire the right

to operate telecom services, obtaining of licence was a sine qua non. The

term of the licence was twenty years from the date of commencement

and therefore the expenditure is in the nature of capital expenditure.

6.9. Per contra, the contention of the assessee before the High Court

was that the licence fee payable under the Policy of 1999 was in the

nature of revenue expenditure. This was because the earnings are

shared and the licence fee depends upon the gross revenue and is

payable yearly. That the new operators under the Policy of 1999 were

issued licences and were required to pay a one-time licence fee for entry

and to start operations and in addition, yearly turn over based licence

fee was payable. One-time payment of licence fee was capital

expenditure in nature but yearly payable licence fee was revenue

expenditure. It was a running expense for maintaining and operating

the business of telecommunication and therefore, considered in the

10

commercial sense, the yearly payment was in the nature of revenue

expenditure.

6.10. Since the Tribunal had held that variable licence fee paid by the

assessees was properly deductible as revenue expenditure, the

substantial question of law raised by the High Court at the instance of

appellant Revenue was, “whether the variable licence fee paid by

the respondents under the Telegraph Act, and Indian Wireless

Telegraphy Act, 1933 payable under the New Telecom Policy 1999

or 1994 Agreement, is revenue expenditure or capital expenditure

which is required to be amortized under Section 35ABB of the

Act?”

The pertinent observations of the High Court and the salient

aspects discussed in the judgment dated 19 December, 2013 are as

under:

i. Section 35ABB applies when expenditure of a capital nature is

incurred by an assessee for acquiring a right for operating

telecommunication services. It is immaterial whether the

expenditure is/was incurred before or after commencement of the

business to operate telecommunication services but what is

material is that the payment should be actually made. That Section

35ABB is not a deeming provision but comes into operation and is

effective when the expenditure itself is of a capital nature and is

incurred towards acquiring a right to operate telecommunication

11

services or for the purposes of obtaining a licence for the said

services. That Section 35ABB does not help in determining and

deciding the question, as to, whether licence fee paid under the

Policy of 1999 or under the 1994 Agreement, was/is capital or

revenue in nature.

ii. That there was no decision of the Supreme Court or any of the High

Courts directly applicable to the factual matrix of the case and

therefore, it would be useful to consider a number of decisions of

this Court including, Empire Jute Co. Ltd. vs. Commissioner of

Income Tax, (1980) 124 ITR 1 (“Empire Jute Co. Ltd.”); Assam

Bengal Cement Co. Ltd. vs. CIT, West Bengal, (1955) 27 ITR 34

(“Assam Bengal Cement Co. Ltd. ”); Board of Agricultural

Income Tax, Assam vs. Sindhurani Chaudurani , (1957) 32 ITR

169 (“Sindhurani”); Enterprising Enterprises vs . Deputy

Commissioner of Income Tax , (2007) 293 ITR 437

(“Enterprising Enterprises”).

iii. Having referred to the aforesaid decisions, three other judgments

were noticed by the Delhi High Court which, according to learned

ASG appearing for the appellant-Revenue were wrongly applied to

the case at hand. The said judgments are, Jonas Woodhead and

Sons Ltd. vs. Commissioner of Income Tax, (1997) 224 ITR 342

(“Jonas Woodhead and Sons ”), Southern Switch Gear Ltd. vs.

CIT, (1998) 232 ITR 359 (“Southern Switch Gear Ltd. ”); CIT,

12

Madras vs. Best and Co. (Pvt.) Ltd., (1966) 60 ITR 11 (“Best and

Co.”).

iv. After considering all of the aforesaid judgments, the Delhi High

Court in paragraph 29 discerned the facts of the present case as

under:

“29. When we turn to the facts of the present

case, the following position emerges:

i. The licence was issued under a statutory

mandate and was required and acquired,

before the commencement of operations or

business, to establish and also to maintain and

operate cellular telephone services.

ii. The licence was for initial setting up but,

thereafter for maintaining and operating

cellular telephone services during the term of

the licence.

iii. Contrary to what was stated, under the licence

agreement executed in 1994 the considerations

paid and payable were with the understanding

that there would be only two players who would

have unfettered right to operate and provide

cellular telephone service in the circle. The

payment, therefore, had element of warding off

competition or protecting the business from

third party competition.

iv. Under the 1994 agreement, the licence was

initially for 10 years extendable by one year or

more at the discretion of the

Government/authority.

v. 1994 Licence was not assignable or

transferable to a third party or by way of a sub-

licence or in partnership. There was no

stipulation regarding transfer or issue of

shares to third parties in the company.

13

vi. Under the 1994 agreement, the licencee was

liable to pay fixed licence fee for first 3 years.

For 4

th year and onwards, the licencee was

liable to pay variable licence fee @ Rs.

5,00,000/- per 100 subscribers or part thereof,

with a specific stipulation on minimum licence

fee payable for 4

th to 6

th year and with modified

but similar stipulations from 7

th year onwards.

vii. The licence could be revoked at any time on

breach of the terms and conditions or in default

of payment of consideration by giving 60 days'

notice.

viii. The authority also reserved the right to revoke

the licence in the interest of public by giving 60

days' notice.

ix. Under 1999 policy, the licencee had to forego

the right of operating in the regime of limited

number of operators and agreed to multiparty

regime competition where additional licences

could be issued without limit.

x. There was lock in period on the present

shareholding for a period of 5 years from the

date of licence agreement i.e. the effective date

and even transfer of shareholding directly or

indirectly through subsidiary or holding

company, was not permitted during this

period. This had the effect of ‘modifying’ or

clarifying the 1994 agreement, which was

silent.

xi. Licence fee calculated as a percentage of gross

revenue was payable w.e.f. 1 August, 1999.

This was provisionally fixed at 15% of the gross

revenue of the licensee but was subject to final

decision of the Government about the quantum

of revenue share to be charged as licence fee

after obtaining recommendation of the Telecom

Regulatory Authority of India (TRAI).

xii. At least 35% of the outstanding dues including

interest payable as on 31 July, 1999 and

liquidated damages in full, had to be paid on or

14

before 15 August, 1999. Dates for payments of

arrears were specified.

xiii. Past dues upto 31 July, 1999 along with

liquidated damages had to be paid as

stipulated in the 1999 policy, on or before 31

January, 2000 or earlier date as stated.

xiv. The period of licences under 1999 policy was

extended to 20 years starting from the effective

date.

xv. Failure to pay the licence fee on yearly basis

would result in cancellation of licences.

Therefore, to this extent licence fee was/is

payable for operating and continuing

operations as cellular telephone operator.”

v. On a consideration of the aforesaid aspects, the Delhi High Court

held that the payment of licence fee was capital in part and revenue

in part and that it would not be correct to hold that the whole fee

was capital or revenue in nature in its entirety. It was further

observed that the licencees/assessees in question required a

licence in order to start or commence business as cellular telephone

operators; that payment of a licence fee was a precondition for the

assessees to commence or set up the business. That it was a

privilege granted to the assessee subject to payment and

compliance with the terms and conditions. For immediate

reference, paragraph Nos.31 to 36 of the said judgment are

extracted as under:

“31. Licence fee under the 1994 agreement ensured

that there would be only two private operators in a

circle and thus their limited monopoly would be

protected and competition by way of third-party private

15

players was warded off. Restricted monopoly of the

licencees was ensured. The licence fee fixed included

an element towards the said right of the licencees. 1994

agreement, for first three years postulated a lump-sum

payment irrespective of number of subscribers.

Minimum fee was also prescribed for later years. It

appears that licencees were unable to make payments

as per the 1994 agreement and under the 1999 policy,

were required to pay lump-sum payment for past

arrears before specified dates.

32. There was restriction under the 1994

agreement, on transfer of the licence or even grant sub-

licence but there was no specific restriction on change

of shareholding. 1999 policy ensured that even

shareholding did not change for a period of 5 years from

the effective date. The effect of acquiring the licence has

been examined in paragraph 15 above. The licence was

not assignable or transferrable as such, but induction

of share capital, transfer of shares etc. was permitted

subject to conditions in the 1999 policy. In commercial

sense the licence constituted and continues to be the

most valuable right which the company has and

possesses. Thus, the payment made is for acquiring the

licence which is essential and mandatory, prerequisite

for establishing the business and for operations or

continuance and running of business. Yet, as observed

below, it cannot be equated with one time entry fee

which a person has to pay to establish the business. It

therefore, represents composite payment, both capital

and revenue.

33. The licence fee was imposed and payable under

the Indian Telegraph Act and other statutory provisions

and was/is mandatory. Failure to pay the same

would/will result in discontinuance or stoppage of

business operations. Under 1999 policy, the amount

payable speaks of sharing of gross revenue earned by

the service provider from the customers. 1994

agreement as noticed did have a provision for sharing

but with minimum payment stipulation. In case of non-

payment of licence fee, the licence could be revoked and

licencee was not permitted to carry on and continue

cellular telephone service. Thus, the licence fee payable

was/is equally with the objective and purpose to

16

maintain and operate cellular telephone services. It

was also an operating expense and non payme nt can

lead to cancellation as one of the consequences.

Endurement requires current expenses and is subject

to payment on revenue share. It will not be correct to

hold or propound that entire payment during the term

of licence, is deferred capital payment. This was/is not

the intent under the 1994 agreement or 1999 policy.

The intent is to also share the gross earning to

maintain and operate the licence.

34. The licence fee as such is similar to both

prospecting fee, acquisition of right to lease as well as

leases which enabled removal of sand/tendu leaves,

etc. as nothing has to be won over, or extracted. Part

payment was towards an initial investment which an

assessee had to make to establish the business. It was

a precondition to setting up of business. It has element

and includes payment made to acquire the ‘asset’ i.e.

the right to establish cellular telephone service. But the

licence permits and allows the assessee to maintain,

operate and continue business activities. Payment of

licence fee has certain ingredients and is like lease rent

which is payable from time to time to be able to use the

licence.

35. The licence acquired was initially for 10 years

and the term was extended under the 1999 policy to 20

years but this itself does not justify treating the licence

fee paid on revenue sharing basis under the 1999

policy as a capital expense made to acquire an asset.

As observed in Empire Jute Co. Ltd. (supra), the

enduring benefit test has limitation and cannot be

mechanically applied without considerin g the

commercial or business aspects. Practical and

pragmatic view and considerations rather than juristic

classification is the determinative factor. The payment

of yearly licence fee on revenue sharing basis is for

carrying on business as cellular telephone operator. It

is a normal business expense.

36. Read in this manner, the licence granted by the

Government/authority to the assessee would be a

17

capital asset, yet at the same time, the assessee has to

make payment on yearly basis on the gross revenue to

continue, to be able to operate and run the business, it

would also be revenue in nature. Failure to make

stipulated revenue sharing payment on yearly basis

would result in forfeiting the right to operate and in

turn deny the assessee, right to do business with the

aid of the capital asset. Non-payment will prevent and

bar an assessee from providing services.”

vi. In paragraph 36, it was observed that the licence granted by the

Government or the concerned authority to the assessee would be a

capital asset and yet, since the assessee had to make the payment

on a yearly basis on the gross revenue to continue to be able to

operate and run the business, it would also be in the nature of

revenue expenditure. Having opined thus, the High Court decided

to apportion the licence fee as partly revenue and partly capital and

divided the licence fee into two periods, that is, before and after

31 July, 1999 and observed that the licence fee that had been paid

or was payable for the period upto 31 July, 1999 i.e. the date set

out in the Policy of 1999, should be treated as capital expenditure

and the balance amount payable on or after the said date should

be treated as revenue expenditure. The reasons for the same were

stipulated in paragraphs 43 to 46 of the said judgment which reads

as under:

“43. Licence fee was payable for establishment,

maintenance and operation of cellular telephone service.

Establishment and set up took place in the initial years

and thereafter the payments made were/are for operation

or maintaining the cellular telephone service. Initial

18

outlay and payment, therefore, is capital in nature,

whereas the outlays and payments made subsequently

are to operate and maintain the service. 1999 policy in

the form of letter dated 22 July, 1999 also refers to one

time entry fee which is chargeable and had to be

calculated as licence fee dues payable upto 31 July, 1999

and licence fee was thereafter payable on percentage

share of gross revenue. The new licences issued to others

also stipulated one time entry fee and then licence fee

payment on sharing basis. In view of the new 1999 policy,

the earlier policy which restricted competition,

underwent a change and licencees forgo their right to

operate in the regime of limited number of operators.

Another reason why we feel that licence fee payable for

the period on or before 31 July, 1999 should be treated

as capital and the amount payable thereafter as revenue,

is justified and appropriate in view of Section 35ABB. We

have already quoted the said section above. The provision

provides that licence fee of capital nature shall be

amortized by dividing the amount by number of

remainder years of licences. Thus, the capitalized amount

of licence fee is to be apportioned as a deduction in the

unexpired period of the licence. The provision will have

ballooning effect with amortized amount substantially

increasing in the later years and in the last year the entire

licence fee alongwith the brought forward amortized

amount would be allowed as deduction. After a particular

point of time, deduction allowable under Section 35ABB

would be more than the actual payment by the assessee

as licence fee for the said year. This would normally

happen after the mid-term of the licence period. Section

35ABB, therefore, ensures that the capital payment is

duly allowed as a deduction over the term and once the

expenditure is allowed, it would be revenue or tax neutral

provided the tax rates remain the same during this

period.

44. ITA Nos. at serial Nos. 1 to 9 above primarily

relate to variable licence fee, which is to be shared under

the 1999 Policy whereas, ITA No. 417/2013 filed against

Hutchison Essar Ltd. relates to the period of variable

licence fee payable for the fourth year under the 1994

Agreement.

45. The effect thereof is that we are treating about

20% of the expenditure in terms of the tenure as per the

1999 Policy as capital in nature, whereas if we apply the

19

1994 Agreement, we would be treating about 40% of the

expenditure as per the tenure as payable towards

establishing or setting up of cellular business. By the

time 1999 Policy was implemented in the case of the

respondents-assessees, the cellular telephone business

had already commenced and was in operation. The 1999

Policy had the effect of extending period of licence from

10 years to 20 years, but from the effective date. The view,

we have taken, effectively means that the entire licence

fee paid in the initial first four years is treated as capital

in nature i.e. the expenditure incurred to establish

cellular telephone business, whereas the balance

expenditure payable on year to year basis from 5 year

onwards is treated as revenue expenditure to run and

operate cellular telephone business.

46. However, we would like to discuss two judgments

relied upon by Huthison Essar Pvt. Ltd. in support of

their contention that the variable fee even prior to 31

July, 1999 should be treated as revenue expenditure. As

noted above, this was the 4 year and the contention of the

assessee is that in this year even as per the 1994

agreement, payment had to be made on revenue sharing

basis subject to the minimum guarantee. Learned

counsel for the assessee had relied upon CIT v. Sharda

Motors Industry Ltd. (supra). In the said case reference

was made to J.K. Synthetics Ltd. (supra) to hold that no

substantial question of law arises. The Revenue had

relied upon Southern Switch Gear Ltd. v. CIT (1998) 232

ITR 359 (SC), but the said judgment was distinguished on

the ground that lump-sum royalty was paid and 25%

thereof was disallowed by the tribunal on the ground that

it was capital payment. In Sharda Motor Industries Ltd.

(supra), royalty was to be paid on quantity of goods

produced calculated per piece. However, this does not

appear to be sole basis why the payment made was

treated as revenue expenditure. The court had relied

upon other facts which are noticed in paragraph 3 of the

same judgment i.e. the payment was made for running

business. The question of apportionment and payment

was not made to establish business. In CIT v. Modi Revlon

(P.) Ltd. (2012) 26 Taxmann.com 133 (Delhi), a Division

Bench of this High Court observed that the tests evolved

20

over the period have disapproved the applicability of the

‘once and for all’ payment and more structured approach

which would take into account several factors like the

licence tenure; whether licence created further rights;

whether there was restriction for use of confidential

information; whether benefits were transferred once and

for all; whether after expiry of the licence, plans and

drawings were to be returned, etc. As held and observed

above, it is nature and object for which the payment is

made which determines the character of payment. In the

said case, it was observed that there was nothing to show

or to suggest vesting of knowhow in the assessee and

therefore, the assessee did not derive any enduring

benefit. Thus, the royalty payment was held to be revenue

in nature.”

In view of the above discussion, the substantial question was

answered by the High Court in the following manner:

“47. In view of the aforesaid findings, the substantial

question mentioned above in item Nos. 1 to 9 is

answered in the following manner:

(i) The expenditure incurred towards licence fee is

partly revenue and partly capital. Licence fee

payable upto 31 July, 1999 should be treated

as capital expenditure and licence fee on

revenue sharing basis after 1 August, 1999

should be treated as revenue expenditure.

(ii) Capital expenditure will qualify for deduction as

per Section 35ABB of the Act.

48. The appeal ITA No. 417/2013 by the

Revenue in the case of Hutchison Essar Pvt. Ltd.,

pertains to the assessment year 1999-2000 i.e. year

ending 31 March, 1999. It is for the period prior to

the period 31 July, 1999. As per the discussion

above, the licence fee payable on or before 31 July,

1999 should be treated as capital expenditure and

the licence fee payable thereafter should be treated

as revenue expenditure. In view of the aforesaid

21

position, the question of law admitted for hearing in

this appeal as recorded in the order dated 21

August, 2013, has to be answered in favour of the

revenue and against the respondent assessee.”

6.11. Aggrieved by the aforesaid reasoning and conclusions arrived at

by the High Court of Delhi in its judgment dated 19 December, 2013,

which has been followed by High Courts of Delhi, Bombay and

Karnataka, the appellant-Revenue has preferred these appeals.

Submissions:

7. We have heard the learned Additional Solicitor General of India

(ASG), Sri N. Venkataraman for the Revenue and learned senior counsel

Sri Ajay Vohra, Sri Arvind Datar and learned counsel Sri Sachit Jolly,

for the respondent-assessees and perused the material placed on

record.

Submissions on behalf of the appellant-Revenue:

7.1. Learned ASG, at the outset, submitted that the judgment of the

High Court of Delhi dated 19 December, 2013 is incorrect inasmuch as

it has sought to dissect the payment of licence fee to hold that the entry

fee paid in the initial four years ought to be treated as capital

expenditure and amortised accordingly, while the fee payable on an

annual basis from the fifth year onwards, as a percentage of the gross

revenue of the assessees was treated as revenue/business expenditure.

