There has been a long-drawn controversy regarding the tax treatment of payment for technical know-how. Broadly speaking, when an expenditure is incurred in order to bring into existence an asset or an advantage of enduring benefit, such an expenditure is properly attributable to capital and not to revenue. But where the payment is made for the purpose of running the business more profitably and effectively, the payment will be revenue in nature. Various courts have laid down the guidelines to determine the nature of expense, whether capital or revenue, but the diversity of facts may be such that the principles laid down by the courts may not be applicable in the peculiar circumstances of each case.
The aforesaid situation has resulted in disputes arising in a large number of cases, but no clear guidelines are yet available to decide whether the expense is capital or revenue. However, as far as the payment for know-how in lump-sum is concerned, the situation was somewhat clarified by the insertion of Section 35AB with effect from assessment year 1986-87, which remained in force up to 1998-99 only. During this period, the lump-sum consideration paid for acquiring technical know-how was allowed as a deferred revenue expenditure by spreading the same in six equal installments. In specified cases, the deduction was allowed only in three years.
The provisions of Section 35AB were discontinued with effect from assessment year 1999-2000. But an important amendment was made effective from that very year by virtue of which the cost of know-how became eligible for depreciation. After the aforesaid amendments, the legal position is that either the payment for technical know-how will be allowed as a revenue expenditure or, if the same is treated as capital expenditure, depreciation shall be allowed on the same.
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The terms and conditions of the collaboration agreements between the parties will primarily decide whether the expense is capital or revenue. If a taxpayer desires the payment to be treated as a revenue expenditure, the collaboration agreement should clearly reflect that the payment is for running of his business more profitably and effectively and that the payment does not bring any advantage of enduring nature. The period of agreements sometimes is very crucial to decide whether an advantage of enduring nature accrues to the taxpayer or not.
In a recent case, the Calcutta High Court (251 ITR 155) was seized with the matter to decide whether the payment for know-how was revenue or capital. An Indian company had paid a lump-sum consideration for technical know-how and claimed the same as revenue expenditure. The income tax department took the view that as the Indian company acquired an enduring benefit, the payment was of capital nature and therefore, could not be allowed as a deduction from income. Interestingly, both sides quoted various Supreme Court decisions in support of their claim. However, the fact which clicked the issue was the duration of the agreement. The agreement provided that the same would be valid for five years, but even after the expiry of the period of five years, the Indian company might continue to use the technical know-how provided to it by the foreign company.
The court observed: