Computation of Income from Business : Adjustments to the profit and Loss as per books


CERTAIN RECEIPTS ARE DEEMED AS INCOME AND CERTAIN EXPENSES ARE NOT ALLOWED AS DEDUCTION

Certain Receipts are deemed as dividend income under section 2(22)(a) to 2(22)(e)
Exception Advance in ordinary course of business cannot be considered as deemed dividend U/s. 2(22)(e) of IT Act, 1961

SUMMARY OF CASE LAW
Once it is held that the business transactions do not fall within section 2(22)(e), one need not to go further to section 2(22)(e)(ii) to take away the basic meaning, intent and purport of the main part of section 2(22)(e). 
CASE LAW DETAILS
Decided by: HIGH COURT OF DELHI, In The case of: CIT v. Creative Dyeing & Printing Pvt. Ltd., Appeal No.: ITA No. 250/2009, Decided on: September 22, 2009
RELEVANT PARAGRAPH
9.       In the present case the Tribunal on considering decisions in various cases held as under:
“From the ratio laid down in above cases and on the basis of judicial interpretation of words. ‘Loans’ or ‘Advances’, it can be held that section 2(22)(e)can be applied to ‘Loans’ or ‘Advances’. Simplicitor and not to those transactions carried out in course of business as such. In the course of carrying on business transaction between a company and a stockholder, the company may be required to give advance in mutual interest. There is no legal bar in having such transaction. What is to be ascertained is what is the purpose of such advance. If the amount is given as advance simplicitor or as such per se without any further obligation behind receiving such advances, may be treated is ‘deemed dividend’, but if it is otherwise, the amount given cannot be branded as ‘advances’ . Within the meaning of deemed dividend under section 2(22)(e). Just as per clause (ii) of section 2(22)(e), dividend is not to include advance or loan made by a company in the ordinary course of business where the lending of money is a substantial part of the business of the company advance in the ordinary course of carrying on business cannot be considered as dividend within the meaning of section 2(22)(e). By granting advance if the business purpose of the company is served and which is not the sum, which it otherwise would have distributed as dividend, cannot be brought within the deeming provision of treating such ‘Advance’ as deemed dividend ”
10.  We agree with the aforesaid observations. The finding of facts, arrived at by the Tribunal in the present case is that the transaction in question was a business transaction and which transaction would have benefited both the assessee company and M/s. Pee Empro Exports Pvt. Ltd. In fact, as stated above, the counsel for the appellant has conceded that the amount is in fact not a loan but only an advance because the amount paid to the assessee company would be adjusted against the entitlement of moneys of the assessee company payable by M/s. Pee Empro Exports Pvt. Ltd. in the subsequent years.
11. The counsel for the appellant has very strenuously urged that neither the Tribunal nor the judgment o f this Court in Rajkumar .s case (supra) deals with that part of the definition of deemed dividend under Section 2(22)(e) which states that deemed dividend does not include an advance or loan made to a shareholder by a company in the ordinary course of its business where the lending of money is a substantial part of the business of the company [Section 2(22)(e)(ii)] i.e. there is no deemed dividend only if the lending of moneys is by a company which is engaged in the business of money lending. Dilating further the counsel for the appellant contended that since M/s. Pee Empro Exports Pvt. Ltd. is not intothe business of lending of money, the payments made by it to the assessee company would therefore be covered by Section 2(22)(e)(ii) and consequently payments even for business transactions would be a deemed dividend. We do not agree. The Tribunal has dealt with this aspect as reproduced in para (9) above. The provision of Section 2(22)(e)(ii) is basically in the nature of an explanation. That cannot however, have bearing on interpretation of the main provision of Section 2(22)(e) and once it is held that  the business transactions does not fall within Section 2(22)(e), we need not to go further to Section 2(22)(e)(ii). The provision of Section 2(22)(e)(ii) gives an example only of one of the situations where the loan/advance will not be treated as a deemed dividend, but that .s all. The same cannot be expanded further to take away the basic meaning, intent and purport of the main part of Section 2(22)(e). We feel that this interpretation of ours is in accordance with the legislative intention of introducing Section 2(22)(e) and which has been extensively dealt with by this Court in the judgment in Raj Kumar .s case(supra). This Court in Raj Kumar .s case (supra) extensively referred to the report of the Taxation Enquiry Commission and the speech of the Finance Minister in the Budget while introducing the Finance Bill. Ultimately, this Court in the said judgment held as under:
“10.3 A bare reading of the recommendations of the Commission and the Speech of the then Finance Minister would show that the purpose of insertion of clause (e) to section 2(6A) in the 1922 Act was to bring within the tax net monies paid by closely held companies to their principal shareholders in the guise of loans and advances to avoid payment of tax.
10.4 Therefore, if the said background is kept in mind, it is clear that sub-clause (e) of section 2(22) of the Act, which is pari material with clause (e) of section 2(6A) of the 1922 Act, plainly seeks to bring within the tax net accumulated profits which are distributed by closely held companies to its shareholders in the form of loans.The purpose being that persons who manage such closely held companies should not arrange their affairs in a manner that they assist the shareholders in avoiding the payment of taxes by having these companies pay or distribute, what would legitimately bedividend in the hands of the shareholders, money in the form of an advance or loan.
10.5 If this purpose is kept in mind then, in our view, the word ‘advance’ has to be read in conjunction with the word ‘loan’.  Usually attributes of a loan are that it involves positive act of lending coupled with acceptance by the other side of the money as loan: it generally carries an interest and there is an obligation of repayment. On the other hand, in its widestmeaning the term ‘advance’ may or may not include lending. The word ‘advance’ if not found in the company of or in conjunction with a word ‘loan’ may or may not include the obligation of repayment. If it does then it would be a loan. Thus, arises the conundrum as to whatmeaning one would attribute to the term ‘advance’.  The rule of construction to our minds which answers this conundrum is noscitur a sociis. The said rule has been explained both by the Privy Council in the of Angus Robertson v. George Day (1879) 5 AC 63 by observing “it is a legitimate rule of construction to construe words in an Act of Parliament with reference to words found in immediate connection with them” and our Supreme Court in the case of Rohit Pulp & Paper Mills Ltd. v. Collector of Central Excise, AIR 1991 SC 754 and State of Bombay v. Hospital Mazdoor Sabha A IR 1960 SC 610.”


12. Therefore, we hold that the Tribunal was correct in holding that the amounts advanced for business transaction between the parties, namely, the assessee company and M/s. Pee Empro Exports Pvt. Ltd. was not such to fall within the definition of deemeddividend under Section 2(22)(e). The present appeal is therefore dismissed.


Section 14A read with Rule 8D - Expenditure on Exempt income not allowable




14A while computing MAT
Special Bench confirms non-applicability of expense disallowance methodology under Rule 8D to Minimum Alternate Tax

This Tax Alert summarizes the Delhi Tribunal Special Bench (SB) ruling dated 16 June 2017 in the case of Vireet Investment Pvt. Ltd. (Taxpayer) where the issues before the SB were (a) whether the disallowable expense computation mechanism of Section (S.) 14A of the Indian Tax Laws (ITL) for computing expenditure incurred in relation to exempt income would extend to Minimum Alternate Tax (MAT) while determining the “book profit” and (b) whether investments on which no exempt income is earned during the relevant tax year should be included in the disallowance computation.

On the first issue relating to MAT, noticing the conflict of views expressed by the jurisdictional Delhi High Court (Delhi HC) in the earlier case of Goetze India Ltd. (in favor of Tax Authority) and later in the case of Bhushan Steel (in favor of taxpayer, but without noticing the earlier Goetze ruling), the SB preferred to follow the later ruling favoring the taxpayer. For this, the SB relied on the Supreme Court (SC) ruling in the case of Vegetable Products Ltd. Accordingly, the SB held that while expenditure relatable to income that is exempt under both normal and MAT computation, needs to be added to “book profit”, the computation mechanism of S. 14A disallowance relevant to normal computation cannot be applied while computing book profit under MAT provisions. The MAT disallowance has to be based on expenditure debited to Profit & Loss Account (P&L).

On the second issue relating to normal tax computation, having regard to Delhi HC rulings in cases of Holcim India Pvt. Ltd. and Cheminvest Ltd. which held that disallowance under S.14A does not apply to investments on which no exempt income is earned during the tax year under reference, the SB held that such investments should also be excluded while computing disallowance as per the normative methodology prescribed in the Income Tax Rules.


Deferred Revenue Expenditure treatment under Accounting and Tax Laws

Generally any pre incorporation costs and pre operating costs will be deferred over 3 to 5 years. These preliminary expenses not written off will be carried to balance sheet and shown after current assets.

But after issue of AS-26 by ICAI, companies cannot carry forward it in their Balance sheet.

The reason being as per AS 26, an intangible asset can be recognised only when it meets the following criteria

(a) it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
(b) the cost of the asset can be measured reliably.


Preliminary expenses, therefore, incurred on or after, the date on which the Standard becomes mandatory for an enterprise or the preliminary expenses incurred on or after the date on which the enterprise opts to apply the Standard in the preparation and presentation of financial statements would be written off in the year in which they are incurred.

The expenditure on preliminary expenses shall not be carried forward in the balance sheet to be written off in subsequent accounting periods.

Applicability of AS 26:

Accounting Standard (AS) 26, 'Intangible Assets' comes into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1‑4‑2003 and is mandatory nature from that date for the following:
(i) Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange in India as evidenced by the board of directors' resolution in this regard.
(ii) All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crores.
In respect of all other enterprises, the Accounting Standard comes into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1‑4‑2004 and is mandatory from that date. The Accounting Standard, however, encourages earlier application.

Paragraph 56 ofAS 26 provides some examples where the expenditure is recognised as an expense when it is incurred. The examples given include,

Expenditure on start‑up of activities (start‑up costs), unless the expenditure is included in the cost of an item of fixed asseet under AS 10. Start-up costs may consist of preliminary expenses incurred in establishing a legal entity such as legal and secretarial costs, expenditure to open a new facility or business (pre‑opening costs) or expenditure for commencing new operations or launching new products or processes (pre‑operating costs).


