Royalty paid to acquire technical know-how to be used in manufacture is capital expenditure

  • Corporate Law
  • High court
  • Financeseva

Assessee paid royalty to Hitachi Construction Machinery Company Private Limited, Japan (HCM). Such an amount was paid for the use of technical know-how and a grant of rights for manufacturing Hitachi’s licence products, which included intellectual property.  

Assessee claimed deduction under Section 37(1) on the ground that the aforesaid amount was used for the purposes of its business.Assessing Officer (AO) held that as per the agreement between the parties, there was no payment in lumpsum and royalty was payable at the rate of 1% of the net factory selling price. 

The royalty was required to be paid in respect of each of the new HCM licence products sold by assessee for a period of 7 years from the date of commencement of commercial production or 10 years from the execution of the agreement, whichever is earlier.  

AO concluded that the payment was made for the acquisition of the right, which provided lasting benefit. Therefore, the same was held as a capital expenditure. Accordingly, the assessee’s claim of deduction under section 37(1) was disallowed. 

On appeal, Karnataka High Court held that from the perusal of the relevant clauses of the agreement, it was clear that the assessee was a joint venture company. Under the agreement, it had been granted a non-transferable licence to manufacture/assemble the Hitachi’s licence products within the territory using technical know-how furnished by it and to otherwise dispose of its licence products. Items can be sold only under the trade/brand name of Tata Hitachi. 

Even after the expiry of the 11 years from the date of commercial production, the assessee was entitled to continue the manufacture and sale of Hitachi licence products for the aforesaid term of the agreement. Under the agreement, the assessee had incurred an expenditure which gives him enduring benefit, therefore, the same had to be treated as capital expenditure.Thus, the order passed AO as well as ITAT holding that payment of royalty made by assessee was a capital expenditure and was not a permissible deduction under section 37(1) was upheld by Karnataka High Court.