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Capital Expenditure Vs. Revenue Expenditure - under the 'Income Tax Act.'

As the Act does not define the terms “capital expenditure” and “revenue expenditure”, one has to depend upon its natural meaning as well as decided cases:

  • Acquisition of fixed assets v. Routine expenditure -

Capital expenditure is incurred in acquiring, extending or improving a fixed asset, whereas revenue expenditure is incurred in the normal course of business as a routine business expenditure.

  • Several previous years v. One previous year -

Capital expenditure produces benefits for several previous years, whereas revenue expenditure is consumed within a previous year.

  • Improvement v. Maintenance -

Capital expenditure makes improvements in earning capacity of a business. Revenue expenditure, on the other hand, maintains the profit-making capacity of a business.

  • Non-recurring v. Recurring -

Usually capital expenditure is a non-recurring outlay, whereas revenue expenditure is normally a recurring item.

  • Lump sum payment v. Periodic payment -

In order to determine whether an expenditure is capital or revenue in nature, the fact that it is a lump sum payment or periodic payment is not important.

Though the dividing line between a capital and revenue expenditure is real, yet sometimes it becomes difficult to draw. Therefore, the distinction depends on facts and surrounding circumstances of each case.

For computing profits of a business taxable under this Act, only revenue expenses are allowed to be deducted. Hence it becomes essential 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 asset or in connection with installation of fixed asset is capital expenditure.

Whereas

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 discharge a capital liability is a capital expenditure.

Whereas

An expenditure incurred to discharge 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 whereas amount paid by a person—with whom he has entered into contract for supply of goods for a period of 5 years—but he fails to supply goods after 3 years, the compensation will be a revenue expenditure as it is to discharge the revenue liability.

(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.

Whereas

An expenditure incurred to earn an income is revenue expenditure, e.g., salary of the staff, advertisement expenses, etc.

(iv) Purpose of transaction. If the amount is spent on increasing the earning capacity of an asset, it is capital expenditure, e.g., expenditure incurred for fitting new windows of factory building.

Whereas

Any expenditure incurred on keeping an asset in running condition is revenue expenditure, e.g., amount spent on protection of fixed assets which have already been acquired.

(v) Nature of payment in the hands of payer. If an expenditure is incurred by an assessee as a capital expenditure, it will remain as 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. Similarly, if the nature of payment in the hands of payer is of revenue nature, it will be a revenue expenditure even if it is capital receipt in the hands of receiver.

Capital Expenditure

  1. Cost of reconstructing, refurnishing, etc. of a business building.

  2. Payment made by the assessee with a view to keeping his competitor out of his field of business.

  3. Expenditure incurred in converting business premises when switching over from manufacture of one product to another.

  4. Expenditure on litigation in connection with acquiring or curing a defect in assessee’ s title to the assets of the business.

  5. Compensation paid for cancellation of contract for the purchase of machinery.

  6. Price paid for the purchase of partner’s share in the firm.

  7. Expenditure incurred on the maintenance of business reputation.

Revenue Expenditure

  1. Payments made for use of quota rights, or for use of patents and trade marks.

  2. Payment made for technical assistance and access to the fruits of continuing research [C.I. T. v. Ciba of India Ltd. (1968) 69 1. T.R. 692 (S. C.)].

  3. Expenditure incurred by professionals on study tour abroad to acquire latest knowledge [Dr. Vadamalayan v. C.I. T. (1960) 40 I. T.R. 50].

  4. Any expenditure necessary at the time of purchase to render the asset so purchased, serviceable, will be added to the initial cost as capital expenditure. But any expenditure on the replacement of part of a plant which does not bring any additional advantage to the business of assessee is revenue expenditure [C.I. T. v. Shri Rama Sugar Mills Ltd. (1952) 91 1. T.R. 191].

  5. Expenditure incurred to send employees abroad for practical training in the field of the business of the assessee.

  6. Expenditure incurred by way of fee paid to valuer for assessing the business premises.

  7. Expenditure incurred in raising loans, e.g., stamp duty, registration and legal fees, brokerage etc.

  8. Expenditure to oppose threatened nationalization of the industry.

  9. Expenditure incurred to secure overdraft facilities from a bank.

  10. Payment to the government to obtain monopoly to run buses on a route.

  11. Compensation or other payment made to get rid of a servant or a managing agent in the interest of the business.

  12. Any such expenditure incurred wholly, totally, necessarily for the business.

Revenue Expenditure [Section 35(1)(i)]:

All revenue expenses laid out or expended on scientific research during the previous year are fully allowed as a deduction.

It has further been provided that following revenue expenses, expended or laid out during three years immediately preceding the commencement of the business, shall be deemed to be the expenditure of the previous year in which the business commences and therefore, shall be allowable in that year to the extent these are certified by the prescribed authority:

(a) payment of salary to employees engaged in scientific research;

(b) purchase of material used in scientific research.

For example,

if the assessee commences its business on 15.12.2018 then all revenue expenses on scientific research related to the business incurred, on or after 15.12.2018, will be allowed as a deduction. Further, expenses incurred during the period 15.12.2015 to 14.12.2018 and which are certified by the prescribed authority will be deemed to be expenses of the previous year 2018-19 and will be allowable in that year.

 

More Topics ...
Capital Expenses Vs. Revenue Expenses - under 'Capital Gains'
Capital Receipts vs Revenue Receipts - under 'Capital Gains'
Revenue Losses Vs. Capital Losses under Income Tax Act.

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