Section 37: Fees paid for enhancement of authorized capital; revenue or capital expense??

CA Akarsh Gupta

Introduction

This article is about one of the most important things which came out in terms that how to treat fees paid for enhancement of authorized capital to Registrar of Companies.

Will it be a revenue expenditure or capital expenditure?

Before starting it up and finding the answer let’s just start it with what is Section 37 of the Income Tax Act, 1961 all about.

Section 37 is based upon four limbs which need to be binged upon:

a) It should not be an expenditure of the nature described in Section 30 to 36

b) Expenditure should not be of capital nature

c) Expenditure should not be of personal nature

d) Expended wholly and exclusively for the purpose of business or profession

What is Capital Expenditure or Revenue expenditure?

Capital Expenditure: It is an expense incurred on assets to create future enduring benefit (i.e., acquisition of assets that will have a useful life beyond the tax year). For example, a business might buy new assets, like buildings, machinery, or equipment, or it might upgrade existing facilities so their value as an asset increases.

Revenue Expenditure: Revenue expenditure is an amount that is expended immediately—thereby being matched with revenues of the current accounting period. It is the expenses incurred during the normal course of business for its day-to-day operations. For example, routine expenses such as rent, wages, power etc.

What the Courts’ say

Let us look at what courts have to say with this subject of treatment of fees paid to ROC for enhancement of authorized capital.

The Head Side:

a) In Brooke Bond India Ltd. v. CIT [1983] 140 ITR 272, the Calcutta High Court, Sabyasachi Mukharji J. , took the view that where the object of incurring an expenditure is to affect the capital structure as a result of which certain incidental advantage flows, the expenditure will be of capital nature.  Therefore, it was held that by acquiring capital, it is increasing earning of income or earning of the profit. That is the physical test. It is the resultant advantage obtained by incurring the expenditure along with the purpose and object of incurring the expenditure that should be the guide to determine the question, whether expenditure is capital or revenue and in the present case, it was held that such expenditure is of capital nature.

b) In Punjab State Industrial Development Corporation vs CIT [1997] 225 ITR 792 Lordships took a view that they do not consider it necessary to examine all the decisions in extenso because of the opinion that the fee paid to the Registrar for expansion of the capital base of the company was directly related to the capital expenditure incurred by the company and although incidentally that would certainly help in the business of the company and may also help in profit-making, it still retains the character of a capital expenditure since the expenditure was directly related to the expansion of the capital base of the company. Therefore, the view taken by the different High Courts in favour of the Revenue in this behalf is the preferable view as compared to the view based on the decision of the Madras High Court in Kisenchand Chellaram’s case.

c)  In Groz-Beckert Saboo Ltd. v. CIT [1986] 160 ITR 743, the Punjab and Haryana High Court, agreeing with the decision of the Calcutta High Court, took the view that the fee paid under the Companies Act for increasing the share capital was an expenditure of capital nature.

d) Similarly, in Mohan Meakin Breweries Ltd. v. CIT (No. 2) [1979] 117 ITR 505, the Himachal Pradesh High Court took the same view that increase of share capital and fees paid to Registrar of Companies for increasing authorized capital will result in an advantage of enduring nature and is, therefore, capital expenditure and is not allowable as revenue expenditure. Therefore, the majority of the High Courts have taken the view that whenever there is an increase of the capital by increasing of the shares and it adds advantage to the capital asset of the company then such expenditure shall be treated to be capital expenditure and not revenue expenditure and not allowable under Section 37 of the Act.

