REVENUE CAPITAL EXPENSE |
Business income ID – (JBC-029) |
Expenditure vs. Contingent Liability.
Expenditure is not necessarily confined to the money which has been actually paid out. Expenditure may also cover a provision for a liability which has accrued or which has been incurred during the year but which has not been paid.
General note on business expense
Business income is computed according to ordinary principles of commercial accounting. Even so, section 29 would require that the income should be computed "in accordance with the provisions contained in sections 30 to 43D". These Sections list out certain permissible deductions, while prohibiting some others. At the same time, these are not exhaustive as pointed out by the Supreme Court in the case of Badridas Daga v. CIT when it allowed the money lost on embezzlement, though not specifically listed as a deduction. Capital expenditure has to be disallowed even where it is not specifically ruled out as under section 37 because both capital receipt and capital expenditure should ordinarily be treated as being outside the scope of computation of income.
In order that specific deductions should be available, the assessee should carry on the business during the year with the result that the expenditure in connection with the closure of a business or even of its transfer may well get hit notwithstanding the fact that such expenditure has been incurred genuinely, and in connection with the business.
Provision must be construed liberally
On accepted commercial practice and trading principles an item of business expenditure must be deducted in order to arrive at the true figure of profits and gains for tax purposes. If the contents of this rule be true on general principle, there is no good reason why the scope of section 37(!) should not be construed liberally - CIT V/s. Kalyanji Mavji & Co. [1980] 122 ITR 49 (SC).
Powers of departmental authorities
It is not open to the department to prescribe what expenditure an assessee should incur and in what circumstances he should incur that expenditure. Every businessman knows his interest best - CIT V/s. Dhanrajgiri Raja Narasingirji [1973] 91 ITR 544 (SC).
Students Summery |
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Meaning of ‘expenditure’
‘Expenditure’ is what is ‘paid out or away’ and is something which has gone irretrievably - Indian Molasses Co. (P) Ltd. V/s. CIT [1959] 37 ITR 66 (SC). ‘Expenditure’ is not necessarily confined to the money which has been actually paid out. It covers a liability which has accrued or which has been incurred although it may have to be discharged at a future date. However, a contingent liability which may have to be discharged in future cannot be considered as expenditure. In its normal meaning, the expression ‘expenditure’ denotes ‘spending’ or ‘paying out or away’, i.e., something that goes out of the coffers of the assessee. A mere liability to satisfy an obligation by an assessee is undoubtedly not ‘expenditure’
Illegal payments
The expenditure that can be allowed must be legitimate and not illegal. In a large number of decisions, a consistent view has been taken that though the illegal transaction might have resulted in profit and which may be taxable, no deduction for such unlawful means employed for this purpose can be given. It is true, that under the Act the income is of course taxed, but the illegal ways and means employed by the assessee for procuring such illegal profit cannot be countenanced and it is against the public policy - CIT V/s. Sauser Liquor Traders [1996] 222 ITR 33 (MP).
Contingent liabilities
Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which is deductible for income-tax purposes is towards a liability actually existing at the time but the setting apart money which might become expenditure on the happening of an event is not expenditure - Shree Sajjan Mills Ltd. V/s. CIT [1985] 156 ITR 585 (SC); Indian Molasses Co. (P) Ltd. V/s. CIT [1959] 37 ITR 66 (SC).
No test is paramount or conclusive.
There is no all embracing formula which can provide a ready solution to the problem, no touchstone has been devised. Every case has to be decided on its own facts, keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. No two cases are alike and quite often emphasis on one aspect or the other may tilt the balance in favour of capital expenditure or revenue expenditure - CIT V/s. Coal Shipments (P) Ltd. [1971] 82 ITR 902 (SC); Bringing into existence an asset or advantage of enduring nature would lead to the inference that the expenditure disbursed is of a capital nature. Ultimately, the question will have to depend on the facts and circumstances of each case, namely, quality and quantum of the amount, the position of the parties, the object of the transaction which has impact on the business, the nature of trade for which the expenditure is incurred and the purpose thereof, etc.
