DCIT, NEW DELHI vs. M/S. BAXTER INDIA (P) LTD., HARYANA

Aggrieved, the Department has now approached the Tribunal and has raised the following grounds of appeal:

Grounds of appeal (ITA No. 5323/D/2012):

2. The ld. CIT(A) has erred on facts and in law and on the facts in ignoring that payment of royalty was made for procuring and usage of trade mark in technical know-how which is clearly unambiguously an expenditure which is capital in nature. 3. The appellant craves leave for reserving the right to amend, modify, alter, add or forego any grounds of appeal at any time before or during the hearing of this appeal.

Grounds of appeal (ITA No. 2798/D/2012):

1. The ld. CIT (A) has erred on facts and in law in deleting addition of Rs. 2,42,09,240/- on account of Royalty.

2. The ld. CIT (A) has erred on facts and in law in deleting the addition of Rs. 18,423/- on account of extra depreciation claimed on UPS. 3. The ld. CIT (A) has erred on facts and in law in deleting the addition of Rs. 34,17,901/- on account of interest income. 4. The appellant craves leave for reserving the right to amend, modify, , 2798 & 5323/D/12 And CO No. 399/D/2010 Page 4 of 24 Baxter India (P) Ltd.

alter, add or forego any grounds of appeal at any time before or during the hearing of this appeal. Grounds of appeal (ITA No. 4785/D/2010):

1. The ld. CIT(A) has erred on facts and in law in deleting addition of Rs. 1,33,83,745/- made on account of disallowance of royalty payment ignoring that payment of royalty was made for procuring and usage of ‘trade mark’ and ‘technical know-how’, which is clearly unambiguously an expenditure capital in nature. Further, it is a case, where it can be easily construed that he assessee company owned the ‘trade mark’ and ‘technical know-how’ “partly” along with its parent company for its operation for the period of ten years.

2. The appellant craves leave for reserving the right to amend, modify, alter, add or forego any grounds of appeal at any time before or during the hearing of this appeal.

Grounds of CO No. 399/D/2010:

1. The ld. CIT(A) has erred on facts and in law in deleting addition of Rs. 1,33,83,745/- made on account of disallowance of royalty payment ignoring that payment of royalty was made for procuring and usage of ‘trade mark’ and ‘technical know-how’, which is clearly unambiguously an expenditure capital in nature. Further, it is a case, where it can be easily construed that he assessee company owned the ‘trade mark’ and ‘technical know-how’ “partly” along with its parent company for its operation for the period of ten years.

“The question whether a particular payment made by an assessee under the terms of the agreement forms a part of capital expenditure or revenue expenditure will depend upon several factors, namely, whether the assessee has obtained a completely new plan with a complete new process and completely new technology for manufacture of the product or the payment is made for the technical know-how which is for the betterment of the product in question which is already being produced; whether the improvisation made is the part and parcel of the existing business or a new business is set up with the so-called technical know-how for which payments are made; whether on expiry of the period of agreement the assessee is required to give back the plans and designs which are obtained, though the assessee can manufacture the product in the factory that has been set up with the collaboration of the foreign firm; the cumulative effect on a construction of the various terms and conditions of the agreement; whether the assessee derives benefits coming to its capital for which the payment is made. The Supreme Court in the case of Alembic Chemical Works Co. Ltd. vs. CIT (1989) 177 ITR 377 has indicated that ‘in the infinite variety of situational diversities in which the concept of what is capital expenditure and what is revenue arises, it is not possible to form any general rule even in the generality of cases, sufficiently accurate and reasonably comprehensive, to draw any clear line of demarcation’. The Supreme Court further held that 2798 & 5323/D/12 And CO No. 399/D/2010 Page 6 of 24 Baxter India (P) Ltd. a particular outlay is capital or revenue. And, therefore, ‘once for all’ test as well as the test of ‘enduring benefit’ may not be conclusive. Consequently, the various items and conditions of the agreement, the advantages derived by an agreement, are all to be taken into account and then it has to be decided whether the whole or a part of the payment thus made is a capital expenditure or a revenue expenditure. The Courts have applied different expenditure starting of a new business on the basis of technical know-how received from the foreign firm, exclusive right of the company to use the patent or trademark which it receives from the foreign firm, the payments made by the company to the foreign firm, whether a definite one or dependent upon certain contingencies, right to use the technical know-how of production or the activity even after the completion of the agreement, obtaining enduring benefit for a considerable part on account of the technical information received from a foreign firm, payment whether made ‘once for all’ or in different installments co- relatable to the percentage of gross turnover of the product to ultimately find out whether the expenditure or payment thus made makes an accretion to the capital asset and after the court comes to the conclusion that it does so, then it has to be held to be a capital expenditure. No single definitive criterion by itself could be determinative and, therefore, keeping in mind the changing economic realities of business and the varieties of situational diversities the various clauses of the agreement in question are to be examined. In the case on hand, the Tribunal having considered the different clauses of the agreement and having come to the conclusion that under the agreement with the foreign firm what was set up by the assessee was a new business and the foreign firm had not only furnished information and the technical know-how but rendered valuable services in setting up for the factory itself and even after the expiry of the agreement there was no embargo on the , 2798 & 5323/D/12 And CO No. 399/D/2010 Page 7 of 24 Baxter India (P) Ltd. assessee to continue to manufacture the product in question, it was difficult to hold that the entire payment made was a revenue expenditure merely because the payment was required to be made on a certain percentage of the rates of the gross turnover of the products as royalty. In the facts and circumstances of the case, the High Court was fully justified in answering the reference in favour of the revenue and against the assessee.

