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Differences between Revenue Expenditure & Capital Expenditure for Entrepreneurs

by Paul Joseph January 11, 2012 Featured

Lawyers at VakilSearch shed some light The categorisation of an expense as revenue expenditure or capital expenditure has been a perpetual ground for litigation between assessees and the authorities. The classification of an expense as a revenue expense affects the tax calculation as well as the tax liability of the assessee. The recent judgement by the Delhi High Court on the Airport Authority of India v. Commissioner of Income Tax (CIT) hopes to clear the air and bring clarity to the issue. Let us start by looking at the general understanding. The General Understanding: The general understanding given towards distinguishing the two is this: If the expenditure leads to creation of an asset or an advantage of an enduring benefit, then it is Capital expenditure. If the expenditure has been incurred in the normal course of business but does not give the business any enduring benefit, it is revenue expenditure . While expenses like rent, electricity expenses etc. were allowed as revenue expenses, purchase or construction of assets like machinery, buildings etc are treated as assets in the balance sheet. The confusion The definitions were so absolute and rigid that a lot of items that fell in the “grey area”, i.e. they were either disallowed or disputed in courts for years together. For instance, repairs and maintenance of machinery or buildings is usually treated as revenue expenditure as they are necessary for the efficient functioning of the machinery. However, a company might have to replace a part of the machinery or building to allow it to function. While the Income tax authority may argue that the addition is of an enduring benefit and hence should be a capital expenditure, the assessee might argue that the replacement is nothing but a repair as it was necessary for the machine to even carry on its operation. In comes the recent decision of the Delhi High Court in Airport Authority of India vs. CIT The Delhi High Court Bench ruled that: ‘”If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If, on the other hand, it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure.” For instance, in context of the case, if a person purchases land and incurs expenditure to level it or landscape it, the expenditure is usually treated as capital expenditure as it is of enduring advantage to the company.  However, if the company buys land and incurs expenditure to remove encroachments and any other obstacle that is going to interfere with the smooth running of the business, then it is expenditure incurred for “working it with a view to produce profits” and is therefore revenue expenditure. Before this judgement, there would have been a lack of clarity as to whether it fell under revenue expenditure or capital expenditure. While it is not certain as to how the department will act, this decision does bring some clarity to this complex subject. About VakilSearch VakilSearch is India’s leading online legal services provider for businesses and individuals. As the official partner of the Confederation of Indian Industry (CII) and knowledge contributor to Sulekha.com, the Hindu Business Line, Entrepreneur Magazine and the All India Rubber Association, VakilSearch reaches out to thousands of businesses, entrepreneurs and individuals on a regular basis. So when you visit vakilsearch.com , you can be assured of quality legal guidance and comprehensive documentation for your business and personal needs, at affordable prices.

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Understanding Stamp Duty for Entrepreneurs

by Paul Joseph January 6, 2012 Featured

Lawyers at VakilSearch tell you more As an entrepreneur, a word you might have heard very often is ‘Stamp Duty’. As per the Stamp Act, practically every document and agreement you enter into with another party has to be stamped. Here, in this piece, we will be introducing you to the basic concepts surrounding Stamp Duty payment. Why do we pay Stamp Duty? We owe the concept of Stamp Duty and Stamp Paper to the British, who used Stamps as a way of raising revenue in the aftermath of war, when the treasury had been completely drained. The British themselves stole the idea from the Spaniards, who had used it to raise revenue as well. Who levies Stamp Duty? The Parliament (Central Government) has the power to levy stamp duty on the instruments specified in Article 246 read with Entry 91 of the Union List in Schedule VII. The Union list consists of items of national relevance. The State Government has the power to levy stamp duty on instruments falling under Article 246 read with Entry 63 of the State List in Schedule VII. The State list consists of items of relevance to a particular state. Your agreement has to be printed on non-judicial stamp paper provided by the State Government, and not by the Central Government. How can I save Stamp Duty? There are multiple ways to save on Stamp Duty. For instance, if you are transferring a property to a loved one, it makes sense to enter into a settlement deed wherein the property is settled in favour of that person, rather than a gift deed or a sale deed, where the Stamp Duty is very high. While the Stamp Duty for a settlement deed is a fixed Rs. 10,000, the Stamp Duty on a gift deed can be as high as 5% of the value of the gift. If you are entering into a Rental or Lease Agreement, you can enter into a 11 month rental agreement. Except in a few states like Maharashtra, a 11 month rental agreement need not be registered, and the Stamp Duty is also lower. If you are entering into a Contract, there are a few ways to minimize your Stamp Duty liability. So for instance, unless it is necessary, do not include an indemnity clause. An indemnity clause in Bangalorewill mean that you have to pay an additional Stamp Duty as per Article 5 of the Karnataka Stamp Act. If you are leasing out a commercial premises, (or even a residential premises), having a security deposit in Mumbai increases the Stamp Duty, since Stamp Duty has to be paid as a percentage of the value of the rent + the security deposit which is paid to the landlord. Conclusion All these suggestions and prescriptions are general guidelines and not set in stone. In many cases, paying additional Stamp Duty may not be avoidable, and you may not have any recourse but to pay it. But if possible, look for ways to minimize your liability. You might end up saving a considerable amount of money! About VakilSearch VakilSearch is India’s leading online legal services provider for businesses and individuals. As the official partner of the Confederation of Indian Industry (CII) and knowledge contributor to Sulekha.com, the Hindu Business Line, Entrepreneur Magazine and the All India Rubber Association, VakilSearch reaches out to thousands of businesses, entrepreneurs and individuals on a regular basis. So when you visit vakilsearch.com , you can be assured of quality legal guidance and comprehensive documentation for your business and personal needs, at affordable prices.

