Income from business and profession

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PROFITS AND GAINS FROM BUSINESS OR PROFESSION 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] The following incomes shall be chargeable under this head :- 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 was carried on by the assessee at any time during the previous year; (ii) any compensation or other payment due to or received by, — (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; 96(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 an 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 : Exception : this sub-clause (a) shall not apply to— (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”; (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 Programme, in accordance with the terms of agreement entered into with the Government of India. 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 clause (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 section 35AD. 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)] (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 xxx Add : Expenses disallowed/Inadmissible Expenses [i.e. items already debited in P/L A/c but not xxx eligible for deduction] Less : Incomes Credited in P/L A/c to be treated separately (xxx) under difference heads of income Less : Expenses allowed as per Provisions (xxx) Income from Business xxx Computation of Income from Profession Receipts relating to Profession (on Cash Basis) xxx Less : Payment relating to profession (both cash and accrual basis) (xxx) Income from Profession xxx Expenses which are allowed as deduction [Sections 30 to 37] RENT, RATES, TAXES, REPAIRS AND INSURANCE FOR 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 Depreciation Statement as per Income Tax Act, 1961 Particular of WDV as on Additions at Deductions Net Value Depreciation for WDV as on Asset 01.4 Actual Cost of Block Current Year 31.03 1 2 3 4 5 6 7 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 Incometax 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. 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 as reduced by amount of depreciation actually allowed to such asset, but it should not exceed the written down value of the block as at the end of the Previous Year in it cannot be negative. *** Written down value in case of slump sale. *** (v) Written down value in case of demerged company [Explanation 2A of Sec. 43(6)]: Written down value of resulting 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 to Sec. 43(6)] Written down value of resulting company = Written down value of assets as appearing in the books of the demerged company before the demerger. (vii) Written down value in case of corporatisation [Explanation Sec. 5 to Sec. 43(6)] Written down value of a company under a = Written down value of the transferred asset by a scheme of corporatisation approved by SEBI recognised 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. 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 2003-2004] 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 teh amount of depreciation attributable to such revaluation of the asset. Computation of written down value where income of an asscsscc 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. Sub-clause (b) of clause (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 Hon’ble Supreme Court in the case of C1T vs. Doom Dooma India Ltd 222 CTR 105 (SC) has held that in view of the language employed in sub-clause (b) of clause (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 5,000 Less: Expenses: Depreciation - (10% of ` 5,000) (500) Others expenses (1,500) Composite income 3,000 Income subject to charge under the Income-tax Act, 1961 by application of rule 8 (40% of 3,000) 1,200 Income not chargeable to income-tax (60% of 3,000) 1,800 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 sub-clause (b) of clause (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. ADDITIONAL DEPRECIATION : Sec. 32(1)(iia) has been inserted by the Finance Act, 2002 w.e.f. from Assessment Year 2003-04 to provide additional depreciation @20% of the actual cost of new machinery and plant (other than ships and air craft) which has been acquired and installed after the 31.3.2002 by an assessee engaged in the business of manufacture or production of any article or thing provided that such further deduction of 20% shall be allowed to : (i) a new industrial undertaking during any Previous Year in which such undertaking begins to manufacture or produce any article or thing on or after 1.4.2002. or (ii) any industrial undertaking existing before the 1.4.2002, during any Previous Year in which it achieves the substantial expansion by way of increase in installed capacity by not less than 25% provided further that no deduction shall be allowed in respect of : (a) any machinery or plant which, before its installation by the assessee was used either within or outside India by any other person; or (b) any machinery or plant installed in office premises for any residential accommodation including accommodation in the nature of a guest house; or (c) any office appliances or road transport vehicles; or (d) any machinery or plant, the whole of the actual cost which is allowed as 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. 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. Illustration 1 : The WDV of plant and machinery on 1.4.2010 of Z Ltd. engaged in manufacturing of PVC granules is ` 2000 lacs. Company purchased additional plant and machinery for ` 1,600 lacs on 18.4.2010 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 1.12.2010. Work out by giving reasons the amount of allowable depreciation. Assessee : Z Ltd. Previous Year : 2010-11 Assessment Year : 2011-12 Computation of Depreciation Particulars Lakhs ` ` Opening WDV 2,000 Add : Additions During the year 1,600 Net Value for the purpose of Depreciation 3,600 Less : Depreciation of the Year — On Opening Block - ` 2,000 Lakhs × 15% 300 — On Additions (Period of usage less than 180 days) 120 — ` 1,600 lakhs × 15% × 50% — Additional Depreciation on Eligible Assets (Notes) 120 540 Closing WDV 3,060 Notes : 1. Second hand machinery imported from China 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%. DEPRECIATION AT REDUCED RATE Where an asset referred in clause (i) or clause (iii) as the case may be, is acquired by the assessee during the Previous Year and is put to use for the purposes of Business or Profession for less than 180 days in that Previous Year, the depreciation allowable in respect of such asset shall be restricted to 50% of the normal rate. Illustration 2 : Depreciation at Reduced Rate W.D.V. of Machinery (Rate of Depreciation @15%) = ` 5,00,000 New Machinery Purchased (on 31.12.10) = ` 1,00,000, having same rate of depreciation. Calculate : Depreciation u/s 32 Block A : Machinery (Rate of Depreciation = 15%) W.D.V. of the Machinery 5,00,000 Add : Cost of New Asset Purchased Nil (relating to the Block) [Put to Use > 180 Days] Less : Government Subsidy Received for Nil Purchase/Acquisition Asset Less : Adjustment for CENVAT Credit Nil Less : Sale of Asset from the Block Nil W.D.V for Charging Depreciation 5,00,000 Less : Depreciation @ 15% 75,000 Closing WDV 4,25,000 Block B : Machinery (Rate of Depreciation = 7.5% of 15%, since Acquired & Put to Use for less than 180 Days) Cost 1,00,000 Less : Depreciation @ 7.5% 7,500 Closing WDV 92,500 Total Depreciation u/s 32 = 75,000 7,500 82,500 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 (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 OC < WDV = Capital Gain = Balancing Charge Where, NC = Net Sale Consideration OC = Original Cost WDV = Written Down Value Illustration 3 : Kalpataru power Projects is a power generating unit. On 1.4.2008, 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 21.4.2010 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 A B C D W.D.V. as on 1.4.2010 35,00,000 35,00,000 35,00,000 35,00,000 Less: Sale Proceeds 8,50,000 32,00,000 45,00,000 52,00,000 Balance 26,50,000 30,00,000 (10,00,000) (17,00,000) Terminal depreciation 26,50,000 3,00,000 NIL NIL Balancing charge NIL NIL 10,00,000 15,00,000 Short term capital Gain NIL NIL NIL 2,00,000 Computation of Depreciation: Original cost 50,00,000 Less: Depreciation 7,50,000 WDV as on 1.4.2009 