2014 (10) TMI 4 - HC - Income Tax

Classification of expenses Revenue expenses or not - Expenses on payment of salaries Held that - Assessee was engaged in the business of oil drilling operations and drilling oil wells - making the oil rigs operational was the very business of the assessee - It was this business activity, which yielded income in the form of earning or even hire charges the Tribunal was of the view that the new rigs purchased by the assessee were financed - The financing cost was allowed as revenue expenditure - The new oil rigs were a new capital asset - the rigs had to be installed for the purpose of making them operational - The assessee had deployed their workers and technicians to whom salaries were paid to make the rigs operational - The business of the respondent assessee was continuous and ongoing - The business required constant deployment, installation and re-installation of the rigs, which upon purchase or on shifting from an location to the other had to be made functional - The rigs, no doubt, constitute capital asset, but, the expenditure incurred on the salary paid to the employees can be treated as capital expenditure. The expenditure was incurred on labour, i.e., wages - it would be a revenue expenditure unless there are special or specific reasons why it should be treated as capital in nature, the expenditure being akin to raw material - after the oil rigs were acquired by the assessee as a capital asset, they had to be made operational and functional - This was the very business or the activity, which was undertaken by the assessee - The activity required expenditure in the form of salary to workers - It was in the nature of running expenses - Drilling operations being the very business of the assessee, expenditure incurred to make the rig operational would be covered and should be treated as revenue expenditure , whereas the cost of the rig would fall and should be treated as a capital expenditure thus, the order of the Tribunal is upheld Decided against revenue.

Issues Involved:
1. Whether the expenses of Rs. 38,91,369/- incurred by the assessee on payment of salaries were revenue in nature.

Detailed Analysis:

1. Nature of Salary Expenses:
The primary issue in this case revolves around whether the expenses of Rs. 38,91,369/- incurred by the assessee on payment of salaries should be classified as revenue expenditure or capital expenditure. The respondent assessee, engaged in oil drilling operations, argued that these expenses were for the extension of existing business and not for setting up a new business. The Assessing Officer (AO) initially disallowed the claim, treating the expenses as capital expenditure, reasoning that they pertained to the acquisition of plant and machinery (three drilling rigs).

2. Assessing Officer's Findings:
The AO observed that the respondent assessee had capitalized the cost of acquisition and deployment of the three additional rigs in the books of account but claimed the expenditure as revenue in nature. The AO held that the expenditure on salaries should be capitalized because it was related to the acquisition of plant and machinery.

3. Commissioner of Income Tax (Appeals) [CIT(A)] Findings:
The CIT(A) examined the details of the expenditure and noted that the major expenses included consumption of stores and spares, sub-contract charges, salaries, travelling and conveyance, loans, and other financing charges. The CIT(A) allowed the interest and financial charges as revenue expenditure but disallowed the other expenses, including salaries, treating them as capital expenditure.

4. Income Tax Appellate Tribunal (ITAT) Findings:
The ITAT accepted the findings of the CIT(A) regarding consumption of stores and spares, sub-contract charges, etc., as direct costs for the rigs. However, it differentiated the salary expenses, noting that they could not be treated as direct costs for acquiring the rigs and should be considered revenue expenses. The ITAT emphasized that the entries in the books of accounts are not definitive in determining whether an amount should be capitalized or treated as revenue expenditure.

5. High Court's Analysis:
The High Court delved into the nature of the business and the purpose of the expenses. It noted that the business of the assessee involved continuous and ongoing operations, requiring constant deployment, installation, and re-installation of rigs. The Court pointed out that making the oil rigs operational was the very business of the assessee, and the salaries paid to workers and technicians for this purpose should be treated as revenue expenditure.

6. Legal Principles and Precedents:
The Court referred to several legal precedents to elucidate the distinction between capital and revenue expenditure. It cited the Supreme Court's decision in M.K. Brothers Private Limited versus Commissioner of Income Tax, which emphasized the purpose of the payment and the nature and quality of the payment as determinative factors. The Court also referred to the principles set out in CIT versus J.K. Synthetics Limited, highlighting that the aim and object of the expenditure determine its character, not the source and manner of payment.

7. Commercial and Business Perspective:
The Court underscored that the nature of the advantage obtained from the expenditure should be considered in a commercial sense. If the expenditure facilitates trading operations or enables the management to conduct business more efficiently, it should be treated as revenue expenditure. The Court emphasized that practical and business considerations should take precedence over pure legal and technical aspects.

Conclusion:
The High Court concluded that the expenditure incurred on salaries was in the nature of running expenses necessary for making the rigs operational, which was the core business activity of the assessee. Therefore, these expenses should be treated as revenue expenditure. The Court affirmed the ITAT's decision and answered the question of law in favor of the respondent-assessee, dismissing the appeal by the revenue without costs.

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