Issue for Consideration
Section 35 AB introduced by the Finance Act, 1985, w.e.f 1st April 1986, provides for
deduction of an amount paid towards any lump sum consideration for acquiring
know-how for the purposes of business in six equal annual instalments
commencing from the previous year in which the deductions is first allowed. The
relevant part contained in s/s. (1) reads as ; “S. 35AB. Expenditure on
know-how. (1) Subject to the provisions of sub-section (2), where the assessee
has paid in any previous year relevant to the assessment year commencing on or
before the 1st day of April, 1998 any lump sum consideration for
acquiring any know-how for use for the purposes of his business, one-sixth of
the amount so paid shall be deducted in computing the profits and gains of the
business for that previous year, and the balance amount shall be deducted in
equal instalments for each of the five immediately succeeding previous years.”
The term ‘know-how’ is exhaustively defined vide an
Explanation to the section to mean any industrial information or technique
likely to assist in the manufacture or processing of goods or in the working of
mine, oil, etc.
Prior to the insertion of section 35AB, an expenditure of
revenue nature, incurred on know-how, was allowed as deduction u/s. 37 of the
Income tax Act. A capital expenditure on know-how was not allowable as a
deduction and its treatment was governed by the other provisions of the Income
tax Act. With insertion of section 35AB, a capital expenditure became eligible
for deduction, subject to compliance of the prescribed conditions, in the
manner specified in the section.
Section 37 provides for a deduction of any expenditure laid
out or expended wholly and exclusively for the purposes of business or
profession, in full, provided it is not in the nature of a capital expenditure
or personal expenses of the assessee and further that the expenditure is not in
the nature of the one described in section 30 to section 36 of the Act.
Section 35 AB while opening a door for deduction of a capital
expenditure fuelled a new controversy, perhaps unintentionally, involving the
denial of 100% deduction to a revenue expenditure on know-how which was
hitherto allowable. It is the stand of the Revenue authorities that with the
introduction of section 35AB, the deduction for an expenditure on know-how, of
any nature, would be governed strictly by the new provision and be allowed in
six instalments and would not be allowed u/s. 37 as was the case before
insertion of the specific provision. Like any provision, a new one in
particular, section 35AB became a highly debatable provision not on one count
but on various counts. The related issues that arose, besides the issue of
identification of the relevant provision of the Act under which the deduction
for the revenue expenditure is allowable, are whether it was necessary that the
assessee acquired ownership rights over the know-how and whether the condition
for ‘lump sum’ payment meant payment in one go or even in instalments.
Various High Courts had occasion to examine these issues or
some of them, leading to a fierce controversy surrounding the eligibility of a
deduction, in full u/s. 37, of an expenditure on a know-how, otherwise of a
revenue nature. The Madras, MP and the Bombay High Courts decided the issue in
favour of the Revenue by denying the deduction u/s. 37 and the Gujarat,
Karnataka and Punjab & Haryana High Courts favoured the deduction u/s. 37
for such an expenditure, incurred on know-how, in favour of the assessee. On
the issue of ‘lump sum’ payment , the Bombay High Court in two cases held that
the payment in instalments would not cease to be lump sum. The High Court also
decided that for application of section 35AB , it is not necessary to be an
owner of the know-how.
Anil Starch Products Ltd.’s case
The issue arose in the case of DCIT vs. Anil Starch
Products Ltd., 57 taxmann.com 173 (Guj.) for A.Y 1990-91, 1992-93 and
1993-94. While admitting one of the appeals, the following substantial
questions of law arose for the determination of the court; “Whether,
the Appellate Tribunal was justified in law and on facts in confirming the
order of the Commissioner of Income-tax (A) who held that the expenditure under
consideration was revenue in nature and allowable u/s 37 of the Act
disregarding the special provisions of sec.35AB?”
The Gujarat High Court at the outset noted that an identical
question had arisen before them in another appeal of the assessee for A.Y.
1989-90 numbered 326 of 2000 decided on 03.07.2012 , not otherwise reported,
and chose to reproduce the facts, pleadings, law and even the decision therein
to finally conclude, in the cases before them, that the provisions of section
35 AB were not applicable to the case of a revenue expenditure which was
allowable u/s. 37 of the Act. The facts and the sequence of events of the case
is therefore not available in the judgement and therefore the facts, pleadings
and the outcome of the case heavily relied upon by the court are placed and
considered here as had been done by the court.
