Chapter 5: Capital and Revenue

Very Short Question Answer

State the expenses that are treated as capital expenditure according to Income Tax Act, 2058.

Income Tax Act, 2058 has treated the following expenses as capital expenditure:

• Expenditure incurred for feasibility study, exploration and development of natural resources.
• Expenditure incurred for obtaining assets with useful life of more than 12 months.
• Expenditure incurred on the disposal of a liability.

State any two differences between capital receipts and revenue receipts.

Capital Receipts	Revenue Receipts
1. An amount received as fixed capital or for fixed assets is a capital receipt; e.g., amounts received by a company on the issue of its shares, sale proceeds of a motor car by a cloth merchant.	1. An amount received as circulating capital or for floating assets is a revenue receipt; e.g., sale proceeds of a motor car by a car dealer.
2. A receipt in substitution of a source of income is a capital receipt.	2. A receipt in substitution of an income is a revenue receipt.

Which of the following expenses are capital expenditures?

1. Expenditure incurred for acquisition of source of income
2. Expenditure incurred for purpose of earning of income
3. Expenditure incurred for increasing the earning capacity.
4. Expenditure incurred in relation to a fixed asset.

The capital expenses are:

1. Expenditure incurred for acquisition of source of income
2. Expenditure incurred for increasing the earning capacity.
3. Expenditure incurred in relation to a fixed asset.

Short Question Answer

‘Activities of the receiver determine the nature of receipts whether it is capital or revenue.’ Discuss this statement with appropriate examples.

Activities of the receiver determine whether a particular receipt is to be treated as capital receipt or revenue receipt. For example, an amount received as fixed capital i.e. issue of shares or debentures or sale of fixed assets is capital receipt. But if the amount is received as circulating capital i.e. sales proceeds of trading stock, then it is a revenue receipt. Likewise, a receipt in substitution of a source of income is a capital receipt whereas a receipt in substitution of an income is a revenue receipt.

How has the capital expenditure been defined in the act?

Expenditures are of two types: capital expenditure and revenue expenditure.

Capital expenditure is in relation to capital and it is not deductible but the revenue expenditure is deductible for tax purposes. Hence, it is very essential to know the distinction between the two. ITA, 2058 has treated the following expenses as capital expenditure:

-Expenditure incurred for feasibility study, exploration and development of natural resources.

-Expenditure incurred for obtaining assets with a useful life of more than 12 months. Expenditure incurred on the disposal of a liability.

Mention any three differences between capital receipts and revenue receipts.

The three differences are:

Capital Receipts	Revenue Receipts
1. An amount received as fixed capital or for fixed assets is a capital receipt; e.g., amounts received by a company on the issue of its shares, sale proceeds of a motor car by a cloth merchant.	1. An amount received as circulating capital or for floating assets is a revenue receipt; e.g., sale proceeds of a motor car by a car dealer.
2. A receipt in substitution of a source of income is a capital receipt; e.g. compensation received by an employee from his employer for the termination of his service.	2. A receipt in substitution of an income is a revenue receipt; e.g., a prize received by an employee from his employer in consideration of his good services is a revenue receipt.
3. An amount received as a compensation for the surrender of certain rights under an agreement is a capital receipt.	3. An amount received under an agreement, as compensation for loss of future profits is a revenue receipt

How would you distinguish a capital loss from a revenue loss? Explain with illustrations.

The excess of expenditure over income is defined as loss. Losses are also of two types: capital loss and revenue loss (business loss). The distinction between the two is important because the rules of set off and carry forward of losses are different. There are no hard and fast rules to distinguish between the two. The following tests are generally helpful in this connection:

• Loss on account of fixed capital asset (loss on sale of machine) is a capital loss while loss on account of circulating capital assets (loss due to damage of inventory) is a revenue loss.
• Loss incidental to business is a revenue loss.

Income Tax Act, 2058 has made following provisions relating to capital losses:

• Loss on disposal of a pool of depreciable assets is shown as deduction from business or investment incomes.
• Loss on disposal of non-business chargeable assets can be carried forward forever and adjusted against the gain on disposal of non-business chargeable assets.
• Loss on disposal of business assets (or liabilities) can be carried forward forever and adjusted with gain on disposal of business as well as non-business chargeable assets.