Supreme Court rules expenditure on acquiring technical know-how is deductible under Section 35AB (of Income Tax Act, 1961), not Section 37 (of Income Tax Act, 1961).

Case Name

Drilcos (India) Pvt. Ltd. Vs Commissioner of Income Tax

Civil Appeal No.1400 of 2005

Key Takeaways

- Expenditure incurred for acquiring technical know-how for business purposes is deductible under Section 35AB (of Income Tax Act, 1961).

- Section 35AB (of Income Tax Act, 1961) provides for amortization (deduction in installments) of such expenditure over a period of 6 years.

- Once Section 35AB (of Income Tax Act, 1961) applies, Section 37 (of Income Tax Act, 1961) (related to general business expenditure) does not apply for such expenses.

- The court emphasized that the expenditure should have been incurred "for the purposes of the business" for Section 35AB (of Income Tax Act, 1961) to apply, even if the entire payment could not be made.

Issue

Whether the expenditure incurred by the assessee company for acquiring technical know-how from an American company should be deducted under Section 35AB (of Income Tax Act, 1961) or Section 37 (of Income Tax Act, 1961), even though the entire payment could not be made due to disputes between the parties.

Facts

- The assessee company, Drilcos (India) Pvt. Ltd., manufactures mining equipment.

- In 1990, the company entered into a "License and Technical Assistance Agreement" with an American company to acquire technical know-how.

- The total consideration was US$ 225,000, to be paid in three installments.

- The first installment of Rs. 17,49,889 was paid on November 29, 1990.

- However, disputes arose between the parties, and the American company did not transfer the know-how.

- The assessee claimed deduction of Rs. 17,49,889 under Section 37 (of Income Tax Act, 1961).

Arguments

- Assessee's argument:

The expenditure should be deducted under Section 37 (of Income Tax Act, 1961) (general business expenditure) since the entire payment could not be made due to disputes.

- Income Tax Department's argument:

The expenditure should be amortized (deducted in installments) under Section 35AB (of Income Tax Act, 1961), which deals specifically with expenditure for acquiring technical know-how.

Judgement

The Supreme Court dismissed the assessee's appeal and upheld the Income Tax Department's decision. The court held that the expenditure incurred by the assessee for acquiring technical know-how should be deducted under Section 35AB (of Income Tax Act, 1961), and not under Section 37 (of Income Tax Act, 1961).

The court reasoned that Section 35AB (of Income Tax Act, 1961) clearly states that expenditure incurred for acquiring know-how "for the purposes of the business" should be amortized (deducted in installments) over a period of 6 years. The court emphasized the phrase "for the purposes of the business," stating that the expenditure was incurred for acquiring know-how to be used in the assessee's business, even though the entire payment could not be made due to disputes.

Once Section 35AB (of Income Tax Act, 1961) applies, Section 37 (of Income Tax Act, 1961) (related to general business expenditure) does not apply for such expenses.

FAQs

Q1. What is the significance of this Supreme Court ruling?

A1. This ruling clarifies the applicability of Sections 35AB and 37 of the Income Tax Act, 1961, for expenditure incurred in acquiring technical know-how for business purposes. It establishes that such expenditure should be deducted under Section 35AB (of Income Tax Act, 1961), even if the entire payment could not be made due to disputes.

Q2. Does this ruling apply only to technical know-how, or can it be extended to other types of expenditure?

A2. While the specific case dealt with expenditure for acquiring technical know-how, the ruling's interpretation of Sections 35AB and 37 could potentially have broader implications for other types of expenditure related to acquiring intangible assets for business purposes.

Q3. What is the legal reasoning behind the court's decision?

A3. The court reasoned that Section 35AB (of Income Tax Act, 1961) specifically deals with expenditure incurred for acquiring know-how "for the purposes of the business." Since the assessee had incurred the expenditure for acquiring know-how to be used in its business, Section 35AB (of Income Tax Act, 1961) applied, even though the entire payment could not be made due to disputes.

Q4. What are the implications of this ruling for the parties involved?

A4. For the assessee company, this ruling means that the expenditure incurred for acquiring technical know-how should be deducted under Section 35AB (of Income Tax Act, 1961) (amortized over 6 years) and not under Section 37 (of Income Tax Act, 1961) (general business expenditure). For the Income Tax Department, it clarifies the interpretation and application of Sections 35AB and 37 in such cases.

Q5. Does this ruling set a precedent for future cases involving expenditure for acquiring intangible assets?

A5. While the ruling does not explicitly cite legal precedents, it could potentially serve as a guiding decision for future cases involving the interpretation of Sections 35AB and 37 and the deductibility of expenditure incurred for acquiring intangible assets for business purposes.

Heard learned counsel on both sides.

This civil appeal filed by the Department concerns Assessment Year 1993-1994.

The assessee manufactures equipments which are used for mining. It entered into an Agreement with an American company on 7th June, 1990. The Agreement with the American company called ‘Licence and Technical Assistance Agreement" under which the American company was required to transfer technical know-how to the assessee for consideration of US $2,25,000/- to be paid in three instalments. The first instalment in convertible Indian currency amounting to Rs.17,49,889/- was paid on 29th November, 1990. Subsequently, disputes arose between the contracting paries and the know-how was not transferred by the American company. The short question which arises for determination is whether the amount of Rs.17,49,889/- could be claimed by the assessee as a deduction under Section 37 (of Income Tax Act, 1961)?

The claim of the assessee under Section 37 (of Income Tax Act, 1961) [‘Act’, for short] was rejected by the Department. However, the Department allowed the expenditure to be amortized under Section 35AB (of Income Tax Act, 1961).

The contention of the assessee is that Section 35AB (of Income Tax Act, 1961) is not applicable to this case. We find no merit in the said contention. Sub-section (1) of Section 35AB (of Income Tax Act, 1961) clearly states that where the assessee has paid in any previous year any lump sum consideration for acquiring any know-how for use for the purposes of his business, then one-sixth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year and the balance amount shall be deducted in equal instalments for each of the five immediately succeeding previous years. Explanation to the said section says that the word ‘know-how’ means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine. If one carefully analyzes Section 35AB (of Income Tax Act, 1961), it is clear that prior to 1st April, 1986, there was some doubt as to whether such expenditure could fall under Section 37 (of Income Tax Act, 1961). To remove that doubt, Section 35AB (of Income Tax Act, 1961) stood inserted. In sub- section (1) of Section 35AB (of Income Tax Act, 1961), there is a concept of amortization of expenditure. In the present case, it is true that on account of certain disputes which arose between the parties, the balance amount was not paid by the assessee to the American company. However, the word ‘for’ in Section 35AB (of Income Tax Act, 1961), which is a preposition in English grammar, has to be emphasised while interpreting Section 35AB (of Income Tax Act, 1961). Section 35AB (of Income Tax Act, 1961) says that the expenditure should have been incurred for the purposes of the business of the assessee. In the present case, the Technical Assistance Agreement was entered into between the assessee and the American company for acquiring know-how which was, in turn, to be used in the business of the assessee. Once Section 35AB (of Income Tax Act, 1961) comes into play, then Section 37 (of Income Tax Act, 1961) has no application.

For the afore-stated reasons, we see no error in the impugned judgment of the High Court.

Accordingly, the civil appeal filed by the assessee stands dismissed with no order as to costs.

[S.H. KAPADIA]

[MADAN B. LOKUR]

New Delhi,

September 06, 2012.