The assessee in that case, a company engaged in manufacturing
of starch and other similar products, during the year under consideration
relevant to assessment year 1989-90, paid
the technical know-how and service fees, totalling to a sum of
Rs.23,23,880 and claimed deduction thereof in full as the revenue expenditure.
The assessee had contended that the provisions of section 35AB of the Act were
applicable only in respect of the capital expenditure and not in respect of the
revenue expenditure. The assessee further contended that the company while
acquiring such know-how, obtained no ownership right on such information and
know-how was furnished by the foreign company to the assessee under an
agreement. The assessee also contended that such technical know-how was for the
purpose of production of its existing items which are being manufactured by the
assessee company since many years.
The AO held that such expenditure fell within section 35AB of
the Act. The AO, did not accept the contentions of the assessee, though agreed
that such expenditure was revenue in nature and was covered within section 35AB of the Act and were to be amortised, as provided under the said
section, by spreading the benefit over a period of six years. Dissatisfied with
such a decision of the AO, the assessee carried the matter in appeal. Before
the CIT (Appeals), the assessee in addition to contending that a revenue
expenditure could not be brought under the ambit of section 35AB of the Act,
further contended that the provision of section 35AB of the Act was an enabling
provision, introduced to facilitate the deduction for a capital expenditure.
The CIT (A) rejected the assessee’s appeal as he was of the
opinion that section 37(1) of the Act, which covered expenditure not being in
the nature of the expenditure described in sections 30 to 36, would not apply
in the case by virtue of the provisions contained in section 35AB of the Act.
He held that since section 35AB of the Act made a specific provision to treat
the expenditure incurred for acquisition of technical know-how by way of lump
sum payment and that even if such a payment was revenue in nature, it would not
fall within sub-section (1) of section 37 of the Act.
On a further appeal by the assessee, the Tribunal reversed
the decisions of the revenue authorities. The Tribunal noted that as per the
agreement, all information and know-how furnished by the foreign company
remained the property of that company; the payment was made as a lump sum
consideration for use of the know-how, only, for the purpose of its running
business, for a limited period. The Tribunal noted that undisputedly, there was
no purchase of the know-how from the foreign company. The Tribunal held that
the case of the assessee was not covered u/s.35AB of the Act and that section
35AB had no application in the case and the assessee was entitled to deduction
u/s. 37(1) of the Act.
In the appeal to the High Court, by the Revenue, it was
contended that the Tribunal committed grave error in allowing the assessee’s
appeal; that section 35AB of the Act was widely worded and included any
expenditure incurred for acquisition of technical know-how and that the concept of ownership was not material for
section 35AB; that once an expenditure, whether revenue or capital, was covered
u/s. 35AB of the Act then by virtue of the language of sub-section
(1) of section 37 of the Act, the assessee could not claim any benefit thereof
u/s. 37 of the Act. Reliance was placed on the decision of the Madras High
Court in the case of Commissioner of Income Tax vs. Tamil Nadu Chemical
Products Ltd., reported in 259 ITR 582, wherein a division bench of the
Madras High Court had held that during the period when section 35AB of the Act
remained effective, any expenditure towards acquisition of know-how,
irrespective of whether it was a capital or a revenue expenditure, was to be
treated only in accordance with section 35AB and the deduction allowable in
respect of such know-how was 1/6th of the amount paid as lump sum consideration
for acquiring know-how. The Revenue relying on the decision of the MP High
Court in the case of Commissioner of Income Tax vs. Bright Automotives and
Plastics Ltd., reported in 273 ITR 59 further contended that in
order to attract the rigour of section 35AB of the Act, it was not necessary
for the assessee to actually become an absolute owner of the know-how and also
that the nature of expenditure whether revenue or capital, was of no
consequence.
