Every business entity is required to maintain the accounts in a proper way as per rules applicable. The expenditure incurred by the business entity is allowed/disallowed by the Income Tax authorities while computing the profit and loss accounts of the business entity. There is always problem in identifying some sort of expenditures as to whether revenue expenditure or capital expenditure. Much expenditure has been disallowed by the Income Tax authorities for wrong classification of expenditure.
Revenue expenditure is an expenditure charged against operation. It is a term used to contrast with capital expenditure. Revenue expenditure is intended to benefit the current expenditure. Some of the examples for revenue expenditure are-
Expenses incurred in the normal course of business viz., expenses of administration, manufacturing and selling products;
· Expenses incurred to maintain the business, e.g., replacements for maintaining the existing permanent assets; cost of stores consumed in the course of manufacturing e.g., oil, cotton waste;
· Cost of goods purchased for resale;
· Depreciation on fixed assets, interest on loan for business, loss from sale of fixed assets;
· Obsolescence cost.
Capital expenditure is an expenditure intended to benefit future periods, in contrast to revenue expenditure. The term is generally restricted to expenditures that add fixed assets or that has the effect of increasing the capacity, efficiency, life span, or economy of operation of an existing fixed asset.
An addition increases the quantity of fixed assets. Hence amount spent on the purchase of fixed asset is treated as capital expenditure. The quality of a fixed asset is said to have increased when expenditure results in any or some of the following events:
· When probable useful life of the fixed asset increases;
· When capacity of the fixed asset increases;
· When efficiency of the fixed asset increases;
· When operating economy is achieved;
· When quantity of its output increases beyond that originally anticipated.
Replacement involves a substitution of a new asset or component for part or all of an existing asset.
Expenditure cannot be said to be a capital expenditure only because-
· The amount is large;
· The amount is paid in lump sum. A capital expenditure can be paid either in lump sum or installment;
· The amount is paid out of that fund which has been received out of the sale of fixed asset;
· The receiver of the amount is going to treat it for the purchase of fixed asset.
Some items of expenditures seem to be revenue expenditure but in actual practice they are treated as capital expenditure since they lead to the business being established and run efficiently. Some of the examples for the same-
· Expenses for the formation of a company - preliminary expenses;
· Cost of issuing shares and debentures and raising loans, such as legal expenses, underwriting commissions etc.,;
· Interest on capital up to the point of production is ready to commence, where the nature of business is such that construction work must go on for a long period before production can start;
· Expenses on acquisition and installation of assets: for example legal fees to acquire property, or expenses incurred to renovate machinery bought secondhand or wages of workmen who install the machinery.
DEFERRED REVENUE EXPENDITURE:
Some of the expenditure may be available for a period of two or three or even more years. Such expenditure is known as deferred revenue expenditure and is written off over a period of a few years and not wholly in the year in which it is incurred.
- CIT V. Ramaraju Surgical Cotton Mills 2007 -TMI - 2064 - SUPREME COURT OF INDIA
Point: Whether the expenditure on replacement of an asset is capital expenditure or revenue expenditure?
Ramaraju Surgical Cotton Mills, the assessee is a manufacturing company. It replaced some of its assets during the relevant assessment year so as to increase its production capacity. The replacement was not for the reason that the old assets were worn out but for increasing the production capacity. However even on replacement of the assets, the production capacity of the company remained constant. Hence the expenditure on replacement was claimed as revenue expenditure under Sec. 37 of the Income Tax Act, 1961 by the assessee company in its Income tax return for that year.
The court held that any expenditure to fall in the purview of capital expenditure definition, it should provide long term benefit. However in the given case, replacement of an asset does not contribute to any benefit, long term or short term and hence it is revenue expenditure.
Point: Essentials for treating expenditure as revenue expenditure
- Commissioner of Income Tax V. Gopald Motors Services (P) Ltd., 100 ITR 240
The court held - 'In order to entitle a deduction under Sec. 37 of the Income Tax Act, two conditions must be satisfied viz.,
Ø The expenditure should have been incurred wholly and exclusively for the purposes of the business; and
Ø Such expenditure shall not be in the nature of capital expenditure.
CIT V. Madras Auto Service (P) Ltd., (1998) 233 ITR 468
The Supreme Court while considering whether a particular expenditure is capital or revenue held as follows:
Ø 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;
Ø Expenditure may be treated as property attributable to capital when it 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 get rid of by a lump payment is an annual business expense chargeable against revenue, the lump sum payment should equally be regarded as a business expenditure, but if the lump sum payment brings in a capital asset, then that puts the business on another footing altogether;
Ø 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.
