Technical Know-How and Royalty Payments made by Honda SEIL Cars to HCL, Japan is Capital Expenditure: SC [Read Judgment]

In Honda SEIL Cars India Ltd v. CIT, a two-judge bench of the Supreme Court held that the technical Know-how and royalty payments made by Honda SEIL Cars to HCL, Japan under the joint venture agreement amount to capital expenditure for which no deduction is allowable under the Income Tax Act.

The factual settings of the case are that as per a joint venture agreement, known as ‘Technical Collaboration Agreement’, between the assessee and HCL, Japan, the latter agreed to give ‘license’ and ‘technical assistance’ to the assessee. The TCA also stipulated different kinds of technical know-how and technical information which were to be provided by HMCL, Japan (as a licensor) to the assessee (as a licensee). The above facilities were provided for a consideration of 30.5 million US Dollar payable in five equal installments on yearly basis. Apart from this, assessee was also liable to pay royalty of 4%, both on internal and exports, subject to taxes.

The department, while rejecting the assessees’ claim for expenditure, took a stand that the above technical fee of 30.5 million is capital expenditure. The royalty paid was also treated as capital expenditure by the AO. On appeal, the ITAT reversed the order and held that the amount claimed must be treated as revenue expenditure. However, the High Court, on departmental appeal, quashed the ITAT order and sustained the order of the AO.

Before the Apex Court, assessee maintained that the Technical know-how and royalty payments must be treated as revenue expenditure since it had acquired mere right to use technical information provided by HMCL, Japan and it did not lead to creation of any asset of enduring nature. The Revenue, on the other hand, contended that these payments are of enduring nature and, therefore, they would qualify as capital expenditure.

Relying upon a plethora of decisions, the bench observed that in case where there is a transfer of ownership in the intellectual property rights or in the licences, it would clearly be a capital expenditure. However, when no such rights are transferred but the arrangement facilitates grant of licence to use those rights for a limited purpose or limited period, the royalty paid for use of such technical information or know-how would be in the nature of revenue expenditure as no enduring benefits is acquired thereby.

It was further noted that the agreement placed limitations on the right of the assessee in dealing with the know-how and the conditions as to non partibility, confidentiality and secrecy of the know-how inclined towards the inference that the right pertained more to the use of know-how than to its exclusive acquisition.

Concurring with the findings of the High Court, the bench observed that though the technical know-how, in the present case was for the limited period i.e. for the tenure of the agreement, in case of termination of the Agreement, joint venture itself would come to an end and there may not be any further continuation of manufacture of product with technical know-how of foreign collaborator. “The High Court has, thus, rightly observed that virtually life of manufacture of product in the plant and machinery, establishes with assistance of foreign company, is co-extensive with the agreement.”

It was noted that the Agreement is framed in a manner so as to given a colour of licence for a limited period having no enduring nature but when a close scrutiny into the said Agreement is undertaken, it shows otherwise. It further provides that in the event of expiration or otherwise termination, whatsoever, licensee, i.e., joint venture company/ Assessee shall discontinue manufacture, sale and other disposition of products, parts and residuary products. All these things then shall be at the option of licensor. “In other words, licensee in such contingency would hand over unsold product and parts to licensor for sale by him. In case licensor does not exercise such an option and the product is allowed to be sold by licensee, it would continue to pay royalty as per rates agreed under the agreement. Clauses 19 and 21, in our view, make the Agreement in question, i.e., establishment of plant, machinery and manufacture of product with the help of technical know-how, co-extensive, in continuance of Agreement. The Agreement also has a clause of renewal which, in our view, in totality of terms and conditions, will make the unit continue so long as manufacture of product in plant and machinery, established with aid and assistance of foreign company, will continue. Since, it is found that the Agreement in question was crucial for setting up of the plant project in question for manufacturing of the goods, the expenditure in the form of royalty paid would be in the nature of capital expenditure and not revenue expenditure.”

Read the full text of the Judgment below.