Honda SIEL Cars India Ltd. (“Assessee”) was a Joint Venture companyincorporated by Honda Motors CompanyLtd., Japan (“HMCL”) and SEIL Ltd., India.
HMCL, Japan entered into a Technical Collaboration Agreement (“TCA”) withAssessee wherein different kinds ofknow-how and technical informationwere to be provided by HMCL (as alicensor)to Assessee (as a licensee)for alump sum fee to be paid in 5 equalinstalments commencing from third yearof commencement of commercialproduction along with royalty for internalsales and exports.
Apart from this, three memoranda were also executed for providing necessary guidance for setting up of a plant.
- Assessee filed its return of income for AY 1999-2000 classifying such payments for TCA as “revenue expenditure” and payments for memoranda as “capital expenditure”.
- A Notice u/s 148 was issued stating that payments for TCA were capital in nature and later, orders were passed treating the same as capital expenditure.
- While, ITAT gave decision in favor of the Assessee, High Court agreed with the view of the Assessing Officer (“AO”)
- Assessee contended that ownership rights in the know-how continued to remain with HMCL. It had merely acquired right to use technical information provided by HMCL. Thus, payments made were to be treated as revenue expenditure. For this, Assessee relied upon the Delhi High Court judgement in case of CIT V. Hero Honda Motors (2015) 327 ITR 481 (Delhi)
- As per Revenue, the technical know-how and royalty payments were of “enduring nature” and therefore, they would qualify as capital expenditure. A new asset in the form of setting up of a new company had come into existence with the aid of technical know-how.
Ruling of the Supreme Court
- The Supreme Court affirmed decision of the Allahabad High Court stating that admittedly, there was no existing business and thus, question of improvising the existing technical know-how by borrowing the technical know-how of the HCML, Japan did not arise.
- The very purpose of the Agreement between two companies was to set up JV company with aim and objective to establish a unit for manufacture of automobiles & parts thereof. This technical collaboration not only included transfer of technical information, but, complete assistance, actual, factual and on the spot, for establishment of the unit.
- Though Supreme Court acknowledged that tenure of the agreement is limited and rights of Assessee as licensee were limited. However, the Supreme Court further noted that in case of termination of the Agreement, JV itself would come to an end and there may not be any further continuation of product with technical know-how of foreign collaborator.
- The Supreme Court found ITAT’s opinion incorrect which said that only other three memoranda were necessary for setting up the manufacturing facilities and the payment for this Agreement was not in connection with setting up of a plant.
- Referring to the Delhi High Court judgement in case of CIT V. Hero Honda (2015) 327ITR481(Delhi), Supreme Court said that it should be noticed that in that case, technical know-how was obtained for improvising scooter segment, which unit was already in existence. On the contrary, in the present case, the agreement was for setting up a new plant for the first time to manufacture cars. The aforesaid distinction between the two agreements has made all the difference in the results and as a consequence, the Supreme Court agreed with the views of High Court and dismissed the appeal of the assessee with costs.
By this decision, Supreme court has laid down a principle that the “purpose and the objective” of the agreement regarding technical know-how would determine the character of the expenditure, i.e., whether capital or revenue. An expenditure incurred to acquire or bring into existence an asset or an advantage of enduring benefit of the business is a capital expenditure. The Supreme Court appears to have not given much importance to the rights granted to licensee under and tenure of the technical assistance agreement, by way of which technical knowhow is provided. The Supreme Court has also highlighted a very fine distinction between setting up a new asset/ business and improving upon an old asset/ business and held that while the expenditure incurred for latter can be considered as revenue expenditure, any expenditure for creating new asset/ business would qualify for being a capital expenditure. This decision has also again re-emphasized the principle that overall conduct of parties and viewing transaction on a holistic picture is important to characterize nature of any transaction or item of income/ expenditure. In our view, this decision will change the way such agreements are interpreted by tax authorities and their tax treatment.
Author: Rakesh Nangia - Managing Partner, Nangia Advisors