Commissioner of Income Tax-IV v. Hero Honda Motors Limited

7 February, 2015 a Through Mr RohitMadan, Mr. P. Roy Chaudhuiy &Mr. Rucliir Bhatia, Advocates. versus hero HONDA Ti nnah Mr AiayVohra, Sr. Advocate with Ms.KavitaJha&Mr. VivekBansal, HON'BLE MR.

JUSTICE V. J/o ™scomnaondec.ston/*„twoo.ddisposeofthe^ese t.1.ppeaisrdedhytheReveatrere.ata.toAssesstrteatYea.. OO.t 2O N, 02 and2002-03. These appeals ratpugned the order dated 6 Apt passed hy the hreo.e Tax AppellateTrlhuaal (Trlbuaal, for short. Th substaatial questio.. ofla» required tobe decided aad adat.tted for heat. by order dated 20^'' April, 2012 reads as under.- "Whetherthe Irrcome TaxAppellateTribunalwas ri^ht in holding that the payment made to Honda Mo Limited under the "know how" agreement da e 2.6.1995 is revenue expense and not partly or who y capital expense?"

2. • The respondent-assessee Hero MotocoiT Limited, earlier Imown as Herd Honda Motors Limited, was ajoint venture between the Hero Group ITA 694, 696, 698, 699/2011 & 625, 633/2012 ^ and Honda licenced by Honda. mannfectute and sale of mo ^,,e „, f9S[4], «Mcb «as mv.sed by collaboration contract d agreements were valid second and third and Honda thereupon for a period often years. 3,^4 entered into another ^„„,,„ed in the present technical assistance agreem ^ -'•-•"trr:::— raised IS whether royalty p tinn raised by the Revenue is ri^fttrp Another contention raisea uy or partly capital expen • nvahle under the agreement „., „..a., -« ™ ••" aawd T' Jwte, mi f" \ by the Revenue relates to payme items arise for the same was but these aspects h^^^ consideration inAssessm and raised in the appeals preterrea 10 2002-03. • cthe relevant clauses ofthe 'licence and Before we critically examine the releva technical assistance agreement' dated 2- June. 1995 " ™ ' rr know-how. Afrequent and prim y ^ capital and revenue expenditure,s the enduring nsLssee incurs expenditure which gives enduring benefit m the cap: distinctfrL expenditureofconcurrentandreoccurringnature in reverefield, itistreatedandregardedascapita.^ tc3t is applied on the basis ofcommercial principles and^not. astia.t- ITA 694, 696, 698, 699/2011 &625, 633/2012 694, 696, 698, 699/2011 &625,633/2012 ITA Page 3 of; ITR 1(SC) exempUfied that when the anadvantageofendnmgbene^t•^,,, nature ofadvantage eonsi ere ^ management to conduet assessee's trading ormore profitability, whileleavingthe assessee's busrness more „ t fixed capital untouc e.. ^ indefinite future. The test o though the advantage may en ur conclusive test; it enduring benefit is, there ore, camrot be applied impetuo y p^.^^t.mal,:: r- - common sensical and down sent case we have to consider whether the 4, In the facts of t epre ^ information and expenditure mcuri-ed on acquisi 10 know-how would satisfy theendurmg business apparatus, in right acquiredhad enabledfire assessestrading practical and commercial sense. •Xeclmicalmformationandhnov.howmei^^^^^^^^ characteristics as distinct from tangi eas person over aperiod of time or — nansfer ownership or grant alicence ^ limited rights, while retaining ownership riglrts. i„,.,-... »-*" -•"• '"f,:t» WO.IJ..»».»! " ~ "'l " " ownership. its relevance in determiningwhether the \4 The aforesaid aspect and r„ eap.ta, expenditure was to acquire tec mca commissioner of or revenue field was elucidated y ^j„,aed, (1968) 69 ITR Income'Tax, Bombay Citf Iversus ^ pecember, 1967 is 692 (SC). This judgment question/issue. Inthe said case, ioeessantlycitedandappliedtodeede^^9 tire assessee company had procured to formulae, scientific p„„peny, to produce licensed property rights inIndia. Inspite ofthe fact diat the preparationstodto promomtltor^,ghtand Swiss Company ha 8™ t^nts listed in Scheduled, to ucenee" in the territory ofIndia „ o3e ^ „.heuse, exercise todvendttom— rhetrademartosetoutmSche^ ^ court held that what was conferre assessee, it was observed, was no ^ infonnation was not to trademarks etc. As per the agreemen,. be divulged to third parties wtoout access to the technical toowle ge an,rdtrademarksfor aliimtedptom^ ^ - assetofitsbusiness,nordid^m[1] ^, advantage of ™.o^toess as amanufacturer tod rely draw for tire purpose,,as no ^ upon tire technical know eg,,3oiutely infavouroftheIndian attempt to partwith technical taow eg fo,- all assessee. It was not acase of transfei Thus,theexpendlmre incurredwas revenuein nature. ITA 694, 696, 698, 699/2011 & 625, 633/2012 • 1? •• fmds resonance in subsequent decisions T The aforesaidlegal positron find n H in CITvs. Brilish Indian Corp. Ltd. ) ofthe Supreme Court mCI and CIT 51 (SC), CITvs. Indian Oxygen ^ vs. Wavin (India) Hi- (1999) 2 wiow-how andwhatwas granted outrightsaleoftechnicalinformation^an was non-exclusive or ose the loiow-how after (supra), the Indian company was terminationofagreement. „ftime for use ofknow-how Absence ofstipulationas to dum^» etc., and whether itwouldbe etermi^ whether itisacaseofouttiglfttr»^ Ini^tstries ^ideredhy l^e -Ihr, the said case, the Indian Ud. vs. CIT (1981) 127 ^on-transferable atrd nonassessee had been ^,„owledge and secretprocess for assignable licence in respect „tcept tuanufacture of sealed ^gteement, it was obseiwed with the consent of 8 terminated at end of oontemplatedthatitwould contmueunl s^^ 10 years and at end of succee mg ^ inference that years was consideredtobe notun u g jy the division bench aoine lasting advantage was obtaine p^noiple held that once conclusion was reac e paymentmade for „,ntmade for acquisition of assets and pay between apayment ^ p^l,[3] mto only use of intellectual property rig. ^ ^ insignificance. Payment Similarly, whether period, it will be only jt,,,finthe absence ofother paymentwas fn, acquisition of acapital facts, help decide whether th g ^

