Full Day CPE Seminar on “ISSUES in TAX AUDIT and BUSINESS DEDUCTIONS UNDER IT ACT, 1961 on Friday 21St August, 2009 at ICAI Bhavan, Visakhapatnam

Issues in Tax Audit & Business Deductions under IT Act, 1961

Full Day CPE Seminar on “ISSUES IN TAX AUDIT AND BUSINESS DEDUCTIONS UNDER IT ACT, 1961 On Friday 21st August, 2009 At ICAI Bhavan, Visakhapatnam

Organised by : VISAKHAPATNAM BRANCH OF SOUTHERN INDIA REGIONAL COUNCIL OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA D. No. 9-36-22/2, Pithapuram Colony, Visakhapatnam - 530 003, Ph : 2755019 e-mail : [email protected] Website : www.icaivisakhapatnam.org

Visakhapatnam Branch of SIRC of ICAI 1 Issues in Tax Audit & Business Deductions under IT Act, 1961

Full Day CPE Seminar on “ISSUES IN TAX AUDIT AND BUSINESS DEDUCTIONS UNDER IT ACT, 1961”

FIRST TECHNICAL SESSION

Time : 10.00 A.M.

Subject : ISSUES IN TAX AUDIT

Speaker : CA. KAMLESH VIKAMSEY Past President - ICAI, Mumbai

12.45 P.M : FLOOR PARTICIPATION

01.15. P.M. : LUNCH

SECOND TECHNICAL SESSION

Time : 02.00 P.M

Subject : BUSINESS DEDUCTIONS AND RECENT CASES ON DOMESTIC TDS

Speaker : CA.K.K.CHYTHANYA BANGALORE

04.30 P.M : FLOOR PARTICIPATION

05.00 P.M. : VALADICTORY SESSION

Visakhapatnam Branch of SIRC of ICAI 2 Issues in Tax Audit & Business Deductions under IT Act, 1961

Visakhapatnam Branch of SIRC of ICAI 3 Issues in Tax Audit & Business Deductions under IT Act, 1961

ISSUES IN TAX AUDIT

CA. Kamlesh Vikamsey, FCA

Visakhapatnam Branch of SIRC of ICAI 4 Issues in Tax Audit & Business Deductions under IT Act, 1961

BIO DATA CA. KAMLESH SHIVJI VIKAMSEY

CA.Kamelesh Vikamsey is a practicing Chartered Accountant since 1982. He is a Senior Partner – in M/s. KHIMJI KUNVERJI & CO.Chartered Accountants, Mumbai, the firm registered with the Institute of Chartered Accountants of India & in practice since 1936, having over 69 years of experience in the areas of Auditing;Taxation; Corporate & Personal Advisory Services; Business & Management Consulting Services; Due diligence; Valuations; Inspections; Investigations, etc.

BRIEF PROFILE: He is Presently : · President of The Confederation of Asian and Pacific Accountants · Member of Standing Committee on Accounting Issues of Insurance Regulatory and Development Authority of India (IRDA) · Member of Appellate Authority constituted under section 22A of the Chartered Accountants Act, 1949

CA.Kamelesh Vikamsey is Past President of The Institute of Chartered Accountants of India during 2005-06

He was a Board Member of International Federation of Accountants (IFAC) and Member of Steering Committee Member of United Nations - Appointed by Secretary General of United Nations Mr.Kofi Annan, as a member of Steering Committee for Comprehensive Review of Governance and Oversight within the United Nations, and its funds, programme and specialized agencies.

He was Chairman of : · Strategic Committee of The Confederation of Asian and Pacific Accountants during 2005- 2007 and · Centre of Excellence on Education, Training and CPD of South Asian Federation of Accountants 2004–2005

He was Member of several Committees and Regulatory Bodies , to name a few : • Information Technology Committee of the ICAI • Group on XBRL in India • IFAC during 2006-2008

Contribution & Participation: Contributed and participated in Corporate Governance Leadership program conducted by Center for International Private Enterprise & Global Corporate Governance Forum .

He is also Director of Several Organisations, to name a few · General Insurance Corporation of India, , · the Reinsurance Company in India owned by the Government of India, · Axis Mutual Fund Trustee Limited · Aditya Birla Retail Limited

He is Trustee of: • Global Vipassana Foundation, an internationally renowned Trust • Dhamma Pattan Vipassana Kendra

Visakhapatnam Branch of SIRC of ICAI 5 Issues in Tax Audit & Business Deductions under IT Act, 1961

ISSUES IN TAX AUDIT CA. Kamlesh Vikamsey, FCA

Seminar on Tax Audit and Tax Audit Report Business Deduction under Income Tax Act, 1961 § Form 3CA – Report that Statutory Audit was conducted in pursuance of Statute applicable Issues in Tax Audit under Income Tax to a’ee Act, 1961 § Form 3CB – Report that Tax Audit is conducted in accordance with S. 44AB. Presented by: Express opinion whether financial statements CA Kamlesh Vikamsey give true & fair view of-

§ Of state of affairs of a’ee as represented by balance sheet Applicability of Tax Audit – § Of Profit / Loss or Income / Expenditure S. 44AB as represented by Profit / Loss Account § Every person carrying on business whose Gross Turnover, Receipts Or Total Sales § Express opinion whether particulars exceed Rs. 40 Lakhs mentioned in Annexure 3CD & Annexure I § Every person carrying on profession whose & II are true & correct Gross Receipts exceed Rs. 10 Lakhs § Where profits & gains of person from business are taxable on estimated basis u/ ss. 44AD, 44AE, 44AF, 44BB or 44BBB & such person claims his income to be lower than profits & gains so estimated Tax Audit Procedures § Primary responsibility of a’ee to prepare relevant information Tax Audit § Tax Auditor (TA) to verify compliance Objective: § TA to- § To assist Income Tax Department to assess § Use professional skill & expertise correct income of a’ee § Apply Generally Accepted Auditing Main report: Procedures as applicable for other § Form 3CA: Applies where accounts of audits business or profession of a’ee have been § Apply techniques of reasonable test audited under any other law audit checks & compliance tests § Form 3CB: Applies in other cases depending upon internal controls of a’ee § Annexure I – Financial Reporting § Annexure II – Report on FBT § Follow principles of ‘Materiality’, ‘Prudence’ & ‘Substance Over Form’ Annexure in Form 3CD to main report

Visakhapatnam Branch of SIRC of ICAI 6 Issues in Tax Audit & Business Deductions under IT Act, 1961

Tax Audit Procedures Annexure to Tax Audit Report § Documentation (SA 230)- (Form - 3CD) § Keep detailed notes of evidences relied Clauses 1-6:

upon § General details about a’ee § Maintain all working papers including Clause 7: notes on following- § Is applicable to Firms & Association of • Work done while conducting audit Persons & by whom § Names of partners / members & their profit- • Explanation & information given sharing ratios [Sub-Clause (a)] during course of audit & by whom § Changes in the constitution, or profit- • Decision on various points taken sharing, of Partnership / Association & the & judicial pronouncements relied particulars of change [Sub-Clause (b)] upon • MRs / Certificates issued by client § Design audit programme as would Annexure to Tax Audit reveal extent of checking & ensure Report (Form - 3CD) adequate documentation Clause 7: Relevant Issues § If you are also Statutory Auditor, § Will change in remuneration paid to advisable to carry out both audits partners without change in profit-sharing concurrently ratio would require any disclosure in tax audit report?

Tax Audit Procedures § When partner in representative capacity

§ Refer to following publications issued by retires & admitted as partner in individual ICAI- capacity, will it amount to change in

§ Standards on Audit (SAs) partnership?

§ Guidance Notes (GNs) on Audit Reports & Certificates for Special Purposes Annexure to Tax Audit Report (Form - 3CD) § GN on Tax Audit , Supplementary GN on Tax Audit, GN on Audit of FBT, GN Clause 8: on S. 145A considering VAT & GN on S. 14A § Nature of Business / Profession (If more § Issues on Tax Audit than one business / profession is carried out, then nature of every business / § SA 700 - Auditor’s report on financial statements profession) [Sub-Clause (a)]

§ Statement on qualifications in Auditor’s § Particulars of change in business / report profession [Sub-Clause (b)]

Visakhapatnam Branch of SIRC of ICAI 7 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit (Form - 3CD) Report (Form - 3CD) Clause 11: Clause 8: Relevant Issues § Method of Accounting followed in P.Y [Sub-Clause (a)] § If a’ee starts another business whose gross § Any change in method of accounting in receipts are not material compared to relation to last P.Y [Sub-Clause (b)] existing business, would it still amount to § Effect of such change on profit / loss [Sub- Clause (c)] change in business? § Details of deviation of such method from prescribed accounting standards & effect § If a’ee manufactures certain products & on profit / loss [Sub-Clause (d)] also sells certain components which are Relevant Issues used in manufacture of product, would he § Does change in accounting policy amount be categorized as trader or manufacturer? to change in ‘method of accounting’? § If preceding P.Y’s accounts were not § If nature of business covers vast no. of subject to tax audit, is it sufficient to rely activities, is it sufficient for TA to obtain only upon information & explanations provided by client? management representations?

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 9: Clause 12: § Method of Valuation of Closing Inventory § Whether books of accounts are prescribed employed in P.Y [Sub-Clause (a)] as per S. 44AA? [Sub-Clause (a)] § Details of deviation of such method of § Books of Accounts maintained (In case of valuation from method prescribed u/s. computerized system of accounting, men- 145A & effect on profit / loss [Sub-Clause (b)] tion books of account generated by such system) [Sub-Clause (b)] ü What is objective behind S. 145A? § List of books examined [Sub-Clause (c)] ü Whether there is any effect on Profit & Loss Account by adopting ‘Inclusive Annexure to Tax Audit Report Method’ as per S. 145A ? Method of Valuation of Closing Stock - S. (Form - 3CD) 145A

Clause 9: Relevant Issues Method of Valuation of § Where stock records are not maintained Closing Stock - S. 145A

Particulars Qty Rate (Excl. Rate of Excise due to high volume of transactions, what is Excise Duty) Duty Opening Stock 10 10 2 TA’s stand? RM Purchased 90 10 2 Other Manufacturing 80 10 - § Would post audit print-outs of accounts pre- Cost FG Manufactured 80 - - pared be sufficient evidence of audit with- Sales of FG 60 25 3 Closing Stock of RM 20 10 2 out audit ticks? Closing Stock of FG 20 20 3

Visakhapatnam Branch of SIRC of ICAI 8 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Profit / Loss Account as per (Form - 3CD) ‘Exclusive Method’ Clause 12: Computation of Total Taxable Income would appear as under-

Profit as per P & L a/c as per Exclusive method 300 Add: Adjustments u/s. 145A 1. Excise Duty on Sales 180 2. Excise Duty on Closing Stock of RM 40 3. Excise Duty on closing stock of FG 60 4. CENVAT Credit utilised on Consumption of RM 160 440

740 Less: 1. Excise Duty on opening stock of RM 20 2. Excise Duty on Purchase of RM 180 3. Excise Duty on Sales 180 (380)

360 Deduction u/s. 43B if Excise Duty on FG paid on or before due of filing ROI (60)

300

Annexure to Tax Audit Report (Form - 3CD)

Profit / Loss Account as per Clause 12: Relevant Issues ‘Inclusive Method’ - S.145A § Where closing inventories are valued at

Particulars Uni t Rat Amt Particulars Uni t Rat Amt s e s e market price (being lower than cost), (j) Opening Stock 10 12 120 (s) Sale 60 28 1680 (k) Purchase of raw 90 12 1080 (t) By closing stock of 20 23 460 should excise duty be added to such mat er ial s finished goods Total 100 12 1200 amount for complying with S. 145A? (l) Less : Closing Stock of 20 12 240 raw material (m) Less: CENVAT credit 80 2 160 (n) Raw Material 80 10 800 Whether this Annexure to Tax Audit Report consumed treatment required (o) To manufacturing cost 80 10 800 in case of VAT on FG? (Form - 3CD) (p) Excise duty on 60 3 180 Additional Entry in finished goods sold supplementary GN? (q) Excise duty on 20 3 60 Clause 12A: closing stock of finished goods (r) Gross profit 300 Give following particulars of Capital Asset TOTAL 2140 TOTAL 2140 converted into Stock-in-Trade-

