How to differentiate between capital receipts and revenue receipt ?

In the determination of the question whether a receipt is capital or revenue, it is not possible to lay down any single test as infallible or any single criterion as decisive. The question must ultimately depend on the facts of the particular case, and the authorities bearing on the question are valuable only as indicating the mat­ters that have to be taken into account in reaching a decision. The question also involves a conclusion of law to be drawn from those facts—CIT v Rai Bahadur Jariam Valji [1959] 35 ITR 148 (SC). However, it would be worthwhile to gain an understanding of some of the important tests which are usually applied in distinguishing between capital receipts and income receipts.

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Tests for differentiating capital receipts and revenue receipts :

1. A receipt by way of price or compensation on disposal of circulating capital or stock-in-trade is a revenue receipt. A reception on the disposal of a capital asset referable to fixed capital is a capital receipt. Whether an asset is a capital asset or a trading asset must be determined on the facts of each.

• Ordinarily, fixed capital is retained in business in order to earn profits., e.g., plant, machinery and building etc. Circulating capital circulates in the business and it is out of this circulation (e.g., capital invested in stock-in-trade) that the profit is earned.
• Compensation received for the immobilisation, sterilisation or destruction of a capital asset is a capital receipt while compensation for injurious affectation of a trading asset is a revenue receipt.

2. Receipt in substitution of a source of income is of capital nature while the amount that substitutes income itself shall be the income chargeable to tax. For example, compen­sation for loss of an agency is a capital receipt (though taxable) whereas the amount received for breach of business contract shall be a revenue receipt.

3. In the case of an isolated transaction of purchase and sale of property the motive of the seller is a deciding factor in determining the nature of a receipt. Sale proceeds, of securities (where they are held as investments) will be capital receipt, but on the other hand, where these securities are held as stock-in-trade, the receipts will be of revenue nature.

4. When a sum is received for the surrender of certain rights under an agreement, it is a capital receipt because a capital asset (namely, the rights) is given up. But where the sum received is in the nature of compensation for loss of future profits, it is a revenue receipt. For example, a pension received by an employee from his former employer is a revenue receipt being compensation for past services, but a lump-sum received in com­mutation of a pension is a capital receipt because of its being compensation for the sur­render of a right i.e., the right to pension. Commutation of pension is, however, taxed as ordinary income outside specified limit.