(Mag.). The ld. DR also supported the assessment order on the issue of deletion of additions in respect of extra depreciation on UPS and interest income.

On the issue of Royalty, the ld. AR placed reliance on the decision in Hero Honda Motor Corp. Ltd. vs. ACIT in and also supported the impugned orders on the issue for all the three years under appeal. The ld. AR submitted that only non exclusive usage rights in the trademark and technical know-how with no right to sub-license was available to the assessee and that the ownership was never transferred to it at ITA Nos. 4785/D/2010, 2798 & 5323/D/12 And CO No. 399/D/2010 Page 8 of 24 Baxter India (P) Ltd. any stage.

S.No. A.Y. Interest during the year Interest declared in TDS claimed during the return the year 1 2006-07 2332749 0.00 0.00 2 2007-08 3417901 0.00 766977 3 2008-09 6753475 0.00 1497245 4 2009-10 3767833 16271958 853790 , 2798 & 5323/D/12 And CO No. 399/D/2010 Page 9 of 24 Baxter India (P) Ltd.

The above figure of Rs. 1,62,71,958/- includes the interest of Rs. 1,25,04,125/- pertaining to FY 2006-07, 2007-08, 2008-09. Year Amount 2006-07 23,32,749.00 2007-08 34,17,901.00 2008-09 67,53,475.00 2009-10 37,67,833.00 Total 1,62,71,958.00

of the difference of the year. This is a settled law that income is recognized in the year in which it is crystallized. As the case was decided in financial year 2008-09, the assessee declared the whole interest in the return and paid the tax fully. Contrary to the above, the AO added the amount of the interest of Rs. 3417901.00 in the year 2007-08 causing the same income being double taxed in the assessment year 2007-08 and financial year

2009-10 which is against the principal of law.

, 2798 & 5323/D/12 And CO No. 399/D/2010 Page 10 of 24 Baxter India (P) Ltd.

Clause 7 of the agreement safeguards the licensor’s right to protect the patent rights, trademark rights and software copyright rights and know-how rights. Clause 9 provides that either party can terminate either the whole or part of the agreement upon service of 30 days’ prior notice to the other party and that the initial tenure of the agreement is for ten years which is extendable for one year every year subject to the termination by notice by either of the parties. However, no where does the agreement mention that Patent/Trademark/Software copyright/know-how is being purchased by the licensee/assessee and that the assessee will have an unfettered right over the same. The ld. DR could not point out to any clause in the agreement which would suggest that there was a transfer of ownership right and that by virtue of the agreement the assessee will become the owner of such trade- mark/patent/technical know-how. It is undisputed that the royalty expenditure is a recurring expenditure in the present appeals and is payable 2798 & 5323/D/12 And CO No. 399/D/2010 Page 11 of 24 Baxter India (P) Ltd. for every year the technical know-how/patent/trade-mark continues to be used. In the case of CIT vs. Lumax Industries Ltd. – 173 Taxman 390 (Delhi), the assessee company entered into an agreement with M/s Stanley Electric Co. Ltd. (SECL) on year to year basis for acquisition of technical knowledge. The assessee claimed the said payment as revenue expenditure.

