[Opinion] Capital vs Revenue Receipts in Infrastructure Taxation

Bhoomija Verma – [2026] 187 taxmann.com 68 (Article)

1. Introduction

The distinction between a capital receipt and a revenue receipt is perhaps the most consequential, and most litigated classification question in Indian Income Tax law. Unlike many other taxing systems, the Income Tax Act does not charge “income” by reference to an exhaustive statutory definition. The Act instead relies on the presumption that capital receipts lie outside the charge, while revenue receipts are generally taxable, subject to exemptions. The importance of this threshold inquiry, therefore cannot be overstated – a wrong characterisation at the first stage colours every subsequent step of the assessment.

The question arises with particular acuity in the context of infrastructure concessions, where the project entity – almost invariably constituted as a Special Purpose Vehicle (SPV) – receives money from the project authority during a construction phase that may stretch across several assessment years before a single rupee of toll or user-fee revenue is earned. Revenue authorities, confronted with a credit entry in the SPV’s books, have displayed a recurring tendency to treat such receipts as taxable business income without first asking the antecedent question – is the receipt income at all, and if so, is it capital or revenue in character? A pending appeal before the Income Tax Appellate Tribunal, New Delhi in Ashok Kumar v. ITO [IT Appeal Nos. 782 & 783 (Delhi) of 2025, dated 30-7-2025] arising from assessments of an SPV executing a DBFOT highway project provides a sharp factual lens through which the governing legal principles may be examined and restated.

This article traces the evolution of the capital-revenue distinction in Indian tax jurisprudence, analyses the principal tests laid down by the Supreme Court and the High Courts, and applies those tests to the distinctive factual matrix of an SPV in the pre-commencement phase of a Build-Operate-Transfer concession.

2. The Threshold Question – Is the Receipt “Income” at All?

Before the capital-revenue debate is even reached, there is a logically prior question – does the receipt constitute “income” within the meaning of Section 2(24) of the Act? The Supreme Court and the High Courts have consistently held that a reimbursement in the nature of a pass-through of a cost that the recipient was never legally or economically obliged to bear – is not income in the hands of the recipient. In CIT v. Walchand & Co. Pvt. Ltd. [1967] 65 ITR 381 (SC), the Court affirmed that the commercial reality and economic substance of a transaction, rather than its superficial form, must govern its tax treatment.

Where a contract expressly places a financial obligation on Party A and designates Party B as the mere conduit through which that obligation is discharged, a payment flowing from A through B to the ultimate service provider creates no economic enrichment in B’s hands. The gross receipt equals the gross payment; the net economic position of B is nil. A nil-net receipt cannot be income, irrespective of the mode of payment or the fact that tax is deducted at source on the gross amount. The deduction of tax at source is a compliance mechanism imposed on the payer as a withholding agent; it neither determines the character of the underlying transaction nor converts a non-income receipt into taxable income.

It is only if this threshold analysis yields a receipt that qualifies as income that the further enquiry into the capital or revenue nature becomes necessary. However, since Revenue authorities routinely collapse both questions into one, it is prudent to address both dimensions and demonstrate that the receipt fails on each count.

3. The Classical Tests for the Capital–Revenue Distinction

Case law has, over the decades, crystallised several tests for distinguishing capital receipts from revenue receipts. They are to be applied collectively, with the facts and circumstances of each case providing the ultimate guide.

3.1 The Fixed Capital/Circulating Capital Test

The earliest and most enduring test originates in the English common law of income tax and was adopted by the Privy Council and subsequently by Indian courts. A receipt is capital in nature if it represents a return of, or payment for, fixed capital assets that are employed in the business to earn profit rather than assets that are themselves the subject of the business. A receipt that goes to restore or replenish fixed capital is capital; a receipt that represents the price obtained in the ordinary course of business activity is revenue.

3.2 The Enduring Benefit Test

In Assam Bengal Cement Co. Ltd. v. CIT [1955] 27 ITR 34 (SC), the Supreme Court adopted the test of “enduring benefit” i.e. an expenditure (or its mirror, a receipt) is capital in character if it brings into existence an asset or advantage of an enduring nature. This test has been applied to receipts as well, where a receipt in consideration of something that confers a lasting advantage on the payer or which flows from and is embedded in the long-term capital structure of the payee, partakes of the character of capital.

