LEILA SETH, J.--These six income-tux refer,-aces at the instance of the Commissioner of Income- tax, pertain to the assessm ent years 1965-66 to 1969-70 and 1972-73. The point in issue in each of them pertains to the question of deductibility of royalty. The question posed for our opinion under section 256(1) of the Income-tax Act, 1961 (to referred to in short as "the Act"), in the first of two years is as follows :-- "Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the royalty amounts paid by the assessee to the foreign collaborators for the assessm ent years 1965-66 and 1966-67 were of revenue nature?"
2. The question posed in the subsequent three years is identical except that the assessment years 1967-68, 1968-69 and 1969-70 have been inserted in place of 11,65-66 and 1966-67. The question posed for the year 1972-73 is substantially the same, though slightly differently worded and set out: "Whether on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Royalty amounting to Rs. 39,656 paid by the assessee to the foreign collaborators for the assessm ent year 1972-73 was of revenue nature?"
3. The assessee, Mes3rs Shama Engine Valves Ltd., was engaged in the manufacture of valves. A company known as B. K. Khanna & Co. Pvt. Ltd. Tin short "Khanna") -entered into an agreement, dated 25th October, 1961 with a foreign company, Bayariocbee Leichtmetal Work Kommanditgesslieehaft of Munchan (to be referred to its "BLW") to manufacture valves in India. B. L.
W. Was already engaged in the design, manufacture and sale of valves in Germany and export thereof. Art. 1 of the agreement provided that the period of the agreement was for ten years thereafter it was automatically renewable, with prior approval of the Government of India, unless terminated six months registered notice, from year to year.
4. Art. 2 is set out LICENCE B. L. W. Hereby grants to Khanna the following rights and agrees to furnish Khanna which all information, data etc.
(a) an exclusive right to manufacture in the Republic of India and Nepal, Burma, Ceylon, Thailand, Pakistan, Indonesia. Hong Kong, Laos, Vietnam and Kambodecha valves.
(b) an exclusive licence to and sell the valves as manufactured by Khanna in India and Nepal, Burma, Ceylon, Thailand, Pakistan, Indonesia, Hong Kong, Laos, Vietnam and Kambodecha.
(c) outside the territories mentioned under (a) and (b), Khanaa is authorised to sell valves produced under this licence only with B. L. W.'s prior written permission.
(d) B. L. W grants to Khanna an exclusive right to sell in the territories mentioned under (a) and (b), the valves B. L. W. Manufactures in Germany.
This exclusive selling right for Khanna will be stated by B. L. W. In a separate agreement, which shall be part of this principal agreement."
5. Under Art. 3, B. L. W. Was to communicate to Khanna the complete information required to produce valves. It was required to render assistance including all knowledge to. Produce valves economically and efficiently and strictly in accordance with any particular customer's requirements. B. L. W. Was also to provide, whenever required, the Jige, tools and gauges and other information to manufacture the valves. It was also to furnish all information including production data, designs, drawings, working drawings, production schedules, control schedules and calculation scheme etc. In addition B. L. W. Had to design a complete layout plan for the valve factory and provide the detailed machinery specifications and instructions for its erection in the building as also the installation of electrical and other amenities. The complete list of staff and labour required was also to be worked out by B. L. W. It was to train the specialists sent to it by Khanna at its factory in Germany.
6. Khanna was given permission to use 'B. L. W.' trade name and sign as B. L. W.'s licences. B. L. W.
Undertook to disclose to Khanna the latest methods and information within its knowledge re- manufacture of valves, i.e. a supply of complete technical knowhow. However, Khanna was to the best of his ability not to "communicate or disclose, and shall take reasonable precautions to prevent the communication or disclosure by its employees, or otherwise any information (other than such information as shall have become generally known to the industry) to any third party in any way whatsoever, without B. L. W.'s prior written consent".
