1982-VIL-498-CAL-DT

Equivalent Citation: [1984] 146 ITR 405, 36 CTR 224, 13 TAXMANN 162

CALCUTTA HIGH COURT

Date: 17.08.1982

COMMISSIONER OF INCOME-TAX, WEST BENGAL III

Vs

STANTON AND STAVELY (OVERSEAS) LIMITED

BENCH

Judge(s)  : SUHAS CHANDRA SEN., SABYASACHI MUKHERJEE 

JUDGMENT

SABYASACHI MUKHARJI J.-In this reference under s. 256(1) of the I.T. Act, 1961, the following question has been referred to this court:

" Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the amounts described as 'commission' in the agreement dated 9th October, 1956, between the assessee and the Indian Iron and Steel Co. were in the nature of royalties and fees covered by the exemption provided in rule 1 (ix) and rule 1(x) of, the First Schedule to the Companies (Profits) Surtax, Act, 1964, and were liable to be excluded from the total income of the assessee in computing the chargeable profits for the assessment years 1965-66, 1966-67, 1967-68 and 1969-70 ? "

This reference arises out of the assessment for the assessment years 1965-66, 1966-67, 1967-68 and 1969-70 under the provisions of the C.(P.) S.T.. Act, 1964. Now it would be relevant to refer to the relevant provisions of the said Act. The First Schedule to the said Act provides rules for computing the chargeable profits under the provisions of that Act. Rule stipulates that income, profits and gains and other slims falling within the clauses mentioned thereafter should be excluded from the total income of cls. (ix) and (x). Clause (ix) of r. 1 of the First Schedule to the said Act reads as follows :

"income by way of royalties received from Government or a local authority or any Indian concern."

Clause (x) reads as follows:

"In the case of a non-resident company which has not made the prescribed arrangements for the declaration and payment of dividends within India, its income by way of any interest or fees for rendering technical services received from Government or a local authority or any Indian concern."

The question before us is whether the amounts mentioned in the orders which are under appeal before the Tribunal would come within the expression " income by way of royalties received from local government or local authority or any Indian concern " and similarly " in the case of a non-resident company ", which the assessee is in the instant reference before us, " its income by way of any interest or fees for rendering technical services received from Government or a local authority or any Indian concern " or in other words whether the amounts in dispute were royalties received from an Indian concern so far as the assessee is concerned or whether it should be considered to be fees for rendering technical services. Therefore, the controversy centres round the true nature and character of the amounts of Rs. 7,85,967, Rs. 8,56,670, Rs. 12,40,990 and Rs. 6,72,480. It was claimed by the assessee before the ITO that under cls. (ix) and (x) of r. 1 of the First Schedule to the Surtax Act the above amounts were excluded by the assessee from the total income for the purpose of computation of chargeable profits as they represented royalties and fees for rendering technical services as received by the non-resident assessee from the Indian Iron and Steel Co. Ltd. (hereinafter referred to as the " IISCO "). Since the assessee had no other source of income in India, the chargeable profits were shown as nil by it. The agreement between the assessee and the IISCO has referred the these amounts as " commission " and so, the ITO did not accept the plea that these amounts represented royalties or technical fees and, there fore did not grant exemption in respect of these amounts under r. 1(ix) and r. 1(x) of the First Schedule to the said Act.The question is whether these amounts were really " commission " as described in the agreement or these amounts could be described as either royalties or commission as was claimed by the assessee. The AAC was also of the opinion that the expression " commission " advisedly used by the parties to the agreement could not be ignored or re-defined so as to suit the convenience of the assessee. He, therefore, held that the assessee's contention was not tenable and upheld the order and action of the ITO. The assessee went up in appeal before the Tribunal. Several contentions were urged before the Tribunal. One of the main contentions urged before the Tribunal was, as we have mentioned, the true nature and characteristic of various amounts indicated before. The agreement between the assessee and the IISCO has referred to these amounts as " commission ". It is material to refer to the relevant provisions of the agreement. The agreement is dated the 9th October, 1956. It is an exhaustive agreement. It has several clauses containing definitions about drawings and various other things. This agreement was entered into by and between the assessee, STANTON IRONWORKS COMPANY LTD., which was incorporated in Great Britain and whose registered office is situated at Stanton by Dale in the County of Derby which is called in the agreement as " Stanton " which was said to include its subsidiary and controlled companies of the one part and the Indian Iron & Steel Company Ltd., as we have mentioned, which is called IISCO of the other part. On behalf of the as it was claimed that this agreement could properly be described as technical know-how collaboration agreement and the amounts paid in respect of different items should be considered to be royalties or fees and would not merit consideration as commission. In order to decide the controversy it is material to refer to certain relevant clauses. The agreement recites that the Stanton had authorised IISCO to establish and work a plant at Kulti for the manufacture of centrifugally cast iron pipes and joints for use therewith. The agreement was called "Export Agreement" supplemental to the Manufacturing Agreement of that date. It appears, therefore, that there was a " Manufacturing Agreement entered into between the parties on that date, whereunder Stanton was appointed as the agent of IISCO for the sale of export products for use in the export territory, being defined therein. It further recited that IISCO had duly established the plant at Kulti and that Stanton and IISCO had performed their respective obligations under the Manufacturing Agreement and Export Agreement, but due to the demand for pipes in India the parties' intentions with regard to the Export Agreement were frustrated as no pipes had so far been available for export nor for the like reason it appeared likely to be available for export for some years to come. It further recited that IISCO was desirous not only of continuing to manufacture centrifugally cast iron pipes and joints for use therewith at the said plant at Kulti but of considerably enlarging the capacity of the said plant and in connection therewith of purchasing from Stanton copies of the drawings and specifications mentioned in the agreement and for obtaining further information and advice from Stanton and for obtaining from Stanton a licence or licences under certain letters patent of Stanton and the consent of Stanton to the use of Stanton's processes in the manufacture of centrifugally cast iron pipes and joints for use therewith and to use the name of Stanton in connection with the sale of products so manufactured and Stanton was willing to make such sale and to give such information, advice and licences to the extent and upon the terms subject to the conditions mentioned in the agreement.