11 A detaileddispussiononthesaidaspectistobefoundrnthedecision iTrfr^ r70091 176 Taxman 355 lueij, ofthiscourtinCITvs. J.K.SyntiieticsIt.i2m^^ wherein the principles to distinguish capl a an ^,TA694, 696,698, 699/2011 a625,633/2012,, i:ve to refer to clauses 5and 6.no We would only litre set out in paragraph 38. we thereof which reads as under:-,.f T•,cense which aceords..(V) expenditure mcuned for g.an icess"toteehnicai „rdina,ii, be treated technieal knowledge and 'nforma ^ - o-e"uld.rave to e.oael, look at tbe the gram from the enau, attendant cireumstances, such as.-. (a)thetenure oftheLicence. ' •nt ifany in the licensee to create furtheiiig (b) the right, if any, m in favour ofthird parties,. •. • parting with aconfidentia

(c) the prohibition, i any parties information received under without the consent ofthe heenso, trptn^fers the "fruits of research

(d) wlreter the Licence transfers ofthe licensor,"once tor all, • oaf the Licence the licensee is (e) whether on expii^ obtained required to ^retuin ^^^^or even though the licensee under the Licence o ^ product, in respect of, "tTess-- ritnowledge was obtained during the which subsisteneeottheUcerroe. tt,wbedtera„,seo.totpro.ss«^ by the licensor od be would ordiuarily be aLss to such secret process construed as capital mnature. COnSUU&Ll ".r nnnld use the technical knowledge