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Legal Know-hows For Indian Startups Setting Up Business Overseas

by Paul Joseph November 23, 2011 Featured

Legal experts from NovoJuris show you the way If you as a business setting up business outside of India, then not only do the legal requirements of that country becomes applicable, but quite a few of the Indian legislation and statutory requirements have to be kept in mind as well.  In this post, we are focusing on the Overseas Direct Investment (ODI) governed by the Foreign Exchange Management Act, 1999 and the regulations there under. A quick thumb rule to understand if you are reading foreign exchange related matters like this one (at a very very high level) is, if the foreign exchange is getting into India there are quite a few relaxations including valuation terms.  Obviously, the country needs foreign exchange.  However, when there is foreign exchange outflow from India, there are quite a few restrictions. The Master Circular on Overseas Direct Investment issued on 1 July 2011 covers many of these aspects that we have captured below. You’ll find the is under the Notifications tab on RBI’s website. We would have loved to give a link to the right circular, but RBI website’s Terms of Service requires their prior permission . Under the ODI Indian Entities can directly invest outside India by way of contribution to the capital or through subscription to the Memorandum of Association of the foreign entity, as this signifies long term interest in the overseas entity. In other words there are limited options available are through a Joint Venture (JV) or a wholly owned subsidiary (WOS). A JV means a foreign concern formed, registered or incorporated in a foreign country in accordance with the laws and regulations of that country and in which investment has been made by an Indian entity.  In  a WOS scenario, the entire capital is owned by an Indian entity. Legal Entities permitted to make investments: Company incorporated in India Body created under an Act of Parliament ( NTPC, Airport Authority of India) Partnership registered under the Partnership Act, 1932 (and no, LLP or an individual is not permitted.  See below for exceptions) Legal entities permitted to open overseas branches A firm A company Body corporate registered and incorporated in India Proprietary concern Category of Investment Criteria for Investment Mode of Investment How to Apply Investment in a JV or a WOS Direct investment can be made in a foreign entity engaged in the same core activity carried on by the Indian party. The Indian Party should have earned net profit during the preceding three accounting years.   Investment in an overseas JV/WOS may be funded out of one or more of the following sources: Drawal of foreign exchange from an AD (bank) in India Capitalization of exports Swap of shares Proceeds of External Commercial Borrowings (ECBs)/ Foreign Currency Convertible Bonds (FCCBs) In exchange of ADRs/GDRs issued in accordance with the Scheme for issuing of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993, and the guidelines issued thereunder from time to time by the Government of India. Balance held in EEFC account of the Indian party Proceeds of foreign currency funds raised through ADR/GDR issues.   It should be noted that the ceiling of 400% of the net worth will apply to the last two points    To submit Form ODI , duly completed, to the designated branch of an Authorised Dealer (AD) Category- I (Bank) for onward transmission to Reserve Bank. Investment out of ADR/GRD (American Depository Receipt/ Global Depository Reciept) The ADR/GDR that is issued has to be in accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme 1993 and the guidelines issued thereunder. The Indian Party is required to report such acquisition in Form ODA to the AD Bank for submission to the Reserve Bank within a period of 30 days from the date of the transaction. Investment in equity of companies registered overseas Should be a  Listed Indian company but investment should not exceed more than 50% of the net worth as on the date of the last audited balance sheet Listed Indian companies can invest in shares, bonds / fixed income securities, rated not below investment grade by accredited / registered credit rating agencies, issued by listed overseas companies The Indian Party is required to route such transaction through the designated branch of an authorized dealer in India Investment by capitalization Indian party should have supplied technical know-how, consultancy, managerial and other services within the ceilings applicable. Direct investment is permitted by way of capitalization in full or part. Capitalization of export proceeds remaining unrealised beyond a period of six months of realization will require prior approval of the Reserve Bank. Indian software exporters are permitted to receive 25 % of the value of their exports to an overseas software start-up company in the form of shares without entering into Joint Venture Agreements, with prior approval of the Reserve Bank. Investment by individuals Resident of India Shares can be acquired in a foreign entity as consideration for professional services rendered to the foreign entity.       