Difference between capital receipts and revenue receipts in income tax

Difference between capital receipts and revenue receipts in income tax

A capital receipt is generally not taxable unless the law specifically states otherwise, while a revenue receipt is taxable unless explicitly exempted under the law. Capital receipts are taxed under the category of "Capital Gains," while revenue receipts are taxed under other headings. The law does not provide a clear and comprehensive definition of "income," which can make it difficult to distinguish between capital and revenue receipts. However, based on various court rulings, the following key principles can help clarify the distinction

Key Point to Remember

Receipts

Lump Sum vs. Installments

It doesn’t matter if income is paid all at once (lump sum) or in smaller amounts (instalments)—its nature stays the same.

Example: An employee is supposed to get ₹ 5,000 per month as salary. Instead, he agrees to get ₹1,80,000 upfront for three years. Whether monthly or lump sum, it’s still salary and considered revenue income.

Who Receives the Income Matters

Whether the money is capital or revenue depends on the person receiving it.

Example: Even if a new business pays salary out of its capital, the employee still gets it as revenue income (salary).

How It’s Recorded in Books Doesn’t Matter

The way income is labeled or treated in accounting books doesn’t change whether it’s capital or revenue.

Income from Exhaustible or wasting Assets

Profits from resources that are used up, like mining royalties, are taxable as income (revenue), even though they involve using up capital.

Amount of Income Doesn’t Matter

Whether the income is large or small, its size doesn’t decide if it’s capital or revenue.

Timing of Receipt is Key

The nature of the money is decided when it’s received, not later when the recipient decides how to use it.

Voluntary or Obligatory

It doesn’t matter whether the income is given voluntarily or because of a legal obligation—it’s still treated the same way for taxes.

Purpose Behind an Asset

The purpose of owning something can change how it’s treated:

Example: If you buy a sculpture to display at home, selling it later gives you capital income.

But if you’re an art dealer selling the same sculpture, it’s revenue income because selling art is your business.

Here are some examples of capital transactions that are still taxable under the law:

Capital Gains on Selling Assets

If you sell a capital asset (like property, shares, or jewelry), the profit (capital gain) you make is taxable. This is explained in Section 45 of the tax law.

Compensation for Job-Related Changes

If you get money because your job is terminated or the terms of your job are changed, this is taxable as per Section 17(3).

Payments Related to Business or Professional Activities

If you receive compensation or any other payment under specific circumstances mentioned in Sections 28(ii) and 28(va), those are also taxable.

Expenses

Capital expenditure cannot be treated as an expense unless the law specifically allows it. However, revenue expenditure can be treated as an expense unless the law says it shouldn’t be. Based on various court decisions, here are some key points to understand:

Acquiring an asset or long-lasting benefit

If the money spent creates an asset or benefit that lasts for a long time, it’s usually considered a capital expense.

Capital assets belonging to others

 If the money spent creates an asset, but that asset belongs to someone else, then the expenditure will be treated as a revenue expense.

Profit-earning activities

If the money spent is directly related to the business’s operations and helps earn profits, not to acquire a long-lasting asset, it’s considered a revenue expense.

Purpose of the transaction

 The reason for the expense, how it impacts the business, and the nature of the trade matter when deciding if the expense is capital or revenue.

Fixed vs. Circulating capital

Money spent on fixed capital (long-term investments) is usually capital expenditure. But money spent on circulating capital (like stock) is considered a revenue expense.

Removing restrictions

If the business already has the right to operate, and the money spent removes restrictions or barriers, it’s a revenue expense, as long as it doesn’t create a new asset.

Payments to competitors

If a payment is made to a rival to avoid competition, it’s considered capital expenditure.

Routine business expenses

 Regular expenses that are part of normal business operations are treated as revenue expenses, not capital.

Initial costs or business expansion

If money is spent to start or expand a business or replace equipment, it’s capital expenditure. However, if the money is spent to run the business or to earn profits, it’s a revenue expense.

Ensuring raw material supply

 If money is spent to secure the regular supply of raw materials, even for several years, it is considered a revenue expense.

Improvements to property

 If an owner spends money on improving a building and increasing its value, it’s capital expenditure. But if a tenant spends money on renovating a rented property, it’s generally treated as a revenue expense.

Goodwill acquisition

 If a business buys goodwill, it’s treated as capital expenditure. This remains true whether it’s paid all at once or in installments. However, if the expense is for the right to use goodwill rather than owning it, it’s a revenue expense.

Expenses for legal rights

Money spent on creating or securing a legal right is capital expenditure. But if it’s spent on protecting that right, it’s a revenue expense.

This is clear and structured understanding of the "Differences between Capital vs. Revenue Receipts", along with relevant examples and tax implications. 

For more understanding, may take help of following scenario.

Scenario 

ABC Ltd., a cement manufacturing company, entered into an agreement with a supplier for the purchase of an additional cement plant. One of the conditions stipulated in the agreement was that, if the supplier failed to deliver the machinery within the agreed timeframe, the company would be compensated at 5% of the price of the respective portion of the machinery, without requiring proof of actual loss. As a result of the supplier's failure to deliver the machinery within the stipulated time, the company received ₹8.50 lakhs as liquidated damages.

Question: What is the nature of the liquidated damages received by Birla Ltd. from the supplier — a capital receipt or a revenue receipt?

Solution: In the case of "CIT v. Saurashtra Cement Ltd." (2010), the Supreme Court held that damages received under such circumstances are directly and intimately linked to the procurement of a capital asset. These damages compensate for the delay in the establishment of the profit-making apparatus. Consequently, the receipt is not earned during the ordinary course of business and does not arise from the profit-earning process. Therefore, the compensation received for the sterilization of the profit-earning source, rather than being a revenue receipt, is classified as a "capital receipt" in the hands of the assessee.