Warranty claims
It is well-established that under the accrual or mercantile system of accounting, the taxpayer is entitled to make a provision for all liabilities which are foreseen in relation to transactions of the year, whether it is payable during the year or not. The court has pointed out that taxable income is not on gross receipts but on profits and gains of the business. The profits, as was pointed out by the House of Lords should be understood in its natural and proper sense, in a sense which no commercial man would misunderstand. It has to be real profits. It was for this reason that the assessee was allowed deduction of a provision in respect of what he has undertaken by way of amenities, when it had sold a plot in a layout. This has been followed in a number of cases. It was for this reason that the warranty claim was considered and found allowable in CIT v. Majestic Auto Ltd. [1993] 204 ITR (AT) 14, though it was claimed for the first time by a change in the method of accounting. [1959] 037 ITR 0001- Calcutta Co. Ltd. vs. Commissioner of Income-tax (Supreme Court of India)
Remuneration to karta
It is necessary that before a karta receives remuneration, it should be under a valid agreement which would justify the payment of remuneration to a karta of a HUF for managing the business of the family. To be deductible under section 37(1), the test which should be applied is whether the agreement has been made by or on behalf of all the members of the HUF and whether it was in the interests of the business of the family so that it could be justified on grounds of commercial expediency. If such remuneration is not excessive and is reasonable and is not a device to escape income-tax, then it will be a legitimate deduction in computing the profits of the business. If, on the other hand, the amount paid is unreasonably high and is disproportionate to the services rendered by the karta, then it may be treated as part of the profits of the HUF distributed in a particular manner - Jugal Kishore Baldeo Sahai V/s. CIT [1967] 63 ITR 238 (SC).
Where turnover and income of firm had increased, a corresponding increase in allowance to karta, who was partner in firm, could not be described as an unreasonable decision or a decision actuated by motives other than business - Brij Mohan V/s. CIT [1993] 69 Taxman 523/201 ITR 831 (SC)
Shifting of plant and machinery
Where the assessee shifted his sugar factory from a disadvantageous location to another location, the expenditure incurred on the shifting of plant/machinery to the new site was clearly not incurred for the purpose of carrying on the concern but was incurred in setting up the concern with a greater advantage for the trade than it had in its previous set-up. The expenditure was not incurred in earning any profit but only for putting its factory (capital) in better shape, and it went towards effecting a permanent improvement in the profit-making machinery. It was therefore a capital expenditure and not revenue expenditure -Sitalpur Sugar Works Ltd. V/s. CIT [1963] 49 ITR 160 (SC).
Principles to distinguish capital revenue expenditure -
Capital expenditure cannot be attributed to revenue and vice versa.
It is equally clear that a payment in a lump sum does not necessarily make the payment a capital one. It may still possess revenue character in the same way as a series of payments.
If there is a lump sum payment but there is no possibility of a recurrence, it is probably of a capital nature, though this is by no means a decisive test.
If the payment of a lump sum closes the liability to make repeated and periodic payments in the future, it may generally be regarded as a payment of a revenue character.
If the ownership of the money, whether in point of fact or by a resulting trust, be still in the taxpayer, then there is acquisition of a capital asset and not an expenditure of a revenue character - Indian Molasses Co. (P) Ltd. V/s. CIT [1959] 37 ITR 66 (SC).
When expenditure is incurred not only once and for all, and with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, ordinarily such expenditure is on capital account;
Where the expenditure is incurred in the field of fixed capital, it is on capital account, but if it is a part of the circulating capital, it is on revenue account;
If the expenditure is a part of the working expenses in ordinary commercial trading, it is not capital but revenue expenditure;
If the expenditure is incurred for the initial outlay or for extension of business or substantial replacement of equipment, it is capital expenditure but if it is incurred for running the business or is laid out as part of the process of profit making, it is revenue in character; and
If expenditure is incurred for ensuring the regular supply of raw material, maybe for period extending over several years, it is on revenue account - Gujarat Mineral Development Corp. Ltd. v. CIT [1983] 143 ITR 822 (Guj.).
Where the expenditure laid out for the acquisition or improvement of a fixed capital asset is attributable to capital, it is a capital expenditure, but if it is incurred to protect the trade or business of the assessee, then it is a revenue expenditure. What the Courts have to see is whether the expenditure in question was incurred to create any new asset or was incurred for maintaining the business. If it is the former, it is capital expenditure; if it is the latter, it is revenue expenditure - Dalmia Jain & Co. Ltd. V/s. CIT [1971] 81 ITR 754 (SC).
What is material to consider is the nature of the advantage in a commercial sense and it is only when the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If an advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future.
Whether a particular expenditure is capital or revenue expenditure
Outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment;
Expenditure may be treated as properly attributable to capital when it is made not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. If what is got rid of by a lump sum payment is an annual business expense chargeable against revenue, the lump sum payment should equally be regarded as a business expense, but if the lump sum payment brings in a capital asset, then that puts the business on another footing altogether
Whether for the purpose of the expenditure, any capital was withdrawn, or, in other words, whether the object of incurring the expenditure was to employ what was taken in as capital of the business. Again, it is to be seen whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital.