As per IT Act, Preliminary expenses shall be allowed for 10 years under section 35D. That means only one tenth of total expenditure is allowed each year for 10 years. This is a timing difference as per AS 22 and company shall create DTL for this difference.


CASE LAWS

Whether for computing book profit u/s 115JB(2), expenditure incurred in relation to exempt income is to be disallowed by invoking Sec 14A read with Rule 8D - NO: ITAT




THE issue is - Whether for computing book profit u/s 115JB(2), expenditure incurred in relation to exempt income is to be disallowed by invoking Sec 14A read with Rule 8D. NO is the answer.
Facts of the case
Assessee company is engaged in the business of manufacturing of S.S. Billets, Angles, Flat Bars, Channels, S.S.Wire Rods etc. During the year under consideration, the assessee company derived income of Rs.28,19,03,964/- from Business & Profession after claiming deduction of Rs.1,20,36,43,184/- u/s 10B and Rs 67,03,000/- u/s 80G of the Act.
During the course of the assessment proceedings, the AO noticed that the assessee company has investments in equity shares of various companies totaling to Rs.51,03,59,701/- as on 31-03-2008. The assessee company was asked to explain as to why disallowance u/s 14A of the Act read with Rule 8D of Income Tax Rules, 1962 should not be invoked in respect of the exempt income. In response, the assessee company submitted that the assessee company has not earned any exempt income during the relevant assessment year and with prejudice to the above contentions, the assessee company submitted the working of disallowance u/s 14A of the Act. The AO rejected the contentions of the assessee company and held that since the assessee company has blocked its funds in investments not yielding any income or yielding exempt income, the invocation of Section 14A of the Act is proper. The AO relied upon the decision of Special Bench, ITAT, Mumbai in ITA NO 8057/Mum/03 dated 20.10.2008 in the case of M/s Daga Capital Management Private Limited = 2008-TIOL-509-ITAT-MUM-SB and held that both direct and indirect expenses are disallowable u/s 14A of the Act which have any relation with the income not chargeable to tax under Act. The AO also relied upon the decision of Bombay High Court in Godrej & Boyce Manufacturing Company Limited v. DCIT 2010-TIOL-564-HC-MUM-IT and made disallowance of Rs.73,07,018/- u/s 14A of the Act read with Rule 8D(2)(ii) (Rs.58,87,196/-) and 8D(2)(iii)(Rs.14,19,892/-) of Income Tax Rules, 1962.

Similarly for computing book profits u/s 115JB of the Act, the AO added Rs.73,07,018/-being disallowance u/s 14A of the Act read with Rule 8D of Income Tax Rules,1962 being expenditure in relation to the earning of exempt income to the book profit in accordance with clause (f) to explanation 1 to Section 115JB(2) of the Act.

With Respect to the re-computation of the book profit u/s 115JB of the Act by the AO by adding the sum of Rs.73,07,018/- disallowed u/s 14A of the Act, the assessee company submitted before the CIT(A) that disallowance u/s 14A of the Act cannot be added while computing the book profit u/s 115JB of the Act as the provisions of Section14A of the Act are limited for the purpose of computation of income under Chapter IV of the Act and the same cannot be extended to the MAT provisions u/s 115JB of the Act which is a self contained code. The assessee company submitted that no exempt income has been earned during the assessment year. The assessee company also submitted that no expenditure has been incurred by the assessee company in relation to the exempt income. The assessee company submitted that since no amount has been debited to the Profit and Loss Account as referred to in clause (f) to Explanation (1) to Section 115JB(2) of the Act the disallowance made by the AO by invoking the provision of Section 14A of the Act read with Rule 8D of Income Tax Rules, 1962 amounting to Rs.73,07,018/- cannot be increased for the purpose of arriving at the book profit. The assessee company relied upon the judgments in the case of Apollo Tyres Limited v. CIT 2002-TIOL-185-SC-IT-LB; CIT v. HCL Connect Systems and Services Limited 2008-TIOL-182-SC-IT; ACIT v. Spray Engineering devices Limited 2012-TIOL-438-ITAT-CHD.
The CIT(A) allowed the appeal of the assessee company by holding that as observed in Apollo Tyres Limited v. CIT by Apex court that where Profit and Loss Account has been prepared in accordance with Part II and III of Schedule VI to the Companies Act,1956 and which has been scrutinized and certified by the statutory auditors and relevant authorities, the AO has no power to scrutinize the net profit and loss account except to the extent provided in the explanation to Section 115JB of the Act. The CIT(A) also held that the same view has been reiterated by Bombay High Court in Kinetic Motor Co. Ltd. v. DCIT wherein it has been held that there is no scope for the AO to make adjustment to Book Profits beyond what was authorized by the definition in Explanation1 to Section 115J of the Act. The term book profit has been defined as the net profit as per Profit and Loss Account as adjusted in accordance with the statutory additions and statutory deductions as provided. The CIT(A) held that the AO cannot go beyond the net profit as shown in the Profit and Loss Account except to the extent provided in the explanation to Section 115JB of the Act and hence the CIT(A) held that the AO while computing Book Profit u/s 115JB of the Act cannot make disallowance u/s 14A of the Act as such disallowances are not covered by the exceptions as provided in the explanation to Section115JB of the Act.

Aggrieved by the orders of the CIT(A), the Revenue is in appeal before Tribunal with respect to the orders of the CIT(A) deleting the additions of Rs.73,07,018/- made u/s 14A read with Section 115JB of the Act disregarding the provisions of Section 115JB(2) read with explanation 1 read with clause f of which requires any expenditure in relation to the exempt income also to be taken into consideration while computing the book profit u/s 115JB(2) of the Act.

Having heard the matter, the Tribunal held that,

++ the explanation 1 clause (f) to Section 115JB(2) of the Act stipulates that amount of expenditure relatable to any exempt income, other than Section 10(38) of the Act, is liable to be added back to net profit shown in Profit and Loss Account if the amount referred to therein is debited to Profit and Loss Account;

++ Perusal of Section 14A of the Act provides that it mandates disallowance of expenditure ‘in relation' to the income which does not form part of the total income under the Act while clause (f) in explanation1 to Section 115JB (2) of the Act mandates disallowance of expenditure ‘relatable' to the income to which Section 10 (other than Section 10(38) of the Act) or Section 11 or Section 12 of the Act applies. The close perusal of the both the above provisions reveals that more or less similar language is used in both the afore-stated provisions. The dividend income is declared on the share investment which is exempt u/s 10(33) of the Act (not Section 10(38) of the Act). The clause (f) to explanation 1 to Section 115JB(2) of the Act requires expenditure relatable to the exempt income to be disallowed provided the same is debited to Profit and Loss Account while Section14A(2) of the Act mandates that if the AO is not satisfied with the correctness of the claim of the assessee with regard to the expenditure incurred by the assessee in relation to the income which does not form part of the total income, then disallowance shall be computed in accordance with the prescribed method. Rule 8D of Income Tax Rules, 1962 prescribes the method for computing disallowance of expenditure in relation to earning of exempt income. The said Rule 8D is a machinery provision to compute disallowance of expenditure u/s 14 A of the Act in relation to the income which does not form part of the total income and is held to be applicable w.e.f. assessment year 2008-09 as held by Bombay High Court in Godrej and Boyce Manufacturing Limited decision. The impugned assessment year under appeal in present case is also assessment year 2008-09 and hence Section 14A of the Act read with Rule 8D of Income Tax Rules,1962 is applicable;

++ It is axiomatic to assume that the amount computed under Section 14A of the Act read with Rule 8D of Income Tax Rules, 1962 shall have no reference to the amount debited to the Profit and Loss Account and there cannot be any disallowance u/s 14A of the Act unless the expenditure is debited to Profit and Loss Account and hence disallowance u/s 14A is always a part of expenditure debited to the Profit and Loss Account. In the instant case under appeal, the AO has disallowed the expenditure of Rs.73,07,018 computed u/s 14A of the Act read with Rule 8D of Income Tax Rules, 1962 for computing normal taxable income which is upheld by the CIT(A) in the first appeal and the same amount of expenditure of Rs.73,07,018/- is added to compute book profit u/s 115JB of the Act which is computed u/s 14A of the Act read with Rule 8D of Income Tax Rules,1962;

++ the AO cannot tinker with the profit and loss prepared by the assessee company in accordance with the Provisions of The Companies Act,1956 and which are certified by the statutory auditors and approved by the Company in Annual General Meeting and scrutinised by the Registrar of Companie to be so maintained in accordance with the Provisions of the Companies Act, 1956 . Perusal of Section 115JB of the Act will reveal that the tinkering with the Profit and Loss Account as prepared in accordance with the Provisions of The Companies Act, 1956 is permitted to the extent provided in explanation 1 to Section 115JB(2) of the Act. Clause (f) to explanation 1 to Section 115JB(2) of the Act permit the Book profit to be increased with the expenditure relatable to any income to which Section 10 (other than Section 10(38) of the Act), Section 11 or Section12 of the Act applies and hence the decision in Apollo Tyres Limited 2002-TIOL-185-SC-IT-LB is not applicable to the facts of the case;

++ In view of foregoing discussion, there is no infirmity with the orders of the AO and it was held that the AO has rightly disallowed the expenditure of Rs.73,07,018/- by invoking the provisions of Section 14A of the Act read with Rule 8D of Income Tax Rules, 1962 for computing book profit u/s 115JB(2) of the Act read with clause (f) to explanation 1 to clause 115JB(2) of the Act. Therefore, the orders of the CIT(A) was set aside and restored the orders of the AO.


Section 41 : Reversal of Liability is deemed as Income
Liability outstanding for long period of time in books is  also assessable as income ( even if not written back)

In a 2013 decision, Mumbai Income Tax Tribunal has held that where a liability was outstanding on books for a disproportionately long period of time and the assessee is unable to prove the identity & genuineness of creditors, such long outstanding liability will be assessed as income under section 41(1) of the Income Tax Act, 1961.

