“Convergence – Divergence? The Evolving Relationship Between Direct and Indirect Taxes in India” – Part 4 – Capex
In Part 1, the author of the article has dealt with aspects of revenue recognition, in Part 2, the author of the article has dealt with the contours of inventories and in Part 3, the author has discussed aspects of revenue expenditure by discussing Convergence-Divergence? In this article, author is discussing The Evolving Relationship Between Direct and Indirect Taxes in India” vis-à-vis Capex. Also Read: Direct vs. Indirect Tax in India: Part 5 – Related Party Transactions
Financial statements are considered a reflection and barometer of business enterprises’ performance. They ensure compliance with complex legal frameworks, including Generally Accepted Accounting Principles (GAAP), Accounting Standards (AS), Indian Accounting Standards (Ind AS), Auditing Standards (Statements of Auditing), and Direct and Indirect Tax Laws, while leveraging modern technological advancements. All financial statements are prepared following various allied laws, such as Corporate Laws, Customs Acts, Contract Acts, Sale of Goods Acts, Factories and Establishment Acts, Stamp Duty Laws, Evidence Laws, Digital Laws, the Prevention of Money Laundering Act, the Benami Property Act, the Legal Metrology Act, FEMA, Local Laws, and others.
Various stakeholders utilise financial statements to derive valuable insights regarding enterprise value and intrinsic value and key financial metrics such as EBITDA, ROC, ROCE, CAGR, PEG, NCF, margin trends, ratio analysis, PE ratio, dividend yield, and other indicators. These metrics are often compared with industry peers to assess the company’s financial health and performance. Tax authorities also conduct similar analyses to evaluate the disclosures in audited financial statements. While listed companies publish their financial statements publicly, unlisted and closely held companies do not. With technological advancements, financial data and records reported under statutory and regulatory frameworks are now seamlessly shared among tax authorities. This enables them to review and examine potential revenue leakages in real-time—at speed comparable to light.
In this article, the author explores key aspects of Direct and Indirect Taxes under the Income Tax Act 1961, and the Goods and Services Tax (GST) Act 2017, respectively. These tax laws are fundamentally applicable to every enterprise, depending on its size, volume, and the nature of its business activities. When analysing the application of direct and indirect tax laws, they can be metaphorically compared to the **two poles—North and South—**, raising the question of whether they share any similarities or are entirely distinct. The core issue to examine is whether a meaningful comparison exists between Direct Tax Laws, which have evolved and stabilised over nearly a century, and Indirect Tax Laws, which remain in a nascent stage of development, having been in effect for just about seven years. The implementation of each tax law has significant ramifications on working capital management and the overall regulatory taxation framework. This becomes particularly crucial in an era where regulatory authorities are leveraging data-sharing mechanisms and digital reporting systems, ensuring that all stakeholders remain duty-bound to comply with evolving tax regulations.
In this article, the author has attempted to explore complementary or completely opposing perspectives by examining aspects such as revenue recognition of revenues and expenditures, inventories, capital expenditures (Capex), and related party transactions.
All readers would agree that conducting business within India or internationally has become akin to solving a jigsaw puzzle of multiple regulatory compliances. This means that before executing any transaction, one must carefully evaluate all applicable regulations to arrive at a validated conclusion for the execution of economic business transactions. With the continuous growth of trade, commerce, and industry, regulatory compliance requirements are expected to increase multifold, further emphasising the need for meticulous adherence to legal and financial frameworks.
The article has been crafted to discuss broadly Direct and Indirect Tax Regime provisions with a broad framework:
1. Revenue Recognitions – Revenues – Toplines
2. Inventories
3. Revenue Recognitions – Expenditure
4. Capex
5. Related Party Transactions
Part 4. Capex
Direct Taxes – Broad Framework
Capital expenditure (Capex) is considered one of the foundations of any business enterprise. Such spending enables enterprises to generate revenues from operations by manufacturing goods intended for supply, thereby deriving economic benefits.
Usually, the life of the capex may run from 3 years to 20 years, depending on the size, nature and volume of business activities. In value terms capex, monies outgo in one go can be significant compared to everyday regular business operating expenses. E.g. Plant and Machinery, Office Equipment, Factory Building, Electrical Installations, Air Conditioners, Intangibles, Motor Cars and/or other assets. Such capex is incurred essentially for the furtherance of business, as generally understood. Capex is recognised as Fixed Assets in the financial statements and is reflected on the assets side of the balance sheet.
As per Section 2(14) of the ITA, “capital asset” includes property of any kind held by an assessee, whether or not connected with his business or profession. Thus, we can say that “capital asset” would include personal assets under the direct tax regime, viz. Residential Property, Commercial Property, Shares and Securities (Listed and Unlisted), Gold, Jewellery, bullions, Diamonds, Artefacts, Watches, Paintings etc. Personal assets are typically not accounted for in business financial statements, but they can be reported depending on the books of accounts maintained.
