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Commissioner Of Income Tax v. M/S Prem Family Trust - INCOME TAX REFERENCE No. 88 of 1994  RD-AH 889 (29 March 2005)
Income Tax Reference No. 88 of 1994
The CIT, KanpurVs.. M/s Kanpur Cigarettes (P) Ltd.
Hon'ble R.K. Agrawal, J
Hon'ble Prakash Krishna, J
The assessee/respondent is a company manufacturing cigarettes under the franchise agreement with M/s G.T.C. Industries Ltd., Bombay. The assessment year 1986-87 was the first year of the business of the assessee company and it has paid a sum of Rs. 3,26,520/- as royalty charges to M/s G.T.C. Industries Ltd during the assessment year 1986-87 and claimed payment of said royalty charges as revenue expenditure. There was an agreement dated 18th January, 1985 of the assessee/respondent with M/s GTC Industries Limited according to which the assessee respondent was required to pay royalty charges of Rs. 1/- per thousand cigarettes manufactured for acquiring GTC's know how and technical assistance as well as for the use of their trade mark. The GTC Company as per the terms of the agreement agreed to provide the services of its technical personnels as and when required, but the marketing of the cigarettes was left to the assessee/respondent. The said agreement was valid for a period of five years with the condition that after expiry of five years, the assessee/respondent would continue to manufacture the cigarettes and to use technical know how provided to it by M/s GTC Industries Ltd. on such terms and conditions as may be mutually agreed upon.
The assessing officer took a view that payment of royalty which is subject matter of present reference by the assessee company was a capital expenditure and accordingly it was disallowed and added back in the income of the assessee for the assessment year in question i.e. 1986-87. The said order was confirmed in appeal by the CIT (Appeals), but has been set aside by the Tribunal. The Tribunal held that the payment of royalty by the assessee/respondent was nothing but a revenue expenditure just to keep their factory going and no asset of enduring nature was obtained by the assessee.
At the instance of the Commissioner of Income Tax, the Income Tax Appellate Tribunal, Allahabad has referred the following question of law for opinion to this Court.
"Whether on the facts and in the circumstances of the case the Hon'ble Income Tax Appellate Tribunal was justified in holding that payment of royalty by the assessee company to M/s G.T.C. Industries Ltd. in a revenue expenditure?"
We have heard Sri A.N. Mahajan, learned Standing Counsel for the Department and none appeared on behalf of the respondent/assessee.
For computing the income chargeable under the head "profits and gains of business or profession", Section 37 of the Income Tax Act enables the deduction of any expenditure laid out or expended wholly and exclusively for the purpose of the business or profession, as the case may be. The fact that an item of expenditure is wholly and exclusively laid out for purposes of the business, by itself, is not sufficient to entitle its allowance in computing the income chargeable to tax. The expenditure should not be in the nature of capital expenditure. A distinction in between the revenue expenditure and capital expenditure has been drawn by a catena of decisions. It is almost impossible to formulate any general rule with sufficient accuracy and reasonable comprehension in clear line of demarcation in between the capital expenditure and revenue expenditure. It has been held in catena of decisions that an expenditure which is of enduring nature is a capital expenditure. Such expenditure is made not only once and for all but with a view to bring into existence an asset or addition in the enduring benefit of trade.
The question as to the payment of royalty by the assessee in pursuance of an agreement with another person has come up for consideration in a number of cases. The Supreme Court in Alembic Chemical Works Co. Limited Vs.. C.I.T. (1989) 177 ITR 377 has held that acquisition of know how to provide higher yield sub culture of high yielding strain of penicillin was not a capital expenditure, it is revenue expenditure and allowable as deduction under Section 37 of the Act.
In Jonas Woodhead and Sons (India) Ltd. Vs. C.I.T. (1997) 224 ITR 342 the Apex Court has considered that when a particular payment made by an assessee under the terms of an agreement forms a part of capital expenditure or revenue expenditure. It 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. In this case the Supreme Court has considered its earlier judgment given in the case of Alembic Chemical Works Co. Ltd. Vs. CIT (supra)
In a recent case the Supreme Court in C.I.T. Vs.. I.A.E.C. (Pumps) Ltd. (1998) 232 ITR 316 has held that where under the agreement with the foreign company the assessee was granted a licence to use its patents and designs exclusively in India and the agreement was for a duration of ten years with the parties having option to extend or renew the agreement, the agreement clearly established that what was obtained by the assessee was only a licence and what was paid by the assessee to the foreign company only a licence fee and not the price of acquisition of any captical assets. It was held that the expenditure incurred by the assessee was only revenue expenditure. In the case in hand the Tribunal has recorded a finding that the right acquired by the assessee was not exclusive and that too was for a limited period and which too could be terminated earlier within the period of agreement and payment was dependant on the quantum of the items manufactured. In view of these findings the Tribunal has rightly concluded that the payments towards royalty was nothing but a revenue expenditure and was allowable deduction. We find no illegality in the order of the Tribunal.
Therefore, we answer the question referred to us in the affirmative i.e. in favour of the assessee and against the Revenue. There shall be no order as to costs.
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