If the expenditure is for the initial outlay or for acquiring or bringing into existence an asset or advantage of an enduring benefit to the business that is being carried on, or for extension of the business that is going on, or for a substantial replacement of an existing business asset, it would be capital expenditure.
If, on the other hand, the expenditure, although for the purpose of acquiring an asset or advantage, is for running of the business or for working out that asset with a view to produce profit, it would be revenue expenditure.
If the outgoing is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit earning process or operations, and not for the acquisition of an asset of a permanent character, the possession of which is a condition precedent for the running of the business, then it would be expenditure of a revenue nature.
Special knowledge, or technical knowledge, or a patent, or a trade mark, is an asset and if it is acquired by payment for use and exploitation for a limited period, and what is acquired is not an asset or advantage of an enduring nature and at the end of the agreed period that advantage or asset reverts back intact to the giver of that special knowledge or the owner of the patents or trade marks, it would be expenditure of a revenue nature.
If it is intrinsically a capital asset, it is immaterial whether the price for it is paid once and for all, or periodically, or whether it is paid out of capital or income, or linked up with the net sales. The outgoing, in such a case, would be of the nature of capital expenditure.
If the amount paid for the acquisition of an asset of an enduring nature is settled, the mere fact that the amount so settled is chalked out into various small amounts or periodic installments, the capital nature of expenditure would not cease to be so or alter into the nature of a revenue expenditure.
A lump sum amount for liquidating recurring claims would not cease to be revenue expenditure or get converted into capital expenditure merely because its payment is spread over a number of years. It is the intention and object with which the asset is acquired, that determines the nature of the expenditure incurred over it, and not the method or the manner in which the payment is made, or the source of such payment.
If the expenditure is recurring and is incurred during the course of business or manufacture, it would be revenue expenditure.
An asset or advantage of an enduring nature does not mean that it should last for ever. If the capital asset is, in its nature, a short-lived one, the expenditure incurred over it does not, for that reason, cease to be a capital expenditure.
It is not the law that if an enduring advantage is obtained, the expenditure for securing it must always be treated as capital expenditure. If the advantage acquired is to get the stock-in-trade of the business, then it would be revenue expenditure. But if what is acquired is not the advantage of getting the stock-in-trade directly, but of something which has to be dressed up or processed before it is converted into stock-in-trade, the expenditure incurred over it would be capital expenditure.
Clarification and Instruction of CBDT issued in past.
The salaries and wages paid to the employees for the period of the training in the courses organised by the Central Board of Workers’ Education should be allowed as admissible deductions while computing the income of the employers
The expenditure by way of membership fee of the Indian Institute of Foreign Trade can be said to be wholly and exclusively incurred for the purpose of business of the members. Therefore, such expenditure may be allowed as admissible deduction under section 37(1) in the hands of the payers in computing their total income from business.
Expenses incurred by a company on getting its shares listed in a stock exchange should be considered as laid out wholly and exclusively for the purposes of the business and, therefore, admissible as business expenditure under section 37(1).
Professional tax paid by a person carrying on a business or trade can be allowed to him as a deduction under section 37(1).
Rebate or bonus (which is in the nature of deferred discount) passed on by the consumer co-operative stores to their members on the value of the purchases made by them during a year should be allowed as a deduction in computing the business income of such a society.
Reasonable remuneration paid by a company to its Registrar for performing duties in connection with the company’s legal obligations to be discharged under the company law should be regarded as revenue expenditure provided the company is not itself maintaining a separate organization for the performance of such duties.
The expenses incurred in original proceedings for assessment to sales tax as also in appeals arising from such proceedings should be allowed as a deduction in income-tax assessments
The initial expenditure on the first installation of fluorescent lights, including the expenditure on wiring and fittings, should be treated as capital expenditure as it creates an asset, and all subsequent expenditure for replacement of the tubes should be treated as of a revenue nature, allowable in toto.
The question of admissibility of expenditure on visits to foreign countries should not be approached from the point of view as to whether such visits result immediately in the earning of profits. All that the law requires is that the expenditure should not be in the nature of capital expenditure or personal expenditure of the assessee, and should be wholly and exclusively laid out for the purposes of the business
Interest charged by the Government for delay in payment of tax is in the nature of personal liability which cannot be allowed as a deduction in the computation of the taxable income
Legal expenses incurred in connection with the renewal of lease should be allowed as an admissible deduction for purposes of income-tax provided that the renewal of the lease is for a period of less than fifty years. Expenditure incurred on the compulsory removal of business premises, i.e., in cases where the removal has taken place under the directions of Government should, as in the case of air raid precautions expenditure, be allowed as a deduction for purposes of income-tax.
