Case Law Details
“Unlocking the essence of capital vs. revenue expenditure through Faurecia Emissions vs. DCIT, ITAT Chennai’s verdict on royalty payments for technical know-how.”
Faurecia Emissions Control Technologies India Pvt. Ltd. Vs DCIT (ITAT Chennai)
Royally paid for exclusive right to obtain technical & engineering instruction know how to manufacture is Capital Expenditure
The appellant namely Faurecia Emissions Control Technologies India Pvt. Ltd. is a company incorporated under the provisions of the Companies Act, 1956. It is engaged in the business of manufacturing of automobile exhaust systems, catalytic convertors. While doing Assessment, the AO treated the royalty expenditure of Rs. 3,46,44,391/- paid to Sango Co. Ltd., Japan and Faurecia Systems Dechappement, France as a capital expenditure as against claim by the assessee as revenue expenditure. However, the AO allowed depreciation @ 25% of the capital expenditure. The AO had come to the conclusion that it is a capital expenditure taking note of the fact that the appellant had been granted the exclusive right to obtain the technical and engineering instruction know how to manufacture, assemble, sale and distribution of exhaust products and this expenditure had resulted in an enduring benefit to the assessee.
The short issue in the grounds of appeal is relates to whether the royalty payment made to the Sango Co. Ltd., Japan and Faurecia Systems Dechappement, France can be disallowed as being capital in nature. The appellant had entered into an agreement with M/s. Sango Co., Ltd., Japan in terms of which the appellant is granted exclusive license for the manufacture in the territory of the customer agreed and non-exclusive right outside the territory of the customer. The assessee is also entered in an agreement with M/s. Faurecia Systems D’echappement, France in terms of which the appellant is granted for exclusive license for exclusive, non-transferable and non-assignable. In terms of the said agreements, the assessee after the expiry of the license granted the assessee has to return all the documents relates to the technical information received and the royalty shall be paid as a percentage of the turnover. Therefore, the issue that comes whether this payment of royalty can be considered as a capital or revenue.
Recently the Hon’ble Supreme Court in the case of Honda Siel Card India Ltd. v. CIT [2019] 101 taxmann.com 222 (SC) held as follows:
“No doubt, this technical know-how is for the limited period i.e. for the tenure of the agreement. However, it is important to note that in case of termination of the Agreement, joint venture itself would come to an end and there may not be any further continuation of manufacture of product with technical know-how of foreign collaborator. The High Court has, thus, rightly observed that virtually life of manufacture of product in the plant and machinery, establishes with assistance of foreign company, is co-extensive with the agreement. The Agreement is framed in a manner so as to given a colour of licence for a limited period having no enduring nature but when a close scrutiny into the said Agreement is undertaken, it shows otherwise. It is significant to note in this behalf that the Agreement provides that in the event of expiration or otherwise termination, whatsoever, licensee, i.e., joint venture company/ Assessee shall discontinue manufacture, sale and other disposition of products, parts and residuary products. All these things then shall be at the option of licensor. In other words, licensee in such contingency would hand over unsold product and parts to licensor for sale by him. In case licensor does not exercise such an option and the product is allowed to be sold by licensee, it would continue to pay royalty as per rates agreed under the agreement. Clauses 19 and 21, in our view, make the Agreement in question, i.e., establishment of plant, machinery and manufacture of product with the help of technical know-how, coextensive, in continuance of Agreement. The Agreement also has a clause of renewal which, in our view, in totality of terms and conditions, will make the unit continue so long as manufacture of product in plant and machinery, established with aid and assistance of foreign company, will continue. Since, it is found that the Agreement in question was crucial for setting up of the plant project in question for manufacturing of the goods, the expenditure in the form of royalty paid would be in the nature of capital expenditure and not revenue expenditure. The Tribunal is conclusion that it is only the other three memoranda which were necessary for setting up the manufacturing facilities and payment thereunder would qualify as capital expenditure, and not the payment of technical fees/royalty on the ground that this Agreement was not in connection with the setting up of a plant or manufacturing facilities, is not correct. It would be interesting to note that even the Tribunal had nurtured doubt on the nature of this expenditure as TCA was signed simultaneously with the other memoranda to facilitate setting up of a new factory and not improvising the earlier set up. This doubt has expressed by the ITAT itself in the following words:
““Our doubt was why the payment, at least of the lump sum technical know-how fees, cannot be considered as being connected to the initial starting up of the business and hence not allowable since the know-how was bring obtained for the first time and was crucial to the setting up of the business of the assessee which undisputedly was to manufacture Honda cars in India. It may be recalled that this was also the view taken by the Assessing Officer. Further, the assessee was not already in the manufacture of cars and was commencing such an activity for the first time. It was not a case of a business already in existence. The payment was an “once for all” payment, though staggered over a period of years.”
