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Income Tax Appellate Tribunal, DELHI BENCHES : I-1 : NEW DELHI
Before: SHRI R.S. SYAL & SHRI SUDHANSHU SRIVASTAVA
ORDER
PER R.S. SYAL, AM:
This appeal by the assessee emanates from the final assessment order passed by the Assessing Officer (AO) u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called ‘the Act’) on 24.10.2011 in relation to the assessment year 2007-08.
Ground nos. 1 to 6 were withdrawn by the ld. AR because of the settlement of dispute under Mutual Agreement Procedure (MAP) proceedings. These grounds, therefore, stand dismissed as withdrawn.
The only effective ground is against the confirmation of disallowance of Rs.2,94,77,926/- on account of payment for technical know-how and trademark/logo.
Succinctly, the facts of the case are that the assessee, an Indian company, is a part of GKN Group. It is engaged in the business of manufacture and sale of Constant Velocity Joints (CVJ). The assessee entered into an agreement with GKN Automotive GmbH, a German group company for use of know-how to manufacture the CVJ in its plant. The assessee also entered into an agreement with its another Associated enterprise, namely GKN Holdings plc., UK, for use of trademarks in respect of the products manufactured. The assessee paid a total sum of Rs.2,94,77,926/- to these two companies towards know-how fees and trademark/brand royalty. The AO perused the technical collaboration agreement dated 11.1.2003 entered into between the assessee and GKN Automotive, Germany, which was amended from time to time. He observed that the assessee, under these agreements, received technical know-how and technical assistance in relation to design, manufacture and sale of CVJ. On being called upon to explain as to why such payment be not treated as a capital expenditure, as against the revenue claimed by the assessee, it was submitted that the expenditure did not result into an enduring benefit and fell in the revenue field. The assessee relied on certain decisions to fortify its view.
After taking into consideration certain decisions, the AO came to hold that total amount of Rs.2.94 crore paid by the assessee to both its AEs was a capital expenditure. He, therefore, proposed the disallowance of Rs.2.94 crore in the draft order. The assessee remained successful before the Dispute Resolution Panel (DRP) which observed that this issue has been in dispute between the assessee and the Revenue for the immediately two preceding assessment years and, still, there was no finality. The AO made the addition in the impugned order. The assessee is aggrieved against this addition.
We have heard the rival submissions and perused the relevant material on record. It is noticed that the AO as well as the DRP have proceeded by treating total payment of Rs.2.94 crore as royalty without making a distinction between the payment made for know-how and for trademarks/logo. Out of total payment of Rs.2.94 crore, the assessee paid Rs.71 lac as technical know-how fees to GKN Automotive GmbH, Germany and the remaining amount of Rs.2.23 crore to GKN Holdings, UK for use of brand name. Since there is a distinction between the nature of these two payments and different consequences can follow as regards their treatment for tax purpose, we proceed to discuss them separately.
Firstly, we are taking up the payment of Rs.71 lac made by the assessee to GKN Automotive GmbH, Germany, towards technical know-how. The assessee entered into an agreement with GKN Automotive GmbH, Germany, on 11.1.2003, a copy of which is available on pages C-1 onwards of the paper book. This Agreement provides that GKN Automotive GmbH, Germany, is a Licensor which is engaged in the manufacture of CVJ in automotive drive shafts and is in a position to provide know-how in respect of the design, manufacture and sale of such CVJ. The assessee-Licensee is engaged in manufacture and sale of certain types of CVJ by using technical know-how received under an earlier Agreement dated 30th June, 1987, which was subsequently amended from time to time. Clause 3 of the Agreement dated 11th January, 2003 provides that the licensor grants to licensee:
“3.1.1. the exclusive right (subject to Sub-clause 3.2) to use the Know-How to manufacture the Joints in the Licensee’s Plants from components (other than the bought out components listed in Schedule 2) manufactured by Licensee or purchased by Licensee from Licensor or from a source approved by Licensor; 3.1.2 The non-exclusive right to sell the Joints in the Territory; 3.1.3 The non-exclusive right to export the Joints to all countries except (otherwise than t\with the consent of Licensor) where the Licensor or any Company in the GKN Group manufactures or has existing licensing arrangements for Joints, namely:- ………”
The term ‘Know-How’ has been defined in this Agreement to mean: 5
“1. The information and skills available to the Licensor at the Signature date all as defined in Clause 4 hereof concerning the manufacture of Joint components and the assembly of Joints (but excluding any information on forging, forming or extrusion used in the manufacture of components for Joints); and 2. any further information passed from Licensor to Licensee during the term of this Agreement.”