The agreement clause defines certain expressions, with which we are not concerned. Clause 2 of the agreement stipulated that Stanton undertook with IISCO (except always in so far as it might be prevented by force majeure), inter alia, as follows and it is material to set out sub-cls. (i), (ii) (iii) and (iv) leaving aside the proviso thereunder, with which we are not concerned :

" (i) Forth to sell and deliver to IISCO copies of all such detailed drawing and specifications as IISCO may reasonably require for the purchase and installation and operation of the Specialist Plant;

(ii) To lend to IISCO as and when may be required by IISCO on reasonable notice for temporary service with IISCO a qualified engineer whose duties shall be to supervise the erection of the Kulti extension and in particular the installation and starting up of the Specialist Plant;

(iii) During the continuance of this agreement to permit IISCO to send to Stanton's plant at Stanton by Dale on reasonable notice such employees (not exceeding ten in all) of IISCO as IISCO shall, deem suitable to be trained to operate the Specialist Plant to be incorporated in the Kulti extension which training Stanton hereby agrees to use its best endeavours to impart and which shall include instruction in what is in the opinion of Stanton the best method of operating the Specialist Plant;

(iv) Generally during the continuance of this agreement to act as consultants to IISCO on the manufacture of Stanton Products and as such consultants to advise IISCO on, problems of a technical nature including the imparting to IISCO of particulars of all improvements in the manufacturing technique of Stanton products made by Stanton as a result of research, work carried, out by Stanton during the continuance of this agreement and which in the opinion of Stanton would be of assistance to IISCO in reducing the cost of production and/or increasing the quality of Stanton products manufactured by IISCO ...... .."

Clause 3 of the agreement stipulated that Stanton authorised IISCO "to use during the continuance of the, agreement the information to be communicated to it pursuant to the agreement for the manufacture of Stanton products in IISCO territory".

Clause 4 of the agreement provides as follows:

"For the purpose of the manufacture of Stanton products (but not further or otherwise) Stanton hereby agrees to grant to IISCO and IISCO hereby agrees to take for the continuance of this agreement or the respective lives of the Stanton patents whichever shall be the shorter full and free licence and authority to manufacture in territory as aforesaid Stanton products in accordance with the specifications of the said Stanton patents or any part thereof or any process or invention therein described and to sell the same for use within, IISCO territory. Every such licence shall be in the form specified in the First Schedule hereto."

It is relevant to bear in mind that these items, viz., sub-cls. (i), (ii) and (iii) of cl. 2, cl. 3 as well as cl. 4, fall for our consideration. So far as subcl. (i) of cl. 2 is concerned, there is really no dispute, because it was an agreement to sell and deliver to and purchase by IISCO and the price would be their purchase price. But the controversy is round cl. 3 and cl. 4. While on behalf of the assessee it was emphasised that these can be considered to be either royalties or fees and as such merit for exemption under cl. (ix) and cl. (x) of r. 1 of the First Schedule to the Surtax Act, it was contended on behalf of the Revenue that the price and the nature indicated therein should be royalty and, therefore, should not merit for exemption.

Clause 5(i) of the agreement deals with the payment of the consideration for the sale and delivery of the drawings and specifications mentioned in cl. 2(i) of the agreement and it provides that the sum to be paid would be Six thousand seven hundred and fifty pounds, which is of course the purchase price. Clause 5(ii) deals with the consideration of the services to be rendered by Stanton to IISCO under sub-cls. (ii), (iii) and (iv) of cl. 2 of the agreement and the rights and privileges to be afforded by Stanton to IISCO under cls. 3, 4 and 8 of the agreement; the considerations that would be paid, are material for our consideration and the agreement for consideration provides as follows:

"(a) A commission at the specified rate (as hereinafter defined) on the nett selling price (as hereinafter defined) of all Stanton products manufactured and sold by IISCO during the continuance of this agreement, such commission to become due and payable in the manner specified in cl. 6 hereof. The specified rate in respect of all Stanton products manufactured prior to the reduced commission date shall be three per centum and thereafter one and a half percentum. The nett selling price above referred to shall mean the nett price, at the plant of manufacture realised by IISCO:

