IN 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 Income Tax Act, 1961 (Act, in short) by revenue relates to Assessment Year 1991-92 and vide order dated 21st October, 2002 stands admitted for hearing on following substantial question of law: Whether on facts and in circumstances of case Tribunal was correct in law in holding that ITA No.142/2002 Page 1 of 15 expenses of Rs. 38,91,369/- incurred by assessee on payment of salaries were revenue in nature? 2. respondent assessee during period relevant to Assessment Year in question was engaged in business of oil drilling operations and drilling oil wells. respondent assessee owned oil rigs were given to different clients like ONGC, Oil India Ltd. etc. 3. 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. revision was on account of depreciation claimed. 4. Assessing Officer, on issue in question, in Assessment Order dated 10.02.1994 has observed that for previous year ending 31.03.1991, amount of Rs. 3.89 Crores had been capitalized or kept apart for allocation towards three deep drilling rigs. Out of said three rigs, one was commissioned in February, 1991 and remaining two were commissioned in subsequent year. Assessing Officer held that respondent assessee had capitalized cost of acquisition and deployment of three additional rigs in books of account but had claimed ITA No.142/2002 Page 2 of 15 aforesaid expenditure as revenue in nature on plea that expenses incurred were for extension of existing business and not for setting up of new business. Assessing Officer disallowed claim and treated aforesaid amount of Rs. 3.89 Crores as capital expenditure as it pertained to acquisition of plant and machinery namely three rigs. aforesaid amount included expenditure incurred on salaries paid to employees which was treated as capital expenditure on ground that if respondent assessee had employed engineers/workers from external agency amount paid would have been capitalized. Assessing Officer observed that it would not make any difference if assessee had procured raw material first and then converted them into plant and machinery after incurring some expenditure or to reduce his headache assessee had brought/purchased ready to use plant and machinery from market. In either case principle for computing cost of plant and machinery would remain same. He further held that in latter case, it was not material whether assessee was assembling plant and machinery in his own premises. No part of such expenditure should be debited to profit and loss account and allowed as revenue expenditure. ITA No.142/2002 Page 3 of 15 5. Aggrieved, respondent assessee preferred appeal and Commissioner of Income Tax (Appeals) (CIT(A), in short) called for details of expenditure incurred and perused same. He noticed that 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/-). last two amounts were incurred for acquisition of rigs. He observed that it was not disputed that out of three rigs, one had become operational in previous year, whereas other two became operational in subsequent year. CIT(A) allowed 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 rigs but other expenses i.e. on consumption of stores and spares, sub-contract charges, salaries, travelling and conveyance were disallowed. 6. Income Tax Appellate Tribunal (Tribunal, in short) has accepted findings of CIT (A) relating to consumption of stores and spares, sub-contract charges etc. as these were direct cost for rigs. However, with regard to salaries, Tribunal noted ITA No.142/2002 Page 4 of 15 that salaries could not be treated as direct cost for acquisition of rigs and should be treated as revenue expenses. It was noted that salaries computed and attributed at Rs. 38,91,369/- , were proportionate amount and not actual amount which had been reflected in books for setting up whole or part of rigs. Tribunal observed that entries in book of accounts would not be definitive on issue whether amount should be capitalized or treated as revenue expenditure. 7. findings recorded by Tribunal make it apparent that new rigs purchased by assessee were financed. financing cost was allowed as revenue expenditure. new oil rigs were new capital asset. Thereafter, rigs had to be installed for purpose of making them operational. assessee had deployed their workers and technicians to whom salaries were paid to make rigs operational. business of respondent assessee was continuous and ongoing. business required constant deployment, installation and re-installation of rigs, which upon purchase or on shifting from location to other had to be made functional. rigs, no doubt, constitute capital asset, but, we do not think, expenditure incurred on salary paid to employees can be ITA No.142/2002 Page 5 of 15 treated as capital expenditure. 8. business undertaken by assessee, as already noticed, was oil drilling operations, drilling oil wells and giving on hire oil rigs to clients. Making oil rigs operational was very business of assessee. It was this business activity, which yielded income in form of earning or even hire charges. respondent-assessee had employed salaried workers or technicians for purpose of its business, i.e., drilling of oil wells with help of rigs and carry out drilling operations and thereafter to give said oil rigs on hire. 9. line between capital or revenue expenditure in-spite settled principles is beset with difficulties and onerous task. In M.K. Brothers Private Limited versus Commissioner of Income Tax, (1973) 3 SCC 30, Supreme Court held that answer does not depend upon fact whether amount spent is large or small, paid in lumpsum or in instalment, but upon purpose for which payment was made and expenditure incurred. nature and quality of payment was determinative and decisive. test, whether payment was made to acquire capital asset or for running of business and working with view ITA No.142/2002 Page 6 of 15 to produce profits is helpful. principal or main test normally applied is that of enduring benefit but Supreme Court in Empire Jute Company Limited versus Commissioner of Income Tax, (1980) 124 ITR 1 (SC) cautioned that in spite of palpable advantages, test may break down and what is material to be considered is nature of advantage in commercial sense. If advantage consists of merely facilitating assets in trading operations or enabling management to conduct of business more efficiently, it would amount to revenue expenditure , even though 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 expenditure is not for 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 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 process by which organisation operates to obtain regular returns on other, but with warning that business structure or entity may assume almost infinite variety of shapes and, therefore, it may be difficult to comprehend. 