INTERMEDIATE : PAPER -

DIRECT TAXATION GROUP - I

STUDY NOTES

INTERMEDIATE

The Institute of Cost Accountants of India

CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

First Edition : February 2013

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Syllabus
PAPER 7: DIRECT TAXATION (DTX) Syllabus Structure The syllabus comprises the following topics and study weightage: A B C Income Tax Wealth Tax International Taxation
C 25% B 10% A 65%

65% 10% 25%

ASSESSMENT STRATEGY There will be written examination paper of three hours. OBJECTIVES To gain knowledge about the direct tax laws in force for the relevant previous year and to provide an insight into procedural aspects for assessment of tax liability for various assessees. Learning Aims The syllabus aims to test the students ability to: Understand the basic principles underlying the Income Tax Act and Wealth Tax Act  Compute the taxable income of an assessee Analyze the assessment procedure and representation before appropriate authorities under the law  Apply the Generally Accepted Cost Accounting Principles and Techniques for determination of arms length  price for domestic and international transactions Skill set required Level B: Requiring the skill levels of knowledge, comprehension, application and analysis. Note : Subjects related to applicable statutes shall be read with amendments made from time to time.
Section A : Income Tax 65% 1. Income Tax Act, 1961 (a) Basic Concepts and definitions (b)  Tax Accounting Standards (by the Central Board of Direct Taxes) 2.  Income which do not form part of Total Income (Section 10, 10A, 10B and 11-13A) 3.  Heads of Income and Computation of Total Income under various heads 4.  Income of other Persons included in Assessees Total Income; Aggregation of Income and Set off or Carry Forward of Losses; Deductions in computing Total Income; Rebates and Reliefs; Applicable rates of Tax and Tax Liability 5.  Taxation of Individuals including Non-residents, Hindu Undivided Family, Firms, LLP, Association of Persons, Cooperative Societies, Trusts, Charitable and Religious Institutions 6.  Corporate Taxation classification, Tax Incidence, computation of Taxable Income and Assessment of Tax Liability, Dividend Distribution Tax ( DDT), Minimum Alternate Tax and other Special provisions relating to Companies 7.  Tax Deduction at Source, Tax Collection at Source, Recovery and Refund of Tax, Advance Tax, Refunds 8. Tax Planning and Tax Management Section B : Wealth Tax 10% 9. Wealth Tax Act, 1957 Section C : International Taxation 25% 10.  (a)  Basic concepts of International Taxation and Transfer Pricing (b)  General Anti-Avoidance Rules ( GAAR) concept and application (c )  Advance Pricing Agreement ( APA) concept and application

SECTION A: INCOME TAX [65 MARKS] 1. Income Tax Act, 1961 (a) Basic Concepts and definitions (i) Background, concepts, definitions (ii)  Capital and revenue receipts, expenditures (iii) Basis of charge and scope of total income (iv) Residential Status and Incidence of Tax (b)  Tax Accounting Standards by the Central Board of Direct Taxes (CBDT) 2.  Incomes which do not form part of Total Income [Sec.10, 10A, 10B and 11 to 13A] 3.  Heads of Income and Computation of Total Income under various heads (a) (b) (c) (d) (e) Income from salaries Income from House property Profits and gains from Business or Profession Capital gains Income from other sources

4.  Income of other persons included in Assessees Total Income; Aggregation of Income and Set off or Carry Forward of Losses; Deductions in computing Total Income; Rebates & Reliefs; Applicable Rates of Tax and Tax Liability 5.  Taxation of Individuals including Non-residents, Hindu Undivided Family, Firms, LLP, Association of Persons, Cooperative Societies, Trusts, Charitable and Religious Institutions 6. Corporate Taxation classification, tax incidence, computation of taxable income and assessment of tax liability,  Dividend Distribution Tax (DDT), Minimum Alternate Tax and other special provisions relating to companies Tax Planning and Tax Management Tax Planning: (i) Concept and application (ii)  For setting up new business units - study of location, nature of business, tax holiday offered [ with special reference to provisions in Chapter VIA of the Act] (iii)  Tax incentives and Export Promotion Schemes, other applicable tax benefits and exemptions Tax Management (i)  Computation of income and Return of Income Tax, Filing procedure, e-filing (ii)  Assessment, Reassessment, Appeals, Revisions, Review rectifications, Settlement of cases (iii)  Special procedure for assessment of Search cases (iv)  E-commerce transactions, Liability in Special cases (v) Penalties, Fines and Prosecution Wealth Tax Act, 1957

7.  Tax Deduction at Source, Tax Collection at Source, Recovery and Refund of Tax, Advance Tax, Refunds 8. (a) (b) 9.

SECTION B: WEALTH TAX [10 MARKS] (a) Background, concept and charge of wealth tax (b) Assets, deemed assets, exempted assets (c) Valuation of assets (d) Computation of net wealth (e) Return of Wealth Tax and assessment procedure SECTION - C - INTERNATIONAL TAXATION [25 MARKS] 10. International Taxation and Transfer Pricing (a)  Basic concepts of International Taxation and Transfer Pricing (i)  Residency issues, source of income, tax heavens, withholding tax, unilateral relief, double taxation avoidance agreements (ii)  Transfer Pricing concepts, meaning of International transactions (iii) Costing Issues in Transfer Pricing (iv)  Computation of Arms length Price methods (v)  Governance through application of generally accepted cost accounting principles and techniques for assessment of arms length price a measure to curb revenue leakages/tax evasion (vi)  Reference to Cost Accounting Records and Cost Audit Reports.

(b)  General Anti-Avoidance Rules (GAAR) concept and application (c)  Advance Pricing Agreement (APA) concept and application

Content
SECTION A - INCOME TAX
Study Note 1 : Types of Taxes
1.1 1.2 1.3 1.4 Basis of Taxation Direct Taxes and Indirect Taxes Sources and authority of taxes in India Seventh Schedule of the Constitutiono 1.1 1.1 1.2

1.2

Study Note 2 : The Source of Income Tax Law

2.1 2.2 2.3 2.4 Basic Concepts Rates of Income Tax for Assessment Year 2013-14 Definition Heads of Income 2.1 2.2 2.4 2.10

Study Note 3 :Residential Status and Tax Incidence

3.1 3.2 3.3 3.4 3.5 3.6 3.7 Introduction Residential status of Individuals Residential status of Hindu Undivided Family (HUF) Residential status of Firm/Association of Persons (AOP)/Limited Liability Partnership (LLP)/Every other Person Residential status of a Company Residential Status and Incidence of Tax Special Provisions relating Interest Income on Royalty Income and Fees for Technical Services 3.1 3.3 3.4 3.6 3.7 3.7 3.9 3.9

Study Note 4 : Income from Salaries

4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 Introduction Meaning of Salary Allowances Death-cum-Retirement Benefits Profits in lieu of salary [Section 17(3)] Deductions against salary Valuation & Taxability of Perquisites Provident Funds Salary under different circumstances at a glance Tax on Salary of Non-Resident Technicians [Section 10(5B)] Relief under section 89 4.1 4.1 4.5 4.10 4.16 4.17 4.17 4.27 4.28 4.29 4.29

Study Note 5 : Income from House Property

5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 Chargeability Deemed Owner Applicability of Section 22 in certain situations Principle of Mutuality read with Section 22 Property Income is Exempt from Tax to Certain Persons Computation of income from a let out house property Computation of income from self-occupied property Recovery of Unrealized Rent Receipt of Arrears of Rent Municipal Tax Deduction from Net Annual Value Computation of Prior Period Interest 5.1 5.1 5.2 5.3 5.4 5.4 5.6 5.8 5.8 5.9 5.9 5.10

Study Note 6 : Profits and Gains of Business or Profession

6.1 6.2 6.3 Definition of Business and Profession Chargeability Computation of Income from Business or Profession 6.1 6.1 6.4

Study Note 7 : Capital Gains

7.1 Charging Section: 45(1) 7.2 Provision for computation of capital gains and related exemptions 7.1 7.1

Study Note 8 : Income from Other Sources

8.1 Income from Other Sources - Basis of charge 8.2 Chargeable income [ Sec. 56(2) ] 8.1 8.1

Study Note 9 : Clubbing of Income

9.1 Clubbing of Income 9.1

Study Note 10 : Set Off or Carry Forward and Set Off of Losses
10.1 Introduction 10.2 Set off of loss in the Same Year 10.3 Carry forward and set off of loss in Subsequent Year 10.1 10.1 10.3

Study Note 11 : Deduction in Computing Total Income

11.1 Introduction 11.2 Deductions from Gross Total Income 11.1 11.2

Study Note 12 : Incomes Which do not form Part of Total Income

12.1 12.2 12.3 Incomes not included in Total Income [Sec.10] Special Provisions Expenditure incurred in relation to income not included in Total Income [ Sec.14A] 12.1 12.34 12.39

Study Note 13 : Agricultural Income and Aggregation of Incomes

13.1 Agricultural Income and Tax Liability 13.1

Study Note 14 : Minimum Alternate Tax (MAT) and Alternate Minimum Tax (AMT)
14.1 14.2 Minimum Alternate Tax Alternate Minimum Tax 14.1 14.3

Study Note 15 : Return of Income

15.1 15.2 Return of Income Annual Information Return 15.1 15.9

Study Note 16 : Assessment Procedure

16.1 Assessment Procedure 16.1

Study Note 17 : Assessment of Various Entities & Tax Planning

17.1 17.2 17.3 17.4 17.5 17.6 17.7 17.8 17.9 Assessment of Individual Assessment of HUF Assessment of Firm Assessment of LLP Assessment of AOP & BOI Assessment of Companies Assessment of Co-operative Society Assessment of Trust Tax Planning 17.1 17.5 17.7 17.9 17.10 17.12 17.18 17.18 17.62

Study Note 18 : Grievances Redressal Procedure

18.1 18.2 18.3 18.4 18.5 Grievances Redressal Procedure Rectifications Appeal and Appellate Hierarchy Revision General Provision 18.1 18.1 18.4 18.4 18.5

Study Note 19 : Study Note 19 : Interest

19.1 19.2 19.3 Interest payable Interest Recevable Rounding off 19.1 19.4 19.5

Study Note 20 : Advance Payment of Tax

20.1 20.2 20.3 Advance Payment of Tax Collection of Advance Tax Recovery of Tax 20.1 20.1 20.3

Study Note 21 : Collection and Recovery of Tax

21.1 21.2 21.3 21.4 When Tax Payable and when Demand in Default Penalty Payable when Tax is in Default Certificate to Tax Recovery Officer Recovery of Tax 21.1 21.1 21.2 21.3

Study Note 22 : Deduction and Collection of Tax At Source

22.1 22.2 Deduction of Tax at Source Tax Collection at Source 22.1 22.10

Study Note 23 : Penalty & Prosecution

23.1 Penalties and Prosecution for defaults 23.1

Study Note 24 : Refund

24.1 24.2 24.3 Refund Interest on Refund Setoff of Refunds again the remaining payable 24.1 24.2 24.4

Study Note 25 : Settlement of Cases

25.1 25.2 Settlement of Cases [Section 245A to 245L] Advance Ruling 25.1 25.9

Study Note 26 : Tax Administration

26.1 Tax Administration 26.1

Study Note 27 : Double Taxation Relief

27.1 27.2 27.3 Agreement with Foreign Countries or Specified Territories Countries with which no agreement exists Double Taxation relief in case of Specified Association 27.1 27.2 27.2

SECTION B - WEALTH TAX

Study Note 28 : Wealth Tax
28.1 28.2 28.3 Introduction Valuation of Assets Other Issues relating to Wealth Tax 28.1 28.5 28.7

SECTION C - INTERNATIONAL TAXATION & TRANSFER PRICING

Study Note 29 : Taxation of International Transactions
29.1 29.2 29.3 29.4 29.5 29.6 29.7 29.8 29.9 International Taxation and Transfer Pricing Introduction International Transaction Arms Length Principle Transfer Pricing Classification of Methods Transfer Pricing issues Cross-border transactions Associated Enterprise Computation of Arms Length Price 29.1 29.1 29.2 29.3 29.3 29.6 29.10 29.11 29.12

Steps in the process of computing Arms length price Transfer Pricing (TP) Study

Section - A INCOME TAX

Study Note - 1
TYPES OF TAXES
This Study Note includes 1.1 Basis of Taxation 1.2 Direct Taxes and Indirect Taxes 1.3 Sources and Authority of Taxes in India 1.4 Seventh Schedule of the Constitution 1.1 BASIS FOR TAXATION India is a socialist, democratic and republic State. Constitution of India is supreme law of land. All other laws, including the Income-tax Act, are subordinate to the Constitution of India. The Constitution provides that no tax shall be levied or collected except by authority of law. The Constitution includes three lists in the Seventh Schedule providing authority to the Central Government and the State Governments to levy and collect taxes on subjects stated in the lists.

Tax

Direct Tax
Central Excise Duty

Indirect Tax
Customs Duty Customs Tax
Value Added Tax (VAT)

Income Tax

Wealth Tax

Service Tax

Central Sales Tax

Miscellaneous / Miscellaneous Other Taxes

1.2 DIRECT TAXES & INDIRECT TAXES Particulars Meaning Direct Tax Indirect Tax

Direct Taxes are the taxes in which Indirect Taxes are such type of taxes where the incidence and impact falls on the incidence and impact fall on two different same person/assessee persons. Direct Tax is progressive in nature. Indirect Taxes are regressive in nature. Taxable Income / Taxable Wealth of Purchase / Sale / Manufacture of goods the Assessees. and /or rendering of services. Levied and Assessee. collected from the Levied & collected from the consumer but paid / deposited to the Exchequer by the Assessee / Dealer.

Nature of tax Taxable Event Levy & Collection

Shifting of Burden

Tax Burden is directly borne by the Tax burden is shifted to the subsequent / Assessee. Hence, the burden cannot ultimate user. be shifted. Tax is collected after the income for a At the time of sale or purchases or rendering year is earned or valuation of assets is of services. determined on the valuation date.

Tax Collection

DIRECT TAXATION I 1.1

Types of Taxes 1.3 SOURCES AND AUTHORITY OF TAXES IN INDIA Powers of Central or State Government to levy tax Article 246(1) 246(1) 246(3) Empowers Central or State Government Central Government State Government Central and State Government For Levy of various taxes Levy taxes in List I of the Seventh Schedule of the Constitution. Levy taxes in List II of the Seventh Schedule of the Constitution. List III of Seventh Schedule.

1.4 SEVENTH SCHEDULE OF THE CONSTITUTION

Seventh Schedule to Article 246 of the Indian Constitution List I Union List
Taxation under Constitution
Union List (List I) Only Union Government can make laws. Given in Schedule Seven of Constitution Important taxes in Union List Entry No. 82 Tax on income other than agricultural income. Entry No. 83 Duties of customs including export duties. State List (List II) Only State Government can make laws. Given in Schedule Seven of Constitution. Important taxes in State List Entry No. 46 Taxes on agricultural income. Entry No. 51 Excise duty on alcoholic liquors, opium and narcotics. Entry No. 84 Duties of excess on tobacco and other goods Entry No. 52 Tax on entry of goods into manufactured or produced in India except alcoholic liquors for a local area for consumption, use or sale human consumption, opium, narcotic drugs, but including medicinal therein (usually called Entry Tax or Octroi). and toilet preparations containing alcoholic liquor, opium or narcotics. Entry No. 85 Corporation Tax. Entry No. 54 Tax on sale or purchase of goods other than newspapers except tax on interstate sale or purchase. Entry No. 86 Taxes on the capital value of assets, exclusive of Entry No. 55 Tax on advertisements other agricultural land, of individuals and companies; taxes on capital of than advertisements in newspapers. companies Entry No. 92A Taxes on the sale or purchase of goods other than Entry No. 56 Tax on goods and passengers newspapers, where such sale or purchase takes place in the course carried by road or inland waterways. of Interstate trade or commerce. Entry No. 92B Taxes on consignment of goods where such Entry No. 59 Tax on professions, trades, consignment takes place during Interstate trade or commerce. callings and employment. Entry No. 92C Tax on services [Amendment passed by Parliament on 15-1-2004, but not yet made effective]. Entry No. 97 Any other matter not included in List II, List III and any tax not mentioned in list II or list III. (These are called Residual Powers.)

List II State List

List III Concurrent List

istIII : Concurrent List L Both Union and State Government can exercise power Given in Schedule Seven of Constitution Entry No.17A Forest Income Entry No. 25 Education Income

1.2 I DIRECT TAXATION

Study Note - 2
THE SOURCE OF INCOME TAX LAW
This Study Note includes 2.1. 2.2 2.3 2.4 Basic Concepts Rates of Income Tax for Assessment Year 2013-14 Definition Heads of Income

2.1 BASIC CONCEPTS THE ELEMENTS / SOURCES OF INCOME TAX LAW 1. The Income Tax Act, 1961 (a) Income tax in India is governed by the Income Tax Act, 1961 (b) It came into force w.e.f.1.4.1962 (c) The Act contains 298 sections and XIV Schedules (d) The Finance Act shall bring amendment to this Act. (e) The Law provides for determination of taxable income, tax liability and procedure for assessment, appeal, penalties and prosecutions. 2. Finance Act (a) Finance Minister presents this as Finance Bill in both the Houses of Parliament. (b) Part A of the Budget contains proposed policies of the Government in fiscal areas. (c) Part B contains the detailed tax proposals. (d) Once the Finance Bill is approved by the Parliament and gets the assent of the President, it becomes the Finance Act. (e) The rate of tax, at which income shall be charged, is prescribed in the Schedule I of Finance Act. (f) The Finance Act brings amendments to both the Direct Tax Laws (i.e. Income Tax, Wealth Tax etc.) and Indirect Tax Laws (i.e. law relating to Central Excise, Customs Duty, Service Tax etc.) 3. The Income Tax Rules, 1962 (a) The administration of Direct Taxes is vested with Central Board of Direct Taxes (CBDT). (b) Under Section 295 of IT Act, CBDT is empowered to frame rules from time to time to implement the amendment in tax provisions for proper administration of the Act. (c) All forms, procedures and principles of valuation of perquisites prescribed under the Act are provided in the Rules framed by CBDT. 4. Circulars / Notifications from CBDT (a) In exercise of the powers u/s 119, CBDT issues circulars and notifications from time to time. (b) These circulars clarify doubts regarding the scope and meaning of the various provisions of the Act.

DIRECT TAXATION I 2.1

The Source of Income Tax Law (c) These circulars act as guidance for officers and assessees. (d) These circulars are binding on Assessing Officers but not on assessees and Courts. (e) The circulars issued by the CBDT shall not be in contrary to the provisions of the Act. Note: Subordinate Legislation The Government enacts the law in the Parliament, e.g. Income Tax Act, Central Excise Act, etc. Where there is a need for detailed rules and regulations, the enactment is to be done by either CBDT or CBE&C. The rules and regulations enacted by CBDT or CBE&C are Income Tax Rules, CENVAT Credit Rules, and the Notifications and Circulars issued by CBDT, CBE&C is called Subordinate Legislation. 5. Supreme Court and High Court Decisions (a) The Supreme Court and the High Court can give judgment only on the question of law. (b) The Law laid down by the Supreme Court is the law of the land. (c) The decision of High Court will apply in the respective States, within its jurisdiction. DETERMINING THE RATES OF TAX UNDER THE INCOME TAX ACT, 1961 1. Income Tax shall be charged at the rates fixed for the year by the Annual Finance Act. 2. The First Schedule to the Finance Act provides the following rates of taxation. Part I Part II Part III The tax rates applicable to income of various types of assessees for the Assessment Year Rates of TDS for the current Financial Year Rates of TDS for salary and advance tax (which becomes Part I of the next Assessment Year)

2.2. RATES OF INCOME-TAX FOR ASSESSMENT YEAR 2013-14 Normal Rates of Income Tax I. Rate of Tax applicable to any Resident Senior Citizen (who attains 60 years age or more during any time of the Previous Year but not more than 80 years of age) Net Income Range Upto ` 2,50,000 ` 2,50,001 to ` 5,00,000 ` 5,00,001 to ` 10,00,000 ` 10,00,000 onwards Rate of Income Tax Nil @10% on total income minus ` 2,50,000 ` 25,000 + @20% on total income minus ` 5,00,000 ` 1,25,000 + @30% on total income minus ` 10,00,000 Education Cess Nil @2% of Income Tax @2% of Income Tax @2% of Income Tax Secondary and Higher Education Cess Nil @1% of Income Tax @1% of Income Tax @1% of Income Tax

II. Rate of Tax applicable to any Resident Super Senior Citizen (who attains 80 years age or more during any time of the Previous Year)

2.2 I DIRECT TAXATION

Net Income Range Upto ` 5,00,000 ` 5,00,001 to ` 10,00,000 ` 10,00,000 onwards

Rate of Income Tax Nil @20% on total income minus ` 5,00,000 ` 1,00,000 + @ 30% on total income minus ` 10,00,000

Education Cess Nil @ 2% of Income Tax @ 2% of Income Tax

Secondary and Higher Education Cess Nil @ 1% of Income Tax @ 1% of Income Tax

III. In the case of any other Individual or Hindu Undivided Family or AOP/BOI (other than a co-operative society) whether incorporated or not, or every Artificial Judicial Person Net Income Range Upto ` 2,00,000 ` 2,00,001 to ` 5,00,000 ` 5,00,001 to ` 10,00,000 ` 10,00,000 onwards Rate of Income Tax Nil @10% on total income minus ` 2,00,000 ` 30,000 + @ 20% on total income minus ` 5,00,000 ` 1,30,000 + @ 30% on total income minus ` 10,00,000 Education Cess Nil @ 2% of Income Tax @ 2% of Income Tax @ 2% of Income Tax Secondary and Higher Education Cess Nil @ 1% of Income Tax @ 1% of Income Tax @ 1% of Income Tax

Note : The above rate is applicable to any individual who is not a Senior Citizen. No Addl / special benefit is awarded to Women tax payers. Here, the other individual includes Non-resident individual also irrespective of their age. No surcharge is payable by the above assessees. 2.2.1 Other Assessees: Assessee For Firms (including Liability Partnership) Domestic Companies Foreign Companies : Royalty received from Indian Total Income x 50%+ EC@ 2% + Surcharge @ 2% if the total income exceeds ` 1 crore Government or an Indian concern SHEC @ 1% in pursuance of an agreement made by it with the Indian concern after March 31, 1961, but before April 1, 1976, or fees for rendering technical services in pursuance of an agreement made by it after February 29, 1964 and where such agreement has, in either case been approved by the Central Government Rate of Tax Surcharge Limited Total Income 30% + EC@ 2% + Surcharge NIL SHEC @ 1%. Total Income 30% + EC@ 2% + Surcharge @ 5% if the total SHEC @ 1%. income exceeds ` 1 crore

DIRECT TAXATION I 2.3

The Source of Income Tax Law Other Income For Local Authorities For Co-operative Societies Total Income x 40%+ EC@ 2% + Surcharge @ 2% if the total SHEC @ 1% income exceeds ` 1 crore Total Income 30% + EC@ 2% + Surcharge is not applicable. SHEC @ 1%. For First `10,000 @ 10% For Next `10,000 @ 20% For the Balance @ 30% EC @ 2% and SHEC @ 1% are applicable. MAT = Minimum Alternate Tax AMT = Alternate Minimum Tax 18.5% of Book Profit + EC @ 2% + Surcharge if Book Profits exceed SHEC 1% ` 1 crore. 18.5% of Book Profit + EC @ 2% + Surcharge if Book Profits exceed SHEC 1% ` 1 crore. Surcharge is not applicable.

2.3 DEFINITION Assessee: [Section 2(7)] Any person who is liable to pay any tax or any other sum under the Income Tax Act, 1961, and Assessee includes: (a) Every person in respect of whom any proceeding has been taken for the assessment of: (i) His income or of the income of any other person; (ii) Loss sustained by him or other person; (iii) Refund due to him or such other person. (b) Every person who is deemed to be an assessee under the Act. (c) Every person who is deemed to be an assessee in default under the Act. Assessment Year [Section 2 (9)] Assessment Year means the period of twelve months commencing on the 1st day of April every year. It relates to the previous year for which the income is assessed to tax. The present Assessment Year is 2013-14 relating to Previous Year 2012-13. Previous Year [Section 3] Previous Year means the Financial Year immediately preceding the Assessment Year. The year in respect of the income of which tax is levied is called Previous Year. The present Previous Year 2012-13 and its Assessment Year is 2013-14. Note: Previous Year for newly established business from the date of setting up of the business to the end of the Financial Year in which business was set up. Example: X Ltd. started business on 1.11.12. So for X Ltd. Previous Year will be considered as 1.11.12 to 31.3.13.

2.4 I DIRECT TAXATION

Income [Section 2(24)] includes : 1. Profits or gains of business or profession. 2. Dividend. 3. Voluntary Contribution received by a Charitable / Religious Trust or University / Education Institution or Hospital 4. Value of perquisite or profit in lieu of salary taxable u/s 17 and special allowance or benefit specifically granted either to meet personal expenses or for performance of duties of an office or an employment of profit. 5. Export incentives, like Duty Drawback, Cash Compensatory Support, Sale of licences etc. 6. Interest, salary, bonus, commission or remuneration earned by a partner of a Firm from such Firm. 7. Capital Gains chargeable u/s 45. 8. Profits and gains from the business of banking carried on by a cooperative society with its members. 9. Winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature whatsoever. 10. Deemed income u/s 41 or 59. 11. Sums received by an assessee from his employees towards welfare fund contributions such as Provident Fund, Superannuation Fund etc. 12. Amount received under Keyman Insurance Policy including bonus thereon. 13. Amount received under agreement for (a) not carrying out activity in relation to any business, or (b) not sharing any knowhow, patent, copyright etc. 14. Benefit or perquisite received from a Company, by a Director or a person holding substantial interest or a relative of the Director or such person. 15. Gift as defined u/s 56 (2)(vi) (w.e.f. A.Y 2008-2009). Any sum of money exceeding ` 50,000, received by an Individual or a HUF from any person during the previous year without consideration on or after 1.4.2007, then the whole of aggregate of such sums will be taxable. 16. Any consideration received for issue of shares as exceeds the fair market value of the shares referred to in Section 56(2)(vii)(b). PREVIOUS YEAR & ASSESSMENT YEAR WILL BE SAME in the following cases : 1. Shipping business of nonresident [Section 172] 2. Persons leaving India [Section 174] 3. AOP or BOI or Artificial Juridical Person formed for a particular event or purpose [Sec. 174A] 4. Persons likely to transfer property to avoid tax [Section 175] 5. Discontinued business [Section 176]

DIRECT TAXATION I 2.5

The Source of Income Tax Law RELEVANT PREVIOUS YEAR FOR UNDISCLOSED SOURCES OF INCOME SEC. 68 69 69A 69B 69C 69D UNDISCLOSED SOURCES Unexplained Cash Credits Unexplained investments PREVIOUS YEAR The year in which books of accounts are found credited The year in which the investment made

Unexplained money, bullion or jewel or The year in which it is found valuable article Undisclosed investments Unexplained expenditure The year in which the investment made The year in which it was incurred

Amount borrowed or repaid on hundi, other The year in which the amount was borrowed or than by way of account payee cheque in repaid on hundi. excess of ` 20,000.

Application of Income An obligation to apply income, which has accrued or has arisen or has been received amounts to merely the apportionment of income. Therefore the essentials of the concept of application of income under the provisions of the Income Tax Act are : 1. Income accrues to the assessee 2. Income reaches to the assessee 3. Income is applied to discharge an obligation, whether self-imposed or gratuitous. Diversion of Income An obligation to apply the income in a particular way before it is received by the assessee or before it has arisen or accrued to the assessee results in diversion of income. The source is charged with an overriding title, which diverts the income. Therefore the essentials are the following: 1. Income is diverted at source, 2. There is an overriding charge or title for such diversion, and 3. The charge / obligation is on the source of income and not on the receiver. Examples of diversion by overriding title are (a) Right of maintenance of dependants or of coparceners on partition (b) Right under a statutory provision (c) A charge created by a decree of a Court of law. TOTAL INCOME [Sec. 2(45)] Total Income means the total amount of income as referred to in Sec. 5 and computed in the manner laid down in the Act. Total income constitutes the tax with reference to which income tax is charged. ROUNDING OFF TOTAL INCOME AND TAX Rounding Off Income [Sec. 288A]: The Total Income computed under this Act, shall be rounded off to the nearest multiple of ` 10. Rounding Off Tax [Sec. 288B] : The amount of Tax including Tax Deducted at Source (TDS) and advance tax, interest, penalty, fine or any other sum payable, and the amount of refund due under the Income Tax Act, shall be rounded off to the nearest ` 10. BOOKS OF ACCOUNT [Sec. 2(12A)]

2.6 I DIRECT TAXATION

It includes Ledgers, Day Books, Cash Books, Account Books and other books, whether kept in the written form or as printouts or data stored in a floppy, disc, tape or any other form of electromagnetic data storage device. DOCUMENT [Sec. 2(22AA)] It includes an electronic record as defined in clause (t) of sub-section (1) of section 2 of the Information Technology Act, 2000 (21 of 2000). INFRASTRUCTURAL CAPITAL COMPANY [Sec. 2 (26A)] Infrastructure Capital Company means such company which makes investments by way of acquiring shares or providing long-term finance to any enterprise or undertaking wholly engaged in the business referred to in sub-section (4) of section 80 IA or sub-section (1) of section 80-IAB or an undertaking developing and building a housing project referred to in sub-section (10) of section 80- IB or a project for constructing a hospital with at least one hundred beds for patients. INFRASTRUCTURAL CAPITAL FUND [Sec. 2 (26B)] Infrastructure Capital Fund means such fund operating under a trust deed registered under the provisions of the Registration Act, 1908 established to raise monies by the trustees for investment by way of acquiring shares or providing long-term finance to any enterprise or undertaking wholly engaged in the business referred to in sub-section (4) of section 80-IA or sub-section (1) of section 80- IAB or an undertaking developing and building a housing project referred to in sub-section (10) of section 80-IB or a project for constructing a hotel of not less than three star category as classified by the Central Government or a project for constructing a hospital with at least one hundred beds for patients. INSURER [Sec. 2(28BB)] It means an insurer being an Indian insurance company, as defined under clause (7A) of section 2 of the Insurance Act, 1938 (4 of 1938), which has been granted a certificate of registration under section 3 of that Act. SUBSTANTIAL INTEREST [Sec. 2 (32)] Person who has a substantial interest in the company, in relation to a company, means a person who is the beneficial owner of shares, not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits, carrying not less than twenty per cent of the voting power. In the case of a non-corporate entity, a person can be said to have substantial interest if 20% or more share of profit is held. RELATIVE [Sec. 2(41)] In relation to an individual, means the husband, wife, brother or sister or any lineal ascendant or descendant of that individual. RESULTING COMPANY [Sec. 2(41A)] It means one or more companies (including a wholly owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger and, the resulting company in consideration of such transfer of undertaking, issues shares to the shareholders of the demerged company and includes any authority or body or local authority or public sector company or a company established, constituted or formed as a result of demerger. CHARGE OF INCOME TAX [Sec. 4] According to Sec. 4 of the Income Tax Act, 1961 the following basic principles are followed while charging Income-tax (i) Income-tax is a tax on the annual income of an assessee, (ii) Usually, the income of the Previous Year (PY) is charged to the following Assessment Year (AY) at the prescribed rate fixed by the relevant Financial Act, and

DIRECT TAXATION I 2.7

The Source of Income Tax Law (iii) Tax is levied on the total income of every assessee RECEIPT OF INCOME - DEEMED INCOME [Sec. 7] The following income shall be deemed to be received in the Previous Year : (i) Employers contribution to recognized provident fund in excess of 12% of salary and interest credited to the recognized provident fund in excess of 9.5% (ii) The transfer balance in a recognized provident fund, to the extent provided in Sub-rule 4 of Rule 11 of Part A of Fourth Schedule. DIVIDEND INCOME [Sec. 8] Dividend include (a) any distribution by a company of accumulated profits whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company; (b) any distribution to its shareholders by a company of debentures, debenture-stock, or deposit certificates in any form, whether with or without interest, and any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalised or not ; (c) any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not ; (d) any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits which arose after the end of the Previous Year ending next before the 1st day of April, 1993, whether such accumulated profits have been capitalised or not; (e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) [made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern)] or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits; But dividend does not include (i) a distribution made in accordance with sub-clause (c) or sub-clause (d) in respect of any share issued for full cash consideration, where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ; (ia) a distribution made in accordance with sub-clause (c) or sub-clause (d) in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of March, 1964 ; (ii) any advance or loan made to a shareholder [or the said concern] by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company; (iii) any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off;

2.8 I DIRECT TAXATION

 (iv) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956 (1 of 1956); (v) any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company) Explanation 1 The expression accumulated profits, wherever it occurs in this clause, shall not include Capital Gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956. Explanation 2 The expression accumulated profits in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include all profits of the company up to the date of liquidation,[but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive Previous Years immediately preceding the Previous Year in which such acquisition took place]. Explanation 3 For the purposes of this clause, (a) concern means a Hindu Undivided Family, or a Firm or an Association of Persons or a Body of Individuals or a Company ; (b) a person shall be deemed to have a substantial interest in a concern, other than a company, if he is, at any time during the Previous Year, beneficially entitled to not less than twenty per cent of the income of such concern; CAPITAL AND REVENUE RECEIPTS The objective of the Income-tax Act is to tax only income generally revenue receipts unless specifically exempted. On the other hand capital receipts are not chargeable to tax except when specifically provided in the Act. The distinction between a capital receipt and a revenue receipt should be perceived based on the facts and circumstances of each case. There is no specific provision in the Act to distinguish between a capital receipt and revenue receipt. It may be observed that : A receipt in substitution of a source of income is a capital receipt while a receipt in substitution of an income is a revenue receipt. An amount received as a compensation for surrender of certain rights under an agreement is a capital receipt whereas an amount received under an agreement as compensation for loss of future profit is a revenue receipt. CAPITAL AND REVENUE EXPENDITURE In computing taxable income normally revenue expenditure incurred for the purpose of earning income is deductible from revenue receipt unless the law provides specific rules to disallow such expenditure wholly or partly. On the other hand capital expenditure is not deductible while computing taxable income unless the law expressly so provides. Neither the capital expenditure nor revenue expenditure has been defined in the Act. However, from the facts and circumstances of each case and from the judicial decisions the following general principles to be kept in mind: (i) Capital expenditure is incurred in acquiring, extending or improving a fixed asset whereas revenue expenditure is incurred in the normal course of business as a routine expenditure. (ii) Capital expenditure incurred for enduring benefits whereas revenue expenditure is consumed within a Previous Year.

DIRECT TAXATION I 2.9

The Source of Income Tax Law (iii) Capital expenditure makes improvement with earning capacity of a business whereas a revenue expenditure maintains the profit making capacity of a business. (iv) Capital expenditure is a nonrecurring expenditure whereas revenue expenditure is normally a recurring one. 2.4 HEADS OF INCOME [SEC 14] Significance of Heads of Income: 1. The income chargeable under a particular head cannot be charged under any other head. 2. The Act has self contained provisions in respect of each head of income. 3. If any income is charged under a wrong head of income, the assessee will lose the benefit of deduction available to him under that head.

Heads of Income

Income from Salaries

Income from House Property

Profits & Gains from Business or Profession

Inocome from Capital Gains

Income from Other Sources

Relevance of method of accounting for heads of income:

Heads of Income Chapter Salaries Chapter IV-A

Section Coverage (Sec.15 - 17)

Relevance of Method of Accounting 1. Taxable on due basis or on receipt basis, whichever is earlier. 2. Method of accounting is irrelevant 1. Income from house property is taxable only on accrual basis. 2. Method of accounting is not relevant.

House Property

Chapter IV- C

(Sec. 22-27)

2.10 I DIRECT TAXATION

Income Business Profession

from Chapter IV-D or

(Sec. 28-44DB)

1. U/s 145 assessee may follow either Cash or Mercantile system of accounting regularly employed by the assessee. Certain payments are 2. Exceptions: allowable only on actual payment basis. Accrual concept does not hold good (a) Employers contribution to PF, ESI, Tax, Duty, Cess, Fees to Government, Interest on loans and advances from banks and financial institutions, provision for leave encashment, bonus or commission etc. (b) Telecommunication Licence Fee is allowable in instalments only from the year of payment. (c) Preliminary Expenses distributed over five years. (d) Amalgamation / Demerger Expenses distributed over five years. (e) Amount paid in connection with Voluntary Retirement Scheme distributed over five years.

Capital Gains

Chapter IV-E

(Sec. 45 - 55A)

1. Income from Capital Gains shall be taxable during the Previous Year Capital Gains in which the Capital Asset is transferred (i.e year of accrual). 2. The method of accounting is not relevant for taxing the income under the head Capital Gains.

Other Sources

Chapter IV-F

(Sec. 56 - 59)

U/s 145 assessee may follow either on Cash or Mercantile System of accounting regularly employed by the assessee.

DIRECT TAXATION I 2.11

Study Note - 3
RESIDENTIAL STATUS AND TAX INCIDENCE
This Study Note includes 3.1 3.2 3.3 3.4 3.5 3.6 Introduction Residential status of Individuals Residential status of Hindu Undivided Family (HUF) Residential status of Firm/Association of Persons (AOP)/Limited Liability Partnership (LLP)/Every other Person Residential status of a Company Residential Status and Incidence of Tax

3.1 INTRODUCTION Sometimes it is difficult for people to understand the fundamental difference between Nationality, Residency and Citizenship and the rights they have being nationals, residents and citizens of a State. Nationality and Citizenship are two terms that are sometimes used interchangeably. Some people even use the two words citizenship and nationality as synonyms. But this is not true and they differ in many aspects. Nationality Citizenship

Nationality can be applied to the country where Citizenship is a legal status, which means that an an individual was born. Hence an individual is a individual has been registered with the Government national of a particular country by birth in some country Nationality is got through inheritance from his An individual becomes a citizen of a country only parents which is called a natural phenomenon when he is accepted into that countrys political framework through legal terms No one will be able to change his nationality One can have different citizenship No country can confer honorary nationality on any Some nations also confer honorary citizenship to one as his birthplace cannot be changed individuals Nationality can be described as a term that refers to belonging to a group having same culture, traditions history, language and other general similarities Example: (1) Elaborating the two words, an individual born in India, will be having Indian nationality. But he may have an American citizenship once he has registered with that country. (2) An Indian can have an American or Canadian citizenship but he cannot change his nationality. Another example is that people of the European Union may have European Union Citizenship but that persons nationality does not change. Citizenship may not refer to people of the same group. For example, an Indian may be having a US citizenship but he will not be belonging to the same group as that of the American nationals

DIRECT TAXATION I 1

Residential Status and Tax Incidence Citizenship and Residency/Residential Status can be differentiated in the following ways: Citizenship Residency/Residential Status Residency means that a person is a resident of a country but not a citizen

Citizenship means that a person is a citizen of a Residential status forms the basis of incidence country with certain rights and responsibilities. and levy of tax liability

Residential status is determined on the basis of number of days an Individual was physically present in a country during the Previous Year/ Financial Year income during that period is subject to assessment under tax laws. 3.1.1 Residential Status The residential status of a person as referred in Sec. 2(31) of the Act for each Assessment Year under consideration to determine the scope of Total Income. 3.1.2 Salient Features The following are the salient features of this study on Residential Status : (i) A person can have different residential status in different years. (ii) A person can have different residential status in different countries. (iii) In the same year an assessee cannot have different residential status for different source of income. (iv) Residential status once decided, shall continue to be applied during the previous year under consideration. 3.1.3. Study of Residential Status The concept of Residential Status could be understood in the following categories :

Residential Status

Individual

Company

HUF

Firm/AOP/LLP/ Every Other Person

3.1.4 Importance 1. Total income of an assessee cannot be determined without knowing his residential status. 2. The residential status shall be determined for every person for each Previous Year independently. 3. The onus of responsibility to prove the residential status is on the assessee.

3.2 I DIRECT TAXATION

3.2 RESIDENTIAL STATUS OF AN INDIVIDUAL [SEC. 6(1)]

Residential Status of an Individual

Resident

Non-Resident

Ordinarily Resident

Not Ordinarily Resident

3.2.1. Steps to ascertain Residential Status

Control and Management Basicof HUF is of the affairs condition wholly or partly in India?

Satisfied

No

Non Resident (NR)

Yes Resident

Check Additional Conditions

Satisfied - Additional Condition No. 1 Resident in India for at least 2 years in the 10 Previous Years, preceding the Previous Year

No

RNOR Satisfied - Additional Condition No. 2 Physically Present in India for at least 730 days during 7 Previous Years preceding the Previous Year Yes ROR No

DIRECT TAXATION I 3.3

Residential Status and Tax Incidence 1. Basic Conditions: (a) If the Individual stayed in India for a period of 182 DAYS OR MORE during the Relevant Previous Year (RPY), he is Resident of India; (OR) (b) If he stayed in India for a period of 60 DAYS OR MORE during Relevant Previous Year (RPY) and 365 DAYS OR MORE during the four preceding Previous Years, he is Resident of India. If the assessee fails to satisfy either of the above basic conditions, as applicable, then the assessee is a Non-Resident for that Relevant Previous Year. Note: The day on which he enters India as well as the day on which he leaves India shall be taken into account as the stay of the Individual in India. Special exceptional situations: For the following persons, condition mentioned in 1(a) above only shall apply to determine their Residential Status (i) Individual, an Indian citizen, leaving India for employment outside India, or (ii) Indian Citizen being a crew member of an Indian ship leaving India, or (iii) Individual, an Indian citizen or a person of Indian origin, visiting India. 2. Additional Conditions: Sec. 6(6)(a) (i) Resident in India for at least 2 years out of the preceding 10 Previous Years. (ii) Physically present in India for at least 730 days during the 7 preceding Previous Years. Status of an Individual Resident and ordinarily Resident u/s 6(6) Basic condition Satisfied Additional condition/(s) Satisfied both the conditions May or may not satisfy any of the additional condition Not required to check the additional condition/(s)

Resident but not ordinarily Resident u/s 6(6) Satisfied Non Resident Fails to satisfy

3.3 RESIDENTIAL STATUS OF HUF [SEC. 6(2) READ WITH SEC. 6(6)] A Hindu Undivided Family (HUF) is either resident in India or non-resident in India. A resident Hindu undivided family is either ordinarily resident or not ordinarily resident. Residential Status of HUF Resident (R) Ordinarily Resident (ROR) Non-Resident (NR)

Non Ordinarily Resident (RNOR)

3.4 I DIRECT TAXATION

Control and Management of the affairs of HUF is wholly or partly in India?

No

Non Resident (NR)

Yes Resident

Check Additional Conditions

Satisfied - Additional Condition No. 1 ? Karta is Resident in India for at least 2 years in the 10 Previous Years, preceding the Previous Year

No

Yes
Satisfied - Additional Condition No. 2 ? Karta Physically Presents in India for at least 730 days during 7 Previous Years preceding the Previous Year Yes ROR No

RNOR

3.3.1 When a Hindu Undivided Family is Resident or Non-Resident: If the control and management of the affairs of a HUF is 1. Wholly or partly in India 2. Wholly outside India Note: (i) The onus of proving that HUF was non-resident is on the assessee [Subbayya Chettiar (V.VR.N.M) vs. CIT (1951) 19 ITR 168 (SC) Residential Status Resident Non-resident

(ii) Control and Management means de facto control and management and not merely the right to control or manage CIT vs. Nandalal Gandalal [1960] 40 ITR 1 (SC). (iii) Place of Management - control and management is situated at a place where the head, the seat the directing power are situated. The head and brain is situated where vital decisions concerning the policies of the business, such as, the raising finance and its appropriation for specific purposes, appointment and removal of staff, expansion, extension, or diversification of business, etc., are taken place San Paulo ( Brazilian) Railway Co. vs. Carter[1886] AC 31 (HL).

DIRECT TAXATION I 3.5

Residential Status and Tax Incidence (iv) The term affairs in the clause refers to operations or activities in relation to the income which is sought to be assessed. Thus, mere activity of an entity at a place which does not give rise to any income does not make that entity resident of that place [Subbayya Chettiar (V.VR.N.M) vs. CIT (1951) 19 ITR 168 (SC)]. Further, the mere fact that the assessee HUF has a house in India where some of the members live, cannot constitute that place the seat of control and management of the affairs of the family. (v) Occasional visits of a non-resident Karta of HUF to India or casual directions given in respect of business carried on in India while on such visits would not make the HUF resident of India. [Raja K.V.Narsimha Rao Bahadur vs. CIT (1950) 18 ITR 181 (Mad.)]. On the other hand, mere absence of the Karta from India throughout the year does not mean that business of the HUF is controlled from outside India [ Annamalai Chettiar vs. ITO(1958) 34 ITR 88 (Mad.)] 3.3.2. Where a resident HUF is Ordinarily Resident in India or Not Ordinarily Resident in India The HUF which is Resident in India shall be said to be Resident and Ordinarily Resident in India if the Karta of the HUF satisfies both the following conditions: (a) He (Karta) must be resident in India for at least 2 out of 10 Previous Years immediately preceding the relevant Previous Year; and (b) He must be in India for at least 730 days during 7 Previous Years immediately preceding the relevant Previous Year As per Sec.6(6)(b), a HUF, which is Resident in India is said to be Resident but not Ordinarily Resident in India during the relevant Previous Year, if the manager (Karta) of the HUF does not satisfy any one, or both of the conditions mentioned in clauses (a) & (b) above. 3.4 RESIDENTIAL STATUS OF FIRM/AOP/LLP/EVERY OTHER PERSON (OTHER THAN AN INDIVIDUAL, HUF & COMPANY) [SEC. 6(2) READ WITH SEC. 6(4)] While determining residential status of a Firm/AOP/LLP/Every other person (other than an Individual, HUF & Company), the residential status of the partners/members that Firm/AOP/LLP/Every other Person is not relevant. The Firm/AOP/LLP/Every other Person can only be either Resident or Non-Resident. There is no scope for further classification of resident for these assesees.

Control and Management of the affairs of FIRM/AOP/LLP or every other person is wholly or partly in India?

No

Non Resident (NR)

Yes Resident

3.4.1 When a FIRM/AOP/LLP/EVERY OTHER PERSON is Resident or Non-Resident: If the control and management of the affairs of a FIRM/AOP/LLP/Every other Person [other than Individual, HUF & Company] 1. Wholly or partly in India 2. Wholly outside India Residential Status Resident Non-resident

3.6 I DIRECT TAXATION

3.4.2. Control and Management in relation to FIRM/AOP/LLP/EVERY OTHER PERSON: Assessee Firm/LLP AOP Every other Person 3.5 RESIDENTIAL STATUS OF A COMPANY [SECTION 6(3)] 1. Indian Company 2. Other Companies - Control and management of the affairs of a company is : (a) Wholly in India (b) Wholly or partly outside India Resident Non-resident Resident Control and Management vests with Partners Principal Officer Principal officer

Residential Status of a Company

Indian Company Always Resident in India

Resident in India

Foreign Company

Non-Resident in India

Here, the term control and management refers to head and brain which directs the affairs of policy, finance, disposal of profits and vital things concerned in the management of a company. Control is not necessarily situated in the country in which the company is registered. The mere fact that a parent company exercises shareholders influence on its subsidiaries does not generally imply that subsidiaries are to be deemed residents of the state in which the parent company resides [Vodafone International Holdings B.V. vs. Union of India (2012) 204 Taxman 408 (SC)]. Note: If a Person is a resident for one source of income in a Previous Year, he shall be deemed to be a resident for all other sources of income also. [Section 6(5)] 3.6 RESIDENTIAL STATUS AND INCIDENCE OF INCOME-TAX [SEC.5] The incidence of tax on a tax-payer depends on his residential status as well as on the place and time of accrual or receipt of income.

DIRECT TAXATION I 3.7

Residential Status and Tax Incidence 3.6.1. TAX INCIDENCE FOR AN INDIVIDUAL AND HUF Particulars of Income Resident (a) Income received in India whether accrued in India or outside India. (b) Income deemed to be received in India whether accrued in India or outside India. (c) Income accruing or arising in India whether received in India or outside India. (d) Income deemed to accrue or arise in India, whether received in India or outside India. (e) Income received and accrued outside India from a business controlled or profession set up in India. (f) Income received and accrued outside India from a business controlled from outside India or profession set up outside India. (g) Income earned and received outside India but later on remitted to India. Gross Total Income 3.6.2. TAX INCIDENCE FOR COMPANY, FIRM, AOP, HUF & EVERY OTHER PERSON (OTHER THAN AN INDIVIDUAL & HUF) NATURE OF INCOME Income received in India (irrespective of whether the income was earned) Income earned in India (irrespective of whether the same was received) Income earned and received outside India from a source controlled from India Income earned and received outside India from a source not controlled from India 3.6.3. SIGNIFICANT AMENDMENTS: Income through the Transfer of Capital Asset situated in India [U/s. 9(1)(i)] With effect from the Assessment Year 2013-14, the provision of section 9(1)(i) of the Act relating to Income through the transfer of Capital Asset situated in India has been amended. Explanation 4 & 5 have been included in section 9(1)(i) with retrospective effect of 1st April 1962 to provide that : 1. The expression through shall mean and include and shall be deemed to have always meant and include by means of, in consequence of or by reason of RESIDENT TAXABLE TAXABLE TAXABLE TAXABLE NON RESIDENT TAXABLE TAXABLE NON TAXABLE NOT TAXABLE Yes Yes Yes Yes Yes Tax incidence in case of Resident but not Ordinarily Resident Yes Yes Yes Yes Yes Non Resident Yes Yes Yes Yes No

Yes

No

No

No (a) to (f)

No (a) to (e)

No (a) to (d)

3.8 I DIRECT TAXATION

2. An asset or any capital asset being any share or interest in a company / entity registered or incorporated outside India shall mean and shall be deemed to be and shall always be deemed to have been situated in India if the shares or interest derives, directly or indirectly, its value substantially from the assets located in India. 3.7 SPECIAL PROVISIONS RELATING INTEREST INCOME/ROYALTY INCOME AND FEES FOR TECHNICAL SERVICES Certain income is deemed to accrue or arises in India under section 9, even though it may actually accrue or arise outside India. Section 9 applies to all assesses irrespective of their residential status and place of business. The categories of income which are deemed to accrue or arise in India under section 9 are as under:3.7.1. Interest Income [Section 9(1)(v)]- Interest shall be deemed to accrue or arise in India if: PAYER Indian Government Resident in India No condition The borrowed amount must not be used for the purpose of business or profession carried on by such person outside India or for the purpose of making or earning an income from any source outside India The borrowed amount must be used for the purpose of business or profession carried on by such person in India CONDITIONS

Non Resident in India

3.7.2. Royalty Income [Section 9(1)(vi)]- Royalty income shall be deemed to accrue or arise in India if: PAYER Indian Government Resident in India No condition The royalty amount must not be paid in respect of any right , property or information used or services utilised for the purpose of business or profession carried on by such person outside India or for the purpose of making or earning an income from any source outside India. The royalty amount must be paid in respect of any right , property or information used or services utilised for the purpose of business or profession carried on by such person in India or for the purpose of making or earning an income from any source in India. CONDITIONS

Non Resident in India

Amended provisions of section 9(1)(vi) provides to include explanation 4 to clarify that the transfer in respect of any right, property or information includes transfer of all rights for the use or right to use a computer software including granting of a licence irrespective of the medium through which such right is transferred Explanation 5 also has been included to clarify that the Royalty income includes consideration in respect of any right or property or information whether or not: (a) the possession or control of such right / property/ information is with the payer (b) such right/property/information is used directly by the payer (c) the location such right/property/information is located in India

DIRECT TAXATION I 3.9

Residential Status and Tax Incidence 3.7.3. Taxability for Fees for Technical Services [Section 9(1)(vii)] - The fees for technical services shall be deemed to accrue or arise in India if: PAYER Indian Government Resident in India No condition The fees for technical services amount must not be paid in respect of any services utilised for the purpose of business or profession carried on by such person outside India or for the purpose of making or earning an income from any source outside India. The fees for technical services amount must be paid in respect of any services utilised for the purpose of business or profession carried on by such person in India or for the purpose of making or earning an income from any source in India. CONDITIONS

Non Resident in India

3.10 I DIRECT TAXATION

PROBLEMS ON RESIDENTIAL STATUS AND TAX INCIDENCE Problem 1. X, after about 30 Years stay in India, returns to America on January 29, 2010. He returns to India in June 2012 to join an American company as its overseas branch manager. Determine his residential status for the Assessment Year 2013-14. Solution: For the Assessment Year 2013-14, the Year 2012-13 is the Previous Year. During 2012-13, X is in India for more than 274 days. He is, therefore, resident in India. He is resident in India for 2 years out of 10 years (i.e., 20022003 to 2011-12), and he has stayed for more than 730 days during the seven years preceding the Previous Year 2012-13. He is, therefore, Resident and Ordinarily Resident in India for the Assessment Year 2013-14. Problem 2. Indian citizen and businessman Shri Hari, who resides in Kolkata, went to France for employment purposes on 15.8.2012 and would come back to India on 10.11.2013. He has never been out of India in the past. (a) Determine residential status of Shri Hari for the Assessment Year 2013-14. (b) Will your answer be different if he had gone on a leisure trip? Solution: (a) The previous year for the Assessment Year 2013-14 is 2012-13. During this period he was in India for 137 days (30+31+30+31+15). As he is not in India for 182 days, he does not satisfy the first condition of category A. The second condition of category A is also not satisfied because he is a citizen of India and leaves India during the Previous Year for employment outside India and is therefore, covered under exception No. 1 where 60 days will be substituted by 182 days. (b) In this case, although he does not satisfy the first condition of category A, he satisfies the second condition as he was in India for more than 60 days in the relevant Previous Year and was also here for more than 365 days during four preceding Previous Years. He is therefore, resident in India. The exception will not be applicable to him because he did not leave India for the purpose of employment. He satisfies both the conditions of category B because he was always been in India before 15.8.2012. The status of the assessee for the Previous Year 2012-13 will in this case be resident and ordinarily resident in India. Problem 3. B, an Indian citizen left India for the first time on 21.9.2011 for employment in Denmark. During the Previous Year 2011-12 he comes to India on 5.5.2012 for 150 days. Determine the residential status of B for Assessment Years 2012-13 and 2013-14. Solution : During the Previous Year 2011-12 B was in India for 174 days (30+31+30+31+31+21) and therefore, does not satisfy the first condition. As regards the second condition, although he was here in the four preceding Previous Years for more than 365 days as he was permanently in India but for the relevant Previous Year 2011-12 he should have been here for 182 days instead of 60 days as he is a citizen of India and leaves India in 2011-12 for employment abroad. He neither satisfies the first, nor the second condition and is therefore, Non-Resident in India. Similarly, during the previous year 2012-13 he visits India for 150 days. In this case also, the period of 60 days will be substituted by 182 days as he is a citizen of India. Therefore, he will be a Non-Resident in India even for the Previous Year 2012-13. Problem 4. The Head office of XY, a Hindu Undivided Family, is situated in Hong Kong. The family is managed by Y (since 1980) who is resident in India in only 3 out of 10 years preceding the Previous Year 2012-13 and he is present in India for more than 729 days during the last 7 years. Determine the residential status of the

DIRECT TAXATION I 3.11

Residential Status and Tax Incidence family for the Assessment Year 2013-14 if the affairs of the familys business are (a) wholly controlled from Hong Kong (b) partly controlled from India. Solution: (a) If affairs of a Hindu Undivided Family are controlled from a place outside India, the family will be nonresident. Accordingly, XY HUF is Non-resident for the Assessment Year 2013-14. (b) Affairs of the familys business are partly controlled from India during the Previous Year 2012-13. Therefore, the family is resident in India. However, it would be ordinarily resident in India if Karta satisfies the following two conditions laid down u/s 6(6)(b): (1) He has been resident in India in at least 2 out of 10 years preceding the Previous Year; (2) He has been physically present in India for at least 730 days during seven years preceding the Previous Year.

As the Karta (i.e. Y)is resident in India in 3 out of 10 years preceding the Previous Year, and he is present in India for more than 730 days during the 7 years, preceding the Previous Year, the family would be Resident and Ordinarily Resident in India for the Assessment Year 2013-14. Problem 5. A Hindu Undivided Family (Mr. B is Karta, X, Y and Z are coparceners) carries on cloth business in Burma. X comes to India and starts a cloth business at Mumbai in partnership with some other persons. The capital contributed by X to this firm is found to have come from the family. Subsequently, Y joins the firm as partner. Later on another business is started at Benaras with the same persons and one outsider as partner. Z joins this firm. The Assessing Officer wants to treat the family as resident on the ground that its coparceners are partners in firms, financed out of the family funds, and the firms are resident in India. Is the Assessing Officer legally correct? Solution: A case on similar facts was examined by the Supreme Court of India in the case of CIT vs. Nandlal Gandalal (1960) 40 ITR 1, wherein the Apex Court pointed out that both under the Hindu Law and under the Law of Partnership, the Hindu Undivided Family as such could exercise no control over the management of a firm in which some of its coparceners were partners, even if capital contributed by coparceners was found to have come from the family. The position in Hindu Law with regard to coparcener who has entered into partnership with others is well settled. The partnership is a contractual partnership and is governed by the Indian Partnership Act, 1932. The partnership is between the coparcener individually and the other partners and not between the family and other partners. This remains so even if the coparcener is accountable to the family for the income received. Thus, control and management over the firms business lies in the hands of individual coparceners and not in the hands of the family. The Assessing Officer is, therefore, not justified while holding the HUF as resident in India. Problem 6. Mr. Waugh, an Australian National, visits India since the Previous Year 2002-03 and resided for 90 days per year. Ascertain his Residential Status for the Assessment Year 2013-14. What would be the opinion if he was in India for (i) 100 days per Previous Year (ii) 110 days per Previous Year?

3.12 I DIRECT TAXATION

Solution: Mr. Waugh visits India for 90 days in each of the Previous Year since 2002-03. To ascertain his Residential Status:
90 days per Year
Previous Year No. of Days Physically Present in India during the Previous Year Total number of days during the preceding four Years Prior to the Previous Year Residential Status No. of Days Physically Present in India during the Previous Year Total number of days during the preceding four Years Prior to the Previous Year

100 days per Year

Residential Status No. of Days Physically Present in India during the Previous Year Total number of days during the preceding four Years Prior to the Previous Year

110 days per Year

Residential Status

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13

90 90 90 90 90 90 90 90 90 90 90

Nil 90 180 270 360 360 360 360 360 360 360

NR NR NR NR NR NR NR NR NR NR NR

100 100 100 100 100 100 100 100 100 100 100

Nil 100 200 300 400 400 400 400 400 400 400

NR NR NR NR RNOR RNOR RNOR RNOR RNOR RNOR RNOR

110 110 110 110 110 110 110 110 110 110 110

Nil 110 220 330 440 440 440 440 440 440 440

NR NR NR NR RNOR RNOR RNOR ROR ROR ROR ROR Resident and Ordinarily Resident (ROR)

Non-Resident (NR)

Resident but not Ordinarily Resident (RNOR)

Explanation: Case I : If he was present for 90 days every Year (a) Physically present in India for more than 60 days during any Previous Year (b) Physically present in India for less than 365 days during four Previous Years preceding the Previous Year So, the assessee, fails to satisfy the Basic condition of physically present in India for at least 60 days during the Previous Year and at least 365 days during the four Previous Years preceding the Previous Year. Hence, the Assessee is a Non-Resident for the Assessment Year 2013-14 related to Previous Year 2012-13. Case II : If he was present for 100 days every Year (a) Physically present in India for more than 60 days during any Previous Year (b) Physically present in India for more than 365 days during four Previous Years preceding the Previous Year So, the assessee satisfies the Basic condition of physically present in India for at least 60 days during the Previous Year and at least 365 days during the four Previous Years preceding the Previous Year. Hence, the Assessee is a Resident for the Assessment Year 2013-14 related to Previous Year 2012-13. Now, we will have to check the Additional conditions: (c) Additional Condition No.1 The assessee must be a Resident in India for at least two times during the 10 Previous Years, preceding the Previous Year 2012-13. The Assessee satisfies this additional condition, as he was a resident for more than two times during the 10 Previous Years, preceding the Previous Year.

DIRECT TAXATION I 3.13

Residential Status and Tax Incidence (d) Additional Condition No.2 The assessee must be physically present in India for at least 730 days during the 7 Previous Years, preceding the Previous Year 2012-13. The Assessee fails to satisfy this additional condition, as he was physically present in India for 700 days only during the 7 Previous Years, preceding the Previous Year. Since the assessee satisfies either of the additional condition/(s), the Assessee is determined as Resident but not Ordinarily Resident (RNOR) for the Previous Year 2012-13. Case III : If he was present for 110 days every Year (a) Physically present in India for more than 60 days during any Previous Year (b) Physically present in India for more than 365 days during four Previous Years preceding the Previous Year So, the assessee satisfies the Basic condition of physically present in India for at least 60 days during the Previous Year and at least 365 days during the four Previous Years preceding the Previous Year. Hence, the Assessee is a Resident for the Assessment Year 2013-14 related to Previous Year 2012-13. Now, we will have to check the Additional Conditions: (c) Additional Condition No.1 The assessee must be a Resident in India for at least two times during the 10 Previous Years, preceding the Previous Year 2012-13. The Assessee satisfies this additional condition, as he was a resident for more than two times during the 10 Previous Years, preceding the Previous Year. (d) Additional Condition No.2 The assessee must be physically present in India for at least 730 days during the 7 Previous Years, preceding the Previous Year 2012-13. The Assessee also satisfies this additional condition, as he was physically present in India for 770 days (i.e. more than 730 days) only during the 7 Previous Years, preceding the Previous Year. Since the assessee satisfies both the additional condition/(s), the Assessee is determined as Resident and Ordinarily Resident (ROR) for the Previous Year 2012-13. Problem 7. Subhash discloses following particulars of his receipts during the Previous Year 2012-2013: (i) Salary income earned at Pune but received in Sri Lanka (ii) Profits earned from a business in Kenya which is controlled in India, half of the profits being received in India. (iii) Income from property, situated in Nairobi and received there (iv) Income from agriculture in Bangladesh and brought to India (v) Dividend-paid by an Indian company but received in London on 15th May, 2012 (vi) Interest on USA Development Bonds, one half of which was received in India (vii) Past foreign untaxed income brought to India (viii) Gift of $1000 from father, settled in USA, received in India (ix) Capital Gains on sale of Land in Delhi, consideration received in Canada (x) Income from structure-designing consultancy service, set up in Germany, controlled from India, profits being received outside India (xi) Loss from foreign business, controlled from India, sales being received in India 2,50,000 2,20,000 75,000 95,000 22,000 76,000 2,10,000 80,000 2,50,000 4,00,000 2,00,000

3.14 I DIRECT TAXATION

Determine his Gross Total Income for the Previous Year 2012-2013 if he is (i) Resident and Ordinarily Resident, (ii) Resident but not Ordinarily Resident, (iii) Non Resident. Solution: Computation of Gross Total Income for the Previous Year 2012-13 Particulars (i) Salary earned at Pune but received at Sri Lanka. Salary is deemed to accrue or arise at a place where services are rendered, place of receipt being immaterial [ Sec. 9(1)(ii)] Hence, it is taxable in all cases Profits of `2,00,000 earned from a business in Kenya, controlled in India: 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 ROR 2,50,000 RNOR 2,50,000 NR 2,50,000

(i)

(a) One half of profits are taxable on receipt basis (b) Other half profitsfrom foreign business controlled in India (in case of resident and ordinarily resident, place of control is of no relevance) (iii) Income from property in Nairobi and received there : income accruing or arising outside India (iv) Income from agriculture in Bangladesh and brought to India: It is not income received in India as receipt means first receipt. Hence, it is not taxable in case of not ordinarily resident and non-resident. In case of ordinarily resident, it is income accruing or arising outside India. Hence, it is taxable. It should be noted that it is not agricultural income as it is not received from land, situated in India, and hence not derived from sources of income being exempted u/s 10(1). (v) Dividend paid by an Indian company but received in London: Dividend paid by an Indian Company is deemed to accrue or arise in India. However, any dividend paid, declared or distributed by a domestic company on or after 1st April,2005 is exempt from tax u/s 10(34). Therefore, such dividend is not taxable (vi) Interest on USA Development Bonds: (a) One half of taxable on receipt basis (b) Other half is taxable only in case of ordinarily resident as it is foreign income accruing or arising outside India (vii) Past untaxed foreign income brought to India. It is not an income received in India. Furthermore, it is not the income of the Previous Year 2012-13. Hence, it is not taxable in any case (viii) Gift from a relative is not taxable (ix) Capital gain is deemed to accrue or arise in India u/s 9(1)(i) (x) Income from consultancy profession, set up outside India, profits being received outside India: Taxable in case of ordinarily resident, as income accruing or arising outside India and received outside India [Sec.5(1)(c)] In case of not ordinarily resident, as it is not income from profession set up in India, control and management applies to business and not to professions. Hence, it is not taxable [ Sec. 5(1) (c) r.w. proviso]

75,000 95,000

38,000 38,000

38,000

38,000

2,50,000 4,00,000

2,50,000

2,50,000

DIRECT TAXATION I 3.15

Residential Status and Tax Incidence

(2,00,000) (xi) Loss from foreign business, controlled from India Income includes loss also. Profits are embedded in sales. As sales realization were received in India, the place of control and management is not relevant. Business loss can be set off against business profits and thereafter against the income of any other head except income from salary and chance winnings (Sec.70) (2,00,000) (2,00,000)

Gross Total Income

11,46,000

5,38,000

4,38,000

Problem 8. Mr. Tajuddin, an Indian citizen, earns the following income during the Previous Year 2012-2013: Particulars (i) Profits from a business in Mumbai, managed from France ` 5,20,000 1,80,000 1,85,000 12,000 1,50,000 1,26,000 2,00,000 2,50,000 1,70,000 1,75,000 2,30,000

(ii) Pension for services rendered in Kenya but kept with State Bank in Kenya with the permission of the Reserve Bank of India (iii) Income from property in Kuwait, received in India (iv) Profits from business in Nepal and deposited in a bank there (v) Income received in Oman from a profession, which was set up in India, extended to Oman and managed from Kenya (vi) Profit on sale of machinery in India but received in Italy (vii) Profits, before allowing depreciation, from business Kuwait 50% of profits were received in India Total depredation (viii) Interest on foreign bank deposit, received by his minor son in India Bank deposit was made out of funds gifted by grandfather (ix) A German company credited commission to his Bank Account outside India for sale of goods by him in India (x) Commission earned and received by him outside India on export orders collected by him in India for foreign exporters, without any authority being given to him by them (xi) Dividends remitted in India by an Egyptian company to him under his instruction through Bank of Patiala

1,80,000

Determine his Gross Total Income for the Previous Year 2012-2013 if he is (i) Resident and Ordinarily Resident; (ii) Resident but not Ordinarily Resident; and (iii) Non Resident Solution: Computation of Gross Total Income for the Previous Year 2012-13

3.16 I DIRECT TAXATION

Particulars (i) Profits from a business at Mumbai, managed from France: Income from business accrues at the place where the business is done, place of management being of no relevance. Hence, it is taxable in all cases.

ROR 5,20,000

RNOR 2,50,000

NR 2,50,000

(ii) Pension for services rendered in Kenya, received there: Pension is deemed to accrue or arise at a place where services are rendered (iii) Rent of house property, situated in Kuwait, but received in India (iv) Profits from business in Nepal and deposited in Bank there: Income accruing or arising outside India (v) Income from profession in Oman which was set up in India, received there, managed from there: Foreign Income accruing or arising outside India from a Profession set up in India is taxable in case of ROR and RNOR. Its control and management is not relevant (vi) Profit on sale of machinery in India but received in Italy: Income from asset situated in India is deemed to accrue or arise in India. Hence, it is taxable in all cases (vii) Profits from foreign business (viii) Depreciation of foreign business It can be set off first from business profits and thereafter against the income of any other head u/s 32(2) (ix) Income of a minor child is included in total income of that parent whose income, before including such income is greater [Sec.64(1A)], however, an exemption upto `1,500 is to be allowed u/s 10(32) (x) Commission from German company received outside India is deemed to accrue or arise in India because of business connection in India u/s 9(1)(i) (xi) Commission earned and received outside India on export orders collected in India is deemed to accrue or arise in India [Explanation 2 of Sec.9(1)(i) w.e.f. A.Y. 2007-08] (xii) Dividends from foreign company received outside India Gross Total Income

1,80,000

1,85,000 12,000 1,50,000

1,85,000 1,50,000

1,85,000

1,26,000

1,26,000

1,26,000

2,00,000 (2,50,000)

1,00,000 (1,25,000)

1,00,000 (1,25,000)

1,68,500

1,68,500

1,68,500

1,75,000

1,75,000

1,75,000

2,30,000

2,30,000

2,30,000

1,80,000 18,76,500

15,29,500

13,79,500

Problem 9. Kimono, a Japanese national discloses the following particulars of his income during Previous Year 2012-2013. (i) Income from house property in Japan, remitted by tenant to him in India through State Bank of India (ii) Loss from business in India (iii) Profits from speculation business in India (iv) Profit from business in Japan, controlled and managed from India but being received in Japan (v) Interest received on bonds of Indian companies outside India 4,00,000 (-) 3,00,000 2,00,000 20,00,000 1,45,000

DIRECT TAXATION I 3.17

Residential Status and Tax Incidence (vi) Net dividends received from Japanese companies outside India (tax deducted at source ` 15,000) (vii) Interest received on compensation of land, acquired by Government of India during the Previous Year 2007-08 Determine his Gross Total Income for the Previous Year 2012-2013 in the following cases: (i) He is Resident and Ordinarily Resident during the Previous Year; (ii) He is Resident but not Ordinarily Resident during the Previous Year; (iii) He is Non Resident during the Previous Year. Solution: Computation of Gross Total Income for the Previous Year 2012-2013 Particulars (i) Income from House Property in Japan received in India (ii) Loss from Business in India to be set off against business profits and thereafter against any other income except salary income and winning from lotteries/ horse race, etc u/s 70 (iii) Profits from speculation business in India (iv) Profits from business in Japan, received outside India, control and management of foreign business in India is not relevant in the case of non-resident (v) Interest from investments in Public Sector Companies in India deemed to accrue or arise in India though received outside India (vi) Dividends of `2,35,000 received from Japanese companies outside India, not accruing or deemed to accrue or arise in India (vii) Interest for land compensation taxable on accrual basis: `60,000/6 = `10,000 [ Rama Bai vs. CIT (1991) 181 ITR 400 (SC)] Gross Total Income ROR 4,00,000 (3,00,000) RNOR 4,00,000 NR 4,00,000 2,35,000 60,000

(3,00,000) (3,00,000)

2,00,000 20,00,000

2,00,000 20,00,000

2,00,000

1,45,000

1,45,000

1,45,000

2,35,000 10,000 26,90,000

10,000 24,55,000

10,000 4,55,000

Problem 10. Ms. R discloses the following particulars of her income during the Previous Year 2012-2013: Particulars ` 5,00,000 (i) Dividends from Sri Lankan companies received in India Dividends were received partly in cash and partly in shares. Face value of shares is `1,00,000 but their market value is `4,00,000. However, currently there is no buyer in the market (ii) Pension remitted to her in India by Sri Lankan Government after deduction of tax at source (`15,000) (iii) Fees received in Ceylon for arguing a patent case in Delhi High Court on behalf of a fellow-lawyer friend of Mumbai (iv) Commission credited to her account in India under her instructions by law firms in India, for referring clients from outside India but commission was received in Mauritius (v) Share of income from a Partnership firm, in which she is a partner received in Kolkata

1,70,000 2,00,000 1,00,000

1,50,000

3.18 I DIRECT TAXATION

 (vi) Income from law practice in Mauritius and Qatar, received there, but practice was set up in Delhi (vii) 5% commission for the Year 2012-2013 from publishers of law books on their annual profits, received in India, commission has been paid after setting off `30,000 for books purchased by her. She has purchased the dealership rights from Mumbai Law House on 1 January, 2012. (viii) Gift from a foreign client, received outside India

6,80,000 1,20,000

20,000

Determine her Gross Total Income for the Previous Year 2012-2013 if she is (i) Resident and Ordinarily Resident; (ii) Resident but not Ordinarily Resident; and (iii) Non Resident Solution: Computation of Gross Total Income for the Previous Year 2012-13 Particulars (i) Dividend received in India (a) Cash dividend (b) Dividend in kind to be valued at market price of shares (ii) Pension received outside India and not deemed to accrue or arise in India [ CIT vs. Kalyanakrishnan 195 ITR 534] (iii) Fees for arguing patent case in Delhi, but received in Ceylon Income from business connection deemed to accrue or arise in India (iv) Commission credited to the account of payee under her instruction in the books of payer is a deemed receipt in India [Raghava Reddy vs.CIT (1962) 441 ITR 720 (SC)] (v) Share income received from Partnership firm exempt from tax as tax liability borne by Firm (vi) Income from profession set up in India, extended outside India Income being received outside India (vii) Commission on account of dealership rights, received in India @ 5% or the annual profits of the publishers - Commission not to be apportioned between seller and purchase on time basis (viii) Gift from a foreign client, received outside India [Sec.28(iv)] Gross Total Income 1,00,000 4,00,000 1,70,000 2,00,000 1,00,000 4,00,000 2,00,000 1,00,000 4,00,000 2,00,000 ROR RNOR NR

1,00,000

1,00,000

1,00,000

6,80,000 1,50,000

6,80,000 1,50,000

1,50,000

20,000 18,20,000

16,30,000

9,50,000

Problem 11. Compute Income for Mr. Jaikishan for the Previous Year 2012-13. (b) Profit from hotel business in Japan (c) Dividends declared in Japan received in India (d) Gain from transfer of capital asset in India (e) Interest on Debentures of a company in New York received in India (f) Royalty received in Germany from a resident in India for technical services provided for a business in Germany Particulars ` 30,000 60,000 15,000 35,000 19,000 20,000 (a) Salary accrued and received in India

DIRECT TAXATION I 3.19

Residential Status and Tax Incidence (g) Interest received in UK from Mr. Robert, a non-resident, on loan provided to him for business in India (h) Fees from an Indian company carrying on business in the UK for technical services rendered in London, directly deposited in his bank account in India 6,000 25,000

Compute the Gross Total Income Mr. Jaikishan for the relevant Previous Year 2012-13, if he is (i) Ordinarily Resident, (ii) Not Ordinarily Resident, (iii) Non Resident. Solution: Computation of Gross Total Income of Mr. Jaikishan for the Previous Year 2012-2013 Particulars (a) Salary accrued and received in India (b) Profit from hotel business in Japan (c) Dividends declared in Japan received in India (d) Gains from transfer of a capital asset in India deemed to accrue or arise in India (e) Interest on debentures of a company in New York but received in India (f) Royalty received in Germany from a resident in India for technical services provided for a business in Germany (g) Interest received in UK from Mr. Robert, a non-resident, on loan provided to him for business in India (h) Fees from an Indian company, carrying on business in UK for technical services rendered in London, directly deposited in his Bank Account in India Gross Total Income ROR 30,000 60,000 15,000 35,000 19,000 20,000 6,000 25,000 RNOR 30,000 15,000 35,000 19,000 6,000 25,000 NR 30,000 15,000 35,000 19,000 6,000 25,000

2,10,000

1,30,000

1,30,000

Problem 12. Mr.X furnishes the following particulars of his income earned during Previous Year 2012-13: (i) Income from agriculture in Bangladesh, received there ` 3,80,000, but later on remitted to India. (ii) Interest on Pakistani Development Bonds, ` 90,000, one-sixth of which received in India. (iii) Gift of ` 70,000 received in foreign currency from a relative in India. (iv) Arrears of salary ` 1,50,000 received in Pakistan from a former employer in India. (v) Income from property received outside India ` 3,00,000 (`1,00,000 is used in Bahrain for the educational expenses of his son in Bahrain, and ` 2,00,000 later on remitted to India). (vi) Income from business in Iran which is controlled from India (`1,00,000 being received in India) `2,00,000. (vii) Dividends received on 30.06.2012 outside India from an Indian company, ` 2,50,000. (viii) Untaxed profit of the FY 2007-2008 brought to India in July 2012, ` 2,50,000. (ix) Profit from business in Kolkata managed from outside India ` 1,00,000, 60% of which is received outside India. Determine the Gross Total Income of Mr. X for Previous Year 2012-2013, if Mr. X is (a) Resident and Ordinarily Resident; (b) Resident but not Ordinarily Resident; (c) Non Resident.

3.20 I DIRECT TAXATION

Solution: Computation of Gross Total Income for the Previous Year 2012-13 Particulars (i) Income from agriculture in Bangladesh, received there but later on remitted to India (a) 1/6th of `90,000 received in India (b) 5/6th of `90,000 being received in India (iii) Gift received from a relative in India is exempted u/s 57(v) (iv) Salary arrears received in Pakistan from a former employer in India (v) Income from property received outside India but later on remitted to India (vi) Profit from a business in foreign land but controlled from India (a) Profits received in India (b) Profits received outside India (vii) Dividends received from an Indian Company, outside India, deemed to accrue or arise but exempted u/s 10(34) (viii) Untaxed foreign profit of 2007-08 brought to India (ix) Profit from business in India `1,00,000, 60% of which was received outside India Gross Total Income 1,00,000 1,00,000 1,00,000 12,20,000 1,00,000 1,00,000 1,00,000 4,65,000 1,00,000 1,00,000 3,65,000 ROR 3,80,000 RNOR NR -

(ii) Interest on Development Bonds in a foreign land : 15,000 75,000 1,50,000 3,00,000 15,000 1,50,000 15,000 1,50,000 -

DIRECT TAXATION I 3.21

Study Note - 4
INCOME FROM SALARIES
This Study Note includes 4.1 Introduction 4.2 Meaning of Salary 4.3 Allowances 4.4 Death-cum-Retirement Benefits 4.5 Profits in lieu of salary [Section 17(3)] 4.6 Deductions against salary 4.7 Valuation & Taxability of Perquisites 4.8 Provident Funds 4.9 Salary" under different circumstances at a glance 4.10 Tax on Salary of Non-Resident Technicians [Section 10(5B)] 4.11 Relief under section 89 4.1 INTRODUCTION Any person employed gets compensated by way of remuneration for services rendered. This is called Salary. It is received in cash or in kind by way of amenities, benefits, perquisites. Which emoluments are salary how to value perquisites and what deductions are available from salary has been dealt with under this head of income. Certain tax-free items of remuneration have been enumerated under section 10 and are discussed in this chapter. 4.2 MEANING OF SALARY The meaning of the term salary for purposes of Income tax is much wider than what is normally understood. Every payment made by an employer to his employee for service rendered would be chargeable to tax as income from salaries. The term salary for the purposes of Income Tax Act will include both monetary payments (e.g. basic salary, bonus, commission, allowances etc.) as well as non-monetary facilities (e.g. housing accommodation, medical facility, interest free loans etc). (1) Employer-employee relationship: Before an income can become chargeable under the head salaries, it is vital that there should exist between the payer and the payee, the relationship of an employer and an employee. (2) Full-time or Part time employment: It does not matter whether the employee is a fulltime employee or a part-time one. Once the relationship of employer and employee exists, the income is to be charged under the head Salaries. If, for example, an employee works with more than one employer, salaries received from all the employers should be clubbed and brought to charge for the relevant Previous Years. (3) Foregoing or sacrificing of salary: Once salary accrues, the subsequent waiver by the employee does not absolve him from liability to Income- tax. Such waiver is only an application and hence chargeable.

DIRECT TAXATION I 4.1

Income from Salaries (4) Surrender of salary: However, if an employee surrenders his salary to the Central Government u/s 2 of the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961, the salary so surrendered would be exempt while computing his taxable income. (5) Salary paid tax-free: This, in other words, means that the employer bears the burden of the tax on the salary of the employee. In such a case, the income from salaries in the hands of the employee will consist of his salary income and also the tax on this salary paid by the employer. This means both the salary and the tax paid thereon will be taxable in the hands of the employee. (6) Voluntary Payments: Whether the payment from an employer is based on a contract or not, it constitutes salary in the hands of the employee. However, many employers give personal gifts and testimonials to the employees. For example, employees who complete 20 years of service may be given a wrist watch. The question arises whether the value of the watch can be taxed in the hands of the employee. Courts have taken the view that such gifts are not taxable. However, in these cases it is important that such gifts must be given to employees pursuant to a scheme applicable to employees in general. If gifts are given purely on a selective basis they will become chargeable in the hands of the recipient. Chargeability of Salary in the relevant Previous Year : [Sec.15] (1) Due or receipt whichever falls earlier: Salary is taxable on due basis or on receipt basis, whichever is earlier. Hence, (a) Salary due in a Previous Year is taxable, even if it not received. (b) Salary received in a Previous Year is taxable, even if it is not due. (c) Arrears of salary received during the current Previous Year shall be taxable in the current year if not charged to tax in an earlier Previous Year.

(2) No double taxation: once salary is taxed on due/receipt basis, it will not be taxed again on receipt/ falling due, as the case may be. (3) The assessee can claim relief u/s 89(1) for arrears or advance salary. (4) Loan from employer is not salary. Advance salary is taxable, while advance against salary is not taxable. (5) For Government employees, the period of chargeability of salary is from March to February. For example, salary from 1st March 2012 to 28th February 2013 is chargeable as Income of the Assessment Year 2013-14. Place of accrual of Salary (1) The place of accrual of salary is the place of employment. (2) Service rendered in India: U/s 9(1)(ii), salary earned in India is deemed to accrue or arise in India even if (a) it is paid outside India, (b) it is paid or payable after the contract of employment in India comes to an end.

(3) If an employee gets pension paid abroad in respect of services in India, the same will be deemed to accrue or arise in India.

4.2 I DIRECT TAXATION

(4) Leave salary paid abroad in respect of leave earned in India is deemed to accrue or arise in India. (5) Services rendered outside India: Sec. 9(1)(iii) provides that income chargeable under the head Salaries payable by the Government to a citizen of India for service provided outside India will be deemed to accrue or arise in India. (6) U/s10(7), any allowance or perquisites paid or allowed outside India by the Government to a citizen of India for rendering services outside India will be fully exempted. Place of accrual of Salary - at a glance: Received / Earned in India Deemed to be earned in India Taxable in the hands of all persons /assessees whether resident or nonresident in India. The same would be taxable provided : 1. The services are rendered in India. 2. The leave period preceding / succeeding the tenure of services rendered in India & forms part of the contract of service.

Definition of Salary [u/s 17] In accordance with the provisions of Sec. 17(1) of Income Tax Act,1961, the term Salary includes:

Wages Any annuity or pension Any gratuity Any fees, commission, perquisite or profits in lieu of or in addition to any salary or wages Any advance salary Encashment of leave-not-availed Interest earned in excess of 9.5% on Recognized Provident Fund (RPF) Amount transferred in excess of 12% of Salary to RPF Contribution made by Central Government or any other employer (w.e.f. A.Y. 2008-09) in the Previous Year to the account of an employee under Pension Scheme u/s 80CCD Money embezzled by an employee constitutes his income.

Item wise applicability of Salary: While deciding on the issue of applicability of taxable salary, the following matrix would be of immense help: Particulars Wages for Workers Salary received by a partner of a firm Director Fees Salary received by a proprietor Director Remuneration Treatment The same would be treated as Salary and would be taxable accordingly. There arises no difference between wages & salary Such remuneration would be treated as Business Income since the partner is not an employee of the entity Sitting fees paid to directors for attending Board Meeting is not a salary but taxable as Other Income Proprietor is not an employee and hence any amount received by him would not be treated as salary Any amount payable to any whole time directors who are also an employee of the company would be treated as salary. In any other case, the same would be treated as Other Income

DIRECT TAXATION I 4.3

Income from Salaries Pension to retired employee Pension to legal heir of the deceased employee Remuneration paid to teacher of any University / College Voluntary Retirement payment by employer to employees Remuneration to the MP / MLA Pension is paid in pursuance to the terms of employment. Hence any amount received as pension would be considered as Salary in the hand of the recipient Amount received by legal heir of the deceased employee, who is not an employee of the organization, would be considered as Income from Other Sources and not as Income from Salary Any such remuneration would be treated as Salary if the terms of employment provide a condition for checking such any paper. However, in any other case, such income shall be considered as Other Income Since the employee would get the amount in accordance with the terms of employment obligation, the same would be considered as Salary Such income shall be considered as Income from Other Sources as there exist no employer / employee relationship

Fully taxable components of Salary : 1. Basic Salary 2. Dearness Allowance 3. Advance Salary 4. Arrears of Salary 5. City Compensatory Allowance 6. Bonus 7. Commission as a percentage on turnover 8. Fixed Medical Allowance 9. Project Allowance Profits in Lieu of Salary [u/s 17(3)] (1) Compensation due or received from present/former employer in connection with (a) termination of employment, or (b) modification of terms and conditions of employment. 10. Fees 11. Lunch/Tiffin Allowance 12. Overtime Allowance 13. Servant Allowance 14. Warden Allowance 15. Non-practicing Allowance 16. Family Allowance 17. Leave encashment during service 18. Holiday Allowance

(2) Any amount received from an Unrecognized Provident Fund, to the extent of Employers contributions, along with interest on such contribution. (3) Sum received under Keyman Insurance Policy, including Bonus on it. (4) Any sum received (either in lump sum or otherwise), either prior to employment or after cessation of employment. Specified Employee An Individual will be considered as a Specified Employee if: (1) He is a director of a company, or (2) He holds 20% or more of equity voting power in the company,

4.4 I DIRECT TAXATION

(3) Monetary salary in excess of ` 50,000: His income under the head salaries, (from any employer including a company) excluding non-monetary payments exceeds ` 50,000. For the above purpose, salary, should be arrived at after making the following deductions: (a) Entertainment Allowance (b) Professional Tax 4.3 ALLOWANCES Allowance is a fixed monetary amount paid by the employer to the employee for meeting some particular expenses, whether personal or for the performance of his duties. These allowances are generally taxable and are to be included in the gross salary unless specific exemption has been provided in respect of any such allowance. 4.3.1 Taxability of Allowances Allowances received by an employee may be classified as follows:

1. Fully taxable allowances without any exemptions: 1. City Compensatory Allowance 2. Dearness Allowance / Pay 3. Fixed Medical Allowance 4. City Compensatory Allowance 5. Deputation Allowance 6. Family Allowance 7. Project Allowance 8. Lunch/Tiffin Allowance 9. Overtime Allowance 10. Servant Allowance 11. Warden Allowance 12. Non-practicing Allowance 13. Leave encashment during service 14. Holiday Allowance

2. Specific allowances that are fully exempt in the hands of employees Allowance 1. Travelling Allowance Conditions to claim full exemption Should be provided by the employer and spent by the employee to meet the cost of official tour or transfer expenses. Cost of travel or transfer includes payments for transfer, packing and transportation of personal effects.

DIRECT TAXATION I 4.5

Income from Salaries 2. Daily Allowance 3. Conveyance Allowance 4. Helper Allowance 5. Academic Allowance 6. Uniform Allowance Should be spent by the employee for meeting the daily charges incurred on a tour or transfer. Should be used by the employee to meet the expenditure on conveyance in performance of official duties. Should be used by an employee to meet the expenditure on a helper who assists him in the performance of official duties. Should be used by the employee for his academic research and training pursuits. Should be spent by the employee for purchasing/maintaining office uniform for official duties.

7. Allowances and perks paid Fully exempted by Government of India to an Indian citizen outside India Example: During the Previous Year 2012-13, the following allowances are given to X by the employer company Amount of allowance (`) 36,000 40,000 50,000 68,000 1,00,000 18,000 Amount actually spent for the purpose (`) 32,000 41,000 42,000 64,000 90,000 17,000 Amount chargeable to tax (`) 4,000 Nil 8,000 4,000 10,000 1,000

Nature of allowance Travelling allowance for official purpose Travelling allowance given at the time of transfer of X from Delhi to Ajmer Conveyance allowance for official purposes Helper allowances for engaging helper for official purpose Research allowance Uniform allowance for official purposes

3. When Exemption does not depend upon Expenditure In the case given below, the amount of exemption does not depend upon expenditure incurred by the employee. Regardless of the amount of expenditure, the allowances given below are exempt to the extent of (a) the amount of allowance; or (b) the amount specified in rule 2BB, whichever is lower. On the above basis, exemption is available in the case of the following allowances. It may be noted that in these cases, the amount of actual expenditure is not taken into consideration:Allowance Special Compensatory (Hill Areas) Allowance Nature of allowance It includes any special compensatory allowance in the nature of special compensatory (hilly areas) allowance or high altitude allowance or uncongenial climate allowance or snow bound area allowance or avalanche allowance. Exemption as specified in rule 2BB Amount exempt from tax varies from ` 300 per month to ` 7,000 per month.

4.6 I DIRECT TAXATION

Border Area Allowance

It includes any special compensatory allowance in the nature of border area allowance or remote locality allowance or difficult area allowance or disturbed area allowance Tribal areas allowance is given in (a) Madhya Pradesh; (b) Tamil Nadu; (c) Uttar Pradesh; (d) Karnataka; (e) Tripura; (f) Assam; (g) West Bengal; (h) Bihar; (i) Odisha. It is an allowance granted to an employee working in any transport system to meet his personal expenditure during his duty performed in the course of running of such transport from one place to another place provided that such employee is not in receipt of daily allowance This allowance is given for Childrens education. This amount is granted to an employee to meet the hostel expenditure on his child. If this exemption is taken, the same employee cannot claim any exemption in respect of border area allowance mentioned above. Transport allowance is granted to an employee to meet his expenditure for the purpose of commuting between the place of his residence and the place of his duty. Underground allowance is granted to an employee who is working in uncongenial, unnatural climate in underground mines. It is granted to the member of armed forces operating in high altitude areas.

The amount of exemption varies from ` 200 per month to ` 1,300 per month

Tribal Areas/ Scheduled Areas Allowance

` 200 per month

Allowance for Transport Employees

The amount of exemption is :(i) 70 % of such allowance; or (ii) ` 10,000 per month, whichever is lower.

Children Allowance Hostel Allowance

Education

The amount exempt is limited to ` 100 per month per child up to a maximum of two children. It is exempt from tax to the extent of ` 300 per month per child up to a maximum of two children. Exemption is limited to ` 2,600 per month in some cases.

Expenditure

Compensatory Field Area Allowance

Transport Allowance

It is exempt up to ` 800 per month.

Underground Allowance

Exemption is limited to ` 800 per month.

High Altitude Allowance

It is exempt from tax up to ` 1,060 per month (for altitude of 9,000 to 15,000 feet) or ` 1,600 per month

DIRECT TAXATION I 4.7

Income from Salaries Example:- The following example are given to have better understanding: (i) During the Assessment Year 2013-14, the following allowances are given to A by the employercompany Amount of allowance (`) 3,000 1,800 900 1,080 6,600 12,000 Amount spent (`) Not relevant Not relevant Not relevant Not relevant Not relevant Not relevant Amount of exemption (`) 200 p.m. 100 p.m. 100 p.m. 300 p.m. 800 p.m. Amount chargeable to tax (`) 600 600 900 Nil 3,000 2,400

Nature of allowance Tribunal area allowance for As posting in Assam for two months Child education allowance for As elder son Child education allowance for As younger son Child education allowance for As daughter Hostel expenditure allowance for As elder son Transport allowance for commuting between office and residence

(i) The following allowances are given by a transport company to its drivers to meet personal expenditure in the course of running truck from one place to another place :Name of drivers A B C D Amount of allowance (`) 72,000 7,20,000 1,30,000 46,200 Amount spent (`) Amount not chargeable to tax (`) 70% of `72,000 `10,000 per month `10,000 per month 70% of `46,200 Amount chargeable to tax (`) 21,600 6,00,000 10,000 13,860

Not relevant Not relevant Not relevant Not relevant

C is in employment only for 2 months during the Previous Year 2012-13; D is in employment only for 7 months during the Previous Year 2012-13. 4.3.2 Various items of salary for which exemptions are available subject to limitations: A. LEAVE TRAVEL ASSISTANCE (LTA) u/s 10(5) Rule 2B Conditions for claiming the benefit: (a) An individual can avail the benefit of LTA offered by his employer, twice in a block of four years. (b) The present block of four years applicable for A.Y.2013-14 is calendar years 2011-2014. (c) LTA may be provided by the employer to the employee and his family: (i) In connection with his proceeding on leave to any place in India, while in service; (ii) Proceeding to any place in India after retirement or termination from service.

4.8 I DIRECT TAXATION

When Taxable:

LTA encashed without performing journey is fully taxable Expenses reimbursed other than the fare like boarding or lodging is fully taxable. Amount received from employer in excess of the cost of traveling on the shortest route.

Family of an Individual means: Spouse and children of the individual, and Parents, brothers and sisters of the individual or any of them, wholly or mainly dependent on the individual.

B. HOUSE RENT ALLOWANCE [Sec.10(13A) Rule 2A] Conditions for claiming exemption:

Assessee is in receipt of HRA Pays Rent Rent paid is more than 10% of salary

Very Important: The exemption shall be calculated on the basis of where the accommodation is situated. If the place of employment is the same for the whole year, then exemption shall be calculated for the whole year. If there is a change in place during the Previous Year, then it will be calculated on a monthly basis. Exemption should be calculated in respect of the period during which rental accommodation is occupied by the employee during the Previous Year. Salary for the period during which rental accommodation is not occupied shall not be considered.

Salary for HRA= Basic Pay + DA (considered for retirement benefits) + Commission (if received as a fixed percentage on turnover as per terms of employment) Computation of Taxable House Rent Allowance (HRA) Particulars Amount received during the financial year for HRA Less: Exemption u/s 10(13A) Rule 2A: Least of the followings: (a) Actual amount received (b) 50% ( for metro cities) / 40 % ( for non-metro cities) of Salary (c) Rent paid less 10 % of Salary Taxable HRA ` ` xxx

xxx xxx xxx

xxx xxx

DIRECT TAXATION I 4.9

Income from Salaries 4.4 DEATH-CUM-RETIREMENT BENEFITS A. Gratuity u/s 10(10)

For Non-Government Employee Covered by Payment of Gratuity Act, 1972 Computation of Taxable Gratuity Particulars Amount received as Gratuity Less: Exemption u/s 10(10)(ii) Least of the followings: (i) Actual amount received (ii) 15/26 x Last drawn salary x No. of years of completed service or part thereof in excess of 6 months (iii) Maximum limit Taxable Gratuity Note: Salary = Basic Pay + Dearness Allowance In case of seasonal employment, instead of 15 days, 7 days shall be considered. For Non-Government Employee Not-covered by Payment of Gratuity Act, 1972 Computation of Taxable Gratuity Particulars Amount received as Gratuity Less: Exemption u/s 10(10)(iii) Least of the followings: (i) Actual amount received (ii) x Average Salary x No. of fully completed years of service (iii) Maximum limit Taxable Gratuity ` ` xxxx ` ` xxxx

xxx xxx 10,00,000 xxxx xxxx

xxx xxx 10,00,000

xxxx xxxx

Note: Salary = 10 months average salary preceeding the month of retirement. = Basic Pay + Dearness Allowance considered for retirement benefits + Commission (if received as a fixed percentage on turnover)

4.10 I DIRECT TAXATION

Gratuity received while in service:Any gratuity paid to an employee while he continues to remain in service (whether or not after he has put in minimum specified period of service) is not exempt from tax. Tax exemption will be available only if gratuity is paid on (i) retirement; (ii) becoming incapacitated prior to such retirement; (iii) termination of employment; (iv) resignation; or (v) death. Gratuity received under other circumstances would not be exempt from tax, though the assessee can claim relief under section 89. Very Important:

Where an individual receives retirement gratuity from more than one employer, he can claim exemption in respect of both of them. However, the maximum amount of exemption should not exceed ` 10,00,000. When gratuity is received from more than one employer during different periods of time, the maximum exemption claimed by an assessee during his entire life should not exceed ` 10,00,000.

Gratuity received by family members after the death of the employee:If gratuity is paid after the death of an employee, then the case may fall in one of the following situations given below:Normal date of retirement of employee (say A) Situation 1 Situation 2 Situation 3 June 30, 2012 June 30, 2012 June 30, 2018 When gratuity become due June 30, 2012 June 30, 2012 July 6, 2012 Date of payment of gratuity July 11, 2012 July 11, 2012 July 11, 2012 Date of death of A July 20, 2012 July 6, 2012 July 6, 2012

Situation 1 - The gratuity become due (and paid) during the lifetime of X, it is taxable in the hand of X. He can claim exemption under section 10(10). Situation 2 - Gratuity becomes due on June 30, 2012 at the time of retirement. It is taxable in the hand of A even if it is received by legal heirs on July 11, 2012 after his death. After claiming exemption under section 10(10) (ii)/(iii), the balance shall be included in the salary income of X. Income-tax return shall be submitted by Mrs. A(or her children) as legal heirs of A. Situation 3 - A dies on July 6, 2012 while in service. Gratuity is sanctioned after his death on July 6, 2012. It cannot be taxed in the hands of deceased employee X as it becomes due and is paid after his death. This amount is not taxable in the hands of legal heirs also as it does not partake the character of income in their hands but is only a part of the estate devolving upon them. B. Pension

DIRECT TAXATION I 4.11

Income from Salaries

Tax treatment of pension in different cases:Different situations Case -1 Case -2 Pension is received from UNO by the employee or his family members Family pension received by the family members of armed forces (after the death of employee) Family pension received by family members in other cases (after the death of employee) Tax treatment It is not chargeable to tax It is exempt under section 10(19) after fulfilling of certain condition. It is taxable in the hand of recipients under section 56 under the head "Income from Other Sources. Standard deduction is available under section 57 which is 1/3 of such pension or ` 15,000, whichever is lower.

Case -3

1. Taxability of Uncommuted Pension or Monthly Pension: (a) Pension is received periodically by the retired employee (b) It may be received by Government or non-government employees (c) Amount received shall be fully taxable under the head Salaries 2. Taxability of Commuted Pension: (a) Pension is received in lumpsum as per the terms of the employment on retirement or superannuation. (b) Full Value of Commuted Pension = Amount received on commutation/percentage of commutation. (c) Taxability: Recipient Government employee ( Central/State/Local Authority or Statutory Corporation) Non-Govt. employee who has also received Gratuity u/s 10(10A)(ii) Non-Govt. employee who has not received Gratuity u/s 10(10A)(iii) Amount Taxable Fully exempted u/s 10(10A)(i) Amount Received Less: 1/3 of Full Value of Commuted Pension Amount Received Less:1/2 of Full Value of Commuted Pension

4.12 I DIRECT TAXATION

In accordance with the aforesaid rules, pension is chargeable to tax on "accrual" basis whether it is received voluntarily or under a contract. Arrears of pension are also assessable on "due" basis whether paid or not. In respect of the arrear pension which is not exempt from tax, the assessee can, however, claim relief under section 89. Notified Pension Scheme- These provisions are given below:(i) Contribution by Central Government or any other employer to the Notified Pension Scheme (NPS) is first included under the head Salaries in hand of employee. (ii) Such contribution is deductible (to the extent of 10 percent of the salary of the employee) under section 80CCD. (iii) Employees contribution to the Notified Pension Scheme (NPS) (to the extent of 10 percent of the salary of the employee) is also deductible under section 80CCD. (iv) When pension is received out of the aforesaid amount, it will be chargeable to tax in the hand of the recipient. (v) The aggregate amount of deduction under section 80C, 80CCC and 80CCD cannot exceed `1,00,000. (vi) Salary for the purpose of point (ii) & (iii) includes basic salary and dearness allowance (if the term of employment so provided) but excluded all other allowances and perquisites. C. Leave Encashment

1. Leave encashment while in service is fully taxable as income of Previous Year in which it is encashed. 2. Leave encashment on retirement: (a) If an individual receives leave encashment on his retirement, then the amount received will be eligible for exemption. (b) The amount of exemption is based on his employment: (i) Government employee: fully exempted from tax (ii) Non-Govt. employee: An individual who is not a Government employee is also entitled for exemption in respect of leave encashment compensation received by him.

DIRECT TAXATION I 4.13

Income from Salaries 3. Computation of exemption from Leave Encashment: Step 1: Computation of Salary = 10 months average salary preceding the month of retirement. Step 2: Salary = Basic Pay + Dearness Allowance (forming a part of salary for retirement benefits) + Commission (if received as a fixed percentage on turnover) Step 3: This calculation is only applicable where the employer has sanctioned leave to the employee in excess of 30 days for every completed year of service. Particulars (i) Leave credit available on the date of retirement Less: Excess leave sanctioned by the employer (Leave sanctioned by the employer per year leave @ 30 days per year) x No. of completed years of service Leave credit on the basis of 30 days credit for completed years of service (ii) Leave salary on the basis of 30 days credit = Step 3(i) Step 1 (Amount in `) No. of Days xxx (xxx) xxx

` xxxx

Note: In case the employer sanctioned leave of 30 days or less for completed year of service then the salary for actual leave balance shall be considered and Step 3(i) shall not apply. 4. Computation of Taxable Leave Salary/Encashment on Retirement: Particulars Amount received on Leave Salary/Encashment Less: Exemption u/s 10(10AA): Least of the followings: (i) Actual amount of leave encashment received (ii) Average salary of the individual x 10 months (iii) Maximum limit (iv) Leave credit ( as per computation stated in 3 above) Taxable Value of Leave Salary/Encashment Note: (a) If the individual receives leave encashment from more than one employer, the quantum of exemption will be computed independently in respect of each employer. (b) The total amount of exemption should not exceed ` 3,00,000 during his life time. D. Retrenchment Compensation [Sec.10(10B)] Compensation is received by a workman at the time of: (i) Closing down of the undertaking. (ii) Transfer (irrespective of by agreement/compulsory acquisition) if the following conditions are satisfied: Amount (`) Amount (`) xxxx

xxxx xxxx 3,00,000 xxxx xxxx

Service of workmen interrupted by transfer Terms and conditions of employment after transfer are less favourable New employer is not under a legal obligation whether under the terms of transfer or otherwise to pay compensation on the basis that the employees service has been continuous and has not been interrupted by transfer.

4.14 I DIRECT TAXATION

Note: (a) Retrenchment compensation received in accordance with any scheme, which is approved by the Central Government, is fully exempt from tax. (b) An individual who receives retrenchment compensation is entitled for exemption u/s 10(10B). Computation of Taxable Retrenchment Compensation Particulars Amount received as Retrenchment Compensation Less: Exemption u/s 10(10B): Least of the followings: (i) Actual amount received (ii) Amount determined under the Industrial Disputes Act,1947 (iii) Maximum Limit Taxable amount of Retrenchment Compensation E. Voluntary Retirement Compensation u/s 10 (10C) Amount (`) xxxx xxxx 5,00,000 xxxx Amount (`) xxxx

Conditions for claiming exemption: (i) An individual, who has retired under the Voluntary Retirement Scheme, should not be employed in another company of the same management. (ii) He should not have received any other Voluntary Retirement Compensation before from any other employer and claimed exemption. (iii) Exemption u/s 10(10C) in respect of Compensation under VRS can be availed by an Individual only once in his lifetime.

DIRECT TAXATION I 4.15

Income from Salaries Computation of Exemption: Step 1: Salary = Last drawn salary = Basic Pay + D.A. (considered for retirement benefits) Step 2: Computation of Taxable VRS compensation Particulars Amount received as VRS Compensation Less: Exemption u/s 10(10C): Least of the followings: (i) Actual amount received (ii) Maximum Limit (iii) The highest of the followings : (a) Last drawn salary x 3 x No. of fully completed years of service xxxx (b) Last drawn salary x Balance no. of months of service left xxxx Taxable amount of Retrenchment Compensation 4.5 PROFITS IN LIEU OF SALARY [SECTION 17(3)] These payments are made to an employee in lien of salary even if these payments have no connection with the Profits of the employer. These are the followings:(a) Compensation for loss of employment or modification of the employment terms- Compensation for loss of employment or modification of terms of employment is generally treated as a capital receipt. But by virtue of section 17(3)(i), any compensation due to or received by an assessee from his employer or former employer at or in connection with the termination of his employment or modification of terms of employment is taxable as profit in lieu of salary. It is taxable on due or receipt basis, whichever come earlier. The recipient may claim exemption under section 10(10B) or 10(10C). The silent features are:(i) Compensation is received by an assessee from his employer or former employer; (ii) It is received at or in connection with termination of his employment or modification of terms and conditions relating thereto. (b) Payment from unrecognized provident or superannuation fund- Accumulated balance in any provident fund/superannuation fund of employers portion consists of the following:(i) Employers contribution; (ii) Interest on employers contribution is taxable subject to the following propositions (1) The provident fund/ superannuation fund is an unapproved fund; (2) These are taxable at the time of payment to the assessee Amount (`) Amount (`) xxxx xxxx 5,00,000 xxxx xxxx xxxx

(c) Payment from Keyman insurance policy- Any sum received under Keyman insurance policy (including the sum allocated by way of bonus on such policy) is taxable as policy in lieu of salary. (d) Profits in lieu of salary will include amount received in lump sum or otherwise, prior to employment or after cessation of employment for the purpose of taxation. (e) Any other payment due to or received [excluding Sec. 10(10A) /10(10B) /10(11) /10(12) / 10(13) / 10(13A)] by an assessee from his employer or former employer is treated as Profit in Lieu in Salary.

4.16 I DIRECT TAXATION

4.6 DEDUCTIONS AGAINST SALARY 1. Entertainment Allowance: Applicable only for Government Employees [ Sec.16(ii)] Least of the following will be allowed as a deduction: (i) Actual amount of entertainment allowance received; (ii) 20% of basic salary of the individual (iii) ` 5,000 2. Professional Tax [Sec.16(iii)] (i) Professional tax or tax on employment paid by an employee, levied under a State Act shall be allowed as deduction ;

(ii) such deduction is available only on actual payment; (iii) If an employer pays professional tax on behalf of his employee, then it will first be included in the Salary as a perquisite and then, allowed as a deduction. 4.7 VALUATION & TAXABILITY OF PERQUISITES Perquisite: A perquisite is defined in the Oxford English Dictionary as any casual emolument, fee or profit, attached to an office or position in addition to the salary or wages. Perquisite has a known normal meaning, namely, personal advantage. In simple words, perquisites are the benefits in addition to normal salary to which the employee has a right by virtue of his employment. The essential feature of a perquisite is that an employee should have a right to the same and that it should not be a mere voluntary or contingent payment. Perquisite includes: (a) Value of rent free accommodation given by the employer (b) Value of accommodation given at concessional rate (c) Value of benefit given free of cost or at concessional rate in the following cases: (i) given by employer to his Director Employee; (ii) given by employer to his employee who owns 20% or more of voting power in the company, and (iii) given by any employer (including company) to his employees whose monetary salary exceeds `50,000

(d) Any sum paid by the employer on behalf of the employees (e) Sum paid/payable by the employer towards insurance on the life of the individual or annuity payments (f) Value of any other fringe benefit or amenity. [Sec. 17(2)(vi)]

DIRECT TAXATION I 4.17

Income from Salaries 4.7.1 Perquisites which are fully exempted from Tax The following perquisites are exempt from tax in all cases and hence not includible for the purpose of tax deduction at source under section 192: 1. Provision for medical facilities subject to limit 2. Tea or snacks provided during working hours 3. Free meals provided during working hours in a remote area or an offshore installation 4. Perquisites allowed outside India by the Government to a citizen of India for rendering service outside India. 5. Sum payable by an employer through a recognized provident fund or an approved superannuation or deposit-linked insurance fund established under the Coal Mines Provident Fund or the Employees Provident Fund. 6. Employers contribution to staff group insurance scheme. 7. Leave travel concession subject to Sec. 10(5) 8. Payment of annual premium by employer on personal accident policy affected by him on his employee 9. Free educational facility provided in an institute owned/maintained by employer to children of employee provided cost/value does not exceed ` 1,000 per month per child (no limit on no. of children)

10. Interest-free/concessional loan of an amount not exceeding ` 20,000 11. Computer/laptop given (not transferred) to an employee for official/personal use. 12. Transfer without consideration to an employee of a movable asset (other than computer, electronic items or car) by the employer after using it for a period of 10 years or more. 13. Traveling facility to employees of railways or airlines. 14. Rent-free furnished residence (including maintenance thereof) provided to an Official of Parliament, a Union Minister or a Leader of Opposition in Parliament. 15. Conveyance facility provided to High Court Judges u/s 22B of the High Court Judges (Conditions of Service) Act, 1954 and Supreme Court Judges u/s 23A of the Supreme Court Judges (Conditions of Service) Act, 1958. 16. Conveyance facility provided to an employee to cover the journey between office and residence. 17. Accommodation provided in a remote area to an employee working at a mining site or an onshore oil exploration site, or a project execution site or an accommodation provided in an offshore site of similar nature. 18. Accommodation provided on transfer of an employee in a hotel for not exceeding 15 days in aggregate. 19. Interest free loan for medical treatment of the nature given in Rule 3A. 20. Periodicals and journals required for discharge of work. 21. Tax on perquisite paid by employer [Sec. 10(10CC)] 22. Other Exempted Payments: (a) Bonus paid to a football player after the World Cup victory to mark an exceptional event; (b) Payment made as a gift in appreciation of the personal qualities of the employee;

4.18 I DIRECT TAXATION

(c) Payment of proceeds of a benefit cricket match to a great cricket player after he retired from test match; (d) Trust for the benefit of employees children.

4.7.2 Medical Facilities (a) Fixed medical allowance is fully taxable (b) Medical payments include reimbursements also [Circular no.603/6.6.1991] Medical Treatment in India: 1. Local treatment to employee or any member of his family in: (a) Hospital maintained by employer (b) Government Hospital (c) Notified hospital for prescribed diseases [Sec.17(2)(v)] Family includes spouse, children (whether dependent or independent) and parents, brothers and sisters wholly dependent on the employee. 2. Group Medical insurance paid u/s 36(1)(ib) & Medical Insurance paid u/s 80D- which are approved by the Central Govt. or IRDA w.e.f. A.Y.2007-08. 3. Any other medical expenditure reimbursed subject to a maximum of ` 15,000. Medical Treatment Abroad (for the patient and the attendant): If the employee underwent medical treatment abroad and the expenditure is met by the employer, the exemption will be subject to the following: 1. Medical treatment and stay expenses abroad (both for the patient and the attendant) is exempt from tax, subject to the maximum amount permitted by the Reserve Bank of India. 2. Travel expenditure of the patient and the attendant: Gross Total Income, before including reimbursement of Foreign Travel Expenditure Upto ` 2,00,000 Above ` 2,00,000 3. Computation of exemption for foreign travel expenditure Step 1: Compute Gross Total Income of the assessee without considering foreign travel reimbursement but after set-off loss and unabsorbed depreciation. Step 2: If the Gross Total Income does not exceed ` 2 lakhs, Foreign Travel Reimbursement is not taxable otherwise fully taxable. Step 3: If Foreign Travel reimbursement is taxable as per Step 2, recomputed the income under the head Salary after including foreign travel reimbursement and Gross Total Income must also be recomputed. Amount of Exemption Fully Exempted Fully Taxable

DIRECT TAXATION I 4.19

Income from Salaries 4.7.3 Accommodation Facilities 1. Value of Unfurnished Accommodation: Explanation 1 to Sec.17(2), Rule 3(1) Nature of Perquisite Provided by Central Govt. or State Govt. Taxable Value of Perquisite Licence fee determined by the Government Less: Rent recovered from employee

Provided by Employer other than Central or State Government (a) owned by employer In cities having population exceeding 25 lakhs as per 2001 census: 5% of Salary Less Rent actually paid by employee In cities having population exceeding 10 lakhs but not exceeding 25 lakhs as per 2001 census: 10% of Salary Less Rent actually paid by employee In other places: 7.5% of Salary Less Rent actually paid by employee (b) taken on lease by the employer Rent paid by the employer or 15% of Salary whichever is lower Less Rent recovered from employee 24% of salary paid/payable or actual charges paid/payable whichever is lower Less: Amount paid or payable by the employee

(c) Accommodation in a hotel

Hotel Accommodation: Accommodation provided in a hotel will not be a taxable perquisite if the following two conditions are fulfilled: (a) The period of such accommodation does not exceed 15 days (b) Such accommodation has been provided on the transfer of the employees from one place to another. 2. Value of Furnished Accommodation Particulars Value of unfurnished accommodation as above Add : Value of Furniture provided: If owned by employer, 10%p.a. of original cost of such furniture If hired from third party, then Actual hire charges Less: Any charges paid or payable by the employee Value of Furnished Accommodation (xxx) xxx ` xxx xxx

Note: Furniture includes Television sets, radio, refrigerator, other household appliance, air-conditioning plant or equipment.

4.20 I DIRECT TAXATION

3. Valuation not applicable: (a) Employees working at mining site, onshore oil exploration site, offshore site, project execution site, dam site, power generation site. (b) Conditions to be fulfilled: (i) The accommodation should be of a temporary nature, and (ii) Plinth area should not exceed 800 square feet (iii) Accommodation should be located at least 8 kms away from local limits of municipality/ cantonment or located in a remote area

Remote area means area located at least 40 kms away from town having a population not exceeding 20,000 based on latest published All-India census. 4. Valuation of accommodation in case of Employees on transfer: (a) For the first 90 days of transfer: Where accommodation is provided both at existing place of work and in new place, the accommodation, which has lower value, shall be taxable. (b) After 90 days: Both accommodations shall be taxable. 5. Salary for Valuation of Accommodation facilities: Salary includes Basic Salary D.A. (if considered for retirement benefits) All taxable allowances Bonus or commission or ex-gratia Any other monetary payment Salary excludes Other D.A Employers contribution to PF Exempted allowances Perquisites u/s 17(2) Perquisites u/s 17(2)(iii) or its provisions

4.7.4 Other Facilities and Perquisites to Employee and his Household Rule 3(3) 3(4) Nature of Perquisite Service of sweeper, gardener or watchman or personal attendant Supply of gas, electricity or water for household consumption Taxable Value of Perquisite(TVP) Actual cost to the employer Less: Amount paid by employee (i) Procured from outside agency Amount paid to outside agency (ii) Resources owned by employer himself Manufacturing cost per unit Less: amount paid by the employee If the cost of education per child does not exceed ` 1,000 p.m.- then not taxable For points (b) & (c) In other case, cost to the employer Less: amount recovered from employee

3(5)

Education facilities to members of his household (a) free education to children in the school maintained by the employer or the school sponsored by the employer (b) other schools (c) for other members of the household

DIRECT TAXATION I 4.21

Income from Salaries 3(7)(i) Housing Loan/Vehicle Loan- for acquiring capital assets and not for repairs SBI Rate= SBI Rate prevailing on the first day of the Previous Year Other Loans Interest charged by employer is equal to or higher than SBI rates. It is not a taxable perquisite. Interest charged is lower than SBI rates: Interest charged at SBI rates on maximum outstanding balance Less: Interest paid by the employee on that loan Exceptions : (a) Medical loan for treatment of diseases specified in Rule 3A except loan reimbursed by medical insurance (b) Loan not exceeding ` 20,000 in aggregate 3(7) (vii) Use of any movable asset other than computer or laptops or other assets already mentioned 10% of Actual Cost if owned by the employer; or Actual rental charge paid/payable by the employer Less: Amount recovered from employee

Note: Members of household includes: spouse(s), children and their spouses, parents, servants and dependents. 4.7.5 Transfer of Movable Assets to Employees [Rule 3(7)(viii)] Particulars Computer & Electronic Gadgets WDV 50% XXXXX (XXXXX) XXXXX (XXXXX) XXXXX Car Other Movable Assets SLM 10% XXXXX (XXXXX) XXXXX (XXXXX) XXXXX

Method of Depreciation Rate of Depreciation for every completed year Actual Cost Less : Depreciation for completed years WDV at the end of completed years Less :Sale Value taken from Employee Taxable Value of Perquisite Note:

WDV 20% XXXXX (XXXXX) XXXXX (XXXXX) XXXXX

(a) Electronic gadgets include computer, digital diaries and printers, but excludes washing machines, microwave ovens, hot plates, mixers, ovens, etc. (b) Transfer of Assets, which are 10 years old, shall not attract tax liability. (c) Member of household includes: Spouse(s), children and their spouses, parents, servants and dependents. (d) Completed year means actual completed year from the date of acquisition of the asset to the date of transfer of such asset to the employees.

4.22 I DIRECT TAXATION

4.7.6 Taxability of Perquisites provided by Employers 4.7.6.1 Taxability of Motor Car Benefits Owner of Car 1(a) Employer 1(b) Employer Expenses borne by Employer Employer Purpose Fully official Fully private Taxable value of Perquisite Not a perquisite provided the documents as specified in Rule 3(2)(B) are maintained Total of: (i) Actual expenditure on car (ii) Remuneration to Chauffeur (iii) 10% of the above cost of car (normal wear & tear) Less: Amount charged from employee Cubic capacity of car engine upto 1.6 litres ` 1,800 p.m. + ` 900 p.m. for chauffeur Cubic capacity of car engine above 1.6 litres ` 2,400 p.m. + ` 900 p.m. for chauffeur Cubic capacity of car engine upto 1.6 litres ` 600 p.m. + ` 900 p.m. for chauffeur Cubic capacity of car engine above 1.6 litres ` 900 p.m. + ` 900 p.m. for chauffeur Not a perquisite provided the documents as specified in Rule 3(2)(B) are maintained Subject to Rule 3(2)(B) Actual expenditure incurred Less: Car cubic capacity upto 1.6 litres [i.e. value as per 1(c)(i)] Or Car cubic capacity above 1.6 litres [ i.e. value as per 1(c)(i)] Not a perquisite provided the documents as specified in Rule 3(2)(B) are maintained

1(c)(i) Employer

Employer

Partly official and partly for personal use Partly for official and partly for personal use Fully official use Partly official and partly personal

1(c)(ii) Employer

Employee

2(i) Employee 2(ii) Employee

Employer Employer

3(i) Employee owns other automotive but not car 3(ii) employee owns other automotive but not car

Employer

Fully official use

Employer

Partly for official use and partly for personal use

Subject to Rule 3(2)(B) Actual expenditure incurred by employer Less: ` 900 p.m.

Note: 1. Using cars from pool of cars owned or hired by Employer: The employee is permitted to use any or all cars for both official and personal use: For one car For more than one car Valued as per 1(c)(i) Valued as per 1(b) as if fully used for personal purpose

2. Documents to be maintained for claiming non-taxable perquisite or higher deduction wherever applicable [ Rule 3(2)(B)]: (a) Employer should maintain complete details of journey undertaken for official purpose, which includes date of journey, destination, mileage and amount of expenditure incurred thereon.

DIRECT TAXATION I 4.23

Income from Salaries (b) Certificate of supervising authority of the employee, wherever applicable, to the effect that the expenditure incurred for wholly and exclusively for performance of official duties, should be provided.

4.7.6.2 Taxability of other benefits Rule 3(6) Nature of Perquisite Transportation of goods or passengers at free or concessional rate provided by the employer engaged in that business (other than railways/airlines) Travelling, touring, accommodation and other expenses met by the employer other than specified in Rule 2B (this shall be calculated only for the period of vacation) Free meals during office hours. Free meal in remote area or offshore installation area is not a taxable perquisite Taxable Value of Perquisite (TVP) Value at which offered to public Less: Amount recovered from the employee

3(7)(ii)

Amount recovered by employer or value at which offered to public Less: Amount recovered from employee

3(7)(iii)

Actual cost to the employer in excess of ` 50 per meal or tea or snacks Less: Amount recovered from the employee Tea or non-alcoholic beverages and snacks during working hours is not taxable Value of gift ( In case the aggregate value of gift during the Previous Year is less than ` 5,000, then it is not a taxable perquisite) Actual expenditure to employer is taxable Less: Amount recovered from employee (If it is incurred for official purpose and supported by necessary documents then it is not taxable) Actual expenditure incurred by the employer Less: Amount recovered from employee If the expenditure is incurred exclusively for official purposes and supported by necessary documents then it is not taxable. Initial fee of corporate membership of a club is not a taxable perquisite Cost to the employer Less: Amount recovered from employee

3(7) (iv)

Value of any gift or voucher or token other than gifts made in cash or convertible into money (i.e. gift cheques) on ceremonial occasion Expenditure incurred on credit card or add on card including membership fee and annual fee Expenditure on club other than health club or sports club or similar facilities provided uniformly to all employees

3(7)(v)

3(7)(vi)

3(7)(ix)

Any other benefit or amenities or service or right or privilege provided by the employer other than telephone or mobile phone

Note: Members of household includes spouse/(s), children and their spouses, parents, servants and dependants

4.24 I DIRECT TAXATION

4.7.6.3 Employee Stock Option [ESOP] 1. Employee Stock Option means any specified Securities or Sweat Equity Shares, allotted or transferred by the present or former Employer, to the Employee, directly or indirectly, either free of cost or at a concessional price. 2. Specified Security means Securities as defined in Securities Contracts (Regulation) Act, 1956 and where Employees Stock Option has been granted under any plan or scheme, includes securities offered under such Plan/ Scheme. 3. Sweat Equity Shares means Equity Shares issued by a Company to its Employees or Directors, at a discount or for consideration other than cash, for a) providing know-how, or (b) making available intellectual property rights, or (c) value additions, by whatever name called. 4. Value of the Security or Sweat Equity Shares = FMV of the Security / Sweat Equity Shares as on the date of exercise of Option Minus Amount recovered from the Employee. 5. Fair-Market Value (FMV) means the Value determined in the prescribed manner. [See Table below] 6. Option means a right but not an obligation granted to an Employee, to apply for the specified Security or Sweat Equity Shares, at a pre-determined price. As per Rule 40C the Fair Market Value shall be determined as underParticulars 1. Shares of an Unlisted Company 2. Shares of a Listed Company (a) Trading on the date of vesting of option: Listed in one Recognised Stock Exchange Listed in more than one Recognised Stock Exchange (b) No Trading on the date of vesting of option: Listed in one Recognised Stock Exchange Listed in more than one Recognised Stock Exchange Fair Market Value As determined by a Merchant Banker on the specified date.

Average of Opening and Closing Price on the date of exercising of option. Average of Opening and Closing Price in the Stock Exchange that records the highest volume of trading in Shares on the date of exercising of option. Closing Price of the Share on any Recognised Stock Exchange on a date closest and immediately preceding the date of exercising of option. Closing Price of the Share on the Stock Exchange on a date closest and immediately preceding the date of exercising of option in the Stock Exchange that records the highest volume of trading in shares. As determined by a Merchant Banker on the specified date. (Notfn. No.11/2008 dt. 18.01.2008)

3. FMV of specified Security, not being an Equity Share in the Company (Rule 40D)

DIRECT TAXATION I 4.25

Income from Salaries 4.7.6.4 Taxability of Perquisites (At a glance) Perquisites Rent free/concessional accommodation Watchman, gardener, sweeper, personal attendant engaged by employee and expenses met by the employer The aforesaid mentioned servants provided in any other manner Gas, electricity, water, etc. for household consumption and the connection in the name of employee but expenses paid by the employer Above facilities provided in any other manner Education expenses, if the bills are in the name of employee, but met by employer Above facilities provided in any other manner Transport facilities provided by transport undertakings, other than Railways, Airlines Interest free loans or loans provided at concessional rates by the employer to employee Holiday home facilities provided Club facility provided by employer(other than official purposes) Computer/laptop provided by the employer for use by the employee Other movable assets provided by the employer for use by the employees Sale/transfer of movable assets to employees Magazines, periodicals, journals, etc. for official work Medical facilities, if the bills are in the name of employee, but met by employer above ` 15,000 Above facility in any other manner Leave travel concession Stock option under approved scheme Specified Employee Taxable Taxable Non-Specified Employee Taxable Taxable

Taxable Taxable

Non-taxable Taxable

Taxable Taxable Taxable Taxable Taxable Taxable Taxable Non-taxable Taxable Taxable Not taxable Taxable Taxable Not taxable subject to 10(5) Not taxable

Non-taxable Taxable Non-taxable Taxable Taxable Taxable Taxable Non-taxable Taxable Taxable Not taxable Taxable Non-taxable Not taxable subject to Sec.10(5) Not taxable

4.26 I DIRECT TAXATION

4.8 PROVIDENT FUNDS Particulars Statutory Provident Fund(SPF) Provident Funds Act,1952 Recognized Provident Fund (RPF) EPF and Miscellaneous Provisions Act, 1952 & recognized by the Commissioner of PF and CIT Employer and employee Deduction u/s 80C Amount exceeding 12% of salary is taxable Exempted upto 9.5% p.a. Any excess is taxable Unrecognized Provident Fund (URPF) Not recognized by the Commissioner of Income Tax Public Provident Fund (PPF) Public Provident Fund Act,1968 Account in SBI or Post Offices

Constituted under

Contributed by Assessees contribution Employers Contribution Interest credited

Employer and employee Deduction u/s 80C Not taxable

Employer and employee No Income tax benefit Not taxable at the time of contribution On Employees Contribution Taxable under the Head Income from Other Sources On Employers contribution not taxable at the time of credit

All assessees independently Deduction u/s 80C Not applicable

Fully exempted

Fully exempted

Withdrawal at the time of retirement or resignation or termination, etc

Exempted u/s 11

Exempted u/s 10(12) subject to conditions

Employees contribution and interest thereon is not taxable Employers contribution and interest thereon is taxable as Profits in lieu of Salary, under the head Salaries

Exempted u/s 10(11)

Note: Sum received by an Employee under approved Superannuation Fund is also exempt from tax u/s 10(13). Amount transferred from unrecognized provident fund to recognized provident fund- Out of the sum standing to the credit of an employee under recognized provident fund which is accorded recognition for the first time or a part of the sum transfer from unrecognized provident fund to the recognized provident fund is taxable under the head salaries. Of all the sums comprises in the transferred balance, the amount which would have been liable to tax if provident fund had been recognized from the date of institution of the fund, shall be deemed to be the income received by the employee in the Previous Year in which

DIRECT TAXATION I 4.27

Income from Salaries recognition of the fund takes effect. The remaining amount is not chargeable to tax. No other relief or exemption is granted. Employers Contribution to RPF is excluded from Salary 1. If the employee has rendered continuous service with his employer for a period of 5 years or more. 2. If he has not rendered such continuous service of 5 years, then the service has been terminated: (a) By reason of such employees ill health, or (b) By the contraction or discontinuance of the employers business, or (c) Any other cause beyond the control of the employee 3. If, on the cessation of his employment, the employee obtains employment with another employer, to the extent, the accumulated balance due and becoming payable to him is transferred to his individual account in any recognized fund maintained by such employer. The period of service rendered under the previous employer(s) should also be included in determining the period of continuous service in (3) above. 4.9 SALARY UNDER DIFFERENT CIRCUMSTANCES AT A GLANCE For the purpose of 1. Deduction for Entertainment Allowance u/s 16(ii) in case of Government employees 2. Voluntary Retirement Compensation u/s 10(10C) 3. Exemption from Gratuity covered under Payment of Gratuity Act u/s 10(10)(ii) 4. Exemption from Gratuity not covered under Payment of Gratuity Act u/s 10(10)(iii) 5. Exemption for Leave Salary u/s 10(10AA) 6. Exemption for House Rent Allowance u/s 10(13A) Rule 2A 7. Contribution to Recognized Provident Fund 8. Determination of Specified Employee u/s 17 including the value of non-monetary benefits 9. Rent- free accommodation Basic Pay Basic Pay + D.A. ( forming part of salary for retirement benefits) Basic Pay + D.A. Basic Pay + D.A. ( forming part of salary for retirement benefits) + Commission ( if received as a fixed percentage on turnover) Same as above Same as above Same as above Income under the head salaries without benefits Salary includes: Basic Pay Dearness Allowance ( forming part of salary for retirement benefits) Employers Contribution to RPF All Taxable allowances Bonus or commission or ex-gratia Any other monetary payment Means

4.28 I DIRECT TAXATION

Salary excludes: Dearness Allowance ( not forming part of salary) Exempted allowances Perquisites u/s 17(2) or 17(2)(iii) or its provisions Any allowance in the nature of medical facility to the extent not taxable 4.10 TAX ON SALARY OF NON-RESIDENT TECHNICIANS [SECTION 10(5B)] In Finance Act, 1993 clause (5B) has been inserted in section 10 with effect from the Assessment Year 199495. Exemption under section 10(5B) is not available from the Assessment Year 2003-04. Salary of Foreign Citizens: (i) Salary of diplomatic personnel [Section 10(6)(ii)]- Remuneration received by foreign citizen as an official of an embassy, high commission, legation, commission, consulate or trade representation of a foreign state, or a member of the staff of any of that official will be exempt from tax if corresponding Indian official in that foreign country enjoys a similar exemption. (ii) Salary of foreign employees [Section 10(6)(vi)]- The remuneration received by a foreign national, as an employee of a foreign enterprise, for services rendered by him during his stay in India, is totally exempt from tax provided: (a) the foreign enterprise is not engaged in any business or trade in India; (b) his stay in India does not exceed a period of 90 days in such Previous Year; and (c) such remuneration is not liable to be deducted from the income of the employer chargeable under the Income Tax Act. (iii) Salary received by a ships crew [Section 10(6)(viii)]- Salary received by, or due to, a non-resident foreign national as a member of a ships crew is exempt from tax provided his total stay in India does not exceed 90 days during the Previous Year. (iv) Remuneration of a foreign trainee of foreign nation as an employee of a foreign government, during his stay in India, is exempt from tax, if remuneration is received in connection with training in an undertaking or office owned by-(a) the Government; or(b) any company owned by the Central Government or any State Government; or (c) any company which is subsidiary of a company referred to in (b) supra; or (d) any statutory corporation; or (e) any co-operative society, wholly financed by the Central Government, or any State Government. 4.11 RELIEF UNDER SECTION 89 If an individual receives any portion of his salary in arrears or in advance or receives profit in lieu of salary, he can claim relief in terms of section 89 read with rule 21A as under: Computation of relief when salary has been received in arrears or in advance [Rule 21A(2)] The relief on salary received in arrears or in advance (hereinafter to be referred as additional salary) is computed in the manner laid down in rule 21A (2) as under: 1. 2. 3. 4. Calculate the tax payable on the total income, including the additional salary, of the relevant Previous Year in which the same is received. Calculate the tax payable on the total income, excluding the additional salary, of the relevant Previous Year in which the additional salary is received. Find out the difference between the tax at (1) and (2). Compute the tax on the total income after including the additional salary in the Previous Year to which such salary relates.

DIRECT TAXATION I 4.29

Income from Salaries 5. 6. 7. Compute the tax on the total income after excluding the additional salary in the Previous Year to which such salary relates. Find out the difference between the tax at (3) and (4). The excess of tax computed at (3) over tax computed at (6) is the amount of relief admissible under section 89. No relief is, however, admissible if tax computed at (3) is less than tax computed at (6). In such a case, the assessee-employee need not apply for relief.

If the additional salary relates to more than one Previous Year, salary would be spread over the Previous Years to which it pertains in the manner explained above.

4.30 I DIRECT TAXATION

ILLUSTRATIONS ON INCOME FROM SALARIES

Illustration 1. Mr. Z has joined ICC Ltd. on 1st July, 2009 in the scale of `15,000 -1,500 21,000 2,500 31,000. Compute gross salary for the Previous Year 2012-13. Solution: Computation of Gross Salary for the Previous Year 2012-13 Particulars Salary for (i) April 2012 to June 2012 (ii) July 2012 to March 2013 Gross Salary Workings: Previous Year 2009-10 2010-11 2011-12 2012-13 April to June Nil 15,000 16,500 18,000 July to March 15,000 16,500 18,000 19,500 Amount (`) 18,000 x 3 19,500 x 9 Amount (`) 54,000 1,75,500 2,29,500

Illustration 2. Mr. Kabir is getting a salary of ` 12,000 p.m. w.e.f. 1.4.2011. He is promoted w.e.f. 31.12.2011 and got arrears of ` 75,000. Bonus for the year 2012-13 is ` 15,000 remains outstanding but bonus of ` 12,000 for the year 2011-12 was paid on 1st January 2013. In March 2013, he got two months salary i.e. April and May 2013 in advance. Compute gross salary for the Previous Year 2012-13. Solution: Computation of Gross Salary for the Previous Year 2012-13 Particulars Basic Salary : `12,000 x 12 months Add: Arrears of Salary Add: Bonus for the year 2012-13 ( Receivable) Add: Bonus for the year 2011-12 ( Received) Add: Advance Salary : for April & May 2013 : `12,000 x 2 months Gross Salary Amount (`) Amount (`) 1,44,000 75,000 12,000 24,000 2,55,000

Illustration 3. Mr. Pradip, a foreign technician is employed with an Indian company. His contract of service was approved by the Government. He was in receipt of bonus from the said Company where he is working. The Assessing Officer subjected the amount to tax on the ground that bonus receipt falls outside the purview of the contract of service. Is the Assessing Officer justified? Solution: U/s 9(1)(ii) salary earned in India is deemed to accrue or arise in India and is taxable in India. The salary and bonus paid to a foreign technician for services rendered in India is taxable in India and the same is not entitled for any exemption from the Assessment Year 2008-09 onwards. Illustration 4. Amal Kumar, an Indian citizen, is posted in the Indian High Commission at Nairobi during the Previous Year 2012-13. His emoluments consist of Basic Pay of `1,50,000 per month and overseas allowance of ` 60,000 per month. Besides, he is entitled to & fro journey to India and also use Governments car at Nairobi. He has no taxable income except salary income stated above.

DIRECT TAXATION I 4.31

Income from Salaries Compute tax liability if he is a non-resident during the Previous Year 2012-13 Solution: (1) U/s 9(1)(iii), Salary paid by the Government of India to an Indian citizen for services rendered outside India is deemed to accrue or arise in India and is therefore taxable in India. (2) U/s 10(7), allowances or perquisites paid by the Government of India to an Indian citizen or services rendered outside India, is fully exempt from tax. (3) Computation of Gross Salary for the Previous Year 2012-13 Particulars Salary : `1,50,000 x 12 months Add: Overseas allowance `60,000 x 12 months Less: Exemption u/s 10(7) Gross Salary Less: Deduction u/s 16 Income under the head Salaries 7,20,000 7,20,000 Nil 18,00,000 Nil 18,00,000 Amount (`) Amount (`) 18,00,000

Computation of Tax Liability

Particulars Upto ` 2,00,000 ` 2,00,001 to ` 5,00,000 = @ 10% of ` 3,00,000 ` 5,00,001 to ` 10,00,000 = @ 20% of ` 5,00,000 ` 10,00,001 to ` 18,00,000 = @ 30% of ` 8,00,000 Tax ( excluding cess) Add: Education Cess @ 2% Add: Secondary and Higher Education Cess @ 1% Tax Liability ( including Cess) Amount (`) Nil 30,000 1,00,000 2,40,000 3,70,000 3,70,000 7,400 3,700 3,81,100 Amount (`)

Illustration 5. A, is entitled to a basic salary of ` 5,000 p.m. and dearness allowance of ` 1,000 p.m., 40% of which forms part of retirement benefits. He is also entitled to HRA of ` 2,000 p.m. He actually pays ` 2,000 p.m. as rent for a house in Delhi. Compute the taxable HRA. Solution: Salary for House Rent Allowance = Basic Pay + D.A. (considered for retirement benefits) + Commission (if received as a fixed percentage on turnover as per terms of employment) = (5,000 12) + (40% 1,000 12) = 64,800 Computation of Taxable House Rent Allowance Particulars Amount received during the financial year for HRA Less: Exemption u/s 10(13A) Rule 2A Least of the followings: (a) Actual amount received (b) 50% of Salary of ` 64,800 (c) Rent paid less 10% of Salary [2,000 12 10% of 64,800] Taxable House Rent Allowance 24,000 32,400 17,520 ` ` 24,000

17,520 6,480

4.32 I DIRECT TAXATION

Illustration 6. X, is employed at Delhi as Finance Manager of R Ltd. The particulars of his salary for the Previous Year 2012-13 are as under: Basic Salary ` 16,000 p.m.; Dearness allowance ` 12,000 p.m.; Conveyance Allowance for personal purpose ` 2,000p.m.; Commission @2% of the turnover which was achieved ` 9,00,000 during the Previous Year and the same was evenly spread. HRA of `6,000 p.m. was received. The actual rent paid by him `5,000 p.m. for an accommodation at till 31.12.12. From 1.1.13 the rent was increased to `7,000 p.m. Compute taxable HRA. Note : If there is an increase in rent paid, it is advisable to calculate the exemptions separately based on the time period. Rent before and after increase. Solution: Salary for HRA (for 9 months)= Basic Pay + DA(considered for retirement benefits) + Commission (if received as a fixed percentage on turnover as per terms of employment = (16,000 9)+ (12,000 9) + (2% of 9,00,000 9/12) = 2,65,500. Computation of Taxable House Rent Allowance Particulars Amount received during the financial year for HRA Less: Exemption u/s 10(13A) Rule 2A Least of the followings: (a) Actual amount received (b) 50% of Salary (c) Rent paid less 10% of Salary [5,000 9 10% of 2,65,500] Taxable House Rent Allowance Amount (`) Amount (`) 54,000

54,000 1,32,750 18,450 18,450 35,550

Salary for HRA (for 3 months) = Basic Pay + DA (considered for retirement benefits) + Commission (if received as a fixed percentage on turnover as per terms of employment) = (16,000 3) + (12,000 3) + (2% of 9,00,000 3/12) = 88,500. Computation of Taxable House Rent Allowance Particulars Amount received during the financial year for HRA Less: Exemption u/s 10(13A) Rule 2A Least of the followings: (a) Actual amount received (b) 50% of Salary (c) Rent paid less 10% of Salary [7,000 3 10% of 88,500] Taxable House Rent Allowance ` ` 18,000

18,000 44,250 12,150 12,150 5,850

Illustration 7. Z is employed in A Ltd. As on 31.3.13, his basic salary is `6,000 p.m. He is also entitled to a dearness allowance of 50% of basic salary. 70% of the dearness allowance is considered for retirement benefits. The company gives him HRA ` 3,000p.m. With effect from 1.1.13 he receives an increment of `1,000 in his basic salary. He was staying with his parents till 31.10.2012. From 1.11.12 he takes an accommodation on rent in Delhi and pays ` 2,500 pm as rent for the accommodation. Compute taxable HRA for the Previous Year 2012-13.

DIRECT TAXATION I 4.33

Income from Salaries Solution: Salary for the purpose of HRA shall cover the time period for which the assessee, who is in receipt of HRA, resided in a rented accommodation and the rent paid by such assessee, is more than 10% of salary. Salary for HRA (for 5 months) = Basic Pay + DA (considered for retirement benefits) + Commission (if received as a fixed percentage on turnover as per terms of employment) Basic Pay = (5,000 2) + (6,000 3) Add: DA = 50% of Basic Pay 70% forming part of retirement benefits [50 % 28,000 70%] = 9,800 Total Salary for HRA 37,800 = 28,000

Computation of Taxable House Rent Allowance Particulars Amount received during the financial year for HRA (3,000 12) Less: Exemption u/s 10(13A) Rule 2A Least of the followings: (a) Actual amount received (b) 50% of Salary (c) Rent paid less 10% of Salary [2,500x 5 10% of 37,800] Taxable House Rent Allowance Amount (`) Amount (`) 36,000

36,000 18,900 8,720

8,720 27,280

Illustration 8. Mr. Hari retires on 15th October 2012, after serving 30 years and 7 months. He gets ` 3,80,000 as gratuity. His salary details are given below: FY 2012-13 FY 2011-12 Salary `16,000 pm Salary `15,000 pm D.A. 50% of salary. 40% forms part of retirement benefits. D.A. 50% of salary. 40% forms part of retirement benefits

Determine the taxable value of gratuity in the following cases: (i) He retires from Government service (ii) He retires from seasonal factory in a private sector, covered under Payment of Gratuity Act, 1972. (iii) He retires from non-seasonal factory, covered by Payment of Gratuity Act, 1972 (iv) He retires from private sector, not covered by payment of Gratuity Act, 1972 Solution: (i) The amount of gratuity received as a Government employee is fully exempt from tax u/s 10(10)(i) (ii) As an employee of a seasonal factory, in a private sector, covered under the Payment of Gratuity Act, 1972 Computation of Taxable Gratuity

4.34 I DIRECT TAXATION

Particulars Amount received as Gratuity Less: Exemption u/s 10(10)(ii) Least of the followings: (a) Actual amount received (b) 7/26 x Last drawn salary x No. of years of completed service [ 7/26 x 24,000 x 31] (c) Maximum Limit Taxable Gratuity

Amount (`)

Amount (`) 3,80,000

3,80,000 2,00,308 10,00,000 2,00,308 1,79,692

(iii) As an employee of a non-seasonal factory, covered by Payment of Gratuity Act, 1972 Computation of Taxable Gratuity Particulars Amount received as Gratuity Less: Exemption u/s 10(10)(ii) Least of the followings: (a) Actual amount received (b) 15/26 x Last drawn salary x No. of years of completed service [ 15/26 x 24,000 x 31] (c) Maximum Limit Taxable Gratuity Note: Salary = Basic Pay + Dearness Allowance In case of seasonal employment, instead of 15 days, 7 days shall be considered. (iv) As an employee of a private sector, not covered by Payment of Gratuity Act, 1972. Computation of Taxable Gratuity Particulars Amount received as Gratuity Less: Exemption u/s 10(10)(iii) Least of the followings: (a) Actual amount received (b) x Average Salary x No. of fully completed years of service [ x18,720 x 30] (c) Maximum Limit Taxable Gratuity Note: Salary = 10 months average salary preceding the month of retirement. = Basic Pay + Dearness Allowance considered for retirement benefits + commission (if received as a fixed percentage on turnover) Salary for the months December 11 till September 12 shall have to be considered. 3,80,000 2,80,800 10,00,000 2,80,800 99,200 Amount (`) Amount (`) 3,80,000 3,80,000 4,29,231 10,00,000 3,80,000 NIL Amount (`) Amount (`) 3,80,000

DIRECT TAXATION I 4.35

Income from Salaries Basic Salary: (i) December 11 to March 12 (ii) April 12 to September 12 Total Basic Salary Add: D.A. [50% of 1,56,000 40%, forming part of superannuation benefits] Salary for 10 months Average salary = 1,87,200/10 15,000 4 16,000 6 60,000 96,000 1,56,000 31,200 1,87,200 18,720

Illustration 9. Mr. Surya was an employee of Z Ltd. After 38 years of service, he retired on 28.2.13. He was drawing a monthly salary of ` 18,000. On retirement he received a gratuity of ` 4,00,000. Compute taxable gratuity. Solution: Computation of Taxable Gratuity (Assuming employee not covered by Payment of Gratuity Act, 1972) Particulars Amount received as Gratuity Less: Exemption u/s 10(10)(iii) Least of the followings: (a) Actual amount received (b) Average Salary No. of fully completed years of service [ 18,000 38] (c) Maximum Limit Taxable Gratuity Note: Salary = 10 months average salary preceding the month of retirement. = Basic Pay + Dearness Allowance considered for retirement benefits + commission (if received as a fixed percentage on turnover) In this case, Average salary for 10 months preceding the month of retirement is ` 18,000 only. Illustration 10. Mr. King is getting a salary of ` 5,400 pm since 1.1.11 and dearness allowance of ` 3,500 p.m., 50% of which is a part of retirement benefits. He retires on 30th November 2012 after 30 years and 11 months of service. His pension is fixed at ` 3,800 pm. On 1st February 2013 he gets 3/4ths of the pension commuted at ` 1,59,000. Compute his gross salary for the Previous Year 2012-13 in the following cases : (i) If he is a Government employee, getting gratuity of ` 1,90,000 (ii) If he is an employee of a private company, getting gratuity of ` 1,90,000 (iii) If he is an employee of a private company but gets no gratuity. Solution: Previous Year 2012-13. Tenure of Service: 1.4.12 to 30.11.12 = 8 months Post-retirement period: December 12 to March 13 = 4 months Particulars Salary Add: Dearness Allowance Add: Taxable Gratuity Add: Uncommuted Pension [(3,8002)+(9502)] Add: Commuted Value of Pension Gross Salary Case (i) 43,200 28,000 Exempted 9,500 Exempted 80,700 Case (ii) 43,200 28,000 82,750 9,500 88,333 2,51,783 Case (iii) 43,200 28,000 Nil 9,500 53,000 1,33,700 4,00,000 3,42,000 10,00,000 3,42,000 58,000 Amount (`) Amount (`) 4,00,000

4.36 I DIRECT TAXATION

Case (ii) Gratuity received by an employee of a private company Particulars Actual amount received Less: Exempted amount ( least of the followings): (i) Actual amount received (ii) Average Salary No. of years of completed service [ x 7,150 30] (iii) Maximum limit Taxable Gratuity Computation of Taxable Value of Commuted Value of Pension (Non-Government employee and gratuity received) Actual commuted value of pension received Less: Exempted u/s 10(10A) 1/3 rd of Full Value of Commuted Pension [1/3 2,12,000]
Full value of commuted pension = Amount received on commutation Percentage of pension commuted = 1,59,000 / 75 % = 2,12,000

Amount (`)

Amount (`) 1,90,000

1,90,000 1,07,250 10,00,000 1,07,250 82,750

1,59,000 70,667

Taxable Commuted Value of Pension Case (iii) Computation of Taxable Value of Commuted Value of Pension (Non-Government employee and gratuity not received) Actual commuted value of pension received Less: Exempted u/s 10(10A) of Full Value of Commuted Pension [1/2 x 2,12,000]

88,333

1,59,000 1,06,000 53,000

Full value of commuted pension = Amount received on commutation Percentage of pension commuted = 1,59,000 / 75 % = 2,12,000

Taxable Commuted Value of Pension

Illustration 11. Ms. Vandana retires on 16th October 2012 after 30 years and 8 months of service. Salary structure is given below: FY 2012-13 FY 2011-12 Salary ` 15,000 pm Salary ` 12,000 pm D.A ` 7,500 pm D.A ` 6,000 pm

40%of dearness allowance forms a part of superannuation benefits. Record of Earned Leave is given below: Leave allowed for one year of completed service - 20 days; Leave taken while in service -150 days; Leave encashed during the year 60 days. Determine the gross salary in the following cases: (i) He retires from Government service (ii) He retires from the service of Delhi Municipal Corporation (iii) He retires from the service of Life Insurance Corporation of India (iv) He retires from private sector

DIRECT TAXATION I 4.37

Income from Salaries Solution: Particulars Salary for 6 months & 16 days Dearness Allowance Taxable amount of Leave Encashment Gross Income from Salary Working Notes: Average monthly salary for 10 months, prior to retirement: Salary of 6 months 16 days : ( 1st April,2012 to 16th October,2012) Salary of 3 months 14 days: ( 17 December,2012 to 31 March,2012)
th st

Case(i) 98,000 49,000 Exempted 1,47,000

Case(ii) 98,000 49,000 1,25,116 2,72,116

Case(iii) 98,000 49,000 1,25,116 2,72,116

Case(iv) 98,000 49,000 1,25,116 2,72,116

98,000 41,600 1,39,600 49,000 20,800 69,800 27,920 1,67,520

Total Basic Salary (A) Add: Dearness Allowance For 6 months 16 days : ( 1st April,2012 to 16th October,2012) For 3 months 14 days: ( 17th December,2012 to 31st March,2012) Total D.A. D.A. [ @ 40% of `69,800, forming part of retirement benefits] (B) Total Salary of 10 months [(A) + (B)] Average Salary = 1,67,520/10 = ` 16,752 Computation of Taxable Leave Encashment Particulars Amount of encashment received [ (30 20) (150 + 60)] (15,000 + 7,500)/30 Less : Exempted u/s 10(10AA) Least of the followings: Actual amount received 10 months salary ( preceding the month of retirement) Leave credit on the date of retirement [ (30 20) (150 +60)] 16,752/30 Maximum Limit Taxable amount of Leave Encashment 2,92,500 1,67,520 2,17,776 3,00,000 Amount (`)

Amount (`) 2,92,500

1,67,520 1,24,980

Note : To avoid the fractions and ease of calculation, per day remuneration is calculated by dividing 30 days. Illustration 12. Ms. Parinita retired from service after 28 years from ABC Ltd. Leave sanctioned by employer 45 days p.a. Leave availed during service 400 days. Leave encashment received: ` 4,30,000. Average salary for 10 months preceding the month of retirement `15,000.Compute taxable amount of Leave encashment for the Previous Year 2012-13.

4.38 I DIRECT TAXATION

Solution : Since leave sanctioned by the employer is more than 30 days p.a., the following calculation is required, to determine the amount of leave credit on the date of retirement. Particulars (i) Leave credit available on the date of retirement = Total Leave sanctioned during tenure of employment Total leave availed during service = [( 28 45) 400] Less: Excess leave sanctioned by the employer [(45 30 days) per year 28) Leave credit on the basis of 30 days credit for completed years of service (ii) Leave salary on the basis of 30 days credit = Step (i) Average Salary = 440 (15,000/30) Taxable Leave Salary on Retirement Particulars Amount Received on Leave Encashment Less: Exemption u/s 10(10AA) Least of the followings: (i) Actual amount of Leave encashment received (ii) Average salary of the individual for the past 10 months 10 months (iii) Maximum Limit (iv) Leave at credit at the rate of 30 days p.a. for every completed year of service as calculated in Step (ii) Taxable Leave Encashment 4,30,000 1,50,000 3,00,000 2,20,000 1,50,000 2,80,000 Amount (`) Amount (`) 4,30,000 No. of Days 860 420 440 2,20,000

Illustration 13. Mr.Clever was retrenched from service of UGLY Ltd. The scheme of retrenchment is approved by the Central Government. Retrenchment compensation received ` 8 lakhs. What is the taxability? Solution : When retrenchment compensation is received in accordance with any scheme, which is approved by the Central Government, it is fully exempted from tax. Illustration 14. Mr. Flemming was retrenched from service of GO SLOW Ltd. Retrenchment compensation received `6,00,000. Amount determined under the Industrial Disputes Act, 1948 `4,75,000. What is the taxability? Solution: Computation of Taxable Value of Retrenchment Compensation Particulars Amount received as Retrenchment Compensation Less: Exemption u/s 10(10B): Least of the followings: (i) Actual amount received (ii) Amount determined under the Industrial Disputes Act, 1948 (iii) Maximum Limit Taxable Retrenchment Compensation ` ` 6,00,000 6,00,000 4,75,000 5,00,000

4,75,000 1,25,000

DIRECT TAXATION I 4.39

Income from Salaries Illustration15. Mr. Hitesh, after serving Z Ltd. for 23 years 7 months, opted the Voluntary Retirement Scheme. Total tenure of service: 30 years. Compensation received ` 8,00,000. Last drawn Salary (i.e. Basic Pay + D.A, forming part of retirement benefits) ` 15,000. Compute exemption & taxable value of VRS compensation. Solution : Total tenure of service = 30 12=360 months Actual length of service = 23 years 7 months = 283 months No. of months of service left= (360 283) months = 77 months Computation of Taxable VRS compensation Particulars Amount received as VRS Compensation Less: Exemption u/s 10(10C): Least of the followings: (i) Actual amount received (ii) Maximum Limit (iii) The highest of the following: Last drawn salary x 3 x No. of fully completed years of service =15,000 x 3 x 23= 10,35,000 Last drawn salary x Balance of no. of months of service left. = 15,000 x 77 months= 11,55,000 Taxable VRS Compensation Amount (`) Amount (`) 8,00,000

8,00,000 5,00,000

11,55,000

5,00,000 3,00,000

Illustration 16. Ms. Neha is a Senior Accountant in the Ministry of Defence, Govt. of India. She received entertainment allowance ` 5,000 p.m. Her basic salary is ` 35,000 p.m. Professional tax paid ` 5,000. Compute Income from Salary. Solution: Basic Salary : 35,000 x 12 Add: Entertainment Allowance: 5,000 x 12 Gross Income from Salary Less: Deduction u/s 16(ii): Entertainment allowance Least of the following will be allowed as a deduction: (i) Actual amount of entertainment allowance received (ii) 20% of Basic salary of the Individual [20% of 4,20,000] (iii) Statutory limit Exempted amount being the least Gross Income from Salary Less: Professional Tax paid u/s 16(iii) Income from Salary 60,000 84,000 5,000 5,000 4,75,000 5,000 4,70,000 Computation of Income from Salary Particulars Amount (`) Amount (`) 4,20,000 60,000 4,80,000

4.40 I DIRECT TAXATION

Illustration 17. Calculate the perquisite value of the expenditure on medical treatment, which is assessable in the hands of an employee of a company, inclusive of the conditions to be satisfied: Gross Total Income, inclusive of salary ` 2,00,000 (a) amount spent on treatment of the employees wife in a hospital maintained by the employer (b) amount paid by the employer on treatment of the employees child in a hospital (c) medical insurance premium reimbursed by the employer on a policy covering the employee, his wife and dependent parents (d) (i) Amount spent on medical treatment of the employee outside India (ii) Amount spent on travel and stay abroad (e) Amount spent on travel and stay abroad of attendant Solution: Nature of Perquisites Treatment of employees wife in a hospital maintained by employers Reimbursement of expenses incurred on treatment of employees child in hospital Reimbursement of medical insurance premium paid Medical treatment outside India Amount spent on travel and stay abroad for the employee (herein referred as the patient) Amount spent on travel and stay abroad of the attendant Amount Taxable Nil Nil Taxability/Non-taxability Fully exempted Not taxable: since the amount is less than ` 15,000 `20,000 ` 14,000 ` 7,000 ` 2,50,000 ` 90,000 ` 60,000

Nil

Not taxable: since medical insurance premium referred to u/s 80D is paid on the employee and members of his family It is assumed that the whole of such expenditure is permitted by RBI Not taxable: as the Gross total income does not exceed ` 2,00,000 Not taxable: as the Gross total income does not exceed ` 2,00,000

Nil Nil

Nil

Illustration 18. Mr. Goutam is a Central Govt. employee. He is provided with an accommodation. The Licence fee determined by the Government is ` 500 p.m. An amount of ` 50 is deducted from his salary towards such rent. Determine the taxable value of perquisite. Solution: Computation of Taxable Perquisite related to unfurnished accommodation vide Explanation No.1 to Sec.17(2) Rule 3(1) Particulars Licence fee determined by the Government (` 500 x 12) Less: Rent recovered from employee (` 50 x 12) Taxable Value of Perquisite Amount (`) 6,000 600 5,400

Illustration 19. R submits the following information regarding his salary income for the year 2012-13: Basic

DIRECT TAXATION I 4.41

Income from Salaries salary `15,000 p.m.; D.A (forming part of salary) 40% of basic salary; City Compensatory Allowance `300 p.m.; Children Education Allowance `400 p.m. per child for 3 children; Transport Allowance `1,000 p.m. He is provided with a rent free unfurnished accommodation which is owned by the employer. The fair rental value of the house is ` 24,000 p.a. Compute the gross salary assuming accommodation is provided in a city where population is (a) exceeding 25 lakhs (b) exceeding 10 lakhs but not exceeding 25 lakhs (c) less than 10 lakhs. Solution : Computation of Income from Salary Particulars Basic salary 15,000 12 Add: D.A. (40% of 1,80,000) Add: City Compensatory Allowance (fully taxable) (300 12) Add: Children Education Allowance Actual amount received (400 12 3) Less: Exemption u/s 10(14) @ Rs.100 per month per child subject to a maximum of 2 children (100 12 2) Add: Transport Allowance Actual amount received ( 1,000 12) Less: Exemption u/s 10(14) @ ` 800 p.m. (800 12) Gross Income from Salary u/s 17(1) Add: Value of Unfurnished accommodation u/s 17(2) rule 3(1) explanation 1 [Case (a) Population exceeding 25 lakhs] 15% of salary ` 2,70,000 Salary = Basic Pay + DA( forming part of retirement benefits) + all other taxable allowances = 1,80,000 + 72,000 + 3,600 + 12,000 + 2,400 = 2,70,000 Total Income from Salary Note: Case (b): Where population is exceeding 10 lakhs but not exceeding 25 lakhs 10% of Salary shall be considered as the value of taxable perquisite = 10% of ` 2,70,000 = ` 27,000 Hence, under this situation, Total Income from Salary = ` (2,70,000 + 27,000) = ` 2,97,000 Case (c): Where population is less than 10 lakhs 7.5 % of salary shall be considered as the value of taxable perquisite = 7.5% of ` 2,70,000 = ` 20,250 14,400 12,000 Amount (`) Amount (`) 1,80,000 72,000 3,600

(2,400) 12,000 9,600

2,400 2,70,000

40,500 3,10,500

4.42 I DIRECT TAXATION

Hence, under this situation, Total Income from Salary = ` (2,70,000 + 20,250) = ` 2,90,250 Illustration 20. Mr. Kushal submits the following information regarding his salary income which he gets from ABC Ltd. Basic salary ` 15,000 p.m.; D.A. 40% of Basic Salary (forming part of retirement benefits); City Compensatory Allowance ` 300 p.m.; Children Education Allowance ` 400 p.m.( for 3 children); Transport allowance `1,000 p.m.; Reimbursement of Medical Expenses ` 25,000. He is also entitled to HRA of ` 6,000 p.m. from 1.4.2012 to 31.8.2012. He was paying a rent of ` 7,000 p.m. for a house in Delhi. From 1.9.2012 he was provided with an accommodation by the company for which the company was paying the rent of `5,000 p.m. The company charged him ` 1,000 pm as rent for the accommodation. Compute Gross Salary for the Assessment Year 2013-14. Solution: Computation of Income from Salary Particulars Basic Salary : (15,000 12) Add: D.A. (40% of 1,80,000) Add: City Compensatory Allowance (fully taxable) [(300 12) ] Add: House Rent Allowance (April to August 2012) Actual amount received ( 6,000 5) Less: Exemption u/s 10(13A) Rule 2A Least of the followings: (a) Actual amount received 30,000 (b) 50% of salary 52,500 (c) Rent paid 10% of Salary 24,500 [ 7,000 x 5 10% of 1,05,000] Note: Salary for HRA (5 months) Basic salary:15,000 5 = 75,000 Add: D.A. = 40% of 75,000 = 30,000 Total Salary for the purpose of HRA 1,05,000 Add: Children Education Allowance Actual amount received (400 12 3) Less: Exemption u/s 10(14) @ `100 per month per child subject to a maximum of 2 children (100 12 2) Add: Transport Allowance Actual amount received ( 1,000 12) Less: Exemption u/s 10(14) @`800 p.m (800 12) Gross Income from Salary u/s 17(1) Add: Value of Unfurnished accommodation u/s 17(2) rule 3(1) Explanation 1 [Assuming Population exceeding 25 lakhs (as accommodation provided in a Metro city)] 15% of salary for 7 months (September 2012 to March 2013) Salary = Basic pay + DA (forming part of retirement benefits) + all other taxable allowances = [(15,000 7) + (40% of 1,05,000) + (300 7)+ {(400 7 3) (100 7 2)}+ {(1000 800) 7}] = 1,57,500 Total Income from Salary 14,400 2,400 12,000 9,600 12,000 Amount (`) Amount (`) 1,80,000 72,000 3,600

30,000

24,500 5,500

2,400 2,75,500

23,625 2,99,125

DIRECT TAXATION I 4.43

Income from Salaries Illustration 21. Mr. Sambhu was provided an accommodation in a hotel by his employer for 22 days before providing him a rent free accommodation which is owned by the employer. The hotel charges paid ` 6,000 of which ` 1,000 was recovered from the employee. Salary for the purpose of accommodation for the period of 22 days is ` 11,000. Compute the taxable perquisite of accommodation. Solution : In case of accommodation provided to the assessee on account of transfer, which is exceeding 15 days cumulatively, such shall be taxable as a perquisite. The company recovered ` 1,000 from the employee. Computation of Taxable Value of Perquisite for Accommodation in a Hotel Particulars Lower of the followings: (i) 24% of Salary paid/payable = 24% of ` 11,000 = 2,640 (ii) Actual Charges paid/payable = 6,000 Less: Amount recovered from the employee Taxable Value of Perquisite Amount (`)

2,640 1,000 1,640

Illustration 22. Value of unfurnished accommodation (computed) ` 50,000. Cost of furniture provided by the employer ` 80,000. Hire charges of furniture (other than those owned by employer) provided in the accommodation ` 500 p.m. Amount recovered from employee ` 200 p.m. Compute taxable value of perquisite. Solution: Computation of Taxable Value of Perquisite related to furnished accommodation Particulars Value of unfurnished accommodation [given] Add: Value of furniture provided (i) 10% p.a. of original cost of such furniture (ii) Actual Hire charges of furniture [ hired from third party] Less : Amount recovered from the employee (` 200 x 12) Taxable Value of perquisite related to furnished accommodation Amount (`) 50,000 8,000 6,000 64,000 (2,400) 61,600

Illustration 23. Mr. Ritesh is provided with an accommodation in Kolkata since April 2012. Salary ` 40,000 p.m. Cost of furniture provided ` 80,000. On 1st October, 2012, following a promotion with a increase in Salary by ` 15,000, he was transferred to Jharkhand (population less than 25 lakhs but more than 10 lakhs), and was also provided an accommodation there. Mr. Ritesh was allowed to retain the Kolkata accommodation till March, 2013. Compute taxable value of perquisite. Solution: Phase 1: Value of Furnished Accommodation (Kolkata) (April to September 2012) Particulars Value of unfurnished accommodation (15% of 40,000 6 months) Add: Value of Furniture provided: 10%p.a. of original cost of such furniture (10% of 80,000 x 6/12 months) Taxable Value of Perquisite related to Furnished Accommodation Amount (`) 36,000 4,000 40,000

4.44 I DIRECT TAXATION

Phase 2: Valuation of accommodation (October 2012 to December 2012) (a) For the first 90 days of transfer: Where accommodation is provided both at existing place of work and in new place, the accommodation, which has lower value, shall be taxable. (b) After 90 days: Both accommodations shall be taxable. Computation for the first 90 days of transfer: (October 2012 to December 2012) Particulars Lower of the followings: (i) (ii) Value of accommodation at existing place of work Value of accommodation at new place of work 24,750 2,000 26,750 Amount (`)

Value of accommodation at existing place of work (i.e. Kolkata) 15% of Salary for 3 months (i.e. 90 days) = 15% of ` 55,000 x 3 months Add: Cost of Furniture provided : 10% p.a. on ` 80,000 x 3/12 months Taxable Value of Perquisite Value of accommodation at new work place (Jharkhand) 10% of salary for 3 months (i.e. 90 days) = 10% of 55,000 3 months = 16,500 Therefore, the assessee shall be assessed to tax on `16,500 (being the lowest) Phase 3: Valuation of accommodation (after 90 days) (January 2013 to March 2013) (i)For Kolkata accommodation: 15% of 55,000 x 3 months Add: Cost of furniture provided: 10% x 80,000 x 3 months Total value of perquisite (ii)For Jharkhand accommodation: 10% of 55,000 x 3 months/12 months Total Taxable Value of Perquisite Particulars Phase 1: Accommodation in Kolkata Phase 2: Accommodation in Jharkhand (being the lower during 90 days) Phase 3: (i)Accommodation in Kolkata (ii)Accommodation at Jharkhand Total Taxable Value of Perquisite Taxable value of perquisite (`) 40,000 16,500 26,750 16,500 99,750 = ` = 24,750 2,000 26,750 = 16,500

Illustration 24. Mr. E is employed with N Ltd. He also gets the services of sweeper and watchman. Determine his gross salary in the following cases: (i) His salary is ` 4,200 pm. Employer provides the services of sweeper and watchman. He pays them `600 pm and ` 500 pm; (ii) His salary is ` 4,200 pm. Sweeper and watchman are engaged by E at the rates given in clause (1) above but their wages are reimbursed by the employer;

DIRECT TAXATION I 4.45

Income from Salaries (iii) His salary is ` 4,210 p.m. Employer provides the services of sweeper and watchman at the above rates but he recovers from E ` 200 p.m. and ` 300 p.m. respectively. E has paid employment tax of ` 400. Solution: Particulars Case (1) Case (2) [Ref.Sec.17(2) (iv), Rule 3(3)] 50,400 7,200 6,000 63,600 Case (3) [Ref.Sec.17(2) (iii) Rule 3(3)] 50,520 4,800 2,400 57,720

Salary Wages of sweeper Wages of watchman Gross Salary

50,400 Sec.17(2)(iii) not taxable Sec.17(2)(iii) not taxable 50,400

Working Note: Case (1): He is a non-specified employee. Perquisites provided by employer u/s 17(2)(iii) are not chargeable to tax: Salary : ` 4,200 x 12 months Less: Professional tax paid u/s 16(iii) Monetary income not exceeding ` 50,000 50,400 400 50,000

Case (2): If the facility is engaged by the employee but reimbursed by the employer, it is an obligation of employee, discharged by employer u/s 17(2)(iv), it is always taxable. Case (3): He is a specified employee, as his monetary income, chargeable under the head salaries exceeds ` 50,000. Salary : ` 4,210 x 12 months Less: Professional tax paid u/s 16(iii) Monetary income exceeding ` 50,000 50,520 400 50,120

Illustration 25. G Ltd. provides electricity to its employee, P. Annual consumption as per meter reading comes to 2,250 units. Determine the value of the perquisite in the following cases: (1) Electricity meter is in the name of P and the rate of electricity is ` 3 per unit (2) Electricity meter is in the name of G Ltd. the rate of electricity is ` 3 per unit. (3) G Ltd. is a power-generating company. Manufacturing cost is 90 paise per unit but supplied to public @ ` 2 per unit. However, it charges 30 paise per unit from employees. Solution: With reference to Rule 3(4) (1) Perquisite value of free electricity is ` 6,750 (2,250 3). As the electric meter is in the name of the employee, it is his obligation to pay the bill. However, as the bill has been paid by the employer, it is an obligation of employee, discharged by the employer. It is always taxable u/s 17(2)(iv). (2) Perquisite value of free electricity will be ` 6,750. It shall be assessed to tax, if the employee is a specified employee as per Sec. 17(2)(iii) (3) Perquisite value of electricity supplied = ` 2,250 (0.90 0.30) = ` 1,350

4.46 I DIRECT TAXATION

Illustration 26. Determine the value of education facility in the following cases: (1) Three children of G, an employee of S Ltd., are studying in a school, run by S Ltd. School fees is ` 2,500 p.m. and hostel fees is ` 2,000 p.m. But the employer recovers only ` 600 p.m. and ` 500 p.m. respectively. However, a similar school or a hostel around the locality charges ` 1,800 p.m. and ` 1,200 p.m. respectively. (2) The employer has also reimbursed the school fees of ` 1,200 p.m. of his nephew, fully dependent on him after the death of his brother. Solution: Computation of Taxable value Perquisite- related to education facility [As per Rule 3(5)] Particulars 1. (a) School fees of his children, studying in a school run by employer : (`1,800 3 12) (`1,000 3 12) (`600 3 12) (b) Hostel fees: (`2,000 3 12) (`500 3 12) 2. School fee of nephew (`1,200 12) Total value of Taxable Perquisite Taxable value of perquisite Amount (`) 7,200 54,000 14,400 75,600

Illustration 27. Mr. Z is the manager of F Ltd. His son is a student of Amity International School. School fees of ` 4,000 p.m. and hostel fees of ` 3,000 p.m., are directly paid by Z Ltd. to the school but it recovers from Z only 30%. F also joins an advanced course of Marketing Management for 4 months at IIM, Ahmedabad, fees of the course, ` 2,50,000 is paid by F Ltd. determine the taxable value of perquisite related to educational facilities. Solution: Computation of Taxable value Perquisite- related to education facility [As per Rule 3(5)] 1.(a) School fees of his child, studying in a school not owned/controlled by employer (` 4,000 x 12) (` 1,200 x 12) (b) Hostel Fees : (` 3,000 x 12) (` 900 x 12) 2. Fees paid for marketing management course for Mr. Z ( it is fully exempted perquisite) Total value of Taxable Perquisite 33,600 25,200 Nil 58,800

Illustration 28. Mr. D takes interest-free loan of ` 2,50,000 on 1.11.12 from his employer to construct his house. The loan is repayable in 50 monthly installments from January 2013. Compute the value of interest free loan. SBI Lending rate 8.5% p.a. (for housing loans not exceeding 5 years). Solution: Computation of Taxable Value of Perquisite related to Loan provided by employer [As per Rule 3(7)(i)] Time period during which loan remains outstanding November December January February March Total Perquisite value of interest-free loan: 12,20,000 8.5% 1/12 = ` 8,642 Balance on the last day of the month (`) 2,50,000 2,50,000 2,45,000 2,40,000 2,35,000 12,20,000

DIRECT TAXATION I 4.47

Income from Salaries Illustration 29. Mr. Prabir Nandy is a manager in H Ltd. He gets salary @ ` 30,000 pm. He is also allowed free use of computer, video-camera and television of the company. H Ltd. has purchased (i) Computer for ` 1,00,000 (ii) Video-camera for ` 30,000. Their written down value on 1.4.12 is ` 60,000 and ` 30,000 respectively. Television set has been taken on lease rent @ ` 100 p.m. Compute his gross salary for the Assessment Year 2013-14. Solution: Computation of Taxable Value of Asset provided by Employer [As per Rule 3(7)(vii)] Particulars Salary : ` 30,000 x 12 Add: Free use of computer u/s 17(2)(vi) read with Rule 3(7)(vii) Add: Free use of video camera u/s 17(2)(vi) read with Rule 3(7)(vii) [10% of ` 30,000] Add: Free use of telephone u/s 17(2)(vi) read with Rule 3(7)(vii) [` 100 x 12] Gross Salary Amount (`) 3,60,000 Nil 3,000 1,200 3,64,200

Illustration 30. Mr. C is an accountant of D Ltd. He gets salary of ` 25,000 pm. He has purchased motor car and washing machine from the company on 1 February 2013. Particulars of cost and sale price of the two assets are given below: Year of Purchase 01.07.2009 15.09.2008 Particulars of the Asset Motor car Washing Machine Purchase Price (`) 2,50,000 10,000 Sale price (`) 85,000 5,000

Compute the taxable value of perquisites for the Assessment Year 2013-14. Solution: Computation of Taxable Value of Perquisite on Transfer of Moveable Assets [As per Rule 3(7)(viii) Nature of Asset transferred Motor Car Motor Car (Actual Cost) Less: Depreciation @ 20% on WDV from 01.07.2009 to 30.06.2010 W.D.V. as on 30.06.2010 Less: Depreciation @ 20% on WDV from 01.07.2010 to 30.06.2011 W.D.V. as on 30.06.2011 Less: Depreciation @ 20% on WDV from 01.07.2011 to 30.06.2012 W.D.V. as on 30.06.2012 Nature of Asset transferred Washing Machine Washing Machine (Actual Cost) Less: Depreciation @ 10% on SLM from 15.09.2008 to 14.09.2009 W.D.V. as on 15.09.2009 Less: Depreciation @ 10% on SLM from 15.09.2009 to 14.09.2010 W.D.V. as on 15.09.2010 Less: Depreciation @ 10% on SLM from 15.09.2010 to 14.09.2011 W.D.V. as on 15.09.2011 Less: Depreciation @ 10% on SLM from 15.09.2011 to 14.09.2012 W.D.V. as on 15.09.2012 Amount (`) 2,50,000 50,000 2,00,000 40,000 1,60,000 32,000 1,28,000 Amount (`) 10,000 1,000 9,000 1,000 8,000 1,000 7,000 1,000 6,000

4.48 I DIRECT TAXATION

Particulars W.D.V. of the Asset on the date of transfer Less: Amount recovered from employee Taxable Value of Perquisite

Motor Car (`) 1,28,000 85,000 43,000

Washing Machine (`) 6,000 5,000 1,000

Illustration 31: Shri A. Chakraborty, Director (Administration) in MNPC Ltd. He is entitled to a motor car (1.8 ltrs) to be used for both official & private purposes. Discuss the taxability of perquisite if: (i) The car is owned by the employer, expenses paid by employer & it is a chauffeur driven car. (ii) The car is owned by Sri Chakraborty. Expenses incurred ` 20,000 & chauffeur paid a salary of `60,000 provided by the employer. Solution: As per notification No. 24 dated 18.12.09, the taxable value of perquisite will be: (i) `2,400 p.m + ` 900 p.m for chauffeur = `3,300 p.m. 12 months = `39,600 Particulars Amount of expense Add: Salary to Chauffeur Less: Value of perquisite if the car was owned by the employer [as computed in (i) above] Taxable Value of Perquisite (ii) Computation of Taxable Value of Perquisite Amount (`) 20,000 60,000 80,000 39,600 40,400

Illustration 32: Aniket joined a company on 1.7.2012 and was paid the following emoluments and allowed perquisites as under: Emoluments: Basic Pay ` 35,000 per month; D.A. ` 20,000 per month; Bonus ` 20,000 per month. Perquisites : (i) Furnished accommodation owned by the employer and provided free of cost; (ii) Value of furniture therein ` 3,60,000; Hire charges of Furniture provided ` 20,000 p.a. (iii) Motor car owned by the company (with engine c.c. less than 1.6 litres) along with chauffeur for official and personal use, expenses met by Employer. (iv) Sweeper salary paid by company ` 1,500 per month; amount recovered @ ` 200 pm. (v) Watchman salary paid by company ` 1,500 per month; amount recovered @ ` 300 pm. (vi) Educational facility for 2 children provided free of cost. The school is owned and maintained by the company. Elder child studies in class V and younger child in class II. Tuition fee per month ` 1,600 & ` 900 respectively. (vii) Loan of ` 5,00,000 repayable within 7 years given on 1.9.2012 for purchase of a house. No repayment was made during the year; interest charged by employer @ 2% p.a. Interest chargeable as per Income Tax Act @ 10% p.a.

DIRECT TAXATION I 4.49

Income from Salaries (viii) Interest free loan for purchase of computer ` 50,000 given on 1.2.2013. No repayment was made during the year. (ix) Corporate membership of a club. The initial fee of ` 1,00,000 was paid by the company. Aniket paid the bills for his use of club facilities. You are required to compute the income of Aniket under the head Salaries in respect of Assessment Year 2013-14. Solution: Particulars Basic Pay Add: Dearness Allowance Add: Bonus Add: Taxable Value of Perquisite related to: - - - - - - - furnished accommodation motor car provided by employer salary of sweeper salary of watchman educational facilities interest free housing loan interest free computer loan Note 1 (1,800 + 900) x 9 months (1,500 200) x 9 months (1,500 300) x 9 months Note 2 Note 3 Note 4 1,28,250 24,300 11,700 10,800 5,400 23,333 1,375 8,80,158 Assessee: Mr.Aniket Computation of Income from Salary Amount (`) 35,000 x 9 months 20,000 x 9 months 20,000 x 9 months Amount (`) 3,15,000 1,80,000 1,80,000 Assessment Year: 2013-14

Gross Income from Salary Note 1: Salary for the purpose of computing taxable value of furnished accommodation: Particulars Basic Salary Dearness Allowance Bonus

Amount (`) 3,15,000 1,80,000 1,80,000 6,75,000

Assuming, Mr. Aniket stays in a city where population is more than 25,00,000 as per 2001 census, Value of unfurnished accommodation = 15% of salary Value of furniture provided = 15% of ` 6,75,000 = `1,01,250 = 10% p.a. of actual cost = 10% of ` 3,60,000 9/12 =` 27,000

(Assuming, value of furniture given in the problem represents actual cost.)

4.50 I DIRECT TAXATION

Note 2 : Computation of taxable value of perquisite related to educational facility. Where the school is owned and maintained by employer, if the cost of education provided is less than `1,000 p.m. then the value of perquisite is NIL. If the cost of education exceeds `1,000 p.m. then the value of perquisite will be equal to the actual cost of education provided in excess of `1,000 p.m. per child maximum for two children. Value of perquisite for elder child = ` (1,600 1,000) 9 m = ` 5,400 (where 9 months = from 1.7.2012 to 31.3.2013) Value of perquisite for younger child = NIL, since tuition fee per month is less than ` 1,000. Assuming, cost of education provided to Anikets children is less than ` 1,000 p.m. value of perquisite provided is NIL. Note 3: Computation of taxable value of perquisite related to interest free housing loan. Value of Perquisite = Interest @ 10% p.a. less Actual interest charged = (10% - 2%) x ` 5,00,000 x 7/12 = ` 3,333 Note 4 : Computation of taxable value of perquisite interest free loan to purchase computer Value of Perquisite = Interest @ 16.50% p.a. less Actual interest charged = (16.50% - 0%) x ` 50,000 x 2/12 = ` 3,333

Illustration 33: A was employed with Z Ltd. He retired w.e.f. 1.2.2013 after completing a service of 24 years and 5 months. He submits the following information: Basic Salary : `5,000 per month ( at the time of retirement) Dearness Allowance : 100% of Basic Pay ( 60% of which forms part of salary for retirement benefits). Last increment : ` 500 w.e.f. 1st July, 2012 His pension was determined at ` 3,000 per month. He got 50% of the pension commuted w.e.f. 1.3.2013 and received a sum of ` 1,20,000 as commuted pension. In addition to this, he received a gratuity of `1,50,000 and leave encashment amounting to ` 56,000 on account of accumulated leave of 240 days. He was entitled to 40 days leave for every year of service. Compute his Gross Salary for Assessment Year 2013-14 assuming that he is not covered under Payment of Gratuity Act. Solution: Assessee: Mr.Aniket Computation of Income from Salary Particulars Basic Pay - - April 2012 to June 2012 @ ` 4,500 p.m. July 2012 to January 2013 @ `5,000 p.m. 13,500 35,000 48,500 48,500 3,000 1,500 4,500 Amount (`) Amount (`) Assessment Year: 2013-14

Add: Dearness Allowance @ 100 % of Basic Pay Add: Uncommuted value of pension - - February 2013 @ `3,000 p.m March 2013 `1,500 p.m. ( since 50% already commuted)

DIRECT TAXATION I 4.51

Income from Salaries Add: Commuted Value of Pension Amount Received Less: Exemption u/s/ 10(10A) 1/3rd of full value of commuted pension [ 1/3rd of `2,40,000] Full Value of commuted pension = Amount received / % commuted = ` 1,20,000 / 50% = `2,40,000 Add: Taxable Value of Gratuity Amount received as Gratuity Less: Exemption u/s 10(10) Least of the followings: (i) Actual amount received = 1,50,000 (ii) Maximum limit = 10,00,000 (iii) months average salary for each years of completed service = [ x 7,760 x 24] = 93,120 Salary for Gratuity (not covered by Payment of Gratuity Act) = Basic Pay + D.A. (forming part of salary for retirement benefits) Average Salary = Total salary of 10 months preceding the month of retirement / 10 = (48,500 + 60% of 48,500)/10 = ` 7,760 Add: Taxable Value of Leave Encashment Amount Received Less : Exemption u/s 10(10AA) Least of the followings: (i) Actual amount received (ii) 10 months average salary (iii) Maximum limit (iv) Leave credit ( - refer Note 1) Notes: Calculation of leave credit Total leave entitlement (24 years x 40 days p.a.) Less: Leave availed during service = Total leave entitlement leave encashment = ( 960 days 240 days) = 960 days = 720 days 240 days 56,000 1,50,000 1,20,000 80,000 40,000

93,120

56,880

= 56,000 = 77,600 = 3,00,000 = NIL

NIL

56,000

Less: Leave in excess of 30 days p.a. granted by employer [ 24 years ( 40 days p.a. granted by employer - 30 days p.a. as per rules)] = 24 x 10 = 240 days NIL Gross Income from Salary 2,54,380

4.52 I DIRECT TAXATION

Illustration 34 : During the Previous Year ending March 31, 2013, Adi, a salaried employee (age: 40 years), received `10,70,000 as basic salary and `20,000 as arrears of bonus of the financial year 1992-93. During the Previous Year 1992-93, Adi has received `50,000 as salary. Adi deposits `1,500 (during 1992-93) and `13,000 (during 2012-13) in public provident fund. Solution: The admissible relief under section 89, in respect of bonus paid in the financial year 2012-13 will be computed as under: Taxable income and tax liability on receipt basis Assessment Year Salary Arrears of salary Gross Salary Less: Standard seduction under section 16(i) Gross Total Income Less: Deduction under section 80C Net Income Tax on net income Less: Rebate under section 88 Tax Add : Surcharge Tax and surcharge Add : Education cess Add: Secondary and higher education cess Tax liability 2013 14 ` 10,70,000 20,000 10,90,000 Nil 10,90,000 13,000 10,77,000 1,53,100 Nil 1,53,000 Nil 1,53,000 3,062 1,531 1,57,693 1993 94 ` 50,000 50,000 12,000 38,000 Nil 38,000 2,000 300 1,700 1,700 1,700 Taxable income and tax liability on accrual basis 2013 14 ` 10,70,000 10,70,000 Nil 10,70,000 13,000 10,57,000 1,47,000 Nil 1,47,000 Nil 1,47,000 2,942 1,471 1,51,513 1993 94 ` 50,000 20,000 70,000 12,000 58,000 Nil 58,000 6,800 300 6,500 6,500 6,500 ` Tax liability of the two Assessment Years on receipt basis Tax liability of the two Assessment Years on accrual basis Tax relief under section 89 for the Assessment Year 2013-14 (i.e., `1,59,393 - `1,58,013) Tax payable for the Assessment Year 2013-14 (i.e., `1,57,693,- `1,380) 1,59,393 1,58,013 1,380 1,56,313

Note : For the Assessment Year 1993-94, an assessee, having income under the head "salaries", is eligible for deduction u/s 16 (1) of a sum equal to 331/3% of the salary on `12,000 which ever is less. However, Section 16 (i) has been omitted by finance Act, 2005.

DIRECT TAXATION I 4.53

Study Note - 5
INCOME FROM HOUSE PROPERTY
This Study Note includes 5.1 Chargeability 5.2 Deemed Owner 5.3 Applicability of Section 22 in certain situations 5.4 Principle of Mutuality read with Section 22 5.5 Property Income is Exempt from Tax to Certain Persons 5.6 Computation of income from a let out house property 5.7 Computation of income from self-occupied property 5.8 Recovery of Unrealized Rent 5.9 Receipt of Arrears of Rent 5.10 Municipal Tax 5.11 Deduction from Net Annual Value 5.12 Computation of Prior Period Interest 5.1 CHARGEABILITY [Section 22] 1. The basis of chargeability under the head income from house property is Annual Value. 2. The property must consist of Building or Lands Appurtenant thereto. 3. The assessee must be the owner of such property. 4. The property may be used for any purpose other than the assessees business or profession. 5.2 DEEMED OWNER [SECTION 27] 1. Owner: An Individual shall be considered as owner of a property when the document of title to the property is registered in his name. 2. Deemed Owner: Under the following circumstances, Income from House Property is taxable in the hands of the Individual, even if the property is not registered in his name: (a) Where the Property has been transferred to spouse for inadequate consideration other than in pursuance of an agreement to live apart. (b) Where the Property is transferred to a minor child for inadequate consideration (except a transfer to minor married daughter) (c) Where the Individual holds an impartible estate. (d) Where the Individual is a member of Co-operative Society, Company, or other Association and has been allotted a house property by virtue of his being a member, even though the property is registered in the name of the Society / Company / Association. (e) Where the property has been transferred to the individuals name as part-performance of a contract u/s 53A of the Transfer of Property Act, 1882. (i.e. Possession of the Property has been transferred to Individual, but the Title Deeds have not yet been transferred).

DIRECT TAXATION I 5.1

Income from House Property (f) Where the Individual is a holder of a Power of Attorney enabling the right of possession or enjoyment of the property. (g) Where the property has been constructed on a leasehold land. (h) Where the ownership of the Property is under dispute. (i) Where the property is taken on a lease for a period of not less than 12 years, then the lessee shall be deemed as the owner of the property. 5.3 APPLICABILITY OF SECTION 22 IN CERTAIN TYPICAL SITUATIONS Following points are relevant for understanding the implications and scope of section 22: 1. House property in a foreign country- A resident assessee is taxable under section 22 in respect of annual value of a property situated in a foreign country. A resident but not ordinarily resident or non-resident is, however, chargeable under section 22 in respect of income of a house property situated abroad, if income is received in India during the Previous Year. If tax incidence is attracted under section 22 in respect of a house property situated abroad, annual value will be computed as if the property is situated in India. The Madras High Court in CIT vs. R. Venugopala Reddiar [1965] 58 ITR 439 observed that while computing taxable income, no distinction should be made between a house property situated in India and a house property situated abroad. 2. Disputed ownership- If title of ownership of a house property is under dispute in a court of law, the decision as to who is the owner rests with the Income-tax Department. The department has prima facie the power to decide whether the assessee is the owner and is chargeable to tax under section 22, without waiting for judicial judgment of any suit filed in respect of the property-Re. Keshardeo Chamaria [1937] 5 ITR 246 (Cal.). It was observed in Franklin vs. IRC 15 TC 464 that the recipient of income is taxable though there may be a rival claim as to the title of source of income and he may have to give up and account for what he is taxed upon. 3. Property held as stock-in-trade - As a specific head of charge is provided for income from house property, annual value of house property cannot be brought to tax under any other head of income. It will remain so even if a. the property is held by the assessee as stock-in-trade of a business; or b. assessee is engaged in the business of letting out of property on rent; or c. if the assessee is a company which is incorporated for the purpose of owning house property.

House-owning, however profitable, is neither trade nor business for the purpose of the Act. Where income is derived from house property by the exercise of property rights, income falls under the head "Income from House Property- CIT vs. National Storage (P.) Ltd [1963] 48 ITR 577(Bom.). 4. Splitting up of a Composite Rent- Apart from recovering rent of the building, in some cases, the owner gets rent of other assets (like furniture) or he charges for different services provided in the building (for instance, charges for lift , security, air conditioning, etc.). The amount so recovered is known as Composite Rent. The tax treatment of the composite rent is as follows (i) Where Composite Rent includes rent of building and charges for different services (like lift, air conditioning) - If the owner of a house property gets a composite rent for the property as well as for services rendered to the tenants, composite rent is to be split up and the sum which is attributable to the use of property is to be assessed in the form of annual value under section 22. The amount which relates to rendition of the services (such as electricity supply, provision of lifts, supply of water, arrangement for scavenging, watch and ward facilities, etc.) is charged to tax under the head Profit and Gains of Business or Profession or under the head Income from Other Sources .

5.2 I DIRECT TAXATION

(ii) Where Composite Rent is rent of letting out of building and letting out of other assets (like Furniture) and the two letting are not separable - If there is letting of machinery, plant and furniture and also letting of the building and the two lettings form part and parcel of the same transaction or the two lettings are inseparable (in the sense that letting of one is not acceptable to the other party without letting of the other), then such income is taxable either as Business Income or Income from Other Sources. This rule is applicable even if sum receivable for the two lettings is fixed separately. (iii) Where Composite Rent is rent of letting out of building and letting out of other assets and the two letting are separable - If there is letting out of building and letting of other assets and the two lettings are separable (in the sense that letting of one is acceptable to the other party without letting out of the other; for instance letting out of building along with car), then income from letting out of building is taxable under the head Income from House Property and income from letting out of other assets is taxable either as Business Income or Income from Other Sources. This rule is applicable even if the assessee receives composite rent from his tenant for two lettings. 5. Property owned by co-owners [Sec. 26] - If a house property is owned by two or more persons, such persons are known as co-owners. Section 26 covers a case if a property is owned by co-owners. Section 26 is applicable if the following conditions are satisfied 1. The property must consist of building or building and land appurtenant thereto. 2. It is owned or deemed to be owned by two or more persons. 3. The respective shares of the co-owners are definite and ascertainable.

If these conditions are satisfied, then the share of each co-owner in the income of the property (as computed under the head Income from House Property) shall be included in the total income of each such person. The following points should be noted 1. In respect of property income, co-owners shall not be assessed as an Association of Persons. 2. The concessional tax treatment in respect of self-occupied property is applicable as if each such person is individually entitled to such relief.

6. Other points- One should also keep in view the following proposition: Transfer by book entries - If a firm transfers its house property to its partners before dissolution, merely by book entries, annual value of the property is taxable in the hands of the firm [lnder Narain Har Narain vs. CIT[1980] 3 Taxman 365 (Delhi )] 5.4 PRINCIPLE OF MUTUALITY VIS-A-VIS SECTION 22 Tax levied under section 22 is tax on income from house property and it is not tax on house property. A club owns a house property and it provides recreational and refreshment facilities exclusively to its members and their guests. Its facilities are not available to non-members. The club is run on no profit no loss basis in that the members pay for all their expenses and are not entitle to any share in the profit. Surplus, if any, is used for maintenance and development of the club. The business of trust is governed by principle of mutuality. It is not only the surplus from the activities of the business of the club that is excluded from the levy of Income-tax, even the annual value of the club house as contemplated in section 22 will be outside the purview of the levy of Income-tax.

DIRECT TAXATION I 5.3

Income from House Property 5.5 PROPERTY INCOME IS EXEMPT FROM TAX TO CERTAIN PERSONS

10(19A) 10(20) 10(21) 10(23B) 10(23BB) 10(23BBA) 10(23C) 10(24) 10 (26B) 10(27) 11 13A

An Ex-Ruler for his occupation (palace) Local Authority. Approved Scientific Research Association. Institution for the development of Khadi and Village Industries. Khadi and Village Industries Boards. A body or authority for administering religious or charitable Trust or endowments. Certain Funds, educational institutions, hospitals etc. Registered Trade Union. Statutory Corporation or an institution or association financed by the Government for promoting in the interests of members of SC or ST. Co-operative Society for promoting the interest of the members of SC or ST. Charitable Trust. Political Party.

5.6 COMPUTATION OF INCOME FROM A LET OUT HOUSE PROPERTY Income from a let out house property is determined as follows` Gross Annual Value Less: Municipal Taxes Net Annual Value Less: Deduction under section 24 - - Standard deduction Interest on borrowed capital xxxx xxxx xxxx xxxx xxxx xxxx

Income from House Property

Gross Annual Value [Section 23(1)] - Tax under the head Income from House Property is not a tax upon rent of a property. It is taxed on inherent capacity of a building to yield income. The standard selected as a measure of the income to be taxed is Annual Value. Gross Annual Value is determined as followsStep I Step II Step III Step IV Step V Find out reasonable expected rent of the property [given below] Find out rent actually received or receivable after excluding unrealized rent but before deducting loss due to vacancy [given below] Find out which one is higher amount computed in step I or step II. Find out loss because of vacancy Step III minus Step IV is Gross Annual Value [given below]

5.4 I DIRECT TAXATION

Step 1- Find out Reasonable Expected Rent [Sec. 23(1 )(A)] - Reasonable expected rent is deemed to be the sum for which the property might reasonably be expected to be let out from year to year. In determining reasonable rent, several factors have to be taken into consideration, such as, location of the property, annual ratable value of the property fixed by municipalities, rents of similar properties in neighborhood, rent which the property is likely to fetch having regard to demand and supply, cost of construction of the property and nature and history of the property. These factors play a vital role in determining reasonable expected rent of a house property. In a majority of cases, however, reasonable expected rent can be determined by taking into consideration the following factors: a. municipal valuation of the property; or b. fair rent of the property. The higher of (a) or (b) is generally taken as reasonable expected rent. If, however, a property is covered by a Rent Control Act, then the amount so computed cannot exceed the standard rent determinable under the Rent Control Act. (a) Municipal Valuation- For collecting municipal taxes, local authorities make a periodical survey of all buildings in their jurisdiction. Such valuation may be taken as a strong evidence representing the earning capacity of a building- C.J. George vs. CIT [1973]92 ITR 137 (Ker.). It cannot, however, be considered to be a conclusive evidence-Jamnadas Prabhudas vs. CIT [1951] 20 ITR 160 (Bom.). Moreover, in some big cities (like Delhi, Mumbai, Chennai, Kolkata) municipal authorities determine net ratable value after deducting 10 per cent of the gross ratable value, on account of repairs, and an allowance for service taxes (such as sewerage tax and water tax). The net municipal valuation, therefore, requires an adjustment for determining reasonable expected rent for Incometax purposes. (b) Fair Rent of the Property- Fair rent of the property can be determined on the basis of a rent fetched by a similar property in the same or similar locality. Though two properties cannot be alike in every respect, it has been observed in Stocks vs. Sulley 4 TC 98 that the evidence afforded by transactions of other parties in the matter of other properties in the neighbourhood, more or less comparable with the property in question, is very relevant in arriving at reasonable expected rent. (c) Standard Rent under the Rent Control Acts - Standard rent is the maximum rent which a person can legally recover from his tenant under a Rent Control Act. The Supreme Court has observed in the cases of Shiela Kaushish vs. CIT [1981] 7 Taxman 1 and Amolak Ram Khosla vs. CIT[1981] 7 Taxman 51 that a landlord cannot reasonably expect to receive from a hypothetical tenant anything more than the standard rent under the Rent Control Act. This rule is applicable even if a tenant has lost his right to apply for fixation of the standard rent. This rule is also applicable to the owner himself. These judgments make it clear that if a property is covered under the Rent Control Act, its reasonable expected rent cannot exceed the standard rent (fixed or determinable) under the Rent Control Act. Provision Illustrated- As mentioned earlier, the reasonable expected rent under computation will be computed on the basis of three factors, namelya. Municipal Valuation (MV); b. Fair Rent of the property (FR); and c. Standard Rent of the property (SR). The higher of (MV) and (FR), subject to maximum of (SR), is expected rent under Step I. The example given below illustrates the aforesaid propositions- A Municipal Value (MV) Fair Rent (FR) Standard Rent (SR) Reasonable Expected Rent under Step I [MV or FR, whichever is higher, subject to maximum of (SR)] 50 56 NA 56 B 50 56 55 55 (` In thousands) C 50 56 45 45 D 50 58 55 55 E 50 61 73 61

DIRECT TAXATION I 5.5

Income from House Property Reasonable expected rent cannot exceed the amount of standard rent. Reasonable expected rent can, however, be lower than standard rent-see Dr. Balbir Singh vs. MCD [1985] 152 ITR 388 (SC). In other words, standard rent is the maximum amount of reasonable expected rent. In the case of E, ` 61,000 (being higher of municipal valuation and fair rent) is the reasonable expected rent. Since this amount is lower than the maximum ceiling (i.e., standard rent: ` 73,000), it is taken as reasonable expected rent. Step II - Find Out Rent Actually Received or Receivable- For the purpose of Step II, rent received or receivable shall be calculated as followsRent of the Previous Year (or that part of the Previous Year) for which the property is available for letting out Less: Unrealized rent if a few conditions are satisfied Rent received/ receivable before deducting loss due to vacancy 5.7 COMPUTATION OF INCOME FROM SELF-OCCUPIED PROPERTY Before steps for computation are explained, it would be advisable to highlight the following features which regulate tax incidence on self-occupied properties : A property occupied for own business purposes - Where an assessee uses his property for carrying on any business or profession, no income is chargeable to tax under the head Income from House Property. The assessee, in such a case, is not entitled to claim any deduction on account of rent in respect of such house property in computing taxable profits of the business or profession. When more than one property is occupied for own residential purposes -Where the person has occupied more than one house for his own residential purposes, only one house (according to his own choice) is treated as self-occupied and all other houses will be deemed to be let out. In the case of deemed to be let out properties, the taxable income will be calculated in the manner explained above (Gross Annual Value shall be taken as reasonable expected rent). In the case of one self-occupied property (treated as such), the procedure for determining taxable income is as follow: 5.7.1 Computation of Annual Value of one self-occupied property One self-occupied property, treated as such, may fall in any one of the following categories: If such property is used throughout the Previous Year for own residential purposes, it is not let out or put to any other use. If such property could not be occupied throughout the Previous Year because employment, business or profession of the owner is situated at some other place. When a part of the property (being independent residential unit) is self-occupied and the other part is let out. When such property is self-occupied for a part of the year and let out for the other part of the year. 1. A House Property fully utilised throughout the Previous Year for self-residential purposes [Section 23(2) (a)] Where the property consists of one house in the occupation of the owner for his own residence, the annual value of such house shall be taken to be nil, under section 23(2)(a), if the following conditions are satisfied Condition 1- The property or part thereof is not actually let during whole (or any part) of the Previous Year. Condition 2- No other benefit is derived there from. xxxx xxxx xxxx

5.6 I DIRECT TAXATION

Computation of income In the case of one property (which is not let out nor put to any other use) used throughout the previous year by the owner for his residential purpose, income shall be determined as followsGross Annual Value Less: Municipal tax Net Annual Value Standard deduction Income from one self-occupied house property Nil Nil Nil Nil xxxx

Interest on borrowed capital Deductible

2. A House Property, which is not actually occupied by the owner owing to employment or business/ profession, carried on at any other place [Section 23(2)(B) The provision of the section is applicable if the following conditions are satisfied Condition 1 The taxpayer owns a house property, which cannot actually be occupied by him by reason of the fact that owing to his employment, business or profession, carried on at any other place. Condition 2 He has to reside at that other place in a building not owned by him. Condition 3 No other benefit is derived from the above property by the owner. The method of computation of Income from House property is same as in the case of self-occupied house property. 3. When a part of property is self-occupied and a part is let out If a house property consists of two or more independent residential units, one of which is self-occupied for own residential purpose and other unit(s) are let out, income is computed as follows Unit self-occupied for residential purpose throughout the Previous Year (which is not let out nor put to any other use) as given above in Section 23(2)(a). Let out units as given earlier in the case of let out property. Units self-occupied for residential purpose for a part of year and lying vacant for remaining part because of business or profession is situated at some other place as given above in Section 23(2)(b). 4. Where a house is self-occupied for a part of the year and let out for remaining part of the year In this case, the benefit of section 23(2)(a) is not available and income will be computed as if the property is let out. 5.7.2 Brief Provision- Tax incidence on self-occupied house property may be summarized as follows Self -occupied property i) If such property is used by the owner for the purpose of carrying on his business or profession Tax treatment Income is not taxable under the head "Income from House Property". Any income and expenditure in respect of such property will be considered while calculating income from business or profession under section 28.

ii) If such property is used for residence of the owner and his family members

DIRECT TAXATION I 5.7

Income from House Property A. If only one property is used for such purpose If such property is used throughout the previous year for own residential purposes, it is not let out or put to any other use If such property could not be occupied throughout the previous year because employment, business or profession of the owner is situated at some other place When a part of the property (being independent residential unit) is self-occupied and the other part is let out Nothing is taxable. Only interest on borrowed capital is deductible subject to a maximum of `30,000 /`1,50,000 [Section 23(2)(a)]. Nothing is taxable. Only interest on borrowed capital is deductible subject to a maximum of `30,000 /`1,50,000 [Section 23(2)(a)] subject to satisfaction of the all conditions which are specified in Section 23(2)(b). Income from the independent unit, which is self-occupied, will not be taxable. Interest on borrowed capital is deductible up to ` 30,000 / `1,50,000. Income from the unit which is let out is to be computed as if the unit is let out. No concession is available. The house will be taken as let out property Only one property selected by the taxpayer will be treated as self-occupied. Other remaining properties will be deemed as let out.

When such property is self-occupied for a part of the year and let out for the other part of the year

B. If more than one property is used for residential purpose

5. 8 RECOVERY OF UNREALISED RENT [SECTION 25AA] 1. Unrealized Rent means the rent not paid by the tenant to the owner and the same shall be deducted from the Actual Rent Receivable from the property before computing income from that property, provided the following conditions are satisfied: (i) The tenancy is bonafide (ii) The defaulting tenant should have vacated the property (iii) The assessee has taken steps to compel the defaulting tenant to vacate the property (iv) The defaulting tenant is not in occupation of any other property owned by the assessee (v) The assessee has taken all reasonable steps for recovery of unrealized rent or satisfies the Assessing Officer that such steps would be useless.

2. Chargeability: Recovery of Unrealized Rent is chargeable to tax as Income from House Property. 3. Year of Taxability: Unrealized Rent recovered is taxable in the financial year in which it is recovered. 4. Non-subsistence of Ownership: It will be taxable in the hands of Individual even if he does not own the property to which such rent pertains during the relevant Previous Year. 5. Deduction: No deduction will be allowed against such receipt. 5.9 RECEIPT OF ARREARS OF RENT [SECTION 25B] 1. Meaning: Arrears of Rent means the incremental rent relating to earlier financial years which has not been offered to tax in those financial years itself, but received during the current financial year. 2. Chargeability: Receipt of Arrears of Rent will be chargeable to tax under the head Income from House Property only.

5.8 I DIRECT TAXATION

3. Year of Receipt: It is taxable as income of the financial year in which he receives the arrears of rent. 4. Non-subsistence of Ownership: It is taxable in the hands of the Individual even if he does not own the property at the time of receipt of arrears of rent. 5. Deduction: A standard deduction of 30% of the amount of arrears received will be allowed as deduction. 5.10 MUNICIPAL TAX 1. Municipal Tax includes services tax like Water Tax and Sewerage Tax levied by any Local Authority. It can be claimed as a deduction from the Gross Annual Value of the Property. 2. Conditions: (a) Paid by Owner. The tax shall be borne by the owner and the same was paid by him during the Previous Year. (b) Property Let out: Municipal Tax can be claimed as a deduction only in respect of let out or deemed to be let out properties (i.e. not in respect of the self-occupied house property or one of the self-occupied properties which the assessee chose as self occupied in case where assessee owns more than one property self occupied). (c) Year of Payment: Municipal Tax relating to earlier Previous Years, but paid during the current Previous Year can be claimed as deduction only in the year of payment. (d) Advance Taxes: Advance Municipal Tax paid shall not be allowed as deduction in the year of payment, but can be claimed in the year in which it falls due. (e) Borne by Tenant: Municipal Taxes met by tenant are not allowed as deduction.

3. Foreign Property: For a property situated outside India, Municipal Tax levied by foreign Local Authority can be claimed as a deduction. 5.11 DEDUCTION FROM NET ANNUAL VALUE A. Standard Deduction u/s 24(a) Standard deduction of 30% of NAV (Net Annual Value) shall be allowed to the assessee in respect of (i) maintenance charges, (ii) repairs, (iii) collection charges, (iv) electricity, (v) fire insurance premium, (vi) ground rent, and (vii) depreciation. Hence, expenses on maintenance charges, repairs, collection charges, electricity, fire insurance premium, ground rent and depreciation incurred by the assessee relating to the house property will not further be allowed to be deducted in calculation Income from House Property. B. Interest on Loan u/s 24(b)

1. Purpose of Loan: The loan shall be borrowed for the purpose of acquisition, construction, repairs, renewal or reconstruction of the house property. 2. Accrual Basis: The interest will be allowed as a deduction on accrual basis, even though it is not paid during the financial year. 3. Interest on Interest: Interest on unpaid interest shall not be allowed as a deduction. 4. Brokerage: Any brokerage or commission paid for acquiring the loan will not be allowed as a deduction. 5. Prior Period Interest: Prior Period Interest shall be allowed in five equal installments commencing from the financial year in which the property was acquired or construction was completed.

DIRECT TAXATION I 5.9

Income from House Property 6. 7. 8. 9. Note: Prior period interest means the interest from the date of borrowed of the loan up to the end of the financial year immediately preceding the financial year in which acquisition was made or construction was completed. Interest on fresh loan to repay existing loan: Interest on any fresh loan taken to repay the existing loan shall be allowed as a deduction. [Circular 28 / 20.9.1969] Inadmissible Interest: Interest payable outside India without deduction of tax at source and in respect of which no person in India is treated as an Agent u/s 163 shall not be an allowable expenditure. [Section25] Certificate: The assessee should furnish a certificate from the person from whom the amount is borrowed. Maximum Ceiling: (a) In case of self occupied house property: Interest on borrowed capital [of current year and preconstruction period] is deductible subject to a maximum ceiling given below If the following three conditions are satisfied, interest on borrowed capital is deductible up to `1,50,000 Condition 1 Capital is borrowed on or after April 1, 1999 for acquiring or constructing a property. Condition 2 The acquisition or construction should be completed within 3 years, from the end of the financial year in which the capital was borrowed. Condition 3 The person extending the loan certifies that such interest is payable in respect of the amount advance for acquisition or construction of the house or as re-finance of the principle amount outstanding under an earlier loan taken for such acquisition or construction. In any other case, interest on borrowed capital is deductible up to ` 30,000. (b) In case of let-out house property or deemed let-out house property: Deduction of interest on borrowed capital is not subjected to maximum ceiling. 5.12 COMPUTATION OF PRIOR PERIOD INTEREST Let us illustrate the steps with an example: Loan taken on1.7.09 ` 8,00,000 @ 9% p.a. Date of completion of construction 31.5.12. Loan amount remains outstanding till date. Prior Period and Interest u/s 24(b) are determined as under : Step 1: Identify the Date of Borrowal of Loan Step 2: Identify the Date of Completion / Acquisition Step 3: Identify Last Date of the Financial Year immediately preceding the date of Completion / Acquisition. Step 4: Prior Period = Calculated Period from Step 1 to Step 3 Rate of interest Amount of Loan Step 5: Prior Period Interest = Prior Period as per Step 4/12 months = 1.7.09 (P.Y : 09-10) 31.5.12 (P.Y : 12-13) 31.3.12 (P.Y: 11-12) = 1.7.09 - 31.3.12 = 33 months 9 33 ___ ___ 8,00,000 100 12

= 1,98,000 Step 6: Allowable Prior Period Interest = Prior Period Interest as per Step 5/ 5 Current Year Interest = 8,00,000 9% = 72,000 Therefore, Interest allowable u/s 24(b) = CYI + 1/5 PCPI = 39,600

5.10 I DIRECT TAXATION

= 72,000+1/5x 1,98,000 = 72,000 + 39,600 = 1,11,600

A SNAPSHOT OF THE COMPUTATION OF GAV AND INCOME FROM HOUSE PROPERTY

COMPUTATION OF GROSS ANNUAL VALUE 1. Municipal Value 2. Fair Rental Value or Notional Rental Value 3. Higher of (1) and (2) 4. Standard Rent (if applicable) 5. Reasonable Expected Rent= Lower of Step (3) and (4) 6. Annual Rent (total rent assuming the property to be let out throughout the Previous Year) 7. Deduct: Unrealized Rent as per Rule 4 8. Actual Rent= Step (6) (7) 9. Higher of Reasonable Expected Rent (Step 5) & Actual Rent (Step 8) 10. Deduct: Vacancy Allowance (proportionately on the basis of Annual Rent in Step 6) 11. GROSS ANNUAL VALUE COMPUTATION OF INCOME FROM HOUSE PROPERTY GROSS ANNUAL VALUE Less: Municipal Taxes paid during the year NET ANNUAL VALUE Less: Standard Deduction @ 30% of NAV u/s 24(a) Less: Interest on Loan u/s 24(b) Add: Recovery of Unrealized Rent u/s 25 AA Income from House Property before considering Arrears of Rent Add: Arrears of Rent Received Less: Deduction u/s 25B: 30% of Arrears Received NET INCOME FROM HOUSE PROPERTY xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx

DIRECT TAXATION I 5.11

Income from House Property

ILLUSTRATIONS ON INCOME FROM HOUSE PROPERTY

Illustration 1. R owns a house. The municipal value of the house is ` 80,000. He paid ` 18,000 as local taxes during the year. He uses this house for his residential purposes but let out half of the house at ` 3000 per month with effect from 1st January 2013. Compute the Annual Value of the house. Solution : Mr. R uses the house for his residential purpose and let out half of the house for 3 months. Accordingly, the house shall be treated as partly self occupied and partly let out Particulars Municipal value Fair Rent Actual Rent receivable Municipal Tax Computation of Net Asset Value (NAV) Step Particulars Municipal Value Fair Rent I II Reasonable Rent Actual Rent receivable Unrealised Rent GAV higher of Step I & II Less: Municipal Tax Net Annual Value Nil Nil Working 1 :1 30000 x 12 Higher of above two 3000 x 3 Unit 1 (self occupied) 40000 Unit 2 (let out) 40000 36000 40000 9000 40000 (9000) 31000 Total 80000 36000 3000 x 3 18000 Unit 1 (self occupied) 40000 9000 Unit 2 (let out) 40000 36000 9000 9000

5.12 I DIRECT TAXATION

Illustration 2. Mr. Rohan owns two houses. Their particulars for the Previous Year 2012-2013 are given below: Particulars House I House II

Construction completed on 01.04.2011 Self-occupied

Let out

Municipal Valuation Fair Rent Standard Rent Annual Rent received /receivable Municipal Taxes paid Insurance premium paid Repair expenses Unrealised rent-conditions of Rule 4 satisfied Interest on loan for the pre-construction period Interest on loan for the post construction period for the PY year 2012-2013 Date of borrowing the loan Certificate of interest attached to the return.

10,00,000 12,00,000 8,00,000 Nil 1,20,000 10,000 1,50,000 Nil 3,00,000 1,00,000 31.12.2005 No

15,00,000 14,00,000 16,00,000 18,00,000 150,000 15,000 2,00,000 4,50,000 4,50,000 1,50,000 31.12.2005 No

Determine the Income from House Property for the Assessment Year 2013-2014. Would you change your answer if construction is completed on 31-3-2011 and interest certificate is also attached? Solution : Computation of Income from House Property for the AY 2013-2014
House No. I-Self-occupied Particulars Date of completion 1-4-2011 failing after 3 years from the end of FY in which loan was taken Interest certificate not relevant (a) ` Gross Annual Value (a) Annual Letable Value (Higher of MV & FR subject to SR) (b) Annual rent received excluding unrealised rent Whichever is higher, is GAV Less : Municipal taxes paid Net Annual Value Less : Permissible deductions : (i) Statutory deduction : 30% of Net Annual Value (ii) Interest on loan Income from House Property Nil House No. II-Let out Date of completion House No. II-Let out 31-3-2011 within Interest certificate & 3 years from the end Date of competing of FY in which loan construction are was taken not relevant. Interest certificate attached (b) ` Nil ` 15,00,000

Nil Nil Nil Nil

Nil Nil Nil Nil

13,50,000 15,00,000 (-) 1,50,000 13,50,000

Nil (-) 30,000 (-) 30,000

Nil (-) 1,50,000 (-) 1,50,000

(-) 4,05,000 (-) 2,40,000 7,05,000

DIRECT TAXATION I 5.13

Income from House Property Note : 1. Interest for House No. I- Self-occupied : (a) (i) Interest for pre-construction period 5 : 3,00,000 5= ` 60,000 (ii) Interest for post-construction period : ` 1,00,000 (i) + (ii) = ` 1,60,000 Where loan is taken on or after 01.04.1999 but the house is not completed within 3 years from the end of the financial year in which the loan was taken, maximum ceiling of interest, eligible for deduction is only ` 30,000. It is operative from the AY 2005-2006 and subsequent years. In the instant case, self-occupied house is completed after the prescribed time-limit of 3 years. Hence, deduction is restricted to ` 30,000. (b) (i) In the instant case, self-occupied house has been completed within 3 years from the end of the financial year in which loan was taken and certificate of interest is also attached. Hence, interest on loan, subject to the maximum ceiling of ` 1,50,000 has been allowed. (ii) Construction is completed within the prescribed time-limit of 3 years from the end of the FY in which loan was taken but interest certificate is not attached. Hence, interest on loan, subject to a maximum of ` 30,000, has been allowed. (i) Interest for pre-construction period: 4,50,0005 = 90,000 (ii) Interest for post-construction period during 2012-2013: 1,50,000 Interest eligible for deduction (i) + (ii) = 2,40,000

2. Interest for House No. II. Deduction has been worked out as under:

3. No deduction is available for insurance premium and repair expenses incurred. Illustration 3. Mr. Shyam owns two houses, which are occupied by him for his own residence. The detailed particulars of houses and his other incomes for the Previous Year 2012-13 are given below: Particulars Fair Rent Municipal Value Standard Rent Municipal taxes paid Interest on loan for the FY 2012-13 Date of loan Date of completion Certificate of interest attached with return of income Mr. Shyam earns income from other sources amounting to ` 2,00,000 Compute his Total Income and advise him which house should be opted for self-occupation. House A ` 5,00,000 4,20,000 4,50,000 50,000 1,60,000 1.12.2002 31.03.2004 No House B ` 5,00,000 4,50,000 6,20,000 60,000 2,20,000 1.04.2003 31.03.2006 Yes

5.14 I DIRECT TAXATION

Solution : Computation of Income from House Property under different options Particulars (a) Assuming both properties are self-occupied (SO) Annual Value Less : Interest on loan Loss from House Property (b) Assuming both properties as deemed let out (DLO) Gross Annual Value Less : Municipal taxes paid Net Annual Value Less : Permissible deduction : (i) Statutory deduction : 30% of Net Annual Value (ii) Interest on loan Income from House Property (c) Criteria for selection of house for self-occupied : Lowest taxable income Income from house A Income from house B Income from Other Sources Total Income Conclusion : House B should be treated as self-occupied. (-) 1,20,000 (-)1,60,000 1,20,000 Option I (-)30,000 (SO) 88,000 (DLO) 2,00,000 2,58,000 (-) 1,32,000 (-) 2,20,000 88,000 Option II 1,20,000 (DLO) 1,50,000 (SO) 2,00,000 1,70,000 4,50,000 (-) 50,000 4,00,000 5,00,000 (-) 60,000 4,40,000 Nil (-) 30,000 (-) 30,000 Nil (-) 1,50,000 (-) 1,50,000 House A ` House B `

Illustration 4. Dr. (Ms) Priyanka is the owner of a big house consisting of three units. Unit I consist of 40% area and Unit II and III are equal dimension, each occupying 30% area. The construction of house was completed on 1st April 2007 at a cost of ` 10,00,000. The municipal value of the house for the Previous Year 2012-13 has been fixed at ` 2,00,000. Municipal Taxes have been levied and paid @ 15% of rateable value. The rent under the Rent Control Act is ` 1,50,000. Unit I is let out @ `10,000 p.m. for residential purposes. Unit II is self-occupied. Unit III is used by her for her professional purposes. The tenant did not pay two months rent and conditions of Rule 4 are satisfied. She paid ground rent ` 9,000; interest on loan, taken during 20032004 for the construction of the house and payable during the PY 2012-2013 ` 1,50,000; insurance premium, ` 6,000. She spent ` 30,000 on repair of the house. Depreciation for the clinic portion is ` 15,000. Her gross receipt from professional during the Previous Year 2012-2013 amounted to ` 5,00,000. Compute her Gross Total Income for the Assessment Year 2013-2014.

DIRECT TAXATION I 5.15

Income from House Property Solution : Computation of Income from House Property for the Assessment Year 2013-2014 Particulars House Let-out ` House Self-occupied `

Gross Annual Value : (a) ALV : House let out (i) 40% of municipal value : ` 80,000 or (ii) 40% of the standard rent : ` 60,000 ALV is restricted to ` 60,000 (b) Actual rent for 40% portion for 10 months : ` 1,00,000 Gross Annual Value Less : Municipal taxes paid by the owner for 40%

1,00,000

Nil

= ` 12,000 Portion ` 2,00,000 Net Annual Value Less : Deduction from net annual value (Sec. 24) 1. Statutory deduction : 30% of Net Annual Value 2. Interest on loan : 40% of ` 1,50,000 for let out
Income from House Property Computation of taxable income from profession : Gross professional income Less : Expenses for 30% portion used for profession 1. Municipal taxes ` 2,00,000

12,000 88,000 (-) 26,400 (-) 60,000 1,600

Nil Nil Nil (-) 30,000 (-) 30,000 5,00,000

(Sec. 30)

9,000 9,000 2,700 45,000 1,800 15,000

2. Repair : 30% of ` 30,000 (Sec. 30) 3. Ground rent : 30% of ` 9000 (Sec. 30) 4. Interest on loan : 30% of ` 1,50,000 [Sec. 36(1)(iii)] 5. Insurance premium : 30% of ` 6000 (Sec.30) 6. Depreciation (Sec. 32) Taxable Income from Profession

82,500 4,17,500

Computation of Total Income : 1. Income from House Property : (a) Let out (b) Self-occupied 2. Income from profession Gross Total Income/Total Income

1,600 (-)30,000

(-) 28,400 4,17,500 3,89,100

5.16 I DIRECT TAXATION

Illustration 5. Mr. Ranjit Sinha is employed with HUD Co. Ltd. @ ` 25,000 p.m. He is the owner of a house property construction of which was completed on 1st April 2004. Since then, it has been in his self-occupancy for residential purposes. The particulars in respect of the house for financial year 2012-2013 are given below: Municipal Valuation Municipal tax paid Ground rent outstanding Insurance premium paid ` 2,00,000 20,000 5,000 3,000

Interest on loan, taken on 1-6-2011 for renovation of the house, is ` 75,000 for the year 2012-2013. However, he could pay only, ` 45,000 during the year. He is transferred in February 2013 to the Nagpur Branch of the Company. He intends to allow his sister to occupy the house free of rent in his absence. He seeks your advice in this connection. Compute his total income for AY 2013-2014. Solution : Computation of Total Income Assessee : Mr. Ranjit Sinha A. Y : 2013-14 Case I House Case II House kept Vacant is occupied by his sister in ` his absence ` Nil Nil Nil Nil (-) 30,000 (-) 30,000 3,00,000 (-) 30,000 2,70,000 2,00,000 (-) 20,000 1,80,000 (-) 54, 000 (-) 75,000 51,000 3,00,000 51,000 3,51,000

Particulars

Income from House Property : Gross Annual Value Less : Municipal taxes paid Net Annual Value Less : Permissible deduction (Sec. 24) (i) Statutory deduction 30% of Net annual value (ii) Interest on loan for renovation Income from House Property Statement of Total Income : Income from Salary Income from House Property Total Income

Advise : From tax angle it is not advisable to allow his sister to occupy the house in his absence. Illustration 6. Mr. Kalidas is the owner of a house property. Its municipal valuation is ` 3,00,000. It has been let out for ` 4,40,000. The local taxes payable by the owner amounted to ` 30,000 but as per agreement between the tenant and the landlord, the tenant has paid them direct to the municipality. The landlord, however, bears the following expenses on tenants amenities during the year 2012-2013.

DIRECT TAXATION I 5.17

Income from House Property Expenses of water connection Water charges Lift maintenance Salary of gardener Lighting of stairs Maintenance of swimming pool The landlord claims the following deductions : Repairs Land revenue paid Collection charges Compute the Taxable Income from the House Property for the Assessment Year 2013-14 Solution : Computation of Income from House Property Assessee : Mr. Kalidas Particulars Gross annual value to be higher of the following : (a) ALV : Municipal valuation : 3,00,000 Or (b) Actual Rent : 3,69,000 Whichever is higher, is GAV Less : Local taxes payable Net Annual Value Less : Statutory deduction : 30% of Net Annual Value Taxable Income from House Property Note : Composite rent Less : Value of the amenities provided by the assessee : (i) Water connection expenses : Not allowed beings capital expenditure (ii) Water charges (iii) Lift maintenance (iv) Salary of gardener (v) Lighting of stairs (vi) Maintenance of swimming pool Actual Rent 20,000 15,000 18,000 6,000 12,000 A.Y : 2013-14 ` ` ` 10,000 20,000 15,000 18,000 6,000 12,000 30,000 6,000 10,000

3,69,000 Nil 3,69,000 1,10,700 2,58,300 4,40,000

(-) 71,000 3,69,000

5.18 I DIRECT TAXATION

Illustration 7. Mr. M. Saha is the owner of a house in Kolkata consisting of three identical floors, (ground floor, first floor and second floor). Ground floor is let out and the rest is occupied by him for his residence. The full particulars of the house for the Previous Year 2012-2013 are given below: Particulars (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) Municipal Valuation Fair Rent Standard Rent Annual Rent of the ground floor Municipal taxes paid by Mr. M. Saha Water/sewerage benefit tax, paid to Kolkata Municipal Corporation House remains vacant for 2 months Unrealized rent, condition of Rule 4 are satisfied Interest on loan, taken for the purchase of the house in April 2011 as per certificate ` 12,00,000 5,00,000 Nil 6,00,000 1,50,000 70,000 2,50,000 2,70,000

Compute the Income from the House Property for the AY 2013-2014. Solution : Assessee : Mr. M. Saha Computation of Income from House Property Particulars

AY 2013-2014 I & II floor in self-occupancy ` Nil Nil

Ground floor ` 5,00,000 3,50,000

Gross Annual Value (a) ALV (b) Actual Rent received / receivable Even without vacancy, actual rent received is lower than the ALV: 6,00,000 2,50,000 = 3,50,000. Thus, the loss is not wholly due to vacancy. Hence, only loss due to vacancy is to be deducted from ALV to determine GAV. GAV is (5,00,000-1,00,000) Less : Municipal taxes paid Net Annual Value Less : (1) Statutory deduction 30% of AV. (2) Interest on loan Income from House Property

4,00,000 (-) 50,000 3,50,000

Nil Nil Nil

(-)1,05,000 (-) 90,000 1,55,000

(-) 1,50,000 (-) 1,50,000

DIRECT TAXATION I 5.19

Income from House Property Illustration 8 . Mr. Ashis discloses the following particulars of the property owned by him during the PY 20122013. Particulars House selfoccupied 5,00,000 4,00,000 60,000 60,000 20,000 5,000 1,000 Flat allotted by HB Society let out ` 2,00,000 2,50,000 80,000 30,000 50,000 3,60,000 12,000 2,000 2,000 Shops & godowns let out ` 4,00,000 5,00,000 80,000 80,000 7,00,000 2,60,000 6,000 Nil 6,000 600 20,000

Municipal Value Fair Rent Municipal taxes payable (a) Paid by Ashis (b) Paid by tenant Annual Rent Expenses incurred by Ashis : Maintenance charges Repairs Collection charges Electricity bills paid Insurance premium Ground rent Depreciation Other information :

(i) He has taken the loan on 1st July 2010 to purchase the house in self-occupancy. However, he could purchase the house on 1st May 2011. He repaid ` 6,30,000 on 1st July 2012. This includes a charge of ` 1,20,000 on account of interest from the date of borrowing.

(ii) The flat has been purchased under EMI scheme of the Gujarat Apartment Cooperative House Building Society Ltd. He has to pay 120 EMI of ` 10,000 each, which includes 50% charge on account of interest. He has defaulted in payment of the last 20 EMI. To repay the outstanding EMI and penal interest of ` 20,000, he borrowed ` 2,20,000 on 1st October 2012 @ 15% p.a. The flat remained vacant for 1.5 months and rent of 3/4th month could not be realized. Conditions of Rule 4 have been satisfied. (iii) Shops and godowns are held as stock-in-trade. However, till a suitable buyer is found, these are let out. P claims that income from letting should be computed under the head Profits and Gains of Business of Profession. He has borrowed money to construct/repair the godowns/ shops. He paid ` 20,000 on account of brokerage for arranging the loan. Interest is payable outside India, in two equal installments of ` 50,000 each. The first installment was paid net of tax at ` 40,000. However, the second instilment was paid without deducting tax at sources as the recipient had given an undertaking in the prescribed form to pay the tax. Compute Income from House Property for the Assessment Year 2013-2014.

5.20 I DIRECT TAXATION

Solution : Assessee : Mr. Ashis Particulars Gross Annual Value

Computation of Income from House Property House self-occupied ` Nil Nil 24,000 (24,000) Flat let-out ` 2,92,500 30,000 2,62,500 78,750 37,500 1,46,250

A. Y : 2013-14 Shops and godowns let out ` 7,00,000 7,00,000 2,10,000 50,000 4,40,000

Less: Municipal taxes paid by the assessee Net Annual Value Less: Deductions u/s 24 Statutory deduction u/s 24(a) @ 30% of NAV Interest on Loan u/s 24(b) Income from House Property Workings: 1. Gross Annual Value: (a)ALV (b)Annual Rent (3,60,000 22,500) Higher of the above (a) & (b) Less: Vacancy Allowance

2,50,000 3,37,500 3,37,500 (45,000) 2,92,500

2. Interest on loan taken for self occupied: (i) Amount of interest = ` 1,20,000 (ii) Period of interest = 01.07.2010 to 01.07.2012 = 2 years (iii) Pre-acquisition period = 01.07.2010 to 31.3.2011 = 9 months (iv) Interest for pre-acquisition period =1,20,000 9/24 = ` 45,000 (v) Interest for 2011-2012 = ` 1,20,000/2 = ` 60,000 (vi) Interest for 2012-2013 for 3 months = 1,20,000 3/24 = 15,000 (vii) Interest deductible during PY 2012-2013 = (45,000/5) + (15,000) = 24,000 3. Interest for the flat: (i) Interest included in EMI from 01.04.2012 to 30.09.2012: ` (10,000 6/2) = ` 30,000 (ii) Interest on money borrowed to repay original loan interest ` (10,000 20/2) = (1,00,000 15% 1/2) = 7,500 (iii) Total interest = ` (30,000 + 7,500) = ` 37,500 (iv) No deduction is allowed for penal interest. 4. Letting out of shops and godowns, held as stock-in-trade: Section 22 excludes from its charge only such building as is occupied by the assessee for his business or profession, profits of which are chargeable to tax. In the instant case, as letting out is not the business of

DIRECT TAXATION I 5.21

Income from House Property the assessee, so, it cannot be said that he has occupied shop and godown for his business. Accordingly, income from letting out shop and building, held as stock-in- trade is assessable under the head Income from House Property. Where an assessee is not holding shops and godowns as stock-in-trade but engaged in the business of letting them on hire, the income is again chargeable under the head House Property as it is a specific head of income dealing with letting out of buildings only. 5. Deduction in respect of other expenses: Section 24 does not allow any deduction in respect of (i) maintenance charges, (ii) repairs, (iii) collection charges, (iv)electricity, (v) fire insurance premium, (vi) ground rent, and (vii) depreciation. Illustration 9. Puja has occupied three houses for her self-occupancy. Their particulars for the Previous Year 2012- 2013 are given below: Particulars Municipal Value Municipal taxes paid Fair Rent Standard Rent Repairs Ground rent paid Insurance premium paid Interest on loan taken for purchase of H.P. Year of the loan House X ` 3,60,000 40,000 5,40,000 4,50,000 1,50,000 20,000 5,000 75,000 1998-99 House Y ` 9,60,000 80,000 8,00,000 6,00,000 2,50,000 25,000 6,000 1,20,000 1998-99 House Z ` 9,50,000 90,000 10,00,000 9,00,000 3,00,000 30,000 7,000 2,00,000 2006-07

She has suffered loss in his business, amounting ` 3,00,000 Compute her total income, advising her which house should be specified for self- occupancy concession: Solution : Computation of Income from House Property under different options : (a) Assuming all the properties are self-occupied (SO) Annual Value Less: Interest on loan Loss from House Property (b) Assuming all the properties as Deemed Let Out (DLO) House X (DLO) ` 4,50,000 40,000 4,10,000 1,23,000 75,000 2,12,000 House X (SO) ` Nil 30,000 30,000 House Y (SO) ` Nil 30,000 30,000 House Y (DLO) ` 6,00,000 80,000 5,20,000 1,56,000 1,20,000 2,44,000 House Z (SO) ` Nil 1,50,000 1,50,000 House Z (DLO) ` ,00,000 90,000 8,10,000 2,43,000 2,00,000 3,67,000

Gross Annual Value Less: Municipal taxes paid Net Annual Value Less: Statutory deduction u/s 24(a) @ 30% of Net Annual Value Interest on Loan u/s 24(b) Income from House Property

5.22 I DIRECT TAXATION

(c) Total Income under different options for self-occupancy: Particulars Option 1 House X `
(-) 30,000 (SO) 2,44,000 (DLO) 3,67,000 (DLO) 5,81,000 (-) 3,00,000 2,81,000

Option 2 House Y `
2,12,000 (DLO) (-) 30,000 (SO) 3,67,000 (DLO) 5,49,000 (-) 3,00,000 2,49,000

Option 2 House Z `
2,12,000 (DLO) 2,44,000 (DLO) (-)1,50,000 (SO) 3,06,000 (-)3,00,000 6,000

House House House

X Y Z

Income from House Property Loss from business Total Income

Conclusion: A house with minimum income/maximum loss should be opted for self-occupancy concession to minimize the tax liability. The option can be changed from year to year. In the instant case, House Z should be treated as self-occupied. Illustration 10. Mr. Pradipto completed construction of a residential house on 1.4.2012. Interest paid on loans borrowed for purpose of construction during the 2 years prior to completion was ` 40,000. The house was let-out on a monthly rent of ` 4,000. Annual Corporation Tax paid is ` 2,000. Interest paid during the year is ` 16,000. Amount spent on repairs is ` 2,000. Fire Insurance Premium paid is ` 1,500 p.a. Property was vacant for 3 months. Annual letting value as per corporation records is ` 30,000. Compute the income under the head Income from House Property for the A.Y. 2013-14. Solution : Assessee : Mr. Pradipto Previous Year : 2012-2013 Assessment Year : 2013-14

Computation of Income from House Property Particulars Gross Annual Value u/s 23(1)(c) Less : Municipal Taxes Paid Net Annual Value (NAV) Less : Deduction u/s 24 (a) 30% of Net Annual Value (` 34,000 30%) (b) Interest on Borrowed Capital : Interest for Current Year Interest of Prior Period (` 40,000 1/5) Income from House Property (Note 1) ` ` 36,000 (2,000) 34,000 10,200 ` 16,000 ` 8,000 24,000 (34,200) (200)

DIRECT TAXATION I 5.23

Income from House Property Note : Computation of Gross Annual Value Municipal Value Annual Rent (4,000 12) () Unrealised Rent Annual Rent Higher of MV & Actual Rent Less : Vacancy Allowance 3 Gross Annual Value 30,000 48,000 Nil 48,000 48,000 12,000 36,000

Illustration 11. Mr. Suman owned a house property at Chennai which was occupied by him for his residence. He was transferred to Mumbai in June 2012 and therefore he let out the property with effect from 1.7.2012 on a monthly rent of ` 5,000. The corporation tax payable in respect of the property was ` 10,000 of which 50% was paid by him before 31.3.2013. Interest on money borrowed for the construction amounted to ` 20,000. Compute the income from house property for the A.Y. 2013-14. Solution : Assessee : Mr. Suman Previous Year : 2012-2013 Particulars Annual Value u/s 23(1)(a)/(b) Rent receivable for the whole year Less : Municipal Taxes paid ` 10,000 50% Net Annual Value Less : Deduction u/s 24 (a) 30% of Net Annual Value (b) Interest on borrowed Capital Income from House Property Assessment Year : 2013-14

Computation of Income from House Property ` ` 60,000 (5,000) 55,000 ` 55,000 30% 16,500 20,000 (36,500) 18,500

Illustration12. Mr. G and N constructed their houses on a piece of land purchased by them at Kolkata. The built-up area of each house was 1,000 sq ft. Ground floor and an equal area in the First floor. Mr. G started construction on 1.7.2011. Mr. G occupied the entire house on 1.4.2012. Mr. N occupied the Ground floor on 1.7.2012 and let-out the first floor for a rent of ` 20,000 p.m. However, the tenant vacated the house on 31.12.2012 and Mr. N occupied entire house during 1.1.2013 to 31.3.2013. Following are the other information : (i) Fair Rental Value of each unit (Ground floor/First floor) (ii) Municipal Value of each unit (Ground floor/First floor) (iii) Municipal taxes paid by (iv) Repair and Maintenance charges paid by ` 2,00,000 p.a. ` 90,000 p.a. G ` 12,000 N ` 12,000 G ` 40,000 N ` 50,000

5.24 I DIRECT TAXATION

Mr. G has availed a housing loan of ` 16.00 Lakhs @ 12% p.a. on 1.4.2011. N has availed a housing loan of ` 18.00 Lakhs @ 10% p.a. on 1.7.2011. No repayment was made by either of them till 31.3.2013. Compute Income from House Property for G and N for the A.Y. 2013-14. Solution : Assessee : Mr. G Previous Year : 2012-2013 Particulars Nature : Self Occupied Annual Value u/s 23(2) Less :Deduction u/s 24 : Interest ` 16 Lakhs 12% = ` 1,92,000 (Restricted to ` 1,50,000) Loss from House Property Assessment Year : 2013-14 Computation of Income from House Property ` NIL 1,50,000 (1,50,000)

Note : Since construction of property is completed in the year of borrowal of loan itself, prior period interest does not arise. Assessee : Mr. N Previous Year : 2012-2013 Particulars Ground Floor Nature : Self Occupied Annual Value u/s 23(2) Less : Deduction u/s 24 : Interest on Borrowed Capital Current Year : ` 18,00,000 10% 50% Prior Period : ` 18,00,000 10% 9/12 50% 1/5 First Floor Nature : Let-Out Annual Value u/s 23(1)(a)/(b) Higher of Fair Rent vs. Municipal Rent [See Note 1] Municipal Taxes (` 12,000 50%) Net Annual Value Less : Deduction u/s 24 (a) 30% of Net Annual Value (b) Interest on borrowed Capital Current Period Interest (` 18,00,000 10% 50%) Net Income from House Property Note : 1. Since the construction of property was completed on 1.7.2012, Fair Rent, Municipal Rent and Actual Rent receivable are to be considered only for a period of 9 months. Fair Rent = 2,00,000x9/12= 1,50,000 Municipal Value = 90,000x9/12 = 67,500 2. Since the house is self occupied for part of the year and let out for part of the year, income from house property shall be calculated for the whole year as deemed let out property. Therefore Rent receivable is ` 1,80,000 (` 20,000 9).
Higher of Rent selected above vs. Acual Rent received [See Note 2] Less :

Assessment Year : 2013-14

Computation of Income from House Property ` ` NIL 90,000 13,500 (1,03,500) (1,03,500) `

1,50,000 1,80,000

1,80,000 (6,000) 1,74,000

52,200 90,000 13,500 (1,55,700)

Prior Period Interest (` 18,00,00010% 9/1250% 1/5)

18,300 (85,200)

DIRECT TAXATION I 5.25

Income from House Property Illustration 13. Mr. L is the owner of a commercial property let out at ` 30,000 p.m. The Municipal tax on the property is ` 15,000 annually, 60% of which is payable by the tenant. This tax was actually paid on 15.4.2013. He had borrowed a sum of ` 20 Lakhs from his cousin, resident in USA (in dollars) for the construction of the property on which interest at 8% is payable. He has also received arrears of rent of ` 40,000 during the year, which was not charged to tax in the earlier years. What is the Property Income of X for A.Y. 2013-14? Solution : Assessee : Mr. L Previous Year : 2012-2013 Assessment Year : 2013-14 Computation of Income from House Property Particulars Let Out : So, Annual Value u/s 23(1)(a)/(b) = Actual Rent = ` 30,00012 Less : Municipal Taxes Paid during the F.Y. 2012-13 Net Annual Value Less : Deduction u/s 24 30% of NAV Interest on Housing Loan (Note) ` ` 3,60,000 NIL 3,60,000 ` 3,60,000 30% ` 20,00,000 8% 1,08,000 1,60,000 40,000 (12,000)

(2,68,000) 92,000 28,000 1,20,000

Income from House Property before considering Arrears of Rent Arrears of Rent Received Less : Deduction u/s 25B 30% of Arrears received ` 40,000 30% Net Income from House Property

Note : It is presumed that the tax has been deducted at source on the amount of interest payable outside India.

5.26 I DIRECT TAXATION

Study Note - 6
PROFITS AND GAINS OF BUSINESS OR PROFESSION
This Study Note includes 6.1 Definition of Business and Profession 6.2 Chargeability 6.3 Computation of Income from Business or Profession 6.1 DEFINITION OF BUSINESS AND PROFESSION BUSINESS [Sec. 2(13)] Definition of Business includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. Certain terms used in the definition can be understood as follows: Trade is the activity of purchase and sale of goods with an object of making profit. Commerce means trade repeated on a large scale. Manufacture is said to have taken place when as a result of certain process(es) applied on a product, a new and commercially different product comes into existence which is known to the market as different from the raw material. Adventure or concern in the nature of trade, commerce or manufacture has to be decided on the basis of cumulative effect of the facts and circumstances of each case i.e. scale of activity, time period covered by it, nature of the commodity etc. in order to decide whether the act is an adventure or concern. Business necessarily means a continuous activity with a profit motive by the application of labour and skill. Under certain circumstances a single and isolated transaction may also constitute business provided it bears clear indications of trade or is an adventure in the nature of trade. PROFESSION [Sec. 2(36)] Profession involves an exercise of intellect and skill based on learning and experience. It includes vocation. Vocation refers to any work performed on the strength of ones natural ability for that work. Regularity and profit-motive are not necessary for an activity to be called a vocation. 6.2 CHARGEABILITY [SEC. 28] U/s 28, the following income shall be chargeable to Income-tax under the head Profits and Gains of Business or Profession, (i) The profits and gain of any business or profession which has been carried on by the assessee at any time during the Previous Year; (a) any person, by whatever name called, managing the whole or substantially the whole of the affairs of an Indian company, at or in connection with the termination of his management or the modification of the terms and conditions relating thereto;

(ii) Any compensation or other payment due to or received by,

DIRECT TAXATION I 6.1

Profits and Gains of Business or Profession

(b) any person, by whatever name called, managing the whole or substantially the whole of the

affairs in India of any other company, at or in connection with the termination of his office or the modification of the terms and conditions relating thereto ;

(c) any person, by whatever name called, holding any agency in India for any part of the activities relating to the business of any other person at or in connection with the termination of the agency or the modification of the terms and conditions relating thereto ; (d) any person, for or in connection with the vesting in the Government, or in any corporation owned or controlled by the Government, under any law for the time being in force, of the management of any property or business ;

(iii) Income derived by a trade, professional or similar association from specific services performed for its members ; (a) Profits on sale of a licence granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947 (18 of 1947); (b) Cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India ;
(c) Any duty of customs or excise re-paid or re-payable as drawback to any person against exports

under the Customs and Central Excise Duties Drawback Rules, 1971;

(d) Any profit on the transfer of the Duty Entitlement Pass Book Scheme, being the Duty Remission Scheme under the export and import policy formulated and announced under section 5 of the Foreign Trade (Development and Regulation) Act, 1992 (22 of 1992); (e) Any profit on the transfer of the Duty Free Replenishment Certificate, being the Duty Remission Scheme under the export and import policy formulated and announced under section 5 of the Foreign Trade (Development and Regulation) Act, 1992 (22 of 1992);

(iv) The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession; (v) Any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm. Exception : Where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under clause (b) of section 40. The income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted ; (va) any sum, whether received or receivable, in cash or kind, under an agreement for (a) not carrying out any activity in relation to any business; or (b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services. (i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head Capital Gains;

Exception: This sub-clause (a) shall not apply to

(ii) any sum received as compensation, from the multilateral fund of the Montreal Protocol on Substances that Deplete the Ozone layer under the United Nations Environment Program, in accordance with the terms of agreement entered into with the Government of India.

6.2 I DIRECT TAXATION

Explanation: For the purposes of this clause, (i) agreement includes any arrangement or understanding or action in concert, (A) whether or not such arrangement, understanding or action is formal or in writing; or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;

(ii) service means service of any description which is made available to potential users and includes the provision of services in connection with business of any industrial or commercial nature such as accounting, banking, communication, conveying of news or information, advertising, entertainment, amusement, education, financing, insurance, chit funds, real estate, construction, transport, storage, processing, supply of electrical or other energy, boarding and lodging; (vi) Any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy. Explanation : For the purposes of this clause, the expression Keyman insurance policy shall have the meaning assigned to it in sub-section (10D) of section 10; (vii) any sum, whether received or receivable, in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded or transferred, if the whole of the expenditure on such capital asset has been allowed as a deduction under section35AD. Speculative Business : Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as speculation business) shall be deemed to be distinct and separate from any other business. In the context of computation of income under the head profits and gains of Business or Profession, the following points may be noted: (a) Profits chargeable to tax are computed on the basis of commercial principles including Generally Accepted Accounting Principles and Practices. (b) Only profits or gains are liable to Income-tax and not mere gross receipts. Capital receipts and Capital expenditures are not generally to be taken into account while computing profits under this section unless it expressly provides in the provisions of the Income Tax Act. (c) Taxable profits or gains should be real and not notional. Anticipated losses are not provided for and unrealized gains are not considered except in case of stock valuation which is valued at lower of cost or market price. (d) Profits and gains arises to Business or Profession carried on by the assessee are computed in relation to a time period which is covered by a Previous Year. It is not necessary that Business or Profession should be carried on throughout the Previous Year. However, as an exception, the following incomes are taxable by virtue of express provisions under the Act even if no business was carried on during the Previous Year. (i) Recovery against any loss, expenditure or trading liability earlier allowed as deduction. [Sec. 41(1)] (ii) Balancing charge i.e. profits or gains from sale of a building, machinery, plant or furniture owned by a power undertaking. [Sec. 41(2)] (iii) Profits and gains from sale of capital asset used for scientific research. [Sec. 41(3)] (iv) Recovery against bad debt. [Sec. 41(4)]

DIRECT TAXATION I 6.3

Profits and Gains of Business or Profession (v) Amount withdrawn from special reserve. [Sec. 41(4A)] (vi) Profits and gains from transfer of the Business or interest in the petroleum and natural gas business. [Sec. 42(2)] (vii) Any sum received after the discontinuance of a business. [Sec. 176(3A), Sec. 176(4)]

(e) Profits and gains can not arise by trading with oneself. (f) Taxability of an income depends on its source. Thus, profits and gains that arise to an assessee during the Previous Year may not be taxed under the head Business or Profession, its taxability depends on source. For example : (i) Profits from activity of purchasing and selling real estate properties is taxable under the head Profits and Gains of Business or Profession. However, rental income from any of such properties is taxable under the head Income from House Property.

(ii) Interest on securities held as investment is charged to tax under the head Income from Other Sources. However, interest on securities held as stock-in-trade is charged under the head Profits and Gains of Business or Profession . (g) Profits and gains from illegal business are also chargeable to Income-tax under this head. (h) Income from letting or exploiting of commercial assets is charged under the head Business or Profession but the intention of the assessee should be to treat the asset as commercial asset. 6.3 COMPUTATION OF INCOME FROM BUSINESS OR PROFESSION (SEC. 29)

Format for Computation of Business or Profession Income : Computation of Income from Business Net Profit as per Profit & Loss Account Add : Expenses disallowed/Inadmissible Expenses [i.e. items already debited in P & L A/c but not eligible for deduction] Less : Incomes Credited in P & L A/c to be treated separately under difference heads of income Less : Expenses (not debited to P & L A/c) allowed as per Provisions Income from Business Computation of Income from Profession Receipts relating to Profession (on Cash Basis) Less : Payment relating to profession (both cash and accrual basis) Income from Profession xxx (xxx) xxx xxx

xxx (xxx) (xxx) xxx

6.4 I DIRECT TAXATION

Expenses which are allowed as deduction [Sections 30 to 37] Rent, Rates, Taxes, Repairs and Insurance of Buildings [Sec. 30] In respect of rent, rates, taxes, repairs and insurance for premises, used for the purposes of the business or profession, the following deductions shall be allowed (a) where the premises are occupied by the assessee (i) as a tenant, the rent paid for such premises ; and further if he has undertaken to bear the cost of repairs to the premises, the amount paid on account of such repairs;

(ii) otherwise than as a tenant, the amount paid by him on account of current repairs to the premises ; (b) any sums paid on account of land revenue, local rates or municipal taxes ; (c) the amount of any premium paid in respect of insurance against risk of damage or destruction of the premises. Repairs and Insurance of Machinery, Plant And Furniture [Sec. 31] In respect of repairs and insurance of machinery, plant or furniture used for the purposes of the business or profession, the following deductions shall be allowed (i) the amount paid on account of current repairs thereto ; (ii) the amount of any premium paid in respect of insurance against risk of damage or destruction thereof Depreciation [Sec. 32] Depreciation is the diminution in the value of an asset due to normal wear and tear or due to obsolescence. In order to allow depreciation as notional expenses in computing profits and gains of Business or Profession, the following conditions are to be fulfilled; (i) There must be assets : It may be classified into two types. (a) Tangible assets : Buildings, machinery, plant or furniture. (b) Intangible assets : Know-how, patents, copy rights, trademarks, licences, franchise or any other business or commercial right of similar nature acquired on or after 1st April, 1998.

(ii) Such asset should be owned, wholly or partly, by the assessee : Ownership does not necessarily mean legal ownership. Assessee will be treated as owner if he is capable of enjoying the right of the owner in respect of asset in his own right and not on behalf of the owner in whom title vests even though a formal deed of title has not been executed and registered (Mysore Minerals Ltd. vs. CIT[(1999) 239 ITR 775(SC)]. In case of a building in which Business or Profession is carried on is not owned by the assessee but he holds a lease or other right of occupancy though he is not entitled to depreciation on the building, depreciation is allowed on the capital expenditure incurred for the purposes of Business or Profession on construction of any structure or renovation etc. (iii) Such asset should be used for purposes of Business or Profession. (iv) It should be used during the relevant Previous Years. Depreciation Statement as per Income Tax Act, 1961 Particular of Asset 1 WDV as on 01.4.... 2 Additions at Actual Cost 3 Deductions Net Value of Block 5 Depreciation for Current Year 6 WDV as on 31.03... 7

DIRECT TAXATION I 6.5

Profits and Gains of Business or Profession Block of Assets [Sec. 2(11) and Explanation 3 to Section 32]: It means a group of assets falling within a class of assets comprising, (i) Tangible assets : Buildings, machinery, plant or furniture; (ii) Intangible assets : Know-how, patents, copyright, trademarks, licences, franchises or any other business or commercial rights of similar nature in respect of which same percentage of depreciation has been prescribed. Aligning the definition of Block of Asset [Explanation 3 to Section 32(1)] [W.e.f. A.Y. 2010-11] The term Block of Assets has been defined in section 2(11) and in Explanation3 to section 32(1) of the Income-Tax Act. However, these definitions are not identical and therefore they are subject to misuse. Accordingly, Explanation of section 32(1) has been amended so as to delete the definition of Block of Assets provided therein. Consequently, Block of Assets will derive its meaning only from section 2(11) and Explanation 3 shall contain the meaning of assets which shall be applicable for electricity undertaking only. Written Down Value [Sec. 43(6)] (i) In case of assets acquired in the Previous Year, Written Down Value is the actual cost to the assessee. (ii) In case of assets acquired before the Previous Year :- Written Down Value is the actual cost of the asset to the assessee as reduced by depreciation actually allowed to him in respect of such asset under this Act. (iii) In case of any block of assets : Written Down Value of the block of asset is computed as per the following mechanism. ` Written Down Value of the block of assets at the beginning of the current Previous Year. Add: Actual cost of assets falling within that block, acquired during the Previous Year. Less: Moneys Payable and scrap value if any, in respect of asset sold/discarded/ demolished/destroyed during the Previous Year Written Down Value *** *** *** ***

(iv) In case of block of assets when there is a slump sale: In accordance with Section 2(42C), slump sale means the transfer of one or more undertakings as a result of the sale for lump sum consideration without values being assigned to the individual assets and liabilities in such sales. In such a situation it is not possible to deduct the money receivable in respect of the asset sold, as is done normally.

6.6 I DIRECT TAXATION

Written Down Value in case of slump sale is computed as per the following mechanism. ` Written Down Value of the entire block at the beginning of the relevant Previous Year. Add: Actual cost of assets falling within that block, acquired during the Previous Year. Less: Moneys payable and scrap value if any, in respect of asset sold/discarded/demolished/destroyed during the Previous Year Less: Actual cost of the asset falling within that block transferred by "Slum Sale"as reduced by amount of depreciation actually allowed to such asset, it should not exceed the written down value of the block as at the end of the Previous Year, it cannot be negative. Written Down Value *** *** *** *** ***

*** ***

(v) Written down value in case of demerged company [Explanation 2A of section 43(6)] Written Down Value of demerged company Written Down Value of assets prior to demerger shall be reduced by the written down value of assets transferred pursuant to demerger.

(vi) Written Down Value in case of resulting company [Explanation 2B of Sec. 43(6)] Written Down Value of resulting company Written Down Value of transferred assets as appearing in the books of the demerged company before the demerger.

(vii) Written Down Value in case of Corporatization [Explanation 5 of Section 43(6)] Written Down Value of a company under the scheme of corporatization Written Down Value of the transferred asset by a scheme of corporatization approved by SEBI to recognized stock exchange in India immediately before such transfer.

Note : Written down value cannot be negative i.e. it shall be reduced to nil in the following situations : (a) Where the block of assets ceases to exist i.e., all the assets of the block are transferred. (b) Where a part of the block is sold and the sale consideration of the assets sold exceeds the value of the block.

DIRECT TAXATION I 6.7

Profits and Gains of Business or Profession Written Down Value where the assessee was not required to compute his total income of any earlier Previous Year [Explanation 6* to section 43(6) inserted by the Finance Act, 2008, w.r.e.f Assessment Year 20032004] Where an assessee was not required to compute his total income for the purposes of this Act for any Previous Year or years preceding the Previous Year relevant to the assessment year under consideration, (a) the actual cost of an asset shall be adjusted by the amount attributable to the revaluation of such asset, if any, in the books of account; (b) the total amount of depreciation on such asset, provided in the books of account of the assessee in respect of such previous year or years preceding the Previous Year relevant to the Assessment Year under consideration shall be deemed to be the depreciation actually allowed under this Act for the purposes of this clause; and (c) the depreciation actually allowed under clause (b) shall be adjusted by the amount of depreciation attributable to such revaluation of the asset. Computation of Written Down Value where income of an assessee is derived in part from agriculture and in part from business chargeable to Income-tax under the head Profits and Gains of Business or Profession [Explanation 1 to Section 43(6)] [W.e.f. A.Y. 2010-11] Section 32(l)(iii) provides that depreciation is to be allowed and computed at the prescribed percentage on the Written Down Value (WDV) of any block of assets. Clause (b) of sub-section (6) of section 43 provides that WDV in the case of assets acquired before the Previous Year shall be computed by taking the actual cost to the assessee less all depreciation actually allowed to him under the Income Tax Act. Rules 7A, 7B and 8 of the Income Tax Rules, 1962, deal with the computation of composite income where income is derived in part from agricultural operations and in part from business chargeable to tax under the Income Tax Act, 1961 under the head Profits & Gains of Business. These rules prescribe the method of computation in the case of manufacture of rubber, coffee and tea. In such cases, the income which is brought to tax as Business Income is a prescribed fixed percentage of the composite income. The Honble Supreme Court in the case of CIT vs. Doom Dooma India Ltd 222 CTR 105 (SC) has held that in view of the language employed in clause (b) of sub-section (6) of section 43 regarding depreciation actually allowed, where any income is partially agricultural and partially chargeable to tax under the Income Tax Act, 1961 under the head Profits & Gains of Business, the depreciation deducted in arriving at the taxable income alone can be taken into account for computing the WDV in the subsequent year. For instance, Rule 8 prescribes the taxability of income from the manufacture of tea. Under the said rule, income derived from the sale of tea grown and manufactured by seller shall be computed as if it were income derived from business, and 40% of such income shall be deemed to be income liable to tax. As a result of the Court decision, the resultant computation of depreciation is as per the following illustration : ` Sale proceeds of tea Less: Expenses: Depreciation - (10% of ` 5,000) Others expenses Composite income Income subject to charge under the Income Tax Act, 1961 by application of rule 8 (40% of 3,000) Income not chargeable to income Tax (60% of 3,000) 5,000

(500) (1,500) 3,000 1,200 1,800

6.8 I DIRECT TAXATION

According to the interpretation of the Court, the W.D.V. of the fixed asset for the immediately succeeding year is to be taken at ` 4,800 (` 5,000 minus ` 200 being depreciation allocated for business income) and not ` 4,500 (` 5,000 minus depreciation of ` 500 allowed for determining composite income). Thus the depreciation for which deduction is allowed to the assessee while computing its agricultural income is to be ignored for computing the W.D.V. of the asset according to the Court ruling. The above interpretation is not in accordance with the legislative intent. WDV is required to be computed by deducting the full depreciation attributable to composite income. Hence in the above illustration, the WDV of the fixed asset for the immediately succeeding year is to be taken at ` 4,500 and not 4,800 as held by the Supreme Court. The ambiguity in this case has arisen on account of the interpretation of the meaning of the phrase actually allowed in clause (b) of sub-section (6) of section 43. Therefore Explanation 7 has been inserted in section 43(6) to provide that where the income of an assessee is derived, in part from agriculture and in part from business chargeable to Income-tax under the head Profits and Gains of Business or Profession, for computing the written down value of assets acquired before the Previous Year, the total amount of depreciation shall be computed as if the entire income is derived from the business of the assessee under the head Profits and Gains of Business or Profession and the depreciation so computed shall be deemed to be the depreciation actually allowed under this Act. Moneys Payable [Explanation To Sec. 41] Moneys payable in respect of any building, machinery, plant and furniture includes (a) any insurance, salvage or compensation moneys payable in respect thereof; (b) where the building, machinery plant or furniture is sold, the price for which it is sold. Depreciation Mandatory Explanation 5 to Sec. 32 inserted by the Finance Act, 2001 w.e.f. 1.4.2002, it is clarified that the depreciation provisions shall apply, whether or not the assessee has claimed the deduction in respect of depreciation in computing his total income. Rate of Depreciation for different 'Block of Asset': Section 2(11) provides that it is not necessary that assets should be used for purpose of business during the year under consideration. The use of the asset is important for the purpose of actual alllowability of depreciation, but not for determining whether the asset falls within the block of assets or not. A taxpayer may have different block of assets as given below Number Block 1 Block 2 Nature of Assets Building- Residential building other than hotels and boarding houses Building- Office, factory, godowns or buildings which are not mainly used for residential purpose (it cover hotels and boarding houses except cover under Block 3) Buildings- The followings buildings: i. building acquired on or after September 1, 2002 for installing machinery and plant forming part of water supply project or water treatment system and which is put to use for the purpose of business of providing infrastructure facilities under section 80IA(4)(i). ii. temporary erection such as wooden structures Any furniture/ fitting including electrical fittings Any plant & machinery (except covered by Block 6, 7,8, 9, 10, 11 or 12) and motor cars (other than those used in a business of running them on hire) acquired or put to use on or after April 1, 1990 Rate of Depreciation 5% 10%

Block 3

100%

Block 4 Block 5

10% 15%

DIRECT TAXATION I 6.9

Profits and Gains of Business or Profession Block 6 Block 7 Ocean-going ships, vessels ordinarily operating on inland waters including speed boats Buses, lorries and taxies used in the business of running them on hire, machinery used in Semi-conductor industry, moulds used in rubber and plastic goods factories. Aero planes- besides, it includes commercial vehicle which is acquired after September 30, 1998 but before April 1, 1999 and it is put to use for any period prior to April 1, 1999, life saving medical equipment Containers made of glass or plastic used as refills and plant and machinery which satisfy conditions of rule 5(2) and the followingi. new commercial vehicle acquired during 2001-02 and put to use before March 31, 2002 for the purpose of business or profession; ii. machinery/plant used in weaving, processing and garment sector of textile industry which is purchase under Technology Upgradation Fund Scheme during April 1, 2001 and March 31, 2004 and put to use up to March 31, 2004; and iii. new commercial vehicle which is acquired during January 1, 2009 and September 30, 2009 and put to use before October 1, 2009 for the purpose of business or profession. Computers including computer software. Besides, it includes new commercial vehicles acquired in replacement of condemned vehicle of 15 years of age and put to use before April 1, 1999 or put to use before April 1, 2000. It also includes books owned by a professional. It also includes gas cylinders; plant used in field operation by mineral oil concerns; direct fire glass melting furnaces Energy saving device; renewal energy devices; rollers in flour mills, sugar works & steel industry. Air pollution control equipments; water pollution control equipments; solid water control equipments; recycling and resource recovery systems; machinery acquired and installed on or after September 1, 2002 in a water supply project or water treatment system or for the purpose of providing infrastructure facilities; wooden parts used in artificial silk manufacturing machinery; cinematograph films, bulbs of studio lights; wooden match frames; some plants used in mines, quarries and salt works: and books carrying on business in running lending libraries Intangible assets- Know-how, patents, copyrights, trademarks, Licences, Franchises and any other business or commercial rights of similar nature 20% 30%

Block 8

40%

Block 9

50%

Block 10

60%

Block 11 Block 12

80% 100%

Block 13

25%

6.10 I DIRECT TAXATION

RATES OF DEPRECIATION

First year of Acquisition

Subsequent Year

Put to use 180 days or more

Less than 180 days

Half the of the normal Half normal rate rate of Depreciation

Full rate of Depreciation

Full rate of Depreciation

Additional Depreciation :

Finance Act, 2012 extends this facilities to an assessee engaged in the business of generation or generation and distribution of power Applicable For assesses engaged in the business of manufacture or production of any article or thing

Assets eligible for ad- Any new plant or machinery acquired and installed after 31.3.2005 ditional depreciation Assets not eligible for (a) Ships and aircrafts; additional deprecia- (b) Any machinery or plant which, before its installation by the assessee, was tion used either within or outside India by any other person, or (c) Any machinery or plant installed in any office premises or any residential accommodation, including accommodation in the nature of a guest house, or (d) Any office appliance or road transport vehicle, or (e) Any machinery or plant, the whole of which is allowed as deduction (whether by way of depreciation or otherwise) in computing the income chargeable under the head Profits and Gains from Business or Profession of any Previous Year Rate of Additional Depreciation 20% of the Actual Cost of Plant or Machinery

Adjusted rate of ad- If the newly acquired asset is put to use for a period of less than 180 days durditional depreciation ing the Previous Year, in which it is acquired, the rate of additional depreciation shall be provided at 50% of the normal rate = 50% 20% = 10% Additional depreciation as per section 32(1)(iia) is available on furnishing the details of machinery or plant and increase in the installed capacity of production in the prescribed form along with the returned income and the report of an accountant as defined in the explanation below subsection 2 of section 288 certify that the deduction has been correctly cleaned in accordance with the provisions of this clause. (i) Even after the amendment, a power generating unit which claims depreciation on straight-line basis under section 32(1)(i) cannot claim any additional depreciation in respect of investment in new plant and machinery. This is because of the fact that the additional depreciation under section 32(1) (iia) is available only in those cases where normal depreciation is claimed under section 32(1)(ii) on the basis of written down value of block of assets.

DIRECT TAXATION I 6.11

Profits and Gains of Business or Profession (ii) manufacturing companies (owning power generation units for captive consumption) were eligible for additional depreciation even before the amendment.

Illustration 1 : The WDV of plant and machinery on 1.4.2012 of Z Ltd. engaged in manufacturing of PVC granules is ` 2000 lacs. Company purchased additional plant and machinery for ` 1,600 lacs on 18.4.2012 inclusive of second-hand machine imported from Ireland of ` 400 lacs to increase its installed capacity of production from 1000 TPA to 1500 TPA. The production from new machine commenced w.e.f 1.12.2012. Work out by giving reasons the amount of allowable depreciation. Solution: Assessee : Z Ltd. Particulars ` Opening WDV Add : Additions During the year Net Value for the purpose of Depreciation Less : Depreciation of the Year On Opening Block ` 2,000 Lakhs 15% On Additions (Period of usage less than 180 days) ` 1,600 lakhs 15% 50% Additional Depreciation on Eligible Assets (Notes) Closing WDV 300 120 120 540 3,060 Previous Year : 2012-13 Computation of Depreciation Lakhs ` 2,000 1,600 3,600 Assessment Year : 2013-14

6.12 I DIRECT TAXATION

Notes : 1. Second hand machinery imported from Ireland is not an eligible asset for the purpose of Additional Depreciation computation. Therefore, cost of eligible assets = ` 1,600 lakhs ` 400 lakhs = ` 1,200 lakhs. 2. Period of usage of new machine is less than 180 days. Therefore, they are entitled to only 50% of additional depreciation rate of 20%. Illustration 2: W.D.V. of Machinery (Rate of Depreciation @15%) = ` 5,00,000 New Machinery Purchased (on 31.12.12) = ` 1,00,000, having same rate of depreciation. Calculate : Depreciation u/s 32 Solution: Block A : Machinery 5,00,000 Nil Nil Nil Nil 5,00,000 75,000 4,25,000 Block B : Machinery (Rate of Depreciation = 50% of 15%, since Acquired & Put to Use for less than 180 Days) Cost Less : Depreciation @ 7.5% Closing WDV From Block A From Block B Total Depreciation u/s 32 Illustration 3: From the following details, ascertain the amount of depreciation admissible. Particulars Opening WDV Addition during the year Sale during the year Rate of Depreciation Machinery 500000 600000 1200000 15% Building 2000000 Nil 400000 10% = 75,000 = 7,500 82,500 1,00,000 7,500 92,500

(Rate of Depreciation = 15%) W.D.V of the machinery Add: Cost of New asset Purchase (relating to the Block) [Put to Use > 180 Days] Less: Government subsidy Received for Purchase/ Acquisition Asset Less: Adjustment for CENVAT credit Less: Sale of Asset from the Block W.D.V for charging Depreciation Less: Depreciation @15% Closing W.D.V

DIRECT TAXATION I 6.13

Profits and Gains of Business or Profession Solution : Statement showing calculation of depreciation on machinery (Rate of depreciation @ 15%) Particulars Opening WDV Add : Addition during the year Less : Money receivable on sale of assets Closing WDV before depreciation Depreciation charged @15% Closing Written Down Value after depreciation Short Term Capital Gains Statement showing calculation of Depreciation on Building (Rate of depreciation @10%) Particulars Opening WDV Add : Addition during the year Less : Money receivable on sale of assets Closing WDV before depreciation Depreciation charged @10% Closing Written Down Value after depreciation Short Term Capital Gains Amount (`) 20,00,000 Nil (4,00,000) 16,00,000 1,60,000 14,40,000 Nil Amount (`) 5,00,000 6,00,000 (12,00,000) (1,00,000) Nil Nil 1,00,000

Note: Excess of the value of sale proceeds over the written down value of the block of asset, would result Short Term capital Gains. TERMINAL DEPRECIATION [SEC. 32(1)(III)] Terminal Depreciation (i.e. Loss on Transfer) & Balancing Charge (i.e. Gain on Transfer) (a) Applicable for any undertaking engaged in generation or generation and distribution of power; (b) It must be a depreciable asset, on which depreciation is claimed on straight line basis; (c) Such depreciable asset is sold, discarded, demolished or destroyed in a Previous Year. If there arises: (i) Loss on Sale = Terminal Depreciation;

(ii) Gain on Sale= Balancing Charge. Calculation of Terminal Depreciation: 1. Calculate Written Down Value of the depreciable asset on the first day of the Previous Year in which such asset is sold, discarded, demolished or destroyed. 2. Ascertain Net Sale Consideration. If value as per (1) > value as per (2) = Loss= Terminal Depreciation Note: (i) Sale Consideration is money payable to the tax payer in respect of such depreciable asset (+) Scrap Value, if any

6.14 I DIRECT TAXATION

 (ii) Net Sale Consideration = Sale Consideration (-) Expenses on Transfer; (iii) Sale consideration is the actual money, received or receivable in cash or by cheque or draft; (iv) It excludes any other thing or benefit which can be measured and converted in terms of money; (v) If the asset is sold or discarded, etc, in the Previous Year in which it is first put to use, any loss on transfer of that asset shall be treated as capital loss and not as terminal depreciation; (vi) The asset must be used by the assessee for the purpose of business or profession, at least for some considerable time period during the Previous Year, in which the transfer/sale takes place; (vii) Terminal depreciation can only be allowed, if the asset is completely written off from the books of accounts. Balancing Charge u/s 41(2) and Capital Gain u/s 50A: If value as per (2) > value as per (1) = Gain = Balancing Charge NC > WDV = Balancing Charge NC > OC = Capital Gain OC < WDV = Balancing Charge

Where, NC = Net Sale Consideration OC = Original Cost WDV = Written Down Value Illustration 4 : Kalpataru Power Projects is a power generating unit. On 1.4.2010, it purchased a plant of ` 50,00,000, eligible for depreciation @15% on SLM. Compute balancing charge or terminal deprecation assuming the plant is sold on 21.4.2012 for : (a) ` 8,50,000 (b) ` 32,00,000 (c) ` 45,00,000 (d) ` 52,00,000 Solution : Computation of Terminal Depreciation or Balancing Charge, Capital Gain. Particulars W.D.V. as on 1.4.2012 Less: Sale Proceeds Balance Terminal Depreciation Balancing Charge Short term capital Gain Computation of Depreciation: Original cost Less: Depreciation for the year 2010-11 WDV as on 1.4.2011 Less : Depreciation for the year 2011-2012 WDV as on 1.4.2012 A B C 35,00,000 45,00,000 (10,00,000) NIL 10,00,000 NIL D 35,00,000 52,00,000 (17,00,000) NIL 15,00,000 2,00,000

35,00,000 35,00,000 8,50,000 32,00,000 26,50,000 26,50,000 NIL NIL 50,00,000 7,50,000 42,50,000 7,50,000 35,00,000 3,00,000 3,00,000 NIL NIL

DIRECT TAXATION I 6.15

Profits and Gains of Business or Profession Section 43(1) Actual Cost Actual Cost [Sec. 43 (1)] for the purpose of determination of Depreciation:Explanation 1 2 3 Nature of Acquisition Assets used in scientific research subsequently put into use for the business Asset received under gift, will or inheritance Acquisition of asset to claim depreciation on enhanced cost to reduce tax liability Actual Cost NIL WDV to the previous owner Cost as determined by the Assessing Officer with the prior approval of Joint Commissioner of Income Tax

Transfer and re-acquisition of the same asset Least of the followings: (i) WDV at the time of original transfer (ii) Re-purchase price Sale and Lease Back Building previously used for private purpose WDV to the transferor Cost of Acquisition or construction Less : Deemed Depreciation Deemed depreciation refers to the total depreciation that would have been allowable had the building been used for business purpose since its acquisition WDV to the previous owner WDV to Parent company WDV to Indian Subsidiary Company

4A 5

Succession of business 6 Transfer by Parent Company to its wholly owned Indian Subsidiary Company Transfer by wholly owned Indian Subsidiary Company to its Indian Parent Company 7 7A Amalgamation (Amalgamated Company must be an Indian Company) Demerger : In the hands of the Demerged Company after demerger

WDV to the Amalgamating Company WDV of Demerged Company before Demerger Less : WDV of assets transferred to Resulting Company WDV to Demerged Company

7A

Demerger: In the hands of the Resulting Company

6.16 I DIRECT TAXATION

8,9,10

Asset acquired by the Assessee

Cost of Acquisition Add : (i) Interest on loan for the period upto the date of usage of the asset (ii) Freight & Insurance (iii) Loading, Unloading Charges (iv) Installation Charges Less : (i) Government Subsidy or Grant received related to purchase of asset (ii) CENVAT Credit Actual cost of Acquisiton Less : Notional depreciation for the period such asset was held outside India Actual Cost as if there is no such corporatization.

11

Assets brought into India by a Non-resident

12

Asset acquired by a company under a scheme of Corporatization of Recognized Stock Exchange

Note: The followings are to be considered for determination of Actual Cost (i) Actual cost refers to the cost of the asset to the assessee; (ii) Interest on loan after commencement of commercial production should not be included in the Actual Cost; (iii) Trial Run expenses should be included in Actual Cost, after adjusting any income derived during the trial run period; (iv) All expenses directly attributable (e.g. salaries, guest house for staff engaged in installation activities, travelling expenses incurred ) to setting up of plant and machinery, will be included; (v) Loss arising out of exchange rate differences, should be included in Actual Cost; (vi) Subsidy received from Government for units in backward areas should not be adjusted against Actual Cost of project, for computing depreciation; (vii) Cost of land shall not be considered for claiming depreciation; (viii) Interest receipts and Hire charges received from Contractors should be reduced from Actual Cost; (ix) Conversion cost incurred for transforming an asset shall be included in Actual Cost; (x) Interest earned on deposits made to open Letter of Credit for purchase of any asset will be adjusted to reduce Actual Cost. SALE AND LEASEBACK [EXPLANATION 4A OF SECTION 43(1)] Explanation 4A to section 43(1) is applicable if the following conditions are satisfied (i) Mr. A as second person owns an asset. (ii) The asset is used by A for the purpose of his business or profession. (iii) Depreciation under section 32 is claimed by A. (iv) A transfer the assets to Mr.B.

DIRECT TAXATION I 6.17

Profits and Gains of Business or Profession (v) Mr.A acquired the same asset from B by lease, hire or otherwise. If all the aforesaid conditions are satisfied, then, actual cost of asset in the hand of B for the purpose of depreciation will be the written down value of the asset in the hands of A at the time of transfer of asset by A to B. Subsidy [Explanation 10 of section 43(1)] Explanation 10 to section 43(1) provides that where a portion of the cost of an asset acquired by the assessee has been met, directly or indirectly, by the Central Government or State Government, or any Authority established under any law, or by any other person, in the form of subsidy or grant or reimbursement, then in a case where the subsidy is directly relatable to the asset, such subsidy shall not be included in the actual cost of the asset. In a case where the subsidy is directly relatable to the asset, such subsidy shall not be included in the actual cost of the asset. In a case where such subsidy, or grant or reimbursement, is of such nature that it cannot be directly relatable to any particular asset, so much of the amount which bears to the total subsidy or reimbursement or grant the same proportion as such asset bears to all the assets in respect of which or with reference to which such grant or subsidy or reimbursement is received, shall not be included in the actual cost of the asset to the assessee. Treatment of Trial Run Expenses and Income earned during Trial Run Period Illustration 5 : X Ltd. acquired a printing machine for ` 25,00,000. Transport Cost, including loading and unloading charges ` 35,000. Expenses incurred during the trial run period ` 2,00,000. Output generated during trial run period was sold for ` 90,000. Depreciation @ 15% . Compute WDV. Would your answer differ if the output generated during trial run period was ` 3,00,000. Assessee : X Ltd Previous Year : 2012-13 Computation of Depreciation Particulars Expenses incurred during trial run period Less : Income from sale of output generated during trial run period Net Cost / Gain Actual Cost of the Machine Add : Net Cost during trial run Less : Net Gain during trial run Actual Cost of Machine for charging depreciation Less : Depreciation @ 15% Written Down Value (W.D.V.) Treatment of Currency Exchange Fluctuation Illustration 6 : Z Ltd. purchased machinery (rate of depreciation 15%) from Japan for US$ 2,50,000 on 17. 08.2011 (US $ = `43.25) by borrowing from Hero Bank Ltd. Z Ltd. took a forward contract on 11.07.2011, when the exchange rate was ` 45.70 per US$. This was put to use from 23.11.2011. Compute Depreciation for the Previous Years 2011-12 and 2012-13. Amount (`) 2,00,000 (90,000) 1,10,000 25,35,000 1,10,000 26,45,000 3,96,750 22,48,250 Amount (`) 2,00,000 (3,00,000) (1,00,000) 25,35,000 (1,00,000) 24,35,000 3,65,250 20,69,750

6.18 I DIRECT TAXATION

Assessee: Z Ltd Previous Year : 2011-12 & 2012-13 Computation of Depreciation and Written Down Value Particulars Cost of the Asset ( US$ 2,50,000 ` 43.25) Less : Depreciation @ 50% of 15% (since Put to Use < 180 days) for Previous Year 2011-12 (` 1,08,12,500 50% 15%) WDV as on 01.04.2012 Add : Exchange Rate Difference [US$ 2,50,000 ` (45.70 43.25)] WDV for claiming depreciation Less : Depreciation @ 15% for the Previous Year 2012-13 (` 1,06,14,062 15%) WDV as on 01.04.2013 CENVAT Credit Adjustment Illustration 7 : Pharma Ltd. imported machinery from Germany on 27.8.12 at a cost of ` 40 crores. Customs Duty paid @ 20%. Government granted subsidy of ` 25 crores. The entire logisitics was supported by Nexgen Courier Ltd., an Indian Company. Total Service charges paid to them ` 20 lacs (Pre-acquision cost) including service tax of ` 2,20,000. Compute Actual Cost, if assessee, avail CENVAT credit adjustment. Assessee: PharmaLtd Computation of Depreciation and Written Down Value Particulars Cost of Purchase Add: Customs Duty @ 20% on ` 40 crores Add: Service charges (Being pre-acquisition cost) Less: Government subsidy granted Less: CENVAT Credit ( Service Tax paid included in the payment made to Naxgen Courier Ltd.) Actual Cost for the purpose of charging depreciation Illustration 8: ZED Ltd. imported machinery from South Korea on 12.5.2012 for US$ 50,000. Exchange rate on that date : US$ = 44. 70. Customs Duty paid @ 20%. Government granted subsidy of ` 15,00,000. The assessee had a forward contract on 2.4.2012 at US$ ` 45.30. Logistics services was provided by Carrywell Courier Ltd. Service Charges paid ` 2,00,000 including service tax of ` 25,000. Engineers and labourers were engaged at site for installation of the machinery. Salary and wages paid for site engineers and labourers including their travelling expenses amounted to ` 4,60,000. Expenses incurred during trial run period ` 1,50,000. Sale of output produced during trial run period ` 90,000. Interest earned on deposits made to open Letter of Credit for purchase of this machinery` 15,000 . The machine was put to use from 05.10.12. Depreciation @15%. Compute Actual Cost and Written Down Value. Amount (`crores) 40.000 8.000 0.200 25.000 0.022 23.178 Previous Year : 2012-13 Amount (`) 1,08,12,500 (8,10,938) 1,00,01,562 6,12,500 1,06,14,062 15,92,109 90,21,953

DIRECT TAXATION I 6.19

Profits and Gains of Business or Profession Assessee: ZED Ltd. Particulars Cost of the Asset ( US$ 50,000 ` 44.70) Add : Customs Duty paid @ 20% on ` 22,35,000 Less : Government Subsidy granted Add : Exchange Rate Difference [US$ 50,000 ` (45.30 - 44.70)] Add : Transportation charges paid ` 2,00,000 (including Service Tax ` 25,000) Less : CENVAT credit adjustment (credit for Service tax included in service charges paid to Carrywell Courier Ltd.) Add : Installation expenses incurred for payment of site engineers & labourers including travelling expenses Add : Expenses incurred during trial run period Less : Sale of output generated during trial run period Less : Interest earned on deposits made to open Letter of Credit for purchase of this machinery Actual Cost for the purpose of determining depreciation Less : Depreciation @ 50% of 15% (since Put to Use < 180 days) for Previous Year 2012-13 (` 18,92,000 50% x 15%) WDV as on 01.04.2013 Previous Year : 2012-13 Computation of Actual Cost and Written Down Value Amount (` crores) 22,35,000 4,47,000 (15,00,000) 30,000 2,00,000 (25,000) 4,60,000 1,50,000 (90,000) (15,000) 18,92,000 1,41,900 17,50,100

Proportionate Depreciation In the following cases, depreciation is allowed on proportionate basis where in any Previous Year, there is:(a) Succession of a partnership firm by a company [u/s. 47(xiii)] or (b) Succession of a proprietary concern by a company [u/s. 47(xiv)]or (c) Succession of any business other than on death [u/s. 170] or (d) Amalgamation of company [u/s. 2(1B)] or (e) Demerger of any company [u/s. 2(19AA)] Depreciation : Adjustments required after Succession of Business Illustration 9 : Conversion of Sole-proprietorship into Company A Bros., a sole-proprietorship concern, was converted into a A Ltd. on 20.9.2012. Before the conversion, the concern had a block of furniture (rate of depreciation @ 10%), whose WDV as on 01.04.2012 was ` 6,50,000. On 01.05.2012, a new furniture of the same block was purchased for ` 50,000. A Ltd. purchased another furniture of the same type on 20.12.2012 for ` 48,000. Compute depreciation that would be claimed by A Bros. and A Ltd for the Previous Year 2012-13. Solution : (1) Depreciation shall have to be calculated at the prescribed rates, as is applicable for a going concern, without considering the event of amalgamation or demerger. (2) Depreciation shall have to be apportioned between the predecessor and the successor in the ratio of number of days for which such assets were held for their business purpose and used by them.

6.20 I DIRECT TAXATION

Depreciation to be apportioned = [W.D.V. as on 1.4.2012 + New Purchases on 01.05.2012] = ` (6,50,000 + 50,000) = ` 7,00,000 10% = ` 70,000

Apportionment of Depreciation and Allowable Depreciation Assessee No. of Days Depreciation on Assets on the date of succession ` 70,000 173/365 = ` 33,178 ` 70,000 192/365 = ` 36,822 Depreciation on Assets acquired after Succession Nil Total Depreciation for the Previous Year 2012-13 ` 33,178

A Bros. (Sole- Proprietorship concern) A Ltd. (Company)

01.04.2012 to 20.9.2012 = 173 days 21.09.2012 to 31.3.2013

` 48,000 50% ` 39,222 10% = ` 2,400 (Put to use < 180days)

Illustration 10 : Amalgamation of Companies P Ltd. was taken over by Q Ltd. with effect from 31.7.2012. This satisfies the conditions of Sec. 2(1B) of the Income Tax Act, 1961. From the following information, compute deductions admissible u/s 32 to P Ltd and Q Ltd. for the previous year 2012-13. Assets Rate of Depreciation 10% 15% 15% 60% 10% WDV in the hands of P Ltd (as on 01.04.2012) 30,00,000 20,00,000 8,00,000 5,00,000 3,00,000 Transfer Value to Q Ltd. (`)

Building Plant & Machinery Motor Car Computers Furniture Solution :

45,00,000 15,00,000 6,00,000 2,00,000 1,40,000

(1) Depreciation shall have to be calculated at the prescribed rates, as is applicable for a going concern, without considering the event of amalgamation or demerger. (2) Depreciation shall have to be apportioned between the predecessor and the successor in the ratio of number of days for which such assets were held for their business purpose and used by them.

DIRECT TAXATION I 6.21

Profits and Gains of Business or Profession Depreciation Statement as per Income Tax Act, 1961 Particulars of Block of Rate Of W.D.V as on Additional Debenture Net Value Depreciation W.D.V. as Assets Dept. 01.04.2012 Actual Cost of Block for the Curon rent Year 31.3.2013 1 Block I Building Block II Plant & Machinery Block III Motor Car Block IV Computers Block V Furniture 2 10% 15% 3 30,00,000 20,00,000 4 Nil Nil 5 Nil Nil 6 30,00,000 20,00,000 7 3,00,000 3,00,000 27,00,000 17,00,000

15% 60% 10%

8,00,000 5,00,000 3,00,000 66,00,000

Nil Nil Nil

Nil Nil Nil

8,00,000 5,00,000 3,00,000 66,00,000

1,20,000 3,00,000 30,000 10,50,000

6,80,000 2,00,000 2,70,000 55,50,000

TOTAL DEPRECIATION ADMISSIBLE ` 10,50,000 Apportionment of Depreciation and Allowable Depreciation Assessee No. of Days Depreciation on Assets on the date of amalgamation `10,50,000 173/365 = ` 4,97,671 `10,50,000 243/365 = ` 6,99,041 Depreciation on Assets acquired after amalgamation Nil Total Depreciation for the Previous Year 2012-13 `4,97,671

P Ltd.

01.04.2012 to 31.7.2012 = 122 days 01.08.2012 to 31.3.2013 = 243 days

Q Ltd.

Nil

`6,99,041

Depreciation : Personal Assets used in the Business Illustration 11 : Mr. Hari purchased a house property on 18.11.2008 for `15,00,000. Till 1.7.2012, the same was self-occupied for own residence. Thereafter, the said building was brought into use for the purpose of his profession. Determine the amount of depreciable admissible for the Assessment Year 2013-14, given rate of depreciation @ 10%. Solution : Property acquired by the assessee himself: As per Sec. 43(1), if a building/asset used for private purpose of the assessee is subsequently put to use for the purpose of business, the cost of acquisition shall be determined in the following manner:

6.22 I DIRECT TAXATION

Assessee : Mr. Hari

Previous Year : 2012-13

Assessment Year : 2013-14 ` 15,00,000 75,000 14,25,000 1,42,500 12,82,500 1,28,250 11,54,250 1,15,425 10,38,825 1,03,883 9,34,942

Cost of acquisition of Residential House Property as on 18.11.2008 Less: Deemed depreciation for the Financial Year 2008-09 @ 50% of 10% on `15,00,000 (since period of usage is less than 180 days) WDV as on 01.04.2009 Less: Deemed Depreciation for Financial Year 2009-10 @ 10% on `14,25,000 WDV as on 01.04.2010 Less: Deemed Depreciation for Financial Year 2010-11 @ 10% on `12,82,500 WDV as on 01.04.2011 Less: Deemed Depreciation for Financial Year 2011-12 @ 10% on `11,54,250 WDV as on 01.04.2012 = Actual cost for the purpose of charging depreciation Less: Depreciation Admissible for Financial Year 2012-13 @ 10% on `10,38,825 WDV as on 01.04.2013 ASSET IS PARTLY USED FOR BUSINESS, PARTLY FOR PERSONAL PURPOSES [SEC. 38(2)]

If any asset is partly used for business and partly for personal purposes, depreciation u/s. 32(1)(ii) shall be restricted to a fair proportionate part thereof which the Assessing Officer may determine having regard to the user of such assets (building, machinery, plant or furniture) for the purposes of business or profession. UNABSORBED DEPRECIATION [SEC. 32(2)] Unabsorbed depreciation shall be treated as part of the current year depreciation such unabsorbed depreciation can be set off not only against income under Profits and Gains of Business or Profession but also against income under any other head. Unabsorbed depreciation can be carried forward indefinitely and the business need not be continued in order to get the benefit of carry forward of unabsorbed depreciation. SPECIAL PROVISION FOR COMPUTATION OF CAPITAL GAINS IN CASE OF DEPRECIABLE ASSETS [SECTION 50] Notwithstanding anything containing in section 2(42A), where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act, then the provisions of sections 48 and 49 shall be subject to the following modifications:(1) Where the full value of the consideration arising as a result of the transfer of one or more capital asset forming part of block of assets exceeds the aggregate of the following amount (i) expenditure incurred wholly and exclusively in connection with such transfer or transfers; (ii) the written down value of the block of assets at the beginning of the Previous Year; and (iii) the actual cost of any asset falling within the block of assets acquired during the Previous Year. Such excess shall be deemed to be the Capital Gains arising from the transfer of short-term capital assets; (2) Where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the Previous Year, then the following shall be deemed to be short-term capital gains/losses:

DIRECT TAXATION I 6.23

Profits and Gains of Business or Profession ` Full Value of Consideration Less: (i) WDV of the block of assets at the beginning of the Previous Year (ii) Actual cost of the assets falling within the block acquired during the Previous Year (iii) Expenses for transfer Short Term Capital Gain/Loss INVESTMENT ALLOWANCE [SEC.32A] In respect of a ship or an aircraft or machinery or plant specified in sub-section 2, which is owned by the assessee and is wholly used for the purposes of the business carried on by him, there shall, in accordance with and subject to the provisions of this section, be allowed a deduction, in respect of the Previous Year in which the ship or aircraft was acquired or the machinery or plant was installed or, if the ship, aircraft, machinery or plant is first put to use in the immediately succeeding previous year, then, in respect of that Previous Year, of a sum by way of investment allowance equal to twenty-five per cent of the actual cost of the ship, aircraft, machinery or plant to the assessee. TEA DEVELOPMENT ACCOUNT, COFFEE DEVELOPMENT ACCOUNT AND RUBBER DEVELOPMENT ACCOUNT [SECTION 33AB] (1) The provisions of this section are applicable to an assessee carrying on business of growing and manufacturing tea or coffee or rubber in India and the assessee has before the expiry of 6 months from the end of the previous year or before furnishing the return of income, whichever is earlier (a) deposited any amount with National Bank for Agricultural and Rural Development in an account maintained by the assessee with that Bank in accordance with, and for the purposes specified in,a scheme approved in this behalf by the Tea Boa rd or Coffee Board or Rubber Board (b) deposited any amount in Deposit Account opened by the assessee i n accordance with, and for the purposes specified in, a scheme framed by the Tea Board or Coffee Board or Rubber Board with the previous approval of the Central Government. On making the deposit within th e stipulated time, the assessee will be entitled to a deduction (such deduction being allowed before set off of any unabsorbed losses of Previous Years) equal to the amount of deposit which will, however, be restricted t o 40% of the profits of such business. xxx xxx xxx xxx xxx

(2) Where the deduction is allowed to a Firm or any Association of Persons or any Body of Individuals, it will not again be allowed in the hand of any of its partner/member. (3) The accounts of the Business of the assessee for the Previous Year for which the deduction is claimed have been audited by a Chartered Accountant and the assessee furnishes, along with his return of income, the report of such audit in the prescribed Form No. 3AC duly signed and verified by such accountant. (4) The deduction under this section will not be allowed in respect of any amount utilized for the purchase of: (i) any machinery or plant to be installed in any office premises or residential accommodation, including accommodation in the nature of guesthouse; (ii) any office appliances (not being computer) (iii) any new machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise); and

6.24 I DIRECT TAXATION

(iv) any machinery or plant to be installed in an industrial under taking for the purpose of business of construction, manufacture or production of any article or thing specified in the list in the Eleventh Schedule.

(5) Any amount standing to the credit of the assessee in the account (mentioned earlier) or the Deposit Account shall not be allowed to be withdrawn except for the purposes specified in the scheme or, as the case may be, in the deposit scheme or in the circumstances specified below: (a) Death of an assessee; (c) Partition of HUF; (e) Liquidation of a company

(6) Where any amount withdrawn from the said account is utilized by the assessee for the purposes of any business expenditure in accordance with the scheme or the deposit scheme, then such expenditure will not be allowed as deduction in computing the income chargeable under the Head Profit and gains of business or profession. (7) Where any amount standing to the assessee in the special account or in the Deposit Account is released/withdrawn during any previous year for being utilized by the assessee for purpose of business in accordance with the scheme and such amount is not so utilized, within that previous year, the amount not so utilized shall be deemed to be Business Income of the previous year. (8) Where any asset acquired in accordance with the scheme or the deposit scheme is sold or otherwise transferred in any Previous Year within 8 years from the end of the Previous Year in which it was acquired, such part of the cost of such asset as is relatable to the deduction earlier allowed shall be deemed to be the profits and gains of business or profession of the Previous Year in which the asset is sold or otherwise transferred. (9) Deduction under this section is computed before apportioning the income under Rule 7A/7B/8, Rule 7A/7B/8 provides that in case of an assessee carrying on business of growing and manufacturing of tea or coffee or rubber, computation of Agricultural and business income is done on the basis of percentage of business profits in the following manner Rule 7A 7B 8 Nature of Business Sale of centrifuged latex or cenex manufactured from rubber Sale of grown and cured coffee by the seller in India Sale of grown, cured, roasted and grounded coffee by the seller in India Sale of grown and manufactured tea Agricultural Income % 65 75 60 60 Business Income % 35 25 40 40

DIRECT TAXATION I 6.25

Profits and Gains of Business or Profession (10) Procedure of computation of Business Income in case of 33AB along with Rule 7A/7B/8: Particulars Profit from business before deduction u/s 33AB Less: Deduction u/s 33AB: Least of the following: (a) 40% of the Profit from the business (b) Amount deposited within the specified time in the specified account Profit of the Business Less: Agricultural Income [as per Rule 7A/7B/8] Business Income Less: Unabsorbed business loss or unabsorbed depreciation Taxable Business Income Illustration 12 Cash Book of M/S Brinda Rubber for financial year 2012-13 is given below: Cash Book Dr. Particulars To, Balance b/d To, Sale of centrifuged latex To, Interest on Bank FD Amount (`) Particulars 15,750 By, Salaries & Wages A/c 14,45,800 By, Electricity Charges A/c 14,45,800 By, Printing & Stationery A/c 38,000 By, Other Expenses A/c By, Amount deposited to Special A/c [specified by Rubber Board and approved by Central Govt.] By, Amount deposited to a account not specified by Central Govt. By, Bank Charges A/c By, Balance c/d 14,99,550 Additional Information: 1. Deprecation allowed u/s 32 of Income Tax Act is ` 28,200 but depreciation to be charged to the Profit & Loss A/c is ` 31,550. 2,00,000 Cr. Amount (`) 9,78,000 32,500 2,890 28,110 2,00,000 xxx xxx xxx xxx xxx xxx xxx xxx Amount (`) Amount (`) xxx

1,550 56,500 14,99,550

6.26 I DIRECT TAXATION

2. Unabsorbed business loss brought forward is ` 30,000[A.Y. 2011-12]. You are required to prepare Profit & Loss A/c and calculate the Taxable Business Profit for the Assessment Year 2013-14. Solution: Profit & Loss A/c for the year ended 31st March, 2013 Particulars To, Salaries & Wages A/c To, Electricity Charges A/c To, Printing & Stationery A/c To, Other Expenses A/c To, Bank Charges A/c To, Depreciation A/c To, Net Profit - transferred Amount (`) Particulars Amount (`) 14,45,800 38,000 9,78,000 By, Sale of centrifuged latex 32,500 By, Interest on Bank FD 2,890 28,110 1,550 31,550 4,09,200 14,83,800

14,83,800

Statement showing calculation of Business Income Particulars Net Profit as per Profit & Loss A/c Add: Depreciation debited to Profit & Loss A/c Less: depreciation allowable under Section 32 Income chargeable under other head Business Profit Less: Deduction u/s 33AB: Least of the following: (a) 40% of the Profit from the business ` 1,49,820 (b) Amount deposited within the specified time in the specified account ` 2,00,000 Profit of the Business Less: Agricultural Income [as per Rule 7A] Business Income Less: Unabsorbed business loss Taxable Business Income Illustration 13 : X Ltd., is a company engaged in the business of growing, manufacturing and selling of tea. For the accounting year ended 31st March, 2012, its composite business profits, before an adjustment under section 33AB of the Income-tax Act, were `60 lakhs. In the year, it deposited `25 lakhs with NABARD. The company has a business loss of `10 lakhs brought forward from the Previous Year. The company withdrew in February, 2012 `20 lakhs from the deposit account to buy a non-depreciable asset for `18 lakhs and could not use the balance before the end of the accounting year. The withdrawal and the purchase were under a scheme approved by the Tea Board. Amount (`) 4,09,200 31,550 4,40,750 28,200 38,000 3,74,550

1,49,820 2,24,730 1,46,075 78,655 30,000 48,655

DIRECT TAXATION I 6.27

Profits and Gains of Business or Profession The non-depreciable asset was sold in November, 2012 for `29 lakhs. Indicate clearly the tax consequences of the above transactions and the total income for the relevant years. Solution: Computation of total income of X Ltd. for A.Y. 2012-13 Particulars Net profits before adjusting deduction u/s 33AB Less: Deduction u/s 33AB [Lower of (i) 40% of `60 lakhs = `24 lakhs; or (ii) actual amount deposited with NABARD = `25 lakhs Profiits after adjusting deduction u/s 33AB As per Rule 8 of Income-tax Rules, 40% of this sum is subject to income-tax and the balance 60% is treated as agricultural income. Hence, the business income is 40% of `36 lakhs Add: Non-utilisation of amount withdrawn: ` 2 lakhs [i.e. (`20 lakhs `18 lakhs)] 80,000 15,20,000 10,00,000 Total Income Computation of total income of X Ltd. for A.Y. 2013-14 Particulars Business income (See Note 2) Capital gains (Short-term) (See Note 1) Total Income Note 1 - Computation of capital gains Particulars Sale proceeds Less: Cost of acquisition Short term capital gains (since the period of holding is less than 36 months) ` 29,00,000 18,00,000 11,00,000 ` 7,20,000 11,00,000
18,20,000

` 60,00,000 24,00,000

36,00,000

14,40,000

40% is taxable as business income (the balance 60% is treated as agricultural income). Business Income Less: Business loss brought forward from the Previous Year

5,20,000

6.28 I DIRECT TAXATION

Note 2 - Computation of business income: Since the asset is sold within 8 years, the cost of the asset i.e. ` 18 lakhs should be treated as income since the same has been allowed as deduction in the Assessment Year 2012-13. However, out of this `18 lakhs, 60% would be agricultural income and the balance 40% i.e. `7.2 lakhs would be business income of P.Y. 2012-13. This is because deduction under section 33AB was allowed in P.Y. 2011-12 before disintegration of income into agricultural income and non-agricultural income. (i) The assessee must be engaged in the business of tea, coffee or rubber plantation in India (ii) The amount must be deposited in a Special Account Specified in Section 33AB. (iii) The deposit should be made within the specified time limit. (iv) The accounts should be duly audited.

The assessment must satisfy the following conditions :

Amount of Deduction : Least of the followings : (i) Amount Deposited (ii) 40% of the Profit of the Business before any adjustment u/s 33AB & Sec. 72.

Site Restoration Fund [Sec. 33ABA] Deduction under section 33ABA is allowed to an assessee who satisfies the following conditions: Essential conditions: 1) The assessee is carrying on business consisting of prospecting for or extraction or production of petroleum or natural gas or both in India and in relation to which the Central Government has entered into an agreement with such assessee for such business. The assessee has before the end of the previous year (a) deposited with the State Bank of India any amount(s) in a special account maintained by the assessee with that bank, in accordance with and for the purposes specified in, a scheme approved in this behalf by the ministry of Petroleum and Natural Gas of the Government of India; or (b) deposited any amount in the Site Restoration Account opened by the assessee in accordance with, and for the purpose specified in a scheme framed by the aforesaid Ministry. This scheme is known as Deposit Scheme. The assessee must get its accounts audited by a Chartered Accountant and furnish the report of such audit in the Form No. 3AD along with the return of income. In a case where the assessee is required by or any other law to get its accounts audited, it shall be sufficient compliance if such assessee gets the accounts of such business audited under such law and furnishes the report of the audit as required under such other law and a further report in the form prescribed. Quantum of deduction: Quantum of deduction shall be: (a) the amount deposited in the scheme referred to above; or (b) 20% of the profit of such business computed under the head profits and gains of business or profession, whichever is less. Restriction on utilization of the deposit amount: The amount standing to the credit of the assessee, in the Special Account o f State Bank of India or the Site Restoration Account, is to be utilized for the business of the assessee in accordance with the scheme specified. However, no deduction shall be allowed in respect of any amount utilized for the purchase of:

2)

3)

4) 5)

DIRECT TAXATION I 6.29

Profits and Gains of Business or Profession a) any machinery or plant to be installed in any office premises or residential accommodation, including any accommodation in the nature of a guest house; b) any office appliances (not being computers); c) any machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise) in computing the income chargeable under the head Profits and Gains of Business or Profession of any one Previous Year; d) any new machinery or plant to be installed in an industrial undertaking for purposes of business of construction, manufacture or production of any article or thing specified in the list in the Eleventh Schedule.

6) Withdrawal of deposit: Any amount deposited in the special account maintained with State Bank of India or the Site Restoration Account shall not be allowed to be withdrawn, except for the purposes specified in the scheme or, as the case may be, in the deposit scheme. 7) Withdrawal of deduction: The deduction will be withdrawn under the following circumstances: (1) Where any amount standing to the credit of the assessee in the special account or in the Site Restoration Account is withdrawn on closure of the account during any Previous Year by the assessee, the amount so withdrawn from the account, as reduced by the amount, if any, payable to the Central Government by way of profit or production share as provided in the agreement referred to in section 42, shall be deemed to be the Profits and Gains of Business or Profession of that Previous Year and shall accordingly be chargeable to income-tax as the income of that Previous Year. Further, if the business carried on by the assessee is no longer in existence, these provisions shall apply as if the business is in existence in that Previous Year. (2) Where any amount, standing to the credit of the assessee in the special account or in the Site Restoration Account, which is released during any Previous Year by the State Bank of India or which is withdrawn by the assessee from the Site Restoration Account for being utilized by the assessee for the purposes of such business in accordance with the scheme or the deposit scheme is not so utilized, either wholly or in part, within that Previous Year, the whole of such amount or, as the case may be, part thereof which is not so utilized shall be deemed to be profits and gains of business and accordingly chargeable to income-tax as the income of that Previous Year. (3) Where any asset acquired in accordance with the scheme is sold or otherwise transferred before the expiry of 8 years from the end of the Previous Year in which it was acquired, such part of the cost of the asset as is relatable to the deduction allowed, shall be treated as the income of the Previous Year in which the asset is sold or otherwise transferred. where the asset is sold or transferred by the assessee to Government, local authority or a statutory corporation or a Government company;

The restriction of 8 years will not be applicable in the following cases (i)

(ii) Where the sale or transfer of the asset is made in connection with the succession of a firm by a company provided the following conditions are satisfied: (a) all the assets and all the liabilities of the firm relating to the business or profession immediately before the succession become the assets and liabilities of the company; (b) all the shareholders of the company were partners of the firm immediately before the succession.

Where any amount standing to the credit of the assessee in the special account or in the Site Restoration Account is utilized by the assessee for the purpose of any expenditure in connection with such business in accordance with the scheme or the deposits scheme, such expenditure shall not be allowed in computing the income chargeable under the head Profits and Gains of Business or Profession.

6.30 I DIRECT TAXATION

Expenditure On Scientific Research [Sec. 35] Scientific Research means any activities for the extension of knowledge in the filed of natural or applied sciences including agriculture, animal husbandry and fisheries. [Sec. 43(4)] Section 35(1) (i) Particulars Revenue Expenditure related to the business incurred for own business Deduction Current year Prior Period For undertaking Scientific research For undertaking Scientific research 125% of amount paid 100% 100% upto 3 years prior to commencement 175% of amount paid

35(1) (ii) 35(1) (iia)

35(1) (iii)

For research in Social Science or Statistical research 35 ( 1 ) ( i v ) Capital expenditure incurred for own related to the r e a d w i t h business business Current year 35 (2) (excluding cost of land) Prior Period 35(2AA) Any sum paid to National Laboratory For undertaking a or University or IIT or a specified program approved person by the prescribed Authority In house research and development Bio-technology or inof Bio-technology in the business of house research manufacture or production of any article or thing, not being an article or thing specified in list of Eleventh Schedule

Any sum paid to approved Scientific Research Association or University or College or Institution Any sum paid for scientific research, to a company, registered in India, having an object to carry out scientific research and development activities Any sum paid to an approved University, College or other Institution

125% of amount paid

100% reduction 100% upto 3 years prior to commencement 200% of amount paid

35(2AB)

200% of expense incurred allowed upto 31.3.2017

Expenditure on scientific research- In view of section 43(4)(ii), reference to expenditure incurred on scientific research includes all expenditure incurred for the prosecution, or the provision of facilities for the prosecution, of scientific research, but do not include any expenditure incurred in the acquisition of rights in, or arising out of, scientific research. Any methodical or systematic investigation based on science into the study of any materials and sources, is a scientific research. The dismantling of the imported coffee machine with a view to decipher how the said machine functions and also with a view to develop a new model of the machine with the intention of making the said machine suitable to the Indian condition is an investigation based on science and included in the definition of scientific research. When the term investigation based on science, it included in the definition of scientific research. When the term scientific research is used in relation to business, it does not have to be a research only in the field of natural or applied sciences.

DIRECT TAXATION I 6.31

Profits and Gains of Business or Profession Scientific research related to business- In view of section 43(4)(iii), reference to scientific research related to a business or class of business include: I) II) any scientific research which may lead to or facilitate an extension of that business or, as the case may be, all businesses of that class; and any scientific research of a medical nature which has a special nature which has a special relation to the welfare of workers employed in that business or, as the case may be, all businesses of that class.

Carry forward and setoff of deficiency in subsequent year- If on account of inadequacy or absence of profit of the business, deduction on account of capital expenditure referred to in section 35(1)(iv) cannot be allowed, fully or partly, the deficiency so arising is to be carried forward for unlimited years and set-off in any subsequent Assessment Year. However, carry forward of deficiency is subject to the condition that business loss already brought forward, if any, will have precedence over such deficiency in the matter of set-off. To put it little differently, the aforesaid deficiency will be given the same treatment as is given to unabsorbed depreciation vis-a-vis brought forward business losses. Consequence in the case of Amalgamation- In pursuance of an agreement of amalgamation, if the amalgamating company transfer to the amalgamated company, which is an Indian Company, any asset representing capital expenditure on scientific research, provision of section 35 would apply to the amalgamated company as they would have applied to the amalgamating company if the latter had not transferred the asset. Expenditure on acquisition of patent rights and copyrights [section 35A] If expenditure on acquisition of patent rights/ copyrights is incurred after March 31, 1988, depreciation is available under section 32. Now a day no deduction is available under section 35A. Deduction in respect of expenditure on Know-how [section 35AB] Deduction under section 35AB is available only if expenditure is incurred before April 1, 1998. If expenditure on acquisition of technical Know-how is incurred after March 31,1998, depreciation is available under section 32. AMORTISATION OF TELECOM LICENCE FEES [Sec. 35ABB] Expenditure incurred for obtaining licence to operate telecommunication services shall be allowed for deduction / amortization, if the following conditions are satisfied: (i) Expenditure should be capital in nature; (ii) Expenditure should have been incurred for purpose of acquiring any right to operate telecommunication services; (iii) Payment should have been actually made to obtain a licence; (iv) Expenditure may be incurred either before commencement of business or at any time during the previous year. (i) If licence fees is actually paid before commencement of business = Licence fees actually paid before commencement of business which

Mode of calculating deduction :

No. of years from the previous year of commencement of business to the previous year in licence expires (ii) If licence fees is paid after commencement of business = Licence fees actually paid after commencement of business

6.32 I DIRECT TAXATION

No. of years from the Previous Year in which licence fee actually paid to the Previous Year in which licence expires In case of transfer : (a) Calculate Unallowed amount = Actual cost of licence fee paid less amount of deduction already claimed u/s 35ABB (b) For consideration received on transfer: (i) If whole licence is transferred and net consideration is less than Unallowed Amount Business Expenditure = Unallowed amount less Net consideration (ii) Where part of licence is transferred and net consideration is less than Unallowed amount Unallowed Amount less Net Consideration Remaining period of licence

Amount of deduction =

(iii) Where whole or part of licence is transferred and net consideration is more than Unallowed amount Net consideration more than Unallowed Amount Business Income = Net Consideration less Unallowed but less than Original Cost of licence amount Net Consideration is more than Original Cost of licence and Un allowed Amount Business Income = Original cost of licence less Unallowed Amount Capital Gain = Net Consideration less Original Cost of licence The following table would explain the various situations Transfer of licence
B A Full In Part 7 7

Licence period (years) Acquisition cost

C Full 7 140 80 60 50 10

D In part 7 140 80 60 30 30

140 80 60 140

140 80 60 45 15

Deduction claimed so far (4 years) Unamortised value Sale price current year Amount remaining to be amortised Amount deductible U/s.35ABB(3) Amount chargeable to tax as business income Amount to be amortised in remaining 3 years

80 5 10

Consequences in the case of amalgamation or demerger- Where under the scheme of amalgamation, a telecom licence is transferred by the amalgamating company to the amalgamated company (being an Indian Company) or by a demerged company to a resulting company (being an Indian company), then deduction will not be available under section 35ABB continue to apply to the amalgamated company. However, the provisions of section 35ABB continue to apply to the amalgamated company if the latter had not transferred the licence. Where a deduction for any Previous Year is claimed and allowed under section 35ABB, then no deduction of the same expenditure shall be allowed under section 32 for the same Previous Year or any subsequent Previous Year.

DIRECT TAXATION I 6.33

Profits and Gains of Business or Profession Illustration 14 : Free Call Ltd. obtained a telecom licence on 15.6.09 for a period of 8 years ending on 31.3.2017 against a fee of ` 30 crores to be paid in four instalments of `12 crores, `7 crores, `6 crores, `5 crores by June 2008, June 2010, June 2011 and June 2012 respectively. Explain how the payment for licence fee shall be dealt under the Income Tax Act, 1961. Solution : Assessee : Free Call Ltd. Previous Year 2012-13 Assessment Year : 2013-14 (a) U/s 35ABB, expenditure incurred for the purpose of acquiring any right to operate telecommunication services is allowed equally as deduction throughout the unexpired life of the licence. Deduction shall be allowed only for the actual payment made. (b) If only part payment is made, amortization is based on the amount paid and not on the basis of total consideration. For any further payments, deduction/amortization is allowed equally for the remaining unexpired useful life. (c) Computation of amount of eligible deduction u/s 35 ABB: Previous Year 2009-10
2010-11 2011-12

Amount paid (` Crores) 12.00 7.00 6.00 5.00

Unexpired Period of Licence on the date of actual payment 8 years 7 years 6 years 5 years

Amount of Deduction (` Crores) 1.50 [1.50 + (7.00/7)] = 2.50 [2.50 + (6.00/6)] = 3.50 [3.50 + (5.00/5)] = 4.50

2012-13 Illustration 15 :

Hello International Ltd. incurs an expenditure of ` 240 crores for acquiring the right to operate telecommunication services for Assam & Sikkim. The payment was made in November 2010 and the licence to operate the services was valid for 15 years. In December 2011, the company transfers part of the licence, in respect of Assam, to Hi International Ltd. for a sum of `56 crores and continue to operate the licence in Sikkim. What is the deduction allowable u/s 35ABB to Hello International Ltd. for the Assessment Year 2013-14? Solution : Assessee: Hello International Ltd. Previous Year : 2012-13 Assessment Year : 2013-14 (a) u/s 35ABB, where part of the Telecom Licence is transferred and Net Consideration received on such transfer, is less than the expenditure remaining unallowed, the amount of deduction shall be computed as follows : (i) Unallowed amount as on 01.04.2011 = Total Expenditure Less Deduction for Financial Year 2010-11 = ` 240 crores Less ( ` 240 crores/licence period of 15 years) (ii) Net Consideration received (iii) Remaining period of licence (iv) Deduction u/s 35 ABB = ` 240 crores less ` 16 crores = ` 224 crores. = ` 56 crores = 14 years (including current Previous Year) = ` (224 crores less 56 crores)/14 years = ` 12 crores.

Illustration 16 :

6.34 I DIRECT TAXATION

Jammer International Ltd. incurs an expenditure of ` 300 crores for acquiring the right to operate telecommunication services for Odisha and Jharkhand. The payment was made in August 2011 and the licence to operate the services was valid for 12 years. In December 2012, the company transfers part of the licence, in respect of Odisha to Hammer International Ltd. for a sum of `280 crores and continue to operate the licence in Jharkhand . What is the deduction allowable u/s 35ABB to Jammer International Ltd. for the Assessment Year 2013-14? Solution: Assessee: Jammer International Ltd. Previous Year : 2012-13 Assessment Year : 2013-14 (a) u/s 35ABB, where part of the Telecom Licence is transferred and Net Consideration received on such transfer, is more than the expenditure remaining unallowed, the amount of deduction shall be computed as follows : (i) Unallowed amount as on 01.04.2012 = Total Expenditure Less Deduction for Financial Year 2011-12 = `300 crores Less ( `300 crores / licence period of 12 years) (ii) Net Consideration received (iii) Remaining period of licence (iv) Deduction u/s 35 ABB (v) Business Income = `300 crores less `25 crores= `275 crores. = `280 crores = 11 years (including current Previous Year) = Nil = ` (280 275) = ` 5 crores.

Illustration 17 : Ms.Chitralekha, a retail trader of Kolkata furnishes the following Trading and Profit and Loss Account for the year ending 31st March, 2013 : Trading and Profit and Loss Account for the year ended 31.03.2013 To To To Particulars Opening Stock Purchases Gross Profit ` 90,000 By Sales Particulars ` 12,11,500 2,400 6,100 1,80,000 14,00,000 3,06,000

10,04,000 By Income from UTI 3,06,000 By Other business receipts By Closing stock 14,00,000 60,000 By Gross profit b/d 36,000 15,000 1,05,000 23,200 1,640 8,100 7,060 50,000 3,06,000

To To To To To To To To To

Salary Rent and Rates Interest on loan Depreciation Printing & stationery Postage & telegram Loss on sale of shares (Short term) Other general expenses Net Profit

3,06,000

Additional Information :

DIRECT TAXATION I 6.35

Profits and Gains of Business or Profession (i) It was found that some stocks were omitted to be included in both the Opening and Closing Stock, the values of which were Opening Stock ` 9,000 Closing Stock ` 18,000 (ii) Salary includes ` 10,000 paid to his brother, which is unreasonable to the extent of ` 2,000. (iii) The whole amount of Printing and Stationery was paid in cash. (iv) The depreciation provided in the Profit and Loss Account ` 1,05,000 was based on the following information : The written down value of plant and machinery is ` 4,20,000. A new plant falling under the same Block of depreciation of 25% was bought on 1.7.2012 for `70,000. Two old plants were sold on 1.10.2012 for ` 50,000. (v) Rent and Rates includes sales tax liability of ` 3,400 paid on 7.4.2012. (vi) Other business receipts include ` 2,200 received as refund of sales tax relating to 2010-11. (vii) Other general expenses include ` 2,000 paid as donation to a Public Charitable Trust. You are required to advise Ms.Chitralekha whether she can offer her business income for the A.Y. 2013-14. Solution : Computation of Income from Business Assessee : Ms. Chitralekha A.Y : 2013-14. ` ` Net Profit as per Profit and loss account Add : Inadmissible expenses / losses and unrecorded items 18,000 2,000 23,200 1,05,000 8,100 2,000 1,58,300 2,08,300 Under valuation of closing stock Unreasonable salary paid to brother [section 40A(2)] Printing and Stationery paid in cash [Section 40A(3)] 100% of `23,200 Depreciation (considered separately) Short term capital loss on shares Donation to public charitable trust 50,000

Less :

Deductions items:

Under valuation of opening stock Income from UTI Refund of sales tax [Taxable u/s.41(1) No adjustment necessary] Business income before depreciation Less : Depreciation (see note 1)

9,000 2,400 11,400 1,96,900 66,000 1,30,900

6.36 I DIRECT TAXATION

Note 1 Calculation of Depreciation WDV of the block of Plant & Machinery as on the first day of Previous Year Add : Cost of new Plant & Machinery Less : Sale proceeds of assets sold WDV of the block of Plant & Machinery as on the last day of Previous Year Depreciation @ 15% 4,20,000 70,000 4,90,000 50,000 4,40,000 66,000

Note 2 : No additional depreciation is allowable as the assessee is not engaged in manufacture or production of any article. Note 3: Since sales-tax liability has been paid before the due date of filing return of income under section 139(1), the same is deductible. Illustration 18 : Discuss the tax implications of the following transactions in the case of a doctor running a nursing home : ` (1) (2) Amount paid to a scientific research association approved by the Central Government and run by a drug manufacturing company Amounts received from the employees of the nursing home as contributions towards provident fund for the month of March, 2013 paid to the PF Commissioner on 25th April, 2013 Repayment made in cash towards purchases of medicines Repayment of loan taken from a bank for doing a post-graduate course in medicine instalment Interest Answer : (i) Under section 35(1)(ii), 175% of the sums paid to scientific research association, which has as its object the undertaking of scientific research is deductible. Deduction admissible = 20,000 175% = ` 35,000. 20,000 25,000 50,000 50,000 10,000

(3) (4)

(ii) Under clause (x) of sub section 24 of section 2, any sum received by an assessee from his employees as contribution to any provident fund is deemed to be his income. Such income is deductible under section 36(1) (va) only if it is credited to the employees account in the relevant fund by the due date. Under Employees Provident Fund Act, the due date for the payment of the contribution is the 15th of the month following the month for which the contribution is due. A grace period of 5 days is also allowed. Hence the payment of the employees contribution for the P.F. Commissioner should have been made by 20th April. Since the payment has been made on 25th April, the deduction is not available.

DIRECT TAXATION I 6.37

Profits and Gains of Business or Profession (iii) Under section 40A(3) payments made in cash exceeding ` 20,000 are not allowable in computing the income from business or profession. Hence ` 50,000 will be disallowed. It is assumed that the case is not covered by the exceptions under Rule 6DD. (iv) Under section 80E, a deduction is admissible in the case of an individual towards any amount paid in the previous year by way of interest on loan taken from any financial institution for the purpose of pursuing his higher education. The purpose stated in the question is covered by the section. The deduction is allowable only towards payment of interest. The amount deductible under section 80-E would be `10,000. Expenditure On Eligible Projects/Schemes [Sec. 35AC] Where an assessee incurs any expenditure by way of payment of any sum to a public sector company or a local authority or to an association or institution approved by the national committee for carrying out any eligible project or scheme it will be allowed as deduction. In order to avail the deduction under this section the assessee should furnish with return of income, a certificate from the Chartered Accountant to that extent. National committee can withdraw the approval granted by it to an association or institution on the ground that the project or scheme is not being carried out in accordance with all or any of the conditions subject to which approval was granted or the notification through which a project or scheme was notified after giving reasonable opportunity. The contribution or donation received by the company or authority or association or institution, as the case may be, or the deduction claimed by company in respect of any expenditure incurred directly on the eligible project or scheme, the approval for which is withdrawn by the national committee shall be deemed to be the income of the company or authority or association or institution as the case may be, of the year in which such approval or notification is withdrawn w.e.f. AY 2003-04 and shall be taxed at the maximum marginal rate of tax in force for that year. Deduction in Respect of Expenditure on Specified Business [Sec. 35AD] Section 35AD has been inserted (with effect from the Assessment Year 2010-11) to provide for investmentlinked tax incentive. Conditions - The following conditions should be satisfied to avail of the benefit of deduction under section 35AD Condition 1 SPECIFIED BUSINESS - Deduction under section 35AD is available only in the case of a specified business given below Specified business 1. Setting up and operating a cold chain facility [Note 1] 2. Setting up and operating a ware- housing facility for storage of agricultural produce. 3. Laying and operating a crosscountry natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network Who should own Approval (if any) the business Any person Not required Any person An Indian company or a consortium of Indian companies or an authority /Board/ corporation established under any Central or State Act Not required Should be approved by Petroleum and Natural Gas Regulatory Board and notified by the Central Government [Note 2] Date of commencement of business On or after April 1, 2009 On or after April 1, 2009 On or after April 1, 2007, in the case of laying and operating a cross-country natural gas pipeline net-work for distribution or storage. In other cases, on or after April 1, 2009.

6.38 I DIRECT TAXATION

4. Building and operating Any person anywhere in India a hotel of 2 star or above category [Note 3]

5. Building and operating, anywhere in India, any hospital with at least 100 beds for patients 6. Developing and building a housing project

Any person

No approval required; however, hotel should be classified by the Central Government as 2 star hotel or above category No approval required

On or after Aptil 1, 2010

On or after April 1, 2010

Any person

7. Developing and building a housing project

Any person

On or after April 1, 2010 Developing and building housing project should be under a scheme for slum redevelopment or rehabilitation framed by the Central Government/ State Government and notified by the Board in accordance with prescribed guidelines Developing and On or after April 1. 2011 building a housing project should be under a scheme for affordable housing framed by the Central Government or a State Government and notified by the Board [Rule 11-OA] Not required On or after Aptil 1, 2011 As notified or approved under the Customs Act No approval No approval On or after April 1, 2012 On or after April 1, 2012 On or after April 1, 2012

8. Production of fertilizer in India 9. Setting up and operating an inland container depot or a container freight station 10. Bee-keeping and production of honey and beeswax 11. Setting up and operating a warehousing facility for storage of sugar

Any person Any person Any person Any person

DIRECT TAXATION I 6.39

Profits and Gains of Business or Profession Note 1 - Cold chain facility means a chain of facilities for storage or transportation of agticultural and forest produce, meat and meat products, poultry, marine and dairy products, products of horticulture, florticulture and apiculture and processed food items under scientifically controlled conditions including refrigeration and other facilities necessary for the preservation of such produce. In this definition, the words storage and transportation are separated by the conjunction or. Storage and transportation are complementally to each other and the absence of one will not make the chain complete. However, separation is specified by use of the word or . Consequently, an assessee is eligible for deduction under section 35AD even if it has operated only cold storage plant and does not operate transportation facility. Note 2 - This business should make not less than one-third (for a natural gas pipeline network) or one-fourth (for petroleum product pipeline network) of its total pipeline capacity available for use on common carrier basis by any person other than the assessee or an associated person. Associated person is a person who participates in the management of the assessee; holds at least 26 per cent voting power in the assessee; appoints more than half of the board of directors or who guarantees not less than 10 per cent of the total borrowing of the assessee. Note 3 - Where an assessee builds a two-star (or above category) hotel and, subsequently, while continuing to own the hotel, transfers the operation thereof to another person, the assessee shall be deemed to be carrying on the specified business of building and operating hotel for the purpose of section 35AD (applicable from the Assessment Year 2011-12). Condition - 2 SPECIFIED BUSINESS SHOULD BE NEW BUSINESS The specified business should not be set by splitting up, or the reconstruction, of a business already in existence. Moreover, it should not be set up by the transfer of old plant and machiney.However, 20 percent old machinery is permitted. Second-hand imported machinery is treated as new subject to the following conditions:-

1. Such machinery or plant was not, at any time previous to the date of the installation by the assessee, used in India. 2. Such machinery or plant is imported into India from any country outside India. 3. No deduction on account of depreciation in respect of such machinery or plant has been allowed or is allowable under the Act in computing the total income of any person for any period prior to the date of the installation of the machinery or plant by the assesse. Condition - 3 AUDIT OF BOOKS OF ACCOUNT Books of account of the assessee should be audited. Amount of deduction 100 per cent of capital expenditure incurred wholly and exclusively for the purpose of specified business carried on by an assessee is deductible in the Previous Year in which the expenditure is incurred. However, this is subject to the following propositions 1. Expenditure incurred on the acquisition of any land or goodwill or financial instrument is not eligible for any deduction under section 35AD. 2. Expenditure incurred prior to the commencement of operation, wholly and exclusively, for the purpose of any specified business, shall be allowed as deduction during the Previous Year in which the assessee commences the operation of his specified business, if the amount is capitalized in the books of account of the assessee on the date of commencement of operation. 3. If operation of the business of laying and operating a cross-country natural gas distribution network is commenced during April, 2007 and March 31, 2009 and deduction for such amount has beeen allowed to the assessee in any earlier year.

6.40 I DIRECT TAXATION

CONSEQUENCES OF CLAIMING DEDUCTION UNDER SECTION 35AD The following consequences should be noted 1. If deduction is claimed and allowed under section 35AD, the assessee shall not be allowed any deduction in respect of the specified business under the provisions of Chapter VIA under sections 80HH to 80RRB for the same or any other Assessment Year. 2. No deduction in respect of the expenditure in respect of which deduction has been claimed shall be allowed to the assessee under any other provisions of the Income-tax Act. 3. Any sum received or receivable on account of any capital asset, in respect of which deduction has been allowed under section 35AD, being demolished, destroyed, discarded or transferred shall be treated as income of the assessee and chargeable to income-tax under the head Profits and Gains of Business or Profession. 4. Any loss computed in respect of the specified business shall not be set off except against profits and gains, if any, of any other specified business. To the extent the loss is unabsorbed, the same will be carried forward for set off against profits and gains from any specified business in the following Assessment Year and so on. 5. If the assessee owns two units one of them qualifies for deduction under section 35AD and the other one is not eligible for the same and there is inter-unit transfer of goods or services between the two units, then for the purpose of section 35AD calculation will be made as if such transactions are made at the market value. EXPENDITURE BY WAY OF PAYMENT TO ASSOCIATION AND INSTITUTION FOR CARRYING OUT RURAL DEVELOPMENT PROGRAMME [SEC. 35CCA] Where an assessee incurs any expenditure by way of payment of any sum- a) to an association or institution engaged in any programme of rural development, or b) to an association or institution which undertakes training of persons for implementing any programme of rural development or c) to National fund set up for rural development notified in this behalf by the Central Government or to the National Urban Poverty Eradication fund set up and notified by the Central Government, he will be allowed a deduction of the amount of such expenditure incurred during the Previous Year. EXPENDITURE ON AGRICULTURAL EXTENSION PROJECT [ SEC. 35 CCC] Section 35CCC provides that when an assessee incurs any capital or revenue expenditure for agricultural extension project notified by the CBDT, he will be allowed weighted deduction of 150% of such expenditure. [ w.e.f. AY 2013-14 ] EXPENDITURE FOR SKILL DEVELOPMENT [ SEC. 35 CC D ] Section 35CCD provides that where a company incurs expenditure (other than expenditure on any land or building) on any skill development project notified by the CBDT, it will be allowed weighted deduction of 150% of such expenditure.[ w.e.f. A.Y.2013-14] AMORTISATION OF CERTAIN PRELIMINARY EXPENSES [SEC. 35D] The deduction is allowed under this section only in case of an Indian company or a person (other than company) resident in India. The deduction is in respect of the expenditure incurred after 31.3.1970 and expenditure may be of the type which was incurred (i) before the commencement of the business, or (ii) after the commencement of his business, in connection with the extension of existing industrial unit.

DIRECT TAXATION I 6.41

Profits and Gains of Business or Profession The following expenses shall be eligible for deduction u/s 35D(2): (a) expenditure in connection with(i) preparation of feasibility report; (ii) preparation of project report; (iii) conducting market survey or any other survey necessary for the business of the assessee; (iv) engineering services relating to the business of the assessee.

(b) Legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee. (c) The following expenses in case of company assessees : (i) legal charges for drafting the Memorandum and Articles of Association of the company; (ii) on printing of the Memorandum and Articles of Association; (iii) by way of fees for registering the company under the provision of the Companies Act, 1956; (iv) in connection with the issue, for public subscription, of shares in or debentures of the company being underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus.

(d) Such other item of expenditure (not being expenditure eligible for any allowance or deduction under any other provision of this Act) as may be prescribed. Mode of Deduction: Deduction of qualified amount is allowed in 5 equal instalements beginning with the Previous Year in which the business is commenced. Amount of expenditure qualifying for deduction :The aggregate amount of expenditure referred to clause (a) to (d) above shall not exceed 5% cost of project if such expenditure incurred after 1.4.1998. But in case of an Indian company, 5% of the cost of the project or 5% of the capital whichever is higher. Capital employed means the aggregate of issued capital debentures and long term borrowings (repayable during a period of not less that 7 years) as on the last day of relevant Previous Year. In case of an Indian company under amalgamation/demerger, no deduction shall be allowed to amalgamating/ demerged company for the Previous Year in which amalgamation/demerger takes place. Deduction is allowed to the amalgamated company/ resulting company in the same manner as allowable to amalgamating/demerged company. Audit of accounts is necessary for claiming deduction where accounts are not audited under any other law.

6.42 I DIRECT TAXATION

SEC. 35D AMORTISATION OF PRELIMINARY EXPENSES Illustration 19 : Sleepwell Ltd. is an existing Indian Company, which sets up a new industrial unit. It incurs the following expenditure in connection with the new unit: ` Preparation of project report Market survey Legal and other charges for issue of additional capital required for the new unit Total The following further data is given: Cost of project Capital employed in the new unit 30,00,000 40,00,000 What is the deduction admissible to the company under section 35D for Assessment Year 2013-14? Solution: The deduction admissible under section 35D is one-fifth of the expenditure incurred for the project. This works out to `2,20,000. However, such expenditure should not exceed the following limits as prescribed in section (3): (a) 5% of cost of the project or (b) 5% of the capital employed in the new industrial undertaking (being a company) whichever is higher. (a) (b) 5% of the project cost is `1,50,000 and 5% of the capital employed is `2,00,000. 4,00,000 5,00,000 2,00,000 11,00,000

In this case

Hence, the expenditure eligible for amortization under section 35D would be ` 2,00,000. And the admissible deduction for the current assessment year is 2,00,000 1/5 = ` 40,000. AMORTISATION OF EXPENDITURE IN CASE OF AMALGAMATION OR DEMERGER [SEC. 35DD] Where an Indian company incurs any expenditure on or after 1.4.1999, wholly and exclusively for the purposes of amalgamation or demerger of an undertaking, the assessee company is allowed deduction in respect of such expenditure over a period of five years equally beginning with the Previous Year in which amalgamation or demerger takes place. AMORTISATION OF EXPENDITURE INCURRED UNDER VOLUNTARY RETIREMENT SCHEME [SEC.35DDA] Where any expenditure is incurred by way of compensation to an employee under VRS in accordance with any scheme is allowed deduction over a period of 5 years equally from the year in which compensation is paid. W.e.f. Assessment Year 2001-02 inserted by the Finance Act, 2002 to provide that where an undertaking of an Indian company, entitled to deduction for amortisation of voluntary retirement expenses, is transferred before the expiry of the period specified to another Indian company in a scheme of amalgamation or demerger, the deduction shall continue to be available to the amalgamated company or the resulting company as if the amalgamation or demerger had not taken place.

DIRECT TAXATION I 6.43

Profits and Gains of Business or Profession In case of reorganisation of certain form of business where by a firm for a proprietary concern is succeeded by a company, the deduction shall continue to be available to the successor company. Deduction is not available to amalgamating company or demerged company or to the firm or proprietary concern, as the case may be, in the year of transfer. Illustration 20 : Suppose the payment of voluntary retirement is made ot X as under : Previous Year 2008-09 2009-10 2010-11 Amount paid (`) 20,00,000 12,00,000 14,00,000 46,00,000

In this case the deduction of expenses incurred under voluntary retirement scheme shall be allowed as under : Assessment Year 2009-10 : ` 4,00,000 (1/5th of ` 20,00,000) and balance ` 16,00,000 in 4 equal instalments in the next four Assessment Years i.e. Assessment Years 2010-11 to 2013-14. Assessment Year 2010-11 : ` 6,40,000 i.e. ` 4,00,000 on account of payment made in Previous Year 2008-09 and ` 2,40,000 (1/5th of ` 12,00,000 paid on Previous Year 2009-10). Assessment Year 2011-12 : ` 9,20,000 i.e. ` 6,40,000 (` 4,00,000 + ` 2,40,000 for payment made in Previous Year 2008-09 and 2009-10 respectively) and ` 2,80,000 on account of payment made in Previous Year 2010-11. Assessment Year 2012-13 : ` 9,20,000 (` 4,00,000 + ` 2,40,000 + ` 2,80,000) Assessment Year 2013-14 : ` 9,20,000 (` 4,00,000 + ` 2,40,000 + ` 2,80,000) Assessment Year 2014-15 : ` 5,20,000 (` 2,40,000 + ` 2,80,000) Assessment Year 2015-16 : ` 2,80,000 Total amount allowed in various Assessment Years ` 46,00,000. DEDUCTION FOR EXPENDITURE ON PROSPECTING ETC. FOR CERTAIN MINERALS [SEC. 35E] Where an assessee being a Indian company or a person other than a company who is resident in India, is engaged in any operation relating to prospecting for, extraction or production of any mineral and incurs after 31.3.1970 any expenditure during the period of 5 years ending with the year of commencement of commercial production is allowed as deduction over a period of 10 years in equal installments. Auditing of Accounts : The accounts of the assessee have got to be audited by a qualified Chartered Accountant and a copy of the audited report is to be sent as an accompaniment to the return of income. Companies and cooperative societies getting their accounts audited ordinarily need not get them audited specifically for this purpose. Expenses amortised not deductible : Expenses which are included for amortisation will not be deducted while computing business profit or loss under any other section of this Act. OTHER DEDUCTIONS [SEC. 36] The deduction provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in Sec. 28. INSURANCE PREMIUMFOR STOCK AND STORES [SEC. 36(1)(i)] The amount of any insurance premium paid in respect of insurance against risk of damage or destruction

6.44 I DIRECT TAXATION

of stocks or stores used for the purpose of the Business or Profession. PREMIUM PAID BY FEDERAL MILK COOPERATIVE SOCIETY [SEC. 36(1)( ia)] A federal milk cooperative will be allowed deduction in respect of any premium paid by it towards an insurance policy in the life of cattle owned by a member of a primary cooperative society, which is engaged in supply of milk (raised by its members) to the federal milk cooperative society. PREMIUM FOR EMPLOYEES HEALTH INSURANCE [SEC. 36(1)(ib)] The amount of any premium paid by any mode of payment other than cash by the assessee as an employer to effect or to keep in force an insurance on the health of his employees under a scheme in this behalf by the General Insurance Corporation of India and approved by the Central Government. BONUS OR COMMISSION TO EMPLOYEES [SEC. 36(1)(ii)] Any sum paid to an employee as bonus or commission for services rendered is deductible provided it would not otherwise be payable to him as profits or dividend, before due date subject to section 43B. INTEREST ON BORROWED CAPITAL [SEC. 36(1)(iii)] The amount of the interest paid in respect of capital borrowed for the purposes of the business or profession subject to section 43B. DISCOUNT ON ZERO COUPON BONDS [SEC. 36(1)(iiia)] Applicability : Infrastructure Capital Company/Fund, Public Sector Company, Scheduled Bank issuing Zero Coupon Bonds which are specified by the Central Govt. by notification in the Official Gazatte Conditions : (a) Life of the bond should be less than 10 years and not more than 20 years. (b) The investor will not received or due to receive any payment or benefit before before the maturity redemption date (c) Discount is the difference between Maturity/Redemption Value and the issue price. (d) Discount can be written off on a pro rata basis over the period of the bond. (e) No tax will be deducted at source under section 194 A by the payer company. Illustration 21: M Ltd. , an infrastructure capital company, issued 1,00,000 Zero Coupon Bonds (Face Value ` 100) on 5th September, 2012 at a price of ` 75. The redemption date of the bonds is 21st. September, 2024. These bonds are notified by the Central Government as Zero Coupon Bond. You are required to compute the amount of discount allowable as deduction while computing business income of the M Ltd. Solution : Discount on Zero Coupon Bond is allowable to M Ltd. on pro-rata basis. Total Amount of Discount = (`100 - `75) `1,00,000 = ` 25,00,000 Date of issue : 5th September, 2012 [as it is less than 15 days, it shall be ignored and date of issue will be taken as 1st September, 2012] Date of redemption : 21st September, 2024 [if it is 15 days or more, it is taken as one month and so redemption date will be taken as 30th September, 2024] Total life of the bond : 1st September, 2012 to 30th December, 2024 i.e. 145 months.

DIRECT TAXATION I 6.45

Profits and Gains of Business or Profession Prorated discount for one month = 25,00,000/145 = `17,241 Amount of discount allowable for the Previous Year 2012-13 = ` (17,241 7) = ` 1,20,687 Amount of discount allowable for the Previous Year 2013-14 to 2023- 24 = ` (17,241 12) = ` 2,06,892 Amount of discount allowable for the Previous Year 2012-13 = ` (17,241 6) = ` 1,03,446 CONTRIBUTION TOWARDS RECOGNISED PROVIDENT FUND OR AN APPROVED SUPERANNUATION FUND [SEC.36(1)(iv)] Any sum paid by the assessee as an employer by way of contribution to a recognized provident fund or an approved superannuation fund subject to limits prescribed in this regard in section. 43B. EMPLOYERS CONTRIBUTION TO NOTIFIED PENSION SCHEME [SEC. 36(1)(iva)] Clause (iva) has been inserted in section 36(1) (with effect from the Assessment Year 2012-13) so as to provide that any sum paid by an assessee as an employer by way of contribution towards a pension scheme [as referred to in section 80CCD] on account of an employee shall be allowed as deduction in computing the income under the head Profits and Gains of business or profession. Deduction will, however, be limited to the extent of 10 per cent of the salary of the concerned employee in the Previous Year. Salary for this purpose means basic salary and includes dearness allowance, if terms of employment so provide. It also includes commission based on a fixed percentate of turnover achieved by an employee as per terms of contract of employmentGestener Duplicators (P.) Ltd. Vs. CIT [1979] 1 Taxman 1/117 ITR 1(SC). However, it does not include any other allowances and perquisities. CONTRIBUTION TOWARDS AN APPROVED GRATUITY FUND [SEC. 36(1)(v)] Any sum actually paid by an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrecoverable trust subject to Section. 43B. CONTRIBUTIONS RECEIVED FROM EMPLOYEES TO A WELFARE OF THE EMPLOYEES [SEC. 36(1)(va)] Deductions in respect of any sum received by the assessee as a contribution from his employees towards provident fund or any other welfare fund of such employees is allowed only if such sum is credited by the tax payer to the employees accounts in the relevant funds on or before due date.i.e. the date by which the assessee is required as an employer to credit such contribution to the employees account under the provisions of any law or term of contract of service or otherwise. If payment is not made within the due date such contribution should be treated as income of the assessee. DEDUCTION IN RESPECT OF ANIMALS USED FOR BUSINESS WHICH HAVE DIED OR BECOME PERMANENTLY USELESS [SEC. 36(1)(vi)] In respect of animals used for the purpose of Business or Profession (but not stock in trade) who have died or become permanently useless, the difference between the actual cost to the assessee of the animals and the amount, if any, realised in respect of carcasses or animals, will be allowed as a deduction. BAD DEBTS [SEC. 36(1)(vii)] Any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the Previous Year will be allowed as deduction if (i) the debt is incidental to business, (ii) it should have been taken into account in computing income of the assessee, or it should represent money lent in the ordinary course of banking or money lending business, (iii) it should be written off in the books of account (iv) the business in respect of which the debt is incurred should be continued during, the Previous Year.

6.46 I DIRECT TAXATION

The successor of a business is entitled to claim deduction in respect of debt created by the predecessor CIT vs. T. Veerabhadra Rao, K. Koteswara Rao & Co. 155 ITR 152. PROVISION FOR BAD AND DOUBTFUL DEBTS [Sec. 36(1)(viia)] Provision for bad and doubtful debts made by : (i) Schedule bank (not incorporated outside India) or non-schedule bank or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank, upto 7.5% of its total income and an addition at 10% average advances made by the rural branches of such bank. Option has also been given to bank to claim deduction in respect of any provision for doubtful or loss of assets as per RBI guidelines, upto a maximum of 5% of such assets at the end of the relevant Previous Year for the AY 2000-01 to 2002-03 and upto 10% of such assets for AY 2003-04 and 2004-05. A bank incorporated outside India upto 5% of its total income.

(ii)

(iii) A Public Financial Institution on a State Financial Corporation or a state industrial investment corporation, upto 5% of its total income. Option is also given to Financial Institution/Corporation to claim deduction in respect of any provision for doubtful or loss assets as per RBI guidelines, upto a maximum of 10% of such assets at the end of the Previous Year relevant to Assessment Year 2003-04 or 2004-05. Total income for this purpose means income computed before making any deduction under Chapter VIA. Deduction in the case of an assessee who is eligible for deduction under section 36(1)(vii) and (viia)- In the case of the above taxpayer, no deduction is allowed under section 36(1)(vii) in respect of bad debts unless the amount of bad and doubtful debt is debited to the provision for bad and doubtful debts account and the deduction admissible under section 36(1)(vii) is limited to the amount by which such debts or part thereof exceeds the credit balance in the provision for bad and doubtful debts account. SPECIAL RESERVE CREATED AND MAINTAINED BY A FINANCIAL CORPORATION [SEC.36(1)(viii) Deduction under this section is allowed in respect of any special reserve created and maintained by : (a) a financial corporation which is engaged in providing long time finance for industrial or agricultural development in India or for development for infrastructure facility in India; or (b) a public company formed and registered in India with the main objective of carrying on the business of providing long time finance for construction of purchase of houses in India for residential purposes. The deduction under this section shall be an amount transferred to reserve account or an amount not exceeding 20 % of the profits derived from such business which ever is less. If the amount of reserve is more than twice the paid up share capital and general reserve, the excess amount is not deducted. Special deduction under section 36(1)(viii) allowed to National Housing Bank of an amount not exceeding 20% of the profits subject to creation of a reserve [Section 36(1)(viii)][W.e.f. A.Y. 2010-11] Section 36(1)(viii) provides special deduction to financial corporations and banking companies of an amount not exceeding 20% of the profits subject to creation of a reserve. National Housing Bank (NHB) is wholly owned by Reserve Bank of India and is engaged in promotion and regulation of housing finance institutions in the country. It provides re-financing support to housing finance institutions, banks, ARDBs, RRBs, etc., for the development of housing in India. It also undertakes financing of slum projects, rural housing projects, housing projects for EWS and LIG categories, etc. NHB is also a notified financial corporation under section 4A of the Companies Act. A view has been expressed that NHB is not entitled to the benefits of section 36(1)(viii) on the ground that it is not engaged in the long-term financing for construction or purchase of houses in India for residential

DIRECT TAXATION I 6.47

Profits and Gains of Business or Profession purpose. The amendment has been made in clause (b) of Explanation to section 36(1)(viii) to provide that corporations engaged in providing long-term finance (including re-financing) for development of housing in India will be eligible for the benefit under section 36(1)(viii). EXPENDITURE INCURRED BY COMPANY FOR PROMOTING FAMILY PLANNING AMONGST ITS EMPLOYEES [SEC. 36(1)(ix)] The company assessee is entitled to claim deduction in respect of bonafide revenue expenditure incurred by it in a Previous Year for the purposes of promoting family planning amongst its employees. In case of expenditure of a capital nature, the deduction is allowed in 5 equal yearly installments commencing from the Previous Year in which such expenditure is incurred. The capital expenditure under this section is governed by the same conditions as are applicable to capital expenditure for scientific research. The unabsorbed expenditure under this section can be carried forward and set off in the following years like unabsorbed depreciation allowance. CONTRIBUTION TOWARDS EXCHANGE RISK ADMINISTRATION FUND [SEC. 36(1)(x)] The contribution made by the public financial institutions to the Exchange Risk Administration Fund will be allowed as a business deduction in computing their income up to the Assessment Year 2007-2008. REVENUE EXPENDITURE INCURRED BY ENTITIES ESTABILSHED UNDER ANY CENTRAL, STATE OR PROVINCIAL ACT [SEC. 36(1)(xii)] Any revenue expenditure incurred by a notified corporation or a body corporate (by whatever name called) constituted (or established) by a Central, State or Provincial Act for the objects and purposes authorised by the Act, shall be allowed as a deduction. CONTRIBUTION TO CREDIT GUARANTEE TRUST FUND [SEC. 36(1)(xiv)] From the Assessment Year 2008-09, a public financial institution can claim deduction in respect of its contribution to a notified credit guarantee trust fund for small industries (i.e., Credit Guarantee Fund Trust for Micro and Small Enterprises). BANKING CASH TRANSACTION TAX : [SEC. 36(1)(xiii)] Condition : Actual amount of BCTT paid during the Previous Year shall be allowed as deduction. SECURITIES TRANSACTION TAX PAID [W.E.F. AY 2009-2010] : [SEC. 36(1)(xv)] Condition : (a) Taxable Securities transactions should be entered into in the course of his business during the Previous Year. (b) Income arising from such transaction is included under the head Profit & Gains of Business or Profession. COMMODITIES TRANSACTION TAX NOT OPERATIONALISED [ SECTION 36(1)(xvi)] [W.R.E.F. A.Y. 2009-10] The provisions for levy of Commodities Transaction Tax were introduced by Chapter VII of Finance Act, 2008. However, the levy has not yet been operationalised. In view of the recommendations of the Prime Ministers Economic Advisory Council, a new section 121A in Chapter VII of Finance Act, 2008 has been inserted to provide that the Chapter relating to levy of Commodities Transaction Tax shall not apply on or after 1-4-2009. The Act has made it consequential amendment in clause (xvi) in sub-section (1) of section 36 of the Income-tax Act by omitting the said clause, where CTT was allowable as deduction. GENERAL DEDUCTIONS [SEC. 37] Any expenditure not being expenditure of the nature described in sec. 30 to 36, and not being in the nature of capital expenditure or personal expenses of the assessee paid out or expended wholly and exclusively

6.48 I DIRECT TAXATION

for the purposes of the Business or Profession shall be allowed in computing the income chargeable under the head Profits and Gains of Business or Profession- Sec. 37(1). The conditions to be fulfilled for general deductions u/s 37 are as follows (i) It should be in respect of a business carried on by an assessee; (ii) It should have been paid out or expended wholly and exclusively for the purpose of the business; (iii) It must have been incurred during the Previous Year; and (iv) It should not be in the nature of capital expenditure or personal expenses of the assessee. Thus expenses incurred on the occasion of Dewali or Mahurat subject to being satisfied that the expenses are not expenses of a personal, social or religious nature- allowed deduction u/s37. Loss through embezzlement by an employee or recurring expenses incurred on imparting basic training to apprentices under the Apprentices Act, 1961 are general deductions u/s 37. Any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure [Explanation to Sec. 37(1)]. ADVERTISEMENT EXPENDITURE [Sec. 37(2B)] No allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any Souvenir, Brochure, Pamphlet or the like published by a political party. INADMISSIBLE EXPENDITURE [Sec. 40, 40A, 43B] AMOUNT NOT DEDUCTIBLE [Sec. 40(a)] Notwithstanding anything contained in section 30 to 38, no deduction shall be allowed in respects of the following in computing the total income : 1. any interest, fees for technical services or other sum chargeable under this Act, which is payable to a Non Resident on which tax is deductible such tax has not been deducted or, after deduction, has not been paid during the Previous Year, or in the subsequent year before the expiry of the time prescribed. However, if paid in subsequent year, then it shall be allowed as deduction in such subsequent year. any interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident, or amounts paid to a resident contractor or sub-contractor , on which tax is deductible at source and such tax has not been deducted or after deduction has not been paid. All the expenditure are allowed if TDS paid before due date u/s 139(1)

2.

3. Fringe benefit tax 4. Income-tax 5. Wealth-tax 6. Salary payable outside India without tax deduction 7. Provident fund payment without tax deduction at source 8. Tax on perquisite paid by the employees. Amendments effective from Assessment Year 2013-2014: Disallowances u/s. 40(a)(ia) is applicable in the following two cases : Case 1 Tax is deductible on certain payments ( interest, commission, royalty, rent, fees for technical & professional services) to a resident , but is not deducted ;

DIRECT TAXATION I 6.49

Profits and Gains of Business or Profession Case 2 Tax is deductible (and also so deducted), on the aforesaid payment, but the amount of tax so deducted has not been deposited by the deductor till the date due date for submission of return of income In both the above case, disallowances u/s. 40(a)(ia) is applicable and accordingly such payments would not be allowed as deduction. Relief has been allowed from the Assessment Year 2013-14 in respect of case 1 if the following conditions are satisfied : 1. 2. Tax is deductible on the above / aforesaid payments and has not been deducted by the payer whether in full or in part The payer is not an assessee in default u/s 201(1) of the Act by proving that the payee has furnished his return u/s 139 after taking into account such income and paid tax on such income.

If the above conditions are satisfied, then for the purpose of section 40(a)(ia) it shall be deemed that the payer has deducted and paid the tax on such amount on the date of furnishing the return of income by the resident receipient. DISALLOWANCE IN THE CASE OF PARTNERSHIP FIRMS (INCLUDING LIMITED LIABILITY PARTNERSHIP) [Sec. 40(b)] [w.e.f. A.Y. 2010-11] (i) Interest to a partner by a firm is not deductible unless the following conditions are fulfilled: 1. It should be authorised by the partnership deed. 2. It should relate to a period falling after the date of the Partnership deed. 3. It should not exceed 12% p.a. simple rate of interest.

Explanation 1 : If a person is a partner in his representative capacity in the firm and if he receives interest in his individual capacity from the firm such interest should not be disallowed. Explanation 2 : If a person who is a partner in his individual capacity receives interest for and on behalf of some one else from the firm in which he is a partner such interest should not be disallowed. (ii) Any amount paid by way of salary, bonus, commission or remuneration by a firm to a partner is not deductible in the computation of income of the firm unless the following conditions are fulfilled : 1. 2. 3. It should be authorised by partnership deed. It should relate to a period falling after the date of the partnership deed. It should be within the prescribed limits as follows :

The Act has made upward revision of the existing limits of the remuneration. Further, uniform limits have been prescribed for both professional and non-professional firms for simplicity and administrative case. The revised limits are as under : (a) On the first ` 3,00,000 of the Book-profit or in case of a loss (b) On the balance of the Book-profit 4. It should be paid to a working partner. ` 1,50,000 or at the rate of 90% of the Book-profit, whichever is more; At the rate of 60%.

Explanation 3 : Book Profit means the net profit, as shown in the Profit and loss Account for the relevant Previous Year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been debited while computing the net profit.

6.50 I DIRECT TAXATION

Explanation 4 : Working partner means an individual who is actively engaged in conducting the affairs of the Business or Profession of the firm of which he is a partner. CBDT issued circular no. 739 dt. 25.3.96 stating that disallowance of salary to partners shall be made in the case of a firm if the partnership deed does not specify the amount of remuneration payable to each individual working partner or it does not lay down the manner of quantifying such remuneration. DISALLOWANCE IN THE CASE OF ASSOCIATION OF PERSONS AND BODY OF INDIVIDUALS [Sec. 40(ba)] Any payment by way of interest, salary, bonus, commission or remuneration paid by an Association of Persons or Body of Individuals to any of its members shall be disallowed. Explanation 1 : If the member who received interest from the AOP or BOI also pays interest to the AOP or BOI during the same Previous Year only the net excess interest paid by the AOP to such member should be disallowed. Explanation 2 : If a person is a member in his representative capacity in the AOP or BOI and if he received interest in his individual capacity from the AOP or BOI such interest should not be disallowed. Explanation 3 : If a person who is a member in his individual capacity received interest for and on behalf of some one else from the AOP or BOI in which he is a member such interest should not be disallowed. SECTION 40A(1) Expenses or payment as provided in subsection (2), (3), (7) and (9) of Section 40A are not deductible. SECTION 40A(2) Where an assessee incurs any expenditure, in respect of which payment has been made or is to be made to certain specified persons and in the opinion of Assessing Officer such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made, then so much of expenditure which is considered by the Assessing Officer to be excessive or unreasonable, shall not be allowed as deduction. As per Finance Act, 2012, this reasonable amount should be calculated at Arms length Price. Assessee (i) Individual Specified persons (a) any relative (i.e., spouse, any brother, sister, lineal ascendant descendant) of such individual; (b) any person in whose business or profession the assessee (i.e. individual) himself or his relative has substantial interest.

(ii) Company, Firm, (a) any director of the company, partner of the firm, or member of the association, or family, or any relative of such director, partner or member; AOP or HUF (b) any person in whose Business or Profession the assessee or director, partner or member of the assessee or any relative of such person has a substantial interest. (iii) All assessees (a) any individual who has substantial interest in the Business or Profession of the assessee; (b) a company, firm, AOP or HUF [or any director, partner or member of any such person or any relative of such person] having a substantial interest in Business or Profession of the assessee (c) any other company carrying on Business or Profession in which the assessee has substantial interest.

DIRECT TAXATION I 6.51

Profits and Gains of Business or Profession Transfer Pricing Provisions to apply in respect of transactions covered u/s. 40A(2). The provision of section 40A(2) empowers the Assessing Oficer to disallow unreasonable expenditure incurred between relared parties. The provisions of section 40A(2) has been amended as follows : 1. Disallowances on account of any expenditure being excessive or unreasonable having regard to the fair market value shall not be made in respect of a specified domestic transaction (as referred to section 92BA of the Act), if such transaction is at Arms Length Price as per section 92F of the Act Meaning of the term Related Party under section 40A(2) has been modified to include any transaction between companies having the same holding / controlling company for the purpose of any expenditure incurred so.

2.

DISALLOWANCE OF CASH EXPENDITURE EXCEEDING ` 20,000 [Sec. 40A(3), RULE 6DD] Where the assessee incurs any expenditure over ` 20,000 otherwise than by account payee cheque drawn on a bank or account payee bank draft, 100% deduction will be disallowed in respect of such expenditure. Enhancement of limit for disallowance of expenditure made otherwise than by an account payee cheque or account payee bank draft for plying, hiring or leasing goods carriages in the case of transporters to ` 35,000 from the existing limit of ` 20,000 (Section 40A(3) and (3A) applicable to transactions effected on or after 1-10-2009) Under the existing provisions of the Income-Tax Act, where an assessee incurs any expenditure, in respect of which payment in excess of ` 20,000 is made otherwise than by an account payee cheque or account payee bank draft, such expenditure is not allowed as a deduction. Given the special circumstances of transport operators for incurring expenditure on long haul journeys for plying, hiring or leasing goods carriages, the Act has inserted proviso 2 to section 40A(3) and (3A) in order to raise the limit of payment to such transport operators otherwise than by an account payee cheque or account payee bank draft to ` 35,000 from the existing limit of ` 20,000. The existing limit for other categories of payments will remain at ` 20,000 subject to the exceptions declared in Rule 6DD of the Income-Tax Rules. Exceptions under Rule 6DD (a) Payments made to banks, including cooperative bank or land mortgage bank, Life Insurance Corporation and financial institution like IDBI, UTI, Industrial Development Corporations and State Financial Corporations, Primary Agricultural Credit Society. (b) Payments made to Government, where such payment is required to be made in legal tender e.g. payment of sales-tax, customs duty, excise duty, etc. (c) Payments under contracts entered into before 1.4.1969. (d) Payments made by way of any Letter of Credit, telegraphic transfer, transfer from one bank account to another, or through Bill of Exchange payable to a bank. (e) Where the payment is made by way of adjustment against the amount of any liability incurred by the payee for any goods supplied or services rendered by the assessee to such payee. (f) Payment for purchase of (i) agricultural or forest produce, (ii) the produce of animal husbandry (including hides and skins), dairy or poultry farming, (iii) fish or fish-products, or (iv) products of horticulture, or apiculture if the payment is made to the cultivator, grower or producer of such articles, produce or products.

6.52 I DIRECT TAXATION

(g) Payment made for purchase of products manufactured or processed without the aid of power in a cottage industry, if the payment is made to the producer of such products. (h) Where the payment is made in a village or town, which is not served by any bank, to any person who ordinarily resides or is carrying on any business, profession or vocation in any village or town. (i) Payment by way of gratuity, retrenchment compensation or similar terminal benefits made to an employee or his legal heirs, if the income under the head salary of the employee does not exceed ` 7500 for the current year as well as for the immediately preceding Previous Year. Payment made by way of salary to its employees after deducting the income-tax from the salary, when such an employee is temporarily posted for a continuous period of fifteen days or more in a place other than his normal place of duty or on a ship and the employee does not maintain any account in any bank at such place.

(j)

(k) Where the payment is required to be made on a day on which the banks were closed, either on account of holiday or strike. (l) Payments made by any person to his agent who is required to make payments in cash for goods or services on behalf of such person.

(m) Where the payment is made by an authorised dealer or a money changer against purchase of foreign currency or travellers cheques in the normal course of his business. [Notification No. 11476, dated 6.9.2000 applicable retrospectively from 25.7.1995] PROVISION FOR GRATUITY [Sec. 40A(7)] No deduction shall be allowed in respect of any provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason. However, any provision made by the assessee for the purpose of payment of any contribution towards an approved gratuity fund or for the purpose of payment of any gratuity which has become payable during the Previous Year shall be allowed as deduction. NON STATUTORY/UNRECOGNISED WELFARE FUND CONTRIBUTIONS [Sec. 40A(9)] Any contribution made by the assessee to unrecognised or non-statutory welfare fund accounts is not deductible. SPECIAL PROVISION FOR COMPUTING DEDUCTIONS IN THE CASE OF BUSINESS REORGANIZATION OF COOPERATIVE BANKS [SEC. 44DB] After section 44DA of the Income Tax Act, the following sections shall be inserted with effect from the 1st day of April, 2008, namely : 44DB. Special provision for computing deductions in the case of business reorganization of co-operative banks. (1) The deduction under section 32, section 35D, section 35DD or section 35DDA shall, in a case where business reorganization of a co-operative bank has taken place during the financial year, be allowed in accordance with the provisions of this section. (2) The amount of deduction allowable to the predecessor co-operative bank under section 32, section 35D, section 35DD or section 35DDA shall be determined in accordance with the formula
B A C

where A = the amount of deduction allowable to the predecessor co-operative bank if the business reorganisation had not taken place; B = the number of days comprised in the period beginning with the 1st day of the financial year and ending on the day immediately preceding the date of business reorganisation; and

DIRECT TAXATION I 6.53

Profits and Gains of Business or Profession C = the total number of days in the financial year in which the business reorganisation has taken place. (3) The amount of deduction allowable to the successor co-operative bank under section 32, section 35D, section 35DD or section 35DDA shall be determined in accordance with the formula
A B C

where A = the amount of deduction allowable to the predecessor co-operative bank if the business reorganisation had not taken place; B = the number of days comprised in the period beginning with the date of business reorganisation and ending on the last day of the financial year; and C = the total number of days in the financial year in which the business reorganisation section is transferred before the expiry of the period specified therein to a successor co-operative bank on account of business reorganisation, apply to the successor co-operative bank in the financial years subsequent to the year of business reorganisation as they would have applied to the predecessor co-operative bank, as if the business reorganisation had not taken place. SECTION 43B Certain expenses are allowed only on payment basis within a stipulated time period irrespective of method of accounting and the evidence of such payment is furnished alongwith the return of income. Nature of Expense 1. Any sum payable by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force. Any sum payable to an employee as bonus or commission for services rendered. Stipulated time period Due amount should be paid on or before the due date of furnishing the return of income u/s. 139(1) in respect of the Previous Year. In which the liability to pay such sum was incurred and proof of payment should be attached alongwith the return of income.

2.

3.

Any sum payable by the assessee as However, in cases (1) to (5), if the payment of interest on any loan or borrowing from outstanding liability is made after the due date, any public financial institution or State deduction can be claimed in the year of payment. Financial Corporation or State Industrial Investment Corporation like IDBI, IFCI, UPSIDC, Delhi Financial Corporation, etc. in accordance with the terms and conditions of the agreement governing such loan or borrowing. Any sum payable by the assessee as -dointerest on any term loan from a scheduled bank in accordance with the terms and conditions of the agreement governing such loan. Any sum payable by the assessee as an However, if the deduction has already been allowed employer in lieu of any leave at the credit on due basis before this amendment, the same will not of his employee (inserted w.e.f. AY 2002-03) be allowed again when the sum is actually paid.

4.

5.

6.54 I DIRECT TAXATION

6.

Any sum payable by the assessee as an employer by way of contribution to any provident fund of superannuation fund or gratuity fund or any other fund for the welfare of employees.

Payments should be made in cash or by issue of a cheque or draft, or by any other mode on or before the due date by which the employer is required to credit an employees contribution to the employees account in the relevant fund under the respective Act, Rule, Order or Notification. Where the payment has been made otherwise than in cash, the sum should be realised within fifteen days from the relevant due date

DEEMED PROFIT/DEEMED INCOME [Sec 41(1)] Where deduction has been made in respect of loss, expenditure or trading liability for any year and subsequently the assessee or successor of the business has obtained any amount in respect of such loss expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained or the value of benefit accrued shall be deemed to be income. The provisions are applicable even to the successor who receives the amount/benefit. The successor in business, for this purpose, means (a) Where there has been an amalgamation of a company with another company, the amalgamated company; (b) Where any person is succeeded by another person in carrying on the Business or Profession, such other person; (c) Where a firm carrying on a Business or Profession is succeeded by another firm, such other firm. (d) Where there has been a demerger, the resulting company. If there is a remission or cessation of a trading liability which was earlier allowed as deduction, it is chargeable to tax. Even if the remission or cessation is effected by a unilateral Act of writing off of such liability by the assessee, the amount so written off is chargeable to tax. The above mentioned sub-section covers loss, expenditure and trading liability.e.g. (i) If stock is destroyed by fire and allowed as trading loss but later insurance compensation is received, the same is assessable u/s. 41(1). (ii) If credit purchase of raw material is made and claimed as deduction but later, a lesser amount is settled to the supplier creditor, the benefit accruing on remission of the trading liability will be deemed as income u/s. 41(1). SECTION 41(2) In the case of an undertaking engaged in the generation or generation and distribution of power, option is available to claim depreciation on straight line method with reference to each individual asset. If such option is exercised, block of asset concept does not apply. In the case of such an assessee, where any building, machinery, plant or furniture is transferred for a consideration which is more than the depreciated value, the surplus to the extent of depreciation already allowed shall be assessed as business income. This is normally described as Balancing Charge. SECTION 41(3) Any amount realised on transfer of an asset used for scientific research is taxable as business income to the extent of deduction allowed u/s. 35 in the year in which the transfer takes place. SECTION 41(4) Any amount recovered by the assessee against bad debt earlier allowed as deduction shall be taxed as income in the year in which it is received.

DIRECT TAXATION I 6.55

Profits and Gains of Business or Profession SECTION 41(4A) Under sec. 36(1)(viii) any special reserve created and maintained by a financial corporation or public company specified there under qualifies for deduction subject to the limit prescribed. Sub-section (4A) is introduced in sec.41 to make it clear that where a deduction has been so allowed, any amount subsequently withdrawn from such special reserve shall be deemed to be the profits of the year of such withdrawal and shall be charged to tax accordingly. The chargeability applies even if the business is no longer in existence during the relevant Previous Year. SECTION 41(5) In the case of an assessee who is chargeable to tax in respect of any amount deemed as profit u/s. 41 relating to a discontinued business, any loss incurred in the year in which the business was discontinued shall be allowed to be set off against such profit and only the balance, if any, shall be taxed. SECTION 176(3A) Where any business is discontinued in any year, any sum received after discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the person who carried on the business had such sum been received before such discontinuance. SECTION 176(4) Where any profession is discontinued in any year on account of the cessation of the profession by, or the retirement or death of, the person carrying on the profession, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, as if such sum would have been included in the total income of the aforesaid person had it been received before such discontinuance. INCOME FROM UNDISCLOSED SOURCES CASH CREDITS [Sec. 68] Where any sum is found credited in the books of an assessee, maintained for any Previous Year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that Previous Year. UNEXPLAINED INVESTMENTS [Sec. 69] Where in the Financial Year immediately preceding the Assessment Year, the assessee has made investments which are not recorded in the books of account, if any, maintained by him for any source of income and the assessee offers no explanation about the nature and source of the investments or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the value of the investments may be deemed to be the income of the assessee of such Financial Year. UNEXPLAINED MONEY ETC. [Sec. 69A] Where in any financial year, the assessee is found to be the owner of any money, bullion, jewellery or other valuable article and such money, bullion, jewellery or valuable article is not recorded in the accounts, if any maintained by him for any source of income, and the assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewellery or other valuable article, or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the money and the value of the bullion, jewellery or other valuable articles may be deemed to be the income of the assessee for such Financial Year.

6.56 I DIRECT TAXATION

INVESTMENTS, ETC. NOT FULLY DISCLOSED IN BOOKS OF ACCOUNT [Sec. 69B] Where in any Financial Year, the assessee has made investments or is found to be the owner of any bullion, jewellery or other valuable article, and the Assessing Officer finds that the amount expended on making such investments or in acquiring such bullion, jewellery or other valuable article exceeds the amount recorded in his behalf in the books of account maintained by the assessee for any source of income and the assessee offers no explanation about such excess amount or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the excess amount may be deemed to be the income of the assessee for such Financial Year. UNEXPLAINED EXPENDITURE [Sec. 69C] Where in any Financial Year, an assessee has incurred any expenditure and he offers no explanation about the source of such expenditure or part thereof, or the explanation, if any, offered by him is not, in the opinion of the Assessing Officer, satisfactory, the amount covered by such expenditure or part thereof, as the case may be, may be deemed to be the income of the assessee for such Financial Year. Further, notwithstanding anything contained in any other provision of the Income Tax Act, such unexplained expenditure which is deemed to be the income of the assessee, shall not be allowed as a deduction under any head of income. UNEXPLAINED AMOUNT BORROWED OR REPAID ON HUNDI [Sec. 69D] Where any amount is borrowed on a hundi from, or any amount due thereon is repaid to any person otherwise than through an account payee cheque drawn on a bank, the amount so borrowed or repaid shall be deemed to be the income of the person borrowing or repaying the amount aforesaid for the Previous Year, in which the amount was borrowed or repaid, as the case may be, provided that, if in any case any amount borrowed on a hundi has been deemed under the provisions of this Section to be the income of any person, such person shall not be liable to be assessed again in respect of such amount under the provisions of this Section on repayment of such amount. Explanation : For the purposes of the Section, the amount repaid shall include the amount of interest paid on the amount borrowed. EXCHANGE RATE FLUCTUATION [Sec. 43A] Where an assessee acquires an asset from abroad and in consequence of the variation in exchange rate, the liability of the assessee in terms of payment towards the acquisition of that asset increases or decreases, then the actual cost of that asset shall be increased or decreased accordingly. The effect of exchange rate fluctuation shall be taken into consideration for the purpose of deduction u/s. 32, 35, 35A, 36(1)(ix) and for the purpose of computation of capital gains u/s. 48 or u/s. 50 as the case may be. The increase or decrease in liability due to exchange rate fluctuation shall be taken into account at the time of making payment also. COST OF ACQUISITION OF CERTAIN ASSETS [Sec. 43C] Mode of acquisition 1) Amalgamation Cost of acquisition (a) Cost to the amalgamating company (b) Cost of improvement (c) Expenses incurred for transfer (a) Cost to the donor, (b) Cost of improvement (c) Expenses incurred for accepting the gift and the gift tax paid by the donor

2)

Gift

DIRECT TAXATION I 6.57

Profits and Gains of Business or Profession 3) Partition of HUF (a) Cost to the HUF (b) Cost of improvement (c) Expenses incurred for partition. Will (a) Cost to the previous owner (b) Cost of improvement (c) Expenses incurred for probating the will (a) Cost to the previous owner (b) Cost of improvement (c) Expenses incurred for establishing the Trust.

4)

5)

Irrevocable Trust

SPECIAL PROVISIONS FOR DEDUCTION IN CASE OF TRADE, PROFESSIONAL OR SIMILAR ASSOCIATION [Sec.44A] Amount received from members of trade, professional or similar associations by way of subscription or membership fee falls short of the expenditure incurred, such deficit will be allowed as deduction in computing the income under the head Profits and Gains of Business or Profession. If there is no income under that head or if the income under that head is inadequate to absorb the deficit, it can be set off against the income of the association computed under any other head of income. In any case any loss or allowance brought forward from earlier Assessment Year, the deduction permissible under this provision cannot exceed 50% of the total income for that Previous Year computed before allowing this deduction. Sec. 44 is applicable only to the trade, professional or similar association the income of which or any part thereof is not distributed to its members except as grants to any association, or institution affiliated to it. Excess over expenditure received by a club from facilities extended to members as part of advantages attached to such membership shall not be chargeable to tax on the principle of mutuality- CIT vs. Bankipur Club Ltd. 226 ITR 97

6.58 I DIRECT TAXATION

COMPULSORY MAINTENANCE OF ACCOUNTS [Sec. 44AA, RULE 6F] Applicability of this section depends on the type of activity carried on by the person. For this purpose. Persons are classified as follows :Person

Note : Film Artist Means

Specified Profession Legal Medical Engineering Architechtural Accountancy Technical Consultancy Interior Decoration Authorised Representative Film Artist Company Secretary Information Technology or Any Other Notified Profession Producer of a Cinematograph film An Actor / Actress; A Cameraman; A Music Director; An Art Director; A Dance Director An Editor; A Story Writer A Screen play writer A Dialogue writer A Dress Designer Classification Specified Person
Condition

Non-specified Profession Other than Specifified Profession

Requirement of Compulsory maintenance of Books of Account : Catagory A

Gross Receipts `1,50,000 in any of the three years immediately preceeding the Previous Year

If newly set up in the Previous Year, then his gross total Not Required to Maintain any Books receipts in the profession for that year are not likely to of Account as prescribed in Rule 6F exceed the said amount B Specified Person Required to maintain such Books of Gross Receipts ` 1,50,000 in all the three years immediately preceeding the Previous Year

If newly set up in the previous year, then his gross total receipts in the profession for that year are likely to Account as prescribed in Rule 6F. exceed the said amount

DIRECT TAXATION I 6.59

Profits and Gains of Business or Profession

C

Non-Specified Person

Income from such Business or Profession `1,20,000 or total sale or turnover or gross receipts there of are less than ` 10,00,000 in all the three years immediately preceeding the Previous Year

Not Required to Maintain any Books If newly set up in the Previous Year, then his gross total of Account receipts in the profession for that year are not likely to exceed the said amount
D

Non-Specified Person

Income from such Business or Profession 1,20,000 or total sale or turnover or Gross receipts there of are less than ` 10,00,000 in all the three years immediately Required to maintain such Books of preceeding the previous year Account as prescribed in Rule 6F. If newly set up in the Previous Year, then his gross total This category includes an assessee receipts in the profession for that year are likely to covered u/s 44AD, 44AE, 44BB, exceed the said amount 44BBB

Rule 6F(2) prescribes the books to be maintained are as follows :(a) Cash Book (b) Ledger (c) (e) Journal (if mercantile system is adopted) Copies of bills issued for amounts exceeding ` 25. (d) Bills and vouchers in respect of expenses incurred In case of medical practitioner, the following additional books are to be maintained. (a) Daily case register (Form 3C) (b) Inventory as on the first and last day of the Previous Year, showing the stock of medicines drugs and medicines are dispensed during the course of practice) (where

Rule 6F(5) provides that the books of account and documents are required to be kept for six years from the end of the relevant Assessment Year In case of assessment relating to any Assessment Year reopened u/s. 147 of the I.T. Act within the period specified in section 149 of the Act, the books and documents relating to that year are required to be kept and maintained till the assessment so reopened has been completed. AUDIT OF ACCOUNTS [Sec. 44AB] In case of following person carrying on business or profession are required to get his accounts audited before the specified date by an accountant and to furnish such report in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed before the specified date. Carrying on business where total sales turnover or gross receipts exceeds `1 crore; Carrying on profession where gross receipts exceed ` 25,00,000; or

Carrying on business referred to in section 44AD or 44AE or and claiming his income to be lower than the income prescribed under the relevant section. Types of Audit Report [Rule 6G] Form No. 3CA : For the person who carries on Business or Profession and who is required by or under any other law to get his accounts audited.

6.60 I DIRECT TAXATION

Form No. 3CB : For the person carrying on Business or Profession who are not required to get his account audited under any other law. Form No. 3CD : The particulars of which are required to be furnished u/s. 44AB. SPECIFIED DATE [EXPLANATION TO SEC. 44AB] Specified date in relation to the accounts of the assessee of the Previous Year relevant to the Assessment Year, means the 30th September of the Assessment Year. In case the assessee has undertaken any international transactions as per section 92B or specified domestic transaction as per newly inserted section 92BA, the Specified Date is extended to 30th November. It may also be noted that the requirement of Audit u/s 44AB does not apply to person who derives income referred to in Sec. 44B, 44BB, 44BBA and 44BBB. In case of an agent who earns only commission income, the audit of accounts is required only if the commission exceeds ` 1 crore. [CBDT circular No. 452 dt. 17.3.1986] Illustration 22: Mukund is a person carrying on profession as film artist. His gross receipts from profession are as under : Financial year Financial year 2010-2011 2011-2012 ` 1,25,000 ` 1,60,000

Financial year 2012-2013 ` 1,80,000 Is he required to maintain any books of account under Section 44AA of the Income-tax Act? If so, what are these books? Answer : Section 44AA requires every person carrying on any profession, notified by the Board of the Official Gazette (in addition to the professions already specified) to maintain such books of account and other documents as may enable the Assessing Officer to compute his total income in accordance with the provisions of the Income-tax Act. The CBDT has notified the profession of film artists as one such profession (S.O. No.17E/12-1-77). Hence section 44AA applies to Mukund. Sub-section (3) of section 44AA authorizes the Board to prescribe by rules, the books of account and other documents (including inventories) to be kept and maintained under sub-section (1), the particulars to be contained therein etc. The prescribed rule is Rule 6F, under which every person carrying on the specified profession, including a film artist, is required to maintain the books of account and other documents specified in sub-rule (2). However, under the proviso to Sub-rule (1), nothing contained therein shall apply in the case of a person, if his gross receipts do not exceed `1,50,000/- in any one of the three years, immediately preceding the Previous Year. The significance of this rule is that if the gross receipts from profession do not exceed `1,50,000 in any one of the previous 3 years, he is not required to maintain the books of account specified in sub-rule (2) of Rule 6F. Since in one of the three previous years the gross receipts are below `1,50,000, the assessee is not required to maintain books of account and other documents as he is not governed by section 44AA. Presumptive Income Computation of income on estimated basis in the case of taxpayers engaged in certain business [section 44AD]- The provision of section 44AD will be applicable only if the following conditions are satisfiedi) Eligible assessee- The assessee should be an eligible assessee. Eligible assessee for this purpose is a resident individual, a resident Hindu Undivided Family or a resident partnership firm (not being a Limited Liability Firm).

DIRECT TAXATION I 6.61

Profits and Gains of Business or Profession ii) iii) Has not claimed some deduction- The assessee has not claimed any deduction under sections 10A, 10AA, 10B, 10BA, 80HH to 80RRB in the relevant Assessment Year. Eligible business- The assessee should be engaged in any business (whether it is retail trading or wholesale trading or civil construction or any other business). However following person are not eligible to avail any benefit under section 44AD(a) A profession referred in section 44AA, (b) Commission or Brokerage, (c) Any agency business, (d) A person who is in the business of plying, hiring or leasing goods carriages.

iv) Total turnover/ gross receipt in the Previous Year of the eligible business should not exceed ` 1 crore. If the above conditions are satisfied, the income from the eligible business is estimated at 8 percent of the gross receipt or total turnover. Presumptive income for truck owners [Section 44AE] [W.e.f A.Y. 2011-12] Under the existing provisions of section 44AE, a presumptive scheme is available to assesses engaged in business of plying, hiring or leasing goods carriages. The scheme applies to an assessee, who owns not more than 10 goods carriages at any time during the Previous Year. The Act has enhanced the presumed income per vehicle for the owners of (i) Heavy goods vehicle to ` 5,000 p.m.; and (ii) Other than heavy goods vehicles to ` 4,500 p.m. The Act has further provided an anti-avoidance clause stating that a prescribed fixed sum or a sum higher than the / aforesaid sum claimed to have been earned by the assessee shall be deemed to be profits and gains of such business. SPECIAL PROVISIONS FOR COMPUTING PROFITS & GAINS FOR NON-RESIDENTS Section Nature of Business 44B
44BB

Profit- % on Turnover 1 72 % 10%

Shipping business in case of non-resident. Business of providing services or facilities in connection with orsupplying plant and machinery on hire used in the prospecting for or extraction or production of mineral oils in case of non-resident. Business of operation of aircraft in case of non-resident. In case of foreign company engaged in :i) Civil construction ii) erection of plant or machinery iii) testing or commissioning thereof in connection with turnkey power project approved by the Central Government, income is determined at 10% of the gross amount.

44BBA

44BBB

5% 10% of the gross amount paid or payable in India or out of India.

Stock Valuation : Valuation of stock plays a vital role in determining the taxable income of an assessee from business as correct profits cannot be ascertained unless the opening and closing stocks are valued correctly. Though the valuation of stock does not generate funds, it does affect taxable income of the business.

6.62 I DIRECT TAXATION

Cost or market price whicever is less Neigher the Income-tax Act nor the Income-tax Rules prescribes or permits any particular method of valuation of stock. An assessee may value its stock either at cost price or at market price, whichever is less. It is now well-settled law that the assessee has a right to value his closing stock at cost price or market price, whcihever is lower. Where the goods are saleable only in certain foreign markets and there is no demand for the goods in such foreign markets, the assessee is entitled to value the goods at nil. It such a case he is not bound to show that he had made efforts to sell the goods in other foreign markets or in the local market before valuing the stock at nilK. Mohammad Adam Sahib v CIT [1965] 56 ITR 360 (Mad.) Change of method of stock valuation Once a particular method of valuation is adopted, the same should be continued in subsequent yearCIT v. A.V. Appu Chettiar [1962] 45 ITR 152 (Mad.). The method of valuation of stock may, however, be changed. The new method of stock valuation cannot be rejected merely because there would be loss of revenue in the year of change. What is relevant is to consider whether the method adopted is one of the recognised methods and further whether the changed method of stock valuation is followed consistently year after year. Change in the method of stock valuation cannot be restricted to a particular year. If the new method of stock valuation is followed consistently year after year, the tax authorities have no option but to accept such method notwithstanding the fact that, in the initial year when the changed method is brought about, it may result in a prejudice or detriment to the revenue. The change of method must be bonafide and must not be restricted to a particular year CIT v. Delta Plantation Ltd. [1993] 71 Taxman 329 (Cal.). The change has to be affected by adopting the new method for valuing the closing stock of the current year (in which change takes place), which will, in its turn, become the value of the opening stock of the next year. According to section 145, the books of account and financial statements is to be prepared in accordance with the regular method of accounting followed by the assessee. However, according to section 145A while determining the income chargeable under the head Profits and gains of business or profession, valuation of purchase and sale of goods and inventory should be not only in accordance with the method of accounting regularly employed by the assessee but should also be further adjusted as follows : (i) sale and purchase of goods should be shown at gross amount including duty, tax, cess, etc.; (ii) while valuing opening and closing inventory tax, duty, cess, etc., should be included as part of cost (or value) of the inventory. Head office expenditure in the case of non-resident [Sec. 44C] Head office expenditu re in the case of a n on- resident is allowed in accordance with the provision of section 44C. This section is a non obstante provision and anything contrary contained in sections 28 to 43A is not applicable. Deduction in respect of head office expenditure is restricted to the least of the following : a. an amount equal to 5 per cent of adjusted total income, or in the case of loss, 5 per cent of average adjusted total income, or b. the amount of so much of the expenditure in the nature of head office expenditure incurred by the assessee as is attributable to the business or profession of the assessee in India. MEANING OF ADJUSTED TOTAL INCOME Adjusted total income means the total income computed in accordance with the provisions of the Act without giving effect to the following : Allowance under section 44C Unabsorbed depreciation allowance under section 32(2) Expenditure incurred by a company for the purpose of promoting family planning amongst its employees under the first proviso to clause (ix) of section 36(1) Businrss loss brought forward under section 72(1)

DIRECT TAXATION I 6.63

Profits and Gains of Business or Profession Speculation loss brought forward under section 73(2) Loss under the head Capital gains under section 74(1) Loss from certain specified sources brought forward under section 74A(2) Deductions under sections 80C to 80U.

Average Adjusted Total Income Where the total income of the assessee is assessable for each of the three assessment years immediately preceding the relevant Assessment Year, one-third of the aggregate amount of the adjusted total income in respect of the Previous Years relevant to the aforesaid three Assessment Years is average adjusted total income. Where the total income of the assessee is assessable only for two of the aforesaid three Assessment years, one- half of the aggregate amount of the adjusted total income in respect of the Previous Years relevant to the aforesaid two assessment years is taken as average adjusted total income. Where the total income of the assessee is assessable only for one of the aforesaid three Assessment Years, the amount of the adjusted total income in respect of the previous year relevant to that Assessment Year is average adjusted total income.

Head Office Expenditure - Head office expenditure means executive and general administration expenditure incurred by the assessee outside India, including expenditure incurred in respect of : a. rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession ; b. salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary, whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India ; c. travelling by any employee or other person employed in, or managing the affairs of, any office outside India ; and d. such other matters connected with executive and general administration as may be prescribed. Computatiqn of income by way of royalties and technical service fees in the case of foreign companies [Sec. 44D] The provisions are given below : AGREEMENT MADE BEFORE APRIL 1, 1976 Where such income is received under an agreement made before April1, 1976, the deduction in respect of expenses incurred for earning such income is subject to a ceiling limit of 20 per cent of the gross amount of such income, as reduced by the amount, if any, of so much of the royalty income as consists of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property. The aforesaid ceiling limit is applicable in relation to all royalties and technical service fees received by foreign companies from Indian concerns, irrespective of whether such royalties or technical service fees are received under agreements which have been approved by the Central Government or not. For this purpose, an agreement made by a foreign company with an Indian concern on or after April 1, 1976 is regarded as agreement made before that date if such agreement is made on the basis of proposals approved by the Central Government before that date and the foreign company has exercised an option in this behalf under section 9(1)(vi). AGREEMENT MADE ON OR AFTER APRIL 1, 1976 NOT BEING COVERED BY SECTION 44DA [Sec.115A] Royalties and technical service fees received under an agreement made on or after April 1, 1976 not being covered by section 44DA, are chargeable to tax @ 10 per cent (+SC+EC+SHEC) by virtue of section 115A in following four cases a. where such agreement is with the Government of India; or

6.64 I DIRECT TAXATION

b. where such agreement is with an Indian concern, the agreement is approved by the Central Government ;or c. where such agreement relates to a matter included in the industrial policy, for the time being in force, of the Government of India, the agreement is in accordance with that policy ; or d. where such royalty is in consideration for the transfer of all or any rights (including the granting of a licence) in respect of copyright in any book on a subject referred to in the proviso to sub section (1A) of section 115A to the Indian concern or in respect of computer software referred to the second proviso to section 115A(1A) to a person resident in India. In other words, the gross amount of income by way of royalties or fees for technical services received by a non- resident from an Indian concern is chargeable to tax. In the aforesaid four cases, the gross amount of such income is chargeable to tax at the flat rate of 30/20/10 per cent (plus surcharge plus education cess plus secondary and higher education cess) by virtue of section 115A. In other remaining cases, such gross income is taxable at the normal rate [i.e., 40 per cent (+SC+EC+SHEC)]. According to section 440, while calculating the aforesaid income no deduction under sections 28 to 44C shall be allowed to foreign companies having income by way of royalty or fees for technical services received from Central Government or Indian concern for agreement with them after March 31, 1976 but before April 1, 2003 [applicable even if the agreement is not approved by the Central Government]. Whether tax paid on behalf of foreign companies is to be grossed up - If tax is payable on the aforementioned income by the Indian counterpart on behalf of foreign companies, then in few cases tax shall not be grossed up in the hands of foreign company. Indian Concern - An Indian concern in section 115A should be taken as a business carried on in India which may include a business carried on in India even by a non-resident.

Section 44DA Section 44DA has been inserted to harmonise the provisions relating to the income from royalty or fees for technical services attributable to a fixed place of profession or a permanent establishment in India with similar provisions in the various Double Taxation Avoidance Agreements. The provisions of section 44DA are given below. When Section 44DA is applicable - Section 44DA is applicable if the following conditions are satisfied 1. The taxpayer is a foreign company or non-resident non-corporate-assessee. 2. The taxpayer carries on a business in India through a permanent establishment situated in India. Alternately, the taxpayer performs professional services from a fixed place of profession situated in India. Permanent establishment includes a fixed place of business through which the business of an enterprise is wholly or partly carried on.

3. The taxpayer gets income by way of royalty or fees for technical services. One may refer to section 9(1) for meaning of royalty and fees for technical services. 4. The aforesaid royalty or technical fees is received from a. Government (i.e., the Central Government or a State Government); or b. an Indian concern.

5. The income mentioned in (3) is received in pursuance of an agreement made by the taxpayer with the Government or the Indian concern after March 31, 2003. If such agreement is made before April 1, 2003, then section 44D is applicable (not section 44DA). 6. The right, property or contract in respect of which the royalties or fees for technical services are paid to the taxpayer is effectively connected with permanent establishment or fixed place of profession [as mentioned in (2)].

DIRECT TAXATION I 6.65

Profits and Gains of Business or Profession Conclusion : The cumulative impact of sections 44D, 44DA and 115A is given below Royalty or fees for technical service received by a foreign company or a non-resident non-corporate assessee from Government or an Indian concern 1 A Such royalty is received under an agreement made before April 1, 1961 or such technical fee is received under an agreement made before March 1, 1964 A1 Where the agreement is approved by the Government A2 Where the agreement is not approved Note 1 Note 1 Deduction is available Deduction is available 40 per cent 40 per cent Deductions under sections 28 to 44D and 57 2 Deductions under sections 80C to 80U 3 Rate of tax on such royalty or fees or fees [on 1-2-3] 4

Such royalty is received under an agreement made after March 31, 1961 but before April 1, 1976 or such technical fee is received under an agreement made after February 29, 1964 but before April 1, 1976 B1 Where agreement is approved by the Central Government Note 1 Deduction is available Deduction is available 50 per cent 40 per cent

B2 Where such agreement is not approved by the Note 1 Central Government

6.66 I DIRECT TAXATION

Such royalty or technical fee is received under an agreement made after March 31, 1976 but before April 1, 2003 C1 Where such agreement is with the Government C2 Where such agreement is with an Indian concern, the agreement is approved by the Central Government C3 Where the agreement relates to a matter included in the industrial policy, for the time being in force, of the Government of India, the agreement is in accordance with that policy C4 Where such royalty is in consideration for the transfer of all or any rights (including the granting of a licence) in respect of copyright in any book on a subject referred to in the proviso to subsection (1A) of section 115A to the Indian concern or in respect of computer software referred to in the second proviso to section 115A(1A) to a person resident in India C5 In any other case

No deduction No deduction

Deduction is available Deduction is available Deduction is available Deduction is available

10 per cent [See Note 5] 10 per cent [See Note 5] 10 per cent [See Note 5] 10 per cent [See Note 5]

No deduction

No deduction

No deduction Deduction is in the case available of foreign company. Deduction is, however, available if tax- payer is non- resident non- corporate assessee

Applicable rate

DIRECT TAXATION I 6.67

Profits and Gains of Business or Profession D Such royalty or technical fee is received under an agreement made after March 31, 2003 D1 Where royalty or technical fees is effectively connected to Permanent Establishment in India D2 Where PE is absent but the case is covered by section 115A(1) [i.e. C1 to C4] D3 In any other case Deduction is available No Deduction Deduction is available [Note 3] Deduction is available Deduction is available Deduction is available Applicable rate 10 per cent [See Note 5] Applicable rate

Notes : 1. Deduction shall not exceed in the aggregate 20 per cent of the gross amount of such royalty or fees as reduced by so much of the gross amount of such royalty as consists of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property. 2. The tax rates given in the column 4 of the table supra are not applicable where a lower rate is prescribed under an Avoidance of Double Taxation Agreement entered into by the Central Government under section 90. 3. Neither section 44D (agreement is made after March 31, 2003) nor section 115A (3) (it is not agreement covered by C1 to C4) will apply in such a case. In other words, the computation will be governed by the normal provisions of the Act. 4. Provisions of sections 70, 71, 72 will be applicable before computing the aforesaid income. 5. Rate of tax is 30 percent if agreement is made before June 1, 1997 and 20 percent if agreement is made after May 31, 1997 but before June 1, 2005. Computation of income and tax under sections 115A, 115AB, 115AC, 115AD, 115BBA and 115D - The chart given below highlights the provisions of sections 115A, 115AB, 115AC, 115AD, 115BBA and 115D regarding computation of income and tax thereon :

Section

Nature of income

Deductions under sections 28 to 44C and 57

Whether the ben- Dedutctions efit of computing under section Capital Gain in foreign currency 80C to 80U as provided by the first proviso to section 48 and the rule of indexation as provided by the second proviso to section 48 are applicable

Tax rate

Is it necessary to submit return of income

6.68 I DIRECT TAXATION

115A (1)(a)

The following incomes in the case of a non-resident noncorporate assessee or a foreign company a. dividend (not being dividend covered under section 115-O) b. interest received from Government or an Indian concern on moneys borrowed or debt incurred by Government or the Indian concern in foreign currency c. interest received from an infra- structure debt fund referred to in section 10(47) (applicable from June 1, 2011, i.e., Assessment Year 2012-13) d. interest from an Indian company referred to in section 194LC (applicable from July 1, 2012, i.e., Assessment Year 2013-14) e. income received in respect of units, purchased in foreign currency, of a Mutual Fund specified under clause (23D) of section 10 or of the Unit Trust of India Not available Not available 20 per ce Note 1 Not available Not available 5 per cent Note 1 Not available Not available 20 per cent 20 per cent Note 1

Not available

Not available

Note 1

Not available

Not available

5 per cent

Note 1

115A (1)(b)

Royalty or technical fees of a non- resident non-corporate assessee or a foreign company The following incomes of an assessee, being an overseas financial organization a. income received in respect of units purchased in foreign currency

As given in earlier chart

As given in earlier chart

As given in earlier chart

Yes

115AB

First proviso is not Not available relevant (as it is applicable only in the case of shares/ debentures) Second proviso to section 48 is not applicable Not available

Not available

10 per cent

Yes

b. income by way of longterm capital gains arising from the transfer of units purchased in foreign currency

10 per cent

Yes

DIRECT TAXATION I 6.69

Profits and Gains of Business or Profession

115AC The following incomes of a nonresident: a. income by way of interest or dividends (not being covered by section 115-O), on bonds or Global Depository Receipts of an Indian company issued in accordance with the notified scheme, i.e., Foreign Currency Convertible Bonds and Ordinarily Global Depository Receipts (Through Depository Receipt Mechanism) Scheme, 1993/Issue of Foreign Currency Exchangeable Bonds Scheme, 2008 or (with effect from October 1, 1996) on bonds/Global Depository Receipts of a public sector company sold by the Government and purchased by him in foreign currency b.income by way of Llong-term Capital Gains arising from transfer of bonds or, as the case may be, Global Depository Receipts referred above Not available Not available 10 per cent Note 1

First and second proviso to section 48 are not applicable

Not available

10 per cent

Yes

115ACA

Income from Global Depository Receipts held by a resident individual who is an employee of an Indian company engaged in specified knowledge based industry or service or an employee of its subsidiary engaged in specified knowledge based industry or service Dividend (not being covered by section 115-O) on Global Depository Receipts of an Indian company engaged in specified knowledge based industry/service issued under notified employees stock option scheme and purchased in foreign currency Long-term capital gain on transfer of such receipts Not available

Not available

10 per cent

Yes

First and second proviso to section 48 are not applicable

Not available

10 per cent

Yes

115AD

The following income of a notified Foreign Institutional Investor : a.income (not being dividend covered by section 115-O) received in respect of securities (other than units referred to in section 115AB) b.income by way of short-term or long- term capital gains arising from the transfer of such securities

Not available

Not available

20 per cent

Yes

Long- term 10 percent First and second proviso to section 48 are not applicable Not available short-term u/s 111A 15 per cent, any other short-term 30 per cent Yes

6.70 I DIRECT TAXATION

115BBA(1) (a)

The following income of nonresident sportsman who is a foreign citizen i participation in India in any game (other than a game the winnings wherefrom are taxable under section 115BB) or sport; or ii. advertisement; or iii. contribution of articles relating to any game or sport in India in newspapers, magazines or journals

Not available

Not available Not available

20 per cent 20 per cent 20 per cent

Note 1 Note 1

Not available Not available

Not available

Note 1

115BBA (1 )(b)

Any amount guaranteed to be paid or payable to a nonresident sports association or institution in relation to any game (not being a game referred to in section 115BB) or sports played in India

Not available

Not available

20 per cent

Note 1

115BBA (1 )(c)

Income of a non-resident foreign citizen entertainer (applicable from the Assessment Year 2013-14) The following incomes of a nonresident Indian a. investment income from foreign exchange assets b. Long-term Capital Gain on transfer of foreign exchange assets

Not available

Not available

20 per cent

Note 1

115D

No deduction under any provision

First proviso to section 48 is applicable but not the second proviso.

Not available Not available

20 per cent 10 per cent

Note 1 Note 1

Note : 1. 2. It is not necessary for an assessee referred to in section 115A(1), 115AC(1), 115BBA or 115D to furnish his return of income under section 139(1). Rate of tax is to be increased by Surcharge, Education Cess and Secondary and Higher Secondary Cess.

REQUIREMENT AS TO MODE OF ACCEPTANCE, PAYMENT OR REPAYMENT IN CERTAIN CASES TO COUNTERACT EVASION OF TAX MODE OF TAKING OR ACCEPTING CERTAIN LOANS AND DEPOSITS [SEC. 269SS] No person shall, after the 30th day of June, 1984, take or accept from any other person (hereafter in this section referred to as the depositor), any loan or deposit otherwise than by an account payee cheque or account payee bank draft if, (a) the amount of such loan or deposit or the aggregate amount of such loan and deposit is twenty thousand or more. (b) on the date of taking or accepting such loan or deposit, any loan or deposit taken or accepted earlier by such person from the depositor is remaining unpaid (whether repayment has fallen due or not), the amount or the aggregate amount remaining unpaid ; or

DIRECT TAXATION I 6.71

Profits and Gains of Business or Profession (c) the amount or the aggregate amount referred to in clause (a) together with the amount or the aggregate amount referred to in clause (b), is twenty thousand rupees or more Provided that the provisions of this section shall not apply to any loan or deposit taken or accepted from, or any loan or deposit taken or accepted by, (a) Government ; (b) any banking company, post office savings bank or co-operative bank ; (c) any corporation established by a Central, State or Provincial Act ; (d) any Government company as defined in section 617 of the Companies Act, 1956 (1 of 1956) ; (e) such other institution, association or body or class of institutions, associations or bodies which the Central Government may, for reasons to be recorded in writing, notify in this behalf in the Official Gazette : Provided further that the provisions of this section shall not apply to any loan or deposit where the person from whom the loan or deposit is taken or accepted and the person by whom the loan or deposit is taken or accepted are both having agricultural income and neither of them has any income chargeable to tax under this Act. Mode of repayment of certain loans or deposits [Sec. 269T] No branch of a banking company or a co-operative bank and no other company or co-operative society and no firm or other person shall repay any loan or deposit made with it otherwise than by an account payee cheque or account payee bank draft drawn in the name of the person who has made the loan or deposit if (a) the amount of the loan or deposit together with the interest, if any, payable thereon, or (b) the aggregate amount of the loans or deposits held by such person with the branch of the banking company or co-operative bank or, as the case may be, the other company or co-operative society or the firm, or other person either in his own name or jointly with any other person on the date of such repayment together with the interest, if any, payable on such loans or deposits, is twenty thousand rupees or more. Provided that where the repayment is made by a branch of a banking company or co-operative bank, such repayment may also be made by crediting the amount of such loan or deposit to the savings bank account or the current account (if any) with such branch of the person to whom such loan or deposit has to be repaid . Provided further that nothing contained in this section shall apply to repayment of any loan or deposit taken or accepted from (i) Government; (ii) any banking company, post office savings bank or co-operative bank; (iii) any corporation established by a Central, State or Provincial Act; (iv) any Government company as defined in section 617 of the Companies Act, 1956 (1 of 1956); (v) such other institution, association or body or class of institutions, associations or bodies which the Central Government may, for reasons to be recorded in writing, notify in this behalf in the Official Gazette. Mode of repayment of Special Bearer Bonds, 1991 [Sec. 269TT] Notwithstanding anything contained in any other law for the time being in force, the amount payable on redemption of Special Bearer Bonds, 1991, shall be paid only by an account payee cheque or account payee bank draft drawn in the name of the person to whom such payment is to be made.

6.72 I DIRECT TAXATION

Income from Business or Profession and Tax Planning Following are certain measures should be kept in mind for tax planning for income from business or profession. 1. Nature of business: Economic factors such as scope, profitability, feasibility factors, etc. are important for determining the nature of business but the benefits and concessions available to each line of business may also be presumed before expanding an existing line of business. Location of business: Although certain factors such as nearness to the source of raw materials or markets or availability of infrastructure may be useful in taking decision on the location of business, tax consideration is also equally important. If an industry is located in backward area, deduction under section 80-IB is available. Sources of funds: There are different sources of funds depending upon the needs, availability, terms, etc. However for availing the tax benefits, there should be proper debt- equity mix in the capital structure and a clear policy on return on capital employed. Travel Expenses: The travel expenses of spouse were held as inadmissible, if such travel is not for business consideration. She may be made a partner in the firm to claim business expenditure on travel and further the share of profit of the spouse cannot be clubbed with that of the husband as the same is exempt u/s 10(2A). Employee welfare funds: The contribution of the employees welfare funds should be paid within time limits prescribed under the relevant Acts. It would be better to borrow and pay the tax liability on or before relevant due date. Contribution made to the welfare funds after the due date does not qualify for deduction even in the year of payment. However interest on money borrowed for meeting such liability qualifies as business expenses.

2.

3. 4.

5.

SHORT QUESTIONS & ANSWERS ON PROFITS AND GAINS FROM BUSINESS OR PROFESSION State the deductibility of the following expenses : 1) Anticipated hedging loss under a contract to purchase raw material. 2) Non-recovery of a bill due to negligence of an employee. 3) Initial expenditure incurred on installation of fluorescent tube lights. 4) Non-recovery of advance allowed to 100% subsidiary company engaged in the business of financing subsidiary companies. 5) Consultation fees paid to tax advisor. 6) Lump sum payment made to acquire a licence regarding technical information to reduce the production cost. 7) Payment made to catering agency for providing food/beverages to employees, working in overtime @ ` 75 per employee for 20 days. 8) Subsidy received from the government to compensate the loss suffered in exports under government sponsored scheme, has been directly credited to Capital Reserve A/c. The assessee claims it as exempt. 9) Compensation paid to an employee under voluntary retirement scheme which does not conform to the guide lines under Sec. 10(10C). 10) Commission accrued during the year but not credited in books as it has been held back due to breach of certain conditions, which may create liability to pay damages. 11) Rent of quarters, located near factory, let out to the employees of the factory, was treated as income from house property.

DIRECT TAXATION I 6.73

Profits and Gains of Business or Profession 12) Fees of ` 40,000 were paid by the company to a lawyer to defend the company in a court case. Lawyer is the brother of the director of the company. The fees have been paid by a bearer cheque and it is found excessive to the extent of ` 20,000. Employees contribution to the recognised provident fund, ` 60,000 has been charged to the Profit and Loss Account but only ` 25,000 was credited to their accounts on due date and the balance was credited to their account on the due date fixed for furnishing return of income for the relevant Previous Year.

13)

14) Bonus/commission to employees was paid: (a) during the Previous Year; or (b) after the previous year but on or before the due date of return of income for that year, or (c) after the due date the return of income for that Previous Year. 15) Salary has been paid to a resident employee outside India and non-resident employee in India but no tax has been paid thereon or deducted therefrom. 16) Advertisement expanses incurred outside India in foreign currency. RBI permission has not been obtained. 17) Municipal taxes and land revenue in respect of staff quarters were paid after due date of furnishing return of income for the relevant Previous Year. 18) Foreign tour expanses of the managing director for 10 days. However, 2 days were devoted to personal work. 19) Advertisement in a journal published by political party. 20) 600 VIP brief cases, costing `1,500 each, presented to customers. 21) Voluntary payment of gratuity paid on account of commercial expediency to an employee who died on business tour. 22) Traveling expenses to explore the feasibility of new line of business. 23) Annual payments in installments over a period of 10 years to seek assistance in technical know-how for improving quality of product. 24) Expenses incurred for registration of trademarks. 25) Employees were issued shares at par to protect business interest. Difference of market price and par value was charged as revenue expenditure. 26) Expenditure incurred on neon-sign board for the business premises. 27) Theft of stock-in-trade assuming (a) it is insured (b) it was uninsured 28) Expenditure incurred for new telephone connection. 29) Purchase of sanitary and pipeline for factory 30) Legal charges incurred for framing the scheme of amalgamation of C company with the assessee company.

31) Compensation paid to cancel the purchase order of a machine due to abnormal rise in its price. The assessee claims it as trading loss, or capital loss. 32) Confiscation of goods, imported without a valid import licence. The assessee was also fined by Custom authorities. The assessee claims deduction for both of them under general deductions Sec. 37(1). 33) The assessee claims the set-off unabsorbed depreciation of a discontinued business against the profits of another business. 34) Whether the Transfer Pricing Provisions are applicable to any domestic transactions between related parties?

6.74 I DIRECT TAXATION

Solution : 1) Anticipated hedging loss under a forward contract is not allowed to be deducted. 2) 3) Loss caused due to negligence of employee is allowed to be deducted. Initial expenditure on installation of fluorescent tube lights is a capital expenditure, not deductible [Sec. 37(1)].

4) As the business of 100% subsidiary is to finance subsidiary company, loss on account of non-recovery of such advances relates carrying on business. Such loss is an allowable deduction. 5) Consultation fee paid to tax-advisor is allowed under Sec. 37(1). 6) Payment made to acquire licence regarding technical information is a capital expenditure. Depreciation is allowed under Sec. 32 on such cost. 7) Payment made to catering agency to provide food/beverages to employees is allowed under Sec. 37(1). 8) Subsidy granted by government against loss suffered by exporters under government-sponsored scheme, is a trading receipt. Recovery of loss is taxable under Sec. 41(1). 9) Compensation paid under voluntary retirement scheme is allowed to be deducted in five equal annual instalments [Sec. 35DDA]. Scheme of voluntary retirement need not be in accordance with the guidelines of Sec. 10(10C).

10) Commission accrued during the year is taxable under mercantile system. Liability to pay damages for breach of certain conditions is a contingent liability. No deduction can be allowed for such provision. 11) Rent from quarters, let out to employees, is a business income provided the letting is subservient and incidental to the main business. 12) Payment made by a company to the brother of the director of the company, is covered under Sec. 40A(2). Therefore, excessive fees of ` 20,000 have to be disallowed. Provisions of Sec. 40A(3) apply to the balance payment since it has been made by bearer cheque. Accordingly, the balance of `20,000 shall have to be disallowed in computing taxable business profits, w.e.f. A.Y.2010-11.

13) Deduction is allowed for employees contribution credited to their account on the due date under provident fund rules. No deduction is allowed for such contribution credited to their account thereafter. Employees contribution, deducted from their salaries, is first treated as business income. If the same has not been credited to their account, the same has to be treated business income first. 14) Bonus/commission paid to the employees during the Previous Year or paid after the Previous Yearbut before the due date fixed for furnishing return of income for the Previous Year is allowed to be deducted in the same previous year in which the liability to pay such bonus/commission arose. Any bonus/ commission, paid to employees after such due date, is allowed to be deducted in the Previous Year in which the date of payment falls. 15) Salary paid to any person outside India (resident or non-resident) or salary paid to a non-resident in India is not allowed to be deducted if tax has not been paid thereon nor deducted therefrom [Sec. 40(a)(iii)]. Thus, no deduction is allowed in the instant case. It is operative from the Assessment Year 2006-2007. 16) Advertisement expenditure incurred in India or outside India is allowed to be deduction under Sec. 37(1) provided it is not of capital nature and it is incurred wholly and exclusively for the purposes of business. Permission of RBI is not relevant. 17) Deduction of municipal taxes and land revenue in respect of staff quarters, will be deducted in the Previous year in which the date of payment falls (Sec. 43B).

