$~R-71
* IN THE HIGH COURT OF DELHI AT NEW DELHI
Date of decision: September 18, 2014
+ ITA 142/2002
COMMISSIONER OF INCOME TAX ..... Appellant
Through: Mr.Balbir Singh,
Sr.Standing Counsel with
Mr.Abhishek Singh Baghel,
Mr.Arjun Harkauli, Advs.
versus
M/S. TRIVENI OIL FIELD SERVICES LTD ...... Respondent
Through:
CORAM:
HON'BLE MR. JUSTICE SANJIV KHANNA
HON'BLE MR. JUSTICE V. KAMESWAR RAO
SANJIV KHANNA, J (ORAL)
1. This appeal under Section 260A of the Income Tax Act, 1961
(Act, in short) by the revenue relates to the Assessment Year 1991-92
and vide order dated 21st October, 2002 stands admitted for hearing
on the following substantial question of law:
"Whether on the facts and in the circumstances of
the case the Tribunal was correct in law in holding that
ITA No.142/2002 Page 1 of 15
the expenses of Rs. 38,91,369/- incurred by the
assessee on payment of salaries were revenue in
nature?
2. The respondent assessee during the period relevant to the
Assessment Year in question was engaged in the business of oil
drilling operations and drilling oil wells. The respondent assessee
owned oil rigs were given to different clients like ONGC, Oil India
Ltd. etc.
3. The respondent assessee filed their return of income on
31.12.1991 declaring loss of Rs. 3,17,55,920/-, which was revised to
Rs. 3,65,06,041/- on 9.11.1992. The revision was on account of
depreciation claimed.
4. The Assessing Officer, on the issue in question, in the
Assessment Order dated 10.02.1994 has observed that for the
previous year ending 31.03.1991, an amount of Rs. 3.89 Crores had
been capitalized or kept apart for allocation towards three deep
drilling rigs. Out of the said three rigs, one was commissioned in
February, 1991 and the remaining two were commissioned in the
subsequent year. The Assessing Officer held that the respondent
assessee had capitalized the cost of acquisition and deployment of the
three additional rigs in the books of account but had claimed the
ITA No.142/2002 Page 2 of 15
aforesaid expenditure as revenue in nature on the plea that the
expenses incurred were for extension of existing business and not for
setting up of a new business. The Assessing Officer disallowed the
claim and treated the aforesaid amount of Rs. 3.89 Crores as capital
expenditure as it pertained to acquisition of plant and machinery
namely the three rigs. The aforesaid amount included the
expenditure incurred on salaries paid to the employees which was
treated as capital expenditure on the ground that if the respondent
assessee had employed engineers/workers from an external agency
the amount paid would have been capitalized. The Assessing Officer
observed that it would not make any difference if the assessee had
procured the raw material first and then converted them into plant
and machinery after incurring some expenditure or to reduce his
headache the assessee had brought/purchased a ready to use plant and
machinery from the market. In either case the principle for
computing the cost of plant and machinery would remain the same.
He further held that in the latter case, it was not material whether the
assessee was assembling the plant and machinery in his own
premises. No part of such expenditure should be debited to profit and
loss account and allowed as a revenue expenditure.
ITA No.142/2002 Page 3 of 15
5. Aggrieved, the respondent assessee preferred an appeal and the
Commissioner of Income Tax (Appeals) (CIT(A), in short) called for
details of expenditure incurred and perused the same. He noticed
that the major expenditure was related to consumption of stores and
spares (Rs. 55,17,748.90) , sub-contract charges (Rs. 18,06,300/-) ,
salaries (Rs.38,91,263.52), travelling and conveyance
(Rs.32,90,757.35) , loans (Rs.1,66,94,413/-) and other financing
charges (Rs.26,13,851/-). The last two amounts were incurred for the
acquisition of the rigs. He observed that it was not disputed that out
of the three rigs, one had become operational in the previous year,
whereas the other two became operational in the subsequent year.
CIT(A) allowed the interest expenditure of 1,66,94,413/- and
financial charges of Rs. 26,13,851/- as revenue expenditure as they
had been incurred for acquisition of the rigs but the other expenses
i.e. on consumption of stores and spares, sub-contract charges,
salaries, travelling and conveyance were disallowed.
