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Judgment
Ajit K. Sengupta, J.—In this reference u/s 256(2) of the income tax Act, 1961 (''the Act'') made at the instance of the assessee, the following questions have been referred to this Court:
Common questions for the assessment years 1978-79 to 1981-82:
Whether, on the facts and in the circumstances of the case, and on a correct interpretation of the relevant clauses of the two agreements, the Tribunal was right in holding that the gross amount of fees received or receivable by the assessee-company under the said agreements was its income and, therefore, deduction in terms of section 44D of the income tax Act, 1961, was allowable ?
Assessment year 1979-80:
Whether, on the facts and in the circumstances of the case, the Tribunal was right in dismissing the assessee''s appeal as academic and upholding the Commissioner (Appeals) ''s order u/s 154 on merits ?
Assessment year 1981-82:
Whether, on the facts and in the circumstances of the case, and having regard to the terms of the agreement and the certificate referred to in its order, the Tribunal was right in allowing only a token deduction of Rupee 1 u/s 44D of the Act ?
This reference relates to the income tax assessment of the assessee-company for the assessment years 1978-79 to 1981-82. The facts as found by the Tribunal are as under.
The assessee is a non-resident company deriving income by way of royalty or fees received from Wheels India Ltd., Madras. The Indian company was paying royalty to the assessee-company for grant of licence to use the process in the manufacture of rims and wheels and to sell them in India for a period of 20 years in terms of an agreement executed between the parties on 27-6-1960. The following clauses of the said agreement are relevant:
DUNLOP during the continuance of this agreement hereby covenants with the licensees as follows:
(a) that Dunlop shall communicate the licensees any modifications, improvements or additions to the equipment or the processes which Dunlop may invent, make or discover and shall permit the licensees to use and apply the same in the manufacture of the equipment.
(b) that Dunlop shall from time to time on the request of the licensees give to the licensees advice and assistance in the purchase of plant and machinery to be purchased from third parties and required by the licensees in the manufacture of the equipment. On all such purchases the licensees shall pay to Dunlop, a buying commission of 2� per cent on the invoice price of the goods to the licensees.
5(a) to (h) ******
(i) that the licensees shall pay to Dunlop by way of agreed consolidated fees in respect of the licences and other rights granted by Dunlop to the licensees and the expenses to be incurred by Dunlop outside the territory in connection with or incidental to the territory in connection with or incidental to research and development work in relation to the equipment and made available to the licensees under clause 3(a) hereof the communication of the information and otherwise under the provisions of this agreement (excluding the buying commission payable under clause 3(b) hereof a sum equal to 2 per cent on the total cost of production of the licensees in respect of the manufacture of the equipment in each calendar quarter ending the 31st March, 30th June, 30th September and 31st December in each and every year during the continuance of this agreement. The expression ''total cost of production'' shall mean the actual production cost of the equipment fairly and equitably determined under the headings specified in the Second Schedule hereto which shall include the payment of the said consolidated fees. Indian income tax, if any, payable on such consolidated fees shall be borne by Dunlop.
The aforesaid agreement was amended by an agreement dated 2-5-1975. It is specified in clause 5(i) of the original agreement dated 27-6-1960 as well as amended agreement dated 2-5-1975 that the said royalty and fees were in respect of licence and other rights granted by the assessee-company to the Indian company including the cost to be incurred by the assessee-company outside India in connection with or incidental to research and development work. The assessee-company had a Wheels Division in U.K. which is said to be doing some research and development work. The stand of the assessee-company has been that the entire expenditure on the Wheels Division involved in research and development should be first reimbursed out of the royalty and fees and the balance should be taken as taxable income of the assessee. Out of such balance, deduction should be allowed to the extent of 20 per cent in terms of section 44D of the Act. The Assistant Commissioner (Assessment) allowed deduction at the rate of 20 per cent of the royalty and fees received by the assessee-company in respect of the assessment years 1978-79 to 1980-81. In respect of the previous year relevant to the assessment year 1981-82, he did not even allow deduction at the rate of 20 per cent of the gross amount of royalty and fees since, according to him, the certificate of the Chartered Accountants filed by the assessee-company did not indicate the amount of expenditure incurred by it overseas as may be reasonably attributable to earning of income by way of royalty from the Indian company. The Commissioner (Appeals) also dismissed the appeals filed by the assessee-company for the assessment years 1978-79, 1980-81 and 1981-82. The appeal for the assessment year 1979-80 which was earlier allowed by the Commissioner (Appeals) was later dismissed by a rectificatory order passed u/s 154 of the said Act.