DIRECT TAXATION I 6.75

Profits and Gains of Business or Profession 18) Proportionate foreign tour expenses of the director relating to personal work are not to be allowed; such expenditure has not been incurred wholly and exclusively for the purposes of business. However, air fare (both ways) will be fully allowed. 19) No deduction can be allowed for advertisement in the journals published by a political party [Sec. 37(2B)]. 20) Presentation of VIP bags to customers is allowed as expenditure on advertisement under Sec. 37(1). There is no ceiling limit for gift articles. 21) Voluntary payment of gratuity on account of commercial expediency is allowable deduction under Sec. 37(1). Sec.37(1). It may be capitalized for the purposes of Sec. 35D. 22) Travelling expenditure for exploring new line of business is a capital expenditure. It is not allowed under 23) Annual installment paid for technical know-how is a revenue expenditure. It is allowed under Sec. 37(1). 24) Expenses incurred for registration of trademark is a revenue expenditure. It is, therefore, allowed under Sec.37(1). 25) Waiver of premium while issuing shares to employees, is not a trading transaction. It is not deductible. 26) Expenditure incurred on neon-sign board is a capital expenditure. It is not allowed in computing business income [(Sec. 37(1)]. However, depreciation can be claimed on it @ 15%. 27) Loss of stock-in-trade due to theft is allowed under Sec. 29 as incidental to business. However, if it is insured insurance compensation will be a trading receipt. 28) Expenditure on new telephone lines is allowed under Sec. 37(1). It is a revenue expenditure incurred for the purposes of business. 29) Purchase of sanitary pipe-line is a capital expenditure, not allowable under Sec. 37(1). However, depreciation is allowed under Sec. 32 @ 15%.

30) Amalgamation expenses are allowed to be deducted in computing taxable profits under Sec. 35DD in five equal annual instalments. 31) Compensation paid to cancel the purchase order of a machine, is a capital expenditure. It avoids futile investment in machine. It cannot be deducted under Sec. 37(1). As there is no transfer of a capital asset, compensation paid cannot be claimed is a capital loss also. 32) Explanation to Sec. 37(1) does not allow any illegal expense in computing taxable profit of business. Therefore, fine imposed for illegal import cannot be allowed [Explanation to Sec. 37(1)]. However, loss by way of the confiscation of goods can be allowed as incidental to business under Sec. 29.

33) Unabsorbed depreciation of a discontinued business now can be set-off against the profits of any other business and thereafter against the income of any other head. It is operative from the assessment year 2003-2004. 34) Yes, the provisions of transfer pricing is also applicable to domestic transactions.

6.76 I DIRECT TAXATION

PROBLEMS ON PROFITS AND GAINS FROM BUSINESS OR PROFESSION Illustration 23 : Mr Sameer, resident in India, for the year ending on 31st March 2013 providing the following P/L A/c. Compute his income from business and gross total income for the assessment year 2013-2014. Profit & Loss Account for the year ended 31.3.13 Dr.
Expenditure To To To To To To To To To To To To To Purchases Salaries and wages Trade expenses Purchase of trademarks Registration of trademarks Rent, rates and taxes Discount allowed Household expenses Advertisement bill paid in cash Income Tax Sales tax paid Purchased technical know-how Expenses incurred on income tax and sales tax proceedings To Contribution paid to a trust for staff welfare To To To To To To To To To To To To To To To To To Staff welfare expenses incurred OYT deposit Postage and telegrams Donation to National Defence Fund Life insurance premium on the life of the assessee Interest on capital Interest on loan taken to pay Income Tax Wealth Tax Audit fee Entertainment expenditure Gifts and present to five customers, costing ` 3,000 each Expenses on apprentice training Emergency risk insurance Fire insurance premium for stock Provision for bad and doubtful debts Reserve for pecuniary losses Net Profit (`) 1,90,000 1,40,000 1,000 50,000 2,000 5,000 1,500 6,000 30,000 10,000 3,000 12,000 15,100 1,000 700 5,000 1,300 2,500 2,000 5,000 500 500 1,000 30,000 15,000 4,000 200 400 3,000 5,000 76,000 6,18,700 6,18,700 Receipts By Sales less returns By Bad debts recovered, allowed in earlier years by the Assessing Officer By Interest on securities (gross) By Dharmada, mandir and gaushala receipts By Refund on Income Tax By Proceeds of life insurance policy on maturity

Cr.
(`)

5,69,300 2,000

892 2,000 1,008 43,500

Total

DIRECT TAXATION I 6.77

Profits and Gains of Business or Profession Solution : Assessee : Mr. Sameer Computation of Gross Total Income A. Y : 2013-2014
Particulars Income from Business Net Profit as per Profit and Loss Account Add: Expenses inadmissible in computing profits and gains from business or profession: Purchase of trademarks Household expenses [Sec. 37(1)] Advertisement bills paid in cash [Sec. 37(1) r.w. Sec. 40A(3)] @ 100% of ` 30,000 Income tax [Sec. 40(a)(ii)] Purchase of technical know-how Contribution to a Trust for staff welfare fund [Sec. 40A(9)] Donation for National Fund [Sec. 37(1)] Life Insurance premium [Sec. 37(1)] Interest on capital [Sec. 36(1)(iii)] Interest on loan to pay income tax [Sec. 37(1) r.w. 40{a)(ii)] Wealth tax [Sec. 40(a)(iii)] Provision for bad and doubtful debts [Sec. 37(1) r.w. 36(1)(vii)(2)] Reserve for pecuniary losses [Sec. 37(1)] 50,000 6,000 30,000 10,000 12,000 1,000 2,500 2,000 5,000 500 500 3,000 5,000 1,27,500 76,000 ` `

Less: Income not relating to business or profession: [Sec. 28(i)] (a) Interest on government securities (b) Dharada, mandir and gaushala receipts (c) Refund of income tax (d) Proceeds of L.I.P.: It is not a business receipt and exempt [Sec. 10(10)] (e) Depreciation on trademarks; 25% of `50,000 (f) Depreciation on know-how: 25% of ` 12,000 Income from Business Statement of Gross Total Income for the Assessment Year 2013-2014 1. Income from Business 2. Income from Other Sources Interest on securities Gross Total Income

1,27,500 2,03,500

892 2,000 1,008 43,500 12,500 3,000

62,900 1,40,600 1,40,600 892 1,41,492

Note : 1) Bad debts deducted in earlier years and now recovered, has been rightly included in the Profit and Loss Account as business income [Sec. 41(4)]. 2) Since payment of income tax is not deductible, its refund cannot be taxed as deemed profits [Sec. 41(1)]. 3) OYT (own your telephone) deposit is an allowable deduction in the year in which it is paid. 4) Dharmada, mandir and gaushala receipts are customarily levies by trader for charitable purposes. Amount received under these heads are not trading receipts. The fact that the amount collected under

6.78 I DIRECT TAXATION

these heads are spent for other purposes would amount to breach of trust but it would not affect the initial nature and character of the receipt. Such receipts are not taxable. 5) The assessee is entitled to the deduction in respect of donation to National Defence Fund under Sec. 80G. 6) Life insurance paid by assessee on his life is allowed to be deducted in imputing total income under Sec. 80C. 7) Any payment on advertisement exceeding ` 20,000 should be made by on account payee cheque or account payee bank draft. Since the payment has been made in cash, 100% of advertisement has been disallowed [Sec. 37(1) r.w. Sec. 40A(3)]. Crossed cheque requirement has been amended by account payee cheque. It is operative from 13-07-2008. 8) From the assessment year 2001-2002, intangible assets also fall within the scheme of depreciation. Hence, depreciation has been allowed on trademarks and know-how. 9) Registration expense of trademarks is revenue expenditure, allowed under Sec. 37(1). Illustration 24 : Dr L.Kochagaway is a renowned medical practitioner. He furnishes his receipts and payments account for the previous year 2012-2013 : Dr. Cr.
Receipts To Balance b/d To Consultation fees : 2010-2011 25,000 2011-2012 1,80,000 2012-2013 2,62,000 To Visiting fees To Loan from bank for professional purposes To Sale of medicines To Gift/presents from patients To remuneration from articles published in professional magazines To Rent from house property To Interest on Post Office National Savings Certificates ` 35,000 Payments By Rent of clinics: 2010-2011 13,600 2011-2012 44,800 2012-2013 26,600 By E lectricity and water By Purchase of professional books By Household expenses By Municipal taxes paid in respect of property By Purchase of motor car By Telephone Charges By Fire insurance in respect of property By Surgical equipment By Advance income tax By Salary and perquisite to compounder By Entertainment expenses By Purchase of X-ray machine By Expenses of income-tax proceedings By Life insurance premium By Gifts to wife By I nterest on loan By Loan A/cinstalment paid By Donation to Political Party By Car expenses By Purchase of medicines By Balance c/d `

4,67,000 1,30,000 2,25,000 1,73,000 15,000 26,000 96,000 17,000

85,000 12,000 18,000 97,800 12,000 2,45,000 10,000 3,200 44,700 43,000 72,000 16,000 2,00,000 15,000 25,000 25,000 12,000 25,000 2,500 36,000 1,05,000 79,800

11,84,000

11,84,000

DIRECT TAXATION I 6.79

Profits and Gains of Business or Profession Compute his income from Profession and Gross Total Income for the assessment year 2013-2014 after taking into account the following additional information: 1. One-third of the car expenses are in connection with personal use. 2. Depreciation on motor car is allowed at the rate of 15%. 3. The construction of the house property was completed in March 2008. It was let out for residential purposes. 4. Expenses on income tax proceeding include ` 1,000 paid for the preparation of return of income. 5. Receipts outstanding from patients for 2012-2013, amount to ` 8,000. 6. Closing stock of medicines is ` 8,000 but its current market price is ` 12,000. 7. Books purchased include annual publications of ` 12,000, purchased in December 2012. Solution : (a) Computation of income from profession for the Assessment Year 2013-2014 :
Particulars Income from Profession : (a) Receipt from profession: 1. Consultation fees: [Sec. 28(i)]: (` 25,000 + ` 1,80,000 + ` 2,62,000) 2. Visiting fees [Sec. 28(i)] 3. Sale of medicines [Sec. 28(i)] 4. Gifts and presents from patients [Sec. 28(iv)] 5. Remuneration from articles published in professional magazines [Sec, 28(i)] (b) Closing stock of medicines Total receipts and closing stock Less: Expenses allowable: 1) Rent of clinic [Sec. 30]( `13,600 + `44,800+ `26,600) 2) Electricity and water [Sec. 37(1)] 3) Salary of compounder [Sec. 37(1)] 4) Entertainment expenses [Sec. 37(1)] 5) Expenses on income-tax proceedings [Sec. 37(1)] 6) Interest on loan [Sec. 37(1)(iii)] 7) Purchase of medicines [Sec. 37(1)] 8) Car expenses [Sec. 37(1)] (2/3 x ` 36,000) 9) Depreciation on professional books : (i) Annual publications: 12,000 100% 50% (ii) Other books: 6,000 60% 10) Depreciation on car [Sec. 32 r.w. Sec. 38] : 15% of 2,45,000 2/3 11) Depreciation on plant and machinery: (i) X-ray machine 2,00,000 (ii) Surgical equipment 44,700 Depreciation @ 15% of 2,44,700 12) Telephone Charges Taxable Income from Profession 6,000 3,600 24,500 ` `

4,67,000 1,30,000 1,73,000 15,000 26,000

8,11,000 8,000 8,19,000

85,000 12,000 72,000 16,000 15,000 12,000 1,05,000 24,000

36,705 10,000

(4,21,805) 3,97,195

6.80 I DIRECT TAXATION

Computation of Income from House Property: Gross Annual value on the basis of rental valuation Less: Full municipal taxes paid by the owner Net Annual Value Less: Statutory deduction: 30% of net annual value Income from House Property Gross Total Income

B/F 96,000 12,000 84,000 25,200

3,97,195

58,800 4,55,995 25,000 2,500 4,28,495 4,28,490

Less: Deduction u/s 80C (LIC premium paid assumed that the premium is 10% of the capital sum insured Less: Deduction u/s 80GGC- Actual amount of donation to political party Total Income Total Income rounded off u/s 288A

Notes : 1. 2. Purchase of motor car is capital expenditure. Hence, it is not deductible. Depreciation has been allowed on motor car. Plant includes books and surgical equipment. Depreciation on professional books is allowed @ 60% but annual publications are written off @ 100%. However, as annual publications have been put to use for less than 180 days during the year, depreciation has been allowed @ 50%. The assessee can claim depreciation on surgical equipment at general rate. Expenses in income-tax proceedings are wholly deductible [Sec. 37(1)].

3. Contribution of articles to periodicals and magazines constitutes income from vocation of the assessee. 4. 5. One-third of car expenses and proportionate deprecation in respect of motor car have been disallowed as they are in connection with the personal use of the assessee. 6. 7. Interest on Post Office National Saving Certificates is exempt from income tax [Sec. 10(15)]. Profits and gains of the business or profession are computed according to the method of the accounting regularly followed by the assessee (Sec. 145). Since the assessee has adopted cash system of accounting. Income is taxable on receipt basis and expenditure is allowed to be deducted on payment basis, irrespective of the previous year to which the receipt of payment belongs. Receipts outstanding for the previous year 2011-2012 will not be taken into consideration. Profits and gains of business or profession is required to be computed according to the system of accounting regularly followed by the assessee but if the income cannot be properly deduced therefrom, the Assessing Officer may compute the income on such basis and in such manner as he may deem fit [Proviso to Sec. 145(1)]. In view of this, the Assessing Officer may take into account the value of closing stock while determining profits even under cash system of accounting Donation to Political Party is allowed to be deducted from gross total income under Sec. 80GGC.

8.

9.

DIRECT TAXATION I 6.81

Profits and Gains of Business or Profession Illustration 25: The Profit and Loss Account of RAI & Co. for the previous year 2012-2013 is given as follows:
Particulars Purchases of goods Salaries, bonus and commission Rent, rates and taxes Depreciation @ 16% on WDV Travelling expenses Interest on capital Advertisement Entertainment expenses Expenditure on neon-sign board New telephone deposit under OYT scheme Compensation for cancelling purchase order of an outdated machine Expenses for promoting family planning among employees Net profit ` 10,00,000 8,00,000 60,000 20,000 1,50,000 25,000 1,20,000 60,000 50,000 5,000 10,000 20,000 3,57,000 26,77,000 26,77,000 Particulars Sale of goods Closing stock Interest on drawings Interest on Govt. securities ` 26,00,000 50,000 7,000 20,000

Additional Information : (i) Salaries, bonus and commission include: (a) Salary to the proprietor ` 1,50,000 (b) Bonus paid to employees on 15-10-2013 ` 75,000 (c) Salary of ` 1,20,000 was paid in India to B, a non-resident employee but neither any tax was deducted at source nor paid thereon. However, B is a PAN holder and has cleared his tax liability. (d) Advertisement includes: (i) a hoarding bill paid in cash,` 38,000 (ii) advertisement published in souvenir, published by a political party `10,000

(e) Depreciation has been charged on plants and machinery and furniture and fittings in proportion of 4:1. Depreciation @ 15% on plant and @10% on furniture. (f) Purchases include goods of `1,00,000, imported without a licence and confiscated by the customs authorities. (g) Travelling expenses include a sum of `1,00,000 on foreign travel to purchase a machine. Negotiations have not been finalized. (h) (i) Annual stock taking revealed a theft of goods, costing `30,000. This year stock valuation was deviated from the market price to cost price which is 20% less than its market price.

Compute taxable business profits for the Assessment year 2013-14.

6.82 I DIRECT TAXATION

Solution : Computation of Taxable Business Profits for the Assessment Year 2013-2014
Particulars Income from Business Net Profit as per Profit and Loss account Add: Inadmissible Expenses (a) Salary paid to Proprietor (b) Bonus paid to employees: Deduction will be allowed in Previous Year 2013-14 (Sec.43B, being disallowance of unpaid liability) (c) Salary paid to non-resident employee, without deducting or paying TDS[Sec.40(a)(iii)] (d) Advertisement bills paid in cash [Sec. 37(1) r.w. Sec. 40A(3)] @100% of ` 38,000 (e) Advertisement in sourvenir published by political party [Sec.37(2B)] (f) Depreciation to be treated separately (g) Expenses on family planning: allowable only to a company assessee [Sec.36(1)(ix)] (h) Foreign travel to acquire a new machine, ( being capital in nature, deal not yet finalized. It may be added to the cost of the asset when such asset is actually procured) (i) Interest on capital [Sec. 36(1)(iii)] [There is no borrowings] (j) Expenditure on neon sign board, being a capital expenditure on advertisement, hence disallowed. (k) Compensation paid to cancel a capital liability, capital in nature, hence disallowed u/s 37(1) (l) Under valuation of closing stock:[50,000/80% - 50,000] ` ` 3,57,000 1,50,000 75,000 1,20,000 38,000 10,000 20,000 20,000 1,00,000

25,000 50,000 10,000 12,500 6,30,500 9,87,500 7,000

Less: Expenses allowed : Interest on Drawings Depreciation u/s 32: (a) Plant and machinery: WDV on 01.04.2012 : 20,000 4/5 100/16 Add: Cost of neon-sign board Less: Depreciation @15% WDV as on 31.3.13 (b) Furniture and Fittings: WDV on 01/04/12 : 20,000 1/5 100/16 Less: Depreciation @10% WDV on 31.3.2013 Less: Incomes credited to Profit and Loss A/c to be treated under separate Head of Income Interest on Government Securities Taxable Business Profits 1,00,000 50,000 1,50,000 22,500 1,27,500 25,000 2,500 22,500

22,500

2,500

20,000 9,35,500

DIRECT TAXATION I 6.83

Profits and Gains of Business or Profession Note : (1) Loss due to theft of stock-in-trade is allowable in computing business profits u/s 29. Such loss is incidental to business operation. Since purchase of goods have already been debited to profit and loss account, no separate adjustment is required. (2) Loss in illegal business may be allowed u/s 29. Explanation to Sec.37(1) does not apply to Sec. 29. (3) Dr.
Particulars Cost of goods sold Salaries & wages Rent of business premises, owned by the assessee Repairs and renewals Income tax paid Excise duty paid Sales tax payable Legal expenses Municipal taxes payable for staff quarters Provision for bad debts Contingency reserve Employees contribution to recognised fund Net profit ` Particulars ` 34,70,000 3,00,000 5,00,000 16,00,000 Sales 9,00,000 Rent of staff quarters 2,50,000 Sale price of machinery block on 1,40,000 31-03-2012 60,000 1,00,000 2,00,000 3,00,000 10,000 60,000 1,00,000 50,000 5,00,000 42,70,000 42,70,000

Deposit for new telephone connection is allowable u/s 37(1). Hence, no adjustment is required. Cr.

Illustration 26 : The Profit & Loss Account of Mr.Dipak Sinha for the previous year 2012-2013 is given below :

Additional Information : (i) Salaries include: (a) ` 1,20,000 was paid outside India to an employee, resident in India but neither tax was deducted nor tax has been paid thereon, (b) ` 90,000 was paid in India to an employee resident in India but neither tax deducted therefrom nor paid thereon.

(ii) Excise duty of ` 50,000 for the Assessment year 2012-2013 was paid on 1 January 2013 but it was not included in the Profit and Loss a/c. (iii) (iv) (v) Sales tax amounting ` 1,30,000 was paid on 31 July 2013 and the balance was paid on 1 August 2013, the due date of furnishing return of income is 31 July 2013. Repairs/renewals include remodelling and renovation costing ` 80,000. Legal expenses include: (a) Lawyer fee of ` 50,000 paid by bearer cheque to K, nephew of the proprietor. The Assessing Officer disallowed a sum of ` 10,000, being found in excess of the desired qualifications; (b) Gift of ` 1,00,000, made to wife, a tax-advisor, but disallowed by the A.O.

6.84 I DIRECT TAXATION

(vi)

Employees contribution include: (a) ` 30,000 credited to their account on due date under Provident Fund rules, (b) ` 20,000 credited to their account in November 2013.

(vii) Commission receipts of ` 1,00,000 have not been credited to the Profit and Loss Account as their recovery seems to be doubtful. (viii) WDV of machinery on 01-04-2012 was ` 6,50,000. (ix) WDV of business premises and staff quarters as on 01-04-2012 : ` 10,00,000 and ` 30,00,000, respectively. Depreciation @ 10% on Business Premises and @ 5% on staff quarters. Compute taxable profits for the previous year 2012-2013. Solution : Computation of Business Profits for the Assessment Year 2013-14
Particulars Net profit as per Profits and Loss a/c Add: Inadmissible Expenses/Unrecorded Incomes: (i) Rent of business premises owned by the assessee (Sec. 30) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) Remodelling and renovation, being repairs of capital nature Income tax paid [Sec. 40(a) (ii)] Sales tax remaining unpaid up to due date of furnishing return of income Legal expense includes: (a) Gift made to wife, Sec. 37(1) (b) Fees paid to lawyer (being a relative) Sec. 40A(2) & Section 40A(3) Salaries paid outside India to a resident employee TDS [Sec. 40(a)(iii)] Salaries paid in India to a resident employer without TDS Municipal tax payable for staff quarters [Sec. 43B] Provision for bad debts [Sec. 36] Contingency reserve [Sec. 37(1)] Employees contribution credited to their account after due date Commission receipts which have accrued during the year but recovery seems 1,00,000 50,000 1,20,000 10,000 60,000 1,00,000 20,000 1,00,000 10,20,000 15,20,000

`
5,00,000

2,50,000 80,000 60,000 70,000

doubtful

Less: Inadmissible receipts/ admissible claims: (i) Excise duty (Sec. 43B) (ii) Sale price of machine, being capital receipts (iii) Depreciation: (a) Staff quarters: 5% of 30,00,000 (b) Business Premises: 10% of 10,00,000 Taxable Business Profits Note :

50,000 5,00,000 1,50,000 1,00,000 8,00,000 7,30,000

Sale of machinery block: Sale of machinery block results into short-term capital loss of ` 1,50,000 (` 6,50,000 ` 1,00,000) under Sec. 50.

DIRECT TAXATION I 6.85

Profits and Gains of Business or Profession No capital loss, whether short-term or long term, can be set- off against any income. It is to be carried forward for next 8 assessment years. Illustration 27 : The firm of M/s Amal & Associates is engaged in the business of growing and manufacturing tea. The Profit & Loss Account for the year 2012-2013 is given as follows: Dr.
Particulars Cost of growing and manufacturing tea Salaries and wages Advertising Entertainment expenses Travelling expenses Fine and penalties Cost of patent rights Expenses on scientific research General and sundry expenses Net profit

Cr. ` Particulars
40,00,000 Sales 15,00,000 Stock 5,00,000 1,00,000 3,00,000 50,000 6,00,000 6,00,000 2,00,000 30,00,000 1,08,50,000 1,08,50,000

`
95,00,000 13,50,000

You are further informed : (i) Advertising includes payment of ` 2,00,000 made to a political party for insertion of advertisement in partys journal. The payment has been made by bearer cheque, (ii) Travelling expenses include a visit of the director to UK for 10 days (including 2 days for travelling). Five days were utilized for business purpose. Permission for foreign exchange was granted for ` 50,000. Total expenditure on the visit is ` 1,00,000 (including air fare of ` 40,000). (iii) Expenses on scientific research include: (a) Purchase of land ` 1,50,000 (b) Contribution to Agricultural Research Institute, New Delhi which is a National Laboratory ` 20,000. (c) Contribution to Bhaba Atomic Research Centre (an approved research association)for statistical research, which is not related to business ` 30,000. (iv) Refund of custom duty, deducted in the previous year, 2010-2011, amounting to ` 50,000, has not been credited to the Profit and Loss Account. (v) Sundry expenses include a contribution of ` 60,000 to Kolkata Municipal Corporation for undertaking a Drinking Water Project for slum-dwellers. The Project has been approved by National Committee but KMC has not issued any certificate indicating the progress of the project. (vi) A deposit of ` 12,00,000 was made in instalments with National Bank for Agriculture and Rural Development (a) ` 4,00,000 in September 2012, (b) ` 6,00,000 in July 2013 and (c) ` 2,00,000 in December 2013. It has not been included in the Profit and Loss account. Date of submitting return of income 30/09/2013. (vii) (a) W.D.V. of machinery on 01-04-2012 (Rate of depreciation 15%) ` 15,00,000 (b) Machinery purchased in December 2012 for scientific research ` 4,00,000 (c) Purchase of five small drier machine, each costing ` 10,000 (d) Sale price of an old machinery (Rate of depreciation 15%) ` 5,00,000 (viii) Lump sum payment of ` 5,00,000 was made to acquire a licence regarding technical information to improve tea-flavour. It has not been charged to P & L A/c.

6.86 I DIRECT TAXATION

Solution : Computation of Business Profits for the Assessment Year 2013-2014

Particulars Net Profit Add: Inadmissible Expenses: 1. Advertisement payment to a political party [Sec. 37(2B)] 2. Travelling outside India [Sec. 37(1)]. Proportionate expenses of foreign travel, (excluding air fare) not relating to business: 60,000 3/8 3. 4. 5. 6. Fine and penalties Cost of patent rights Expenditure on scientific research (Sec. 35): Purchase of land Contribution to Kolkata Municipal Committee (Sec. 35 AC): Since the Certificate indicating progress in the prescribed form has not been issued, no deduction is allowed.

30,00,000

2,00,000 22,500 50,000 6,00,000 1,50,000 60,000

10,82,500 40,82,500 50,000

Add: Deemed profit: Refund of Customs Duty, deducted in earlier years, not credited in the Profit and Loss A/c [Sec.41(1)] Less: Admissible expenses: Capital expenditure on scientific research [Sec.35(1)(iv)(2)] Depreciation on Patent rights @ 25% of ` 6,00,000 Depreciation on know-how: @ 25% of ` 5,00,000 Depreciation on Machinery: WDV as on 01/04/2012: 15,00,000 Add: Purchase of driers 50,000 15,50,000 Less: Sale of Old Machinery 5,00,000 WDV as on 31/3/2013 10,50,000 Depreciation @ 15% on ` 10,50,000 Weighted Deduction for scientific research: (i) National Laboratory: @ 200% of `20,000 = ` 40,000 ` 20,000 = `20,000 (ii) Bhaba Atomic Research Laboratory: @ 175% of ` 30,000 =

41,32,500
4,00,000 1,50,000 1,25,000

1,57,500

`52,500 ` 30,000 = ` 22,500

Therefore, total deduction `(20,000 + 22,500) Composite Profits before making deduction u/s 33AB Less: Deposit with NABARD (Sec.33AB) Least of the followings: (i) Deposit of `10,00,000 (within the due date of submission of return) (ii) 40% of Business Profits: 40% of ` 32,57,500 Composite Profits after deduction u/s 33AB Apportionment of profits into agricultural income and business income (As per Rule 8)[since the assessee is engaged in the business of growing and manufacturing tea] Taxable Business Income [40% of ` 22,57,500]

42,500

8,75,000 32,57,500

10,00,000 13,03,000 10,00,000 22,57,500

9,03,000

DIRECT TAXATION I 6.87

Profits and Gains of Business or Profession Compute the taxable business profits for the Assessment Year 2013-2014. Illustration 28 : State whether the provisions of Sec. 41(1) of the Act can be applied to a case, where refund of excise duty has been obtained by the assessee on the basis of a decision of the CEGAT and where the matter has been taken up in further appeal to the Court by the Central Excise Department. Solution : This question has been answered by the Apex Court in Polyflex (India) Pvt. Ltd. v. CIT [2003] 257 ITR 343. (SC) The refund of excise duty pursuant to the decision of the CEGAT would be subject to tax by virtue of Sec. 41(1) and it is not necessary that the revenue should await the verdict of a higher court. Illustration 29 : In the course of an assessment proceeding, the Assessing Officer enhanced the value of the closing stock and added the difference to the total income. In the assessment year subsequent to this, the assessee wants the Assessing Officer to enhance, by the same amount, the value of the opening stock of the year. Discuss the validity of the claim. Solution : The value of the closing stock of the preceding year must be the value of the opening stock of the succeeding year. Hence, if the value of closing stock at the end of a year is enhanced, the enhanced value should be taken as the value of the opening stock of the next year for the purpose of income tax. The claim of the assessee in this case is, therefore, valid. Illustration 30 : What would be your advice regarding admissibility of the following items of expenditure in computing the business income: (a) A donation of ` 1 lakh made to a University for starting a laboratory for scientific research (i) relating to the assessees business, (ii) not relating to the assessees business. (b) Travelling expenses include a sum of ` 15,000 incurred by a director in travelling abroad for negotiating purchase of plant and purchase of plant and machinery. (c) (d) (f) (g) (h) Amount payable as damages to Government on account of shortfall in export target. Overdraft from bank for payment of income tax: interest charged by the bank is ` 20,000. ` 12,000 paid for shifting of business from the original site to the present place which is more advantageously located. Retrenchment compensation of ` 4 lakh paid to the workmen on the closure of one of the units. Fees paid to the Registrar of Companies for bringing about a change in the Memorandum and Articles of Association in regard to issue of Equity.

(e) Payment of interest of ` 40,000 on monies borrowed from bank for payment of dividends to shareholders.

Answers : (a) The donation has been made to University to be used for scientific research for starting a laboratory. If the University is approved for the purpose of Sec. 35(1)(ii), then irrespective of the consideration whether the scientific research is related to assessees business or not, deduction could be claimed @ 175% of amount paid. If it is not approved, donation could not be claimed as a deduction under Sec. 35 in the computation of business income. However, the assessee could claim deduction from Gross Total Income under Sec. 80G, if the same is eligible. (b) Travelling expenses incurred by the director for negotiating the purchase of plant and machinery is a capital expenditure and hence to be disallowed. (c) The payment is not for any infraction of law but for failure to reach a target undertaken by the company being payment made wholly in the course of business, it is deductible.

6.88 I DIRECT TAXATION

(d) (e) (f) (g)

Interest on overdraft taken to pay income tax is not allowable under Sec. 36(1)(iii). Interest on borrowings utilized for payment of dividend is allowable under Sec. 36(1)(iii). Shifting expenses of business premises resulting in an expenditure of enduring benefit is a capital expenditure and is not allowable. Retrenchment compensation payable to workmen on the total closure of a business cannot be allowed as deduction as the expenses are not incurred for the purpose of carrying on of its business. When, however, the tax-payer closes one of its units and continues to carry on the same business as before, the compensation will be admissible under Sec. 37(1). Fee paid to Registrar of Companies for bringing about change in Memorandum and Articles of Association is a capital expenditure, where it relates to issue of equity shares. Where alterations are warranted by the changes made in the Companies Act, the expenses are allowable.

(h)

Illustration 31 : A company engaged in the manufacturing of fertilizer products, commenced its business on 01.04.2012. During the financial years 2009-2010 to 2011-2012 it had incurred ` 4.00 lakh annually as expenditure on salaries and purchase of raw material for the purpose of research connected with its business. During the previous year 2012-2013 incurred on scientific research, revenue expenditure of ` 3.00 lakh and a capital expenditure of ` 4.50 lakh on purchase of plant and machinery. Since the result of the research was unsuccessful, the company sold it its plant and machinery on 31.12.2012 for ` 8.00 lakh and closed its research activity. Compute the admissible deduction under Sec. 35 for the assessment year 2013-2014. Solution : Computation of deduction u/s 35 for Expenditure on scientific research
Particulars Expenditure incurred during the earlier 3 years on salaries and purchase of raw material for the purpose of research connected with the business fully allowed in the year of commencement of business by virtue of Explanation to Sec. 35(1)(i) : [` 4,00,000 3] Revenue expenditure on scientific research incurred during the previous year 2012-2013 Capital expenditure on scientific research incurred during the previous year 2012-2013 Total Weighted deduction 200% on ` 7.50 lakh u/s 35(2AB) Admissible deduction u/s 35 for the A.Y. 2013-2014 3,00,000 4,50,000 7,50,000 15,00,000 27,00,000

12,00,000

Illustration 32 : A company engaged in pharmaceuticals manufacturing, debited to its Profit and Loss Account a sum of ` 50,000, being the interest on loan of ` 5,00,000 taken for financing its expansion scheme. The plant and machinery purchased for the project with the loan were not received during the year and those were still in transit at the end of the year. A sum of ` 4,000 was paid to a broker who arranged the loan. Discuss the admissibility of the interest. Answer : Interest paid in respect of capital borrowed for the purposes of business or profession is admissible u/s 36(1)(iii). As per the Proviso to Sec. 36(1)(iii) inserted by the Finance Act, 2005, from Assessment Year 2006-2007, interest paid in respect of capital borrowed for acquiring an asset for extension of existing business or profession (whether capitalised in the books of account or not) for any period beginning from the date on which the capital is borrowed for acquisition of the asset till the date on which such asset is first put to use cannot be allowed as deduction. In this case, the asset has not been put to use till the end of the Previous Year. Therefore, interest of ` 50,000 is not be allowed as deduction. However, the cost of

DIRECT TAXATION I 6.89

Profits and Gains of Business or Profession the asset is to be increased by the amount of interest and depreciation is admissible on enhanced cost [Proviso to Sec. 36(1)(iii)].The deduction on brokerage of ` 4,000 paid to a broker for arranging the loan there is a bit controversial One view is that definition of the term interest u/s 2(28A) includes service fee or other charges in respect of monies borrowed, brokerage can be considered to fall under the scope of the term other charges and is therefore included under the definition of interest. Hence, brokerage of ` 4,000 for arranging the loan should be treated in the same way as interest. As per the other view, where brokerage or commission paid to an agent for arranging a loan for the purpose of business is not allowable as deduction u/s 36(1) (iii), but is allowable under Sec. 37(1). As per this view, ` 4,000 paid to a broker for arranging a loan is allowable as a deduction under Sec.37(1). Illustration 33 : Apporva Shantilal filed his return of income for the Assessment Year 2012-13 on 29-1-2013 showing a loss of ` 11,42,000. The same represented unabsorbed depreciation of foundary business of ` 9,00,000 and the balance loss in foundry business. During the previous year relevant to the assessment year 2013-14, two businesses are carried on by him a steel rolling mill at Kanpur and a fertilser manufacturing company at Cuttack. The foundry business was not carried on (discontinued). Separate books of account are being maintained for the two business carried on at different places. The following information is made available to you : Relating to steel rolling mill at Kanpur Particulars (a) Business Income prior to depreciation and following adjustments (b) Opening WDV of factory building This building, constructued 5 years back, was sold for (c) Machinery (entitled to depreciation @ 15%) Opening WDV All machines sold in March 2013 for (d) Car Opening WDV Relating to fertiliser unit at Cuttack Particulars (a) Factory building (purchased in March, 2008) Opening WDV (b) New Machinery (Rate of depreciation 15%) purchased in June, 2012 (c) Jeep Opening WDV (d) Furniture Opening WDV (e) Business income prior to above adjustments Compute the total income of Mr. Apoorva Shantilal for the A.Y. 2013-14 Solution : Computation of total income in the case of Mr. Apoorva Shantilal for the A.Y. 2013-14 : ` 2,80,000 50,00,000 1,80,000 80,000 7,16,000 ` 5,60,000 6,20,000 10,28,000 3,20,000 5,10,000 1,20,000

6.90 I DIRECT TAXATION

Particulars Profits and Gains of business Profits prior to depreciation of steel rolling mill Profits prior to depreciation of fertilizer unit

` 5,60,000 7,16,000 12,76,000 7,74,500 5,01,500 5,01,500 1,28,000 1,28,000

Depreciation for the year (Note - 1) Less : Set-off of Brought Forward Unabsorbed Depreciation u/s 31(2) related Capital Gains Short-term Capital Gain on Sale of Building (Note-1) Less : Set-off of Brought forward Unabsorbed Depreciation for the A.Y. 201213 restricted to the amount of profits Gross Total Income () Deduction under Chapter-VIA Total Income Working Note : 1. Computation of Depreciation and Short Term Capital Gaions
Block-I Factory Particulars Rate of Depreciation Opening WDV Kanpur Cuttack Total opening WDV Add : Additions during the year 6,20,000 2,80,000 9,00,000 Nil 9,00,000 Sales during the year Less : Short term Capital Gains Net Book Value Depreciation for the year Less : Closing WDV Total Depreciation 8,000 + 7,21,500 + 45,000 = 7,74,500 10,28,000 1,28,000 Nil Nil Nil Nil 80,000 80,000 Nil 80,000 Nil N/A 80,000 8,000 72,000 Building 10% Block-II Furniture & Fixture 10%

Nil

Nil Nil Nil Nil

Block-III Plant & Machinery 15% 3,20,000 Nil 3,20,000 50,00,000 53,20,000 5,10,000 N/A 48,10,000 7,21,500 40,88,500

Block-IV Moter Vehicles 15% 1,20,000 1,80,000 3,00,000 Nil 3,00,000 Nil N/A 3,00,000 45,000 2,55,000

2. Unabsorbed Depreciation to be carried forward from Assessment Year 2013-14 ` 2,70,500 (after Set-off of ` 6,29,500 against income during the year) relating to Assessment Year 2012-13. 3. Unabsorbed Business loss of ` 2,42,000 ( = ` 11,42,000 9,00,000) of A.Y : 2012-13 cannot be brought forward for setting off as the return of income for that Assessment Year was filed after due date of furnishing return u/s 139(1).

DIRECT TAXATION I 6.91

Profits and Gains of Business or Profession Illustration 34 : A firm comprising of four partners A, B, C and D carrying on business in partnership, sharing profits/losses equally shows a profit of ` 2,00,000 in its books after deduction of the following amounts for the year :
Particulars (a) Remuneration to partner A who is not actively engaged in business (b) Remuneration to partners B & C actively engaged in business Partner B Partner C (c) Interest to partner D on loan of ` 1,50,000 80,000 90,000 36,000

`
60,000

The deed of partnership provides for the payment of above remuneration and interest to partners. You are required to work out the taxable income of the firm as well as partners for assessment year 2013-14. Solution : Computation of Income under the head Profits and Gains of Business or Profession
Particulars Net profit as per P/L A/c Add : Inadmissible expenses (i) Remuneration to A (not an active partner) disallowed u/s 40(b) (ii) (iii) Remuneration to B and C (considered separately [ ` 80,000 + ` 90,000]) Interest paid to D on Loan advanced

`
2,00,000 60,000 1,70,000 36,000 4,66,000 18,000 4,48,000

Net Profit before Interest and Remuneration to Partners Less : Maximum Permissible Interest u/s 40(b) @ 12% on Loan from D = ` 1,50,000 12% p.a. Book Profit Less : Maximum Permissible Remuneration to B and C u/s 40(b) (i) upto ` 3,00,000 `1,50,000 or 90% of Book = 2,70,000 88,800 3,58,800 (ii) Actual Remuneration paid 1,70,000 Profits, whichever is higher

Balance of Book Profits 60% of Book Profits = 60% of 1,48,000 =

1,70,000 2,78,000

lower of (i) & (ii), allowed as deduction Taxable Income

Taxable income of the partners A.Y.2013 - 14 Particulars Remuneration Interest Taxable Income A Nil Nil Nil
B

C 90,000 Nil 90,000

80,000 Nil 80,000

Nil 18,000
18,000

6.92 I DIRECT TAXATION

Working notes : (1) In the case of a firm, remuneration to a partner who is not a working partner is not eligible for deduction. In the case of working partners the remuneration paid is disallowed if it exceeds the limit prescribed u/s 40(b) with reference to book profit. Working partners remuneration is worked out as under : ` First ` 3,00,000 of the book profit @ 90% On the balance ` 1,58,000 of book profit @ 60% Total 2,70,000 88,800
3,58,800

(2) Any interest and salary to partners disallowed in the firms case shall not be included in the total income of the partner and shall not be chargeable to tax in the partners hands. (3) Share of profits of the partners is exempt u/s 10(2A) of the Income-tax Act and therefore, not included in the partners taxable income. Illustration 35 : X Ltd., carrying on business in manufacture and sale of textiles, showed a net profit of ` 10,50,000 in its Profit and Loss Account for the period ending March 31, 2013. On the basis of the following particulars noted from the companys accounts and ascertained on enquiry, compute, giving reasons, the total income of the company for the assessment year 2013-14. The company maintains books of account on the basis of mercantile system. 1. The General Reserve account shows a credit of ` 2,75,000 under the head Surplus on devaluation. The enquiries show that the company had exported textile to U.S.A. during the year 1995-96. The sale proceeds were placed in a separate bank account in U.S.A. which were utilized for import of cotton from time to time. After obtaining permission from the Reserve Bank of India, in January 2013 the company remitted to India a sum of ` 2 lakh, being the balance standing to its credit in the said bank account which included the above surplus realized on account of devaluation of the rupee in June 1996. The company claims that the said surplus is not taxable, firstly, on the ground that the said surplus did not relate to the previous year and secondly, the said surplus is not a trading receipt. The company had imported automatic looms under a special permission granted by the Textile Commissioner under the Cotton Textile (Control) Order, 1948. One of the conditions laid down while granting the permission was that the company should execute a bond in favour of President of India agreeing to export an agreed quantify of cloth and in default pay a sum calculated at the rate of 10 paise per metre to cover the shortfall. The company fell short of the target during the previous year as a result of which it was required to pay a sum of ` 40,000 towards the shortfall. The company has debited the said amount to General Expenses Account. The company has set up a laboratory for conducting research in textile technology. It has incurred a capital expenditure of ` 1,00,000 for the said purpose. The amount is shown in the balance sheet us Laborotory Equipment Account but is claimed as deduction in the return of income for the Assessment Year 2013-14. The interest account includes payments amounting to ` 50,000 on deposits made by non-resident buyers of textile manufactured by the company. The said payments were made outside India without deduction of tax. The legal charge includes a sum of ` 60,000 paid to solicitors for framing a scheme of amalgamation of allother textile mill with the assessee-company. The scheme is approved by the Central Government in public interest.

2.

3.

4.

5.

DIRECT TAXATION I 6.93

Profits and Gains of Business or Profession 6. Travelling expenses include a sum of ` 1,25,000 being expenditure incurred by the directors of the campany in connection with their tour to USA and UK for the purchase of new machinery for setting up a new plant for manufacture of caustic soda. ` 1,00,000 (debited to Profit and Loss Account) is paid to an approved Notional Laboratory with a specific direction that it shall be used for on approved scientific research programme.

7.

Solution : Computation of Income from Business A. Y : 2013-14

` Net profit as per Profit and Loss Account Adiustments : Surplus arose on conversion of foreign currency into Indian currency (since foreign currency was kept for purchasing stock-in-trade, it will be revenue receipt) Payment of ` 40,000 towards the shortfall in export (allowable as deduction since the payment is not penalty) Capital expenditure on scientific research Interest to non-residents [not deductible under section 40(a) since payment was made without deducting tax at source] Legal charges for framing amalgamation scheme [deductible u/s 35DD in five years) Travelling expenses of directors [section 37(1) does not permit a deduction of capital expenditure] Weighted deduction under section 35(2AA) in respect of ` 1,00,000 paid to a National Laboratory [amount deductible is 200% of ` 1,00,000, () Amount Show in P/L A/c Expenses not debited ealier Net Income 2,00,000 1,00,000 1,00,000 () 1,00,000 13,48,000 (+) 2,75,000 () 1,00,000 (+) 50,000 (+) 48,000 (+) 1,25,000 10,50,000

Illustration 36 : D Ltd., carrying on business in manufacture, sale and export of tyres, tubes and accessories, has disclosed a net profit of ` 21,00,000 in its P & L Account for the period ending March 31, 2013. On the basis of the following particulars furnished by the company and ascertained on inquiry, compute, giving reasons, its total income for the assessment year 2013-14. The company follows the mercantile system of accounting : (a) A sum of ` 20,000 is debited to compensation account. The company had placed an order for machinery to manufacture tyres with a UK company. However, due to a sudden increase in the price of machinery by the vendor, the assessee, had to cancel the contract, in liew of compensation The company claims the said amount as deduction on revenue account or, in the alternate, as loss under the head Capital Gains as the payment was mode towards extinguishment of right to acquire a capital asset.

(b) Loss on Export of Accessories Account shows a debit of ` 4 lakh. In this connection it is explained that two trucks belonging to the company carrying tyres accessories were intercepted at the international border and seized by customs authorities for illegal export. The goods were confiscated by the customs authorities and a fine of ` 2 lakh was levied. The company claims the value of confiscated goods as a trading loss under section 28 and the payment of the fine of ` 2 lakh which is debited to rates and taxes account as an expenditure in the course of business under section 37(1). (c) The company had set up a separate unit for manufacture of plastic tubes at Bangolore in 1996. The said unit suffered heavy losses. As a result the same was closed down and the plant and machinery were

6.94 I DIRECT TAXATION

sold away. The company, however, claims unabsorbed depreciation amounting to ` 8 lakh in its return of income. It is not debited to the Profit and Loss Account.
(d) During the previous year 1996-97, the assessee-company acquired 5,000 shares of E Ltd., on Indian

company, as a result, the entire share capital of the said company is now held by the assessee-company. In May 2012, the assessee-company sold to E Ltd. plant and machinery for ` 6,00,000. The actual cost is ascertained at ` 4,00,000 and written down value at ` 1,50,000. In the years 2001-2002 and 2002-03, the Government of India arranged exports of tyres and tubes through the Federation of Tyre Dealers of which the company was a member. The exports which were made to For Eastern countries resulted in loss which was shared by all members including the company. The Federation thereafter took up the questions of reimbursement of losses with the Government, which after protracted discussion and correspondence agreed to grant a subsidy calculated at a certain percentage of exports. The assessee-company received its share of subsidy amounting to ` 3 lakh in the previous year. The amount stands credited to the Capital Reserve Account and claimed as exempt.

(e)

(f) ` 28,00,000 was paid on voluntary retirement scheme. The company claims the full amount as deduction. Solution : Computation of Total Income for A.Y. 2013-14 `
Net profit as per Profit and Loss Account Adjustments : (i) Payment of compensation [not allowable since payment is in the nature of capital expenditure, being made to avoid unnecessary investment in capital asset ; nor can it be allowed as capital loss as there is no transfer of capital asset] (ii) Loss arising out of confiscation of stock by customs authorities [allowable as ] (iii) Fine [not allowable as penalty paid for breach of law is not normal incidence of business (iv) Unabsorbed depreciation of a unit closed before the commencement of previous year [allowable as deduction] (v) Recovery of loss [taxable under section 41 (1)] (vi) Compensation paid on voluntary retirement of employees [under section 35DDA, one-fifth of such compensation is deductible in the year in which the expenditure is incured and the balance is deductible in the next four years; section 35DDA is applicable even if the voluntary retirement scheme has not been framed in accordance with the guidelines given under section 10(10C); [28,00,000 - 28,00,000 / 5] 21,00,000

(+) 20,000 (+) 2,00,000 () 8,00,000 (+) 3,00,000

(+) 22,40,000

Business Profit Capital gain on sale of machinery to wholly owned subsidiary company [since transferee-company is wholly owned Indian subsidiary company of the assessee, the transaction is not treated as transfer under section 47(iv) and surplus arising on transfer is not taxable as capital gain]

40,60,000

Net Income Note :

40,60,000

Loss arising out of confiscation of stock by customs authority allowable as deduction [Dr. T. A. Quereshi vs. CIT (2006) 157 Taxman 519 (SC)]

DIRECT TAXATION I 6.95

Profits and Gains of Business or Profession Illustration 37 : Bharat, owner of Great India Roadways, furnishes following details for the A.Y. 2013-14. Revenue from customers Less : Expenses Rent of office premises Rent of godown Truck Driver salary Allowance to truck driver Cost of petrol, diesel, etc Other expenses other than depreciation Income from business without charging depreciation

31,00,000 1,80,000 2,40,000 5,00,000 1,20,000 7,50,000 2,00,000 11,10,000

Additional Information : Great India Roadways have following details of its assets Assets Written down value as on 1.4.2012 Office Premises ` 2,50,000 Machinery block (30%) consists of ` 20,00,000 2 Diesel engine trucks of 13000 kgs each 2 Diesel engine trucks of 10000 kgs each 1 Petrol engine truck of 12000 kgs During the year, he purchased 2 medium-size-truck (petrol engine) for ` 3,50,000 each on 13.7.2012. However, one petrol engine truck of 12,000 kgs was sold on 9.9.2012 for ` 1,00,000. Compute his income under the head Profits & Gains of Business or Profession. Solution : Computation of Profits & gains of business or profession of Shri Bharat for the A.Y. 2013-14 Particulars Net profit as per Profit and Loss A/c Less : Expenditure allowed but not debited to P & L A/c Depreciation u/s 32 (Note) Profits & gains of business or profession Note : Computation of depreciation allowed u/s 32 8,05,000 3,05,000
Amount (`)

11,10,000

6.96 I DIRECT TAXATION

Particulars Block 1 : Office Premises @ 10% W.D.V. as on 1.4.2012 Add : Purchase during the year

Details

Amount (`)

Less : Sale during the year

2,50,000 Nil 2,50,000 Nil 2,50,000

Depreciation @ 10% on ` 2,50,000 Block 2 : Trucks @ 30% W.D.V. as on 1.4.2012 Add : Purchase during the year Less : Sale during the year Depreciation @ 30% on ` 26,00,000 Depreciation allowed u/s 32

20,00,000 7,00,000 27,00,000 1,00,000 26,00,00

25,000

7,80,000 8,05,000

Alternative II : Computation of income u/s 44AE

No. of vehicle 2 Diesel engine trucks of 13000 kgs each 2 Diesel engine trucks of 10000 kgs each 1 Petrol engine truck of 12000 kg 2 medium size truck Profit and Gains of Business or Profession Type of goods carriage Heavy Other vehicle Other vehicle Other vehicle Month including part of month 12 12 6 9 Details 3500122 3150122 315061 315092 Income

84,000 75,600 18,900 56,700 2,35,200

Income of the assessee under the head Profits & Gains of Business or Profession shall be ` 2,35,200 u/s 44AE. Illustration 38 : During the previous year 2012-13, Profit and Loss Account of Shri Amarnath, proprietor of Free Bird Enterprises engaged in the business of readymade garments, shows profits of ` 4,50,000. With the following information, compute his taxable income from business (a) Interest on capital ` 5,000 (b) Purchases include goods of ` 42,000 from his younger brother in cash. However, market value of such goods is ` 35,000. (c) Interest paid outside India ` 1,00,000 without deducting tax at source. (d) Penalty paid to local government for non-filing of sales tax return ` 5,000 (e) Penalty paid to customer for non-fulfilling of order within time ` 10,000

DIRECT TAXATION I 6.97

Profits and Gains of Business or Profession (f) Bad debts ` 1,00,000. Money has been advanced for purchase of Building. (g) Revenue expenditure on promoting family planning among employees ` 10,000. (h) Premium paid on health of employees ` 6,000 in cash (i) Premium paid on health of his relatives ` 6,000 in cheque (j) Employers contribution to RPF ` 12,000. One-half of the amount is paid after due date as per relevant Act but before 31.3.2013 (k) Employees contribution to RPF ` 10,000. of the amount is paid after due date as per relevant Act. (l) Interest on late payment of sales tax ` 1,000 (yet to be paid) (m) Interest on loan from State Bank of India `10,000 (` 5,000 is not paid till due date of filing of return) (n) Interest on late refund from income tax department ` 500 (o) Sale includes sale to Amarnath ` 10,000. (Cost of such goods ` 8,000; Market value of such goods ` 12,000) (p) He received ` 80,000 from a debtor at a time in cash. (q) Recovery of bad debt `10,000 (out of which ` 8,000 was allowed as deduction during AY. 2007-08) (r) Depreciation (being not debited in accounts) ` 20,000 allowed as deduction u/s 32 Solution : Computation of Profits and gains of business or profession of Shri Amarnath for the AY. 2013-14 Particulars Note Details Net profit as per Profit and Loss Account Add : Expenditure disallowed but debited in P &L A/c Interest on capital Payment to relative in excess of market value of goods Interest paid outside India without deducting tax at source Penalty paid to local government for non-filling of sales tax return Bad debt Premium paid on health of employees in cash Premium paid on health of his relatives in cheque Employees contribution to RPF Interest on loan from State Bank of India Cost of goods sold to himself

Amount (`)

4,50,000 1 2 3 4 6 8 9 11 13 14 5,000 42,000 1,00,000 5,000 1,00,000 6,000 6,000 5,000 5,000 8,000

2,82,000 7,32,000

Less : Expenditure allowed but not debited in P & L A/c Depreciation u/s 32 Less : Income not taxable but credited to P & L A/c Sales to himself (goods withdrawn for personal purpose) Recovery of bad debts Less : Income taxable under other head but credited to P & L A/c Interest on late refund from income tax department Profits and gains of business or profession

20,000 10,000 2,000 500 16 32,500 6,99,500

14 15

6.98 I DIRECT TAXATION

Notes : (1) Interest on capital to proprietor is not allowed as no one can earn from a transaction with himself. The provider of loan and receiver of loan are same hence does not involves any actual expenses. (2) Any unreasonable payment to relative is disallowed u/s 40A(2). Hence, `7,000 is disallowed. Cash payment towards allowed expenditure (i.e. `35,000) exceed ` 20,000, hence provision of sec. 40A(3) is also applicable. (3) Any interest paid outside India without deducting tax at source is disallowed u/s 40(a). Assume the payment is made to a non-resident. (4) Any payment made for infringement of law is disallowed. (5) Payment made for non-fulfilling of contract is not a payment for infringement of law Hence, allowed u/s 37(1). (6) Bad debt is allowed only when such debt has been taken into account as income of previous year or any earlier previous year(s) [Sec. 36(1)(vii)]. Since, the debt is in respect of purchase of a building, which was not considered as income of any previous year, hence it is disallowed. (7) Any expenditure for promoting family planning is allowed to company assessee [Sec. 36(1)(ix)]. However, such expenditure (revenue in nature) incurred by assessee other than company shall be allowed u/s 37(1). (8) Payment of insurance premium on health of employees in cheque is allowed u/s 36(1)(ib). (9) Payment of insurance premium on health of relative is not related to business, hence disallowed. (10) Employers contribution towards RPF is allowed if payment is made before due date of filing of return irrespective of fact that such payment was made after due date prescribed in the relevant Act. (11) Any sum received from employees as their contribution towards RPF is allowed only when such sum has been credited to such fund within the due date prescribed in the relevant Act [Sec. 36(1)(va)]. (12) Interest on late payment of sales tax is not a penalty but compensatory in nature. Hence, it is allowed u/s 37(1) Further such interest is not governed by the provisions of sec. 43B. (13) Any interest payable to any scheduled bank is allowed on cash basis [Sec. 43B]. Hence, unpaid amount is disallowed. (14) Any expenditure of personal nature is not allowed. Further, no one can earn from a transaction with himself. Hence, sale made to himself is not treated as income. (15) Bad debt recovery is treated as income in the year of recovery to the extent of bad debt allowed in the earlier year [Sec. 41(4)] (16) Interest on late refund of income tax is taxable under the head Income from other sources. (17) Receipt from debtor ` 80,000 in cash is not attracted by provision of sec. 40A(3). Illustration 39 : Discuss the admissibility or otherwise of the following claims in connection with assessment to income-tax. They do not necessarily relate to the same assessee: (i) An expenditure of ` 1,00,000 was incurred on the occasion of the silver jubilee of the company for presentation of silver mementos to shareholders and directors, the value of each memento being ` 1,000 only. (ii) An assessee carries on business in respect of which it holds tenancy rights. It carries out improvements to the said building at a cost of ` 2,00,000 and claims depreciation @ 10% thereon. The assessing officer

DIRECT TAXATION I 6.99

Profits and Gains of Business or Profession rejects the claim on the ground that the assessee is not the owner of the building. (iii) Excise duty amounting to ` 2,00,000 for the period 2012-13 was paid by the company by 30-9-2012 before furnishing the return of income for the Assessment Year 2013-14. (iv) A criminal case was filed against a company under the Essential Commodities Act, 1955. The company incurred litigation expenses amounting to ` 50,000 to defend the directors. The directors were ultimately acquitted. (v) A company was generating electricity privately for its factory. Later, at its expense, electric lines were laid from the trunk road to the factory. It paid ` 5,00,000 to the State Electricity Board as its contribution for this purpose. The ownership of the power-line was to vest with the State Electricity Board. (vi) X and Y are two shareholders of Pooja Ltd., a closely held company. X holds 55% share capital on 30-12012, X transfers his shares to A. Pooja Ltd. wants to set of brought forward loss of ` 4,00,000 (business loss ` 1,00,000; unadjusted depreciation ` 3,00,000) of the Previous Year 2011-12 against the income of the previous year 2012-13 (i.e., ` 9,00,000). Can it do so? Solution : (i) As per the decision of the Apex Court in the case of Aluminum Corporation of India Ltd. v CIT (1972) 86 ITR 11 (SC) and various other decisions, where an expenditure is incurred for commercial expediency, the same shall be allowed as deduction under section 37(1). If at the time the expenditure is incurred, commercial expediency justifies it, it will be taken to be for the purpose of the business even though not supported by any prevailing practice. Presentation of silver mementos to the directors and shareholders on the occasion of silver jubilee is to motivate both the directors and the shareholders. The expenditure has been incurred on account of commercial expediency and should qualify for deduction under section 37(1).

(ii) According to Explanation to section 32(1) where the business or profession of the assessee is carried on in a building not owned by him but in respect of which the assessee holds a lease or other right of occupancy and any capital expenditure is incurred by the assessee for the purposes of the business or profession on the construction of any structure or doing of any work, in or in relation to, and by way of renovation or extension of, or improvement to, the building, then, the provisions of section 32 shall apply as if the said structure or work is a building owned by the assessee. Hence, depreciation in this case will be allowable. (iii) As the excise duty has been paid on or before the due date of furnishing return under section 139(1) in respect of the previous year in which the liability to pay such sum was incurred, the same shall be allowed as deduction on due basis as per section 43B. (iv) Section 37(1) does not make any distinction between expenditure incurred in civil litigation and that incurred in criminal litigation. All that the court has to see is whether the legal expenses were incurred by the assessee in his character as a trader, in other words, whether the transaction in respect of which proceedings are taken arose out of and was incidental to assessees business. Further, it is to be seen whether the expenditure was bona fide incurred wholly and exclusively for the purpose of the business. [CIT vs. Birla Cotton Spg. & Wvg. Mills Ltd. (1971) 82 ITR 166 (SC)]. In view of this, the litigation expenses of ` 50,000 incurred in detending directors is deductible under section 37(1). (v) The new electric power lines were laid to run the factory efficiently but since the ownership of the power lines was to vest with the State Electricity Board, the contribution of ` 5,00,000 paid to the State Electricity Board shall be allowable as revenue expenditure under section 37(1). (vi) According to section 79 the losses of a closely held company can be carried forward and set off in the subsequent assessment year only when at least 51% of the shares of the company carrying voting rights are held by the same persons as on the last day of the Previous Year in which the loss was incurred and the last day of the previous year in which the losses are set off. In this case business loss will not be allowed to be set off but unabsorbed depreciation is not a loss and shall be allowed to be set off.

6.100 I DIRECT TAXATION

Illustration 40 : Discuss the correctness or otherwise of the following propositions with reasons therefore : (a) Where a person draws from his own stock-in-trade for personal use, there can be no taxable profit. (b) Even an outlay for acquiring an enduring advantage for business may be deductible as revenue expenditure. Solution : (a) The Supreme Court in CIT vs. Kikabhai Premchand (1953) 24 ITR 506 held that when a person draws from his own stock-in-trade for personal use, there can be no taxable profit as in this case the vendor and the vendee are not different. To constitute a sale these should be one buyer and seller. The buyer and seller has to be different entity to constitute a proper sale. (b) Normally, an amount spent for acquiring an enduring advantage for business is of capital nature but there can be certain cases when the amount spent on acquiring an enduring advantage may be treated as revenue expenditure. The Supreme Court in CIT vs. Empire Jute Co. Ltd. (1980) 124 ITR 1 held that when a jute mill as a result of an arrangement with other Jute mil had undertaken to work only for specified hours during a week but exceeded the same and paid for such excess period to other members of the pooling arrangement, such payment is known as purchasing loom hours. Though looms are capital assets, the payment was for their operations. By the purchase of loom hours no new asset was created and there was no addition to or expansion of the profit-making apparatus of the company. Hence, such payment is of revenue nature. Illustration 41 : A Public Limited Company engaged in the generation and distribution of power had its business acquired by the Government in June 2010. Certain items of plant and machinery used by the Company in its business were taken over by the Government at a price which resulted in the Company realizing a surplus of ` 26,60,000 over its written down value. The compensation was received by the Company in April 2012 which was accepted by it under protest. The Company proceeded to initiate arbitration proceedings under law and was granted an additional compensation of ` 16 Lakhs. This was decided by the arbitrators in December 2012 and received by the Company in March 2013. The Company claims that the assessment of the Company to tax should not be made since the business was completely taken over by the Government in June 2010 and at the time of final determination of compensation in March 2013, the Company did not exist. Do you agree to the Companys claim? Discuss with reference to the Assessment Year(s) to which the claim to tax, if any, can be related. Solution : 1. In case of acquisition of property under any law, the balancing charge u/s 41(2) is taxable as income of the previous year in which it becomes due and not in the year in which it was settled. [United Provinces Electric Supply Co. 110 Taxman 134 (SC)] As per Explanation to Section 41(2), even when the business is not in existence, such balancing charge shall be taxable in its hands as if it is in existence in the relevant previous year. (a) Surplus of ` 26,60,000 taxable in A.Y. 2011-12 as Balancing Charge under the Business Income. (b) Additional Compensation of `16,00,000 determined in December 2011 taxable as Balancing Charge in AY 2013-2014 under Business Income.

2.

3. Conclusion :

DIRECT TAXATION I 6.101

Profits and Gains of Business or Profession Illustration 42: Mr. Tony has estates in Rubber, Tea and Coffee. He derives income from them. He has also a nursery wherein he grows plants and sells. For the previous year ending 31.3.2013, he furnishes the following particulars of his sources of income from estates and sale of Plants. You are requested to compute the taxable income for the Assessment year 2013-2014. (a) (b) (c) (d) Manufacture of Rubber Manufacture of Coffee grown and cured Manufacture of Tea Sale of Plants from Nursery ` 5,00,000 ` 3,50,000 ` 7,00,000 ` 1,00,000

Assessee : Mr. Tony Previous Year : 2012-13 Assessment Year : 20132014 From the words Mr. Tony has estates, it is presumed that he had grown Tea, Coffee and Rubber, and also Plants in his Estates, and the amount given is the Profits of the Business. Computation of Taxable Income is as under
Particulars Growing and Manufacture of Rubber [Rule 7A] Grown and Cured Coffee [Rule 7B] Growing and Manufactured of Tea [Rule 8] Growing & Sale of Plant by Nursery [See Note] Total Taxable Income ` 11,07,500 Exempt u/s 10(1) ` 5,42,500 ` 5,42,500 7,00,000 60% = ` 4,20,000 ` 1,00,000 7,00,000 40% = ` 2,80,000 Agricultural Income 5,00,000 65% = ` 3,25,000 3,50,000 75% = ` 2,62,500 Non-Agricultural Income 5,00,000 35% = ` 1,75,000 3,50,000 25% = ` 87,500

Illustration 43: A firm of Cost Accountants earned a net profit of ` 8,00,000. Such profit is derived after charging interest @10% pa. ` 1,00,000 and after charging remuneration of ` 7,00,000. There is unabsorbed depreciation of ` 1,00,000 and brought forward losses of ` 2,00,000. Determine the amount oif taxable income of the firm Solution Computation of taxable income of a firm of Cost Accountants Particulars Net Profit as per profit & loss account Interest paid partners is allowable expenditure Remuneration as per books of accounts (refer notes) Profits & Gains from Business & Profession Remuneration allowed to partners being minimum of the following: Maximum remuneration allowed to partners (note) ` 930000 Actual remuneration as per p & l account
` 700000 `

800000 -700000 1500000 700000

6.102 I DIRECT TAXATION

Profits & Gains from Business & Profession Less : Brought Forward Loss Less : Unabsorbed depreciation Taxable Profits & Gians from Business & Profession Working Note Computation of allowable remuneration to Partners Profits & Gains of Business & profession after interest But before remuneration Less : Unabsorbed depreciation Book Profit for the purpose of computation of remuneration Maximum Remuneration allowed to partners (300000 x 90% + 1100000 x 60%)
` 1,00,000 ` 14,00,000 ` 9,30,000

800000 200000 100000 500000

` 15,00,000

DIRECT TAXATION I 6.103

Study Note - 7
CAPITAL GAINS
This Study Note includes 7.1 Charging Section 7.2 Provision for computation of capital gains and related exemptions 7.1 CHARGING SECTION: 45(1) Any profits or gains arising from transfer of any capital asset shall be chargeable to Income-tax as Capital Gains and shall be deemed to be the income of the previous year in which the transfer took place. 7.2 PROVISION FOR COMPUTATION OF CAPITAL GAINS AND RELATED EXEMPTIONS 1. Capital Asset: [Section 2(14)] Includes: Property of any kind, whether or not connected with business or profession Excludes: (a) (b) (c) (d) (e) (f) Stock in Trade Personal Effects Rural Agricultural Lands in India 6 % Gold Bonds, 1977; 7% Gold Bonds 1980 & National Defence Gold Bonds, 1980. Special Bearer Bonds, 1991 Gold Deposit Bonds issued under Gold Deposlt Scheme, 1999

N.B: Items (d) and (e) instruments do not exist now; they are only for academic significance. For the above purpose: (a) Stock in Trade means: Raw material or Consumable Stores used by the assessee in his business or profession. (b) W.e.f. A.Y. 2008-09, Personal effect means Movable property including wearing apparel and furniture held for personal use by the assessee or any member of his family dependent on him but excludes: (i) Jewellery (iv) Paintings (ii) Archaeological collections (v) Sculptures or (iii) Drawings (vi) Any work of art.

Definition of Capital Asset Amended Section 2(14) With effect of Assessment Year 2013-14, the definition of Capital Asset (Property) includes any rights in or in relation to an Indian Company including rights of management or control or any other rights whatsoever. This amendment has taken place with retrospective effect from 1st April 1962 2. Short-term Capital Asset (STCA) [Section 2(42A)] (a) For all Capital Assets other than financial assets: Capital Assets held by an assessee for not more than 36 months immediately preceding the date of transfer are treated as Short-term Capital Assets.

DIRECT TAXATION I 7.1

Capital Gains (b) For Financial Assets: Equity or Preference shares of a company, Unit of UTI or unit of Mutual Fund u/s 10(23D), Securities listed in a recognized stock exchange, Zero Coupon Bonds treated as STCA if they are not held for more than 12 months.

3. Long-term Capital Asset (LTCA) [Section 2(29A)] - Not a short-term capital asset. 4. Capital Gains: (a) Long-term Capital Gain [Section 2(29B)] - Capital Gain arising from transfer of Long Term Capital Asset. (b) Short-term Capital Gain [Section 2(42B)] - Capital Gain arising from transfer of Short Term Capital Asset. (a) Zero Coupon Bond means a bond (i) Issued By: (I) Any Infrastructure Capital Company, or (II) Infrastructure Capital Fund, or (III) Public Sector Company.

5. Zero Coupon Bond [Section 2(48)]

(ii) Issue Date: On or after 01.06.2006. (iii) Payment/Benefit: No payment and benefit is received or receivable before maturity or redemption from Infrastructure Capital Company / Infrastructure Capital Fund Public Sector Company, and (iv) Notified by Central Government: The Central Government may, by notification in the Official Gazette, specify in the behalf. (i) Is the difference between Maturity / Redemption Value and the Issue Price.

(b) Treatment in the hands of Issuer u/s 36(1) (iiia) : Discount on Zero Coupon Bonds. (ii) Can be written off on a pro-rata basis over the period of the bond. (i) Financial Asset: Zero Coupon Bond is a Financial Asset for the purpose of Capital Gains.

(c) Treatment in the hands of Investor: (ii) Taxability: Transfer or Maturity of Zero Coupon Bond will be taxable as Capital Gains.

Infrastructure Capital Company and Infrastructure Capital Fund for the purpose of Zero Coupon Bonds. (a) Infrastructure Capital Company [Sec.2 (26A)] : It is a Company which makes investment by way of acquiring shares or providing long-term finance to any prescribed enterprise or undertaking. (b) Infrastructure Capital Fund [Sec.2 (26B)] : It is a Fund operating under a Trust Deed established to raise monies by Trustee for investment by way of acquiring shares or providing long-term finance to any prescribed enterprise or undertaking. (c) Prescribed Undertaking/Enterprise : (i) Enterprise/Undertaking wholly engaged in the infrastructure business referred in Sec. 80-IA/80IAB, or

(ii) Housing Projects referred in Section 80-IB, or (iii) Project for constructing a Hotel (atleast of 3 Star Category) or Hospital with one hundred beds for patients.

7.2 I DIRECT TAXATION

6. Transfer u/s 2 (47) Sec 2(47) (i) (ii) (iii) (iv) (iva) (v) (vi) (vii) (viii) Nature of Transaction Sale, exchange, relinquishment Extinguishment of any rights in an asset Compulsory acquisition thereof under any law Conversion of capital asset into stock-in-trade Maturity/Redemption of a Zero Coupon Bond Part performance of a Contract u/s 53A of the Transfer of Property Act of possession of property Transactions, which have the effect of transferring/enabling the enjoyment of immovable property. Disposing of or parting with an asset or any interest therein, or Creating any interest in any asset in any manner whatsoever

Note : The last two inclusion has come into effect from Assessment Year 2013-14 Sale: As per Sec. 54 of the Transfer of Property Act, Sale is a transfer of ownership in exchange for a price paid or promised or part paid and part promised. Exchange: As per the Transfer of Property Act, 1882, when two persons mutually transfer the ownership of one thing for the ownership of another, neither thing or both things being money only, the transaction is called an exchange. Relinquishment: Relinquishment means withdrawn from, abandoning or giving up anything. Where an assessee gives up the right to claim specific performance for purchase of immovable property, it is relinquishment of a capital-asset. Extinguishment of any rights in an asset: It means total destruction, annihilation, termination or extinction of a capital asset. It refers to extinguishment of rights on account of transfer (Vania Silk Mills Ltd.) 7. Indexed Cost of Acquisition (ICA) and Indexed Cost of Improvement (ICI) [Section 48] When asset is acquired by assessee himself (a) Acquired prior to 1.4.1981 Indexed Cost Acquisition Fair Market Value on 01.04.1981 or cost of acquisition whichever is high Cost of Inflation Index for the year of transfer/100. Indexed cost of Acquisition= Cost of Acqusition x CII for year of transfer CII for year of Acqusition Indexed Cost of Improvement = Cost of Improvement x CII for year of transfer CII for year of Improvement ICI can be computed only if it is incurred after 01.04.1981. When assessee received the asset u/s 47

(b) Acquired after 1.4.1981,

(c) Asset acquired prior to 1.4.1981 by previous owner and received by the assessee prior to 1.4.1981.

DIRECT TAXATION I 7.3

Capital Gains lCA = FMV on 1.4.81 or Cost of acquisition by previous owner whichever is high x CII for year of transfer/100. ICA =
FMV on 1.4.81 or Cost of acquisition by previous owner whichever is high x CII for Year of transfer CII of year in which the asset is first held by the assessee

(d) Asset acquired prior to 1.4.81 by previous owner and received by the assessee after 1.4.81.

(e) Asset acquired after 1.4.1981 by previous owner and received by assessee after 1.4.1981. Indexed Cost of Acquisition =
Cost of acquisition to the previous owner x CII for year of transfer CII of year in which the asset is first held by the assessee

In the above cases: Indexed Cost of Improvement =

Cost of improvement x CII for year of transfer CII of year in which the asset is first held by the assessee

8. List the circumstances in which benefit of indexation is not available Nature of LTCA Transferred Assessee Not Eligible for Indexation benefit Bonds/Debentures except Capital Indexed Bonds Issued by All Assesses Govt. Shares/Debentures of Indian Company acquired by using Non Residents Convertible Forex under First Proviso to Section 48 Depreciable Assets All Assesses Slump Sale All Assesses Units Purchased in Foreign Currency u/s 115AB Off Shore Fund GDRs purchased in Foreign Currency u/s 115AC Non Residents and Resident Individual Securities u/s 115AD Foreign Institutional Investors Foreign Exchange Asset u/s 115 D Non Resident Indian 9. Cost Inflation Index as notified by the Central Government is as under: Financial Year 1981-1982 1982-1983 1983-1984 1984-1985 1985-1986 1986-1987 1987-1988 1988-1989 1989-1990 1990-1991 1991-1992 Cost Inflation Index (CII) 100 109 116 125 133 140 150 161 172 182 199 Financial Year 1992-1993 1993-1994 1994-1995 1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001 2001-2002 2002-2003 Cost inflation Index (CII) 223 244 259 281 305 331 351 389 406 426 447 Financial Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 2010-2011 2011-2012 2012-2013 Cost inflation Index (CII) 463 480 497 519 551 582 632 711 785 852

7.4 I DIRECT TAXATION

10. Exceptions to transfer u/s 46 & 47 Section 46(1) 47(i) 47(iii) Nature of transaction not considered as a Transfer Distribution of a capital asset in specie on liquidation of a company by a liquidator to its shareholders Any distribution of capital assets on the total or partial partition of a HUF. Any transfer of a capital asset under a gift or will or an irrevocable trust. Exception is also applicable in case of shares or securities received by employees from the company free of cost or at a concessional rate. However, a provision has been added to provide that this clause shall not apply to transfer under a gift or an irrevocable trust of a capital asset being shares, debentures or warrants allotted by a company directly or indirectly to its employees under ESOS or ESOP of the company offered to such employees in accordance with the guidelines issued by the Central Government in this behalf. Transfer of any capital asset by a holding company to its 100% subsidiary company which is an Indian company. When a transfer has been made by a 100% subsidiary to its Indian holding company. Both the sections 47(iv) and (v) are subject to the restrictive conditions imposed u/s 47A(1), which are as follows: (a) If within the course of 8 years from the date of transfer, holding company loses its 100% stake on the subsidiary company. (b) If the transferee company transfers this capital asset as their stock-in-trade within 8 Years. In both the above cases, the earlier exemption so granted shall be withdrawn and there would arise incidence of capital gains, in the original year of transfer, which would be initiated as per Sec.155(7B) amendment proceedings. Transfer of a capital asset in a scheme of amalgamation where the amalgamated company is an Indian company. The conditions of Sec.2(1B) of the Act, must be fulfilled: (a) All the property and liabilities of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of amalgamation. (b) Shareholders holding not less than 75% in the value of shares in amalgamating company or companies (other than shares held therein immediately before the amalgamation or by a nominee for the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of amalgamation. Amalgamation as per Income-tax includes merger and absorption, provided the conditions of Sec.2 (1B) are satisfied. Transfer of shares of an Indian company by an amalgamating foreign company to a foreign amalgamated company, provided the following conditions are satisfied: (a) The transfer of shares is under a scheme of amalgamation between two foreign companies; (b) At least 25% of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company; (c) No tax is levied on such capital gain in the country where foreign amalgamating company is incorporated.

47(iv) 47(v)

47(vi)

47(via)

DIRECT TAXATION I 7.5

Capital Gains 47(viaa) 47(vib) Transfer of capital asset by a banking company to a banking institution in a scheme of amalgamation sanctioned by the Central Government u/s 45(7) of the Banking Act 1949. Transfer of a capital asset by the demerged company to the resulting Indian company, subject to the fulfillment of the following conditions: (a) Transfer of capital asset should be from demerged company to a resulting company; (b) Resulting company should be an Indian company; 47(vic) (c) Transfer of capital asset should be made in a scheme of demerger. Transfer of shares of Indian company by a demerged foreign company in a demerger to a foreign company, shall not be treated as transfer provided the following conditions are fulfilled: (a) The shareholders holding not less than 75% in value of shares of the demerged foreign company continue to remain shareholders of the resulting foreign company; and (b) No tax is levied on capital gain in the foreign country in which the demerged company is incorporated. The provisions of Sections 391 to 394 of the Companies Act, 1956 shall not apply in case of demergers referred in this clause. Any transfer, in a business reorganization, of a capital asset by the predecessor co-operative bank to the successor co-operative bank. Any transfer by a shareholder, in business reorganization, of a capital asset being a share or shares held by him in the predecessor co-operative bank if the transfer is made in consideration of allotment to him of any share or shares in the successor co-operative bank. Transfer/allotment of shares by the resulting company to the shareholders of the demerged company in a scheme of demerger. Only shares must be exchanged against shares. Allotment of shares in amalgamated company to the shareholders of amalgamating company, will not be considered as a transfer if: (a) The transfer is made in consideration of allotment to him of any share or share in the amalgamated company. As per Finance Act, 2012 [w.e.f. A.Y. 2013-14], it shall not be necessary for the amalgamated company to issue shares to the shareholders of the amalgamating company when a subsidiary company amalgamates with a holding company; and 47(viia) 47(viii) 47(ix) (b) The amalgamated company is an Indian company. Transfer of shares/bonds or Global Depository Receipts (GDRs) referred to in Section 115AC (1), i.e., those bonds, shares or GDRs of a public company (being an Indian company) is purchased in foreign currency, outside India by a non-resident to another non-resident. Transfer of urban agricultural land in India effected before 1.3.1970 Transfer of a capital asset being a work of art, archaeological, scientific or art collection, book, manuscript, drawing, painting, photograph or print to Government or University or National Museum or National Art Gallery, National Archives or any other public museum or institution, as may be notified by the Central Government in the Official Gazette to be of national importance or to be of renown throughout any State or States. Conversion of bonds or debentures, debentures-stock or deposit certificates in any form, of a company into shares or debentures of that company

47(vica) 47(vicb)

47(vid) 47(vii)

47(x)

7.6 I DIRECT TAXATION

47(xi) 47(xii)

Transfer of membership of a recognized stock exchange in India by a person (not being a company) on or before 31st December 1998, to a company in exchange of shares allotted by that company, subject to the restrictions of Sec.47A(2) Transfer of capital asset being land of a sick industrial company made under a scheme prepared and sanctioned u/s 18 of the Sick Industrial Companies (Special Provisions) Act, 1985, where such sick industrial company is being managed by its workers cooperative. Transfer should be made during the period commencing from the Previous Year in which the said company has become a sick industrial company u/s 17(1) of the Act and ending with the Previous Year during which the entire net worth of such company become equal to or exceeds the accumulated losses. Transfer of capital assets or intangible assets in the course of demutualization or corporatisation of a recognized stock exchange in India, on succession of a firm concern by a company, provided the following conditions are fulfilled: (a) All the assets and liabilities of the erstwhile firm or AOP/BOI, relating to the business immediately before succession becomes the assets and liabilities of the company; (b) All the partners of the firm before the succession becomes the shareholders of the company in the same proportion in which their Capital Accounts stood in the books of the firm on the date of succession; (c) The partners are not in receipt of any other benefit, whether directly or indirectly, in any form or manner, other than by way of allotment of shares in the company; (d) The aggregate of the shareholding in the company of the partners of the firm is not less than 50% of the total voting power in the company; (e) Their shareholding continues for a period of 5 years from the date of the succession; (f) The demutualization or corporatisation of a recognized stock exchange in India is carried out in accordance with a scheme of corporatisation which is approved by SEBI. Transfer of a capital asset being a membership right held by a member of a recognized stock exchange in India for acquisition of shares and trading or clearing rights acquired by such member in that recognized stock exchange in accordance with a scheme of demutualization or corporatisation which is approved by SEBI. Transfer of capital asset or intangible assets where a sole proprietary concern is succeeded by a company, provided the following conditions are fulfilled: (a) All the assets and liabilities of the erstwhile sole proprietary concern, relating to the business immediately before succession becomes the assets and liabilities of the company; (b) The sole proprietor is not in receipt of any other benefit, whether directly or indirectly, in any form or manner, other than by way of allotment of shares in the company; (d) The shareholding of the sole proprietor in the company is not less than 50% of the total voting power in the company;

47(xiii)

47(xiiia)

47(xiv)

47(xv)

(e) His shareholding continues for a period of 5 years from the date of the succession; Any transfer under the Securities Lending Scheme, 1997 for lending of any securities under an agreement or arrangement between the assessee and borrower of securities as per the guidelines issued by SEBI or RBI.

DIRECT TAXATION I 7.7

Capital Gains 11. Cost of acquisition u/s 55(2) The price paid by the assessee for the acquisition of the asset. Expenses incurred for completing the title is included in the cost of the asset. Expenses incurred in acquiring the asset or acquiring better voting rights Interest on capital borrowed for acquiring capital asset (however, expenditure incurred for acquiring loan amount for acquiring capital asset is not a part of cost of acquisition) Amount paid for discharge of mortgage, where the asset was mortgaged by the previous owner. Extra amount paid by coparcener for full ownership in specific property allotted to him by HUF

12. Deemed cost of acquisition (a) Cost to the previous owner u/s 49 (1): Where the capital asset or intangible asset of a firm or a sole proprietary concern succeeded by company, the cost of acquisition of the asset shall be deemed to be cost for which the previous owner of the property acquired it, in the following cases: (i) on the distribution of assets on total or partial partition of HUF; (ii) under a gift or will; (iii) by succession, inheritance or devolution; (iv) distribution of assets on the liquidation of a company; (v) transfer to a revocable or irrevocable trust; (vi) transfer by a wholly owned Indian subsidiary company to its holding company or vice versa; (vii) transfer in the scheme of amalgamation of two Indian companies u/s 47(vi); (viii) transfer in the scheme of amalgamation between two foreign companies; (ix) transfer of capital asset by a banking company to a banking Institution in the scheme of amalgamation; (x) transfer in the case of business reorganization by a predecessor cooperative bank to the successor cooperative bank (xi) any transfer in a scheme of conversion of private company/unlisted public company into LLP which comes under section 47(xiiib) (xii) on any transfer in the case of conversion of firm/sole proprietary concern in company which comes under section 47(xiii)/(xiv)[applicable from the A.Y. 1999-2000] (xiii) on the conversion of a self acquired property of a member of an HUF to the joint property of the HUF.

(b) Cost of Shares of Amalgamated Company u/s 49(2): The cost of acquisition of shares in the amalgamating company. (c) Cost of acquisition in case of shares/debentures acquired on conversion of debentures u/s 49(2A): The cost of the shares/debentures issued on conversion shall be deemed to be that part of the cost of debenture/debenture stock/deposit certificate, in relation to which such an asset is acquired by the assessee. (d) Cost of acquisition of shares, debentures or warrants u/s 49(2AA): The fair market value on the date of exercise of such option.

7.8 I DIRECT TAXATION

(e) Cost of acquisition of specified security or sweat equity shares u/s 49(2AB) read with Sec.115 WC (1)(ba): ( w.e.f. A.Y.2010-11) The fair market value of securities on the date on which the option vests with the employee. The holding period shall be reckoned from the date of allotment or transfer of such shares. (f) Cost of acquisition of resulting companys shares on demerger [Section 49(2C)]
Cost of acquisition of Demerged Companys SharesNet Book Value of assets transferred to Resulting Company.

Net Worth of the Demerged Company before demerger Net Worth of demerged company=Paid up Share Capital and General Reserve as per books before demerger. (g) Cost of acquisition of demerged companys shares after demerger [Section 49(2D)] Original Cost of Acquisition of shares in demerged company Less Cost of Acquisition of Resulting Companys shares (as calculated above)

(h) Cost of acquisition to Transferee Company where section 47A is applicable [Section 49(3)] The cost of acquisition of the capital asset to the transferee company shall be the cost for which such asset was acquired by it. (i) Business reorganization of Co-operative Bank [Sec 49(2E)] Sec 49(2C) and Sec 49(2D) are applicable to business reorganization of a Co-operative Bank u/s 44DB. Cost of acquisition of Bonus Shares u/s 55(2)(iiia) Where bonus shares are issued prior to 1.4.81, the cost of acquisition shall be the fair market value as on1.4.81. Where such bonus shares are issued on or after 1.4.81, the cost of acquisition shall be taken as NIL. Where the original shares were acquired prior to 1.4.81, the cost of acquisition shall be the higher of the fair market value as on 1.4.81 or the original cost of acquisition. Where such shares were acquired on or after 1.4.81, the original cost of acquisition shall be considered. Cost of acquisition shall be the amount actually paid by the assessee to acquire such shares [Sec.55(2)(aa)(iii)] If such shares were acquired prior to 1.4.81, the assessee shall be entitled to opt for fair market value on 1.4.81 as the cost of acquisition. If the rights entitlement is renounced, the cost of acquisition of renouncing the rights entitlement to the renouncer is nil. Where the renounce acquires the right entitlement, the cost of acquisition of right shares to the renounce is the aggregate of (i) the amount paid to the renouncer (ii) the amount paid by him to the company/institution for acquiring such right shares [ Sec.55(2)(aa) (iv)].

(j)

(k) Cost of acquisition of Original Shares u/s 55(2)(b)

(l)

Cost of Right Shares u/s 55(2) (aa) read with Sec. 55 (2) (b)

(m) Cost of acquisition of (i) shares allotted to a shareholder under a scheme of Demutualization or Corporatisation and (ii) Trading or Clearing Rights of a Recognized Stock Exchange [Sec. 55 (2) (ab)]

DIRECT TAXATION I 7.9

Capital Gains The cost of acquisition is the cost of acquisition of his original membership of the stock exchange. Cost of Right is taken as NIL.

13. Capital Gain in case of amount received from an insurer on account of damage or destruction of any capital asset u/ s 45( 1A) Damage or destruction of assets as a result of Chargeability 1. Flood, typhoon, hurricane, cyclone, 1. Chargeable as income of the year in which earthquake or other convulsion of nature money or other asset was received from the insurer. 2. Riot or civil disturbance 2. In case of receipt of other assets, the Consideration = the Fair Market Value (FMV) of the asset received. 3. Accidental fire or explosion 3. Capital Gain = Money received or FMV of asset received Less Cost of Acquisition or Indexed Cost of Acquisition. 4. Action by an enemy or action taken in combating an enemy (whether with or without a declaration of war) Note for Depreciable Assets: 1. 2. The compensation received shall be reduced from the WDV of the block and any surplus shall be chargeable as Short Term Capital Gains and loss shall be treated as Short Term Capital Loss. If some asset still exists in the block and no surplus is available, then depreciation may be claimed on the balance.

Illustration 1: Ria owns a house property which was purchased by her on 1.5.1979 for `3 lacs. The said property was destroyed by fire on 3.4.12 and she received a sum of `25 lacs from the insurance company during the year. The market value of the above property as on 1.4.81 was ` 4,50,000. Compute Capital Gains for the P.Y. 2012-13. Solution: Computation of Capital Gains Consideration for Transfer Less: Indexed Cost of Acquisition 4,50,000 Long Term Capital Loss (38,34,000) 13,34,000 A. Y: 2013-14 25,00,000

Illustration 2: The W.D.V. of the block of assets as on 1.4.2012 was `5 lacs. Rate of Depreciation @ 15%. An asset of the same block was acquired on 11.5.12 for `3 lacs. There was a fire on 18.9.2012 and the assets were destroyed by fire and the assessee received a sum of ` 12 lacs from the insurance company. Compute the Capital Gain assuming: (a) All the assets were destroyed by fire (b) Part of the block was destroyed by fire Would your answer differ if the assessee received ` 7,00,000 from insurance company assuming: (a) All the assets were destroyed by fire (b) Part of the block was destroyed by fire

7.10 I DIRECT TAXATION

Solution: If Compensation received ` 12,00,000 Block of Assets u/s 2(11) Particulars 1.4.12 W.D.V. of the Block Add : Cost of New Asset purchased relating to the Block Less : Compensation received Short Term Capital Gains All assets destroyed 5,00,000 3,00,000 8,00,000 12,00,000 4,00,000 u/s 50(2) Part of Block destroyed 5,00,000 3,00,000 8,00,000 12,00,000 4,00,000 u/s 50(1)

If Compensation Received ` 7,00,000 Block of Assets u/s 2(11) Particulars 1.4.12 W.D.V. of the Block Add : Cost of New Asset purchased relating to the Block Less : Compensation received Short Term Capital Loss Less : Depreciation @ 15% All assets destroyed 5,00,000 3,00,000 8,00,000 7,00,000 1,00,000 u/s 50(2) Part of Block destroyed 5,00,000 3,00,000 8,00,000 7,00,000 1,00,000 =WDV (Depreciation 15,000 to be charged on WDV) 85,000 14. Capital Gain on conversion of capital asset into stock-in-trade u/s 45(2) When a capital asset is converted into stock-in-trade, it is a transfer u/s 2(47). Transfer shall be deemed to have taken place in the year in which the asset is so converted. Capital Gain will arise in the Previous Year in which such converted asset is sold or otherwise transferred. Indexation of cost of acquisition and cost of improvement, if required, will be applicable for the Previous Year in which such conversion took place. Full value of consideration = Fair Market Value of the capital asset(on the date of conversion) There will also arise Business Income in the Previous Year in which such converted asset is being sold. Business Income = Sale Price - Fair Market Value of the asset on the date of conversion.

Illustration 3: Mr.B invested `2,00,000 on the purchase of gold ornaments on 10.1.90. He holds the gold ornaments as investments. On 16.1.2008, he started a business in dealing in jewellery and converts his holding into his stock-in-trade. The market value of the gold ornaments as on the date of conversion was

DIRECT TAXATION I 7.11

Capital Gains `10,00,000 and therefore, B credited his Capital Account by `10,00,000 and debited Stock Account by `10,00,000. The gold ornaments are now reflected in the business of Mr. B. these gold ornaments were sold in the Previous Year 2012-13 for a sum of `15,00,000. Compute the Capital Gain and Business Income. Solution: The conversion of capital asset into stock-in-trade is treated as a trsnsfer as per sec. 2(47). Capital asset was converted into stock-in-trade on 16.1.08 i.e. during the Previous Year 2007-08. Therefore, it will be treated as transfer of the Previous Year 2007-08. The taxability for Capital Gains shall arise only in the Previous Year in which the asset is sold i.e. Previous Year 2012-13. Capital Gains for the Assessment Year 2013-14 Consideration for Transfer (Market value as on the date of conversion) Less: Indexed Cost of Acquisition2,00,000 Long Term Capital Gains Business Income for the A.Y. 2013-14 Sale Price Less : Fair Market Value as on the date of conversion Business Income 15,00,000 10,00,000 5,00,000 10,00,000 6,40,698 3,59,302

Illustration 4: Romit acquired a plot of land on 1.6.75 for `4,00,000. He converts the plot into stock in trade of his real estate dealing business on 18.2.2007 when the fair market value of the plot was ` 35,00,000. The stock-in-trade is sold by him on 18.5.2012 for ` 40,00,000 (FMV as on 1.4.81 was ` 6,00,000 and FMV as on 1.4.76 `4,50,00). Solution: The conversion of capital asset into stock-in-trade is treated as a transfer as per Sec. 2(47). Capital asset was converted into stock-in-trade on 18.2.2007 i.e. Previous Year 2006-07. Computation of Capital Gains Consideration for Transfer (FMV) Less: Indexed Cost of Acquisition 6,00,000 Long Term Capital Gains ` 35,00,000 31,14,000 3,86,000

Computation of Business Income ` Less : Sale Proceeds of HP FMV on the date of conversion Business Income 40,00,000 35,00,000 5,00,000

7.12 I DIRECT TAXATION

15. Treatment of Depreciable Assets [ Section 50 ] Capital Gains on transfer of depreciable assets would results in Short Term Capital Gains only In other words, Capital Gains is derived as under : Period of Holdings Held for more than 36 months Held for less than 36 months Nature of Asset Long Term Capital Asset Short Term Capital Asset Nature of Gains on Transfer Short Term Capital Gains Short Term Capital Gains

16. Chargeability of Capital Gain on Transfer of Beneficial interest in Securities by the Depository u/s 45(2A) Section 45(2A) was inserted by the Depositories Act, 1996. The said Act provides that dematerialisation of securities to avoid physical movement of scrips is required in order to ensure faster settlement of trade. In the register of the issuing company, the depository (a company registered with SEBI) appears to be a registered owner of the dematerialised securities. In the books of the depository, the real owner of the securities appears as the beneficial owner. A depository interacts with the investors through participants (agents of depository). For this purpose investors have to enter into an agreement and open an Account (which is just like a Bank Account) with the participant. An investor may hold his dematerialised holdings in more than one Account with one or more depositories. All the transactions of sale and purchase of dematerialised securities are through the participants and are entered in the respective accounts. The ownership is transferred through book entries in the statement of Accounts. Capital Gain accrues to the beneficial owner (i.e. the investor)-taxable as the income of the beneficial owner of the Previous Year in which the transfer took place. Cost of Acquisition and period of holding is to be determined on FIFO Method Particulars Shares of XYZ LTD. purchased in physical form on 10.11.2001 @ ` 20 per share Purchased dematerialised shares of Y Ltd. on 25.11.2002 @ ` 70 per share Shares of XYZ LTD. held in physical form, were got dematerialised on 01.12.2004 Quantity 300 500

Illustration 5: The Depository Account shows the following details of Ms holdings: Date of Credit 10.11.2001 30.11.2002 06.12.2004

M sold 600 dematerialised shares on 6th June 2012 @ ` 200 per share. Brokerage is paid @2% of sale price. Compute Capital Gains. Solution: (a) Person Liable : The sale of shares held under dematerialized format with a depository is chargeable to tax as the income of the beneficial owner. (b) Cost of Acquisition and period of holdings : The cost of acquisition and the period of holding shall be determined on FIFO Method. [Circular No. 768 dated 24.6.1998] (i) FIFO Method will be applied for each Account independently. (ii) When physical stock is dematerialized, the date of credit into the Depository Account shall be considered for the purpose of FIFO Method, but indexed cost of acquisition shall be computed on the basis of year of acquisition.

DIRECT TAXATION I 7.13

Capital Gains ` Consideration for Transfer 600 Share @ ` 196 per share Less : Indexed Cost of Acquisition (i) 500 70 (ii) 100 20 Long Term Capital Gain (66,711) (4,000) 46,889 1,17,600

17. Capital Gain on transfer of capital asset by a partner/member to a firm/AOP/BOI as capital contribution u/s 45(3) There shall arise Capital Gain from the transfer of capital asset held by a person, to a firm or AOP or BOI in which he is or becomes a partner or member. Such transfer of capital asset may be by way of capital contribution or otherwise. It shall be chargeable to tax as his income of the Previous Year in which such transfer took place. Full value of consideration (for computing Capital Gains) = the amount recorded in the books of accounts of the firm. Market value of the asset on the date of transfer is not relevant. Cost of acquisition and cost of improvement shall be allowed to be indexed accordingly.

Illustration 6: Nisith acquired a property by way of gift from his father in the Previous Year 1988-89 when its FMV was `3 lacs. His father had acquired the property during 1981-82 for ` 4 lacs. This property was introduced as capital contribution to a partnership firm in which Nisith became a partner on 15.6.2012. The market value of the asset as on that date was ` 20 lacs, but it was recorded in the books of account of the firm at ` 17 lacs. Is there any Capital Gain chargeable in the hands of Mr. Nisith? Solution: Computation of Capital Gains A.Y: 2013-14 ` Consideration for Transfer Less : Indexed Cost of Acquisition 4,00,000 Long Term Capital Loss 17,00,000

21,16,770 4,16,770

(a) Full value of consideration is taken as the value at which it is recorded in the books of accounts of the firm. (b) Cost of acquisition is taken as cost to the previous owner but indexation has been done from the date it was first held by the assessee. (c) Market value of the asset on the date of transfer is not relevant. Illustration 7: Ayan has two motor cars which are used by him exclusively for his personal purposes. The

7.14 I DIRECT TAXATION

cost of the cars was ` 6,50,000 and ` 8,00,000. The first car was transferred by him on 15.1.2013 to a firm in which he is a partner as his capital contribution. The market value of the car as on 15.1.2013 is ` 5,00,000, but it was recorded in the books of account of the firm at ` 6,00,000. Compute the Capital Gain if any, chargeable for the A.Y. 2013-14. Solution: Since the car is a moveable property and was used by Mr. Ayan for his perosnal purposes only, it will be treated as a personal effect. W.e.f. A.Y. 2008-09, Personal effect means moveable property including wearing apparels and furniture held for personal use by the assessee or any member of his family dependent on him but excludes : (i) Jewellery (ii) Archaeological collections (iii) Drawings (iv) Paintings (v) Sculptures (vi) Any work or art. 18. Capital Gain on transfer of a capital asset by way of distribution on the dissolution of a Firm/AOP/ BOI u/s 45(4) Transfer: Distribution of a capital asset by a Firm / AOP / BOI on its dissolution or otherwise is a transfer. Year of Taxability: Capital Gain shall be chargeable to tax in the hands of Firm/ AOP /BOI in the Previous Year in which such transfer takes place. Capital Gain = Fair Market Value on the date of transfer Less Cost or Indexed cost of acquisition. Depreciable Assets: Transfer of depreciable asset results in Short-term Capital Gain or Loss u/s 50.

Illustration 8. PQR & Co. is a partnership firm, consisting 3 partners P, Q and R. the firm is dissolved on 31.12.12. The assets of the firm were distributed to the partners as under: Particulars Block of Machinery (given to P) 1990-91 7,20,000 15,00,000 10,40,000 10,00,000 Stock (given to Q) 2002-03 4,00,000 6,00,000 4,50,000 Land (given to R) 1978-79 10,000 25,00,000 18,00,000 2,70,000

Year of acquisition Cost of acquisition (`) Market value as on 31.12.12 WDV as on 31.12.12 Value at which given to partners as per agreement Market value as on 1.4.81

Compute the income taxable in the hands of the firm for the Assessment Year 2013-14. What shall be the cost of acquisition of such assets to the partners of the firm? Solution: Computation of Short Term Capital Gains on Block of Machinery ` Sale consideration (i.e. the market value) Less : Cost of Acquisition (WDV of the block) Short Term Capital Gains 15,00,000 10,40,000 4,60,000

DIRECT TAXATION I 7.15

Capital Gains Income from Business (on transfer of stock) ` Market value of stock Less : Cost of Acquisition Business Income 6,00,000 4,00,000 2,00,000

Computation of Capital Gains on transfer of land ` Consideration for transfer Less : Indexed cost of Acquisition : 2,70,000 Long Term Capital Gains 1,99,600 Cost of acquisition of assets to the partners ` Partner P Partner Q Partner R Less : Indexed cost of Acquisition : 2,70,000 10,00,000 4,50,000 18,00,000 23,00,400 9,49,600 25,00,000 23,00,400

Illustration 9: A firm consists of 3 partners X, Y & Z. Z retires from the firm on 15.10.2012. His capital balance and the profits till the date of retirement stood at ` 16 lacs. The firm transferred its land to Z in settlement of his Account. The market value of the land as on that date was ` 30 lacs. The land was acquired by the firm on 1.5.93 for ` 4 lacs. Compute the Capital Gains in the hands of the firm. Solution: Computation of Long Term Capital Gains for the A.Y. 2013-14 Consideration for Transfer Less : Indexed Cost of Acquisition 4,00,000 Long Term Capital Gain ` 30,00,000 13,96,721 16,03,279

19. Capital Gain on transfer by way of compulsory acquisition of an asset u/s 45(5) Chargeability: It is a transfer u/s 2(47) chargeable to tax under the head Capital Gains. Taxability of Normal/Original Compensation [Section 45(5)(a)]
u

Normal or original compensation is taxable in the Previous Year in which it is first received.

7.16 I DIRECT TAXATION

Whole of the compensation is taxable even if a portion of the amount is received.

Capital Gain=Whole of the normal compensation Less Cost or Indexed cost of Acquisition. Indexation shall be applied for the year in which the asset is compulsorily acquired. Taxability of Enhanced Compensation [Section 45(5)(b)]
u u u

Enhanced compensation shall be taxable in the Previous Year in which it is received. The Cost of acquisition and the cost of improvement shall be taken as NIL. Capital Gain=Enhanced Compensation received Less Expenses on Receipt of Enhanced Compensation

Compensation received by Legal Heirs: The Compensation received subsequent to the death of the assessee is taxable in the hands of his legal heirs. Reduction of Compensation: Where normal compensation / enhanced compensation is reduced by Court or Tribunal, then the Capital Gain shall be recomputed accordingly. Interest on enhanced compensation on account of compulsory acquisition is chargeable under the head Income from Other Sources.

Illustration 10: Mr. B acquired a house property for ` 50,000 in 1969-70. On his death in October 1985 the house was acquired by his son C. The market value of the house as on 1/4/81 was ` 3,00,000. This house was acquired by the Government on 15.3.2008 and a compensation of ` 16 lacs is paid to him on 25.3.2012. C filed a suit against the Government challenging the quantum of compensation and the court ordered for giving additional compensation of ` 14,00,000. He incurred an expenditure of ` 40,000 as an expenditure in connection with the suit. The additional compensation was received on 25.3.2013. Compute Capital Gains chargeable to tax. Solution: Capital Gain on initial compensation shall be chargeable in the A.Y. 2012-13, i.e. for the Previous Year 2011-12. Computation of Long Term Capital Gains for the A.Y. 2012-13 Consideration for transfer (being the compensation) Less : Indexed Cost of Acquisition 3,00,000 Long Term Capital Loss ` 16,00,000 17,70,677 1,70,677

Note: This loss shall be carried forward for adjustment only against Long Term Capital Gains arising within the next 4 Assessment Years. Computation of Long Term Capital Gains for the A.Y. 2013-14 Enhanced Compensation received Less : Cost of Acquisition Cost of Improvement Expenses on Transfer Long Term Capital Gains Balance of LTCG Less : Long Term Capital loss Set off from the A.Y. 2012-13 ` 14,00,000 NIL NIL (40,000) 13,60,000 (1,70,677) 11,89,323

DIRECT TAXATION I 7.17

Capital Gains 20. Capital Gain on conversion of debentures into shares (i) Conversion of debentures into shares is exempted u/s 47(x) (ii) In case of subsequent transfer by the transferee, the holding period in the hands of the transferee u/s 2(42A) shall not include the holding period of the earlier asset. (iii) Cost of new asset in the hands of the transferee u/s 49 shall be the cost at which old asset is converted.

Illustration 11: R acquired 400 listed debentures of `100 each on 15.9.2010. 50% value of the debentures was converted into 4 listed equity shares of the face value of ` l0 each on 20.8.2012. R therefore, received 800 shares of face value of ` 10 each and left with 200 debentures. The shares were sold on 25.12.12 @ ` 100 per share through recognized stock exchange and R paid ` 200 as securities transaction tax. Compute the Capital Gains chargeable for the Assessment Year 2013-14. Solution: Convertion of Debentures into shares is exempted from Transfer u/s 2(47)(x). Now these shares are sold within a period of 12 months. It is a Short-term Capital Asset. Computation of Long-Term Capital Gains for the A.Y. 2013-14 Consideration for transfer of 800 shares @ ` 100 each Less : Cost of Acquisition (200100) Short Term Capital Gains 21. Capital Gains on distribution of assets by companies in liquidation u/s 46 No Capital Gain to company on distribution of assets to shareholders on liquidation u/s 46(1) provided the distribution of assets in specie (i.e. in the same form). 22. Shareholders liable to Capital Gain tax on receiving money and asset on the liquidation of the company: Where a shareholder on the liquidation of a company, receives any money or other asset from the company in lieu of the shares held by him, such a shareholder shall be chargeable to Income Tax under the head Capital Gains in respect of the excess money and the assets so received over the cost of the shares held by him. In this case, the consideration price for Capital Gain purposes shall be money received and/or the market value of the other assets on the date of distribution minus deemed dividend within the meaning of Sec.2(22)(c). Deemed Divided means any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalized or not. Accumulated profits for a company in liquidation includes all profits of the company upto the date of liquidation. Accumulated profits should include the credit balance of Profit and Loss Account, General Reserves, Investment Allowance Reserve, capitalized profits and profits of the year upto the date of distribution/ liquidation. However, provisions and reserves meant for specific liability, to the extent of the liability shall not be included. Provision for Income Tax, Provision for Dividend, Reserve for Depreciation do not form part of the accumulated profits. Securities premium is not accumulated profits. It may consist of exempted ` 80,000 20,000 60,000

7.18 I DIRECT TAXATION

incomes, like agricultural income. It will include current profits and all profits of the company till the date of liquidation, subject to the exception provided therein. Illustration 12: A holds 15,000 shares (10% of total share holding) in B Ltd. which he had purchased on 10.2.96 for ` 6,00,000. The company went into liquidation on 16.7.2012 and paid a sum of ` 20 per share in cash and an asset whose market value as on the date of distribution i.e. 5.10.12 was ` 18,20,000 to A. The accumulated profits of the company were ` 15 lacs. (a) Compute the income of A for the A.Y. 2013-14 assuming that he has no other income. (b) Compute the Capital Gain chargeable to tax if the asset of B Ltd. is sold by A for ` 20 lacs on 28.3.13. Solution: Computation of Capital Gains of Mr. B for the A.Y. 2013-14 (a) (i) Capital Gain on transfer of shares Total consideration (15,00020+18,20,000) Less : Proportionate amount of deemed dividend (10% of ` 12,86,353) Less : Indexed Cost of Acquisition 6,00,000 Long Term Capital Gains ` 21,20,000 1,28,635

18,19,217 1,72,148

(ii) Income from others Sources Dividiend from Indian Company Exempted 1,72,148

(b) Capital Gain on transfer of asset (B Ltd.) Full Value of Consideration Less : Cost of Acquisition (being the market value as on the date of distributions) Short Term Capital Gains Accumulated Profits Dividend tax @ 16.60875% (=15%+7.5% + 2% Education cess +1% SHEC) Hence, the amount to be distributed plus tax @16.60875% on such amount should be ` 15,00,000 Amount of tax = ` 15,00,000 x = 2,13,647 20,00,000 18,20,000 1,80,000 15,00,000

Profits available for distribution= `(15,00,000 2,13,647)=`12,86,353. 23. Capital Gain on sale of goodwill of a business, trademark or brand name, tenancy rights, route permits or loom hours, right to manufacture or right to carry on any business.

DIRECT TAXATION I 7.19

Capital Gains The following are chargeable to tax as Capital Gains: (i) Goodwill of a business. There will not arise any Capital Gain on the goodwill of a profession; (ii) Trademark or brand name associated with the business; (iii) Right to manufacture, produce or process any article or thing, for a consideration e.g. patent, copyright, formula, design; (iv) Right to carry on any business; (v) Tenancy rights; (vi) Route permits; (vii) Loom hours. Cost of Acquisition u/s 55(2) (a) (a) If the assets are purchased- original cost of acquisition. (b) In any other case- nil Cost of Improvement (a) In case of goodwill of a business, right to manufacture, produce or process any article or thing and right to carry on any business (whether self generated or purchased), shall always be taken as nil. (b) For the other assets as mentioned above, it shall be taken as the actual capital expenditure incurred by the assessee on the improvement of that asset, whether such asset is self generated or purchased. Computation of Capital Gains in case of Self Generated Goodwill of a Business (Not of a profession), Right to Manufacture/Produce/Process an article or Right to Carry on any business. Particulars Sale Consideration (Actual Amount) Less: Expenses of Transfer (Actual Amount) Net Consideration Less: Cost of Acquisition Less: Cost of Improvement Taxable Capital Gains ` ` xxx xxx xxx NIL NIL NIL xxx

Computation of Capital Gains in case of Self Generated Tenancy Rights, Route Permits, Loom Hours, Trade Marks, Brand Name related with business Particulars Sale Consideration (Actual Amount) Less: Expenses of Transfer (Actual Amount) Net Consideration Less: Cost of Acquisition Less: Cost of Improvement (Actual Amount) Taxable Capital Gains NIL XXX ` xxx xxx xxx xxx xxx

Illustration 13: (a) P commenced a business on 10.5.92. The said business is sold by P on 25.8.12 and he received ` 10 lacs towards goodwill.

7.20 I DIRECT TAXATION

(b) What will be your answer in the above case, if P had acquired the goodwill for this business for a consideration of ` 3,00,000. Solution: Computation of Long Term Capital Gains for the A.Y. 2013-14 (a) Consideration for transfer Less : Indexed Cost of Acquisition (Self-Generated) Long Term Capital Gains ` 10,00,000

NIL 10,00,000

(b) Consideration for transfer Less : Indexed Cost of Acquisition = 3,00,000 Long Term Capital Loss

10,00,000

11,46,188 1,46,188

Illustration 14: R has been living in a rented accommodation since August 1983, and he is paying a rent of `4000 per month. The landlord got the house vacated from R on 16.7.2012 and paid a sum of `15 lacs for vacating the house. Compute Capital Gains, if any, in the hands of R. Solution: Computation of Long Term Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Indexed Cost of Acquisition (Self-generated Asset) Long Term Capital Gains ` 15,00,000 NIL 15,00,000

llustration 15: Mr. Nitin is a Chartered Accountant practicing in Delhi since January 1983. He transfers the practice to another Chartered Accountant on 15.7.2012 and charges ` 10 lacs for goodwill. Solution: Since the asset transferred is Goodwill of a profession and not of a business, it is treated as self-generated asset and there is no Capital Gain on self-generated asset. Illustration 16: R purchased tenancy right on 1.4.1980 for ` 4,60,000. The same was sold by him on 14.8.2012 for ` 45 lacs. FMV of tenancy right as on 1.4.81 ` 6,50,000.

DIRECT TAXATION I 7.21

Capital Gains Solution: Computation of Long term Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Indexed Cost of Acquisition 4,60,000 Long Term Capital Gains ` 45,00,000

39,19,200 5,80,800

Illustration 17: R purchased 1200 shares on 1.4.80 for ` 40 each. He was allotted 1200 right shares on 1.5.80 for ` 50 each. He was also allotted 2,400 bonus shares on 1.3.81. Again, on 4.5.91, he was further allotted 4,800 right shares for ` 80 each. Further on 27.9.01, he was allotted 4,800 bonus shares. The fair market value of these shares on 1.4.81 was `60 each. All the above shares are sold by R on 16.10.12 for ` 400 per share. Compute the Capital Gains assuming : (a) The above shares are not sold through recognized stock exchange. (b) The above share is sold through recognized stock exchange and necessary securities transaction tax was paid by R. Solution: (a) Where Shares were not sold through recognised stock exchange Computation of Capital Gains for the A.Y. 2013-14 Consideration for transfer (14,400400) Less : Indexed Cost of Acquisition (i) 1,200 60 (ii) 1,200 60 (iii) 2,400 60 (Bonus shares issued prior to 1.4.81 shall opt for Fair market value as on 1.4.81 and shall be allowed to be indexed) (iv) 4,800 80 (v) Cost of Acquisition for Bonus shares after 1.4.81 Long term Capital Gains (16,44,060) (NIL) 16,62,180 ` 57,60,000

(6,13,440) (6,13,440) (12,26,880)

(b) Where shares are sold through recognised stock exchange and securities transaction tax has been paid by the assessee, entire Long Term Capital Gain on the share shall be exempted u/s 10(38)

7.22 I DIRECT TAXATION

24. Capital Gains u/s 50b in case of slump sale u/s 2(42c) Slump Sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. Cost of acquisition and cost of improvement in case of slump sale: Net Worth of the undertaking or the division. (NO INDEXATION OF SUCH COSTS WILL BE ALLOWED). Note: Cost of acquisition of assets in case of slump sale of business specified under section 35AD [Section 50B] [W.e.f. A.Y. 2010-11] Section 50B relating to slump sale amended: While computing the net worth in case of slump sale for the purpose of computing Capital Gain, in the case of capital assets in respect of which the whole of the expenditure has been allowed or is allowable as a deduction under section 35AD, its cost shall be taken as NIL. NET WORTH = AGGREGATE VALUE OF TOTAL ASSETS of the undertaking or division as reduced by the VALUE OF LIABILITIES of such undertaking or division as appearing in its books of account. Aggregate value of total assets: (a) In case of depreciable assets- the written down value of the block of assets. (b) In case of any other assets- the book value of such assets. Note : (1) Any change in the value of assets on account of revaluation of assets shall be ignored for the purposes of computing the net worth. (2) Benefit of unabsorbed losses and unabsorbed depreciation of the undertaking transferred shall not be available to the transferee company. (3) If the business is transferred on severable sale basis, the surplus will be Short-term Capital Gains in case of depreciable assets. While in case of other assets, it may be short- term or long-term depending upon the holding period. (4) No profit under the head Profit or Gains from Business or Profession shall arise even if the stock of the said undertaking is transferred along with other assets. (5) Determination of value for stamp duty, registration fees shall not be regarded as assigning values to individual assets or liabilities. (6) Report of a Chartered Accountant in prescribed Form 3CEA shall be enclosed. Illustration 18: X Ltd. has two divisions namely A and B. The Balance Sheet as at 31.3.2012 is as follows: Paid up capital Reserves Surplus Creditors: Division A Division B ` 6,00,000 Fixed Assets (W.D.V. as on 31.3.12) Land & Building 8,40,000 Plant & Machinery Investments Debtors 3,00,000 Stock-in-trade Other current assets 6,00,000 23,40,000 2,00,000 1,50,000 50,000 A` B` 6,00,000 1,50,000 2,50,000 2,00,000 3,00,000 4,00,000 40,000 Total ` 6,00,000 1,50,000 2,50,000 2,00,000 5,00,000 5,50,000 90,000 23,40,000

DIRECT TAXATION I 7.23

Capital Gains The company decides to sell division A which was established in 1983 to another company G Ltd. on 1.5.2012 for a lump sum of ` 14 lacs. The fixed assets of the company includes land and building whose W.D.V. as on 1.4.08 is ` 15 lacs, but it has been valued as ` 5 lacs for the purpose of stamp duty. Compute the Capital Gain taxable in the aforesaid case assuming that the market value of the stock transferred is ` 2 lacs. Solution: Computation of Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Net worth of the division Land and Building (WDV) Plant & Machinery (WDV) Debtors (Book Value) Stock (Book Value) Others Current Assets (Book Value) Less : Liabilities Long Term Capital Gains ` ` 14,00,000 2,00,000 1,50,000 50,000 4,00,000 3,00,000

1,00,000 13,00,000

25. Capital Gain on re-purchase of units of Mutual Funds under Equity Linked Savings Scheme u/s 45(6) 1. 2. 3. Where a shareholder receives any consideration from the company for purchase of its own units, it is a transfer chargeable under the head Capital Gains. The Capital Gain is chargeable to tax in the Previous Year in which the units are purchased by the Company. Capital Gains = Value of Consideration Received Less Cost of Acquisition or Indexed Cost of Acquisition. In case of buy back of shares, there is no question of deemed dividend u/s 2(22) (d).

26. Capital Gains on purchase by company of its own shares or other specified securities u/s46A Capital Gain = (Value of consideration received by the shareholder) - (Cost of acquisition of shares or specified securities) The capital Gain is chargeable to tax in the Previous Year in which the shares or specified securities are purchased by the company. Specified securities has been defined as per Sec.77A of the Companies Act, 1956. Specified securities include employees stock option or other securities as may be notified by the Central Government from time to time. 27. Capital Gains on violation of the provision of Sec. 47(iv) and 47(v) due to withdrawal of exemption u/s 47A. Any transfer of capital asset by a company to its wholly owned Indian subsidiary company [Section 47(iv)] or by a wholly owned company to its Indian holding company [Section 47(v)], subject to certain condition as mentioned in point 10, is not a transfer and hence, does not arise any Capital Gains. If any of the conditions is failed, the earlier exemption so granted shall be withdrawn and the transfer

7.24 I DIRECT TAXATION

of capital asset is chargeable to tax u/s 47A. Cost of acquisition in this case is the cost for which asset was acquired. Illustration 19: R Ltd. is a wholly owned subsidiary company of S Ltd. Both R Ltd. and S Ltd. are Indian companies. R Ltd. transferred a plot of land to S Ltd. on 21.10.1982 for ` 3 lacs. R Ltd. had acquired this land on 1/1/76 for `80,000. The market value as on 1.4.81 was ` 1,50,000. What would be the Capital Gains if any, chargeable in the hands of R Ltd and S Ltd. in the following situations: (a) S Ltd. sells the land on 2.9.12 for ` 12 lacs. S Ltd. continues to hold 100% shares of RLtd. (b) S Ltd. converted the land as its stock-in-trade on 5.10.88 and then sold it on 12.9.12 for ` 16 lacs. The market value of the asset on 5.10.88 was ` 8 lacs. Solution: Assessee S. Ltd. Computation of Capital Gains for the A.Y. 2013-14 ` 12,00,000 (a) (i) Consideration for Transfer Less : Indexed Cost of Acquisition 1,50,000 Long Term Capital Loss 12,78,000 78,000

(ii) There will be no Capital Gains for R Ltd. either in the year of transfer to S Ltd. or in the year sale by S Ltd, as the land has not been converted into stock and it remains a wholly owned subsidiary company. (b) (i) In the case of R Ltd. Since the land has been converted into stock-in-trade on 05.10.88 which falls within eight years of the original transfer, there will be Capital Gains to R Ltd. and its assessment for the A. Y. 1983-84 (P. Y: 82-83) will be rectified u/s 155 as under: Consideration for transfer (amount at which it is transferred to S Ltd.) 3,00,000 Less : Cost of Acquisition 80,000 Long Term Capital Gains 2,20,000 The LTCG of ` 2,20,000 will be included in the total income for the A.Y. : 83-84 and taxed according to the provisions applicable at that time. (ii) Although the land was converted into stock-in-trade on 5.10.88, it will be regarded as transfer, but Capital Gain on such transfer will be taxable in the Previous Year in which such converted land was sold. The cost of acquisition in this case will be the value at which the asset was transferred to it. Computation of Capital Gain for the A.Y. 2013-14 Consideration for transfer (being the Market value as on the date of conversion) Less : Indexed Cost of Acquisition 3,00,000 Long Term Capital Gains Business Income = 12,00,000 8,00,000 = 4,00,000 ` 8,00,000 4,43,119 3,56,881

DIRECT TAXATION I 7.25

Capital Gains 28. Exemptions of Capital Gains 1. 2. Capital Gain on transfer of units of US 64 exempt if transfer takes place on or after 1.4.02 u/s 10(33) w.r.e.f. A.Y. 2005-06. Long-term Capital Gain on eligible equity shares exempt if the shares are acquired within a certain period u/s 10(36) w.e.f. A.Y. 2006-07. These assets must have been acquired on or after 1.3.03 but before 1.3.04 and held for a period of more than 12 months. Exemption of Capital Gains on compensation received on compulsory acquisition of agricultural land situated within specified urban limits u/s 10(37) w.e.f. A.Y. 2005-06. (a) Where the compulsory acquisition has been taken place before 1.4.04 but the compensation is received after 31.3.05, it shall be exempted. (b) If the part of the original compensation in the above case has already been received before 1.4.04, then the exemption shall not be available even though the original compensation is received after 31.3.05. (c) If enhanced compensation is received on or after 1.4.04 against agricultural land compulsorily acquired before 1.4.04 shall be exempted.

3.

4. Exemption of Long Term Capital Gain arising from sale of shares and units u/s 10(38) w.e.f. 1.10.04. Any income arising on or after 1.10.04 from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund shall be exempted provided: (a) Such equity shares are sold through recognized stock exchange, whereas units of an equity oriented fund may either be sold through the recognized stock exchange or may be sold to the mutual fund. (b) Such transaction is chargeable to securities transaction tax.

5. Exemption of Capital Gain on transfer of an asset of an undertaking engaged in the business of generation, etc of power u/s 10(41), provided such transfer is effected on or before 31.3.07 to the Indian company notified u/s 80 IA(v)(a) 29. Explain the tax treatment of Capital Gain on transfer of shares, debentures of Indian Company held by Non Residents. [Section 48 (Proviso) read with Rule 115A]. 1. 2. 3. 4. Applicability: All Non Residents including Foreign Companies except persons covered u/s 115AC & 115AD. Assets Transferred: Shares or Debentures in an Indian Company. Nature of Capital Gain: Short term or long term Average TT Rate = (Buying Rate + Selling Rate adopted by State Bank of India)/2 Value in ` Conversion Rate Value in Foreign Curr. xxxx xxx xxxx xxx

Computation of Capital Gains Particulars Sale Consideration Less: Expenses on Transfer Net Consideration Less: Cost of Acquisition

xxxx Avg. TT Rate on the date of Transfer xxx Avg. TT Rate on the date of Transfer xxxx (xxxx) Avg. TT Rate on the date of Acquisition

7.26 I DIRECT TAXATION

Capital Gain in Foreign Currency Capital Gain in ` Less: Exemption u/s 115F, wherever applicable Taxable Capital Gain Note : Indexation Benefit is not available.

xxxx Capital Gain In Foreign Currency Buying Rate on the date of Transfer Capital Gains Amount invested Net Consideration xxx (xxx)

xxx

31. What are the conditions and exemption from Long-term Capital Gains on transfer of foreign exchange asset by a Non Resident Indian [Section 115F] 1. Condition : Long-term Capital Gain on transfer of foreign exchange asset is entitled for exemption if the whole or part of the net consideration is invested within 6 months after the date of such transfer in prescribed assets. Prescribed Assets: (a) Shares of an Indian Company or debentures of an Indian Public Limited Company. (b) Deposit with an Indian Public Limited Company. (c) Central Government securities. (d) National Savings Certificates VI and VII issue. Exemption: If the whole of the net consideration is invested, then entire Capital Gain is exempt. If a part of the net consideration is invested, then the deduction shall be computed as follows: Amount Exempted = Capital Gains Amount Invested/Net Consideration Holding period of the asset: 3 years from the date of acquisition. Sale/conversion within the holding period: Amount exempted shall be chargeable to tax as Long Term Capital Gain in the year of transfer. Income based on Market Value: (a) Market Value: Market Value of DDBs will be determined at the end of every financial year, 31st March, that is, as per the values declared by RBI or Primary Dealers Association of India, jointly with the Fixed Income Money Market and Derivatives Association of India. (b) Income: The difference between market values on the opening and closing dates of that financial year constitutes income of that year. (c) Computation of Income: The income chargeable will be computed as under For Original Subscribers: Difference between market values on 31st March (Closing date) and 1st April (Opening date) of that financial year. For Subsequent purchasers: Difference between market values on 31st March (Closing date) and cost of Purchase of bond.

2.

3.

4. 5.

31. Explain the tax treatment of income from Deep Discount Bonds (DDBs). 1.

(d) Taxable as- this income will be treated as interest in case of investors and business income in case of traders.

DIRECT TAXATION I 7.27

Capital Gains 2. Transfer before maturity: If the bondholder transfers the bond before maturity (a) In case of Investors: Capital Gains = Sale Price Less Cost of Acquisition of the Bond Nature of Capital Gain: Capital Gain is always Short Term since income is offered upto 31st March of the Previous Year and the holding period will always be less than 12 months. Cost of Bond = Cost of Acquisition (subscription price paid by original investor or purchase price paid by intermediate purchaser) and the income already offered to tax by the bondholder upto the date of transfer.

3.

(b) In case of Traders: Business Income = Sale Price Less Cost of Acquisition of the Bond Redemption on Maturity: (a) If the original subscriber redeems the DDB In case of Investors: Interest Income = Redemption Price Less Market Value as on the last valuation date immediately preceding the maturity date In case of Traders: Business Income = Redemption Price Less Market Value as on the last valuation date immediately preceding the maturity date

(b) If an intermediate purchaser redeems the DDB Interest or Business Income = Redemption Price Less Cost of the Bond to such Purchaser Cost = Cost of Acquisition (subscription price paid by original investor or purchase price paid by intermediate purchaser) and the income already offered to tax by the bondholder upto the date of redemption. Nature of Asset: Land or Building or both Consideration for transfer: Amount is less than the value adopted or assessed by the State Government Authority (referred to as the Stamp Valuation Authority for the purpose of payment of stamp duty.) Value to be adopted for Capital Gains: Value adopted by the Stamp Valuation Authority.

32. Capital Gains on Sale of Property at less than Government Value. [Sec. 50C] 1. 2.

3.

Provisions for deemed valuation of immovable property in certain cases of Transfer [Section 50C] [W.e.f. A.Y. 2010-11] Further, new Explanation 2 has been inserted to section 50C(2) so as to clarify the meaning of the term assessable. Explanation 2 For the purposes of this section, the expression assessable means the price which the Stamp Valuation Authority would have, notwithstanding anything to the contrary contained in any other law for the time being in force, adopted or assessed, if it were referred to such authority for the purposes of the payment of stamp duty. 4. Reference to Valuation Officer: (a) The assessee can claim that the value adopted or assessed by the Stamp Valuation Authority exceeds the Fair Market Value of the property as on the date of transfer. (b) Value adopted by the Stamp Valuation Authority is not disputed before any authority or Court. (c) In such case, the Assessing Officer may refer the case to the Valuation Officer.

7.28 I DIRECT TAXATION

(d) Where the value determined by the Valuation Officer exceeds the value adopted by the Stamp Valuation Authority, the Capital Gain shall be considered as follows Capital Gains = Value adopted by Stamp Valuation Authority Less Cost or Indexed Cost of Acquisition.

33. Consideration for transfer of capital asset cannot be ascertained [Section 50D] As per Finance Act, 2012, section 50D (w.e.f. A.Y. 2013-14) provides that where the consideration received or accrued for transfer of a capital asset is not ascertainable or cannot be determined, then the fair market value of the said asset shall be deemed to be the full value of the consideration on the date of transfer for computing the Capital Gain. This situation may arise in a case where the capital asset is transferred in exchange of another capital asset. 35. Advance money received on Capital Gains [Section 51] 1. Reduce from Cost/WDV/FMV: Any advance money or any other sum received and retained by the assessee is to be reduced either from (a) Cost of Acquisition; or (b) Written Down Value; or (c) Fair Market Value. Applicability: This provision is applicable only when the transfer as per the original agreement does not take place and the advance money is received and forfeited by the assessee as per the agreement.

2.

Illustration 20: Rohit purchased a house in Delhi in December 2004 for ` 2,50,000. In March 2012, he entered into an agreement to sell the property to Z for a consideration of `5,00,000 and received an earnest money of ` 50,000. As per the terms of agreement, the balance payment was to be made within 30 days of the agreement. If the intending purchaser does not make the payment within 30 days, the earnest money would be forfeited. As Z could not make the payment within the stipulated time the amount of ` 50,000 was forfeited by Rohit. Subsequently, on 16.6.12, Rohit sold the house to Mohit for ` 6,00,000. He paid 3% brokerage on sale of the house. Compute Capital Gains chargeable to tax for the Assessment Year 2013-14. Solution: Computation of Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Expenses on transfer (Brokerage @ 3% on 6,00,000) Net Consideration Less : Indexed Cost of Acquisition Cost of Acquisition Less : Amount received and forfeited (u/s 51 to be adjusted against cost) Net Cost of Acquisition Indexed Net cost of Acquisition = 2,00,000 Long Term Capital Gains 35. Reference to Valuation Officer [Section 55A] 3,55,000 2,27,000 ` 6,00,000 18,000 5,82,000 2,50,000 50,000 2,00,000

DIRECT TAXATION I 7.29

Capital Gains Under the following circumstances the Assessing Officer may refer the valuation of the capital asset to the Valuation Officer and his valuation report shall be binding on the Assessing Officer1. 2. Where the value of the asset is estimated by the registered valuer but the Assessing Officer is of the opinion that the value so determined is less than its fair market value. In any other case, the Assessing Officer is of the opinion that (a) The fair market value of the asset exceeds the value of the assets declared by the assessee either by more than 15% or by ` 25,000 (Rule 11AA); or (b) The nature of the asset and other relevant circumstances are such that, it is necessary to do so.

Amendment: This section is amended w.e.f. 1-7-2012. Under this section, the AO can make a reference to the Valuation Officer with a view to ascertain the fair market value of the capital asset. At present, such reference can be made when the AO is of the view that the value disclosed by the assessee is less than the fair market value. In some cases it is held that when the assessee exercises his option to substitute fair market value of the capital asset as on 1-4-1981, for the cost of the asset, and if the AO is of the view that such market value as declared by the assessee was more, he cannot make a reference to the Valuation Officer. To overcome this position, this amendment provides that w.e.f. 1-7-2012 the AO can make such reference to the Valuation Officer. This amended provision will apply w.e.f. 1-7-2012 but will have retroactive effect, inasmuch as, the AO can make such a reference to the Valuation Officer in respect of all pending assessments of earlier years. 36. Exemptions from Capital Gains for transfer of residential house property u/s54 Applicability Asset Transferred Nature of the Asset New Asset to be acquired Amount to be invested in New Asset Amount of Exemption Individual / HUF Residential House Property Long Term Capital Asset Residential House Property Long Term Capital Gain on Transfer Least of: (a) Amount invested in New Residential House, or (b) Capital Gain Time Limit for Investment (a) For Purchase: Within one year before or two years after the date of transfer (b) For Construction: Within three years after the date of transfer. (a) Amount not utilized before the due date of filing return shall be kept in Capital Gain Account Scheme of a Nationalized Bank. Unutilized Amount (b) The amount should be utilized within the prescribed period. (c) Amount not utilized within the prescribed period shall be treated as LTCG of the Previous Year in which prescribed period expires. Three years from the date of acquisition or construction

Holding Period of New Asset

7.30 I DIRECT TAXATION

Sale of New Asset within holding period

Short Term Capital Gain computed as follows Sale Consideration of New Asset Less Cost of Acquisition reduced by Capital Gains exempted u/s 54

Illustration 21: Ravi owns a residential house which was purchased by him in 1975 for `80,000. The FMV as on 1.4.81 was ` 2,00,000. This house is sold by him on 16.7.2012 for a consideration of ` 15,00,000. The brokerage and expenses on transfer was ` 15,000. Compute Capital Gains for the Assessment Year 2013-14. If he invests ` 5,00,000 for purchase of a new house on 15.3.2013. If the HP so purchased in 15.3.2013 is again sold in 21.10.13 for ` 9 lacs, what will be the tax liability? Solution: Computation of Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Expenses on transfer Net Consideration Less : Indexed Cost of Acquisition 2,00,000 Long Term Capital Loss Less : Exemption u/s 54 Cost of New HP Purchased ` 5,00,000 (exemption restricted upto the balance of LTCG) Taxable Long Term Capital Loss ` 15,00,000 15,000 14,85,000 17,04,000 2,19,000

NIL 2,19,000

If the HP purchased in 15.3.2013 is again sold on 21.10.13 for ` 9 lacs, there arise Short Term Capital Gain. The cost of acquisition shall be adjusted to the extent of Long Term Capital Gain exemption already availed. Computation of Capital Gains for the A.Y. 2014-15 Consideration for transfer Less : Cost of Acquisition Cost of purchase Less : Exemption u/s 54 availed during A.Y. 2013-14 now withdrawn Short Term Capital Gains ` 9,00,000 5,00,000 NIL 5,00,000 4,00,000

DIRECT TAXATION I 7.31

Capital Gains 37. Exemptions available for Capital Gains on transfer of urban agricultural land u/s 54B Applicability Asset Transferred Individual Urban Agricultural Land used for agriculture by him or by his parents for two years immediately prior to the date of transfer. Finance Act, 2012 provides that even if such land was used by the HUF in which the assessee or his parent was a member, this exemption can also be claimed. Long Term or Short Term Capital Asset Agricultural Land Capital Gain on Transfer Least of: (a) Amount invested in New Agricultural Land, or (b) Capital Gain Within Two Years from the date of transfer. (a) The amount not utilized before the due date of filing return shall be kept in Capital Gain Account Scheme of a Nationalized Bank. (b) The amount should be utilized within the prescribed period. (c) Amount not utilized within the prescribed period shall be treated as LTCG of the Previous Year in which prescribed period expires. Three Years from the date of acquisition Short Term Capital Gain computed as follows: Sale Consideration of New Asset Less: Cost of Acquisition reduced by Capital Gains exempted u/s 54B Illustration 22: On 16th January 2013, Suman sold agricultural land for `22 lacs. He incurred selling expenses for `50,000. Compute Capital Gains: If the land sold, was purchased on 1st February 1995 for ` 4 lacs, and the land was used for agricultural purposes by his mother. He again purchased agricultural land of ` 8 lacs on 25th January 2013. Amount deposited in a scheduled bank under Capital Gains Deposit Scheme ` 4 lacs on 6th April 2013.

Nature of the Asset New Asset to be acquired Amount to be invested in New Asset Amount of Exemption Time Limit for Investment Unutilized Amount

Holding Period of New Asset Sale of New Asset within holding period

7.32 I DIRECT TAXATION

Solution: Computation of Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Expenses on transfer Net Consideration Less : Indexed Cost of Acquisition 4,00,000 Long-term Capital Gains Less : Exemption u/s 54B Cost of New Land purchased Less : Amount deposited in Capital Gains Account Scheme before due date of furnishing return specified u/s 139(1) ` 4,00,000 or the balance amount of Capital Gains, ` (8,34,1708,00,000) = ` 34,170 whichever is less Taxable Long Term Capital Gains 34,170 NIL ` 22,00,000 50,000 21,50,000 13,15,830 8,34,170

8,00,000

38. Exemptions available for Capital Gains on compulsory acquisition of land and building used for industrial purposes u/s 54D Applicability Asset Transferred All Assesses Land and Building used by an Industrial undertaking which is compulsorily acquired and such land and building were used for business purpose during the two years before the date of transfer Long Term or Short Term Capital Asset Land and Building for Industrial Purpose Capital Gain on Transfer Least of: (a) Amount invested in New Land and Building, or (b) Capital Gain Within Three Years from the date of transfer. (a) The amount not utilized before the due date of filing return shall be kept in Capital Gain Account Scheme of a Nationalized Bank. (b) The amount should be utilized within the prescribed period. (c) Amount not utilized within the prescribed period shall be treated as LTCG of the Previous Year in which prescribed period expires.

Nature of the Asset New Asset to be acquired Amount to be invested in New Asset Amount of Exemption Time Limit for Investment Investment of Unutilized Amount

DIRECT TAXATION I 7.33

Capital Gains Holding Period of New Asset Three Years from the date of acquisition Sale of New Asset within holding period Short Term Capital Gain computed as follows: Sale Consideration of New Asset Less Cost of Acquisition reduced by Capital Gains exempted u/s 54D Illustration 23 : ABC Ltd. purchased a building for an industrial undertaking on 1.1.06 for `5 lacs. Prior to this the company had taken this building on rent for the last 3 years and was using it for its industrial activities. There is no other building in the block. This property was compulsorily acquired by the State Government on 16.7.12 and a compensation of ` 7 lacs was given to the company on 31.3.13. The company purchased another building for shifting its Industrial undertaking for ` 4 lacs on 20th November 2013. Compute the Capital Gain for the Assessment Year 2013-14. Rate of Dep. of Building 5%. Solution: Computation of Capital Gains for the A.Y. 2013-14 Consideration for transfer Less : Cost of Acquisition WDV as on 1.4.2012 Short Term Capital Gains Less : Exemption u/s 54D Cost of Building purchased ` 4 lacs or the Short Term Capital Gains ` 3,41,643 whichever is less Taxable Short Term Capital Gains ` 7,00,000 3,58,357 3,41,643

3,41,643 NIL

7.34 I DIRECT TAXATION

Working: W.D.V as on 1.4.12: Purchase price (05-06) Less : Dep. for 2005-06 (less than 180 days) Rt. of Dep. @ 50% of 5% = 2.5% on 5,00,000 Less : Dep. for 2006-07 @ 5% Less : Dep. for 2007-08 @ 5% Less : Dep. for 2008-09 @ 5% Less : Dep. for 2009-10 @ 5% Less : Dep. for 2010-11 @5% 12,500 4,87,500 24,375 4,63,125 23,156 4,39,969 21,998 4,17,971 20,899 3,97,072 19,854 3,77,218 18,861 3,58,357 All Assessees Any Long Term Capital Asset Long Term Capital Asset Bonds redeemable after 3 years issued on or after 01.04.2007 by National Highway Authorities of India (NHAI) or Rural Electrification Corporation Limited (RECL).However, deductions against these investments, once availed u/s 54EC cannot be availed u/s 80C. Long Term Capital Gain on Transfer. Maximum amount that can be invested by the Assessee during any Financial Year is `50 lakhs Least of the followings:(a) Amount invested in bonds; or, (b) Capital Gains Within six months from the date of transfer Three years from the date of acquisition Long Term Capital Gains already exempted u/s 54EC shall be charged as LTCG of the assessee in the year of sale or creation of charge on the new asset 5,00,000

Less : Dep. for 2011-12 @5% W.D.V. as on 1.4.12 39. Exemptions from Capital Gains for investments in notified bonds u/s 54EC Applicability Asset Transferred Nature of the Asset New Asset to be acquired

Amount to be invested in New Asset

Amount of exemption Time limit for investment Holding period of new asset Sale of new asset within holding period

DIRECT TAXATION I 7.35

Capital Gains Illustration 24: Saptarshi acquired shares of G Ltd. on 15.12.99 for `5 lacs which were sold on 14.6.12 for `16 lacs. Expenses on transfer of shares ` 20,000. He invests ` 8 lacs in the bonds of Rural Electrification Corporation Ltd. on 16.10.2012. (a) Compute Capital Gain for the Assessment Year 2013-14. (b) State the period for which the bonds should be held by the assessee. What will be the consequences if such bonds are sold within the specified period? (c) What will be the consequences if Saptarshi takes a loan against the security of such bonds? Solution: Computation of Capital Gains for the A.Y. 2013-14 onsideration for transfer C Less : Expenses on Transfer Net Consideration ess : Indexed Cost of Acquisition 5,00,000 L Long-term Capital Gains Less : Exemption u/s 54EC Taxable Long-term Capital Gain ` 16,00,000 20,000 15,80,000 10,95,116 4,84,884 4,84,884 NIL

(b) Saptarshi should not transfer or convert (otherwise than transfer) into money such bonds within 3 years from the date of their acquisition. If these bonds are transfered or converted into money within 3 years, Capital Gain of `4,84,884 exempted earlier shall attract taxability towards Long-term Capital Gain of the Previous Year in which such asset is transferred or converted into money.

(c) If any loan is taken against security of such bonds, it shall be taxable as Long-term Capital Gains of the Previous Year in which such loan is taken against the security of such bonds. Illustration25: Anand sold a residential building at Kolkata for ` 25,60,000 on 1.11.2012. The building was purchased during 1979-80 for ` 1,45,000. FMV as on 1.4.81 ` 2,75,000. Brokerage paid on sales @ 2%. deposited ` 8 lakhs in NHAI Capital Gains Bond in February 2013. Compute Taxable Capital Gains. Solution: Assessee: Anand Computation of Taxable Capital Gains for the A.Y. 2013-14 Particulars Consideration for Transfer Net Consideration Less: Expenses on Transfer ( i.e. Brokerage 2% on `25,60,000) Amount (`) 25,60,000 51,200 25,08,800

7.36 I DIRECT TAXATION

Less: Indexed Cost of Acquisition = Cost of Acquisition x CII of ear of Transfer CII of the year of Acquisition = ` 2,75,000

23,43,000

Long Term Capital Gains Amount invested in NHAI Bonds `8 lakhs. Deduction restricted upto the balance of LTCG

1,65,800 1,65,800

Less: Exemption u/s 54 EC

Taxable Capital Gains

Nil

40. Exemptions from Capital Gains for transfer of any long term capital asset other than a residential house property u/s54F Applicability Asset Transferred Nature of the Asset Condition New Asset to be acquired Amount to be invested in New Asset Amount of Exemption Time Limit for Investment Individual / HUF Any Long Term Capital Asset other than Residential House Property Long Term Capital Asset On the date of transfer of the LTCA, the assessee should not own more than one Residential House Property Residential House Property Net Consideration Long Term Capital GainAmount invested in Residential House Net Consideration (a)For Purchase: Within One Year before or Two Years after the date of transfer (b)For Construction: Within Three Years after the date of transfer. Unutllized Amount (a)The amount not utilized before the due date of filing return shall be kept in Capital Gain Account Scheme of a Nationalized Bank (b)The amount should be utilized within the prescribed period (c)Amount not utilized within the prescribed period shall be treated as LTCG of the Previous Year in which the prescribed period expires Holding Period of New Asset Sale of New Asset within holding period Three Years from the date of acquisition or construction (a)Short Term Capital Gain on New Asset shall be taxed separately. (b)Long Term Capital Gain exempted u/s 54F shall be chargeable to tax as Long Term Capital Gain in the year of transfer.

Illustration 26: Bipasha purchased jewellery worth ` 2,20,000 during 1985-86. During the year 1990-91, she further purchased jewellery worth ` 3,50,000. All the jewellery was sold by her on 15.6.12. The jewellery purchased in 1985-86 was sold for ` 20 lacs and that purchased in 1990-91 was sold for ` 32 lacs. On 26.6.12 she deposited `50 lacs in Capital Gains Scheme Account.

DIRECT TAXATION I 7.37

Capital Gains On 21.10.12 withdrawing from the Deposit Account, she utilised ` 48 lacs for purchase of a residential house property in Kolkata. On the date of transfer she owns only one residential house. Solution: Computation of Capital Gains for the A.Y. 2013-14 (a) On transfer of jeweller purchased during 85-86 Consideration for transfer Less : Indexed Cost of Acquisition 2,20,000 ` 20,00,000 14,09,323 5,90,677 32,00,000

Long-term Capital Gains (b) On transfer of jewellery purchased during 1990-91 Consideration for transfer Less : Indexed Cost of Acquisition 3,50,000 Long-term Capital Gains

16,38,462 15,61,538

In order to avail the maximum benefit u/s 54F, the exemption should be computed as follows: ` Total long-term Capital Gain (5,90,677 + 15,61,538) 21,52,215 LTCG

Less: Exemption u/s 54F Note: 1. =

Cost of New House + Amount Deposited Net Consideration

]
20,69,437 82,778

21,52,215

Taxable Long-term Capital Gains

In this case, Bipasha has not fully utilised the deposit account for acquiring a residential house property. Out of ` 50 lacs deposited for acquiring the house, it is utilised to the extent ` 48 lacs. ` 2,00,000 52,00,000 21,52,215 82,778 19,86,659

Tax treatment of unutilised amount, will be as follows: (a) Unutilised amount (b) Net sale consideration (c) Original Capital Gain (d) Notional Long-term Capital Gain [ x 21,52,215 ] (e) Effective exemption u/s 54F [` 20,69,437 82,778]

7.38 I DIRECT TAXATION

` 82,778 will be chargeable to tax as Long-term Capital Gain after expiry of 3 years from the date of transfer of jewellery (i.e. 15.6.12). Consequently it will be taxable for the Assessment Year 201617. The unutilised amount of ` 2 lacs can be utilised by Bipasha at any time after 15.6.12. If Bipasha sells this new house property before 21.10.15, then ` 20,69,437 (exemption u/s 54F) will be to tax as Long-term Capital Gain of the year in which the house is sold. If Bipasha purchases another house before 15.6.14 or constructs any other house (income of which is taxable u/s 22) before 15.6.15, then ` 20,69,437 (exemption u/s 54F) will be deemed as Long-term Capital Gain of the year in which another house is purchased or constructed.

2. 3. 4.

41. Exemptions available for Capital Gains on shifting of industrial undertaking from urban to rural area u/s 54G Applicability Asset Transferred All Assesses Land and Building, Plant and Machinery used by Industrial Undertaking and shifting of such undertaking from Urban Area to Non-urban Area Any Capital Asset Land, Building, Plant and Machinery for Industrial Undertaking in Non-urban Area or to meet the expenses of shifting

Nature of the Asset New asset to be acquired

Amount to be invested in New Capital Gain on Transfer Asset Amount of Exemption Least of - (a) Amount invested in New Land and Building or New Plant and Machinery, or (b) Capital Gain Time Limit for Investment Unutilized Amount Within one year prior to the date of transfer or within three years after the date of transfer. (a)Amount not utilized before the due date of filing return shall be kept in Capital Gain Account Scheme of a Nationalized Bank. (b) The amount should be utilized within the prescribed period. (c)Amount not utilized within the prescribed period shall be treated as LTCG of the Previous Year in which the prescribed period expires. Holding Period of New Asset Three years from the date of acquisition

Sale of New Asset within holding Short Term Capital Gain computed as follows: period Sale Consideration of New Asset Less: Cost of Acquisition reduced by Capital Gains exempted u/s 54G Illustration 27: P Ltd. owns an industrial undertaking manufacturing chemicals in Bangalore owns the following assets(a) Plant and Machinery (WDV `5 lacs) sold for `15 lacs. (b) Building (WDV ` 12 lacs) sold for ` 60 lacs. (c) Furniture and Fixtures (WDV ` 50,000) sold for ` 1,80,000

DIRECT TAXATION I 7.39

Capital Gains (d) Land cost of acquisition ` 5,00,000 during 1984-85 and sold for ` 30 lacs The industrial undertaking was shifted as per policy of the Government from urban area to other area. The new assets acquired during the period 1.1.13 to 31.3.13 are as under: Plant and machinery `20 lacs; Buildings `40 lacs. Compute Capital Gain chargeable to tax for the Assessment Year 2013-14. Solution: Computation of Capital Gains for the A.Y. 2013-14 ` Short-term Capital Gains on Depreciable assets (i) Plant & Machinery (15,00,000 5,00,000) (ii) Buildings (60,00,000 12,00,000) (iii) Furniture & Fixtures (1,80,000 50,000) Long-term Capital Gains on Industrial Land: onsideration for transfer C Less : Indexed Cost of Acquisition 5,00,000 10,00,000 48,00,000 1,30,000 30,00,000 59,30,000 `

34,08,000

(4,08,000) 55,22,000

Total Capital Gains 20,00,000 40,00,000 60,00,000

Less : Exemption u/s 54G Plant & Machinery Building but restricted to ` 53,92,000 [= ` 55,22,000 1,30,000, being STCG on furniture, not eligible for the purpose of claiming exemption u/s 54G] Short Term Capital Gains (on furniture)

53,92,000

1,30,000

42. Exemption available to an undertaking which shifts its base to a special economic zone and in the course makes gain on transfer of asset u/s 54GA Applicability Asset Transferred All Assesses (a) Land and Building, Plant and Machinery or any right in Land or Building used by Industrial Undertaking. (b) Transfer as a result of shifting of such undertaking from Urban Area to Special Economic Zone (which may be situated in Urban or Any other area). Nature of the Asset Any Capital Asset

7.40 I DIRECT TAXATION

New Asset to be acquired

(a) Plant and Machinery for use in the Undertaking in the SEZ. (b)Acquired Land and Acquired/Constructed Building for purpose of business in SEZ (c) Shifted the undertaking to the SEZ. (d) Expenses incurred for such purposes as specified by under the Scheme by the Central Government is also eligible for claiming exemption.

Amount to be invested in New Capital Gain on Transfer Asset Amount of Exemption Least of: (a) Amount invested in any Land and Building or any Plant and Machinery and Expenses incurred in relation to transfer, or (b) Capital Gain Time Limit for Investment Unutilized Amount Within one year prior to the date of transfer or within three years after the date of transfer Amount not utilized before the due date of filing return shall be kept in Capital Gain Account Scheme of a Nationalized Bank. The amount should be utilized within the prescribed period. Amount not utilized within the prescribed period shall be treated as LTCG of the Previous Year in which the prescribed period expires. Holding Period of New Asset Three years from the date of acquisition Sale of New Asset within holding Short Term Capital Gain computed as follows: period Sale Consideration of New Asset Less: Cost of Acquisition Less: Capital Gains exempted u/s 54GA Illustration 28: The house property of A is compulsorily acquired by the Government for ` 10,00,000 vide Notification issued on 12.3.2005. A had purchased the house in 1986-87 for ` 2,00,000. The compensation is received on 15.4.2009. The compensation is further enhanced by an order of the court on 15.5.2012 and a sum of ` 2,00,000 is received as enhanced compensation on 21.10.2012. A wants to claim full exemption of the Capital Gains, advise A in this respect. Compute the Capital Gain and determine the year in which it is taxable. Also specify the period upto which the investment in the new house should be made by the assessee. Solution: Although the house property is compulsorily acquired on 12.3.2005, the Capital Gain will arise in the Previous Year in which full or part of the compensation is first received i.e. Previous Year 2009-10. However, indexation will be done till the year of compulsory acquisition. Therefore, Capital Gains will be calculated as under: Computation of Capital Gain for the A.Y. 2013-14 Assessment Year 2010-11 Full value of consideration Less : Indexed cost of acquisition ` 2,00,000 Long-term Capital Gain ` 10,00,000 6,85,714 3,14,286

DIRECT TAXATION I 7.41

Capital Gains The assessee should either invest at least ` 3,14,286 for the purchase/construction of a residential house property on or before 31.7.2010 (relevant due date) and /or deposit the amount under the Capital Gain Scheme on or before 31.7.2010, to be utilised for purchase of house property by 14.4.2011 and / or construction of the house property by 14.4.2012. Computation of Capital Gain for the A.Y. 2013-14 ` Enhanced compensation Received Less : Cost/Indexed cost of acquisition Long-term Capital Gain 2,00,000 Nil 2,00,000

The assessee should either invest at least ` 2,00,000 for the additional construction of a residential house property already acquired for claiming under section 54 on or before 31.7.2013 (relevant due date) and/ or deposit the amount under the Capital Gain Scheme on or before 31.7.2013 may invest ` 2,00,000 in the bonds specified under section 54EC. 43. Exemption available to an individual or HUF for investment in equity shares of sme company U/S 54GB: Applicability Asset Transferred Nature of Asset New Asset to be acquired Conditions Individual or HUF Residential Property (a house or plot of land) transferred on or before 31.03.2017 Long Term Capital Asset Equity Shares of a Small or Medium Enterprise (SME) Company (i) The investee company should qualify as a Small or Medium Enterprise under the Micro, Small and Medium Enterprises Act, 2006. (SME). (ii) The company should be engaged in the business of manufacture of an article or a thing. (iii) SME company should be incorporated within the period from 1st of April of the year in which Capital Gain arises to the assessee and before the due date for filing the return by the assessee u/s.139(1). (iv) The assessee should hold more than 50% of the share capital or the voting right after the subscription in the shares of a SME company. (v) The company will have to utilise the amount invested by the assessee in the purchase of new plant and machinery. If the entire amount is not so invested before the due date of filing the return of income by the assessee u/s.139, then the company will have to deposit the amount in the notified scheme by the Central Government. (vi) The above new plant and machinery acquired by the company cannot be sold for a period of 5 years. Long Term Capital Gain x Amount invested in Equity Shares of SME Company Net Consideration Before the due date of furnishing of Return of Income under section 139(1)

Amount of Exemption Time Limit for Investment

7.42 I DIRECT TAXATION

Holding Period of the Investment Consequence if the amount so subscribed is not utilized by the company

Five Years from the date of subscription If the amount of net consideration which has been received by the company for the issue of equity shares by the individual or HUF is not utilized by the company for the purchase of a new asset (eligible plant and machinery) before the due date of furnishing the return of income under Section 139, Capital Gain so exempted in the year of purchased is taxable. Where the amount so deposited in deposit scheme is not utilized, wholly or partly for the purchase of new asset within a period of one year from the date of subscription in equity shares by the individual or HUF, then the difference between: (a) the exemption allowed under section 54GB earlier; And

(b) the exemption that should have been allowed based on the amount actually utilized, in the purchase of new asset/ shall be taxable as Long Term Capital Gain in the hands of individual or HUF in which the period of one year from the date of subscription in equity share by the assessee expires and the company shall be entitled to withdraw such amount in accordance with the scheme, (a) If the equity shares acquired by the individual or HUF are sold or otherwise Consequence if transferred within a period of 5 years from the date of its acquisition, the equity shares or new Capital Gain shall arise as under: asset is transferred within a period of 5 (i) The Capital Gain arising from the transfer or equity shares shall be taxable years from the date in the Previous Year in which such shares are transferred, which can be of its acquisition short term or long-term depending upon the period of holding. And (ii) The amount of Capital Gain arising from the transfer of residential property not charged under section 45(1) earlier shall be deemed to be the Longterm Capital Gain of the Previous Year in which such shares are sold or otherwise transferred and hence taxable. (b) Similarly, if the new asset (eligible plant and machinery) is sold or otherwise transferred by the company within a period of 5 years from the date of its acquisition, the Capital Gain shall arise as under: (i) The Capital Gain, if any arising from the transfer of such asset will be taxable in the hands of company, which will be short-term as asset is a depreciable asset forming part of block of asset. And (ii) The amount of Capital Gain which was exempt under section 45(1) earlier shall be taxable as Long-term Capital Gain in the hands of such individual or HUF in the Previous Year in which such asset is sold or otherwise transferred. The unutilized amount should be deposited before the said due date under a deposit scheme, notified by the Central Government in this behalf and the return furnished by the assessee shall be accompanied by proof of such deposit having been made. The amount so utilized and the amount so deposited in the deposit scheme shall be deemed to be the cost of a new asset (eligible plant and machinery).

DIRECT TAXATION I 7.43

Capital Gains Illustration 29: Ravi transferred a plot of land situated in Patna for ` 70,00,000 on 14th July, 2012. The land was purchased by him on 1.2.1984 for ` 1,00,000. Ravi paid stamp duty of ` 6,00,000. On 11th December, 2012 he purchased 60,000 equity shares of T Ltd. @ ` 100 per share and thereby he gained 57% voting power of that company. T Ltd. is incorporated on 1st December, 2012 for manufacture of chemical goods in Andhra Pradesh. T Ltd. purchased new plant for ` 70,00,000 on 10th January, 2013. Find out the amount of Long Term Capital Gains chargeable to tax in the hands of Ravi. What will be the implication of tax, if on 12th December, 2013, T Ltd. sold the plant for ` 80,00,000. Solution: Assessee : Ravi Previous Year: 2012-13 Computation of Capital Gains Sale Consideration Less: Stamp duty paid Net Sale Consideration Less: Index cost of acquisition 1,00,000 Long Term Capital Gains Less: Exemption u/s 54GB 57,18,400 Taxable Long Term Capital Gains T Ltd. sold the plant for ` 80,00,000 on 12th December, 2013 Assessee : Ravi Previous Year: 2013-14 Computation of Capital Gains Sale Consideration Less: Cost of acquisition Long Term Capital Gains ` 80,00,000 70,00,000 10,00,000 Assessment Year: 2014-15 49,01,486 8,16,914 6,81,600 57,18,400 ` 70,00,000 6,00,000 64,00,000 Assessment Year: 2013-14

For Ravi, ` 49,01,846 (claimed deduction u/s 54GB in the A.Y. 2013-14) will be taxed as Long Term Capital Gain in the Assessment Year 2014-15. 44. Extension of time limit for acquiring new asset, when enhanced compensation is paid u/s 54H (a) Initial Compensation: If initial compensation is received in parts, then the entire initial compensation is taxable in the year in which a part is first received. Time limit for acquiring the new asset u/s 54, 54B, 54D, 54EC and 54F shall be determined on the basis of dates of receipt of different parts of initial compensation. (b) Enhanced Compensation: If any enhanced compensation is received, it is taxable in the year in which such compensation is received and for acquiring the new asset u/s 54, 54B, 54D, 54EC

7.44 I DIRECT TAXATION

and 54F, the time limit shall be determined from the date of receipt of additional (enhanced) compensation. Illustration 30 : Mr. Sahani was the owner of a residential house property which was purchased by him on 1.8.1981 for ` 50,000. The Government acquired the house as per notification on 1.4.2009 against the compensation of ` 10,00,000 out of which ` 6,00,000 was received by Mr. Sahani on 31st December, 2012 and ` 4,00,000 was received on 30th April, 2013. On his appeal, the court enhanced its compensation from ` 10,00,000 to ` 12,00,000. Mr. Sahani received the additional compensation on 21st January, 2016. Ascertain the amount of investment and time of investment for availing the maximum exemption u/s 54. Solution : Assessee : Mr. Sahani Previous Year : 2012-13 Computation of Capital Gain Consideration received Less: Index cost of acquisition 50,000 Long Term Capital Gain ` 10,00,000 4,26,000 5,74,000 Assessment Year : 2013-14

In order to avail the exemption u/s 54, Mr. Sahani has to purchase a house property of ` 5,74,000 or more within one year before the date of receipt of initial compensation or upto the due date of filing the Income Tax Return u/s 139 for the A.Y. 2013-14. Otherwise he can also deposit the amount in the deposit account with a nationalized bank within the due date of filing return. However in this case he has to purchase the house property within 2 years or constructed it within 3 years from the date of receipt of the part of the initial compensation, which can be shown as follows: Date of part received Amount of part received Minimum investment to get full exemption u/s 54 Date by which a house should be purchased by withdrawing from deposit account Date by which a house should be constructed by withdrawing from deposit account Additional compensation received on 21st January, 2016 : Assessee : Mr. Sahani Previous Year : 2015-16 Computation of Capital Gain Consideration received Less: Cost of acquisition Long Term Capital Gain ` 2,00,000 NIL 2,00,000 Assessment Year : 2016-17 31/12/2012 6,00,000 1,74,000 31/12/2014 30/12/2015 30/04/2013 4,00,000 4,00,000 29/04/2015 29/04/2016

Ravi should purchase a new house property of ` 2,00,000 or more within one year beore the additional compensation received or upto the due date of filing the Income Tax Return u/s 139 for the A.Y. 201617. Otherwise, he can also deposit the amount in the deposit account with a nationalized bank within the due date of filing return but in this case he has to purchase the house within 20th January, 2018 or constructed it within 20th January, 2019.

DIRECT TAXATION I 7.45

Capital Gains 45. PROVISIONS RELATING TO CLAIMING OF EXMPTION IN ORDER TO REDUCE TAX LIABILITY ON SHORT TERM CAPITAL GAINS Exemption u/s 54B 54D 54G 10(37) 10(41) Applicable for Transfer of Agricultural Land Transfer by way of compulsory acquisition by Government Shifting of Industrial Undertaking from Urban to Rural Area Compulsory acquisition of Agricultural Land by Central Government/RBI. Transfer by companies engaged in Power Sector Business

46. Cost in relation to certain financial assets u/s55 Particulars of asset 1. Shares originally purchased: Date of Allotment Allotment price Amount paid + Brokerage Charges + Adjustment for ex. & cum. dividend/ interest As above (excluding Brokerage) FIFO Method FIFO Method Date of Acquisition/ Holding Cost of Acquisition Period

(a) Primary Market (b) Secondary Market (i)

Transactions through share brokers Date of brokers note Transactions between parties directly

(ii) 2. 3.

Date of contract of sale

Shares acquired in different lots at FIFO Method different points of time Shares held in depository system (taxable in hands of beneficial owner) FIFO Method

4. 5. 6.

Right shares offered to existing Date of allotment shareholders and subscribed by him Right shares acquired by a person Date of allotment by way of renouncement Renouncement of right shares in favour of another person

Offer Price Offer Price + Amount paid for renouncement

Holding period is date of of- NIL fer of such right to the date of renouncement (always STCG) Date of allotment of such financial assets 1.4.1981 NIL Fair Market Value as on 1.4.1981

7. 8.

Financial asset acquired without any payment/consideration Bonus share acquired be 1.4.81

Other Points: 1. Splitting of shares is not a transfer. 2. Debentures and Bonds are not entitled for benefit of Indexation u/s 48.

7.46 I DIRECT TAXATION

47. DIVIDEND STRIPPING enforced by Section 94(7) of the Income-tax Act, 1961. (a) Purchase: The securities or units are purchased within 3 months prior to the record date. (b) Sale: Sale or transfer is done within (I) 3 Months for Securities, and (II) 9 Months for Units, after the record date.

(c) Exempt Income: Dividend / Income on such securities/units is exempted from tax. (d) Dividend Stripping: Loss arising out of such purchase and sale is ignored to the extent of dividend income. (e) Record Date means such date as fixed by (i) A Company for the purposes of entitlement of the holder of the securities to receive dividend.

(ii) A Mutual Fund or the Administrator of the Undertaking / Company specified u/s 10(35) Explanation, for the purposes of entitlement of the holder of the units to receive income or additional units, without any consideration.

48. BONUS STRIPPING as per Section 94(8): (a) Applicability: All Assesses (b) Transaction: Any person who purchases Units (Original Units) within a period of 3 months prior to record date and sells such units within a period of 9 months after such record date. On the record date, he was allotted Bonus Units (additional units without any payment) (c) Tax Implication: (i) The loss on sale of such original units shall be ignored for the purpose of computing his income.

(ii) Loss so ignored will be deemed as the Cost of Acquisition of such additional units, on their subsequent sale/transfer.

49. Rates of capital gain tax - Section 112 (a) Short-term Capital Gain is taxed at normal rate or slab (b) Long-term Capital Gain other than gains arising out of transfer of security including Zero Coupon Bonds are taxed as follows: Kind of Assessee (a) Individual and HUF Resident Non-Resident [not covered in (d)] (b) Venture Capital Company on transfer of equity shares of Venture Capital Undertaking (c) Company [not covered in (b)] Domestic Company Foreign Company (not covered in (d)] 20% 20% Tax % 20% 20% 20%

DIRECT TAXATION I 7.47

Capital Gains (d) Offshore funds on-resident Assesses, Foreign Institutional Investors covered by Sections 115AB /115AC N /115AD (e) Any others (Firm, AOP, BOI etc.) Resident Non-Resident [not covered in (d)]

15%

20% 20%

Note: The rates given above are Basic Rates. Appropriate Surcharge, Education Cess and Secondary and Higher Education Cess are also applicable in addition to the tax rate mentioned above. (c) Long-term Capital Gain arising from transfer of security listed in a Recognized Stock Exchange, not covered by Securities Transaction Tax: (i) Compute Capital Gain without indexation and charge tax @ 10%. (ii) Compute Capital Gain with indexation and charge tax @ 20% as per Section 112 (iii) The assessee has the option to choose either of the above whichever is beneficial to him. (iv) Long Term Capital Gain arising on listed securities being Equity Shares and Units of Equity Oriented Fund

Notes : With effective from the Assessment Year 2013-2014, tax would be applicable at the rate of 10% plus Education cess and Higher Education cess in any such above cases where Long-term Capital Gain arising from transfer of security listed in a Recognized Stock Exchange, not covered by Securities Transaction Tax and no benefit of Indexation shall be available (i) No deduction shall be allowed under Chapter VIA in respect of income from Long-term Capital Gain. Applicability: Resident Individual or Resident HUF Condition: Total income excluding Long-Term Capital Gains is less than the basic exemption. Benefit: Tax on Long-term Capital Gain is determined as follows

(ii) Special Benefit for Resident Individuals or HUF

Tax on LTCG = 20% [Total Income including LTCG - Basic Exemption] Only that amount of Long-term Capital Gains which is included in the total income would be subject to tax at a prescribed flat rate u/s 112. [Cir. No.721/13.9.95} (d) Tax on Short Term Capital Gain on Listed Securities - Section 111A (w.e.f. 1.10.2005) (i) Applicability: All Assesses (ii) Source of Income: Income from Short Term Capital Gains arising from any Equity Shares of a Company or unit of an Equity Oriented Fund. The transfer has been affected on or after 1.10.2005 Such transaction is liable for Securities Transaction Tax.

(iii) Rate of Tax: 15% of Short-term Capital Gains (w.e.f 2009-10)

7.48 I DIRECT TAXATION

Notes: (i) Chapter VI-A deduction shall not be allowed in respect of income from such Short Term Capital Gain. Applicability: Resident Individual or Resident HUF Condition: Total income excluding Short -Term Capital Gains is less than the basic exemption. Benefit: Tax on Short-Term Capital Gain is determined as follows: Tax on STCG = 15% [Total Income including STCG - Basic exemption] Funds transferred on or after 1.10.2005 is exempt from tax u/s 10(38).

(ii) Special Benefits for Resident Individuals or Resident HUF

(e) Securities Transaction Tax (STT): (I) Section 98 of the Finance (No. 2) Act, 2004, providing for rates of STT has been amended w.e.f. 1-72012. The revised rates of STT in Cash Delivery Segment are reduced from 0.125% to 0.1%. Therefore, in the case of delivery-based transaction relating to equity shares of a company or units of equity oriented fund of a mutual fund entered into through a recognised Stock Exchange, the STT payable by (i) a purchaser is reduced from 0.125% to 0.1% and (ii) a seller is reduced from 0.125% to 0.1% w.e.f. 1-7-2012. (II) In order to encourage unlisted companies to get them listed in recognised Stock Exchange, it is now provided that sale of unlisted equity shares by any holder of such shares, under an offer for sale to the public included in an Initial Public Offer (IPO), if subsequently such shares are listed on the recognised Stock Exchange, will be liable for payment of STT at 0.2%. If such STT is paid, Long-term Capital Gain on such sales will be exempt from tax and tax on Short-term Capital Gain will be payable at concessional rate of 15% u/s.111A.

50. Set off and carry forward of losses under the head Capital Gains. (a) Treatment for Current Year Loss: (Section 70 &. 71) (i) Current year Short Term Capital Loss can be set off against any Capital Gain accrued during the Previous Year, but It cannot be set off against income under any other head.

(ii) Current year Long Term Capital Loss shall be set off only against Long Term Capital Gains. (i) Unabsorbed Loss under the head Capital Gains shall be carried forward for a period of 8 Assessment Years immediately following the Assessment Year in which such loss was incurred.

(b) Treatment for Carry Forward Loss: (Section 74)

(ii) The carry forward Short-term Capital Loss can be set off against any capital gains. (iii) The carry forward Long Term Capital Loss can be set off only against Long Term Capital Gains.

DIRECT TAXATION I 7.49

Study Note - 8
INCOME FROM OTHER SOURCES
This Study Note includes 8.1 Income from Other Sources - Basis of charge 8.2 Chargeable income [ Sec. 56(2) ]

8.1 INCOME FROM OTHER SOURCES - BASIS OF CHARGE [SEC. 56] This is the residual head of charge of income. Where a source of income does not specifically fall under any one of the other heads of income viz. Salaries, Income from House Property, Profits and Gains of Business or Profession and Capital Gains, such income is to be brought to charge under Sec. 56 under the head Income from Other Sources- S.G. Mercantile Corp. P. Ltd. vs. CIT 83 ITR 700(SC). This residuary head of income would be invoked only if all the following conditions are fulfilled: 1. 2. 3. There is a taxable income- Sec. 2(24) read with Sec. 4 & 5 The income is not exempt from tax under - Sec. 10 to 13A Income should not fall under any of the four specific heads of income viz. Salaries, Income from House Property, Profits and Gains of Business or Profession and Capital Gains. 8.2 CHARGEABLE INCOME [ SEC. 56(2) ] As per Sec. 56(2), the following incomes are expressly stated to be chargeable to tax under the head Income from Other Sources (i) Dividend [Sec. 56 (2) (i)] (ii) Any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or form, gambling or betting of any form or nature whatsoever [Sec. 56(2)(ib)] (iii) Any sum received by assessee from his employees as contributions to any provident fund or superannuation fund or any fund set up under the provisions of the Employees State Insurance Act, 1948 or any other fund for the welfare of the employees, if such income is not chargeable under the head Profits and Gains of Business or Profession [Sec. 56(2)(ic)]. (iv) Income by way of interest on securities, if it is not chargeable as Profits and Gains of Business i.e. where securities are held as investments [Sec. 56(2)(id)]. (v) Income from machinery, plant or furniture belonging to the assessee let on hire, if the income is not chargeable to Income-tax under the head Profits and Gains of Business or Profession [Sec. 56(2)(ii)]. (vi) Where an assessee lets on hire machinery, plant or furniture belonging to him and also buildings, and the letting of the buildings is inseparable from the letting of the said machinery, plant or furniture, the income from such letting, if it is not chargeable to Income-tax under the head Profits and Gains of Business or Profession [Sec. 56(2)(iii)]. (vii) Any sum received under Key man insurance policy including bonus, if not charged under the head Profits and Gains of Business or Profession [Sec. 56(2)(iv)].

DIRECT TAXATION I 8.1

Income from other Sources (viii) Gifts aggregating to more than ` 50,000 in a year on or after 1st Day of April, 2006 [Sec. 56(2)(vi)]. (ix) Taxation of property acquired without consideration or for an inadequate consideration as Income from Other Sources (Section 56(2)(vii)) [W.e.f. 1-10-2009] Section 56(2)(vi) provides that any sum of money (in excess of the prescribed limit of ` 50,000) received without consideration by an individual or HUF will be chargeable to Income Tax in the hands of the recipient under the head Income from Other Sources. However, receipts of money (a) from relatives or (b) on the occasion of marriage or (c) under a will or inheritance or (d) in contemplation of death of payee or donor are outside the scope of the provisions of Section 56(2)(vi) of the Income-tax Act. Similarly, anything which is received in kind having moneys worth i.e. property is also outside the purview of the existing provisions. The Act has amended Section 56 of the Income-tax Act by inserting a new clause (vii) to Section 56(2) w.e.f. 1-10-2009 to provide that the value of any property received without consideration or for inadequate consideration will also be included in the computation of total income of the recipient. Such properties will include: (i) immovable property being land or building or both, (ii) shares and securities, (iii) jewellery, (iv) archaeological collections, (v) drawings, (vi) paintings, (vii) sculptures (viii) any work of art. In a case where an immovable property is received without consideration and the stamp duty value of such property exceeds ` 50,000, the whole of the stamp duty value of such property shall be taxed as the income of the recipient. If an immovable property is received for a consideration which is less than the stamp duty value of the property and the difference between the two exceeds ` 50,000 (inadequate consideration), the difference between the stamp duty value of such property and such consideration shall be taxed as the income of the recipient. If the stamp duty value of immovable property is disputed by the assessee, the Assessing Officer may refer the valuation of such property to a Valuation Officer. In such cases, the provisions of existing Section 50C and Section 155(15) of the Income-tax Act shall, as far as may be, apply for determining the value of such property. In a case, where movable property is received without consideration and the aggregate fair market value of such property exceeds ` 50,000, the whole of the aggregate fair market value of such property shall be taxed as the income of the recipient. If a movable property is received for a consideration which is less than the aggregate fair market value of the property and the difference between the two exceeds ` 50,000, the difference between the fair market value of such property and such consideration shall be taxed as the income of the recipient. It has also been provided that: (a) The value of moveable property shall be the fair market value as on the date of receipt in accordance with the method prescribed; and (b) In the case of immovable property, the value of the property shall be the stamp duty value of the property. (c) Relative shall have the meaning assigned to it in the Explanation to Clause (vi) of Section 56(2). Further, Section 56(2)(vii) shall not apply to any sum of money or any property received (a) from any relative; or (b) on the occasion of the marriage of the individual; or (c) under a will or by way of inheritance; or

8.2 I DIRECT TAXATION

(d) in contemplation of death of the payer or donor, as the case may be; or (e) from any local authority as defined in the Explanation to Subsection 20 of Section 10; or (f) from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in Subsection 23C of Section 10; or (g) from any trust or institution registered under Section 12AA; or (h) an HUF received money or any property from its members. It may, however, be noted here that as per Section 64(2), if a member of the HUF converts his separate property into the property belonging to the family otherwise than for adequate consideration, the income derived from the converted property shall be deemed to arise to the individual and not the family. Section 2(24) relating to definition of income amended: The Act has inserted Clause (xv) to Section 2(24) to provide that any sum of money or value of property referred to in Section 56(2)(vii) shall also form part of income. Cost of disquisition of the property required in a manner given under Section 56(2)(vii): The Act has inserted Sub-section (4) to Section 49 to provide that where the Capital Gain arises from the transfer of a property, the value of which has been subject to Income-tax under Section 56(2)(vii), the cost of acquisition of such property shall be deemed to be the value which has been taken into account for the purposes of the said Clause (vii).

Related amendments: 1.

2.

(x) Share Premium in excess of the Fair Market Value to be treated as income [Section 56(2) (viib)] [W.e.f. A.Y. 2013-14] In Finance Act, 2012 a new Clause (viib) has been inserted to Section 56(2) to provide that where a company, not being a company in which the public are substantially interested, receives, in any Previous Year, from any person being a resident, any consideration for issue of shares and if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to Income-tax under the head Income from Other Sources. However, the above provision shall not apply where the consideration for issue of shares is received: (a) by a Venture Capital Undertaking from a Venture Capital Company or a Venture Capital Fund; or (b) by a company from a class or classes of persons as may be notified by the Central Government in this behalf. Further, an opportunity has been provided to the company to substantiate its claim regarding the fair market value. Accordingly, an Explanation has been inserted to the above Sub-clause to provide that for the purpose of this clause the fair market value of the shares shall be the value(a) as may be determined in accordance with such method as may be prescribed; or (b) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets, being goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature (i.e. the value shall be determined as per the net asset method including the value of intangible assets which are specified) whichever is higher.

(xi) Interest received on delayed compensation or enhanced compensation shall be deemed to be income of the year in which it is received [Section 56(2)(viii), Section 57(iv) and Section 145A] [W.e.f. A.Y. 2010-11]

DIRECT TAXATION I 8.3

Income from other Sources The existing provisions of Income-tax Act provide that income chargeable under the head Profits and Gains of Business or Profession or Income from Other Sources, shall be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Further, the Honble Supreme Court, in the case of Rama Bai vs. CIT (1990) 181 ITR 400 (SC) has held that arrears of interest computed on delayed or enhanced compensation shall be taxable on accrual basis. This has caused undue hardship to tax payers. With a view to mitigating the hardship, the following changes have been made in this regard: (1) Clause (b) to Section 145A inserted: The Act has amended Section 145A to provide that the interest received by an assessee on compensation or enhanced compensation shall be deemed to be his income for the year in which it is received, irrespective of the method of accounting followed by the assessee. (2) Interest on compensation or on enhanced compensation to be taxed under other sources: Clause (viii) in Sub-section (2) of Section 56 has been inserted to provide that income by way of interest received on compensation or on enhanced compensation referred to in Subclause (b) of Section 145A shall be assessed as Income from Other Sources in the year in which it is received. (3) 50% deduction to be allowed from such interest: Clause (iv) has been inserted to Section 57 to provide that in the case of income of the nature referred to in section 56(2)(viii), a deduction of a sum equal to 50% of such income shall be allowed and no deduction shall be allowed under any other clause of this section.

Some important items of income stated above are hereunder discussed : DIVIDEND [Sec. 56(2)(i)] Dividend means the sum paid to or received by a shareholder proportionate to his shareholding in a company out of the total sum distributed. The definition of Dividends under Section 2(22) is an inclusive definition and it means dividend as normally understood and include in its connotation several other receipts set out in the definition- Kantilal Manilal vs. CIT 41 ITR 275(SC).

Dividend

Dividend Received

Dividend

Taxability of Dividend Received

Taxability of Deemed Dividend Received

8.4 I DIRECT TAXATION

The term Dividends includes deemed dividends of the following nature : (i) Any distribution of accumulated profits entailing the release of companys assets - Sec. 2(22)(a). (ii) Any distribution of debenture stock, deposit certificates to shareholders and bonus to preference shareholder - Sec. 2(22)(b). (iii) Any distribution to shareholders on liquidation of company to the extent to which the distribution is attributable to the accumulated profits of the company, other than distribution in respect of any share issued for full cash consideration where the shareholder is not entitled to participate in the surplus assets in the event of liquidation - Sec. 2(22)(c). (iv) Any distribution on reduction of share capital to the extent to which the company possesses accumulated profit except a distribution in respect of any share issued for full cash consideration where the shareholder is not entitled to participate in the surplus asset in the event of liquidation Sec. 2(22)(d). (v) Any payment by way of advance or loan by a closely held company to : (i) (a) a shareholder, being a person who is the beneficial owner of shares (other than shares entitled to a fixed rate of dividend) holding not less than 10% of voting power; or (b) any concern in which such shareholder is a member or partner and in which he has a substantial interest; or (c) a person acting on behalf or for the individual benefit of any such shareholder - Sec. 2(22)(e)] An advance or loan to a shareholder of the said concern in the ordinary course of the business of the company where the lending of money is a substantial part of the companys business will not be regarded as dividend.

Note:

(ii) Any payment made by a company on purchase of its own shares from a shareholder in accordance with Sec. 77A of the Companies Act, 1956, is not treated as dividend. (iii) Distribution of shares by the resulting company to the shareholder of the demerged company is also not to be treated as dividend. Dividend exempt (i) Dividend declared/distributed/paid by domestic company including deemed dividend (i.e. other than the dividend u/s. 2(22)(e) or dividend from a foreign company) is exempt in the hands of shareholder. However, the company has to pay dividend distribution tax on it under Section 115-O [Sec. 10(34)]

(ii) any dividend : (a) on units of a Mutual Fund specified under Clause (23D); or (b) in respect of units from the Administrator of the specified undertaking; or (c) in respect of units from the specified company [Sec. 10(35)] EMPLOYEES CONTRIBUTIONS TO PROVIDENT FUND ETC, [Sec. 56(2)(IC)] It has to be remembered that any sum received by the assessee from his employees as contributions to any provident fund or superannuation fund or any fund set up under the provisions of the Employees State Insurance Act, 1948 or any other fund for the welfare of such employees is income in the hands of the assessee and is chargeable as Income from Other Sources if not chargeable as Profits and Gains on Business or Profession [Sec. 2(24)(x)] However, the tax payer is entitled to deduction of the sum of such contributions received from his employees if such sum is credited by the taxpayer to the employees account in the relevant fund on or before the due date. Here, the due date means the date by which the assessee is required as an

DIRECT TAXATION I 8.5

Income from other Sources employer to credit an employees contribution to the employees account in the relevant fund under an Act, rule, etc. issued in that behalf [Sec. 36(1)(va)]. Therefore, any sum received by the assessee from his employees as contributions to any fund as aforesaid and is not deposited or deposited belatedly to the employees account, it becomes income of the assessee. INTEREST ON SECURITIES Interest on securities is chargeable as Income from Other Sources if it is not chargeable as Profits and Gains of Business or Profession, i.e. when the securities are held as investment. (a) Basis of Charge If the books of account are maintained on cash basis the interest on securities will be chargeable on receipt basis. However, where books of account are maintained on mercantile system or where no method of accounting is regularly employed by the assessee, such interest will be chargeable on accrual basis i.e. as the income of the Previous Year in which such interest is due to the assessee Second Proviso to Sec. 145(1). (b) Interest on Securities ExemptThe interest on securities of the following description is exempt from tax (i) Interest on notified securities, bonds or certificates issued by the Central Govt. Interest on Post Office Savings Bank Account will be exempted only to the extent of ` 3,500 in case of an individual and ` 7,000 in case of joint account w.e.f. AY 2012-13

(ii) Interest to an individual or a HUF on 7% Capital Investment Bond or on notified Relief Bonds. (iii) Interest to non-resident Indians on notified bonds. (iv) Interest on securities held by Issue Department of the Central Bank of Ceylon. (v) Tax planning - Taxpayer is entitled to the deduction of any reasonable sum paid as commission or remuneration to a banker or any other person for the purpose of realizing interest on securities. Similarly, he will also be entitled to the deduction of interest on capital borrowed for investing in securities.

INCOME FROM INSEPARABLE LETTING OF MACHINERY, PLANT OR FURNITURE WITH BUILDING If an assessee lets on hire machinery, plant or furniture and also buildings and the letting of building is inseparable from the letting of machinery, plant or furniture, the income from such letting would be chargeable to tax under the residuary head where it is not chargeable under the Profits and Gains of Business or Profession. What is therefore, necessary to examine is whether the letting is by way of business. Whether a particular letting is of business has to be decided in the circumstances of each case. Each case has to be looked at from a businessmans point of view to find out whether the letting was the doing of business or the exploitation of his property by the owner. A commercial asset is only an asset used in a business and nothing else, and business may be carried on with practically all things. Therefore, it is not possible to say that a particular activity is business because it is concerned with an asset with which trade is carried on- Sultan Bros. (P) Ltd. vs. CIT (1964) ITR 353 (SC). Example : Mr. A let out his building along with air conditioning plant, tube-wells, refrigerators, etc. Though separate rent is fixed in the lease deed refers to them collectively as demised premise, it will be a case of inseparable letting and the entire rental income will be assessable as Income from Other Sources. GIFT Now gift received during the Previous Year shall be included in the income if the aggregate of the gifts received exceeds ` 50,000.

8.6 I DIRECT TAXATION

However, the following gifts are not included in taxable income, viz. (a) from any relative; or (b) on the occasion of the marriage of the individual; or (c) under a will or by way of inheritance; or (d) in contemplation of death of the payer; or (e) from any local authority as defined in the Explanation to clause (20) of section 10; or (f) from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in Sub-section (23C) of Section 10; or (g) from any trust or institution registered under Section 12AA; or (h) received money or any property by an HUF from its members. For these purposes of this clause, relative means (i) spouse of the individual; (ii) brother or sister of the individual; (iii) brother or sister of the spouse of the individual; (iv) brother or sister of either of the parents of the individual; (v) any lineal ascendant or descendant of the individual; (vi) any lineal ascendant or descendant of the spouse of the individual; (vii) spouse of the person referred to in clauses (ii) to (vi). Gifts from relatives, although exempt from tax, in respect of income earned from such a gift, provisions relating to clubbing of income apply in certain cases e.g. gift received from spouse and father-in-law. Gift from the following relatives is tax free
Brother & Spouse Sister & Spouse Brother & Spouse Sister & Spouse

Father

Mother

Relative

Father Sister & Spouse Mother Member

Brother & Spouse

INDIVIDUAL

SPOUSE

Sister & Spouse Brother & Spouse

HUF

Daughter & Spouse

Son & Spouse

DIRECT TAXATION I 8.7

Income from other Sources OTHER INCOMES INCLUDIBLE UNDER THE HEAD Apart from the incomes specified in Sec. 56(2) of the Act, as mentioned above, courts have held that incomes of the following nature will be chargeable as Income from Other Sources: Income of company in winding-up. Vijay Laxmi Sugar Mills Ltd. vs. CIT. Gratuity received by a director who is not an employee of the company- CIT vs. Lady Navajbai R.J. Tata. Interest is assessed under the head Income from Other Sources, if it not taxed as business or professional income- CIT vs. Govinda Choudhury & Sons . Interest on tax refunds- Smt. B. Seshamma vs. CIT. Interest earned prior to commencement of business - CIT vs. Modi Rubber Ltd. / Goa Carbon Ltd. vs. CIT. Interest earned on short-term investment of funds borrowed for setting up of factory during construction of factory before commencement of business has to be assessed as Income from Other Sources and it cannot be held to be non-taxable on ground that it would go to reduce interest on borrowed amount which would be capitalized - Tuticorin Alkali Chemicals & Fertilizers Ltd. vs. CIT. Tax on salary of assessee borne by payer, for whom assessee was working under a contract, under a legal obligation - Emil Webber vs. CIT Sale receipts prior to commencement of business - CIT vs. Rassi Cement Ltd. If the business as a whole is let out the income i.e. the rent, would not be liable to be assessed as income from business. If only the commercial assets are leased out the income would continue to be income from business- CIT vs. Biswanath Roy, CIT vs. Kuya & Khas Kuya Colliery Co. Reimbursement of taxes on salary Z. Zizlaw Skakuz vs. CIT Interest on employees contribution to unrecognised provident fund- CIT vs. Hyatt Interest on bank deposits of idle business funds - Collis Line P. Ltd. vs. ITO Interest deposit of share capital in bank before commencement of business Traco Cable Co. Ltd. vs. CIT Interest on realizations put by liquidator of company in fixed deposits- Vijay Lakshmi Sugar Mills Ltd. vs. CIT Interest received from Government u/s. 214/243/244/244A of the Income Tax Act, 1961- Smt. B. Seshmma vs. CIT Income from subletting of a house property by a tenant. Insurance commission, if it is not assessable as income from business. Family Pension Directors Sitting Fees for attending board meeting Income from undisclosed sources Income received after discontinuance of business Examinorship fee received by a teacher.

INCOME NOT CHARGEABLE UNDER RESIDUARY HEAD Income of the following nature will not be chargeable as Income from Other Sources but on business income I. Interest on short-term deposit with State Bank received by a cooperative society carrying on banking business- Bihar State Cooperative Bank Ltd. vs. CIT

8.8 I DIRECT TAXATION

II. III.

Income to the principal from business carried on through an agent- CIT vs. S.K. Sahana and Sons Ltd. Portion of business received by beneficiary from trust or wakf- CIT vs. P. Krishna Warier.

IV. Income from temporary letting out of business assets as a part of exploitation is to be assessable as Business Income and not as Income from Other Sources- CIT vs. Vikram Cotton Mills Ltd. INCOME FROM LETTING OF MACHINERY, PLANT OR FURNITURE The income from machinery, plant or furniture belonging to the assessee and let out on hire is chargeable as Income from Other Sources, if it is not chargeable as Profits and Gains of Business or Profession. - Sec. 56 (2) (ii). DEDUCTIONS [Sec. 57] The income chargeable under the head Income from Other Sources shall be computed after the following deductions, namely (a) In the case of dividend income and interest on securities (i) Any reasonable sum paid by way of remuneration or commission for the purpose of realizing dividend or interest, and

(ii) Interest on borrowed capital if required for investment in shares or securities. (i) Current repairs to building - Sec. 30(a)(ii;)

(b) In the case of income from machinery, plant or furniture let on hire (ii) Current repairs to machinery, plant or furniture and insurance premium - Sec.(31); (iii) Depreciation on building, machinery, plant or furniture - Sec. 32 subject to Sec.38; and (iv) Unabsorbed depreciation - Sec. 32(2).

(c) In the case of income in the nature of family pension- ` 15,000 or 33.33% of such income whichever is less. (d) In the case of income specified in Sec. 2(24)(x) i.e. deductions from employee salary for any fund, expenses of nature specified in Sec. 36(1)(va) i.e. contribution to such fund on or before the due date. (e) Any other expenditure (not being a personal or capital expenditure) expended wholly and exclusively for the purpose of earning such income. However, this deduction is not available to a foreign company in respect of dividend income. AMOUNTS NOT DEDUCTIBLE [Sec. 58] The following amounts are not deductible while computing Income from Other Sources Personal expenses of the assessee Sec. 58(1)(a)(i) Interest payable outside India on which tax has not been paid or deducted at source Sec. 58(1) (a)(ii) Salary payable outside India on which no tax has been paid or deducted at source Sec. 58(1)(a)(iii) Any sum paid on account of Wealth Tax - Sec. 58(1A). any expenditure referred to Sec. 40A i.e. excessive payment to relatives u/s. 40A(2) & 100% of cash payment where it exceeds ` 20,000 u/s. 40A(3).

Enhancement of limit for disallowance of expenditure made otherwise than by an account payee cheque or account payee bank draft for plying, hiring or leasing goods carriages in the case of transporters to ` 35,000 from the existing limit of ` 20,000 [(Section 40A(3) and (3A)] (applicable to transactions effected on or after 1-10-2009)

DIRECT TAXATION I 8.9

Income from other Sources The existing limit for other categories of payments will remain at ` 20,000 subject to the exceptions declared in Rule 6DD of the Income-tax Rules. Where an assessee has income from other sources no deduction of any expenditure or allowance in connection with such income shall be allowed under any other provisions of the Act in computing the income by way of any winnings from lotteries, crossword puzzles, races including horse races, and games Sec. 58(4). However, this prohibition will not apply to the owner of the horse maintained by him in horse race in computing his income from the activity of owning and maintaining such horses Proviso to Sec.58(4).

PROFITS CHARGEABLE TO TAX [Sec. 59] Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee and subsequently during any Previous Year he has obtained any amount or benefit in any form in respect of such loss or expenditure or trading liability, the amount or value of benefit obtained by such person shall be deemed to be Income from Other Sources. If any amount or benefit is obtained by a successor it shall be chargeable to Income-tax as income of such a successor. In short, provision of Sec. 41(1) of the Act are made applicable while computing the income of an assessee under the head Income from Other Sources, as they apply in computing the income of an assessee under the head Profits and Gains of Business or Profession. METHOD OF ACCOUNTING [Sec. 145] Income chargeable under the head Income from Other Sources shall be computed in accordance with cash system of accounting or mercantile system of accounting regularly employed by the assessee. Exception to this general rule is deemed dividend income covered by Clause (e) of Sub-section (22) of Section 2 which is chargeable to tax on payment basis as prescribed under Section 8 of the Incometax and not on the basis of method of accounting followed. Points to be noted: (i) An assessee is entitled to change his regular method of accounting by another regular method and such change can be effected in respect of a part of assesses income.- Snow White Food Products Co. Ltd. vs. CIT

(ii) Where assesses is allowed to change his method of accounting from an accounting year he is entitled to claim computation of income on changed basis.- Seth Chemical Works vs. CIT (iii) A company was regularly valuing its stock under total cost method and wanted to change the method of valuation which excluded certain expenses which were to be included under former method. The company is allowed to change method- CIT vs. Carborandum Universal Ltd. (iv) Mere circumstances that appellant should dividend income under this head in its return could not in law decide nature of dividend income. Brooke Bond & Co Ltd. vs. CIT SC.

8.10 I DIRECT TAXATION

QUESTIONS & ANSWERS ON INCOME FROM OTHER SOURCES Question 1. A Company, incorporated for the manufacture of steel, had not commenced production. The plant and machinery was in the stage of erection. During the Previous Year ending 31.3.2013, it paid interest on borrowings, amounting to ` 20 Lakhs. It also received interest of ` 1.50 Lakhs on investment in shortterm deposits of moneys not immediately required for business. The Assessing Officer assessed the interest income under other sources. Discuss the correctness of the assessment. Answer: (a) Interest on surplus funds: Interest income earned on deposits made out of surplus funds before commencement of business is taxable as Income from Other Sources. (b) In view of the above judgment, the sum received as interest on deposits shall be charged to tax under the head Income from Other Sources. (c) No part of the interest paid on the loan borrowed shall be allowed as deduction u/s 57 as the same was not borrowed wholly and exclusively for the purpose of earning such interest. Whole of such interest shall be capitalised. (d) Therefore, the action of the Assessing Officer is correct. Question 2. A Chartered Accountant handles the moneys belonging to his clients and maintains a separate account for these moneys. Part of these moneys, in excess of current requirements, is kept in deposit on which interest is earned. The Assessing Officer proposes to assess the interest income in the hands of the Chartered Accountant. How would you contest the action of the Assessing Officer? Answer: (a) Under the Chartered Accountants Act, 1949, a Chartered Accountant has to keep the monies belonging to a client in a separate bank account. He holds these funds only in a fiduciary capacity. Therefore, the Chartered Accountant cannot make use of such monies for his own benefit. (b) The beneficial interest in the monies so deposited in a separate bank account lies with the owner of the funds, i.e. the clients. Therefore, the interest accrued on such funds also belongs to the clients. (c) In view of the above, the interest do not accrue in the hands of the Chartered Accountant and hence not chargeable to tax in his hands. (d) Therefore, action of the Assessing Officer is not correct. Question 3. Discuss the correctness or otherwise of the following proposition: Kumar took part in a motorcar rally and is awarded a prize money of ` 10,000 for winning a race. He claims that the amount of ` 10, 000 is exempt from tax. Answer: (a) Winnings from motorcar rally are a return for skill and endurance. It is taxable as income. (b) In view of the above Supreme Court ruling, the amount of ` 10,000 won by Mr. Kumar shall be treated as income and chargeable to tax under the head Income from Other Sources. (c) Therefore, contention of Mr. Kumar is not correct and valid in law. Question 4. Discuss the taxability of gifts received by an Assessee. Answer: 1. 2. Applicability: Gifts received by Individual and HUF irrespective of Residential Status. Taxability: Any sum of money, aggregate value of which exceeds ` 50,000, is received during the Previous Year without consideration, by an Individual or a HUF from any person(s) on or after 1.4.2007, then the whole of the aggregate of such sum will be taxable. Exceptions: (a) Gifts received from the following persons not taxable

3.

DIRECT TAXATION I 8.11

Income from other Sources 4. From a relative, or On the occasion of the marriage of the individual, or Under a will or by way of inheritance, or In contemplation of death of the payer, or From any Local Authority, or From any Fund/Foundation/University/Educational Institution or Hospital or other Medical Institution or Trust or Institution referred u/s 10(23C), or From any Trust / Institution registered u/s 12AA, or By an HUF from its member.

(b) Gifts received in kind not taxable. Relative means: (a) Spouse of the individual, (b) Brother or sister of the individual, (c) Brother or sister of the spouse of the individual, (d) Brother or sister of either of the parents of the individual, (e) Any lineal ascendant or descendant of the individual, (f) Any lineal ascendant or descendant of the spouse of the individual, (g) Spouse of the person referred to in clauses (b) to (f) above.

Question 5. B an individual, gets ` 70,000 as a birthday gift from his Grandfather. Is the receipt taxable under the Income Tax Act? Answer : B has received the gift from his grandfather. Grandfather is a relative. Hence, the receipt is not taxable. Question 6. Discuss the taxability or otherwise of the following gifts received by H, an individual, during the Financial Year 2012-13: (a) ` 25,000 each from his four friends on the occasion of his birthday. (b) Wrist watch valued at ` 40,000 from his friend. Answer: (a) ` 1,00,000 (i.e. ` 25,000 4) from his four friends on the occasion of his birthday, is taxable as Income from Other Sources, since friends are not relatives and the amount has exceeded ` 50,000. (b) Gift in kind is not taxable. Hence, wrist watch of ` 40,000 received as a gift from friend is not taxable. Question 7. Fiona received the following gifts during the year ending 31.03.2013: (a) ` 40, 000 from her elder sister. (b) ` 60,000 from the daughter of her elder sister. (c) ` 1,25,000 from various friends on the occasion of her marriage, Discuss the taxability or otherwise of these gifts in the hands of Fiona. Answer : (a) ` 40,000 received from elder sister, is not taxable, as elder sister is a relative.

8.12 I DIRECT TAXATION

(b) ` 60,000 received from the daughter of her elder sister, is taxable, as the donor, in this case, is not a relative as per the definition of the Act. (c) ` 1,25,000 is not taxable as it is received on the occasion of her marriage. Question 8. Discuss the taxability of Family Pension. Answer : Family pension means pension received by the family members of the deceased employee. It is chargeable to tax under the head Income from Other Sources. Deduction u/s 57: Least of the following is allowed as a deduction (a) 33 1/3 % of gross pension (b) ` 15,000 Exemptions : (a) Family pension received by family members of Army personnel who are recipient of gallantry awards [Section 10(18)]. (b) Family pension received by the widow or children or nominated heirs of a member of the armed forces (including paramilitary forces) whose death has occurred in the course of operational duties [Section 10(19)]. Question 9. V. G. had placed a deposit of ` 10 Lakhs in a bank on which he received interest of ` 80,000. He had also borrowed ` 5 Lakhs from the same bank on the security of the deposit and was liable to pay ` 50,000 by way of interest to the bank. He therefore offered the difference between two amounts of ` 30,000 as Income from Other Sources. Is this correct? Answer : (a) U/s 57, any expenditure (not being capital expenditure) expended to earn income chargeable under the head Income from Other Sources will be allowed as deduction against such income. (b) Interest on Bank FD was the income in the hands of the assessee and the interest on the loan taken from bank on that deposit is not an allowable expenditure. Therefore, in the given case, the interest of ` 50,000 paid by V.G. is not allowable as deduction, and the entire interest of ` 80,000 is fully taxable. Question 10. Shrey purchased in 2003, 10,000 Shares of Hero Ltd. for ` 5 Lakhs by borrowing money from a bank. He holds them as Investments. He received dividend during the Previous Year 201213. He has paid interest of ` 85,000 on the loan to the bank during the Previous Year. Please advise Shrey, how should he deal with these facts in computing his income? Answer : (a) In computation of total income under the Income Tax Act, the expenditure incurred in relation to income, which does not form part of Total Income, shall not be allowed as deduction. [Section 14A] (b) Dividend Income is exempt u/s 10(34) and hence does not form part of Total Income. Therefore, the interest payment is not an allowable expenditure.

DIRECT TAXATION I 8.13

Income from other Sources Question 11. Mr JK gets the following gifts during the Previous Year 2012-2013. Date of Gift 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 01.07.2012 01.09.2012 01.12.2012 15.12.2012 21.12.2012 15.01.2013 31.01.2013 01.02.2013 15.02.2013 31.03.2013 Name of the Donor Gift from R, a friend, by cheque Cash gift from N, nephew Gift of diamond ring on his birthday, by a friend, C Cash gifts of ` 31,000 each made by four friends on the occasion of his marriage Cash gift made by wifes sister on house opening ceremony Cash gift from a close friend of father-in-law. Cash gift made by great-grandfather Cash gift received under the Will of a friend, who is seriously ill. Cash gift made by a business friend on his birthday Cash gifts made by three friends of ` 25,000 each Amount of Gift (` ) 50,000 1,00,000 75,000 1,24,000 51,000 1,51,000 1,51,000 1,65,000 51,000 75,000

Besides this, JK is engaged in the business of sale and purchase of retail goods. He maintains no account books. Gross turnover from retail trading is ` 35,00,000. Compute his total income for the Assessment Year 2013-2014. Answer :Computation of Taxable Income for the AY 2013-2014 Particulars 1. Income from retail trading business [Sec. 44 AD] 8% ` 35,00,000 2. Income from Other Sources (money gifts): (i) Cash gift from a friend, by cheque 50,000 1,00,000 75,000 1,51,000 51,000 75,000 7,82,000 (ii) Cash gift from nephew, not covered by the definition of relative (iii) Gift of diamond ringJewellery gift taxable (iv) Cash gifts on the occasion of marriage are not chargeable even if such gifts are made by unrelated persons (v) Cash gift made by wifes sister, a relative, not taxable (vi) Cash gift by a friend of father-in-law, unrelated person (vii) Cash gift made by great-grand father, a relative (viii) Cash gift received under Will in contemplation of death of a friend (ix) Cash gift made by a business friend on his birthday (x) Cash gifts, made by three friends, of ` 25,000 each Amount (` ) 2,80,000

Total Income

8.14 I DIRECT TAXATION

Question 12. Mr Ayan Goel receives the following gifts of money: S.No. Date of Gift Donor 1. 2. 3. 4. 5. 6. 7. 8. 31.3.2012 01.05.2012 30.07.2012 01.10.2012 15.11.2012 05.12.2012 01.01.2013 31.03.2013 Friend Brother Non-resident friend Brother-in-law Great-grandfather-in-law Cousin brother Neighbour Friend Form of Gift Amount Remarks of Gifts Cheque Bank draft Cheque Cash Cash Cash NSC-VIII Issue Cash 25,000 Cheque is 03.04.2012 50,000 30,000 10,000 40,000 21,000 On the occasion of the marriage 10,000 Maturity date 31.03.2013 10,000 encashed on

Determine the chargeability of the aforesaid gifts. Would it make any difference if the amount of gift made on 31.03.2013 is ` 10,001? Answer: Computation of Taxable Gifts for the AY 2013-2014. Particulars 1. Gift of cheque dated 31.03.2012 from a friend but encashed on 03.04.2012 is not taxable since it does not exceed ` 25,000. Chargeability is governed by the date of receipt and not by date of encashment. Gift from brother is exempt Gift from friend Gift from brother-in-lawExempt Gift from great grandfather-in-law: Exempt Gift on the occasion of the marriage Gift from neighbour Gift from friend Total Taxable Gift Case I ` Case II `

2. 3. 4. 5. 6. 7. 8.

30,000 10,000 10,000 50,000 Exempt

30,000 10,000 10,001 50,001 50,001

DIRECT TAXATION I 8.15

Study Note - 9
CLUBBING OF INCOME
This Study Note includes 9.1 Clubbing of Income

9.1 CLUBBING OF INCOME Certain provisions are included in the act as anti tax avoidance measures. Provisions for inclusion in assessees income, income of some other person, which is not at arms length, are a kind of such provisions. Such provisions arrest tax leakage likely to result from certain transactions with relatives or diversion of title without losing control over the same, etc. ENCOMPASS OF CLUBBING PROVISIONS 1 2 3 Clubbing of income where control over assets or income is retained while title is transferred Clubbing of income of relatives under certain circumstances. Clubbing of income of minor child Sections 60, 61, 64(1)(iv),(vi),(vii),(viii) Sections 64(ii) Section 64(1A)

TRANSFER OF ASSETS [ Sec. 60] Where any person transfers income without transferring the ownership of the asset, such income is taxable in the hands of the transferor. Such transfer may be revocable or irrevocable. The provision applies irrespective of the time when the transfer has been made i.e. it may be before or after the commencement of the Income-tax Act. REVOCABLE TRANSFER OF ASSETS [Sec. 61] Any income arising to any person by virtue of revocable transfer of assets is chargeable to tax as the income of transferor. For this purpose, transfer may include any settlement or agreement. The transfer is said to be revocable if it contains any provision for the re-transfer of the whole or any part of the income or assets to the transferor or a right to re-assume power over the whole or any part of the income or assets. If any settlement contains a clause for forfeiture of rights of beneficiaries under certain circumstances, the settlement will be regarded as revocable CIT vs. Bhubaneshwar Kuer 53 ITR 195 (SC). IRREVOCABLE TRANSFER OF ASSETS FOR SPECIFIED PERIOD [Sec. 62] (1) The provisions of Section 61 shall not apply to any income arising to any person by virtue of a transfer (i) by way of trust which is not revocable during the lifetime of the beneficiary, and, in the case of any other transfer, which is not revocable during the lifetime of the transferee ; or Provided that the transferor derives no direct or indirect benefit from such income in either case.