(vi) the fact^ that assessee for the purposes of its obtained during the tenuie o expired, and in that sense, business after the ^ has been categorically resulting in an endnrmg a ^ by itself, passage oftimebecome obsolete,TA694, 696, 698, 699/2011 8. 625, 633/2012 2015:DHC:11016-DB. +1 o riprkion of the Bombay High The said decision makes reference to the decisi ^ loe sdiu u ^ Engineermg & Court in Commtdone, of Income Tax v. Tata g r Pvi m (1980) 123 ITR 538 (Bom) where payment was Locomotive Co Pvt Ltd ^ made to the foreign collaborator m respec information reciuired for manufacture of automohve products. T liningadoptedbyDivisionBenchoftheBombayHr^Courtwasto the effectthat teclmicallcnowhow made available under an agieemen not stand on the same footing as protected rights of aregistered paten •••mto use in limited sense was granted. It was not holder, as mere ng material whether assessee could use the knowno ^ agreement on the ground that this aspect was wholly —ua^ • • n on other grounds/reasoning recorded in the sai express no opinion on otner g decision.) • T-TA "NTn I4'b0/2010 titled CIT vs.

19 PecentlY the Delhi High Court in ITA No. 1450/2Uiu J -A A n99^''Aunust 2012, observed that when Modi Revlon PvL Ltd., decided o '.r nit would - Q; p fnr use of know-how, it wouio. royalty was paid for alimited purpose, i.e. for use Kn be revenue in nature as the entire benefit of know-how was mean manufacture ofproducts. Itwasnotamatterwhereassesseeha undertake the manufacture through acontractor. In the sai case, olrship of the brand, remained property of the foreign party and a licence to operate in adefined territory was granted. Expenditure wa. allowedundersection37(1)oftheAct. Thiswas inspite ofthefacttha originallicencewasforindefiniteperiodandthesupplementary agre^ did not indicate aterminuo,uo. It was, however, obseiwed agreement could be terminated and upon such expiration or teimmahon. Therewasnovestingofknow-how or goodwillintheIndianassessee. if?