The assessee in response contended that the expenditure in
question was purely revenue in nature and the same was, therefore, not covered
u/s. 35AB of the Act; that the said provision was made to encourage acquisition
of know-how to improve the quality and efficiency of Indian manufacturing; that
the assessee had acquired the know-how for a limited period and had never
enjoyed any ownership or domain right over the know-how; that the know-how was
utilised for manufacturing of its existing items and that neither any new
manufacturing unit was established nor new item of manufacturing was
introduced. It was pointed out that even the AO agreed that the expenditure in
question was a revenue expenditure; that section 35AB of the Act had no
application to such an expenditure since the provision of section 35AB was an
enabling provision that was not introduced to limit the benefits which were
already existing. Attention was also drawn to the C.B.D.T. Circular No.421
dated 12.6.1985 wherein with respect to deduction in respect of an
expenditure on know-how, it was clarified that, the provision was inserted with
a view to providing encouragement for indigenous scientific research. Heavy
reliance was placed on the decision of the Apex Court in the case of Commissioner
of Income Tax vs. Swaraj Engines Ltd., 309 ITR 443 in which the Apex Court
had an occasion to examine the decision of the Punjab & Haryana High Court
on the question of applicability of section 35AB of the Act.
The Gujarat High Court noted that the AO himself had accepted
that the expenditure in question was of revenue nature and that the circular
No. 421 confirmed that the provisions of section 35AB were enabling provision
and if that be so, the deduction of such expenditure could not be limited by
applying section 35AB of the Act. The Court took note of the facts in Swaraj
Engines Ltd.’s case and also of the decision therein and observed as under;
“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
amortisation and spreading over, as contemplated under section 35AB of the Act
would come into play.”
The Court held that such provision, as was clarified by the
C.B.D.T, was made with a view to providing encouragement for indigenous
scientific research; that such statutory provision was made for making
available the benefits which were hitherto not available to the manufacturers
while incurring expenditure for acquisition of technical know-how; that to the
extent such expenditure was covered u/s. 35AB, amortised deduction spread over
six years was made available; that where such expenditure was capital in
nature, prior to introduction of section 35AB of the Act, no such deduction
could be claimed; that with introduction of section 35AB, to encourage
indigenous scientific research, such deduction was made available; that such a
provision could not 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 u/s. 37(1)
of the Act, was never meant to be disallowed or taken away or limited by
introduction of section 35AB of the Act.
The Gujarat High Court also cited with approval the paragraph
from the Ninth Edition, Volume-I of Kanga & Palkhivala, while
explaining the provisions of section 35AB of the Act, : “This section
allows deduction, spread over six years, of a lump sum consideration paid for
acquiring know-how for the purposes of business even if later the assessee’s
project is abandoned or if such know-how subsequently becomes useless or if the
same is returned. The section, which is an enabling section and not a disabling
one, should be confined to that consideration which would otherwise be
disallowable as being on capital account. A payment for acquiring know-how or
the use of know-how which is on revenue account is allowable under section 37,
and does not attract the application of this section at all.”
The High Court concluded that the provisions of section 35AB
of the Act could apply only in case of a capital expenditure and would not
apply to a revenue expenditure even if the same was incurred for acquisition of
technical know-how and the deduction thereof could not be curtailed or limited
by applying section 35AB.A revenue expenditure remained within the ambit of
section 37(1) of the Act. The Court observed that it was unable to concur with
the view of the Madras High Court in case of Commissioner of Income Tax vs.
Tamil Nadu Chemical Products Ltd. (supra), which was in any case rendered
prior to the decision of the Apex Court in the case of Commissioner of
Income Tax vs. Swaraj Engines Ltd. (supra).
Accordingly, the Gujarat High Court, in the case before it,
in appeal, in Anil Starch Ltd.’s case, dismissed the Revenue’s appeal
holding that the provisions of section 35AB did not apply to an expenditure
which otherwise was of a revenue nature. In deciding the case, the High Court
followed the ratio of the decisions in the cases of DCIT vs. Sayaji
Industries Ltd. 82 CCH 412 and the Karnataka High Court in the case of Diffusion
Engineers Ltd. vs. DCIT, 376 ITR 487.
Standard Batteries Ltd.’s case
Recently the issue came up for consideration, before the
Bombay High Court, in the case of Standard Batteries Ltd. vs. CIT, 255
Taxman 380 (Bom.). The assessee, in that case, had entered into an
agreement with ‘O’, UK, in terms of which, the assessee was to receive outside
India a license to transfer and import information, know-how, advice,
materials, documents and drawings as required for the manufacture of miners’
cap lamp batteries and stationery batteries for a lump sum consideration paid
in three equal instalments, where the permission was only to use the know-how
and information without transfer of ownership. The assessee claimed deduction
in respect of the said payment u/s. 37(1). The AO however, rejected the claim
of the assessee but allowed deduction to the extent of 1/6th of the amount
spent and claimed, and the balance amount was to be deducted in equal
instalments for each of the five immediately succeeding previous years in terms
of section 35AB.