(b) Except always in so far as: may otherwise be agreed in writing from time to time an amount equivalent to the cost to Stanton of all salary and travelling expenses (including board while in IISCO territory) of the engineer whose services shall be lent to IISCO pursuant to clause 2 of this agreement and all other engineers or other employees of Stanton whose services Stanton may hereafter agree shall be lent to IISCO in connection with the operation Of any plant of IISCO for manufacture of Stanton products or the construction of any plant by IISCO for such purpose or advice in regard thereto, such payment to be made on monthly account nett against invoices ;

(c) Amounts equivalent to any sums paid by Stanton to any engineers or other employees of IISCO who may be sent by IISCO to Stanton's plant (for the avoidance of doubt it is hereby agreed and declared that all salaries and travelling expenses including board while in England of any such employees shall be borne solely by IISCO)."

Clause 6 of the agreement deals with the maintenance of accounts which is not material for our present purpose; so is cl. 7. Clause 8 which is another service to be rendered by the assessee for information exchanged and in consideration thereof certain payments to be made as noted hereinbefore, is as follows:

"If during the continuance of this agreement either party shall make, discover or acquire any further invention, patent, process or design in connection with or improvements upon or addition to the methods of manufacturing Stanton products or any modifications of or developments in machinery or apparatus used in connection therewith such party shall (unless prevented by the terms of any such acquisition) communicate the same to the other party and shall ensure if it shall have acquired the right so to do that such other shall receive full and sufficient licences, information and assistance thereon and in relation thereto and be enabled to use the same for the manufacture (in the case of IISCO) of Stanton products in IISCO territory during the continuance of this agreement and in accordance therewith without payment other than such as is hereinbefore provided or (in the case of Stanton) of or otherwise in relation to any products of Stanton (but not for the manufacture of Stanton products in IISCO territory during the continuance of this agreement) PROVIDED ALWAYS that if such rights shall only have been acquired by the one party subject to payment, that party shall be entitled to require from the other and the other shall if it shall desire to use such rights pay a fair proportion (to be agreed between the parties hereto or failing such agreement to be determined by the respective auditors for the time being of the parties or an umpire previously appointed by such auditors) of such payment. "

The other clauses of the agreement are not material, except that cl. 10 provides that " IISCO acknowledges and recognises Stanton's right in the ownership of the trade mark or trade name STANTON ".

The Tribunal referred to the several clauses which we have mentioned hereinbefore and it also noted the contentions urged on behalf of the respective parties. The Tribunal was of the view that the agreement could be actually termed as, a collaboration agreement by virtue of which the non-resident assessee-company had allowed the Indian company to use its patents, privileges, technical information, etc., for a limited period and at a price. The non-resident company had placed at the disposal of the Indian company its services through its employees and had also agreed to train up the personnel or employees of the IISCO. The agreement related to the manufacture of Stanton products which briefly meant cast iron pipes and joints for use therein. Then the Tribunal referred to the several clauses relevant for the purpose of the contentions urged before the Tribunal and set them out in its order.

The Tribunal observed that on a careful reading and on a conspectus of the above clauses, it would be evident that the amounts in dispute represented fees for rendering certain technical services envisaged in subcls. (ii), (iii) and (iv) of cl. 2 and also royalties payable to Stanton by the IISCO in respect of the rights and privileges to be afforded by it as per cls. 3, 4 and 8.

The Tribunal then referred to the meaning of the expression " royalty ". The Tribunal referred to Wharton's Law Lexicon ( 14th edn ), where the term has been explained as a payment to a patentee by agreement on every article made according to his patent or to an author by publisher on every copy of his book sold or to the owner of minerals for the right of working the same on every ton or other weight raised. The Tribunal has also referred to the Law Dictionary by Mozley & Whiteley's which had been relied upon by the departmental representative, where It royalty " had been described as a pro rata payment to a grantor or lessor on the working of the property leased or otherwise on the profits of the grant or lease. The term was used especially with reference to the patents, mines, copyrights, etc.