13 Learned counsel for the assessee has ^so referred to decisions ut • ^ • (m ltd (1981) 127 ITR 409 (AP), Electrical Imdmtnes (P) Pw, U 1 ^0091 254 ITR 294(Guj), CIT vs. Jyoti Carbon Lid, (2002) 294 iiiv v 170021 255 ITR 345(Guj), S.if.f. Took ltd. vs. CIT Electric Motors ad. (2002) 2t, ^ m i,d (2000) (1999) 237 ITR684 (Mad), CITvs. Southern Pressings (P) L ( ) 242 ITR67 (Mad) and CITvs. B.N. Bias& Co. (P) Ud. (m 190(Cal). Weneednotspecifically dilate any more onthe sarc aspec m a O- oflaw as expounded above. However, we would like view ofthe position oflaw as expou noRat 148 to refer to the decision in Cirvs; SotrtfcOT SM..fcfcg<K"-T •( ITR272 (Mad)reliedonbytherevenue. Inthe saidcase,the assessee la for settingupofafactory andoperationthereof. Theforeigncompany ta treednottomanufactureproductsinIndiaorgiverighttoathirdperson to dothe same. Referringto the clauses ofthe agreement, theHigh Com Held that technical knowledge so secured had resulted man en uimg advantage andbenefit, asthe same was available even aftertermination o trtreement sincethe factory and its operationwould have coi—. The duration of the agreement was 5years but the method, production plcedure, etc.wouldremainwiththeIndian assessee and, th.efore m enduring benefit/advantage was acquired. There was also con eimei exclusive right to manufacture and sell the articles, » independent right secured and was of an enduring nature. Accm gy A- iinwpfl as caoital expenditure. Noticeably, 25% ofthe royalty paid was disallowe as capi P • hwas obseiwed that fire entire royalty was foi acquisition ^ p,„Uegeto manufacrnre andselltheproducts and, therefore, itwas pa y capitalandpartlyrevenueinnature. Theaforesaiddecisionwasuphel y^ the SupremeCourtby ashortorderobservingthatthey weienotpeisua ! l!:: that the view ofdre High Court was erroneous vide W... 2-4 A (199S) 2.32 ITR.s. J^asc™.d«edb, Switchgear • ^ S*''S''"'' •. «d (2009) 319 359, The decision 1 ^ Motor Industna the Delhi High Court" ^ facts. „Kl09(Del)-d-sdisting.a «utispi-dhelote>.j;-^J;^^^^^^^„„a,,^ The tenn riDted 2"'^ nthose patents, utility agi-eement stood defined to mea 'intellectual property ng intellectual property HE • t^pitents and other mrei to manufacturing ot rtdels design patents thereof or to man Lctlytotheproductsorthelicens^ P pa^tH. the products and their ptopertyrightsrelating 0*^= nti;inodels,designpatentsan terin rZal property limited to dravrtugs, stand p^nducts or U •Kand direction maps etc. directy term manuals ai manufacture of i rtini t nf or necessary fo^^ any technical parts thereof, ct^.^ov/-lioNV technical information' was to m product 01 rLmationtrot includedin-;::,leofproductorlicensedparts linensedpartorwasnecessaryfor orwoul ^ «hiehtheHondaownedatfoe ^^^^^^nent, The^n^ own from time to tune urin as expressly spe t anCts' meant two-wl^eelei development codes, v.. " rat and (h). identifiedby dcensorsd J „„her clauses (a) an ( sloped an 198s, KCCA. etc. which (e), dw manufacture under the earlier a^^^ pursuant to inolude additional models or yp.p,, n new.„30del ehange' as speet^d r,r CQR 699/2011 St 625, bfi3/ ITA 694, 696, 698, b,esponde.tassessee.Uhaew deve P.,„P Si.Ua.y. t.e^,as»a.eby a ttaougb «feh anew mode „„t lumted ebange many part menUm.y.dmeaeb easewas.ppeaeanee,struemre,charactenst ^,,„,ded • •.t to anew model agreement. The ag subject to a new engaged mm,,st the respondent assessee ws ^„,,,ee utanubacturlng, assembling, se.gj,,e earl.er wheelers and their parts as J,,Psequen eollaboration agreement date,,3po„den.. t thereto which confened ana distribute,, amendment tttereto „,„„fseture. assemble, sell, ussessee a right and hcen,epalrandservicetwo/threewheel. r>fthe agreement were. IS The otherterms ofthe agr •• tdbythelicensorto the respondentassesses (1) Rights and licenses grane. (enable, without tire iig t o, „ere ettCusWe,,,„,Ue the ^""1: - rights and duties under the agreement product or pa s ^„,,,ectly. (orthetermoftheagreement, i.e. 10 years (« ^"^--^ldl"^':::;;,jaJune.1994. from the effective date 01/ from the effective date 01/ (3) The Agreement defaulting party, if d ai e ^ (orthwlth by aparty, if tte other party Page i3of 20 PA694,696,696,69S/mU[8].a«,633/201/ mereed with, or was adead, o. iaddecd. change in shareholdingown r fi-ip Qsicemctrt, iupan expiration of termmation. due to eau ^^^ufacture, assemble,, t pmsessee could contm obligations, respondent assess cf then deliver services but indudingpaytnentofroyalty..areeventofpre—— ro defanltofperformanceo^oj^^^^,„a oh. ^"•^""''''TrToLcts and the parts, as well as tire tts dispositions 0 information..rtellectnalpropertyng ^^^ (6) Purther inthe eventof propertiesm conneclron ropronrptlyretnrnalldocu.^-^^^^^^ and all r,hh the agreement »^ andconfrdent.alityclanses. rntormationreceive un ^^^.[3] factories and other Honda had right to access.e re.^^^ ^..^er facilities for rverebeingcompliedwith conditions/obligations n (3) ffnowhow, technical —- ^ ^^,,3,Hy the husiness information was 0rema^^ ^^„,,,„ce for property ofHonda and was 0 ^^3 „„t rc he Honda by the respondent ass.se. ^ny divulged, communicated or y^d. Respondentwas to mannerwhatsoever, exceptasexpressyp,r,e9a,ess,sss,sss/mrr--s,e3S/zors 2- • „to keep the said infomiation secret and take all necessary precau ^ the present agreement. Th for protection ofsecrecy. „aintamintert.a,regn,.ionsand^^^^ The informatron con ^ fo, hte approved sub-contractors tvh purpose of manufacWre. asse ^ ^^foeontractors to — ^'1"™:: al—tiai. •treataninformatronassec. _ enexp.ration (p^Theaforesaidrightsandohiigationsweretopersrs orterminationoftheagreement. ^ nt to use or cause or permit use by y (10)The respondent assessee was n foformation third party, totellectual property rrght orevidedunder the agfcement. ^ ewas not to claim any title or property rrgh an Ice ofthe agreement. Upontermination whatsoever during the exrs aresult ofdefault ofthe respondent assessee. ropehyorinterestwhatsoevercouldbeciarmed... respondent assessee became aware or • et" propertyrrghtofHondainlndiabyathrrdparty. (13)Therespondentwas^;-rXoltyand/orsale form to Honda regarding ma ol ofparts or products. Hondawa^a accounts, financial statements and records.. Lactionsascontemplatedundertheagreement.,TA694,696,698,699/2011[8],625,633/2012,, jiot written consent, responaent conta trot, — ^ aitecUy or tnatreetiy or — agent or any other or otherwise deaintg tn irranufactnting, assembhng. two/threewheelers ofother pat -::-j RuimingRoy^^^y- ^under the new a, ^Moaei fee' was agreenrent. P—^,,,,on stipniated the amonn^o payments. The agreemeirt „f usi „odel fee payable in respee ^ 10,00,000/- was payable mtr the,rst 60 days of the ^^--1,,,, „1 Honda Government ^^-^'^YVtletJeimiealhtfottnationnecessaryfor deliveringtotheresponden ^fter the.watmfaeture and assembly, an had partiescortftrmedm writtngth eommeneed on commerc.al basts, whicheverwas earlier. ^^ b. Royalty was running and multiplying the rate ''•'•'r irx:::'.' specified m Bxhibii warehouse sales price. r -d terms and conditions and applying the • 15, Readmg the aforesaid term „,,houwere for rightto expounded, ithastobeheldthatthepayments. Pag0 16of20 ITA694,696,698,699/2011 & 625,633/2012,., vnowbow and information. Tde or rather for access to thetaowho« or technical owcrship aad the mtellectua p „3pondent irformation «ere never transfe b, Tlrecrvrtershlp^-^^^ ^^^^^ Honda. Theproprietorshrp m th,3e on the respondent assessee but ony^ i„tarrgible strict and stringent terms were gr^te^^^,be. continued to remain the ^..gpondent assessee for day to informatiorr.etc.weremadeava.a^ „s bay mnnlng and OP^ sales had already commence was not exactly new. M of the fns aaber the agreement dated 24 - • oontrnu.ty * « n"-;•

