[ITA No. 325/2005, decided on 20th April, 2018]
The Delhi High Court in the case of M/s Hilton Roulunds Ltd. versus Commissioner of Income Tax, while deciding the nature of the expenditure made for the exclusive use of the trademark as ‘Revenue Expenditure’, determined the fundamental test as to whether a trademark has been licensed or assigned.
Brief facts of the case are as follows:
Three companies, being M/s Roulands Fabriker Denmark (RF), M/s Hilton Rubbers Limited (HRL) and Industrialization for Developing Countries, Copenhagen (IFU), formed the Appellant as a joint venture in India. At the time of formation of the Appellant, HRL granted the license to exclusively use the Trade Mark HILTON to the Appellant vide a Trade Mark License Agreement dated 27th January, 1993 (First License Agreement) in respect of Raw-Edge and Wrapped V-Belts, which was later substituted with a License Agreement, dated 9th November, 1995 (Second License Agreement).
Under the First License Agreement, the Appellant was required to pay a running royalty on the domestic sale at a rate of 1.8% of the net selling price from the date of commercial production. The license was for 10 years and was terminable by 12 months’ notice or by 30 days’ notice in case of breach of the terms
Under the Second License Agreement, the HRL sold its entire shareholding to the Appellant and instead of a royalty being paid periodically, the parties agree for a one-time royalty of Rs.1 Crore towards the license to exclusively use the trademarks HILTON.
While filing its return of income, the Appellant sought a deduction of Rs 1 Crore (the one-time royalty being paid) under Section 37(1) of the Income Tax Act, 1961. The Assessing Officer, however, declined to allow the deduction on the ground that since the payment of Rs.1 Crore was absent in the First License Agreement and it was for use of the brand, the expenditure of Rs.1 Crore cannot be related to the Appellant’s business. The Assessing Officer, therefore, termed the expenditure as ‘Capital Expenditure’.
However, the Commissioner of Income Tax Appeals termed the expenditure as ‘Revenue Expenditure’ and allowed the deduction.
The Income Tax Appellate Tribunal (ITAT) observed that the First License Agreement was for the use of the trademark and the Second License Agreement was for the sale of shareholding, therefore the payment of Rs. 1 Crore was not purely for the license to exclusively use the Trade Mark. The ITAT further held that since the right to use the Trademark was for an unlimited period, and there was no clause for renewal and/or further consideration, the Second License Agreement, was for the sale of the Trademark and not for the license. The ITAT, thus, held that the payment of Rs. 1 Crore was for an enduring benefit and capital in nature.
Aggrieved by the ITAT’s observations, the Appellant preferred an appeal in Delhi High Court.
The High Court, after extensively referring to the various judgments passed by the Supreme Court, laying down the tests distinguishing capital and revenue expenditure, held that in order to determine whether a particular expenditure is capital or revenue in nature, the Court not only has to examine the terms of the agreements(s) but also the facts and circumstances surrounding the agreements.
The Court, while examining the terms of the agreements, observed that the fundamental test to determine as to whether a particular mark is licensed or assigned is to see if the proprietor of the trademark has retained any rights in the mark. The license is normally a permissive use, however, the assignment is a complete transfer of the right. The Court observed that if the proprietor has retained the rights in the trademark, then it’s a license and if no rights are retained, then it’s an assignment.
The Court applied this fundamental test in the given case, and observed that the agreements were the license agreement on the following grounds:
Firstly, the First License Agreement granted an exclusive right to the Appellant to use the trademark HILTON.
Secondly, the Appellant had no right to apply for the registration of the trademark without HRL’s permission and the registration can only be secured jointly. The Appellant could not, even take actions against any infringement without HRL’s prior consent.
Thirdly, the First License Agreement had a termination clause and upon termination, the Appellant would have no rights to use the trademark.
The Court, in order to determine, if the expenditure of Rs. 1 Crore was capital or revenue, gone further deeper and tested whether any long-term benefit was acquired by the Appellant under the Second License Agreement.
While answering the question in negative, the Court concluded that “When the benefit of the use of the mark has inured to the licensor i.e. HRL, the amount, that has been paid to HRL was a consideration for permission to use the mark, and not for acquiring ownership rights in the mark. The mark “HILTON” did not belong to the Appellant. It also did not belong to either of its current promoters i.e. RF or IFU. It belonged to HRL which was one of the joint venture partners when the Appellant was initially formed. The use of the mark “HILTON” thus, merely facilitated the Appellant’s business in India. The question of law is answered in the negative, in favour of the Assessee and against the Revenue. It is directed that the payment of Rs. 1 crore be treated as revenue expenditure.”