The Assessing Officer disallowed the claim holding that by virtue of the agreement, the assessee had derived an asset of enduring nature. On appeal, the CIT (A) allowed the assessee's claim holding that the expenditure incurred by the assessee was a recurring expenditure and not a capital expenditure. The Tribunal upheld the order of the CIT (A). On Revenue's appeal to the High Court, it was held as under:-

"A perusal of the Circular No.21 of 1969, dated 9-7-1969 shows that if in terms of the agreement, only a license is required 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 an enduring advantage to the Indian party. Relying upon this circular, the Commissioner (Appeals) concluded that the assessee had been paying the license fee to 'S' on a year-to- year basis for acquisition of technical knowledge, and even if the assessee acquired a set-up of an enduring nature, it would not amount to a capital expenditure but to a revenue expenditure. The Commissioner (Appeals) also noted that from the financial year 1985-86 till 1993-94, the assessee had been paying the license fee every year and for each of those years it had been incurring , 2798 & 5323/D/12 And CO No. 399/D/2010 Page 12 of 24 Baxter India (P) Ltd. expenses claimed as revenue expenditure and that was being allowed by the Assessing Officer. Therefore, there was no reason as to why after a gap of almost 10 years, the Assessing Officer should suddenly change his mind and decide to treat the expenditure incurred by the assessee as a capital expenditure. The Tribunal added that even if the assessee had obtained a long term advantage of an enduring advantage, that, by itself, would not covert any expenditure incurred by it into a capital expenditure. In the instant case, the facts had been fully considered and a concurrent opinion had been expressed, both by the Commissioner (Appeals) as well as by the Tribunal that the expenditure was of a revenue nature and not of a capital nature. There was no reason to differ with the opinion on the facts of the instant case and it was quite dear that the ratio of the decisions of the Supreme Court in Jonas Woodhead & Sons ((India) Ltd. v. OT [1997] 224 ITS 342/91 Taxman 1 and in Empire Jute Co.Ltd. v. CIT [1980] 124 iTR 1/3 Taxman 69 was fully applicable to the facts of the instant case and both the authorities were right in concluding that the payment made by the assessee towards licence fee to S' was a revenue expenditure. "

[2008] 171 Taxman 81 (Delhi), the facts of the case were that the assessee company had entered into a technical collaboration agreement with a Japanese company, 'R' for the manufacture of piston rings. The said agreement mentioned that the technical know-how would be sold by 'R' to the assessee for a fixed amount and the payments would be made on the fulfillment of certain conditions. The agreement enabled the , 2798 & 5323/D/12 And CO No. 399/D/2010 Page 13 of 24 Baxter India (P) Ltd. t assessee to sub-license the technical knowhow to another Indian party subject to the prior written permission of 'R'. The validity of the agreement was for a period of five years, but it could be terminated before the expiry of that period in the event of any default by any of the parties. The agreement laid down that the right of the assessee to market any of the products manufactured under the agreement would cease upon its expiry or termination. Pursuant to the said agreement, the assessee paid certain amount to 'R' and claimed same as revenue expenditure. The lower authorities, relying on the word 'sold’ in the agreement, held that it was a case of sale of technical know-how by 'R1 to the assessee and, therefore, payment in question could not be treated as revenue expenditure. However, the Tribunal held that there was no sale of technical knowhow by 'R’ to the assessee and, therefore, the payment was revenue expenditure. It was held as under:-

"There was, in fact, no absolute transfer of any right in the documentation given by ‘R’ to the assessee. The assessee was entitled to use the technical know-how for a period of five years or for a lesser period, in case the agreement was terminated before that. The assessee did not have a free hand to sub-license the technical know-how and that was possible only with the prior written permission from ‘R’. For all other matters, the assessee was liable to treat as confidential all inventions, drawings, documents, specifications, etc., furnished by ‘R’ to it.

