Vildirect: IncomeTax-caselaws-2008-VIL-577-DEL-DT

2008-VIL-577-DEL-DT

Equivalent Citation: [2008] 307 ITR 363 (Delhi)

DELHI HIGH COURT

70 of 1988

Date: 29.04.2008

SHRIRAM PISTONS AND RINGS LTD.

COMMISSIONER OF INCOME-TAX

Ajay Vohra with Ms. Kavita Jha for the assessee.
Ms. Prem Lata Bansal, for the Commissioner.

BENCH

MADAN B. LOKUR and MANMOHAN SINGH JJ.

JUDGMENT

The judgment of the court was delivered by

MADAN B. LOKUR, J. - By an order dated 24th April, 2008, we had disposed of the reference made at the instance of the Assessee since it was conceded by learned counsel for the Assessee that the questions of law are required to be answered in the negative, in favour of the Revenue and against the Assessee.

2. Consequently, we are now dealing only with the reference made under Section 256(1) of the Income Tax Act, 1961 (the 'Act') at the instance of the Revenue.

3. The questions of law that have been referred for our opinion are as follows:-

"1. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 1,96,988/- paid by the assessee to M/s. Riken Piston Rings Inds. Co. Ltd., Tokyo revenue expenditure?"

2. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the expenditure on gifts amounting to Rs. 10,58,855/- was not of the nature of advertisement failing within the purview of Section 37(3) of the Income-tax Act read Rule 6B of the Income-tax Rules and was of the nature of a trade discount?.

3. Whether the Tribunal was right in holding that the payments made by the assessee to its employees under the nomenclature 'Good Work Reward' did not constitute bonus within the meaning of Section 36(1)(ii) of the Income-tax Act,1961 and were allowable as normal business expenditure under section 37?"

4. Insofar as the first question is concerned, the Assessee had entered into a Technical Collaboration Agreement with M/s Riken Piston Ring Ind. Co. Ltd. of Japan (for short 'Riken') for the manufacture of piston rings. The agreement was really in two parts: one to provide comprehensive technical know-how and the other dealing with technical assistance by Riken to the Assessee for manufacturing and selling the product known as piston rings. We are only concerned with the transfer of know-how. We have gone through the Agreement with the assistance of learned counsel for the parties.

5. The term 'know-how' is defined under clause 3.0 of the Agreement to include designs, research and development systems and methods, drawings, documents and other related technical information as is or may be available from and used by Riken in the manufacture and sale of the product during the period of the Agreement. The clause covers manufacturing drawings and specifications; furnishing of required drawings for jigs/tools/gauges etc.; manufacturing processes; particulars of machine tools, inspection and testing equipment; investment estimates for the machine tools and equipments; and such other technical information as may be required for achieving acceptable standards of quality and production and rejections rates achieved by Riken.

6. Clause 3.1 of the Agreement requires Riken to supply to the Assessee know-how documents to enable it to achieve the purpose of the Agreement within four months of its effective date.

7. The aspect of consideration is dealt with in clause 5.0 of the Agreement. Since this is somewhat important, it is quoted below:-

5.0 In consideration of the KNOW HOW SOLD BY LICENSOR under Clause 3.0 of this agreement, LICENSEE will pay to Licensor an amount of Japanese Yen 8,820,000 (Japanese Yen eight million and eight hundred twenty thousand only), subject to applicable Indian Taxes, in the following manner:-

* One-third on taking the agreement on record by the Government of India.

* One-third on transfer of technical documentation.

* One-third after the commencement of commercial production which, under this agreement, shall be taken as 4 (Four) months the date of receipt of technical documentation by LICENSEE."

8. It is important to notice that the Agreement mentions that the know-how would be sold by Riken to the Assessee for a fixed amount and the payments would be made on the fulfillment of certain conditions. Learned counsel for the Revenue laid emphasis on the word 'sold' used in clause 5.0 of the Agreement.

9. Clause 10.0 of the Agreement enables the Assessee to sub-license the technical know-how to another Indian party subject to the prior written permission of Riken, should it become necessary.

10. Clause 10.1 of the Agreement requires the Assessee to treat as a confidential matter all inventions, drawings, documents, specifications, engineering data, processes and other information or material furnished by Riken to the Assessee pursuant to the Agreement.

11. Clause 11.0 of the Agreement lays down that the right of the Assessee to market any of the products manufactured under the Agreement would cease upon its expiry or termination.

12. The validity of the Agreement was for a period of five years and that is mentioned in clause 15.0 of the Agreement, but it could be terminated before the expiry of that period in the event of any default by any of the parties as mentioned in clause 17.0 of the Agreement.

13. On the expiry or termination of the Agreement, whether by efflux of time or by its termination by the parties, the Assessee would have a perpetual non-exclusive right to manufacture the products under the Agreement without further payments.

