Commissioner of Income-Tax, Bombay v. Ciba of India Ltd.

Judgment

The Judgment of the Court was delivered by Shah, J. The Income-tax Appcl!Jtc Tribunal referred two questions to the High Court of Judicature at Bombay under s. 66( I) of the Indian Income-tax Act, 1922: " ( 1) Whether on the facts and in the 'circumstances of the case, the payment niade by the asscssee to Ciba Ltd. Basic in pursuance of the agreement dated 17-12-194 7 is an admissible deduction -under the provisions of s. 10(2 )(xii) ofihe Income-tax Act. and if not. under s. I 0(2) (xv) of the Act, either in part or whole? ( 2) Whether on the facts and in the circumstances of the case. the payment made in accordance with the terms of the agreements dated 15-11-1944 and I 8-6-1948 for meeting the expenses of Suit No. 890 of 1946 is an allowable expense under s. I 0(2)(xv) of the Income-tax Act?"

In answer 'lo the first question the High Court recorded that the · payment made by the assessee to Ciba Ltd., Basic, in pursuance of the agreement dated December 17, 1947 is an admissible deduction under s. 10(2) (xv) of the Income-tax Act, but not under s. 10(2) (xii) of the Act. The second question was answered in the negative. Against the answer recorded on the first question the Commissioner of Income-tax has appealed. and against the answer recorded on the second question the assessce has appealed. The assessee which was originally floated in the name of Ciba Pham1a Ltd .. and is now called Ciba of India Ltd. is an Indian subsi.diary of Ciba Ltd., Basie (hereinafter referred to as 'the Swiss Company') which is engaged in the development, manufacture and sale of medical and pharmaceutical preparations. The Swiss Company originally carried on business in India of selling [ts products through a subsidiary called Ciba (India) Ltd. After the incorporation of the assesscc on December 13.

1947 the activities of the Swiss Company in India were bifurcated : the pharmaceutical section was taken over by the assessee from January I. 1948. and the other lines of business relating to dyes and chemicals were continued by its subsidiary Ciba (India) Ltd., the name whereof was later changed to Ciba Dyes Ltd. By a deed dated December 17, 1947 the Swiss Company agreed with the assessce in consideration of payment of a "technical and research contribution for the use of its Indian patents and/or Trade Marks", to communicate the results of its research work, insofar as they relate to the products which were already manufactured or processed or sold by the asscssce or which may. with the prior approval of the Swiss Company. in future be manu- C.I.T. V. CIBA OF INDIA LTD. (Shah,/.) factured or processed or sold by the assessee. . The preamble of the agreement, inter alia, recited :

"Ciba Pharma has installed its own tabletting 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 Basie commands 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 Basie a technical and research contribution for the use of its Indian patents and/ or Trade Marks referring to the said product~. The technical and research contribution is at the same time a consideration for the scientific and technical assistance and will refund partly Ciba Basie's costs and expenses for the maintenance and development of the research work described in this Preamble."

The preamble was followed by six Articles and two Schedules, the first Schedule setting out the numbers of the Indian Patents, and the Second Schedule setting out the names and numbers of the Indian Trade-Marks. Article 1 provided : "

1Ciba Basie will communicate currently and/ or at request of Ciba Pharma all the results 'of its research work, insofar as they relate to the said products which are already manufactured or processed or sold by Ciba Pharma or which shall hereafter with the prior approval of Ciba Basie 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 Basie, the pertaining patent right and Trade Marks will be licensed to Ciba Pharma according to the terms of Articles II and III. In this case Ciba Basie undertakes to deliver to Ciba Pharma all pro- · cesses, formulae, scientific data, working rules and p,rescriptions pertaining to the manufacture or processing of said products, which have been discovered and developed in Ciba Basie'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. .

2Ciba Pharma agrees not at any time to divulge to third parties without Ciba Basie's consent any confidential information received .under this Agreement from Ciba Basie and in particular to keep all data connected with the manufacturing processes under lock and key." By cl. 2 of Article II, the Swiss Company granted to the assessce "full and sole right and licence" in the territory of India under the patents listed in Sch. I, to make use, exercise and vend the inventions referred to therein, and to use the Trade-Marks set out in Sch. II in the territory of India. By cl. 3 the sole right of the asscssee under the Swiss Company's Indian patents was limited by existing licences granted by the Swiss Company to third parties. and right was also reserved to the Swiss Company to conclude othc• licence agreements with third parties. By the first clause of Article I II, it was provided :