Annexure to Tax Audit Report § Description of Capital Asset [Sub-Clause (Form - 3CD) (a)] Clause 12: Adjustments required u/s. 145A Particulars in Profits in Profits § Date of Acquisition [Sub-Clause (b)] Increase in cost of Opening Stock of RM on inclusion of CENVAT Credit 20 Increase in purchase on account of inclusion of § Cost of Acquisition [Sub-Clause (c)] CENVAT Credit 180 Increase in sales of FG on account of inclusion of Excise Duty 180 § Amount at which asset is converted into Excise Duty Paid on sale of FG as result of its inclusion in sales 180 Stock-in-Trade [Sub-Clause (d)] Increase in Closing Stock of RM on inclusion of Excise Duty 40 Increase in Closing Stock of FG on inclusion of Excise Duty 60 Increase in Excise Duty on Closing Stock of FG as result of its inclusion in Closing Stock of FG 60 Accounting of CENVAT Credit availed & utilised on RM Consumed in payment of Excise Duty of FG accounted on Ø Newly inserted from A.Y 2008-09 basis of RM Consumed 160 Total 440 440

Visakhapatnam Branch of SIRC of ICAI 9 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 13: Clause 13: Relevant Issues § Amounts not credited to Profit / Loss Ac- Any other Income count, being- § Will incomes from debentures & bonds & § items falling within scope of S. 28 [Sub- gains from sale of capital items which are Clause (a)] credited to capital account of a’ee (propri- § pro forma credits, drawbacks, refunds etor) be required to be disclosed under of customs or excise duties or service Clause 13? tax, sales tax or VAT, where same are § In case of incomes exempt for individuals, admitted as due by concerned authori- should same be disclosed under Sub- ties [Sub-Clause (b)] Clause (d)? § escalation claims accepted during P.Y [Sub-Clause (c)] Annexure to Tax Audit Report § any other items of income [Sub- Clause (d)] (Form - 3CD) § capital receipt [Sub-Clause (e)] Clause 14: § Particulars of depreciation as per Income Tax Act, 1961 for each block of assets in Annexure to Tax Audit Report following form- (Form - 3CD) § description of asset / block of assets [Sub-Clause (a)] Clause 13: Relevant Issues § rate of depreciation [Sub-Clause (b)] Capital receipts § actual cost / WDV [Sub-Clause (c)] § Does phrase ‘Capital Receipts, if any’ cover § Additions (alongwith date of asset capital contribution like gifts, share capital, being put to use) / deductions made etc? to block alongwith following § What types of Capital Receipts be indicated adjustments [Sub-Clause (d)]- under this clause? • CENVAT claimed & allowed § Should Interest on FDs or Other Incomes • Change in exchange rates like rentals etc be mentioned, if reduced from cost of Fixed Assets / CWIP? • Subsidy, grant or reimbursement § Depreciation allowable [Sub-Clause (e)] Annexure to Tax Audit Report (Form - 3CD) § WDV at end of P.Y [Sub-Clause (f)] Clause 13: Relevant Issues Items falling within scope of S. 28 Annexure to Tax Audit Report § Where any foreign tour is conducted for (Form - 3CD) dealers of companies on achieving desired Clause 14: Relevant Issues level of sales, what is TA’s duty in this § Where companies are exempt from In- regard? come Tax u/ss. 10, 10A or 10B, should Escalation claims accepted during P.Y TA give details of depreciation allowable § Where a’ee follows cash method of under I T Act? accounting, is it necessary to give details § Foreign Exchange Fluctuation loss on of escalation claims accepted during P.Y? borrowings against fixed assets- AS 11, Sch. VI of Companies Act – S. 43A?

Visakhapatnam Branch of SIRC of ICAI 10 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 14: Relevant Issues Clause 15: Relevant Issues § How would TA deal with mistakes in § In case where audit is required under classification of assets in prior P.Ys? certain sections to claim deduction & separate auditor is appointed for this § In cases where depreciation is not provided purpose, is it enough to rely upon such for & same is not claimed in return of auditor’s report for claiming deduction? income, should TA state particulars of What would be TA’s stand in case audit depreciation under this clause? report of such auditor is unavailable? § Does a’ee have option of charging less § With regard to Ss. 35D, 35DD, 35DDA, etc. depreciation than rates prescribed under I where auditors of company have changed, T Act? What is TA’s duty in this regard? can TA rely on preceding P.Y’s computation & audit report or should scrutinize expenses incurred in earlier years as debited to ‘Preliminary Expenses’? Annexure to Tax Audit Report (Form - 3CD) Annexure to Tax Audit Report Clause 14: Relevant Issues (Form - 3CD) § In case subsidy is received in excess of Clause 16: WDV, how should same be accounted for? § Sum paid to employee as bonus or commission, where same was payable as § In case subsidy sanctioned is not profits or dividend [Sub-Clause (a)] received, should same be deducted to arrive at actual cost of asset? § Sums received from employees as contributions to any provident or § How should TA ascertain date of asset superannuation funds or any other fund u/s. being put to use? Is an expert’s opinion 2(24)(x); due date for payment & actual date necessary or is certificate from a’ee of payment to concerned authorities u/s. enough in this regard? 36(1)(va) [Sub-Clause (b)]

Annexure to Tax Audit Report (Form - 3CD) Annexure to Tax Audit Report Clause 16: Relevant Issues (Form - 3CD) § Is it mandatory to disclose that employers have not deducted / collected Provident Clause 15: Fund, etc. from employees? Amounts admissible u/ss. 33AB, 33ABA, § In case of non-corporate a’ee following 33AC (wherever applicable), 35, 35ABB, cash system of accounting, if provident 35AC, 35CCA, 35CCB, 35D, 35DD, fund contributions are not deposited before 35DDA & 35E- end of relevant P.Y but remitted within § Debited to Profit / Loss Account (showing statutory due dates, will same be allowed amount debited & deduction allowable as deduction? under each section) [Sub-Clause (a)] § How can TA verify details of payments of § Not Debited to Profit / Loss Account [Sub- provident fund, etc. in tax audit of sub- Clause (b)] contractor particularly when liability is on main employer?

Visakhapatnam Branch of SIRC of ICAI 11 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 17: Clause 17: § Amounts debited to Profit / Loss, being- § Provision for gratuity not allowable u/ § capital expenditure [Sub-Clause (a)] s. 40A(7) [Sub-Clause (i)]

§ personal expenditure [Sub-Clause (b)] § Any sum paid as employer not § expenditure on advertisement in any allowable u/s. 40A(9) [Sub-clause (j)] publication of political party [Sub- Clause (c)] § Particulars of contingent liability [Sub- § expenditure incurred at clubs [Sub- Clause (k)] Clause (d)]- § Amount of deduction inadmissible as • as entrance fees & subscription per S. 14A relating to expenditure • as cost for club services & facilities pertaining to Income not forming part used of Total Income [Sub-Clause (l)] § expenditure by way of penalty or fine for violation of any law [Sub-Clause § Amount inadmissible under proviso to (e)(i)] S. 36(1)(iii) [Sub-Clause (m)] § any other penalty or fine [Sub-Clause (e)(ii)] Annexure to Tax Audit Report § expenditure incurred for an offensive purpose or that which prohibited [Sub- (Form - 3CD) Clause (e)(iii)] Clause 17 (l): § Amount inadmissible u/s. 40(a) [Sub- Clause (f)] § Amount of deduction inadmissible in terms of S. 14A Annexure to Tax Audit Report (Form - 3CD) S. 14A- Clause 17: § Disallowance of ‘expenditure incurred in § Amounts debited to Profit / Loss, being- relation to income which does not form part § Amounts inadmissible u/ss. 40(b) / 40 of total income’ (S. 14A expenses) [Sub- (ba) & computation thereof, by way of [Sub-Clause (g)]- sec. (1)] • Interest § AO empowered to determined amount • Salary inadmissible as per R. 8D only if not satisfied • Bonus with correctness of – • Commission or remuneration § A’ees claim having regard to accounts § Whether certificate is obtained from a’ee regarding payments relating to of a’ee, or expenditures covered u/s. 40A(3) that same were made by account payee § A’ees claim of NIL expenditures cheque / draft [Sub-Clause (h A)] incurred u/s. 14A § Amount inadmissible u/s. 40A(3) read with r. 6DD & computation thereof [Sub-secs. (2) &(3) r.w.r 8D(1)] [Sub-Clause (h B)]

Visakhapatnam Branch of SIRC of ICAI 12 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) R. 8D (2): Method of computation of S. 14A § TA entitled to rely on MR – Refer Para 5 of expenses- SA – 580 on ‘Representation by Aggregate of – Management’ § Exp directly relating to income which does not form part of total income § Seek corroborative audit evidence from § Interest exp not directly attributable to any sources inside / outside particular income or receipt : A X (B / C) § Evaluate whether MR appears reasonable A - interest exp other than interest included in & consistent with other audit evidences clause (i) & interest directly attributable to obtained, including other representations; particular income or receipt & B - average of investment, income from which § Consider whether individuals making does not or shall not form part of total income, representation can be expected to be well st as appearing in B/S, on 1 day & last day of informed on matter P. Y C - average of total assets as appearing in B/S, § If TA in agreement with a’ee, report with on 1st day & last day of P.Y suitable disclosure of material § 0.5 % of average of investment, income from assumptions, if any which does not or shall not form part of total § If not in agreement, give qualified opinion / income, as appearing in B/S, on 1st day & adverse opinion / disclaimer of opinion, as last day of P.Y case may be (‘Total Assets’ - total assets as appearing in B/ Position post ITAT - Mumbai (Special Bench) S excluding increase on account of decision in case of Daga Capital revaluation of assets but including decrease Management Pvt Ltd- on account of revaluation of assets) § Can a’ee estimate S. 14A expenses? Annexure to Tax Audit Report (Form - 3CD) Annexure to Tax Audit Report § Method prescribed under R. 8D (2) applicable only when AO is dissatisfied at (Form - 3CD) time of assessment Clause 17(m): § R. 8D does not mandate a’ee to necessarily compute S. 14A disallowance as per Sub- Interest inadmissible under proviso to S. Rule (2) 36(1)(iii) § A’ee may / may not adopt Sub-Rule (2) § A’ee to estimate S. 14A expenses w.r.t Proviso to S. 36(1)(iii) disallows ‘Interest’ paid established principles of allocation of - expenses based on logical parameters like § in respect of capital borrowed proportion of exempt & taxable income recorded, turnover, man hours spent. For § for acquisition of assets allocation of interest between taxable & non- § for extension of existing business / taxable income, quantum of investment, profession period & rate of interest are generally relevant factors § for any period from date of borrowing till § Primary responsibility of a’ee to furnish date of put to use of asset details § TA to verify amount determined by a’ee & estimates - Refer SA – 540 on ‘Audit of Annexure to Tax Audit Report Accounting Estimates’ § Adopt one or combination of following (Form - 3CD) approaches- Clause 17: Relevant Issues § review & test process used by a’ee to Expenditure of Capital Nature develop estimate § use independent estimate for § Interest on fixed assets borrowings charged comparison with that prepared by a’ee; to P & L Account as per AS 16 or § review subsequent events which § Foreign Exchange Fluctuation Loss on fixed confirm estimate made assets borrowings as per AS 11

Visakhapatnam Branch of SIRC of ICAI 13 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 17: Relevant Issues Clause 17: Relevant Issues Expenses of Personal Nature Ss. 40(b) / 40(ba) § Whether there can be personal expenses § While computing book profits, can carried in case of companies? Where director of forward losses be considered while company, under terms of appointment, uses computing partners remuneration allowable company’s car for official as well as personal under Income Tax Act? purposes, will expenditure on such car be S. 40A(3) treated as personal expenditure? § How is TA supposed to verify whether § How to decide on the personal element in payments are made by ‘account payee case of cars, phones etc. used for personal cheque’ in case of payments exceeding Rs. as well as official purpose? 20,000 for purposes of S. 40A(3)? § How would TA determine amount of Contingent Liabilities expenditure as personal expenditure in respect of house property of firm used partly § Whether leave encashment expenses for residence & partly for business by booked on basis of leave standing to credit partner? of employee at close of P.Y, should shown be as contingent liability or not? § Are there any instances regarding Annexure to Tax Audit Report contingent liabilities being shown as (Form - 3CD) provision for purpose of Sub-Clause (k)? Clause 17: Relevant Issues Penalties & Fines Annexure to Tax Audit Report Explanation to S.37(1) - Any expenditure incurred by a’ee for any purpose which is (Form - 3CD) offence or which is prohibited by law is Clause 17A: disallowed § Amount of interest inadmissible under S. § Penalty or fines – S. 37(1) - Whether to 23 of Micro, Small & Medium Enterprises report only those fines which are penal in Development Act, 2006 nature? Should we report fines / penalty Annexure to Tax Audit Report (Form - 3CD) which are compensatory in nature ? Clause 18: § Is compounding fee paid to various departments considered as penalty or fine? § Particulars of payments made to persons specified u/s. 40A(2)(b) § In case of abnormal expenses by way of penalties reimbursed to distributors, should same be reported or not? Relevant Issues § Is it required to report interest u/ss. 234A, § Are payments made of capital nature to 234B, 234C & 234D where same has been persons covered u/s. 40A(2)(b) to be debited to profit / loss account? reported under this clause?

