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Petitioner: COMMISSIONER OF INCOME-TAX, BOMBAY CITY 1 VS Respondent: CIBA PHARMA (PRIVATE) LTD.Honorable Justice Y. S. TAMBEG. N. Joshi,N. A. Palkhivala
1966 P T D 209
1966 P T D 209
[Bombay (India)]
Before Y. S. Tambe and V. S. Desai, JJ
COMMISSIONER OF INCOME‑TAX, BOMBAY CITY 1
versus
CIBA PHARMA (PRIVATE) LTD.
Income‑tax Reference No. 67 of 1961 decided on 21st January 1965.
Business expenditure‑Scientific research expenditure‑Tech nical and research contribution. paid to another company for acquiring know‑how‑Whether scientific research expenditure or business expenditure‑Litigation expenses‑Indian Income‑tax Act, 1922, S.10(2)(xii), (xv).
The assessee‑company, a subsidiary of a Swiss company, entered into an agreement with the Swiss company whereby it agreed to pay a percentage of its net sales to the Swiss company and in consideration thereof the Swiss company would communicate currently or at the request of the assessee all the results of its research work in so far as it related to the products manufactured by the assessee‑company. The informa tion received by the assessee was not to be divulged during the currency of the agreement and on termination of the agreement the assessee had to return copies of the information to the Swiss company. The assessee company claimed that the amount paid by it as research contribution was deductible under section 10(2)(xii) or alter nately that it was business expenditure allowable under section 10(2)(xv):
Held, that the research carried on by the Swiss company was for the advancement of its own business and not on behalf of, or at the instance of, the assessee. The consideration paid was not therefore an expenditure laid down or expended on scientific
But the use of the knowledge which the assessee‑company acquired was limited for the purpose of the conduct of the business during the duration of the agreement and so an asset of an enduring nature was not acquired. The amount expended on acquiring the knowledge was spent wholly and exclusively for purposes of business and was allowable under section 10(2)(xv).
In order to bring a case under section 10 (2)(xii) it is incumbent on the assessee on whom the burden lies to establish that the expenditure incurred by him was on a research carried on either by himself or on his behalf or at his instance for the purposes of his own business.
The assessee‑company under an agreement dated June 18, 1948, purchased from another company "Ciba Dyes" its stock‑in trade, etc., and undertook to discharge liabilities of "Ciba Dyes" as from and after January 1, 1948. 1t had also entered into an agreement with the Swiss company whereby it agreed to assist the Swiss company in the defence of patents and trade marks by giving all useful information. The Swiss company incurred expenses in the defence of patents and trade marks by a suit instituted in 1946 and the assessee‑company claimed that it had contributed to the expenses and that the sum contributed was allowable as business expenditure as it was incurred in consequence of its agreement with "Ciba Dyes" and alternately under its agreement with the Swiss company:
Held, that as no evidence was tendered showing that the liability of the Swiss company towards defence of patents and trade marks had been taken over by "Ciba Dyes", the assessee did not succeed to the liability under the agreement entered into on June 18, 1948. The agreement entered into between the assessee and Swiss company did not provide for sharing of expenses in respect of infringement of trade marks. Moreover, the agreement was not retrospective and as the facts showed that the expenses were incurred prior to the incorporation of the assessee, the amount was not allowable under section 10(2)(xv).