The assessee filed appeals before the Tribunal in respect of the assessment years 1978-79, 1980-81 and 1981-82. A separate appeal was filed by the assessee-company before the Tribunal against the order passed by the Commissioner (Appeals) u/s 154 in the assessment year 1979-80. The department had also filed an appeal before the Tribunal against the original order of the Commissioner (Appeals) for the assessment years 1979-80. It was contended on behalf of the assessee before the Tribunal that in view of clause 5(1) of the original agreement, the consolidated fees payable by the Indian company were not only in respect of licence and other rights granted by the assessee but also towards expenses to be incurred by the assessee-company in connection with or incidental to research and development work relating to the manufacturing process in respect of rims and wheels, the results whereof were being communicated to the Indian company in terms of clause 3(a) of the said agreement. According to the assessee-company, the royalty or fees so agreed upon included reimbursement by the Indian company towards cost or expenditure incurred overseas in connection with research and development work carried out by it. It was, therefore, contended on behalf of the assessee-company that while assessing income by way of royalty and fees receivable by the assessee-company from the Indian company, the expenditure incurred by the assessee-company towards research and development work in U.K. should first be deducted and the balance alone should be subjected to the provisions of section 44D. In other words, the contention was that the balance amount of royalty and fees received by the assessee-company should further be reduced by 20 per cent thereof in terms of section 44D.
On the other hand, the contention on behalf of the revenue before the Tribunal was that the deduction in terms of section 44D can in no case exceed 20 per cent of the gross amount of such royalty and fees as reduced by any lump sum consideration for the transfer outside India or the imparting of information outside India in respect of any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property. The Tribunal upheld the order of the Commissioner (Appeals) in respect of the assessment years 1978-79, 1980-81 and 1981-82 and it also upheld the order passed by the Commissioner (Appeals) in respect of assessment year 1979-80 u/s 154. The departmental appeal for the assessment year 1979-80 against the original order of the Commissioner (Appeals) was duly allowed. The Tribunal found as a matter of fact that the consolidated amount receivable by the assessee-company from the Indian company by way of royalty and/or fees varied between Rs. 15 lakhs to Rs. 21 lakhs in aforesaid 4 years as against the claim of the assessee-company towards research and developmental work in the sum of Rs. 20 lakhs in the assessment year 1978-79, Rs. 15 lakhs in the assessment year 1979-80, Rs. 87 lakhs in the assessment year 1980-81 and Rs. 94 lakhs in the assessment year 1981-82. The Tribunal noted that such substantial expenditure incurred by the assessee-company overseas represented entire cost incurred by it on its Wheels Division which is said to be involved in research and developmental work. It was not possible to ascertain the share of such cost as may be reasonably attributed to the information supplied by the assessee-company to the Indian company as a result of research and development carried out by it in its ''Wheels'' Division in U.K. The Tribunal also observed that the assessee-company might be having its own factories elsewhere and might have also entered into similar agreement with several other manufacturers around the world. Otherwise, such substantial expenditure could not have been incurred in the ''Wheels'' Division at U.K. In this view of the matter, the Tribunal held that the gross amount of royalty and fees received or receivable by the assessee-company from the Indian company must be considered as its income and deduction u/s 44D can be allowed only with reference to such gross amount. In respect of the assessment year 1981-82, the Tribunal referred to the certificate dated 28-4-1982 issued by Ernest & Whimney, Chartered Accountants, Birmingham, U.K. which read as under:
In accordance with a request made by our client Dunlop Ltd., we have examined the books and records of Wheel Division, Dunlop Ltd. for the year ended 31 December, 1978 and report that costs incurred by Wheel Division departments involved in research and development, including that relating to Wheels India Ltd., amounted in total to � 5,67,700.
The IAC (Assessment) had observed that the aforesaid certificate did not clearly indicate the amount of expenditure incurred by the assessee-company as can be attributed to the earning of income by way of royalty from the Indian company. He had, therefore, disallowed the entire claim for expenditure in respect of the assessment year 1981-82. The Tribunal referred to the provisions of section 44D and found that the deduction under that section could not exceed 20 per cent of gross amount received by way of royalty and fee. If the amount actually spent is less than 20 per cent of the royalty and fees, the assessee-company cannot get deduction to the extent of 20 per cent of the gross amount. According to the Tribunal, the assessee-company failed to establish the actual amount of expenditure incurred by it on research and developmental work which can be attributed to the earning of royalty and fee from the Indian company. The Tribunal observed that the burden lay on the assessee-company to establish its claim of deduction and since, according to the Tribunal, the assessee-company failed to discharge such burden, the Tribunal allowed only a token deduction of Re. 1 u/s 44D in respect of the assessment year 1981-82.
It would be convenient at this stage to quote the relevant provisions of section 44D as under:
Special provisions for computing income by way of royalties, etc., in the case of foreign companies. ?Notwithstanding anything to the contrary contained in sections 28 to 44C, in the case of an assessee, being a foreign company,?