The Tribunal held that the assessee had acquired the
ownership rights in the technical know-how and accordingly the assessee was
entitled to deduction u/s. 35AB, and not u/s. 37(1) as was claimed by the
assessee.
On appeal by the assessee to the High Court, the three
aspects before the Court were about the application of section 35 AB to the
case where; (i) a revenue expenditure was incurred (ii) payment was made in
instalments and (iii) the assessee was not an owner of the rights or asset for
an effective application of section 35AB.
On behalf of the assessee, it was contended that the expenditure
for receipt of technical know-how would
not fall u/s. 35AB of the Act but would appropriately fall u/s. 37 of
the Act for the following reasons;
(a) Section 35AB of the Act
required a lump sum consideration to be paid for acquiring any technical
know-how, while in the case before the Court admittedly payment was made in 3
instalments, therefore could not be regarded as a lump sum payment and as such
was therefore, outside the scope of section 35AB of the Act;
(b) There was no acquisition of a technical
know-how in the facts of the case, as the applicant merely obtained a lease /
license of the rights to use such technical know-how; not having any ownership
rights over the technical know-how, the requirement of acquiring the know-how
u/s. 35AB of the Act was not satisfied and was thus, outside the mischief of
section 35AB of the Act;
(c) The technical know-how
obtained by the applicant under the agreement dated 19th June, 1984
was to be used in the regular course of its business of manufacturing batteries
and therefore, would be revenue in nature; section 35AB would apply only where
the expenditure was in the nature of a capital expenditure; the expenditure for
obtaining technical know-how being of revenue nature, would fall in the
residuary section 37 of the Act.
In response, it was contended on behalf of the Revenue, that
:—
(a) The payment made in three equal instalments
continued to be a lump sum payment;
(b) Section 35AB of the Act, did not require
obtaining ownership of the technical know-how; the license to use the know-how
by itself would be covered by the words “consideration paid for acquiring
any know-how”; there was no basis for restricting the plain meaning of the
word “acquiring” in section 35AB of the Act;
(c) The applicant had used the technical know-how
so obtained in its business and on plain interpretation of section 35AB of the
Act, it would apply; it did not exclude revenue expenditure from its purview,
as there was no requirement in section 35AB that the same would be available
only if the expenditure was of a capital nature and not if it was revenue in
nature: that wherever the legislature wanted to restrict the benefit in respect
of the deduction claimed of expenditure dependent upon its nature, described in
sections 30 to 36 of the Act, it specifically provided so therein as was in
sections 35A and 35ABB of the Act;
(d) In any event, section 37 of the Act excluded
expenditure of a nature described in sections 30 to 36 from the purview of s.
37 of the Act; section 35AB fell within sections 30 to 36 and therefore, no
occasion to apply section 37 of the Act would arise;
Relying on the decision of the Court in the case of CIT
vs. Raymond Ltd., 209 Taxman 154 (Bom.), the Court held that merely because
the payments were made in instalments for using the technical know-how, it
would not cease to be a lump sum payment where the amount payable was fixed and
not variable more so when the words used in section 35AB were ‘lump sum’
payment and not a one time payment. Therefore, making of lump sum payment in 3
instalments would not make the payment any less a lump sum payment.
On the issue of the need to be an owner of know-how, the
assessee reiterated that the word ‘acquiring’ as used in section 35AB would
necessarily mean, acquisition of ownership rights of the technical know-how;
that a mere lease / license, would not amount to acquisition of technical
know-how as per the dictionary meaning of the word “acquisition”. The
Court however held that the dictionary meaning relied upon did not exclude the
cases of obtaining any knowledge or a skill, as was in the case before them or
technical know-how for a limited use. It held that the gaining of knowledge was
complete / acquired by transfer of know-how and the limited use of it would not
detract the same from being included in the scope and meaning of the word
acquisition; that the word “acquisition” as defined in the larger
sense even in the Oxford Dictionary referred to above, would cover the use of
technical knowledge know-how by the applicant assessee which was made available
to it; thus, the restricted meaning of the word ‘acquisition’ to mean ‘only
obtaining rights on ownership’ was not the plain meaning in English language
and obtaining of technical know-how under a license would also amount to
acquiring know-how as the words ‘on ownership basis’ were completely absent in
section 35AB(1) of the Act. The Court held that accepting the contention of the
applicant, would necessarily lead to adding the words ‘by ownership’ after the
word ‘acquiring’ in section 35AB(1) of the Act, which addition was not
permitted while interpreting a fiscal statute.