G. N. Joshi with R. J. Joshi for the Commissioner.
N. A. Palkhivala with F. N. Kaka for the Assessee.
JUDGMENT
Y. S. TAMBE, J.‑This is a reference under subsection (1) of section 66 of the Indian Income‑tax Act and is in respect of the five reference applications made to the Tribunal relating to the assessment years 1949-50, 1950‑51, 1951‑52, 1952‑53 and 1953‑54, the accounting years being the respective previous calendar years. After consolidation of these five reference applications relating to the aforesaid assessment years, two questions of law have been referred to this Court. The first question is common for all the five years and the second question is common only for three assessment years, viz., 1950‑51; 1951‑52 and 1952‑53. Facts giving rise to this reference in brief are:
The assessee‑company, Messrs Ciba Pharma Private Limited, Bombay, hereinafter referred to as the "Ciba Pharma", is a cent per cent. Indian subsidiary of Ciba Limited, Basle (Switzer land), hereinafter referred to as the "Ciba Basle". Ciba Basle deals is drugs, medicines, chemicals, pharmaceuticals and biological products. Ciba Pharma has been incorporated in India on 13th December 1947. Prior to incorporation of Ciba Pharma and for some little time after its incorporation, Ciba Basle was carry ing on its business in India through a company called Ciba (India) Limited, which was also a cent. per cent. subsidiary company of Ciba Basle. The activities of the Ciba Basle carried on in India through Ciba (India) Ltd. consisted of dealings both in pharmaceuticals as well as dealings in dyes and chemicals. In the year 1948, the activities of Ciba Basle in India till then carried on through Ciba (India) Ltd. were bifurcated. The pharmaceu tical section was carved out and given over to Ciba Pharma and the rest of the activities in dyes and chemicals were being continued by' Ciba (India) Ltd. , under a changed name, Ciba Dyes Ltd.
Now, with regard to the business in pharmaceuticals, which was handed over to Ciba Pharma, an agreement has been entered into between the Ciba Basle and Ciba Pharma. The agreement is of date December 17, 1947, and is Annexure "A" to the statement of the case. The answer to the first question turns on the construction of this agreement. The preamble of this agreement consists of two paras. The first paragraph describes the various activities of Ciba Basle and the second paragraph sets out the business which Ciba Pharma had installed for carrying on its business and the consideration it had agreed to pay to Ciba Basle for obtaining the necessary information for the conduct of its business. After the preamble, the operative part of the agreement consists of 6 articles. Articles 1 and 2 set out the obligations, which Ciba Basle had undertaken to perform or fulfil. Article 1 relates to the technical. consultancy which Ciba Basle had agreed to give to Ciba Pharma and Article 2 relates to the licence under Ciba Basle's patent and trade mark rights, the use of which Ciba Basle had agreed to grant to Ciba Pharma. Article 3 describes the consideration, which Ciba Pharma had agreed to pay to Ciba Basle. Article 4 prohibits Ciba Pharma from assigning the benefit and the obligation of this agreement without the written consent of Ciba Basle. It similarly prohibits Ciba Pharma from granting any sub‑licence under the patents and/or trade marks of Ciba Basle without its previous written consent. Article 5 relates to the duration of the agreement and its termination. It provides that the agree ment would come into force from January 1, 1948, and its duration was five years, but terminable on three months notice in the event of default in the performance of its obligations by any party. Article 6 relates to the arbitration in the event of any dispute arising between the parties to the agreement. We are here concerned principally with the preamble and Articles 1 to 3.
The first paragraph of the preamble shows that Ciba Basle, at the material time, was engaged in the development, manufac ture and sale of medical, pharmaceutical, biological and bacte riological preparations. These products have been referred to in this agreement as "the said products". For the purpose of the production or of the trade with the said products, Ciba Basle had established and was maintaining and continuously developing chemical, medical, biological, bacteriological and pharmaceutical research laboratories, factory laboratories standardization depart ments, engineering departments and propaganda and patent depart ments. Ciba Basle, therefore, had acquired valuable scientific know ledge, research methods, data and material concerning its activates in the aforesaid sphere of development, manufacture and sale of medical, pharmaceutical, biological and bacteriological prepara tions. The preamble further states that the work, Which had been allocated to these various departments essentially consisted of discovery of new pharmaceutical products, the introduction thereof into the clinical, medical and general use, as the case of each parti cular product may be, the elaboration of processes of production on factory scale and the improvement of already used processes, the drawing up and filing and supervising of patent applications as well as the continuous watch on patent, the standardization of processes and of new products; the design and construction of suitable engines for the production on laboratory and factory scale, the continuous entertainment of relations with the scientific and medical professions in order to secure their help as well as the results of their medical, clinical and scientific work. Para graph 1 of the preamble further states that for these pur poses Ciba Basle had employed and was employing in its various departments, chemists, physicians, druggists, lawyers, engineers and other scientific and technical experts. It had also secured the help of considerable number of famous university professors and other well‑known scientific authorities. Ciba Basle was also engaged in training certain staff members in various departments with a view to sending them out to its affiliated and associated companies in order to give the benefit of the special knowledge acquired by these members of the staff fn the various departments conducted by Giba Basle. The concluding part of the first paragraph of the preamble is:
"The yearly amount of current costs, salaries and expenses incurred by abs Bale in the‑ maintenance and the development of these departments as well as in new equipments formd part of Ciba Basle's general costs."