Section 2(11) defines “block of assets” means a group of assets falling within a class of assets comprising—
a. tangible assets, being buildings, machinery, plant or furniture;
b. intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, not being goodwill of a business or profession
in respect of which the same percentage of depreciation is prescribed
Section 2(29AA) defines “long-term capital asset” means a capital asset which is not a short-term capital asset
Section 2(29B) “long-term capital gain” means capital gain arising from the transfer of a long-term capital asset.
Section 2(42B) defines “short-term capital gain” means capital gain arising from the transfer of a short-term capital asset
Indirect Taxes – Broad Framework
The concept of capex under the direct tax regime is pari materia to the Indirect Tax regime only with one caveat as per Section 2(19) of the CGST Act, 2017, which defines “Capital Goods” as the goods the value of which is capitalised in the books of accounts.
Given the above background concerning Capex, let us try to examine the implications of Direct Taxes and Indirect Taxes on illustrative relevant Capex treatment in the tabular format:
| Type of Capex/ Expenditure | Direct Tax Regime | Indirect Tax Regime |
| Ownership | Capex should be legally owned by the business enterprises for recognition as Capex in the financial statements.
If not legally owned, it cannot be recognised as capex and is not eligible for tax benefits. |
Ownership of Capex is pari materia to the provisions applicable under the provisions of the Indirect Tax Regime. |
| Furtherance of Business | Capex should be incurred exclusively for business. If so, tax benefits such as a depreciation allowance are permissible.
If capex is incurred for personal purposes, even though it is termed a capital asset as per section 2(14), it cannot be classified as business capex. Examples include a personal motor car and personal household items. |
Capex should be incurred exclusively for the furtherance of business. For such expenditures, GST benefits in the form of ITC, as per sections 16 & 17 of the CGST Act 2017, are permissible.
If Capex is incurred for personal purposes, then ITC on such capex is implicitly blocked by Section 17 of the CGST Act, 2017. E.g., personal motor cars, personal household items, etc. |
| Depreciation vis-à-vis ITC claim.
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Section 32 of ITA prescribes multiple rates of depreciation (10%, 15%, 40%, etc.) based on the classification of the capex and the number of days the taxpayer uses it.
Under section 32, Capex is classified as a “Block of Assets,” meaning all the assets fall under the same class and have the same prescribed depreciation rates. To claim depreciation, one must own such capex, which the taxpayer shall use in the previous year relevant to the assessment year. Such depreciation rates are to be claimed based on the written-down value (WDV) of the Capex for each previous year. Thus, the depreciation allowance is amortized in the books of accounts over a number of years. No depreciation is admissible on the personal assets. A person may adopt different accounting methods for providing depreciation in the books of accounts. Still, depreciation has to be claimed deductible as per rates specified u/s 32 of the Income Tax Act, 1961 and disallowing depreciation provided as per books of accounts if rates vary compared to section 32 of the ITA. For any business, depreciation relating to business capex must be claimed as per Section 32 of the ITA. ITC claimed under the Indirect tax regime needs to be reduced from the capex value for a depreciation claim under section 32 of the ITA. Depreciation can be claimed on the immovable property u/s 32 of the ITA. |
Whereas under the indirect tax regime, any capex expenditure for the furtherance of business is entitled to claim the benefit of ITC if required conditions of Section 16 & Section 17 are satisfied.
ITC can be claimed by the person as soon as it is purchased and procured, irrespective of whether they have been put to use. Thus, for a claim of depreciation under the direct tax is put to use is mandatory, but the same requirement doesn’t apply under the Indirect Tax regime. As explained above, the ITC on personal capex is implicitly blocked u/s 17 of the CGST Act, 2017; the same needs to be appropriately reported in the GST Returns by the persons viz. GSTR 3B, GSTR 9 & 9C etc. Under the Indirect Tax Regime, ITC may or may not be claimed, but as far as I understand, no option is available. For any business, claiming the ITC on capital goods as per section 2(19) of the GST Act, 2017, is not mandatory but optional. Further, ITC claims u/s 17 are specifically blocked from purchasing immovable property, as the sale of land or buildings is not specified as a supply of goods or services per Schedule III of the CGST Act, 2017. |
| Disposal of Capex vis-à-vis ITC | Net consideration for the disposal of capex is reduced from the block of assets.
If the block of assets is extinguished, then the gain on disposal is offered to tax as a short-term capital gain u/s 50 of the ITA. If the block of assets is not extinguished, the taxpayer can continue to claim depreciation u/s 32 on the balance WDV value of the block of assets. Suppose the capital asset is disposed of on which depreciation has not been claimed. In that case, the gain on disposal of such capex will be termed either short-term capital gain or long-term capital based on the period of holding such assets, and tax on such gains will be payable as per rates specified under the ITA. |
The net consideration for disposing of capex is the transaction value adopted to levy GST, read with Section 15 of the CGST Act, 2017.