42,50,000 Less: Depreciation for the year 2009-2010 7,50,000 WDV as on 1.4.2010 35,00,000 SECTION 43(1) — ACTUAL COST Actual Cost [Sec. 43 (1)] for the purpose of determination of Depreciation Explanation Nature of Acquisition Actual Cost 1 Assets used in scientific research subsequently put into use NIL for the business 2 Asset received under gift, will or inheritance WDV to the previous owner 3 Acquisition of asset to claim depreciation on enhanced cost Cost as determined by the to reduce tax liability Assessing Officer with the prior approval of Joint Commissioner of Income Tax 4 Transfer and re-acquisition of the same asset Least of the followings: (i) WDV at the time of original transfer (ii) Re-purchase price 4A Sale and Lease Back WDV to the transferor 5 Building previously used for private purpose 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 Succession of business WDV to the previous owner 6 Transfer by Parent company to its wholly owned Indian WDV to Parent company subsidiary company Transfer by wholly owned Indian subsidiary company to WDV to Indian Subsidiary its Indian Parent company company 7 Amalgamation (amalgamated company must be an Indian WDV to the amalgamating company)” company 7A Demerger : In the hands of the Demerged Company after WDV of Demerged Co. before demerger Demerger Less : WDV of assets transferred to Resulting Co. 7A Demerger: In the hands of the Resulting Company WDV to Demerged Company 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 11 Assets brought into India by a Non-resident Actual cost of Acquisiton Less : Notional depreciation for the period such asset was held outside India 12 Asset acquired by a company under a scheme of Actual Cost as if there is no such Corporatisation of Recognized Stock Exchange corporatization. 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 , traveling 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. Treatment of Trial Run Expenses and Income earned during Trial run period Illustration 4 : 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 : 2010-11 Computation of Depreciation Particulars Amount (`) Amount (`) Expenses incurred during trial run period 2,00,000 2,00,000 Less : Income from sale of output generated (90,000) (3,00,000) during trial run period Net Cost / Gain 1,10,000 (1,00,000) Actual Cost of the Machine 25,35,000 25,35,000 Add : Net Cost during trial run 1,10,000 — Less : Net Gain during trial run (1,00,000) Actual Cost of Machine for charging depreciation 26,45,000 24,25,000 Less : Depreciation @ 15% 3,96,750 3,63,750 Written Down Value (W.D.V.) 22,48,250 20,61,250 Treatment of Currency Exchange Fluctuation Illustration 5 : Z Ltd. purchased machinery (rate of depreciation 15%) from Japan for US$ 2,50,000 on 17. 08.2009 ( US $ = 43.25) by borrowing from Hero Bank Ltd. Z Ltd. took a forward contract on 11.07.2009, when the exchange rate was ` 45.70 per US$. This was put to use from 23.11.2009. Compute Depreciation for the previous years 2009-10 and 2010-11. Assessee: Z Ltd Previous Year: 2009-10 & 2010-11 Computation of Depreciation and Written Down Value Particulars Amount (`) Cost of the Asset ( US$ 2,50,000 × ` 43.25) 1,08,12,500 Less : Depreciation @ 50% of 15% (since Put to Use < 180 days) (8,10,938) for previous year 2009-10 (` 1,08,12,500 × 50% × 15%) WDV as on 01.04.2010 1,00,01,562 Add : Exchange Rate Difference [US$ 2,50,000 × ` (45.70 - 43.25)] 6,12,500 WDV for claiming depreciation 1,06,14,062 Less : Depreciation @ 15% for the previous year 2010-11 15,92,109 (` 1,06,14,062 × 15%) WDV as on 01.04.2011 90,21,953 Illustration 6 : Pharma Ltd. imported machinery from Germany on 27.8.10 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 including service tax of ` 2,20,000. Compute Actual Cost, if assessee, avail CENVAT credit adjustment. Assessee : Pharma Ltd Previous Year : 2010-11 Computation of Depreciation and Written Down Value Particulars Amount (` crores) Cost of Purchase 40.00 Add: Customs Duty @ 20% on ` 40 crores 8.00 Less: Government subsidy granted 25.00 Less: CENVAT Credit ( Service Tax paid included in the payment made to Nexgen Courier Ltd.) 0.22 Actual Cost for the purpose of charging depreciation 22.78 Illustration 7 : ZED Ltd. imported machinery from South Korea on 12.5.2010 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 2.4.2010 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 05.10.10. Depreciation @ 15%. Compute Actual Cost and Written Down Value. Assessee: ZED Ltd. Previous Year: 2010-11 Computation of Actual Cost and Written Down Value Particulars Amount (` crores) Cost of the Asset ( US$ 50,000 × ` 44.70) 22,35,000 Add : Customs Duty paid @ 20% on ` 22,35,000 4,47,000 Less : Government Subsidy granted (15,00,000) Add : Exchange Rate Difference [US$ 50,000 × ` (45.30 - 44.70)] 30,000 Add : Transportation charges paid ` 2,00,000 (including Service Tax ` 25,000) 2,00,000 Less : CENVAT credit adjustment (credit for Service tax included in service (25,000) charges paid to Carrywell Courier Ltd.) Add : Installation expenses incurred for payment of site engineers & labourers 4,60,000 including travelling expenses Add : Expenses incurred during trial run period 1,50,000 Less : Sale of output generated during trial run period (90,000) Less : Interest earned on deposits made to open Letter of Credit for purchase of this machinery (15,000) Actual Cost for the purpose of determining depreciation 18,92,000 Less : Depreciation @ 50% of 15% (since Put to Use < 180 days) for previous year 2010-11 ( ` 18,92,000 × 50% x 15%) 1,41,900 WDV as on 01.04.2011 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)] (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 8 : Conversion of Sole-proprietorship into Company A Bros., a sole-proprietorship concern, was converted into a A Ltd. on 20.9.2010. Before the conversion, the concern had a block of furniture (rate of depreciation @ 10%), whose WDV as on 01.04.2010 was ` 6,50,000. On 01.05.2010, a new furniture of the same block was purchased for ` 50,000. A Ltd. purchased another furniture of the same type on 20.12.2010 for ` 48,000. Compute depreciation that would be claimed by A Bros. and A Ltd for the previous year 2010-11. 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. Depreciation to be apportioned = [W.D.V. as on 1.4.2010 + New Purchases on 01.05.2010] = ` (6,50,000 + 50,000) = ` 7,00,000 × 10% = ` 70,000 Apportionment of Depreciation and Allowable Depreciation Assessee No. of Days Depreciation Depreciation Total on Assets on Assets Depreciation on the date of acquired after for the Previous succession Succession Year 2010-11 A Bros. (Sole- 01.04.2010 to ` 70,000 × Nil Proprietorship 30.9.2010 173/365 ` 33,178 concern) = 173 days = ` 33,178 A Ltd. 21.09.2010 to ` 70,000 × ` 48,000 × 50% × ` 39,222 (Company) 31.3.2011 192 × 365 10% ` 36,822 = ` 2,400 ( Put to use < 180 days) Illustration 9 : Amalgamation of Companies P Ltd. was taken over by Q Ltd. with effect from 31.7.2010. 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 2010-11. Assets Rate of Depreciation WDV in the hands Transfer Value to Q Ltd. of P Ltd (as on 01.04.2010) (` ) Building 10% 30,00,000 45,00,000 Plant & Machinery 15% 20,00,000 15,00,000 Motor Car 15% 8,00,000 6,00,000 Computers 60% 5,00,000 2,00,000 Furniture 10% 3,00,000 1,40,000 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. Depreciation to be apportioned = [W.D.V. as on 1.4.2010 + New Purchases on 01.05.2010] = ` (6,50,000 + 50,000) = ` 7,00,000 × 10% = ` 70,000 Depreciation Statement as per Income Tax Act, 1961 Particulars Rate W.D.V as Additional Debenture Net Value Depreciation W.D.V. as of Block of Of on Actual Cost of Block for the on Assets Dept. 01.04.2010 Current Year 31.3.2011 1 2 3 4 5 6 7 Block I - 10% 30,00,000 Nil Nil 30,00,000 3,00,000 27,00,000 Building Block - II 15% 20,00,000 Nil Nil 20,00,000 3,00,000 17,00,000 Plant & Machinery Block - III 15% 8,00,000 Nil Nil 8,00,000 1,20,000 6,80,000 Motor Car Block - IV 60% 5,00,000 Nil Nil 5,00,000 3,00,000 2,00,000 Computers Block - V 10% 3,00,000 Nil Nil 3,00,000 30,000 2,70,000 Furniture 56,00,000 56,00,000 10,50,000 45,50,000 TOTAL DEPRECIATION ADMISSIBLE ` 10,50,000 Apportionment of Depreciation and Allowable Depreciation Assessee No. of Days Depreciation on Assets Depreciation Total on the date of amalgamation on Assets Depreciation acquired