Question: Define Capital and Revenue Receipt. How we can differentiate between capital and revenue receipts?
An inflow of money from the sale of fixed asset or on account of capital by owner or long-term loan from the bank etc. is called capital receipt.
An inflow of money from the sale of goods or services in ordinary course of business is term as revenue receipt.
NEED FOR DISTINCTION
Why we should differentiate between a capital and a revenue receipt. Following are main points of distinction between capital and revenue receipt.
- Income tax is charged on revenue receipts.
- Capital receipts are not chargeable to tax.
- Revenue receipts find place in profit and loss account.
- Capital receipt find place in balance sheet.
- To find tax net, revenue expenditures are deducted out of revenue receipt and not from capital receipts.
PRINCIPLES FOR REVENUE OR CAPITAL RECEIPT
It is not easy to differentiate between a capital and revenue receipts. There is no hard and fast rule for distinction between capital and revenue receipt, following are certain tests.
- NATURE OF ASSET SOLD
- Fixed asset
- Floating asset
Fixed asset are purchased with the purpose to use in the business; usually such assets exist over a longer period of time. For example building, plant, machinery and furniture etc. Receipt from sale of fixed assets is called capital receipt i.e. amount received from the sale of plant and machinery.
Assets which are consumed or sold out within one accounting period are called floating or circulating asset. For example stock of goods or merchandise. Receipts from sale of floating assets are called revenue receipts. For example money received from, the sale of goods or merchandise will be revenue receipts.
SURRENDER OF RIGHTS
- Complete surrender
- Partial surrender
If owner of certain rights i.e. copyrights, Patents rights or trademark etc. receive money from complete surrender or sale of his right. Such receipt will be considered as capital receipts. For example, if Muazzam Mughal author of book income tax law sell the copyright of his book for Rs. 100,000 completely to the publisher then it will be his capital receipts.
When these rights are given only for use up to a specific period of time, it is known as partial surrender. Amount received on partial surrender will be revenue receipts.
For example: if the author surrender his copy right only for 1000 copies or 6 month then money so received will be called revenue receipt.
SUBSTITUTION OF INCOME OR SOURCE OF INCOME
- Substitution of sources
- Substitution of income
Substitution of source
If an amount received is received in substitution of sources of income then such receipt will be capital receipt. For example Mr. Nadir sales his car, which was used as taxi such received will be a capital receipts because it is substitution of car, which was his source to earn income.
Substitution of Income
If money received in substitution of income only, then it will be a revenue receipts. For example Mr. Asher received 9 months’ salary Rs.90,000 rupees in advance (Rs.10,000*9). This Rs.90,000 is substitution of income of next 9 months. It will be a revenue receipt for him.
MOTIVE BEHIND THE TRANSACTION
- Use purpose
- Re-sale purpose
Whether a receipt is a capital or revenue, especially in case of isolated transection.
An answer to this question is motive of person behind such transection.
When any asset is a acquired for use propose and later it is sold, money received from sale of such asset will be a capital receipt because intention was to use and not resell.
For example: Mr. Basit purchase a motor car for his personal use and after some time he sell. Money received from sale of this car will be his capital receipt.
When a person purchased any asset with intension to resale it; receipt from such sale will be treated as revenue receipts.
For example: Mr. Nadir(a property dealer) receipt from sale of building which he had purchased to re-sell it on profit will be his revenue receipts.
RECEIPTS VIEW POINT
- Receipts view point
- Payer view point
Weather a receipt is a capital or revenue, it will always determine from recipient view point and not from the payer view point. Salaam received wages Rs.5,000 for installation of machinery from Ashraf sugar mill it is revenue receipt Mr. Salaam. On the other hand, Ashraf sugar mill it is capital expenditures.
LUMP SUM RECEIPT
There is a general confusion about lump sum receipts. A receipts cannot be declare as revenue or capital on the basis of lump sum or installment, sometime lump sum receipt is wrongly taken as capital receipt.
Lump sum receipt or in installment may be capital or revenue nature. It will depend upon the nature of transection.
For example Mr. Nadir sold his house For Rs.300,000 it is his capital receipt whether he receives it in lump sum or in installment.
Suzuki Motors sells a motor car for Rs.600,000; money received from sale of this car is revenue receipt for Suzuki Motor, either it is received in lump sum or in installment.
Example of Capital Receipt:
- Receipt from sale of fixed asset
- Insurance amount received under a policy which insured building against loss by fire.
- Damage awarded to a railway passenger who become permanently disabled.
- Receipt received from sale of mining rights
- Premium issued of share
- Amount received by a director by virtue of a contract between him and the company in which he undertook not to do a particular business.
Example of Revenue Receipt:
- Receipt from sale of floating asset
- Received dividend from a Public Company
- Received commission for performing services
- Received interest on bank deposit
- Miscellaneous receipts