Capital or revenue expenses:- membership fees etc, having enduring advantage

[DEV KUMAR KOTHARI]

Summary:

Some contributions or payments in nature of membership fees or development fees are made in the course of business or profession to other organizations or for trade or local development etc. This facilitates carrying of business. Therefore such expenses are allowed for commercial expediency as well as having been incurred for the purpose of business or profession. However, controversy arises when a view is taken that the expenses have some lasting utility and assessee gets benefit over more than one accounting period. Therefore, a central legislation cannot be applied in a uniform due to different possible views prevailing.

Incidentally a draft provision is suggested to provide for a spread over any expenses which results in to benefit over a period of more than one accounting period. If so provided it will go a long way to assess real income of all accounting periods. 

Trade or professional bodies:

For carrying out a trade or profession effectively one may have to become a member of trade or professional associations. The membership may be compulsory or optional. For example, a person who wants to carry a profession should qualify for such profession and then become a member of the professional body, and if the law, by-laws or regulations so require, he must obtain a certificate of practice. For example, we can consider a case of Chartered Accountant or any other professionals who are governed by professional bodies, which regulate the profession.  

The contributions or fees, which are compulsory to be paid to such institution, are generally considered revenue expenditure. For example, admission fees for membership as well as annual fees both are considered as revenue expenditure.

Similarly in case of a person who wants to carry business of a share broker he has to be a member of the stock exchange. For membership of stock exchange, he is required to pass certain tests of personal and financial abilities then apply and pay an admission fees and annual fees to the stock exchange.

In case of admission fees or contribution for development it can be said that the expenses are normal business expenses and are allowable in the year of accrual or payment. However, the fact remains that the assessee gets some benefit for a period of more than one accounting period.

Practice of revenue department:

It is general practice that when a petty amount is paid, generally it is claimed and allowed. In case a petty amount is disallowed, the disallowance is also accepted to avoid litigation. However, when a substantial amount is paid, an attempt is made to disallow the same on one or other ground. This leads to litigation and we find that even a Central law is not enforced uniformly all over India.

Voluntary memberships:

Some times a businessman or a professional person may become a member of some trade or professional association on voluntary basis and not for any legal or contractual requirement. Such memberships are generally adopted for better communication and to have a platform for discussions, communication, meetings, and exchange of ideas etc., which help in improvement of business and professional enrichment and scope. Admission fees and renewal fees of such organizations are also generally allowed. For example a CA in practice may also obtain membership of ICWAI, ICSI and some other professional associations.

In such cases one can take a view that admission fees paid to the ICAI by a newly qualified CA is to set-up his professional practice, so it a capital expense. Whereas similar admission fees paid to ICWAI or ICSI is not for setting up profession but just to acquire additional membership of other institutes, so it is a revenue expenditure. In case of a new CA, suppose the candidate used to render services of accounting or tax matters after completing his training for CA course, in that case it can be said that the obtaining degree and membership and certificate of practice was to continue the professional activities of an accountant/ advisor, and it is not to setup practice but to carry the activity in more profitable manner because as a CA in practice more opportunities and privileges are available. Therefore, even admission fee is  a revenue expenditure.

Contributions other than for entry or renewal of membership:

Many times in any trade or profession some contributions are made for development of the trade or professional bodies or associations and their infrastructure facilities like - buildings, library, more branches, websites etc. When one continue member of such bodies he get benefit of improved infrastructure and facilities of trade or professional bodies. There can be a long-term benefit from such contribution. However, the fact remains that such long-term or enduring benefit derived is in the revenue field for carrying business or profession more conveniently and profitably and thus the benefit is not in capital field. This is because capital assets created from such contributions are owned by the professional bodies and not by the contributors. The benefit derived simply help the trader or professional in having better facilities, improved information platform, etc. at or through the association.

Recent cases on this issue:

 Admission fees/contribution to infrastructure development paid to stock exchange was held deductible as  revenue expenditure U/S 37(1) for  A/y 1993-94, 1994-95, 1996-97  in CIT v. S. Venkatasubramaniam 2006 -TMI - 13370 - (MADRAS High Court), and the case was decided in favour of Assessee. In this case the assessee is a share broker who  had incurred expenditure towards the admission fees of the Coimbatore Stock Exchange as well as contribution of development charges. By incurring the same he acquired the right of trading in shares and securities at the terminals of the stock exchange.

The High Court held that such payment was necessary for assessee to carry on the business. The assessee was not the owner of any of the assets in the stock exchange so no enduring benefit had accrued to him. Such payment of admission fee and contribution to infrastructure development was like nature of license fees and it was paid only for carrying on business. This, was, thus, a revenue expenditure and was deductible. The High Court relied on law relating to capital and revenue expenses and considered several judgments of the Supreme Court, Privy Council, house of lords and High Courts.

The high Court  of Madras dissented from Calcutta high Court in case of Rajendra Kumar Bachhawat v. CIT 2002 -TMI - 10507 - (CALCUTTA High Court) in which similar expenses were held capital expenditure.

In CIT v. Chemicals and Plastics India Ltd. 2007 -TMI - 13430 - (MADRAS High Court), a case relating to non compulsory contribution  was decided in favour of  the assessee by holding that  Amount paid towards construction of building of State Chamber of Commerce was allowable as revenue expenditure u/s 37(1). The reasons which prevailed in favour of the assessee were:

a. The contribution was for the Chamber of Commerce whose activities were closely linked with the welfare of corporate entities.

