Distinction between Capital & Revenue Receipt

Advocate Akhilesh Kumar Sah

In CIT vs. Bharti Hexacom Ltd. [2014] 221 TAXMAN 323, the Delhi High Court has observed (at page 341), that if the money paid related to structure of assessee’s profit making apparatus and affected the conduct of business, the sum received for cancellation or variation of agreement, would be a capital receipt.

The Income-tax Act does not define the term ‘Capital receipt’ & “‘Revenue receipt’. Also, it has not laid down the criterion for differentiating the capital and revenue receipt. Yet, it has exempted certain capital receipts from taxation while certain capital receipts have been taken into ambit of capital receipts chargeable as capital gains e. g. w. e. f. 1.4.2000 a new sub- section 45(1A) has been inserted in section 45 which provides that not withstanding anything contained in sub-section (1) (to Sec. 45), where any person receives at any time during any previous year any money or other assets under an insurance from an insurer on account of damage to, or destruction of, any capital asset, as a result of:

(i) flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or

(ii) riot or civil disturbance; or

(iii) accidental fire or explosion or

(iv) action by an enemy or action taken in combating an enemy (whether with or without a declaration of war), then, any profits or gains arising from receipt of such money or other assets shall be chargeable to income-tax under the head “Capital gains”.

Also, certain revenue receipts have been exempted from taxation under Income-tax Act while certain receipts have been taken as income chargeable to income-tax. For example under section 28 certain receipts have been made chargeable to income-tax under the head “profits and gains of business or profession“. The Supreme Court in Oberoi Hotel (P) Ltd. Vs. CIT (1999) XI SITC 109 (SC), has held that the question whether the receipt is the capital or the revenue has to be determined by drawing the conclusion of law ultimately from the facts of the particular case and it is not possible to lay down any single test as infallible or any single criterion as decisive. Also the Supreme Court, in CIT Vs. Prabhu Dayal (1971) 82 ITR 804, has held that the question whether a particular receipt is capital or income is not one of fact though it is dependant to a very great extent on the particular facts of each case, the question does involve conclusion of law to be drawn from those facts. Privy Council (PC) in the case Minister of National Revenue Vs. Cantherine Spooner(1933) 1 ITR 299, has held that the question whether a particular sum reed, is of the nature of an annual profit or gain or is of a capital nature does not depend upon the language in which the parties have chosen to describe it. It is necessary in each case to examine the circumstances and see what the sum really is. Also, PC has held, in CIT Vs. Sir Kameshwar Singh (1935) 3 ITR 305, that whether a particular item or receipt is taxable or not depends upon the nature of the recipients business. The Supreme Court in Commissioner of Income-tax & Excess Profits Tax Act Vs. South India Pictures Ltd. (1956) 29 ITR 910 has observed that it is well recognised that the problem of discriminating between an income receipt and a capital receipt and between an income disbursement and a capital becomes one of much refinement, “while each case is found to turn upon its own facts, and no infallible criterion emerges, nevertheless the decisions are useful as illustrations and as affording indications of the kind of considerations which may relevantly be borne in mind in approaching the problem………..

………. The nature of a receipt may vary according to the nature of the trade in connection with which it arises. The price of the sale of a factory is ordinarily a capital receipt, but it may be an income receipt in the case of a person whose business it is to buy and sell factories. The Bombay High Court in CIT Vs. Mahindra And Mahindra Ltd. (1973) 91 ITR 130 has observed that a receipt is not taxable if it is referable to fixed capital. It is taxable as a revenue item when it is referable to circulating capital or stock-in-trade. The fixed capital is what the owner turns to profit by keeping it in his own possession. Circulating capital is what he makes profit of by parties with it and letting it change its masters. The determining factors must be the nature of the trade in which the asset is employed. The land upon which a manufacturer carries on his business is part of fixed capital. The land with which a dealer in real estate carries on his business is part of his circulating capital. The machinery with which a manufacturer makes the articles that he sells is part of his fixed capital. The machinery that a dealer in machinery buys and sells is part of his circulating capital, as is the coal that a coal merchant buys and sells in the course of his trade. So, too, is the coal that a manufacture makes the articles that he sells is part of his fixed capital. The machinery that a dealer in machinery buys and sells is part of his circulating capital, as is the coal that a coal merchant buys and sells in the course of his trade. So, too, is the coal that a manufacturer of gas buys and from which he extracts his gas (CIT Vs. Motilal Chhadaml Lal Jain) (1998) 142 Taxation 295 (All)).