14. Under these circumstances, the question that has arisen for consideration is whether the amount paid by the Assessee to Riken is a revenue expenditure or not. To answer this question, it is necessary for us to determine as to whether what was transferred to the Assessee was only a right to use the technical know-how or was it a sale of know-how to the Assessee in perpetuity.

15. The leading decision on the subject is Commissioner of Income Tax vs. Ciba of India Ltd. [1968] 69 ITR 692(SC). In this decision, the terms of the agreement entered into by a Swiss company with Ciba Pharma were considered. Some of the clauses of the agreement are similar to the Agreement that we are considering namely that it was to remain in force for a period of five years and there was a provision for earlier termination of the agreement. It was also provided in clause IV of the agreement that Ciba Pharma could neither assign the benefit and the obligations of the agreement without the written consent of Ciba Basle nor could Ciba Pharma grant any sub-licence under the patents and/or trade marks of Ciba Basle without its previous written consent.

16. On these broad terms of the agreement, the Supreme Court held that the assessee did not become entitled exclusively even for the period of the agreement to the patent and trade mark of the Swiss Company. It had merely access to the technical knowledge and experience in the pharmaceutical field which the Swiss company commanded. In that sense, the assessee was a mere licensee for a limited period of the technical knowledge of the Swiss company with the right to use the patents and trade marks of that company. The assessee merely had access to technical knowledge of the assessee for the purpose of running its business.

17. The Supreme Court held that there was no attempt on the part of the Swiss company to part with technical knowledge absolutely in favour of the assessee inasmuch as the secret processes were not sold by the Swiss company to the assessee; it was entitled to use the technical knowledge for a limited period of five years only or for a lesser period in case of earlier termination of the contract. The Indian company was expressly prohibited from divulging confidential information to third parties without the consent of the Swiss company and there was no transfer of the fruits of research once for all.

18. Similarly, in Alembic Chemical Works Co. Ltd. vs. Commissioner of Income Tax, [1989] 177 ITR 377, the Supreme Court dealt with an agreement entered into between the assessee and a Japanese company for the purpose of increasing the yield of penicillin. As per the agreement, the Japanese company agreed to supply to the assessee the requisite technical know-how so as to achieve substantially higher levels of performance or production.

19. One of the terms of the agreement entered into between the parties concerned itself with the placing of limitations on the right of the assessee in dealing with know-how and the conditions as to non-partibility, confidentiality and secrecy of the know-how.

20. The Supreme Court interpreted this to mean that the right pertained more to the use of the know-how than to its exclusive acquisition by the assessee. The Supreme Court also noted that there is no single definitive criterion which by itself is determinative of the question whether a particular outlay was revenue in nature. What is relevant is to see the intended object and effect of the agreement between the parties, considered in a common sense manner having regard to business realities. The Supreme Court noted that in a given case, the test of 'enduring benefit' might break down as laid down by the Supreme Court in Commissioner of Income Tax vs. Associated Cement Companies Ltd., [1988] 172 ITR 257.

21. In Triveni Engineering Works Ltd. vs. Commissioner of Income Tax, New Delhi, [1982] 136 ITR 340, a Division Bench of this Court dealt with an agreement entered into between the assessee and a company in U.K. where, in terms of the agreement, the British company agreed 'to sell outright' to the assessee, technical know-how in respect of steam turbines for use in India. It was provided in the agreement that the technical know-how would be exclusive to the assessee and shall not be disposed of by the British company to any other person in India.

22. Clause 8 of the agreement between the parties provided that all copies of drawings supplied under the agreement shall be deemed to be the property of the assessee as soon as they are received. Clause 9 provided that copyright in such drawings, patterns and jigs shall, however, remain vested with the British company when the assessee is having a licence to use the same for the purpose of the agreement only.

23. The Division Bench considered the judgment of the Supreme Court in Ciba of India Ltd. and noted that the question for consideration was whether the agreement resulted in an absolute sale of know-how and whether the payment was for the use of know-how provided by the British company to the assessee. The Division Bench considered the use of the expression 'agreed to sell outright' occurring in the agreement as well as some similar words such as 'sold', 'absolute property', 'deemed to be the property' in other parts of the agreement and after observing the use of these expressions, the Division Bench noted that on an examination of the agreement, it was clear that it was valid for only 10 years and it could be terminated earlier; it was limited to the Republic of India though exclusive to the assessee; though the data, documents and dies, etc. were said to be the absolute property of the assessee, yet the copyright remained vested in the British company when the assessee is having only a licence to use the same during the agreement; the assessee was obliged to observe complete confidentiality with regard to the know-how and could not disclose any information or assign the agreement without the written consent of the British company.