Paragraph 2 of the preamble provides:
"Ciba Pharma has installed its own tab letting, ampoule filling and finishing work and has an organisation suited for the distribution and promotion of the said products. Ciba Pharma wishes to acquire the extensive knowledge and practical experience in the pharmaceutical field that Ciba Basle com mands by reason of its long and extensive research work and scientific and practical experience. Therefore, the parties have agreed that Ciba Pharma shall pay to Ciba Basle a. technical and research contribution for the use of its Indian patents and/ or trade marks referring to the said products. The technical and research contribution is at the same time a consideration for the scientific and , technical assistance and will refund partly Ciba Basle's costs and expenses for the maintenance and development of the research work described in this preamble."
Article 1 consists of two paragraphs and paragraph 1, which is the material paragraph, reads:
"Ciba Basle will communicate currently and/or at request of Ciba Pharma all the results of its research work, in so far as they relate to the said products, which are already manufactur ed or processed or sold by Ciba Pharrna or which shall here after with the prior approval .of Ciba Basle be manufactured or processed or sold by Ciba Pharma. Whenever manufacture or processing of a preparation is taken up by Ciba Pharma with the prior approval of Ciba Basle, the pertaining patent rights and trade marks will be licensed to Ciba Pharma according to the terms of articles I and III. In this case Ciba Basle undertakes to deliver to Ciba Pharma all processes, formulae, scientific data, working rules and prescriptions pertaining to the manufacture or processing of the said products, which have been discovered and developed in Oba Basle's laboratories and will forward to Ciba Pharma as far as possible all scientific and bibliographic information, pamphlets or drafts, which might be useful to introduce licensed preparations and to promote their sale in India. All physical material shall be in voiced by Ciba Basle to Ciba Pharma at costs price."
Paragraph 2 of Article I prohibits Ciba Pharma from divulging to third parties confidential information received by Ciba Pharma from Ciba Basle and requires Ciba Pharma to keep all data connected with the manufacturing processes under lock and key. Paragraph 1 of Article 2, which relates to the licence under Ciba Basle's patent and trade mark rights, states:
"Ciba Basle is registered or has applied for the registration as the case may be as the proprietor of several Letters Patent in India relating to the pharmaceutical products and listed in Schedule I of this agreement. Furthermore, Ciba Basle is registered proprietor or has applied for the registration as the case may be of several trade marks relating to pharmaceutical products and giving protection in India, these trade marks being set out in Schedule II of this agreement."
Under paragraph 2 of the said article II Ciba Basle granted to Ciba Pharma the full and sole right and licence under the patents listed in Schedule I to make use of, exercise and vend the inventions referred to therein in India. It similarly granted Ciba Pharma the full and exclusive licence to use the trade marks set out in Schedule II. The other paragraphs of this article are not material for the purpose of this case. Paragraph 1 of article III is in the following terms:
Technical Research Contributions
As consideration for Ciba Basle's obligation stipulated in Articles I and 11, Ciba Pharma agrees to pay to Ciba Basle half yearly the following percentage contributions of the total of the net selling prices of all pharmaceutical products manufactured or processed and/or sold by Ciba Pharma
(a) Contribution towards technical consultancy and technical service rendered and research work done.
5%
(b) Contribution towards cost of raw material used for experimental work.
3%
(c) Royalties on trade marks used by Ciba Pharma.
2%
Total
10%
The said technical research contribution of 10 % was reduced to 6 % with effect from January 1, 1949. It has been stated at the Bar by counsel for the parties that the reduction was froth 5 % to 1 % in the aforesaid item (a). The other paragraphs of article III are not material for the purposes of this case. Schedule I sets out the Indian patents of which Ciba Basle had been registered as a proprietor or which had been applied for. It may be mentioned that it held a patent for a preparation known as "Cibazol" Schedule II gives a list of these trade marks of which Ciba Basle was the proprietor or which had been applied for by Ciba Basle. It may be mentioned that it was also proprietor of the Indian trade mark "Cibazol".
