1.26 Query
Treatment of expenditure on know-how
. public limited company has entered into an agreement with a foreign collaborator to provide technical know-how for manufacture of road rollers as per the guidelines issued by the Government of India in this regard. As per the agreement, the technical know-how fees is payable in three equal instalments. The company has already paid two instalments and the last instalment is due in the current year, i.e., 1985-86. A new section 35 AB has been inserted by the Finance Bill 1985 according to which “lump sum consideration for acquiring any know-how for use for the purpose of business, 1/6 of the amount so paid shall be deducted in computing the profits and gains of the business and the balance amount shall be deducted in equal instalments for each of the five immediately succeeding years”. In the light of the above the company wants to treat the amount paid in current year only as deferred revenue expenditure to be written-off in six years. The company is however advised that this should be charged to revenue as was the practice in earlier years.
2. The querist has also furnished the following details with regard to the above query:
(i) The technical know-how pertains to manufacturing process and designs and drawings of manufacture of road rollers,
(ii) clause 10 of the technical collaboration agreement lays down to payment schedule as below:
“1. As consideration for the supply of know-how and grant of other rights hereunder to the licensee (i.e. the company in question) by the licensor (i.e. the foreign collaborator) the licensee shall pay to the licensor a fee of Rupee eight lacs (subject to Indian taxes) and shall be paid in the manner following:
(a) one-third of the said sum after the agreement has been taken on record by the Government of India and before drawings and documents are transferred by the licensor to the licensee in terms of clause 3 hereof,
(b) one-third of the said sum at the time of the transfer of the said drawings and documents, and
(c) the remaining one-third of the said sum after the commencement of commercial production or four years after thr collaboration agreement is taken on record by Government of India whichever is earlier of the products.
(d) payment under this clause shall be subject to applicable taxes.
2. For purposes of this clause “commercial production” means the first day of the calender month in which the licensee shall have manufactured the products for sale”.
(iii) Commercial production of the products covered by the agreement was started in March 1985.
(iv) Date on which the agreement was entered into is 20th January, 1982.
(v) The duration of the agreement shall be for a period of 5 years from the date the agreement is taken on record or 5 years from the date of commercial production, provided production is not delayed beyond 3 years of the date agreement is taken on record (i.e. a maximum period of 8 years from the date).
Opinion October 14,1986
1.The Committee is of the view that the manner of treatment of expenditure in the books of account of an entity should be decided on the basis of the relevant accounting principles and practices rather than on the basis of the relevant tax provisions which might have been enacted to fulfill different objectives.
2. The Committee notes that the accounting treatment of expenditure incurred on know-how has been laid down in the Guidance Note on Treatment of Expenditure During Construction Period and Statement on Auditing Practices, issued by the Research Committee of the Institute of Chartered Accountants of India.
3.Guidance Note on Treatment of Expenditure During Construction Period recommends in para 9.7 (a) that “…….. the consideration, if any, which is paid separately for the value of the technical know-how supplied by the contractors would have to be accounted for, depending on the nature of the technical know how which is supplied. 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 …………. If, on the other hand, the technical know-how which is supplied relates to productive facilities and processes, its value would have to be treated initially as an item of deferred revenue expenditure to be amortised in suitable instalments after the commencement of production, preferably over a period not exceeding 3 to 5 years after the commencement of production…………”. The Committee also notes that the treatments prescribed in this Guidance Note will also be applicable in the case of capital expansion of an existing entity as indicated in para 16.1 of the Guidance Note.
4. Para 3.23 of the Statement on Auditing Practices recommends that “Where the consideration for the supply of know-how is a series of recurring annual payments over a period of year, such payments being described as royalties, technical assistance fees, contributions of research etc. the payments so made can be properly written-off against the profits of each year. If, however, the essential nature of the consideration is a lump sum amount payable in instalments over a period of year, the mere fact that the payment is separate over a period of time cannot change the nature of the payment and accordingly the lump sum amount must be treated as described in the immediately preceding paragraphs.”
5The Committee notes that the amount of Rs. 8 lacs is a consideration in lump sum payable in instalments at specified stages for the supply of know-how for manufacturing a new product which is prima facie, related to manufacturing process of road rollers and does not appear to include any fees for plans, designs for plant and machinery etc. The Committee is therefore of the opinion that since the liability was incurred before the commencement of commercial production of road rollers, it should have been treated as a deferred revenue expenditure to be written off over a period not exceeding 3 to 5 years after commencement of commercial production.
6.The Committee however notes that the company did not follow the accounting treatment suggested in the above paragraph but charged off to revenue the instalment amounts in the year in which they were paid.
7. The Committee is therefore of the opinion that since the liability on account of know-how was incurred as a lumpsum though payable in instalments, the amounts of instalments debited to the profit and loss accounts of earlier years should be credited to the current year’s profit and loss account as a prior period item1 and disclosed as suggested in para 9 of Accounting Standard 5 (AS-5) on Prior Period and Extra-ordinary Items and Changes in Accounting Polices, issued by the Institute of Chartered accountants of India, which is reproduced below: “Prior period items should be separately disclosed in the current statement of profit and loss together with their nature and amount in a manner that their impact on current profit or loss can be perceived.”
8. The total amount of fee (including the amounts written back) should be debited to Deferred Revenue Expenditure and be written off over a period of 3 to 5 years as may be decided by the company. __________________ _____________________ 1 Prior period items are “material charges or credits which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods” (para 3.1 of AS-5).
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