Royalty for technical know-how treated as revenue expenditure, while section 80-I relief must first absorb carried-forward depreciation and rebate.

Royalty paid under a foreign collaboration agreement for technical specifications, formulae and related know-how used in running the tyre factory was treated as revenue expenditure, because its character under the agreement was connected with business operations and did not amount to acquisition of a capital asset. For relief under section 80-I, unabsorbed depreciation and development rebate of earlier years had to be deducted before computing the profits attributable to the priority industry, applying the principle that carried-forward business adjustments are first absorbed in the income computation before the special deduction is calculated.

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Issues: (i) Whether the royalties paid to the foreign collaborator for technical specifications, formulae, and other technical information were revenue expenditure or capital expenditure. (ii) Whether, for computing relief under section 80-I, unabsorbed depreciation and development rebate of earlier years had to be deducted before arriving at the profits attributable to the priority industry.

Issue (i): Whether the royalties paid to the foreign collaborator for technical specifications, formulae, and other technical information were revenue expenditure or capital expenditure.

Analysis: The payment was made under a collaboration agreement for the supply of specifications, formulae, and technical information required for the running of the tyre factory. The Court held that the nature and object of the payment showed that no part of the royalty was capital in character, even though the information supplied may have resulted in an enduring advantage to the business. The decisive test was the character of the payment under the agreement and its connection with the business operations.

Conclusion: The royalty was revenue expenditure and was allowable as a deduction; the issue was decided in favour of the assessee.

Issue (ii): Whether, for computing relief under section 80-I, unabsorbed depreciation and development rebate of earlier years had to be deducted before arriving at the profits attributable to the priority industry.

Analysis: Relief under section 80-I was computed by a straight deduction from total income on the basis of profits attributable to the priority industry, using language materially similar to section 80E. The Court applied the principle stated by the Supreme Court that items such as unabsorbed depreciation and unabsorbed development rebate must be deducted in arriving at the figure on which the percentage deduction is to be worked out. The same standards govern computation of business income and the special relief under the provision.

Conclusion: Unabsorbed depreciation and development rebate of earlier years had to be deducted before computing the relief under section 80-I; the issue was decided against the assessee.

Final Conclusion: The reference was answered partly in favour of the assessee and partly in favour of the Revenue, with the royalty deduction accepted as revenue expenditure but the section 80-I relief computation required reduction by earlier years' unabsorbed depreciation and development rebate.

Ratio Decidendi: For computing a statutory percentage deduction based on profits attributable to an or priority activity, items included in the business computation under the Act, including carried-forward depreciation and development rebate where applicable, must be taken into account before the special relief is calculated; royalty paid for technical know-how under a collaboration agreement is revenue expenditure where it is incurred for the conduct of the business and does not secure capital asset acquisition.

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