I. „„.».. »"»•' „„ „ „«»-M '» ".. V- '• »• f-~'.*• » agreement merely penmtted ptoprietorship and ownership payment ofroyalty and that after 10 years and tightwas never granted or trans jospondent assessee could still after returningthe jlowhow and information would be a have continued to use tec ic automobile industry, ttWia, and inconseTuentra,;^;;J^p:,onearethedayswhenone teclmology upgradation is cons ^ ^ob or two manufacturers ernoyedmonop^^ of out-of-date models. indeterminate wart an... artloiow-how is injectedevery year TTTbttdC.tltoheepupandupgradewouldresultm:r::-:l-msales.-Tersistentupgradationandcuttingedge Page17 of20,TA 694, 696, 698, 699/2011 & 625, 653/2012 ^6 „„irement inthe competitive market technology is.mandate attdbusittessreq,Pt«o/three wheelers. Model fee. subieet matter of PP^.„ 2001-02 is.merely Rs.4.09 lakhs an ^,ears. crores. The said royalty pa.d to assessment-year 2001-02 was R• •.,^,,,„,mal Hortda. if pa.d f- tiEbt to nse of m ^ ponble property right, would poss.bly 3^, Ore sa.d Taxation Avoidance Agreemen ^^3 absolute paymentmightnotbetaxablernM^a^ by arrd complete transfer of ' f3permanentEstablishme.tt(See Horrdato thelndian assessee ma between Mdicles7andl2ottheDo«bleTaxat.on Indiaa.td,Tapan). „ear 2000-01. Revenue has also •