24. Having noted this, the Division Bench held that this could hardly be equated to a situation where a seller sells his goods outright to a buyer. The Division Bench noted that there was no provision in the agreement for the return of drawings, documents etc. the copies of which were deemed to become the property of assessee on transmission but it was observed that with fast technological development and scientific research, such drawings become obsolete and mere scraps of paper very soon unless they were updated.

25. Following the law laid down by the Supreme Court in Ciba of India Ltd. [1968] 69 ITR 692 and despite the use of the words 'to sell outright', the Division Bench came to the conclusion that the assessee had merely obtained a licence for limited use of the knowledge and information possessed by the British company.

26. Learned counsel for the Revenue relied upon Scientific Engineering House P. Ltd. vs. Commissioner of Income Tax, [1986] 157 ITR 86 (SC). But we find that the controversy in that case is not quite apposite to the controversy in the present case. This is clear from the question of law that was framed in that decision. The question of law framed reads as follows (page 88) :-

"Whether, on the facts and in the circumstances of the case and on a true interpretation of the collaboration agreements between the assessee and M/s Metrimpex Hungarian Trading Company, Budapest, the payment of Rs. 1,60,000/- by the assessee to the foreign collaborator was attributable partly or wholly towards the acquisition of a depreciable asset?"

27. On a reading of the decision, it appears that there was no dispute about the fact that the payment made by the assessee to the Hungarian company on the basis of the collaboration agreements was a capital expenditure incurred by it. The limited question was whether the drawings and designs that the Hungarian company had parted with could fall in the category of 'books' and 'plant' as laid down in Section 43(3) of the Act and if so, whether the capital expenditure brought into existence a depreciable asset.

28. The Supreme Court answered the question by coming to the conclusion that the drawings/designs etc. were actually 'plant' as defined under Section 43(3) of the Act and would therefore, be a depreciable asset.

29. As already noted above, this is not the question before us inasmuch as it is not an admitted fact that the expenditure incurred by the Assessee was of a capital nature. On the contrary, what we have to answer is whether the expenditure incurred was of a capital nature or of a revenue nature unlike the factual matrix in Scientific Engineering House P. Ltd. [1986] 157 ITR 86 (SC).

30. Our attention was then drawn to Bajaj Tempo Ltd. vs. Commissioner of Income Tax [1994] 207 ITR 1017, wherein the Bombay High Court distinguished the decision rendered by the Supreme Court in Scientific Engineering House P. Ltd. [1986] 157 ITR 86 and noted that among other things, the question that was debated before the Supreme Court was as to whether the documents supplied to the assessee amounted to 'books' or 'plant' and as such, whether the assessee was entitled to claim depreciation thereon.

31. We are therefore not impressed by the judgment cited by learned counsel for the Revenue in Scientific Engineering House P. Ltd. [1986] 157 ITR 86 (SC). We find that it is not relevant to the facts of the present case.

32. Applying the various principles that have been laid down, we find that there was in fact no absolute transfer of any right in the documentation given by Riken to the Assessee. The Assessee was entitled to use the technical know-how for a period of five years or for a lesser period, in case the Agreement was terminated before that. The Assessee did not have a free hand to sub-license the technical know-how and that was possible only with the prior written permission from Riken. For all other matters, the Assessee was liable to treat as confidential all inventions, drawings, documents, specifications etc. furnished by Riken to the Assessee. Even though the Assessee was entitled to use the name of Riken in the marketing of its products but that right would cease upon the expiry or termination of the agreement.

33. As already noted, the Agreement was valid only for a period of five years but could be terminated earlier. There is no magic in the word 'sold' used in clause 5.0 of the Agreement because on a reading of the Agreement as a whole, it appears to us that what was transferred to the Assessee was only a right to use the technical know-how of Riken and there was no sale of the technical know-how which the Assessee could exploit. The Assesee's rights were hedged in with all sorts of conditions, clearly making it a case of right to use the technology and not sale of the technical know-how.

34. That being our conclusion, we are in agreement with the view expressed by the Tribunal that there was no sale of technical know-how by Riken to the Assessee and therefore, the payment made by the Assessee to Riken was a revenue expenditure.

35. Accordingly, Question No.1 is answered in the affirmative, in favour of the Assessee and against the Revenue.

36. Insofar as the second question is concerned, it appears from the statement of case that it is not actually the Assessee that was directly spending any amount on gifts. The gifts were given by the dealers of the Assessee to their customers and the Assessee was merely reimbursing the dealers to the extent of the value of the gifts.

37. Section 37(3) of the Act as it stood relevant at the time reads as follows:-

"37(3). Notwithstanding anything contained in sub-section (1), any expenditure incurred by an assessee after 31st day of March, 1964, on advertisement or on maintenance of any residential accommodation including any accommodation in the nature of a guest-house or in connection with travelling by an employee or any other person (including hotel expenses or allowances paid in connection with such travelling) shall be allowed only to the extent, and subject to such conditions, if any, as may be prescribed."