The first question relates to the payment made by Ciba Pharma to Ciba Basle under the aforesaid paragraph I of article III of the said agreement. Paragraph 6 of the state ment of the case shows that under the certificate dated June 6, 1950, given by the Swiss company, it is found that out of the total expenditure of 8,409,364 Swiss francs incurred in 1948 on research, recoveries from several entities like the Ciba Pharma and others came only to 4,613,701 Swiss francs. It is not necessary for us to give the figures of all the 5 years of the contributions made by Ciba Pharma to Ciba Basle. Barring the difference in the figures and the amount paid, the facts are identical. We may, therefore, take the assessment figures of 1949‑50.
Now, in the assessment year (949‑50 Ciba Pharma claimed deduction under section 10 in respect of the payment of 10 % of its net sale price made by it to Ciba Basle under paragraph 1 of Article III of the agreement. 2 % out of the said amount had been allowed by the Income‑tax Officer being a payment towards royalties on trade marks used by Ciba Pharma. But the remaining 8 % which amounted to Rs. 6,32,948 had been disallowed by the Income‑tax Officer on the ground that the expenditure was incurred by the Swiss company for its own business and that the assessee was not a manufacturing company so as to be eligible to get the benefit of research expenditure.
The assessee took an appeal to the Appellate Assistant Commissioner, who took the view that the said payment, which has been made under the agreement of December 17, 1947, was clearly in the nature of a purchase price paid for the permanent rights of acquisition conferred upon the appellant‑company under the agreement of the knowledge and the technical "know‑how" of the parent company for the enduring benefit of the undertaking of the appellant's business in pharmaceuticals, which is in the offing to be set up. The payment is clearly in the nature of a payment by annual instalments of a capital sum. In this view of the matter, the Appellate Assistant Commissioner held that the payment is in the nature of a capital expenditure. He, therefore, disallowed the claim of the Ciba Pharma that the said payment was an expenditure incurred on scientific research relating to its business. In this view of the matter the Appellate Assistant Commis sioner dismissed the appeal. The assessee‑company took a further appeal to the Tribunal. Before the Tribunal, the aforesaid amount was claimed as an allowable expenditure under section 10(2) (xii) as well as under section 10 (2)(xv). The Tribunal accepted the contentions of the assessee and allowed the assessee's claim on the ground that the expenditure was incurred in connection with the research in the line of the assessee's business. It, therefore, came within the provisions of section 10 (2)(xii). There was nothing to show in section 10 (2)(xii) that the expenditure must be incurred by the assessee. The Tribunal also; in the alternative, held that the expenditure was laid out wholly and exclusively for the assessee's business and there was no capital element involved in the expenditure. The Tribunal, therefore, in the alternative held that the expenditure would be an allowable deduction under section 10(2)(xv) of the Income‑tax Act. At the instance of the Department, the following questions have been referred to us:
"Whether, on the facts and in the circumstances of the case, the payment made by the assessee to Ciba Basle Ltd. in pursuance of the agreement dated December 17, 1947, is an admissible deduction under the provisions of section 10 (2)(xii) of the Income‑tax Act and if not, under section 10 (2)(xv) of the Act, either in part or whole ?"
It would be convenient to deal with this question first before we proceed to deal with the second question. The first aspect of the question; therefore, that arises is whether the said payment, which admittedly is made in pursuance of the agreement dated December 17, 1947; is an expenditure laid out and expended on scientific research relating to the business within the meaning of section 10 (2)(xii) of the Indian Income‑tax Act.
