Differences between Revenue Expenditure & Capital Expenditure for Entrepreneurs

The categorisation of an expense as revenue expenditure or capital expenditure has been a perpetual ground for litigation between assessees and the authorities.

The classification of an expense as a revenue expense affects the tax calculation as well as the tax liability of the assessee. The recent judgement by the Delhi High Court on the Airport Authority of India v. Commissioner of Income Tax (CIT) hopes to clear the air and bring clarity to the issue. Let us start by looking at the general understanding.

The General Understanding:

The general understanding given towards distinguishing the two is this:

If the expenditure leads to creation of an asset or an advantage of an enduring benefit, then it is Capital expenditure.

If the expenditure has been incurred in the normal course of business but does not give the business any enduring benefit, it is revenue expenditure.

While expenses like rent, electricity expenses etc. were allowed as revenue expenses, purchase or construction of assets like machinery, buildings etc are treated as assets in the balance sheet.

The confusion

The definitions were so absolute and rigid that a lot of items that fell in the “grey area”, i.e. they were either disallowed or disputed in courts for years together. For instance, repairs and maintenance of machinery or buildings is usually treated as revenue expenditure as they are necessary for the efficient functioning of the machinery.

However, a company might have to replace a part of the machinery or building to allow it to function. While the Income tax authority may argue that the addition is of an enduring benefit and hence should be a capital expenditure, the assessee might argue that the replacement is nothing but a repair as it was necessary for the machine to even carry on its operation.

In comes the recent decision of the Delhi High Court in Airport Authority of India vs. CIT

The Delhi High Court Bench ruled that:

‘”If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If, on the other hand, it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure.”

For instance, in context of the case, if a person purchases land and incurs expenditure to level it or landscape it, the expenditure is usually treated as capital expenditure as it is of enduring advantage to the company. However, if the company buys land and incurs expenditure to remove encroachments and any other obstacle that is going to interfere with the smooth running of the business, then it is expenditure incurred for “working it with a view to produce profits” and is therefore revenue expenditure.

Before this judgement, there would have been a lack of clarity as to whether it fell under revenue expenditure or capital expenditure. While it is not certain as to how the department will act, this decision does bring some clarity to this complex subject.

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