"As consideration for Ciba Basie's obligations stipulated in Article I and II, Ciba Pharma agrees to pay to Ciba Basic half-yearly the following percentage contnbutions 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 technicaf service rendered and research work done. 5 '7o (b )Contribution towards cost of raw material used for experimental work. ( c) Royalties on trade marks used by Ciba Pharma. Total. ... I 0%" Article IV imposed certain restrictions upon the assessee. It provided : "I. Ciba Phanna shall not assign the benefit and the obligations of this Agreement without the written consent of Ciba Basic; and 2. Ciba Phanna shall not grant any sub-licence under the patents and/ or trade marks of Ciba Basie without its previous written consent." Article V dealt with duration and termination of the agreement. It provided : "I. This Agreement comes into force on January I st, 1948, and shalfcontinuc in force for a period of 5 years.

Therefore provided that if one of the parties fails to perform or observe the provisions of this Agreement the other party may cancel the same by giving to C.l.T. V. CIBA OF INDIA LTD. (Shah, /.) the party in default 3 months' notice by registered letter or by cable. 2. If Ciba Basie shall be compelled for any reason beyond its control to transfer or part with all or any of its shares in Ciba Pharma, it will have the right !o immediately determine this Agreement.

3Upon the termination of this Agreement for any cause Ciba Pharma shall cease to use the patents and trade marks to which this Agreement refers except as to stocks then on hand and sliall return to Ciba Basie or to such persons as they may appoint for thaf purpose all copies of information, scientific data or material sent to it by Ciba Basie under this Agreement and then in its possession and shall expressly refrain from communicating any such information, scientific data or material received by it hereunder to any person, firm or company whomsoever other than Ciba, Basie." Article VI incorporated an arbitration agreement. By a supplementary agreement dated July 15, 1949, the contribution under - .Article III payable by the assessee was reduced from to 6% of the net selling price of the pharmaceuticals. Pursuant to this Agreement, the assessee paid year after year diverse sums of money to the Swiss Company.

In proceedings for assessment to tax for the assessment years 1949-50 to 1953-54 payments'made fo the Swiss Cmnpany were claimed as permissible allowance in the computation of taxable income under s. 10(2) (xii) of the Indian Income-tax Act, 1922. The Income-tax Officer disallowed the claim (except as to 2 % paid as royalty on trade marks used by the assessee). The order was confirmed in appeal by the Appellate Assistant Commissioner. The Income-tax Appellate Tribunal held that the payments made by the assessee to the Swiss Company were al!owable under s. 10(2)(xii) and in any event under s. 10(2)(xv). The High Court disagreed with the Tribunal as to the admissibility of the expenditure under s. IO ( 2) (xii) of the Jnd.ian Income-tax Act. but agreed with the Tribunal on its admissibility under s. 10(2)(xv). Correctness of the view taken by the High Court is challenged on behalf of the Commissioner.

Expenditure (not being in the nature of capital expenditure) laid out or expended on scientific research related to the business of a person in an admissible allowance under s. 10(2) (xii) of the Indian Income-tax Act in computation of the taxable .profits and gains of the business of the assessee. One of the conditions of the admissibility of an allowance under cl. (xii) of s, 10(2) is that the expenditure must be laid out or expended on scientific research by the assessee. The amounts paid by the assessce were not laid out or expended by the assessee on scientific research related to the business of the assessee. Payment made to recoup another person for expenditure for scientific research incurred by that other person, even if it may ultimately benefit the asscssee is. unless it is carried on for or on behalf of the assessee, not expenditure laid out or expended on scientific research ;related to the business of ·the assessee.

The High Court was. therefore right in rejecting the claim for allowance under s. 10(2)(xii) of the Income-lax Act. But the outgoing was properly treated as an allowable expenditure under s. 10(2) (xv) of the Income-tax Act. lJnder the terms of the agreement, 1he Swiss Company had-( I ) undertaken to deliver to the assessec all processes, formulae, scientific data. working-rules and prescriptions pertaining to the manufacture or processing of products discovered and developed in the Swiss Company's laboratories and to forward to the assessee 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: (cl. I of Arti.cle I): and (2) had granted to the assessee full and sole right and licence under the patents ·listed in Sch. I, to make use, exercise and vend the inventions referred to in India and had also granted a licence "to use the trade marks" in Sch.

