Revenue Expenditure

Introduction

A revenue expenditure is immediately expensed off in the year in which it is incurred. All revenue expenditures are allowable as deduction unless there is a restriction under Income-tax against its deduction. Revenue expenditures are incurred to meet the ongoing operational costs of running a business.

1. About

1.1. What is revenue expenditure?

A revenue expenditure is the cost incurred by the entity on day-to-day operation and it is expensed off in the accounting year in which it is incurred. In other words, the cost will be matched with the revenues of the accounting year in which the expenditure took place. This is in contrast to a capital expenditurein which the cost is amortized or expensed off over several accounting years.

1.2. Deduction as per method of accounting

Deduction for revenue expenditure is allowed in accordance with the method of accounting followed by the assessee. In case of mercantile system of accounting, a revenue expense is allowed as deduction in the previous year itself in which it is incurred. The deduction for revenue expenses shall also be matched with the business receipts charged to tax during the previous year. In other words, if a business receipt is not chargeable to tax in the previous year, the revenue expenditure in relation to such receipts shall not be allowed as deduction in that year.

If books of accounts are maintained on cash basis, the deduction is allowed on payment basis, even of all those expenditures which are paid in advance. This rule is, however, subject to an exception. All expenses as referred to in Section 37 shall be allowed as deduction only on payment basis even if assessee follows mercantile system of accounting.

1.3. Business should be carried on during previous year

In order to avail of deduction of an expenditure incurred in respect of a business, it is necessary that the business should be carried on by the assessee during the previous year. If the business has been closed or discontinued before the commencement of the previous year, no deduction is permissible in respect of an expenditure incurred in respect of a discontinued business. However, this is rule is subject to an exception covered in Section 38.

1.4. No deduction for pre-incorporation expenses

In case of a new business, the first previous year begins from the date on which business or profession is set-up. Therefore, expenditure incurred before setting up a business is not deductible while computing income of the previous year. However, certain expenses, incurred before setting-up a business, are allowed as deduction in Sections 45, Section 44 and Section 51.

1.5. Only Real expenditure is deductible

Income-tax Act allows deduction only of real expenditures incurred by the assessee. All anticipated loss or contingent expenses are not allowed to be deducted even if the loss is certain. In other words, if a loss or expense is not incurred in the previous year, it is not deductible against the actual receipts of the year.

2. Identification of revenue expenditure

The Gujarat High Court

Positive Tests

If expenditure is incurred:

(a) With a view to bring profits or monetary advantage either today or tomorrow

(b) To render the assessee immune from impending or reasonably apprehended litigation

(c) In order to save losses in foreseeable future

(d) For effecting economy in working which may pay dividends today or tomorrow

(e) For increasing efficiency in working

(f) For removing inefficiency in the working

(g) Where the expenditure incurred is such as a wise, prudent, pragmatic and ethical man of the world of business would conscientiously incur with an eye on promoting his business prospects, subject to it being genuine and within reasonable limits

(h) Where it is incurred solely by way of a civil duty owed by the assessee to the society having regard to the nature of his business which brings him profits but results in some detriment to the public at large either by way of health hazard or ecological pollution or serious inconvenience to the citizens with a view to mitigate the aforesaid evil consequences and consequences of a like nature, subject to it being genuine and within reasonable limits.

Negative Test

If the expenditure is incurred:

(a) For a mere altruistic consideration

(b) To satisfy the philanthropic urges of assessee

(c) To win applause or public appreciation

(d) For illegal, immoral or corrupt purposes or by any such means or for any such reasons

(e) To oblige a relative or an official

(f) To earn the goodwill of a political party or a politician

(g) To show off or impress others with his affluence or for ostentatious purposes

(h) Apparently for a factor listed as a positive factor, but in reality for one of the obnoxious purposes listed as a negative factor

(i) On a nebulous plea or pretext by way of an alibi in the name of winning profits in remote future but really for one or the other of the purpose listed as negative tests

(j) It is a bogus, fictitious or sham transaction

(k) It is unreasonable and out of proportion

(l) It is an expenditure merely with a view to avoid tax liability without any genuine purpose or reason in good faith

(m) The advantage to be secured by incurring the expenditure is of the nature of a remote possible advantage depending on ‘ifs’ and ‘buts’ and, if at all, to be secured at an uncertain future date which may be considered too remote.

3. Deduction for revenue expenditure

As a general rule, a revenue expenditure shall be deductible from the taxable profits of the assessee, unless such expenditure is specifically disallowed under the Act. There are certain revenue expenditures which are allowed as deduction on fulfilment of conditions specified under various provisions of the Income-tax Act. These revenue expenditures are listed below.

References

CIT v. Navsari Cotton & Silk Mills Ltd. [1982] 135 ITR 546 (Guj.)

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.