Annual fee paid to foreign company under collaboration agreement is revenue expenditure if it is related to the carrying on or conduct of the day to day business of the assessee-company and does not result in the acquisition of an asset or a right of a permanent character.

Headnote:
INCOME TAX - Annual fee paid to foreign company under collaboration agreement - Whether revenue expenditure or capital expenditure - Held, revenue expenditure.
Fact of the Case:

The assessee, a private limited company, entered into a collaboration agreement with a foreign company for the manufacture and sale of card clothing and accessories. The agreement provided for the payment of an annual fee to the foreign company for the services rendered and the license granted. The ITO disallowed the deduction claimed by the assessee on the ground that it was capital expenditure. The AAC and the Tribunal held that the payment was revenue expenditure and allowed the deduction.
Finding of the Court:

The court held that the annual fee paid to the foreign company was revenue expenditure and not capital expenditure. The court observed that the services rendered by the foreign company were related to the carrying on or conduct of the day to day business of the assessee-company and did not result in the acquisition of an asset or a right of a permanent character.
Issues: Whether the annual fee paid to the foreign company under the collaboration agreement was revenue expenditure or capital expenditure.
Ratio Decidendi: The court held that the annual fee paid to the foreign company was revenue expenditure and not capital expenditure. The court observed that the services rendered by the foreign company were related to the carrying on or conduct of the day to day business of the assessee-company and did not result in the acquisition of an asset or a right of a permanent character.
Final Decision: The reference was answered in the affirmative and against the Revenue. The assessee was entitled to the costs of the reference.

Judgment :-

VENUGOPAL J.

This is a reference at the instance of the Revenue referring the following question of law :

"Whether, on the facts and in the circumstances of the case, it has been rightly held that payment of annual fee under 9 of the collaboration agreement was in the nature of revenue expenditure and should therefore, be allowed under section 37 of the Income-tax Act, 1961 ?" *

The assessee is a private limited company carrying on business in the manufacture and sale of card clothing. The company was incorporated in 1961. It entered into a collaboration agreement with Graf Sales Limited of Switzerland (hereinafter to be referred to as the "foreign company") on February 23, 1961. Clauses 3 and 9 of the collaboration agreement provide :

"3. For the consideration mentioned in clause 9 hereof, Graf shal grant to Lakshmi the sole exclusive non-transferable right to manufacture and sell in the Republic of India, the Portugueses possession in India, the Kingdom of Nepal and neighboring countries of India expect Europe, card clothing and accessories as specified in para. (2) on the basis of Graf's designs and manufacturing methods patented or unpatented.

9. During a period of ten years from the conclusion of this agreement, Graf will forward from time to time to Lakshmi any new data, specifications, processes, revised and additional manufacturing methods, drawings and improvements on their current designs of card clothing and accessories, thus enabling Lakshmi to follow without delay the latest technical developments of the Graf card and clothing and accessories. For these services as also for the licenses granted under clause 3, Lakshmi shall pay to Graf in Switzerland, free of any deduction of any kind whatsoever (including taxes, if any) an annual fee of Swiss Francs 6, 000 (six thousand) on or before the last day of July of each English calendar year for a period of ten years, the first payment to be made on July 1, 1961. Lakshmi shall, without any payments, place at the disposal of Graf all information relating to their experiences and own inventions and developments, if any, and obtain Graf's prior approval before adopting them. Constructional alterations should, however, not be introduced by Lakshmi before consulting Graf." *

For the licence granted under clause 3 and for the services rendered in pursuance of clause 9, the assessee has to pay to the foreign company an annual fee of 6, 000 francs for a period of 10 years, the first payment commencing from July 1, 1961. The ITO came to the conclusion that it is in the nature of capital expenditure and disallowed the deduction claimed.On appeal, the AAC held that the consideration for the services in the shape of technical advice and for the grant of license to exploit the foreign company's patents in India is partly for services and partly in the nature of royalty and it is, therefore, on revenue account and qualified for deduction. On further appeal, the Tribunal, after analysing clauses 3 and 9 and also looking into the correspondence, came to the conclusion that the payment to the foreign company for sending periodical instruction on various points regarding raw materials, designs, drawings, etc., is only in the nature of royalty and the instructions given by the foreign company from time to time is to help the assessee in the normal running of its manufacturing business and the amount paid to the foreign company is only a revenue expenditure and should be allowed as a deduction under s. 37(1). At the instance of the Revenue, the question set out supra has been referred for being answered by this court.

The learned counsel for the Revenue relying on the three decisions in Fenner Woodroffe and Co. Ltd. v. CIT Addl. CIT v. southern Structural Limited and Jonas Woodhead & Sons (India) Ltd. v. CIT, contended that the assessee, with the technical know-how supplied by the foreign company under the collaboration agreement, has set up a plant to manufacture cotton card clothin

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