JI in the territory of India, subject to any existing licence which third parties held at the date of the agreement, or which the Swiss Company granted to third parties after that date: (cl. 2 of Article II and cl. 3 of Article II). In consideration of the right to receive scientific and technical assistance the assessee had agreed to make the stipulated contributions, and had agreed (a) not to divulge to third parties without the consent of the Swiss Company any confidential information_ received under the agreement: (Article I cl. 2); and (b) without the written consent of the Swiss Company not to assign the benefit of the agreement or grant sub-licences of the patents and trade mark> of the Swiss Company (Article IV, els.

I and 2); and had further agreed ( c) upon the termination of the agreement for any cause to cease to use the patents and trade marks and to return to the Swiss Company all copies of information, scientific data or material sent to it ~nd ·to refrain from communicatinr. any such information, scientific data or material received by it to any person : (Article V cl. 3). The asscssee did not, under the agreement, become entitled exclusively even for the period of the agreement, to the patents and trade marks of the Swiss Company : it had merely access to the technical knowledge and cxi)erience in the pharmaceutical field which the Swiss Company commanded. The asscssec was on 8 C.J.T. v. CIBA OF INDIA LTD. (Shah, J.) 70 3 that account a mere licensee for a limited period of the technical knowledge of the Swiss Company with the right to use the patents and trade marks of that Company.

The assessee contends that the contribution for being permitted to have access Jo this technical knowledge for the purpose of running the business during thl' period of the agreement falls within the terms or s.. ~ 0 ( 2 )( ~v) of the Income-tax Act, 1922. That clause, insofar as it 1s matenal. provides : "Such profits or gains shall be computed after making the following allowances, namely :- (xv) any expenditure not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purpose of siich business, profession or vo_cation." The expenditure ipcurred by the assessee is not an allowancl' the nature described in els. (i) to (xiV). Again the expenditure i' laid out or expended wholly and exclusively for the purpose of the business of the assessce.

Counsel for the Revenue however contends that the expenditure is of capital nature and on that account not admis>ibk ~" ;i,1 ::!!lowance in the computation of the taxable income. The asscssee acquired under the agreement merely the right to draw, for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products, upon the technical knowledge of the Swiss Company for a limited period : by making that technical knowledge available the Swiss Company did not part with any asset of its business nor did the assessee acquire any asset or advantage of an enduring nature for the benefit of its business. Counsel for the Commissioner strongly pressed for acceptance of what he called the principle of the speeches of Viscount Simonds and _Lord Tucker and Denning in Evans Medical Supp/jes Ltd. y. Moriarty (H.M. Inspector of Taxes)(').

Counsel said 'that it was ruled in that case by the mlljority of the House that money received by a tax-payer for making available to another person a right to technical 'know-how' is liable to be treated as a capital receipt. It must in the first instance be noted that the House of Lords was dealing with the true character of a receipt by a tax-payer who had made technical 'know-how' available to another in consideration of a certain payment. The nature of a receipt as capital or II) 37TC. 54 J. SUPREME COURT REl'ORTS revenue is not always dctenninative of the nature of the outgoing in the hands of the person who pays it. Again the view expres.sed by the majority of the House does not lay down any principle which may be of value in deciding this case.

In Evans Medical Supplies Ltd.'s case(') the Burme5e Government granted a contract to the taxpayer. company engaged in the manufa~ture of pharmaceutical products with a world-wide trading organisation and which till then carried on business in Burma through an agency to set up a pharmaceutical industry in Burma. The Company undenook to disclose secret processes to the Burmese Government and to provide other infonnation i11 consideration of the payment of a "capital sum of £ 1,00,000''. The asscssee had not entered into any other similar agreement with any other foreiyn Government or any other pany. The Court of Appeal held that the amount of £ 1,00,000 arose to the assesse as a receipt of its trade. but a part of that sum which was attributable to the disclosure of secret processes was a ~apital receipt, and on that view remanded the case to the Commissioners to determine the pJJ.rt so attributable.

The speeches of the Law Lords in dealing with the appeals of lhe Crown and the Company disclose a remarkable divergence of opinions. Viscount Simonds and Lord Tucker held that by the transaction the assessee had parted with a capital asset for a price. and that the Crown could not be permitted to make out a new case that a part of the amount received by the assessee was capital and the rest mcome. Lord Monon of Henryton agreed with the Court of Appeal.