RBI will permit after giving due consideration to the following: i. credentials and net worth of the individual and the nature of his profession; ii. the extent of his forex earnings/balances in his EEFC and/or RFC account; iii. financial and business track record of the foreign entity; iv. potential for forex inflow to the country; v. other likely benefits to the country.   Other Investments in Foreign Securities Resident of India Foreign Securities can be acquired: ● as a gift from any person resident outside India; -  under cashless Employees Stock Option Programme (ESOP) issued by a company outside India, provided it does not involve any remittance from India -inheritance from a person whether resident in or outside India -  to purchase equity shares offered by a foreign company under its ESOP Schemes, if he is an employee, or, a director of an Indian office or branch of a foreign company, or, of a subsidiary in India of a foreign company, or, an Indian company in which foreign equity holding, either direct or through a holding company/Special Purpose Vehicle (SPV), is not less than 51 per cent. AD Category – I banks are permitted to allow remittances for purchase of ESOP shares by eligible persons irrespective of the method of operationalisation of the scheme i.e where the shares under the scheme are offered directly by the issuing company or indirectly through a trust / a Special Purpose Vehicle (SPV) / step down subsidiary, provided (i) the company issuing the shares effectively, directly or indirectly, holds in the Indian company, whose employees / directors are being offered shares, not less than 51% of its equity, (ii) the shares under the ESOP Scheme are offered by the issuing company globally on a uniform basis, and (iii) an Annual Return (Annex B) is submitted by the Indian company to the Reserve Bank through the AD Category – I bank giving details of remittances / beneficiaries, etc.   General permission to individuals Resident of India -qualification shares for becoming a director of a company outside India provided it does not exceed 1 % of the paid up capital of the overseas company and the consideration for the acquisition does not exceed USD 20,000 in a calendar year – rights shares provided that the rights shares are being issued by virtue of holding shares in accordance with the provisions of law for the time being in force – purchase of shares of a JV / WOS abroad of the Indian promoter company by the employees/directors of Indian promoter company which is engaged in the field of software where the consideration for purchase does not exceed  USD 10,000 or its equivalent per employee in a block of five calendar years; – purchase of foreign securities under ADR / GDR linked stock option schemes by resident employees of Indian companies in the knowledge based sectors, including working directors provided purchase consideration does not exceed  USD 50,000 or its equivalent in a block of five calendar years.   To submit Form ODI , duly completed, to the designated branch of an Authorised Dealer (AD) Category- I (Bank) for onward transmission to Reserve Bank. Obligations of Indian Entity: The Indian party which has made direct investment abroad is under obligation to: Receive share certificate or any other document as evidence of investment. Repatriate to India the dues receivable from foreign entity. Submit the documents/ Annual Performance Report to the Reserve Bank through the AD Category- I Bank. The nuances of reporting, compliances, application process is still arduous, but then if your startups market or business is outside of India, the logistics of getting out on foreign shores should not hold you back!   Disclaimer:  This post is meant for information purposes only and is not a legal opinion.   About NovoJuris Sharda Balaji founded NovoJuris with the realization that technology innovations are fast outpacing the legal framework. NovoJuris counts over 200 small and medium business and over 10 investment houses as their customers over the last 3 years. NovoJuris values a culture of providing professional legal help and obsesses about the success of their customers. The management team at NovoJuris brings over 30 years of experience in technology and law into practice. Do check out their website for further details. You may also like to read: How to Plan Stock Options for your Foreigner Employees: Startup Legal Talk FDI Policy Changes Startups, Are you raising VC money? Here is your ESOPs checklist

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