The Tribunal referred to the decision on the expressions " royalty as used by Lord Denman in R. v. Westbrook [1847] 10 QB 178, which the Privy Council relied and approved in the decision in the case of Raja Bahadur Kamakshya Narain Singh of Ramgarh v. CIT [1943] 11 ITR 513. Inasmuch as our attention was drawn to the said decision, it may not be inappropriate to refer to this decision briefly at this stage. There, the assessee received large payments by way of royalty on the various mining leases. The leases purported to grant and demise unto the lessees for 999 years the underground coal mining rights specified in the schedule to the leases and all the estate, right, title and interest of the lessor into and upon the same and every part thereof with full liberty and power to the lessees to search for, work, make merchantable and carry away the coal there found and with power to dig and sink pits, to erect engines, machinery, buildings, workshops, cottages and to make such railways, tramways, and roads as were required. In return for these rights the lessees were to pay a sum by way of salami or premium and an annual sum as royalty computed at a certain rate per ton on the amount of coal raised and coke manufactured, subject always to a minimum annual sum. The lessor had the right to re-enter in case of failure to pay the rent or royalties. It was contended on behalf of the assessee that the sums, received as salami and royalty did not constitute income but were capital receipts representing the price of the minerals removed. It was held by the Privy Council affirming the decision of the High Court at Patna, (i) that the salami was paid for the acquisition of the right, of the lessees to enjoy the benefits granted to them by the lease and that right being a capital asset, the money paid to purchase it was a payment on capital account, (ii) that the minimum royalty being a species of annual guarantee was income flowing from the covenants in the lease and was in no sense a payment on capital account, (iii) that it was fallacious to envisage the royalty payable every year under the terms of the lease as merely the price of the actual, tons of coal; it was compensation which the lessees paid the lessor for that species of occupation which the contract between them allowed and it was, therefore, income from other sources within the meaning of s. 12 of the Indian I.T. Act, 1922. If the receipts were income, it was not material for tax purposes that that for which they are paid came from a waste property. It may be mentioned, as it would be apparent from the facts given before, that the concept of royalty was discussed in the said decision in the background whether it was a capital receipt or revenue receipt. In the background of the facts given, the nature of royalty came up for consideration and on behalf of the parties, reliance was placed on certain observations appearing at pp. 522-523 of the report. Lord Wright, speaking for the judicial Committee, observed as follows:

" The royalty is in substance a rent ; it is the compensation which the occupier pays the landlord for that species of occupation which the contract between them allows to quote the words of Lord Denman in R. v. Westbrook (1847) 10 QB 178. He was referring to leases of coal mines, clay pits and slate quarries. He added that in all these the occupation was only valuable by the removal of portions of the soil. It is true that he was dealing with occupation from the point of view of rating, but occupation has the same meaning in its application to matter & of taxation such as are involved in this case."

In that background, in the opinion of the judicial Committee, there was no justification for treating the royalty as capital payments. We are, however, not concerned with the controversy in the instant case and we do not, therefore, want to detain ourselves with the judgment any further.

The Tribunal also referred to the decision of this court in the case of CIT v. Hindustan General Electrical Corporation Ltd. [1971] 81 ITR 243. .There also the controversy was different. There, the question was whether certain payments made for know-how and advice were royalty and as such liable to be treated as capital receipt or revenue receipt. Reliance was also placed on the decision of the Andhra Pradesh High Court in the case of Raja Manyam Meenakshamma v. CIT [1956] 30 ITR 286. Deducing the principles referred to in this decision, the Tribunal was of the opinion that cls. 3, 4 & 8 of the agreement, in the instant case, provided for the use by IISCO of certain valuable rights, licence and technical information which could be collectively described, in the words of the Tribunal, as " rights and privileges " under the agreement.

Coming to the amounts received by the assessee and referable to the services to be rendered by the assessee under paras. (ii), (iii) and (iv) of cl. 2, the Tribunal found that those were technical services to be rendered by the assessee either by way of consultancy or by way of training to th employees of the IISCO. The Tribunal then referred to the circulars issued by the CBDT, from time to time on foreign collaboration agreements, technical fees of the know-how an as to how they were to be understood. Our attention was drawn to Circular No. 21 of 1969, dated 9th July, 1969, which would be found in the Statute portion at p. 19 of 73 ITR. The circular was issued on the subject of foreign technical collaboration, payments for technical know-how, etc. This circular was issued in clarification of certain facts. Paragraph 8 of the said circular refers to the participant's tax liability in a foreign collaboration agreement in the context Of capital and revenue receipts. Paragraphs 8, 9 and 10 of the said circular stated as follows:

"8. As regards the foreign participant's tax liability also, the first question would be whether the amount received for the supply on technical know-how, is a receipt on capital account or on revenue account. The answer would again depend on the facts of the case. It has to be observed that the nature of the outgoing in the hands of the Indian participant will not always be determinative of the nature of the receipt in the hands of the foreign party. In the U.K., it has been held by courts that a receipt from the sale of know-how would be a capital receipt only where the sale of the technical know-how or the imparting of technical knowledge and information results in the transfer or parting with of the property or assets or any special knowledge or skill Which would ripen into a form of property and that after such transfer, the transferor is deprived of using the asset. (Please see Moriarty v. Evans Medical Supplies Ltd. [1959] 35 ITR 707 (HL)). In all other cases, where no capital asset or property is parted with and the transaction is merely a method of trading by which the recipient acquires the particular sum of money as profits and gains of that trade, the consideration received for the sale of technical know-how will be on revenue account.

9. If the amount received by the foreign participant is a revenue receipt in his hands and the amount is received by him outside India the further questions that would arise are, whether the payment is:

(i) for services rendered abroad, or

(ii) for services rendered in India, or

(iii) represents royalty.

If the amount received by the foreign participant is for services rendered entirely outside India, that sum will not be subject to tax in India, because the income will be accruing to the non-resident wholly outside India. Where the payment received is for services rendered in India, the amount will be taxable in India, subject, of course, to the deduction of legitimate expenses of a revenue nature incurred by the foreign participant for the purpose of earning such income. If the payment received is royalty, the question of allocating the income between India and outside India would not arise and the whole amount would be liable to tax in India where the patent has been exploited. Deduction will, however, be admissible against the royalty income for the cost of current services rendered in order to earn the royalty.

