Commissioner of Income Tax vs Revathi, C.P. Equipments Ltd.

R. Jayasimha Babu, J.—At the instance of the Revenue, the following questions have been referred to us, arising"" out of the Tribunal''s order

relating to the assessment of the respondent''s income for the assessment year 1979-80 :

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is right in law in upholding the order of the Commissioner of

Income Tax (Appeals) granting depreciation on the properties purchased by document dated May 7, 1979, for the assessment year 1979-80 ?

Whether, on the facts and in the circumstances of the case and having'' regard to the provisions of Section 34 of the Income Tax Act, 1961, the

Appellate Tribunal''s conclusion that the assessee is entitled for depreciation for the assessment year 1979-80 on the properties purchased by

document dated May 7, 1979, is supported by valid materials and sustainable in law ?

''Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right and had valid materials to hold that a sum of Rs.

3,09,500 paid by the assessee to Consolidated Pneumatic Tool Co. (India) Ltd. for developing new prototype of a more efficient compressor to

be supplied to the assessee only and not to any other rig manufacturer in India, is allowable as revenue expenditure by treating that expenditure did

not confer enduring benefit to the assessee ?

The assessee is a manufacturer of rigs. Compressors are essential parts of rigs, but the compressors are not manufactured by the assessee. The

compressors are purchased by it from a company in Bombay, named, Consolidated, Pneumatic Tool Co. (India) Limited. The business of the

assessee appears to have been set up some time in the year 1977. In the order of assessment, it has been noted by the Assessing Officer that the

company at Bombay is a subsidiary of an American company with which the assessee had entered into a separate agreement for supply of

technical know-how, as the assessee wanted to purchase compressors for being used in its rigs and those compressors could not be made without

the technical know-how given by the American company. The assessee-company and the company at Bombay agreed to share the cost of

manufacture of the prototype of compressors and the assessee''s expenditure in the cost of development of the prototype came to Rs. 3,09,500.

The assessee claimed that expenditure was revenue expenditure which claim was rejected by the Assessing Officer. The Tribunal, however,

accepted the assessee''s case and the decision that was rendered by the Tribunal is being questioned before us by the Revenue. There are also two

other questions raised with regard to the allowability of depreciation on the lands acquired by the assessee-company. We shall deal with those

questions a little later.

Learned counsel for the Revenue submitted that the sum of Rs. 3,09,500 expended by the assessee was an expenditure in the capital field.

Counsel contended that this amount was paid to the Bombay company for the specific purpose of developing a prototype of compressors and the

assessee-company was to have an exclusive right to buy the compressors in the event of the prototype proving successful. Counsel contended that

the assessee thus acquired an exclusive right to purchase compressors from the Bombay company which right would not have accrued to it but for

the incurring of this expenditure. The fact that the assessee purchased the compressors by paying value therefore for its rigs would not, in the

submission of counsel, have the effect of converting what was initially capital expenditure into revenue expenditure. Counsel did not dispute the fact

that the Bombay company was already engaged in the manufacture of compressors and that the company had only been asked to build up a

prototype to meet the specific requirements of the assessee.

Learned counsel contended that the facts of this case are analogous to the facts considered by the Supreme Court in the case o K.T.M.T.M.

Abdul Kayoom and Another Vs. Commissioner of Income Tax, . In that case, the assessee therein had acquired exclusive rights, liberty and

authority to fish for, take and carry away all chank shells in the sea off the coastline of a certain area specified in the lease granted to the assessee

by the Government. The apex court negatived the assessee''s claim that the rent paid by the assessee to the Government was revenue expenditure.

The court held that the rent so paid was an amount paid to obtain an enduring asset in the shape of an exclusive right to fish ; that the payment was

not related to the chanks which the assessee might or might not bring to the surface ; that it was not an amount spent for acquiring its stock-in-trade

but for acquiring an asset from which it may collect its stock-in-trade.

Learned counsel also relied on the judgment of the Rajasthan High Court in the case of Jaswant Trading Co. Vs. Commissioner of Income Tax,

wherein the court held that the expenditure on the development of the land which had been incurred by the developmental authority and collected

from the allottees of the land as also the capital cost for the water treatment plant erected by the authority for the benefit of industries located on

the plots allotted by it were expenditure in the capital field, as such expenditure if it had been incurred by the assessee, would have been in the

capital field and the fact that it was incurred by an authority for common benefit of several persons did not make a difference.

Counsel lastly relied on the decision of the apex court in the case of Jonas Woodhead and Sons (India) Ltd. Vs. Commissioner of Income Tax,

, wherein the court made observations with regard to the circumstances in which an expenditure can be regarded either as capital or as revenue

and held that the cost of acquiring technical information and services rendered for setting up a new industry was capital expenditure.

The observations made in the case of Jonas Woodhead and Sons (India) Ltd. Vs. Commissioner of Income Tax, are instructive and it is useful

to set out the same. The court observed in that case as under (headnote) :

The question whether a particular payment made by an assessee under the terms of an 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 payment 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 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.