§ Are expenses for defending employees § How can TA ascertain details regarding alleged to have committed an offence, in the persons covered u/s. 40A(2) & how can nature of penalty or fine? transactions with such persons be verified?

Visakhapatnam Branch of SIRC of ICAI 14 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 20: Clause 21: Relevant Issues § Should documents for proof of payment be § Amount of profit chargeable to tax u/s. 41 attached by a’ee when same are certified & computation thereof by TA as true & correct in Form No. 3CD? § Is profession tax liability required to be reported u/s. 43B? Relevant Issues § Where taxes, duties, etc. referred to in S. § Where liability becomes time barred but is 43B are paid after tax audit is completed not written-back by debtor, would it still be but before due date of filing returns, how should same be dealt with by TA? treated as cessation of liability? If yes, would it be treated as income u/s. 41? Annexure to Tax Audit Report § In case of refund of excise duty / sales tax, (Form - 3CD) can S. 41 be invoked, if matter is pending Clause 22: in appeal before higher authority? § Amount of CENVAT Credit utilized during P.Y § If any liability has been disallowed earlier u/ & treatment in profit / loss account & s. 43B, 40(a)(i) / 40(a)(ia), etc, whether to treatment of CENVAT Credit outstanding [Sub-Clause (a)] be disclosed u/s. 41? § Particulars of Income / Expenditure of prior periods credited / debited to Profit / Loss Annexure to Tax Audit Report Account [Sub-Clause (b)] (Form - 3CD) Annexure to Tax Audit Report Clause 21: (Form - 3CD) § In respect of any sum referred to in Clauses (a), (b), (c), (d), (e) or (f) of S. Clause 22: Relevant Issues 43B, liability for which- CENVAT Credit § Where CENVAT Credit as per a’ees books § Pre-existed on first day of P.Y but was is reconciled with Credit as per Excise not allowed in assessment of Department, which entries are to be preceding P.Y & was- considered under this clause? • Paid during P.Y Prior-Period Items • Not paid during P.Y [Sub-Clause § Where particular item is considered as prior period item by TA but not by statutory auditor, (i A)] what is TA’s duty in this respect? § Was incurred in P.Y & was- § How should sales tax refund determined as • Paid on or before due date for result of order passed in last month of furnishing returns of P.Y u/s. 139 preceding P.Y but received in current P.Y, be treated? (1) § How should claim made for short supply of • Not paid on or before due date RM in preceding P.Y, settled in this P.Y, be [Sub-Clause (i B)] treated? v State whether sales tax, customs duty, § Wage disputes started in preceding P.Y but excise duty or any other indirect tax, levy, settled in current P.Y-Whether increase in cess, impost etc. is passed through profit wages pertaining to earlier P.Ys paid in current P.Y should be disclosed as prior / loss account period item?

Visakhapatnam Branch of SIRC of ICAI 15 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 24: Clause 24: Relevant Issues § Particulars of each loan / deposit exceeding limits specified u/s. 269SS taken or § What are reporting requirements in case accepted during P.Y- where deposit is received alongwith interest by other than account payee cheque or § Name, address & PAN of lender / draft? depositor § Where current account is maintained for § Amount of loan / deposit sister concern in respect of purchase of § Whether loan / deposit was squared goods, cheques received, etc., how should up during P.Y same be approached by TA? § Maximum amount outstanding at any § What is treatment of booking amount time in P.Y received against sale of goods? § Whether loan / deposit was taken / § Where asset is purchased under hire accepted otherwise than by account purchase finance, payment for which is payee cheque or account payee made by account payee cheque by bank draft [Sub-Clause (a)] financier to supplier, is such loan taken by a’ee in infringement of S. 269SS?

§ Does S. 269SS include loans from finance companies & co-operative banks? Annexure to Tax Audit Report (Form - 3CD) Clause 24: Annexure to Tax Audit Report § Particulars of loan / deposit repaid (Form - 3CD) exceeding limits specified u/s. 269T during Clause 24: Relevant Issues P. Y- § Where payment to creditor is made by § Name, address & PAN of payee sister concern of a’ee, will same be required § Amount of repayment to be reported under this clause? § Maximum amount outstanding at any § Where repayment of loan is made by time during P.Y crossed cheque to creditor of a’ees lender, will same be covered under this clause? § Whether repayment was made otherwise than by account payee § Where in loan account there is no cheque or account payee bank draft transaction apart from interest to be paid & [Sub-Clause (b)] TDS on such interest due, should same be reported under this clause? § Whether certificate has been obtained from a’ee regarding taking or accepting, or § Where creditors for supplies are converted repayment of same through account payee into unsecured loans, what are reporting cheque / draft [Sub-Clause (c)] requirements? § Such particulars are not necessary in case § Current account loans taken & repaid on of government companies, banking different dates during P.Y, should same be companies or corporations established disclosed in respect of each credit entry under Central, State or Provincial Act under this clause?

Visakhapatnam Branch of SIRC of ICAI 16 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 24: Relevant Issues § Where a’ee makes payments of LIC Clause 26: Premium or Advance Tax on behalf of its § Section-wise details of deductions depositors in account payee cheque of amounts exceeding limits specified in S. admissible under Chapter VI-A 296T, would same be required to be Relevant Issues disclosed? § Can TA rely on certificates issued by § What is position if transfer entries are made in books as authorized by letter of professionals other than CAs? depositor? § Where payments qualifying for deduction § Opening balance of loan account is Rs. 1 u/s. 80D etc. might not have been paid lakh & only Rs. 10,000 has been accepted out of business income but personal during P.Y, should same be reported? income, should same be disclosed? § Opening balance of loan account is Rs. 1 lakh & there absolutely no movement in § Where in preceding P.Y, admissibility of account either by way of further acceptance deductions claimed u/ss. 80-I, 80-IA, etc. / repayment or interest during P.Y, should are not questioned & allowed from return same be reported? of income, is TA required to verify § Is any comment required from TA in respect of contravention of provisions of Ss. 69D, allowability of same? 269SS & 269T?

Annexure to Tax Audit Report (Form - 3CD) Compliance with TDS - Clause 25: Clauses 27 & 17(f) § Details of brought forward loss or depreciation allowance, in following Clause 27: manner [Sub-Clause (a)]- § Whether a’ee has complied with Nature of Loss/ Amount as Amount as assessed Assessment Serial No Allowance returned (give reference to Remarks Year (in Rs.) (in Rs.) relevant order) Chapter XVII-B regarding- § Deduction of TDS, &

§ Where change in shareholding of company § Payment thereof to Govt [Sub- has taken place in P.Y due to which losses Clause (a)] incurred in preceding P.Ys cannot be carried forward as per S. 79 [Sub-Clause (b)] § Disclose following- Annexure to Tax Audit Report (i) Tax Deductible & not deducted at all (Form - 3CD) (ii) Shortfall on account of lesser deduction Clause 25: Relevant Issues (iii) Tax deducted late § Where assessments are in various stages of litigation, is it correct to merely state that (iv) Tax deducted but not paid to Govt before ‘information is not readily available & hence last day of P.Y or due date for TDS not furnished’? § How should TA certify amounts of brought deducted in March month of P.Y forward losses / depreciation, where records of earlier years are not produced? In such cases, what safeguards are necessary?

Visakhapatnam Branch of SIRC of ICAI 17 Issues in Tax Audit & Business Deductions under IT Act, 1961

Compliance with TDS - Compliance with TDS - Clauses 27 & 17(f) Clauses 27 & 17(f) S. 40(a)(ia)- Clause 17(f): v ‘Stipulated Time’ for payment to Govt.: § Amounts inadmissible u/s. 40(a)(i) / 40(a)(ia) March expenses - Due date of filing returns S. 40(a)(i)- Other Expenses - March 31st § Disallowance of payments made to NRs v TDS paid to Govt. after stipulated time will without deducting TDS u/s. 195 read with be allowed in subsequent P.Y in which it is relevant DTAA paid § Reliance on CA Certificate on TDS taken v This is not covered under tax audit report at time of remittance & separate CA Certificate to be taken § Lower TDS Certificates obtained u/s. 195(2) / 197 Compliance with TDS - Clauses 27 & 17(f) § Refer to relevant section of Act, DTAAs, CBDT circulars, Notifications & Judicial § In case of voluminous transactions, apply Precedents test checks & compliance tests based on internal controls of a’ee § In case of dispute, mention in report ü If satisfied, bring out compliance in following manner: “We have verified the compliance with the provisions of Chapter XVII-B regarding Compliance with TDS - the deduction of tax at source & regarding the payment thereof to the credit of the Clauses 27 & 17(f) Central Government in accordance with the Auditing Standards generally accepted i n India which include test checks & the S. 40(a)(ia)- concept of materiality. Such audit procedures did not reveal any significant § Disallowance of following expenses non-compliance with the provisions of without deducting TDS / Payment to Chapter XVII-B” Govt. within stipulated time- ü In case of non-compliance, replace last line as under: § Payments to Contractors & Sub- “……The noncompliance as revealed contractors [S. 194-C] during such audit procedures are as mentioned in clause (b) hereunder” § Interest [S. 193 / 194A]

§ Commission / Brokerage [S. 194H] Compliance with TDS - Clauses 27 & 17(f) § Rent [S. 194-I] Clause 17 (f): Issues on S. 40(a)(ia) § Royalties [S. 194J] § Whether entire expenses will be disallowed in case short deduction of TDS? § Fees for Professional / Technical § Can we rely on CA certificate for foreign Services [S. 194J] remittances or should we decide on each & every foreign payments based on underlying documents/ agreements? Visakhapatnam Branch of SIRC of ICAI 18 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Annexure to Tax Audit Report (Form - 3CD) (Form - 3CD) Clause 28: Relevant Issues Clause 28: § How must quantitative details be disclosed in case of retail traders where there are § In case of trading concern, quantitative variety of items traded? details of principal goods traded- § Will TA be justified in conducting his audit in proper manner if he accepts MRs § Opening Stock regarding quantitative details of items, in case there is no mechanism to record § Purchases during P.Y stock? § How should TA report in case of civil § Sales during P.Y contractor or construction company under this clause? § Closing Stock § Where a’ee was not valuing work-in- § Short / Excess [Sub-Clause (a)] progress because processing time was minimal, how should TA report this issue under this clause? § In case of manufacturing concern, § In case where units of raw materials & quantitative details of raw materials, finished closing stock are not same, how should goods & / or by-products- yield & shortage / excess of stock be measured? § Opening Stock § Are a’ees rendering technical services required to maintain quantitative details of § Purchases during P.Y drawing materials like tracing papers, etc?