, 2798 & 5323/D/12 And CO No. 399/D/2010 Page 14 of 24 Baxter India (P) Ltd.

Even though the assessee was entitled to use the name of ‘R’ in the marketing of its products, yet that right would cease upon the expiry or termination of the agreement. The agreement was valid only for a period of five years, but could be terminated earlier. There was no magic in the word 'sold' used in clause 5.0 of the agreement because on a reading of the agreement as a whole, it appeared that what was transferred to the assessee was only a right to use the technical know-how of ‘R’ and there was no sale of the technical know- how which the assessee could exploit. The assessee's rights were hedged in with all sorts of conditions, clearly making it a case of right to use the technology and not sale of the technical know- how. Therefore, the Tribunal was justified in holding that there was no sale of technical know-how by ‘R’ to the assessee and, hence, the payment made by the assessee to ‘R‘was a revenue expenditure."

109 (Delhi), the facts were that the assessee had entered into two agreements with a Korean company under which the assessee was to pay a lump sum amount for transfer of technical know-how and running royalty at a specified rate per "piece of production" of different products.

The assessee showed the lump sum payment against transfer of technical know-how provided by the Korean company as capital expenditure and claimed that the royalty was business expenditure. The Assessing , 2798 & 5323/D/12 And CO No. 399/D/2010 Page 15 of 24 Baxter India (P) Ltd.

Officer treated the royalty as capital expenditure. The order of the Assessing Officer was reversed by the Commissioner (Appeals) and this was affirmed by the Appellate Tribunal. On appeal, it was held as under:-

"That the finding of the Commissioner (Appeals) that the payment of royalty was purely a revenue expenditure, which was annual expenditure depending upon the quantum of production in the relevant year was a finding of fact rightly arrived at."

discussed the earlier decision of Hon’ble Jurisdictional High Court in the case of CIT Vs. J.K.Synthetics Limited - [2009] 309 ITR 371 (Delhi) wherein their Lordships have enumerated certain principles for determining whether the payment of royalty is a capital expenditure or revenue expenditure. The same is discussed at pages 111 & 112 of 319

ITR and is being reproduced herein below for ready reference:-

"(v) expenditure incurred for grant of licence which accords 'access' to technical knowledge, as against, 'absolute' transfer of technical knowledge and information would ordinarily be treated as revenue expenditure. In order to sift, in a manner of speaking, the grain from the chaff, one would have to closely look at the attendant circumstances, such as : the tenure of the licence, (a) the right, if any, in the licensee to create further rights in favour of (b) Tribunal third parties, 2798 & 5323/D/12 And CO No. 399/D/2010 Page 16 of 24 Baxter India (P) Ltd. the prohibition, if any, in parting with a confidential information received (c) under the licence to third parties without the consent of the licensor, whether the licence transfers the 'fruits of research' of the licensor, 'once for (d) all', whether on expiry of the licence the licensee is required to return back the (e) plans and designs obtained under the licence to the licensor even though the Hence may continue to manufacture the product, in respect of which 'access' to knowledge was obtained during the subsistence of the licence. whether any secret or process of manufacture was sold by the licensor to (f) the licensee. Expenditure on obtaining access to such secret process would ordinarily be construed as capital in nature;” In the present case, on facts, it was, inter alia, found as follows: "(a) in that case the grant of technical aid was for setting up of the factory combined with the right to sell products while in our case our company is already producing exhaust systems and the technology agreement was not for setting up of the factory. in the cited case the foreign company who gave the technology agreed not (b) to manufacture similar products in India while there is no such regulation in our agreement. (c) in the cited case the technical knowledge obtained was held to give an advantage of enduring nature to the assessee-company and as it had the right to continue to manufacture the product even after termination of the agreement. While in our case the design patent applies to the foreign company and we are only licensed to produce the goods for Hyundai Car and we cannot continue to produce the goods if the agreement is terminated. This itself is a major difference between the case cited by your honour and the facts of our case." On the facts and after applying the aforesaid principle, it becomes crystal dear that the expenditure is of revenue nature."