It was further contended as follows:

22

i. That the schedule of payment cannot recharacterize the

transaction under income tax law, particularly when this Court had

laid down from time to time that the schedule of payment, whether

lump-sum or periodical, is immaterial in determining its

classification under income tax law. The payment(s) towards the

same purpose, i.e., payment of licence fee, cannot be characterised

partly as capital and partly as revenue in nature by artificially

defining one part as an entry fee and the remainder, payable

annually, when both types of payment was towards licence fees.

ii. That when the respondent-assessees have duly amortised the

licence fee paid annually as capital expenditure, under the 1994

licence regime as well as the entry fee under the Policy of 1999

regime, there was no basis to reclassify the same as revenue

expenditure insofar as variable licence fee is concerned for the

subsequent years. Variable payments made annually, based on the

annual gross revenue in the relevant year were also towards licence

fee. Therefore, there could not have been a shift in the tax treatment

thereof upon migration to a new regime , wherein merely the

payment schedule was revised while preserving the character of the

payment.

iii. That payments made, either of entry fee or of annual licence fee, is

in essence only towards securing a licence to establish, maintain

or operate a telegraph i.e. system. If either of the aforesaid

payments is not made, or short paid, the licence would be revoked

23

under Section 8 of the Telegraph Act. Further, Section 4 of the said

Act authorises the Government to grant licence against a

consideration. Therefore, both entry fee as well as annual licence

fee are included within the ambit of ‘consideration’ chargeable

under Section 4. Hence, any submission that licence fee should be

split into two components, namely, entry fee for acquiring the

licence and variable licence fee for operating the licence, has no

legal basis. Such a fragmentation is neither statutorily permissible,

nor prescribed in the licence agreement.

iv. Referring to Section 35ABB of the Act, which allows amortisation

of expenditure incurred for obtaining a licence to operate

telecommunication services, it was contended that the said

provision applies in relation to payments made for “acquiring any

right to operate telecommunication services” whether such

payment was made “before the commencement of the business to

operate or thereafter at any time during the previous year.” In view

of the aforesaid expression, the mode and manner of payment

becomes irrelevant. As long as the payment is towards licence fee,

the expenditure so incurred will be “in the nature of capita l

expenditure” as envisaged under Section 35ABB of the Act.

v. That the expression “either before the commencement of the

business to operate or thereafter” is also found in Section 35ABA

of the Act which pertains to the right to use Spectrum, similar to

Section 35ABB which relates to licence to operate

24

telecommunication services. The legislative intent is therefore clear

that both these rights would flow from the Central Government on

payment, and further, the payment would be partly lump-sum and

partly in a deferred manner, considering the nature of rights

acquired.

vi. Reliance was placed on the decision of a Constitution-Bench of this

Court in Aditya Minerals Pvt. Ltd. vs. Commissioner of Income

Tax, (1999) 8 SCC 97 (“Aditya Minerals Pvt. Ltd.”) to assert that

the law laid down therein is that as long as payment is towards a

capital expenditure, it is immaterial whether it is paid in lump-sum

or as periodical payments, or, as a combination of both. That the

mode of payment will not be determinative in identifying the nature

of the expenditure, i.e., as to whether it is capital or not.

vii. That the decision of this Court in Assam Bengal Cement Co. Ltd.

has clarified that the aim and object of the expenditure would

determine the character thereof, while the source and manner of

payment would have no consequence.

viii. Referring to the cases of Jonas Woodhead and Sons, Southern

Switch Gear Ltd. and Best and Co., which have been referred to

by the High Court of Delhi in the impugned judgement, it was

submitted that reliance on the said cases is misplaced inasmuch

as the said cases did not deal with a single source/purpose towards

which payments in different forms had been made. On the contrary,

in the said cases, the purpose of payments was traceable to

25

different subject matters and accordingly, this Court held that the

payments could be apportioned. However, in the present case, the

licence issued under Section 4 of the Telegraph Act is a single

licence to establish, maintain and operate telecommunication

services. Since it is not a licence for divisible rights which conceives

of divisible payments, apportionment of the licence fee by holding

that the entry fee paid is towards establishment and therefore,

capital, while the licence fee paid as a percentage of gross revenue

is towards operation and maintenance and therefore, Revenue, is

without legal basis.

ix. Reliance was placed on the decision of this Court in CIT vs. Jalan

Trading Co. Pvt. Ltd., (1985) 4 SCC 59 (“Jalan Trading Co.”) to

submit that in the said case this Court had an occasion to consider

an annual payment in the form of profit sharing towards the right

to carry on business. That in the said case, this Court concluded

that the annual payment of 75% profit share would still be a

payment that was capital in nature, as the same was paid as

consideration under a deed of assignment for the right to carry on

business. That this judgement will squarely apply to the facts of the

present case since the annual payment based on AGR is only

towards licence fees and merely because it is paid on the annual

gross revenue, the payment cannot be construed as a rev enue

expenditure.

26

With the aforesaid submissions, it was prayed that these

appeals filed by the Revenue be allowed and the impugned

judgments of the High Courts of Delhi, Bombay and Karnataka,

following the judgment of the Division Bench of the High Court of

Delhi dated 19 December, 2013, be set aside and it be declared that

the annual payment is in the nature of a capital expenditure.

7.2. Per contra, learned senior counsel, Sri Ajay Vohra, appearing on

behalf of the respondent-assessees in Civil Appeal No. 11130 of 2016,

supported the judgment of the Division Bench of the High Court of Delhi

dated 19 December, 2013 and submitted that the said judgment was

passed based on a correct appreciation of the facts of the case and the

law and therefore, the same would not call for any interference by this

Court. It was further submitted as follows:

i. That on a bare reading of the said provision and the mode of

amortisation of expenses, it is patently clear that the same would

be applicable only if the following cumulative conditions are

satisfied:

a) the expenditure is capital in nature;

b) the expenditure is incurred by an assessee on acquisition of

the right to operate telecom services;

c) the expenditure represents payment actually made to obtain a

licence.

27

Thus, for attracting the provisions of Section 35ABB, it is

necessary that the expenditure under consideration must be

capital in nature and is incurred for acquiring or obtaining a

licence, which gives the right to the assessee to operate telecom

services.

ii. That in the present case, the respondent-assessees had obtained

the licence in the year 1994 and had thereafter set up the

telecommunication infrastructure and started operating

telecommunication services. The payment of licence fee under the

fixed regime, i.e., prior to migration to the Policy of 1999 was for

obtaining the licence, thereby resulting in the acquisition of the

right to operate telecommunication services. Therefore, the fixed

licence fee upto 31 July, 1999 was amortised and allowed in terms

of Section 35ABB of the Act. On the other hand, the variable licence

fee payable w.e.f. 01 August, 1999, is a percentage of the AGR. The

same is not in the nature of capital expenditure as it is not incurred

with a view to acquire the right to operate telecommunication

services. The said services were already being operated by the

respondents by virtue of a licence which had been obtained in the

year 1994. The variable licence fee was, thus, for continuing the

right to operate telecommunication services, which were already

being operated and provided by the respondent-assessees.

iii. Referring to the salient features of the Policy of 1999, it was

submitted that the said policy made a paradigm shift by making

28

qualitative changes in licence conditions. It facilitated the entry of

new players on payment of one-time entry fee and variable revenue

share. The policy document hi ghlights and emphasises the

distinction between a one-time fee which is the payment for

obtaining the licence, on the one hand and the variable licence fee,

which is payment made on a recurring basis based on revenue

share, for continuing the right to operate telecommunication

services. Therefore, the one-time entry fee to be paid by a new

entrant obtaining a licence post 31 July 1999 is required to be

amortised under section 30ABB of the Act while the variable licence

fee payable as a revenue share would b e admissible business

expenditure or revenue deduction.

iv. That the Policy of 1999 has not only changed the mechanism of

payment but also modified the rights accruing under the licence

already obtained vide the original agreement dated 29 November

1994, in lieu of the payment of variable licence fee. The tenure of

the licence was increased from ten to twenty years; the licence fee

was bifurcated into two parts, i.e., fixed entry fee paid for obtaining

the licence and variable annual licence fee paid for continuing with

the licence. Thereby the whole complexion of the consideration

provided under the original agreement, was changed. That, since

the restriction of the number of players or operators in each region

was completely lifted, coupled with the fact that variable licence fee

was to be paid on an annual basis, in order to continue with the

29

right to operate telecommunication services, no enduring benefit

was accruing to the respondent-assessees. Neither was there any

monopoly right, nor would the licence remain valid and subsist for

an indefinite period of time. The licence would be valid only so long

as the annual payment of variable licence fee was made.

v. That the provisions of Section 35ABB of the Act were introduced in

the year 1996. At that time, the concept of variable licence fee did

not exist. Application of the said provision to variable licence fee

would give rise to absurd results, not intended by the Legislature.

vi. That payment of variable licence fee from 01 August, 1999 is not

for “acquiring any right to operate telecommunication services”,

which right vested in and was being exploited by the assessees

pursuant to obtaining the licence in 1994 and setting up the

requisite infrastructure.

vii. Further, variable licence fee paid from 01 August, 1999 could not

be regarded as payment made “to obtain a licence”, so as to fall

within the ambit of Section 35ABB of the Act.

That Section 35ABB of the Act would not be attracted in the

present case to require amortisation of the variable licence fee,

because:

a) payment of variable licence fee is not in the nature of capital

expenditure;

b) such payment is not incurred for “acquiring any right to

operate telecommunication services”;

c) such payment has not been made “to obtain a licence”.

30

With the aforesaid submissions, it was prayed that the High

Courts’ decision as to the inapplicability of Section 35ABB of the

Act, to the facts of the present case, be upheld, and these appeals

be dismissed as being devoid of merit.

7.3. Learned senior counsel, Sri Arvind P. Datar, appearing on behalf

of some of the respondent-assessees in Civil Appeal Nos. 11131 of 2016

and 153 of 2021 adopted the submissions of Sri Ajay Vohra and further

submitted as under:

i. That it would be incorrect to suggest that the annual licence fee

which is paid as a percentage of the revenue earnings is paid to

acquire the right and obtain the licence. That it is absurd to state

that every year, each telecom licencee acquires the right and

obtains a licence. Acquisition of the right and obtaining the licence

is a one-time event and the expenditure for acquisition of the

licence is always capital expenditure. Section 35ABB of the Act

covers this aspect of the transaction.

ii. That the annual licence fee, even though termed as a licence fee is

in essence, expenditure incurred to operate the telecommunication

services from year to year. Such expenditure is incurred annually

to earn revenue and consequently is an annual revenue

expenditure. In various sectors, such as mining, oil exploration,

etc., the licences are acquired on payment of a lump-sum amount.

This expenditure is to acquire a right and obtain licence to engage

31

in mining, oil exploration, and so on. Thereafter, annual amounts

are paid, depending on the quantities of minerals or petroleum that

is extracted. It was submitted that by analogy, the one-time entry

fee paid by existing telecom operators and the entry fee that was

paid by all the new entrants, was capital expenditure which

resulted in acquisition of rights and obtaining licence. However, the

annual licence fee, which varied according to the AGR in the

relevant year, was incurred annually on revenue earned and

consequently is an annual revenue expenditure.

iii. Referring to the decision of this Court in Mewar Sugar Mills Ltd.

vs. CIT, (1973) 3 SCC 143 (“Mewar Sugar Mills Ltd.”), it was

submitted that in the said case, the expenditure incurred by the

assessee was apportioned and it was held that the sums paid by

the assessee for acquisition of monopoly rights for manufacture of

sugar were in the nature of capital expenditure, while the royalty

paid on a yearly basis was revenue expenditure. It was submitted

in that context that the principle laid down in the said case would

directly apply to the case at hand. The one-time entry fee is payed

for acquiring the licence and is therefore in the nature of capital

expenditure; whereas, the annual licence fee is to operate the

licence and earn profits, therefore, the same is revenue

expenditure.

iv. That a similar view was taken in CIT vs. Sarada Binding Works,

(1976) 102 ITR 187 (“Sarada Binding Works ”) wherein the

32

Madras High Court considered various judgments of this Court and

held that a lump-sum payment to acquire a right would be capital

expenditure, whereas any amount paid as royalty based on annual

earnings or profit would be revenue expenditure. That the payment

of annual licence fee, in the present case, would be similar to the

payment of royalty as it relates to the annual turnover and would

therefore be revenue in nature.

v. That it could not be axiomatically held that the nomenclature

‘annual licence fee’ would itself indicate that the annual variable

licence fee was also incurred for the purpose of acquiring the capital

asset, i.e., the licence and therefore, had to be amortised under

Section 35ABB of the Act. The nomenclature does not mean that a

licence is acquired annually or the licence is obtained annually.

This amount is the expenditure incurred to operate the telecom

licence and earn revenue or profits. In this regard, reliance was

placed on the dictum of this Court in Sundaram Finance Ltd. vs.

State of Kerala, (1966) 2 SCR 828 to submit that the use of a

particular expression is not conclusive of the nature of a

transaction.

vi. That the judgment of this Court in Jalan Trading Co., sought to

be relied upon by the appellant-Revenue would have no application

to the facts of the present case as unlike in the case at hand, there

was no lump-sum payment in the said case. The agreement itself

provided for 75% of the net profits to be paid for the assignment of

33

the right to carry on business. The aim or object of payment of the

said consideration was for the purpose of acquiring the right to

carry on business. However, in the present case, the annual licence

fee is paid not to acquire the licence, but to operate the telecom

licence and earn revenue or profits. Hence, the decision of this

Court in Jalan Trading Co., turns on its own facts.

7.4. Sri Sachit Jolly, learned counsel appearing for the respondent-

assessees in Civil Appeal No. 4902 of 2022 adopted the submissions of

learned senior counsel, Sri Ajay Vohra and Sri Arvind P. Datar and

further contended as follows:

i. That merely because the DoT can rescind the licence owing to non-

payment of the variable licence fee, it does not mean that the

payment of such fee is towards the acquisition of the licence.

Violation of other conditions of licence like non-maintenance of

KYC of subscribers could also lead to cancellation of licence. In fact,

payment of licence fee for any one year, neither leads to acquisition

of any new asset nor to any enduring benefit. Further, the benefit,

if any, of the variable licence fee is only restricted to one year to

which the payment pertains. Hence, the same could not be held to

be capital expenditure or expenditure incurred for acquisition of a

capital asset.

ii. That the interpretation sought to be canvassed by the appellant

would result in a completely absurd result wherein the deduction

34

under Section 35ABB would exceed the actual payment made by

the assessee in a given year, in the later years. This aspect of the

matter was rightly appreciated by the Delhi High Court in the

impugned judgement and it was accordingly held that the

interpretation proposed by the appellant would give Section 35ABB

a ballooning effect with the amortised amount substantially

increasing in the later years and in the last year, the entire licence

fee along with the brought forward, amortised amount would be

allowed as deduction. It was rightly held that after a certain point

of time, deduction allowable under Section 35ABB would be more

than the actual payment made by the assessee as licence fee for

that year.

In this context, reliance was placed on the decision of this

Court in CIT, Bangalore vs. J.H. Gotla, A.I.R. 1985 SC 1698 to

contend that it is settled law that an interpretation which leads to

an absurd result should be avoided and such interpretation should

give way to a more harmonious interpretation so that the legislation

is given its desired result.

iii. With the aforesaid submissions, it was stated that the impugned

decision of the High Court of Delhi is detailed and well-reasoned. It

is not contrary to any principle laid down by this Court and hence

does not merit interference. It was prayed that the appeals filed by

the Revenue be dismissed on the ground that there is no infirmity

in the impugned judgment of the High Court of Delhi.

35

Reply arguments:

8. By way of reply, learned ASG, Sri N. Venkataraman, reiterated his

submissions while also contending that the judgment of this Court in

Mewar Sugar Mills Ltd. and the judgment of the Madras High Court

in Sarada Binding Works, relied upon by Sri Datar to substantiate

the claim that the same source of expenditure incurred by an assessee

could be construed as partly capital and partly revenue would not come

to the aid of the respondents-assessees in the present case. In this

regard, it was further submitted as follows:

i. That in both the aforesaid cases sought to be relied upon by Sri

Datar, a single source of expenditure was not split partly as capital

and partly as revenue expenditure. On the contrary, in both of

those decisions, this Court examined two different constituents of

expenditure and held one to be capital and the other to be revenue

in nature.

ii. That in Sarada Binding Works the facts were that the agreement

in question envisaged conveyances of two distinct aspects: first, the

right to run the business of Chandamama Publications for a

consideration of a fixed sum of Rs.5000/- per annum; second,

royalty on the sales equivalent to 10% of the net profit of each year

of business. The High Court’s judgment categorically records that

annual payments based on the turnover had no nexus with the

payment made to acquire the right to carry on trade, which was

36

also paid annually at Rs.5000/- every year. However, in the facts

of the present case, the entry fee as well as the annual licence fee

payable as a percentage of AGR, are both towards the same

purpose, i.e., acquisition of licence to carry on telecommunication

operator services.

iii. That similarly, in the case of Mewar Sugar Mills Ltd., two different

payments were made, relatable to two different subject matters. In

the said judgment, this Court noted that the payment of royalty

based on quantity of sugar manufactured, was not with a view to

acquire monopoly rights. In the said case, there were two clearly

discernible purposes towards which the payment of lump-sum

consideration and payment of royalty were made. However, in the

present case, the purpose of payment of entry fee as well as the

annual licence fee, is singular, i.e., to acquire and retain the right

to carry on the business of rendering telecommunication services.

In light of the aforesaid submissions, Sri N. Venkataraman

urged that this Bench may allow the appeals filed by the Revenue.

Points for consideration:

9. Having heard the learned counsel for the respective parties and

on perusal of the material on record, the following points would emerge

for our consideration:

i. Whether the variable annual licence fee paid by the respondents-

assessees to the DoT under the Policy of 1999 is revenue in nature

37

and is to be allowed deduction under Section 37 of the Act, or, the

same is capital in nature and is accordingly required to be

amortised under Section 35ABB of the Act?

ii. Whether the High Court of Delhi was right in apportioning the

licence fee as partly revenue and partly capital by dividing the

licence fee into two periods, that is, before and after 31

st July, 1999

and accordingly holding that the licence fee paid or payable for the

period upto 31 July, 1999 i.e. the date set out in the Policy of 1999

should be treated as capital and the balance amount payable on or

after the said date should be treated as revenue?

iii. What order?

Statutory Framework:

10. The statutory scheme and structure of the Act on the

characterisation of capital expenditure is as follows:

10.1. Section 32 of the Act identifies tangible and intangible assets

which are capital in nature and prescribes the mode and manner of

depreciation. Section 32(1)(i) identifies a list of tangible assets and

Section 32(1)(ii), a set of intangible assets which includes licences.

Explanation 3 to Section 32(1) defines ‘assets’ into two categories, i.e.,

tangible and intangible. Licences are identified as intangible assets and

are therefore, capital in nature.

38

10.2. Any capital asset is depreciable in terms of Section 32 of the Act,

unless specifically dealt with elsewhere. One of the exceptions to

depreciation of capital assets is amortisation. Sections 35A, 35AB,

35ABA and 35ABB form one cluster of exceptions wherein, the capital

assets referred to in the relevant sections have to be amortised in the

manner and mode prescribed therein.

10.3. Amortisation is a form of depreciation, however, the distinction

between the two being that in the case of depreciation, an asset may be

depreciated progressively, and may even be exhausted before the

lifetime expectancy of the asset in question, whereas, in the case of

amortisation, the value of the asset gets progressively depleted,

matching with the expected timeframe of the right.

10.4. A brief overview of the provisions of the Act which provide for

amortisation as a prescribed method, is as under:

i. Section 35A of the Act provides for amortisation of expenditure

incurred on acquisition of patent rights or copyright which are

intangible assets.

ii. Section 35AB of the Act prescribes the method of amortisation in

the case of acquisition of know-how.

iii. Section 35ABA of the Act prescribes the method of amortisation of

expenditure incurred on obtaining the right to use spectrum.

39

iv. Section 35ABB of the Act provides for amortisation of the

expenditure incurred for obtaining a licence to operate

telecommunication services.

