Commissioner of Income Tax, Tamil Nadu-III vs Sundaram Clayton Ltd.

Sethuraman, J.—The following common question have been referred by the Tribunal under s. 256(1) of the I.T. Act for the assessment

years 1966-67 to 1969-7 :

(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the entire technical aid fees paid by

the assessee to M/s Clayton Dewandre Company Ltd., U.K., and the royalty USA under the collaboration agreement should be allowed as a

deduction ?

(2) Whether the Tribunal was justified in holding that the cross-objections of the assessee would fall to be technically allowed as the Tribunal had

upheld the finding of the Appellate Assistant Commissioner ?

The assessee, is a company which was incorporated some time in 1962. Its busines is in the manufacture and sale of air-compressor equipments

for automotive vehicles and industrial equipment. It entered into a technical collaboration agreement with M/s. Clayton Dewandre Company Ltd.,

U.K., on July 1, 1962, and another agreement with M/s Bendix Westinghouse Automotive Air Brake Company Ltd., USA, on January 9, 1964.

The assessee claimed that the payments made to the respective foreign companies in accordance with the terms of the two agreements should be

allowed as deductions in arriving at the taxable income for the years mentioned above. Taking the assessment years 1966-67 as typical, the

amounts paid to M/s. Clayton Dewandre Co. Ltd., fall in two part : (1) royalty, and (2) technical aid fees. Royalty come to Rs. 9,965 and

technical aid fees to Rs. 7,473. Similarly, in the case of M/s. Bendix Westinghouse Automotive Airbrake Co., the amount paid as royalty was Rs.

31,302. For the other years, the figures vary, but the nature of the payments is the same.

The ITO allowed the royalty paid to M/s. Clayton Dewandre Co. Ltd., as revenue expenditure in each of the assessment years under

consideration. However, in respect of payments of technical aid fees, he disallowed 50% as being in the nature of capital expenditure on the

ground that the assessee derived an enduring benefit therefrom. In the case of payment to M/s. Bendix Westinghouse Automotive Air Brake Co.,

he disallowed 20% of the royalty as constituting capital expenditure. The assessee appealed to the AAC who after referring to some decided cases

and observing that the assessee was expressly prohibited from divulging confidential information obtained under the agreement to third parties,

came to the conclusion that the entire expenditure was admissible as deduction since the foreign companies had not parted with any assets. In his

view, the assessee had also not acquired any benefit or advantage of an enduring value. The revenue appealed to the Tribunal and the assessee

filed what was called ""cross-objection"", The Tribunal had disposed of similar matters and after referring to the submission that the collaboration

agreement in the matters already disposed of were similar to the agreements before them on the present occasion, came to the conclusion that the

payment was made for using the knowledge and using the licences and patents of the collaboration for a short duration, that it related to the

production and the turnover of the company and that, therefore, it would be of a revenue nature. It is as against the order so the Tribunal that the

reference application were made by the Commissioner of Income Tax, and the questions already extracted were not referred.

Mr. Jayaraman, the learned counsel for the Commissioner, contended that the agreements in the present case had been entered into for stating

or initiating the business and that the payments could be taken only as capital in nature. His further submission was that there was no provisions in

the agreement prohibiting the user of the knowledges after the agreement came to an end and that, therefore, the assessee had acquired an

enduring benefit so as to bring the expenditure within the scope of capital expenditure. Agreements of a similar nature have been considered on a

number of occasions. the Tribunal has in its order referred to the decision in I.T.A. Nos. 514 to 517 of 1969-70, dated December 31, 1971. that

order has been annexed to the statement of the case. The said order was the subject-matter of a reference to this court and the decision of this

court is reported as Commissioner of Income Tax Vs. Lucas-T.V.S. Limited (No. 1), . The cases proceeded before the Tribunal on the basis that

the agreements in the present case were substantially similar to the one considered in the reported decision. It was pointed out by this court in

Commissioner of Income Tax Vs. Lucas-T.V.S. Limited (No. 1), as follow :

It is not disputed before us that ultimately the question has to be decided on the basis of the terms of the particular agreement and the only general

principle that can be derived from the decision referred to above is that under the terms of the agreement if the assessee acquires a benefit of

enduring nature that will constitute ''acquisition of an asset'' and any amount paid for the same would constitute ''capital expenditure'' and on the

other hand if the assessee had acquired merely technical knowledge or knowledge for the manufacture of any particular item for a specified

duration than he had acquired only a licence to use the other party''s patent and knowledge and the amount would constitute ''revenue

expenditure.

