Itta/153/2004 Of The Commissioner Of Income Tax v. M/S.advanta India Ltd

*THE HONB’E SRI JUSTICE G. CHANDRAIAH AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM +I.T.T.A.No.153 OF 2004 %09.10.2015 The Commissioner of Income-tax, Hyderabad-I AND ..... APPELLANT M/s. Advanta India Ltd., Secunderabad .....RESPONDENT ! Counsel for the appellant: Sri J.V. Prasad ^ Counsel for respondent : Sri Percy Pardivala < Gist: > Head Note: ? Cases referred: 148 ITR 272 2.232 ITR 359 3.(1997) 224 ITR 342 4.(1989) 177 ITR 377 (SC) 5.(1998) 232 ITR 316 (SC) 6. (1989) 177 ITR 377 (SC) 7. (1994) 207 ITR 813 (Cal) 8.(1998) 231 ITR 849 (Mum) 9. 251 ITR 155 (Cal) THE HONB’E SRI JUSTICE G. CHANDRAIAH AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM I.T.T.A.No.153 OF 2004 JUDGMENT: (per GC,J) This appeal is filed by the Revenue under Section 260-A of the Income Tax Act,1961 (for short, the “the Act”), questioning the order dated 21.02.2003, passed by theIncome Tax Appellate Tribunal, Hyderabad Bench ‘B’, Hyderabad, inI.T.A.No.37/Hyd/99, for the assessment year 1995-96, raising the followingsubstantial questions of law for consideration of this Court: i. “Whether on the facts and in circumstances of the case the Tribunal wascorrect in law in holding that the payment of technical know-howfee was revenue expenditure and not capital in nature. ii. Whether on the facts and in the circumstances of the case, the Tribunalwas correct in law in holding that the expenditure on account ofpayment of royalty was revenue in nature.”was correct in law in holding that the expenditure on account ofpayment of royalty was revenue in nature.” The brief facts of the case are that the respondent/assessee was originallyincorporated under the name and style of M/s. I.T.C Zeneca Limited and its namewas changed to M/s. Advanta India Limited on 30.09.1998. In the course of itsbusiness during the assessment year 1995-96, the assessee paid an amount ofRs.2,75,85,300/- to M/s. Zeneca Limited, U.K towards technical know-how fee andthe assessee had also paid an amount of Rs.47,34,306/- towards royalty andclaimed the said payments as revenue expenditure. It is further stated that theAssessing Officer observed that the expenditure incurred by the assessee towardstechnical know-how fee falls within the ambit of Section 35AB of the Act and allowed1/6[th] of the amount so claimed as deduction. The Assessing Officer had also treated1/4[th] of royalty paid as capital expenditure. On appeal filed by the assessee, theCommissioner of Income Tax (Appeals) (for short “the C.I.T Appeals”) treated 75% ofthe technical know-how fees as revenue expenditure and 25% as being capital innature, and thus allowing 75% of the fees paid towards Technical know-how asdeduction under Section 37 of the Act. The C.I.T (Appeals) had also held that thedisallowance of 1/4[th] royalty payment as capital in nature. Aggrieved thereby, theassessee filed an appeal before the Income Tax Appellate Tribunal inI.T.A.No.37/Hyd/1999 and the Department being aggrieved by the order of the C.I.T(Appeals) in treating only 25% of technical know-how fees as capital in nature, filedan appeal in I.T.A.No.109/Hyd/1999 before the Tribunal. The Tribunal clubbed boththe appeals filed by the assessee and the department and disposed of the same bya common order dated 21.02.2003, partly allowing I.T.A.No.37/Hyd/1999 anddismissed the I.T.A.No.109/Hyd/1999. Aggrieved the order dated 21.02.2003,passed by the Tribunal in I.T.A.No.37/Hyd/1999, the present appeal is filed by thedepartment. Heard Sri J.V. Prasad, learned standing counsel for the appellant/ department andSri Percy Pardivala, learned senior counsel for the respondent/assessee. Heard Sri J.V. Prasad, learned standing counsel for the appellant/ department andSri Percy Pardivala, learned senior counsel for the respondent/assessee. The facts are not in dispute. The principal question which falls for consideration inthe present case and the facts as found by the Tribunal as to “whether theexpenditure incurred by the respondent-assessee is to be fully allowed as a revenueexpenditure or a part of it is to be capitalized as a capital expenditure”. It is well recognized by various judicial pronouncements that a particular expenditure isrevenue or capital in nature is a vexed question and the same would have to bedetermined in each case on appreciation of the facts of the particular case. Thequestion as to whether the amount paid for acquiring Germplasm and Technicalknow-how needs to be determined with particular reference to the terms of thecontract and agreement between the assessee and the foreign company