11. At this juncture, it would be useful to reproduce Section 35ABB

(1) of the Act, which reads as under:

“35ABB. Expenditure for obtaining licence to

operate telecommunication services.—

(1) In respect of any expenditure, being in the nature

of capital expenditure, incurred for acquiring any

right to operate telecommunication services

either before the commencement of the business

to operate telecommunication services or

thereafter at any time during any previous year

and for which payment has actually been made

to obtain a licence, there shall, subject to and in

accordance with the provisions of this section, be

allowed for each of the relevant previous years, a

deduction equal to the appropriate fraction of the

amount of such expenditure.

Explanation.—For the purposes of this section,—

(i) “relevant previous years” means,—

(A) in a case where the licence f ee is

actually paid before the commencement

of the business to operate

telecommunication services, the

previous years beginning with the

previous year in which such business

commenced;

(B) in any other case, the previous years

beginning with the previous year in

which the licence fee is actually paid,

and the subsequent previous year or

years during which the licence, for

which the fee is paid, shall be in force;

(ii) “appropriate fraction” means the fraction the

numerator of which is one and the

denominator of which is the total number of

the relevant previous years;

40

(iii) “payment has actually been made” means

the actual payment of expenditure

irrespective of the previous year in which the

liability for the expenditure was incurred

according to the method of accounting

regularly employed by the assessee.”

(2) Where the licence is transferred and the proceeds

of the transfer (so far as they consist of capital

sums) are less than the expenditure incurred

remaining unallowed, a deduction equal to such

expenditure remaining unallowed, as reduced by

the proceeds of the transfer, shall be allowed in

respect of the previous year in which the licence

is transferred.

(3) Where the whole or any part of the licence is

transferred and the proceeds of the transfer (so

far as they consist of capital sums) exceed the

amount of the expenditure incurred remaining

unallowed, so much of the excess as does not

exceed the difference between the expenditure

incurred to obtain the licence and the amount of

such expenditure remaining unallowed shall be

chargeable to income-tax as profits and gains of

the business in the previous year in which the

licence has been transferred.

Explanation.—Where the licence is transferred in

a previous year in which the business is no longer

in existence, the provisions of this sub-section

shall apply as if the business is in existence in

that previous year.

(4) Where the whole or any part of the licence is

transferred and the proceeds of the transfer (so

far as they consist of capital sums) are not less

than the amount of expenditure incurred

remaining unallowed, no deduction for such

expenditure shall be allowed under sub-section

(1) in respect of the previous year in which the

licence is transferred or in respect of any

subsequent previous year or years.

(5) here a part of the licence is transferred in a

previous year and sub-section (3) does not apply,

the deduction to be allowed under sub-section (1)

for expenditure incurred remaining unallowed

shall be arrived at by—

41

(a) subtracting the proceeds of transfer (so far as

they consist of capital sums) from the

expenditure remaining unallowed; and

(b) dividing the remainder by the number of

relevant previous years which have not

expired at the beginning of the previous year

during which the licence is transferred.

(6) Where, in a scheme of amalgamation, the

amalgamating company sells or otherwise

transfers the licence to the amalgamated

company (being an Indian company),—

(i) the provisions of sub-sections (2), (3) and (4)

shall not apply in the case of the

amalgamating company; and

(ii) the provisions of this section shall, as far as

may be, apply to the amalgamated company

as they would have applied to the

amalgamating company if the latter had not

transferred the licence.

(7) Where, in a scheme of demerger, the demerged

company sells or otherwise transfers the licence

to the resulting company (being an Indian

company),—

(i) the provisions of sub-sections (2), (3) and (4)

shall not apply in the case of the demerged

company; and

(ii) the provisions of this section shall, as far as

may be, apply to the resulting company as

they would have applied to the demerged

company if the latter had not transferred the

licence.

(8) Where a deduction for any previous year under

sub-section (1) is claimed and allowed in respect

of any expenditure referred to in that sub-section,

no deduction shall be allowed under sub-section

(1) of section 32 for the same previous year or any

subsequent previous year.

11.1. Section 35ABB of the Act governs the treatment of expenditure

incurred by entities to obtain a licence for operating telecommunication

services in India. The provision addresses the tax treatment of such

42

expenses and ensures that they align with the income tax framework.

With effect from 1 April 1996, this provision provides for amortisation

of capital expenditure incurred for acquisition of any right to operate

telecommunication services, regardless of whether such cost is incurred

before the commencement of such business or thereafter. The cost is

allowed to be amortised in equal instalments in the years for which the

licence is in force. The amortisation commences from the year in which

such business commences (where such cost is incurred before the

commencement of such business) or the year in which such cost is

actually paid, irrespective of the method of accounting adopted by the

assessee for such expenditure.

11.2. In order for Section 35ABB of the Act to be applicable, the

following cumulative conditions specified in Section 35ABB (1) of the

Act are to satisfied:

First, the expenditure must be capital in nature;

Second, the expenditure must be incurred by an assessee for the

purpose of acquisition of the right to operate telecom services;

Third, the expenditure must represent the payment actually made

to obtain a licence.

Thus, for attracting the provisions of Section 35ABB, it is

necessary that the expenditure under consideration must be capital in

nature and is incurred for acquiring or obtaining a licence which gives

the right to the assessee to operate telecommunication services. Section

43

35ABB of the Act operates and is effective when the expenditure itself

is of a capital nature and is incurred for acquiring a right to operate

telecommunication services or is made to obtain a licence for the said

services.

Further, the definitions of “relevant previous years”, “appropriate

fraction” and “payment has actually been made” have been given by way

of an Explanation for the purpose of this Section. Sub-section (2) to (5)

deal with deduction to be made accordingly when a licence is

transferred and the proceeds of the transfer (so far as they consist of

capital sums) are less than or exceed the expenditure incurred

remaining unallowed. Sub-section (6) to (7) deal with situation where,

in a scheme of amalgamation, demerger, etc. as to how the provisions

of sub-section (2), (3) and (4) of Section 35ABB would not apply but the

provisions of this Section shall, as far as may be, apply to the

amalgamated company or to the demerged company, apply to the

resulting company as they would have applied to the amalgamating

company if the latter had not transferred the licence or to the demerged

company if the latter had not transferred the licence, as the case may

be. Sub-section (8) states that where a deduction for any previous years

under sub-section (1) is claimed and allowed in respect of any

expenditure referred to in that sub-section, no deduction shall be

allowed under the sub-section (1) of Section 32 for the same previous

year or any subsequent previous year.

44

11.3. The salient aspects of Section 35ABB (1) of the Act may be read

as under:

(i) Purpose and nature of expenditure - Capital expenditure

incurred for the purpose of obtaining licence to operate

telecommunication services.

(ii) Mode of amortisation of expenses – For each year of the relevant

previous years, a deduction equal to the appropriate fraction of the

amount of such expenditure, shall be allowed.

(iii) Conditions to be satisfied for applicability of the Provision –

(a) The expenditure must be capital in nature;

(b) The expenditure must be incurred by an assessee for the

purpose of acquisition of the right to operate telecom services;

(c) The said expenditure may be incurred before the

commencement of business to operate telecommunication

services, or thereafter at any time during any previous year;

(d) The expenditure must represent the payment actually made to

obtain a licence.

12. Since the variable licence fee paid by the respondents-assessees

to the DoT under the Telecom Policy of 1999 is stated to be imposed and

collected on the strength of the Telegraph Act, the relevant provisions of

the said Act are extracted hereinunder for immediate reference:

“4. Exclusive privilege in respect of telegraphs, and

power to grant licences:-

45

(1) Within India, the Central Government shall have

the exclusive privilege of establishing,

maintaining and working telegraphs:

Provided that the Central Government may grant

a licence, on such conditions and in consideration

of such payments as it thinks fit, to any person to

establish, maintain or work a telegraph within

any part of India:

Provided further that the Central Government

may, by rules made under this Act and published

in the Official Gazette, permit, subject to such

restrictions and conditions as it thinks fit, the

establishment, maintenance and working-

(a) of wireless telegraphs on ships within Indian

territorial waters and on aircraft within or above

India, or Indian territorial waters, and

(b) of telegraphs other than wireless telegraphs

within any part of India.

Explanation.-- The payments made for the grant

of a licence under this subsection shall include

such sum attributable to the Universal Service

Obligation as may be determined by the Central

Government after considering the

recommendation made in this behalf by the

Telecom Regulatory Authority of India established

under sub-section (1) of section 3 of the Telecom

Regulatory Authority of India Act, 1997 (24 of

1997).

(2) The Central Government may, by notification in

the Official Gazette, delegate to the telegraph

authority all or any of its powers under the first

proviso to sub-section (1).

The exercise by the telegraph authority of any

power so delegated shall be subject to such

restrictions and conditions as the Central

Government may, by the notification, think fit to

impose.”

(3) Any person who is granted a license under the

first proviso to sub-section (1) to establish,

maintain or work a telegraph within any part of

46

India, shall identify any person to whom it

provides its services by--

(a) authentication under the Aadhaar (Targeted

Delivery of Financial and Other Subsidies,

Benefits and Services) Act, 2016 (18 of 2016);

or

(b) offline verification under the Aadhaar

(Targeted Delivery of Financial and Other

Subsidies, Benefits and Services) Act, 2016 (18

of 2016); or

(c) use of passport issued under section 4 of the

PassportsAct, 1967 (15 of 1967); or

(d) use of any other officially valid document or

modes of identification as may be notified by

the Central Government in thisbehalf.

(4) If any person who is granted a license under

the first proviso to sub-section (1) to establish,

maintain or work a telegraph within any part of

India is using authentication under clause (a) of

sub-section (3) to identify any person to whom it

provides its services, it shall make the other

modes of identification under clauses (b) to (d) of

sub-section (3) also available to such person.

(5) The use of modes of identification under sub-

section (3) shall be a voluntary choice of the

person who is sought to be identified and no

person shall be denied any service for not having

an Aadhaar number.

(6) If, for identification of a person, authentication

under clause (a) of sub-section (3) is used, neither

his core biometric information nor the Aadhaar

number of the person shall be stored.

(7) Nothing contained in sub-sections (3), (4) and

(5) shall prevent the Central Government from

specifying further safeguards and conditions for

compliance by any person who is granted a

license under the first proviso to sub-section (1)

in respect of identification of person to whom it

provides its services.

47

Explanation.-- The expressions "Aadhaar

number" and "core biometric information" shall

have the same meanings as are respectively

assigned to them in clauses (a) and (j) of section 2

of the Aadhaar (Targeted Delivery of Financial and

Other Subsidies, Benefits and Services) Act, 2016

(18 of 2016).

xxx xxx

“8. Revocation of licen ces:- The Central

Government may, at any time, revoke any licence

granted under section 4, on the breach of any of the

conditions therein contained, or in default of

payment of any consideration payable there under.”

xxx xxx

“PART IV

PENALTIES

20. Establishing, maintaining or working

unauthorized telegraph:–

(1) If any person establishes, maintains or works a

telegraph within India in contravention of the

provisions of section 4 or otherwise than as

permitted by rules made under that section, he

shall be punished, if the telegraph is a wireless

telegraph, with imprisonment which may extend

to three years, or with fine, or with both, and in

any other case, with a fine which may extend to

one thousand rupees.

(2) Not withstanding anything contained in the Code

of Criminal Procedure, 1898 (5 of 1898), offences

under this section in respect of a wireless

telegraph shall, for the purposes of the said Code,

be bailable and non-cognizable.

(3) When any person is convicted of an offence

punishable under this section, the Court before

which he is convicted may direct that the

telegraph in respect of which the offence has been

committed, or any part of such telegraph, be

forfeited to Government.”

48

“20A. Breach of condition of licence:– If the holder

of a licence granted under section 4 contravenes any

condition contained in his licence, he shall be

punished with fine which may extend to one thousand

rupees, and with a further fine which may extend to

five hundred rupees for every week during which the

breach of the condition continues.”

“21. Using unauthorized telegraphs:– If any person,

knowing or having reason to believe that a telegraph

has been established or is maintained or worked; in

contravention of this Act, transmits or receives any

message by such telegraph, or performs any service

incidental thereto, or delivers any mes sage for

transmission by such telegraph or accepts delivery of

any message sent thereby, he shall be punished with

fine which may extend to fifty rupees.”

12.1. The Telegraph Act is the parent legislation under which licences to

establish, maintain or work a telegraph are issued. Section 4(1) of the

Telegraph Act states that the Central Government shall have the

exclusive privilege of establishing, maintaining and working telegraphs.

The proviso to Section 4(1) indicates that the Central Government may

grant a licence to any person to establish, maintain or work a telegraph

within any part of India on such conditions and in consideration of such

payment as it thinks fit.

12.2. Section 8 of the Telegraph Act allows the Central Government to

revoke at any time any licence granted under Section 4 thereof, on

breach of any of the conditions therein contained or in default of

payment of any consideration payable thereunder.

49

12.3. Section 20 of the Telegraph Act declares that any person who

establishes, maintains or works a telegraph in contravention of the

provisions of Section 4 shall be punished with imprisonment, which may

extend to three years, or with fine, or with both. Section 20A and 21 deal

with breach of conditions of licence and the consequences of using

unauthorised telegraphs.

12.4. A bare perusal of the aforesaid provisions of the Telegraph Act

would throw light onto the following aspects:

i. The Central Government may grant a licence to establish,

maintain or work a telegraph, by granting a licence on payment of

a licence fee, under the proviso to Section 4(1) of the Telegraph

Act.

ii. The Central Government may, under Section 8, revoke any licence

issued under Section 4 of the Telegraph Act, on ground of default

in payment of consideration.

iii. Any contravention of Section 4 of the Telegraph Act, or of

conditions of the licence issued under Section 4, would invite

imprisonment and/or imposition of fine.

13. We shall now refer to the terms of the Licence Agreement entered

into under the Policy of 1994 and the terms of migration of the existing

licencees to the New Telecom Policy, 1999 regime, with a view to examine

whether the nature and character of the licence fee was changed in light

of migration.

50

13.1. For ready reference, a specimen licence agreement dated 29

November, 1994, in favour of Bharti Cellular Ltd. is extracted

hereinunder. It is to be clarified at this juncture that the date of

agreement with each respondents may be different but the terms are

identical:

“Licence Agreement under the Indian Telegraph

Act

This Agreement made the 29th day of November, 1994

between the President of India acting through the

Director (TM-IX), Department of Telecommunications

(called the Licenser) of the ONE PART and M/s. Bharti

Cellular Ltd., registered under The Companies Act

1956 and having its registered office at 15th Floor,

Devika Tower, 6 Nehru Place, New Delhi -110 019.

(hereinafter called the Licensee which expression shall

unless excluded by repugnant to this context be

deemed to include its successor in business) of the

OTHER PART.

Whereas in exercise of the powers of the Central

Government under Sub Section 2 of Section 4 of the

Indian Telegraph Act 1885, the Central Government

delegated its powers to Telegraph Authority

(hereinafter referred to as Authority) by GSR 806

Gazette of India, Part II, Section 3(i) dated 24th August

1985.

And whereas pursuant to the request of the Licensee

the Authority has agreed to grant licence to the

Licensee on the terms and conditions appearing

hereinafter to establish, maintain and operate

Cellular Mobile Telephone Service upto the

subscriber's terminal connection (hereinafter called

the Service) in the areas given in Schedule "A"

annexed hereto and the Licensee has agreed to accept

the same on the terms and conditions appearing

hereinafter.

Now this Agreement witnesseth as follows:

51

1. In consideration of mutual covenants as well as the

licence fee payable in advance in terms of schedule 'C'

and observations and/or due performance of all the

terms and conditions to be observed/performed on

the part of the licensee, the Licenser does hereby grant

licence to the Licensee to establish, maintain and

operate Cellular Mobile Telephone Service upto the

subscriber's terminal connection in the areas given in

Schedule "A" annexed hereto on the terms and

conditions mentioned in Schedule “C” annexed

hereto.

2. The licence is granted initially for a period of 10

years extendible for one year or more at a time at the

discretion of the authority, on such terms and

conditions as the Authority may, at his sole discretion,

agree provided that the Licensee is not in default or

has committed/any breach of any terms and

conditions of the Licence. The licence fee payable is

given in Schedule "C" condition 19 of this licence.

3. The licence is governed by the provisions of the

Indian Telegraph Act, 1885 and Indian Wireless

Telegraphy Act, 1933 as modified from time to time.

4. Unless otherwise mentioned in the subject or

context appearing hereinafter the main body of the

agreement and all the Schedules annexed hereto

including the tender documents will form part and

parcel of this agreement provided however in case of

conflict terms of this agreement and those of

schedules hereto will prevail over the tender

documents.

5. In this Agreement words and expressions will have

the same meaning as are respectively assigned to

them in the Schedule "C" Part-I.

6. The licensee should clearly indicate the

specifications of the service to the subscribers at the

time of signing the contract with them.

7. The Ceiling Tariff to be charged from the

subscribers of the service is given in Schedule "B"

annexed hereto. Licensee can charge less tariff

without any approval of the Authority.

52

8. The bank guarantees to be given by the licensee

prior to the signing of the Licence Agreement is given

in Schedule "D" annexed hereto.

9. The Licensee will not assign or transfer its rights in

any manner whatsoever under the licence to a third

party or enter into any agreement for sub -licence

and/or partnership relating to any subject matter of

the licence to any third party either in whole or in part

i.e. no sub-leasing /partnership/third party interest

shall be created.

10. In case of interruption of service lasting for more

than 72 hours, an appropriate rebate shall be given to

the users of the service by the Licensee. The Authority

reserves the right to, in case of a default, impose any

penalty as it may deem fit.

11. The Authority may at any time revoke the licence

on the breach of any of the terms and conditions

therein contained or in default of payment of any

consideration payable thereunder by giving a 60 days

notice.

12.1 The Licensee is not allowed to use any encryption

in the network.

12.2 The Licensee is required to provide list of

subscribers to the Authority every quarter regularly

and, as and when required by the Authority.

12.3 The Authority or its representative will have an

access to the MSC as well as the technical facility

provided by the Licensee for monitoring, inspection

etc. without giving any prior notice.

13. It is further agreed and declared by the parties

that notwithsta nding anything contained

hereinbefore, that

(i) The licence is issued on non-exclusive basis. The

Authority reserves the right to operate the service

within the same geographical area.

(ii) The Authority reserves the right to modify at any

time the terms and conditions of the licence covered

under Schedules "A", "B", "C", and "D", annexed

53

hereto, if in the opinion of the Authority it is necessary

or expedient to do so in the interests of the general

public or for the proper conduct of telegraphs or on

security consideration.

(iii) The Authority reserves the right to revoke the

licence at any time in the interest of public by giving

a 60 days’ notice.

(iv) Notwithstanding anything contained anywhere

else in the licence the Authority's decision shall be

final.

(v) The authority reserves the right to take over the

entire services and networks of the licensee or revoke/

terminate /suspend the licence in the interest of

national security or in the event of a national

emergency/war or low intensity conflict type of

situations.