10. Delhi High Court in CIT versus J.K. Synthetics Limited, (2009) 309 ITR 371 (Delhi) after referring to case law on subject had set out test or principles, which read as under:- overall view of judgments of Supreme Court, as well as of High Courts would show that following broad principles have been forged over years which require to be applied to facts of each case : (i) expenditure incurred towards initial outlay of business would be in nature of capital expenditure, however, if expenditure is incurred while business is on going, it would have to be ascertained if expenditure is made for acquiring or bringing into existence asset or advantage of enduring benefit for business, if that be so, it will be in nature of capital expenditure. If expenditure, on other hand, is for running business or working it with view to produce profits it would be in ITA No.142/2002 Page 8 of 15 nature of revenue expenditure ; (ii) it is aim and object of expenditure, which would determine its character and not source and manner of its payment ; (iii) test of once and for all payment, i.e., lump sum payment made, in respect of, transaction is inconclusive test. character of payment can be determined by looking at what is true nature of asset which is acquired and not by fact whether it is payment in lump sum or in instalment. In applying test of advantage of enduring nature, it would not be proper to look at advantage obtained, as lasting forever. distinction which is required to be drawn is, whether expense has been incurred to do away with, what is recurring expense for running business as against expense undertaken for benefit of business as whole ; (iv) expense incurred for acquisition of source of profit or income would in absence of any contrary circumstance, be in nature of capital expenditure. As against this, expenditure which enables profit-making structure to work more efficiently leaving source or profit making structure untouched would be in nature of revenue expenditure. In other words, expenditure incurred to fine tune trading operations to enable management to run business effectively, effi-ciently and profitably leaving fixed assets untouched would be expenditure of revenue nature even though advantage obtained may last for indefinite period. To that extent, 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 manner of speaking, grain from chaff, one would have to closely look at attendant circumstances, such as : (a) tenure of licence. (b) right, if any, in licensee to create further rights in favour of third parties, (c) prohibition, if any, in parting with confidential information received under licence to third parties without consent of licen-sor, (d) whether licence transfers fruits of research of licen-sor, once for all , (e) whether on expiry of licence licensee is required to return back plans and designs obtained under licence to licensor even though licensee may continue to manufacture product, in respect of which access to knowledge was obtained during subsistence of licence. (f) whether any secret or process of manufacture was sold by licensor to 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) fact that assessee could use technical knowledge obtained during tenure of licence for purposes of its business after agreement has expired, and in that sense, resulting in enduring advantage, has been categorically rejected by courts. courts have held that this by itself cannot be decisive because knowledge by itself may last for long period even though due to rapid change of technology and huge strides made in field of science, knowledge may with passage of time become obsolete ; (vii) while determining nature of expenditure, given diversity of human affairs and complicated nature of business ; test enunciated by courts have to be applied from business point of view and on fair appreciation of whole fact situation before concluding whether expenditure is in 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 concept of income, which refers to income generated during two particular points of time by 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 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 Framework for Presentation and Preparation of Financial Statements published by International Accounting Standards Board, word expense would mean decreases in economic benefits during accounting period in form of outflows and depletions of assets or incurrence of liabilities. Thus, word expense will take into account decreases in future economic benefits relating to asset. Referring to Section 37 of 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. expression capital or revenue expenditure must be construed in business sense and by applying sound accountancy principles unless there is statutory mandate to 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 advantage was in capital field, ITA No.142/2002 Page 12 of 15 expenditure could be disallowed by applying enduring benefit test. If advantage consisted merely facilitating trading operations or enabling management or conduct of business more efficiently or profitably, while leaving fixed capital ntouched, said expenditure would be on revenue account, though advantage may endure for indefinite period. Enduring benefit test, therefore, was not conclusive and cannot be mechanically applied without considering commercial aspect. 17. second test which can be applied was fixed and circulating capital test. Fixed capital being what owner turns to profit by keeping it in his ossession; circulating capital is what assessee makes profit by parting or letting product/asset change masters/hands. This test could be applied when acquisition of asset clearly falls within one of two categories but test would breakdown where expenditure does not fall easily within specified category. demarcation line between assets out of which profits were earned and 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 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 ground that source of profit or income was 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 expenditure was relating to operation or working of looms, which constituted profit earning apparatus. Supreme Court, however, added word of caution that in field of taxation, analogies could be deceptive and misleading but nevertheless they referred to example of assessee acquiring raw material regulated under quota system to increase his production. Money spent to acquire quota right, it was observed would entitle assessee to acquire more raw material to increase profitability of profit making apparatus and would undoubtedly be revenue expenditure as it was part of operating cost. However, 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. question should be judged in context of business necessity or expediency; was expenditure part of assessee s working expenditure or part of process of profit earning; whether expenditure was necessary to acquire right of permanent character, possession of which was condition for carrying on trade etc? 13. In facts of present case, we notice that expenditure was incurred on labour, i.e., wages. Normally, it would be revenue expenditure unless there are special or specific reasons why it should be treated as capital in nature, ITA No.142/2002 Page 14 of 15 expenditure being akin to raw material. We have already noticed factual matrix of present case that after oil rigs were acquired by assessee as capital asset, they had to be made operational and functional. This was very business or activity, which was undertaken by respondent-assessee. said activity required expenditure in form of salary to workers. It was in nature of running expenses. Drilling operations being very business of assessee, expenditure incurred to make rig operational would be covered and should be treated as revenue expenditure , whereas cost of rig would fall and should be treated as capital expenditure . 14. Thus, we do not think, order of Tribunal requires any interference. question of law is accordingly answered against appellant-revenue and in favour of respondent-assessee. 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 Commissioner of Income-tax v. M/s. Triveni Oil Field Services Ltd