38. A perusal of this section shows that expenditure incurred by the Assessee on advertisement would be allowed as a deduction subject to prescribed conditions. Rule 6B of the Income Tax Rules, 1962 prescribed a ceiling which was Rs. 50 in respect of each article. The statement of case shows that the gifts given by the dealers of the Assessee did not bear the logo and name of the Assessee nor did the gifts emanate from the coffer of the Assessee in any manner. Consequently, insofar as the customer is concerned, it could not have any knowledge that the gift was connected or concerned with was the Assessee. Under these circumstances, the gift given by the dealer to the customer did not have any advertisement value insofar as the Assessee is concerned.

39. In Commissioner of Income Tax vs. Indian Aluminium Cables Ltd.(No.2) [1990] 183 ITR 611, a Division Bench of this Court laid emphasis on the advertisement value of the gift, but, as learned counsel for the Revenue has rightly pointed out the gifts in that decision pertained to gifts made during festive occasions including weddings. To this extent, the decision relied upon by learned counsel for the Assessee may not be relevant but it is nevertheless appropriate to refer to this decision because it deals with the advertisement value of the gift which is what Section 6B of the Rules also deals with. If a gift does not have any advertisement value, it cannot be deemed to fall within the category of 'advertisement' as understood for the purposes of Rule 6B of the Rules.

40. In Commissioner of Income Tax vs. Modi Spinning and Weaving Mills Co. Ltd. [1993] 202 ITR 708, a Division Bench of this Court held that Rule 6B of the Rules would apply only when there is presentation of articles by way of advertisement. If this is so, insofar as the present case is concerned, since we have held that the gifts given by the dealers to their customers were not in the nature of advertisement, they would not fall within the financial limits as laid down under Rule 6B of the Rules.

41. Under these circumstances, the second question is answered in the affirmative, in favour of the Assessee and against the Revenue.

42. The third question that has been referred for our consideration relates to 'good work reward' and whether it constitutes bonus within the meaning of the Section 36(1)(ii) of the Act.

43. The Tribunal has noted that the word 'bonus' has not been defined anywhere including in the Payment of Bonus Act, 1965. However, for the purpose of industrial law, four types of bonus have been recognized and they are as follows:-

(a) Production bonus

(b) Contractual bonus

(d) Profit sharing bonus.

44. The 'good work reward' that is given by the Assessee to some employees on the recommendation of senior officers of the Assessee does not fall in any one of these above categories.

45. For the purpose of Section 36(1)(ii) of the Act, it has been held by this Court in Commissioner of Income Tax vs. Kelvinator India Ltd. [IT Case No. 266/1983, decided on 23^rd July, 1987] that bonus is related only to the profit that a company makes and is not relatable to production incentive.

46. The Revenue had challenged the decision of this Court by filing a Special Leave Petition in the Supreme Court as reported in [1988] 171 ITR 256 ST. The special leave petition was dismissed by the Supreme Court on 11^th May, 1988 thereby, in a sense affirming the view taken by this Court that production incentive paid to an employee was not bonus and therefore, is not covered under the provisions of Section 36(1)(ii) of the Act.

47. Insofar as the present case is concerned, there is nothing to suggest that the good work reward given by the Assessee to its employees has any relation to the profits that the Assessee may or may not make. It appears from the order of the Tribunal that it has relation to the good work that is done by the employee during the course of his employment and that at the end of the financial year on the recommendation of a senior officer of the Assesseee, the reward is given to the employee. Consequently, the 'good work reward' cannot fall within the ambit of Section 36(1)(ii) of the Act as contended by the Revenue.

48. In Commissioner of Income Tax vs. Autopins (India), [1991] 192 ITR 161, a Division Bench of this Court had occasion to consider payment of various kinds of bonus such as production bonus, attendance bonus and incentive bonus and whether they were within the contemplation of the Payment of Bonus Act, 1965. It was held that such types of bonus as well as ex gratia payment would not fall within the provisions of Section 36(1)(ii) of the Act and that they were payments allowable as revenue expenditure having been incurred for the purpose of business expediency. These payments were not of the type contemplated by the Payment of Bonus Act. It was held that it was an ex gratia payment or some sort of reward given to an employee for the good work done by him and would therefore, fall within the category of expenditure incurred for the purpose of business expediency and for improving the working of the Assessee. Therefore, it would not fall within the meaning of Section 36(1)(ii) of the Act but would fall within the ambit of Section 37 of the Act.

49. Accordingly, the third question is answered in the affirmative, in favour of the Assessee and against the Revenue and it is held that the 'good work reward' is allowable as business expenditure under Section 37(1) of the Act.

50. The reference is disposed of accordingly.

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