ZenecaLimited, U.K. Though, the assessing authority sought to invoke Section 35AB of theAct to the expenditure, the C.I.T Appeals after analyzing the nature of transactionsinvolved in the agreement had categorically negatived the same. It may be notedthat the revenue did not question about the decision of the C.I.T Appeals, so far asSection 35AB of the Act, has no application. The First Appellate Authority afteranalyzing the agreement in detail and by placing reliance on the judgment of theMadras High Court in the case of Commissioner of Income Tax, Tamil Nadu vs.Southern Switchgear Limited as confirmed by the Supreme Court in SouthernSwitchgear Limited vs. Commissioner of Income Tax, Tamil Nadu, haddisallowed 1/4[th] of the expenditure paid as consideration for the agreement dated01.10.1994. Both the revenue and the assessee filed appeals separately against theC.I.T Appeal’s common order. The Tribunal had analyzed the agreement in detailand by applying the principles laid down in various judgments held that theexpenditure incurred by the assessee in obtaining Germplasm and the technicalknow-how under the agreement dated 01.10.1994, would qualify to be allowed fullyas revenue expenditure. In the process of discussion, the Tribunal found that theassessee came into existence by acquisition of the existing business of Hyson IndiaLimited and the business commenced from 1.9.1994. The Germplasm andTechnical know-how were acquired by the assessee after commencement of thebusiness by the assessee. By applying the six tests laid down in the case of JonasWoodhead & Sons (India) Limited vs. CIT, the Tribunal came to conclusion thatthere was no new business which was started on the basis of Technical know-howreceived from the foreign firm. With regard to Test No.2, though the Article 18 of theagreement gives exclusive rights to the assessee company, the assessee is notentitled to sub license in whole or in part of the licensee without consent from thelicensor and further the licensor has right to assign or otherwise transfer theagreement or any rights there-under. With regard to 3[rd] test, the consideration for theagreement was certain and definite except with respect to royalty which is to becomputed based on the production. Tribunal found the consideration which was agreed to be paid under the agreement is both for providing Germplasm as well asthe technical know-how. With regard to 4[th] test, it was found that the assessee has toreturn the Germplasm, but continue to use the technical know-how. However, thetechnical information can be continued to be used by them. Further, it was found thatthere is a mutual obligations to exchange the developments and improvements thatmay result on account of constant research on the part of the licensee and licensorand it is provided distinctly as to how the improved property could be shared basedon certain definitive parameters. With regard to 5[th] test considering the nature of thetechnology and the rapid advancements taking place in the filed of biotechnology, itwas found that there is enduring benefit that is derived by the assessee. So far asthe 6[th] test is concerned, the same was not dealt with as in the present case thepayment was one lump sum payment for acquiring Germplasm along with technicalknow-how and the duration of the agreement was five years. Before us, on behalf of the revenue, it was emphatically canvassed that theassessee had acquired Germplasm which itself is an asset and further the technicalknow-how for use to exploit the same for the purpose of the assessee’s business.The technical know-how and the Germplasm is an asset of capable of giving anenduring benefit to the assessee and further considering the facts on record hadrightly apportioned the expenditure in the ratio 1/4[th] as capital in nature and 2/3[rd] inthe nature of revenue by applying the legal tests laid down in a judgment of theMadras High Court in CIT vs. Southern Switchgear Limited (1 supra) which isapproved by the Supreme Court in Southern Switchgear Limited vs. CIT (2 supra). The learned counsel for the appellant/revenue also relied upon the followingjudgments v. Jyothi Electric Motors Ltd. Vs. CIT (1999) 237 ITR 280 (Guj) vi. Fenner Woodroffe & Co. Ltd. Vs. CIT, Madras (1976) 102 ITR 665(Mad.