- CIT V. General Insurance Corporation Ltd., 286 ITR 232
Point: Whether the expenditure incurred in connection with the issuance of bonus shares is capital expenditure or revenue expenditure?
The issue of bonus shares by capitalization of reserves is merely a reallocation of company's funds. There is no inflow of fresh funds or increase in the capital employed, which remains the same. If that be so, then it cannot be held that the company has acquired a benefit of advantage of enduring nature. The total funds available with the company will remain the same and the issue of bonus shares will not result in any change in the capital structure of the company. Hence it is revenue expenditure.
- Shree synthetics Ltd., V. CIT and another 205 CTR 386 (HC)
Point: Expenses incurred in execution of debentures
Expenses incurred by an assessee in execution of debentures for financing modernization etc., squarely falls within the four corners of Sec. 35D of the Act and hence it can be allowed by way of deduction only in accordance with the procedure specified in Sec. 35 D but not as revenue expenditure.
- Enterprising Enterprises V. DCIT
Point: Expenditure on lease rent
Assessee is a company enters into lease agreement. According to the agreement assessee is required to pay proportionate lease rent for acquiring leasehold right for extracting minerals from mineral bearing land. The court held that the proportionate rent paid by the assessee is of revenue expenditure because it is the nature of royalty.
Point: Replacement of machinery
- CIT V. Janakiram Mills Ltd., (2005) 275 ITR 403
It was held that all plant and machinery put together amounts to a complete spinning mill which is capable of manufacturing yarn and hence, each replaced machine could not be considered as an independent one and no intermediate marketable product was produced. Thus on the basis of the above, the expenditure on replacement of machinery is revenue expenditure and therefore, the tribunal was right in allowing the claim of the assessee.
- CIT V. Loyal Textiles Mills Ltd., (2006) 202 CTR (Mad) 251
The assessee replaced some machinery in the mills by putting new machineries. The assessee considered new machine as capital assets in the books and capitalized the same, though claimed as revenue expenditure in the come tax return.
The CIT (Appeal) and the tribunal found that the replaced machines did not create any asset or any distinct advantage to the assessee and did not bring about any structural changes.
The High Court held that the question whether the expenditure is capital or revenue in nature has to be determined by applying provisions of the Act and not by the accounting practice of the assessee or the treatment given in the books of account. Expenditure on replacement of machinery of textile mills was revenue expenditure in view of the findings of CIT (A) and the tribunal that no new asset was created and no distinct advantage arose to the assessee and that it did not bring about any structural changes.
- TI Diamond Chain Ltd., V. CIT (2006) 202 CTR (Mad) 272
Point: Payment of Compensation
The assessee terminated agreement with its marketing agents and took over the agents marketing establishments for the distribution of its products and paid compensation for the same. The compensation is also for-
Ø The acquisition of staff, personnel and other infrastructure which was intangible;
Ø A negative covenant in the agreement restraining the distributing agents from dealing with similar products for a period of four years;
Ø A large sales organization and a marketing network developed by the distribution by virtue of agreement;
It was held since the assessee acquired a profit marking apparatus by the payment the amount paid the assessee is a capital expenditure.
- Kumbakonam Rural Society Ltd., V. JCIT (2006) 101 ITD 46 (Chennai)
Point: Treatment of subsidy received
The assessee was correct in treating subsidy received as revenue expenditure.
- National Aluminum Co., Ltd., V. DCIT (2006) 153 Taxman 18 (Cal)
Point: Loss on account of depletion
The loss on account of depletion in cost of stores and spares related to past years can be allowed as revenue expenditure.
- Finolex Industries Ltd., V. DCIT (2006) 101 TTJ 463 (Pune)
Point: Expenses of debenture involving in expansion of existing business
It was held that setting up of a new industrial unit involved in commencement of a new business and the debenture issue expenses were capital in nature. On consideration of factors like common management, common fund, common place of business etc., it was held that setting up of the new industrial unit involved in 'expansion of existing business' and not 'commencement of new business' and therefore allowed the expenses as revenue expenditure.
- CIT V. Club Resorts (P) Ltd., 203 CTR 587 (Mad)
Point: Expenses incurred for the business during the commencement of business
The assessee, a construction company had set up operating offices, started construction work and launched publicity campaign. The direct construct expenses and staff costs and other expenses for development of the project were charged to revenue. Expenses were disallowed by the Assessing Officer on the basis that no business was carried out and no sales were accounted.
