T N Pandey: Revenue vs capital expenditure

TAXING MATTERS

The issue whether the nature of an expenditure is capital or revenue has been referred to in a number of decisions by the courts, including the Supreme Court.

It again came up for the consideration of the Full Bench of the Karnataka High Court in the Senapathy Synams Insulations (P) Ltd vs Commissioner of Income Tax case, 248 ITR 656 (Karnataka).

The issue was whether expenditure incurred by the company on demolition and rebuilding of a compound wall could be considered a revenue expenditure.

The matter had been decided against the company holding that the expenditure was of capital nature. The reasoning of the high court, contained in paragraph 8 of the order reads:

"In the Commissioner of Income Tax vs Binny Ltd case, (1995) 215 ITR 536 (Madras), the Madras High Court observed, the entire structure of the spinning department was not altered. Replacing of the roof was for repairing the existing roof. The expenditure incurred for replacing the roof could not be considered to be for obtaining an enduring benefit. The expenditure incurred for re-roofing of the spinning department was allowable as revenue expenditure.

"There can be no quarrel with the proposition that even where substantial repairs are carried out to put to use an existing asset, the same could still be termed as a revenue expenditure. But where there is replacement 'as a whole' it amounts to reconstruction and not repairs. It is pertinent that the asset in its old form must continue to exist to say that the expenditure involved in improving the asset is a revenue expenditure. Where effacement takes place and a new asset comes into being then the expenditure involved would become a capital expenditure."

But in many cases, a contrary view has also been expressed. (See 202 ITR 942 (Gujarat)). There had been controversies regarding situations when an expenditure could be said to be of an enduring/lasting nature. There may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may , nevertheless, be on revenue account and the test of enduring benefit may break down.

What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure will be disallowable on an application of the above test.

If the 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, expenditure will be on revenue account, even though the advantage may endure for an indefinite future.

See the Empire Jute Company Ltd vs Commissioner of Income Tax case, (1980) 124 ITR 1, 10 (SC); the Commissioner of Income Tax vs Associated Cement Companies Ltd case, (1988) 172 ITR 257, 262 (SC); the Saraswati Industrial Syndicate Ltd vs Commissioner of Income Tax case, (1982) 137 ITR 886, 889-890 (Punjab).

The test prescribed in the Empire Jute Company Ltd case has been explained in several decisions of the high courts. In the Commissioner of Income Tax vs Elecon Engineering Company Ltd case, (1981) 132 ITR 7852, the Gujarat High Court said:

"The Supreme Court pointed out that if there was no addition to or expansion of the profit making apparatus of the assessee and the income-earning machine remains what it was prior to the incurring of the expenditure, what it amounts to is that the assessee is merely enabled to operate the profit-making structure in a better manner and thus, the question to be asked, according to the apex court, is whether there is any addition to the fixed capital of the company by reason of the expenditure incurred.

"It may not be an immediate addition or it may be even an anticipated addition to the fixed capital but if the expenditure is merely incurred for running the profit making apparatus or income earning machine more efficiently and in a better manner or better utilisation of the profit making apparatus, then, it is not an expenditure of a capital nature...."(page.761).

The Calcutta High Court has said the test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case (See the Commissioner of Income Tax vs Cominco Binani Zinc Ltd, (1993) 204 ITR 56, 61 (Calcutta))

The court decisions have accepted the position that there can be no exhaustive or universal application of the concept of enduring benefit and no clear line of demarcation can be drawn on this basis whether an expenditure is of a capital or revenue nature. No single definitive criterion is possible to decide this issue.

The question whether a particular expenditure is a capital expenditure or a revenue expenditure has to be decided on the basis of the facts and circumstances of each case.

The phrase "capital expenditure" has not been defined in the Act and sound accountancy principles also have to be kept in view for deciding this controversy. Some tests have been laid down in cases but ultimately the answer will depend upon the facts and circumstances of each case.

See the Commissioner of Income Tax vs Warrier Hindustan Ltd, (1986) 160 ITR 217, 236 (AP). The controversy will continue as there can be no finality on the issue.