(Mad. vii. Ram Kumar Pharmaceutical Works vs. CIT (1979) 119 ITR 33 (All.) apart from making submissions with regard to inapplicability of the judgments citedon behalf of the respondent/assessee. Likewise, learned senior counsel Sri ParsiPardivala, on behalf of the assessee, had also placed reliance on the followingjudgments: i. CIT vs. CIBA of India Ltd (1968) 69 ITR 692 (SC) ii. Praga Tools Ltd vs. CIT (1980) 123 ITR 773 (AP) iii. Coromandal Fertilizers Ltd vs. CIT (1984) 148 ITR 546 (AP) iv. Alembic Chemicals Works Company Ltd vs. CIT (1989) 177 ITR 377 (SC) v. Veljan Hydrair Pvt Ltd vs. CIT (1989) 177 ITR 552 (AP) vi. CIT vs. Avery India Ltd (1994) 207 ITR 813 (Cal) vii. CIT vs. Kirloskar Tractors Ltd (1998) 231 ITR 849 (Mum) viii. CIT vs. I.A.E.C (Pumps) Ltd (1998) 232 ITR 316 (SC) ix. CIT vs. J.K Synthetics Ltd (2009) 309 ITR 371 (Delhi)x. CIT vs. Hero Honda Motors Ltd (2015) 372 ITR 481 (Del)x. CIT vs. Hero Honda Motors Ltd (2015) 372 ITR 481 (Del) We have heard the elaborate arguments on both sides and perused the record apartfrom going through the various judgments relied upon by both the counsel. Havinggiven our anxious thought to the matter in issue we do not find it necessary to extractor deal with a large number of case law which has been cited before us by variousCourts except making a reference to the judgments of the Supreme Court whereinthe cases of this nature were considered. In this context, it is useful to refer to theguidance provided by the Supreme Court in the cases of Alembic ChemicalsWorks Company vs. CIT and Jonas Woodhead and sons India (3 supra), andthe Supreme Court had summarized the tests by reference to various cases earlier. We have heard the elaborate arguments on both sides and perused the record apartfrom going through the various judgments relied upon by both the counsel. Havinggiven our anxious thought to the matter in issue we do not find it necessary to extractor deal with a large number of case law which has been cited before us by variousCourts except making a reference to the judgments of the Supreme Court whereinthe cases of this nature were considered. In this context, it is useful to refer to theguidance provided by the Supreme Court in the cases of Alembic ChemicalsWorks Company vs. CIT and Jonas Woodhead and sons India (3 supra), andthe Supreme Court had summarized the tests by reference to various cases earlier. In the context of the guidance provided in those judgments, we may consider thearguments advanced before us. At this stage, we may note that the CIT Appealsitself did not agree with the views of the assessing officer in entirety and howeverfound that only a small portion of the expenditure could be treated as capital innature by applying the principles laid down in the case of Southern SwitchgearLimited (2 supra) whereas the assessee had relied on the judgment reported in acase of CIT vs. I.A.E.C (Pumps) Ltd as more appropriate. All the cases ultimatelyemphasis as a rule, the analysis and proper understanding of the agreementbetween the parties as providing a correct picture with respect to the aspect as tohow a particular expenditure is to be treated. In the case on hand, we had set out thefindings as recorded by the Tribunal in the earlier paragraphs. In the present case,there is no challenge to the findings recorded by the Tribunal by raising a questionof perversity of a fact. In view of the settled principles of law, the questions raisedbefore us are required to be considered and answered on the facts as found andrecorded by the Tribunal. On the analyses of the agreement, we find that 1) it is termed as a licensingagreement and the parties contemplated the same to be as a licensing agreement.2) Under the agreement, the assessee (licensee) to get a right and license to use thetechnical information and the Licensor Germplasm to research and develop,produce and sell products within the India. 3) The assessee gets immunity fromlegal proceedings with respect to patent rights, if any in India. The assesseeacquires documents relating to technical information and with genetic material formaize, sunflower, canola, mustard, sorghum, millet and cotton. Assessee also wouldget assistance in acquiring appropriate personal, facilities, plant, machinery andequipment for the research, development, production and processing of products bythe licensee. Assessee gets the right to use, produce and sell the Germplasm in aspecified products by way of sub-license to its affiliates.) One of the conclusions arrived at by the Tribunal is with regard to whether there isany enduring benefit likely to accrue in favour of the assessee on account of theagreement. This question was answered in the negative by the Tribunal by reference to the fast changing development in the filed of biotechnology. Reliancewas also placed on the judgment of the Supreme Court in the case of AlembicChemicals Works Company vs. CIT apart from the judgments in the cases of CITvs. Avery India Ltd, CIT vs. Kirloskar Tractors Ltd and CIT