Sunday, June 27, 2010

ITAT (AHM):Royalty: Necessary ingredient for treating a payment as royalty is exclusiveness of right of a person over design or invention invented by him

Royalty: Necessary ingredient for treating a payment as royalty is exclusiveness of right of a person over design or invention invented by him


Once there is no patent or any intellectual right vested in a person over a thing, no claim of royalty can be allowed to him.

[2010] 5  TAXMAN 113 (Ahd. - ITAT) ITAT, AHMEDABAD BENCH `C' AHMEDABAD ITO v.Patwa Kinariwala Electronics Ltd.ITA Nos. 2781/Ahd/2008, 934/Ahd/2006, 2448/Ahd/2005 and 2826/Ahd/2006 May 31, 2010

FACTS 

During the course of assessment proceedings in the first round AO noted that assessee company as paid royalty of Rs.8,22,773/- @ 3% of the net value of the "electrical yarn cleaner & classikin". When enquired it was explained that `electrical yarn cleaner is a product which is originally manufactured by few companies in the world. It requires high degree of technology and is costly if imported. Shri Rajan Patwa is a technical expert who invented an electrical yarn cleaner in India. These instruments are now manufactured by the assessee company. Shri Rajan Patwa gave advice and guidance right from the design, development and manufacturing stage. It was for the said services that company has paid royalty @ 3% to him. The AO however, held that payments to Shri Rajan Patwa were unjustified and unreasonable and accordingly he disallowed the entire claim. The ld. CIT(A) vide his order dated 19.11.2001 sustained the said disallowance of royalty payment. In second appeal vide its order dated 27.10.2006, the Tribunal set aside the issue and restored the matter to the file of AO with direction to decide the matter considering the evidence produced by the assessee to prove that the payment of royalty was for business purposes. Fresh evidences were called for in the reassessment proceedings. The assessee furnished copies of patent certificate, copy of agreement dated 12.12.1976 between Shri Rajan Patwa and M/s Kinariwala R.J.K. Industries which was one of the patent holders. Subsequently fresh agreement renewing the terms of the agreement of 12.12.76 was executed on 4.4.1996. The AO after examining all these documents held that the patent is not registered in the name of Shri Rajan Patwa to whom the royalty payment was made. Therefore, following the decision in first round, the AO disallowed the claim again 



HELD
Firstly when we examine the present case, we notice that no material is placed before us to show that there was a claim of royalty in the firm and it was allowed after scrutinizing the issue. The necessary data like profit and loss account or balance sheet, assessment order under section 143(3) in the case of the firm are not produced before us. Secondly the firm is no longer in existence in the assessment year 1997-98. We are examining the case of the company and, therefore, the issue is required to be looked into differently afresh. Earlier the patent certificate issued in 1978 had the effect of allowability of the claim of royalty. There is no evidence before us to show that patent certificate(s) were submitted to the AO while making the assessment of the firm so that they could know that patent had expired after 14 years and, therefore, claim of royalty is required to have a re-look. After formation of the company in 1996, the effect of allowability of the claim in earlier years in the firm no longer survives in the subsequent years. Once there is no patent or any intellectual right vested in Shri Patwa no claim of royalty can be allowed to him. The term royalty has been defined by Courts as a payment of any kind received as consideration for the use of or the right to use industrial, commercial or scientific equipment. It normally connotes, the payment made to a person, who has exclusive right over a thing for allowing another to make use of that thing which may be either physical or intellectual property or thing. Mere passing of information concerning the design of a machine which is a tailor made to meet the requirement of a buyer does not by itself amount to transfer of any right of exclusive user so as to term the payment made therefore as royalty. The expression `royalty' defined in Explanation-2 of section 9(1)(vi)(b) means consideration including any lump sum consideration paid for imparting any information concerning the working of or use of a patent, invention, model, design, secret formula, or process or trade mark or similar property. The dictionary meaning of the term royalty connotes payment of periodic or at one time for use by one person of such exclusive right belonging to any other person. Thus the necessary ingredient for treating the payment as royalty is exclusiveness of the right. After patent having expired it cannot be said that Shri Patwa had exclusive right over the design or invention invented by him in 1978. In fact he never had any such patent in his name. We agree with ld. DR that after expiry of life of patent exclusiveness comes to an end and the invention goes into public domain, any one can use the technology and manufacture the device. Whether other manufacturers have so far not used the technology to manufacture similar device is not relevant as what is important is the legal right available to use the

