By TIOL News Service

HYDERABAD, OCT 27, 2015: THE issue is - Whether sum spent on acquiring a living organism & knowhow is to be treated as capital in nature where products developed by using them are revenue-earning in nature. YES is the answer.

Facts of the case

The assessee during the course of its business in A.Y 1995-96, paid an amount of Rs.2,75,85,300/- to M/s. Zeneca Limited, U.K towards technical know-how fee and also paid an amount of Rs.47,34,306/- towards royalty and claimed the said payments as revenue expenditure. During assessment, the AO observed that the expenditure incurred by the assessee towards technical know-how fee falls within the ambit of Section 35AB and allowed 1/6th of the amount so claimed as deduction. The AO also treated 1/4th of royalty paid as capital expenditure. On appeal, the CIT(A) treated 75% of the technical know-how fees as revenue expenditure and 25% as being capital in nature, and thus allowing 75% of the fees paid towards technical know-how as deduction u/s 37. The CIT(A) also held that the disallowance of 1/4th royalty payment as capital in nature. On further appeal, the Tribunal partly allowed the appeal of assessee and dismissed the appeal of Revenue.

Having heard the parties, the High Court held that,

++ the principal question which falls for consideration as found by the Tribunal as to "whether the expenditure incurred by the assessee is to be fully allowed as a revenue expenditure or a part of it is to be capitalized as a capital expenditure". It is well recognized by various judicial pronouncements that a particular expenditure is revenue or capital in nature is a vexed question and the same would have to be determined in each case on appreciation of the facts of the particular case. The question as to whether the amount paid for acquiring Germplasm and Technical know-how needs to be determined with particular reference to the terms of the contract and agreement between the assessee and the foreign company Zeneca Limited, U.K. Though, the AO sought to invoke Section 35AB to the expenditure, the CIT(A) after analyzing the nature of transactions involved in the agreement had categorically negatived the same. It may be noted that the revenue did not question about the decision of the CIT(A), so far as Section 35AB has no application. It is noted that the Supreme Court in the cases of Alembic Chemicals Works Company vs. CIT and Jonas Woodhead and sons India, had summarized the tests by reference to various cases earlier. In the present case, there is no challenge to the findings recorded by the Tribunal by raising a question of perversity of a fact. In view of the settled principles of law, the questions raised before this court are required to be considered and answered on the facts as found and recorded by the Tribunal. On the analyses of the agreement, we find that 1) it is termed as a licensing agreement and the parties contemplated the same to be as a licensing agreement. 2) Under the agreement, the assessee (licensee) to get a right and license to use the technical information and the Licensor Germplasm to research and develop, produce and sell products within the India. 3) The assessee gets immunity from legal proceedings with respect to patent rights, if any in India. The assessee acquires documents relating to technical information and with genetic material for maize, sunflower, canola, msustard, sorghum, millet and cotton. Assessee gets the right to use, produce and sell the Germplasm in a specified products by way of sub-license to its affiliates. One significant aspect of the agreement is that the assessee is not required to return the licensee's Germplasm, except in the case of termination of the agreement, which was wrongly assumed by the Tribunal as returnable. Article 16 provides for termination of the agreement only in case of the breach of the agreement as set out therein;

++ a close reading of the agreement in the present case would disclose that the consideration is paid for acquiring a living organism Germplasm and also for technical know-how. The CIT(A) had apportioned the same, 1/4th as on capital account and 2/3rd on revenue account. Under the licensing agreement, the products produced or developed with the Germplasm and the technical know-how provided under the agreement are the revenue earning products for the assessee. In other words, they are material or tools in the hands of the assessee for generating the revenue. The agreement is valid for a period of five years from the date of commercial production and eight years from the date of execution. In the sense, the Germplasm is the revenue earning apparatus. The technical knowledge which has been acquired in the process of implementation particularly in the bio-technology filed would certainly benefit the assessee even after the expiry of the agreement period and there is no embargo on the assessee for using the expertise and knowledge acquired. Further, by clearly defining 'Licensee Germplasm' and 'Licensor Germplasm' and setting out a right to access the 'Licensor's' improvements during the currency of the agreement, the agreement has ensured the benefits of research, development and improvements to the Licensee, the assessee. Further, the Licensor have access to the Licensee's improvements but subject to payment of consideration. These clauses viewed in the context of the intention of the parties would certainly point out that both the parties intended to benefit for a considerable period of time out of the relationship emanating from the agreement. Even though in the Bio-technology field changes are likely to happen in fast phase, the assessee still has the benefit of the same in view of the dynamic nature of the agreement entered into between the assessee and the technology provider. This in our considered view is a distinct and distinguishing factor, which would benefit the assessee giving an enduring benefit to the assessee. In that view of the matter, apportioning a part of the expenditure in the nature of a capital expenditure by the CIT(A) annot be termed as erroneous. So far as the amount of royalty is concerned, it is agreed to be paid by the assessee and the same needs to be treated as revenue expenditure particularly considering the fact that the same is linked to the percentage of consideration received on sale of the products produced by the assessee by use of the Germplasm and with the help of the technical know-how. Accordingly, this question is answered in favour of the assessee.

(See 2015-TIOL-2487-HC-AP-IT)