§ Consumption / Production during P.Y

§ Closing Stock Annexure to Tax Audit Report (Form - 3CD) § Short / Excess Clause 29: In case of domestic company , details of tax on distributed profits u/s. 115-O in following form- § Total amount of distributed profits [Sub- Annexure to Tax Audit Report Clause (a)] § Total tax paid thereon [Sub-Clause (Form - 3CD) (b)]

Clause 28: § Dates of payment with amounts [Sub- Clause (c)] § Yield of finished products * § New Amendment introduced w.e.f. § Percentage of yield *[Sub-Clause (b)] 1.4.2008 to S. 115-O- Company can set off dividends received from immediate subsidiary v Information may be given to the extent (i.e where equity holding is more than 50 %) against dividend distributed by it available; applies to raw materials only

Visakhapatnam Branch of SIRC of ICAI 19 Issues in Tax Audit & Business Deductions under IT Act, 1961

Annexure to Tax Audit Report Meaning of ‘Fringe Benefits’ (Form - 3CD) – S. 115WB(1) Clause 29: Relevant Issues § Any privilege, service, facility or amenity, directly or indirectly, provided by employer, § Where tax audit is completed after whether by way of reimbursement or dividend is declared but before dividend otherwise, to his employees (including distribution tax is paid, will it be sufficient former employees) provided to employee compliance to report on dividend declared in preceding P.Y but paid in current P.Y? § Any free or concessional ticket for private travel by employee or his family members § Any contribution to approved Annexure II - Superannuation Fund § Sweat Equity shares allotted or Fringe Benefit Tax transferred, directly or indirectly by the employer free of cost or at concessional Applicability - S. 115W rate to his employees (including former § FBT is applicable to ‘employer’ employees) being- § company § firm Deemed Fringe Benefits – S. 115WB(2) § AOP or BOI, whether incorporated or not § FB shall be deemed to be provided by an employer if he incurs expenses or makes § local authority payment for the purpose of 16 items, in § every artificial juridical person not course of his business or profession falling above (including any activity whether or not such activity is carried on with object of deriving § Not applicable to Individuals & HUFs income, profits or gains) § Not applicable to any fund / trust / i § FB deemed to be provided irrespective of nstitution whether expenses incurred in relation to employees or not § eligible for exemption u/s. 10(23C) § Expenditure on Non-transferable per-paid § registered u/s. 12AA electronic meal card is excluded from ‘Deemed FBs’ § Political Party § Applicable to employer having at least one employee based in India Value of Deemed Fringe Benefits

Basis of charge – S. 115 WA FBT charged at 30% (plus 10% SC*, 2% EC & 1% SHEC) on value of: § FB provided by employer to employee – S. 115WB(1) § FB deemed to be provided by employer to employee – S. 115WB(2) *(If applicable)

Visakhapatnam Branch of SIRC of ICAI 20 Issues in Tax Audit & Business Deductions under IT Act, 1961

Recent Amendments in FBT Fringe Benefit Tax- Some § Expenditure on or payment through Non- Issues Transferable Prepaid Electronic Meal § Whether expenses to include service tax, Card useable only at eating joints & which sales tax, VAT, etc.? fulfill prescribed conditions is exempt [Clause (B)] – conditions recently § Whether Prior-period expenses are subject prescribed to FBT? § Whether advance against expenses are § Following expenses excluded from subject to FBT? ‘Employee Welfare’- § Providing Crèche Facility for children of employees Annexure II-FBT (S. 115WC § Sponsored Sportsman, being r.w.s 115WB) employee Disclosure: § Organize Sport Events for employees [Clause (E)] § Classification of expenses for purposes of FBs / deemed FBs

§ Maintenance of Guest House is now § Amount of Expenditure- exempt [Clause (K)] § Debited to Profit / Loss Account § Accounted in B / S - Ex. Where expenses are capitalized to fixed General Principles proposed assets by CBDT Circular No.8 § Re-imbursement - Ex. Out-of-pocket expenses reimbursed from clients § Classification of expenditure is to be done on basis of proximate purpose & not § Any other head - Ex. Depreciation ultimate purpose (clarifications to FAQ. Motor Car as per IT Act 11) § Deductions - Ex. Out-of-pocket expenses § Items forming part of ‘Salary’ cannot be reimbursed to auditors, lawyers, etc. subject to FBT (clarifications to FAQs. 44, § Value of FBs 47, 48 & 69) § FBT is payable on whole of expenses falling under relevant head determined as Recent Amendments by per Books of accounts (clarifications to FAQs. 14 & 15) Finance Act, 2008 § FBT is payable on all expenses falling Business Income – Deductions under relevant head irrespective of whether revenue or capital S. 35: Expenditure on Scientific Research & Development § Net expenses are to be considered for purpose of FBT. Ex. If an employer incurs § Deduction available w.r.t companies- total expenditure of Rs. 10 lakhs & § Incorporated in India recovers Rs. 1 Lakh from its employees, value of FB shall be calculated on basis § Has main object of scientific research of net expenditure of Rs. 9 lakhs (FAQ. & development 32) § Is approved by prescribed authority in § FBT not payable on FBs in respect of prescribed manner which there is no provision for computing value § Satisfies other conditions § Consider expenses in accordance with § No deduction will be available u/s. 35(2AB) regular method of accounting of 125 % if claimed u/s. 35(1)(iia)

Visakhapatnam Branch of SIRC of ICAI 21 Issues in Tax Audit & Business Deductions under IT Act, 1961

Recent Amendments by Recent Amendments by Finance Act, 2008 Finance Act, 2008

S. 35D: Preliminary Expenditure (Especially TDS Provisions: Post-Commencement Expendture) S. 194C: Payments made to Contractors / § Deduction earlier available to ‘Industrial Sub-Contractors liable to TDS Undertaking’ in respect of expenses after commencement § All AOP & BOIs, incorporated or not, which are subject to Tax Audit, liable to § Deduction now available to service sector deduct TDS u/s.194C w.e.f June 1, 2008 units for post-commencement expenses S. 195: Payments made to NRs liable to S. 40A(3) &(3A): Payment otherwise than by TDS Account Payee Cheque / Draft § Deductor required file information relating Disallowance in respect of- to payment to NR electronically w.e.f July 1, 2009 § 100 % expenditure incurred in P.Y / preceding P.Ys

§ In respect of which, payments are made to particular party in one day

§ Of sum exceeding Rs. 20,000

§ By other than account payee cheque / draft

Thank you…

Visakhapatnam Branch of SIRC of ICAI 22 Issues in Tax Audit & Business Deductions under IT Act, 1961 Notes ......

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Visakhapatnam Branch of SIRC of ICAI 23 Issues in Tax Audit & Business Deductions under IT Act, 1961

BUSINESS DEDUCTIONS AND RECENT CASES ON DOMESTIC TDS

CA. K.K. Chythanya, FCA

Visakhapatnam Branch of SIRC of ICAI 24 Issues in Tax Audit & Business Deductions under IT Act, 1961

BIO DATA CA. K.K. Chythanya, FCA

Name : Chythanya K.K. Age : 40 years Qualification : B.Com, FCA, LLB Marital Status : Married Academics : 1. II PUC Commerce Eighth rank in Karnataka State 2. B.com First rank in Mysore University 3. CA Intermediate Forty seventh rank (All India) 4. CA Final Fifteenth rank (All India) topping Karnataka State Professional : 1. Articleship Price Waterhouse Coopers, Bangalore 2. Industrial Training Hindustan Lever Limited, Bangalore 3. Practice B As chartered accountant for fourteen years specialising in taxation matters B Now as an advocate in Bangalore Others : 1. Guest/Visiting Faculty at B IIM, Bangalore B MDP of ICAI, New Delhi B MDP of ICAI, Bangalore B ICAI for CA students B Direct taxes training centre of Income tax department B MBA, Bangalore University 2. Presented papers in income tax and VAT at various Metros and other cities 3. Regular speaker at various other forums 4. Conducted in-house training in companies like IBM, KSSIDC, BPL, GE Medical etc. 5. Member of study group of ICAI for framing Guidance Note on Transfer Pricing. 6. Co-authored a book on Tax Holiday under Sections 10A & 10B published by Wolters Kluwer, a reputed German published 7. Authored a book on Special Economic Zone and articles in the ‘Chartered Accountant’ published by ICAI, New Delhi, Taxman, CTR, and other journals.

Visakhapatnam Branch of SIRC of ICAI 25 Issues in Tax Audit & Business Deductions under IT Act, 1961 BUSINESS DEDUCTIONS

CA. K.K. Chythanya, FCA

GENERAL PARAMETERS MEANING OF TRADING § “Profits” to be understood in its commercial RECEIPTS sense –Calcutta Company Ltd. v. CIT [1959] 37 ITR 1 SC; § Whatever tax collected constitutes trading receipt - Chowringhee Sales Bureau Pvt. § For determining the question of taxability, Ltd. v. CIT [1973] 87 ITR 542 SC; well settled legal principles as well as § Payment from Public Fund to assist principles of accountancy to be taken into assessee in carrying his trade, is revenue account – CIT v. U.P. State Industrial receipt – Sahaney Steel & Press Works Development Corporation [1997] 225 ITR Ltd. v. CIT [1997] 228 ITR 253 SC & Ponni Sugars and Chemicals Ltd. [2008] 306 703 SC; ITR 392 (SC)

§ The term “Profits” in various Sections of § The word Income should be the same as Income-Tax Act do not have the same that of word occurring in the Legislative list and that it is of widest amplitude and meaning : It could be assessable profits must be given natural and grammatical under some context or commercial profits meaning - CIT V G.R.Karthikeyan (1993) in other contexts – CIT v. Orient Paper Mills 201 ITR 866 SC [1983] 139 ITR 763 Cal;

Deduction under section 28 ONE OFF TRANSACTION itself § Loss v. Expenditure – Loss covered by sec § Even a single transaction could be termed as business 28 : Dr. T.A.Quereshi [2006] 287 ITR 547 - CIT v. S.P. Balasubramaniam [2002] (SC) 120 Taxman 491 [Mad.]; 250 ITR 127 Contra : Woodward Governor India P. Ltd., - CIT v. Sutlej Cotton Mills Supply [2009] 312 ITR 254 (SC) Agency Ltd. [1975] 100 ITR 706 SC; - Raja J. Rameshwar Rao v. CIT [1961] 42 ITR 179 SC § Real Income Theory – Loss due to deduction of damages from current bills § Contra against supplies is allowable - CIT v. Carbon Industries Pvt. Ltd. [2004] 134 - Indian Hume Pipe Co. Ltd. v. CIT [1992] Taxman 368 [Mad.]; 195 ITR 386 [Bom.]; - CIT v. Sashikumar Aggarwal [1992] 195 ITR 767 (All.) § A claim for deduction for which there is no specific provision is admissible under - Patiala Biscuit Mfg. P. Ltd. v. CIT [1971] 82 ITR 812 (SC) Section 28 itself – CIT v. Mahsana District Co-Operative Mils Products Union Ltd. - M.V. Chandrashekar: SLP (C) No. 4779 of 2009 [2009] 312 ITR [St] 335 [2005] 146 Taxman 355 [Guj.];

Visakhapatnam Branch of SIRC of ICAI 26 Issues in Tax Audit & Business Deductions under IT Act, 1961

INTEREST – BUSINESS OR RENTAL - BUSINESS OR OTHER SOURCES OTHER SOURCES - East India Housing [1961] 42 ITR 49 SC (3 § Nature of charge under section 56 judges) - Sultan Brothers Pvt. V CIT [1964] 51 ITR § Onus of proof : Maharaja Shopping 353 (SC) (5 judges) Complex [2009] 312 ITR 68 (Karn) - SG Mercantile 83 ITR 700 SC (4 judges) - Universal Plast 237 ITR 454 SC (3 judges) § Short Term Deployment Trade Surplus § No precise test can be laid down is Business Income – § It is a mixed question of law & fact and - A.P.Industrial Infrastructure Corp Ltd. should be determined from point of view v. CIT [1989]175 ITR 361 [A.P.]; of a businessman in that business on facts & circumstances of each case, including - CIT v. TN Diary Development Corp true interpretation of the agreement under Ltd. [1995] 216 ITR 535 [Mad]; which the assets are let out. - CIT v. Choudhury & Sons [1993] 203 § Where all assets of business are let out, ITR 881 [SC]; the period for which the assets are let out is a relevant factor - Continental Construction 195 ITR 81 § When assets are let out temporarily as assessee carries on other business § Contrary – Murali Investment Company activities, it’s exploiting business assets; v. CIT [1987] 167 ITR 368 [Raj.; § But if business never started/has started but ceased with no intention to be resumed, assets also will cease to be business assets and the transaction will only be exploitation INTEREST – BUSINESS OR of property by an owner thereof, but not OTHER SOURCES exploitation of business assets.