In the case before the Mumbai Tribunal, the assessee, engaged in the business of civil construction and labour contractor, had an amount of Rs. 86.25 lakhs shown as outstanding labour charges in his balance sheet that had remained unpaid for more than three years. The Assessing Officer (AO) held that the fact that the amount was outstanding for so many years was abnormal. As the assessee was unable to give the addresses and labour bills of the labourers, he held that the assessee had failed to prove the genuineness of the liability and that it had ceased to exist. He therefore assessed the said sum as income u/s 41(1). On appeal, the CIT(A) reversed the AO on the ground that the fact that the amount was outstanding for a long period and that the assessee was unable to furnish confirmations did not mean that there was a remission or cessation of liability during the assessment year so as to attract s. 41(1).

On appeal by the department to the Tribunal while allowing the appeal observed that it is very improbable that payments to labour can remain outstanding for more than three years. The assessee has not been able to produce the records relating to the name, addresses and bills of the labour etc to prove that the liability continues to exist. It is accordingly a case of cessation of liability. The assessee has just continued the entry of the same in his books of account without any intention to pay back the same.

The view was taken that it would be illogical to say that a debtor or an employer, holding on to unpaid dues, should be given the benefit of his showing the amount as a liability, even though he would be entitled in law to say that a claim for its recovery is time barred, and continue to enjoy the amount. It was observed that the assessee cannot be allowed to show an amount as a liability even though he has no intention to pay it back but to enjoy the same for an unlimited period without being added to his income only on the excuse that he has not written off the same in his books of accounts. However, if the facts of the case establish that the liability has been genuinely shown by the assessee and his subsequent conduct shows that he has paid back the said credits and his intention was not to enjoy the amount for unlimited period without any intention to pay back the same, then it cannot be said to be a case of cessation of liability.

On the above premise, the Tribunal opined that on facts, not only is the existence of outstanding liability of labour charges for so many years improbable in the normal course of business but the assessee has also failed to give any evidence regarding the identity & genuineness of the creditors. Accordingly it is a case of cessation of liability and s. 41(1) applies.

The above decision of the Mumbai Tribunal is contrary to the law laid down by the Mumbai High Court in J.K.Chemicals and by the Delhi High Court in Vardhaman Overseas Ltd where the law was laid down that section 41(1) does not apply if the amount of liability is not written back in the accounts.




Interest paid for delayed deposit of TDS is allowable expenditure
TDS IS PART OF SUM PAYABLE TO PAYEE and is trading liability- 
October, 13th 2017
References and links:
Lachmandas Mathura vs. CIT 254 ITR 799 (SC) 1997 (12) TMI 16 - SUPREME Court Interest paid on sales tax arrears is deductible u/s. 37(1) Ld. CIT(A) after considering the submission of assessee has deleted the addition made
Commissioner Of Income-Tax Versus Mysore Electrical Industries Limited 1991 (3) TMI 30 - KARNATAKA High Court
- Interest for failure to pay PF contribution was held deductible u/s. 37(1).
Bharat Commerce And Industries Ltd. Versus Commissioner of Income-Tax 1998 (3) TMI 2 - SUPREME Court
Recent judgment of Kolkata ITAT in case
DCIT, Circle-3(1), Kolkata Vs. M/s Narayani Ispat Pvt. Ltd dt. 30.08.2017 in ITA No.2127/Kol/2014 for Assessment Year: 2010-11 2017 (10) TMI 67 - ITAT KOLKATA
Summary:
TDS/TCS are part of sum payable for business expenses. Deposit of TDS/ TCS results into payment to payee who get credit for TDS/ TCS deposited. In case of delay in deposit of TDS/ TCS, interest is payable for such late deposit. This is in relation to business expenditure. Therefore, interest paid for delay in deposit of TDS/ TCS is also a business expenditure. In this article author had discussed several aspects of TDS/TCS . Recently honourable Kolkata ITAT has considered this issue and allowed such interest under section 37.
This judgment of ITAT, on issue of interest for late deposit of TDS seems to be first reported judgment. In the judgment ITAT has also not referred to any other judgment on the issue.This way we can consider that generally such interest is being allowed by tax authorities.
Tax Deducted at Source(TDS) and Tax collection at source (TCS)
Tax may be deducted from various sums payable by assessee to his employees, service providers and suppliers. The tax has to be deducted as per provisions and then deposited within time prescribed from time to time.
Similarly Tax may be collected from customers or suppliers of goods as per law. TCS is also required to be collected in respect of prescribed transactions and then deposited within prescribed period.
TDS and TCS are part of trading or business operations:
In case of assessee engaged in business or profession he employ people or receives services from others, purchase or sell goods in course of business. TDS and TCS are intimately connected to such business operations.
Just like GST, VAT, sales tax, profession tax, or any other tax collected from other parties or otherwise payable in account of other government or authorities the amount of TDS and TCS are also payable. Amount of TDS and TCS arises in course of business or profession and such obligation is imposed on assessee and therefore, he deduct or collect tax and then pay to or deposit in account of concerned government or its department, as per prescribed method of deposits in banks or treasury.
TDS is part payment of business expenditure or trading liability:
TDS is a part of payment to be made to payee (supplier or service provider).
For example:
A. Suppose gross salary payable is ? 1000 K, out of which following deductions are made
For PF ? 100 K
For profession tax Rs. 10 K
TDS Rs. 90 K
Net salary payable to employees ? 800 K
In accounting entry ? 1000K will be debited to salary account, deductions will be credited to respective accounts. Then when payments are made respective account will be debited.
Salary of ? 1000 K (Rs. ten lakh) is allowable expenditure. PF, PT, and TDS are sums withheld by employer and are deposited in respective account, for which employees will get credit as the sums were deducted from their salary. Gross salary of ? 1000K is income of employees. The will get deductions for sums deducted from their salary. TDS will also be credited in their account with Income-tax Department and it will be reflected in their TDs report in form 26AS. PF will be credited in their account. Profession tax is tax paid on behalf of employees and is allowable in their hands against salary income.

Therefore, the amount first deducted and then paid or deposited for PF, P.Tax and TDS are part and parcel of salary payable by employer.
B. payment to contractor:
Suppose gross sum payable to a contractor is Rs. ten lakh, out of which TDS is ? 20K. The assessee shall pay ? 980K to contractor and deposit ? 20K as TDS for which contractor shall get credit against income-tax payable by him.
C. payment to professionals:
Suppose gross sum payable to a professional is Rs. ten lakh, out of which TDS is Rs. one lakh. The assessee shall pay ? 9 lakh to professional and deposit Rs. one lakh as TDS for which professional shall get credit against income-tax payable by him.
TDS can also be at lower rate:
Suppose contractor or professional furnishes permission or order form his Assessing Officer (AO) for TDS at lower rate, then the assessee will deduct tax at such lower rate and deposit amount based on such rate. The amount so deducted will be deposited and balance amount shall be payable to the contractor or professional.
Similarly in case of payment of salary, the amount of TDS can be lower, if employees had made investments in tax saving scheme and furnished evidence to the employer.
TDS is against personal liability of tax payable by payee:
Above discussions and examples are given just to emphasise that the payment of salary to employees or to contractors and professionals are made in course of business or profession and TDS is a part of full amount payable by assessee to his employees, contractor or professionals.
The sum do TDS is tax paid on behalf of payee. This will be adjusted against tax liability of payee. This will be credited in account / PAN of payee and reflected in tax credit in form 26AS.
Tax deductor has separate and independent personal liability to pay his income-tax
Tax deductor also earn income and he has separate and independent personal liability to pay his income-tax, on the total income which he earns during any previous year. A tax deductor, may not have tax liability due to exemption or loss. Even if there is no personal liability of income-tax, still he is liable to deduct or collect tax if makes payment of prescribed sums from which tax is to be deducted or collected.
This also make clear that the amount of TDS is not part of tax payable by tax deductor on his income. The tax deductor has to pay his income-tax separately. This can be by way of TDs of various sums received by him if they are subject to provisions of TDS/ TCS , balance income-tax payable by him has to be paid by him by way of instalment of advance tax, self- assessment tax, and in case on assessment additional liability arises, then pay tax determined by AO. These are his personal liabilities and his income-tax is payable out of his income.
Interest payable to employee, supplier service provider is allowable:
Suppose there is delay in payment of salary, or payment to contractor or professional and assessee is to make payment of interest for such delay, then interest so payable / paid will be allowable expenditure.
Allowability of interest payable under two circumstances:
In case TDS / TCS is deposited late, interest is payable by tax deductor / tax collector.
As discussed earlier, TDS is in discharge of business expenditure. Therefore, in case there is delay in deposit of TDS, interest paid for such delay should be allowed as business expenditure being incidental to business or profession and in relation to business expenditure.
In case instalment of advance tax, and self- assessment tax or assessed tax is paid, then also interest is payable by assessee. However, this is for delayed payment of personal income-tax of assessee and not of any other person. This is for delayed discharge of personal tax obligation. The income-tax payable by assessee on his income is not allowable, so the interest payable for delayed deposit of such tax is also not allowable.
The position about allowability of interest for delayed deposit of statutory liabilities like Excise duty, GST, VAT, sales tax, Cess, is well settled. Generally interest payable is compensatory in nature and is allowable. In other words, when it is compensatory in nature and is not in nature of penalty it is allowable.
However, allowability of interest for late deposit of TDS is a bit new area of litigation. Based on discussion, made hereinbefore, author had always considered that interest for delayed deposit of TDS/ TCS is allowable expenditure. However, when sums involved are small, assesses may avoid litigation.
Recent judgment of Kolkata Tribunal:
Recently a judgment, as referred in opening of the article, was pronounced in which some of aspects as discussed by author were considered in relation to allowability of interest paid for late deposit of TDS. The Tribunal, while confirming order of CIT(A) and dismissing ground of revenue, held that interest for delayed deposit is also allowable under section 37 of the Income-tax Act, 1961.
The relevant ground (with highlights added by author about interest on delayed deposit of TDS) reads as follows:
" On the facts and circumstances of the case, the Learned CIT(A) is not justified in deleting disallowance of interest of ? 15,880/- on service tax and Rs.70,000/- on TDS because of the fact that the assessee failed to deposit the taxes of other parties to the other parties to the Central Government account within due time.
xxx