(ii) made before the 1st day of April, 1961, which is not revocable for a period exceeding six years:

DIRECT TAXATION I 9.1

Clubbing of Income (2) Notwithstanding anything contained in Sub-section (1), all income arising to any person by virtue of any such transfer shall be chargeable to Income-tax as the income of the transferor as and when the power to revoke the transfer arises, and shall then be included in his total income. TRANSFER AND REVOCABLE TRANSFER DEFINED UNDER SECTION 63 For the purposes of sections 60, 61 and 62 and of this section, (a) A transfer shall be deemed to be revocable if (i) it contains any provision for the re-transfer directly or indirectly of the whole or any part of the income or assets to the transferor, or (ii) it, in any way, gives the transferor a right to re-assume power directly or indirectly over the whole or any part of the income or assets ; (b) Transfer includes any settlement, trust, covenant, agreement or arrangement. REMUNERATION OF SPOUSE [Sec. 64(1)(ii)] An individual assessee is chargeable to tax in respect of any remuneration received by the spouse from a concern in which the individual has substantial interest. However, remuneration, which is solely attributable to technical or professional knowledge and experience of the spouse, will not be clubbed. Where both the spouses have a substantial interest in the concern and both are in receipt of the remuneration for such concern, such remuneration will be included in the total income of the husband or wife whose total income excluding such remuneration is greater. The individual is deemed to have substantial interest, if the beneficiary holds equity share carrying not less than 20% voting power in the case of a company or is entitled to not less than 20% of the profits, in any other concern, not being a company at any time during the Previous Year. INCOME FROM ASSETS TO SPOUSE [Sec. 64(1)(iv)] Where an asset (other than house property) is transferred by an individual to his or her spouse directly or indirectly otherwise than for adequate consideration or in connection with an agreement to live apart any income from such asset will be deemed to be the income of transferor. However, this section is not applicable in the following cases (a) if assets are transferred before marriage. (b) if assets are transferred for adequate consideration. (c) if assets are transferred in connection with an agreement to live apart. (d) if on the date of accrual of income, the transferee is not spouse of the transferor. (e) if property is transferred by the Karta of HUF, gifting co-parcenary property to his wife. (f) the property is acquired by the spouse out of the pin money (i.e., an allowance given to the wife by her husband for her dress and usual household expenses). INCOME FROM ASSETS TRANSFERRED TO SONS WIFE OR MINOR CHILD [Sec. 64(1)(vi)] If an individual directly or indirectly transfers the assets after 1.6.73 without adequate consideration to sons wife or sons minor child (including sons minor step child or sons minor adopted child), income arising from such assets will be included in the total income of the transferor from the Assessment Year 1976-77 onwards. INCOME FROM ASSETS TRANSFERRED TO A PERSON FOR THE BENEFIT OF SPOUSE OR MINOR CHILD [Sec. 64(1)(vii)] Where an asset is transferred by individual, directly or indirectly, without adequate consideration to a person or persons for the immediate or deferred benefits of his or her spouse or minor child, income arising from the transferred assets will be included in the total income of the transferor to the extent of such benefit. If no income is accrued out of the property transferred by an individual, then nothing will be included in the income of the individual.

9.2 I DIRECT TAXATION

INCOME FROM ASSET TRANSFERRED TO A PERSON FOR THE BENEFIT OF SONS WIFE [Sec. 64 (1)(viii)] Where an asset is transferred by an individual, directly or indirectly, or after 1.6.73 without adequate consideration to a person or an Association of Persons for the immediate or deferred benefits of sons wife, income arising directly or indirectly from transferred asset will be included in the total income of the transferor to the extent of such benefit with effect from the Assessment Year 1985-86. INCOME OF MINOR CHILD [Sec.. 64(1A)] In computing the total income of any individual, there shall be included all such income as arises or accrues to his minor child. However, income of the following types will not be included in the total income of the individual where income arises or accrues to the minor child on account of any (a) manual work done by him; or (b) activity involving application of his skill, talent or specialised knowledge and experience. Person in whose hands to be clubbed: (i) 1st year : that parent whose income is higher. Subsequent years : the same parent unless the AO is satisfied that it should be clubbed with the other parent.

(ii) Where marriage does not subsist, in the hands of the custodian parent. However, a deduction Upto ` 1,500 per minor child [Sec. 10(32)] shall be allowed against such income which is clubbed in the hands of the parent. CONVERSION OF SELF-ACQUIRED PROPERTY INTO JOINT FAMILY AND SUBSEQUENT PARTITION [Sec. 64(2)] Where a member of a HUF has converted his self-acquired property into joint family property after 21.12.1969, income arising from the converted property will be dealt with as follows :(i) For the Assessment Year 1976-77 onwards, the entire income from the converted property is taxable as the income of the transferor.

(ii) If the converted property is subsequently partitioned amongst the members of the family, the income derived from such converted property, as is receivable by the spouse and minor child of the transferor will be taxable in his hands. INCOME FROM THE ACCRETION TO ASSETS In the above mentioned cases the income arising to the transferee from the property transferred, is taxable in the hands of the transferor. However, income arising to the transferee from the accretion of such property or from the accumulated income of such property is not includible in the total income of the transferor. Thus, if Mr. A transfers ` 60,000 to his wife without any adequate consideration and Mrs. A deposits the money in a bank, the interest received from the bank on such deposits is taxable in the hands of Mr. A. If, however, Mrs. A purchases shares in a company from the accumulated interest, the dividend received by Mrs. A, will be taxable in her hands and will not be clubbed with the income of Mr. A. CLUBBING OF NEGATIVE INCOME [EXPLANATION TO Sec. 64] The income of a specified person is liable to be included in the total income of the individual in the circumstances mentioned earlier. For the purposes of including income of the specified person in the income of the individual, the word income includes a loss. RECOVERY OF TAX U/S. 60 TO 64 [Sec. 65] As per incomes belonging to Sec.s 60 to 64 to other persons are included in the total income of the assessee in such cases, by virtue of sec. 65, the actual recipient of income is liable, on the service of notice of demand, to pay the tax assessed in respect of income included in the income of other person (where the Income Tax Officer so desires).

DIRECT TAXATION I 9.3

Clubbing of Income PROBLEMS ON CLUBBING OF INCOME 1. Mrs.G holds 7% equity shares in B Ltd., where her married sister, Mrs. N also holds 14% equity shares. Mr.G is employed with B Ltd., without holding technical professional qualification. The particulars of their income for the Previous Year 2012-2013 are given as follows: (i) Gross Salary from B Ltd. (ii) Dividend from B Ltd. (iii) Income from House Property Particulars Gross Salary Taxable Salary to be included in the total income of Mrs G [Sec. 64(1)(ii)] Add: Income from House Property Add: Income from Other Sources : Dividends to Mrs G, but exempt under Sec. 10(34) Total Income Note: 1. In the instant case, Mrs. G along with his sister, holds substantial interest in B Ltd. and Mr. G does not hold professional qualification. Accordingly, remuneration of Mr.G has been included in the total income of Mrs. G. If the requisite conditions of clubbing are satisfied, clubbing provision will apply even if their application results into lower incidence of tax. 90,000 90,000 Nil 1,02,000 Income of Mr G ` 1,02,000 90,000 Income of Mrs G ` 6,000 Mr. G ` Mrs. G ` 1,02,000

Answer: Computation of Total Income of Mr. G & Mrs. G for the A.Y. 2013-2014

2.

2. Mrs. C, a law graduate, is legal advisor of L Ltd. She gets salary of ` 1,80,000. Mr. C is holding 20% shares in L Ltd. His income from business, during the Previous Year 2012-2013 is ` 4,00,000. Compute their Total Income. Answer: Computation of Total Income of Mr. C & Mrs. C for the A.Y. 2013-2014 Particulars 1. 2. Gross salary Business profits Total Income Mr. C ` 4,00,000 4,00,000 Mrs. C ` 1,80,000 1,80,000

Note: Since Mrs. C holds professional qualification, salary income is assessable in her hands.

3. Mr. B holds 5% shares in A Ltd., where his brother and nephew hold 11% and 6% shares, respectively. Mrs. B gets commission of ` 1,00,000 from A Ltd. for canvassing orders. She holds no technical/ professional qualification. Mr. B earns income of ` 5,00,000 from sugar business. Compute their Total Income for the Assessment Year 2013-14.

9.4 I DIRECT TAXATION

Answer: Computation of Total Income for the AY 2013-14 Particulars of income Income from sugar business Commission for canvassing orders from A Ltd. Total Income Mr. B ` 5,00,000 5,00,000 Mrs. B ` 1,00,000 1,00,000

Note: In the instant case, Mr. B holds 5% and his brother holds only 11% shares in A Ltd. The total of their shareholding is less than 20%. They have no substantial interest. Therefore, commission income is assessable as income of Mrs. B. (i) Shareholding of K 7% 9% 8% 5%

4. The shareholding of Mr. K and Mrs. K in S Ltd, is given as follows: (ii) Shareholding of Mrs. K (iii) Shareholding of M, brother of K (iv) Shareholding of F, father of Mrs. K Mr. K and Mrs. K are employed with S Ltd. None of them hold technical qualification. Mr. K gets salary @ ` 10,000 p.m and Mrs. K gets @ ` 12,000 p.m. Income from Other Sources: Mr. K Mrs. K ` 80,000 1,00,000

Compute total income for the Assessment Year 2013-2014 Answer: Computation of Total Income for the AY 2013-14 Particulars 1. Gross Salary Salary income of Mr. K to be included in the total income of Mrs. K as her Income from Other Sources is greater and both of them have substantial interest along with their relative in S Ltd. Income from Other Sources Total Income 80,000 80,000 Mr. K (`) 1,20,000 Mrs. K ` (`) 1,44,000 1,20,000

2. 5.

1,00,000 3,64,000

Mr. A gifts ` 4,00,000 to Mrs. A 1st February 2013. Mrs. A starts crockery business and invests ` 1,00,000 from her account also. She earns profit of ` 60,000 during the period ending on 31March 2013. How would you tax the business profits? Answer: Proportionate profits, in proportion to the gifted amount from the spouse on the first day of the Previous Year bears to the total investment in the business on the first day of the Previous Year, will be taxable in the income of the transferor spouse. As Mrs. A has started the new business, the first Previous Year will begin on the date of setting up and will end on 31st March, immediately following. Thus, the first Previous Year will consist a period of 2 months from 1st February 2013 to 31st March, 2013. Therefore, proportionate profit of ` 48,000, computed as below, will be included in the income of Mr.A:

DIRECT TAXATION I 9.5

Clubbing of Income 4,00,000 60,000 = 48,000 5,00,000

6. Mr. A gifts ` 3,00,000 to Mrs. A on 1st February 2013. Mrs. A invests the same in the existing crockery business where she has already invested ` 5,00,000. Mrs. A earns ` 3,00,000 from the business during the year 2012-2013 ending on 31st March, 2013. How would you assess the profits? Answer: The Previous Year of the existing business is April to March. On the first day of the Previous Year (i.e. 1 April 2012), total investment has come from Mrs. A account. As the proportion of the gifted amount from spouse on 1 April 2012 to the total investment in business on the same day is NIL, the whole of the profits of ` 3,00,000 for the year 2012-2013 will be included in the total income of Mrs A. From the Previous Year 2013-2014, 60% [= 3,00,000/5,00,000 100] of the business profits will be included in the total income of Mr. A.

7. Mrs. Z is the owner of the business units A and B. A unit has been started with capital contribution from Mr. Z and B unit has been started out of capital contribution from Mrs. Z. The particulars of their income for the Pre vious Year 2012-2013 are as follows: (i) Particulars Income from A unit Mrs. Z 4,00,000 Mr. Z () 6,00,000 2,50,000

(ii) Income from B unit (iii) Income from House Property How would you assess them for the Assessment Year 2013-2014? Answer :

(a) Mrs. Z is assessable on the profits from B unit. She cannot set-off the loss from A unit against the profits of B unit. Thus, she would be assessed on ` 4,00,000. (b) The loss from A unit will be included in the total income of Mr Z in view of Sec. 64(1)(iv). Income includes loss also. Mr Z is entitled to set-off business loss of As unit against Income from House Property. Thus, loss of ` 3,50,000 would be carried forward but could be set-off only against business profits.

8. Mr. Goutam, out of his own funds, had taken a FDR for ` 1,00,000 bearing interest @ 10% p.a. payable half-yearly in the name of his wife Latika. The interest earned for the year 2012-2013 of ness of packed spices which resulted in a net profit ` 10,000, was invested by Mrs. Latika in the busi of ` 55,000 for the year ended 31st March, 2013. How shall the interest on FDR and income from business be taxed for the Assessment Year 2013-2014? Answer: Where an individual transfers an asset (excluding house property), directly or indirectly to his/her spouse, other wise than for adequate consideration, or in connection with an agreement to live apart, income from such asset is included in the total income of such individual [Sec. 64(1)(iv)]. Accordingly, interest on FDR, accruing to wife, is included in the total income of her husband. However, business profits cannot be clubbed with total income of husband. Clubbing applies only to the income from assets transferred with out adequate consideration. It does not apply to the income from accretion of the transferred assets. Hence, business profit is taxable as the income of wife.

9. Sawant is a fashion designer having lucrative business. His wife is a model. Sawant pays her a monthly salary of ` 20,000. The Assessing Officer, while admitting that the salary is an admissible deduction, in computing the total income of Sawant, had applied the provisions of Sec. 64(1) and had clubbed the income (salary) of his wife in Sawants hands.

9.6 I DIRECT TAXATION

Discuss the correctness of the action of the Assessing Officer. Answer: Where an individual has got substantial interest in a concern and his spouse derives any income from such con cern by way of salary, commission, fees or by any other mode, such income is clubbed with the total income of such indi vidual [Sec. 64(1)(ii)]. However, clubbing provision does not apply if the earning spouse holds technical or professional qualification and the income is solely attributable to the application of such knowledge and experience. Salary earned by wife as model from the concern where her husband holds substantial interest is assessable as her income. Smt. Vatika carried on business with the gifted funds of her husband Mr. Dabbu. For the Previous Year ending 31.3.2013, Vatika incurred loss of ` 5 lakh which Dabbu wants to set-off from his taxable income. Answer: Funds for business were gifted by husband to wife. Accordingly, income from business should be clubbed with the income of husband [Sec. 64(1)(iv)]. Income includes loss also. Hence, husband is entitled to set-off the business loss of wife against his taxable in come.

10. Discuss whether the loss could be set-off in the following case:

DIRECT TAXATION I 9.7

Study Note - 10
SET OFF OR CARRY FORWARD AND SET OFF OF LOSSES
This Study Note includes 10.1 Introduction 10.2 Set off of loss in the Same Year 10.3 Carry forward and set off of loss in Subsequent Year 10.1 INTRODUCTION If income is one side of the coin, loss is the other side. When a person earns income, he pays tax. However, when he sustains loss, law affords him to have benefit in the form of reducing the said loss from income earned during the subsequent years. Thus, tax liability is reduced at a later date, if loss is sustained. Certain provisions govern the process of carry forward and set off of loss. This will be discussed on: 1. 2. Set off of Loss in the Same Year Carry forward and Set off of Loss in Subsequent Years i) ii) Basic Conditions for carry forward of loss. Conditions applicable to each Head of Income

As stated in Section 14 of the Act computation of total income is made under certain heads viz. (i) Salaries (ii) Income from House Property (iii) Profits and Gains of Business or Profession (iv) Capital Gains and (v) Income from Other Sources. In case computation results in to a positive figure, it is Income. Likewise, if the computation results into a negative figure, it is Loss. Therefore, there cannot be loss from the head Salary. Loss can occur from all the remaining heads. 10.2 SET OFF OF LOSS IN THE SAME YEAR For the purpose of computing total income and charging tax thereon, income from various sources is classified under the following heads: A. Salaries B. House Property C. Profits and Gains of Business or Profession D. Capital Gains E. Other Sources These five heads of income are mutually exclusive. If any income falls under one head, it cannot be considered under any other head. Income under each head has to be computed as per provisions under that head. Then, subject to provisions of Set off of Losses (Sec. 70 to Sec. 80) between the heads of income, the income under various heads has to be added to arrive at a Gross Total Income. From this Gross Total Income, deductions under Chapter VIA are to be allowed to arrive at the total income. In this part, the provisions relating to set off, carry forward and set off of losses are categorised as under:

DIRECT TAXATION I 10.1

Set off or Carry Forward and Set off of Losses Set off of losses within the same head [Section 70] Where the net result for any Assessment Year in respect of any source falling under any head of income is a loss, the assessee shall be entitled to have the amount of such loss set off against his income from any other source under the same head of income for the Assessment Year. (1) Where the result of the computation made for any Assessment Year under sections 48 to 55 in respect of any short-term capital asset is a loss, the assessee shall be entitled to have the amount of such loss set off against the income, if any, as arrived at under a similar computation made for the Assessment Year in respect of any other capital asset. (2) Where the result of the computation made for any Assessment Year under sections 48 to 55 in respect of any capital asset (other than a short-term capital asset) is a loss, the assessee shall be entitled to have the amount of such loss set off against the income, if any, as arrived at under a similar computation made for the Assessment Year in respect of any other capital asset not being a short-term capital asset. (3) Where result of the computation made for the Assessment Year in respect of speculative business is a loss, the assessee shall be entitled to have the amount of such loss set off against the income, if any, as arrived under a similar computation made for the Assessment Year in respect of speculative business only. (4) Where result of the computation made for the Assessment Year in respect of a specified business as per Section 35AD is a loss, the assessee shall be entitled to have the amount of such loss set off against the income, if any, as arrived under a similar computation made for the Assessment Year in respect of other specified business covered by Section 35AD. (5) Where any loss made in the business of owning and maintaining race horses, the assessee shall not be entitled to have the amount of such loss set off against any income except income from the business of owning and maintaining race horses. Set off of losses among different head of income [Section 71] Where the net result of the computation under any head of income in respect of any Assessment Year is a loss, the assessee shall be entitled to have such amount of loss set off against his income assessable for that Assessment Year under any other head of income. Exceptions to provisions of Sections 70 and 71 are as follows: (a) Loss from Speculation Business: Speculation transaction means a transaction in which a contract for the purchase or sale of any commodity including stocks and shares is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or scripts [Sec. 43(5)]. Loss from speculative transaction, if it is in the nature of business, can be set off only against income of another speculative business. (b) Loss under the head Long Term Capital Gains: Long Term Capital Loss arising from transfer of longterm capital assets will be allowed to be set off only against Long Term Capital Gains. Note: 1. 2. 3. Loss can be set off against deemed income. Inter head adjustment is made only when the net income computed under a head is a loss. The scheme of inter source and inter head adjustment is mandatory.

(c) Loss from owning and maintaining race horses: Loss from owing and maintaining race horses can be set off only against income of that activity. (d) Loss from lottery, card games, races, etc: No expenditure or allowance is allowed from wining from lotteries, crossword puzzles, card games etc. similarly, no loss from any lottery, card games, races, etc. is allowed to be set off from the income of such sources. [Sec. 58(4)]

10.2 I DIRECT TAXATION

(e) Loss from exempt Income: Loss incurred by an assessee from a source, income from which is exempt cannot be set off against income from a taxable source. (f) Loss from business specified in Section 35AD: Any loss arising from specified business u/s 35AD, cannot be set off against any other income. (g) Loss from business: Loss from business and profession including unabsorbed depreciation cannot be set off against Income from Salary. 10.3 CARRY FORWARD AND SET OFF OF LOSS IN SUBSEQUENT YEARS Basic conditions for carry forward of loss Section 80: loss returns In order to carry forward loss under section 72, 73, 74 and 74A, return of income to be submitted within the due date as prescribed in Section 139(1). No loss which has not been determined in pursuance of a return filed within the date in accordance with the provisions of Section 139(3) shall be carried forward under the provisions of section. The condition for filing of return in accordance with the provisions of Sec. 139(3) shall not apply to loss from House Property carried forward u/s. 71B and unabsorbed depreciation u/s. 32(2). Brought forward loss of earlier Assessment Year in accordance with Sec.s 72, 73, 74, 74A can be set off against the income of that Assessment Year and can be carried forward further, even if the return is not filed within the due date specified in Section 139(1) of the Act. CBDT has issued Circular vide No. 8 of 2001 dated 16.5.2001 clarifying that the power has been delegated to Commissioner to condone delay in filing return and carry forward losses in cases where the claim for loss does not exceed ` 10,000 for each Assessment Year and to Chief Commissioner/ Director General upto ` 1 lakh and beyond such limit CBDT will exercise the power. Conditions applicable to each head Sec. 71B: Carry forward and set off of loss from House Property Where for any Assessment Year the net result of computation under the head Income from House Property is a loss to the assessee and such loss cannot be or is not wholly set off against income from any other head of income in accordance with the provisions of Section 71 so much of the loss as has not been so set-off or where he has no income under any other head, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following Assessment Year and (i) be set off against the income from House Property assessable for that Assessment Year; and (ii) the loss, if any, which has not been set off wholly, the amount of loss not so set off, shall be carried forward to the following Assessment Year, not being more than eight Assessment Years immediately succeeding the Assessment Year for which the loss was first computed. Sec 72A: Carry forward and set off of accumulated loss in Scheme of Amalgamation or Demerger or Business Re- organization. Where there has been an amalgamation of (a) a company owning an industrial undertaking or a ship or a hotel with another company; or (b) a banking company referred to in Clause (c) of Section 5 of the Banking Regulation Act, 1949 (10 of 1949) with a specified bank; or (c) one or more public sector company or companies engaged in the business of operation of aircraft with one or more public sector company or companies engaged in similar business.

DIRECT TAXATION I 10.3

Set off or Carry Forward and Set off of Losses Accumulated loss and the unabsorbed depreciation of such company shall be deemed to be the loss of such amalgamated company for the Previous Year in which the Scheme of Amalgamation was brought into force if the following conditions are satisfied: 1. The amalgamating company should have been engaged in the business for three years or more. 2. The amalgamating company should have continuously held at least three-fourths of the book value of fixed assets for at least two years prior to the date of amalgamation. 3. The amalgamated company will hold continuously for a period of five years at least three-fourths of the book value of the fixed assets of the amalgamated company acquired on amalgamation. 4. The amalgamated company will continue the business of the amalgamated company for a period of at least 5 years. 5. The amalgamated company, which has acquired an industrial undertaking of the amalgamated company by way of amalgamation, shall achieve the level of production of at least 50% of the installed capacity of the amalgamated industrial undertaking before the end of four years from the date of amalgamation and continue to maintain the minimum level of production till the end of five years from the date of amalgamation [ this condition may be relaxed by Central Government on an application made by the amalgamated company]. 6. The amalgamated company shall furnish a certificate in Form 62, duly verified by an accountant, to the Assessing Officer. If any of the aforesaid conditions are not fulfilled, then the amount of brought forward business loss or unabsorbed depreciation so set off in any Previous Year in the hands of the Amalgamated Company will be deemed to be the income chargeable to tax, the hands of that Amalgamated Company, for the year in which such conditions are not fulfilled. In case of Demerger, the amount of set off of the accumulated loss and unabsorbed depreciation, if any, allowable to the assessee being a resulting company shall be (i) the accumulated loss or unabsorbed depreciation of the demerged company if the whole of the amount of such loss or unabsorbed depreciation is directly relatable to the undertakings transferred to the resulting company; or (ii) The amount which bears the same proportion to the accumulated loss or unabsorbed depreciation of the demerged company as the assets of the undertakings transferred to the resulting company bears to the assets of the demerged company if such accumulated loss or unabsorbed depreciation is not directly relatable to the undertakings transferred to the resulting company. Unabsorbed loss can be carried forward for the unexpired period of out of total 8 years. Conditions specified in Section 72A are applicable to amalgamation only and not to demerger. However, the Central Government may, for the purposes of this section, by notification in the Official Gazette, specify such other conditions as it considers necessary to ensure that the demerger is for genuine business purposes. In case of Business Re-organisation, set off of the accumulated loss and unabsorbed depreciation, if any, allowable to the assessee being the successor company for a period of 8 years commencing from the Previous Year of such business re-organisation. Sec 72AA: Provision relating to carry forward and set off of accumulated loss and unabsorbed depreciation allowance in a scheme of amalgamation of banking company in certain cases Notwithstanding anything contained in Section 72(2)(1B)(i)to (iii) where there has been an amalgamation of a banking company with any other banking institution under a scheme sanctioned and brought into force by the Central Government under Sec 45(7)of Banking Regulation Act , 1949 the accumulated loss and the unabsorbed depreciation of such banking company shall be deemed to be the loss or, as the case may be, allowance for depreciation of such banking institution for the Previous Year in which the scheme of amalgamation was brought into force and other provision of this Act relating to

10.4 I DIRECT TAXATION

set off and carry forward of loss and allowance for depreciation shall apply accordingly. In this case conditions u/s 2(1B) or 72A may or may not be satisfied. For the purposes of this section: (i) Accumulated loss means so much of the loss of the amalgamating banking company, under the head Profits and Gains from Business (not being a loss sustained in a speculation business) which such amalgamating banking company, would have been entitled to carry forward and set off under the provision of Section 72 if the amalgamation had not taken place;

(ii) Banking company shall have the same meaning as assigned to it in Sub-section (15) of Section 45(15) of the Banking Regulation Act, 1949. (iii) Banking institution shall have the same meaning as assigned to it in Sub-section (15) of Section 45(15) of the Banking Regulation Act, 1949. (iv) Unabsorbed depreciation means so much of the allowance for depreciation of the amalgamating banking company which remains to be allowed and which would have been allowed to such banking company if amalgamation had not taken place. Reverse Merger One may see that Sec. 72A is an exception of the general rule that the benefit of carry forward of loss and unabsorbed depreciation allowance is available to the same person who incurred the loss or suffered depreciation. However, one may also find that Sec. 72D is not available to him as the entity in which the loss is incurred does not qualify as an industrial undertaking or that some of the conditions of Sec. 72D are onerous to fulfil. Therefore, to get over these problems, the concept of reverse merger gained momentum. Under a normal merger, it is a sick industrial undertaking that is wound up and merged with a healthy undertaking. Under a reverse merger, a healthy company is merged with the sick company that has losses and unabsorbed depreciation allowances carried forward. Thus, the profits of the healthy company after amalgamation will be available for set off to the losses and unabsorbed depreciation allowances. The sick company that incurred the losses and suffered depreciation allowance will be the same person as the person who will carry them forward and adjust against the profits. Thus, Sec. 72D will not apply and the purpose of set off of losses and unabsorbed depreciation allowances will still be achieved. Based on facts in given cases the route merger of reverse merger will suit some companies. Sec. 72AB: Provisions relating to carry forward and set off of accumulated loss and unabsorbed depreciation allowance in Business Re-organisation of Co-operative Banks (1) The assessee, being a successor co-operative bank, shall, in a case where the amalgamationhas taken place during the Previous Year, be allowed to set off the accumulated loss and the unabsorbed depreciation, if any, of the predecessor co-operative bank as if the amalgamation had not taken place, and all the other provisions of this Act relating to set off and carry forward of loss and allowance for depreciation shall apply accordingly. (2) The provisions of this section shall apply if (a) the predecessor co-operative bank (i) has been engaged in the business of banking for three or more years; and (ii) has held at least three-fourths of the book value of fixed assets as on the date of the business re-organisation, continuously for two years prior to the date of business re-organisation; (i) holds at least three-fourths of the book value of fixed assets of the predecessor cooperative bank acquired through business re-organisation, continuously for a minimum period of five years immediately succeeding the date of business re-organisation;

(b) the successor co-operative bank

DIRECT TAXATION I 10.5

Set off or Carry Forward and Set off of Losses (ii) continues the business of the predecessor co-operative bank for a minimum period of five years from the date of business re-organisation; and (iii) fulfils such other conditions as may be prescribed to ensure the revival of the business of the predecessor co-operative bank or to ensure that the business re-organisation is for genuine business purpose.

(3) The amount of set-off of the accumulated loss and unabsorbed depreciation, if any, allowable to the assessee being a resulting co-operative bank shall be, (i) the accumulated loss or unabsorbed depreciation of the demerged co-operative bank if the whole of the amount of such loss or unabsorbed depreciation is directly relatable to the undertakings transferred to the resulting co-operative bank; or

(ii) the amount which bears the same proportion to the accumulated loss or unabsorbed depreciation of the demerged co-operative bank as the assets of the undertaking transferred to the resulting co-operative bank bears to the assets of the demerged co-operative bank if such accumulated loss or unabsorbed depreciation is not directly relatable to the undertakings transferred to the resulting co-operative bank.

(4) The Central Government may, for the purposes of this section, by notification in the Official Gazette, specify such other conditions as it considers necessary, other than those prescribed under Subclause (iii) of Clause (b) of Sub-section (2), to ensure that the business re-organisation is for genuine business purposes. (5) The period commencing from the beginning of the Previous Year and ending on the date immediately preceding the date of business re-organisation, and the period commencing from the date of such business re-organisation and ending with the Previous Year shall be deemed to be two different Previous Years for the purposes of set off and carry forward of loss and allowance for depreciation. (6) In a case where the conditions specified in Sub-section (2) or notified under Sub-section (4) are not complied with, the set off of accumulated loss or unabsorbed depreciation allowed in any Previous Year to the successor co-operative bank shall be deemed to be the income of the successor cooperative bank chargeable to tax for the year in which the conditions are not complied with. Section 73A: Set of off loss of the specified business (w.e.f A.Y. 2010-11) With reference to newly inserted Section 35AD (w.e.f A.Y. 2010-11), any loss computed in respect of the specified business shall not be set off except against profits and gains, if any, of any other specified business. To the extent the loss is unabsorbed the same will be carried forward for set off against profits and gains from any specified business in the following Assessment Year and so on. Section 71B 32(2) 72 73 73A 74 74A Losses Brought forward loss from House Property Brought forward unabsorbed depreciation Carried forward and set-off of business losses other than speculative business. Losses in speculation business. Brought forward loss from Specified Business u/s 35AD Losses under the head Capital Gains. Losses from owning and maintaining race horses.

10.6 I DIRECT TAXATION

Sec. 32(2) 71B

Nature of loss Brought forward unabsorbed depreciation Brought forward loss from House Property Brought forward unabsorbed business loss other than Speculation Loss

Details of set off Set off against any head of income Set off only against income from House Property Set off only against income under the head Profits and Gains of Business or Profession.

72

73

Brought forward unabsorbed Speculation Business Loss

Set off only against income under Speculation Business

73A

74

Brought forward unabsorbed loss from Specified Business u/s 35AD Brought forward unabsorbed loss under the head Capital Gains.

Set off only against income from any other Specified Business only Set off only against income under the head Capital Gain.

Conditions / Exceptions Unabsorbed depreciation loss can be carried forward for any number of years until it is fully set off. Carry forward and set off is permissible for 8 Assessment Years immediately succeeding the Assessment Year for which such loss was computed 1. Carry forward and set off is permissible for 8 Assessment Years immediately succeeding the Assessment Year for which the loss was computed. 2. Loss can be carried forward only if the return is filed u/s 139(1) and it is determined and communicated u/s 157. 1. Carry forward and set off is permissible for 4 Assessment Years immediately succeeding the Assessment Year for which the loss was computed. 2. Loss can be carried forward only if the return is filed u/s 139(1) and it is determined and communicated u/s 157. Carry forward for any number of years until it is fully set off 1. Carry forward and set off is permissible for 8 Assessment Years immediately succeeding the Assessment Year for which the loss was computed. 2. STCL can be set off against any Capital Gain. However, LTCL can be set off only against LTCG. 3. Loss can be carried forward only if the return is filed u/s 139(1) and it is determined and communicated u/s 157. 1. Carry forward and set off is permissible for 4 Assessment Years immediately succeeding the Assessment Year for which the loss was computed. 2. Loss can be carried forward only if the return is filed u/s 139(1) and it is determined and communicated u/s 157.

74A

Brought forward unabsorbed loss from activity of owning and maintaining race horses

Set off only against income from owning and maintaining race horses

Special provisions Section 78(1) : Where a change has occurred in the constitution of the firm, the firm shall not be entitled to carry forward and set off so much of the loss proportionate to the share of a retired or deceased partner remaining unabsorbed. This restriction shall not apply to unabsorbed depreciation. Change in constitution of the firm for the purpose of this section takes place

DIRECT TAXATION I 10.7

Set off or Carry Forward and Set off of Losses If one or more of the partners cease to be partners due to retirement or death of anyone or more partners, in such circumstances that one or more of the persons who were partners of the firm before the change, continue as partner or partners after the change (provided the firm is not dissolved on the death of any of its partners). This section does not cover change in constitution of the firm due to change in the profit sharing ratio or admission of new partners. Section 78(2) : Where any person carrying on any Business or Profession has been succeeded in such capacity by another person otherwise than by inheritance, then the successor cannot have the loss of predecessor carried forward and set off against his income. Section 79 : Losses (other than unabsorbed depreciation) in case of closely held company: In case of a company in which public are not substantially interested (defined in Sec. 2(18) of the Act), the unabsorbed business loss relating to any Assessment Year can be carried forward and set off against the income in a subsequent Assessment Year only if the shares of the company carrying not less than 51% of the voting power were beneficially held by the same persons both on the last day of the Previous Year(s) in which the loss claimed to be set off and on the last day of the Previous Year in which loss was incurred. Exceptions: The provisions stated supra shall not apply if (a) the change in the voting power takes place due to the following reasons : (i) the death of a shareholder; or (ii) transfer of shares by way of gift to any relative of the shareholder making such gift.

(b) W.e.f. AY 2000-01, this section shall not apply to any change in the shareholding of an Indian company which is subsidiary of a foreign company arising as a result of amalgamation or demerger of a foreign company subject to the condition that 51% of the shareholders of the amalgamating or demerged foreign company continue to remain the shareholders of the amalgamated or the resulting foreign company. Notes: Unabsorbed business losses can be carried forward and set off against profits from any business from A.Y. 2000-01. There is no need to continue the same business in which the loss was incurred. For example: FY 2010-2011 Shareholders and their holding of shares with Amount of business profit/loss voting power as at close of each year Profit 200,000 Ali 11% Bony 19% Cady 30% Dany 40% Loss 100,000 Ali 5% Bony 29% Cady 30% Dany 36% Profit 400,000 Adi 5% Sony 19% Rani 26% Dany 51%

2011-2012

2012-2013

10.8 I DIRECT TAXATION

In this case, the loss of financial year 2011-12 will not be set off against the profit of financial year 201213 since the persons, Bony and Cady, or Bony and Dany or Cady and Dany who hold between them as a pair 51% shares as at the end of financial year 2011-12 do not hold 51% shares at the end of financial year 2012-13. Order of Priority in carry forward and set-off of losses Depreciation can be carried forward and set off against the profits from any business in the succeeding AssessmentYearupto A.Y. 2001-02. The business in which the loss was incurred need not be continued in that year. The effect of depreciation and business loss should be given in the following order: Current years Depreciation Unabsorbed Business loss Unabsorbed Depreciation

A return of loss is required to be furnished for determining the carry forward of such losses, by the due date prescribed for different assesses under section 139(1) of the Act. (Sec. 80).

DIRECT TAXATION I 10.9

Set off or Carry Forward and Set off of Losses PROBLEMS ON SET-OFF AND CARRY FORWARD OF LOSSES 1. Following are the particulars of the income of Mr. Srikant for the Previous Year 2012-2013 ` 1. Income from House Property (a) Property R (b) Property J 2. Profits and Gains from Business: (A) Non-speculation: (i) Business X (ii) Business Y (B) Speculation: (i) Silver (ii) Bullion 3. Capital Gains: (i) Long-term Capital Gains (ii) Short-term Loss 4. Income from Other Sources: (i) Card games-loss (ii) From the activity of owing and maintaining race horses: (a) Loss at Mumbai (b) Profit at Kolkata (iii) Dividend from Indian companies (iv) Income by letting out plant and machinery The following losses have been carried forward: (i) Long-term Capital Loss from the Assessment Year 2008-2009 (ii) Loss from silver speculation from the Assessment Year 2009-2010 and which was discontinued in the Assessment Year 2010-2011 Compute the Gross Total Income for the Assessment Year 2013-2014. (+) 12,000 (-) 20,000

40,000 (-) 50,000 40,000 (-) 10,000 (+) 30,000 (-) 10,000 (-)10,000 (-) 50,000 (+) 40,000 10,000 1,11,000 18,000 25,000

10.10 I DIRECT TAXATION

Solution: Computation of Gross Total Income for the Assessment Year 2013-2014 Particulars 1. Income from House Property (+ 12,000 - 20,000) 2. Profits from speculation: (i) Profit from Silver Business Less: Current year loss from bullion Less: Carried forward silver speculative loss Surplus from Speculation Business (ii) Add: Business profit from X business (iii) Less: Business loss from Y business 3. Capital Gains: Long-term Capital Gains Less: Short-term Capital Loss Long-term Capital Gain 4. Income from Other Sources: (i) Income by letting out plant and machinery (ii) Card game-loss Neither it can be set-off nor it can be carried forward (iii) Profit from race horses at Kolkata Less: Loss from race horses at Mumbai Less: to be carried forward for next four Assessment Year (iv) Dividend from Indian companies: Exempt under Sec. 10(34) Aggregated income after setting-off current year losses from house property, profit and business against income from other sources: Less : Carried forward Long-term Capital Loss, from the Assessment Year 2008-2009 to be set-off against Long-term Capital Gains Gross Total Income or total income as there is no deduction available from GTI ` ` (-) 8,000

40,000 (-) 10,000 30,000 (-) 25,000 5,000 40,000 (-) 50,000 30,000 (-) 10,000 20,000

(-) 5,000 20,000

10,000 (+)40,000 (-) 50,000 (-) 10,000

1,11,000

Nil 1,18,000 18,000 1,00,000

Unabsorbed business loss may be set-off against the income of any other head except salaries and winnings from lottery, card games, crossword puzzle, betting on race horses, etc.

2. Mr. Dey furnishes the following particulars of his income for the Previous Year 2012-2013: Particulars ` (-) 4,00,000 (-) 2,00,000 10,00,000 2,00,000 Unit A: Business loss Unabsorbed depreciation Unit B: Business profit Income from House Property Apart from the above mentioned, the following are unabsorbed Carried forward losses and allowance: Unit C business was discontinued on 31-12-2006: 1. Business loss 2. Unabsorbed depreciation These are occurred during the Previous Year 2006-2007 Unit D business was discontinued on 1-3-2008: 1. Business loss 2. Unabsorbed depreciation These are occurred during the Previous Year 2007-2008

(-) 3,00,000 (-) 2,00,000 (-) 3,00,000 (-) 1,00,000

DIRECT TAXATION I 10.11

Set off or Carry Forward and Set off of Losses Compute his total income for the Assessment Year 2013-14. Solution: Computation of Total Income for the AY 2013-2014 Particulars Income from House Property Business - Profession Profit of B Business Less: Business loss of A Business Depreciation of A Business Aggregated Income Less: Carried forward business loss: (i) Loss of C Business to be set-off against business profits (ii) Loss of D Business Total Income ` ` 2,00,000

(+) 10,00,000 (-) 4,00,000 (-) 2,00,000 (+) 4,00,000 (-) 3,00,000 (-) 3,00,000

4,00,000 6,00,000 (-) 6,00,000 Nil

Note : Where business loss and depreciation both are being carried forward, business loss has got priority, over deprecia tion. Unabsorbed depreciation is carried forward without time-limit.

3. XYZ & Co., a partnership firm, submits the following particulars of its income and carry forward losses for the Previous Year 2012-2013: Particulars 1. 2. 3. Gross prize on race horses Expenses incurred: (i) Horses purchased during the year (ii) Medical expenses (iii) Animal trainer fees (iv) Fodder expenses (v) Stable-rent/insurance (vi) Depreciation in the value of horses (vii) Staff salaries Loses brought forward from the Assessment Year 2010-2011 Betting on race horses Betting on race horses made lawfully (` ) made illegally (` ) 15,00,000 5,00,000 6,00,000 1,00,000 50,000 2,60,000 1,20,000 4,60,000 1,00,000 6,00,000 75,000 20,000 15,000 50,000 36,000 1,50,000 40,000 2,00,000

Solution :

Computation of Total Income for the Assessment Year 2013-14 Particulars Betting on race horses made lawfully (` ) 15,00,000 (-) 1,00,000 (-) 50,000 (-) 2,60,000 (-) 1,20,000 (-) 1,00,000 8,70,000 6,00,000 2,70,000 Betting on race horses made illegally (` ) 5,00,000 (-) 20,000 (-) 15,000 (-) 50,000 (-) 36,000 (-) 40,000 3,39,000 Nil 3,39,000

Gross prize Less: Expenses incurred: (i) Horses purchasednot allowed (ii) Medical expenses (iii) Animal trainer fees (iv) Fodder expense (v) Stable rent/insurance (vi) Staff salaries (vii) Depreciation in the value of horsesnot allowed Less: Brought forward loss Total Income of the firm = ` 6,09,000

10.12 I DIRECT TAXATION

Note: Horse race means a horse race upon which wagering or betting may be lawfully made [Explanation (b) to Sec. 74A]. Thus, where wagering or betting is not lawfully made on race horses, any loss incurred on such betting can neither be set off nor carried forward. Hence, the carried forward loss of ` 2,00,000 cannot be set-off. House Property Business or Profession Speculation ` P 3,00,000 S (-)2,00,000 Nonspeculation ` X 5,00,000 Y (-) 3,00,000 Capital Gains STCG ` C 6,00,000 D (-) 3,00,000 LTCG ` F 7,00,000 E (-)5,00,000 Income from Other Sources Family pension 95,000 Loss from (-) 50,000 letting out from machinery/plant

4. Mr. N discloses the following incomes for the Previous Year 2012-2013:

` A 50,000 B (-) 40,000

Determine income under head of income for the A. Y. 2013-2014 Solution : Aggregation of income under each head of income: A. Y. 2013-2014 House Property ` A 50,000 B (-)40,000 10,000 Business or Profession Speculation ` P 3,00,000 S (-)2,00,000 1,00,000 Nonspeculation ` X 5,00,000 Y (-)3,00,000 2,00,000 Capital Gains STCG ` C 6,00,000 D (-)3,00,000 3,00,000 LTCG ` F 7,00,000 E (-)5,00,000 2,00,000 Income from Other Sources ` Family pension 95,000 Loss from (-)50,000 letting out machinery/ plant 45,000 ` 6,00,000 (-) 2,00,000 (-) 2,50,000 2,00,000 (-) 3,00,000

5. A discloses the following incomes from business or profession for the Previous Year 2012-2013: (i) Profit from X business (ii) Loss from Y business (iii) Loss from profession Z (iv) Profit from speculation business M (v) Loss from speculation business N Solution : Income from Business or Profession for the AY 2013-2014 Particulars (i) X (ii) Y (iii) Z Total Income from Non Speculation Business and Profession Income from Speculation Business (i) M (ii) N Loss from Speculation Business ` 6,00,000 (-) 2,00,000 (-) 2,50,000 1,50,000 2,00,000 (-)3 ,00,000 (-) 1,00,000

Determine the Income from Business or Profession for the Assessment Year 2013-2014

DIRECT TAXATION I 10.13

Set off or Carry Forward and Set off of Losses Speculation loss cannot be set-off against the income from business profit, though both of them fall under the same head of income. Thus, taxable business profits for the Assessment Year 2013-2014 is ` 1,50,000. The speculation loss will be carried forward for future set-off for 4 Assessment Years, immediately succeeding the Assessment Year for which it was first com puted [Sec. 73(4)]. The time-limit of 4 years is applicable from the Assessment Year 2014-2015 and subsequent year.

6. D has earned income of ` 5,60,000 from speculation business during the PY 2012-2013. However, he has suffered losses in business and profession ` 3,20,000 and ` 1,70,000, respectively during the same period. Determine his income from business profession for the Assessment Year 2013-2014. Solution : Income from Business and Profession for the AY 2013-2014: Profits from Speculation Business (ii) Loss from Profession Particulars ` 5,60,000 (-) 3,20,000 (-) 1,70,000 70,000

Less. (i) Loss from Non Speculation Business Income from Business and Profession 7. Mr. Samir submits the following information for the A.Y. 2013-14. Taxable Income from Salary Income from House property: House 1 Income House 2 loss Particulars

` 1,64,000 37,000 (53,000) (20,000) (80,000) (25,000) (15,000) 40,000 62,000 10,000

Textile Business (discontinued on 10.10.2012) Brought forward loss of textile business - A.Y. 2009-10 Chemical Business (discontinued on 15.3.2012) b/f loss of Previous Year 2009-10 unabsorbed depreciation of Previous Year 2009-10 Bad debts earlier deducted recovered in July 2012

Leather Business Interest on securities held as stock in trade

Determine the Gross Total Income for the Assessment Year 2013-14 and also compute the amount of loss that can be carried forward to the subsequent years.

10.14 I DIRECT TAXATION

Solution: Computation of Gross Total Income A.Y. 2013-14 Particulars I. Income from Salary II. Income from House property: House 1 Income House 2 Loss III. Profits and Gains of Business or Profession: (i) Textile business loss (iii) Chemical business Bad debts recovered taxable u/s 41(4) Less: (i) Set off of brought forward loss of P.Y. 2009-10 u/s. 72 (iii) Leather Business Income (iv) Interest on securities held as stock-in-trade Less: B/f business loss ` 80,000 restricted to Gross Total Income ` ` 1,64,000

37,000 (53,000) (20,000) 40,000 (25,000) 62,000 10,000 15,000 (5,000) 72,000 67,000 67,000

(16,000)

Nil 1,48,000

Note: 1. 2. The unabsorbed loss of ` 13,000 (80,000-67,000) of Textile business can be carried forward to A.Y. 2014-15 for setoff u/s. 72, even though the business is discontinued. The unabsorbed depreciation of ` 15,000 is eligible for set off against any income other than salary income. Since, Gross Total Income contains the balance of Income from Salary only, unabsorbed depreciation cannot be adjusted, and hence, carried forward for adjustment in the subsequent years.

Illustration 8: An assessee has filed a belated return showing a business loss. What is the remedy available to him for carry forward and set off of the said loss? AG Ltd. filed its return of loss for the Assessment Year 2013 2014 on 10.01.2014 beyond the time prescribed u/s 139(3) declaring a total loss of ` 12,00,000. It approaches you for your advice regarding the course of action to be taken to secure the benefit of carry forward of the business loss for set off against future profits. Advise the company suitably. Solution : A. CBDTs Powers: CBDT has the powers to condone the delay in filing return in cases having claim of carry forward of losses. [ Associated Electro Ceramics vs. CBDT 201 ITR 501 ( Kar.)] B. Monetary limits prescribed for the condonation of delay are as under [ Cir. No. 8/2001 dt. 16.5.2001] Refund claimed Upto ` 10,000 ` 10,001 - ` 1,00,000 ` 1,00,001 and above Authority empowered to condone Assessing Officer with the prior approval of the CIT Assessing Officer with the prior approval of the CCIT / DGIT Central Board of Direct Taxes

C. Analysis and conclusion: Here, since the loss of AG Ltd. is ` 12,00,000, the authority empowered to condone the delay is CBDT. Hence, AG Ltd. has to file a condonation petition to the CBDT to carry forward the business loss.

DIRECT TAXATION I 10.15

Set off or Carry Forward and Set off of Losses

10.16 I DIRECT TAXATION

Study Note - 11
DEDUCTION IN COMPUTING TOTAL INCOME
This Study Note includes 11.1 Introduction 11.2 Deductions from Gross Total Income

11.1 INTRODUCTION In order to further the Government Policy of attracting investment and activity in the desired direction and to provide stimulus to growth or to meet social objectives, concession in the form of deduction from Taxable Income is allowed. Chapter VI-A of the Income-tax Act, 1961 contains such deduction provisions. With the advent of new philosophy of giving direct assistance to the desired goal and avoiding indirect route of tax concessions, the numbers of deductions are being omitted. This is also with a view to avoid complexity of tax law. In computing Total Income of an assessee deductions under sections 80CCC to 80U are permissible from Gross Total Income. [Section 80A (1)] Deduction not to be allowed unless return furnished [Sec. 80AC] Where in computing the Total Income of an assessee of the Previous Year relevant to theAssessment Year commencing on the 1st day of April, 2006 or any subsequent Assessment Year, any deduction is admissible under Section 80-IA or Section 80-IAB or Section 80-IB or Section 80-IC or Section 80-ID or Section 80-IE, no such deduction shall be allowed to him unless he furnishes a return of his income for such Assessment Year on or before the due date specified under sub-section (1) of section 139. Gross Total Income means the aggregate of income computed under each head as per provisions of the Act, after giving effect to the provisions for clubbing of incomes (Sections 60 to 64) and set off of losses and but before making any deductions under this chapter. [Section 80B(5)] The deductions under Chapter VIA are not available from the following incomes though these are included in the Gross Total Income: (i) Long Term Capital Gains; (ii) Winnings from lotteries, cross word puzzles etc.; (iii) Incomes referred to in Sections 115A to AD, 115BBA and 115D. The aggregate amount of deductions under Chapter VIA [Sections 80CCC to 80U] shall not exceed the Gross Total Income of the assessee. [Section 80A (2)]

DIRECT TAXATION I 11.1

Deduction in Computing Total Income 11.2 DEDUCTIONS FROM GROSS TOTAL INCOME
Deductions under Chapter VIA

I In respect of expenditure or investments made by assessee [Sec 80C to Sec 80 GGA]

II In respect of certain income [Section 80HH to 80 RRB]

III Other Deductions [Section 80U]

DEDUCTION IN RESPECT OF LIP, CONTRIBUTIONS TO PF, ETC [SEC. 80C]: 1 2 3 4 Eligible Assessee Condition Maximum Deduction Special Provisions Individual and HUF Investment or application of funds during the Previous Year ` 1,00,000 in a Previous Year Withdrawal of deductions for certain premature exit from certain investments or application of funds

Rate of deduction [Section 80C(1)] This deduction shall be admissible only to an assessee, being an Individual or a Hindu Undivided Family. The amount of deduction shall be actual amount paid or deposited during the Previous Year in prescribed saving schemes [to be calculated] as qualifying amount for deduction u/s 80C or ` 1,00,000 whichever is less. Qualifying Amount For Deduction u/s 80C (i) to effect or to keep in force an insurance on the life of persons specified in sub-section (4); Note: Insurance premium on the life of an insured / premium payer, spouse and any children is allowable as deduction within the overall limit of ` 1,00,000. However, if the premium payable for any year is more than 20% of the actual sum assured, the excess amount does not qualify for any deduction. With effect from the Assessment Year 2013-14, if the premium payable for any year is more than 10% of the actual sum assured, the excess amount does not qualify for any deduction. The revised / amended provision is as follows : 1. The above provisions shall be applicable in case of policies issued on or after 1st April 2012. 2. In respect of the old policies, the earlier provision of 20% ceiling shall be applicable 3. Actual sum assured in relation to any life insurance policy shall mean the minimum amount assured under that policy on the happening of the insured event at any time during the term of the policy, not taking into account-

11.2 I DIRECT TAXATION

(a) the value of any premiums agreed to be returned, or (b) any benefit by way of bonus or otherwise over and above the sum actually assured, which is to be or may be received under the policy by any person.

(ii) to effect or to keep in force a contract for a deferred annuity, not being an annuity plan referred to in Clause (xii), on the life of persons specified in sub-section (4) Provided that such contract does not contain a provision for the exercise by the insured of an option to receive a cash payment in lieu of the payment of the annuity;

(iii) by way of deduction from the salary payable by or on behalf of the Government to any individual being a sum deducted in accordance with the conditions of his service, for the purpose of securing him a deferred annuity or making provision for his spouse or children, in so far as the sum so deducted does not exceed one-fifth of the salary; (iv) as a contribution by an individual to any provident fund to which the Provident Funds Act, 1925 (19 of 1925) applies; (v) as a contribution to any provident fund set up by the Central Government and notified by it in this behalf in the Official Gazette, where such contribution is to an account standing in the name of any person specified in sub-Section (4); (vi) as a contribution by an employee to a recognised provident fund; (vii) as a contribution by an employee to an approved superannuation fund; (viii) as subscription to any such security of the Central Government or any such deposit scheme as that Government may, by notification in the Official Gazette, specify in this behalf; (ix) as subscription to any such savings certificate as defined in clause (c) of Section 2 of the Government Savings Certificates Act, 1959 (46 of 1959), as the Central Government may, by notification in the Official Gazette, specify in this behalf; (x) as a contribution, in the name of any person specified in sub-section (4), for participation in the Unit-linked Insurance Plan, 1971 (hereafter in this Section referred to as the Unit-linked Insurance Plan) specified in Schedule II of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002); (xi) as a contribution in the name of any person specified in sub-section (4) for participation in any such unit-linked insurance plan of the LIC Mutual Fund referred to in clause (23D) of Section 10, as the Central Government may, by notification in the Official Gazette, specify in this behalf; (xii) to effect or to keep in force a contract for such annuity plan of the Life Insurance Corporation or any other insurer as the Central Government may, by notification in the Official Gazette, specify; (xiii) as subscription to any units of any Mutual Fund referred to in clause (23D) of Section 10 or from the Administrator or the specified company under any plan formulated in accordance with such scheme as the Central Government may, by notification in the Official Gazette, specify in this behalf; (xiv) as a contribution by an individual to any pension fund set up by any Mutual Fund referred to in clause (23D) of Section 10 or by the Administrator or the specified company, as the Central Government may, by notification in the Official Gazette, specify in this behalf; (xv) as subscription to any such deposit scheme of, or as a contribution to any such pension fund set up by, the National Housing Bank established under Section 3 of the National Housing Bank Act, 1987 (53 of 1987) (hereafter in this Section referred to as the National Housing Bank), as the Central Government may, by notification in the Official Gazette, specify in this behalf; (xvi) as subscription to any such deposit scheme of (a) a public sector company which is engaged in providing long-term finance for construction or purchase of houses in India for residential purposes; or

DIRECT TAXATION I 11.3

Deduction in Computing Total Income (b) any authority constituted in India by or under any law enacted either for the purpose of dealing with and satisfying the need for housing accommodation or for the purpose of planning, development or improvement of cities, towns and villages, or for both, as the Central Government may, by notification in the Official Gazette, specify in this behalf;

(xvii) as tuition fees (excluding any payment towards any development fees or donation or payment of similar nature), whether at the time of admission or thereafter, (a) to any university, college, school or other educational institution situated within India; (b) for the purpose of full-time education of any of the persons specified in sub-section (4);

(xviii) for the purposes of purchase or construction of a residential house property the income from which is chargeable to tax under the head Income from House Property (or which would, if it had not been used for the assessees own residence, have been chargeable to tax under that head), where such payments are made towards or by way of (a) any installment or part payment of the amount due under any self-financing or other scheme of any development authority, housing board or other authority engaged in the construction and sale of house property on ownership basis; or (b) any installment or part payment of the amount due to any company or co-operative society of which the assessee is a shareholder or member towards the cost of the house property allotted to him; or (c) repayment of the amount borrowed by the assessee from (1) the Central Government or any State Government, or (2) any bank, including a co-operative bank, or (3) the Life Insurance Corporation, or (4) the National Housing Bank, or (5) any public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes which is eligible for deduction under clause (viii) of subsection (1) of Section 36, or (6) any company in which the public are substantially interested or any co-operative society, where such company or co-operative society is engaged in the business of financing the construction of houses, or (7) the assessees employer where such employer is an authority or a board or a corporation or any other body established or constituted under a Central or State Act, or (8) the assessees employer where such employer is a public company or a public sector company or a university established by law or a college affiliated to such university or a local authority or a co-operative society; or

(d) stamp duty, registration fee and other expenses for the purpose of transfer of such house property to the assessee, but shall not include any payment towards or by way of (A) the admission fee, cost of share and initial deposit which a shareholder of a company or a member of a co-operative society has to pay for becoming such shareholder or member; or (B) the cost of any addition or alteration to, or renovation or repair of, the house property which is carried out after the issue of the completion certificate in respect of the house property by the authority competent to issue such certificate or after the house property or any part thereof has either been occupied by the assessee or any other person on his behalf or been let out; or

11.4 I DIRECT TAXATION

(C) any expenditure in respect of which deduction is allowable under the provisions of Section 24;

(xix) as subscription to equity shares or debentures forming part of any eligible issue of capital approved by the Board on an application made by a public company or as subscrip tion to any eligible issue of capital by any public financial institution in the prescribed form; ExplanationFor the purposes of this clause, (i) eligible issue of capital means an issue made by a public company formed and registered in India or a public finan cial institution and the entire proceeds of the issue are uti lised wholly and exclusively for the purposes of any business referred to in sub-Section (4) of Section 80-IA;

(ii) public company shall have the same meaning assigned to it in Section 3 of the Companies Act, 1956 (1 of 1956); (iii) public financial institution shall have the same meaning assigned to it in Section 4A of the Companies Act, 1956 (1 of 1956);

ferred to in clause (23D) of Section 10 and (xx) as subscription to any units of any mutual fund re approved by the Board on an application made by such mutual fund in the prescribed form; (xxi) as term deposit (a) for a fixed period of not less than five years with a scheduled bank; and (b) which is in accordance with a scheme framed and notified, by the Central Government, in the Official Gazette for the purposes of this clause.

(xxii) as subscription to such bonds issued by the National Bank for Agriculture and Rural Development, as the Central Government may, by notification in the Official Gazette, specify in this behalf; (xxiii) deposit in an account under the Senior Citizens Savings Scheme Rules,2004; (xxiv) deposit in an account under the Post Office Time Deposit Rules,1981 for a period of five years; Taxability of Amount Received 1. In following cases the assessee shall have to pay tax on any amount received on: (i) Termination of his contract of insurance referred to at point (i) above by notice to that effect or where the contract ceases to be in force by reason of failure to pay any premium, by not reviving contract of insurance: (a) in case of any single premium policy, within two years after the date of commencement of insurance; or (b) in any other case, before premiums have been paid for two years; or

(ii) Termination of his participation in any unit-linked insurance plan referred to above in point (x) and (xi) by notice to that effect or where he ceases to participate by reason of failure to pay any contribution, by not reviving his participation, before contributions in respect of such participation have been paid for five years; or (iii) Transfer of the house property before the expiry of five years from the end of financial years in which possession of such property is obtained by him, or receives back, whether by way of refund or otherwise, any sum specified in that clause, then : (a) no deduction shall be allowed to the assessee under 80C(1) with reference to any of the sums referred to in point (i), (x), (xi) and (xviii), paid in such Previous Year; and (b) the aggregate amount of the deductions of income so allowed in respect of the Previous Year or years shall be deemed to be the income of the assessee of such Previous Year and shall be liable to tax in the Assessment Year relevant to such Previous Year.

DIRECT TAXATION I 11.5

Deduction in Computing Total Income DEDUCTION IN RESPECT OF CONTRIBUTION TO PENSION FUND OF LIC OR ANY OTHER PENSION FUND [SEC. 80CCC] 1 2 3 4 Eligible Assessee Condition Maximum Deduction Special Provisions Individual Investment or application of funds during the Previous Year ` 1,00,000 in a Previous Year Withdrawal of deductions for certain premature exit from certain investments or application of funds

Deduction of a maximum amount of ` 1,00,000 is allowed to an individual assessee for the amount paid or deposited by the assessee during Previous Year to effect or keep in force a contract for annuity plan of LIC or any other insurer for receiving pension from the fund referred to inSec.10(23AAB). The whole of the amount received by an assessee or his nominee shall be taxable in the year in which the amount is so received. It may be mentioned that where deduction is claimed in respect of any amount paid or deposited, under this Section, no rebate u/s.88 shall be allowed with reference to the same amount. However, any payment in commutation of pension received from the fund referred to in Section 10(23AAB) is exempt u/s.10(10A)(iii). Where any amount paid or deposited by the assessee has been taken into account for the purposes of this Section : (a) a rebate with reference to such amount shall not be allowed under sec 88 for any Assessment Year ending before the 1st day of April, 2006; (b) a deduction with reference to such amount shall not be allowed under Section 80C for any Assessment Year beginning on or after the 1st day of April, 2006. IN RESPECT OF CONTRIBUTION TO PENSION SCHEME OF CENTRAL GOVERNMENT [SEC. 80 CCD] 1 2 3 4 Eligible Assessee Condition Maximum Deduction Special Provisions Individual Investment or application of funds during the Previous Year Up to 10% of his salary subject to maximum of ` 1,00,000 Withdrawal of deductions for certain premature exit from certain investments or application of funds

Where any amount paid or deposited by the assessee has been allowed as a deduction under this Section: (a) No rebate with reference to such amount shall be allowed under Section 88 for any Assessment Year ending before the 1st day of April,2006; (b) No deduction with reference to such amount shall be allowed under Section 80C for any Assessment Year beginning on or after the 1st day of April,2006. Tax benefits for New Pension System - extended also to self-employed, and tax treatment of savings under this system as exempt-exempt-taxed [Section 10(44), 115-0,197A and 80CCD W.r.e.f. A.Y. 2009-10] Amendment in Section 80CCD: The tax benefit under Section 80CCD of the Income-tax Act, 1961 was hitherto available to employees only. However, the NPS now has been extended also to selfemployed. Therefore, the Act has also amended sub-Section (1) of Section 80CCD so as to extend the tax benefit there under also to self-employed individuals. Further, in the case of an employee of Central Government or of any other employer, the deduction of employees contribution shall be limited to 10% of his salary. Whereas in the case self-employed persons, it shall be limited to 10% of his Gross Total Income in the Previous Year. Note: The Act has also inserted sub-section (5) to Section 80CCD to provide that for the purposes of

11.6 I DIRECT TAXATION

the said Section the assessee shall be deemed not to have received any amount in the Previous Year if such amount is used for purchasing an annuity plan in the same Previous Year. RESTRICTION ON THE OVERALL LIMIT OF DEDUCTION [SEC. 80CCE ] The aggregate amount of deductions under Sec. 80C, Sec. 80CCC and Sec. 80CCD shall not, in any case, exceed one lakh rupees. DEDUCTION IN RESPECT OF SUBSCRIPTION TO LONG-TERM INFRASTRUCTURE BONDS[SEC. 80CCF] 1 2 3 Eligible Assessee Individual and HUF Condition Subscription paid or deposited in notified long-term infrastructure bonds Maximum Deduction ` 20,000.

However, this Section is discontinued from the Assessment Year 2013-14 DEDUCTION IN RESPECT OF INVESTMENT MADE UNDER AN EQUITY SAVINGS SCHEME [SEC. 80CCG] [W.E.F. A.Y. 2013-14] 1 2 Eligible Assessee Conditions Individual who is resident in India has, in a Previous Year, acquired listed equity shares in accordance with a scheme, as may be notified by the Central Government in this behalf (i) The Gross Total Income of the assessee for the relevant Assessment Year should not exceed ` 10,00,000 (ii) The assessee is a new retail investor as may be specified under the scheme notified in this behalf; (iii) The investment is made in such listed equity shares as may be specified under the notified scheme; (iv) The investment is locked-in for a period of three years from the date of acquisition in accordance with the notified scheme; and 3 Maximum Deduction (v) Such other condition as may be prescribed. The assessee shall be allowed a deduction, in the computation of his Total Income of the Assessment Year relevant to such Previous Year to the extent of (a) 50% of the amount invested in such equity shares (b) ` 25,000 Whichever is less. If any amount of deduction is claimed by any assessee in any year, the assessee would not be allowed to any other deduction under this section. If any assessee after claiming the deduction fails to satisfy any of the conditions, the deduction originally allowed, shall be deemed to be income of the assessee of that year in which the condition so violated. DEDUCTION IN RESPECT OF MEDICAL INSURANCE PREMIUM [SEC.80D] 1 2 3 Eligible Assessee Condition Individual and HUF Investment or application of funds during the Previous Year by any mode of payment other than cash Maximum Deduction ` 15,000. If they medical insurance premium is paid for senior citizen, then maximum deduction is up to ` 20,000

Deduction is allowed for any medical insurance premium paid by any mode of payment other than cash out of assessees Taxable Income to GICI or any other approved insurer during the Previous Year,

DIRECT TAXATION I 11.7

Deduction in Computing Total Income upto a maximum amount of ` 15,000. The deduction is allowed in respect of the following :(a) In case of an individual insurance on the health of the assessee or wife or husband, dependent parents or dependent children. (b) In case of a HUF insurance on the health of any member of the family. However, where the assessee or his wife or her husband or dependent parents or any member of his family of HUF is a senior citizen(whose age at any time during the year is 60 years or above w.e.f. A.Y. 2013-14), the limit of deduction is raised from ` 15,000 to ` 20,000. Payment made on preventive health check-up for self, spouse, dependant children or parents during the Previous Year by any mode of payment (including cash), is eligible for deduction u/s 80D to the maximum of ` 5,000 [w.e.f. AY 2013-14]. DEDUCTION IN RESPECT OF MEDICAL TREATMENT OF HANDICAPPED DEPENDENT [SEC. 80DD] Section 80DD of the Income Tax Act provides for a deduction to an individual or HUF, who is a resident in India, in respect of the following: (a) Expenditure for the medical treatment (including nursing), training and rehabilitation of a dependant, being a person with disability; and (b) Amount paid to LIC or other insurance in respect of a scheme for the maintenance of a disabled dependant. 1 2 3 Eligible Assessee Condition Maximum Deduction Individual and HUF Expenditure for medical treatment during the Previous Year ` 50,000, but where dependent is a person with severe disability, maximum deduction is ` 1,00,000.

If the handicapped dependent predeceases the individual or the member of HUF in whose name money has been deposited or paid, an amount equal to the amount paid or deposited under the scheme shall be deemed to be the income of the assessee of the Previous Year in which sum amount is received by the assessee and chargeable to tax in that Previous Year. For the purpose of this Section dependent means a person who is not dependent for the suspect or main term on any person other than the assessee. DEDUCTION IN RESPECT OF MEDICAL TREATMENT, ETC. [SEC. 80DDB] 1 2 3 4 Eligible Assessee Condition Maximum Deduction Special Provisions Individual and HUF The amount should be actually paid for the medical treatment of specified disease ` 40,000 but if the amount paid is for senior citizen (aged 60 years or more) then the ceiling limit is ` 60,000 The assessee is required to furnish with the return of income, a certificate is prescribed Form No. 10-I

Deduction is allowed to a resident individual or Hindu Undivided Family in respect of expenditure actually during the P.Y., incurred for the medical treatment of specified disease or ailment as specified in the Rules 11DD for himself or a dependent relative or a member of an HUF. Conditions : (i) The assessee has to furnish a certificate in Form 10 I from any doctor registered with Indian Medical Association with postgraduate qualifications.

(ii) Dependent means a person who is dependent for his support or maintenance on the assessee and on no other person.

11.8 I DIRECT TAXATION

A deduction of ` 40,000 is allowed as reduced by the amount received, if any, from an insurer or reimbursed by an employer for the medical treatment of such person. Specified diseases and ailments under Section 80DDB and Rule 11DD (i) Neurological Diseases i.e. (a) Dementia; (b) Dystonia Musculorum Deformans (c) Motor Neuron Disease; (d) Atanxia; (e) Chorea; (f) Hemiballismus (g) Aphasia (h) Parkinsons Desease

(ii) Cancer (iii) AIDS (iv) Chronic Renal Failure (v) Hemophilia (vi) Thalassalmia Note: From the Assessment Year 2013-14, the qualifying age for senior citizen has been reduced from 65 years to 60 years for the purpose of Section 80D and 80DD. DEDUCTION IN RESPECT OF INTEREST ON LOAN TAKEN FOR HIGHER EDUCATION [SEC. 80E] 1 2 3 4 Eligible Assessee Condition Individual The amount is paid by the assessee out of his income as interest on loan taken for higher education. Maximum Deduction 100% of the interest paid on loan taken without any monetary ceiling limit. Special Provisions The assessee can claim the amount of interest in the initial Assessment Year & carry forward up to 7 Assessment Years.

In computing the Total Income of an assessee, being an individual, there shall be deducted, in accordance with and subject to the provisions of this Section, any amount paid by him in the Previous Year, out of his income chargeable to tax, by way of interest on loan taken by him from any financial institution or any approved charitable institution for the purpose of higher education of him or his relative [Section 80E(1)] The deduction specified above shall be allowed in computing the Total Income in respect of the initial Assessment Year and seven Assessment Years immediately succeeding the initial Assessment Year or until the interest referred above is paid by the assessee in full, whichever is earlier [80E(2)] Meaning of relative enlarged: The Act has enlarged the definition of relative given in clause (e) of sub-Section (3). As per the new definition relative, in relation to an individual, means the spouse and children of that individual or the student for whom the individual is the legal guardian. DEDUCTION IN RESPECT OF DONATIONS TO CERTAIN FUNDS, CHARITABLE INSTITUTIONS, ETC. [SEC. 80G] Deduction under this Section is available to all assessees. Conditions for claiming deduction:(i) The donation should be of a sum of money and not in kind.

DIRECT TAXATION I 11.9

Deduction in Computing Total Income (ii) The donation should be to specified funds/institutions. (iii) Amount paid by any mode of payment other than cash and if paid in cash the amount should not exceed ` 10,000. 1. Eligible Donation PMs National Relief Fund; Qualifying Deduction Permissible Amount Quantum of deduction for item Nos. 1 to 18, 24 & 30 = 100% of the qualifying amount. For other items, quantum of deductions=50%of the qualifying amount. From item Nos. 1 to 23 there is no maximum limit 2. PMs Armenia Earthquake Relief Fund; (i.e. 100% of the amount 3. The Africa (Public Contributions India) Fund; will qualify for deduction) 4. The National Foundation for Communal Harmony 5. 6. 7. A university or any educational institution of national eminence as may be approved; The National Illness Assistance Fund; Any Zila Saksharta Samiti for improvement of primary education in villages and towns and for literacy activities; National Blood Transfusion Council or to any State Blood Transfusion Council; Any fund set up by the State Government for medical relief to the poor;

8. 9.

10. The Army Central Welfare Fund or the Indian Naval Benevolent Fund or the Airforce Central Welfare Fund established by the armed forces of the Union for the welfare of the past and present members of the such forces or their dependants; 11. The Chief Ministers Relief Fund or the Lieutenant Governors Relief Fund in respect of any State or Union Territory, as the case may be; 12. The National Sports Fund to be set up by the Central Government; 13. The National Cultural Fund set up by the Central Government; 14. The Fund for Technology Department and Application setup by the Central Government; 15. The National Defence Fund; 16. Any fund setup by the State Government of Gujarat exclusively for providing relief to the victims of earthquake in Gujarat; 17. Any sum paid during the period beginning with 26.1.2001 and ending on 30.9.2001 to any trust, institutions or fund recognised under Section 80G for providing relief to the victims of earthquake in Gujarat;

11.10 I DIRECT TAXATION

18. National Trust for Welfare of Persons with Autism, Cerebral Palsy, Mental Retardation and Multiple disabilities constituted under the relevant Act of 1999; 19. PMs Drought Relief Fund; 20. The National Childrens Fund; 21. Jawaharlal Nehru Memorial Fund; 22. Indira Gandhi Memorial Trust; 23. Rajiv Gandhi Foundation; 24. Contribution by a company as donations to the Indian Olympic Association or to any other Association notified by the Central Government u/s. 10(23); From Sl. Nos. 24 to 30 qualifying amount shall be restricted to 10% of Adjusted Total Income

25. Any approved fund or institution established (i.e. G.T.I. as reduced by for charitable purposes; deductions u/s. 80CCC 26. Government or local authority to be used for to 80U other than 80G and other income on charitable purpose; 27. Any authority set up for providing housing which no tax is payable and other incomes on accommodation or town planning; which deductions under 28. Any corporation established by Government Chapter VIA are not for promoting interest of schedules caste/ allowed) scheduled tribe/backward class; 29. Renovation of notified temple mosque, church, or gurudwara or any other notified place of national importance; 30. Government or local authority or approved institution/association for promotion of family planning; DEDUCTION IN RESPECT OF RENTS PAID [SEC. 80GG] 1 2 3 Eligible Assessee Condition Maximum Deduction Individual The condition for deduction in respect of rents paid is given below. Amount of deduction is also given below.

The deduction in respect of rent paid is available to Individual with effect from Assessment Year 1998-99. Conditions : (i) The assessee is not being in receipt of any house rent allowance following under clause (13A) of Section 10 from his employer.

(ii) The expenditure incurred (for the purpose of his own residence) by way of rent for any furnished or unfurnished accommodation is in excess of 10% of his Total Income after allowing all deductions except deduction under this Section. (iii) The assessee or his spouse or minor child or an HUF of which he is a member, does not own any accommodation at the place where he ordinarily resides or performs duties of his office or employment or carries on his business/profession. (iv) If the assessee owns any accommodation at any place other than the place of employment or business and such accommodation is not in the occupation of the assessee and shall not be assessed in his hands as self occupied property.

DIRECT TAXATION I 11.11

Deduction in Computing Total Income Deduction : Least of the following : (i) Rent paid minus 10% of Adjusted Total Income (ii) 25% of Adjusted Total Income (iii) ` 2,000 p.m. Adjusted Total Income : Gross Total Income as reduced by : (a) Long Term Capital Gain, if any, included in the Gross Total Income (b) Short Term Capital Gain under section 111A, if any, included in the Gross Total Income (c) All deduction under Chapter VIA (Section 80CCC to 80U) other than the deduction under this Section. (d) Any income referred to in Sections 115A to D included in the Gross Total Income. DEDUCTION IN RESPECT OF CERTAIN DONATIONS FOR SCIENTIFIC RESEARCH OR RURAL DEVELOPMENT [SEC. 80GGA] In computing the Total Income of an assessee whose Gross Total Income does not include income from Profits and Gains of Business or Profession, deduction shall be allowed of an amount paid by him to (a) an approved scientific research association or University or College or other institution to be used for scientific research, research in social science or statistical research. (b) an approved association or institution to be used for carrying out any approved programme or rural development, (c) an approved institution or association which has the object of training of persons for implementing programmes of rural development [Sec. 35CCA] (d) public sector company or local authority or an approved association or institution for carrying out any eligible project or scheme u/s 35AC. (e) association/institution/fund which has the object of carrying out any programme of conservation of natural resources or afforestation [Sec. 35CCB] (f) National Urban Poverty Eradication Fund (NUPEF). Section 80GGA (2A) provides that no deduction shall be allowed under section 80GGA in respect of any sum exceeding ` 10,000 unless such sum is paid by any mode other than cash. DEDUCTIONS BY COMPANIES TO POLITICAL PARTIES [SEC. 80GGB] Allowable to : An Indian Company Amount of Deduction : 100% of sum contributed during a Previous Year to any political party, registered u/s 29A of Representation of the People Act, 1951. DONATIONS TO POLITICAL PARTIES [SEC. 80GGC] Allowable to : Any person except local authority and an artificial juridical person wholly or partly funded by the Government. Amount of Deduction : 100% of sum contributed during a Previous Year to any political party, registered u/s 29A of Representation of the People Act, 1951. Contributions to an Electoral Trust also eligible for deduction under Section 80GGB and 80GGC DEDUCTIONS IN RESPECT OF PROFITS & GAINS FROM INDUSTRIAL UNDERTAKINGS OR ENTERPRISES ENGAGED IN INFRASTRUCTURE DEVELOPMENT [SEC. 80IA] The deduction under this Section is applicable to all assessees whose Gross Total Income includes any

11.12 I DIRECT TAXATION

profits and gains derived from any business of an industrial undertaking or an enterprise as below : Sl. No. (i) Classification of Industries Any enterprise carrying on the business of developing or maintaining and operating or developing, maintaining and operation any infrastructure facility Any undertaking providing telecommunication services whether basic or cellular including radio paging, domestic satellite service or network of trunking and electronic data interchange services. Any undertaking which develops or develops and operates or maintains and operates an industrial park notified by the Central Government. An Industrial undertaking set up in any part of India for the generation or generation and distribution of power. An industrial undertaking which starts transmission or distribution of power by laying a network of new transmission or distribution lines. An industrial undertaking starts business of substantial renovation and modernisation of existing transmission / distribution lines in Power Sector. Undertaking established for reconstruction / revival of Power Generation Plant Period of commencement On or after 1.4.1995 From 1.4.95 to 31.3.2005 Deduction 100% for 10 consecutive Assessment Years. 100% for first 5 years & 30% for the next 5 years.

(ii)

(iii)

From 1.4.97 to 31.3.2011 From 1.4.93 to 31.3.2013 From 1.4.99 to 31.3.2013 From 1.4.2004 to 31.3.2013

100% for 10 consecutive Assessment Years. 100% for 10 consecutive Assessment Years. 100% for 10 consecutive Assessment Years. 100% for 10 consecutive Assessment Years.

(iv) (v)

(vi)

(vii)

Established before 100% for 10 consecutive 30.11.2005 to Assessment Years. 31.3.2011

The deduction under this Section is available at the option of the assessee for any 10 consecutive Assessment Years out of 15 years beginning from the year in which the undertaking or enterprise develops and begins to operate any infrastructure facility or starts providing telecommunication services or develops an industrial part or generates power or commences transmission or distribution of power. However, in case of an infrastructure facility being a high way project including housing or other activities being an integral part of a high way project, the assessee can claim deduction for any 10 consecutive Assessment Years out of 20 years beginning from the year of operation. Other Conditions: (i) For the purpose of completing deduction under this Section, the profits and gains of the eligible business shall be computed as if such eligible business were the only source of income during the relevant Previous Year.

(ii) Where housing or other activities are an integral part of the high way project and the profits and gains of which have been calculated in accordance of the provision of the Section, the profits have not been liable to tax if the following conditions are not fulfilled: (a) The profits have been transferred to a special reserve account (b) The same is actually utilised for the high way project excluding housing and other activities before the expiry of 3 years following the year of transfer to the reserve account.

DIRECT TAXATION I 11.13

Deduction in Computing Total Income (c) The amount remaining unutilised shall be chargeable to tax as income of the year in which such transfer to reserve account took place.

(iii) Where the assessee is a person other than a company or a cooperative society, the deduction shall not be admissible unless the accounts of the industrial undertaking for the Previous Year relevant to the Assessment Year for which the deduction is claimed have been audited by an accountant and the report in Form No. 10CCB (Rule 18BBB) is furnished along with the return of income. (iv) Where any goods or services held for purposes of the eligible business are transferred to any other business carried on by the assessee or vice versa and if the consideration for such transfer does not correspond to the market value of such goods of services as on the date of transfer, the profits and gains of the eligible business shall be computed as if the transfer had been made at the market value of such goods or services as on that date However, if the computation of profits and gains presents any difficulty in the opinion of the Assessing Officer, he may compute such profits and gains on such reasonable basis as he may deem fit. Similarly, where due to close connection between the assessee and other person for any other reason it appears to the Assessing Officer that the profits of the eligible business is increased to more than the ordinary profit, the Assessing Officer shall compute the profit on a reasonable basis for allowing the deduction. (v) If the profits and gains are allowed as deduction under this Section for any Assessment Year, no deduction under Sections 80HH to 80RRA to the extent of such profits and gains shall be allowed. (vi) Where any undertaking of an Indian company which is entitled to the deduction under this Section is transferred before expiry of the period of deduction to another Indian company in a scheme of amalgamation or demerger, no deduction has been admissible to the amalgamating or demerged company for the Previous Year in which amalgamation or demerger expressed and the amalgamated or the resulting company shall be entitled to the deduction as if the amalgamation or demerger had not been taken place. Amendments in Section 80-IA (A) Section 80IA(4): Extension of tax benefits for developing, operating, maintaining an infrastructure facility to authorities constituted under a Central or State Act. The Act has amended Section 80-IA(4) so as to enable an authority or a board or a corporation or any other body established or constituted under a Central or State Act which is not incorporated under the Companies Act, 1956 also to take advantage of the benefits provided under the said Section.

(B) Extension of sunset clause for tax holiday under Section 80-IA to extend the terminal date for commencing the activity of generation, transmission or distribution of power in case of an undertaking owned by an Indian company and set up for reconstruction or revival of a power generating plant before 31-12-2005 [Section 80-IA(4)] Under the existing provisions of Section 80-IA(4)(v), an undertaking owned by an Indian company and set up for reconstruction or revival of a power generating plant is eligible for 10 year tax benefit, if it fulfills the following conditions : (i) Such Indian company is formed before 30-11-2005 with majority equity participation by public sector companies for enforcing the security interest of the lenders to the company owning the power generating plant; (ii) Such Indian company is notified by the Central Government before 31-12-2005; and (iii) The undertaking begins to generate or transmit or distribute power before 31-3-2008. The Act has amended sub-clause (b) of clause (v) of sub-Section (4) of Section 80-IA to extend the terminal date for commencing the activity of generation, transmission or distribution of power in case of such undertaking from 31-3-2008 to 31-3-2011.

11.14 I DIRECT TAXATION

Summary of significant amendment is appended below : Nature of the Undertaking Undertaking for Generation and Distribution of Power Undertaking engaged in Transmission and Distribution of power by laying a network of new transmission and distribution lines. Substantial renovation and modernization of existing distribution network of transmission or distribution lines Commencement of operation At any time during the period beginning on 1st April, 2012 and ending on 31st March, 2013 At any time during the period beginning on 1st April, 2012 and ending on 31st March, 2013 At any time during the period beginning on 1st April, 2012 and ending on 31st March, 2013 In all the above case, the terminal date has been extended to 31st March, 2013.

DEDUCTIONS IN RESPECT OF PROFITS AND GAINS BY AN UNDERTAKING OR ENTERPRISE ENGAGED IN DEVELOPMENT OF SPECIAL ECONOMIC ZONE [SEC. 80IAB] (1) Where the Gross Total Income of an assessee, being a Developer, includes any profits and gains derived by an undertaking or an enterprise from any business of developing a Special Economic Zone, notified on or after the 1st day of April, 2005 under the Special Economic Zones Act, 2005, there shall, in accordance with and subject to the provisions of this Section, be allowed, in computing the Total Income of the assessee, a deduction of an amount equal to one hundred per cent of the profits and gains derived from such business for ten consecutive Assessment Years. (2) The deduction specified in sub-section (1) may, at the option of the assessee, be claimed by him for any ten consecutive Assessment Years out of fifteen years beginning from the year in which a Special Economic Zone has been notified by the Central Government Provided that where in computing the Total Income of any undertaking, being a Developer for any Assessment Year, its profits and gains had not been included by application of the provisions of sub-section (13) of Section 80-IA, the undertaking being the Developer shall be entitled to deduction referred to in this Section only for the unexpired period of ten consecutive Assessment Years and thereafter it shall be eligible for deduction from income as provided in sub-section (1) or sub-section (2), as the case may be Provided further that in a case where an undertaking, being a Developer who develops a Special Economic Zone on or after the 1st day of April, 2005 and transfers the operation and maintenance of such Special Economic Zone to another Developer (hereafter in this Section referred to as the transferee Developer), the deduction under sub-section (1) shall be allowed to such transferee Developer for the remaining period in the ten consecutive Assessment Years as if the operation and maintenance were not so transferred to the transferee Developer.

(3) The provisions of sub-section (5) and sub-sections (7) to (12) of Section 80-IA shall apply to the Special Economic Zones for the purpose of allowing deductions under sub-section (1). DEDUCTION IN RESPECT OF PROFITS AND GAINS FOR CERTAIN INDUSTRIAL UNDERTAKING OTHER THAN INFRASTRUCTURE DEVELOPMENT UNDERTAKINGS [SEC. 80IB] The deduction is available to the following undertaking or enterprises etc. Sl. Undertaking No. A. Ship- brought into use between 1.4.91 & 31.3.95 B. Hotel commenced between 1.4.97 and 31.3.2001 approved hotel in hilly are or rural area or a place of pilgrimage or in a notified area C. Any other approved hotel (Hotels in the cities of Calcutta, Chennai, Delhi and Mumbai are not eligible) commenced between 1.4.97 and 31.3.2001 % of Profit deductible 30 50 30 Period of deduction For the first 10 years For the first 10 years For the first 10 years

DIRECT TAXATION I 11.15

Deduction in Computing Total Income D. Sl. Classification of Industries Period of Commencement No. between 1 Industrial undertaking located in an 1.4.1993 and 31.3.2004 industrially backward state specified (1.4.1993 and 31.3.2012 for in the Eighth Schedule; an industrial undertaking in the State of Jammu and Kashmir) Deduction of profits dividend 100% for initial 5 years. Thereafter 30% for 5 years in case of company otherwise 25%. For cooperative society deduction is 100% of initial 5 years and thereafter 25% of 7 years. 1.10.1994 and 31.3.2004 100% for 5 years and 30% for next 5 years in case of companies (25% for others). For cooperative society 25% for 7 years. after 100% for initial 5 years. 100% for 3 years and 30% for next 5 years in case of company (25% for others). For cooperative society 25% for 9 years after 100% for initial 3 years. Approved by the prescribed 100% of the profits derived authority after business for from such business for 10 31.3.2000 but before 1.4.2007 years starting from the initial Assessment year. 100% for the first 7 consecutive Assessment Years starting from the Before 1.4.97 initial Assessment Years. On or after 1.4.97 On or after 1.10.98 but before 1.4.2012 On or after 1.4.2009 1.10.98 and 31.3.2008 100% of the profit derived [In case where housing from such business. project has been approved by local authority during 2004-05, the construction should be completed within 4 years from the end of the financial year in which the project is approved and if the project is approved on or after 1st April,2005, the construction should be completed within 5 years from the end of the financial year in which the project is approved]

Industrial undertaking located in industrially backward district notified by the Central Government -Category A

-Category B

Any company engaged in scientific and industrial research and development. Undertaking which begins commercial production of mineral oil a) in North Eastern Region. b) in other Regions Undertaking which begins refining of mineral oil. Undertaking which begins production of natural gas Undertaking engaged in developing and building housing projects approved by a local authority: profits derived from of the plot of land minimum 1 acre area and residential unit built up to 1000 sq. ft. where such residential units are in Delhi/Mumbai or within 25 kms. for the municipal limits of these cities and 1500 sq. ft. at any other place. The build-up area of the shops and other commercial establishments included in the housing project should not exceed 3% of the total build-up area of the housing project or 5,000 sq.ft., whichever is more.[see note]

11.16 I DIRECT TAXATION

Sl. Classification of Industries Period of Commencement No. between 6 Industrial undertaking deriving profit 1.4.1999 and 31.3.2004 from the business of setting up and operating a cold chain facility for agricultural produce.

Undertaking engaged in integrated business of handling, storage and transportation of food grains. Processing, preservation and packaging of meat and meat products or poultry/marine/dairy products Finance Act, 2002, inserted Sec. 80IB(7A) and Sec.80IB(7B) allowing deduction in case of any multiplex theatre and convention centers w.e.f. AY 2003-04 as under : - Multiplex theatre other than located within the municipal jurisdiction of Chennai, Delhi, Mumbai or Kolkata. - Convention Centre

On or after 1.4.2001

On or after 1.4.2009

Deduction of profits dividend 100% for initial 5 years and thereafter 30% for 5 years in case of company (25% for others). For Cooperative Society after initial 5 years @100%, the next 7 years @ 25% 100% for initial 5 years. Thereafter 30% for 5 years for company (25% for others).

1.4.2002 and ending 31.3.2005 1.4.2002 and ending 31.3.2005

50% of the profits of 5 consecutive years beginning from the initial Assessment Year. 50% of the profits of 5 consecutive years beginning from the initial Assessment Year. 100% of the profits derived from such business for 5 consecutive years beginning from the initial Assessment Year.

Operating and maintaining a hospital From 1.10.2004 to 31.3.2008 -in rural area -in anywhere in India other than From 1.4.2008 to 31.3.2013 excluded area (w.e.f. AY 2009-10)

Note: The objective of the tax benefit for housing projects is to build housing stock for low and middle income households. This has been ensured by limiting the size of the residential unit. However, this is being circumvented by the developer by entering into agreement to sell multiple adjacent units to a single buyer. Accordingly, the Act has inserted new clauses viz. clause (e) and (f) to Section 80-IB(10) to provide that the undertaking which develops and builds the housing project shall not be allowed to allot more than one residential unit in the housing project to the same person, not being an individual, and where the person is an individual, no other residential unit in such housing project is allotted to any of the following person: (i) The individual or the spouse or minor children of such individual; (ii) The Hindu Undivided Family in which such individual is the Karta; (iii) Any person representing such individual, the spouse or minor children of such individual or the Hindu Undivided Family in which such individual is the Karta. This amendment will take effect from 1-4-2010 and shall accordingly, apply in relation to Assessment Year 2010-11 and subsequent years. Further, as per the Finance (No. 2) Act, 2009 the deduction will be available if the project is approved by the local authority before 31-3-2008 instead of 31-3-2007.

DIRECT TAXATION I 11.17

Deduction in Computing Total Income SPECIAL PROVISIONS IN RESPECT OF CERTAIN UNDERTAKINGS OR ENTERPRISES IN CERTAIN SPECIAL CATEGORY STATES [SEC. 80-IC] (1) Where the Gross Total Income of an assessee includes any profits and gains derived by an undertaking or an enterprise from any business referred to in sub-section (2), there shall, in accordance with and subject to the provisions of this Section, be allowed, in computing the Total Income of the assessee, a deduction from such profits and gains, as specified in sub-section (3). (2) This Section applies to any undertaking or enterprise, (a) which has begun or begins to manufacture or produce any article or thing, not being any article or thing specified in the Thirteenth Schedule, or which manufactures or produces any article or thing, not being any article or thing specified in the Thirteenth Schedule and undertakes substantial expansion during the period beginning (i) on the 23rd day of December, 2002 and ending before the 1st day of April, 2007 in any Export Processing Zone or Inte grated Infrastructure Development Centre or Industrial Growth Centre or Industrial Estate or Industrial Park or Software Tech nology Park or Industrial Area or Theme Park, as notified by the Board in accordance with the scheme framed and notified by the Central Government in this regard, in the State of Sikkim; or

(ii) on the 7th day of January, 2003 and ending before the 1st day of April, 2012, in any Export Processing Zone or Inte grated Infrastructure Development Centre or Industrial Growth Centre or Industrial Estate or Industrial Park or Software Tech nology Park or Industrial Area or Theme Park, as notified by the Board in accordance with the scheme framed and notified by the Central Government in this regard, in the State of Himachal Pradesh or the State of Uttaranchal; or (iii) on the 24th day of December, 1997 and ending before the 1st day of April, 2007, in any Export Processing Zone or Integrated Infrastructure Development Centre or Industrial Growth Centre or Industrial Estate or Industrial Park or Software Technology Park or Industrial Area or Theme Park, as notified by the Board in accordance with the scheme framed and notified by the Central Government in this regard, in any of the North-Eastern States;

(b) which has begun or begins to manufacture or produce any article or thing, specified in the Fourteenth Schedule or com mences any operation specified in that Schedule, or which manu factures or produces any article or thing, specified in the Fourteenth Schedule or commences any operation specified in that Schedule and undertakes substantial expansion during the period beginning (i) on the 23rd day of December, 2002 and ending before the 1st day of April, 2007, in the State of Sikkim; or

(ii) on the 7th day of January, 2003 and ending before the 1st day of April, 2012, in the State of Himachal Pradesh or the State of Uttaranchal; or (iii) on the 24th day of December, 1997 and ending before the 1st day of April, 2007, in any of the North-Eastern States. in the case of any undertaking or enterprise referred to in sub-clauses (i) and (iii) of clause (a) or sub-clauses (i) and (iii) of clause (b), of sub-section (2), one hundred per cent of such profits and gains for ten Assessment Years commencing with the initial Assessment Year;

(3) The deduction referred to in sub-Section (1) shall be (i)

(ii) in the case of any undertaking or enterprise referred to in sub-clause (ii) of clause (a) or subclause (ii) of clause (b), of sub-section (2), one hundred per cent of such profits and gains for five Assessment Years commencing with the initial Assessment Year and thereafter, twenty-

11.18 I DIRECT TAXATION

five per cent (or thirty per cent where the assessee is a company) of the profits and gains. (4) This Section applies to any undertaking or enterprise which fulfils all the following conditions, namely: (i) it is not formed by splitting up, or the reconstruc tion, of a business already in existence Provided that this condition shall not apply in respect of an undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such undertaking as is referred to in Section 33B, in the circum stances and within the period specified in that Section;

(ii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose. Explanation: The provisions of Explanations 1 and 2 to sub-Section (3) of Section 80-IA shall apply for the purposes of clause (ii) of this sub-section as they apply for the purposes of clause (ii) of that sub-section.

(5) Notwithstanding anything contained in any other provision of this Act, in computing the Total Income of the assessee, no deduction shall be allowed under any other Section contained in Chapter VIA or in Section 10A or Section 10B, in relation to the profits and gains of the undertaking or enterprise. (6) Notwithstanding anything contained in this Act, no deduction shall be allowed to any undertaking or enterprise under this Section, where the total period of deduction inclusive of the period of deduction under this Section, or under the second proviso to sub-section (4) of Section 80-IB or under Section 10C, as the case may be, exceeds ten Assessment Years. (7) The provisions contained in sub-section (5) and sub-sections (7) to (12) of Section 80-IA shall, so far as may be, apply to the eligible undertaking or enterprise under this Section. (8) Deduction u/s 80-IC will not be allowed if the assessee does not furnish the Return of Income u/s 139(1). (9) For the purposes of this Section, (i) Industrial Area means such areas, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government;

(ii) Industrial Estate means such estates, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government; (iii) Industrial Growth Centre means such centres, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government; (iv) Industrial Park means such parks, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government; (v) Initial Assessment Year means the Assessment Year relevant to the Previous Year in which the undertaking or the enterprise begins to manufacture or produce articles or things, or commences operation or completes substantial expansion; (vi) Integrated Infrastructure Development Centre means such centres, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government; (vii)North-Eastern States means the States of Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland and Tripura;

DIRECT TAXATION I 11.19

Deduction in Computing Total Income (viii) Software Technology Park means any park set up in accordance with the Software Technology Park Scheme notified by the Government of India in the Ministry of Commerce and Industry; (ix) Substantial Expansion means increase in the investment in the plant and machinery by at least fifty per cent of the book value of plant and machinery (before taking depreciation in any year), as on the first day of the Previous Year in which the substantial expansion is undertaken; (x) Theme Park means such parks, which the Board, may, by notification in the Official Gazette, specify in accordance with the scheme framed and notified by the Central Government.

DEDUCTION IN RESPECT OF PROFITS AND GAINS FROM BUSINESS OF HOTELS AND CONVENTION CENTRES IN SPECIFIED AREA [SEC. 80ID] (1) Where the Gross Total Income of an assessee includes any profits and gains derived by an undertaking from any business referred to in sub-section (2) (such business being hereinafter referred to as the eligible business), there shall, in accordance with and subject to the provisions of this Section, be allowed, in computing the Total Income of the assessee, a deduction of an amount equal to one hundred per cent of the profits and gains derived from such business for five consecutive Assessment Years beginning from the initial Assessment Year. (2) This Section applies to any undertaking, (i) engaged in the business of hotel located in the specified area, if such hotel is constructed and has started or starts functioning at any time during the period beginning on the 1st day of April, 2007 and ending on the 31st day of July, 2010; or

(ii) engaged in the business of building, owning and operating a convention centre, located in the specified area, if such convention centre is constructed at any time during the period beginning on the 1st day of April, 2007 and ending on the 31st day of July, 2010; or (iii) engaged in the business of hotel located in specified district having a World Heritage Site, if such hotel is constructed and has started or starts functioning at any time during the period beginning on the 1st day of April, 2008 and ending on 31st day of March, 2013. (i) the eligible business is not formed by the splitting up, or the reconstruction, of a business already in existence;

(3) The deduction under sub-section (1) shall be available only if

(ii) the eligible business is not formed by the transfer to a new business of a building previously used as a hotel or a convention centre, as the case may be; (iii) the eligible business is not formed by the transfer to a new business of machinery or plant previously used for any purpose. (iv) the assessee furnishes along with the return of income, the report of an audit in such form and containing such particulars as may be prescribed, and duly signed and verified by an accountant, as defined in the Explanation to sub-section (2) of Section 288, certifying that the deduction has been correctly claimed.

(4) Notwithstanding anything contained in any other provision of this Act, in computing the Total Income of the assessee, no deduction shall be allowed under any other Section contained in Chapter VIA or Section 10AA, in relation to the profits and gains of the undertaking. (5) The provisions contained in sub-section (5) and sub-sections (8) to (11) of Section 80-IA shall, so far as may be, apply to the eligible business under this Section. (6) For the purposes of this Section, -

11.20 I DIRECT TAXATION

(i)

Convention Centre means a building of a minimum 25,000 square metre covered plinth area with centralised air-conditioner comprising of at least 10 conventional halls to be used for the purpose of holding conference and seminars having other specified facilities and amenities. Hotel means two-star, three-star or four-star category hotels as classified by the Central Government.

(ii)

(iii) Specified Area means the National Capital Territory of Delhi and the district of Budh Nagar, Faridabad, Gurgaon, Gautam and Ghaziabad.

SPECIAL PROVISIONS IN RESPECT OF CERTAIN UNDERTAKINGS IN NORTH- EASTERN STATES [SEC. 80IE] (1) Where the Gross Total Income of an assessee includes any profits and gains derived by an undertaking, to which this Section applies, from any business referred to in sub-section (2), there shall be allowed, in computing the Total Income of the assessee, a deduction of an amount equal to one hundred per cent of the profits and gains derived from such business for ten consecutive Assessment Years commencing with the initial Assessment Year. (2) This Section applies to any undertaking which has, during the period beginning on the 1st day of April, 2007 and ending before the 1st day of April, 2017, begun or begins, in any of the NorthEastern States, (i) to manufacture or produce any eligible article or thing; (ii) to undertake substantial expansion to manufacture or produce any eligible article or thing; (iii) to carry on any eligible business. (i) it is not formed by splitting up, or the reconstruction, of a business already in existence Provided that this condition shall not apply in respect of an undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such undertaking as referred to in Section 33B, in the circumstances and within the period specified in the said Section;

(3) This Section applies to any undertaking which fulfils all the following conditions, namely:

(ii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose. Explanation: The provisions of Explanations 1 and 2 to sub-Section (3) of Section 80-IA shall apply for the purposes of clause (ii) of this sub- section as they apply for the purposes of clause (ii) of that sub-section.

(4) Notwithstanding anything contained in any other provision of this Act, in computing the Total Income of the assessee, no deduction shall be allowed under any other Section contained in Chapter VIA or in Section 10A or Section 10AA or Section 10B or Section 10BA, in relation to the profits and gains of the undertaking. (5) Notwithstanding anything contained in this Act, no deduction shall be allowed to any undertaking under this Section, where the total period of deduction inclusive of the period of deduction under this Section, or under Section 80-IC or under the second proviso to sub-section (4) of Section 80-IB or under Section 10C, as the case may be, exceeds ten Assessment Years. (6) Deduction u/s 80-IE will not allowed if the assessee does not furnish the Return of Income u/s 139(1) (7) The provisions contained in sub-section (5) and sub- sections (7) to (12) of Section 80-IA shall, so far as may be, apply to the eligible undertaking under this Section. (8) For the purposes of this Section, -

DIRECT TAXATION I 11.21

Deduction in Computing Total Income (i) Substantial Expansion means increase in the investment in the Plant and Machinery by at least 25% of the book value of Plant and Machinery as on the 1st day of the Previous Year in which substantial expansion is undertaken.

(ii) Eligible Article or Thing means the article or thing other than tobacco, manufactured tobacco substitute, plastic carry bag (Less than 20 Microns), and goods produced by petroleum oil or gas refineries. (iii) Eligible Business includes Hotel (Not Below 2 Star Category), Adventure & Leisure Sports including Ropeways, Nursing Homes (Minimum 25 Beds), Old-age Home, Information Technology related Training Centre, Manufacturing Information Technology related Hardware, Vocational Training Institute for Hotel Management, Food Craft, Entrepreneurship Development, Nursing & Para Medical, Civil Aviation & Fashion Design & Industrial Training. Bio-technology

DEDUCTION IN RESPECT OF PROFITS AND GAINS FROM BUSINESS OF COLLECTING AND PROCESSING OF BIO- DEGRADABLE WASTE. [SEC. 80JJA] With effect from Assessment Year 1999-2000, where the Gross Total Income of an assessee include profits and gains derived from the business of collecting and processing or treatment of bio-degradable waste for generating power, or producing bio-fertilizers, bio-pesticides or other biological agents or for producing bio-gas or making pellets or briquettes for fuel or organic manure these shall be allowed in computing the Total Income of the assessee, a deduction of an amount equal to the whole of such profits and gains for a period of five consecutive Assessment Years beginning with the Assessment Year relevant to the Previous Year in which such business commences. DEDUCTION IN RESPECT OF EMPLOYMENT OF NEW WORKMEN [SEC 80JJAA] With effect from Assessment Year 1999-2000, an Indian company is allowed for deduction provided the following conditions are satisfied : (i) The Gross Total Income of the assessee includes profits and gains derived from any industrial undertaking

(ii) Such industrial undertaking is engaged in the manufacture or production of article or thing. (iii) Such industrial undertaking is not forwarded by (a) splitting up of an existing undertaking, or (b) reconstruction of an existing undertaking or (c) amalgamation with another industrial undertaking. (iv) The assessee employs new regular workmen in the Previous Year. (v) The assessee furnishes the report of a Chartered Accountant in Form No. 10DA [Rule 19AB] Deduction is available for 3 Previous Years commencing from the Previous Year in which such employment is provided. Amount of deduction (i) New industrial undertaking : 30% of the wages paid to regular workmen in excess of 100 regular workmen employed during the year.

(ii) Existing undertaking : 30% of the wages paid to new regular workmen provided these is at least

11.22 I DIRECT TAXATION

10% increase in number of regular workmen over the existing member of workmen employed in such undertaking, as on the last day of the preceding year. Regular workmen It does not include : (a) a casual workmen or (b) a workmen employed through contract labour; or (c) any other workman employed for a period of less than 300 days during the Previous Year.

DEDUCTIONS IN RESPECT OF CERTAIN INCOMES OF OFFSHORE BANKING UNITS AND INTERNATIONAL FINANCIAL SERVICES CENTRE [ SEC. 80LA] (1) Where the Gross Total Income of an assessee, (i) being a scheduled bank, or, any bank incorporated by or under the laws of a country outside India; and having an Offshore Banking Unit in a Special Economic Zone; or

(ii) being a Unit of an International Financial Services Centre, includes any income referred to in sub-Section (2), there shall be allowed, in accordance with and subject to the provisions of this Section, a deduction from such income, of an amount equal to (a) one hundred per cent of such income for five consecutive Assessment Years beginning with the Assessment Year relevant to the Previous Year in which the permission, under clause (a) of sub-section (1) of Section 23 of the Banking Regulation Act, 1949 (10 of 1949) or permission or registration under the Securities and Exchange Board of India Act,1992 (15 of 1992) or any other relevant law was obtained, and thereafter; (b) fifty per cent of such income for next five Assessment Years.

(2) The income referred to in sub-section (1) shall be the income (a) from an Offshore Banking Unit in a Special Economic Zone; or (b) from the business referred to in sub-section (1) of Section 6 of the Banking Regulation Act, 1949 (10 of 1949) with an undertaking located in a Special Economic Zone or any other undertaking which develops or develops and operates or develops, operates and maintains a Special Economic Zone; or (c) from any Unit of the International Financial Services Centre from its business for which it has been approved for setting up in such a centre in a Special Economic Zone.

(3) No deduction under this Section shall be allowed unless the assessee furnishes along with the return of income, (i) the report, in the form specified by the Central Board of Direct Taxes under clause (i) of subSection (2) of Section 80LA, as it stood immediately before its substitution by this Section, of an accountant as defined in the Explanation to sub-section (2) of Section 288, certifying that the deduction has been correctly claimed in accordance with the provisions of this Section; and

(ii) a copy of the permission obtained under clause (a) of sub-section (1) of Section 23 of the Banking Regulation Act, 1949 (10 of 1949). Explanation: For the purposes of this Section, (a) International Financial Services Centre shall have the same meaning as assigned to it in clause (q) of Section 2 of the Special Economic Zones Act, 2005; (b) Scheduled Bank shall have the same meaning as assigned to it in clause (e) of Section 2 of the Reserve Bank of India Act, 1934 (2 of 1934);

DIRECT TAXATION I 11.23

Deduction in Computing Total Income (c) Special Economic Zone shall have the same meaning as assigned to it in clause (za) of Section 2 of the Special Economic Zones Act, 2005; (d) Unit shall have the same meaning as assigned to it in clause (zc) of Section 2 of the Special Economic Zones Act, 2005.

DEDUCTION IN RESPECT OF CO-OPERATIVE SOCIETIES [SEC. 80P] The following amounts are allowed as deduction under this Section (i) 100% of the profits attributable to any or more of the following activities in the case of a cooperative society engaged in (a) carrying on business of banking or providing credit facilities to its members; or (b) a cottage industry; or (c) the marketing of the agricultural produce of its members; or (d) the purchase of agricultural implements, seeds, live stock or other articles intended for agriculture for the purpose of supplying them to its members; or (e) processing, without aid of power, of the agricultural produce of its members; or (f) the collective disposal of the labour of its members; or (g) fishing or allied activities; or (h) primary cooperative society engaged in supplying milk raised by its member to a Federal Milk Coop. Society or to the Government or a local authority or a Govt. Company or Corporation established under Central/State or Provincial Act. Similar benefit is also extended to a primary Cooperative Society engaged in supplying oilseeds, fruits and vegetables raised or grown by its members.

(ii) The whole of interest and dividend income derived by a Cooperative Society from its investments in any other Cooperative Society; (iii) The whole of interest income from securities and property income in the case of a Cooperative Society other than housing society or an urban Consumer Society or a Society carrying on transport business where Gross Total Income does not exceed ` 20,000. Urban Consumer Cooperative Society means a society for the benefit of consumers within the limits of Municipal Corporation, municipality, municipal committee, notified area committee, town area or cantonment.

(iv) The whole of the income from letting of godowns or warehouses for storage, processing or facilitating the marketing of commodities. (v) In respect of other activities carried on either independently or in addition to above activities upto a sum of ` 50,000 (` 1,00,000 in case of Consumer Corporation Society) U/s. 80P(2)(c). DEDUCTION IN RESPECT OF ROYALTY OF AUTHORS [SEC. 80QQB] Allowable to : Any resident individual, being an author/joint author, in respect of any income by way of lump sum consideration or otherwise as royalty or copyright fees for assignment or grant of any of his interests in the copyright of any book. Amount of Deduction: 100% of the royalty income etc. subject to a maximum of ` 3,00,000. In case of royalty or copyright fees, not in lump sum consideration, deduction shall be restricted to 15% of the value of books sold during the Previous Year. Conditions: (1) The assessee shall furnish a certificate in Form 10CCD. (2) In case of income received from a source outside India, the assessee shall furnish a certificate in Form 10H.

11.24 I DIRECT TAXATION

DEDUCTION IN RESPECT OF ROYALTY ON PATENTS [SEC. 80RRB] 1 2 Eligible Assessee Condition Any resident individual He must be registered under the Patents Act, 1970 on or after 1.4.2003, as the true and first inventor in respect of an invention, including a co-owner of the patent. The deduction is not available to assignees or mortgagees in respect of all or any rights of the patent 100% of such income subject to a maximum ` 3,00,000. (a) a certificate in Form 10CCE duly signed by the Controller under Patents Act. (b) a certificate in Form 10H, in case of income received from abroad, certifying that the deduction has been correctly claimed in accordance with this Section. DEDUCTION IN RESPECT OF INTEREST ON DEPOSITS IN SAVINGS ACCOUNTS TO THE MAXIMUM EXTENT OF ` 10,000 [SECTION 80TTA] [W.E.F. A.Y. 2013-14] Allowable to: an individual or a Hindu Undivided Family Conditions: Where the Gross Total Income of an assessee, includes any income by way of interest on deposits (not being time deposits) in a saving account with(a) a banking company to which the Banking Regulation Act, 1949 applies (including any bank of banking institution referred to in Section 51 of that Act); (b) a co-operative society engaged in carrying on the business of banking (including a co-operative land mortgage bank or a co-operative land development bank); or (c) a Post Office as defined in clause (k) of Section 2 of the Indian Post Office Act, 1898. Allowable Deduction: A deduction of such interest shall be allowed to the maximum extent of ` 10,000. However, where the income referred to in this Section is derived from any deposit in a savings account held by, or on behalf of, a Firm, an Association of Persons or a Body of Individuals, no deduction shall be allowed under this Section in respect of such income in computing the Total Income of any partner of the firm or any member of the association or any individual of the body. Exemption U/s. 10(15)(i) Post Office Savings Bank Account exempt upto ` 3,500/- (in an individual account) and ` 7,000 (in a joint Account) by virtue of notification number 32/ 2011 A consolidated study of Section 10(15)(i) and Section 80TTA provides (from Assessment Year 2013-14) as follows : i) ii) Exemption upto ` 3,500/- in a single account or / and ` 7,000/- in a joint account as deduction u/s. 10(15)(i) Deduction upto ` 10,000/- under Section 80TTA

3 4

Maximum Cap Special Provisions

DEDUCTION IN RESPECT OF TOTALLY BLIND OR MENTALLY RETARDED OR PHYSICALLY HANDICAPPED PERSON [SEC. 80U] A resident individual suffering from permanent physical disability or total blindness or partial blindness or mental retardation reducing his capacity substantially for gainful employment is allowed a deduction of ` 50,000 or ` 1,00,000 in case of severe disability. The extent of blindness or other physical disability has to be certified by a Registered Medical Practitioner of the concerned discipline. Such certificate has to be obtained from a physician, surgeon, etc. working in a Govt. Hospital. For the purpose of Sec. 80U of the Income Tax Act, 1961 any of the following disabilities shall be regarded as a permanent physical disability [Rule 11DD] e.g. (i) permanent physical disability of more than 50% in one limb; or

DIRECT TAXATION I 11.25

Deduction in Computing Total Income (ii) permanent physical disability of more than 60% in two or more limbs; or (iii) permanent deafness with hearing impairment of 71 decibels and above; or (iv) permanent and total loss of voice. PROBLEM ON DEDUCTIONS FROM GROSS TOTAL INCOME Illustration 1: Mr. N is employed at a gross salary of ` 8,00,000. He gets ` 15,000 interest on bank deposit. He has made the following investment/deposit during the year 2012-2013: ` Life insurance premium: (i) Own life, insured for ` 80,000 (ii) Brothers life, dependent on him (iii) Major son, not dependent on him Contribution to unrecognised provident fund Contribution to public provident fund Contribution to ULIP Repayment of loan to SBI to purchase a residential house: 50% repayment is towards interest. He has paid education fees for his 3 children: A B C 1. 2. 3. 4. 5. 15,000 5,000 4,000 60,000 20,000 5,000 1,20,000

12,000 9,000 6,000

Besides, interest of ` 1,632 on NSC-VIII, (purchased during the year 2008-2009) has been credited on them during the year 2012-2013. Compute deduction u/s 80C for the Assessment Year 2013-2014. Solution: Computation of Deduction u/s 80C of Mr. N for the Assessment Year 2013-2014 Particulars Deduction in respect of contribution to approved savings (Sec. 80C): 1. Life insurance premium(assumed issued before 1st April, 2012); (i) Own life (ii) Brothers life (iii) Major son 2. Contribution to unrecognised provident fund 3. Contribution to ULIP 4. Contribution to public provident fund 5. Repayment of housing loan to SBI 6. Accrued interest on NSC- VIII issue 7. Education fees for two children: A B Deduction restricted upto ` 1,00,000 ` `

15,000 4,000 5,000 20,000 60,000 1,632 12,000 9,000 1,26,632

1,00,000

11.26 I DIRECT TAXATION

Illustration 2: Mr. Jamal resident in India, has paid ` 60,000 for medical expenses during the Previous Year 2012-2013 for his wife suffering from cancer. Mrs. Jamal is also resident in India and turns 60 years of age on 31st March 2013. The full treatment cost has been reimbursed by the General Insurance Corporation of India. Please determine if Mr. Jamal is entitled to any deduction under Sec. 80DDB and if the answer is yes, determine the quantum of deduction. Also, please work out the quantum of deduction in the following circumstances : I. II. III. Mrs. Jamal turns 60 years of age on 1 April 2013 and the amount reimbursed by the insurer is ` 25,000. Payment of medical treatment was made out of exempted income. Mr. Jamal turns 60 years of age on 1 April 2012 but Mrs. Jamal is 59 years, 11 months and 30 days as on 31 March 2013 and the insurer has not reimbursed any expenditure. Mrs. Jamal is 61 years of age, a non-residential in India and the insurer has reimbursed ` 35,000

IV. Mr. Jamal, though having assessable income in India, is actually resident in Sri Lanka and is getting his wife treated in India for sake of better and more advanced medical facilities Mrs. Jamal is residential in India and the insurer has reimbursed ` 20,000. V. The expenditure is incurred by the assessee on cancer treatment of his 25 year old grandson who is dependent on him and is resident in India. The insurer has not reimbursed the claim.

VI. Mr. Jamal is able to produce the receipt of the medical expenditure only to the extent of ` 10,000 as he misplaced other receipts and the certificate in Form 10-I regarding the treatment of his wife does not mention the total amount incurred by him during the Previous Year. The insurer has reimbursed only ` 5,000. Solution: Amount of deduction under Sec. 80DDB: PY 2012-2013 / AY 2013-2014 Particulars Existing Gross deduction u/s 80DDB in 60,000 respect of specified ailment of dependant wife. Less : Insurance claim received Net deduction allowable u/s 80DDB Working Notes : 1. In order to be a senior citizen, a person should be a resident in India and be 60 years of age at any time during the Previous Year, be it one the last day of the Previous Year or at any time during the Previous Year. Therefore, except when Mrs. Jamal turns 60 after the end of the Previous Year or when she is a non-resident in India, the gross amount of deduction will be ` 40,000. The assessee individual must be resident in India in order to be eligible to the deduction. Form No. 10-I does not require the doctor to certify the amount incurred. 60,000 Nil I 40,000 II 40,000 III 40,000 IV Nil V Nil VI 10,000

25,000 15,000

Nil 40,000

35,000 5,000

Nil Nil

Nil Nil

5,000 5,000

2. 4.

3. A grandson is not covered by the definition of dependant. Illustration 3: Mr. C, manager of L Ltd., has paid ` 38,000 during the Previous Year 2012-2013 by way of medical insurance under GIC approved medical policies. The details are given as below: (i) For himself ` 6,000 (ii) For Mrs. C, a Canadian citizen, resident in Toronto and not dependent on him ` 5,000 (iii) For B, married son living with him and dependent on him ` 3,000 (iv) For D, minor son resident in Toronto and not dependent on him ` 3,000

DIRECT TAXATION I 11.27

Deduction in Computing Total Income (v) For Mrs. B, daughter-in-law, dependent on him ` 5,000 (vi) For E, a minor grandson dependent on him ` 3,000 (vii) For K, father, 67 years, resident and dependent on him ` 3,000 (viii) For M, mother, 66 years, resident in Toronto and dependent on him ` 6,000 (ix) For Grandfather, dependent on him, 95 years of age and resident in India ` 4,000. C has earned gross salary of ` 2,50,000 during the year and also earns ` 95,000 as interest from 7% Capital Invest ment Bonds, purchased on 31 May 2004. Compute his eligible deduction u/s 80D for the Previous Year 2012-2013 assuming the following situations: I. II. III. Premium is paid by cheque from his salary income. Premium is paid in cash from his salary income. He holds a valid receipt for cash payment. Premium is paid by cheque out of interest from 7% Capital Investment Bonds, acquired on 31-5-2004.

IV. Premium is paid in cash out of interest from 7% Capital Investment Bonds, acquired on 1-6-2004. Solution: Computation of Deduction for Medical Insurance Premium u/s 80D Particulars of Medical Insurance premium paid For himself For Mrs. C, a Canadian citizen, resident in Toronto and not dependent on him For B, married son living with him and dependent on him For D, minor son resident in Toronto and not dependent on him For Mrs. B, daughter-in-law, dependent on him For E a minor grandson, dependent on him For K, father, 67 years, resident in India, a senior citizen and dependent on him For M, mother, 66 years, resident in Toronto -not a senior citizen but dependent on him For Grandfather, 95 years of age, dependent on him, resident in India, and senior citizen (not a parent, hence not eligible) Eligible premium for Deduction u/s 80 D Working Notes : 1. Medical insurance premium on spouses health is always eligible irrespective of whether the spouse is depend ent on the assessee or not. The condition of dependency applies only in case of children and parents. Medical premium on health of grandson, grandparents, daughter-in-law or son-in-law are not eligible for deduction u/s 80D. Only the premium on health of dependent father will qualify for relaxation as a senior citizen. Since dependent mother is non-resident and, therefore, outside the purview of being a senior citizen. However, the premium for health of mother will qualify for the normal limit irrespective of the residential status. Any premium paid in cash or by cheque or out of exempted income does not quality for deduction u/s 80D. I ` 6,000 5,000 3,000 Nil Nil Nil 3,000 6,000 Nil 23,000 II ` Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil III ` Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil IV ` Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil

2. 3.

4.

11.28 I DIRECT TAXATION

Illustration 4: Mr. Maity, a resident individual, furnishes the following particulars of his income/expenditure for the Previous Year 2012-2013: ` (i) (ii) (iii) (iv) Gross Salary Income from House Property Share of profit from an AOP Long-term Capital Gain 3,00,000 1,70,000 25,000 50,000

He has paid medical insurance on his life, his wife and his dependent children. Total premium paid under GIC approved policies is ` 10,000 but a sum of ` 1,000 was paid in cash due to a prolonged bank clearing strike. He has spent ` 20,000 on the treatment of his brother, a dependant with disability. He has also deposited ` 25,000 with a specified company u/s 2(h) of Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2003 for maintenance of his brother. He has paid the following donations during the year: Particulars of donations made during the year Donation to P.M.s National Relief Fund Donation to Jamia Milia University Donation to National Cultural Fund, set up by Central Government Donation to Delhi Municipal Corporation for Family Planning Donation to Birla Temple (notified): (i) for repair and renovation of the temple (ii) for religious ceremonies, prasad, etc. for the benefit of devotees in general Donation to a temple managed by the Residents Welfare Association for its much needed repair and maintenance. The Association is a non-profit entity registered with the Registrar of Societies. Following donations to Pt. Pyare Lai Charitable Trust recognised by the Commissioner u/s 80G(5)(vi): (i) Donation in form of equity shares of blue chip companies: The shares were sold by the Trust at their market value of ` 75,000 and used wholly towards its charitable objectives. However, shares were transferred at cost, (ii) Donation paid in cash, (iii) Donation made by cheque, (iv) 50 blankets costing ` 100 each. Donation made to Indian Olympic Association 80G(2)(c) paid by A/c payee cheque, Donation for developing low cost homes for slum-dwellers, paid (i) Delhi Development Authority, (ii) Delhi Slum-dwellers Rehabilitation Society duly registered with the Registrar, The Rajiv Gandhi Foundation National Childrens Fund ` 10,000 5,000 5,000 12,000 2,000 5,000 5,000

25,000 5,000 7,000 5,000 7,500 3,000 2,500 6,000 3,000

Mr. Maity borrowed a sum of ` 2,00,000 in 2003 @ 9% interest from Harsh Vardhan Charitable Trust (registered under Sec. 80G) to complete his B.Tech. degree from Nalanda University. In March 2013, he repaid a sum of ` 75,000 (includ ing ` 20,000 interest) to the said trust. Compute his Total Income for the Assessment Year 2013-2014.

DIRECT TAXATION I 11.29

Deduction in Computing Total Income Solution: Computation of Total Income of Mr. Maity for the Assessment Year 2013-2014 Particulars 1. Income from Salary 2. 3. 4. Income from House Property Share of profits from an AOP : Exempt (Sec. 86) Long-term Capital Gains ` ` 3,00,000 1,70,000 Nil 50,000 5,20,000

Gross Total Income 5. Deduction from Gross Total Income : (i) Medical insurance premium (Sec. 80D) (ii) Expenditure on medical treatment and deposit for maintenance of a handicapped dependent relative (Sec. 80DD) (iii) Repayment of interest on loan for higher studies (Sec. 80E) (No deduction is allowed for repayment of principal amount of educational loan w.e.f. A.Y. 2008-2009) (iv) Charitable donations Sec. 80G [See Note below] 9,000 50,000

20,000 79,000 42,500 1,21,500 3,98,500

Total Income Working Note: ` Goss Total Income Less : Aggregate of: (i) Share of profit in AOP entitled to rebate u/s 86. Nil 79,000 50,000 Nil (ii) Any amount qualifying for deduction from GTI exempt for deduction for donation u/s 80G itself. (iii) Long-term Capital Gain (iv) Any to a NRI from dividend and interest etc. on foreign currency investment referred to u/s 115A, 115AB, 115AC, 115ACA, 115AD. Computation of Deduction for Donations u/s 80G ` A. Donations not subject to qualifying amount, eligible for deduction @ 100% of the amount donated : (i) Donation to P.M.s National Relief Fund (ii) Donation to National Cultural Fund, set up by Central Government 10,000 5,000

` 5,20,000

1,29,000 3,91,000

Adjusted Gross Total Income

15,000

11.30 I DIRECT TAXATION

` B. Donation not subject to qualifying amount, eligible for deduction @ 50% of the amount donated : (i) The Rajiv Gandhi Foundation (ii) National Childrens Fund Only 50% of the amount of donation available as deduction 6,000 3,000 9,000 12,000

4,500

C. Donation subject to qualifying amount : (i) Donation to Delhi Municipal Corporation for Family Planning (ii) Donation made to Indian Olympic Association 80G (2)(C) (available only to a company assessee) (iii) Donation to Jamia Milia University (iv) Donation to Birla Temple (notified) for repair and renovation of the temple. (v) Monetary donation to Pt. Pyare Lal Charitable Trust recognized by the Commissioner u/s 80G (5) (vi). (vi) Donation to Delhi Development Authority Aggregate of donations subject to qualifying amount Qualifying amount : Lower of the following : (a) 10% of Adjusted Gross Total Income, i.e. ` 39,100, or (b) Aggregate of donations, ` 34,000 Whichever is less, is qualifying amount = 34,000 100% of ` 12,000 out of the QA of 34,000 12,000 11,000 23,000 42,500 Nil 5,000 2,000

12,000 3,000 34,000

1. 2. 3.

50% of the balance of the QA i.e. 50% of (34,000-12,000) Total deduction for donations u/s 80G Medical Insurance Premium paid in cash is not allowable as a deduction.

Donation to a notified temple is allowed only if it is towards its repairs or maintenance and not otherwise. Only donations paid in monetary terms that is, either in cash or by cheque are eligible for deduction. Conversion of donations in kind into cash by the donee or mere possibility of their conversion is immaterial.

4. Temple managed by the Resident Welfare Association is not a notified temple. Illustration 5: Mr. Jamal, a resident assessee, runs a manufacturing business in Delhi. For the Previous Year 2012-2013, he disclosed his Taxable Income as below: Business Profits Long-term Capital Gains Short-term Capital Gain ` 2,55,000 25,000 15,000

DIRECT TAXATION I 11.31

Deduction in Computing Total Income He has hired furnished accommodation for his own use and pays ` 4,000 p.m. He has paid donation amounting to ` 10,000 to National Defence Fund. He has deposited ` 50,000 under a scheme framed by the Life Insurance Corporation for maintenance of his dependant brother with a disability. The disability is certified by the medical authority. Compute his Total Income for the Assessment Year 2013-2014. Solution: Computation of Total Income of Mr Jamal Assessment Year 2013-2014 Particulars Income from Business (computed) Long-term Capital Gain (computed) Short-term Capital Gain (computed) Gross Total Income Deductions from Gross Total Income: (i) Deposit for maintenance of a dependent with disability [Sec. 80DD]: (ii) Charitable donations to National Defence Fund [Sec. 80G]: Amount of Deduction @ 100% of ` 10,000 (iii) Expenditure incurred on rent [Sec. 80GG] [ W.N.1 ] Total Income Workings Note : Particulars Expenditure incurred on rent [Sec. 80GG]: [Rent paid -10% of AGTI], i.e. 48,00021,000 = 27,000, or 25% of AGTI, i.e. 25% of 2,10,000 = 52,500, or ` 2,000 p.m. = ` 24,000 whichever is less, is to be deducted, i.e. ` 24,000 Adjusted Gross Total Income for Sec. 80GG: Gross Total Income Less: Aggregate of 2. All permissible deduction from GTI except for deduction for u/s 80GG (ii) Any Long-term Capital Gain Adjusted Gross Total Income [AGTI] for Sec. 80GG ` ` ` ` 2,55,000 25,000 15,000 2,95,000

50,000 10,000 60,000 24,000

84,000 2,11,000

2,95,000

60,000 25,000

85,000 2,10,000

Illustration 6: M, resident in India, furnishes the following particulars of his receipts and outgoings during the Previous Year 2011-2012. ` Receipts: (i) Income from Salary (ii) Income from House Property (iii) Gross winning from crossword puzzle Outgoing: (i) Contribution to LIC annuity plan (ii) Medical insurance premium: (a) For himself (b) His wife, not dependent (c) Mother, non-resident, 67 years, dependent 2,00,000 3,00,000 3,50,000 15,000 4,000 3,000 5,000

11.32 I DIRECT TAXATION

 (d) Nephew, wholly dependent with disability 3,000 (e) Grandson, dependent 2,000 (iii) Expenditure on medical treatment and maintenance of the nephew referred to 30,000 (iv) Medical treatment for grandson, suffering from a disease specified under 50,000 Income-tax Rules(v) (v) Donation to Gujarat Government for family planning 50,000 (vi) Scholarship to a poor but meritorious student 20,000 (vii) Contribution to approved scientific research association 30,000 (viii) Contribution to Delhi Municipal Corporation for sewage scheme for slum-dwellers, 50,000 approved by National Committee (ix) Donation to Political party paid during November 2012 20,000 Compute his Total Income for the Assessment Year 2013-2014. Make necessary assumptions and clarify them. Solution: Computation of Total Income for AY 2013-2014 Particulars Income from Salary Income from House Property Gross winnings from crossword puzzle Gross Total Income Less: Deductions under Chapter VIA : Contribution to LIC annuity plan [Sec. 80CCC] Medical insurance premium [Sec, 80D] Self 4,000 His wife 3,000 Mother, 67 years old 5,000 Nephew dependent with disability Nil Grand son Nil Maintenance and medical treatment of a dependent with disability [Sec. 80DD] Expenditure for medical treatment of grandson [Sec. 80DDB] Donations for scientific research or rural development [Sec. 80-GGA] (a) Donation to approved scientific research association (b) Contribution to MCD for slum-dwellers scheme, approved by National Committee Donations to political party [Sec. 80GGC w.e.f. 22.9.2004] Charitable donations [Sec. 80G] (a) Scholarship to a poor meritorious student (b) Gujarat government for family planning: 100% of qualifying amount 1. Actual donation = 50,000, or 2. 10% of specified GTI = 37,300 8,50,000 (3,50,000 + 15,000 + 12,000 + 30,000 + 50,000 + 20,000) = ` 3,73,000 whichever is less, is QA 37,300= 100% of 37,300 Total Income ` ` 2,00,000 3,00,000 3,50,000 8,50,000

15,000

12,000 Nil Nil 30,000 50,000 20,000 Nil

37,300

1,64,300 6,85,700

DIRECT TAXATION I 11.33

Deduction in Computing Total Income Illustration 7: SK Industries, a diversified group, discloses profit from the following sources for the Previous Year 2012-2013: (` in lakhs) (i) Profits from small-scale unit, started in 2003-2004 6.00 (ii) Profit from industrial undertaking 1998-99, in Vidisha, a B-class 10.00 industrially backward district. (iii) Profit from multiplex theatre, started in 2007-2008 (a) Delhi 4.00 (b) Allahabad 2.00 (iv) Profits from convention centre, started in 2009-2010 (a) Delhi 5.00 (b) Allahabad 3.00 (v) Profits from Hill View, a hotel started in 2004-2005 at Manali in 10.00 Himachal Pradesh. Hotel is approved by prescribed authority (vi) Profits from undertakings engaged in refining of mineral oil since 10.00 st 1 January 2005 in Uttar Pradesh, not listed in backward state in Eighth Schedule. Compute the Total Income for the Assessment Year 2012-2013. Solution: Assessee: S.K Industries Computation of Total Income Previous Year-2012-13 Assessment Year- 2013-14 (` lakhs) (` lakhs) 6.00 10.00 6.00 8.00 10.00 10.00 50.00

Particulars (i) Profits from SSI (ii) Profits from undertaking located in industrially backward B-class district (iii) Profits from multiplex theatre: (4 + 2) = (iv) Profits from convention centre : (5+3) = (v) Profits from Hill View Hotel (vi) Profits from refining undertaking Gross Total Income Less : Deduction in respect of profits and gains from certain industrial undertaking, other than infrastructure undertakings (Sec. 80-IB) : 1. Profits from SSI [Sec. 80-IB (3)] : 25% of ` 6 Lakh 2. Profits from undertaking in B-class industrially backward district [Sec. 80-IB (4)] [No deduction is available] 3. Profits from multiplex theatre [Sec. 80-IB(7A) 50% of ` 2 lakh (No deduction is available) 4. Profits from convention centre [Sec. 80-IB(7B)] [No deduction is available] 5. Profits from Hill View Hotel [Sec. 80-IB(7)] Allowed only for Indian company 6. Profits from refining undertaking [Sec. 80-IB(9)]-100% of profits for 7 Assessment Years Total Income

1.50 Nil Nil Nil Nil 10.00 11.50 38.50

11.34 I DIRECT TAXATION

Illustration 8 : Evergreen Construction (P) Ltd. has earned profits during the P.Y. 2012-2013 from construction and sale of flats under three housing projects, developed at Rajarhat, Kolkata, details of which are given below: (a) Profits from construction and sale of flats, built up on a plot of 1.5 acres, built up area of the flat 1400 sq. feet, located 30 k.m. from Kolkata. 60.00 40.00 built up area 1050 sq. feet, located within 25 k.m. from Mumbai. built up area 1000 sq. feet, located 35 k.m. from Kolkata. (b) Profits from construction and sale of flats, built up on a plot of 1 acre, (c) Profits from construction and sale of flats, built on a plot of 0.90 acre, (` in lakhs) 80.00

The housing projects have been approved by the Kolkata Industrial Development Authority in the year 1st April, 2006. Compute its Total Income for the Previous Year 2012-2013 relevant for the A.Y. 2013-2014. Would your answer be dif ferent in the following cases: (i) The housing projects were not approved. (ii) The housing project is carried out in accordance with a scheme approved by West Bengal Government for redevelop ment of buildings in slum areas. (iii) The company was engaged only in the sale of flats and not developing and building the housing project. Solution: Particulars Profits from Project (a) Profits from Project (b) Profits from Project (c) Less: Deductions from profits and gains from certain industrial undertaking other than infrastructure undertaking (Sec. 80-IB): (1) Profits from Housing Project (a) are fully deductible as the size of flat not exceeding the prescribed area 1500 sq feet. (2) Profits from Housing Project (b) not deductible as the area of the flat exceeds the prescribed area of 1000 sq feet. (3) Profits from Housing Project (c) not deductible as the size of the Housing plot is less than 1 acre. Total Income (i) 80.00 Nil Nil () 80.00 100.00 Computation of Total Income for the AY 2013-2014 (` in lakh) (` in lakh) 80.00 60.00 40.00 180.00

If the housing projects were not approved, then no deduction u/s 80IB is available. Hence, Total Income will be ` 180 Lakhs

(ii) Here, deduction u/s 80IB is allowed and hence, Total Income is ` 100 Lakhs (iii) Here, deduction u/s 80IB is not allowed, hence, Total Income is ` 180 Lakhs Illustration 9: Mekon Ltd., an Indian company, starts an industrial undertaking on 1st April, 2012. During the Previous Year, it earns profits of ` 80 lakh before allowing any deduction for wages. Compute its Total Income for the Previous Year 2012-2013 taking into account the following employment schedules of workers:

DIRECT TAXATION I 11.35

Deduction in Computing Total Income Date of employment 1-5-2012 1-6-2012 1-7-2012 Solution : Computation of Total Income for the AY 2013-2014 Particulars Profits before allowing deduction for wages Less: Wages paid to workers [Sec. 37(1)]: (i) 90 ` 3000 11 29,70,000 8,00,000 3,60,000 (-) 41,30,000 38,70,000 (-) 1,20,000 (ii) 20 ` 4000 10 (iii) 10 ` 4000 9 Business Profits and Gross Total Income Less: Deduction in respect of employment of new workmen [Sec. 80 JJAA] 30% (` 40001010)[Excess of 100 workmen (including casual)] Total Income ` ` 80,00,000 Number of workers 90 20 10 Status of workers Casual Regular Regular Rate of wages 3000 p.m. 4000 p.m. 4000 p.m.

37,50,000

Illustration 10 : Mr. R has developed an improved economical model of a motor cycle and got it patented on 31-3-2012 under the Patent Act, 1970. He allowed Z Ltd. to use his patent rights and licenses has been granted to it under the Patent Act, 1970. He has received royalty of ` 8,00,000 during the Previous Year 2012-2013. However, the royalty in accordance with the terms and conditions of the license settled by the Controllers under the said Act is ` 2,80,000. He has incurred ` 1,00,000 expenses in developing his invention and getting it patented. Compute his Total Income for the Assessment Year 2013-2014 (i) if he is resident in India, (ii) non-resident India. Solution: Particulars Income from Other Sources Less : Expenses Gross Total Income (GTI) Less: Deduction for respect of royalty on patent (Sec. 80-RRB) Least of the followings: (a) Income from royalty ` 8,00,000; or (b) Royalty under the terms of license settled by the Controller ` 2,80,000; 2,80,000 4,20,000 Nil 7,00,000 Whichever is less, is to be deducted (c) Maximum limit ` 3,00,000 Total Income Computation of Total Income for the Assessment Year 2013-2014 (i) ` 8,00,000 1,00,000 7,00,000 (ii) ` 8,00,000 1,00,000 7,00,000

11.36 I DIRECT TAXATION

Illustration 11: Mr. J is suffering with 60% locomotor disability which is certified by medical authority. He is employed as Techni cal Supervisor with Air Tel at a salary of ` 20,000 p.m. (i) Particulars ` 20,000 (-) 40,000 1,00,000 1,00,000 10,000 18,000 Income from Government securities

(ii) Long-term Capital Loss (iii) Short-term Capital Gain (Sec. 111A) (iv) Insurance commission (gross) (v) Interest on Saving Fund A/c from Bank (i) Medical insurance paid by cheque for his father, resident in India and 70 years

He has incurred the following expenses: (ii) Deposit with LIC for maintenance of father, mainly dependant on him for support and maintenance and suffering from low-vision with a severe disability of 80%, as per certificate of the medical authority (iii) Rent paid for the year 2012-2013 for accommodation hired by him. Compute his Total Income for the Assessment Year 2013-2014. Solution: Computation of Total Income for the Assessment Year 2013-2014 Particulars 1. Income from Salaries 2. 3. Income from Capital Gains : (a) Short-term Capital Gains (Sec. 111A) (b) Long-term Capital Loss to be carried forward Income from Others Sources : (a) Interest from Government securities (b) Interest on Savings Fund A/c with Bank (c) Insurance commission 20,000 10,000 1,00,000 1,30,000 4,70,000 18,000 1,00,000 10,000 50,000 1,00,000 Nil ` ` 2,40,000

1,00,000 40,000

Gross Total Income Less : Deductions under Chapter VIA: Medical insurance (Sec. 80D) Deduction in respect of maintenance including medical treatment of a dependant, a person with severe disability (Sec. 80DD) Deduction in respect of Interest on Savings Fund A/c (Sec. 80TTA) Deduction in case of a person with disability (Sec. 80U) Deduction u/s 80GG :( Least of the followings) (a) (i) Rent paid less 10% of Adjusted Gross Total Income 40,00019,200 = 20,800, (b) (ii)25% of 1,92,000 Adjusted Gross Total Income=48,000, (iii)2,000 p.m. 12 = 24,000 20,800

Whichever is less, is or be deducted Total Income

1,98,800 2,71,200

DIRECT TAXATION I 11.37

Deduction in Computing Total Income Illustration 12: Mr. Krishna is a lawyer of Allahabad High Court. He keeps his accounts on cash basis. His Receipts and Payments A/c for the year ending 31-03-2013 is given below: Dr. Receipts Balance b/d Legal fees Special commission fees Salary from Law College as part time lecture Exam. Remuneration Interest on Bank Deposit Sale proceeds property of residential ` Payments 3,820 Purchase of Infrastructure Bonds 3,45,000 Subscription and membership 5,500 Purchase of legal books 87,000 1,480 3,500 3,01,000 1,000 Rent Municipal Tax paid on H. P. Car expenses Office expenses Electricity Exps. Income Tax Gift to daughter Cr. ` 20,000 4,500 17,500 47,500 3,000 44,000 38,500 4,000 8,000 12,000 85,000 12,000 3,27,000 16,000 1,26,300 7,65,300

Dividend from Co-operative society Dividend received from the units of UTI Rent from house property

2,000 Domestic expenses 15,000 Donation to Institutions approved u/s 80G Car purchased Life Insurance premium 7,65,300 Balance c/d

Following information are available: 1. 2. 3. 4. 5. 6. 7. The Rent and Electric expenses are related to a house, of which half portion in used for self residence and remaining half portion in used for office. Car is used only for professional purposes. Outstanding legal fees ` 10,000. Rent has been paid for 10 months only. Car was purchase on 25-09-2012. Law books purchased are annual publications out of which books of ` 2,000 were purchasd on 6-4-2012 and balance on 31-10-2012. The house was purchased in January 1988 for ` 50,000 and sold on 1-7-2012. Rent of the property which has been sold was ` 5,000 p.m. The property was vacated by the tenant on 30-6-2012. Compute his Total Income for the Assessment Year 2013-14. Computation of Total Income of Mr. Sen for the Assessment Year 2013-14 Particulars 1. Income from Salary Salary as a part time lecturer Less: Deduction ` 87,000 Nil `

Solution:

87,000

11.38 I DIRECT TAXATION

Particulars 2. Income from House Property Annual Rent Less: Vacancy Allowance Gross Annual Value (GAV) Less: Municipality Tax paid Net Annual Value (NAV) Less: Standard deduction @30% of NAV 3. Income from Profession Professional Earnings: (i) Legal fees (ii) Special commission Less: Allowable expenses (i) Subscription etc. (ii) 1/2 Rent (Office) (iii) Car expenses (iv) 1/2 electric charges (v) Office expenses (vi) Depreciation on car @ 15% on 3,27,000 (vii) Depreciation on books

` 60,000 45,000 15,000 3,000 12,000 3,600

8,400

3,45,000 5,500 3,50,500 4,500 23,750 44,000 2,000 38,500 49,050

@100% on Annual Publication of ` 2,000 = 2,000 @50% on Others of 15,500 = 7,750 4. 5. Capital Gains: Sale consideration

9,750

1,71,550 3,01,000 2,84,000

1,78,950

Less: Indexed cost of acquisition 50,000 lncome from Other Sources: Interest on bank deposit Examiners fees Dividend from Co-operative Society Dividend from UTI Gross Total Income Less: Deductions (i) 80C - LIP (ii) 80G - Donation @ 50% of ` 12,000 (iii) 80CCF - Purchase of Infrastructure Bonds (discontinued) (iv) 80TTA Interest on bank deposit (assumed savings deposit) Total Income

17,000

3,500 1,480 1,000 Exempt 16,000 6,000 Nil 3,500

5,980 2,97,330

25,500 2,71,830

DIRECT TAXATION I 11.39

Deduction in Computing Total Income Notes: 1. As the assessee follows the cash system of accounting, amount actually received and payment actually made on account of expenditure, during the year, shall be considered for computing the income. Therefore, any outstanding receipts will not be included in the Total Income. Similarly, rent not paid for two months will not be allowed as deduction. The system of accounting does not affect the computation of Income from Salary, House Property and Capital Gains. Therefore, in this case, rent for three months, though not received (as it has not been shown in the Receipt and Payment Account) shall be taken into account in computing the income under the head House Property. Car was purchased and put to use for more than 180 days. Therefore, full depreciation @15% has been claimed. Law books worth ` 2,000 were purchased and put to use for more than 180 days and are, therefore, eligible for depreciation @100%. The balance books worth ` 15,500 were purchased on 31-10-2012; therefore, 50% of the normal depreciation will be allowed as the books were purchased and put to use for less than 180 days. The total depreciation shall, therefore, be ` 2,000+50% of ` 15,500=` 9,750.

2.

3. 4.

Illustration 13: Dr. Paul is running a Nursing Home with his wife Dr. (Mrs.) Paul as a partnership firm Paul & Co. On the basis of the following particulars, compute the Total Income of Dr. Paul and Dr. (Mrs.) Paul for the Assessment Year 2013-14. (A) Particulars of income of the Nursing Home (i) Income as per Income and Expenditure Account (ii) Firms tax not provided in the account (iii) Dontation to Public Charitable Trust exempt u/s 80G debited in the A/c (i) 40% of profit from Nursing Home as per books ` 1,28,000 ` 3,20,000 48,000 35,000

(B) Particulars of Income of Dr. Paul: (ii) Dr. Paul had purchased 500 shares of Laha (P) Ltd. at ` 110 each in May 1990. On 14-5-2012 Dr. Paul sold 300 shares at ` 400 per share. He invested ` 40,000 out of the net sale proceeds in Bonds of RECL in June, 2012. The balance of 200 shares were sold in December, 2012 at ` 380 per share. (iii) Dr. Paul is a Director in Raha (P) Ltd. from which he received directors fees amounting to ` 4,000. (iv) Dr. Paul has obtained a loan of ` 50,000 from the said company for renovating the Nursing Home. The balance sheet of Raha (P) Ltd. for the Accounting year, inter alia, disclosed the following particulars. (a) General Reserve 40,000 20,000 60,000

(b) Profit & Loss Account (Cr. Balance)

(v) Share of income from property belonging to HUF of which Dr. Paul is the Karta amounts to ` 30,000. ` 1,92,000 18,000 48,000 (i) 60% share of profit from Nursing Home as per books

(C) Particulars of Income of Dr. (Mrs.) Paul: (ii) Income from dividend from UTI (iii) Income from house property (as computed under Income-tax Act)

(D) Particulars of Income of Master Pritam:

11.40 I DIRECT TAXATION

Pritam minor son of Dr. Paul and Dr. (Mrs.) Paul has been admitted to the benefits of partnership in Paul & Co. which is carrying on business as Chemists & Druggists. The said firm has two other partners Soham (brother of Dr. Paul) and Priya [sister of Dr. (Mrs.) Paul]. Pritams share of profits is determined at ` 20,000. Computation of Total Income of Paul & Co. A.Y: 2013-14 ` Income as per Income and Expenditure Account Add: Donation to public charitable trust Gross Total Income Donation to public charitable trust being restricted to 10% of Gross Total Income (3,55,000) i.e. 50% of ` 35,000 Total Income Total tax plus education cess plus SHEC payable by the firm ` 1,04,288. Computation of Total Income of Dr. Paul Particulars 1. His income from the Nursing Home is not taxable. (as already paid by the firm) 2. Capital Gains Sale proceeds: 300 shares of ` 400 each 200 shares of ` 380 each Less: Indexed cost : 55,000 Long term Capital Loss Income from other sources: (a) Directors fees (b) Deemed dividends u/s 2(22)(e) for having taken a loan from the company in which the assessee has substantial holding Gross Total Income Deduction under Chapter VI A Total Income ` tax is A.Y.: 2013-14 ` Nil 3,20,000 35,000 3,55,000 17,500 3,37,500

Solution:

1,20,000 76,000 1,96,000 2,57,473 () 61,473

3.

4,000 50,000

54,000 54,000 Nil 54,000 A.Y.: 2013-14 ` Nil 48,000 Exempt 48,000 Nil 48,000

Computation of Total Income of Dr. (Mrs.) Paul 1. 2. 3. 60% share from Nursing Home is not taxable (as tax is already paid by the firm) Income from house property (net). Income from other sources dividends from UTI

Gross Total Income Less: Deduction under Chapter VIA Total Income

DIRECT TAXATION I 11.41

Deduction in Computing Total Income Notes: 1. 2. Share of profit from the firm accruing to minor is not included in the Total Income of parent as share of profit to a partner is exempt. Long-term Capital Loss cannot be set off against other income and therefore has to be carried forward.

Illustration 14: From the following details compute the Total Income of Mr. X, a resident of Delhi, for the A.Y. 2013-14. Particulars (a) Salary including Dearness Allowance (b) Bonus (c) Contribution to a Recognised Provident Fund (d) Life Insurance Premium (e) Rent paid by the Employer for flat provided to Mr. X (f) Cost of Furniture provided by the employer at the aforesaid flat (g) Rent recovered from Mr. X by employer (h) Bills paid by the employer for gas, electricity and water provided free of cost at the above flat (i) Mr. X was provided with Companys car (with driver) also for personal use, not possible to determine expenditure on personal use and all expenses were borne by the employer. ` Mr. X owns a house. The particulars are: Rent received (12 months) Municipal valuation Municipal taxes paid Ground rent Insurance charges Collection charges Interest on borrowing used for construction of house (constructed in June 2004) Other Information: Dividend received from UTI Deposits under National Saving Certificate 14,000 20,000 72,000 48,000 12,000 2,000 1,000 3,400 48,000 ` 6,30,000 57,600 36,000 57,000 90,000 80,000 36,000 18,000

11.42 I DIRECT TAXATION

Solution: Assessee: Mr. X Particulars Income under the head Salary Salary including Dearness Allowance Bonus Gross Salary before including value of perquisites Value of Concessional Furnished Accommodation [Rule 3(1)] Least of Rent Paid by employer [` 90,000 or 15% of Salary ` 6,87,600] [` 80,000 10%] 90,000 8,000 (36,000) 62,000 18,000 32,400 8,00,000 Add: 10% of Furniture Value Less: Rent recovered from Mr. X Gas, Electricity and Water provided by the employer Motor Car provided to the employee for use (assumed capacity upto 1.6 liitres) [(` 1,800 p.m. + ` 900 p.m. for chauffeur) 12 Months)] as per Rule 3 Gross Income from Salary Income from House Property: Gross Annual Value u/s 23(1) Higher of Municipal Value ` 48,000 or Rent Received ` 72,000 72,000 (12,000) 60,000 (18,000) (48,000) (6,000) Nil 14,000 (14,000) 36,000 57,000 20,000 1,13,000 (1,00,000) 6,94,000 7,94,000 Less: Municipal Taxes paid Net Annual Value Less: Deduction Standard deduction @ 30% of Net Annual Value u/s 24(a) Interest on borrowed capital u/s 24(b) Income from Other Sources: Income from UTI Exemption u/s 10(35) GROSS TOTAL INCOME Less: Deduction under Chapter VIA - Section 80C - Contribution to RPF - LIC Premium - Deposits in NSC Deduction u/s 80C restricted to ` 1,00,000 [Sec. 80CCE] Previous Year: 2012-13 Computation of Total Income ` ` 6,30,000 57,600 6,87,600 Assessment Year: 2013-14

TOTAL INCOME (Rounded Off u/s 288A)

DIRECT TAXATION I 11.43

Deduction in Computing Total Income Illustration 15 : Mr. X, Finance Manager of K Ltd. Mumbai, furnishes the following particulars Previous Year 2012-2013. (a) Gross Salary (per month) [Tax deducted from Salary ` 1,09,000] (b) Valuation of medical facility in a hospital maintained by the Company (c) Rent Free Accommodation owned by the Company (d) Housing Loan of ` 6,00,000 at the interest rate of 5% p.a. (no repayment made during the year, to be repaid within 10 years)[Standard Rate of SBI is 10% p.a.] (e) Gift made by the Company on the occassion of wedding anniversary of X (f) A wooden table and 4 Chairs were provided to X at his residence (Dining Table). This was purchased on 1.5.2009 for ` 60,000 and sold to X on 1.8.2012 for ` 30,000 (g) Personal purchases through Credit Card provided by the Company amounting to ` 20,000 was paid by the Company. No part of the amount was recovered from X. (h) A Maruti Esteem Car which was purchased by the Company on 16.7.2008 for ` 5,50,000 was sold to the assessee on 14.8.2012 for ` 1,30,000. (i) Other income received by the assessee during the Previous Year 2012-2013 are: Interest on Fixed Deposits with a Company Income from specified mutual fund Interest on bank deposits of a minor married daughter Income from UTI received by his handicapped minor son (j) Contribution to LIC towards Premium u/s 80CCC (k) Deposit in PPF Account made during the year 2012-2013 (l) Bonds of ICICI (Tax Savings) eligible for tax deduction Compute the Taxable Income of Mr. X and the tax liability for the A.Y. 2013-2014. for the ` 64,000 7,000

4,750

` 5,000 3,000 3,000 1,200 10,000 75,000 25,000

11.44 I DIRECT TAXATION

Solution: Assessee: Mr. X

Previous Year: 2012-13 Computation of Total Income

Assessment Year: 2013-14 ` ` 7,68,000

Particulars Income from Salaries: Basic Salary (` 64,00012) Add: Value of Perquisities: 1. Value of Medical Facility in hospital maintained by K Ltd. Treatment in hospital maintained by Employer Fully Exempt 2. Rent Free Accommodation owned by Company Explanation 1 to Sec.17(2) 15% of salary = 15% of ` 7,68,000 (Population > 25 Lakhs) 3. Housing Loans at concessional rate Rule 3(7)(i) = ` 6,00,000 (10% 5%) 4. Use of Furniture & Fittings upto 1.8.2012 - Rule 3(1)(vii) = 10% ` 60,000 4/12 5. Transfer of Assets - Rule 3(7)(viii) Dining Table as per WN 1 (a) Motor Car as per WN 1 (b) 6. Gifts made by the Company on the occasion of the Wedding Anniversary 7. Credit Card Purchases taxable as perquisite u/s 17(2) Gross Income from Salary Less: Deduction u/s 16 Net Income from Salaries Income from Other Sources : Interest on Fixed Deposits with a Company Income from specified mutual fund 3,000 Less: Exempt u/s 10(35) (3,000) Interest on Bank Deposits of minor married daughter 3,000 Less: Exempt u/s 10(32) (1,500) Income received by handicapped minor son - not clubbed u/s 64(lA) GROSS TOTAL INCOME Less: Deduction under Chapter VI-A U/s 80CCC Contribution towards Pension Fund U/s 80C Contribution towards PPF Bonds of ICICI (Tax Savings) Subject to the maximum of ` 1,00,000 TOTAL INCOME TAX PAYABLE Add: Education Cess @ 2% Add: Secondary and Higher Education Cess @ 1% Gross Tax Payable Less: Tax Deducted at source Net Tax Liability

Nil 1,15,200 30,000 2,000 12,000 95,280 1,07,280 Nil 20,000 10,42,480 Nil 10,42,480 5,000 Nil 1,500 Nil

6,500 10,48,980

10,000 75,000 25,000 1,10,000

1,00,000 9,48,980 1,19,796 2,396 1,198 1,23,390 1,09,000 4,390

DIRECT TAXATION I 11.45

Deduction in Computing Total Income Working Notes: 1. Valuation of Perquisites on transfer of Movable Assets: (` ) 60,000 (18,000) Purchase Price Less: Depreciation till date of Sale (` 60,000 3 10%) WDV as at date of transfer Less: Deduction for collection from Employee Value of Perquisite 42,000 (30,000) 12,000 ` 5,50,000 1,10,000 4,40,000 88,000 3,52,000 70,400 2,81,600 56,320 2,25,280 1,30,000 95,280 (a) Transfer of Assets: Dining Table

(b) Motor Car 2. Cost of Purchase (16.7.2008) Less: Depreciation @ 20% (16.7.2008 - 15.7.2009) 16.7.2009 WDV Less: Depreciation for 16.7.2009 - 15.7.2010 16.7.2010 WDV Less: Depreciation for 16.7.2010 - 15.7.2011 16.7.2011 WDV Less: Depreciation for 16.7.2011 - 15.7.2012 16.7.2012 WDV Less: Amount Recovered on Transfer Value of Perquisite Gifts received from the employer on the occasion of the wedding anniversary (a) Taxable as perquisite u/s 17(2).

(b) As per Rule 3(7)(vi), value of any gift or voucher or token (other than made in cash) or convertible; in cash on ceremonial occasion or otherwise shall be taxable if the the aggregate value of Gift during the Previous Year is ` 5,000 or more. Since the value of gifts received is less than ` 5,000, it shall be exempt from tax.

Illustration 16: M, an individual, retired from the services of a Company on 31.10.2012. He joined another employer on 1.11.2012 and was in service till end of March 2013, when he furnishes the following details and information 1. Salary and Allowances for the period From First Employer Basic Salary Dearness Allowance Conveyance Allowance Basic Salary Fixed Conveyance Allowance ` Per month 30,000 16,000 6,000 ` Per month 35,000 8,000

From Second Employer

11.46 I DIRECT TAXATION

2.

While he was with the first employer, M contributed 10% of his basic salary to a Provident Fund Account with the Regional Provident Fund Commissioner. He did not become a member of the Provident Fund maintained by the second employer. M was permitted by the second employer to encash 15 days leave he had accumulated during his service and received ` 12,500 from his employer. M had constructed a residential house in Chennai in February 2008 for ` 30 Lakhs. Part of the costs of construction was met by borrowals of ` 20 lakhs from the Housing Development Corporation, at interest of 12.5% p.a. The loan was taken on June 2007. The loan outstanding at the beginning of the current year was ` 12,00,000. The rate of interest applicable for the current year was reduced to 9% p.a. due to reduction in rates. [He had also borrowed from some relatives ` 4,00,000 on which interest at 15% p.a. was due.] The property had been let-out soon after completion. In the Assessment Year 2008-09, M was allowed a deduction of ` 50,000 for irrecoverable rents. The annual value decided by the Corporation of Channai for the property is ` 80,000. The property was let-out in the current year to a Company on a rent of ` 20,000 p.m. The half-yearly municipal taxes on the property were fixed by the Corporation of Channai only in August 2012 at ` 15,000 for every half year from 1.4.2009. M paid the taxes due in September 2012 upto the year ending 31.3.2012. M also received from the previous tenant ` 40,000 (out of the dues of ` 50,000). After retirement from the first employer, M received ` 4,50,000 from the Regional Provident Fund Commissioner, money was fully invested by him in the 15% Non-Redeemable Debentures issued by the Indian Oil Corporation interest on these had not come in by the end of March 2013. M received interest of ` 60,000 on long-term fixed deposits with Banks, ` 2,500 as interest on Post Office Savings Bank Accounts and ` 20,000 as income from units. M owns a car which is used for office purposes also and it is found that the entire conveyance allowance from his employer had been fully spent on travel for official purposes.

3. 4.

5.

6. 7.

8. 9.

10. One of the policies of insurance taken by M had matured for payment and ` 8,00,000 received by him in June 2012 from the LIC was invested by him, in the name of his 16-year old son, in fixed deposits with companies. Interest received uplo 31.3.2013 on these deposits was ` 90,000. On one of the continuing policies of insurance, M paid a premium of ` 60,000 in the year. Compute Ms Total Income for the Assessment Year 2013-14. Solution: Assessee: Mr. M Previous Year: 2012-13 Computation of Total Income ` Income under the head Salaries From First Employer Basic Pay Dearness Allowance Conveyance Allowance Less: Exempt u/s 10(14) Amount received from Regional Provident Fund Commissioner Less: Exempt u/s 10(12) ` ` Assessment Year: 2013-14

(` 30,000 7) (` 16,000 7) (` 6000 7)

2,10,000 1,12,000 42,000 (42,000) 4,50,000 (4,50,000) Nil 3,22,000

Nil

DIRECT TAXATION I 11.47

Deduction in Computing Total Income From Second Employer Basic Salary (` 35,000 5) Conveyance Allowance (` 8,000 5) Less: Exempt u/s 10(14) (incurred for official performance of duties) Leave Encashment - Fully taxable while in service Gross Income from Salary Income from House Property: Gross Annual Value u/s. 23(1) Higher of Municipal Value of ` 80,000 or Actual Rent of ` 2,40,000 Less: Municipal Taxes paid during the year @ ` 15,000 for every half year from 1.4.2009 upto 31.3.2012 (Current Year - Not Paid) Net Annual Value (NAV) Less: Deduction @ 30% of NAV u/s 24(a) Interest on Borrowed Capital u/s 24(b) Loan from Housing Development Corporation: Current Period Interest: ` 12,00,000 9% Prior Period Interest (Interest upto 31.3.2008) [(` 20,00,000 12.5%) +(4,00,000 15%)] 10/12 1/5 Loan from Relative - Current Period Interest (` 4,00,000 x 15%) Add: Unrealised Rent recovered (taxable in the year of recovery u/s 25AA] Income from Other Sources Interest on Long-term Fixed Deposits with Bank Interest on Post Office Savings Bank A/c Less: Exempt u/s 10(15) Income from Units of UTI Less: Exempt u/s. 10(35) LIC Policy matured Less: Exempt u/s. 10(1D) Interest from Fixed Deposits with Companies in the name of minor son Less: Exemption u/s. 10(32) Gross Total Income Less: Deduction under Chapter VIA: u/s 80C LIC Premium RPF 10% of ` 2,10,000 Total Income Total Income (Rounded Off u/s 288A)

1,75,000 40,000 (40,000) Nil 12,500

1,87,500 5,09,500

2,40,000 (90,000) 1,50,000 (45,000)

1,08,000 51,667 60,000 (2,19,667) 40,000 60,000 2,500 (2,500) 20,000 (20,000) 8,00,000 (8,00,000) 90,000 (1,500) Nil Nil Nil 88,500 1,48,500 5,83,333

(74,667)

(60,000) (21,000)

81,000 5,02,333 5,02,330

11.48 I DIRECT TAXATION

Assumptions: 1. 2. 3. 4. It is presumed that Mr. M accounts for his interest income on receipt basis. Assumed that there has been no repayment of Housing Loan Principal during the year ending 31.3.2007 for the purpose of calculation of prior period interest. Recognised Provident Fund received on retirement shall not be taxable u/s 10 (assuming conditions are satisfied). Unrealised Rent recovered: Since the assessee has been allowed a deduction of ` 50,000 from his house property income in ealier years in respect of Unrealised Rent, entire ` 40,000 recovered during current year becomes taxable. Deduction of Interest u/s 24 shall be allowed even if the amount is borrowed from any person other than the Banks/Financial Institutions in respect of Let Out property.

5.

llustration 17 : Mr. A, a Senior Citizen, has furnished the following particulars relating to his House Properties Particulars Nature of Occupation Municipal Valuation Fair Rent Standard Rent Actual Rent per month Municipal Taxes paid Interest on Capital borrowed House I ` Self Occupied 60,000 90,000 75,000 6,000 90,000 House II ` Let-out 1,20,000 1,50,000 1,40,000 12,000 12,000 80,000

Loan for both Houses were taken on 1.4.2007. House II remained vacant for 4 months. Besides the above two house, A has inherited during the year 1988-89 an old house from his grandfather. Due to business commitments, he sold the house immediately for a sum of ` 250 Lakhs. The house was purchased in 1962 by his grandfather for a sum of ` 2 Lakhs. However, the Fair Market Value as on 1.4.1981 was ` 30 Lakhs. With the sale proceeds, A purchased a new house in March 2013 for a sum of ` 140 Lakhs and the balance was used in his business. The other income particulars of Mr. A besides the above are as follows (AY 20132014) Business Loss Income from Other Sources (Bank Interest) Investments made during the year PF ICICI Infrastructure Bond Purchased ` 12 Lakhs ` 1 Lakh ` 70,000 ` 30,000

Compute Total Income of Mr. A and his Tax Liability for the Assessment Year 20132014.

DIRECT TAXATION I 11.49

Deduction in Computing Total Income Solution: Assessee: Mr. A Previous Year: 2012-13 Computation of Total Income Particulars ` 1. Income from House Property: (a) House I: Self Occupied Annual Value u/s 23(2) Less: Deduction u/s 24(b) = Interest on Housing Loan taken on 1.4.2007 (Note 3) 90,000 (90,000) (21,200) (1,11,200) (12,00,000) 2,50,00,000 Nil 2,50,00,000 Nil 2. 3. 4. 1. ` ` Assessment Year: 2013-14

(b) House II: Let-out (Note 6) Profits and Gains of Business or Profession Loss Capital Gains Sale of Residential House Property Long Term Asset Sale Consideration Less: Expenses on Transfer Net Consideration Less: Indexed Cost of Acquisition Fair Market Value as on 1.4.81 CII of year of Sale /CII of year of first holding (` 30 Lakhs )

Long Term Capital Gain Less: Exemption u/s 54 New House purchased Income from Other Sources: Bank Interest Gross Total Income (assuming this balance is out of Income from other sources only) Less: Deduction under Chapter VI-A u/s 80C Deposits in PPF u/s 80TTAA Interest on Savings Bank Interest However, i.e. Deduction restricted upto the balance of Gross Total Income Total Income

1,58,75,776 91,24,224 1,40,00,000

Nil 1,00,000 (12,11,200)

70,000 10,000 80,000 Nil Nil

Notes: Assumed that loss from House Property & Loss from Business are at first adjusted inter-head, against Long Term Capital Gains and then against Income from Other Sources since it is beneficial to the assessee. Deduction under Chapter VIA cannot be done against LTCG. It is assumed that the construction of the house was completed within 3 years from the end of the financial year in which the loan was taken. Deduction in respect of Investment in Long Term Infrastructure Bond u/s 80CCF is discontinued. It is assumed that Bank Interest represents Interest from Savings Bank Account. Annual Value of House Property II is computed as under (i) Municipal Value (MV) 1,20,000

2. 3. 4. 5. 6.

11.50 I DIRECT TAXATION

(ii) Fair Rental Value (FRV) (iii) Higher of MV + FRV (iv) Standard Rent (v) Reasonable Expected Rent (RER) [lower of (iii) + (iv)] (vi) Annual Rent @` 12,000 pm (vii) Unrealised Rent (viii) Actual Rent [(vi) (vii)] [Higher than RER] (ix) Vacancy Allowance[ Less: Municipal Tax paid Net Annual Value (NAV) Less: Standard deduction @30% of NAV u/s 24(a) Less: Interest on borrowed Capital u/s 24(b) Income for House II 4]

1,50,000 1,50,000 1,40,000 1,40,000 1,44,000 Nil 1,44,000 48,000 96,000 12,000 84,000 25,200 80,000 (21,200)

(x) Gross Annual Value [(viii) (ix)]

Illustration 18: Mr. Ashok a senior citizen, owns a property consisting of two blocks of identical size. The first block is used for business purposes. The other block has been let out from 1.4.2012 to his cousin for ` 20,000 p.m. The cost of construction of each block is ` 5 lacs (fully met from bank loan), rate of interest on bank loan is 10% p.a. The construction was completed on 31.3.2012. During the year ended 31.3.2013, he had to pay a penal interest of ` 2,000 in respect of each block on account of delayed payments to the bank for the borrowings. The normal interest paid by him in respect of each block was ` 42,000. Principal repayment for each block was ` 23,000. An identical block in the same neighbourhood fetches a rent of ` 25,000 per month. Municipal Tax paid in respect of each block was ` 12,000. The income from business prior to adjustment towards depreciation on any asset is ` 2,20,000. He follows Mercantile System of Accounting. Depreciation on equipments used for business is ` 30,000. On 23.2.2013, he sold shares of B Ltd., a listed share in BSE for ` 2,30,000. The share had been purchased 10 months back for ` 1,80,000. Security transaction tax paid may be taken as ` 220. Brought forward business loss of a business discontinued on 12.1.2010 is ` 90,000. This loss has been determined in pursuance of a return of income filed in time and the current year is the seventh year. The following payments were affected by him during the year : 1. 2. LIP of ` 20,000 on his life and ` 12,000 for his son aged 22, engaged as a software engineer and drawing salary of ` 25,000 per month. Mediclaim premium of ` 6,000 for himself & ` 5,000 for above son. The premiums were paid by cheque.

You are required to compute the Total Income for the Assessment Year 2013-14 and the tax payable. The various heads of income should be properly shown. Ignore the interest on bank loan for the period prior to 1.4.2012, as the bank had waived it.

DIRECT TAXATION I 11.51

Deduction in Computing Total Income Solution: Computation of Total Income of Mr. Ashok for A.Y. 2013-14. Particulars (1) Income from House Property (Let out) Gross Annual Value (being Fair rent) Less: Municipal Tax Net Annual Value (NAV) Less: Deduction: u/s 24(a) Standard Deduction (30% of NAV) u/s 24(b) Interest on loan (2) Profits and Gains of Business or Profession Net Profit before depreciation Less: Expenditure allowed but not debited in P & L Account Depreciation on equipment Depreciation on building i.e. 10% of ` 5,00,000 Profits and Gains of Business or Profession of current year Less: Brought forward losses set off u/s 72 (3) Capital Gains Consideration for Transfer Less: Cost of acquisition Short Term Capital Gains Gross Total Income Less: Deduction u/s 80C: LIC Premium paid Repayment of bank loan 80D: Medical insurance premium Total Income Tax Payable Notes: 1. 2. Penal interest is not allowed u/s 24(b) It has been assumed that interest, municipal tax on property used for business have already being charged while computing Business Income Before Depreciation i.e. ` 2,20,000. 3. STT is not allowed as expenditure on transfer. Illustration 19. Thomas aged 56 years, took voluntary retirement from State Bank of India on 1st April, 2012 under the Voluntary Retirement Scheme (VRS) and received a sum of ` 25 lakh on account of VRS benefits. At the time of his retirement, Thomas was having 47 months of service left and had served the organisation for 18 years 11 months. His last drawn Basic Pay ` 60,000, D.A. @60% of B/Pay (80% of which forming part of salary). Later, he started a business of plying, hiring and leasing of goods carriages from 1st June, 2012 by acquiring 3 heavy vehicles for ` 12 lakh, 2 medium goods vehicle for ` 5 lakh and 3 light commercial vehicles for ` 6 lakh. Although, he did not maintain regular books of account for his business, the diary maintained by him revealed gross receipts of ` 3,12,000 for the financial year ended 31st March, 2013 and he incurred an expenditure of ` 1,68,500 on the business towards salaries of drivers, repairs, fuel, etc. Depreciation on vehicle is not included in the said expenditure. Amount ` Amount `

3,00,000 12,000 2,88,000 86,400 42,000

1,28,400 2,20,000

1,59,600

30,000 50,000

80,000 1,40,000 (90,000) 2,30,000 (1,80,000)

50,000

50,000 2,59,600 32,000 23,000

55,000 6,000

61,000 1,98,600 Nil

11.52 I DIRECT TAXATION

During the financial year 2012-13, he received a sum of ` 3,00,000 on account of pension from bank and he contributed a sum of ` 65,000 to his PPF account maintained with the said bank in the same year. His PPF account was credited with interest of ` 35,000 during the financial year 2012-13. He also purchased long-term infrastructure bonds for ` 20,000; Repayment of educational loan interest for the year ` 50,000. He also paid medical insurance premium of ` 14,000. Further, he had two residential properties, one is self occupied and other is let out. During the financial year 2012-13, Thomas was able to let out his property for 12 months on a monthly rent of ` 17,000. The total municipal taxes on the let out property was ` 18,000, 50% of which was paid by the tenant and 50% by him. The interest on loan taken for renovation of the self occupied property paid by him during the year was ` 34,000. The insurance premium on the house and actual repairs and collection charges paid are ` 1,600 and ` 18,000 respectively and the entire expenditure is borne by him. During the financial year 2012-13, he was able to recover the unrealized rent of ` 33,000 from old tenant who vacated the house during the August, 2009 after spending litigation expenses of ` 15,000. During the financial year 2012-13, Thomas suffered short term capital loss on account of sale of shares on various dates amounting to ` 8,50,000. From the aforesaid information, you are required to compute the Total Income of Thomas for the A.Y. 2013-14 giving reasons in respect of each and every item and indicate the relief/rebate/deduction which he is entitled to claim. Solution: Assessee: Mr. Thomas Previous Year: 2012-2013 Computation of Total Income ` (1) Income from Salary Pension Received Voluntary Compensation Actual Amount Received Less: Exemption u/s 10(10c) Least of the following: (i) Actual Amount Received 25,00,000 (ii) Maximum limit 5,00,000 (iii) Higher of the following: (a) Last Drawn Salary 3 No. of Fully completed years of service = 88,800 3 18=47,95,200 (b) Last Drawn Salary Balance of number of months of service left = 88,800 47 = 41,73,600 47,95,200 5,00,000 20,00,000 ` 3,00,000 25,00,000 Assessment Year: 2013-2014

Last Drawn Salary = B/ Pay + D.A (forming part) = ` [60,000 + 60% of 80% of 60,000] = ` [60,000 + 28,800] = ` 88,800

DIRECT TAXATION I 11.53

Deduction in Computing Total Income ` (2) Income from House Property (a) Self occupied: Annual Value Nil () Interest on Loan u/s 24(b) ` 34,000 restricted upto ` 30,000 (30,000) (b) Let-out House Property Gross Annual Value (being the Rental Value) = 17,000 12 2,04,000 Less: Municipal Tax Paid by the assessee during the year = 18,000 50% 9,000 Net Annual Value (NAV) 1,95,000 Less: Standard deduction @30% of NAV u/s 24(a) 58,500 Less: Interest on loan u/s 24(b) Nil (3) Income from Business or Profession Presumptive Income u/s 44AE in the Business of plying, leasing or hiring trucks (i) Light goods vehicles = 3 4,500 10 = 1,35,000 (ii) Medium goods vehicles = 2 4,500 10 = 90,000 (iii) Heavy goods vehicles = 3 5,000 10 = 1,50,000 (5) Income from Captal Gains Short Term Capital Loss Gross Total Income Less: Deductions under Chapter VIA u/s 80 C Deposits in PPF 65,000 u/s 80D Medical Insurance Premium 14,000 u/s 80E Interest paid on Education loan 50,000 Total Income Tax on Total Income of ` 18,02,500 (+) E/C @2% (+) SHEC @1% Tax Payable Tax Payable (Rounded off u/s 288B) `

(30,000)

1,36,500

1,06,500

3,75,000 (8,50,000) 19,31,500

1,29,000 18,02,500 3,70,750 7,415 3,708 3,81,873 3,81,870

Note: Deduction u/s 80CCF, in respect of investment made in Long Term Infrastructure Bond, is discontinued from the A.Y. 2013-14.

11.54 I DIRECT TAXATION

Study Note - 12
INCOMES WHICH DO NOT FORM PART OF TOTAL INCOME
This Study Note includes 12.1 Incomes not included in Total Income [Sec.10] 12.2 Special Provisions 12.3 Expenditure incurred in relation to income not included in Total Income [ Sec.14A] 12.1 INCOMES NOT INCLUDED IN TOTAL INCOME [SEC. 10] In computing the Total Income of a Previous Year of any person, any income falling within any of the following clauses shall not be included 1. 2. Agricultural Income [Section 10(1)] Any income arising from agricultural activities; Income received by a member of HUF out of Family income [Section 10 (2)]

Any sum received by an individual as a member of a Hindu Undivided Family, where such sum has been paid out of the income of the Family, or, in the case of any impartible estate, where such sum has been paid out of the income of the estate belonging to the Family. Case Laws: (i) Amount must be received in position as member of HUF - If a person who is a member of a HUF received an allowance not because he is such a member but wholly apart from that position, the exemption does not apply. It is only if the assessee has received the sum in question by virtue of his position as a member of the undivided family to which he claims to belong, that the application of section 14(1) of the 1922 Act is attracted - Maharaj Kumar of Vizianagaram, 2 ITR 186 /Vijayananda Galapati, Maharaj Kumar of Vizianagaram vs. CIT 9 ITC 73.

(ii) Member must be entitled to demand partition or maintenance - Only those members of a HUF can claim exemption who either on partition would be entitled to demand a share or are entitled to maintenance under the Hindu law and who, therefore, might be said to have an interest in the joint income of the family - Kedar Narain Singh vs. CIT 6 ITR 157. 3. 4. Share of Income of a Partner [ Section 10(2A)] In the case of a person being a partner of a firm which is separately assessed as such, his share in the total income of the firm. Income by way of interest on such securities or bonds as may be notified by the Central Government

Section 10(4): In the case of a non-resident, any income by way of interest on such securities or bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf, including income by way of premium on the redemption of such bonds. Case Law : Interest on deposit of foreign currency not covered by declaration - The foreign currency, for which no

DIRECT TAXATION I 12.1

Incomes Which do not form Part of Total Income declarations under section 13 of FEMA had been produced by the respondent-assessee but only exchange vouchers issued by the exchange centres outside the country were produced, even if deposited in the NRE account cannot be said to be moneys standing to the credit of the respondent in the NRE account in accordance with the FEMA and the rules made there under and the income by way of interest on such moneys would not be exempt from inclusion in the total income of the respondent under section 10(4)(ii) - CIT vs. Purshottam Khatri 155 Taxman 399. Section 10(4B): In the case of an individual, being a citizen of India or a person of Indian origin, who is a non-resident, any income from interest on such savings certificates issued before the 1st day of June, 2002 by the Central Government as that Government may, by notification in the Official Gazette, specify in this behalf. Provided that the individual has subscribed to such certificates in convertible foreign exchange remitted from a country outside India in accordance with the provisions of the Foreign Exchange Regulation Act, 1973 (46 of 1973), and any rules made there under. Explanation For the purposes of this clause, (a) a person shall be deemed to be of Indian origin if he, or either of his parents or any of his grandparents, was born in undivided India; (b) convertible foreign exchange means foreign exchange which is for the time being treated by the Reserve Bank of India as convertible foreign exchange for the purposes of the Foreign Exchange Regulation Act, 1973 (46 of 1973), and any rules made there under; 5. Leave Travel Allowance / Concession [Section 10(5)] In the case of an individual, the value of any travel concession or assistance received by, or due to him (a) from his employer for himself and his family, in connection with his proceeding on leave to any place in India ; (b) from his employer or former employer for himself and his family, in connection with his proceeding to any place in India after retirement from service or after the termination of his service; subject to such conditions as may be prescribed (including conditions as to number of journeys and the amount which shall be exempt per head) having regard to the travel concession or assistance granted to the employees of the Central Government. Explanation For the purposes of this clause, family, in relation to an individual, means (i) the spouse and children of the individual ; and (ii) the parents, brothers and sisters of the individual or any of them, wholly or mainly dependent on the individual Case Law : Employer must preserve evidence about correctness of leave travel concession availed by employee - An employer, discharging his statutory obligation under section 192, is not only required to satisfy himself that payment made by him to his employees in respect of leave travel concession is not taxable, as envisaged under section 10(5), but also has to preserve evidence in relation thereto so as to demonstrate and establish to the satisfaction of officer to whom return prescribed under section 206 has been filed that he has not neglected to discharge his statutory obligation of deducting tax at source - C.E.S.C. Ltd. vs. ITO 134 Taxman 511. Remuneration received by a Non Resident [ Section 10(6)]

6.

In the case of an individual who is not a citizen of India,

12.2 I DIRECT TAXATION

the remuneration received by him as an official, by whatever name called, of an embassy, high commission, legation, commission, consulate or the trade representation of a foreign State, or as a member of the staff of any of these officials, for service in such capacity [Sec.10(6)(ii)].

Provided that the remuneration received by him as trade commissioner or other official representative in India of the Government of a foreign State (not holding office as such in an honorary capacity), or as a member of the staff of any of those officials, shall be exempt only if the remuneration of the corresponding officials or, as the case may be, members of the staff, if any, of the Government resident for similar purposes in the country concerned enjoys a similar exemption in that country. Provided further that such members of the staff are subjects of the country represented and are not engaged in any business or profession or employment in India otherwise than as members of such staff. (ii) the remuneration received by him as an employee of a foreign enterprise for services rendered by him during his stay in India [Sec.10(6)(vi)], provided the following conditions are fulfilled (a) the foreign enterprise is not engaged in any trade or business in India ; (b) his stay in India does not exceed in the aggregate a period of ninety days in such Previous Year ; and (c) such remuneration is not liable to be deducted from the income of the employer chargeable under this Act ;

(III) any income chargeable under the head Salaries received by or due to any such individual being a non-resident as remuneration for services rendered in connection with his employment on a foreign ship where his total stay in India does not exceed in the aggregate a period of ninety days in the Previous Year [ Sec.10(6)(viii)]; (IV) As per Sec.10(6)(xi), the remuneration received by him as an employee of the Government of a foreign State during his stay in India in connection with his training in any establishment or office of, or in any undertaking owned by, (i) the Government ; or (ii) any company in which the entire paid-up share capital is held by the Central Government, or any State Government or State Governments, or partly by the Central Government and partly by one or more State Governments ; or (iii) any company which is a subsidiary of a company referred to in item (ii) ; or (iv) any corporation established by or under a Central, State or Provincial Act ; or (v) any society registered under the Societies Registration Act, 1860 (14 of 1860), or under any other corresponding law for the time being in force and wholly financed by the Central Government, or any State Government or State Governments, or partly by the Central Government and partly by one or more State Governments. Income by way of royalty or fees for technical services by a foreign company [Section 10(6A)]

7.

Where in the case of a foreign company deriving income by way of royalty or fees for technical services received from Government or an Indian concern in pursuance of an agreement made by the foreign company with Government or the Indian concern after the 31st day of March, 1976 but before the 1st day of June, 2002 and, (a) where the agreement relates to a matter included in the industrial policy, for the time being in force, of the Government of India, such agreement is in accordance with that policy ; and (b) in any other case, the agreement is approved by the Central Government, the tax on such income is payable, under the terms of the agreement, by Government or the Indian concern to the Central Government, the tax so paid.

DIRECT TAXATION I 12.3

Incomes Which do not form Part of Total Income Explanation For the purposes of this clause and clause (6B) (a) fees for technical services shall have the same meaning as in Explanation 2 to clause (vii)of sub-section (1) of section 9 (b) foreign company shall have the same meaning as in section80B (c) royalty shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9 8. Income other than by way of royalty or fees for technical services by a non-resident [Section 10(6B)] Where in the case of a non-resident (not being a company) or of a foreign company deriving income (not being salary, royalty or fees for technical services) from Government or an Indian concern in pursuance of an agreement entered into before the 1st day of June, 2002 by the Central Government with the Government of a foreign State or an international organisation, the tax on such income is payable by Government or the Indian concern to the Central Government under the terms of thatagreement or any other related agreement approved by the Central Government, the tax so paid. 9. Income from the business of operating aircraft by a foreign State or a foreign enterprise [Section 10(6BB)]

Where in the case of the Government of a foreign State or a foreign enterprise deriving income from an Indian company engaged in the business of operation of aircraft, as a consideration of acquiring an aircraft or an aircraft engine (other than payment for providing spares, facilities or services in connection with the operation of leased aircraft) on lease under an agreement entered into after the 31st day of March, 1997 but before the 1st day of April, 1999, or entered into after the 31st day of March, 2007 and approved by the Central Government in this behalf and the tax on such income is payable by such Indian company under the terms of that agreement to the Central Government, the tax so paid. Explanation For the purposes of this clause, the expression foreign enterprise means a person who is a non-resident. 10. Income by way of royalty or fees for technical services by the specified foreign company [Section 10(6C)] Any income arising to such foreign company, as the Central Government may, by notification in the Official Gazette, specify in this behalf, by way of royalty or fees for technical services received in pursuance of an agreement entered into with that Government for providing services in or outside India in projects connected with security of India. 11. Allowances or Perquisite paid outside India [Section 10(7)] Any allowances or perquisites paid or allowed as such outside India by the Government to a citizen of India for rendering service outside India. 12. Income in connection with any co-operative technical assistance programmes and projects: Section 10(8) In the case of an individual who is assigned to duties in India in connection with any co-operative technical assistance programmes and projects in accordance with an agreement entered into by the Central Government and the Government of a foreign State (the terms whereof provide for the exemption given by this clause) (a) the remuneration received by him directly or indirectly from the Government of that foreign State for such duties, and (b) any other income of such individual which accrues or arises outside India, and is not deemed to

12.4 I DIRECT TAXATION

accrue or arise in India, in respect of which such individual is required to pay any income or social security tax to the Government of that foreign State ; Section 10(8A) In the case of a consultant (a) any remuneration or fee received by him or it, directly or indirectly, out of the funds made available to an international organisation [hereafter referred to in this clause and clause (8B) as the agency] under a technical assistance grant agreement between the agency and the Government of a foreign State ; and (b) any other income which accrues or arises to him or it outside India, and is not deemed to accrue or arise in India, in respect of which such consultant is required to pay any income or social security tax to the Government of the country of his or its origin. Explanation In this clause, consultant means (i) any individual, who is either not a citizen of India or, being a citizen of India, is not ordinarily resident in India; or

(ii) any other person, being a non-resident, engaged by the agency for rendering technical services in India in connection with any technical assistance program or project, provided the following conditions are fulfilled, namely : (A) the technical assistance is in accordance with an agreement entered into by the Central Government and the agency ; and (B) the agreement relating to the engagement of the consultant is approved by the prescribed authority for the purposes of this clause.

Section 10(8B) In the case of an individual who is assigned to duties in India in connection with any technical assistance programme and project in accordance with an agreement entered into by the Central Government and the agency (a) the remuneration received by him, directly or indirectly, for such duties from any consultant referred to in clause (8A) ; and (b) any other income of such individual which accrues or arises outside India, and is not deemed to accrue or arise in India, in respect of which such individual is required to pay any income or social security tax to the country of his origin, provided the following conditions are fulfilled, namely : (i) the individual is an employee of the consultant referred to in clause (8A) and is either not a citizen of India or, being a citizen of India, is not ordinarily resident in India ; and

(ii) the contract of service of such individual is approved by the prescribed authority before the commencement of his service.

Exemption u/s. 10(9) The income of any member of the family of any such individual as is referred to in clause (8) or clause (8A) or, as the case may be, clause (8B) accompanying him to India, which accrues or arises outside India, and is not deemed to accrue or arise in India, in respect of which such member is required to pay any income or social security tax to the Government of that foreign State or, as the case may be, country of origin of such member. 13. Death-cum-retirement gratuity [Section 10(10)] (i) Any death-cum-retirement gratuity received under the revised Pension Rules of the Central

DIRECT TAXATION I 12.5

Incomes Which do not form Part of Total Income Government or, as the case may be, the Central Civil Services (Pension) Rules, 1972, or under any similar scheme applicable to the members of the civil services of the Union or holders of posts connected with defence or of civil posts under the Union (such members or holders being persons not governed by the said Rules) or to the members of the all-India services or to the members of the civil services of a State or holders of civil posts under a State or to the employees of a local authority or any payment of retiring gratuity received under the Pension Code or Regulations applicable to the members of the defence services ; (ii) Any gratuity received under the Payment of Gratuity Act, 1972 (39 of 1972), to the extent it does not exceed an amount calculated in accordance with the provisions of sub-sections (2) and (3) of section 4 of that Act ; (iii) Any other gratuity received by an employee on his retirement or on his becoming incapacitated prior to such retirement or on termination of his employment, or any gratuity received by his widow, children or dependants on his death, to the extent it does not, in either case, exceed one-half months salary for each year of completed service, calculated on the basis of the average salary for the ten months immediately preceding the month in which any such event occurs, subject to such limit as the Central Government may, by notification in the Official Gazette, specify in this behalf having regard to the limit applicable in this behalf to the employees of that Government. Case Laws: (i) In cases not governed by section 10(10)(i) or 10(10)(ii), section 10(10)(iii) applies which excludes the gratuity amount up to rate of 15 days wages for every year of completed service subject to a maximum in this regard. Therefore, the prescribed limit of gratuity which is to be excluded under section 10(10) is the same irrespective of whether it is paid under the 1972 Act or any other scheme and, therefore, the limit of 15 days wages for completed services, as prescribed under section 10(10)(iii), is not discriminatory and violative of article 14 - Gwalior Rayons Staff Association vs. UOI 152 Taxman 520.

(ii) Salary includes dearness allowance and special allowance - Dearness allowance and special allowance must be treated as salary for computing exemption on gratuity - Addl. CIT vs. P. Krishna Kamat 99 ITR 74. (iii) Salary need not be given a wide meaning - The expression salary found in section 10(10) and 10(10AA) cannot be given a wider meaning than found in clause (h) of Rule 2 of Part A of the Fourth Schedule - K. Gopalakrishnan vs. CBDT 206 ITR 183/73 Taxman 220. 14. Payment in commutation of pension received [Section 10(10A)] (i) Any payment in commutation of pension received under the Civil Pensions (Commutation) Rules of the Central Government or under any similar scheme applicable to the members of the civil services of the Union or holders of posts connected with defence or of civil posts under the Union (such members or holders being persons not governed by the said Rules) or to the members of the all-India services or to the members of the defence services or to the members of the civil services of a State or holders of civil posts under a State or to the employees of a local authority or a corporation established by a Central, State or Provincial Act; (ii) Any payment in commutation of pension received under any scheme of any other employer, to the extent it does not exceed (a) in a case where the employee receives any gratuity, the commuted value of one-third of the pension which he is normally entitled to receive; and (b) in any other case, the commuted value of one-half of such pension, such commuted value being determined having regard to the age of the recipient, the state of his health, the rate of interest and officially recognised tables of mortality;

(iii) Any payment in commutation of pension received from a fund under clause (23AAB)

12.6 I DIRECT TAXATION

Case Law: Commuted pension - It cannot be said that entire commuted pension is not taxable; it is taxable subject to the provisions of section 10(10A) (iib) - CIT vs. K.A. Narayan 124 Taxman 880/254 ITR 683. 15. Cash equivalent of the leave salary [Section 10(10AA)] (i) Any payment received by an employee of the Central Government or a State Government as the cash equivalent of the leave salary in respect of the period of earned leave at his credit at the time of his retirement whether on superannuation or otherwise ; (ii) Any payment of the nature referred to in sub-clause (i) received by an employee, other than an employee of the Central Government or a State Government, in respect of so much of the period of earned leave at his credit at the time of his retirement whether on superannuation or otherwise as does not exceed ten months, calculated on the basis of the average salary drawn by the employee during the period of ten months immediately preceding his retirement whether on superannuation or otherwise, subject to such limit as the Central Government may, by notification in the Official Gazette, specify in this behalf having regard to the limit applicable in this behalf to the employees of that Government. Provided that where any such payments are received by an employee from more than one employer in the same Previous Year, the aggregate amount exempt from Income-tax under this sub-clause shall not exceed the limit so specified. Provided further that where any such payment or payments was or were received in any one or more earlier Previous Years also and the whole or any part of the amount of such payment or payments was or were not included in the total income of the assessee of such Previous Year or Years, the amount exempt from Income-tax under this sub-clause shall not exceed the limit so specified as reduced by the amount or, as the case may be, the aggregate amount not included in the total income of any such Previous Year or Years. Explanation For the purposes of sub-clause (ii), The entitlement to earned leave of an employee shall not exceed thirty days for every year of actual service rendered by him as an employee of the employer from whose service he has retired; Case Law: Leave encashment while in service is not exempt - The words or otherwise in section 10(10AA) must draw the restricted meaning qua the immediately preceding word superannuation which signifies an employees severance of relationship with his employer in terms of the contract of employment. Therefore, the words or otherwise will not cover cases where the assessee continues to be under the employment of the same employer and receives leave encashment receipt. Such a receipt will not be exempt from tax - CIT vs. Ram Rattan Lal Verma 145 Taxman 256 /CIT vs. Vijai Pal Singh144 Taxman 504 /CIT vs. Ashok Kumar Dixit 273 ITR 126. 16. Compensation received by a workman under the Industrial Disputes Act [Section 10(10B)] Any compensation received by a workman under the Industrial Disputes Act, 1947 (14 of 1947), or under any other Act or Rules, orders or notifications issued there under or under any standing orders or under any award, contract of service or otherwise, at the time of his retrenchment. Provided that the amount exempt under this clause shall notexceed (i) an amount calculated in accordance with the provisions of clause (b) of section 25F of the Industrial Disputes Act, 1947 (14 of 1947); or

(ii) such amount, not being less than fifty thousand rupees, as the Central Government may, by notification in the Official Gazette, specify in this behalf(currently it is `5,00,000); (iii) Actual amount of compensation received, whichever is less

DIRECT TAXATION I 12.7

Incomes Which do not form Part of Total Income Provided further that the preceding proviso shall not apply in respect of any compensation received by a workman in accordance with any scheme which the Central Government may, having regard to the need for extending special protection to the workmen in the undertaking to which such scheme applies and other relevant circumstances, approve in this behalf. Explanation For the purposes of this clause (a) Compensation received by a workman at the time of the closing down of the undertaking in which he is employed shall be deemed to be compensation received at the time of his retrenchment; (b) Compensation received by a workman, at the time of the transfer (whether by agreement or by operation of law) of the ownership or management of the undertaking in which he is employed from the employer in relation to that undertaking to a new employer, shall be deemed to be compensation received at the time of his retrenchment if (i) the service of the workman has been interrupted by such transfer ; or (ii) the terms and conditions of service applicable to the workman after such transfer are in any way less favourable to the workman than those applicable to him immediately before the transfer ; or (iii) the new employer is, under the terms of such transfer or otherwise, legally not liable to pay to the workman, in the event of his retrenchment, compensation on the basis that his service has been continuous and has not been interrupted by the transfer ;

(c) The expressions employer and workman shall have the same meanings as in the Industrial Disputes Act, 1947 (14 of 1947) 17. Amount received in connection with the Bhopal Gas Leak Disaster [Section 10(10BB)] Any payments made under the Bhopal Gas Leak Disaster (Processing of Claims) Act, 1985 (21 of 1985), and any scheme framed there under except payment made to any assessee in connection with the Bhopal Gas Leak Disaster to the extent such assessee has been allowed a deduction under this Act on account of any loss or damage caused to him by such disaster; 18. Compensation on account of disaster [Section10(10BC)] Any amount received or receivable from the Central Government or a State Government or a local authority by an individual or his legal heir by way of compensation on account of any disaster, except the amount received or receivable to the extent such individual or his legal heir has been allowed a deduction under this Act on account of any loss or damage caused by such disaster. Explanation For the purposes of this clause, the expression disaster shall have the meaning assigned to it under clause (d) of section2 of the Disaster Management Act, 2005 (53 of 2005) 19. Amount received on Voluntary Retirement Scheme (VRS) Section 10(10C) Any amount of compensation received or receivable at the time of voluntary retirement as per the Voluntary Retirement Scheme by an employee of (i) a public sector company ; or (ii) any other company ; or (iii) an authority established under a Central, State or Provincial Act; or (iv) a local authority ; or (v) a co-operative society ; or (vi) a University established or incorporated by or under a Central, State or Provincial Act and an institution declared to be a University under section 3 of the University Grants Commission Act, 1956 (3 of 1956) ; or

12.8 I DIRECT TAXATION

(vii) an Indian Institute of Technology within the meaning of clause (g) of section 3 of the Institutes of Technology Act, 1961 (59 of 1961); or (viia) any State Government; or (viib) the Central Government; or (viic)an institution, having importance throughout India or in any State or States, as the Central Government may, by notification in the Official Gazette, specify in this behalf; or (viii) such institute of management as the Central Government may, by notification in the Official Gazette, specify in this behalf. However, the amount so received should not exceed ` 5,00,000. Double benefit under Section 10(10C) and Section 89 not allowed [Section 10(10C) and section 89] [W.e.f. A.Y. 2010-11] Very often, a person receives arrears or advance of salary due to him. Since arrears and advance salary is liable to tax, the total income (including such arrears and advance) is assessed at a rate higher than that at which it would otherwise have been assessed if the total income did not include arrears and advance of salary. In other words, arrears and advance salary result in bracket creeping and higher tax burden. With the view to mitigating this excess burden, the provisions of section 89 of the Income-tax Act provide for backward spread of the arrears and forward spread of the advance. Under the voluntary retirement scheme, the retiree employee receives lump-sum amount in respect of his balance period of service. Such amount is in the nature of advance salary. Section 10(10C) provides for an exemption of ` 5 lakhs in respect of such amount. This exemption is provided to mitigate the hardship on account of bracket creeping as a result of the receipt of the amount in lump sum upon voluntary retirement. However, some taxpayers have claimed both the benefit under section 10(10C) and section 89. The courts have also upheld their claims. To nullify the judgement of Courts, the following changes have been made in this regard: (a) Insertion of proviso to section 89: With the view to preventing the claim of double benefit, the Act has inserted a proviso to section 89 to provide that no relief shall be granted in respect of any amount received or receivable by an assessee on his voluntary retirement or termination of his service, in accordance with any scheme or schemes of voluntary retirement or in case of a public sector company referred to in section 10(10C)(i), a scheme of voluntary separation, if an exemption in respect of such voluntary retirement or termination of his service or voluntary separation has been claimed by the assessee under section 10(10C) in respect of such or any other Assessment Year. (b) Insertion of third proviso to section 10(10C): Correspondingly, the Act has inserted a third proviso to section 10(10C) to provide that where any relief has been allowed to any assessee under section 89 for any Assessment Year in respect of any amount received or receivable on his voluntary retirement or termination of service or voluntary separation, no exemption under section 10(10C) shall be allowed to him in relation to such or any other Assessment Year. Case Law: Provision is not discriminatory - Under section 10(10C) there is neither invidious distinction between public sector employees and private sector employees in the matter of taxation nor is it arbitrary and unintelligible amounting to hostile discrimination - Shashikant Laxman Kale vs. Union of India 52 Taxman 352/185 ITR 104 20. Individual deriving income in the nature of a perquisite [Section10(10CC)] In the case of an employee, being an individual deriving income in the nature of a perquisite, not provided for by way of monetary payment, within the meaning of clause (2) of section 17, the tax on such income actually paid by his employer, at the option of the employer, on behalf of such employee, notwithstanding anything contained in section 200 of the Companies Act, 1956 (1 of 1956).

DIRECT TAXATION I 12.9

Incomes Which do not form Part of Total Income 21. Exemption of any amount received from Life Insurance Policies [Section 10(10D)] Any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, other than (a) any sum received under sub-section (3) of section 80DD or sub-section (3) of section 80DDA ; or (b) any sum received under a Keyman insurance policy; or (c) any sum received under an insurance policy issued on or after the 1st day of April, 2003 but before 1st day of April, 2012 in respect of which the premium payable for any of the years during the term of the policy exceeds twenty per cent or ten per cent if the policy is issued on or after 1st day of April, 2012 of the actual capital sum assured. Provided that the provisions of this sub-clause shall not apply to any sum received on the death of a person. Explanation For the purposes of this clause, the expression actual capital sum assured means the minimum amount assured under the policy on happening of the insured event at any time during the term of the policy, not taking into account(i) the value of any premiums agreed to be returned, or (ii) any benefit by way of bonus or otherwise over and above the sum actually assured, which is to be or may be received under the policy by any person. 22. Payment from Provident Fund [Section 10(11)] Any payment from a provident fund to which the Provident Funds Act, 1925 (19 of 1925), applies or from any other provident fund set up by the Central Government and notified by it in this behalf in the Official Gazette. 23. Amount received or receivable by an employee participating in a Recognized Provident Fund [Section 10(12)] The accumulated balance due and becoming payable to an employee participating in a recognised provident fund, to the extent provided in rule 8 of Part A of the Fourth Schedule; 24. Payment from Approved Superannuation Fund [Section 10(13)] Any payment from an approved superannuation fund made (i) on the death of a beneficiary ; or (ii) to an employee in lieu of or in commutation of an annuity on his retirement at or after a specified age or on his becoming incapacitated prior to such retirement ; or (iii) by way of refund of contributions on the death of a beneficiary; or (iv) by way of refund of contributions to an employee on his leaving the service in connection with which the fund is established otherwise than by retirement at or after a specified age or on his becoming incapacitated prior to such retirement, to the extent to which such payment does not exceed the contributions made prior to the commencement of this Act and any interest thereon; Case Law : Amount received on retirement before specified age is not exempt - Clause (13) of section 10 exempts only the payments received on retirement at or after a specified age. Payments made on resignation will be exempt only if it is after the specified age. Thus, amount received from superannuation fund on resignation before specified age is not eligible for exemption under section 10(13) - Yogesh Prabhakar Modak, 268 ITR 26/138 Taxman 121.

