THE issues before the HC are - Whether when the non-resident partner of the JV does not tranfer the right of technical knowhow, even partly, for manufacture of products, royalty payment as per agreement is to be construed as revenue expenditure and whether any disallowance can be made with respect to brand promotion expenses. And the verdict goes in favour of the assessee.
Facts of the case
A) Assessee, an Indian company, is a joint venture (JV) between Modi Mundipharma Pvt. Ltd. (MMPL) and Revlon Mauritius Ltd. (RML) for manufacturing and marketing Revlon products in India and neighboring countries on an
exclusive basis. MMPL and RML had invested in the ratio of 74:26 to form the assessee-company. In terms of the JV agreement, MMPL was responsible for the setting up, manufacturing, distribution and marketing Revlon products in the designated territory. RML was to provide know-how, trade mark, etc. The assessee entered into a technical know-how agreement with Revlon Mauritius Ltd. for supply of technical know-how to manufacture the goods. Under the said agreement, in consideration for the supply of know-how, the assessee had to pay, every year, royalty (net of taxes) at the rate of 5 %, on domestic sales and 8 %, on export sales. During the year, the assessee paid royalty of Rs. 4,73,06,822 to RML in pursuance of the grant of right to use the technical know-how. The assessing officer disallowed this royalty expenditure stating that the amount paid to the licensor was not expenditure wholly and exclusively incurred for the business of the assessee and that it was incurred partly for the business of the sister concerns of the assessee, i.e., its contract manufacturer M/s. Kamakhya Cosmetics and Pharmaceuticals Pvt. Ltd., and its distributor M/s. Win Medicare Ltd. It was held that deduction of royalty could be allowed in the hands of the assessee on the basis of the proportion of its sales to the total sales on which royalty was calculated and payable to the licensor. The assessing officer treated part of royalty payment as capital in nature, and disallowed 25%, of such royalty payment. The AO’s objection while capitalizing 25 per cent, of the royalty paid was on account of his opinion that the know-how agreement was open ended in terms of duration and that the assessee had exclusive right to use the know-how and patents and the new products developed by the licensor. The Appellate Commissioner, on appeal by the assessee held that capitalization of 25% was unjustified; the amount was reduced to 5%. The ITAT allowed the assessee’s appeal, on this aspect, and dismissed that of the revenue.
B) Assessee had claimed publicity expenses of Rs. 30.51 lakhs during the year, for promotion of the “Revlon” brand. The AO disallowed Rs. 14.57 lakhs, holding that such proportionate amount could not be attributable to the assessee’s business. This was confirmed by the CIT (A). The ITAT considered the submissions of the parties, and observed that the agreement entered into by the assessee with WMPL obliged the latter only to bear the cost of advertising and other expenses relatable to the customer sector and that the expense for brand promotion was that of the assessee exclusively. It was also held the agreement with WMPL did not in any manner preclude the assessee undertaking that expenditure, since it was a purely commercial decision, entitled to promote the brand, as its exclusive user. The ITAT went by the previous years’ practice, where such expenditure had been allowed by the AO.
C) During the AY, the assessee paid Rs. 88.98 lakhs to MMPL as consultancy charges under the agreement dated 1-1-1995. This payment to MMPL was for the latter’s advice concerning day-to-day conduct of management of the assessee-company in respect of setting up and monitoring of distribution and marketing management, manufacturing of Revlon products according to the latter’s internationally applicable specifications and standards, suggesting changes in the product design and the specifications based on market feedback of new products, product advertising policies and campaign, price negotiations of various inputs from the suppliers, etc. The assessing officer alleged that consultancy charges were nothing but an arrangement to siphon off part of the assessee’s profits to its sister concern and JVs. The assessing officer allowed Rs. 30 lakhs as directors’ remuneration and disallowed Rs. 58.98 lakhs under Section 40A(2), holding it as unreasonable and excessive. The Commissioner (Appeals) deleted this disallowance holding that the assessing officer wrongly concluded that no services had been rendered by MMPL. The Commissioner (Appeals) held that rendering of services by MMPL was proved from the records, and no disallowance was warranted under Section 40A (2). The revenue’s appeal to the ITAT on this score was rejected.