Relevant facts on the issue of interest on TDS are analysed below:
The assessee during the year has claimed the interest & finance expenses in its profit and loss account for ? 3,48,00,349.00 which inter alia includes Interest paid for late deposit of TDS amounting to ? 70,777/-
Assessing Officer was of the view that interest paid for the late payment of TDS is not allowable for the deduction from the income.
AO relied on the judgment of Hon'ble Supreme Court in the case of Bharat Commerce Industries Ltd. Vs. CIT (1998) reported in 1998 (3) TMI 2 - SUPREME Court and disallowed the claim of such interest
On appeal of assessee the Ld. CIT(A) allowed the claim . Considering submission of assessee the the ratio laid down by the Hon'ble Supreme Court in the case of Bharat Commerce Industries Ltd. (supra) has been misunderstood by the AO as, in that case, the disallowance was made on account of interest under section 215 of the Act due to the delay in the payment of income tax on the income disclosed under Voluntary Disclosure of income and Wealth Act, 1976.
In the case before CIT(A) the issue relates to the interest charged on account of late deposit of TDS and not personal income-tax on income of assessee.
Assessee relied on Lachmandas Mathura vs. CIT 1997 (12) TMI 16 - SUPREME Court in which case Interest paid on sales tax arrears is deductible u/s. 37(1) and CIT vs. Mysore Electrical Industries Ltd. 1991 (3) TMI 30 - KARNATAKA High Court = 196 ITR 884 (Kar)in which interest for failure to pay PF contribution was held deductible u/s. 37(1) .
Ld. CIT(A) after considering the submission of assessee has deleted the addition made
by the AO by observing as under:-
"4-. Ground No. (i) relates to disallowance of ? 86,657/- made by the Assessing Officer The total amount of ? 86,657/- includes ? 15,880/- towards interest paid on service tax and ? 70,777/- towards interest disallowed the same following the decision of Hon'ble Supreme Court in the case of Bharat Commerce And Industries Ltd. Versus Commissioner of Income-Tax 1998 (3) TMI 2 - SUPREME Court = 230 ITR 733(SC). However, in that case the dispute was related to allowability of interest u/s.139 & 215 of the IT Act, 1961 whereas in the present case the expenditure related to interest paid on service tax and interest paid on TDS. In view of the facts and submission of the appellant, I find that the expenses are allowable u/s. 37 of the IT Act, 1961 as the same were incurred wholly and exclusively for the purpose of business. Therefore, the AO was not justified to disallow the same. Hence, he is directed to delete the addition."
Analysis of order of ITAT on issue of interest for TDS:
Tribunal considered the rival contentions of both the parties and perused the material available on record.
The AO has disallowed the interest expenses incurred by the assessee on account of late deposit of TDS after having reliance on the judgment of Hon'ble Supreme Court in the case of Bharat Commerce Industries Ltd. Vs. CIT (1998) (Supra) in which the Supreme Court has settled law that when interest is paid for liability to pay income tax by assessee ( that is personal income-tax) and interest is levied for late payment under any provision ( in that case it was S.139 and 215 **of I.T. Act) then such interest will not be allowable because income-tax itself is not allowable. In conclusion it was held as follows:
Under the Act, the payment of such interest is inextricably connected with the assessee's tax liability. If income-tax itself is not permissible deduction under section 37, any interest payable for default committed by the assessee in discharging his statutory objection under the Act, which is calculated with reference to the tax on income, cannot be allowed as a deduction.
Therefore, it was to be held that deduction of interest levied under sections 139 and 215 would not be allowable under section 37.
Per author: (** At present such interest on own tax liability will be u/s 234A, 234B and 234C) and this will not be allowable.
The Tribunal noted that the facts of the instant case are distinguishable as in the case is for interest paid for delayed deposit of TDS. The interest for the delay in making the payment of service tax & TDS is compensatory in nature.
As such the interest on delayed payment is not in the nature of penalty.
The issue of delay in the payment of service tax is directly covered by the judgment of Hon'ble Apex Court in the case of Lachmandas Mathura vs. CIT 254 ITR 799 (SC) 1997 (12) TMI 16 - SUPREME Court in favour of assessee. The relevant extract of the judgment is reproduced below (highlights added):
"The High Court has proceeded on the basis that the interest on arrears of sales tax is penal in nature and has rejected the contention of the assessee that it is compensatory in nature. In taking the said view the High Court has placed reliance on its Full Bench's decision in Saraya Sugar Mills (P.) Ltd. v. CIT 1978 (5) TMI 22 - ALLAHABAD High Court = [1979] 116 ITR 387 (All.) The learned counsel appearing for the appellant-assessee states that the said judgment of the Full Bench has been reversed by the larger Bench of the High Court in Triveni Engg. Works Ltd. v. CIT 1983 (10) TMI 49 - ALLAHABAD High Court = [1983] 144 ITR 732 (All.) (FB), wherein it has been held that interest on arrears of tax is compensatory in nature and not penal. This question has also been considered by this Court in Civil Appeal No. 830 of 1979 titled Saraya Sugar Mills (P.) Ltd. v. CIT decided on 29-2-1996. In that view of the matter, the appeal is allowed and question Nos. 1 and 2 are answered in favour of the assessee and against the revenue."

Tribunal held that in view of the above judgment, there remains no doubt that the interest expense on the delayed payment of service tax is allowable deduction.
Then Tribunal held that The above principles can be applied to the interest expenses levied on account of delayed payment of TDS as it relates to the expenses claimed by the assessee which are subject to the TDS provisions. The assessee claims the specified expenses of certain amount in its profit & loss account and thereafter the assessee from the payment to the party deducts certain percentage as specified under the Act as TDS and pays to the Government Exchequer. The amount of TDS represents the amount of income tax of the party on whose behalf the payment was deducted & paid to the Government Exchequer. Thus the TDS amount does not represent the tax of the assessee but it is the tax of the party which has been paid by the assessee. Thus any delay in the payment of TDS by the assessee cannot be linked to the income tax of the assessee and consequently the principles laid down by the Hon'ble Apex Court in the case of Bharat Commerce Industries Ltd. Vs. CIT (1998) reported in 230 ITR 733 cannot be applied to the case on hand.
Accordingly Tribunal concluded that :
Law laid down by the Hon'ble Supreme Court in the case of Bharat Commerce Industries Ltd. (supra) is not applicable in the instant facts of the case. And that the Assessing Officer in the instant case has wrongly applied the principle laid down by the Hon'ble Supreme Court in the case of Bharat Commerce Industries Ltd.(supra).
Law laid down by the Hon'ble Supreme Court in the case of Lachmandas Mathura (Supra) in which Hon'ble Supreme Court has allowed the deduction on account of interest on late deposit of sales tax u/s 37(1) of the Act. In view of the above, we conclude that the interest expenses claimed by the assessee on account of delayed deposit of service tax as well as TDS liability are allowable expenses u/s 37(1) of the Act.
Therefore Tribunal confirmed order of CIT(A) and dismissed ground of Revenue.
Conclusion:
The order of the ITAT is based on settled legal position by way of precedence from the honourable Supreme Court. The law applied is correct. On facts also as discussed in article, TDS is nothing but a part payment to payee. If there is delay in such part payment and tax deductor is required to pay interest, such interest is also an allowable expenditure.
Author hopes that revenue will not challenge the judgment of ITAT.

UNDERSTANDING TAX JARGON


Distinction between Unabsorbed Depreciation carry forward and Loss Carry Forward

Business Loss can be carried forward and set off for period of 8 years (even if the business in respect of which it was incurred has been discontinued). However, such loss cannot be set off against income under any other head. In respect of unabsorbed depreciation from business,it can be set off against any other source of income in the absence of business income and can be carried forward indefinitely,( even if the business through which depreciation was incurred has ceased to exist.)

 Carry forward of losses  is permissible only if the return of income for the year, in which loss is incurred, is filed in time. Such late filing will not impact  loss from house property and unabsorbed depreciation


Prior period expenditure- Allowability under Income Tax


In case of CIT vs. Vishnu Industrial Gases (Delhi High Court)Where the department had not disputed that the expenditure was deductible in principle but was only disputing the year in which the deduction could be allowed HELD, castigating the department, that as the tax rates were the same in both years, the department should not fritter away its energies in raising questions as to the year of deductibility/taxability.



whether notional exchange gain/loss arising on account of exchange rate adjustment is taxable?

A: Gain on revenue account is taxable on accrual basis and in case of loss it is an allowable expenditure .(CIT Vs Woodward Governor (SC))

However increase /decrease in cost of depriciable asset due to exchange fluctuation is added/deducted in the block of assets in the year of actual payament under section 43A. Prior to 2003, 43A allowed adjustment of cost of asset as on date of balance sheet on accrual basis


How to account for foreign exchange fluctuation : AS 11 vs Companies Act Vs IT Act

AS - 11 :As per AS 11 any foreign exchange loss or gain (including on loans taken for acquisition of capital asset) shall be transferred to P&L Account.

Companies Act :
Companies (accounting standards) Amendment Rules, 2009 has given an option to capitalise the fluctuation difference. This option is available only up to 01-04-2011.That means both AS 11 and Companies Act are same in treating the revenue related fluctuation i.e it shall be transferred to P&L Account.But in case of fluctuation difference relating to acquisition of depreciable capital asset, company has an option to capitalise the difference.

Income Tax Act:
As per IT Act, the cost of asset shall be effected only on actual payment. (Sec. 43A)  Reinstatement of loan liability incurred for acquisition of capital asset will not effect cost of the asset under IT Act unlike Companies Act.



Distinction between shares held as stock-in-trade and shares held as investment

1.The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset.

2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).
3. Trading asset is dealt with under Section 28 of the Act.

4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that: Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed : The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.


8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :- (i) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction; (ii) the substantial nature of transactions, the manner of maintaining books of accounts, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions; (iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt.

9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:- We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stockin-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits.

10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.