12.10 I DIRECT TAXATION

25. House Rent Allowance [Section 10(13A)] Any special allowance specifically granted to an assessee by his employer to meet expenditure actually incurred on payment of rent (by whatever name called) in respect of residential accommodation occupied by the assessee, to such extent as may be prescribed having regard to the area or place in which such accommodation is situate and other relevant considerations. Explanation For the removal of doubts, it is hereby declared that nothing contained in this clause shall apply in a case where (a) the residential accommodation occupied by the assessee is owned by him ; or (b) the assessee has not actually incurred expenditure on payment of rent (by whatever name called) in respect of the residential accommodation occupied by him ; Case Law: Where the assessee was residing in his own house and there was no payment of rent, the provisions of sub-section (13A) of section 10 were not attracted - CIT vs. P.D. Singhania156 Taxman 504. 26. Exemption of any Special Allowances [Section 10(14)] (i) Any such special allowance or benefit, not being in the nature of a perquisite within the meaning of clause (2) of section 17 specifically granted to meet expenses wholly, necessarily and exclusively incurred in the performance of the duties of an office or employment of profit as may be prescribed, to the extent to which such expenses are actually incurred for that purpose;

(ii) Any such allowance granted to the assessee either to meet his personal expenses at the place where the duties of his office or employment of profit are ordinarily performed by him or at the place where he ordinarily resides, or to compensate him for the increased cost of living, as may be prescribed and to the extent as may be prescribed. Provided that nothing in sub-clause (ii) shall apply to any allowance in the nature of personal allowance granted to the assessee to remunerate or compensate him for performing duties of a special nature relating to his office or employment unless such allowance is related to the place of his posting or residence. 27. Income by way of interest, premium on redemption or other payment on such securities [Section 10(15)] (i) Income by way of interest, premium on redemption or other payment on such securities, bonds, annuity certificates, savings certificates, other certificates issued by the Central Government and deposits as the Central Government may, by notification in the Official Gazette, specify in this behalf, subject to such conditions and limits as may be specified in the said notification ;

(iib) In the case of an Individual or a Hindu Undivided Family, interest on such Capital Investment Bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf. (iic) in the case of an individual or a Hindu undivided family, interest on such Relief Bonds as the Central Government may, by notification in the Official Gazette, specify 6 in this behalf; (iid) interest on such bonds, as the Central Government may, by notifications in the Official Gazette, specify, arising to (a) a non- resident Indian, being an individual owning the bonds, or (b) any individual owning the bonds by virtue of being a nominee or survivor of the non- resident Indian; or (c) any individual to whom the bonds have been gifted by the nonresident Indian. Provided that the aforesaid bonds are purchased by a non- resident Indian in foreign exchange and the interest and principal received in respect of such bonds, whether on their maturity or otherwise, is not allowable to be taken out of India

DIRECT TAXATION I 12.11

Incomes Which do not form Part of Total Income Provided further that where an individual, who is a non- resident Indian in any previous year in which the bonds are acquired, becomes a resident in India in any subsequent year, the provisions of this subclause shall continue to apply in relation to such individual Provided also that in a case where the bonds are uncashed in a previous year prior to their maturity by an individual who is so entitled, the provisions of this sub- clause shall not apply to such individual in relation to the assessment year relevant to such Previous Year. Provided also that the Central Government shall not specify, for the purposes of this sub-clause, such bonds on or after 1st June, 2002. Explanation - For the purposes of this sub- clause, the expression non- resident Indian shall have the meaning assigned to it in clause (e) of section 115C; (iii) interest on securities held by the Issue Department of the Central Bank of Ceylon constituted under the Ceylon Monetary Law Act, 1949 ; (iiia) interest payable to any bank incorporated in a country outside India and authorised to perform central banking functions in that country on any deposits made by it, with the approval of the Reserve Bank of India, with any scheduled bank. Explanation - For the purposes of this sub- clause, scheduled bank shall have the meaning assigned to it in 2 clause (ii) of the Explanation to clause (viia) of sub- section (1) of section 36; (iiib) interest payable to the Nordic Investment Bank, being a multilateral financial institution constituted by the Governments of Denmark, Finland, Iceland, Norway and Sweden, on a loan advanced by it to a project approved by the Central Government in terms of the Memorandum of Understanding entered into by the Central Government with that Bank on the 25th November, 1986; (iiic) interest payable to the European Investment Bank, on a loan granted by it in pursuance of the framework-agreement for financial co-operation entred into on the 25th November, 1993 by the Central Government with that Bank; (iv) interest payable (a) by Government or a local authority on moneys borrowed by it before the 1st June, 2001 from, or debts owed by it before 1st June, 2001 to, sources outside India; (b) by an industrial undertaking in India on moneys borrowed by it under a loan agreement entered into before 1st June, 2001 with any such financial institution in a foreign country as may be approved in this behalf by the Central Government by general or special order; (c) by an industrial undertaking in India on any moneys borrowed or debt incurred by it before 1st June, 2001 in a foreign country in respect of the purchase outside India of raw materials or components or capital plant and machinery, to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government in this behalf, having regard to the terms of the loan or debt and its repayment. Explanation 1 - For the purposes of this item, purchase of capital plant and machinery includes the purchase of such capital plant and machinery under a hire- purchase agreement or a lease agreement with an option to purchase such plant and machinery; Explanation 2 For the removal of doubts, it is hereby declared that the usance interest payable outside India by an undertaking engaged in the business of ship-breaking in respect of purchase of a ship from outside India shall be deemed to be the interest payable on a debt incurred in a foreign country in respect of the purchase outside India; (d) by the Industrial Finance Corporation of India established by the Industrial Finance Corporation Act, 1948 (15 of 1948 ), or the Industrial Development Bank of India established under the Industrial Development Bank of India Act, 1964 (18 of 1964 ), or the Export- Import Bank of India established under the Export- Import Bank of India Act, 1981 (28 of 1981), or the National Housing

12.12 I DIRECT TAXATION

Bank established under section 3 of the National Housing Bank Act, 1987 (53 of 1987 ), or the Small Industries Development Bank of India established under section 3 of the Small Industries Development Bank of India Act, 1989 (39 of 1989 ), or the Industrial Credit and Investment Corporation of India a company formed and registered under the Indian Companies Act, 1913 (7 of 1913 ), on any moneys borrowed by it from sources outside India, to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government in this behalf, having regard to the terms of the loan and its repayment; (e) by any other financial institution established in India or a banking company to which the Banking Regulation Act, 1949 (10 of 1949 ), applies (including any bank or banking institution referred to in section 51 of that Act), on any moneys borrowed by it from sources outside India under a loan agreement approved by the Central Government where the moneys are borrowed either for the purpose of advancing loans to industrial undertakings in India for purchase outside India of raw materials or capital plant and machinery or for the purpose of importing any goods which the Central Government may consider necessary to import in the public interest, to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government in this behalf, having regard to the terms of the loan and its repayment; (f) by an industrial undertaking in India on any moneys borrowed by it in foreign currency from sources outside India under a loan agreement approved by the Central Government before 1st June, 2001 having regard to the need for industrial development in India, to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government in this behalf, having regard to the terms of the loan and its repayment;

(fa) by a scheduled bank to a non- resident or to a person who is not ordinarily resident within the meaning of sub- section (6) of section 61, on deposits in foreign currency where the acceptance of such deposits by the bank is approved by the Reserve Bank of India. Explanation - For the purposes of this item, the expression scheduled bank shall have the meaning assigned to it in clause (ii) of the Explanation to clause (viia) of subsection (1) of section 36; (g) by a public company formed and registered in India with the main object of carrying on the business of providing long- term finance for construction or purchase of houses in India for residential purposes, being a company approved by the Central Government for the purposes of clause (viii) of sub- section (1) of section 36 on any moneys borrowed by it in foreign currency from sources outside India under a loan agreement approved by the Central Government before 1st June, 2003, to the extent to which such interest does not exceed the amount of interest calculated at the rate approved by the Central Government in this behalf, having regard to the terms of the loan and its repayment. Explanation - For the purposes of items (f), (fa) and (g), the expression foreign currency shall have the meaning assigned to it in the Foreign Exchange Regulation Act, 1973 (46 of 1973 ); (h) by any public sector company in respect of such bonds or debentures and subject to such conditions, including the condition that the holder of such bonds or debentures registers his name and the holding with that company, as the Central Government may, by notification in the Official Gazette, specify in this behalf; (i) by Government on deposits made by an employee of the Central Government or a State Government, or a public sector company in accordance with such scheme as the Central Government may, by notification in the Official Gazette, frame in this behalf, out of the moneys due to him on account of his retirement, whether on superannuation or otherwise.

DIRECT TAXATION I 12.13

Incomes Which do not form Part of Total Income (v) interest on (a) securities held by the Welfare Commissioner, Bhopal Gas Victims, Bhopal, in the Reserve Bank s SGL Account No. SL/DHO 48; (b) deposits for the benefit of the victims of the Bhopal gas leak disaster held in such account, with the Reserve Bank of India or with a public sector bank, as the Central Government may, by notification in the Official Gazette, specify, whether prospectively or retrospectively but in no case earlier than the 1st April, 1994 in this behalf;

(vi) Interest on Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 notified by the Central Government; (vii) Interest on bonds (a) issued by a local authority or by a State Pooled Finance Entity; and (b) specified by the Central Government by notification in the Official Gazette.

(viii) any income by way of interest received by non-resident or a person who is not ordinarily resident, on a deposit in India on or after 1st April, 2005, in an Offshore Banking Unit referred to in clause (u) of section 2 of the Special Economic Zones Act, 2005. Case Law: Interest on terminal benefits - Under the Income-tax Act, if any income is liable to be taxed, it is not open for High Court to issue a direction to employer (Government of India/Income Tax Department) not to levy Income-tax on interest earned by assessees (employees) on their retirement/terminal benefits - R.K. Srivastava vs. Union of India 141 Taxman 84.

28. Payment made by Indian Company engaged in the business of operation of aircraft [Section 10(15A)] Any payment made, by an Indian company engaged in the business of operation of aircraft, to acquire an aircraft or an aircraft engine (other than a payment for providing spares, facilities or services in connection with the operation of leased aircraft) on lease from the Government of a foreign State or a foreign enterprise under an agreement, not being an agreement entered into between the 1st day of April, 1997 and the 31st day of March, 1999 and approved by the Central Government in this behalf. Provided nothing contained in this clause shall apply to any such agreement entered into on or after the 1st day of April, 2007. Case Law: Application for approval of lease agreement - Rejection of application for approval of agreement by Central Government without a speaking order is not justified - AFT Trust-Sub1 vs. Chairman, CBDT 192 CTR 406. 29. Scholarships granted to meet the cost of education [Section 10(16)] Any scholarship granted to meet the cost of education. Case law: Scholarship granted by employer to son of employee could not be treated as perquisite but would be exempt under section 10(16) - CIT v. B.L. Garg155 Taxman 189. 30. Payment to Parliament or of any State Legislature or of any Committee thereof [Section 10(17)] Any income by way of (i) daily allowance received by any person by reason of his membership of Parliament or of any State Legislature or of any Committee thereof;

12.14 I DIRECT TAXATION

(ii) any allowance received by any person by reason of his membership of Parliament under the Members of Parliament (Constituency Allowance) Rules, 1986; (iii) any constituency allowance received by any person by reason of his membership of any State Legislature under any Act or rules made by that State Legislature; 31. Any payment made as a reward [Section10(17A)] Any payment made, whether in cash or in kind, (i) in pursuance of any award instituted in the public interest by the Central Government or any State Government or instituted by any other body and approved by the Central Government in this behalf; or

(ii) as a reward by the Central Government or any State Government for such purposes as may be approved by the Central Government in this behalf in the public interest. 32. Pension received by an individual who has been in the service of the Central Government or State Government and has been awarded Param Vir Chakra etc. [Section 10(18)] Any income by way of (i) pension received by an individual who has been in the service of the Central Government or State Government and has been awarded Param Vir Chakra or Maha Vir Chakra or Vir Chakra or such other gallantry award as the Central Government may, by notification in the Official Gazette, specify in this behalf;

(ii) family pension received by any member of the family of an individual referred to in sub-clause (i). Explanation For the purposes of this clause, the expression family shall have the meaning assigned to it in the Explanation to clause (5); 33. Family pension received by the widow or children or nominated heirs, as the case may be, of a member of the armed forces (including Para-military forces) of the Union [Section 10(19)] Family pension received by the widow or children or nominated heirs, as the case may be, of a member of the armed forces (including Para-military forces) of the Union, where the death of such member has occurred in the course of operational duties, in such circumstances and subject to such conditions, as may be prescribed. 34. Annual Value of Palace of a Ruler [Section 10(19A)] The annual value of any one palace in the occupation of a Ruler, being a palace, the annual value whereof was exempt from Income-tax before the commencement of the Constitution (Twenty-sixth Amendment) Act, 1971, by virtue of the provisions of the Merged States (Taxation Concessions) Order, 1949, or the Part B States (Taxation Concessions) Order, 1950, or, as the case may be, the Jammu and Kashmir (Taxation Concessions) Order, 1958. Provided that for the Assessment Year commencing on the 1st day of April, 1972, the annual value of every such palace in the occupation of such Ruler during the relevant Previous Year shall be exempt from Income-tax. 35. Income of Local Authority from House Property [Section 10(20)] The income of a local authority which is chargeable under the head Income from House Property, Capital Gains or Income from Other Sources or from a trade or business carried on by it which accrues or arises from the supply of a commodity or service (not being water or electricity) within its own jurisdictional area or from the supply of water or electricity within or outside its own jurisdictional area.

DIRECT TAXATION I 12.15

Incomes Which do not form Part of Total Income Explanation For the purposes of this clause, the expression local authority means (i) Panchayat as referred to in clause (d) of article 243 of the Constitution; or (ii) Municipality as referred to in clause (e) of article 243P of the Constitution; or (iii) Municipal Committee and District Board, legally entitled to, or entrusted by the Government with, the control or management of a Municipal or local fund; or (iv) Cantonment Board as defined in section 3 of the Cantonments Act, 1924 (2 of 1924). Case Laws: (i) State Road Transport Corporation is not a local authority - A State Transport Corporation is not a local authority and is, therefore, not entitle to claim exemption of its income by virtue of section 10(20) calculate - Calcutta State Transport Corpn. vs. CIT 85 Taxman 402/219 ITR 515

(ii) Forest Corporation - U.P. State Forest Corporation established for preservation of forest could not be treated as local authority merely because the Act which has created the Corporation has called it a local authority - CIT vs. U.P. Forest Corpn. 97 Taxman 259/230 ITR 945. 36. Income of a Research Association for the time being approved for the purpose of clause (ii) of sub-section (1) of section 35 [ Section 10(21)] Any income of a research association for the time being approved for the purpose of clause (ii) or clause (iii) of sub-section (1) of section 35: Provided that the research association (a) applies its income, or accumulates it for application, wholly and exclusively to the objects for which it is established, and the provisions of sub-section (2) and sub-section (3) of section 11 shall apply in relation to such accumulation subject to the following modifications, namely : (i) in sub-section (2), (1) the words, brackets, letters and figure referred to in clause (a) or clause (b) of sub-section (1) read with the Explanation to that sub-section shall be omitted; (2) for the words to charitable or religious purposes, the words for the purposes of scientific research or research in social science or statistical research shall be substituted; (3) the reference to Assessing Officer in clause (a) thereof shall be construed as a reference to the prescribed authority referred to in clause (ii) of sub-section (1) of section 35;

(ii) in sub-section (3), in clause (a), for the words charitable or religious purposes, the words the purposes of scientific research or research in social science or statistical research shall be substituted; and (i) any assets held by the research association where such assets form part of the corpus of the fund of the association as on the 1st day of June, 1973;

(b) does not invest or deposit its funds, other than

(ii) any assets (being debentures issued by, or on behalf of, any company or corporation), acquired by the research association before the 1st day of March, 1983; (iii) any accretion to the shares, forming part of the corpus of the fund mentioned in sub-clause (i), by way of bonus shares allotted to the research association; (iv) voluntary contributions received and maintained in the form of jewellery, furniture or any other article as the Board may, by notification in the Official Gazette, specify, for any period during the Previous Year otherwise than in any one or more of the forms or modes specified in subsection (5) of section 11.

12.16 I DIRECT TAXATION

Provided further that the exemption under this clause shall not be denied in relation to voluntary contribution, other than voluntary contribution in cash or voluntary contribution of the nature referred to in clause (b) of the first proviso to this clause, subject to the condition that such voluntary contribution is not held by the research association, otherwise than in any one or more of the forms or modes specified in sub-section (5) of section 11, after the expiry of one year from the end of the Previous Year in which such asset is acquired or the 31st day of March, 1992, whichever is later. Provided also that nothing contained in this clause shall apply in relation to any income of the research association, being profits and gains of business, unless the business is incidental to the attainment of its objectives and separate books of account are maintained by it in respect of such business. Provided also that where the research association is approved by the Central Government and subsequently that Government is satisfied that (i) the research association has not applied its income in accordance with the provisions contained in clause (a) of the first proviso; or (ii) the research association has not invested or deposited its funds in accordance with the provisions contained in clause (b) of the first proviso; or (iii) the activities of the research association are not genuine; or (iv) the activities of the research association are not being carried out in accordance with all or any of the conditions subject to which such association was approved, it may, at any time after giving a reasonable opportunity of showing cause against the proposed withdrawal to the concerned association, by order, withdraw the approval and forward a copy of the order withdrawing the approval to such association and to the Assessing Officer; 37. Income of Specified News Agency [Section 10(22B)] Any income of such news agency set up in India solely for collection and distribution of news as the Central Government may, by notification in the Official Gazette, specify in this behalf. Provided that the news agency applies its income or accumulates it for application solely for collection and distribution of news and does not distribute its income in any manner to its members; Provided further that any notification issued by the Central Government under this clause shall, at any one time, have effect for such Assessment Year or Years, not exceeding three Assessment Years (including an Assessment Year or Years commencing before the date on which such notification is issued) as may be specified in the notification; Provided also that where the news agency has been specified, by notification, by the Central Government and subsequently that Government is satisfied that such news agency has not applied or accumulated or distributed its income in accordance with the provisions contained in the first proviso, it may, at any time after giving a reasonable opportunity of showing cause, rescind the notification and forward a copy of the order rescinding the notification to such agency and to the Assessing Officer. 38. Income received for rendering any specific services or income by way of interest or dividends [Section 10(23A)] Any income (other than income chargeable under the head Income from House Property or any income received for rendering any specific services or income by way of interest or dividends derived from its investments) of an association or institution established in India having as its object the control, supervision, regulation or encouragement of the profession of law, medicine, accountancy, engineering or architecture or such other profession as the Central Government may specify in this behalf, from time to time, by notification in the Official Gazette. Provided that (i) the association or institution applies its income, or accumulates it for application, solely to the objects for which it is established; and

DIRECT TAXATION I 12.17

Incomes Which do not form Part of Total Income (ii) the association or institution is for the time being approved for the purpose of this clause by the Central Government by general or special order. Provided further that where the association or institution has been approved by the Central Government and subsequently that Government is satisfied that (i) such association or institution has not applied or accumulated its income in accordance with the provisions contained in the first proviso; or (ii) the activities of the association or institution are not being carried out in accordance with all or any of the conditions subject to which such association or institution was approved, it may, at any time after giving a reasonable opportunity of showing cause against the proposed withdrawal to the concerned association or institution, by order, withdraw the approval and forward a copy of the order withdrawing the approval to such association or institution and to the Assessing Officer. 39. Any income received on behalf of any Regimental Fund or Non-Public Fund [Section 10(23AA)] Any income received by any person on behalf of any Regimental Fund or Non-Public Fund established by the armed forces of the Union for the welfare of the past and present members of such forces or their dependants. 40. Income received by any person on behalf of a fund established [Section 10(23AAA)] Any income received by any person on behalf of a fund established, for such purposes as may be notified by the Board in the Official Gazette, for the welfare of employees or their dependants and of which fund such employees are members if such fund fulfils the following conditions, namely : (a) The fund (i) applies its income or accumulates it for application, wholly and exclusively to the objects for which it is established; and

(ii) invests its funds and contributions and other sums received by it in the forms or modes specified in sub-section (5) of section 11;

(b) The fund is approved by the Commissioner in accordance with the rules made in this behalf Provided that any such approval shall at any one time have effect for such Assessment Year or years not exceeding three Assessment Years as may be specified in the order of approval. 41. Income of a Fund [Section 10(23AAB)] Any income of a fund, by whatever name called, set up by the Life Insurance Corporation of India on or after the 1st day of August, 1996 or any other insurer under a pension scheme (i) to which contribution is made by any person for the purpose of receiving pension from such fund;

(ii) which is approved by the Controller of Insurance or the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999), as the case maybe. Explanation For the purposes of this clause, the expression Controller of Insurance shall have the meaning assigned to it in clause (5B) of section 2 of the Insurance Act, 1938 (4 of 1938). 42. Income of an institution solely for development of Khadi or Village Industries or both [Section 10(23B)] Any income of an institution constituted as a public charitable trust or registered under the Societies Registration Act, 1860 (21 of 1860), or under any law corresponding to that Act in force in any part of India, and existing solely for the development of khadi or village industries or both, and not for purposes of profit, to the extent such income is attributable to the business of production, sale, or marketing, of khadi or products of village industries.

12.18 I DIRECT TAXATION

Provided that (i) the institution applies its income, or accumulates it for application, solely for the development of khadi or village industries or both; and

(ii) the institution is, for the time being, approved for the purpose of this clause by the Khadi and Village Industries Commission. Provided further that the Commission shall not, at any one time, grant such approval for more than three Assessment Years beginning with the Assessment Year next following the Financial Year in which it is granted; Provided also that where the institution has been approved by the Khadi and Village Industries Commission and subsequently that Commission is satisfied that (i) the institution has not applied or accumulated its income in accordance with the provisions contained in the first proviso; or (ii) the activities of the institution are not being carried out in accordance with all or any of the conditions subject to which such institution was approved. However, it may, at any time after giving a reasonable opportunity of showing cause against the proposed withdrawal to the concerned institution, by order, withdraw the approval and forward a copy of the order withdrawing the approval to such institution and to the Assessing Officer. Explanation For the purposes of this clause, (i) (ii) Khadi and Village Industries Commission means the Khadi and Village Industries Commission established under the Khadi and Village Industries Commission Act, 1956 (61 of 1956); Khadi and village industries have the meanings respectively assigned to them in that Act

43. Income of an Authority established for the development of Khadi or Village industries [Section 10(23BB)] Any income of an authority (whether known as the Khadi and Village Industries Board or by any other name) established in a State by or under a State or Provincial Act for the development of khadi or village industries in the State. Explanation For the purposes of this clause, khadi and village industries have the meanings respectively assigned to them in the Khadi and Village Industries Commission Act, 1956 (61 of 1956). 44. Income of any body or authority provides for the administration of any public religious or charitable trusts or endowments or societies for religious or charitable [Section 10(23BBA)] Any income of any body or authority (whether or not a body corporate or corporation sole) established, constituted or appointed by or under any Central, State or Provincial Act which provides for the administration of any one or more of the following, that is to say, public religious or charitable trusts or endowments (including maths, temples, gurdwaras, wakfs, churches, synagogues, agiaries or other places of public religious worship) or societies for religious or charitable purposes registered as such under the Societies Registration Act, 1860 (21 of 1860), or any other law for the time being in force. Provided that nothing in this clause shall be construed to exempt from tax the income of any trust, endowment or society referred to therein. 45. Income of the European Economic Community [Section 10(23BBB)] Any income of the European Economic Community derived in India by way of interest, dividends or capital gains from investments made out of its funds under such scheme as the Central Government may, by notification in the Official Gazette, specify in this behalf. Explanation For the purposes of this clause, European Economic Community means the European Economic Community established by the Treaty of Rome of 25th March, 1957.

DIRECT TAXATION I 12.19

Incomes Which do not form Part of Total Income 46. Income of SAARC Fund [Section 10(23BBC)] Any income of the SAARC Fund for Regional Projects set up by Colombo Declaration issued on the 21st day of December, 1991 by the Heads of State or Government of the Member Countries of South Asian Association for Regional Cooperation established on the 8th day of December, 1985 by the Charter of the South Asian Association for Regional Cooperation. 47. Income of ASOSAI-SECRETARIAT [Section 10(23BBD)] Any income of the Secretariat of the Asian Organisation of the Supreme Audit Institutions registered as ASOSAI-SECRETARIAT under the Societies Registration Act, 1860 (21 of 1860) for ten Previous Years relevant to the Assessment Years beginning on the 1st day of April, 2001 and ending on the 31st day of March, 2011. 48. Income of Insurance Regulatory Development Authority (IRDA) [Section 10(23BBE)] Any income of the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999). 49. Income of the Central Electricity Regulatory Commission [Section 10(23BBG)] Any income of the Central Electricity Regulatory Commission constituted under sub-section (1) of section 76 of the Electricity Act, 2003 (36 of 2003); 50. Income of Prasar Bharati (Broadcasting Corporation of India) [Section 10(23BBH)] Any income of the Prasar Bharati (Broadcasting Corporation of India) established under sub-section(1) of section 3 of the Prasar Bharati (Broadcasting Corporation of India)Act,1990, from Assessment Year 2013-14 is exempted from tax. 51. Exemption in Special Cases [Section 10 (23C)] Any income received by any person on behalf of (i) the Prime Ministers National Relief Fund; or (ii) the Prime Ministers Fund (Promotion of Folk Art); or (iii) the Prime Ministers Aid to Students Fund; or (iiia) the National Foundation for Communal Harmony; or (Iiiab) any university or other educational institution existing solely for educational purposes and not for purposes of profit, and which is wholly or substantially financed by the Government; or (iiiac)any hospital or other institution for the reception and treatment of persons suffering from illness or mental defectiveness or for the reception and treatment of persons during convalescence or of persons requiring medical attention or rehabilitation, existing solely for philanthropic purposes and not for purposes of profit,and which is wholly or substantially financed by the Government; or (iiiad)any university or other educational institution existing solely for educational purposes and not for purposes of profit if the aggregate annual receipts of such university or educational institution do not exceed the amount of annual receipts as may be prescribed; or (iiiae)any hospital or other institution for the reception and treatment of persons suffering from illness or mental defectiveness or for the reception and treatment of persons during convalescence or of persons requiring medical attention or rehabilitation, existing solely for philanthropic purposes and not for purposes of profit, if the aggregate annual receipts of such hospital or institution do not exceed the amount of annual receipts as may be prescribed; or (iv) any other fund or institution established for charitable purposes which may be approved by the prescribed authority, having regard to the objects of the fund or institution and its importance throughout India or throughout any State or States; or

12.20 I DIRECT TAXATION

(v) any trust (including any other legal obligation) or institution wholly for public religious purposes or wholly for public religious and charitable purposes, which may be approved by the prescribed authority, having regard to the manner in which the affairs of the trust or institution are administered and supervised for ensuring that the income accruing thereto is properly applied for the objects thereof; or (vi) any university or other educational institution existing solely for educational purposes and not for purposes of profit, other than those mentioned in sub-clause (iiiab) or sub-clause (iiiad) and which may be approved by the prescribed authority; or (via) any hospital or other institution for the reception and treatment of persons suffering from illness or mental defectiveness or for the reception and treatment of persons during convalescence or of persons requiring medical attention or rehabilitation, existing solely for philanthropic purposes and not for purposes of profit, other than those mentioned in sub-clause (iiiac) or sub-clause (iiiae) and which may be approved by the prescribed authority. Provided that the fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or subclause (via) shall make an application in the prescribed form and manner to the prescribed authority for the purpose of grant of the exemption, or continuance thereof, under sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via). Provided further that the prescribed authority, before approving any fund or trust or institution or any university or other educational institution or any hospital or other medical institution, under sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via), may call for such documents (including audited annual accounts) or information from the fund or trust or institution or any university or other educational institution or any hospital or other medical institution, as the case may be, as it thinks necessary in order to satisfy itself about the genuineness of the activities of such fund or trust or institution or any university or other educational institution or any hospital or other medical institution, as the case may be, and the prescribed authority may also make such inquiries as it deems necessary in this behalf. Provided also that the fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) (a) applies its income, or accumulates it for application, wholly and exclusively to the objects for which it is established and in a case where more than fifteen per cent of its income is accumulated on or after the 1st day of April, 2002, the period of the accumulation of the amount exceeding fifteen per cent of its income shall in no case exceed five years; and (b) does not invest or deposit its funds, other than (i) any assets held by the fund, trust or institution or any university or other educational institution or any hospital or other medical institution where such assets form part of the corpus of the fund, trust or institution or any university or other educational institution or any hospital or other medical institution as on the 1st day of June, 1973; (ia) any asset, being equity shares of a public company, held by any university or other educational institution or any hospital or other medical institution where such assets form part of the corpus of any university or other educational institution or any hospital or other medical institution as on the 1st day of June, 1998; (ii) any assets (being debentures issued by, or on behalf of, any company or corporation), acquired by the fund, trust or institution or any university or other educational institution or any hospital or other medical institution before the 1st day of March, 1983; (iii) any accretion to the shares forming part of the corpus mentioned in sub-clause (i) and subclause (ia), by way of bonus shares allotted to the fund, trust or institution or any university or other educational institution or any hospital or other medical institution;

DIRECT TAXATION I 12.21

Incomes Which do not form Part of Total Income (iv) voluntary contributions received and maintained in the form of jewellery, furniture or any other article as the Board may, by notification in the Official Gazette, specify, for any period during the Previous Year otherwise than in any one or more of the forms or modes specified in subsection (5) of section 11.

Provided also that the exemption under sub-clause (iv) or sub-clause (v) shall not be denied in relation to any funds invested or deposited before the 1st day of April, 1989, otherwise than in any one or more of the forms or modes specified in sub-section (5) of section 11 if such funds do not continue to remain so invested or deposited after the 30th day of March, 1993. Provided also that the exemption under sub-clause (vi) or sub-clause (via) shall not be denied in relation to any funds invested or deposited before the 1st day of June, 1998, otherwise than in any one or more of the forms or modes specified in sub-section (5) of section 11 if such funds do not continue to remain so invested or deposited after the 30th day of March, 2001. Provided also that the exemption under sub-clause (iv) or sub-clause (v) or sub-clause (vi) or subclause (via) shall not be denied in relation to voluntary contribution, other than voluntary contribution in cash or voluntary contribution of the nature referred to in clause (b) of the third proviso to this subclause, subject to the condition that such voluntary contribution is not held by the trust or institution or any university or other educational institution or any hospital or other medical institution, otherwise than in any one or more of the forms or modes specified in sub-section (5) of section 11, after the expiry of one year from the end of the Previous Year in which such asset is acquired or the 31st day of March, 1992, whichever is later. Provided also that nothing contained in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) shall apply in relation to any income of the fund or trust or institution or any university or other educational institution or any hospital or other medical institution, being profits and gains of business, unless the business is incidental to the attainment of its objectives and separate books of account are maintained by it in respect of such business. Provided also that any notification issued by the Central Government under sub-clause (iv)or subclause(v), before the date on which the Taxation Laws (Amendment)Bill,2006 receives the assent of the President (i.e. 13.07.2006), shall, at any time, have effect for such Assessment Year or Years, not exceeding three Assessment Years (including an Assessment Year or Years commencing before the date on which such notification is issued) as may be specified in the notification. Provided also that where an application under the first proviso is made on or after the date of which the Taxation Laws (Amendment) Bill, 2006 receives the assent of the President (i.e. 13.07.2006), every notification under sub-clause (iv) or sub-clause (v) shall be issued or approval under sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) shall be granted or an order rejecting the application shall be passed within the period of 12 months from the end of the month in which such notification was received. Provided also that where the total income, of the fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or subclause (v) or sub-clause (vi) or sub-clause (via), without giving effect to the provisions of the said subclauses, exceeds the maximum amount which is not chargeable to tax in any Previous Year, such trust or institution or any university or other educational institution or any hospital or other medical institution shall get its accounts audited in respect of that year by an accountant as defined in the Explanation to sub-section (2) of section 288 and furnish along with the return of income for the relevant Assessment Year, the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed. Provided also that any amount of donation received by the fund or institution in terms of clause (d) of sub-section (2) of section 80G in respect of which accounts of income and expenditure have not been rendered to the authority prescribed under clause (v) of sub-section (5C) of that section, in the manner specified in that clause, or which has been utilised for purposes other than providing relief to the victims

12.22 I DIRECT TAXATION

of earthquake in Gujarat or which remains unutilised in terms of sub-section (5C) of section 80G and not transferred to the Prime Ministers National Relief Fund on or before the 31st day of March,2004 shall be deemed to be the income of the Previous Year and shall accordingly be charged to tax. Provided also that where the fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) does not apply its income during the year of receipt and accumulates it, any payment or credit out of such accumulation to any trust or institution registered under section 12AA or to any fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) shall not be treated as application of income to the objects for which such fund or trust or institution or university or educational institution or hospital or other medical institution, as the case may be, is established. Provided also that where the fund or institution referred to in sub-clause (iv) or trust or institution referred to in sub-clause (v) is notified by the Central Government or is approved by the prescribed authority, as the case may be, or any university or other educational institution referred to in sub-clause (vi) or any hospital or other medical institution referred to in sub-clause (via), is approved by the prescribed authority and subsequently that Government or the prescribed authority is satisfied that (i) such fund or institution or trust or any university or other educational institution or any hospital or other medical institution has not (A) applied its income in accordance with the provisions contained in clause (a) of the third proviso; or (B) invested or deposited its funds in accordance with the provisions contained in clause (b) of the third proviso; or

(ii) the activities of such fund or institution or trust or any university or other educational institution or any hospital or other medical institution (A) are not genuine; or (B) are not being carried out in accordance with all or any of the conditions subject to which it was notified or approved;

it may, at any time after giving a reasonable opportunity of showing cause against the proposed action to the concerned fund or institution or trust or any university or other educational institution or any hospital or other medical institution, rescind the notification or, by order, withdraw the approval, as the case may be, and forward a copy of the order rescinding the notification or withdrawing the approval to such fund or institution or trust or any university or other educational institution or any hospital or other medical institution and to the Assessing Officer; Provided also that in case the fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in the first proviso makes an application on or after the 1st day of June, 2006 for the purposes of grant of exemption or continuance thereof, such application shall be made on or before the 30th September of relevant Assessment Year from which the exemption is sought; Provided also that any anonymous donation referred to in section 115BBC on which tax is payable in accordance with the provisions of the said section shall be included in the total income; Provided also that all pending applications, on which no notification has been issued under sub-clause (iv) or sub-clause (v) before the 1st day of June, 2007, shall stand transferred on that day to the prescribed authority and the prescribed authority may proceed with such applications under those subclauses from the stage at which they were on that day.

DIRECT TAXATION I 12.23

Incomes Which do not form Part of Total Income Amendment to Section 10(23C) (iv) & (v) - Assessment of charitable organization in case commercial receipts exceed the specified threshold of `25,00,000 [w.e.f. A.Y. 2009-10] Section 2(15) provides that if the object of advancement of general public utility involves carrying on of any activity in the nature of trade, commerce or business, etc. and the aggregate value of the receipts from such activity exceeds ` 25,00,000, the trust will not be considered as charitable trust. New sub-section (8) has been inserted in section 13 and a proviso has been added in section 10(23C), with retrospective effect from A.Y. 2009-10, to provide that the trust or institution will not be granted exemption only for the year in which such receipts exceed ` 25,00,000. Such loss of exemption in that year will not affect the registration of the trust or institution u/s.12AA. The exemption can be claimed in subsequent years when such receipts do not exceed ` 25,00,000. Extension of time limit to 30th September for filing application for approval under section 10(23C) for fund or trust or institution or any university or other educational institution or any hospital or other medical institution [Section 10(23C)] [For the financial year 2008-09 and subsequent years] Section 10(23C) stipulates that income of institutions specified under its various sub-clauses (fund or trust or institution or any university or other educational institution or any hospital or other medical institution) shall be exempt from income tax. For trusts or institutions covered under section 10(23C)(iv), (v), (vi) and (via), approvals are required to be taken from prescribed authorities, in the prescribed manner, to become eligible for claiming exemption. Under the existing provisions, any institution (having receipts of more than rupees one crore) has to make an application for seeking exemption at any time during the financial year for which the exemption is sought. In practice, an eligible institution has to anticipate its annual receipts in decide whether the application for exemption is required to be filed or not. This has often led to avoidable hardship. In order to mitigate this hardship, the Act has extended the time limit for filing such application to the 10th day of September in the succeeding financial year. This relaxation has been provided for the financial year 2008-09 and subsequent years. In other words, where the gross receipts of a trust or institution exceeds rupees one crore in the financial year 2008-2009, it can file the application for exemption up till 30th September 2009. 52. Income of Mutual Fund [ Section 10(23D)] Subject to the provisions of Chapter XII-E, any income of (i) a Mutual Fund registered under the Securities and Exchange Board of India Act, 1992 (15 of 1992) or regulations made there under;

(ii) such other Mutual Fund set up by a public sector bank or a public financial institution or authorised by the Reserve Bank of India and subject to such conditions as the Central Government may, by notification in the Official Gazette, specify in this behalf. Explanation For the purposes of this clause, (a) the expression public sector bank means the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding new Bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980) and a Bank included in the category other public sector banks by the Reserve Bank of India; (b) the expression public financial institution shall have the meaning assigned to it in section 4A of the Companies Act, 1956 (1 of 1956); (c) the expression Securities and Exchange Board of India shall have the meaning assigned to it in clause (a) of sub-section (1) of section 2 of the Securities and Exchange Board of India Act, 1992 (15 of 1992).

12.24 I DIRECT TAXATION

Amendment to section 10(23) of the Income Tax Act, 1961- Incorporating Other Public Sector Banks under the expression Public Sector Bank [Section 10(23D)] [W.e.f.A.Y.2010-11] Income of a mutual fund set up by a Public Sector Bank is exempt under section 10(23D). The expression public sector banks has been defined in the Explanation to section 10(23D). Reserve Bank of India has categorized a new sub-group called other public sector banks. The Central Government holds more than 51% shareholding in IDBI Bank Limited, which has been categorized under other public sector banks by RBI. Since other public sector banks, has not been included in the expression public sector banks as defined in the Explanation to section 10(23D), the Act has amended the relevant provisions of the Income-tax Act, 1961 to do so. Hence, income of a mutual fund set up by other public sector banks shall also be exempt. 53. Contribution received from Recognised Stock Exchange [Section 10(23EA)] Any income by way of contributions received from recognised stock exchanges and the members thereof, of such Investor Protection Fund set up by recognisedstock exchanges in India, either jointly or separately, as the Central Government may, by notification in the Official Gazette, specify in this behalf. Provided that where any amount standing to the credit of the Fund and not charged to income-tax during any Previous Year is shared, either wholly or in part, with a recognised stock exchange, the whole of the amount so shared shall be deemed to be the income of the Previous Year in which such amount is so shared and shall accordingly be chargeable to Income-tax. 54. Income of the Credit Guarantee Fund Trust for Small Industries [Section 10(23EB)] Any income of the Credit Guarantee Fund Trust for Small Industries, being a trust created by the Government of India and the Small Industries Development Bank of India established under sub-section (1) of section 3 of the Small Industries Development Bank of India Act, 1989 (39 of 1989), for five Previous Years relevant to the Assessment Years beginning on the 1st day of April, 2002 and ending on the 31st day of March, 2007. 55. Contributions received from Commodity Exchanges [Section 10(23EC)] Any income, by way of contributions received from commodity exchanges and the members thereof, of such Investor Protection Fund set up by commodity exchanges in India, either jointly or separately, as the Central Government may, by notification in the Official Gazette, specify in this behalf. Provided that where any amount standing to the credit of the said Fund and not charged to Incometax during any Previous Year is shared, either wholly or in part, with a commodity exchange, the whole of the amount so shared shall be deemed to be the income of the Previous Year in which such amount is so shared and shall accordingly be chargeable to income tax. 56. Income of a Venture Capital Company or Venture Capital Fund [Section 10(23FB)] Any income of a venture capital company or venture capital fund from investment in a venture capital undertaking. Explanation 1 For the purposes of this clause (a) venture capital company means such company (i) which has been granted a certificate of registration under the Securities and Exchange Board of India Act, 1992 (15 of 1992), and regulations made there under;

(ii) which fulfils the conditions as may be specified, with the approval of the Central Government, by the Securities and Exchange Board of India, by notification in the Official Gazette, in this behalf;

DIRECT TAXATION I 12.25

Incomes Which do not form Part of Total Income (b) venture capital fund means such fund (i) operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908) or operating as a venture capital scheme made by the Unit Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963); (ii) which has been granted a certificate of registration under the Securities and Exchange Board of India Act, 1992 (15 of 1992), and regulations made there under; (iii) which fulfils the conditions as may be specified, with the approval of the Central Government, by the Securities and Exchange Board of India, bynotification in the Official Gazette, in this behalf;

(c) venture capital undertaking means such domestic company whose shares are not listed in a recognised stock exchange in India and which is engaged in the (i) business of (A) nanotechnology; (B) information technology relating to hardware and software development; (C) seed research and development; (D) bio-technology; (E) research and development of new chemical entities in the pharmaceutical sector; (F) production of bio-fuels; (G) building and operating composite hotel-cum-convention centre with seating capacity of more than three thousand; (H) developing or operating and maintaining or developing, operating and maintaining any infrastructure facility as defined in the Explanation to clause (i) of sub-section (4) of section 80-IA;

(ii) dairy or poultry industry;

From Assessment Year 2013-14, Venture Capital Undertaking means a venture capital undertaking referred to in the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 made under the Securities and Exchange Board of India Act,1992 (15 of 1992). 57. Income from House Property and from Other Sources of a Registered Union and an Association of Registered Union [Section 10(24)] Any income chargeable under the heads Income from House Property and Income from Other Sources of (a) a registered union within the meaning of the Trade Unions Act, 1926 (16 of 1926), formed primarily for the purpose of regulating the relations between workmen and employers or between workmen and workmen; (b) an association of registered unions referred to in sub-clause (a) Case Law: Ancillary and incidental objects are not barred - Section 10(24) does not lay down that the association must be formed wholly and exclusively for the purposes enumerated in that provision. An association registered under the Trade Unions Act, having other ancillary and incidental objects apart from the primary object of regulation between its members and their employees, is also entitled to exemption CIT vs. Calcutta Hydraulic Press Association 121 ITR 414.

12.26 I DIRECT TAXATION

58. Income of Provident Fund or Income received by the Trustees [Section 10(25)] (i) Interest on securities which are held by, or are the property of, any provident fund to which the Provident Funds Act, 1925 (19 of 1925), applies, and any capital gains of the fund arising from the sale, exchange or transfer of such securities;

(ii) Any income received by the trustees on behalf of a recognised provident fund; (iii) Any income received by the trustees on behalf of an approved superannuation fund; (iv) Any income received by the trustees on behalf of an approved gratuity fund; (v) Any income received (a) by the Board of Trustees constituted under the Coal Mines Provident Funds and Miscellaneous Provisions Act, 1948 (46 of 1948), on behalf of the Deposit-linked Insurance Fund established under section 3G of that Act; or (b) by the Board of Trustees constituted under the Employees Provident Funds and Miscellaneous Provisions Act, 1952 (19 of 1952), on behalf of the Deposit-linked Insurance Fund established under section 6C of that Act.

59. Income of the Employees State Insurance Fund [Section 10(25A)] Any income of the Employees State Insurance Fund set up under the provisions of the Employees State Insurance Act, 1948 (34 of 1948). 60. Exemption in respect of Scheduled Tribe of Specified Area [Section 10(26)] In the case of a member of a Scheduled Tribe as defined in clause (25) of article 366 of the Constitution, residing in any area specified in Part I or Part II of the Table appended to paragraph 20 of the Sixth Schedule to the Constitution or in the States of Arunachal Pradesh, Manipur, Mizoram, Nagaland and Tripura or in the areas covered by notification No. TAD/R/35/50/109, dated the 23rd February, 1951, issued by the Governor of Assam under the proviso to sub-paragraph (3) of the said paragraph 20 as it stood immediately before the commencement of the North-Eastern Areas (Reorganisation) Act, 1971 (81 of 1971) or in the Ladakh region of the State of Jammu and Kashmir, any income which accrues or arises to him (a) from any source in the areas or States aforesaid, or (b) by way of dividend or interest on securities; Case Law: Provision is constitutionally valid - Section 10(26)(a) is constitutionally valid. The classification therein for the purpose of exemption from tax between income from a specified area and income from outside that specified area is not discriminatory and does not offend article 14 of the Constitution - ITO v. N. Takin Roy Rymbai 103 ITR 82. 61. Income of an individual being a Sikkimese [Section 10(26AAA)] In case of an individual, being a Sikkimese, any income which accrues or arises to him (a) from any source in the State of Sikkim; or (b) by way of dividend or interest on securities: Provided that nothing contained in this clause shall apply to a Sikkimese woman who, on or after the 1st day of April, 2008, marries an individual who is not a Sikkimese. Explanation For the purposes of this clause, Sikkimese shall mean (i) an individual, whose name is recorded in the register maintained under the Sikkim Subjects Regulation, 1961 read with the Sikkim Subject Rules, 1961 (hereinafter referred to as the Register of Sikkim Subjects), immediately before the 26th day of April, 1975; or

DIRECT TAXATION I 12.27

Incomes Which do not form Part of Total Income (ii) an individual, whose name is included in the Register of Sikkim Subjects by virtue of the Government of India Order No. 26030/36/90-I.C.I., dated the 7th August, 1990 and Order of even number dated the 8th April, 1991; or (iii) any other individual, whose name does not appear in the Register of Sikkim Subjects, but it is established beyond doubt that the name of such individuals father or husband or paternal grandfather or brother from the same father has been recorded in that register; 62. Income of an agricultural produce market committee [Section 10(26AAB)] Any income of an agricultural produce market committee or board constituted under any law for the time being in force for the purpose of regulating the marketing of agricultural produce. 63. Income of a Corporation established for promoting the interests of the members of the Scheduled Castes or the Scheduled Tribes or backward classes [Section 10(26B)] Any income of a corporation established by a Central, State or Provincial Act or of any other body, institution or association (being a body, institution or association wholly financed by Government) where such corporation or other body or institution or association has been established or formed for promoting the interests of the members of the Scheduled Castes or the Scheduled Tribes or backward classes or of any two or all of them. Explanation For the purposes of this clause, (a) Scheduled Castes and Scheduled Tribes shall have the meanings respectively assigned to them in clauses (24) and (25) of article 366 of the Constitution; (b) Backward Classes means such classes of citizens, other than the Scheduled Castes and the Scheduled Tribes, as may be notified (i) by the Central Government; or (ii) by any State Government,

as the case may be, from time to time. 64. Income of a corporation established for promoting the interests of the members of a minority community [Section 10(26BB)] Any income of a corporation established by the Central Government or any State Government for promoting the interests of the members of a minority community. Explanation - For the purposes of this clause, minority community means a community notified as such by the Central Government in the Official Gazette in this behalf. 65. Income of a corporation established for the welfare and economic upliftment of ex-servicemen being the citizens of India [Section 10(26BBB)] Any income of a corporation established by a Central, State or Provincial Act for the welfare and economic upliftment of ex-servicemen being the citizens of India. Explanation - For the purposes of this clause, ex-serviceman means a person who has served in any rank, whether as combatant or non-combatant, in the armed forces of the Union or armed forces of the Indian States before the commencement of the Constitution (but excluding the Assam Rifles, Defence Security Corps, General Reserve Engineering Force, Lok Sahayak Sena, Jammu and Kashmir Militia and Territorial Army) for a continuous period of not less than six months after attestation and has been released, otherwise than by way of dismissal or discharge on account of misconduct or inefficiency, and in the case of a deceased or incapacitated ex-serviceman includes his wife, children, father, mother, minor brother, widowed daughter and widowed sister, wholly dependent upon such ex-serviceman immediately before his death or incapacitation.

12.28 I DIRECT TAXATION

66. Income of a co-operative society formed for promoting interest of the members of the Scheduled Castes or Scheduled Tribes [Section 10(27)] Any income of a co-operative society formed for promoting the interests of the members of either the Scheduled Castes or Scheduled Tribes or both referred to in clause (26B). Provided that the membership of the co-operative society consists of only other co-operative societies formed for similar purposes and the finances of the society are provided by the Government and such other societies. 67. Income of certain specified Board or Authority [Section 10(29A)] Any income accruing or arising to (a) the Coffee Board constituted under section 4 of the Coffee Act, 1942 (7 of 1942) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1962 or the Previous Year in which such Board was constituted, whichever is later; (b) the Rubber Board constituted under sub-section (1) of section 4 of the Rubber Board Act, 1947 (24 of 1947) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1962 or the Previous Year in which such Board was constituted, whichever is later; (c) the Tea Board established under section 4 of the Tea Act, 1953 (29 of 1953) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1962 or the Previous Year in which such Board was constituted, whichever is later; (d) the Tobacco Board constituted under the Tobacco Board Act, 1975 (4 of 1975) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1975 or the Previous Year in which such Board was constituted, whichever is later; (e) the Marine Products Export Development Authority established under section 4 of the Marine Products Export Development Authority Act, 1972 (13 of 1972) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1972 or the Previous Year in which such Authority was constituted, whichever is later; (f) the Agricultural and Processed Food Products Export Development Authority established under section 4 of the Agricultural and Processed Food Products Export Development Act, 1985 (2 of 1986) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1985 or the Previous Year in which such Authority was constituted, whichever is later; (g) the Spices Board constituted under sub-section (1) of section 3 of the Spices Board Act, 1986 (10 of 1986) in any Previous Year relevant to any Assessment Year commencing on or after the 1st day of April, 1986 or the Previous Year in which such Board was constituted, whichever is later; (h) the Coir Board established under section 4 of the Coir Industry Act,1953 (45 of 1953). Case Law: Retrospective effect of introduction provisions of section 10(29A)(d) - In view of the provisions of section 10(29A)(d) introduced by the Finance Act, 1999, the assessee-Tobacco Boards income would become exempt from Income-tax for any Assessment Year with effect from 1-4-1975 or the Previous Year in which the Board was constituted and the assessments already made would stand set aside by virtue of section 10(29A)(d) with retrospective effect, and the assessee will also be entitled to refund consequent to the retrospective amendment passed by Parliament - Tobacco Board vs. CIT 243 ITR 4. 68. Income from the business of growing and manufacturing tea in India [Section 10(30)] In the case of an assessee who carries on the business of growing and manufacturing tea in India, the amount of any subsidy received from or through the Tea Board under any such scheme for replantation or replacement of tea bushes or for rejuvenation or consolidation of areas used for cultivation of tea as the Central Government may, by notification in the Official Gazette, specify.

DIRECT TAXATION I 12.29

Incomes Which do not form Part of Total Income Provided that the assessee furnishes to the Assessing Officer, along with his return of income for the Assessment Year concerned or within such further time as the Assessing Officer may allow, a certificate from the Tea Board as to the amount of such subsidy paid to the assessee during the Previous Year. Explanation In this clause, Tea Board means the Tea Board established under section 4 of the Tea Act, 1953 (29 of 1953) Case Law: Scope of deduction - Since expression or for rejuvenation or consolidation of areas used for cultivation of tea was inserted in section 10(30) by Finance Act, 1984 with effect from 1-4-1985, benefit of deduction in respect of rejuvenation subsidy granted by Tea Board to assessee would be available only from Assessment Year 1985-86 and not for Assessment Year 1984-85 - Kil Kotagiri Tea & Coffee Estate Co. Ltd. vs. CIT 108 Taxman 125. 69. Income of assessee who carries on the business of growing and manufacturing rubber, coffee etc. [Section 10(31)] In the case of an assessee who carries on the business of growing and manufacturing rubber, coffee, cardamom or such other commodity in India, as the Central Government may, by notification in the Official Gazette, specify in this behalf, the amount of any subsidy received from or through the concerned Board under any such scheme for replantation or replacement of rubber plants, coffee plants, cardamom plants or plants for the growing of such other commodity or for rejuvenation or consolidation of areas used for cultivation of rubber, coffee, cardamom or such other commodity as the Central Government may, by notification in the Official Gazette, specify. Provided that the assessee furnishes to the Assessing Officer, along with his return of income for the Assessment Year concerned or within such further time as the Assessing Officer may allow, a certificate from the concerned Board, as to the amount of such subsidy paid to the assessee during the Previous Year. Explanation In this clause, concerned Board means, (i) in relation to rubber, the Rubber Board constituted under section 4 of the Rubber Act, 1947 (24 of 1947),

(ii) in relation to coffee, the Coffee Board constituted under section 4 of the Coffee Act, 1942 (7 of 1942), (iii) in relation to cardamom, the Spices Board constituted under section 3 of the Spices Board Act, 1986 (10 of 1986), (iv) in relation to any other commodity specified under this clause, any Board or other authority established under any law for the time being in force which the Central Government may, by notification in the Official Gazette, specify in this behalf. 70. Exemption in respect of Clubbing of Income [ Section 10(32)] In the case of an assessee referred to in sub-section (1A) of section 64, any income includible in his total income under that sub-section, to the extent such income does not exceed one thousand five hundred rupees in respect of each minor child whose income is so includible. 71. Income arising from the transfer of a Capital Asset, being a unit of the Unit Scheme, 1964 [Section 10(33)] Any income arising from the transfer of a capital asset, being a unit of the Unit Scheme, 1964 referred to in Schedule I to the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002) and where the transfer of such asset takes place on or after the 1st day of April, 2002.

12.30 I DIRECT TAXATION

72. Dividend received [Section 10(34)] Any income received by way of dividends referred to in section 115-O. 73. Income received in respect of the units of a Mutual Fund [Section 10(35)] Any income by way of (a) income received in respect of the units of a Mutual Fund specified under clause (23D); or (b) income received in respect of units from the Administrator of the specified undertaking; or (c) income received in respect of units from the specified company. Provided that this clause shall not apply to any income arising from transfer of units of the Administrator of the specified undertaking or of the specified company or of a mutual fund, as the case may be. Explanation For the purposes of this clause (a) Administrator means the Administrator as referred to in clause (a) of section 2 of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002); (b) Specified Company means a company as referred to in clause (h) of section 2 of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002). 74. Income arising from the transfer of a Long-term Capital Asset, being an Eligible Equity Share [Section 10(36)] Any income arising from the transfer of a long-term capital asset, being an eligible equity share in a company purchased on or after the 1st day of March, 2003 and before the 1st day of March, 2004 and held for a period of twelve months or more. Explanation For the purposes of this clause, Eligible Equity Share means (i) any equity share in a company being a constituent of BSE-500 Index of the Stock Exchange, Mumbai as on the 1st day of March, 2003 and the transactions of purchase and sale of such equity share are entered into on a recognised stock exchange in India;

(ii) any equity share in a company allotted through a public issue on or after the 1st day of March, 2003 and listed in a recognised stock exchange in India before the 1st day of March, 2004 and the transaction of sale of such share is entered into on a recognised stock exchange in India. 75. Income of any HUF in respect of Capital Gains from the transfer of agricultural land [Section 10(37)] In the case of an assessee, being an individual or a Hindu Undivided Family, any income chargeable under the head Capital Gains arising from the transfer of agricultural land, where (i) such land is situate in any area referred to in item (a) or item (b) of sub-clause (iii) of clause (14) of section2;

(ii) such land, during the period of two years immediately preceding the date of transfer, was being used for agricultural purposes by such Hindu Undivided Family or individual or a parent of his; (iii) such transfer is by way of compulsory acquisition under any law, or a transfer the consideration for which is determined or approved by the Central Government or the Reserve Bank of India; (iv) such income has arisen from the compensation or consideration for such transfer received by such assessee on or after the 1st day of April, 2004. Explanation For the purposes of this clause, the expression compensation or consideration includes the compensation or consideration enhanced or further enhanced by any court, Tribunal or other authority.

DIRECT TAXATION I 12.31

Incomes Which do not form Part of Total Income 76. Income arising from the transfer of a long-term capital asset, being an equity share [Section 10(38)] Any income arising from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund where : (a) the transaction of sale of such equity share or unit is entered into on or after the date on which Chapter VII of the Finance (No. 2) Act, 2004 comes into force; and (b) such transaction is chargeable to securities transaction tax under that Chapter. Provided that the income by way of Long-term Capital Gain of a company shall be taken into account in computing the Book Profit and Income-tax payable under section 115JB. Explanation For the purposes of this clause, equity oriented fund means a fund (i) where the investible funds are invested by way of equity shares in domestic companies to the extent of more than sixty-five per cent of the total proceeds of such fund; and (ii) which has been set up under a scheme of a Mutual Fund specified under clause (23D). Provided that the percentage of equity shareholding of the fund shall be computed with reference to the annual average or the monthly averages of the opening and closing figures. 77. Income arising from any International Sporting Event [Section 10(39)] Any specified income, arising from any international sporting event held in India, to the person or persons notified by the Central Government in the Official Gazette, if such international sporting event (a) is approved by the international body regulating the international sport relating to such event; (b) has participation by more than two countries; (c) is notified by the Central Government in the Official Gazette for the purposes of this clause. Explanation - For the purposes of this clause, the specified income means the income, of the nature and to the extent, arising from the international sporting event, which the Central Government may notify in this behalf. 78. Income of any subsidiary company by way of grant or otherwise received from an Indian Company [Section 10(40)] Any income of any subsidiary company by way of grant or otherwise received from an Indian company, being its holding company engaged in the business of generation or transmission or distribution of power if receipt of such income is for settlement of dues in connection with reconstruction or revival of an existing business of power generation. Provided that the provisions of this clause shall apply if reconstruction or revival of any existing business of power generation is by way of transfer of such business to the Indian company notified under subclause (a) of clause (v) of sub-section (4) of section 80-IA. 79. Income arising from transfer of a Capital Asset, being an asset of an undertaking engaged in the Business of Generation or Transmission or Distribution of Power [Section 10(41)] Any income arising from transfer of a capital asset, being an asset of an undertaking engaged in the business of generation or transmission or distribution of power where such transfer is effected on or before the 31st day of March, 2006, to the Indian company notified under sub-clause (a) of clause (v) of sub-section (4) of section 80-IA. 80. Specified income arising to a Body or Authority [Section 10(42)] Any specified income arising to a body or authority which (a) has been established or constituted or appointed under a treaty or an agreement entered into

12.32 I DIRECT TAXATION

by the Central Government with two or more countries or a convention signed by the Central Government; (b) is established or constituted or appointed not for the purposes of profit; (c) is notified by the Central Government in the Official Gazette for the purposes of this clause. Explanation For the purposes of this clause, specified income means the income, of the nature and to the extent, arising to the body or authority referred to in this clause, which the Central Government may notify in this behalf. 81. Amount received as a loan [Section 10(43)] Any amount received by an individual as a loan, either in lump sum or in installment, in a transaction of reverse mortgage referred to in clause (xvi) of section 47. Reverse Mortgage Scheme means a scheme under which generally a senior citizen, who owns a house property but does not have any regular source of income, can mortgage his house property with a scheduled bank or a housing finance company for a lump sum or periodic installment during his lifetime. The borrower (i.e. the senior citizen) can continue to stay in the property during his lifetime and as well continue to receive regular income from the lender. The borrower does not pay the principal as well as interest to the lender during his lifetime. The lender will recover the loan along with the accumulated interest by selling the house after the death of the borrower. Any excess amount after recovering the total dues will be remitted back to the legal heirs of the borrower. However, before resorting to disposal of the property, an option will be given to the legal heirs to repay the loan amount including the interest and to get the mortgaged property released. 82. Income received for or on behalf of New Pension System Trust [Section 10(44)] Any income received by any person for, or on behalf of, the New Pension System Trust established on the 27th day of February, 2008 under the provisions of the Indian Trusts Act, 1882 (2 of 1882). 83. Allowance or perquisite, paid to the Chairman or Retired Chairman or Member or Retired Member of Union Public Service Commission (UPSC) [Section 10(45)] Any allowance or perquisite, as notified by the Central Government, paid to the Chairman or Retired Chairman or Member or Retired Member of Union Public Service Commission (UPSC). The allowances and perquisites notified by the Central Government are: (a) In case of serving Chairman and members of UPSC: (i) The value of Rent Free Accommodation; (ii) The value of conveyance facilities including transport allowance; (iii) The Sumptuary Allowance (iv) The value of Leave Travel Concession provided to the serving Chairman and members of UPSC and members of their family. (i) Maximum amount of ` 14,000 p.m. for discharging the service of an orderly and for meeting the expenses incurred towards Secretarial Assistance on contract basis;

(b) In case of retired Chairman and retired members of UPSC

(ii) The value of a residential telephone free of cost subject to a maximum of ` 1,500 p.m. over and above the number of free calls per month allowed by the telephone authorities.

84. Specified income of notified Body or Authority or Board or Commission [Section 10(46)] Specified income of notified Body or Authority or Board or Commission if such Body or Authority or Board or Commission is constituted by a Central, State or Provincial Act or constituted by the Central Government or a State Government with the object of regulating or administering any activity for the benefit of general public.

DIRECT TAXATION I 12.33

Incomes Which do not form Part of Total Income Provided (a) The notified Body or Authority or Board or Commission is not engaged in any commercial activity; (b) The notified Body or Authority or Board or Commission is notified by the Official Gazette for the purpose of this clause. 85. Income of an Infrastructural Debt Fund [Section 10(47)] Income of an Infrastructural Debt Fund set up in accordance with the prescribed guidelines given under Rule 2F which is notified by the Central Government in the Official Gazette for the purposes of this clause. Even if the income is exempted, such fund will have to submit return of income u/s 139. Amendments: Any interest received by a non-resident from the aforesaid fund shall be taxable @ 5% on the gross amount of such interest income and tax shall be deducted at source @ 5% by the fund in respect of any interest paid to non-resident by it. 86. Exemption in respect of Income received by a Foreign Companies in Indian Currency for import of Oil [Section 10(48)] [w.e.f. 01.04.2012] Any income of a foreign company received in India, in Indian currency, on account of sale of crude oil to any person in India. Provided (i) the receipt of money is under an agreement which is entered into by the Central Government or approved by it,

(ii) the foreign company and the arrangement or agreement has been notified by the Central Government and (iii) the receipt of the money is the only activity carried out by the foreign company in India. (iv) This provision is introduced in view of the mechanism devised by the Government to make payment to certain foreign companies in Indian currency for import of crude oil. 12.2 SPECIAL PROVISION 12.2.1 Tax Exemption in case of newly established industrial undertakings in Free Trade Zones, etc. [Sec. 10A (Rule - 16D)] Profits or gains from exports of newly established Industrial undertakings set up in Free Trade Zones, Electronic Hardware Technology Park or Software Technology Park in Special Economic Zone are fully exempt for ten consecutive Assessment Years beginning with the Assessment Year relevant to the Previous Year in which the industrial undertakings begin to manufacture or produce articles or things or computer software specified by the assessee. No deduction under this section is available for the Assessment Year beginning on 1.4.2012 and subsequent years. Exemptions will also be available to successor company w.e.f. AY 2003-04 in case of business reorganisation Sec. 10A(9A) for Assessment Year 2003-04 exemption is restricted to 90% of the profit. Sec. 10A (1A): The Finance Act, 2005 has inserted a proviso to provide that no deduction shall be allowed under this section to an assessee who does not furnish a return of his income on or before the due date specified under sub- section (1) of section 139. Return of income of SEZ undertakings to be filed on or before due date for claiming benefit under section 10A, w.e.f. from A.Y. 2006-07. Sub-section (1A) of section 10A provides that an undertaking which begins to manufacture or produce articles or things or computer software during the Previous Year relevant to any Assessment Year commencing on or after 1st April , 2003 in any Special Economic Zone (SEZ), is eligible for a deduction , 100% of the profits and gains derived from export of such articles or

12.34 I DIRECT TAXATION

things or computer software for the first five consecutive years and 50% of such profits and gains for the next two consecutive years followed by a deduction to the extent of 50% of profits credited to a reserve account, to be utilized for the purpose of the business, for the next three consecutive years. 12.2.2 Tax Exemption in respect of 100% Exports Oriented Undertaking [Sec. 10B] Profit or gains of export derived from 100% Export Oriented Unit (EOU) is exempt from tax for 10 consecutive years beginning with the initial Assessment Year in which the undertaking begins to manufacture or produce articles or things or computer software. This tax concession is available to all tax payers including companies in lieu of all other tax concessions. Conditions for tax exemptions are that: (i) It is a manufacturing undertaking; (ii) It is not formed by splitting up or the reconstruction of a business already in advance; (iii) It should not use old machinery valued more than 20% of the value of total plant and machinery; (iv) No deduction under section 80HH, 80HHA, 80-I and 80-IA shall be allowed in relation to the profits and gains of the undertaking. Exemption is also available to Successor company in case of reorganization Section 10B (9A) w.e.f. AY 2003-04. For the Assessment Year 2003-04, exemption is restricted to 90% of the profit; Case Law: Scope of exemptions - Since section 10B provides 100 per cent exemption for export income and not for other income, assessee cannot adjust unabsorbed depreciation against other income so as to take exemption from payment of tax even for other income - CIT vs. Himatasingike Seide Ltd. 156 Taxman 151. Extension of sunset clause for units in Free Trade Zone under section 10A and for Export Oriented Undertakings under section 10B by one year i.e., the deduction will be available up to Assessment Year 2011-12 [Section 10Aand 10B] Under the existing provisions, the deductions under section 10A and section 10B of the Income Tax Act are available only up to the Assessment Year 2010-11. The Act has amended sections 10A and 10B to extend the tax benefit under both these sections by one year i.e., the deduction will be available up to Assessment Year 2011-12 or for a period of 10 years whichever expires earlier. 12.2.3 Tax exemption in respect of newly established units in Special Economic Zone [Section 10AA] Section 10AA has been inserted to give deduction for units newly established in Special Economic Zone subject to the following conditions: (i) The assessee is an entrepreneur who is granted a latter of approval by the Development Commissioner, to set up a unit in a Special Economic Zone.

(ii) The unit in SEZ begins to manufacture or produce articles or things or provide services on or after 1st April, 2006. (iii) It should not be formed by splitting up or by reconstruction of an existing business. However, rehabilitation u/s 33B is permitted. (iv) It should not be formed by the transfer, to a new business, of machinery or plant previously used for any purpose. (v) The assessee has income from export of articles or thing or from services from such unit out of India from SEZ by land, sea, air or by any other mode, whether physical or otherwise. (vi) The books of account of the assessee should be audited and Audit Report should be furnished in Form No. 56F along with the return of income. (vii) Deduction u/s 10AA is not available unless it is claimed in the return of income.

DIRECT TAXATION I 12.35

Incomes Which do not form Part of Total Income A deduction of (i) 100% of profits derived from the exports for a period of 5 consecutive Assessment Years beginning with the Assessment Year relevant to the Previous Year in which the unit begins to manufacture or produce articles or things or provide services.

(ii) 50% of such profits for the next 5 Assessment Years. (ii) so much of the amount not exceeding 50% of such profit in respect of which the deduction is to be allowed and credited to Special Economic Zone Re-investment Allowance Reserve A/c. Under section 10AA(7) of the Income-tax Act, the exempted profit of a SEZ unit is the profit derived from the export of articles or things or services and same is required to be calculated as under: The exempted profit of the SEZ unit is equal to Profits of the business of the unit Export turnover of the unit Total Turnover of the business carried on by the undertaking

This method of computation of the profits of business with reference to the total turnover of the assessee is perceived to be discriminatory in so far as those assessees are concerned who were having multiple units in both the SEZ and the Domestic Tariff Area (DTA) vis-a-vis those assessees who were having units in only the SEZ. With a view to remove the anomaly, the Act has amended the provisions of section 10AA(7) of the Income Tax Act so as to provide that the deduction under section 10AA shall be computed with reference to the total turnover of the undertaking. Utilisation of Reserve so created: (i) The amount available in Special Economic Zone Re-investment Allowance Reserve A/c should be utilised for the purpose of acquiring new plant and machinery and such new plant and machinery should be first put to use before the expiry of 3 years from the end of the year in which such reserve is created.

(ii) The amount available in Special Economic Zone Re-investment Allowance Reserve A/c should not be used for distribution by way of dividends or profits/for remittance outside India as profit/ for creating asset outside India. (iii) The assessee should submit details of new machinery and plant along with the return of income for the Previous Year in which such machinery and plant was first put to use in Form No. 56FF. If the amount available in Special Economic Zone Re-investment Allowance Reserve A/c is misutilised, then the deduction would be taken back in the year in which the amount misutilised. Again, if the Reserve is not utilised within the prescribed period, it shall be treated as income of the Previous Year immediately following the period of three years. Consequence of Amalgamation and Demerger: Where the undertaking, entitled to deduction u/s 10AA, is transferred under a scheme of amalgamation or demerger, the deduction u/s 10AA shall be allowable in the hands of amalgamated or the resulting company for the unexpired period. However, no deduction is available to the amalgamating or demerged company for the Previous Year in which amalgamation or demerger takes place. Impact of availing deduction u/s 10AA: (i) Unabsorbed depreciation allowance or unabsorbed capital expenditure on scientific research or unabsorbed family planning expenditure or unabsorbed business loss or unabsorbed loss under the head Capital Gains are not allowed to be carried forward and set off against the income of Assessment Years following the period of deduction. However, this restriction is not applicable to losses in respect of other business.

(ii) Depreciation will be deemed to have been allowed and the WDV of the assets after exemption period will be computed accordingly.

12.36 I DIRECT TAXATION

(iii) Deduction u/s 80IA and 80IB shall not be allowed. (iv) Provisions of Sec. 80IA (8) relating to inter-unit transfer and provisions of Sec. 80IA (10) relating to showing excess profit from such unit apply to this undertaking. 12.2.4 Meaning of computer programmes in certain cases [Sec.10BB] The profits and gains derived by an undertaking from the production of computer programmes under section 10B, as it stood prior to its substitution by section 7 of the Finance Act, 2000 (10 of 2000), shall be construed as if for the words computer programmes, the words computer programmes or processing or management of electronic data had been substituted in that section. 12.2.5 Special provision in respect of certain industrial undertakings in North- Eastern Region [10C] (1) Subject to the provisions of this section, any profits and gains derived by an assessee from an industrial undertaking, which has begun or begins to manufacture or produce any article or thing on or after the 1st day of April, 1998 in any Integrated Infrastructure Development Centre or Industrial Growth Centre located in the North-Eastern Region (hereafter in this section referred to as the industrial undertaking) shall not be included in the total income of the assessee. (2) This section applies to any industrial undertaking which fulfils all the following conditions, namely : (i) It is not formed by the splitting up, or the reconstruction of, a business already in existence; Provided that this condition shall not apply in respect of any industrial undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such industrial undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section;

(ii) It is not formed by the transfer to a new business of machinery or plant previously used for any purpose.

(3) The profits and gains referred to in sub-section (1) shall not be included in the total income of the assessee in respect of ten consecutive Assessment Years beginning with the Assessment Year relevant to the Previous Year in which the industrial undertaking begins to manufacture or produce articles or things. (4) Notwithstanding anything contained in any other provision of this Act, in computing the total income of the assessee of any Previous Year relevant to any subsequent Assessment Year (i) section 32, section 35 and clause (ix) of sub-section (1) of section 36 shall apply as if deduction referred to therein and relating to or allowable for any of the relevant Assessment Years, in relation to any building, machinery, plant or furniture used for the purposes of the business of the industrial undertaking in the Previous Year relevant to such Assessment Year or any expenditure incurred for the purposes of such business in such Previous Year had been given full effect to for that Assessment Year itself and, accordingly, sub-section (2) of section 32, sub-section (4) of section 35 or the second proviso to clause (ix) of sub-section (1) of section 36, as the case may be, shall not apply in relation to any such deduction;

(ii) no loss referred to in sub-section (1) of section 72 or sub-section (1) or sub-section (3) of section 74, in so far as such loss relates to the business of the industrial undertaking, shall be carried forward or set off where such loss relates to any of the relevant Assessment Years; (iii) no deduction shall be allowed under section 80HH or section 80HHA or section 80-I or section 80-IA or section 80-IB or section 80JJA in relation to the profits and gains of the industrial undertakings; and (iv) in computing the depreciation allowance under section 32, the written down value of any asset used for the purposes of the business of the industrial undertaking shall be computed as if the

DIRECT TAXATION I 12.37

Incomes Which do not form Part of Total Income assessee had claimed and been actually allowed the deduction in respect of depreciation for each of the relevant Assessment Years. (5) The provisions of sub-section (8) and sub-section (10) of section 80-IA shall, so far as may be, apply in relation to the industrial undertaking referred to in this section as they apply for the purposes of the industrial undertaking referred to in section 80-IA or section 80-IB, as the case may be. (6) Notwithstanding anything contained in the foregoing provisions of this section, where the assessee before the due date for furnishing the return of his income under sub-section (1) of section 139, furnishes to the Assessing Officer a declaration in writing that the provisions of this section may not be made applicable to him, the provisions of this section shall not apply to him in any of the relevant Assessment Years. Provided that no deduction under this section shall be allowed to any undertaking for the Assessment Year beginning on the 1st day of April,2004 and subsequent years. 12.2.6 Income of Trusts or Institutions from contributions [Sec. 12] (1) Any voluntary contributions received by a trust created wholly for charitable or religious purposes or by an institution established wholly for such purposes (not being contributions made with a specific direction that they shall form part of the corpus of the trust or institution) shall for the purposes of section 11 be deemed to be income derived from property held under trust wholly for charitable or religious purposes and the provisions of that section and section 13 shall apply accordingly. (2) The value of any services, being medical or educational services, made available by any charitable or religious trust running a hospital or medical institution or an educational institution, to any person referred to in clause (a) or clause (b) or clause (c) or clause (cc) or clause (d) of sub-section (3) of section 13, shall be deemed to be income of such trust or institution derived from property held under trust wholly for charitable or religious purposes during the Previous Year in which such services are so provided and shall be chargeable to Income-tax notwithstanding the provisions of sub-section (1) of section 11. (3) Notwithstanding anything contained in section 11, any amount of donation received by the trust or institution in terms of clause (d) of sub-section (2) of section 80G in respect of which accounts of income and expenditure have not been rendered to the authority prescribed under clause (v) of sub-section (5C) of that section, in the manner specified in that clause, or which has been utilised for purposes other than providing relief to the victims of earthquake in Gujarat or which remains unutilised in terms of sub-section (5C) of section 80G and not transferred to the Prime Ministers National Relief Fund on or before the 31st day of March, 2004 shall be deemed to be the income of the Previous Year and shall accordingly be charged to tax. Case Law: Specific directive to apply for charitable/religious purposes is necessary - The most relevant condition is that the contributions are applicable solely to charitable or religious purposes. It is implied that there has to be a specific directive for applying the donations solely for charitable or religious purposes - R.B. Shreeram Religious & Charitable Trust vs. CIT 172 ITR 373. 12.2.7 Incomes of Political Parties [Section 13A] Any income of a political party which is chargeable under the head Income from House Property or Income from Other Souces or Capital Gains or any income by way of voluntary contributions received by a political party from any person shall not be included in the total income of the Previous Year of such political party subject to the following conditions: 1. 2. The political party keeps and maintains such books of account and other documents as would enable the Assessing Officer to properly deduced its income from there. The political party keeps and maintains a record of each voluntary contribution in excess of ` 20,000 and of the names and addresses of the persons who have made such contribution.

12.38 I DIRECT TAXATION

3. 4.

The accounts of the political party are audited by an accountant as defined in the Explanation to sub-section 2 of section 288. The treasurer of such political party or any other person authorized by the political party in this behalf shall in each financial year prepares a report in respect of contribution received by the political party in excess of `20,000 from any person or company in that year and submit it, before the due date of submission of return of income, to the Election Commission.

12.2.8 Voluntary contribution received by Electoral Trust [Section 13B] Any voluntary contribution received by an electoral trust shall not be included in the total income of the Previous Year of such electoral trust if (i) such electoral trust distributes to any political party, registered under section 29A of the Representation of the People Act, 1951 (43 of 1951), during the said Previous Year, 95 percent of the aggregate donations received by it during the said Previous Year along with the surplus, if any, brought forward from any earlier Previous Year; and (ii) such electoral trust functions in accordance with the rules made by the Central Government. 12.3 EXPENDITURE INCURRED IN RELATION TO INCOME NOT INCLUDED IN TOTAL INCOME [SEC. 14A] 1. In computation of Total Income under the Income Tax Act, the expenditure incurred in relation to income, which does not form part of Total Income, will not be allowed as deduction. 2. Power of AO to determine expenditure [w.e.f. A.Y.2007-08]: Having regard to the accounts of the assessee, if the Assessing Officer is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to exempt income, Assessing Officer shall determine the amount of expenditure incurred in relation to such exempt income in accordance with method prescribed in Rule 8D. 3. Prescribed Method (Rule 8D): Expenditure will be the aggregate of (a) Amount of expenditure directly relating to income which does not form part of Total Income. (b) If interest expenditure is not directly attributable to any particular income or receipt, then B interest disallowed = A x C where, A= Amount of Interest B= Average of the Value of Investment, income from which is exempt. [Average of Opening and Closing Balance as appearing in the Balance Sheet of the Assessee for the Previous Year] C=Average of the Total Assets appearing in the Balance Sheet of the Assessee of the first and last day of the Previous Year. (c) 0.5% of the Average Value of Investment income from which is exempt. Note: Total Assets means Total Assets as appearing in the Balance Sheet excluding the increase on account of revaluation of assets, but including the decrease on account of revaluation of assets. Case Laws: (i) Where it is found that for earning exempted income no expenditure has been incurred, disallowance under Section 14A cannot stand - CIT vs. Hero Cycles Ltd, November 4, 2009 (P&H) (ii) Condition precedent for disallowance of expenditure in relation to exempt income is proximate cause between expenditure and exempt income. Where purchase of securities cum-dividend is sold at a loss, the claim to set off of loss is permissible. The loss is not an expenditure relating to dividend - CIT vs. Walfort Share and Stock Brokers Private Ltd 326 ITR 1 (SC) (iii) In the absence of any material or basis to hold that interest expenditure directly or indirectly was attributable for earning dividend income, Interest expenditure could not be disallowed u/s 14A CIT Vs K Raheja Corporation P Limited (2011) (Bom)

DIRECT TAXATION I 12.39

Incomes Which do not form Part of Total Income

ILLUSTRATIONS ON INCOME EXEMPT FROM TAX

Illustration 1. H Bros., an HUF, started an undertaking in Special Economic Zone during the Previous Year 2007-2008. From the following particulars relating to the Previous Year 2012-2013, compute the Total Income for the Assessment Year 2013-2014: ` (in lakh) (i) Total Turnover (ii) Export Sales (iii) Business Profits (iv) Receipt of convertible foreign exchange in India up to 30th September 2013 (v) Convertible foreign exchange kept outside India with the permission of RBI for importing a new machinery (vi) Receipt of convertible foreign exchange in December 2013 (vii) Convertible foreign exchange received for reimbursement for freight,insurance attributable to export Solution : Computation of Total Income ` (in lakhs) Business Profits Less : Deduction for Export Profits : 15 [ Sec. 10AA] Total Income Note : 1. 2. 3. Convertible foreign exchange received in December, 2013 has not been included in Export turnover, because it is received after the prescribed time limit without approval of the competent authority. Convertible foreign exchange kept outside India with the permission of RBI is included in Export turnover. Reimbursement of freight and insurance in convertible foreign exchange is not included in Export turnover. 15 10 5 30 25 15 16 4 3 2

Illustration 2. The books of account maintained by a National Political Party registered under the Representation of the People Act, 1951 for the year ended on 31-3-2013 disclose the following receipts: (a) Rent of property let out to a departmental store at Chennai (b) Interest on deposits other than banks (c) Contribution from 100 persons (who have secreted their names) of ` 33,000 each (d) Contribution @ ` 22 each from 1,00,000 members in cash (e) Net Profit of cafeteria run in the premises at Delhi 22,00,000 3,00,000 10,00,000 2,00,000 33,00,000

Compute the total income of the political party for the Assessment Year 2013-2014, with reason for inclusion or otherwise. Solution : Computation of income of National Political Party: AY 2013-2014

12.40 I DIRECT TAXATION

Particulars

` 3,00,000 33,00,000 36,00,000

(a) Rent from property: Exempt under Sec. 13A (b) Income from BusinessProfits of cafeteria (c) Income Other Sources: (i) Interest on deposit other than banks: Exempt under Sec. 13A (ii) Contributions from 100 persons exceeding ` 22,000 each (See Note below) (iii) Contributions from 1,00,000 members: Exempt Sec. 13A. Total Income

Note: Any income of a political party received by way of voluntary contributions is exempt, provided: (i) it keeps and maintains such books of account and other documents as would enable the Assessing Officer to properly deduce its income there from; (ii) it keeps and maintains a record, name and address of the person who has contributed in excess of ` 20,000; and (iii) its accounts are audited by an accountant defined in Explanation to Sec. 288(2). Thus, in order to claim exemption in respect of voluntary contributions exceeding ` 20,000, a political party is required to keep and maintain a record, and names, addresses of persons who have made such contributions. The legislative intention is to ensure that there is transparency in the process of collection of funds [Common Cause vs. Vol. 222 ITR 260 (SC)]. Hence, no exemption can be allowed in respect of contributions exceeding ` 20,000 from persons who have secreted their names. Illustration 3. A company is engaged in the development and sale of computer software applications. It has started a new undertaking in SEZ. It furnishes the following data and requests you to compute the deduction allowable to it under Sec. 10AA is respect of Assessment Year 2013-2014. Particulars Total Profit of the Company for the Previous Year Total Turnover, i.e. Export sales and Domestic sales for the Previous Year Consideration received in respect of export of software received in convertible foreign exchange within 6 months of the end of the Previous Year Sale proceeds credited to a separate account in a bank outside India with the approval of RBI Telecom and insurance charges attributable to export of software Staff costs and travel expenses incurred in foreign exchange to provide technical assistance outside India to a client Solution: Computation of Income of an Undertaking in SEZ: AY 2013-2014 Total Profit Less: Deduction under Sec. 10AA: Total Profit Taxable Profits Particulars Export Turnover Total Turnover 250 500 ` (in lakh) 50 = 50 x 25 25 ` (in lakh) 50 500 250 50 10 40

DIRECT TAXATION I 12.41

Incomes Which do not form Part of Total Income Note : Export Turnover (i) Sale proceeds of software received in convertible foreign exchange within the prescribed period (ii) Sale proceed in convertible foreign exchange kept outside India with the approval of RBI Less: (i)Telecom and insurance charges attributable to Export Turnover (ii)Expenses incurred in foreign exchange outside India to provide (-) 40 250 technical assistance to a client there Export Turnover 50 (-) 10 250 (` in lakh)

300

Illustration 4. XY & Co., a partnership concern had established an undertaking for manufacturing computer software in Special Economic Zone. It furnishes the following particulars of its second year operations, ending on 31-03-2013: Particulars Total Sales of business Export Sales Profit of the business ` (in lakh) 100.00 80.00 10.00

Out of the total export sales, realisation of sale of ` 5 lakh is difficult because of the deficiency of the buyer. Realisation of rest of the sales is received in time. The plant and machinery used in the business had been depreciated @ 15% on SLM basis of depreciation and depreciation of ` 3 lakh was charged to the Profit and Loss Account. Compute the taxable income of XY & Co for the Assessment Year 2013-2014. Solution: Particulars Profit of business Add : Depreciation charged on SLM basis Less : Depreciation on WDV basis @ 15% of 17,00,000 [See Note below] Computation of Taxable Income for the A.Y. 2013-14 ` (in lakh) 10,00,000 3,00,000 13,00,000 2,55,000 10,45,000 7,83,750 2,61,250

Less : Deduction under Sec. 10AA : 10,45,000 75 100 Taxable Income

12.42 I DIRECT TAXATION

Note : 1. Computation of Depreciation: Total purchase price of machine : [3,00,000 15] 100 Less: Depreciation in the first year @ 15% WDV at the end of first year Less: Depreciation for second year @ 15% 20,00,000 3,00,000 17,00,000 2,55,000 14,45,000 80,00,000 5,00,000 75,00,000 `

WDV at the end of second year 2. Export Turnover: Export Sales Less: Remittance not received due to insolvency of buyer

Illustration 5: Mr. Anurag is a Cost Accountant in practice. The Income & Expenditure Account for the year ending March 31, 2013 read as follows: Income & Expenditure Dr. Expenses To, Employees cost To, Travelling & Conveyance To, Administration & Office exp. To, Interest To, Demat charges To, Excess of Income over Expenditure [Profit] ` Income ` 16,00,000 2,00,000 1,00,000 Cr.

1,50,000 By, Professional earnings 50,000 By, Dividend income 4,00,000 from shares 1,50,000 from equity oriented mutual funds 10,000 11,40,000 19,00,000 Total

Total

19,00,000

Other Information: (a) Entire Dividend income is claimed as exempt from taxation by virtue of Section 10(34) and 10(35). (b) Anurag claims that no expenditure has been incurred against the dividend income, which is claimed as exempt from tax. (c) The value of investment in shares as on the first day and the last day of the Previous Year is ` 7,50,000 and ` 9,00,000 respectively. (d) The value of investment in units of Mutual Funds as on the first day and the last day of the Previous Year is ` 5,00,000 and 2,00,000 respectively. (e) All expenditure including interest expenditure of ` 1,50,000 incurred by Anurag are relating to taxable and non Taxable Income. Demat charges are directly attributable to exempt income. (f) The value of the total assets as appearing in the Balance sheet of the assessee as on the first day and last day of the Previous Year is ` 60,00,000 and ` 80,00,000 respectively. You are required to compute the Taxable Income of Anurag for the Assessment Year 2013-14.

DIRECT TAXATION I 12.43

Incomes Which do not form Part of Total Income Solution: Computation of Taxable Income A.Y. 2013-14 Particulars Income from Profits & Gains of Business or Profession as per Working Note 1 as per Working Note 2 Total 8,40,000 Nil 8,40,000 41,054 7,98,946 ` Net profit as per Income & Expenditure Account Less: Income considered under other heads Dividend Income from shares Income from UTI Taxable Income from Profession 2,00,000 1,00,000 3,00,000 8,40,000 ` 11,40,000 Income from Other Sources `

Add: Disallowance u/s 14A as per Working Note 3 Taxable Income

Working Note 1 Profits & Gains of Business or Profession

Working Note 2 Income from other sources ` 1. 2. Dividend Income from Shares Less: Exemt under sec 10(34) Income from units in Mutual funds Less: Exempt under sec 10(35) Taxable Income from Other Sources 2,00,000 2,00,000 1,00,000 1,00,000 Nil Nil Nil `

Working Note 3 Disallowance u/s 14A ` (a)Amount of expenditure directly relating to exempt income (Other than interest) Demat charges (b)Amount of interest incurred by way of expenditure other than those included above (1,50,00011,75,000/70,00,000) (c)Amount equal to 0.5% of the average value of Investments (11,75,0000.5%) Total amount disallowed u/s 14A (a) + (b) + (c) Note: 1. Average value of Investment = [(7,50,000 + 9,00,000) / 2] + [(5,00,000 + 2,00,000)/2] = ` 11,75,000 2. Average value of Total Assets = (60,00,000 + 80,00,000) / 2 = ` 70,00,000. 10,000 25,179 5,875 41,054

12.44 I DIRECT TAXATION

Study Note - 13
AGRICULTURAL INCOME AND AGGREGATION OF INCOMES
This Study Note includes 13.1 Agricultural Income and Tax Liability 13.1 AGRICULTURAL INCOME AND TAX LIABILITY Article 270 of the Constitution of India empowers Government of India to collect tax on income other than agricultural income. Agricultural income has been placed in the State list and as such the Central Government cannot levy tax on agricultural income. Sec. 2(1A) provides definition of the term. Agricultural Income means (a) any rent or revenue derived from land which is situated in India and is used for agricultural purposes. (b) any income derived from such land by (i) agriculture; or (ii) the performance by a cultivator or receiver of rent-in-kind of any process ordinarily employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by him fit to be taken to market; or (iii) the sale by a cultivator or receiver of rent in kind of the produce raised or received by him, in respect of which no process has been raised or received by him, in respect of which no process has been performed other than a process of the nature described in para (ii) of the sub-clause:

(c) any income derived from any building owned and occupied by the receiver of rent or revenue of any such land provided the following conditions are satisfied (i) the building should be on or in the immediate vicinity of land and is used for agricultural purposes; (ii) the cultivator or receiver of rent-in-kind uses the building as a dwelling house or a store house; and (iii) the land is assessed to land revenue or local rate or the land is not not situated within the jurisdiction of municipality/cantonment having a population of not less than 10,000 persons or within distance of not more than 8 k.m. It may be pointed out that sec.10(1) exempts, from Income-tax, Agricultural Income covered by the aforesaid definition. However, in case of certain category of assessees e.g. individuals, HUFs, having income more than maximum amount not liable for tax, Agricultural Income is taken into consideration to determine tax on non-agricultural income. Case Laws: Essential Conditions: Agriculture not involving any basic operation like tilling, sowing or dissemination of seeds and planting on land would not constitute agriculture merely because they have relation or connection with land. Term agriculture does not include breeding and rearing of live stock, dairy farming, butter, cheese making, poultry, etc.- CIT vs. Raja Benoy Kumar Sahas Roy 32 ITR 466 (SC).

DIRECT TAXATION I 13.1

Agricultural Income and Aggregation of Incomes Agricultural Income: Where the owner himself performs slaughter tapping and then sells the rubber, the income is agricultural income. Jacob(K.C.) vs. Ag. ITO 110 ITR 402. Lease rent received for leasing out land for grazing of cattle required for agricultural pursuits, is agricultural income. CIT vs. Rai Shamsherjang Bahadur 24 ITR 1. Compensation received from an insurance company on account of damaged caused to the crop is an agricultural income.- CIT vs. B. Gupta Tea Pvt. Ltd. 74 ITR 337. Seeds are clearly a product of agriculture and the income derived from the sale of seeds derived on account of cultivation by the assessee is an agricultural income.- CIT vs. Soundharya Nursury 241 ITR 530. Income from nursery operation is an agricultural income. Miscellaneous income from plantation: Miscellaneous income from plantation should also be agricultural income except in respect of sale of trees of spontaneous growth. Thus, where a state had received income by sale of firewood, grazing permits and compounding fee for trespasses into the plantation, the same shall be treated as agricultural income.-CIT v Tamil Nadu Forest Plantation Corporation 248 ITR 331. Income from sale of trees replanted in denuded part of forest is an agricultural income. Salary, share of profit and interest on capital received by partner from a firm engaged in agricultural operation is an agricultural income. Income derived by growing special quality of grass required for creating golf course is an agricultural income. Non-agricultural Income: Dividend received from company having only agricultural income is not agricultural income for a shareholder-CIT vs. Mrs. Bacha F. Guzdar 27 ITR 1 (SC). Conversion of sugarcane into Gur-No Agriculture income - Seth Banarasi Dass Gupta vs. CIT. 106 ITR 804. Income from agricultural lands situated outside India is not agricultural income within the meaning of the Indian Income-tax. Similarly if there is a figure of loss from agricultural lands, situated outside India, it has got to be deducted while computing the total income of the resident assessee in India - CIT vs. Carew & Co. Ltd. 120 ITR 540. Compensation for acquisition of land - Where land of assessee-tea company was requisitioned by State Government and same was given to refugees who carried on cultivation thereon and at time of requisition assessee too was carrying on agricultural operations on land, compensation received by assessee was to be treated as agricultural income - CIT vs. All India Tea & Trading Co. Ltd. 85 Taxman 391/219 ITR 544. Following are certain instances defining the scope of agricultural income. Rent or revenue should be derived from land: Any loan obtained by a shareholder out of accumulated profits of the company having only agricultural income, which is liable to be treated as deemed dividend, is not agricultural income in the hands of recipient. Interest on arrears of cess or rent payable by a tenant to his landlord is no doubt revenue but it is not revenue derived from land and hence it is not agricultural income. Commission earned by a broker for selling agricultural produce of an agriculturist is not agricultural income.

13.2 I DIRECT TAXATION

 Any capital gain arising from the transfer of agricultural land is not treated as revenue derived from land and hence it is not agricultural income. Income held as not derived from land: Mutation fees paid by tenant on succession to a holding by inheritance. Fees paid by tenants for renewal of leases and fees paid for recognising the distribution of holding on partition would not be income derived from land, since there are payments made for administrative services rendered by the landlord, akin to registration fees. Receipts from the supply of water tank in an agricultural land Use of building or land for agricultural purpose: Any income arising from the use of land or building for any purpose (including letting for residential purpose or for the purpose of any business or profession) other than agriculture shall not be agricultural income. Any income attributable to farm house situated in urban areas will not be treated as agricultural income unless the land on which the farm house is situated is assessed to land revenue or any local rate. On the other hand, in case of farm house situated in rural areas, the income will be treated as agricultural income even where the land on which farm house is situated is not assessed to land revenue or any local rate. Other cases: Any income arising from Stone Quarries is not an agricultural income. Any income from sale of salt produced by flooding of land with sea water is not an agricultural income. Remuneration of fixed percentage of Net Profit received by Managing Agent from a company earning agricultural income is not an agricultural income. Interest received by a money lender in the form of agricultural product is not an agricultural income. Income from business of growing mulberry leaves and feeding them to silk worms and obtaining silk cocoons is not a agricultural income. Agriculture Income and Income-tax [Section 10(1)]: Agricultural Income (i) Section 10(1) provides that agricultural income is not to be included in the total income of the assessee. The reason for totally exempting agricultural income from the scope of central income tax is that under the Constitution, the Parliament has no power to levy a tax on agricultural income.

(ii) Indirect way of taxing agricultural income - However, since 1973, a method has been found out to levy tax on agricultural income in an indirect way. This concept is known as partial integration of taxes. It is applicable to individuals, HUF, unregistered firms, AOP, BOI and artificial persons. Two conditions which need to be satisfied for partial integration are: 1. 2. The net agricultural income should exceed `5,000 for the year and Non-agricultural income should exceed the maximum amount not chargeable to tax. (e. g. ` 2,50,000 for senior citizens aged 60 years or not more but below 80 years, ` 5,00,000 for senior citizens above 80 years of age, ` 2,00,000 for all other individuals and HUFs.)

It may be noted that aggregation provisions do not apply to company, firm assessed as such (FAS), co-operative society and local authority. The object of aggregating the net agricultural income with non-agricultural income is to tax the non-agricultural income at higher rates.

DIRECT TAXATION I 13.3

Agricultural Income and Aggregation of Incomes Tax calculation in such cases is as follows: Step 1: Step 2: Add non-agricultural income with net agricultural income. Compute tax on the aggregate amount. Add net agricultural income and the maximum exemption limit available to the assessee (e.g. ` 2,00,000/ ` 2,50,000 / ` 5,00,000, etc. as applicable). Compute tax on the aggregate amount. Deduct the amount of income tax calculated in step 2 from the income tax calculated in step 1 i.e. Step 1 Step 2. Deduct any applicable rebate from the amount of tax obtained in step 3. Add surcharge, if applicable, to the amount obtained in step 4 above. The sum so arrived at shall be increased by education and higher secondary cess.

Step 3: Step 4: Step 5: Step 6:

These steps are applicable whenever tax liability is to be worked out e.g. self-assessment tax, advance tax, tax on regular assessment.

13.4 I DIRECT TAXATION

ILLUSTRATIONS ON AGRICULTURAL INCOME AND TAX LIABILITY

Illustration 1. Mr. X furnishes the return of income for the financial year 2012-2013. His total income (nonagricultural) is `12,10,000 and net agricultural income is ` 1,90,000. Compute the amount of tax payable by Mr. X for the Assessment Year 2013-2014. Solution : Computation of tax for the Assessment Year 2013-2014 (a) Income tax on the aggregate of non-agricultural income and net agricultural income (i.e. ` 14,00,000) as if it is the total income. On the first On the next On the next On the balance 2,00,000 3,00,000 5,00,000 4,00,000 14,00,000 Nil 10% 20% 30% Nil 30,000 1,00,000 1,20,000 2,50,000

(b) Income tax on net agricultural income plus the basic exemption limit i.e. ` 2,00,000 (i.e. ` 3,90,000) as if it is the total income. On the first On the next 2,00,000 1,90,000 3,90,000 Net Income Tax: (a) (b) = ` 2,50,000 19,000= Add: (i) Education cess @ 2% (ii) SHEC @ 1% Tax Payable Nil 10% Nil 19,000 19,000 2,31,000 4,620 2,310 2,37,930

Illustration 2. Mr. Gangaprasad, resident in India, turns out 60 years of age on 31st December 2012. He furnishes the following particulars of his income for the Previous Year 2012-2013: Particulars (i) Rent from agriculture land, located in a village of Jharkhand district (ii) Rent from building, located in the vicinity of agriculture land, which is assessed to land to revenue and the tenant, cultivating the agricultural land, occupies it for his dwelling and storing purposes (iii) Income from business (iv) Long-term Capital Gain ` 2,50,000 60,000 3,00,000 1,00,000

He maintains a motor car which is used 70% for business purpose, 10% for collecting rent from building and 20% for collecting rent from agriculture land. He has incurred an expenditure of `1,00,000 by way of petrol, repair and salary of the driver. He also claims depreciation on the written down value of the motor car on 1.4.2012, ` 2,00,000 @ 15%. He has paid ` 2000 as local tax to the village panchayat in respect of the building. He also paid ` 30,000 land revenue to the Government on account of agriculture land. Determine his total income and tax liability in the following cases: (i) Agriculture produce goes under marketing process to fetch better rates in the market, (ii) Agriculture produce goes under marketing process to make it saleable in the local market.

DIRECT TAXATION I 13.5

Agricultural Income and Aggregation of Incomes Solution : Computation of Total Income for the Assessment Year 2013-2014 (i) Income from House Property: Gross annual value based on rent Less : Local tax to village panchayat: No deduction is allowed as it is not a municipal tax Net Annual Value (NAV) Less: Statutory deduction @ 30% of NAV Income from House Property Income from house property to be treated as agriculture income provided the agriculture produce is not subjected to marketing produce to fetch better rates [Sec. 2(1A)(c)] (ii) Income from Business (iii) Long-term Capital Gain (iv) Income from other sources : Rent from agriculture land Less: Permissible deduction (Sec. 57) : (a) Land revenue (b) Realisation expenses (c) Depreciation: Not admissible Sec. 57(ii) (see Note below) Income from agriculture [Sec. 2(1A)(a)] Total income, subject to increase by ` 42,000 when produce is subjected to marketing process to fetch better rates.

60,000 Nil 60,000 18,000

42,000

3,00,000 1,00,000 2,50,000 (-) 30,000 (-) 20,000 Nil 2,00,000 4,42,000

13.6 I DIRECT TAXATION

Computation of Tax Liability: AY. 2013-2014 Particulars

Non-agriculture income Agriculture income Total Income (a) Tax on non-agriculture income + agriculture income as if it is the total income: (i) Tax on long-term capital gain @20% (ii) Tax on balance of total income at slab rates [i.e. ` 6,42,000 ` 1,00,000] Gross Tax Liability (i) + (ii) (b) Tax on agriculture income + basic exemption limit [ i.e. ` 2,50,000] (c) Tax payable: (a) (b) Add: Education cess @ 2% SHEC @ 1% Tax Payable Tax payable to be rounded off to the nearest multiple of ` 10 (Sec. 288B) Note :

Senior citizen Case I Case II Produce Produce subjected to subjected to marketing marketing process for process to make it better rates saleable ` ` 4,42,000 4,00,000 2,00,000 2,42,000 6,42,000 6,42,000 20,000 33,400 53,400 20,000 33,400 668 334 34,402 34,400 20,000 33,400 53,400 24,200 29,300 584 292 30,076 30,080

While computing income under other sources depreciation is allowed only in case where plant, machinery or furniture is let out on hire or building along with plant, machinery or furniture is let out on hire [Sec. 57(ii)] Hence no depreciation is allowed in respect of motor car. Proportionate depreciation on motor car is permissible under the head business or profession. It is assumed it has been allowed as the expression income from business refers to taxable income after permissible deductions. Illustration 3. RP (HUF), furnishes the following particulars of its income and outgoing for the Previous Year 2012-2013. Receipts : (i) (ii) (iii) (iv) Short-term Capital Gain Gross winning from lottery Sale consideration of 3/4th of agriculture produce, derived from land located in India, the balance produce has been kept for family use. Net sale proceeds of wild grass and fruits from trees of spontaneous growth 4,00,000 1,00,000 12,00,000 50,000

DIRECT TAXATION I 13.7

Agricultural Income and Aggregation of Incomes Payments: (i) (ii) (iii) (iv) (v) Repair of tube-well WDV of tuble-well on 1-4-2012 Wages paid to agriculture labour Manuring and spraying charges Rent of the building, used for storing agriculture produce on site Petrol, repair, salary of driver and insurance of motor car. WDV of motor car on 1-4-2012 50% use of the motor car is for personal purpose of the family (vi) LIP paid to insure members of the family School fees paid for 3 children of the family @ ` 15,000 per child Purchase of infrastructure bonds Deposit with LIC for maintenance of a dependant member with disability Unabsorbed losses brought forward: AY: 2003-2004 AY: 2005-2006 AY: 2008-2009 20,000 45,000 90,000 (vii) (viii) (ix) 60,000 10,00,000 6,00,000 50,000 50,000 1,50,000 2,00,000

40,000 1,00,000 45,000

Determine the Total Income of the HUF and its tax liability for the Assessment Year 2013-2014. Solution: Assessee : R P (HUF) Computation of Total Income: AY 2013-2014 Particulars ` ` Computation of net agriculture income for the purpose of aggregation to determine the rate of tax applicable to non-agriculture income of the HUF. Such computation is done under the head business profession: (1)Sale proceeds of agriculture produce Add: Market value of produce kept for family use: 12,00,000 (4/3) (1/4) Less: Permissible deductions: (i) Repair of tube-well (ii) Wages (iii) Rent (iv) Petrol, repair, salary of driver 50% (v) Manuring and spraying

12,00,000 4,00,000 16,00,000 60,000 6,00,000 50,000 75,000 50,000

13.8 I DIRECT TAXATION

(vi) Depreciation on tube-well @ 10% on WDV (vii) 50% depreciation on motor car: (15% of 2,00,000) 50% Less: Adjustment for Carry Forward Losses: (i) Loss 2003-2004-not allowed (ii) Loss from AY 2005-2006 (iii) Loss from AY 2008-2009 Net Agriculture Income (2)Computation of Total Income (a) Short-term Capital Gain (b) Income from Other Sources: (i) Winnings from lottery (ii) Net sale proceeds of non-agriculture produce Gross Total Income (excluding Agricultural Income) Less 1: Contributions paid for approved savings [Sec. 80C(2)]: (i) LIP on the life of members (ii) School fees for 3 children of the HUF [Sec. 80C(4)(c)] But deduction restricted upto a maximum of `1,00,000 2. Deposit for maintenance (including medical treatment) of a dependant with disability (Sec. 80DD) Total Non-Agricultural Income Computation of Tax Liability (i) Income tax on winnings 30% on ` 1,00,000 (ii) Income tax on non-agriculture + agriculture income: 3,80,000 + 5,05,000 at slab rates (Non-agricultural income = 3,80,000 = 5,50,000 1,00,000 20,000 50,000) (a) Income tax on 8,85,000 as if it is the total income (b) Income tax on agriculture income + exemption limit as if it is the Total Income: 5,05,000 + 2,00,000 = 7,05,000 Income tax on non-agriculture income: (a) (b) Tax on Total Income Add: (i) Education cess @ 2% (ii) SHEC @ 1% Tax Payable 1,07,000 71,000 36,000 66,000 1,320 660 67,980 20,000 Nil 20,000 20,000 50,000 4,80,000 30,000 1,00,000 50,000 1,00,000 15,000 Nil 1,00,000 45,000

9,50,000

1,45,000 5,05,000 4,00,000 1,50,000 5,50,000

Note : Deduction u/s 80CCF in respect of purchase of infrastructure bond is discontinued from the AY 2013-14.

DIRECT TAXATION I 13.9

Agricultural Income and Aggregation of Incomes Illustration 4. B Ltd. grows sugarcane to manufacture sugar. The data for the financial year 2012-13 is as follows : Cost of cultivation of sugarcane Market value of sugarcane when transferred to factory Other manufacturing cost Sales of sugar Salary of Managing Director who looks after all operations of the Company Determine its Business Income and Agricultural Income. Solution : (1) Business Income: Sales of Sugar Other manufacturing cost Salary of Managing Director Market value of sugarcane when transferred to factory ` 25,00,000 ` 10,00,000 ` 6,00,000 ` 3,00,000 ` 6,00,000 ` 10,00,000 ` 6,00,000 ` 4,00,000 Less: Market value of sugarcane when transferred to factory ` 6,00,000 ` 10,00,000 ` 6,00,000 ` 25,00,000 ` 3,00,000

(2) Agricultural Income: Less: Cost of cultivation

Illustration 5. Mr. P has estates in Rubber, Tea and Coffee. He has also a nursery wherein he grows plants and sells. For the Previous Year ending 31.3.2013, he furnishes the following particulars of his sources of income from estates and sale of Plants. You are requested to compute the taxable income for the Assessment Year 2013-2014: Manufacture of Rubber Manufacture of Coffee grown and cured Manufacture of Tea Sale of Plants from Nursery Solution: Computation of Taxable Income for the Assessment Year 2013-14 Rule 7A 7B 8 Nature of Business Sale of centrifuged latex or cenex manufactured from rubber [65% is Agricultural Income] Sale of grown and cured coffee by seller in India [ 75% is Agricultural Income] Growing and Manufacturing Tea [60% is Agricultural Income] Sale of plants from nursery Total Agl Inc. 3,25,000 2,62,500 4,20,000 1,00,000 11,07,500 Non-Agl. Inc. 1,75,000 87,500 2,80,000 5,42,500 ` 5,00,000 ` 3,50,000 ` 7,00,000 ` 1,00,000

13.10 I DIRECT TAXATION

Computation of Tax Liability : (a) Total Income (Agricultural Income + Non-agricultural Income) (b) Tax on (a) above (c) Total of (Agricultural Income + Basic Exemption Limit) (d) Tax on (c ) above (e) Tax Payable (b) (d) Add: Education Cess @ 2% Add: SHEC @ 1% Total Tax Liability Tax payable rounded off u/s 288B ` 16,50,000 3,25,000 13,07,500 2,22,250 1,02,750 2,055 1,028 1,05,833 1,05,830

DIRECT TAXATION I 13.11

Study Note - 14
MINIMUM ALTERNATE TAX (MAT) AND ALTERNATE MINIMUM TAX (AMT)
This Study Note includes 14.1 Minimum Alternate Tax 14.2 Alternate Minimum Tax 14.1 MINIMUM ALTERNATE TAX (MAT) [SEC.115JB] 1. Section 115JB provides that, in the case of a company, if the tax payable on the total income as computed under the Income-tax Act in respect of any Previous Year is less than 18.5 per cent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable for the relevant Previous Year shall be 18.5% of such book profit. The Profit and Loss Account should be prepared in accordance with Parts II and III of Schedule VI of the Companies Act, 1956.

2.

The Accounting Policies and the Accounting Standards adopted for preparing such accounts and the method and rates adopted for calculating the depreciation, shall be the same as have been adopted for the purpose of preparing such accounts and laid before the company at its AGM. Book Profit means the net profit as shown in the Profit and Loss Account, as increased by (a) the amount of income-tax paid or payable, and the provision therefore; or (b) the amounts carried to any reserves, by whatever name called other than a reserve specified under section 33AC; or (c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or (d) the amount by way of provision for losses of subsidiary companies; or (e) the amount or amounts of dividends paid or proposed; or (f) the amount or amounts of expenditure relatable to any income to which section 10 [other than the provisions contained in section 10(38) ] or section 11 or section 12 apply; (g) the amount of depreciation; (h) the amount of deferred tax and the provision created therefore and any amount set aside as provision for diminution in the value of any asset. If any amount referred to in clauses (a) to (h) is debited to the profit and loss account, and as reduced by (i) The amount withdrawn from any reserve or provision, if any such amount is credited to the Profit and Loss Account subject to the proviso stated in the section; or

(ii) Incomes exempt under any of the provisions of section 10 other than the provisions contained in section 10(38) [LTCG on transfer of securities subject to STT] or section 11 or section 12 [Charitable or religious Trusts income], if any such income is credited to the Profit and Loss Account; or (iii) The amount of depreciation debited to Profit and Loss Account excluding the depreciation on account of revaluation of assets; or (iv) The amount withdrawn from revaluation reserve and credited to Profit and Loss Account, to the extent

DIRECT TAXATION I 14.1

Minimum Alternate Tax (Mat) and Alternate Minimum Tax (AMT) it does not exceed the amount of depreciation on account of revaluation of assets; or (v) The amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account. However, for the purpose of this clause (a) the loss shall not include depreciation; (b) the provisions of this clause shall not apply if the amount of loss brought forward or unabsorbed depreciation is nil; or

(vi) The amount of profits of sick industrial company during the years in which such company has become sick industrial company under the provisions of Sick Industrial Companies (Special Provision) Act,1985. (vii) The amount of deferred tax, if any such amount is credited to the Profit and Loss Account. 3. 4. 5. Provisions shall not affect carried forward of depreciation and losses under the applicable provisions mentioned in sub-section (3) of section 115JB. Profits of an Entrepreneur in SEZ or Developer of SEZ are not liable for MAT. Tax paid under section 115JB for A.Y. 2012-13 and any subsequent year would be allowed as a credit from the normal tax payable for any subsequent year in accordance with the provisions contained in section 115JAA. However, the amount of tax credit cannot be carried forward for set off beyond the tenth Assessment Year immediately succeeding the Assessment Year in which tax credit becomes allowable. A report in prescribed form (Form No. 29B as per Rule 40B) from an accountant as defined in the section 288 shall be furnished along with the return of income. All companies are liable for payment of advance tax having regard to the provisions contained in new section 115JB. Consequently, the provisions of sections 234B and 234C for interest on defaults in payment of advance tax and deferment of advance tax would also be applicable where facts of the case warrant. - Circular : No. 13/2001, dated 9-11-2001.

6. 7.

Sunset provisions inserted regarding exemption from Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT) in case of Special Economic Zones [Sections 115JB(6), 115-O(6) read with section 10AA & 80-IAB] Under the existing provisions of section 10AA of the Income-tax Act, a deduction of 100% is allowed in respect of profits and gains derived by a unit located in a Special Economic Zone (SEZ) from the export of articles or things or services for the first five consecutive Assessment Years; of 50% for further five Assessment Years; and thereafter, of 50% of the ploughed back export profit for the next five years. Further, under section 80-IAB of the Income-tax Act, a deduction of 100% is allowed in respect of profits and gains derived by an undertaking from the business of development of an SEZ notified on or after 1.4.2005 from the total income for any ten consecutive Assessment Years out of fifteen years beginning from the year in which the SEZ is notified by the Central Government. Under the existing provisions of section 115JB(6), an exemption is allowed from payment of Minimum Alternate Tax (MAT) on book profit in respect of the income accrued or arising on or after 1.4.2005 from any business carried on, or services rendered, by an entrepreneur or a Developer, in a Unit or Special Economic Zone (SEZ), as the case may be. Further, under the existing provisions of section 115-O(6), an exemption is allowed from payment of tax on distributed profits [Dividend Distribution Tax (DDT)] in respect of the total income of an undertaking or enterprise engaged in developing or developing and operating or developing, operating and maintaining a Special Economic Zone for any Assessment Year on any amount declared, distributed or paid by such Developer or enterprise, by way of dividends (whether interim or otherwise) on or after

14.2 I DIRECT TAXATION

1.4.2005 out of its current income. Such distributed income is also exempt from tax under section 10(34) of the Act. The above provisions were inserted in the Income-tax Act by the Special Economic Zones Act, 2005 (SEZ Act) with effect from 10th February, 2006. Currently, there is no sunset date provided for exemption from MAT in the case of a developer of an SEZ or a unit located in an SEZ. Similarly, there is no sunset date for exemption from DDT in the case of a developer of an SEZ. The Finance Act, 2011 has sunset the availability of exemption from Minimum Alternate Tax in the case of SEZ Developers and units in SEZs in the Income-tax Act as well as the SEZ Act w.e.f. A.Y. 2012-13. Hence, units of SEZ and developers of SEZ shall be liable to MAT w.e.f. A.Y. 2012-13. It has further discontinued the availability of exemption from dividend distribution tax in the case of SEZ Developers under the Income-tax Act as well as the SEZ Act for dividends declared, distributed or paid on or after 1.6.2011 which shall be taxable @ 16.223% [15% + 5% SC + 3% (EC + SHEC)]. Consequential amendments have also be made by omitting Explanation to section 10(34) of the Income-tax Act w.e.f. 1.6.2011. 14.2 ALTERNATE MINIMUM TAX (AMT) [SEC.115JC TO 115JF] Where the regular Income Tax payable for a Previous Year by a person (other than a company) is less than the Alternate Minimum Tax payable for such Previous Year, the Adjusted Total Income shall be deemed to be the total income of such person and he shall be liable to pay Income-tax on such Total Income at the rate of 18.5% [Section115JC (1)] To whom Alternate Minimum Tax shall be applicable [Section 115JEE (1)] The provisions of Alternate Minimum Tax shall apply to a non-corporate assessee who has claimed any deduction under: (a) Sections 80-IA to 80RRB other than section 80P; or (b) Section 10AA. To whom Alternate Minimum Tax shall not be applicable [Section 115JEE (2)] The provisions of Alternate Minimum Tax under Chapter XII-BA shall not apply to(a) an Individual; or (b) a Hindu Undivided Family; or (c) an Association of Persons or a Body of Individuals (whether incorporated or not) or (d) an Artificial Juridical Person referred to in section 2(31) (vii), if the Adjusted Total Income of such person does not exceed ` 20,00,000 Steps involving calculation of Tax where Alternate Minimum Tax provisions applies: Step 1: Calculate the regular Income-tax liability of the non-corporate assessee ignoring the provisions of Sections 115JC to 115JF. Step 2: Calculate Adjusted Total Income of the non-corporate assessee. Step 3: Calculate Alternate Minimum Tax by applying 19.055 percent (18.5 % + 2% EC + 1% SHEC) on Adjusted Total Income computed under Step 2. Step 4: Compare tax liability computed under Step 1 and Alternate Minimum Tax computed under Step 3. If amount computed under Step 1 is equal to or more than amount computed under Step 3, then the provisions of Alternate Minimum Tax will not apply.

DIRECT TAXATION I 14.3

Minimum Alternate Tax (Mat) and Alternate Minimum Tax (AMT) Step 5: If amount computed under Step 1 is less than amount computed under Step 3, then amount computed under Step 3 will be deemed as tax liability of the non-corporate assessee for such Previous Years. In this case, the excess amount computed under Step 3 over the amount computed under Step 1 will be available as credit and can be carried forward and set off against regulars tax liability of the non-corporate assessee of the next year or subsequent years. Report from an accountant [Section 115JC (3)]: Every non-corporate assessee to whom this section applies shall obtain a report, in such form as may prescribed, from an accountant, certifying that the Adjusted Total Income and the Alternate Minimum Tax have been computed in accordance with the provisions of this Chapter and furnish such report on or before the due date of furnishing of return of income under section 139(1). Tax credit for AMT: Section 115JD provides the credit for tax (tax credit) paid by a non-corporate on account of AMT under Chapter XII-BA shall be allowed to the extent of the excess of the AMT paid over the regular Income-tax. This tax credit shall be allowed to be carried forward up to the tenth Assessment Year immediately succeeding the Assessment Year for which such credit becomes allowable. It shall be allowed to be set off for an Assessment Year in which the regular income-tax exceeds the AMT to the extent of the excess of the regular Income-tax over the AMT. No interest shall be payable on tax credit allowed under section 115JD. For the purpose of the given sections: Adjusted Total Income means the Total Income or Net Income of the non-corporate assessee as increased by (a) Amount claimed as deduction by the non-corporate assessee under sections 80H to 80RRB other than section 80P; (b) Amount claimed as deduction by the non-corporate assessee under section 10AA. Alternate Minimum Tax shall be the amount of tax computed on Adjusted Total Income at a rate of eighteen and one-half per cent. Application of other provisions of this Act [Section 115JE]: Save as otherwise provided in this Chapter, all other provisions of this Act shall apply to a non-corporate referred to in this Chapter. Hence, all other provisions relating to Advance tax, interest under sections 234A, 234B and 234C penalty, etc. shall apply to such non-corporate also.

14.4 I DIRECT TAXATION

ILLUSTRATIONS ON ALTERNATE MINIMUM TAX Illustration 1: The following particulars are furnished for the Previous Year 2012-13 Net Profit as per Profit & Loss A/c (after deducting Depreciation of ` 5,80,000) Depreciation allowable u/s 32 of Income Tax Act Disallowable expenses Deduction received u/s 10AA (as calculated) Long Term Capital Gains (on sale of land) Deduction received under Chapter VI A(as calculated): 80G 80IB Calculate Tax Liability assuming that the Assessee is an LLP, Firm, Individual, HUF, AOP and BOI Solution: Statement showing computation of Total Income (applicable for all types of Assessee) Particulars Net Profit as per Profit & Loss A/c Add: Depreciation Disallowable expenses Less: Depreciation allowable u/s 32 of Income Tax Act. Less: Deduction received u/s 10AA Business Profit Add: Long Term Capital Gains Gross Total Income Deduction received under Chapter VI A : 80G 80IB Total Income Computation of Adjusted Total Income (applicable for all types of Assessee) Particulars Total Income ( as computed above) Add: Deduction claimed u/s 80IB Add: Deduction claimed u/s 10AA Adjusted Total Income ` 10,30,000 60,000 80,00,000 90,90,000 ` 5,80,000 75,000 ` 88,97,000 6,55,000 95,52,000 6,27,000 89,25,000 80,00,000 9,25,000 2,00,000 11,25000 95,000 10,30,000 35,000 60,000 ` 88,97,000 6,27,000 75,000 80,00,000 2,00,000

35,000 60,000

Statement showing computation of Tax Liability and Alternate Minimum Tax and Credit on Alternate

DIRECT TAXATION I 14.5

Minimum Alternate Tax (Mat) and Alternate Minimum Tax (AMT) Minimum Tax for the Assessment Year 2013-14 Particulars Tax on Long Term Capital Gains (@ 20% of ` 2,00,000) Tax on balance Total Income (@ 30% for Firm or LLP and at Slab Rate for Individual or HUF or AOP or BOI) Add: Education Cess @ 2% Add: Secondary and Higher Secondary Education Cess @ 1% Tax Liability (a) Tax on Adjusted Total Income @ 18.5% Add: Education Cess @ 2% Add: Secondary and Higher Secondary Education Cess @ 1% Alternate Minimum Tax (b) Tax Payable [Higher than (a) and (b)] Alternate Minimum Tax credit [(a) (b)] Firm/ LLP ` Individual/ HUF/AOP/BOI ` 40,000 40,000 96,000 1,36,000 2,720 1,360 1,40,080 16,81,650 33,633 16,817 17,32,100 17,32,100 15,92,020

2,49,000 2,89,000 5,780 2,890 2,97,670 16,81,650 33,633 16,817 17,32,100 17,32,100 14,34,430

Illustration 2 : The following is the Profit and Loss Account for the year ending 31.3.2013 of XYZ (LLP) having 3partners: Dr. Profit and Loss Account for the year ended 31.3.2013 ` 48,00,000 Gross Profit Profit on sales of equity shares sold after 2 years through Recognized Stock Exchange 90,000 1,20,000 60,000 2,70,000 Rent from house property Interest on bank deposits Profit on equity shares sold after 2,40,000 10 months through Recognized Stock Exchange 1,80,000 4,20,000 16,60,000 71,50,000 ` ` Cr. ` 68,20,000 1,40,000 60,000 10,000 1,20,000

Establishment & other expenses Interest to partner @15% X Y Z Salary to designated partners X Y Net Profit

71,50,000

Additional information: (1) Establishment expenses include `1,20,000 on account of bonus which was due on 31.3.2013. (2) The LLP is eligible for 100% deduction under section 80-IC as it is established in notified area in Himachal Pradesh. (3) Shares were sold through recognized stock exchange and securities transaction tax of `1000 is included in the establishment expenses on account of the same. Compute the tax payable by the Limited Liability Firm.

14.6 I DIRECT TAXATION

Solution: Computation of Total Income of XYZ (LLP) for the A.Y. 2013-14 Particulars Income under the head House Property Actual Rent Less: Deduction 30% Business Income Net Profit as per P&L A/c Less : Income credited but either exempt or taxable under other head Rent Profit on sale of shares sold after 2 years Interest on bank deposit Profit on sale of shares sold after 10 months Add: Expenses disallowed Bonus as per section 43B Securities Transaction Tax Interest to partners in excess of 12% Salary to partners Book profit Less: Salary as per section 40(b) (See working note) Short-term Capital Gain on sale of equity shares Income from Other Sources Gross Total Income Less: Deduction under section 80-IC Deduction under section 80TTA [Assumed interest is from Savings Account] Total Income Regular Income Tax Payable on Total Income (1) Short-term Capital Gain of `1,20,000 @ 15% (2) Balance total income `42,000 @ 30% Adjusted Total Income Total Income Add: Deduction u/s Chapter VIA 1,62,000 15,05,000 16,67,000 18,000 12,600 30,600 ` ` 60,000 18,000 16,60,000 60,000 1,40,000 10,000 1,20,000 `

42,000

3,30,000 1,20,000 13,30,000 1,000 54,000 4,20,000 5,95,000 19,25,000 4,20,000

15,05,000 1,20,000 10,000 16,77,000 15,15,000 1,62,000

15,05,000 10,000

Alternate Minimum Tax (AMT) 18.5% on `16,67,000 = `3,08,395 [ Higher of ` 30,600] Hence, adjusted total income shall be total income and the tax (payable shall be the Alternate Minimum Tax) i.e. on `16,67,000 @ 18.5% + 3% (EC + SHEC). Tax Payable Alternate minimum tax 18.5% on `16,67,000 Add: 3% Education Cess & SHEC Rounded off ` 3,08,395 9,252 3,17,647 3,17,650

DIRECT TAXATION I 14.7

Minimum Alternate Tax (Mat) and Alternate Minimum Tax (AMT) Working Note 1. Book Profit Maximum salary allowed First 3,00,000 of book profit90% Balance `16,25,000 of book profit 60% 2,70,000 9,75,000 12,45,000 19,25,000

Salary allowed shall be `12,45,000 or `4,20,000 whichever is lower i.e. `4,20,000. 2. Long term Capital Gains arising from transfer of Equity Shares through Recognized Stock Exchange, on which STT is paid, is exempted from Tax [Sec.10(38)]

14.8 I DIRECT TAXATION

ILLUSTRATIONS ON MINIMUM ALTERNATE TAX (MAT)

Illustration 1: D Ltd., a closely-held Indian company, is engaged in the business of manufacture of chemical goods (value of plant and machinery owned by the company is ` 55 lakh). The following informations for the financial year 2012-13 are given: D Ltd. is engaged in the business of manufacture of garments. ` Sale proceeds of goods (domestic sale) Sale proceeds of goods (export sale) Amount withdrawn from general reserve (reserve was created in 1997-98 by debiting P&L A/c) Amount withdrawn from revaluation reserve Total Less : Expenses Depreciation (normal) Depreciation (extra depreciation because of revaluation) Salary and wages Wealth tax Income-tax Outstanding customs duty (not paid as yet) Proposed dividend Consultation fees paid to tax expert Other expenses Net Profit For tax purposes the company wants to claim the following: Deduction under section 80-IB (30 per cent of ` 14,56,500). Depreciation under section 32 (` 5,36,000) The company wants to set off the following losses/allowances: For tax purposes ` For accounting purposes ` 4,00,000 70,000 25,00,000 7,00,000 2,00,000 1,50,000 35,50,000 6,16,000 2,70,000 2,10,000 10,000 3,50,000 17,500 60,000 21,000 1,39,000 18,56,500

Brought forward loss of 2005-06 Unabsorbed depreciation

14,80,000

Compute the net income and tax liability of D Ltd. for the Assessment Year 2013-14 assuming that D Ltd. has a (deemed) Long-term Capital Gain of ` 60,000 under proviso (i) to section 54D(2) which is not credited in Profit and Loss Account.

DIRECT TAXATION I 14.9

Minimum Alternate Tax (Mat) and Alternate Minimum Tax (AMT) Solution: Computation of Book Profit & Minimum Alternate Tax for the Assessment Year 2013-14 Particulars Net Profit as per P&L A/c Add: Excess depreciation [i.e., ` 6,16,000 + ` 2,70,000 ` 5,36,000] Wealth tax Income tax Customs duty which is not paid Proposed dividend Total Less : Amount withdrawn from reserve (i.e., ` 2,00,000+` 1,50,000) Business income Less: Unabsorbed loss Business Income Long-term Capital Gain Gross Total Income Less: Deductions under section 80-IB [30% of ` 4,14,000] =[` (8,14,000 4,00,000)] Net Income (rounded off) Tax liability (under normal provisions) [20% of ` 60,000 + 30% of ` 6,89,800, plus 3% of tax as Cess] Book Profit Net Profit Add: Depreciation (i.e. ` 6,16,000 + ` 2,70,000) Wealth tax Income-tax Proposed dividend Less : Amount withdrawn from general reserve Unabsorbed depreciation Depreciation (normal) Amount withdrawn from revaluation reserve to the extent it does not exceed extra depreciation because of revaluation Book Profit Tax liability (19.055% of 21,16,500) Amount (`) 18,56,500 3,50,000 10,000 3,50,000 17,500 60,000 26,44,000 3,50,000 22,94,000 14,80,000 8,14,000 60,000 8,74,000 1,24,200 7,49,800 2,25,508

18,56,500 8,86,000 Nil 3,50,000 60,000 () 2,00,000 () 70,000 () 6,16,000 () 1,50,000 21,16,500 4,03,299

D Ltd. will pay ` 4,03,299 as tax for the Assessment Year 2013-14 as per section 115JB. Tax credit is however, available in respect excess tax (i.e., ` 1,77,791) under section 115JB.

14.10 I DIRECT TAXATION

Study Note - 15
RETURN OF INCOME
This Study Note includes 15.1 Return of Income 15.2 Annual Information Return 15.1 RETURN OF INCOME The starting point for assessment of income is furnishing of return of income. Filing of return of income is mandatory for certain category of assessees. Incidental provisions for accompaniments to the return of income, error correction and belated returns have been made. Now filing of the return electronically has been made mandatory for certain category of assessees. Return of income is the format in which the assessee has to furnish information as to his total income and tax payable. The format for filing of returns by different assessees is notified by the CBDT. 15.1.1 Compulsory Filing of Return of Income [Section 139(1)] (1) As per section 139(1), it is compulsory for companies and firms to file a return of income for every Previous Year. (2) In case of a person other than a company or a firm, filing of return of income is mandatory, if his total income or the total income of any other person in respect of which he is assessable under this Act during the Previous Year exceeds the basic exemption limit. (3) Such persons should, on or before the due date, furnish a return of income in the prescribed form and verified in the prescribed manner and setting forth such other particulars as may be prescribed. (4) Further, every person, being an individual or a HUF or an AOP or BOI or an artificial juridical person whose total income or the total income of any other person in respect of which he is assessable under this Act during the Previous Year without giving effect to the provisions of section 10A or 10B or 10BA or Chapter VI-A - exceeded the basic exemption limit is required to file a return of his income or income of such other person.

Every Individual, HUF, etc. must file their return of income if its Gross Total Income exceeds the exempted income ceiling : Assessee Resident Super Senior Citizen Resident Senior Citizen Resident or Non-resident Individual HUF Exempted Ceiling ` 5,00,000 ` 2,50,000 ` 2,00,000 ` 2,00,000

(5) For company and certain other assessees like firm having tax audit, filing of return in an electronic form is mandatory. (Section 139D) (6) Compulsory filing of Income-tax return in relation to assets located outside India : It is mandatory to furnish return of income from the Assessment Year 2012-13 if the following conditions are satisfied : (a) The person is resident in India (but other than not ordinarily resident), and (b) He or it has any assets (including financial interest from any entity) located outside India or signing authority in any account located outside India.

DIRECT TAXATION I 15.1

Return of Income From the above we can understand that for any person (may be individual or a person other than individual) who satisfies the above two conditions, furnishing of return has become mandatory, irrespective of the fact whether the person has taxable income or not. The above provisions are not applicable if the concerned person is a non-resident or if he/it is a resident but not ordinarily resident in India for the relevant Assessment Year.

(7) Political Parties : Political parties are under a statutory obligation to file return of income in respect of each Assessment Year in accordance with the provisions of the Income-tax Act and the total income for this purpose has to be computed without giving effect to the provision of section 13A and Chapter VI-A of the Act. (8) Liquidator : Under the Companies Act, 1956, a liquidator is not exempt from making an Income-tax return on business managed by him for the beneficial winding up of the company. (9) Charitable Trust : Submission of return by charitable trust is essential even if its income is exempt. If the total income of a charitable trust (without claiming exemption under section 11 and 12) exceeds the maximum amount not chargeable to tax, then submission of return by the trust is essential. (10) No need to file return if Non-agricultural income is less than the amount of exemption limit in the case of an Individual/ HUF. Exemption provided by the Government when taxable income of an individual is up to ` 5,00,000 : If the following conditions are satisfied, the taxpayer has an option to submit his return of income or not to submit his return of income i) ii) iii) The taxpayer is an individual. He may be resident or non-resident. His taxable income does not exceed `5,00,000. Taxable income should consist of salary and/ or saving bank account interest (but interest should not be more than `10,000). The individual has reported to his employer his Permanent Account Number (PAN).

iv) The individual has reported to his employer his saving bank interest for the purpose of calculating tax deductible under section 192. v) The Individual has received a certificate of tax deduction in Form No. 16 from his employer which mentions the PAN, details of income, tax deducted at source by the employer and deposited to the credit of the Central Government.

vi) The individual has no claim of refund of taxes due to him for the income of the Assessment Year. vii) The individual has received salary from only one employer for the Assessment Year. However, in case notice under section 142(1), 148, 153A or 153C has been issued for filing a return of income for the relevant Assessment Year, exemption is not available. Due date means (a) 30th November of the Assessment Year, where the assessee is required to furnished a report in Form No. 3CEB under section 92E pertaining to international transactions. (b) 30th September of the Assessment Year, where the assessee is (i) a company; or (ii) a person (other than a company) whose accounts are required to be audited under the Income-tax Act, 1961 or any other law in force; or (iii) a working partner of a firm whose accounts are required to be audited under the Income-tax Act, 1961 or any other law for the time being in force.

(c) 31st July of the Assessment Year, in the case of any assessee other than those covered in (a) & (b) above.

15.2 I DIRECT TAXATION

15.1.2 Interest for Default in Furnishing Return of Income [Section 234A] (1) Interest under section 234A is attracted where an assessee furnishes the return of income after the due date or does not furnish the return of income. (2) The interest is payable for the period commencing from the date immediately following the due date and ending on the following dates When the return is furnished after due date: the date of furnishing of the return Where no return is furnished: the date of completion of assessment

(3) The interest has to be calculated on the amount of tax on total income as determined under section 143(1) or on regular assessment as reduced by the advance tax paid and any tax deducted or collected at source @ 1% for every month or part of the month. 15.1.3 Option to Furnish Return of Income to Employer [Section 139(1A)] (1) This section gives an option to a person, being an individual who is in receipt of income chargeable under the head Salaries, to furnish a return of his income for any Previous Year to his employer, in accordance with such scheme as may be notified by the CBDT and subject to such conditions as may be specified therein. (2) Such employer shall furnish all returns of income received by him on or before the due date, in such form, including on a floppy, diskette, magnetic cartridge tape, CD-ROM or any other computer readable media and manner as may be specified in that scheme. (3) In such a case, any employee who has filed a return of his income to his employer shall be deemed to have furnished a return of income under sub-section (1). 15.1.4 Income Tax Return through Computer Readable Media [Section 139(1B)] (1) This sub-section enables the taxpayer (company or a person other than company) to file his return of income in computer readable media, without interface with the department. (2) Such person may, on or before the due date, furnish a return of income in accordance with such scheme as may be notified by the CBDT, in such form, including on a floppy, diskette, magnetic cartridge tape, CD-ROM or any other computer readable media and manner as may be specified in that scheme. (3) In such case, the return furnished under such scheme shall be deemed to be return furnished under sub-section (1) of section 139. 15.1.5 Return of Loss [Section 139(3)] (1) This section requires the assessee to file a return of loss in the same manner as in the case of return of income within the time allowed under section 139(1). (2) Under section 80, an assessee cannot carry forward or set off his loss against income in the same or subsequent year unless he has filed a return of loss in accordance with the provisions of section 139(3). (3) A return of loss has to be filed by the assessee in his own interest and the non-receipt of a notice from the Assessing Officer requiring him to file the return cannot be a valid excuse under any circumstances for the non-filing of such return. (4) In particular, a return of loss must be filed by an assessee who has incurred a loss under the heads Profits and Gains from Business or Profession, Capital Gains, and income from the activity of owning and maintaining race horses taxable under the head Income from Other Sources. (5) However, loss under the head Income from House Property under section 71B and unabsorbed depreciation under section 32 can be carried forward for set-off even though return of loss has not been filed before the due date.

DIRECT TAXATION I 15.3

Return of Income Synopsis of Loss filing of return is as follows : Section Ref. 71 B 72 73 74 74A 32(2) Nature of Loss Loss under the head Income from House Property Business or Profession Loss Speculative Business Loss Loss under the head Capital Gains Loss from the activity of owning and maintaining race horse Unabsorbed Depreciation Allowance Filing of Return Loss return must be filed Loss return should be filed timely Loss return should be filed timely Loss return should be filed timely Loss return should be filed timely Loss return should be filed

If return of Loss is not filed timely, the losses under section 72, 73, 74, and 74A could not be carried forward to subsequent years for set off. 15.1.6 Belated Return [Section 139(4)] (1) Any person who has not furnished a return within the time allowed to him under section 139(1) or within the time allowed under a notice issued under section 142(1) may furnish the return for any Previous Year at any time (i) before the expiry of one year from the end of the relevant Assessment Year; or (ii) before the completion of the assessment, whichever is earlier.

(2) Interest is required to be paid under section 234A, as stated earlier. (3) A penalty of ` 5,000 may be imposed under section 271F if belated return is submitted after the end of Assessment Year. 15.1.7 Return of Income of Charitable Trusts and Institutions [Section 139(4A)] (1) Every person in receipt of income (i) derived from property held under a trust or any other legal obligation wholly or partly for charitable or religious purpose; or

(ii) by way of voluntary contributions on behalf of such trust or institution must furnish a return of income if the total income in respect of which he is assessable as a representative assessee, computed before allowing any exemption under sections 11 and 12 exceeds the basic exemption limit.

(2) Such persons should furnish the return in the prescribed form and verified in the prescribed manner containing all the particulars prescribed for this purpose. (3) This return must be filed by the representative-assessee voluntarily within the time limit. Any failure on the part of the assessee would attract liability to pay interest and penalty. 15.1.8 Return of Income of Political Parties [Section 139(4B)] (1) Under this section, a political party is required to file a return of income if, before claiming exemption under section 13A, the party has taxable income. (2) The grant of exemption from Income-tax to any political party under section 13A is subject to the condition that the political party submits a return of its total income within the time limit prescribed under section 139(1). (3) The chief executive officer of the political party is statutorily required to furnish a return of income of the party for the relevant Assessment Year, if the amount of total income of the Previous Year exceeds the basic exemption limit before claiming exemption under section 13A.

15.4 I DIRECT TAXATION

15.1.9 Return of Income of Research Associations etc. [Section 139(4C)] Any assessee being a research association of which income before claiming exemption u/s. 10 exceeds the maximum amount which is not chargeable to Income Tax must file a return of income. Section Ref 10(21) 10(22B) 10(23A) / 10(23B) 10(23C)(v) 10(23C)(vi) 10(23C)(via) 10(24) 10(46) 10(47) Nature of Organisation Research association including an association having its object of undertaking research in social science or statistical science News Agency Specified association or institution Specified Trust or institution Any University of other educational institution Any Hospital or other medical institution Trade Union Any Body / Authority / Trust Infrastructure Debt Fund

15.1.10 Return of Income of University or College or Other Institution [Section 139(4D)] Every university or college or other institution referred to in clause (ii) and clause (iii) of sub-section (1) of section 35, which is not required to furnish return of income or loss under any other provision of this section, shall furnish the return in respect of its income or loss in every Previous Year and all the provisions of this Act shall, so far as may be, apply as if it were a return required to be furnished under sub-section (1). 15.1.11 Revised Return [Section 139(5)] (1) If any person having furnished a return under section 139(1) or in pursuance of a notice issued under section 142(1), discovers any omission or any wrong statement therein, he may furnish a revised return at any time before the expiry of one year from the end of the relevant Assessment Year or before completion of assessment, whichever is earlier. In other words : Such return can be submitted at any time :a) before the expiry of one year from the end of the relevant Assessment Year; or b) before the completion of assessment Whichever is earlier

(2) It may be noted that a belated return cannot be revised. It has been held in Kumar Jagdish Chandra Sinha vs. CIT 1996 86 Taxman 122 (SC) that only a return furnished under section 139(1) or in pursuance of a notice under section 142(1) can be revised. A belated return furnished under section 139(4), therefore, cannot be revised. 15.1.12 Particulars required to be furnished with the Return [Section 139(6)] The prescribed form of the return shall, in certain specified cases, require the assessee to furnish the particulars of (i) income exempt from tax (ii) assets of the prescribed nature, value and belonging to him (iii) his bank account and credit card held by him (iv) expenditure exceeding the prescribed limits incurred by him under prescribed heads (v) such other outgoings as may be prescribed.

DIRECT TAXATION I 15.5

Return of Income 15.1.13 Defective Return [Section 139(9)] (1) Under this sub-section, the Assessing Officer has the power to call upon the assessee to rectify a defective return. (2) Where the Assessing Officer considers that the return of income furnished by the assessee is defective, he may intimate the defect to the assessee and give him an opportunity to rectify the defect within a period of 15 days from the date of such intimation. The Assessing Officer has the discretion to extend the time period beyond 15 days, on an application made by the assessee. (3) If the defect is not rectified within the period of 15 days or such further extended period, then the return would be treated as an invalid return. The consequential effect would be the same as if the assessee had failed to furnish the return. (4) Where, however, the assessee rectifies the defect after the expiry of the period of 15 days or the further extended period, but before assessment is made, the Assessing Officer can condone the delay and treat the return as a valid return. (5) A return can be treated as defective if it is not properly filled in or the necessary enclosures are not accompanying the return. Specific defects are only illustrative and not exhaustive - CIT vs. Rai Bahadur Bissesswarlal Motilal Malwasie Trust 195 ITR 825.

15.1.14 Permanent Account Number (PAN) [Section 139A] (1) Where any person in the following category has not been allotted a Permanent Account Number (PAN), he should apply to the Assessing Officer within the prescribed time for allotment of a PAN (i) Every person whose total income or the total income of any other person in respect of which he is assessable under this Act during any Previous Year exceeded the basic exemption limit; or

(ii) Every person carrying on any business or profession whose total sales, turnover or gross receipts exceeds or is likely to exceed `5 lakhs in any Previous Year; or (iii) Every person who is required to furnish a return of income under section 139(4A); or

(2) The CBDT had introduced a new scheme of allotment of computerized 10 digits PAN. Such PAN comprises of 10 alphanumeric characters and is issued in the form of a laminated card. (3) All persons who were allotted PAN (Old PAN) earlier and all those persons who were not so allotted but were required to apply for PAN, shall apply to the Assessing Officer for a new series PAN within specified time. (4) Once the new series PAN is allotted to any person, the old PAN shall cease to have effect. No person who has obtained the new series PAN shall apply, obtain or process another PAN. (5) On receipt of allotment of PAN it must be mentioned on all tax payment challans, returns, correspondence. (6) Where TDS or TCS is made, the person from whom it is made must communicate his PAN to the person deducting or collecting tax. (7) Every person receiving any document relating to a transaction prescribed under clause (c) of subsection (5) shall ensure that the Permanent Account Number or the General Index Register Number has been duly quoted in the document. 15.1.15 Scheme for Submission of Returns through Tax Return Preparers [Section 139B] (1) The Tax Return Preparer shall assist the specified class or classes of person in furnishing the return in a manner that will be specified in the Scheme, and shall also affix his signature on such return. The

15.6 I DIRECT TAXATION

specified class or classes of persons for this purpose means any person other than a company or a person whose accounts are required to be audited under section 44AB (tax audit) or under any other existing law, who is required to furnish a return of income under the Act. (2) A Tax Return Preparer can be an individual, other than (i) any officer of a scheduled bank with which the assessee maintains a current account or has other regular dealings.

(ii) any legal practitioner who is entitled to practice in any civil court in India. (iii) a chartered accountant. (iv) an employee of the specified class or classes of persons. (i) The manner in which and the period for which the Tax Return Preparers shall be authorised,

(3) The Scheme notified under the said section may provide for the following (ii) The educational and other qualifications to be possessed, and the training and other conditions required to be fulfilled, by a person to act as a Tax Return Preparer, (iii) The code of conduct for the Tax Return Preparers, (iv) The duties and obligations of the Tax Return Preparers, (v) The circumstances under which the authorisation given to a Tax Return Preparer may be withdrawn, and (vi) Any other relevant matter as may be specified by the Scheme.

15.1.16 Power of Board to dispense with furnishing documents, etc. with the Return [Sec. 139C] (1) The Board may make rules providing for a class or classes of persons who may not be required to furnish documents, statements, receipts, certificates, reports of audit or any other documents, which are otherwise under any other provisions of this Act, except section 139D, required to be furnished, along with the return but on demand to be produced before the Assessing Officer. (2) Any rule made under the proviso to sub-section (9) of section 139 as it stood immediately before its omission by the Finance Act, 2007 shall be deemed to have been made under the provisions of this section. 15.1.17 Filing of return in electronic from [Sec. 139D] The Board may make rules providing for (a) the class or classes of persons who shall be required to furnish the return in electronic form; (b) the form and the manner in which the return in electronic form may be furnished; (c) the documents, statements, receipts, certificates or audited reports which may not be furnished along with the return in electronic form but shall be produced before the Assessing Officer on demand; (d) the computer resource or the electronic record to which the return in electronic form may be transmitted.

DIRECT TAXATION I 15.7

Return of Income 15.1.18 Return by whom to be signed [Section 140] The return under section 139 shall be signed and verified as under: Sr. No. 1 Assessee Category Individual Who can Sign (i) By the individual himself; (ii) Where he is absent from India, by the individual himself or by some person duly authorised by him in this behalf; (iii) Where he is mentally incapacitated from attending to his af fairs, by his guardian or any other person competent to act on his behalf; and (iv) Where, for any other reason, it is not possible for the individual to sign the return, by any person duly authorised by him in this behalf By the Karta or where the Karta is absent from India or is mentally incapacitated from attending to his affairs, by any other adult member of such family Managing director or where for any unavoidable reason, managing director is not able to sign or where there is no managing director, by any director thereof. Exceptions: (a) Where the company is being wound up : by the liquidator (b) Where the management of the company has been taken over by the Government : the principal officer thereof (c) Company is not resident in India : a person who holds a valid power of attorney Managing partner or where for any unavoidable reason managing partner is not able to sign and verify the return, or where there is no managing partner, by any partner thereof The Principal officer thereof The Chief Executive Officer of such party Any Member of the Association or the Principal Officer thereof By that person or by some person competent to act on his behalf

Hindu Undivided Family (HUF) Company

A Firm / Limited Liability Partnership (w.e.f. A.Y 2010-11) A Local Authority A Political Party Any other Association Any other Person

5 6 7 8

15.1.19 Prescribed Forms: Forms ITR-1 (SAHAJ) Applicability For individual having income from salary/ one house property (not being brought forward loss from Previous Years)/ income from other sources (except winning from lotteries and income from race horses) For individuals and HUFs not having business or professional income For individual or HUFs being partners in firms and not carrying out business or profession under any proprietorship For individual and HUFs having income from a proprietary business or profession For individual or HUF deriving business income and such income is computed in accordance with special provision referred to in sections 44AD and 44AE

ITR-2 ITR-3 ITR-4 ITR-4S(SUGAM)

15.8 I DIRECT TAXATION

ITR-5 ITR-6 ITR-7 ITR-V

For firms, AOPs and BOIs or any other person (not being individual or HUF or company or to whom ITR-7 is applicable) For companies other than companies claiming exemption under section 11 For persons including companies required to furnished return under section 139(4A)/(4B)/(4C)/(4D) Where the data of the return of income in forms ITR-1, ITR-2, ITR-3, ITR-4, ITR-5 and ITR-6 transmitted electronically without digital signature.

15.1.20 Self Assessment Tax Payment [Section 140A] (1) Where any tax is payable on the basis of any return required to be furnished under section 139 or section 142 or section 148 or section 153A or, as the case may be, section 158BC, after taking into account taxes paid earlier. The assessee shall be liable to pay such tax together with interest payable under any provision of this Act for any delay in furnishing the return or any default or delay in payment of advance tax, before furnishing the return and the return shall be accompanied by proof of payment of such tax and interest. (2) If assessee fails to pay the whole or any part of such tax or interest or both on self assessment, he shall be deemed to be an assessee in default in respect of the tax or interest or both remaining unpaid. Penalty can be imposed on any assessee who is in default. (3) With effect from the Assessment Year 2013-14, the amount of credit available to be set off according to the provisions of section 115JD (Alternative Minimum Tax) will also be taken into account u/s 140A for the purpose of computing the amount of tax payable and interest chargeable under section 234A, 234B and 234C before filing the return of income. 15.2 ANNUAL INFORMATION RETURN [SECTION 285BA] The annual information return shall be furnished by every person, being i) ii) iii) v) an assessee; or the prescribed person in the case of an office of Government; or a local authority or other public body or association; or the registering authority empowered to register motor vehicles under Chapter IV of the Motor Vehicles Act, 1988; or

iv) the Registrar or Sub-Registrar appointed u/s 6 of the Registration Act, 1908; or

vi) the Post Master General as referred to in clause (j) of section 2 of the Indian Post Office Act, 1898; or vii) the Collector referred to in clause (c) of section 3 of the Land Acquisition Act, 1894; or viii) the recognised stock exchange referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956; or ix) an officer of the Reserve Bank of India, constituted u/s 3 of the Reserve Bank of India Act, 1934; or x) a depository referred to in clause (e) of sub-section (1) of section 2 of the Depositories Act, 1996, who is responsible for registering or maintaining books of account or other document containing a record of any specified financial transaction in respect of all transactions of the specified nature and value which are registered or recorded by him during Financial Year 2004-05 and onwards.

DIRECT TAXATION I 15.9

Return of Income Specified transactions are as follows: Sl. No. 1 Class of Person Banking Company Nature of Transaction Cash deposit Value of Transaction Aggregate deposit of ` 10 lakhs or more in any Savings Account of a person maintained in that Bank Aggregating to ` 2 lakhs or more in a year An amount of ` 2 lakhs or more An amount of ` 5 lakhs or more An amount of ` 1 lakh or more An amount of ` 30 lakhs or more Aggregating to ` 5 lakhs or more in a year

Banking Company or any Company / Institution issuing Credit Card Trustee of Mutual Fund or other person authorized in this behalf Company or Institution issuing bonds or debentures Company issuing shares through a public or rights issue Registrar or Sub-Registrar u/s 6 of Registration Act, 1908 Person being an officer of the RBI or a person authorized by RBI

Payment of bills on behalf of any person to whom the card is issued Receipt for acquiring Units Receipt for acquiring bonds or debentures Receipt for acquiring shares issued by the company Purchase of sale of immovable property Receipt for bonds issued by the Reserve Bank of India

3 4 5 6 7

The return referred to above shall be furnished to the Commissioner of Income Tax [Central Information Branch]. Where the Board has authorized an agency to receive such return on behalf of the Commissioner Income Tax [Central Information Branch], the return shall be furnished to that agency. The return comprising Part A and Part B of Form No. 61A shall be furnished, on computer readable media, along with Part A thereof on paper, on or before August 31 immediately following the financial year in which the transaction is registered or recorded. Defective Return Where the prescribed Income Tax Authority considers that the annual information return is defective, he may intimate the defect to the person who has furnished such return and give him an opportunity of rectifying the defect within a period of one month from the date of such intimation or within extended period. If the defect is not rectified within the said period, such return shall be treated as an invalid return and the provisions of this Act shall apply as if such person had failed to furnish the annual information return. Notice for submission of return Where a person, who is required to furnish an annual information return, has not furnished the same within the prescribed time, the prescribed Income Tax Authority may serve upon such person a notice requiring him to furnish such return within a period not exceeding 60 days from the date of service of such notice.

15.10 I DIRECT TAXATION

QUESTIONS & ANSWERS ON RETURN OF INCOME Question 1. What is the due date of filling of return of income in case of a non-working partner of a firm whose accounts are not liable to be audited? Answer : Due date of furnishing return of income in case of non-working partner shall be 31st July of the Assessment Year whether the accounts of the firm are required to be audited or not. A working partner for the above purpose shall mean an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner and is drawing remuneration from the firm. Question 2. What do you mean by annexure less return? What is the manner of filling the return of income? Answer : The return of income required to be furnished in Form No.ITR-1,ITR-2,ITR-3,ITR-4,ITR-5 or ITR-6 shall not be accompanied by a statement showing the computation of the tax payable on the basis of the return, or proof of the tax, if any, claimed to have been deducted or collected at source or the advance tax or tax on self-assessment, if any, claimed to have been paid or any document or copy of any account or Form or report of audit required to be attached with the return of income under any of the provisions of the Act. Manner of filling the return: The return of income referred to in sub-rule (1) may be furnished in any of the following manners, namely:(i) Furnishing the return in a paper form; (ii) Furnishing the return electronically under digital signature; (iii) Transmitting the data in the return electronically and thereafter submitting the verification of the return in Form ITR-V; (iv) Furnishing a bar-coded return in paper form. Question 3. Is e-filling of return mandatory? State the assessees for whom e-filling of returns is mandatory? Answer : It shall be mandatory for the following assessees to file the return electronically: (a) A firm required to furnish the return in Form ITR-5 and to whom provisions of Section 44AB are applicable, or (b) A company required to furnish the return in Form ITR-6 Question 4. Can unabsorbed depreciation be carried forward even if the return is filed after due date? Answer : Unabsorbed depreciation can be carried forward even if the return of loss is submitted after the due date, as it is not covered under Chapter VI of set off or carry forward of losses but covered u/s 32(2).[ East Asiatic Co.(India) Pvt. Ltd. vs.CIT (1986) 161 ITR 135(Mad.)] Question 5. Can a belated return of income filed u/s 139(4) be revised? Answer : There was a difference of opinion among various courts regarding filling of revised return in respect of belated returns. However, it has been held that a belated return filed u/s 139(4) cannot be revised as section 139(5) provides that only return filed u/s 139(1) or in pursuance to a notice u/s 142(1) can be revised [ Kumar Jagdish Chandra Sinha vs.CIT(1996) 220 ITR 67(SC)]. Question 6. Can a revised return be further revised? Answer : If the assessee discovers any omission or any wrong statement in a revised return, it is possible to revise such a revised return provided it is revised within the same prescribed time [Niranjan Lal Ram Chandra vs.CIT (1982) 134 ITR 352 (All.)]

DIRECT TAXATION I 15.11

Return of Income Question 7. Can an Assessing Officer himself allot Permanent Account Number to an assessee? Answer: The Assessing Officer having regard to the nature of the transactions as may be prescribed may also allot a Permanent Account Number to any other person( whether any tax is payable by him or not) in the manner and in accordance with the procedure as may be prescribed. Question 8. What are the consequences if a person fails to comply with the provisions of Sec.139A i.e. quoting of PAN? Answer : As per Sec.272B(2), if a person fails to comply with the provisions of Sec.139A, the Assessing Officer may direct that such person shall have to pay, by way of penalty, a sum of `10,000. Question 9. Who can sign the return of HUF, if HUF does not have a major member? Answer : If the HUF has no major members as its Karta, a return may validly be signed by the eldest minor member of the family who manages the affairs of the family [Sridhar Udai Narayan vs.CIT(1962) 45 ITR 577 (All.)] Question 10. Is thumb impression valid for furnishing the Return of Income? Answer : The General Clauses Act accepts the thumb impression, as one of the modes of signing, valid and binding. [CIT vs. Kanhaiya Lal And Sons (2005) 273 ITR 425 (All.)]

15.12 I DIRECT TAXATION

Study Note - 16
ASSESSMENT PROCEDURE
This Study Note includes 16.1 Assessment Procedure 16.1 ASSESSMENT PROCEDURE 16.1.1 Inquiry before assessment [Section 142] Inquiry: (1) The Assessing Officer has power to make inquiry from any person (a) who has made a return under section 139 or (b) in whose case the time allowed under sub-section (1) or sub-section (4) of section 139 for furnishing the return has expired. For this purpose a notice can be issued for : (i) where such person has not made a return within the time allowed under section 139(1) or 139(4), to furnish a return of his income, or

(ii) to produce such accounts or documents as the Assessing Officer may require, or (iii) to furnish in writing and verified in the prescribed manner information in such form and on such points or matters including a statement of all assets and liabilities of the assessee, whether included in the accounts or not, as the Assessing Officer may require Provided that (i) Previous approval of Joint Commissioner shall be obtained before requiring the assessee to furnish a statement of all assets and liabilities not included in the accounts.

(ii) The Assessing Officer shall not require the production of any accounts relating to a period more than three years prior to the Previous Year.

(2) For the purpose of obtaining full information in respect of the income or loss of any person, the Assessing Officer may make such inquiry as he considers necessary. Audit If the Assessing Officer, having regard to the nature and complexity of the accounts of the assessee and the interests of the revenue, opines that it is necessary so to do, he may with the prior approval of the Chief Commisioner or Commisioner, direct the assessee to get the accounts audited by an accountant, as defined in the Explanation below section 288(2) and to furnish an audit report, within such period as may be specified, in the prescribed form. The expenses of such audit shall be paid by the assessee These provisions of audit shall have effect notwithstanding that the accounts of the assessee have been already audited. Opportunity to Assessee: The assessee shall be given an opportunity of being heard in respect of any material gathered on the basis of any inquiry or any audit and proposed to be utilised for the purposes of the assessment. Such opportunity need not be given where the assessment is made under section 144. 16.1.2 Estimate by Valuation Officer in certain cases [Sec. 142A] For the purposes of making an assessment or reassessment under this Act, where an estimate of the value

DIRECT TAXATION I 16.1

Assessment Procedure of any investment referred to in section 69 or section 69B or the value of any bullion, jewellery or other valuable article referred to in section 69A or section 69B or fair market value of any property reffered to in sub-section 2 or section 56 is required to be made, the Assessing Officer may require the Valuation Officer to make an estimate of such value and report the same to him. On receipt of the report from the Valuation Officer, the Assessing Officer may, after giving the assessee an opportunity of being heard, take into account such report in making such assessment or reassessment. Case Law : Assessing Officer can look into documents other than books of account for issuing directions - Submission of audited accounts per se would not oust the jurisdiction of the Assessing Officer to pass a direction for special audit. While applying his mind, the Assessing Officer need not confine himself only to the books of account submitted by the assessee, but can take into consideration such other documents related thereto which would be part of the assessment proceedings - Rajesh Kumar Ors. vs. Dy. CIT.287 ITR 91. 16.1.3 Assessment [Section 143] 16.1.3.1 Summary Assessment [Section 143(1)] Assessing Officer can complete the assessment without passing a regular assessment order. The assessment is completed on the basis of return submitted by the assessee. Assessing Officer has adopted a two-stage procedure of assessment as part of risk management strategy. In the first stage, all tax returns are processed to correct arithmetical mistakes, internal inconsistencies, tax calculation and verification of tax payment. At this stage, no verification of the income is undertaken. In the second stage, certain percentage of the tax returns are selected for scrutiny/ audit on the basis of the probability of deducting tax evasion. At this stage, the tax administration is concerned with the verification of the income. Total income of the assessee shall be computed under section 143(1) after making the following adjustments to the total income in the return (i) any arithmetical errors in the return; or (ii) an incorrect claim, if such incorrect claim is apparent from any information in the return. An intimation shall be sent to the assessee specifying the sum determined to be payable by, or the amount of refund due to, the assessee after the aforesaid corrections. The amount of refund due to the assessee shall be granted to him. No intimation shall be sent after the expiry of one year from the end of the financial year in which the return is made. The acknowledgement of the return shall be deemed to be the intimation in a case where no sum is payable by, or refundable to, the assessee, and where no adjustment has been made. An incorrect claim apparent from any information in the return has been defined. It means claim on the basis of an entry, in the return (i) of an item, which is inconsistent with another entry of the same or some other item in such return; (ii) information required to be furnished to substantiate such entry, has not been furnished under the Act; or (iii) in respect of a deduction, where such deduction exceeds specified statutory limit which may have been expressed as monetary amount or percentage or ratio or fraction As per amendment in section 143(1D) provides that processing of a return under section 143(1) shall not be necessary, where a scrutiny notice has been issued to the assessee under sub-section (2) of Section 143 (w.e.f. July 1, 2012) Adjustment through computerised processing only : All the adjustments such as arithmetical error,

16.2 I DIRECT TAXATION

incorrect claim, etc. are made only in the course of computerised processing. For this purpose, a system of centralised processing of returns has been established by the Department. A software will be designed to detect arithmetical inaccuracies and internal inconsistencies and make appropriate adjustments in the computation of total income. To facilitate this, the Board has formulated a scheme with view to expeditiously determine the tax payable by, or refund due to, the assessee. 16.1.3.2 Notice under section 143(2) A notice shall be served on the asessee within a period of 6 months from the end of the financial year in which return is furnished. The notice requires the assessee to produce any evidence which the assessee may rely in support of the return. If notice is sent to the assessee by registered post on last day of the period of limitation and it is served on the assessee a few days later, beyond period of limitation, it cannot be said to be validly served. 16.1.3.3 Regular Assessment [Section 143(3)] Where a return has been furnished under section 139, or in response to a notice under sub-section (1) of section 142, the Assessing Officer shall, if he considers it necessary or expedient to ensure that the assessee has not understated the income or has not computed excessive loss or has not under-paid the tax in any manner, serve on the assessee a notice requiring him under section 143(2)(ii), either to attend his office or to produce, any evidence on which the assessee may rely in support of the return. On the day specified in the notice issued under section 143(2) or as soon afterwards as may be, after hearing such evidence as the assessee may produce and such other evidence as the Assessing Officer may require on specified points and after taking into account all relevant material which Assessing Officer has gathered, the Assessing Officer shall, by an order in writing, make an assessment of the total income or loss of the assessee, and determine the sum payable by him or refund of any amount due to him on the basis of such assessment. Tax has to be determined and such determination is to be made in the assessment order or computation sheet to be annexed with the assessment order. [Kalyan Kumar Ray vs. CIT] The assessed income may be lower than the returned income. The boards circular no 549 para 5.12 dt. 31.10.1989 has been held to be ultra-vires [Gujarat Gas Co Ltd vs. JCIT(A)] 16.1.4 Best Judgement Assessment [Section 144] Best judgement assessment that is popularly known as ex-parte assessment can be made if the assessee fails to comply with the requirement of law as following :(1) The assessee fails to file a return u/s 139 and has not made a return or a revised return under subsection (4) or (5) of Section 139. (2) He fails to comply with the terms of the notice issued u/s 142(1) or fails to comply with a direction issued u/s 142(2A). (3) After filing a return he fails to comply with all the terms of the notice issued u/s 143(2). The non-compliances are independent and not cumulative. A single non compliance can lead to best judgement u/s 144. In such a situation the A.O. after taking into account all relevant materials which he has gathered and after giving the assessee an opportunity of being heard shall make an assessment of income or loss to the best of his judgement and determine the sum payable by him. However, where a notice u/s 142(1) has already been issued to the assessee it will not be necessary to give him such opportunity of being heard. Provided that such opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to shaw cause, on a date and time to be specified in the notice, why the assessment should not be completed to the best of his judgment.

DIRECT TAXATION I 16.3

Assessment Procedure Best judgement assessment is mandatory for any one of the defaults u/s 144 - CIT vs. Segn. Buchiah Sethy [1970] 77 ITR 539 (SC). Where Assessing Officer, on finding that assessee had not maintained and kept any quantitative details/ stock register for goods traded in by it; that there was no evidence on record or document to verify basis of valuation of closing stock shown by assessee; and that GP rate declared by assessee during Assessment Year did not match result declared by assessee itself in previous Assessment Years, rejected assessees books of account and resorted to best judgment assessment under section 144, it was held that since cogent reasons had been given by Assessing Officer for doing so, there was no reason to take a different view - Kachwala Gems vs. Jt. CIT 158 Taxman 71. The assessments made on the basis of the assessees accounts and those made on best judgment basis are totally different types of assessments - CST vs. H.M. Esufali H.M. Abdulai 90 ITR 271. The mere fact that the material placed by the assessee before the Assessing Officer is unreliable does not empower the officer to make an arbitrary order. The power to make a best judgment assessment is not an arbitrary power - State of Orissa vs. Maharaja Shri B.P. Singh Deo 76 ITR 690. 16.1.5 Power of Joint Commissioner to issue directions in certain cases [Sec. 144A] A Joint Commissioner may, on his own motion or on a reference being made to him by the Assessing Officer or on the application of an assessee, call for and examine the record of any proceeding in which an assessment is pending and, if he considers that, having regard to the nature of the case or the amount involved or for any other reason, it is necessary or expedient so to do, he may issue such directions as he thinks fit for the guidance of the Assessing Officer to enable him to complete the assessment and such directions shall be binding on the Assessing Officer. Provided that no directions which are prejudicial to the assessee shall be issued before an opportunity is given to the assessee to be heard. 16.1.6 Reference to Commissioner in certain cases [Section 144BA] [Applicable w.e.f. 1.4.2014] (1) If, the Assessing Officer, at any stage of the assessment or reassessment proceedings before him having regard to the material and evidence available, considers that it is necessary to declare an arrangement as an impermissible avoidance arrangement and to determine the consequence of such an arrangement within the meaning of Chapter X-A, then, he may make a reference to the Commissioner in this regard. (2) The Commissioner shall, on receipt of a reference u/s 144BA (1), if he is of the opinion that the provisions of Chapter X-A are required to be invoked, issue a notice to the assessee, setting out the reasons and basis of such an opinion, for submitting objections, if any, and providing an opportunity of being heard to the assessee within such period, not exceeding sixty days, as may be specified in the notice. (3) If the assessee does not furnish any objection to the notice within the time specified in the notice issued under sub-section (2) of this section, the Commissioner shall issue such directions as it deems fit in respect of declaration of the arrangement to be an impermissible avoidance arrangement. (4) In case the assessee objects to the proposed action, and the Commissioner, after hearing the assessee in the matter, is not satisfied by the explanation of the assessee, then, he shall make a reference in the matter to the Approving Panel for the purpose of declaration of the arrangement as an impermissible avoidance arrangement. (5) If the Commissioner is satisfied, after having heard the assessee that the provisions of Chapter X-A are not to be invoked, he shall by an order in writing communicate the same to the Assessing Officer with a copy to the assessee. (6) The Approving Panel, on receipt of reference from the Commissioner u/s 144BA (4) shall issue such directions, as it deems fit, in respect of the declaration of the arrangement as an impermissible

16.4 I DIRECT TAXATION

avoidance arrangement in accordance with the provisions of Chapter X-A including specifying the Previous Year or Years to which such declaration of an arrangement as an impermissible avoidance arrangement shall apply. (7) No direction under sub-section (6) shall be issued unless an opportunity of being heard is given to the assessee and the Assessing Officer on such directions which are prejudicial to the interest of the assessee or the interest of the revenue, as the case may be. (8) The Approving Panel may, before issuing any direction u/s 144BA (6), (i) if it is of the opinion that any further inquiry in the matter is necessary, direct the Commissioner to make such further inquiry or cause to make such further inquiry to be made by any other income-tax authority and furnish a report containing the results of such inquiry to it; or

(ii) call for and examine such records related to the matter as it deems fit; or (iii) require the assessee to furnish such document and evidence as it may so direct.

(9) No direction u/s 144BA (6) shall be issued after a period of six months from the end of the month in which the reference u/s 144BA (4) was received by the Approving Panel. (10) The Board shall, for the purposes of this section constitute an Approving Panel consisting of not less than three members, being (i) income-tax authorities not below the rank of Commissioner; and (ii) an officer of the Indian Legal Service not below the rank of Joint Secretary to the Government of India.

16.1.7. Provision for constitution of alternate dispute resolution mechanism for order of the Transfer Pricing Officer, and foreign company (Section 144C) [W.e.f. 1-10-2009] The dispute resolution mechanism presently in place is time consuming and finality in high demand cases is attained only after a long drawn litigation till Supreme Court. Flow of foreign investment is extremely sensitive to prolonged uncertainty in tax related matter. Therefore, the Act has amended the Income-tax Act to provide for an alternate dispute resolution mechanism, which will facilitate expeditious resolution of disputes in a fast track basis. The salient features of the alternate dispute resolution mechanism are as under: 1. The Assessing Officer shall not withstanding anything to the contrary contained in this Act, forward a draft of the proposed order of assessment (hereinafter in this section referred to as the draft order) to the eligible assessee if he proposes to make, on or after 1-10-2009, any variation in the income or loss returned which is prejudicial to the interest of such assessee. 2. On receipt of the draft order, the eligible assessee shall, within thirty days of the receipt by him of the draft order, (a) File his acceptance of the variations to the Assessing Officer; or (b) File his objections, if any, to such variation with, (i) The Dispute Resolution Panel; and (ii) The Assessing Officer.

3. The Assessing Officer shall complete the assessment on the basis of the draft order, if (a) The assessee intimates to the Assessing Officer the acceptance of the variation; or (b) No objections are received within the period specified in sub-section (2) i.e. 30 days of the receipts of draft order by the eligible assessee.

DIRECT TAXATION I 16.5

Assessment Procedure 4. The Assessing Officer shall, notwithstanding anything contained in section 153 or section 153B, pass the assessment order under section 144C(3) within one month from the end of the month in which, (a) The acceptance is received; or (b) The period of filing of objections under sub-section (2) expires. The Dispute Resolution Panel shall, in a case where any objections are received under sub-section (2), issue such directions, as it thinks fit, for the guidance of the Assessing Officer to enable him to complete the assessment. The Dispute Resolution Panel shall issue the directions referred to in sub-section (5), after considering the following, namely: (a) Draft order; (b) Objections filed by the assessee; (c) Evidence furnished by the assessee; (d) Report, if any, of the Assessing Officer, Valuation Officer or Transfer Pricing Officer or any other authority; (e) Records relating to the draft order; (f) Evidence collected by, or caused to be collected by, it; and (g) Result of any enquiry made by, or caused to be made by it. The Dispute Resolution Panel may, before issuing any directions referred to in sub-section(5), (a) Make such further enquiry, as it thinks fit; or (b) Cause any further enquiry to be made by any Income Tax Authority and report the result of the same to it. The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction under sub-section (5) for further enquiry and passing of the assessment order. Explanation- For the removal of doubts, it is hereby declared that the power of the Dispute Resolution Panel to enhance the variation shall include and shall be deemed always to have included the power to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding that such matter was raised or not by the eligible assessee. If the members of the Dispute Resolution Panel differ in opinion on any point, the point shall be decided according to the opinion of the majority of the members.

5.

6. 7. 8.

9.

10. Every direction issued by the Dispute Resolution Panel shall be binding on the Assessing Officer. 11. No direction under sub-section (5) shall be issued unless an opportunity of being heard is given to the assessee and the Assessing Officer on such directions which are prejudicial to the interest of the assessee or the interest of the revenue, respectively. 12. No direction under sub-section (5) shall be issued after nine months from the end of the month in which the draft order is forwarded to the eligible assessee. 13. Upon receipt of the directions issued under sub-section (5), the Assessing Officer shall, in conformity with the directions, complete, notwithstanding anything to the contrary contained in section 153 or section 153B, the assessment without providing any further opportunity of being heard to the assessee, within one month from the end of the month in which the direction is received. 14. The Board may make rules for the efficient functioning of the Dispute Resolution Panel and expeditious

16.6 I DIRECT TAXATION

disposal of the objections filed, under sub section (2), by the eligible assessee. 15. According to sub-section 14A of section 144C [w.e.f. 1.4.2013], the provisions of this section shall not apply to any assessment or reassessment order passed by the Assessing officer with the prior approval of the commissioner u/s 144BA(12). 16. For the purposes of this section, (a) Dispute Resolution Panel means a collegium comprising of 3 Commissioners of Income Tax constituted by the Board for this purpose; (b) eligible assessee means, (i) Any person in whose case the variation referred to in sub-section (1) arises as a consequence of the order of the Transfer Pricing Officer passed under sub-section (3) of section 92CA; and

(i)

(ii) any foreign company. Section 131(1) so as to provide that Dispute Resolution Panel shall have the same powers as are vested in a Court under the Code of Civil Procedure, 1908;

Further, the following consequential amendments have been made

(ii) Section 246(1)(a) has been amended so as to exclude the order of assessment passed under section 143(3) or order of re-assessment under section 147 in pursuance of directions of Dispute Resolution Panel as an appealable order. (iii) Section 253(1) has been amended to insert clause (d) so as to include an order of assessment passed under section 143(3) or order of re-assessment under section 147 in pursuance of directions of Dispute Resolution Panel as an appealable order.

An order passed under section 154 rectifying such order shall also be appealable to IT Act. 16.1.8 Income Escaping Assessment [Sec. 147] If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any Assessment Year, he may, subject to the provisions of section 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or recompute the loss or the depreciation allowance or any other allowance, as the case may be, for the Assessment Year concerned. Where an assessment under section 143(3) or section 147 has been made for the relevant Assessment Year, no action shall be taken under this section after the expiry of four years from the end of the relevant Assessment Year, unless any income chargeable to tax has escaped assessment for such Assessment Year by reason of the failure on the part of the assessee to make a return under section 139 or in response to the notice issued under section 142 or section 148 or to disclose fully and truly all material facts necessary for his assessment, for that Assessment Year. Nothing contained in the first proviso shall apply in a case where any income in relation to any assets (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment for any Assessment Year. The Assessing Officer may assess or reassess such income, other than the income involving matters which are the subject matters of any appeal, reference or revision, which is chargeable to tax and has escaped assessment. Reassessment of income in relation to any asset located outside India : The existing time limit for reassessment of 4 years from the end of the Assessment Year, shall not apply in a case where any income in relation to any asset (including financial interest in any asset located

DIRECT TAXATION I 16.7

Assessment Procedure outside India) which is chargeable to tax, has been escaped assessment for any Assessment Year. Assessing Officer empowered to touch upon any other issue for which no reasons have been recorded notwithstanding that the reasons for such issue have not been included in the reasons recorded [Section 147] [W.r.e.f. Assessment Year 1989-90] The existing provisions of section 147 provides, inter alia, that if the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any Assessment Year, he may assess or reassess such income after recording reasons for re-opening the assessment. Further, he may also assess or reassess such other income which has escaped assessment and which comes to his notice subsequently in the course of proceedings under this section. Sonic Courts have held that the Assessing Officer has to restrict the reassessment proceedings only to issues in respect of which the reasons have been recorded for reopening the assessment. He is not empowered to touch upon any other issue for which no reasons have been recorded. The above interpretation is contrary to the legislative intent. With a view to further clarifying the legislative intent, the Act has inserted Explanation 3 in section 147 to provide that the Assessing Officer may assess or reassess income in respect of any issue which comes to his notice subsequently in the course of proceedings under this section, notwithstanding that the reason for such issue has not been included in the reasons recorded under section 148(2). Case Law : (i) A writ petition challenging reassessment, cannot be thrown out at the threshold on the ground that it is not maintainable - Techspan India (P.) Ltd. vs. ITO 283 ITR 212 .

(ii) If the direction by the Commissioner is to reopen the assessment under section 147 by passing the statutory formalities, that would probably amount to dictating his subordinate to act in a particular way thereby taking away the discretion vested in the subordinate - CIT vs. Abdul Khader Ahamed 156 Taxman 206. (iii) Disclosure in wealth-tax proceedings will not suffice - Arun Kumar Maheshwari vs. ITO 144 Taxman 651. 16.1.9 Issue of notice where income has escaped assessment [Section 148] (1) Before making the assessment, reassessment or recomputation under section 147, the Assessing Officer shall serve on the assessee a notice requiring him to furnish within specified period, a return of his income or the income of any other person in respect of which he is assessable. (2) The Assessing Officer shall, before issuing any notice under this section, record his reasons for doing so. Legal Notes Notice under this section is to be mandatorily served by the Assessing Officer before initiating proceedings u/s 147. The notice is served on the assessee when it is received by him. Notice is to be issued within the time limits prescribed by section 149. Section 149(2) states that issue of such notice is subject to the provisions of section 151. Thus, approval for the issue of such notice is to be taken u/s 151 before its issue. Such notice can be issued by the Assessing Officer only after he records his reasons for doing so. The return to be furnished in response to such notice is treated as a return required to be furnished u/s 139 and the provisions of this Act, so far as may be, apply accordingly. Return in response to a notice under this section is to be furnished even if a return has been furnished earlier by the assessee under other provisions of the Act.

16.8 I DIRECT TAXATION

Notice under this section can be issued even where an assessment u/s 143(3) has not been made but related intimations have been sent. [Ranchi Club Ltd. vs. CIT214 ITR 643] If reasons are supplied along with the notice under section 148(2), it shall obviate unnecessary harassment to the assessee as well as to the revenue by avoiding unnecessary litigation which will save courts also from being involved in unproductive litigation. Above all, it shall be in consonance with the principles of natural justice - Mitilesh Kumar Tripathi vs. CIT 280 ITR 16.

Case Law: (i)

(ii) The notice prescribed by section 148 cannot be regarded as a mere procedural requirement. It is only if the said notice is served on the assessee that the ITO would be justified in taking proceedings against the assessee. If no notice is issued or if the notice issued is shown to be invalid, then the proceedings taken by the ITO would be illegal and void - Y. Narayana Chetty vs. ITO 1959 35 ITR 388; CIT vs. Thayaballi Mulla Jeevaji Kapasi 66 ITR 147 ; CIT vs. Kurban Hussain Ibrahimji Mithiborwala 82 ITR 821. (iii) Where the Appellate Assistant Commissioner set aside the reassessment on the only ground that the assessee was not afforded opportunity to put forward his case, but did not hold that the notice issued under section 148 was invalid, there would be no need for the ITO to issue a fresh notice to the assessee - CIT vs. T.S.PL.P. Chidambaram Chettiar 80 ITR 467. (iv) Notice cannot be issued unless the return which has already been filed has been disposed of - CIT vs. M.K.K.R. Muthukaruppan Chettiar 78 ITR 69 ; Bhagwan Das Sita Ram (HUF) vs. CIT 146 ITR 563. 16.1.10 Time limit for notice [Section 149] (1) No notice under section 148 shall be issued for the relevant Assessment Year (a) if four years have elapsed from the end of the relevant Assessment Year, unless the case falls under clause (b) or clause (c); (b) if four years, but not more than six years, have elapsed from the end of the relevant Assessment Year unless the income chargeable to tax which has escaped assessment amounts to or is likely to amount to one lakh rupees or more for that year. (c) If four years, but not more than sixteen years, have elapsed from the end of the relevant Assessment Year unless the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment. Time-limit applies for Issue and not for service - R.K. Upadhyaya vs. Shanabhai P Patel 1987 166 ITR 163 (SC). Amended law will apply only if limitation has not already expired - Chandiram vs. ITO 1996 87 Taxman 418 (Raj.). The word issued in section 149 should be given its natural meaning and not the strained wider meaning of served. Consequently, where the notice was issued within time but was served on the assessee after the expiry of the time-limit, it could not be held to be invalid - R.K. Upadhyaya vs. Shanabhai P. Patel 166 ITR 163 (SC); CIT vs. Sheo Kumari Debi 157 ITR 13 and Jai Hanuman Trading Co. (P.) Ltd. vs. CIT 110 ITR 36. 16.1.11 Provision for cases where assessment is in pursuance of an order on appeal, etc. [Section150] (1) Notwithstanding anything contained in section 149, the notice under section 148 may be issued at any time for the purpose of making an assessment or reassessment or recomputation in consequence of or to give an effect to any finding or direction contained in an order passed by any authority in any proceeding under this Act by way of appeal, reference or revision or by a Court in any proceeding under any other law. (2) The provisions of sub-section (1) shall not apply in any case where any such assessment, reassessment or recomputation as is referred to in that sub-section relates to an Assessment Year in respect of

DIRECT TAXATION I 16.9

Assessment Procedure which an assessment, reassessment or recomputation could not have been made at the time the order which was the subject-matter of the appeal, reference or revision, as the case may be, was made by reason of any other provision limiting the time within which any action for assessment, reassessment or recomputation may be taken. This section prescribes the time limit for issuance of notice u/s 148 in a special case. This section overrides the provisions of section 149. Section 149 vide sub-section (2) provides that issue of notice u/s 148 is subject to the provisions of section 151. Thus, approval u/s 151 for issue of notice u/s 148(1) is not required in a case covered by section 150 [Sukhdayal Pahwa vs. CIT [1983] 140 ITR 206 (MP)]. Notwithstanding the time limits prescribed by section 149, notice u/s 148 can be issued at any time for making assessment, etc., to give effect to any finding or direction referred to in subsection (1). The order referred to therein may be an order u/s 250, 254, 260, 262, 263 or 264. The power conferred by sub-section (1) to the revenue for making assessment, etc., is withdrawn in a special case covered by sub-section (2). This covers a case where the order for an Assessment Year is made such order being the subject matter of an appeal, reference or revision, the finding or direction of which results in an assessment, etc., referred to in subsection (1). However, at the time such order is made, the assessment etc, in respect of that A.Y. is itself time barred by virtue of any other provision of this Act. Sub-section (2) applies to such cases. Also see Explanations 2 and 3 to section 153.

16.1.12 Sanction for issue of notice [Section 151] (1) In a case where an assessment under sub-section (3) of section 143 or section 147 has been made for the relevant Assessment Year, no notice shall be issued under section 148 by an Assessing Officer, who is below the rank of Assistant Commissioner or Deputy Commissioner, unless the Joint Commissioner is satisfied on the reasons recorded by such Assessing Officer that it is a fit case for the issue of such notice. Provided that, after the expiry of four years from the end of the relevant Assessment Year, no such notice shall be issued unless the Chief Commissioner or Commissioner is satisfied, on the reasons recorded by the Assessing Officer aforesaid, that it is a fit case for the issue of such notice.

(2) In a case other than a case falling under sub-section (1), no notice shall be issued under section 148 by an Assessing Officer, who is below the rank of Joint Commissioner, after the expiry of four years from the end of the relevant Assessment Year, unless the Joint Commissioner is satisfied, on the reasons recorded by such Assessing Officer, that it is a fit case for the issue of such notice. Reasons need not be communicated to assessee. Commissioner must not accord sanction mechanically. Ascent must be commissioners own hand. Commissioner must give fair hearing to assessee. Whether a mere yes or no endorsement will suffice. Case Law: There is no requirement in any of the provisions of the Act or any section laying down as a condition for the initiation of the proceedings that the reasons which induced the Commissioner to accord sanction to proceed under section 147 must also be communicated to the assessee [S. Narayanappa vs. CIT 63 ITR 219]. 16.1.13 Other provisions [Section 152] (1) In an assessment, reassessment or recomputation made under section 147, the tax shall be chargeable at the rate or rates at which it would have been charged had the income not escaped assessment.

16.10 I DIRECT TAXATION

(2) Where an assessment is reopened under section 147, the assessee may, if he has not impugned any part of the original assessment order for that year either under sections 246 to 248 or under section 264, claim that the proceedings under section 147 shall be dropped on his showing that he had been assessed on an amount or to a sum not lower that what he would be rightly liable for even if the income alleged to have escaped assessment had been taken into account, or the assessment or computation had been properly made. Provided that in so doing he shall not be entitled to reopen matters concluded by an order under section 154, 155, 260, 262 or 263. 16.1. 14 Time limit for completion of assessment and reassessment [Section 153] Regular assessment u/s 143 or 144 must be made within two years of the relevant Assessment Year or one year from the end of the Financial Year in which the return was filed whichever is later. The provisions of Section 153 and 153B has been amended to provide an additional 3 months time limit for completion of assessment over the previous time line. The present position is appended below : Proceeding section 143 under Previous allowed time limit Amended time limit 24 months from the end of the Assessment Year 36 months from the end of the Assessment Year 24 months from the end of the financial year in which notice was issued 24 months from the end of the financial year in which notice was issued 12 months from the end of the financial year in which order was received 24 months from the end of the financial year in which order was received

21 months from the end of the Assessment Year 143 and 92CA (Trans- 33 months from the end of the fer pricing) Assessment Year 21 months from the end of the 148 financial year in which notice was issued 148 & 92CA 250, 254 or 263 250,254,263 & 92CA 21 months from the end of the financial year in which notice was issued 9 months from the end of the financial year in which order was received 21 months from the end of the financial year in which order was received

Note : Corresponding changes has also been incorporated in Wealth Tax Provisions. 16.1.15 Assessment in case of search or requisition [Section 153A] Notwithstanding anything contained in section 139, section 147, section 148, section 149, section 151 and section 153, in the case of a person where a search is initiated under section 132 or books of account, other documents or any assets are requisitioned under section 132A after the 31st day of May, 2003, the Assessing Officer shall (a) issue notice to such person requiring him to furnish within such period, as may be specified in the notice, the return of income in respect of each Assessment Year falling within six Assessment Years referred to in clause (b), in the prescribed form and verified in the prescribed manner and setting forth such other particulars as may be prescribed and the provisions of this Act shall, so far as may be, apply accordingly as if such return were a return required to be furnished under section 139; (b) assess or reassess the total income of six Assessment Years immediately preceding the Assessment Year relevant to the Previous Year in which such search is conducted or requisition is made. The Assessing Officer shall assess or reassess the total income in respect of each Assessment Year falling within such six Assessment Years.

DIRECT TAXATION I 16.11

Assessment Procedure It is provided that assessment or reassessment, if any, relating to any Assessment Year falling within the period of six Assessment Years referred to in section 153A(1) pending on the date of initiation of the search under section 132 or making of requisition under section 132A, as the case may be, shall abate. Provided also that the Central Government may by rules made by it and published in the Official Gazette (except in case where any assessment or reassessment has abated under the second proviso), specify the class or classes of cases in which the Assessing Officer shall not be required to issue notice for assessing or reassessing the total income for six Assessment Years immediately preceding the Assessment Year relevant to the Previous Year in which search is conducted or requisition is made. Except as otherwise provided in this section, section 153B and section 153C, all other provisions of this Act shall apply to the assessment made under this section; In an assessment or reassessment made in respect of an Assessment Year under this section, the tax shall be chargeable at the rate or rates as applicable to such Assessment Year. 16.1.16 Prior approval necessary for assessment in cases of search or requisition [Section 153D] No order of assessment or reassessment shall be passed by an Assessing Officer below the rank of Joint Commissioner in respect of each Assessment Year referred to in clause (b) of section 153A or the Assessment Year referred to in clause (b) of sub-section (1) of section 153B, except with the prior approval of the Joint Commissioner.

16.12 I DIRECT TAXATION

QUESTIONS & ANSWERS ON ASSESSMENT PROCEDURE

Question 1: What is a protective assessment under Income-tax law? What is the procedure followed for the recovery of tax in such cases? Answer: A protective assessment is made in a case where there are doubts relating to the true ownership of the income. If there is an uncertainty about the taxing of an income in the hands of Mr. A or Mr. B, then at the discretion of the Assessing Officer, the same may be added in the hands of one of them on protective basis. This is to ensure that on finality, the addition may not be denied on the ground of limitation of time. Once finality regarding the identity of the tax payer to be taxed is established, the extra assessment is cancelled. But the Department cannot recover the tax from both the assessees in respect of the same income. Penalty cannot be imposed on the strength of a protective assessment. Question 2: Joseph, engaged in profession, filed his return of income for Assessment Year 2013-14 on 15th November, 2013. He disclosed an income of `4,00,000 in the return. In February, 2014 he discovered that he did not claim certain expenses and filed a revised return on 3rd February, 2014 showing an income of `1,80,000 and claiming those expenses. Is the revised return filed by Joseph acceptable? Answer: Joseph is engaged in profession. The due date for filing income tax return for Assessment Year 2013-14 as per section 139(1) of the Income-tax Act is 30th September, 2013 if his accounts are required to be audited under any law. The due date is 31st July, 2013 if the accounts are not required to be audited under any law. The return was filed beyond the due date prescribed in section 139(1). The return so filed is covered by section 139(4) and the time limit is one year from the end of the relevant Assessment Year. The Apex court in Kumar Jagadish Chandra Sinha vs. CIT 220 ITR 67 (SC) has held that a return filed under section 139(4) is not eligible for revision and hence a revised return cannot be filed. Hence, the revised return filed by Joseph is not valid as the original return was not filed before the due date mentioned in section 139(1). Question 3: An assessee filed a return of income on 31.8.2013 in respect of Assessment Year 2013-14 disclosing an income of `5 lakhs from business. It was not accompanied by proof of payment of tax due on self-assessment. Discuss the validity of such a return. Answer :As per Explanation to sub-section (9) of section 139 a return is regarded as defective unless it is accompanied by proof of tax deducted at source, advance tax and tax on self-assessment, if any, claimed to have been paid. Therefore, the return is prima facie defective. It is not invalid at that stage. On receipt of the return, the Assessing Officer has to intimate the defect to the assessee and give him an opportunity to rectify the defect within a period of 15 days from the date of such intimation or within such further period which, on application by the assessee, he may, in his discretion, allow. If the defect is not rectified within the said period, the return will be treated as an invalid return and the provisions of the Income-tax Act shall apply, as if the assessee has failed to furnish the return. Also, it may be noted that section 140A(3) says that if an assessee fails to pay tax or interest on self assessment he shall be deemed to be an assessee in default in respect of the tax or interest or both remaining unpaid and all the provisions of the Act shall apply accordingly. Question 4: If an assessment is remanded back to Assessing Officer, can he introduce new sources of income for assessment? Answer: Where the assessment is set aside by the Tribunal and the matter remanded to the Assessing Officer, it is not open to him to introduce into the assessment new sources of income so as to enhance the assessment. Any power to enhance is confined to the old sources of income which were the subject matter of appeal [Kartar Singh vs.CIT (1978) 111 ITR 184 (P &H)]. Question 5: Can Department make fresh computation, once the assessment is made final? Answer: It is now a well settled principle that an assessment once made is final and that it is not open

DIRECT TAXATION I 16.13

Assessment Procedure to the department to go on making fresh computation and issuing fresh notices of demand to the end of all time. [ITO vs.Habibullah (S.K.) (1962) 44 ITR 809 (SC)] Question 6: Can an Assessing Officer make an assessment for a year other than the assessment year for which the return is filed? Answer: It is not open to the Assessing Officer to make assessment in respect of a year other than the Assessment Year for which the return is filed. Thus, in respect of a return filed for Assessment Year 201011, assessment cannot be made for the Assessment Year 2011-12. [CIT vs. Amaimugan Transports Pvt. Ltd. (1995) 215 ITR 553 (Mad.)] Question 7: Can an Assessing Officer assess the income below the returned income or assess the loss higher than the returned loss? Answer: The Assessing Officer cannot assess income under section 144 for an assessment below the returned income or cannot assess the loss higher than the returned loss. Question 8: Can incomplete, unsigned or unverified return lead to best judgement assessment? Answer: Incomplete, unsigned or unverified return may lead to best judgement assessment. A best judgement assessment can be made when the return is filed woefully incomplete or not signed and verified. [Behari Lal Chatterji vs.CIT (1934) 2 ITR 377 (All.)] Question 9: Can assessee follow different method of accounting for different businesses? Answer: If an assessee is carrying on more than one business, he can follow cash system of accounting for one business and mercantile system (accrual system) of accounting for other business. Similarly, if he had more than one sources of income under the head Income from Other Sources, he can follow accrual system for one source of income under the head Income from Other Sources, and cash system for other sources of income. Question 10: What can Assessing Officer do when the assessment is not set aside for fresh assessment but annulled? Answer: Where an assessment is not set aside for fresh assessment but annulled, no extended limitation is available. However, if the original time limit is available, the Assessing Officer may proceed from the stage at which illegality which resulted into the annulment of the assessment supervened and make the assessment afresh. [CIT vs.Mrs.Ratanbai N.K. Dubhash (1998) 230 ITR 495(Bom.)]

16.14 I DIRECT TAXATION

Study Note - 17
ASSESSMENT OF VARIOUS ENTITIES & TAX PLANNING
This Study Note includes 17.1 Assessment of Individual 17.2 Assessment of HUF 17.3 Assessment of Firm 17.4 Assessment of LLP 17.5 Assessment of AOP & BOI 17.6 Assessment of Companies 17.7 Assessment of Co-operative Society 17.8 Assessment of Trust 17.9 Tax Planning 17.1 ASSESSMENT OF INDIVIDUALS Tax incidence on Individuals While computing taxable Income of an Individual following points should be considered. Nature of Income Income earned by the taxpayer Tax Treatment Except the following all other incomes shall be included (a) Income exempt under sections 10 to 13A (b) Incomes to be included in income of others by virtue of section 60 to 64. Share of Profit from Hindu Undivided Family Share of Profit from a firm assessed as firm Salary and Interest from the aforesaid firm It is exempt under section 10(2) It is exempt under section 10(2A) These are taxable as business Income

Share of profit from an Association of Persons/Body If the association/body is taxable at the maximum of Individuals marginal rate (or at higher rate), then share of profit is not taxable in hands of recipient. Income earned by others and included in the Such income shall be included in the income of the income of the taxpayer by virtue of section 60 to 64 taxpayer. Special Provisions for persons governed by Portuguese Civil Law (Section 5A) This Section is applicable for the appropriation of income between spouses governed by the Portuguese Civil Code which is in force in the state of Goa and Union territories of Dadra and Nagar Haveli and Daman and Diu. By virtue of this section, income from all other sources, except from salary, should be apportioned equally between husband and wife. The income so apportioned will be included separately in the total income of the husband and of the wife and the remaining provisions of act shall apply accordingly. Salary Income is, however, taxable in the hands of the spouse who has actually earned it.

DIRECT TAXATION I 17.1

Assessment of Various Entities & Tax Planning Even the income from profession will be apportioned equally between the husband and the wife- CIT vs. Datta vs. Gaitonde [2002] 241 ITR 241/108/ taxman 533(Bom). Taxable income shall be computed as follows : Step 1- Step 2- Income under the different heads of income -First find out income under the five heads of income Adjustment of losses of the current year and earlier years- Losses should be set off according to the provisions of sections 70 to 78. The income after adjustment of losses is the gross total income. Deduction from gross total income- Deductions specified under Chapter VI A should be considered while calculating the gross total income. Rounding off- The balance should be rounded off to the nearest ` 10. It is called as net income or taxable income or total income.

Step 3- Step 4- Tax Liability :

Normal Rates of Income Tax I. In the case of every Individual (including Non Resident) or Hindu Undivided Family or AOP/BOI (other than a co-operative society) whether incorporated or not, or every Artificial Judicial Person Upto ` 2,00,000 ` 2,00,001 to ` 5,00,000 ` 5,00,001 to ` 10,00,000 Above ` 10,00,000 Nil 10% 20% 30%

II. In the case of every individual, being a resident in India, who is of the age of 60 years or more at any time during the Previous Year. [Senior Citizen] Upto ` 2,50,000 ` 2,50,001 to ` 5,00,000 ` 5,00,001 to ` 10,00,000 Above ` 10,00,000 Nil 10% 20% 30%

III. In the case of every individual, being a resident in India, who is of the age of 80 years or more at any time during the Previous Year. [Super Senior Citizen] Upto ` 5,00,000 ` 5,00,001 to ` 10,00,000 Above ` 10,00,000 Note : No surcharge is payable by the above assessees. Education Cess @ 2%, and Secondary and Higher Education Cess (SHEC) @ 1% on income tax shall be chargeable. Calculation of Tax Liability: Step 1 Determine Net Income and tax payable thereon at the slab rate. Step 2 Add education cess and secondary and higher secondary education cess Step 3 Deduct rebate u/s 86, 89, 90,90A and 91 Nil 20% 30%

17.2 I DIRECT TAXATION

Step 4 Add interest payable (if any) Step 5 Deduct amount of prepaid taxes paid (Advance Tax, Tax Deducted at Source, etc.) The Balance so arrived is the amount of tax to be paid. Note: From the Assessment Year 2013-14, tax payable (i.e. amount arrived at Step 3) cannot be less than 18.5 percent of Adjusted Total Income in some Specified Cases. Special Provisions relating to non-residents [Section 115C to 115I] The benefit of special provisions can be claimed by non-resident Indians. The following are non-resident Indians for the purpose: a. b. citizen of India who is a non-resident ; a person of Indian origin who is a non-residen

A person shall be deemed to be of Indian origin if he or either of his parents or any of his grandparents, was born in an undivided India. The Provisions of Section 115C to 115I are applicable only in respect of the following incomes derived by a non resident Indian: a. b. Investment income derived from a foreign exchange assets; and Long Term Capital Gains on sale or transfer of foreign exchange assets.

Foreign Exchange Asset - It means those specified asset which the assessee has acquired or purchased with, or subscribed to in, convertible foreign exchange; The following are the specified assets: a. b. c. d. e. shares in an Indian Company (public or private) debentures issued by an Indian Company which is not a Private Company ; deposits with an Indian Company which is not a Private Company, it may be even deposit with SBI or any other Banking Company; any security of the Central Government ; and such other asset as the Central Government may specify in this behalf by notification in the Official Gazette.

Investment Income In computing the Investment income of a non-resident Indian, no deduction in respect of any expenditure or allowance shall be allowed under any provision of the Act. Moreover, no deduction under Sections 80C to 80U shall be allowed in respect of investment income of nonresident Indians. Long Term Capital Gain Long Term Capital Gain on sale or transfer of foreign exchange assets shall be calculated subject to: 1. 2. The benefit of Indexation is not available for the sale or transfer of foreign exchange assets. The non-resident Indian can claim exemption under section 115F by investing sale consideration in another asset.

3. No deduction is permissible under section 80C to 80U in respect of Long Term Capital Gain.

DIRECT TAXATION I 17.3

Assessment of Various Entities & Tax Planning Tax treatment on Investment and Long Term Capital Gain: Non-resident Indians are chargeable to tax on investment and Long Term Capital Gain at the rate of 20 percent and 10 percent respectively. (plus surcharge, education cess and secondary and higher secondary education cess) General Provisions Rate of Tax Similar to resident assessees. Special rates of tax on Dividends, interest income from units of Mutual Fund and UTI, bonds or shares purchased in foreign currency and Capital Gains arising from their transfer : 20% of the dividends [which have not been subjected to additional Income Tax u/s 115-O] [other than dividends mentioned in clause (iv)]; 20% of the interest received from Government or an Indian concern on monies borrowed or debt incurred in foreign currency; 20% of the income received in respect of units purchased in foreign currency, of a Mutual Fund specified u/s 10(23D) or of the Unit Trust India; 10% of the interest or dividends [which have not been subjected to additional income tax u./s 115-O], in respect of bonds or Global Depository Receipts in an Indian company purchased in foreign currency and issued under the Foreign Currency Convertible Bonds and Ordinary shares (Through Depository Receipt Mechanism) Scheme, 1993 (commonly known as Euro Issues/Euro Bonds) or in respect of bonds or Global Depository Receipts issued against shares of a public sector company sold by the Government to the non-resident in foreign currency; and 10% of the Long-term Capital Gains arising from the transfer of the aforesaid bonds or Global Depository receipts.

Filing of return Similar to resident assessees : However, a non-resident shall not be required to file a return of income u/s. 139(1), if his total income consists only of income subject to special rates of tax as mentioned in rate of tax under clauses (iv) supra and the tax has been deducted there from at source. Return of Income not to be filled in certain cases: Where a non-resident Indian has income only from a foreign exchange asset or income by way of Long Term Capital Gains arising on transfer of a foreign exchange asset, or both, and tax deductible at source from such income has been deducted, he is not required to file the return of income under section 139(1). The income from foreign exchange assets and Long Term Capital Gains arising on transfer of such assets would be treated as separate block and charged to tax at a flat rate as explained above. If the non-resident Indian has other Income in India, such other income is treated as an altogether separate block and charged to tax in accordance with other provisions of the Act. Benefit available even after the assessee becomes resident These provisions are as follows: 1. 2. A non-resident Indian in any Previous Year becomes assessable as resident in India in any subsequent year. He may furnish to the Assessing Officer a declaration in writing(along with his return of income under section 139 for the Assessment Year for which he is so assessable)to the effect that the special provisions shall continue to apply to him in relation to the investment income derived from any

17.4 I DIRECT TAXATION

foreign exchange asset. 3. The foreign exchange assets for this purpose are debentures and deposit with an Indian public limited company and Central Government securities.

The special provisions shall continue to apply for that Assessment Year and for every subsequent Assessment Year till the transfer or conversion (otherwise than by transfer) into money of such assets. Special Provisions not to apply if the assessee so chooses (Section 115-I) A non-resident Indian may opt that the special provisions should not apply to him by making a declaration to that effect in his return of income for the relevant Assessment Year. In such case the whole of his Income (including income from foreign exchange assets and Long Term Capital Gains arising on transfer of a foreign exchange asset) is chargeable to tax under the general provisions of the Act. 17.2 ASSESSMENT OF HINDU UNDIVIDED FAMILY U/s 4 of the Income Tax Act, 1961, Income-tax is payable by every person. Person includes a Hindu Undivided Family as defined in sec. 2(31). The definition of Hindu Undivided Family is not found in the Income-tax Act. Therefore the expression Hindu Undivided Family must be construed in the sense in which it is understood under the Hindu Law [Surjit Lal Chhabda vs. CIT 101 ITR 776(SC)]. According to Hindu Law, Hindu Undivided Family is a family which consists of all persons lineally descended from a common ancestor and includes their wives and unmarried daughters. A Hindu Undivided Family is neither the creation of law nor of a contract but arises from status. A Hindu coparcenary includes those persons who acquire by birth an interest in joint family property. Only a male member of a family can be a coparcener while the membership of a HUF consists of both males and females. All the coparceners of the family constitute what is called a Coparcenery. All the coparceners are members of a HUF but all members of a HUF are not coparceners. A coparcener of a joint family, who acquires by birth an interest in the joint property of the family, whether inherited or otherwise acquired by the family, may have a right to enforce partition whereas the members of the family who are not coparcenars have no right to enforce partition. When a partition takes place, member (mother or widow) of the joint family may get a share equal to the sons and also it is necessary to provide for maintenance and marriage of the unmarried daughter out of family property. There are two schools of Hindu Law- 1) Mitakshara and 2) Dayabhaga. Under the Mitakshara school, each son acquires by birth an equal interest with his father in the ancestral property. Under the Dayabhaga School which prevails in West Bengal and Assam, a son does not acquire by birth in ancestral property. He acquires interest only on the death of his father. Father enjoys an absolute right to dispose of the property of the family according to his desire. After the death of father, his son does not, by operation of law, become members of the joint family. The sons remain as co-owners with definite shares in the properties left by father unless they decide to live as a joint family. Case Laws: (i) A single person, male or female, cannot constitute a Hindu Undivided Family. An individual, who has obtained a share on partition of a joint family, has potentialities of creating a joint family; but until he marries, he alone cannot be considered as a joint family [C. Krishna Prasad vs. CIT97 ITR 493].

(ii) A joint family may consist of a single male member with his wife and daughter(s) and it is not necessary that there should be two male members to constitute a joint family [Gowli Buddanna vs. CIT 60 ITR 193]. Jain & Sikh families are not governed by Hindu Law. However, for the purpose of Income tax Act, such families are treated as Hindu Undivided Families.

DIRECT TAXATION I 17.5

Assessment of Various Entities & Tax Planning The income of a joint Hindu family may be assessed in the status of HUF if the following conditions are satisfied:(i) There should be a coparcenership (ii) There should be a joint family property which consists of ancestral property, property acquired with the aid of ancestral property and property transferred by its members. It may be pointed out that once a joint family income is assessed as that of Hindu Undivided Family, it will continue to be assessed as such in future years till partition is claimed by its coparceners. Under the Hindu Law, ancestral property is the property which a person inherits from any of these three immediate male ancestors, i.e. his father, grandfather and great grandfather. Income of ancestral property is taxable as income of HUF in the following cases: (i) family of husband and wife without any children; (ii) family of two widows of deceased brothers; (iii) family of two or more brothers; (iv) family of uncle and nephew; (v) family of mother, son and sons wife; (vi) family of a person and his late brothers wife; (vii) family of widow mother and her sons. While computing income of a Hindu Undivided Family one should give due consideration of the following: (i) Where a member of HUF converts his self acquired property into joint family, income from such property shall not be treated as income of HUF u/s. 64(2). It shall continue to be taxed in the hands of the transferor who is the member of the HUF.