On the main issue of allowability u/s. 37, it was reiterated
that the technical know-how which had been obtained was used in the regular
course of its business of manufacturing batteries and it would necessarily be
in the nature of revenue expenditure, allowable u/s. 37 of the Act. Reliance
was placed upon the decisions of Gujarat High Court in DCIT vs. Anil Starch
Products Ltd. 232 Taxman 129 and DCIT vs. Sayaji Industries Ltd. 82
CCH 412 and the decision of the Karnataka High Court in Diffusion Engineers
Ltd. vs. DCIT 376 ITR 487, to contend that the issue stood concluded in
favour of the company for the reason that while dealing with an identical
situation, the courts in the above referred three cases, have held that section
35AB of the Act would not be applicable where the expenses were of revenue
nature, and the expenditure was deductible u/s. 37(1) of the Act.
In contrast, the Revenue reiterated that section 37 of the
Act itself excluded expenditure of the nature described in sections 30 to 36
without any qualification as was held by the Madhya Pradesh High Court in CIT
vs. Bright Automotives & Plastics Ltd. 273 ITR 59 and the Madras High
Court in CIT vs. Tamil Nadu Chemical Products Ltd. 259 ITR 582. That the
courts in those cases had held that the expenditure incurred for acquiring technical
know-how would fall u/s. 35AB of the Act irrespective of the fact that the
expenditure was revenue in nature.
On due consideration of the submission of the parties , the
Bombay High Court held as under;
- The submission that the expenditure in
question be allowed u/s. 37 could not be accepted for the reason that section
35AB of the Act itself specifically provided that any expenditure incurred for
acquiring know-how for the purposes of the assessee’s business be allowed under
that section; that as detailed in the Explanation thereto the know-how to
assist in the manufacturing or processing of goods would necessarily mean that
any expenditure on know-how which was used for the purposes of carrying on
business would stand covered by section 35AB of the Act.
- Section 37 of the Act itself excluded
expenditure of the nature described in sections 30 to 36 of the Act without any
qualification.
- On examination of sections 30 to 36 to find
whether any of them restricted the benefit to
only capital expenditure, it was found that section 35AB of the Act made no
such exclusion / inclusion on the basis of the nature of expenditure i.e.
capital or revenue. In fact, wherever the parliament sought to restrict the benefit
on the basis of nature of expenditure falling u/s. 30 to 36 of the Act, it
specifically so provided viz. section
35A which was introduced along with
section 35AB of the Act w.e.f. assessment year 1986-87. In fact, later sections
35ABA and 35ABB have also provided for deduction thereunder only for a capital
expenditure .
- Wherever the Parliament sought to restrict
the expenditure falling within sections 30 to 36 only to a capital expenditure,
the same was expressly provided for in the section concerned. To illustrate,
section 35A and 35ABB of the Act have specifically restricted the benefits
thereunder only to a capital expenditure.
- In the above view, submission on behalf of
the assessee that section 35AB of the Act would apply only to the case of a
capital expenditure and exclude the revenue expenditure, required adding words
to s. 35AB which the legislature had specifically not put in; the court could
not insert words while interpreting the fiscal legislation in the absence of
any ambiguity in reading of section as it stood; thus, even if technical
know-how was revenue in nature, yet it would be excluded from the provisions of
section 37 of the Act.
