Chapter 6 CAPITAL AND REVENUE TY OF DIFFERENTIATION js necessary for a student of tax that he shot o capital and revenue. Actually, witbowt ae me ifferens wm earned by & uiness canes correctly be calculated, pee pe di srentiate between capital and revenue receipts because jj jevied 07 revenue receipts only and not on capital receipts. On Poems tax is capability 10 differentiate between capital and revenue iataese, pecauses while ascertaining profits of a business, only the Samun expendinures are deducted from the trading receipts. The deduction Tevemue s not allowed. Of capital expenditure i . It is extremely difficult 7 lay down a hard and fast rule as to wher dividing line separates capital receipts from revenue receipts and card ditures from revenue expenditures. There is much ivergeast ot opinion and practice on this matter. = CAPITAL AND REVENUE EXPENDITURES While deciding whether an item of expenditure is a capital expentiar: ora revenue expenditure, many points should be kept in mind, eg. the sanz of expenditure, the source from which the money is being spent, whether Se complete amount has been paid collectively or it is a recurnng the motive behind the transaction, etc. However, the main test for this PapOst is to ascertain whether a permenent asset has been increased by incoming such expenditure. If so, then such cases it will be a capital expenditure. Ifthe expenditure does not result in an increase of a pe expenditure will be of revenue nature. The following tests may.be applied to determine whether @ certain item of expenditure is capital expenditure or revenue expenditure. NI 1. PURCHASING AN ASSET decision ween Ven certain expenditure is incurred to purchase a te fat ot her it is a capital or revenue expenditure W? 1 be . “fixed asset’ or a ‘floating asset’ has been acdo as ‘an asset purchased for the purpose of ‘ i of re-sale in ent or Geplehy Such an asset is not for the purpose : of business. izath for re- are those assets which an organization ys a ar the ya shape or after some manufacturing process) profit. ~ a nt on the purchase of fixed assets is capital = cass the ee al floating assets results ina revenue expenditure. Teo ‘Acotton ginning factory purchases: () cotton ginning machinery; and (i) cotton. : Machinery is @ fixed asset for the factory so the amount spent on its purchase will be a capital expenditure. Cotton is 2 circulating or floating asset so this expenditure will be a revenue expenditure. 2. PERIOD OF BENEFIT ‘Another test to differentiate between capital and revenue expenditure is to ascertain the period for which this expenditure is expected to benefit the trade. If it 1s of a continuous benefit, it will be a capital expenditure but if it will provide benefits to the organization for less than one accounting period (normally one year) it will be a revenue expenditure. ISTRATION 2 anne expenditures incurred by an organization to introduce # ridley or boost a new business are capital expenditures becaus = eatin wl benefit the organization throughout the life of pain a ae The benefits of normal day-to-day advertising expenditues one accounting period and so these are revenv® 3 ITIATION OF BUSINESS All the i errata Teor At the initiation of business are capil Vine fees = om Spent ori construction of building. oom deed are al tures, purchase of equipment, preparation ci Pital expenditures. Initial expenditures are wea!CAPITAL AND REVENUE 168 capital because expenditures fhe ; ; gre incurred for setting the Se are not incurred in earning profits, rather Profit earning machinery in motion. Legal fee paid to legal adyj, Association of a company ie ating Memorandum or Articles of = i eee of business. Wie eee because the amount is o 8 iser shall be treated as revenue expendi going, the salary nditure. 4. EXTENSION OF BUSINESS Expenditures incurred on_ extensi i expenditures. Construction of new building business are also capital 2 7 » CTectis * purchasing new patents or copyrights to exten: Hon of new machinery, expenditures. dd the business are all capital TERS A company wants to extend its business and in order to raise more capital issues more shares. The advertising expenditure incurred for sale of these shares will be treated as capital expenditure. ~ 5. PRINCIPLE OF EARNING CAPACITY Another test that helps in differentiating between capital and revenue expenditure is whether the earning capacity of the organization has increased due to this expenditure or not. If an expenditure results in increasing the eaming capacity of te business, it will be treated as capital expenditure. On the other hand, if the expenditure is incurred for maintaining the caning capacity, it is @ revende expenditure. An organization spent on a machine: (0 Rs. 1,000 for replacement of worn-out par's: rich esbled (i) Rs, 20,000 for additions incorporating new deviess the output to be doubled. sintain the because it will ing the First expenditure is a revenue expenditure ming capacity. As the sccond expenditure caring capacity, it is a capital expenditure. will resultace INCOME TAX Examples of Capital Expenditures 4 1.» Cost of freehold land and building and the legal charBe® * = . purchasing them. trade marks, copyrights, designs, et 2, — Cost of patents, 3. Cost of ex} iments. : ¢ it into workable ted asset 10 pu Repairs on purchase of a dilapidal condition. 