The Flip Tail Side:

a) In CIT v. Kisenchand Chellaram (India) P. Ltd. [1981] 130 ITR 385, the Madras High Court took the view that the assessee paid fees for raising the capital of the company to the Registrar of Companies and claimed the amount paid as a revenue expenditure which was negatived by the Income-tax Officer, but it was allowed by the Appellate Assistant Commissioner and the same was upheld by the Tribunal. On a reference, the court held that without capital a company cannot carry on its business and hence the expenses incurred for increasing the capital were bound up with the functioning and financing of the business. . It is clear from the pronouncement of the Supreme Court in India Cements Ltd. v. CITthat it is the nature or character of the expenditure that determines the allowability. Just as the expenditure on money borrowed for a capital purpose did not affect the allowance, similarly, the fact that the expenditure contributed to the increase in capital should not make a difference to its allowability, if it was otherwise not capital expenditure. Accordingly, the assessee’s claim for deduction was allowable.

b) In Warner Hindustan Ltd. v. CIT [1988] 171 ITR 224 (AP), their Lordships dissenting from the view expressed by the Bombay High Court, the Himachal Pradesh High Court and the Delhi High Court, agreed with the view of the Madras High Court and made a, reference to the decision of the Supreme Court given in Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1. It was held that amount was spent by the assessee by way of fees to the Register of Companies for increasing its authorised capital. The increase in the authorised capital does not by itself result in expending the capital base or the fixed capital company. This expenditure is more in the nature of expenditure laid out for facilitating the assessee’s operations and to enable it to carry on its business more efficiently and profitably. This was done with a view to facilitate a better conduct of the assessee’s business. We may again point out that by merely obtaining an authorization for increasing the authorised capital, the fixed capital of the company was not enhanced or enlarged. In this connection, we may refer to the annual report of the assessee for the year 1972, which shows that while the authorised capital rose from Rs. 1.5 crores in the previous year to Rs. 3 crores in this year, the issued and subscribed capital remained the same at Rs. 30 lakhs (5% non-cumulative redeemable preference shares of Rs. 10 each) and Rs. 98 lakhs (enquiry shares of Rs. 10 each fully paid-up). This aspect shows that on account of the increase in the authorised capital, the fixed capital or share capital of the company remained unaltered. Similarly, in Hindustan Machine Tools Ltd. (No. 3) v. CIT [1989] 175 ITR 220 (Kar), a sum of Rs. 75,600 incurred by way of filing fee paid to the Registrar of Companies in respect of enhancement of the authorized share capital of the company was held deductible as revenue expenditure.

Jotted Conclusion:

With the above facts and the cases being quoted we could see that it is all about interpretations which have been different of different high courts. Some relied on the earlier judgments and some based their opinion based upon the definitions that have come up overtime of what exactly is capital expenditure. Every case had to be decided on its own canvass keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. The decided cases have, from time to time, evolved various tests for distinguishing between capital and revenue expenditure but no test is paramount or conclusive. There is no all-embracing formula which can provide a ready solution to the problem; no touchstone has been devised. Every case has to be decided on its own facts keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. The treatment that practitioners generally carry on is of the majority judgments i.e treating this particular fee as capital expenditure relying on high-profile judgments and probably saving the assessees from going deep into further litigations in the future.

Writer’s View:

The view that I am expressing is my personal opinion, my interpretation based on upon what I see this particular section as and based upon what I feel capital expenditure is specifically. I believe that if you see in a common parlance a “capital expenditure” is an expenditure which you have incurred on assets from which you are going to have an enduring benefit in a way that that particular asset will act as a source of income for you. Fees paid to ROC for increase in authorised capital does not exactly relate to asset being created in here and is paid to ease the influx of share capital that is going to be brought in subsequently. The influx of capital will ultimately be used by the enterprise for their ordinary course of business. The Lordships in PSIDC and Brooke Bond’s case mentioned that there is a change in a “capital structure” of the company due to this fees being paid, but it is for us to see that in that case pending allotment of shares and their subscription subsequently would also rake in the same consequences. The capital base in that case will also change, structure will change, the filing fees paid to ROC for share allotment should also be treated be the same then which is not what we do exactly in our normal practice by charging it in profit & loss account. Therefore, what I see fees paid to ROC for enhancement of authorised capital is as a revenue expenditure being incurred so that further infusion of capital could happen with ease and no new asset being created.

Disclaimer: The views expressed above are author’s personal views. No part of it can be copied or reproduced. The author can be easily contacted @guptaakarsh92@gmail.com.

(Republished With Amendments)