It is the contention of Mr. Joshi, learned counsel for the revenue, that the payment is not an expenditure within the meaning of section 10(2)(xii) of the Act. It is his argument that on a true construction of the said agreement of December 17, 1947, it is not an expenditure laid out or expended by Ciba Pharma on scientific research. On the other hand, it is a contribution made towards the expenditure incurred by Ciba Basle. The organisation or the research carried on by Ciba Basle is maintained by Ciba Basle for its own purpose and for the purpose of extending its own business. The research, which is carried on by Ciba Basle is not dependent on whether the contribution is made by Ciba Pharma or not. There is also no obligation on Ciba Basle to carry on any research in a particular manner as such at the instance of Ciba Pharma. Ciba Pharma, therefore, has neither incurred any expendi ture on scientific research nor has it incurred any expenditure on scientific research carried on its behalf. On the other hand, it is the argument of Mr. Kaka, learned counsel for the assessee, that the expenditure falls under section 10(2) (xii) of the Act. To attract the provisions of section 10(2) (xii) it is sufficient to establish that it is an expenditure, not being in the nature of a capital expenditure, laid out and expended on scientific research relating to the business. It has not been held that the expenditure is in the nature of a capital expenditure. For an expenditure to be laid out or expended on scientific research, it is not necessary that an assessee himself must expend it on the research. If two or more persons agree to conduct for their mutual benefit research work and share the expenses, the contribution made by each would be an expenditure incurred, laid out or expended on such research. It will thus be an allowable deduction as an expenditure laid out or expended on scientific research relating to the business. Mr. Kaka also drew our attention to the following observation of the Tribunal in its order
"There is no dispute that this expenditure relates to the appellant's business . . ."
and contended that one of the conditions that the expenditure must relate to the business has been established. There is also no dispute that Ciba Basle was carrying on research and the research carried on by Ciba Basle was also in respect of the products in which Ciba Pharma is dealing. There could, therefore, be no doubt that the expenditure incurred by Ciba Pharma was an expenditure relating to its business. Mr. Kaka also further drew our attention to the first sentence in paragraph 10 of the Tribunal's order, which reads
"The amount paid per article III of the agreement appears to us to be in the nature of a share of expenses incurred by the foreign company for conducting research for itself and also on behalf of the Indian company."
Relying on the aforesaid observation Mr. Kaka argued that the Tribunal has found as a fact that the research, which was carried on by Siba Basle was on behalf of the assessee‑company. That being the position, it can hardly be said that the contribution made by Ciba Pharma towards the expenditure incurred by Ciba Basle was not an amount laid out or expended on scientific research. We are unable to accept Mr. Kaka's contention that in the aforesaid observation on which reliance has been placed by Mr. Kaka, there is any finding of fact as such that the research carried on by Ciba Basle was a research carried on by itself and on behalf of Ciba Pharma. On the other hand, reading the judgment as a whole, it is clear that the said view taken by the Tribunal is on the construction of the agreement. The Tribunal does not say that they so hold on consideration of the evidence, but on the other hand, what is said by the Tribunal is "it appears to them" that the amount paid under article III of the agreement to be "in the nature of a share of expenses incurred by the foreign company" for conducting research for itself and also on behalf of the Indian company. After setting out the facts up to paragraph 4, the Tribunal has set out article III of the agreement. In paragraph 5 the reduction in the percentage contributions is referred to. Paragraph 6 refers to the calculation of 8 per cent. and in paragraphs 6A and 7 of the judgment the arguments advanced on behalf of Ciba Pharma as well as the Department are summarised. The arguments advanced by Ciba Pharma as summarised in paragraph 6A show that the contentions raised before it were two‑fold: in the first instance it was contended that the contribution made as per agreement represented a part of, or an addition to, the invoice cost of the goods and as such allow able under section 10(1) on the principles of commercial account ancy. In the alternative, it was argued that it was allowable under section 10(2),(xii), 10(2) (xiv) or 10(2)(xv). The arguments advanced related to the construction of the agreement. Paragraphs 8 and 9 deal with the first part of the argument as to whether it was a part of the sale price, and the sentence is on which reliance placed is the first sentence of paragraph 10 of the judgment. In our opinion, therefore, the observations on which reliance is placed are made on a construction of the agreement and the question to be considered is whether such a position emerges on the construction of the agreement. Section 10 (2) (xii) is in the following terms
"(1) The tax shall be payable by an assessee under the head `profits and gains of business, profession or vocation, in respect of the profits or gains of any business, profession or vocation carried on by him.
(2) such profits or gains shall be computed after making the following allowances, namely : . . .
(xii) any expenditure (not being in the nature of capital expenditure) laid out or…
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