Differentiating capital and revenue receipts is vital in taxation to determine tax liability. While revenue receipts from regular operations are taxable, capital receipts, often from non-recurring sources like asset sales or loans, are generally exempt unless specified.
Introduction
Generally, all incomes are classified into taxable income and non-taxable income. The nature of receipts also determines the tax liability. The general rule is that revenue receipts are taxable but capital receipts are not taxable. The Income Tax Act has not defined revenue receipts and capital receipts. Income tax as the name implies, is a tax on income and not a tax on every item of money received. Therefore, unless the receipts in question constitute income as distinguished from capital, it cannot be charged to tax, for this purpose income should be distinguished from capital which gives rise to income. However, some capital receipts have been specifically included in the definition of income. Capital receipts are inflows of funds that lead to the creation of capital from non-recurring sources. These receipts are recorded in the balance sheet and do not appear on the income statement, some examples of capital receipts are sell of fixed assets, long-term loans, funds received from shareholders, government grants for capital expenditure, proceeds from the sale of investments, etc. Revenue receipts are inflows of funds that arise from the normal operations of the firm. The revenue receipts are recorded in the profit and loss account (income statement), some examples of revenue receipts are sales receipts and interest income. In other words; an amount referable to fixed capital is a capital receipt whereas a receipt referable to circulating capital would be a revenue receipt. While the latter is chargeable to tax, the former is not subject to income tax unless otherwise expressly provided.
Meaning of Capital Receipts
Capital receipts are inflows of funds that lead to the creation of capital from non-recurring sources. These receipts irregularly arise rarely, it involves the long-term financial position of the firm. Any long-term loans taken by the firm are considered as capital receipts, and sales of fixed assets such as property, plant, and machinery generate capital receipts. These receipts are recorded in the balance sheet and do not appear on the income statement, some examples of capital receipts are sell of fixed assets, long-term loans, funds received from shareholders, government grants for capital expenditure, proceeds from the sale of investments, etc.
Meaning of Revenue Receipts
Revenue receipts are inflows of funds that arise from the normal operations of the firm. The revenue receipts are recorded in the profit and loss account (income statement) of the firm.
Criteria for Determining Whether a Receipt is a Capital or Revenue in Nature
The Income Tax Act does not define the term “Capital receipt” and “Revenue receipt.” Also, it has not laid down the criteria for differentiating the capital and revenue receipt. Yet it has exempted certain capital receipts from taxation, while certain capital receipts have been taken into the ambit of capital receipts chargeable as capital gains. The following test can be applied to determine the nature of a particular receipt:
- Type of Capital will Depend Upon the Nature of Business: An amount received on account of the sale of trading goods or receipts in respect of circulating capital or of flowing capital is revenue receipts, for example, the sale of a car by a dealer. On the other hand, a receipt on account of the sale of fixed assets is a capital receipt, for example, an amount received on the sale of a car by a person who is not a car dealer.
- Nature of Receipt Depends Upon the Reference to the Recipient: Whether a particular receipt is capital or revenue in nature must be determined regarding the recipient who is sought to be taxed as the assessed. For tax purposes, the capital or revenue character of the receipt must be determined based on the nature of the trade in the course of which or in connection with which it arises. For example, where a person sells his properties and the sale price is payable to him by the purchaser in the form of annuities of a fixed sum so long as the seller is alive or until he attains a particular age.
- Capital and Revenue Receipts Concerning Business Activities: Profits and gains arising from various transactions which are entered into in the ordinary course of business of the business of the taxpayers or those which are incidental to or closely associated with his business would be revenue receipts chargeable to tax. But even in these cases, the receipts may be of a capital nature in certain circumstances. For example; income from letting out buildings owned by a company to its employees, profits arising from dealings in foreign exchange by a banker or other financial institutions, profits on the purchase and sale of shares by a broker on his account, etc.
Identify the Nature of Receipts; Capital or Revenue Receipts
- ABC Pvt. Ltd. received 1 lakh rupees as compensation from XYZ Pvt. Ltd. for the premature termination of the contract of the agency. In this case, the amount received by ABC Ltd. from XYZ Pvt. Ltd. for premature termination of an agency contract is a capital receipt because the receipt in substitution of a source of income is a capital receipt, though the same is taxable under Section 28 (ii) (c) of the Income Tax Act, 1961.
- Sales tax collected from the buyer of goods. In this case, the sale tax is the liability of a seller to pay to the Government on the sale of goods made by him, which is allowed as a deduction as revenue expenditure. If any part of the sale tax is collected from the buyer of goods that may be treated as a revenue receipt. Thus the sale tax collected from the buyer of goods is a revenue receipt.
- ABC Pvt. Ltd. instead of receiving royalty year by year received it in advance in lump sum. In this case, the receipt of lump sum royalty in lieu of future royalties is a revenue receipt, as it is an income from royalty.
- An employee director of a company was paid 1 lakh rupees as a lump sum consideration for not resigning from directorship. In this case, the amount received 1 lakh rupees for not resigning from directorship is a reward received from the employer. Therefore it is a revenue receipt.
Conclusion
Thus in the context of taxation, the capital receipts and the revenue receipts help to determine the taxability of the income sources. Revenue receipts arising from the normal course of business are taxable, whereas capital receipts specifically derived from non-recurring sources such as long-term loans or the sale of fixed assets are generally exempt from tax unless specifically provided under the head of capital gain. These distinctions help to assess the tax obligations of taxpayers. Examples like compensation for premature termination of contracts, sale tax collection, and lump sum royalty payments help to identify the nature, whether the receipts are revenue or capital receipts.