A perusal of the above clauses of the Agreement reveals that the assessee was given an exclusive right `to use’ the know-how to manufacture the joints in its plants and non-exclusive right to sell the products in the defined territory. What follows from this clause is that the assessee was granted a simple user of the know-how during the currency of the Agreement which, as per clause 2.3, is ten years from the Effective date or seven years from the date of commencement of the commercial production. Clause 3.3 of the Agreement provides as under:-
“Licensee acknowledges that Licensor is the owner of the Copyright and all other proprietary rights in Know-How supplied by Licensor to Licensee hereunder.”
Through the above clause of the Agreement, the assessee admits that the Licensor is the owner of the copyright and intellectual property rights of the know-how supplied, who holds all the proprietary rights in it. Clause 7 of the Agreement has been captioned as ‘Confidentiality’ which reads as under:-
“Licensee shall keep secret and confidential and use its best endeavours to prevent disclosure of the Know-How and to limit access thereto such of its employees or such others (including permitted sub-licensees under Clause 13) as reasonably require the same for the purpose for which the Know-How is stated in Clause 3 to be supplied and without prejudice to the extent of the foregoing obligation shall in particular take all measures by contract and otherwise which a prudent, determined and reasonable owner of the rights in the Know-How acting in his own interests and desiring to protect such rights, would take to ensure that the Know-How is not disclosed by those to whom disclosure is made in accordance with the provisions of this clause.”
A perusal of this clause of the Agreement divulges that the assessee shall keep secret and confidential the know-how received from the Licensor and shall ensure that it is not disclosed to others. Clause 11 of the Agreement deals with ‘Assignment and Sub-Licence’. Clause 11.2 provides that the : “Licensee shall not be entitled to assign its rights or obligations under this Agreement without the prior consent in writing of Licensor”. Clauses 13 and 14 deal with Termination and effects of expiration/termination. Clause 14.2 of this Agreement provides that in the event of this Agreement being lawfully terminated by the Licensor, the Licensee shall cease to manufacture all the Joints and shall not use any part of the know-how and shall return to Licensor all tangible know- how material and all copies thereof. Clause 9 of the Agreement deals with ‘Consideration’ which refers to ‘lumpsum payment and royalty.’ Clause 9.1 of the Agreement deals with lumpsum payment which is 13337 Eur. within 30 days of the effective date, then equal amount within 30 days of the completion of the delivery to Licensee of the technical documentation and, again, an equal amount on commencement of commercial production or three years from the effective date, whichever is earlier. Since this Agreement was entered into on 11.1.2003, these lumpsum payments were made in earlier years. No lumpsum payment was stated to have been made by the assessee during the year, which contention has remained uncontrovered by the ld. DR. Then, there is Clause 9.2 of the Agreement which provides for payment of royalty at the rate of 3% of the selling price of all Joints sold by the Licensee. It is this 3% of the selling price which has been paid by the assessee during the year amounting to Rs.71 lac. A careful perusal of 8 the above discussed clauses of the Agreement manifests that the assessee was granted the use of know-how by GKN Automotive GmbH, Germany; the assessee admitted the Licensor as the owner of proprietary rights in the know-how; the assessee was prevented from disclosing such know-how to others; the assessee could not assign it to others; and at the termination of the Agreement, the assessee could not use the know-how provided to it. When we consider the nature of payment for use of technical know-how made during the year, which is @ 3% of the selling price for the ‘use of technical know-how’, there remains no doubt that this payment is in the nature of a revenue expenditure.
The ld. DR vehemently argued that Clause 14 of the Agreement empowers the Licensee to terminate the Agreement and, thereafter, use the know-how free of charge. It was submitted that the free user of the technical know-how meant that the payment made for use of technical know-how was a capital expenditure entitling the assessee to use such know-how in perpetuity.
