Section 37 (1) is a residuary section. In order to claim deduction under this section, the following conditions should be satisfied-
1- The expenditure should not be of the nature described under section 30 to 36.
2- It should not be of in the nature of capital expenditure.
3- It should have been incurred in the previous year.
4- It should be in respect of business carried on by the assessee.
5- It should have been expended wholly and exclusively for the purpose of such business.
6- It should have been incurred for any purpose which is an offence or is prohibited by any law.
It should not be of in nature of capital expenditure
Expenditure incurred by the assessee may be of two type- (1) capital expenditure (2) revenue expenditure.
Distinction between revenue and capital expenses - The line of demarcation between capital and revenue expenditure is very thin and the ultimate conclusion on the nature of the expenditure is always a question of law and fact. As the Act does not define the terms capital expenditure and revenue expenditure, one has to depend their natural meaning as well as decided cases
Revenue expenditure is outlay or expenses incurred in the day to day running of a company. In most cases revenue expenditure involves the procurement of services and goods that will be used within a financial year. Revenue expenditure does not improve or increase the income generating abilities of a company rather at best it leads to the maintenance of the current organisational revenue generating capacity.
All expenses of a revenue nature are recorded in the profit and loss account as either operating expenses, marketing and selling expenses and administrative expenses. Revenue expenses play a role in determining the profit earned or a loss by a company.
Revenue expenses are routine and recurring in nature and some examples of revenue expenditure include payments in staff wages and salaries, heating and lighting, depreciation, legal and professional fees, travel and subsistence, insurance, administrative expenses, most of marketing and public relations expenses, audit fees, office supplies, staff training costs, staff recruitment costs and minor or immaterial items of equipment.
Capital expenditure represents outlay on fixed assets. Capital expenditure can be outlay of resources on the investment of long-term income generating capability of the company. Investment in fixed assets will lead to an increase or improvement in the investing company's revenue generating capacity. Capital expenditure can also be in the form of significant acquisitions or purchases of more expensive items of equipment that will last longer than a financial year.
All capital expenditure is recorded on the balance sheet. Capital expenditure will be depreciated or amortised annually to ensure that an expense is charged to the profit and loss account to reflect the capital expenditure's usage by the company.
Some of the examples of capital expenditure include outlay on land and buildings, plant and equipment, vehicles, computer equipment, product development costs, finance leases and software development costs.
General Principles- To decide whether an expenditure is capital and revenue in nature the following points should be considered.
1. 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 business expenditure.
2. Several previous year v. One previous year- Capital expenditure produces benefits for several previous years, whereas revenue expenditure is consumed within a previous year.
3. 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.
4. Non-recurring v. Recurring- usually capital expenditure is a non-recurring outlay, whereas revenue expenditure is recurring outlay.
Judicial Ruling- Capital Expenditure v. Revenue Expenditure
COMMISSIONER OF INCOME-TAX Versus (1) ESCORTS AUTO COMPONENTS LTD. and (2) ECO AUTO COMPONENTS LTD. 2010 -TMI - 76186 - HIGH COURT OF PUNJAB AND HARYANA-held that, expenses for expansion and diversification of new project is not capital expenditure thus allowed for deduction.
Dr. Aswath N. Rao versus ACIT2010 -TMI - 76068 - HIGH COURT OF KARNATAKA- held that, purchase of second hand machinery for use of its part to maintain existing machinery is not capital expenditure and allowed as revenue expenses.
COMMISSIONER OF INCOME-TAX Versus P. I. INDUSTRIES LTD. 2010 TMI - 75608 - RAJASTHAN HIGH COURT, held that expenditure on voluntary retirement scheme is capital expenditure.
COMMISSIONER OF INCOME-TAX Versus SUNDARAM CIAYTON LTD. 2010 TMI - 75530 - MADRAS HIGH COURT, held that, Expenditure on upgradation of computers is a revenue expenditure - Expenses incurred in purchase of software components is to be treated as revenue expenditure.