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Revenue & Capital Incomes/Expenses – Difference & Treatment

Bought ₹10L machinery - expense this year? Or spread over years? Capital! Paid ₹50k for repairs - capitalize? Revenue expense! This distinction determines your tax liability - let's master it!

Why This Matters?

Revenue Expense: Fully deductible in current year → Lower tax NOW

Capital Expense: NOT deductible, only depreciation allowed → Tax spread over years

Wrong classification = Incorrect tax = Penalty + Interest

Revenue vs Capital - Core Concept

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Tests to Determine Nature

Test 1: Enduring Benefit Test

Capital: Benefit lasts multiple years (creates/enhances income-earning capacity)

Revenue: Benefit exhausted in same year

Examples:

Capital:

  • Buy factory building (₹2 cr) → Use 30+ years → Capital
  • Purchase machinery (₹50L) → Use 10 years → Capital

Revenue:

  • Pay ₹5L salaries → Benefit this year only → Revenue
  • Rent ₹3L/year → This year's use → Revenue

Test 2: Frequency Test

Capital: One-time, non-recurring

Revenue: Recurring, regular

Examples:

Capital: Land purchase (once)

Revenue: Monthly electricity bills (recurring)

Test 3: Purpose Test

Capital: Create/acquire asset or enhance earning capacity

Revenue: Maintain existing capacity or day-to-day operations

Examples:

Capital: Factory expansion (₹1 cr) → Increases capacity → Capital

Revenue: Factory roof repair (₹2L) → Maintains status quo → Revenue

Test 4: Asset vs Benefit Test

Capital: Acquires an asset (tangible/intangible)

Revenue: Consumes for immediate benefit

Examples:

Capital: Buy trademark → Asset → Capital

Revenue: Advertising expense → Immediate benefit → Revenue

Capital Receipts vs Revenue Receipts

Receipts (Income) also classified!

Revenue Receipts

Taxable as business income (Section 28)

Examples:

  • Sales revenue
  • Service fees
  • Commission income
  • Interest from trade debtors

Treatment: Fully taxable in year received

Capital Receipts

NOT taxable as business income

Taxed under: Capital Gains (if asset sale) or Exempt

Examples:

  • Sale of factory building → Capital Gains (not business income)
  • Sale of shares (investment) → Capital Gains
  • Loan received → Exempt (liability, not income!)
  • Capital introduced by partner → Exempt

Capital Expenditure Examples

1. Purchase of Fixed Assets:

  • Land, building → Capital
  • Plant, machinery → Capital
  • Furniture, computers → Capital

2. Cost of Acquisition:

  • Cost of land: ₹1 cr → Capital
  • Registration fees: ₹2L → Add to capital cost

3. Improvement/Extension:

  • Adding new wing to building → Capital (enhances asset)
  • Replacing old with new asset → Capital

4. Preliminary Expenses:

  • Company incorporation fees → Capital (amortized)

5. Non-Compete Agreement Payment:

  • Pay ₹10L to competitor not to compete → Capital (enduring benefit!)

Revenue Expenditure Examples

1. Operating Expenses:

  • Salaries, wages → Revenue
  • Rent for premises → Revenue
  • Electricity, water → Revenue

2. Repairs & Maintenance:

  • Ordinary repairs (maintains asset) → Revenue
  • Painting, minor fixes → Revenue

3. Current Replacements:

  • Replace worn parts → Revenue
  • Damaged window glass → Revenue

4. Administrative Expenses:

  • Office supplies → Revenue
  • Telephone, internet → Revenue

5. Selling & Distribution:

  • Sales commission → Revenue
  • Advertising (normal) → Revenue

Gray Areas - Tricky Cases

Case 1: Repairs vs Improvement

Ordinary repair (maintain) → Revenue

Improvement (enhance) → Capital

Example:

Factory roof leaking:

  • Fix leak (₹50k) → Revenue (maintains)
  • Entirely new roof with better material (₹5L) → Capital (improves!)

Case 2: Replacement

Part replacement → Revenue

Entire asset replacement → Capital

Example:

Machine:

  • Replace motor (₹50k) → Revenue
  • Buy new entire machine (₹10L) → Capital

Case 3: Legal Expenses

Defend business operations → Revenue

Acquire/defend capital asset → Capital

Examples:

Legal fees:

  • Defend tax case on business income → Revenue
  • Registration for land purchase → Capital
  • Defend title to land → Capital

Case 4: Advertising

Normal advertising → Revenue

Initial advertising for new business/product (benefit > 1 year) → Capital

Example:

₹50L spent on launch campaign for new product (benefits 5 years) → Capital (amortize over 5 years)

Case 5:Insurance Premium

Revenue expenditure (yearly benefit)

Exception: If prepaid for multiple years, allocate proportionately

Tax Treatment Summary

NatureTax Treatment
Revenue ExpenseFully deductible in current year (Sections 30-37)
Capital ExpenseNOT deductible, depreciation allowed (Section 32)
Revenue ReceiptFully taxable as business income (Section 28)
Capital ReceiptNOT business income, may be Capital Gains or exempt

Practical Example - Complete Classification

XYZ Manufacturing (FY 2024-25):

ExpenseAmountNatureTreatment
Purchase machinery₹15,00,000CapitalDepreciate @ 15% = ₹2.25L deductible
Salaries₹30,00,000RevenueFully deductible
Factory rent₹6,00,000RevenueFully deductible
Machine repairs₹80,000RevenueFully deductible
Office building purchase₹1,00,00,000CapitalDepreciate @ 10% = ₹10L deductible
Advertising₹2,00,000RevenueFully deductible
Electricity₹4,00,000RevenueFully deductible

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Capital assets (₹1.15 cr): Only ₹12.25L deductible in Year 1!

Deferred Revenue Expenditure

Certain revenue expenses with enduring benefit (but not capital asset)

Examples:

  • Preliminary expenses (₹5L)
  • Heavy advertising for launch (₹10L)

Treatment: Amortize over 5 years (1/5th per year)

Example:

Preliminary expenses: ₹5,00,000

  • Deduction per year: ₹1,00,000 (for 5 years)

Not fully capital, not fully revenue!

Key Judicial Principles

Bombay High Court: "Enduring benefit > 1 year → Capital"

Supreme Court: "Creating new asset vs maintaining existing → Capital vs Revenue"

Tests are guidelines, not rigid rules (case-by-case analysis!)

Summary

  • Revenue: Day-to-day, recurring, current year benefit, fully deductible (salaries, rent, repairs)
  • Capital: Long-term, one-time, multi-year benefit, only depreciation allowed (machinery, building, land purchase)
  • Tests: Enduring benefit (multi-year = capital), frequency (recurring = revenue), purpose (create/enhance = capital, maintain = revenue)
  • Revenue receipts: Fully taxable as business income (sales, fees, commission)
  • Capital receipts: Not business income, may be capital gains or exempt (asset sale, loan, capital introduction)
  • Gray areas: Repairs vs improvement (maintain = revenue, enhance = capital), replacement (part = revenue, entire = capital)
  • Deferred revenue: Preliminary expenses, heavy launch advertising amortized over 5 years

Quiz Time! 🎯

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Next Chapter: Allowable Business Expenses (Sections 30-37)! 📝

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