(ii) Income from an impartible estate is taxable in the hands of the holder of the estate and not in the hands of HUF. (iii) Income from Stridhan of a woman is not taxable in the hands of HUF. (iv) Personal income of members cannot be treated as income of HUF. (v) Where the funds of HUF are invested in a company or a firm, fees or remuneration received by the member as a director or a partner in the company or a firm may be treated as income of HUF in case the fees and remuneration is earned essentially as a result of investment funds. (vi) Where remuneration is paid by HUF to Karta or any other member for services rendered by him in conducting familys business, the remuneration is deductible provided the remuneration is paid : (i) under a valid bonafide agreement; (ii) in the interest of, and expedient for the family business, and (iii) genuine and not unreasonable.

Case law: Remuneration and commission received by the Karta of HUF on account of his personal qualifications and exertions and not on account of investments of the family funds in the company cannot be treated as income of HUF [Subbiah Pillai (K.S.) vs. CIT 103 Taxman 400/237 ITR 11].

17.6 I DIRECT TAXATION

Taxable income shall be computed as follows : Step 1 - Income under the different heads of income - First find out income under the five heads of income Step 2 - Adjustment of losses of the current year and earlier years - Losses should be set off according to the provisions of sections 70 to 78. The income after adjustment of losses is the gross total income. Step 3 - Deduction from gross total income - Deductions specified under Chapter VI A should be considered while calculating the gross total income. Step 4 - Rounding off - The balance should be rounded off to the nearest ` 10. It is called as net income or taxable income or total income. Calculation of Tax Liability: Step 1 Determine Net Income and tax payable thereon at the slab rate. Step 2 Add education cess and secondary and higher secondary education cess Step 3 Deduct rebate u/s 86, 90,90A and 91 Step 4 Add interest payable (if any) Step 5 Deduct amount of prepaid taxes paid (Advance Tax, Tax Deducted at Source, etc.) The Balance so arrived is the amount of tax to be paid. Note: From the Assessment Year 2013-14, tax payable (i.e. amount arrived at Step 3) cannot be less than 18.5 percent of Adjusted Total Income in some Specified Cases. PARTITION OF HUF Partition may be a (i) total or complete partition (ii) partial partition. Where all the properties of the family are divided amongst all the members of the family, and the family ceases to exist as an undivided family, it is known as total or complete partition. On the other hand, where one or more coparceners of the HUF may separate from others and the remaining coparceners may continue to be joint or some of the properties are divided and the balance remain joint it is known as partial partition. W.e.f. 31st December, 1978 partial partition is not recognised for tax purposes and as such the joint family shall continue to be liable to be assessed as if no such partial partition had taken place. Each member of such family, immediately before such partial partition and the family shall be jointly and severally liable for any sum payable under the Act. [Sec. 171(9)] 17.3 ASSESSMENT OF FIRMS From the Assessment Year 1993-94 partnership firm has been classified for the purpose of computation of income and its assessment as under: (a) Partnership Firm assessed as such (PFAS) (b) Partnership Firm assessed as an Association of Person (PFAOP).

DIRECT TAXATION I 17.7

Assessment of Various Entities & Tax Planning Provisions relating to assessment of firms and partners are analyzed as under : Specific provisions to firm assessed as an AOP Particulars Disallowance of salary and interest to partner Method of computing partners share in the income of PFAOP Rate of tax in respect of income of AOP/BOI Taxability of partners share of income Assessment of firms and conditions to be fulfilled to avail the status of PFAS [Sec. 184] Where a firm wants to avail the status of PFAS, it has to satisfy the following conditions:(i) The firm shall be evidenced by an instrument and the individual shares of the partner shall be specified therein. [Sec. 184(1)] Sections 40(ba) 67A 167B 86, 110

(ii) A certified copy of the instrument of partnership shall accompany the return of income of the Previous Year relevant to the Assessment Year 1993-94 or subsequent year in respect of which assessment of the firm is first sought. [Sec.184(2)] (iii) Wherever during a Previous Year a change takes place in the constitution of the firm or in the sharing ratio of partners, a certified copy of the revised instrument of partnership be submitted along with the return of income of the concerned year of assessment. [Sec. 184(4)] (iv) There should not be any failure on the part of the firm as is specified in Sec. 144 [Sec. 184(5)] It may be mentioned that once a firm is assessed as PFAS after fulfillment of the above conditions, it will be assessed as PFAS, for every subsequent year provided there is no change in either firms constitution or partners profit sharing ratio. However, there should not be any failure mentioned in Sec. 144. [Sec. 184(3)] A partnership deed shall be certified in writing by all the major partners. Where, however, the firm is dissolved and the return is filed after its dissolution, then the copy of deed may be certified by all the major partners in the firm immediately before its dissolution. Where a partner is dead, then it will have to be certified by his legal representative. [Sec. 184(2) Expl.] Computation of Income The following provisions should be given due consideration while computing income of a firm(i) Provision relating to deductibility of remuneration paid to partners by firm. (ii) Provision relating to deductibility of interest paid to partners by firm. Taxable income shall be computed as follows : Step 1 - Income under the different heads of income - First find out income under the five heads of income Step 2 - Adjustment of losses of the current year and earlier years - Losses should be set off according to the provisions of sections 70 to 78. The income after adjustment of losses is the gross total income. Step 3 - Deduction from gross total income - Deductions specified under Chapter VI A should be considered while calculating the gross total income. Step 4 - Rounding off - The balance should be rounded off to the nearest ` 10. It is called as net income or taxable income or total income.

17.8 I DIRECT TAXATION

Calculation of Tax Liability: Step 1 Determine Net Income and tax payable thereon at a normal rate of 30%. Step 2 Add education cess and secondary and higher secondary education cess Step 3 Deduct rebate u/s 86, 90, 90A and 91 Step 4 Add interest payable (if any) Step 5 Deduct amount of prepaid taxes paid (Advance Tax, Tax Deducted at Source, etc.) The Balance so arrived is the amount of tax to be paid. Note: From the Assessment Year 2013-14, tax payable (i.e. amount arrived at Step 3) cannot be less than 18.5 percent of Adjusted Total Income in some Specified Cases. 17.4 ASSESSMENT OF LIMITED LIABILITY PARTNERSHIP (LLP) A Limited Liability Partnership (LLP) is a body corporate formed or incorporated under the Limited Liability Partnership Act, 2008. It is a legally separate entity from its partners. It has perpetual succession i.e. any change in its partners will not have any impact on its existence, rights and liabilities. It is a corporate business form which gives benefits of limited liability of a company and the flexibility of a partnership. It contains elements of both a company as well as a partnership firm and thus it is called a hybrid between a partnership and a company. The Income-tax Act provides for the same taxation regime for a Limited Liability Partnership as is applicable to a partnership firm. It also provides tax neutrality (subject to fulfilment of certain conditions) to conversion of a Private Limited Company or an Unlisted Public Company into an LLP. However, Presumptive Tax Scheme u/s 44AD is not applicable to LLP. An LLP being treated as a firm for taxation, has the following tax advantages over a company under the Income-tax Act: (i) it is not subject to Minimum Alternate Tax;

(ii) it is not subject to Dividend Distribution Tax (DDT); and (iii) it is not subject to surcharge. (iv) It is not subject to Wealth Tax. In order to preserve the tax base vis-a-vis profit-linked deductions, a new Chapter XII-BA has been inserted in the Income-tax Act containing special provisions relating to certain Limited Liability Partnerships. Calculation of Total income: Step 1 - Income under the different heads of income - First find out income under the five heads of income Step 2 - Adjustment of losses of the current year and earlier years - Losses should be set off according to the provisions of sections 70 to 78. The income after adjustment of losses is the gross total income. Step 3 - Deduction from gross total income - Deductions specified under Chapter VI A should be considered while calculating the gross total income. Step 4 - Rounding off - The balance should be rounded off to the nearest ` 10. It is called as net income or taxable income or total income.

DIRECT TAXATION I 17.9

Assessment of Various Entities & Tax Planning Remuneration and interest to partners are deductible if condition of section 40(b) and 184 are satisfied. Taxability: Step 1 Determine Net Income and tax payable thereon at a normal rate of 30%. Step 2 Add education cess and secondary and higher secondary education cess Step 3 Deduct rebate u/s 86, 90, 90A and 91 Step 4 Add interest payable (if any) Step 5 Deduct amount of prepaid taxes paid (Advance Tax, Tax Deducted at Source, etc.) The Balance so arrived is the amount of tax to be paid. Note: From the Assessment Year 2013-14, tax payable (i.e. amount arrived at Step 3) cannot be less than 18.5 percent of Adjusted Total Income if certain conditions are satisfied. Share of profit in LLP is not taxable in the hands of partners. However, remuneration and interest are taxable under section 28 under the Profits and Gains of Business or Profession in the hands of partners to the extent these are allowed as deduction in the hands of LLP. 17.5 ASSESSMENT OF ASSOCIATION OF PERSONS / BODY OF INDIVIDUALS Association of Persons : Where two or more persons voluntarily joint together in a common purpose or action with the object of producing income, Profits and Gains, they are said to have formed an Association of Persons. Body of Individuals: It is a conglomerate of individuals who happen to have come together to carry on sum activity with a view to earn income i.e. co-heirs inheriting shares or securities. Distinction between AOP & BOI : (i) AOP may consist of non-individuals but BOI has to consist of individuals only (ii) An AOP is a voluntary combination of persons in a joint enterprise or common action to produce income whereas in case of BOI will only consist of two or more persons, may or may not have any common object. (iii) A BOI may become an AOP, but not vice versa. Share of members of AOP/BOI shall be deemed to be indeterminate or unknown, if such shares (in relation to the whole or any part of the income) are indeterminate or unknown on the date of formation of such AOP/BOI or any time thereafter. Any payment of interest, salary, bonus, commission or remuneration by the AOP/BOI to a member is not allowable as deduction. Where interest is paid by AOP/BOI to a member who has also paid interest to the AOP/BOI, the amount of interest to be disallowed will be limited to the net amount of interest paid by the AOP/BOI. [Sec. 40(ba)]

17.10 I DIRECT TAXATION

Tax Rates : Where shares of members are Where shares of members determinate and known are indeterminate or unknown None of the members having A t t h e r a t e s a p p l i c a b l e t o At the maximum marginal taxable income individual rate. Any member having income. At the maximum marginal rate At the maximum taxable marginal rate.

1. 2.

Maximum Marginal Rate means the rate of tax (including surcharge, if any) applicable to the highest slab of income in case of individuals. [Sec.2(29C)] From the Assessment Year 2013-14, tax payable (i.e. tax liability) cannot be less than 18.5 percent of Adjusted Total Income in some specified cases. Ascertainment of members share in AOP/BOI where shares are determinate and its taxability [Sec. 67A, 86 & 110] (i) Ascertainment of share in AOP/BOI [Sec. 67A] Total income of the AOP/BOI Less: Interest, salary, commission or other remuneration paid to any member Balance apportionable to the members in proportion to their shares Share of income allotted to a member Add: Salary, interest, commission or other remuneration received by the member of the AOP or BOI Total share Less: Interest paid on capital borrowed for the purpose of investment in the AOP/BOI Net assessable share income `

*** *** *** *** *** *** *** ***

(ii) Tax treatment of share income of members [Sec. 86 and Sec. 110] In computing total income of an assessee, there shall be included share income of a member of an AOP or BOI subject to Sec. 86 and 110 of the I.T. Act. The assessment of the members of AOP or BOI depends on whether the AOP or BOI is chargeable to tax at the maximum marginal rate or at slab rate or is not chargeable to tax at all. Tax-treatment in the three cases is discussed below: (i) Where AOP or BOI is chargeable to tax at a maximum marginal rate or any higher rate, the share of profit of a member is exempt from tax. Thus, it is not to be included in the total income of the member [Sec. 86(a)]

(ii) Where AOP or BOI is not taxed at the maximum marginal rate but it is taxed at slab rates, the share of profit of a member from AOP or BOI is to be included in the total income of the member only for rate purposes. The member is entitled to a rebate of tax on the entire share of profit at the average rate of tax applicable to total income. [Sec. 86(b)]. (iii) Where AOP or BOI is not chargeable to tax at all, the share of profit of a member from AOP or BOI is included in his total income and he will pay tax on it. He is not entitled to any rebate of tax on such profits [Proviso to Sec. 86(b)].

DIRECT TAXATION I 17.11

Assessment of Various Entities & Tax Planning Taxation of AOP/BOI [Sec 167B ] Tax treatment of share income in the hands of members of AOP/BOI [Sec. 86 & 110]

1. AOP or BOI is taxed at maximum marginal rate Share income of the member is not taxable. or at a higher rate. 2. AOP or BOI is taxed at normal rates applicable Share income computed u/s 67A is included into an Individual. The total income of the member but rebate u/s 110 at the average of tax in respect of such share income has to be allowed. 3. AOP or BOI is not taxed at all. Share income will be included in the total income of the member and taxed at the rates applicable to him.

Average rate of Income-tax is defined u/s. 2(10) to mean the rate arrived at by dividing the amount of Income-tax calculated on the total income, by such total income. 17.6 ASSESSMENT OF COMPANIES In computing tax incidence companies are classified as follows : (i) Domestic Company

(ii) Foreign Company Company means (i) any Indian company; or (ii) body corporate incorporated outside India under the laws of a foreign country; or (iii) any institution, association or a body which is assessed or was assessable/assessed as a company for any Assessment Year commencing on or before 1.4.1970; or (iv) any institution, association or body whether incorporated or not and whether Indian or non-Indian which is declared by general or special order of the Central Board of Direct Taxes to be a company. [Sec. 2(17)] Domestic Company means (i) an Indian company; or (ii) any other company which, in respect of its income liable to tax under the Act, has made the following prescribed arrangements for the declaration and payment of dividends within India in accordance with Sec. 194 read with Rule 27 of the Rules: (a) The share register of the company for all shareholders should be regularly maintained at its principal place of business in India, in respect of any Assessment Year, from 1st April of the relevant Assessment Year. (b) The general meeting for passing of accounts of the relevant Previous Year and for declaring dividends in respect thereof should be held only at a place within India. (c) The dividends declared, if any, should be payable only within India to all shareholders. [Sec. 2(22A)]

Foreign Company means company which is not a domestic company. [Sec. 2(23A)]

17.12 I DIRECT TAXATION

Indian Company means a company formed and registered under the Companies Act, 1956. Besides, it includes the following:(a) a company formed and registered under any law relating to companies formerly in force in any part of India; (b) a corporation established by or under a Central, State or Provincial Act; (c) any institution, association or body which is declared by the Board to be a company u/s. 2(17). (d) a company formed and registered under any law in force in the State of Jammu and Kashmir; (e) a company formed and registered under any law for the time being in force in the Union territories of Dadra and Nagar Haveli, Daman and Diu, Pondicherry and State of Goa. In the aforesaid cases, a company, corporation, institution, association or body will be treated as an Indian company only if its registered or principal office is in India. [Sec. 2(26)] Company in which the public are substantially interested[Section 2(18)] A company is said to be a company in which the public are substantially interested, if(a) a company owned by Government or Reserve Bank of India or in which not less than 40% shares are held singly or taken together by the Government or the Reserve Bank or a corporation owned by the Reserve Bank; or (b) it is a company registered u/s. 25 of the Companies Act, 1956, i.e., companies incorporated for promotion of Commerce, Arts, Science, Religion, Charity and prohibiting the payment of any dividends to its members; or (c) it is a company having no share capital and it is declared by the CBDT to be a company in which the public are substantially interested; or (d) it is a company which carries on, as its principal business, the business of acceptance of deposits from its members and which is declared by the Central Government u/s. 620A of the Companies Act to be a Nidhi or Mutual Benefit Society; or (e) it is a company which is not a private company and its equity shares are, as on the last day of Previous Year, listed in a recognised stock exchange in India; or (f) it is a company which is not a private company and its shares carrying not less than 50% of the voting power (40% in the case of Indian companies whose business consists mainly in the construction of ships or in the manufacture or processing of goods or in mining or in the generation or distribution of electricity or any other form of power)have been allotted unconditionally to or acquired unconditionally to, or acquired unconditionally by, and were throughout the relevant Previous Year beneficially held by (i) the Government; or (ii) a Statutory Corporation; or (iii) a company in which the public are substantially interested or any wholly owned subsidiary of such company.

(g) it is a company, wherein equity shares carrying not less than 50% of the voting power have been unconditionally allotted to or acquired by and were throughout the relevant Previous Year beneficially held by, one or more cooperative societies. Minimum Alternative Tax on certain companies A company is liable to pay tax on the total income computed in accordance with the provisions of the Income Tax Act, but the Profit and Loss Account is prepared as per provisions of the Companies

DIRECT TAXATION I 17.13

Assessment of Various Entities & Tax Planning Act. There were large number of companies who had book profits as per Profit and Loss Account but the total income as per provision of the Income-tax Act was either nil or negative or insignificant and as a result such companies were not paying any Income-tax though sometimes, such companies were paying dividends to shareholder. These companies are popularly known as Zero Tax Companies. In order to being these companies under the Income-tax Act, the following sections were included time to time from Assessment Year 1997-98. According to Sec. 115JB, in case of Companies, if the tax payable on the total income as computed under Income Tax Act in respect of any Previous Year is less than 18.5% of its book profit, such book profit shall be deemed to be total income of the assessee and tax payable for the relevant Previous Year shall be 18.5% of such book profit. Amalgamation [Sec. 2(1B)] Amalgamation in relation to companies means the merger of one or more companies with another company, or merger of two or more companies to form a new company. The company so merged goes out of existence is amalgamating company. The company into which the amalgamating company merges, or the new company that is formed to effect amalgamation, is amalgamated company in such a manner that : (a) All property of amalgamating company, immediately before amalgamation, should become the property of amalgamated company, (b) All liabilities of amalgamating company, immediately before amalgamation, should become the liabilities of amalgamated company, (c) Shareholders holding 75% in value of the shares in amalgamating company should become shareholders of the amalgamated company. However, if the amalgamated company or its subsidiary/nominee already holds some shares in the amalgamating company, value of such shares is excluded for calculating 75% of the value of shares of the amalgamating company. A merger of companies will not be treated as amalgamation in case of sale or liquidation of company. The effective date in a scheme of amalgamation is the date of transfer specified in the scheme and not the date of high courts order approving the scheme. So long as the court does not modify the date specified in the scheme, amalgamation takes effect on date of transfer specified in the scheme. The income of the amalgamating company from such date of transfer shall be assessed as income of the amalgamated company and shall be assessed accordingly. [Marshall Sons and Co. (India) Ltd. vs. ITO (SC), 223 ITR 809] Certain concessions are provided under various provisions of the Income-tax Act in respect of amalgamation which are as under: (a) To amalgamating company 1) Sec. 47 (vi): In a scheme of amalgamation if an Indian Company satisfies the condition of Sec 2(1B), Capital Gains tax is not attracted in case of transfer of capital asset by the amalgamating company to the amalgamated company. Sec. 47(via): Tax concession to foreign amalgamating company.

2)

By virtue of Sec. 47(via), transfer of shares in an Indian Company held by a foreign company to another foreign company in a scheme of amalgamation is not treated as transfer if the following conditions are satisfies :-

17.14 I DIRECT TAXATION

(i)

Shares in an Indian company held by a foreign company.

(ii) Business of the foreign company is taken over by another company in a scheme of amalgamation. (iii) Atleast 25% of the shareholders of amalgamation foreign company continue to remain shareholders of the amalgamated company. (iv) Such transfer does not attract tax on Capital Gains in the company in which the amalgamating company is incorporated. (b) To shareholders of an amalgamating company Sec. 47(vii) : Transfer by a shareholder in a scheme of amalgamation of a capital asset being a share or shares held by him in amalgamating company if such transfer is made in consideration of allotment to him of shares in the amalgamated company and the amalgamated company is an Indian Company. (c) To amalgamated company The following benefits in the hands of amalgamating company are available to the amalgamated company: Sec. 35(5) : Expenditure on scientific research Sec. 35A(6) : Expenditure on acquisition of patent right or copy right Sec. 35AB(3) : Expenditure on know how Sec. 35ABB(6) : Expenditure for obtaining license to operate telecommunication services Sec. 35D(5) : Amortisation of preliminary expenses Sec. 36E(7) Sec. 36(ix) Sec. 72A Sec. 35DD : Deduction for expenditure on prospecting etc. for certain minerals : Expenditure incurred for the purpose of promoting family planning. : Carry forward and set off of accumulated and unabsorbed depreciation : Amortisation of expenditure in case of amalgamation or demerger

Further, the amalgamated company is entitled for : Demerger [Sec. 2(19AA)] Demerger in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company in such a manner that (i) all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;

(ii) all the liabilities relatable to the undertaking being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger; (iii) the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger; (iv) the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis; (v) the shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the

DIRECT TAXATION I 17.15

Assessment of Various Entities & Tax Planning resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger. Otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company; (vi) the transfer of the undertaking is on a going concern basis; (vii) the demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf. For the purpose of this definition, undertaking shall include any part of an undertaking, or a unit of division of an undertaking or a business activity taken as a whole, but does not include individual assets and/or liabilities or a combination of these not constituting a business activity. For determining the value of the property which is subject matter of demerger, any change in the value of assets on account of revaluation shall be ignored. Splitting up or the reconstruction of any authority or a body constituted or established under any Act, or a local authority or a public sector company, into separate authorities or bodies or local authorities or companies shall be deemed to be the demerger if such split up or reconstruction fulfils the conditions as may be notified by the Central Government. Demerged Company [Section 2(19AAA)] : It means the company whose undertaking is transferred, pursuant to a demerger, to a resulting company. Resulting Company : means one or more companies (including wholly owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger and the resulting company in consideration of such transfer of undertaking, issues shares to shareholders of the demerged company and includes any authority or body or local authority or public sector company or a company established, constituted or formed as a result of demerger.

Provisions applicable to Company Amalgamation/Demerger Capital Gain - Gains arising on transfer of a capital asset in a scheme of amalgamation / demerger to the amalgamated/resulting company being an Indian Company is exempt. Carry forward of accumulated loss and/or unabsorbed depreciation Accumulated loss and unabsorbed depreciation of an amalgamating company owning an industrial undertaking or a ship or a hotel or a banking company can be transferred to the amalgamated company provided: 1. It continuously holds 3/4th value of the assets acquired in a scheme of amalgamation for at least five years from the date of amalgamation. 2. It continues to carry on business of amalgamating company for at least five years from the date of amalgamation and the amalgamating company. Accumulated loss and unabsorbed depreciation of a demerged company will be transferred to resulting company: 1. 2. Where it is directly relatable to undertaking transferred, it should be such relatable amount. Where it is not directly relatable to the undertaking transferred, it should be apportioned in the ratio of assets retained by the demerged company and transferred to resulting company.

Carry forward of accumulated loss and/or unabsorbed depreciation of the Banking Company in a Scheme of Amalgamation with Banking Institution. Allowability of expenditure relating to amalgamation/demerger An Indian company will be allowed a deduction of 1/5th of the expenditure incurred for the purposes

17.16 I DIRECT TAXATION

of amalgamation or demerger after 1st April, 1999 for five years from the years of amalgamation/ demerger. (Sec. 35DD) Depreciation in the year of amalgamation/demerger Depreciation to amalgamated company and amalgamating company in the year of amalgamation and depreciation to demerged company and the resulting company in the year of demerger shall be apportioned in the ratio of the number of days for which the assets were used (Sec. 32) (5th proviso). Actual Cost Actual cost of the capital asset transferred to amalgamated/resulting company shall be the actual cost in the hands of the amalgamating/demerged company provided it does not exceed WDV of such assets in the hands of the demerged company. Written Down Value WDV in the hands of amalgamated company shall be the WDV of the block of assets in the hands of the amalgamating company less depreciation allowed in the year of amalgamation. WDV in the hands of the resulting company shall be the WDV of transferred assets as per books of the demerged company immediately before demerger. WDV in the hands of the demerged company shall be the WDV of the block of assets before demerger less book value of assets transferred to the resulting company. Deduction claimed under Section 33AC (Reserve for shipping business) would not be withdrawn on sale or transfer of a ship in any scheme of demerger. Transfer of patent rights or copyrights (Sec. 35A) or transfer of licence to operate telecommunication services (Sec. 35ABB) or transfer of business for prospecting etc. mineral oil (Sec. 42) in a scheme of amalgamation/demerger will not be treated as either sale or transfer. The deductions hitherto granted to amalgamating/demerged company relating to patent rights and copyrights (Sec. 35A) / Expenditure on know-how (Sec.35AB) / Licence fees to operate telecommunication services (Sec. 35ABB) / Preliminary expenses (Sec. 35D) / expenditure for prospecting etc., for certain minerals (Sec. 35E) / business for prospecting etc., for mineral oil (Sec. 42) would be available for balance period to the amalgamated/resulting company. Gains arising on transfer of shares of amalgamating company in exchange of shares of amalgamated company, being an Indian Company is exempt from tax. Acquisition of shares of the resulting company by the shareholders in demerger will not be taxed either as Capital Gain or deemed dividend. Cost of acquisition of shares of : - - - The amalgamated company will be the cost incurred for acquiring shares of amalgamating company. The resulting company will be the : Original cost of shares of demerged company X net book value of assets transferred to resulting company/ net worth of the demerged company before demerger (net worth is equal to Paidup Share Capital + General Reserve as per books). The demerged company will be the original cost of shares of demerged company cost of shares of the resulting company as computed above.

Provisions applicable to Shareholders

DIRECT TAXATION I 17.17

Assessment of Various Entities & Tax Planning 17.7 ASSESSMENT OF CO-OPERATIVE SOCIETIES Introduction Cooperative society is a society registered under the Cooperative Societies Act, 1912, or under any other law for the time being in force in any State for registration of cooperative societies. A cooperative society is entitled, to some deduction u/s. 80P of the Income-tax Act. Steps in computing tax liability of Cooperative Societies The steps areStep- I Step-II : : Compute gross total income, ignoring income exempt from tax u/s. 10 to 13A Deduct permissible deductions u/ss. 80G, 80GGA, 80I, 80I-A 80IB, 80JJA, etc. and 80P as applicable. Apply the tax rates for the relevant Assessment Year to arrive at the tax incidence.

Step-III :

The tax rates applicable are as follows : The rates of Income-tax are Income Range 1. Where the total income does not exceed ` 10,000 2. Where the total income exceeds ` 10,000 but which the does not exceed ` 20,000 3. Where the total income exceeds ` 20,000 Rates of tax 10% of the total income ` 1,000 plus 20% of the amount by total income exceeds `10,000 ` 3,000 plus 30%, of the amount by which the total income exceeds ` 20,000

However, the tax payable by every cooperative society shall be increased by education cess @2% and secondary and higher education cess @ 1%. However, from the Assessment Year 2013-14, tax payable cannot be less than 18.5% of Adjusted Total Income in some specified cases. 17.8 ASSESSMENT OF TRUSTS Introduction Trust A Trust is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner. The person who reposes or declares the confidence is called the author of the trust. The person who accepts the confidence is called the trustee. The person for whose benefits the confidence is accepted is called the beneficiary.

Author of Trust Trustee Beneficiaries

In order to ascertain the incidence of tax it is essential to know the nature and character of trusts and also the mode of computation of its income and conditions for exemptions. For the purpose of levy of income-tax, trusts may be of the following types :-

17.18 I DIRECT TAXATION

1. 2. 3.

Charitable Trust Private Discretionary Trust Oral Trust

Charitable Trusts A charitable trust is a trust established in accordance with law for charitable purpose. Charitable purpose includes relief of the poor, education, medical relief and the advancement of any other object of general public utility. [Sec. 2(15)] Promotion of sports and games is considered to be a charitable purpose and as such an association or institution engaged in promotion of sports and games can claim exemption u/s.11, although it is not approved u/s. 10(23). Conditions for exemption The following essential conditions are to be fulfilled for claiming exemption u/s. 11 : (i) The property from which income of the trust is derived should be held for charitable or religious purposes.

(ii) The exemption is confined to such portion of the trusts income as is applied to charitable or religious purposes in India except in cases enumerated in Sec.11(1)(c) (iii) If the trust property comprises of a business undertaking, the income shown in the books of account should not be less than the income determined by the A.O. according to provisions of the Incometax Act. From A.Y. 1992-93, trusts or institution can carry out business activities if such business activities are incidental to the attainment of its objectives and separate books of accounts are maintained. (iv) The trust should make an application in Form No. 10A to the Commissioner of Income Tax within one year of creation of trust or the institution and such trust or institution get registered u/s. 12AA. (v) Limit for audit of charitable institutions rationalized [Section 12A] - Trusts and institutions covered under sections 11 and 12 to get their accounts audited only when their total income, before giving effect to the provisions of sections 11 and 12,exceeds `1,00,000.

(vi) The funds of the trust should be invested or deposited in any one or more of the modes or forms [Sec. 11(5)] such as investment in Government Savings Certificate; deposits in any Post Office Savings Bank Account; deposit in any account with any Scheduled or Cooperative Bank; investment in any Central Government or State Government securities or in the units of the Unit Trust of India; investment in debentures of any corporate body, guaranteed by the Central Government or a State Government ; investments in immovable property or deposit in any public sector company ; deposit or investments in any Bond issued by a public company having main object of carrying on business of providing long term finance for urban infrastructure in India. any other form or mode of investment/deposit as may be prescribed in this behalf.

DIRECT TAXATION I 17.19

Assessment of Various Entities & Tax Planning In order to claim exemption, a charitable trust or institution will have to apply at least 85% of, the income to charitable and religious purposes. Where 85% of the income is not applied to charitable or religious purposes the trust or institution may accumulate or set apart either the whole or part of its income for future application for such purposes in India. Special rates of tax on Certain Income of Charitable Institutions. Taxation of certain anonymous donations under section 115BBC Income of wholly or partly charitable or religious trust etc. is exempt subject to certain conditions. Unaccounted contribution to those institutions by way of anonymous donation a new section 115BBC has been inserted so as to provide that any income by way of anonymous donation shall be included in the total income and taxable @ 30%. Note : Anonymous donation means any voluntary contribution referred to Sec 2(24)(iia). Tax relief on anonymous donations for partly religious and partly charitable institutions, and wholly charitable institutions (Section 115BBC) [W.e.f. A.Y. 2010-11] (A) Under the current provisions of section 115BBC, wholly religious entities are outside the purview of taxation of anonymous donations. Partly religious and partly charitable entitles have also been, exempted from the taxation of anonymous donations, except where the anonymous donation is made to an educational or medical institution run by such entity in which case such donations are taxed at the rate of 30%. In the case of wholly charitable entities, all anonymous donations are taxed at the rate of 30%. In order to mitigate the compliance burden, the Act has provided relief to such organizations by exempting a part of the anonymous donations from being taxed. The amendment will result in the following: 1. 2. Anonymous donations received by wholly religious institutions shall remain exempt from tax. In the case of partly religious and partly charitable institutions, anonymous donations directed towards a medical or educational institutions run by such entities shall be taxable @ 30% on the aggregate of anonymous donation received in excess of the higher of the following, namely: (a) 5% of the total donations received by the assessee, or (b) ` 1,00,000. In the case of wholly charitable institutions, anonymous donations shall be taxable @ 30% on the aggregate of anonymous donation received in excess of the higher of the following, namely (a) 5% of the total donations received by the assessee, or (b) ` 1,00,000.

3.

(B) Meaning of charitable purpose amended: See para 2 above. Forfeiture of Exemption [Sec. 13] The following incomes of charitable or religious trusts and institutions will not qualify for exemption u/s. 13 : (i) income from property held under a trust for private religious purpose which does not ensure for the

17.20 I DIRECT TAXATION

benefit of the public. [Sec. 13(1)(a)] (ii) income of a charitable trust/institution established on or after 1.4.1962 for the benefit of any particular religious community or caste. [Sec. 13(1)(b)] (iii) income of religious/charitable trust/institutions established after 31.3.1962 for the benefit of any person specified in Sec. 13(3) viz. author, founder or substantial contributor of the trust or any relative of them. Where the income is used or applied during the relevant year for the direct or indirect benefit of the above mentioned persons. [Sec. 13(1)(c)(i) and (ii)] (iv) income of a trust/institution, if its funds are invested/deposited otherwise than as specified u/s. 11(5). [Sec. 13(1)(d)] However, the provisions of section 13(1)(d) shall not apply in relation to following : any asset forming part of the corpus of the trust as on 1.6.1973; any accretion to the corpus shares by way of bonus shares allotted to the trust; debentures issued by or on behalf of any company or corporation and acquired by the trust before March 1, 1983; any asset not covered u/s. 11(5) where such asset is held for not more than 1 year from the end of the Previous Year in which such asset is acquired; any fund representing the profits and gains of business, being profits and gains of any Previous Year relevant to the Assessment Year 1984-85 or any subsequent Assessment Year. But such relaxation of the restriction will be denied unless the trust keeps separate accounts for the business. As already noted, subject to certain exceptions, such business profits no longer enjoy exemption u/s. 11.

Changes Relating To Income of Charitable Institutions. Anonymous donations to form part of income of trust [Section 13 ] As per the new section 115BBC, anonymous donation shall now be taxable at the maximum marginal rate of 30%. Consequently, a new sub-section (7) has been inserted in section 13 to provide that nothing contained in section 11 or section 12 shall operate so as to exclude from the total income of the Previous Year of the person in receipt thereof, any anonymous donation referred to in the new section 115BBC on which tax is payable in accordance with the provisions of that section. In other words anonymous donation shall not be excluded from the total income of the assessee. Taxation of Trust A. Public Trust u/s. 164(2) (i) If income is not exempt u/s. 11 or 12, income of Trust is taxable at the rates applicable to an Association of Person.

(ii) If the exemption is forfeited due to contravention of Sec. 13(1)(c) or 13(1)(d), such income of trust is taxable at maximum marginal rate. (i) If income does not include business Profits, the trustee is assessable at the rates applicable to each beneficiary. [Sec. 161(1)]

B. Private Trust (shares of beneficiaries are determinate or known)

(ii) If income includes profits from business, the whole income is taxable at maximum marginal rate. [Sec. 161(1A)]

DIRECT TAXATION I 17.21

Assessment of Various Entities & Tax Planning C. Private Trust (share of beneficiaries in determinate or unknown) [Sec. 164(1)] (i) If income does not include business profits, income is taxable at the rates applicable to an AOP if none of the beneficiaries has taxable income or is a beneficiary in any other trust. the trust is non-testamentary trust created before 1.3.1970 exclusively for the relative dependents of the settle; or it is the only trust declared by a WILL exclusively for the benefit of any dependent relative. In any other case, income is taxable of maximum marginal rate.

(ii) If income includes business profits, the whole income is taxable at maximum marginal rate.

D. Oral Trust [Sec. 160(1)(v), Sec. 164A] : Oral Trust means a trust which is not declared by a duly executed instrument in writing including any wakf deed which is valid under the Mussalman wakf validating Act, 1913 and which is not deemed to be trust by virtue of explanation I to Sec. 160. (i) Income of Oral trust is taxable at maximum marginal rate. (ii) If Oral trust is declared to be a trust by furnishing a statement in writing containing purposes, particulars and details of trust, beneficiaries and property to the assessing officer within 3 months from the date of declaration of the trust, indicating the share of beneficiaries, the income of the trust is assessable in the hands of trustee at the rates applicable to beneficiaries.

E. Income from property held under Trust partly for religious purposes and partly for other purposes [Sec. 164(3)] Where property is held under trust partly for religious purposes and partly for other purposes and the individual share of the beneficiaries in the income applicable to purposes other than charitable purposes, is not known, the Income-tax liability will be aggregated as follows : (i) the tax which would be chargeable on the part of the relevant income which is applicable to charitable or religious purposes (as reduced by the income which is exempt u/s. 11 as if such part were the total income of an Association of Persons); and

(ii) the tax on that part of income attributable to purposes other than charitable or religious and in respect of which shares of beneficiaries are indeterminate or unknown, at the maximum marginal rate.

Where any part of income is not exempt u/s. 11 or 12 by virtue of sec. 13(1)(c) or (d), tax is charged on the relevant income at the maximum marginal rate. Case Laws : (i) For purpose of section 164(1) what is relevant is that income is receivable on behalf of beneficiaries and is not necessary that income is received by beneficiaries - Gosar Family Trust vs. CIT 81 Taxman 146/215 ITR 55.

(ii) Provision merely sets out how tax is to be charged and does not create a charge on the income - CIT vs. Kamalini Khatau 209 ITR 101.

17.22 I DIRECT TAXATION

ILLUSTRATIONS ON ASSESSMENT OF AOP / BOI

Illustration 1. A & B are members of AOP, sharing profit and losses in the ratio of 5 : 3 and they are allowed the following payments: A ` (i) Salary (ii) Interest on capital or loan 40,000 20,000 B ` 60,000 10,000

You are required to compute taxable business profits of AOP and share of each member for the Previous Year 2012-2013 in the following cases: (a) AOP has earned profit of ` 3,00,000 after making the above payments; (b) AOP has earned profit of ` 3,00,000 before making the above payments; (c) AOP has suffered loss of ` 3,00,000 after making the above payments; and (d) AOP has suffered loss of ` 3,00,000 before making the above payments. Solution: Computation of income of AOP for the P.Y. 2012-2013 : Particulars ` Profit/ loss Add: Inadmissible payments [Sec. 40 (ba)]: (i) Salary to members (40,000+60,000) (ii) Interest on capital/loan to members: (20,000 + 10,000) Profit/Loss as per Income Tax Law (+) 1,00,000 (+) 30,000 (+) 4,30,000 (+) 3,00,000 (+) 1,00,000 (+) 30,000 (-) 1,70,000 (-) 3,00,000 Case (a) ` (+) 3,00,000 Case(b) ` (+) 3,00,000 Case (c) ` (-) 3,00,000 Case (d) ` (-) 3,00,000

Computation of members share in the income/loss of the AOP

Particulars A ` Salary Interest Divisible profit: (a) 4,30,0001,30,000 (b) 3,00,0001,30,000 (c) () 1,70,000 +()1,30,000 =(-)3,00,000 (d) (-) 3,00,000 + (-) 1,30,000= (-) 4,30,000 Share of profit/loss 40,000 20,000 1,87,500 X X X 2,47,500 Case (a) B ` 60,000 10,000 1,12,500 X X X 1,82,500 A ` 40,000 20,000 X 1,06,250 X X 1,66,250 Case (b) B ` 60,000 10,000 X 63,750 X X 1,33,750 A ` 40,000 20,000 X X (1,87,500) X (1,27,500) Case (c) B ` 60,000 10,000 X X (1,12,500) X (42,500) A ` 40,000 20,000 X X X (2,68,750) (2,08,750) Case (d) B ` 60,000 10,000 X X X (1,61,250) (91,250)

(i)

Where assessed business income is a profit: Beneficial payments (i.e. salary, bonus, commission and interest) made to partners should be deducted from assessed profit to arrive at divisible profit, which is to be apportioned among members.

DIRECT TAXATION I 17.23

Assessment of Various Entities & Tax Planning (ii) Where assessed business income is a loss: Beneficial payments made to partners should be added to assess loss to arrive at the divisible loss which is to be apportioned among members. Illustration 2. Anand and Aniket are equal members in AA & Associates. The Profit and Loss Account of the AOP for the year ending 31st March 2013 is as follows: Particulars Selling and administrative Expenses Interest to Anand @ 15% Remuneration: Anand Aniket Net Profit: Anand Aniket ` 8,00,000 60,000 1,50,000 1,50,000 6,00,000 6,00,000 23,60,000 Other information : 1. Selling and administrative expenses include ` 60,000 paid to a consultant in cash. 2. The other income/investment details of the members are given as below: Members Anand Aniket Income 3,90,000 5,00,000 Source of income Interest on fixed deposit from bank Interest on Govt. securities Investments Purchase of NSC VIII ` 30,000 Contribution to PPF ` 50,000 23,60,000 Particulars Gross Profit Income from House Property ` 20,00,000 3,60,000

Compute the tax liability of the AOP and it members. Solution: Computation of total income of AOP: PY 2012-2013 Particulars Net Profit Add: Inadmissible payments. 1. Fees paid to consultants in cash Sec. 40A (3) 2. Interest paid to members [Sec. 40(ba)]: 3. Remuneration paid to members Sec. 40(ba) Less: Income from House Property Business Profits Add: Income from House Property Total Income Tax Liability of AOP on Total Income Tax on slabs rates Add: Education cess 2% SHEC @ 1% Tax Payable ` 12,00,000 60,000 60,000 3,00,000 16,20,000 3,60,000 12,60,000 3,60,000 16,20,000 3,16,000 6,320 3,160 3,25,480

17.24 I DIRECT TAXATION

Allocation of income amongst the members: Particulars Interest Remuneration Share of divisible profit (12,60,000-60,000-3,00,000) Share of profit Share of income from House Property Anand ` 60,000 1,50,000 4,50,000 6,60,000 1,80,000 8,40,000 Computation of total income of members: Particulars Share income from AOP Income from Other Sources: Interest on bank deposits Interest on Government securities Gross total income Less: Deduction under Sec. 80C Total income Tax liability of members : Tax on slab rates Add: Education cess @ 2% on income tax Add : SHEC @ 1% Less: Rebate on share of profit at the average: (See Note below) Tax Payable Tax Payable rounded off to the nearest multiple of ` 10 (See. 288B) Note: Anand: 1,95,700/12,00,000x 8,40,000 Aniket : 2,04,970/12,30,000 7,80,000 Note: Assumed that the provisions of Alternate Minimum Tax are not applicable in the above case. Illustration 3. A, B and C Ltd. are three members of an AOP, sharing profit and losses in the ratio 2:2:1. The AOP discloses its income for the PY 2012-2013 as below: Particulars (i) Long-term Capital Gains (ii) Business Profits Determine tax liability of AOP in the following cases: (i) C Ltd. is an Indian company (ii) C Ltd. is a foreign company ` 4,00,000 6,00,000 Anand ` 8,40,000 3,90,000 12,30,000 30,000 12,00,000 1,90,000 3,800 1,900 1,95,700 1,36,990 58,710 58,710 Aniket ` 7,80,000 5,00,000 12,80,000 50,000 12,30,000 1,99,000 3,980 1,990 2,04,970 1,29,981 74,989 74,990 Aniket ` 1,50,000 4,50,000 6,00,000 1,80,000 7,80,000 Total ` 60,000 3,00,000 9,00,000 12,60,000 3,60,000 16,20,000

DIRECT TAXATION I 17.25

Assessment of Various Entities & Tax Planning Solution: Allocation of income of AOP among partners Particulars of income Long-term Capital Gains Business Profits Share income of the members Tax liability of AOP Particulars Case I C Ltd. an Indian company ` 37,080 Case II C. Ltd. as foreign company ` 49,440 A ` 1,60,000 2,40,000 4,00,000 B ` 1,60,000 2,40,000 4,00,000 C Ltd ` 80,000 1,20,000 2,00,000

Tax on the share of C Ltd. Case I : 1,20,000 x 30.90% Case II: 1,20,000 x 41.20% Tax on balance income at AOP: (i) Long-term Capital Gain 4,00,000 x 20.60% (ii) Business Profits 4,80,000 x 30.90% Total Tax Payable Total Tax (Rounded off u/s 288B)

82,400 1,48,320 2,67,800 2,67,800

82,400 1,48,320 2,80,160 2,80,160

Note : Assumed that the provisions of AMT are not applicable in the above case. Illustration 4. R, S and T Ltd. (a widely held domestic company) are members in an AOP for the Previous Year 2012-2013. They share profit and losses in the ratio 30%, 40% and 30%. Taxable business income of AOP is determined at ` 8,00,000. Personal incomes of the partners are given below: (`) R - House Property S Short-term Capital Gain 90,000 1,00,000

R deposits ` 20,000 in CTDS-15-year account in Post Office in February 2013. S purchases NSC VIII-Issue for ` 25,000 in December 2012. Determine the tax liability of the AOP and its partners Solution : (a) Computation of tax liability of AOP for the Previous Year 2012-2013. Allocation of AOP income among members: Particulars Business Profit Tax liability of AOP: 8,00,000 30.90% = 2,47,200 R ` 2,40,000 S ` 320000 T Ltd. ` 240000

17.26 I DIRECT TAXATION

Tax liability of members: Particulars Share income from AOP AOP charged at maximum marginal rate
Personal income of members after deduction under Chapter VIA

R ` 2,40,000 Exempt 70,000 Exempt

S ` 320000 Exempt 75,000 Exempt

T Ltd. ` 240000 Exempt Nil X

Personal income below taxable limit Note : Assumed that AMT is not applicable in the above case.

Illustration 5. GMK are partners in a firm assessed as an association of persons. They share profit and losses in the ratio of 4:3:3. The abridged profit and loss for the Previous Year 2012-2013 is as follows: Particulars Business expenses Salaries to partners G M K Bonus to partners: G M Commission to K Interest to partners: G M K Net Profit G M K ` 5,00,000 60,000 40,000 50,000 30,000 20,000 40,000 20,000 15,000 25,000 80,000 60,000 60,000 10,00,000 Particulars Gross Profits Short-term Capital Gain Interest on drawings G M K ` 6,85,000 2,80,000 5,000 20,000 10,000

10,00,000

Business expenses include donation to Nalanda University ` 50,000. Compute the taxable income of AOP, its tax liability and tax liability of its members in the following Personal income of members Case-I ` 2,40,000 2,65,000 2,50,000 20,000 Case-II ` 1,00,000 1,20,100 1,10,000 20,000

G: Interest on bank deposits M: Interest on Government securities K: Income from House Property LIP paid by every member on a policy of ` 1,00,000.

DIRECT TAXATION I 17.27

Assessment of Various Entities & Tax Planning Solution : (a) Computation of Taxable Business Profits Particulars Net Profit as per Profit & Loss A/c Add: (i) Donation to Nalanda University (ii) Salaries to partners [Sec. 40(ba)] (60,000 + 40,000 + 50,000) (iii) Bonus to partners (30,000 + 20,000) (iv) Interest on capital (Net of Interest on Drawings) G 20,000 5,000 = K 25,000 10,000 = (v) Commission to K Less: Short-term Capital Gain Taxable Business Profits Computation of Total Income Add: (i) Business Profits (ii) Short-term Capital Gain Gross Total Income Less: Deduction for charitabe donation (Sec. 80G) (a) Actual donation ` 50,000 or, 10 (b) 10% of gross total income: 5,20,000 = 52,000 100 whichever is less, is qualifying amount. i.e. ` 50,000. Amount of deduction 50% of ` 50,000, qualifying amount Total Income Tax liability of AOP : Particulars (a) Tax on Total Income at slab rates including Education Cess and SHEC (b) Tax on Total Income at maximum marginal rates including surcharge plus education cess plus SHEC Tax Payable Tax Payable rounded off ( u/s 288 B) Case I 30,385 30,385 30,390 Case II 1,52,955 1,52,955 1,52,960 25,000 4,95,000 ` 2,00,000 50,000 1,50,000 50,000 15,000 15,000 40,000 5,20,000 2,80,000 2,40,000

2,40,000 2,80,000 5,20,000

17.28 I DIRECT TAXATION

Tax liability of members: Share of income from AOP: (i) Salary (ii) Bonus (iii) Commission (iv) Interest G (`) 60,000 30,000 15,000 1,05,000 (v) Divisible loss : (2,40,000-25,000)-270,000 = (-) 55,000 Share of Business Profit Share of Short-term Capital Gain Share of income from AOP Total Income and Tax Liability of members : Case:(a) where AOP is taxed at slab rates: Particulars Income from House Property Income from Other Sources Share income from AOP Gross Total Income Less: Deduction under Sec. 80C: LIP restricted to 20% of policy [Assumed the policy is issued before 1.4.2012] Total Income Gross income tax at slab rate Add: Surcharge Add: Education Cess @ 2% Add : SHEC @ 1% G 2,40,000 1,95,000 4,35,000 20,000 4,15,000 21,500 Nil 430 215 22,145 Less: Rebate on share of profit from firm at the average rate Tax Payable Tax Payable rounded off ( u/s 288B) Note 1: 22,145 4,15,000 1,95,000 = 10,405 Note 2: 17,768 3,72,500 1,27,500 = 6,082 Note 3: 20,858 4,02,500 1,72,500 = 8,939 10,405 11,740 11,740 M 2,65,000 1,27,500 3,92,500 20,000 3,72,500 17,250 Nil 345 173 17,768 6,082 11,686 11,690 K 2,50,000 1,72,500 4,22,500 20,000 4,02,500 20,250 Nil 405 203 20,858 8,939 11,919 11,920 (-) 22,000 83,000 112,000 1,95,000 M (`) 40,000 20,000 60,000 (-) 16,500 43,500 84,000 1,27,500 K (`) 50,000 40,000 15,000 1,05,000 (-) 16,500 88,500 84,000 1,72,500 Total (`) 1,50,000 50,000 40,000 30,000 2,70,000 (-) 55,000 2,15,000 2,80,000 4,95,000

DIRECT TAXATION I 17.29

Assessment of Various Entities & Tax Planning Case (b) where AOP is taxed at maximum marginal rate: G 1. Share of profit from AOP; Since the AOP was assessed at the maximum marginal rate, share of income from AOP is exempt (Sec. 86) 2. Personal income: Income from House Property Income from Other Sources Less: Deduction u/s 80C Total Income Tax Payable Note : Provisions of AMT are not applicable in the above case. Illustration 6. T and Q are individuals, who constitute an Association of Persons, sharing profit and losses in the ratio of 2:1. For the accounting year ending 31st March 2013, the Profit and Loss Account of the business was as under: Particulars Cost of goods sold Remuneration to: T Q Employees Interest to : T Q Other expenses Sales-tax penalty due Net Profit Additional information furnished: (i) Other expenses included: (a) entertainment expenses of ` 35,000; (b) wristwatches costing ` 2,500 each were given to 12 dealers, who had exceeded the sales quota prescribed under a sales promotion scheme; (c) employers contribution of ` 6,000 to the Provident Fund was paid on 14th January 2013. (d) ` 30,000 was paid in cash to an advertising agency for publicity. ` in `000 Particulars ` in `000 9,900.00 25.00 1,640.00 M K

1,00,000 (-) 20,000 80,000 Nil

1,20,100 (-) 20,000 1,00,100 Nil

1,10,000 (-) 20,000 90,000 Nil

6,250.00 Sales Dividend from companies 130.00 170.00 Long-term Capital Gains 256.00 48.30 35.70 111.70 39.00 4,524.30 11,565.00

11,565.00

(ii) Outstanding sales tax penalty was paid on 15th April 2013. The penalty was imposed by the sales tax officer for non-filing of returns and statements by the due dates. (iii) T and Q had, for this year, income from other sources of ` 3,50,000 and ` 2,10,000, respectively.

17.30 I DIRECT TAXATION

Required to : (i) Compute the total income of the AOP for the Previous Year 2012-2013.

(ii) Ascertain the tax liability of the Association for that year; and (iii) Ascertain the tax liability for that year of the individual members. Solution : (i) Computation of total income of the AOP for PY 2012-2013 Particulars Profit and Gains of Business (see Working Note below) Long Term Capital Gain Income from Other Sources [dividend is exempt u/s 10(34), assuming it is from domestic companies] Total Income Working Note: Computation of profits and gains of business: Net profit as per Profit and Loss Account Add: Inadmissible payments: Interest to members T & Q (` 48,300 + ` 35,700) Advertising [disallowance u/s 40A(3) Remuneration to members T & Q (` 1,30,000 + ` 1,70,000) Sales tax penalty due (See Note 3 below) Less : Income not taxable under this head Dividend from companies Long term Capital Gain Profits and Gains of Business (ii) Computation of tax liability of the AOP for PY 2012-2013 Particulars Long-term Capital Gain (` 16,40,000 20%) Other Income ( ` 33,12,300 30%) Tax on Total Income Add : Education cess @ 2% Add : SHEC @ 1% Total Tax due Total Tax Rounded off (u/s 288B) Note : 1. 2. 3. 4. Since one of the members has individual income more than the basic exemption limit, the AOP will be assessed at the maximum marginal rate. Since the employers contribution to PF has been paid during the Previous Year 2012-2013 itself, it is allowable as deduction. Penalty imposed for delay in filing sales tax return is not deductible since it is on account of infraction of the law requiring filing of the return within the specified period. Gift paid to dealers are solely for business purpose and hence, fully deductible item. ` ` 3,28,000 9,93,690 13,21,690 26,434 13,217 13,61,341 13,61,340 ` ` 33,12,300 16,40,000 NIL 49,52,300

45,24,300 84,000 30,000 3,00,000 39,000 25,000 16,40,000

4,53,000 49,77,300 16,65,000 33,12,300

DIRECT TAXATION I 17.31

Assessment of Various Entities & Tax Planning (iii) Computation of Tax Liability of members T & Q for the PY 2012-2013 Particulars Tax on ` 3,50,000 Add : Surcharge Add : Education cess @ 2% Add : SHEC @ 1% Net Tax Payable Particulars ` 15,000 Tax on ` 2,10,000 Nil Add : Surcharge 15,000 Add : Education cess @ 2% 300 Add : SHEC @ 1% 150 15,450 Net Tax Payable ` 1,000 Nil 1,000 20 10 1,030

17.32 I DIRECT TAXATION

ILLUSTRATIONS ON ASSESSMENT OF CHARITABLE TRUSTS

Illustration 7. Shri Dubbawala Charitable Trust (Regd.) submits the particulars of its income / outgoing for the Previous Year 2012-2013 as below : ` (i) Income from property held under trust for charitable purposes: (` 2,20,000 out of ` 10,00,000 is received in PY 2013-2014) (ii) Voluntary contributions (out of which ` 50,000 will form part of the corpus) 2,00,000 10,00,000

The trust spends ` 1,77,500 during the Previous Year 2012-2013 for charitable purposes. In respect of ` 2,20,000, it has exercised its option to spend it within the permissible time-limit in the year of receipt or in the year, immediately following the year of receipt. The trust spends ` 2,00,000 during the Previous Year 2011-2012 and ` 1,00,000 during the Previous Year 2013-2014. Compute and discuss the chargeabiliry of the income of the trust. Solution : (a) Computation of taxable income and tax liability of the charitable trust for the PY 2012-2013 / AY 2013-2014 Particulars (i) Income from property held under trust for charitable purposes (ii) Voluntary contributions (` 2,00,000 - ` 50,000) Less: 15% set apart for future application Balance Less: Amount spent during the Previous Year for charitable purposes Balance Less: Income not received during the Previous Year 2012-2013 Taxable Income Tax payable: Rate of tax 2,00,000 Nil 3,00,000 10% 80,000 20% Add: Education Cess @ 2% Add: SHEC @ 1% ` 10,00,000 1,50,000 11,50,000 1,72,500 9,77,500 1,77,500 8,00,000 2,20,000 5,80,000

Tax Payable (b) Previous Year 2013-2014 /AY 2014-2015 Income received during the Previous Year 2013-2014 Amount spent for charitable purposes during 2012-2013 Taxable Income

30,000 16,000 46,000 920 460 47,380

2,20,000 1,00,000 1,20,000

Illustration 8. Shri Mungeri Ram Temple Trust (Regd.) derived ` 6,00,000 income from the property held under charitable trust during the Previous Year 2012-2013. About 40% of the income has been received by the end of the financial year. The trust could spend ` 60,000 for charitable purposes during the year 2012-2013 and 40% receipts, received by the year end in 2012-2013, are being planned to be applied for charitable purposes during the Previous Year 2013-2014. Compute its income for the said two years if the amount planned to be spent during Previous Year 2013-2014 for charitable purposes is ` 1,00,000.

DIRECT TAXATION I 17.33

Assessment of Various Entities & Tax Planning Solution : (a) Computation of Taxable Income of Charitable Trust: PY 2012-2013/AY 2013-2014 Particulars Income from property held under Trust Less: 15% set apart for future application for charitable purposes Balance Less : Income applied for charitable purposes during the year 2012-2013 Balance Less: Income realised by the close of the Previous Year40% of ` 6,00,000 Taxable Income (b) Previous Year : 2013-2014/A.Y. 2014-2015 Amount set apart in 2012-2013 to be applied for charitable purposes in 2013-2014 = 2,40,000 Less: Amount applied for charitable purposes = 1,00,000 Taxable Income 1,40,000 ` 6,00,000 90,000 5,10,000 60,000 4,50,000 2,40,000 2,10,000

Illustration 9. Devdas Charitable Trust submits the particulars of its receipts and outgoing during the Previous Year 2012-2013 as below : (i) (ii) (iii) (iv) (v) (vi) Income from property held under trust for charitable purposes Voluntary contribution (out of which ` 5,00,000 will form part of the corpus) Donations paid to blind charitable school Scholarship paid to poor students Amount spent on holding free eye camps in urban slums Amount set apart for setting up an old age home by March 2015 ` 20,00,000 ` 15,00,000 ` 6,00,000 ` 4,00,000 ` 3,00,000 ` 10,00,000

Compute the total income of the trust for the Previous Years 2012-2013 and 2015-2016 if it spends ` 3,00,000 during the Previous Year 2014-2015 and ` 5,00,000 during the Previous Year 2015-2016 in setting up the old age home. Solution : (a) Computation of the Taxable Income of the trust for Previous Year 2012-2013/AY 2013-2014. Particulars (i) Income from property held under charitable trust (ii) Income from voluntary contributions (` 15,00,000 - ` 5,00,000) Total Less : 15% set apart for future application Balance Less: Income applied for charitable purposes: (i) Donations to blind charitable school (ii) Scholarship to poor students (iii) Free eye camps in urban slums Total Amount set apart for old age home Taxable Income (b) Previous Year 2015-2016 /AY 2016-2017: Amount set apart for old age home Less : 1. Amount spent during 2014-2015 2. Amount spent during 2015-2016 Taxable Income ` 20,00,000 10,00,000 30,00,000 4,50,000 25,50,000 6,00,000 4,00,000 3,00,000 13,00,000 10,00,000

(23,00,000) 2,50,000

10,00,000 (3,00,000) (5,00,000) 2,00,000

17.34 I DIRECT TAXATION

Illustration 10. CD Charitable Trust furnishes the following particulars, for the year 2012-2013: (i) (ii) (iii) (iv) Sale price of capital assets Expenses incurred in connection with sale of the asset Cost of the asset sold (purchased in 2011-2012) Compute Capital Gain in the following cases: (a) Cost of the new asset to be acquired (b) Cost of the new asset to be acquired (c) Cost of the new asset to be acquired (`) 15,30,000 30,000 5,00,000 15,00,000 8,00,000 4,00,000

Solution: Computation of Capital Gain: PY 2012-2013/AY 2013-2014 Particulars Sale price Less: (i) Selling expenses (ii) Cost of the asset Short-term Capital Gain Less: Exemption in respect of Capital Gain Taxable Capital Gain Note : Case-l ` 15,30,000 (-) 30,000 (-) 5,00,000 10,00,000 10,00,000 Nil Case-II ` 15,30,000 (-) 30,000 (-) 5,00,000 10,00,000 3,00,000 7,00,000 Case-III ` 15,30,000 (-) 30,000 (-) 5,00,000 10,00,000 Nil 10,00,000

1. Cost of new asset - cost of asset sold: 8,00,000 - 5,00,000 = 3,00,000 2. Cost of new asset - cost of asset sold: 4,00,000 - 5,00,000 = Nil

DIRECT TAXATION I 17.35

Assessment of Various Entities & Tax Planning

ILLUSTRATIONS ON ASSESSMENT OF COOPERATIVE SOCIETIES

Illustration 11. Dinesh Pally Cooperative Society Ltd. furnishes the following particulars of its income for the Previous Year ending on 31st March 2013: (i) (ii) (iii) (iv) (v) (vi) (vii) Interest on government securities Profits from banking business Income from purchase and sale of agricultural implement and seeds to its members Income from marketing of agricultural produce of its members Profits and gains of business Income from cottage industry Interest and dividends (gross) from other cooperative societies 40,000 3,50,000 2,50,000 4,00,000 2,20,000 3,50,000 30,000

Compute Total Income of the society and calculate the Tax Payable by it for the Assessment Year 2013-2014. Solution : Dinesh Pally Cooperative Society Ltd. Computation of income of the for the Previous Year 2012-2013 relating to the Assessment Year 20132014 : Particulars 1. Profits and Gains of Business or Profession: a) Banking business b) Income from purchase and sale of agricultural implements and seeds to its members c) Income from marketing of agricultural produce of its members d) Profits and gains of business e) Income from cottage industry 2. Income from Other Sources: a) Interest on Government securities b) Interest and dividends from other cooperatives Gross Total Income Less: Deduction allowable from gross total income under Sec. 8OP 1. Banking business [Assumed it is a Rural Development Bank] 2. Income from purchase and sale of agricultural implement and seeds to its members 3. Income from marketing of agricultural produce of its members 4. Income from cottage industry 5. Interest on government securities(not eligible for deduction) 6. Interest and dividends from other cooperative societies Total Income 3,50,000 2,50,000 4,00,000 3,50,000 Nil 30,000 ` 3,50,000 2,50,000 4,00,000 2,20,000 3,50,000 40,000 30,000 `

15,70,000

70,000 16,40,000

13,80,000 2,60,000

17.36 I DIRECT TAXATION

Computation of Tax Liability : Particulars On first ` 10,000 On next ` 10,000 On balance ` 2,40,000 Income Tax Payable Add: Education cess @ 2% Add: SHEC @ 1% Tax Payable Note: It is assumed that the provisions of Alternate Minimum Tax are not applicable. Illustration 12. A co-operative society, engaged in the business of banking, seeks your opinion by the matter of eligibility of deduction under Sec. 8OP on the following items of income earned by it during the year ending 31-3-2013. (i) Interest on investment in Government securities made out of statutory reserves Rate 10% 20% 30% ` 1,000 2,000 72,000 75,000 1,500 750 77,250

(ii) Hire charges of safe deposit lockers. Solution : From the Assessment Year 2008-2009 and onward, no deduction is allowed under Sec. 80P to any cooperative bank. However, a primary agricultural credit society or primary cooperative agricultural and rural development bank is outside the purview of this provision [Sec. 80P(4)]. Illustration 13. A cooperative society was engaged in the business of banking or providing credit facilities to its members. It sold goods on credit to its members. Is the cooperative society entitled to special deduction under Sec. 80P(2)(a)(i) in respect of income derived from such an activity? Solution : Society is not entitled to the special deduction under Sec. 80P(2)(a)(i).

DIRECT TAXATION I 17.37

Assessment of Various Entities & Tax Planning

ILLUSTRATIONS ON ASSESSMENT OF INDIVIDUAL

Illustration 14. Salil was running a business. He died on 20th December, 2012, leaving behind his wife Sruti and two minor sons - Sampat and Samar. He did not have any will. Sruti is running the business for and on behalf of herself and the minor children. Salil owned two house properties. Discuss how the rental income and the business income of the financial year 31st March, 2013 will be assessed and in whose hands. Solution: Section 159 provides that if an assessee dies during the Previous Year, the income of the period beginning from the commencement of Previous Year and ending with the date of death is taxable in the hands of the legal representative as if the assessee had not died. Therefore, the business profits and the rental income accruing from 1st April, 2012 to 20th December, 2012 will be assessable in the hands of the legal representatives. Sruti represents the estate and hence is liable to be assessed as the legal representative of Salil. Business profits and rental income arise from 21st December, 2012 to 31st March, 2013: As far as rental income is concerned, it will be assessed as income of Sruti, Sampat and Samar according to their shares. According to provisions of Hindu Succession Act, when a male Hindu dies intestate, his estate will devolve on the heirs mentioned in the Schedule by succession and not by survivorship. Hence, the widow and minor children became co-owners and Section 26 will apply since the respective shares are definite and ascertainable. The rental income will be divided into three parts. However, income of Sampat and Samar will be clubbed with income of Sruti by virtue of section 64(1A). As far as business profit is concerned, the Andhra Pradesh High Court in Deccan Wine and General Stores vs. CIT [1977] 106 ITR 111 has held on similar facts that it is to be assessed in the status of Body of Individuals. Illustration 15 : Ria, Gia and Ira are persons ,aged 30 years, 34 years and 35 years respectively, of Indian origin, though their residential status is non-resident. During the Previous Year relevant for the Assessment Year 2013-14, their income from investment in India is as follows: Particulars a. Interest on deposits with public limited companies received on March 31, 2013 b. Interest on Government securities received on December 31,2012 c. Interest on deposits with private limited companies on September 30, 2012 Tax deducted at source, i.e., @ 20.6 per cent in respect of foreign exchange assets (a) and (b); and @ 30.9 per cent in respect of (c) Ria ` 35,000 2,25,000 Nil 53,560 Gia ` 80,000 2,20,000 1,00,000 92,700 Ira ` 1,50,000 2,70,000 8,80,000 3,58,440

Determine the amount of tax liability/refund for the Assessment Year 2013-14. Also discuss whether the assessee should opt under section 115-I, i.e., not to be governed by provisions of sections 115C to 115-I. Solution: Tax liability if the assessee opts under section 115-I, not to be governed under the provisions

17.38 I DIRECT TAXATION

of sections 115C to 115-I: Particulars Gross Total Income [(a) + (b) + (c)] Less: Deduction Net Income Tax Add: Education Cess Add: Secondary and Higher Secondary Education Cess Less: Tax Deduction at Source Final tax liability/(-)refund Tax liability if provisions of sections 115C to 115-I are applicable: Income from foreign exchange assets eligible for provisions of sections 115C to 115-I [i.e., (a) + (b)] Tax on income from foreign exchange assets [i.e., @ 20.6% in the case of Ria, Gia and Ira] (1) Other Income [i.e., (c)] Less: Deduction Taxable Income Tax Add: Education Cess Add: Secondary and Higher Secondary Education Cess Tax on Other Income Tax liability [i.e., (1) + (2)] Less: Tax Deducted at Source Final tax liability/(-)refund Ria ` 2,60,000 Nil 2,60,000 6,000 120 60 6,180 53,560 (-)47,380 2,60,000 53,560 Nil Nil Nil Nil Nil Nil Nil 53,560 53,560 Nil Gia Ira ` ` 4,00,000 13,00,000 Nil Nil 4,00,000 13,00,000 20,000 2,20,000 400 4,400 200 2,200 20,600 2,26,600 92,700 3,58,440 (-)72,100 (-)1,31,840 3,00,000 4,20,000

61,800 86,520 1,00,000 8,80,000 Nil Nil 1,00,000 8,80,000 Nil 1,06,000 Nil 2,120 Nil 1,060 Nil 1,09,180 61,800 1,95,700 92,700 3,58,440 (-)30,900 (-)1,62,740

Note: in the problem given above, Ria and Gia should opt under section 115-I (i.e., not to be governed by special provisions of sections 115C to 115-I) by furnishing return of income under section 139. Ira should take the benefit of special provisions of sections 115C to 115-I. Illustration 16 : From the Profit and Loss Account of Alo of 36 years old for the year ending March 31, 2013, ascertain her Total Income and Tax liability for the Assessment Year 2013 14: Particulars Particulars ` ` General Expenses 13,500 Gross Profits 3,17,000 22,000 Commission 8,800 Bad debts 3,000 Brokerage 37,000 Advance Tax 800 Sundry receipts 2,500 Insurance 1,200 Bad debt recovered ( earlier al11,000 Printing & Stationery 27,000 lowed as deduction) Salary to Staff 51,000 Interest on debentures (i.e., net Salary to Alo 4,000 amount `18,000 + tax deducted at Interest on Overdraft Interest on loan to Chandra 41,000 source : ` 2,000) 20,000 Interest on capital of Alo 22,000 Interest on deposit with a company Depreciation 48,000 (non trade) (net interest : ` 13,500 + Advertisement expenditure 7,000 tax deducted at source : ` 1,500) 15,000 Contribution to employees Recognized Provident Fund 7,800 Net Profit 1,63,000 4,11,300 4,11,300 Other Information:

DIRECT TAXATION I 17.39

Assessment of Various Entities & Tax Planning 1. 2. 3. 4. 5. 6. The amount of depreciation allowable is ` 45,000 as per the Income Tax Rules. It includes depreciation on permanent sing board. Advertisement expenditure includes ` 2000, being cost of permanent sing board fixed on office premises. Income of ` 2500, accrued during the Previous Year, is not recorded in the Profit and Loss Account. Alo pays ` 9000 as premium on own life insurance policy of ` 1,00,000. General expenses include: (a) ` 1,500 given to sister for arranging a party in her birthday party (b) ` 1,000 being contribution to a political party. Loan was taken from Chandra for payment of arrears of Income tax.

17.40 I DIRECT TAXATION

Solution : Assessee : Alo Previous Year : 2012-2013 Assessment Year : 2013-2014 ` 1,500 1,000 3,000 51,000 22,000 41,000 2,000 48,000 ` 1,63,000

Particulars Net profit as per Profit & Loss Account Add: Inadmissible expenses: Expenses for arranging personal party Contribution to a political party Advance tax Salary to Alo Interest on capital to Alo Interest on loan taken for payment of Income-tax Capital expenditure on advertisement Depreciation debited to the Profit & Loss A/c Add: Income not recorded in the Profit and Loss Account Less: Income credited to the Profit and Loss Account but not chargeable under the head Profits and gains of business or profession. Interest on debentures Interest on company deposit Less: Depreciation allowable Income Tax Rules Business Income Computation of Net Income of Alo Profits and Gains of Business or Profession Income from Other Sources (interest on debentures and company deposit) Gross Total Income Less: Deductions Under section 80C (payment of insurance premium) Deduction under section 80GGC (being contribution to a political party) Net Income Tax on Net Income Add: Surcharge (surcharge is not applicable for the Assessment Year 201314) Tax and Surcharge Add: Education cess (2% of tax and Surcharge) Add: Secondary and higher education cess [1% of tax and Surcharge] Tax Less: Pre-paid tax (i.e., advance tax + tax deducted at source) Tax Payable (rounded off) Note : Provisions of Alternate Minimum Tax are not applicable.

1,69,500 3,32,500 2,500 3,35,000

20,000 15,000

35,000 3,00,000 45,000 2,55,000 2,55,000 35,000 2,90,000

9,000 1,000

10,000 2,80,000 8,000 Nil 8,000 160 80 8,240 6,500 1,740

DIRECT TAXATION I 17.41

Assessment of Various Entities & Tax Planning

ILLUSTRATIONS ON ASSESSMENT OF HUF

Computation of Tax-liability of an HUF : 1. Gross income tax on its total income at the prescribed rates as aforesaid: (a)Gross income tax on winnings from lotteries, cross word puzzle, races and horse races, card games, gambling or betting under Sec. 115BB (b)Gross income tax on Long-term Capital Gains [Sec. 112(1)] (c)Gross income tax on Short-term Capital Gain [Sec. 111A] (d)Gross income tax on the balance of Total Income Total Gross Income Tax 2. Less: Rebate from gross income tax under Sec. 88E Net Income Tax 3. Add: Surcharge on income tax 4. Add: Education surcharge @ 2% on the aggregate income tax and surcharge 5. Add: SHEC @ 1% Total Tax (3 + 4+ 5) 6. Less : (a) Rebate on share of profit from AOP under Sec. 86 where AOP (Association of Person) has been taxed at normal rate (b)Relief under Sec. 89(1) (c)Double taxation relief under Sec. 91 Tax due from an HUF Less: Prepaid taxes: (a)Tax deducted at source (b)Advance payment of tax (c)Tax paid on self-assessment under Sec. 140A Tax payable/refund due to the assessee Tax payable is rounded off to the nearest multiple of ` 10 (Sec. 288B). xxx xxx xxx xxx xxx xxx xxx xxx xxx `

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

17.42 I DIRECT TAXATION

Illustration 17. The following details have been supplied by the Karta, of an HUF aged 62 years. You are required to compute its total income and tax liability for the Assessment Year 2013-2014. Particulars (i) Profits from business (after charging ` 1,00,000 salary to Karta for managing the business) (ii) Salary received by the member of a family (iii) Directors fee received by Karta from B Ltd where HUF holds 20% shares but he became director because of his qualifications, (iv) Rental income from house property (after deduction of municipal taxes ` 12,000) (v) Dividends (gross) from Indian companies (vi) Long-term Capital Gain (vii) Short-term Capital Gain (viii) Donation to a school, which is an approved institution (ix) Deposits in Public Provident Fund (x) NSC-VIII issues purchased Solution: Computation of Total Income for the A.Y. 2013-14 Particulars (i) Income from House Property: Gross annual value (` 78,000 + ` 12,000) Less: Municipal Taxes paid Annual value Less: Statutory deduction: 30% 78,000 (ii) Profits and gains from business (iii) Capital Gains (a) long-term + (b) short-term (iv) Income from other sourcesgross dividends from Indian companies: Exempt [Sec. 10(34)] Gross Total Income Less: 1. Contribution to approved savings (Sec. 80C) (i) Deposits in Public Provident Fund (ii) NSC-VIII Issue 2. Donation to recognised school: (a) Actual donation: ` 1,00,000 or (b) 10% of adjusted total income = (Gross Total Income Long Term Capital Gains All deductions under Chapter VIA excluding Sec. 80G) of ` 15,24,600 (16,64,600 - 80,000 - 60000) whichever is less, is qualifying amount. Amount of deduction: : 50% of ` 1,00,000 Total Income ` 90,000 12,000 78,000 23,400 ` ` 15,00,000 60,000 40,000 78,000 15,000 80,000 30,000 1,00,000 20,000 40,000

54,600 15,00,000 1,10,000 Nil 16,64,600

20,000 40,000 60,000

50,000

1,10,000 15,54,600

DIRECT TAXATION I 17.43

Assessment of Various Entities & Tax Planning Computation of Tax Liability: Particulars of total income (a) Long-term Capital Gain (b) Balance of total income: ` 14,74,600 (i) First (ii) Between 2,00,000 5,00,000 (iii) Between 5,00,000 10,00,000 (iv) Between 10,00,000 14,74,600 Gross Income Tax Add: Education cess @ 2% on income tax SHEC @ 1% on income tax Tax Payable Rounded off u/s 288B Rate of income tax ` 80,000 2,00,000 3,00,000 5,00,000 4,74,600 ` 20% Nil 10% 20% 30% 16,000 30,000 1,00,000 1,42,380 2,88,380 5,768 2,884 2,97,032 2,97,030 `

Note : Assumed applicability conditions of AMT are not satisfied and hence, AMT provisions are not applicable. Illustration 18. Prem was the Karta of HUF. He died leaving behind his major son Anand, his widow, his grandmother and brothers wife. Can the HUF retain its status as such or the surviving persons become co-owners? Answer: Income-tax law does not require that there should be at least two male members to constitute an HUF [Gowli Buddanna vs. CIT (1966) 60ITR 293 (SC)]. The expression Hindu Undivided Family used in the Act should be understood in the sense in which it is understood under the Hindu personal law. The expression Hindu Undivided Family under the Income-tax Act is known as Joint Hindu Family, under the Hindu personal law. A Joint Family may consist of a single male member and the widows of the deceased male members. The property of the Hindu joint family does not cease to be an HUF property merely because that the HUF, consist of one male member at a given point of time, exercising the proprietary rights over the property of HUF property. Illustration 19. J (HUF) was the owner of a house property, which was being used for the purposes of a business carried on by a partnership firm JC & Co. in which the Karta and other members of the HUF were partners in their individual capacity. The Assessing Officer proposes to assess the annual letting value of the said property as the HUFs income from house property. The HUF contends that the building was used for business purposes and, therefore, the annual letting value thereof was not taxable in its hands as income from house property under Sec. 22. Examine the rival contention. Answer: Section 22 directs not to tax the annual value of a house property which is used by the owner for his business profession, the profits of which are chargeable to tax. In the instant case, the HUF is not using its property for its business. The Karta of the Hindu undivided family and other members of the HUF are partners in the firm in their personal capacity. They have not joined the partnership on behalf of the HUF. Therefore, it cannot be said that the HUF property was being used by the HUF for its business. Hence, the Assessing Officer is justified to tax the income of the HUF property as income from House Property. Illustration 20. J.Hazra was the Karta of a Hindu Undivided Family which was assessed to income tax. He died in an air crash and his two sons received ` 8 lakhs as compensation and ` 6 lakhs from the insurance company. The said amount of ` 14 lakhs was invested in units. The assessee claims that the

17.44 I DIRECT TAXATION

income from these units is assessable as income of the Hindu Undivided Family composed of his sons and their families. Discuss. Answer: The right to receive compensation and insurance claim did not vest in the assessee during his life-time. It came into existence only after his death. The income from investment and compensation would be personal income of the assessee [CIT vs. L. Bansi Dhar & Sons (1980) 123 ITR 58 (Del.)]. Illustration 21. C, the Karta of a Hindu Undivided Family, was appointed as the treasurer of a private sector bank on his furnishing security of the family property valued at ` 3,00,000, as required by the service rules of the bank. C does not own any self-acquired property. (i) Discuss how the remuneration of C as the treasurer should be assessed. (ii) Will your answer be different if C had joined a partnership firm as a partner by contributing family funds of ` 30,000. Answer: (i) Remuneration from bank cannot be treated a return on the security of family property, pledged with the bank to secure the continuity of service. It cannot be treated as income of the HUF. Remuneration is a compensation for services rendered by C, in his personal capacity on account of personal qualifications. C is assessable on remuneration as income from salary. He can claim standard deduction under Sec. 16.

(ii) Membership of partnership has been obtained because of HUF funds and not because of personal skill or qualification of C. Therefore, any income from partnership firm will be treated as income of the HUF.

DIRECT TAXATION I 17.45

Assessment of Various Entities & Tax Planning

ILLUSTRATIONS ON ASSESSMENT OF FIRM / LLP

Illustration 22: R (29 years) and S (28 years) are two partners of R&S Co. (a firm of Cost Accountants). On March 31, 2012, there is no provision for payment of salary and interest to partners. On April 1, 2012, the deed of partnership has been amended to provide salary and interest as follows: Salary Interest Particulars R ` 21,000 per month 14 per cent per annum S ` 23,000 per month 14 per cent per annum

The Income and Expenditure Account of R&S Co. for the year ending March 31, 2013 is as follows: Particulars Office Expenses Salary to employees Income tax Salary to R Salary to S Interest on capital to R @ 14% p.a. Interest on capital to S @ 14% p.a. Net Profit (shared by R and S equally as per the terms of partnership deed) Other Information: 1. 2. 3. Out of office expenses, ` 19,000 is not deductible by virtue of sections 30 to 37. During the year the firm sells a capital asset for ` 8,10,000 (indexed cost of acquisition being ` 1,88,865). Personal income and investments of partners are as follows: Particulars Interest from Government securities Fixed Deposit interest Deposit in public provident fund Mediclaim insurance premium R ` 5,70,000 2,00,000 1,00,000 12,000 S ` 5,23,000 1,08,000 85,000 11,000 Particulars ` 2,59,000 Receipt from clients 80,000 Interest recovered from R and S on 41,000 drawings 2,52,000 2,76,000 14,000 21,000 1,17,000 10,60,000 ` 10,57,000 3,000

10,60,000

Find out the net income and tax liability of the firm as well as the partners for the Assessment Year 201314.

17.46 I DIRECT TAXATION

Solution :

Particulars

` 1,17,000 41,000 19,000 5,28,000 5,000 7,10,000 5,16,000 1,94,000

Computation of net income/tax liability of the firm Net profit as per Income and Expenditure Account Add: Income tax Office expenses Salary to R and S (`2,52,000 + `2,76,000) Interest to R and S [to the extent not allowed as deduction, i.e., {(` 14,000 + ` 21,000)-12/14 of (` 14,000 + ` 21,000)}] Book Profit Less: Remuneration to partners [maximum deductible amount is 90% of ` 3,00,000 + 60% of ` 4,10,000] Income from the Profession Capital Gains Sale proceeds Less: Indexed const of acquisition Net income (rounded off) Tax Income-tax on Long-term Capital Gain [20% of ` 6,21,135] Income-tax on balancing amount [@30%] Tax Add: Surcharge (not applicable) Tax and surcharge Add: Education cess (2% of tax) Add: Secondary and higher education cess (1% of income-tax) Tax liability of the firm (rounded off) Computation of net income and tax liability of partners Profits and gains of business or profession Interest from the firm(to the extent allowed as deduction, i.e., 12/14 of ` 14,000 and ` 21,000) Salary received from the firm(to the extent allowed as deduction, i.e., ` 5,16,000 distributed in the ratio of 63:69) Income from profession Income from other sources Gross total income Less: Deduction under sections 80C to 80U Under section 80C Under section 80D Net Income (rounded off) Tax on income Income-tax Add: surcharge (not applicable in case of an individual for the assessment year 2013-14) Tax and surcharge Add: Education Cess (2% of tax) Add: Secondary and Higher Secondary Education Cess (1% of tax) Tax liability (rounded off) Note: Interest recovered from partners is fully taxable. Provisions of Alternate Minimum Tax are not applicable in the above cases.

8,10,000 1,88,865

6,21,135 8,15,135 1,24,227 58,200 1,82,427 Nil 1,82,427 3,649 1,824 1,87,900

R ` 12,000 2,46,273 2,58,273 7,70,000 10,28,273 1,00,000 12,000 9,16,270 1,13,254 Nil 1,13,254 2,265 1,133 1,16,652

S ` 18,000 2,69,727 2,87,727 6,31,000 9,18,727 85,000 11,000 8,22,730 94,546 Nil 94,546 1,891 945 97,382

DIRECT TAXATION I 17.47

Assessment of Various Entities & Tax Planning Illustration 23 : Bebo and Lolo are partners in a partnership firm, K & Co.. They share profit at a ratio of 1:4. The firm is engaged in the business of civil construction. The Profit and Loss Account of the firm for the year ending March 31, 2013 is as follows: Particulars Opening stock of raw material Depreciation Salary to employees Purchase of raw material Interest on loan taken for business purposes Travelling expense Entertainment expense Advertisement expenses Other expenses Municipal tax and insurance (` 8,000 + ` 1,600) of godown Salary to partners as per partnership deed Bebo Lolo Interest to partners as per partnership deed @ 20 per cent p.a. Bebo Lolo Net Profit ` 1,12,200 2,56,400 1,65,000 33,12,000 76,400 27,200 12,500 33,700 4,15,000 9,600 2,28,000 2,40,000 20,000 60,000 7,81,800 5,74,9800 5,74,9800 Particulars Sales turnover Rent of a godown Interest on company deposits Closing stock of raw material ` 48,90,400 60,000 1,86,800 6,12,600

Other Information: 1. Out of other expenses debited to P&L A/c ` 15,700 is not deductible under section 37(1). 2. Out of travelling expenses ` 7,500 is not deductible under section 37(1). 3. On April 1, 2012, the firm owns the following depreciable assets: Block 1 Plants 1 and 2, depreciated value: ` 4,70,000, rate of depreciation : 15%. Block 2 Plants 3 and 4, depreciated value : ` 5,20,000, rate of depreciation : 30%. On January 1, 2013, the firm sells Plant 4 for ` 8,90,000 and purchases Plant 5 (rate of depreciation 15%) for ` 4,00,000. 4. The firm gives a donation of ` 1,50,000 to a notified charitable institute which is included in other expenses. The firm wants to set off the following losses brought forward from earlier years: Particulars Business Capital Loss (short-term) Assessment Years 2011-12 2010-11 ` ` 25,000 --5,000 3,000

17.48 I DIRECT TAXATION

Income of partners Bebo and Lolo is as follows: Particulars Interest on Fixed Deposits LIC Premium paid (Capital Sum Assured is more than 10% of Premium paid) Bebo ` 5,36,000 50,000 Lolo ` 8,20,000 80,000

Firm wants to pay tax under section 44AD. Find out the net income and tax liability of the firm and partners for the Assessment Year 2013-14 on the assumption that a. b. Conditions of sections 184 and 40(b) are satisfied; and Conditions of section 184 and/or section 40(b) are not satisfied.

Solution: Situation (a): Situation (b): When condi- When conditions of sec- tions of Section tions 184 and 184 and/or 40(b) are 40(b) are not satisfied satisfied ` ` 3,91,232 48,000 3,43,232 2,95,939 47,293 36,400 22,293 3,62,000 1,86,800 6,07,493 30,375 5,77,120 1,73,136 Nil 1,73,136 3,463 1,731 1,78,330 3,91,232 --3,91,232 --3,91,232 36,400 3,66,232 3,62,000 1,86,800 9,51,432 47,572 9,03,860 2,71,158 Nil 2,71,158 5,423 2,712 2,79,290

Particulars

Computation of business income of the firm Income from civil construction business [i.e., 8% of ` 48,90,400] Less: Interest on capital to partners @ 12% [i.e.12/20(20,000+60,000)] Book Profit Less: Remuneration to partners [i.e., 90% of ` 3,00,000 and 60% of ` 43,232] Income from the business of civil construction Computation of income Property income [i.e., ` 60,000 ` 8,000 30% of ` 52,000] Business income (minus brought forward business loss) Capital Gain on sale of Plant 4 under section 50 [i.e., ` 8,90,000 ` 5,20,000 8,000 brought forward Short-term Capital Loss) Income from Other Sources Gross Total Income Less: Deduction under section 80G [i.e., 50% of 10% of ` 6,07,493 or ` 9,51,432] Net Income (rounded off) Tax Add: Surcharge [not applicable in the case of a partnership firm for the Assessment Year 2013-14] Tax and surcharge Add: Education cess (2% on tax and surcharge) Add: Secondary and higher education cess (1% on tax and surcharge) Tax liability (rounded off)

DIRECT TAXATION I 17.49

Assessment of Various Entities & Tax Planning Computation of net income and tax liability of partners Business Income: Interest from firm Salary from firm (` 2,95,939 shall be divided between Bebo and Lolo in the ratio of 228 : 240) Business income under section 28 Bank interest (fixed deposits) Gross total income Less: Deduction under section 80C Net Income (rounded off) Tax Add: Surcharge Tax and surcharge Add: Education Cess (2% of tax) Add: Secondary and Higher Secondary education Cess [1% of tax] Tax liability (rounded off) Situation (a) Bebo Lolo ` ` 12,000 1,44,175 1,56,175 5,36,000 6,92,175 50,000 6,42,175 58,435 --58,435 1,169 584 60,190 36,000 1,51,764 1,87,764 8,20,000 10,07,764 80,000 9,27,764 1,15,553 --1,15,553 2,311 1,156 1,19,020 Situation (b) Bebo Lolo ` ` ------5,36,000 5,36,000 50,000 4,86,000 28,600 --28,600 572 286 29,460 ------8,20,000 8,20,000 80,000 7,40,000 78,000 Nil 78,000 1,560 780 80,340

Note : Provisions of Alternate Minimum Tax are not applicable in the above cases. Illustration 24 : A, B and C are three partners (3: 3: 4) of ABC & Co., a LLP engaged in manufacturing leather goods and it has agencies of different companies. The Profit and Loss Account of the LLP for financial year ending March 31, 2013 is as follows: Particulars Cost of goods sold Salary to staff Depreciation Remuneration to Partners : A B C Interest on capital to partners A B C Other expenses Net Profit: A B C Particulars ` 7,90,000 Sales 7,80,000 Long-term Capital Gains 2,50,000 1,92,000 Short-term Capital Gain under 96,000 section 111A 1,80,000 Other Short-term Capital Gain Fixed deposit interest 17,000 Other business receipts 30,000 Interest on drawings recovered 40,000 from A 1,65,000 21,000 21,000 28,000 26,10,000 ` 21,22,000 3,00,000

55,000 65,000 50,000 2,000 16,000

26,10,000

17.50 I DIRECT TAXATION

Other information: 1. 2. 3. 4. The LLP satisfies conditions of sections 184 and 40(b). The LLP is not eligible for deduction under section 80-IA/80-IB. The LLP has given donation of ` 70,000 to a notified public charitable trust which is not debited to the Profit and Loss Account. Up to March 31, 2012, there is no provision in the partnership deed to pay remuneration to partners. The deed is amended on April 1, 2012 to pay remuneration/interest to partners as under: Particulars A B C 5. 6. 7. Remuneration ` 16,000 per month 8,000 per month 15,000 per month Interest on capital ` 17 per cent simple interest 15 per cent simple interest 20 per cent simple interest

Depreciation as per section 32 comes to ` 95,000 Other expenses to the tune of ` 65,000 is not deductible under sections 30 to 43D. For the Assessment Years 2011-12 and 2012-13, the firm has assessed business loss of ` 30,000 and Long-term Capital Loss of ` 15,000 (which has not been set off so far).

SOLUTION : Particulars Computation of remuneration deductible under section 40(b) Net Profit as per P&L A/c (` 21,000+`21,000+`28,000) Add: Depreciation debited to P&L A/c Remuneration to partners (i.e., ` 1,92,000+`96,000+`1,80,000) Interest to partners (to the extent not deductible) (i.e., 5/17 of ` 17,000 + 3/15 of ` 30,000 + 8/20 of ` 40,000) Other expenses (to the extent not deductible) Less: Capital Gain (` 3,00,000+`55,000+`65,000) Interest on Bank Fixed Deposit Depreciation as per Section 32 Book Profit Remuneration deductible (90% of ` 3,00,000 + 60% of `15000) ` 70,000 2,50,000 4,68,000 27,000 65,000 8,80,000 4,20,000 50,000 95,000 3,15,000 2,79,000

DIRECT TAXATION I 17.51

Assessment of Various Entities & Tax Planning Computation of income of the firm Business Income Book Profit Less : Remuneration deductible Balance Less : Brought forward business loss Long-term Capital Gain (minus brought forward Long-term Capital Loss of `15,000) Short-term Capital Gain under section 111A Other short-term Capital Gain Interest on Fixed Deposit Gross total income Less: Deduction under section 80G [i.e., 50% of 10% of ` (4,61,000-2,85,000-55,000)] Net Income (rounded off) Computation of tax of firm Long-term Capital Gain (20% of 2,85,000) Short-term Capital Gain under section 111A (15% of ` 55,000) Other Income (30% of ` 1,14,950) Total Add: Surcharge Total Add: Education cess Add: Secondary and higher education cess Tax liability of the firm (rounded off) Note: 1. 2. Interest recovered from partners is fully taxable. Provisions of Alternate Minimum Tax are not applicable in the above cases. ` 3,15,000 2,79,000 36,000 30,000 2,85,000 55,000 65,000 `

6,000

4,05,000 50,000 4,61,000 6,050 4,54,950 57,000 8,250 34,485 99,735 Nil 99,735 1,995 997 1,02,730

Illustration25 : The following is the Profit and Loss Account for the year ending 31.3.2013 of XYZ(LLP) having 3partners: Profit and Loss Account Establishment & other expenses Interest to partner @15% X Y Z Salary to designated partners X Y Net Profit ` 45,50,000 Gross Profit 90,000 1,20,000 60,000 Rent from house property Interest on Bank deposits 2,70,000 ` 69,20,000 1,60,000 20,000

2,40,000 1,80,000

4,20,000 18,60,000 71,00,000 71,00,000

17.52 I DIRECT TAXATION

The LLP is eligible for 100% deduction under section 80-IC as it is established in notified area in Himachal Pradesh. Compute the tax payable by the Limited Liability Firm. Solution: Computation of Total Income of XYZ (LmLP) for the A.Y. 2013-14 ` Income under the head House Property Actual Rent Less: Deduction 30% Business Income Net Profit as per P&L A/c Less: Income credited but either exempt or taxable under other head Rent Interest on bank deposit Add: Expenses disallowed Interest to partners in excess of 12% [i.e. 3/152,70,000] Salary to partners Book Profit Less: Salary as per section 40(b) (See working note) Income from Other Sources Gross Total Income Less: Deduction under section 80-IC Deduction under section 80TTA [Assumed Savings Account] Total Income Regular income tax payable on Total Income Total Income of `1,22,000 @ 30% Adjusted Total Income Total Income Add: Deduction u/s 80-IC 1,22,000 17,34,000 18,56,000 36,600 ` 1,60,000 48,000 18,60,000 1,60,000 20,000 ` 1,12,000

1,80,000 16,80,000 4,74,000 21,54,000 4,20,000 17,34,000 10,000 17,34,000 20,000 18,66,000 17,44,000 1,22,000

54,000 4,20,000

Alternate Minimum Tax (AMT) 18.5% on `18,56,000 = `3,43,360 Hence, adjusted total income shall be total income and the tax (payable shall be the Alternate Minimum Tax) i.e. on ` 18,56,000 @ 18.5% + 3% (EC + SHEC).

DIRECT TAXATION I 17.53

Assessment of Various Entities & Tax Planning Tax Payable Alternate Minimum Tax 18.5% on `18,56,000 Add: 3% Education Cess & SHEC ` 3,43,360 10,301 3,53,661 3,53,660

Rounded off Working Note Book Profit

21,54,000

Maximum salary allowed First 3,00,000 of book profit90% Balance `18,54,000 of book profit 60% Salary allowed shall be `13,82,400 or `4,20,000 whichever is lower i.e. `4,20,000. Illustration26. Discuss whether Mr. Das, an individual, can become a partner in dual capacity, that is, one representing HUF as Karta and the other as representing himself. Is a firm constituted by partners, including a partner in dual capacity, entitled to get the deduction of salary and interest paid to its partner? Solution : There is nothing in law which prevents an individual to become partner in a firm in dual capacity so long as there is one or more other individuals to join in the partnership. Such partnership is valid and legal and entilled to get the deduction of salary and interest paid to its partners if the requisite conditions are satisfied. [CIT vs. Budhalal Amolakhdas [1981] 5 Taxman 176 (Guj.)] Hence, Mr. Das can become a partner in dual capacity of a firm and the firm is eligible to get deduction of salary and interest paid to its partners if the requisite conditions are satisfied. 2,70,000 11,12,400 13,82,400

17.54 I DIRECT TAXATION

ILLUSTRATIONS ON ASSESSMENT OF COMPANIES

Illustration 27. From the following information, determine the tax liability of Z Ltd., domestic company, for the Assessment Year 2012-2013 and 2013-2014. S. No. 1. 2. Solution : Surcharge is not considered assuming, Net Income less than ` 1 crore Assessment Year Bookprofit Total Income Tax on Book-Profit Tax on Tax Credit Tax Payable Tax credit Total In= Tax on after tax balance come Book Profits credit set off, @ 30.9% () Tax on if any rounded off Total Inu/s 288B come (`) (`) (`) (`) @ 30.9% on 1,30,000 = 40,170 13,184 53,354 13,184 @ 30.9% on 2,00,000 = 61,800 48,616 [61,800 13,184] Assessment year 2012-2013 2013-2014 Book-profits (`) 2,80,000 3,00,000 Total income (`) 1,30,000 2,00,000

2012-2013

(`) (`) 2,80,000 1,30,000

(`) @ 19.055% on 2,80,000 = 53,354 @ 19.055% on 3,00,000 = 57,165

2013-2014

3,00,000 2,00,000

Note : Tax Payable is rounded off to the nearest multiple of ` 10 (Sec. 288B)

DIRECT TAXATION I 17.55

Assessment of Various Entities & Tax Planning Illustration 28. Fashion Ltd., a well-diversified group, gives below its Profit and Loss Account for the Previous Year 2012-2013 : Particulars Manufacturing expenses Salaries/wages Cultivation expenses Power generation/distribution expenses Irrigation expenses Expenses of I.U., located in backward district Expenses of I.U., located in free trade zone(Sec. 10A) Expenses of I.U. (Sec. 10B) Expenses of I.U. located in NRE Provision for losses of subsidiary Sundry expenses Provision for bad and doubtful debts Provision for bills under discount Provision for sales tax, wealth tax against demand notice Income tax provision against demand notice Dividend paid on preference shares Proposed dividend on equity shares Transfer to General Reserve Dividend Equalisation Reserve Penalties under direct tax laws Goodwill written off Depreciation Amortisation of patent rights Expenses on transfer of equity shares Net Profit ` 9,00,000 5,50,000 4,00,000 4,00,000 6,00,000 5,00,000 1,50,000 1,00,000 50,000 4,00,000 10,000 2,00,000 50,000 3,30,000 3,00,000 2,00,000 4,00,000 1,00,000 2,00,000 60,000 50,000 3,00,000 30,000 20,000 42,00,000 1,05,00,000 Particulars Sale of manufactured goods Sale of agriculture produce Receipt from generation / distribution of power Receipt from I.U. set up in backward district in July 2004 Transfer from Reserve & Provision A/c, debited to Profit and Loss Account in 2005-06 on account of free service under warranty period Sale of goods of I.U. (Sec. 10B) Sale of goods of I.U, located in free trade zone (Sec. 10A) Receipt from water supply/irrigation project Income from UTI Sale of goods of I.U. located in Northern Eastern Region (NER) (Sec. 10C) Long Term Capital Gain on sale of equity shares, transaction chargeable to Securities Transaction Tax ` 15,00,000 10,00,000 15,00,000 10,00,000

9,50,000 2,00,000 2,00,000 1,00,000 50,000 5,00,000

35,00,000

1,05,00,000

The following additional information is provided as below: 1. Depreciation includes, a sum of ` 1,00,000 on account of revaluation of building and plant and machinery. 2. Past year losses, before depreciation, are given below: 2008-2009 2009-2010 2010-2011 2011-2012 Loss (`) (-) 5,00,000 Nil (-) 7,00,000 (-) 5,00,000 Depreciation (`) (-) 6,00,000 (-) 5,00,000 (-) 4,00,000 Nil

17.56 I DIRECT TAXATION

Compute book-profits for the Previous Year 2012-2013/AY 2013-2014 for MAT under Sec. 115 JB. Solution : Computation of Book Profit for the AY 2013-2014 Particulars Net Profit as per Profit and Loss Account Add: (i) Cultivation expenses (ii) Expenses of I.U. located in Free Trade Zone (Sec. 10A) (iii) Expenses of I.U. under Sec. 10B (iv) Provision of loss of subsidiary (v) Provision for bad and doubtful debts an unascertained liability (vi) Provision for bills under discount an unascertained liability (vii) Provision for wealth-tax, sales- tax, against demand notice an ascertained liability (viii) Income-tax provision an ascertained liability to be added back (ix) Dividend paid on preference shares (x) Proposed dividend on equity shares (xi) Transfer to General Reserve (xii) Dividend Equalisation Reserve (xiii) Depreciation [Sec. 115JB(2)(g) w.e.f. AY 2011-2012] Adjusted Profits Less: (i) Sales of agriculture produce [Sec. 10(1)] (ii) Receipt from I.U. in Free Trade Zone [Sec. 10A] (iii) Receipt from I.U. Sec. 10B (iv) Depreciation, excluding depreciation on account of revaluation of assets (v) Withdrawals from Reserve & Provision for free sale service, under warranty scheme (vi) Long-term capital gain on transfer of equity shares [Sec. 10(38)] see Note below (i) Receipts from UTI [Sec. 10(35)] (ii) Brought forward loss or depreciation, whichever is less. Book-profits Note: 1. Calculation of brought forward losses or depreciation: 2008-2009 2009-2010 2010-2011 2011-2012 1. Loss Loss/depreciation Depreciation Loss/depreciation Total 5,00,000 Nil 4,00,000 Nil 9,00,000 4,00,000 1,50,000 1,00,000 4,00,000 2,00,000 50,000 3,00,000 2,00,000 4,00,000 1,00,000 2,00,000 3,00,000 ` ` 42,00,000

28,00,000 70,00,000

10,00,000 2,00,000 2,00,000 2,00,000 9,50,000 Nil 50,000 9,00,000

35,00,000 35,00,000

Transfer from provision for after sale service, free of cost, made during the year 2005-2006, debited to Profit and Loss A/c and now credited to Profit and Loss A/c and the amount so credited to Profit and Loss A/c is an allowable deduction [Sec. 115-JB(2)].

DIRECT TAXATION I 17.57

Assessment of Various Entities & Tax Planning 2. Long-term Capital Gain from the transfer of equity shares in a company is exempt is chargeable to Securities Transaction Tax (STT). However, for the purposes of computing Book-profits, it is not to be deducted [Sec.10(38)]. Accordingly, the expenditure incurred for the transfer of equity shares has not been added back in computing Book Profits.

Illustration 29 Classic Exporters Ltd, runs a new industrial undertaking set up in 2006-2007 which satisfies the conditions of Sec. 80-IB. Given below is the Profit and Loss Account for the Previous Year 2012-2013 : Particulars Stock Purchases Salaries and wages Entertainment expenses Freights and insurance attributable to exports Travelling expenses Depreciation Selling expenses Income tax paid Income-tax penalty Wealth tax paid Custom duty payable against demand notice Provision for unascertained liabilities Provision for ascertained liabilities Proposed dividend Loss of subsidiary company Net Profit ` 4,00,000 23,00,000 9,70,000 1,30,000 3,00,000 2,20,000 1,50,000 1,20,000 90,000 20,000 10,000 30,000 20,000 50,000 3,00,000 50,000 32,40,000 84,00,000 You are further informed: (i) Excise duty for 2011-2012, amounting ` 1,20,000 was paid on 15th December 2012. (ii) Depreciation under Sec. 32 is ` 2,20,000. (iii) During the year 2008-2009, contingency reserve, amounting ` 10,00,000, debited to Profit and Loss A/c, was added back to the extent of ` 4,00,000 in the computation of Book-profits. The company has transferred the said reserve to the Profit and Loss A/c during the year. (iv) Brought forward business loss/depreciation: PY 2008-2009 2009-2010 Accounting purposes Loss (-) 10,00,000 (-) 2,00,000 Depreciation (-) 1,00,000 (-) 3,00,000 Tax purposes Loss (-) 5,00,000 (-) 1,00,000 Depreciation (-) 2,50,000 (-) 2,00,000 84,00,000 Particulars Domestic sales Export sales Export incentives Sec. 28(iiia)/(iiic) Profit of foreign branch Brokerage/ commission/interest/ rent, etc Transfer from contingency reserve Stock ` 24,00,000 43,00,000 50,000 2,50,000 50,000 10,00,000 3,50,000

Compute the following: (a) Total Income, (b) Book-profits and (c) Tax Liability.

17.58 I DIRECT TAXATION

Solution : (a) Computation of Total Income for the AY 2013-2014 Particulars Net Profit as per Profit & Loss A/c Add : Expenses debited to P&L A/c disallowed (i) Income tax (ii) Wealth tax (iii) Custom duty payable (iv) Provision for unascertained liability (v) Proposed dividend (vi) Loss of subsidiary company (vii) Income-tax penalty (viii) Depreciation Less : Allowable Expenses and wrong credits in P&L A/c (i) Withdrawals from contingency reserve (ii) Excise duty (iii) Depreciation (iv) Brokerage, commission, interest and rent, etc. Business Profits Add: Income from Other Sources: Brokerage/ commission, etc. Aggregate Income Less: (i) Brought forward losses (Sec. 72) (ii) Brought forward depreciation [Sec. 32(2)] Gross Total Income Less: Profit from industrial undertaking Sec. 80IB: 30% of ` 15,20,000 as included in GTI Total Income ` ` 32,40,000 90,000 10,000 30,000 20,000 3,00,000 50,000 20,000 1,50,000

6,70,000 39,10,000

10,00,000 1,20,000 2,20,000 50,000

13,90,000 25,20,000 50,000 25,70,000

6,00,000 4,50,000

10,50,000 15,20,000 4,56,000 10,64,000

DIRECT TAXATION I 17.59

Assessment of Various Entities & Tax Planning (b) Computation of Book Profits for the AY 2013-2014 Particulars Net profits as per Profit & Loss A/c Add : Expenses disallowed (i) Income tax (ii) Provision for unascertained liability (iii) Proposed dividend (iv) Loss of subsidiary Less : Allowable expenses and wrong credit in P/L A/c (i) Withdrawals from contingency reserve (ii) Brought forward business loss or depreciation whichever is less 2008-2009 Depreciation 2009-2010 Loss Book-profits (c) Computation of Tax Liability for the AY 2013-2014 Particulars (a) Tax on Total Income (including Education Cess and SHEC) = 30.9% of 10,64,000 (b) Tax on Book Profits (including Education Cess and SHEC) = 19.055% on 30,00,000 Tax payable Note : (i) No adjustment is required for depreciation debited to Profit and Loss A/c because it is not on account of revaluation of any asset. ` 3,28,776 5,71,650 5,71,650 90,000 20,000 3,00,000 50,000 4,00,000 1,00,000 2,00,000 ` ` 32,40,000

4,60,000 37,00,000

7,00,000 30,00,000

(ii) MAT credit available ` (5,71,650 3,28,776) = ` 2,42,874 (iii) Any penalty, interest, etc. paid under any of the direct tax laws or for infraction of any other laws and debited to Profit & Loss Account will be allowed and hence, need not be added back. Illustration 30. Z Ltd is a qualifying shipping company which has got two qualifying ships during the Previous Year 2012-2013 : Ship Ship A Ship B Tonnage weight 37,949 tonnes and 990 kg 25,550 tonnes and 275 kg No. of operational days 300 days 365 days

Compute its tonnage income under Tonnage Tax Scheme for the Assessment Year 2013-2014.

17.60 I DIRECT TAXATION

Solution: Ship A (i) Tonnage consisting of kilograms is ignored. (ii) If such tonnage is not a multiple of 100 tonnes and the last two digits are less than 50, the tonnage is reduced to the previous lower tonnage which is a multiple of 100. (iii) Tonnage rounded off = 37,900 tonnes Income computation under TTS Daily TI: First 1,000 tonnes = ` 46 10 = Next 9,000 tonnes = ` 35 90 = Next 15,000 tonnes = ` 28 150 = Balance 12,900 tonnes = ` 19 129 = Daily TI: Total TI for the Previous Year ` 10, 261 300 ` 460 3,150 4,200 2,451 Ship B (i) Tonnage consisting of kilograms is ignored. (ii) If such tonnage is not a multiple of 100, and last two degits are 50 or more, the tonnage is increased to next higher tonnage which is a multiple of 100 (iii) Tonnage rounded off - 25,600 tonnes Income computation under TTS Daily TI: First 1,000 tonnes = ` 46 10 = Next 9,000 tonnes = ` 35 90 = Next 15,000 tonnes = ` 28 150 = Balance 600 tonnes = ` 19 6 = ` 460 3,150 4,200 114 7,924 28,92,260

10,261 Daily TI: 30,78,300 Total TI for the Previous Year ` 7,924 365

DIRECT TAXATION I 17.61

Assessment of Various Entities & Tax Planning 17.9 DIFFERENT ASPECTS OF DIRECT TAX PLANNING Introduction: The provisions of the Income-Tax are contained in the Income-Tax Act, 1961 (the Act), which extends to whole of India and is operative from the 1st day of April, 1962(the Rules). The Act provides for determination of taxable income, tax liability, procedures for assessment, appeals, penalties, interest levies, the tax payment schedules and its determination, refunds and prosecutions. Depending upon Government polices certain income is exempted from tax, for example SEZ (Special Economic Zone) units income, Agriculture income, etc. and deduction are also provided on fulfillment of prescribed criteria. Provisions relating to such exemptions and deduction are also contained in the Act. Corporate form of business is much in vogue. Therefore, certain taxes specific to companies like Tax on Book profit (115JB), tax on Dividend Distributed (115O), are levied. At times in Cross border transactions income earned get exposed to tax in India as well as in some other countries. Provisions for upholding relief from double taxation are also made in the Income Tax Act. The Act also lays down the powers duties of various income-tax authorities. Being revenue legislation, the act is amended once a year through union budgets and the finance bill is normally presented to the Parliament for approval around February. The Act has empowered the Central Board of Direct Taxes (CBDT) to frame the rules and these rules are implemented after necessary Gazette notifications. The CBDT also issues circulars and clarifications from time to time for implementation by the income-tax authorities by virtue of section 119, which gives such rule making powers to the CBDT. It is impracticable for the Act to provide exhaustively for everything relating to limits, conditions, procedures, forms and various other aspects. Therefore this power has been delegated to CBDT and thus periodical changes and modification by an executive authority is facilitated. The power to frame rules is vested with the Board u/s 295 of the Act and the word prescribed used in section 2(33) means what is prescribed by rules made under the Act. The Income-Tax Act gives definitions of the various terms expressions used in the Act. Unless the context otherwise requires, these definition should be applied. The words means includes and means and includes are used in these definitions and the significance of these terms needs to be understood. When a definition uses the word means the definition is self-explanatory, restrictive and in a sense exhaustive. It implies that the term or expression so defined means only as to what is defines as and nothing else. For example, the terms agricultural income assessment year capital asset, are exhaustively defined. When the legislature wants to widen the scope of a term or expression and where an exhaustive definition cannot be provided, it uses the word includes in the definition. Generally an inclusive definition provides an illustrative meaning and the definition could include what is not specifically mentioned in the definition so long as the stipulated criteria are satisfied. To illustrate refer to the definitions of income, person, transfer in the Act. When the legislature intends to define a term or expression to mean something and also intends to specify certain items to be included, other the words means as well as includes are used. Such definition is not only exhaustive but also illustrative in specifying what is intended to be included. Sometimes specific items are included in an exhaustive definition in order to avoid ambiguity and to provide clarity. Please refer to definitions of assessee, Indian company,recognised provident fund, under the Act. Further any decision given by the Supreme Court also becomes a law on the subject and will be binding on all the courts, tribunals, income-tax authorities as well as the taxpayers. In case of apparent contradictions in the Supreme Court rulings, the following rules may have to be followed:1. 2. The decision of the larger bench would prevail. The principle of the later decision shall prevail, where the decisions are by equal number if judges. Decisions given by High Courts are binding on all taxpayers and It authorities, which fall under its jurisdiction till it is overruled by higher authority.

17.62 I DIRECT TAXATION

Tax Planning vs. Tax Evasion The word tax planning connotes the exercise carried out by the taxpayer to meet his tax obligations in proper, systematic and orderly manner availing all permissible exemptions, deductions and reliefs available under the statute as may be applicable to his case. To illustrate, assessee software company setting up assessee software technology park in assessee notified area to avail benefits of section 10A of the Act is assessee legally allowable course. Planning does not necessarily mean reduction in tax liability but is also aimed at avoiding controversies and consequential litigations. Every taxpayer is expected to voluntarily make disclosures of his incomes and tax liabilities through legal compliance. When a tax payer deliberately or consciously do not furnish material particulars or furnishes inaccurate or false particulars or defrauds the State by violating any of the legal provisions, it shall be termed as tax evasion. It is also illegal, but also unethical and immoral. Inflation of expenditure, suppuration of income, recording of fictitious transactions, claiming deductions wrongly are few examples. Benjamin Franklin is credited with this classical statement: There are two certainties in this world death and taxes. This makes all tax payers in general, and the companies in particular, realize the bitterness or hardship of taxes. Three methods of saving taxes have been developed in most countries of the world in the past few decades: tax evasion, tax avoidance and tax planning. A great deal of confusion prevails in corporate sector about correct connotations of these terms. Hence, we shall attempt to explain these terms to show tax planning is absolutely legal. The expression Tax Evasion means illegally hiding income or concealing the particulars of income or concealing the particular source or sources of income or in manipulating the accounts so as to inflate the expenditure and other outgoings with a view to illegally reduce the burden of taxation. Hence, tax evasion is illegal and unethical. It is uneconomical as well. It deserves to be deprecated not only by the Government but by the companies as well. The next expression is Tax avoidance which is assessee art of dodging taxes without breaking the law. In my opinion, tax avoidance means traveling within framework of the law or acting as per language of the law only in form, but murdering the very spirit of the law and defeating the purpose of the particular legal enactment. If, by adopting an artifice or device against the intension of the legislature but apparently on the face of it acting within the framework of the law, a company is able to dodge income tax, it would be a clear case of tax avoidance. In contrast, Tax Planning takes maximum advantages of the exemptions, deductions, rebates, reliefs, and other tax concessions allowed by taxation statutes, leading to the reduction of the tax liability of the tax payer. Tax planning has been contrasted with the expression tax avoidance and has the legal sanction of the Supreme Court as well. In recent years the sentiments in favor of tax avoidance have changed and the courts view tax avoidance with displeasure. For example, Lord Summer in IRC Vs Fisher s Executors ac 395, 412 had earlier as per the ratio of Westminister s case said: My Lords, the highest authorities have always recognized that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so with the law, and that he may legitimately claim the advantage of any express terms or any omissions that he could find in this favor in taxing Acts. In so doing, he neither comes under liability nor incurs blame. The significance of Ramsay as assessee turning point in the interpretation of tax laws in England and the departure from the principle of Westminister s case were explained in TRC Vs. Burmah Oil Co. Ltd., STC 30 where Lord Diplok said: It would be disingenuous to suggest and dangerous on the part of those who advise on elaborate tax-avoidance scheme to assume, that Ramsay s case did not mark assessee significant change in the approach adopted by this House its judicial role to assessee pre-ordained series of transactions into which they were inserted steps that have no commercial purpose apart from the avoidance of tax liability, which in the absence of those particular steps would have been payable. The difference is in approach.

DIRECT TAXATION I 17.63

Assessment of Various Entities & Tax Planning Commenting on this judgment the Supreme Court of India in the McDowell Co. Ltd., Vs. CTO 154 ITR 148(SC) said: It is neither fair nor desirable to except the legislature to intervene and take care of every device and scheme to avoid taxation, it is up to the court to determine the nature of new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices for what they really are and to refuse to give judicial benediction. In the same judgment, Supreme Court Judges made a clear distinction between tax avoidance and tax planning. This is what the judges of the Supreme Court have said in the same case: Tax Planning may be legitimate provided it is within the framework of law. Colorable devises cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. Form the above it is very clear that tax planning by Assessee Company cannot be called a crime or an illegal activity or an immoral action as is wrongly considered by confused thinkers on the subject. What constitutes a crime is tax evasion and what is undesirable is tax avoidance but it is certainly desirable to engage in the exercise of tax planning. In UK, wherefrom the principal coined in McDowells case was coined, the House of Lords expressly reaffirmed the basic principle, A subject is entitled to arrange his affairs so as to reduce his liability to tax. The fact that the motive for a transaction may be to avoid tax does not invalidate it unless a particular enactment so provides. The House of Lords expressly reaffirmed the cardinal principle of Duke of Westminister, Given that a document or transaction is genuine, the Court cannot go behind it to some supposed underlying substance. They only ruled against the principle being overstated or overextended. Mukharji J, who in his prompt and lethal report in CWT v Arvind Narottam said: no amount of moral sermons would change peoples attitude towards tax avoidance, and soon thereafter in UoI v Playworld Electronics stated: one should avoid subverting the rule of law. As a matter of law, the Supreme Court in these two latter cases reiterated that where the true effect of a transaction is clear, the appeal to discourage tax avoidance is not a relevant consideration. In any event, when the language of a deed of settlement is clear, an attempt to invoke McDowell would be futile even if the deed results in tax avoidance. as the Madras High Court held in Valliapan Vs. ITO, McDowell does not hit tax planning. The manner in which McDowell is to be dealt with was well summed up by the Gujarat High Court in Banyan and Berry Vs. CIT thus: The court (in McDowell) nowhere said that every action or inaction on the part of the taxpayer which results in reduction of the tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act. The principle enunciated in the above case has not affected the freedom of the citizen to the act in a manner according to his requirements, his wishes in the manner to do any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same falls in the category of colourable device. The House concluded that steps which had no commercial purpose and had been artificially inserted for tax purposes into a composite transaction, should be disregarded; but that a transaction which came into statutory language could not be disregarded merely because it was entered into solely for tax purposes. Therefore, while tax planning these principles emanating from court made law need to be kept in sight. Otherwise, planning looking good on paper may fail in practice.

17.64 I DIRECT TAXATION

Tax Management Planning which leads to filing of various returns on time, compliance of the applicable provisions of law and avoiding of levy of interest and penalties can be termed as efficient tax management. In short, it is an exercise by which defaults are avoided and legal compliance is secured. Through proper tax planning and management, the penalty of upto `100000 for delay in furnishing of tax audit reports u/s 44AB can be avoided. Similarly by applying for Permanent Account Number (PAN), the penalty under the Act can be avoided. The borrowal of loan otherwise than by way of an account payee cheque or bank draft attracts 100% penalty and this can be avoided by conscious planning of the execution of loan transactions. Planning is a perception conceived on legitimate grounds and achieved through genuine transactions within the framework of law e.g. contribution to Public Provident Fund and claiming rebate u/s 88 of the Act. The filing of the returns with all proper documentary evidence for the various claims, rebates, reliefs, deductions, income computations and tax liability calculations would also be termed as tax management. Tax management is also an important aspect of tax planning. Assessee is exposed to certain unpleasant consequences if obligations cast under the tax laws are not duly discharged. Such consequences take shape of levy of interest, penalty, prosecution, forfeiture of certain rights, etc. Therefore, any effort in tax planning is incomplete unless proper discharge of responsibilities is not made. Tax management includes: 1. 2. 3. 4. 5. Compiling and preserving data and supporting documents evidencing transactions, claims, etc. Making timely payment of taxes e.g. advance tax, self assessment tax, etc. TDS and TCS compliance Following procedural requirements e.g. payment of expenses or acceptance of loans or repayment thereof, over ` 20,000 by account payee bank cheque or bank draft, etc. Compliance with the prescribed requirements like tax audit, certification of international transactions, etc. Responding to notices received from the authorities.

6. Timely filing of returns, statements, etc. 7. 8. Preserving record for the prescribed number of years. 9. Mentioning PAN, TAN, etc. at appropriate places. 10. Responding to requests for balance confirmation from the other assessees. Tax Implications in Planning The main objectives in any exercise on tax planning are to : 1. Avail all concessions and relief s and rebates permissible under the Act. 2. Arrange the affairs in a commercial way to minimize the incidence of tax. 3. Claim maximum relief where taxes are paid in more than one country. 4. 6. 8. Become tax compliant and avoid penalties, prosecutions and interest payments. Timely compliance of procedural requirements like tax audit, TDS, TCS, etc. Avoidance of litigation. 5. Fruitful investment of savings. 7. Appropriate record keeping

DIRECT TAXATION I 17.65

Assessment of Various Entities & Tax Planning 9. Growth of economy and its stability.

10. Pay taxes not a penny more, not a penny less. E-Commerce and Taxation: In the era of e-commerce, the determination of the place of source with reference to an item of income may quite often pose difficulty. The source-based taxation of business income depends on physical presence in the form of fixed place of business or a dependent agent in the source country. With e-commerce the need for physical presence virtually ceases. The change in mode of delivery from physical to online raises characterization issues and the lack of physical presence also creates problems in enforcement of tax laws. Therefore the long- term solution of the problems created by characterization lies in making direct taxation identical for all streams of income in a manner aimed at ensuring equitable sharing of revenues between residence country and source country. The following rulings by the Authority for Advanced Ruling may be worth remembering in this context: 1. A company incorporated in Mauritius for sale and distribution of television channels enters into an agreement with an Indian company where under the latter would solicit orders from purchasers of airtime and pass on those orders to the former. The business profits earned by the Mauritian company through Indian company are profits deemed to accrue or arise in India u/s 9 of the Act. However by virtue of Article 7 of the DTAA between India and Mauritius, they are not liable to be taxed in India, if: a) The liability of the Mauritian company to pay tax in Mauritius was established and b) The Mauritian company and not the Indian company is shown to exercise generally the power to conclude the advertisement contract for sale of airtime - P No. 296 of 1996 T V M Vs CIT 237 ITR 230 (AAR). An American company is engaged in providing international credit cards, travelers cheques and travel related services. It has Central Processing Unit (CPU) in USA and Consolidated Data Network (CDN) in Hong Kong. Indian company is given access to the CPU through CDN for the reporting and processing of information on travel by customers in India. Charges for the use of CPU and CDN of American company paid by Indian company is royalty for the case of design or model, plan secret formula and process and therefore taxable in India under Article 12(3)(a) of DTAA between India and USA p. no. 30 of 1999 238 ITR 296 (AAR). Where there is a PE for a non resident income attributable to such PE is chargeable to tax in the country in which such PE exist p. no.28 of 1999 242 ITR 208 (AAR). A foreign company having a fixed office will be constructed to have a PE-p. no.13 of 1995 228 ITR 487 (AAR).

2.

3.

Strategic Management Decisions Tax Implications In business, the decisions are taken with a view of optimize returns to the stakeholders. A dominant aspect to be considered taking in view the tax consequences of the same on the bottom-line so as to share minimum profits with Government without violating any tax or any other laws in force. It is significant that tax consequences alone need not bind the management to take a decision and it is only a factor which influences the management decisions. Moreover, in case of taxes, there are both direct as well as indirect taxes and in efforts for planning implications of both category of taxes are required to be considered. Management decisions, which have a bearing on the bottom line are analyzed below from the point of view of income-tax implications. (a) Make or Buy (b) Own or Lease (c) Retain or Replace (d) Repair/Scrap or Return

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(e) Export or Domestic Sale (f) Shut Down or Continue (g) Expand or Contract (h) Demerger (i) (j) New Capital Investments Accounting Standards for Taxes on Income TAX PLANNING-AN OVERVIEW Q.1. Why is tax planning necessary? Answer. The tax paid is an addition to the cost. Just as every businessman tries to maximise his profit by reducing the cost, he should also arrange his affairs in such a way, that he pays the least amount of tax. This however should be done within the four corners of law and there should be no element of fraud in it. Q. 2. Is tax planning confined only to direct taxes? Answer. No. The effect of other taxes like sales-tax, customs duty and excise, are to be taken into account. It is a dynamic concept and the decision once taken is not valid for all times and requires continuous reappraisal. Q.3. Is tax planning harmful? Answer. Tax planning is not harmful. The tax saved can always be recycled in business and not necessarily wasted in conspicuous personal expenditure. The idea behind grant of incentives is to stimulate economy and hence there should be proper planning to make use of these incentives. Q. 4. When should planning be done? Answer. Planning has to be done before the income accrues or arises, i.e., at the source itself. Planning done after receipt of income is only diversion of income and may even lead to an inference of fraud. Q. 5. What are the factors to be taken in tax planning? Answer. The choice of taxable entity and other choice like time and place have all are common instances. Time is relevant for fixing the year of accrual. Place is relevant for fixing the residential status. The status in which the income is to be assessed, i.e., individuals, HUF firm or AOP or company is also to be considered. Q. 6. Has tax planning any effect on the rate of tax? Answer. Yes. As dispersal of income over different taxable entities, slab rate can be reduced . Q. 7. What is the difference between dispersal and diversion of income? Answer. Dispersal ensures that income accrues separately in different hands. Diversion is said to take place when money is siphoned off to other hands after accrual in one hand. The decision of the Supreme Court in CIT v Sitaldas Thirakhdas is as to what constitutes diversion as distinct from dispersal. In this case, an amount of annuity decreed by the court to be paid by son to his mother in view of his obligation was held to be dispersal, i.e., diversion by overriding title, so that he was entitled to re-duce such payment from his taxable income. While diversion by overriding title will amount to dispersal, any other diversion without title at source is a mere application of income. The decision of Supreme Court in CIT v Thakar Das Bhargava illus-trates the principle of application of income, which does not help, where a lawyer who had assigned his right to fees to a charitable institution and had not received the same was still held liable to pay tax on such fees.

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Assessment of Various Entities & Tax Planning Q. 8. Does tax planning include compliance within law? Answer. Certainly. Timely filing of returns, payment of advance tax, finally tax deduction at source, etc., are all important to avoid penal interest, penalty, prosecution, etc. Q. 9. Is method of accounting important? Answer. Yes. It is because income for tax purposes is one which is ascertained on the basis of what is computed under ordinary principles of commercial accounting subject only to such adjustments as are specifically required by the statute. Q.10. What is the caution necessary in tax planning? Answer. Tax planning may be legitimate provided it is within the law. But colorable devices are not only dishonorable but should not be recognized by the Assessing Officer. One such device is to avoid tax though not prohibited by the statute. It is not necessary that there should be a specific disapproval of every device or scheme. If they are artificial, they are prone to be rejected.3 What is to be noted is that the de-vice should be genuine in that the income really goes to the person to whom it is in-tended and does not come back or held effectively by the devisor of the scheme. Though the decision of the Supreme Court in Union of India v Azadi Bachao Andolan has granted great recognition to tax planning, the warning against artificial transactions lacking in commercial credibility in McDowells case is still valid. The concessional treatment for short-term capital gains is available on such gains under section 111A. It may, however, be noticed that these concessions are available only where the transactions are on capital account and not where the shares are held as stock-in-trade. Tax Planning-Available Areas Q. 1. How to choose the most suitable form of organisation for tax planning? Answer. It depends on the rate of tax applicable to the organisation, business needs, risk of nonobservation of formalities, ability to raise finance, etc. Q. 2. In what way, does the choice of head of income affect tax? Answer. Actually assessment under different heads has diverse results as regards deduction and taxability. An asset, if it is property, gets a lump sum deduction at one fourth of annual value and as a business asset it gets depreciation on cost. On sale long term capital gains arises in former case and Short Term Capital Gains in latter. Q. 3. How to select a location for business? Answer. Deficiencies in infrastructure have to be balanced against the tax incentives. Excise and Salestax implications may also prove to be of greater importance. Q. 4. How to choose a proper type of business for maximum tax benefit? Answer. New industrial undertakings on registration under Hardware or Software Technology Park Schemes or 100% Export Oriented Undertaking under section 10A or 10B would be entitled to total exemption for and up to assessment year 2010-11, the last year of available exemption being assessment year 200910, subject to such concessions being available for a maximum period of ten consecutive years from the year of establishment. Exemptions for exports under various provisions under sections 80HHC, 80HHE and 80HHF are on the way out, since they are being phased out so that they will no longer be available from assessment year 2005-06. Concessions for new industrial undertakings under sections 80IA and 80IB are available for a longer period. Reliefs under sections 10A and 10B are now subject to fresh conditions incorporating the bar against transfer of beneficial interest under section 79 and introducing the exemption proportionate to the export turnover as for section 80HHC.

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A new vista of exemption has opened under section 10C now shifted to section 80-IC. The most recent bunch of incentives offered by Special Economic Zones Act, 2005 which would require attention of those who wish to avail tax benefits. Q. 5. What is the impact of the size of the business? Answer. Small units gets some concession from State authorities. Dispersal amongst separate subsidiaries will give relief under certain sections. Q. 6. Can accounting method have an impact on tax? Answer. Yes. At present, only two methods mercantile and cash are available. For professionals and money lenders cash system is preferred. Also accounting practices to reflect the correct amount of income have to be adopted so that there is no overload in some years and deficiency in others. Inventory valuation is another area of ac-counting, which has impact on tax. But it should also be borne in mind that where the statute itself determines the income, accounting method has no relevance. Q. 7. In what way capital can be restructured for maximum benefit? Answer. A balance between own and borrowed capital has to be achieved. When own capital is more there will be larger taxable profits and poorer after-tax return. With more borrowed capital, taxable profits are less but after-tax return on own investment is better. There should be a continuous appraisal in this behalf. Q. 8. What is the best investment? Answer. Choice of investment depends on the expectations of the investors. Risky investments may involve larger profit or loss. Safe investments give a lesser but steady return. Period of holding depends upon varying needs of liquidity for the investors. As between investment in shares, deposits and debentures in companies, dividends have an edge because these are not taxed in the hand of the receiver. Interest is fully taxed subject to certain deductions. Q. 9. What should be the consideration regarding investment in plant and machinery? Answer. Depreciation is a significant deduction from taxable income. Plant and machinery relating to generation of power and pollution control equipment, and those relating to Research and Development, etc., are eligible for 100% deduction. Plant and machinery can be acquired, replaced, repaired, purchased or hired or assembled with different tax consequences. There has been drastic reduction in rates of depreciation effective from assessment year 2006-07. Q. 10. Is there any restriction in method of valuing stock? Answer. Accountancy text books give various methods like: cost, market value, cost or market value whichever is less, FIFO, LIFO, etc. Some value obsolete or slow-moving stocks at lesser cost. At any rate the method adopted should be regular and should not distort the profits inviting rejection of accounts. Q. 11. Is transfer pricing important? Answer. Transfer pricing is important in reckoning of reliefs as well as in matters of non-resident taxation. Adoption of correct transfer pricing is a matter of concern for Revenue, but it should be equally a matter of concern for taxpayer lest the method adopted loses for himself the benefit which is otherwise available. This is all the more important in international transactions. Sections 92 to 92F may be seen. Q. 12. What is the importance of dividend policy? Answer. Dividend policy determines liquidity, possible impact as price of shares, credit rating, borrowing capacity, shareholder satisfaction, etc., which are matters of business policy. It also affects shareholders tax liability. It is of importance in closely held companies particularly because even loans to substantial shareholders are treated as deemed dividends under section 2(22)(e) of the I.T. Act.

DIRECT TAXATION I 17.69

Assessment of Various Entities & Tax Planning Q. 13. What are the factors to be borne in foreign collaborations? Answer. The degree of participation of the foreign concern in Indian business, the extent of investment, duration of physical presence in India, the manner in which such participation is expected, whether by way of equity, loan, royalty, technical fees, etc., would decide liability. For the Indian partner the question whether payments made will be allowed as a deduction will be relevant. Double taxation agreements and where there is none section 91 of Income tax Act will also have relevance. The new provision introduced by Finance Act, 2001 in respect of transfer pricing in sections 92 to 92F w.e.f. 1.4.2002 would require consideration in matters of taxation of business income of non-residents. Q. 14. Can an employee benefit from tax planning? Answer. There is large scope for tax benefit for employees. This is done by designing a pay package taking into consideration tax-free and concessional perquisites in a manner that take-home pay is maximum. (See para 2.22 and also separate chapter on the subject). The Central Board of Direct Taxes has been given powers to prescribe the value of any fringe benefit or amenity in such matters, where perquisite value has not been prescribed in the statute itself. Rules have since been notified. It was expected that the value of fringe benefit would be the cost to the employer. New Rules by and large adopt the cost for a number of perquisites. Rule 3 has undergone drastic changes by Notification No.266(E) dated 28th February, 2005 as a step to reconcile with fringe benefit tax, which would treat some of the perquisites hitherto taxable in the hands of employees under Rule 3 by a new tax, FBT in the hands of the employer, so that one has to reappraise the tax liability of the employee and the employer in the light of these developments. TAX PLANNING-FOR INCOME FROM HOUSE PROPERTY Q. 1. How is income to be computed, if a property is partly let out and partly self-occupied? Answer. It has to be treated as two residential units and income from each unit has to be computed according to law by allocating common outgoings on a basis proportionate to area of occupation. Q. 2. Is it necessary that the person must be a legal owner in order that the income should be computed under the head income from property? Answer. No. If a person is entitled to the income under the law, such income is bound to be assessed under the head income from property. Tax laws are generally concerned with beneficial ownership as laid down in CIT vs. Podar Cement Pvt. Ltd. Q.3. Is municipal tax deductible in computation of income from: (i) self-occupied property; and (ii) where demand notice is reserved but it has not been paid? Answer. Since income from one self-occupied property is nil, subject only to deduction of interest the question of deduction of municipal tax does not arise. For let out proper-ties, municipal tax is deductible only if it is paid during the year. Q.4. Is deduction for repairs available, when tenant undertakes repairs under the rental agreement? What is meant by repairs? Answer. By repairs we mean only substantial repairs as held in CIT vs. Parbutty Churn Law and Sir Shadi Lai & Sons vs. CIT. Where even substantial repairs other than normal maintenance is undertaken by tenant, annual value should get enhanced by the extent of repairs which should have been borne by the landlord so that any deduction for repairs then available to landlord will neutralise the amount added to annual rent. It would, therefore, mean that where there is specific stipulation that all repairs will be borne by tenant, there can be no deduction for repairs. Q. 5. Is an annual charge on rent receivable on account of mortgage of property for obtaining funds for business or paying income tax deductible under section 24(1 )(iv) of the Income Tax Act, 1961 ? Answer. No. Since it is a charge created voluntarily by the assessee, it is not deductible as was held in

17.70 I DIRECT TAXATION

CIT vs. Indramani Devi Singhcmia1 in case of a business loan and CIT vs. Tarachand Kalyanji in the case of a charge created for payment of excess profit tax In the latter case, it was held that the amount is not deductible even if the charge has been created before 1st April, 1969, when such amount was deductible in law. Q. 6. What are the conditions for deduction of unrealised rent? Answer. Rule 4 of the Income-tax Rules as substituted by the Income-tax (Eighth Amendment) Rules, 2001 prescribes the conditions as under: Unrealised rentFor the purposes of the Explanation below sub-section (1) of section 23, the amount of rent which the owner cannot realise shall be equal to the amount of rent payable but not paid by a tenant of the assessee and so proved to be lost and irrecoverable where, (a) the tenancy is bona fide; (b) the defaulting tenant has vacated, or steps have been taken to compel him to vacate the property; (c) the defaulting tenant is not in occupation of any other property of the assessee; (d) the assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or satisfies the Assessing Officer that legal proceedings would be useless. Q.7. Is salary paid to a caretaker deductible? Answer. No. Only deductions specified under section 24 are deductible. Q. 8. How is the income of co-owned property computed? Answer. Income has to be split up between co-owners and each co-owner has to be assessed as his share of the income as provided under section 26 of the Act. Q. 9. Where an assessee borrows a second loan for repaying the first loan taken for acquiring a property, will the interest on second loan be deductible as amount borrowed for acquiring the property? Answer. Yes. It is so conceded in Boards Circular No. 28 dated 20th August, 1969. Q. 10. Ground rentwhether arrears of earlier years deductible? Answer. No. The deduction under section 24(1 )(v) is confined to the ground rent of previous year, and thus arrears of earlier years are not deductible. Ground rent is no longer deductible from A.Y.2002-2003. Q. 11. Interest deductible under section 24(1 )(vi): whether simple interest or compound Interest? Answer. Only simple interest is deductible. Q. 12. What is the treatment given to loss from property? Answer. Loss from property can be set off against other heads of income in the same year and to the extent unabsorbed, it will be carried forward and set off in next eight years. Q. 13. Where municipal valuation is higher than the rent charged, what is the basis of computation of property income? Answer. The law requires that either annual value as fixed by the local authorities or actual rent received, whichever is higher, should be treated as annual value. But where the assessee is unable to enhance the rent due to Rent Control Act, there is a case for acceptance of rent receivable as the basis. It was so held in CIT vs. Sampathammal Chordia . Q.14. Are municipal taxes allowed on the basis of tax leviable for a year or on the basis of payment? If it is on the basis of what is leviable, what happens if demand for earlier years is received only during the year with the result that the payments for earlier years are made during the year?

DIRECT TAXATION I 17.71

Assessment of Various Entities & Tax Planning Answer. Section 23(1) allows property tax levied by local authority on the basis of payment from assessment year 1985-86 vide amendment by Taxation Laws (Amendment) Act, 1984 so that the controversy in the prior law is now avoided. So, the amount paid during the year, including any amount of arrears for earlier years, is deductible in the year of payment. Q. 15. Where the assessee is a mutual association having a property, will the property income be covered by the principle of mutuality so as to be exempt? Answer. Yes, it has been held that principle of mutuality applies even to income from house property in Chelmsford Club vs. CIT. Q. 16. The assessee Mrs. A is in enjoyment of the property but the right is limited only for life under a Will in her favour. Who has to pay the tax, whether she as the person in enjoyment of the property as the holder of life interest or the remainderman treated as the owner in law? Answer. Ownership is a bundle of rights. Right to enjoy the property is also a right which is part of such ownership right. Hence it will be assessable in the hands of life interest owner. It has been so held in Estate of Ambalal Sarabhai vs. CIT. Q. 17. Where an assessee receives interest on deposit taken from a tenant, is it necessary to enhance the annual value by the notional interest which would have otherwise been payable? Answer. Where actual rent received is more than the fair rent, i.e., annual value fixed by the local authorities, notional interest need not be added. It was so held in CIT v J.K. Investors (Bombay) Ltd. Where such notional interest is to be taken, as for example, where no rent is charged because of such interest free deposit, the interest or other income earned by deployment of the interest free deposit will have to be correspondingly reduced from the annual value but the law does not provide for the same. But it stands to reason that such reduction may have to be allowed, though it is doubtful whether such reasonable interpretation will be acceptable to revenue. Q. 18. Is it open to the Assessing Officer to substitute reasonable rent where the property is let out to an associate company at a lower rate? Answer. Since annual value is not the only criterion, it is open to the Assessing Officer to adopt a reasonable rate where it is let out at a concessional rate. It was so held in T. V. Sundaram Iyengar & Sons Ltd. vs. CIT . Q. 19. Where the property is in existence for less than 12 months, is it possible to assess the income as income from property since the scheme of the Act is to assess the annual rent? Does the income escape assessment in such cases? Answer. The argument that the property should have been held for entire 12 months to be assessable under the head Income from property was accepted in P.J. Eapen vs. CIT. But it was held that such income will be assessable under Other sources. The decision is open to doubt because there is no reason why the proportionate income should not be assessed with reference to the period of holding because such proportionality is recognised in section 23 where the property is let out for part of the year and used for own residence for rest of the year under section 23(2)(a)(ii). Hence, similar apportionment should be possible though the annual value is with reference to the income which the property might fetch if let out from year to year. Q. 20. Where the deduction under section 24 exceeds the available income, can such excess be allowable? Answer. Where the property is partly let out and partly used for own residence, the deduction under section 24(1) will be limited to the income determined under that clause under the substituted section 24 by Finance Act, 2001. with effect from 1.4.2002, there are no detailed deductions but only 30% of annual value and interest on borrowed capital subject to the limit of Rs.30,000 for self-occupied property with enhanced limit up to Rs.1.50 lakhs subject to conditions as to the date of the loan and the date of construction. Hence, there can be a loss

17.72 I DIRECT TAXATION

from the property depending upon interest on borrowed capital. It is only in respect of annual value, that there cannot be loss. Q. 21. There is a practice of receiving deposit instead of rent. The assessee accounts for interest on such deposits as its income. Should he also ac-count for notional income from property? Answer. The answer was against the assessee in S.Ujjanappa vs. CIT, where it was held that ownership confers the duty to account for notional income from such property. The issue as to whether it involves double taxation was not posed in this case. Interest income earned by the assessee on the deposits or notional interest when used in business could have been set off against such income. There is clearly double taxation implicit in such cases. In Webbs Agricultural & Automobile Industries vs. ITO , a car received by way of lottery winnings brought to tax as income was held to be eligible for depreciation, though assessee had not paid for the same, because of the notional cost. This line of reasoning should avoid elimination of double taxation by setting off the two incomes one notional and the other real as between them, but the law on the subject is still nebulous. Q.22. Is the amount of interest paid on unpaid consideration for acquiring property deductible as interest on borrowing under section 24(1 )(vi) of the Income-tax Act? Answer. In the context of similar interest on unpaid consideration for acquiring a business; the Supreme Court had held in Bombay Steam Navigation Co. (1953) P. Ltd. vs. CIT that such interest is not deductible under section 36(l)(iii) of the Income-tax Act, 1961. But in the same case, it was found that it can be allowed as deduction under section 37 of the Act. It is for this reason that it has felt that in absence of similar residuary clause, interest on unpaid consideration for acquiring property would not be deductible. However it was found in CIT vs. Sunil Kumar Sharma following CIT vs. R.P. Goenka and J.P. Goenka that it makes no difference, whether the buyer borrows from a third party to acquire a property or gets the necessary financial assistance from the seller of the property. It should be construed that the seller is the lender and the purchaser is the borrower. It would thus appear that such interest is deductible. Q. 23. What is the change in respect of computation of property income by the Finance Act, 2005? Answer. There is no change in computation of property income, but the incentive for re-payment of loan for acquiring a property is enlarged by removing the limit of ` 20,000 in respect of such repayment and by providing such repayment as an outright deduction from the gross total income by the new section 80C substituting section 88, subject, however, to the limit of total deduction under section 80C to ` 1 lakh. Interest payable on such loan would be admissible as deduction, if the property were let out, subject to limit of `30,000 in case of self- occupation. Q.24. If a person puts up a property on leased land, is the lease rent deductible as income from property? Answer. There is no special provision for deduction of lease rent as was available in the pre-existing law under section 24 either as an annual charge on the property or as ground rent, but all the same, what is payable on leased land gets diverted at source and should not be part of the annual value, so that in determination of annual value, the amount should be deductible. Any other view could not be reasonable. An alternative argument may well be that if it is not deductible, income itself may not be assessable as a property income as the assessee is not the full owner of the property, so that income will be assessable as from Other sources, so that the deduction in such a case cannot be denied, though the assessee may not be eligible for an ad hoc deduction at 30%; but only actual repairs, where it is assessable as income from other sources. Q.25. Where a landlord undertakes to meet the expenses of watch and ward, corridor, lighting, lift, etc., are such expenses deductible from property income? Answer. Expenses which are ordinarily borne by the tenant, but undertaken by the landlord according to terms of rental agreement will go to reduce the annual value, because the rental value of the property can only be the net income after meeting the tenants burden.

DIRECT TAXATION I 17.73

Assessment of Various Entities & Tax Planning Q.26. Where the assessee allows the property to be used by firm of which he is a partner without charging rent, is he entitled to self-occupation allowance or depreciation? Answer. Since the firm is not a separate legal entity, the use of property by the firm should be treated as use and occupation of the property by the partner itself, so that self-occupation benefit will be available from income from such property. If the property is used for business, there is eligibility for depreciation also. Q. 27. Where a partner allows the use of the property by the firm and charges rent for the same, would he be entitled to ad hoc deduction at 30% or depreciation of the property because of the use for business? Answer. Since the rent is received from a firm of which he is a partner, the amount of rent receivable may not be treated as received in his capacity as landlord, but as a partner. If the property is used for business, the owner should be entitled to depreciation. It was so held in CIT vs. Ramlubhaiya R. Malhotra following A.M. Ponnuranga Mudaliar vs. CIi. The latter decision was followed in CIT vs. Texspin Engineering and Manufacturing Works . Q.28. In the case where a tenant sublets the property, is the rent paid by the tenant deductible from the income from subletting? Answer. Since the tenant is not the owner, the income should ordinarily be assessable as income from other sources, so that the rent paid should be deductible. Even if it were lease- hold property, the rent paid may have to be taken into account in determining the annual value. Contrary view taken in CIT vs. Hemraj Mahabir Prasad Ltd. would need review. Q.29. Where the assessee borrows money on mortgage of his property for his daughters marriage, is such interest paid deductible from the property income? Answer. Merely because the loan is charged on the property, interest does not become deductible, because the amount is not borrowed for purpose of acquiring or constructing the property. Q.30. To take advantage of mutuality principle, persons renting the hall of a club for marriage become temporary members. Is such receipt exempt from liability in the hands of the club? Answer. No. There is no mutuality involved. Temporary membership for an ulterior Bur- pose is not permissible. The rents are taxable in the hands of the club. TAX PLANNING-FOR BUSINESS EXPENDITURE Q. 1. There is a prevailing practice of a businessman taking loan of stock from another businessman and returning the same. Since he may have to pay for replacement at a higher price for return of loan of stock, can a provision made for the extra cost be deductible? Answer. The issue had come up in Welding Rods Manufacturing Co. vs. CIT, where it was found that the price rise at the time of closure of accounts in respect of outstanding loan of stock could be recognised and the provision therefore would be allowed as a deduction. In coming to the conclusion the High Court followed the decision in Calcutta Co. Ltd. Vs. CIT. In this context, one may refer to the statutory provision in section 47(xv) in respect of capital gains on stock lending, whereby tax on capital gains is spared on such stock lending, if the guidelines issued by Securities and Exchange Board of India had been followed. The provision, however, is only for exemption from capital gains and the mere act of lending of securities in pursuance of stock lending scheme. It cannot have application for dealers in shares. Similarly, the final outcome of the transaction even in the case of an investor may have to be recognised for capital gains tax pur-poses under the law as exemption is at the stage of lending and not at the stage when the contractual obligation gets discharged. Q. 2. Does a liability arise under excise law on show cause notice, which makes a special recognition for show cause notice, where such notice has been issued? Answer. Notwithstanding the effect of a show cause notice, it does not create a demand for payment by itself, so as to justify the amount covered by the notice as statutory liability, on the basis of the decision

17.74 I DIRECT TAXATION

in Kedarnath Jute Mfg. Co. Ltd. vs. CIT3. It was so pointed out in CIT vs. Morarji Goculdas Spg. & Wvg. Co. Ltd. Q. 3. Should the right to deduction await final result of any claim? Answer. Courts have not taken a uniform view. Ordinarily when a final decision is awaited, deduction could be made only in the year in which the matter gets resolved as in the case of requirement of approval from the authorities following the decision in Nonsuch Tea Estate Ltd. vs. CIT . But in a case on converse facts, it was held that in the accrual concept in mercantile system of accounting, a mere requirement of approval, when it has become available at the time of assessment or even in appeal, such delay in approval need not bar assessment in the year of receipt as was held in CIT vs. Jai Hind Travels (P) Ltd. , where the concept of the doctrine of relating back was adopted for accrual system. Such a view cannot be treated as non-controversial. Deduction need not be denied, where ex post facto approval is a formality. It is difficult to draw a line in such cases. It is for the taxpayer to make a provision in such cases in the year of claim, so that even if it is disallowed, it can be claimed in the year of payment. Failure to make the claim in an earlier year may lose the right, if revenue decides that the claim could be allowed only in the first year. Q. 4. Is it open to the Revenue to disallow a portion of electricity charges paid with reference to the refund claim made during the year, but given in a subsequent year? Answer. Receipt of refund in a subsequent year cannot be taken as a ground for not allowing a deduction at the time, when it was payable as was held in Travancore Chemical and Mfg. Co.Ltd. vs. CIT following the decision in CIT v Bharat Iron and Steel Industries , The High Court pointed out that the need for section 41(1) to tax amounts that had been remitted or waived would not have arisen, if allowance due for an earlier year could be modified with reference to the later waiver or remission. Q. 5. Is it possible to value stock by methods other than cost, market value, or cost or market value, whichever is lower? Answer. Any method which is consistently followed and is not likely to distort the income and is consistent with accounting principles should be acceptable. Lower valuation for slow moving goods in the view that future carrying cost would require to be taken into consideration was approved in India Motor Parts and Accessories P. Ltd. vs. CIT. The method, it was pointed out, had been suggested as a proper valuation in Industrial Accountants Hand Book edited by Wyman P Firke of John A. Beckett. Such a view had also the approval of Delhi High Court in CIT vs. Bharat Commerce and Industries Ltd. . Q. 6. How is the work in progress valued? Should the overheads be treated as part of cost? Answer. Work-in-progress is generally valued at cost. The issue as to whether the over-heads should be taken into consideration by adoption of on-cost basis or whether only direct cost should be taken was considered in Duple Motor Bodies Ltd. vs. Inland Revenue Commissioner , where it was found that either method can be adopted but where the assessee has adopted one method, it is not open to him to change it. Where an assessee had followed a method of accounting, which excluded over-heads in valuation of work-in-progress on the ground that the goods under manufacture may not result in marketable commodities, the Tribunal rejected the change mainly on the ground that there was no evidence of possible deterioration of work-in-progress. The High Court, however, found that since the assessee had followed the same method in earlier years, it was entitled to continue the same practice. The Supreme Court in CIT vs. British Paints India Ltd. decided on the short point that merely because a system has been consistently followed, it does not mean that Revenue is bound by it, if it finds that it is not consistent with accounting principles. If the income could xiot be rightly deduced from the system followed, it was open to the Assessing Officer to reject the same, since there is no estoppel in such matters. According to this decision, the cost ordinarily has to reckon overheads as well. The distinction between finished stock and work-in-progress was however not appreciated in this case, when it reversed the decision of the Calcutta High Court. But it is still an authority for the view that the method followed should be

DIRECT TAXATION I 17.75

Assessment of Various Entities & Tax Planning consistent with accounting principles. A scientific method of valuation of work-in-progress is probably only the retrievable value or a value which makes an allowance for a situation, if the goods turn out to be non-marketable. In other words, valuation at less than the cost or market value for work-in-progress should be permissible in certain lines of manufacture, where there is possible wastage before completion of the manufacture of the product, if such valuation is consistently followed. Q. 7. An assessee had the practice of accounting receipts from contract only when the bills raised by it were passed by the contractee. Where such a method is regularly followed, can it be rejected by the Assessing Officer? Answer. Yes. It was so held in CIT vs. Shaik Mohd Rowther Shipping and Agencies (P) Ltd. , where it was pointed out that the method is not consistent with any accounting principles. The work has been done on the basis of which bills were raised. 90% of the amount was also received, the balance pending for passing of the bills. Merely because the amount received is shown as advance, it is not possible to postpone recognition of revenue. The mere fact that the Assessing Officer had not disturbed the system in earlier years does not prevent him from correcting the same as the principle of res judicata can have no application to tax cases as was pointed out in CIT vs. Brit. Q.8. Which is the best head of income from tax point of view, where there is a possible choice? Answer. The best head is business as it is eligible for a list of deductions and reliefs. Q.9. A business executive has purchased and sold shares through a stock broker. Will the loss, if any, be assessable under the head business or capital gain? Answer. The mere fact that he has purchased and sold shares through a broker does not entitle the assessee to treat the income as business income. There should be a continuous activity. Moreover, if the interval between purchase and sale is short, profit will be referred under the head Short Term Capital Gains without any advantage. Q.10. A piece of land acquired five years before is plotted out and sold. What is the head of income? Answer. To treat the sale of land as a business transaction more facts are required. There should be facts to suggest that the land was converted to a business asset and dealt with as such and the sale is not just for the sake of realisation of appreciation in value. Q.11. Can what is accrued but not due ever be treated as accrued for tax purposes? What is the correct treatment of interest from cumulative deposits in the hands of payer and payee? Answer. This depends on the system of accounting. An assessee might choose with advantage to declare that income from year to year on accrual basis. However, the payer will deduct tax on the accumulated interest at the time of payment accords to section 194A in which case the assessee may have to ask for a refund. Q.12. How far are Accounting Standards relevant in computation of business income? Answer. Income for income-tax purposes is computed under ordinary principles of commercial accounting. Accounting Standards lay down such principles accepted by the profession and have even been made mandatory for purposes of company law. Hence they have great persuasive value. Q.13. A taxpayer has changed his method of stock valuation. Statutory audi-tors did not agree to the change and have qualified the balance sheet. Assessing Officer relies upon the decision of Supreme Court in British Paints case for rejecting the change. Is he justified in doing so? Answer. What is required is that the change in the method of valuation should be bona fide and thereafter followed continuously. In Karnataka State Forest Industries Corporation Ltd. vs. CIT High Court found that the Income-tax Officer cannot reject a change in the method of valuation of stock merely because statutory auditors objected to it.

17.76 I DIRECT TAXATION

Q.14. A firm replaces defective TV sets long after the guarantee period was over with a view to maintain goodwill of the firm. Cost of replacement is disallowed by the Assessing Officer. Is he right? Answer. Since the outlay was incurred on grounds of commercial expediency the claim is admissible. The paragraph under commercial expediency (supra) would give necessary authorities for the same. Q.15. Is a payment made to Life Insurance Corporation of India towards group gratuity fund deductible under section 36(1 )(v), though it has not been routed through an approved gratuity fund? Answer. The deduction need not be denied merely because a direct payment has been made as long as it is towards account of group gratuity fund. It was so decided in CIT vs. Textool Co. Ltd. In fact this would have even otherwise been allowed under sec. 37. Q.16. Can dumpers used in contract work be classified as earth moving machinery? Answer. Yes. They are entitled to depreciation and extra depreciation as earth moving machinery as held in CIT vs. Abdulkarim Stone Contractor . They are not road transport vehicles. Q.17. What is meant by block asset? Answer. Certain types of assets are grouped into one block and additions to the same will be treated as part of the block. Q.18. What are the changes brought about by bringing in the concept of block asset in evaluating cost for depreciation? Answer. Each item of machineries is not separately considered for depreciation. Where a particular capital asset or assets forming part of the block is sold, the difference between the full value of the consideration on one hand and the WDV of the block asset, plus expenditure incurred in the transfer, plus value of any asset added to the block on the other hand is treated as Short-term Capital Gains.(Sec. 50) The idea was to give up the profit under section 41(2) as it stood then which represented the amount of depreciation actually received. Earlier this amount was added as income and any excess above the depreciation was to be treated as capital gains as held in CIT vs. Artex Manufacturing Co. However section 41(2) has now been reintroduced with effect from 1.4.1998 but confined to power sector. Q. 19. The assessee has a project report for a new venture carried out at the cost of Rs.5 lakhs. Assessing Officer disallows the same as the venture re-lates to a new business. Is the assessee eligible for deduction and if not, is he eligible for depreciation? Answer. If the project report relates to an existing business for its expansion, it will be a revenue expenditure. But if it relates to a new business, it will be a capital expenditure eligible for depreciation as decided in CIT vs. Harsha Tractor Ltd. following the decision in Scientific Engineering House P. Ltd. vs. CIT. After amendment to section 32(1) allowing depreciation on intangible assets from 1.4.1998, it is a matter of statutory right for the assessee to get depreciation not merely by treating such project report as a plant as under the pre-existing law but as an intangible asset on par with other tangible assets, so that the cost is entitled to depreciation like other intangible assets like know-how, patents, copyrights, trademarks, licence, franchise or any other business or commercial rights of similar nature. Q.20. Where an air-conditioning plant is fixed in a bus, would such air-conditioner and bus be eligible for rates respectively applied to them? Answer. Air-conditioning plant, which is an integral part of bus would not be entitled to rate of depreciation different from what is available for motor vehicles, where they are installed1. Q.21. Can fencing be treated as a plant? Answer. No, it can be treated only as a building in the facts of the case2.

DIRECT TAXATION I 17.77

Q.22. It is the normal practice of revenue to deduct all depreciation allowed including initial depreciation in arriving at the WDV. Is this correct? Answer. According to Gujarat High Court, depreciation is referable to wear and tear. Initial depreciation being in the form of an incentive is not to be deducted. Q.23. Where a wholly owned subsidiary company acquires depreciable assets from the holding company at market value, is it eligible for depreciation on such market value? Answer. No. Explanation 6 to section 43(1) provides that in the case of acquisition of as-sets by a whollyowned subsidiary from its holding company, the written down value of the holding company will be the actual cost to the subsidiary as held in Dalmia Ceramic Industries Ltd. vs. CIT. Q.24. Could a road in a factory building used exclusively for industrial purpose be treated as a plant for purposes of depreciation? Answer. Road could not be treated as a plant, but only as a building for purposes of depreciation. Q.25. Where the assessee undertook gratuity liability of the vendor of the business as per agreement for sale, such liability is also consideration, so that it could be treated as part of the cost of assets entitled to depreciation. Is this correct? Answer. Since the assessee has undertaken only a future liability, it cannot form part of the cost so as to be entitled to depreciation. Q.26. Is it possible to capitalise expenditure as cost of the asset for purposes of depreciation? Answer. Expenditure which has nexus with the asset can be treated as part of the cost of the asset. Cost of temporary electricity connection, power line and inspection fee relating thereto were held to be part and parcel of cost of machinery for purposes of depreciation. Q.27. Are computers office equipments so as to be ineligible for investment allowance or additional depreciation? Answer. Office equipment has not been defined in the statute. What is barred is plant and machinery installed in office premises. Office premises have also not been defined. In case of a doctor, a clinic may be his office, but at the same time, it is also his place of practice. A computer is not ordinarily an office equipment like a typewriter or a duplicating machine. Computers are, therefore, eligible for investment allowance, when it was in vogue and additional depreciation.

Study Note - 18
GRIEVANCES REDRESSAL PROCEDURE
This Study Note includes 18.1 Grievances Redressal Procedure 18.2 Rectifications 18.3 Appeal and Appellate Hierarchy 18.4 Revision 18.5 General Provision 18.1 GRIEVANCES REDRESSAL PROCEDURE When the assessment order is passed against the assessee, and if he is not satisfied with any order passed by the Assessing Officer, he may appeal to higher court. Procedure for appeal is laid down under the act. The redressal procedure under the act includes the following: 1. Rectification 2. Appeal 3. Revision 18.2 RECTIFICATION 18.2.1 Rectification of mistake [Section 154] (1) For rectifying any mistake apparent from the record an Income Tax Authority referred to in section 116 may, (a) amend any order passed by it under the provisions of this Act; (b) amend any intimation or deemed intimation under sub-section (1) of section 143. (c) amend any intimation under sub-section (1) of section 200A w.e.f. 1.7.12

(1A) Where any matter has been considered and decided in any proceeding by way of appeal or revision relating to an order referred to in sub-section (1), the authority passing such order may, notwithstanding anything contained in any law for the time being in force, amend the order under that sub-section in relation to any matter other than the matter which has been so considered and decided. (2) Subject to the other provisions of this section, the authority concerned (a) may make an amendment under sub-section (1) of its own motion, and (b) shall make such amendment for rectifying any such mistake which has been brought to its notice by the assessee or by the deductor, and where the authority concerned is the Commissioner (Appeals), by the Assessing Officer also.

(3) An amendment, which has the effect of enhancing an assessment or reducing a refund or otherwise increasing the liability of the assessee or the deductor, shall not be made under this section unless the authority concerned has given notice to the assessee or the deductor of its intention so to do and has allowed the assessee or the deductor a reasonable opportunity of being heard.

DIRECT TAXATION I 18.1

Grievances Redressal Procedure 18.2.2 At whose instance mistakes can be rectified : The concerned authority may [implies discretion] make the necessary amendment of its own motion. The concerned authority has to make [implies that there is no discretion] such amendment for rectifying any mistake brought to its notice by the assessee. Where the concerned authority is the Commissioner (Appeals) and the mistake has been brought to his notice by the Assessing Officer, it has to make such amendment [implies that there is no discretion]. An amendment of the following nature can be made only after the concerned authority has given notice in this respect and also a reasonable opportunity of being heard to the assessee or deductor(a) Amendment which enhances an assessment. (b) Amendment which reduces a refund. (c) Amendment which otherwise increases the liability of the assessee or deductor. If any amendment enhances the assessment or reduces a refund already made, a notice of demand is served on the assessee or deductor. Such notice is deemed to be a notice u/s 156. If any amendment reduces the assessment, refund due to the assessee is made unless it is withheld u/s 241.

18.2.3 Procedure for such rectification under sub-section (3),(5) and (6),

18.2.4 Time Limit for Rectification: Period of limitation for making rectification as prescribed in sub-section (7) of section154 is as follows: No amendment under this section can be made after the expiry of 4 years from the end of the financial year in which the order sought to be amended was passed. It may be noted that an amendment is made when the related order is passed. This period of limitation is not applicable in case the provision of section 155 are applicable. However, if a valid application has been made by the assessee for rectification within the statutory time limit but is not disposed of by the concerned authority within the time specified, it may be disposed of even after the expiry of such time limit [Circular No. 73, dated 7th January, 1972]. This relief is, however, not admissible in case rectification proceedings are initiated by the department itself.

18.2.5 Action against rectification order: Following action may be taken against a rectification order: Appeal can be made to the Commissioner (Appeals) u/s 246A. Appeal can also be made against an order passed under this section refusing to rectify a mistake [Chennai Prop. & Inv. Ltd. v. CIT [2001] 247 ITR 226 (Mad.)]. Appeal can be made to the Appellate Tribunal u/s 253. Revision application can be made u/s 264.

18.2.6 Other amendments- For Rectification of Assessment of a Firm [Section 155]: (1) Where, in respect of any completed assessment of a partner in a firm for the Assessment Year commencing on the 1st day of April, 1992, or any earlier Assessment Year, it is found (a) on the assessment or reassessment of the firm, or (b) on any reduction or enhancement made in the income of the firm under this section, section 154, section 250, section 254, section 260, section 262, section 263 or section 264, or

18.2 I DIRECT TAXATION

(2)

(3)

(4)

(5)

(6)

(c) on any order passed under sub-section (4) of section 245D on the application made by the firm, that the share of the partner in the income of the firm has not been included in the assessment of the partner or, if included, is not correct, the Assessing Officer may amend the order of assessment of the partner with a view to the inclusion of the share in the assessment or the correction thereof, as the case may be; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the financial year in which the final order was passed in the case of the firm. Where as a result of proceedings initiated under section 147, a loss or depreciation has been recomputed and in consequence thereof it is necessary to recompute the total income of the assessee for the succeeding year or years to which the loss or depreciation allowance has been carried forward and set off under the provisions of sub-section (1) of section 72, or sub-section (2) of section 73, or sub-section (1) or sub- section (3) of section 74, or sub-section (3) of section 74A, the Assessing Officer may proceed to recompute the total income in respect of such year or years and make the necessary amendment; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the financial year in which the order was passed under section 147. Where any deduction in respect of any expenditure on scientific research has been made in any Assessment Year under sub-section (2B) of section 35 and the assessee fails to furnish a certificate of completion of the programme obtained from the prescribed authority within one year of the period allowed for its completion by such authority, the deduction originally made in excess of the expenditure actually incurred shall be deemed to have been wrongly made, and the Assessing Officer may, notwithstanding anything contained in this Act, recompute the total income of the assessee for the relevant Previous Year and make the necessary amendment; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the Previous Year in which the period allowed for the completion of the programme by the prescribed authority expired. Where as a result of any proceeding under this Act, in assessment for any year of a company is whose case an order under section 104 has been made for that year, it is necessary to recompute the distributable income of that company, the Assessing Officer may proceed to recompute the distributable income and determine the tax payable on the basis of such recomputation and make the necessary amendment; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the financial year in which the final order was passed in the case of the company in respect of that proceeding. Where in the assessment for any year, a capital gain arising from the transfer of a long-term capital asset, is charged to tax and within a period of six months after the date of such transfer, the assessee has made any investment or deposit in any specified asset within the meaning of Explanation 1 to sub- section (1) of section 54E, the Assessing Officer shall amend the order of assessment so as to exclude the amount of the capital gain not chargeable to tax under the provisions of sub-section (1) of section 54E; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the financial year in which the assessment was made. Where in the assessment for any year, a capital gain arising from the transfer of any original asset as is referred to in section 54H is charged to tax and within the period extended under that section the assessee acquires the new asset referred to in that section or, as the case may be, deposits or invests the amount of such capital gain within the period so extended, the Assessing Officer shall amend the order of assessment so as to exclude the amount of the capital gain not chargeable to tax under any of the sections referred to in section 54H; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of section 154 being reckoned from the end of the Previous Year in which the compensation was received by the assessee.

DIRECT TAXATION I 18.3

Grievances Redressal Procedure (7) Where in the assessment for any year commencing before the 1st day of April, 1988, the deduction under section 80-O in respect of any income, being the whole or any part of income by way of royalty, commission, fees or any similar payment as is referred to in that section, has not been allowed on the ground that such income has not been received in convertible foreign exchange in India, or having been received in convertible foreign exchange outside India, or having been converted into convertible foreign exchange outside India, has not been brought into India, by or on behalf of the assessee in accordance with any law for the time being in force for regulating payments and dealings in foreign exchange and subsequently such income or part thereof has been or is received in, or brought into, India in the manner aforesaid, the Assessing Officer shall amend the order of assessment so as to allow deduction under section 80-O in respect of such income or part thereof as is so received in, or brought into, India; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the Previous Year in which such income is so received in, or brought into, India; so, however, that the period from the 1st day of April, 1988 to the 30th day of September, 1991 shall be excluded in computing the period of four years. (8) Where in the assessment for any year, the deduction under section 80HHB or section 80HHC or section 80HHD or section 80HHE or section 80-O or section 80R or section 80RR or section 80RRA has not been allowed on the ground that such income has not been received in convertible foreign exchange in India, or having been received in convertible foreign exchange outside India, or having been converted into convertible foreign exchange outside India, has not been brought into India, by or on behalf of the assessee with the approval of the Reserve Bank of India or such other authority as is authorised under any law for the time being in force for regulating payments and dealings in foreign exchange and subsequently such income or part thereof has been or is received in, or brought into, India in the manner aforesaid, the Assessing Officer shall amend the order of assessment so as to allow deduction under section 80HHB or section 80HHC or section 80HHD or section 80HHE or section 80-O or section 80R or section 80RR or section 80RRA, as the case may be, in respect of such income or part thereof as is so received in, or brought into, India; and the provisions of section 154 shall, so far as may be, apply thereto, and the period of four years shall be reckoned from the end of the Previous Year in which such income is so received in, or brought into, India. (9) Where in the assessment for any year, a capital gain arising from the transfer of a capital asset, being land or building or both, is computed by taking the full value of the consideration received or accruing as a result of the transfer to be the value adopted or assessed by any authority of a State Government for the purpose of payment of stamp duty in accordance with sub-section (1) of section 50C, and subsequently such value is revised in any appeal or revision or reference referred to in clause (b) of sub-section (2) of that section, the Assessing Officer shall amend the order of assessment so as to compute the capital gain by taking the full value of the consideration to be the value as so revised in such appeal or revision or reference; and the provisions of section 154 shall, so far as may be, apply thereto, and the period of four years shall be reckoned from the end of the Previous Year in which the order revising the value was passed in that appeal or revision or reference. 18.3 APPEAL AND APPELLATE HIERARCHY Appeal is a complaint to a higher court relating to an injustice done by a lower court. The party complaining is called appellant and the other party is known as respondent. There are various provisions in the Income-tax Act relating to appeals and revision of orders. Under the Income-tax Act, the following remedial measures are available to the assessees if he is not satisfy with any order passed by the Assessing Officer :(i) Appeal w.e.f. 1.10.1998 first shall lie with the Commissioner of Income Tax (Appeals) against the order of the Assessing Officer (sec. 246A), or

18.4 I DIRECT TAXATION

(ii) Revision if appeal is not preferred or it could not be filed within the time limit allowed, the assessee can apply u/s. 264 to the Commissioner of Income Tax for revision of orders passed by the Assessing Officer. The Commissioner of Income-tax can also take up suo moto the case for revision. Where, however, in the opinion of the Commissioner of Income Tax the order passed by the Assessing Officer is erroneous and prejudicial to the interest of revenue, the Commissioner of Income Tax can also take up the case for revision u/s. 263. 18.3.1 Appeal to Commissioner of Income Tax (Appeals) [Section 246A] An aggrieved assessee or the deductor may appeal to the Commissioner of Income Tax (Appeals) against the following orders of Assessing Officer(a) An order against the assessee, where the assessee denies his liability to be assessed under this Act; or (b) Any order of assessment u/s 143(3) or sub-section (1) of section 200A or section 144, where the assessee objects : to the income assessed, or to the amount of tax determined, or to the amount of loss computed, or to the status under which he is assessed;

(c) An order of assessment, reassessment or recomputations u/s. 147 except order passed in pursuance of direction of the Dispute Resolution Panel or sec. 150; (d) An order or rectification made u/s. 154 or order u/s. 155 having the effect of : enhancing the assessment, or reducing a refund, or order refusing to allow the claim made by the assessee under either of these sections;

Except where it is in respect of an order referred to in sub-section (12) of section 144BA.

(e) An order u/s. 163 treating the assessee as the agent of a non-resident; (f) An order u/s. 170(2), (3) relating to succession to business otherwise than on death; (g) An order u/s. 171 relating to assessment after partition of a HUF; (h) An order u/s. 201 treating the assessee deemed to be assessee in default for failure to deduct the whole or any part of the tax or pay tax after deduction ; (i) An order u/s. 237 relating to refunds; (j) An order imposing penalty u/ss. 221, 271, 271A, 271B, 272A and 272BB,272AA; (k) An order made by Dupty Commissioner imposing a penalty u/ss. 271C, 271D, 271E and 272AA; (l) An order of Dupty Commissioner/Dupty Director imposing a penalty u/s. 272A; (m) An order imposing a penalty under chapter XXI i.e. u/s 270 to 275; (n) An order of assessment made by an Assessing Officer under clause (c) of section 158BC i.e. Block Assessment, in respect of search initiated u/s. 132 or books of account, other documents or any asset requisitioned u/s.132A, on or after 1.1.1997; (o) An order imposing a penalty u/s. 158BFA(2) in case of Block Assessment ;

DIRECT TAXATION I 18.5

Grievances Redressal Procedure (p) An order made by an Assessing Officer other than Deputy/Joint Commissioner under the provisions of this Act in the case of such person or class of persons, as the Board may, having regard to the nature of the cases, the complexities involved and other relevant considerations direct. Case Laws: 1. Non-allowing of interest in rectification order is appealable: When the ITO rectifies an assessment under section 154/155 and grants refund but fails to grant interest on the refund, such rectificatory order has the effect of reducing the amount payable to the assessee and hence appealable under section 246(1)(b) - CIT vs. Perfect Pottery Co. Ltd.173 ITR 545 2. Denial of liability to tax under particular circumstances is also covered - The expression denial of liability is comprehensive enough to take in not only the total denial of liability but also the liability to tax under particular circumstances. Thus, an assessee has a right of appeal against the order of the ITO assessing the AOP instead of the members thereof individually - CIT vs. Kanpur Coal Syndicate 53 ITR 225 3. Objection as to place of assessment cannot be raised - No appeal can lie against an order determining the place of assessment - Rai Bahadur Seth Teomal vs. CIT 36 ITR 9 Amendment in section 246A(1) regarding appeal to Commissioner (Appeals) [Section 246A(1)] (W.e.f. 1-10-2009) The Act has amended section 246A to provide that the appeal against the order passed by the Assessing Officer under section 143(3) or order of re-assessment under section 147 except an order passed in pursuance of directions of Dispute Resolution Panel shall lie to the Commissioner (Appeals). 18.3.2 Appeal by person denying liability to deduct tax in certain cases.[Section 248] Where under an agreement or other arrangement, the tax deductible on any income, other than interest, under section 195 is to be borne by the person by whom the income is payable, and such person having paid such tax to the credit of the Central Government, claims that no tax was required to be deducted on such income, he may appeal to the Commissioner (Appeals) for a declaration that no tax was deductible on such income. Case Law: AAC can determine quantum also : In an appeal filed under section 248, AAC has jurisdiction to deal with the quantum of sum chargeable under the provisions of the Act on which the assessee is liable to deduct tax under section 195 - CIT vs. Westman Engg. Co. (P.) Ltd. 188 ITR 327 18.3.3 Procedure for filing appeal [Section 249 & Rules 45 & 46] (i) An appeal in Form No. 35 should be filed within 30 days of a) the date of service of notice of demand relating to assessment or penalty if it relates to assessment or penalty; or b) the date of payment of tax, if it relates to any tax deducted u/s. 195(1) in respect of payment to non-resident in certain cases; or c) the date on which intimation of the order sought to be appealed against is served if it relates to any other cases. The Commissioner of Income-tax (Appeals) may condone the delay in filing appeal petition if he satisfied that the appellant had sufficient cause for not presenting it within that period.

(ii) No appeal shall be admitted unless at the time of filing of appeal the appellant has paid : (a) the tax due on the income returned by him, or (b) where no return has been filed the assessee has paid the amount equal to the amount of advance tax which was payable by him. However, the Commissioner (Appeals) may, for any

18.6 I DIRECT TAXATION

good and sufficient reason to be recorded in writing, exempt the appellant from the payment of such tax. (iii) Appeal is required to be made in duplicate. The memorandum of appeal, statement of facts and grounds of appeal should be accompanied by a copy of the order appealed against and the notice of demand in original, if any. (iv) Fee for filing appeal : The memorandum of appeal shall be accompanied by a fee as under : a) Where assessed income is ` 1,00,000 or less b) Where assessed income exceeds ` 1,00,000 but does not exceed ` 2,00,000 `1,000 ` 250 c) Where assessed income exceeds ` 2,00,000 d) other case except (a),(b) & (c) ` 250 ` 500

W.e.f. 1.6.1999 fee for filing appeal relating to matters which may not have nexus with the returned income (e.g. TDS defaults, non-filing of return) has been prescribed to be ` 250 for appeal before Commissioner (Appeals). [Sec. 249] The Commissioner (Appeals) after hearing the assessee and the income-tax department will pass an order in writing and communicate his order to the Assessee and the Commissioner of Income Tax. The Commissioner (Appeals) may confirm, reduce, enhance or annul an assessment against which the appeal is made. However, he has no power to set aside the assessment and refer the case back to the Assessing Officer for making a fresh assessment according to his direction. He may confirm or cancel the order of penalty. In other cases, he can pass such orders as he thinks fit. [Sec. 251] Case Laws: (1) Demand notice need not be enclosed to memo of appeal - Neither section 249 nor rule 45 makes it incumbent on the assessee-appellant to enclose the demand notice along with the memo of appeal - Addl. CIT vs. Prem Kumar Rastogi 115 ITR 503 (2) Appellate authority is statutorily bound to consider condonation of delay - Where an application for condonation of delay in filing an appeal is preferred, it is the statutory obligation of the appellate authority to consider whether sufficient cause for not presenting the appeal in time was shown by the appellant - Shrimant Govindrao Narayanrao Ghorpade vs. CIT 48 ITR 54 18.3.4 Procedure in appeal.[Section 250] (1) The Commissioner (Appeals) shall fix a day and place for the hearing of the appeal, and shall give notice of the same to the appellant and to the Assessing Officer against whose order the appeal is preferred. (2) The following shall have the right to be heard at the hearing of the appeal (a) the appellant, either in person or by an authorized representative; (b) the Assessing Officer, either in person or by a representative.

(3) The Commissioner (Appeals) shall have the power to adjourn the hearing of the appeal from time to time. (4) The Commissioner (Appeals) may, before disposing of any appeal, make such further inquiry as he thinks fit, or may direct the Assessing Officer to make further inquiry and report the result of the same to the Commissioner (Appeals). (5) The Commissioner (Appeals) may, at the hearing of an appeal, allow the appellant to go into any ground of appeal not specified in the grounds of appeal, if the Commissioner (Appeals) is satisfied that the omission of that ground from the form of appeal was not wilful or unreasonable.

DIRECT TAXATION I 18.7

Grievances Redressal Procedure (6) The order of the Commissioner (Appeals) disposing of the appeal shall be in writing and shall state the points for determination, the decision thereon and the reason for the decision. (6A) In every appeal, the Commissioner (Appeals), where it is possible, may hear and decide such appeal within a period of one year from the end of the financial year in which such appeal is filed before him under sub-section (1) of section 246A. (7) On the disposal of the appeal, the Commissioner (Appeals) shall communicate the order passed by him to the assessee and to the [Chief Commissioner or Commissioner]. Case Laws: 1) Appeal once filed cannot be withdrawn - An assessee having once filed an appeal, cannot withdraw it. Even if the assessee refuses to appear at the hearing, the AAC can proceed with the enquiry and if he finds that there has been an under-assessment, he can enhance the assessment - CIT v. Rai Bahadur Hardutroy Motilal Chamaria 66 ITR 443 (SC)/CIT v. B.N. Bhattachargee 118 ITR 461 2) Revenue can object to delay in filing appeal - If an appeal by an assessee is admitted without the fact of delay in its presentation having been noticed, it is open to the department to raise the objection at the time of hearing of the appeal - Mela Ram & Sons v. CIT 29 ITR 607 18.3.5 Powers of the Commissioner (Appeals) [Section 251] (1) In disposing of an appeal, the Commissioner (Appeals) shall have the following powers (a) in an appeal against an order of assessment, he may confirm, reduce, enhance or annul the assessment. (b) in an appeal against the order of assessment in respect of which the proceeding before the Settlement Commission abates under section 245HA, he may, after taking into consideration all the materials and other information produced by the assessee before, or the results of the inquiry held or evidence recorded by, the Settlement Commission, in the course of the proceedings before it and such other material as may be brought on his record, confirm, reduce, enhance or annul the assessment; ( c ) in an appeal against an order imposing a penalty, he may confirm or cancel such order or vary it so as either to enhance or to reduce the penalty; (d) in any other case, he may pass such orders in the appeal as he thinks fit.

(2) The Commissioner (Appeals) shall not enhance an assessment or a penalty or reduce the amount of refund unless the appellant has had a reasonable opportunity of showing cause against such enhancement or reduction. ExplanationIn disposing of an appeal, the Commissioner (Appeals) may consider and decide any matter arising out of the proceedings in which the order appealed against was passed, notwithstanding that such matter was not raised before the Commissioner (Appeals) by the appellant. 18.3.6 Appellate Tribunal. [Section 252] (1) The Central Government shall constitute an Appellate Tribunal consisting of as many judicial and accountant members as it thinks fit to exercise the powers and discharge the functions conferred on the Appellate Tribunal by this Act. (2) A judicial member shall be a person who has for at least ten years held a judicial office in the territory of India or who has been a member of the Indian Legal Service and has held a post in Grade II of that Service or any equivalent or higher post for at least three years or who has been an advocate for at least ten years. ExplanationFor the purposes of this sub-section, (i) in computing the period during which a person has held judicial office in the territory of India,

18.8 I DIRECT TAXATION

there shall be included any period, after he has held any judicial office, during which the person has been an advocate or has held the office of a member of a Tribunal or any post, under the Union or a State, requiring special knowledge of law; (ii) in computing the period during which a person has been an advocate, there shall be included any period during which the person has held judicial office or the office of a member of a Tribunal or any post, under the Union or a State, requiring special knowledge of law after he became an advocate. (2A) An accountant member shall be a person who has for at least ten years been in the practice of accountancy as a Chartered Accountant under the Chartered Accountants Act, 1949 (38 of 1949), or as a registered accountant under any law formerly in force or partly as a registered accountant and partly as a Chartered Accountant, or who has been a member of the Indian Income-tax Service, Group A and has held the post of Additional Commissioner of Income-tax or any equivalent or higher post for at least three years. (3) The Central Government shall appoint the Senior Vice-President or one of the Vice-Presidents of the Appellate Tribunal to be the President thereof. (4) The Central Government may appoint one or more members of the Appellate Tribunal to be the Vice- President or, as the case may be, Vice-Presidents thereof. (4A) The Central Government may appoint one of the Vice-Presidents of the Appellate Tribunal to be the Senior Vice-President thereof. (5) The Senior Vice-President or a Vice-President shall exercise such of the powers and perform such of the functions of the President as may be delegated to him by the President by a general or special order in writing. 18.3.7 Appeal to the Appellate Tribunal [Section 253] The Appellate Tribunal is constituted by the Central Government and has two classes of members Judicial and Accountant. An assessee may file an appeal before the Appellate Tribunal against the following orders u/s. 253(1) : (a) an order passed by Commissioner (Appeals), in the following cases : (i) an order u/s. 250 i.e. order passed on the appeal filed before him. (ii) an order imposing penalty u/s. 271, 271A, 272A. (iii) an order u/s. 154 regarding rectification of mistakes in an order passed, if the rectification has not been satisfactorily done by him. an order passed by a Commissioner u/s. 12AA relating to registration of a trust or institution ; (ii) an order passed by a Commissioner u/s. 263 or u/s. 272A; or (iii) order passed by a Chief Commissioner, Director General or Director u/s. 272A imposing penalty; or (iv) order passed u/s. 154 amending his order u/s. 263. (v) an order passed by an Assessing Officer under sub-section (3) of section 143 or section 147 or section 153A or section 153C with the approval of the commissioner as referred to in subsection (12) of section 144BA or an order passed under section 154 or section 155 in respect of such order.

(b) (i)

The Commissioner may also, if he objects to any order passed by the Commissioner (Appeals) u/s. 154/250, direct the Assessing Officer to appeal to the Appellate Tribunal against the order [Sec. 253(2)].

DIRECT TAXATION I 18.9

Grievances Redressal Procedure The Commissioner may, if he objects to any direction issued by the Dispute Resolution Panel under subsection (5) of section 144C in respect of any objection filed on or after the 1st day of July, 2012, by the assessee under sub-section (2) of section 144C in pursuance of which the Assessing Officer has passed an order completing the assessment or reassessment, direct the Assessing Officer to appeal to the Appellate Tribunal against the order. It may be mentioned that the Appellate Tribunal is the fact finding authority and hence the order passed by it on questions of fact are final and conclusive. The appeal should be filed in Form 36, in triplicate, accompanied by : 1. Two copies (at least one of which should be certified copy) of the order appealed against and two copies of the relevant order of the Assessing Officer. 2. Challan as proof of payment of appeal fee. The fee is payable as follows : (a) Total income assessed is upto ` 1,00,000 (b) Total Income assessed is ` 1,00,001 to `2,00,000 (c) Total Income assessed is over ` 2,00,000 (d) Where the subject-matter of appeal is not covered under (a), (b), (c) above (e) Application for stay of demand Fee of ` 500 Fee of ` 1500 Fee of 1% of the assessed income (maximum of `10,000) Fee of ` 500 Fee of ` 500

3. Three copies of the paper book containing copies of all documents, if any, to be relied upon. 4. Three copies of any order of the Tribunal or a High Court or the Supreme Court, relied upon. Where the department prefers an appeal against the order of Commissioner (Appeals) to the Appellate Tribunal a notice of the same along with a copy of the appeal shall be served on the assessee. The assessee should furnish a memorandum of cross objections in Form No. 36A before the Appellate Tribunal within 30 days of receipt of such notice. Similarly, the Department can also file a cross objections before the Tribunal on an assessees appeal. Every appeal under sub-section (2A) shall be filed within sixty days of the date on which the order sought to be appealed against is passed by the Assessing Officer in pursuance of the direction of the Dispute Resolution Panel under sub-section (5) of section 144C. The Assessing Officer or the assessee, as the case may be, on receipt of notice that an appeal against the order of the Deputy Commissioner (Appeals) or, as the case may be, the Commissioner (Appeals) or the Assessing Officer in pursuance of the directions of the Dispute Resolution Panel has been preferred under sub-section (1) or sub-section (2) or sub-section (2A) by the other party, may, notwithstanding that he may not have appealed against such order or any part thereof; within thirty days of the receipt of the notice, file a memorandum of cross-objections, verified in the prescribed manner, against any part of the order of the Assessing Officer, in pursuance of the directions of the Dispute Resolution Panel, or Deputy Commissioner (Appeals) or, as the case may be, the commissioner (Appeals), and such memorandum shall be disposed of by the Appellate tribunal as if were an appeal presented within the time specified in sub-section (3) or sub-section (3A). The Tribunal may decide the appeal within four years from the end of the Financial Year in which such appeal is filed. Where the Tribunal has issued a stay order, the appeal shall be disposed of within a period of 180 days from the date of stay order otherwise the stay order shall stand vacated (on expiry of the said period). [Sec. 254(2A)] Case Law: i) Where Tribunal found that cross-objections were belated by a period of one year and eleven months

18.10 I DIRECT TAXATION

and Tribunal came to conclusion that no sufficient cause had been made out explaining delay, Tribunal was justified in holding that delay in filing cross-objections could not be condoned - Vareli Textile Industries vs. CIT 154 Taxman 33. 18.3.8 Orders of Appellate Tribunal [Sec. 254] (1) The Appellate Tribunal may, after giving both the parties to the appeal an opportunity of being heard, pass such orders thereon as it thinks fit.

(2) The Appellate Tribunal may, at any time within four years from the date of the order, with a view to rectifying any mistake apparent from the record, amend any order passed by it under sub-section (1), and shall make such amendment if the mistake is brought to its notice by the assessee or the Assessing Officer. Provided that an amendment which has the effect of enhancing an assessment or reducing a refund or otherwise increasing the liability of the assessee, shall not be made under this sub-section unless the Appellate Tribunal has given notice to the assessee of its intention to do so and has allowed the assessee a reasonable opportunity of being heard. Provided that any application filed by the assessee in section 254(1) on or after 1.10.1998, shall be accompanied by a fee of ` 50.

(2A) In every appeal, the Apellate Tribunal, where it is possible may hear and decide such appeal within a period of 4 years from the end of the financial year in which such appeal is filed u/s 253 (1), (2) or (2A). Provided that the Appellate Tribunal may, after considering the merits of the application made by the assessee, pass an order of stay in any proceedings relating to an appeal filed under sub-section (1) of section 253, for a period not exceeding one hundred and eighty days from the date of such order and the Appellate Tribunal shall dispose of the appeal within the said period of stay specified in that order. Provided further that where such appeal is not so disposed of within the said period of stay as specified in the order of stay, the Appellate Tribunal may, on an application made in this behalf by the assessee and on being satisfied that the delay in disposing of the appeal is not attributable to the assessee, extend the period of stay, or pass an order of stay for a further period or periods as it thinks fit; so, however, that the aggregate of the period originally allowed and the period or periods so extended or allowed shall not, in any case, exceed three hundred and sixty-five days and the Appellate Tribunal shall dispose of the appeal within the period or periods of stay so extended or allowed. Provided also that if such appeal is not so disposed of within the period allowed under the first proviso or the period or periods extended or allowed under the second proviso, the order of stay shall stand vacated after the expiry of such period or periods. (2B) The cost of any appeal to the Appellate Tribunal shall be at the discretion of that Tribunal. (3) The Appellate Tribunal shall send a copy of any orders passed under this section to the assessee and to the Commissioner. (4) Save as provided in section 256 or section 260A, orders passed by the Appellate Tribunal on appeal shall be final. Case Laws: 1. Jurisdiction is not higher than that of ITO The jurisdiction of the Tribunal in the hierarchy created by the Act is no higher than that of the ITO; it is also confined to the year of assessment ITO vs. Murlidhar Bhagwan Das 52 ITR 335. 2. Tribunal cannot assume powers inconsistent with statutory provisions CIT vs. Manick Sons 74 ITR 3. Jurisdiction is restricted to subject-matter of appeal- The powers of the Tribunal in dealing with appeals are expressed in section 254(1) in the widest possible terms. The word thereon of course restricts

DIRECT TAXATION I 18.11

Grievances Redressal Procedure the jurisdiction of the Tribunal to the subject-matter of the appeal Hukumchand Mills Ltd. vs. CIT 63 ITR 232 . 18.3.9 Procedure of Appellate Tribunal [Sec. 255] (1) The powers and functions of the Appellate Tribunal may be exercised and discharged by Benches constituted by the President of the Appellate Tribunal from among the members thereof. (2) Subject to the provisions contained in sub-section (3), a Bench shall consist of one judicial member and one accountant member. (3) The President or any other member of the Appellate Tribunal authorised in this behalf by the Central Government may, sitting singly, dispose of any case which has been allotted to the Bench of which he is a member and which pertains to an assessee whose total income as computed by the AssessingOfficer in the case does not exceed five hundred thousand rupees, and the President may, for the disposal of any particular case, constitute a Special Bench consisting of three or more members, one of whom shall necessarily be a judicial member and one an accountant member. (4) If the members of a Bench differ in opinion on any point, the point shall be decided according to the opinion of the majority, if there is a majority, but if the members are equally divided, they shall state the point or points on which they differ, and the case shall be referred by the President of the Appellate Tribunal for hearing on such point or points by one or more of the other members of the Appellate Tribunal, and such point or points shall be decided according to the opinion of the majority of the members of the Appellate Tribunal who have heard the case, including those who first heard it. (5) Subject to the provisions of this Act, the Appellate Tribunal shall have power to regulate its own procedure and the procedure of Benches thereof in all matters arising out of the exercise of its powers or of the discharge of its functions, including the places at which the Benches shall hold their sittings. (6) The Appellate Tribunal shall, for the purpose of discharging its functions, have all the powers which are vested in the Income Tax Authorities referred to in section 131, and any proceeding before the Appellate Tribunal shall be deemed to be a judicial proceeding within the meaning of sections 193 and 228 and for the purpose of section 196 of the Indian Penal Code (45 of 1860), and the Appellate Tribunal shall be deemed to be a civil court for all the purposes of section 195 and Chapter XXXV of the Code of Criminal Procedure, 1898 (5 of 1898). Case Laws : 1. Statement to be relied upon must be got recorded: If the Tribunal desires to rely upon a statement, it should formally call upon counsel for the assessee to record the statement in writing so as to enable the ITO to meet the case - CIT vs. Thayaballi Mulla Jeevaji Kapasi 66 ITR 147. 2. Fiscal matters must be disposed of expeditiously : Law must move quickly not only in the Courts but also before the Tribunals and officers charged with the duty of expeditious administrative justice. Indeed administrative officers and Tribunals are taking much longer time than is necessary, thereby defeating the whole purpose of creating quasi-judicial Tribunals calculated to produce quick decisions especially in fiscal matters ITO vs. Ramnarayan Bhojnagarwala 103 ITR 797. 18.3.10 Statement of case to Supreme Court in certain cases [Section 257] If, on an application made [against an order made under section 254 before the 1st day of October, 1998,] under section 256 the Appellate Tribunal is of the opinion that, on account of a conflict in the decisions of High Courts in respect of any particular question of law, it is expedient that a reference should be made direct to the Supreme Court, the Appellate Tribunal may draw up a statement of the case and refer it through its President direct to the Supreme Court.

18.12 I DIRECT TAXATION

18.3.11 Appeal to the High Court [Section 260A & 260B] An appeal shall lie to the High Court from every appellate order passed in appeal by the Tribunal, before the date of establishment of the National Tax Tribunal if the High Court is satisfied that the case involves a substantial question of law. The appeal may be filed by the Chief Commissioner or the Commissioner or the assessee. The Memorandum of Appeal shall precisely state the substantial question of law involving the appeal. An appeal along with a fee (as per Court Fees Act), shall be filed within 120 days of the date of receipt of the order appealed against. The question of law shall be formulated by the High Court, then the appeal shall be heard by a bench of at least two judges and decided by majority opinion. [Secs. 260A and 260B] Case Laws : 1. Even if the High Courts have consistently taken an erroneous view, it would be worthwhile to let the matter rest, since large number of parties have modulated their legal relationship based on this settled position of law Union of India vs. Azadi Bachao Andolan 132 Taxman 373/263 ITR 706. 2. Revenue authorities to follow decision of jurisdictional High Court: Revenue authorities within State cannot refuse to follow jurisdictional High Courts decision on ground that decision of some other High Court was pending disposal by Supreme Court CIT vs. G.M. Mittal Stainless Steel (P.) Ltd. 130 Taxman 67/263 ITR 255. 18.3.12 Appeal to the Supreme Court [Section 261] An appeal lies before the Supreme Court, against an order of the High Court in a reference, or in an appeal. Such appeal can be filed only if the High Court certifies it to be a fit case for appeal to the Supreme Court. If the High Court refuses to grant such a certificate, the assessee can file a Special Leave Petition (SLP)before the Supreme Court. If the SLP is granted, the Supreme Court will hear and decide the appeal on merits. [Sec. 261] Case Laws : 1. Certificate will not issue against judgment of single Judge: Under article 133(3) of the Constitution, no appeal shall lie to the Supreme Court from the judgment, decree or final order of one Judge of the High Court. Consequently, no certificate can be issued in respect of such a judgment, decree or order State Bank of India vs. State Bank of India Employees Union 169 ITR 675 . 2. Question must be of great public or private importance A certificate under section 261 which does not set out precisely the grounds or does not raise a question of great public or private importance does not comply with the requirements of the Act. The jurisdiction of the Supreme Court to entertain an appeal from the opinion recorded under the Act arises only when a certificate is properly issued by the High Court or when the Supreme Court grants special leave under article 136 of the Constitution. India Machinery Stores (P.) Ltd. vs. CIT 78 ITR 50 ; CIT vs. Central India Industries Ltd. 82 ITR 555 . 18.3.13 Hearing before Supreme Court. [Section 262] (1) The provisions of the Code of Civil Procedure, 1908 (5 of 1908), relating to appeals to the Supreme Court shall, so far as may be, apply in the case of appeals under section 261 as they apply in the case of appeals from decrees of a High Court : Provided that nothing in this section shall be deemed to affect the provisions of sub-section (1) of section 260 or section 265.

(2) The costs of the appeal shall be in the discretion of the Supreme Court. (3) Where the judgment of the High Court is varied or reversed in the appeal, effect shall be given to the order of the Supreme Court in the manner provided in section 260 in the case of a judgment of the High Court.

DIRECT TAXATION I 18.13

Grievances Redressal Procedure Case Law : 1. Question not raised earlier cannot be raised: An independent issue, not considered by Tribunal or High Court, could not be permitted to be raised for first time before Supreme Court RM. Arunachalam vs. CIT 93 Taxman 423/227 ITR 222. 18.4 REVISION Provisions relating to powers of revision of the Commissioner of Income Tax provides in sections 263 and 264 of the Income-tax Act which are analysed in a tubular form as under : Section 263 I. Scope: (a) Revision of order erroneous and prejudicial to the Revision of other orders by any sub- ordinate interest of revenue passed by the Assessing Officer authority. (b) Two circumstances must exist to enable the Commissioner to exercise the power of revision viz. (i) the order should be erroneous; and (ii) by virtue of the order being erroneous prejudice must have been caused to the interest and of the Revenue. CIT vs. Gabriel India Ltd., 203 ITR 108(Bom). II. Procedure : (a) Commissioner of Income Tax may call for and Commissioner of Income-tax either on his own examine the records and revise the orders after motion or on an application by the assessee hearing the assessee. can call for the records and revise the order. (b) Record shall include all records relating to any Every application for revision should be proceeding available at the time of examination accompanied by a fee ` 500. of the file by the Commissioner of Income-tax. III. Nature of order : (a) An order enhancing, modifying or cancelling the An order which is not prejudicial to the interest assessment can be passed by the Commissioner. of the assessee can be passed. (b) If the Income-tax Officer makes any mistake Commissioner declining to interfere will not in carrying out the directions of the Appellate amount to passing of an order prejudicial to Assistant Commissioner or the Tribunal, his order the assessee. can be revised by the Commissioner of Income Tax. Warner Lambert Co.vs. CIT,205 ITR 395(Bom). (c) The Commissioner of Income Tax has jurisdiction and powers to initiate proceedings in respect of issues not touched by the CIT(Appeals) in his Appellate Order- CIT vs. Jayakumar B. Patil, 236 ITR 469(SC). Where depreciation was not claimed before the Income-tax Officer or the Appellate Assistant Commissioner but was claimed for the first time before the Commissioner of Income Tax in an application u/s.264, the Commissioner must allow the claim on merits. Rashtriya Vikas Ltd. vs. CIT,196 ITR694(All.) The Commissioner shall not revise any order where the appeal against the order is pending before the first or second appellate authorities (or) where the time for filing appeal has not lapsed the assessee has not waived his right of appeal. Section 264

18.14 I DIRECT TAXATION

IV. Time limit : (a) No order can be passed after the expiry of 2 years Commissioner should pass an order disposing from the end of the Financial Year in which the of the revision petition within one year from the order to be revised was passed. end of the Financial Year in which the revision petition was filed by the assessee. (b) An order in revision may be passed at any time in On assessees application- within one year the case of an order which has been passed in from the end of financial year in which the consequence of or to give effect to any finding or application was filed. direction contained in an order of the Appellate Tribunal, the High Court or the supreme court. V. Remedy : Appeal can be filed to the Appellate Tribunal. 18.5 GENERAL PROVISIONS 18.5.1 Tax to be paid notwithstanding reference, etc.[Section 265] Notwithstanding that a reference has been made to the High Court or the Supreme Court or an appeal has been preferred to the Supreme Court, tax shall be payable in accordance with the assessment made in the case. 18.5.2 Execution for costs awarded by Supreme Court.[Section 266] The High Court may, on petition made for the execution of the order of the Supreme Court in respect of any costs awarded thereby, transmit the order for execution to any court subordinate to the High Court. 18.5.3 Amendment of assessment on appeal.[Section 267] Where as a result of an appeal under section 246 or section 246A or section 253, any change is made in the assessment of a body of individuals or an association of persons or a new assessment of a body of individuals or an association of persons is ordered to be made, the Commissioner (Appeals) or the Appellate Tribunal, as the case may be, shall pass an order authorising the Assessing Officer either to amend the assessment made on any member of the body or association or make a fresh assessment on any member of the body or association. 18.5.4 Exclusion of time taken for copy.[Section 268] In computing the period of limitation prescribed for an appeal or an application under this Act, the day on which the order complained of was served and, if the assessee was not furnished with a copy of the order when the notice of the order was served upon him, the time requisite for obtaining a copy of such order, shall be excluded. 18.5.5 Filing of appeal or application for reference by Income Tax Authority [Section 268A] (1) The Board may, from time to time, issue orders, instructions or directions to other Income-tax Authorities, fixing such monetary limits as it may deem fit, for the purpose of regulating filing of appeal or application for reference by any Income-tax Authority under the provisions of this Chapter. (2) Where, in pursuance of the orders, instructions or directions issued under sub-section (1), an Incometax Authority has not filed any appeal or application for reference on any issue in the case of an assessee for any Assessment Year, it shall not preclude such authority from filing an appeal or application for reference on the same issue in the case of (a) The same assessee for any other Assessment Year; or There is no right of appeal but appeal vests under constitution.

DIRECT TAXATION I 18.15

Grievances Redressal Procedure (b) any other assessee for the same or any other Assessment Year.

(3) Notwithstanding that no appeal or application for reference has been filed by an income-tax authority pursuant to the orders or instructions or directions issued under sub-section (1), it shall not be lawful for an assessee, being a party in any appeal or reference, to contend that the income-tax authority has acquiesced in the decision on the disputed issue by not filing an appeal or application for reference in any case. (4) The Appellate Tribunal or Court, hearing such appeal or reference, shall have regard to the orders, instructions or directions issued under sub-section (1) and the circumstances under which such appeal or application for reference was filed or not filed in respect of any case. (5) Every order, instruction or direction which has been issued by the Board fixing monetary limits for filing an appeal or application for reference shall be deemed to have been issued under sub-section (1) and the provisions of sub-sections (2)(3) and (4) shall apply accordingly. 18.5.6 Definition of High Court.[Section 269] In this Chapter, High Court means (i) in relation to any State, the High Court for that State ; (ii) in relation to the Union territory of Delhi, the High Court of Delhi ; (iii) in relation to the Union territory of the Andaman and Nicobar Islands, the High Court at Calcutta; (iv) in relation to the Union territory of Lakshadweep, the High Court of Kerala; (v) in relation to the Union territory of Chandigarh, the High Court of Punjab and Haryana; (vi) in relation to the Union territories of Dadra and Nagar Haveli and Daman and Diu, the High Court at Bombay; and (vii) in relation to the Union territory of Pondicherry, the High Court at Madras.

18.16 I DIRECT TAXATION

Study Note - 19
INTEREST
This Study Note includes 19.1 Interest payable 19.2 Interest Recevable 19.3 Rounding off 19.1 INTEREST PAYABLE Sections 234A, 234B and 234C provide for charging of mandatory interest since word shall is used in the said sections. (CIT v, Anjum M.H. Ghaswala) 19.1.1 Interest For failure to deduct or pay any TDS [Section 201(A)]: Where a person responsible for deducting tax at source does not deduct at source under Chapter XVII or after deducting tax fails to pay the same as required by Act, he is liable to pay interest @ 1% for every month or part of a month on the amount of such tax from the date on which tax deductible till the date it is actually paid. Finance Act, 2010 has been amended with effect from July 1, 2010. Under the amended version, interest will be payable as followsRate of Interest (per month or part) 1 percent 1.5 percent Period for which interest is payable From the date on which tax was deductible to the date on which tax is actually deducted From the date on which tax was actually deducted to the date on which tax is actually paid

The Finance Act, 2012 has amended the aforesaid provisions, with effects from July 1, 2012. After this amendment, the payer shall not be deemed to be an assessee in default if the resident recipient has included such income in the return submitted under section 139 and the recipient has paid tax on such income, and the payer submits a certificate to this effect from Chartered Accountant.

In that case interest shall be payable at the rate of 1 percent from the date on which tax was deductible to the date of furnishing of return of income by the resident recipient. Before furnishing the quarterly statement for each quarter in accordance with the provisions of sub-section (3) of section 200, such interest should be paid on self- assessment basis. 19.1.2 Interest for failure to collect any tax or pay TCS [Section 206C(7)] : Where a person responsible for collecting tax at source under section 206C does not collect or after collecting tax fails to pay the same as required by Act, he is liable to pay interest @ 1% for every month or part of a month on the amount of such tax from the date on which tax should have been collected till the date it is actually paid. Any person, other than dealers of jewellry responsible for collection of tax at source under section 206C fails to collect full or part of the tax and the above conditions thereof are not fulfilled, the date of submission by the buyer / lessee shall be taken as the date of payment of tax by the seller.

