CAPITAL -VS.

- REVENUE Receipts A capital receipt is not liable

to tax, unless specifically provided in the Act, whereas, a
revenue receipt is not exempted, unless specifically provided in
the Act. Further, capital receipts are to be charged to tax under
the head “Capital Gains” and revenue receipts are taxable
under other heads.The Act does not provide exhaustive
definition of the income, thus, distinction between capital
receipts and revenue receipts is not easily made. However,
based on a number of judicial pronouncements, the following
principles are worthwhile to note: 1. Receipt in lump sum or in
Instalments: Whether any income is received in lump sum or in
instalments, it will not make any difference as regards its
nature, e.g., an employee is to get a salary of ` 10,000 p.m.
Instead of this he enters into an agreement to get a sum of `
3,60,000 in lump sum to serve for a period of 3 years. The
receipt where it is monthly remuneration or lump sum for 3
years is a revenue receipt. 2. Nature of receipt in the hands of
recipient: Whether a receipt is capital or revenue will be
determined in the hands of the persons receiving such income.
No attention will be paid towards the source from which the
amount is coming. Salary even if paid out of capital by a new
business will be it revenue receipt in the hands of employee. 3.
Accounting treatment: The name given to the transaction by
the parties involved or its treatment in the books of account
may not alter its character as capital or revenue. 4. Income
from wasting assets: Profits from capital which is consumed
and exhausted in the processof realization, e.g. royalties from
mines and quarries, is taxable as income regardless of
theconsumption of capital involved in the process. 5.
Magnitude of receipt: The magnitude of the receipt, whether
big or small, cannot decide the nature of the receipt. 6. Time of
receipt: The nature of the receipt has to be determined at the
time when it is received and not afterwards when it has been
appropriated by the recipient. 7. Quality of receipt: Whether
the income is received voluntarily or under a legal obligation, it
will not make any difference as regards its nature. 8. Tests as to
the purpose of keeping an article: If a person purchases a piece
of sculpture to keep as decoration piece in his house, if sold
later on, will bring capital receipt but if the same sculpture is
sold by an art dealer it will be his revenue receipt. Instances of
transactions which are capital in nature but specifically
taxable: 1. Capital gains arising from sale of capital assets being
defined u/s 2(14). [Sec. 45] 2. Compensation for termination of
service or modification in the terms of service [Sec. 17(3)] 3.
Compensation or other payments due to or received by the
persons specified u/s 28(ii)/28(va). Expenses Similarly, a capital
expenditure is not allowable as expenses, unless specifically
allowed in the Act, whereas, a revenue expenditure is allowable
as expenses, unless specifically disallowed in the Act. Based on
a number of judicial pronouncements, the following principles
are worthwhile to note: 1. Acquiring asset or advantage of
enduring nature: Bringing into existence an asset or advantage
of enduring nature2 would lead to the inference that the
expenditure disbursed is of a capital nature. 2. Capital assets
belonging to third parties: Even though a expenditure results in
the creation of a capital asset, if the capital asset belongs to a
third party, such expenses will be treated as revenue
expenditure. 3. Profit-earning process: Where the outgoing
expenditure 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 and not for acquisition of an asset or a
right of a permanent character, the possession of which is a
condition of the carrying on of the business, the expenditure
may be regarded as revenue expenditure 4. Object of the
transaction: 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. 5. Fixed capital -vs.-
Circulating capital: An item of disbursement may be regarded
as of a capital nature when it is relatable to a fixed capital,
whereas if it is related to circulating capital or stock-in-trade it
would be treated as revenue expenditure. 6. Expenditure on
removing restriction: Where the assessee has an existing right
to carry on a business, any expenditure made by it during the
course of business for the purpose of removal of any restriction
or obstruction or disability would be on revenue account,
provided the expenditure does not result in the acquisition of
any capital asset. 7. Payment made to rival dealer to ward off
competition in business would constitute capital expenditure 8.
If the expenditure is a part of the working expenses in ordinary
commercial trading, it is not capital but revenue expenditure. 9.
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. 10. If expenditure is incurred for
ensuring the regular supply of raw material, maybe for period
extending over several years, it is on revenue account 11. When
an owner incurs expenditure on additions in a building which
enhances its value the expenditure can be of a capital nature.
But, if a tenant incurs an expenditure on a rented building for
its renovation, he does not acquire any capital asset, because
the building does not belong to him and, ordinarily, such an
expenditure will be of a revenue nature. 12. Acquisition of the
goodwill of the business is acquisition of a capital asset, and,
therefore, its purchase price would be capital expenditure. It
would not make any difference whether it is paid in a lump sum
at one time or in instalments distributed over a definite period.
Where, however, the transaction is not one for acquisition of
the good¬will, but for the right to use it, the expenditure would
be revenue expenditure 13. Expenses incurred by the assessee
for the purpose of creating, curing or completing the title is
capital expenditure and on the other hand if such expenses are
incurred for the purpose of protecting the same, it is revenue
expenditur ILLUSTRATION 2 Birla Ltd., a cement manufacturing
company, entered into an agreement with a supplier for
purchase of additional cement plant. One of the conditions in
the agreement was that if the supplier failed to supply the
machinery within the stipulated time, the company would be
compensated at 5% of the price of the respective portion of the
machinery without proof of actual loss. The company received `
8.50 lakhs from the supplier by way of liquidated damages on
account of his failure to supply the machinery within the
stipulated time. What is the nature of liquidated damages
received by Birla Ltd. from the supplier of plant for failure to
supply machinery to the company within the stipulated time —
a capital receipt or a revenue receipt? [CMA – Inter Dec. 2011]
Solution In the case of CIT -vs.- Saurashtra Cement Ltd. (2010)
325 ITR 422, the Apex Court has held that the damages were
directly and intimately linked with the procurement of a capital
asset, which lead to delay in coming into existence of the profit-
making apparatus. It was not a receipt in the course of profit
earning process. Therefore, the amount received by the
assessee towards compensation for sterilization of the profit
earning source, not in the ordinary course of business, is a
capital receipt in the hands of the assessee.