The Hindu Business Line : Easier to tell a donkey from an elephant than capital from revenue

FLOWER petal game is an ancient preoccupation of the indecisive. It involves pulling out the petals one by one, with a binary question such as `He loves me, he loves me not,' and arriving at the answer even as the pitiable flower gets bald. Not the right way to resolve, you may argue, but when a problem is tricky and vexing, reading tealeaves or even tossing a coin is okay.

They say, CA students use some similar technique in exam halls, as do accountants when deciding whether to book expenditure as capital or revenue. On the latter, there are a few interesting cases in a recent issue of Income-tax Tribunal Decisions.

One is of Vinod Kothari Consultants where the Kolkata ITAT decided that consideration paid for takeover, where the essence of an agreement is the warding off of competition, is of capital nature. Here, VK had paid Rs 2 lakh to Wise Men's Consultancy Co P Ltd as `seminar expenses' and claimed the outgo as revenue expenditure. But the assessing officer (AO) noticed that VK had paid the sum for taking over Wise Men's business of conducting training courses in the fields of leasing and hire-purchase. Consideration was for acquiring an enduring benefit, said the AO, because VK could conduct Wise Men's activities for an indefinite period.

There can be more than one view on matters such as of VK. So, it is not surprising that the ITAT ruling in the VK case had to involve a Third Member. The Accountant Member said that the payment was of a revenue nature, because "training materials, in the fast changing scenario, are bound to be outdated within a relatively short time."

However, the Judicial Member applied the Viscount Cove's test — that of bringing into existence an asset or an advantage for an enduring benefit — and said that the expenditure was of capital nature. Before concurring with the Judicial Member, the Third Member cited dozens of cases, to leave one with enough wisdom to appreciate that the capital-revenue tangle can be as unpredictable as termites.

Another case, again on the C vs R knot, was that of Elegant Chemicals Enterprises P Ltd before the Hyderabad ITAT. The story begins, about a decade ago, with Elegant getting a project from Procter & Gamble (P&G) to manufacture, on job-work basis, certain formulations to be supplied to Latin America. Within a few months, on the advice of P&G, Elegant purchased equipment such as shifter, multi mill, blender and so on, for the purpose, and produced on trial basis "Vicks Action 1000 by name Vick Noctyl and Vick Diatyl" and supplied to Latin America.

However, P&G terminated the project the very next year, and paid Rs 1.08 crore to Elegant as "compensation for losses suffered due to discontinuance of the project."

Of this amount, Elegant booked Rs 87 lakh as capital receipt, stating that it was "for sterilisation of capital asset resulting in extinction of the profit earning source." But the taxman was of a different view. The Department said that, as per the correspondence between P&G and Elegant, the compensation received was for expenditure such as interest, depreciation and so on, which are all of revenue nature.

It was also pointed out by the Department that even after the termination, Elegant "continued to have physical possession of assets and continued to claim depreciation and interest expenditure on borrowings relatable to the said assets." Though purchased for the project, the assets could be used for the manufacture of formulations for others on job-work basis, reasoned the Department, arguing that the compensation was "not for loss of assets or for destruction of assets but only for the loss of profit which the assessee would have earned had the Latin American project been continued".

Elegant's counsel relied on an earlier judgment of the Andhra Pradesh High Court in the Barium Chemicals case to press his point about the receipt being capital in nature. However, the tribunal cited the same case to state that there is no infallible test to draw a clear cut demarcation between a capital receipt and a revenue one: "To decide whether or not a payment is a revenue receipt, its true nature and substance must be looked into; the form in which it is expressed is not decisive. How the assessee treated the payment is not conclusive of its nature."

An important point that caught the attention of the tribunal was that, soon after the project was abandoned, Elegant had put forward to P&G a claim for Rs 1.53 crore without indicating how much of it was for sterilisation of capital assets. Nor was any evidence available that P&G had "reimbursed a particular percentage of assets." Thus, the ruling went against the company and the whole sum was treated as revenue receipt.

Studious auditors may ask why there was no bifurcation of the payment, while hardcore researchers would be happy to expense, rather than capitalise, payments for aborted projects, even if the machinery acquired is useful for other jobs. For accountants confronted with thorny transactions such as this, the question that would continue to haunt would be the right classification, between capital and revenue. There are no foolproof answers, and so the flower petal game may still help.

Perhaps, as Ferdinand tells the Princess in Love's Labour's Lost, "The extreme parts of time extremely forms all causes to the purpose of his speed, and often at his very loose decides that which long process could not arbitrate." Because, Neil Peart would remind you that if you choose not to decide, you still haven't made a choice.

As with electing the CEO for a democracy where one has to bite the ballot, or closing a brigand's chapter with a bullet to fill up a dug-up grave, so too in accounting where debits and credits are not the last word on transactions but often simple burials in a hurry, even if a tax tribunal may have to exhume the books at a later date.

AccountSpeak@TheHindu.co.in

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