In Witness whereof the parties hereto have caused this

Agreement to be executed through their respective

authorized representatives the day and year first

before written

Signed and Delivered

for and on behalf of

President of India”

(Emphasis by us)

13.2. The conditions on which the licence was granted were stipulated

in Schedule A and Schedule B of the licence agreement. The payment

of licence fee was in the following terms:

“PAYMENT OF LICENCE FEES

19.1 The Licence fee payable by licencee for each

service area shall be regulated as follows: -

Licence Fee For

Service

Area

1st Year 2nd Year 3rd Year

(Rupees in Crores)

Bombay 3 6 12

Delhi 2 4 8

54

Calcutta 1.5 3 6

Madras 1 2 4

4

th

Year and onwards

@ Rs. 5 lakhs (five lakhs) per 100 (one hundred)

subscribers or part thereof; subject to the minimum

shown below :-

Minimum Licence Fee for

Fourth to Sixth

Service Area

Year Seventh (for

each year)

year onwards (for

each year)

(Rs.in crores)

Bombay 18 24

Delhi 12 16

Calcutta 9 12

Madras 6 8

a) For purpose of charging the lump-sum Licence

fee for the first three years, the year shall be

reckoned as twelve months, beginning with the

date of commissioning of services or

completion of 12 months from date of signing

of Licence Agreement, whichever is earlier.

b) The fourth year for purpose of charging the

Licence fee shall be the period from the

completion of the third year as defined above to

the 31

st day of March succeeding. The annual

Licence Fee for the fourth year will therefore,

be computed prorate with reference to the

actual number of days. Thereafter, the year for

purpose of levy of Licence fee shall be the

financial year i.e. 1

st April to 31

st March and

part of the year as balance period, if any.

c) For the purpose of calculation of Licence fee

from the fourth year onwards as indicated in

para 19.1 above, the number of subscribers at

the end of each month shall be added for all the

months of the year and divided by the number

of completed months.

XXX

55

(f) The rate of Rs. five lakhs per hundred

subscribers or part thereof is based on the unit

call rate of Rs. 1.10. Fourth year onwards, as

defined in the clause 19.1(d), the rate of Rs. five

lakhs will be revised based on the prevalent

unit call rate. The revision will be limited to

75% of the overall increase in the unit rate

during the period preceding such revision.”

The Agreement further stipulated:

“19.2 On completion of three years from the date

of commissioning/provision of services; the

Authority reserves the right to fix the share of the

gross revenue from rental, air time charges for all

other services provided from the cellular network of

the Licensee, as additional licence fee.

19.3 The annual Licence fee as prescribed above

does not include Licence fees payable to WPC wing

of Ministry of Communications (WPC) for use of

Radio Frequencies which shall be paid separately

by the Licensee on the rates prescribed by the WPC

and as per procedure specified by it (condition 20).”

13.3. The key features of the licence agreement under the 1994 Policy

regime may be enumerated as under:

i. The licence was granted enabling the licencee to establish,

maintain and operate cellular mobile telephone service, within a

given geographical area.

ii. The licence was granted for a period of ten years, which was

extendable for five years or more, at the discretion of the

licensor, i.e., the Central Government, unless terminated earlier.

iii. Fixed amount of licence fee was to be paid for the first three

years, irrespective of the number of subscribers, as provided in

56

paragraph 19 of the agreement and such amounts was subject

to increase annually.

iv. From the fourth year onwards, the amount of licence fees to be

paid, was dependent on the number of subscribers, irrespective

of the revenue accrued by the licencee from such subscribers,

subject to the prescribed minimum.

v. The consequence of non-payment of licence fee was termination

of the licence agreement.

vi. In accordance with the Policy of 1994, the condition of

maintaining duopoly in the market was formalised in the licence

agreement.

vii. The licence was non-assignable.

13.4. Subsequently, with a view to implement the Policy of 1999, letters

dated 27 July, 1999 were issued by the DoT proposing the package for

migration of existing licencees to the Policy of 1999 regime. It was

stated that the conditions prescribed therein are to be accepted as a

package, in entirety. Pursuant to the acceptance of the terms of

migration, the original licence agreement was amended. The relevant

portions of a specimen letter evidencing the amendments is extracted

as under:

“GOVERNMENT OF INDIA

MINISTRY OF COMMUNICATIONS

DEPARTMENT OF TELECOMMUNICATIONS

(VAS CELL)

57

SANCHAR BHAWAN,

20, ASHOKA ROAD,

NEW DELHI-110001

No 842-47/2000-VAS/Vol. IV

Dated: January 29, 2001

To

M/s Bharti Cellular Ltd.

D-184, OKHLA Industrial Area, Phase-1,

New Delhi-110 020.

Subject:- Amendment in the Licence Agreement

No 842-1893-TM Dated 29.11.1994 for Cellular

Mobile Telephone Service in Delhi Metro Service Area

as a consequence to Migration to revenue sharing

regime of New Telecom Policy-1999 (NTP-99)

Sirs,

In consideration of the acceptance by the Licensee, of

the terms and conditions contained in the offered

Migration Package vide No. 842-153/99-VAS (Vol. V)

(Pt.) dated 22.7.1999 for migration to the revenue

sharing regime under New Telecom Policy-1999, the

license agreement shall stand substituted and

modified as follows with effect from 1.8,1999,

notwithstanding anything contained in the License

Agreement:

(i) The Licensee shall forego the right of operating in

the regime of limited number of operators after

01.08.1999 and shall operate in a multipoly regime,

that is to say that the Licensor may issue additional

licenses for the Service without any limit in the Service

Area where the Licensee Company is provid ing

Cellular Mobile Telephone Service.

(ii) Licence fee: With effect from 1.8.1999, the

payable license fee shall be equal to prescribed

percentage as share of gross revenue of the Licensee

Company. Provisionally the licensor has fixed 15% of

the gross revenue as license fee and presently the

gross revenue for this purpose shall mean the total

58

revenue of the Licensee Company under the license

excluding,

(a) the PSTN related call charges paid to Bharat

Sanchar Nigam Limited (BSNL)/MTNL or any other

Telecom Service Provider and,

(b) service tax or charge collected by the Licensee

on behalf of the Government from their subscribers.

The Government will take a final decision about the

quantum of revenue share, definition of revenue for

this purpose, after taking into consideration the

recommendations of

(iii) Period of Licence: The period of license shall

be twenty years from the effective date of the existing

license agreement unless terminated for the reasons

stated therein. The Licensor may extend the period of

license, if requested during 19

th year from the effective

date for a period of 10 years at a time on mutually

agreed terms and conditions The decision of licensor

shall be final in regard to grant of extension.

(iv) The acceptance of the Migration Package shall

be taken and deemed as full and final settlement of all

existing disputes whatsoever, for the period upto

31.7.1999 (the cut-off date) irrespective of whether

they are related to the Migration Package or not. No

dispute or difference shall be raised by the licensee for

the said period at any later date.”

(Emphasis supplied)

13.5. Thereafter, the DoT introduced further amendments to the licence

agreement, w.e.f. 01 August, 1999. The relevant portions of a specimen

letter dated 25 September, 2001 evidencing the amendments is

extracted as under:

“GOVERNMENT OF INDIA

MINISTRY OF COMMUNICATIONS

DEPARTMENT OF TELECOMMUNICATIONS

(VAS CELL)

59

SANCHAR BHAWAN,

20, ASHOKA ROAD,

NEW DELHI-110 001

Dated 25 September, 2001

No.842-47/2000-VAS(Vol. IV) (Part)

To

M/s Bharti Cellular Ltd.

D-184, Okhla Industrial Area,

Phase-1, New Delhi-110020.

Subject: Amendment in the Licence Agreement No.

842-18/93-TM dated 29.11.1994 for Cellular Mobile

Telephone Service in Delhi Service Area as a

consequence to Migration to revenue sharing regime

of New Telecom Policy-1999 (NTP-99).

In continuation of Amendment dated 29th January,

2001 of the aforesaid License Agreement and more

specifically Para (ii) thereto, reserving the power to

take a final decision on the quantum of license fee and

WPC charges; the licensor hereby decides the

following in pursuance of the said power which shall

modify and supersede whate ver is contained and

described in the Licence Agreement or the above

stated Amendment.

(i) Annual License fee at the rate of 15% of Adjusted

Gross Revenue (AGR) shall be payable by you, with

effect from 1

st August, 1999.

(ii) In addition the cellular licenses shall pay

spectrum charges, with effect from (1.8.1999) the cut-

off date of change over to NTP-99 regime, on revenue

share basis of 2% of AGR towards WPC Charges

covering royalty payment of the use of cellular

spectrum upto 4.4 MHz+4.4 MHz and Licence fee for

Cellular Mobile handsets & Cellular Mobile Base

Stations and also for possession of wireless telegraphy

equipment as per the details prescribed by Wireless

Planning & Coordination Wing (WPC). Any additional

band width, if allotted subject to availability and

justification shall attract additional License fee as

revenue share (typically) 1% additional revenue share

60

if Bandwidth allocated is upto 6.2 MHz + 6.2 MHz is

place of 4.4 MHz+4,4 MHz).”

(Emphasis supplied)

13.6. The pertinent qualitative changes effected in the licence

conditions, following migration into the Policy of 1999 regime, may be

presented in a tabular form, as under:

Sl.

No.

Parameters for

Distinction

National Telecom

Policy, 1994

New Telecom Policy,

1999

1. Details of the

payment to be

made by the

operator:

i. Fixed licence fee for

the first three years;

ii. From the fourth

year onwards, the

amount of licence

fees to be paid, was

dependent on the

number of

subscribers,

irrespective of the

revenue account by

the licencee from

such subscribers,

subject to the

prescribed

minimum

i. One-time entry fee

paid by existing

telecom operators

and entry fee that

was paid by all the

new entrants;

ii. Variable annual

licence fee paid as

a percentage of

AGR.

2. Maximum

number of

operators

permissible in a

circle

Two No restriction

3. Validity of the

licence

10 years, subject to

extension.

20 years, subject to

extension.

4. Right of the

operator/

licencee to

assign/transfer

the licence

Licence was non-

assignable and non-

transferable.

Restriction on

assignment/transfer

of licence was

relaxed.

14. The discussion on the points set out above, in our view, must begin

with a detailed review of relevant case law detailing the nature and

61

characteristics of capital expenditure and revenue expenditure and the

tests to identify the same.

14.1. In the impugned order, the High Court of Delhi found that there

was no decision of the Supreme Court or any of the High Courts directly

applicable to the factual matrix of the case and therefore, considered a

number of decisions of this Court which we shall refer to as under:

(a) At the outset, we preface our discussion by the observations of

this Court in Alembic Chemical Works Co. Ltd. vs. CIT, (1989) 3 SCC

329 (“Alembic Chemical Works Co. Ltd. ”) wherein the transaction in

question was with regard to the one-time payment made under an

agreement with a foreign firm, by the assessee, to obtain technical

know-how for increasing yield of penicillin in its existing plant. While

considering the nature of the said transaction, this Court indicated that

“in the infinite variety of situational diversities in which the concept of

what is capital expenditure and what is revenue arises,” it is not possible

“to formulate any general rule even in the generality of cases, sufficiently

accurate and reasonably comprehensive, to draw any clear line of

demarcation”. This Court further held that there is no single definitive

criterion which by itself demarcates whether a particular outlay is

capital or revenue. Therefore, the “once for all” test as well as the test of

“enduring benefit” may not be conclusive. Consequently, the various

terms and conditions of the agreement, the advantages derived by an

assessee under the agreement, the payment made by the assessee

62

under the agreement are all to be taken into account and then it has to

be decided whether the whole or a part of the payment thus made is a

capital expenditure or a revenue expenditure.

This Court observed that courts have applied different tests like

starting of a new business on the basis of technical know-how received

from the foreign firm; exclusive right of the company to use the patent

or trademark which it receives from the foreign firm; the payments made

by the company to the foreign firm whether, a definite one or dependent

upon certain contingencies; right to use the technical know-how for

production even after the completion of the agreement ; obtaining

enduring benefit for a considerable part on account of the technical

information received from a foreign firm, payment whether made “once

for all” or in different installments co-relatable to the percentage of gross

turnover of the product, etc. to ultimately find out whether the

expenditure or payment thus made makes an accretion to the capital

asset(s) and after the court comes to the conclusion that it does, then,

has to be held to be a capital expenditure.

It was further observed that no single definitive criterion by itself

would be determinative and therefore, bearing in mind the changing

economic realities of business and the varieties of situational diversities,

the various clauses of the agreement are to be examined.

On fact, as regards the question as to whether “once for all”

payment made under an agreement with a foreign firm by the assessee

to obtain technical knowhow, for increasing yield of penicillin in its

63

existing plant with a condition to keep the said know-how confidential,

constituted business expenditure allowable for deduction, this Court

held in the affirmative. M.N. Venkatachalia, J. (as the learned Chief

Justice then was) held that in computing the income chargeable under

the head “Profits and Gains of Business or Profession”, Section 37 of

the Act enables the deduction of any expenditure laid out or expended

wholly and exclusively for the purpose of the business or profession, as

the case may be. The fact that an item of expenditure is wholly and

exclusively laid out for purposes of the business, by itself, is not

sufficient to entitle its allowance in computing the income chargeable to

tax. In addition, the expenditure should not be in the nature of a capital

expenditure.

(b) In Empire Jute Co. Ltd., the question which arose was whether

the sale of loom hours was to be held to be in the nature of capital

receipt and hence not taxable. The transaction involved one jute mill

transferring loom hours to another for consideration, subject to certain

conditions. It was observed in the said case that a capital expenditure

would be for securing an enduring benefit but when it comes to

acquiring an advantage in the commercial sense, the enduring benefit

test should not be applied mechanically. In the said case, another test

was adopted, i.e., fixed and circulating capital test. It was observed that

the purchase of loom hours was not like circulating capital (labour, raw

material, power etc.) but loom hours were also not part of fixed

capital. It was observed that whether an expenditure is revenue or

64

capital should depend upon practical and business considerations

rather than juristic classification of legal rights. That the test to be

adopted was whether the expenditure was in view of a business

necessity or expediency, i.e., was the expenditure a part of assessee’s

working expenditure or a part of process of profit earning; whether the

expenditure was necessary to acquire a right of permanent character,

the possession of which was a condition for carrying on trade was

highlighted.

(c) Insofar as lease agreements are concerned, this Court in Assam

Bengal Cement Co. Ltd., in the context of acquiring lease of mining

stone quarries for manufacture of cement for twenty years on payment

of yearly rent as well as protection fee to ward off competition held the

same to be capital expenditure. It was observed in the said case that

the consideration payable was per annum but was for the entire or

whole duration of the lease and it protected and gave right to the

assessee to carry on business unfettered from outsiders. It was held

that the expenditure was not a part of the working or operational

expenses but for acquiring a capital asset.

(d) In Sindhurani, salami or lump-sum payment of non-recurring

nature made by the prospective tenant to the landlord as consideration

for settlement of agricultural land and parting with certain rights paid

anterior to landlord and tenant relationship was held not to be in the

nature of rent and thus capital payment. It was held that the payment

65

was not for use of land but for the land to be put to use by the assessee.

Salami was not rent paid in advance.

(e) In Enterprising Enterprises, this Court affirmed the decision of

Madras High Court after referring to Pingle Industries Ltd. vs.

CIT, (1960) 40 ITR 67 (SC) (“Pingle Industries Ltd.”); Gotan Lime vs.

CIT, (1999) 239 ITR 718 (“Gotan Lime”) and Aditya Minerals Pvt.

Ltd. to hold that there is a distinction between a payment of royalty or

rent and where the entire amount of lease premium was paid either at

one time or in instalments. Royalty or rent is a revenue expenditure

whereas the payment of a lease premium either at one time or in

instalments would be a capital expenditure.

14.2. Having referred to the aforesaid decisions, three other judgments

were noticed by the Delhi High Court which, according to learned ASG

appearing for the appellant-Revenue were erroneously applied to the

case at hand. They could be alluded to as under:

(a) In Jonas Woodhead and Sons , the question was whether 25%

of the gross revenue paid as royalty to the foreign company for technical

information/know-how relating to setting up of a plant for manufacture

of products, was capital expenditure. The issue depended upon several

factors including whether the assessee had set up an entirely new

business, or whether the technical knowhow was for the betterment of

the product which was already being produced; whether it was a part

and parcel of the existing business or a new business?; whether on

66

expiry of the period of agreement, the assessee was required to give back

the plans, drawings etc., which were obtained from the foreign company

or could continue to manufacture the products? The assessing officer

in the said case had treated 25% of the amount paid as royalty as capital

and the balance amount was treated as revenue expenditure.

The question that came up for consideration before this Court

was, whether, on the facts and in the circumstances of the said case,

the Tribunal was right in holding that 25% of the amount paid by the

assessees therein as royalty to Jonas Woodhead and Sons was capital

expenditure and therefore not allowable as revenue expenditure under

the provisions of the Act for the Assessment years 1961-1968 and

1968-1969.

It was observed that this question would depend upon several

factors stated above and the cumulative effect of a construction of the

various terms and conditions of the agreement; whether the assessee

derived benefits coming to its capital for which the payment was made

or not so.

Considering the different clauses of the agreement in the said

case, it was concluded that the agreement with the foreign firm was to

set up a new business by the assessee and the foreign firm had not only

furnished information and technical know-how but had also rendered

valuable services in setting up of the factory itself and even after the

expiry of the agreement, there was no embargo on the assessee to

continue to manufacture the product in question. Therefore, it was

67

difficult to hold that the entire payment mad e was a revenue

expenditure merely because the payment was required to be made on a

certain percentage of the rates of the gross turnover of the products of

the income as royalty. That alone did not make it a revenue

expenditure. Therefore, the question raised was answered in favour of

the Revenue and the appeals filed were dismissed.

b) In Southern Switch Gear Ltd., this Court affirmed the decision

of the Madras High Court, wherein royalty payable was apportioned and

25% thereof was treated as capital payment or expenditure on the

ground that the right to manufacture certain goods exclusively in India

should be taken as an independent right secured by the assessee from

the foreign company and this right was of enduring nature.

(c) In Best and Co., the respondent assessee therein was carrying on

business and had innumerable agencies and compensation was

received on account of cancellation of one agency and the question was,

whether, the said compensation was capital or revenue receipt in

nature; whether by the termination of an agency the asseessee therein

had lost an earning asset and the compensation paid for the destruction

of such an asset was a capital receipt and therefore not liable to tax. K.

Subba Rao. J. (as the learned Chief Justice then was) speaking for a

three-Judge Bench observed that the question , as to, whether, the

compensation received by an assessee for the loss of agency is a capital

receipt or a revenue receipt depends upon the circumstances of each

case. This is because many questions have to be asked and answered,

68

particularly, whether the loss of an agency was an ordinary incidence

in the course of business or did it amount to loss of an enduring asset

causing an unabsorbed shock dislocating the entire or a part of the

earning apparatus or structure. It was held that if a loss of a particular

agency was incidental to the business, compensation received would be

a revenue receipt but if it was compensation received for the loss of an

enduring asset, then it would be a capital receipt. But for this, the

previous history of the business and relative importance of the agency

lost and the position of the business after the loss of the said agency

have to be scrutinized by the department. While considering the said

issue, on the facts of the said case, it was held that the asseessee therein

was a well-established and long standing company in South India which

had taken up innumerable agencies in different lines and one such

agency had been taken from the Imperial Chemical Industries (Exports)

Limited, Glasgow. When there was no material to show that the loss of

the said agency was so large that the business of the agency was

dislocated, on considering the facts of the said case, this Court observed

that the loss of the said agency by the assessee was only a normal

trading loss and the income it received was revenue receipt.