§ Preconstruction period Interest;

- Assessable under other head as RENTAL - BUSINESS OR per Tuticorn Alkali Chemicals & OTHER SOURCES Fertilisers Ltd. v. CIT [1997] 227 § Where assessee gives certain quarters ITR 172 SC; on rent to his employees and charges rent, rental income to be treated as business income - CIT v Delhi Cloth & - Not Assessable but to be reduced General Mills Co. Ltd [1966] 59 ITR 152 from capital cost as per CIT v. [Punj.] Bokaro Steel Lltd, [1999] 236 ITR ? Where premises are given for locating a 315 SC; branch of bank, police station, excise office, etc., to run business of assessee more efficiently, rentals to be taxable as - Bongaigaon Refinary and business income - CIT v National Petrochemicals Ltd. v. CIT [2001] Newsprint & Paper Mills Ltd. [1978] 114 251 ITR 329 SC ITR 388 (MP.)

Visakhapatnam Branch of SIRC of ICAI 27 Issues in Tax Audit & Business Deductions under IT Act, 1961

ONE BUSINESS OR SEVERAL SETTING UP OF BUSINESS BUSINESSES § Difference between setting up and § Several activities constitute one business commencement - CIT v. Coromandal if there is Unity of Control & Management Fertilizers Ltd., 2003 261 ITR 408 AP & & Interlacing of Funds – Hotel Alankar v CIT (1982) 133 ITR 866 (GUJ) - Jayashri Tea & Industrial Ltd. v. CIT [2005] 272 ITR 193 [Cal.]; - When a business is established and is - BR Ltd. 113 ITR 647 SC ready to commence business it can be said of that business that it is set up - Appollo Tyres 255 ITR 273 SC - The words ‘ready to commence’ would not necessarily mean that all the integrated Computation under other activities are fully carried out and/or wholly completed so that the business can be head – business character not commenced lost § Previous year begins when business is set § The breaking up of business income under up - Western India Vegetable Products Ltd. different heads for computation purpose V. CIT [1954] 26 ITR 151 Bby does not render income to be non-business - CIT v. Chugandas & Co. [1965] 55 ITR 17 SC; SETTING UP OF BUSINESS - CIT v. Cocanada Radha Swamy Bank Ltd. [1965] 57 ITR 306 SC; § Placing P.O.s or receiving P.O.s could - Brooke Bond & Co. Ltd. v. CIT [1986] 162 mean setting up - CIT v Stones & ITR 373 SC; Minerals Associate Ltd (2002) 257 ITR - DCIT v. Jindal Aluminum [2003] 87 ITD 598 479 [Bang.]; § When trial production takes place, - Apollo Tyres Ltd. v. CIT [2002] 255 ITR 273 business is set up - CIT v. Kanoria SC General Dealers P.Ltd [1986] 159 ITR 524 Cal.

§ Negotiation for obtaining and for acquiring a land is a part of business expenses and if advance was made for BUSINESS PERQUISITES this purpose, business is set up - CIT V.CHEMCROWN (IND) LTD. (2003)262 § Car received by a dealer as a gift is a ITR 177 (Cal.) trading receipt –Boeing v. CIT [2002] 122 Taxman 49 [Mad.]; § Where business consists of different categories, business is set up from the § Unexpected benefits received do not date when one of the categories of the come under Section 28 [iv] – Mahindra business is started and it is not & Mahindra Ltd. v. CIT [2003] 261 ITR necessary that all the categories of the 501 (Bom) business must start either simultaneously or that the last stage must start before it can be said that the business was set up - Prem Conductors [P] Ltd. [108 ITR 654]

Visakhapatnam Branch of SIRC of ICAI 28 Issues in Tax Audit & Business Deductions under IT Act, 1961

Rent, repairs & rates DEPRECIATION

§ For the applicability of section 31(i), test is § Meaning : Mysore Minerals Ltd. V. CIT (1999) 239 ITR 775 SC not whether the expenditure is revenue or capital in nature, but whether the § Depreciation allowance is expenditure is “current repairs”. The basic mandatory

test to find out as to what is current repairs § Where Sec 144 assessment is is that the expenditure must have been made taking Net profit %, the incurred to “preserve and maintain” an Depreciation should be allowed - Circular No.29D Dt 31.08.1965 already existing asset, and the object of the expenditure must not be to bring a new § Where income is assessed at 8% asset into existence or to obtain a new Gross profit rate, Depreciation should be allowed - CIT v Sriram & advantage CIT vs. Saravana Spinning Mills Co (2002) 120 Taxman 238 (Raj) & P. Ltd. (2007) 293 ITR 201 (SC) CIT v Amritlal Khatri (2002) 123 Taxman 457, CIT v. Jain Construction Co. 245 ITR 527 § Such expenditure is not allowable under sec 37 also : M/s Sri Mangayarkarasi Mills (P) Ltd 2009-TIOL-86-SC DEPRECIATION

§ Municipal tax is a recurring liability whereas § A partner can claim depreciation building tax under the Kerala Building-tax on his assets used by firm from his share of salary and Act, 1975 is a one time liability, which is remuneration (if he has retained entirely different CIT v. HOTEL SHAH & ownership over the assets) - CIT CO [2005] 146 TAXMAN 86 (KER) v Ramlubhaya R Malhotra (2002) 254 ITR 165 (Guj)

§ Applicability of sec 14A in case of partner Marezban Bharucha v. Some special cases ACIT 12 SOT 133 (Mumb)

§ Present return form recognises § Expenditure incurred in keeping in the same existence corporate entity and to comply § In the case of land and building, with statutory obligations under various the splitting has to be made both statutes even while there was no business u\s 32 and u\s 45 as held in the activity in the relevant year is incidental to following cases:

business activity as per Gojer Bros (P) Ltd. - Vimal Chand Golecha (1993) v. ITO (2005) 142 Taxman-Mag 39 (Kol) 201 ITR 442 (Raj) - Dr.D.L.Ramachandra Rao (1999) 236 ITR 87, T C Itty Xpe § Contra : INTERNATIONAL MARKETING (2001) 119 Taxman 137 LTD vs. ITO (2007) 159 TAXMAN 24 (Madras) (DELHI)

Visakhapatnam Branch of SIRC of ICAI 29 Issues in Tax Audit & Business Deductions under IT Act, 1961

DEPRECIATION - USE DEPRECIATION- MOTOR VEHICLE - “Use” means ‘kept ready for use’ § The MV Act does not lay-down that a and not the actual use - Capital person cannot be the owner of a motor Bus Service (P) Ltd v CIT (1980) vehicle unless the motor vehicle is 123 ITR 404(Delhi) registered in his name - K.L. Johar and Co. v. Deputy CTO [1965] 16 STC 213 - The word “used” should be [SC] understood in a wide sense, so as § Motor vehicle is a movable property, to include passive as well as active transfer of ownership is governed by user - CIT v. Viswanath Bhaskar the Sale of Goods Act and it takes effect Sathe (1937) 5 ITR 621 (Bby) from the date of sale. Registration is not necessary to pass title in motor vehicle, to claim depreciation under the - User of machinery in test Income-tax Act. - CIT v. Nidish production was user for the Transport Corporation [1990] 185 ITR purposes of the assessee’s 669 [Ker] business - Ramakrishna and Sons Ltd. v. CIT (1984) 149 ITR 554 § Vehicle registered in partner’s name, firm is entitled to depreciation if funded (Mad.) by firm and used by firm - CIT v Mohd. Bux Shokat Ali (2002) 256 ITR 356 - ‘Use’ is sufficient not degree or (Raj) extent of use - CIT v Union Carbide (I) Ltd (2002) 124 Taxman 859 (Cal) DEPRECIATION- MOTOR VEHICLE DEPRECIATION - USE § Motor car registered in the name of a - Contra : DCIT v YELLAMMA director is entitled to depreciation in the DASAPPA hands of the company - Chhabria Textile HOSPITAL,BANGALORE 2007 Mills Pvt Ltd. v. ACIT ITAT Mumbai ‘E’ (62) KAR.L.J.42 (HC) (DB) Bench 2004-05 38 BCAJ 579 § Car includes jeeps - Crompton Engg. Co (Madras) Ltd v CIT (1992) 193 ITR 483 - Not followed in CIT and another (Mad.) & Southern Roadway Ltd v CWT v. Chamundeshwari Sugar Ltd. (2002) 122 Taxman 128 (Mad) [2009] 309 ITR 326 (Karn) HC § Depreciation of car – Lease or hire

- Gupta Global Exim P. Ltd. [2008] 305 ITR 132 (SC) DEPRECIATION - USE - CIT v Madan & Co (2002) 254 ITR 445 (Mad.) - Where assessee bought cars on - CIT v. SOUTH INDIA last day of accounting year and VISCOSE(2005)272 ITR 115 (MADRAS) had not registered same for being - CIT v. Kotak Mahindra (2003) 130 brought on roads and there being Taxman 130 Bby no evidence of assessee having - Circular No.2 of 2001, dated February used said cars before end of 9, 2001 accounting year, it was not entitled - ABB Ltd v. IFCI (2005) 56 SCL 21 [154 to depreciation in respect of those Taxman 512] vehicles CIT v. MAPS TOURS - J. M. Shares & Stock broker vs. Deputy AND TRAVELS (2004) 141 Commissioner of income tax (2007) 109 TAXMAN 38 (Madras) TTJ (Mumbai) 311

Visakhapatnam Branch of SIRC of ICAI 30 Issues in Tax Audit & Business Deductions under IT Act, 1961

DEPRECIATION- COMPUTER INTEREST DEDUCTION - Capital u/s 36(1)(iii) means § Colour xerox machine run with “money” and not any other asset help of computer & printer and as held by the Supreme court in scanner are integral part of the case of Bombay Steam computer system – colour xerox Navigation Co.(1953) Pvt Ltd machine to be treated as (1965) 56 ITR 52. computer & entitled to higher rate of depreciation - ITO v. SAMIRAN - Unless nexus is proved between MAJUMDAR [2005] 280 OF ITR loan taken and loan given, interest [A.T.] 74 [KOLKATA] cannot be disallowed : British Paints (India) Ltd v CIT (1991) 190 § A ‘Router’ which transfers data ITR 196 (Cal) packets in LAN and WAN is an integral part of computer system - The case where loan is advanced for facilitating high speed internet to a subsidiary stands on a connectivity and depreciation at different footing than advance the rate of 60% is allowable M/s made to a sister-concern. In the Cincom System India Pvt Ltd latter situation, interest can be 2009-TIOL-371-ITAT-DEL.pdf disallowed, but not in the case Contra : Routermania where advances are made to a Technologies (P.) Ltd. v. ITO subsidiary company for purposes [2007 16 SOT 384 (ITAT – Mum.) of business : S.A.BUILDERS LTD & Venture Infotek Global Pvt Ltd vs. CIT (APP) (2007) 288 ITR 1 Vs DCIT 2008-TIOL-526-ITAT- (SC) MUM (ATM machine)