In the light of the above principles, the expenditure of royalty cannot be treated as revenue expenditure and therefore, we upheld the action of the lower authorities.
FULL TEXT OF THE ORDER OF ITAT CHENNAI
These two appeals filed by the assessee as well as Revenue directed against the orders of the learned Commissioner of Income Tax (Appeals)-13 & 6, Chennai (hereinafter called as ‘CIT(A)’) dated 21.12.2017 & 30.11.2017 for the assessment years (AY) 2011-12 & 2013-14.
2. Since, the identical facts and issues are involved in these appeals, we proceed to dispose the same vide this common order.
3. For the sake of convenience and clarity the facts relevant in ITA No.876/Chny/2018 for assessment year 2011-12 are stated herein.
4. The assessee raised the following grounds of appeal:
“Based on the facts and circumstances of the case, the Appellant respectfully craves leave to prefer an appeal against the order dated 21 December 2017 (serviced on 12 January 2018) issued by the Hon’ble Commissioner of Income-tax (Appeals) – 13, Chennai (hereinafter referred to as ‘Hon’ble CIT(A)’), under Section 250 of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’).
The following grounds of appeal are independent of and without prejudice to one another.
On the facts and in circumstances of the case and in law, the learned Assessing Officer (‘Ld. AO’) has erred and the Hon. CIT(A) has further erred in upholding / confirming the action of the Ed. AO in:
1. Disallowance of Royalty payments
1.1 erred in treating the royalty payment of 1NR 34,644,391 as capital expenditure and disallowing the same.
1.2 erred in not following the decisions rendered by the Hon’ble ITAT on similar issue, which were in favour of the Appellant for earlier assessment years.
2. Disallowance of fees paid to Registrar of Companies (‘ROC’)
2.1 disallowing the fees paid to ROC of INR 510,000 for increasing the authorized share capital.
The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before or at, the time of hearing of the appeal, so as to enable the ld. AO to decide this appeal according to law.”
5. The brief facts of the case are as under:
The appellant namely Faurecia Emissions Control Technologies India Pvt. Ltd. is a company incorporated under the provisions of the Companies Act, 1956. It is engaged in the business of manufacturing of automobile exhaust systems, catalytic convertors. The return of income for the AY 2011-12 was filed on 30.09.2011 disclosing total income of Rs. 6,21,91,840/-. Against the said return of income, the assessment was completed by the Dy. CIT, Corporate Circle-2(1), Chennai (hereinafter called “AO”) vide order dated 12.03.2015 passed u/s. 143(3) r/w s. 92CA(3) of the Income Tax Act, 1961 (in short ‘the Act’) at total income of Rs. 8,29,84,700/-. While doing so, the AO treated the royalty expenditure of Rs. 3,46,44,391/- paid to Sango Co. Ltd., Japan and Faurecia Systems Dechappement, France as a capital expenditure as against claim by the assessee as revenue expenditure. However, the AO allowed depreciation @ 25% of the capital expenditure. The AO had come to the conclusion that it is a capital expenditure taking note of the fact that the appellant had been granted the exclusive right to obtain the technical and engineering instruction know how to manufacture, assemble, sale and distribution of exhaust products and this expenditure had resulted in an enduring benefit to the assessee.
6. Being aggrieved, an appeal was preferred before ld. CIT(A), who vide impugned order confirmed the action of the AO placing reliance on the decision of Hon’ble Jurisdictional High Court in the case of CIT v. Southern Switchgear Ltd. [1984] 16 Taxman 79 (Mad) as the appellant was given an exclusive right to use the technical know-how for the purpose of manufacturing the exhaust products in India. Being aggrieved, the assessee is in appeal before us in the present appeal.
7. It is contended that the royalty payment was only for the purpose of use of technical information in the manufacture and sale of the products. The proprietary ownership rights in the know-how never vested with Sango Co. Ltd., Japan and Faurecia Systems Dechappement, France at all the time there is no parting know-how in favour of the assessee resulting in the acquisition of any asset no benefit of any enduring nature had accrued to the appellant. It is further stated that the ratio of the decision of Hon’ble Jurisdictional High Court in the case of Southern Switchgear Ltd. (supra) is not applicable to the facts of the present case as no lump sum payment was made and the payment of royalty was made in terms of percentage of the sales. On the other hand, the ld. Sr. Departmental Representative placed reliance on the orders of lower authorities.
8. We heard the rival submissions and perused the material on record. The short issue in the grounds of appeal is relates to whether the royalty payment made to the Sango Co. Ltd., Japan and Faurecia Systems Dechappement, France can be disallowed as being capital in nature. The appellant had entered into an agreement with M/s. Sango Co., Ltd., Japan in terms of which the appellant is granted exclusive license for the manufacture in the territory of the customer agreed and non-exclusive right outside the territory of the customer. The assessee is also entered in an agreement with M/s. Faurecia Systems D’echappement, France in terms of which the appellant is granted for exclusive license for exclusive, non-transferable and non-assignable. In terms of the said agreements, the assessee after the expiry of the license granted the assessee has to return all the documents relates to the technical information received and the royalty shall be paid as a percentage of the turnover. Therefore, the issue that comes whether this payment of royalty can be considered as a capital or revenue. The decision of Hon’ble Jurisdictional High Court in the case of CIT v. Southern Switchgear Ltd. (supra) invoking the identical facts is as follows:
“10. A perusal of the above clauses clearly indicates that the technical knowledge the assessee-company obtained through this agreement from the foreign company secured to the assessee an enduring advantage and benefit in that the same was available to the assessee for its manufacturing and industrial processes even after the termination of the agreement. The technical assistance contemplated in the agreement covers the establishment of the factory and the operation thereof for the manufacture of transformers of all kinds and types. The foreign company also makes available to the assessee its procedures, designs, experience and technical know-how in respect of the same. Though the duration of the agreement is five years, the assessee even after the expiry of the period, could use the methods of production, procedure, experiments, improvements which had been made available to them in pursuance of the agreement. Thus, the assessee had acquired a knowledge of enduring nature. Further, apart from the technical know-how supplied by the foreign company and the grant of patent rights, the foreign company has agreed not to manufacture in India any of the scheduled products or to grant or make available to any other person, firm or company any manufacturing information, licences, rights for any one of the scheduled products in India, thus conferring an exclusive benefit on the assessee-company to manufacture and sell the scheduled products. The conferment of an exclusive benefit to manufacture and sell the articles which are the subject-matter of the agreement cannot be said to be a part of a mere know-how agreement. The right to make or manufacture certain goods exclusively in India should be taken to be an independent right secured by the assessee from the foreign company which is of an enduring nature. Therefore, the principle laid down by this Court in Transformer & Switchgear Ltd. vs. CIT (supra), Fenner Woodroffe & Co. Ltd. vs. CIT (supra) and M. R. Electronic Components Ltd. vs. CIT (supra), straightaway applies, and, therefore, the entire technical fees cannot be allowed as a revenue expenditure.