(a) the deductions admissible under the said sections in computing the income by way of royalty or fees for technical services received from an Indian concern in pursuance of an agreement made by the foreign company with the Indian concern before the 1st day of April, 1976, shall not exceed in the aggregate twenty per cent of the gross amount of such royalty or fees as reduced by so much of the gross amount of such royalty as consists of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property;
(b) no deduction in respect of any expenditure or allowance shall be allowed under any of the said sections in computing the income by way of royalty or fees for technical services received from an Indian concern in pursuance of an agreement made by the foreign company with the Indian concern after the 31st day of March, 1976.
Section 44D was brought on the statute book by the Finance Act, 1976 with effect from 1-6-1976. This section lays down special provisions for computing income by way of royalty and fees for technical services received by a non-resident assessee from an Indian concern. A plain reading of clause (a) of section 44D makes it quite clear that notwithstanding anything to the contrary contained in sections 28 to 44C of the said Act, the deduction admissible to a foreign company in computing its income by way of royalties and fees for technical services received from an Indian concern in pursuance of an agreement made before 1-4-1976 shall not exceed in the aggregate 20 per cent of the gross amount of such royalty or fees as reduced by the lump sum consideration for the transfer outside India of or the imparting outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property. In our view there is no room for contending that the assessee-company could claim by way of deduction from the gross amount of royalty or fees received by it for rendering technical services to the Indian company any amount in excess of 20 per cent of such gross amount of royalty and fees. The agreement entered into by the assessee-company with Wheels India Ltd., Madras, only indicates the various types of services which the assessee-company will render to the Indian company in order to become entitled to receive the royalties and fees as aforesaid. Clause 5(1) of the said agreement only clarifies that the payment of such royalty as agreed to in the said agreement shall be a consolidated payment in respect of the licences and other rights granted by the assessee-company to the Indian company as well as towards expenditure that might be incurred by the assessee-company outside the Indian territory and in connection with or incidental to the research and development work. The terms of clause 5(i), in our view, are only clarificatory in nature so that at no point of time the assessee-company can ever ask for any extra payment by way of reimbursement or otherwise towards expenditure that may be incurred by it in connection with or incidental to the research and development work to be carried on by it outside the Indian territory. In our view, therefore, the Tribunal was fully justified in holding that the assessee-company cannot claim any deduction for expenditure higher than 20 per cent of the gross amount of such royalty or fees as may be received by it from the Indian company in view of the clear provisions of clause (a) of section 44D. In this view of the matter both the first and second questions must be answered in the affirmative and in favour of the revenue.
Coming to the third question which relates to the assessment year 1981-82 we are of the view that the Tribunal was not justified in granting a token deduction of Re. 1 u/s 44D. In paragraph 8 of the said order, the Tribunal has recorded that the assessee-company has been incurring substantial expenses on research and development work outside the Indian territory year after year. The expenditure incurred on this account as noted by the Tribunal was Rs. 20 lakhs for the assessment year 1978-79, Rs. 15 lakhs in the assessment year 1979-80 and Rs. 87 lakhs in the assessment year 1980-81. In each of these 3 years the Tribunal, agreeing with the IAC (Assessment), allowed full deduction of 20 per cent of the gross income by way of royalty and fees received by the assessee-company from the Indian concern in pursuance of section 44D. The expenditure incurred by the assessee-company in the previous year relevant to the assessment year 1981-82 on research and development work was Rs. 94 lakhs. The Chartered Accountants'' certificate filed by the assessee-company did indicate that the total expenditure of � 5,67,700 equivalent to Rs. 94 lakhs was incurred by the assessee-company on research and development in its ''Wheels'' Division Overseas and such expenditure included expenses relating to the Indian company Wheels India Ltd. as well. The Tribunal also recorded that by no process of calculation, it was possible to ascertain the share of cost incurred by the assessee-company which could be attributed to the information given by it to the Indian company Wheels India Ltd. In the face of this finding and having regard to the fact that full 20 per cent deduction with reference to the gross amount of income by way of royalty and fees received by the assessee-company from the Indian concern was granted in each of the 3 earlier years, namely, assessment years 1978-79 to 1980-81, wherein the expenses incurred on research and developmental work was far lower than Rs. 94 lakhs, incurred in the previous year relevant to the assessment year 1981-82, there is point in denying the statutory deduction u/s 44D. We are of the view that the Tribunal should have allowed full 20 per cent deduction with reference to the gross amount of royalty and fees towards expenditure incurred by the assessee-company u/s 44D(a) in respect of the assessment year 1981-82 as well. There is no reason to allow only a token deduction of Rupee 1 in the assessment year 1981-82. We, therefore, answer the third question in the negative and in favour of the assessee.
Sen, J.
I agree.