UNABSORBED DEPRECIATION Interest on capital borrowed § Unabsorbed depreciation carried for acquisition of an asset forward from earlier years can be allowed to be set off against income - Proviso to section 36(1)(iii) wef assessed under other heads as 01.04.2004 inserted by Finance held - CIT v Virmani Industries (P) Act 2005 ltd (1995) 216 ITR 607 (SC)/CIT v Jaipuria China Clay Mines (1996) - Vardhman Polytex Ltd. [2008] 299 59 ITR 555 (SC) ITR 152 (P&H) (FB) HC - Core Health Care Ltd. [2008] 298 § Legal fiction of sec 32(2) for ITR 194 (SC) deeming unabsorbed depreciation as part of current year’s - Explanation 8 to section 43(1) depreciation is only to achieve inserted by Finance Act 1986 wef limited purpose of carry forward & 01.04.1974 and Challapalli Sugar adjustment of same against other Mills Ltd. V. CIT (1975) 98 ITR heads of income, in the absence 167 SC of which, the aforesaid set off - JCT LTD v. DCIT [2005] 144 against other incomes would not TAXMAN – TAX REPORTS 435 have been available - Mother India [CAL.] Refrigeration Industries [1985] 155 ITR 711 SC

§ Unabsorbed depreciation v. sections 71, 79 and 80 (F.No.13/8/ 69-IT (A2) dated June 24, 1969)

Visakhapatnam Branch of SIRC of ICAI 31 Issues in Tax Audit & Business Deductions under IT Act, 1961

BAD DEBTS Time Limit u/s 40a (ia)

? Section 36(1) (vii) as amended by the Finance Act, 2001 requires not only debit Tax was In any other to Profit and Loss account but also credit deducible and case to the party’s account as per Jubliant Organosys vs CIT [2004] 265 ITR 421 On or before So deducted during the 31st March of PY (All.). SLP dismissed in 266 ITR 108 last month of PY

? There is no need to establish that the debt On or before due date as per has become bad and it is sufficient if the 139 (1) debt is written off as bad in the books - DCIT v. Oman International Bank (2006) 100 ITD 285 (Bby SB)

Link between sec 40a(i), (ia) Section 40a(ia) & (iii)

§ Sec 192, 194, 194B, 194BB, 194D, 194G § Any interest, commission or brokerage, & 194LA rent, royalty, fees for professional services or fees for technical services - Although not covered under sec 40a(ia) payable to a resident, or will get covered under sec 40a(i) or (iii) when paid to a resident but outside India § Amounts payable to a contractor or subcontractor, being resident, for § Sec 194 carrying out any work (including supply of labour for carrying out any work), - Applies only in case of sec 2(22)(e) - Paid to resident in India : Not covered § On which tax is deductible at source - Paid to non resident in India : Covered under Chapter XVII-B and - Paid outside India to a resident/non resident : Covered

Section 40a(ia) – contd..

§ Such tax has not been deducted or, after deduction, has not been paid,—

(A) in a case where the tax was deductible and was so deducted during the last month of the previous year, on or before the due date specified in sub- section (1) of section 139; or

(B) in any other case, on or before the last day of the previous year

Visakhapatnam Branch of SIRC of ICAI 32 Issues in Tax Audit & Business Deductions under IT Act, 1961

Proviso-40a(i) Issue 1A – Sum not chargeable to tax

Tax was deducted in previous Tax is deducted year but paid after expiry of time as per sec. 200(1) • Where sum paid is not chargeable to tax • Implications of section 4(2) • Implications of section 190(2) In any subsequent year Issue 2 – Payment without Deduction will be allowed in the deduction

Previous year of payment 1. Section 40a (i) & (ia) covers cases where- - Tax has not been deducted or Proviso to section 40a (ia) - After deduction, has not been paid 2. Literal reading disallows cases of Tax is Tax is payment without deduction deducted deducted 3. Intention of provision – Memo/Board In the PY In any Circular subsequent 4. Support from section 195A of grossing up year During March During any principle other month 5. Short deduction is to be determined Paid after Paid after the accordingly for the purpose of due date end of PY disallowance.

Deduction will be allowed in the PY of payment Issue 3 – Implication of short deduction Issue 1: Deductible v. deducted v. paid • Short deduction arising from • Credited as well as deducted in March? - Due to clerical error • Paid as well as deducted in March? - Due to incorrect application of section • Credited in Dec. but deducted in March • Short deduction – possibilities through a JE? - Entire sum is allowable • Paid in Dec. but deducted in March - Entire sum is disallowable through a JE? - Prorata disallowance Inductotherm (India) • Credited or paid in some past years but P. Ltd. v. ACIT [2007] 294 ITR 341 (Guj) deducted in March through a JE? HC • FM’s speech emphasizes on deductibility in March. • Amendment doesn’t suggest so. Issue 4 – Non deduction of SC • Absence of ‘coma’ after words ‘so and cess deducted’ indicates that ‘during the last month of PY’ is qualified only by ‘was so deducted’ and not by ‘was • Section 40a refers to ‘tax deductible at deductible’. See 172 Taxman 418 AAR, source under Chapter XVII-B’ 103 TTJ 861, 304 ITR 235 Bby • Surcharge/cess is deductible by virtue of • Proviso to section 40 a (ia) also refers section 2 of Finance Act to ‘deducted in March’ and not • Sec 2(37A) which defines ‘Rate or Rates ‘deductible and deducted in March’. in force’ refers to only income tax • Board Circ No.1 of 2009

Visakhapatnam Branch of SIRC of ICAI 33 Issues in Tax Audit & Business Deductions under IT Act, 1961

Issue 4 – (contd..) Certain decisions

• Tax as per sec 2(43) consists only • Southern Agro Engine (P.) Ltd. v. Union income tax of India [2008] 170 Taxman 468 (Mad) – Stay of operation of sec 40a was • K. Srinivasan’s case 83 ITR 346 SC refused • Supplementary Guidance Note : Page 183 – Short payment include non payment of SC Certain decisions

• Van Oord ACZ India (P) Ltd vs. ACIT Issue 5 – Effect of tax [2008] 114 TTJ (Del) 808 – Failure to directly paid by payee deduct such tax as required by s. 195, disallowance is attracted as per s. 40 • Is section 40a attracted when tax is (a) (i). While deciding the issue under directly paid by payee though assesee s. 40 (a) (i) one need not to look into has not deducted tax? the nature of such payments made to non-resident nor are required to look • Implications of section 191 into whether such payments are income or part of the income in the hands of • The Board Circular no. 275/20/195-IT(B) dated January 29, 1997, wherein it was recipient non-resident taxable in India conceded that where tax has been paid and many other relevant factors relating by the deductee, no demand could be to taxability of the payment in the hands made on the deductor. of recipient non-resident as its income in India.

Issue 5 (contd..) • Interest on unpaid installments of • What is the date of payment of tax by purchase price does not have the payee normal character of interest, so that - Advance tax such payment to non-resident may not - TDS/TCS be disallowed as held in CIT v. India - Self assessment tax and return filed : Pistons Ltd. [2006] 282 ITR 632 [Mad.] 140A & [2007] 295 ITR 550 (Mad) - Any other tax payment

Issue 6 – Capital payment Certain decisions without TDS • On the plain reading of section 40 (a)(i) of the Act, as long as the tax was • Payment to contractors without TDS deducted within the year, as was done where such payments are capitalized in the present case, the provisions of • Scope of section 40a – non obstante the section come into play and the clause in respect of sections 30 to 38 assessee must, therefore, be entitled to its benefit CIT v. Oracle software India • Effect on depreciation claim : Nectar Ltd. [2007] 293 ITR 353 (Delhi) Beverages Pvt Ltd Vs DCIT 2009-TIOL- 81-SC

Visakhapatnam Branch of SIRC of ICAI 34 Issues in Tax Audit & Business Deductions under IT Act, 1961

Section 43B Section 40A(3)

? Contribution to PF and ESI ? Constitutional validity upheld in case of Attar Singh Gurumukh Singh (1991) 191 Whether section 43B covers both employee ITR 667 SC contribution and employer contribution ? Validity upheld even after amendment to Rule 6DD as per Kamath Marbels v ITO and others (2003) 260 ITR 470 (Ker) - Yes as per Hitech India Pvt. Ltd v. UOI ? Whether section 40A(3) applies to split (1997) 227 ITR 446 AP, CIT v. Madras payments Radiators and Pressings Ltd., 2003, 129 - Latest amendment Taxman 709 Mad & Sabari Enterprises - No as per CIT v Aloo Supply Co (1980) [2008] 298 ITR 141 (Karn) HC 121 ITR 680 (Orissa) & Shree Mahaveer Corporation v ITO (2002) 258 ITR (AT) 55 (ITAT- Bang) - Contra : I.T.C. Ltd [2008] 115 TTJ (Kol) (SB) - Yes as per Shri Radhika Prakashan v CIT 45 (2002) 123 Taxman 213 (MP)

GENERAL DEDUCTIONS Section 43B ? Mere non making of entry doesn’t deprive ? Contribution to PF and ESI assessee of his right of deduction, so also a mere disputing of his liability - Sutlej Whether amendment to section 43B Cotton mills Ltd v CIT (1979) 116 ITR 1 (omission of Second Proviso) is SC retrospective? ? The expression “wholly and exclusively” used in section 37(1) does not mean - Sabari Enterprises [2008] 298 ITR 141 “necessarily” - Sasson J.David & Co. (Karn) HC P.Ltd. v. CIT (1979) 118 ITR 261 SC

- CIT v. Vinay Cement Ltd. [2007] 213 CTR ? The expression “for the purpose of business” is wider than the expression (SC) 268 “for the purpose of earning profits” - CIT v. Malayalam Plantations Ltd. (1964) 53 ITR 140 (SC) Section 43B

? Whether section 43B overrides section GENERAL DEDUCTIONS 40A(7) PF and ESI ? “Spending’ in the sense of ‘paying out or away’, of money is the primary meaning of ‘expenditure’. ‘Expenditure’ is what is paid - Yes as per Sree Kamakhya Tea Co.(P) Ltd out or away and is something which is gone vs CIT Cal., A.T.E. (P) Ltd. v. ACIT (2004) irretrievably - General Insurance Corpn. of 84 TTJ 186 (ITAT – Mumbai) India v. CIT (1999) 240 ITR139 SC ? Benefit to third party is not a criteria - - No as per George Williamson (Assam) Ltd. Eastern Investments Ltd. v. CIT, 20 ITR 1 v. CIT[1997]228 ITR 343 Gau. & [SC] ? A company cannot as such have personal COMMONWEALTH TRUST (I.) LTD. expenditure - Sayaji Iron & Engg co v CIT (2004) 269 ITR 291 (2002) 121 Taxman 43 [253 ITR 749] (Guj)

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Capital or Revenue Crystalisation of contractual ? Expenditure incurred by the assessee in acquisition of an income earning asset is liability a capital expenditure and the expenditure ? This liability may be claimed in the year to incurred in the process of earning of which the transaction relates provided it income was a revenue expenditure - can be fairly ascertained or estimated on Assam Bengal Cement Co. Ltd. v. CIT agreed and admitted terms of the contract [1955] 27 ITR 34 SC - Calcutta Co. Ltd. v. CIT [1959] 37 ITR ? Test of enduring benefit may break down - 1 SC Empire Jute Co. Ltd., v. CIT [1980] 124 - Metal Box Co. of India Ltd. v. Their ITR 1 SC Workmen [1969] 73 ITR 53 SC