11. The learned counsel for the assessee relies on the decision of the Supreme Court in CIT vs. Ciba of India Ltd. (1968) 69 ITR 692 (SC), Mysore Kirloskar Ltd. vs. CIT 1978 CTR (Kar) 198 (FB) : (1978) 114 ITR 443 (Kar) (FB) and Praga Tools Ltd. vs. CIT (1980) 16 CTR (AP) 356 (FB) : (1980) 123 ITR 773 (AP) (FB). But these decisions do not assist the petitioner. In Mysore Kirloskar Ltd. vs. CIT (supra), the Full Bench of the Karnataka High Court, after considering the terms of the know-how agreement in that case, held that under the agreements, the assessee acquired merely the right to draw upon the technical knowledge of the foreign companies for a limited period, for the purpose of carrying on its business, that the foreign companies did not part with any of their assets absolutely for ever or for a limited period of time, that they continued to have the right to use their knowledge and, even after the agreements had run their course, their rights in this behalf was not lost, that the assessee bad not, therefore, acquired any asset or advantage of an enduring nature for the benefit of its business and that the payments were, therefore, revenue in nature and were deductible. The Full Bench followed the decision of the Supreme Court in CIT vs. Ciba of India Ltd. (supra). In the said case, the Supreme Court has held that in making the technical knowledge available to the Indian company, the foreign company did not part with any assets of its business or advantage of an enduring nature for the purpose of business. The decision in Praga Tools Ltd. vs. CIT—is also to the same effect. All the above three cases dealt with a mere know-how agreement under which the Indian company acquired only technical knowledge from the foreign company and did not acquire any other right or advantage of an enduring nature for the purpose of its business, unlike the facts in this case. Here, in addition to the acquisition of technical knowledge, the assessee-company got an exclusive right to manufacture and sell its articles without any objection from anyone including the foreign company and this is clearly an advantage of enduring nature.
12. It is well-established that even without acquisition of an asset, a right of a permanent advantage could be acquired and the cost of acquisition of such a right could be taken to be capital expenditure. In Regent Oil Co. Ltd. vs. Strick (Inspector of Taxes)(1966) AC 295 : (1969) 73 ITR 301 (HL), the House of Lords had expressed the view that payments made by an assessee to secure exclusive sales stations are payments for permanent assets and for an enduring benefit, and, therefore, the expenditure is capital in nature. Lord Reid in that case observed thus :
” Whether a particular outlay by a trader can be set against income or must be regarded as a capital outlay has proved to be a difficult question…… So it is not surprising that no one test or principle or rule of thumb is paramount. The question is ultimately a question of law for the Court, but it is a question which must be answered in the light of all the circumstances which it is reasonable to take into account, and the weight which must be given to a particular circumstance in a particular case must depend rather on common sense than on strict application of any single legal principle.”
13. We have, therefore, to hold, following the above said decisions of this Court that in this case, the Tribunal is right in holding that 25 per cent of the technical fee has to be taken as a capital expenditure and as such cannot be allowed as a revenue expenditure.
14. Coming to the second issue as to whether the Tribunal is right in upholding the disallowance of 25 per cent of the royalty paid, the ITO, the appellate authority as well as the Tribunal have all concurrently held that the disallowance of 25 per cent of the royalty is justified. Under the terms of the know-how agreement, the royalty is payable on all switchgear products and the parts thereof sold on behalf of the Indian company at the rate of 2 1/2 per cent of the invoice value of all low tension switchgear products at 5 per cent in all the high tension switchgear parts and a royalty of 7 per cent in all switchgear products exported. Thus, it is seen that the assessee paid a royalty for the acquisition of an exclusive privilege of manufacturing and selling the products. The acquisition of such a right has rightly been treated partly towards capital and partly towards the Revenue. The Tribunal has chosen to estimate the value of that portion of the royalty which is relatable to acquisition of right of an enduring nature. In this view, the Tribunal is right in holding that 25 per cent of the royalty is to be disallowed.”
9. The above decision was affirmed by the Hon’ble Supreme Court in the case of Southern Switchgear Ltd. v. CIT 232 ITR 359 (SC). Further recently the Hon’ble Supreme Court in the case of Honda Siel Card India Ltd. v. CIT [2019] 101 taxmann.com 222 (SC) held as follows:
“No doubt, this technical know-how is for the limited period i.e. for the tenure of the agreement. However, it is important to note that in case of termination of the Agreement, joint venture itself would come to an end and there may not be any further continuation of manufacture of product with technical know-how of foreign collaborator. The High Court has, thus, rightly observed that virtually life of manufacture of product in the plant and machinery, establishes with assistance of foreign company, is co-extensive with the agreement. The Agreement is framed in a manner so as to given a colour of licence for a limited period having no enduring nature but when a close scrutiny into the said Agreement is undertaken, it shows otherwise. It is significant to note in this behalf that the Agreement provides that in the event of expiration or otherwise termination, whatsoever, licensee, i.e., joint venture company/ Assessee shall discontinue manufacture, sale and other disposition of products, parts and residuary products. All these things then shall be at the option of licensor. In other words, licensee in such contingency would hand over unsold product and parts to licensor for sale by him. In case licensor does not exercise such an option and the product is allowed to be sold by licensee, it would continue to pay royalty as per rates agreed under the agreement. Clauses 19 and 21, in our view, make the Agreement in question, i.e., establishment of plant, machinery and manufacture of product with the help of technical know-how, coextensive, in continuance of Agreement. The Agreement also has a clause of renewal which, in our view, in totality of terms and conditions, will make the unit continue so long as manufacture of product in plant and machinery, established with aid and assistance of foreign company, will continue. Since, it is found that the Agreement in question was crucial for setting up of the plant project in question for manufacturing of the goods, the expenditure in the form of royalty paid would be in the nature of capital expenditure and not revenue expenditure. The Tribunal is conclusion that it is only the other three memoranda which were necessary for setting up the manufacturing facilities and payment thereunder would qualify as capital expenditure, and not the payment of technical fees/royalty on the ground that this Agreement was not in connection with the setting up of a plant or manufacturing facilities, is not correct. It would be interesting to note that even the Tribunal had nurtured doubt on the nature of this expenditure as TCA was signed simultaneously with the other memoranda to facilitate setting up of a new factory and not improvising the earlier set up. This doubt has expressed by the ITAT itself in the following words:
““Our doubt was why the payment, at least of the lump sum technical know-how fees, cannot be considered as being connected to the initial starting up of the business and hence not allowable since the know-how was bring obtained for the first time and was crucial to the setting up of the business of the assessee which undisputedly was to manufacture Honda cars in India. It may be recalled that this was also the view taken by the Assessing Officer. Further, the assessee was not already in the manufacture of cars and was commencing such an activity for the first time. It was not a case of a business already in existence. The payment was an “once for all” payment, though staggered over a period of years.”
10. In the light of the above principles, the expenditure of royalty cannot be treated as revenue expenditure and therefore, we upheld the action of the lower authorities.
11. In the result, the appeal filed by the assessee in ITA No.876/Chny/2018 for assessment year 2011-12 is dismissed.
Revenue appeal in ITA No.708/Chny/2018 for assessment year 2013-14:
12. Since, the facts in the present appeal are identical to the facts in appeal ITA No.876/Chny/2018 for assessment year 2011-12, in the reasons mentioned therein, the royalty expenditure cannot be treated as a revenue expenditure and accordingly, we reverse the findings of ld. CIT(A) and allow the Revenue’s appeal. Hence, the above captioned appeal filed by the Revenue is allowed.
13. In the result, the appeal filed by the assessee in ITA No.876/Chny/2018 for assessment year 2011-12 is dismissed and the appeal filed by the Revenue in ITA No.708/Chny/2018 for assessment year 2013-14 is allowed.
Order pronounced on the 23rd day of April, 2019 in Chennai.
