Maruti Suzuki India Ltd. Vs ACIT (ITAT Delhi)
The royalty paid to Suzuki Motor Corporation Japan by Maruti Suzuki India Ltd. for the use of licensed information held to be revenue expenditure
An expenditure whether pertains to capital or a revenue one has remained controversial in many cases. Help in resolving this issue is taken from the decided cases, on the facts and circumstances of the particular case with reference to Income Tax Act. Recently, in Maruti Suzuki India Ltd. vs. ACIT [ITA No.-6021/Del/2012, decided on 09.11.2017], amongst 19 grounds raised in the appeal before Delhi ITAT, one of the ground was in respect to the disallowance of Rs.192.77 Crores royalty paid to Suzuki Motor Corporation, Japan (‘SMC’), by Maruti Suzuki India Limited. In the case, the assessee paid royalty of Rs.495,15,40,443/- to Suzuki Motor Corporation, Japan (‘SMC’) for use of licensed information for the engineering, design and development, manufacture, testing, quality control, sale and after sales service of products and parts, but the Assessing Officer(AO), in the assessment order, had held that inasmuch as the life cycle of a car was only 5 years whereas the license agreement was for 10 years, extendable by 5 years and even thereafter the assessee could produce the said model of car, and the license agreement led to the assessee setting up a new factory based on new technology, and for these reasons the assessee had enduring benefit as such royalty paid by the assessee was capital in nature, and consequently, held that the entire royalty was disallowable. On this premise, basing on the adjustment of Rs.237.24 crores, made by TPO the AO had computed the disallowance out of royalty payments to a tune of Rs. 192.77 Cr.
The Authorised Representative of the assessee submitted that the AO failed to appreciate the fact that the nature and purpose for which the royalty had been paid to SMC was only the use of licensed information for the engineering, design and development, manufacture, testing, quality control, sale and after sales service of products and parts, and as per clause 7.01 of the agreement the duration of the agreement has been specified as 10 years and vide clause 7.04 of the agreement it was subject to termination at earlier date for breach. He submitted that as evidenced by clause 2.02 of the agreement SMC did not transfer to MSIL any specific patents or copyrights or other secret or protected information or knowhow so as to make MSIL a proprietor of the same or so as to enable MSIL to exercise proprietary rights such as unrestricted rights of transfer to third party, either by way or assignment or license.
According to AR in order to determine the nature of the royalty payment, whether capital or revenue, what was material was the underlying purpose for which payment was made and not the tenure or its extendibility or the life cycle of the product that was manufactured with the help of the technology that was accessed from SMC. If the payment was for use of technical knowhow, simplicitor, then the payment had to be regarded as revenue, irrespective of the tenure for which permission was granted for such use. Since in the present case, under the License Agreement, the assessee was merely granted permission to access the technical knowhow for the limited purpose of using the technology relating to the new models during the currency of the agreement and the proprietary rights for the know-how and the intellectual property rights in relation thereto continue to be owned by SMC alone, the payment was undoubtedly revenue in nature.
While placing reliance on Circular No. 21 of 1969 issued by CBDT, AR argued that if in terms of the Agreement, only a license was obtained for user of technical knowledge from a foreign participant for a limited period together with or without the right to use the patents and trademarks of the foreign party, the payment would not bring into existence an asset of enduring advantage to the Indian party. He further submitted that while following the aforesaid Circular, the jurisdictional Delhi High Court in case of CIT v. Lumax Industries Limited: 173 Taxman 390 held that similar royalty payment was allowable as revenue deduction.
