POLYFORMALIN P LTD Vs. COMMR OF INCOMETAX

JUDGEMENT

(1.) The Income Tax Appellate Tribunal, Cochin Bench has referred the following questions to this Court under S.256(1) of the Income Tax Act:

(2.) The assessee is a company incorporated on 18-5-1974 with the object of manufacturing and selling organic and synthetic chemicals. The company had its buildings constructed and machineries installed and it started producing Formal in from 24-2-1975 onwards. The assessee entered into a collaboration agreement on 23-5-1975 with a neighbouring concern by name M/s. Arborites (P) Ltd. for the production of Urea Formaldehyde Resin. The term of the agreement was initially for a period of five years, but it was provided that the term can be extended subject to further agreement between the parties. As per the agreement M/s. Arborites (P) Ltd. transferred its technical know-how and the right to use the trade mark to the assessee. The assesses was required to keep the technical know-how in confidence. Information about further improvements in the technical know-how was also agreed to be transferred to the assessee. In consideration of the transfer of the technical know-how the assessee company was to pay to the Arborites (P) Ltd. a royalty calculated at the rate of Rs. 100/- per ton of the contract product manufactured. There was a further agreement on 28-5-1975 as per which M/s. Arborites (P) Ltd. transferred its plant and machinery to the assessee for a price fixed at Rs. 1,00,000/- and vacated the rental premises occupied by it. There was yet another agreement on 22-3-1978 by way of clarification of the agreement dated 23-5-1975 that there was no absolute transfer of the technical know-how, the ownership in respect of which continued with M/s. Arborites (P) Ltd. and the assessee was only entitled to the use of it for a period of five years on payment of royalty as agreed to between the parties.

(3.) The assessee claimed deduction of the royalty of Rs. 34,779/- paid during the accounting period relevant to the assessment year 1976-77 as a revenue expenditure. The Income Tax Officer disallowed the claim for deduction holding that the expenditure was of a capital nature. In appeal at the instance of the assessee the Appellate Assistant Commissioner allowed the claim for deduction in the view that he took that the royalty paid constitutes revenue expenditure. On appeal by the Department the Tribunal held that part of the payment of royalty under the agreement attributable to the initial manufacture would be capital in nature and the rest of the payments would be revenue in nature. Accordingly the Tribunal held that the amount of royalty paid in the first year will be treated as capital expenditure and the royalty to be paid in subsequent years will be revenue expenditure. The royalty of Rs. 34,779/- paid during the relevant accounting period was accordingly held to be capital in nature to be added to the cost of machinery and plant and the assessee was held entitled to depreciation and development rebate admissible under the Act.