Royalty payments forming part of acquisition consideration are capital expenditure and not deductible under income tax law.

Royalty payments payable under an agreement that together with an instalment formed the consideration for acquiring rights to manufacture and sell a patented product are capital expenditure and not deductible under Section 10(2)(ix) of the Income Tax Act. The agreement must be construed as a whole, and a royalty described as contingent at inception becomes definite and ascertainable as sales occur and can be accounted for. Where such payments operate as part of the purchase consideration for an asset or right conferring ongoing benefit, they are properly characterised as capital rather than revenue expenditure.

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Issues: Whether payments made under a clause providing for a royalty on each article sold formed part of the purchase consideration for acquiring rights and therefore amounted to capital expenditure not deductible under Section 10(2)(ix) of the Indian Income Tax Act.

Analysis: The agreement must be construed as a whole; the instalment sum and the royalty clause together constitute the consideration for acquiring the rights to manufacture and sell the patented product. A payment described as a royalty payable as long as the company exists, although contingent in amount at the date of agreement, becomes definite and ascertainable as sales occur and is capable of being shown in the accounts. Where such payments form part of the consideration for acquisition of an asset or rights conferring ongoing benefit, they are properly characterized as capital expenditure rather than expenditure incurred solely for the purpose of earning profits or gains under the revenue deduction provision.

Conclusion: The royalty payments payable under the agreement are part of the purchase consideration for the acquired rights and are capital expenditure; they are not sums lawfully deductible under Section 10(2)(ix) of the Indian Income Tax Act.

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