Issues in deductions allowable under computation of Business Income - By K.C. Devdas, Chartered Accountant

1.         Some of the issues concerning Deductions allowable under computation of Business Income are presented hereunder

2.         Section 28 of the IT act, 1961 mostly deals with deduction of losses and Section 37 deals with expenditure expended by the company.

2.1.      Section 29     - INCOME FROM PROFITS AND GAINS OF BUSINESS OR PROFESSION, HOW COMPUTED

The income referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43D.

2.2.      TRADING LOSSES:-

Losses incidental to business are allowable as deduction despite there being no specific provision for the same.   Some of the important tests laid down by leading judgements as to allowability of trading losses are as follows:-


i)          Business loss is allowable if it is of a non-capital in nature and if the same is not only connected with trade but is incidental to trade itself.

ii)          The degree of the risk or its frequency is not of much relevance but its nexus to the nature of business is material.

iii)         The loss for which a deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it, and not any loss sustained by the Assessee even if it has some connection with his business.

iv)        If there is a direct and proximate nexus between the business operation and the loss or it is incidental to its, then the loss is deductible, as without the business operation and all that is incidental to is, no profit can be earned.

v)         The two requisites are (a) the loss is incidental to trade itself, that is to say, there must be a nexus between the loss and the trade which should have been incurred in the course of the trade and (b) the loss should have been incurred by one in the character of a trader and the same should fall on him the said character.

In Sellora International Ltd vs. Joint CIT (2003) 74 TR (Dir-Tax) (Del-Trib) 244; (2003) 44 SCL 686 (Del-Trib) it was held that if an Assessee could not receive the goods in exchange of advance, the amount has to be treated as a business loss.

            Likewise the  Mumbai Tribunal in BDC vs. Dy. C.I.T. reported in 175 Taxation 60 held that an advance given during the course of business against supply of gift articles, therefore, non-recovery of such advance clearly represented the loss suffered by the Assessee during the course of business and was held deductible.

2.3.      LOSS DUE TO ILLEGALITY OF TRANSACTIONS

As a general rule, loss due to infraction of law is not allowable as deduction.  Loss arising out of confiscation of valuable goods and levy of fine in respect of legal business are not allowable as deduction from profits computed of such business.

But losses due to infraction of law in respect of illegal business are allowable while computing profits of such business (CIT v. S.C. Kothari (1971) 82 ITR 794 (SC).  The Hon’ble Supreme Court in CIT v. Piara Singh (1980) 124 ITR 40 has laid down as follows:

“if the activity of smuggling can be regarded as business, those are carrying on that business must be deemed to be aware that a necessary incident involved in the business, its detection by the customs authorities and the consequent confiscation of the currency notes.  It is an incident as predictable in the course of carrying on the activity as any other feature of it.  Having regard to the nature of the activity possible detection by the customs authorities constitutes a normal feature integrated into all that is implied and involved in it.   The confiscation of the currency notes is a loss occasioned in pursuing the business, it is a loss in much the same way as if the currency notes had been stolen or dropped on the way while carrying on the business.   It is a loss which springs directly from the carrying on of the business and is incidental to it”.


The Hon’ble Supreme court in Piara Singh’s case, distinguished the earlier quoted decisions on the ground that the infraction of law in those cases was not the business of the Assessee and therefore the loss was not allowed.

In CIT v. Badam Subha Rao (1996) 85 Taxman 631 (AP) the assessee claimed to be carrying on business of money lending.  Central Excise authorities had seized and confiscated some gold and silver articles from Assessee’s premises.  The Assessing Officer added the value of the same as income under section 69.  On appeal, the Assessee claimed that the business was illegal and therefore loss due to confiscation was allowable as deduction.  On reference, the Hon’ble High Court held that the Assessee never claimed that he was carrying on business of smuggling and therefore loss due to confiscation was not allowable as deduction.


In Ishwar Das alias Ishwar Lal Sindhi V. CIT, 155 CTR (All) 373, another case of its kind, it has been held that the loss due to confiscation of gold by customs department in case of a licensed goldsmith would not be allowed as deduction.


            With regard to expenses allowable under section 37, explanation has been inserted with retrospective effect from 1.4.1962 to provide that any expense, the purpose of which is an offence or is prohibited by law shall not be allowed as deduction.

2.4.      Section 37 – THE OMINIBUS PROVISION

(1)        Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession".

            Explanation [1], - For the removal of doubts, it is hereby declared that 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 2, - For the removal of doubts it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an Assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the Assessee for the purposes of the business or profession.

            (2B)  Notwithstanding anything contained in sub-section (1), no allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or the like published by a political party.


EXPLANATION TO SECTION 37(1)

Explanation has been inserted to sub section (1) of section 37 by Finance (No.2) Act, 1988, with retrospective effect from 1-4-1962 to restrict the scope of deduction allowable under section 37(1).  It provides that any expenditure incurred by an Assessee for any purpose (a) which is an offence or (b) which is prohibited by law shall not be allowed as deductio0n.   As such, even if an expenditure is otherwise allowable as deduction under section 37(1), if the same is for any purpose which is an offence or which is prohibited by law shall not be allowable as deduction.

As observed by the Apex Court in Maddi Venkataraman & Co. (P) Ltd. V. CIT [1998] 229 ITR 534, it would be against the public policy to allow the benefit of deduction under one statute of expenditure incurred in violation of the provisions of another statute.   The mere fact that payment has been made by itself does not constitute a justification for allowing that payment as an item of deduction under section 37 of the Act.  The fact that payment has been reflected in the books of account does not also lead to the conclusion that such payment has been made bonafide.


The Participants may consider allowability of following expenditure in light of explanation to section 37(1).


è   Mr. XYX had, in financial year 1998-99, written off in its books of accounts a debt due in respect of export sales without obtaining prior permission from the RBI.  Further, a payment of commission to a foreign agent was made without obtaining prior permission.  Both the transactions have been subsequently permitted by the RBI in August, 1999, and penalty was levided which has been paid.  Whether the following are allowable as deduction:

a)           Penalty Paid.
b)          Bad debts written off in AY 1999-00.
c)           Commission paid.

è   M/s. PQR has constructed a high storied building and sold all the units therein by the Financial Year 1997-98 and accordingly profit was determined and offered to tax for the assessment year 1998-99.  Recently, the local administration has initiated proceedings on the ground that top three stories of the building are in violations of the rules and the permission for work granted and has initiated proceedings.  The firm is now attempting to regularize the construction by purchasing TDR’s and compounding the matter with the local authorities.  The assessment proceedings are in progress and the Assessing Officer is proposing to disallow cost of construction of top three stories without reducing sale consideration received for sale of such units.  Please advice.


è   Mr. A is chairman and Managing Director of a listed company, B Ltd. carrying on business of manufacturing household utilities.  The management of the company were receiving threats for extortion from gang which were not entertained.  Mr. A’s son was kidnapped by the said gang and the board of directors decided to pay the ransom out of companies funds as the kidnapping of the son of Chairman was as a fall out of unheeded threats received by the company.  Please advise whether the same is allowable as deduction.  Whether the same can be disallowed as personal expense.  Also consider the applicability of explanation to section 37(1).


            Also consider whether the answer would be different if the money was paid in pursuance of threats before kidnapping.  Also consider whether the answer would be different in chairman was kidnapped instead of his son and all other facts remain the same.

2.5.      Sub-section 1 of section 37 is an omnibus provision for deductions in computing business income.  Following conditions have been specified which need to be satisfied for claiming deduction under the said section:

i)          It is not an expenditure of the nature described under sections 30 to 36.  Sections 30 to 36 prescribe different set of conditions for allowability of expense and therefore it is those conditions that need to be satisfied to claim deduction.  The Courts have been liberal in construing this condition.  If an expense, though similar in nature to those described in sections 30 to 36, does not fall within the exact description in those sections, that such expense has been held to be allowable under section 37.

ii)          The expenditure is not capital in nature.
            The expenditure is not personal expense of the assessee.  In the new millennium, when seamless office and paperless communication is the order of the day, and   when the thin line between personal life and professional life is fast eroding, it will become more and more difficult to determine whether an expense was incurred in personal capacity or professional capacity.  In CIT v. Jeevandas Laljee & Sons [1999] 106 Taxman 139 (Mad), the Hon’ble Court has dealt with the thin line following words: “Though the expenditure incurred for the purpose of business can be varied forms and cannot be exhaustively enumerated, a line has to be drawn between the expenditure for business purpose and expenditure on gifts made on occasions of marriages in the families of directors of the companies with which the Assessee has business dealings, friends and relatives, which cannot quality as business expenditure.  If the Assessee chooses to make such gifts out of the income received by the Assessee in the course of his business, he can do so but cannot claim it as a legitimate expenditure while computing his income for the purpose of taxation.  The gift made by an Assessee carrying on business, on such occasions would be similar to that of any other person, who makes a gift on such occasions to his friends or relatives or official superiors or colleagues, such gift being made out of taxed income.  Though it is difficult to draw a line with precision demarcating business from personal relationships, nevertheless, it has to be drawn somewhere and the marriages within the family of business associates, friends and relatives cannot be regarded as occasions requiring an Assessee carrying on business to make gifts as a matter of commercial expediency and claim the same as business expenditure.  Therefore, expenses incurred by Assessee on occasion of marriage of daughter of Chairman of the company with which he had business relations and personal gifts on festive occasions to others, would not be allowable as business expenditure.”

2.6.      LEASE EQUALISATION CHARGES (LEC):

            The (T & AP) High Court in CIT vs. PACT Securities & Financial Services reported in 374 ITR 681 held that according to standards issued by ICAI are not to be disregarded and held that LEC are deductible from Lease Rental Income.

2.7.      SECTION 43-B DISALLOWANCE

            The Hon’ble Supreme Court in CIT vs. Travancore Sugars & Chemicals Ltd reported in 374 ITR 585 held that levy of vend fee is arrack business is a “fee” and attract disallowance.

2.8.      PREMIUM ON KEYMEN INSURANCE

            The Bombay HC in CIT vs. Agarwal Enterprises reported in 374 ITR 240 (Bom) held that premium on Keyman Insurance of persons was held deductable u/s 37 of the IT Act, 1961.

