The need for specialisation and constant updation in today?s world often requires corporates to pay a technical know-how fee or support fee to an overseas company for the use of updated technical information in the manufacturing process.
Often deductibility of such technical know-how fee becomes the subject matter of dispute on the pretext that it is of capital nature. This dispute becomes further acute in cases where such fee relates to the first year of operation.
Section 37 of the Indian Income-Tax Act allows deduction in respect of any expenditure not specifically covered otherwise, provided it has been wholly and exclusively incurred for the purpose of business or profession and it is not in the nature of capital expenditure.
On the other hand, amortization in the form of depreciation is permissible in respect of certain tangible and intangible assets (including know-how) under Section 32 of the Act. However, it must be noted that amortization of costs allowed under Section 32 is in the nature of beneficial provision and does not require an expenditure, which is of revenue nature per se to be capitalised.
The primary question which, therefore, arises in these cases is whether technical know-how fee is a capital expenditure eligible for depreciation under Section 32 or a revenue expenditure eligible for 100% deduction under Section 37 of the Act.
The apex court has dealt with this issue in the case of Ciba of India Ltd (1967) (69 ITR 693). The question, which came up for consideration before the court, was whether contribution made by an Indian company to a foreign company in consideration of the right to receive scientific and technical assistance was capital or revenue in nature. The court observed that under the agreement the taxpayer did not became exclusively entitled to the patent or trademark but merely had access to the technical knowledge and the experience commanded by the foreign company. Therefore, the contribution paid was deductible as business expenditure of revenue nature.
In a recent decision in ITA Nos 3098 & 2664/ Del/ 2004, the Delhi Tribunal decided the deductibility of the technical costs paid in the very first year of operation.
The tax authorities contended that payment for know-how for starting a new business was to be treated as capital in nature. However, the tribunal, having examined and analysed the agreement in detail, noted that the Indian company was merely granted the right to use technical information and did not acquire any rights whatsoever in the technical information. All documents and drawings were to remain the sole propriety of the licensor and had to be returned to the licensor on termination of the agreement. Therefore, the expenditure was of revenue nature.
Though there was an initial lump sum payment and that technical information was obtained at the start of a new business, these facts were held to be immaterial for the purpose of deductibility of expenditure as revenue in nature.
In another important decision rendered in ITA No. 5079/Del of 2004, the Delhi Tribunal held that the fee paid in the very initial year of operation towards technical know-how, design and drawings, which merely enabled a company to manufacture the products as per requirements and was not in respect of setting up of manufacturing facilities, was in the nature of revenue expenditure. The tribunal observed that such payments actually amounted to acquisition of guidance or payment of consultancy.
These decisions go on to prove that any fee paid for the provision of technical services cannot automatically be considered to be a payment of capital nature unless it results in absolute transfer of technical knowledge to the taxpayer.
Where the fee is paid by the taxpayer only for obtaining access to information, which does not become its own, it would be deductible as revenue expenditure. It is immaterial whether such fee relates to the first year of operation or subsequent years.
?Lala is executive director and Kumar is associate director of PricewaterhouseCoopers ?Tax Litigation Cell.