This argument of the ld. DR, though appears attractive at first flush, but, loses its shine on an in-depth analysis. In order to appreciate the contention of the ld. DR in correct perspective, it would be relevant to note Clause 13 and relevant parts of Clause 14 of the Agreement, which are as under :-
“13. Termination 13.1 Each party shall have the right to terminate this Agreement, by notice in writing to operate on the date specified in the notice, if; 13.1.1 the other party fails to observe any of the terms hereof to a material and significant extent and to remedy such failure (where it is capable of being remedied) within the period specified in a notice given to it by the aggrieved party calling for remedy, being a period not less than thirty (30) days; 13.1.2 the other party is for any cause prevented from performing its duties hereunder for a total period of six (6) months in any period of twelve (12) calendar months; 13.1.3 the other party becomes insolvent, makes any arrangement or composition with its creditors, or has a receiver appointed over the whole or any part of its assets or execution or distress levied upon its assets provided that in the case of execution or distress it is such as would materially affect the ability of that party to discharge its obligations under this Agreement; 13.1.4 an order is made or a resolution is passed for winding- up or liquidation of the other party (except that where any such event is only for the purpose of amalgamation with another or reconstruction and the resultant 10 company emerging is or agrees to be bound by the terms hereof and is a company whose shares are owned by persons not in competition with the other party except to an amount not exceeding five percent, this provision shall not apply); 13.1.5 by reason of any order of a government or other authority the continued operation of this Agreement in all its provisions is prevented or delayed for an unspecified and indeterminate period. 13.2 Licensor shall have the right to terminate this Agreement by notice in writing to operate on the date specified in the notice if Licensee shall come under the direct or indirect control whether jointly or otherwise or shall enter into any partnership or joint venture with any concern or concerns interested in or connected with the manufacture, sale or supply of goods which may compete with any of the Joints manufactured, sold or supplied by Licensor or any goods in relation to which Licensor’s Know-How or other manufacturing information is or may be used. 13.3 A party having such right may terminate this Agreement by notice in writing to operate on the date specified in the notice, which date may be a date earlier than the date of the notice so as to defeat any title which a trustee in bankruptcy or a receiver or liquidator or other such person might otherwise acquire to the rights conferred hereby. 13.4 No waiver of any antecedent breach and no grant of time or indulgence shall prejudice any subsequent right to terminate this Agreement.”
“14. Effect of Expiration/Termination. 14.1 In the event that this Agreement expires by effluxion of time, or is lawfully terminated by Licensee, Licensee may continue to use the Know-How free of charge.
14.2 In the event that this Agreement is lawfully terminated by Licensor:- 14.2.1 Licensee shall cease manufacture of the Joints and shall not use any part of the Know-How and shall return to Licensor all tangible Know-How material and all copies made thereof; 14.2.2 Licensee shall have a period of nine (9) months to dispose of stocks of the Joints in hand and to fulfil orders in hand subject to payment of royalty in accordance with Sub-clause 9.2. 14.3. On termination of this Agreement whether terminated by Licensor or by Licensee or by effluxion of time:- 14.3.1 the rights of either party against the other which may have accrued up to the date of termination or expiration shall not be prejudiced by termination or expiration; 14.3.2 Licensee shall have no rights whatsoever under or in connection with this Agreement except as provided under the provisions of this Agreement.”
On going through Clause 14 of the Agreement, it becomes evident that the same can be terminated in three ways, namely, by Licensee, by Licensor and by effluxion of time. In case the Agreement is lawfully terminated by the Licensor, then, as per clause 14.2, 14.2.1 and 14.2.2, the Licensee shall cease to manufacture the Joints and shall not use any part of the Know-How and shall return to the Licensor all tangible Know-How material and all copies made thereof. In other words, the Licensee will be debarred from using the know-how after the termination of the Agreement by the Licensor. If the Agreement is terminated by effluxion of time, then clause 14.3 read with clause 14.3.1 and 14.3.2. come into play. Albeit there is some dichotomy in these clauses, but the essence is that the Licensee shall have no right whatsoever under the Agreement, except as provided under the provisions of this Agreement, which as per clause 14.3 may be to allow the continuation of use of know-how free of charge. But the fact of the matter is that by the time the termination of the agreement approaches by effluxion of time, the technology becomes obsolete and remains hardly of any significance. The third situation, which has been accentuated by the ld. DR to bring home his argument, is the termination by the Licensee. Clause 14.1 provides that the Agreement can be lawfully terminated by the Licensee in which case the Licensee may continue to use the know-how free of charge. It is this clause 14.1 of the Agreement which has been greatly emphasized by the ld. DR to bolster his argument that if the assessee-Licensee terminates the Agreement at his volition, say within a short span after signing, he may continue to use 13 the know-how free of charge for an unlimited period, which shows that the payment made by it is for acquisition of know-how and not its mere use and hence lies in the capital field. It is, no doubt, true that if the Licensee lawfully terminates the Agreement, it may continue to use the know-how free of charge, but, the important thing is that a Licensee can lawfully terminate the Agreement only in the situations as have been discussed in Clause 13 of the Agreement. When we peruse Clause 13, it emerges that the Licensee (‘each party’) shall have a right to terminate the Agreement if the Licensor (‘the other party’) fails to observe any of the terms or fails to perform its duties or becomes insolvent or goes into winding up or liquidation etc. in terms of sub-clauses 13.1.1 to 13.1.4.