2.9.      INTEREST FREE ADVANCES TO SUBSIDIARIES

The Hyderabad Bench of I.T.A.T in Addl. CIT vs. Hill Country Properties reported in 154 ITD 177 held that no disallowance could be made of Interest on Borrowed Capital where Assessee was having share capital, reserves & surplus, interest free advances from customers and deposits to give interest free advances to subsidiaries and thus no disallowance could be made of interest.  See also Bombay HC decision in the case of Reliance Utilities & power Ltd reported in 313 ITR 340.  Please also see 24 iTR (Tribunal) Hyd 290 – SSPDL LTd vs. DCIT.

2.10.    BUSINESS EXPENDITURE – YEAR IN WHICH ALLOWABLE

            The Supreme Court in Taparia Tools Ltd vs. JCIT reported in 372 ITR 605 held that the option give to non-convertible debenture holders to receive periodically or as a one time payment of lower sum payable immediately accrued in the year of excercise of the option by subscriber notwithstanding the fact that onetime payment of interest was shown in the books as a deferred expenditure.  Please also see Allahabad HC decision in CIT vs. Shivram Motors Pvt Ltd – 272 CTR (All) 277.

2.11.    COMMISSION


The Supreme Court in the case of Premier Breweries Ltd vs. CIT repoted in 372 ITR 180 held that where the Govt Corporation exclusively marketed alchoholic bewerages in state and the Assessee pays commission to agents to obtain supply orders from government, government corporation were not deductible.


2.12.    BOGUS PURCHASES

The Bombay HC in CIT vs. Nikmy Exim Enterprises Pvt. Ltd reported in 372 ITR 619 held that where suppliers filed confirmation letters, copies of invoices, bank statements and none appeared before authorities could not be a ground to hold that purchases were bogus and therefore no addition could be made.


2.13.    DEDUCTION OF DEPRECIATION AND INTEREST WHERE PROFITS ARE ESTIMATED

The (T&AP) High Court in the case of CIT vs. Y. Ramchandra Reddy reported in 372 ITR 77 held that depreciation and interest are deductible even where profits are estimated.


2.14.    EXPENDITURE INCURRED ON CORPORATE SOCIAL RESPONSIBILITY

            The Finance (No.2) Act, 2014 amended section 37 of the IT Act, 1961 with effect from 1-4-2015 to clarify that for the purposes of sub section (1) of section 37 any expenditure incurred by an Assessee on Corporate Social Responsibility shall not be deemed to have been incurred for the purpose of business and hence, shall not be allowed as a deduction u/s 37.   Please see section 37 – explanation 2 of IT Act, 1961.



2.15.    EXPENDITURE INCURRED IN PROMOTING COMPANIES

EXP:   Incurred in promoting other companies can be claimed as a deduction and ser off against the profits of the existing company.  On the facts and circumstances of the case in CIT vs. Senapathy Whitley Ltd., reported in 198 ITR 753 the Karnataka High Court held that the expenditure was deductible as:-


i.          The existing company was in the Business of manufacturing and sale of elec: insulating press boards & multiple press paper.

ii.          The M/s & A/A authorised the company to carry on the Business of promoting other companies.

iii.         The Exp; was incurred as part of it’s existing Business operations for promoting a new company for the manufacture of Mica Paper.

iv.        If for any reason the new company could not obtain the import licenses or issue shares to the Assessee in lieu of transfer of assets, these assets would have been with the company.

2.16.    PENSION TO WIDOW EMPLOYEE

Pension to a widow of a Director of the basis of the policy decision of the Board to pay pension to the Director during his lifetime and after his death to his widow was held deductible by the Madras H.C. in CIT vs. Lucas Indian Service Ltd., reported in 239 ITR 429.   Please also see 118 ITR 261 (SC).

2.17.    CONTRIBUTION TO DEATH RELIEF FUND


Such exp; was held deductible as it was for the benefit of employees as a labour welfare measure in CIT vs. E.I.D. Parry India Ltd., 240 ITR 253 (Mad).

2.18.    DEDUCTION ON AMOUNT SPENT FOR OBTAINING SURVEY AND FEASIBILITY REPORT

Expenditure incurred for obtaining survey & Feasibility reports deductible when the setting up of the plant was necessary for the products manufactured by the Assessee as held by the Rajasthan High Court in Maharaj Shri Umaid Mills Ltd., vs. CIT reported in 175 ITR 72.

When an existing business incurs an expenditure on Feasibility in connection with a new venture and the new unit has not been established and the decision was to utilize the surplus funds more profitability and efficiently such expenditure was held deductible by the A.P. High Court in C.I.T. vs. Coramandal Fertilizers 105 Taxman – 490 (AP).

The Gauhati High Court in Deputy CIT vs. Assam Asbestos Ltd. reported in 263 ITR 7 held that where a company manufacturing asbestos sheets incurs expenditure on a feasibility report for setting up a Mini Cement Plant, but the project did not materialize; such expenditure being abortive expenditure was deductible.

2.19.    EXPENDITURE ON DEVELOPMENT OF SOFTWARE:

Expenditure on Development of Software is deductible as held by the Jaipur Bench of the I.T.A.T in Business Information Processing Services vs. ACIT – 239 ITR (AT) 19.

It seems to me that the cost of software itself acquired for use in business involving rapid obsolescence is deductible following the ratio laid down by the SC in Alembic Chemical Works vs. CIT 177 ITR 377 (SC) & 187 ITR 688 (SC). .  However presently software is clubbed with computers and qualifies for Depreciation @ 60%.

2.20.    TRAVELLING EXPENSES OF WIFE OF DIRECTOR

The Accompaniment of the spouse is for purposes of promoting the Business rather than the pleasure of those who manage the company and whether it would help the Business of the Assessee cannot be judged by the Assessing Officer as held by the Madras High Court in CIT vs. Sundaram Clayton reported in 240 ITR 271 (Mad).  Please also see:-


Decisions in Favour
Decisions Against
207 / 647 (Cal)
153 / 422 (Mad)
234 / 130 (Gan)
153 / 437 (Bmy)
235 / 106 (Ker)
110 / 855 (All)
237 / 76\06 (Ker)
220 / 552 (MP)

257 / 289 (Ker)
It appears that the issue is essentially one of the fact so that the amount would be admissible in the case that is able to show that the wife would help to promote Assessee’s Business.


2.21.    COST OF EDUCATION AND RELATED PERSON

It is not unusual in the business for an employer to meet the cost of higher education of its employees so that they can attain proficiency, which would help the business in return.  Where the person deputed for education happens to be a related person, the reason for incurring the expenditure becomes a matter of doubt as to whether it is bona fide incurred for purposes of business.  In such matters, it could only be a matter of inference from the relevant facts as to the nature and course of study, its usefulness for the business and other relevant factors.  Court have taken different views on the subject non on account of any difference in principle, but with reference to the facts of the case.  Even the cost of education of a partner was allowed in CIT v Kohinoor Paper Products [1997] 226 ITR 220 (MP), while a similar payment was found to be of personal nature in CIT v. Hindustan Hosiery Industries [1994] 209 ITR 383 (Bom).


The Delhi High Court in N.K. (India) Rubber Company Pvt. Ltd. vs. CIT reported in 263 ITR 521 held that the amount claimed towards educational expenses of relatives of Directors was not proved to be deductible because the private employment of the Son of the Managing Director was not of any duration, but only shortly before departure and it did not appear to be solely intended for the benefit of the company.


Again the Delhi High Court in the case of Siddho Mal & Sons vs. ITO, 122 ITR 839, while examining the issue observed that the courts and Authorities are not to bear blinkers to overlook or condone the passing of public revenue to one’s own kith and kin by subterfuge or clandestine or clever devices clothed in legalistic jargon.  Instead it is the duty to lift the veil of apparent legality and to get to the truth or substance of a transaction to deal with it in accordance with law.  It is only appropriate, indeed normal, that dealings involving transfer of funds to dear ones need to be looked into with care and caution and necessary inferences are drawn if there are abnormalities attaching to such transactions.


The Bombay High Court in the case of CIT vs. Hindustan Hosiery Industries reported in 209 ITR 383 was concerned with the case of a partner being sent abroad for pursuing his higher studies.  The claim was negative for the following reasons:

i.    The firm is more of a family concern of the mother and her four sons; and
ii.    The business of the firm and the higher education pursued abroad had no nexus.

The Madras High Court in the case of M. Subramanian & Bros vs. CIT, 250 ITR 769, negative the claim primarily for the following reasons:


The agreement does not provide for any penalty in the event of breach of the condition to work for the firm for 5 years;

It cannot i.e., considered as deputation form the firm; and

The agreement merely gives a colour of commercial expediency.


In CIT vs. RKKR Steels (P) Ltd., 258 ITR 306, the Madras High Court negative the case for the following reasons:

i.       There is no scheme for sending employees abroad for training;
ii.       No agreement between the beneficiary and the company; and
iii.      No requirement has been stipulated that he should join the company after coming back to India.


In Delhi High Court, in the case of Enkay (India) Rubber Co. (P) Ltd vs. CIT, 132 Taxman 35, rejected the claim in view of the fact that there was no scheme prepared by the Company.  Besides, the person was not working in the company when the expenditure was incurred.


In the case of T.V. Sundaram Ieyngar & Sons vs. CIT, 244 ITR 133 (Mad), the employee was sent abroad within a few days of appoint for post-graduation.  Even after coming back to India, he did not render any service to the company.  There was no agreement for indemnity to the company.  On these grounds, the disallowance of expenditure incurred was upheld.


However, the claim was favourably considered in the case of Jahlani Holdings Pvt. Ltd. Vs. ITO, 105 Taxation 6 (Delhi).  The Tribunal held that the expenditure is allowable for the reason that the education of the employee has improved the business of the company and the company was largely benefited by his commercial knowledge in business.   The employee joined the company as undertaken by him before going abroad.  After he came back he joined the company on a merger salary of Rs.1000 per month.  On these facts the Tribunal came to the conclusion that just because the employee happens to be the Director’s son the expenditure cannot be disallowed.