7. In accordance with Art. 5 Khanna bad the right to proclaim its valves in India as manufactured under B. L. W. Licence styled as "BLW--SHAMA" and sell them under this description in the territories covered by the agreement.
8. In terms of Art. 6(a), Khanna bad to pay B. L. W. Immediately on receipt of the planning design and data required for establishment of a valve factory and production, a non-recurring fixed sum of 30,000 German Marks. This payment was to be made irrespective of whether the valve production started and no deductions could be made from it.
9. Under Art. 6(b) Khanna was also to pay to B. L. W. a royalty of one per cent on the "not selling value" of all valves produced and sold by Khanna under licence of this agreement. A detailed statement of the amounts was to be given to B. L. W. Every three months and payment was to be made within sixty days of the end of the same periods without any deduction. It is the nature of these royalty payments that is the point in issue.
10. Art. '' which deals with patents provides for the situation at the end of the agreement.
"After conclusion of this Agreement B. L. W. Shall place at Khanna's disposal B. L. W.'s patent applications so that Khanna can then file the applications in India, under B. L. W's. Name and at Khanna's expense."
11. Art. 10 dealing with termination is set out in extenso: TERMINATION If either party shall :-
(a) default in the performance of any of the covenants or conditions of this Agreement and shall fail to make good or remedy such default, within ninety (90) days after receipt of notice thereof in writing from the other party, giving reasonable particulars thereof and of the intention of the party serving the notice to terminate this Agreement unless such default is made good or remedied or
(b) becomes insolvent or goes into liquidation on receivership or be admitted to the benefits of any procedure for the settlement of debts or declared bankrupt, or
(c) be dissolved, or
(d) if Khanna has not begun to establish the factory as contemplated in this agreement within three years after B. L. W. Has placed at Khanna's disposal all plans etc. As covered by this Agreement, then this Agree--ment and any and all licences and rights granted and obligations assumed hereby (except the obligation to pay, any money theretofore due and payable) may be terminated not less than thirty (30) days after the date when notice of the same is given.
On the expiration or termination of this Agreement or any cause whatsoever, Khanna shall have a perpetual non-exclusive right to manufacture valves as being manufactured hereunder without further payment. If this Agreement is terminated prematurely through Khanna's fault, Khanna shall continue to pay the Royalty stipulated in Art. 6 (b) of this Agreement, for the duration of this Agreement, if B. L. W. Is prepared to grant Khanna the use of B. L. W.'s trade Name for the duration of such payments.
Khanna shall however, have the right under such circumstances to use the trade name even after the expiration or termination of the agreement for the purpose of executing the orders against quotation submitted before such termination, subject to the payment of royalty with respect thereto in the same amounts and to the same effect as if this agreement had not been terminated for the purposes of such orders.
12. Further, under Art. 14 Khanna has "the right to assign all its rights and duties under this agreement to the Shama Engine Valves Limited a new company, which will undertake the manufacture and sale of valves in the territories stipulated in this agreement. B. L. W. Agrees to this assignment already at this time of contract of agreement".
13. In consequence of this assignment the assessee had to make pay--ments to B. L. W. The first payment pertained to 30,000 German Marks, which it is common ground is a capital expenditure: However, the payment pertaining to royalty for the various years was claimed by the assessee as a deductible revenue expenditure. In making this assertion, it relied on the decision of the Supreme Court in Commissioner of Income-tax, Bombay v. Ciba of India, Ltd. ((1968) 69 I T R 692 : AIR 1968 SC 1131).