6. The Income Tax Appellate Tribunal (Tribunal, in short) has
accepted the findings of the CIT (A) relating to consumption of
stores and spares, sub-contract charges etc. as these were direct cost
for the rigs. However, with regard to the salaries, the Tribunal noted
ITA No.142/2002 Page 4 of 15
that the salaries could not be treated as direct cost for acquisition of
the rigs and should be treated as a revenue expenses. It was noted
that the salaries computed and attributed at Rs. 38,91,369/- , were the
proportionate amount and not the actual amount which had been
reflected in the books for setting up whole or part of the rigs. The
Tribunal observed that the entries in the book of accounts would not
be definitive on the issue whether the amount should be capitalized
or treated as revenue expenditure.
7. The findings recorded by the Tribunal make it apparent that the
new rigs purchased by the assessee were financed. The financing
cost was allowed as revenue expenditure. The new oil rigs were a
new capital asset. Thereafter, the rigs had to be installed for the
purpose of making them operational. The assessee had deployed
their workers and technicians to whom salaries were paid to make the
rigs operational. The business of the respondent assessee was
continuous and ongoing. The business required constant deployment,
installation and re-installation of the rigs, which upon purchase or on
shifting from an location to the other had to be made functional. The
rigs, no doubt, constitute capital asset, but, we do not think, the
expenditure incurred on the salary paid to the employees can be
ITA No.142/2002 Page 5 of 15
treated as capital expenditure.
8. The business undertaken by the assessee, as already
noticed, was oil drilling operations, drilling oil wells and giving
on hire oil rigs to clients. Making the oil rigs operational was the
very business of the assessee. It was this business activity, which
yielded income in the form of earning or even hire charges. The
respondent-assessee had employed salaried workers or
technicians for the purpose of its business, i.e., drilling of oil
wells with the help of rigs and carry out drilling operations and
thereafter to give the said oil rigs on hire.
9. The line between capital or revenue expenditure in-spite the
settled principles is beset with difficulties and an onerous task. In
M.K. Brothers Private Limited versus Commissioner of Income
Tax, (1973) 3 SCC 30, the Supreme Court held that the answer
does not depend upon the fact whether the amount spent is large
or small, paid in lumpsum or in instalment, but upon the purpose
for which the payment was made and the expenditure incurred.
The nature and quality of payment was determinative and
decisive. The test, whether the payment was made to acquire a
capital asset or for running of business and working with a view
ITA No.142/2002 Page 6 of 15
to produce profits is helpful. The principal or the main test
normally applied is that of enduring benefit but the Supreme
Court in Empire Jute Company Limited versus Commissioner of
Income Tax, (1980) 124 ITR 1 (SC) cautioned that in spite of
palpable advantages, the test may break down and what is
material to be considered is the nature of the advantage in the
commercial sense. If the advantage consists of merely facilitating
assets in trading operations or enabling the management to
conduct of business more efficiently, it would amount to ,,revenue
expenditure, even though the advantage may be of indefinite
future. Earlier in Assam Bengal Cement Company Limited
versus CIT, West Bengal, (1955) 27 ITR 34 (SC) it was observed
that if the expenditure is not for the purpose of bringing into
existence any asset or advantage, but for running of business or
working with it to produce profits, it would be ,,revenue
expenditure. Reference in the said decision was made to Dixon,
J. opinion in Sun Newspapers Limited and Associated
Newspapers Limited versus Federal Commissioner of Taxation,
(1938) 61 CLR 337 wherein distinction between ,,revenue and
,,capital was made by drawing distinction between business
ITA No.142/2002 Page 7 of 15
entity, structure or organisation set up or established for earning
of profits on one hand and the process by which an organisation
operates to obtain regular returns on the other, but with a warning
that business structure or entity may assume almost infinite
variety of shapes and, therefore, it may be difficult to
comprehend.
