Following tests are important in determining whether a particular expenditure is a capital expenditure or revenue expenditure. These principles are not exhaustive but they serve as guidelines to solve problems.
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12 tests to differentiate between capital expenditures and revenue expenditures :
1. If the expenditure is for the initial outlay or for acquiring or bringing into existence an asset or advantage of an enduring benefit to business that is being carried on or for extension of the business that is going on, or for a substantial replacement of an existing business asset, it would be capital expenditure.
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2. If on the other hand, the expenditure, although for the purpose of acquiring an asset or advantage, is for running of the business or for working out that asset with a view to producing profit, it would be revenue expenditure.
3. If the outgoing is related to the carrying on or the conduct of the business and if it is regarded as an integral part of the profit earning process or operations, the expenditure would be of revenue nature. It may be seen that any asset of permanent character has not been acquired.
4. Special knowledge, technical knowledge, patent or trade will be taken to be assets if acquired for payment. On the other hand if these are acquired for exploitation over a limited period and it is not an advantage of enduring nature and when it is to revert back intact after the agreed period, it will be an expenditure of revenue nature.
5. If the asset acquired is intrinsically a capital asset, it is immaterial whether the price for it is paid once and for all, or periodically or whether it is paid out of capital or income, or linked up with the net sales. The outgoing, in such a case, would be in the nature of capital expenditure.
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6. If the amount paid for the acquisition of an asset of an enduring nature is settled, the mere fact that the amount so settled is chalked out into various small amounts or periodic installments, the capital nature of expenditure would not cease to be so or alter into the nature or a revenue expenditure.
7. A lump-sum amount for liquidating recurring claims would not cease to be revenue expenditure or get converted into capital expenditure merely because its payment is spread over a number of years. It is the intention and object with which the asset is acquired that determine the nature of the expenditure incurred over it and not the method or the manner in which the payment is made, or the source of such payment.
8. If the expenditure is recurring and is incurred during the course of busing or manufacture, it would be revenue expenditure.
9. An asset or advantage of an enduring nature does not mean that it should last for ever. If the capital asset is, in its nature, a short-lived one, the expenditure incurred over it does not, for that reason, cease to be a capital expenditure.
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10. “Enduring benefit” means enduring in the way that fixed capital endures and it does not connote a benefit which endures in the sense that for a good number of years it relieves the assesses of a revenue payment— Assam Bengal Cement v CIT27 ITR 34 (SC).
It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to be considered is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. 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 while leaving the fixed capital untouched, the expenditure would be on revenue account even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case. CIT v Pioneer Engineering Syndicate [1989] 175 ITR-93 (Mad):
11. An outlay is deemed to be capital when it is made for the initiation of a business, extension of a business or for a substantial replacement of equipment.
12. Expenditure may be treated as properly attributable to capital when it is made not only once and for all but with a view to bringing into existence an asset or advantage for the enduring benefit or trade. It must be seen whether for the purposes of expenditure any capital was withdrawn. It must also be found whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital.