Commissioner of Income Tax vs Lakshmi Card Clothing Mfg. Co. (P.) Ltd.

P. Venugopal, J.—This is a reference at the instance of the revenue referring the following question of law:

Whether, on the facts and in the circumstances of the case, it has been rightly held that payment of annual fee under clause 9 of the collaboration

agreement was in the nature of revenue expenditure and should, therefore, be allowed u/s 37 of the income tax Act, 1961?

The assessee is a private limited company carrying on business in the manufacture and sale of card clothing. The company was incorporated in

1961. It entered into a collaboration agreement with Graf Sales Ltd. of Switzerland (''foreign company'') on 23-2-1961. Clauses 3 and 9 of the

collaboration agreement provide:

For the consideration mentioned in clause 9 hereof, Graf shall grant to Lakshmi the sole exclusive non-transferable right to manufacture and sell

in the Republic of India, the Portuguese possessions in India, the Kingdom of Nepal and neighbouring countries of India except Europe, card

clothing and accessories as specified in para (2) on the basis of Graf''s designs and manufacturing methods patented or unpatented.

During a period of ten years from the conclusion of this agreement, Graf will forward from time to time to Lakshmi any new data, specifications,

processes, revised and additional manufacturing methods, drawings and improvements on their current designs of card clothing and accessories,

thus enabling Lakshmi to follow without delay, the latest technical developments of the Graf card clothing and accessories. For these services as

also for the licences granted under clause 3, Lakshmi shall pay to Graf in Switzerland, free of any deduction of any kind whatsoever (including

taxes, if any) an annual fee of Swiss Francs 6,000 (six thousand) on or before the last day of July of each English calendar year for a period of ten

years, the first payment to be made on 1-7-1961. Lakshmi shall, without any payments, place at the disposal of Graf, all information relating to

their experiences and own inventions and developments, if any, and obtain Graf''s prior approval before adopting them. Constructional alterations

should, however, not be introduced by Lakshmi before consulting Graf.

For the licence granted under clause 3 and for the services rendered in pursuance of clause 9, the assessee has to pay to the foreign company an

annual fee of 6,000 francs for a period of 10 years, the first payment commencing from 1-7-1961. The ITO came to the conclusion that it is in the

nature of capital expenditure and disallowed the deduction claimed. On appeal, the AAC held that the consideration for the services in the shape of

technical advice and for the grant of licence to exploit the foreign company''s patents in India is partly for services and partly in the nature of royalty

and it is, therefore, on revenue account and qualified for deduction. On further appeal, the Tribunal, after analysing clauses 3 and 9 and also

looking into the correspondence, came to the conclusion that the payment to the foreign company for sending periodical instructions on various

points regarding raw materials, de signs, drawings, etc., is only in the nature of royalty and the instructions given by the foreign company from time

to time is to help the assessee in the normal running of its manufacturing business and the amount paid to the foreign company is only a revenue

expenditure and should be allowed as a deduction u/s 37(1) of the income tax Act, 1961 (''the Act''). At the instance of the revenue, the question

set out supra has been referred for being answered by this Court.

The learned counsel for the revenue relying on the three decisions inFenner Woodrqffe & Co. Ltd. v. C IT (1916) 102 ITR 665 (Mad.),

Additional Commissioner of Income Tax and Another Vs. Southern Structurals Ltd., and Jonas Woodhead and Sons (India) Ltd., Madras Vs.

Commissioner of Income Tax, Madras, , contended that the assessee, with the technical know-how supplied by the foreign company under the

collaboration agreement, has set up a plant to manufacture cotton card clothing and accessories and the supply of new data, specifications,

processes, revised and additional manufacturing methods, drawings and improvements on their current designs of card clothing and accessories

enabling the assessee to follow the latest technical developments is only to further augment the technical know-how and data originally supplied for

setting up the plant to manufacture cotton card clothing and this has resulted in an enduring benefit and a permanent advantage to the assessee-

company and the annual fee paid in pursuance of clause 9 is only capital expenditure and not an expenditure on revenue account. Whether the fee

paid to the foreign company is capital expenditure or revenue expenditure is to be decided with reference to the construction of the collaboration

agreement and other surrounding facts and circumstances of the case and not with reference to any decided case law.

The foreign company has to hand over to the assessee:

all necessary drawings for all parts of card clothing and accessories (vide clause 4 of the agreement);

supply exact specifications of all raw materials used for the manufacture of card clothing and accessories (vide clause 5);

provide exact instructions for the manufacture of card clothing and accessories as specified in para 2 (vide clause 6);

train three qualified Indian technicians from the assessee-company''s factory on terms and conditions to be agreed upon (vide clause 7).

For these services rendered under clauses 4 to 7, a payment of 2,75,000 Swiss francs is provided under clause 10 of the agreement. Under clause

3, the foreign company gives to the assessee the sole exclusive non-transferable right to manufacture and sell card clothing and accessories in

certain territories on the designs and manufacturing methods patented or unpatented. Under clause 9, the foreign company for a period of ten years

has to forward to the assessee-company any new data, specifications, processes, revised and additional manufacturing methods; drawings and

improvements on their current designs of card clothing and accessories enabling the assessee to follow without delay the latest technical

developments of the foreign company. For the licence granted under clause 3, i.e., right to manufacture and sell the card clothing and accessories

on the basis of the foreign company''s designs and manufacturing methods, patented or unpatented, and for the services rendered under clause 9,

an annual payment of 6,000 francs had to be paid to the foreign company. It is significant to note that the licence granted under clause 3 or services

rendered under clause 9 has nothing to do with the setting up of the plant by the assessee-company. After the setting up of the plant, the foreign

company has to render certain services specified in the collaboration agreement to enable the assessee-company to follow the latest technical

developments of the foreign company in the manufacture of card clothing. The services rendered are in the nature of instructions and information

relating to the foreign company''s latest technical development in the manufacture of card clothing and is related to the carrying on or conduct of the

day to day business of the assessee-company. Thus, the services rendered in pursuance of clause 9 have not resulted in the acquisition of an asset

or a right of a permanent character. The Tribunal is, therefore, justified in coming to the conclusion that the fee paid in pursuance of clause 9 is in

the nature of revenue expenditure and is an allowable deduction in the computation of the assessee''s income u/s 37. The reference is answered in

the affirmative and against the revenue. The assessee is entitled to the costs of this reference. Counsel''s fee Rs. 500.