10. The Delhi High Court in CIT versus J.K. Synthetics
Limited, (2009) 309 ITR 371 (Delhi) after referring to the case
law on the subject had set out the test or principles, which read as
under:-
"An overall view of the judgments of the
Supreme Court, as well as of the High
Courts would show that the following broad
principles have been forged over the years
which require to be applied to the facts of
each case :
(i) the expenditure incurred towards initial
outlay of business would be in the nature of
capital expenditure, however, if the
expenditure is incurred while the business is
on going, it would have to be ascertained if
the expenditure is made for acquiring or
bringing into existence an asset or an
advantage of an enduring benefit for the
business, if that be so, it will be in the
nature of capital expenditure. If the
expenditure, on the other hand, is for
running the business or working it with a
view to produce profits it would be in the
ITA No.142/2002 Page 8 of 15
nature of revenue expenditure ;
(ii) it is the aim and object of expenditure,
which would determine its character and not
the source and manner of its payment ;
(iii) the test of once and for all payment,
i.e., a lump sum payment made, in respect
of, a transaction is an inconclusive test. The
character of payment can be determined by
looking at what is the true nature of the
asset which is acquired and not by the fact
whether it is a payment in lump sum or
in an instalment. In applying the test of an
advantage of an enduring nature, it would
not be proper to look at the advantage
obtained, as lasting forever. The distinction
which is required to be drawn is, whether
the expense has been incurred to do away
with, what is a recurring expense for
running a business as against an expense
undertaken for the benefit of the business as
a whole ;
(iv) an expense incurred for acquisition of a
source of profit or income would in the
absence of any contrary circumstance, be in
the nature of capital expenditure. As against
this, an expenditure which enables the
profit-making structure to work more
efficiently leaving the source or the profit
making structure untouched would be in the
nature of revenue expenditure. In other
words, expenditure incurred to fine tune
trading operations to enable the
management to run the business effectively,
effi-ciently and profitably leaving the fixed
assets untouched would be an expenditure
of a revenue nature even though the
advantage obtained may last for an
indefinite period. To that extent, the test of
enduring benefit or advantage could be
ITA No.142/2002 Page 9 of 15
considered as having broken down ;
(v) expenditure incurred for grant of licence
which accords "access" to technical
knowledge, as against, "absolute" transfer
of technical knowledge and information
would ordinarily be treated as revenue
expenditure. In order to sift, in a manner of
speaking, the grain from the chaff, one
would have to closely look at the attendant
circumstances, such as :
(a) the tenure of the licence.
(b) the right, if any, in the licensee
to create further rights in favour of
third parties,
(c) the prohibition, if any, in
parting with a confidential
information received under the
licence to third parties without the
consent of the licen-sor,
(d) whether the licence transfers the
"fruits of research" of the licen-sor,
once for all",
(e) whether on expiry of the licence
the licensee is required to return
back the plans and designs obtained
under the licence to the licensor
even though the licensee may
continue to manufacture the
product, in respect of which
"access" to knowledge was
obtained during the subsistence of
the licence.
(f) whether any secret or process of
manufacture was sold by the
licensor to the licensee.
Expenditure on obtaining access to
such secret process would
ordinarily be construed as capital in
nature ;
ITA No.142/2002 Page 10 of 15
(vi) the fact that the assessee could use the
technical knowledge obtained during the
tenure of the licence for the purposes of its
business after the agreement has expired,
and in that sense, resulting in an enduring
advantage, has been categorically rejected
by the courts. The courts have held that this
by itself cannot be decisive because
knowledge by itself may last for a long
period even though due to rapid change of
technology and huge strides made in the
field of science, the knowledge may with
passage of time become obsolete ;
(vii) while determining the nature of
expenditure, given the diversity of human
affairs and complicated nature of business ;
the test enunciated by courts have to be
applied from a business point of view and
on a fair appreciation of the whole fact
situation before concluding whether the
expenditure is in the nature of capital or
revenue."
11. In Oracle India Private Limited versus Commissioner of
Income Tax, (2014) 264 CTR 144 (Del) reference was made to
the concept of income, which refers to income generated during
two particular points of time by a person without impoverishing
oneself. It was observed that accounting and reporting standards
are based upon conventions or standards designed to achieve
what are perceived to be the desired objectives of financial
accounting and reporting. Word ,,expense it was elucidated
ITA No.142/2002 Page 11 of 15
would include depreciation in form of outflow caused due to
depletion of assets. Referring to the Framework for the
Presentation and Preparation of Financial Statements published
by the International Accounting Standards Board, the word
,,expense would mean decreases in economic benefits during the
accounting period in the form of outflows and depletions of assets
or incurrence of liabilities. Thus, the word ,,expense will take
into account decreases in future economic benefits relating to an
asset. Referring to Section 37 of the Act, it was held that
emphasis is placed on business and commercial considerations
rather than pure legal and technical aspects. Thus, primacy is to
be given to practical and business point of view and not on
juristic classification. The expression ,,capital or ,,revenue
expenditure must be construed in a business sense and by
applying sound accountancy principles unless there is a statutory
mandate to the contrary.