DIRECT TAXATION I 19.1

Interest Consequently, the interest under section 206C(7) shall be payable from the date on which such tax was collectible to the date of furnishing of return of income of buyer / lessee. The Finance Act, 2012 has amended the aforesaid provisions, with effect from July 1, 2012. After this amendment, the payer shall not be deemed to be an assessee in default if the resident recipient has included such income in the return submitted under section 139 and the recipient has paid tax on such income, and the payer submits a certificate to this effect from Chartered Accountant.

In that case interest shall be payable at the rate of 1 percent from the date on which tax was deductible to the date of furnishing of return of income by the resident recipient. (the above relaxation is applicable only when the recipient is resident and the default pertains to the period commencing on or after July 1, 2012.) Before furnishing the quarterly statement for each quarter in accordance with the provisions of subsection (3) of section 200, such interest should be paid on self- assessment basis. 19.1.3 Interest on Delayed Payment of Tax other than Advance Tax [Section 220(2)] Where an assessee fails to pay any tax, penalty, etc. within 30 days from the date of the Notice of Demand issued under Section156, he shall be liable to pay interest on the outstanding demands @1% for every month or part of a month, for the period of default. The finance Act, 2012 has been amended the section 220 with effect from July 1, 2012 to provide that when interest is charged under section 201(1A) on the amount specified in the intimation issued under section 200A(1), then no interest will be chargeable for the same amount for the same period under section 220(2). Where the Notice of Demand issued under section156 is issued for payment of Advance Tax, interest is not chargeable on the outstanding demand, if any. Penalty is prescribed under section 221 for any default in payment of advance tax, any other tax, penalty, etc. within 30 days from the date of the Notice of Demand issued under Section156. Penalty can be to the extent of the amount of tax in arrears. However, where assessee has preferred, the AO can exercise his discretion so as to treat the assessee as not being in default in respect of nonpayment of tax on the amounts disputed in first appeal and then penalty under section 221 does not attract [Sec. 220(6)] The following additional points should be considered :(i) Interest charged under Section 220 (2) is reduced in case of reduction of tax in appeal, rectification or revision. (ii) Interest under Section 220(2) is to be paid on delayed payments even if extension of time for making payment has been granted. 19.1.4 Interest for defaults in furnishing return of income [Section 234A] If the return of income is furnished after the due date or is not furnished, the assessee is liable to pay interest under section 234A. Interest is calculated @ 1 percent per month or part of month (simple interest) commencing on the date immediately following the due date for filing the return of income and ending on(i) The date of furnishing the return (where return has been filed after the due date) or (ii) The date of completion of assessment under section 144 (where no return has been furnished) Amount on which interest is payable is calculated as under: (i) Find out the tax on total income as determined under section 143(1) or on assessment under section 143(3) or section 147 or 153A (if the assessment is made for the first time under section 147 or 153A)

19.2 I DIRECT TAXATION

(ii) From the tax so determined advance tax paid, tax deducted or collected at source, relief under section 90/90A/91, MAT credit under section 115JD but not tax paid under section 140A) shall be deducted. Amount on which interest is payable: (i) Under Section 234A(1): Interest is payable on tax determined u/s 143(1) or on regular assessment u/s 143(3)/144/147/153A minus TDS/ Tax collected at source and advance tax paid by the assessee. (ii) Under Section 234A(3): Tax determined u/s 147 or 153A minus tax on total income determined u/s 143(1), 144 or 147 earlier. Provisions of section 234A, 234B and 234C have been amended so as to provide that credit to be set off in accordance with the provision of section 115JD of the Act, ( Alternate Minimum Tax ) taken into account for calculating interest liability under this sections. The amended provision has been applicable for the Assessment Year 2013-14. No Interest if Taxes are paid : Where the assessee had paid the taxes before the date of filling the return but could not file the return for reasons beyond his control but filled it belatedly, the charge of interest u/s 234A is not valid as in such cases there is no loss to the revenue. However interest would be payable where tax has not been deposited prior to the date of filling of the return. [Prannoy Roy (Dr.) vs CIT 121 Taxman 314 (Del)] 19.1.5 For default in paying Advance Tax [Section 234B] : Where an assessee who has failed to pay advance tax, interest @ 1% for every month or part of month is payable on assessed tax. Such interest is payable from April 1 of the Assessment Year to the date of determination of income under section 143(1) or on regular assessment. Where an assessee who had paid advance tax but the amount of advance tax paid by him less than 90% of assessed tax, interest is payable @1% for every month or part of the month on the assessed tax minus advance tax is paid. Such interest is payable from April 1 of Assessment Year upto the date of determination of income u/s/ 143(1) or on regular assessment. Relief under section 90/90A/91, MAT credit under section 115JAA and Alternate Minimum Tax credit under section 115JD shall be deducted from Assessed Tax. Finance Act, 2012 amended the provision that only tax actually deducted/collected shall be reduced from assessed tax. If tax is deductible or collectible but the payer or collector has not deducted/collected tax at source, such tax cannot be reduced. This rule is applicable only from April 1, 2012. Where, before the date of completion of regular assessment, tax is paid on the basis of self assessment under section140A or otherwise, the interest will be calculated as follows(i) upto the date of payment of tax under section 140A or otherwise, interest will be calculated as mentioned earlier; and (ii) from the date of payment of tax under section 140A or otherwise, interest will be calculated on the amount by which advance tax and tax payment stated in (a) above falls short of assessed tax. The CBDT is empowered to relax the provisions of Sec. 234B in appropriate cases. [Sec. 119(2)(a)] 19.1.6 Interest for Deferment of Advance Tax [Sec. 234C] An advance tax is said to have been deferred, if any one or more of the installments are not paid or tax paid is less than prescribed under the law. In case of such deferment of advance tax simple interest shall be payable as follows :

DIRECT TAXATION I 19.3

Interest (i) For Assessee other than Companies : (a) If the tax paid upto 15th September is less than 30% (b) If the tax paid upto 15th December is less than 60% (c) If the tax paid upto 15th March is less than 100% of the tax due (ii) For Company Assessees : (a) If the tax paid upto 15th June is less than 15% (b) If the tax paid upto 15th September is less than 45% (c) If the tax paid upto 15th December is less than 75% (d) If the tax paid upto 15th March is less than 100% Simple interest on the amount of shortfall @1% p.m. for 3 months do do Simple interest on the amount of shortfall @ 1% for 1 month Simple interest on the amount of shortfall @1% p.m.for 3 months do Simple interest on the amount of shortfall @ 1%.

No interest under section 234C is leviable where the shortfall in payment of advance tax installments is on account of under-estimate/non-estimate of any capital gains or winning from lotteries, crossword puzzles, races, etc. This concession of not charging of interest is applicable where such incomes arise after payment of any of the installments and the whole tax on the items of income stated herein before is deposited along with the next succeeding installment falling due after the income arose. 19.1.7 Interest for Failure to pay Advance Tax [Sec. 234B and 234C] Interest under sections 234B and 234C is payable even in cases where the assessee fails to pay advance tax at all. Any tax paid after 15th March but before 31st March is considered as advance tax paid. 19.1.8 Fees for default in furnishing Quarterly Returns [ Sectioin 234E] Section 234E has been inserted with effect from July 2012. It shall be applicable with respect of quarterly TDS / TCS return which are submitted on or after July 1st 2012. In other words, it would be applicable from the first quarter of the financial year 2012-13. Under this section, if a person fails to deliver, or caused to be delivered, any TDS/ TCS Return within the time limit prescribed in section 200(3), or the provision of section 206C(3), need to pay a fees of a sum of Rs 200 for every day during which the failure continues. 19.2 INTEREST RECEIVABLE 19.2.1 Interest Charged Under Section 234D Section 234D was inserted by Finance Act 2003 with effect from June 2003. Under this section, interest is recovered on refund granted earlier. Where any refund has been granted to the assessee under section 143(1) and subsequently on regular assessment no refund / or demand had arisen, then the assessee shall be liable to pay simple interest at the rate of 1/2 % p.m on the excess amount so refunded for the period starting from the date of refund to the date of final assessment. 19.2.2 Interest is payable to assessee on refund [Section. 244A] Interest on excess payment of advance tax, tax deducted or collected at source and any other tax or penalty becoming refundable shall be paid @ 1/2% for every month or part of a month. The period for which the interest is payable will be: (i) For refund out of advance and tax deducted at source, from 1st April of relevant Assessment Year

19.4 I DIRECT TAXATION

to the date on which the refund is granted. However, no interest is payable, if the amount of refund is less than 10% of the tax determined under section 143(1) or on regular assessment or assessment of FBT under section 115WE, and (ii) For all other tax or penalties, from the date of payment of tax or penalty to the date on which the refund is granted. Delay in granting refund attributable to the assessee is excluded from the period for which interest is payable. Where the amount on which interest was payable is increased or decreased due to regular assessment orders, reassessment, rectification, appeals, revision or Settlement Commissions order, interest is also will be increased of decreased. Interest earned by assessee under section 244A is treated as taxable income of the Previous Year in which it is allowed. 19.3 ROUNDING OFF 19.3.1 Rounding off of Month [Rule 119A] The interest is to be calculated, any fraction of a month deemed to be full month and the interest shall be so calculated. 19.3.2 Rounding off of Amount [Rule 119A] The amount of tax, penalty or other sum in respect of which interest is to be calculated is to be rounded off to the nearest multiple of ` 100 and for this purpose any fraction of ` 100 is to be ignored.

DIRECT TAXATION I 19.5

Interest

ILLUSTRATIONS ON INTEREST u/s 234A, 234B & 234C

Illustration 1. A firm made the following payments of advance tax during the Financial Year 2012-13 : 15.09.2012 15.12.2012 15.03.2013 Figures in ` Lakhs 9.30 9.0 13.9 32.20

The income returned by the firm is ` 100 Lakhs under the head Business and ` 10 Lakhs by way of Long-term Capital Gains on sale of a property effected on 1.3.2013 What is the interest payable by the assessee u/s 234B and 234C of the Income Tax Act for Assessment Year 2013-2014? Assume that the return of income was filed on 31.07.2013 and tax was fully made upon self-assessment. Solution : Assessee : Firm Previous Year : 2012-2013 Assessment Year : 2013-2014 (a) Interest u/s 234B = Nil [since more than 90% of Tax Payable has been paid before the end of the Previous Year] (b) Interest u/s 234C
Due date Advance Tax Payable (`) 30% of ` 30,90,000 [See note] = 9,27,000 60% of ` 30,90,000 = 18,54,000 100% of ` 32,96,000 [See note] = 32,96,000 Advance Tax paid (`) 9,30,000 Cumulative Advance Tax paid before due date (`) 9,30,000 Shortfall in Payment (`) Surplus (`) Months Interest @ 1% p.m. (`)

15.9.2012

3,000

15.12.2012

9,00,000

18,30,000

24,000

720

15.3.2013

13,90,000

32,20,000

76,000

760

1,480

Note : Tax on LTCG has been considered only for the 3rd instalment as such gain had arisen only on 1.3.2012. Computation of Actual Tax Payable by the Firm : Particulars Profits and Gains of Business or Profession Capital Gains Long Term Capital Gain Total Income Tax on Total Income including Surcharge and Cess On Long Term Gain of ` 10 lakhs @ 20%+ EC @ 2%+ SHEC @ 1% On Business Income @ of ` 100 lakhs @ 30%+ EC @ 2%+ SHEC @ 1% Net Tax Payable 2,06,000 30,90,000 32,96,000
` `

1,00,00,000 10,00,000 1,10,00,000

19.6 I DIRECT TAXATION

Note : Tax on Business income alone considered for computation of 1st and 2nd installment. Illustration 2. A firm made the following payments of advance tax during the Previous Year 2012-13 :
` in

lakh

September 15, 2012 December 15, 2012 March 15, 2013 The return of income is filed on 31.7.2013 showing Bonus income Long Term Capital Gain taxable @ 20% (as on 1.12.2012) Compute interest payable u/s 234C. Solution : Computation of tax liability for the A.Y. 2013-14
` 80 ` 20

7.00 7.75 13.00 27.75 lakh lakh

` in

lakh

Particulars Income Tax rate Tax liability before surcharge Add : Education Cess & SHEC Tax liability including cess ..Total Tax Liability = (24.72 + 4.12) lakhs = ` 28.84 lakhs. Computation of interest payable u/s 234
Due date Advance Tax Payment ` 30% of ` 24,72,000 = 7,41,600 60% of ` 24,72,000 = 14,83,200 (+) 60% of 4,12,000 = 2,47,200 100% of ` 28,94,000 = 28,94,000 Advance Tax paid ` 7,00,000 7,75,000

Business Income 80.00 30% 24.00 0.72 24.72

Long Term Capital Gain 20.00 20% 4.00 0.12 4.12

15.9.2012 15.12.2012

Cumulative Advance Tax paid before due date ` 7,00,000 14,75,000

Shortfall in Payment ` 41,600 2,55,400

Surplus Months ` 3 3

Interest @ 1% p.m. ` 1,248 7,662

15.3.2013

13,00,000

27,75,000

1,19,000

1,190 10,100

DIRECT TAXATION I 19.7

Interest Illustration 3. In the case of Ms Laxmi, you are required to compute the interest u/s 234A, 234B & 234C from the following details Tax on total income ` 2,00,000; Due date for filing the return 30.09.2013; Actual date of filing the return 1.10.2014 and tax paid on 30.09.2013 ` 2,00,000. Solution : Computation of interest u/s 234A Particulars Tax Less : Advance tax paid TDS Amount on which interest is payable Period of default (October being part of a month shall be considered) Interest u/s 234A (1% ` 2,00,000 1 month) Computation of interest u/s 234B Since assessee did not pay any amount by way of advance tax, hence she is liable to pay interest u/s 234B. Particulars Shortfall Period of default (From April to September) Interest (1% ` 2,00,000 6 months) Computation of interest u/s 234A Due date Advance Tax Payment
`

As per assessed income Nil Nil

` 2,00,000

Nil

` 2,00,000

1 month

` 2,000

Assessed income
`

2,00,000 6 months
`

12,000 Interest @ 1% p.m.

`

Advance Tax paid

`

Cumulative Advance Tax paid before due date

`

Shortfall in Payment
`

Surplus Months
`

15.9.2012 15.12.2012

30% of ` 2,00,000 = 60,000 60% of ` 2,00,000 = 1,20,000 100% of ` 2,00,000 = 2,00,000

Nil Nil

Nil Nil

60,000 1,20,000

3 3

1,800 3,600

15.3.2013

Nil

Nil

2,00,000

2,000

7,400 Total interest payable

19.8 I DIRECT TAXATION

Particulars U/s 234A U/s 234B U/s 234C Total

Amount 2,000 12,000 7,400 21,400

Illustration 4. During the Previous Year 2012-13, Mrs. X (aged 46 years) pays the following installments of advance tax :
`

On September 15, 2012 On December 15, 2012 On March 15, 2013 On March 16, 2013

6,000 14,000 16,000 18,000

Mrs. X files return of ` 7,01,000. Assessment is also completed on the basis of income returned by Mrs. X after making addition of ` 25,000 (date of assessment order : January 20, 2014). Mrs. X is entitled to tax credit of ` 12,510 on account of tax deducted at source. Compute interest under sections 234B and 234C. Solution : Interest liability under section 234B Income(7,01,000+25,000)= Tax on `7,26,000 Less: Tax deducted at source Assessed tax 90% of assessed tax Advance tax paid during 2012-13 (i.e., ` 6,000 + 14,000 + 16,000 + 18,000) = `

7,26,000

77,456 12,510 64,946 58,451 54,000

Since advance tax during the Previous Year 2012-13 is less than 90% of assessed tax, Mrs. X is liable to pay interest under section 234B, i.e., on the shortfall of ` 10,946 (being ` 64,946 54,000) for 10 months (` 10,946 1/100 10) which comes to ` 1,095. Interest liability under section 234C : Tax on ` 7,01,000 = 70,200 + 3% on Education and Higher Education Cess = 72,306
Due date Advance Tax Payment ` 30% of ` 72,306 = 21,692 60% of ` 72,306 = 43,384 100% of ` 72,306 = 72,306 Advance Tax paid ` 6,000 Cumulative Advance Tax paid before due date ` 6,000 Shortfall in Payment ` 15,692 Surplus Months ` Interest @ 1% p.m. ` 471

15.9.2012

15.12.2012 15.3.2013

14,000 34,000

20,000 54,000

23,384 18,306

3 1

702 183 1,356

DIRECT TAXATION I 19.9

Study Note - 20
ADVANCE PAYMENT OF TAX
This Study Note includes 20.1 Advance Payment of Tax 20.2 Collection of Advance Tax 20.3 Recovery of Tax 20.1 ADVANCE PAYMENT OF TAX Tax Payable By An Assesses Shall Be Paid In Advance [Section 4] Who is liable to pay Advance Tax When the Advance Tax-payable by any person for the Assessment Year Immediately following the financial year is ` 10,000 or more. (Section 208) Tax on Total Income Amount of Advance Tax payable Less: Rebate and relief Add: Surcharge Less: Tax deducted at source and Tax collected at source. Due Date of Installment in a relevant Previous Year On or before June 15 On or before September 15 On or before December 15 On or before March 15 Note : Any amount paid by way of advance tax on or before 31st March of the relevant Previous Year shall also be treated as Advance Tax paid during the financial year ending on that day. If the due date of payment of advance tax is a banking holiday, the Assessee can make the payment on the next immediately following working day. In such cases, no interest shall be leviable u/s 234B or 234C. No Advance tax payable by senior citizens u/s.207 This section provides for payment of Advance Tax in instalments. It is now provided, w.e.f. 1-4-2012, that a senior citizen who has no income from business or profession will not be required to pay any Advance Tax. 20.2 COLLECTION OF ADVANCE TAX 20.2.1 Procedure for Payment of Tax under a Demand Notice Issued U/S 156 1. 2. Due date for payment of tax [Section 220(1)]: Any amount of tax other than Advance Tax specified as payable in a notice of demand u/s 156 shall be paid within 30 days. Reduction of time limit: If the Assessing Officer has any reason to believe that it would be detrimental to revenue if the full period of 30 days as aforesaid is allowed, he may, with the previous approval of Amount payable by Corporate Assesses 15% of Advance tax payable 45% of Advance tax payable 75% of Advance tax payable 100% of Advance tax payable Amount payable by Non Corporate Assesses
Not Applicable 30% of Advance tax payable 60% of Advance tax payable 100% of Advance tax payable

DIRECT TAXATION I 20.1

Advance Payment of Tax the Joint Commissioner, direct that the sum is to be paid within any period less than 30 days. 3. Extension of time limit: The Assessing Officer may extend the time on the basis of an application made by the Assessee to pay the tax demanded u/s 156(1) or allow payments by installments subject to conditions as he may think fit to impose.

20.2.2 Circumstances of Assessee be Treated as Deemed to be in Default 1. Assessee deemed to be in default [Section 220 (4)]: The Assessee shall be deemed to be in default if the amount specified in the notice u/s 156 is not paid within the time allowed or within such extended time u/s 220(3). 2. Amount of default [Section 220(5)] Where the payment is allowed by instalments, the amount of default shall be the amount outstanding. All the other instalments shall be deemed to be in default on the same date as the instalment actually in default. Circumstances under which the Assessee is not deemed to be in default: i. If the Assessee presents an appeal to the CIT (Appeals), the Assessing Officer may, in his discretion and subject to such conditions as he may think fit to impose, treat the Assessee as not being in default as long as the appeal is not disposed of. [Section 220(6)] Where the income of an Assessee arising outside India is assessed in a Country where the laws prohibit or restrict the remittance of money to India, such an Assessee shall not be treated as Assessee in default in respect of tax due on the income which cannot be brought into India. [Section 220(7)] Where the demand in dispute has arisen because the Assessing Officer has adopted an interpretation of law in respect of which there are conflicting High Court decisions and the Department has not accepted the interpretation of the Court, the Assessee shall not be deemed in default. [Circular No.530/ 6-3-1989]

3.

ii.

iii.

iv. Where the demand in dispute relates to issues which are decided earlier in the Assessees favour by an appellate authority / Court in his own case (say, for preceding Assessment Years), the Assessee shall not be deemed to be in default to the extent of tax liability relatable to such disputed points. [Circular No.530/6-3-1989] Interest for belated payment of tax: [Section 220(2)] (a) Interest : If the amount demanded as per notice u/s 156 is not paid within the period specified in that notice, the Assessee shall be liable to pay a simple interest @ 1 % per month or part of a month. (b) Period of Interest : The period of interest shall be from the day immediately following the end of the period mentioned in the notice ending with the day on which the amount is paid, Penalty: [Section 221] (a) Where the Assessee is in default or deemed to be in default in making payment of tax, the Assessing Officer may direct the Assessee to pay a penalty not exceeding the amount of tax in arrears. (b) Penalty may be levied even if the tax is paid belatedly but before the levy of such penalty. Opportunity to Assessee : The Assessee shall be given a reasonable opportunity of being heard. No penalty: In case the Assessee proves to the satisfaction of the Assessing Officer that the default was for good and sufficient reasons, no penalty shall be levied. Refund of penalty : In case the amount of tax was wholly reduced in any final order, then the penalty levied shall be cancelled and amount of penalty paid shall be refunded.

20.2.3 Consequences of Non-Payment or Delay in Payment at Tax as Demanded by Notice u/ s 156 1.

2.

3. 4. 5.

20.2 I DIRECT TAXATION

20.3 RECOVERY OF TAX 20.3.1 Certificate of Recovery u/s 222(1) 1. Certificate of Recovery [Section 222(1)]: When an Assessee is in default or deemed to be in default in payment of tax, the Tax Recovery Officer may draw up a statement under his signature in Form No.57 specifying the amount of arrears due from the Assessee. Such a statement is called Certificate. The Assessee cannot dispute the correctness of any certificate drawn up by the TRO on any ground. [Section 224] It is lawful on the part of the TRO to cancel the certificate for any reason he thinks necessary so to do or to correct any clerical or arithmetical mistake therein. [Section 224]

2. 3.

20.3.2 Modes of Recovery of Tax Under the Pro Visions of The Act, by The Tax Recovery Officer 1. Modes of Recovery of tax [Section 222]: In accordance with the rules laid down in the Second Schedule, the amount specified in the certificate may be recovered by any one or more of the following modes 2. (a) Attachment and sale of the Assessees movable property, (b) Attachment and sale of the Assessees immovable property, (c) Arrest of the Assessee and his detention in prison, (d) Appointing a receiver for the management of the Assessees movable and immovable properties. Movable and immovable property includes any property which has been transferred directly or indirectly by the Assessee to his spouse or minor child or sons wife or sons minor child for inadequate consideration and the same is held by such persons. Property held by major: Any movable property or immovable property transferred to the minor child or sons minor child shall be treated as the Assessees property even after the minor attains majority. The Tax Recovery Officer may take action u/s 222(1) for recovery of tax arrears even though any other proceedings for recovery of arrears have been taken, Applicability: Section 226 is applicable in the following situations: (a) No certificate u/s 222 has been drawn by the Assessing Officer (b) Where a certificate has been drawn u/s 222, the Tax Recovery Officer, without any Prejudice to the modes of recovery specified in Section 222, can recover by any one or more of the other modes u/s 226. Modes of Recovery:
Tax arrears due from Salaried Employee Arrears of tax to be deducted by Person paying salary to such person Payment of sum deducted To the credit of Central Government Other Provisions Not applicable where the salary is exempt from attachment under the Code of Civil Procedure

3.

4.

20.3.3 Other Modes of Recovery [Section 226]: 1.

2.

Mode Attachment of Salary [Section 226(2)]

DIRECT TAXATION I 20.3

Advance Payment of Tax

Garnishee Order [(Section 226(3)] Any Assessee Any Person from whom money is due or may become due to the Assessee or any person who holds any money for the Assessee jointly with any other person Court To the credit of Central Government If the assessee fails to make payment in pursuance to the notice, the assessee shall be deemed to be an assessee in default in respect to the amount specified in the notice and further proceeding may be taken against him as per section 222 to 225. -

Assessee whose Recovery from money is in Courts money belonging custody to Assessee lying in Courts custody [Section 226(4)] Recovery of arrears of tax by distraint and sale [Section 226(5)] Any Assessee

To the AO or TRO to the extent of liability Not Applicable

Not Applicable

It should be authorized by the CIT/ CCIT by general or special order. The distraint or sale shall be made in the manner as that for an attachment and sale of movable Property attachable by actual seizure

20.4 I DIRECT TAXATION

Illustration 1 : Compute the Advance Tax payable by R from the following estimated income submitted for the Previous Year 2012-13. ` (1) Income from Salary (2) Rent from house property (per annum) (3) Interest on Government securities (4) Interest on bank deposits (5) Receipt from horse race (net) (6) Agricultural Income (7) Contribution towards PPF Tax deducted at source by the employer on salary is ` 9,680. Solution: Computation of Estimated Total Income for the Previous Year 2012-13 ` Income from Salary: Gross salary Less : Deduction Income from House Property: Rent received Less : (Statutory deduction u/s 24(a ) @ 30%) Income from Other Sources: Interest on Government securities Interest on Bank Deposit Horse Races (Gross) Estimated Gross Total Income Less : Deduction under section 80C Estimated Tax: Step-1 : Aggregate of Agricultural income + Non-Agricultural income (90,000 + 5,08,000) = 5,98,000 Tax on: Income from Horse Race of ` 20,000 @ 30% Balance income of ` 5,78,000 Step-2 : Aggregate of Basic exemption limit of agricultural income (2,00,000 + 90,000) = 2,90,000 Tax on ` 2,90,000 3,64,000 Nil 1,80,000 54,000 5,000 3,000 20,000 28,000 5,1 8,000 10,000 5,08,000 1,26,000 3,64,000 ` 3,64,000 1,80,000 5,000 3,000 14,000 90,000 10,000

6,000 45,600 51,600

9,000

DIRECT TAXATION I 20.5

Advance Payment of Tax Step-3 : Tax on non-agricultural income Tax under step-1 - Tax under step-2 (51,600 9,000) = 42,600 Estimated tax payable
Add: Education cess @2% Add: SHEC @1% Less : Estimated TDS

42,600 852 426 43,878 9,680 6,000 15,680 28,198 8,459 8,459 11,280

on salary on horse races Advance tax payable (rounded off) First installment payable by 15.9.2012 (30%)
Second installment payable by 15.12.2012 (30%) Third installment payable by 15.3.2013 (balance 40%)

Working notes: 1. Computation of gross winnings from horse races: Net Amount Grossing up 14,000 X100/70 Tax deducted at source (Gross amount ` 20,000 Amount received ` 14,000) 2. Interest on Bank deposit assumed not to be from savings deposit. Illustration 2. X Ltd. estimates its income for the Previous Year 2012-13 at ` 1,20,000. Besides this income, it has also earned Long-Term Capital Gain of ` 80,000 on transfer of gold on 1.12.2012. Compute the advance tax payable by the company in various instalments. Solution: ` Tax on ` 1,20,000 @30% LTCG of ` 80,000 @ 20% Add: Education cess @ 2% SHEC @1% Amount payable on 1st and 2nd instalment For the first two instalments tax on LTCG will not be taken into account as this accrued on 1.12.2012 i.e. after the due date of the first 2 instalments. ` Tax including Education Cess and SHEC payable without Long-term Capital Gain (` 36,000 + 720 +360) 37,080 36,000 16,000 52,000 1,040 520 53,560 ` 14,000 20,000 6,000

20.6 I DIRECT TAXATION

Advance Tax Payable Due Date 15.6.2012 15.9.2012 15.12.2012 15.3.2013 Tax Liability as on due date 15% of 37,080 = 45% of 37,080 = 75% of 53,560 = 5,562 16,686 40,170 Amount of Instalment Payable (` ) ` 5,562 = 16,686 5562 = 11,124 = 40,170 5,562- 11,124 = 23,484 100% of 53,560 = 53,560 = 53,560 5,562-11,124-23484 = 13,390 Illustration 3. Find out the amount of advance tax payable by ABC Ltd. on specified dates for the Previous Year 2012-13: Business income
Long Term Capital Gain on 31-7-2012 Bank interest TDS on business income

` 1,75,000 ` 3,50,000 ` 10,000 ` 19,995

Solution: Computation of Total Income of ABC Ltd. for the Previous Year 2012-13
Particulars Amount

Profits and Gains of Business or Profession

Capital gains: Long Term Capital Gains Income from other sources: Bank Interest [Not from saving Account ]

` 1,75,000 3,50,000 10,000

5,35,000

Total Income

DIRECT TAXATION I 20.7

Advance Payment of Tax Computation of tax liability of ABC Ltd. for the previous year 2012-13 Particulars Income
Tax rate Tax on above
Add : Education cess & SHEC

Long Term Capital Gain

Other income

` 3,50,000 20% 70,000 2,100 72,100 72,100

` 1,85,000 30%
55,500

1,665
57,165 19,995 37,170

Tax and cess payable

Less : TDS

Advance tax payable Advance tax to be paid on specified dates Advance tax on LTCG Date 15.06.2012 15.09.2012 15.12.2012 15.03.2013 Total Workings As LTCG occurred on 31.7.12 45% of ` 72,100 30% of ` 72,100 25% of ` 72,100 Amount (a) `

Advance tax on income other than LTCG Workings Amount (b) ` 5,576 11,151 11,151 9,292 37,170 Total (a+b) ` 5,576 43,596 32,781 27,317 1,09,270

Nil 15% of ` 37,170 32,445 30% of ` 37,170 21,630 30% of ` 37,170 18,025 25% of ` 37,170 72,100

Illustration 4. Find out the amount of advance tax payable by Mr. A on specified dates under the Income Tax Act, 1961 for the Previous Year 2012-13: `
Business income Long Term Capital Gain on 31-5-2012 Winning from lotteries on 12-6-2012 Bank interest Other income Investment in PPF

2,75,000 1,60,000 50,000 10,000 5,000 40,000 48,000 25,000

Tax deducted at source :

Case I Case II

Solution: Computation of Total Income of Mr. A for the Previous Year 2012-13: Particulars Profits and Gains of Business or Profession Capital gains : Long Term Capital Gains Details Amount (`) 2,75,000 1,60,000

20.8 I DIRECT TAXATION

Income from Other Sources Winning from lotteries Bank interest Other income Gross Total Income Less : Deduction u/s 80C Deposits in PPF Deduction u/s 80TTA Total Income Computation of Tax liability of Mr. A for the Previous Year 2012-13: Income Long Term Capital Gain (` 1,60,000 @ 20%) Winning from lotteries (` 50,000 @ 30%) Balance Income (` 2,50,000) Tax Add : Education cess & SHEC Less : Tax Deducted at Source Total Tax Payable Advance tax to be paid on specified dates Case I: Since amount of tax payable is less than ` 10000, assessee is not liable to pay advance tax. Case II : Advanc e Tax Payable Due Date Tax Liability (`) 15.6.2012 30% of 28,560 = 8,568 15.9.2012 60% of 28,560 = 17,136 15.12.2012 100% of 28,560 = 28,560 Amount of Instalment (`) 8,568 = 17,136 8,568 = 8,568 = 28,560 8,568 8,568 = 11,424 Case 1 (`) Case 2 (`) 32,000 32,000 15,000 15,000 5,000 5,000 52,000 1,560 53,560 48,000 5,560 52,000 1,560 53,560 25,000 28,560 50,000 10,000 5,000 40,000 10,000 65,000 5,00,000 50,000 4,50,000

DIRECT TAXATION I 20.9

Study Note - 21
COLLECTION AND RECOVERY OF TAX
This Study Note includes 21.1 21.2 21.3 21.4 When Tax Payable and when Demand in Default Penalty Payable when Tax is in Default Certificate to Tax Recovery Officer Recovery of Tax

21.1WHEN TAX PAYABLE AND WHEN DEMAND IN DEFAULT [SECTION 220] Any amount specified as payable in a notice of demand u/s. 156 shall be paid within 30 days of the service of the notice at the place and to the person mentioned in the notice. Where the A.O. has any reason to believe that it will be detrimental to revenue if full period of 30 days is allowed, he may, with the previous approval of the Deputy Commissioner, direct the sum specified in the notice of demand to be paid within such period being a period less than 30 days. Where the amount specified in any notice of demand u/s. 156 is not paid within the period of 30 days, the assessee shall be liable to simple interest @1 % for every month or part of a month comprised in the period commencing from the immediately following the end of the period and ending with the day on which the amount is paid. However, the Chief Commissioner or Commissioner may reduce or waive the amount of interest if he is satisfied that the payment of such amount would cause genuine hardship to the assessee, the default in the payment of the amount on which interest was payable was due to circumstances beyond the control of the assessee and the assessee cooperated in any enquiry relating to the assessment or any proceeding for the recovery of amount due from him. However, the Assessing Officer may, on an application made by the assessee before the due date of payment of tax, extend the time for payment or allow payment by installments, subject to such conditions as he may think fit. If the amount is not paid within the time limit of 30 days or within the extended time limit, the assessee shall be deemed to be in default. Case Law: If tax is refunded pursuant to first appeal, but later restored and paid in second appeal, interest cannot be levied on refund made. Vikrant Tyres Ltd. vs. First ITO 247 ITR 821. 21.2PENALTY PAYABLE WHEN TAX IS IN DEFAULT [SECTION 221] When an assessee is in default, he shall, in addition to the amount of the arrears and the amount of interest payable u/s. 220(2), be liable to pay penalty such amount as the A.O. may direct and in case of continuing default, such further amount as the A.O. may direct, so, however, that the total amount of penalty does not exceed the amount of in arrears.

DIRECT TAXATION I 21.1

Collection and Recovery of Tax 21.3CERTIFICATE TO TAX RECOVERY OFFICER [SECTION 222] In the case of default of an assessee, the Tax Recovery Officer may draw up a statement (called certificate) in the prescribed form specifying the amount of arrears due from the assessee and proceed to recover by one or more of the following modes(i) (ii) attachment and sale of assessees movable property; attachment and sale of assessees immovable property;

(iii) arrest of the assessee and his detention in prison (iv) appointing a receiver for the management of the assessees movable and imovable properties. Case Law: Recovery proceedings can be taken against the legal representatives - First Addl. ITO vs. T.M.K. Abdul Kassim 46 ITR 149 . 21.3.1 Tax Recovery Officer by whom recovery is to be effected. [Section 223] (1) The Tax Recovery Officer competent to take action under section 222 shall be (a) the Tax Recovery Officer within whose jurisdiction the assessee carries on his business or profession or within whose jurisdiction the principal place of his business or profession is situate, or (b) the Tax Recovery Officer within whose jurisdiction the assessee resides or any movable or immovable property of the assessee is situate, the jurisdiction for this purpose being the jurisdiction assigned to the Tax Recovery Officer under the orders or directions issued by the Board, or by the Chief Commissioner or Commissioner who is authorised in this behalf by the Board in pursuance of section 120.

(2) Where an assessee has property within the jurisdiction of more than one Tax Recovery Officer and the Tax Recovery Officer by whom the certificate is drawn up (a) is not able to recover the entire amount by sale of the property, movable or immovable, within his jurisdiction, or (b) is of the opinion that, for the purpose of expediting or securing the recovery of the whole or any part of the amount under this Chapter, it is necessary so to do, he may send the certificate or, where only a part of the amount is to be recovered, a copy of the certificate certified in the prescribed manner and specifying the amount to be recovered to a Tax Recovery Officer within whose jurisdiction the assessee resides or has property and, thereupon, that Tax Recovery Officer shall also proceed to recover the amount under this Chapter as if the certificate or copy thereof had been drawn up by him.

21.3.2 Validity of certificate and cancellation or amendment thereof [Section 224] It shall not be open to the assessee to dispute the correctness of any certificate drawn up by the Tax Recovery Officer on any ground whatsoever, but it shall be lawful for the Tax Recovery Officer to cancel the certificate if, for any reason, he thinks it necessary so to do, or to correct any clerical or arithmetical mistake therein. 21.3.3 Stay of proceedings in pursuance of certificate and amendment or cancellation thereof [Section 225] (1) It shall be lawful for the Tax Recovery Officer to grant time for the payment of any tax and when he does so, he shall stay the proceedings for the recovery of such tax until the expiry of the time so granted.

21.2 I DIRECT TAXATION

(2) Where the order giving rise to a demand of tax for which a certificate has been drawn up is modified in appeal or other proceeding under this Act, and, as a consequence thereof, the demand is reduced but the order is the subject-matter of further proceeding under this Act, the Tax Recovery Officer shall stay the recovery of such part of the amount specified in the certificate as pertains to the said reduction for the period for which the appeal or other proceeding remains pending. (3) Where a certificate has been drawn up and subsequently the amount of the outstanding demand is reduced as a result of an appeal or other proceeding under this Act, the Tax Recovery Officer shall, when the order which was the subject-matter of such appeal or other proceeding has become final and conclusive, amend the certificate, or cancel it, as the case may be. 21.4RECOVER OF TAX 21.4.1 Other modes of recovery [Section 226] If any assessee is in receipt of any income chargeable under the head salaries, the Assessing Officer, Tax Recovery Officer may require any person paying the same to deduct from any payment subsequent to the date of such requisition any arrears of tax due from such assessee, and such person shall comply with any such requisition and shall pay the sum so deducted to the credit of the Central Government or as the Board directs. The Assessing Officer or Tax Recovery Officer may, if authorised by the Chief Commissioner or Commissioner by general or special order, recover any arrears of tax due from an assessee by distrait and sale of his movable property in the manner laid down in the Third Schedule. Case Laws: (i) ITO can simultaneously take action under section 156 and section 226. Third ITO v. M. Damodar Bhat 71 ITR 806.

(ii) A garnishee order could be passed only if income-tax had been assessed and had remained unpaid - All India Reporter Ltd. vs. Ramchandra D. Datar 41 ITR 446. 21.4.2Recovery through State Government [Section 227] If the recovery of tax in any area is entrusted to a State Government under article 258(1) of the Constitution of India, then State Government may direct, with respect to that area or any part thereof, that tax shall be recovered therein with, and as an addition to, any municipal tax or local rate is recovered. 21.4.3 Recovery of tax in pursuance of agreements with foreign countries [Section 228A] (1) Where an agreement is entered into by the Central Government with the Government of any country outside India for recovery of income-tax under this Act and the corresponding law in force in that country and the Government of that country or any authority under that Government which is specified in this behalf in such agreement sends to the Board a certificate for the recovery of any tax due under such corresponding law from a person having any property in India, the Board may forward such certificate to any Tax Recovery Officer within whose jurisdiction such property is situated and thereupon such Tax Recovery Officer shall (a) proceed to recover the amount specified in the certificate in the manner in which he would proceed to recover the amount specified in a certificate drawn up by him under section 222; and (b) remit any sum so recovered by him to the Board after deducting his expenses in connection with the recovery proceedings.

DIRECT TAXATION I 21.3

Collection and Recovery of Tax (2) Where an assessee is in default or is deemed to be in default in making a payment of tax, the Tax Recovery Officer may, if the assessee has property in a country outside India (being a country with which the Central Government has entered into an agreement for the recovery of Incometax under this Act and the corresponding law in force in that country), forward to the Board a certificate drawn up by him under section 222 and the Board may take such action thereon as it may deem appropriate having regard to the terms of the agreement with such country. 21.4.4Recovery of Penalties, Fine, Interest and Other Sums [Section 229] Any sum imposed by way of interest, fine, penalty or any other sum payable under the provisions of this Act, shall be recoverable in the manner provided in this Chapter for the recovery of arrears of tax as stated earlier. 21.4.5 Tax clearance certificate [Section 230] (1) Subject to such exceptions as the Central Government may, by notification in the Official Gazette, specify in this behalf, no person, (a) who is not domiciled in India; (b) who has come to India in connection with business, profession or employment; and (c) who has income derived from any source in India, shall leave the territory of India by land, sea or air unless he furnishes to such authority as may be prescribed (i) an undertaking in the prescribed form from his employer; or (ii) through whom such person is in receipt of the income,

to the effect that tax payable by such person who is not domiciled in India shall be paid by the employer referred to in clause (i) or the person referred to in clause (ii), and the prescribed authority shall, on receipt of the undertaking, immediately give to such person a no objection certificate, for leaving India Provided that nothing contained in sub-section (1) shall apply to a person who is not domiciled in India but visits India as a foreign tourist or for any other purpose not connected with business, profession or employment.

(1A) Subject to such exceptions as the Central Government may, by notification in the Official Gazette, specify in this behalf, every person, who is domiciled in India at the time of his departure from India, shall furnish, in the prescribed form to the Income-Tax Authority or such other authority as may be prescribed (a) the Permanent Account Number allotted to him under section 139A: Provided that in case no such Permanent Account Number has been allotted to him, or his total income is not chargeable to income tax or he is not required to obtain a Permanent Account Number under this Act, such person shall furnish a certificate in the prescribed form;

(b) the purpose of his visit outside India; (c) the estimated period of his stay outside India: Provided that no person (i) who is domiciled in India at the time of his departure; and (ii) in respect of whom circumstances exist which, in the opinion of an Income-tax Authority render it necessary for such person to obtain a certificate under this section,

shall leave the territory of India by land, sea or air unless he obtains a certificate from the Income-

21.4 I DIRECT TAXATION

Tax Authority stating that he has no liabilities under this Act, or the Wealth-tax Act, 1957 (27 of 1957), or the Gift-tax Act, 1958 (18 of 1958), or the Expenditure-tax Act, 1987 (35 of 1987), or that satisfactory arrangements have been made for the payment of all or any of such taxes which are or may become payable by that person. Provided that no Income Tax Authority shall make it necessary for any person who is domiciled in India to obtain a certificate under this section unless he records the reasons therefor and obtains the prior approval of the Chief Commissioner of Income-tax.

(2) If the owner or charterer of any ship or aircraft carrying persons from any place in the territory of India to any place outside India allows any person to whom sub-section (1) or the first proviso to sub-section (1A) applies to travel by such ship or aircraft without first satisfying himself that such person is in possession of a certificate as required by that sub-section, he shall be personally liable to pay the whole or any part of the amount of tax, if any, payable by such person as the Assessing Officer may, having regard to the circumstances of the case, determine. (3) In respect of any sum payable by the owner or charterer of any ship or aircraft under sub-section (2), the owner or charterer, as the case may be, shall be deemed to be an assessee in default for such sum, and such sum shall be recoverable from him in the manner provided in this Chapter as if it were an arrear of tax. (4) The Board may make rules for regulating any matter necessary for, or incidental to, the purpose of carrying out the provisions of this section. ExplanationFor the purposes of this section, the expressions owner and charterer include any representative, agent or employee empowered by the owner or charterer to allow persons to travel by the ship or aircraft.

21.4.6 Recovery by Suit or Under Other Law not Affected [Section 232] The several modes of recovery specified in this Chapter shall not affect in any way(a) any other law for the time being in force relating to the recovery of debts due to Government; or (b) the right of the Government to institute a suit for the recovery of the arrears due from the assessee; and shall be lawful for the Assessing Officer or the Government, as the case may be, to have recourse to any such law or suit, notwithstanding that the tax due is being recovered from the assessee by any mode specified in this Chapter.

DIRECT TAXATION I 21.5

Study Note - 22
DEDUCTION AND COLLECTION OF TAX AT SOURCE
This Study Note includes 22.1 Deduction of Tax at Source 22.2 Tax Collection at Source 22.1 DEDUCTION OF TAX AT SOURCE (TDS) 22.1.1 Liability for TDS Any person responsible for making payment of certain category of incomes is liable to deduct tax at source at an appropriate occasion. The law prescribes time when the TDS is to be made, rate at which it should be made and, when TDS should be paid to the Government and associated administrative responsibilities of payer (tax deductor) and payee (tax deductee) have been prescribed. The following chart states at a glance incomes from which TDS should be made :
Section 192 Nature of Income/ Payment Salary Threshold Limit Maximum amount not liable to tax for employee Person Nature of Rate at which to be Responsible to payee deducted Make TDS Any person Employee average rate of incomebeing an having taxable tax computed on the Employer salary basis of rates inforce for the financial year in which the payment is made, on the estimated salary income of the employee for that financial year Any person Any person Discussed later issuing the security Company Any person other than individual or HUF Any person Any resident in India @10% if PAN is provided @20% if PAN is not provided @10% if PAN is provided @20% if PAN is not provided

193

Interest on securities

194 194A

Dividend Any interest other than interest on securities

10,000, if income from 8% Saving Bonds, 2003 5,000, if interest on debenture Nil Exceeding ` 5,000 in a year or 10,000 in case payer is banking company or cooperative society or deposit with post office

DIRECT TAXATION I 22.1

Deduction and Collection of Tax at Source

Section 194B Nature of Income/ Payment Winnings from lottery or crossword Puz- zle or card game and other game of any sort incl- uding television game Winnings from horse race Any Payment in pursuance of any contract for consideration Threshold Limit ` 10,000 Person Nature of Responsible to payee Make TDS Any person Any person Rate at which to be deducted 30% [Sec. 115BBB]

194BB 194C

` 5,000 If a contract exceeds contract ` 30,000 or total in a year contracts with the same contractor or subcontractor exceed ` 75,000.

Winning from horse race Central or State Government, Local Authority, Central/State or Provincial Corpn., Company Cooperative Society Housing Board, Trustor University,Firm Any person Any person

Any person Any resident contractor or sub-contractor for carrying out any work including supply of labour

30% [Sec. 115BBB] If the receipient is an individual/HUF = 1% If the recipient is any other person = 2% 20%, if PAN is not provided (in the both the cases). If the receipt is a transport operator and he furnishes his PAN to payer, TDS rate = Nil 10% if PAN furnished 20%, if PAN not furnished 20%

194D 194E.

194E.

194EE

194F

Insurance commission Income for (i) participation in any game or sport in India; (ii) by way of remuneration for articles on sports, etc Guaranteed sum in relation to any game or sport played in India. Any sum out of National Savings Scheme u/s 80CCCA Amount on account of re purchase rele vant of units covered u/s. 80CCB

` 20,000 Nil

Any resident person Any nonresident sportsman who is not a citizen of India

Nil

Any person

Any nonresident association or institution. Any person

20%

` 2,500

Any person

20%

Nil

Any person

Any person

20%

22.2 I DIRECT TAXATION

Section 194G

Nature of Income/ Payment Commission, remuneration or prize relating to lottery tickets Commission or Brokerage Rent

Threshold Limit Exceeding ` 1,000

194H

Exceeding ` 5,000 p.a ` 1,80,000 p.a

Person Nature of Responsible to payee Make TDS Any person Any person stocking, pur chasing or selling lottery tickets. Other than Any person individual and HUF Other than individual and HUF Other than individual & HUF Any person Any person

Rate at which to be deducted 10%

10%, if PAN furnished 20%, if PAN not furnished 2% on Machinery or plant equipment 10%, any land or building or furniture or fittings. 10%, if PAN furnished 20%, if PAN not furnished 10%

194-I

194J

94LA

194LB

Fees for ` 30,000 p.a Professional or technical services Immovable ` 2,00,000 p.a Property (other than (w.e.f. 1-7-2012) agricultural land) Acquisition Compensation. Nil Interest payable on Infrastructure debt fund

Any person

Any resident person

Any person

Non-resident/

foreign company

5% + EC + SHEC 2% Surcharge if interest amount Exceeds ` 1 crore

194LC

195

Interest paid Nil or Payable to a non-resident/ Foreign Company Any interest Nil or any sum chargeable as income (other than salary) Income in respect Nil of units referred to in Sec. 115AB purchased in foreign currency or income of long term capital gains from such units.

Specified Company Any person

Non-resident/ 5% +EC+SHEC Foreign 2% Surcharge Company if interest amount Exceeds ` 1 crore Any nonIf the NR is resident of resident a country with which other than India has Double company Tax Avoidance Any foreign Agreement, (DTAA) company beneficial of the rate as per FA or DTAA. Off shore fund 10%

196B

Any person

Notes : 1. 2. Threshold Limit: payments in a year upto this limit are not liable for TDS. If the amount of payment exceeds threshold limit, then provisions of TDS apply. Rate of TDS is prescribed by the Finance Act (FA) that is applicable during the year whe TDS is to

DIRECT TAXATION I 22.3

Deduction and Collection of Tax at Source be made. For example, for the current year from 1st April, 2012 to 31st March, 2013 (2012-13) TDS rates will be available in the Finance Act, 2012. 3. TDS rates specified herein above are rates of income tax. These are required to be increased by surcharge specified in The Finance Act applicable. Education cess and secondary and higher education cess is applicable when salary is paid to a resident or non-resident and when any amount (other than salary) is paid to a non-resident or a foreign company. Individual and HUF : An individual or a Hindu Undivided Family, whose total sales, gross receipts or turnover from the business or profession carried on by him exceed the monetary limits specified under clause (a) or clause (b) of section 44AB during the financial year immediately preceding the financial year in which such income is credited or paid, shall be liable to deduct Income-tax under this section. Payments made by way of fees which are exclusively for personal purposes will not attract provisions of sec. 194J.

4.

22.1.2 Rationalisation of provisions relating to Tax Deduction at Source (TDS) [W.e.f. 1-10 2009] Tax deduction at source is a method of collecting taxes on behalf of the Government at the time of payment or credit. The Income-tax Act casts a legal responsibility on the deductor to deduct tax on the correct amount, at the correct rate and deposit it to the Government account. The TDS rates are specified partly in the Finance Act and partly in the provisions of the Income-tax Act. Dcductors are also required to compute surcharge and cess over and above some of the prescribed rates of TDS. If the deductor fails to deduct the tax or fails to deposit the tax after deduction, interest, penalty and prosecution provisions may get attracted. Further, under the provisions of section 40(a)(;a), if the deductor fails to deduct tax on a prescribed payment or fails to deposit the tax deducted in time, the entire expenditure is disallowed while computing his total income. To assist deductors in complying with their TDS obligations and reduce their compliance burden, it is proposed to rationalise the provisions of TDS as under: (A) Amendment in Section 193: At present, no tax is required to be deducted at source if interest payable to a resident individual on debentures issued by a listed company does not exceed ` 2,500 in a year. This limit is increased to ` 5,000 w.e.f. 1-7-2012. This concession will now apply to debentures issued by unlisted public companies as well as to interest payable to resident HUF. The existing exemption in respect of interest paid on debentures issued by listed companies which are held in Demat Account will continue without any limit. The amendment in this section comes into force on 1-7-2012. (B) Amendment in TDS rates and other provisions of section 194C (i) Rate of TDS under section 194C rationalized [W.e.f. 1-10-2009]: Under the existing provisions of section 194C of the Income-tax Act, TDS at the rate of 2% is deducted on payment for a contract in case of receipient is otherthan Individual/HUF and 1% in case of Individual/HUF. In order to reduce the scope for disputes regarding classification of contract as sub contract, the Act has specified the same rate of TDS for payments to both contractors as well as subcontractors. To rationalise the TDS rates and to remove multiple classifications the Act has provided same rate of TDS in the case of payment for advertising contracts. To avoid hardship to small contractors/sub-contractors most of whom are organized as individuals/HUFs, the Act has prescribed following rates of TDS: (a) 1% where payment for a contract are to individuals/HUF (b) 2% where payment for a contract are to any other person. The nil rate will be applicable if the transporter quotes his PAN. If PAN is not quoted the rate will be 1% for an individual/HUF transporter and 2% for other transporters up to 31.3.2010.

22.4 I DIRECT TAXATION

The rate of TDS will be 20% in all the above cases, if PAN is not quoted by the deductee w.e.f. 1-4-2010. (i) Provisions for payments and tax deducted at source to transports [W.e.f. 1-10-2009] : Under section 194C, tax is required to be deducted on payments to transport contractors engaged in the business of plying, hiring or leasing goods carriages. However if they furnish a statement that they do not own more than two goods carriages, tax is not to be deducted at source. Transport operators report problem in obtaining TDS certificates as these are not issued immediately by clients and they are not able to approach the client again as they may have to move across the country for their business. The Act has inserted sub-section (6) to section 194C and has exempted payments to transport operators (as defined in section 44AE) from the purview of TDS. However, this would only apply in cases where the operator furnishes his Permanent Account Number (PAN) to the deductor. As per section 194(7), the dcductors who make payments to transporters without deducting TDS (as they have quoted PAN) will be required to intimate these PAN details to the Income Tax Department in the prescribed format. (iii) Clarification regarding work under section 194C [W.e.f. 1-10-2009]: There is ongoing litigation as to whether TDS is deductible under section 194C on outsourcing contracts and whether outsourcing constitutes work or not. To bring clarity on this issue, the Act has provided that work shall not include manufacturing or supplying a product according to the requirement or specification of a customer by using raw material purchased from a person other than such customer ns such a contract is a contract for sale. This will however not apply to a contract, which does not entail manufacture or supply of an article or thing (e.g. a construction contract). The Act has included manufacturing or supplying a product according to the requirement or specification of a customer by using material purchased from such customer, within the definition of work. It is further provided in section 194C(3) that in such a case TDS shall be deducted on the invoice value excluding the value of material purchased from such customer if such value is mentioned separately in the invoice. Where the material component has not been separately mentioned in the invoice, TDS shall be deducted on the whole of the invoice value. Further, in a case where the payment is made by an individual or HUF to the contractor exclusively for personal purposes of such individual or member of HUF, there will be no need to deduct tax at source under section 194C.

(C) Rate of TDS reduced in case of section 194-I : Under the existing provisions of section 194-I of the Income-tax Act, TDS on rental payments is prescribed at the rate of (a) 2% for the use of any machinery or plant or equipment, (b) 10% for the use of any land or building or furniture or fittings, if the payee is an individual or HUF, and The Act has rationalised and reduced the TDS rates on rental payments as under: (a) 2% for the use of any machinery or plant or equipment, (b) 10% for the use of any land or building or furniture or fittings for all persons. The rate of TDS will be 20% in all the above cases, if PAN is not quoted by the deductee w.e.f. 1-42010. This section is now amended w.e.f. 1-7-2012. It will now be necessary for a company to deduct tax at source from any remuneration, fees or commission paid or payable to a director, if no tax is deductible u/s.192 under the head salary. The rate for TDS is 10%. It may be noted that the manner in which the section is amended indicates that this deduction is to be made irrespective of the quantum of such payment in the year. As regards professional fees, technical service fees,

(D) Section 194J TDS on fees from professional or technical services:

DIRECT TAXATION I 22.5

Deduction and Collection of Tax at Source royalty, etc. to which this section applies, it is provided that tax is to be deducted only if payment under each head exceeds ` 30,000 in the financial year. Therefore, in case of payment of fees to non-executive directors and independent directors as Directors Fees, the tax at 10% will be deductible even if the total payment in the F.Y. is less than ` 30,000 to each of them. (E) Section 194LC: This is a new section inserted in the Income-tax Act w.e.f. 1-7-2012. It provides for deduction of tax at the concessional rate of 5% plus applicable surcharge and education cess, in respect of interest paid to a non-resident, other than a foreign company. This interest should relate to monies borrowed by an Indian company from the nonresident at any time on or after 1-7-2012 and before 1-7-2015 in foreign currency from a source outside India. This borrowing should be (i) under a loan agreement or (ii) by way of issue of long-term infrastructure bonds approved by the Central Government. Further, the rate of such interest should not exceed the rate approved by the Government for this purpose. Rate of TDS has been reduced by the Finance (No. 2) Act, 2009 from 20% to 10% in case of the following : (i) TDS on interest on unlisted debentures and on any income other than mentioned in Para l(o) of Part II of Schedule I to the Finance (No. 2) Act, 2009 relating to TDS rates in case of a person other than a company who is resident in India has been reduced from 20% to 10%.

(F) Rate of TDS on unlisted debentures or security or on Interest other than securities reduced to 10%.

(ii) Similarly, TDS on interest other than interest on securities and on any income other than mentioned in Para 2(a) of Part II of the Schedule I to the Finance (No. 2) Act, 2009 in case of a domestic company has also been reduced from 20% to 10%. In order to ease the computation of TDS, the Act has removed surcharge and education cess & SHEC on tax deducted on any payment made to resident taxpayers except in case of salary. In case of salary TDS shall be deductible after including education cess and SHEC. This provision shall be effective after the Finance (No. 2) Act becomes the Act. The directors of the assessee company have routed the loan taken in their individual capacity in the name of company. The company was merely acting as the agent of the directors for receiving & disbursing the loans to the directors. It was held that as per the provisions of section 194A, TDS is to be made at the time of credit of such income to the account of the payee. So the company was liable to deduct tax on the interest payment to lenders as there was no resolution passed by the Board of Directors which empowered the company to merely act as a medium for routing the borrowing & repayment - CIT vs. Century Building Industries P. Ltd. 293 ITR 194.

(G) TDS to be deducted at basic rates

Case Law : (i)

(ii) The assessee has entered into an agreement for use of the premise for storage of goods. While making payment the assessee deducted tax at 2% u/s 194C considering that it was a contractual payment. However it was concluded that the payment made by the assessee is in the nature of rent u/s 194I of the Act & TDS should have been made @ 20%. The Apex court held that once tax is paid by the deductee on the income received from the deductor, the deductor cannot be once again called upon to pay the tax on same income. However the assessee is liable to pay interest u/s 201(1A) for delay or non-payment of tax to the Government within prescribed time. Hindustan Coca Cola Beverages P. Ltd. vs. CIT 293 ITR 226 (SC)

22.6 I DIRECT TAXATION

22.1.3 IMPORTANT POINTS 1. Time Schedule Nature of Activity Time of Deduction Time Frame Salary : At the time of payment

Others : When income paid or credited to the account including payable or suspense account whichever is earlier. Time of deposit of tax (a) If credited on the date on which accounts are made, within two (Other than on behalf of months from the end of the month in which income is credited. Government) (b) Any other case, within one week from the end of the month in which deduction is made. Statement For each Quarter TDS Type Form For all category due date of submission of quarterly returns Salary No 24Q Q1 : April June 15th July Non Resident No 27Q Q2 : July September 15th October All Others No 26Q Q3 : October December 15th January Q4 : January - March - 15th May Electronic For every office of Government and the principal officer in the case of every company, firm, whose total sales, gross receipts or turnover from the business or profession carried on by it exceed the monetary limits specified under clause (a) or clause (b) of section 44AB during the financial year immediately preceding the financial year in which such income is credited or paid. 1. 2. Copies of Form Nos. 15G and 15H received by the payer have to be filed with the Chief Commissioner Commissioner within 7 days of the succeeding month. If the person responsible for deducting and paying tax fails to do so, he shall be considered as an assessee in default, liable to pay interest @ 12% p.a. on the amount of such tax from the date on which such tax was deductible to the date of actual payment, and penalty, not exceeding the amount of tax and rigorous imprisonment ranging from 3 months to 7 years and fine. The interest payment needs to be paid before filing of Quarterly Return. Sec. 199 Credit for tax deducted : a. b. c. Credit will be given for the Assessment Year in which such income is assessble. Where such income is assessable in the hands of any other person, credit shall be given to such other person. When any security, property etc. is jointly owned by two or more persons not constituting partnership, credit for TDS on income there from shall be given to such persons in the proportion in which the income is distributed.

3.

4. 5. 6.

A payee from whose income TDS is made must intimate his PAN to tax deductor. Tax deductor must to quote PAN of payees in TDS Certificate and TDS return [Sec. 139A]. TAN/TDCAN to be quoted on all quarterly statements of TDS/ TCS section 203A(ba). A declaration for non-deduction of tax u/s. 197A can be furnished by the assessee only if his aggregate income is less than threshold limit. Senior Citizens can file declaration if tax on their estimated total income is likely to be NIL. Disallowance due to non-deduction: If tax deductible u/ss. 193, 194A, 194C, 194H, 194J and 195 is not deducted/paid before applicable

7.

DIRECT TAXATION I 22.7

Deduction and Collection of Tax at Source due dates, the relevant expenditure otherwise allowable in computing Total Income of the payer would be liable for disallowance u/s 40(a)(i)/(ia). The deduction will be allowed in the year in which TDS is paid. For details see section 40(a). 8. Salary TDS: TDS by Employer : In respect of any perquisite which is not provided for by way of monetary payment, the Employer, at his option, may pay tax on the whole or part of such income without making any deduction there from, For the purpose of paying tax as aforesaid, tax shall be determined at the average of income-tax computed on the basis of the rates in force for the financial year, on the income chargeable under the head Salaries. Simultaneous employment / Successive employment : the employee may furnish to one of the many or successive employers such details of the income under the head Salaries due or received by him from the other employer or employers, the tax deducted at source there from and such other particulars and thereupon such employer shall take into account the details so furnished for the purposes of making the TDS. Relief Under Section 89(1) : Government servant or an employee in a company, co-operative society, local authority, university, institution, association or body is entitled to the relief under section 89(1), he may furnish to the employer, such particulars and thereupon the said Employer shall compute the relief and take it into account in making the TDS. Other Income: Employee has any income chargeable under any other head of income for the same financial year, not being a loss under any such head other than the loss under the head Income from House Property, he may send to the Employer the particulars of (a) such other income and of any tax deducted thereon under any other provision of this Chapter; (b) the loss, if any, under the head Income from House Property, and thereupon the Employer shall take (i) such other income and tax, if any, deducted thereon; and (ii) the loss, if any, under the head Income from House Property, also into account for the purposes of making the TDS.

9.

After considering such other information there should be no reduction in TDS from Salary, except reduction on account of loss from House Property head. PF, Superannuation Trusts : The trustees the fund at the time an accumulated balance due to an employee is paid, make there from the deduction provided in rules. Salary payable in foreign currency: Value in rupees of such salary shall be calculated at the prescribed rate of exchange. Income payable net of tax: In a case where, the tax chargeable on any income referred subject to TDS, the amount of TDS is to be borne by the person by whom the income is payable, then, for the purposes of deduction of tax under those provisions such income shall be increased to such amount as would, after deduction of tax thereon at the rates in force for the financial year in which such income is payable, be equal to the net amount payable under such agreement or arrangement. [Sec. 195A] To obtain Tax Dedcution and Collection Account Number (TAN) by applyinf in Form No. 49B [sec. 203A and Rule 114A]

22.1.4 Procedure for TDS (i)

(ii) To deduct tax at source as per provisions. TDS should be at an appropriate time and at appropriate rate.

22.8 I DIRECT TAXATION

(iii) To deposit tax in the Government treasury within the time in proper challan. (iv) To submit quarterly TDS statements. 22..1.5 Consequence of non compliance of TDS provisions : Sr. Section No. or Chapter 1 197A 2 3 4 5 Default Section 272A(2)(j) 271C(1)(a) 201(1A) 272A(2)(k) 272BB Consequence Effect ` 100 per day / Max. Tax Amount on Decleration Penalty of a sum equal to the amount of TDS not so deducted. Interest @ 1% p.m ` 100 per day / Max. Tax Amount of TDS in of Quarterly TDS Statement Penalty ` 10,000

Delay, no submission of no TDS declarations Chapter Fails to deduct the whole or any XVII - B part of TDS 200 Delay in payment of TDS 200 Delay, no submission of Quarterly TDS Statement 203A Default in the matter of TAN

22.1.6 Improving compliance with provisions of quoting PAN through the TDS regime [Section 206AAJ] [W.e.f. 1-4 2010] In order to strengthen the PAN mechanism, the Act has made amendments in the Income Tax Act to provide that any person whose receipts are subject to deduction of tax at source i.e. the deductee, shall mandatory furnish his PAN to the deductor failing which the deductor shall deduct tax at source at higher of the following rates: (i) The rate prescribed in the Act; (ii) At the rate in force i.e., the rate mentioned in the Finance Act; or (iii) At the rate of 20%. TDS would be deductible at the above-mentioned rates even in a case where the taxpayer files a declaration in form 15G or I5H (under section 197A) but does not provide his PAN. Further, no certificate under section 197 will be granted by the Assessing Officer unless the application contains the PAN of the applicant. These provisions will also apply to non residents where TDS in deductable on payments or credits made to them. To ensure that the deductor knows about the correct PAN of the deductee it is also provided for mandatory quoting of PAN of the deductee by both the deductor and the deductee in all correspondence, bills and vouchers exchanged between them. 22.1.7 Processing of statements of Tax Deducted at Source (Section 200A inserted w.e.f. 1-4-2010) Currently almost all statements of tax deducted at source are filed in an electronic mode. The processing of these statements should, therefore, be done only in a computerized environment. New section 200A has been inserted provide for processing of statements of tax deducted at source on computer so that liabilities on account of interest and other defaults in TDS payment are promptly calculated and intimated to the deductor. In order to process TDS statements on computer, the Act has provided for electronic processing on the same lines as processing of Income-tax returns. Further, the following adjustments can be made during the computerized processing of statements of tax deducted at source : (i) Any arithmetical error in the statement; or (ii) An incorrect claim, if such incorrect claim is apparent from any information in the statement, for example, in respect of rate of deduction of tax at source where such rate is not in accordance with the provisions of the Act.

DIRECT TAXATION I 22.9

Deduction and Collection of Tax at Source The Act has provided that after making adjustments, tax and interest [e.g. under section 201(1A)] would be calculated and sum payable by the deductor or refund due to the deductor will be determined. An intimation will be sent to the deductor informing him of his tax liability or granting him the refund due within one year from the end of the financial year in which the statement is filed. The Act has also provided that the processing of these statements can be undertaken in a centralized processing centre. 22.1.8 Providing time limits for passing of orders under section 201(1) holding a person to be an assessee in default Currently, the Income Tax Act does not provide for any limitation of time for passing an order under section 201(1) holding a person to be an assessee in default. In the absence of such a time limit, disputes arise when these proceedings are taken up or completed after substantial time has elapsed. In order to bring certainty on this issue, the Act has inserted sub-section (3) to section 201 to provide for express time limits in the Act within which specified order under section 201(1) will be passed. An order under section 201(1) passed on or after 1-4-2010, for failure to deduct the whole or any part of the tax as required under this Act, if the deductee is a resident taxpayer shall be passed within two years from the end of the financial year in which the statement of tax deduction at source is filed by the deduetor. Where no such statement is filed, such order can be passed up till four years from the end of the financial year in which the payment is made or credit is given. Further, Explanation to section 153 regarding exclusion of certain period (like injunction by Court) to calculate time limit shall also be applicable while determining the above time limit. Similarly like section 153(3) there will be no time limit in consequence of or to give effect to any finding or direction contained in an order under section 250, 254, 260A, 262, 263 or 264 or order of a Court. To provide sufficient time for pending cases, the Act has provided that such proceedings for a financial year beginning from 1-4-2007 and earlier years can be completed by the 31-3-2011. However, no time-limits have been prescribed for order under section 201(1) where (a) The deductor has deducted but not deposited the tax deducted at source, as this would be a case of defalcation of Government dues, (b) The employer has failed to pay the tax wholly or partly, under section 192(1A), as the employee would not have paid tax on such perquisites (c) The deductee is a non-resident as it may not be administratively possible to recover the tax from the non-resident. These amendments shall be effective from 1-4-2010. Accordingly it will apply to such orders passed on or after the 1-4-2010. 22.2 TAX COLLECTION AT SOURCE [SECTION. 206C] Every seller at the time of debiting the buyer with the amount payable or receiving payments from buyers engaged in business of alcoholic liquor, forest produce, scrap, timber, tendu leaves, etc. shall collect tax at the following rates: Sr.No 1 2 3 Nature of goods Alcoholic liquor for human consumption (other than Indian made foreign liquor) Tendu leaves Timber obtained under a forest lease TCS Rate 1% 5% 2.5%

22.10 I DIRECT TAXATION

Sr.No 4 5 6 7 8

Nature of goods Timber obtained by any mode other than under a forest lease Any other forest produce not being timber or tendu leaves Scrap Indian made foreign liquor Minerals being coal or liquor or iron ore

TCS Rate 2.5% 2.5% 1% 1% 1%

Every person, who grants a lease or a license or enters into a contract, etc for the purpose mentioned below shall collect tax at the following rates: TABLE Sl. No. (i) (ii) (iii) Nature of contract or licence or lease, etc. Parking lot Toll plaza Mining and quarrying TCS Rate 2% 2% 2%

The amount of tax so collected shall be paid, within one week seven from end of the month of tax collection. Delay or failure attracts interest @ 1% p.m. [sec. 206C(7) & (8)] Detail Provisions of section 206C This section provides for collection of tax at source from sale of alcoholic liquor, tendu leaves, timber, forest products, scrap, etc. at the rates ranging from 1% to 5% of the sale price. The scope of this provision for TCS is extended w.e.f. 1-7-2012 as under. (i) In respect of sale of minerals, being coal or lignite or iron ore, tax is to be collected by the seller at the rate of 1% of the sale price.

(ii) However, such tax is not to be collected if the purchase of such goods listed in section 206C(i) is made by the buyer for the purpose of manufacturing, processing or producing articles or things or for the purposes of generation of power. For this purpose the buyer of such goods has to give a declaration in Form No. 37C. (iii) In order to reduce the quantum of cash transactions in bullion or jewellery sector and for curbing the flow of unaccounted money in the trading system, it is now provided that the seller of bullion or jewellery shall collect from the buyer tax at the rate of 1% of the sale consideration. For this purpose it is provided that the collection of the above tax of 1% shall be made if the sale price in cash exceeds the following amounts: (a) For bullion, if the sale price exceeds Rs.2 lac. It may be noted that for this purpose definition of Bullion does not include coin or any other article weighing ten grams or less. (b) For jewellery, if the sale price exceeds Rs.5 lac. It may be noted that this tax will be collected from the buyer even if the buyer has purchased bullion or jewellery for personal use or for manufacture or processing the same for his business. Further, it appears that persons who purchase bullion or jewellery for personal use will not be able to get credit for the tax collected at source because there will be no corresponding income from sale of bullion or jewellery in respect of which such credit for tax can be claimed. Further, the person making such payment for purchase of bullion or jewellery in cash will have to prove the source from which such cash is paid.

(iv) There are certain consequential amendments made in section 206C on the same lines as in section 201. According to these amendments, if the seller, who is required to collect tax under this section fails to do so, he will not be deemed to be in default if he can establish that the buyer has filed his return u/s.139 and paid tax on his income after considering the goods purchased by him. Consequential provision for reduction in the period for which interest is payable u/s.206C is also made.

DIRECT TAXATION I 22.11

Deduction and Collection of Tax at Source 22.2.1 Responsibility & Liability of the Tax Collector 1. 2. 3. 4. 5. To obtain Tax Collection Account No. [Section 206CA(1)] To quote TCS No. in all returns, certificates and challans. [Section 206CA(2)] To furnish quarterly return in Form No. 27EQ within stipulated time i.e. within fifteen days from the end of a quarter for the first three quarters and by 30th April for the last quarter. Failure to furnish TCS return: Penalty @ 100/- per day, during which the default continues, but not exceeding the amount of TCS. [Section 272A(2)(g)] Failure to deposit TCS in Government treasury, rigorous imprisonment for a term of not less than 3 months, but which may extend to 7 years, in addition to fine [Sections 276B & 276BB]

Thus, administrative provisions are similar to TDS administration. 22.2.2 Filing of TDS and TCS statements (W.e.f. 1-10-2009) Section 200(3) of Income-tax Act provides that any person deducting tax in accordance with the provisions of Chapter XVII B has to furnish, within the prescribed time, quarterly statements for the period ending on the 30th June, 30th September, 31st December and 31st March in each financial year. Similarly, filing of quarterly returns for Tax Collection at Source (TCS) have been provided in sub-section (3) of section 206C of the Act. Further section 206A provides furnishing of quarterly return in respect of payment of interest to residents without deduction of tax. In order to provide administrative flexibility in deciding the periodicity of such TDS related statements, the Act has modified the existing provisions so as to allow the Government to prescribe periodicity of such TDS statements besides prescribing their form and manner. Further, section 272A(2) relating to non-filing of quarterly statement of TDS/TCS has been amended in order to delete the word quarterly given for such statements.

22.12 I DIRECT TAXATION

Study Note - 23
PENALTY & PROSECUTION
This Study Note includes 23.1 Penalties and Prosecution for defaults 23.1 PENALTIES AND PROSECUTION FOR DEFAULTS Section 158BFA 221(1) 271(1)(b) 271(1)(c) 271A 271AA Minimum Penalty 100% of the tax on undisclosed income Such amount as the Assessing Officer may impose Failure to comply with a notice u/s. ` 10,000 for each failure 142(1) or 143(2) or with a direction issued u/s 142(2A). Concealment of the particulars of 100% of Tax sought to income or furnishing inaccurate be evaded. particulars of income. Failure to keep or maintain books of ` 25,000 A/c, document as required u/s.44AA. Failure to keep and maintain A sum equal to two information and document in respect per cent of the value of international transaction. of each international transaction entered into by such person. Penalty where search has been A sum computed at the initiated rate of ten per cent of the undisclosed income of the specified Previous Year. Failure to get accounts audited u/s.44AB or to furnish such report along with return of income by due date Failure to submit report U/S 92E Failure to deduct the whole or any part of tax u/s.192 to 195 or (w.e.f. 1.6.97) failure to pay the whole or any part of tax u/s.115 O(2) or 2nd proviso to sec. 194B. 1/2% of Total Sales, Turnover or Gross receipts. ` 1,00,000 Amount of Tax required to be deducted at source. Nature of Default Undisclosed income determined by the Assessing Officer u/s.158BC(c) Default in making a payment of tax within prescribed time Maximum Penalty 300% of the tax on undisclosed income Amount of Tax in arrears ` 10,000 for each failure. 300% of Tax sought to be evaded. ` 25,000 A sum equal to two per cent of the value of each international transaction entered into by such person. A sum computed at the rate of ten per cent of the undisclosed income of the specified Previous Year. ` 1,50,000

271AAA

271B

271BA 271C

` 1,00,000 Amount of Tax required to be deducted at source.

DIRECT TAXATION I 23.1

Penalty & Prosecution Section 271CA 271D 271E 271F Nature of Default Minimum Penalty Penalty for failure to collect tax at A sum equal to the source amount of tax failed to collect Taking or accepting any loan or Amount of Loan/ deposit in contravention of the Deposit so taken or provisions of Section 269SS accepted Repaying of any deposit otherwise Amount of deposit so than in accordance with the repaid. provisions of Sec. 269 T (i)Failure to furnish return of income ` 5000 u/s.139(1) before the end of the relevant Assessment Year (w.e.f. 1.4.99) (ii)Failure to furnish return of income as per proviso to Sec.139(1) by the end of relevant Assessment Year . Failure to furnish annual information return within the prescribed time under section 285BA(1) Penalty for failure to furnish return of fringe benefits ` 5000 Maximum Penalty A sum equal to the amount of tax failed to collect Amount of Loan/ Deposit so taken or accepted Amount of deposit so repaid. ` 5000

` 5000 ` 100 for every day during the failure continue a sum of one hundred rupees for every day during which the failure continues. 2% of value of the international transaction for each failure ` 1,00,000 ` 10,000 for each default ` 10,000 for each default ` 10,000 for each default ` 100 for every day during the failure continues

271FA 271FB

271G

` 100 for every day during the failure continue a sum of one hundred rupees for every day during which the failure [Fringe Benefit Tax is not applicable continues. from A.Y. 2010-11 onwards] Failure to furnish information or 2% of value of the documents under section 92D(3) international transaction for each failure ` 10,000 ` 10,000 for each default ` 10,000 for each default ` 10,000 for each default

Failure to submit in quarterly TDS/ TCS returns 272A(1)(a) Refuses to answer any question put to a person regarding his assessment by an I.T. Authority. 272A(1)(b) Refuses to sign any statement made by a person in course of I.T. Proceeding. Failure to comply with summons 272A(1) (c) issued u/s.131(1) 272A(2)

271H

Failure to comply with a notice u/s ` 100 for every day 94, 176(3), 133, 206, 206C, 285B, 134 during the failure to furnish return of Income u/s 139(4A) continues or 139(4C) or to delivery in due time a declaration mentioned in section 197A or 206C(1A), to furnished certificate u/s 203 or 206C

23.2 I DIRECT TAXATION

Section 272AA

Nature of Default Minimum Penalty Failure to comply with provisions of Any amount upto ` 1,000 Sec. 133B. Failure to comply with the provisions of section 139A or for quoting or intimating a PAN which is false. [w.e.f. 1.6.2002] Failure to comply with the provisions of of sec. 203A Failure to comply with the provisions of section 203A (i.e. failure to obtain TAN or after obtaining failure to quote TAN in all challans, certificates and returns etc.) Failure to comply before 1.10.2004 with the provisions of section 206CA relating to obtaining & quoting TCAN. ` 10,000

Maximum Penalty ` 1,000

272B

` 10,000

272BB(1) 272BB

Up to ` 10,000 ` 10,000

` 10,000 ` 10,000

272BBB

` 10,000

` 10,000

275A 275B 276 276A

276B

276BB 276C(1)

276C(2)

Rigorous imprisonment Minimum Period Maximum Period Dealing with seized assets in Any period up to 2 2 years and fine contravention of the order made by years and fine the officer conducting search Failure to comply with the provision of Any period up to 2 2 years and fine section 132(1)(iib) years and fine Removal, concealment, transfer or Any period up to 2 2 years and fine delivery of property to tax recovery years and fine Failure to comply with the provisions Any period up to 2 2 years of section 178(1) & (3) by liquidator of years but not less than a company 6 months in absence of special and adequate reasons Failure to pay tax to the Governments 3 months and fine 7 years and fine treasury or failure to pay to the Government tax payable by him as required by section 115-O(2) or second proviso to section 194B Failure to pay to the credit of Central 3 months and fine 7 years and fine Government tax collected u/s. 206C Wilful attempt to evade tax penalty If tax evaded exceeds If tax evaded exceeds ` 1,00,000, or interest imposable under the ` 1,00,000, then for 6 Act (non-cognizable as per sec. months & fine; otherwise 7 years & fine; otherwise 279A) 3 months and fine. 3 years and fine. Wilful attempt to evade the payment 3 months and fine 3 years and fine of any tax, penalty or interest (noncognizable as per sec. 279A).

DIRECT TAXATION I 23.3

Penalty & Prosecution Section 276CC Nature of Default Wilful failure to file return of income in time u/s. 139(1), or in response to notice u/s. 142(1) or sec. 148(Noncognizable as per Sec. 279A) Minimum Penalty If tax evaded exceeds ` 1,00,000 & 6 months and fine In any other case, 3 months and fine. Note: No prosecution if : (i) the return is filed before the expiry of the Assessment Year; or (ii) the tax payable on regular assessment, as reduced by TDS and advance tax does not exceed ` 3,000 Wilful failure to furnish in due time 3 months and fine the return of total income which is required to be furnished u/s. 158BC. Wilful failure to produce books of Any period upto 1 year account and documents u/s. 142(1) and/or fine of ` 4 for or wilful failure to comply with a every day during which direction to get the accounts audited default continues. u/s. 142(2A) Making a false statement in verification or delivering a false account or statement(non-cognizable as per Sec.279A) Abetment to make a false statement or declaration. (non- cognizable as per, Sec. 279A) Maximum Penalty If tax evaded exceeds ` 1,00,000, 7 years & fine; otherwise 3 years and fine

276CCC 276D

3 months and fine

277

278

Punishment for second and subsequent offences u/ss. 276B, 276C(1), 276CC, 277 or 278. 278B and Offences committed by companies/ 278C firms or HUFs- Criminal liability of managing director managing partner, karta or any such officer, who wilfully committed the offence for the company/firm or HUF. 280(1) Disclosure of particulars by public servants in contravention of Sec. 138(2) (prosecution to be instituted with the approval of Central Government )

278A

1 year and/or fine of ` 10 every day during which default continues. If tax evaded exceeds If tax evaded ` 1,00,000; 6 months & exceeds ` 1,00,000, fine; otherwise 3 months 7 years & fine; otherwise and fine. 3 years and fine. If tax evaded exceeds If tax evaded ` 1,00,000; 6 months; exceeds ` 1,00,000, otherwise 3 months and 7 years; otherwise 3 fine. years and fine. 6 months for every 7 years for every offence offence & fine Same as in the case of the company/firm/ HUF 6 months and fine

Same as in the case of the company/firm/ HUF Up to 6 months (and fine)

Up to 6 months and fine. 6 months and fine.

23.4 I DIRECT TAXATION

If there is a reasonable cause, it can be offered as a defense against penalty, prosecution, etc. Reasonable cause can be reasonably said to be a cause which prevents a man of average intelligence and ordinary prudence, acting under normal circumstances, without negligence or inaction or want of bona fides - Azadi Bachao Andolan vs. Union of India 252 ITR 471 (Delhi). Reasonable cause as applied to human action is that which would constrain a person of average intelligence and ordinary prudence. It means an honest belief founded upon reasonable grounds, of the existence of a state of circumstances, which, assuming them to be true, would reasonably lead any ordinary prudent and cautious man, placed in the position of the person concerned, to come to the conclusion that the same was the right thing to do - Woodward Governors India (P.) Ltd. vs. CIT 118 Taxman 433 (Delhi). The words reasonable cause in the section must necessarily have a relation to the failure on the part of the assessee to comply with the requirement of the law which he had failed to comply with. Kalakrithi vs. ITO 125 Taxman 97 (Mad.). Liability of directors of private company in liquidation. Under certain circumstances directors of private company in liquidation are liable to tax liability of the company. Care should be taken to ensure that directors are not exposed to this risk. Section 179 provides that where any tax due from a private company in respect of any income of any Previous Year or from any public company of any Previous Year during which such other company was a private company cannot be recovered, then, every person who was a director of the private company at any time during the relevant Previous Year shall be jointly and severally liable for the payment of such tax. No recovery can be made from a director if the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company. Section 179 operates without regard to any contrary provision about limited liability, etc. contained in the Companies Act, 1956.

DIRECT TAXATION I 23.5

Study Note - 24
REFUND
This Study Note includes 24.1 Refund 24.2 Interest on Refund 24.3 Setoff of Refunds again the remaining payable 24.1 REFUND 24.1.21 When Right to Claim Refund Arises [Section 237] Where any person satisfies the Assessing Officer that the amount of tax paid by him or on his behalf for any Assessment Year exceeds the amount with which he is properly chargeable under this Act for that year, he is entitled to the refund of the excess amount paid. Case Law : The tax paid by the assessee must be accepted as it is, and in the event of the tax paid being in excess of the tax liability duly computed on the basis of return furnished and the rates applicable, the excess shall be refunded to the assessee, since its retention may offend article 265 of the Constitution - CIT v. Shelly Products 261 ITR 367. 24.1.2 Who Can Claim Refund? [Section 238] Usually refund can be claimed by a person who has made excess payment of tax. If income of a person is included in the total income of another person u/s. 60 to 64, the refund can be claimed by the latter and not by the former. Where a person cannot claim any refund because of his death, incapacity, insolvency, liquidation or other cause, his legal representatives or the trustee or guardian or receiver, as the case may be, will be entitled to claim and receive such refund for the benefit of such person or his estate. 24.1.3 How to Claim Refund? [Section 239] Refund claim should be made in Form No. 30 and verified in the prescribed manner. In the following cases, where an otherwise valid refund claim u/s. 237 is filed by an assessee after the expiry of the time limit, the Assessing Officer, may admit the refund claim if the following conditions are satisfied(i) It has been decided that cases where delayed claims of refund are being considered would be taken up for scrutiny.

(ii) The refund has arisen as a result of excess tax deducted/collected at source and payment of advance tax and the amount of refund does not exceed ` 50,00,000 for one Assessment Year. (iii) The income of the assessee is not assessable in the hands of any other person under any of the provisions of the Act. (iv) No interest will be admissible on the belated refund claims. (v) No claims under this provision will be entertained where a period of more than 6 Assessment Years has elapsed.

DIRECT TAXATION I 24.1

Refund Board have also decided that in such cases : In case of refund does not exceed ` 10,00,000 for any Assessment Year, the Assessing officer shall obtain the prior approval of the Commissioner of Income-tax before entertaining a belated refund claim, (i) In case of refund exceeds ` 10,00,000 but does not exceeds ` 50,00,000 for any Assessment Year, the Assessing Officer shall obtain the prior approval of Chief Commissioner of Income Tax or Director General of Income Tax before entertaining a belated refund claim, and

(ii) Where the refund exceeds ` 50,00,000, approval of the Board is required. Case Law : Board is competent to admit an application for refund even after expiry of period prescribed under section 239, for avoiding genuine hardship in any case or class of cases. Union of India vs. Azadi Bachao Andolan 263 ITR706. 24.1.4 Refund on Appeal [Section 240] Assessee is entitled to interest if the interest is paid u/s 220(2) subsequently becomes refundable: Interest u/s 244A is payable in respect of the amount of interest earlier paid by the assessee u/s 220(2) but later determined as refundable. Modipon Ltd. vs. CIT 270 ITR 257. Case Laws : (i) Revenue is liable to pay interest on the amount of interest which it should have paid to the assessee but has unjustifiably failed to do - CIT vs. Narendra Doshi 254 ITR 606/122 Taxman 717. (ii) Interest on delayment payment of interest: The Department is liable to pay interest on interest under sections 214 and 244(1A) if payment of interest is delayed - MC, Nally Bharat Engg. Co. Ltd. vs. CIT Tax L.R. 638 (iii) Calculation of interest Interest cannot be granted till date of dispatch of refund order but it has to be granted till date when order regarding payment of interest has been signed - Rajasthan State Electricity Board vs. CIT 281 ITR274 (iv) Where return is filled belatedly: Where delay in completion of assessment which led to refund was on account of delay in filing returns by assessee, assessee was not entitled to interest for period of said delay in terms of section 244A(2) - M. Ahammadkutty Haji vs. Chief CIT 155 Taxman 315 21.1.5 Correctness of assessment not to be questioned [Section 242] In a claim under this Chapter, it shall not be open to the assessee to question the correctness of any assessment or other matter decided which has become final and conclusive or ask for a review of the same, and the assessee shall not be entitled to any relief on such claim except refund of tax wrongly paid or paid in excess. 24.2 INTEREST ON REFUND 24.2.1 Interest on Delayed Refunds [Section 243] (1) If the Assessing Officer does not grant the refund, (a) in any case where the total income of the assessee does not consist solely of income from interest on securities or dividends, within three months from the end of the month in which the total income is determined under this Act, and b) in any other case, within three months from the end of the month in which the claim for refund is made under this Chapter, the Central Government shall pay the assessee simple interest at fifteen per cent per annum on the amount directed to be refunded from the date immediately following the expiry of the period of three months aforesaid to the date of the order granting the refund.

24.2 I DIRECT TAXATION

Explanation If the delay in granting the refund within the period of three months aforesaid is attributable to the assessee, whether wholly or in part, the period of the delay attributable to him shall be excluded from the period for which interest is payable.

(2) Where any question arises as to the period to be excluded for the purposes of calculation of interest under the provisions of this section, such question shall be determined by the Chief Commissioner or Commissioner whose decision shall be final. (3) The provisions of this section shall not apply in respect of any assessment for the Assessment Year commencing on the 1st day of April, 1989 or any subsequent Assessment Years. 24.2.2 Interest on refund where no claim is needed [Section 244] (1) Where a refund is due to the assessee in pursuance of an order referred to in Section 240 and the Assessing Officer does not grant the refund within a period of three months from the end of the month in which such order is passed, the Central Government shall pay to the assessee simple interest at fifteen per cent per annum on the amount of refund due from the date immediately following the expiry of the period of three months aforesaid to the date on which the refund is granted. (1A) Where the whole or any part of the refund referred to in sub-section (1) is due to the assessee, as a result of any amount having been paid by him after the 31st day of March, 1975, in pursuance of any order of assessment or penalty and such amount or any part thereof having been found in appeal or other proceeding under this Act to be in excess of the amount which such assessee is liable to pay as tax or penalty, as the case may be, under this Act, the Central Government shall pay to such assessee simple interest at the rate specified in sub-section (1) on the amount so found to be in excess from the date on which such amount was paid to the date on which the refund is granted. Provided that where the amount so found to be in excess was paid in instalments, such interest shall be payable on the amount of each such instalment or any part of such instalment, which was in excess, from the date on which such instalment was paid to the date on which the refund is granted. Provided further that no interest under this sub-section shall be payable for a period of one month from the date of the passing of the order in appeal or other proceeding. Provided also that where any interest is payable to an assessee under this sub-section, no interest under sub-section (1) shall be payable to him in respect of the amount so found to be in excess.

(2) Where a refund is withheld under the provisions of Section 241, the Central Government shall pay interest at the aforesaid rate on the amount of refund ultimately determined to be due as a result of the appeal or further proceeding for the period commencing after the expiry of three months from the end of the month in which the order referred to in Section 241 is passed to the date the refund is granted. (3) The provisions of this section shall not apply in respect of any Assessment for the Assessment Year commencing on the 1st day of April, 1989, or any subsequent Assessment Years. 24.2.3 Interest on Refund [Section 244A] Interest on Refund of Income Tax: Where refund of any amount becomes due to the assessee under the Income Tax Act, he shall be entitled to receive, in addition to the said amount, simple interest on the refund calculated in the following manner: (a) Where the refund is out of any tax deducted at source/ tax collected at source or advance tax paid or treated as paid u/s 199 during the financial year, interest will be paid at the rate of %, per month or part of a month from the period starting from 1st day of April of the Assessment Year to the date on which refund is granted.

DIRECT TAXATION I 24.3

Refund However, no interest shall be payable if the amount of refund is less than 10% of the tax determined u/s 143(1) or on regular assessement.

(b) In other cases, interest shall be paid @ % per month for every month or part of month for the period commencing from the date of payment of tax or penalty to the date on which refund is granted. Judicial Decisions (i) Section 244(1) nowhere speaks of interest. Provisions of section 240 & 244 reveal liability to pay interest on delayed payment of refund amount but do not provide for payment of any interest on interest even though there is delay in payment of such interest to assessee- Sandvik Asia Ltd. vs. CIT 280 ITR 643 (SC)

(ii) As the assessee has not received the refund of the excess advance tax, he preferred a writ petition before the Delhi High Court. When the writ petition was pending, the Department granted refund of advance tax along with interest thereon. The petitioner claimed interest on delayed payment of interest. The Delhi High Court held that the petitioner is entitled to interest on delayed payment of interest & accordingly directed the revenue to pay interest on interest- R.K. Jain & Sons vs. CIT193 CTR 659. (iii) Assessee is entitled to interest if the interest is paid u/s 220(2) subsequently becomes refundable: Interest u/s 244A is payable in respect of the amount of interest earlier paid by the assessee u/s 220(2) but later determined as refundable- Modipon Ltd. vs. CIT 270 ITR 257. 24.3 SET OFF OF REFUNDS AGAINST THE REMAINING PAYABLE [SECTION 245] Where a refund is found to be due to any person, the tax authorities may, in lieu of payment of the refunds, set off the amount of refund against the sum payable under the Income-tax Act. Case Law : Prior intimation to assessee whether mandatory: While making set off of refunds against tax remaining payable, intimation is certainly not a jurisdictional requirement and absence thereof is merely an irregularity and, therefore, want of intimation would not vitiate the adjustment - Brij Bhushan Lal & Sons vs. Designated Authority 246 ITR 353. Refund due to assessee cannot be adjusted against demand raised, against a third party Archana Shukla vs. Joint CIT 244 ITR 829. Where refund arises as a result of any order passed in appeal or other proceedings under the Act, no formal application from the assessee is required. The Assessing Officer has to grant refund suo moto.

24.4 I DIRECT TAXATION

Study Note - 25
SETTLEMENT OF CASES
This Study Note includes 25.1 Settlement of Cases [Section 245A to 245L] 25.2 Advance Ruling 25.1 SETTLEMENT OF CASES [SECTION 245A TO 245L] 25.1.1 Meaning of Case [Section 245 A (b)] An assessee can make an application to the Settlement Commission at any stage of a Case relating to him. The Finance Act, 2007 substitute clause (b) of section 245A which has changed the meaning of the term case and reduce the scope of settlement of cases. When proceeding is taken as pending proceeding: In search case, a proceeding for assessment or reassessment for six (6) Assessment Years shall be deemed to have been commenced on the date of issue of notice initiating such proceedings and concluded on the date on which assessment is made, In other cases, proceeding shall be deemed to have commenced on the first day of Assessment Year and concluded on the date on which the assessment is made

The list of cases given below where one can have recourse to Settlement Commission at any time on or after the first day of the Assessment Year but before the date of making assessmentCases where settlement is not possible up to May 31, 2010 (i) Reassessment proceeding under section 147 (ii) Proceeding for assessment/ reassessment in search cases (iii) Fresh assessment in pursuance of an order under section 254/263/264 setting aside or cancelling an assessment Cases where settlement is not possible with effect from June 1, 2010 i) Reassessment proceeding under section 147 ii) Fresh assessment in pursuance of an order under section 254/263/264 setting aside or cancelling an assessment

25.1.2 Income-tax Settlement Commission [Section 245B] (1) The Central Government shall constitute a Commission to be called the Income-tax Settlement Commission for the settlement of cases under this Chapter. (2) The Settlement Commission shall consist of a Chairman and as many Vice-Chairmen and other members as the Central Government thinks fit and shall function within the Department of the Central Government dealing with direct taxes. (3) The Chairman Vice-Chairman and other members of the Settlement Commission shall be appointed by the Central Government from amongst persons of integrity and outstanding ability, having special knowledge of, and, experience in, problems relating to direct taxes and business accounts. Provided that, where a member of the Board is appointed as the Chairman Vice-Chairman or as a member of the Settlement Commission, he shall cease to be a member of the Board.

DIRECT TAXATION I 25.1

Settlement of Cases 25.1.3 Jurisdiction and Powers of Settlement Commission [Section 245BA] (1) Subject to the other provisions of this Chapter, the jurisdiction, powers and authority of the Settlement Commission may be exercised by Benches thereof. (2) Subject to the other provisions of this section, a Bench shall be presided over by the Chairman or a Vice-Chairman and shall consist of two other Members. (3) The Bench for which the Chairman is the Presiding Officer shall be the principal Bench and the other Benches shall be known as additional Benches. (4) Notwithstanding anything contained in sub-sections (1) and (2), the Chairman may authorize the Vice-Chairman or other Member appointed to one Bench to discharge also the functions of the Vice-Chairman or, as the case may be, other Member of another Bench. (5) Notwithstanding anything contained in the foregoing provisions of this section, and subject to any rules that may be made in this behalf, when one of the persons constituting a Bench (whether such person be the Presiding Officer or other Member of the Bench) is unable to discharge his functions owing to absence, illness or any other cause or in the event of the occurrence of any vacancy either in the office of the Presiding Officer or in the office of one or the other Members of the Bench, the remaining two persons may function as the Bench and if the Presiding Officer of the Bench is not one of the remaining two persons, the senior among the remaining persons shall act as the Presiding Officer of the Bench. Provided that if at any stage of the hearing of any such case or matter, it appears to the Presiding Officer that the case or matter is of such a nature that it ought to be heard of by a Bench consisting of three Members, the case or matter may be referred by the Presiding Officer of such Bench to the Chairman for transfer to such Bench as the Chairman may deem fit.

(5A)Notwithstanding anything contained in the foregoing provisions of this section, the Chairman may, for the disposal of any particular case, constitute a Special Bench consisting of more than three Members. (6) Subject to the other provisions of this Chapter, the places at which the principal Bench and the additional Benches shall ordinarily sit shall be such as the Central Government may, by notification in the Official Gazette, specify and the Special Bench shall sit at a place to be fixed by the Chairman. 25.1.4 Vice-Chairman to act as Chairman or to discharge his functions in certain circumstances [Section 245BB] (1) In the event of the occurrence of any vacancy in the office of the Chairman by reason of his death, resignation or otherwise, the Vice-Chairman or, as the case may be, such one of the ViceChairmen as the Central Government may, by notification in the Official Gazette, authorise in this behalf, shall act as the Chairman until the date on which a new Chairman, appointed in accordance with the provisions of this Chapter to fill such vacancy, enters upon his office. (2) When the Chairman is unable to discharge his functions owing to absence, illness or any other cause, the Vice-Chairman or, as the case may be, such one of the Vice-Chairmen as the Central Government may, by notification in the Official Gazette, authorise in this behalf, shall discharge the functions of the Chairman until the date on which the Chairman resumes his duties. 25.1.5 Power of Chairman to transfer cases from one Bench to another [Section 245BC] On the application of the assessee or the Chief Commissioner or Commissioner and after notice to them, and after hearing such of them as he may desire to be heard, or on his own motion without such notice, the Chairman may transfer any case pending before one Bench, for disposal, to another Bench.

25.2 I DIRECT TAXATION

25.1.6 Decision to be taken by majority [Section 245BD] If the Members of a Bench differ in opinion on any point, the point shall be decided according to the opinion of the majority, if there is a majority, but if the Members are equally divided, they shall state the point or points on which they differ, and make a reference to the Chairman who shall either hear the point or points himself or refer the case for hearing on such point or points by one or more of the other Members of the Settlement Commission and such point or points shall be decided according to the opinion of the majority of the Members of the Settlement Commission who have heard the case, including those who first heard it. 25.1.7 Application for settlement of cases [Section 245C] (1) An assessee may, at any stage of a case relating to him, make an application in such form and in such manner as may be prescribed, and containing a full and true disclosure of his income which has not been disclosed before the Assessing Officer, the manner in which such income has been derived, the additional amount of Income-tax payable on such income and such other particulars as may be prescribed, to the Settlement Commission to have the case settled and any such application shall be disposed of in the manner hereinafter provided : Provided that no such application shall be made unless (i) the additional amount of Income-tax payable on the income disclosed in the application exceeds the amount given below Application can be filed only if the additional amount of Income-tax payable on the income disclosed in the application exceeds the amount of tax given below Up to May 31 From June 1, 2010 With effect from 2010 to May 31, 2011 June 1, 2011 Settlement ` 50 Lakhs ` 50 Lakhs not possible

Different situations

Case 1 When an application is filed before the Settlement Commission, in cases where proceedings for assessment or reassessment have been initiated as a result of requisition of books of account or other documents or any assets. Case 2 Where the applicanta. is related to the person [referred to in Case 1 above] in whose case proceedings have been initiated as a result of search and who has filed an application; and b. is a person in whose case proceedings have also been initiated as a result of search Case 3 Where an application is filed in any other case

Settlement not possible

` 50 Lakhs

` 10 Lakhs

` 3 Lakhs

` 10 Lakhs

` 10 Lakhs

(ii) such tax and the interest thereon, which would have been paid under the provisions of this Act had the income disclosed in the application been declared in the return of income before the Assessing Officer on the date of application, has been paid on or before the date of making the application and the proof of such payment is attached with the application.

(1A) For the purposes of sub-section (1) of this section, the additional amount of Income-tax payable in respect of the income disclosed in an application made under sub-section (1) of this section shall be the amount calculated in accordance with the provisions of sub-sections (1B) to (1D).

DIRECT TAXATION I 25.3

Settlement of Cases (1B) Where the income disclosed in the application relates to only one Previous Year, (i) if the applicant has not furnished a return in respect of the total income of that year, then, tax shall be calculated on the income disclosed in the application as if such income were the total income;

(ii) if the applicant has furnished a return in respect of the total income of that year, tax shall be calculated on the aggregate of the total income returned and the income disclosed in the application as if such aggregate were the total income.

(1C) The additional amount of Income-tax payable in respect of the income disclosed in the application relating to the Previous Year referred to in sub-section (1B) shall be, (a) in a case referred to in clause (i) of that sub-section, the amount of tax calculated under that clause; (b) in a case referred to in clause (ii) of that sub-section, the amount of tax calculated under that clause as reduced by the amount of tax calculated on the total income returned for that year;

(1D) Where the income disclosed in the application relates to more than one Previous Year, the additional amount of Income-tax payable in respect of the income disclosed for each of the years shall first be calculated in accordance with the provisions of sub-sections (1B) and (1C) and the aggregate of the amount so arrived at in respect of each of the years for which the application has been made under sub-section (1) shall be the additional amount of Income-tax payable in respect of the income disclosed in the application. (2) Every application made under sub-section (1) shall be accompanied by a fee of ` 500 (3) An application made under sub-section (1) shall not be allowed to be withdrawn by the applicant. (4) An assessee shall, on the date on which he makes an application under sub-section (1) to the Settlement Commission, also intimate the Assessing Officer in the prescribed manner of having made such application to the said Commission. Case Law: Application must disclose undisclosed income: The requirement is that there must be an income disclosed in a return furnished and undisclosed income disclosed to the Commission by a petition u/s 245C CIT vs. Damani Bros. 259 ITR 475/126 Taxman 321 Additional tax shall be computed as follows :(i) Where the income disclosed in the application relates to only one Previous Year a) b) If the applicant has not furnished a return of income of that year Tax on income disclosed in the application as if such income were the total income Tax on the aggregate of the total income returned and income disclosed in the application for settlement minus tax calculated on returned income

If the applicant has furnished a return in respect of total income of that year (ii) Where the income disclosed relates to more Aggregate of the amount of tax determined for than one Previous Year each year according to rules mentioned.

25.1.8 Procedure for Receipt of Application [Section 245D] (1) On receipt of an application under section 245C, the Settlement Commission shall, within seven days from the date of receipt of the application, issue a notice to the applicant requiring him to explain as to why the application made by him be allowed to be proceeded with, and on hearing the applicant, the Settlement Commission shall, within a period of fourteen days from the date of the application, by an order in writing, reject the application or allow the application to be proceeded with.

25.4 I DIRECT TAXATION

Provided that where no order has been passed within the aforesaid period by the Settlement Commission, the application shall be deemed to have been allowed to be proceeded with. (2) A copy of every order under sub-section (1) shall be sent to the applicant and to the Commissioner. (2A) Where an application was made under section 245C before the 1st day of June, 2007, but an order under the provisions of sub-section (1) of this section, as they stood immediately before their amendment by the Finance Act, 2007, has not been made before the 1st day of June, 2007, such application shall be deemed to have been allowed to be proceeded with if the additional tax on the income disclosed in such application and the interest thereon is paid on or before the 31st day of July, 2007. Explanation In respect of the applications referred to in this sub-section, the 31st day of July, 2007 shall be deemed to be the date of the order of rejection or allowing the application to be proceeded with under sub-section (1). (i) in respect of an application which is allowed to be proceeded with under sub-section (1), within thirty days from the date on which the application was made; or

(2B) The Settlement Commission shall,

(ii) in respect of an application referred to in sub-section (2A) which is deemed to have been allowed to be proceeded with under that sub-section, on or before the 7th day of August,2007, call for a report from the Commissioner, and the Commissioner shall furnish the report within a period of thirty days of the receipt of communication from the Settlement Commission.

(2C) Where a report of the Commissioner called for under sub-section (2B) has been furnished within the period specified therein, the Settlement Commission may, on the basis of the report and within a period of fifteen days of the receipt of the report, by an order in writing, declare the application in question, after giving opportunity of being heard to the applicant, as invalid, and shall send the copy of such order to the applicant and the Commissioner; (2D) Where an application was made under sub-section (1) of section 245C before the 1st day of June, 2007 and an order under the provisions of sub-section (1) of this section, as they stood immediately before their amendment by the Finance Act, 2007, allowing the application to have been proceeded with, has been passed before the 1st day of June, 2007, but an order under the provisions of sub-section (4), as they stood immediately before their amendment by the Finance Act, 2007, was not passed before the 1st day of June, 2007, such application shall not be allowed to be further proceeded with unless the additional tax on the income disclosed in such application and the interest thereon, is, notwithstanding any extension of time already granted by the Settlement Commission, paid on or before the 31st day of July, 2007. (3) The Settlement Commission, in respect of (i) an application which has not been declared invalid under sub-section (2C); or (ii) an application referred to in sub-section (2D) which has been allowed to be further proceeded with under that sub-section, may call for the records from the Commissioner and after examination of such records, if the Settlement Commission is of the opinion that any further enquiry or investigation in the matter is necessary, it may direct the Commissioner to make or cause to be made such further enquiry or investigation and furnish a report on the matters covered by the application and any other matter relating to the case, and the Commissioner shall furnish the report within a period of ninety days of the receipt of communication from the Settlement Commission; (i) sub-section (2B) or sub-section (3), or

(4) After examination of the records and the report of the Commissioner, if any, received under (ii) the provisions of sub-section (1) as they stood immediately before their amendment by the

DIRECT TAXATION I 25.5

Settlement of Cases Finance Act, 2007, and after giving an opportunity to the applicant and to the Commissioner to be heard, either in person or through a representative duly authorized in this behalf, and after examining such further evidence as may be placed before it or obtained by it, the Settlement Commission may, in accordance with the provisions of this Act, pass such order as it thinks fit on the matters covered by the application and any other matter relating to the case not covered by the application, but referred to in the report of the Commissioner. (4A) The Settlement Commission shall pass an order under sub-section (4), (i) in respect of an application referred to in sub-section (2A) or sub-section (2D), on or before the 31st day of March, 2008;

(ii) in respect of an application made on or after the 1st day of June, 2007, but before the 1st day of June, 2010, within twelve months from the end of the month in which the application was made; (iii) in respect of an application made on or after June 1, 2010, within eighteen months from the end of the month in which application was made;

(5) Subject to the provisions of section 245BA, the materials brought on record before the Settlement Commission shall be considered by the Members of the concerned Bench before passing any order under sub-section (4) and, in relation to the passing of such order, the provisions of section 245BD shall apply. (6) Every order passed under sub-section (4) shall provide for the terms of settlement including any demand by way of tax, penalty or interest, the manner in which any sum due under the settlement shall be paid and all other matters to make the settlement effective and shall also provide that the settlement shall be void if it is subsequently found by the Settlement Commission that it has been obtained by fraud or misrepresentation of facts. (6A) Where any tax payable in pursuance of an order under sub-section (4) is not paid by the assessee within thirty-five days of the receipt of a copy of the order by him, then, whether or not the Settlement Commission has extended the time for payment of such tax or has allowed payment thereof by instalments, the assessee shall be liable to pay simple interest at one & one-fourth percent per month (or part of month)on the amount remaining unpaid from the date of expiry of the period of thirty-five days aforesaid. Interest is payable even if the Settlement Commission has extended the time of payment. (7) Where a settlement becomes void as provided under sub-section (6), the proceedings with respect to the matters covered by the settlement shall be deemed to have been revived from the stage at which the application was allowed to be proceeded with by the Settlement Commission and the Income-tax Authority concerned, may, notwithstanding anything contained in any other provision of this Act, complete such proceedings at any time before the expiry of two years from the end of the financial year in which the settlement became void. (8) For the removal of doubts, it is hereby declared that nothing contained in section 153 shall apply to any order passed under sub-section (4) or to any order of assessment, reassessment or re-computation required to be made by the Assessing Officer in pursuance of any directions contained in such order passed by the Settlement Commission and nothing contained in the proviso to sub-section (1) of section 186 shall apply to the cancellation of the registration of a firm required to be made in pursuance of any such directions as aforesaid. Case laws: (1) Effect of omission of sub-section (1A) of section 245D: Where the applications of the respondents were not proceeded with only because of the objection raised by the Commissioner under subsection (1A), having regard to the fact that the said sub-section (1A) was removed from the statute book subsequent to 1991, there was no reason why the Settlement Commission could not

25.6 I DIRECT TAXATION

have entertained fresh applications under section 245C and this would not be a case of review at all - CIT vs. Bhaskar Picture Palace 113 Taxman 109. (2) Power to over-rule objections is procedural: Amendment of section 245D with effect from 1-41979 empowering Settlement Commission to overrule objections of Commissioner was procedural and an order passed by Commissioner under section 245D prior to aforesaid amendment without giving applicant an opportunity of hearing was a nullity being passed in violation of principles of natural justice and after amendment of section 245D with effect from 1-4-1979 assessee was entitled to be heard on objections of Commissioner R.B. Shreeram Durga Prasad and Fatechand Nursing Das vs. Settlement Commission (IT & WT) 176 ITR 169/43 Taxman 34.

25.1.9 Provisional Attachment to protect Revenue [Section 245DD] If during the pendency of any proceedings the Commission is of the opinion that for the purpose of protecting the interests of the revenue, it is necessary to do so, it may attach provisionally for six months any property belonging to the applicant in the manner provided in the Second Schedule to the Act. Such attachment shall not extend in any case more than two years. 25.1.10 Reopening of completed proceedings [Section 245E] If the Settlement Commission is of the opinion that for the proper disposal of the case pending before it, it is necessary or expedient to reopen any proceedings connected with the case but which has been completed by any Income-tax Authority before the application was made, it may, with the concurrence of the applicant reopen such proceedings and pass such orders thereon as it thinks fit. However, no proceeding shall be reopened by the Settlement Commission under this provision if the period between the end of the Assessment Year to which such a proceeding relates and the date of application for settlement u/s. 245C exceed nine years. Case Law: Others/matters relating to jurisdiction of Settlement Commission: Failure on the part of the petitioner to deduct tax at source does not come within purview of section 245C(1). Section 245E contemplates reopening of completed proceedings not for benefit of assessee but in the interest of the revenue -CIT vs. Paharpur Cooling Towers (P.) Ltd. 85 Taxman 357. 25.1.11 Exclusive jurisdiction of the Settlement Commission over the admitted applications [Section 245F] After an application made u/s. 245C has been allowed to be proceeded with, the Settlement Commission will have exclusive jurisdiction over the case till an order u/s. 245D(4) has been made. During this period the Settlement Commission will have all the powers vested in an Income-tax Authority under the Act. However, in the absence of any express direction to the contrary by the Settlement Commission nothing contained in Section 245F shall effect the operation of any other provisions of the Act requiring the applicant to pay tax on the basis of Self Assessment in relation to the matters before the Settlement Commission. Case Law: A final decision, however wrong, is still final and its binding force does not depend upon its correctness Capital Cables (India) (P.) Ltd. vs. Income-tax Settlement Commission 267 ITR 528/139 Taxman 332 25.1.12 Inspection, etc. Reports [Section 245G] No persons shall be entitled to inspect or obtain copies of any reports made by any Income-tax Authority to the Settlement Commission but the Settlement Commission may in its discretion, furnish copies thereof to any such person or an application made to in this behalf. However, for the purposes of enabling any person whose case is under consideration to rebut any evidence on record against him in any such report, the Commission shall furnish him a certified copy of any such report if the applicant makes an application in this behalf. The copies will be supplied to the applicant on payment of the prescribed fee.

DIRECT TAXATION I 25.7

Settlement of Cases 25.1.13 Immunity from Prosecution and Penalty [Section 245H] If the Settlement Commission is satisfied that any person who made the application for settlement has cooperated with the Settlement Commission in the proceedings before it and has made a full and true disclosure of his income and the manner in which such income has been derived, it may grant immunity from prosecution under the Income-tax Act or under the Indian Penal Code or under any other Central Act as also the imposition of any penalty under the Income-tax Act with respect to the case covered by the settlement. However, w.e.f. 1.6.2007 no such immunity shall be granted by the Settlement Commission in cases where the proceedings for prosecution for any such offence have been instituted before the date of receipt of the application under Section 245C. An immunity granted by the Settlement Commission shall stand withdrawn if the applicant fails to pay the sum specified in the order of settlement within the time specified in such order or within such further time as may be allowed by the Settlement Commission or fails to comply with any other condition subject to which the immunity was granted. The immunity may also be withdrawn if the Settlement Commission is satisfied that the applicant has, in the course of proceedings, concealed any particular material to the settlement or had given false evidence. Once the immunity granted is withdrawn, the assessee may be tried for offence with respect to which the immunity was granted or for any other offences of which he appears to have been guilty in connection with the Settlement and shall also become liable to imposition of any penalty under this Act to which such person would have been liable, had not such immunity been granted. 25.1.14 Abatement of proceeding before settlement Commission [Section 245HA] Proceedings for settlement shall abate from the date given below Circumstances in which the proceeding abates Date of abatement Where the application is made on or after June 1, 2007 Date on which the application is rejected. and is rejected within 14 days from the date of application under section 245D(1) An application made before June 1, 2007 but the tax is July 31, 2007. not paid before July 31, 2007 and hence it is rejected under section 245D(2D) An application made under section 245C declared as The last day of the month in which the invalid with or without the report of the Commissioner application is declared as invalid. under section 245D(2C) An application made under section 245C and the order is Date on which the time period specified not passed within the time prescribed in section 245D(4A) in section 245D(4A) expires. Where the proceedings before the Settlement Commission abates, the Assessing Officer or any other Income-tax Authority before whom the proceedings are pending at the time of making the application under section 245C shall reassume jurisdiction and shall dispose of the case in accordance with the provisions of the Act. For the purpose of disposing the case, Assessing Officer can use Material and other information produced by the Assessee before the Settlement Commission; or Result of the inquiry held or evidence recorded by the Settlement Commission in the course of the proceedings before it. Commencing on and from the date of application; and Ending on date of abatement.

Time limit for Sections 149, 153, 153B, 154, 155, 158BE, 231, 243, 244, 244A will be extended by the period

25.8 I DIRECT TAXATION

25.1.15 Credit of Tax paid in case of abatement of proceedings [Section 245HAA] Where an application made u/s 245C on or after 1st day of June, 2007, is rejected u/s 245D(1) or any other application made u/s 245C is not allowed to be proceeded or is declared invalid or an order has not been passed within the time period, the Assessing Officer shall allow the credit for the tax and interest paid on or before the date of making the application or during the pendency of the case before Settlement Commission. 25.1.16 Order of the Settlement Commission to be conclusive [Section 245-I] Order passed by the Commission u/s. 245D(4) is conclusive as to the matter stated therein and no matter covered by such order shall be reopened in any proceeding under this Act or under any other law for the time being in force save as provided under Chapter XIXA. The order of the Commission can only be challenged through a written petition under Article 226 of the Constitution of India in a High Court or through Special Leave Petition under Article 136 in the Supreme Court on the ground that while making such order, principles of the natural justice has been violated or mandatory procedural requirements of law were not complied with or if it is found that there is no nexus between the reasons given and the decision taken. 25.1.17 Payment of the sums due under order of settlement [Section 245J] Any sum specified in an order of settlement passed u/s. 245D(4) may be recovered and any penalty for default in making payment of such sum may be impose and recovered in accordance with the provisions of Chapter XVII by the Assessing Officer having jurisdiction over the person who made the application for settlement u/s. 245C. 25.1.18 Bar on subsequent application for settlement in certain cases [Section 254K] In cases where an order has been passed u/s. 245D(4) providing for the imposition of penalty on the ground of concealment of particulars of income or after passing the order u/s.245D(4), such person is convicted of any offence under Chapter XXII of the Income-tax Act in relation to that case of the case of such person is sent back to the Assessing officer u/s. 245BA, he shall not be entitled to apply for Settlement u/s. 245C in relation to any other matter. 25.1.19 Proceedings before the Settlement Commission to be judicial proceedings [Section 245L] Any proceedings under Chapter XIXA before the Settlement Commission shall be deemed to be a judicial proceeding within the meaning of Sec. 193 and 228, and for the purposes of Sec. 196 of the Indian Penal Code. 25.2 ADVANCE RULING Finance Act, 1993 inserted a Chapter XIX-B in the Income-tax Act, 1961 to provide provisions of Advance Rulings to avoid dispute in respect of assessment of Income-tax liability in the case of nonresident. W.e.f. 1.10.1998, the scheme has been extended to cover notified resident applicants also. The Chapter XIX-B contains sections 245N to 245V. Advance Ruling means a determination by the Authority for Advance Rulings, in relation to (i) a transaction which has been undertaken or is proposed to be undertaken by a non-resident or by a resident with a non-resident, including a determination of a question of law or of fact, and (ii) issues relating to computation of income pending before the Income-tax authority or the tribunal including a determination of a question of a law or of fact. [Sec. 245N(a)] An application may be made by (i) non-resident, (ii) a resident entering into transaction with a nonresident, or (iii) a resident of the notified class or category i.e. a public sector company or a person indulging in a transaction with a non-resident. [Sec. 245N(b)] Application for advance ruling should be in the prescribed form as below duly verified, along with a payment of fee of ` 2,500 shall be submitted to the authority for advance rulings.

DIRECT TAXATION I 25.9

Settlement of Cases Form No 34C 34D 34E Class of Assesses Non- resident desires of obtaining an advance ruling. Resident persons seeking advance ruling in relation to a transaction with a non-resident. Resident person of notified class or category.

The application for advance rulings should be in quadruplicate and the applicant may withdraw such application within 90 days from the date of application. [Sec. 245Q] An advance ruling shall not be allowed where (i) question of law or fact is already pending either before any Income-tax Authority or the Appellate Tribunal (except in case of a resident applicant of notified class or category) or any court, (ii) a transaction, which is designed for the avoidance of Income-tax; or (iii) determination of the fair market value of any property. However, no application shall be rejected unless an opportunity has been given to the applicant of being her and if the application is rejected, reasons for such rejection shall be given in the order. [Sec. 245R] The Authority shall pronounce the advance ruling within six months after the receipt of the application. [Sec. 245R(6)] In case an application for advance ruling has been made, in respect of an issue by a resident applicant, no Income-tax Authority or the Appellate Tribunal shall give a decision on the same issue. [Sec. 245RR] The advance ruling shall be binding only on the applicant who has sought it in respect of the specific transaction covered thereunder, on the Commissioner and the Income-tax Authorities subordinate to him, having jurisdiction over the applicant. The advance ruling will continue to remain in force unless there is a change either in law or in fact on the basis of which the advance ruling was pronounced. [Sec. 245S] Case Laws: (i) Settlement Commission cannot be equated with CBDT for exercise of power of relaxation under section 119(2)(a) - CIT vs. Anjum M.H. Ghaswala 119 Taxman 352/ 252 ITR 1.

(ii) Commission is not bound to proceed with any application filed under section 245C - CIT vs. Hindustan Bulk Carriers 259 ITR 449/126 Taxman 321.

25.10 I DIRECT TAXATION

Study Note - 26
TAX ADMINISTRATION
This Study Note includes 26.1 Tax Administration 26.1 TAX ADMINISTRATION 26.1.1 Income Tax Authorities [Section 116] In order to discharge executive and administrative functions relating to the Act, the following Incometax Authorities have been constituted (a) The Central Board of Direct Taxes; (b) Directors General of Income-tax or Chief Commissioners of Income-tax; (c) Directors of Income-tax or Commissioners of Income-tax or Commissioners of Income-tax (Appeals); (d) Additional Directors of Income-tax or Additional Commissioners of Income-tax or Additional Commissioners of Income-tax (Appeals); (e) Joint Directors of Income-tax or Joint Commissioners of Income-tax; (f) Deputy Director of Income-tax or Deputy Commissioner of Income-tax or Deputy Commissioner of Income-tax (Appeals); (g) Assistant Directors of Income-tax or Assistant Commissioners of Income-tax; (h) Income-tax Officers; (i) Tax Recovery Officers; (j) Inspectors of Income-tax. 26.1.2 Appointment of Income-Tax Authorities [Section 117] (1) The Central Government may appoint such persons as it thinks fit to be Income-tax Authorities. (2) Without prejudice to the provisions of sub-section (1), and subject to the rules and orders of the Central Government regulating the conditions of service of persons in public services and posts, the Central Government may authorize the Board, or a Director-General, a Chief Commissioner or a Director or a Commissioner to appoint Income-tax Authorities below the rank of an Assistant Commissioner or Deputy Commissioner. (3) Subject to the rules and orders of the Central Government regulating the conditions of service of persons in public services and posts, an Income-tax Authority authorised in this behalf by the Board may appoint such executive or ministerial staff as may be necessary to assist it in the execution of its functions. 26.1.3 Control of Income-Tax Authorities [Section 118] The Board may, by notification in the Official Gazette, direct that any Income-tax Authority or authorities specified in the notification shall be subordinate to such other Income-tax Authority or authorities as may be specified in such notification.

DIRECT TAXATION I 26.1

Tax Administration 26.1.4 CENTRAL BOARD OF DIRECT TAXES (CBDT) The Central Board of Direct Taxes (CBDT) has been constituted under the Central Board of Revenue Act, 1963. It functions under the Ministry of Finance. The important powers of CBDT are: (i) To make rules for carrying out purposes of the Act [Sec. 295]. (ii) To decide jurisdiction of the Income-tax Authorities [Sec. 120]. (iii) To issue instructions, orders and directions to other Income-tax Authorities for proper administration of this Act and all other persons employed in the execution of this Act. However, it cannot issue instructions to the Commissioner of Income-tax (Appeals). It cannot issue a direction to any Income-tax Authority to dispose of a case in a particular manner. [Sec. 119], (iv) To declare an organization as company [Sec. 2(17) (iv)]. (v) To entertain objections in respect of search and seizure under the Act. [Sec. 132]. (vi) To relax the provisions of Sections 139, 143, 144, 147, 148, 154, 155, 158BFA, 201(1A), 210, 211, 234A, 234B, 234C, 271 and 273 or otherwise [Section 119(2)(a)]. (vii) Power of relaxing any requirement contained in Chapter IV (provisions for computation of income under various heads) or Chapter VI-A (provisions for deductions from Gross Total Income) [Section 119(2)(c)]. (viii) Issue such general or special orders for relaxation of the provisions of sections relating to FBT viz; 115WD, 115WE, 115WF, 115WG, 115WH, 115WJ and 115WK [Section 119(2)(a)]. (ix) Prescribe categories of transactions and documents pertaining to business or profession, where quoting of PAN is necessary [Sec, 139A]. (x) Frame a scheme in respect of Tax Return Preparers [Sec. 139B]. (xi) Prescribe class of persons by whom return of income [Sec. 139D] and TDS statements [Sec. 200] should be filed electronically. (xii) Prescribing qualifications for Authorized Representatives [Sec. 288]. (xiii) Condone delay for seeking CBDTs approval, where it is required [Sec. 293B] and authorize any Income Tax Authority not being Commissioner of Income-tax (Appeals), to admit belatedly ant claim for exemption, deduction, refund or relief [Section 119(2)(b)]. (xiv) To prescribe method for computation of arms length price [Section 92C] and to prescribe record to be kept and the time for which it is to be preserved [Section 92D]. Circulars issued by the CBDT are legally binding on the revenue and this binding character attaches to the circulars even if they are found not in accordance with the correct interpretation of a statutory provision and they depart or deviate from such construction - K.P. Varghese vs. ITO 131 ITR 597 (SC). It is well-settled that circulars can bind the ITO but will not bind the appellate authority or the Tribunal or the Court or even the assessee - CIT vs. Hero Cycles (P.) Ltd. 228 ITR 463 (SC). CBDT has power, interalia, to tone down the rigor of the laws and ensure fair enforcement of its provision by issuing circular. Circular contemplated in Sec.119 (2)(a) cannot be adverse to the assessee. Power is given for the purpose of just, proper and efficient management of work of assessment. Circular, however are not meant for contradicting or nullifying any provision of the statue. They are meant to mitigate the rigor of application of a particular provision. So long as such a circular is in favour, it would be binding on the departmental authorities in view of the provision of sec. 119 to ensure a uniform and proper administration & application of the IT Act - UCO Bank vs. CIT 237 ITR 899 (SC).

26.2 I DIRECT TAXATION

26.1.5 Director General/Director The Central Government has power to appoint Director General and Director [Sec. 117]. The CBDT authorize them to perform such functions as may be assigned to them by [Sec. 120]. The powers enjoyed by them include: (i) To appoint an Income-tax Authority below the rank of Assistant Commissioner/Deputy Commissioner, if authorised by the Board [Sec. 117].

(ii) To direct the Joint Commissioner to function and assume the powers of Assessing Officer, if so authorised by the Board [Sec. 120]. (iii) To transfer cases from one or more Assessing Officers to any other Assessing Officer who is subordinate to him [Sec. 127]. (iv) To enquire or investigate concealed income of any person within his jurisdiction [Sec. 131(1A)]. (v) Authorise any Joint Director / Joint Commissioner, Deputy Director / Deputy Commissioner, Assistant Director / Assistant Commissioner or Assessing Officer to enter, search and seize valuables [Sec. 132(1)]. (vi) To requisition books of accounts, etc.[Sec. 132A]. (vii) To survey [Sec. 133A]. (viii) To make an enquiry [Sec. 135]. (ix) To collect certain information [Sec. 133B] 26.1.6 Commissioners of Income Tax / Chief Commissioners of Income Tax The Central Government has power to appoint Director General and Director [Sec. 117]. The CBDT authorize them to perform such functions as may be assigned to them by [Sec. 120]. The powers enjoyed by them include: (i) To appoint an Incometax Authority below the rank of Assistant Commissioner/Deputy Commissioner, if authorised by the Board [Sec. 117].

(ii) To direct the Joint Commissioner to function and assume the powers of Assessing Officer, if so authorised by the Board [Sec. 120]. (iii) To transfer cases from one or more Assessing Officers to any other Assessing Officer who is subordinate to him [Sec. 127]. (iv) To enquire or investigate conceal income of any person within his jurisdiction [Sec. 131(1A)]. (v) To authorise any Joint Director/Joint Commissioner, Deputy Director/Deputy Commissioner, Assistant Director/Assistant Commissioner or Assessing Officer to enter, search and seize valuables [Sec. 132(1)]. (vi) To requisition books of accounts, etc. [Sec. 132A]. (vii) To survey [Sec. 133A]. (viii) To make an enquiry [Sec. 135]. (ix) To collect certain information [Sec. 133B] 26.1.7 Additional Powers (i) Power regarding discovery, production of evidence, etc. [Sec. 131]. (ii) To sanction reopening of assessments after the expiry of four years. [Sec.151(1)]. (iii) To direct the Assessing Officer to prefer appeal to the Tribunal against the order of First Appellate Authority. [Sec. 253(2)]

DIRECT TAXATION I 26.3

Tax Administration (iv) Request the Tribunal to file Reference to High Court. [Sec. 256]. (v) To revise any order passed by the Assessing Officer that is prejudicial to revenue. [Sec. 263]. (vi) To revise any order passed by a subordinate authority on an application by the assessee or suo moto when the revision is in favour of the assessee. [Sec.264] 26.1.8 Commissioner of Income-Tax (Appeals) Appointment is made by the Central Government. The following are important powers: (i) Power regarding discovery, production of evidence etc. [Sec. 131] (ii) To condone delay in filing of appeal. (iii) Power to call for information. [Sec. 133] (iv) Power to inspect register of companies. [Sec. 134] (v) To dispose of an appeal and to confirm, reduce, enhance or annul the assessment. - [Sec. 251] (vi) Power to impose a penalty. [Sec. 271] (vii) Power to set off any refund against arrears of tax. [Sec. 245]. (viii) The Commissioner (Appeals) has inherent powers to stay recovery proceedings Paulsons Litho Works vs. ITO 208 ITR 676 (Mad.). 26.1.9 Joint Commissioner of Income Tax They are appointed by the Central Government. They enjoy the following powers :(i) Power regarding discovery, production of evidence, etc. [Sec. 131] (ii) Power of search and seizure, if authorised. [Sec. 132] (iii) Power to call for information. [Sec. 133] (iv) Power to survey [Sec. 133A] (v) Power to make an enquiry [Sec. 135] (vi) Power to collect certain information [Sec. 133B] (vii) Power to inspect register of companies. [Sec. 134] (viii) To sanction reopening of assessment after the expiry of 4 years, if the assessment is made under any section other than sections 143(3) and 147. 26.1.10 Assessing Officer Assessing Officer means the Assistant Commissioner or Deputy Commissioner or Assistant Director or Deputy Director or the Income-tax Officer who is vested with the relevant jurisdiction by virtue of directions or orders issued under Section 120 or any other provision of this Act, and the Additional Commissioner or Additional Director or Joint Commissioner or Joint Director who is directed under the said section 120 to exercise or perform all or any of the powers and functions conferred on, or assigned to, an Assessing Officer under this Act [Sec. 2(7A)] The following are some of the powers of Income-tax Officers (i) Power regarding discovery, production of evidence, etc. [Sec. 131] (ii) Power of search and seizure, if authorised. [Sec. 132] (iii) Power to requisition books of accounts. [Sec. 132A] (iv) To apply the assets seized and retained u/s. 132 in satisfaction of the existing liabilities of the assessee under Direct Taxes Act. [Sec. 132B]

26.4 I DIRECT TAXATION

(v) Power to call for information. [Sec. 133] (vi) Power to collect certain information- [Sec. 133B] (vii) Power to inspect register of companies. [Sec. 134] (viii) Power to allot Permanent Account Number. [Sec. 139A] (ix) Power to direct an assessee to get his accounts audited. [Sec. 142] (x) Power to make assessment. [Sec. 143, 144] (xi) Power to reassess income which has escaped assessment.[ sec. 147] (xii) Power to rectify mistakes apparent from the records, either on his own or on an application made by the assessee. [Sec. 154] (xiii) Power to grant a certificate to an assessee to receive a payment without deduction of tax at source or deduction of tax at source at a lower rate than prescribed [Secs. 194, 195, 197] (xiv) Power to impose penalty for default in payment of a tax. [Sec. 221] (xv) Power to grant refund. [Sec. 237, 240] (xvi) Power to withhold refund in certain cases [Sec. 241] (xvii) Power to adjust the refund against any demand of tax etc. outstanding against the assessee. [Sec. 245]. (xviii) Power to impose penalty for the prescribed defaults under the Act [Chapter XXI] (xix) Power to initiate prosecution for the prescribed offences under the Act [Chapter XXII] (xx) Power to determine arms length price of international transactions [Sec. 92C] 26.1.11 Inspectors of Income Tax Inspectors are appointed by the Commissioner of Income Tax. They have to perform such functions as are assigned to them by the Commissioner or any other Incometax Authority under which they are appointed to perform their functions. In case of survey, inspectors have power to inspect books of account and other documents, place marks of identification, to take statements at any function, ceremony or event [Sec. 133A]. 26.1.12 Change of incumbent of an office [Section 129] Whenever in respect of any proceeding under this Act an Income-tax Authority ceases to exercise jurisdiction and is succeeded by another who has and exercises jurisdiction, the Income-tax Authority so succeeding may continue the proceeding from the stage at which the proceeding was left by his predecessor. Provided that the assessee concerned may demand that before the proceeding is so continued the previous proceeding or any part thereof be reopened or that before any order of assessment is passed against him, he be reheard.

DIRECT TAXATION I 26.5

Study Note - 27
DOUBLE TAXATION RELIEF
This Study Note includes 27.1 Agreement with Foreign Countries or Specified Territories 27.2 Countries with which no agreement exists 27.3 Double Taxation relief in case of Specified Association 27.1AGREEMENT WITH FOREIGN COUNTRIES OR SPECIFIED TERRITORIES [SECTION 90] (1) The Central Government may enter into an agreement with the Government of any country outside India or specified territories outside India (a) for the granting of relief in respect of (i) Income on which have been paid both Income-tax under this Act and Income-tax in that country or specified territory; or

(ii) Income-tax chargeable under this Act and under the corresponding law in force in that country or specified territory to promote mutual economic relations, trade and investment, or

(b) For the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory, or (c) For exchange of information for the prevention of evasion or avoidance of Income-tax chargeable under this Act or under the corresponding law in force in that country or specified territory, or investigation of cases of such evasion or avoidance, or (d) for recovery of Income-tax under this Act and under the corresponding law in force in that country, and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.

(2) Where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee. (2A) Notwithstanding anything contained in sub-section 2, the provisions of Chapter X-A of the Act shall apply to the assessee, even if such provisions are not beneficial to him w.e.f. 1.4.2013 (3) Any term used but not defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf. (4) An assessee, not being a resident, to whom an agreement referred to sub-section (1) applies, shall not be entitled to claim any relief under such agreement unless a certificate, containing such particulars as may be prescribed, of his being a resident in any country outside India or Specified tTerritory outside India, as the case may be, is obtained by him from the Government of that country as specified territory w.e.f. 1.4.2013.

DIRECT TAXATION I 27.1

Double Taxation Relief Explanation:- For the removal of doubts, it is hereby declared that the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as less favorable charge or levy of tax in respect of such foreign company. 27.2COUNTRIES WITH WHICH NO AGREEMENT EXISTS [SECTION 91] (1) If any person who is resident in India in any Previous Year proves that, in respect of his income which accrued or arose during that Previous Year outside India (and which is not deemed to accrue or arise in India), he has paid in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation, Income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian Income-tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal. In the other words, where section 90 does not apply, unilateral relief will be available, if the following conditions are satisfied: (i) The assessee in question must have been resident in India in the Previous Year. (ii) That some income must have accrued or arisen to him outside India during the Previous Year & it should also be received outside India. Such income must not be deemed to accrue or arise in India. (iii) The income should be taxed in India & in a foreign country & there should be no reciprocal arrangements for relief or avoidance on double taxation with the country where income has accrued or arisen. (iv) In respect of that income, the assessee must have paid by deduction or other wise, tax under the law in force in the foreign country in question in which the income outside India has arisen. If all the above conditions are satisfied, such person shall be entitled to deduction from the Indian Income-tax payable by him of a sum calculated on such doubly taxed income :(a) at the average Indian rate of tax or the average of tax of the said country, whichever is lower, or (b) at the Indian rate of tax if both the rates are equal. Average rate of tax means the tax payable on total income, after deduction of any relief due under the provision of this act but before deduction of any relief due under this chapter, divided by the total income. 27.3 DOUBLE TAXATION RELIEF IN CASE OF SPECIFIED ASSOCIATIONS [SECTION 90A] Section 90A has been inserted with effects from the Assessment Year 2006-07 to provides the following :i) ii) iii) There is a specified association in India. It enters into an agreement with any specified association in a specified territory outside India. The central Government may, by notification in the Official Gazette, make the necessary provision for adopting and implementing such agreement for grant of double taxation relief, for avoidance of double taxation; for exchange of information for the prevention of evasion or avoidance of Income-tax; for recovery of Income-tax.

(iv) In relation to any assessee to whom the said agreement applies, the provisions of the Income-tax

27.2 I DIRECT TAXATION

Act shall apply to the extent they are more beneficial to the assessee. Tax Residency Certificate [ TRC Section 90 & 90A] For claiming relief under DTAA section 90 & 90A empowers the Central Government to enter into Double Taxation Avoidance Agreement with the foreign countries / foreign territories. With effect from 1st April 2013, to avail the benefit, submission of TRC would be necessary . ILLUSTRATIONS ON DOUBLE TAXATION RELIEF Illustration 1. R a resident Indian, has derived the following income for the Previous Year relevant to the Assessement Year 2013-2014. Particulars Income from profession Share of income from a partnership in country X ( tax paid in Country X for this income in equivalent Indian Rupees 25,000) Commission income from a concern in country Y ( tax paid in country Y @ 20%, converted in equivalent Indian Rupees) Interest on scheduled banks [ other than savings account] Amount (`) 3,00,000 2,00,000 40,000 20,000

R wishes to know whether he is eligible to any double taxation relief, if so, its quantum. India does not have any Double Taxation Avoidance Agreement with countries X and Y. Solution: (1) Computation of Total Income for the Assessment Year 2013-14 Particulars Income from Business: Income from profession Share income in partnership firm in country X Income from Other Sources: Interest from schedule bank Commission earned in country Y, assumed from other sources Total Income (2) Computation of Tax Liability on Total Income for the Assessment Year 2013-14 Particulars Tax on Total Income of ` 5,60,000 Add: Surcharge on Income Tax ( assuming total income is less than one crore) Add: Education Cess @ 2% Add: Secondary and Higher Education Cess @ 1% Less: Double taxation relief : (2,00,000 + 40,000) = 2,40,0000 x 7.725% Tax Payable (ii) Average rate of tax in India: = 43,260/5,60,000 x 100 = 7.725% Whichever is less, is applicable Amount (`) 42,000 Nil 840 420 43,260 18,540 24,720 5,60,000 Amount (`) 3,00,000 2,00,000 20,000 40,000 60,000 5,00,000 Amount (`)

Note: (i) Average rate of tax in the foreign country = [ (25,000 + 8,000)/ (2,00,000 +40,000)] = 13.75%

Illustration 2. Mr. Prasad, ordinarily resident in India, furnished the following particulars of his income/ savings during the Previous Year 2012-2013.

DIRECT TAXATION I 27.3

Double Taxation Relief (i) Income from foreign business (Including ` 2,00,000 from business connection in India) accruing outside India () 2,00,000 4,00,000 60,000 70,000 2,50,000 12,00,000

(ii) Loss from Indian business (iii) Income from house property (iv) Dividends gross from Indian companies (v) Deposit in Public Provident Fund (vi) Tax paid in foreign country There is no double taxation avoidance treaty. Compute the tax liability Amount (`) (2,00,000) 10,00,000 2,00,000

Solution: (1) Computation of Total Income for the Assessment Year 2013-14 Particulars 1. Income from House Property 2. Income from Business: (a) Income from Indian Business (b) (i) Income from foreign business accruing or arising outside India (ii)income from foreign business deemed to accrue or arise in India 3. Income from other sources Dividends from Indian Companies- exempted u/s 10(34) Gross Total Income Less: Deduction for approved savings u/s 80C PPF deposits Total Income Amount (`) 4,00,000

10,00,000 Nil 14,00,000 70,000 13,30,000 Amount (`) 2,29,000 Nil 4,580 2,290 2,35,870 1,77,300 58,570

(2) Computation of Tax liability on Total Income for the Assessment Year 2013-14 Particulars Tax on Total Income of ` 13,30,000 Add: Surcharge on Income Tax ( assuming total income is less than one crore) Add: Education Cess @ 2% Add: Secondary and Higher Education Cess @ 1% Less: Double taxation relief : 10,00,000 x 17.73% Tax Payable

Note: 1. Relief is allowed on the doubly taxed income either at average rate of Indian tax or average rate of foreign income tax, whichever is lower:(a) Average rate of Indian income tax : 2,35,870/ 13,30,000 100 = 17.73% (b) Average rate of foreign income tax: (2,50,000/12,00,000) 100 = 20.833% 2. The amount of doubly taxed income has been worked out as under: Income from foreign business, accruing outside India Less: Income from business connection deemed to accrue or arise in India which is not entitled to double taxation relief. Doubly taxed income 2,00,000 10,00,000 12,00,000 3.

Loss from Indian business has been set-off against profits from foreign business which is deemed to accrue or arise in India. The mode of set-off increases the amount of double taxation relief.

27.4 I DIRECT TAXATION

Illustration 3. The Income-tax Act, 1961 provides for taxation of a certain income earned by X. The Double Taxation Avoidance Agreement, which applies to X, excludes the income earned by X from the purview of tax. Is X liable to pay tax on the in come earned by him? Discuss. Solution: Where any conflict arises between the provisions of the Double Taxation Avoidance Agreement and the Income-tax Act, 1961, the provisions of the Double Taxation Avoidance Agreement would prevail over those of the Income-tax Act. X is, therefore, not liable to pay tax on the income earned by him. Illustration 4. Explain briefly the proposition of law in case of any conflict between the provisions of the Double Taxation Avoid ance Agreement (DTAA) and the Income-tax Act, 1961. Solution: Where there is conflict between the provision as contained in the tax treaty and the provisions of Income Tax Act, a payer can take advantage of those provisions which are more beneficial to him. Thus, tax treaties override the provisions of Income Tax Act which can be enforced by the Appellate Authorities/Courts. Illustration 5. Arif, a resident both in India and Malaysia in Previous Year 2012-2013, owns immoveable properties (including residential house) at Malaysia and India. He has earned income of ` 50 lakh from rubber estates in Malaysia during the Previous Year 2012-2013. He also sold some property in Malaysia resulting in short-term capital gain of ` 10 lakh during the year. Arif has no permanent establishment of business in India. However, he has derived rental income of ` 6 lakh from property let out in India and he has a house in Lucknow where he stays during his visit to India. The Article 4 of the Double Taxation Avoidance Agreement between India and Malaysia provides that where an individual is a resident of both the Contracting States, he shall be deemed to be resident of the Contracting State in which he has permanent home avail able to him. If he has permanent home in both the Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests). You are required to state with reasons whether the business income of Arif arising in Malaysia and the capital gains in respect of sale of the property situated in Malaysia can be taxed in India. Solution: Where the Central Government has entered into an agreement with the Government of any other country for granting relief to tax or for avoidance of double taxation, the provisions of the Incometax Act, 1961 are applicable in such case to the extent they are more beneficial to the assessee. Arif has a residential house both in Malaysia and India. Thus, he has a permanent home in both the countries. How ever, he has no permanent establishment of business in India. The Double Taxation Avoidance Agreement (DTAA) with Malaysia provides that where an individual is a resident of both countries, he is deemed to be resident of that country in which he has a permanent home and if he has a permanent home in both the countries, he is deemed to be resident of that country, which is the centre of his vital interests, i.e. the country with which he has closer personal and economic relations. Arif owns rubber estates in Malaysia from which he derives business income. However, Arif has no permanent establish ment of his business in India. Therefore, his personal and economic relations with Malaysia are closer, since Malaysia is the place where: (a) the property is located ; and (b) the permanent establishment (PE) has been set-up. Therefore, he is deemed to be resident of Malaysia for A.Y. 2013-2014. So, in this case, Arif is not liable to Income tax in India for Assessement Year 2013-2014 in respect of business income and capital gains arising in Malaysia.

DIRECT TAXATION I 27.5

Double Taxation Relief Illustration 6. Ms. Sania, a resident Indian, furnishes the details for the Assessement Year2013-2014: Particulars (1) Income from profession (2) Share of income from a partnership in country X ( tax paid in Country X for this income in equivalent Indian Rupees 8,000) (3) Commission income from a concern in country Y ( tax paid in country Y @ 20%, converted in equivalent Indian Rupees (4) Interest on scheduled banks [ other than savings account] Amount (`) 1,94,000 40,000 30,000 20,000

Ms. Sania wishes to know whether she is eligible to any double taxation relief, if so, its quantum. India does not have any Double Taxation Avoidance Agreement with countries X and Y. Solution : (1) Computation of Total Income for the Assessment Year 2013-14 Particulars (a) Income from Business or Profession: (i) Income from Profession (ii) Share of income in partnership firm in country X (b) Income from other sources: (i) Interest from scheduled bank (ii) Commission earned in Country Y, assumed from other sources Total Income Particulars Tax on Total Income of ` 2,84,000 Add: Surcharge on Income Tax Add: Education Cess @ 2% Add: Secondary and Higher Education Cess @ 1% Less: Double taxation relief : 70,000 x 3.05% Tax Payable Rounded off u/s 288B Amount (`) 1,94,000 40,000 20,000 30,000 Amount (`) 2,34,000 50,000 2,84,000 Amount ( `) 8,400 Nil 168 84 8,652 2,135 6,517 6,520

(2) Computation of Tax Liability on Total Income for the Assessment Year 2013-14

Note : (i) Average rate of tax in the foreign country = 20% i.e. [(` 8,000 + 20% of ` 30,000)/(40,000+30,000)] x 100 (ii)Average rate of tax in India = (8,652/2,84,000) x 100 = 3.05% Illustration 7. Mr. B is a musician deriving income from foreign concerts performed outside India, ` 50,000. Tax of ` 10,000 was deducted at source in the country where the concerts were given. India does not have any agreement with that country for avoidance of double taxation. Assuming that Indian income of B is ` 2,00,000, what is the relief due to him under Sec. 91 for the Assessement Year 2013-2014. Solution: (1) Computation of Total Income for the Assessment Year 2013-14 Particulars Indian Income Foreign Income Gross Total Income or Total Income Amount (`) 2,00,000 50,000 2,50,000

27.6 I DIRECT TAXATION

(2) Computation of Tax Liability on Total Income for the Assessment Year 2013-14 Particulars Tax on Total Income Add: Education Cess @ 2% Add: Secondary and Higher Education Cess @ 1% Less: Double taxation relief u/s 91 = ` 50,000 x 2.06% Tax Payable Note: 1. Average rate of Indian income tax: (5,150 x 2,50,000) x 100 = 2.06% 2. Average rate of foreign income tax: Relief is allowed either at the average rate of Indian Income Tax or the average rate of Foreign Income Tax = (10,000/50,000) x 100 = 20% whichever is lower. Accordingly, the relief has been allowed at the average rate of Indian Income tax. Amount (`) 5,000 100 50 1,030 4,120

Illustration 8. A resident assessee, earned foreign exchange of ` 78,800. The foreign income was also subjected to tax deduction of ` 8,800 at source in the foreign country with which India had no agreement for avoidance of double taxation. The assessee claimed relief under Sec. 91 of the Income-tax Act in respect of the whole foreign income. Discuss his contention with reference to decided case laws. Solution: Where any income is taxed outside India as well as in India, a resident assessee is entitled to claim double taxa tion relief on such doubly taxed income provided such income is not deemed to accrue or arise in India. If any income aris ing outside India, is not subjected to tax in India, such foreign income does not form part of doubly taxed income for the purposes of Sec. 91. The expression doubly taxed income refers to foreign income which also suffered tax in India. Where any foreign income, taxed outside India, is also eligible to deduction in computing total income in India, dou ble taxation relief would be allowed only on such income as forms part of total income. On the amount of doubly taxed income, Income-tax is calculated at the Indian rate of tax and rate of tax of the foreign country. The foreign tax rate has to be calculated separately for each country CIT vs. Bombay Burmah Trading Corpn. Ltd. [2003] 126 Taxman 403 (Bom.) Double taxation relief will be allowed on such doubly taxed income either at the average rate of Foreign Income Tax or Indian Income Tax, whichever is lower out of the two.

DIRECT TAXATION I 27.7

Section - B WEALTH TAX

Study Note - 28
WEALTH TAX
This Study Note includes 28.1 Introduction 28.2 Valuation of Assets 28.3 Other Issues relating to Wealth Tax 28.4 Illustrations

28.1 INTRODUCTION Wealth tax is not a very important or high revenue tax in view of various exemptions. Wealth tax is a socialistic tax. It is not on income but payable only because a person is wealthy. Wealth tax is payable on net wealth on valuation date. As per Section 2(q), valuation date is 31st March every year. It is payable by every individual, HUF and company. Tax rate is 1% on amount by which net wealth exceeds ` 30 lakhs. No surcharge or education cess is payable. No wealth-tax is chargeable in respect of net wealth of any company registered under section 25 of the Companies Act, 1956; any co-operative society; any social club; any political party; and a Mutual fund specified under section 10(23D) of the Income-tax Act [section 45] COMPUTATION OF NET WEALTH Particulars Assets specified in Section 2(ea) chargeable in the hands of assessee on the basis of location of the assets and the assessees nationality and residential status Less: Aggregate value of all the debts owed by the assessee on the valuation date incurred in relation to the above said assets Less: Assets exempt u/s 5 Add: Deemed asset in the assessees hands u/s 4 Net Wealth as per Wealth Tax Act ` xxx (xxx) (xxx) xxx xxx

Rounding off Net Wealth [Section 44C] : The net wealth computed above shall be rounded off to the nearest multiple of one hundred rupees. Debt should have been incurred in relation to the assets which are included in net wealth of assessee. Only debt owed on date of valuation is deductible. In case of residents of India, assets outside India (less corresponding debts) are also liable to wealth tax. In case of non-residents and foreign national, only assets located in India including deemed assets less corresponding debts are liable to wealth tax [section 6]. Net wealth in excess of ` 30,00,000 is chargeable to wealth-tax @ 1 per cent (on surcharge and education cess).

DIRECT TAXATION I 28.1

Wealth Tax Assessment year - Assessment year means a period of 12 months commencing from the first day of April every year falling immediately after the valuation date [Section 2(d)]. 28.1.1 Assets Assets are defined in Section 2(ea) as follows. Guest house, residential house or commercial building - The following are treated as assets Any building or land appurtenant thereto whether used for commercial or residential purposes or for the purpose of guest house A farm house situated within 25 kilometers from the local limits of any municipality (whether known as a municipality, municipal corporation, or by any other name) or a cantonment board [Section 2(ea)(i)] A residential house is not asset, if it is meant exclusively for residential purposes of employee who is in whole-time employment and the gross annual salary of such employee, officer or director is less than ` 10,00,000. Any house (may be residential house or used for commercial purposes) which forms part of stock-intrade of the assessee is not treated as asset. Any house which the assessee may occupy for the purposes of any business or profession carried on by him is not treated as asset. A residential property which is let out for a minimum period of 300 days in the previous year is not treated as an asset. Any property in the nature of commercial establishments or complex is not treated as an asset. Motor cars - Motor car is an asset, but not the following - (a) motor cars used by the assessee in the business of running them on hire (b) motor cars treated as stock-in-trade [Section 2(ea)(ii)]. In the case of a leasing company, motor car is an asset. Jewellery, bullion, utensils of gold, silver, etc. [Section 2(ea)(iii)] - Jewellery, bullion, furniture, utensils and any other article made wholly or partly of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals are treated as assets [Section 2(ea)(ii)] For this purpose, jewellery includes ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals, and also precious or semi-precious stones, whether or not set in any furniture, utensils or other article or worked or sewn into any wearing apparel. Where any of the above assets (i.e., jewellery, bullion, utensils of gold, etc.) is used by an assessee as stock-in-trade, then such asset is not treated as assets under section 2(ea)(iii). Yachts, boats and aircrafts - Yachts, boats and aircrafts (other than those used by the assessee for commercial purposes) are treated as assets [Section 2(ea)(iv)] Urban land - Urban land is an asset [Section 2(ea)(v)] Urban land means land situated in the area which is comprised within the jurisdiction of a municipality and which has a population of not less than 10,000 according to the last preceding census. Land occupied by any building which has been constructed with the approval of the appropriate authority is not asset. Any unused land held by the assessee for industrial purposes for a period of 2 years from the date of its acquisition by him is not an asset. Any land held by the assessee as stock-in-trade for a period of 10 years from the date of its acquisition by him is also not an asset. Cash in hand - In case of individual and HUF, cash in hand on the last moment of the valuation date in excess of ` 50,000 is an asset. In case of companies, any amount not recorded in books of account

28.2 I DIRECT TAXATION

is asset [Section 2(ea)(vi)] 28.1.2 Deemed assets Often, a person transfers his assets in name of others to reduce his liability of wealth tax. To stop such tax avoidance, provision of deemed asset has been made. In computing the net wealth of an assessee, the following assets will be included as deemed assets u/s 4. Assets transferred by one spouse to another - The asset is transferred by an individual after March 31, 1956 to his or her spouse, directly or indirectly, without adequate consideration or not in connection with an agreement to live apart will be deemed asset [Section 4(1)(a)(i)] If an asset is transferred by an individual to his/her spouse, under an agreement to live apart, the provisions of section 4(1)(a)(i) are not applicable. The expression to live apart is of wider connotation and even the voluntary agreements to live apart will fall within the exceptions of this sub-clause. Assets held by minor child - In computing the net wealth of an individual, there shall be included the value of assets which on the valuation date are held by a minor child (including step child/adopted child but not being a married daughter) of such individual [Section 4(1)(a)(ii)] The net wealth of minor child will be included in the net wealth of that parent whose net wealth [excluding the assets of minor child so includible under section 4(1)] is greater. Assets transferred to a person or an association of persons - An asset transferred by an individual after March 31, 1956 to a person or an association of person, directly or indirectly, for the benefit of the transferor, his or her spouse, otherwise than for adequate consideration, is deemed asset of transferor [Section 4(1)(a)(iii)] Assets transferred under revocable transfers - The asset is transferred by an individual to a person or an association of person after March 31, 1956, under a revocable transfer is deemed asset of transferor [Section 4(1)(a)(iv)] Assets transferred to sons wife [Section 4(1)(a)(v)] - The asset transferred by an individual after May 31, 1973, to sons wife, directly or indirectly, without adequate consideration will be deemed asset of transferor [Section 4(1)(a)(iv)] Assets transferred for the benefit of sons wife - If the asset is transferred by an individual after May 31, 1973, to a person or an association of the immediate or deferred benefit of sons wife, whether directly or indirectly, without adequate consideration, it will be treated as deemed asset of the transferor [Section 4(1)(a)(vi)]. Interest of partner- Where the assessee (may or may not be an individual) is a partner in a firm or a member of an association of persons, the value of his interest in the assets of the firm or an association shall be included in the net wealth of the partner/member. For this purpose, interest of partner/member in the firm or association of persons should be determined in the manner laid down in Schedule III to the Wealth-tax Act [Section 4(1)(b)]. Admission of minor to benefits of the partnership firm - If a minor is admitted to the benefits of partnership in a firm, the value of his interest in the firm shall be included in the net wealth of parent of minor in accordance with the provisions of section 4(1)(a)(ii). It will be determined in the manner specified in Schedule III. Conversion by an individual of his self-acquired property into joint family property - If an individual is a member of a Hindu undivided family and he converts his separate property into property belonging to his Hindu undivided family, or if he transfers his separate property to his Hindu undivided family, directly or indirectly, without adequate consideration, the converted or transferred property shall be deemed to be the property of the individual and the value of such property is includible in his net wealth [Section 4(1A)] If there was such transfer and if the converted or transferred property becomes the subject-matter of a total or a partial partition among the members of the family, the converted or transferred property or

DIRECT TAXATION I 28.3

Wealth Tax any part thereof, which is received by the spouse of the transferor, is deemed to be the asset of the transferor and is includible in his net wealth. Gifts by book entries - Where a gift of money from one person to another is made by means of entries in the books of account maintained by the person making the gift, or by an individual, or a Hindu undivided family, or a firm or an association of persons, or a body of individuals with whom he has business connection, the value of such gift will be included in the net wealth of the person making the gifts, unless he proves to the satisfaction of the Wealth-tax Officer that the money had actually been delivered to the other person at the time the entries were made [Section 4(5A)] Impartible estate - For the purpose of the Wealth-tax Act, the holder of an impartible estate shall be deemed to be the owner of all the properties comprised in the estate [Section 4(6)] Property held by a member of a housing society - Where the assessee is a member of a co-operative housing society and a building or part thereof is allotted or leased to him, the assessee is deemed to be the owner of such building and the value of such building is includible in computing his net wealth. In determining the value of such building, any outstanding instalments, payable by the assessee to the society towards the costs of such house, are deductible as debt owed by the assessee. The above rules are also applicable if the assessee is a member of a company or an association of persons [Section 4(7)] Property held by a person in part performance of a contract [Section 4(8)] - A person who is allowed to take or retain possession of any building or part thereof in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882. Similarly, a person can acquire any rights, excluding any rights by way of a lease from month to month or for a period not exceeding one year, in or with respect to any building or part thereof, by virtue of transaction as is referred to in section 269UA(f) of the Income-tax Act. In above cases, the assets are taxable in the hands of beneficial owners, in the same manner in which they are taxed under the Income-tax Act : 28.1.3 Assets which are exempt from tax The following assets are exempt from wealth-tax, as per section 5. Property held under a trust - Any property held by an assessee under a trust or other legal obligation for any public purpose of charitable or religious nature in India is totally exempt from tax. [Section 5(i)]. Business assets held in trust, which are exempt - The following business assets held by as assessee under a trust for any public charitable/religious trust are exempt from tax (a) where the business is carried on by a trust wholly for public religious purposes and the business consists of printing and publication of books or publication of books or the business is of a kind notified by the Central Government in this behalf in the Official Gazette (b) the business is carried on by an institution wholly for charitable purposes and the work in connection with the business is mainly carried on by the beneficiaries of the institution (c) the business is carried on by an institution, fund or trust specified in sections 10(23B) or 20(23C) of the Income-tax Act. Any other business assets of a public charitable/religious trust is not exempt. Coparcenary interest in a Hindu undivided family - If the assessee is a member of a Hindu undivided family, his interest in the family property is totally exempt from tax [Section 5(ii)]. Residential building of a former ruler - The value of any one building used for the residence by a former ruler of a princely State is totally exempt from tax [Section 5(iii)] Former rulers jewellery - Jewellery in possession of a former ruler of a princely State, not being his personal property which has been recognised as a heirloom is totally exempt from tax [Section 5(iv)]

28.4 I DIRECT TAXATION

The jewellery shall be permanently kept in India and shall not be removed outside India except for a purpose and period approved by the Board. Reasonable steps shall be taken for keeping that jewellery substantially in its original shape. Reasonable facilities shall be allowed to any officer of the Government, or authorised by the Board, to examine the jewellery as and when necessary. Assets belonging to the Indian repatriates - Assets (as given below) belonging to assessee who is a person of Indian origin or a citizen of India, who was ordinarily residing in a foreign country and who has returned to India with intention to permanently reside in India, is exempt. A person shall be deemed to be of Indian origin if he, or either of his parents or any of his grand-parents, was born in undivided India. After his return to India, following shall not be chargeable to tax for seven successive assessment years (a) moneys brought by him into India (b) value of asset brought by him into India (c) moneys standing to the credit of such person in a Non-resident (External) Account in any bank in India on the date of his return to India and (d) value of assets acquired by him out of money referred to in (a) and (c) above within one year prior to the date of his return and at any time thereafter [Section 5(v)] One house or part of a house - In the case of an individual or a Hindu undivided family, a house or a part of house, or a plot of land not exceeding 500 sq. meters in area is exempt. A house is qualified for exemption, regardless of the fact whether the house is self-occupied or let out. In case a house is owned by more than one person, exemption is available to each co-owner of the house [Section 5(vi)] 28.2 VALUATION OF ASSETS The value of an asset, other than cash, shall be its value as on the valuation date determined in the manner laid down in Schedule III. Valuation of a building - Value of any building or land appurtenant thereto, or part thereof, is to be made in accordance with Part B of Schedule III to the Wealth-tax Act The first step is to find out gross maintainable rent. Gross maintainable rent is (a) annual rent received/ receivable by the owner or annual value of the property as assessed by local authority, whichever is higher (if the property is let out) or (b) annual rent assessed by the local authority or if the property is situated outside the jurisdiction of a local authority, the amount which the owner can reasonably be expected to receive as annual rent had such property been let (if the property is not let). In the following cases actual rent shall be increased in the manner specified below : (a) Taxes borne by tenant (b) If property is rented, one-ninth of actual rent will be added, if expenditure on repairs in respect of the property is borne by the tenant (c) Interest @ 15% on deposit given by tenant or difference (d) Premium received as consideration for leasing of the property or any modification of the terms of the lease will be divided over the number of years of the period of the lease and will be added to actual rent (d) If there derives any benefit or perquisite as consideration for leasing of the property or any modification of the terms of the lease, the value of such benefit or perquisite shall be added to actual rent. Net maintainable rent is determined by deducting from the gross maintainable rent (a) the amount of taxes levied by any local authority in respect of property (deduction is available even if these are to be borne by the tenant) ; and (b) A sum equal to 15% of gross maintainable rent. The net maintainable rent is finally capitalized to arrive as value of net asset. This can be done by multiplying the net maintainable rent by 12.5. If the property is constructed on leasehold land, net maintainable rent is to be multiplied by 10 when the unexpired period of lease of such land is 50 years or more and multiplied by 8 where the unexpired period of lease of such land is less than 50 years). If a property is acquired/constructed after March 31, 1974, then the value of the house property is determined as above. Original cost of construction/acquisition plus cost of improvement of the house property is calculated. The higher of the above is taken as capitalised value of net maintainable rent. This exception is applicable in respect one house property. The cost of acquisition/construction (plus cost of improvement) does not exceed ` 50 lakh, if the house is situated at Mumbai, Kolkata, Delhi and Chennai (` 25 lakh at any other place).

DIRECT TAXATION I 28.5

Wealth Tax If unbuilt area of the plot of land on which the property is built exceeds the specified area, premium is to be added to the capitalised value determined above. After calculating capitalized value of net maintainable rent as above, the next step is to add a premium to it if unbuilt area of the plot of land on which the property is built exceeds the specified area. Unbuilt area means the part of such aggregate area on which no building has been erected, where aggregate area means the aggregate of the area on which the property is built and also the unbuilt area. Specified area means: (1) Where the property is situated at Mumbai, Kolkata, Delhi or Chennai 60% of the aggregate area, (2) Where the property is situated at Agra, Ahmedabad, Amritsar, Allahabad, Bangalore, Bhopal, Cochin, Hydrabad, Indore, Jabalpur, Jamshedpur, Kanpur, Lucknow, Ludhiana, Madurai, Nagpur, Patna, Pune, Salem, Sholapur, Srinagar, Surat, Tiruchirapalli, Trivandrum, Vadodara or Varanasi 65% of the aggregate area, (3) Where the property is situated at any place other than specified in (1) and (2) 70% of the aggregate area. However, where the minimum area of the plot required to be kept as open space, for the enjoyment of the property exceeds the specified area, such minimum area is deemed to be the specified area. The amount of premium to be added to the capitalised value of net maintainable rent is determined as follows: The excess of unbuilt area over specified area Not more than 5% of the aggregatet value More than 5% but not more than 10% of the aggregate value More than 10% but not more than 15% of the aggregate value More than 15% but not more than 20% of the aggregate value More than 20% of the aggregate value Premium Nil 20% of capitalised value 30% of capitalised value 40% of capitalised value Rules given in Part B of Schedule III are not applicable. Value of the asset is estimated either by Assessing Office himself or by Valuation Office if reference is made to him.

The value so arrived after adding premium to the capitalized value of net maintainable rent is called Adjusted Net Maintainable Rent. The next step is to deduct the amount of unearned increment payable or 50% of the value of the property, whichever is less [if the value of the property includes any unearned increment payable]. Valuation of self-occupied property - If assessee owns a house (or a part of the house), being an independent residential unit and is used by the assessee exclusively for his residential purposes throughout 12 months ending on the valuation date, valuation will be as per provisions of section 7(2). Assessee can either take value of the house as determined above on the valuation date relevant for the current assessment year or he can take value of the house, as determined above, on the first valuation date next following the date on which he became the owner or the valuation relevant for the assessment year 1971-72, whichever is later. The choice is of the assessee. Where the house has been constructed by the assessee, he shall be deemed to have become the owner thereof on the date on which the construction of such house was completed.

28.6 I DIRECT TAXATION

Valuation of assets of business - If the assessee is carrying on a business for which accounts are maintained by him regularly, the net value of the assets of the business as a whole, having regard to the Balance Sheet of such business on the valuation date, is taken as value of such assets [Part D, Schedule III]. (A) The assets are valued as follows - Depreciable assets - Written down value, plus 20%, Non-depreciable assets (other than stock-in- trade) - Book value, plus 20%, Closing stock - Value adopted for the purpose of income- tax, plus 20%. (B) The value of house property, life interest, jewellery and other assets is calculated as per other provisions of Wealth Tax Act. Where (A) < (B) = (B) is taken as value of the assets Where (A) > (B) = Aggregate value of depreciable assets, non-depreciable assets and closing stock is taken as value of the assets. Higher of A or B is taken as value of assets. Value of interest in firm or association of persons - The net wealth of the firm on the valuation date is ascertained. For determining the net wealth of the firm (or association), no account shall be taken of the exemptions given by section 5. The portion of the net wealth as is equal to the amount of the capital of the firm or association is allocated amongst the partners or the members in the proportion in which capital has been contributed by them. The residue of the net wealth is allocated amongst the partners or the members in accordance with the agreement of the partnership or association of persons for the distribution of assets in the event of dissolution of the firm or association or in the absence of such agreement, in the proportion in which the partners (or members) are entitled to share profits [Part E, Schedule III] Value of life interest - The value of life interest of an assessee shall be determined as per Part F, Schedule III. Average net annual income of the assessee derived from the life interest during 3 years ending on the valuation date is calculated. While computing net annual income, expenses incurred on the collection of such income (maximum of 5% of the average of annual gross income) shall be deducted. This is multiplied as per formula prescribed to arrive at value of asset. Valuation of jewellery - The value of jewellery shall be estimated to be the price which it would fetch if sold in the open market on the valuation date (i.e., fair market value). Where the value of jewellery does not exceed ` 5,00,000, a statement in Form No. O-8A is to be submitted. Where the value of the jewellery exceeds ` 5,00,000, a report of a registered valuer in Form No. O-8 should be submitted. The report is not binding on Assessing Officer (Valuation Officer) and he can determine fair market value of jewellery. The value of jewellery determined by the Valuation Officer for any assessment year shall be taken to be the value of such jewellery for the subsequent four assessment years subject to the prescribed adjustments. Valuation of any other asset - The value of any asset, other than cash (being an asset which is not covered in above) shall be estimated either by the Assessing Officer himself or by the Valuation Officer if reference is made to him under section 16A. In both these cases, the value shall be estimated to be the price which it would fetch if sold in the open market, on the valuation date. If the asset is not saleable in the open market, the value shall be determined in accordance with guidelines or principles specified by the Board from time to time by general or special order. 28.3 OTHER ISSUES RELATING TO WEALTH TAX Charitable or religious trusts - A trust can forfeit exemption for any of the following reasons - (a) any part of the trusts property or any income of the trust, including income by way of voluntary contributions, is used for the benefit of the settlor, the trustee, their relatives etc.; or (b) any part of the income of the trust, created on or after April 1, 1962, including income by way of voluntary contributions, enures directly or indirectly, for the benefit of any of the persons referred to in section 13(3) of the Income-tax Act ; or (c) any funds of the trust are invested or deposited or any shares in a company are held by the trust in

DIRECT TAXATION I 28.7

Wealth Tax contravention of the investment pattern for trust funds laid down in section 11(5) of the Income-tax Act. In such case, tax shall be leviable upon and recoverable from the trustee or manager in respect of the property held by him under trust at the rate of tax applicable to a resident in India. These provisions are not applicable in the case of a scientific research association [Section 10(21) of the Income-tax Act] and in the case of any institution, fund or trust referred to in section 10(22), (22A), (22B) or (23C) of the Income- tax Act in specified situations [Section 21A] Association of persons where shares of members are indeterminate/unknown - If assets chargeable to wealth-tax are held by an association of persons and the individual shares of the members in the income or assets of the association are indeterminate or unknown, wealth-tax is levied to the same extent as it would be leviable upon and recoverable from an individual who is citizen of India and resident in India [Section 21AA] Return of wealth and assessment Every person is required to file with the Wealth-tax Officer a return of net wealth in Form BA, if his net wealth or net wealth of any other person in respect of which he is assessable under the Act on the valuation date is of such an amount as to render him liable to wealth-tax. Return can be filed on or before the due date specified under section 139 of the Income-tax Act. Return in response to a notice - In the case of any person who, in the opinion of Wealth-tax Officer, is assessable to tax, the Wealth-tax Officer may, before the end of the relevant assessment year, issue a notice requiring him to furnish, within 30 days from the date of service of such notice, a return of net wealth in the prescribed form. Assessment - The assessee is required to pay the tax before filing of the return and such return is to be accompanied by the proof of such payment. Provisions of regular assessment, as applicable under Income Tax, will apply to wealth tax also. Interest or penalty and prosecution - Interest @ 1% per month is payable for failure to pay wealth tax on due date. Penalty and prosecution provisions also apply. Recent Amendments Section 17 Wealth-escaping assessment : This section is amended w.e.f. 1-7-2012 It is now provided in this section that if any person is found to have any asset or financial interest in any entity located outside India, it will be deemed to be a case where net wealth chargeable to tax has escaped assessment. In such cases the wealth tax assessment can be reopened by the AO within 16 years. Section 17A Time limit for completion of assessment and reassessment : This section is amended w.e.f. 1-7-2012. As discussed earlier, while considering the amendments in sections 153 and 153B of the Income tax, this amendment has the effect of increasing the time limit by 3 months for completion of assessment/reassessment proceedings. Section 45 : This section provides for exemption from wealth tax to companies registered u/s 25, co-operative societies, social clubs, recognised political parties, mutual funds, etc. This list is now expanded to provide that the Reserve Bank of India will not be liable to pay wealth tax w.e.f. 1-4-1957.

28.8 I DIRECT TAXATION

Whether to be

Whether to be deducted
Debts located outside India

Assets located Assets located Debts located in in India outside India

India

1 (A) In case of a citizen of India

resident and ordinarily resident in India resident but not ordinarily resident in India non-resident

Yes

Yes

Yes

Yes

Yes

No

Yes

No To be deducted if it is incurred , in relation to asset located in India

Yes

No

Yes Not to be deducted if it is incurred, in relation to asset located outside India

No To be deducted if it is incurred, in relation to asset located in India

The scope of net wealth in case of three assesses may be summarized as under: 1 (B) In case of an individual who is a foreign national (Residential Status in this case shall not have an y effect) Yes No Yes Not to be deducted if it is incurred, in relation to asset located outside India 2. In case of HUF resident and ordinary resident non-resident or resident but not ordinarily resident in India Yes No Yes Not to be deducted if it is incurred, in relation to asset located outside India No To be deducted if it is incurred, in relation to asset located in India Yes Yes Yes
Yes

No To be deducted if it is incurred, in relation to asset located in India

DIRECT TAXATION I 28.9

Wealth Tax In case of a company resident non-resident Yes Yes Yes No Yes Yes Yes No

Not to be To be deducted if it is deducted if it incurred, in relation to is incurred, in asset located in India relation to asset located outside India If any asset is includible in the computation of net wealth of a person, the debt incurred in relation to that asset shall be deductible whether such debt is located in India or outside India. On the other hand, if any, asset is not includible in the computation of net wealth, the debt, whether located in India or outside India, incurred in relation to that asset shall also be excluded.

28.10 I DIRECT TAXATION

ILLUSTRATIONS ON WEALTH TAX Illustration 1 : ALtd is engaged in the construction of residential flats. For the valuation date 31.3.2013, it furnishes the following data and requests you to compute the taxable wealth (a) Land in urban area (Construction is not permitted as per Municipal Laws in force) ` 55,00,000 (b) Motor-cars (used on hire by the company) ` 10,00,000 (c) Jewellery (Investment) ` 25,00,000. Loan taken for purchasing the same ` 20,00,000 (d) Cash Balance (as per books) ` 2,75,000 (e) Bank Balances ` 5,50,000 (f) Guest House (situated in a place which is 30 Kms away from the local limits of the municipality) ` 10,00,000 (g) Residential flats occupied by the Managing Director ` 15,00,000. The Managing Director is on whole time appointment and is drawing remuneration of ` 2,00,000 per month. (h) Residential house were let out on hire for 200 days ` 10,00,000 Solution : Valuation Date: 31.03.2013 Nature of asset Land in Urban Area Motor Cars Jewellery Cash Balance Bank Balance Guest House Residential Flat occupied by MD Residential House Let-out Total Assets Less: Debt incurred in relation to an asset: Loan for Jewellery Taxable Net Wealth Less : Basic Exemption Taxable Net Wealth Tax Payable @1% Computation of Taxable Wealth ` Reason NIL Land in which construction is not permitted as per municipal law is not an asset u/s 2(ea) NIL 25,00,000 NIL NIL 10,00,000 Motor cars used in business of hire is not an asset u/s 2(ea) Not held as stock in trade Cash as per books - Not an asset u/s 2(ea) Asset u/s 2(ea)

15,00,000 Asset u/s 2(ea) since Annual Gross Salary is greater than `10,00,000. 10,00,000 Asset U/s 2(ea) as it is not let-out for a period - 300 days. 60,00,000 (20,00,000) 40,00,000 30,00,000 10,00,00 10,000

Illustration 2. Samir furnishes the following particulars for the compilation of his Wealth Tax return for Assessment Year 2013-14. (a) Gifts of jewellery made to wife from time to time aggregating ` 80,000.Market value on valuation date `3,00,000 (b) Flat purchased under installment payment scheme in 1990 for ` 9,50,000. Used for purposes of his residence and market value as on 31.3.2013. (Installment remaining unpaid ` 80,000) ` 10,00,000 (c) Urban land transferred to minor handicapped child valued on 31.3.2013 ` 5,00,000.

DIRECT TAXATION I 28.11

Wealth Tax Solution : Valuation Date: 31.03.2013 Particulars Gift of Jewellery made to wife Flat used for residence Computation of Taxable Wealth
Taxable

Reasons Deemed asset u/s 4. Fair Market Value of the Jewellery is taxable. Taxable as an asset u/s 2(ea) but the assessee can claim exemption u/s 5(vi). So full value of the asset is exempt from tax. Asset held by the minor who is handicapped u/s 80U, clubbing provisions does not apply.

` 3,00,000 NIL

Urban Plot in the hands of the minor NIL

Illustration 3. Compute the net wealth of Nivedita, a resident individual as on 31.3.2013 from the following particulars furnished (a) She has a house property at Delhi, valued at ` 20,00,000 which is occupied by a firm in which she is a partner for its business purposes. Another house at Mumbai, valued at ` 8,00,000 is being used for his own business. (b) Vehicles for personal use - (i) Motor Car ` 10,00,000 (ii) Motor Van ` 3,00,000 (iii) Jeep ` 5,00,000 (c) Cash in hand - ` 3,10,000 (d) Jewellery - ` 10,00,000 (e) Nivedita has gifted to a Trust a residential property situated at Kolkata purchased 5 years back for ` 20,00,000 for the benefit of the smaller HUF consisting of herself and her spouse and let-out for 8 months. Schedule-Ill, Rule 3 value as on 31.3.2013 is ` 14 Lakhs. (f) She had transferred an urban house plot in February 1999 in favour of her niece which was not revocable during her life time. This niece died on 14.3.2013. Nivedita could get the title to the plot retransferred to her name only on 15.4.2013 despite sincere and honest efforts. The market value of the house as on 31.3.2013 is ` 10,00,000. (g) Nivedita is the holder of an impartible estate in which urban agricultural lands of the value of ` 4,30,000 as on 31.3.2013 are comprised.

28.12 I DIRECT TAXATION

Solution : Assessee: Ms. Nivedita Nature of Asset House Property at Delhi used for business by a firm in which he is a partner House Property at Mumbai used for his own business Vehicles for Personal Use 1. Motor-car 2. Motor-van 3. Jeep Cash in Hand Jewellery Property at Kolkata transferred to a Trust 20,00,000
Less: Exemption u/s 5(vi) 20,00,000

Valuation Date: 31.3.2013 Computation of Net Wealth Amount Reasons

Taxable

Assessment Year: 2013-14

NIL Property used for business purpose is not an asset u/s 2(ea) NIL Property used for business purpose is not an asset u/s 2(ea) 10,00,000 Vehicles used for personal purposes are assets 3,00,000 u/2(ea) 5,00,000 2,60,000 For an Individual, cash in excess of ` 50,000 shall be chargeable to Wealth Tax u/s 2(ea) (`3,10,000 - `50,000) 10,00,000 Jewellery other than those held as stock-in-trade are asset u/s 2(ea) Taxable u/s 4(1A). Value = Higher of Value as on Valuation Date `14 Lakhs or Cost of Acquisition ` 20 Lakhs

NIL

Urban House Plot transferred to 10,00,000 Taxable u/s 4(5) as the title to the property stands Niece vested in Niveditas hands immediately on nieces demise Urban Agricultural Land NET WEALTH Less : Basic Exemption Taxable Net Wealth Taxable Payable @ 1%
4,30,000

Holder of an impartible estate is deemed to be the owner of all properties comprised therein u/s 4(6)

44,90,000 30,00,000 14,90,000 14,900

Illustration 4. SIPRA Constructions Ltd. is engaged in the construction of residential flats. For the valuation date 31.3.2012, furnishes the following data and requests you to compute the taxable wealth: (a) Land in urban area (construction is not permitted as per Municipal laws in force) ` 50 lakhs (b) Motor-cars (in the use of company) `10 lakhs (c) Jewellery (Investment) `10 lakhs (d) Cash balance (As per books) ` 3 lakhs (e) Bank Balance (As per books) ` 6 lakhs (f) Guest House (Situated in rural area) ` 8 lakhs

DIRECT TAXATION I 28.13

Wealth Tax (g) Residential flat occupied by Managing Director (Annual remuneration of whom is ` 11 Lakhs excluding perquisites) ` 10 lakhs (h) Residential house let-out for 100 days in the financial year ` 5 lakhs (i) Loan obtained for : Purchase of Motor Car ` 3 lakhs Purchase of Jewellery ` 2 lakhs Valuation Date: 31.3.2013
Reasons

Assessee: SIPRA Constructions Ltd. Nature of Asset Land in Urban Area Motor-cars Jewellery Cash Balance Bank Balance Guest House Residential Flat occupied by MD Let-out Residential House Property TOTAL ASSETS Less: Debt incurred in relation to Assets 1. Purchase of Motor-car 2. Purchase of Jewellery NET WEALTH Less : Basic Exemption Taxable Net Wealth Taxa Payable @ 1% (` Lakhs)

Assessment Year: 2013-14

Amount taxable

NIL Land in which construction is not permitted as per municipal laws is not an asset u/s 2(ea) 10 Motor-car other than those used in the business of hire or held as stock-in-trade is an asset u/s 2(ea) 10 Not held as stock-in-trade - asset u/s 2(ea) NIL Cash as per books - not an asset u/s 2(ea) NIL Not an asset u/s 2(ea) 8 Asset u/s 2(ea) 10 Asset u/s 2(ea)-since Gross Annual Salary of Managing Director is greater than ` 10 Lakhs 5 Asset u/s 2(ea) - since not let-out for a period exceeding 300 days 43

(3) (2) 38 30 8 8,000

Illustration 5. Sunrise Promoters & Developers Ltd. a widely held company owns the following assets as on 31.3.2013 : (a) Land at Rajarhat (West Bengal) purchased in 2003 on which a residential complex consisting of 24 flats, to be sold on ownership basis, is under construction for last 18 months (b) Two office flats at Noida purchased for resale in the year 2004 (c) Shares of Group Companies, break-up value of which is ` 19,00,000 (d) Cash at construction site ` 8,00,000 (e) Residential flat in occupation of companys whole-time director drawing a salary of `4,50,000 per annum. Which of the above assets will be liable for wealth? Give reasons in brief.

28.14 I DIRECT TAXATION

Solution : Assessee: Sunrise Promoters & Developers Ltd. Valuation Date: 31.3.2013 Assessment Year: 2013-14 Nature of Asset Land at Rajarhat purchased in 2006 Residential Flats at Noida purchased in 2005 for resale Shares of Group Companies Cash at construction site Residential House Property for Whole-Time Director
Taxable

Amount

Reasons NIL Urban Land held as stock-in-trade for a period less than 10 Years -not an asset u/s 2(ea) NIL House Property held as stock-in-trade - not an asset u/s 2(ea) NIL Not an asset u/s 2(ea) NIL Any amount recorded in the books of account is not an asset u/s 2(ea) NIL Since Gross Annual Salary of Whole Time Director is less than ` 10 Lakhs - not an asset u/s 2(ea)

Illustration 6. Hassan, a person of Indian origin was working in Australia since 1986. He returned to India for permanent settlement in June 2009 when he remitted the moneys into India. He furnished the following particulars of his wealth as on 31.3.2013. You are required to arrive at his wealth in respect of Assessment Year 2013-14 : (a) Market Value of Residential house in Jharkhand (let-out for residence) ` 10,00,000 with Net Maintainable Rent p.a. of ` 1,20,000. (b) Share in building owned by a firm in which Hassan is a Partner - used for business ` 5,00,000 (c) Motor-car purchased in April 2010, out of moneys remitted to India from Australia ` 4,00,000 (d) Value of interest in Firm excluding item (b) above ` 5,00,000 (e) Shares in companies (quoted) ` 2,00,000 (f) Assets purchased out of amount remitted from Australia : Jewellery purchased in March 2002 ` 5,50,000 Vacant land purchased in October 2000 ` 10,00,000

(g) Amount standing to the credit of NRE Account ` 15,00,000 (h) Cash in hand (out of sale proceeds of agricultural income) ` 65,000

DIRECT TAXATION I 28.15

Wealth Tax Solution : Nature of Asset Residential House in Jharkhand Share in the building owned by the firm Motor-car 4,00,000 Less: Exempt u/s 5(v)-acquired out of money brouqht into India (4,00,000) Value of Interest in a Firm Shares in Companies Value of Jewellery Vacant Land Money in NRE A/c Cash in Hand in excess of ` 50,000 NET WEALTH Tax Liability Since less than the Basic Exemption limit. Illustration 7. Romit Roy, a Not Ordinarily Resident in India seeks your advice with regard to the furnishing of his Wealth Tax Return. The value of assets held on 31.3.2013 is indicated below. You are requested to compute the Taxable Wealth. Motor cars of foreign make held as Fixed Assets `26 lakhs Gold bonds under Gold Deposit Scheme, 2000 `25 lakhs Residential House Property at Kolkata let out w.e.f.10.2.2012 `30 lakhs Jewellery held `20 lakhs Lands purchased for industrial purpose: (a) on 1.1.2006 ` 7 lakhs (b)on 24.2.2012 `10 lakhs Loans against the purchase of land : (a) on 1.1.2007 ` 4 lakhs (b) on 24.2.2012 `5 lakhs Fixed Assets located in Abu Dhabi ` 80 lakhs Cash at Bank `4 lakhs Cash in Hand ` 80,000 Mrs. Roy acquired out of gifts received from her husband: (a) Shares and securities `3,00,000 NIL 5,00,000 Assumed as deemed asset u/s 4(1)(b) NIL Not an asset u/s 2(ea) 5,50,000 Asset u/s 2(ea) - Not entitled for exemption 10,00,000 Asset u/s 2(ea) - Purchased in October 2000 NIL Not an asset u/s 2(ea) 15,000 Asset u/s 2(ea), being an Individual 20,65,000 Nil Assessee: Hassan Valuation Date: 31.3.2013 Computation of Net Wealth Amount Reasons
Taxable

NIL Not an Asset u/s 2(ea) - Let-out for whole year -Hence, not taxable NIL Not an asset u/s 2(ea), used for its own business - not chargeable to tax Asset u/s 2(ea). But, exemption available u/s 5(v), since acquisition out of money brought into India.

(b) Residential House property at Bangalore `20,00,000

28.16 I DIRECT TAXATION

Solution : Assessee : Romit Roy Nature of Asset Motor-cars Gold Bonds, 2000 Residential House Property Jewellery Land purchased on 1.1.06 for Industrial Purpose Land purchased 24.2.2012 Cash-in-Hand Cash-at-Bank Fixed Asset located in Abu Dhabi Deemed Assets acquired and held by Mrs.Roy (a) Shares and Securities (b) Res.House Property at Bangalore 20,00,000 Less: Exemption u/s 5(vi) (20,00,000) Total Assets Less: Debts incurred on Taxable Assets On Land acquired on 1.1.2006 Net Wealth Less: Basic Exemption Taxable Wealth Tax Payable @ 1%

Valuation Date : 31.3.2013 Computation of Taxable Wealth ` Reasons

Assessment Year : 2013-14

26,00,000 Motor-car other than those used in the business of hire or held as stock-in-trade is an asset u/s 2(ea) Nil Not an asset under WT Act. Nil Any residential house property let-out for 300 days or more is not an asset 20,00,000 Jewellery other than those held as stock-in-trade is an asset 7,00,000 Land held beyond two years from the date of acquisition for industrial purposes is an asset Nil Land held for first two years from the date of acquisition for industrial purposes is not an asset 30,000 Cash held beyond ` 50,000 is an asset Nil Not an asset under WT Act. Nil Not chargeable to tax for Not Ordinary Resident Nil Not an asset u/s 2(ea) Asset u/s 2(ea).

Nil One house or part of the house exempt u/s 5(vi) 53,30,000 Wealth Tax Liability and Debts incurred in relation to exempted assets are not deductible (4,00,000) 49,30,000 30,00,000 19,30,000 19,300

VALUATION OF IMMOVABLE PROPERTY Illustration 8. Abhishek, a person of Indian origin was working in Austria since 1991. He returned to India for permanent settlement in May 2012 when he remitted money into India. For the valuation date 31.3.2013, the following particulars were furnished. You are required to compute the taxable wealth. The reason for inclusion or exclusion should be stated Building owned and let-out for 270 days for residence. Net maintainable rent `1,00,000 and the Market Value (Excess of Unbuilt Area over Specified Area is 20% of the Aggregate Area) ` 30 lakhs Jewellery : (a) Purchased in April 2012 out of money remitted to India from Austria `12,00,000

DIRECT TAXATION I 28.17

Wealth Tax (b) Purchased in May 2012 out of sale proceeds of motor-car brought from abroad and sold for ` 40 lakhs. Value of interest in urban land held by a firm in which he is a partner `10 lakhs Bonds held in companies `10 lakhs Motor car used for own business ` 25 lakhs Vacant house plot of 480 sq. mts. (purchased in December 2003) market value of ` 20,00,000 Cash in hand ` 45,000 Urban land purchased in the year 2012 out of withdrawals of NRE Account ` 15,00,000 Valuation Date : 31.3.2013 Computation of Net Wealth Nature of the Asset Value of the House Jewellery: Purchased in April 2012 Less: Exempt u/s 5(v) Jewellery: Purchased in May 2012 Less: Exempt u/s 5(v) Interest in Urban Land held by firm Bonds held in companies Motor car Vacant House Plot (480 sq. mts.) Less: Exempt u/s 5(vi) Cash in hand Urban Land Purchased Less: Exempt u/s 5(v) NET WEALTH Less : Basic Exemption Net Taxable Wealth Tax Payable @ 1% (1) Working Notes: Valuation of Building : Net Maintainable Rent(NMR) = `1,00,000 Capitalized Value of NMR=NMR12.5 (Owner of the land) = ` 1,00,000 12.5 = `12,50,000 Add : Premium for excess of unbuilt area (20%) over specified area = 40% of CNMR = ` 5,00,000 VALUE OF THE HOUSE ` 17,50,000 15,00,000 (15,00,000) 20,00,000 (20,00,000) 12,00,000 (12,00,000) 40,00,000 (40,00,000) ` ` Reasons 17,50,000 Asset u/s 2(ea). Working Note 1 Nil Asset u/s 2(ea). Purchased out of money brought into India Nil Asset u/s 2(ea).Purchased out of sale proceeds of assets brought into India 10,00,000 Deemed Asset u/s 4(1)(b) Not an asset u/s 2(ea) Asset u/s 2(ea). Not held as stock-in25,00,000 trade Nil Asset u/s 2 (ea).House/part of house/ plot less than 500 sq.mts. Nil Since not exceeding ` 50,000 Nil Purchased out of money brought into India 52,50,000 30,00,000 22,50,000 22,500 Nil Assessment Year : 2013-14

Solution : Assessee : Abhishek

28.18 I DIRECT TAXATION

Illustration 9. Mr. Kushal Sengupta owns a house at Jharkhand, which is let-out at `1,35,000 per annum. The annual value of the property as per municipal records also is `1,00,000. Municipal taxes are partly borne by the owner (`5,000) and partly by the tenant (`6,000). Repair expenses are borne by tenant (`10,000) the difference between the un-built area and specified area does not exceed 5%. The property was acquired on 10.5.1998 for ` 15,00,000. Determine for purposes of Wealth Tax Act, the value of the property as on 31.3.2013 on the following situations (a) The house is built on a freehold land. (b) It is built on a leasehold land, the unexpired period of lease of the land is more than 50 years. (c) If the area of the plot on which the house is built is 800 sq. meters. FSI, permissible is 1.4 and FSI utilised is 1088 Sq. metres. (136 Sq. metres 8 Storeys) Solution : Assessee : Mr. Kushal Sengupta Valuation Date : 31.3.2013 For Situations (a) & (b): Computation of Value of House Property Computation of Gross Maintainable Rent (Amount in `) Particulars Actual Annual Rent Add: Municipal Taxes borne by the tenant
l/9th of Actual Rent Receivable since repair expenses are borne by the tenant (`1,35,000/ 9)

Assessment Year : 2013-14

No Rental Deposit 1,35,000 6,000 15,000 Nil 1,56,000 11,000 23,400 1,21,600 15,20,000 12,16,000 15,00,000 15,00,000

Rental Deposit excess of 3 Mths 1,35,000 6,000

15,000

Rental Deposits - 15% Interest on ` 1,00,000 GROSS MAINTAINABLE RENT Less: Municipal Taxes Paid Less: 15% of Gross Maintainable Rent Net Maintainable Rent Case (a) Capitalization of Net Maintainable Rent -Freehold Land NMR x 12.5 Case (b) Capitalization of Net Maintainable Rent -Leasehold Land - Unexpired Lease 50 Years = NMR10 Property Acquired after 31.3.1974 i.e. 10.5.1999 Therefore, Value of the Property (whether on Lease-hold Land or on Freehold Land) For Situation (c) : In case of excess unbuilt area :

15,000 1,71,000 11,000

25,650 1,39,350 16,79,375

13,43,500
15,00,000 15,00,000

Unbuilt Area = (Actual Area of the Land less Built up Area) = (800 sq. mt less 136 sq. mt). = 664 sq. mt. Excess Unbuilt Area = (Unbuilt Area less Specified Area) = 664 sq. mt. less 70% of 800 sq. mt. = 664 Less 560 = 104 sq. mt % of Excess Unbuilt Area = Excess Unbuilt Area 100/Aggregate Area = 104 100/800 = 13% Therefore, Value of the Property = Substituted Net Maintainable Rent i.e. `15,00,000 + 30% of SNMR = ` 19,50,000

DIRECT TAXATION I 28.19

Wealth Tax Illustration 10. From the following dated furnished by Mr.Soumitra, determine the value of house property built on leasehold land as at the valuation date 31.3.2012 : Particulars Annual Value as per Municipal valuation Rent received from tenant (Property vacant for 3 months during the year) Municipal tax paid by tenant Repairs on property borne by tenant Refundable deposit collected from tenant as security deposit which does not carry any interest The difference between unbuilt area and specified area over aggregate area is 10.5%. Solution : Assessee: Mr. Soumitra Valuation Date: 31.3.2012 Computation of Value of House Property Step I: Computation of Gross Maintainable Rent(GMR) Particulars Actual Annual Rent- ` 1,08,000 x 12 Months/9 Months Add: Municipal tax paid by the Tenant
l/9th of Actual Rent Receivable as repair expenses are borne by the tenant - ` 1,44,000/9

` 1,40,000 1,08,000 10,000 8,000 50,000

Assessment Year: 2013-14

` 10,000 16,000 5,625

` 1,44,000

Interest on Refundable Security Deposit- ` 50,000 x 15% x 9/12 GROSS MAINTAINABLE RENT (GMR) Step II: Computation of Net Maintainable Rent (NMR) Particulars Gross Maintainable Rent (GMR) Less: Municipal Taxes levied by the local authority 15% of Gross Maintainable Rent - ` 1,75,625 x 15% NET MAINTAINABLE RENT (NMR)

31,625

17,05,625

` 10,000 26,399

` 1,76,000
(36,399)

1,39,281

Step III: Capitalisation of the Net Maintainable Rent (CNMR) (Assumed that unexpired lease period is more than 50 Years) NMR Multiple Factor for an Unexpired Lease Period - ` 1,39,281 10 = ` 13,92,810 Step IV: Addition of Premium to SNMR in case of excess inbuilt area: Particulars Add: Capitalisation of the Net Maintainable Asset Premium for excess of 10.5% unbuilt area over specified area-30% of CNMR Value of House Property as per Wealth Tax Act ` 13,92,810 4,17,843 18,10,653

28.20 I DIRECT TAXATION

Illustration 11. Property Company Ltd. has let-out a premise with effect from 1.10.2012 for monthly rent of `1.5 lakh. The lease is valid for 10 years and the tenant has made a deposit equivalent to 3 months rent. The tenant has undertaken to pay the municipal taxes of the premises amounting to ` 2 lakh. What will be the value of the property under Schedule III of the Wealth Tax Act for assessment to wealth tax? Solution : Assessee: Property Company Ltd. Valuation Date: 31.3.2013 Assessment Year : 2013-14 Computation of Value of Let-out Property Actual Annual Rent Receivable - ` 1,50,000 12 Months Add: Municipal Taxes borne by the Tenant GROSS MAINTAINABLE RENT 18,00,000
2,00,000

20,00,000

Less: Municipal Taxes levied by the Municipal Authority Less: 15% of Gross 2,00,000 Maintainable Rent ` 20,00,000 15%) NET MAINTAINABLE RENT 3,00,000 15,00,000 Value of the Property = Capitalized Value of NMR NMR 8 (unexpired period of lease is less than 50 years) = ` 15,00,0008 = ` 1,20,00,000 VALUATION OF PARTNERS INTEREST IN FIRM Illustration 12. Net wealth of firm consisting of three partners Bidyut, Kingshuk and Deepak in 2:2:1 and a capital contribution of `17 Lakhs, `13 Lakhs, and `12 Lakhs respectively is as under (a) Value of assets located outside India
(b) (c)

` 30,00,000 ` 80,00,000 ` 40,00,000

Value of assets located in India Debts incurred in relation to assets in India

Determine the value of interest of the partners in the firm under the Wealth Tax Act, 1957. Solution : Assesses : Bidyut, Kingshuk & Deepak Valuation Date : 31.3.2013 Computation of net wealth of the Firm Particulars Value of Assets located in India Less: Liability in relation to assets in India Value of Assets located outside India Net Wealth of the Firm Solution : Computation of Interest of the Partner in the net wealth of the Firm (Amount in `) Particulars To the extent of Capital Contribution Balance (Net Wealth-Capital Contribution) in Profit sharing ratio since dissolution ratio is not given Interest of the Partner in the Net Wealth of the Firm Bidyut 17,00,000 11,20,000 28,20,000 Kingshuk 13,00,000 11,20,000 24,20,000
Deepak

Assessment Year: 2013-14

` 80,00,000 40,00,000

` 40,00,000 30,00,000 70,00,000

12,00,000
5,60,000 17,60,000

DIRECT TAXATION I 28.21

Wealth Tax Computation of the Interest of the Partner in the net wealth of the Firm on the basis of location of assets: (Interest of the Partner in the Firm apportioned in the ratio of 4:3) Particulars Assets Located Inside India Assets Located Outside India Interest of the Partner in the Net Wealth of the Firm VALUATION OF LIFE INTEREST Illustration 13. Satender is aged 35 years. His father settled a property in trust giving whole life interest therein to Satender. The income from the property for the years 2008-09 to 2011-12 was ` 70,000, ` 84,000, ` 90,000, ` 108,000, respectively. The expenses incurred each year were ` 2,000, ` 4,000, ` 5,000 and `6,000 respectively. Calculate the value of life interest of Mr. Jogi in the property so settled on the valuation date 31.3.2012, with the help of the factor of 9.267. Step Procedure 1
2 3 4 5

Balu 16,11,429 12,08,571 28,20,000

Kausik 13,82,857 10,37,143 24,20,000

Deepu

10,05,714 7,54,286
17,60,000

Average Income for last three years = ( ` 84,000 + ` 90,000 + ` 1,08,000)/ 3 = ` 94,000. Average Expenses for the last three years = (` 4,000 + ` 5,000 + ` 6,000) / 3 = ` 5,000. Maximum Permissible Expenses = Average Expenses or 5% of Average Income, whichever is less = 5% of ` 94,000 = ` 4,700 Average Annual Income = ` 94,000 Less ` 4,700 = ` 89,300. Life Interest=Average Annual IncomeLife Interest Factor = ` 89,300 9.267 = ` 8,27,543.

Illustration 14.X received a vacant site under his fathers will. The value of the site on 31.3.2013 is `15 Lakhs. As per terms of the Will in the event X wants to sell the site he should offer it to his brother for sale at `10 Lakhs. X, therefore, claims that the value of the site should be taken at `10 Lakhs as at 31.3.2013. Is the claim correct? Solution : 1. As per Rule 21 of Schedule III to the Act, the price or other consideration for which any property may be acquired by or transferred to any person under the terms of a deed of trust or through or under any restrictive agreement in any instrument of transfer shall be ignored for the purpose of determining the value under the provisions of the Schedule.

2. In view of the above, the value of the site should be taken as ` 15 Lakhs and not as ` 10 Lakhs. 3. Therefore, claim of X is incorrect.

28.22 I DIRECT TAXATION

Section - C INTERNATIONAL TAXATION & TRANSFER PRICING

Study Note - 29
TAXATION OF INTERNATIONAL TRANSACTIONS
This Study Note includes 29.1 International Taxation and Transfer Pricing Introduction 29.2 International Transaction 29.3 Arms Length Principle 29.4 Transfer Pricing Classification of Methods 29.5 Steps in the process of computing Arms length price Transfer Pricing (TP) Study 29.6 Transfer Pricing issues 29.7 Cross-border transactions 29.8 Associated Enterprise 29.9 Computation of Arms Length Price 29. 1 INTERNATIONAL TAXATION AND TRANSFER PRICING INTRODUCTION The source rule/statutory provision relating to levy and collection of tax liability on international transactions is empowered through Sec.92 to 92F of the Income Tax Act, 1961. These provisions were inserted by the Finance Act, 1976. With the opening up of global economy, apart from goods, there has been transfer or transaction relating to rendering of services cross-border. There is a magnanimous increase in the volume of cross-border transactions, which calls for attracting the provisions of Indirect Taxes in India. There arises the necessity and therefore leads to computation of reasonable, fair and equitable profit and tax in India are not being eroded of Indian tax revenue. Any income arising from an international transaction shall have to be computed having regard to arms length price. 29.2 INTERNATIONAL TRANSACTION As per Sec. 92B of the Income Tax Act,1961, (1) For the purposes of this section and sections 92, 92C, 92D and 92E, international transaction means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise.

DIRECT TAXATION I 29.1

Taxation of International Transactions 29.3 ARMS LENGTH PRINCIPLE The arms length principle seeks to ensure that transfer prices between members of an MNE (controlled transactions), which are the effect of special relationships between the enterprises, are either eliminated or reduced to a large extent. It requires that, for tax purposes, the transfer prices of controlled transactions should be similar to those of comparable transactions between independent parties in comparable circumstances (uncontrolled transactions). In other words, the arms length principle is based on the concept that prices in uncontrolled transactions are determined by market forces and, therefore, these are, by definition, at arms length. In practice, the arms-length price is also called market price. Consequently, it provides a benchmark against which the controlled transaction can be compared. The Arms Length Principle is currently the most widely accepted guiding principle in arriving at an acceptable transfer price. As circulated in 1995 OECD guidelines, it requires that a transaction between two related parties is priced just as it would have been if they were unrelated. The need for such a condition arises from the premise that intra-group transactions are not governed by the market forces like those between two unrelated entities. The principle simply attempts to place uncontrolled and controlled transactions on an equal footing. 29.2.1 Why Arms Length Pricing? The basic object of determining Arms Length Price is to find out whether any addition to income is warranted or not, if the following situations arises: (a) Selling Price of the Goods < Arms Length Price (b) Purchase Price > Arms Length Price Total Income as disclosed by an Assessee Add: Understatement of profit due to overstatement of purchase price Add: Understatement of profit due to understatement of selling price Total Income after Assessment 29.2.2 Role of market forces in determining the Arms Length Price In case of transactions between Independent enterprises, the conditions of their commercial and financial relations (eg. The price of goods transferred or services provided and the conditions of the transfer or provision) are, ordinarily, determined by the market force. Whereas, In case of transactions between MNEs (Multinational Enterprises), their commercial and financial relations may not be affected by the external forces in the same way, although associated enterprises often seek to replicate the dynamics of the market forces in their dealings with each other. 29.2.3 Difficulties in applying the arms length principle The arms length principle, although survives upon the international consensus, does not necessarily mean that it is perfect. There are difficulties in applying this principle in a number of situations. (a) The most serious problem is the need to find transactions between independent parties which can be said to be exact compared to the controlled transaction. (b) It is important to appreciate that in an MNE system, a group first identifies the goal and then goes on to create the associated enterprise and finally, the transactions entered into. This procedure obviously does not apply to independent enterprises. Due to these facts, there may be transactions within an MNE group which may not be between independent enterprises. (c) Further, the reductionist approach of splitting an MNE group into its component parts before XXXX XXX XXX XXXX

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evaluating transfer pricing may mean that the benefits of economies of scale, or integration between the parties, is not appropriately allocated between the MNE group. (d) The application of the arms length principle also imposes a burden on business, as it may require the MNE to do things that it would otherwise not do (i.e. searching for comparable transactions, documenting transactions in detail, etc). (e) Arms length principle involves a lot of cost to the group. 29.4 TRANSFER PRICING CLASSIFICATION OF METHODS In order to ensure that a transfer price meets the arms length standard, the OECD (Organization for Economic Co-operation and Development) guidelines have indicated five transfer pricing methods that can be used. These methods fall in two categories: (1) Traditional Transaction Methods; (2) Transactional Profit Methods. As per Sec.92C of the Income Tax Act, 1961, the methods for determining Arms Length Price may be represented as under: (1) Comparable Uncontrolled Price Method, (2) Resale Price Method, (3) Cost plus Method, (4) Profit Split Method, (5) Transactional Net Margin Method, (6) Such other method as may be prescribed by the Board.