The AR submitted that in a host of following decisions, the issue of allowability of royalty payments as revenue expenditure was covered in favour of the assessee company:
The AR further relied upon the decision of the Hon’ble Jurisdictional High Court in the case of CIT v. J.K Synthetics: 309 ITR 371 at page 391, wherein while culling out legal principles based on various decisions it was held that the fact that assessee could use the technical knowledge obtained during the tenure of the License for the purposes of its business after the agreement has expired, and in that sense, resulting in an enduring advantage, has been categorically rejected by the Courts, and that this, by itself, cannot be decisive because knowledge by itself may last for a long period even though due to rapid change of technology and huge strides made in the field of science, the knowledge may with passage of time become obsolete. AR disputed the factual correctness of the observation of the assessing officer that the license Agreement led to the assessee setting up a new factory based on new technology, and submitted that no new plant/ factory was setup by the assessee on the basis of the agreement entered into for use of technical knowledge/ information. According to him the AO failed to appreciate that the assessee was engaged in the business of manufacture of automobiles and various models of the cars introduced by the assessee from time to time were nothing but part of the same business of the assessee, as such the mere fact that new models/ variants of car were introduced by the assessee based on the license agreement did not mean that an altogether new product was manufactured. He made a reference to the decisions of the Delhi High Court in case of CIT v. Hero Honda Motors Ltd.: 372 ITR 481 and decision of the Delhi Bench of the Tribunal in the case of Hero Honda Motors Limited v. DCIT: ITA no. 5130/Del/2010 for A.Y. 2006-07, and also to the decision of the Delhi Bench of the Tribunal in the case of Hero Honda Motors Limited v. DCIT in ITA Nos. 716 to 718/Del/2008 for the assessment years 2000-01 to 2002-03 wherein, a coordinate Bench of Delhi ITAT, after analyzing all the decisions, held royalty to be in the nature of revenue expenditure even though royalty was paid for exclusive use of technical knowhow/ information, the agreement was for 10 years and extendable, the assessee was permitted to continue to manufacture motorcycles even after termination of the agreement. The AR submitted that the aforesaid issue has now been decided in favour of the assessee by the Delhi Bench of the Tribunal in assessee’s own case for the AY 2006-07 and AY 2007-08holding that amount of royalty considered by AO as capital expenditure should be allowed as revenue expenditure. For these reasons he prayed that the AO may be directed to allow the entire royalty payment as allowable revenue deduction.
The Departmental Representative vehemently defended the observations of the AO, while submitting that in the scenario of a New Model coming every 2nd or 3rd year and the old Models getting phased out, License Agreement was for 10 years, extendable by 5 years and even thereafter MSIL could produce the said model of Car, is more than enduring. Further, there had been technology transfer for manufacturing the product, and the personnel of the company had been technically trained. The transfer of technology was as per the License Agreement but the skill which had been acquired year after year due to training of the companies personnel has been absorbed in the company and can be used across the other Products. This was again an enduring benefit. Referring to the cases cited by the AR, it was the argument of the DR that in all the cases where the Courts have held that the Royalty payment is Revenue and not capital are the ones where the License Agreement was only to approach or access the technology without imparting any trade secrets and above all the time period was much short, say 5 years or less coupled with the fact that , the product was different and the right given was not exclusive. He submitted that the Tribunal’s order in assessee’s own case for AY 2007-08 cannot be relied upon because on this aspect the Tribunal was swayed by the assessee’s contention that TPO has disallowed the royalty, but as a matter of fact, TPO had determined the value of the ALP of the co-branding done by Suzuki. The value of the same is determined by equating the trade mark royalty Maruti was paying to Suzuki for its brand. The logic was simple if Maruti was paying licensed trade name royalty to Suzuki then Suzuki should also be paying back the trade name royalty to Maruti. Whereas it was a fact that royalty being paid is a composite royalty including the usage of Trademark and technical information. It was Suzuki who has been charging this royalty even if its name was used only on the rear of the vehicle. But now after taking over the management of the company, it had repositioned its name and brand and logo on these vehicles. The question was whether any independent party that had assiduously over the years had built up a name and reputation would have allowed so. And that too absolutely free when the other party had been throughout charging it for whatever it was providing it be it machinery, technology, spare parts, technical assistance, corporate guarantee, trade name, trade mark. That did not seem to be a situation in normal and independent circumstances and this was not appreciated by the Tribunal, as a consequence of which the Revenue preferred an appeal on this issue also. According to him, the Tribunal had merely relied on its order for earlier years which in turn relied merely on decision of Hon’ble Delhi High Court in Hero Honda Motors Ltd. (2015) 372 ITR 481 (Del) and not discussed the facts that are recorded in the assessment order. It was submitted that on the basis of the facts mentioned in the assessment order, the ratio decidendi of the Delhi High Court decision in Hero Honda Motors Ltd. (supra) would not be applicable in the instant case. Lastly, it was argued by the DR that these were continuous issues forming part of the assessment order for AY 2005-06, 2006-07 and 2007-08 also, and were at present pending adjudication before Hon’ble Delhi High Court.
