Capital or revenue?

Whether a particular expenditure is capital or revenue in nature for the purposes of income tax has always engaged tribunals and courts in India. The reason for this is obvious — revenue expenditure would hit the expenditure account and would be eligible for a tax deduction whereas capital expenditure would mean that only depreciation can be claimed. The tax deduction in both the cases may not be the same.

Various courts have laid down many tests to ascertain whether a particular expenditure is revenue or capital in nature. One of these tests is that of enduring benefit — if the entity estimates that it will receive an enduring benefit from the expenditure, it would be classified as capital. However, the Supreme Court in the case of Empire Jute Co Ltd vs CIT (1980)124 ITR 1 ruled that there may be cases where the expenditure can be such that there could be an enduring benefit but the expenditure can still be classified as revenue expenditure. Such decisions only added to the confusion and getting a deduction soon became a game of chance.

This game of chance was evident in response to the question whether non-compete fee received was capital or revenue in nature. Majority opined that it was a capital receipt. After the financial year ending 2003, it was brought to tax under the head profits and gains of business or profession as mandated by Section 28(va) of the Income Tax Act. After this amendment, one had to determine whether capital gains or normal business taxes would be applicable to non-compete fees received.

Just as the debate on non-compete fees was settling, another issue started troubling the tribunals and courts — Carbon credits. The UN’s Kyoto Protocol commits certain developed countries to reduce their GHG emissions and, for this, they will be given carbon credits. A reduction in emissions entitles the entity to a credit in the form of a Certified Emission Reduction (CER) certificate.

The CER is tradable and its holder can transfer it to an entity which needs carbon credits to overcome an unfavourable position on carbon credits. Income tax department has been treating the income on transfer of carbon credits as business income which is subject to tax at the rate of 30 per cent. However, divergent decisions have been given by the courts on the issue as to whether the income received or receivable on transfer of carbon credit is a revenue receipt or capital receipt.

To bring clarity on the issue of taxation of income from transfer of carbon credits and to encourage measures to protect the environment, Budget 2017 proposes to insert a new section 115BBG to provide that where the total income of the assessee includes any income from transfer of carbon credit, such income shall be taxable at the concessional rate of 10 per cent (plus applicable surcharge and cess) on the gross amount of such income. No expenditure or allowance in respect of such income shall be allowed under the Act.

Some entities such as coal mining companies are already paying a Clean Environment cess. Paying a carbon credit cess in addition to this would soon mean that coal companies would soon be paying as much cess and they are paying taxes. The Government should not add another cess on carbon credits; a flat rate of 10 per cent would be ideal.

The writer is a chartered accountant