B The assessee was a member and interest of members were taken care of by the  Chamber,

c. whether expense incurred was compulsory or otherwise is not much relevant, if it satisfied the commercial expediency test,

d. the building to be constructed will belong to the chamber,

e. the amount paid towards the construction of building of the State Chamber of Commerce was allowable as business expenditure.

Judgment in Rajendra Kumar Bachhawat v. CIT 2002 -TMI - 10507 - (CALCUTTA High Court) needs reconsideration:

In this case the assessee paid Rs.25 lakh for development purposes of becoming a member of the Calcutta Stock Exchange and claimed that is a revenue expenditure. he also claimed that alternatively the same may be allowed over a period of ten years.

The high court held that  a very enduring benefit was accruing to the assessee on payment of development charges. That would render the expenditure as a capital expenditure. Regarding splitting of expenses over ten years the high court held as follows:

 "We are quite unaware of any authority given in the income-tax Act, for carrying forward revenue expenditure, after dividing it, as per the assessee's own wish, into subsequent years."

Thus, the high court did not find any point of law worth the name out of the Tribunals order and dismissed the petition.

Apparent contradiction in observation-

With all respect to the court author feels that some contradiction is apparent in observations of the court as the court has used the words "carrying forward revenue expenditure" , thus apparently court has considered that spread over of revenue expenditure is not authorised and it has not  been held that  amortization of capital expenditure is not authorised.

In case carry forward of revenue expenditure is not allowed than it should be allowed in one year.

In the case before Calcutta high Court, as per  the reported judgment we do not find any name of counsel on behalf of the revenue and the assessee. Thus, it appears that the honorable High Court was not properly assisted and the order has been passed merely on the perusal of the order of the ITAT and the petition. It appears that the ITAT has also not referred to or relied on any judgments on the point of revenue expenditure / business expenditure and commercial expediency etc. or the method of accounting. There is no discussion about how the assessee got a very enduring benefit and what is nature and tenure of such benefit. Therefore, this judgment needs a review by the court and is suitable for challenge before the Supreme Court.

Enduring benefit:

It is well settled that simply enduring benefit does not result into a capital expenditure. An enduring benefit in a revenue filed will not disentitle an assessee from claiming the deduction as revenue expenditure. Furthermore, when an expenditure is likely to give benefit over a period of time, a matching principal of spreading such expenses is now well recognised in accounting and taxing matters. For example, expenses on issuance of debenture is a revenue expenditure, however, when the tenure of such debenture spreads over more than one accounting period , the same can be spread over such period -  Madras Industrial Investment Corpn. Ltd. v. CIT [1997] 91 Taxman 340/225 ITR 802 (SC).= [2008 -TMI - 5591 - SUPREME Court]

A case for depreciation allowance:

It is true that a membership of institution like a Stock Exchange, which is allowed on some substantial payment, is a necessity for the purpose of carrying such business. The right of membership is for a period spread over more than one year, the rights of membership can also be transferred. Therefore, such rights are in nature of business rights which entitle the holder to carry such business may be  subject to some more requirements or compliances like training or continuing training, some annual payments  etc.

Therefore, rights obtained on payment of such amount can be considered as an intangible asset acquired for the purpose of carrying business. In section 32 we find mention of intangible assets as follows:

"know-how, patents, copyrights, trade marks, license, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April, 1998".

A membership of stock exchange is like a license or any other business or commercial right to carry business of share and security brokers. Therefore, costs of such membership is eligible for depreciation allowance u/s 32 if acquired on or after 1^st April, 1998.

Similarly route permit is in nature of a license for plying a vehicle on specified route. The cost of route permit can therefore be amortized u/s 32 read with the appendix to the I.T.Rules.  

Expenditure incurred for obtaining an industrial licence can also be considered as cost of acquiring an intangible asset and it can be amortized by way of claiming depreciation allowance.

It is desirable that expenses considered as capital expenditure in earlier years, which resulted into acquisition of some enduring rights, should also be allowed to be amortized by way of depreciation allowance.

A need to provide for amortization or spread over

There are many expenses, which can result in to benefit over a period of time spread over more than one accounting period. Even some annual payments may be for meeting obligations of business for more than one accounting period. For example, insurance premium paid for a year after 1^st April of the previous year runs useful benefit period over two years. Some payments are made for more than one year at a time for example Road tax for vehicles in some states, building tax levied by municipalities at some places, expenses incurred to obtain loan for a period of more than one year, lease for a period of more than one year etc. Therefore, it is desirable that suitable amendment should be made to amortize such expenses over the useful period. For this purpose a special provision can be inserted on the following lines:

Section 35F. Amortization of expenses over relevant period:

Any allowable expenditure incurred by the assessee during the previous year, which relates to a period of the previous year and also period beyond the end of the previous year shall be allocated and allowed proportionately during the previous year and in subsequent year or years, as the case may be.

Provided that when an expenditure incurred and actually paid is for a period of more than five years, the allocation of such expenses shall will be in proportionate manner, as aforesaid, after taking into account net present value method by applying a discounting rate of nine percent. per annum.  

A provision on above lines will help in assessing real income based on the principal of matching principal according to which all expenses incurred which are relevant to the accounting period and / or for earning of revenue during relevant period should be accounted for.