invention for own advantage. Unless Shri Patwa can show that legal action can be taken against any manufacturer manufacturing same device as being manufactured by the assessee company exclusiveness over the right cannot be accepted. In view of this, we hold that what is being paid by assessee company to Shri Patwa cannot be termed as royalty.

______ORDER________
Per D. C. Agrawal, Accountant Member.

These are four appeals –one filed by the Revenue for Asst. Year 1997-98, i.e. ITA No.2781/Ahd/2008 and the other three are filed by the assessee i.e. ITA Nos.934/Ahd/2006, 2448/Ahd/2005 & 2826/Ahd/ 2006 for Asst. ITA No.2781/Ahd/2008 Asst . Year :1997-98 ITA Nos.934/Ahd/2006,2448/Ahd/2005 & 2826/Ahd/2006 Asst . Years : 1998-99, 2002-03 & 2003-04 Years 1998-99, 2002-03 & 2003-04 respectively. These appeals involve common issue and therefore, they are taken up together for the sake of convenience. The lead year in which the issue has first arisen is Asst. Year 1997-98 being the appeal filed by the Revenue and hence it is taken up first. 

2. In this year the Revenue has raised the following ground :- 

(1) The ld. CIT(A) has erred in law and on facts in directing the A.O. to delete the addition of Rs.8,27,773/- in respect of royalty payment though it is in violation of Section 40(A)(2).

3. The main issue involved in this appeal and other appeals is about claim of royalty expenses paid to Mr. Rajan Patwa. The brief facts of the case are that during the course of assessment proceedings in the first round AO noted that assessee company has paid royalty of Rs.8,22,773/- @ 3% of the net value of the "electrical yarn cleaner & classikin". When enquired it was explained that `electrical yarn cleaner is a product which is originally manufactured by few companies in the world. It requires high degree of technology and is costly if imported. Shri Rajan Patwa is a technical expert who invented an electrical yarn cleaner in India. These instruments are now manufactured by the assessee company. Shri Rajan Pata gave advice and guidance right from the design, development and manufacturing stage. It was for the said services that company has paid royalty @ 3% to him. The AO however, held that payments to Shri Rajan Pata were unjustified and unreasonable and accordingly he disallowed the entire claim. The ld. CIT(A) vide his order dated 19.11.2001 sustained the said disallowance of royalty payment. In second appeal vide its order dated 27.10.2006, the Tribunal set aside the issue and restored the matter to the file of AO with direction to decide the matter considering the evidence produced by the assessee to prove that the payment of royalty was for business purposes. Fresh evidences were called for in the reassessment proceedings. The assessee furnished copies of patent certificate, copy of agreement dated 12.12.1976 between Shri Rajan Patwa and M/s Kinariwala R.J.K. Industries which was one of the patent holders. Subsequently fresh agreement renewing the terms of the agreement of 12.12.76 was executed on 4.4.1996. The AO after examining all these documents held that the patent is not registered in the name of Shri Rajan Patwa to whom the royalty payment was made. Therefore, following the decision in first round, the AO disallowed the claim again 

4. The ld. CIT(A) examined the issue and found that as per article of the agreement dated 12.12.76 between Shri Rajan Patwa and M/s Kinariwala R.J.K. Industries, R.J.K. Industries would be bearing monthly expenses of Shri Rajan Patwa while the technology was being developed. Article-5 of the agreement stipulated that technology after development would be registered in the name of the firm. Article -7 provided a joint right between Shri Rajan Patwa and RJK to commercially exploit the invention, by providing licence to others. In that case it was mutually agreed that 4.5% of the value of the sales would be charged and which would be shared as 1.5% to M/s R.J.K. Industries and 3% to Shri Rajan Patwa. This agreement was considered valid for 21 years. Shri Rajan Patwa succeeded in developing the technology for clearing yarn by opto electric method in 1978 and patent certificate was issued by Patent Office on 23.10.1978 registering the invention. The device was allowed to be manufactured by M/s Patwa Kinariwala Electronics firm whose managing partner was Shri Patwa himself. It paid the royalty @ 4.5% which was shared by M/s R.J.K. Industries @ 1.5% and Shri Rajan Patwa at 3%. This arrangement continued upto 4.4.1996 and as per earlier agreement the right of the technology claimed to have reverted back to Shri Rajan Patwa the inventor. Thereafter it is claimed that Shri Rajan Patwa entered into agreement dated 4.4.96 with Patwa Kinariwala Electronics Ltd. (PKEL) when the firm with the same name was converted in the company with the same name. It is claimed that with the agreement dated 4.4.1996 Shri Rajan Patwa and P.K.E.L. agreed to continue the earlier arrangements on the same terms for 10 years and accordingly PKEL would continue to pay 3% royalty to Shri Rajan Patwa. On the basis of these facts, the ld. CIT(A) held that :- 

(a) Shri Rajan Patwa was the inventor of the device. 

(b) There was an agreement between Shri Rajan Patwa and RJK Industries to allow PKE to exploit the device commercially on payment of royalty. 

(c) the payment of royalty was under contractual obligation, and

(d) the agreement was carried on vide agreement dated 4.4.96 between Shri Rajan Patwa and M/s PKEL (the successor to PKE).

On this basis, he further held that payment was not made to a stranger. There is a contractual agreement between the company and the assessee. The payment of royalty was not without consideration as Shri Patwa provided valuable services to the company. It is immaterial that Shri Rajan Patwa himself is not the holder of the patent. On this basis ld. CIT(A) allowed the claim of the assessee.

5. Before us, ld. DR submitted that what is paid by the company to Shri Rajan Patwa who is the Managing director of the company cannot be termed as royalty because Shri Patwa is no longer or rather never a patent holder of the alleged design. Once the patent is expired after 14 years of certification, the design comes into public domain and, therefore, no payment under the head `royalty' can be paid to Shri Patwa. There is no material on record, the ld. DR submitted, that Shri Patwa has provided any special service of the nature of intellectual property right so as to enable Shri Patwa to receive royalty from the company. He referred to the decision of ld. CIT(A) in the first inning and submitted that there is no evidence that he is rendering services and advice of the technical nature as claimed. The payment is not justified looking into the nature and extent of the services/advice provided by Shri Patwa to the assessee company. Shri Patwa is the Managing Director and his family members control the entire business of the company. The onus lying on the assessee that what was paid in fact was royalty is not discharged. The ld. DR then submitted that the agreement dated 4.4.96 between the assessee and the company is a self-serving instrument in the sense that both the parties signing the agreement have a vested interest and they are on the same side. Shri Patwa is the Managing Director himself or his family members on behalf of the company could sign the agreement. Therefore, such an agreement cannot become the basis for reducing the taxable income by claiming expenses which are otherwise not supported by any evidence. Even before the Tribunal evidences for alleged royalty payment were not furnished.

6. Against this, ld. AR for the assessee submitted that assessee company is carrying on the business of manufacturing of electronic equipments for textile industries. These instruments are electronic yarn cleaner (EYC. The assessee company has exclusive right of manufacturing these products. The technology was invented by Shri Rajan Patwa who is B.E., M.S. Electronic from USA. He is a technical expert. Royalty has been paid to Shri Rajan Pata following agreement dated 12.12.76. The patent was also registered in the name of the firm and Shri Rajan Patwa was allowed to share the royalty payment. Since 1978 onwards the manufacturer of these instruments are paying royalty and Shri Patwa is enjoying it @ 3%.. The patent was registered in the name of RJK industries (KRJK) and Ahmedabad Texteile Industries Association (ATIRA). The partnership firm in the name of Patwa Kinariwala Electrical Industries has started manufacturing these instruments/devices. Licence was given to this firm who paid the royalty to KRJK and Shri Rajan Patwa. The royalty is being paid since 1978, initially by the firm. The firm is now converted into a company under the same name and the royalty is being paid by the company to Shri Patwa @ same rate of 3%. For this arrangement agreement was entered into between the assessee company and Shri Rajan Patwa on 4.4.96.

7. The ld. AR submitted that in the past no disallowance of royalty paid has been made. Therefore, following the principle of consistency, payment of this royalty should have been allowed in the case of assessee company. Ld. AR submitted that payment is being made as per the agreement. Shri Rajan Patwa, the Managing Director is not receiving any other payment for managing the affairs of the company. He is not taking any remuneration except the royalty. Therefore, the claim of the royalty was justified.

8. The ld. AR submitted that as Managing Director Shri Patwa is providing following services :-

(1) Maintenance and upgradation of technology used by the company in manufacturing the device.

(2) Further development/improvement in the technology in manufacturing this device. These developments from 1996 onwards were as under :-

Developed common sensor for manual winding machine and auto winder 
1996

Redesign cleaner for product to an MC68HC811E2P 1998

Redesign cleaner for product cost effective, Mc908SRl2 1999



Cost reduction of cleaner by 25% using DSP TMS320LF2407 for 8 clearer 2002

Develop cleaner for Jute Yarn  2003

Due to memory of space constrain, we develop new control box using DSP TMS320F2812 2004

Used CPLD to reduced size of the product 2005


Develop clearer for Chenille yarn cleaner 2006

Yarn diameter tracking that is calibration of continuous yarn sensor calibration for avoiding unnecessary cuts  2006

Introduced capacitance type sensor for effectively detecting long thin & long thick place  2006

Fail Safe Power supply for better reliability  2008

Making clearer for different version of Automatic winding Machines  2009-10

9. Ld. DR in rejoinder submitted that merely maintenance or development or upgradation of technology used by an assessee company cannot be made equivalent to a patent or any intellectual property right entitling the assessee company to make the payment of royalty. It may be the payment for technical services rendered by Shri Patwa but not a payment against intellectual property right. Further evidence of services rendered justifying payment of royalty to Shri Patwa have not been provided.

10. We have considered the rival submissions and perused the material on record. What is undisputed is that Shri Patwa is a technocrat. He has originally invented the devices which were later got patented in 1978 in the name of two concerns namely ATIRA and RJK Industries. Licences were issued to PKE a firm run by Shri Patwa. Royalty @ 4.5% was paid by the firm which was shared @ 3% by Shri Patwa and 1.5% by RJK Industries. It is not known as to whether payment @ 1.5% continued to the firm RJK Industries. However, payment @ 3% continued upto 4.4.96 by the firm to Shri Patwa. The firm was taken over by the company and Shri Patwa became the Managing Director thereof. Other shareholders of the company are the family members of Shri Patwa. The patent certificate issued in 1978 expired after 14 years. There is no evidence as to what extent Shri Patwa has rendered services to the company except a general statement that he is continuously engaged in development of the product, providing technical services, advice and guidance. It is also clarified that Shri Patwa is not claiming any remuneration from the company except royalty. It is also emphasized by the ld. AR that claim of royalty has been allowed in the assessment of the firm and, therefore, merely because firm is now converted into a company the claim should not be disallowed.