The Bombay High Court in Sakpal Papers (P) Ltd vs. CIT, 114 ITR 256, reversing the order of the Tribunal, held that the expenditure is allowable on the following facts;

i.       The person sponsored worked for nearly five years as an apprentice before sent to abroad;
ii.       The course pursued and training undergone were relevant to the business and benefited the company; and
iii.      On return from abroad the employee once again joined the company and was still working with the company.

Similarly, the Madhya Pradesh High Court in CIT vs. Kohinoor Paper Products, 226 ITR 220, held allowable the education expenses of a partner, on the ground that on return to India he continued to serve the firm and his experience proved beneficial to the firm.

The Karnataka HC in Mallinage Medical Centre (P) Ltd vs. JCIT reported in 375 ITR 522 held that the higher studies expenditure of MD’s daughter who was working in hospital was deductible as she joined the hospital on return and the expenditure had a direct nexus with business of assessee.

From the above analysis, it emerges that in order to avail the deduction of expenditur4e incurred by an Assessee enterprise by deputing a person for higher education and training abroad the following aspects must be taken care:

i.            The person concerned must be an employee for a reasonable period before sent abroad;
ii.           There must be a scheme evolved entailing the employees to go abroad with stringent conditions regarding the resumption of service on return; salary payable and indemnity on breach thereof.
iii.          There must be an agreement evidencing the above terms and more particularly stipulating the specific period for which employee shall serve the company on his return.
iv.          There must be nexus between the business of the Assessee and the course/ training offered abroad and the expenditure should be incurred in furtherance of the interest of the assessee.
v.           On return the employee should serve the Assessee enterprise as undertaken before learning India.
vi.          The son/daughter of the director should be major & not be minor.
vii.         He/She should preferably be an employee of the assessee before he / she is sent abroad for higher education.
viii.        The higher educational course to be undertaken should have intimate connection with the business of the assessee.
ix.          There should be an enforceable undertaking by the son/daughter of the director given to the assessee to rejoin the business of the assessee for specified number of years after the completion of the course.
x.           Salary offered after the completion of the course should be competitive having regard to market conditions and the qualifications obtained.
xi.          The likely benefit to be reaped by the assessee for which, the son/daughter was being sent abroad for higher education, should find exhaustive mention in the sponsorship letter.
xii.         After completion of the course, the son/daughter should join the employment for the undertaken period.
xiii.        Detailed record should be kept to substantiate the contribution of the son/daughter in the overall performance of the business of the assessee and role of such higher education in that business.
xiv.        Sponsorship agreement should be comprehensively drafted so as to bring the business interest of the assessee at the forefront.
xv.         Expenses on education including boarding and lodging alone may be deductible. Any personal expenditure of the son/daughter would be liable to be disallowed.
xvi.        Copy of degree / diploma as evidence of completion of higher education may be retained to be furnished at appropriate time.
xvii.       Board resolution authorizing the company-assessee to send the son/daughter for higher education in the interest of the business should preferably be passed.

2.22.    REVENUE EXPENDITURE

The Madras High Court in CIT vs. Sakthi Textiles Ltd. [2001] 250 ITR 449 / [2000] 120 Taxman 268 held that installation of dust extraction plant to protect health of workmen in revenue in nature.

Similarly in CIT vs. Steel Complex Ltd. [1999] 238 ITR 1054 (Ker), the Assessee in the course of business of manufacture of steel, claimed expenditure in the course of business of manufacture of steel, claimed expenditure incurred on installation or water treatment plant and fume extraction plant as revenue expenditure.  In this case the Tribunal gave the following finding:-


(a)     That the two plants were for the purposes of improvement in operation of the existing systems with greater efficiency and profitability;
(b)     That originally the municipality was supplying water to the Assessee for running the factory, that since it was found that the municipality was not supplying sufficient quantity of water, the Assessee dug wells, but the well water was found to be salty, that therefore, they installed the water treatment plant for getting pure water with an intention to improve the functioning of the factory;
(c)     That the installation of water treatment plant did not in any way enhance the production of steel.

In further support of the claim of the Assessee the Tribunal noted that the fume extraction plant also did not lead to any increase in the volume of production and it was installed to ward off the health hazards and in compliance with statutory requirements.  The Kerala High Court affirmed the finding of the Tribunal and held that the expenditure incurred on each of the two items was revenue in nature and hence, an allowable deduction.


2.23.    ALLOWABILITY OF DEPRECIATION ON TOLL ROAD:

The Delhi HC in the case of Moradabad Toll Road Co. Ltd vs. Asst. CIT ( 2014 Taxpub (DT) 4494 (Del-HC) on a claim for depreciation on Toll Road treating it as plant held that Toll road could not be treated as plant but only as Building and allowed depreciation as such.   The Allahabad HC in CIT vs. NOIDA Toll Bridge Co. Ltd (2013) 213 Taxman 333 held that Toll Road was eligible for Depreciation.


However the Bombay HC struck a dissenting note in North Karnataka Expressway Ltd. Vs. CIT (2014) Taxpub (DT) 4206 held that under THE NATIONAL HIGHWAY Act 1956 the ownership of the Toll Road vests with the Government and the Assessee is not entitled to depreciation on Toll Road.


2.24.    ALLOWABILITY OF EMPLOYEE’S CONTRIBUTION TO PROVIDENT FUND DEPOSITED BEFORE DUE DATE OF FURNISHING OF RETURN OF INCOME

Whether the employees contribution towards PF deposited in allowable where it is deposited after due date specified under section 36(1)(v)(a) that before due for furnishing of return has been the subject matter of controversy.   Most of the High Courts except Gujarat has taken the view that it is deductible if paid before the due date of filing the return of income.   The decisions in favour are:-

SNo
Name of the Case
Court
Citation
1
CIT vs. SABARI Entreprises
Karnataka
298 ITR 141
215 Taxmann 597
2
CIT vs. Kicha Sugar Company
Uttarakhand
356 ITR 351
216 Taxman 90
3
CIT vs. AIML Ltd
Delhi
321 ITR 508
4
CIT Vs. Nipso Poly Fabricks
HP
350 ITR 327
5
Essae Teraoka (P) Ltd vs. DCIT
Kar
57 (I) ITCL 28


The Gujarat HC in CIT vs. Gujarat State Road Transport Corporation reported in 57 (I) ITCL 72 held to the contrary.


3.         PROVISO TO SECTION 69C

Along with insertion of the explanation to section 37, the Finance [No.2] Act, 1998 also inserted proviso to section 69C though prospectively with effect from 1-4-1999.   Section 69C provides that where an Assessee has incurred any expenditure and he is not able to explain the source thereof, than the amount of such expenditure which cannot be explained shall be treated as income.  The new proviso thereto provides that where any sum is so treated as income than expense shall not allowed as deduction even if it is otherwise allowable as deduction.  As such, where the source from which the expenditure is incurred cannot be explained and the amount represented by such expenditure is treated as income, than such expenditure cannot be allowed as deduction in computation of income.

The participants may consider applicability of proviso to section 69C in following circumstance:


i.       The Assessee if found to be in possession of excess stock and the amount of purchase price thereof is treated as income.  The said stock was in hand even at the end of the year and accordingly has been included in closing stock.  Whether the Assessee will be allowed deduction of purchase price so determined and assessed as income.
ii.      The Assessing Officer doubted the amount of cost of construction of factory debited in the books of accounts.  To avoid disputes, the Assessee accepted an additional sum of Rs.40 lakhs as being spent on construction of factory building and offered the same as income.  Whether the Assessee would be entitled to depreciation on enhanced cost as offered in view of non-obstante clause in the proviso of section 69C.
iii.    The department has detected that the part of the business transaction of the Assessee are unrecorded.   The unrecorded transaction includes transaction of sales, purchase and expenses.   The Assessee has offered estimated gross profit on estimated unrecorded sales.  The department has accepted the estimate of profit bus intends to apply provisions of sections 40A(3) and proviso to section 69C and disallow most of the expense and purchase which are unrecorded.  Whether the stand of the department is correct.

4.         ENTRIES IN BOOKS OF ACCOUNTS – HOW FAR RELEVANT FOR ALLOWABILITY OF DEDUCTION

Section 145 provides that profit shall be determined as cash or mercantile system of accounting regularly followed by the Assessee in maintaining its books of accounts.  Books of accounts maintained by the Assessee in regular course and in accordance with accepted system of accounting is the starting point for determination of income and thereby allowability of deductions.   However, the entries in books of account are not sacrosanct and only by presence of or absence of certain entries would not determine allowability of any expense.  In Kedarnath Jute Mfg. Co. Ltd. V. CIT (1971) 82 ITR 363 (SC), the Hon’ble Supreme Court had held that the Assessee cannot be denied deduction of liability incurred merely because of absence of entries in his books of accounts.

In United Commercial Bank vs. CIT 240 ITR 355 [SC], the said principle of Kedarnath’s case was reiterated.


Depreciation In Company Books On Vehicle Registered In The Director's Or Other Officer

It is observed that in many instances Vehicles purchased by Companies were registered in the name of Director's or other officers of company under the Motor Vehicles Act, 1988 (generally for ease of insurance claim settlement)

 So the question arises as to whether Companies are entitled to claim depreciation under Income tax act, on vehicles registered in the name of its directors or other officers of company.

 In the case of SWAGAT INFRASTRUCTURES v. JCIT-2013 (Ahd.) tribunal held that claim of depreciation cannot be denied to the taxpayer as long as it is proved that the asset is under its dominion control and is being utilised for the business purpose of assesse, even though the tax payer is not registered owner of the asset.

 Companies should ensure the following to use the above mentioned judgement.

 1. A resolution should be passed by the Company to purchase and register these vehicle in the name of the Director or other officer of the company.


2. Proper documentation should be prepared to substantiate that the vehicles were utilized for business purposes



Income Tax Case Laws : Reimbursement of expenses can not be included in income

SUMMARY OF THE CASE LAWS
The question as to whether a reimbursement for expenses would form part of the taxable income is not res integra insofar as this Court is concerned. In CIT v. Siemens Aktiongesellschaft [2009] 177 Taxman 81 (Bom.), a Division Bench of this Court held that sharing of expenses of the research utilised by the subsidiaries as well as the head office organization would not be income which would be assessable to tax.

