HIGH COURT OF DELHI Treatment to be given to payment of royalty to foreign collaborators for providing technical services

Treatment to be given to payment of royalty to foreign collaborators for providing technical services



When the payment is not because of ‘transfer” of technology, but for providing “technical services”, the payment of royalty, which is a continuous process, should be treated as revenue expenditure.



HIGH COURT OF DELHI

Climate Systems India Ltd.

v.

CIT

ITA No. 44 of 2009

October 9, 2009

RELEVANT EXTRACTS:

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6. We have given our due consideration to the aforesaid submissions made by the learned counsel for both the parties. Since the answer to the question formulated above depends on the construction of Technical Collaboration Agreement dated 25.05.1999 entered into between the assessee and the foreign collaborators, viz., Ford Motors Company, we have scanned the said Agreement as well, minutely. As per Article 2 of the Agreement, the licensor has granted to the assessee non-exclusive rights and licenses during the term of the Agreement in the contract territory to manufacture, sale, retail and service license products, using technical information furnished by the licensor and under Industrial Property Rights. Article 3 provides that the licensor shall supply the assessee with technical information promptly to assist the assessee to introduce manufacture of licensed products. During the term of the Agreement, the licensor also agreed to supply technical improvement and infusion in use in mass production by the assessee relating to the licensed products without additional charge. Article 4 deals with payments to be made by the assessee as a consideration for the aforesaid transfer of technology, etc. It is in two parts. Clause 1 (a) of Article 4 stipulates making payments of lump sum fee and reads as under:

"a) For transfer of CAB technology by Licensor to Licensee, Licensee shall pay the Licensor a lump sum of USS One Million (1,000.000) in three equal installments."

Clause 1 (b) of Article 4 deals with royalty payment (with which we are concerned) reads as under:

"b) In consideration of the obligations of providing Technology Services, License shall pay a royalty of 3% on domestic and 5% on export sales, subject to tax, calculated on the basis of the net ex-factory sale price as stated in the Licensee's invoice of all Licensed product produced by or for Licensee, exclusive of Excise duties minus the cost of standard bought out components and the landed cost of imported components, irrespective of the source or procurement including ocean freight, insurance, custom duties, etc. Royalty shall be paid for a period of seven years from the date of the commencement of commercial production."

7. Thus for transfer of technology, the assessee agreed to pay lump sum amount of US$ 1 billion. This payment is admittedly treated as capital expenditure by the assessee and has been shown as such. However insofar as payment of royalty is concerned which is an issue before us, that depends on the domestic as well as export sales. Quantum of the said sales would determine the extent of royalty to be paid and it will decrease or increase every year depending upon the decrease or increase in the sales. Significantly, 'this payment is not because of "transfer" of technology, but for providing "technical services". In such circumstance, we are of the opinion that this payment of royalty, which is a continuous process, should have been treated as revenue expenditure. In a recent judgment given by this Court in the case of Commissioner of Income Tax Vs. Sharda Motor Industrial Ltd- in ITA No.837/20096 decided on 03.09.2009, identical issue arose. In the aforesaid case also, lump sum payment was made for providing technical know-how, which was considered as capital expenditure. In addition, royalty was also paid by the assessee at a particular percentage of the sales. Holding that, the said payment would be in the nature of revenue expenditure. This Court dealt with the issue in the following manner:

"3. Insofar as lump sum payment against transfer of technical knowhow provided by the Korean company is concerned, the assessee had admittedly shown these expenses as capital expenditure. It was the royalty paid during the year in question which was treated as revenue expenditure by the assessee. The CIT(A) found that as per the agreement, this royalty was running royalty payable every year, which depended upon the number of pieces produced of the aforesaid products, namely, catalytic converter and exhaust muffler.

4. We are of the opinion that this finding of the CIT(A), as approved by the ITAT, is a finding of fact which is rightly arrived at as expenditure is purely a revenue expenditure, which is annual expenditure depending upon' the quantum of production in the relevant year.

5. In CTT v. J.K. Syntheticx Ltd., 309 ITR 371, after elaborately discussing the entire case law on the subject, the Court culled out the broad principles to determine as to whether expenditure in a particular case would be capital or revenue expenditure. One of the principle enumerated therein reads as under :-

"(v) expenditure incurred for grant of licence which accords "access" to technical knowledge, as against, "absolute" transfer of technical knowledge and information would ordinarily be treated as revenue expenditure. In order to sift, in a manner of speaking, the grain from the chaff, one would have to closely look at the attendant circumstances, such as :

a) the tenure of the licence,

b) the right, if any, in the licensee to create further rights in favour of third parties.

c) the prohibition, if any, in parting with a confident/a? information received under Che licence to third parties without the consent of the licensor, whether the licence transfer the "fruits of research" of the licensor, "once for all",

d) whether on expiry of the licence the licensee is required to return back the plans and designs obtained under the licence to the licensor even thojgh the licensee may continue to manufacture the product, in respect of which "access" to knowledge was obtained during the subsistence of the licence. whether any secret or process of manufacture was sold by the licensor to the licensee. Expenditure on obtaining access to such secret process would ordinarily be construed as capital in nature."

8. In these circumstances, we answer the question in favour of the assessee and against the Revenue. As a result, order of the Authorities below is set aside. No costs.

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