If the ITC claim is claimed on capital goods as defined u/s 2(19), then reversal under Rule 43 needs to be determined, considering 5% per quarter or any part thereof on the disposal of capex. If the capex is sold after 5 years from the date of purchase, then reversal under Rule 43 is not required. GST levies are payable only on the transaction value. |
| Capital Expenditure is recognised as Revenue Expenditure. | If capital expenditures are recognized as revenue expenditures in the financial statements, a claim for deduction of such expenditures is specifically disallowed under Section 37 of the Income Tax Act (ITA), except for certain exceptions provided under the ITA, such as scientific research expenditures under Section 35, etc.
The Tax Auditor is obliged to report such transactions where capital expenditure is incorrectly claimed as revenue expenditure in the relevant paragraphs of Form 3CA/3CB along with Form 3CD. The tax auditor must qualify the tax audit report in such cases. If a statutory audit is applicable, then the Independent Auditor’s Report must also be qualified accordingly to state that the profit/loss and statement of affairs do not reflect a true and fair view of the business operations for the previous year under consideration.
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Suppose the Capital expenditure is recognised as Revenue expenditure in the financial statements. In that case, technically, there is no impact on a claim of ITC as per sections 16 & 17 of the CGST Act, 2017.
As no audit is applicable under the GST provisions now, to my limited understanding, such accounting doesn’t create any apparent issues under the Indirect Tax provisions. Further, as far as I understand, qualification in the Independent Auditors report under the Companies Act 2013 also doesn’t create any apparent issues under the Indirect Tax provisions. |
| Subsidy | The subsidy may be linked to capital investment receipts or revenue receipts. If linked to capital investment, the subsidy’s value is reduced from the value of the capital expenditure.
Readers may read the detailed discussion on subsidy (supra- Revenue recognition forming part of this article) |
If the Subsidy is linked to capital investment and reduced from the value of such capital expenditure, tax treatment does not change under the Indirect Tax regime.
Readers may read the detailed discussion on subsidy (supra- Revenue recognition forming part of this article) |
| Refunds | Considering the substantial capital expenditure incurred by taxpayers during any financial year, combined with significant claims of depreciation allowance under Section 32, any income tax refund arising from the determination of total income will be processed by the Income Tax Department as per the provisions of the ITA. | There is no specific provision under the Indirect tax regime to claim a refund of ITC paid on capex. Still, only when a person applies for a refund u/s 54 read with rule 89(4)(B), where such rule expressly provides that “Net ITC” means input tax credit availed on inputs and input services during the relevant period. Thus, in such scenarios, ITC on capex is to be ignored for GST Refunds filed as per the provisions of the Act and Rules framed thereunder. |
Readers, please note that I have attempted to explain Capex transactions to highlight the distinction between both regimes. However, numerous other transactions may need to be considered and validated to fully decipher the implications under either law. Therefore, the above tabulations should not be regarded as exhaustive in understanding the convergence.
Conclusion:
Readers of this article should keep in mind probable future developments which are envisaged as under:
- Expansion of data reporting under the Direct Tax and Indirect Tax regimes especially if we examine the definition of computer systems as provided under the new Income Tax Bill 2025 which is reproduced below;
- Clause 261 (e) states “computer system” means computers, computer systems, computer networks, computer resources, communication devices, digital or electronic data storage devices, used on stand-alone mode or part of a computer system, linked through a network, or utilised through intermediaries for information creation or processing or storage or exchange, and includes the remote server or cloud server or virtual digital space;
- Whether such change would mean the integration of evidence law, digital data protection laws, digital data sharing and extended by the invasion of privacy of the taxpayers (Food for thought)
- KYC (Know your customer) requirements;
- Digital Trail Monitoring and the significance of electronic evidence;
- Increase in data points applicable to E-Invoicing requirements & mandatory e-invoicing for B2C transactions;
- Geo Tagging and Mapping of Place of Business & movement of supply to plug leakage of revenues;
- Implementation of Unique Identification Markings for implementing the Track and Trace Mechanism.
- Mandatory Bio-metric authentication for registrations, additional or change in place of Business;
- Data locking of values reported in the returns filed under GST Returns;
- Synchronization of data across allied laws vis-à-vis direct tax and indirect tax regime;
- Deep dive to verify the inputs and output analysis using the nexus theory mapped to HSN and SAC Classifications;
- Advanced AI, ML and RMS tools to plug out revenue leakages etc.
In this article, the author has sought to restrict discussions to the broad areas specified while being fully aware that there could be many more aspects that can be discussed and engaged for the discussions. Given the fast-evolving nature of laws and their underlying regulations, the statements made herein may undergo significant changes due to amendments, notifications, or circulars issued after the article’s publication. The author urges all readers to validate the assertions and statements by corroborating them with the latest legal precedents before drawing any conclusions or relying on this document. Any suggestions for improving the content of the article are welcome with folded hands. Further, my views are personal and based on my limited understanding of the subject. My views shall not be considered explicit/implicit opinions. They are not binding on me as an organisation established for the benefit of all indirect professionals based in and outside India.
In the upcoming article, Part 5, the author will discuss the aspects of Related Party Transactions from the perspective of Convergence – Divergence. The Evolving Relationship Between Direct and Indirect Taxes in India.
Happy reading to all.
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