10. Cases where payments of each of the above categories are clearly and truly ascertainable from the terms of the agreement and with reference to all relevant facts will not present serious difficulty. But in cases where the agreement stipulates a consolidated payment or where the true character of the payment is different from that ascribed to it in the agreement, difficulty would arise in the allocation of the payment for the various services rendered under the agreement. Ordinarily, a payment expressed as a percentage of the sales in India is to be treated as payment of royalty and taxed in India. When the payment is stated to be for technical know-how or services rendered abroad but is related to the sales, the Income-tax Officer will have to go into the facts of the case and determine the extent to which the payment attributed to technical services abroad represents in fact payment for, (i) services abroad, (ii) services in India and (iii) royalty or extra royalty for exploiting the know-how in India.

It is therefore necessary that the utmost care should be exercised by the assessing officers in determining the true nature of the payment when it is a consolidated figure or is expressed as a percentage of sales, by whatever term the contracting parties may decide to call it. Allocation of the payment among the various services in India and abroad and towards the royalty element, if any, included in the arrangement, has to be made objectively and after a careful appraisal of the precise terms of the collaboration agreement and the actual manner in which the terms have been implemented in practice."

In the aforesaid background, the Tribunal was of the opinion that the amounts receivable in respect of these services could be, called " fees ". The Tribunal referred to r. 1(ix) and r. 1(x) of the Surtax Act, First Schedule, and observed that a specific exemption or exclusion had been conferred on income by way of royalties receivable from any Indian concern as receipts by way of fees for rendering technical services by a non-resident company from any Indian concern. Commission, on the other hand, would take in payments like broker's remuneration, agent's remuneration, or payments, according to the Tribunal, connected with selling agencies and the like. The Tribunal was of the view that none of the definitions given in any of the legal dictionaries bears out the stand taken by the Revenue. The receipts in question, therefore, according to the Tribunal, would be more appropriately covered by the term " royalties " and " fees " rather than by the expression " commission ". The Tribunal, therefore, held that the amounts described as " commission " in the agreement were really in the nature of fees and royalties and were covered by the exemption provided in r. 1(ix) and r. 1(x) of the First Schedule to the Surtax Act. The Tribunal observed that it was well known that how the parties described an item in the agreement was not decisive of the character of the payments or the amounts received. Therefore, the Tribunal held in favour of the assessee on this aspect.

Before us, same arguments were repeated, apart from drawing our attention to certain dictionary meanings in the English law and certain decisions which we shall presently refer to. Our attention was drawn to the meaning of expressions " royalty " and " fees " in Jowl's Dictionary of English Law, 1977 Edn. There, it has been described as follows:

"Royalty, a payment reserved by the grantor of a patent, lease of mine or similar right, and payable proportionately to the use made of the right of the grantee. It is usually a payment of money, but may be pay merit in kind, that is, of part of the produce of the exercise of the right.

Royalty also means a payment which is made to an author or composer by a publisher in respect of each copy of his work which is sold, or to an inventor in respect of each article sold under the patent.

Fees, perquisites allowed to officers in the administration of justice, as a recompense for their labour and trouble, ascertained either by Acts of Parliament, by rule or order of court, or by ancient usage, in modern it times frequently commuted for a salary, e.g., by the Justices Clerks Act, 1877, ss. 2-4 (repealed).

Although, however, the officers of a court may be paid by salary instead of by fees, the obligation of suitors to pay fees usually remains. See the Supreme Court Order, 1970 ; County Court Fees Order, 1981.

The mode of collecting fees in a public office is, under the Public Offices Fees Act, 1879 (repealing and replacing the Public Offices Fees Act, 1866), by stamps or money, as the Treasury may direct.

The fees of the steward of a manor were regulated entirely by custom, and a customal or list of fees to be taken, under every circumstance, was generally handed down from steward to steward. When the steward made excessive charges, the copyholder could bring an action on the case to recover the excess, and an indictment would lie for extortion colore officio. In transactions where these fees were large or numerous a special agreement was generally made (Allen v. Aldridge [1843] 5 Beav. 401).

Reference was also made to Ramanatha Aiyar's Law Lexicon for the expressions " royalty " and " fees " and it is not necessary to set out the actual meaning given in the said book. But, there, the fees have been described as charge or compensation for particular acts or services ; reward or compensation for services rendered or to be rendered; a payment in money for official or professional services, whether the amount would be optional or fixed by custom ; compensation paid to professional men, as an attorney or physician. There, royalty is given several meanings: (1) percentages or dues payable to landowners for mining rights, (2) sums paid for the use of a patent, (3) percentages paid to an author by a publisher on the sales of a book. There are other definitions also, viz., royalty is a tax or duty paid to the owner of a patent for the privilege of manufacturing or using the patented article.