after for the Previous amalgamation Year 2010-11 P Ltd. 01.04.2010 to 31.7.2010 ` 10,50,000 × 173/365 Nil ` 4,97,671 = 122 days = ` 4,97,671 Q Ltd. 01.08.2010 to 31.3.2011 ` 10,50,000 × 243 × 365 Nil ` 6,99,041 = 243 days = ` 6,99,041 Depreciation : Personal Assets used in the Business Illustration 10 : Mr. Hari purchased a house property on 18.11.2006 for `15,00,000. Till 1.7.2010, 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 2011-12, given rate of depreciation @ 10%. Solution : (a) 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: 111 Assessee: Mr. Hari Previous Year: 2010-11 Assessment Year: 2011-12 ` Cost of acquisition of Residential House Property as on 18.11.2006 15,00,000 Less: Deemed depreciation for the Financial year 2006-07 @ 50% of 10% on 75,000 ` 15,00,000 (since period of usage is less than 180 days) WDV as on 01.04.2007 14,25,000 Less: Deemed Depreciation for Financial year 2007-08 @ 10% on `14,25,000 1,42,500 WDV as on 01.04.2008 12,82,500 Less: Deemed Depreciation for Financial year 2008-09 @ 10% on `12,82,500 1,28,250 WDV as on 01.04.2009 11,54,250 Less: Deemed Depreciation for Financial year 2009-10 @ 10% on `11,54,250 1,15,425 WDV as on 01.04.2010 = Actual cost for the purpose of charging depreciation 10,38,825 Less: Deemed Depreciation for Financial year 2010-11 @ 10% on `10,38,825 1,03,883 WDV as on 01.04.2011 9,34,942 Additional Depreciation : Applicable For assesses engaged in the business of manufacture or production of any article or thing Assets eligible for additional depreciation Assets not eligible for additional depreciation Rate of Additional Depreciation Adjusted rate of additional depreciation Any new plant or machinery acquired and installed after 31.3.2005 (a) Ships and aircrafts; (b) Any machinery or plant which, before its installation by the assessee, was 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 20% of the Actual Cost of Plant or Machinery If the newly acquired asset is “put to use” for a period of less than 180 days during 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% 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 purposed 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. 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/COFFEE/RUBBER DEVELOPMENT ACCOUNT [Sec. 33AB] Sec.33AB Tea Development Account Illustration 11 : X Ltd., is a company engaged in the business of growing, manufacturing and selling of tea. For the accounting year ended 31st March, 2010, 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, 2010 `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. The non-depreciable asset was sold in November, 2010 for `29 lakhs. Indicate clearly the tax consequences of the above transactions and the total income for the relevant years. Computation of total income of X Ltd. for A.Y. 2010-11 Particulars ` Net profits before adjusting deduction u/s 33AB 60,00,000 Less: Deduction u/s 33AB 24,00,000 [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 36,00,000 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 14,40,000 Add: Non-utilisation of amount withdrawn: ` 2 lakhs [i.e. (`20 lakhs - `18 lakhs)] 40% is taxable as business income (the balance 60% is treated as agricultural income). 80,000 Business income 15,20,000 Less: Business loss brought forward from the previous year 10,00,000 Total income 5,20,000 (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” Amount of deduction = Unallowed amount less Net consideration Remaining period of licence (iii) Where whole or part of licence is transferred and net consideration is more than “Unallowed amount” Net consideration more than Unallowed amount but Business Income = Net Consideration less Unallowed less than Original Cost of licence amount Net Consideration is more than Original Cost of licence Business Income = Original cost of licence less and Un allowed amount Unallowed amount Capital Gain = Net Consideration less Original Cost of licence The following table would explain the various situations A B C D Transfer of licence Full In Part Full In part Licence period (years) 7 7 7 7 Acquisition cost 140 140 140 140 Deduction claimed so far (4 years) 80 80 80 80 Unamortised value 60 60 60 60 Sale price - current year 140 45 50 30 Amount remaining to be amortised 15 30 Amount deductible U/s.35ABB(3) 10 Amount chargeable to tax as business income 80 Amount to be amortised in remaining 3 years 5 10 Illustration 12 : Free Call Ltd. obtained a telecom licence on 15.6.07 for a period of 8 years ending on 31.3.2015 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 2009, June 2010 and June 2011 respectively. Explain how the payment for licence fee shall be dealt under the Income Tax Act, 1961. Solution : Assessee : Free Call Ltd. Previous Year 2010-11 Assessment Year: 2011-12 (a) U/s 35ABB, expenditure incurred for the purpose ofacquiring 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 Amount paid Unexpired Period of Amount of Deduction (` Crores) Licence on the date of (` Crores) actual payment 2007-08 12.00 8 years 1.50 2008-09 7.00 7 years [1.50 + (7.00/7)] = 2.50 2009-10 6.00 6 years [2.50 + (6.00/6)] = 3.50 2010-11 5.00 5 years [3.50 + (5.00/5)] = 4.50 Illustration 13 : 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 2009 and the licence to operate the services was valid for 15 years. In December 2010, 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 2011-12? Solution : Assessee: Hello International Ltd. Previous Year: 2010-11 Assessment Year : 2011-12 (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 01.04.2010 = Total Expenditure Less Deduction for Financial Year 2009-10 = `240 crores Less ( `240 crores/licence period of 15 years) = `240 crores less `16 crores = `224 crores. (ii) Net Consideration received = `60 crores (iii) Remaining period of licence = 14 years (including current previous year) (iv) Deduction u/s 35 ABB = ` (224 crores less 56 crores) / 14 years= `12 crores. Illustration 14 : Jammer International Ltd. incurs an expenditure of `300 crores for acquiring the right to operate telecommunication services for Orissa and Jharkhand. The payment was made in August 2009 and the licence to operate the services was valid for 12 years. In December 2010, the company transfers part of the licence, in respect of Orissa 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 2011-12? Solution: Assessee: Jammer International Ltd. Previous Year: 2010-11 Assessment Year : 2011-12 (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 01.04.2010 = Total Expenditure Less Deduction for Financial Year 2009-10 = `300 crores Less ( `300 crores / licence period of 12 years) = `300 crores less `25 crores= `275 crores. (ii) Net Consideration received = `280 crores (iii) Remaining period of licence = 11 years (including current previous year) (iv) Deduction u/s 35 ABB = ` (224 crores less 56 crores) / 14 years = `12 crores. Sec. 35D Amortization of Preliminary Expenses Illustration 15 : 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 4,00,000 Market survey 5,00,000 Legal and other charges for issue of additional capital required for the new unit 2,00,000 Total 11,00,000 The following further data is given: Cost of project 30,00,000 Capital employed in the new unit 40,00,000 What is the deduction admissible to the company under section 35D for Assessment Year 2011-12? 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. In this case (a) 5% of the project cost is `1,50,000 and (b) 5% of the capital employed is `2,00,000. 