HIGH COURT OF DELHI
Commissioner of Income-tax
versus
Modi Revlon (P.) Ltd.
IT APPEAL NOS. 1450, 1451, 1640 & 1652 OF 2010 & 825 OF 2011
CM APPL. NOS. 12275 & 12282 TO 12284 OF 2012
AUGUST 29, 2012
ORDER
S. Ravindra Bhat, J. – The revenue appeals against order of the Income Tax Appellate Tribunal (ITAT) in ITA Nos. 5/Del/2009, 2063/Del/2009, 155/Del/2009 and 3083/Del/2009 dated 18-12-2009.
2. The following questions of law arise in the present appeals:
(1) Whether the ITAT erred in holding that royalty paid by the assessee could be capitalized only to the extent of 5 per cent(instead of 25 per cent held by the Appellate Commissioner) (arising in ITA Nos. 1451 & 1652/2010 and 825/2011)
(2) Whether the disallowance of publicity expenses, set aside by the ITAT is in error of law (arising in ITA Nos. 1450 & 1640/2010)
(3) Whether the ITAT erred in setting aside the disallowance of consultancy charges, under section 40A (2) of the Income-tax Act; (arising in ITA Nos. 1451, 1652/2010 & 825/2011)
3. The facts in brief are that the assessee, an Indian company, is the result of a joint venture (JV) between Modi Mundipharma Pvt. Ltd. (MMPL) and Revlon Mauritius Ltd. (RML) for manufacturing and marketing Revlon products in India and neighbouring countries on an exclusive basis. MMPL and RML had invested in the ratio of 74:26 to form the assessee-company. In terms of the JV agreement, MMPL was responsible for the setting up, manufacturing, distribution and marketing Revlon products in the designated territory. RML was to provide know-how, trademark, etc. The assessee entered into a technical know-how agreement with Revlon Mauritius Ltd. for supply of technical know-how to manufacture the goods. Under the said agreement, in consideration for the supply of know-how, the assessee has to pay, every year, royalty (net of taxes) at the rate of 5%, on domestic sales and 8 per cent on export sales. During the year, the assessee paid royalty of Rs. 4,73,06,822 to RML in pursuance of the grant of right to use the technical know-how. The Assessing Officer disallowed this royalty expenditure stating that the amount paid to the licensor was not expenditure wholly and exclusively incurred for the business of the assessee and that it was incurred partly for the business of the sister concerns of the assessee, i.e., its contract manufacturer M/s. Kamakhya Cosmetics and Pharmaceuticals Pvt. Ltd., and its distributor M/s. Win Medicare Ltd. It was held that deduction of royalty could be allowed in the hands of the assessee on the basis of the proportion of its sales to the total sales on which royalty is calculated and payable to the licensor. The Assessing Officer treated part of royalty payment as capital in nature, and disallowed 25 per cent of such royalty payment. The AO’s objection while capitalizing 25 per cent, of the royalty paid was on account of his opinion that the know-how agreement was open ended in terms of duration and that the assessee had exclusive right to use the know-how and patents and the new products developed by the licensor. The Appellate Commissioner, on appeal by the assessee held that capitalization of 25 per cent was unjustified; the amount was reduced to 5 per cent. The ITAT allowed the assessee’s appeal, on this aspect, and dismissed that of the revenue.
4. The assessee had claimed publicity expenses of Rs. 30.51 lakhs during the year, for promotion of the “Revlon” brand. The Assessing Officer disallowed Rs. 14.57 lakhs, holding that such proportionate amount could not be attributable to the assessee’s business. This was confirmed by the CIT (A). The ITAT considered the submissions of the parties, and observed that the agreement entered into by the assessee with WMPL obliged the latter only to bear the cost of advertising and other expenses relatable to the customer sector and that the expense for brand promotion was that of the assessee exclusively. It was also held the agreement with WMPL did not in any manner preclude the assessee undertaking that expenditure, since it was a purely commercial decision, entitled to promote the brand, as its exclusive user. The ITAT went by the previous years’ practice, where such expenditure had been allowed by the Assessing Officer.
5. During the AY, the assessee paid Rs. 88.98 lakhs to MMPL as consultancy charges under the agreement dated 1-1-1995. This payment to MMPL was for the latter’s advice concerning day-to-day conduct of management of the assessee-company in respect of setting up and monitoring of distribution and marketing management, manufacturing of Revlon products according to the latter’s internationally applicable specifications and standards, suggesting changes in the product design and the specifications based on market feedback of new products, product advertising policies and campaign, price negotiations of various inputs from the suppliers, etc. The Assessing Officer alleged that consultancy charges were nothing but an arrangement to siphon off part of the assessee’s profits to its sister concern and JVs. The Assessing Officer allowed Rs. 30 lakhs as directors’ remuneration and disallowed Rs. 58.98 lakhs under Section 40A(2), holding it as unreasonable and excessive. The Commissioner (Appeals) deleted this disallowance holding that the Assessing Officer wrongly concluded that no services had been rendered by MMPL. The Commissioner (Appeals) held that rendering of services by MMPL was proved from the records, and no disallowance was warranted under section 40A(2). The revenue’s appeal to the ITAT on this score was rejected.
6. The revenue argues that the fact that the know-how agreement between the assessee and Revlon Mauritius was a continuing one, and the time agreed to originally had long since passed. This, coupled with the fact that the Revlon brand was given over exclusively to the assessee by its owner, is a clear pointer to its conferring an enduring capital advantage to the former. Thus, the conclusion drawn by the AO that disallowance to the extent of 25% of royalty payment was warranted. Counsel for the revenue relied on the judgment of the Madras High Court in CIT v. Madras Rubber Factory Ltd. [1983] 144 ITR 678 to say that the royalty resulted in the foreign brand owner imparting to the assessee an advantage that “on operational matters might tend to outlast, and endure beyond, the contract period” clearly amounting to a capital advantage of an enduring nature. Reliance was also placed on the judgment in CIT v. Kirloskar Cummins Ltd. [1993] 202 ITR 36 (Bom.) and the judgments reported as CIT v. I.A.E.C. (Pumps) Ltd. [1998] 232 ITR 316 (SC).
7. On the question of consultancy charges it was argued that the AO given cogent and sound reasons for not allowing more than Rs. 30 lakhs. This was based on the permissible limit of remuneration payable to a company, under the Companies Act. The assessee had incurred more than Rs. 58 lakhs in excess of that limit. Moreover, the AO reasoned that the amount paid as consultancy was excessive, regard being had to the nature of activities of MMPL, since production and distribution were undertaken by other sister concerns, on behalf of the assessee. Therefore, the so-called consultancy charges were a mode to claim exaggerated amounts, disproportionate to the services rendered. The CIT(A) and the ITAT fell into error in interfering with the findings of the AO, which were based on the appreciation of documents. The assessee had a duty to explain how such expenses were reasonable. It failed to do so.
8. On the third aspect, the revenue’s Counsel highlighted that the two sister concerns were assigned specific and substantial duties, i.e. manufacturing and distribution of the Revlon products, of which the assessee was the licensee. They were also given the responsibility of bearing the advertising and promotion charges and expenses. In spite of this, the AO reasonably allowed more than 50 per cent of the “brand promotion” expenditure. However, the ITAT set aside the disallowance. The mere circumstance that in previous years, the expenditure had been allowed would not amount to a binding practice, especially when it is not legally tenable. Furthermore, the Tribunal’s reasoning that the brand promotion expenditure was based on a commercial decision, cannot be sustained. If every commercial decision were to be let alone, the Income Tax authorities would be bereft of jurisdiction and would be obliged to accept, uncritically, such arguments on their face value.
9. Learned counsel for the Assessee argues that the Revenue’s contention is groundless. On the question of payment of royalty, it was submitted that the material on record showed that the original know-how license agreement was entered into on 14.01.1994 and was in force till August 2002; it was in accordance with the approval of the Central Government. The royalty payment in the Assessment Year in question was in terms of the Supplementary Agreement dated 16.09.2003. It is clear that the royalty payable was for the continued use of the brand and patents owned by the licensor company. This was a clear indicator that no asset of enduring nature, vested in the assessee’s favour, justifying the AO to hold that 25 per cent of the expenditure in that regard had to be treated as capital. It was further submitted that merely because two sister concerns were engaged in the distribution and production of Revlon products did not mean that the Assessee was not the licensee. The Assessee does business affairs in the most efficient manner possible which meant in turn that it gave the job of production to one sister concern and distribution of the product to another. Further, the evidence showed that royalty liability was not passed on to the product manufacturer. The benefit of know-how, for manufacturing of the products was given for this purpose without any obligation to pay royalty to the licensor. Consequently, the payment of royalty was revenue in nature and could not be classified as capital expenditure. Learned counsel relied upon the judgment of this Court in CIT v. Sharda Motor Industrial Ltd. [2010] 319 ITR 109 and that of the Supreme Court in CIT v. CIBA of India Ltd. [1968] 69 ITR 692 (SC) and submitted that as long as the licensee or the beneficiary did not become entitled exclusively to use the patent or the know-how as its owner, mere access to technical knowledge or specific process did not amount to accrual of a capital advantage. It was submitted that the decision in Sharda Motor Industrial Ltd. (supra) is instructive on the question as to whether the licensing arrangement which merely allows access to technical knowledge as against absolute transfer has to be seen in the context of certain parameters such as license tenure; whether the licensee can create further rights in favour of third parties as regards use of technical knowledge; whether there is any restriction or prohibition with regard to assuring of confidential information received by the licensee to the third parties without consent of the licensor; whether license transfer benefits once and for all; whether on expiry of the term the licensee has to return plans, designs and other process knowledge to licensor even though it may continue to manufacture the product; whether any secret or process of manufacture was sold by the licensor to the licensee.
10. It was submitted in the present context that the royalty payable was in respect of the brand and the technical know-how available to the assessee with regard to manufacture and sale of Revlon products in India for the duration of the agreement. The revenue did not point to any factor that could have justified the conclusion that the benefit of the licensing arrangement accrued once and for all and that right to use any technical know-how or process was obtained finally. Such being the case, the benefit of the technical know-how and the brand did not vest once and for all thereby resulting in creation of an asset of enduring nature.
11. Learned counsel for the Assessee further submitted that as far as brand promotion expenses are concerned, there was nothing in the Income-tax Act nor were there any materials on record suggestive of the fact that the Assessee could not claim them. It was submitted that even though one of its sister concerns, i.e. the distributor had to bear normal advertising expenses; the fact remained that as brand licensee, in a highly competent consumer market, the Assessee had to stay ahead of its competition and thus engage itself in brand promotional activities. This had to be distinguished from advertisements. Learned counsel here underlined the fact that the AO did not reject the expenses claimed in its entirety and it allowed as much as 50 per cent. However, the reasoning of the AO and the CIT (Appeals) in disallowing the sum of Rs. 14.87 lakhs was tenuous and unsustainable. It was submitted that having accepted the fact that the Assessee could spend amounts for brand promotion activities, the tax authorities could not dictate as to what proportion of such expenses were justified. Learned counsel submitted that such expenses is not supported by legal authority and the partial disallowance was correctly set aside by the Tribunal in its impugned order.
12. It was lastly urged by learned counsel that as regards the consultancy charges payable to MMPL, the AO did not reject this head of expenditure outright; but instead allowed only Rs. 30 lakhs, rejecting the balance of Rs. 58.98 lakhs. The reasoning for the AO holding the amount in excess of Rs. 30 lakhs to be disproportionate was unsustainable. Learned counsel submitted that the finding of the AO and as endorsed by the CIT(Appeal) that the maximum amount payable in terms of the Companies Act was Rs. 30 lakhs per month, was based upon a reading of the provision which pertained to public limited companies. The Assessee in this case was not a public limited company and the cap of Rs. 30 lakhs, indicated in Schedule XIII, Part II, Section II, Clause 1(B) of the Companies Act was, therefore, inapplicable in its case. The AO clearly, therefore, fell into error of law in holding that such a cap was warranted. It was submitted that in this regard, the Tribunal noticed that there was sufficient evidence before the AO indicative of the MMPL actively involving itself in the day-to-day activities of the Assessee. The MMPL also had disclosed consultancy charges, having received from the Assessee, in its returns, and paid Income-tax. It was submitted that the Tribunal correctly relied upon the judgment of the Supreme Court in CIT v. Dhanrajgiriji Raja Narsinghji [1973] 91 ITR 544 (SC)
Analysis and Reasoning
13. Before discussing the rival submissions, it would be essential to extract the relevant portion of the know-how agreement below:
“THIS AGREEMENT dated as of July 27, 1994 between REVLON MAURITIUS LIMITED, a Mauritius Corporation (“Licensor”) and MODI-REVLON PRIVATE LIMITED, an Indian Corporation (“Licensee”).
