Royalty disallowance under section 40A(2)(b) fails without evidence of excessiveness against fair market value.

Royalty expenditure could not be disallowed under section 40A(2)(b) unless it was shown to be excessive or unreasonable by reference to fair market value, the business need, or the benefit derived. Mere reliance on earlier-year comparison and the fact that the royalty agreement was unregistered was insufficient because the statutory inquiry had to be made for the relevant year against comparable market conditions. On that basis, the royalty disallowance was deleted in favour of the assessee.

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Issues: Whether the disallowance of royalty expenditure under section 40A(2)(b) was justified.

Analysis: The disallowance under section 40A(2)(b) can be sustained only if the expenditure is shown to be excessive or unreasonable having regard to the fair market value of the goods, services or facilities, the legitimate needs of the business, or the benefit derived therefrom. The Assessing Officer relied mainly on comparison with earlier years and on the royalty agreement being unregistered, but did not undertake an exercise to determine the fair market value of the royalty for the relevant year. Mere comparison with prior-year payments or the absence of registration of the agreement was held insufficient for invoking section 40A(2)(b), since the statutory inquiry had to be made with reference to the relevant year and comparable market conditions.

Conclusion: The disallowance of royalty expenditure was deleted and the issue was decided in favour of the assessee.

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