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. Illustration 16 : On Sec.44AF Ms.Chitralekha, a retail trader of Kolkata furnishesthe following Trading and Profit and Loss Account for the year ending 31st March, 2011 : Trading and Profit and Loss Account for the year ended 31.03.2011 ` ` To Opening stock 90,000 By Sales 12,11,500 To Purchases 10,04,000 By Income from UTI 2,400 To Gross Profit 3,06,000 By Other business receipts 6,100 By Closing stock 1,80,000 14,00,000 14,00,000 To Salary 60,000 By Gross profit b/d 3,06,000 To Rent and rates 36,000 To Interest on loan 15,000 To Depreciation 1,05,000 To Printing & stationery 23,200 To Postage & telegram 1,640 To Loss on sale of shares (Short term) 8,100 To Other general expenses 7,060 To Net Profit 50,000 3,06,000 3,06,000 Additional Information : (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 1.7.2010 for `70,000. Two old plants were sold on 1.10.2010 for ` 50,000. (v) Rent and rates includes sales tax liability of `3,400 paid on 7.4.2010. (vi) Other business receipts include `2,200 received as refund of sales tax relating to 2008-09. (vii) Other general expenses include `2,000 paid as donation to a Public Charitable Trust. You are required to advise Ms.Chitralekha whether he can offer his business income under section 44AF i.e. presumptive taxation. Solution: Let us assume that the facts relate to previous year relevant to assessment year 2011-12 and accordingly compute the income of Ms.Chitralekha. Computation of business income of Mr. Sivam for the assessment year 2011-12. Net Profit as per profit and loss account 50,000 Add : Inadmissible expenses / losses Under valuation of closing stock 18,000 Unreasonable salary paid to brother (section 40A(2) 2,000 Printing and stationery paid in cash [Section 40A(3)] 100% of `23,200 43,200 Depreciation (considered separately) 1,05,000 Short term capital loss on shares 8,100 Donation to public charitable trust 2,000 1,78,300 2,28,300 Less : Deductions items: Under valuation of opening stock 9,000 Income from UTI 2,400 Refund of sales tax [Taxable u/s.41(1) - No adjustment necessary] — 11,400 Business income before depreciation 2,16,900 Less : Depreciation (see note 1) 66,000 1,50,900 Computation of business income as per section 44AF As per section 44AF, the business income would be 5% of turnover 12,11,500 × 5 /100 = `60,575 The business income under section 44AF is ` 60,575. As the business income under section 44AF is lower than the business income as per the normal provisions of the Act, it is advisable for Mr. Sivam to offer the business income under section 44AF of the Act Note 1 Calculation of depreciation WDV of the block of plant & machinery as on the first day of previous year 4,20,000 Add : Cost of new plant & machinery 70,000 4,90,000 Less : Sale proceeds of assets sold 50,000 WDV of the block of plant & machinery as on the last day of previous year 4,40,000 Depreciation @ 15% 66,000 Note : No additional depreciation is allowable as the assessee is not engaged in manufacture or production of any article. Note 2 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 17 : Mukund is a person carrying on profession as film artist. His gross receipts from profession are as under : Financial year 2008-2009 1,25,000 Financial year 2009-2010 1,60,000 Financial year 2010-2011 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. Illustration 18 : Discuss the tax implications of the following transactions in the case of a doctor running a nursing home : ` (1) Amount paid to a scientific research association approved by the Central Government and run by a drug manufacturing company 20,000 (2) Amounts received from the employees of the nursing home as contributions towards provident fund for the month of March, 2011 paid to the PF Commissioner on 25th April, 2011 25,000 (3) Repayment made in cash towards purchases of medicines 50,000 (4) Repayment of loan taken from a bank for doing a post-graduate course in medicine - instalment 50,000 Interest 10,000 Answer : (i). Under section 35(ii), 125% of the sums paid to scientific research association, which has as its object the undertaking of scientific research is deductible. Deduction admissible = 20,000 + (1/4 × 20,000) = `25,000. (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 employee’s 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. (iii) Under section 40A(3) payments made in cash exceeding ` 20,000 are not allowable in computing the income from business or profession. 20% of such expenditure is liable to be disallowed. Hence ` 10,000 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. 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. Investment-linked tax incentive for specified business - cold chain facilities, warehousing facilities for storage of agricultural produce, and cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities [Section 35AD, 28(vii) and 73A] [W.e.f. A.Y. 2010-11] The Income tax Act provides for a number of profit-linked exemptions/deductions. Such benefits are inefficient, inequitable, impose higher compliance and administrative burden, result in revenue loss, increase litigations and lead to competitive demand for similar tax benefits. Further, these benefits also encourage diversion of profits from the taxed sector to the exempt/untaxed sector. However, investment-linked incentives are relatively less distortionary in their impact. 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. 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 employed at the option of the company. “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. The qualifying amount of preliminary expenditure is allowed as deduction over a period of 5 years in equal installments. 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. 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. 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 19 : Suppose the payment of voluntary retirement is made ot X as under : Previous year Amount paid (`) 2007-08 20,00,000 2008-09 12,00,000 2009-10 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 2008-09 : ` 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 2009-10 to 2012-13. Assessment year 2009-10 : ` 6,40,000 i.e. ` 4,00,000 on account of payment made in previous year 2007-08 and ` 2,40,000 (1/5th of ` 12,00,000 paid on previous year 2008-09). Assessment year 2010-11 : ` 9,20,000 i.e. ` 6,40,000 (` 4,00,000 + ` 2,40,000 for payment made in previous year 2007-08 and 2008-09 respectively) and ` 2,80,000 on account of payment made in previous year 2009-10. Assessment year 2011-12 : ` 9,24,000 (` 4,00,000 + ` 2,40,000 + ` 2,80,000) Assessment year 2012-13 : ` 9,20,000 (` 4,00,000 + ` 2,40,000 + ` 2,80,000) Assessment year 2013-14 : ` 5,20,000 (` 2,40,000 + ` 2,80,000) Assessment year 2014-15 : ` 2,80,000 Total amount allowed in various assessment years ` 46,00,000. 1 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 PREMIUM FOR STOCK AND STORES [Sec. 36(1)(i)] The amount of any insurance premium paid in respect of insurance against risk of damage or destruction 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. 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 S. 43B. 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 Sec. 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 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. If payment is not made within the due date such contribution should be treated as income of the assessee. However, deduction will be allowed in respect of any such sum received as stated above only if such sum is credited by the assessee to the employee’s account in relevant fund on or before the due date, i.e. the date by which the assessee is required as an employer to credit such contribution to the employee’s account under the provisions of any law or term of contract of service or otherwise. 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. 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 MADE BY [Sec. 36(1)(viia)] :- (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. (ii) A bank incorporated outside India upto 5% of its total income. (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. 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) to a financial corporation which is engaged in providing long time finance for industrial or agricultural or development in India or for development for infrastructure facility in India; or (b) by 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(l)(1)(viii)[W.e.f. A.Y. 2010-11] Section 36(l)(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(l)(v/ii) on the ground that it is not engaged in the long-term financing for construction or purchase of houses in India for residential purpose. The amendment has been made in clause (b) of Explanation to section 36(l)(v/ii) 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(l)(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. 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 Minister’s 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 for the purposes of the business 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/s.37. 