It is not disputed that the assessee herein is not the manufacturer of compressors. It is engaged in the manufacture of rigs of which compressors

form a part. The compressors required for making the rigs complete are bought out by the assessee from sources outside and such purchase is

bound to be a continuous on going activity of the assessee as the rigs would be incomplete without compressors and the assessee has necessarily

to sell rigs to continue to remain in the market as a manufacturer and seller of rigs. The assessee had entered into an agreement with the

manufacturer of compressors for the supply of compressors. It is not disputed by the Revenue that the company at Bombay had been engaged in

the manufacture of compressors even before it entered into an agreement with the assessee to create a prototype which, if successful, would be

followed by the manufacture of compressors of the type required by the assessee. So far as the manufacturer at Bombay was concerned, when it

agreed to create a prototype all that it was doing was to improve the product in the manufacture of which it had already been engaged or at best to

manufacture a special type of compressor different from other types which were till then being manufactured by it. The facilities rendered for the

manufacture of compressors, it may be reasonably assumed, had been installed and were available to the company at Bombay which agreed to

create the prototype. It was not a part of the agreement that a new factory was to be set up by the company at Bombay specially for the purpose

of manufacturing and supplying compressors required by the assessee. Apparently, the facilities available in the Bombay company for the

manufacture of compressors were to be utilised for making a kind of compressors which the assessee wanted and for which a prototype had been

built. The additional cost which the company at Bombay anticipated was only the cost of the prototype and not the cost of installing machinery for

manufacturing the compressors or erecting a new plant specially for the purpose of supply of the kind of compressors required by the assessee.

Building of a prototype compressor cannot be regarded as a preliminary to setting up a completely new plant for the manufacture of completely

a new product with completely new process. All that was contemplated was building of compressors to the specifications desired by the assessee.

Had the prototype failed, the company at Bombay would not have ceased to carry on its business of manufacture of compressors, but would still

have remained in the business of manufacture of compressors and would have sold the products to other consumers and its continuance was not

dependent upon the success or failure of this prototype.

In so far as the assessee was concerned, the assessee''s interest was to secure supply of compressors which answered the specifications

required by the assessee for the purpose of efficient user in the rigs manufactured by the assessee. As the compressors had to be purchased from

outside, such purchases would have to be a continuous on going affair and it was for the assessee to locate a supplier capable of manufacturing the

kind of compressors it required and capable of supplying the same within the time specified. Had the assessee decided to set up a manufacturing

plant, undoubtedly, the expenditure on such a plant would have been regarded as expenditure in the capital field. That was not the course adopted

by the assessee. It also did not bear the cost of setting"" up a new manufacturing unit for the manufacture of compressors. It merely located the

manufacturer of compressors which had the facilities required to make compressors and engaged in that business and was agreeable to supply the

kind of compressors required by the assessee. The assessee was willing to share the cost of prototype if the prospective supplier supplied regularly

the compressors of the type required by the assessee. The cost of manufacture of the prototype, in these circumstances, does not meet the test for

capital expenditure laid down by the apex court in the case of Jonas Woodhead and Sons (India) Ltd. Vs. Commissioner of Income Tax, , for

determining as to whether a particular item of expenditure is capital expenditure or revenue expenditure. It cannot be said that the assessee derived

enduring benefit from the prototype. The successful working of the prototype may have enabled the manufacturer at Bombay to manufacture and

sell compressors of that type. Had that manufacturer closed down its operation or decided to stop supply of compressors needed by the assessee,

the assessee could not possibly be regarded as having acquired enduring benefit. It was equally open to the assessee to stop buying from that

manufacturer in which event also it could not be stated that it had acquired any enduring benefit. Moreover, as pointed out by the apex court, the

test of enduring benefit is not a rigid test nor is it the sole test to decide whether the expenditure incurred is of capital character or revenue

character. With rapid changes in technology, it is difficult to regard the acquisition of the current state of technology as an enduring benefit as the

usability of that technology is often for a relatively short period on account of rapid advances in science and technology.

The Tribunal, in our opinion, was right in concluding that the expenditure incurred by the assessee to the extent of 50 per cent, of the cost of

development of the prototype such development having been made by the prospective supplier of compressors at Bombay was not an expenditure

in the capital field. Our answer to the question with regard to the sum of Rs. 3,09,500 paid to the manufacturer of compressors for developing the

prototype is that the expenditure was of revenue character and not of capital character. Our answer to the question is in favour of the assessee and

against the Revenue.

As regards the other questions raised by the Revenue concerning depreciation on the factory building, counsel for the Revenue has very fairly

brought to our notice the decision of the apex court in the case of Commissioner of Income Tax, Bombay etc. Vs. M/s. Podar Cement Pvt. Ltd.

etc., and the unreported decision of this court in T.C. No. 912 of 1984--( Tamilnadu Dairy Development Corporation Ltd. Vs. Commissioner of

Income Tax, , decided on March 30, 1998. It has been held therein that for claiming depreciation, it is not essential that the claimant should be the

owner of the asset and for claiming"" depreciation, what is necessary is that the asset should have been in the possession and enjoyment of the

claimant who should have used the same for the purpose of business. All those requirements have been fully met by the assessee herein. The order

of the Tribunal discloses that the assessee had been put in possession of the property on which it erected a factory building on August 19, 1977,

and that it had also paid the consideration for the land in the sum of Rs. 13,54,500. Prior to that date, a release deed had also been executed, but

on account of delay in receiving clearance from the Government that deed was not registered and a fresh deed was executed subsequently on May

7, 1979. Considering the fact that the assessee had paid the consideration, the fact that it had been put in possession in the year 1977 itself, the

further fact that the assessee was thus in possession and enjoyment exclusively throughout the previous year relevant to the assessment year in

question and had used the land for the purpose of business, it was entitled to depreciation. Our answers to those questions, therefore, are also in

favour of the assessee and against the Revenue.

The assessee is entitled to costs in the sum of Rs. 1,000.