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PETITIONER:

M/S. JONAS WOODHEAD & SONS LTD., MADRAS.

Vs.

RESPONDENT:

THE COMMISSIONER OF INCOME-TAX, MADRAS

DATE OF JUDGMENT: 11/02/1997

BENCH:

S.C. AGRAWAL, G.B. PATTANAIK

ACT:

HEADNOTE:

JUDGMENT:

J U D G M E N T

G.B. PATTANAIK, J.

These two appeals by special leave at the instance of

the assessee are directed against the order of the Madras

High Court answering the question posed in favour of the

revenue and against the assessee. The Income-tax Appellate

Tribunal, Madras Bench, referred the following question to

the Madras High Court for its opinion:

"Whether, on the facts and in the

circumstances of the case, the

Tribunal was right in holding that

25% of the amount paid by the

assessee as royalty to Messrs Jonas

Woodhead & Sons., was capital

expenditure and therefore not

allowable as revenue expenditure

under the provisions of the Income-

tax under the provisions of the

Income-tax Act, 1967, for the

assessment years 1967-68 and 1968-

69?"

The aforesaid question of law arose out of order of the

Appellate Tribunal arising out of assessment proceedings for

the assessment years 1967-68 and 1968-69. The assessee, a

limited company incorporated in March 1963 to carry on the

business of manufacture of automobiles springs entered into

an agreement with M/s. Jonas Woodhead and Sons Ltd.,

(hereinafter referred to as "foreign company") of United

Kingdom for manufacture of all types of springs and

suspension for road and rail vehicles. Under the terms and

conditions of the agreement between the parties it was

stipulated that the foreign firm will give the assessee the

technical information and know-how relating to the setting

up of a plant suitable for manufacture of the products as

well as the technical know-how relating to the setting up of

the plant itself, the drawings, estimates, specifications,

manufacturing methods, blue prints of production and testing

equipment and other data and information necessary to

manufacture the products and to set up proper and efficient

plants. The said agreement between the parties also provide

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that in consideration of the information to be furnished and

services to be rendered to the assessee by the foreign firm

the assessee shall pay a royalty at the rates of the

licensed products, turnover of the assessee to be calculated

in accordance with the provisions of the agreement. The

production of the assessee commenced on 1.1.1966 and in

terms of the agreement the assessee made payments of Rs.

24,/000/- and Rs. 47,000/- respectively to the foreign firm

for assessment years 1967-68 and 1968-69 as royalty. In the

assessment proceedings the Income-tax Officer disallowed

1/4th of the aforesaid payments on the ground that such

payment represented the consideration for service provided

by the foreign company of an enduring nature and is,

therefore, a capital receipt. The assessee preferred appeals

before the Appellate Assistant Commissioner and being

unsuccessful therein preferred second appeal to the Income-

tax Appellate Tribunal. The Tribunal having dismissed the

second appeal an application was filled by the assessee

under Section 256(1) of the Income-tax Act for referring the

question of law as already indicated to the High Court of

Madras for being answered. The High Court by the impugned

judgment answered the question in favour of the revenue and

against the assessee. The assessee thereafter moved this

Court and on leave being granted, these appeals have been

registered. In answering the question posed in favour of the

revenue the High Court considered the different clauses of

the agreement between the parties and is of the opinion that

the assessee acquired a benefit of enduring nature which

will constitute "acquisition of an asset and amount paid for

the same would constitute capital expenditure". The High

Court also came to the conclusion that the payment

stipulated under clause 12 of the agreement by the assessee

to the foreign firm was not the remuneration for using of

the rights granted by the foreign firm but a composite

payment for all the services rendered and information

furnished by the said foreign firm to the assessee in the

setting up of the factory as well as in the manufacture of

the licensed products in that factory. The judgment of the

High Court has since been reported in 117 (1979) ITR 55.

Mrs. Janaki Ramachandran, the learned counsel appearing for

the appellant contended that the High Court was in error in

answering the question in favour of the revenue on a finding

that the payment was made to the foreign company for

obtaining advantage of enduring benefit in as much as it

does not offer advantage of enduring nature acquired by an

assessee which could be held to be a capital expenditure.

