1.19 Query:    

  Treatment of know-how cost incurred

on environment conservation plant.

1. A Government of India Undertaking is registered under the Companies Act, 1956. The company is engaged in refining and marketing of petroleum products, having its refineries in Bombay and Visakhapatnam.

2. The company’s Visakhapatnam Refinery has a Sulphur Recovery Unit (SRU) set up as an environmental project in order to reduce the quantity of
Sulphur Dioxide emission into the air. The technical know-how amounting to $ 7,83,720 was for setting up of the plant and was obtained from a US company. The entire project was conceived on the basis of such technology which was exclusively meant for SRU. As a part of the consideration for the technical know-how the company had to pay to the US company a license fee amounting to US $ 5,93,720 in consideration of non-exclusive license to have the plant engineered, supplied and constructed and subsequently modified, if required, and to operate the plant.

3.  In this context, the querist has quoted the relevant extract from para 9.7(a) of the Guidance Note on Treatment of Expenditure during Construction Period, issued by the Institute of Chartered Accountants of India, as under:

“If the technical know-how which is supplied by the contractors relates to the construction of the plant, it may be added to the value of the plant.”

Further, para 16.5 of Accounting Standard-10 on Accounting for Fixed Assets issued by the Institute is quoted as under:

“16.5    Know-how related to plans, designs and drawings of…..plant and machinery is capitalised under the relevant asset heads….Know-how related to manufacturing processes is usually expensed in the year in which it is incurred.”

4. License fees paid to the US company referred above are related to the construction and installations of the SRU. The amount of license fee paid has been related to the estimated cost of installation of the plant, and the entire amount had to be paid even before the plant was actually commissioned. Further, no part of the license fee paid is in any way related to the recovery of sulphur. As such, no part of the technical know-how can be considered to be related to manufacturing processes of the company. The Sulphur Recovery Unit is an environment conservation project without any connection with the manufacturing process of the company’s Visakh Refinery, which is involved in refining of petroleum products. In view of this, license fees paid for technical know-how, even if indirectly or partly related to the process of SRU, cannot be considered as linked with the manufacturing process of petroleum refining for charging the same to revenue.

5.  In addition to the above, it is noted by the querist from the contract with the US company that the benefits of the technical know-how purchased is available throughout the life of the plant. In fact, it is specifically mentioned in para 13.3 of the agreement that:

“Any termination of this agreement shall not…..affect or impair the company’s rights and immunities with respect to the LO-CAT II process to the extent of rights acquired and paid for.”

In view of the above, capitalisation of the entire amount paid for technical know-how as a part of the plant cost has been found to be justified in the view of the querist.

6. The querist has sought the opinion of the Expert Advisory Committee as to whether capitalising license fee paid towards technical know-how purchased as described above is the appropriate treatment to be given in the books of account.

Opinion                                  November 1, 1995

 

1. The Committee notes para 38 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which is reproduced below:

“38. Amount paid for know-how for the plans, layout and designs of buildings and/or design of the machinery should be capitalised under the relevant asset heads, such as, buildings, plants and machinery etc. Depreciation should be calculated on the total cost of those assets, including the cost of the know-how capitalised. Where the amount paid for know-how is a composite sum in respect of both the manufacturing process as well as plans, drawings and designs for buildings, plant and machinery, etc., the management should apportion such consideration into two parts on a reasonable basis.”

2.   The Committee is of the view that it is necessary to determine for the purpose of treatment in the books of account as to whether the know-how is related to the plans, designs and drawings of the plant and machinery of the Sulphur Recovery Unit (SRU) or the know-how is related to the manufacturing process of the Sulphur Recovery Unit (SRU). The Committee, however, notes that these details are not available in the facts of the query.

3. The Committee is of the view that the expression “manufacturing process”, in connection with the SRU should be taken to mean the process for reducing the quantity of Sulphur Dioxide emission into the air, and not the manufacturing process of the refinery plant as such.

4.  On the basis of the above, the Committee is of the opinion that capitalising the license fee paid towards technical know-how purchased by the querist will be the appropriate treatment to be given in the books of account if the know-how relates to plans, designs and drawings of plant and machinery of the SRU.

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