By TIOL News Service

AHMEDABAD, JULY 08, 2014: THE issue before the Bench is - Whether if an expenditure is held to be capital in nature, it automatically invites the application of provisions of Sec 35AB in such a case. And the answer goes against the Revenue.

Facts of the case

The assessee Company had claimed technical know how fees of Rs.24,04,000/- in the Profit & Loss Account. The AO held this to be capital in nature and also held that the assessee's request for applying Section-37 was also incorrect. The expenses of technical know-how was covered by the provision of Section-35AB and there would not arise question of applicability of provision of Section-37 and accordingly, such technical know-how was added to the total income of assessee. On appeal, CIT(A) confirmed the view of AO by holding that it had agreed with the contention of AO that the word 'know-how' has been given a very wide meaning by explanation to Section-35AB. As per explanation 'know-how' means any industrial information or technique likely to assist in the manufacture of proceeding of goods or in the working of mine, oil well etc. It is important to note that even the wordings of Section-37, Sub-section (1) suggest wide meaning to word process know-how, in so far as the word 'Any' has been reduced. I would, therefore, hold that the Assessing Officer was fully justified in not allowing entire claim and restrictions the deduction under provision of Sec.35AB. The addition made by the Assessing Officer is hereby confirmed. On further appeal, Tribunal followed its own decision rendered in the case of 'Sayaji Industries Ltd'. It had also examined the agreement entered into by the assessee with the foreign company and discussing various clauses, and concluded in favour of the assessee and directed AO to grant relief by holding such expenditure as allowable u/s 37(1).

Held that,

++ the Tribunal also had followed its own decision of the 'Deputy Commissioner of Income Tax Vs. Sayaji Industries Ltd.' which when came up for consideration before this Court, decided the same [(2013) 81 DTR (Guj.) 418] answering the question against the revenue and in favour of the assessee, by also taking into consideration the decision of the Apex Court rendered in the case of CIT Vs. Swaraj Engines Ltd., 2008-TIOL-105-SC-IT holding that the moot question is whether such provisions contained in section 35AB of the Act would cover also revenue expenditure. In this context, we may peruse the decision of the Apex Court in case of Commissioner of Income Tax v. Swaraj Engines Ltd. more closely. The said decision was rendered in an appeal filed by the revenue challenging the decision of the Punjab & Haryana High Court in the case of Commissioner of Income Tax v. JCT Electronics Ltd., 2006-TIOL-204-HC-P&H-IT . In that case, the assessee had claimed a deduction of a sum of Rs.26.65 lakhs (rounded off) paid to one M/s Kirloskar Oil Engines Ltd. As royalty on the basis of an agreement for the purpose of acquiring technical know-how for the manufacturing of diesel engines. The Assessing Officer was of the opinion that such expenditure was covered under section 35AB of the Act and the same could not be treated as a revenue expenditure. After considering the assessee's reply, the Assessing Officer applied section 35AB to such expenditure. The assessee approached the Commissioner (Appeals) against such a decision contending that under the said agreement, the assessee had not become the owner of the technical know-how and no benefit of enduring nature had been received by the assessee. The CIT (Appeals) granted benefit to the assessee to the extent such expenditure represented the royalty calculated on the basis of the sales including excise duty and sales tax. The CIT (Appeals) held that such expenditure was revenue in nature and accordingly, allowed the assessee's appeal. The Department, thereupon, approached the Tribunal. The Tribunal rejected the revenue's appeal. The Tribunal referred to various clauses of the agreement between the assessee and the know-how provider to hold that such expenditure was revenue in nature. When the matter reached the High Court at the hands of the revenue, the High Court rejected the appeal on a somewhat different ground. The High Court held and observed that effort of the revenue to bring the expenditure within the domain of section 35AB of the Act was totally misplaced since the pre-condition for application of section 35AB of the Act was that the payment had to be a lump sum consideration for acquiring any know-how. Such pre-condition was not satisfied. On this basis, the High Court dismissed the appeal. It was this decision of the High Court which came up for consideration before the Apex Court in the case of Commissioner of Income Tax v. Swaraj Engines Ltd. The Apex Court observed that, “At the same time, it is important to note that even for the applicability of section 35AB, the nature of expenditure is required to be decided at the threshold because if the expenditure is found to be revenue in nature, then section 35AB may not apply. However, if it is found to be capital in nature, then the question of amortization and spread over, as contemplated by section 35AB, would certainly come into play.”. With the above observations, the Apex Court proceeded to remand the matter before the High Court observing that such question needs to be decided authoritatively by the High Court as it was an important question of law, particularly, after insertion of section 35AB.;

