Facts of the Case

M/s Gujarat Guardian Ltd. established a float glass manufacturing plant in Gujarat with technical assistance obtained from Guardian Industries Corporation, USA. The foreign company provided engineering services, technical expertise, supervision, training, and assistance for setting up the plant.

During the financial year 1992-93, the assessee paid engineering service fees to the foreign company. Initially, the expenditure was recorded as deferred revenue expenditure. Subsequently, upon professional advice that the expenditure had been incurred before commencement of production and was therefore required to be capitalized, the assessee revised its return and capitalized the expenditure in its books.

The assessee claimed depreciation on the capitalized engineering service fees. The Assessing Officer disallowed the claim, holding that the expenditure represented payment for technical know-how and was therefore eligible only for deduction under Section 35AB of the Income-tax Act, 1961.

The Commissioner of Income Tax (Appeals) allowed the assessee's claim for depreciation. The Income Tax Appellate Tribunal upheld the order of the CIT(A). Aggrieved by the Tribunal’s decision, the Revenue filed an appeal before the Delhi High Court.

Issues Involved

  1. Whether the engineering service fees paid by the assessee to the foreign company were for setting up the float glass plant or for acquisition of technical know-how relating to manufacture and production.
  2. Whether the assessee was entitled to claim depreciation under Section 32 of the Income-tax Act, 1961 on the capitalized expenditure.
  3. Whether the expenditure was covered by Section 35AB of the Income-tax Act, 1961 relating to acquisition of know-how.

Petitioner’s Arguments (Revenue)

The Revenue contended that:

  • The engineering service fees paid to the foreign company represented consideration for technical know-how.
  • Since the expenditure related to know-how, the assessee was entitled only to deduction under Section 35AB of the Income-tax Act.
  • The claim of depreciation under Section 32 was not permissible.
  • The Tribunal erred in treating the expenditure as capital expenditure eligible for depreciation.

Respondent’s Arguments (Assessee)

The assessee argued that:

  • The collaboration agreement primarily related to planning, design, engineering services, erection, installation, commissioning, and setting up of the float glass plant.
  • The payments were made for establishing the plant and not for manufacturing or processing goods.
  • Technical know-how relating to production and operational assistance was governed by a separate agreement.
  • Therefore, the engineering service fees formed part of the cost of setting up the plant and were rightly capitalized.
  • Consequently, depreciation under Section 32 was allowable.

Court Findings

The Delhi High Court examined the collaboration agreement and the related arrangements between the assessee and the foreign company.

The Court observed that:

  • The collaboration agreement clearly established that the foreign company was engaged for providing complete design, engineering services, training, supervision, erection, commissioning, and assistance in setting up the float glass plant.
  • Documentary evidence and bills produced by the assessee demonstrated that payments were made for services rendered by foreign technicians engaged in setting up the plant.
  • The expenditure was directly connected with establishment of the plant and not with manufacture or processing of goods.

The Court further analysed the Explanation to Section 35AB(3), which defines "know-how" as industrial information or techniques likely to assist in the manufacture or processing of goods.

According to the Court:

  • The engineering service fees in question were not paid for information or techniques assisting manufacture or processing.
  • The expenditure was incurred solely for setting up the plant.
  • Technical know-how relating to manufacturing operations was covered by a separate agreement.
  • Therefore, Section 35AB had no application to the expenditure under consideration.

The Court also noted that the Tribunal had rightly observed that the definition of "plant" under Section 43(3) is broad enough to include technical know-how in the form of drawings, designs, charts, and plans, making it a depreciable asset.

Court Order

The Delhi High Court upheld the decision of the Income Tax Appellate Tribunal and held that:

  • Engineering service fees paid for setting up the float glass plant constituted capital expenditure forming part of the plant.
  • Such expenditure was eligible for depreciation under Section 32 of the Income-tax Act, 1961.
  • Section 35AB was not applicable because the payment was not made for know-how used in manufacture or processing of goods.
  • No substantial question of law arose for consideration.

Accordingly, the Revenue's appeal was dismissed.

Important Clarification

This judgment draws an important distinction between:

Expenditure for Setting Up a Plant

Where payments are made for design, engineering, erection, commissioning, installation, and establishment of a plant, such expenditure may be capitalized and depreciation can be claimed under Section 32.

Expenditure for Technical Know-How Used in Manufacturing

Where payments are made for industrial information or techniques assisting manufacture or processing of goods, the provisions of Section 35AB may apply.

The determining factor is the true nature and purpose of the payment rather than the terminology used in the agreement.

Sections Involved

  • Section 32 of the Income-tax Act, 1961 – Depreciation
  • Section 35AB of the Income-tax Act, 1961 – Expenditure for Acquisition of Know-How
  • Section 43(3) of the Income-tax Act, 1961 – Definition of Plant
  • Section 260A of the Income-tax Act, 1961 – Appeal to High Court

Link to download the order -

https://delhihighcourt.nic.in/app/case_number_pdf/2007:DHC:581-DB/MBL24052007ITA762006.pdf

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