In Commissioner of Income Tax Vs. Lucas-T.V.S. Limited (No. 1), , by the agreement similar to the one under consideration, the assessee was

granted exclusive right and licence to make use, exercise and vend various items of electrical equipment for vehicles and engines. The payments

made in accordance with the terms of the agreement were claimed as deductible expenditure. It was pointed out by this court in answering the

reference that in view of the clauses which provided that even the stock which remained in the hands of the assessee after the expiry of the period

of the licence should be sold within a period of one year and the royalties payable therefore, should be paid, it would follow that the assessee had

no right to manufacture fresh articles on the basis of the know-how which it obtained from the foreign company and that the entire payments made

by the assessee to the foreign company will, therefore, be in the nature of licence fee and constitute an item of expenditure in the computation of its

profits and gains.

We have also examined this question in T.C.Nos. 665 to 667 of 1975 Commissioner of Income Tax Vs. Brakes India Ltd., (Appendix), (infra).

One of the orders referred to by the Tribunal and annexed to the statement of the case was the subject-matter of the reference. In disposing of the

claim for deduction of the amounts paid in the said case, we observed (See p. 328 infra :

.... we do not consider that there is any capital element in the payment with which we are now concerned. The payment made in the present case

is for specific purposes and not for acquisition of any knowledge of a permanent nature with which the assessee could carry on its business and any

person who enters into a collaboration agreement would necessarily acquire some knowledge during the process of manufacture carried on with

the held of the collaboration agreement. Knowledge acquired cannot be disgorged and ordinarily forms part of the equipment of the person

concerned. It is not for the acquisition of the knowledge, but for application thereof, that the consideration is paid. The real test that has to be

applied to cases like this is find out whether the consideration was startedly for any such enduring purposes or merely for the held rendered during

the period of the agreement.

The agreement in the present case with M/s. Clayton Dewandre Company Ltd., grants a licence for the entire territory of India. the licence is

exclusive and non-transferable and is for the purposes of using and selling in India the licensed devices, and parts thereof, but there is no right to

import or export of sell for import of export into other countries such licensed devices. Articles IV required the foreign company upon the written

request of the Indian company to supply blue prints of assembly and detailed drawings and the results of technical investigations, tests, and

research. The information has to be kept confidential and has not to be disclosed to any other person at any time. In consideration of the technical

services rendered, the foreign company was entitled to by paid a fee amounting to one and a half per cent of the factory cost of all licensed devices

and spare parts for such devices sold by the assesse-company. In consideration of the licences and other rights granted under the agreement in

respect of the licensed patents and licensed devices, a royalty amount of 2% of the factory cost of all licensed device and spare parts was also to

be paid to the foreign company. The agreement was to be in force for a period of 10 years, subject to extension for a further period of five years,

unless notice was given by either party by registered notice of its intention to terminate the agreement. The notice had to be given at least one years

prior to such termination date. In the event of the termination of the agreement, all future and continuing rights and obligations were to cease and

terminate. The Indian company will also have the right during the ensuring years subsequent to the termination of the agreement to dispose of any

stock on hand. The nature of the agreement appears to us to be purely for the purposes of obtaining the relevant know-how for manufacturing and

selling the materials manufactured. The agreement is for the purposes of running the business. Though the agreement may have been entered into

soon after the formation of the company, it cannot be stated that the payments under the agreement are liable to be treated as capital expenditure

merely because the agreement came into existence at the commencedment of the company''s career. Even at the initial stages after the formation of

the company, it may enter into agreements for the purposes of enabling it to manufacture the proposed goods. Just as it enters into agreements with

its employees, engineers, technicians, etc., it enters into agreement for the purposes of the obtaining the know-how. The nature of the expenditure

is not dependent upon the time at which the relevant agreement came into existence. The quality of the expenditure will have to be tested with

reference to the object for which it was incurred. Judged by this test, we do not find that there is any capital element in the expenditure.