Instance of a Capital & Revenue Receipt:

In CIT Vs. Silver Cloud Forest & Plantations (1998) 146 Taxation 509 (Mad), the assessee was a registered firm running a coffee and tea estate in which there were also shade trees such as bamboos and silver oaks. Permits were issued for the removal of the Bamboos. According to the said permits only dead and flowered bamboos alone can be removed. The assessee was also periodically cutting live bamboos and selling them, the income from which was subjected to tax in the earlier years. The contention of the assessee was that for the A. Y. s 1972-75 and 1975-76, the bamboos which were removed at the roots could not give test to an income as the sale proceeds would constitute only capital receipt, not liable to tax. The sale proceeds of the dead and flowered bamboos is the subject matter in the apples before the Commissioner of Income-tax. He held that the income from such was different from the income earned by the periodical cutting of live bamboos; the former would be a capital receipt, whereas the latter would be a revenue receipt. On appeal the Tribunal accepted the order passed by the CIT. On further appeal to Madras High Court it relied the decision of Supreme Court in A.K.T.K.M. Vishnudatta Antharjanam Vs. Commissioner of Agricultural income-tax (1970) 78 ITR 58, where the Apex court held that the sale of the trees affected the capital structure, because by removing the roots the source from which fresh growth of trees could take place was removed and the sale could not therefore, give rise to a revenue receipt. The receipt from the sale of the teak trees was capital in nature. Madras High Court observed that since according to the facts arising in the present case, the sale proceeds consisting of the sale of dead and flowered bamboos which were removed once for all, it cannot be considered as revenue in nature. As per the decision of the Supreme Court, the sale proceeds of the dead and flowered bamboos would only be in the nature of capital receipt. In a case before Delhi High Court (CIT Vs. Manoranjan Pictures Corporation (P) Ltd. (1998) 142 Taxation 303, the assessee was an incorporated company engaged in the business of exhibition of cinematographic films. It signed agreements with the producers of three films, namely, “Saheli”, “Sagaai” and “Aaye Din Bahar Ke” for their distribution, exhibition and exploitation in the territories of Delhiand U.P. On September 1, 1956, it entered into a partnership with eight partners and the firm was styled as “Film Friends”.

The business of the firm was to take over the above three films for the purpose of exploitation. As per the terms of the partnership, the distribution and exploitation of the films was to be done exclusively by the assessee who was to sign the agreement of exhibition with cinemas in its own name and also to deal with the producers. For such distribution, the assessee was to receive 5% as commission on the collections of the films on screening. Subsequently, the assessee signed with the producers of three more films for their distribution, exploitation and exhibition in the above territories. The share of the assessee in the firm was to be 25% and the above; the assessee also signed two more agreements with the procedures of two films, namely, “saajan” and “Aay Sawan Jhoom Ke”, for their distribution, exploitation and exhibition. For the exploitation of the said two films, the assesee entered into another partnership on March 17, 1967, with ten other partners and that firm was styled as “Film Enterprises” In this firm also, the assessee held 25% share and was also entitled to 5% commission on the collections of the films for the work performed on behalf of the firm. Subsequently, vide two separate sale deeds, both dated December 28, 1970 the assessee sold its interest in the above two firms to Shri B.N. Gupta and Vijay Sharma and received Rs. 30,500/- for films Friends and Rs. 32,000/-for Film Enterprises by way of compensation for the unexpired period of the contracts with the producers of the affronted films, taken over by the two firms, with the result that the assessee ceased to be a partner with 12% share in each of the said in each of the said firms. During the course of assessment proceeding for the relevant assessment year, 1971-72 the question arose about the taxability of the said amount of Rs. 62, 500/-in the hands of the assessee. It was claimed that the receipt was of capital nature and it was not a receipt from carrying on of business or trade, it was also claimed the said amount could not be taxed as capital gains either. The Assessing Officer did not agree with the assessee. On appeal to Delhi High Court it observed that the question whether a receipt is capital or revenue in nature has invariably presented difficulties in solution despite the fact that attempts have been made time and again to enunciate various principles to distinguish a capital receipt from a revenue receipt. It is not possible to lay down any single or exhaustive test as infallible or any single criterion as decisive for determination of the question. Broadly stated, to determine the character of a receipt in such an action would disrupt the entire profit earning structure of the assessee. If that be so, any thing received would partake of the character of a capital receipt. But where, however, the venture is only for the purpose of carrying on the existing business by taking the help of another, compensation received for relinquishing a right in such a venture would be a revenue receipt. As noticed above, the assessee was engaged in the business of distribution and exhibition of cinematographic films, for which it was entering into independent agreement with the producers of each of the films separately. It is apparent from clause 3 of the two deeds of partnership, that the assessee’s partnership with outsiders was for a limited purpose of the business under the rights of distribution acquired by it in respect of the films mentioned their in with the respective producers under the respective agreements. The two covenants reflect the main object of the assessee joining hands with nine persons, viz., for raising finance from them to the extent of three fourths of the total amount payable to the producers of the films by the assessee. As per the partnership deeds, despite substantial investment by the other partners, the distribution and exploitation of films was to be done exclusively by the assessee and it was only the assessee who was to deal with the producers and the exhibitors and none else. In a nutshell, the arrangement was only of financing by the other partners for which they were to get a return on their investments in the form of profits of the firm and nothing more. They had absolutely no part to play in the distribution and exploitation of the films. Such arrangement is normal features in the film trade to raise finance. The learned judges of Delhi High Court further observed that on a conspectus of these facts, we feel it difficult to hold that the two partnerships were the structure of the profit earning apparatus of the assessee. In our view, these two ventures were for the limited purpose of carrying on the assessee’s existing business of film distribution and exploitation more effectually and effectively by taking the financial help of others. Though the deeds of partnership seek to reflect the acquisition of films for distribution and exploitation as joint ventures in effect these were only entered into by the assessee for the limited purpose of obtaining and securing commercial assets in the form of the aforementioned films, which were undoubtedly stock-in-trade of the assessee in the first instance and later of the two firms. Any compensation received for relinquishment interest in such an asset would be a revenue receipt.