CASE LAWS DETAILSI
DECIDED BY: HIGH COURT OF BOMBAY, IN THE CASE OF: DIT (Int’l Taxation) v. Krupp Udhe GmbH, APPEAL NO: ITA No. 2626 of 2009, DECIDED ON March 9, 2010

RELEVANT PARAGRAPH
2. The appeal by the Revenue against the order of the Income Tax Appellate Tribunal for assessment year 1998 ­1999 raises the following three questions of law :
i)Whether on the facts and in the circumstances of the case and in law ITAT was justified in holding that charges towards reimbursement of expenses cannot be included in income?
ii)Whether when income is taxed on gross basis, non inclusion of charges towards reimbursement of expenses would be in violation of law as it would tantamount to taxation of income partly on net basis ?
iii)Whether on the facts and in the circumstances of the case and in law the ITAT was justified in approving the deletion of levy of interest under Section 234B of the Act ?
3. The learned Counsel appearing on behalf of the Revenue has stated that the first and second question relate to the same issue namely whether reimbursement of expenses would be liable to be included in the income and hence they are taken up together.
4. The assessee had entered into a contract with M/s.EID Parry (India) Limited (EID Parry) for the supply of a compressor for an Ammonia Storage Tank. The compressor was found to be in a damaged condition. The assessee deputed two technicians from Germany to the establishment of EID Parry in India. EID Parry remitted an amount of DM202,433,37 comprising of (i) Inspection fees in the amount of DM 170,701.37 for technicians; and (ii) Reimbursement of expenses for air tickets for travel between Germany and India in the amount of DM 11,732. The Commissioner of Income Tax, on the question of reimbursement of expenses, followed the decision of the Andhra Pradesh High Court in the case of Elkem Technology Vs. DCIT 1 and of the Kerala High Court in the case of Cochin Refineries Limited V/s. CIT and held that the decision of the Assessing Officer to treat the reimbursement of expenses as part of taxable income was correct.

5 In appeal, the Tribunal dealt with the issue as regards the payment of fees received by the assessee and of the reimbursement of expenses separately. Inso far as the receipt of fees was concerned, the Tribunal noted that the assessee had deputed its technicians for inspection of the equipment. Inspection could not be done unless the personnel deputed had technical knowledge in respect of the equipment to be inspected. Consequently the fees received by the assessee were held to amount to fees for technical services. In so far as the issue of reimbursement is concerned, the Tribunal held that though there was a conflict between the judgment of the Kerala High Court, which was relied upon by the Commissioner of Income Tax (Appeals) and the judgment of the Calcutta High Court in the case of CIT V/s. Dunlop Rubber Company Limited, it would follow a view which was favourable to the assessee, consistent with the judgment in Vegetable Products Limited.

6.The question as to whether a reimbursement for expenses would form part of the taxable income is not res ­integra in so far as this Court is concerned. In Commissioner of Income Tax V/s . Siemens Aktiongesellschaft, a Division Bench of this Court held that it was in agreement with the view taken by the Calcutta High Court in Dunlop Rubber Company Limited (supra) and by the Delhi High Court in Commissioner of Income Tax V/s. Industrial Engineering Products (Private) Limited. The observations of this court in Siemens (supra) are as follows :
“33.That leaves us with the last contention as to whether the amounts by way of reimbursement are liable to tax. To answer that issue, we may gainfully refer to the judgment of a Division Bench of the Delhi High Court in CIT V. Industrial Engineering Products(P) Ltd., (supra). The learned Division Bench of the Delhi High Court was pleased to hold that reimbursement of expenses can, under no circumstances, be regarded as a revenue receipt and in the present case the Tribunal had found that the assessee received no sums in excess of expenses incurred. A similar issue had also come up for consideration before the Division Bench of the Calcutta High Court in CIT v. Dunlop Rubber Co. Limited (supra). The learned Division Bench was answering the following question :
Whether, on the facts and in the circumstances of the case, the amounts received by the assessee (English company ) from M/s. Dunlop Rubber Co. (India) Ltd., (Indian company) as per agreement dt. 29 th Jan., 1957 constituted income assessable to tax ?

On considering the issue the learned Bench noted that the Tribunal was of the view that what was recouped by the English company was part of the expenses incurred by it. The learned Court upheld the said finding. The learned Bench was pleased to hold that sharing of expenses of the research utilised by the subsidiaries as well as the head office organisation would not be income which would be assessable to tax. A similar view was taken in CIT v. Stewarts & Lloyds of India Ltd., (supra).
Consequently , in view of the judgment in Siemens , the first and second issue would not raise any substantial question of law since they are covered against the Revenue.



 Case Law Summary 


'The following case laws are from the first three chapters of Direct Taxation Paper. 

CIT v. Saurashtra Cement Ltd
liquidated damages received by a company from the supplier of plant for failure to supply machinery to the company within the stipulated time is. a capital receipt.

CIT v. M.Venkateswara Rao
The partnership firm has to explain the source of income of the partners as regards the amount contributed by them towards capital of the firm, in the absence of which the same would be treated as the income of the firm, was not tenable.

CIT v. Kribhco
No disallowance can be made under section 14A in respect of income included in total income in respect of which deduction is allowable under section 80C to 80U.

DIT (Exemption) v. Khetri Trust
In a case where properties bequeathed to a trust could not be transferred to it due to ongoing court litigation and pendency of probate proceedings, violation of the provisions of section 11(5) will not be attracted.

DIT (Exemptions) v. Ramoji Foundation
Trust deed amended by the trustees can be relied upon by the Revenue authorities for the purpose of granting registration under section 12AA.

CIT v. Shankar Krishnan
Notional interest on security deposit given to the landlord in respect of residential premises taken on rent by the employer and provided to the employee, shall not be included in the perquisite value of rent-free accommodation given to the employee.

CIT (TDS) v. Director, Delhi Public School
Rs.1,000 per month per child is not a standard deduction to be provided while calculating such a perquisite.

New Delhi Hotels Ltd. v. ACIT
Rental income derived from unsold flats which were shown as stock-in-trade in the books of the assessee should be assessed under the head "Income from house property" and not under the head "Profits and gains from business or profession".

Azimganj Estate (P.) Ltd. v. CIT
Rental income from the unsold flats of a builder shall be taxable as "Income from house property" but not as business income.

CIT v. Hariprasad Bhojnagarwala
Benefit of self-occupation of house property under section 23(2) cannot be denied to a HUF on the ground that it, being a fictional entity, cannot occupy a house property.

CIT v. Asian Hotels Ltd

Notional interest on interest-free deposit received by an assessee in respect of a shop let out on rent can neither be brought to tax as business income nor as income from house property.


Tax Accounting Standards by CBDT :Income Computation and Disclosure Standards (ICDS) applicable w.e.f 1.4.2015 


Business Income and Other income to be as per the standards laid down by the Central Board of Direct Taxes (CBDT) from AY 2016-17

The new standards will reduce the discretion which is currently available with the taxpayers under the standards prescribed by the Institute of Chartered Accountants of India (ICAI), thus bringing down chances of litigation with the tax department.

The tax accounting standards are expected to bring certainty in treatment of various items. The standards may affect sectors such as real estate, construction, and treatment of contracts, government grants, and foreign exchange treatment.

For example, there is lot of litigation about treatment of government grant. The CBDT panel has proposed that it should be treated as income and if it is treated as capital than one should account for depreciable asset.

Tax auditors of entities need to be more cautious while checking income tax calculation.

Main Features of ICDS:
  1. Effective Date of ICDS is 01stApril, 2015 i.e. FY: 2015-16 & AY: 2016-17.
  2. ICDS applicable to all Assesses i.e. Corporate & Non Corporate Assesses.
  3. ICDS is meant for normal computation of income not for Minimum Alternate Tax (MAT) Calculation.
  4. Entity need not to maintain Books of accounts for ICDS. ICDS is only for computation of income under the head “Profit and gains of business or profession” or “Income from other sources”.
  5. No Net Worth or Turnover Criteria Prescribed for applicability.
  6. In the case of conflict between the provisions of the Income‐tax Act, 1961 and Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent.
 Major Standards
Inventories: (ICDS-II): Clause No:22 envisage valuation opening stock i.e.The value of the inventory as on the beginning of the previous year shall be
  1. the cost of inventory available, if any, on the day of the commencement of the business when the business has commenced during the previous year; and
  2. the value of the inventory as on the close of the immediately preceding previous year, in any other case.
Construction Contract: ICDS-III: Clause No:20 envisage revenue recognition of contract at early stage i.e During the early stages of a contract, where the outcome of the contract cannot be estimated reliably contract revenue is recognised only to the extent of costs incurred. The early stage of a contract shall not extend beyond 25 % of the stage of completion.
Borrowing Cost: ICDS-IX: the definition of borrowing cost as per ICDS does not provide for exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. The same provision contained in para 4(e) of AS-16 and para 6(e) of INDAS-23. Entity having borrowing cost by virtue of above mentioned AS & IndAS will not be entitled to claim borrowing cost under ICDS while computation of income.

Government Grants: ICDS-VII: Clause no5 envisage treatment of Government Grant i.e.Where the Government grant relates to a depreciable fixed asset or assets of a person, the grant shall be deducted from the actual cost of the asset or assets concerned or from the written down value of block of assets to which concerned asset or assets belonged to.

Effects of changes in foreign exchange rates : ICDS-VI: Clause No:9(c): exchange differences on translation of non-integral foreign operations i.e.all resulting exchange differences shall be recognised as income or as expenses in that previous year.

Effects of changes in foreign exchange rates : ICDS-VI: ClauseNo: 5 (i)envisage recognition of exchange difference arising on settlement of monetary items.Exchange Difference in respect of monetary items, exchange differences arising on the settlement thereof or on conversion thereof at last day of the previous year shall be recognized as income or as expense in that previous year.