Thus it is discernible that the Licensee can terminate the Agreement only when there is some default or insolvency, etc., of the Licensor and not otherwise at his own sweet will. Clause 13.1.5 provides that the assessee can terminate the Agreement if the continued operation of this Agreement is prevented by reason of any order of Government or any other authorities. Clauses 13.2 to 13.4 either deal with the right of the Licensor to terminate the Agreement or the procedural aspects of the 14 termination. Thus, it is apparent that the assessee-Licensee can terminate the Agreement, under all the sub-clauses of Clause 13.1 of the Agreement, either due to some default or incapacity of the Licensor or Government order. All these situations make it crystal clear that the Licensee cannot, at his own sweet will, terminate the Agreement and, thereafter, continue to use the know-how received from Licensor free of charge. Such a right to terminate the Agreement vests in the Licensee only if the default is committed by the Licensor. The Licensee, under no circumstance, can suo motu terminate the Agreement without any default by the Licensor and also reap the benefits of free user of technical know-how. Ergo, Clause 14.1 of the Agreement, which has been greatly harped on by the ld. DR, does not defend the case of the Revenue because the assessee cannot, at its pleasure, terminate the Agreement and use the technical know-how without any consideration.
When we consider the effect of termination of the Agreement in totality, what emerges is that the Licensee, on such termination, shall be bound to return the know-how acquired from the Licensor, which remains his exclusive property. 15
The Hon’ble jurisdictional High Court in CIT VS. Hero Honda Motors Ltd. (2015) 372 ITR 481 (Del) has held that where the ownership and the intellectual property rights in the knowhow or technical information were never transferred or became an asset of the respondent assessee; the ownership rights were protected by the licensee and the proprietorship in the intellectual property was not conveyed to the assessee but only a limited and restricted right to use on strict and stringent terms was granted, the payment was deductible. The facts of the extant case are quite close to those considered and decided by the Hon’ble High Court. All the salient features of transfer of technical know-how, as discussed above, go to show that the assessee paid 3% of selling price of the Joints sold by it for the ‘use of’ technical know-how provided by the Licensor, which is not a consideration for acquiring any know-how. It is a case of parting by the Licensor, for consideration, with the partial ownership of technical know-how, that is, for allowing only a right to use to the assessee; and not a case of parting with full ownership of technical know-how, that is, for transferring the ownership to the assessee. Hence, the amount so paid is eligible for deduction as a 16 revenue expenditure. We, therefore, overturn the assessment order on this point and allow deduction of the amount paid for the use of technical know-how.