++ the Apex Court decision would suggest that for determining whether certain expenditure would fall within section 35AB or not, it would be important to examine the nature of the expenditure. If it is found that the same is revenue in nature, the question of applicability of section 35AB of the Act would not arise. On the other hand, if it is found to be capital in nature, then the question of amortization and spreading over, as contemplated under section 35AB of the Act would come into play. It was in this background that the Apex Court desired that this question, that is, the question of the nature of expenditure, whether revenue or capital, be first decided before final answer to the applicability or otherwise of section 35AB could be given. We may recall that the Punjab & Haryana High Court in the decision under challenge before the Supreme Court had not given any clear finding on this aspect though the Tribunal had confirmed the view of the CIT (Appeals) that the expenditure was revenue in nature. It was precisely for this reason that the Apex Court remanded the proceedings for authoritatively declaration on this point by the High Court;

++ in addition to the decision of the Apex Court in the case of Commissioner of Income Tax v. Swaraj Engines Ltd., we also would like to place reliance on the clarificatory circular issued by the C.B.D.T. bringing out the nature of the benefit being provided under section 35AB and the purpose for introduction of such provision in the statute. Such provision, as was clarified, was made with a view to providing further encouragement for indigenous scientific research. Thus, such statutory provision was made for making available the benefits which were hither to not available to the manufacturers while incurring expenditure for acquisition of technical knowhow. To the extent such expenditure was covered under section 35AB of the Act, amortized deduction spread over six years was made available. If such expenditure was capital in nature, prior to introduction of section 35AB of the Act, no such deduction could be claimed. With introduction of section 35AB, to encourage indigenous scientific research, such deduction was made available. Such a provision cannot be seen as a limiting provision restricting the existing benefits of the assessee. In other words, the revenue expenditure in the form of acquisition of technical know-how which was available as deduction under section 37(1) of the Act, was never meant to be taken away or limited by introduction of section 35AB;

++ to our mind, therefore, the provisions of section 35AB of the Act can apply only in case of capital expenditure and of course, provided the conditions set out therein are fulfilled. In such a case, during the period when section 35AB remained in operation, the assessee could claim benefit thereof. However, such provision would not apply to a revenue expenditure even if the same was incurred for acquisition of technical know-how. Deduction on such expenditure was available even before the introduction of section 35AB of the Act and such deduction cannot be curtailed or limited by applying section 35AB. In that view of the matter, taking such an expenditure out of section 37(1) of the Act, would not arise. We are unable to concur with the view of the Madras High Court in case of Commissioner of Income Tax v. Tamil Nadu Chemical Products Ltd., which was in any case rendered prior to the decision of the Apex Court in the case of Commissioner of Income Tax v. Swaraj Engines Ltd. Before closing, we may clarify that in the present case, the Assessing Officer himself proceeded on the basis that the expenditure was revenue in nature. In that view of the matter, the interpretation that we have adopted would apply and the case of the assessee would not fall under section 35AB of the Act. In a given case, if the expenditure is held to be capital in nature, further question of applicability of section 35AB of the Act may arise. In essence, therefore, each case would have to be examined separately and on the strength of material on record. Learned counsel Shri Patel however requested that the matter be remanded to the Assessing Officer for consideration whether the expenditure was capital or revenue in nature. We find that when the Assessing Officer had himself held that it is revenue expenditure, there would be no purpose of such a remand. In the result, the third question is answered in the negative, that is, against the revenue and in favour of the assessee. Appeal is allowed in part and disposed of accordingly. In light of the above pronouncement, when the facts and circumstances of the case are examined, we noticed that the Assessing Officer had proceeded on the basis that the expenditure was revenue in nature. The CIT [A] also concurred with such findings of the Assessing Officer. As lastly noted in the case of 'CIT Vs. Sayaji Industries' in each case, it would be necessary to gather whether the expenditure was capital on revenue in nature. As there is no dispute in respect of nature of expenditure, the issue proposed it. The present appeal also requires to be answered in favour of the assessee and against the Revenue. The Tax Appeal is accordingly disposed of.

(See 2014-TIOL-1072-HC-AHM-IT)