5. Cost of issuing shares and debentures. tion for securing cancellation of a contract 6.» Amount paid as compensal nditures f conzacst es of Revenue Expe! ga suit for breach 0 Exampl 1. Legal expenses incurred in defendin supply goods g the old machinery Expenses on overhaulin| Rent paid fora hired machinery pension paid to employee Exhibition expenses ade for use of @ right . av eyen Payment mi eae G s whether the following expenses St capisl & State with reason: revenue: Legal expenses incurred in raising 9 loan * Amount spent for construction of 4 building Advertising charges normally incurred Cost of affixing a signboard at the busi Freight expenses paid on purchase of stoc! Cost of white-washing the business building Royalty paid for acquiring a copyright Legal expenses incurred in drafting a partnership deed iness place k in trade. SPI Aw YD10, ital and revenu Tis not easy to differentiate between capital and re blem ha: CAPITAL AND REVENUE 167 Interest on loan borrowed for business Wages paid for the manufacture of Product for gale It is a capital expenditure because it is Connected with initiation’ extension of business. v It is a capital expenditure. The amount has been acquiring a fixed asset. Spent for It is a revenue expenditure. The ber nefits of this expense are restricted to one accounting period or less . Capital expenditure. A fixed asset is being acquired, the organization will receive continuous benefits of publicity through this expenditure. Revenue expenditure. It relates to a floating asset which is being purchased for the purpose of re- sale. It is a revenue expenditure because the expenditure will not increase the earning capacity of the business It is an expenditure of Capital nature because it has been incurred for purchase of an intangible asset Itis a capital expenditure. The amount is being spent on initiation of the business, ‘ carrying on Revenue expenditure, \t is incurred for the purpose of carrying the business concern, fete ‘i ting asset. Revenue expenditure as it is incurred on a circulating EIPTS CAPITAL AND REVENUE REC Su following tests s been discussed very frequently in the courts. The Talo : enue receipts. ‘may be used to distinguish between capital and revenue 1 SALE OF AN ASSET When an amount is being ree "be decided will be, whether it is d ® account of fixed asset which is mea jon 1, the questi d due to sale ofan Lan re tb d or a circulating as An Oe t for keeping 1 sit atall168 ecw Tax Capital Peceiy CHuling atte on at a receipt on account of s floating oy Mss : An organization sells a building which was being used for ‘business Purposes, the amount received will be a capital receipt. If stock-in trade 1s sold, the amount received will be a revenue receipt. 2. AMOUNT RECEIVED ON ACCOUNT OF A RIGHT If a person is owner of a right, e.g. copyright, patent, trademark, etc, and he is receiving certain amount on its account, the decisive question will be whether the right is being completely surrendered or it is being given for use for some period of time on hire. If the amount is received for the complete surrender of right, it will be a capital receipt. In case the right is not surrendered by the owner and is given for use, for a specific period. te amount received will be a revenue receipt. Ue Ge 20,000. it wit The owner of a patent sells it to an Organization, for Rs. 20, be a capital receipt for him because the Tight has been completly surrendered by him. On the other hand, if he provides the patent for use for a payment of Rs. 2,000 Per annum for a period of years, the amount received by him annually will be a revenue receipt. _3._ SUBSTITUTION OF SOURCE OF INCOME An amount received in substitution of source of income is a capital receipt, but where it is a substitution of income alone, it will be a revenut receipt. ILLUSTRATION 9 A person after retiring from service decides to get whole of his pensica commuted. The amount received is a capital receipt because Tepresents substitution of source of income. On the other hand, if due 10 some reason, he is unable to receive his pension for a few months and ultimately receives it collectively the amount is a Tevemue F because it is a substitution of income, the source of income 1s present.Jihile differentiating between capital oe always judge it from the point at vlew of the Person who is receiving it It should not be considered from the pu cos, of a payer. PLLUSTRATION 10] A legal practitioner received his fee for drafting a partnership deed. The Smount received by him is a Fevenue receipt because it is his income. We should not consider it Capital expenditure for the business making the payment. 