Another question which was considered was whether

compensation received by the assessee in lieu of a restrictive covenant

was a capital receipt. It was observed that the non-compete clause came

into operation after the termination of the agency and it was an

independent obligation undertaken by the assessee therein not to

69

compete with the new agent in the same field for a specified period and

therefore, the compensation received was attributable to the restrictive

covenant and was a capital receipt and hence not assessable to tax.

The majority judgment answered the said question by observing

that compensation on cancellation of an agency could be both capital

and revenue depending upon facts of each case and whether, the

cancellation had affected the earning apparatus or structure from a

physical, financial, commercial and administrative point of view. In the

said case, compensation received was held to be revenue receipt as the

respondent assessee had innumerable agencies in different lines and

had given up only one to continue business in other lines. Loss of an

agency, it was observed, was in the normal course of business and a

part of normal business, therefore, the amount received as

compensation was revenue in nature. At the same time, it was accepted

that the compensation paid/received on account of a restrictive

covenant for a specified period on which the assessee had undertaken

not to take up competitive agency was a capital receipt and therefore,

not taxable.

14.3. In Alembic Chemical Works Co. Ltd. , on facts, it was observed

that the improvisation in the process and technology in some areas of

the enterprise was supplemental to the existing business and there was

no material to hold that it amounted to a new or fresh venture. That the

further circumstance that the agreement pertained to a product already

70

in the line of the established business of the assessees and not to a new

product indicated that what was stipulated was an improvement in the

operations of the existing business and its efficiency and profitability

not removed from the area of the day-to-day business of the assessee.

In the above context, it was held that the expenditure was in the

nature of a revenue expenditure and not capital expenditure. It was

further observed that there was no material before the Tribunal to hold

that the area of improvisation was not a part of the existing business or

that the entire existing manufacturing operations for the commercial

production of penicillin in the assessees existing plant had become

obsolete or inappropriate in relation to the exploitation of the new sub-

cultures of the high-yielding strains of penicillin supplied by a company,

Meiji and that the mere introduction of the new bio-synthetic source

required the erection and commissioning of a totally new and different

type of plant and machinery.

14.4. Another case which has been discussed by the High Court in the

impugned Judgment and relied upon by the appellant –Revenue

is Pingle Industries Ltd. In the said case, the majority judgment stated

that the payment in question therein was made with a view to acquire

a long-term lease and a right to mine stones and the lease was conveyed

to the assessee who had to extract the stones and convert them as

a stock-in-trade. That the expenditure was incurred towards securing a

capital asset from which, after extraction, stones could be converted

71

into stock-in-trade. The payment, though periodic, in fact, was neither

rent nor royalty but a lump-sum payment in instalments for acquiring

a capital asset of enduring benefit to his trade. In this view of the matter,

the High Court treated the outgoings as on capital account. On facts, it

was observed that the assessee therein had made a down payment of

Rs.96,000/- and for the remaining amount for the acquisition of lease

had asked for easy terms. The remaining amount was paid every month

but it was not for acquisition of the right from month to

month. According to this Court “it was really the entire sum chopped

into small payments for his convenience.” Hence, the amount could not

be described as a business expense, because the outgoings every month

were not to be taken as spent over purchase of stones but in discharge

of the entire liability to the jagir. This was because the lease was taken

to excavate stones from certain quarries in six villages from the quarry

situated therein.

The assessee had undertaken not to manufacture cement and not

to allow any other person to excavate stones in the area of those six

villages. The lease was in the nature of exclusive right and a monopoly.

In case of any default of the instalment, the contract would be re-

auctioned after one month's notice to the contractor, who would be

responsible for any shortfall but would not have the benefit of any extra

amount.

72

14.5. Learned ASG also relied upon the judgment in Jalan Trading Co.

In the said case, a manufacturing company gave its sole selling agency

to a firm, namely, Jalan Trading Company for two years with a right to

renew by an agreement under a deed of assignment. The benefit of the

agreement was assigned to the assessee on its payment of 75% of its

profit and commission, remuneration and other moneys received under

the said agreement or any further agreement. The assessees therein

claimed the payment of 75% of their profits in the relevant assessment

year as a business deduction. The question was, whether, the payment

was a revenue expenditure or a capital expenditure. It was observed, on

facts, that the assessee therein was a new company and it had acquired

under the contract the right to carry out a business on a long-term basis

subject to the renewal of the agreement on payment of 75% of its annual

net profits. The question was whether the assessee had acquired a

capital asset and therefore, the payment was not admissible as a

deduction under Section 10(2)(vii) of the Act. On perusing the clauses

of the deed of assignment, this Court held that the payment of 75% of

the profits and commission paid under the said agreement was in the

nature of a capital expenditure and the same was not allowable as a

deduction under the Act.

14.6. Learned senior counsel Sri Datar relied upon four decisions which

we shall discuss as under:

73

(a) In Travancore Sugars and Chemicals Ltd. vs. Commissioner of

Income-tax, (1966) 62 ITR 566 (SC) (“Travancore Sugars and

Chemicals Ltd.”), the facts were that three undertakings run by

the Government of Travancore were taken over by a company under

an agreement wherein the assets of the three undertakings were

agreed to be sold by the Government to the new company. Cash

consideration for the sale of the assets of the three undertakings

was to be paid and also 20% of the annual net profit subject to a

maximum of Rs.40,000/- was to be paid to the Government. The

said 20% was later reduced to 10% by an amendment of the terms

of the agreement. The question was, whether, the said payment

was allowable under Section 10 of the Act. The High Court held

that the amount constituted a capital expenditure. However, this

Court held that the payment in question was in the nature of

revenue expenditure for the following reasons:

i) The payment was for an indefinite period and had no limitation

of time attached to it.

ii) The payment was related to the annual profits which flowed

from the trading activities of the appellant-company and had

no relation to the capital value of the assets and;

iii) The payment was not related to or tied up, in any way, to any

fixed sum agreed between the parties as part of the purchase

price of the three undertakings.

74

This Court held that the real nature of the transaction had to

be gathered not only from concerned documents but also from the

surrounding circumstances.

(b) In M/s. Devidas Vithaldas and Co. vs. C.I.T., Bombay City,

(1972) 3 SCC 457, (1972) 184 ITR 277 (SC) (“Devidas Vithaldas

and Co.”) this Court was dealing with the question regarding

acquisition of a running business and whether, the acquisition of

goodwill of the business would amount to an acquisition of a capital

asset and the purchase price will be a capital expenditure. This

Court also considered the question whether, it would make any

difference whether, the consideration is paid in lump-sum, or at

one time, or in instalments, distributed over a definite period. It

was held that where the acquisition is not of the goodwill itself but

for the right to use it, the expenditure would be a revenue

expenditure. It was further observed that if the payment is in the

nature of royalty it has to be treated as a revenue expenditure. The

main reason for holding that the transaction did not amount to the

sale of goodwill was that the duration of the payment as also the

amount of consideration was indefinite as they depended on the

rise and fall in the profits of the business. In the said case, it was

observed by a majority of 3:1 that “in distinguishing between capital

and revenue expenditure, the courts have applied in different cases

different tests. Nonetheless, it is recognised that none of them by

75

itself is conclusive and the determination one way or the other has

to be made on the facts and circumstances of each case.

However, Sikri, C.J. in his dissenting opinion reasoned that

the mode of payment of purchase price of any capital asset cannot

convert the capital payment into a revenue payment in the hands

of the vendee. The mode of payment may affect the character of

the receipt in the hands of the vendor but as far as the vendee is

concerned, what is obviously a capital payment cannot b e

converted to a revenue payment. However, the majority held that

the transaction did not amount to a sale and that the payment of

consideration for the use of the goodwill of the business which is

indefinite and depends on the profits earned by the company each

year can be a revenue expenditure.

(c) Reliance was also placed on Sarada Binding works by Sri

Datar. In the said case, a registered firm carrying on business as a

book binder and publisher had entered into an agreement with “B”

under which it obtained the right to run the business of a

publication concern for a consideration of a fixed sum of Rs.5,000/-

per annum plus a sum equivalent to 10% of the net profits of each

year of business. The assessee claimed the said amount as a

business expenditure. The Madras High Court held that where the

transaction in question amounted to a purchase of the business,

the consideration paid partly as a fixed annual sum and partly a

periodical payment on a certain percentage of the profits earned by

76

the assessee from the said business could not be treated entirely

as capital payment. The fixed annual sum payable was a capital

payment but the periodical payments of sums which were indefinite

depending upon the future profits earned could not be treated as

capital in nature. In the said case, the following extract from

Wheatcroft’s treatise on The Law of Income Tax, Sur Tax and Profits

Tax, was quoted wherein three types of cases where the purchase

price may be paid periodically or in instalments and the points of

distinction between them were quoted:

"First, there are cases where all the payments

must be treated as income of the recipient and

the payer is entitled to deduct tax on payment

and to a deduction in computing his total income.

Secondly, there are cases where the payments are

all treated as capital and are neither taxable to

the recipient nor deductible in computing the

payer's total income. Thirdly, there are cases

where the payments must be dissected into an

income content and a capital content so that the

former part is taxable and deductible whilst the

latter is not."

On facts, the case before was classified as falling under the

third category and it was held that the question, whether, the

payment is capital or revenue has to be considered in relation to

the facts of each case and the true nature of the payment has to be

ascertained from the documents and all the surrounding

circumstances with the important features to consider being the

nature of the original obligation, the period of time during which

77

the payments are to continue, whether or not they are expressed in

the form of instalments of some capital sum and what provisions,

if any, are made for commutation.

Further, four tests in deciding the question, whether, a

particular expenditure is allowable or not were also quoted from the

same treatise. The said extract is as under:

"In general, however, in order to decide whether

some particular expenditure of a trader should be

brought into account, four tests, similar to those

considered in relation to receipts, should be

applied. First, is the expenditure wholly and

exclusively laid out for the purposes of the trade?

If not, it will be excluded. Secondly, is the

expenditure of a revenue, and not of a capital

nature ? Unless it is of a revenue nature it will be

excluded. Thirdly, may tax be deducted and

retained on payment ? If so, it will be excluded.

Finally, is there some other special provision of

the Income-tax Act which permits, or requires,

the payment to be brought in, or left out of

account ?"

Therefore, in the said case, the Madras High Court held that

the payments were of revenue character and that there were no

elements present which would justify the court in attributing to the

payments a capital character. The payments were fixed with

reference to the profits which were indirectly related to the

turnover. The payments were not related to any specified sum

which was agreed upon by the parties as purcha se price of the

78

business. The decision of the Madras High Court was upheld by

this Court.

(d) Sri Datar has also referred to the decision of this Court in Mewar

Sugar Mills Ltd. In the said case, a licence was granted by the

then ruler of Udaipur State for the manufacture of sugar which was

to be a monopoly enduring to the assessee’s benefit for thirty two

years. One of the conditions was that no permission would be

granted to any other person for starting a sugar factory for a period

of thirty-two years from the date of the said order. Another

condition was that royalty must be charged on the

sugar manufactured in the factory. No other tax was to be

charged. After the grant of the monopoly, a limited company was

floated called the Mewar Industries Ltd. and the company took

steps to set up a factory, obtained requisite machinery and

installed it. After completion of the factory, production could not be

started on account of financial difficulties. As a result, an

agreement was entered into with two other persons to acquire from

the company all the rights and assets held by it for the unexpired

period of twenty-eight years and to run the business in

consideration of the payment of 10% of the net profits. Before this

Court, two controversies arose, namely, i) relating to the deduction

of the payments made by the appellant therein for monopoly rights

and ii) concerning the payment to the State of the royalty of the

price of sugar manufactured by the company. The challenge to the

79

question as to the disallowance of the payments made by the

assessee in respect of the monopoly rights was given up. The only

other question being that the payment of 2% royalty on the price of

sugar manufactured by the appellant therein was relatable to the

monopoly rights and therefore was capital expenditure was

considered.

It was found that the payment of the 2% royalty on the price of

sugar manufactured by the appellant therein had no relationship

with the payment referable to the monopoly conferred under the

grant. It was observed that on the facts and circumstances of the

said case, the expenditure incurred, that is, payment of 2% royalty

payment on the sugar manufactured was a revenue expenditure

while the payment made in respect of the monopoly rights obtained

was of a capital nature.

The applicability of the judgments discussed hereinabove to

the case at hand, shall be examined at a later juncture.

15. A tabular representation outlining the classification of different

transactions by this Court in various cases, is as under:

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

1. Assam Bengal

Cement Co.

Ltd. vs.

Commissioner

of Income Tax,

Payment made by

the assessee for

acquiring a lease of

mine stone quarries

for the manufacture

Capital

expenditure

It was held that the

expenditure was not a

part of working or

operational expenses, but

was for acquiring a capital

80

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

West Bengal,

(1955) 27 ITR

34 (SC).

of cement, for a

period of twenty

years, on payment

of yearly rent as well

as a protection fee to

ward off

competition.

asset. The expenditure

was held to be a capital

expenditure although it

was payable per annum,

as it protected and gave

the right to the assessee to

carry on business

unfettered by outsiders.

2. Member of the

Board of

Agricultural

Income Tax,

Assam vs.

Sindhurani

Chaudurani,

(1957) 32 ITR

169 (SC).

Lump-sum payment

(non-recurring)

made by the

prospective tenant

to the landlord as

consideration for

settlement of

agricultural land.

Capital

expenditure

It was held that such

payment was not in the

nature of rent, but in the

nature of capital

expenditure as the same

was incurred prior to the

coming into effect of the

landlord-tenant

relationship.

1. 3. Pingle

Industries

Ltd. vs.

Commissioner

of Income Tax,

(1960) 40 ITR

67 (SC).

Lump-sum amount,

payable in

instalments for

acquiring exclusive

monopoly rights to

extract flag stones

from certain

quarries.

Capital

expenditure

That the assessee had

acquired through the long

term lease, the right to

extract stones and that

the lease conveyed to the

assessee a part of the

land. The lease was held

to be a capital asset,

which could be converted

into stock-in-trade.

2. 4. Commissioner

of Income Tax,

U.P. vs

Maheshwari

Devi Jute Mills

Ltd., (1965) 57

ITR 36 (SC).

Receipt of the

assessee on sale of

loom-hours.

Capital

receipt

That the surplus loom-

hours were disposed of by

the assessee and no

interest remained therein

with the assessee. It was

not a case of exploitation

of the loom hours by

permitting an additional

user, while retaining

ownership. Therefore,

receipt by sale of loom

hours must be regarded

as a capital receipt.

3. 5. R.B. Seth

Moolchand

Suganchand

Prospecting licence

fee and tender

money for mica

Capital

expenditure

That 1/20

th of the licence

fee could not be claimed

as revenue expenditure on

81

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

vs.

Commissioner

of Income Tax,

Delhi, (1973) 3

SCC 257.

mining rights for a

period of twenty

years.

a yearly basis. That the

lease in question was for a

long period; the amount

paid was for acquiring a

right of enduring nature

to extract and remove the

Mica and bring it to the

surface.

4. 6. CIT, Bombay

vs. Jalan

Trading Co.,

(1985) 4 SCC

59.

75% profit share,

paid as

consideration under

a deed of

assignment, for the

right to carry on

business.

Capital

expenditure

That what was conveyed

was the right to carry on

the whole business and

what was agreed to be

paid was a profit share of

75% every year, as

consideration to acquire

this right. The fact that

the payments were made

annually would have no

bearing on the nature of

the transaction.

5. 7. Commissioner

of Income Tax

vs. Bombay

Burmah

Trading

Corporation,

(1986) 161 ITR

386 (SC).

Lump-sum

consideration paid

by the assessee for

surrender of export

rights in a forest

lease, where the

assessee had the

right to extract and

cut timber and

remove them on

payment of royalty.

Capital

expenditure

That the payment was for

sterilisation of the profit-

making apparatus, i.e.,

the capital asset. The

payment was not only

with a view to earn profit

in a new form, but was

made to structure the

assessee’s profit-making

apparatus and affected

the conduct of business.

6. 8. Aditya

Minerals Pvt.

Ltd. vs.

Commissioner

of Income Tax,

(1999) 239 ITR

817.

Advance rent for

fifteen years to be

paid, calculated at

the rate of Rs. 35/-

per month, for lease

of land for

excavation of

minerals and

subsidiary

purposes.

Capital

expenditure

That the rent paid by the

assessee was in the

nature of a deposit and

was adjustable against

the rent of each month.

Since the rent for the

entire period of lease was

paid in advance, the

expenditure would be

capital expenditure.

Reliance was placed on

Pingle Industries Ltd.

82

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

7. 9. Enterprising

Enterprises

vs. Deputy

Commissioner

of Income Tax,

(2007) 293 ITR

437 (SC).

Proportionate lease

rent paid by mining

lessee for acquiring

leasehold right for

extracting minerals

from mineral

bearing land.

Capital

expenditure

Acquisition of a leasehold

right to extract minerals.

8. 10. M/s Gotan

Lime

Syndicate vs.

Commissioner

of Income Tax,

(1966) 59 ITR

718 (SC).

Royalty paid by the

assessee per annum

in lieu of a mining

lease/ rights to

excavate limestone

in a certain area.

Revenue

expenditure

That the lease was for

excavation of limestone

alone and no other rights

were created in

immovable property. That

the royalty paid was not a

payment for securing

enduring advantage but

was a payment in order to

obtain raw material and

hence, was in the nature

of a revenue expenditure.

11. Commissioner

of Income

Tax vs. Best

and Co. (Pvt.)

Ltd. (1966) 60

ITR 11 (SC).

Compensation

received by the

assessee on account

of cancellation of

one of its agencies.

Revenue

receipt

That the assessee had

innumerable agencies in

different lines and had

given up only one, to

continue business in

other lines. Loss of agency

was in the normal course

of business and a part of

normal business,

therefore, the amount

received as compensation

was revenue in nature.

12. Travancore

Sugars and

Chemicals

Ltd. vs.

Commissioner

of Income-tax,

(1966) 62 ITR

566 (SC).

Payment of 20% of

the annual net

profits subject to a

maximum of

Rs.40,000/- which

was to be paid to the

Government by the

assessee, in

addition to a one-

time cash

consideration, on

taking over three

Revenue

expenditure

That the payment was to

be made for an indefinite

period and had no

limitation of time attached

to it; The payment was

related to the annual

profits which flowed from

the trading activities of

the appellant-company

and had no relation to the

capital value of the assets.

83

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

undertakings run

by the Government

of Travancore.

13. Commissioner

of Income Tax,

Bombay City I

vs. CIBA India

Ltd., (1968) 69

ITR 692 (SC).

Contribution

payable by the

assessee at the rate

of 6% of the net

selling price, to the

Swiss Company, on

receiving the

formula, scientific

data, working rules

and prescriptions

pertaining to the

manufacturing and

processing of

products discovered

and developed in the

Swiss Company’s

laboratories.

Revenue

expenditure

That the assessee did not

become entitled, even for

the period of the

agreement to the patents

and trademark of the

Swiss Company. That the

assessee merely had a

licence to trade and

access to the patents and

trademark of the Swiss

Company for the limited

period of the agreement.

That the assessee did not

acquire any asset or

advantage of enduring

nature.

14. Jabbar (M.A.)

vs.

Commissioner

of Income Tax,

Andhra

Pradesh,

(1968) 68 ITR

493 (SC).