The Court took note of the fact that Gujarat High Court in Anil
Starch Products Ltd.’s case (supra) and Sayaji Industries Ltd.’s
case (supra) did not agree with the view of the M.P. High Court in Bright
Automotives & Plastics Ltd.’s case (supra) and of the Madras
High Court in Tamil Nadu Chemical Products Ltd.’s case (supra). It also
noted that the Karnataka High Court in Diffusion Engineers Ltd.’s case
(supra) did not agree with the view of the Madras High Court in Tamil
Nadu Chemical Products Ltd.’s case (supra). Having taken note, it
observed that the basis of all the above referred three decisions was the
subsequent decision of the Apex Court in CIT vs. Swaraj Engines Ltd. 301 ITR 284. It further noted that the
above case before the Apex Court arose from the decision of the Punjab &
Haryana High Court in Swaraj Engines Ltd.’s case, wherein it was held
that payments made on account of the royalty would be deductible u/s. 37 and
not u/s 35AB of the Act; that the Apex Court had restored the issue to the
Punjab & Haryana High Court, by way of remand; that the Apex Court directed
that the High Court should first decide whether the expenditure incurred on
royalty would be capital or revenue in nature at the very threshold before
deciding the applicability of section 35AB or 37 of the Act.
The Court also observed that the Apex Court, while restoring
the issue, had clearly recorded that it had not expressed any opinion on the
matter and on the question whether the expenditure was revenue or capital in
nature and had instead, depending on the answer to that question, directed the
High Court to decide the applicability of section 35AB, and had kept all
contentions on both sides expressly open.
The entire issue, in the opinion of the Bombay High Court,
about whether section 35AB applied only in case of capital expenditure and not
in case of revenue expenditure had not been decided by the Apex Court in Swaraj
Engines Ltd.’s case (supra) and was left to be decided by the Punjab
& Haryana High Court on the basis of the fresh submissions to be made by
the respective parties. It was clear to the High Court that the Apex Court in Swaraj
Engines Ltd.’s case (supra) had not concluded the issue by holding
that section 35AB would apply only in cases where the expenditure was capital in
nature. Instead the Apex Court had expressed only a tentative view and the
issue itself was left open to be decided by the Punjab & Haryana High Court
on remand.
The Bombay High Court importantly held that the reliance by
the Gujarat High Court in Anil Starch Products Ltd.’s case (supra)
and Sayaji Industries Ltd.’s case (supra) and by the Karnataka
High Court in Diffusion Engineers Ltd.’s case (supra), on the
Apex Court decision in Swaraj Industries Ltd.’s case (supra), to
hold that an expenditure which was revenue in nature would not fall u/s. 35AB
and would have necessarily to fall u/s. 37 of the Act, was not warranted by the
decision of the Apex Court in Swaraj Engines Ltd.’s case (supra).
Hence, the Bombay High Court was unable to agree with the decisions of the
Gujarat High Court and the Karnataka High Court, in as much as the Apex Court
had not conclusively decided the issue and left it open for the Punjab &
Haryana High Court to adjudicate upon the said issue.
Observations
That the expenditure of revenue nature on acquiring know-how
is eligible for deduction u/s. 37 in full, prior to insertion of section 35AB,
was a position in law that was well settled by several decisions of the courts,
and in particular, the decisions in the cases of Ciba of India Ltd.69 ITR
692(SC), IAEC(Pumps) Ltd. 232 ITR 316(SC), Indian Oxygen Ltd. 218 ITR 337(SC)
and Alembic Works Co Ltd. 177 ITR 377(SC).In contrast, the expenditure of
capital nature on know-how was not eligible for deduction u/s. 37, prior to
insertion of section 35AB, in as much as the section itself prohibited
deduction of an expenditure of a capital nature, though in the above referred
cases, the deduction was held to be allowable even where the expenditure
resulted in some enduring benefits.
This settled position in law was disturbed by the
introduction of section 35AB. With its introduction, the deduction for all
expenses on know-how, capital or revenue, was governed by the provisions of
section 35AB, was the understanding of the Revenue, a stand that was not
supported by the comments of the leading jurists published in the 9th
edition of the book titled Kanga & Palkhivala’s Law and Practice of
Income tax. In contrast, tax payers hold that the insertion of section 35
AB had not changed the settled position for deduction in full u/s. 37 of the
Act for an expenditure of revenue nature.
Both the views, as noted, are supported by the conflicting
decisions of about six High Courts where some of the decisions are delivered in
favour of the taxpayers on the ground that the issue has already been settled
by the Apex Court in the case of Swaraj Engines Ltd.(supra) while
recently the Bombay High Court held to the contrary, leading to one more
controversy involving whether the Apex Court really adjudicated the issue for
good or it has left the issue open.
