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Introduction
This Article explains Empire Jute Company V. CIT Case.
A revenue expenditure is a cost that is immediately paid to expense after it is incurred. A company may use the matching concept to connect expenses to revenues produced in the same reporting period by doing so. The income statement would be the most reliable as a result of this method. There are two categories of tax expenditures: (1) revenue expenditures and (2) revenue expenditures. (1) Maintaining a revenue generating asset. In this Repair and maintenance costs are included because they are incurred to maintain existing activities and do not prolong or increase the asset’s life and they are incurred to support current operations, and do not (2) Generating revenue. This category includes all of the day-to-day costs of running a company, such as sales wages, rent, office supplies, and utilities.
Since they contribute to the production of potential sales, some forms of costs are not considered tax expenses. The acquisition of a fixed asset, for example, is classified as an asset and paid to expense over several periods in order to match the asset’s cost to multiple possible periods of revenue generation. This are referred to as capital expenses.
In the present article, a dispute between classification of an expenditure into capital or revenue for the purpose of deduction under the Income Tas Act has arisen which is elaborate below.
Facts of the Case
The present cases the appellant has approached the Hon’ble Supreme Court by the way of Special leave from the High court.
In this case, the assessee (Appellant) is a limited company engaged in the jute manufacturing industry. It has a factory in West Bengal with a certain number of looms. The Indian Jute Mills Association is a member of the company. The Association was founded with the aim of protecting the interests of its members, which include a variety of jute-manufacturing mills.
The objects of the Association, are as follows;
(i) to protect, forward and defend the trade of members;
(ii) to impose restrictive conditions of the conduct of the trade;
(iii) to adjust the production of the Mills in the membership of the Association to the demand of the world market.
A working time agreement was entered into between the members of the Association in the year 1939 to limit the number of working hours per week for which mills shall be entitled to work their looms. This was done in order to adapt the mills’ output to the demand in the world market and increasing production.
The primary working time agreement was entered into in January 1939 and it was for a length of five years and on its termination, the second and from there on the third working time arrangements, each for a time of five years and in pretty much comparable terms, were gone into in June, 1944 and 25th November 1949 respectively
The third working time understanding was going to lapse on 11th December, 1954 and since it was felt that the need to limit the quantity of working hours of the week actually proceeded, a fourth working time arrangement was gone into between the individuals from the in the year 1954 and it was to stay in power for a time of a long time from 1954. In the current case the fourth working time agreement is where the issue has arisen,
In the working time agreement, there was a clause related to the transfer of working hours (called as “Loom Hours”) to another party who is a signatory to the agreement. The consequence of such transfer was that the hours of work per week transferred by a member were liable to be deducted from the working hours per week allowed to such member under the working time agreement and the member in whose favour such transfer was made was entitled to utilise the number of working hours per week transferred to him in addition to the working hours per week allowed to him under the working time agreement.
It was under this clause that the assessee purchased loom hours from four different jute manufacturing concerns which were signatories to the working time agreement for a sun of Rs. 2,03,255/- In the assessment year, the assessee claimed to deduct this amount of Rs. 2,03,255/- as revenue expenditure on the ground that it was part of the cost of operating the looms which constituted the profit-making apparatus of the assessee.
The claim was disallowed by the Income-tax Officer but on appeal, the Appellate Assistant Commissioner accepted the claim and allowed the deduction on the view that the assessee did not acquire any capital asset when it purchased the loom hours and the amount spent by it was incurred for running the business or working it with a view to producing day-to-day profits and it was part of operating cost or revenue cost of production.
The Revenue preferred an appeal to the Tribunal but the appeal was unsuccessful and the Tribunal taking the same view as the Appellate Assistant Commissioner, held that the expenditure incurred by the assessee was in the nature of revenue expenditure and hence deductible in computing the profits and gains of business of the assessee and shall not be considered as an Capital Expenditure.
This view taken by the Tribunal was challenged in a reference made to the High Court at the instance of the Revenue. The High Court too was inclined to take the same view as the Tribunal and the Revenue had no choice but to approach the Supreme Court by the way of Special leave from the High court.
Issues raised in the case
‘In the present case, the issue that has arisen for consideration before thee Hon’ble Tribunal is that “whether a particular expenditure incurred by the assessee is of capital or revenue nature”
Summary of Decision of the Court in the case
The Hon’ble Supreme Court held that the allocation of weekly working hours under the working time agreement was simply not a privilege conferred on a mill that was a signatory to the agreement. It was more of a voluntary restriction agreed by each mill in order to adapt output to market demand, and this restriction could not possibly be considered an advantage of such a mill. Therefore, this restriction had the unintended consequence of restricting the mill’s output and, as a result, the profit that the mill might otherwise make by working full loom hours.