Payment made for a

short term lease of

eleven months for

quarrying and to

carry away, sell and

dispose of sand

which was lying on

the surface of a river

bed.

Revenue

expenditure

That the lease was for a

short period and the

expenditure incurred by

the assessee was not

related to the acquisition

of an asset or of a right of

enduring nature, but

merely to obtain stock-in-

trade in the form of sand.

15. Lakshmiji

Sugar Mills

Co. Pvt. Ltd.

vs.

Commissioner

of Income Tax,

(1972) 82 ITR

376 (SC).

Expenditure

incurred on

construction and

development of

roads between

different sugarcane

producing centres

and sugar factories.

Revenue

expenditure

That the said expenditure

was incurred for the

purpose of providing ease

of transportation to the

assessee and facilitating

the assessee’s business.

There was no evidence to

show that without such

roads, the assessee would

be unable to carry on

business. Therefore, the

expenditure was incurred

merely for commercial

expediency.

84

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

16. Devidas

Vithaldas and

Co. vs. C.I.T.,

Bombay City,

(1972) 3 SCC

457.

Purchase price (as a

percentage of

profits), paid on

acquisition of a

running business,

as consideration for

the right to use the

goodwill of the

business.

Revenue

Expenditure

(Majority of

3:1; Sikri C.J.

Dissenting)

That the transaction did

not amount to the sale of

goodwill, as the duration

of the payment as also the

amount of consideration

was indefinite as they

depended on the rise and

fall in the profits of the

business. It was held that

where the acquisition is

not of the goodwill itself

but for the rights to use it,

the expenditure in the

nature of royalty would be

a revenue expenditure.

17. Mewar Sugar

Mills Ltd. vs.

CIT, (1973) 3

SCC 143.

i. Payment made by

the assessee to

acquire monopoly

rights to

manufacture

sugar in Udaipur;

ii. 2% royalty paid

to the ruler of

Udaipur State on

the price of the

sugar

manufactured.

Payment of

two percent

royalty on the

sugar

manufacture

was held to be

revenue

expenditure

while the

payment

made in

respect of the

monopoly

rights

obtained was

held to be of

capital

nature.

That payment of

the two per cent royalty

on the price of sugar

manufactured by the

appellant therein had no

relationship with the

payment in reference to

the monopoly conferred

under the grant.

18. Empire Jute

Co. Ltd vs.

Commissioner

of Income Tax,

(1980) 124 ITR

1 (SC).

Payment made by

the assessees for

purchase of loom

hours, and for

allotment of hours

of work per week,

under a contractual

agreement between

various mills ,

restricting the right

Revenue

Expenditure

The payment made by the

assessees for purchase of

loom hours was held to be

expenditure incurred as

part of the process of

profit earning. The said

expense was categorised

as an outlay of a business

in order to carry it on and

to earn profit out of the

expense. It was concluded

85

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

of every mill to work

at full capacity.

that the expense was a

part of the cost of

operating the profit

earning apparatus and

was clearly in the nature

of revenue expenditure.

19. L.H. Sugar

Factory and

Oil Mills Pvt.

Ltd. vs.

Commissioner

of Income Tax,

U.P., (1980)

125 ITR 293.

i. Assessee’s

contribution

towards the

construction of

a dam,

pursuant to the

request of the

Collector;

ii. Expenditure

incurred by the

assessee

towards the

construction of

roads in the

area around its

factory, under a

Sugarcane

Development

Scheme floated

by the State

Government.

i. Merely an

act of good

citizenship

and not

“deductibl

e

expenditur

e”.

ii. Revenue

expenditur

e

i. That the assessee’s

contribution towards

the construction of a

dam, carried no

advantage for the

business of the

assessee. The same

was contributed

without any obligation

to do so and was

simply an act of good

citizenship and hence,

not deductible.

ii. That construction of

roads in the area

around the assessee’s

factory would be

considerably

advantageous to the

business of the

assessee as it would

facilitate transport of

sugarcane into the

factory and

manufactured sugar

out of the factory.

Hence, such

expenditure was

indubitably connected

with the business

activity of the

assessee.

20. Commissioner

of Income Tax

vs. Associated

Cement

Companies

Ltd., (1988)

Expenditure

incurred by the

assessee under a

tripartite agreement

with the State

Government and

Revenue

expenditure

That the advantage

secured by the assessee

by making the

expenditure was the

securing of absolution or

immunity from liability to

86

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

172 ITR 257

(SC).

Municipality of

Shahabad, to

supply water and

electricity to

Shahabad and to

concrete the road

from the factory to

the railway station.

In consideration of

these amenities to

be provided by the

assessee company,

the assessee

secured immunity

from payment of

municipal taxes for

a period of 15 years.

pay municipal rates and

taxes for a period of

fifteen years. If these

liabilities had been paid,

the payments would have

been on revenue account

and hence the advantage

secured was in the field of

revenue and not capital.

As a result of the

expenditure there was no

addition to the capital

assets of the assessee

company and no change

in its capital structure.

The pipelines which came

into existence as a result

of the expenditure

belonged to the

Municipality.

21. Alembic

Chemical

Works Co. Ltd.

vs.

Commissioner

of Income Tax,

Gujarat (1989)

177 ITR 377

(SC).

One-time payment

made under an

agreement with a

foreign firm by the

assessee to obtain

technical

knowhow, for incr

easing yield of

penicillin in its

existing plant with a

condition to keep

the said know-how

confidential.

Revenue

expenditure

First, that the expenditure

was incurred for the

purpose of existing day-

to-day business, i.e.,

manufacture of penicillin

and not for an entirely

new venture unconnected

or different from the

existing business;

Second, that given the

rapid advancements in

the field of medicine, a

degree of durability and

permanence cannot be

attributed to the technical

know-how, particularly

when it is not a case of

exclusive acquisition.

22. Jonas

Woodhead

and Sons.

India Ltd. vs.

Commissioner

of Income Tax,

i. Payment made

towards

accessing the

know-how and

technical

information

The

consolidated

payments

made were

apportioned

and 25%

Under the agreement with

the foreign company,

what was set up by the

assessee was a new

business and the foreign

company had not only

87

Sl.

No.

Citation Transaction In

Question

Classification

of the

Transaction

in Question

by this Court:

Reasons for

classification:

(1997) 224 ITR

342 (SC).

regarding the

setting up of a

plant;

ii. Payment in the

form of royalty

for the services

to be rendered

to the assessee

by the foreign

firm.

thereof was

held to be in

the nature of

capital

expenditure

while 75%,

payable on

services, was

held to be

revenue

expenditure.

furnished information

and technical know-how

but had also rendered

valuable services in the

setting up of the factory

itself. That even after

expiry of the agreement

there was no embargo on

the assessee to continue

to manufacture the

product.

23. Commissioner

of Income Tax

vs. Madras

Auto Services

Pvt. Ltd.,

(1998) 233 ITR

468 (SC).

Expenditure

incurred by the

assessee on

demolishing an

existing building

and constructing a

new building,

during the

subsistence of a 39

year lease,

whereafter, the

assessee continued

to be a lessee in the

building which

belonged to the

lessor.

Revenue

expenditure

That the asset created,

though of an enduring

nature, did not belong to

the assessee.

24. Honda Siel

Cars India

Ltd. vs.

Commissioner

of Income Tax,

Ghaziabad,

(2017) 8 SCC

170.

Lump-sum fee

payable by the

assessee to M/s

Honda Motors

Company Ltd.,

Japan in five

continuous

instalments after

commencement of

commercial

production of

Honda cars by the

assessee, under a

licensing and

technical assistance

agreement between

the parties.

Revenue

expenditure

That the payment w as

made by the assessee, not

to set up the plant to

manufacture Honda cars

but so as to obtain the

licence to manufacture

Honda cars in India,

which were its stock in

trade. That the agreement

was framed in a manner

as to give licence for a

limited period, having no

enduring nature.

88

Details of certain decisions of various High Courts, which have also

been considered are presented in the table hereinbelow:

Sl.

No.

Cause Title

and Citation

Transaction in

Question

Classification of

the Transaction

in question by

the High Court:

Reasons for

classification:

1. Mohan Meakin

Breweries Ltd.

vs.

Commissioner

of Income Tax,

(1997) 220 ITR

878. (High

Court of

Himachal

Pradesh,

Shimla)

Annual payment

made to the State

towards licence fee

for

working/operating

of a distillery.

Capital

expenditure

That but for the licence

so obtained, the

assessee could not have

established the

distillery.

2. Commissioner

of Income Tax

vs. Sarada

Binding

Works, (1976)

102 ITR 187

(Madras High

Court)

i. Payment made

by the

assessee, of a

fixed sum of

Rs. 5000/- per

annum to

acquire the

right to run the

business of

‘Chandamama

Publications’;

ii. Royalty paid

annually on

sales

equivalent to

10% of the

annual net

profits.

i. The

expenditure

incurred

towards the

right to run

the business

of

‘Chandamam

a

Publications’

was held to

be Capital

expenditure;

ii. Royalty was

held to be in

the nature of

revenue

expenditure.

That payments

calculated as a certain

percentage of profits of

a business for an

indefinite period of time

cannot be treated as

payments by

instalments of a capital

sum. The payment of

royalty was related to

the future profits of the

assessee and had no

nexus with the capital

sum.

3. Commissioner

of Income Tax

vs. Southern

Switch Gear

Ltd., (1984)

148 ITR 272

(Madras High

Court)

Decision

affirmed by

i. Payment of

technical

collaboration/

technical aid

fees by the

assessee to a

foreign

company;

ii. Royalty

payable in five

i. Technical

collaboration

fee was held

to be capital

expenditure;

ii. 25% of the

royalty was

held to be

capital in

nature, while

That by making a

payment of royalty, the

assessee had acquired

an exclusive privilege to

manufacture and sell

the products.

Therefore, the said

expenditure was to be

treated partly as capital

and partly revenue. The

89

Sl.

No.

Cause Title

and Citation

Transaction in

Question

Classification of

the Transaction

in question by

the High Court:

Reasons for

classification:

this Court in

Southern

Switch Gear

Ltd. vs. CIT,

(1998) 232 ITR

35 (SC).

instalments

for the

acquisition of

an exclusive

privilege of

manufacturin

g and selling

the products.

75% was

stated to be

revenue

expenditure.

value of the royalty

related to the

acquisition of the right

of enduring nature was

estimated at 25% and

treated as capital

expenditure, while the

rest was stated to be

revenue expenditure.

4. CIT vs. Saw

Pipes Ltd.,

(2008) 300 ITR

35 (High Court

of Delhi)

Service charges

paid by the

assessee to

Maharashtra State

Electricity Board

(MSEB) to set up a

service line for

supplying

electricity, as part

of an arrangement

wherein the

ownership of the

cables would

remain with the

MSEB.

Revenue

expenditure

That the service lines

did not belong to the

assessee but to the

MSEB and were laid out

to enable the assessee

to conduct its business

more effectively. Hence,

the same was to be

regarded as revenue

expenditure.

5. CIT vs. J.K.

Synthetics,

(2009) 309 ITR

371 (High

Court of Delhi)

Payment made by

the assessee under

an agreement to

access technical

information of a

foreign company,

whereby there

would be no

transfer of

ownership of the

know-how in

favour of the

assessee, and the

access was granted

on a non-exclusive

basis.

Revenue

expenditure

That the assessee only

acquired “access” to the

technical information

which related to the

process of

manufacture, which

was not related to any

secret process or

intellectual property

rights. The products in

question were already

being manufactured by

the assessee and the

know-how would only

increase the assessee’s

profitability. Therefore,

the expenditure would

be in the nature of

revenue expenditure.

6. Commissioner

of Income Tax

Royalty payable

annually by the

Revenue

expenditure

That since royalty was

payable on the quantity

90

Sl.

No.

Cause Title

and Citation

Transaction in

Question

Classification of

the Transaction

in question by

the High Court:

Reasons for

classification:

vs. Sharda

Motors, (2009)

319 ITR 109

(High Court of

Delhi)

assessee, on the

number of pieces

manufactured, to a

Korean Co. which

had provided

technical know-

how to the

assessee.

of the good produced,

the same would be

revenue expenditure.

7. CIT vs. Modi

Revlon Pvt.

Ltd., 2012

SCC OnLine

Del 4463 (High

Court of Delhi)

Royalty

consideration paid

by the assessee

annually, as a

percentage of sales

price, to Revlon

Mauritius Ltd. for

supply of technical

know-how to

manufacture

goods.

Revenue

expenditure

That notwithstanding

the fact that the

assessee was the sole

licencee of the brand

within a given territory,

expenditure would be

revenue in nature

because the ownership

of the brand continued

to be with Revlon

Mauritius. That there

was nothing in the

agreement suggestive of

any vesting of the

know-how or part of it,

or the goodwill of the

brand, in the assessee.

16. We may also refer to some decisions of the Courts in England,

with a view to cull-out certain tests, which, although should not be

treated as over-exacting, may suggest some broad and general

guidelines to ascertain as to which side of the line the outlay in any

particular case might reasonably be held to fall.

16.1. The City of London Contract Corporation Ltd. vs. Styles,

(1887) 2 TC 239 is the first of the line of cases where courts in England

considered the issue as to the categorisation of expenditure, as capital

91

or revenue. Bowen, L.J. broadly indicated that the outlay on the

"acquisition of the concern" would be capital while an outlay in "carrying

on the concern" is revenue.

16.2. In Vallambrosa Rubber Co. Ltd. vs. Farmer, (1910) 5 T.C.

529, Lord Dunedin observed that a proposition could be stated “in a

rough way”, to the effect that capital expenditure is a thing that is going

to be spent once and for all and income expenditure is a thing which

will incur every year.

This test was adopted by Rowalatt J. in Ounsworth (Surveyor of

Taxes) vs. Vickers Ltd., (1915) 3 K.B. 267 (“Vickers Ltd.”) wherein

it was observed that the real test was between expenditure which was

made to meet a continuous demand for expenditure as opposed to an

expenditure which was made once and for all. In the course of the

judgment however, it was suggested that what was determinative was

whether the particular expenditure could be put against any particular

work or whether it was to be regarded as an enduring expenditure to

serve the business as a whole.

16.3. The latter guideline laid down in Vickers Ltd. served as the

foundation for the test prescribed by Viscount Cave L.C. in the oft-cited

case on the subject, British Insulated Helsby Cables Ltd. vs.

Atherton, (1926) AC 205 (“Atherton”), wherein it was observed that

when an expenditure is made, not only once and for all, but with a view

to bringing into existence an asset or an advantage for the enduring

92

benefit of trade, such an expenditure is property attributable to capital

and not to revenue.

16.4. The expression "enduring benefit of a trade" was further explained

as meaning not "everlasting", but "in the way capital endures" vide Du

Parcq, L.J., in Henriksen vs. Grafton Hotel Ltd., (1942) 24 T.C. 453.

In the said case, Lord Greene stated that if the sum payable is not in

the nature of revenue expenditure, it cannot be made so by permitting

it to be paid by annual instalments. The payments by instalments in

respect of monopoly value do not have the quality of annual payments

or the grant of the annual excise licence, but are of a different character

altogether.

16.5. Viscount Haldane however, in John Smith & Son vs. Moore,

(1921) 12 T.C. 266, suggested another test- the test of fixed or

circulating capital. Fixed capital being what the owner turns to profit by

keeping in his possession; circulating capital is what the assessee

makes profit from by parting or letting the product/asset change hands.

However, in the said case, it was observed that the demarcation line

between assets out of which profits were earned and the profit made

upon assets or with assets, was thin and difficult to draw in several

cases.

16.6. It was clarified in Mallet vs. Staveley Coal and Iron Co., (1928)

2 K.B. 405 (“Mallet”) that where the expenditure is to bring into the

93

hands of the company a necessary ingredient of their existing business,

which is important but still ancillary to the business, the expenditure

is to be debited to the circulating capital rather than to the fixed capital,

which is employed in and sunk in the permanent assets of the business.

16.7. The test of fixed or circulating capital was also adopted by Lord

Hanworth, M.R. in Anglo-Persian Oil Co. vs. Dale, (1932) 1 K.B. 124

(“Dale”) wherein it was observed:

“I am inclined to think that the question whether the

money paid is provided from the f ixed or the

circulating capital comes as near to accuracy as can

be suggested.”

In further elucidation of the principle, it was laid down as follows:

a) The expenditure is to be attributed to capital if it be made “with

a view” to bringing an asset or advantage into existence, however,

it is not necessary that it should always achieve the intended

result in order to be held to be capital in nature. Thus the sum

spent in trying to procure an agency agreement or a licence, may

be capital expenditure though the intended agency or licence may

not be ultimately secured.

b) By ‘enduring’, it is meant “enduring in the way that fixed capital

endures” and it does not connote a benefit that endures in a sense

that for a good number of years it relieves the assessee of a

revenue payment.

94

However, in Van Den Berghs, Limited vs. Clark (H.M.

Inspector of Taxes), (1935) 19 T.C. 390, Lord Macmillan veered

round to the test of enduring benefit and expressed reservations

regarding the test of fixed and circulating capital. That “where the

character of the expenditure shows that what has resulted is

something which is to be used in the way of business, the test may

be useful; but in cases close to the dividing line, the test seems

useless.”

16.8. A third test was propounded in Robert Addie & Sons Collieries

Ltd. vs. Commissioners of Inland Revenue, (1924) 8 T.C. 671, while

determining whether a given expenditure is capital or revenue in

nature:

"Is it part of the Company's working expenses, is it

expenditure laid out as part of the process of profit-

earning? or, on the other hand, is it a capital

outlay, is it expenditure necessary for the

acquisition of property or of rights of a permanent

character, the possession of which is a condition of

carrying on its trade at all?"

The said test was adopted by the Privy Council in Tata Hydro-

Electric Agencies Ltd., Bombay vs. Commissioner of Income-tax,

(1937) L.R. 64 IndAp 215 wherein it was stated that the expenditure

which is part of the working expenses in ordinary commercial trading

was not capital but revenue. It was further observed that the

determinative question would be whether the expenditure is “a part of

95

the company's working expenses; is it expenditure laid out as part of the

process of profit earning ?”

Referring to the facts of the said case, the Privy Council came to

the conclusion that the obligation to make the payments was

undertaken by the appellants therein in consideration of their

acquisition of the right and opportunity to earn profits, i.e., of the right

to conduct the business and not for the purpose of producing profits

in the conduct of the business. The distinction was thus made between

the acquisition of an income-earning asset and the process of the

earning of the income. Expenditure in the acquisition of that asset was

capital expenditure and expenditure in the process of the earning of

the profits was revenue expenditure. It was further observed that on

acquisition of a business and when a liability to pay yearly sums is

taken over, those yearly sums were not deductible in computing future

profits for tax purposes, as they form a part of the consideration for the

acquisition of the business.

16.9. A similar guideline was expressed in Sun Newspapers Limited

and the Associated Newspapers L imited vs. The Federal

Commissioner of Taxation , (1938) 61 C.L.R. 337, wherein it was

stated that the expenditure incurred towards establishing, replacing

and enlarging the profit yielding subject must be contrasted with the

continual flow of working expenses, which ought to be supplied

continually out of the returns of revenue. While the former category of

96

expenditure would be capital in nature, the latter would be revenue. It

was further held that while applying the ‘enduring benefit’ test the

words, ‘permanent’ or ‘enduring’ are not to be understood to mean ever-

lasting. The distinction which is drawn is that between more or less

recurrent expenses involved in running a business and an expenditure

for the benefit of the business as a whole.