11. In our considered view consistency is the recognized principle and carves out an exception from the principle of res judicata, if facts and circumstances of the case remain the same and position of law has not changed. In any case there is a necessary condition inherent in the "principle of consistency" that stand of the AO in the past should be legally correct and there is no error, either of law or of fact. It is also a judicially recognized principle that there is no heroism to continue to commit errors from one year to another. If AO has not at all considered the issue; or assessment has been accepted under section 143(1); or all the necessary facts for applying mind on the issue are not brought into the knowledge of the AO; or while accepting a position in the earlier assessment years, grave error of law or fact has been committed; or there has been change in law; or there is a judicial decision on the subject; or there are discovery of new facts which were not available in the earlier years then principle of consistency cannot bind the AO and he has to apply his mind afresh and arrive at a fresh decision.

12. Firstly when we examine the present case, we notice that no material is placed before us to show that there was a claim of royalty in the firm and it was allowed after scrutinizing the issue. The necessary data like profit and loss account or balance sheet, assessment order under section 143(3) in the case of the firm are not produced before us. Secondly the firm is no longer in existence in the assessment year 1997-98. We are examining the case of the company and, therefore, the issue is required to be looked into differently afresh. Earlier the patent certificate issued in 1978 had the effect of allowability of the claim of royalty. There is no evidence before us to show that patent certificate(s) were submitted to the AO while making the assessment of the firm so that they could know that patent had expired after 14 years and, therefore, claim of royalty is required to have a re look. After formation of the company in 1996, the effect of allowability of the claim in earlier years in the firm no longer survives in the subsequent years. Once there is no patent or any intellectual right vested in Shri Patwa no claim of royalty can be allowed to him. The term royalty has been defined by Courts as a payment of any kind received as consideration for the use of or the right to use industrial, commercial or scientific equipment. If normally connotes, the payment made to a person, who has exclusive right over a thing for allowing another to make use of that thing which may be either physical or intellectual property or thing. Hon. Madras High Court in Commissioner of Income tax v. Neyveli Lignite Corporation Ltd. (2000) 243 ITR 459 (Mad) had an occasion to explain the term `royalty'.

The Hon. Court held that the exclusivity of the right in relation to the thing for which royalty is paid should be with the guarantor of that right. Mere passing of information concerning the design of a machine which is a tailor made to meet the requirement of a buyer does not by itself amount to transfer of any right of exclusive user so as to term the payment made therefore as royalty. The expression `royalty' defined in Explanation-2 of section 9(1)(vi)(b) means consideration including any lump sum consideration paid for imparting any information concerning the working of or use of a patent, invention, model, design, secret formula, or process or trade mark or similar property. The dictionary meaning of the term royalty connotes payment of periodic or at one time for user by one person of such exclusive right belonging to any other person. Thus the necessary ingredient for treating the payment as royalty is exclusiveness of the right. After patent having expired it cannot be said that Shri Patwa had exclusive right over the design or invention invented by him in 1978. In fact he never had any such patent in his name. We agree with ld. DR that after expiry of life of patent exclusiveness comes to an end and the invention goes into public domain. any one can use the technology and manufacture the device. Whether other manufacturers have so far not used the technology to manufacture similar device is not relevant as what is important is the legal right available to use the invention for own advantage. Unless Shri Patwa can show that legal action can be taken against any manufacturer manufacturing same device as being manufactured by the assessee company exclusiveness over the right cannot be accepted. In view of this, we hold that what is being paid by assessee company to Shri Patwa cannot be termed as royalty.

13. We, however, uphold the alternative arguments of ld. AR that Shri Patwa being Managing Director is providing services to the assessee company as Managing Director and supervising the manufacturing of the device by the assessee company. He is, therefore, rendering technical services to the assessee company in the form of guidance and advice though, however, extent of such services and proof thereof is not brought on record. In view of this, what can be paid by the assessee company to the Managing Director would be the remuneration and not the royalty. Once no remuneration is claimed by Shri Patwa then what is paid by the assessee company to Shri Patwa has to be alternatively considered as remuneration and claim can be allowed in the hands of the company to the extent, payment of remuneration is permissible to Shri Patwa under Companies Act. We, therefore, restore the matter to the file of AO to calculate the permissible payment of remuneration to Shri Patwa as Managing Director of assessee company and to allow the claim of expenditure to that extent. If permissible claim under Companies Act is more that the payment of royalty then entire claim should be allowed but in case any restriction is placed for which no material is placed before us, then to the extent of maximum permissible limit remuneration should be allowed as deduction in the hands of the assessee company. In view of this, we restore the matter to the file of AO for calculating the allowable remuneration as deduction to the assessee.