These definitions and decisions cited before us, some of which we shall presently refer, are illustrative of some of the principles which may be borne in mind in deciding whether a particular payment would be termed as royalty or commission or fees in the background of the facts of the particular case. Reliance was placed on the decision in the case of Golan Lime Syndicate v. CIT [1966] 59 ITR 718 (SC), where at p. 726, the court discussed the nature of royalty. There, of course, the discussion was whether a certain payment would be considered to be revenue or capital. The court held that, in the facts of that case, royalty was not a direct payment for securing an enduring advantage, it had relation to the raw material to be obtained. Therefore, it was held to be revenue receipt.

Our attention was drawn to the decision of the Supreme Court in the case of Travancore Sugars and Chemicals Ltd. v. CIT [1966] 62 ITR 566 (SC). There the court was concerned with the question whether a particular expenditure before the court was capital or revenue. There, the, Supreme Court at p. 572 of the report referred to the decision of the Court of Appeal in IRC v. 36149 Holdings Ltd. (in liquidation) [1943] 25 TC 173 (CA), where Lord Greene, Master of the Rolls, observed as follows (at p. 182 of the report) :

" The true nature of a sum payable to a recipient for purposes such as the present is to be ascertained from all the circumstances relevant to that matter. The true nature of the sum is not necessarily its nature in law but its nature in business or in accountancy whichever way one likes to put it, because from the legal point of view there may be no difference whatsoever as between the parties between a capital and an income sum. It may be totally irrelevant to the legal relationships into which they are proposing to enter. When, however, the tertius gaudens, in the shape of the Revenue, appears on the scene, that matter which as between the parties may have been a matter of not the slightest importance becomes immediately a matter of very great importance, and it is necessary to examine the circumstances of each individual case, including any documents which require to be construed, in order to ascertain what is the character to be attributed to the payment."

The same view of the Supreme Court was recorded in the decision of the Bombay High Court in the case of CIT v. Kolhia Hirdagarh Co. Ltd. [1949] 17 ITR 545. There it has been held that in taxation matters it is not necessary to construe documents from their purely legal aspect and it is open to the High Court not only to look at the documents themselves, but also to consider the surrounding circumstances so as to arrive at a conclusion as to what was the real nature of the transaction from the point of view of two businessmen who were carrying out the transaction. In all taxation matters more emphasis must be placed upon the business aspect of the transaction rather than on the purely legal and technical aspect.

Reference has also been made to the decision of the Bombay High Court in the case of Harihar Cotton Pressing Factory v. CIT [1960] 39 ITR 594. There the court was concerned with the expression " commission The expression " commission " had no technical meaning but both in legal and commercial acceptation of the term it has a definite signification and is understood as an allowance for service or labour in discharging certain duties such as, for instance, of an agent, factor, broker or any other person who manages the affairs or undertakes to do some work or renders some service to another. Mostly, it was a percentage on price or value upon the amount of money involved in any transaction of sale or service or the quantum of work involved in a transaction. It could be for a variety of services and was of the nature of recompense or reward for such services. " Rebate ", on the other hand, was a remission or a payment back and of the nature of a deduction from the gross amount. It was sometimes spoken of as a discount or a drawback.The dictionary meaning of the term included a refund to the purchaser of a thing or commodity or a portion of the price paid by him. It was not confined to a transaction of sale and included any deduction or discount from a stipulated payment, charge or rate. It need not necessarily be taken out in advance of payment but might be handed back to the payer after he had paid the stipulated sum. The repayment need not be immediate. It could be made later and in case of persons who bad continuous dealings with one another it was nothing unusual to do so. That is not the question with which we are concerned.

Our attention was also drawn to a decision of Rajasthan High Court in the case of CIT v. Associated Stone Industries (Kotah) Ltd. [1981] 130 ITR 868. There the controversy was again between capital and revenue expenditure and whether a certain amount was revenue expenditure and whether a certain amount payable was minimum royalty or recovery of taxes. Our attention was drawn to the observations of the court at p. 888. Reference was also made in the case of CIT v. New Great Insurance Co. Ltd. [1973] 90 ITR 348 (Bom). Reliance was placed on the observations of the court at pp. 352 and 360. This decision was referred to on behalf of the assessee for the purpose of emphasizing that what the section required was not that strictly exemption should be limited to royalties or fees but the section required computation of capital to be limited strictly to those payments which could be strictly considered to be royalties or fees which could be considered to be income by way of dividends. The Bombay High Court at p. 360 of that report referred to s. 85A of the I.T. Act, 1961, and noted that the expression " any income by way of dividends " in the section would not make any difference, because dividends received are always income and the words used were just a convenient mode of description. Reliance was also placed on the decision of the Bombay High Court in In re Tata Iron and Steel Company Ltd. [1921] 1 ITC 125 (Bom). There the Division Bench observed that the amount of money paid by a joint stock company to the underwriters on an issue of new shares increasing the capital of the company cannot be allowed to be deducted as an expenditure coming under s. 9(2)(ix) of the I.T. Act. In the course of the judgment Mr. justice Shah observed at p. 133 that the expression " capital expenditure " was not defined and the words " in the nature of capital expenditure " made the meaning of the expression more elastic in its application to the facts of each case. The observation of Mr. justice Shah, in the aforesaid decision, was relied on in aid of the submission on behalf of the assessee that inasmuch as the expression " royalty, fees or commission " was not defined in the Surtax Act with which we are concerned, the expression " any income by way of dividends " in the background of the expression royalties or fees should be considered to be more elastic.

Reliance was also placed on the meaning of the expression " fees " on certain observations of the Supreme Court in Corporation of Calcutta v. Liberty Cinema , AIR 1965 SC 1107, where at p. 1115 the Supreme Court referred to the expression " fees ". Of course, these observations, it must be borne in mind, were made in contrasting the expression " fees in contradistinction to " tax " in the legal and constitutional provision. Our attention was also drawn to certain expressions used in certain agreements entered into with different countries for relief of double taxation. For the purpose of this case, in support of the assessee's contention that a payment of the nature, with which we are concerned, should properly be construed as either royalties or fees and not commission, it is not necessary, in our opinion, to refer in detail to all those different agreements to which our attention was drawn. Reference was also made to a decision of the Allahabad High Court in the case of Raja Ram Kumar Bhargava v. CIT [1963] 47 ITR 680 (All). There the expression " commission " it held, in view of the context in which it was used in s. 10(2)(x) of the Act, did not include commission which formed part of the salary. There the Allahabad High Court was contrasting " commission " with " bonus ". Great reliance, however, was placed by both sides on the observations of the Gujarat High Court in the case of CIT v. Ahmedabad Manufacturing & Calico Printing Co. [1983] 139 ITR 806. There the assessee was paying to a foreign collaborator 1% of the net sale proceeds as " research contribution " for use of the collaborator's secret formula and benefits of further research. The question was whether payment was " royalty " liable to suffer deduction of tax at lower rate of 50%- Pt. II, 2(b)(ii), of the Finance (No. 2) Act, 1971, and s. 195 of the I.T. Act, 1961. It is not necessary for our purpose to set out the actual controversy referred to therein. There the court reiterated that the expression " royalty " was not defined in the Act. That is true in the instant case also. The court also referred to certain definitions in Corpus Juris Secundum, Vol. 77, at p. 542, on the expression " royalty " and also in Words and Phrases Legally Defined, Vol. 4, at p. 384, and also the meaning of that word in Australian and Canadian decisions. It may, however, be illustrative to refer to the meaning of " royalty " in the Encyclopaedia Britannica, 1972 Edn., Vol. 19, at p. 676, which the court in that case noted :

" ' the payment made to the owners of certain types of rights by those who are permitted by the owners to exercise the rights. The rights concerned are literary, musical and artistic copyright, rights in inventions and designs, and rights in mineral deposits including oil and natural gas. The term originated from the fact that in Great Britain for centuries gold and silver mines were the property of the Crown; such 'royal' metals could be mined only if a payment ('royalty') were made to the Crown ........ An individual inventor without capital or plant must licence others to manufacture his invention. When owners of rights make arrangements for such exploitation by others, the remuneration they received in exchange is often in the form of a royalty, usually based on the actual extent of the exploitation'.

As regards inventions it has been pointed out:

As to inventions, a royalty may be said to be a compensation paid under a licence granted by the owner of a patent ('the licensor') to another person ('the licensee') who wishes to make use of the invention, the subject of the patent. The patent remains the property of the licensor. A licence may be exclusive, in which case the patent owner precludes himself from granting licences to third parties, or non-exclusive, in which case the patent owner may grant licences to as many persons as he wishes. The granting of licence and the payment of royalties thereunder are purely a matter of contract between licensor and licensee. It is essential that all relevant matters be provided for in the contract, especially the amount of royalties, and the precise method of computing them. A licence may be limited or not, according to the intentions of the parties. It may be limited to certain purposes or to geographical areas or in any other way permissible under the national laws having jurisdiction over the transaction. It will normally be for the full term of the patent .

A royalty may be a single payment covering the whole use of the patent for the term, but the more usual practice is to make periodic payments and to relate the amounts of those payments to the actual use of the patent by the licensee. It is common to charge royalties on the basis of a percentage of the price for which the licensee sells the articles or on the basis of the number of the articles made under the patent. Although the amount of royalties is generally a matter of free bargaining between the licensor and the licensee, in some countries governments preclude their nationals from paying royalties to foreign patent owners in excess of a certain maximum fixed by the government. Some governments also reserve the right to approve the entire licence contract concluded between their nationals and aliens.

Royalty payments may be in exchange for something in addition to the mere use of the invention. The most common example is that wherein the licensor not only grants the right to use the invention but also undertakes to supply the licensee with technical 'know how', that is to say, information from his own experience on the most efficient and economical way of working the patent. It is estimated that more than 50% of licence contracts include 'know-how' provisions.

When applied to industrial designs, the meaning of the word 'royalty' is roughly the same as in the case of patented inventions. Designs, Depending on their nature or the various national laws, may be protected by patents, copyright or registration. The form of legal protection, however, does little to change the system of royalty payment as described in regard to patents. "

The court, therefore, was of the opinion that in the case of secret processes, patents, special inventions, when right of exploitation was given by the owner of inventions, patents, etc., to a third party instead of outright sale, then for the right to exploit these inventions, secret processes, some amount might be paid and the amount paid might be correlated to the extent of exploitation. Then, the court discussed the agreement between the parties before their Lordships and held that the payment made in that case was nothing else but royalty as known to law and to the international commercial world.