18. in the appeal for lakhs paid as technical guidance challenged the tax treatment • has -• -^-"^-^^'nCl^ilantRcvenue. Intheabsertceofany notbeenplaced onrecordby the pp documentandevendetails astothematur^.^^^^^^ ca.mot adjudicate and dex.de thrs.ssu.eatmentgivenbytheTribunalis,therefore, n -ng the course ofhearing had drawn our,p. The respondent assessee urmg.„,™-.. ' • " " " - " ~ nature had arisen for the fir expenditure and. therefore. Tribunal had held that ^be.r dec.sion reported as;r;;^ - «"•«-—t::r",TA694, 696,698,699/2011 a625,635/2012 May 2005. The Delhi Commissioner ofIncome Tax, deeide ^ on the said -».—-ttryT - aspeet in the appeal of the Rev dismissed. For ^ ~ UoO.s...e.pe.a..cof the assessment yeais gied by tee«as allowedasrevennee.pen^ the Revenue on the sat ^^3 g,e,„d and reason, as «ould not Hke to dectde P,,e ffiglt court „„ „,ether the Hrglt Court. We do rrot eornmen f„,„e any under Seetion 260A ol tne additional question oflaw.. • t the eontention ot tire respondent/assessee w.th

20. We also rejeet th •:„„er under Section 263 ofthe Act reference to the power,^p,g„ed order the Tribunal relating to assessment year 2Uti onthesaidquestionheld:- _ ^,3, assessmentyear "Learned counsel has ^^^e ^elhi High Court was 2001-02, the 263 appeal befo ^ourt passed the not pressed by the assessee ^nd Hon consideration orde'r to the effect that the -sue will be op in other years. In our v, expenses being acoirect Officer allowing '^odel fee and.ggessment order view, there was no eiTOi in pas g ^002-03 is quashed. Therefore, 263 -f;r2^order passed 'by GIT Since we have quas ciT(A)'s consequential subsequent proceedmgs I.e. AO sand Uit ) orders thereon are also quashed. A reading ofthe aforesaid reasoning clearly eluc.dates that the Tr.buna has held that payments made by respondent to Honda were revenue escpendtture and not capital. On the said finding on merh, the Trtbunal observed that there was no error in the order passed by the Assessmg Officer. Power under Section 263 can be invoiced by the Commtss.oner onlywhentheorderpassedbytheAssessrngOfficerrserroneousandnot <>-2^ It is in these circumstances, that no specific quesfion of law ' der Section 263 ofthe Act, has been framed m with reference to power under theappeal relatingto assessmentyear2001-02.

21 Inview oftheaforesaiddiscussion, thesubstantial questionsoflaw •nnsweredrnfavour oftherespondentassesseeandagarnsttheappell are Revenue. to costs. ITA j There will be no order as

22. -The appeals are accordingly disposed.