Mr. Jayaraman contended that as the assessee was starting its business it is quite conceivable that the foreign company had assisted the

assessee-company in establishing the factory and that, therefore, a part of the expenditure at least should be attributed to capital. There is nothing

in the agreement to show that the foreign company was called upon to render any assistance for giving the blue print of the factory or for procuring

any machinery. In the absence of any such clause, it is possible that, if at all the foreign company had rendered any assistance in the procurenment

of the machinery or in giving the plan for the factory, it did so without any consideration being stipulated therefor. Even a hardheaded businessman

sometimes enter into business agreement without any economic return. Having regard to the terms of the agreement without any economic return.

Having regard to the terms of the agreement before us, we do not find that there is any capital element in it.

Mr. Jayaraman invited our attention to an unreported decision in T.C. No. 254 of 1975 dated July 8, 1981 M.R. Electronic Components Ltd.

Vs. Commissioner of Income Tax, Madras, . In that case, clause 9(a) of the agreement provided for assistance in the construction of the factory.

Though no separate consideration was provided for in the agreement for such assistance, it was held that a part of the consideration was liable to

be ascribeds to capital. The significant feature in the present case is that there is no such clauses similar to clause 9(a) in the case mentioned above.

We do not, therefore, find any scope for ascribing any portion of the consideration in the present case to capital. Further, in T.C. No. 254 of 1975

(M.R. Electronic Components Ltd. v. CIT) (p. 305 supra) there was also an obligation on the part of the foreign company to give the know-how

in relation to the fresh products manufacture by it so as to enable the Indian company to manufacture the said items if it considered it expedient.

There is no such clause in the present case. Therefore, it is not possible to attribute any capital element in the consideration. As earlier pointed out,

each case has to be decided in accordance with the terms of the agreement concerned, and the agreement considered in T.C. No. 254 of 1975

(M.R. Electronic Components Ltd. v. CIT) (ss p. 305 supra) is so different from the one before us that we do not think it proper to take any

assistance from the said decision.

As far as the other agreement is concerned, the terms are admittedly more or less identical and, therefore, we do not think it necessary to

cover the same ground agains. Whatever we have said as regards the quality of the consideration with reference to the agreement dated July 1,

1962, would equally apply to the consideration paid under the agreement dated January 9, 1964.

The result is that the first question has to be and is answered in the affirmative and in favour of the assessee.

The assessee had wholly succeeded before the AAC and the Tribunal as far as the claim for deduction of this expenditure is concerned. It is,

therefore, somewhat curious to find that the assessee has chosen to file ""cross-objections"" before the Tribunal, which the Tribunal disposed of at

the end of the order under reference. In dealing with the cross-objections, the Tribunal observe :

The cross-objection is preferred by the assessee are not really effective cross-objections. The only contention in them is that order of the

Appellate Assistant Commissioner should be upheld and the appeals preferred by the Income Tax Officer, dismissed. Since we have held that the

departmental appeals should fail, these cross-objections are technically allowed.

When it was pointed out by the Tribunal itself that the cross-objection were not effective, the only course open to it was to dismiss the same

Allowing the cross-objection would means interfering with the order of the AAC which it ultimately did not do. Just as in the casse of an appeal, if

it is allowed to interfere with the order of the appellate authority either in part or in whole similarly allowing the cross-objections would have the

consequence of interfering with the appellate order to some extent. As in the present case, the Tribunal has confirmed the order of the AAC there

is no question of allowing the cross-objections. It is the unfortunate wording in para 14 of the Tribunal''s order that has given rise to the second

question.

A cross-objection is only in the nature of an appeal. A person who has substantially succeeded in a forum may not think it necessary to file an

appea : but when an appeals is actually filed, he may take advantage of the filling of the appeal by the other side so as to file cross-objections to get

rid of the order in so far as it is adverse to him, as the period of limitation for the filing of the cross-objections is calculated from the dated of the

service of the appellate grounds. In effect, in such a case, a party who did not file an appeal, gets an extended period or limitation for filing what is

in effect an appeal. When the assessee has succeeded wholly before the AAC and the Tribunal, there was no scope for filing an appeal or cross-

objections. The Tribunal should have dismissed the cross-objections in limine as not being entertainable. The procedure of filing cross-objections in

is not be gone through merely for the purpose of putting forward arguments in support of an order which is in favour of the cross-objector. In these

circumstances the second question has to be answered in the negative and in favour of the revenue. As the assessee has substantially succeeded in

the reference, it will be entitled to costs - counsel''s fee Rs. 500 (one set)