14. The amounts paid for the various assessment years, the correspond--ing previous years ending on 30th September are as follows: 1965-66Rs.24,747/1966-67Rs.39,068 1967-68 Rs. 30,945 1968-69 Rs. 25,621 1969-70 Rs. 28,922 1972-73 Rs. 39,666
15. The Income-tax Officer found that tare facts did not justify the applicability of the ratio of the decision of Ciba's rose (AIR 1968 SC 1131) and held that the expenditure incurred was of a capital nature, as the assessee got an enduring benefit. Ciba's case was distinguished mainly on the ground that there, merely a right to draw upon the practical knowledge of the Swiss Company for a limited period was granted, whereas in the pro-sent case the assessee acquired an exclusive right to manufacture and to all existing skills and future improve--ments. The stipulation with regard to automatic renewal of the agreement after ten years and the right of the assessee to continue manufacture without payment on the termination of the agreement, for any reason, weighed with the income-tax Office:, He said, "The assessee gets all the knowledge to that date. His loss is only the inability to use B. L. W. Name. The payment said to be made by way of royalty is of a ca ital nature. The payment of royalty is, therefore, being disallowed".
16. The Appellate Assistant Commissioner affirmed the order of the Income-tax Officer.
17. On further appeal to the Income-tax Appellate Tribunal, the assessee's appeal was allowed. The Tribunal held that it had to look not only at the agreement but at the surrounding circumstances to ascertain the teal nature of the payment from a commercial point of view. It found a striking similarity in the clauses of the present case to that of the Ciba's case and the case decided by the Calcutta High Court in Commissioner of Income-tax v. Hindustan General Electrical Corporation ((1971) 81I T R 243).
18. The Tribunal was of the opinion that in the present case as in the Ciba's case, there was no payment for parting with technical knowhow perma--nently in favour of the assessee. It further observed that the "object of payment of royalty was for the purpose of getting benefits of technical assis--tance for running the business", like in the two above-mentioned cases. The payment of royalty was recurring in nature based upon the sales. The assessee was prohibited from divulging information to the third pacts without the consent of B. L. W. The payments were for a limited period, i.e. The period of the agreement, the only difference being that in the Ciba case the tenure was for five years whereas in the present case it was for ten years. The fact that the assessee was starting a new business was not of much significance. It, therefore, held that "the payment of royalty related to the current expenses for the purpose of carrying on manufacture of valves" agreed to be carried on in accordance with the terms of the agreement. The payment of royalty was, therefore, referable to a pooling arrangement between the assessee and B. L. W for manufacture of valves. No secret process was sold and as such the payment could not be treated as relating to capital expenditure. Distinguish--ing the case of Messrs Kirloskar Ltd. v.
Commissioner of Income-tax ((1968) 57 I T R 23 (Mys.)), it held that the knowhow did not become the property of the assessee even at the end of the period of agreement.
19. By our judgment in Shriram Refrigeration Industries Ltd. v. Commis--sioner of Income-tax, Delhi-I ((1981) 127 ; T R 746 : (1980) T L R NO C 165 (Delhi)) applying the principles enunciated in Ciba by the Supreme Court, we have held that the collaboration agreement with Meeting house providing for technical knowhow did not amount to a permanent parting of the technical knowledge in favour of Shrirams. We have taken a similar view in Triveni Engineering Works Ltd. v. Commissioner of income-tax New Delhi (1982 T L R 1777), Income-tax Reference Nos. 106 and 107 of 1974 disposed of on 5th April, 1982. We, therefore, do not propose to deal with the case-law in any detail.
20. What has to be seen in each case is the substance of the matter and not the words used, the surrounding circumstances and the nature of the expenditure. What is it that the assessee leas acquired? An exclusive licence for a limned period or an advantage of enduring benefit? It would seem to us the former. In coming to this conclusion we have examined the totality of theterms of the agreement. These are :-
(i) The period of the agreement is limited to ten years; though it is automatically renewable thereafter it is terminable with six months notice, further, the extensions, which are to be from year to year, require prior approval of the Government of India on each occasion. Also the agreement can be terminated even before the expiry of the ten years period in certain eventualities (Art. 10);
(ii) Though there is an exclusive right to manufacture in India and the specified countries and also an exclusive licence to use and sell the valves so manufactured in the specified countries, the payment of royalty of one per cent is linked with the "not selling value". A detailed statement has to be furnished every three months and the amounts paid every sixty days to B. L. W. The royalty is a recurring payment based OD the sales of the assessee
(iii) Though the assessee can sell the valves manufactured here outside the specified territories and pay the royalty as above-mentioned, it has to obtainB. L. W.'s written consent ;
(iv) Even the valves manufactured by B. L. W. In Germany can be sold by the assessee in the specified countries but here too royalty will have to be paid. The payment of royalty would, therefore, appear to be a recurring and current expenditure connected with the sales of the valves ;
(v) In case of default, under Art. 10, the agreement can be terminated after the requisite notice. If the agreement is terminated due to Khanna's fault, prematurely, he will have to pay the royalty only if B. L. W. Permits Khanna to use the B. L. W. Trade name for the duration of the agreement. After the expiration of the agreement, Khanna-can use the trade name only for the purpose of executing orders against quotations submitted before termination. Of course, royalty has to be paid.
Otherwise on termination Khanna retains only a non-exclusive right of manufacture without further payment
(vi) A restriction is placed on Khanna or his assignee, the assessee, peertaining to confidentiality ; he is not permitted to communicate or disclose any information to any third party without B. L. W.'s written consent ;
(vii) A right has been given to Khanna to assign the agreement to the assessee. This has been provided for in the agreement. Nothing further is mentioned therein with regard to further assignment ;
(viii) Though the latest and other methods of information available with B. L. W. Are to be disclosed during the currency of the agreement to the assesses, he is debarred from disclosing them to any third party.
(ix) The object of obtaining the technical knowhow was clearly for running the business ;
(x) Though there is no provision in the agreement for return of the documents which form part of the knowhow including the drawings, production schedules, calculation schemes etc., this is not pertinent as in the present state of fast technological developments these become obsolescent and mere scraps of paper unless updated; and.
(xi) This updating or providing of information would naturally stop at the end of the period of the agreement.
21. It would, therefore, appear to us that what the assessee has obtained is a licence to manufacture valves, a right to sell the same and assistance in carrying this out. The recurring payment of royalty is for the use of the know--how/assistance and not for its acquisition.
22. The payment of royalty is a recurring charge on the "not selling value and zoo advantage of enduring benefit has been obtained. The restric--petition pertaining to confidentiality of information would further indicate that no secret process or technical knowhow has been sold to Khanna/assesses and there was no permanent parting of technical knowhow.
23. It is true that in the present case, B. L. W. Bad to place the patent applications at the assessee's disposal on termination of the agreement so that the assessee can file them. This would give the impression that the assesses bad a protected patent right. In any case, this right, if at all, only accrues to the assesses at the time of termination. Further, as earlier noticed, a lump sum payment of D. M. 30,000 had been made to provide for the capital element of the agreement. In the present case, it would appear to us that the payment of royalty, despite its nomenclature, has a direct nexus with the carrying on or conduct of the business of the assessee; and commercial considered, it must be treated as an integral part of the profit-making process, the purpose of payment of royalty, being based upon the production and sale e of the valves manufactured by the assesses.
Therefore, we are in agreement with the view of the Tribunal that the expenditure must be treated a revenue.
24. Learned counsel for the assessee had alternatively urged that as technical knowhow is an intangible asset it cannot be transferred and, therefore, the assesses cannot be held to have acquired an advantage of an enduring nature. In support of his proposition he relied on Commissioner of Income tax v. Tata Engineering and Locomotive Co. (P) Ltd ((1980) 123 I T R 538 (Bom.)) and Praga Tools Ltd. v. Commissioner of Income-tax. Hyderabad ((1980) 123 I T R 773 : 1980 T L R 528 (Andh. Pra.)).
25. This is an interesting issue but in the view we have taken above, we need not express arty opinion on this aspect of the matter.
26. For the reasons outlined above, we answer the question in the affirmative and in favour of the assesses. As the assesses has succeeded, it will be entitled to costs; Counsel's fee Rs. 350 (one set).
M.Z.M.