Now, we take up payment of Rs.2.23 crore made by the assessee to GKN Holding, UK, towards royalty for trademark/ brand. The assessee entered into an agreement dated 1.12.2003 with its group company, a copy of which is available on record. Recitals of this Agreement provide that the Licensor (GKN Holding, UK) is the proprietor of the trademarks and the Licensor wishes to permit the Licensee (the assessee) to use the trademarks in respect of the products and the services. Clause 2 of the Agreement reads as under:-
“2. GRANT The Licensor grants to the Licensee, on the terms set out in this Agreement, a non-exclusive Licence:- 2.1 under the registrations; and 2.2 to use the Trade Marks in those countries in the Territory where they are not registered;” 16. It emerges from a simple reading of the above clause that GKN Holdings, UK granted a non-exclusive License to the assessee ‘to use’ the trademarks. Clause 6.1 of the Agreement provides that: “All use of any Trade Marks by the Licensee shall be for the benefit of the Licensor and the goodwill accrued to the Licensee arising from its use of the Trade Marks (but no greater or other goodwill) shall accrue to and be held in trust by the Licensee for the Licensor which goodwill the Licensee agrees to assign free of charge to the Licensor at its request at any time whether during or after the term of this Agreement.” On going through the above clause of the Agreement, it becomes crystal clear that the assessee has been allowed user of trademarks held by the Licensor, which shall remain the exclusive property of the Licensor alone. Clause 7 of the Agreement, which is relevant for our purpose, reads as under:-
“7. OWNERSHIP 7.1 The Licensor warrants that it is the proprietor of the Trade Marks and that it is not aware (but does not warrant or represent) that the use of the Trade Marks on or in relation to the provision of the Products and Services in the Territory infringes the rights of any third party. The Licensor gives no warranty as to the validity or enforceability of the Registration. 7.2 The Licensee undertakes not to do or permit to be done any act which would or might jeopardizes or invalidate any registration of the registered Trade Marks or application thereof nor to do any act which might assist or give rise to an application to remove any of the registered Trade Marks from 18 the Register or which might prejudice the right or title of the Licensor to any of the Trade Marks. 7.3 The Licensee will on request give to the Licensor or its authorized representatives any information as to its use of the Trade Marks which the Licensor may require and will (subject to the provisions of clause 8) render any assistance reasonably required by the Licensor in maintaining the Registrations and/or prosecuting any application therefor. The Licensee will not make any representation or do any act 7.4 which may be taken to indicate that it has any right, title or interest in or to the ownership or use of any of the Trade Marks except under the terms of this Agreement and acknowledge that nothing contained in this agreement shall give the Licensee any right, title, or interest in or to the Trade Marks save as granted by this Agreement.”
This Clause makes it palpable that the Licensor is the proprietor of the trademarks and the Licensee undertakes not to do anything which might jeopardize the trade mark in any manner. Clause 9 deals with the termination of the Agreement. Para 9.2 of the Agreement provides as under:-
“9.2 Upon the termination of this Agreement for whatever reason the Licensee shall cease to make any use of the Trade Marks save that if the Licensee has a stock of Products existing or in the course of manufacture or unfulfilled orders on hand at the date of termination of this Agreement, the Licensee may, but only with the Licensor’s specific permission, sell such stock on the terms hereof or such other terms as may be agreed.”
This clause provides in unambiguous terms that upon the termination of this Agreement for whatever reason, the assessee shall cease to make any use of the trade marks. Clause 4 of the Agreement is ‘Consideration clause’, which fixes the rate of royalty for use of trade mark at 0.5% of the annual sales. It is a matter of record that this Agreement dated 1.12.2003 remained in force till its succession by another Agreement dated 16.2.2008, which has been made effective from 1.1.2007. Clause 4 of the later Agreement, therefore, covers a period of three months from 1st January, 2007 to 31st March, 2007 relating to the previous year relevant to the assessment year under consideration. Under this later Agreement, the rate of royalty has been varied. Clause 4.2 of this Agreement provides that the amount of royalty for use of trademark shall be as under:-
“- where the Operating Margin for the relevant Financial Period is less than 3%, a rate of 0.5% shall be applied; - Where the Operating Margin for the relevant Financial Period is 3% or more but less than 7%, a rate of 1% shall be applied; and - Where the Operating Margin for the relevant Financial Period is 7% or more, a rate of 1.5% shall be applied.”
All other relevant clauses of the later Agreement are similar to the clauses of the earlier Agreement dated 1.12.2003, under which the assessee paid royalty for use of trademarks. When we consider all the relevant clauses of the royalty Agreement, it becomes clear that the assessee did not acquire any ownership right in trademarks by paying the consideration as set out therein. Such payment was made simply for the use of the trademarks, and that too, by means of a non-exclusive License. It has been made clear in the Agreement that the ownership in the trademarks shall remain the intellectual property of the Licensor and the assessee shall have a mere right to use them. Further, upon the termination, the Licensee shall cease to make any use of such trademarks. Thus, it is patent that the payment has been made by the assessee for ‘use of ’ trademarks and not for acquiring trademarks as an owner. It goes without saying that any payment made for a mere use of an asset falls in the realm of a revenue expenditure and cannot be treated as a capital expenditure. We, therefore, hold that payment of Rs.2.23 crore made by the assessee for use of trade mark is a revenue expenditure. 21
To sum up, total payment of Rs.2.94 crore made by the assessee for use of technical know-how and trademarks is a revenue expenditure and cannot be treated as a capital expenditure. Ex consequenti, a deduction is allowed for this sum. This ground is allowed.
In the result, the appeal is partly allowed.
The order pronounced in the open court on 30.06.2016.