? Expenditure should result in creation of an ? Where, a dispute is raised by the parties, it asset in favour of the assessee - L.H.Sugar would be allowable only on its final outcome Factory and Oil Mills (P.) ltd v. CIT [1980] of the dispute either in the year of amicable 125 ITR 293 SC settlement by the parties or in the year of final determining of judicial process as per Swadeshi Cotton & Flour Mills [P.] Ltd. Capital or Revenue [1964] 53 ITR 134 [SC] ? Payment of technical know-how in this age of fast changing technology is ordinarily understood as constituting revenue expenditure - Alembic Chemical Works Crystalisation of statutory Co. Ltd. v. CIT [1989] 177 ITR 377 (SC) liability ? Statutory liabilities arise according to the ? Sum paid as royalty may have to be split provisions of law and do not depend on between capital and revenue - Jonas the view which the assessee may take of Woodhead and Sons (India) Ltd. v. CIT its rights. Therefore, even if, such liabilities [1997] 224 ITR 342 (SC) are disputed or contested before the Courts, deduction in respect thereof would ? Incurring a lump sum expenditure in lieu be allowable as per Kedarnath Jute Mfg. of revenue expenditure over a long period Co. Ltd. V. CIT [1971] 82 ITR 363 (SC) is also in the revenue field as per CIT v MADRAS AUTO SERVICE (P) LTD [1998] 233 ITR 468 (SC) Infraction of law s Irrespective of nomenclature, one has Deferred Revenue to find out whether it is compensatory ? Deferred revenue income or penal in nature in order to allow compensatory part as deduction u/s - In a Time share scheme only annual 37(1) : Swadeshi Cotton Mills Ltd v CIT income may be recognised in (1998) 233 ITR 199 SC T.K.INTERNATIONAL LTD. v. ACIT 91 ITD 481 (Cuttack) s Infraction of law is not a normal - Contra : Sterling Holiday Resorts v. ACIT incidence of business : Haji Aziz & 295 ITR (AT) 162 (Chennai) Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 SC ? Deferred revenue expenditure s The payment will be deductible only if - The discount on issue of debenture may it is compensatory and not punitive : be amortized as per Madras Industrial Prakash Cotton Mills P.Ltd v. CIT Development Corpn. V. CIT (1997) 225 (1993) 201 ITR 684 (SC) ITR 802 SC

Visakhapatnam Branch of SIRC of ICAI 36 Issues in Tax Audit & Business Deductions under IT Act, 1961

WARRANTY COSTS Infraction of law s Provision made by assessee for warranty claims on the basis of past s Dr. T.A.Quereshi v. CIT [2006] 287 ITR experience is not a contingent liability as the liability towards warranty is 547 (SC) : The Explanation has no certain and had accrued on the date relevance to business loss but only to of sale, therefore, is allowable as a business expenditure. deduction

- Wipro GE Medical Systems Ltd. v. s Bribes cannot be allowed as a DCIT (2003) 81 TTJ 455 (Bang) business expenditure. But “mamools” - CIT v. Beema Mfrs. (P.) Ltd. [2003] 130 Taxman 400 (Mad.) could be so allowed :CIT v. - Maruti Udyog Ltd. V. Deputy Coimbatore Salem Transport (P.) Ltd. Commissioner of Income-tax [1966] 61 ITR 480 (Mad). (2005) 142 TAXMAN – TAX REPORTS 57 (Delhi)

s Compounding fine paid and claimed as business expenditure by builder for s M/s Rotork Controls India (P) Ltd Vs CIT, Chennai (Dated: May 12, 2009) violation of building norm is not 2009-TIOL-64-SC-IT : If warranty is allowable : C.I.T. Mamta Enterprises an integral part of the sale price of the [KAR] [2004] 135 Taxman 393 [KAR] goods and the warranty is attached to the sale price of the product, obligations arising from past events have to be recognized as provisions

Interest on tax SOFTWARE COSTS s Principles - SC TO DECIDE ON SOFTWARE s Interest on outstanding sales tax is an UPGRADE SPEND TAX LIABILITY : allowable expenditure being THE ET, NEW DELHI, DECEMBER compensatory in nature : Lachmandas 11, 2007. - Functional test to be appliedAmway Mathuradas v CIT (2002) 122 Taxman India Enterprises vs. DCIT (2008) 114 828 SC TTJ (Del) (SB) 476 s Capital - CIT v Arawali Construction Co. (P) Ltd s Interest on delay in payment of sales (2002) 124 Taxman 146 (Raj) tax cannot be disallowed : CIT v. Delhi - Maruti Udyog Ltd. V. DCIT (2005) 142 Automobiles (2005) 272 ITR 381 TAXMAN – TAX REPORTS 57 (Delhi) - Sudarshan Chemical Industries Ltd. (Delhi). Vs. Asst. CIT (2007) 108 TTJ 28 (Pune) For SAP R/3 software and s Interest paid to income tax department licence s Revenue cannot be allowed as business expenditure : Bharat Commerce and - G.E. CAPITAL SERVICES LTD. [2008] Industries Ltd. v CIT (1998) 230 ITR 300 ITR 420 (Delhi) : For MS office - IBM India LTD 105 ITD 1 (BANG.) : 733 SC Application software

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CA fees for IT return - D.B.Madan v CIT (2003) 261 ITR 193 (Mad.) s Allowable s Not allowable - CIT v Birla Cotton Spinning & Weaving - Ram Bahadur Thakur Ltd v CIT (2002) (1971) 82 ITR 166 SC 257 ITR 289 Ker Partners’ life insurance premium - H S Shivakantappa v CAIT (1982) 134 ITR 481 Ker s Allowable s Not allowable - ITO v. Thakur Vaidyanath Aiyer & Co. (1984) 7 ITD 9 (Bby) - Associated stone Ind (Kotah) Ltd v CIT - Clarification by the LIC vide its ACTL/ (2002) 123 Taxman 643 (Raj) 1729/4,dated July 24,2000 Foreign travel – Director’s wife s Not allowable s Allowable - CIT v. Khodidas Motiram Panchal - CIT v Appollo Tyres Ltd (1999) 237 ITR (1986) 161 ITR 99 (Guj) 706

CONCLUSION

s Business income computation is a complex exercise thanks to ambiguities in relevant tax provisions

s This head of income contributes maximum litigation

s This paper seeks to bring out some critical aspects which may not be taken as exhaustive

Thank You

Visakhapatnam Branch of SIRC of ICAI 38 Issues in Tax Audit & Business Deductions under IT Act, 1961 Notes ......

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Visakhapatnam Branch of SIRC of ICAI 39 Issues in Tax Audit & Business Deductions under IT Act, 1961 RECENT CASE LAWS ON DOMESTIC TAX DEDUCTION AT SOURCE

Some broad principles Eli Lilly and Co. (India) P. Ltd.

• If a person is not liable for payment of tax • Expat’s salary : Home salary and overseas at all, at any time, the collection of tax from salary to be combined by the host him with a possible contingency of refund company for TDS at a later stage, will not make the original • Plea of ‘impossibility of performance’ not levy valid : Bhawani Cotton Mills Ltd vs taken [Woodward Governor India P. Ltd. State of Punjab (1967) 20 STC 290 (SC) [2007] 295 ITR 1 (Delhi) HC] • Plea of deduction only at payment not taken • ex abundanti cautela - Poompuhar • Section 192(2) and 192(2B) rendered Shipping Corpn. Ltd. vs. ITO (2007) 108 nugatory TTJ (Chennai) 970 • Mitigating factor – have evidence of rendition of service to overseas employer (eg Stewardship – see 292 ITR 416 SC) Multiple sections dealing • Effect on FBT on ESOP : Circular 9 of 2007 with same payment

• Section 194I v. section 194J – equipment Other decisions lease rentals • Eli Lilly and Co. I.P. Ltd. [2008] 297 ITR 300 (Delhi) HC - CIT v. Prasar Bharti (2007) 158 TAXMAN • CIT v. Eli Lilly and Company India (P) Ltd.: 470 (DELHI): If, on the same date, two SLP (C) No. 18062 of 2008.-SLP provisions are introduced in the Act, one dismissed on delay leaving the question specific to the activity sought to be taxed of law open and the other in more general terms, • Marubeni India P. Ltd. [2007] 294 ITR 157 resort must be had to the specific (Delhi) HC provision which manifests the intention of • In Re: British Gas India P. Ltd. [2006] 287 the Legislature. It is not, therefore, ITR 462 (AAR) possible to accept the contention of the revenue that programmes produced for television , including ‘commissioned Documentary evidence – programmes’, will fall outside the realm Employer’s responsibility? of section 194C Explanation III of the Act. • CIT Vs M/s Larsen & Toubro Ltd (Dated: January 21, 2009) 2009-TIOL-06-SC-IT - Circular 720 of 30.8.95 & CIT Vs ITI, Limited (Dated: January 21, 2009) 2009-TIOL-08-SC-IT - LTC& Conveyance allowance : Neither sec 192 nor Board Circ insists on Eli Lilly and Co. (India) P. Ltd. collection of evidence by employer 312 ITR 225 [SC] • Circ no.9 of 2008 • TDS is in the nature of a vicarious liability, - Para 5.2.9 : Evidence of rent for HRA which pre-supposes existence of primary exemption- Para 5.4 (G) : Evidence for liability. rent for sec 80GG - Para 5.4 (21) : Particulars and information • The said liability is a vicarious liability and as may be necessary for being satisfied the principal liability is of the person who with genuineness of claim regarding is taxable. deposit • Contrary decision in C.E.S.C. Ltd. v. ITO • Extra territorial effect upheld (17 ITR 63 SC) (Cal.) [2004] 134 TAXMAN 511 (Cal.) overruled

Visakhapatnam Branch of SIRC of ICAI 40 Issues in Tax Audit & Business Deductions under IT Act, 1961

Documentary evidence- Interest contd..? • At the time of issue of bonds, interest that accrued against each folio issued against • A declaration should suffice as per HCL each bond was less than Rs 2500. Since INFO SYSTEM LTD. [2005] 146 interest accrued on each bond would have TAXMAN 227 [DELHI] for LTA and been less than Rs 2500 against each folio, Nicholas Piramal India Ltd. [2008] 299 no TDS was called for on such a sum : ITR 356 (Bom) HC for Children edu/ Sahara Airlines Limited Vs JCIT, Lucknow hostel allowance (Dated: February 22, 2009) 2009-TIOL- 393-ITAT-DEL • A declaration with complete details of journey should suffice as per • FCI Contributory Provident Fund Trust, Semiconductor Complex Ltd. 292 ITR 636 P&H 177 Taxman 224 (Del.) : Assessee Corporation, a provident fund trust of • No authority nor obligation to examine employees is assessable in the status of source of investment of employees as per individual and hence not liable to deduct State Bank of Patiala (1999) 236 ITR 281 tax at source u/s. 194A. (P & H) • Spread over of lumpsum interest paid over • Misuse of meal coupon : Employer not the period for which interest is paid : liable as per Reliance Industries Ltd. Permissible even for TDS purpose as per [2009] 308 ITR 82 (Guj) HC Oriental Insurance Company Ltd., 2009 (66) KLJ 94 (HC) – refer 181 ITR 400 SC • TDS cannot be reduced proportionately merely because assessee gives assurance in writing that he will make savings of a particular amount as per Interest Major General Vinay Kumar Singh v UOI 123 Taxman 750 MP • Status of interest component in price of goods sold on credit

Salary v. Professional - India Pistons Ltd. [2007] 295 ITR 550 (Mad) HC : The unpaid installment is not same as loan and therefore, interest paid • (2004) 138 TAXMAN 113 (AAR – NEW DELHI) : Applicant is obliged to deduct could not be treated as paid on the loan tax at source from payment of honorarium and hence, TDS was not attracted. See to honorary part-time teachers under 101 ITR 502 SC. section 192. - Usance interest is not part of purchase • CIT v. Dr. Mrs. Usha Verma (2002) 254 price as per Vijay Ship Breaking Corpn. ITR 404 : when a doctor attached to 261 ITR 113 Guj [reversed in 175 Taxman Government hospital works in a paying 77 SC on a different ground of retro clinic and receives a share of fees, such insertion of Expl 2 to sec 10(15)(iv)(c)] fees will have to be regarded as salaries. - ITO vs. Kanha Vanaspati Ltd. (2007) 108 • CIT vs P. Ramajayam, 136 Taxman 33 TTJ (Del) 816 Discounting charges paid (Mad.) : Assessee a manager of retail store entitled to fixed salary and to financiers in relation to moneys commission on retail sales effected borrowed through bills was interest within through him, such commission is the meaning of s. 2(28A) hence liable to business income. TDS under s. 194A.