Commitment charge payable by a party on the unused portion of the loan which has not been drawn, has to be taken as an expenditure laid out wholly and exclusively for the purposes of the business and, therefore, permissible as a revenue deduction under section 37(1).
As the expenses incurred on the occasion of Dewali and mahurat are in the nature of business expenditure, it has been decided not to lay down any monetary limits for the purpose of their allowance.
It is open to the subscriber either to claim the entire amount paid under the OYT scheme in the year in which the payment is made or proportionately in the years for which advance payment of rent is made. Where the installation of telephone is in the previous year subsequent to the previous year in which the deposit is made, the deduction for the payment should be allowed in the year of payment irrespective of the fact whether the telephone has been installed or not.
Amount paid by an assessee for obtaining a new telephone connection under the “Tatkal Telephone Deposit Scheme”, can be allowed as revenue expenditure in the year of payment. The refund of said amount, if any, will be taxed under section 41(1)-Circular: No. 671,
Since the deposit of Rs. 10,000 for a telex connection does not earn any interest when the telex machine is installed, at that stage, this amount may be treated as a revenue expenditure allowable as a deduction, if the assessee makes such a claim. However, when the amount is returned by the postal authorities when the telex connection is finally closed, the refund of Rs. 10,000 shall be treated as an income of the assessee of the year in which the amount is refunded.-Circular: No. 420
With regard to expenses incurred by members of delegation going abroad for exploring new markets for Indian products and similar export promotional activities, all reasonable expenditure incurred by the members of the delegations should be allowed in the assessment of the members concerned.
Business concerns are required to take the following civil defence measures as part of the civil defence plan in respect of their property:
Raise, train the following civil defence services at the scale laid down in the Home Ministry’s hand books: Messenger service, casualty service, rescue service, etc.
Purchase of civil defence equipment, stirrup pump, helmets, sirens, etc., as per prescribed scale.
Fire-fighting system is to be brought to the required standard to cope up with likely effect of air raids.
A warning system is to be laid to receive air raid warning from the nearest civil defence control centre and disseminate the same to the workers.
In addition, some special civil defence measures relating to water supply system, piping system, concealment from glow, etc., are also to be adopted.
All expenses on civil defence measures may be allowed as revenue expenditure unless any portion thereof is of an enduring nature whose usefulness may be extended beyond the period of emergency in which case depreciation admissible as per rules can be allowed.
Expense prohibited under the law
Here is a recent decision by the Mumbai Bench of ITAT in Dy. CIT v. Salman Khan [2011] 130 ITD 81 / 9 taxmann.com 74 in which a claim was made by the actor for allowance of deduction of expenditure on legal charges for defending him from criminal proceedings and the Bench held it as an expenditure of personal nature. It is not unknown that the actor in this case was implicated under Wildlife Protection Laws for shooting a black duck in Rajasthan. The failing arguments of the assessee before the Tribunal were that legal expenditure was incurred by the assessee for exemption from appearance in the Court and also to defend the assessee as otherwise the assessee had to himself attend which would have meant loss of business to the actor and in the consequence loss to the revenue. The following words explain the saga (Pg. 92):
"On the other hand, learned counsel of the assessee strongly supported the order of first appellate authority and also relied on the decision of Birla Cotton Spg. & Wvg. Mills Ltd.’s case (supra) as well as Dhanrajgiri Raja Narasinggiriji’s case (supra). He further submitted that certain criminal complaints were lodged against the assessee and the assessee has to defend himself otherwise assessee was required to attend criminal proceedings personally which would cause the business loss because assessee is an actor and if he is away from the profession he would lose the income. Therefore, by acting in the profession he could generate income and pay more tax also. He also relied ....."
Rejecting such not-so-straight arguments, the Mumbai Bench went on to hold that the expenses in the instant case were personal expenses of the actor without appreciating that there is a thin line in the professional and personal life of an actor. The actors in general have little personal life. They are public personalities and often judged by their reputation. At the time when the assessee was implicated in the criminal proceedings he had been on the top ladder of the acting career and even maintained such image during all the time the proceedings continued and, therefore, it was imperative for him to protect his image and reputation and further, therefore, in order to defend such reputation the assessee was obliged to engage reputed lawyers to present his case and further to represent him in the proceedings. Thus, it may not be perfect to view that such complaints have nothing to do with the professional activities of the assessee for these would otherwise prove to be detrimental to the reputation of the assessee actor and often these would impact their professional career. The Patna High Court’s decision (supra) further points out to the allowance of deduction of such expenditure incurred to preserve the reputation of the assessee.