According to the learned counsel the payments made by the

assessee to the foreign firm for the technical know-how and

assistance rendered by the said foreign firm enabled the

assessee to carry on its business more efficiently and more

profitably leaving fixed capital untouched and, therefore,

the said payment or any part of it cannot be held to be a

capital expenditure. In support of this contention reliance

was placed on the decision of this court in the case of

Empire Jute Co. Ltd. vs. Commissioner of Income-Tax, 124

(1980) ITR 1. According to the learned counsel for the

appellant a technical know-how or technical advice received

from a foreign firm cannot be held to be a tangible asset

and any payment made to the foreign firm for such know-how

is nothing but a revenue expenditure. The learned counsel

places reliance on the decision of Bombay High Court

reported in 123 (1980) ITR 539. The learned counsel also

urged that the payment required to be made by the assessee

to the foreign firm was merely for the better conduct and

improvement of the existing business and as such was revenue

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in nature and can't held to be a capital expenditure.

Mr. Chaudhary, the learned counsel appearing for the

revenue on the other hand contended that the question

whether a particular payment made by the assessee would form

a part of revenue expenditure or capital expenditure would

depend upon the relevant facts and the terms and conditions

of the agreement between the parties under which the payment

is made. According to the learned counsel the various

clauses of the agreement having been analysed and the

Tribunal having found that the foreign firm not merely

provided the technical know-how for manufacturing the

product but also gave plan and designs and established the

factory for manufacture of the products and the business

concerned being totally new business and even after the

conclusion of the agreement period the assessee was required

merely to return the plans and designs, but there was no

embargo on the assessee to manufacture the product in

question and the payments under the agreement being of a

composite nature the Tribunal was fully justified in holding

the part of the payments made by the assessee did form the

capital expenditure and the High Court was wholly justified

in answering the reference in favour of the revenue.

The question whether a particular payment made by an

assessee under the terms of the agreement forms a part of

capital expenditure or revenue expenditure would depend upon

several factors, namely, whether the assessee obtained a

completely new plan with a complete new process and

completely new technology for manufacture of the product or

the payments was made for the technical know-how which was

for the betterment of the product in question which was

already being produced; whether the improvisation made, is

the part and parcel of the existing business or a new

business was set up with the so-called technical know-how

for which payments were made; whether on expiry of the

period of agreement the assessee is required to give back

the plans and designs which were obtained, but the assessee

could manufacture the product in the factory that has been

set up with the collaboration of the foreign firm; the

cumulative effect on 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. This court in the case of Alembic Chemical Works Co.

Ltd. vs. Commissioner of Income Tax, Gujarat, 177 (1989) ITR

377 has 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 form any general rule even in the generality of

cases, sufficiently accurate and reasonable comprehensive,

to draw any clear line of demarcation". This Court further

held that there is no single definitive criterion which by

itself is demarcative, whether a particular outlay is

capital or revenue. And therefore, "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, are all to be taken in 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.

In the case of Commissioner of Income-Tax, Bombay City

I vs. CIBA of India Ltd., 69 (1968) ITR 692, the question

for consideration was whether the contribution payable by

the assessee at the rate of 6 per cent of the net ceiling

price of firm categories which the assessee produced on

getting the formulae, scientific data, working rules and

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prescriptions pertaining to the manufacture or processing of

products discovered and developed in the Swiss company's

laboratory can be held to be a business expenditure or is a

capital expenditure. This Court held on consideration of the

agreement between the parties that the assessee did not

become entitled exclusively even for the period of the

agreement, to the patents and trademark of the Swiss

company; it had merely access to technical knowledge and

experience in the pharmaceutical field which the Swiss

company commanded. The assessee on that account have a mere

licence for a limited period of a technical knowledge of the

Swiss company with the right to use the patent and trademark

of that company. The assessee acquired under the agreement

merely the right to trade for the purpose of carrying on its

business as a manufacturer or dealer and obtained the

technical knowledge of Swiss company for limited period. By

making a technical knowledge available the Swiss company did

not part with any asset of its business, nor did the

assessee acquire any asset or advantage of an enduring

nature for the benefits of its business and, therefore, the

said contribution was merely a revenue expenditure or a

business expenditure.

In the case of Commissioner of Income-Tax vs. Lucas-

T.V.S. Limited, 110 (1977) ITR 338, the question for

consideration before the Madras High Court was whether the

payments made under the collaboration agreement with the

foreign firm by the assessee for the exclusive right and

licence to make various items of electrical equipments for

vehicles by the foreign firm is a capital expenditure or

revenue expenditure. The Madras High Court came to the

conclusion that since under the agreement the assessee had

no right to manufacture fresh articles on the basis of the

know-how which had obtained from the foreign firm after the

expiry of the period of licence, the payments made by the

assessee to the foreign firm for the technical know-how will

be in the nature of a licence fee and will constitute an

expenditure in computation of profits and gains and cannot

be held to be a capital expenditure.