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] SECTION 40(a) • Interest, salary, royalty, fees for beneficial services or any other sum payable outside India is not deductible unless tax is deducted at source or tax is paid. • Income Tax and Wealth Tax are not deductible. • Any tax paid by the employer on the perquisites not provided by way of monetary payment is not deductible in computing business income of the employer w.e.f. Assessment Year 2003-04. 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 18% p.a. (12% p.a. w.e.f. 1.6.2002) 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. It should be authorised by partnership deed. 2. It should relate to a period falling after the date of the partnership deed. 3. 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 ` 1,50,000 or at the rate of 90% of the book-profit, or in case of a loss whichever is more; (b) On the balance of the book-profit At the rate of 60%. 4. It should be paid to a working partner. 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. 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. Assessee Specified persons (i) Individual (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 AOP or HUF family, or any relative of such director, partner or member; (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 having a substantial interest in Business or Profession of the assessee or any director, partner or member of any such person or any relative of any. DISALLOWANCE OF CASH EXPENDITURE EXCEEDING ` 20,000 [Sec. 40A(3), RULE 6DD] Where the assessee incurs any expenditure incurred 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. (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. (j) 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. (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 co-operative 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. 129 PROFITS AND GAINS OF BUSINESS OR PROFESSION (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 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— 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 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. 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 settledto the supplier creditor, the benefit accruing on remission of the trading liability will be deemed as incomeu/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. 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, if such sum would have been included in the total income of the aforesaid person had in been received before such discontinuance. 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. 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. 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 Stipulated time period 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. 2. Any sum payable to an employee as bonus or commission for services rendered. 3. Any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or State 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. 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. However, in cases (1) to (5), if the payment of outstanding liability is made after the due date, deduction can be claimed in the year of payment. 4. Any sum payable by the assessee as interest on -do- any term loan from a scheduled bank in accordance with the terms and conditions of the agreement governing such loan. 5. Any sum payable by the assessee as an employer However, if the deduction has already been in lieu of any leave at the credit of his employee allowed on due basis before this amendment, the (inserted w.e.f. AY 2002-03) same will not be allowed again when the sum is actually paid. 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 employee’s contribution to the employee’s 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 COST OF ACQUISITION OF CERTAIN ASSETS [Sec. 43C] Mode of acquisition Cost of acquisition 1) Amalgamation (a) Cost to the amalgamating company (b) Cost of improvement (c) Expenses incurred for transfer 2) Gift (a) Cost to the donor, (b) Cost of improvement (c) Expenses incurred for accepting the gift and the gift tax paid by the donor 3) Partition of HUF (a) Cost to the HUF (b) Cost of improvement (c) Expenses incurred for partition. 4) Will (a) Cost to the previous owner (b) Cost of improvement (c) Expenses incurred for probating the will 5) Irrevocable trust (a) Cost to the previous owner (b) Cost of improvement (c) Expenses incurred for establishing the trust. 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 `60,00,000; • Carrying on profession where gross receipts exceed ` 15,00,000; or • Carrying on business referred to in section 44AD or 44AE or 44AF 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. 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. 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 ` 60 lakhs. [CBDT circular No. 452 dt. 17.3.1986] INCOME PARTLY AGRICULTURE AND PARTLY BUSINESS Rule 7A : Income from manufacture of Rubber :- 35% of such income shall be deemed to be business income and liable to tax. 65% of such income shall be deemed to be Agricultural income. Rule 7B : Income from the manufacture of coffee :- 40% of such income shall be deemed to be business income and liable to tax. 60% of such income shall be deemed to be agricultural income. Rule 8 : Income from the manufacture of tea :- 40% of such income shall be deemed to be business income and liable to tax. 60% of such income shall be deemed to be agricultural income. PRESUMPTIVE INCOME PROFITS AND GAINS OF BUSINESS OF CIVIL CONSTRUCTION (SEC.44AD) Applicable only if the gross receipts paid or payable (to the assessee) does not exceed `60 lakhs. Income : 8% of such gross receipts. However, if the asssessee, declares higher income, that shall be considered. PROFITS AND GAINS OF BUSINESS OF PLYING, HIRING OR LEASING GOODS CARRIAGES (SEC.44AE) Applicable to an assessee who owns not more than 10 goods carriages at any time during the previous year and who is engaged in the business of plying, hiring or leasing of such goods carriages: (I) For heavy goods vehicle- ` 5,000 for every month or part of a month during which the heavy vehicle is owned by the assessee in the previous year. (II) For goods carriage other than heavy goods vehicle- ` 4,500 for every month or part of a month during which the goods carriage is owned by the assessee. PROFITS AND GAINS OF RETAIL BUSINESS (SEC.44AF) Applicable only if the turnover of such retail trade does not exceed ` 60 lakhs in the previous year. Income : 5% of the turnover. However, if the assessee, declares higher income, that shall be considered. 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 aforsaid sum claimed to have been earned by the assessee shall be deemed to be profits and gains of such business. Presumptive income scheme for retail business merged with section 44AD [Section 44AF] [W.e.f. A.Y. 2011-12] SPECIAL PROVISIONS FOR COMPUTING PROFITS & GAINS FOR NON-RESIDENTS Section Nature of Business Profit- % on Turnover 44B Shipping business in case of non-resident. 7-1/2% 44BBB Business of providing services or facilities in connection 10% with orsupplying plant and machinery on hire used in the prospecting for or extraction or production of mineral oils in case of non-resident. 44BBA Business of operation of aircraft in case of non-resident. 5% 44BBB In case of foreign company engaged in 10% of the gross i) Civil construction amount paid or ii) erection of plant or machinery payable in India iii) testing or commissioning thereof in connection with or out of India. turnkey power project approved by the Central Government, income is determined at 10% of the gross amount. 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 ; or (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 (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 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. 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. 2. 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. 3. 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. 4. 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). 5. 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. 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. 12) Fees of ` 30,000 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. 13) 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. 