"Held, allowing the appeal, that under the agreement, payments were to be made by the assessee in two parts: a lump sum fee for transfer of technology (which the assessee had admitted as being of capital nature) and royalty payment in consideration of providing technology services. The payment of royalty depended on the quantum of domestic as well as export sales which would decrease or increase every year depending upon the decrease or of increase in the sales. This payment was not because transfer" of technology, but for providing "technical services", in such circumstance, the payment of royalty, which was a continuous process, should have been treated as revenue expenditure.”

A manufacture the shock absorbers but not for acquiring technology itself and, therefore, they could not be held to capital expenditure. On appeal, their Lordships of Jurisdictional High Court held as under:-

Held, dismissing the appeals, that the know-how was granted by the foreign company solely for the purpose of manufacture, assembly and sale of products during the term of the contract and the license was to pay royalty to the licensor. The drawings and designs which were supplied by the licensor only enabled the assessee to manufacture the shock absorbers. The assessee was required to change the design of such shock absorbers from time to time for which new drawings and designs were required. For this purpose, the training of the personnel of the assessee was imperative. Under the agreement, the know-how acquired related to the process of manufacturing and for a technical and the documents, designs and specifications which had been supplied by the licensor were only for facilitating this purpose of manufacturing. This was basically in the realm of technical support.

“6.1 The issue involved and the submissions made by the appellant have been considered. Facts emerging from the assessment order and the submissions made by the appellant are that there was a dispute between the appellant and Wockhardt Lifesciences Ltd (WLS) on account of non fulfillment of certain conditions by the Wockhardt Lifesciences Ltd. specified in the BTA. The dispute was referred for arbitration. Pending decision of the arbitrator the appellant placed a deposit in Fifth Escrow Account of Rs.82,92,600/-with the Citi bank; Escrow agent. The arbitrator gave its award in the FY 2008-09 relevant to AY 2009- 10. The appellant got the amount deposited in the Escrow a/c alongwith interest of Rs. 1,62,71,958/-. The appellant declared this interest amount in the ITR for the AY 2009-10 and claimed TDS of Rs.8,58,53,790/-. The AO has however, treated the interest accrued in the AY 2007-08 at Rs.34,17,901/- as income not declared by the appellant inspite of the fact that it had claimed credit for TDS on the same in the AY 07-08. As per practice with the bank interest on FDR/Escrow Account is credited on accrual basis. The bank kept on giving credits for the interest accrued to the appellant and TDS was also deducted as and when the interest, amount was credited in the appellant's a/c The appellant however, did not have any legal right to withdraw the amount of deposit and neither of the accrued interest from the Escrow Account because the matter was pending before the arbitrator. The legal right of the appellant arose only when the arbitrator gave its award in the previous year relevant to AY 2009-10 in favour of the appellant. The appellant has declared interest of Rs.1,62,71,958/- in its return of income for AY 2009- 10 cause the interest income has accrued to it during the AY 2009-10. The breakup of the interest pertaining to the AY 2006- 07, 2007-08, 2008-09 & 2009-10 credited by the bank in its 2798 & 5323/D/12 And CO No. 399/D/2010 Page 22 of 24 Baxter India (P) Ltd. account has been given by the appellant as noted above. Since the appellant did not have any right to claim the interest, it did not have any income accrued to it on account of interest in the Asst. Years preceding 2009-10. However, since the TDS was deducted on the interest credited by the bank, the appellant has taken credit on the same in the ITRs for the earlier Asst. Years. Since the appellant has declared the interest accrued for the entire period at Rs.1,62,71,958/- in the AY 2009-10 when it got the right to interest income ,the action of the AO in assessing the interest credited by the bank at Rs. 34,17,901/- in the AY 2007-08 is not in order. Had the appellant not claimed TDS deducted by the bank in the respective assessment years, the TDS would have been lost. As per the appellant-for the Assessment Year 2008-09 the AO has not made any addition on this account. Therefore the addition made by the AO is deleted and the ground of appeal is allowed.”

Accordingly, is also dismissed.