5. LUMPSUM RECEIPT The fact that amount is being received in lumpsum or in instalments should never be considered while distinguishing between capital and Tevenue teceipts. It will simply confuse your judgement because a lumpsum-receipt can bea revenue-receipt and in certain cases, an amount received monthly or annually can be a capital receipt. ERSTE” amount will be peid in Mr. B sold a trademark for Rs. 60,000. The equal instalments of Rs. 1,000 per month. For Mz. 2 this receipt is a capital receipt because he has completely surrendered 2 ight, whether the amount is received in Jumpsum or in instalments does not change its capital nature, 6 ISOLATED TRANSACTIONS In case of an isolated transaction, the motive behind the transaction is of immense importance. The mative of the Person receiving the amount will decide whether it is a capital or a revenue receipt. ILLUSTRATION. 12 « After pany for investment purposes. A person purchases shares of a com Fr re, Some period of time, he is in need of money and, in order to fulfil f aed ital need, he sells the shares, the amount received by capris = : Teceipt. On the other hand, if a person purchases ae the sale will Motive of reselling them at profit, the amount realize 4 revenue receipt.in incowe TAX Exai a mples of Capital Recelpts by insured bul 1, Insurance amount receive against loss by fire Z Damage awarded to @ rail disabled in an accident. .d under & policy whic! became permanently way passenget who 3. Royalty received from sale of mining nights. ¢ of shares. iv i by vil 5. Amount received by @ director the company in which he undertook not ue Recelpts fa house by 9 property dealer. building in advance. 4. Premium on issu rtue of a contract between him and to do a particular business. Examples of Rev en 1. Profiton sale of Receipt of three years’ rent of on temporary disability. 2. 3. Compensation received 4, ployee engaged in construction of a building Salary received by an em for business purposes. Royalty received from the user ofa right (RETO State with reasons whether the following are cay ital or Te’ ne receips: 1. Royalty received from transfer of copyright. 2. Amount received on sale of a house purchased for resident purposes. 3, Legal fee received for drafting a Memorandum or Articles Association of a company. 4. Royalty received on lease of a mine by way of a percentage price of output. ; 5. Amount received on sale of Defence Saving © ertifica® purchased to save income tax. : 6. anaes money received under a policy w hich insured sg s of profit resulting from stoppage of business due © 7 ' Insurance amount received under a policy which insured sok? trade against damacaCAPITAL ano Revenue m 8 Gratuit i * ty Feceived by an employee on hig retirement from 9. Compensation Teceived from ‘emament = ~ Acquisition of building recently Constructed for bus, Ompuisory 10. Amount Teceived from a debtor who Purchased Perpoor ] : : sed mer, i Whose account was Previously written Off as bad, Chandise ang Solution . Ll. Itisa capital Teceipt. The ri ht is bei . is be by the owner, 7 “ine completely surrendered 2 Capital receipt. The motive behind this ; . this isol, sacti: Not to sell the house on Profit, “einted transaction = 3. It is revenue Teceipt for the legal Practitioner. We should no: confuse our Judgement by considering that it is a ‘copia expenditure for the Payer, . 4, Revenue receipt. The right of mining is not Surrendered, rather ig 1s given for use only. : 3. Capital receipt. The motive behind the transaction was to keep the investment. The investment was not for speculation purposes 6. Itis a revenue Teceipt as it is intended not to secure a gain but to Teplace a sum equivalent to the estimated gain. 7. Revenue receipt. The amount is being received on account of circulating asset. . on . y him for 8. It is a revenue receipt because it is an income camed by him the service rendered during his employment. on rae ived on accout 9. It is a capital receipt. The amount is being receiv fixed asset. _ + being received o ipt because the amount is being rece? 10. It will be a revenue receip| on account of circulating assets. ight or 8 CAP n asset, a Fgh ITAL LOSS ital expenditure, he gets ie ‘amount ia When a person incurs a capital manent benefit in exchange. In case of a capital loss, nthe business is completely lost i172 Income TAX Examples of Capital Loss 1. a 3. 4. Loss due to insolvency of a business. arising from damage or destruction of an uninsured capital assee ness hours. th the raising of money for business, Loss Theft in the business after busi Loss incurred in connection wil Bee shen sn?