On behalf of the Revenue, our attention was drawn to certain observations in the case of Collins v. Firth Brearley Stainless Steel Syndicate Ltd. [1925] 9 TC 520 (CA) at pp. 567 and 569. We are of the opinion that this decision, in the facts and circumstances of this case, is not necessary to be discussed in greater detail. Their Lordships were concerned with entirely different circumstances. Our attention was also drawn to a decision in the case of IRC v. Longmans Green & Co. Ltd. [1932] 17 TC 272 (KB). There the court was concerned with the copyright royalties payable to owners whose usual place of abode was not within the United Kingdom. This case also has dealt with the peculiar facts of that case and in the background of the provisions which were entirely different. It will serve no useful purpose, in our opinion, to discuss the decision in greater detail. We have referred to several decisions as well as the meaning of the expression. We are of the opinion that these decisions are illustrative of the principles that should guide or help the courts in construing expressions of this nature. But it is to be borne in mind that these expressions which are not defined in the Act should be construed in the background of commercial point of view having regard to certain well-known concepts (as to) how people in the trade or commerce of the natural world understand it. It is also to be emphasised, as emphasised in several decisions, that any nomenclature given by the parties in the agreement between them, which is not defined in the Act, would not be conclusive or decisive of the matter.

Bearing the aforesaid principles in mind, which we have said are illustrative, in the background of the facts and circumstances of this case and the expression used in the context of r. 1(ix) and r. 1(x) of Sch. to the Surtax Act, we are of the opinion that it cannot be said that the Tribunal came to an improper or unreasonable or illegal conclusion or violated any principle of law in construing the provisions. On the whole we are, therefore, in agreement with the conclusion arrived at by the Tribunal in the background of the facts and circumstances of this case. But before we conclude we must mention that, on behalf of the Revenue, it was contended that IISCO is not a company within the meaning of the expression of any Indian concern in r. 1(ix) of the 1st Schedule to the Surtax Act, 1964, or r. 1(x) thereof.

Reliance was placed on certain observations of the Madras High Court in the case of CIT v. Craigmore Land and Produce Co. Ltd. [1977] 110 ITR 730 (Mad). There the accounts of the assessee-company showed that depreciation claimed year after year had not been deducted from the value of the buildings or machinery which continued to be shown at the original value. The claim of the assessee for taking into account a sum of Rs. 8,00,000 shown as replanting, buildings and machinery reserve was allowed by the officer, but rejected by the Commissioner in suo motu revision proceedings. The Tribunal, however, after obtaining a remand report from the AAC in which it was stated that no part of the amount allowed as depreciation was contained in this sum of Rs. 8,00,000, held that the amount fell within the scope of reserve as contemplated in r. 1 of the Second Schedule to the Super Profits Tax Act, 1963. On a reference at the instance of the Department it was held that under r. 1 of the Second Schedule to the Super Profits Tax Act, 1963, the reserve is includible for the computation of capital so long as the amounts credited to it have not been allowed in computing its profits for the purpose of the Indian I.T. Act, 1922, or the I.T. Act, 1961, and in view of the finding of the AAC in the remand report that the reserve of Rs. 8,00,000 did not contain any part of the amount allowed as depreciation, there was no ground for excluding the sum of Rs. 8,00,000 from the computation of the capital. There the assessee, a non-resident company, received interest from the Indian branch of the Mercantile Bank Ltd., which was also a non-resident company incorporated outside India. The officer did not accept the claim of the assessee for exclusion of the interest so received from the chargeable profits under cl. (x) of r. 1 of the First Schedule to the Super Profits Tax Act, 1963. The Tribunal, however, held that the Indian branch of the Mercantile Bank Ltd. was a unit by itself managed by local manager who had sufficient powers to manage it and hence this unit which carried on business in India could be held to be an Indian concern. On a reference to the High Court at the instance of the Department it was held that as, admittedly, the Mercantile Bank Ltd. was incorporated outside India and it was a non-resident company, its branch could not be treated as an Indian concern. Therefore, the interest received from the bank could not be deducted under cl. (x) of r. 1 of the First Schedule to the Super Profits Tax Act, 1963.

As would be evident from the facts narrated, there the controversy arose in an entirely different context. Here IISCO was not incorporated outside India and was not a non-resident company.

In the premises, it is not necessary to refer to or rely on the said decision for the purpose of dealing with the contention on behalf of the Revenue that IISCO was not an Indian concern as contemplated in the scheme of r. 1 (ix) and r. 1 (x) of the First Schedule to the Super Profits Tax Act, 1963. It, however, appears that this fact was not argued or agitated before the Tribunal. In the premises, we are unable to accept the contention on behalf of the Revenue. In that view of the matter the question is answered in the affirmative and in favour of the assessee.

Parties will pay and bear their own costs.

SUHAS CHANDRA SEN.-I agree.

 

 

 

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