Some settled views:

The Supreme Court in A.K.T.K.M. Vishnudatta Antharjanam Vs. Commissioner of Agricultural Income-tax (1970) 78 ITR 58 has held that profit motive to not decisive of the question whether a particular receipt is capital or income. An accretion to capital does not become taxable income merely because an asset is acquired in the hope that it may be sold at a profit. Also the Supreme Court in CIT Vs. Kamal Behari lal Singha (1971) 82 ITR 460 has observed that it is now well settled that in order to find out whether a receipt is a capital receipt or a revenue receipt. One has to see what it is in the hands of the receiver and not its nature in the hands of the payer. In other words, the nature of the receipt is determined entirely by its character in the hands of the receiver and the source from which the payment is made has no bearing on the question. Where an amount is paid which, so far as the payer is concerned, is paid wholly or partly out of capital, and the receiver receives it as income on his part, the entire receipt is taxable in the hands of the receiver. The Rajasthan High court, in Eklingji Trust Vs. CIT (1986) 53 CTR (Raj) 40, has held that some principles that can be deducted from the various decisions for determining whether a particular amount received by the assessee is capital or revenue in nature, are:

(1) the fact that a certain payment is measured by the estimated annual yield or profits does not make the payment an income receipt,

(2) the fact that the receipt is a periodic receipt or a single receipt is immaterial for the purpose of determining its nature; an income receipts is not necessarily recurring, nor a capital receipt necessarily recurring, nor a capital receipt necessarily single;

(3) the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. In such a situation, the question always is what is the real character of the payment, not what the parties call it.

Conclusion:

Whether a particular receipt is capital or income from business has frequently engaged the attention of the courts (Kettlewell Bullen & Co. Ltd. Vs. CIT (1964) 53 ITR 261 (SC)). There is nothing in the income-tax Act laying down any legal criterion for distinguishing between capital and revenue receipts, nor does any definite and clear criterion emerge from English or Indian decisions on the subject. It depends upon the facts or each case which must be considered for determining whether a particular payment should be held to be chargeable as income under the Income-tax Act or not. (B. Guha & Co. Vs. CIT (1958) 34 ITR 877 (Punj-Del. Bench). It is well settled that the words of the statute, when there is doubt about their meaning, are to be understood in the sense in which they best harmonise with the subject of the enactment and the object which the legislature has a view. Their meaning is found not so much in a strictly grammatical or ethnological property of language, nor even in its popular use, as in the occasion on which they are used, and the object to be attained (Shri Ashok Kumar (HUF) & another Vs. Asstt. CIT (1999) 152 Taxation 30 (Del-Trib)-at page 34)). The onus in upon the income-tax authorities to show that there exist facts or circumstances which would make payment an income (Maharaja Chintamani Saran Nath Sah Deo Vs. CIT (1971) 82 ITR 464 (SC)).

Where the deposit of money is directly linked with the purchase of plant & machinery, any income earned on such deposit is incidental to acquisition of asset and therefore capital in nature (CIT vs. Karnal Co-operative Sugar Mills Ltd. (2000) 14 SITC 578 (SC).

Where assessee firm under an agreement sold boilers alongwith drawings, designs and know-how with further stipulation not to carry out business in the manufacture and design of boilers in future, the receipt on sale of these was held to be of capital nature (Lipi International vs. CIT (2008) 203 Taxation 370 (Bom)).

The Supreme Court in KCP Ltd. vs. CIT (2000) 245 ITR 421 has held that it is not the name given by the assessee or even the revenue of anyone else that matters, but it is the true character of the receipt that determines its taxability and being regarded as falling within the capital field or out of it.

Bottomline:

There have been dispute in many cases regarding whether receipt in question belongs to capital or revenue, the above may be of some use in this respect.