Technical know how fee paid for acquiring a non exclusive licence to manufacture machines for the term of five years is revenue expenditure

Recently, the Bombay High Court in the case of M/s. Essel Pro pack Limited [2010-TIOL-209-HC-MUM-IT] held that the technical know how fee paid by the taxpayer for acquiring non exclusive licence to manufacture some machines, which was confined to the territory of India for the term of five years during which the proprietary rights in the patents of the licence continued to vest in the licencor,

was revenue expenditure and was allowed under section 37(1) of the Income-tax Act, 1961 (the Act).

Facts of the case

• The taxpayer entered into an agreement with a Mauritian company, KMK Lizence Limited (Li-censor), for granting of a non exclusive licence to manufacture and use tube making machines, tools and parts thereof with the right to register the licence from 1 September 1997 to 31 August 1999.
• As per the agreement, the sole proprietary right in the patents vests with the licencor. The licencor indemnified the taxpayer as licensee against all actions, claims, proceedings, costs and damages arising out of any breach of the warranties made by the licensor. Further, the taxpayer was entitled to initiate proceedings for infringement of the patent in order to defend the proprietary rights of the licensor against reimbursement of expenses by the licensor. The initial agreement was modified on 15 June 1998.
• The modification was related to the payment of consideration and the terms of the licence. Under the modified agreement, a technical know how fee of INR 68.2 million was payable in four instalments and the royalty was fixed at five percent for each captive use / domestic sale of a machine and eight percent for exports for five years. The term of the agreement was extended up to 31 August 2002. The taxpayer considered both the expenditures as revenue expenditures and claimed under section 37(1) of the Act.
• However, the Assessing Officer (AO) disallowed the technical know how fee after considering it as a capital expenditure incurred for acquiring an intangible asset in the form of technical know how. The Commissioner of Income-tax (Appeals) [CIT (A)] and the Income-tax Appellate Tribunal (the Tribunal) allowed the claim of the taxpayer. The Tribunal observed that the rights acquired by the taxpayer were not absolute and it was for a specific tenure. Further the taxpayer was not entitled to transfer the rights which was obtained under the licence and had a limited right to use the technical know how for manufacturing machines over a limited tenure. Accordingly, the Tribunal upheld the order of CIT(A).

Issue before the High Court:- Whether the technical know how fee paid by the taxpayer for acquiring non exclusive licence to manufacture some machines is revenue expenditure allowable under section 37(1) of the Act?

Tax department’s contention:- The tax department contended that the acquisition of know how under a licence was capital expenditure and it would fall within the ambit of amended section 32 of the Act with effect from 1 April 1998.

High Court’s ruling

• The High Court observed that the agreement was entered into on 1 September 1997 which was prior to 1 April 1998 when section 32 of the Act was amended to provide depreciation on intangible assets. Thus, the agreement was operative during the course of financial year 1997- 1998 prior to the enforcement of the amended provisions of section 32 of the Act.
• The High Court held that depreciation provisions (Section 32 of the Act) would not get attracted because the taxpayer had obtained the benefit of a licence on a non-exclusive basis which was confined to the territory of India for a limited term and the proprietary rights in the patents of the licence continued to vest in the licensor. The High Court relied on the decision of the Supreme Court in the case of CIT Vs. Ciba of India Ltd. (1968) 69 ITR 692 (SC).
• Accordingly, the High Court held that the technical know how fee paid by the taxpayer for acquiring non exclusive licence was revenue expenditure allowed under section 37(1) of the Act.

Our Comments

The erstwhile provisions of section 35AB of the Act allowed one sixth of the lump sum consideration paid for acquiring any know how. These provisions were omitted with effect from 1 April 1998 and the provisions of section 32 were amended to provide depreciation on intangible assets including know how. During this period, various Courts (See Note- 1 for List of Judgements) have allowed the expenditure on acquisition of know how as revenue expenditure.

The present case is pertaining the period prior to 1 April 1998 when section 35AB was applicable. However, the Delhi High Court has allowed the technical know how fee for acquiring non exclusive licence as revenue expenditure under section 37(1) of the Act.

It is also pertinent to refer to the decision of the Delhi Tribunal in the case of ITO v. Shivani Locks Ltd. [2008] 118 TTJ 467 (Del) where it was held that the payment made by the taxpayer for the limited right to use know how was revenue expenditure allowable under section 37(1) of the Act. The Tribunal also dealt with section 32 of the Act and held that depreciation under section 32 of the Act would have been allowed if the know how was owned by the taxpayer.

NOTE:-1

• Amtrex Appliances Ltd. Vs DCIT [2003] 94 TTJ 396 (Ahmedabad)
• K.B. Mehta Vs. DCIT [2004] 265 ITR 17 (Pune)
• CIT Vs. Elecon Engg. Co. Ltd [2001] 170 CTR 267 (Guj)
• CIT Vs. Sayaji Iron & Engg. Co. Ltd. (1994) 210 ITR 950 (Guj)

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