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 an 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. Solution : 1) Anticipated hedging loss under a forward contract is not allowed to be deducted. 2) Loss caused due to negligence of employee is allowed to be deducted. 3) 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). However, the employer becomes liable to pay Fringe Benefit Tax. 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 year but 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). 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). 22) Travelling expenditure for exploring new line of business is a capital expenditure. It is not allowed under Sec. 37(1). It may be capitalised for the purposes of Sec. 35D. 23) Annual instalment 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 in-come [(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. PROBLEMS ON PROFITS AND GAINS FROM BUSINESS OR PROFESSION Illustration 20 : Mr Sudhir Sharma, resident in India, for the year ending on 31 March 2011. Compute his income from business and his gross total income for the assessment year 2011-2012. Profit & Loss Account for the year ended 31.3.10 Dr. Cr. Expenditure ` Receipts ` To purchases To salaries and wages To trade expenses To purchase of trademarks To registration of trademarks To rent, rates and taxes To discount allowed To household expenses To advertisement bill paid in cash To income tax To sales tax paid To purchased technical know-how To expenses incurred on income tax and sales tax proceedings To contribution paid to a trust for staff welfare To staff welfare expenses incurred To OYT deposit To postage and telegrams To donation to National Defence Fund To life insurance premium on the life of the assessee To interest on capital To interest on loan taken to pay income tax To wealth tax To audit fee To entertainment expenditure To gifts and present to five customers, costing ` 3,000 each To expenses on apprentice training To emergency risk insurance To fire insurance premium for stock To provision for bad and doubtful debts To reserve for pecuniary losses To net profit 1,90,000 By sales less returns 5,69,300 1,40,000 By bad debts recovered, 2,000 1,000 allowed in earlier years by the 50,000 Assessing Officer 2,000 By interest on securities (gross) 892 5,000 By dharmada, mandir and 2,000 1,500 gaushala receipts 6,000 By refund on income tax 1,008 30,000 By proceeds of life insurance 43,500 10,000 policy on maturity 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 4,000 200 200 3,000 5,000 76,000 Total 6,18,700 6,18,700 Solution : Computation of Gross Total Income for the Assessment Year 2011-2012 Particulars ` ` Income from Business Net profit as per profit and loss account 76,000 Add: Expenses inadmissible in computing profits and gains from business or profession: Purchase of trademarks 50,000 Household expenses [Sec. 37(1)] 2,500 Advertisement bills paid in cash [Sec. 37(1) r.w. Sec. 40A(3)] @ 100% of ` 30,000 30,000 Income tax [Sec. 40(a)(ii)] 10,000 Purchase of technical know-how 12,000 Contribution to a Trust for staff welfare fund [Sec. 40A(9)] 1,000 Donation for National Fund [Sec. 37(1)] 2,500 Life Insurance premium [Sec. 37(1)] 2,000 Interest on capital [Sec. 36(1)(iii)] 5,000 Interest on loan to pay income tax [Sec. 37(1) r.w. 40{a)(ii)] 500 Wealth tax [Sec. 40(a)(iii)] 500 Provision for bad and doubtful debts [Sec. 37(1) r.w. 36(1)(vii)(2)] 2,000 Reserve for pecuniary losses [Sec. 37(1)] 6,000 1,24,000 1,24,000 2,00,000 Less: (a) Income not relating to business or profession: [Sec. 28(i)] 892 Interest on government securities (b) Dharada, mandir and gaushala receipts 2,000 (c) Refund of income tax 1,008 (d) Proceeds of L.I.P.: It is not a business receipt and exempt 43,500 [Sec. 10(10)] (e) Depreciation on trademarks; 25% of ` 50,000 12,500 (f) Depreciation on know-how: 25% of ` 12,000 3,000 59,400 Income from business 1,40,600 Statement of Gross Total Income for the Assessment Year 2010-2011 1. Income from business 1,40,600 2. Income from other sources— Interest on securities 892 Gross total income 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 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 21 : Dr L.Kochagaway is a renowned medical practitioner. He furnishes his receipts and payments account for the financial year 2010-2011: Dr. Cr. Receipts ` Payments ` To balance b/d 35,000 By rent of clinics: To consultation fees : 2007-2008 25,000 2008-2009 1,80,000 2009-2010 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 2008-2009 13,600 2009-2010 44,800 2010-2011 26,600 85,000 4,67,000 By electricity and water 12,000 1,30,000 By purchase of professional books 18,000 2,25,000 By household expenses 97,800 By municipal taxes paid in respect 12,000 1,73,000 of property 15,000 By purchase of motor car 2,45,000 26,000 By Telephone Charges 10,000 By fire insurance in respect of 3,200 property 96,000 By surgical equipment 44,700 17,000 By advance income tax 43,000 By salary and perquisite to 72,000 compounder By entertainment expenses 16,000 By purchase of X-ray machine 2,00,000 By expenses of income-tax 15,000 proceedings By life insurance premium 25,000 By gifts to wife 25,000 By interest on loan 12,000 By loan a/c—instalment paid 25,000 By donation to Political Party 2,500 By car expenses 36,000 By purchase of medicines 1,05,000 By balance c/d 79,800 11,84,000 11,84,000 Compute his income from profession and gross total income for the assessment year 2011-2012 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 2006. 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 2010-2011, 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 2010. Solution : (a) Computation of income from profession for the assessment year 2011-2012 : Particulars ` ` Income from Profession : (a) Receipt from profession: 1. Consultation fees: [Sec. 28(i)]: (` 25,000 + ` 1,80,000 4,67,000 + ` 2,62,000) 2. Visiting fees [Sec. 28(i)] 1,30,000 3. Sale of medicines [Sec. 28(i)] 1,73,000 4. Gifts and presents from patients [Sec. 28(iv)] 15,000 5. Remuneration from articles published in professional 26,000 magazines [Sec, 28(i)] 8,11,000 (b) Closing stock of medicines 8,000 Total receipts and closing stock 8,19,000 Less: Expenses allowable: 1) Rent of clinic [Sec. 30] 85,000 2) Electricity and water [Sec. 37(1)] 12,000 3) Salary of compounder [Sec. 37(1)] 72,000 4) Entertainment expenses [Sec. 37(1)] 16,000 5) Expenses on income-tax proceedings [Sec. 37(1)] 15,000 6) Interest on loan [Sec. 37(1)(iii)] 12,000 7) Purchase of medicines [Sec. 37(1)] 1,05,000 8) Car expenses [Sec. 37(1)] (2/3 x ` 36,000) 12,000 9) Depreciation on professional books : (i) Annual publications: 12,000 × 100% × 50% 6,000 (ii) Other books: 6,000 × 60% 3,600 10) Depreciation on car [Sec. 32 r.w. Sec. 38] : 15% of 2,45,000 × 2/3 24,500 11) Depreciation on plant and machinery: (i) X-ray machine 2,00,000 (ii) Surgical equipment 44,700 Depreciation @ 15% of 2,44,700 36,705 12) Telephone Charges 10,000 4,09,805 Taxable Income from Profession 4,09,195 B/F 4,09,195 Computation of Income from House Property : Gross annual value on the basis of rental valuation 96,000 Less: Full municipal taxes paid by the owner 12,000 Net annual value 84,000 Less: Statutory deduction: 30% of net annual value 25,200 58,800 Income from House Property 58,800 Gross Total Income 4,67,995 Less: Deduction u/s 80C (LIC premium paid) 25,000 Less: Deduction u/s 80GGC 2,500 Actual amount of donation to political party Total Income 4,40,495 Total Income rounded off u/s 288A 4,40,490 Notes : 1. Purchase of motor car is capital expenditure. Hence, it is not deductible. Depreciation has been allowed on motor car. 2. 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. 3. Contribution of articles to periodicals and magazines constitutes income from vocation of the assessee. 4. Expenses in income-tax proceedings are wholly deductible [Sec. 37(1)]. 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. Interest on Post Office National Saving Certificates is exempt from income tax [Sec. 10(15)]. 7. 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 2010-2011 will not be taken into consideration. 