12. Similarly in Commissioner of Income Tax versus Bharti
Hexacom Limited, (2014) 265 CTR 130 (Del) it was held:-
"16. ......The nature of advantage has to be
considered in commercial sense and only
when the advantage was in capital field, the
ITA No.142/2002 Page 12 of 15
expenditure could be disallowed by
applying the enduring benefit test. If the
advantage consisted merely facilitating
trading operations or enabling the
management or conduct of business more
efficiently or profitably, while leaving the
fixed capital ntouched, the said expenditure
would be on revenue account, though the
advantage may endure for an indefinite
period. Enduring benefit test, therefore, was
not conclusive and cannot be mechanically
applied without considering the commercial
aspect.
17. The second test which can be applied
was fixed and circulating capital test. Fixed
capital being what the owner turns to profit
by keeping it in his ossession; circulating
capital is what the assessee makes profit by
parting or letting the product/asset change
masters/hands. This test could be applied
when the acquisition of asset clearly falls
within one of the two categories but the test
would breakdown where the expenditure
does not fall easily within the specified
category. The demarcation line between
assets out of which profits were earned and
the profit made upon assets or with assets,
was thin and difficult to draw in several
cases. It was observed that purchase of
loom hours was not like circulating capital
(labour, raw material, power etc.), but
"loom hours" were also not a part of fixed
capital. Revenue,,s contention that purchase
of loom hours was for acquisition of source
of profit or income and, therefore, capital
expenditure, was rejected on the ground that
source of profit or income was the profit
making apparatus which had remained
untouched. There was no enlargement of
ITA No.142/2002 Page 13 of 15
permanent structure or capital assets.
Primarily and essentially the expenditure
was relating to operation or working of
looms, which constituted profit earning
apparatus. The Supreme Court, however,
added a word of caution that in the field of
taxation, analogies could be deceptive and
misleading but nevertheless they referred to
an example of an assessee acquiring raw
material regulated under a quota system to
increase his production. Money spent to
acquire the quota right, it was observed
would entitle the assessee to acquire more
raw material to increase profitability of the
profit making apparatus and would
undoubtedly be revenue expenditure as it
was a part of the operating cost. However,
the said example relates to already existing
or ongoing industry. Outgoing whether it
was revenue or capital, it was highlighted,
should depend upon practical and business
point of view, rather than juristic
classification of legal rights. The question
should be judged in the context of business
necessity or expediency; was the
expenditure a part of assessee,,s working
expenditure or a part of process of profit
earning; whether the expenditure was
necessary to acquire a right of permanent
character, the possession of which was a
condition for carrying on trade etc?"
13. In the facts of the present case, we notice that the
expenditure was incurred on labour, i.e., wages. Normally, it
would be a ,,revenue expenditure unless there are special or
specific reasons why it should be treated as capital in nature, the
ITA No.142/2002 Page 14 of 15
expenditure being akin to raw material. We have already noticed
the factual matrix of the present case that after the oil rigs were
acquired by the assessee as a capital asset, they had to be made
operational and functional. This was the very business or the
activity, which was undertaken by the respondent-assessee. The
said activity required expenditure in the form of salary to
workers. It was in the nature of running expenses. Drilling
operations being the very business of the assessee, expenditure
incurred to make the rig operational would be covered and should
be treated as ,,revenue expenditure, whereas the cost of the rig
would fall and should be treated as a ,,capital expenditure.
14. Thus, we do not think, the order of the Tribunal requires any
interference. The question of law is accordingly answered against
the appellant-revenue and in favour of the respondent-assessee.
The appeal is disposed of. No costs.
SANJIV KHANNA, J
V. KAMESWAR RAO, J
SEPTEMBER 18, 2014/akb
ITA No.142/2002 Page 15 of 15
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