It was observed, on the issue, a coordinate Bench of Delhi ITAT in assessee’s own case for AY 2007-08, referred to order for AY 2006-07 and held as under:
“8.5. The ld. DR has relied on certain decisions, which categorize payment for use of technical know-how etc. as a capital expenditure. Similarly, the ld. AR has also relied on certain decision which mark such payment as a revenue expense. In all these decisions, the dividing line is whether the consideration is for purchase of technical information, know-how information, designs and drawings, etc., or for its use. If it is for use alone, then it is revenue and vice versa. Recently, the Hon’ble jurisdictional High Court in CIT v. Hero Honda Motors Ltd. (2015) 372 ITR 481 (Del), on consideration of the relevant clauses of the agreement before it, which considerably match with the Agreement under consideration, has held that the payments made for Model fee (which is equivalent of Lumpsum royalty in our case) and Running royalty are revenue expenses. In this judgment, the Hon’ble jurisdictional High Court has considered several judgments of the Hon’ble Supreme Court and Hon’ble High Courts and on consideration of their cumulative effect, it has come to the conclusion that both the amounts are revenue in nature. The Hon’ble Delhi High Court in an earlier judgment in Shriram Refrigeration Industries Ltd. vs. CIT (1981) 127 ITR 746 (Del), has held that the lumpsum royalty is a revenue expenditure. After going through the relevant clauses of the Agreement, we have noted that royalty paid by the assessee is for use of licensed information and no part of the same is towards its acquisition as an owner. In the light of the above discussion, it is absolutely clear that the view canvassed by the AO in treating this amount as capital expenditure, is not sustainable.
8.6. Our above finding decides the nature of royalty payment for use of licensed information as revenue expenditure and not its quantum part. We have noticed above that the tribunal in its order for the immediately preceding year has also given some observations, which prima facie indicate that the entire amount of royalty is for the use of licensed information. Since we have held the royalty for use of licensed information as revenue expenditure, the quantification aspect becomes irrelevant. It is so because the TPO has held royalty for use of licensed information at ALP. We, therefore, hold that the amount of royalty considered by the AO as capital expenditure should be allowed as a revenue expenditure. At the same time, depreciation allowed by the AO on this amount should be taken back.”
Following the above decision for AY 2006-07, which was on an identical issue in the case of assessee itself, the Delhi ITAT for the AY 2007-08, hold that the amount of royalty considered by the AO as capital expenditure should be allowed as a revenue expenditure, and at the same time, depreciation allowed by the AO on this amount should be taken back. The Delhi ITAT specifically held that the terms of the agreement considered by the Hon’ble Jurisdictional High Court in CIT vs. Hero Honda Motors Ltd. (2015) 372 ITR 481 (Del), were considerably matching with the Agreement under consideration. On the face of this observation, without the same being disturbed by the higher forums, the learned Members of the Delhi ITAT found it difficult to countenance the argument of the DR that the ratio decidendi of the Delhi High Court decision in Hero Honda Motors Ltd. (supra) would not be applicable in the facts of the instant case. Therefore, the learned Members respectfully following the same held that the amount of royalty considered by the AO as capital expenditure should be allowed as a revenue expenditure, and at the same time, depreciation allowed by the AO on this amount should be taken back.