Judgement Briefs

Taxation Law

Honda Siel Cars India Ltd. v. Commissioner of Income Tax

(2017) 8 SCC 170; (2017) 395 ITR 713

Citation
(2017) 8 SCC 170; (2017) 395 ITR 713
Court
Supreme Court of India
Date
9 June 2017
Bench
A.K. Sikri and Ashok Bhushan JJ.

Facts

  • Honda Motor Company Ltd., Japan, and an Indian company entered into a joint-venture agreement for manufacturing Honda cars in India.
  • Honda Siel Cars India Ltd. was incorporated for establishing and operating this new car-manufacturing business.
  • In 1996, the assessee entered into a Technical Collaboration Agreement with Honda Japan.
  • Honda Japan agreed to provide:
  • technical know-how;
  • manufacturing information;
  • drawings and specifications;
  • production techniques;
  • assistance relating to quality control and manufacturing.
  • The assessee was granted a non-transferable licence to use this technical information for manufacturing Honda cars in India.
  • It agreed to pay:
  • a lump-sum technical fee of USD 30.5 million in five instalments; and
  • continuing royalty calculated with reference to sales.
  • The assessee claimed that these payments were revenue expenditure because:
  • ownership of the intellectual property remained with Honda Japan;
  • the licence was limited in duration;
  • the assessee did not acquire the know-how permanently.
  • The Revenue treated the payments as capital expenditure because the technical know-how enabled the assessee to establish an entirely new manufacturing business.

Issue

  • Whether the technical know-how fee and royalty paid to Honda Japan were:
  • deductible revenue expenditure under section 37; or
  • capital expenditure incurred for establishing the assessee’s profit-making structure.

Rule

  • The capital or revenue character of technical know-how payments depends on the commercial purpose and effect of the expenditure.
  • A payment is more likely to be capital where it:
  • creates or establishes a new business;
  • provides the basic technical foundation for a new manufacturing facility;
  • forms part of the assessee’s profit-earning structure.
  • A payment may be revenue where:
  • the assessee already has an established business;
  • the know-how merely improves an existing product or production process;
  • no new source of income or manufacturing apparatus is created.
  • Absence of permanent ownership of the know-how is relevant but not decisive.
  • The court must examine what the payment achieved in practical and commercial terms.

Application

  • Before entering into the agreement, Honda Siel did not have an existing business manufacturing Honda cars.
  • The technical information was not introduced merely to improve an already functioning production process.
  • It supplied the basic technology without which the new manufacturing activity could not have been commenced.
  • The know-how covered the complete manufacture of Honda vehicles, including:
  • design;
  • production techniques;
  • material specifications;
  • quality-control standards;
  • assembly processes.
  • The Court accepted that the assessee did not become the legal owner of Honda’s intellectual property.
  • However, capital expenditure does not require an absolute transfer of ownership.
  • An enduring commercial advantage can arise through a sufficiently valuable and long-term right of use.
  • The technical collaboration formed an integral part of the arrangement under which:
  • a new company was incorporated;
  • a new factory was created;
  • a new line of automobile production was established.
  • The Court distinguished cases where technical payments were treated as revenue because the taxpayer was already carrying on the same business.
  • In those cases, the new technology merely modernised or improved the existing operations.
  • Here, the technology was the very foundation of the assessee’s income-producing structure.
  • The fact that the agreement was for a limited period and that the material had to be returned after termination did not alter its essential commercial effect.
  • The expenditure brought the new manufacturing apparatus into existence rather than meeting the ordinary recurring costs of operating that apparatus.

Held

  • The Supreme Court held that the technical know-how payments were capital expenditure.
  • A later clarification expressly confirmed that both:
  • the lump-sum technical fee; and
  • the continuing royalty for the relevant assessment years were treated as capital expenditure.
  • Since the amounts were capitalised, the assessee was entitled to claim depreciation in accordance with law.