3.3 The Source/Profit-Making Structure Test

A receipt is capital if it derives from the disposal, impairment, or compensation in respect of a source of income, rather than from the exploitation of that source. Indian courts have consistently employed the metaphor of the tree and its fruit – the source of income is the tree; the periodical returns derived from working or exploiting it are the fruit. A payment that goes to the very root of the profit-making apparatus by affecting its structure, its capital base, or the source itself – is capital; a payment that is one product of the ordinary, recurring use of that apparatus is revenue. This distinction, firmly embedded in the jurisprudence of the Supreme Court and the High Courts across decades of income-tax litigation, forms the third principal test for characterising a receipt as capital or revenue in nature.

3.4 The Primary Object Test

A fourth and increasingly significant test which the ITAT, Kolkata, elaborated with precision in PFH Mall & Retail Management Ltd. v. ITO [2008] 110 ITD 337 (Kolkata)/[2007] 16 SOT 83 (Kolkata), looks to the primary object of the assessee in undertaking the relevant activity. The Tribunal held that the character of any receipt must be determined with reference to the primary object of the assessee while exploiting the relevant asset or undertaking the relevant activity – and not merely by examining the formal or superficial character of the individual receipt in isolation. This test acquires particular salience in cases involving SPVs, whose entire legal and commercial existence is defined by a single primary object i.e. the construction and operation of a capital asset.

4. The Bokaro Steel Ratio – Receipts Arising During the Construction Phase

The single most important decision in this area is that of the Supreme Court in CIT v. Bokaro Steel Ltd. [1999] 102 Taxman 94 (SC)/[1999] 236 ITR 315 (SC), decided on 18 December 1998. The assessee was a company in the process of setting up a large steel plant where, it had not commenced commercial production during the years in question. During the construction phase, it received amounts from contractors who were engaged on-site and who used ancillary services provided by the assessee, such as canteen, transport, and accommodation for the construction workforce. The Revenue sought to tax these as business income, contending that they arose from the provision of services.

The Supreme Court rejected the Revenue’s contention and laid down the following definitive test – where receipts are inextricably linked with the process of setting up of a capital asset – that is, receipts which would not have arisen but for the fact that the capital asset was being set up, then those receipts go to reduce the cost of the capital asset and are therefore capital receipts, not income. The Court held that such receipts do not have an independent character as business income; they are intrinsic to and inseparable from the capital project, and their proper accounting treatment is as a credit against the capital work-in-progress.

The Bokaro Steel Ltd. (supra) ratio rests on an elegant but important insight – during a pre-commencement or construction phase, the assessee is not yet in the business of earning revenue. The entire apparatus being assembled is the capital asset. Any money flowing in or out in connection with the assembly of that capital asset partakes of its capital character. To isolate an individual receipt arising in that context and characterise it as revenue income is to lose sight of the forest for the trees.

This principle was cited with approval by the Delhi High Court in Addl. CIT v. Indian Drugs & Pharmaceuticals Ltd. [1982] 9 Taxman 95 (Delhi)/[1983] 141 ITR 134 (Delhi), which held that receipts earned by a company during its construction and pre-commencement phase, with an integral nexus to the setting up of the capital asset, were capital receipts. The Supreme Court in Bokaro Steel Ltd. (supra) expressly confirmed the correctness of this Delhi High Court decision, adding doctrinal weight to the construction-phase principle within the Delhi jurisdiction.

The Bokaro Steel Ltd. (supra) ratio has been applied with regularity in recent years, and is still, to this day, good law. In Pr. CIT v. International Coal Ventures Pvt. Ltd. [2025] 170 taxmann.com 168 (Delhi)/[2025] 472 ITR 307 (Delhi)], a joint venture company constituted by public sector undertakings for the purpose of acquiring a coal mine overseas had placed project funds in fixed deposits during the pre-commencement phase, earning interest income. The Delhi High Court held, following Bokaro Steel Ltd. (supra), that since the funds were earmarked for the capital purpose and were not surplus, the interest income was inextricably linked to the setting up of the business, and was thus a capital receipt required to be adjusted against capital work-in-progress and was not taxable as income from other sources. The Court carefully distinguished the contrary decision in CIT v. Tuticorin Alkali Chemicals and Fertilizers Ltd. [1997] 93 Taxman 502 (SC)/[1997] 227 ITR 172 (SC), confining it to situations involving genuinely surplus funds placed at interest.

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