On appeal to the High Court, the Revenue argued that the fact that the know-how agreement between the assessee and Revlon Mauritius was a continuing one, and the time agreed to originally had long since passed. This, coupled with the fact that the Revlon brand was given over exclusively to the assessee by its owner, was a clear pointer to its conferring an enduring capital advantage to the former. Thus, the conclusion drawn by the AO that disallowance to the extent of 25% of royalty payment was warranted. Counsel for the revenue relied on the judgment of the Madras High Court in Commissioner of Income Tax v Madras Rubber Factory to say that the royalty resulted in the foreign brand owner imparting to the assessee an advantage that “on operational matters might tend to outlast, and endure beyond, the contract period” clearly amounting to a capital advantage of an enduring nature.
On the question of consultancy charges it was argued that the AO had given cogent and sound reasons for not allowing more than Rs. 30 lakhs. This was based on the permissible limit of remuneration payable to a company, under the Companies Act. The asseesee had incurred more than Rs. 58 lakhs in excess of that limit. Moreover, the AO reasoned that the amount paid as consultancy was excessive, regard being had to the nature of activities of MMPL, since production and distribution were undertaken by other sister concerns, on behalf of the assessee. Therefore, the so called consultancy charges were a mode to claim exaggerated amounts, disproportionate to the services rendered. The CIT (A) and the ITAT fell into error in interfering with the findings of the AO, which were based on the appreciation of documents. The assessee had a duty to explain how such expenses were reasonable. It failed to do so.
Having heard the parties, the Bench observed that,
A) ++ the question of whether royalty payments constitute capital or revenue expenditure has been the subject of frequent consideration by courts. The traditional view of whether the payment secures an asset of enduring nature, was held, to be inadequate. The new approach to considering whether expenditure is capital or revenue, was taken further, in the decision of Alembic Chemical Works v Commissioner Income Tax (2002-TIOL-160-SC-IT);
++ the tests evolved over a period have disapproved the applicability of the “once and for all” payment approach. A more structured test has been commended, which would take into account several factors, such as license tenure; whether the licensee can create further rights in favor of third parties as regards use of technical knowledge; whether there is any restriction or prohibition with regard to use of confidential information received by the licensee to the third parties without consent of the licensor; whether license transfer benefits once and for all; whether on expiry of the term the licensee has to return plans, designs and other process knowledge to licensor even though it may continue to manufacture the product; whether any secret or process of manufacture was sold by the licensor to the licensee;
++ the know-how agreement between Revlon Mauritius and the assessee initially was for a period contained in the foreign collaboration letter issued by the FIPB, Government of India, dated 14-1-1994; (that fixed the duration of the agreement was ten years from the date of agreement or seven years from the date of commencement of commercial production). The seven year period expired on 29-8-2002. The assessee had requested the Government on 21-7-2003 for extension of technical collaboration agreement. Approval to this was granted by letter dated 6-8-2003. The supplement agreement dated 16-9-2003 was executed between RML (Licensor) and the assessee, made effective from 1-10-2003;
++ in terms of Clause 3 of the agreement, it was treated as part of the original assessment except as modified. Consequently all the terms and conditions remained unchanged. The original know-how licence agreement was dated 14-1-1994 and royalty payments in terms of that agreement were made till August 2002, i.e., for a period of seven years. The payment of royalty in the year under assessment was made in terms of supplement agreement dated 16-9-2003. The Tribunal therefore concluded that there was no question of any fresh input of know-how/technology and the payments were only in respect of continued use of brand name and patents owned by the foreign company. Hence no benefit of enduring nature was derived by the assessee against these payments of royalty;