14. As a result, appeal filed by the Revenue is allowed but for statistical purposes.  ITA No.934/Ahd/2006 for Asst. Year 1998-99

15. This appeal is filed by the assessee raising following grounds :-

(1) The Learned Asstt. Conunissiloner of Income Tax has erred in law and on facts of the appellant' s case in passing an order U/s 147 r.w.s.143[3) of the Act.

The appellant's most humbly submits that the order passed u/s 147 r.w,s 143(3) of the Act is bad in law and prays that the Hon' ble Tribunal be pleased to hold so now and quash the order passed. (2) The Learned Asst. Commissioner of Income Tax has erred in law and on facts of the appellant's case in disallowing entire royalty expense of Rs . 7, 19, 774/- paid on the erroneous plea that the same has been paid to the promoter. 

The appellant most humbly submits that on the facts and circumstances of it's case and in law no part of royalty paid is disallowance as royalty expenses have been incurred wholly & exclusively for the purpose of it's business and looking to the nature of the business of the appellant and the benefit derived from it, same is reasonable. 

In view of the above, the appellant prays that the Hon'ble Tribunal be pleased to hold so now and delete the additions made.

15. The first ground is regarding reopening of assessment which is not pressed and hence dismissed as not pressed.

16. Ground No.2: In this year the AO has disallowed and ld. CIT(A) has confirmed the disallowance in respect of claim of royalty of Rs.7,19,774/-. Following our decision for Asst. Year 1997-98 above, we restored this issue to the AO for deciding the amount of maximum remuneration payable to the Managing Director, as per Companies Act and allow the claim to that extent out of payment of royalty. The claim of royalty as such cannot be allowed except to the extent of maximum permissible remuneration. Therefore, this appeal of the assessee is partly allowed but for statistical purposes.

17. In this year the assessee has raised grounds relating to claim of royalty at Rs.3,25,245/-.

The ground No.3 is relating to disallowance of 1/3 motor car expenses and depreciation. The next ground is regarding disallowance of Rs.13,600/- out of telephone expenses.

18. Ground No.1 being general is not pressed hence it is rejected.

19. Ground No.2 relate to claim of royalty. Following our decision for Asst. Year 1997-98 above, we restore this issue to the AO for deciding the amount of maximum remuneration payable to the Managing Director, as per Companies Act and allow the claim to that extent out of payment of royalty. The claim of royalty as such cannot be allowed except to the extent of maximum permissible remuneration.

20. Ground No.3 is relating to disallowance of 1/3 motor car and depreciation expenses. The issue is covered in favour of the assessee by the decision of the Tribunal in ITA No.55/A/02 for Asst. Year 1997-98. Following the same this ground of assessee is allowed. 

21. Similarly disallowance of telephone expenses is decided in favour of assessee following above referred decision of the Tribunal. As a result, appeal filed by the assessee is partly allowed and partly allowed for statistical purposes. 

22. There are three issues – the first is about royalty expenses of Rs.4,41,285/- and the other two issues are regarding disallowance of 1/3 motor car and depreciation and 25% of telephone expenses.

23. The issue regarding royalty is set aside to the file of AO following our decision for Asst. Year 1997-98 as above and to follow direction as given there this year also.
24. The issue regarding motor car and telephone expenses are allowed following our decision in ITA No.55/Ahd/2002 for Asst. Year 1997-98. As a result, appeal filed by the assessee is partly allowed and partly allowed for statistical purposes. 

25. In the result, appeal of Revenue is allowed for statistical purposes and the appeals of assessee are partly allowed for statistical purposes.

 

 

 

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