TRANSACTION BASED METHODS COMPARABLE UNCONTROLLED PRICE METHOD RESALE PRICE METHOD COST PLUS METHOD

PROFIT BASED METHODS PROFIT SPLIT METHOD TRANSACTION NET MARGIN METHOD

29.5 STEPS IN THE PROCESS OF COMPUTING ARMS LENGTH PRICE TRANSFER PRICING(TP)STUDY Transfer Pricing Study (TP Study) is the prime document which is used during transfer pricing assessment. The statement of particulars to be furnished in the Annexure to Form No.3CEB for the Income Tax Act, 1961 assessment, has thirteen clauses. The following are the steps to be followed:Step 1 Step 2 Step 3 Selection of comparable companies Use of different filters Screening of comparables based on FAR

DIRECT TAXATION I 29.3

Taxation of International Transactions Step 4 Step 5 Step 6 Use of Power under Indirect Tax laws [ special reference to Sec.133(6) of the Income Tax Act,1961] Adjustments 5% Safe Harbour

The steps may be enumerated as follows: Step 1: Selection of Comparable Companies The first step for doing this study is to select comparable companies. This can be selected in the following four ways:(a) Industry-wise selection (b) Product-wise selection (c) NIC Code-wise selection (d) Segment-wise selection The data relating to the financial year in which the international transaction has been entered into must be used in analyzing the comparability of an uncontrolled transaction with an international transaction. Step 2: Use of different filters Once there is a selection of comparable companies, the next step is to filter these companies with the use of quantitative and qualitative filters. The following filters are also used sometimes: (a) Companies whose data is not available for the relevant year (b) Companies for which sufficient financial data is not available to undertake analysis (c) Different financial year filter (d) Turnover filter (e) Service Income filter (f) Export filter (g) Diminishing Loss filter (h) Related party filter (i) (j) (l) Companies that had exceptional year/(s) of operation Employee cost filter Fixed Asset filter

(k) Onsite and offsite filter (m) Research & Development Expense filter (n) Income Tax filter Step 3: Screening of comparables based on FAR Comparability of an international transaction with an uncontrolled transaction shall have to be judged with relevance to the following factors: (a) The specific characteristics of the property transferred or services provided in either transaction; (b) FAR Analysis- the (F) functions performed, taking into account (A)assets employed or to be employed or the (R) risks assumed by the respective parties to the transactions; (c) The contractual terms ( whether or not such terms are formal or in writing) of the transactions which

29.4 I DIRECT TAXATION

lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) Conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, overall economic development and level of competition and whether the markets are wholesale or retail. There may arise situation, where it requires further analysis of the following factors:(i) Is there a public issue in the relevant year or previous year? (ii) Are the entitys profits exempted from tax? (iii) Is there any merger/de-merger, etc., during the relevant time? (iv) Is the depreciation policy different? (v) Is there a wide difference between various segments profitability? (vi) Is the area of operation, i.e. geography different? (vii) Is the volume of operation different? Step 4: Use of power under Indirect Tax Laws This power is usually used by the Revenue Department/Authorities, with a special reference to Sec.133(6) of the Income Tax Act,1961. The authorities may exercise such powers for getting details which are generally not available in the annual reports of the companies. This power is used more in the earlier years. Step 5: Adjustments Based on specific characteristics of the property transferred or the services rendered in either transaction and the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions. The following enterprise level and transaction level adjustments are suggested: (a) Functional differences (b) Asset differences (c) Risk differences (d) Geographical location (e) Size of the market (f) Wholesale or retail market (g) The laws and governmental orders in force (h) Cost of labour (i) (j) (l) (i) Cost of capital in the markets Overall economic development Accounting practices Working capital adjustment

(k) Level of competition However, in practice the following adjustments are provided: (ii) Risk adjustment

DIRECT TAXATION I 29.5

Taxation of International Transactions (iii) Volume/geographical/depreciation/idle capacity/first year operation, etc. Step 6: 5% Safe Harbour (a) If the application of the MAM (Most Appropriate Method) leads to determination of more than one price, the arithmetical mean of such prices shall be taken to be the Arms Length Price (ALP) in relation to the international transaction. (b) If the ALP so determined is within +/- 5% range of international transaction price, then no adjustments are required (c) If the ALP is not within +/- 5% range of the international transaction price, then adjustments are required for the whole difference between the ALP and international transactions and benefit of 5% will not be available. However, the Finance Act, 2012 has fixed the upper limit of safe harbor as 3%. 29.6 TRANSFER PRICING ISSUES In the content of International Transactions and ascertainment of arms length price, the following issues are surfaced. These needs to be further examined in the light of applicable statutory provisions of Indirect Tax laws in India. 29.6.1 Key current and emerging TP Audit issues in India Indian transfer pricing administration over the past 10 years has witnessed several challenges in administration of transfer pricing law. In the above backdrop, this chapter highlights some of the emerging transfer pricing issues and difficulties in implementation of arms length principle. 29.6.2 Key Issues for consideration (a) Challenges in the comparability analysis - Increased market volatility and increased complexity in international transaction have thrown open serious challenges to comparability analysis and determination of arms length price. (b) Issue relating to risks - A comparison of functions performed, assets employed and risks assumed is basic to any comparability analysis. India believes that the risk of a MNE is a byproduct of performance of functions and ownership, exploitation or use of assets employed over a period of time. Accordingly, risk is not an independent element but is similar in nature to functions and assets. In this context, India believes that it is unfair to give undue importance to risk in determination of arms length price in comparison to functions performed and assets employed. (c) Arms length range - Application of most appropriate method may set up comparable data which may result in computation of more than one arms length price. Where there may be more than one arms length price, mean of such prices is considered. Indian transfer pricing regulations provide that in such a case the arithmetic mean of the prices should be adopted as arms length price. If the variation between the arithmetic mean of uncontrolled prices and price of international transaction does not exceed 3% or notified percentage of such transfer pricing, then transfer price will be considered to be at arms length. In case transfer price crosses the tolerance limit, the adjustment is made from the central point determined on the basis of arithmetic mean. Indian transfer pricing regulation do not mandate use of inter quartile range. (d) Comparability adjustment - Like many other countries, Indian transfer pricing regulations provide for reasonably accurate comparability adjustments. The onus to prove reasonably accurate comparability adjustment is on the taxpayer. The experience of Indian transfer pricing administration indicates that it is possible to address the issue of accounting difference and difference in capacity utilization and intensities of working capital by making comparability adjustments. However, Indian transfer pricing administration finds it extremely difficult to make risk adjustments in absence of any reliable and robust and internationally agreed methodology to provide risk adjustment. In some

29.6 I DIRECT TAXATION

cases taxpayers have used Capital Asset Pricing Method (CAPM). (e) Location Savings - It is view of the Indian transfer pricing administration that the concept of location savings which refer to cost savings in a low cost jurisdiction like India should be one of the major aspects to be considered while carrying out comparability analysis during transfer pricing audits. Location savings has a much broader meaning; it goes beyond the issue of relocating a business from a high cost location to a low cost location and relates to any cost advantage. MNEs continuously search options to lower their costs in order to increase profits. India provides operational advantages to the MNEs such as labour or skill employee cost, raw material cost, transaction costs, rent, training cost, infrastructure cost, tax incentive etc. (i) Highly specialized skilled manpower and knowledge (ii) Access and proximity to growing local/regional market (iii) Large customer base with increased spending capacity (iv) Superior information network (v) Superior distribution network (vi) Incentives (vii) Market premium The incremental profit from LSAs is known as location rents. The main issue in transfer pricing is the quantification and allocation of location savings and location rents among the associated enterprises. Under arms length pricing, allocation of location savings and rents between associated enterprises should be made by reference to what independent parties would have agreed in comparable circumstances. The Indian transfer pricing administration believes it is possible to use the profit split method to determine arms length allocation of location savings and rents in cases where comparable uncontrolled transactions are not available. In these circumstances, it is considered that the functional analysis of the parties to the transaction (functions performed, assets owned and risks assumed), and the bargaining power of the parties (which at arms length would be determined by the competitiveness of the market availability of substitutes, cost structure etc) should both be considered appropriate factors.

(f) Intangibles - Transfer pricing of intangibles is well known as a difficult area of taxation practice. However, the pace of growth of the intangible economy has opened new challenges to the arms length principle. Seventy five percent of all private R&D expenditure worldwide is accounted for by MNEs. The transactions involving intangible assets are difficult to evaluate because of the following reasons: (i) Intangibles are seldom traded in the external market and it is very difficult to find comparables in the public domain.

(ii) Intangibles are often transferred bundled along with tangible assets. (iii) They are difficult to be detected. A number of difficulties arise while dealing with intangibles. Some of the key issues revolve around determination of arms length price of rate of royalties, allocation of cost of development of market and brand in a new country, remuneration for development of marketing, Research and Development intangibles and their use, transfer pricing of cobranding etc.

(g) R&D activities - Several global MNEs have established subsidiaries in India for research and development activities on contract basis to take advantage of the large pool of skilled manpower

DIRECT TAXATION I 29.7

Taxation of International Transactions which are available at a lower cost. These Indian subsidiaries are generally compensated on the basis of routine and low cost plus mark up. The parent MNE of these R&D centres justify low cost plus markup on the ground that they control all the risk and their subsidiaries or related parties are risk free or limited risk bearing entities. The claim of parent MNEs that they control the risk and are entitled for major part of profit from R&D activities is based on following contentions: (i) Parent MNE designs and monitors all the research programmes of the subsidiary. (ii) Parent MNE provides fund needed for R&D activities. (iii) Parent MNE controls the annual budget of the subsidiary for R&D activities. (iv) Parent MNE controls and takes all the strategic decisions with regards to core functions of R&D activities of the subsidiary. (v) Parent MNE bears the risk of unsuccessful R&D activities. The Indian transfer pricing administration always undertakes a detailed enquiry in cases of contract R&D centres. Such an enquiry seeks to ascertain correctness of the functional profile of subsidiary and parent MNE on the basis of transfer pricing report filed by the taxpayers, as well as information available in the public domain and commercial databases. After conducting detailed enquiries, the Indian tax administration often reaches the following conclusions: (i) Most parent MNEs were not able to file relevant documents to justify their claim of controlling risk of core functions of R&D activities and asset (including intangible assets) which are located in the country of subsidiary or related party.

(ii) Contrary to the above, it was found that day to day strategic decisions and monitoring of R&D activities were carried out by personnel of subsidiary who were engaged in actual R&D activities and bore relevant operational risks. Marketing related intangible assets are used primarily in the marketing or promotion of products or services. This includes: Trademarks; Trade names; Service marks; Collective marks; Certification marks; Trade dress; Newspaper mastheads; Internet domain names; Non-competitive agreements

(h) Marketing Intangibles

(i) Customer-related intangible assets are generated through inter-action with various parties such as customers, entities in complimentary business, suppliers , etc. these can either be purchased from outside or generated internally. (i) Contractual basis: customer contracts and customer relationships; order or production backlog (ii) Non-contractual basis:- customer lists; non-contractual customer relationships;

(j) Artistic-related intangible assets are rights granted by Government or other authorized bodies to the owners or creators to reproduce or sell artistic or published work. These are on a contractual basis. These includes: Plays, opera and ballets; Books, magazines, newspapers and other literary works; Musical works; Picture and photographs; Video and audio-video material. (k) Intra-group Services - Globalization and the drive to achieve efficiencies within MNE groups have encouraged sharing of resources to provides support between one or more location by way of shared services. Since these intra group services are the main component of tax efficient supply chain management within an MNE group, the Indian transfer pricing authorities attach high priority to this aspect of transfer pricing. The tax administration has noticed that some of the services are relatively straight forward in nature like marketing, advertisement, trading, management consulting etc. However, other services may

29.8 I DIRECT TAXATION

be more complex and can often be provided on stand alone basis or to be provided as part of the package and is linked one way or another to supply of goods or intangible assets. An example can be agency sale technical support which obligates the licensor to assist the licensee in setting up of manufacturing facilities, including training of staff. The Indian transfer pricing administration generally considers following questions in order to identify intra group services requiring arms length remuneration: (i) Whether Indian subsidiaries have received any related party services i.e., intra group services? (ii) Nature and detail of services including quantum of services received by the related party. (iii) Whether services have been provided in order to meet specific need of recipient of the services? (iv) What are the economic and commercial benefits derived by the recipient of intra group services? (v) Whether in comparable circumstances an independent enterprise would be willing to pay the price for such services? (vi) Whether an independent third party would be willing and able to provide such services? The answers to above questions enable the Indian tax administration to determine if the Indian subsidiary has received or provided intra group services which requires arms length remuneration. Determination of the arms length price of intra group services normally involve following steps: (i) Identification of the cost incurred by the group entity in providing intra group services to the related party.

(ii) Understanding the basis for allocation of cost to various related parties i.e., nature of allocation keys. (iii) Whether intra group services will require reimbursement of expenditure along with markup. (iv) Identification of arms length price of markup for rendering of services. Intercompany loans and guarantees are becoming common international transactions between related parties due to management of cross border funding within group entities of a MNE group. Transfer pricing of inte company loans and guarantees are increasingly being considered some of the most complex transfer pricing issues in India. The Indian transfer pricing administration has followed a quite sophisticated methodology for pricing inter company loans which revolves around: (i) comparison of terms and conditions of loan agreement; (ii) determination of credit rating of lender and borrower; (iii) Identification of comparables third party loan agreement; (iv) suitable adjustments to enhance comparability. Transfer pricing administration is more than a decade old in India. However disputes are increasing with each transfer pricing audit cycle, due to the following factors: (i) Cross border transactions have increased exponentially in the last one decade. (ii) Lack of international consensus on taxation of certain group cross border transactions like intangible, financial transactions, intra group services etc. (iii) Difficulty in applying the arms length principle to complex transactions like business restructuring. (iv) Taxpayers in India can postpone payment of tax liability by resorting to litigation. (v) Availability of multiple channels to resolve disputes in India.

(l) Financial Transactions

DIRECT TAXATION I 29.9

Taxation of International Transactions 29.7 CROSS-BORDER TRANSACTIONS Cross Border Transaction services means services related to transaction which involve two or more countries. In India there are two Acts which primarily seems to show concern when a person (Indian Resident or foreign Resident) undertakes cross border transactions viz. (i) Foreign Exchange Management Act,1999 (ii) Income Tax Act,1961 Therefore it is imperative that a person needs to deal with both the above mentioned Acts to enter into a cross-border transaction. 29.7.1. Relevant provisions and the structure In terms of the provisions of Sec.5 (2) of the Income Tax Act,1961, non-residents are also liable to tax in India on the income received or deemed to be received in India. 29.7.1.1. Major charging provision The major charging provision is Sec.5(2) of the Income Tax Act,1961. Two major and specific tests are required to determine the incidence of tax and tax liability thereafter. The tests are related to determining:(i) Whether Income Accruing or Arising in India or not; (ii) Whether the Source of Income is India or not. 29.7.1.2. Deeming provisions The major provisions laying down the source rule are contained in sections 9(1)(vii), 44D,44DA and 115A of the Income Tax Act,1961. There are some specific provisions also related to imposing tax liability on cross-border services, which are, Sections 44B, 44BB, 44BBA, 44BBB. Section 9(1)(vii) Deals with Fees for technical services paid by the Government or a resident is deemed to accrue or arise in India unless such services are utilized by a resident for business or profession carried on outside India or for the purpose of earning income from any source outside India. Fees for technical services paid by a non-resident is deemed to accrue in India only if such services are utilized in a business carried on in India by the non-resident or are utilized for the purpose of earning income from any source in India. 44D Restriction on the right of foreign company to claim deduction for expenses from income in the nature of royalties or fees for technical services received from the Government or an Indian concern as follows: Date of Signature of Agreement Before April 1,1976 restriction on deduction for expenses deduction allowed upto 20% of gross amount of fees for technical services

After 31st March,1976 but before April No deduction allowed. 1,2003 This section is applicable to foreign companies only and not to any other non-residents.

29.10 I DIRECT TAXATION

44DA

Specific provisions dealing with royalties/fees for technical services after 31st March,2003 Provisions laid down in this section emphasizes to harmonise the provisions relating to income from royalty or fees for technical services attributable to a fixed place of profession or permanent establishment in India with similar provisions in various tax treaties. In terms of the provisions of this section, deduction is available for expenses from royalty or fees for technical services to a non-resident if :

(i) (ii) (iii) (iv)

Royalties or FTS are received from Government or an Indian concern Agreement is made after 31st March,2003 Business is carried on in India through a permanent establishment Professional services are provided from fixed place of profession

(v) Right, property or contract for which royalty/fees for technical services arises is effectively connected with the permanent establishment or fixed place of profession.
Permanent Establishment is defined in Sec.92F (iiia),which includes a fixed place of business through which the business of the enterprise is wholly or partly carried on. There are three types of Permanent Establishments (PEs):

(i) Basic rule PE a fixed place of business, office, branch, installation, etc (ii) Service PE presence of employees (iii) Agency PE presence of dependent agent
44C The provision starts with a non-obstante clause, i.e. Notwithstanding anything to the contrary contained in section 28 to 43A... This section overrides Sections 28 to 43A and accordingly the words computation under the head profits and gains of business or profession in accordance with the provisions of ITA would mean that deduction of head office expenses would be allowed subject to restrictions contained in Section 44C. 44DA This section is inserted with a view to harmonize the provisions relating to the income from royalty or fees for technical services attributable to a fixed place of profession or a permanent establishment in India with a similar provisions in various DTAAs.

29.8 ASSOCIATED ENTERPRISE The term associated enterprise has been defined in a broad manner. Based on the same, the following illustrates the definition when Enterprise X (X) would be the associated enterprise of Enterprise Y (Y) : X participates, directly or indirectly, or through one or more intermediaries, in the management, control4 or capital of Y and one or more of the requisites enlisted below are fulfilled; or The same persons participate in the management, control or capital of X, as also that of Y and one or more of the requisites enlisted below are fulfilled. X and Y would be deemed to be associated enterprises if at any time during the previous year: X holds directly or indirectly shares carrying at least 26% voting power in Y or vice versa;

DIRECT TAXATION I 29.11

Taxation of International Transactions Any person holds directly or indirectly shares carrying at least 26% voting power in both X and Y; A loan advanced by X to Y amounts to atleast 51% of book value of the total assets of Y or vice versa; X guarantees at least 10% of the total borrowings of Y or vice versa; More than half of the directors or members of the governing board, or one or more of the executive directors or executive members of the governing board of X are appointed by Y or vice versa; More than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board of X and Y are appointed by the same person(s); The manufacture / processing of goods/articles by, or business of, X, is wholly dependent on use of intangibles or any other commercial rights of similar nature, or any data, documentation or drawing etc., owned by Y or for which Y has exclusive rights; or Atleast 90% of raw materials for the manufacture or processing of goods or articles required by X are supplied by Y or persons specified by Y under commercial terms influenced by Y or; Goods / articles manufactured / processed by X are sold to Y or persons specified by Y, and Y influences the commercial terms relating to the sale or; X is controlled by Mr. A and Y is controlled by Mr. A or relative of Mr. A either individually or jointly; X is controlled by a Hindu Undivided Family, and Y is controlled by a member of such Hindu Undivided Family or by a relative of a member of such Hindu Undivided Family, or jointly by such member and his relative; or X is a firm, association of persons or body of individuals, and Y holds atleast 10% interest in such firm, association of persons or body of individuals; or There exists, between X and Y, any relationship of mutual interest, as may be prescribed (no such relationship has yet been prescribed). 29.9 COMPUTATION OF ARMS LENGTH PRICE 29.9.1. Comparable Uncontrolled Price method (CUP) Step I: Identify the price charged/ paid for property transferred or services provided in a comparable uncontrolled transaction(s). Step II: Adjust the price derived in Step I above for differences, if any, which could materially affect the price in the open market. (a) between the international transaction and the comparable uncontrolled transactions, or (b) between the enterprises entering into such transactions. Step III: Arms Length Price = Step I Add/Less: Step II Illustration 1. Jackle, Korea and CD Ltd, an Indian Company are associated enterprises. CD Ltd manufactures Cel Phones and sells them to Jackle, Korea & Fox, a Company based at Nepal. During the year CD Ltd supplied 2,50,000 Cellular Phones to Jackle Korea at a price of `3,000 per unit and 35,000 units to Fox at a price of `5,800 per unit. The transactions of CD Ltd with Jackle and Fox are comparable subject to the following considerations (a) Sales to Jackle are on FOB basis, sales to Fox are CIF basis. The freight and insurance paid by Jackle for each unit is `700. (b) Sales to Fox are under a free warranty for Two Years whereas sales to Jackle are without any such warranty. The estimated cost of executing such warranty is `500.

29.12 I DIRECT TAXATION

(c) Since Jackles order was huge in volume, quantity discount of `200 per unit was offered to it. Compute the Arms Length Price and the amount of increase in the Total Income of CD Ltd, if any, due to such Arms Length Price. A. Computation of Arms Length Price of Products sold to Jackle Korea by CD Ltd. Particulars Price per Unit in a Comparable Uncontrolled Transaction Less: Adjustment for Differences 700 500 200 (1,400) 4,400 (a) Freight and Insurance Charges (b) Estimated Warranty Costs (c) Discount for Voluminous Purchase Armss Length Price for Cellular Phone sold to Jackle Korea B. Computation of increase in Total Income of CD Ltd. Particulars Arms Length Price per Unit Less: Price at which actually sold to Jackle Korea Increase in Price per Unit No. of Units sold to Jackle Korea Therefore, increase in Total Income of CD Ltd (2,50,000 `1,400) = ` 35 Crores. ` ` 4,400 (3,000) 1,400 2,50,000 ` ` 5,800

29.9.2. Resale price method (rpm) Step I: Identify the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise. Step II: Reduce the normal GP margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from II) obtaining and providing the same or similar services, in a comparable uncontrolled transaction (s). Step III: Reduce expenses incurred by the enterprise in connection with the purchase of property or obtaining of services. Step IV: Adjust for functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market. Step V: Arms Length Price = Step I Less Step II & III Add / Less Step IV. Illustration 2. Swinhoe LLP of France and Rani Ltd of India are associated enterprises. Rani Ltd. imports 3,000 compressors for Air Conditioners from Swinhoe at `7,500 per unit and these are sold to Paharpur Cooling Solutions Ltd at a price of `11,000 per unit. Rani had also imported similar products from Cold Ltd and sold outside at a Gross Profit of 20% on Sales.

DIRECT TAXATION I 29.13

Taxation of International Transactions Swinhoe offered a quantity discount of `1,500 per unit. Cold could offer only `500 per unit as Quantity Discount. The freight and customs duty paid for imports from Poland had cost Rani `1,200 a piece. In respect of purchase from Cold Ltd, Rani had to pay `200 only as freight charges. Determine the Arms Length Price and the amount of increase in Total Income of Rani Ltd. A. Computation of Arms Length Price of Products bought from Swinhoe, France by Rani Ltd. Particulars Resale Price of Goods Purchased from Swinhoe Less: Adjustment for differences ` ` 11,000 2,200 1,000

(a) Normal gross profit margin @ 20% of sale price [20% `11,000] (b)
`500] Incremental Quantity Discount by Swinhoe [ ` 1,500

(c) Difference in Purchase related Expenses [`1,200 `200] 1,000 B. Arms Length Price Computation of Increase in Total Income of Rani Ltd Particulars Price at which actually bought from Swinhoe LLP of France Less: Arms Length Price per unit under Resale Price Method Decrease in Purchase Price per Unit No. of Units purchased from Swinhoe Increase in Total Income of Rani Ltd [3,000 Units`700] ` ` 7,500 (6,800) 700 1,000 `21,00,000 6,800

29.9.3. Cost plus Method in determining ALP Step I: Determine the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise. Step II: Determine the normal GP mark-up to such costs (computed under same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction(s). Step III: Adjust the normal gross profit mark-up referred to in Step II to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market. Step IV: Arms Length Price = Step I Add Step III Illustration 3. Branco Inc., a French Company, holds 45% of Equity in the Indian Company Chirag Technologies Ltd (CTL). CTL is engaged in development of software and maintenance of the same for customers across the globe. Its clientele includes Branco Inc.

29.14 I DIRECT TAXATION

During the year, CTL had spent 2,400 Man Hours for developing and maintaining software for Branco Inc, with each hour being billed at `1,300. Costs incurred by CTL for executing work for Branco Inc. amount to `20,00,000. CTL had also undertaken developing software for Harsha Industries Ltd for which CTL had billed at `2,700 per Man Hour. The persons working for Harsha Industries Ltd and Branco were part of the same team and were of matching credentials and caliber. CTL had made a Gross Profit of 60% on the Harsha Industries work. CTLs transactions with Branco Inc. are comparable to the transactions with Harsha Industries, subject to the following differences: (a) Branco gives technical know-how support to CTL which can be valued at 8% of the Normal Gross Profit. Harsha Industries does not provide any such support. (b) Since the work for Branco involved huge number of man hours, a quantity discount of 14% of Normal Gross Profits was given. (c) CTL had offered 90 Days credit to Branco the cost of which is measured at 2% of the Normal Billing Rate, No such discount was offered to Harsha Industries Ltd. Compute ALP and the amount of increase in Total Income of Chirag Technologies Ltd. (A) Computation of Arms Length Gross Profit Mark-up Particulars Normal Gross Profit Mark up Less : Adjustment for differences (a) Technical support from Branch [ 8% of Normal GP = 8% of 60%] (b) Quantity discount 14% of normal Gross profit [ = 14% of 60%] Add: Cost of Credit to Branco 2% of Normal Bill [2% GP 60%] Arms Length Gross Profit mark-up 4.80 8.40 1.20 (13.20) 46.80 1.20 48.00 ` ` 60.00

(B) Computation of Increase in Total Income of Branco Ltd Particulars Cost of services provided to CTL Arms length Billed Value [ Cost / [ (100 Arms Length mark up)] = ` 20,00,000 / (100% - 48%) Less: Billed amount [ 2,400 hours x ` 1,300 per hour] Therefore, Increase in Total Income of Branco 38,46,154 31,20,000 7,26,154 ` ` 20,00,000

29.9.4 Profit Split Method (PSM) This method is mainly applicable in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter-related that they cannot be evaluated separately for the purpose of determining the Arms Length Price of any one transaction. Step I: Determine the combined net profit of the associated enterprises arising from the international transaction in which they are engaged.

DIRECT TAXATION I 29.15

Taxation of International Transactions Step II: Determine the relative contribution made by each of the associated enterprises to the earning of such combined net profit. This is determined on the basis of the functions performed, assets employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be determined by unrelated enterprises performing comparable functions in similar circumstances. Step III: Split the combined net profit amongst the enterprises on the basis of reasonable returns and in proportion to their relative contributions, as determined in Step II. (See note below) Step IV: Arms Length Price - Profit apportioned to the assessee under Step III. Note: Combined Net Profit shall be split as under: III.A. First Split = Reasonable Return: Allocate an amount to each enterprise so as to provide it with a basic return appropriate for the type of international transaction with reference to market returns achieved in similar types of transactions by independent enterprises. III.B. Second Split = Contribution Ratio: Allocate the residual net profit amongst the enterprises in proportion to their relative contribution. III.C. Total Profit: Share of profit of each enterprise = Step III.A + III.B Illustration 4. NBR Medical Equipments Inc. (NBR) of Canada has received an order from a leading UK based Hospital for development of a hi-tech medical equipment which will integrate the best of software and latest medical examination tool to meet varied requirements. The order was for 3,00,000 Euros. To execute the order, NBR joined hands with its subsidiary Precision Components Inc. (PCI) of USA and Bioinformatics India Ltd (BIL), an Indian Company. PCI holds 30% of BIL. NBR paid to PCI and BIL Euro 90,000 and Euro 1,00,000 respectively and kept the balance for itself. In the entire transaction, a profit of Euro 1,00,000 is earned. Bioinformatics India Ltd incurred a Total Cost of Euro 80,000 in execution of its work in the above contract. The relative contribution of NBR, PCI and BIL may be taken at 30%, 30% and 40% respectively. Compute the Arms Length Price and the incremental Total Income of Bioinformatics India Ltd, if any due to adopting Arms Length Price determined here under:Particulars A. Share of each of the Associates in the Value of the Order value of the order: Share of BIL (given) Share of PCI (given) Share of NBR [ Amount retained = 3,00,000 1,00,000 90,000] B. Share of each of the Associates in the profit of the order Combined Total Profits Share of BIL [Contribution of 40% Total Profit 1,00,000] Share of PCI [Contribution of 30% Total Profit 1,00,000] Share of NBR [Contribution of 30% Total Profit 1,00,000] C. Computation of Incremental Total Income of BIL Total Cost to Bioinformatics India Ltd Add: Share in the Profit to BIL (from B above) Revenue of BIL on the basis of Arms Length Price Less: Revenue Actually received by BIL Increase in Total Income of BIL 80,000 40,000 1,20,000 (1,00,000) 20,000 Euros [ ] 3,00,000 1,00,000 90,000 1,10,000

1,00,000 40,000 30,000 30,000

29.16 I DIRECT TAXATION

29.9.5. TRANSACTION NET MARGIN METHOD (TNMM) Step I: Compute the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise, in relation to costs incurred or sales effected or assets employed by enterprise or having regard to any other relevant base. Step II: Compute the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction (s), having regard to the same base as in StepI. Step III: Adjust the net profit margin as per Step II for differences, if any, which could materially affect amount of net profit margin in the open market : (a) between the international transaction and the comparable uncontrolled transactions, or (b) between the enterprises entering into such transactions. Step IV: Net Profit Margin for uncontrolled transactions = Step II Add/Less Step III. Step V: Arms Length Price = Transaction Value x Net Profit Margin as per Step IV above. Meaning of certain terms: For the computation of Arms Length Price 1. Transaction includes a number of closely linked transactions. 2. Uncontrolled Transaction means a transaction between unrelated enterprises, whether resident or non-resident. 3. Unrelated Enterprises: Enterprises are said to be unrelated, if they are not associated or deemed to be associated u/s 92A. 4. Uncontrolled conditions: Conditions which are not controlled or suppressed or moulded for achievement of pre-determined results are said to be uncontrolled conditions. 5. Property includes goods, articles or things, and intangible property. 6. Services include financial services. Illustration 5. Fox Solutions Inc. a US Company, sells Laser Printer Cartridge Drums to its Indian Subsidiary Quality Printing Ltd at $ 20 per drum. Doc Solutions Inc. has other takers in India for its Cartridge Drums, for whom the price is $30 per drum. During the year, Fox Solutions had supplied 12,000 Cartridge Drums to Quality Printing Ltd. Determine the Arms Length Price and taxable income of Quality Printing Ltd if its income after considering the above is `45,00,000. Compliance with TDS provisions may be assumed and Rate per USD is `45. Also determine income of Doc Solutions Inc. Solution: A. Computation of Total Income of Quality Printing Ltd. Particulars Total Income before adjusting for differences due to Arms Length Price Add: Difference on account of adopting Arms Length price [ 12,000 x $ 20`45] Amount actually paid to Doc Solutions [12,000$ 30`45] Incremental Cost on adopting ALP U/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore, difference on account of ALP is ignored. Total Income of Quality Printing Ltd 45,00,000 (1,62,00,000) 54,00,000
1,08,00,000

` 45,00,000

DIRECT TAXATION I 29.17

Taxation of International Transactions B. Computation of Total Income of Fox Solutions Inc. The provisions relating to taxing income of Fox Solutions Inc., on applying Arms Length Price for transactions entered into by a Foreign Company is given in Circular 23 dated 23.7.1969, which is as follows: (i) Transactions Not Taxable in India: Transactions will not be subject tax in India if transactions are on principal-to-principal basis and are entered into at ALP, and the subsidiary also carries on business on its own.

(ii) Transactions Taxable in India if the Indian Subsidiary does not carry on any business on its own. The following are the other considerations in this regard (i) Adopting ALP does not affect the computation of taxable income of Fox Solutions Inc. if tax has been deducted at source or if tax is deductible.

(ii) Where ALP is adopted for taxing income of the Parent Company, income of the recipient Company (i.e.Quality Printing Ltd) will not be recomputed. Illustration6. Khazana Ltd is an Indian Company engaged in the business of developing and manufacturing Industrial components. Its Canadian Subsidiary Techpro Inc. supplies technical information and offers technical support to Khazana for manufacturing goods, for a consideration of Euro 1,00,000 per year. Income of Khazana Ltd is `90 Lakhs. Determine the Taxable Income of Khazana Ltd if Techpro charges Euro 1,30,000 per year to other entities in India. What will be the answer if Techpro charges Euro 60,000 per year to other entitles. (Rate per Euro may be taken at `50) Solution: Computation of Total Income of Khazana Ltd. Particulars When Price Charged for Comparable Uncontrolled Transaction
Price actually paid by Khazana Ltd [ 1,00,000 x 50]

1,00,000
50,00,000 65,00,000 (15,00,000) 90,00,000 Nil 90,00,000

50,000
50,00,000 30,00,000 20,00,000 90,00,000 20,00,000 1,10,00,000

Less: Price charged in Rupees ( under ALP) [ 1,30,000 x 50] [ 50,000 x 50] Incremental Profit on adopting ALP [A] Total Income before adjusting for differences due to Arms Length Price Add: Difference on account of adopting Arms Length Price [ if (A) is positive] Total Income of Khazana Ltd

Note: U/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore, difference on account of ALP which reduces the Taxable Income is ignored.

29.18 I DIRECT TAXATION

3.10 Explanatory Notes & Illustrations on the different Methods of determination of Arms Length Price u/s 92C of the Income Tax Act,1961 Method 1: Computation of Arms Length Price: COMPARABLE UNCONTROLLED PRICE METHOD (CUP) An uncontrolled price is the price agreed between unconnected parties for the transfer of goods and services. If this transfer is in all material respects comparable to transfers between associates, then that price becomes a comparable uncontrolled price. Under this method, the price at which a controlled transaction is carried out is compared to the price obtained in a comparable uncontrolled transaction. Rule 10B (1) (a) of the Income Tax Rules read with sub-section (2) of Section 92C, the CUP method is described as under: (i) The price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified;

(ii) Such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) The adjusted price arrived at sub-clause(ii) is taken to be an ALP in respect of the property transferred or services provided in the international transaction.1 Terms used: (1) Transaction: As per Sec.92F(v) the term transaction which is defined to include an arrangement, understanding or action in concert, whether or not such arrangement, understanding or action is formal or in writing or whether or not it is intended to be enforceable by legal proceeding. Transaction includes a number of closely linked transactions. (2) Uncontrolled Transaction: a transaction between enterprises other than associated enterprises, whether resident or non-resident. (3) Comparable Transaction: The OECD guidelines further states that an uncontrolled transaction is comparable to a controlled transaction (i.e. it is a comparable uncontrolled transaction) for purposes of the CUP method if one of the two conditions is met: (i) None of the differences(if any) between the transactions being compared or between the enterprises undertaking those transactions could materially affect the price in the open market;

(ii) Reasonably accurate adjustments can be made to eliminate the material effects of such differences. For the purposes of this section and sections 92,92C,92D and 92E, international transaction means a transaction between two or more associated enterprises, either or both of whom are non-residents,
Definition of CUP as per OECD Guidelines:

(4) International transaction : Sub-section (1) of Sec.92B defines the term as follows:
1

The CUP method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. If there is any difference between the two parties, this may indicate that the conditions of the commercial and financial relations of the associated enterprises are not at arms length , and that the price in the uncontrolled transaction may need to be substituted for the price in the controlled transaction.

DIRECT TAXATION I 29.19

Taxation of International Transactions in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. (5) Property includes goods, articles or things and intangible property. (6) Services include financial services. Scope:

Company C FP Manufacturer

Company B DC Unrelated Distributor

Company A Distributor
Company C sells toaster ovens to its subsidiary A and to unrelated distributor C. Toaster ovens sold to A and B are identical and there are no material differences between the C to A and C to B transactions. CUP is the most reliable (best) method. (1) Interest rate charged on a loan; (2) Royalty payment; (3) Industries where CUPs are more prevalent, for example, software development where products are often licensed to a third party; (4) The price charged for the transfer of a homogeneous item, such as traded commodity (5) Extracted raw materials; (6) Harvested crops; (7) Animal products; (8) Fungible chemicals; (9) Other fungible goods i.e. pen, pencil, clips, computer disk, etc.; (10) Transactions which are dependent on publicly available market quotations Methods of CUP: The CUP method provides the best evidence of an arms length price. CUP can be either of the following: (1) Internal CUP: this would be available if the taxpayer (or one of its group entities) enters into a comparable transaction with an unrelated party where the goods or services under consideration are same or similar.

29.20 I DIRECT TAXATION

Situations where Internal CUP may be applicable: (a) The tax payer or any other member of the group sells similar goods in similar quantities and under similar terms to an independent enterprise in a similar market. (b) The tax payer or another member of the group buys similar goods in similar quantities and under similar terms from an independent enterprise in a similar market (an internal comparable).

(2) External CUP: this would be applicable if a transaction between two independent enterprises involves comparable goods or services under comparable conditions. (a) An independent enterprise sells the particular product in similar quantities and under similar terms to another independent enterprise in a similar market; (b) An independent enterprise buys similar goods in similar quantities and under similar terms from another independent enterprise in a similar market.

DIRECT TAXATION I 29.21

Taxation of International Transactions Adjustments to CUP: There will be no comparable transactions to the ones under review and there will be a real doubt over how independent parties would have behaved. It is possible to adjust a potential comparable to take account of factors such as differences in volumes sold, markets traded in, terms of trade,etc. If there are differences between the controlled and uncontrolled transactions that would affect price, adjustments should be made to the price of the uncontrolled transaction according to the comparability provisions. The tax payer must provide sufficient proof by way of concrete documentation that the adjustments made were correct. (1) FAR Analysis; (2) Quality of the product or service; (3) Characteristics of the Property; (4) Contractual terms; (5) Level of the market; (6) Geographic market in which the transaction takes place; (7) Date of the transaction; (8) Intangible property associated with the sale; and (9) Foreign currency risks. Other important factors affecting CUP (1) Time of the transaction and multiple year data (2) Data and assumptions (3) Indirect CUP (4) Use of quotation medium (5) Extra ordinary market conditions Conditions for application of Comparable Uncontrolled Price Method: Where an assessee, being an associated enterprise as per Sec. 92A of the Act had entered into a transaction as per Sec. 92B of the Act, involving transfer of goods or rendering of services as per Sec.92F (v) of the Act, and where such a transaction is uncontrolled in nature, having classified to be a comparable transaction, the Assessing officer shall for the purpose of determining the Arms Length price, being satisfied that the transactions could materially affect the price in the open market and hence comparable; then reasonable adjustments shall be made to eliminate the material effects arising from such differences, for the purpose of determining the Arms Length Price. The adjustments for differences shall be made for: i) ii) iii) v) FAR Analysis; Quality of the product or service; Characteristics of the Property; Level of the market;

iv) Contractual terms; vi) Geographic market in which the transaction takes place; vii) Date of the transaction;

29.22 I DIRECT TAXATION

viii) Intangible property associated with the sale; ix) Foreign currency risks; x) Time of the transaction and multiple year data; xi) Data and assumptions; xii) Indirect CUP; xiii) Use of quotation medium; and xiv) Extra ordinary market conditions. Accountants Report: The arms length price as computed under this method shall be audited and certified in Form No. 3CEB vide Rule 10E. Steps in Computation of Arms Length Price using CUP Method: Step I: Identify the price charged/ paid for property transferred or services provided in a comparable uncontrolled transaction(s). Step II: Adjust the price derived in Step I above for differences, if any, which could materially affect the price in the open market. (a) between the international transaction and the comparable uncontrolled transactions, or (b) between the enterprises entering into such transactions. Step III: Arms Length Price = Step I Add/Less: Step II Computation of Arms Length Price as per Comparable Uncontrolled Price Method No. 1 2 Particulars Price charged or paid for property transferred or services rendered in a comparable uncontrolled transaction Add/Less: Adjustments for differences, having material affect on the price in the open market: i) Adjustments for FAR Analysis ii) Quality of the product or service iii) Characteristics of the Property iv) Contractual terms v) Level of the market vi) Geographic market in which the transaction takes place vii) Date of the transaction viii) Intangible property associated with the sale ix) Foreign currency risks x) Time of the transaction and multiple year data xi) Data and assumptions xii) Indirect CUP xiii) Use of quotation medium xiv) Extra ordinary market conditions Arms Length Price for the purpose of Sec.92C (1 -2) Amount (`) XXXXX

XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX

DIRECT TAXATION I 29.23

Taxation of International Transactions Illustrations on COMPARABLE UNCONTROLLED PRICE METHOD Illustration 1: J Inc. of Korea and CD Ltd, an Indian Company are associated enterprises. CD Ltd manufactures Cell Phones and sells them to J.K. & F Inc., a Company based at Nepal. During the year CD Ltd. supplied 2,50,000 Cellular Phones to J Inc. Korea at a price of `3,000 per unit and 35,000 units to JK & F Inc. at a price of `5,800 per unit. The transactions of CD Ltd with JK & F Inc. are comparable subject to the following considerations Sales to J Inc. are on FOB basis, sales to JK &F Inc. are CIF basis. The freight and insurance paid by J Inc. for each unit @ `700. Sales to JK &F Inc. are under a free warranty for Two Years whereas sales to J Inc. are without any such warranty. The estimated cost of executing such warranty is `500. Since J Inc.s order was huge in volume, quantity discount of `200 per unit was offered to it. Compute the Arms Length Price and the subsequent amount of increase in the Total Income of CD Ltd, if any. (a) Computation of Arms Length Price of Products sold to J Inc. Korea by CD Ltd Particulars Price per Unit in a Comparable Uncontrolled Transaction Less: Adjustment for Differences (a) Freight and Insurance Charges (b) Estimated Warranty Costs (c) Discount for Voluminous Purchase Armss Length Price for Cellular Phone sold to J Inc. Korea (b) Computation of Increase in Total Income of CD Ltd Particulars Arms Length Price per Unit Less: Price at which actually sold to J Inc. Korea Increase in Price per Unit No. of Units sold to J Inc. Korea Increase in Total Income of CD Ltd (2,50,000 x `1,400) Illustration 2: Comparable sales of same product DSM, a manufacturer, sells the same product to both controlled and uncontrolled distributo` The circumstances surrounding the controlled and uncontrolled transactions are substantially the same, except that the controlled sales price is a delivered price to the buyer and the uncontrolled sales are made F.O.B. DSMs factory. Differences in the contractual terms of transportation and insurance generally have a definite and reasonably ascertainable effect on price, and adjustments are made to the results of the uncontrolled transaction to account for such differences. In this case the transactions are comparable and internal CUP can be applied by comparing the prices of both, the controlled and uncontrolled transactions, albeit after subtracting the costs of transportation and insurance of the controlled transaction. Illustration 3: Effect of geographic differences FM, a foreign specialty radio manufacturer, also exports its radios to a controlled U.S. distributor, AM, which serves the United States. FM also exports its radios to uncontrolled distributors to serve in South America. The product in the controlled and uncontrolled transactions is the same, and all other circumstances ` 4,400 (3,000) 1,400 2,50,000 ` 35 Crores. 700 500 200 (1,400) 4,400 ` ` 5,800

29.24 I DIRECT TAXATION

surrounding the controlled and uncontrolled transactions are substantially the same, other than the geographic differences. The geographic differences e.g. differences in purchasing power, levels of economic development, etc, in two different geographies, are likely to have a material effect on price, for which accurate adjustments cannot be made and hence the transactions are not comparable. Thus, CUP method cannot be applied. Illustration 4: External Commercial Borrowing Pharma Ltd, an Indian company has borrowed funds from its parent company at LIBOR plus 150 basis points. The LIBOR prevalent at the time of borrowing is 4% for US$, thus its cost of borrowings is 5.50%. The borrowings allowed under the External Commercial Borrowings guidelines issued under FEMA, for example, say is LIBOR plus 250 basis points, then it can be said that Pharmas borrowing at 5.50% is less than 6.50% and thus at arms length. In this connection, one may rely on Rule 10B (2) (d) which specifies that the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the laws and government orders in force. Method 2: Computation of Arms Length Price: RESALE PRICE METHOD (RPM) The RPM is a direct method which comprises the gross margins (i.e. gross profit over sales) earned in transactions between related and unrelated parties for the determination of the arms-length price. The RPM method requires high level of functional comparability and is mainly applicable where the controlled party is a distributor. Rule 10B (1) (b) of the Income Tax Rules read with sub-section (2) of Section 92C, the RPM method is described as under: (i) The price at which property purchased or services obtained by the enterprises from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) Such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; (iii) The price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services; (iv) The price so arrived at is adjusted to take into account the functional and other differences including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market; (v) The adjusted price arrived at under sub-clause (iv) is taken to be an arms length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise. 2 Terms used: 1)
2

Transaction: As per Sec.92F(v) the term transaction which is defined to include an arrangement,
Definition of RPM as per OECD Guidelines :

a transfer pricing method based on the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. The resale price is reduced by resale price margin. What is left after subtracting the resale price margin can be regarded, after adjustment for other costs associated with the purchase of the product (i.e. custom duties) as an ALP of the original transfer of property between the associated enterprises. For the above purposes, the OECD Guidelines define Resale Price Margin as: a margin representing the amount out of which a reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit.

DIRECT TAXATION I 29.25

Taxation of International Transactions understanding or action in concert, whether or not such arrangement, understanding or action is formal or in writing or whether or not it is intended to be enforceable by legal proceeding. Transaction includes a number of closely linked transactions. 2) 3) Uncontrolled Transaction: a transaction between enterprises other than associated enterprises, whether resident or non-resident. Comparable Transaction: The OECD guidelines further states that an uncontrolled transaction is comparable to a controlled transaction (i.e. it is a comparable uncontrolled transaction) for purposes of the CUP method if one of the two conditions is met: i) ii) None of the differences(if any) between the transactions being compared or between the enterprises undertaking those transactions could materially affect the price in the open market; Reasonably accurate adjustments can be made to eliminate the material effects of such differences.

4)

International transaction : Sub-section (1) of Sec.92B defines the term as follows: For the purposes of this section and sections 92,92C,92D and 92E, international transaction means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Property includes goods, articles or things and intangible property. Services include financial services. Controlled party: Gross margin: Gross margin is calculated as a percentage on sales, earned in transactions between related and unrelated parties for the determination of the arms length price. Tested Party: As per the OECD guidelines, the tested party is ought to be the enterprise that offers a higher degree of comparability or would require lesser adjustment with uncontrolled companies. Consequently, the enterprise that requires the least amount of adjustments as compared to potentially comparable companies should be the tested party. Hence, in most cases, the tested party will be the least complex of the controlled tax payers and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables.

5) 6) 7) 8) 9)

29.26 I DIRECT TAXATION

Applicability of RPM: This method is ideally suited to measure the value of the services performed by a buyer or seller of goods who generally acts as a distributor and does not add a significant value to goods sold. It is applicable even with differences in products, as long as the functions performed are similar. However, it is less useful where goods are further processed or in nature of raw material. RPM is applied in a backward process. From the sale price to an unrelated third party, appropriate adjustments to the gross margin is made by comparing the transaction to other, third party transactions. (1) This method can be applied when there are no comparable uncontrolled sales and an applicable resale price is available within a reasonable time before or after the controlled sale. (2) Where the reseller does not add substantial value to the goods through physical modification. Limited enhancements such as packaging, repackaging, labeling or minor assembly ordinarily do not generally affect the use of RPM. Hence, RPM may not be applicable if the reseller performs value added functions. (3) RPM is more accurate where it is realized within a short time of the resellers purchase of goods. (4) RPM is ordinarily used when the controlled reseller does not use intangible property to add substantial value to the products. (5) RPM is applied when the reseller does not alter the physical characteristics of the product. (6) Where the reseller has the exclusive right to resell the goods, the gross margin would be affected by factors like size of market, existence of substitute goods, and level of activity undertaken by the reseller. Adjustments to RPM: Where it is not possible to compare the transactions even by comparing with the transactions entered by the third party and that the differences have a material effect on price, necessary adjustments shall have to be made to eliminate the effect of such differences.

DIRECT TAXATION I 29.27

Taxation of International Transactions (1) Inventory adjustment: An adjustment to operating income for ratios other than the ROA is necessary if a comparable company has a different relative level of inventory holding than the tested party. The inventory adjustment thus estimates the implicit capital cost of holding inventory (AVGINV). (2) Accounts payable adjustment: This adjustment eliminates the implicit interest in the price of goods purchased on other than a cash basis from supplie` The purpose of this adjustment is to identify and eliminate from profit comparisons the effect of companies decisions on how to finance purchases. (3) Accounts receivable adjustment: This adjustment eliminates the implicit interest in the price of goods or services sold on other tan cash basis to custome` The purpose of this adjustment is to identify and eliminate the profit related to finance decisions of the seller. A company selling on cash basis would receive a lower price than a company selling the goods on terms, because selling on terms subjects the seller to a capital cost that will be reflected in the price. (4) Contractual terms: where the contractual terms includes the provisions like warranties, terms of credit, facilities for transportation and transshipment of goods, facilities related to quantity of purchase or sale of goods. (5) The level of the market: The adjustments also considers the level of the market, i.e. wholesale, retail, etc. (6) Foreign currency adjustments: In case of an export transaction, the foreign exchange loss because of depreciation of the USD is disadvantageous to the exporter and it results in lower margin. The comparable companies having domestic sale transactions will be having higher margin. If the tested party imports raw material from foreign company, being an associated enterprise, it will be exposed to foreign exchange risk. The comparable companies using raw material procured from India will not be exposed from this risk. If the comparable companies hedge, the forex risk using financial instruments adjustment for the same is required for the tested party which does not perform the hedging. Conditions for application of Resale Price Method: Where an assessee, being an associated enterprise as per Sec. 92A of the Act had entered into a transaction as per Sec. 92B of the Act, involving transfer of goods or rendering of services as per Sec.92F (v) of the Act, and where it is not possible to compare the transactions even by comparing with the transactions entered by the third party and that the differences have a material effect on price, the Assessing officer shall for the purpose of determining the Arms Length price having satisfied that the transactions could materially affect the price in the open market and hence comparable; then reasonable adjustments shall be made for such comparable to eliminate the material effects of such differences for the purpose of determining the Arms Length Price. The adjustments for differences shall be made for: i) ii) iii) v) FAR Analysis; Quality of the product or service; Contractual terms; Inventory turnover;

iv) Level of the market; vi) Intangible property associated with the sale; vii) Foreign currency risks; viii) Transport costs; ix) Data and assumptions; x) Extra ordinary market conditions; and xi) Other measurable difference.

29.28 I DIRECT TAXATION

Accountants Report: The arms length price as computed under this method shall be audited and certified Form No. 3CEB vide Rule 10E. Steps in Computation of Arms Length Price as per Resale Price Method: Step I: Identify the price at which property purchased or services obtained by the enterprise from an associated enterprise are resold or are provided to an unrelated enterprise. Step II: Reduce the normal GP margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from (II) obtaining and providing the same or similar services, in a comparable uncontrolled transaction/(s). Step III: Reduce expenses incurred by the enterprise in connection with the purchase of property or obtaining of services. Step IV: Adjust for functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market. Step V: Arms Length Price = Step I Less: Step II & III Add / Less: Step IV. Computation of Arms Length Price as per Resale Price Method No. 1 2 Particulars Price at which property purchased or services obtained by the enterprise from an associated enterprise are resold or are provided to an unrelated enterprise. Add/Less: Adjustments for differences, having material affect on the price in the open market: i) ii) iii) v) Adjustments for FAR Analysis Quality of the product or service Characteristics of the Property Level of the market XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX Amount (`) XXXX

iv) Contractual terms vi) Inventory turnover vii) Intangible property associated with the sale viii) Foreign currency risks ix) Data and assumptions 3 x) Extra ordinary market conditions Arms Length Price for the purpose of Sec.92C (1 -2)

Illustrations on RESALE PRICE METHOD Illustration 5: Megabyte Inc. of France and R Ltd. of India are associated enterprises. R Ltd. imports 3,000 compressors for Air Conditioners from Megabyte Inc. at `7,500 per unit and these are sold to Pleasure Cooling Solutions Ltd at a price of `11,000 per unit. R Ltd. had also imported similar products from Cold Inc. Poland and sold outside at a Gross Profit of 20% on Sales.

DIRECT TAXATION I 29.29

Taxation of International Transactions Megabyte Inc. offered a quantity discount of `1,500 per unit. Cold Inc. could offer only `500 per unit as Quantity Discount. The freight and customs duty paid for imports from Cold Inc. Poland had cost R Ltd. ` 1,200 per piece. In respect of purchase from Cold Inc., R Ltd. had to pay `200 only as freight charges. Determine the Arms Length Price and the amount of increase in Total Income of R Ltd. (a)Computation of Arms Length Price of Products bought from Megabyte Inc., France by R Ltd, India Particulars Resale Price of Goods Purchased from Megabyte Inc. Less: Adjustment for Differences a) Normal Gross Profit Margin at 20% of Sale Price [20% x `11,000] b) Incremental Quantity Discount by Megabyte Inc.[`1,500 - `500] c) Difference in Purchase related Expenses[` 1,200 - `200] Arms Length Price (b)Computation of Increase in Total Income of R Ltd Particulars Price at which actually bought from Megabyte Inc. of France Less: Arms Length Price per unit under Resale Price Method Decrease in Purchase Price per unit No. of units purchased from Megabyte Inc. Increase in Total Income (3,000 units x `700) Illustration 6: A Ltd. an Indian company purchases microwave ovens from its parent company situated in US. The same are sold to third party customers in India. The price of the microwave oven set is ` 9,000 and the same is sold for ` 12,000. A Ltd. also purchases washing machines from another company in UK who is not a related party for ` 10,000. The washing machines are sold to customers in India for ` 12,000. A Ltd. performs the same functions in case of both purchases of microwave oven and washing machines, that is reselling the goods to the Indian customer. Both the products are sold in the same market and in the same conditions. Analysis In this case A Ltd. has transactions with the US Company and the UK Company. The transactions with the US Company are controlled transactions and those with the UK Company are uncontrolled transactions. However, the functions performed in case of both type of transactions are same/similar, that is distributing the same to the third party customers in India without adding any value. Further, the product purchased from US Company and from UK Company are both consumer durables. Though the products need not be similar but the functions are similar and both products broadly fall within the same industry (the white goods industry segment). Hence, for the purpose of RPM, these transactions can be taken as the basis of comparison. The RPM for this product would be calculated as under: Amount (`) 7,500 (6,800) 700 3,000 units `21,00,000 6,800 Amount (`) 11,000 2,200 1,000 1,000

29.30 I DIRECT TAXATION

Particulars Sale Value Cost of Goods Sold Other Expenses Gross Profit (GP) Gross Profit Margin (%)

Microwave Oven(`) 12,000 9,000 1,500 1,500 12.5

Washing Machine(`) 12,000 10,000 1,000 1,000 8.33

In this case the gross profit margin in case of purchases made from related party is higher as compared to the margin in respect of purchases made from the unrelated party. Hence the controlled transactions are at Arms Length. Method 3: Computation of Arms Length Price: COST PLUS METHOD (CPM) The cost plus method determines an arms length price by adding an appropriate gross profit margin to an associated entitys costs of producing products or services. The gross profit margin should reflect the functions performed by an entity and should include a return for capital used and risks accepted by the entity. The gross profit margin for a controlled transaction is calculated by reference to the gross profit margins made in comparative uncontrolled transactions. Rule 10B (1) (c) of the Income Tax Rules read with sub-section (2) of Section 92C, the Cost Plus Method (CPM) method is described as under: (i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an AE, are determined; (ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, determined; (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv) the cost referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v) the sum so arrived at is taken to be an ALP in relation to the supply of the property or provision of services by the enterprise.3

Definition of CPM as per OECD Guidelines:

A transfer pricing method using the costs incurred by the supplier of property (or services) in a controlled transaction. An appropriate cost plus mark up is added to this cost, to make an appropriate profit in light of the functions performed (taking into account assets used and risks assumed) and the market conditions. What is arrived at after adding the cost plus mark up to the above costs may be regarded as an ALP of the original controlled transaction.

DIRECT TAXATION I 29.31

Taxation of International Transactions Scope:

Application of CPM: 1) 2) 3) 4) 5) 1) The CPM is ordinarily used where: Semi finished goods are sold between related parties; Contract/Toll Manufacturing arrangements; Long-term buy and supply arrangements have been entered; and Services are provided. The third party comparable mark-up on a comparable cost. For example, if the supplier to which reference is made in applying the cost plus method in carrying out its activities uses leased business assets, the cost basis may not be comparable without adjustment if the supplier in the controlled transaction owns its business assets. The differences in the level and type of expenses should also be considered while applying the CPM. The assets employed and functions performed by the parties have also to be taken into account while applying the CPM. Appropriate adjustments should be made to ensure that there is accounting consistency between the controlled and uncontrolled transactions. The mark-ups must be measured consistently between the associated enterprises and the independent enterprises. If the tested party employs valuable and unique assets, it would be difficult to apply this method, as comparables may not be available.

Special consideration while applying the CPM:

2) 3) 4) 5) 6)

29.32 I DIRECT TAXATION

Degree of Reliability: The application of CPM is less likely to be reliable if material differences exist between the controlled and uncontrolled transactions with respect to: 1) 2) 3) 4) 5) 6) intangibles; cost structure; business experience; management efficiency; functions performed; and products.

Adjustments to CPM: Some of the factors in respect of which adjustments may be required for application of CPM are: 1) 2) 3) 4) 5) 6) 7) 8) Complexity of manufacturing or assembling; Manufacturing, production and process engineering; Procurement, purchasing, and inventory control activities; Testing functions; Selling, general and administrative expenses; Accounting treatment of costs between controlled and uncontrolled transactions Foreign currency risks; and Contractual terms for example scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms

Issues to be considered while applying the CPM In this method, the direct and indirect costs of production are to be identified. The terms direct or indirect costs are however not defined. A reference may therefore be made to the industry practice. In identifying and adopting the direct and indirect costs, the following factors would also have to be borne in mind: (a) utilisation of the plant; for example, if the plant has been under-utilised; (b) method of absorbing costs; absorption costing method is normally to be preferred; (c) in abnormal situations, marginal-costing principles may have to be applied; for example, use of incremental costing or marginal costing can be applied. Under the Indian Companies Act, there is no requirement to report distinctly the gross profits of companies. Thus, there is no consistency in the accountancy practices across the industry. The non-availability of gross margins of comparable companies from public databases makes the application of this method rare, and hence in practice this method is rarely used for testing the controlled transactions. Conditions for application of Cost Plus Method: Where an assessee, being an associated enterprise as per Sec. 92A of the Act had entered into a transaction as per Sec. 92B of the Act, involving transfer of goods or rendering of services as per Sec.92F (v) of the Act, and where (i) Semi-finished goods are sold between related parties; (ii) Contract/toll manufacturing arrangements;

DIRECT TAXATION I 29.33

Taxation of International Transactions (iii) Long-term buy- and supply arrangements have been entered; and (iv) Services are provided; the Assessing officer, for the purpose of determining the Arms Length price, to eliminate the effect on valuation, shall cause to make appropriate adjustments to ensure accounting consistency between the controlled and uncontrolled transactions, considering the third party comparable mark-up on a comparable cost. The adjustments for differences shall be made for: i) ii) iii) v) FAR Analysis; Complexity of manufacturing or assembling; Characteristics of the Property; Procurement, purchasing and inventory control activities;

iv) Manufacturing, production and process engineering;; vi) Testing functions; vii) Selling, general and administrative expenses; viii) Accounting treatment of costs between controlled and uncontrolled transactions; ix) Intangible property associated with the sale; x) Foreign currency risks; xi) Contractual terms Accountants Report: The arms length price as computed under this method shall be audited and certified in Form No. 3CEB vide Rule 10E. Steps in Computation of Arms Length Price using Cost Plus Method Step I: Determine the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise. Step II: Determine the normal GP mark-up to such costs (computed under same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction(s). Step III: Adjust the normal gross profit mark-up referred to in Step II to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market. Step IV: Arms Length Price = Step I Add Step III Computation of Arms Length Price as per Cost Plus Method

29.34 I DIRECT TAXATION

No. 1 2

Particulars Price at which property purchased or services obtained by the enterprise from an associated enterprise are resold or are provided to an unrelated enterprise. Add/Less: Adjustments for differences, having material affect on the price in the open market: i) ii) iii) v) Adjustments for FAR Analysis Quality of the product or service Characteristics of the Property Level of the market

Amount (`) XXXX

XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX

iv) Contractual terms vi) Inventory turnover vii) Intangible property associated with the sale viii) Foreign currency risks ix) 3 Data and assumptions x) Extra ordinary market conditions Arms Length Price for the purpose of Sec.92C (1 -2)

Illustrations on COST PLUS METHOD Illustration 7: Branco Inc., French Company, holds 45% of Equity in the Indian Company Chirag Technologies Ltd (CTL). CTL is engaged in development of software and maintenance of the same for customers across the globe. Its clientele includes Branco Inc. During the year, CTL had spent 2,400 Man Hours for developing and maintaining software for Branco Inc, with each hour being billed at `1,300. Costs incurred by CTL for executing work for Branco Inc. amount to ` 20,00,000. CTL had also undertaken developing software for Harsha Industries Ltd for which CTL had billed at `2,700 per Man Hour. The persons working for Harsha Industries Ltd. and Branco Inc. were part of the same team and were of matching credentials and caliber. CTL had made a Gross Profit of 60% on the Harsha Industries work. CTLs transactions with Branco Inc. are comparable to the transactions with Harsha Industries, subject to the following differences: a) Branco Inc. gives technical know-how support to CTL which can be valued at 8% of the normal gross profit. Harsha Industries does not provide any such support. b) Since the work for Branco involved huge number of man hours, a quantity discount of 14% of Normal Gross Profits was given. c) CTL had offered 90 Days credit to Branco the cost of which is measured at 2% of the Normal Billing Rate, No such discount was offered to Harsha Industries Ltd. Compute ALP and the amount of increase in Total Income of Chirag Technologies Ltd.

DIRECT TAXATION I 29.35

Taxation of International Transactions (a)Computation of Arms Length Gross Profit Mark Up Particulars Normal Gross Profit Mark Up Less: Adjustment for differences:(which had the effect of reducing the profit of CTL) (i)Technical support from Branco Inc. (8% of Normal Gross Profit 60%) (ii)Quantity Discount @ 14% of Normal Gross Profit (14% of 60%) Normal Gross Profit Rate of CTL, had the transaction been unrelated and there been no technical support or quantity discount Add: Cost of Credit to Branco Inc. @2% of Normal Gross Profit (2% of Gross Profit 60%) [since this had effect of reducing the gross profit of CTL] Arms Length Gross Profit Mark-up (b) Computation of Increase in Total Income of CTL for services to Branco Inc. Particulars Cost of Services provided to Branco Billed Value at Arms Length [ Cost / (100 Arms Length Mark) = [`20,00,000/ (100% -48%] Less: Actual Billing to Branch Inc.[2,400 x 1,300] Increase in Total Income of Branco Inc. Illustration 8: Indco, an Indian company, manufactures specialized stamping equipment for uncontrolled companies in the manufacturing industry using designs supplied to them by the arms length parties. Indco realizes its costs plus a mark-up of 8% on this custom manufacturing. Under the arms length agreements, costs are defined as the sum of direct costs (i.e., labour and materials) plus 50% of the direct costs. The additional 50% of direct costs is intended to approximate indirect costs, including overhead. Indco also manufactures stamping machines for its Chinese subsidiary, Chco, using designs supplied by Chco. Under the Chco agreement, costs are defined as the sum of the direct costs plus the indirect costs, including overhead is also computed at 50% of direct costs, and the mark-up earned is 10% of the direct and indirect costs. The cost plus mark up is calculated as follows: Calculation of mark-up under the uncontrolled transaction Particulars Direct costs Indirect costs(50% * 1,000) Total costs Mark-up 8% Calculation of mark-up under the controlled transaction Particulars Direct costs Indirect costs (50% * 1,000) Total costs Mark-up earned on controlled transactions at 10% Amount(`) 3,000 1,500 4,500 450 Amount(`) 1,000 500 1,500 120 Amount (`) 20,00,000 38,46,154 31,20,000 7,26,154 % 4.80 8.40 % 60.00 13.20

46.80 1.20 48.00

29.36 I DIRECT TAXATION

Calculation of arms length cost mark up Cost plus markup from uncontrolled transactions Cost plus mark up from controlled transactions 8% 10%

Thus the controlled transactions are at Arms Length. However, in practice, globally it is found that it is not feasible to apply this method. Illustration 9: Happy Ltd. , an Indian Company is a wholly-owned subsidiary of Happy Inc. Happy Ltd. is engaged in provision of software development services to its associated enterprise Happy Inc. The following is the income statement if Happy Ltd. for the year ended 31.3.2010 Happy Ltd. All figures in Rupees 000 Revenue from associated enterprises - - - - - - Total operating income Pay roll Rent Depreciation General administration expenses Other operating expenses 95,000 40,000 16,500 9,500 8,200 11,800 86,000 9,000 Costs

Total operating expenses Operating profit Net Cost plus mark-up (%) [Operating profit /total operating expenses] 10.46%

Conclusion: For the financial year ended 31st March, 2010, Happy Ltd has earned a Net Cost Plus markup of 10.46% from its associated enterprises. Accordingly, it is reasonable to conclude that Happy Ltds international transactions with Happy Inc., relating to the provision of software services, appears to be consistent with the arms length standard from the Indian transfer pricing perspective. Use of multi-year data As per Rule 10B (4), the use of the data relating to the financial year in which such international transaction has been entered into, must be considered. Data for earlier years may also be used, if such data reveals facts, which could have an influence on the determination of transfer prices in relation to the transactions being compared. The purpose of using multiple-year data is to ensure that the outcomes for the relevant year Implications of tested party earning lower than arms length mark-up If Happy Ltds actual mark-up is less than the arms length mark-up benchmark of 11.77%, it would need further examination as to whether it is compliant with the arms length standard from an Indian Transfer pricing perspective. We may have two different scenarios: Scenario 1: where Happy Ltds margin is below the arms length mark-up but within the range permissible under the proviso to Sec.92C (2) Scenario 2: Where Happy Ltds margin falls below the lower limit of the range of permissible under the proviso. The calculation of range of permissible margins applying the proviso is shown in Table A. The arithmetic

DIRECT TAXATION I 29.37

Taxation of International Transactions mean of 11.77% is applied to the costs of the tested party (`86,000) to derive the arms length price of the international transaction (refer col.2 figure indicated as ALP ` 96,122) is a balancing figure and refers to the arms length price of the international transaction. The adjustment of (+/-) 5 percent permitted by the proviso is applied to the ALP to give the range of values that would be considered at arms length. Further, as the international transactions consists of export of services, the lower end of the range is 95% of ALP `91,316 (Col.4) representing the lowest possible transaction value that would be considered compliant with the arms length principle. Table A Calculation of Range of outcomes that would meet the arms length standard applying the proviso to Section 92C (2) Profit & Loss Account for the year ended 31st March, 2010 Particulars
Col. 1
Actual

[All figures in Rupees 000]

Col.3

Col. 2
At ALP Refer Note No.

At ALP (+) 5% of ALP ALP 1,00,928

Col.4 At ALP (-)5% of ALP ALP 91,316 (+)5%

ALP (-) 5%

(a) Revenue -From associated enterprises (international transaction) Total Operating Income (b)Costs (all unrelated, no international transactions) Pay roll Rent Depreciation General administration exp. Other operating expenses 95,000 96,122 2

40,000 16,500 9,500 8,200 11,800

40,000 16,500 9,500 8,200 11,800

40,000 16,500 9,500 8,200 11,800 86,000

1

40,000 16,500 9,500 8,200 11,800 86,000 5,316

86,000 86,000 Total Operating expenses 10,122 (c)Operating Profit[=(a) (b)] 9,000 Net Cost Mark-up (%) 10.46% Arms length mark-up [i.e. 11.77% arithmetical mean of the Net Cost Plus mark-up(%) of broadly comparable independent companies] Range of net cost plus markups that would be considered compliant with the arms length standard applying the +/- 5% variation permitted by proviso to Sec.92C(2) [= Operating Profit / Operating expenses]

14,928

17.36%

6.18%

29.38 I DIRECT TAXATION

Notes: 1. 2. Operating profit in Col.2 is a derived figure by applying mark-up of 11.77% to the tested partys total operating expenses of `86,000 (a) Revenue from associated enterprises ( international transaction) in Col.2 is the balancing figure considering operating profit derived in Col.1 above and the total operating expenses remaining unchanged at Rs 86,000. This revenue figure is the Arms Length Price (ALP). (b) Revenue from associated enterprises (international transaction) in Col.3 represents the upper limit of the range permissible under the proviso the Section 92C(2) (c ) Revenue from associated enterprises (international transaction) in Col.4 represents the lower limit of the range permissible under the proviso the Section 92C(2) The Net Cost Plus Mark-up earned by the tested party ( col.1) is higher than the arms length markup (col.2), accordingly the international transaction complies with the arms length principle.

3.

Workings: Computation of Weighted Net Cost-plus mark-ups of broadly comparable independent companies. (on the basis of hypothetical data of 5 such companies for 5 years) Comparable Company 1 Profit and Loss Account (Summary) year ended.. Comparable 1 March March 2006 2007
(1)Time period 12 mnths 12 mnths

(` In Crores) March 2009

12 mnths

March 2008
12 mnths

March 2010
12 mnths

Total

(2)Total Income
(3)Total Cost (4)Net profit [=(2) (3)] (5)Net cost plus mark-up [=(4)/(3) *100] (6)Weighted Average [= {Total of col. (4)/ Total of col.(3)} x 100]

125 118 7 5.93% ----

143 129 14 10.8% ----

155 140 15 10.71% ----

134 128 6 4.69% ----

175 159 16 10.06%

----

732 674 58 ---8.61%

Comparable Company 2
Profit and Loss Account (Summary) year ended.. Comparable 2 March 2006 March 2007 (1)Time period 12 mnths 12 mnths (2)Total Income (3)Total Cost (4)Net profit [=(2) (3)] (5)Net cost plus mark-up [=(4)/(3) *100] (6)Weighted Average [= {Total of col. (4)/ Total of col.(3)} x 100] 152 118 34 28.81% ---134 129 5 3.88% ---March 2008 12 mnths 155 140 15 10.71% ----

(` In Crores)
March 2009 March 2010 Total 12 mnths 12 mnths 143 128 15 11.72% ---157 135 22 16.30% ---741 674 91 ---13.50%

Comparable Company 3 Profit and Loss Account (Summary) year ended.. Comparable 3 March March 2006 2007
(1)Time period 12 mnths 12 mnths

(` In Crores) March 2009

12 mnths

March 2008
12 mnths

March 2010
12 mnths

Total

(2)Total Income
(3)Total Cost

15 13

13 12

15 14

14 12

17 15

74 66

DIRECT TAXATION I 29.39

Taxation of International Transactions

(4)Net profit [=(2) (3)] (5)Net cost plus mark-up [=(4)/(3) *100] (6)Weighted Average [= {Total of col. (4)/ Total of col.(3)} x 100]

2 15.38% ----

1 8.33% ----

1 7.14%
----

2 16.67%
----

2 13.33.%
----

8 ---12.12%

Comparable Company 4
Comparable 4 (1)Time period (3)Total Cost (4)Net profit [=(2) (3)] (5)Net cost plus mark-up [=(4)/(3) *100] (6)Weighted Average [= {Total of col. (4)/ Total of col.(3)} x 100]

(` In Crores)
March 2009 March 2010 Total 12 mnths 12 mnths

Profit and Loss Account (Summary) year ended..

March 2006 March 2007 12 mnths 12 mnths March 2008 12 mnths

(2)Total Income

215.38 191.21 24.17 12.64%

----

183.68 162.55 21.13 13.00%

----

176.85 169.29 7.56 4.47%

----

244.73 212.11 32.62 15.38%

----

267.57 223.34 44.23 19.80%

----

1088.21 958.50 129.71 ---13.53%

Comparable Company 5
Profit and Loss Account (Summary) year ended.. Comparable 5 March 2006 March 2007 (1)Time period 12 mnths 12 mnths (2)Total Income (3)Total Cost (4)Net profit [=(2) (3)] (5)Net cost plus mark-up [=(4)/(3) *100] (6)Weighted Average [= {Total of col. (4)/ Total of col.(3)} x 100] 231.15 211.29 19.86 9.40% ---138.89 132.46 6.43 4.85% ---March 2008 12 mnths 157.86 129.19 28.67 22.19% ----

(` In Crores)
March 2009 March 2010 Total 12 mnths 12 mnths 424.37 392.21 32.16 8.20% ---327.75 303.34 24.41 8.05% ---1280.02 1168.49 129.71 ---11.10%

Summary of Net Cost plus Mark-ups of broadly comparable independent companies

Sl No. 1 2 3 4 5 Company name March 2006 March 2007 March 2008 March 2009 March 2010 Weighted average 8.61% 13.50% 12.12% 13.53% 11.10% 11.77%

Comparable 1 Comparable 2 Comparable 3 Comparable 4 Comparable 5 Arithmetic Mean

5.93% 28.81% 15.38% 12.64% 9.40% 14.43%

10.8% 3.88% 8.33% 13.00% 4.85% 8.17%

10.71% 10.71% 7.14% 4.47% 22.19% 11.04%

4.69% 11.72% 16.67% 15.38% 8.20% 11.33%

10.06% 16.30% 13.33.% 19.80% 8.05% 13.51%

Conclusion: On the basis of the above, the Net Cost-plus mark-ups of broadly comparable independent companies range from 8.61% to 13.53% with an arithmetical mean of 11.77%. Scenario 1: where Happy Ltds margin is below the arms length mark-up but within the range permissible under the proviso to Sec.92C (2)

29.40 I DIRECT TAXATION

Profit & Loss Account for the year ended 31st March, 2010
Particulars Col. 1 Actual Col. 2 At ALP Refer Note No. Col.3 At ALP (+) 5% of ALP

[All figures in Rupees 000]

Col.4 At ALP (-)5% of ALP ALP (+)5% 91,316 ALP (-) 5%

(a) Revenue -From associated enterprises (international transaction) Total Operating Income (b)Costs (all unrelated, no international transactions) Pay roll Rent Depreciation General administration exp. Other operating expenses Total Operating expenses (c)Operating Profit[=(a) (b)] Net Cost Mark-up (%) Arms length mark-up [i.e. arithmetical mean of the Net Cost Plus mark-up(%) of broadly comparable independent companies] Range of net cost plus markups that would be considered compliant with the arms length standard applying the +/- 5% variation permitted by proviso to Sec.92C(2) [= Operating Profit / Operating expenses] 93,500 96,122 2 ALP 1,00,928

40,000 16,500 9,500 8,200 11,800 86,000 7,500 8.72%

40,000 16,500 9,500 8,200 11,800 86,000 10,122 11.77% 1

40,000 16,500 9,500 8,200 11,800 86,000 14,928

40,000 16,500 9,500 8,200 11,800 86,000 5,316

17.36%

6.18%

Notes: 1. 2. Operating profit in Col.2 is a derived figure by applying mark-up of 11.77% to the tested partys total operating expenses of `86,000 (a) Revenue from associated enterprises (international transaction) in Col.2 is the balancing figure considering operating profit derived in Col.1 above and the total operating expenses remaining unchanged at Rs 86,000. This revenue figure is the Arms Length Price (ALP). (b) Revenue from associated enterprises (international transaction) in Col.3 represents the upper limit of the range permissible under the proviso the Section 92C(2) (c ) Revenue from associated enterprises (international transaction) in Col.4 represents the lower limit of the range permissible under the proviso the Section 92C(2) The Net Cost Plus Mark-up of 8.72% earned by the tested party ( col.1) even though below the arms length Net Cost plus mark-up (col.2), still falls within the range permissible under the proviso to Section 92C(2) [Col.(3) & (4)] . Hence no adjustment needs to be made.

3.

DIRECT TAXATION I 29.41

Taxation of International Transactions Scenario 2: Where Happy Ltds margin falls below the lower limit of the range of permissible under the proviso Profit & Loss Account for the year ended 31st March, 2010 Particulars Col. 1
Actual Col. 2 At ALP Refer Note No.

[All figures in Rupees 000]

Col.3 Col.4

(a) Revenue -From associated enterprises (international transaction) Total Operating Income
(b)Costs (all unrelated, no international transactions) Pay roll Rent Depreciation General administration exp. Other operating expenses Total Operating expenses

At ALP (+) 5% of ALP ALP 1,00,928

ALP (+)5%

At ALP (-)5% of ALP

91,316

91,000

96,122

ALP (-) 5%

40,000 16,500 9,500 8,200 11,800

40,000 16,500 9,500 8,200 11,800

40,000 16,500 9,500 8,200 11,800 86,000

1

40,000 16,500 9,500 8,200 11,800 86,000 5,316

86,000 86,000
5,000 10,122

(c)Operating Profit[=(a) (b)] Net Cost Mark-up (%) Arms length mark-up [i.e. arithmetical mean of the Net Cost Plus mark-up(%) of broadly comparable independent companies] Range of net cost plus mark-ups that would be considered compliant with the arms length standard applying the +/5% variation permitted by proviso to Sec.92C(2) [= Operating Profit / Operating expenses]

14,928

5.82%

11.77%

17.36%

6.18%

Notes: 1. 2. Operating profit in Col.2 is a derived figure by applying mark-up of 11.77% to the tested partys total operating expenses of `86,000 (a) Revenue from associated enterprises (international transaction) in Col.2 is the balancing figure considering operating profit derived in Col.1 above and the total operating expenses remaining unchanged at Rs 86,000. This revenue figure is the Arms Length Price (ALP). (b) Revenue from associated enterprises (international transaction) in Col.3 represents the upper

29.42 I DIRECT TAXATION

limit of the range permissible under the proviso the Section 92C (2) 3. (c) Revenue from associated enterprises (international transaction) in Col.4 represents the lower limit of the range permissible under the proviso the Section 92C (2) The Net Cost Plus Mark-up earned by the tested party ( col.1) falls below the lower limit of the range permissible under proviso 92C(2) [Col.(4)] . This situation may expose the tested party to an adjustment to the price charged by it in its international transaction. Such adjustment, if recommended to be made by the TPO to the AO should amount to `316 As explained hereunder. Quantum of adjustment: Value of the international transaction 91,000

4. (i)

(ii) Arms length price 96,122 (iii) Arms length price applying the proviso to Sec.92C(2) 91,316 (iv) Adjustment (iii) (i) Method 4: Computation of Arms Length Price: PROFIT SPLIT METHOD (PSM) The PSM evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arms length with reference to the relative value of each controlled taxpayers contribution to that combined operating profit or loss. The combined operating profit or loss must be derived from the most narrowly identifiable business activity of the controlled taxpayers for which data is available that includes the controlled transactions. Objective of PSM: 1) 2) 3) 4) To determine the relative value of each controlled taxpayers contribution; To assess the impact of the controlled taxpayers contribution on the success of the relevant business activity; To identify and evaluate the impact of the controlled taxpayers contribution that reflects the functions performed, risks assumed, and resources employed. To eliminate the effect on profits of special conditions made or imposed in a controlled transaction (or in controlled transactions that are appropriate to aggregate) by determining the division of profits that independent enterprises would have expected to realize from engaging in the transaction or transactions. To identify the profit to be split for the associated enterprises from the controlled transactions in which the associated enterprises are engaged. To allocate the profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arms length. The Indian TPR regulations provide that PSM is mainly applicable to international transactions involving transfer of unique intangibles or in multiple international transactions which are so interrelated that they cannot be evaluated separately for the purpose of determining the arms length price. Rule 10B (1)(d) of the Income Tax Rules read with sub-section (2) of Section 92C, the Profit Split Method (PSM) method is described as under: (i) the combined net profit of the AE arising from the international transaction in which they are engaged, is determined; 316

5) 6)

DIRECT TAXATION I 29.43

Taxation of International Transactions (ii) the relative contribution made by each of the AE to the earning of such combined net profit, is then evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in the similar circumstances; (iii) the combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated under sub-clause (ii); (iv) the profit thus apportioned to the assessee is taken into account to arrive at an ALP in relation to the international transaction.4

Terms Used: (1) Comparable Residual Profit: A comparable profit split is derived from the combined operating profit of the uncontrolled taxpayers whose transactions and activities are similar to those of the controlled taxpayers in the relevant business activity. (2) Residual Profit Split: This is the residual profit which is apportioned to each party based on ownership of non-routine intangibles (i.e. network reach, efficiency of Sales & Marketing team, etc) (3) Contribution Analysis: Under this approach, the combined profits, which are the total profits from the uncontrolled transactions under examination, would be divided between the AEs based upon the relative value of the functions performed by each of the AEs participating in the controlled transaction, supplemented as much as possible by external market data that indicate how independent enterprises would have divided the profits in similar circumstances. Residual Analysis: Under this analysis, the combined profit from controlled transactions under examination in two stages. In the first stage, each participant is allocated sufficient profit to provide it with a basic return appropriate for the type of transactions in which it is engaged. In the second stage, any residual profit ( or loss) remaining after the first stage division would be allocated among the parties based on an analysis of facts and circumstances that might indicate how this residual profit would have been divided between independent enterprises. Applicability of PSM (Profit Split Method) The Indian TPR affirms that the PSM may be applicable mainly in the following cases: a) Transactions involving transfer of unique intangibles; b) Multiple inter-related international transactions which cannot be evaluated separately for determining the ALP of any one transaction. (i) The extent of economies of backward and forward integration, the existence of intangibles on both sides of the transaction, and complex functional and transactional structures may limit the use of standard approaches to economic analysis for transfer pricing purposes (i.e. performing comparable company searches to apply the TNMM). In those circumstances, the arms length nature of transactions may be better evaluated by considering the transaction from an end-to-end perspective, and thus PSM can be applied.

(ii) This method can be used in situations where economies of integration differentiate the tested party from the comparables, provided these are taken into account in the principle for

Definition of PSM as per OECD Guidelines: A transactional profit method that identifies the combined profit to be split for the associated enterprises from a controlled transaction (or controlled transactions that is appropriate to aggregate) and then splits those profits between the associated enterprises based upon an economically valid basis that approximates the division of profit that would have been anticipated and reflected in an agreement made at arms length.

29.44 I DIRECT TAXATION

allocating profits. The method enables accounting for valuable intangibles being developed on both sides of the transaction. (iii) The allocation of profit can be calculated based on principles that take into account the contribution of intangibles in the industrys or the groups value creation process. (iv) This method is also well suited to complex transactions where several entities are involved in the same functions and it is not possible to define precisely the scope of functions and responsibilities. While this method has not been widely used, it has been somewhat popular in the financial services industry.

Conditions for application of Profit Split Method (PSM): Where an assessee, being an associated enterprise as per Sec. 92A of the Act had entered into a transaction as per Sec. 92B of the Act, involving transfer of goods or rendering of services as per Sec.92F (v) of the Act, and where it is not possible to compare the transactions even by comparing with the transactions entered by the third party and that the differences have a material effect on price, the Assessing officer shall for the purpose of determining the Arms Length price having satisfied that the transactions could materially affect the price in the open market and hence comparable; then reasonable adjustments shall be made for such comparable to eliminate the material effects of such differences for the purpose of determining the Arms Length Price. The adjustments for differences shall be made for: i) ii) iii) FAR Analysis; Quality of the product or service; Contractual terms;

DIRECT TAXATION I 29.45

Taxation of International Transactions iv) Level of the market; v) External Data and Internal Data; vi) Estimation of projected profits; vii) Contribution Analysis; viii) Residual Analysis. Accountants Report: The arms length price as computed under this method shall be audited and certified in Form No. 3CEB vide Rule 10E. Steps in computation of Arms Length Price using Profit Split Method: This method is mainly applicable in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter-related that they cannot be evaluated separately for the purpose of determining the Arms Length Price of any one transaction. Step I: Determine the combined net profit of the associated enterprises arising from the international transaction in which they are engaged. Step II: Determine the relative contribution made by each of the associated enterprises to the earning of such combined net profit. This is determined on the basis of the FAR Analysis: (a) Functions performed; (b) Assets employed; (c)Risks assumed by each enterprise; (d) on the basis of reliable external market data which indicates how such contribution would be determined by unrelated enterprises performing comparable functions in similar circumstances. Step III: Split the combined net profit amongst the enterprises on the basis of reasonable returns and in proportion to their relative contributions, as determined in Step II. (See note below) Step IV: Arms Length Price - Profit apportioned to the assessee under Step III. NOTE: Combined Net Profit shall be split as under: III.A. First Split = Reasonable Return: Allocate an amount to each enterprise so as to provide it with a basic return appropriate for the type of international transaction with reference to market returns achieved in similar types of transactions by independent enterprises. III.B. Second Split = Contribution Ratio: Allocate the residual net profit amongst the enterprises in proportion to their relative contribution. III.C. Total Profit: Share of profit of each enterprise = Step III.A + III.B Computation of Arms Length Price as per Profit Split Method (PSM)

29.46 I DIRECT TAXATION

No. 1 2

Particulars Amount (`) Price at which property purchased or services obtained by the enterprise from an XXXX associated enterprise are resold or are provided to an unrelated enterprise. Add/Less: Adjustments for differences, having material affect on the price in the open market: i) ii) iii) v) Adjustments for FAR Analysis Quality of the product or service Contractual terms External data and internal data XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX

iv) Level of the market vi) Estimation of projected profits vii) Contribution Analysis viii) Residual Analysis 3 Arms Length Price for the purpose of Sec.92C (1 -2) Illustrations on PROFIT SPLIT METHOD

Illustration 10: NBR Medical Equipments Inc. (NBR) of Canada has received an order from a leading UK based Hospital for development of a hi-tech medical equipment which will integrate the best of software and latest medical examination tool to meet varied requirements. The order was for 3,00,000 Euros. To execute the order, NBR joined hands with its subsidiary Precision Components Inc. (PCI) of USA and Bioinformatics India Ltd (BIL), an Indian Company. PCI holds 30% of BIL. NBR paid to PCI and BIL Euro 90,000 and Euro 1,00,000 respectively and kept the balance for itself. In the entire transaction, a profit of Euro 1,00,000 is earned. Bioinformatics India Ltd incurred a Total Cost of Euro 80,000 in execution of its work in the above contract. The relative contribution of NBR, PCI and BIL may be taken at 30%, 30% and 40% respectively. Compute the Arms Length Price and the incremental Total Income of Bioinformatics India Ltd, if any due to adopting Arms Length Price determined here under.

Share of each of the Associates in the Value of the Order Share of BIL [Given] Share of PCI [Given]

3,00,000 1,00,000 90,000 1,10,000 1,00,000 40,000 30,000 30,000

Share of NBR [Amount Retained = 3,00,000 1,00,000 - 90,000] Share of each of the Associates in the Profit of the Order Combined Total Profits Share of BIL [Contribution of 40% x Total Profit 1,00,000] Share of PCI [Contribution of 30% x Total Profit 1,00,000] Share of NBR [Contribution of 30% x Total Profit 1,00,000]

DIRECT TAXATION I 29.47

Taxation of International Transactions

Computation of Incremental Total Income of BIL Total Cost to BIL Ltd Add: Share in the Profit to BIL (from B above) Revenue of BIL on the basis of Arms Length Price 80,000 40,000 1,20,000 (1,00,000) 20,000

Less: Revenue Actually received by BIL

Illustration 11:

Increase in Total Income of BIL

lndco, an Indian company, has developed and manufactures a robot to be used for multiple industrial applications. The robot is considered to be an innovative technological advance. Chco, a Chinese subsidiary of Indco, has developed and manufactures a software programme which incorporates the new programme in the robot and makes it more effective. The success of the robot is attributable to both companies for the design of the robot and the software programme. Indco manufactures and supplies Chco with the robot for installing of the new software programme for assembly and manufacture of the robot. Chco manufactures the robot and sells to an arms length distributor. In light of the innovative nature of the robot and software, the group was unable to find comparables with similar intangible assets. Because they were unable to establish a reliable degree of comparability, the group was unable to apply the traditional transaction methods or the TNMM. However, reliable data are available on robot and software manufacturers without innovative intangible property, and they earn a return of 10% on their manufacturing costs. The total profits attributable to manufacture of robots are calculated as follows: Particulars Sales to the arms length distributor Deduct: Indcos manufacturing costs Chcos manufacturing costs Total manufacturing costs for the group Gross Margin Deduct: Indcos development costs Chcos development costs Indcos operating costs Chcos operating costs Net profit Indcos return to manufacturing (200*10%) Chcos return to manufacturing (300*10%) Residual profit attributable to development Amount (`) Amount (`) 1,000

200 300

500 500

100 50 50 100

300 200 20 30 150

The split of the residual profit has been considered on the basis of the development cost considering the significance of technology in the manufacturing process.

29.48 I DIRECT TAXATION

Based on proportionate development costs Particulars Indcos share of residual profit [100/)100+50)]*150 Chcos share of residual profit [50/(100+50)]*150 Indcos transfer price is calculated as follows: Particulars Manufacturing costs Development costs Operating costs Routine 10% return on manufacturing costs Share of residual profit Transfer price Method 5: Computation of Arms Length Price: TRANSACTION NET MARGIN METHOD (TNMM) Under the Transaction Net Margin Method (TNMM), an arms length price is determined by comparing the operating profit of the tested party with the operating profit of an uncontrolled party engaged in comparable transactions. The tested party is the least complex of the controlled tax payers and does not own valuable intangibles that contribute to the resulting profits from its operations. 5 Objectives of TNMM: (1) Computation of net profit margin realized y an AE from an international transaction to be made in relation to a particular factor such as costs incurred, sales, assets utilized, etc. (2) Aggregate the relevant controlled transactions to test whether the controlled transactions earn a reasonable margin as compared to uncontrolled transactions. (3) Benchmarking the dealings between the tested party and its associated enterprises on the basis of the margins earned by comparable uncontrolled companies. Rule 10B (1)(e) of the Income Tax Rules read with sub-section (2) of Section 92C, the Transaction Net Margin Method (TNMM) is described as under: (i) the net profit margin realised by the enterprise from an international transaction entered into with an AE is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; Amount (`) 200 100 50 20 100 470 (`) 100 50

(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transactions and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);

5 The OECD Guidelines states that TNMM may be particularly sensitive to differences in business structure or management effectiveness between the controlled entities and the tested party, as these factors are likely to impact the operating profits generated across different entities.

DIRECT TAXATION I 29.49

Taxation of International Transactions (v) the net profit margin thus established is then taken into account to arrive at an ALP in relation to the international transaction.6 Application of the TNMM i) An analysis under the TNMM considers the profits of the associated enterprise that are attributable to the company as a whole or to similar functional activities, e.g., manufacturing, trading, etc. TNMM requires establishing comparability at a broad functional level, for example trading function, manufacturing activities, etc. Only one party to the controlled transaction is analysed in applying TNMM. The party to the international transaction whose profitability is examined is known as the tested party. The choice of the tested party depends upon the availability of the data. In general, TNMM is applied to the least complex of the entity involved in the controlled transaction. There are usually more comparable data available in respect of the least complex entities, and fewer adjustments would be required to account for the differences in the functions and risk between the controlled and uncontrolled transactions.

ii) iii)

iv) TNMM requires comparison between net margins derived from the operations of the uncontrolled parties and net margins derived by an AE from similar operations. Net margin is indicated by the rate of return on sales or cost or operating assets, and this forms the basis for TNMM. v) A functional analysis of the tested party or the independent enterprise, as the case may be, is required to determine whether the transactions are comparable and the adjustments that are required to be made to obtain reliable results. The tested party would have to consider other factors, like cost of assets of comparable companies, etc. while applying the return on assets measure.

Steps in computation of Arms Length Price using Transaction Net Margin Method Step I: Compute the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise, in relation to costs incurred or sales effected or assets employed by enterprise or having regard to any other relevant base. Step II: Compute the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction (s), having regard to the same base as in Step I. Step III: Adjust the net profit margin as per Step II for differences, if any, which could materially affect amount of net profit margin in the open market: (a) between the international transaction and the comparable uncontrolled transactions, or (b) between the enterprises entering into such transactions. Step IV: Net Profit Margin for uncontrolled transactions = Step II Add/Less Step III. Step V: Arms Length Price = Transaction Value x Net Profit Margin as per Step IV above. Meaning of certain terms: For the computation of Arms Length Price 1. 2. 3.
6

Transaction includes a number of closely linked transactions. Uncontrolled Transaction means a transaction between unrelated enterprises, whether resident or non-resident. Unrelated Enterprises: Enterprises are said to be unrelated, if they are not associated or deemed to be associated u/s 92A.
Definition of TNMM as per OECD Guidelines:

a transactional profit method that examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a assessee realizes from a controlled transaction (or transactions that it is appropriate to aggregate).

29.50 I DIRECT TAXATION

4. 5. 6. No. 1

Uncontrolled conditions: Conditions which are not controlled or suppressed or moulded for achievement of pre-determined results are said to be uncontrolled conditions. Property includes goods, articles or things, and intangible property. Services include financial services. Particulars Price at which property purchased or services obtained by the enterprise from an associated enterprise are resold or are provided to an unrelated enterprise. Add/Less: Adjustments for differences, having material affect on the price in the open market: i) ii) iii) v) Adjustments for FAR Analysis Quality of the product or service Characteristics of the Property Level of the market XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX XXXX Amount (`) XXXX

Computation of Arms Length Price as per Transaction Net Margin Method

iv) Contractual terms vi) Inventory turnover vii) Intangible property associated with the sale viii) Foreign currency risks ix) x) 3 Data and assumptions Extra ordinary market conditions

Arms Length Price for the purpose of Sec.92C (1 -2)

Use of Profit Level Indicator (PLI) In trying to benchmark the results of the tested party with that of unrelated parties i.e. comparable companies, by applying the TNMM, it is important to use appropriate PLIs. The choice of PLI is dependent upon the following which also includes: (a) the nature of the activities of the tested party, (b) the reliability of the available financial data with respect to comparable companies, (c) the extent to which a particular PLI is applicable to this data. All PLIs not similar. The selection of the appropriate PLI depends on the structure and the business of the tested party. For example, Berry Ratio might be an apt PLI in case of the tax-payers that almost exclusively perform services and distribution activities. On the other hand, a manufacturing concern with an extensive capital investment in plant and equipment might require the application of the return on assets to determine the arms length prices. Use of Operating Margin The operating margin (in this case the ratio of EBIT to Operating Revenue) is a profitability measure. EBIT is a measure of operating profit, which excludes the effect of company financing and taxation decisions as well as abnormal and extraordinary items. The ratio is a useful indicator of comparative performance by showing the ability of a company to control its costs relative to its level of sales.

DIRECT TAXATION I 29.51

Taxation of International Transactions Illustrations on TRANSACTION NET MARGIN METHOD Illustration 12: Fox Solutions Inc. a US Company, sells Laser Printer Cartridge Drums to its Indian Subsidiary Quality Printing Ltd at S 20 per drum. Doc Solutions Inc. has other takers in India for its Cartridge Drums, for whom the price is $ 30 per drum. During the year, Fox Solutions had supplied 12,000 Cartridge Drums to Quality Printing Ltd. Determine the Arms Length Price and taxable income of Quality Printing Ltd if its income after considering the above is `45,00,000. Compliance with TDS provisions may be assumed and Rate per USD is `45. Also determine income of Doc Solutions Inc. (A) Computation of Total Income of Quality Printing Ltd Particulars Total Income before adjusting for differences due to Arms Length Price Add: Difference on Account of adopting Arms Length Price [12,000 x $20 x `45] Less: Amount under Arms Length Price[12,000 x $ 30 x `45] Incremental Cost on adopting ALP u/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore, difference on account of ALP is ignored. Total Income of Quality Printing Ltd. (B) Computation of Total Income of Fox Solutions Inc. The provisions relating to taxing income of Fox Solutions Inc., on applying Arms Length Price for transactions entered into by a Foreign Company is given in Circular 23 dated 23.7.1969, which is as follows: (I) Transactions Not Taxable in India: Transactions will not be subject tax in India if transactions are on principal-to-principal basis and are entered into at ALP, and the subsidiary also carries on business on its own. Amount (`) 1,08,00,000 1,62,00,000 (54,00,000) Amount(`) 45,00,000

45,00,000

(II) Transactions Taxable in India if the Indian Subsidiary does not carry on any business on its own. The following are the other considerations in this regard a) Adopting ALP does not affect the computation of taxable income of Fox Solutions Inc. if tax has been deducted at source or if tax is deductible. b) Where ALP is adopted for taxing income of the Parent Company, income of the recipient Company (i.e. Quality Printing Ltd) will not be recomputed.

Illustration 13: Khazana Ltd is an Indian Company engaged in the business of developing and manufacturing Industrial components. Its Canadian Subsidiary Techpro Inc. supplies technical information and offers technical support to Khazana for manufacturing goods, for a consideration of Euro 1,00,000 per year. Income of Khazana Ltd is `90 Lakhs. Determine the Taxable Income of Khazana Ltd if Techpro charges Euro 1,30,000 per year to other entities in India. What will be the answer if Techpro charges Euro 60,000 per year to other entitles. (Rate per Euro may be taken at `50.)

29.52 I DIRECT TAXATION

Computation of Total Income of Khazana Ltd Particulars When price charged for Comparable Uncontrolled Transaction Price actually paid by Khazana Ltd [1,00,000 x `50] Less: Price charged in Rupees ( under ALP) [1,30,000 x `50] [60,000 x `50] Incremental Profit on adopting ALP (A) Total Income before adjusting for differences due to Arms Length Price Add: Difference on account of adopting Arms Length Price [ if (A) is positive] Total Income of Khazana Ltd. (15,00,000) 90,00,000 NIL 90,00,000 20,00,000 90,00,000 20,00,000 1,10,00,000 Amount 1,00,000 50,00,000 65,00,000 Amount 50,000 50,00,000 30,00,000

Note: u/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore, difference on account of ALP which reduces the Taxable Income is ignored. Illustration 14: Designer Dolls Ltd. (DDI), located in United States, has a subsidiary in India. The Subsidiary manufactures designer dolls, using the unique technology developed by DDI. The Subsidiary has been able to locate from the public data base similar independent doll manufacturer. The Subsidiary pays Royalty to DDI @ 10% on sales, which is part of operating costs, which is the only international transaction that needs to be benchmarked. The following is the profitability of the two companies: Particulars Net Sales Cost of goods sold Operating Costs(including Royalty of ` 25,000) Net Profit Operating Margin: Net Profit/Net Sales *100 Subsidiary Co. (`) 2,50,000 1,50,000 50,000 50,000 20% Independent Co. (`) 7,00,000 4,00,000 2,00,000 1,00,000 14.28%

Thus, as the net profit margins earned by the subsidiary are more than the margin earned by the Independent Ca, the international transactions of the Subsidiary, i.e. Royalty paid of ` 25,000 is at arms length. Cost Cover Ratio The cost coverage ratio measures the ability of a company to cover its operating expenses through operating revenue. Given the limitation of financial information publicly available, the operating expenses of a selected comparable company are the sum of its operating revenue less EBIT. An example explaining the application of Operating margin is given below. Illustration 15: Indco, an Indian company produces a pen for itself and three foreign subsidiaries of its Swiss parent company. The foreign parent owns the rights to the product formulae for the pen. Although Indco has no internal comparable transactions, it has been able to locate data from a public data base, relating to a third party who manufactures similar pens. Indco has been able, after the appropriate functional analysis, to verify that the pen manufacturer is comparable. However, Indco cannot obtain the relevant information at the gross margin level. Therefore, it is unable to apply the CPM. The arms

DIRECT TAXATION I 29.53

Taxation of International Transactions length manufacturer realizes a net mark-up of 10% on the cost of manufacturing pens. The following is the comparison of the net cost plus earned by IndCo, vis--vis the independent manufacturer is calculated as follows: Particulars Indcos cost of goods sold Indcos operating expenses Total costs Sales Price earned by IndCo. Markup earned (` 1430 ` 1300) Net Cost plus earned by IndCo (130/1300*100) Net Cost plus earned by Third Party Manufacturer Thus, IndCos transactions are at arms length. Return on Assets Ratio The return on assets ratio measures the amount of EBIT per rupee of asset invested. This is a profitability ratio measuring each companys operational efficiency, that is, how efficiently the assets have been deployed by the company. Berry Ratio Berry ratio is the ratio of gross profit to operating expenses. It measures the return on operating expenses. As the functions performed by the tax-payers are often reflected in the operating expenses, this ratio determines the relationship of the income earned in relation to the functions performed. This ratio helps in overcoming the difficulties in applying the RPM, which does not explain the creation of gross profit. This ratio is used in conducting an arms length analysis of service-oriented industry such as limited risk distributor, advertising, marketing and engineering services. The Berry ratio may be used to test whether service providers have earned enough mark-up on their operating expenses. In essence, the Berry ratio implicity assumes that there is a relationship between the level of operating expenses and the level of gross profits earned by routine distributors and service providers. The use of Berry ratio is illustrated by way of the following example: An example explaining the application of Operating margin is given below. Illustration 16: ABC Ltd. India acts as a limited risk distributor in respect of the goods manufactured by its parent company. Dr. Profit and loss account of ABC Ltd India for the year ended March 31, 2010 Cr. Particulars To Purchases To Gross profit Total To Employee Cost To Rent To Legal Charges To Depreciation ToTotal Operating Expenses Total To Interest Cost Amount (`) Amount (`) 1,500 1,000 2,500 Particulars By Sales Total Amount (`) Amount (`) 2,500 2,500 Amount (`) 1,000 300 1,300 1,430 130 10% 10%

250 200 100 200

750 1,000 15

Total

1,000

29.54 I DIRECT TAXATION

To Loss on sale of assets To Net Profit before tax Total

2 8 1,000

Total

1,000

In this case, ABC India purchases the goods from its AE only on receipt of orders received from third party domestic customers. Accordingly, it does not bear the risk of inventory. In such a scenario, Berry Ratio would be an appropriate PLI as it represents a return on a companys value added functions and assumes that those functions are captured in its operating expenses. Thus, a Berry Ratio > 1 implies that the distributor earns enough to be able to recover its operating costs. ABC Indias Berry Ratio (Gross Profit/Operating Expenses) works out to be 1.33 (100/75). Similarly, the mean of Berry Ratio of comparable companies is 1.17, which is illustrated as under: Name of the Company A Ltd. B Ltd. C Ltd. D Ltd. Gross Profit (`) 50 75 120 90 Operating Expenses (`) 40 80 80 90 Berry Ratio (GP/Op.Exp) 1.25 0.94 1.50 1.00 1.17

Mean

Since, the Berry Ratio of ABC India is higher than that of the mean of comparable companies the international transactions of ABC India regarding purchase of goods are at arms length. Documentation (Information and documents to be kept and maintained under section 92D) Rule 10D. (1) Every person who has entered into an international transaction shall keep and maintain the following information and documents, namely: Documents Ownership structure Details (a)a description of the ownership structure of the assessee enterprise with details of shares or other ownership interest held therein by other enterprises;

(b) a profile of the multinational group of which the assessee enterprise is a part along with the name, address, legal status and country of tax residence of each of the enterprises comprised in the group with whom international transactions have been entered into by the assessee, and ownership linkages among them; Description of business (c) a broad description of the business of the assessee and the industry in which the assessee operates, and of the business of the associated enterprises with whom the assessee has transacted; (d) the nature and terms (including prices) of international transactions Nature and terms entered into with each associated enterprise, details of property transferred or of international services provided and the quantum and the value of each such transaction transactions or class of such transaction; (e) a description of the functions performed, risks assumed and assets Description of FAR employed or to be employed by the assessee and by the associated enterprises involved in the international transaction; Profile of MNC group

DIRECT TAXATION I 29.55

Taxation of International Transactions Record of economic and market analyses (f) a record of the economic and market analyses, forecasts, budgets or any other financial estimates prepared by the assessee for the business as a whole and for each division or product separately, which may have a bearing on the international transactions entered into by the assessee; Record of uncontrolled (g) a record of uncontrolled transactions taken into account for analysing their comparability with the international transactions entered into, including transactions for a record of the nature, terms and conditions relating to any uncontrolled comparability transaction with third parties which may be of relevance to the pricing of the international transactions; (h) a record of the analysis performed to evaluate comparability of Record of analysis uncontrolled transactions with the relevant international transaction; (i) a description of the methods considered for determining the arms length Description of the price in relation to each international transaction or class of transaction, the methods considered method selected as the most appropriate method along with explanations for determining ALP as to why such method was so selected, and how such method was applied in each case; (j) a record of the actual working carried out for determining the arms length Record of actual price, including details of the comparable data and financial information working used in applying the most appropriate method, and adjustments, if any, which were made to account for differences between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions; (k) the assumptions, policies and price negotiations, if any, which have critically Assumptions, policies and price negotiations affected the determination of the arms length price; Details of adjustments (l) details of the adjustments, if any, made to transfer prices to align them with arms length prices determined under these rules and consequent adjustment made to the total income for tax purposes; Any other information (m) any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of the arms length price.

Non-applicability: Rule 10D(2): Nothing contained in sub-rule (1) shall apply in a case where the aggregate value, as recorded in the books of account, of international transactions entered into by the assessee does not exceed one crore rupees. Provided that the assessee shall be required to substantiate, on the basis of material available with him, that income arising from international transactions entered into by him has been computed in accordance with section 92. Rule 10D (3): The information specified in sub-rule (1) shall be supported by authentic documents, which may include the following: (a) official publications, reports, studies and data bases from the Government of the country of residence of the associated enterprise, or of any other country; (b) reports of market research studies carried out and technical publications brought out by institutions of national or international repute; (c) price publications including stock exchange and commodity market quotations; (d) published accounts and financial statements relating to the business affairs of the associated enterprises;

29.56 I DIRECT TAXATION

(e) agreements and contracts entered into with associated enterprises or with unrelated enterprises in respect of transactions similar to the international transactions; (f) letters and other correspondence documenting any terms negotiated between the assessee and the associated enterprise; (g) documents normally issued in connection with various transactions under the accounting practices followed. Rule 10D (4): The information and documents specified under sub-rules (1) and (2), should, as far as possible, be contemporaneous and should exist latest by the specified date referred to in clause (iv) of section 92F: Provided that where an international transaction continues to have effect over more than one previous year, fresh documentation need not be maintained separately in respect of each previous year, unless there is any significant change in the nature or terms of the international transaction, in the assumptions made, or in any other factor which could influence the transfer price, and in the case of such significant change, fresh documentation as may be necessary under sub-rules (1) and (2) shall be maintained bringing out the impact of the change on the pricing of the international transaction. Rule 10D (5): The information and documents specified in sub-rules (1) and (2) shall be kept and maintained for a period of eight years from the end of the relevant assessment year. Application of Berry Ratio under different propositions Illustration 17: ABC Ltd. An Indian Company, acts as a limited risk distributor in respect of the goods manufactured by its parent company. Dr. Profit and loss account of ABC Ltd India for the year ended March 31, 2010 Cr. Particulars To Purchases To Gross profit Total To Employee Cost To Rent To Legal Charges To Depreciation Total Operating Expenses Total To Interest Cost To Loss on sale of assets To Net Profit before tax Total Amount (`) Amount (`) 1,500 1,000 2,500 Particulars By Sales Total By Gross Profit Amount (`) Amount (`) 2,500 2,500 1,000

250 200 100 200

750 1,000 150 20 80 1,000

Total

1,000

Total

1,000

In this case, ABC Ltd. purchases the goods from its AE only on receipt of orders received from third party domestic customer. Accordingly, it does not bear the risk of inventory. In such a scenario, Berry Ratio would be an appropriate PLI as it represents a return on a companys value added functions and assumes that those functions are captured in its operating expenses. Thus, a Berry Ratio > 1 implies that the distributor earns enough to be able to recover its operating costs. ABC Ltd.s Berry Ratio (Gross Profit/Operating Expenses) works out to be 1.33 (100/75). Similarly, the mean of Berry Ratio of comparable companies is 1.17, which is illustrated as under:

DIRECT TAXATION I 29.57

Taxation of International Transactions Name of the Company A Ltd. B Ltd. C Ltd. D Ltd. Mean Gross Profit (`) 50 75 120 90 Operating Expenses (`) 40 80 80 90 Berry Ratio (GP/Op. Exp) 1.25 0.94 1.50 1.00 1.17 Purchase price in comparable transactions at same quantity by domestic companies from their AEs 1,380 1,390 1,410 1,370 1,387.5

Since, the Berry Ratio of ABC Ltd. is higher than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are at arms length. Alternate Proposition I: If Berry Ratio of ABC Ltd. Is 1.03 as compared to that of mean of comparable companies 1.17, is there any need to order for re-assessment of arms length price? Since, the Berry Ratio of ABC Ltd. is lower than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are not at arms length. Impact on assessment of Arms Length Price: Particulars Net Profit as per Profit & Loss Account before tax Add : Adjustment for over-statement in Purchase Price on goods purchased from AE [= Purchase cost debited in Profit & Loss A/c (-) Average Purchase Price of Comparable Companies = Rs.1,500 1,387.50] Revised Net Profit after adjustment of over-statement in Purchase price but before tax Alternate Proposition II: Interest expense indicates only the extent to which the firms assets are secured by debt and the amount of depreciation recorded on a firms accounts is more likely to reflect the timing of that firms acquisition of assets than the actual depletion of capital assets. What would be the impact on assessment if these both are excluded from Operating expenses for calculation of Berry Ratio? Impact on assessment of Arms Length Price: Particulars Net Profit as per Profit & Loss Account before tax Add : Interest expense already excluded in computing operating expense, hence not considered further Add: Depreciation on assets added back Revised Net Profit after adjustment of over-statement in Purchase price but before tax Revised Operating Expenses = 750-200 =550 Revised Berry Ratio = (Gross Profit/Operating Expenses) works out to be 1.82 (1000/550). Since, the Berry Ratio of ABC Ltd. is higher than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are at arms length. Capacity Utilisation Adjustment Amount (`) 80 Nil 200 Amount (`) 80 112.50

192.50

380

29.58 I DIRECT TAXATION

XYZ Ltd. An Indian Company, acts as a limited risk distributor in respect of the goods manufactured by its parent company. Dr. Profit and loss account of ABC Ltd India for the year ended March 31, 2010 Cr. Particulars To Purchases To Gross profit Total To Employee Cost To Rent To Legal Charges To Depreciation Total Operating Expenses Total To Interest Cost To Loss on sale of assets To Net Profit before tax Total Amount (`) Amount (`) 1,500 1,000 2,500 Particulars By Sales Total By Gross Profit Amount (`) Amount (`) 2,500 2,500 1,000

250 200 100 200

750 1,000 150 20 80 1,000

Total

1,000

Total

1,000

Installed capacity: 10,000 hours. Capacity Utilisation: 75%. Cost of Fixed Assets Rs.10,000, Depreciation provided till date Rs.8,000, rate of depreciation @ 10%. Also given that there are 40 labourers, 260 working days and 8 hours per day. Industry capacity utilization rate is 90% What would be the adjustments required? Solution: (1) Depreciation related to idle assets should be adjusted from Profit & Loss Account. Year Ended Total depreciation charged in Profit & Loss Account Add: Proportionate depreciation in relation to idle assets to the extent of 30%, since utilized capacity is 75% =[ 200 x 25%] Depreciation adjusted in line with capacity utilisation (2) Adjustment in Profit & Loss Account Year Ended Net Profit as per Profit & Loss Account Add: Proportionate depreciation in relation to idle assets to the extent of 25%, since utilized capacity is 75% =[ 200 x 25%], now written back Adjusted Net Profit (3) Adjustment related to utilization of man-power Steps (a) (b) (c ) (d) (e) Year Ended Head counts Maximum number of hours per employee (ie 260 days * 8 hrs per day) Total available hours (c = a * b) Utilisation rate Utilised hours (=c * d) INR000 40 2,080 83,200 75% 62,400 INR000 80 50 130 INR000 200 50

150

DIRECT TAXATION I 29.59

Taxation of International Transactions (f) (g) (h) (i) (j) Unutilised hours (= c e) Unutilised hours after considering the industry unutilised rate of 10% (=f/0.25*0.10) Unutilised head counts (= g/2,080) Employment related costs (i) Adjustment to total employment related Cost (=i/a * h) 20,800 8,320 4 250 25 INR000 2,500 2,420 80 3.31% 25 50 155 6.40% 3.09%

(4) Impact of capacity under-utilisation and its adjustment is shown as under: Year Ended Sales (i) Less: Total Cost (ii) Operating profit (iii = i ii) Cost plus mark-up (iv = iii/ii * 100) Unutilised capacity cost adjustment related to employee cost (v) Unutilised capacity cost adjustment related to depreciation idle asset (vi) Adjusted operating profit (vii = iii + v + vi) Adjusted cost plus mark-up (viii = vii/ii * 100) Net increase in cost plus mark-up (ix = iv viii) Illustrations on Forex Adjustment Illustration 18: (a) An Indian software company receives an order from an European union country. The buyer will pay in four quarterly installments each of 0.5 million, starting from the end of the first quarter. The rates for euros in India is as follow : Spot 3 month forward 6 month forward 9 month forward 1 year forward Rs. 52.80 Rs. 52.70 Rs. 52.55 Rs. 52.50 Rs. 52.48 If an Indian company hedges its foreign exchange rate risk in the forward market, how much revenue does it earn? Spot rate : 3 month forward rate : 3 month interest rates : Re. : $ : 7% p.a. 11% p.a. Rs. 47.88/$ 47.28/$

(b) Are arbitrage gains possible from the following set of information to the arbitrageur?

Answer 18. (a)

Indian software company will have the following income streams : Installment 1st quarter-end 2nd quarter end 3rd quarter-end 4th quarter-end Euro income () 5,00,000 5,00,000 5,00,000 5,00,000 Rate (Rs.) 52.70/ 52.55/ 52.50/ 52.48/ 10,51,15,000 Revenue (Rs.) 2,63,50,000 2,62,75,000 2,62,50,000 2,62,40,000

Total revenue income is

29.60 I DIRECT TAXATION

Answer 18. (b) 3 month forward rate of the dollar is higher (at Rs. 48.28) than the spot rate (Rs. 47.88). It implies that the dollar is at premium. Premium (%) = (Rs.48.28 Rs.47.88)/47,88 x 12/3 x 100 = 11% - 7% = 3.34% per annum 4% per annum Interest rate differential =

Since interest rate differential (4%) and premium % (3.34%) do not match, there are arbitrage gain possibilities. An arbitrageur can take the following steps in this regard : (i) Arbitrageur borrows, say, Rs. 100 million at 7% for 3 months (he borrows in Indian currency as it carries lower interest rate).

(ii) He then converts Rs. 100 million in US $ at the spot rate of Rs. 47.88 in the spot market. He gets an amount of US $ 2,088,554.72 (Rs. 100 million/ Rs. 47.88). (iii) He invests US $ 2,088,554.72 in the money market at 11% interest per annum for 3 months. As a result of this investment, he obtains the interest of US $ 57,435.2548 ($ 2,088,554.72 3/12 11/100). (iv) Total sum available with arbitrageur, 3 months from now is (US $ 2,088,554.72 amount invested + US $ 57,435.2548 interest) = US $ 2,145,989.974. (v) Since he would get US $ 2,1451989.974 after 3 months, he sells forward US $ 2,145,989.974 at the rate of Rs. 48.28. (vi) As a result of a forward deal, at the end of 3 months from now, he would get Rs. 103,608,395.90, i.e. ($ 2,1451989.974 48.28). (vii) He refunds the Rs. 100 million borrowed, along with interest due on it. The refunded sum is Rs. 100 million + Rs. 1,750,000 i.e. (Rs. 100 million 3/12 7/100) = Rs. 101,750,000. (viii) Net gain is Rs. 103,608,395.90 Rs. 101,750,000 = Rs. 18,58,395.90. Illustration 19: The investment manager of a large Indian software company receives the following quotes from its foreign exchange broker. US dollar spot rate : Rs. 47.75/ US $ US dollar option quotation Call March - - 2.45 2.15 2.00 1.45 0.89 0.68 - - - September - - 0.2 0.25 0.70 1.00 1.59 1.70 1.90 2.00 2.30 - 2.9 2.3 1.95 1.85 1.15 0.74 0.52 - - - Put March 1.75 2.50 - - - - - 1.25 1.92 2.20 - - - September 3.0 2.6 2.0 1.85 1.25 0.85 0.50 0.30 0.15 0.10 0.08 December December

Strike price 45.0000 45.5000 46.0000 46.5000 47.0000 47.5000 48.0000 48.5000 49.0000 49.5000 50.0000

DIRECT TAXATION I 29.61

Taxation of International Transactions What calculation will the investment manager make for following questions? (i) What is the intrinsic value for the December 47.5 call option? (ii) What is the intrinsic value for the September 46 put option? (iii) What is the break-even exchange rate for the March 46.5 call and the March 48 put? (iv) If the March spot rate is expected to be Rs. 48.50/US $, which call option should be bought?

(v) The software company will receive its export income in March and the expected spot rate (in March) will be Rs. 46.5/US $, which put option should be bought? Answer 19. Intrinsic value of an option is the amount by which the option is in-the-money. For a call option, intrinsic value = Maximum [(Spot rate Strike rate), 0] For a put option, intrinsic value = Maximum [(Strike rate Spot rate), 0] i. Intrinsic value for the December 47.5 call option = Max [(Rs. 47.75/US $ - Rs. 47.5/US $),0] = Max [Rs. 0.25/ US $, 0] = Rs. 0.25/ US $ ii. iii.

Intrinsic value for the September 46 put option = Max [(Rs. 46/ US $ - Rs. 47.75/US $), 0] = Max [-(Rs. 1.75/ US $), 0] = 0 Rs. 2.15/US $ = Rs. (X 46.5)/US $

The break-even exchange rate for the March 46.5 call on settlement date is Re. X/US $ So, The premium paid = Profit from the call option X = Rs. 48.65/ US $ Premium paid = Rs. 2.50/US $ = Rs. (48 X)/US $ = Rs. 2.50/US $

At break even, Rs. (X 46.5)/US $ = Rs. 2.15/ US $

The break even exchange rate for March 48 put is : Profit from the put option X = Rs. 45.5/US $

At break-even, Rs. (48 X)/US $

iv. For an expected spot rate of Rs. 48.50/US $,, we need to find out profit from buying the March call option at various strike prices. Gain from call option = = Max [(Settlement rate Strike rate),0] Premium value of option at expiration Premium

29.62 I DIRECT TAXATION

 v.

Option Strike price (Rs.) March call March call March call March call March call March call 46.00/ US $ 46.50/ US $ 47.00/ US $ 47.50/ US $ 48.00/ US $ 48.50/ US $

Premium (A) Option value at 2.45/ US $ 2.15/ US $ 2.00/ US $ 1.45/ US $ 0.89/ US $ 0.68/ US $ 2.50 / US $ 2.00/ US $ 1.50/ US $ 1.00/ US $ 0.50/ US $ 0.00/ US $

Gain/ Loss [B A] (Rs.) 0.05/ US $ - 0.15/ US $ - 0.50/ US $ - 0.45/ US $ - 0.39/ US $ - 0.68/ US $

(Rs.) expiration (B) (Rs.)

So, for the expected March spot rate of RS. 48.50/ US $, the March call option of strike price Rs.46.00/ US $ should be bought. Gain from purchasing the March put option of various strikes, for which quotes are available, for an expiration price of Rs. 46.50/ US $. Option Strike price (Rs.) 47.50/ US $ 48.00/ US $ Premium (A) Option value at expiration (B) (Rs.) 1.00 / US $ 1.50/ US $ (Rs.) - 0.75/ US $ - 1.00/ US $ (Rs.) 1.75/ US $ 2.50/ US $ Gain/ Loss [B A]

March put March put

As no gains accrue by purchasing the different March put available for the expected March expiration rate of Rs. 46.50/ US $, the software company should not hedge through the put options.

Illustration 20: (a) XYZ Ltd. a US firm will need 3,00,000 in 180 days. In this connection, the following information is available: Spot rate 1= $2.00 180 days forward rate of as of today = 1.96 Interest rates are as follows: Particulars 80 days deposit rate 80 days borrowing rate U.K. 4.5% 5% U.S. 5% 5.5%

A call option on that expires in 180 days has an exercise price of $1.97 and a premium of $0.04. XYZ Ltd. has forecasted the spot rates 180 days hence as below: Future rate ($) Probability 1.91 25% 1.95 60% 2.05 15%

Which of he following strategies would be most preferable to XYZ Ltd.? (a) a forward contract (b) a money market hedge (c) an option contract (d) no hedging

DIRECT TAXATION I 29.63

Taxation of International Transactions Show calculations in each case.

(b) For imports from UK, Philadelphia Ltd. of USA owes 6,50,000 to London Ltd., payable on May, 2010. It is now 12 February, 2010. The following future contracts (contract size 62,500) are available on the Philadelphia exchange: Expiry March June Current futures rate 1.4900 $/ 1 1.4960 $/ 1 (i)

Illustrate how Philadelphia Ltd. can use future contracts to reduce the transaction risk if, on 20 May the spot rate is 1.5030 $/ 1 and June futures are trading at 1.5120 $/. The spot rate on 12 February is 1.4850 $/ 1.

(ii) Calculate the hedge efficiency and comment on it.

Answer 20. (a) (a) Taking a Forward Contract US $ needed on expiration of 180 days = 3,00,000 $ 1.96 = $5,88,000

(b) Money Market Hedge Transaction Now: Borrow in US dollars and invest in UK pounds on expiration of 180 days On expiration of 180 days: Repay in US $: US $ needed to purchase UK = = 2,87,081 US $ needed to convert into UK = 2,87,081 $2 = $ 5,74,162 = $5,74,162 $1.055 = $6,05,741 Premium per unit 0.04 0.04 0.04 Exercise option No No Yes Total price per unit 1.95 1.99 2.01 Total price for 3,00,000 (x) 5,85,000 5,97,000 6,03,00 Probability (p) 0.25 0.60 0.15 (px) Principal and interest payable in US $loan on expiry of 180 days

(c) Entering into Option Market by taking Call Option Expected spot rate in 180 days 1.91 1.95 2.05

1,46,250 3,58,200 90,450 5,94,900

Answer 20. (b)

(a) For Philadelphia Ltd. the appropriate futures contract will be the one that will expore soonest after the end of the exposure period i.e. the June contract. Number of contracts needed

29.64 I DIRECT TAXATION

= 6,50,000/62,500 = 10.4 (say 10 contracts)

P Ltd. will buy 10 June contracts now (12 Feb.) at $1.4960/1 and sell 10 contracts on 20 May for $1.5120/1, thus making a profit from the futures trading that will largely but not totally, netate the loss from the spot market (since sterling has strengthened between 12 February and 20 May). We now calculate the profit/loss from the futures contracts trade: The tick movement is (1.5120 1.4960) = 0.0160 i.e., 160 ticks (for one tick = 0.00001) (i)

(ii) Tick value per contract = 62,500 0.00001 = $6.25 (iii) Profit = 10 contracts 160 $ 6.25 = $ 10,000 (iv) Overall cost on 20 May when P Ltd. will exchange $ for on the spot market: (v) The net cost to P Ltd. = $ 9,76,950 $ 10,000 = $ 9,66,950

(b) Hedge Efficiency The spot on February 12 was 1.4850 $/1. So 650.000 would have cost $ 9,65,250 and the los on the spot market is $ (9,76,950 9,65,250) = $ 11,700. The hedge efficiency is therefore the future contract profit divided by the spot market loss The inefficiency is due to: (i) rounding the contracts to 10 from 10.4, and (ii) basis risk - the fact that the movement on the futures price has not exactly equalled the movement on the spot rate.

Illustration 21: (a) The following quotes are avilable for 3-months options in respect of a share currently traded at Rs. 31: Strike price Call option Put option Rs. 30 Rs. 3 Rs. 2

An investor devises a strategy of buying a call and selling the share and a put option. Draw his profit/loss profile if it is given that the rate of interest is 10% per annum. What would be the position if the strategy adopted is selling a call and buying the put and the share?

(b) What is the difference between Forward and Futures contracts? Answer 21. (a) Strategy I: Buying a call and selling a put and a shre Initial cash inflow (Rs. 31 Rs. 3 + Rs. 2) Interest rate = 10% Rs. 30.76* = Rs. 30

Amount grows in 3 months to (30 e1 .25) =

If the share price is greater than Rs. 30, he would exercise the call option and buy one share for Rs. 30 and his net profit is Rs. 0.76 (i.e. Rs. 30.76 30). However, if the share price is less than Rs. 30, the counter-party would exercise the put option and the investor would buy one share at Rs. 30. The net profit to the investor is again Rs. 0.76. Strategy II: Selling a calland buying a put and a share

DIRECT TAXATION I 29.65

Taxation of International Transactions In case, the investor has to arrange a loan @ 10% of Rs. 30 (i.e. Rs. 31 + Rs. 2 Rs. Rs. 3). This amount would be repaid after 3 months. Amount payable (30 e1 .25) is Rs. 30.76. After 3 months, if the market price is more than Rs. 30, the counter-party would exercise the call option and the investor would be required to sell the share at Rs. 30. The loss to the investor would be Rs. 0.76 (i.e. Rs. 30.76 30). However, if the rate is less than Rs. 30, the investor would exercise the put option and would get Rs. 30 from the rate of share. The loss to be buyer would again be Rs. 0.76. * Interest can also be calculated on simple interest basis instead of continuous compound interest. Answer 21. (b) Fundamentally, forward and futures contracts have the same function: both types of contracts allow people to buy or sell a specific type of asset at a specific time at a given price. However, it is in the specific details that these contracts differ. First of all, futures contracts are exchangetraded and, therefore, are standardized contracts. Forward contracts, on the other hand, are private agreements between two parties and are not as rigid in their stated terms and conditions. Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never. Secondly, the specific details concerning settlement and delivery are quite distinct. For forward contracts, settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract. Furthermore, settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only possess one settlement date. Lastly, because futures contracts are quite frequently employed by speculators, who bet on the direction in which an assets price will move, they are usually closed out prior to maturity and delivery usually never happens. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an assets price, and delivery of the asset or cash settlement will usually take place. Q. 22. Hedging with Commodity Futures: Bharat Oil Corporation (BOC) imports crude oil for its requirements on a regular basis. Its requirements are estimated at 100 tonnees per month. Of late, there has been a surge in the prices of oil. The current price (month of June) of crude oil is Rs. 5,500 per barrel. The firm expects the price to rise in coming months to Rs. 5,800 by August. It wants to hedge against the rising prices for its requirements of the month of August. Multi Commodity Exchange (MCX) in India offers a futures contract in crude oil. The contract size is 100 barrels and August contract is currently traded at Rs. 5,668 per ballel. (a) How can BOC hedge its exposure against the rising price of crude oil? (b) If Bharat Oil Corporation hede its exposure at MCX, how many contracts it must book? (c) Analyse the position of BOC if in the month of August (i) the spot price is Rs. 5,750 and futures price is Rs. 5,788, (ii) the spot price is Rs. 5,417 and futures market were matched? Ignore marking-to-the-market and initial margin on futures contracts. Answer 22. 1 tonnes = 7.33 barrels (a) Hedging strategy would be to take position in the futures market opposite to that of in the physical market.

29.66 I DIRECT TAXATION

BOC is short on crude oil and therefore they must go long on the futures of crude oil. Following would be the hedging strategy: June : Buy futures contract now August : Purchase crude oil at the price prevailing then in the spot market, and Sell the future contracts. = 100 tonnes or 733 barrels

(b) Quantity to be imported/hedged Contract size = 100 barrels Nos of contracts bought

= 733/100 = 8 (rounded off)

(c) In August, the firm would buy its requirements of crude oil in the market and unwind its position in the futures market by selling the contracts bought in June. By doing so, the gains/loss in the physical market would be offset significantly. August futures on crude oil = Rs. 5,668 per barrel (i) When the price of crude oil rises: Spot crude oil price = Rs. 5,750 Future price = Rs. 5,788 Purchase price in the spot for = 733 5750 = Rs. 42,14,750 Cash flow on futures position Buying price Selling price Profit = Rs. 96,000 5668 5788 120

Realizations from futures market = 8 100 120 Net amount paid Rs. 41,18,750 Effective price per barrel = 41,18,750/733 = Rs. 5,619 Sport crude oil price = Rs. 5,417 Futures price = Rs. 5,455

(ii) When the price of crude oil falls:

Purchase price in the spot for = 733 5417 = Rs. 39,70,661 Cash flow on futures position Buying price Selling price Profit = Rs. 1,70,400 5668 5455 213

Realisations from futures market = 8 100 213 Net amount paid Rs. 41,41,061 Effective price per barrel = 41,41,061/733 = Rs. 5,649 The effective price would be = S1 (F1 F0)

(d) If positions in the physical market and futures market were matched then

DIRECT TAXATION I 29.67

Taxation of International Transactions When price rose the effective price paid is = 5750 (5788 5668) = Rs. 5,630 per barrel = 5417 (5455 5668) = Rs. 5,630 per barrel When price fell the effective price paid is

Illustration 23:

Cancelling a swap A company has borrowed through a fixed rate instrument of 8%. The swap quote from the bank is 7.80/7.90, i.e., bank pays 7.80 fixed for receiving LIBOR and would receive 7.90% fixed for paying LIBOR. The company enters the swap deal with the bank. After some time, the swap market changes to 6.40/6.50 and the company again reverses the original swap by entering into 2nd swap opposite to that of the first one. (a) What does the structure of the first wap achieve? (b) What is the cost of funds for the firm before and after the swap? (c) What is the structure of 2nd swap and what does it do? (d) Find the cost of funds for the company after the second swap? Answer 23. (a) The company would undertake the transform the fixed rate liability to floating rate, as it possibly expects a decline in the interest rates. (b) Cost of funds after swap = L + 0.2% (c) The company would enter into a swap opposite to that of the first one. In the first swap, the firm received fixed and paid variable. Now in the second swap, it would pay fixed while receiving LIBOR. This would enable cancelling the floating leg. The company would gain the differential of the fixed legs of first and second swap. (d) Pay fixed to borrowers Receive fixed from bank (1st swap) Pay fixed to bank (2nd swap) 8.00 7.80 6.50 6.70

Effective cost after 2nd swap

Effect of change in Foreign Investments in equity on Arms Length Price (through Cost Plus Method) Illustration 24: Milano Inc., Italian Company, holds 45% of Equity in the Indian Company, Systems Technologies Ltd (STL). STL is engaged in development of software and maintenance of the same for customers across the globe. Its clientele includes Milano Inc. During the year, STL had spent 2,400 Man Hours for developing and maintaining software for Milano Inc, with each hour being billed at Rs.1,300. Costs incurred by STL for executing work for Milano Inc. amount to Rs. 20,00,000. STL had also undertaken developing software for Harsha Industries Ltd for which STL had billed at Rs.2,700 per Man Hour. The persons working for Harsha Industries Ltd. and Milano Inc. were part of the same team and were of matching credentials and caliber. STL had made a Gross Profit of 60% on the Harsha Industries work. STL is wholly dependent on the use of know-how from Milano Inc.

29.68 I DIRECT TAXATION

STLs transactions with Milano Inc. are comparable to the transactions with Harsha Industries, subject to the following differences: d) Milano Inc. gives technical know-how support to STL which can be valued at 8% of the normal gross profit. Harsha Industries does not provide any such support. e) Since the work for Milano involved huge number of man hours, a quantity discount of 14% of Normal Gross Profits was given. f) STL had offered 90 Days credit to Milano the cost of which is measured at 2% of the Normal Billing Rate, No such discount was offered to Harsha Industries Ltd.

Compute ALP and the amount of increase in Total Income of Systems Technologies Ltd. Alternate proposition I: Will there be any impact on your assessable value, as determined, if Milano Inc., Italian Company, a year ago, having their shareholding at 8% of Equity in the Indian Company, Systems Technologies Ltd (STL) was charged @ Rs. 2,500 per man hour ? Alternate proposition II: Milano Inc. intends to hold investment in STL for a indefinite period of time and it has no intention to resell for short-term profits. i.e. they classify quoted equity securities as Available-for-Sale (AFS) financial assets. As at 31st December, 2010, the fair value (represented by the quoted bid price) of STL shares was Rs.75 per share as compared with the original acquisition cost of Rs.100 per share, representing a decline of 25%. STLs share price has been trading at around Rs.75 per share for the past three months. The historical volatility of STLs share price for the past 5 years is approximately 30 percent. Recent financial analyst reports indicate a target price range of Rs.90 to Rs.125 for STLs share. Milano Inc. assessed the recoverability of the investment based on internally established criteria. Based on the assessment, Milano Inc. concluded that the decline in fair value below cost is not considered to be significant or prolonged and thus, investment is not impaired. Therefore, the unrealized holding loss remains in equity and is not charged to profit or loss. The financial statements for the year ended 31st December 2010 reflected a fair value loss of Rs.1 crore in fair value reserve, under shareholders equity. This is equal to approximately 10% of profit of the year. What should the directors consider when validating the reasonableness of the estimates made by management? What is the impact on assessment of Arms Length Price? Basic Proposition: (a) Computation of Arms Length Gross Profit Mark Up Particulars Normal Gross Profit Mark Up Less: Adjustment for differences:(which had the effect of reducing the profit of STL) (i)Technical support from Milano Inc. (8% of Normal Gross Profit 60%) (ii)Quantity Discount @ 14% of Normal Gross Profit (14% of 60%) Normal Gross Profit Rate of STL, had the transaction been unrelated and there been no technical support or quantity discount Add: Cost of Credit to Milano Inc. @2% of Normal Gross Profit (2% of Gross Profit 60%) [since this had effect of reducing the gross profit of STL] Arms Length Gross Profit Mark-up % 4.80 8.40 % 60.00 13.20

46.80 1.20 48.00

DIRECT TAXATION I 29.69

Taxation of International Transactions (b) Computation of Increase in Total Income of STL for services to Milano Inc. Particulars Cost of Services provided to Milano Billed Value at Arms Length [ Cost / (100 Arms Length Mark) = [Rs.20,00,000/ (100% -48%] Less: Actual Billing to Branch Inc.[2,400 x 1,300] Increase in Total Income of Milano Inc. Alternate Proposition I: It is proposed to ascertain the effect of change in equity on determination of Arms Length Price, with increase in foreign ownership ratio, as compared to past years. The ownership structure can be classified into two class of shareholders: (i) The market investor; (ii) The stable investor. The stable investor, including financial institutions and affiliated firms, tends to have on-going business ties with firms in which it holds shares. Financial institutions such as banks and insurance companies usually have lending, corporate insurance, and other financial transactions with the firms in which they hold shares. Corporate shareholders are usually business partners, suppliers or customers of the firms in which they have cross-shareholdings. Stable shareholders are more interested in stabilizing their business relationship than in the return on investment since the relative cash flows from the former far exceed those of the later. Market investors are those who buy, sell and hold stocks primarily for investment purposes. The main objective of market investors is a high investment return because, unlike stable investors, they have only arms length financial relations with firms in which they own shares. Thus, firms with a larger percentage of outstanding shares held by market investors are under great pressure to adopt profit-maximizing policies. Thus, increase in foreign ownership ratio is positively associated with firm performance. Foreign ownership change is measured in the ratio of firms outstanding shares held by foreign shareholders. Assuming this following information relating to ratio of foreign ownership in comparison to total outstanding shares is already available. Year/Particulars Total shares outstanding Foreign ownership % of Foreign ownership on firms outstanding shares held by stable investors % Increase in foreign equity Price charged per man-hour Decrease in price charged per man-hour % decrease in price charged per man-hour 1 1,00,000 2,000 2% Rs. 2,500 2 1,20,000 2,400 2% Rs. 2,500 3 1,50,000 3,000 2% Rs. 2,500 4 1,50,000 3,000 8% 300% Rs. 2,200 Rs.300 12% 5 2,00,000 90,000 45.00% 2150% Rs. 1,300 Rs.1,200 54.55% Amount (Rs.) 20,00,000 38,46,154 31,20,000 7,26,154

Impact of decrease in price change on increase in foreign equity: = (% decrease in price charged per man-hour) / (% Increase in foreign equity) x 100 = (54.55% /2150%) x 100 = 2.54%

29.70 I DIRECT TAXATION

(a) Computation of Arms Length Gross Profit Mark Up Particulars Normal Gross Profit Mark Up Less: Adjustment for differences:(which had the effect of reducing the profit of STL) (i)Technical support from Milano Inc. (8% of Normal Gross Profit 60%) (ii)Quantity Discount @ 14% of Normal Gross Profit (14% of 60%) Normal Gross Profit Rate of STL, had the transaction been unrelated and there been no technical support or quantity discount Add: Cost of Credit to Milano Inc. @2% of Normal Gross Profit (2% of Gross Profit 60%) [since this had effect of reducing the gross profit of STL] Add: impact of decrease in price charged due to increase in foreign equity investment in STL by Milano Inc. Arms Length Gross Profit Mark-up (b) Computation of Increase in Total Income of STL for services to Milano Inc. Particulars Cost of Services provided to Milano Billed Value at Arms Length [ Cost / (100 Arms Length Mark) = [Rs.20,00,000/ (100% - 50.54%] Less: Actual Billing to Branch Inc.[2,400 x 1,300] Increase in Total Income of Milano Inc. Increase in total income of Milano Inc. due to change in Proposition =Total Income vide Alternate proposition II (-) Total Income vide Alternate proposition I = Rs. 9,23,672 (-) Rs.7,26,154 = Rs.1,97,518 However, Return on Assets (ROA) and Return on Investments (ROI), Sales and Leverage Ratio could also be considered for analyzing the impact of change in equity. Alternate Proposition II: It is important to understand the impairment criteria established by management for assessing whether a decline below cost is significant or prolonged and consider whether the criteria are reasonable and supportable based on relevant facts and circumstances. The share price of an investment could be a relevant supporting criterion if it increases shortly after the reporting date or has a high level of volatility. After looking at the basis, underlying the criteria established, it is important to consider whether the unimpaired share price is reasonable and sensible in light of available market evidence. This could be performed by comparing the cost with relevant factors, for example: (i) Recent financial analysts target price range and outlook; (ii) The net assets per share of the investee; or the fundamental value of the investee; (iii) The earnings multiple, such as price-to-earnings ratios, implied by the acquisition price. In this case, since the historical volatility of STLs share price is approximately 30 percent, the decline does not appear to be significant. The decline of three months would not be considered to be prolonged. Hence, impact of change may be ignored for computation of Arms Length Price. Amount (Rs.) 20,00,000 40,43,672 31,20,000 9,23,672 % 4.80 8.40 % 60.00 13.20

46.80 1.20 2.54 50.54

DIRECT TAXATION I 29.71

Taxation of International Transactions Working Capital Adjustment The need for working capital adjustment Performing working capital adjustment is necessary to ensure that returns derived from a set of comparables can be applied reliably to a tested party operating in a non-arms-length setting. Rationale: The adjustments is economically sound, tax authorities/administrations in many countries across the globe accept/recognise this concept and usually require or at least recommend that taxpayers make such adjustments during the course of defending a transfer pricing audit, or while preparing and advance pricing agreement (APA) to ensure that the results are comparable by smoothening differences in working capital levels amongst otherwise functionally similar companies. Example: For example, in China, the State Administration for Taxation SAT (issued notice on capital adjustment issues in transfer pricing tax administration), vide the release of Circular [2005] 745, explicitly identifies the working capital issue as follows: In this regard, if there are differences in working capital (such as accounts receivables, accounts payables, inventories, etc.) between the investigated enterprise and the comparable companies, adjustments should be made for the effects of implicit interest cost embedded in working capital on profitability levels. Hence, when comparing the profit level of the investigated enterprise and the comparable companies, capital adjustments will increase operating profit reliability from an economic perspective and improve the profit level comparability. Approach adopted for performing working capital adjustments The basis for making the working capital adjustment is that a uniform and harmonised formula is adopted globally for the outcome of this adjustment. The assumption normally considered for such adjustment is that the debtors/ creditors whose name appears in the books of a company or receivables/payables which are there in the books of a company arise during the course of discharge of the business by the company. Working capital adjustment implies adjustment for differences in the credit terms or working capital policies. Companies with higher working capital requirements, other things being equal, would be expected to earn higher levels of operating profit to compensate for the greater use of capital. There are three critical elements in the working capital policy of any entity: 1) 2) 3) time-lag between the sale of products and payments received, which creates accounts receivable; time-lag between the purchase of inputs and payments becoming dur, which creates accounts payable; and time-lag between production and sale, which create inventories.

The objectives of the adjustments to accounts receivables (AR) and accounts payable (AP) are to remove the interest embedded in the AR/AP, attributable to the different levels of AR/AP, carried by the comparables and by the tested party. The step-by-step procedure (synopsis) (explained in detail in the ensuing sections) adopted in performing the accounts receivables (AR) and accounts payables (AP) adjustment(s) are set out as under: Step 1: Calculation of the average AR/AP amount during the year

AR (beginning _ of _ yr) + AR (end _ of _ yr) = 2

29.72 I DIRECT TAXATION

This is performed by both the tested party and the comparables. Step 2: Calculation of AR/AP turnover (times) AR/AP turnover represents the number of times the debtors have been turned over to produce the sales for the year.
AR T/o (times) = AR Step 3: Calculation of average credit period Sales

Average credit period represents the number of days sales that remains with the debtors. AR days = AR _ t / 0 Step 4: Calculation of the differential AR/AP of the comparable vis--vis the tested party. The comparables (C) and the tested part (T) have different credit policies which are reflected in the differential levels of receivables, vis--vis, their sales (S) that they carry. This step aims at identifying the differential values of receivables that are carried by the comparable vis--vis the tested party.
C T Differential AR of C (vis--vis TP) = S S * SC C T Step 5: Calculation of the interest embedded in the differential AR/AP of the comparable vis--vis the tested party. The differential AR/AP of the comparable vis--vis the tested party) contains two elements:

365

AR

AR

the sales price (that would have been paid in a cash sale and referred to as the AR/AP base); an interest element that is a compensation for the credit period advanced.

The interest rate for this purpose is often taken to be the prime lending rate as available on the Reserve Bank of India website. However, it is important to note that depending on the specific facts and circumstances, a different interest rate can also be justified for the purposes of making the working capital adjustments.
Diff _ AR C Diff AR base = 1 + i * AR _ DaysC 365 Diff _ AR C OR 1 + i * AR _ AR C SC

Interest embedded in Diff AR of Comparable = Differential AR of C Minus Diff AR base (as computed above). Step 6: AR/AP adjustment calculation of the differential interest embedded in the sales of the comparable vis--vis the tested party. AR/AP adjustment is the differential interest embedded in the sales of the comparable company vis-vis the tested party and is calculated as follows: Interest embedded in sales of comp=Interest embedded in Diff AR of Comp X Debtors turnover. Capital adjustments often improve the reliability of TNMM comparisons if the tested party differs from the comparables with respect to their relative levels of certain balance sheet items (eg accounts payable, accounts receivable or inventory). Adjustments may differ depending on the profit level indicator selected. The following describes capital adjustments for accounts payable, accounts receivable, and inventory.

DIRECT TAXATION I 29.73

Taxation of International Transactions Accounts payable adjustment 1) 2) 3) The accounts payable adjustment removes implicit interest in the price of goods purchased on other than a cash basis from suppliers. The purpose of this adjustment is to eliminate from profit comparisons the effects of companies decisions on how to finance purchases. A company purchasing goods on a cash basis would receive a lower price than a company purchasing the same goods on terms, because purchasing on terms subjects the seller to a capital cost that will be reflected in the price. Accordingly, if an adjustment is not made to reflect the implicit interest charged by suppliers, then a company that incurs more accounts payable would appear to be less profitable than an otherwise identical company that incurred less accounts payable. The adjustment for this difference, referred to as accounts payable adjustment, adjusts the cost of goods sold for each company by an estimate of the amount of interest included in the purchase price of the goods (or services). In other words, the cost of goods sold and, accordingly, operating profit is adjusted to a level that would be expected to exist if the companies purchased on a cash basis rather than on terms. In simple terms, the embedded interest in cost of goods sold relating to accounts payable financing is estimated by multiplying an interest factor by the average outstanding accounts payable. The amount of the adjustment to operating income is identical, regardless of the PLI. Moreover, because the decision on financing purchases does not affect a companys operating assets, sales or operating expense, this adjustment does not affect the denominator of the ROA, operating margin or Berry ratio. The adjustment affects cost of goods sold and also the denominator of the net cost plus ratio. The company receiving longer terms will report a higher cost of goods sold and as a result lower operating profit. The accounts payable adjustment thus estimates the implicit interest cost embedded in the cost of goods sold (CGS). The adjustment reduces the cost of goods sold (and as a result increases the gross profit) of the tested party and each of the comparables by the implicit interest paid to suppliers for financing received throughout the year. The amount financed by suppliers in a year is reflected by the average reported accounts payable (AVGAP) during that year. To determine the accounts payable adjustment, an interest-free average accounts payable by eliminating the embedded interest from AVGAP is computed. To calculate these interest-free accounts payable by dividing AVGAP by one plus a fraction of a years interest rate corresponding to the number of days, the accounts payable remained outstanding. Finally, the embedded interest paid to the suppliers by multiplying the interest-free accounts payable by an annual interest rate (RATE) is calculated. Accordingly, the formula for the accounts payable adjustment (PAYZ) is:
RATE AVGAP AVGAP 1 + RATE CGS

4)

5) 6)

7) 8)

9)

PAYZ =

This formula is applicable to both the tested party and the comparable companies. If cost of goods sold is controlled (sales in the denominator of the PLI)
AP AP i C T Payables Adjustment = * SC * APC S S T C 1 + i * S C

If sales are controlled (costs TC is the denominator of the PLI)

29.74 I DIRECT TAXATION

 APT APC i * TCC * = Payables Adjustment TCT TCC 1 + i * APC TCC

This formula is applicable only to the comparable companies. Accounts receivable adjustment 1) 2) 3) The accounts receivable adjustment removes implicit interest in the price of goods or services sold on other than cash basis to customers. The purpose of this adjustment is to eliminate the profit related to finance decisions of the seller. A company selling on cash basis would receive a lower price than a company selling the same goods on terms, because selling on terms subjects the seller to a capital cost that will be reflected in the price. Accordingly, if an adjustment is not made to reflect the implicit interest charged to customers, a company that extended longer payment terms would have higher accounts receivable and would appear to be more profitable than an otherwise identical company that extended shorter terms. The adjustment for this difference, referred to as an accounts receivable adjustment, adjusts the sales for each company by an estimate of the amount of interest included in the selling price of the goods or services. In other words, the sales, and accordingly the operating profit, are adjusted to a level that would be expected if the companies sold on cash basis rather than on terms. The amount of the adjustment to operating income is identical, regardless of the PLI. However, the adjustment to the denominator depends on the PLI. For ROA, as the selling terms are being adjusted to a cash basis, accounts receivable are adjusted to zero. Accordingly, accounts receivable are removed from the asset base. For operating margin, as the adjustment for imputed financing costs is to sales, the denominator is reduced by the same amount of imputed interest as the numerator. For the Berry ratio and net cost plus ratio, as the accounts receivable adjustment is to sales, no adjustment is made to the denominator. In simple terms, the embedded interest in sales relating to accounts receivable financing is estimated by multiplying an interest factor by the average outstanding accounts receivable. By allowing customers to defer payment for a certain period, a firm foregoes the right to receive its revenues immediately and to earn additional income by reinvesting these revenues over the deferral period. For instance, a firm which demands immediate payment could invest its revenues in a financial instrument and earn interest over the next 90 days, an opportunity that is not available to a firm that allows its customers 90 days to pay for their purchases. The accounts receivable adjustment thus estimates the implicit interest income embedded in sales (SALE). The adjustment reduces the sales (and as a result reduces the gross profit) of the tested party and each of the comparables by the implicit interest received from customers for financing provided throughout the year. The amount of financing provided to customers in a year is reflected in the reported average accounts receivable (AVGAR) during that year.

4)

5)

6)

7) 8)

9)

10) The prime lending rate has been used as a proxy for computing the opportunity cost to the comparable of choosing a particular level of receivables, and thereby foregoing the interest it could have earned by investing in short-term interest bearing security the excess cash that was tied up in receivables. In the case of cash related assets (ieaccounts receivable and accounts payable), the prime-lending rate is appropriately discounted since receivables/payables are stated at their future value (ie its value in 1year). 11) To determine the accounts receivable adjustment, we first compute an interest- free average accounts receivable by eliminating the embedded interest from AVGAR. We then calculate these

DIRECT TAXATION I 29.75

Taxation of International Transactions interest-free accounts receivable by dividing AVGAR by one plus a fraction of a years interest rate corresponding to the number of days the accounts receivable remained outstanding. Finally, we calculate the embedded interest received from customers by multiplying the interest-free accounts receivable by an annual interest rate (RATE). Accordingly, the formula for the accounts receivable adjustment (RECZ) is provided as under:
RECZ = RATE AVGAR AVGAR 1 + RATE SALE

This formula is applicable not only to the tested party but also to the comparable companies. If the cost of goods sold is controlled (sales in the denominator of the PLI)
AR T AR C i Receivables Adjustment = * SC * AR C S S C T 1 + i * S C

If cost of goods sold is controlled (sales in the denominator of the PLI)

C T Inventory Adjustment = S S * SC * i C T

INV

INV

If sales are controlled (costs in the denominator of the PLI)

C T Inventory Adjustment = TC TC * TCC * i T C

INV

INV

This formula is applicable only to the comparable companies. Treasury instruments are cited here only for illustrative purposes. Clearly, the firm could consider alternative investments with different profiles of risk and expected return. Particulars Sales Operating cost Purchases Cost of goods sold Operating profit Operating profit margin (PLI) Inventory Accounts receivables Accounts payables Accounts receivables period Accounts payables period Inventory holding period Receivables adjustment Payables adjustment Inventory adjustment Capital adjusted operating profits Adjusted sales Capital adjusted Operating Reference A B C D E=A-B F=E/A*100 G H I J K L M N O=[7.58/54.92 P=E+N+M-O Q=A-M R=P/Q*100 Comparable Tested Financial year ended 31.3.2010 8.17 54.92 7.44 44.13 3.60 22.77 3.61 22.31 0.73 10.79 8.94% 19.64% 2.00 7.58 3.33 14.17 0.79 8.92 148.77 94.20 80.10 142.92 202.22 124.11 (0.09) 0.04 (0.07) 0.94 8.26 11.34%

29.76 I DIRECT TAXATION

Case Study 1: J Inc. of Korea and CD Ltd, an Indian Company are associated enterprises. CD Ltd manufactures Cell Phones and sells them to J.K. & F Inc., a Company based at Nepal. During the year CD Ltd. supplied 2,50,000 Cellular Phones to J Inc. Korea at a price of Rs.8,000 per unit and 35,000 units to JK & F Inc. at a price of Rs.16,800 per unit. There being no other customer for CD Ltd. during this year. The transactions of CD Ltd with JK & F Inc. are comparable subject to the following considerations Sales to J Inc. are on FOB basis, sales to JK &F Inc. are CIF basis. The freight and insurance paid by J Inc. for each unit @ Rs.700. Sales to JK &F Inc. are under a free warranty for Two Years whereas sales to J Inc. are without any such warranty. The estimated cost of executing such warranty is Rs.500. Since J Inc.s order was huge in volume, quantity discount of Rs.200 per unit was offered to it. CD Ltd. has borrowed funds amounting to Rs.100 crores, from its parent company at LIBOR plus 150 basis points. The fund is utilized for capital investment purposes, viz, expansion of capacity. The LIBOR prevalent at the time of borrowing is 6% for US$, thus its cost of borrowings is 7.50%. The borrowings allowed under the External Commercial Borrowings guidelines issued under FEMA, for example, say is LIBOR plus 250 basis points, then it can be said that Pharmas borrowing at 7.50% is less than 6.50% and thus at not at arms length. Installed Capacity: 4,00,000 units. Industry utilization rate: 90%. The company works for 300 days in a year at 8 hours per day and has 300 employees. Cost of employees Rs.1,00,000. Total Depreciation charged during the year Rs.10,00,000. Net Profit for the year for CD Ltd. Rs.8,54,000. Net profit ratio is 8%. Compute the Arms Length Price and the subsequent amount of increase in the Total Income of CD Ltd, if any. (a) Computation of Arms Length Price of Products sold to J Inc. Korea by CD Ltd Particulars Price per Unit in a Comparable Uncontrolled Transaction Less: Adjustment for Differences (a) Freight and Insurance Charges (b) Estimated Warranty Costs (c) Discount for Voluminous Purchase (d) External Commercial Borrowings (Working Note 1) (e) Depreciation adjustment (Working Note 2a) (f) Adjustment for under-utilisation of manpower (Working Note 2 c) Armss Length Price for Cellular Phone sold to J Inc. Korea (b) Computation of Increase in Total Income of CD Ltd Particulars Arms Length Price per Unit Less: Price at which actually sold to J Inc. Korea Increase in Price per Unit No. of Units sold to J Inc. Korea Increase in Total Income of CD Ltd (2,50,000 x Rs.2,030.71) Rs. 12,030.71 (10,000) 2,030.71 2,50,000 Rs.50,76,77,500 Crores. 700 500 200 35 1 3333.29 12,030.71 (4,769.29) Rs. Rs. 16,800

DIRECT TAXATION I 29.77

Taxation of International Transactions Working Note 1: Adjustment for External Commercial Borrowings: Excess Interest rate provided in comparison to ECB guidelines = (7.50 -6.50) % = 1% Excess Interest cost = 1% of Rs.100 crores = Rs.1 crore. Installed Capacity = 4,00,000 units. Interest Cost per unit, based on Utilised Capacity = Rs.1,00,00,000 / (2,50,000 + 35,000) = Rs.35 (appx) Capacity Utilised = 2,85,000 /4,00,000 x 100 = 71.25% Working Note 2: (a) Depreciation related to idle assets should be adjusted from Profit & Loss Account. Year Ended Total depreciation charged in Profit & Loss Account Add: Proportionate depreciation in relation to idle assets to the extent of 28.75%, since utilized capacity is 71.25% =[ 10,00,000 x 28.75%] Depreciation adjusted in line with capacity utilisation (b) Adjustment in Profit & Loss Account Year Ended Net Profit as per Profit & Loss Account Add: Proportionate depreciation in relation to idle assets to the extent of 28.75%, since utilized capacity is 71.25% =[ 10,00,000 x 28.75%], now written back Adjusted Net Profit (c) Adjustment related to under-utilization of man-power Steps (a) (b) (c ) (d) (e) (f) (g) (h) (i) (j) (k) (l) Year Ended Head counts Maximum number of hours per employee (ie 300 days * 8 hrs per day) Total available hours (c = a * b) Utilisation rate Utilised hours (=c * d) Unutilised hours (= c e) Unutilised hours after considering the industry unutilised rate of 10% (=f/0.2875*0.10) Total Unutilised head counts (= g/2,400) Proportionate unutilized head counts on the basis of output provided to AE = ( 30 x 2,50,000/2,85,000) Total Employment related costs Proportionate employee related cost on the basis of output provided to Associated Enterprise = (1,00,000/2,85,000 x 2,50,0000) Adjustment to total employee related Cost proportionate to output provided to AE (=k/ i) INR000 300 2,400 7,20,000 71.25% 5,13,000 2,07,000 72,000 30 26.316 1,00,000 87,719 3333.29 Rs. 8,54,000 2,87,500 11,41,500 Rs. 10,00,000 2,87,500

7,12,500

Depreciation adjustment per unit based on utilized capacity = 2,87,500 / 2,85,000 = 1.01 = 1.00 (appx)

29.78 I DIRECT TAXATION

Case Study 2 Happy Ltd., an Indian Company is a wholly-owned subsidiary of Happy Inc. Happy Ltd. is engaged in provision of software development services to its associated enterprise Happy Inc. The following is the income statement if Happy Ltd. for the year ended 31.3.2010 Happy Ltd. All figures in Rupees 000 Revenue from associated enterprises - - - - - - Total operating income Pay roll Rent Depreciation General administration expenses Other operating expenses 95,000 40,000 16,500 9,500 8,200 11,800 86,000 9,000 Costs

Total operating expenses Operating profit

Net Cost plus mark-up (%) [Operating profit /total operating expenses] 10.46% For the financial year ended 31st March, 2010, Happy Ltd has earned a Net Cost Plus mark-up of 10.46% from its associated enterprises. Accordingly, it is reasonable to conclude that Happy Ltds international transactions with Happy Inc., relating to the provision of software services, appears to be consistent with the arms length standard from the Indian transfer pricing perspective. If Happy Ltds actual mark-up is less than the arms length mark-up benchmark of 11.77%, what would be the impact on assessment of arms length price? Solution: It would need further examination as to whether it is compliant with the arms length standard from an Indian Transfer pricing perspective. We may have two different scenarios: Scenario 1: where Happy Ltds margin is below the arms length mark-up but within the range permissible under the proviso to Sec.92C (2) Scenario 2: Where Happy Ltds margin falls below the lower limit of the range of permissible under the proviso. The calculation of range of permissible margins applying the proviso is shown in Table A. The arithmetic mean of 11.77% is applied to the costs of the tested party (Rs.86,000) to derive the arms length price of the international transaction (refer col.2 figure indicated as ALP Rs.96,122) is a balancing figure and refers to the arms length price of the international transaction. The adjustment of (+/-) 5 percent permitted by the proviso is applied to the ALP to give the range of values that would be considered at arms length. Further, as the international transactions consists of export of services, the lower end of the range is 95% of ALP Rs.91,316 (Col.4) representing the lowest possible transaction value that would be considered compliant with the arms length principle.

DIRECT TAXATION I 29.79

Taxation of International Transactions Table A Calculation of Range of outcomes that would meet the arms length standard applying the proviso to Section 92C (2) Profit & Loss Account for the year ended 31st March, 2010 Particulars Col. 1 Actual At ALP Refer Note No. 2 Col. 2 [All figures in Rupees 000] At ALP (+) 5% of ALP 1,00,928 Col.3 At ALP (-)5% of ALP ALP (+)5% 91,316 ALP (-) 5% Col.4

(a) Revenue -From associated enterprises (international transaction) Total Operating Income (b)Costs (all unrelated, no international transactions) Pay roll Rent Depreciation General administration exp. Other operating expenses Total Operating expenses (c)Operating Profit[=(a) (b)] Net Cost Mark-up (%) Arms length mark-up [i.e. arithmetical mean of the Net Cost Plus mark-up(%) of broadly comparable independent companies] Range of net cost plus mark-ups that would be considered compliant with the arms length standard applying the +/5% variation permitted by proviso to Sec.92C(2) [= Operating Profit / Operating expenses] 95,000 96,122 ALP

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

9,000 10.46%

10,122 11.77%

14,928

5,316

17.36%

6.18%

29.80 I DIRECT TAXATION

Notes: 4. 5. Operating profit in Col.2 is a derived figure by applying mark-up of 11.77% to the tested partys total operating expenses of Rs.86,000 (a) Revenue from associated enterprises ( international transaction) in Col.2 is the balancing figure considering operating profit derived in Col.1 above and the total operating expenses remaining unchanged at Rs 86,000. This revenue figure is the Arms Length Price (ALP). (b) Revenue from associated enterprises (international transaction) in Col.3 represents the upper limit of the range permissible under the proviso the Section 92C(2) (c) Revenue from associated enterprises (international transaction) in Col.4 represents the lower limit of the range permissible under the proviso the Section 92C(2) The Net Cost Plus Mark-up earned by the tested party ( col.1) is higher than the arms length markup (col.2), accordingly the international transaction complies with the arms length principle.

6.

Workings: Computation of Weighted Net Cost-plus mark-ups of broadly comparable independent companies. (on the basis of hypothetical data of 5 such companies for 5 years.) Comparable Company 1 Profit and Loss Account (Summary) year ended.. Comparable 1 March March 2006 2007 (1)Time period 12 mnths 12 mnths (2)Total Income 125 143 (3)Total Cost 118 129 (4)Net profit [=(2) (3)] 7 14 (5)Net cost plus mark-up [=(4)/ 5.93% 10.8% (3) *100] (6)Weighted Average ------[= {Total of col. (4)/ Total of col. (3)} x 100] Comparable Company 2 Profit and Loss Account (Summary) year ended.. Comparable 2 March March 2006 2007 (1)Time period 12 mnths 12 mnths (2)Total Income 152 134 (3)Total Cost 118 129 (4)Net profit [=(2) (3)] 34 5 (5)Net cost plus mark-up [=(4)/ 28.81% 3.88% (3) *100] (6)Weighted Average ------[= {Total of col. (4)/ Total of col. (3)} x 100] March 2008 12 mnths 155 140 15 10.71% ---March 2009 12 mnths 143 128 15 11.72% ---(Rs. In Crores) March 2010 12 mnths 157 135 22 16.30% ---Total 741 674 91 ---13.50% March 2008 12 mnths 155 140 15 10.71% ---March 2009 12 mnths 134 128 6 4.69% ---(Rs. In Crores) March 2010 12 mnths 175 159 16 10.06% ---Total 732 674 58 ---8.61%

DIRECT TAXATION I 29.81

Taxation of International Transactions Comparable Company 3 Profit and Loss Account (Summary) year ended.. Comparable 3 March March 2006 2007 (1)Time period 12 mnths 12 mnths (2)Total Income 15 13 (3)Total Cost 13 12 (4)Net profit [=(2) (3)] 2 1 (5)Net cost plus mark-up [=(4)/ 15.38% 8.33% (3) *100] (6)Weighted Average ------[= {Total of col. (4)/ Total of col. (3)} x 100] Comparable Company 4 Profit and Loss Account (Summary) year ended.. Comparable 4 March March 2006 2007 (1)Time period 12 mnths 12 mnths (2)Total Income 215.38 183.68 (3)Total Cost 191.21 162.55 (4)Net profit [=(2) (3)] 24.17 21.13 (5)Net cost plus mark-up [=(4)/ 12.64% 13.00% (3) *100] (6)Weighted Average ------[= {Total of col. (4)/ Total of col. (3)} x 100] Comparable Company 5 Profit and Loss Account (Summary) year ended.. Comparable 5 March March 2006 2007 (1)Time period 12 mnths 12 mnths (2)Total Income 231.15 138.89 (3)Total Cost 211.29 132.46 (4)Net profit [=(2) (3)] 19.86 6.43 (5)Net cost plus mark-up [=(4)/ 9.40% 4.85% (3) *100] (6)Weighted Average ------[= {Total of col. (4)/ Total of col. (3)} x 100] March 2008 12 mnths 157.86 129.19 28.67 22.19% ---March 2009 12 mnths 424.37 392.21 32.16 8.20% ---(Rs. In Crores) March 2010 12 mnths 327.75 303.34 24.41 8.05% ---Total 1280.02 1168.49 129.71 ---11.10% March 2008 12 mnths 176.85 169.29 7.56 4.47% ---March 2009 12 mnths 244.73 212.11 32.62 15.38% ---(Rs. In Crores) March 2010 12 mnths 267.57 223.34 44.23 19.80% ---Total 1088.21 958.50 129.71 ---13.53% March 2008 12 mnths 15 14 1 7.14% ---March 2009 12 mnths 14 12 2 16.67% ---(Rs. In Crores) March 2010 12 mnths 17 15 2 13.33.% ---Total 74 66 8 ---12.12%

29.82 I DIRECT TAXATION

Summary of Net Cost Plus Mark-ups of broadly comparable independent companies Sl No. 1 2 3 4 5 Company name Comparable 1 Comparable 2 Comparable 3 Comparable 4 Comparable 5 Arithmetic Mean March 2006 5.93% 28.81% 15.38% 12.64% 9.40% 14.43% March 2007 10.8% 3.88% 8.33% 13.00% 4.85% 8.17% March 2008 10.71% 10.71% 7.14% 4.47% 22.19% 11.04% March 2009 4.69% 11.72% 16.67% 15.38% 8.20% 11.33% March 2010 10.06% 16.30% 13.33.% 19.80% 8.05% 13.51% Weighted average 8.61% 13.50% 12.12% 13.53% 11.10% 11.77%

Conclusion: On the basis of the above, the Net Cost-plus mark-ups of broadly comparable independent companies range from 8.61% to 13.53% with an arithmetical mean of 11.77%. Scenario 1: where Happy Ltds margin is below the arms length mark-up but within the range permissible under the proviso to Sec.92C (2) Profit & Loss Account for the year ended 31st March, 2010 Particulars Col. 1 Actual At ALP Refer Note No. 2 Col. 2 At ALP (+) 5% of ALP 1,00,928 [All figures in Rupees 000] Col.3 At ALP (-)5% of ALP Col.4

(a) Revenue -From associated enterprises (international transaction) Total Operating Income (b)Costs (all unrelated, no international transactions) Pay roll Rent Depreciation General administration exp. Other operating expenses Total Operating expenses (c)Operating Profit[=(a) (b)] Net Cost Mark-up (%) Arms length mark-up [i.e. arithmetical mean of the Net Cost Plus mark-up(%) of broadly comparable independent companies] 7,500 8.72% 10,122 11.77% 1 14,928 93,500 96,122 ALP ALP (+)5%

91,316 ALP (-) 5%

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

5,316

DIRECT TAXATION I 29.83

Taxation of International Transactions Range of net cost plus mark-ups that would be considered compliant with the arms length standard applying the +/5% variation permitted by proviso to Sec.92C(2) [= Operating Profit / Operating expenses] Notes: 4. 5. Operating profit in Col.2 is a derived figure by applying mark-up of 11.77% to the tested partys total operating expenses of Rs.86,000 (a) Revenue from associated enterprises (international transaction) in Col.2 is the balancing figure considering operating profit derived in Col.1 above and the total operating expenses remaining unchanged at Rs 86,000. This revenue figure is the Arms Length Price (ALP). (b) Revenue from associated enterprises (international transaction) in Col.3 represents the upper limit of the range permissible under the proviso the Section 92C(2) (c) Revenue from associated enterprises (international transaction) in Col.4 represents the lower limit of the range permissible under the proviso the Section 92C(2) The Net Cost Plus Mark-up of 8.72% earned by the tested party ( col.1) even though below the arms length Net Cost plus mark-up (col.2), still falls within the range permissible under the proviso to Section 92C(2) [Col.(3) & (4)] . Hence no adjustment needs to be made. 17.36% 6.18%

6.

Scenario 2: Where Happy Ltds margin falls below the lower limit of the range of permissible under the proviso Profit & Loss Account for the year ended 31st March, 2010 Particulars Col. 1 Actual At ALP Refer Note No. 2 Col. 2 [All figures in Rupees 000] At ALP (+) 5% of ALP 1,00,928 Col.3 At ALP (-)5% of ALP Col.4

(a) Revenue -From associated enterprises (international transaction) Total Operating Income (b)Costs (all unrelated, no international transactions) Pay roll Rent Depreciation General administration exp. Other operating expenses Total Operating expenses 91,000 96,122

ALP

ALP (+)5%

91,316 ALP (-) 5%

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

40,000 16,500 9,500 8,200 11,800 86,000

29.84 I DIRECT TAXATION

(c)Operating Profit[=(a) (b)] Net Cost Mark-up (%) Arms length mark-up [i.e. arithmetical mean of the Net Cost Plus mark-up(%) of broadly comparable independent companies] Range of net cost plus mark-ups that would be considered compliant with the arms length standard applying the +/- 5% variation permitted by proviso to Sec.92C(2) [= Operating Profit / Operating expenses] Notes: 5. 6.

5,000 5.82%

10,122 11.77%

14,928

5,316

17.36%

6.18%

Operating profit in Col.2 is a derived figure by applying mark-up of 11.77% to the tested partys total operating expenses of Rs.86,000 (a) Revenue from associated enterprises (international transaction) in Col.2 is the balancing figure considering operating profit derived in Col.1 above and the total operating expenses remaining unchanged at Rs 86,000. This revenue figure is the Arms Length Price (ALP).

(b)Revenue from associated enterprises (international transaction) in Col.3 represents the upper limit of the range permissible under the proviso the Section 92C (2) (c)Revenue from associated enterprises (international transaction) in Col.4 represents the lower limit of the range permissible under the proviso the Section 92C (2) 7. The Net Cost Plus Mark-up earned by the tested party ( col.1) falls below the lower limit of the range permissible under proviso 92C(2) [Col.(4)] . This situation may expose the tested party to an adjustment to the price charged by it in its international transaction. Such adjustment, if recommended to be made by the TPO to the AO should amount to Rs.316 As explained hereunder. Quantum of adjustment: (v) Value of the international transaction (vi) Arms length price (vii) Arms length price applying the proviso to Sec.92C(2) (viii) Adjustment (iii) (i) 91,000 96,122 91,316 316

8.

DIRECT TAXATION I 29.85

Taxation of International Transactions Case Study 3: ABC ENGINEERING INC The use of Cost Accounting Principles could lead to establishment of an Arms Length Price which is different from the price arrived at by assessee in the TP Study Report. The objective of our study would be to find out whether the Arms Length Price (ALP) worked out using CPM was in accordance with generally accepted cost accounting principles. The assessee had a revenue model that was based on a man-hour rate with its AE. Institute is finding was that the assessee was computing the total cost incurred over the entire available man-hours, which included idle time. Institutes contention was that the total cost needed to be segregated into variable costs and fixed costs and for the purpose of computing cost per hour, the variable costs should be computed based on capacity utilized and not on total hours (including idle hours). Cost of fixed expenses could, however, be computed based on total hours (including idle hours). Computation of cost using CPM (in which it accepted the profit margins adopted by the assessee based on study of comparables) and recommended that the ALP be revised upwards to the tune of Rs.55,83,930. The computation made based on Cost Records are: Annexure - Computation of Arms Length Price ABC ENGINEERING INC. Total available hours Hours billed to HO for work done Idle hours billed to HO External hours billed Total billed hours Capacity utilised for actual work Idle capacity billed Idle capacity not billed Total Variable costs reported in Annexure 3 of TP Study Report(Rs.) Total actual hours of work done Variable Cost per hour (Rs.) Total Fixed Costs reported in Annexure 3 as per TP Study Report(Rs.) Total available hours Fixed Cost per hour Total Cost per hour Normal Margin per Hour (on sales) Arms Length charge per hour (CPM) Variation (-5%) Arms Length Price considered by assessee

A B C D E=B+C+D F= (B+D)*100/A G= C*100/A H= (A-E)*100/A

172,804 47,543 48,447 16,465 112,455 37.04% 28.04% 34.92% 15,399,050 64,008 241 54,427,999 172,804 315 556 27.55% 767 728 645

29.86 I DIRECT TAXATION

Adjustment required (upward) per hour Total upward adjustment required for the year (Rs.) Tax thereon @ 40% Surcharge @ 2.50% E-Cess /H.S.E-Cess @ 3%

83 3,946,069 1,578,428 39,461 1,617,888 48,537 1,666,425

COST RECORDS as an important tool for Assessment under Tax Laws RELEVANCE OF COST ACCOUNTING PRINCIPLES IN ARMS LENGTH PRICING As a concept, the worldwide acceptability of Arms Length Pricing (aka Transfer Price) as the price at which transactions between Associated Enterprises should take place is no more a matter of debate. It is true that some countries in South America have specific guidelines on Transfer Price which do not match with the methods recommended by the OECD but even those guidelines are generally in keeping with the concept of Arms Length. In a business environment in which competitive forces determine revenue earnings, profits are budgeted for by keeping a close control over costs. Cost Control is a byword in all corporate across the world and the better one is able to control costs, the more competitive one can price ones product or services. Global corporations are increasingly centralizing essential functions like purchasing, IT infrastructure, legal service and R & D efforts with the objective of cutting costs and negotiating economies of scale with vendors. As a result, it is quite common now for the parent company to charge a Management Fee from its subsidiaries /associated enterprises or apportion a part of costs as a part of Cost Contribution Arrangements. The term Management Fees is usually used to loosely describe any Inter-Company Transfer that is neither a transfer of tangible property nor one of intangible property. It is often difficult to find comparables for such services or evaluate the benefits received. As a result, tax administrations are generally sceptical about Management Fees and consider them to be prone to potential abuse. There are two views on the issue of Management Fees: Developed nations have adopted rules and regulations on deductibility of Management Fees as an expense so long as it complies with the applicable domestic tax law and Arms Length Principle. However, other nations do not permit deductibility of these expenses and do not even recognize such kinds of expenses. Such nations impose restrictions by way of exchange controls and withholding taxes thus creating a barrier for such nature of remittances. Before any structure can be defined for Management Fees, it is vital to establish the following: - The exact nature of the services to be performed (taking care to exclude Shareholder Activities). - Which entities are to render the services and which are to receive the services. - Actual costs involved in rendering the services. - Deductibility of the expenses in the recipient country The structure of the fees, scope of services and other aspects relating to the arrangement may be documented in the form of a written agreement (bilateral or multilateral) and would also require evidence of costs incurred and services actually rendered. Additionally, country-specific documentation should be added wherever applicable. A recent trend that has been discussed is that tax administrations are now seeking to establish that a direct benefit has resulted and the benefits are not indirect.

DIRECT TAXATION I 29.87

Taxation of International Transactions As mentioned earlier, for such nature of services, it is not easy to establish a comparable with an independent party. When a comparable cannot be established, the usual preference is to use the CPM (Cost Plus Method). This requires establishing the costs, which may be ascertained by using an appropriate cost accounting method. Furthermore, care should also be taken to distinguish between what constitutes a reimbursement and what constitutes a service function. Subject to the limitations discussed above, it would be appropriate to add a cost markup on the actual costs of the service function. Cost sharing is based on the idea that a number of group companies/related companies may get together to fund the costs of research and development of new technologies or know-how. By sharing in the costs, each participant in the CCA obtains a right to the R&D. As soon as viable commercial opportunity arises, each participant may choose to exploit the opportunity optimally. While the concept of cost sharing is simple, there are complex accounting and regulatory issues that arise in practice from such arrangements. For example, if the costs include cost of equipments /machinery, how will this be captured in the books of accounts of the participating entities. Will this be capitalized or charged to revenue? Should there be a profit markup in sharing? There are benefits, too, that arise from cost sharing. For example, it may eliminate the need to pay royalties for transfer of intangible properties because each of the participants, by being a co-funder of the expenses, is entitled to enjoy the fruits of the intangible. Secondly, cost sharing is also a means of financing of R&D. Since related entities /group companies may be expected to benefit from R&D activity carried out by one of the entities (usually the parent company or a Research Centre), if they do not share the costs, it leads to a situation where the related entities get benefits at the cost of one entity only. Cost sharing eliminates this inequity. A valid CCA between related entities involves a written agreement, signed preferably before commencement of the R&D work, to share the costs and risks of the R&D effort under mutual direction and benefit. Each participant agrees to bear a part of the costs and risks and in turn reaps proportionate benefits. Acceptance of CCAs by all tax administrations has not happened yet but these are being recognized more and more by different administrations. The strongest theoretical basis for cost allocation is by reference to the actual benefits derived from the activity (it is respectfully suggested that a recent ruling by the ITAT in the matter of Dressner Rand may not reflect international thought in this matter). However, all R&D expenditure may not necessarily result in commercially exploitable situations and there must be a method of dealing with abortive expenditure as well as successful expenditure. It is because of this that the preferred method of cost allocation is referenced to expected benefit. This calculation, however, is very complicated and may not be economical to perform. In practice, considerable weight is given to expected sales/revenue of each participant. An important point to be remembered in this connection is that while tax administrations, in general, prefer to follow OECD guidelines in the matter of CCAs, some tax administrations have designed and brought into force special regulations dealing with these: For example, Article 41 of the Corporate Income Tax Law of China; Guidelines on CCAs issued in March 2006 by Japan; Taxation Ruling 2004/1 issued by Australia etc. As mentioned earlier, a key issue is on the deductibility of expenses under CCAs. Should they be revenue expenditure of capital expenditure. There is no prescribed guideline on this and the accounting and tax treatment shall have to follow local tax law. A more fundamental issue is on the proportion of costs charged under a CCA and whether this is reasonable. Tax administrations may wish to examine the CCA at a group level rather than at company level to examine this matter. A considerable amount of disclosure may be required to be made by the group in this matter and consequently, the documentation required for this is of crucial importance. From a practical standpoint, it should be remembered that examination by tax authorities is with the

29.88 I DIRECT TAXATION

benefit of hindsight whereas when CCAs are entered into, it is on the basis of foresight. Therefore, there may be instances of abortive expenditure which tax administrations may use to relook at the expected benefits (and consequently the proportion of sharing). In general, whether one is talking about Management Fees or Cost Contribution Arrangements, the Cost Plus Method & Transactional Net Margin Method are of increasing relevance in view of the fact that with such levels of globalization, it is difficult and complex to use CUP as the method of establishing transfer prices because comparables are more and more difficult to identify. In fact, it is expected that once India introduces Advance Pricing Arrangements, the Transactional Net Margin Method will be more commonly applied that CUP or CPM. General Anti Avoidance Rule (GAAR) Applicable of general anti- avoidance rule [Sec.95] General Anti Avoidance Rules (GAAR) have been inserted with effect from April 1, 2014. The following explanation is given in the Memorandum Explaining the provision in the Finance Bill, 2012 The question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of transactions can be dispensed with and the real substance of transaction can be considered while applying the taxation laws, others have held that the form is to be given sanctity. The existence of anti- avoidance principles is based on various judicial pronouncements. There are some specific anti-avoidance provisions but general anti-avoidance has been dealt only through judicial decisions in specific cases. In an environment of moderate rates of tax, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning and use of opaque low tax jurisdictions for residence as well as for sourcing capital. Most countries have codified the substance over form doctrine in the form of General Anti Avoidance Rule (GAAR). In the above background and keeping in view the aggressive tax planning with the use of sophisticated structures, there is a need for statutory provision so as to codify the doctrine of substance over form where the real intention of the parties and effect of transactions and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure that has been superimposed to camouflage the real intent and purpose. Internationally several countries have introduced, and are administering statutory General Anti Avoidance provisions. It is, therefore, important that Indian taxation law also incorporate a statutory General Anti Avoidance Provisions to deal with aggressive tax planning. The basic criticism of statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which at times is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime. Impermissible Avoidance Arrangements An arrangement whose main purpose (or one of the main purposes) is to obtain a tax benefit (and which also satisfies at least one of the four tests), can be declared as an impermissible avoidance arrangements. Four tests- The four tests are The arrangement creates rights and obligations, which are not normally created between parties dealing at arms length. It results in misuse or abuse of provisions of tax laws. It lacks commercial substance or is deemed to lack commercial substance. It is carried out in a manner , which is normally not employed for bona fide purpose

Onus of Proof In the Finance Bill (as presented in Lok Sabha on March 16, 2012) the onus of establishing

DIRECT TAXATION I 29.89

Taxation of International Transactions that the main purpose of the arrangement is not to obtain tax benefit, was on the taxpayer. However, this provision has been removed at the time of passing of the Finance Bill in Lok Sabha. Lack of commercial substance An arrangement will be deemed to lack commercial substance ifa. b. c. The substance or effect of the arrangements as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part ; or It involves or includesi. ii. iii. Round trip financing; An accommodating party: elements that have effect of offsetting or cancelling each other; or

iv. a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of fund which is subject matter of such transaction; or it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining tax benefit for a party Round trip financing- For the above purpose round trip financing includes any arrangement in which, through a series of transaction

a. b.

funds are transferred among the parties to the arrangement; and such transactions do not have any substantial commercial purpose other than obtaining the tax benefit, without having any regard to - - - whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement; the time or sequence, in which the funds involved in the round trip financing are transferred or received; or the means by, or manner in or mode through, which funds involved in the round trip financing are transferred or received.

It is also provided that certain circumstances like period of existence of arrangement, taxes arising from arrangement, exit route, shall not be taken into account while determining lack of commercial substance test for an arrangement. Consequences of an impermissible avoidance arrangement Once the arrangement is held to be an impermissible avoidance arrangement then the consequences of the arrangement in relation to tax or benefit under a tax treaty can be determined by keeping in view the circumstances of the case, however, some of the illustrative steps are a. b. c. d. e. f. g. Disregarding or combining any step of the arrangement, Ignoring the arrangement for the purpose of taxation law, Disregarding or combining any party to the arrangement, Reallocating expenses and income between the parties to the arrangement, Relocating place of residence of a party, or location of a transaction or situs of an asset to a place other than provided in the arrangement, Considering or looking through the arrangement by disregarding any corporate structure, and Re-characterizing equity into debt, capital into revenue, etc. These provisions can be used in addition to or in conjunction with other anti-avoidance provisions or provisions for determination of tax liability, which are provided in the taxation law.

29.90 I DIRECT TAXATION

For effective application in cross border transaction and to prevent treaty abuse, a limited treaty override is also provided.

Procedure for invoking GAAR The procedure for invoking GAAR is as under1. The Assessing Officer shall make a reference to the Commissioner for invoking GAAR and on receipt of reference the commissioner shall hear the taxpayer and if he is not satisfied by the reply of taxpayer and is of the opinion that GAAR provision are to be invoked, he shall refer the matter to an Approving Panel. In case the assessee does not object or reply, the Commission shall make determination as to whether the arrangements is an impermissible avoidance arrangement or not. The Approving Panel has to dispose of the reference within a period of 6 months from the end of the month in which the reference was received from the Commissioner. The Approving Panel shall either declare an arrangement to be impermissible or declare it not to be so, after examining material and getting further inquiry to be made. The Assessing Officer will determine consequences of such a positive declaration of arrangement as impermissible avoidance arrangement. The final order in case any consequence of GAAR is determined shall be passed by the Assessing Officer only after approval by the Commissioner and, thereafter, first appeal against such order shall lie to the Appellate Tribunal. The period taken by the proceedings before the Commissioner and Approving Panel shall be excluded from time limitation for completion of assessment. The Board will set-up an Approving Panel consisting of not less than 3 members being a. b. Income tax authorities (not below the rank of Commissioner) and An official of the Indian Legal Service (not below the rank of Joint Secretary.)

2. 3. 4. 5.

6. 7. 8. 9.

The panel will have a minimum of three members. The procedure and working of Panel shall be administered through subordinate legislation. In addition to the above, it is provided that the Board shall prescribe a scheme for regulating the condition and the manner of application of these provisions.

Advance Pricing Agreement Scheme (APA) Meaning of expressions used in matters in respect of advance pricing agreement. 10F For the purposes of this rule and rules 10G to 10T, (a) agreement means an advance pricing agreement entered into between the Board and the applicant, with the approval of the Central Government, as referred to in sub-section (1) of section 92CC of the Act; (b) application means an application for advance pricing agreement made under rule 10 I ; (c) bilateral agreement means an agreement between the Board and the applicant, subsequent to, and based on, any agreement referred to in rule 44 GA between the competent authority in India with the competent authority in the other country regarding the most appropriate transfer pricing method or the arms length price; (d) competent authority in India means an officer authorised by the Central Government for the purpose of discharging the functions as such for matters in respect of any agreement entered into under section 90 or 90A of the Act;

DIRECT TAXATION I 29.91

Taxation of International Transactions (e) covered transaction means the international transaction or transactions for which agreement has been entered into; (f) critical assumptions means the factors and assumptions that are so critical and significant that neither party entering into an agreement will continue to be bound by the agreement, if any of the factors or assumptions is changed; (g) most appropriate transfer pricing method means any of the transfer pricing method, referred to in sub-section (1) of section 92C of the Act, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or function performed by such persons or such other relevant factors prescribed by the Board under rule 10B and 10C; (h) multilateral agreement means an agreement between the Board and the applicant, subsequent to, and based on, any agreement referred to in rule 44GA between the competent authority in India with the competent authorities in the other countries regarding the most appropriate transfer pricing method or the arms length price; (i) tax treaty means an agreement under section 90, or section 90A, of the Act for the avoidance of double taxation; (j) team means advance pricing agreement team consisting of income-tax authorities as constituted by the Board and including such number of experts in economics, statistics, law or any other field as may be nominated by the Director General of Income Tax (International Taxation); (k) unilateral agreement means an agreement between the Board and the applicant which is neither a bilateral nor multilateral agreement. Persons eligible to apply 10G Any person who (i) has undertaken an international transaction; or (ii) is contemplating to undertake an international transaction, shall be eligible to enter into an agreement under these rules. Pre-filing Consultation 10H (1) Every person proposing to enter into an agreement under these rules shall, by an application in writing, make a request for a pre-filing consultation. (2) The request for pre-filing consultation shall be made in Form No. 3 CEC to the Director General of Income Tax (International Taxation). (3) On receipt of the request in Form No. 3 CEC, the team shall hold pre-filing consultation with the person referred to in rule 10G. (4) The competent authority in India or his representative shall be associated in pre-filing consultation involving bilateral or multilateral agreement. (5) The pre-filing consultation shall, among other things, (i) determine the scope of the agreement; (ii) identify transfer pricing issues; (iii) determine the suitability of international transaction for the agreement; (iv) discuss broad terms of the agreement. (i) not bind the Board or the person to enter into an agreement or initiate the agreement process;

(6) The pre-filing consultation shall

29.92 I DIRECT TAXATION

(ii) not be deemed to mean that the person has applied for entering into an agreement.

Application for advance pricing agreement 10 I (1) Any person, who has entered into a pre-filing consultation as referred to in rule 10H may, if desires to enter into an agreement furnish an application in Form No. 3 CED alongwith the requisite fee. (2) The application shall be furnished to Director General of Income Tax (International Taxation) in case of unilateral agreement and to the competent authority in India in case of bilateral or multilateral agreement. (3) Application in Form No. 3 CED may be filed by the person referred to in rule 10G at any time (i) before the first day of the previous year relevant to the first assessment year for which the application is made, in respect of transactions which are of a continuing nature from dealings that are already occurring; or (ii) before undertaking the transaction in respect of remaining transactions.

(4) Every application in Form No. 3 CED shall be accompanied by the proof of payment of fees as specified in sub-rule (5). Withdrawal of application for agreement 10 J (1) The applicant may withdraw the application for agreement at any time before the finalisation of the terms of the agreement. (2) The application for withdrawal shall be in Form No. 3CEE. (3) The fee paid shall not be refunded on withdrawal of application by the applicant. Preliminary processing of application 10 K (1) Every application filed in Form No. 3CED shall be complete in all respects and accompanied by requisite documents. (2) If any defect is noticed in the application in Form No. 3CED or if any relevant document is not attached thereto or the application is not in accordance with understanding reached in pre-filing consultation referred to in rule 10H, the Director General of Income-tax (International Taxation) (for unilateral agreement) and competent authority in India (for bilateral or multilateral agreement) shall serve a deficiency letter on the applicant before the expiry of one month from the date of receipt of the application. (3) The applicant shall remove the deficiency or modify the application within a period of fifteen days from the date of service of the deficiency letter or within such further period which, on an application made in this behalf, may be extended, so however, that the total period of removal of deficiency or modification does not exceed thirty days. (4) The Director General of Income Tax (International Taxation) or the competent authority in India, as the case may be, on being satisfied, may pass an order providing that application shall not be allowed to be proceeded with if the application is defective and defect is not removed by applicant in accordance with sub-rule (3). (5) No order under sub-rule (4) shall be passed without providing an opportunity of being heard to the applicant and if an application is not allowed to be proceeded with, the fee paid by the applicant shall be refunded. Procedure 10 L (1) If the application referred to in rule 10K has been allowed to be proceeded with, the team or the competent authority in India or his representative shall process the same in consultation and

DIRECT TAXATION I 29.93

Taxation of International Transactions discussion with the applicant in accordance with provisions of this rule. (2) For the purpose of sub-rule (1), it shall be competent for the team or the competent authority in India or its representative to (i) hold meetings with the applicant on such time and date as it deem fit; (ii) call for additional document or information or material from the applicant; (iii) visit the applicants business premises; or (iv) make such inquiries as it deems fit in the circumstances of the case.

(3) For the purpose of sub-rule (1), the applicant may, if he considers it necessary, provide further document and information for consideration of the team or the competent authority in India or his representative. (4) For bilateral or multilateral agreement, the competent authority shall forward the application to Director General of Income Tax (International Taxation) who shall assign it to one of the teams. (5) The team, to whom the application has been assigned under sub-rule (4), shall carry out the enquiry and prepare a draft report which shall be forwarded by the Director General of Income Tax (International Taxation) to the competent authority in India. (6) If the Applicant makes a request for bilateral or multilateral agreement in its application, the competent authority in India shall in addition to the procedure provided in this rule invoke the procedure provided in the rule 44 GA. (7) The Director General of Income Tax (International Taxation) (for unilateral agreement) or the competent authority in India (for bilateral or multilateral agreement) and the applicant shall prepare a proposed mutually agreed draft agreement enumerating the result of the process referred to in sub-rule (1) including the effect of the arrangement referred to in sub-rule (5) of rule 44GA which has been accepted by the applicant in accordance with sub-rule (8) of the said rule. (8) The agreement shall be entered into by the Board with the applicant after its approval by the Central Government. (9) Once an agreement has been entered into the Director General of Income Tax (International Taxation) or the competent authority in India, as the case may be, shall cause a copy of the agreement to be sent to the Commissioner of Income Tax having jurisdiction over the assessee. Terms of the agreement 10 M (1) An agreement may among other things, include (2) (i) the international transactions covered by the agreement; (ii) the agreed transfer pricing methodology, if any; (iii) determination of arms length price, if any; (iv) definition of any relevant term to be used in items (ii) or (iii); (v) critical assumptions; (vi) the conditions if any other than provided in the Act or these rules. The agreement shall not be binding on the Board or the assessee if there is a change in any of critical assumptions or failure to meet conditions subject to which the agreement has been entered into.

(3) The binding effect of agreement shall cease only if any party has given due notice of the concerned other party or parties. (4) In case there is a change in any of the critical assumptions or failure to meet the conditions subject

29.94 I DIRECT TAXATION

to which the agreement has been entered into, the agreement can be revised or cancelled, as the case may be. (5) The assessee which has entered into an agreement shall give a notice in writing of such change in any of the critical assumptions or failure to meet conditions to the Director General of Income Tax (International Taxation) as soon as it is practicable to do so. (6) The Board shall give a notice in writing of such change in critical assumptions or failure to meet conditions to the assessee, as soon as it comes to the knowledge of the Board. (7) The revision or the cancellation of the agreement shall be in accordance with rules 10Q and 10R respectively. Amendments to Application 10 N (1) An applicant may request in writing for an amendment to an application at any stage, before the finalisation of the terms of the agreement. (2) The Director General of Income Tax (International Taxation) (for unilateral agreement) or the competent authority in India (for bilateral or multilateral agreement) may, allow the amendment to the application, if such an amendment does not have effect of altering the nature of the application as originally filed. (3) The amendment shall be given effect only if it is accompanied by the additional fee, if any, necessitated by such amendment in accordance with fee as provided in rule 10 I. Furnishing of Annual Compliance Report 10 O (1) The assessee shall furnish an annual compliance report to Director General of Income Tax (international Taxation) for each year covered in the agreement. (2) The annual compliance report shall be in Form 3CEF. (3) The annual compliance report shall be furnished in quadruplicate, for each of the years covered in the agreement, within thirty days of the due date of filing the income tax return for that year, or within ninety days of entering into an agreement, whichever is later. (4) The Director General of Income Tax (International Taxation) shall send one copy of annual compliance report to the competent authority in India, one copy to the Commissioner of Income Tax who has the jurisdiction over the income-tax assessment of the assessee and one copy to the Transfer Pricing Officer having the jurisdiction over the assessee. Compliance Audit of the agreement 10 P (1) The Transfer Pricing Officer having the jurisdiction over the assessee shall carry out the compliance audit of the agreement for each of the year covered in the agreement. (2) For the purposes of sub-rule(1), the Transfer Pricing Officer may require (i) the assessee to substantiate compliance with the terms of the agreement, including satisfaction of the critical assumptions, correctness of the supporting data or information and consistency of the application of the transfer pricing method; (ii) the assessee to submit any information, or document, to establish that the terms of the agreement has been complied with.

(3) The Transfer Pricing Officer shall submit the compliance audit report, for each year covered in the agreement, to the Director General of Income Tax (International Taxation) in case of unilateral agreement and to the competent authority in India, in case of bilateral or multilateral agreement, mentioning therein his findings as regards compliance by the assessee with terms of the agreement. (4) The Director General of Income Tax (International Taxation) shall forward the report to the Board

DIRECT TAXATION I 29.95

Taxation of International Transactions in a case where there is finding of failure on part of assessee to comply with terms of agreement and cancellation of the agreement is required. (5) The compliance audit report shall be furnished by the Transfer Pricing Officer within six months from the end of the month in which the Annual Compliance Report referred to in rule 10 O is received by the Transfer Pricing Officer. (6) The regular audit of the covered transactions shall not be undertaken by the Transfer Pricing Officer if an agreement has been entered into under rule 10L except where the agreement has been cancelled under rule 10R. Revision of an agreement 10 Q (1) An agreement, subsequent to it having been entered into, may be revised by the Board, if. (a) there is a change in critical assumptions or failure to meet a condition subject to which the agreement has been entered into; (b) there is a change in law that modifies any matter covered by the agreement but is not of the nature which renders the agreement to be non binding ; or (c) there is a request from competent authority in the other country requesting revision of agreement, in case of bilateral or multilateral agreement.

(2) An agreement may be revised by the Board either suo-moto or on request of the assessee or the competent authority in India or the Director General of Income Tax (International Taxation). (3) Except when the agreement is proposed to be revised on the request of the assessee, the agreement shall not be revised unless an opportunity of being heard has been provided to the assessee and the assessee is in agreement with the proposed revision. (4) In case the assessee is not in agreement with the proposed revision the agreement may be cancelled in accordance with rule-10R. (5) In case the Board is not in agreement with the request of the assessee for revision of the agreement, the Board shall reject the request in writing giving reason for such rejection. (6) For the purpose of arriving at the agreement for the proposed revision, the procedure provided in rule 10 L may be followed so far as they apply. (7) The revised agreement shall include the date till which the original agreement is to apply and the date from which the revised agreement is to apply. Cancellation of an agreement 10 R (1) An agreement shall be cancelled by the Board for any of the following reasons: (i) the compliance audit referred to in rule 10P has resulted in the finding of failure on the part of the assessee to comply with the terms of the agreement; (ii) the assessee has failed to file the annual compliance report in time; (iii) the annual compliance report furnished by the assessee contains material errors; or (iv) the agreement is to be cancelled under sub-rule (4) of rule 10Q.

(2) The Board shall give an opportunity of being heard to the assessee, before proceeding to cancel an application. (3) The competent authority in India shall communicate with the competent authority in the other country or countries and provide reason for the proposed cancellation of the agreement in case of bilateral or multilateral agreement. (4) The order of cancellation of the agreement shall be in writing and shall provide reasons for

29.96 I DIRECT TAXATION

cancellation and for non acceptance of assessees submission, if any. (5) The order of cancellation shall also specify the effective date of cancellation of the agreement, where applicable. (6) The order under the Act, declaring the agreement as void ab initio, on account of fraud or misrepresentation of facts, shall be in writing and shall provide reason for such declaration and for non acceptance of assessees submission, if any. (7) The order of cancellation shall be intimated to the Assessing Officer and the Transfer Pricing Officer, having jurisdiction over the assessee. Renewing an agreement 10 S Request for renewal of an agreement may be made as a new application for agreement, using the same procedure as outlined in these rules except pre filing consultation as referred to in rule 10H. Miscellaneous 10 T (1) Mere filing of a application for an agreement under these rules shall not prevent the operation of Chapter X of the Act for determination of arms length price under that Chapter till the agreement is entered into. (2) The negotiation between the competent authority in India and the competent authority in the other country or countries, in case of bilateral or multilateral agreement, shall be carried out in accordance with the provisions of the tax treaty between India and the other country or countries.. (b) after rule 44G of the principal rules, the following rule shall be inserted, namely.Procedure to deal with requests for bilateral or multilateral advance pricing agreements. 44GA (1) Where a person has made request for a bilateral or multilateral advance pricing agreement in an application filed in Form No. 3 CED in accordance with rule 10 I, the request shall be dealt with subject to provisions of this rule. (2) The process for bilateral or multilateral advance pricing agreement shall not be initiated unless the associated enterprise situated outside India has initiated process of advance pricing agreement with the competent authority in the other country. (3) The competent authority in India shall, on intimation of request of the applicant for a bilateral or multilateral agreement, consult and ascertain willingness of the competent authority in other country or countries, as the case may be, for initiation of negotiation for this purpose. (4) In case of willingness of the competent authority in other country or countries, as the case may be, the competent authority in India shall enter into negotiation in this behalf and endeavour to reach a set of terms which are acceptable to the competent authority in India and the competent authority in the other country or countries, as the case may be. (5) In case of an agreement after consultation, the competent authority in India shall formalise a mutual agreement procedure arrangement with the competent authority in other country or countries, as the case may be, and intimate the same to the applicant. (6) In case of failure to reach agreement on such terms as are mutually acceptable to parties mentioned in sub-rule 4, the applicant shall be informed of the failure to reach an agreement with the competent authority in other country or countries. (7) The applicant shall not be entitled to be part of discussion between competent authority in India and the competent authority in the other country or countries, as the case may be; however the applicant can communicate or meet the competent authority in India for the purpose of entering into an advance pricing agreement.

DIRECT TAXATION I 29.97

Taxation of International Transactions (8) The applicant shall convey acceptance or otherwise of the agreement within thirty days of it being communicated. (9) The applicant, in case the agreement is not acceptable may at its option continue with process of entering into an advance pricing agreement without benefit of mutual agreement process or withdraw application in accordance with rule 10J . (c) In Appendix-II of the principal rules, after Form No. 3 CEB, the following Forms shall be inserted, namely: Form No. 3CEC (See sub-rule (2) of rule 10 H) Form No. 3 CED (See sub-rule (1) of rule 10 I) Application for a pre-filing meeting Application for an Advance Pricing Agreement I. General II. Functional analysis III. Industry and market analyses IV. Transfer pricing background V. Transfer Pricing Methodology analysis: Form No. 3 CEE (See sub-rule (2) of rule 10 J) Form No. 3 CEF (See sub-rule 2 of rule 10 O) Annual Compliance Report on Advance Pricing Agreement VI. Impact of proposed TPMs Application for withdrawal of APA request

29.98 I DIRECT TAXATION

Notes

Notes