In the case of Commissioner of Income-Tax, Madras

(Central) vs. Sarada Binding Works, 102 (1976) ITR 187, the

question for consideration was whether the consideration for

a transaction which consist of partly a fixed annual sum and

partly a periodical payment at a certain percentage of the

profits earned by the assessee from the said business would

be treated in its entirety as a capital expenditure or a

revenue expenditure. The Madras High Court came with a

conclusion that the fixed sum paid towards part of the

consideration will be a capital payment while the periodical

payment of sum which are definite and which depend upon the

future profits cannot be treated as a capital expenditure.

In other words, the Court answered the question that since

the payment in question to be made by the assessee was not

related to any specified sum but a percentage of the profits

to be earned which were indefinitive in nature. Such payment

could be treated only as a revenue expenditure.

In the case of Agarwal Hardware Works (P) Ltd., vs.

Commissioner of Income-Tax, West Bengal-I, 121 (1980) ITR

510, the question for consideration before the Calcutta High

Court was whether the payments made by the assessee to a

foreign firm for use of certain patents would be a capital

expenditure or a revenue expenditure. The Calcutta High

Court on consideration of the agreement between the parties

came to the conclusion that since patents are not useable

after termination of the agreement and the payments are

indefinitive in nature based on production of goods, the

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assessee does not acquire any capital asset and, therefore,

such payments made under the agreement are for the purpose

of business and derive business expenditure.

In the case of Commissioner of Income-Tax. Bombay City-

I vs. Tata Engineering & Locomotive Co Pvt. Ltd., 123 (1980)

LTR 538, the question for consideration before the Bombay

High Court was whether the payments made by the assessee to

the foreign firm for the technical know-how and the

technical advice would be a capital expenditure or a revenue

expenditure. The Court answered the question that since

under the agreement the assessee did not acquire a benefit

of enduring nature and the so-called foreign know-how which

is availed of in lieu of payment is in substance a

transaction of acquiring the necessary technical information

with regard to the technique of production and as such it

cannot be held to be a capital expenditure and is a revenue

expenditure.

In the case of Empire Jute Co. Ltd. vs. Commissioner of

Income-Tax, 124 (1980) ITR 1, the question for consideration

before this Court was whether the payments made by the

assessee for purchase of "loom hours" was in the nature of a

capital expenditure or a revenue expenditure. In the said

case the assessee company was carrying on the business of

manufacture of jute and was a member of Indian Jute Mills

Association. The agreement had been entered into between the

members associations restricting the number of working hours

per week for which the mills were entitled to work their

looms. The assessee company purchased "loom hours" from four

other mills for a sum of Rs. 2,03,255/- during the

assessment year 1960-61 and claimed deduction treating the

same as a revenue expenditure. The Tribunal accepted the

assessee's contention and had allowed deduction but on a

reference being made, the High Court had held that the

amount paid by the assessee for purchase of "loom hours" was

in the nature of capital expenditure and as such no

deduction could be claimed. This Court reversed the decision

of the High Court and held that the acquisition of

additional "loom hours" did not add to the fixed capital of

the assessee; the permanent structure of which the income

was obtained remained same. The expenditure incurred for the

purpose of operating the looms for longer working hours was

primarily and essentially related to the operation of

working of the looms which constituted the profit making

apparatus of the appellant and was expenditure laid out as a

part of the process of profit earning. It was an outlay of

business in order to carry it on and to earn a profit out of

this expense as an expense of carrying it on; it was a part

of the cost of operating the profit earning apparatus and

was clearly in the nature of revenue expenditure. The Court

further observed as under:

"There may be cases where

expenditure, even if incurred for

obtaining an advantage of enduring

benefit, may, none the less, be on

revenue account and the test of

enduring benefit may break down. It

is not every advantage of enduring

nature acquired by an assessee that

brings the case within the

principle laid down in this test.