16.10. Certain supplementary tests have been laid down by the

Judicial Committee in Mohanlal Hargovind of Jubbulpore v s.

Commissioner of Income Tax, (1949) L.R. 76 IndAp 235 wherein

the assessee had paid for purchasing tendu leaves from the forest,

which right included the right of entry and coppicing and pollarding.

The said expenditure was for acquiring the raw materials for the

manufacturing business and thus a capital expenditure. In the said

case, the assessee was a paid manufacturer who had obtained short-

term contracts with the Government and other forest owners to obtain

tendu leaves from the forests. The Judicial Committee held that these

contracts were, in a business sense, for the purp ose of securing

supplies to the manufacturers of one of the raw materials of his

business. They granted no interest in land or the plants or trees and

therefore, the expense incurred in this regard was not a capital

expenditure.

97

17. A study of the aforesaid decisions of the Courts of England would

reveal that the following factors have guided the Courts in the said

jurisdiction in determining the nature of transactions:

i. Periodicity of payments: In the broadest sense, capital

expenditure is a thing that is going to be spent once and for all and

income expenditure is a thing which will incur every year. However,

expenditure which is not ‘once and for all’ may nevertheless be

capital. Expenditure of a recurring nature on the acquisition of

assets which are clearly fixed rather than circulating capital,

remains capital. Moreover, an outgoing does not cease to be of a

capital nature merely because it is payable in instalments, vide CIR

vs. Adam, (1928) 14 T.C. 34. The test is therefore to determine,

whether, the payment is made as a matter of such frequent

recurrence that it is a part of ordinary working expenditure,

Bonner vs. Basset Mines Ltd., (1912) 6 T.C. 145.

ii. Object of the expenditure: The Atherton test looks to the purpose

or motive of expenditure. For expenditure to be capital it must be

spent for the acquisition, improvement or disposal of a capital

asset, vide Rolfe vs. Wimpy Waste Management Ltd., (1989) 62

T.C. 399; Tucker vs. Granada Motorway Servi ces Ltd., (1979)

53 T.C. 92 (“Tucker”); Mallet, respectively. However, the

relationship between the expenditure and the acquisition,

improvement or disposal of a capital asset must be proximate and

not remote. For instance, payment made to staff could not be said

98

to be payment made for acquisition of goodwill and hence capital

in nature, although, the staff by serving well may help create the

goodwill, vide Lawson vs. Johnson Matthey Plc., (1992) 65 T.C.

39.

iii. Identifiable asset test: It is necessary to identify a specific capital

asset for which the expenditure is incurred, vide Tucker. When the

asset is an intangible benefit (licences, trading agreements etc.) it

will be necessary to ask whether the identifiable asset is of a

sufficiently substantial and enduring nature to count as capital,

vide Dale; CIR vs. Carron Company, (1968) 45 T.C. 18; Heather

vs. PE Consulting Group Ltd., (1972) 48 T.C. 293.

iv. Expenditure on commercial advantages generally: Expenditure

on commercial advantages dependent on a particular trading

relationship is likely to be capital only if a permanent advantage,

such as the closing down of a potentially damaging competitor, is

secured by the payment, Walker vs. The Joint Credit Card Co.,

(1982) 55 T.C. 617. However, expenditure which is incurred

towards general business convenience (such a s to facilitate

transport, supply-chain management, obtain temporary advantage

over a competitor etc.) is of revenue nature, CIR vs. Nchanga

Copper Mines, (1964) 1 All ER 208 (“Nchanga Copper Mines ”).

v. Effect, if any, of the expenditure on the profit-making

structure: The question to consider is, whether, the payment was

made with a view to earn profit in a new form, or to structure the

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assessee’s profit making apparatus. While the former category of

expenditure would be revenue in nature, the l atter would be

capital.

18. The test that was adopted, almost universally, in the early

decisions in India, is akin to the one laid down by Viscount Cave L.C.

in Atherton.

18.1. In Commissioner of Income Tax, Bombay vs. Century

Spinning, Weaving and Manufacturing Co., (1942) 10 ITR Suppl.,

M.C. Chagla J. observed that the legal touchstone which is most

familiarly applied in the Indian context is that of Viscount Cave in

Atherton's case.

18.2. In Benarsidas Jagannath, In re, (1946) 15 ITR 185 , a Full

Bench of the Lahore High Court attempted to reconcile the tests

referred to hereinabove and deduced the following broad tests for

distinguishing capital expenditure from revenue expenditure:

“It is not easy to define the term 'capital expenditure'

in the abstract or to lay down any general and

satisfactory test to discriminate between a capital and

a revenue expenditure. Nor is it easy to reconcile all

the decisions that were cited before us for each case

has been decided on its peculiar facts. Some broad

principles can, however, be deduced from what the

learned Judges have laid down from time to time. They

are as follows :-

1. Outlay is deemed to be capital when it is made for

the initiation of a business, for extension of a

business, or for a su bstantial replacement of

equipment : vide Lord Sands in Commissioners of

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Inland Revenue v. Granite City Steamship

Company (1927) 13 T.C. 1, 14 ). In City of London

Contract Corporation v. Styles ((1887) 2 T.C. 239),

at page 243, Bowen, L.J. observed as to the capital

expenditure as follows :

"You do not use it 'for the purpose of' your

concern, which means, for the purpose of

carrying on your concern, but you use it to

acquire the concern."

2. Expenditure may be treated as properly

attributable to capital when it is made not only once

and for all, but with a view to bringing into existence

an asset or an advantage for the enduring benefit of a

trade : vide Viscount Cave, L.C., in Atherton v.

British Insulated and Helsby Cables Ltd. ((1925)

10 T.C. 155). If what is got rid of by a lump sum

payment is an annual business expense chargeable

against revenue, the lump sum payment should

equally be regarded as a business expense, but if the

lump sum payment brings in a capital asset, then that

puts the business on another footing altogether. Thus,

if labour saving machinery was acquired, the cost of

such acquisition cannot be deducted out of the profits

by claiming that it relieves the annual labour bill, the

business has acquired a new asset, that is,

machinery. The expressions 'enduring benefit' or 'of a

permanent character' were introduced to make it clear

that the asset or the right acquired must have enough

durability to justify its being treated as a capital asset.

3. Whether for the purpose of the expenditure, any

capital was withdrawn, or, in other words, whether

the object of incurring the expenditure was to employ

what was taken in as capital of the business. Again, it

is to be seen whether the expenditure incurred was

part of the fixed capital of the business or part of its

circulating capital. Fixed capital is what the owner

turns to profit by keeping it in his own possession.

Circulating or floating capital is what he makes profit

of by parting with it or letting it change masters.

Circulating capital is capital which is turned over and

in the process of being turned over yields profit or loss.

Fixed capital, on the other hand, is not involved

directly in that process and remains unaffected by it."

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19. It may be useful at this juncture, to attempt to cull out the broad

principles/tests that have been forged and adopted by this Court from

time to time, while determining whether a given expenditure is capital

or revenue in nature:

i. Capital expenditure is one met with a view to bring into existence

an asset for the enduring benefit of the trade. However, this rule is

not applicable in every case. The nature of the advantage acquired

has to be considered in the commercial sense and only when the

advantage is in the capital field, deduction on the said expenditure

could be disallowed by applying the enduring benefit test. If the

advantage consists merely of facilitating trading operations or

enabling the management or conduct of business more effectively

or profitably, while leaving the fixed capital untouched, the said

expenditure would be on revenue account, though the advantage

may endure for an indefinite period, vide Empire Jute Co. Ltd.

Therefore, the enduring benefit test is not conclusive and cannot

be mechanically applied without considering the commercial aspect

of the transaction involving the expenditure in question.

ii. Where the expenditure is made for the initial outlay or for extension

of a business, or a substantial replacement of the equipment, it is

capital expenditure. If the expenditure is for running the business

or working it with a view to produce profits, it is revenue

expenditure, vide Assam Bengal Cement Co. Ltd. What also

follows from this test is that expenditure which relates to the very

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framework or structure or edifice of the taxpayer’s business is

capital expenditure.

iii. The fixed and circulating capital test provides that where the

expenditure is to bring into the hands of the assessee a necessary

ingredient of their existing business, which is important but still

ancillary to the business, the expenditure is to be debited to the

circulating capital (revenue account) rather than to the fixed capital

(capital account).

iv. Where there is no enlargement of the permanent structure or of

capital assets and the expenditure essentially relates to the

operation or working of the existing apparatus, such an

expenditure would be on revenue account, vide Empire Jute Co.

Ltd.

v. The question as to whether an expenditure is capital or revenue in

nature is to be judged in every case in the context of business

necessity or expediency. The first aspect to be considered is

whether, the expenditure is a part of the assessee’s working

expenditure or a part of profit earning. Further, an inquiry must be

made as to, whether, the expenditure was necessary to acquire a

right of permanent character, the possession of which is a condition

precedent for carrying on a particular trade. In the event that the

answer to the first question is in the negative and the second

question is in the affirmative, the expenditure is inarguably capital

in nature. In this context, we are of the view that the decision of

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this Court in Alembic Chemical Works Co. Ltd. must turn on its

own peculiar facts.

vi. Thus, the aspect to be considered is whether the expenditure is

incurred for the purpose of the existing day-to-day business of the

assessee, or with a view to commence an entirely new venture .

Where the expenditure incurred is merely to enhance the

productivity or profitability of an existing business, without making

significant changes to the structure of the assessee’s profit making

apparatus, the same is revenue in nature. Alembic Chemical

Works Co. Ltd. was decided on the above premise.

vii. It is not necessary that in all cases, once and for all payment would

result in an enduring benefit, nor it is a firm rule that periodical

payment would not carry with it an enduring benefit.

viii. Mere payment of an amount in instalments does not convert or

change a capital payment into a revenue payment. Similarly, lump-

sum payment can represent revenue expenditure if it is incurred

for acquiring circulating capital though payment is made once and

for all. Likewise, payment made in instalments can be for acquiring

a capital asset, the price of which is paid over a period of time.

Therefore, what is relevant is the nature of the original obligation

and whether the subsequent payment made in instalments relates

to or has a nexus with such original obligation or not. Where the

subsequent payments, are towards a purpose which is identifiably

distinct from the original obligation of the assessee, the same would

104

constitute revenue expenditure. However, where each of the

successive instalments relate to the same obligation or purpose,

the cumulative expenditure would be capital in nature.

ix. The general principle that expenditure on the creation of a capital

asset is on capital account applies only where the capital asset

belongs to the assessee. An amount spent by the assessee may be

deductible on revenue account even if it results in the acquisition

of a capital asset by a third party, vide L.H. Sugar Factory and

Oil Mills Pvt. Ltd. vs. Commissioner of Income Tax, U.P., (1980)

125 ITR 293.

x. Another pertinent question to consider is, whether, the expenditure

is incurred towards purchase of an asset, or merely of the right to

use the asset for a given period of time on payment of a certain

consideration for the period of intended use, vide Devidas

Vithaldas and Co. Where the asset is not purchased or is not

vested with the assessee, but the assessee has simply acquired a

right to use the asset, the payment would be of revenue nature,

vide CIT vs. Modi Revlon Pvt. Ltd., 2012 SCC OnLine Del 4463

(“Modi Revlon Pvt. Ltd.”).

Payment of royalty:

20. In the present case, b efore considering the issue as to

categorisation of the variable licence fee payable as a percentage of gross

revenue, it is also necessary to understand the distinction between a

payment made to acquire a right, and payment of royalty in a broad

sense. Stated in the most simplistic manner, acquisition of a right would

105

mean purchase of an asset, tangible or intangible, for the enduring

advantage of the purchaser. When a right is said to be acquired, it

means that the ownership of the said right vests with the purchaser. By

contrast, payment of royalty is to use a right or asset. The right or asset

is not per se acquired by the person or entity authorised to use it but

continues to vest with the owner of the right. In case of royalty, payment

is made merely to secure the right to use an asset for a stipulated

duration. When the payment of royalty ceases, in most cases, the right

to use the asset also ceases. Most often, the amount of royalty to be

paid is dependent on the annual sales vide Commissioner of Income

Tax, Bombay City I vs. CIBA India Ltd., (1968) 69 ITR 692 (SC) (“CIBA

India Ltd.”); Modi Revlon Pvt. Ltd.; annual profits vide Travancore

Sugars and Chemicals Ltd.; or such other variable. Further, in order

to qualify as royalty, the payment must have no nexus with the

acquisition of a capital asset, vide Travancore Sugars and Chemicals

Ltd.; Mewar Sugar Mills Ltd.

20.1. The decision of this Court in Gotan Lime is highly instructive

while attempting to draw a distinction between payment made to

acquire a right, and payment of royalty for use of a right or asset. In the

said case, this Court considered the issue as to the classification of the

annual payment made by the assessee therein, in lieu of the right to

excavate limestone in a certain area. This Court, while holding that the

payment in question therein was revenue expenditure, reasoned that

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the payment was not for securing an enduring advantage but was a

royalty payment in order to obtain raw material and hence, a revenue

expenditure. The pertinent observations of this Court are extracted

hereinunder:

“We are of the opinion that in the present case the royalty

payment is not a direct payment for securing an enduring

advantage; it has relation to the raw material to be

obtained. Ordinarily, a mining lease provides for a capital

sum payment; but the fact that there is no lumpsum

payment here cannot by itself lead to the conclusion that

yearly payments to be made under the mining lease have

relation to the acquisition of the advantage. No material

has been placed on the record as to how any part of the

royalty must, in view of the circumstances of the case, be

treated as premium and be referable to the acquisition of

the mining lease.”

The above dictum is clear on the aspect of the distinction between

payment made to acquire a right and payment of royalty inasmuch as

it lays down in express terms that if a payment is made, not towards

securing an enduring advantage or asset, but towards a right to use an

asset, the same would be royalty. It has further been stated in no

unclear terms that where a payment is not referrable to the acquisition

of a capital asset (particularly, mining lease in the said case), but only

secures a right to use the asset, the same would be royalty and hence

classifiable as a revenue expenditure.

20.2. Relying on the decision in Gotan Lime, this Court in Mewar

Sugar Mills Ltd. while considering a transaction wherein the assessee

therein paid: (a) Lump-sum payment to acquire monopoly rights for

manufacture of sugar in Udaipur; and (b) payment to the ruler of

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Udaipur State, at the rate of 2% of the price of the sugar manufactured,

held that the payment of the 2% royalty on the price of sugar

manufactured by the appellant therein had no relationship with the

payment referable to the monopoly conferred under the grant and

hence, it was in the nature of revenue expenditure.

20.3. Another ingredient of payment as royalty is that in most cases, it

relates to and is dependent on the profit earned or sales made by

working an asset, rather than the acquisition of the asset itself. Such

periodic payments, particularly those which are based on turnover of

profit and which are not related to any predetermined lump-sum are

towards royalty and correctly deductible as revenue expenditure.

20.4. In CIBA India Ltd., this Court held that payments made for the

right to have access to technical knowledge and the fruits of continuing

research and experience of a foreign company and to use its patents

and trademarks would be chargeable on revenue account. This would

demonstrate that even where technical know-how is a capital asset,

amounts paid for its mere use, or for the use of a trademark, trade

name or the right to manufacture and sell certain goods, are allowable

as revenue expenditure in the nature of royalty as the payment is made

for the use of the asset and not for its acquisition. In such cases, the

payment of royalty, has no relation to the capital value of the asset

authorised to be used.

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21. In our view, the following considerations are immaterial in

determining the question, as to, whether, a payment is a capital

disbursement or in the nature of a revenue expenditure:

i. Lump-sum and periodical payment: Lord Greene in Inland

Revenue vs. Williams, 11 ITR Suppl. 84 famously remarked,

“There is no magic in the distinction between a lump-sum and

periodic sums”. That the expense is a periodic expense or a lump-

sum payment is immaterial for the purpose of determining its

nature. A lump-sum payment may be revenue expenditure, for

instance, when it represents the commutation of a series of annual

revenue payments; and a recurring periodic payment may be

capital expenditure, for instance when it represents the payments

by instalments of a capital sum, vide Assam Bengal Cement Co.

Ltd.

ii. Magnitude of payment : The magnitude of a disbursement is

immaterial for the purpose of determining its nature, for,

magnitude is a relative term, vide Prendergast vs. Cameron, 8

I.T.R. Suppl. 75 (HL).

iii. Entries in books of accounts: That an item of expenditure is

debited in an entity’s books of account to revenue account is by no

means conclusive of its nature. Businesses frequently prefer to

debit to the revenue account, payments which are in their nature

to be carried to capital account. Conversely, an assessee may be

entitled to a revenue deduction in respect of expenditure which is

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capitalised in the accounts, vide India Cements vs.

Commissioner of Income Tax, 60 I.T.R. 52 (SC).

22. In considering whether an item of expenditure is of a capital or

revenue nature, we reiterate that one must consider the nature of the

concern, the ordinary course of business usually adopted in that

concern and the object with which the expenditure is incurred, vide

Assam Bengal Cement Co. Ltd. Attention must be paid not only to

the form of the transaction, but also its substance. Where the

transaction takes the form of a contract or other deed, it depends upon

a proper construction of the terms of the contract whether a payment

made thereunder is a capital disbursement or revenue expenditure.

The true nature of a transaction must be gathered by placing emphasis

on the business aspect of the transaction. What is an outgoing of

capital and what is an outgoing on account of revenue depends on what

the expenditure is calculated to effect from the practical and business

point of view. This aspect of the transaction is then, to be reconciled

with juristic classification of the legal rights, if any, secured, employed,

or exhausted in the process.

22.1. Therefore, what is material is the nature of right sought to be

secured through the payment or transaction in question. The purpose

towards which the expenditure is incurred must guide any attempt to

categorise the expenditure. The structure or form of the transaction or

the payment schedule is hardly suggestive of the nature of the

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transaction. Therefore, it cannot be axiomatically held that an

expenditure which in its core, capital in nature, is actually to be treated

as a revenue expenditure simply because the payment is structured in

instalments.

22.2. The determinative test to identify whether an expenditure

structured in the form of instalments is in the nature of a capital

expenditure or revenue expenditure, would be to first assess whether

the payment made either in lump-sum or in instalments relates to the

acquisition or expansion of a capital asset, or by contrast, relates to

the working of an asset to produce profits; whether the consideration

payable towards the acquisition or expansion of a capital asset has

simply been chopped up into smaller sums payable in instalments, for

the sake of convenience. The dictum of this Court in Pingle Industries

Ltd., is relevant in this regard. In the said case, the majority judgment

stated that the payment in question therein was made with a view to

acquire a long-term lease and a right to mine stones, and the lease was

conveyed to the assessee who had to extract the stones and convert

them as a stock-in-trade. That the expenditure was incurred towards

securing a capital asset from which, after extraction, stones could be

converted into stock-in-trade. The payment, though periodic, in fact,

was neither rent nor royalty but a lump-sum payment in instalments

for acquiring a capital asset of enduring benefit to the assessee’s trade.

According to this Court “it was really the entire sum chopped into small

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payments for his convenience.” Hence, the amount could not be

described as a business expense, because the outgoings every month

were not to be taken as spent over purchase of stones but in discharge

of a singular original obligation to the jagir. These observations clearly

establish the difference between a revenue expenditure on the one

hand and capital expenditure incurred in instalments on the other

hand.