++ according to various clauses of the know-how licence agreement read along with the supplement agreement royalty payable as net sales of taxes the know-how was provided by the contract manufacturer in terms of Clause 4.01 of the agreement. This was for the limited purpose of manufacture of Revlon products only. The responsibilities of the contract manufacturer were clearly defined in the agreement between the assessee-company and the contract manufacturer, according to which obligation relating to royalty payment was not passed on to the contract manufacturer. The entire benefit of the know-how was meant for manufacturing the products to be supplied to the company and there was no obligation of the contract manufacturer (i.e. the assessee’s sister concern) to pay royalty to the licensor;
++ the fact that the assessee chose to manufacture through a contractor, i.e. its sister concern, in this Court’s opinion does not undermine its status as a licensee, responsible to pay the royalty. That the assessee was the exclusive licensee of the brand, in the territories, is not a relevant factor. If ownership of the brand continued with the Revlon Mauritius, as it did, in this case, the fact that it did not wish to license its knowhow or patent to anyone else would be a wholly extraneous circumstance. Quite often, brand owners do not – for strategic or business reasons- wish to allow more than one licensee to operate in a defined territory. It could be considerations of exclusivity, avoid intra territory licensee competition, or so on. Therefore, the exclusive nature of the license is not a relevant factor, at least in this case- which could have legitimately weighed with the revenue authorities. As far as the indefinite time period is concerned, the original license was not indefinite; the supplementary agreement no doubt does not indicate a terminus quo. However, that factor is rendered insignificant, because the supplementary agreement expresses the term (of the arrangement) to be the duration of the Central Government approval. Moreover, the arrangement can be terminated. Furthermore, there is nothing in the agreement suggestive of any vesting of the know-how, or part of it, or the goodwill in the brand, in the licensee/ assessee. In these circumstances, this Court is of the opinion that the revenue’s arguments about the royalty amount being really in the nature of capital expenditure, is meritless. The Tribunal’s findings on this point are therefore, upheld;
B) ++ as far as the second aspect, i.e. expenditure for promotion of the brand is concerned, there is no doubt that the dealer’s functions extend to advertising the products of the assessee, manufactured by the sister concern. On this aspect, Section 37 of the Income Tax Act would be relevant;
++ in the present case, the AO was conscious of the fact that brand promotion expenses are a necessary ingredient in marketing strategies. Therefore, he allowed about 50% of those expenses. However, the reasoning for disallowance of the rest, i.e. that the assessee could claim only a proportion of such expenses, since advertising expenses were to be borne by the sister concern dealer, and that the proportion was in respect of its territory, was not upheld. This Court does not see any fallacy in the Tribunal’s approach or reasoning, on this aspect. One is not unmindful of the concerns of a business which engages in sale of consumer items, and faces continuous competition. Brand promotion enhances the visibility of given products or services, and are often perceived as conferring a competitive advantage on those who adopt those strategies or schemes. Expenditure towards that end is based on pure commercial expediency, which the revenue in this case, ought to have recognised, and allowed;
C) ++ this Court notices that in order to determine whether the payment is not sustainable, the AO has to first return a finding that the payment made is excessive, under Section 40-A (2) of the Income Tax Act. If it is found to be so, then the AO has to determine what constitutes the fair market value of the services rendered and disallow the difference between what is claimed and what is such value determined (as fair market value). Apart from the fact that no such exercise was undertaken by the AO, the Court sees that the assessment order went off into a tangent, in following a method that was clearly inapplicable. The annual cap of Rs. 30 lakh payable to managerial personnel applied to public limited companies, and not those such as the assessee. This aspect was noticed by the CIT (A) who set aside the disallowance. The Tribunal upheld that finding. Such view (of admissibility of similar consultancy charges) is supported by several decisions, which have been noticed in the detailed order of the CIT (A). This Court finds no valid grounds to interfere with those findings, which are both sound and reasonable.
No comments:
Post a Comment