It is perhaps not difficult to decide whether the Supreme
court in the case of Swaraj Engines Ltd. (supra), at all concluded the
issue under consideration and if yes, was the conclusion arrived at in favour of
the proposition that the provisions of section 35AB applied only where the
expenditure in question was of capital nature. The Apex Court in Swaraj’s
case had noted, in paragraphs 4 and 5 of the decision, that there was a
considerable amount of confusion whether the AO in the case before him applied
section 35AB at all and whether the said contention regarding applicability of
section 35AB was at all raised. The court had further observed that the order
of the AO was not clear, principally, because the order was focussed only one
point namely, on the nature of expenditure. It further observed that depending
on the answer to the said question, the applicability of section 35AB needed to
be considered; the said question needed to be decided authoritatively by the
High Court as it was an important question of law, particularly, after
insertion of section 35AB. The Court therefore remitted the matter to the High
Court for a fresh consideration in accordance with law. It also clarified, in
para 7, on the second question, that “we do not wish to express any opinion.
It is for the High Court to decide, after construing the agreement between the
parties, whether the expenditure is revenue or capital in nature and, depending
on the answer to that question, the High Court will have to decide the
applicability of section 35AB of the Income-tax Act. On this aspect we keep all
contentions on both sides expressly open”. Accordingly, the impugned
judgment of the High Court was set aside and the matter was remitted for fresh
consideration in accordance with law.
It seems that the
confusion has arisen out of the following observations of the Apex Court in Swaraj’s
case, wherein it stated 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 amortisation and spread over, as
contemplated by section 35AB, would certainly come into play. Therefore, in our
view, it would not be correct to say that in this case, interpretation of section
35AB was not in issue.” These observations, made mainly to emphasise that
the decision of the High Court required to be set aside for further
examination, has been construed differently by the High Courts, some to support
the proposition that section 35AB had no application to an expenditure that was
held to be of revenue nature. In fact, in the said case, when the matter had
reached the High Court, it was dismissed by the Punjab & Haryana High Court
on an altogether different aspect of section 35AB which is not under
consideration, presently. The High Court in that case had held and observed
that effort of the revenue to bring the expenditure within the domain of
section 35AB was totally misplaced, since the pre-condition for application of
section 35AB was that the payment had to be a lump sum consideration for
acquiring any know-how and such pre-condition was not satisfied. On that basis,
the High Court had dismissed the appeal. It was this decision of the High Court
which had come up for consideration of the Apex Court . We respectfully submit
that the decision of the Apex Court in Swaraj Engines Ltd.’s case, has
not concluded that a revenue expenditure was outside the scope of section 35AB
. It has instead left this aspect of the issue open for a fresh consideration,
as has been explained by the Bombay High Court in Standard Batteries Ltd.’s
case.
Having noted the facts, the issue requires to be analysed on
the basis of;
- implication of the decisions favouring the
claim for deduction u/s. 37
- an understanding of the position prevailing
prior to insertion of section 35 AB,
- legislative intent behind introduction of
section 35AB,
- whether section 35AB is an enabler or
disabler,
- language of section 35AB and its scope , and
- restriction in section 37 .
We very respectfully submit that the decisions favouring the
claim u/s. 37, based simply on the perceived findings of the Apex Court in Swaraj
Machines Ltd.‘s case, may not hold any force, in view of our considered
opinion that the Apex Court had, in that case, not adjudicated the issue but
had instead set aside the matter and restored the same to the Punjab &
Haryana High Court. If that is so, the decisions of the courts holding that the
deduction for expenses is governed by section 35AB alone become the only
available decisions of the High Courts leaving no controversy on the subject.
The best hope for the taxpayer is to await the decision of the Apex Court on
the subject. The issue till such time remains not concluded but the one on which
no other High Court has decided in favour of the tax payer after examining the
merits of the case.