8. Profits and gains of business 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 9. Donation to Political Party is allowed to be deducted from gross total income under Sec. 80GGC. 14 Illustration 22 : The Profit and Loss Account of RAI & Co. for the previous year 2010-2011 is given as follows : Particulars ` Particulars ` Purchases of goods 10,00,000 Sale of goods 26,00,000 Salaries, bonus and commission 8,00,000 Closing stock 50,000 Rent, rates and taxes 60,000 Interest on drawings 7,000 Depreciation @ 16% on WDV 20,000 Interest on securities 20,000 Travelling expenses 1,50,000 Interest on capital 25,000 Advertisement 1,20,000 Entertainment expenses 60,000 Expenditure on neon-sign board 50,000 New telephone deposit under OYT 5,000 scheme Compensation for cancelling 10,000 purchase order of an outdated machine Expenses for promoting family 20,000 planning among employees Net profit 3,57,000 26,77,000 26,77,000 Additional Information : (i) Salaries, bonus and commission include: ` (a) Salary to the proprietor 1,50,000 (b) Bonus paid to employees on 15-10-2011 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 3:2. 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) Annual stock taking revealed a theft of goods, costing `30,000. (i) 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 2011-12. Computation of Taxable Business Profits for the Assessment Year 2011-2012 Solution : Particulars ` ` Income from Business Net profit as per profit and loss account 3,57,000 Add: Inadmissible Expenses (a) Salary paid to Proprietor 1,50,000 (b) Bonus paid to employees: Deduction will be allowed in Previous 75,000 Year 2011-12 (Sec.43B, being disallowance of unpaid liability) (c) Salary paid to non-resident employee, without deducting or 1,20,000 paying TDS[Sec.40(a)(iii)] (d) Advertisement bills paid in cash [Sec. 37(1) r.w. Sec. 40A(3)] @100% of ` 38,000 38,000 (e) Advertisement in sourvenir published by political party [Sec.37(2B)] 10,000 (f) Depreciation to be treated separately 20,000 (g) Expenses on family planning: allowable only to a company 20,000 assessee [Sec.36(1)(ix)] (h) Foreign travel to acquire a new machine, ( being capital in nature, 1,00,000 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] 25,000 (j) Expenditure on neon sign board, being a capital expenditure 50,000 on advertisement, hence disallowed. (k) Compensation paid to cancel a capital liability, capital in 10,000 nature, hence disallowed u/s 37(1) (l) Under valuation of closing stock:[50,000/80% - 50,000] 12,500 12,500 6,30,550 Less: Expenses allowed : 9,87,500 Interest on Drawings 7,000 Depreciation u/s 32: (a) Plant and machinery: WDV on 01.04.2010 : 20,000 × 4/5 × 100/16 1,00,000 Add: Cost of neon-sign board 50,000 1,50,000 Less: Depreciation @15% 22,500 22,500 WDV as on 31.3.11 1,27,500 (b) Furniture and Fittings: WDV on 01/04/10: 20,000 × 1/5 × 100/16 25,000 Less: Depreciation @10% 2,500 2,500 WDV on 31.3.2011 22,500 Less: Incomes credited to Profit and Loss A/c to be treated under separate Head of Income Interest on Government Securities 20,000 Taxable Business Profits 9,35,500 148 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) Deposit for new telephone connection is allowable u/s 37(1). Hence, no adjustment is required. Illustration 23 : The Profit & Loss Account of Mr.Dipak Sinha for the previous year 2010-2011 is given below : Dr. Cr. Particulars ` Particulars ` Cost of goods sold 16,00,000 Sales 34,70,000 Salaries wages 9,00,000 Rent of staff quarters 3,00,000 Rent of business premises, owned 2,50,000 Sale price of machinery block on 5,00,000 by the assessee 31-03-2011 Repairs and renewals 1,40,000 Income tax paid 60,000 Excise duty paid 1,00,000 Sales tax payable 2,00,000 Legal expenses 3,00,000 Municipal taxes payable for staff 10,000 quarters Provision for bad debts 60,000 Contingency reserve 1,00,000 Employees contribution to 50,000 recognised fund Net profit 5,00,000 42,70,000 42,70,000 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 2010-2011 was paid on 1 January 2011 but it was not included in the profit and loss a/c. (iii) Sales tax amounting ` 1,30,000 was paid on 31 July 2011 and the balance was paid on 1 August 2011, the due date of furnishing return of income is 31 July 2011. (iv) Repairs/renewals include remodelling and renovation costing ` 80,000. (v) 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 ` 1,20,000, made to wife, a tax-advisor, but disallowed by the A.O. (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 2011. (vii) Commission receipts of ` 2,00,000 have not been credited to the profit and loss account as their recovery seems to be doubtful. (viii) WDV of machinery on 01-04-2010 was ` 6,50,000. (ix) WDV of business premises and staff quarters as on 01-04-2010 : ` 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 2010-2011. Solution : Computation of Business Profits for the Assessment Year 2011-12 Particulars ` ` Net profit as per profits and loss a/c 5,00,000 Add: Inadmissible Expenses: (i) Rent of business premises owned by the assessee (Sec. 30) 2,50,000 (ii) Remodelling and renovation, being repairs of capital nature 60,000 (iii) Income tax paid [Sec. 40(a)(ii)l 60,000 (iv) Sales tax remaining unpaid up to due date of furnishing 70,000 return of income (v) Legal expense includes: (a) Gift made to wife, Sec. 37(1) 1,00,000 (b) Fees paid to lawyer (being a relative) Sec. 40A(2) 10,000 (vi) Salaries paid outside India to a “resident” employee TDS 1,20,000 [Sec. 40(a)(iii)] (vii) Salaries paid in India to a resident employer without TDS — (viii) Municipal tax payable for staff quarters [Sec. 43B] 10,000 (ix) Provision for bad debts [Sec. 36] 60,000 (x) Contingency reserve [Sec. 37(1)] 1,00,000 (xi) Employees’ contribution credited to their account after due date 20,000 (xii) Commission receipts which have accrued during the year 1,00,000 but recovery seems doubtful seems doubtful (xiii) Employees’ contribution not credited to—profit and loss a/c 50,000 10,30,000 15,30,000 Less: Inadmissible receipts/ admissible claims: (i) Excise duty (Sec. 43B) 50,000 (iii) Sale price of machine, being capital receipts 5,00,000 (iv) Depreciation: (a) Staff quarters: 5% of 30,00,000 1,50,000 (b) Business Premises: 10% of 10,00,000 1,00,000 8,00,000 Taxable business profits 7,30,000 Note : 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. 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. 15 Illustration 24 : The firm of M/s Amal & Associates is engaged in the business of growing and manufacturing tea. The Profit & Loss Account for the year 2010-2011 is given as follows: Dr. Cr. Particulars ` Particulars ` Cost of growing and manufacturing tea 40,00,000 Sales 95,00,000 Salaries and wages 15,00,000 Stock 13,50,000 Advertising 5,00,000 Entertainment expenses 1,00,000 Travelling expenses 3,00,000 Fine and penalties 50,000 Cost of patent rights 6,00,000 Expenses on scientific research 6,00,000 General and sundry expenses 2,00,000 Net profit 30,00,000 1,08,50,000 1,08,50,000 You are further informed : (i) Advertising includes payment of ` 2,00,000 made to a political party for insertion of advertisement in party’s 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, 2008-2009, 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 2010, (b) ` 6,00,000 in July 2011 and (c) ` 2,00,000 in December 2011. It has not been included in the profit and loss account. Date of submitting return of income 30/09/2011. (vii) (a) W.D.V. of machinery on 01-04-2010 (Rate of depreciation 15%) `15,00,000 (b) Machinery purchased in December 2010 for scientific research ` 5,00,000 (c) Purchase of five small drier machine, each costing `10,000 (d) Sale price of an old machinery (Rate of depreciation 15%) ` 6,00,000 (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. Compute the taxable business profits for the assessment year 2011-2012. Solution : Computation of Business Profits for the Assessment Year 2011-2012 Particulars ` ` Net profit 30,00,000 Add: Inadmissible Expenses: 1. Advertisement payment to a political party [Sec. 37(2B)] 2,00,000 2. Travelling outside India [Sec. 37(1)]. Proportionate expenses 22,500 of foreign travel, (excluding air fare) not relating to business: 60,000 × 3/8 3. Fine and penalties 50,000 4. Cost of patent rights 6,00,000 5. Expenditure on scientific research (Sec. 35): Purchase of land 1,50,000 6. Contribution to Bombay Municipal Committee (Sec. 35 AC): 60,000 10,82,500 Since the Certificate indicating progress in the prescribed 40,82,500 form has not been issued, no deduction is allowed. Add: Deemed profit: Refund of Customs Duty, deducted in earlier 50,000 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)] 4,00,000 Depreciation on Patent rights @ 25% of ` 6,00,000 1,50,000 Depreciation on know-how: @ 25% of ` 5,00,000 1,25,000 Depreciation on Machinery: WDV as on 01/04/2010: 15,00,000 Add: Purchase of driers 50,000 15,50,000 Less: Sale of Old Machinery 5,00,000 WDV as on 31/3/2011 10,50,000 Depreciation @ 15% on ` 10,50,000 Weighted Deduction for scientific research: 1,57,500 (i) National Laboratory: @ 125% of ` 20,000= ` 25,000 - ` 20,000 = ` 5,000 (ii) Bhaba Atomic Research Laboratory: @ 125% of ` 30,000 = ` 37,500 - ` 30,000 = ` 7,500 Therefore, total deduction `(5,000 + 7,500) 12,500 8,45,000 Composite Profits before making deduction u/s 33AB 32,87,500 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 ` 32,87,500 = 10,00,000 ` 13,15,000 Composite Profits after deduction u/s 33AB 22,87,500 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: 9,15,000 40% of ` 22,87,500 Illustration 25 : State whether the provisions or 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 26 : 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 27 : 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 assessee’s business, (ii) not relating to the assessee’s 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) Amount payable as damages to Government on account of shortfall in export target. (d) Overdraft from bank for payment of income tax: interest charged by the bank is ` 20,000. (e) Payment of interest of ` 40,000 on monies borrowed from bank for payment of dividends to shareholders. (f) ` 12,000 paid for shifting of business from the original site to the present place which is more advantageously located. (g) Retrenchment compensation of ` 4 lakh paid to the workmen on the closure of one of the units. (h) 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. 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 assessee’s business or not, deduction could be claimed @ 125% of amount paid. If it isnot 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. (d) Interest on overdraft taken to pay income tax is not allowable under Sec. 36(1)(iii). Interest on borrowings (e) utilised for payment of dividend is allowable under Sec. 36(1)(iii). (f) Shifting expenses of business premises resulting in an expenditure of enduring benefit is a capital expenditure and is not allowable. (g) 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). (h) 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. Illustration 28 : A company engaged in the manufacturing of fertilizer products, commenced its business on 01.04.2010. During the financial years 2007-2008 to 2009-2010 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 2010-2011 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 31.12.2010 for ` 8.00 lakh and closed its research activity. Compute the admissible deduction under Sec. 35 for the assessment year 2011-2012. 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 12,00,000 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 3,00,000 previous year 2010-2011 Capital expenditure on scientific research incurred during the previous 4,50,000 year 2010-2011 7,50,000 Total Weighted deduction © 150% on ` 7.50 lakh u/s 35(2AB) 11,25,000 Admissible deduction u/s 35 for the AY 2011-2012 23,25,000 Illustration 29 : 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 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 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 30 : Apporva Shantilal filed his return of income for the assessment year 2010-11 on 29-1-2011 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 2011-12, 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 5,60,000 (b) Opening WDV of factory building 6,20,000 This building, constructued 5 years back, was sold for 10,28,000 (c) Machinery (entitled to depreciation @ 15%) Opening WDV 3,20,000 All machines sold in March 2011 for 5,10,000 (d) Car Opening WDV 1,20,000 Relating to fertiliser unit at Cuttack Particulars ` (a) Factory building (purchased in March, 2006) Opening WDV 2,80,000 (b) New Machinery (Rate of depreciation 15%) purchased in June, 2010 50,00,000 (c) Jeep Opening WDV 1,80,000 (d) Furniture Opening WDV 80,000 (e) Business income prior to above adjustments 7,16,000 Compute the total income of Mr. Apoorva Shantilal for the A.Y. 2011-12 Solution : Computation of depreciation/short term capital gains in the case of Mr. Apoorva Shantilal for the A.Y. 2011-12 : Particulars ` Profits and gains of business Profits prior to depreciation of steel rolling mill 5,60,000 Profits prior to depreciation of fertiliser unit 7,16,000 12,76,000 Depreciation for the year (Note - 1) 7,74,500 5,01,500 Less : Set-off of Brought Forward Unabsorbed Depreciation u/s 31(2) - related 5,01,500 Nil Capital Gains Short-term Capital Gain on Sale of Building (Note-1) 1,28,000 Less : Set-off of Brought forward Unabsorbed Depreciation for the A.Y. 2010-11 restrocted to the amount of profits 1,28,000 Nil Gross Total Income Nil (-) Deduction under Cl VIA Nil Total Income Nil Note : The assessee can carry forward ` 4,08,500 being unabsorbed depreciation for set off against income in the future years. Working Note : 1. Computation of Depreciation and Short Term Capital Gaions Block-I Block-II Block-III Block-IV Particulars Factory Furniture Plant & Moter Building & Fixture Machinery Vehicles Rate of Depreciation 10% 10% 15% 15% Opening WDV — Kanpur 6,20,000 Nil 3,20,000 1,20,000 — Cuttack 2,80,000 80,000 Nil 1,80,000 Total opening WDV 9,00,000 80,000 53,20,000 3,00,000 Add : Additions during the year Nil Nil 50,00,000 Nil 9,00,000 80,000 53,20,000 3,00,000 Less : Sales during the year 10,28,000 Nil 5,10,000 Nil Short term Capital Gains 1,28,000 N/A N/A N/A Net Book Value Nil 80,000 48,10,000 3,00,000 Less : Depreciation for the year Nil 8,000 7,21,500 45,000 Closing WDV Nil 72,000 40,88,500 2,55,000 Total Depreciation 8,000 + 7,21,500 + 45,000 = 7,74,500 2. Unabsorbed Depreciation - to be carried forward from Assessment Year 2010-11 ` 2,70,500 (after Set-off of ` 6,29,500 against income during the year) relating to Assessment Year 2010-12. 3. Unabsorbed Business loss of ` 2,42,000 ( = ` 11,42,000 - 9,00,000) of A.Y : 2010-11 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). Illustration 31 : 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 60,000 (b) Remuneration to partners ‘B’ & ‘C’ actively engaged in business Partner ‘B’ 80,000 Partner ‘C’ 90,000 (c) Interest to partner ‘D’ on loan of ` 1,50,000 36,000 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 2011-12. Solution : Computation of Income under the head Profits and Gains of Business or Profession Particulars ` Net profit as per P/L A/c 2,00,000 Add : Inadmissible expenses — (i) Remuneration to A (not an active partner) 60,000 - disallowed u/s 40(b) (ii) Remuneration to B and C 1,70,000 - (considered separately [ ` 80,000 + 90,000] (iii) Interest paid to D on Loan advanced 36,000 Net Profit before Interest and Remuneration to Partners 4,66,000 Less : Maximum Permissible Interest u/s 40(b) @ 12% on Loan from D = ` 1,50,000 × 12% p.a. 18,000 Book Profit 4,48,000 Less : Maximum Permissible Remuneration to B and C u/s 40(b) (i) upto ` 3,00,000 - ` 1,50,000 or 90% of Book Profits, whichever is higher = 2,70,000 Balance of Book Profits - 60% of Book Profits = 60% of 1,48,000 = 88,800 3,58,000 (ii) Actual Remuneration paid lower of (i) & (ii), allowed as deduction 1,70,000 1,70,000 Taxable Income 2,78,000 Taxable income of the partners Particulars A B C D Remuneration Nil 80,000 90,000 Nil Interest Nil Nil Nil 18,000 Taxable income Nil 80,000 90,000 18,000 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”. Book working partners remuneration is worked out as under : ` First ` 3,00,000 of the book profit @ 90% 2,70,000 On the balance ` 1,98,000 of book profit @ 60% 1,18,800 Total 3,88,800 (2) Any interest and salary to partners disallowed in the firm’s case shall not be included in the total income of the partner and shall not be chargeable to tax in the partner’s 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 partner’s taxable income.

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Will come to know how to calculate taxable income from business or profession.


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