22.3. Similarly, in Jalan Trading Co., this Court while considering the

issue as to classification of periodic payments of 75% profit share, as

consideration under a deed of assignment, for the right to carry on

business, held that the same would be capital expenditure. It was

observed that the assessee therein was a new company and it had

acquired under the contract the right to carry on a business on long-

term basis subject to the renewal of the agreement on payment of 75%

of its annual net profits. That since the assessee had acquired a capital

asset (right to carry out the business of the assignor), any payment

made towards securing such a right would be capital in nature. This

dictum would clearly demonstrate that when an expenditure is in its

core capital in nature, neither the fact that the same was paid in

instalments, nor the fact that the quantum of expenditure was

dependent on the revenue or profit of the assessee, would warrant a

change in the classification of the transaction.

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23. Before proceeding to consider the facts of the present case in light

of the precedents discussed hereinabove, it is necessary to preface our

views by stating that it is perhaps one of the most familiar arguments

in Courts (particularly in matters involving an issue as to classification

of expenditure or receipts), that the case at hand bears close

resemblance to another case falling on one or the other side of the line,

and must therefore be decided in the same manner. This thought was

conveyed by Lord Radcliffe in Nchanga Copper Mines wherein it was

pointed out that “in considering allocation of expenditure between

capital and income accounts, it is almost unavoidable to argue from

analogy.” In that context, we must highlight the difficulty of relying on

any single precedent in search for the true classification, and

attempting to draw similarities between the facts of the said case and

the facts of the case at hand. We think that the propositions made in

earlier cases, if sought to be applied to a different case which the

authors of those propositions did not have in mind, could lead to

absurd results.

Further, it is trite that the words in a judgment must not be

construed in the same manner as those in a legislation. Hence, it is

neither wise nor suitable to extend the dictum of one case, premised

on the facts of the said case, to another fact-situation which is

seemingly similar but not really so. This is particularly so when there

is no precedent which has been rendered in an identical fact situation,

as is the case in the instant matters.

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23.1. In such situations, the solution may not be found in any one

precedent. It has to be derived from many aspects of the whole set of

circumstances some of which may point in one direction, while some

to the other. It is an appreciation of all guiding factors, premised in

common business sense, which must provide the ultimate answer,

rather than mere analogy or comparison. It is with such an approach

that we shall proceed to consider the facts of the case at hand in light

of certain precedents referred to or/and relied upon by the High Court

of Delhi as well as those cited at the Bar.

23.2. We also wish to refer to the dictum of the King’s Bench Division

in Commissioners of Inland Revenue vs. Ramsay, 20 T.C. 79 . The

facts of the said case were that the assessee therein agreed to purchase

a dental practice for a primary consideration of £15,000 subject to

increase or diminution as therein provided. The primary price was to

be satisfied by payment of £5000 on the exchange of the agreement,

and as to the balance, by payment each year for ten years of a sum

equal to 25% of the net profits of the practice for each year. If the

amounts so paid over the ten years, were in the aggregate, more or less

than the balance of the primary purchase price, that price was to be

treated as correspondingly increased or diminished. The Court while

considering an issue as to the classification of the payments made each

year held that the annual sums paid under the agreement, were

instalments of capital and were not admissible as revenue deductions.

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23.3. Similarly, as discussed hereinabove, this Court in Jalan

Trading Co. had the occasion to consider the issue pertaining to

classification of an annual payment based on profit sharing towards

the right to carry on business. This Court concluded that since the

annual payment of 75% profit share was paid by the assessee in

consideration of the right to carry on the business of the assignors, the

payment would be capital in nature. In doing so, this Court examined

the contention of the assessee therein that, since what was paid as

consideration was not a pre-determined lump-sum amount but an

annual payment out of profits, such a payment should be held to be

revenue in nature. The three-Judge Bench of this Court rejected the

said contention suggesting that when an expenditure is in its core

capital in nature, neither the fact that the same was paid in

instalments, nor the fact that the quantum of expenditure was

dependent on the revenue or profit of the assessee, would warrant a

change in the classification of the transaction.

This judgment will apply on all fours in deciding the case at hand,

since the annual payment of variable licence fee is only towards licence

fees and merely because it is paid in annual instalments based on the

AGR, the payment cannot be construed as revenue. The annual

payments of licence fee as also the entry fee relate to a singular

purpose, i.e., the acquisition of the right to carry on the business of

rendering telecommunication services. This right being in the nature

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of a capital asset, any payment(s) made towards the acquisition of the

right, whether in lump-sum or in annual instalments dependent on the

AGR, would be in the nature of capital disbursement(s).

23.4. This conclusion is also consistent with the view of this Court in

Pingle Industries Ltd., wherein by a majority of 2:1 held that the

payment, towards acquisition of a long-term lease to win mine stones,

though periodic, was neither rent nor royalty but a lump-sum payment

in instalments for acquiring a capital asset of enduring benefit to trade.

This Court refused to hold that the periodic payments were towards

purchase of stones, but instead opined that the payments were in

discharge of a singular original obligation to the jagir. Therefore, it

emerges that where the periodic payments are referrable to or have a

nexus with the original obligation undertaken by the assessee as

consideration for acquisition of a right, the periodic payments would

be in the nature of capital expenditure, notwithstanding the fact that

they are payable as a percentage of profits, gross revenue or sales.

24. Hence, we are of the considered view that in the present case,

since the entry fee as well as variable licence fees are traceable to the

same source, they would both have to be held to be capital in nature,

notwithstanding the fact that the variable licence fee is paid in a

staggered manner. We shall consider the case law sought to be relied

upon by the learned senior counsel and learned counsel for the

116

respondents-assessees, so as to distinguish the same from the present

case.

24.1. We shall first advert to the decision of this Court in Jonas

Woodhead and Sons. Paragraph 2 of the said judgment, in no unclear

terms captures two underlying transactions arising out of the

agreement in the said case; the first transaction relating to the know-

how and technical information regarding setting up of the plant and

the second transaction relating to the services to be rendered to the

assessee by the foreign firm, the consideration for the second prong

being in the nature of royalty. It is in that backdrop that the

consolidated payment was apportioned and 25% thereof was held to be

in the nature of capital expenditure while 75%, payable on services,

was held to be revenue expenditure.

Further, it is also relevant to note that in the said case the

exercise of apportionment into the aforesaid fractions was carried out

by the Madras High Court. Against the judgment of the High Court, the

Revenue did not prefer an appeal before this Court on the findings

pertaining to apportionment of 75% towards ser vices. What was

appealed against by the assessee was with regard to categorisation of

25% of the consolidated expenditure as capital expenditure. The

assessee alone was the appellant before this Court. Therefore, the

question as to apportionment of 75% tow ards services, was not

considered and decided by this Court in the said case.

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We are of the view that the judgment of this Court in Jonas

Woodhead and Sons would not come to the aid of the respondent-

assessees because the issue before this Court in the said case did not

relate to a single right wherein the payment made towards the same

was held to be partly capital and partly revenue. The purpose of

payments in the said case was traceable to two different subject

matters and therefore apportionment between capital and revenue

expenditure. However, in the present case, the entry fee as well as

variable licence fees are traceable to the same source.

24.2. Similarly, in Best and Co., this Court decided the nature of

expenditure on two separate transactions, though payments made

were consolidated in nature. The first transaction related to the

compensation paid by the principal for the termination of agency

business, while the second was with respect to the payment made

towards the non-compete clause. On the first aspect, namely, the

compensation received for the loss of agency, it was held that what

would be determinative was whether loss of agency would affect the

entire business structure, resulting in a loss of enduring nature, or,

whether it was a loss due to an ordinary incident in the course of

business. If it was the former, it would be capital, and if it was the

latter, it would be revenue in nature. It was concluded vis-à-vis the first

transaction that the loss of the said agency by the assessee was only a

normal trading loss and therefore the income received in this regard

118

was a revenue receipt. As regards the non-compete clause it was held

that the same was a restrictive covenant and was therefore, capital in

nature. In paragraph 14 of the judgment of this Court, it was recorded

in unequivocal terms that the “compensation paid was in respect of two

distinct matters, one taking the character of a capital receipt and the

other of a revenue receipt.” Therefore, Best and Co. is a case where two

independent transactions were considered, one of which was held as

capital and the other as revenue. This case did not decide the

expenditure towards the same right to be partly capital and partly

revenue.

24.3. We shall now consider the decision of the Madras High Court

affirmed by this Court in Southern Switch Gear Ltd. Paragraph 2 of

the judgment of the High Court records two distinct transactions: one,

for provision of technical know-how for the manufacture of switch gear

products and the second, was to share modern developments and also

train necessary personnel in the factory in United Kingdom. The

consideration was fixed £20,000 payable in five instalments of £4000

each. Paragraph 5 of the judgement of the High Court referred to clause

6 of the agreement which dealt with know-how and clause 7 thereof,

which dealt with supervision and direction, besides recommending

appointment or dismissal of employees and also training them in the

factory. In paragraph 6, it was held that expenditure on technical

know-how is capital in nature and should be apportioned at 25% and

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the services rendered relatable to 75% of the consideration was revenue

in nature. When the assessee therein filed an appeal before this Court

against the finding that technical know-how is capital in nature and

should be apportioned at 25%, the appeal was dismissed.

Therefore, it is clear that the said case also did not pertain to one

source of expenditure being split, partly as capital and partly as

revenue in nature. In the said case, the Courts have examined two

different constituents of expenditure and held one component to be

capital in nature while the other to be revenue in nature.

24.4. Next, we advert to the facts in Sarada Binding Works on which

heavy reliance was placed by learned senior counsel Mr. Datar. The

agreement relevant to the said case envisaged conveyances of two

aspects: first, the right to run the business of ‘Chandamama

Publications’ on payment of a fixed sum of Rs. 5000/- per annum;

second, royalty to be paid annually on sales equivalent to 10% of the

annual net profits. The High Court held that the right to run the

business is capital in nature, whereas, the sharing of 10% profit per

annum is revenue in nature. In the concluding paragraph, the High

Court made the following firm conclusions as to why 10% profit sharing

would constitute a revenue expenditure:

i. That payments calculated as a certain percentage of profits of a

business for an indefinite period of time as royalty cannot be

treated as payments by instalments of a capital sum;

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ii. The payment of royalty was related to the future profits of the

assessee and had no nexus with the capital sum.

In the said case, there are clear findings to the effect that the

payment of royalty in instalments, in the absence of any definitive

duration, cannot be linked to the right to carry on trade. That the

payment of royalty had no nexus with the capital sum. However, in the

present case, it cannot be said that the variable licence fee payable

annually has no nexus with the acquisition of the capital asset, i.e.,

the licence to render telecom services, as, it is the payment of entry fee

as well as the variable licence fees which together enable the assessees

to carry on the said business. Hence the aforesaid case would not apply

to the present case having regard to its distinct facts.

24.5. Sri Datar has also sought to rely upon the decision of this Court

in Mewar Sugar Mills Ltd. However, we do not see how this judgment

would bolster up the respondents’ case. In the said case, the grant of

licence by an agreement dated 05 April, 1932 contemplated two

different aspects: first, a monopoly right to cultivate sugarcane and

produce sugar, and second, payment of 2% royalty on the price of the

sugar manufactured. In that backdrop, this Court held that the

payment of 2% royalty on the sugar manufactured was revenue

expenditure while the payment made in respect of the monopoly rights

obtained was of capital nature. It was observed that payment of the 2%

royalty on the price of sugar manufactured by the appellant therein

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had no relationship with the paymen t referable to the monopoly

conferred under the grant.

In the said case, this Court’s dictum is clear to the effect that

royalty based on manufacture was in no way connected to the

acquisition of monopoly rights. But such a finding would be erroneous

in the facts of the present case since what is paid is only for acquisition

of a right by way of licence fee. Further, in the said case, royalty

payment had been divorced from the payment for the right to carry on

business since any failure to pay royalty could not have, by any stretch,

resulted in the withdrawal of the right to carry on trade. The right to

carry on trade would have remained unaffected whether or not royalty

payment was made. Failure to make royalty payment, could have at

the most, led to civil consequences, but not a revocation of the right to

carry on trade, whereas, in this batch of matters, the position is not

the same. Admittedly, any failure to pay the annual variable licence fee

will inevitably lead to revocation of the licence under Section 8 of the

Telegraph Act. Further, the respondents will be disabled from carrying

on the business of offering telecommunication services, even for a day

in the absence of a valid licence. Continuation of the right to carry on

the said business is contingent on the payment of both, entry fee, as

well as variable licence fee.

Therefore, we are unable to rely upon the dictum in Mewar

Sugar Mills Ltd. to hold in favour of the respondent-assessees in this

batch of cases.

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25. In light of the aforesaid discussion and having regard to the tests

and principles forged by this Court from time to time, as detailed in

paragraphs hereinabove, we shall proceed to consider whether the High

Court of Delhi was right in apportioning the licence fee as partly

revenue and partly capital by dividing the licence fee into two periods,

i.e. before and after 31 July, 1999 and accordingly holding that the

licence fee paid or payable for the period upto 31 July, 1999 i.e. the

date set out in the Policy of 1999 should be treated as capital and the

balance amount payable on or after the said date should be treated as

revenue.

We answer the said question in the negative, against the assesses

and in favour of the Revenue for the following reasons:

i. Reliance placed by the High Court on the decisions of this Court

in Jonas Woodhead and Sons and Best and Co. and the decision

of the Madras High Court in Southern Switch Gear Ltd. as

approved by this Court appear to be misplaced inasmuch as the

said cases did not deal with a single source/purpose to which

payments in different forms had been made. On the contrary, in

the said cases, the purpose of payments was traceable to different

subject matters and accordingly, this Court held that the

payments could be apportioned. However, in the present case, the

licence issued under Section 4 of the Telegraph Act is a single

licence to establish, maintain and operate telecommunication

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services. Since it is not a licence for divisible rights that conceive

of divisible payments, apportionment of payment of the licence fee

as partly capital and partly revenue expenditure is without any

legal basis.

ii. Perhaps, the decision of the High Court could have been sustained

if the facts were such that even if the respondents-operators did

not pay the annual licence fee based on AGR, they would still be

able to hold the right of establishing the network and running the

telecom business. However, such a right is not preserved under

the scheme of the Telegraph Act which we have detailed above.

Hence, the apportionment made by the High Court is not

sustainable.

iii. The fact that failure to pay the annual variable licence fee leads to

revocation or cancellation of the licence, vindicates the legal

position that the annual variable licence fee is paid towards the

right to operate telecom services. Though the licence fee is payable

in a staggered or deferred manner, the nature of the payment,

which flows plainly from the licensing conditions, cannot be

recharacterized. A single transaction cannot be split up, in an

artificial manner into a capital payment and revenue payments by

simply considering the mode of payment. Such a characterisation

would be contrary to the settled position of law and decisions of

this Court, which suggest that payment of an amount in

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instalments alone does not convert or change a capital payment

into a revenue payment.

iv. It is trite that where a transaction consists of payments in two

parts, i.e., lump-sum payment made at the outset, followed up by

periodic payments, the nature of the two payments would be

distinct only when the periodic payments have no nexus with the

original obligation of the assessee. However, in the present case,

the successive instalments relate to the same obligation, i.e.,

payment of licence fee as consideration for the right to establish,

maintain and operate telecommunication services as a composite

whole. This is because in the absence of a right to establish,

maintenance and operation of telecommunication services is not

possible. Hence, the cumulative expenditure would have to be held

to be capital in nature.

v. Thus, the composite right conveyed to the respondents-assessees

by way of grant of licences, is the right to establish, maintain and

operate telecommunication services. The said composite right

cannot be bifurcated in an artificial manner, into the right to

establish telecommunication services on the one hand and the

right to maintain and operate telecommunication services on the

other. Such bifurcation is contrary to the terms of the licensing

agreement(s) and the Policy of 1999.

vi. Further, it is to be noticed that even under the 1994 Policy regime

the payment of licence fee consisted of two parts:

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a) A fixed payment in the first three years of the licence regime;

b) A variable payment from the fourth year of the licence regime

onwards, based on the number of subscribers.

Having accepted that both components, fixed and variable, of the

licence fee under the 1994 Policy regime must be duly amortised,

there was no basis to reclassify the same under the Policy of 1999

regime as revenue expenditure insofar as variable licence fee is

concerned.

26. As per the Policy of 1999, there was to be a multi-licence regime

inasmuch as any number of licences could be issued in a given service

area. Further, the licence was for a period of twenty years instead of

ten years as per the earlier regime. The migration to the Policy of 1999

was on the condition that the entire policy must be accepted as a

package and consequently, all legal proceedings and disputes relating

to the period upto 31 July, 1999 were to be closed. If the migration to

the Policy of 1999 was accepted by the assessees herein or the other

service providers, then all licence fee paid upto 31 July, 1999 was

declared as a one time licence fee as stated in the communication dated

22 July, 1999 which was treated to be a capital expenditure. The

licence granted under the Policy of 1999 was non-transferable and non-

assignable. More importantly, if there was a default in the payment of

the licence fee, the entire licence could be revoked after sixty days

notice. The provisions of the Telegraph Act particularly Section 8

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thereof are also to the same effect. Having regard to the aforesaid facts

and in light of the aforesaid conclusions, we hold that the payment of

entry fee as well as the variable annual licence fee paid by the

respondents-assessees to the DoT under the Policy of 1999 are capital

in nature and may be amortised in accordance with Section 35ABB of

the Act. In our view, the High Court of Delhi was not right in

apportioning the expenditure incurred towards establishing, operating

and maintaining telecom services, as partly revenue and partly capital

by dividing the licence fee into two periods, that is, before and after

31 July, 1999 and accordingly holding that the licence fee paid or

payable for the period upto 31 July, 1999 i.e. the date set out in the

Policy of 1999 should be treated as capital and the balance amount

payable on or after the said date should be treated as revenue. The

nature of payment being for the same purpose cannot have a different

characterisation merely because of the change in the manner or

measure of payment or for that matter the payment being made on

annual basis.

27. Therefore, in the ultimate analysis, the nomenclature and the

manner of payment is irrelevant. The payment post 31 July, 1999 is a

continuation of the payment pre 31 July, 1999 albeit in an altered

format which does not take away the essence of the payment. It is a

mandatory payment traceable to the foundational document i.e., the

license agreement as modified post migration to the 1999 policy.

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Consequence of non-payment would result in ouster of the licensee

from the trade. Thus, this is a payment whic h is intrinsic to the

existence of the licence as well as trade itself. Such a payment has to

be treated or characterized as capital only.

28. In the result, the judgment of the Division Bench of the High

Court of Delhi, dated 19 December, 2013 in ITA No. 1336 of 2010 and

connected matters, is hereby set aside. The judgments passed by the

High Courts of Delhi, Bombay and Karnataka, following the judgment

of the Division Bench of the High Court of Delhi, dated 19 December,

2013, are also consequently set aside.

The appeals filed by the appellant(s)-Revenue are allowed.

Parties to bear their respective costs.

Pending applications, if any, stand disposed of in the aforesaid

terms.

……………..………………….J.

[B.V. NAGARATHNA]

……………..………………….J.

[UJJAL BHUYAN]

NEW DELHI;

16

th OCTOBER, 2023.