vs. Shriram BearingsLtd. One significant aspect of the agreement is that the assessee is not required to returnthe licensee’s Germplasm, except in the case of termination of the agreement interms of Article 16 of the Agreement. (Wrongly assumed by the Tribunal asreturnable). Article 16 provides for termination of the agreement only in case of thebreach of the agreement as set out therein. In other words, the Germplasm whichhas been supplied to the assessee and the relevant material on multiplication of thesame is available for the assessee’s use even after the currency of the agreement. One significant aspect of the agreement is that the assessee is not required to returnthe licensee’s Germplasm, except in the case of termination of the agreement interms of Article 16 of the Agreement. (Wrongly assumed by the Tribunal asreturnable). Article 16 provides for termination of the agreement only in case of thebreach of the agreement as set out therein. In other words, the Germplasm whichhas been supplied to the assessee and the relevant material on multiplication of thesame is available for the assessee’s use even after the currency of the agreement. A close reading of the agreement in the present case would disclose that theconsideration is paid for acquiring a living organism Germplasm and also fortechnical know-how. C.I.T (Appeals) had apportioned the same, 1/4[th] as on capitalaccount and 2/3[rd] on revenue account. Under the licensing agreement, the productsproduced or developed with the Germplasm and the technical know-how providedunder the agreement are the revenue earning products for the assessee. In otherwords, they are material or tools in the hands of the assessee for generating therevenue. The agreement is valid for a period of five years from the date ofcommercial production and eight years from the date of execution. In the sense, theGermplasm is the revenue earning apparatus. The technical knowledge which hasbeen acquired in the process of implementation particularly in the bio-technologyfiled would certainly benefit the assessee even after the expiry of the agreementperiod and there is no embargo on the assessee for using the expertise andknowledge acquired. Further, by clearly defining ‘Licensee Germplasm’ and‘Licensor Germplasm’ and setting out a right to access the ‘Licensor’s’improvements during the currency of the agreement the agreement has ensured thebenefits of research, development and improvements to the Licensee, the assessee.Further, in terms of Article 8 of the agreement, Licensor to have access to theLicensee’s improvements but subject to payment of consideration in terms of Article5.1(d) of the Agreement. These clauses viewed in the context of the intention of theparties would certainly point out that both the parties intended to benefit for a considerable period of time out of the relationship emanating from the agreement.Even though in the Bio-technology field changes are likely to happen in fast phase,the assessee still has the benefit of the same in view of the dynamic nature of theagreement entered into between the assessee and the technology provider. This inour considered view is a distinct and distinguishing factor, which would benefit theassessee giving an enduring benefit to the assessee. In that view of the matter, thejudgment of the Supreme Court in Alembic Chemicals Case (5 supra) isdistinguishable. In that view of the matter, apportioning a part of the expenditure inthe nature of a capital expenditure by the CIT Appeals cannot be termed aserroneous. This single distinguishing factor is sufficient to answer the Question No.1in favour of the revenue and against the assessee. Accordingly, the Question No.1 is answered in favour of the revenue and against theassessee. So far as the Question No.2 that is amount of royalty is concerned, it is agreedto be paid by the assessee and the same needs to be treated as revenueexpenditure particularly considering the fact that the same is linked to thepercentage of consideration received on sale of the products produced by theassessee by use of the Germplasm and with the help of the technical know-how. Accordingly, the Question No.2, is answered in favour of the assessee andagainst the revenue. With the above observations, the appeal is disposed of. No order as to costs. Miscellaneous petitions, if any pending in this appeal, shall stand closed. ____________________ Date:09.10.2015. Note: L.R. copy to be marked. B/o. Gk. ____________________________ CHALLA KODANDA RAM, J THE HONB’E SRI JUSTICE G. CHANDRAIAH AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM I.T.T.A.No.153 OF 2004 Date:09.10.2015.