Lord Keith of Avonholm held that the amount in its enitrely was received by the assessee in the course of its trading activity and Lord Denning said that he could see no distinction between the money paid for disclosing inforr.rntion of secret processes and money paid for other information, and that it was a single payment for "know-how" in the course of the assessee's trade and was on. that account income and not capital, but since there was no finding that it was received in the course ·of the existing trade which was being taxed, it was not liable to be brought to tax. The view of the majority of the House reached on different and somewhat contradictory premises is of little assistance in deciding this case. Jn two later cases decided by the House of Lords : Jeffrey v. Rolls Royce Ltd. (2 ); and Musker v. English Electric Co. ltd.('). it was observed that in Evans Medical Supplies Ltd.'s case(') there was a total loss of the business of the company by the communication of secret processes to the Burmese Government and on that account the company parted with an asset against receipt of a capital sum.

In the case of Rolls Royce Ltd. (2) payment received for licensing a foreign Government to manufacture aero engines with the accumulated technical knowledge of the taxpayer and for supplying the necessary infor- (1) 37 T.C. 540. (2) 40 T.C. 443 (3) 41 T.C. 516. C.I.T. V. CIBA OF INDIA LTD. (Shah, J.) mation and \irawings, and for advising the foreign Government as to improvements and modifications in manufacture and design, instructing the licensee's personnel in their works and for releasing members of their own staff to assist in the manufacture of engines by the licensee was held to be received on revenue account of the taxpayer's trade.

In English Electric Company's case(') the taxpayer coritracted with the Admiralty to design and develop turbine and to license its manufacfore by a limited number of companies in the United Kingdom, Australia and Canada and also contracted with the Government of Australia and an American aircraft manufacturing corporation to license the manufacture ·of a bomber which the taxpayer had designed and developed, and received fixed lumpsum payments as a consideration for imparting "manufacturin~ technique'-' to the licensee. The receipts were held to be income. In the case in hand it cannot be said that the Swiss Company had wholly parted with its Indian business. There was also no attempt to part with the technical knowledge absolutely in favour of the ::issessee. The following facts which emerge from the agreement clearly show that the secret processes were not sold by the Swiss Company to the· assessee :

(a) the licence was for a period of five years, liable to be terminated in certain eventualities even before theexpiry of the period; b) the object of the agreement was· to obtain the benefit of the technical assistance for running the business; ( c) the licence was granted to the assessee subject to rights actually granted or which may be granted after the date of the agreement to other persons; ( d) the assessee was expressly prohibited from divulging confidential information to third parties without the consent of the Swiss Col)lpany; ( e) there was no transfer of the fruits of research once for all : the Swiss Company which was continuously carrying on research and had agreed to make it available to the assessee; and (f) the stipulated payment was recurrent dependent upon the sales, and only for the period of theagreement.

We agree with the High Court that the first question was rightly answered in favour ot the assessee. - The second question relates to the admissibility of a share i11 the costs incurred in a Civil Suit in the High Court of Calcutta as an allowable expenditure under s. 10(2) (xv) of the Income- 'tax Act. The relevant facts are these : In accordance with the terms of the agreement dated June 18, 1948, the assessee took over the pharmaceutical section of Ciba (India) Ltd. The pharmaceutical stock-in-trade together with all the 1>1:nding contracts and orders were transferred to the assessee by Ciba (India) Ltd. which then had changed its name to Ciba Dyes Ltif. Under an (1)4; T.C. 556. agreement between the Swiss Comoany with Messrs. May and Baker Ltd., England-hereinaft~r called 'May and Baker'-who were also carrying on business as pharmaceutical manufacturers in India, the two contracting rompanies mutualfy agreed to grant to one another a non-exclusive licence in respect of "sulphathiazol products" in different countries including India.

May and Baker had prior to the date of the agreement obtained patents in India bearing Nos. 26513 and 36850, and the Swiss Company obtained the benefit of those patents 11nder the agreement. By cl. 5 of the agreement "the two companies agreed to take all neces~ry steps to defend patents granted to or applied for by it in respect of "sulphathiazol products" against infringement, and agreed to share equally all costs incurred and all damages or other sums received in respect thereof. Under cl. 8 of the agreement each pany had to take all steps within its power to secure the observance ot the terms of the agreement by its subsidiary or associated companies' licensees and agents. 'Sulpbathiazole' was sold in India by the Swiss Company and by May ·and Baker under the trade names of "Cibasol" and "Thiazamide" respectively. In a suit instituted by May and Baker in the Calcutta High Court against Messrs. Boots Drug Co. alleging that the latter had infringed the Indian patenl' of the plaintiff, it wa' found necessary during the progress of the suit to amend the specifications of the patents.

