1. Ms. LEILA Sue, J.-These six income-tax references 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 at 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 I. T. Act, 1961 (to be referred to in short as "the Act"), its 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 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 p[ace of 1965-66 and 1966-67. The question posed for the year 1972-73 is substantially the same, though slightly differently worded and is set out "Whether, on the facts and in the circumstances of the case, the Tri--bunal was right in law in holding that royalty amounting to Rs. 39,666 paid by the assessee to the foreign collaborators for the assessm ent year 1972-73 was of revenue nature ?"
3. The assessee, Messrs Shama Engine Valves Ltd., is engaged in the manufacture of valves. A company known as B. K. Khanna & Co. Pvt. Ltd. (in short "Khanna") entered into an agreement dated 25th October, 1961, with a foreign company, Bayerisches Leichtmetal Work Kom.
4. Manditgesellschaft of Munchen (to be referred to as "BLW") to manufac--ture valves in India, BLW was already engaged in the design, manufacture and sale of valves in Germany and export thereof. Article I 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 by six months" registered notice from year to year.
5. Article 2 is set out "Licence BLW hereby grants to Khanna the following rights and agrees to furnish Khanna with 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 use and sell the values 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), Khanna is authorised to sell valves produced under this licence only with BLW's prior written permission.
(d) BLW grants to Khanna an exclusive right to sell in the territories mentioned under (a) and (b), the valves BLW manufactured in Germany.
6. This exclusive selling right for Khanna will be stated by BLW in a separate agreement, which shall be part of this principal agree--ment."
7. Under article 3, BLW was to communicate to Khanna the complete information required to produce the valves. It was required to render assis--tance including all knowledge to produce valves economically and efficiently and strictly in accordance with any particular customer's requirements. BLW was also to provide, whenever required, the jigs, tools and gauges and other information to manufacture the valves. It was also to furnish all information including production data, designs, drawing working drawings, production schedules, control schedules and calculation schemes, etc. In addition, BLW had to design a complete layout plan of the valve factory and provide the detailed machinery specifications and instruction for its erection in the bulldog as also the installation of electrical and other amenities. The complete list of staff and labour required was also to be worked out by BLW. It was to train the specialists sent to it by Khanna at its factory in Germany.
8. Khanna was given permission to use "BLW" trade name and sign as BLW's licence. BLW ;and undertook to disclose to Khanna the latest methods and information within its knowledge regarding manufacture of valves. i.e., a supply of complete technical knowhow. However, Khanna was to the best of its 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 BLW's prior written consent".
9. Under Art. 6 (b) Khanna was also to pay to PL W a Royalty on 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 BLW every three months and payment was to be made within sixty days of the end end of the same periods without any deduction. It is the nature of these royalty payments that is the point at issue.
10. Article 7, which deals with patents, provides for the situation at the end of the agreement. It says "After conclusion of this agreement BLW shall place at Khanna's disposal BLW's patent applications, so that Khanna can then file the applications in Indian, under BLW's name, and at Khanna's expense."
11. Article 10 dealing with termination is set out in extenso "Termination If either party shall
(o) 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 tire party serving the notice to terminate this agreement unless such default is made good or remedied ; or
(b) becomes insolvent or goes into liquidation or receivership or be admitted to the benefits of any procedure for the settlement of debts or declared bankrupt ; or
(c) he dissolved ; or
(d) if Khanna has Dot begun to establish the factory as contemplated era this agreement within three years after BLW has placed at Khanna's disposal all plans, etc., as covered by the agreement, then this agreement 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 then when notice of the same is given.
12. On the expiration or termination of this agreement for any cause what--soever, 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 Article 6(b) of this agreement, for the duration of this agreement, if BLW is prepared to grant Khanna the use of BLW's trade name for the duration of such payments.
13. Khanna shall, however, have the right under such circumstances to use the trade name event 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.
14. Further, under Article 14, Khanna has "the rights to assign all its rights and duties under this agreement to the Shama Engine Valves Ltd., anew company, which will undertake the manufacture and sale of valves in the territories stipulated in this agreement. BLW agrees to this assignment already at the time of contract of agreement."
15. The amounts paid for the various assessments years, the corresponding previous years ending on 30September, are as follows Rs.