What is material to consider is the

nature of the advantage in a

commercial sense and it is only

where the advantage is in the

capital field that the expenditure

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would be disallowable on an

application of this test. If the

advantage consists merely in

facilitating the assessee's trading

operations or enabling the

management and conduct of the

assessee's business to be carried

on more efficiently or more

profitably while leaving the fixed

capital untouched, the expenditure

would be on revenue account, even

though the advantage may endure for

an indefinite future. The test of

enduring benefit is, therefore, not

a certain or conclusve test and it

cannot be applied blindly and

mechanically without regard to the

particular facts and circumstances

of a given case."

Thus the so-called test of obtaining enduring benefit

was held not to be a conclusive test and could not be

applied blindly and mechanically without regard to the

particular facts and circumstances of a given case.

In the case of Alembic Chemical Works Co. Ltd. vs.

Commissioner of Income-Tax, Gujarat, 177 (1989) ITR 377, the

question for consideration was whether the lump-sum payment

made by the assessee for obtaining the know-how to produce

higher yield and sub-culture of high yielding strain of

Penicillin would be a capital expenditure or a revenue

expenditure. The Tribunal had rejected the claim of the

assessee holding the expenditure to be a capital

expenditure. On appeal to this Court it was held:

"(i) It would be unrealistic to

ignore the rapid advances in

research in antibiotic medical

microbiology and to attribute a

degree of endurability and

permanence to the technical know-

how at any particular stage in this

fast changing area of medical

science. The state of the art in

some of these areas of high

priority research is constantly

updated so that the know-how could

not be said to bear the element of

the requisite degree of durability

and nonephemerality to share the

requirements and qualifications of

an enduring capital asset. The

rapid strides in science and

technology in the field should make

us a little slow and circumspect in

too readily pigeon-holing an

outlay, such as this, as capital.

(ii) In the infinite variety of

situational diversities in which

the concept of what is capital

expenditure and what is revenue

arises, it is well nigh impossible

to formulate any general rule, even

in the generality of cases,

sufficiently accurate and

reasonably comprehensive, to draw

any clear line of demarcation.

However, some broad and general

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tests have been suggested from time

to time to ascertain on which side

of the line the outlay in any

particular case might reasonably be

held to fall. These tests are

generally efficacious and serve as

useful servants; but as masters

they tend to be overexacting.

(iii) The question in each case

would necessarily be whether the

tests relevant and significant in

one set of circumstances are

relevant and significant in the

case on hand also. Judicial

metaphors are narrowly to be

watched, for, starting as devices

to liberate thought, they end often

by enslaving it.

The idea of "once for all" payment

and "enduring benefit" are not to

be treated as something akin to

statutory conditions; nor are the

notions of "capital" or "revenue" a

judicial fetish. What is capital

expenditure and what is revenue are

not eternal verities but must needs

be flexible so as to respond to the

changing economic realities of

business. The expression "asset or

advantage of an enduring nature"

was evolved to emphasise the

element of a sufficient degree of

durability appropriate to the

context.

There is also no single definitive

criterion which, by itself, is

determinative whether a particular

outlay is capital or revenue. The

"once for all" payment test is also

inconclusive. What is relevant is

the purpose of the outlay and its

intended object and effect,

considered in a common-sense way

having regard to the business

realities. In a given case, the

test of "enduring benefit" might

break down."

It would thus appear that the 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 dependant upon certain contingencies, right

to use the technical know-how of production or the activity

even after the completion of the agreement, obtaining

enduring benefit for a considerable part on account of the

technical informations received from a foreign-firm, payment

whether made "once for all" or in different instalments co-

relatable to the percentage of gross turnover of the product

to ultimately find out whether the expenditure or payment

thus made makes an accretion to the capital asset and after

the court comes to the conclusion that it does so then it

has to be held to be a capital expenditure. As has been held

by this Court and already indicated in Alembic Chemical

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Work's case [177 (1989) ITR 377) no single definitive

criterion by itself could 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. But in the case

in hand the Tribunal having considered the different clauses

of the agreement and having come to the conclusion that

under the agreement with the foreign firm what was set up by

the assessee was a new business and the foreign firm had not

- only furnished information and the technical know-how but

rendered valuable services in setting up of the factory

itself and even after the expiry of the agreement there is

no embargo on the assessee to continue to manufacture the

product in question, it is difficult to hold that the entire

payment made is a revenue expenditure merely because the

payment is required to be made on a certain percentage of

the rates of the gross turnover of the products of the

income as royalty. In our considered opinion, in the facts

and circumstances of the case the High Court was fully

justified in answering the reference in favour of the

revenue and against the assessee. These appeals are

accordingly dismissed but in the circumstances without any

order as to costs.