Income Tax is levied on income of assessee and not an every receipt which he receives. The method of charging tax on different types of receipt is different. Income tax Act, 1961 provides a separate head “ CAPITAL GAINS” for levying tax on capital receipts. Similarly, while calculating net taxable income of an assessee only revenue expenses are allowed to be deducted out of revenue receipts. Particularly while calculating business profit or professional gain only revenue receipts and revenue expenses are considered. This make the distinction between capital and revenue of vital importance. For this distinguish capital and revenue items can be divided in to 3 sub-parts :
Capital Receipts vs Revenue Receipts
Capital Expenses vs Revenue Expenses
Revenue Losses vs Capital Losses
2. CAPITAL RECEIPT VS REVENUE RECEIPTS
As discussed above the capital receipts are to be charged to tax under “ Capital Gains” and revenue receipts are taxable under other heads, it is of vital importance to understand which receipt is a capital receipt and which one is a Revenue. Some tests, however, can be applied in particular cases. These Tests are :
1. On the basis of nature of Assets : If a receipt is referred to Fixed Asset, it is capital receipt and if it is referable to circulating asset it is revenue receipt.
Fixed assets is that with the help of which owner earns profit by keeping it in this possession, e.g. Plant , Machinery, Building or factory etc.
Circulating Asset is that with help of which owner earns profits by parting with it and letting others to become its owner, e.g. Stock-in Trade.
Profit on the sale of Motor Car used in business by an assessee is Capital Receipt whereas the profit earned by an automobile dealer, dealing in cars, by selling a car is his revenue receipt.
2. Termination of source of income : Any sum received in compensation for the termination of source of income is capital receipt, e.g. compensation receive by an employee from its employer on termination of his services is capital receipt.
3. Amount received in substitution of income : Any sum received in substitution of income is revenue receipt,
e.g. ‘A’ company purchased the right to produce a Film fro its earlier producer with the condition that no other produce will be given these rights. Afterwards, it is found that the rights for producing this film had already been sold. The ‘A’ Company claimed damages and was awarded Rs.50,000. It was held that damages received are the compensation for the profits which were to be earned. Hence, this is Revenue Receipt.
4. Compensation received on termination of Lease or surrender of a Right. Any amount received as compensation on surrendering a right or termination of any Lease is Capital Receipt where as any amount received for loss of future income is a revenue receipt.
e.g. An Author gives up his right to publish a book and receives Rs. 1,00,000 as compensation. It is capital receipt but if he receives it as advance Royalty for 5 years it is Revenue receipt.
3. CAPITAL EXPENSES VS REVENUE EXPENSES
To distinguish a Revenue Expenditure from a Capital Expenditure, the following tests can be applied for this purpose :
(i) Nature of the Assets : Any expenditure incurred to acquire a Fixed Assets or in connection with installation of Fixed Assets is Capital Expenditure.
any expenditure incurred as price of goods purchased for resale along with other necessary expenses incurred in connection with such purchase are Revenue Expenses.
(ii) Nature of Liability : A payment made by a person to discharged a capital liability is a capital expenditure.
An expenditure incurred to discharged a revenue liability is Revenue Expenditure,
e.g. Amount paid to a contractor for cancellation of contract to construct a factory building is capital expenditure.
(iii) Nature of Transaction : if an Expenditure is incurred to acquire a source of income, it is Capital Expenditure e.g. purchase of patents to produce picture tubes of T.V. sets.
An Expenditure incurred to earn an income is revenue expenditure , e.g. salary to staff, advertisement expenses. Etc.
(iv) Nature of Payment in the hands of payer : If an expenditure is incurred by an assessee as a Capital Expenditure, it will remain a capital expenditure even if the amount may be revenue receipt in the hands of receiver ,
e.g. purchase of Motor Car by a businessman is capital expenditure in his hands although it is revenue receipt in the hands of car dealer.
4. CAPITAL LOSSES VS REVENUE LOSSES
Distinction has to be made between revenue losses and capital losses of the business because under the provisions of this Act Capital Losses are dealt with under the Chapter “ Capital Gain” whereas Revenue Looses are treated as Business Losses and as such are treated under the head “ Profit and Gains of Business or Profession”.
Distinguish has to be made between Revenue Losses and Capital Losses of the business because under the provisions of this Act, Capital Losses can be set off against the Income from Capital Gain only, whereas the Revenue Losses are business losses and as such can be set off against any other income of the assessee.
It is very difficult to distinguish between a Capital Loss and a Revenue Loss on the basis of certain principles. On the basis of court judgment, following decisions have become distinguishing points :
(i) Loss due to sale of Assets : Where there is loss on selling a Capital Assets, it is a Capital Loss whereas any loss incurred during the sale of Stock-in-Trade is a Revenue Loss.
(ii) Loss due to embezzlement : Where there is embezzlement done by an employee and this causes loss to the business, it is of Revenue Loss.
(iii) Loss due to withdrawal of money from bank : Oncethe amount is deposited in Bank and then it is withdrawn by an employee and is misappropriated , is a Capital Loss.
(iv) Loss due to liquidation of company : Amount deposited by a person with manufacturing industry to get its agency and lost due to company being liquidated is a Capital Loss.
(v) Loss due to Theft by an employee : Losses occurring due to theft or embezzlement of misappropriation committed by an employee is Revenue Loss.
State , giving reasons, whether the following are Capital or Revenue Receipts :
Compensation received for compulsory vacation of place of business.
Bonus shares received by a dealer of shares.
Money received by a Tyre Manufacturing company for sale of technical know-how regarding manufacture of tyre.
Dividend and interest for investment.
Revenue receipt as it is in compensation of assessee’s profit which it would have earned.
If the assessee has also converted the bonus shars into stock in trade then it is a revenue receipt otherwise it is an accretion in the capital assets.
Revenue Receipt but in case the sale of technical know-how results into substantial reduction in value of the tyre company or company closes down its business in that particular line then the receipt would be a Capital Receipt.
Assessee gets the income of dividend and interest regularly and form a define source and it is a return for the use of his asset by somebody else and so it is a revenue receipt.