16. 1965-6624,7471968-6925,621 1966-6739,0681969-7028,922 1967-6830,9451972-7339,666 The I. T. O. Found that the facts did not justify the applicability of the ratio of the decision of Ciba's case and held that the expen--diture incurred was as 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 present case the assessee acquired an exclusive right to manufacture and to all existing skills future improvements. The stipulation with regard to automatic renewal of the agreement after ten years and right of the assessee to continue manufacture without payment on the termination of the agreement, for any reason, weighed with the I. T. O. He said "The assessee gets all the knowledge to that date. His loss is only the inability to use BLW name. The payment said to be trade by way of royalty is of a capital nature. The payment of royalty is, there-- fore, being disallowed."
17. The A.A.C. Alarmed the order of the I.T.O.
18. On further appeal to the Income-tax Appellate Tribunal, the assessee's appeal was allowed. The Tribunal held that it bad to look not only to the agreement but at the surrounding circumstances to ascertain to real nature of the payment from a commercial point of view. It found a striking simi--th larity in the clauses of the present case to that of the Ciba case and the case decided by the Calcutta High Court in C. I. T. v. Hindustan General Electrical Corporation Ltd. ((1971) 81 I T R 243).
19. The Tribunal was of the opinion that in the present case as in the Ciba case, there was no payment for parting with technical knowhow permanently in favour of the assessee. It further observed that the "object of payment of royalty was for the purpose of getting benefit 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 party with--out the consent of BLW. The payments for a limited period, i.e., the period of the agreement, the only difference being that in the CIL case the tenure was for five years whereas in the present case 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 BLW for the manufacture of valves. No secret process was sold and as such the payment could not be treated as relating to capital expenditure.
20. Distinguishing the case of Mysore Kirloskar Ltd. v. C. I. T. ((1968) 67 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 the agreement.
21. By our judgment in Shriram Refrigeration Industries Ltd. v. C. I. T. ((1981) 127 I T R 745), applying the principles enunciated in Ciba, by the Supreme Court, we have held that the collaboration agreement with Westinghouse providing for techni--cal knowhow did not amount to a permanent parting of the technical knowledge in favour of Shriram. We have taken a similar view in Triveri Engineering Works Ltd. v. C. I. T. ((1982) 136I T R 340 (Delhi)). We, therefore, do propose to deal with the case law in any detail.
22. 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 has acquired ? An exclusive licence for limited period or an advantage of enduring benefit ? It would seem to us the former. In Coming to the conclusion we have examined the totality of the terms 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 the prior approval of the Government of India on each occasion. Also the agreement can be terminated even before the expiry of the ten-year period in certain eventualities (Article 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 BLW. The royalty is a recurring payment based on the sales to 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 obtain BLW's written consent
(iv) even the valves manufactured by BLW 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, it will have to pay the royalty only if BLW permits Khanna to use the BLW trade name for the dura--petition of the agreement. After the expiration of the agreement, Khanna can use the trade name only if the purpose of executing orders against quotations submitted before the termination. Of course, royalty has to be paid.
23. Otherwise on termination Khanna retains only a non-exclusive right of manufacture without further payment ;
(vi) a restriction is placed on Khanna or its assignee, the assessee, pertaining to confidentiality; it is not permitted to communicate or disclose any information to any third party without BLW'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 BLW are to be disclosed during the currency of the agreement to the assessee, it 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 a return of the documents which form party 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 obsolete 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.
24. 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.
25. The payment of royalty is a recurring charge on the "not selling value" and no advantage of ensuring benefit has been obtained. The restriction pertaining to confidentiality of information would further indi--cate that no secret process or technical knowhow has been sold to Khanna (assessee) and there was no permanent parting of technical know--how.
26. It is true that the present case, BLW bad to place the patent applica--tions at the assessee's disposal on termination of the agreement so that the assessee can file them. This would give the impression that the assessee had a protected patent right in any case, this right, if at all, only accrues to the assessee at the time of termination. Further, earlier noticed, a lump sum payment of DM 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 commer--cially 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 of the valves manufactured by the assessee. Therefore, we are in agreement with the view of the Tribunal that the expenditure must be treated as revenue.
27. Learned counsel for the assessee had alternatively urged that as technical knowhow is an intangible asset it cannot be transferred and, therefore, the assessee cannot be held to have acquired an advantage of an enduring nature, In support of his proposition he relied on. C. I. T. v.
28. Tata Engineering 8: Locomotive Co. P. Ltd. ((1980) 123I T R 538 (Bom.)) and Praga Tools Ltd. v. C. I. T.
29. ((1980) 123 I T R 773 (A P)).
30. This is an interesting issue but in the view we have taken above, we need not express any opinion on this aspect of the matter.
31. For the reasons outlined above, we answer the question in the affirma--tive and in favour of the assessee. As the assessee has succeeded, it will be entitled to costs. Counsel's fee Rs. 350 (one set).