The High Court allowed the expenses as being revenue in nature as expenses incurred for the business during the year of commencement of business could be charged off to revenue. One or more operating offices for soliciting customers were started and a publicity campaign had also been launched.
- Herbalite International (P) Ltd., V. Asst. CIT 103 TTJ 78 (Del)
Point: Improvements in leasehold premises
Assessee claimed deduction of expenditure incurred for improvements in respect of leasehold premises. Assessing Officer disallowed the claim claiming that the expenditure was capital in nature.
The tribunal came to a conclusion on perusal of the facts and nature of expenses, that the expenses are allowable as revenue expenditure as they were incurred with a view to enable the assessee to carry on its business more effectively and did not create a benefit of enduring nature.
- CIT V. Thirani Chemicals Ltd., (2007) 290 ITR 196 (Delhi)
Point: Expenses for the issue of debentures
The expenses incurred by the company on issue of debentures were allowable, irrespective of the fact that debentures were issued for raising for expansion of its existing business.
- CIT V. Rotork Controls India Ltd., (2007) 209 CTR 297
Point: Provision for warranty
The assessee was engaged in the manufacture and sale of television and audio system. As a matter of policy, on the basis of past experience and the extent of claims made against it, the assessee set aside certain amount to the liability arising out of warrants issued by it to its customers. The assessee claimed the provision for warranty as revenue expenditure. Holding the provisions as unascertained liability, the assessing authority rejected the plea of the assessee. The Chennai High Court hold that the warranty charges as a contingent liability are not deductible.
- CIT V. Honda SIEL Power Products Ltd., 2008 -TMI - 4055 - DELHI HIGH COURT
Point: Payment of advance
The High Court held that the payment of advance made by the assessee for manufacturing tools and dies which continued to remain the property of the manufacturer is revenue expenditure.
- ACIT V. Tirupathi Microtech (P) Ltd., 111 TTJ 149
Point: Expenses for obtaining ISO certificate
The expenditure incurred for obtaining the ISO 9002 certificate is revenue expenditure.
- Empire Jute Co., Ltd., V. CIT (1980) 17 CTR (SC) 113
Point: Determination of revenue expenditure
The Supreme Court has laid down the test for the determination of the revenue of expenditure by providing that if the advantage received on incurring expense facilitates the carrying on the business more efficiently and more profitably leaving the fixed capital untouched, expenditure would be treated as revenue in nature.
- CIT V. Hari Vignesh Motors (P) Ltd., (2006) 206 CTR (Mad) 263
Point: Construction to fulfill the business agreement
The Assessee is a dealer in two wheelers manufactured by TVS Suzuki Limited and was doing business in leasehold premises. During the relevant period the assessee constructed a ground floor over the existing basement floor at a cost of Rs.4,82,688/- according to the specifications given by TVS Suzuki Limited to all its dealers. The assessee claimed that the said sum as revenue expenditure. The assessing officer disallowed the said claim as not relating to business, inasmuch as a new permanent capital asset had been brought into existence and added to the income.
The High Court held that right from the inception the building was of the ownership of the lessor. Therefore, by spending this money, the assessee did not acquire any capital asset. The only advantage that the assessee derived by spending the money was that it got the least of a new building at a low rent.
The court further held that the assessee had put up the ground floor over the existing basement floor only to have the business premises according to the specifications put forth by TVS Suzuki Ltd., and further there is a clear cut stipulation in the lease deed that reimbursement of the expenditure is not possible from the owner of the premises. Hence, in view of the business exigencies, the assessee had put up the construction, in and by which, the assessee would not get any capital asset. The expenditure was therefore to be treated as revenue expenditure.
- CIT V. Southern Roadways Ltd., (2006) 282 ITR 379 (Mad)
Point: Prepaid expenses and up grading of computer
The assessee before the Hon'ble High Court had claimed prepaid expenses as deduction as the actual payment was made during the previous year relevant to the Assessment year 1994-95 against the demand raised by the postal department, telephone department etc., The assessee had claimed the expenditure incurred on up gradation of computers is revenue expenditure.
The court held that the expenditure actually incurred and revenue in nature relating to the business is allowable notwithstanding the method of accounting followed by the assessee.
With respect to the expenditure incurred on up gradation of computers it was observed that up gradation of computers by changing certain parts and thereby enhancing the configuration of the computers for improving their efficiency, but, without making any structural alterations is not of an enduring nature. Further, the assessee had not acquired any computer software. The expenditure incurred by the assessee had therefore to be treated as revenue expenditure.