Furthermore, the court observed that there is no addition to or expansion of the profit making apparatus of the assessee. The income-generating machine has remained unchanged since the purchase of loom hours. The assessee is simply given the ability to run the profit-generating structure for a longer period of time. Its term is restricted to six months, and the additional working hours per week transferred to the assessee are also limited have to be utilised during the week and cannot be carried forward to the next week.
As a result, when dealing with situations like this, where the issue is whether an assessee’s expenditure is capital or revenue expenditure, it is necessary to bear in mind “What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the justice classification of the legal rights, if any, secured, employed or exhausted in the process.” This question must be considered in the light of business need or expediency as a whole.
Henceforth, the Hon’ble Court held that the payment of Rs. 2,03,255/-made by the assessee for purchase of loom hours represented revenue expenditure and was allowable as a deduction Under Section 10(2) (xv) of the Income Tax Act.
Analysis of the case
For the purpose of understanding, it becomes necessary to lay the conditional clauses that were mentioned in the agreement related to the transfer of loom hours. Those are as follows;
(i) No hours of work shall be transferred unless the transfer covers hours of work per week for a period of not less than six months;
(ii) All agreements to transfer shall, as a condition precedent to any rights being obtained by transferees, be submitted with an explanation to the Committee and the Committee’s decision… whether the transfer shall be allowed shall be final and conclusive.
(iii) If the Committee sanctions the transfer, it shall be a condition precedent to its utilisation that a certificate be issued and the transfer registered.
Keeping in mind these conditions, in adjudicating the present Case, the Hon’ble Supreme Court took note of Two tests in determine whether an expenditure is capital or revenue expenditure for it to be taxed.
Enduring benefit test:
When an expenditure is made not only once and for all, but with the intention of creating an asset or an advantage for the long-term enduring gain of a trade, there is very good reason to regard it as properly attributable to capital rather than revenue, unless exceptional circumstances lead to the opposite conclusion. The essence of the advantage in a commercial context is important to note, and the expenditure would be disallowable under this test only if the advantage was in the capital sector.
If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably white leaving the fixed capital untouched, the expenditure would be on revenue account, despite the fact that the advantage could last indefinitely. As a result, the test of lasting gain is neither definite nor definitive, and it cannot be applied mechanically and without consideration for the facts and circumstances of a given situation. But even when this test was applied in the present case, the expenditure did not prove to be of capital in nature and nothing was yielded in favour of the Revenue.
Fixed or circulating capital test:
Fixed capital is what the owner profits from by holding it in his possession; circulating capital is what he profits from by selling it and allowing it to change hands.” Now, as long as the expenditure in question can be explicitly linked to the purchase of an asset that falls into one of these two categories, this test will be crucial.
In the present case the court observed that whether loom hours can be regarded as part of circulating capital like labour, raw material, power etc or not is unclear, but it is clear beyond doubt that they are not part of fixed capital and hence even the application of this test does not compel the conclusion that the payment for purchase of loom hours was in the nature of capital expenditure.
For the purpose of arriving at this conclusion, the court took note of the case of Commissioner of Taxes v. Canon Company 45 TC 18 in which it was observed thatan expenditure to be of revenue of it is to remove antiquated restrictions which were preventing profits from being earned”
Conclusion
In genuine practice there is a decent amount of distinction of assessment regarding whether a specific expenditure is capital or revenue in nature. Once in a while, the differentiation among capital and revenue makes a significant suit like the one in the present case.
Since costs add to the creation of possible deals, a few types of expenses are not viewed as tax expenses. The securing of a fixed assets, for instance, is named a resource and paid to discount more than a few periods to coordinate with the assets expense to multiple potential times of income age. This are alluded to as capital costs.
The expression “capital expenditure” has not been characterized in the Act or in sound accountancy standards additionally must be kept in mind for choosing this debate. A few tests have been set down in cases at the end of the day the appropriate response will rely on facts and circumstances of each case.
In the present case, therefore the Hon’ble Supreme Court allowed the appeal and answer the question referred by the Tribunal in favour of the assesses and against the Revenue. And further ordered the Revenue to pay the assessee costs throughout. Attorney General v. Great Eastern Railway, (1880) 5 AC 473 https://www.thelawlane.com/attorney-general-v-great-eastern-railway-coabridged/