The legal position, prevailing prior to insertion of section
35AB by the Finance Act, 1985, is cleared by the decisions of the Supreme Court
holding that an expenditure, on acquisition of know-how, of revenue nature is
eligible for deduction u/s. 37 of the Act, once it was incurred wholly and
exclusively for the purposes of the business and the expenditure in question
was not of a capital nature or for personal purposes. Ciba of India Ltd.69
ITR 692(SC), IAEC(Pumps ) Ltd. 232 ITR 316(SC), Indian Oxygen Ltd. 218 ITR
337(SC) and Alembic Works Co Ltd. 177 ITR 377(SC) to name a few
wherein the deduction u/s 37 was held to be allowable for an expenditure incurred
on technical know-how acquisition even where the expenditure resulted in some
enduring benefit to the payer.
The CBDT circular No. 421 dated 12.6.1985, vide paragraphs
15.1 to 15.3 explains the intention behind the insertion of the new
provision in the form of section 35AB which is for providing further
encouragement for indigenous scientific research. The memorandum explaining the
provisions of the Finance Bill, 1985 and the Notes thereon have been reiterated
by the circular. They together do not throw any light about the scope of the
new provision, nor about the intention to override the existing understanding,
nor the available decisions on the subject. If that had been the intent, the
same is not expressed by the supporting documents.
Ideally from the tax payers angle, the provision of section
35AB should be construed to be an enabling provision that facilitates the
deduction for a capital expenditure hitherto not available before its
introduction and its scope should be restricted to that. Its insertion should
not be taken as a disabling provision leading to a disentitlement not expressly
provided for nor intended.
Section 35AB in its language does not limit the deduction to
the case of an expenditure that is capital in its nature. It also does not
expressly provide that a revenue expenditure on acquisition of know-how will
fall for deduction only u/s. 35AB. Neither does it provide that such an
expenditure will not qualify for deduction u/s. 35AB and thereby strengthening
the claim for deduction u/s. 37. Useful reference may be made to the provisions
of section 35A and section 35ABA and section 35ABB which specifically apply
only to the cases of capital expenditures.
Section 37 grants deduction for any and all types of
expenditures wholly and exclusively for business purposes, other than those
described under sections 30 to 36 of the Act. The true intent and meaning of
the words ‘not being the expenditure described in s.30 to 36’ placed in
s/s. (1) was examined in various cases by the courts over a period of time. It
has been held by the High Courts, including by the full benches of courts, that
section 37 is a residuary provision and can be activated only where it is found
not to be covered by any of the provisions of section 30 to section 36. If it
is covered by any of those provisions, then the deduction cannot be granted
under the residual section 37. It will be so even where the conditions
prescribed under sections 30 to 36 remain to be satisfied. The use of the term ‘described’
as against the terms ‘covered’ or ‘of the nature covered by or
prescribed in’ is equally intriguing.
If the expenditure on know-how does not satisfy the
conditions of the lump sum payment and of the acquisition, then, in that case,
provisions of section 35AB would have no application. The deduction in such
cases would possibly be governed by the provisions of section 37, subject to
the satisfaction of the conditions satisfied therein. This view however is not
free from debate in view of the discussion in the preceding paragraph.
Obviously, section 35 AB will have no application in cases
where the payment is not lump sum and is periodical or annual or is turnover
based, and the tax payer would be able to stake its claim u/s. 37, provided of
course that the payment is not of the capital nature. Tata Yodogawa Ltd. vs.
CIT, 335ITR 53 (Jhar.).
The Apex Court in the case of Drilcos (India) Pvt. Ltd.vs.
CIT, 348 ITR 382 has held that once section 35AB had come into play,
section 37 had no role to play. This decision of the court, delivered
subsequently to Swaraj Machines’ case, may play an important role in
addressing the outcome of the issue on hand. The Apex Court, in Drilcos’
case, confirmed the decision of the Madras High Court reported in 266
ITR 12, on an appeal by the company challenging the order of the High
Court. The High Court had held that the provisions of section 35AB encompassed
in its scope the case of a revenue expenditure, following the decision in the
case of Tamil Nadu Chemicals Products Ltd.(supra).
While the controversy continues for the past,
the position is now clear with effect from 1.10.1998. A ‘know-how’ is expressly
included in the definition of an intangible asset with effect from 1.10.1998
and is accordingly made eligible for depreciation. Obviously, no depreciation
would be claimed or allowed in respect of a revenue expenditure on know-how,
and with that, such an expenditure, on discontinuation of section 35AB w.e.f
1.04.1998, would be eligible for deduction u/s. 37 of the Act.