Visakhapatnam Branch of SIRC of ICAI 41 Issues in Tax Audit & Business Deductions under IT Act, 1961

Interest Sale v. Contract • Bill discounting v. bill purchase : Circ No.48 dt 7.11.70 and Circ No. 65 dt 02.09.1971 • CIT v. Deputy Chief Accounts Officer, • Hire purchase – Instruction 1425 in F. No. Markfed Khanna Branch 304 ITR 17 275/9/80-IT(B), dated 16-11-1981 (see (P&H) 154 Taxman 512) - Dominant intention test • Interest forming part of judgment debt - Raw material not supplied by payer - Islamic Investment Co. v. UOI [2004] 265 - Risk is assumed by the payee ITR 254 (Bom.) - Property in goods passes after the goods - UNITED INDIA INSURANCE 189 CTR come into being 329 (All India Reporter Ltd. v. A.D.Datar • BDA LTD. v. ITO 281 ITR 99 [BOM.] AIR 1961 SC 943 - the rule that the • CIT v. DABUR INDIA [2006] 283 ITR 197 decree must be executed according to [DEL.] its tenor may be modified by a statutory provision) - State Consumer Disputes Redressal Commission directing refund of amounts Contract v. Profit sharing paid by complainant with interest at 18%. agreement Interest ordered to be paid is of the nature • Competent Films Pvt. Ltd. v. ITO 2009 of damages though for convenient TIOL 273 ITAT (Del.) [2009] 41-A BCAJ standardization specified as interest- 459 deduction of tax at source not permissible - Where the agreement was not for - Ghaziabad Development Authority v services rendered but for sharing the Dr.N.K.Gupta (2002) 258 ITR 337 profits with the assessee, there was no works contract and, therefore, the assessee was not liable to deduct any Contracts tax u/s. 194C of the Act. • The facilities/amenities made available by - The distributor has only given the right to the hotel to its customers do not constitute exhibit the films and the assessee had ‘work’ within the meaning of Section 194C only rendered the services of exhibiting of the Act. the films and therefore the question of deduction of tax by the assessee did not • Circ No.681 dated 8/3/1994 to the extent it arise. holds that the services made available by a hotel to its customers are covered under section 194C of the Act must be held to be bad in law Commission • Supplementary commission by Airlines to See East India Hotels Ltd Vs CBDT (Dated: Agents – Is it commission? March 6, 2009) 2009-TIOL-122-HC-MUM-IT - Yes : CIT Vs Singapore Airlines Ltd (Dated: April 13, 2009) 2009-TIOL-183- Contracts HC-DEL-IT • A cable network operator is liable to deduct - No : CIT, Mumbai Vs Qutar Airways tax at source under Section 194C on (Dated: March 26, 2009) 2009-TIOL-182- payments made to the licensor for obtaining HC-MUM-IT TV signals : Kurukshetra Darpans (P) Ltd. • Commission v. trade discount : CIT Vs v. Commissione rof Income Tax [2008] 217 Moving Picture Company (India) Ltd CTR (P&H) 326 (Dated: March 5, 2009) 2009-TIOL-114- HC- DEL-IT • Bus body built on chassis is the case of • Delhi Milk Scheme v. Commissioner of sale of bus bodies and not works contract - Income-tax and another [2008] 301 ITR CC Sebastian v. State of Kerala 8 VST 798 373 (Delhi) HC [SLP dismissed in 308 Ker ITR (ST) 2

Visakhapatnam Branch of SIRC of ICAI 42 Issues in Tax Audit & Business Deductions under IT Act, 1961

Commission Rent – Others • SIM card distribution – Bhopal Sugar 40 STC 42 SC • Landing fee and parking fee for Aircraft amounts to Rent - United Airlines Vs. CIT - Commission 287 ITR 281 (Delhi) - ACIT vs. BHARTI CELLULAR LIMITED (2007) 105 ITD 129 (KOL) - Hindustan Coco cola 97 ITD 105 Jaipur - Vodafone Essar Cellular Ltd. v. ACIT 181 Composite activities Taxman (BN – i) Part 4 : Post paid v. prepaid • Provision of office and bureau related services comprising of office space, fixed b) Discount assets and machineries and other facilities - Idea Cellular Ltd. vs. DCIT [2009] 121 TTJ such as furniture, fixtures, air-conditioning, (Del) 352 Xerox machines, computers, printers, internet connections, vehicles etc., do not involve carrying out of any work by provider

Advance Rent • who provides a total package of office and • Advance rent : CIT v. Reebok India bureau related services, Company (2007) 291 ITR 455 (Delhi) • which could not be split up into individual or • Circular No.5 of 2001 dated 2.3.2001 independent or item-wise activity; and, therefore, this was not covered under any • Spread over of lumpsum interest paid over the period for which interest is paid : provision regulating TDS : Khaitan & Co. Permissible even for TDS purpose as per V. CIT [2007] 12 SOT 120 Delhi ITAT Oriental Insurance Company Ltd., 2009 (66) KLJ 94 (HC) – Extend logic to advance rent Professional services

• Sec 194J would cover only those technical Rent – Hotel payment servcies which necessarily have an • Hotel payments under agreement are element of human interface : CIT v. Bharti covered by sec 194I : Krishna Oberoi v Cellular Ltd. [2008] 175 Taxman 573 UOI (2002) 257 ITR 105 AP (Delhi) • Reply to Question 20 in CBDT Circ No. 715 dated 08.08.95, - TDS is required to be • Assessee bank availing services of MICR made if the hotel accommodation is taken Centre run by SBI for identifying, reading on regular basis. and clearing cheques through special kind of machines involving human skill, • In CBDT Circular No.5 of 2002 dated payment made by assessee to SBI 30.07.2002 it is clarified that where constitutes fee for technical services earmarked rooms are let out for a specified date and specified period or also where a within the meaning of s. 9 (1) (vii), Expln, room is not so earmarked but the hotel has 2, hence liable to deduction of tax at a legal obligation to provide such types of source under s. 194J - Canara Bank vs. rooms during the currency of an agreement ITO [2008] 116 TTJ (Ahd) 689

Visakhapatnam Branch of SIRC of ICAI 43 Issues in Tax Audit & Business Deductions under IT Act, 1961

Out of pocket expenses “Income comprised therein” - ACC LTD. vs. CIT 201 ITR • Circ No. 715 dated 08.08.95 435 (SC) • The words ‘on income comprised • ITO Vs Dr Willmar Schwabe India (P.) Ltd. therein’ appearing immediately after the words (95 TTJ 53) (Delhi ITAT) ‘deduct an amount equal to two per cent of such sum as income-tax’ from their purport, cannot be understood as the percentage • Asstt. CIT vs. Modicon Network (P.) Ltd. amount deductible from the income of the (2007) 14 SOT 204 (Delhi) contractor out of the sum credited to his account or paid to him in pursuance of the • Aurobindo Pharma Ltd. v. CCE contract. • Moreover, the concluding part of the sub- Visakhapatnam – I [2008] 17 VST 345 section requiring deduction of an amount (CESTAT – B’lore) equal to two per cent of such sum as income-tax, by use of the words ‘on income comprised therein’ makes it obvious that the amount equal to two per cent of the sum required to be deducted Service tax v. TDS is a deduction at source. • It is neither possible nor permissible to the • Service tax – sec 43B is not applicable payer to determine what part of the amount paid by him to the contractor constitutes the income of the latter. - Noble and Hewitt (I) P. Ltd. [2008] 305 ITR 324 (Delhi) HC - Real Image Media Technologies [2008] 116 ACC LTD. vs. CIT 201 ITR 435 TTJ (Chennai) 964 (SC) contd..

• Service tax reimbursed is income for sec • It is not also possible to think that the Parliament could have intended to cast such 44BB impossible burden upon the payer nor could it be attributed with the intention of enacting such - Halliburton Offshore Services Inc (Dated: an impractical and unworkable provision. May 13, 2009) 2009-TIOL-399-ITAT-DEL • Hence, on the express language employed & M/s Technip Offshore Contracting BV in the sub-section, it is impossible to hold (Dated: January 01, 2009) 2009-TIOL-54- that the amount of two per cent required to ITAT-DEL be deducted by the payer out of the sum credited to the account of or paid to the contractor has to be confined to his income • Circular No.4 of 2008 dt 28.04.2008 : component, out of that sum. Service tax paid by tenant doesn’t partake • There is also nothing in the language of the the nature of “income” of the landlord who sub-section which permits exclusion of an acts as a collecting agency for Government amount paid on behalf of the organisation for collection of service tax to the contractor according to cl. 13 of the terms and conditions of the contract in reimbursement of the amount paid by him • Circular F.No. 275/73/2007-IT(B), dated to workers, from the sum envisaged 30.06.2008 : Income v. Sum therein, as was suggested on behalf of the appellant.

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Payee retaining his income Sec 201

• Empty ritual principle : JB Boda & Co. 223 • Karnataka Urban Infrastructure Development ITR 271 SC Finance Corporation v. CIT [2009] 308 ITR 297 (Karn) HC : levy of penalty under section • Retention by payee amounts to payment : 201 and levy of interest under section Mahindra & Mahindra Ltd. vs. DCIT (2009) 201(1A) are entirely different. Both the 122 TTJ (Mumbai) (SB) 577 sections are independent and they are not interlinked and they cannot be read • CIT v. Singapore Airlines Ltd. [2009] 180 conjunctively as levy of interest and levy of Taxman 128 (Delhi) penalty are two different proceedings.

Meaning of credit • When the principal amount which could be recovered in terms of section 201 by considering the assessee to be in default • Provision entry : IDBI vs. ITO (2006) 104 but cannot be recovered in terms of section TTJ 230 (MUMBAI) 231, the question would not arise requiring the assessee to pay interest independently for indefinite period while in respect of the Pass through status principal sum, the assessee cannot be subjected to recovery proceeding under the • Not found acceptable in CIT vs. Century Act of 1961 : Munni Lal and Company [2008] Building Industries P. Ltd. (2007) 293 ITR 298 ITR 250 (Raj) HC 194 (SC) : Interest Sundries • Found acceptable in CIT vs. Nehru Palace • Remittance of tax of one year inadvertently Hotels Ltd.: SLP (C) No. 5706 of 2009 for a different year – credit may be given in [2009] 312 ITR [St] 336 : Tips the former year : CIT v. Smt. Deivamalar [2009] 309 ITR 249 (Mad) HC Sec 201 • Circulars of other authorities are not binding : • No recovery from the payer where payee has MSIL v. Deputy. CIT [2004] 265 ITR 498 already paid the tax : Hindustan Coco Cola (Karn.) Beverages P. Ltd 293 ITR 226 SC • Interest runs upto date of payee filing return • Social security tax (citizen tax) paid overseas : ITO, Vs M/s Intel Tech India Pvt Ltd if covered by diversion by overriding title, is (Dated: April 09, 2009) 2009-TIOL-355- not subject to TDS in India : CIT Vs NHK ITAT-BANG Japan Broadcasting Corporation 2009- • Period of default starts from the date of TIOL-44-SC-IT deductibility till the date of actual payment of tax. Levy of interest is restricted for the above stated period only. Date of payment Sundries by the concerned employee is treated as • Interse adjustment of excess/short amongst date of actual payment CIT vs. Eli Lilly and employees is impermissible as per Shriram Co. [2009] 312 ITR 225 [SC] Pistons & Rings Ltd. V. ITO 73 ITD 30 Delhi. • Due date for passing the order is one year from the end of financial year in which • On date of payment of tax – date of tender proceedings under sec 201 were initiated : of cheque or date of realisation Mahindra & Mahindra Ltd. vs. DCIT (2009) 122 TTJ (Mumbai) (SB) 577 • Order under s. 201(1) is to be treated as an order of assessment or at least akin to the assessment order Mahindra & Mahindra Ltd. vs. DCIT (2009) 122 TTJ (Mumbai) Thank You (SB) 577

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