The High Court of Calcutta made it a condition in granting the application for amendment that May and Baker shall not institute any action for any act of infringement of the patent committed prior to the date of the amendment, and that they shall pay to Bo:its Pure Drug Co. costs of and incidental to the application for amendment of the specifications. May and Baker complied with the ordc: of payment of costs and the Swiss Company paid its share of costs to Mav and Baker under the terms of cl. 5 of the agreement. The assessec reimbursed that amount to the Swiss Company and claimed it as a permissible deduction in proceedings for assessment to tax. The Income-tax Officer disallowed the claim. In appeal, the Appellate Tribunal held that in the payment made by the assessee there was no capital element and the asscssee incurred the expenditure in the course of its business and for the purpose of ensuring that the patents with w~ich it was connected were not infringed.

The Hip.h Court held that the assessee company was not responsible for the payment because the liability of the Swiss Company hzd not at any time devolved upon Ciba (India) Ltd. prior to the transfer of the business in the pharmaceutical section to the assessee. and since the assessec had undertaken the liability to satisfy, dischar~~ and pay all debts and liabilities of Ciba (India) Ltd. and of no other person, the asscssee was not entitled to claim the amount paid to the Swiss Company as an allowable deduction. The High Court also observed that since the agreement between Ciba (India 1 Ltd. and the assessce contained no clause for sharing any expen- C.I.T. v. CIBA OF INDIA. LTD.

(Shah, J.) diture between the assessee and the Swiss Company as wa& to l:!e found in the agreement dated November 15, 1944 between May and Baker and the Swiss Company, the amount paid by the assessee was not a permissible allowance, and even assuming that the agreement to assist implied a stipulation to share the cost, the agreement was only prospective, and did not attn:ct liability in respect of any .infringement before the date of the agreement. Counsel for the assessee contended in the first instance that under the terms of the agreement between the Swiss Company and May and Baker each Company became a licensee for the patents of. the other, and under the agreement with Ciba (India)

Ltd. the assessee was entitled to the rights to the patents of May and Baker and on that account the costs incurred for defending the rights of the Swiss Company as a licensee from May and Baker ensured for the benefit of the assessee and tfie assessee in paying the amount to the Swiss Company was acting for protecting its trading interest. In the alternative, it was contended that the obligations of the Swiss Company arising in respect of the patent~ relating to sulphathiazole were debts which Ciba (India) Ltd. was liable to discharge, and from Ciba (India) Ltd. under the terms of the agreement dated June 18, 1948, that liability devolved upon the assessee. In our view, the contentiOns cannot be accepted.

From the terms of the agreement between the Swiss Company and the assessee it is clear that the assessee was entitled to certain Indian patents but· that did not include any patent either in respect of "sulphathiazole" or "'thiazamide" obtained by the Swiss Company from May and Baker. The two patents Nos. 27,825 and 29,117 obtained by the Swiss Company and the Indian Trade Mark No .. 1621 in respect of "Cibazol" are specifically referred to in the Schedules to the agreement dated December 11, 1949. The right to the patents of May and Baker for the manufacture of "sulphathiazole" and the trade mark in respect of thiazamide did not however devolve upon the assessee. It cannot therefore be assumed that the rights to the patents standing in the name of May and Baker were available to the assessee under its agreement with the Swiss Company.

No argument was apparently advanced e!ther before the Tribunal or before the departmental authorities µtat the assessee was entitled to these patent rights, and no investigation was permissible on that question in the High Court. Suit No. 890 of 1946 was filed before the assesse:e was registered. By paying to the Swiss Company the share of costs in that Suit No. 890 of 1946, the assessee was not seeking to protect its trading interest. ;os SUPRE~IE COURT Rf.PORTS We also agree with the High Court that it is not proved that the obligation of the Swiss Company to pay a share of the costs in Suit No. 890 of I 946 incurred by May and Baker was transmitted from Ciba (India) Ltd. to the assessee. We arc unable to agree with the contention of counsel for the assessec that the Tribunal had found 1hat liability of the Swiss Company in regard to the payment of share of costs of May and Baker devolved upon the assessee.

The Tribunal has not expressly so found and there is no evidence in support of that view. In our view the High Court was right in answering the second question against the assessee. lloth the sets of appeals fail and are dismissed with costs. One hearing fee in each set. V.P.S. Appeals dismissed. L2Sup.Cl/68-28·11·68-2,SOO-Scc. Vl-GIPF.